There were no shares or dilutive securities outstanding prior to November 2, 2001 (date of Anthem’s, whose name changed to WellPoint, demutualization and initial public offering). Accordingly, amounts prior to 2002 represent pro forma earnings per share. For comparative pro forma earnings per share presentation, the weighted average shares outstanding and the effect of dilutive securities for the period from November 2, 2001 to December 31, 2001, was used to calculate pro forma earnings per share for 2001.
VI. Results of Operations-Year Ended December 31, 2005 Compared to the Year Ended December 31, 2004
VIII. Results of Operations-Year Ended December 31, 2004 Compared to the Year Ended December 31, 2003
XI. Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995
Operating revenue reached an all-time high of $44.5 billion in 2005, a 118% increase over 2004. Operating revenue increases were driven by the merger with WellPoint Health Networks Inc., which represented approximately 111% of this increase, supplemented by organic revenue growth, particularly in the individual and small group business, known as ISG, Large Group and National Account businesses.
We have successfully executed our strategy to deliver on our long-term goal of achieving at least 15% growth in fully diluted earnings per share, or EPS, which was exceeded in 2005 as our EPS increased by 29%. We have accomplished this by focusing on profitable enrollment growth with innovative product offerings, pricing with discipline, implementing initiatives to optimize the cost of care, continuing to leverage administrative costs over a larger membership base, further penetrating our specialty businesses and by using our cash flow effectively.
We manage our operations through three reportable segments: Health Care, Specialty and Other.
related to customers of affiliated health plans, which are recorded in benefit expense. Our cost of drugs can be influenced by the volume of prescriptions at our PBM, as well as cost changes, driven by prices set by pharmaceutical companies and mix of drugs sold.
On June 9, 2005, we announced the completion of our acquisition of Lumenos, Inc., or Lumenos, for approximately $185.0 million in cash paid to the stockholders of Lumenos. The acquisition of Lumenos provided us with market leading consumer-driven health programs as well as the service experience with such programs and the customer tools that drive consumerism in health care today. Lumenos is recognized as a pioneer and market leader in consumer-driven health programs. Lumenos served approximately 177,000 members as of the date of acquisition.
On April 25, 2005, WellPoint’s Board of Directors approved a two-for-one split of shares of common stock, which was effected in the form of a 100 percent common stock dividend. All shareholders of record on May 13,
Individual and Small Group, or ISG, consists of individual customers under age 65 as well as those employer customers with one to 50 eligible employees.
National Accounts customers are multi-state employer groups primarily headquartered in a WellPoint service area with 5,000 or more eligible employees, with at least 5% of eligible employees located outside of the headquarter’s state. Service area is defined as the geographic area in which we are licensed to sell BCBS products.
BlueCard host members represent enrollees of non-owned Blue Cross and/or Blue Shield plans who receive health care services in our Blue Cross and Blue Shield licensed markets. BlueCard membership consists of estimated host members using the national BlueCard program. Host members are generally members who reside in or travel to a state in which a WellPoint subsidiary is the Blue Cross and/or Blue Shield licensee and who are covered under an employer sponsored health plan issued by a non-WellPoint controlled Blue Cross Blue Shield licensee (i.e., the “home” plan). We perform certain administrative functions for BlueCard members, for which we receive administrative fees from the BlueCard members’ home plans. Other administrative functions, including maintenance of enrollment information and customer service, are performed by the home plan. Host members are computed using, among other things, the average number of BlueCard claims received per member per month.
In addition to reporting our medical membership by customer type, we report by funding arrangement according to the level of risk that we assume in the product contract. Our two funding arrangement categories are fully-insured and self-funded. Fully-insured products are products in which we indemnify our policyholders against costs for health benefits. Self-funded products are offered to customers, generally larger employers, who elect to retain some or all of the financial risk associated with their employees’ health care costs. Some employers choose to purchase stop-loss coverage to limit their retained risk. These employers are reported with our self-funded business.
Self-funded medical membership increased 3,195,000 or 25%, primarily due to our merger with WellChoice and increases in our BlueCard, National Accounts and Large Group businesses. Fully-insured membership increased by 2,933,000 or 20%, due to our merger with WellChoice. However, on a comparable basis, fully-insured membership decreased by 56,000 primarily due to a Large Group fully-insured account in the East region, which represented approximately 140,000 medical members, converting to self-funded during the third quarter of 2005. This was partially offset by growth in our ISG and State Sponsored businesses, as well as new sales and positive in-group change in Large Group.
Our specialty metrics are derived from membership and activity from our specialty products. These products are often ancillary to our health business, and can therefore be impacted by growth in our medical membership. The membership of these products can also be impacted by our efforts to increase the use of Specialty products by our medical members. Prescription volume at our PBM increased 8,080,000 prescriptions, or 2%, in 2005 primarily due to growth in both our mail order and retail operations. Behavioral Health membership increased 3,916,000, or 33%, in 2005. This growth was primarily due to the transition of 1,900,000 members from an external vendor to our in-house operation, as well as growth within our existing health lines of business, our increased offerings of specialty products to our medical members and a change in counting methodologies contributed to increased Behavioral Health’s membership growth.
Pharmacy benefit cost trend, which previously had been a primary driver of overall trend increases, continues to decline as a result of an increase in generic usage rates, benefit plan design changes, improved pharmaceutical contracting resulting from the merger with WHN, the non-renewal of pharmacy only business from a large state customer with historically high utilization and cost trends effective July 1, 2005 and the impact of lower utilization for the COX 2 Inhibitor therapeutic class of drugs. Late in the third quarter of 2004, the arthritis drug VIOXX® was removed from the market due to concerns about the risk of heart attacks in persons taking this drug for longer than 18 months. We have provided our network physicians with information regarding alternatives to VIOXX and our PBM companies have implemented a process to ensure appropriate usage of the COX 2 Inhibitor therapeutic class of drugs.
Represents the reclassification of certain WHN historical amounts to conform to a consistent presentation with WellPoint.
Our consolidated results of operations for the years ended December 31, 2005 and 2004 are discussed in the following section.
For certain line items impacted by the merger of Anthem and WHN, comparable basis is not meaningful due to related capitalization and purchase accounting.
Administrative fees increased $1,293.0 million, or 90%, to $2,729.9 million in 2005. On a comparable basis, administrative fees increased $237.2 million, or 10%, primarily due to increased self-funded membership in our National and Large Group businesses. These membership gains are driven by the popularity of the BlueCard program, as well as successful efforts to attract large self-funded accounts and the continuing trend towards self-funded arrangements over fully-insured contracts among our Large Group customers.
