As of December 31, 2000, we leased approximately 178,000 aggregate square feet of space for its principal corporate headquarters and executive offices in Costa Mesa and Santa Ana, California. In connection with our operations, as of December 31, 2000, we leased approximately 1.9 million aggregate square feet for office space, subsidiary operations, customer service centers and space for computer facilities. Such space corresponds to areas in which our HMOs or specialty managed care products and services operate, or where we have satellite administrative offices. Our leases expire at various dates from 2001 through 2010.
In February 1997, our 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 “
In December 2000, we limited the enrollment of new members in our Medicare+Choice health plan, Secure Horizons, through a combination of capacity waivers and voluntary closure notices. This plan affected a total of 42 counties in California, Colorado, Oregon, Texas and Washington. Voluntary closures, did not affect current or recently enrolled members in these counties, nor did they affect newly eligible Medicare beneficiaries (those turning 65 or becoming disabled). Retiree enrollment with January 1, 2001 effective dates were accepted, except for those areas affected by the capacity waivers in the Houston, Texas and Washington State areas.
In June 2000, we submitted our 2001 proposed Medicare benefit plan changes to HCFA for approval. These changes include exiting (or partially exiting) Medicare operations in a total of 15 counties in Arizona, Colorado, Ohio, Texas and Washington. This proposal will affect approximately 20,500 Medicare members.
On February 1, 2000, we completed our acquisition of Harris Methodist Texas Health Plan, Inc. and Harris Methodist Health Insurance Company Inc. (together, “Harris”), a health plan and insurance company in Texas with approximately 250,000 commercial and 50,000 Medicare members. See Note 4 of the Notes to Consolidated Financial Statements.
Membership. Total HMO membership increased 10 percent to approximately 4.0 million members at December 31, 2000 from approximately 3.7 million members at December 31, 1999. Our total HMO membership excludes employer self-funded members and PPO and indemnity members.
Commercial HMO membership increased approximately 12 percent at December 31, 2000 compared to the prior year due to:
Growth in California primarily from marketing efforts to retain membership and renew major employer accounts.
Membership decreases primarily in California due to disenrollment resulting from reduced benefits, increased copayments and instituted or increased member-paid supplemental premiums in some counties; and
Net Investment Income. Net investment income increased approximately 29 percent for the year ended December 31, 2000 compared to the prior year due to:
Higher short-term interest rates combined with a higher interest fee structure in the credit facility agreement.
Significant Fourth Quarter Items. During the fourth quarter of 2000, our claims incurred but not reported increased by $21 million for periods prior to September 30, 2000, primarily due to increased utilization and cost of claims under risk-based hospital arrangements. This increase was partially offset by $15 million of reductions in related ancillary reserves, such as reserves for claims backlog and vision and mental health claims. Additionally, during the fourth quarter of 2000, our marketing, general and administrative expenses decreased by $11 million, related to incentive compensation and other accruals.
Commercial HMO membership increased approximately three percent at December 31, 1999 compared to membership at December 31, 1998 due to:
Membership increases in California primarily due to improved sales efforts, and in Colorado as a result of the acquisition of ANTERO Health Plans; partially offset by
Competitor exits in markets where Secure Horizons will remain, primarily Arizona, Colorado, Nevada and Washington; and
The positive results of retention programs initiated during 1998 in California.
Premium rate increases that averaged approximately three percent for the year ended December 31, 1999
Net membership increases (excluding Utah), primarily due to competitors’ exits in markets where Secure Horizons will remain
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, 1999 decreased compared to the prior year due to the following:
The sale of our Utah HMO and workers’ compensation subsidiaries; partially offset by
The shift of more portfolio holdings to tax-exempt investments that have lower interest rates.
Operating Cash Flows. Our consolidated cash, equivalents and marketable securities increased to $2.1 billion at December 31, 2000 from $1.8 billion at December 31, 1999. The combined increase in cash, equivalents and marketable securities occurred primarily due to the trend away from capitated contracts to risk-based and fee-for-service agreements. This shift resulted in the delay of medical expense payments, causing cash levels to build. Cash flows from operations, excluding the impact of deferred revenue, increased $91 million to $605 million at December 31, 2000. The increase is primarily related to changes in assets and liabilities as discussed below in “Other Balance Sheet Change Explanations.”
We received $8 million in 2000 from minority stockholders of a subsidiary; and
We received $2 million in proceeds from issuing common shares in 2000 compared to $23 million in 1999.
