Corporate Headquarters St. Louis, MO 343,017 Leased Document Storage Warehouse St. Louis, MO 73,702 Leased HealthLink, Inc. Headquarters St. Louis, MO 61,829 Leased Southwest Regional Office Springfield, MO 30,000 Owned Southeast Claims Training Cape Girardeau, MO 3,230 Leased Southeast Claims Office Cape Girardeau, MO 42,000 Leased Central Marketing Office Columbia, MO 5,000 Leased
The following discussion should be read in conjunction with the accompanying Consolidated Financial Statements and Notes thereto and the information set forth under the captions "Safe Harbor Statement" and "Factors that May Affect Future Results of Operations, Financial Condition or Business" of Part I, Item I, Business, of this Annual Report, and under the caption in Note 13 entitled, "Contingencies" of Part II, Item 8, Financial Statements and Supplementary Data, of this Annual Report.
For the year ended December 31, Product Group 1998 1997 1996 PPO: Alliance PPO $191,855 $197,329 $234,720 AllianceChoice POS 151,034 124,890 75,700 HMO (includes other POS) 206,292 183,485 139,457 Medicare supplement 94,951 97,157 98,038 Managed indemnity 7,627 12,531 16,425 Other specialty services 42,728 38,875 30,709 Total premium revenue 694,487 654,267 595,049 ASO/Self-funded and other income 73,025 65,144 58,326 Total revenues $767,512 $719,411 $653,375
For the year ended December 31, 1998 1997 1996 Operating revenues: Premium revenue 90.5% 90.9% 91.1% Fees and other income 9.5% 9.1% 8.9% 100.0% 100.0% 100.0% Operating ratios: Medical loss ratio 83.5% 84.8% 82.6% Commission expense ratio 4.1% 4.1% 4.1% General and administrative expense ratio 20.8% 22.7% 22.0% Adjusted general and administrative expense ratio (excludes depreciation and amortization) 18.3% 19.5% 19.7%
* does not include 455,006 and 497,538 additional third-party administrator members as of December 31, 1998, and 1997, 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.
Premium revenue increased $40.2 million to $694.5 million in 1998 from $654.3 million in 1997. As described below, components of premium revenue were affected by shifts in product mix, rate increases and other factors; and as a result, such changes may not be indicative of future periods. The company will continue to strive to establish its commercial premium rates based on anticipated health care costs. Depending on the level of future competition, customer acceptance of the company's premium increases, future health care cost trends or other factors, there can be no assurance that the company will be able to price its products consistent with health care cost trends.
PPO premium revenue increased $20.7 million in 1998 -- $36.3 million due to an 11.0 percent increase in net premium rates, partially offset by a $15.6 million decrease resulting from a 4.1 percent decrease in member months. Net rates increased due in part to the company's targeted general rate increases averaging 7 percent to 19 percent during 1998 enrollment periods. Net rate increases are at the lower end of the targeted range due in part to changes in deductibles, the timing of group renewals throughout the year and product mix changes. Alliance PPO membership decreased by 8,114 members from December 31, 1997, to December 31, 1998, and AllianceChoice POS membership decreased by 4,017 over the same time period. Net membership decreases are due primarily to the company's aforementioned pricing strategy during 1998. Included in the Alliance PPO member count are 7,000 PPO Illinois members as of December 31, 1998, an increase of 4,800 from December 31, 1997.