Benefit expense increased $17,832.1 million, or 116%, to $33,219.9 million in 2005. On a comparable basis, benefit expense increased $1,938.7 million, or 6%, primarily due to increased cost of care, which was driven primarily by higher costs in outpatient and inpatient services. In addition, our benefit expense included $35.0 million in 2005 related to the multi-district litigation settlement agreement discussed in “Significant Transactions” above. On a comparable basis, our benefit expense ratio decreased 50 basis points from 81.1% in 2004 to 80.6% in 2005. The decrease in our benefit expense ratio is driven by moderating cost of care trends coupled with disciplined underwriting practices.
Selling, general and administrative expense increased $3,795.0 million, or 109%, to $7,272.7 million in 2005. On a comparable basis, selling, general and administrative expense increased $435.4 million, or 6%, primarily due to increases in volume-sensitive costs such as higher commissions, premium taxes and other expenses associated with growth in our business; increased incentive compensation, including merger-related stay bonuses; and costs associated with the transition of information technology infrastructure services to IBM. In addition, we incurred expenses related to the multi-district litigation settlement agreement discussed in “Significant Transactions” above; and start-up costs related to Medicare Part D. On a comparable basis, our selling, general and administrative expense ratio decreased 10 basis points to 16.3% in 2005, primarily due to growth in operating revenue and the leveraging of costs over a larger membership base, partially offset by the factors noted above.
Cost of drugs increased $193.0 million, or 203%, to $288.0 million in 2005. On a comparable basis cost of drugs increased $18.2 million, or 7%, primarily due to higher retail and mail-order prescription volume at our PBM companies.
Income tax expense increased $943.3 million, or 195%, to $1,426.5 million in 2005. Included in 2005 was $28.4 million in tax benefits associated with a refund claim, recognizing the deductibility of capital losses on the sale of certain subsidiaries that occurred in prior years. Included in 2004 was $44.8 million in tax benefits associated with a change in Indiana laws governing the state’s high-risk health insurance pool.
operating revenue less benefit expense, selling, general and administrative expense and cost of drugs. It does not include net investment income, net realized gains (losses) on investments, interest expense, amortization of other intangible assets, merger-related undertakings, loss on repurchase of debt or income taxes, as these items are managed in a corporate shared service environment and are not the responsibility of operating segment management. For additional information, see Note 19 to our audited consolidated financial statements included in this Form 10-K. The discussions of segment results for the years ended December 31, 2005 and 2004 presented below are based on operating gain, as described above, and operating margin, which is calculated as operating gain divided by operating revenue. Our definitions of operating gain and operating margin may not be comparable to similarly titled measures reported by other companies.
Operating revenue increased $22,843.0 million, or 116%, to $42,597.5 million. On a comparable basis, operating revenue increased $2,946.4 million, or 7%, primarily due to growth in premium income as a result of premium rate increases in our Large Group and ISG businesses resulting from underwriting discipline. Also
Operating gain increased $1,953.7 million, or 130%, to $3,459.0 million. On a comparable basis, operating gain increased $455.9, or 15%, primarily due to premium rate increases mentioned above along with membership growth and lower than expected cost of care within our ISG, Senior and Large Group businesses. Partially offsetting this increase was the impact of the $103.0 million pre-tax expense recognized in connection with the multi-district litigation settlement agreement in 2005.
Operating revenue from external customers increased $137.6 million, or 65%, to $350.4 million. On a comparable basis, operating revenue from external customers decreased $22.4 million, or 6% primarily due to the movement of certain businesses from the Other segment to the Health Care segment. The elimination of intersegment revenue increased $556.3 million, or 75%. On a comparable basis, the elimination of intersegment revenue increased $222.5 million or 21%, reflecting additional sales by our PBM companies to our Health Care segment.
Operating loss increased $8.8 million, or 8%, to $114.6 million. On a comparable basis, operating loss decreased $27.0 million or 19%, primarily due to expenses not allocated to the Health Care or Specialty segments.
“Comparable Basis” data were calculated by adding historical data for the former WellPoint Health Networks Inc. to historical data for the former Anthem, Inc., and adjusting the combined totals to ensure a consistent approach for calculating membership and volume statistics and to eliminate overlapping BlueCard membership.
Financial results for 2004 include operations of the former WellPoint Health Networks Inc. for the one month period ended December 31, 2004 and the former Anthem, Inc. for the year ended December 31, 2004. Financial results for 2003 represent the results of the former Anthem, Inc. only and have been reclassified to conform to current presentation.
Selling, general and administrative expense ratio = Total selling, general and administrative expense ÷ Total operating revenue.
growth was higher fully-insured membership, primarily in our ISG business. Partially offsetting the growth were shifts by certain customers to self-funding arrangements, resulting in lower revenues. Included in 2003 were premium refunds of $40.4 million issued to policyholders from our Health Care segment, as claims costs in certain lines of business were much lower than expected. Our premium yields, net of buy-downs, for our fully-insured Large Group and ISG businesses were just less than 10% on a rolling 12-month basis as of December 31, 2004, including the business of pre-merger WHN for all periods.
Other revenue is comprised principally of co-payments and deductibles associated with the sale of mail-order drugs by our PBM, which provides its services to members of our Health Care segment and third party clients. Other revenue increased $93.2 million, or 59%, to $252.4 million in 2004, primarily due to additional mail-order prescription volume and increased prices of prescription drugs sold by our PBM, and also due to the impact of the merger with WHN. Increased mail-order prescription volume resulted from both membership increases and additional utilization of our PBM’s mail-order pharmacy option. Effective January 1, 2004, our PBM began to provide pharmacy benefit management services to Virginia customers of our Health Care segment.
Cost of drugs increased $56.3 million, or 145%, to $95.0 million in 2004, primarily due to higher mail-order prescription volume at our PBM.
Interest expense increased $11.1 million, or 8%, to $142.3 million in 2004, primarily due to additional interest expense on the $2.8 billion of debt initially incurred in conjunction with the WHN merger. Debt of $2.8 billion initially incurred in conjunction with the WHN merger was reduced to approximately $1.9 billion at December 31, 2004. Interest expense for this merger-related debt was incurred in December 2004.
Operating gain increased $330.7 million, or 28%, to $1,505.3 million, due to our merger with WHN, improved underwriting results in our Large Group business, and growth in our National Accounts businesses. Included in the 2003 results was a $31.7 million net favorable prior year reserve development recorded during the second quarter of 2003 and a $24.5 million favorable adjustment for resolution of a litigation matter in the
Operating revenue from external customers increased $15.0 million, or 8%, to $212.8 million in 2004, due to the impact of the merger with WHN, as well as an increase in revenues from our Medicare customer service software development contract with CMS. These were partially offset by the loss of our 1-800 Medicare Help Line contract with CMS, which was substantially completed by June 30, 2003. Elimination of intersegment revenues increased $298.8 million, or 67%, reflecting additional sales by our pharmacy benefit management company to our Health Care segment.
