As of December 31, 1998, the Company leased approximately 1.72 million aggregate square feet of space for its principal administrative offices in the greater Minneapolis/St. Paul, Minnesota area and in Hartford, Connecticut. Excluding these areas, as of December 31, 1998, the Company leased approximately 6.38 million aggregate square feet in the United States, and approximately 97,100 aggregate square
feet outside of the United States (including Puerto Rico). Such space accommodates health plans, managed care services, specialty programs or satellite administrative offices. The Company's leases expire at various dates through May 31, 2026. As of December 31, 1998, the Company owned approximately 310,700 aggregate square feet of space for administrative offices in various states and its staff model clinic operations in Florida.
(3) Excluding restructuring charges associated with the acquisition of The MetraHealth Companies, Inc., of $154 million ($97 million after tax, or $0.55 diluted net earnings per common share), 1995 earnings from operations and net earnings would have been $615 million and $383 million, or $2.12 diluted net earnings per common share.
(4) Excluding the nonoperating merger costs associated with the acquisitions of Complete Health Services, Inc. and Ramsay-HMO, Inc., of $36 million ($22 million after tax, or $0.13 diluted net earnings per common share), 1994 earnings before extraordinary gain would have been $310 million or $1.77 diluted net earnings per common share.
(6) During 1998, we issued notes and commercial paper aggregating $708 million, which remained outstanding at December 31, 1998.
1998 was an important year of both challenges and successes for UnitedHealth Group.
- - We achieved record revenues of $17.4 billion, a 47% increase over 1997. This growth was driven primarily by same-store enrollment growth in our UnitedHealthcare business and from successful implementation of our $3.5 billion Medicare supplement insurance program with the AARP.
- - We completed several financing initiatives to achieve a more efficient capital structure, including the redemption of our $500 million convertible preferred stock and the repurchase of 11.3 million shares of our common stock.
(2) Excluding the effects of a $45 million provision for future losses on two large multi-year contracts and $15 million of merger costs associated with the acquisition of HealthWise of America, Inc., earnings from operations, net earnings applicable to common shareholders, and diluted net earnings per common share would have been $641 million, $392 million, and $1.96 per share, respectively.
(3)Includes $175 million of contract losses associated with certain Medicare markets and other increases to commercial and Medicare medical costs payable estimates. The company's ratio of medical costs to premium revenues for the year ended December 31, 1998, would have been 86.0% without these charges.
In 1998, we reported a net loss applicable to common shareholders of $214 million, or $1.12 diluted net loss per common share. However, these results include certain large or unusual events and transactions as described below:
- - In conjunction with our realignment and other initiatives, we recorded $725 million of charges to operations during the second quarter of 1998. The charges included $451 million of asset impairments and $274 million of estimated future costs associated with our initiatives, such as employee terminations; disposing of or discontinuing business units, product lines and contracts; and consolidating certain processing operations and associated real estate obligations. Although our realignment initiatives and the associated nonrecurring charges caused us to report a net loss for 1998, these actions position us to make long-term fundamental process and performance improvements.
Excluding the effects of the events and transactions described above, 1998 underlying earnings from operations and diluted net earnings per common share were $858 million and $2.62 per share, respectively, representing increases of 16% over earnings from operations of $742 million and diluted net earnings per common share of $2.26 in 1997. These increases were primarily driven by improved margins in the commercial product offerings of our UnitedHealthcare business and successful integration and management of our services provided to the AARP, which began on January 1, 1998.
The discussion that follows provides a more detailed analysis of our 1998, 1997 and 1996 operating results.
Our revenues are comprised of: 1) premium revenues associated with our risk-based products (those where we assume financial responsibility for health care costs); 2) management services and fees associated with administrative services only customers, managed health plans, and our Specialized Care Services and Ingenix businesses; and 3) investment and other income.