$4 million net increase in provider receivables as a result of our higher proportion of risk-based hospital contracts.
$14 million increase primarily attributable to membership acquisition and assumptions in Colorado and Washington; partially offset by
$329 million increase in claims incurred but not reported attributable to increases in the number of risk-based hospital arrangements. Under capitation arrangements, physicians and hospitals are prepaid based on a fixed-fee per-member per-month amount, regardless of the services provided to each member. Under risk-based arrangements, claims are payable once incurred. The increase in risk-based arrangements results in an increase in payables for claims incurred, but not yet paid as well as an increase in the estimate of claims incurred but not yet reported to us;
$104 million increase attributable to the Harris acquisition, including $28 million in loss contract reserves to be amortized through the fourth quarter of 2001;
$26 million increase in physician and hospital capitation liabilities primarily due to the timing of capitation for members shifting to new physicians; and
$17 million increase in incentive and other physician and hospital liabilities.
Accrued Liabilities. Accrued liabilities increased $32 million from December 31, 1999 primarily due to the timing of payment of the current year income tax provision and increased accrued interest for amounts borrowed under our credit facility.
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 or cash flows. Factors that could contribute to the loss of membership or lower premiums include:
Our limits on enrollment of new Secure Horizons members in selected markets, through a combination of capacity waivers and voluntary notices;
we anticipated when we designed our 2000 programs. Hospital utilization by our members and cost of claims under risk-based hospital arrangements also significantly exceeded our expectations. We also expect that the changes to our benefits programs and increased premiums for our Secure Horizons members in 2001 will not offset our rising health care costs in some markets.
Insolvency Risk. Under capitated arrangements, we face the risk of a physician group or a physician association becoming insolvent. Depending on state law, we may be held liable for unpaid health care claims that were previously the responsibility of the capitated physician and for which we have already paid capitation. To reduce this insolvency risk, we have developed contingency plans that include shifting members to other physicians and reviewing operational and financial plans to monitor and maximize financial and network stability. Some of our physicians require more frequent monitoring. We may incur additional health care costs in the event of physician instability where we are unable to reach an agreement that is mutually beneficial. These costs may be incurred when we need to contract with other physicians at less than cost-effective rates to continue providing health care to our members. We believe that our December 31, 2000 insolvency reserves, intended to pay for December 31, 2000 and prior health care services that may not be paid by insolvent or unstable physicians, are adequate.
Underwriting Risk. We are enhancing our underwriting systems so that we can better price our commercial products and make market exit decisions for our Medicare markets. The development and implementation of these systems will take time and the investment of substantial resources, including the hiring of additional personnel with the requisite experience and skills. If we are not able to develop and implement these systems in a timely and cost effective manner, our results of operations and cash flows of a future period may be materially and adversely affected.
Pharmacy. Our prescription drug costs have been rising for the past few years. The increases are due to the introduction of new drugs costing significantly more than existing drugs, direct consumer advertising by the pharmaceutical industry creating consumer demand for particular brand drugs, patients seeking medications to address lifestyle changes, higher prescribed doses of medications and enhanced pharmacy benefits for members such as reduced copayments and higher benefit maximums. Our efforts to mitigate these trends and ensure appropriate utilization include formulary management, physician education, successful pharmaceutical contracting and increased utilization of our in-house mail-service pharmacy operated by Prescription Solutions.
Medical Care Ratio Risk Factors. An increase in our consolidated medical care ratio could have an adverse effect on our profitability. Uncertainties that could have a negative impact on our medical care ratio include:
Our inability to successfully implement our new medical management initiatives, including hospital utilization and disease management initiatives;
Existing and proposed legislation that would limit our ability to manage care and utilization such as “any willing provider” and “direct access” laws;
New state and proposed federal laws mandating benefits including those that mandate equal coverage for mental health benefits, commonly called mental health parity;
Proposed legislation to add a prescription drug benefit, provide payment relief for the Medicare+Choice program and regulate drug pricing by the state and federal government could include provisions that impact Secure Horizons;
The success or lack of success of our marketing and sales plans to attract new customers;
Our need for additional investments in medical management, claims processing, underwriting and actuarial resources and technology;
Future Dispositions, Impairments and Restructurings. While we previously announced our decision to withdraw all operations in Ohio and commercial HMO and POS products from certain counties in Colorado, we may announce in the future other dispositions of assets or product exits as we continue to evaluate whether our subsidiaries or products fit within our strategy. In accordance with SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” using the undiscounted cash flow method, we review long-lived assets for impairment when events or changes in business conditions indicate that we may be unable to recover such assets’ full carrying value. Our subsidiaries with operating losses will require more frequent monitoring. If one or more of these subsidiaries generates less operating cash flows than we currently expect, an impairment charge could be necessary. In addition, as we refocus and retool our workforce to shift from a capitated to a risk-based business model, we expect some positions to change or be eliminated, which could result in future restructuring charges. We cannot be certain that the dispositions, impairments or restructuring charges will not result in additional pretax charges. We believe that any disposition, impairment or restructuring charges would not materially affect our current consolidated financial position. However, the disposition, impairment or restructuring charges could have a material effect on the results of operations or cash flows of a future period.
