We own 13 buildings encompassing approximately 445,000 aggregate square feet of space. Three of the buildings, representing approximately 244,000 aggregate square feet of space, are primarily used for administrative operations and are located in California and Guam. The remaining 10 buildings are medical office buildings, of which nine are leased to third parties under a master lease agreement. All 10 medical buildings are being marketed for sale. We also own three parcels of vacant land for a total of 18 acres, all of which are being marketed for sale.
OVERVIEW. PacifiCare sells HMO and HMO-related products primarily to members in two groups: the Secure Horizons program for Medicare beneficiaries and the commercial plans for members of employer groups and individuals. Our specialty managed care HMOs and HMO-related products and services supplement our commercial and Secure Horizons programs. These include life and health insurance, behavioral health services, dental and vision services, pharmacy benefit management and Medicare+Choice management services.
- - In October 1999, our board of directors approved a stock repurchase program that allows us to repurchase up to 12 million shares of our outstanding common stock, including any shares purchased from UniHealth Foundation. From November 8, 1999, through December 31, 1999, we repurchased 6.3 million shares under this authorization. This repurchase program supersedes the stock repurchase program approved in January 1998, under which we purchased 3.2 million shares. Included in this 3.2 million shares were 2.5 million shares repurchased in 1999. We also obtained an amendment to our existing credit facility that increased the maximum allowable amount of share repurchases to $1 billion from $500 million. See Note 6 of the Notes to Consolidated Financial Statements.
- - We signed transition agreements with QualMed Washington Health Plans, Inc., in October 1999 and with QualMed Plans for Health of Colorado, Inc. in September 1999, each a subsidiary of Foundation Health Systems, Inc. During the first quarter of 2000 we will assume approximately 25,000 to 29,000 members in Colorado and approximately 24,000 members in Washington. See Note 12 of the Notes to Consolidated Financial Statements.
MEMBERSHIP. Total membership increased four percent to approximately 3.7 million members at December 31, 1999 from approximately 3.5 million members at December 31, 1998.
Government membership increased four percent at December 31, 1999 compared to membership at December 31, 1998 due to:
- - Competitor exits in markets where Secure Horizons will remain, primarily Colorado, Nevada, Washington and Arizona; and
- - Membership losses attributable to our continued focus on renewing commercial contracts with sufficient price increases to improve gross margin, primarily in Washington and Texas.
Government premium rates on a per member basis increased due to higher HCFA premiums received, changes in membership demographics and health status, higher retiree supplemental premiums and the exit of the Utah Medicaid business.
COMMERCIAL PREMIUMS. Commercial premiums increased four percent or $171 million for the year ended December 31, 1999 compared to premiums in the prior year as follows:
CONSOLIDATED MEDICAL CARE RATIO. The 1999 consolidated medical care ratio (health care services as a percentage of premium revenue) declined slightly compared to 1998 primarily because current year provider reserves were significantly less than in 1998.
GOVERNMENT MEDICAL CARE RATIO. The government medical care ratio for the year ended December 31, 1999 increased compared to the prior year due to:
- - Reduced hospital expenses, primarily because current year provider reserves were significantly less than in 1998.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. For the year ended December 31, 1999 compared to 1998, marketing, general and administrative expenses as a percentage of operating revenue decreased because of:
NET INVESTMENT INCOME. Net investment income decreased approximately 19 percent for the year ended December 31, 1999 compared to the prior year due to the following:
- - Fewer realized gains on sales of marketable securities in the current year; and
- - The 1998 effective tax rate included an increase related to nondeductible losses recognized for the dispositions of the Utah HMO and workers' compensation subsidiaries; and
DILUTED EARNINGS PER SHARE. For the year ended December 31, 1999, net income was $279 million or $6.23 diluted earnings per share. For the year ended December 31, 1998, net income was $202 million or $4.40 diluted earnings per share. The change was due to the following:
GOVERNMENT PREMIUMS. Government premiums increased seven percent or $380 million for the year ended December 31, 1998 compared to premiums in the prior year as follows:
COMMERCIAL PREMIUMS. Commercial premiums increased three percent or $95 million for the year ended December 31, 1998 compared to premiums in the prior year as follows:
The improved commercial product performance was partially offset by increased provider reserves. Excluding these reserves, the consolidated medical care ratio was 84.0 percent. Provider reserves were immaterial in 1997 and totaled $95 million in 1998 as follows:
The majority of the provider reserves related to specific provider bankruptcies. However, the estimate also included reserves for potentially insolvent providers, where conditions indicated claims were not being paid or had slowed considerably. Provider charges include the write-off of uncollectable receivables from providers and the estimated cost of unpaid health care claims covered by our capitation payments. Depending on state law, we may be held liable for unpaid health care claims that were the responsibility of the capitated provider.
