The following selected financial data present consolidated financial information with respect to the Company. The balance sheet data as of December 31, 1998, 1997, and 1996 and the statement of income data for each of the four years in the period ended December 31, 1998, have been derived from the audited consolidated financial statements and notes thereto of the Company. The balance sheet data as of December 31, 1995, and 1994 and the statement of income data for the year ended December 31, 1994 have been derived from unaudited financial statements which, in the opinion of the Company's management, include all adjustments necessary to present the financial position and results of operations at and for the years presented. The consolidated financial statements of the Company do not necessarily reflect the results of operations or financial position that would have resulted had the Company been a separate, independent company and are not necessarily indicative of the results to be expected for any future fiscal year. The following data should be read in conjunction with the Company's consolidated financial statements, the related notes thereto, and "Management's Discussion and Analysis of Financial Condition and Results of Operations".
(1) Ratios are based on health service revenues and selling, general and administrative expenses.
(2) Reflects pro forma adjustments for interest expense on assumed debt. See note 1 (Pro forma Earnings Per Common Share) in the accompanying Consolidated Financial Statements.
(3) Commencing October 1, 1994, the Company's results of operations include the results of operations of Unity. For the years ended December 31, 1994 and 1995, Unity accounted for $23,994,000 and $100,342,000 of the Company's total premium revenue and $112,000 and $1,062,000 of the Company's net income, respectively.
(1) Medical and other benefits as a percentage of premium revenue.
Total revenues in 1998 increased 8.0% to $657.6 million from $609.1 million in 1997. Total revenues in 1997 increased 12.8% from $539.8 million in 1996. These increases were due primarily to membership and rate increases.
OTHER REVENUE- Other revenue from specialty managed care products and services in 1998 increased 10.5% to $44.2 million from $40.0 million in 1997. This increase was due primarily to an increase in managed behavioral health and managed care consulting. In addition, the acquisitions of Intercare and Ladd during 1998 provided $0.6 million and $0.4 million of additional revenue, respectively. Other revenue in 1997 increased 1.3% from $39.5 million in 1996. Included in other revenue in 1996 is a $1.5 million gain on the sale of the vision line of business which is non-recurring. After adjusting for the gain on the sale of the vision line of business, other revenue increased by 5.2% from 1996 to 1997. These increases are primarily attributable to growth in managed behavioral health, electronic claim transmission services and managed care consulting services.
LOSS RATIO-The consolidated loss ratio represents the ratio of medical and other benefits to premium revenue for the Company on a consolidated basis, and is therefore a blended ratio for medical, life, dental, disability and other product lines. The consolidated loss ratio was 85.3% in 1998 compared with 86.5% in 1997 and 86.2% in 1996. The consolidated loss ratio is influenced by the component loss ratio for each of the Company's two primary product lines, as discussed below.
The medical loss ratio for HMO products for 1998 was 88.8%, compared with 90.1% for 1997 and 89.8% for 1996. The decrease in the medical loss ratio in 1998 for HMO products is due primarily to provider recontracting with a continuing shift toward capitation in the southeastern Wisconsin HMO market. For 1998, approximately 54.9% of the medical benefits were provided under capitated arrangements, compared to 47.5% and 48.4% during 1997 and 1996, respectively. The lower loss ratio in 1998 is also attributable to higher premium rate increases and a favorable development in the reserves as of December 31, 1997. The increase in the medical loss ratio in 1997 is attributable to the competitive market conditions in southeastern Wisconsin where pricing pressures, coupled with increased utilization, had an adverse impact on Compcare's loss ratio.
The loss ratio for the risk products within specialty managed care products and services in 1998 was 70.9%, compared with 70.6% in 1997 and 69.8% in 1996. The loss ratios principally relate to the life, disability, workers' compensation and dental product lines of business. These products represent relatively
small blocks of business, and as a result, the loss ratio can exhibit significant volatility due to varying levels of claim frequency and severity. Generally, the anticipated aggregate loss ratio for the four products should range between 70% and 75%. The 1998 and 1997 loss ratios were impacted by a higher level of life and disability claims in comparison to a more favorable level of life and disability claims in 1996.
