(1) The Company expects that the square footage of these properties will be reduced in 1999 as a result of continued consolidation efforts pursuant to the Company's Turnaround Plan.
(1) Per share amounts and weighted-average number of common share amounts have been restated to reflect the two-for-one stock splits in 1996 and 1995.
The medical loss ratio for 1998 and 1997 reflects significant additions to the Company's reserves recorded in each year. A portion of the reserve additions in 1997 and 1998 represent revisions to estimates for claims incurred in prior years. Accordingly, the medical loss ratios on an incurred basis would be different from those shown above.
The Company recorded restructuring charges totaling $174.5 million ($165.8 million after income taxes, or $2.08 per share) in the first half of 1998. These charges resulted from the Company's actions to better align its organization and cost structure as part of the Company's Turnaround Plan. These charges included estimated costs related to: (i) the disposition or closure of noncore businesses; (ii) expected losses on government contracts; (iii) write-down of certain property and equipment; (iv) severance and related costs; and (v) costs of operations consolidation, including long term lease commitments. These reserves are generally classified in the Company's balance sheet as accounts payable and accrued expenses with the exception of property and equipment reserves, which have been classified against fixed assets. These reserve charges and their activity for 1998 are summarized in the table below: [OBJECT OMITTED]
As part of its Turnaround Plan, the Company decided to withdraw from noncore markets in Pennsylvania, Illinois, Florida and New Hampshire by selling or closing its health plans in these markets. Total premium revenue for these businesses in 1998 was approximately $170.4 million, with operating losses totaling approximately $37.0 million. In addition, the Company decided to close its specialty management initiatives and to sell or close certain other health care services operations and investments in noncore businesses. Restructuring reserves were established relating to estimated losses associated with premium deficiencies in the HMO subsidiaries to be sold or closed, the net book value of noncore investments were reduced to their estimated recoverable value, and accruals were recorded for incremental disposition and closing costs associated with the Turnaround Plan. During the second half of 1998, the Company entered into an agreement to sell its Pennsylvania subsidiary to a third party for $7.1 million in cash plus a capital surplus note for $2.5 million and transferred its membership in Illinois to a third party. Operations in Florida, Pennsylvania and New Hampshire are expected to be closed by the middle of 1999 pursuant to plans adopted during 1998. Based on favorable progress to date, the Company has revised its estimate of the remaining costs associated with the final disposition or closure of these operations, and accordingly a total of $13.3 million of reserves were reversed as a reduction of restructuring charges in the fourth quarter of 1998. The Company expects to complete the closure or disposal of these noncore businesses in 1999.
The Company entered into an agreement to dispose of its remaining Medicaid business in the fourth quarter of 1998, completed two Medicare risk transfer agreements late in the third quarter of 1998 and notified HCFA in the fourth quarter of 1998 of its intention to withdraw from Medicare in certain counties effective January 1, 1999. Amortization of the
The Company's Turnaround Plan contemplated significant changes in the Company's senior management and, in connection therewith, certain members of the former management team were granted severance arrangements. As a result, the Company recorded restructuring charges related to severance costs of $20.8 million in the first quarter of 1998 and an additional $4.0 million in the second quarter of 1998 for fifteen former executives and managers. The December 31, 1998 balance represents contracted amounts payable through the first half of 2001.
These write downs have been shown as unusual charges in the accompanying financial statements and are summarized as follows:
The Company's results of operations are dependent, in part, on its ability to predict and maintain effective control over health care costs (through, among other things, appropriate benefit design, utilization review and case management programs and its risk sharing agreements with providers) while providing members with coverage for the health care benefits provided under their contracts. Factors such as new technologies and
health care practices, hospital costs, changes in demographics and trends, selection biases, increases in unit costs paid to providers, major epidemics, catastrophes, inability to establish acceptable compensation agreements with providers, higher utilization of medical services, including higher out-of-network utilization under point of service plans, operational and regulatory issues and numerous other factors may affect the Company's ability to control such costs. The Company attempts to use its medical cost containment capabilities, such as claim auditing systems and utilization review protocols, with a view to reducing the rate of growth in health care service expense. The Company's Turnaround Plan also contemplates attempting to implement new medical management policies aimed at reducing costs in various lines of business, principally through utilization management of hospital services. There can be no assurance that the Company will be successful in mitigating the effect of any or all of the above-listed or other factors. In addition, the Company's relationship with many of its contracted providers were adversely affected by the Company's computer systems and related claims payment problems which could impede the Company's efforts to obtain favorable arrangements with some of these providers going forward. Accordingly, past financial performance is not necessarily a reliable indicator of future performance, and investors should not use historical performance to anticipate results of future period trends. The Company continues to reconcile delayed claims and claims previously paid or denied in error and pay down backlogged claims. Information gained as the process continues may result in future changes to the Company's estimates of its medical costs and expected cost trends.