Commercial provider reserves for FPA totaled $17 million, primarily recognized in the second and third quarters. Other provider reserves of $16 million were recognized in the fourth quarter and related to Arizona, California, Nevada, Texas and Washington. Excluding commercial provider reserves, the 1998 commercial medical care ratio was 82.0 percent.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. For the year ended December 31, 1998 compared to 1997, marketing, general and administrative expenses as a percentage of operating revenue decreased because we realized the benefits of restructuring and a full year of synergies as a result of the FHP acquisition.
IMPAIRMENT, DISPOSITION, RESTRUCTURING, OPM AND OTHER CHARGES. We recognized $11 million of net pretax charges in 1998, primarily for dispositions of unprofitable operations. Favorable OPM settlements in the fourth quarter partially offset increased reserves recognized in the third quarter. In 1997, we recognized $155 million of pretax charges primarily related to our impairment of our Utah and Washington HMOs and our workers' compensation subsidiary. Restructuring reserves recognized in 1997 were paid in 1998. See Note 9 of the Notes to Consolidated Financial Statements.
- - The 1997 effective rate was disproportionately high because most of the pretax charges recorded in the fourth quarter of 1997 were not deductible for tax purposes. The 1997 effective income tax rate without the effect of the pretax charges was approximately 50 percent.
- - We had a smaller percentage of nondeductible goodwill amortization as part of our expenses.
DILUTED EARNINGS PER SHARE. For the year ended December 31, 1998, net income was $202 million or $4.40 diluted earnings per share. For the year ended December 31, 1997, the net loss was $22 million or $0.75 diluted loss per share.
INVESTING ACTIVITIES. For the year ended December 31, 1999, we used $251 million of cash for investing activities, compared to $19 million used in 1998. We purchased more marketable securities and property, plant and equipment in 1999, resulting in the majority of the net increase over the prior year. Property, plant and equipment purchases were primarily related to internally developed software and computer equipment.
- - We repurchased 8.8 million shares of our common stock in 1999 for $480 million compared to 0.8 million shares of our common stock in 1998 for $45 million under our stock repurchase programs;
- - In consideration for UniHealth Foundation's vote for the reclassification of our stock and in consideration for the agreements and covenants contained in the stock purchase agreement between PacifiCare and UniHealth Foundation, we paid UniHealth Foundation $60 million on June 24, 1999, when our stockholders approved the amended and restated certificate of incorporation. We incurred $2 million of expenses related to the reclassification of our common stock and the registration of the shares held by UniHealth Foundation. See Note 4 of the Notes to Consolidated Financial Statements;
- - We received cash for the issuance of common stock totaling $23 million for the year ended December 31, 1999 compared to $18 million for year ended December 31, 1998; and
RECEIVABLES, NET. Receivables, net increased $31 million from December 31, 1998 primarily due to increases in provider receivables as a result of our higher proportion of shared-risk hospital contracts. In shared-risk contracts, PacifiCare shares the risk of certain health care costs not covered by capitation arrangements and we provide additional incentives to the physicians or groups for appropriate utilization of hospital inpatient, outpatient surgery and emergency room services. In some cases, the utilization of the hospital health care costs is above the budgeted percentage as specified in the contract. As a result, the hospital or medical group shares the liability for these costs with PacifiCare.