SGA expenses related to specialty managed care products and services increased 9.7% in 1998 to $63.1 million from $57.5 million in 1997. SGA expenses related to specialty managed care products and services increased 10.8% in 1997 from $51.9 million in 1996. Increases in SGA expenses correlate to premium and other revenue increases which were 8.8% in 1998 compared with 1997 and 12.7% in 1997 compared with 1996. In addition, the mix of business shifted over these yearly periods, as a result of greater growth in ancillary lines of business that have higher SGA expense ratios.
The Company's effective tax rate was 39.4% in 1998, compared with 37.4% in 1997 and 39.4% in 1996. The Company's effective tax rate fluctuates based upon the relative profitability of the Company's two product lines and the differing effective tax rates for each of those product lines.
From time to time, capital contributions are made to the subsidiaries to assist them in maintaining appropriate levels of capital and surplus for regulatory and rating purposes. Insurance subsidiaries are required to maintain certain levels of statutory capital and surplus. In Wisconsin, where a large percentage of the Company's premium is written, these levels are based upon the amount and type of premiums written and are calculated separately for each subsidiary. As of the balance sheet dates presented, statutory capital and surplus for each of these insurance subsidiaries exceeded required levels.
In conjunction with the distribution of assets pursuant to the spin off, UWS assumed a $70 million note obligation to BCBSUW. The assumption of debt was effective September 11, 1998. The obligation and related debt service costs of $1.4 million, for the period subsequent to September 11, 1998, have been reflected in the accompanying consolidated financial statements. The Company recognizes that its debt to equity ratio is high, primarily as a result of its assumption of the $70.0 million loan from BCBSUW. However, the Company believes that this ratio should improve to the extent that BCBSUW purchases new shares of UWS common stock to increase its ownership from 37.8% to approximately 51%. The purchase price for the shares of common stock which are purchased directly from the Company will be paid through either the cancellation of a corresponding portion or all of the $70.0 million debt obligation or in cash. BCBSUW also may purchase some of the shares of common stock in the open market.
Effective January 1, 1992, the Company acquired all of the outstanding capital stock of Valley for cash approximating $2,800,000, representing the net assets of Valley plus $400,000 as negotiated by the Company. Valley, a health maintenance organization located in Eau Claire, Wisconsin, was purchased from Midelfort, which continues to be Valley's primary health care provider. Under the terms of the purchase and sale agreement, Midelfort retained an option to repurchase all of the capital stock of Valley, at a price determined by the formula used in computing the purchase price paid by the Company, at any time until December 31, 1996. The option to repurchase was subsequently amended to permit repurchase at December 31, 1999. The acquisition was accounted for under the purchase method of accounting.
Total revenues subject to repurchase options, pursuant to the various acquisition agreements, totaled $207,014,000, $186,318,000, $169,341,000 for 1998, 1997 and 1996, respectively. Profit sharing expense related to these provider arrangements is calculated based on the profitability of the HMO subsidiary and totaled $3,171,000, $3,960,000, $3,002,000 in 1998, 1997 and 1996, respectively. Total net income subject to repurchase options, pursuant to the various acquisition agreements, totaled 2,358,000 $2,395,000, $2,629,000 for 1998, 1997 and 1996, respectively. Total assets and total net assets subject to repurchase options were $44,798,000 and $21,362,000, respectively, at December 31, 1998 and $49,802,000 and $20,632,000, respectively, at December 31, 1997.
Should the buy back options be exercised, the Company would receive an amount equal to the premium over net assets but would lose rights to the future profits on the HMO. The cash received by the Company pursuant to the exercise of the buy back option could be redeployed to support additional premium writings, acquire other businesses or be invested to earn a portfolio return. Due to these alternative uses of capital, the potential buy back arrangements do not represent material claims against the Company's liquidity and capital resources.
Refer to Note 1 in the accompanying Consolidated Financial Statements for Statement of Financial Accounting Standards (SFAS) recently adopted by the Company. These include SFAS 130, "Reporting Comprehensive Income", SFAS 131, "Disclosures about Segments of an Enterprise and Related Information", and SFAS 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits".
