2. MAMSI has not declared or paid cash dividends on its common stock.
3. The potential for increased medical expenses due to: - Increased utilization by the Company's membership. - Inflation in provider and pharmaceutical costs. - Federal or state mandates that increase benefits or limit the Company's oversight ability.
6. The possibility that one of the Company's vendors will experience year 2000 problems that disrupt the Company's operating or administrative systems.
The effect of HIPAA differs from state to state. In the group market, state laws remain in effect unless they prevent the application of the new federal requirements, and in the individual market, state laws govern if the Health and Human Services Secretary determines that they provide an "acceptable alternative mechanism" to the federal requirement. This means that in those states, like Maryland, where state reforms have already been enacted, the legislation has little, if any, effect in the small group market, but may have some effect in the individual market. In other states, the legislation has a greater effect.
The District of Columbia, which has not previously regulated HMOs, enacted legislation effective July 1, 1997, providing for regulatory oversight similar to that currently provided by other states.
- ----------------------------------------------------------------------------- THE YEAR ENDED DECEMBER 31, 1998 COMPARED TO THE YEAR ENDED DECEMBER 31, 1997 - -----------------------------------------------------------------------------
Consolidated net income of the Company was $9,045,000 and $14,489,000 in 1998 and 1997, respectively. Diluted earnings per share was $.20 in 1998 as compared to $.31 in 1997. This decrease in earnings is primarily attributable to a $16,500,000 non-recurring item related to the results of an audit conducted in connection with the Company's participation in the Federal Employee Health Benefit Program. The audit covered the periods 1992 - 1997 with the audit findings related to years 1992 - 1994. There were no findings for years 1995 - 1997.
In the third quarter of 1998, three HMOs with large Medicare membership in the Mid-Atlantic area announced that effective January 1, 1999 they would not continue their Medicare risk contract with the Health Care Financing Administration ("HCFA"). In response to the Company's perception of increased risk related to these HMOs' departure, the Company requested a change to its already filed rates which were to be effective January 1, 1999. HCFA responded that they would not allow the Company to change its filed rates. Based on HCFA's response, the Company terminated its Medicare contract effective January 1, 1999. At December 31, 1998 the Company had approximately 7,000 Medicare Risk members.
The Company's future membership growth depends on several factors such as relative premium prices and product availability, future increases or decreases in the Company's service area, increased competition in the Company's service area and changes in state mandated enrollment in Medicaid HMO programs in which the Company participates. Enrollment may also decrease if the Company determines that premium reimbursement rates related to certain state Medicaid programs are inadequate, which would cause the Company to voluntarily withdraw from participation.
Revenue from life and short-term disability products contributed $6.9 million in revenue in 1998 as compared with $5.3 in 1997. The increase is mainly due to the products' continued popularity with customers looking for one carrier to provide all of their employee benefit needs.
In the third quarter of 1998, the National Committee for Quality Assurance ("NCQA") announced that OCI and M.D. IPA received three year, full accreditation. Full accreditation is granted to those plans that have excellent programs for continuous quality improvement and meet NCQA's rigorous standards.
In addition to claims made by the OPM auditors as part of the normal audit process, OPM may also refer their results to the United States Department of Justice ("DOJ") for potential legal action under the False Claims Act. The DOJ has the authority to file a claim under the False Claims Act if it believes that the health plan knowingly overcharged the government or otherwise submitted false documentation or certifications. In False Claims Act actions, the government may impose trebled damages and a civil penalty of not less than $5,000 nor more than $10,000 for each separate alleged false claim.
The Company intends to negotiate with OPM on all matters to attain a mutually satisfactory result. There can be no assurance that these negotiations will be concluded satisfactorily, that the audit will not be referred to the DOJ, or that additional, possibly material, liability will be not be incurred. The Company believes that any ultimate liability in excess of amounts accrued would not materially affect the Company's consolidated financial position. However, such liability could have a material effect on results of operations or cash flows of a future period if resolved unfavorably.
The net margin rate decreased from 1.3 percent in 1997 to .8 percent in 1998. This decrease is primarily due to the non-recurring item related to the Company's participation in the FEHBP.