- - $76 million decrease attributable to goodwill and intangible amortization expense;
MEDICAL CLAIMS AND BENEFITS PAYABLE. Medical claims and benefits payable increased $150 million from December 31, 1998 as follows:
- - $120 million increase in claims incurred but not yet reported for increased membership and utilization under shared-risk hospital arrangements. Under capitation arrangements, providers are prepaid based on a fixed-fee per-member per-month, regardless of the services provided to each member. Under shared-risk arrangements, claims are payable, once incurred. This results in a payable for claims incurred, but not yet paid as well as an estimate of claims incurred but not yet reported to PacifiCare;
- - $35 million increase primarily due to increased amounts withheld from capitation for claims we administered on behalf of non-delegated providers;
- - $13 million increase in pharmacy claims attributable to a one day lag in payment to our two largest pharmacy chains. This occurs when the payment date falls on a weekend; partially offset by
ACCOUNTS PAYABLE. Accounts payable increased $26 million primarily due to increased prescription drug inventory purchases from manufacturers that are not payable until January 2000, higher legal and professional costs and higher broker commission accruals due to increased membership.
THREE MONTHS ENDED DECEMBER 31, 1999 COMPARED WITH THREE MONTHS ENDED SEPTEMBER 30, 1999
The following presents our results of operations for the three months ended December 31, 1999 in comparison to the results of operations for the three months ended September 30, 1999. We are presenting this information to assist in the understanding of our discussions about our operating trends. This includes our outlook on future performance and the risks affecting our future performance discussed below in Forward-Looking Information under the Private Securities Litigation Act of 1995.
MEMBERSHIP. Total membership at December 31, 1999 was comparable to the total membership at September 30, 1999.
GOVERNMENT PREMIUMS. Government premiums increased approximately two percent or $26 million for the three months ended December 31, 1999 compared to the three months ended September 30, 1999. The increase was due to $15 million of membership increases and $11 million of premium rate increases, primarily for prior periods related to retroactive adjustments due to changes in members' status, including Medicaid eligibility and employment status.
GOVERNMENT MEDICAL CARE RATIO. The government medical care ratio decreased for the three months ended December 31, 1999 compared to the three months ended September 30, 1999 due to:
- - Premiums received for prior periods related to retroactive adjustments due to changes in members' status, including Medicaid eligibility and employment status; and
- - Decreased hospital costs, primarily settlements and changes in estimates for risk-sharing arrangements.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. Marketing, general and administrative expenses as a percentage of operating revenue for the three months ended December 31, 1999 increased compared to the prior quarter due to higher marketing expenses related to annual open enrollment and charitable contributions.
NET INVESTMENT INCOME. Net investment income increased approximately 15 percent for the three months ended December 31, 1999 compared to the three months ended September 30, 1999. The increase was due to higher invested balances and increases in short-term interest rates.
MEMBERSHIP. We expect the rate of government membership growth to be up to three percent for the year ended December 31, 2000. The increase is primarily due to the Harris acquisition. We expect approximately 40,000 Harris members will remain enrolled by the end of 2000. In addition, we will continue to focus our marketing efforts on group retiree members and growing membership as our competitors exit markets where Secure Horizons will remain. These increases will be partially offset by membership decreases as a result of reducing benefits, increasing copayments and instituting or increasing member-paid supplemental premiums in certain markets. We also experienced a slight membership decrease due to discontinued Medicare risk contracts in 12 counties in Ohio, Washington, California and Oregon effective January 1, 2000.
MEMBERSHIP AND PREMIUM RISK FACTORS. An unforeseen loss of profitable membership or a change in premium expectations could negatively affect our financial position, results of operations and cash flows. Factors that could contribute to the loss of membership or lower premiums include:
- - The effect of premium increases, benefit changes and member-paid supplemental premiums and copayments;
- - Negative publicity and news coverage or threats of litigation;
- - Our failure to successfully complete and/or integrate contemplated acquisitions; and
We work closely with our provider partners to ensure the strength and quality of our network. Under fee-for-service contracts, we have no insolvency risk, however, we do have increased utilization risk. Under our capitated arrangements, we face the risk of a provider becoming insolvent. To minimize our insolvency risk, we have developed contingency plans that include shifting members to other providers and reviewing operational and financial plans to increase financial stability. We believe our December 31, 1999 provider insolvency reserves, intended to pay for December 1999 and prior health care services that may not be paid by insolvent or unstable providers, are adequate.
