Health Power HMO owns two three-story office buildings located in Columbus, Ohio, which are used as its principal office facilities. These buildings contain approximately 14,195 square feet of office space. Health Power HMO also leases office space in Cincinnati, Ohio, which is used for its Cincinnati service area operations.
The following table sets forth selected consolidated financial data, operating statistics, and membership data for the Company as of and for each of the years in the five-year period ended December 31, 1997. All periods in the table have been restated to reflect the acquisition of CompManagement, which was accounted for as a pooling of interests.
(2) HMO selling, general and administrative expenses calculated as a percentage of Medicaid and commercial revenues.
Health Power HMO has also entered into an agreement to transfer the contract rights for its Butler County (between Dayton and Cincinnati), Ohio Medicaid membership to Medical Mutual in exchange for Medical Mutual's contract rights for that entity's Montgomery County (Dayton) Medicaid membership. Under their respective provider agreements, Health Power HMO and Medical Mutual were providing health care services to approximately 500 Butler County Medicaid recipients and 800 Montgomery County Medicaid recipients, respectively, as of December 31, 1997.
The foregoing transactions are subject to a number of conditions, including approvals from ODI and ODHS. Health Power HMO expects to complete these transactions, subject to regulatory approvals, during the second quarter of 1998.
In July 1996, Health Power HMO and Health Power Management entered into agreements with MedOhio Health, Inc. and MedOhio Health Plan, Inc. (collectively, "MedOhio Health") to offer and manage a private label managed care product known as the "University Healthcare Plan." Health Power HMO began offering the University Healthcare Plan to Franklin County Medicaid recipients during the first quarter of 1997. MedOhio Health terminated these agreements effective as of January 31, 1998. The loss of these agreements will not have a significant effect on the operations of Health Power HMO.
accounts as part of the Company's financial turnaround plan, along with the termination of the State of Ohio employee commercial group contracts. See "Recent Developments--Termination of State of Ohio Employee Commercial Group Contracts." Health Power HMO's Medicaid revenues decreased $1.4 million, or 3.2%, to $42.8 million during 1997, as compared to $44.2 million for the prior year. Medicaid revenues decreased primarily as a result of a 4.4% decrease in revenue per member months, which was partially offset by a 1.2% increase in member months. The decrease in the Medicaid revenue per member month resulted from the July 1996 capitation rate reduction of approximately 12% from ODHS, which was partially offset by the July 1997 capitation increase of approximately 4%. Because of favorable economic conditions, Ohio experienced a 13% decrease in the number of eligible Medicaid recipients enrolled in the OWF Program during 1997. This decrease has impacted Health Power HMO by a loss of Medicaid membership during the latter half of 1997 caused by involuntary terminations. Involuntary terminations relate to members who are no longer eligible to receive Medicaid benefits. The decrease in the number of eligible Medicaid recipients may continue to negatively impact Health Power HMO in 1998.
The Company's selling, general and administrative ("SGA") expenses increased $8.7 million, or 54.6%, to $24.6 million for 1997, from $15.9 million for 1996. CompManagement's SGA expenses increased $10.0 million, or 159.2%, to $16.3 million for 1997, from $6.3 million for 1996. This increase was primarily a result of CompManagement Health Systems' expenditures of $8.2 million in 1997 in connection with the operation of its MCO; it was not operational in 1996. The balance of the increase in SGA expenses was to support the increase in the number of employers contracting for CompManagement's services. Health Power HMO's SGA expenses decreased $1.3 million, or 13.7%, to $8.3 million for 1997, from $9.6 million for 1996. These SGA expenses, stated as a percentage of Health Power HMO's revenues (the "HMO administrative ratio"), were 15.5% for 1997, as compared to 16.2% for 1996. The improvement in Health Power HMO's SGA expenses and HMO administrative ratio was the result of management's implementing a plan of action to turn around the HMO business. Among the actions implemented were a reduction in the number of HMO employees, limited use of contract labor, and cost savings in the areas of professional fees, transportation, and advertising.
The Company finances its operations through internally generated funds, and its principal sources of cash have been contract and MCO revenues from CompManagement and CompManagement Health Systems, respectively, premium revenues from Health Power HMO, and investment income. The Company's principal capital needs are to fund ongoing operations and to maintain necessary regulatory capital. At December 31, 1997, the statutory net worth of Health Power HMO was $577,350, which did not meet Ohio's minimum statutory net worth requirements in effect on such date. Furthermore, the minimum statutory net worth dollar amount requirement was increased to $1.7 million effective as of January 1, 1998. See Footnote 14 of the Notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K. Health Power HMO has submitted a corrective action plan to ODI outlining the proposed actions to be undertaken by the HMO to bring it in compliance with the minimum statutory net worth requirements. The corrective action plan is currently under review by ODI. Health Power HMO had been placed under supervision by ODI in December 1996, because of its failure to satisfy the minimum statutory net worth requirements. It was released from supervision in March 1997, after satisfying ODI's release requirements. This increased minimum statutory net worth requirement will place an additional burden on the Company's capital needs during 1998.
CompManagement has entered into a lease agreement to lease a 70,000 square foot building in Dublin, Ohio, and began occupying this space in November 1997. The lease is for a term of 15 years, provides for annual rents ranging from $251,864 in year one to $953,312 in year eight and thereafter, and requires CompManagement to pay all operating expenses for the building. The lease also provides for, among other things, three renewal options of five years each, an option to purchase the building, and a right of first offer with respect to the sale of the building. The lease restricts CompManagement's ability to distribute funds and/or assets to the Company or another affiliate unless CompManagement meets certain tangible net worth requirements.