The following table summarizes premium revenues by business unit for the years ended December 31 (in millions):
Growth in UnitedHealthcare's Medicare programs also contributed to the increase in premium revenues, with same-store growth of 33% in Medicare enrollment. Significant growth in Medicare enrollment affects year-over-year comparability. The Medicare product generally has per member premium rates three times to four times higher than average commercial premium rates because Medicare members typically use proportionately more medical care services. On a year-over-year same-
The increase in UnitedHealthcare's commercial health plan and Medicare product premium revenues was partially offset by a $240 million decrease from other network-based and indemnity products. We expect enrollment in UnitedHealthcare's other network-based and indemnity products will continue to decline through 1999. To the extent possible, we will convert these enrollees to UnitedHealthcare's commercial health plan products.
Management services and fee revenues during 1998 totaled $1.6 billion, representing an increase of approximately $160 million over 1997. The increase is primarily the result of acquisitions by Ingenix during 1997 and 1998. Additionally, our Specialized Care Services business -- most notably United Behavioral Health and Optum,-Registered Trademark- our telephone- and Internet-based health information and services business -- continues to increase the number of individuals it serves.
Investment and other income increased to $249 million in 1998 from $231 million in 1997. The increase of $18 million is primarily attributable to an increase in average cash and investments from $3.6 billion in 1997 to $4.1 billion in 1998. Net capital gains were $26 million in both 1998 and 1997.
The increase in the 1998 medical care ratio is primarily attributable to average Medicare premium rate increases of 2.5% that were more than offset by increased medical utilization, reflected mostly in hospital costs. In 13 of our 24 Medicare markets, representing half of our annual Medicare premiums of $2.4 billion, we incurred contract losses of $111 million. Six of these 13 markets are generally newer markets where we have been unable to achieve the scale of operations necessary to achieve profitability. In numerous counties in the other seven markets, we experienced high medical costs which exceeded the fixed Medicare premiums that increased only 2.5% on average.
Commercial health plan premium rates are established based on anticipated health care costs. During 1998, commercial premium yield increases averaging 5% to 6% minimally exceeded medical cost trends of 4% to 5%. Looking to 1999, we expect average medical cost increases to remain stable in the 4% to 5% range, and we also expect that our medical care ratio will improve as a result of premium yield increases on new and renewal commercial business averaging 7% to 8%.
Selling, general and administrative expenses as a percent of total revenues (the SG&A ratio) decreased from 20.0% in 1997 to 17.1% in 1998. The improvement in the year-over-year SG&A ratio principally reflects the operating leverage we gained with the addition of the AARP business and planned cost reductions we have achieved to date from our realignment initiatives. On an absolute dollar basis, selling, general and administrative costs increased by $600 million, or 25%, over 1997. This increase primarily reflects the additional infrastructure needed to support the $5.4 billion, or 53%, increase in premium-based business.
Depreciation and amortization was $185 million in 1998, and $146 million in 1997. This increase resulted from a combination of higher levels of capital expenditures to support business growth and amortization of goodwill and other intangible assets related to recent acquisitions.
The $451 million of asset impairments recorded in the second quarter of 1998 will reduce depreciation and amortization by approximately $15 million annually. This decrease will be more than offset in 1999 by increased depreciation and amortization related to capital expenditures and intangible assets acquired in acquisitions during 1998.
Businesses we intend to dispose of include our managed workers' compensation business, and medical and behavioral health provider clinics. Markets where we plan to curtail or make changes to our operating presence include our small group health insurance business and three health plan markets that are in non-strategic locations.
Our original provision for operational realignment and other charges was developed based on management's best judgment and estimates at that time. As we began to execute the Plan, we adjusted certain estimates based on more current information related to the amounts to be paid for severance and lease cancellation fees. In addition, based on continuing negotiations related to business dispositions, our original estimates for asset impairments and business disposition costs were revised. In total, our Operational Realignment and Other Charges did not change.
average year-over-year premium rate increases on renewing commercial groups of approximately 5%. Growth in our Medicare programs also contributed to the increase in premium revenues, with a year-over-year same-store increase of 53% in Medicare enrollment.
MANAGEMENT SERVICES AND FEE REVENUES Management services and fee revenues in 1997 totaled $1.4 billion, representing an increase of $30 million, or 2%, over 1996. The increase resulted from enrollment growth within managed health plans and an increase in individuals served by our Specialized Care Services business. Offsetting these increases, fee revenues from self-funded products decreased $15 million because of declining enrollment in these products. In addition, the June 30, 1997, sale of our subsidiary, United HealthCare Administrators, Inc., resulted in a $24 million decrease in these revenues in 1997 compared to 1996.