Consolidated net income (loss) of the Company was $14,489,000 and $(2,768,000) in 1997 and 1996, respectively. Diluted net earnings (loss) per share was $.31 in 1997 as compared to $(.06) in 1996. The increase in earnings is primarily attributable to a decrease in the medical loss ratio for commercial products. The medical loss ratio decreased primarily due to increased efforts by the Company to control medical costs.
Revenue for the year ended December 31, 1997 decreased approximately $22.1 million or 2.0 percent over the year ended December 31, 1996. A 4.4 percent decrease in net average HMO and indemnity enrollment resulted in a decrease of approximately $47.5 million in health premium revenue while a 2.0 percent increase in the average monthly premium per enrollee combined for all products resulted in a $20.2 million increase in health premium revenue.
The administrative expense ratio for 1997 increased to 11.7 percent from 10.7 percent in 1996. This increase is due primarily to increased salaries and expenses in certain administrative areas of the Company, including utilization management claims audit and customer service departments, as well as reduced revenue in 1997.
The net margin rate increased from (.2) percent in 1996 to 1.3 percent in 1997. This increase is primarily due to the decrease in the medical loss ratio.
Accounts receivable decreased from $87.9 million at December 31, 1997 to $79.3 million at December 31, 1998. This decrease is primarily due to a reduction in amounts due from the Federal government and a reduction in receivables from customers offset somewhat by increased medical recoverables.
Prepaid expenses, advances and other current assets increased from $19.3 million at December 31, 1997 to $27.0 million at December 31, 1998, principally due to an increase in income taxes receivable and an increase in hospital working capital advances.
Medical claims payable increased from $98.3 million at December 31, 1997 to $129.3 million at December 31, 1998 primarily due to increased membership and increased medical expense per member.
Treasury stock increased from $41.2 million at December 31, 1997 to $75.6 million at December 31, 1998 due to the purchase of approximately 5 million additional shares by the Company.
The Company currently has access to total revolving credit facilities of $29.0 million, which is used to provide short-term capital resources for routine cash flow fluctuations. At December 31, 1998, approximately $1.9 million was drawn against these facilities. In addition, the Company maintains a $12 million letter of credit for the benefit of the North Carolina Insurance Department in support of operations of MAMSI Life and Health Company and a $300,000 letter of credit for the Company's home health subsidiary. While no amounts have been drawn against these letters of credit, they are a reduction of the Company's credit line availability.
Following is a schedule of the short-term capital resources available to the Company:
Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996............................... 34
Selected Quarterly Financial Data for Fiscal Years 1998 and 1997 (Unaudited)............................................... 55
MAMSI Life and Health Insurance Company ("MAMSI Life") develops and markets indemnity health products and group life, accidental death and short-term disability insurance.
A significant portion of the Company's premium revenue is derived from federal, state and local government agencies, including governmental employees and Medicaid and Medicare recipients. For the years ended December 31, 1998, 1997 and 1996, approximately 11% of premium revenue was derived from federal government agencies which is included in the Medicare and Risk segments, and approximately 18%, 25% and 26%, respectively, was derived from state and local government agencies which is included in the Risk segment.
Floating rate municipal putable bonds, which possess an insignificant risk of loss from changes in interest rates, are held less than three months, are classified as cash equivalents.
Amounts charged to third party payors solely for use of the Company's provider network and its discounted fee-for-service rate structure are recognized as fee revenue. Amounts charged for administrative services only arrangements, entailing only claims payment services and utilization of the provider network without utilization of the Company's primary care physician network and utilization management services, and for which the Company bears no insurance risk, are recognized as fee revenue.
The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that effect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Such estimates and assumptions could change in the future as more information becomes known, which could impact the amounts reported and disclosed herein.
The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for its stock option plans. Under APB 25, because the exercise price of the Company's employee stock options equals the market value of the underlying stock on the date of grant, no compensation expense is recognized.
In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, "Disclosure about Segments of an Enterprise and Related Information" ("Statement No. 131"), which changes the way public companies report information about operating segments. Statement No. 131, which is based on the management approach to segment reporting, establishes requirements to report selected segment information quarterly and to report entity-wide disclosures about products and services, major customers, and the material countries in which the entity holds assets and reports revenue. The Company adopted Statement No. 131 as of December 31, 1997.
