(B) Earnings per share for the year ended December 31, 1995 includes nonrecurring costs of $0.52 per share.
On May 20, 1996, the Company completed the Recapitalization, including the acquisition of the BCC Commercial Operations for $235.0 million in cash. The Recapitalization included the payment of a $995.0 million special dividend funded by $775.0 million in revolving debt and the remainder in cash (see Note 2 to the Consolidated Financial Statements for a description of the Recapitalization).
In order to implement the Company's regional expansion strategy, the Company will need to develop satisfactory provider network and information systems, which will require additional expenditures by the Company. A portion of these expenditures will be reflected in the Company's results of operations.
Prior to their acquisitions by WellPoint, the MMHD large employer group operations, the GBO and BCC Commercial Operations each experienced a higher overall loss ratio than the Company and, as the Company integrates these acquisitions, the Company's overall loss ratio may increase. There can be no assurance that the Company will be able to successfully integrate these recent acquisitions into its business or take appropriate measures to control the loss ratio associated with their operations. In addition, the Company's overall loss ratio may increase as the Company expands its California large group and Medicaid businesses, both of which generally have higher loss ratios than the Company's overall business.
WellPoint's revenues are generated from premiums earned for health care and specialty services provided to its members, fees for administrative services, including claims processing and access to provider networks for self-insured employers, and investment income. WellPoint's operating expenses include health care services and other benefits expenses, consisting primarily of payments for physicians, hospitals and other providers for health care and specialty products claims; selling expenses for broker and agent commissions; general and administrative expenses; interest expense; and income taxes.
(a) California and Out-of-State include 665,454 and 563,854 management services members, respectively, as of December 31, 1996. Of the 665,454 California management services members, 76,385 are from the acquired MMHD operations. California and Out-of-State include 482,572 and 2,886 management services members, respectively, as of December 31, 1995.
(c) As of December 31, 1996, total BCC Commercial Operations medical membership was approximately 264,500, all of which were California members. The majority of these members are included in Group Services.
The 1996 specialty membership includes the acquired MMHD operations which had approximately 0.5 million pharmacy members, 0.9 million dental members, 0.1 million disability members and 0.4 million life members as of December 31, 1996.
COMPARISON OF RESULTS FOR THE YEAR ENDED DECEMBER 31, 1996 TO THE YEAR ENDED DECEMBER 31, 1995
and the BCC Commercial Operations on the Company's overall results. The acquired MMHD operations and the BCC Commercial Operations have traditionally experienced a higher loss ratio than the Company. The increase in the loss ratio was partially offset by the Company's continuing cost containment efforts, such as the hospital recontracting program. Excluding the Company's workers' compensation business and the acquisitions of the MMHD operations and the BCC Commercial Operations, the loss ratio would have been 74.7% for the year ended December 31, 1996. The loss ratio for 1995, also excluding the workers' compensation business, was 75.2%.
Selling expense consists of commissions paid to outside brokers and agents representing the Company. Selling expense for the year ended December 31, 1996 increased 18.0% to $224.5 million compared to $190.2 million in 1995, corresponding with continued overall premium revenue growth and an additional $21.4 million in selling expense attributable to MMHD. The selling expense ratio for 1996 decreased to 5.6% from 6.4% for the prior year, largely due to the acquisition of MMHD, which has a lower selling expense ratio than the Company's existing business, and the BCC Commercial Operations, which has no selling expense. Excluding the acquisitions, the selling expense ratio would have been 6.3% for the year ended December 31, 1996, consistent with the prior year.
arrangements. This conversion was principally due to regulatory actions taken by the California Department of Corporations (the "DOC") related to licensure requirements. In addition, increased premium revenues resulted from a shift to certain HMO products that generate a higher premium per member than the Company's PPO products and from membership growth in specialty products.
Health care services and other benefits expense increased 14.1% to $2,200.0 million for the year ended December 31, 1995 from $1,928.0 million in 1994. The loss ratio for 1995 increased to 75.6% compared to 72.8% in 1994 due to several factors. Membership as a percentage of total medical membership in the Company's large group business, which has a higher loss ratio than the Company's small group and individual business, increased in 1995. In addition, moderately higher medical cost trends, a continued competitive pricing environment and the elimination through new regulations of mandatory minimum premiums ("open rating") in the workers' compensation market also contributed to the higher loss ratio in 1995.
Selling expense for the year ended December 31, 1995 increased 12.2% to $190.2 million compared to $169.5 million for 1994, corresponding with continued overall premium revenue growth. The selling expense ratio increased slightly in 1995 to 6.4% from 6.3% in 1994, largely due to an increase in selling expenses for the Company's workers' compensation products. The commission rates for the Company's workers' compensation products increased due to increased competition resulting from the new California regulations which require open rating. Excluding selling expenses for the Company's workers' compensation products, the selling expense ratio would have decreased from 6.3% in 1994 to 6.2% in 1995.
During the fourth quarter of 1995, the operating results of the Company included charges of $57.1 million ($34.5 million net of a $22.6 million tax benefit) for nonrecurring costs. Approximately $29.8 million resulted from costs, primarily professional fees, associated with the proposed acquisition of Health Systems International which was terminated in December 1995. In addition, the Company recorded a charge of $27.3 million for the impairment of intangible assets associated with its pharmaceutical benefits management business based on the Company's analysis evaluating the impairment of long-lived assets in accordance with Company policy. The impairment reflected an anticipated reduction in future claims
processing fees. The anticipated reduced fees result from an industry-wide market shift whereby pharmaceutical manufacturing companies had purchased pharmaceutical benefits management companies to market their products and thereby reducing claims processing fees. These conditions resulted as the pharmaceutical companies reduced processing fees to increase market share.