- - A few specific health plan markets had medical care ratios substantially higher than our other health plans in the aggregate. The reasons varied from plan to plan, but generally, medical cost controls and provider contracting initiatives were not being fully implemented and commercial premium yields were insufficient compared to corresponding medical costs.
During 1998, we also took several actions to improve our capital structure:
- - We redeemed $500 million of convertible preferred stock with a cumulative dividend rate of 5.75% (a pre-tax effective rate of approximately 9.0%). The redemption of the preferred shares was financed with $650 million of unsecured notes payable at a weighted-average pre-tax effective interest rate of 6.0%, thereby decreasing our financing cost for this $500 million by 34% in the first year. The debt placement consisted of $400 million in unsecured notes due December 1999, with an interest rate of 5.65%, and $250 million in unsecured notes due December 2003, with an interest rate of 6.65%.
- - We repurchased 11.3 million shares of our common stock for an aggregate cost of $436 million, an average cost of approximately $40 per share. Under our stock repurchase program, we may purchase up to 18.7 million shares of our outstanding common stock. Purchases may be made from time to time at prevailing prices, subject to certain restrictions relating to volume, pricing and timing.
The Company's debt arrangements and credit facilities contain various covenants, the most restrictive of which place limitations on secured and unsecured borrowings and require the Company to exceed minimum interest coverage levels. At December 31, 1998, we were well within the requirements of all debt covenants.
Currently, we do not have any other material definitive commitments that require cash resources; however, we continually evaluate opportunities to expand our operations. This includes internal development of new products and programs and may include acquisitions.
GOVERNMENT REGULATION Our primary business, offering health care coverage and health care management services, is heavily regulated at the federal and state levels. We strive to comply in all respects with applicable regulations and may be required to make changes from time to time in our services, products, marketing methods or organizational or capital structure.
Regulatory agencies generally have broad discretion to issue regulations and interpret and enforce laws and rules. Changes in applicable laws and regulations are continually being considered, and the interpretation of existing laws and rules also may change from time to time. These changes could affect our operations and financial results.
The Health Insurance Portability and Accountability Act of 1996 (HIPAA) may represent the most significant federal reform of employee benefit law since the enactment of the Employee Retirement Income Security Act (ERISA) in 1974. Significant provisions of HIPAA include guaranteeing the availability of health insurance for certain employees, limiting the use of preexisting condition exclusions, prohibiting discrimination on the basis of health status, and making it easier to continue coverage in cases where a person is terminated or changes employers. Under HIPAA and other similar state laws, medical cost control through amended provider contracts and improved preventive and chronic care management may become more important. We believe our experience in these areas will allow us to compete effectively.
A comprehensive set of claims regulations has been proposed by the United States Department of Labor (DOL) that could have a significant impact on the Company. These regulations are applicable to employee benefit plans subject to ERISA. In addition to various other requirements, the regulations would create new time frames for processing claims and giving notification of incomplete claims, would impose certain notification requirements following a claim determination, and would impose certain post-appeal disclosure obligations on the Company's insured and self-funded business. The DOL has solicited public comment on the proposals, and the regulations, if adopted, could vary significantly from the proposals.
REGULATORY CAPITAL AND DIVIDEND RESTRICTIONS The Company's operations are conducted through United HealthCare Corporation, its wholly-owned subsidiary United HealthCare Services, Inc. and their respective subsidiaries, which consist principally of Health Maintenance Organizations (HMOs) and insurance companies. HMOs and insurance companies are subject to state regulations that, among other things, may require the maintenance of minimum levels of statutory capital, as defined by each state, and restrict the timing and amount of dividends and other distributions that may be paid to their respective parent companies. Generally, the amount of dividend distributions that may be paid by regulated insurance and HMO companies, without prior approval by state regulatory authorities, is limited based on the entity's level of statutory net income and statutory capital and surplus.
