Overview. We sell HMO and HMO-related products primarily to members in two groups: the commercial programs for employer-group members and individuals and the Secure Horizons program for Medicare beneficiaries. Our specialty managed care HMOs and HMO-related products and services supplement our commercial and Secure Horizons programs. These include pharmacy benefit management, behavioral health services, life and health insurance and dental and vision services.
2000 results include impairment, disposition, restructuring, OPM and other net pretax charges totaling $9 million ($5 million or $0.15 diluted loss per share, net of tax). See Note 9 of the Notes to Consolidated Financial Statements.
In October 2000, we announced our intention to withdraw our commercial HMO and POS products from 15 Colorado counties. This plan affects approximately 25,000 commercial HMO and POS members. The effective date for this withdrawal is May 1, 2001. We will retain our commercial HMO products in other Colorado counties where the vast majority of our members reside. Qualified employers may apply for our PPO, which is not affected by this service area change.
We completed the exit of all HMO operations in Ohio. This exit affected approximately 35,000 commercial members and 3,500 Medicare members located in Ohio and Kentucky who were enrolled in our plans during 2000. (These 3,500 Medicare members were included in our 2001 proposed Medicare benefits plan changes submitted to HCFA as discussed above.) We entered into an agreement with Anthem Blue Cross and Blue Shield to assist in transitioning Ohio’s commercial membership. Medicare members were provided a choice of another Medicare+Choice HMO or traditional fee-for-service Medicare. See Note 4 of the Notes to Consolidated Financial Statements.
During the first half of 2000, we assumed approximately 18,000 members in Colorado and 21,000 members in Washington as a result of transition agreements signed with QualMed Plans for Health of Colorado and with QualMed Washington Health Plans, Inc. (together, “QualMed”), each a subsidiary of Health Net, Inc. See Note 4 of the Notes to Consolidated Financial Statements.
Texas membership includes Harris members totaling approximately 130,000 commercial and 43,000 Medicare at December 31, 2000.
Medicare membership increased four percent at December 31, 2000 compared to the prior year due to:
Competitor exits in markets where Secure Horizons will remain, primarily in Arizona, Nevada and Texas; partially offset by
Membership decreases as a result of our January 2000 county exits in California, Ohio, Oregon and Washington.
Employer self-funded membership increased approximately 18 percent at December 31, 2000 compared to the same period in the prior year primarily due to additional membership from the Harris acquisition, partially offset by membership losses in Colorado. PPO and indemnity membership increased approximately 44 percent at December 31, 2000 compared to the prior year primarily due to additional Harris membership.
Commercial Premiums. Commercial premiums increased 23 percent or $918 million for the year ended December 31, 2000 compared to the prior year as follows:
Premium rate increases that averaged approximately eight percent for the year ended December 31, 2000
Medicare Premiums. Medicare premiums increased nine percent or $540 million for the year ended December 31, 2000 compared to the prior year as follows:
Premium rate increases that averaged approximately seven percent for the year ended December 31, 2000
Other Income. Other income increased approximately 17 percent or $21 million for the year ended December 31, 2000 compared to the prior year. The increases were primarily due to increased mail-service revenues of Prescription Solutions, including mail-service revenues from the acquired Harris business. Prescription Solutions generates mail-service revenues, where we, rather than network retail pharmacies, collect the member copayments.
Consolidated Medical Care Ratio. The consolidated, commercial and Medicare medical care ratios (health care services as a percentage of premium revenue), including favorable changes in estimates for the first quarter, increased for the year ended December 31, 2000 compared to the prior year primarily due to:
Higher physician, hospital, outpatient, emergency service utilization and higher cost of claims under fee-for-service or risk-based contracts; and
The commercial medical care ratio includes the specialty HMOs and indemnity insurance results.
