Medical expenses consist of the hospital charges, physician fees and related health care costs for its members. Medical expenses also include estimates of medical expenses incurred but not yet reported ("IBNR") to the Company, based on a number of factors, including hospital admission data and prior claims experience; adjustments, if necessary, are made to medical expenses in the period the actual claims costs are ultimately determined. The Company believe the IBNR estimates in the Consolidated Financial Statements are adequate; however, there can be no assurance that actual health care claims costs will not exceed such estimates.
Revenue: Premiums earned 97.5% 94.5% 98.2% Interest and other income 2.5 5.5 1.8
Expenses: Hospital services 23.1 20.0 19.2 Physician services 59.5 51.1 53.6 Other medical services 1.7 4.5 7.5
Total medical expenses 84.3 75.6 80.3 General and administrative 24.4 19.8 12.7 Depreciation and amortization 2.0 1.5 1.3 Interest and other expenses 1.6 1.3 0.9
(2) General and administrative expenses as a percentage of total revenue.
Premiums earned in 1996 increased 8.7%, or $12.7 million, to $157.2 million from $144.5 million in 1995. This increase was attributable to premiums generated from WCNY's Medicare Risk contract, a new product line started in October 1, 1995, of $12.0 million; a net increase in Medicaid premiums of $6.0 million (principally due to an increase in member months); offset by a $5.3 million reduction in commercial premiums reflecting reduced membership. The decline in commercial membership is substantially attributable to WellCare's more stringent application of its credit standards, pursuant to which contracts for non-paying or slow-paying groups were canceled or not renewed, as well as to customers' adverse reaction to the negative publicity received by the Company related to the restatement of its 1994 financial results. Although Medicaid members months increased, there was a decrease in actual Medicaid membership at December 31, 1996 from December 31, 1995. The decline in Medicaid membership is attributable to the ban on direct enrollment of Medicaid eligibles by any managed care plans from August 1, 1995 through August 1, 1996 in New York City, thereby not offsetting normal Medicaid disenrollments or permitting growth in enrollment during that period, as well as a statewide decrease in the number of individuals eligible for Medicaid which has caused a decrease in the total number of Medicaid eligibles in all managed care organizations. Total member months increased 3% in 1996 to 1,077,774.
In the absence of the aforementioned changes, medical expenses would have been $129.4 million and the medical loss ratio would have been 82.3%.
General and administrative ("G&A") expenses increased 29.9%, or $9.1 million, to $39.3 million in 1996, and increased as a percentage of total revenue from 19.8% in 1995 to 24.4% in 1996. The increase in G&A expenses resulted primarily from increased salaries and benefits of approximately $2.5 million for severance payments, addition of senior management at higher annual compensation levels, and service and product line expansion, an increase of approximately $2.4 million in reserves established for trade accounts receivables and notes and other receivables (including valuation reserves relating to obligations of the buyer of the assets of WellCare Medical Management, Inc. (See Note 4 of "Notes to Consolidated Financial Statements")), an increase of approximately $2.3 million in unusual legal costs and other professional and outside services specifically relating to the class action litigation, and an increase of $1.5 million related to marketing and consulting costs.
On January 19, 1996, the Company completed a private placement of a subordinated convertible note in the principal amount of $20,000,000 (the "Note") due December 31, 2002, with The 1818 Fund II, L.P., a private equity fund managed by Brown Brothers Harriman & Co. The Company had utilized a part of the net proceeds of this private placement to retire a portion of its debt. The Note, which was amended on February 28, 1997, is convertible into shares of WellCare Common Stock. Prior to the amendment, the Note accrued interest at 6.0% per annum, and currently, the Note accrues interest at 5.5% per annum. The conversion price is equal to 115% of the average of the market price of WellCare Common Stock during the period from August 4, 1996 through February 28, 1997, subject to adjustment for certain dilutive events with a floor of $9 per share and a ceiling of $15 per share. Mr. Walter W. Grist, a Senior Manager of Brown Brothers Harriman & Co. has been added to The WellCare Management Group, Inc. Board of Directors (See Note 11 of "Notes to Consolidated Financial Statements" and See "Certain Relationships and Related Transactions").