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities" ("Statement No. 133"). Statement No. 133 is effective for all fiscal quarters of all fiscal years beginning after June 15, 1999. Statement No. 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designed as part of a hedge transaction and, if it is, the type of hedge transaction. The Company does not expect that the adoption of Statement No. 133 will have a material impact on its consolidated financial statements because the Company does not currently hold any derivative instruments.
The noncurrent portion of notes at December 31, 1998 matures in the year 2000.
M.D. IPA, OCI, OCCI, OCIPA and MAMSI Life maintain reinsurance coverage to provide for reimbursement of claims in excess of certain limits. Reinsurance for health claims generally covers 80% of all hospital costs in excess of a deductible amount per enrollee per year (subject to a $2,000,000 maximum lifetime reinsurance limit per person) but excludes coverage of costs in excess of certain per diem rates. The deductible per enrollee is $200,000. Reinsurance for life and accidental death claims generally covers all settlements in excess of $50,000 per person subject to a $2,500,000 maximum recovery per person. Reinsurance recoveries for the years ended December 31, 1998, 1997 and 1996 were approximately $1,597,000, $2,045,000 and $2,288,000, respectively. In the consolidated statements of operations, reinsurance premiums are shown net of the related recoveries.
Prior to July 1, 1996, contracts with participating physicians allowed for withholdings generally ranging from 5% to 15% from primary care physicians and participating specialists on capitation and fee-for-service payments. The withheld amounts ultimately paid back to providers is generally less than the total amount withheld. Withheld liabilities and related medical expenses were reduced by $14,535,000 in 1996 to reflect amounts not returned to providers. Commencing July 1, 1996, the Company, pursuant to state law changes, discontinued withholding from payments in substantially all areas of operations. Amounts placed in such risk pools, in jurisdictions where it is still permitted, were insignificant in 1998 and 1997.
The Company has a defined contribution 401(k) savings plan covering all full-time employees. Employees are allowed to contribute up to 10% of their pretax earnings annually and the Company makes a matching contribution of 50% on the first 4% of contributions made by employees. Employees vest immediately in the employee contributions and ratably over six years in the Company contributions. During 1998, 1997 and 1996, the Company's contribution to the 401(k) plan aggregated $681,000, $577,000 and $540,000, respectively.
In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("Statement 123"). Statement 123 prescribes accounting and reporting standards for all stock based compensation plans. Statement 123 requires that the Company either adopt the fair value method of accounting for its stock option plans or continue to apply the existing accounting rules but provide supplemental pro forma disclosures as if the new rules had been adopted. The Company elected to follow the existing rules and make the required pro forma disclosures for the first time, in its 1996 consolidated financial statements. Although Statement 123 first became effective in 1996, it requires that the pro forma disclosures include the effects of all awards granted in fiscal years beginning after December 15, 1994, the majority of which were issued under the Company's 1995-1998 stock option plans.
Pro forma net income (loss) $1,502 $9,007 $(8,409) Pro forma basic earnings (loss) per share .03 .19 (.18) Pro forma diluted earnings (loss) per share .03 .19 (.18)
In each year 1990 through 1996 and 1998, MAMSI implemented a non-qualified stock option plan whereby options for the purchase of shares of common stock may be granted to directors, officers and employees of the Company. Shares authorized under the plans total 17,000,000. Options under the plans generally vest over a three-year period and are exercisable at 100% of the fair market value per share on the date the options are granted. The Company accounts for these stock option grants in accordance with APB 25, and, accordingly, recognizes no compensation expense for these stock option grants. Transactions relating to the 1990 - 1996 plans and the 1998 plan through 1998 are summarized as follows:
On August 26, 1996, the Company established the MAMSI Stock Compensation Trust ("SCT") to fund its obligations arising from its various stock compensation plans. MAMSI funded the SCT with 9,130,000 shares of newly issued MAMSI stock. In exchange, the SCT has delivered a promissory note to MAMSI for approximately $129.9 million which represents the purchase price of the shares. Amounts owed by the SCT to MAMSI will be repaid by cash received by the SCT or will be forgiven by MAMSI, which will result in the SCT releasing shares to satisfy MAMSI obligations for stock compensation.
On January 11, 1999 the SCT purchased an additional 1,500,000 shares of the Company's common stock for approximately $18,000,000. The existing promissory note has been modified to reflect this purchase.
