The Company generally receives a fixed premium amount per member per month while the majority of medical expenses are variable and significantly affected by spontaneous member utilization. Even with managed care controls, unusual medical conditions can occur, such as an outbreak of influenza or a higher than normal incidence of high cost cases (such as premature births, complex surgeries, or rare diseases). As a result, the Company's quarterly results can be materially effected and irregular. However, over the longer business cycle, the Company believes that its managed care control systems, underwriting procedures (when allowed) and network of providers will result in continued profitability.
Recently, the "Health Insurance Portability and Accountability Act of 1996, Public Law 104- 191", commonly called the Kennedy-Kassebaum Bill for its primary sponsors, was enacted. This bill establishes certain Federal requirements for large group, small group, and individual health benefit plans, and applies not only to insurers and HMOs but also to ERISA plans.
Kennedy-Kassebaum is intended to make coverage more portable and available by limiting pre-existing condition requirements; providing special enrollment periods for employees who lose other coverage or whose family status changes; prohibiting group plans from denying an individual coverage or charging a higher premium based on the individual's health status or history; and by guaranteeing coverage availability and renewability in certain circumstances in the small group and individual markets. Kennedy-Kassebaum also allows for the establishment of Medical Savings Accounts, increases the penalties for health care fraud and abuse, and calls for standardized health care information in order to reduce administrative costs.
In recent years, state legislatures in the Company's service area have been active in health care reform legislation targeted at the small group market, i.e., usually for groups of 2 to 50 employees. This small group reform is now in place in Maryland, Virginia, Delaware and North Carolina, but not in Pennsylvania, Washington, D.C. or West Virginia. Although different in many of the details, this type of legislation generally requires all HMOs and insurers that offer small group coverage to accept all small employers who apply for coverage and to guarantee coverage to their employees seeking coverage regardless of their health status. The legislation also requires renewal of these small group employer plans, limits rate renewal increases, mandates adjusted community rating and eliminates pre-existing condition limitations either entirely or within a short period of time, usually six months. In addition, many states have begun to legislate certain mandated benefits like minimum hospital length of stays and required coverages.
The Company has implemented increased premium rates across essentially all of its commercial products which began to take effect in July, 1996. As the Company's contracts are generally for a one year period, increased pricing cannot be initiated until a contract reaches its renewal date. Therefore, price increases cannot be made across the Company's membership at the same time. Additionally, the Company received an approximate 5 percent premium rate increase in its Virginia Medicaid program effective July 1, 1997, an approximate 8 percent premium rate decrease in its North Carolina Medicaid program effective August 1, 1997, and an approximate 2 percent premium rate increase in its Medicare program, effective January 1, 1998. Management believes that the commercial premium rate increases may have the effect of slowing the Company's future membership growth as compared to membership growth in 1994 through 1996. In addition, management reevaluated premium reimbursement rates with regard to its Medicare and Medicaid participation and reduced or eliminated certain service areas. Specifically, effective January 1, 1997, 59 counties and cities were eliminated from the Company's Medicare service area. Effective January 1, 1998, the Company again reduced its Medicare service area, modified certain benefits and began charging an additional premium in certain areas. Also effective January 1, 1997, the Company discontinued participation in the mandated portion of the Virginia Medicaid program which serves Medicaid eligibles in the Tidewater area of Virginia. In addition, the Company has withdrawn from the Maryland Medicaid program due to changes to premium and benefit levels and other requirements made by the State of Maryland after it obtained an 1115 waiver and became a mandated state. As the Company was the largest provider of managed care Medicaid in Maryland, the Company continued to provide services in 1997 until an orderly transition was accomplished. The Company was compensated during the transition period at a rate higher than the mandated program allows but lower than historical reimbursement. In 1996, the Company became licensed to serve portions of the Medicaid populations in West Virginia and North Carolina. The Company's
Medical expenses as a percentage of health premium revenue ("medical loss ratio") decreased to 89.4 percent for 1997 as compared to 92.4 percent for 1996 and, on a per member per month basis, medical expenses decreased 1.4 percent. This decrease is due to a combination of factors including continuing efforts by the Company to implement product specific cost containment controls, expanded activity in specialized subrogation areas and claims review for dual health coverage, the adoption of regionalized and product specific fee maximums for health services, and the identification and possible termination of certain providers and specialists from the delivery network following a continuing intensified peer review analysis. In addition, during 1997, the Company identified certain claims which had been overpaid and recorded as a reduction of medical expenses approximately $12 million relating to claims incurred and paid in 1996. The Company believes that it has taken the appropriate action and implemented appropriate controls to ensure that future claims are paid at the appropriate amounts although the complexity of paying claims and the increasing sophistication of providers requires constant evaluation of historical payment patterns which might indicate improper payments. Additionally, the Company has greatly expanded its initial health assessments of new Medicare members after they have enrolled and has also increased its case management personnel. These initiatives should help to control the Company's medical loss ratio. The statements in the preceding paragraphs regarding future utilization rates, cost containment initiatives, total medical costs and future increases in health premiums per member are forward-looking statements. See "Forward-Looking Information" above for a description of risk factors that may affect medical expenses per member and the medical loss ratio.
