The Company has experienced substantial growth in membership and revenues since it began operations in 1986. The membership and revenue growth has been accompanied by increases in the cost of providing health care in New York, New Jersey, Pennsylvania, Connecticut, Illinois, Florida and New Hampshire. The Company does not expect its future growth in membership or revenue, if any, to be similar to its growth in prior years as the Company has to redirect its strategic initiatives to attempt to establish profitability. See "Business-Recent Developments-Turnaround Plan". Since the Company provides services on a prepaid basis, with premium levels fixed for one-year periods, unexpected cost increases during the annual contract period cannot be passed on to employer groups or members.
Commercial premium revenues increased $760.2 million to $2.9 billion in 1997 from $2.2 billion in 1996. Membership growth accounted for substantially all of the change as member months of the Freedom Plan increased 37.2% when compared with 1996, and member months of Oxford's traditional HMOs increased 43.2% over the prior year. Premium rates of commercial programs were about the same in 1997 as in 1996. Software and hardware problems experienced in the conversion of a portion of the Company's computer system in September 1996 resulted in significant delays in the Company's billing of group and individual customers and in 1997 adversely affected the Company's premium billing. The Company's revenues in 1997 were adversely affected by adjustments of approximately $174 million related to estimates for terminations of group and individual members and for non-paying group and individual members. The Company is taking steps to attempt to improve billing timeliness, reduce billing errors, lags in recording enrollment and disenrollment notifications, and the Company's collection processes and is attempting to make requisite improvements in management information concerning the value and aging of outstanding accounts receivable. The Company believes it has made adequate provision in its estimates for group and individual member terminations and for non-paying group and individual members as of December 31, 1997. Adjustments to the estimates may be necessary, however, and any such adjustments would be included in the results of operations for the period in which such adjustments are made.
Premium revenues of government programs increased $384.8 million to $1.2 billion in 1997 from $850.7 million in 1996. Membership growth accounted for most of the change in Medicare as member months increased 46.4% when compared with the prior year. The increase in Medicaid revenues was attributable to a 34.4% increase in member months compared with 1996, offset in part by a 5.2% decrease in average
The Company expects that premium rates for commercial business in 1998 will be higher on average than in 1997. The Company's commercial rates are often higher than those charged by competitors, in part reflecting the size and quality of the Company's provider network, additional services provided by the Company and other features of the Company's products. The Company's ability to receive requested rate increases from group customers may be adversely affected by publicity surrounding the losses announced by the Company for the third and fourth quarters and claims payment issues involving the Company's provider network. The Company believes that commercial premium pricing will continue to be highly competitive and may be more so. However, the Company does not intend to promote revenue growth at the level of prior years because the Company's priority in 1998 will be to attempt to strengthen its service and systems infrastructure. Revenues may also be adversely affected as a result of the Company's decision to reduce its future investment in developing the Florida, Illinois and New Hampshire markets. Moreover, the Company expects that revenue growth will be adversely affected by customers' concern regarding recently publicized operating losses and provider dissatisfaction with timeliness of claims payment.
In 1998, the Company will receive a 2% increase in Medicare premiums, minus the user fee assessment of .428% of the Company's gross monthly Medicare premium. The user fee is applied to all Medicare risk contractors by HCFA to cover HCFA's costs relating to beneficiary enrollment, dissemination of information and certain counseling and assistance programs. On March 2, 1998 HCFA announced a 2% increase in premiums in 1999 for all plans in the Company's service areas. However, the user fee for 1999 has not been determined and may increase since the Clinton Administration is seeking legislation authorizing it to collect additional funds. Under the authority provided by the 1997 Act, HCFA has begun to collect hospital encounter data from Medicare risk contractors. The data will be used to develop and implement a new risk adjustment mechanism by January 1, 2000. Given the relatively high Medicare risk premium levels in the Company's market areas, the Company is in significant jeopardy that the new risk adjustment mechanism to be developed
Premium yields in the Company's Medicaid business in New Jersey and Connecticut will be unchanged in 1998. The Company has notified the relevant regulatory authorities that it will not renew its Medicaid risk contracts in Connecticut and New Jersey due to unfavorable premium and medical expense trends. The Company will, therefore, be withdrawing from those programs effective April 1, 1998 for Connecticut and July 1, 1998 for New Jersey. At December 31, 1997, the Company had approximately 33,000 Connecticut Medicaid members and 46,100 New Jersey Medicaid members. Premium yields in the Company's New York Medicaid program (approximately 43,500 members at December 31, 1997) will be increased 4% effective April1, 1998. The Company expects that premium yields in the Company's Pennsylvania Medicaid program (approximately 67,000 members at December 31, 1997) were increased 7% effective January 1, 1998. No assurances can be given regarding prospective premium yields from these programs.