Total revenues for the year ended December 31, 1998 were $4.7 billion, up 11.0% from $4.3 billion in the prior year. The net loss attributable to common stock for 1998 totaled $624.4 million, or $7.79 per share, compared with a net loss of $291.3 million, or $3.70 per share, for 1997. Results of operations for the year 1998 were adversely affected by significantly higher medical costs in the Company's commercial group business, Medicare, Medicaid and New York Individual Plans as well as approximately $145.5 million of restructuring charges and $38.3 million of unusual charges. Results for 1998 were also adversely affected by interest and financing expense of $57.1 million relating primarily to debt issuance costs and interest on claims for medical services. Results of operations for 1997 were adversely affected by a pretax charge of approximately $173.5 million relating to accounts receivable write-offs and additions to accounts receivable reserves, unusual charges of approximately $41.6 million relating to write-downs of certain investments and a pretax charge of approximately $327.0 million relating to increased reserves for medical costs payable. See "Liquidity and Capital Resources" and "Overview".
Health care services expense stated as a percentage of premium revenues (the "medical loss ratio") was 93.7% for the year 1998 compared with 94.0% for the year 1997. Overall per member per month revenue in 1998 was $199.82, however, overall per member per month health care services expenses increased 3.2% to $187.46 in 1998 from $181.38 in 1997. Software and hardware problems experienced in the conversion of a portion of the Company's computer system in September 1996 resulted in significant delays in the Company's payment of provider claims and adversely affected payment accuracy during 1997. Medical costs for 1997 reflect additions to the Company's reserves for IBNR in the third quarter of 1997 aggregating $88 million and in the fourth quarter of 1997 aggregating $239 million. These reserve additions represent revisions to estimates of the Company's incurred medical costs based on information gained in the process of reviewing and reconciling previously delayed claims and claims paid or denied in error. Results in the fourth quarter of 1998 were affected by the establishment of an additional $49 million in medical claims reserves for disputed claims, a $27 million provision for anticipated losses on individual products and net accruals of $30 million for certain other medical expense liabilities partially offset by favorable medical reserve adjustments totaling $92 million. A portion of these reserve additions represent revisions to estimates for claims incurred in prior periods.
The Company's paid and received claims data and revised estimates showed significant increases in medical costs in 1996, 1997 and 1998 for the Company's commercial, Medicare, Medicaid and New York Individual Plans. These increases resulted primarily from higher expenses for hospital and specialist physician services and increases in per member per month pharmacy costs. Results for 1998 continued to reflect high costs in these areas and the Company expects further increases in 1999. The Company's Turnaround Plan was designed to address the operating losses incurred in these lines of business, but there can be no assurance that the Turnaround Plan will succeed. Moreover, improvement of results in the New York Mandated Plans will require increases in rates or additional cost control measures which require NYSID approval. The Company expects to continue to experience losses in these plans. The Company believes it has made adequate provision for medical costs as of December 31, 1998. There can be no assurance that additional reserve additions will not be necessary as the Company continues to review and reconcile delayed claims and claims paid or denied in error.