Health care costs for the year ended December 31, 2000, were reduced by $9 million ($5 million or $0.14 diluted earnings per share, net of tax), of which $6 million is related to our commercial product line. These reductions were a result of our favorable first quarter 2000 resolution of prior period estimates relating to a provider contract. Excluding the effects of these favorable changes in estimates, the medical care ratios were as follows:
Increases in short- and long-term interest rates combined with the gradual shift of tax-exempt investments to higher yielding taxable securities.
Interest Expense. Interest expense increased approximately 85 percent for the year ended December 31, 2000 compared to the prior year due to:
Provision for Income Taxes. The effective income tax rate was 44.1 percent for the year ended December 31, 2000, compared with 42.2 percent in 1999. Because of lower 2000 earnings, the non-deductible goodwill amortization expense is a higher percentage of pretax income, increasing our 2000 effective tax rate.
Membership. Total HMO membership increased four percent to approximately 3.7 million members at December 31, 1999 from approximately 3.5 million members at December 31, 1998.
Membership losses attributable to our continued focus on renewing commercial contracts with sufficient price increases to improve gross margin, primarily in Washington and Texas.
Medicare membership increased four percent at December 31, 1999 compared to membership at December 31, 1998 due to:
Commercial Premiums. Commercial premiums increased four percent or $171 million for the year ended December 31, 1999 compared to premiums in the prior year as follows:
Premium rate increases that averaged approximately six percent for the year ended December 31, 1999
Medicare premium rates on a per member basis increased due to higher HCFA premiums received, changes in membership demographics and health status, higher retiree supplemental premiums and the exit of the Utah Medicaid business.
Consolidated Medical Care Ratio. The 1999 consolidated medical care ratio (health care services as a percentage of premium revenue) declined slightly compared to 1998 primarily because current year provider reserves were significantly less than in 1998.
Excluding 1998 net provider reserves, the increase in the 1999 consolidated medical care ratio compared to 1998 was primarily due to higher contracted physician costs, increased pharmacy utilization, pharmacy benefit enhancements and higher prescription drug costs for our Secure Horizons members.
Medicare Medical Care Ratio. The Medicare medical care ratio for the year ended December 31, 1999 increased compared to the prior year due to:
Increased pharmacy utilization, pharmacy benefit enhancements and higher prescription drug costs; partially offset by
Reduced hospital expenses, primarily because current year provider reserves were significantly less than in 1998.
Marketing, general and administrative expenses as a percentage of operating revenue
Operating Income. Factors contributing to the increase in operating income are discussed above.
Net Investment Income. Net investment income decreased approximately 19 percent for the year ended December 31, 1999 compared to the prior year due to the following:
Fewer realized gains on sales of marketable securities in the current year; and
Interest Expense. Interest expense decreased approximately 29 percent for the year ended December 31, 1999 compared to the prior year due to the reduction in outstanding borrowings until December 1999, when we borrowed $400 million to fund our share repurchase program, and lower overall average interest rates paid on our credit facility.
