We own 32 buildings encompassing approximately 914,000 aggregate square feet of space. Six of the buildings, representing approximately 348,000 aggregate square feet of space, are primarily used for administrative operations and are located in California and Guam. The remaining 26 buildings are medical office buildings leased under a master lease agreement. All 26 medical buildings are being marketed for sale. We also own nine parcels of vacant land for a total of 46 acres, all of which are being marketed for sale.
In February 1997, PacifiCare's board of directors approved a change in our fiscal year end from September 30 to December 31. This resulted in a transition period for October 1, 1996 through December 31, 1996. The following selected financial and operating data are derived from our audited consolidated financial statements, or from our unaudited internal financial data. For clarity of presentation and comparability, the following selected financial and operating data includes the unaudited period for the twelve months ended December 31, 1996. The selected financial and operating data should be read in conjunction with "
OVERVIEW. PacifiCare sells HMO and HMO-related products primarily to members in two groups: the Secure Horizons program for Medicare beneficiaries and the commercial programs for members of employer groups and individuals. Our specialty managed care HMOs and HMO related products and services supplement our commercial programs. These include behavioral health services, life and health insurance, dental and vision services and pharmacy benefit management.
- - In July 1998, FPA, one of our contracted health care providers, declared bankruptcy. As a result, we terminated all of our FPA contracts. Significant provider insolvency reserves were recognized in 1998.
- - In December 1998, we recognized net pretax credits related to preliminary favorable settlements of OPM claims.
- - In 1998, with the sale of our Utah HMO, we exited the Medicaid line of business.
The information below includes both the Medicare and Medicaid line of business as part of the government program for the 1998 and prior periods presented.
Commercial premiums increased three percent or $95 million over the prior year. The net increase was due to:
- - Increases of $231 million from the inclusion of six additional weeks of results in 1998 from the FHP acquisition;
- - Decreases of $224 million from net membership losses caused by our disposition of Utah and by our premium rate increases primarily in California, Oklahoma and Ohio; and
- - Decreases of $42 million, primarily from discontinued indemnity and workers' compensation products.
Provider insolvency reserves include the write-offs of the providers' uncollectable receivables and estimated cost of unpaid health care claims covered by our capitation payment. Depending on state law, we may be held liable for unpaid health care claims, which were the responsibility of the capitated provider.
FPA declared bankruptcy in July 1998. FPA served approximately 200,000 PacifiCare members in Arizona, California, Nevada and Texas. Reserves for the FPA bankruptcy totaled $57 million, with $41 million attributable to our Nevada HMO. Nevada law specifically requires that we pay all health care services claims for our members including those previously covered by capitation payments. The second quarter FPA insolvency reserves were partially offset by unrelated favorable provider settlements. We periodically make changes in estimates as prior year contract issues are resolved. Increases to FPA reserves were made in the third and fourth quarters as additional claims information was presented for payment. The remaining FPA reserves of $16 million primarily relate to non-contracted claims and receivable write-offs in the remaining HMOs. Unpaid FPA reserves at December 31, 1998 were approximately $20 million.
GOVERNMENT MEDICAL CARE RATIO. The government medical care ratio for the year ended December 31, 1998 increased 0.9 percent compared to the prior year because we recognized $62 million of provider insolvency
reserves. Government insolvency reserves for FPA were $40 million, with the majority of these charges recognized in the second and third quarters. Other provider insolvency reserves of $22 million were recorded, primarily in the fourth quarter. Higher costs incurred for FPA membership shifted into new provider relationships were offset by the disposition of Utah. Excluding government provider insolvency reserves, the government medical care ratio was 85.4 percent.
COMMERCIAL MEDICAL CARE RATIO. The commercial medical care ratio includes the specialty HMOs and indemnity insurance results. The commercial medical care ratio for the year ended December 31, 1998 decreased due to the following:
- - Sale of our Utah HMO and workers' compensation subsidiaries; offset by
- - Nondeductible goodwill amortization was a smaller percentage of taxable income.