- - The mix of our capitated, shared-risk and fee-for-service provider contracts;
- - Our inability to successfully implement our new medical management initiatives including hospital utilization management initiatives;
We have and may continue to incur additional health care costs. The effect of these risks and the need for additional provider reserves could have a material effect on our results of operations or cash flows of a future period. We believe, however, that such reserves would not materially affect our consolidated financial position.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. We expect marketing, general and administrative expenses as a percentage of operating revenue to be comparable or slightly increase compared to 1999. We expect increases as we invest in our medical management initiative by hiring additional personnel and as we make planned investments in technology. We anticipate spending $10 million to $15 million to integrate the Harris acquisition. In addition, we expect to incur employee severance costs in the first quarter. These increases will be partially offset by our plan to gain efficiencies in a number of functional areas including the centralization and consolidation of our sales and marketing and human resources departments.
- - Our compliance with the Health Insurance Portability and Accountability Act of 1996 ("HIPAA");
- - The success of our marketing and sales plans to attract new customers;
- - Our need for increased claims administration for capitated providers;
- - Ineffectiveness of the use of the Internet to originate small group and individual policies; and
FUTURE DISPOSITIONS AND IMPAIRMENTS. We continue to evaluate whether our subsidiaries or products fit within our Health Plans division's strategy and may decide to dispose of some of our businesses or products. We review long-lived assets for impairment when events or changes in business conditions indicate that their full carrying value may not be recovered. We consider assets to be impaired and write them down to fair value if we determine that the realizable value of long-lived assets such as property and equipment, real estate and goodwill are less than the value carried on the consolidated financial statements. We cannot be certain that the dispositions and impairments will not result in additional pretax charges. We believe that any disposition or impairment losses would not materially affect our consolidated financial position. However, the disposition or impairment losses could have a material effect on the results of operations or cash flows of a future period.
OPERATING INCOME. Including first-quarter restructuring charges, we expect the rate of operating income growth to be up to seven percent for the year ended December 31, 2000. This growth expectation is based upon our membership growth and premium growth assumptions and our medical care ratio and marketing, general and administrative assumptions and is subject to the risks discussed for each of these assumptions.
NET INVESTMENT INCOME. We expect net investment income for the year ended December 31, 2000 to increase compared to 1999 due to significant cash balances acquired in the Harris acquisition and expected increases in short-term interest rates.
WEIGHTED AVERAGE NUMBER OF SHARES. We expect the weighted average number of shares used to compute diluted earnings per share to be approximately 34 million to 36 million shares for the year ended December 31, 2000. This range is based on the assumption that we will repurchase approximately 4.8 million shares during 2000. The following factors could affect the weighted average number of shares calculation for 2000:
- - The magnitude of stock options granted during the year;
- - Any unanticipated stock for stock acquisitions, equity, convertible preferred or debt issuances; and
- - Management decisions to use cash from operations or credit facility borrowings on business initiatives other than share repurchases.
DILUTED EARNINGS PER SHARE. We expect to achieve our long-term diluted earnings per share growth goal of approximately 15 percent in 2000.
YEAR 2000. PacifiCare implemented a Year 2000 compliance program to address all major computing information systems, including core application systems, networks, desktop systems, infrastructure and critical information supply chains. We also addressed risks relating to the Year 2000 readiness of third parties with whom we maintain ongoing relationships. We incurred approximately $12 million to make our core computing systems Year 2000 compliant, including approximately $9 million that we incurred prior to 1999 and approximately $3 million that we incurred in 1999. The 1999 expenses related primarily to remedying the claims-based FHP core systems that we acquired with the February 1997 FHP acquisition. We have not experienced any material failures or disruptions of our operations or internal systems due to Year 2000 problems. We also have not experienced any material problems relating to Year 2000 problems of third party vendors, providers or other parties with whom we have relationships. In January 2000, we received our scheduled payment from HCFA without delay. The risk of delayed payment was one of the most significant potential risks we identified and addressed through our contingency plans. We continue to have contingency plans in place and will continue to monitor Year 2000 matters until we are satisfied that we no longer face any material risks.