GENERAL DESCRIPTION OF THE YEAR 2000 ISSUE AND THE NATURE AND EFFECTS OF THE YEAR 2000 ON INFORMATION TECHNOLOGY (IT) AND NON-IT SYSTEMS
The Company has identified required modifications or replacements of its software and certain hardware so that those systems will properly utilize dates beyond December 31, 1999. The Company presently believes that with these modifications or replacements of existing software and certain hardware, the Year 2000 Issue can be mitigated and will not pose significant operational problems. However, if such modifications and conversions are not made or are not completed timely, the Year 2000 Issue could have a material impact on the operations of the Company.
STATUS OF PROGRESS IN BECOMING YEAR 2000 COMPLIANT, INCLUDING TIMETABLE FOR COMPLETION OF EACH REMAINING PHASE
As of December 31, 1998, the Company is approximately 77% complete with the remediation phase for its information technology exposures. Once software is reprogrammed or replaced for a system, the Company will begin testing and implementation. These phases are expected to run concurrently for different systems. For all systems where the Company has completed the remediation phase, the Company has also completed the testing and implementation phases. For those systems where remediation is still underway, the Company expects to complete remediation, testing and implementation by September 30, 1999.
NATURE AND LEVEL OF IMPORTANCE OF THIRD PARTIES AND THEIR EXPOSURE TO THE YEAR 2000
The Company has initiated formal communications with its systems processing vendors, government agencies and all large customers and providers using electronic interfaces to determine the extent to which the Company's interface systems are vulnerable to the failure of third parties to remediate Year 2000 Issues. The Company is not aware of any significant interface issues.
Company management believes it has an effective program in place to resolve the Year 2000 Issue in a timely manner. As noted above, the Company has not yet completed all necessary phases of the Year 2000 program. In the event that the Company is unable to complete the remaining phases, the Company would selectively be unable to bill and collect premiums, adjudicate medical and other claims, manage the utilization of medical services or perform actuarial determinations. In addition, disruptions in the economy generally resulting from Year 2000 issues could also materially adversely affect the Company. The Company could be subject to litigation on a loss of business in the event it failed to complete certain of the remaining remediation and implementation steps. The amount of any potential liability and lost revenue cannot be reasonably estimated at this time. No provision for any such liability or lost revenue has been recorded.
The Company is developing contingency plans for certain critical applications and is working on such plans with major data center vendors. These contingency plans are being developed in the event the system conversions and their functionality or the readiness of Year 2000 are not completed on a timely basis. These contingency plans involve, among other actions, manual workarounds, reducing claim inventories prior to December 31, 1999, and adjusting staffing strategies.
On May 27, 1998, the Board of Directors of American Medical Security Group, Inc. ("AMSG") (formerly United Wisconsin Services, Inc.) approved a formal plan to spin off its managed care companies and specialty business to its shareholders. The spin off involved the creation of a new corporation originally named Newco/UWS, Inc., subsequently renamed United Wisconsin Services, Inc. ("UWS"). The spin off resulted in the distribution of one share of common stock of UWS on September 25, 1998 ("Spin off date") for each share of AMSG common stock held as of September 11, 1998. AMSG received a private letter ruling from the Internal Revenue Service that the spin off is tax free to AMSG, UWS and their shareholders. A further description of the spin off and certain transactions with AMSG is included in Notes 1, 6, 7 and 10.
The Company is affiliated with Blue Cross & Blue Shield United of Wisconsin ("BCBSUW") through certain common officers and directors. At December 31, 1998, BCBSUW owns approximately 38% of the Company's common stock.
Property and equipment are recorded at cost. Depreciation and amortization are provided using the straight-line method over the estimated useful lives, which are 20 to 30 years for land improvements, 10 to 40 years for buildings and building improvements, 3 to 5 years for computer equipment and software and 3 to 10 years for furniture and other equipment.
Goodwill represents the excess of cost over the fair market value of net assets acquired. Goodwill and other intangible assets are being amortized on a straight-line basis over a period of 15 years or less. Accumulated amortization was $1,947,000 and $1,347,000 at December 31, 1998 and 1997, respectively.
