(b) Pro forma earnings per share (unaudited) for the years ended December 31, 1994 and 1993, are computed based on the following: (i) for 1993, 3,250,000 shares of Class A Common Stock and 14,962,500 shares of Class B Common Stock assumed outstanding at the beginning of the year consistent with the company's registration statement, as amended on July 28, 1994, on Form S-1, filed with the SEC under the Securities Act of 1933, and (ii) for 1994, the weighted average number of Class A and Class B Common Stock assumed outstanding, with 14,962,500 shares of Class B Common Stock assumed outstanding at the beginning of the year and giving effect to the issuance of 3,250,000 shares of Class A Common Stock on August 1, 1994, the issuance of 487,500 shares of Class A Common Stock on August 4, 1994, and the repurchase of 10,000 shares of Class A Common Stock in November 1994.
(c) Reflects impact of cumulative effect of accounting changes for postretirement benefits other than pensions and postemployment benefits aggregating $10,437, net of income tax, or $.57 per share.
The following table sets forth premium revenue (in thousands) by product group for the years ended December 31, 1997, 1996, and 1995:
For the year ended December 31, Product Group 1997 1996 1995 PPO: Alliance PPO $197,329 $234,720 $272,769 AllianceChoice POS 124,890 75,700 22,560 HMO (includes other POS) 183,485 139,457 95,927 Medicare supplement 97,157 98,038 104,396 Managed indemnity 12,531 16,425 23,045 Other specialty services 38,875 30,709 19,725 Total premium revenue 654,267 595,049 538,422 ASO/Self-funded and other income 65,144 58,326 53,458 Total revenues $719,411 $653,375 $591,880
For the year ended December 31, 1997 1996 1995 Operating revenues: Premium revenue 90.9% 91.1% 91.0% Fees and other income 9.1% 8.9% 9.0% 100.0% 100.0% 100.0%
Operating ratios: Medical loss ratio 84.8% 82.6% 76.1% Commission expense ratio 4.1% 4.1% 3.3% General and administrative expense ratio (includes depreciation and amortization) 22.7% 22.0% 23.7%
The following table sets forth the number of members by product category:
December 31, % Increase/ Product Group 1997 1996 (Decrease) Underwritten: PPO: Alliance PPO 149,339 193,349 (22.8) AllianceChoice POS 131,924 102,707 28.4 HMO: Commercial (includes other POS) 134,743 103,786 29.8 BlueCHOICE Senior 5,682 5,452 4.2 BlueCHOICE Medicaid (MC+) 5,146 5,063 1.6 Medicare supplement 62,311 68,528 (9.1) Managed indemnity 7,022 10,979 (36.0)
* does not include 497,538 and 643,311 additional third- party administrator members as of December 31, 1997 and 1996, respectively, that are part of The EPOCH Group, L.C., a joint venture with Blue Cross and Blue Shield of Kansas City formed in December 1995.
HMO premium revenue increased $44.0 million, or 31.6 percent -- $40.7 million due to a 31.4 percent increase in member months and a $3.3 million increase resulting from a marginal increase in premium rates. Net premium rates have increased only slightly, despite the company's targeted renewal rate increases of 7 percent to 18 percent during enrollment periods during 1997, due to HMO competition in the company's HMO service areas, the status of a large group (Missouri Consolidated Health Care Plan) with which the company is currently involved in litigation (see Note 13 entitled "Contingencies - Litigation with MCHCP" of Part II, Item 8), shifts in chosen benefit levels, changes in the geographic mix of the HMO business, and product mix shifts due to various new products. Membership increases were driven primarily by the company's HealthNet Blue POS products as well as the company's efforts to expand geographically within the State of Missouri. HealthNet Blue POS gained 7,300 members, or 49.9 percent, in southeast Missouri from December 31, 1996 to December 31, 1997. As of December 31, 1997, there were approximately 14,900 members enrolled in BlueCHOICE HMO and POS products in the six-county area surrounding Joplin, Missouri, representing an increase of 7,200 members over December 31, 1996. In addition, as of December 31, 1997, there were 11,000 members enrolled in BlueCHOICE HMO and POS products in the southwest Missouri area surrounding Springfield, an increase of 9,300 over December 31, 1996. Partially included in the aforementioned HMO membership increases is an increase in the company's MCHCP membership of 15,500 between December 31, 1996 and December 31, 1997. The company's future enrollment growth or decline in these products and geographic regions is dependent on network attractiveness, continued cooperation with physician hospital organizations, market acceptance of rate increases, and other factors. There can be no assurance that these objectives will be realized. Future enrollment growth in the company's products offered to MCHCP and revenues generated therefrom are also dependent on the litigation with MCHCP and other factors (see Note 13 entitled "Contingencies - Litigation with MCHCP" of Part II, Item 8). In addition, the company has made a decision to discontinue its Medicaid product in the 18-county central Missouri region as of March 31, 1998. This determination was made due to what the company believes were unacceptable terms proposed by the State of Missouri. As of December 31, 1997, the company had approximately 5,100 members enrolled in its Medicaid product.