OVERVIEW. In 1997, we began reporting on calendar year end. We previously reported a fiscal year ending September 30. This resulted in an audited transition period from October 1, 1996 to December 31, 1996. For clarity of presentation and comparability, the discussion of results of operations compares the year ended December 31, 1997 to the unaudited twelve months ended December 31, 1996, which is referred to as the prior year.
On February 14, 1997, we finalized the FHP acquisition for a total purchase price, including transaction costs, of $2.2 billion. The FHP acquisition was accounted for as a purchase. Our consolidated results of operations include the results of FHP from the date of the FHP acquisition. See Note 4 of the Notes to Consolidated Financial Statements.
PREMIUM REVENUE. During 1997, total premium revenue increased 88 percent from the prior year, a direct result of the FHP acquisition. Six percent of the increase in premiums resulted from enrollment gains (net of the FHP acquisition) in both government and commercial programs. The remainder of the premium increase was mainly attributable to the government programs, along with our specialty managed care products and services.
Government premiums in 1997 increased 85 percent compared to the prior year. Approximately 81 percent of the total increase was due to the FHP acquisition. The balance of the net increase was due to the following:
- - Increased government per member premium rates due to our exit of Medicaid lines of business in certain markets that had lower average per member premiums;
- - Enrollment gains in the commercial programs, net of acquisition membership, accounted for seven percent, while premium rates remained relatively flat; offset by
PROVISION FOR INCOME TAXES. The majority of the pretax charges were not deductible for income tax purposes. Therefore, we did not record an income tax benefit for most of these charges. The magnitude of these charges, combined with the inability to record a related income tax benefit, resulted in a disproportionately high effective income tax rate. The effective income tax rate, without the effect of the pretax charges, was approximately 50 percent, an increase over the prior year. This increase reflected the additional goodwill amortization expense attributed to the FHP acquisition.
DILUTED EARNINGS PER SHARE. For the year ended December 31, 1997, income excluding the pretax charges described above was $107 million or $2.43 diluted earnings per share. For the year ended December 31, 1996, income excluding pretax charges was $138 million or $4.36 diluted earnings per share. The decrease over the prior year was due to increases in the following:
- - Increases of $224 million in net income; offset by
- - Decreases of $138 million in impairment, disposition, restructuring and other charges; and
FINANCING ACTIVITIES IN 1998. Financing activities used $393 million of cash in 1998, primarily because we paid $391 million on our credit facility and other notes during the year. We also borrowed $30 million under the credit facility to repurchase shares of our outstanding common stock. As of December 31, 1998, we had repurchased 784,000 shares of our Class A and Class B common stock for $45 million. Cash received for the issuance of common and treasury stock was $19 million and was partially offset by $6 million of preferred stock dividends and cash paid on redemption of preferred stock.
RECEIVABLES, NET. Receivables, net decreased by $30 million from 1997 as follows:
- - $31 million increase in provider and pharmacy rebate receivables; offset by
- - $19 million decrease for subsidiary dispositions and discontinued indemnity products; and
- - $9 million decrease in other receivables, including the timing of net investment income receivable.
- - $76 million of goodwill and intangible amortization expense; and
- - $92 million decrease in claims payable, both our risk and claims administered on behalf of providers; and
- - $50 million decrease for dispositions, including Utah's loss contract reserves, and discontinued indemnity products.
Claims payable decreased as our claims inventory fell by 47 percent from the December 1997 level.
INCOME TAXES. Income taxes changed from a receivable in the prior year to a payable in 1998. The change was attributable to the income tax provision on the 1998 income, partially offset by the estimated income tax payments made during the year.
OTHER LIABILITIES. Other liabilities decreased by $47 million from 1997. The decrease was primarily attributable to the disposition of our workers' compensation subsidiary.