Net cash used by operating activities was approximately $4.1 million in 1996 compared to $9.3 million in 1995. The use of cash in 1996 is principally to fund the cash operating loss of $10.3 million, reduced by the cash provided from the $3.5 million increase in medical costs and accounts payable, and the $5.2 million decrease in accounts receivable less the $5 million increase in taxes receivable. The decrease in accounts receivable is the result of WellCare's focus on collecting premiums timely. Medical costs payable increased principally because the Company reassumed in 1996 the responsibility of certain medical services previously contracted to the Alliances (See Notes 1a and 17a of "Notes to Consolidated Financial Statements"). The increase in tax receivables reflects the income tax refund which will result from carrying back the current year's tax operating loss against prior years' income. Cash used for capital expenditures in 1996 was approximately $.5 million used primarily for expanding and upgrading the Company's information systems.
On January 31, 1997, the Company executed a renegotiated $6.0 million line-of-credit with Key Bank of New York. The line expires on May 31, 1998. The Company repaid the outstanding amount ($3.1 million) on the previous line-of-credit in December 1996. At December 31, 1996, the Company was in technical default of certain financial covenants. Key Bank has granted the Company a waiver of these financial covenants for the period ended December 31, 1996 and as of that date, there were no borrowings outstanding on the line-of-credit (See Note 10 of "Notes to Consolidated Financial Statements").
Between April 1, 1996 and June 6, 1996, the Company, its Vice President of Finance and Chief Financial Officer and the Company's former President and Chief Executive Officer, were named as defendants in twelve separate actions filed in Federal Court (the "Securities Litigations"). An additional three directors were also named in one of these actions. Plaintiffs sought to recover damages allegedly caused by the Company's defendants' violations of federal securities laws with regard to the preparation and dissemination to the investing public of false and misleading information concerning the Company's financial condition.
On July 3, 1996, the Securities Litigations were consolidated in the United States District Court for the Northern District of New York, and an amended consolidated complaint was served on August 21, 1996, which complaint did not name the three additional directors. The Company's auditor, however, was named as an additional defendant. On October 23, 1996, the Company filed a motion to dismiss the consolidated amended complaint against the Company as well as the individual defendants. The Company's auditor has likewise filed its own motion to dismiss. Prior to the filing of the motion, discovery had not yet begun and pursuant to the Private Securities Litigation Reform Act, all discovery is necessarily stayed pending the disposition of the motion. Although management is unable to predict the likelihood of success on the merits of the consolidated class action, it has instructed its counsel to vigorously defend its interests. The Company has insurance in effect which may, at least in part, offset any costs to be incurred in these litigations. A decision on the motion to dismiss is expected sometime during 1997.
In June 1995, the Company contributed approximately $5.1 million to its then wholly-owned subsidiary, WellCare Medical Management, Inc. ("WCMM") which was engaged in managing physician practices, and then sold the assets of WCMM for cash of $.6 million and a note receivable of $5.1 million. The Buyer was newly formed to acquire WCMM and, as of March 1, 1997, approximately 11% of the Buyer's equity was directly or indirectly held by current or former directors, officers or employees of WellCare. The Buyer is in the business of managing medical practices and providing related consultative services. The Buyer has entered into agreements to manage the Alliances (See Notes 1a and 17a of "Notes to Consolidated Financial Statements"). The Company also had received a five-year option to acquire the buyer (the "Buyer") at any time on a formula price based on the Buyer's results of operations. This option was canceled in 1996. A gain of approximately $144,000 was not recognized in 1995, pending the repayment of the note. The note receivable bears interest at a rate equal to prime plus 2% (10.25% at December 31, 1996) with interest payable monthly through July 31, 1996 and, thereafter, principal and interest monthly through July 31, 2000. The Buyer is in default on the note and has not paid accrued interest of $.5 million at December 31, 1996.
Subsequently, the Company advanced $2.8 million to the Buyer ($2.1 million in 1996 and $.7 million in 1995) for operating expenses, which obligation is documented at December 31, 1996, by a note of $215,000, receivables of $2.1 million and interest receivable of $.5 million. The note for $215,000 bears interest at a rate equal to prime plus 2% (10.25% at December 31, 1996) and matured December 31, 1996. No payments have been made against this note.