- ----------------------------------------------------------------------------- THE YEAR ENDED DECEMBER 31, 1996 COMPARED TO THE YEAR ENDED DECEMBER 31, 1995 - -----------------------------------------------------------------------------
Consolidated net income (loss) of the Company was $(2,768,000) and $61,124,000 in 1996 and 1995, respectively. Diluted net earnings (loss) per share was $(.06) in 1996 as compared to $1.28 in 1995. The reduction in earnings is primarily attributable to a significant increase in the medical loss ratio for commercial products, continuing losses in the Company's Medicare product and lower earnings from the Company's Medicaid products. The medical loss ratio increased principally due to increased member utilization.
The net margin rate decreased from 6.4 percent in 1995 to (.2) percent in 1996. This decrease is primarily due to the increase in the medical loss ratio.
Prepaid expenses, advances and other current assets decreased from $32.3 million at December 31, 1996 to $19.3 million at December 31, 1997, principally due to the receipt of 1996 tax refunds for net operating loss carrybacks. Statutory deposits increased from $9.1 million at December 31, 1996 to $14.9 million at December 31, 1997 due to the increase in state regulatory deposits related to certain of the Company's regulated subsidiaries.
Deferred tax assets are recognized for deductible temporary differences that, in management's opinion, are more likely than not to be realized in the current or future periods. The Company's history of operating revenue and income growth, and expectation of future operating income, provides strong positive evidence that these deferred tax assets will be realized. A valuation allowance has been recorded for net operating loss carryforwards generated by certain subsidiaries that are not deductible on a consolidated tax return. Management intends to continue to monitor the realizability of deferred tax assets in light of future circumstances and assess the reasonableness of the valuation allowance.
Cash and cash equivalents $ 3,570 $ 4,065 Short-term investments 152,080 151,359 Working capital advances to Maryland hospitals 9,186 6,432 -------- --------
Total available liquid assets 164,836 161,856 Credit line availability 21,526 21,802 -------- -------- Total short-term capital resources $186,362 $183,658 ======== ========
Certain MAMSI subsidiaries that are subject to regulation by state insurance departments must notify state regulators before the payment of any dividends to MAMSI and, in certain circumstances, must receive positive affirmation prior to such payment. The Company does not perceive these requirements to be a significant restriction on the subsidiaries' ability to pay appropriate future dividends to the parent company.
The Company believes that cash generated from operations along with its current liquidity and borrowing capabilities are adequate for both current and planned expanded operations. Certain capital expenditures will be made over the next year to enhance the Company's computer systems, and to make necessary improvements to new and existing administrative offices.
In 1997, the Company began the process of identifying, evaluating and implementing changes to computer programs necessary to address the year 2000 issue. This issue affects computer systems that have time-sensitive programs that may not properly recognize the year 2000. This could result in major system failures or miscalculations. The Company is currently addressing its internal year 2000 issue with modifications to existing programs. The Company is also communicating with vendors, financial institutions, software vendors and others with which it conducts business to help them identify and resolve the year 2000 issue. While the Company has determined that certain of its software programs require modification, it does not anticipate any future material impact on its financial statements. The total cost associated with the required modifications and conversions is not known at this time, however, it is not expected to be material to the Company's results of operations or financial position. The statements in the preceding paragraph regarding future effects of the year 2000 issue is a forward looking statement. See "Forward-Looking Information" for a description of risk factors.
Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 1997, 1996 and 1995........... 30
Selected Quarterly Financial Data for Fiscal Years 1997 and 1996 (Unaudited)............................................... 48
MAMSI delivers managed health care services principally through HMOs. The HMOs, MD- Individual Practice Association, Inc. ("M.D. IPA"), Optimum Choice, Inc. ("OCI"), Optimum Choice of the Carolinas, Inc. ("OCCI") and Optimum Choice, Inc. of Pennsylvania ("OCIPA") arrange for health care services to be provided to an enrolled population for a predetermined, prepaid fee, regardless of the extent or nature of services provided to the enrollees. The HMOs offer a full complement of health benefits, including physician, hospital and prescription drug services.
The Company's operations are conducted within one business segment. 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, 1997, 1996 and 1995, approximately 11%, 11% and 7%, respectively, of premium revenue was derived from federal government agencies, and approximately 25%, 26% and 21%, respectively, was derived from state and local government agencies.
Floating rate municipal putable bonds, which possess an insignificant risk of loss from changes in interest rates, that have been held less than three months, are classified as cash equivalents.
Amounts charged to patients, third party payors and others for home health services are recorded at net realizable amounts, including retroactive adjustments under cost reimbursement agreements with third party payors.
Capitation costs represent monthly fixed fees to participating physicians and other medical providers as retainers for providing continuing medical care.