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward looking statements. The Act was designed to encourage companies to provide prospective information about themselves without fear of litigation. The prospective information must be identified as forward looking and must be accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those projected in the statements. The statements about our plans, strategies, intentions, expectations and prospects contained throughout the document are based on current expectations. These statements are forward looking and actual results may differ materially from those predicted as of the date of this report in the forward looking statements, which involve risks and uncertainties. In addition, past financial performance is not necessarily a reliable indicator of future performance and investors should not use historical performance to anticipate results or future period trends. Stockholders are also directed to the other risks discussed in other documents filed by PacifiCare with the Securities and Exchange Commission.
We expect commercial membership for the year ended December 31, 1999 to increase four to five percent compared to 1998. The majority of the growth will be in California where we plan to:
- - Increase the efficiency and effectiveness of our distribution channels; and
MEMBERSHIP RISK FACTORS. An unforeseen loss of profitable membership could have an effect on our financial position, results of operations and cash flows. Factors that could contribute to the loss of membership include:
- - Failure to obtain new customers or retain existing customers;
PREMIUMS. Effective January 1, 1999, we received Medicare premium rate increases of two percent. We expect to continue to improve our gross margin by renewing commercial employer contracts with price increases. The price increases in our commercial product line are expected to range from zero to 12 percent depending upon competition, employer size, benefit design, geographic market and other factors. We plan to exit markets where our premium revenue does not cover the cost of providing care. While we expect to increase commercial premiums without experiencing significant membership losses, we may have to alter our pricing strategy to avoid such losses. Reduction in Medicare premiums, such as the proposed risk adjusted payment program, could have an effect on our financial position as every one percent change in premium represents approximately $56 million dollars of annual revenue. To counteract this impact, we would need to generate additional revenue or cost savings of approximately $56 per person per year. We could achieve this by increasing member premiums, office copayments, hospital deductibles or prescription copayments.
OTHER INCOME. In 1999, we expect other income to be lower than 1998 because of lower SHUSA revenues. In addition, 1999 rental income is expected to be less than 1998 because several medical clinics were sold in the last half of 1998.
HEALTH CARE PROVIDER CONTRACTS. Our profitability depends, in part, on our ability to control health care costs while providing quality care. Maintaining capitated arrangements with solvent providers, especially in the Nevada market, will be important to improve 1999 results of operations. Securing cost-effective contracts with existing and new physician groups has become more difficult due to increased competition. Failure to secure cost-effective contracts may result in a loss in membership or a higher medical care ratio. Additionally, the negotiation of provider contracts, generally as of January 1, may be impacted by unfavorable state and federal legislation and regulation discussed below. Our inability to contract with providers, loss of contracts with providers, inability of providers to provide adequate care, or insolvency of providers could materially affect us. Based on current information, we believe that our contingency plans are adequate to cover the potential impact of contract terminations.
We continue to evaluate the financial stability of our providers, focusing on providers with significant membership in key geographic areas and providers that have been identified as a poor risk. We are also seeking to improve our performance in 1999 by taking steps to minimize our risk associated with providers. We
COMMERCIAL MEDICAL CARE RATIO. In 1999, we expect the commercial medical care ratio to be consistent with, or improve slightly from 1998. We expect improvements as we continue to renegotiate provider contracts and implement capitated contracts and price increases. Moreover, higher premium rates offered during renewal periods should continue to result in the elimination of some high medical care ratio business. We also plan to exit markets where price increases do not cover the cost of health care.
MEDICAL CARE RISK FACTORS. The government and commercial medical care ratio expectations discussed above could be affected by various uncertainties, including:
- - Medical and prescription drug costs that have been rising faster than premium increases;
- - Termination of provider contracts, provider insolvency or renegotiation of such contracts at less cost-effective rates or terms of payment.
1999 DISPOSITIONS. Dispositions could be announced as we continue to evaluate whether certain subsidiaries or products fit within our core business strategy. There can be no assurance that the dispositions will not result in additional pretax charges. We believe, however, that any disposition operating losses would not materially affect our consolidated financial position. However, the disposition losses could have a material effect on the results of operations or cash flows of a future period.