The overall medical loss ratio increased by 2.2 percent to 84.8 percent in 1997 from 82.6 percent in 1996 primarily as a result of (1) competitive pricing of managed care products, especially in the St. Louis metropolitan market area, (2) higher medical expenses, especially as driven by increased cost and utilization of both outpatient services and drug therapies, (3) growth in regions outside of the metropolitan St. Louis area that have less cost efficient networks, (4) an increase to claims reserves of $3.0 million in 1997 for the estimate of claims that had been incurred but not reported in 1996, and (5) the poor performance of MCHCP that has resulted in large underwriting losses (see Note 13 entitled "Contingencies - Litigation with MCHCP" in Part II, Item 8).
The company's efforts in 1997 to modify its pharmacy benefits management program and recontract with physicians and ancillary service providers have not yielded targeted savings in the anticipated time frame. The drug cost trend (as a percentage) has remained in the low teens, driven by a combination of factors, including introduction of new drug therapies; physicians' use of newer, more expensive drugs; and physicians' decreased use of generic drugs in favor of specific drugs promoted by pharmaceutical companies. Among the medical cost control strategies targeted for 1998 are a combination of changes in the pharmacy program to save costs and increase member satisfaction through: allowing members to make choices, albeit with a higher member copayment; introducing a new three- tiered benefit design; and making other adjustments to copayments, quantity limits and exclusions. Physician education, utilization and prescribing pattern analysis will be increased. The company will also continue its hospital, physician and service recontracting strategy, using the more detailed data and analysis available through the company's information and operations strategy (IOS), which is comprised of projects being implemented to improve business processes and systems. The company also intends to further expand its PGPP program. This program provides incentives to physicians to improve quality, patient satisfaction, and cost savings while providing physician participants with an appealing incentive package. Currently, approximately 36 percent of the BlueCHOICE Commercial panel of 647 primary care physicians in metropolitan St. Louis are enrolled in the program. There can be no assurance that the company's initiatives to control future increases in medical cost trends will be effective.
Commission expense increased by $2.5 million, or 9.3 percent in 1997. The commission expense ratio of 4.1 percent for 1997 remained unchanged from 1996.
General and administrative expenses (excluding depreciation and amortization) increased $11.1 million, or 8.6 percent in 1997 compared to 1996. This increase is primarily due to a $6.7 million increase in HealthLink general and administrative expenses (excluding depreciation and amortization) in 1997, inclusive of a $3.9 million increase in HealthLink HMO expenses. HealthLink's expenses have increased in order to appropriately manage its membership growth as described elsewhere herein. The company's general and administrative expense ratio (excluding depreciation and amortization) improved to 19.5 percent for 1997 compared to 19.7 percent for 1996. Prior to December 31, 1997, the company offered its HealthNet Blue products pursuant to a joint venture agreement with MedAmerica HealthNet, Inc. (MHI), a physician hospital organization. MHI filed for bankruptcy and voted to dissolve the physician hospital organization. Consequently, the pertinent provisions of the provider contracts between MHI and the southeast Missouri doctors, hospitals, and ancillary service providers were selectively assigned to the company in early 1998. The company recorded a $1.7 million charge related to a receivable from MHI that was written off in the fourth quarter of 1997 after MHI declared bankruptcy. Excluding this $1.7 million charge, the company's general and administrative expense ratio for 1997 (excluding depreciation and amortization) was 19.2 percent.