OFFICE OF PERSONNEL MANAGEMENT CONTINGENCIES. We intend to negotiate with OPM on any existing or future unresolved matters to attain a mutually satisfactory result. We cannot be certain that any ongoing and future negotiations will be concluded satisfactorily, that additional audits will not be referred to the Department of Justice, or that additional, possibly material, liability will not be incurred. We believe that any ultimate liability in excess of amounts accrued would not materially affect our 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. See Note 10 of the Notes to Consolidated Financial Statements.
ADJUSTED COMMUNITY RATE FILINGS. We intend to cooperate with HCFA or any person or organization designated by HCFA in all ACR audits. We cannot be certain that any ongoing and future audits will be concluded satisfactorily. We may incur additional, possibly material, liability as a result of these audits. We believe that any ultimate liability would not materially affect our consolidated financial position. However, the incurrence of such liability could have a material effect on results of operations or cash flows of a future period.
RISK-BASED CAPITAL REQUIREMENTS. The National Association of Insurance Commissioners has proposed that states adopt risk-based capital standards that, if implemented, would require new minimum capitalization
LEGISLATION AND REGULATION. Recent changes in state and federal legislation have increased and will continue to increase the costs of regulatory compliance, and proposed changes in the law may negatively impact our financial and operating results. These changes may increase our medical care ratios, decrease our membership or otherwise adversely affect our revenues and our profitability. Regulation and enforcement is increasing both at the state and federal level. Increased regulations, mandated benefits and more oversight, audits and investigations may increase our administrative, litigation and health care costs. The following recent or proposed legislation, regulation or initiatives could materially affect our financial position:
- - Existing and proposed legislation that would limit our ability to manage care and utilization such as "any willing provider" and "direct access" laws;
- - New and proposed legislation that permit and would permit independent physicians to collectively bargain with health plans on a number of issues including financial compensation;
- - Legislation and regulation could also include adverse actions of governmental payors, including reduced Medicare premiums; discontinuance of, or limitation on, governmentally funded programs; recovery by governmental payors of previously paid amounts; the inability to increase premiums or prospective or retroactive reductions to premium rates for federal employees; and adverse regulatory actions;
- - New and increased initiatives at the DOJ, the Office of Inspector General of the United States Department of Health and Human Services, the Office of Inspector General of the United States Office of Personnel Management and the various enforcement divisions of the state regulatory agencies governing health care programs. These initiatives pursue both civil and criminal investigations against health care providers, payors, and pharmaceutical companies for misconduct relating to potential health care fraud and abuse, false claims, ERISA violations, violations of the Medicare program, overbilling of government programs, incorrect reporting of data, improper denial or mismanagement of care;
- - State legislation that may increase the financial capital requirements of providers who contract with HMOs to accept financial risk for health services, or legislation that would otherwise limit our ability to capitate providers or delegate financial risk, utilization review, quality assurance or other medical decisions to our contracting providers; and
INDUSTRY RISK. Consumers are currently attacking practices of the HMO industry through a number of separate class action lawsuits against PacifiCare and against other national HMOs. These lawsuits, including the ones filed to date against PacifiCare, may take years to resolve and, depending upon the outcomes of these cases, may cause or force changes in practices of the HMO industry. These cases also may cause additional regulation of the industry through new federal or state laws. These changes ultimately could adversely affect
the HMO industry and could have a material effect on our financial position, results of operations or cash flows of a future period and prospects of PacifiCare.
- - The investor's perception of our business model and strategy, including the use of capitation and the mix of commercial and Medicare membership;
OTHER. Results may differ materially from those projected, forecasted, estimated and budgeted by us due to adverse results in ongoing audits or in other reviews conducted by federal or state agencies or health care purchasing cooperatives; adverse results in significant litigation matters; and changes in interest rates causing changes in interest expense and net investment income.