Adjusted Community Rate Filings. In addition to the regular ACR proposals submitted in June 2000, we were required to re-submit ACR proposals in January 2001 in accordance with BIPA. In our ACR resubmission, BIPA required that we use increased funding to do one or a combination of the following: to reduce member premiums or cost sharing; to enhance benefits; to contribute to a benefits stabilization fund; or to stabilize or enhance beneficiary access to physicians and hospitals (so long as such action does not result in increased beneficiary premiums, cost-sharing, or reduced benefits). Our January 2001 ACR submission has been filed in accordance with BIPA and accompanying ACR instructions, and has been accepted by HCFA.
Risk-Based Capital Requirements. The National Association of Insurance Commissioners has proposed that states adopt risk-based capital standards that, if implemented, would require increased minimum capitalization limits for health care coverage provided by HMOs and other risk-bearing health care entities. Risk-based capital requirements currently apply for Arizona, Colorado, Indiana, Nevada, Texas and Washington. We do not expect California to adopt risk-based capital in 2001. We do not expect this legislation to have a material impact on our consolidated financial position.
Liquidity and Capital Resources. The final maturity date on our credit facility is January 1, 2002. Our ability to refinance this credit facility depends on our credit rating, results of operations and cash flows from operations. Our ability to repay amounts owed under the credit facility depends on dividends and cash transfers from our subsidiaries. Nearly all of the subsidiaries are subject to HMO regulations or insurance regulations and may be subject to substantial supervision by one or more HMO or insurance regulators. Subsidiaries subject to regulation must meet or exceed various capital standards imposed by HMO or insurance regulations, which may from time to time impact the amount of funds the subsidiaries can pay to us. Our subsidiaries are not obligated to make funds available to us and creditors of our subsidiaries have superior claim to our subsidiaries’ assets. Additionally, from time to time, we advance funds in the form of a loan or capital contribution to our subsidiaries to assist them in satisfying federal or state financial requirements. We may provide additional funding to a subsidiary if a federal or state legislator imposes additional financial requirements due to concerns about the financial position of the subsidiary or if there is an adverse effect resulting from changes to the risk-based capital requirements. This may in turn affect the subsidiary’s ability to pay dividends or make other cash transfers. We will pursue several options to maintain liquidity and refinance our current credit facility. Options include issuing long-term debt and restructuring the existing line of credit.
Other. Results may also 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.
Expectations. We believe the fourth quarter of 2000 most accurately depicts the environment we face as we enter 2001. As a result, 2001 expectations represent a transition year for us. Our expectations highlight the positive effects of current action plans, and are based on annual operations. We expect the individual quarters to fluctuate based on the seasonality of our business.
Premiums. We expect an increase in commercial premium revenue of approximately three percent in 2001. We expect commercial HMO premium rate increases to be about 13 percent in 2001. We expect HCFA premium rate increases, combined with supplemental member premiums, to be about six percent in 2001.
Marketing, General and Administrative Expenses. For the year ending December 31, 2001, we expect our marketing, general and administrative expense ratio to be comparable to the 10.5 percent reported for the year ending December 31, 2000. Additional efficiencies are planned for 2001 but will be partially offset by continued investments in legislative compliance (HIPAA), and investments in underwriting, medical management and claims processing.
Diluted Earnings Per Share. We expect 2001 diluted earnings per share to be approximately $2.94, compared to 2000 diluted earnings per share of $4.73, excluding credits and charges.
Effective Tax Rate. We expect our effective tax rate for 2001 to be approximately 47.5 percent. The increase over the prior-year rate of 44.1 percent is primarily due to nondeductible goodwill increasing as a percentage of pretax income.