Provision for Income Taxes. The effective income tax rate was 42.2 percent in 1999, compared with 47.5 percent in 1998. The rate declined significantly because:
The 1998 effective tax rate included an increase related to nondeductible losses recognized for the dispositions of the Utah HMO and workers’ compensation subsidiaries; and
Financing Activities. For the year ended December 31, 2000, we used $301 million of cash for financing activities compared to $194 million used for the same period in the prior year. The increase of $107 million was the result of the following:
We repurchased 4.0 million shares of our common stock in 2000 for $173 million and 8.8 million shares of our common stock in 1999 for $480 million under our stock repurchase program;
In 1999, we paid UniHealth Foundation $60 million in consideration for UniHealth Foundation’s vote in favor of the reclassification of our stock and in consideration for the agreements and covenants contained in the stock repurchase agreement between PacifiCare and UniHealth Foundation. In addition, we incurred $2 million of expenses related to the reclassification of our common stock and the registration of the shares held by UniHealth Foundation. No consideration of this type was paid in 2000; partially offset because
Receivables, Net. Receivables, net increased $104 million from December 31, 1999 as follows:
$68 million net increase in premium receivables primarily due to premium rate increases;
$13 million net increase in other trade receivables primarily due to higher prescription drug rebate receivables; and
Goodwill and Intangible Assets, Net. Goodwill and intangible assets increased $17 million from December 31, 1999 as follows:
Medical Claims and Benefits Payable. Medical claims and benefits payable increased $476 million from December 31, 1999 as follows:
This document contains forward-looking statements that involve risks and uncertainties. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology including, “may,” “will,” “could,” “should,” “intend,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potentially,” “continue,” or “opportunity” or the negative of these terms or other comparable terminology. The statements about our plans, strategies, intentions, expectations and prospects contained throughout the document are forward-looking and are based on current expectations. Actual results may differ materially from those we predict as of the date of this report in the forward-looking statements. In addition, past financial performance is not necessarily a reliable indicator of future performance and investors should not use historical performance to anticipate results or future period trends. In evaluating these statements, you should specifically consider factors, including the risks described below and in other parts of this document.
The inability of our marketing and sales plans to attract new customers or retain existing customers;
The effect of premium increases, benefit changes and member-paid supplemental premiums and copayments;
Health Care Costs. Our profitability depends, in part, on our ability to control health care costs while providing quality care. Our primary focus is securing cost-effective physician, hospital and other health care contracts to maintain our qualified network in each geographic area we serve.
Formularies are lists of physician-recommended drugs in different therapeutic classes that have been reviewed for safety, efficacy and value. These lists help ensure that members get the right prescription at the right time in the right dose, avoiding potential adverse effects. Formularies also ensure that the costs are effectively managed; if two medications have the same effect, the less expensive option is recommended. Medically necessary drugs not included in the formulary can be obtained through our authorization process provided they are not specifically excluded from coverage or for the treatment of excluded benefits. We continue to conduct member and physician education programs to provide information on the appropriate use of generic drugs, over the counter drugs and antibiotics. Many of our medical groups share the financial risk for prescription drugs as an incentive to find the most effective and cost-efficient treatments for our members. As a way of controlling this health care cost component, we have implemented a decrease in prescription drug benefits for Secure Horizons members in almost all of our geographic areas in 2001.
Changes in the mix of our capitated, risk-based and fee-for-service physician and hospital contracts;
Medical and prescription drug costs that rise faster than premium increases;
The effect of federal and/or state legislation on our ability to secure cost-effective contracts with physicians and hospitals;
Termination of physician or hospital contracts, physician or hospital instability or renegotiations of such contracts at less favorable rates or terms of payment.
Legislation and Regulation. Recent changes in state and federal legislation have increased and will continue to increase the costs of regulatory compliance, and proposed changes in the law may negatively impact our financial and operating results. These changes may increase our health care costs, decrease our membership or otherwise adversely affect our revenues and our profitability. Regulation and enforcement is increasing both at the state and federal level. Increased regulations, mandated benefits and more oversight, audits and investigations may increase our administrative, litigation and health care costs. The following recent or proposed legislation, regulation or initiatives could materially affect our financial position:
Federal regulations that place additional restrictions and administrative requirements on the use, electronic retention, transmission and disclosure of personally identifiable health information (see HIPAA);
New and proposed legislation that permits and would permit independent physicians to collectively bargain with health plans on a number of issues including financial compensation;
Proposed legislation and regulation could also include adverse actions of governmental payors, including reduced Medicare premiums; discontinuance of, or limitation on, governmentally funded programs; recovery by governmental payors of previously paid amounts; the inability to increase premiums or prospective or retroactive reductions to premium rates for federal employees; and adverse regulatory actions;
New and increased initiatives at the DOJ, the Office of Inspector General of the United States Department of Health and Human Services, the Office of Inspector General of the United States Office of Personnel Management and the various enforcement divisions of the state regulatory agencies governing health care programs. These initiatives pursue both civil and criminal investigations against physicians, hospitals, payors, and pharmaceutical companies for misconduct relating to potential health care fraud and abuse, false claims, ERISA violations, violations of the Medicare program, overbilling of government programs, incorrect reporting of data, and improper denial or mismanagement of care;
Existing state legislation and regulation that may increase the financial capital requirements of physicians and hospitals who contract with HMOs to accept financial risk for health services. Proposed state legislation, regulation, or litigation that would otherwise limit our ability to capitate physicians and hospitals or delegate financial risk, utilization review, quality assurance or other medical decisions to our contracting physicians and hospitals; and
Regulatory Oversight. In November 2000, our Texas subsidiary was placed under administrative oversight by the Texas Department of Insurance due to various issues including delegated and non-delegated claims processing timeliness. The Texas Department of Insurance continues to monitor our Texas HMO. We are working with them to resolve any remaining concerns.