For the most recent incurred months, the percentage of claims paid for claims incurred in those months is generally low. This makes the completion factor methodology less reliable for such months. Therefore, incurred claims for recent months are not projected from historical completion and payment patterns; rather they are projected by estimating the claims expense for those months based on recent claims expense levels and health care trend levels, or “trend factors”.
Because the reserve methodology is based upon historical information, it must be adjusted for known or suspected operational and environmental changes. These adjustments are made by our actuaries based on their knowledge and their estimate of emerging impacts to benefit costs and payment speed. Circumstances to be considered in developing our best estimate of reserves include changes in utilization levels, unit costs, mix of business, benefit plan designs, provider reimbursement levels, processing system conversions and changes, claim inventory levels, claim processing patterns and claim submission patterns. A comparison of prior period liabilities to re-estimated claim liabilities based on subsequent claims development is also considered in making the liability determination. In the actuarial process, the methods and assumptions are not changed as reserves are recalculated, rather the availability of additional paid claims information drives our changes in the re-estimate of the unpaid claim liability. To the extent appropriate, changes in such development are recorded as a change to current period benefit expense.
In addition to the pending claims and incurred but not reported claims, the liability for medical claims payable includes reserves for premium deficiencies, if appropriate. Premium deficiencies are recognized when it is probable that expected claims and administrative expenses will exceed future premiums on existing medical insurance contracts without consideration of investment income. Determination of premium deficiencies for
longer duration life and disability contracts includes consideration of investment income. For purposes of premium deficiencies, contracts are grouped in a manner consistent with our method of acquiring, servicing and measuring the profitability of such contracts.
We regularly review our assumptions regarding claim liabilities and make adjustments to benefit expense when necessary. If it is determined that our assumptions regarding cost trends and utilization are significantly different than actual results, our income statement and financial position could be impacted in future periods. Adjustments of prior year estimates may result in additional benefit expense or a reduction of benefit expense in the period an adjustment is made. Further, due to the considerable variability of health care costs, adjustments to claim liabilities occur each quarter and are sometimes significant as compared to the net income recorded in that quarter. Prior year development is recognized immediately upon the actuary’s judgment that a portion of the prior year liability is no longer needed or that additional liability should have been accrued. That determination is made when sufficient information is available to ascertain that the re-estimate of the liability is accurate and will not fluctuate significantly with future development.
A reconciliation of the beginning and ending balance for medical claims payable for the years ended December 31, 2005, 2004 and 2003 is as follows:
Amounts incurred related to prior years vary from previously estimated liabilities as the claims are ultimately settled. Liabilities at any year end are continually reviewed and re-estimated as information regarding actual claims payments, or runout, becomes known. This information is compared to the originally established year end liability. Negative amounts reported for incurred related to prior years result from claims being settled for amounts less than originally estimated. The prior year redundancy of $655.6 million shown in the table above and in Note 10 to our audited consolidated financial statements for the year ended December 31, 2005, represents an estimate based on paid claim activity from January 1, 2005 to December 31, 2005. Medical claim liabilities are usually described as having a “short tail”, which means that they are generally paid within several months of the member receiving service from the provider. Accordingly, the majority, or approximately 87%, of the $655.6 million redundancy relates to claims incurred in calendar year 2004, with the remaining 13% related to claims incurred in 2003 and prior.
4.2% for 2005, 1.4% for 2004 and 2.3% for 2003. This ratio is calculated using the redundancy of $655.6 million, shown above, which represents an estimate based on paid claim activity from January 1, 2005 to December 31, 2005. The 2005 ratio is impacted by having only one month of net incurred medical claims for WHN in 2004. If WHN had been included for the full year 2004 estimated prior year net incurred medical claims would have been $31,281.2 million, and the adjusted ratio would have been approximately 2.1% for the year ended December 31, 2005. The 2.3% ratio for 2003 was impacted by having only five months of net incurred medical claims in 2002 related to the former Trigon Healthcare, Inc. If the former Trigon Healthcare, Inc. had been included for the full year 2002, the ratio would have been approximately 2.0% for 2003.
The 2004 variance of $483.2 million and variance to total incurred medical claims, as reported of 3.2% are impacted by having only one month of total incurred as reported for WHN during 2004. The adjusted variance would be approximately $146.7 million and the variance to total incurred would be approximately 1.0% if the impact of WHN is removed. We expect that substantially all of the development of the 2005 estimate of medical claims payable will be known during 2006. This table, adjusted for the impact of WHN, shows that our estimates of this liability have approximated the actual development.
During 2004 and 2003, the valuation allowance decreased by $33.8 million and $81.9 million, respectively. The 2004 and 2003 reductions resulted from utilizing alternative minimum tax, or AMT, credits and net operating losses on our federal income tax return for which we had a deferred tax asset with a corresponding
valuation allowance. As deferred tax assets related to those deductions are available for use in the tax return, a valuation was no longer required and was reduced. The decrease in the valuation allowance in 2004 was partially offset by an additional $5.6 million related to Indiana state taxes, as discussed below.
During 2005, a refund claim we filed in 2003 was approved by the Congressional Joint Committee on Taxation. The claim relates to initially disallowed losses on the sale of certain subsidiaries in the late 1990s. A tax benefit of $28.4 million related to this claim was recorded in the first quarter of 2005. Net income related to this claim was $0.04 per basic and diluted share for the year ended December 31, 2005.
In the ordinary course of business, we are regularly audited by federal and state authorities, and from time to time, these audits result in proposed assessments. We believe our tax positions comply with applicable tax law and intend to defend our positions vigorously through the IRS appeals process. We believe we have adequately provided for any reasonable foreseeable outcome related to these matters. Accordingly, although their ultimate resolution may require additional tax payments, we do not anticipate any material impact to earnings from these matters. As of December 31, 2005, the IRS concluded its examination of our 2001 and 2002 tax years and has initiated its examination of our 2003 and 2004 tax years. Various tax examinations and proceedings also continue for pre-consolidation periods of subsidiaries.
For additional information, see Note 14 to our audited consolidated financial statements as of and for the year ended December 31, 2005 included in this Form 10-K.
Our consolidated goodwill at December 31, 2005 was $13,469.1 million and other intangible assets were $9,686.4 million. The sum of goodwill and intangible assets represents 45% of our total consolidated assets and 93% of our consolidated shareholders’ equity at December 31, 2005.