Management previously announced its plans to improve the company's overhead cost structure by streamlining operations, focusing on the core business, reviewing investment priorities, and reducing legal, consulting, and non-essential vendor expenses. The company's achievement of overhead reduction goals was delayed, in part, by higher-than-expected staffing levels and additional resources needed to reduce claims backlog that occurred as the company's claims processing functions relocated to the new customer service centers during the first half of 1997. The staffing resources required to resolve the claims backlog delayed the realization of $1.3 million of anticipated overhead savings during 1997.
Non-recurring relocation charges in 1997 and 1996 include $3.3 million and $4.5 million, respectively, related to costs associated with the relocation of the company's St. Louis-based claims, customer service, billing, and provider services functions to its Springfield, Missouri, facility and a new facility in Cape Girardeau, Missouri.
On August 29, 1997, the company announced that it would create a loss reserve for its contract with the Missouri Consolidated Health Care Plan (MCHCP) in the range of $30 million to $40 million as discussed elsewhere herein. The company reported in the third quarter of 1997 a $29.5 million loss reserve provision relating to the MCHCP contract. See Note 13 entitled "Contingencies - Litigation with MCHCP" of Part II, Item 8.
The operating loss, excluding non-recurring relocation charges and the charge for the MCHCP loss reserve, for the company's underwritten segment was $37.7 million in 1997 compared to a loss of $11.0 million in 1996. The increase in losses in 1997 is primarily attributable to a combination of pricing and medical cost trends, including higher outpatient utilization and drug cost trends.
Excluding non-recurring relocation charges, the company's self- funded segment experienced an operating gain of $9.5 million in 1997 as compared to operating income of $1.9 million for 1996. The improvement in 1997 operating income is partially the result of the continued positive performance of HealthLink, which added an additional $3.5 million to this segment's operating income in 1997 as compared to 1996. HealthLink's operating income is inclusive of $3.1 million and $3.3 million in 1997 and 1996, respectively, for amortization expenses related to goodwill and other intangible assets that were acquired through the HealthLink acquisition.
The company's effective income tax rate was 28.4 percent and (48.2) percent for 1997 and 1996, respectively. The company's effective income tax rate for 1997 was affected by gains from the liquidation of company-owned life insurance policies as well as non-deductible goodwill amortization. The 1996 effective rate was also affected by non-deductible goodwill amortization. Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," requires a valuation allowance against deferred tax assets if, based on the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. The company believes that uncertainty exists with respect to the future realization of the undistributed losses of minority-owned subsidiary companies. Therefore, the company maintained a valuation allowance relating to such items of $0.1 million as of December 31, 1997 and 1996. Based upon all the available evidence, management believes it is more likely than not that the company will realize its remaining deferred tax assets and, accordingly, no valuation allowance has been provided against such remaining assets as of December 31, 1997 and 1996.
HMO premium revenue increased $43.5 million, or 45.4 percent -- $50.5 million due to a 50.3 percent increase in member months partially offset by a $7.0 million decrease due to a 3.3 percent net reduction in premium rates. Net premium rates declined due to HMO competition in the company's HMO service areas. Membership increases are due to the introduction and positive momentum of new products - BlueCHOICE Individual (introduced in November 1994), BlueCHOICE Senior (introduced in April 1995), HealthNet Blue POS (introduced in March 1995), and BlueCHOICE Medicaid (introduced in March 1996). These four products collectively account for approximately 34,900 underwritten members at December 31, 1996, which is an increase of 19,900 over December 31, 1995. In addition, the company's arrangement with Freeman Hospitals and Health System, beginning in July 1995, has enabled the BlueCHOICE HMO and POS products to be offered in the six-county area surrounding Joplin, Missouri. As of December 31, 1996, there were approximately 7,700 members enrolled in products sold through this arrangement with Freeman, representing an increase of 5,200 members over December 31, 1995.
Fees and other income from administrative services only/self- funded and network services increased by $4.9 million in 1996 as compared to 1995. This increase is due to three main factors: (1) a net 1996 increase in HealthLink revenues of $20.3 million, offset by (2) a decrease of $6.7 million in net self-funded PPO revenues, due in part to an 8.4 percent decrease in member months in 1996, and (3) the loss of revenues from the company's third-party administrator (TPA) subsidiaries, which were $9.4 million in 1995. These TPA subsidiaries were combined with another TPA company to form The EPOCH Group, L.C. (Epoch) in December 1995. The company owns 50 percent of Epoch and utilizes the equity method of accounting for this entity.