The Company's year-end claim liabilities are substantially satisfied through claim payments in the subsequent year. Any adjustments to prior period estimates are reflected in the current period. Capitation represents fixed per member per month payments to participating physicians, other medical specialists and hospital systems, as compensation for providing comprehensive health or dental care services. In addition, certain subsidiaries have risk-sharing, stop-loss, and bonus arrangements with certain providers. Accruals relating to these arrangements are developed based on historical payment patterns using actuarial techniques. The noncurrent portion of medical and other benefits payable pertaining to long-term disability, workers' compensation and certain life insurance products is $19,375,000 and $20,918,000 at December 31, 1998 and 1997, respectively. The noncurrent portion of long-term disability, worker's compensation and certain life insurance products is estimated using actuarial techniques based on historical patterns. Amounts estimated to be paid more than one year from the balance sheet date are considered noncurrent.
Certain premiums and benefits are assumed from and ceded to other insurance companies under various reinsurance agreements. The ceded reinsurance agreements provide the Company with increased capacity to write larger risks and maintain its exposure to loss within its capital resources. The ceding company is contingently liable on reinsurance ceded in the event that the reinsurers do not meet their contractual obligations. Premiums ceded totaled $45,755,000, $49,522,000 and $46,549,000 in 1998, 1997 and 1996, respectively. Ceded benefits totaled $35,038,000, $42,003,000 and $32,073,000 in 1998, 1997 and 1996, respectively. Premiums assumed totaled $28,682,000, $33,514,000 and $32,642,000 in 1998, 1997 and 1996, respectively. Assumed benefits totaled $22,694,000, $28,213,000 and $21,722,000 in 1998, 1997 and 1996, respectively.
Historical earnings per share ("EPS") has been omitted since the Company was not a separate entity with a capital structure of its own throughout any of the years presented.
Pro forma net income per common and common equivalent share is calculated as if the spin off had occurred at the beginning of fiscal year 1996, and is adjusted in 1998, 1997 and 1996 for additional interest expense, net of related income tax. Pro forma EPS are based on the pro forma weighted average number of shares of outstanding Company common stock and dilutive common equivalent shares from stock options, giving effect to the distribution of one share of Company stock for each share of AMSG common stock. Pro forma dilutive common equivalent shares from stock options are stated at the historical AMSG dilutive common equivalent share level.
As of January 1, 1998, the Company adopted Statement of Financial Accounting Standards ("SFAS") 130, "Reporting Comprehensive Income". SFAS 130 establishes new rules for the reporting and display of comprehensive income and its components; however, the adoption of this statement had no impact on the Company's net income or shareholders' equity. SFAS 130 requires unrealized gains or losses, net of taxes, on the Company's available for sale securities, which prior to adoption were reported separately in shareholders' equity, to be included in other comprehensive income.
Certain reclassifications have been made to the consolidated financial statements for 1997 and 1996 to conform with the 1998 presentation.
The Company is party to certain provider arrangements in conjunction with Unity and Valley, wholly owned HMO subsidiaries included in the Company's consolidated financial statements, which include profit-sharing payments to certain providers and repurchase provisions.
Under the terms of the Valley purchase and sale agreement, as amended, the seller retained an option to repurchase all of the capital stock of Valley as of December 31, 1999, at a price equal to Valley's net assets plus $400,000.
Total revenues subject to repurchase options, pursuant to the various acquisition agreements, totaled $207,014,000, $186,318,000 and $169,341,000 for 1998, 1997 and 1996, respectively. Profit sharing expense related to these provider arrangements is calculated based on the profitability of the HMO subsidiary and totaled $3,171,000, $3,960,000 and $3,002,000 in 1998, 1997 and 1996, respectively. Total net income subject to repurchase options, pursuant to the various acquisition agreements, totaled $2,358,000, $2,395,000 and $2,629,000 for 1998, 1997 and 1996, respectively. Total assets and total net assets subject to repurchase options were $44,798,000 and $21,362,000, respectively, at December 31, 1998 and $49,802,000 and $20,632,000, respectively, at December 31, 1997.