We follow Statement of Financial Accounting Standards No. 141, Business Combinations, and Statement of Accounting Standards No. 142, Goodwill and Other Intangible Assets. FAS 141 specifies the types of acquired intangible assets that are required to be recognized and reported separately from goodwill. Under FAS 142, goodwill and other intangible assets (with indefinite lives) are not amortized but are tested for impairment at least annually. We completed our annual impairment tests of existing goodwill and other intangible assets (with indefinite lives) for each of the years ended December 31, 2005, 2004 and 2003 and based upon these tests we have not incurred any impairment losses related to any goodwill and other intangible assets (with indefinite lives).
On December 28, 2005, we completed our merger with WellChoice and purchased 100% of the outstanding common stock of WellChoice. In accordance with FAS 141, we allocated the purchase price to the fair value of assets acquired, including intangible assets, and liabilities assumed. This allocation process included the review of relevant information about the assets and liabilities, independent appraisals and other valuations to determine the fair value of assets acquired and liabilities assumed. The preliminary allocation resulted in $3.4 billion of non-tax deductible goodwill and $1.7 billion of identifiable intangible assets. The purchase price allocation is preliminary and additional refinements may occur.
On November 30, 2004, we completed our merger with WHN and purchased 100% of the outstanding common stock of WHN. In accordance with FAS 141, we allocated the purchase price to the fair value of assets acquired, including intangible assets, and liabilities assumed. This allocation process included the review of relevant information about the assets and liabilities, independent appraisals and other valuations to determine the fair value of assets acquired and liabilities assumed. The allocation resulted in $7.6 billion of non-tax deductible goodwill and $7.0 billion of identifiable intangible assets.
A summary of available-for-sale investments with unrealized losses as of December 31, 2005 along with the related fair value, aggregated by the length of time that investments have been in a continuous unrealized loss position, is as follows:
The Company’s fixed maturity investment portfolio is sensitive to interest rate fluctuations, which impact the fair value of individual securities. Unrealized losses reported above were primarily caused by the effect of a rising interest rate environment on certain securities with stated interest rates currently below market rates. The Company currently has the ability and intent to hold these securities until their full cost can be recovered. Therefore, the Company does not believe the unrealized losses represent an other-than-temporary impairment as of December 31, 2005.
We have evaluated the impact on the fixed maturity portfolio’s fair value considering an immediate 100 basis point change in interest rates. A 100 basis point increase in interest rates would result in an approximate $573.0 million decrease in fair value, whereas a 100 basis point decrease in interest rates would result in an approximate $534.9 million increase in fair value. An immediate 10% decrease in each equity investment’s value, arising from market movement, would result in a fair value decrease of $144.8 million. Alternatively, an immediate 10% increase in each equity investment’s value, attributable to the same factor, would result in a fair value increase of $144.8 million.
The Company is an independent licensee of the Blue Cross Blue Shield Association (“BCBSA”), an association of independent health benefit plans, and serves its members as the Blue Cross licensee for California and as the Blue Cross and Blue Shield licensee for: Colorado, Connecticut, Georgia, Indiana, Kentucky, Maine, Missouri (excluding 30 counties in the Kansas City area), Nevada, New Hampshire, New York (as Blue Cross and Blue Shield in 10 New York City metropolitan counties, and as Blue Cross or Blue Cross and Blue Shield in selected upstate counties only), Ohio, Virginia (excluding the Northern Virginia suburbs of Washington, D.C.) and Wisconsin. The Company also serves customers throughout various parts of the United States as UniCare.
Two-for-One Stock Split: On April 25, 2005, WellPoint’s Board of Directors approved a two-for-one split of shares of common stock, which was effected in the form of a 100 percent common stock dividend. All shareholders of record on May 13, 2005 received one additional share of WellPoint common stock for each share of common stock held on that date. The additional shares of common stock were distributed to shareholders of
Investments: All fixed maturity and equity securities are classified as “available-for-sale” and are reported at fair value. The Company has determined that certain of these investment securities are available to support current operations and, accordingly, has classified such investment securities as current assets without regard for contractual maturities. Investments used to satisfy contractual, regulatory or other requirements are classified as long-term, without regard to contractual maturity. The unrealized gains or losses on both current and long-term fixed maturity and equity securities are included in accumulated other comprehensive income as a separate component of shareholders’ equity, unless the decline in value is deemed to be other-than-temporary and the Company does not have the intent and ability to hold such securities until their full cost can be recovered, in which case the securities are written down to fair value and the loss is charged to income. The Company evaluates its investment securities for other-than-temporary declines based on quantitative and qualitative factors.
The Company participates in securities lending programs whereby marketable securities in its investment portfolio are transferred to independent brokers or dealers based on, among other things, their creditworthiness in exchange for collateral initially equal to at least 102% of the value of the securities on loan and is thereafter maintained at a minimum of 100% of the market value of the securities loaned. The market value of the securities on loan to each borrower is monitored daily and the borrower is required to deliver additional collateral if the market value of the collateral falls below 100% of the market value of the securities on loan. The fair value of the collateral amounted to $1,389.9 and $658.5, which represents 102% and 102% of the market value of the securities on loan at December 31, 2005 and 2004, respectively. Under the guidance provided in FAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, the Company recognizes the collateral as an asset, which is reported as “securities lending collateral” on its balance sheet and the Company records a corresponding liability for the obligation to return the collateral to the borrower, which is reported as “securities lending payable.” The securities on loan are reported in the applicable investment category on the balance sheet.
The Company’s derivatives are reported as other current assets or liabilities or other noncurrent assets or liabilities, as appropriate, with the exception of embedded derivative instruments not subject to bifurcation, which are reported together with their host instrument. If certain correlation, hedge effectiveness and risk reduction criteria are met, a derivative may be specifically designated as a hedge of exposure to changes in fair value or cash flow. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the nature of any hedge designation thereon.
The contractual or notional amounts for derivatives are used to calculate the exchange of contractual payments under the agreements and are not representative of the potential for gain or loss on these instruments. Interest rates and equity prices affect the fair value of derivatives. The fair values generally represent the estimated amounts that WellPoint would expect to receive or pay upon termination of the contracts at the reporting date. Dealer quotes are available for substantially all of the Company’s derivatives. For derivative instruments not actively traded, fair values are estimated using values obtained from independent pricing services, costs to settle or quoted market prices of comparable instruments.
Property and Equipment: Property and equipment is recorded at cost, net of accumulated depreciation. Depreciation is computed principally by the straight-line method over estimated useful lives ranging from 15 to
39 years for buildings, two to eight years for furniture and equipment, and three to ten years for computer software. Leasehold improvements are depreciated over the term of the related lease. Certain costs related to the development or purchase of internal-use software are capitalized and amortized in accordance with AICPA Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.