Commission expense increased by $7.4 million, or 38.1 percent in 1996, which represents an overall increase in the commission ratio to 4.1 percent of total revenue as compared to 3.3 percent of total revenue for 1995. These increases are due to increased membership growth and more aggressive commission schedules to enhance member growth and persistency.
Excluding non-recurring operating charges, the company's self- funded segment experienced an operating loss of $2.5 million in 1995 as compared to operating income of $1.9 million for 1996. The improvement in 1996 operating income is a direct result of the positive impact of HealthLink, which added $9.1 million to this segment's operating income in 1996 as compared to $3.2 million in 1995 subsequent to HealthLink's acquisition in August 1995. In addition, these HealthLink operating figures are inclusive of $3.3 million and $1.4 million in 1996 and 1995, respectively, for amortization expenses related to goodwill and other intangible assets that were acquired through the HealthLink acquisition.
The company's effective income tax rate was (48.2) percent and 30.8 percent for 1996 and 1995, respectively. The 1996 rate was negatively affected primarily by the impact of non-deductible goodwill amortization. The 1995 rate was positively affected by a $2.1 million final tax audit settlement with the Internal Revenue Service relating to pension, software amortization expenses, and other items. Excluding such settlement, the company's 1995 effective income tax rate was 37.1 percent.
Net cash used in operations totaled $10.9 million for the year ended December 31, 1997. The company's net loss was $24.0 million which included (on a before tax basis) $17.3 million of realized gains from the sale of investments, $25.4 million for the MCHCP loss reserve charge (net of associated amortization), and $23.1 million of depreciation and amortization expenses. In addition, accounts payable and accrued expenses were reduced by $13.1 million which, along with other assets, medical claims payable, receivables from members, and net intercompany receivables were affected by the timing of operating cash payments and receipts, as well as changes in membership and utilization and claims payment trends.
In January 1996, the company began converting its computer systems to be year 2000 compliant (e.g. to recognize the difference between 1999 and 2000 as one year instead of negative 99 years). The company's operations would be significantly impacted by incomplete or untimely resolution of the problem as the company utilizes automated systems to process claims, prepare invoices, retain membership data, perform utilization management, and many other processes. The company believes that at December 31, 1997, approximately 25 percent of the company's systems are compliant, with all systems expected to be compliant by March 31, 1999. The total cost of the project is estimated to be between $8 million and $10 million. The company is expensing all costs associated with these system changes. The company expensed $2.1 million and $0.6 million in 1997 and 1996, respectively, for costs associated with this project. The company anticipates expensing approximately $4 million in 1998 and approximately $3 million in 1999 for the remaining testing and implementation costs. The company anticipates funding these expenses through positive future operating cash flows.
The company's performance targets for 1998 include: overall premium revenue growth per member per month in the 9 percent to 10 percent range, reflecting price increases in the high teens to low twenties (in percentages) for some categories of members, consistent with market trends; maintaining the medical loss ratio in the low eighties (in percentages), with an anticipated net medical cost increase per member per month of approximately 5 percent to 7 percent, inclusive of pharmacy benefits, medical services, and the cost of government-mandated benefits; continued reduction in core overhead expenses, with amortization expense for IOS, investments in programming to accommodate the year 2000, and other initiatives contributing to a general and administrative expense ratio in the low twenties (in percentages).
The company's ability to deliver these performance targets is dependent on, among other things, achieving targeted sales to new members and retention rates at higher prices, and realizing projected medical and overhead cost savings.
The Financial Accounting Standards Board (FASB) recently released Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income," SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," and SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. The standard will require all companies to present all non-owner changes in equity, e.g. market value adjustments to investments and adjustments to the minimum pension liability, in a full set of financial statements. The new rules will be effective beginning first quarter of 1998 and companies will only be required to report total comprehensive income for interim periods. SFAS No. 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. The new rules will be effective for the 1998 fiscal year. Abbreviated quarterly disclosure will be required beginning first quarter of 1999, with both 1999 and 1998 information. SFAS No. 132 revises employers' disclosures about pension and other postretirement benefit plans. It does not change the measurement or recognition of those plans. It standardizes the disclosure requirements for pensions and other postretirement benefits to the extent practicable, requires additional information on changes in the benefit obligations and fair values of plan assets that will facilitate financial analysis, and eliminates certain disclosures that are no longer considered useful. The new rules will be effective for the 1998 fiscal year.