Plans and its Medicaid programs the Company's per member per month medical costs increased, 49.1% and 17.3%, respectively, in 1997. These increases resulted primarily from higher expenses for hospital and specialist physician services and increases in per member per month pharmacy costs of 20.7% and 18.5% in 1996 and 1997, respectively. The Company reviews its ultimate claims liability in light of its claims payment history and other factors, and any resulting adjustments are included in the results of operations for the period in which such adjustments are made. The Company believes it has made adequate provision for medical costs as of December 31, 1997. There can be no assurance that additional reserve additions will not be necessary as the Company continues to review and reconcile delayed claims and claims paid or denied in error. Additions to reserves could also result as a consequence of regulatory examinations and such additions would also be included in the results of operations for the period in which such adjustments are made. See "Business - Government Regulation" and "Legal Proceedings".
Marketing, general and administrative expenses increased 54.5% to $737.4 million in 1997 from $477.4 million in 1996 which, as a percentage of operating revenues, was 17.6% in 1997 compared with 15.7% in 1996. The increase in marketing, general and administrative expenses was attributable to the Company's membership growth, costs associated with expansion into new markets in Florida and Illinois and expenses attributable to strengthening the Company's operations, including costs for independent consultants, additional staff and information system enhancements. Principal areas of increased expense were payroll and benefits
In October 1997, the Company disposed of its 47% interest in Health Partners, Inc. ("Health Partners"). The Company received 2,090,109 shares of common stock of FPA Medical Management, Inc. ("FPAM") stock with a market value as of closing of approximately $76.4 million, resulting in a pretax gain at the time of closing of approximately $63.1 million. As of December 31, 1997, the market value of the FPAM stock had been reduced to approximately $38.4 million. Because management believes that the decline is other than temporary, the Company as of December 31, 1997, wrote down its investment in FPAM by $38.0 million. As a result, the Company ultimately recognized a pretax gain of approximately $25.2 million ($20.5 million after taxes, or $.26 per share) on the sale of Health Partners. The Company's equity in Health Partners net loss for 1997 prior to the sale was $1.1 million compared with a loss of $4.6 million in 1996. The Company contracts with provider groups managed by Health Partners in the Company's service areas. The Company cannot currently predict if the costs of using such provider groups will increase with the change in ownership.
The Company acquired all of the outstanding stock of Compass PPA, Incorporated, a Chicago-based HMO, as of August 1, 1997 for approximately $8.2 million in cash (resulting in goodwill of $24.1 million) and acquired all of the outstanding stock of Riscorp Health Plans, Inc., a Florida-based HMO, as of November 3, 1997, for approximately $5.3 million in cash (resulting in goodwill of $3.9 million). Since the dates of acquisition, the Company made investments in such companies pursuant to a plan to aggressively develop and market the Company's products in the Florida and Chicago markets. As of December 31, 1997, the Company has determined to focus available administrative resources in its core markets in the Northeast and to reduce significantly the level of investment planned for these expansion markets. The Company believes that such reduction in future investments will impact the value of these companies and, accordingly, the Company has reduced the value of its investment in these companies by writing off $27.3 million in goodwill arising from the acquisitions and subsequent investment. The Company also reduced by $14.3 million the carrying value of its investment in the capital stock and subordinated surplus notes of St. Augustine Health Care, Inc., a Florida-based HMO. The Company holds 19.9% of the outstanding voting stock of St. Augustine Health Care, Inc.