Administrative fees include revenue from certain group contracts that provide for the group to be at risk for all, or with supplemental insurance arrangements, a portion of their claims experience. The Company charges these self-funded groups an administrative fee, which is based on the number of members in a group or the group’s claim experience. In addition, administrative fees include amounts received for the administration of Medicare or certain other government programs. Under the Company’s self-funded arrangements, revenue is recognized as administrative services are performed. All benefit payments under these programs are excluded from benefit expense.
benefit generally represents the net change in deferred income tax assets and liabilities during the year. Current income tax expense represents the tax consequences of revenues and expenses currently taxable or deductible on various income tax returns for the year reported.
Stock-Based Compensation: The Company has a plan that provides for stock-based compensation, including stock options, restricted stock awards and an employee stock purchase plan. Stock options are granted for a fixed number of shares with an exercise price at least equal to the fair value of the shares at the date of the grant. Restricted stock awards are issued at the fair value of the stock on the grant date. The employee stock purchase plan allows for a purchase price per share which is 85% of the lower of the fair value of a share of common stock on (i) the first trading day of the plan quarter, or (ii) the last trading day of the plan quarter. The Company accounts for stock-based compensation using the intrinsic method under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and, accordingly, recognizes no compensation expense related to stock options and employee stock purchases. For grants of restricted stock, other than those awarded under long-term incentive agreements, unearned compensation equivalent to the fair value of the shares at the date of grant is recorded as a separate component of shareholders’ equity and subsequently amortized to compensation expense over the award’s vesting period. The Company has adopted the disclosure-only provisions of FAS 123, Accounting for Stock-Based Compensation (“FAS 123”), as amended by FAS 148, Accounting for Stock-Based Compensation-Transition and Disclosure.
On December 16, 2004, FAS 123 (revised 2004), Share-Based Payment (“FAS 123R”), was issued. FAS 123R is a revision of FAS 123, supersedes APB 25 and amends FAS 95, Statement of Cash Flows. Generally, the approach in FAS 123R is similar to the approach described in FAS 123. However, FAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values and pro forma disclosure is no longer an alternative. Additionally, excess tax benefits, as defined in FAS 123R, will be recognized as an addition to additional paid-in-capital and will be reclassified from operating cash flows to financing cash flows in the consolidated statement of cash flows.
The Company’s stock-based employee compensation plans are described in Note 12. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FAS 123 to stock-based employee compensation:
On December 28, 2005, the Company completed its merger with WellChoice, Inc. (“WellChoice”), which was announced on September 27, 2005. The merger was deemed effective December 31, 2005 for accounting purposes; accordingly, the operating results of WellChoice will be included in WellPoint’s consolidated financial statements in periods following December 31, 2005.
The pro forma effects of this acquisition were not material to the Company’s consolidated results of operations.
As described in Note 1, on November 30, 2004, Anthem completed its merger with WHN and purchased 100% of the outstanding common stock of WHN. As a result of the merger, each WHN stockholder received twenty-three dollars and eighty cents ($23.80) in cash, without interest, and one share of WellPoint common stock for each share of WHN common stock held. The purchase price was $15,773.6 and included cash of $3,718.8, the issuance of approximately 310.6 shares of WellPoint common stock, valued at $11,293.8, WHN stock options converted to WellPoint stock options and other stock awards for approximately 43.7 shares, valued at $563.6, and $197.4 of estimated transaction costs. The fair value of common stock issued was based on $36.35 per share, which represents the average closing price of the Company’s common stock for the five trading days ranging from two days before to two days after October 27, 2003, the date the merger was announced.
The estimated fair values of WHN assets acquired and liabilities assumed at the date of the merger, adjusted for final purchase price allocations, are summarized as follows:
Of the $7,031.7 of acquired intangible assets, $4,370.0 was assigned to Blue Cross and Blue Shield and other trademarks, $271.0 was assigned to provider networks, and $258.0 was assigned to a license for a state sponsored program, which are not subject to amortization due to their indefinite life. The remaining acquired intangible assets consist of $2,030.0 of subscriber base with an average life of 20 years and $102.7 of provider contracts with a 23 year life. The values assigned to goodwill and intangible assets with finite and indefinite lives were determined based on independent third-party valuations.
The results of operations for WHN are included in WellPoint’s consolidated financial statements for the periods following November 30, 2004.
The unaudited pro forma information includes the results of operations for WHN for the periods prior to the merger, adjusted for interest expense on long-term debt and reduced investment income related to the cash and investment securities used to fund the acquisition, additional amortization and depreciation associated with the purchase and the related income tax effects. The unaudited pro forma financial information is presented for informational purposes only and may not be indicative of the results of operations had WHN been owned by WellPoint for the full years ended December 31, 2004 and 2003, nor is it necessarily indicative of future results of operations.
A summary of the change in the carrying amount of goodwill by reportable segment (see Note 19) for 2005 and 2004 is as follows:
Goodwill acquired in 2004 included $7,579.6 related to the merger with WHN and $6.1 of additional goodwill related to a contingent earnout for a subsidiary in the Company’s Health Care segment. Goodwill reductions of $17.9 in 2004 relate to the exercise of stock options issued as part of the WHN and Trigon acquisitions.
As of December 31, 2005, estimated amortization expense for each of the five years ending December 31, is as follows: 2006, $296.2; 2007, $280.1; 2008, $263.3; 2009, $246.0; and 2010, $226.4.
The decision to impair a security incorporates both quantitative criteria and qualitative information. The impairment review process considers a number of factors including, but not limited to: (a) the length of time and the extent to which the fair value has been less than book value, (b) the financial condition and near term prospects of the issuer, (c) the intent and ability of the Company to retain its investment for a period of time sufficient to allow for any anticipated recovery in value, (d) whether the debtor is current on interest and principal payments and (e) general market conditions and industry or sector specific factors. For securities that are deemed to be impaired, the security is adjusted to fair value and the resulting losses are recognized in realized gains or losses in the consolidated statements of income. The new cost basis of the impaired securities is not increased for future recoveries in fair value.
Impairments recorded in 2005, 2004 and 2003 were primarily the result of the continued credit deterioration on specific issuers in the bond and equity markets.
At December 31, 2005, no investments other than investments in U.S. government agency securities exceeded 10% of shareholders’ equity.
For the years ended December 31, 2005 and 2004, the Company recognized realized gains related to derivative financial instruments of $1.5 and $0.7, respectively. There were no realized gains or losses on derivative financial instruments for the years ended December 31, 2003.
During the year ended December 31, 2005, the Company entered into two fair value hedges with a total notional value of $660.0. The first hedge is a $360.0 notional amount interest rate swap agreement to exchange a fixed 6.8% rate for a LIBOR-based floating rate and expires on August 1, 2012. The second hedge is a $300.0 notional amount interest rate swap agreement to exchange a fixed 5.00% rate for LIBOR-based floating rate and expires December 15, 2014.