Equity totaled $870.5 million as of December 31, 1996, a decrease of $799.8 million from December 31, 1995. The decrease resulted primarily from the $995.0 million special dividend paid to the stockholders of Old WellPoint and a $11.8 million decrease in the unrealized valuation adjustment on investment securities, net of deferred taxes, due to an increase in market interest rates in 1996 compared to 1995. The decrease was partially offset by net income of $202.0 million in 1996 and additional stock issuances in 1996 totaling $5.0 million under the Company's stock option/award plan and employee stock purchase plan.
The Company's primary sources of cash are premiums and management services revenues received and investment income. The primary uses of cash include health care claims and other benefits, capitation payments, income taxes, repayment of long-term debt, interest expense, broker and agent commissions and administrative expenses. In addition to the foregoing, prospective uses of cash will include costs of provider network and systems development, costs associated with the integration of acquired businesses and capital expenditures. The Company receives premium revenue in advance of anticipated claims for related health care services and other benefits. The Company's investment policies are designed to provide liquidity, preserve capital and maximize yield. Cash and investment balances maintained by the Company are sufficient to meet applicable regulatory financial stability and net worth requirements. As of December 31, 1996, the Company's investment portfolio consisted primarily of fixed maturity securities (which are primarily rated "A" or better by rating agencies) and equity securities.
The Company is required to maintain minimum TNE by the Company's primary regulator, the DOC, and is required to meet minimum capital requirements prescribed by the BCBSA. In measuring capital for the BCBSA, the Company is required to use the method prescribed by the DOC. The failure to meet the Minimum BCBSA Capital requirement can subject the Company to certain corrective actions, while the failure to meet a lower specified level can result in termination of the Company's license agreement with the BCBSA. The Minimum BCBSA Capital requirement, which is more restrictive than DOC requirements, increased as of December 31, 1996. As of December 31, 1996, the Company's TNE (which is also its capital for BCBSA purposes) was approximately $388 million and its Minimum BCBSA Capital was approximately $364 million. As of such date, its required TNE for DOC purposes was approximately $17.0 million.
In order to address an anticipated shortfall in the Company's capital as a result of the increased BCBSA capital requirement and the pending acquisition of the GBO, in November 1996, the Company entered into a subordinated term loan agreement with a bank for a two-year unsecured subordinated term loan facility (the "Subordinated Credit Agreement") of $200.0 million, which could be drawn down through March 17, 1997. On December 30, 1996, the Company borrowed $50.0 million, of which approximately $24.0 million was required in order to meet the increased BCBSA capital requirements. The DOC regulations permit the Company to include in TNE (and thus in capital for BCBSA purposes) any indebtedness subordinated to the Company's obligation to maintain the DOC's required minimum TNE. In March 1997, the Company incurred $150 million in additional indebtedness under the Subordinated Credit Agreement in part as a result of the GBO Acquisition in order to maintain the DOC's required minimum TNE. The Company intends to repay outstanding indebtedness under its senior credit facility with such borrowing. Such borrowings bear interest at interest rates determined by reference to the bank's base rate or to LIBOR plus a margin determined by reference to the Company's leverage ratio or the then-current rating of the Company's unsecured long-term debt by specified rating agencies. The applicable margin will increase with respect to any borrowings outstanding as of July 1, 1997. Interest is paid quarterly. Quarterly principal amortization payments will be due beginning March 31, 1998, and all remaining outstanding borrowings under the Subordinated Credit Agreement will become due on December 31, 1998. The Subordinated Credit Agreement requires compliance with certain financial ratio and other requirements similar to those in the Company's senior credit facility; however, the repayment of borrowings has been subordinated to the Company's requirements to maintain the required minimum TNE under DOC regulations. The Subordinated Credit Agreement also requires that the net proceeds of certain sales of capital stock or subordinated debt issued by the Company be used to repay outstanding amounts under the Subordinated Credit Agreement.
In July 1996, the Company filed a registration statement relating to the issuance of $1.0 billion of senior or subordinated unsecured indebtedness. As of December 31, 1996, no indebtedness had been issued pursuant to this registration statement.
financial condition or results of operations. Additionally, the Company faces competitive pressure to contain premium prices. Fiscal concerns regarding the continued viability of government sponsored programs such as Medicare and Medicaid may cause decreasing reimbursement rates for these programs. Any limitation on the Company's ability to increase or maintain its premium levels may adversely affect the Company's financial condition or results of operations.
As part of the Company's business strategy, the Company has recently acquired significant operations in new geographic markets. These businesses, which include substantial indemnity-based insurance operations, have experienced varying profitability or losses in recent periods. While the integration of these businesses into the Company has begun, there can be no assurances regarding the ultimate success of the Company's integration efforts or regarding the ability of the Company to maintain or improve the results of operations of these businesses as the Company pursues its strategy of motivating the acquired members to select managed care products. In order to implement this strategy, the Company will, among other things, need to develop satisfactory provider networks and information systems, which will require considerable expenditures by the Company in addition to the costs associated with the integration of these acquisitions.
Managed care organizations, both inside and outside California, operate in a highly competitive environment that has undergone significant change in recent periods as a result of business consolidations, new strategic alliances, aggressive marketing practices by competitors and other market pressures. Additional increases in competition could adversely affect the Company's financial condition or results of operations.
(A) Earnings per share for all periods presented prior to the quarter ended June 30, 1996 has been recomputed using 66,366,500 shares, the number of shares outstanding immediately following completion of the Recapitalization. Earnings per share for the quarters ended June 30, September 30 and December 31, 1996 has been calculated using such 66,366,500 shares, plus the weighted average number of shares issued since the Recapitalization.
(B) Includes nonrecurring costs of $57.1 million ($34.5 million net of a $22.6 million tax benefit) or $0.52 per share.