Industry Risk. Consumers, physicians and hospitals are currently attacking practices of the HMO industry through a number of separate purported class action lawsuits against us (see Note 10 of the Notes to Consolidated Financial Statements) and against other national HMOs. These lawsuits, including those filed to date against us, may take years to resolve and, depending upon the outcomes of these cases, may cause or force changes in practices of the HMO industry. These cases also may cause additional regulation of the industry through new federal or state laws. These actions ultimately could adversely affect the HMO industry and could have a material effect on our financial position, results of operations or cash flows of a future period and prospects of PacifiCare.
HIPAA. We expect to modify all of our information systems to comply with the HIPAA regulations regarding standardizing transactions and codes. We also expect to incur expense developing systems and contracts to comply with the HIPAA privacy rules. We estimate that our HIPAA compliance costs will approximate $20 million in 2001. Our estimate of HIPAA compliance costs may change as current HIPAA rules evolve and additional rules are released or as we continue to evaluate the work required to modify our existing information technology and development systems.
Marketing, General and Administrative Risk Factors. The following factors could have an adverse impact on marketing, general and administrative expenses:
Office of Personnel Management Contingencies. We intend to negotiate with OPM on any existing or future unresolved matters to attain a mutually satisfactory result. We cannot be certain that any ongoing and future negotiations will be concluded satisfactorily, that additional audits will not be referred to the DOJ, or that additional, possibly material, liability will not be incurred. Such liability could have a material effect on results of operations or cash flows of a future period if resolved unfavorably. See Note 10 of the Notes to Consolidated Financial Statements.
We have been notified by HCFA that audits of the ACR proposals will be conducted in Arizona, Oklahoma, Oregon and Washington in 2001. We cannot be certain that any ongoing and future audits will be concluded satisfactorily. We may incur additional, possibly material, liability as a result of these audits. The incurrence of such liability could have a material effect on results of operations or cash flows of a future period.
Contracting. We expect the percentage of commercial membership under hospital risk-based contracts to increase only six percent and the percentage of Medicare membership under hospital risk-based contracts to increase only three percent compared to the percentage at December 31, 2000.
Membership. We expect commercial and Medicare membership to decline compared to membership at December 31, 2000, as we exit high-cost service areas and provider contracts. We expect commercial membership to decline 10 to 12 percent compared to December 31, 2000. We expect Medicare membership to decline six to eight percent compared to December 31, 2000.
Medical Care Ratio. We plan to implement premium increases sufficient to offset health care cost increases, to regain long-term stability in our medical care ratio. We expect the commercial medical care ratio for 2001 to range between 86 and 87 percent. We expect the Medicare medical care ratio for 2001 to range between 90 and 91 percent.
Weighted Average Number of Shares. We expect the weighted average number of shares used to compute diluted earnings per share to be approximately 33.6 million shares for the year ended December 31, 2001.
See the Index included at “Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.”