During the year ended December 31, 2004, the Company entered into a $300.0 notional amount interest rate swap agreement to exchange a fixed 3.75% rate for a LIBOR-based floating rate. The swap agreement expires December 14, 2007.
During the year ended December 31, 2005, the Company entered into a floating to fixed rate cash flow hedge with a total notional value of $480.0. The purpose of this hedge is to offset the variability of the cash flows due to the rollover of the Company’s variable-rate one-month commercial paper issuance. This swap agreement expires in December 2007. During the year ended December 31, 2005, no gain or loss from hedged ineffectiveness was recorded in earnings and the commercial paper borrowings remain outstanding at December 31, 2005. The unrecognized gain included in accumulated other comprehensive income at December 31, 2005 was $3.6.
During the year ended December 31, 2005, the Company entered into forward starting pay fixed swaps with an aggregate notional amount of $875.0. The objective of these hedges was to eliminate the variability of cash flows in the interest payments on the debt securities to be issued to partially fund the cash portion of the WellChoice merger. The unrecognized loss included in accumulated other comprehensive income at December 31, 2005 was $12.5. As of December 31, 2005, the total amount of amortization over the next twelve months is expected to increase interest expense by approximately $0.6.
During the year ended December 31, 2004, the Company entered into forward starting pay fixed swaps and treasury lock swaps with an aggregate notional amount of $2,000.0. The objective of these hedges was to eliminate the variability of cash flows in the interest payments on the debt securities to be issued to partially fund the cash portion of the WHN merger. These swaps were terminated in 2004, and the Company received a net $15.7, the net fair value at the time of termination. In addition, the Company recorded an unrealized gain of $10.2, net of tax, as accumulated other comprehensive income. Prior to the WHN merger, the Company reclassified $0.7 ($0.5, net of tax) to net realized gains on investment for the portion of the hedges that were deemed not probable of occurring. Following the completion of the WHN merger on November 30, 2004, the Company issued debt securities, and the unamortized fair value of the forward starting pay fixed swaps included in balances in accumulated other comprehensive income began amortizing into earnings, as a reduction of interest expense, over the life of the debt securities. The unrecognized gain included in accumulated other comprehensive income at December 31, 2005 was $8.9. As of December 31, 2005, the total amount of amortization over the next twelve months will decrease interest expense by approximately $1.3.
WellPoint had cash requirements of approximately $3,138.0 for the WellChoice merger, including both the cash portion of the purchase price and estimated transaction costs. In anticipation of the merger, on December 28, 2005, WellPoint entered into a bridge loan agreement under which it could borrow up to $3,000.0. On December 28, 2005, WellPoint borrowed $1,700.0 under this bridge facility to partially fund the WellChoice merger. The interest rate on this bridge loan is based on either (i) the LIBOR rate plus a predetermined
On December 28, 2005, WellPoint filed a shelf registration with the Securities and Exchange Commission to register an unlimited amount of any combination of debt or equity securities in one or more offerings. On January 10, 2006, the Company issued $700.0 of 5.000% notes due 2011; $1,100.0 of 5.250% notes due 2016; and $900.0 of 5.850% notes due 2036 under this registration statement. The proceeds from this debt issuance were used to repay the bridge loan of $1,700.0 and to repay approximately $1,000.0 of commercial paper obtained to partially fund the WellChoice merger.
On November 29, 2005, the Company entered into a senior credit facility (the “facility”) with certain lenders for general corporate purposes. The facility provides credit for up to $2,500.0 (reduced for any commercial paper issuances) and matures on November 29, 2010. The interest rate on this facility is based on either (i) the LIBOR rate plus a predetermined percentage rate based on the Company’s credit rating at the date of utilization, or (ii) a base rate as defined in the facility agreement. The Company’s ability to borrow under the facility is subject to compliance with certain covenants. Commitment fees for the facility were $1.4 in 2005 and there are no conditions that are probable of occurring under which the facility may be withdrawn. There were no amounts outstanding under the senior credit facility as of December 31, 2005.
In August 2004, the Company issued $200.0 of 3.500% notes due 2007, which were used to exchange and retire $190.0 aggregate principal amount of 4.655% remarketed subordinated debentures. The Company also received approximately $4.7 of cash proceeds, net of underwriting discounts and offering expenses. These notes were issued under a shelf registration filed with the Securities and Exchange Commission in December 2002 for any combination of debt or equity securities in one or more offerings up to an aggregate amount of $1,000.0. This shelf registration was cancelled in December of 2005.
On December 9, 2004, the Company issued $300.0 of 3.750% notes due 2007, $300.0 of 4.250% notes due 2009, $500.0 of 5.000% notes due 2014 and $500.0 of 5.950% notes due 2034. Net proceeds from this offering were approximately $1,583.7 after deducting the initial purchasers’ discount and estimated offering expenses. Proceeds from these notes were used to repay borrowings at November 30, 2004 to partially fund the cash portion of the WHN purchase price and to fund the tender offer to purchase $500.0 of surplus notes of Anthem Insurance Companies, Inc. (“Anthem Insurance”). The remainder of the proceeds was used to repay commercial paper.
Surplus notes are unsecured obligations of Anthem Insurance, a wholly owned subsidiary, and are subordinate in right of payment to all of Anthem Insurance’s existing and future indebtedness. Any payment of interest or principal on the surplus notes may be made only with the prior approval of the Indiana Department of Insurance (“IDOI”), and only out of capital and surplus funds of Anthem Insurance that the IDOI determines to be available for the payment under Indiana insurance laws. During December 2004, WellPoint completed a tender offer to purchase Anthem Insurance surplus notes from the holders, and purchased $258.0 of 9.125% notes
The Company has an authorized commercial paper program of up to $2,000.0, the proceeds of which may be used for general corporate purposes. The weighted-average interest rate on commercial paper borrowings at December 31, 2005 and 2004 were 4.40% and 2.44%, respectively. Commercial paper borrowings have been classified as long-term debt at December 31, 2004 in accordance with FAS 6, as the Company’s practice and intent is to replace short-term commercial paper outstanding at expiration with additional short-term commercial paper for an uninterrupted period extending for more than one year or with borrowings under the senior credit facility described above.
Interest paid during 2005, 2004 and 2003 was $238.7, $146.7 and $136.4, respectively.
Future maturities of debt, including capital leases, are as follows: 2006, $3,782.6; 2007, $495.3; 2008, $9.0; 2009, $307.4; 2010, $45.5 and thereafter $2,166.1.
In the normal course of business, WellPoint invests in various financial assets, incurs various financial liabilities and enters into agreements involving derivative securities.