Shares held by the SCT are excluded from weighted average shares outstanding used in the computation of income or loss per common share.
M.D. IPA contracts with the Office of Personnel Management ("OPM") to provide or arrange health services under the Federal Employee Health Benefit Program ("FEHBP"). The contract with OPM and applicable government regulations establish premium rating requirements for the FEHBP. The premiums established under the OPM contract are subject to periodic review and audit to determine, if they were established in compliance with the community rating and other requirements under the program.
In September, 1998, a pretax charge of approximately $16.5 million which includes approximately $4.4 million of interest, was recognized in the Company's financial statements in anticipation of negotiations relating to potential governmental claims for contracts with OPM related to an audit conducted by the Office of Inspector General concerning the Company's participation in FEHBP for the years 1992-1997 related to findings for years 1992-1994. In the normal course of business, OPM audits health plans with which it contracts to verify, among other things, that the premiums calculated and charged to OPM are established in compliance with the best price community rating guidelines established by OPM. OPM typically audits plans once every five or six years, and each audit covers the prior five or six year period. While the government's initial on-site audits are usually followed by a post-audit briefing as well as a preliminary audit report in which the government indicates its preliminary results, final resolution and settlement of the audits can take two to three years.
Minimum required statutory net worth and actual statutory net worth are as follows:
M.D. IPA, OCI, OCCI, OCIPA and MAMSI Life were in compliance with state depository rules at December 31, 1998 and 1997. OCCI failed to meet its net worth requirement of $2.5 million and working capital requirement of $1.6 million at December 31, 1997. In February, 1998, additional capital was provided so that each of these requirements was met. MAMSI Life was in compliance with the applicable risk-based capital requirements for life and health insurance companies at December 31, 1998 and 1997, and M.D. IPA, OCI, OCCI and OCIPA were in compliance with the applicable newly enacted risk-based capital requirements at December 31, 1998. These MAMSI subsidiaries must notify state regulators before the payment of any dividends to MAMSI and, in certain circumstances, must receive positive affirmation prior to such payment.
Financial instruments that potentially subject the Company to credit risk consist primarily of investments in marketable securities (including money market funds, floating rate municipal putable bonds, intermediate term municipal bonds, and common stocks) and premiums receivable. The Company receives advice through or assigns direct management of short-term
investments in marketable securities to professional investment managers selected for their expertise in various markets, within guidelines established by the Board of Directors. These guidelines include broad diversification of investments. Concentrations of credit risk and business volume with respect to commercial premiums receivable are generally limited due to the large number of employer groups comprising the Company's customer base. As of December 31, 1998, approximately 16% of premium and home health service receivables were due from federal government agencies. The Company performs ongoing credit evaluations of customers and generally does not require collateral.
The Company has three reportable segments: Commercial risk products, Medicare products and Preferred Provider Organizations (PPO). Commercial risk products include traditional HMO and point of service health care plans as well as hybrid products. Traditional products provide for the provision of comprehensive medical care to enrollees for a fixed, prepaid premium regardless of the amount of care provided. Hybrid products offer the ability to tailor employee health care offerings by varying benefit designs, funding methods and insurance risk. These products combine the use of capitated physicians to serve as gatekeepers, employer funding of specialist and institutional claims on an "as paid" basis with MAMSI's underwriting of risk on a specific and/or aggregate stop loss basis. The Medicare product is health coverage offered to Title XVIII Medicare recipients. Under a contractual arrangement with the United States Health Care Financing Administration ("HCFA"), the Company receives a monthly premium for which the Company provides comprehensive medical coverage to those individuals. Effective January 1, 1999, the Company will no longer participate in the Medicare program. The PPO product provides a delivery network of physicians to employers and insurance companies in association with various health plans. PPOs allow enrollees to receive care from participating physicians at contractually negotiated rates. A PPO does not assume any financial risk from medical utilization nor does it typically process claims payments to providers.
The Company evaluates performance and allocates resources based on profit or loss from operations before income taxes, not including gains and losses on the Company's investment portfolio. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies.
Changes in accumulated other comprehensive income related to changes in unrealized gains (losses) on securities net-of-tax were as follows:
We have conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.