CONCENTRATIONS OF CREDIT RISK Investments in financial instruments such as marketable securities and commercial premiums receivable may subject UnitedHealth Group to concentrations of credit risk. Our investments in marketable securities are managed by professional investment managers within an investment policy authorized by the board of directors. This policy limits the amounts that may be invested in any one issuer. Concentrations of credit risk with respect to commercial premiums receivable are limited to the large number of employer groups that comprise our customer base. As of December 31, 1998, there were no significant concentrations of credit risk.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Since the date of the Company's quarterly report filed on Form 10-Q for the quarter ended September 30, 1998, no material changes have occurred in the Company's exposure to market risk associated with our investments in market risk-sensitive financial instruments. We do not believe that our risk of a loss in future earnings or a decline in fair values or cash flow attributable to such investments is material.
While we currently believe our strategies to mitigate health care cost inflation will continue to be successful, competitive pressures, new health care product introductions, demands from health care providers and customers, applicable regulations, or other factors may affect our ability to control the impact of health care cost increases. In addition, certain non-network-based products do not have health care cost containment measures similar to those in place for network-based products. As a result, there is added health care cost inflation risk with these products.
Starting in 1995, our formal Year 2000 Project Office began implementing a remediation plan so that critical information systems applications, end-user developed application tools, and business interfaces remain intact and can function properly through the century change. We are on schedule to complete, test and certify our Year 2000 remediation efforts by September 30, 1999. A more detailed description and current status of our Year 2000 activities follows.
TELECOMMUNICATIONS We have inventoried all of our telecommunication systems-- more than 28,000 telecommunication devices, including traffic routers and phone switches. We are using two outside vendors to assist us in modifying or replacing noncompliant telecommunication systems. As of December 31, 1998, we were approximately 75% Year 2000 compliant with our data and voice networks. We expect all of our telecommunication networks and devices will be Year 2000 compliant by September 30, 1999.
END-USER DEVELOPED APPLICATIONS End-user developed applications are analysis tools that have been internally developed by individual employees or operating segments primarily running on personal computers or client servers. The Year 2000 Project Office has continuously communicated with all employees explaining the risks of noncompliant applications and provided tools and techniques to make them compliant. We have identified and are tracking and assessing Year 2000 compliance issues with respect to all potentially critical end-user applications.
We use approximately 300,000 different medical providers and more than 92,000 vendors. Approximately 2,000 vendors have been identified as critical business partners and suppliers. We are currently in communication with these critical business partners to analyze their Year 2000 compliance efforts. We expect to complete our analysis of critical vendor readiness and identify alternative vendors, where necessary, by July 31, 1999. We will not be individually contacting all of the 300,000 medical providers with whom we conduct business regarding Year 2000 compliance issues. However, we will be testing and verifying the electronic collection of data with our providers through our EDI (electronic data interface) clearinghouse vendors.
Costs associated with modifying internal use software for Year 2000 compliance are charged to expense as incurred. Purchases of hardware or software that replace existing hardware or software that is not Year 2000 compliant are capitalized and amortized over their useful lives. As of December 31, 1998, our historical and projected costs to complete our Year 2000 remediation plan were as follows (in millions):
Although we are committed to completing and testing our remediation plan well in advance of the Year 2000, there are risks if we do not meet our objectives by December 31, 1999. Operationally, the most severe risk is business interruption. Specific examples of situations that could cause business interruption include, but are not limited to: computer hardware or application software processing errors or failures, facilities or infrastructure failures, or critical outside providers, suppliers, or customers who may not be Year 2000 compliant. Depending on the extent and duration of business interruption resulting from noncompliant Year 2000 systems, such interruption may have a material adverse effect on our results of operations, liquidity and financial condition.