Marketing, general and administrative expenses increased 4.7% to $772.0 million during the year 1998 compared with $737.4 million during the year 1997. The increase in 1998 was primarily attributable to a $20.0 million rise in payroll and benefits due to higher average staffing levels through the first half of 1998 and an $8.0 million increase in consulting fees primarily related to enhancements to management information systems offset, in part, by significantly lower marketing expenses for advertising and member acquisition. Marketing, general and administrative expenses as a percent of operating revenue were 16.7% during 1998 compared with 17.6% during 1997. The Company's Turnaround Plan calls for significant reductions in administrative costs, but there can be no assurance the Company will be successful in reducing such costs, and the Company expects that results for 1999 will continue to be adversely affected by high administrative costs. Moreover, the Company may decide to increase certain administrative costs to attempt to improve service levels. Administrative costs in future periods may also be adversely affected by costs associated with responding to regulatory inquiries, investigations and defending pending securities class actions, shareholder derivative and other litigation, including fees and disbursements of counsel and other experts, to the extent such costs are not reimbursed under existing policies of insurance and exceed existing accruals. There can be no assurance that ultimate costs will not exceed those estimates. See "Legal Proceedings". The Company's ability to control administrative costs could also be adversely affected by a continuation of the high level of employee attrition which the Company has experienced over the last several quarters.
Premium revenues of government programs increased 45.2% to $1.2 billion in 1997 from $850.7 million in 1996. Membership growth accounted for most of the change in Medicare as member months increased 46.4% when compared with the prior year. The increase in Medicaid revenues was attributable to a 34.4% increase in member months compared with 1996, offset in part by a 5.2% decrease in average premium rates during 1997. Average premium yields of Medicare programs in 1997 were 4.3% higher than in 1996.
The Company disposed of its 47% interest in Health Partners, Inc. ("Health Partners") in October 1997, and received 2,090,109 shares of common stock of FPA Medical Management, Inc. ("FPAM") stock with a market value approximately $76.4 million, resulting in a pretax gain of approximately $63.1 million. As of December 31, 1997, the market value of the FPAM stock had dropped to approximately $38.4 million. At year-end 1997, the Company wrote down its investment in FPAM by $38.0 million, thereby reducing the pretax gain on the sale of Health Partners to approximately $25.2 million ($20.5 million after taxes, or $.26 per share). The Company's equity in Health Partners net loss for 1997 prior to the sale was $1.1 million compared with a loss of $4.6 million in 1996.
The Company acquired all of the outstanding stock of Compass PPA, Incorporated, as of August 1, 1997 for approximately $8.2 million in cash (resulting in goodwill of $24.1 million) and acquired all of the outstanding stock of Riscorp Health Plans, Inc., a Florida-based HMO, as of November 3, 1997, for approximately $5.3 million in cash (resulting in goodwill of $3.9 million). Since the dates of acquisition, the Company made investments in such companies pursuant to a plan to aggressively develop and market the Company's products in the Florida and Chicago markets. As of December 31, 1997, the Company determined to focus available administrative resources in its core markets in the Northeast and to reduce significantly the level of investment planned for
The income tax benefit for 1997 was $140.3 million, or approximately 32.5% of the Company's pretax loss in 1997. This is lower than the 42.1% effective tax rate for 1996 since, due to the Company's significant net loss, the Company established a valuation allowance related to state net operating loss carryforwards.
Although the rate of inflation has remained relatively stable in recent years, health care costs have been rising at a higher rate than the consumer price index. In particular, the Company has experienced significant increases in medical costs in its commercial, Medicare, Medicaid, and New York Individual Plans. The Company employs various means to reduce the negative effects of inflation. The Company has in prior years increased overall commercial premium rates when practicable in order to attempt to maintain margins. The Company's cost control measures and risk-sharing arrangements with various health care providers as well as its withdrawal from participation in state Medicaid programs may mitigate the effects of inflation on its operations. There is no assurance that the Company's efforts to reduce the impact of inflation will be successful or that the Company will be able to increase premiums to offset cost increases associated with providing health care.
Cash and investments aggregating $44.8 million at December 31, 1998 have been segregated as restricted investments to comply with federal and state regulatory requirements. The Company expects to set aside additional funds not expected to exceed $30 million as collateral for certain advances made by the Company's New Jersey subsidiary (see below). In addition, the Company's subsidiaries are subject to certain restrictions on their abilities to make dividend payments, loans or other transfers of cash to the parent company, which limit the ability of the Company to use cash generated by subsidiary operations to pay the obligations of the parent, including debt service and other financing costs.