EFFECTIVE TAX RATE. We expect the 1999 effective tax rate to decrease three to five percent from 1998. Consistent with our integration strategies, we will complete a legal reorganization of the Company and its subsidiaries. The full year benefit of certain tax strategies is expected to be realized in 1999. The tax strategies are expected to reduce the effective tax rate by one to three percent. The 1998 effective tax rate includes more
than one percent related to the dispositions of Utah and the workers' compensation subsidiary that is not expected to recur. Finally, the impact of nondeductible goodwill on the effective tax rate is expected to decrease by approximately one percent because 1999 pretax income is projected to increase from 1998. There can be no assurance that these tax strategies will be successful or that pre-tax income will increase as projected, for various reasons set forth in this document and other documents we have filed with the Securities and Exchange Commission. As a result, there can be no assurance our tax rate will decrease in 1999.
The Year 2000 Compliance Program includes the following five phases which are listed in logical order, but are being addressed concurrently as appropriate:
- - Inventory and Assessment. A company-wide inventory has been taken of all computer information systems and their components, including infrastructure equipment and hardware, software applications and information supply chains. Through the inventory, we are assessing the business risks and Year 2000 compliance status of each system component. For components which are not Year 2000 compliant, a remediation plan is being developed which includes the Year 2000 remediation action required and the time and resources needed to accomplish it. Priorities are also established based on the relative business critical function of each system component.
- - Testing and Certification. Following the completion of the remediation phase, each computer information system and its components are tested. Actual test results are reviewed and compared to expected test results based on accepted industry standards and methodologies. If the actual test results are acceptable, the system and/or component are certified as Year 2000 compliant. Testing and certification for the PacifiCare core computer system are 90 percent complete. We expect all other systems (except the FHP core system) to be tested and certified as Year 2000 compliant by June 30, 1999. Testing and certification of the FHP core computer systems will occur during 1999 and are expected to be completed in December 1999.
- - Implementation and Close. There will be a final review and confirmation that the remediated systems and components have met all Year 2000 compliance objectives.
If HCFA or certain other third parties experience significant failures or erroneous applications, it could have a material effect on our financial position, results of operations, cash flows, and business prospects. For example, if HCFA, OPM, or our commercial customers experience system failures, this could cause a delay in our receipt of payments from these customers, including a significant HCFA payment due in January 2000. Therefore, we are developing a cash receipts contingency plan.
We also could have difficulties processing Medicare and other claims within required periods, collecting accurate claims and other data on which we depend, or enrolling new members. In preparing contingency plans, we are developing risk reduction strategies. However, some risks may be beyond our control. Further, our marketing, general and administrative expenses could increase due to Year 2000 compliance expenditures.
OPM. OPM generally audits health plans which it contracts with every five or six years. We currently have several audits with OPM that are in various stages. We intend to negotiate with OPM and DOJ on all unresolved matters to attain a mutually satisfactory result. We cannot assure that the negotiations will conclude satisfactorily, or that there will not be additional liability upon completion of the audits. However, we believe that any ultimate liability in excess of amounts already set aside would not materially affect our consolidated financial position. The liability, if material, could have an effect on results of operations or cash flows of a future quarter. See Note 10 of the Notes to Consolidated Financial Statements.
cash flows from operations, existing cash equivalents, marketable securities and other financing sources will be sufficient to meet the requirements of the credit facility.
LEGISLATION AND REGULATION. Federal and state legislation and regulation significantly affect us. During 1998 our government programs, the majority of which are Medicare business, contribute 59 percent of our revenue and an even greater percentage of our profits. Changes in state and federal legislation or regulation could cause actual results to differ materially from the expected results discussed throughout this document. Changes that could effect us materially include:
- - Benefit mandates (including mandatory length of stay and emergency room coverage, many of which become effective in 1999);
- - Adoption on the federal and/or state level of a "Patients Bill of Rights."
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.
OTHER. Results may differ materially from those projected, forecast, 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.
See the Index included at "Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K."