The income tax benefit for 1997 was $140.3 million, or approximately 32.5% of the Company's pretax loss in 1997. This is lower than the 42.1% effective tax rate for 1996 since, due to the Company's significant net loss, the Company established a valuation allowance related to state net operating loss carryforwards. Management believes that and it is more likely than not that future operations will generate sufficient taxable income (estimated to be $330 million) to utilize the unreserved net deferred tax assetsthose deferred tax assets.
The Company expects to report losses in 1998 as the result of high medical costs and high administrative costs as described above. The Company intends to take the steps referred to above and under "Business - Recent Developments-Turnaround Plan" in an effort to better control medical and administrative spending, but there can be no assurance that it will be successful. Results of operations will be adversely affected if such steps cannot be successfully implemented or if there are delays in such implementation.
Total premiums earned for the year ended December 31, 1996 increased 74.3% to $3.02 billion from $1.73 billion in 1995. This overall increase was primarily attributable to a 67.1% increase in member months for commercial and government programs. The substantial growth in membership reflected continued consumer acceptance of health care plans in the Company's markets in general, and the popularity of the products offered by the Company in particular.
Third-party administration revenues for the year ended December 31, 1996 declined to $10.4 million from $11.9 million in 1995, attributable to a 5.1% decrease in per member per month revenue and a 7.8% decrease in member months.
Health care services expense stated as a percentage of premiums earned (the "medical-loss ratio") was 80.1% for the year ended December 31, 1996 compared with 77.5% for the year ended December 31, 1995. The increase in the medical-loss ratio was attributable to a higher percent of membership in the Company's Medicare programs, greater than expected pharmacy costs, and decreased per member per month premium
The provision for income taxes for 1996 was $72.4 million, or approximately 42.1% of the Company's pretax income in 1996, approximately the same as the 1995 tax rate.
Although the rate of inflation has remained relatively stable in recent years, health care costs have been rising at a higher rate than the consumer price index. In particular, the Company has experienced significant increases in medical costs in its Medicare, Medicaid, and New York Mandated Plans. The Company employs various means to reduce the negative effects of inflation. The Company has in prior years increased overall commercial premium rates when practicable in order attempt to maintain margins; nevertheless, these rate increases have tended to be below those of traditional indemnity health plans and comparable to competing health plans, thereby maintaining the Company's competitive position. The Company's cost control measures and risk-sharing arrangements with various health care providers also mitigate the effects of inflation on its operations. There is no assurance that the Company's efforts to reduce the impact of inflation will be successful or that the Company will be able to increase premiums to offset cost increases associated with providing health care.
Cash used by operations during 1997 aggregated $152.6 million, contributing to a reduction in cash and cash equivalents and short-term investments to $639.9 million at December 31, 1997 from $839.5 million at December 31, 1996. In addition, cash used for capital expenditures totaled $101.9 million during 1997. This amount was used primarily for computer equipment and software, reflecting the Company's ongoing need to upgrade and maintain its information systems to support its rapid growth. In addition, significant expenditures were incurred for leasehold improvements related to the Company's headquarters in Norwalk, Connecticut, and existing regional offices, and to expansion of regional offices in Hooksett, New Hampshire and Hidden River, Florida. The Company currently anticipates that capital expenditures for 1998, a significant portion of which will be devoted to management information systems and leasehold improvements, will be less.