HMO premium revenue increased $22.8 million, or 12.4 percent -- $16.7 million due to an 8.0 percent increase in net premium rates and a $6.1 million increase resulting from a 4.1 percent increase in member months. Net premium rates increased in part due to the company's targeted renewal rate increases of 7 percent to 19 percent during 1998 enrollment periods. Net rate increases are lower than the targeted general rate increases due to HMO competition in the company's HMO service areas; shifts in chosen benefit levels; changes in the geographic mix of the HMO business; product mix shifts; and the status of one large group, Missouri Consolidated Health Care Plan (MCHCP), comprised of 33,200 members as of December 31, 1998, with which the company has limited ability to increase premium rates. Membership increases were driven primarily by an enrollment increase of 6,000 members in MCHCP products from December 31, 1997, to December 31, 1998. The company's HMO membership in non- MCHCP products (and excluding the company's Medicaid product) decreased over the same period by 11,600 members or 10.2 percent, due primarily to the company's aforementioned pricing strategy during 1998. The company's future enrollment growth in its products and geographic regions is dependent on network attractiveness, continued cooperation with physician hospital organizations, future pricing strategy 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 these and other factors.
Managed indemnity premium revenue decreased by $4.9 million due to a 44.3 percent decline in member months. Member month declines are consistent with the company's strategy to move toward more highly managed care products.
The company continues the efforts initiated in 1997 to modify its pharmacy benefits management program and recontract with physicians and ancillary service providers. The drug cost trend has increased to the low 20 percent range, 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. One of the company's medical cost control strategies for 1998 was the introduction of a new three-tiered benefit design that allows members to make choices, albeit with a higher member copayment. Through the end of 1998, the company achieved 33 percent penetration of its underwritten membership with respect to the three- tier pharmacy benefit program. The company anticipates that a majority of its underwritten members will be utilizing a three-tier program by October 1999. In addition to continuing the conversion to this new drug benefit program, the company intends to continue to make other adjustments to copayments, quantity limits and exclusions as well as to increase physician education, utilization and prescribing pattern analysis.
The company also intends to continue its hospital, physician and service recontracting strategy, using the more detailed data and analysis available through the company's information and operating strategy (IOS), which is comprised of projects being implemented to improve business processes and systems. The company also intends to further expand its Physician Group Partners Program (PGPP). This program provides incentives to physicians to improve quality and patient satisfaction, while reducing costs. Currently, approximately 44 percent of the BlueCHOICE Commercial panel of primary care physicians in metropolitan St. Louis are enrolled in this program. The company is also working on a similar program for specialists and plans to implement the program during 2000. There can be no assurance that the company's initiatives to control future increases in medical cost trends to improve the medical loss ratio will be effective.
Commission expense increased by $2.1 million, or 7.1 percent, in 1998. The commission expense ratio of 4.1 percent for 1998 remained unchanged from 1997.
General and administrative expenses (excluding depreciation and amortization) increased $0.2 million in 1998 compared to 1997. The company managed to keep general and administrative expenses relatively consistent from 1997 to 1998 despite the fact that HealthLink's comparable expenses increased by $6.5 million in 1998 as compared to 1997. This increase is directly attributable to HealthLink's geographic and member expansion efforts. The company's 1997 general and administrative expenses include a write-off of $1.7 million for amounts due to the company from MedAmerica HealthNet, Inc. (MHI), a physician hospital organization that filed for bankruptcy during the fourth quarter of 1997. The company's general and administrative expense ratio (excluding depreciation and amortization) decreased to 18.3 percent in 1998 compared to 19.5 percent in 1997. Excluding depreciation, amortization and the $1.7 million charge, the general and administrative expense ratio for 1997 was 19.2 percent.
The operating loss, excluding non-recurring relocation and restructuring charges and the charge for the MCHCP loss reserve, for the company's underwritten segment was $22.3 million in 1998 compared to an operating loss of $37.7 million in 1997. The decrease in losses in 1998 is partially attributable to the increase in the company's overall premium rates.
Net investment income includes investment income in the form of interest and dividend income and net realized gains from the sale of portfolio securities. Net investment income of $18.7 million in 1998 represents a decrease of $14.5 million from 1997, inclusive of a $13.3 million decrease in realized gains, net. Realized gains in 1997 include a $5.7 million gain on the sale of company-owned life insurance policies as well as additional 1997 net realized gains from the liquidation of equity securities due to the company's intent to increase its holdings of fixed income securities and the company's decision to repay $15.0 million of its debt in the first quarter of 1997.