Six suits assert claims under the U.S. securities laws against UnitedHealth Group and certain of its current and former officers and directors. The plaintiffs are shareholders of the Company who purport to sue on behalf of a class of purchasers of the Company's common shares during the period February 12, 1998, through August 5, 1998 (the "Class Period"). Each complaint was filed in the United States District Court for the District of Minnesota. Each of the six actions claims violations of Sections 10(b) and 20(a) of the Securities Exchange Act and SEC Rule 10b-5. In substance, the complaints allege that the Company made materially false or misleading statements about the profitability and performance of the Company's Medicare business during the Class Period. Two of the complaints also allege that the Company made materially false statements about its medical costs and the expenses related to its realignment. The complaints also allege that the statements were made with the intention of deceiving members of the investing public and with the intention that the price of the Company's shares would rise, making it possible for insiders at the Company to profit by selling shares at a time when they knew the Company's true financial condition, but the investing public did not. The complaints allege that once the Company's true financial condition was revealed on August 6, 1998, the price of its common shares fell from a closing price of $52 7/8 per share on August 5, 1998, to a closing price of $37 7/8 per share on August 6, 1998. The complaints seek compensatory damages in unspecified amounts.
The statements contained in this Management's Discussion and Analysis of Financial Condition and Results of Operation, and other sections of this annual report to shareholders, include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the "PSLRA"). When used herein, the words or phrases "believes," "expects," "anticipates," "intends," "will likely result," "estimates," "projects" or similar expressions are intended to identify such forward-looking statements. Any of these forward-looking statements involve risks and uncertainties that may cause the Company's actual results to differ materially from the results discussed in the forward-looking statements. Statements that are not strictly historical are "forward-looking" statements under the safe harbor provisions of the PSLRA. Forward-looking statements involve known and unknown risks, which may cause actual results and corporate developments to differ materially from those expected. Factors that could cause results and developments to differ materially from expectations include, without limitation, the effects of state and federal regulations, the effects of acquisitions and divestitures, and other risks described from time to time in each of UnitedHealth Group's SEC reports, including quarterly reports on Form 10-Q, annual reports on Form 10-K, and reports on Form 8-K.
We have prepared the consolidated financial statements in accordance with generally accepted accounting principles and have included the accounts of UnitedHealth Group and its subsidiaries. We have eliminated all significant intersegment and intercompany accounts and transactions.
Medical costs include claims paid, claims adjudicated but not yet paid, estimates for claims received but not yet adjudicated, and estimates for claims incurred but not yet received.
The estimates of medical costs and medical costs payable are developed using actuarial methods based upon historical data for payment patterns, cost trends, product mix, seasonality, utilization of health care services and other relevant factors including product changes. The estimates are subject to change as actuarial methods change or as underlying facts, upon which estimates are based, change. We did not change our actuarial methods during 1998, 1997 or 1996. The impact of any changes in estimates is included in the determination of earnings in the period of change. Management believes that the amount of medical costs payable is adequate to cover the Company's liability for unpaid claims as of December 31, 1998.
Cash and cash equivalents are highly liquid investments with an original maturity of three months or less. The fair value of cash and cash equivalents approximates their carrying value because of the short maturity of the instruments. Investments with a maturity of less than one year are classified as short-term.
Investments held by trustees or agencies according to state regulatory requirements are classified as held-to-maturity based on our ability and intent to hold these investments to maturity. Such investments are reported at amortized cost and are included in long-term investments. All other investments are classified as available for sale and reported at fair value based on quoted market prices and are classified as short-term or long-term depending on their maturity term. Periodically, we sell investments classified as long-term prior to their maturity to fund working capital or for other purposes.
Unrealized gains and losses on investments available for sale are excluded from earnings and reported as a separate component of shareholders' equity, net of income tax effects. To calculate realized gains and losses on the sale of investments available for sale, we use the specific cost of each investment sold. We have no investments classified as trading securities.
Property and equipment is stated at cost. Depreciation is calculated using the straight-line method over the estimated useful life of the respective assets, ranging from three years to 30 years. The weighted-average useful life of property and equipment at December 31, 1998, was approximately six years.
Goodwill represents the purchase price and transaction costs associated with businesses we acquired in excess of the estimated fair value of the net assets of these businesses. To the extent possible, a portion of the excess purchase price and transaction costs is assigned to certain identifiable intangible assets. Goodwill and other intangible assets are being amortized on a straight-line basis over useful lives ranging from three years to 40 years, with a weighted-average useful life of 34 years.