Cash amounts aggregating $610,000 have been segregated as restricted investments as required by the New York State Department of Insurance, the New Jersey Department of Insurance and the Pennsylvania Department of Insurance. In addition, the Company's subsidiaries are subject to certain restrictions on their
Premiums receivable at December 31, 1997 decreased to $275.6 million from $315.1 million at December 31, 1996 primarily due to adjustments relating to group and individual member terminations and non-paying group and individual member previously discussed.
covenant with respect to steps to be taken to refinance the Bridge Notes under certain circumstances. If the Investment Agreement referred to below is terminated or amended or the transactions thereunder are not consummated by June 30, 1998 (subject to extension), and in certain other circumstances, DLJ would be entitled to elect 33% of the total number of two directors and the Company would be required to deliver a resolution of the Company's Board of Directors adopting a plan or proposal for refinancing the borrowings under the Bridge Notes, through the issuance of debt or equity securities or the entering into a strategic transaction acceptable to DLJ, and retain DLJ to effect the implementation of such plan or proposal.
Pursuant to an Investment Agreement, dated as of February 23, 1998 (the "Investment Agreement"), between the Company and TPG Oxford LLC (together with the investors thereunder, the "Investors"), the Investors have agreed to purchase $350,000,000 in Preferred Stock with Warrants to acquire up to 22,530,000 shares of common stock. The Warrants have an exercise price of $17.75, which represents a 5% premium over the average trading price of Oxford shares for the 30 trading days ended February 20, 1998. The exercise price is to become 115% of the average trading price of Oxford common stock for the 20 trading days following the filing of the Company's annual report on Form 10-K for the year ending December 31, 1998, if such adjustment would reduce the exercise price. The Preferred Stock will be issued as Series A and Series B. The Series A Preferred Stock will carry a dividend of 8% and will be issued with Series A Warrants to purchase 15,800,000 shares of common stock, or 19.9% of the present outstanding voting power of Oxford's common stock. The Series A Preferred Stock will have 16.6% of the combined voting power of Oxford's outstanding common stock and the Series A shares. The Series B Preferred stock, which will be issued with Series B Warrants to purchase non-voting junior participating preferred stock, is non-voting and will carry a dividend of 9%. The Series B Preferred Stock will become voting, the dividend rate will decrease to 8% and the Series B warrants will be exercisable for 6,730,000 shares of common stock at such time as Oxford's shareholders approve the increase in voting rights of TPG to 22.1%. The Preferred Stock will not be redeemable by the Company prior to the fifth anniversary of their original issuance. Thereafter, subject to certain conditions, the Series A and Series B Preferred Stock will be redeemable at the option of the Company for an aggregate redemption price of $245 million and $105 million, respectively (in each case, plus accrued and unpaid dividends), and will be subject to mandatory redemption at the same price on the tenth anniversary of their original issuance. The Series A Warrants and the Series B Warrants will expire on the earlier of the tenth anniversary of their original issuance or redemption of the related series of Preferred Stock. The Warrants will be detachable from the Preferred Stock. The investment is subject to various conditions, which include receipt of regulatory approvals, absence of a Material Adverse Effect (as defined) and completion of debt financing in the amount of $350 million. Application for approval of TPG's investment in the Company have been filed with the departments of insurance and/or health, as appropriate, of New York, New Jersey, Connecticut, Pennsylvania, New Hampshire, Florida and Illinois. These regulatory agencies have the authority to approve or disapprove, or impose conditions on, consummation of the transaction. Closing is not subject to shareholder approval.
The Company is currently conducting a comprehensive review of its computer systems to identify the systems that could be affected by the "Year 2000" date conversion and is developing an implementation plan to resolve the issue. The Year 2000 problem is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's programs that have time-sensitive software may recognize the date "00" as the year 1900 rather than the year 2000. This could result in system failure or miscalculations. The Company is utilizing and will utilize both internal and external resources to identify, correct or reprogram, and test the systems for Year 2000 compliance. The Company has not completed its assessment number of the Year 2000 date conversion. Accordingly, the Company cannot estimate itsYear 2000 compliance expense and the related potential effect on the Company's results of operations.