Medical claims reversals result from the determination that the Company has paid claims in excess of contractually obligated amounts. Amounts recognized (through specific identification or estimation) are recorded at their net realizable value as a reduction of medical expense in the consolidated statements of operations and as a reduction of medical claims payable in the consolidated balance sheets.
The income tax provision includes Federal and state income taxes both currently payable and deferred because of differences between financial reporting and tax bases of assets and liabilities. Deferred tax assets and liabilities are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.
Statement of Financial Accounting Standards No. 107, "Disclosure about Fair Value of Financial Instruments" ("Statement No. 107"), requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. Statement No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
statements. The Company is currently evaluating the effect of Statement 130 on its financial statements. Each of these statements is effective for periods beginning after December 15, 1997.
Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("Statement No. 115"). Under this statement, securities are classified into categories and are valued based upon this designation. Securities classified as available-for-sale, which include debt and equity securities that the Company does not have the positive intent to hold to maturity, are marked to market with the resulting unrealized gain or loss reflected in stockholders' equity. Securities classified as held-to-maturity, which are debt securities that the Company has both the positive intent and ability to hold to maturity, are carried at amortized cost. The Company classifies its statutory deposits as held-to-maturity with no effect on the recorded value. All other investments are classified as available-for-sale. Management re-evaluates these designations annually. During 1997, statutory deposit investments with an amortized cost of $3,001,000 were released by state regulatory agencies and transferred to the Company's short-term investment portfolio. The unrealized gain at the date of transfer was $94,000.
The amortized cost and estimated fair value of debt and marketable equity securities at December 31, 1997, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.
Medical recoverables consist of refunds identified on paid claims. This amount has been recorded as a reduction of medical expense in the consolidated statements of operations. Other receivables consist primarily of amounts due for reinsurance recoveries and pharmacy rebates.
The Company has access to total line-of-credit and letter-of-credit facilities of $24 million, which are subject to annual renewal. Borrowings bear interest at a rate based on either the bank's prime rate or the Federal Funds rate plus .75% and are secured by certain cash balances and short-term investments. At December 31, 1997, approximately $2.25 million was outstanding on one of the lines-of-credit at an interest rate of 7.43% and approximately $225,000 was outstanding in letters-of-credit.
Interest expense paid in cash during 1997, 1996 and 1995 was approximately $538,000, $688,000, and $1,541,000, respectively.
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 was raised from $100,000 to $200,000 effective October 1, 1994. Reinsurance for life and accidental death
At December 31, 1997, the Company has net federal operating loss carryforwards of approximately $1.3 million for income tax purposes that expire in various years beginning in the year 2002. Approximately $1.2 million of these carryforwards relate to HomeCall, Inc. operations prior to MAMSI's acquisition. The Company's ability to utilize these net operating loss carryforwards is limited.
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 pre-tax 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 1997, 1996 and 1995, the Company's contribution to the 401(k) plan aggregated $577,000, $540,000 and $433,000, respectively.
Effective December 31, 1994, the Company discontinued its non-contributory defined benefit pension plan (the "Plan"). Benefits earned under the Plan, which covered substantially all employees, were fully vested at that date. The obligation to provide these benefits was satisfied as of December 31, 1995 through a combination of purchases of annuity contracts, transfers of vested funds into the 401(k) plan and cash withdrawals. The Company recognized a gain on the curtailment of the defined benefit pension plan of approximately $345,000.
In accordance with a personal service contract negotiated by the Company, its Chairman is entitled to supplemental pension benefits based upon years of service and attained salary levels. Expense recognized related to this plan was $818,000 and $1,682,000 for the years ended December 31, 1996 and 1995, respectively. During 1997, the service contract was renegotiated, at which time the supplemental pension benefits package was amended to include a fixed payment benefit of $450,000 per year for a fixed term of 15 years. The reduction in pension expense recognized in 1997 related to this change was approximately $1.1 million.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the option's vesting period. The Company's pro forma information follows (in thousands except share amounts):
Pro forma net income (loss) $9,007 $(8,409) $58,670 Pro forma basic earnings (loss) per share .19 (.18) 1.28 Pro forma diluted earnings (loss) per share .19 (.18) 1.23
The effects of applying Statement 123 as computed above are not likely to be representative of the pro forma effects on reported net income in future years as the above only considers options granted in 1997, 1996 and 1995.
On April 17, 1995, the stockholders of MAMSI approved an increase in the number of authorized shares of common stock from 60,000,000 to 100,000,000.
The Company has been named as the defendant in a suit filed by certain medical providers on March 26, 1997 in the Circuit Court for Anne Arundel County, Maryland, which alleges that the Company improperly reduced payments to participating providers in the form of "withhold". It is the plaintiffs' allegation that certain payments should not have been reduced in this manner and seek unspecified damages. This matter has been filed as a class action against the Company. On August 18, 1997, the court stayed further proceedings in the litigation pending plaintiff's pursuit of arbitration as provided for under the contract. While the Company believes that no significant liability exists, it is too early to assess the final outcome.
We have audited the accompanying consolidated balance sheets of Mid Atlantic Medical Services, Inc. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.