In September 1998, the National Association of Insurance Commissioners ("NAIC") adopted new minimum capitalization requirements, known as risk-based capital rules, for health care coverage provided by HMOs and other risk-bearing health care entities. Depending on the nature and extent of the new minimum capitalization requirements ultimately adopted by each state, there could be an increase in the capital required for certain of the Company's regulated subsidiaries. Connecticut has introduced legislation allowing the Connecticut Department of Insurance ("CTDOI") to promulgate regulations based on the NAIC model. The Company expects the CTDOI regulations to be applicable to its 1999 annual financial statements. Neither New York nor New Jersey have introduced similar legislation. However, the New Jersey Department of Banking and Insurance ("NJDBI") has published draft solvency regulations that it estimates will result in an additional $250 million worth of deposit by all
New Jersey health care plans. The New York Superintendent of Insurance has announced an intention to strengthen current solvency regulations to allow the NYSID to take over failing health plans without a court order. The Company intends to fund any increase from available parent company cash reserves; however, there can be no assurance that such cash reserves will be sufficient to fund these minimum capitalization requirements. The new requirements are expected to be effective on or before December 31, 1999 upon enactment by each state.
During 1997 and 1998, the Company made cash contributions to the capital of its HMO subsidiaries aggregating $65.7 million and $537.5 million, respectively. In addition, in 1997, the Company contributed the outstanding capital stock of OHI, its insurance subsidiary, to Oxford NY to increase Oxford NY's surplus. These contributions to its subsidiaries were made to ensure that each subsidiary had sufficient surplus as of December 31, 1998 under applicable regulations after giving effect to operating losses and reductions to surplus resulting from the nonadmissibility of certain assets. The Company expects that additional contributions to the subsidiaries will be required if operating losses are incurred in 1999. Further, additional capital contributions may be required if there is an increase in the nonadmissible assets of the Company's subsidiaries or a need for reserve strengthening as the result of regulatory action or otherwise. See "Business - Government Regulation".
The Company has completed its assessment of its computer systems and facilities that could be affected by the "Year 2000" date conversion and is continuing to carry out the implementation plan to resolve the Year 2000 date issue which it developed as a result of the assessment. The Year 2000 problem is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's programs that have time-sensitive software may recognize the date "00" as the year 1900 rather than the year 2000. This could result in system failure or miscalculations. The Company is utilizing and will utilize both internal and external resources to identify, correct or reprogram, and test the systems for Year 2000 compliance. The Company has divided its Year 2000 compliance program into the following phases: assessment, planning, remediation and testing. As of December 31, 1998, the Company was 80% complete with its Year 2000 compliance program and anticipates being complete with all phases of the program by the second quarter of 1999. The Company's Year 2000 compliance program requires remediation of certain programs within particular time frames in order to avoid disruption of the Company's operations. These time frames include certain dates throughout 1999. Although the Company believes it will complete the remediation of these programs within the applicable time frames, there can be no assurance that such remediation will be completed or that the Company's operations will not be disrupted to some degree.
The Company is communicating with certain material vendors to determine the extent to which the Company may be vulnerable to such vendors' failure to resolve their own Year 2000 issues. The Company is attempting to mitigate its risk with respect to the failure of such vendors to be Year 2000 compliant by, among other things, requesting project plans, status reports and Year 2000 compliance certifications or written assurances from its material vendors, including certain software vendors, business partners, landlords and suppliers. The effect of such vendors' noncompliance, if any, is not reasonably estimable at this time.
Potential consequences of the Company's failure to timely resolve its Year 2000 issues could include, among others: (i) the inability to accurately and timely process claims, enroll and bill groups and members, pay providers, record and disclose accurate data and perform other core functions; (ii) increased scrutiny by regulators and breach of contractual obligations; and (iii) litigation in connection therewith.
See Index to Consolidated Financial Statements and Schedules on page 52.