Other invested assets, long term: The Company’s investments in limited partnerships are carried at its share in the partnerships’ undistributed retained earnings, which approximates fair value.
Amounts incurred related to prior years vary from previously estimated liabilities as the claims are ultimately settled. Liabilities at any year end are continually reviewed and re-estimated as information regarding actual claims payments becomes known. This information is compared to the originally established year end liability. Negative amounts reported for incurred related to prior years result from claims being settled for amounts less than originally estimated. The favorable development in medical claims payable for the years ended December 31, 2005, 2004, and 2003 is primarily attributable to actual medical cost experience being more favorable than that assumed at the time the liability was established.
On December 28, 2005, as partial consideration in the WellChoice merger, the Company issued .05191 of a share of WellPoint common stock for each share of WellChoice common stock outstanding, resulting in additional outstanding shares of approximately 42.7. The $3,200.6 fair value of the common shares issued was determined based on $74.97 per share, which represents the average closing price of the Company’s common stock for the five trading days ranging from two days before to two days after September 27, 2005, the date the merger was announced. Transaction costs of $11.6 reduced the aggregate fair value and $3,189.0 was recorded as par value of common stock and additional paid-in capital.
Effective November 30, 2004, as partial consideration in the WHN merger, the Company issued one share of common stock for each WHN share outstanding, resulting in additional outstanding shares of approximately 310.6. The $11,293.8 fair value of the common shares issued was determined based on $36.35 per share, which represents the average closing price of the Company’s common stock for the five trading days ranging from two days before to two days after October 27, 2003, the date the merger was announced. Offering costs of $8.3 reduced the aggregate fair value and $11,285.5 was recorded as par value of common stock and additional paid-in capital.
In connection with the WellChoice merger, the Company assumed the WellChoice, Inc. 2003 Omnibus Incentive Plan, which provided for the granting of stock options to employees and non-employee directors. WellChoice stock options were converted to WellPoint stock options using the option exchange ratio as defined in the merger agreement. The converted stock options were recorded at the acquisition date as additional paid-in capital and valued at $113.4 using a binomial lattice model. The following weighted-average assumptions were used for the conversion: risk free interest rate of 4.32%; volatility factor of 22.00%; expected dividend yield of 0.00%; and expected option life of three years.
In connection with the WHN merger, the Company assumed the WellPoint Health Networks Inc. 1999 Stock Incentive Plan, the WellPoint Health Networks Inc. 2000 Employee Stock Option Plan, the Cobalt Corporation Equity Incentive Plan, the RightCHOICE Managed Care, Inc. 2001 Stock Incentive Plan, the RightCHOICE Managed Care, Inc. 1994 Equity Incentive Plan and the RightCHOICE Managed Care, Inc. Nonemployee Directors’ Stock Option Plan, which collectively provided for the granting of stock options to employees and non-employee directors. WHN stock options were converted to WellPoint stock options using the option exchange ratio as defined in the merger agreement. The converted stock options were recorded at the acquisition date as additional paid-in capital and valued at $559.9 using a Black-Scholes option-pricing model. The following weighted-average assumptions were used for the conversion: risk free interest rate of 3.07%; volatility factor of 33.00%; expected dividend yield of 0.00%; and expected option life of three years.
During the year ended December 31, 2005, pursuant to the Stock Plan, the Company granted 1.3 shares of restricted stock to eligible employees. The restricted stock vests in equal annual installments over three years.
During the year ended December 31, 2003, pursuant to the Stock Plan, the Company granted 0.1 of restricted stock and stock, primarily for restricted shares to Anthem Southeast employees under long-term incentive agreements and to non-employee directors. The shares were issued at the fair value of the stock on the grant date. The restricted shares vest over periods defined by the long-term incentive agreements.
The binomial lattice and Black-Scholes option-pricing models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s stock option grants have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, existing models do not necessarily provide a reliable single measure of the fair value of its stock option grants.
Under the Board of Directors’ authorization, WellPoint maintains a common stock repurchase program. Repurchases may be made from time to time at prevailing market prices, subject to certain restrictions on volume, pricing and timing. During 2005, WellPoint repurchased and retired approximately 5.1 shares at an average cost per share of $64.92 for an aggregate cost of $333.4. During 2004, the Company repurchased and retired 2.0 shares, at an average per share price of $41.12, for an aggregate cost of $82.3. During 2003, the Company repurchased and retired approximately 6.8 shares, at an average per share price of $32.03, for an aggregate cost of $217.2. The excess of cost of the repurchased shares over par value is charged on a pro rata basis to additional paid-in capital and retained earnings. As of December 31, 2005, the Company had Board of Directors’ authorization to purchase up to an additional $2,000.0 of common stock. The Company’s stock repurchase program is discretionary as the Company is under no obligation to repurchase shares. Shares are repurchased under the program because the Company believes it is a prudent use of capital.
Shares were issued under the long-term incentive plan in April 2004. The Equity Security Unit purchase contracts were settled on November 15, 2004, and approximately 10.6 shares of the Company’s common stock were issued and included in the basic earnings per share calculation.
The net decrease in the valuation allowance for 2005 and 2004 was $0.0 and $33.8, respectively. The valuation allowance is attributable to the uncertainty of alternative minimum tax (“AMT”) credits and net operating loss carryforwards. As deferred tax assets related to these types of deductions are recognized in the tax return, the valuation allowance is no longer required and is reduced. During 2004, the valuation allowance change was due to utilization of AMT credits and net operating loss carryforwards. Also the 2004 valuation allowance was increased by $4.7 as a result of the WHN merger.
Significant components of the provision for income taxes for the years ended December 31, consist of the following:
During the first quarter of 2005, a refund claim filed by the Company in 2003, was approved by the Congressional Joint Committee on Taxation. The claim relates to initially disallowed losses on the sale of certain subsidiaries in the late 1990s. A tax benefit of $28.4 related to this claim was recorded in the first quarter of 2005. Net income per basic and diluted share related to this claim was $0.04 for the year ended December 31, 2005.
As a result of legislation enacted in Indiana on March 16, 2004, the Company recorded deferred tax assets and liabilities, with a corresponding net tax benefit in the income statement of $44.8, or $0.15 per basic share and $0.14 per diluted share, for the year ended December 31, 2004. The legislation eliminated the creation of tax
In certain states, the Company pays premium taxes in lieu of state income taxes. Premium taxes are reported with general and administrative expense.
At December 31, 2005, the Company had unused federal tax net operating loss carryforwards of approximately $202.8 to offset future taxable income. The loss carryforwards expire in the years 2006 through 2024. During 2005, 2004 and 2003 federal income taxes paid totaled $994.0, $646.3 and $303.3, respectively.
Lease expense for 2005, 2004 and 2003 was $149.3, $62.8 and $51.3, respectively.