The company's effective income tax provision (benefit) rate was 40.4 percent and (28.4) percent for 1998 and 1997, respectively. The company's effective tax provision (benefit) rates for 1998 and 1997 were affected by non-deductible goodwill amortization. The company's effective income tax benefit rate for 1997 was also affected by gains from the liquidation of company-owned life insurance policies. 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, 1998, and 1997. 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, 1998, and 1997.
The company's net income for 1998 was $5.7 million, or $0.30 per share, compared to a net loss of $24.0 million, or $1.29 per share for 1997. Excluding the non-recurring restructuring and relocation charges and the charge for the MCHCP loss reserve, the company had net income of $6.2 million, or $0.33 per share, in 1998, compared to a net loss of $2.7 million, or $0.14 per share, in 1997.
Premium revenue increased $59.3 million to $654.3 million in 1997 from $595.0 million in 1996. As described below, components of premium revenue were affected by shifts in product mix, rate increases and other factors; and as a result, such changes may not be indicative of future periods.
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 1997 enrollment periods, 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 has limited ability to increase premium rates; 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. In addition, the company 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.
Revenue from other specialty services, which include certain of the company's drug and dental health care benefit plans, increased $8.2 million due to a 12.6 percent increase in member months and a 12.4 percent increase in net premium rates. The company's drug product revenues increased $7.4 million due primarily to a 13.7 percent increase in member months in 1997 as compared to 1996.
Fees and other income from administrative services only/self-funded and network services increased in 1997 by $6.8 million. ASO revenues from HealthLink increased by $10.1 million in 1997 as compared to 1996. HealthLink's 1997 and 1996 revenues include $7.5 million and $2.7 million of revenues, respectively, from HealthLink HMO, Inc. (HealthLink HMO), which was only 50 percent owned by HealthLink (and not consolidated with the company's operations) prior to its May 31, 1996, acquisition from a subsidiary of Blue Cross and Blue Shield of Kansas City. HealthLink's revenues also increased due to membership gains in its PPO products of approximately 10.7 percent or 71,900 members from December 31, 1996, to December 31, 1997. HealthLink's increases in fees and other income were partially offset by two main factors - decreases to revenue caused by a decline in the HMO self- funded membership of 2,700 members from December 31, 1996, to December 31, 1997, and a decline in the overall PPO self-funded membership of 20,700 members over the same time period.
Three large self-funded group cancellations were effective as of January 1, 1998. As of December 31, 1997, these three groups encompassed approximately 72,000 members, approximately 30,000 of which enrolled in HealthLink's self-funded ASO plans in 1998.
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 resulted in large underwriting losses.
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 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.
Depreciation and amortization expenses increased to $23.1 million in 1997 from $15.0 million in 1996. The primary cause for this $8.1 million increase is an additional $4.9 million of IOS amortization expense incurred in 1997 as compared to 1996. See "Outlook - Information and operations strategy" for more information related to the IOS project. In addition, the company amortized an additional $2.6 million in 1997 compared to 1996 for prepaid reinsurance payments associated with the company's reinsurance agreements with Blue Cross and Blue Shield of Kansas City.
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.
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.
Net investment income of $33.2 million in 1997 represents an increase of $15.7 million from 1996, inclusive of a $14.0 million increase in realized gains, net. Realized gains in 1997 include a $5.7 million gain on the sale of company-owned life insurance policies as well as additional 1997 net realized gains from the liquidation of equity securities due to the company's intent to increase its holdings of fixed income securities and the company's decision to repay $15.0 million of its debt.
The company's net loss for 1997 was $24.0 million, or $1.29 per share, compared to a net loss of $2.0 million, or $0.11 per share for 1996. Excluding the non-recurring relocation charges and the charge for loss reserves, the company had a net loss of $2.7 million, or $0.14 per share, for 1997, compared to net income of $0.9 million, or $0.05 per share, for 1996.