The most significant components of goodwill and other intangible assets are comprised of goodwill of $1.6 billion in 1998 and $1.2 billion in 1997, and employer group contracts and supporting infrastructure, distribution networks, and institutional knowledge of $800 million in 1998 and $900 million in 1997, net of accumulated amortization.
We review long-lived assets for events or changes in circumstances that would indicate we may not recover their carrying value. We consider a number of factors, including estimated future undiscounted cash flows associated with the long-lived asset, to make this decision. We record assets held for sale at the lower of their carrying amount or fair value, less any costs associated with the final settlement.
Basic net earnings (loss) per common share is computed by dividing net earnings (loss) applicable to common shareholders by the weighted-average number of common shares outstanding during the period. Diluted net earnings (loss) per common share is determined using the weighted-average number of common shares outstanding during the period, adjusted for the dilutive effect of common stock equivalents, consisting of shares which might be issued upon exercise of common stock options. In periods where losses are reported, the weighted-average number of common shares outstanding excludes common stock equivalents, since their inclusion would be anti-dilutive.
In December 1997, Ingenix acquired Medicode, Inc. (Medicode), a leading provider of health care information products. We issued 2.4 million shares of common stock and 507,000 common stock options with a total fair value of $127 million in exchange for all outstanding shares of Medicode. We accounted for the acquisition using the purchase method of accounting. The purchase price and costs associated with the acquisition exceeded the preliminary estimated fair value of net assets acquired by $123 million, which was preliminarily assigned to goodwill. During the second quarter of 1998, the Company completed the valuation of the intangible assets acquired in the Medicode transaction. Pursuant to the valuation, we expensed $68 million of the excess purchase price representing purchased in-process technology that previously had been assigned to goodwill. In management's judgment, this amount reflects the amount we would reasonably expect to pay an unrelated party for each project included in the technology. The value of in-process research and development of $68 million represented approximately 48% of the purchase price and was determined by estimating the costs to develop the purchased technology into commercially viable products, then estimating the resulting net cash flows from each project that was incomplete at the acquisition date, and discounting the resulting net cash flows to their present value. The amount of research and development expended by Medicode on these projects prior to the acquisition date totaled $8.5 million, with another $2.2 million expected to be spent to complete these research and development projects. The in-process technology has not yet reached technological feasibility and has no alternative future use. The in-process projects were focused on the continued development and evolution of next-generation medical databases and software solutions. The $68 million charge is included as a component of Operational Realignment and Other Charges in the accompanying Consolidated Statements of Operations for the year ended December 31, 1998. Based on the final valuation, the remaining excess purchase price of $55 million was assigned to existing technologies, trade names and goodwill. The pro forma effects of the Medicode acquisition on our consolidated financial statements were not material.
The following table summarizes the components of the operational realignment and other charges for the year ended December 31, 1998 (in millions):
The asset impairments consist principally of goodwill and other long-lived assets, including fixed assets, computer hardware and software and leasehold improvements, from: 1) businesses we intend to dispose of or discontinue, 2) markets where we plan to curtail our operations or change the nature of our operating presence, or 3) the allocation of the purchase price for the acquisition of Medicode.
Businesses we intend to dispose of include our managed workers' compensation business, and medical and behavioral health provider clinics. Markets where we plan to curtail or make changes to our operating presence include our small group health insurance business and three health plan markets that are in non-strategic locations. We prepared a forecast of expected undiscounted cash flows, where appropriate, to determine whether asset impairments existed. We used discounted cash flows to determine the fair value and measure the write-downs for two of the three health plans. We estimated proceeds on the sale of the managed workers' compensation, small group health insurance, clinical and other health plan businesses in order to determine the fair value and amount of asset write-down for these businesses. The final allocation of the purchase price for the acquisition of Medicode was based on an independent valuation. The asset impairments also consist of other operating assets written down to their net realizable value as a result of operational realignment activities. The carrying value of the net assets held for sale or disposal is approximately $20 million as of December 31, 1998.