Unrealized gains (losses) are computed as the difference between estimated fair value and amortized cost for debt securities classified as available for sale or cost for equity securities. A summary of the net increase (decrease) in unrealized gains, less deferred income taxes, which is included in accumulated other comprehensive income, is as follows:
At December 31, 1998, the insurance subsidiaries had debt securities and cash equivalents on deposit with various state insurance departments with carrying values of approximately $7,627,000, which are included in investments held to maturity on the balance sheet.
As of September 11, 1998, the Company assumed a $70,000,000 note obligation to BCBSUW in connection with the spin off (see note 1). The Company pledged the common stock of certain subsidiaries as collateral for the note obligation. Interest is payable quarterly at a rate equal to the London Interbank Offered Rate plus 1.25%, adjusted quarterly. The principal balance is due on October 30, 1999 and is classified as note payable to affiliates in the consolidated balance sheet. Interest expense and interest paid for the period from September 12, 1998 thru December 31, 1998 totaled $1,411,000.
The Company provides marketing, underwriting, actuarial and certain administrative services for BCBSUW. In addition, BCBSUW provides health insurance to the employees of the Company and provides office space to the Company. These activities are reimbursed at amounts approximating cost, which resulted in allocations to the Company of $14,757,000, $14,564,000 and $13,315,000 in 1998, 1997 and 1996, respectively, and allocations to BCBSUW of $8,964,000, $9,278,000 and $7,474,000 in 1998, 1997 and 1996, respectively. These amounts are included in selling, general and administrative expenses.
Management believes the above stated related-party activity was entered into on a reasonable basis and includes all costs of doing business.
Prior to the spin off, the Company's operations have been financed through its operating cash flows and investments by and advances from AMSG.
The differences between taxes computed at the federal statutory rate and recorded income taxes are as follows:
Insurance companies are subject to regulation by the Office of the Commissioner of Insurance of the State of Wisconsin and certain other state insurance regulators. These regulations require, among other matters, the filing of financial statements prepared in accordance with statutory accounting practices prescribed or permitted for insurance companies. The statutory surplus of insurance subsidiaries at December 31, 1998 and 1997 aggregated $106,069,000 and $95,211,000, respectively. The statutory net income of insurance subsidiaries aggregated $15,893,000, $17,380,000 and $24,159,000 in 1998, 1997 and 1996, respectively.
State insurance regulations also require the maintenance of a minimum compulsory surplus based on a percentage of premiums written. In addition, the Company's insurance subsidiaries are subject to risk-based capital ("RBC") requirements promulgated by the National Association of Insurance Commissioners. The RBC requirements establish minimum levels of capital and surplus based upon the insurer's operations. At December 31, 1998, the Company's insurance subsidiaries were in compliance with these capital surplus requirements.
Based upon the financial statements of the insurance subsidiaries included in these consolidated financial statements as of December 31, 1998, as filed with the insurance regulators, the aggregate amount available for dividends in 1999 without regulatory approval is $7,700,000.
Prior to January 1, 1997, the salaried pension plan provided for benefit payments based on compensation, years of service, year of birth and date of retirement and the hourly pension plan provided for benefit payments of stated amounts based on number of hours worked and years of credited service.
The following table provides a reconciliation of the funded status of the pension plan to the prepaid pension costs:
(1) Options were issued in 1996 at 125% of market value as consideration for an acquisition.
The Company has two reportable business segments: HMO products sold primarily in Wisconsin, and specialty managed care products and services, including dental, life, disability and workers' compensation products, managed care consulting, electronic claim submission, pharmaceutical management, managed behavioral health services, and receivables management sold throughout the United States.
Financial data by segment as of and for the years ended December 31, 1998 and 1997 is as follows:
On February 9, 1999, the Company announced that it had begun negotiations with BCBSUW for the purchase by BCBSUW of approximately 2,750,000 shares of the Company's common stock to be issued in a privately negotiated transaction. This purchase is part of the previously disclosed plan for BCBSUW to increase its ownership in the Company to allow Compcare to use the Blue Cross and Blue Shield brand on its products.