The Anthem Cash Balance Pension Plan (the “Plan”) is a cash balance arrangement where participants have an account balance and earn a pay credit equal to three to six percent of compensation, depending on years of service. The Plan covers part-time and temporary employees as well as full-time employees of Anthem prior to its merger with WHN who have completed one year of continuous service and attained the age of twenty-one. In addition to the pay credit, participant accounts earn interest at a rate based on 10-year Treasury notes. Employees of WHN do not participate in the Plan.
The Employees’ Retirement Plan of Blue Cross of California covers employees of a collective bargaining unit. The WellPoint Health Networks Inc. Pension Accumulation Plan (the “WellPoint Pension Plan”), which was established on January 1, 1987, covers all eligible employees of WHN prior to its merger with Anthem (employees covered under a collective bargaining agreement participate if the terms of the collective bargaining agreement permits) meeting certain age and service requirements. Effective January 1, 2004, non-bargained employees covered by the WellPoint Pension Plan who are age 50 and over, with combined age and service totaling 65 or higher as of December 31, 2003, will continue to earn future contributions based on compensation. While other non-bargained employees covered by the plan will continue to accrue interest on their pension account, generally no additional contributions based on the employee’s earnings will be made. Employees of WHN prior to its merger with Anthem hired after December 31, 2003 are not eligible to participate in the WellPoint Pension Plan. Employees of Anthem do not participate in this plan.
Certain employees of the former Cobalt Corporation, parent company of Blue Cross Blue Shield of Wisconsin and United Government Services, LLC (“UGS”) are covered by the UGS Pension Plan which provides retirement benefits to covered employees (including certain employees covered by a collective bargaining agreement) based primarily on compensation and years of service. Effective January 1, 2004, non-bargained employees covered by the UGS Pension Plan who are age 50 and over, with combined age and service totaling 65 or higher as of December 31, 2003, will continue to earn future contributions based on compensation. While other non-bargained employees covered by the plan will continue to accrue interest on their pension account, generally no additional contributions based on the employee’s earnings will be made. Employees of UGS hired after December 31, 2003 are not eligible to participate in the UGS Pension Plan.
WellChoice sponsors a cash balance defined benefit plan which covers substantially all employees of WellChoice prior to its merger with the Company. Effective January 1, 1999, this plan was redesigned to consolidate multiple other plans, at which time each participant’s account was credited an amount based on the benefits earned in the prior plans. Participant accounts are credited additional amounts based on age and years of service and earn interest each year. Employees of WHN and Anthem do not participate in this plan.
minimum funding requirements set forth in the Employee Retirement Income Security Act of 1974, as amended (“ERISA”) and in accordance with income tax regulations, plus such additional amounts as are necessary to provide assets sufficient to meet the benefits to be paid to plan participants.
The following tables disclose consolidated “pension benefits”, which include defined benefit pension plans described above, and consolidated “other benefits”, which include other postretirement benefits described above. Weighted average calculations were computed using assumptions at the relevant measurement dates.
As of December 31, 2005, certain pension plans of the Company had accumulated benefit obligations in excess of plan assets. For those same plans, the projected benefit obligation was also in excess of plan assets. Such plans had a combined projected benefit obligation, accumulated benefit obligation and fair value of plan assets of $68.8, $60.0 and $0.0, respectively.
An important factor in determining the Company’s pension expense is the assumption for expected long-term rate of return on plan assets. The Company uses a total portfolio return analysis in the development of its assumption. Factors such as past market performance, the long-term relationship between fixed maturity and
The WellChoice transaction was closed on December 28, 2005, after the settlement was reached with the plaintiffs in the CMA Litigation, the Shane Litigation and the Thomas Litigation. The former WellChoice company, now one of the Company’s wholly-owned subsidiaries, continues to be a defendant in the Thomas Litigation, and will not be affected by the settlement between the Company and plaintiffs. The Company intends to vigorously defend this proceeding; however, its ultimate outcome cannot be presently determined.
On July 1, 2005, the Company entered into an agreement with International Business Machines Corporation (“IBM”) to provide information technology infrastructure services. These services were previously performed in-house and resulted in the transfer of approximately 380 related jobs from the Company to IBM. The Company’s commitment under this contract is approximately $718.6 over a seven year period. The Company has the ability to terminate this agreement with 120 days written notice, subject to certain early termination fees. WellChoice had entered into a similar agreement with IBM in 2002 that expires in 2012. Under this agreement, IBM provides certain technology outsourcing services to WellChoice and is enhancing WellChoice’s systems applications. The remaining future contractual obligations under this agreement amount to approximately $366.4 at December 31, 2005. WellChoice can terminate the agreement or portions of the agreement upon the occurrence of certain events, subject to certain early termination fees.
In connection with the formation in 2000 of a joint venture providing Medicaid services in Puerto Rico, the Company agreed under certain circumstances to provide additional funds to the joint-venture entity. The Company agreed that it would make a capital contribution to the joint venture of up to 80% of any amount necessary to increase the entity’s capital to meet minimum regulatory capital requirements if (i) applicable law or regulation requires an increase in the entity’s capital and the entity does not then have capital sufficient to meet the increased requirement or (ii) the entity’s medical care ratio is 100% or greater during any 180-day period and the entity does not then meet statutory capital requirements under the Puerto Rico Insurance Code. The amount of this guarantee will not exceed 80% of the amount necessary to provide the entity with a 12 to 1 premium-to-capital ratio. As of December 31, 2005, the Company’s maximum potential liability pursuant to this guarantee was $30.3. Since the formation of the joint venture in 2000, the Company has not been required to make any payments under this guarantee and the Company does not currently expect that any such payments will be made.
Through its participation in various federal government programs, the Company generated approximately 12%, 17% and 19% of its total consolidated revenues from agencies of the U.S. government for the years ended December 31, 2005, 2004 and 2003, respectively. These revenues are contained in all three of the Company’s reportable segments.
The classification between managed care products and managed care services for the Health Care segment in the above table primarily distinguishes between the level of risk assumed. Managed care products represent insurance products where the Company bears the insurance risk, whereas managed care services represent
WellPoint’s insurance subsidiaries report their accounts in conformity with accounting practices prescribed or permitted by state insurance regulatory authorities (“statutory”), which vary in certain respects from GAAP. Typical differences of GAAP reporting as compared to statutory reporting are the inclusion of unrealized gains or losses relating to fixed maturity securities in shareholders’ equity, recognition of all assets including those that are non-admitted for statutory purposes and recognition of all deferred tax assets without regard to statutory limits. The National Association of Insurance Commissioners (“NAIC”) developed a codified version of the statutory accounting principles, designed to foster more consistency among the states for accounting guidelines and reporting.