Our accompanying financial statements include the operating results of businesses to be disposed of or discontinued in connection with the operational realignment. The losses anticipated on the disposition of these businesses, including severance, impairment of assets, abandoned facilities and additional exit costs, represent approximately $175 million and are included in the $725 million of operational realignment and other charges. Our accompanying Consolidated Statements of Operations include revenues and operating losses from these businesses as follows (in millions):
The table above does not include operating results from the counties where we will be withdrawing our health plan Medicare product offerings effective January 1, 1999. Annual revenues for 1998 from the Medicare counties we are exiting were approximately $225 million.
During the second quarter of 1998, we recorded $175 million of medical cost charges. Of this amount, $101 million related to Medicare contract losses, $19 million related to other increases to Medicare medical costs payable estimates, and $55 million related to increases to commercial medical costs payable estimates.
In connection with our acquisition of The MetraHealth Companies, Inc. (MetraHealth) in 1995, we developed a comprehensive plan to integrate the business activities of the combined companies (the Plan). The Plan included, among other things, the disposition, discontinuance and restructuring of certain businesses and product lines, and the recognition of certain asset impairments. In the fourth quarter of 1995, we recorded $154 million in restructuring charges associated with the Plan.
Our estimate of future revenues and losses under these contracts is as follows (in millions):
On January 1, 1998, we entered into a ten-year contract to provide insurance products and services to members of the AARP. Under the terms of the contract, we are compensated for claims administration and other services as well as for assuming underwriting risk. We are also engaged in product development activities to complement the insurance offerings under this program. The AARP has also contracted with certain other vendors to provide other member and marketing services. We report premium revenues associated with the AARP program net of the administrative fees paid to these vendors and an administrative allowance we pay to the AARP.
Our underwriting results related to the AARP business are recorded as an increase or decrease to a rate stabilization fund (RSF). The RSF is included in other policy liabilities in the accompanying Consolidated Balance Sheets. The primary components of our underwriting results are premium revenue, medical costs, investment income, administrative expenses, member service expenses, marketing expenses and premium taxes. To the extent we incur underwriting losses that exceed the balance in the RSF, we would be required to fund the deficit. Any deficit we fund could be recovered by underwriting gains in future periods of the contract. The RSF balance was $192 million as of January 1, 1998, and is $509 million as of December 31, 1998. We believe the RSF balance is sufficient to cover any potential future underwriting or other risks associated with the contract.
We assumed the policy and other liabilities related to the AARP program and received cash and premiums receivables from the previous insurance carrier equal to the carrying value of the liabilities assumed as of January 1, 1998. The following assets and liabilities were transferred from the program's previous carrier and are included in our Consolidated Balance Sheets (in millions):
The effect of changes in balance sheet amounts associated with the AARP program accrue to the AARP policyholders through the RSF balance. Accordingly, we do not include the effect of such changes in our Consolidated Statements of Cash Flows.
As of December 31, 1998 and 1997, the amortized cost, gross unrealized holding gains and losses, and fair value of cash and investments were as follows (in millions):
As of December 31, 1998, the contractual maturities of cash and cash equivalents and investments were as follows (in millions):
In support of our commercial paper program, we entered into a $600 million credit arrangement with a group of banks. The agreement is comprised of a $300 million five-year revolving credit facility and a $300 million 364-day credit facility. No borrowings were outstanding as of December 31, 1998, under the credit facilities. Debt consists of the following as of December 31, 1998:
The carrying value of the Company's outstanding debt approximates its fair value at December 31, 1998.
The Company's operations are conducted through United HealthCare Corporation, its wholly-owned subsidiary United HealthCare Services, Inc. and their respective subsidiaries, which consist principally of Health Maintenance Organizations (HMOs) and insurance companies. HMOs and insurance companies are subject to state regulations that, among other things, may require the maintenance of minimum levels of statutory capital, as defined by each state, and restrict the timing and amount of dividends and other distributions that may be paid to their respective parent companies. Generally, the amount of dividend distributions that may be paid by regulated insurance and HMO companies, without prior approval by state regulatory authorities, is limited based on the entity's level of statutory net income and statutory capital and surplus.