Net cash provided by operations totaled $11.0 million for the year ended December 31, 1998. The company's net income was $5.7 million, which included (on a before-tax basis) $3.9 million of realized gains from the sale of investments, $9.1 million for the MCHCP loss reserve amortization, and $19.3 million of depreciation and amortization expenses. In addition, other assets, medical claims payable, obligations for employee benefits, receivables from members and net intercompany receivables were affected by the timing of operating cash payments and receipts, intercompany tax settlements, as well as changes in membership, utilization and claims payment trends and actuarial estimates.
Other than continued investment in information technology, investment in new benefit programs and debt repayment, the company currently has no definitive material commitments for future use of its current or expected levels of available cash resources; however, management continually evaluates opportunities to expand the company's specialty managed care services and health plan operations. The company's expansion options may include additional acquisitions and internal development of new products and programs. The company's available cash resources will remain in interest-bearing investments until they are utilized for such purposes.
The following statements are based on short-term expectations. The statements are forward-looking and actual results may differ materially. Reference is made to the information set forth under the captions "Safe Harbor Statement" and "Factors that May Affect Future Results of Operations, Financial Condition or Business" of Part I, Item 1, of this Annual Report.
Integrated testing of purchased or internally developed applications, hardware, operating systems and other support software began in the fourth quarter of 1998. This integrated testing (including the leap year test) includes advancing the hardware dates forward to several key dates in the year 2000. Testing will continue through the end of 1999 for existing systems, new releases and enhancements to provide for continued readiness and to prevent reappearance of Year 2000 problems.
The total cost associated with the modifications required to become Year 2000 ready is estimated to be approximately $12 million to $13 million. The increase from the $10 million to $12 million range reported in the company's Form 10-Q for the period ended September 30, 1998, relates to recently identified incremental Year 2000 readiness costs associated with the company's data warehouse applications and more complete cost estimates for integrated testing. The company is expensing all costs associated with these changes as they are incurred. From 1996 through December 31, 1998, the company has cumulatively expensed $7.4 million on this project, with $4.7 million expensed in 1998. These costs are being funded internally through operating cash flows or investment sales and represent less than 10 percent of the company's information technology budget over the life of the Year 2000 program.
The company is currently preparing its contingency plan in the event that full Year 2000 readiness for critical business functions is not achieved. The company expects to have the plan substantially defined on or before the end of the second quarter of 1999. However, there can be no assurance that the company or any third party upon which the company depends will be able to achieve Year 2000 readiness or will have sufficient contingency plans, which could have a material adverse effect on the company and the market for the company's stock.
The Health Insurance Portability and Accountability Act of 1996 requires private health insurance coverage to be "portable" by employees from job to job and eliminates coverage limitations for pre-existing health conditions. The State of Missouri also has recently passed legislation that mandates various lengths of stay for maternity patients and imposes a number of new restrictions on managed care organizations, which include, among others, health maintenance organizations, health insurers and utilization review organizations. In addition, the Balanced Budget Act of 1997, and the regulations promulgated thereunder, establish a new Medicare+Choice program that significantly expands the health care options to Medicare beneficiaries and imposes a number of new restrictions and requirements on health plans, such as BlueCHOICE, that offer a Medicare+Choice plan. Finally, the State of Illinois recently revised its regulations governing the activities of preferred provider organizations, such as HealthLink, which now impose a number of new provider and client contracting requirements. Although the impact of the provisions of this recent legislation and any future legislation cannot be fully predicted at this time, management of the company believes that the ultimate outcome will not have a material adverse effect on the company. However, there can be no assurance that the company will be able to obtain or maintain required governmental approvals or licenses or that any current or proposed federal and state legislation or other regulatory reform imposed on the company and its subsidiaries will not have a material adverse effect on the company's business or results of operations in the future.