The National Association of Insurance Commissioners has adopted rules which, to the extent that they are implemented by the states, will set new minimum capitalization requirements for insurance companies, HMOs, and other entities bearing risk for health care coverage. The requirements take the form of risk-based capital rules. The change in rules for insurance companies was effective December 31, 1998. The new HMO rules are subject to state-by-state adoption, but few states had adopted the rules as of December 31, 1998. The HMO rules, if adopted by the states in their proposed form, would significantly increase the capital required for certain of our subsidiaries. However, we believe we can redeploy capital among our regulated entities to minimize the need for incremental capital investment of general corporate financial resources into regulated subsidiaries. As such, we do not anticipate a significant impact on our aggregate capital or investments in regulated subsidiaries.
On February 16, 1999, the board of directors approved an annual dividend for 1999 of $0.03 per share payable on April 15, 1999, to holders of common stock as of close of business April 1, 1999.
In 1995, we adopted the Non-employee Director Stock Option Plans (the 1995 Plan) to benefit members of the board of directors who are not employees. As of December 31, 1998, 34,000 shares were available for future grants of non-qualified stock options under the 1995 Plan.
Do Not Use A summary of the activity under our Stock Plans and the 1995 Plan during 1998, 1997 and 1996 is presented in the table below (shares in thousands):
The following table summarizes information about stock options outstanding at December 31, 1998 (shares in thousands):
Principal assumptions used in applying the Black-Scholes model were as follows:
Because we did not apply the fair value method of accounting to options granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of what can be expected in future years.
The Employee Stock Purchase Plan (the ESPP) allows all eligible employees to purchase shares of common stock on semiannual offering dates at a price that is the lesser of 85% of the fair market value of the shares on the first day or the last day of the semiannual period. Employee contributions were $19 million for 1998, $17 million for 1997, and $16 million for 1996. Through the ESPP, we issued to employees 206,000 shares in 1998, 422,000 in 1997, and 392,000 shares in 1996. As of December 31, 1998, 3.0 million shares were available for future issuance.
Consolidated income tax returns for fiscal years 1995 and 1994 were examined by the Internal Revenue Service (IRS). The audit was concluded with no material impact on our consolidated operating results or financial position.
Consolidated income tax returns for fiscal years 1997 and 1996 are currently being examined by the IRS. We do not believe any adjustments that may result will have a material effect on our consolidated operating results or financial position.
We lease facilities, computer hardware and other equipment under long-term operating leases that are noncancelable and expire on various dates through 2011. Rent expense under all operating leases was $119 million in 1998, $104 million in 1997, and $114 million in 1996.
Certain factors relating to the health care industry and our business should be carefully considered. Companies offering health care coverage and health care management services are heavily regulated at federal and state levels. While we cannot predict regulatory changes or their impact, it is possible that operations and financial results could be negatively affected.
After several years of moderate increases in health care costs and utilization, the industry experienced a pronounced increase during 1996. Although the rate of these increases appears to have stabilized, there is no assurance that health care costs and utilization will not continue to increase at a more rapid pace. If they do, we may not be able to meet our objective of maintaining price increases at least sufficient to cover health care cost increases.
Since the date of the Company's quarterly report filed on Form 10-Q for the quarter ended September 30, 1998, no material changes have occurred in the Company's exposure to market risk associated with our investments in market risk-sensitive financial instruments. We do not believe that our risk of a loss in future earnings or a decline in fair values or cash flow attributable to such investments is material.
(1) In 1998, total assets and net assets exclude, where applicable, debt of $708 million, income tax-related assets of $266 million, and income tax-related liabilities of $4 million. In 1997, total assets and net assets exclude, where applicable, redeemable preferred stock of $500 million, income tax-related assets of $41 million, and income tax-related liabilities of $52 million.
Excluding the $725 million operational realignment and other charges and $175 million of charges related to contract losses associated with certain Medicare markets and other increase to commercial and Medicare medical costs payable estimates, 1998 earnings from operations were $503 million for Health Care Services, $161 million for Uniprise, $109 million for Specialized Care Services, $20 million for Ingenix, $65 million for Corporate and $858 million for consolidated UnitedHealth Group.