As previously discussed, the Company's management believes that, barring unforeseen circumstances, the Company's operating results on a consolidated basis will continue to be profitable during 1998. The Company believes that internally generated funds will be sufficient to support the Company's ongoing operations and satisfy regulatory capital requirements during 1998.
The Year 2000 Issue is the result of computer programs having been written using two digits rather than four to define the applicable year. Any of the computer programs used by the Company or its subsidiaries that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of uncertain duration in the Company's operations, including, among other things, an inability to process transactions or engage in normal business activities. The Company's management currently does not believe that the cost of addressing the Year 2000 Issue will materially effect the Company's business, operations, or financial condition or will require material expenditures of capital for Year 2000 compliance.
Health Power HMO participates in the OWF Medicaid program through its contract with ODHS. Under this contract, Health Power HMO is paid a fixed monthly capitation rate from ODHS for each Medicaid recipient enrolled in its HMO. This capitation rate was reduced by approximately 5% in 1995 and further reduced by approximately 12% in 1996. Although increased by approximately 4% in 1997, there can be no assurance that the capitation rates under this contract will not be reduced in the future. The current contract with ODHS expires in September 1998, and there can be no assurance that this contract will be renewed upon its expiration. For the years ended December 31, 1997, 1996, and 1995, Medicaid revenues represented approximately 56%, 67%, and 64%, respectively, of the Company's consolidated revenues. The loss of this contract or further reductions in capitation rates paid by ODHS would have a material adverse effect on the Company's business, financial condition, and operations. Furthermore, because of favorable economic conditions, Ohio experienced a 13% decrease in the number of eligible Medicaid recipients enrolled in the OWF Program during 1997. This decrease has impacted Health Power HMO by a loss of Medicaid membership during the latter half of 1997 caused by involuntary terminations. Involuntary terminations relate to members who are no longer eligible to receive Medicaid benefits. The decrease in the number of eligible Medicaid recipients may continue to negatively impact Health Power HMO in 1998.
employers will be renewed upon their expiration, or if renewed, upon terms favorable to CompManagement. The failure to renew one or more of the contracts with these three trade associations could have a material adverse effect upon the Company's revenues.
Each of the Company's operating subsidiaries are subject to regulation by governmental agencies or are otherwise dependent upon plans or programs administered by governmental agencies. These governmental plans and programs have been implemented pursuant to state statutes and regulations and, in the case of Medicaid, federal statutes and regulations. Health Power HMO is subject to extensive regulation by various state agencies relating to, among other things, scope of benefits, premium rates, quality assurance procedures, enrollment requirements and financial condition. CompManagement Health Systems is subject to extensive regulation by OBWC relating to the operation of its MCO. Any changes to Ohio's statutes or regulations applicable to group rating plans or the Health Partnership Program, or interpretations of these statutes and regulations by OBWC, could have a material adverse effect upon the revenues and operations of CompManagement and CompManagement Health Systems. Any changes to the Medicaid program could have a material adverse effect upon the revenues and operations of Health Power HMO. There can be no assurance that the Company's subsidiaries will be able to continue to maintain required regulatory authority or that regulatory changes will not have an adverse impact on the Company in the future.
Health Power HMO's profitability is dependent, in part, upon its ability to predict and control health care costs. Health care costs are affected by a variety of factors that are difficult to predict and not entirely within Health Power HMO's control, including the severity and frequency of claims. Health care cost inflation, new technologies, natural disasters, epidemics and other external factors may adversely affect Health Power HMO's ability to control the costs of providing health care services. Although Health Power HMO attempts to control these health care costs through a variety of techniques, including capitation and fee schedule arrangements with primary care physicians and other providers, advance approval for elective hospital admissions, utilization review, appropriate underwriting criteria, quality assurance programs and reinsurance arrangements, there can be no assurance that Health Power HMO will be successful in its efforts to control these costs in the future.
The occurrence of certain severe medical claims by HMO members cannot be predicted with any certainty. In order to protect itself against severe claims with respect to its commercial members, Health Power HMO maintains reinsurance coverages in amounts it believes adequate for its commercial business. However, there is a risk that, because of average daily maximum limitations, Health Power HMO could be responsible for hospital costs in excess of its
Health Power HMO is also subject to the risk of other claims normally associated with the operation of an HMO, including claims resulting from decisions regarding providers, medical circumstances or necessity of treatment, including failure to approve medical procedures or hospital admissions, claims against Health Power HMO for malpractice by providers in its network, claims for failure to provide coverage or wrongful termination of coverage, claims resulting from other issues with employer groups, members or providers and other general liability claims. Various claims have recently been made against other HMOs to expand the liability of the HMO to include damages arising from a member's failure to obtain medical treatment due to the HMOs refusal of coverage or the negligence of providers with whom the HMO directly or indirectly contracts. Certain legislation currently before the Ohio General Assembly includes provisions expanding liability of managed health care companies to include damages arising from a member's failure to obtain medical treatment due to the HMOs refusal of coverage. Although Health Power HMO maintains malpractice and general liability insurance and requires its providers to maintain malpractice insurance, there is a risk that claims could exceed or not be covered by insurance.
The operations of Health Power HMO is highly dependent upon the efforts of certain key personnel, particularly Dr. Bernard F. Master, who serves as both its chief executive officer and chief operating officer. The operations of CompManagement and CompManagement Health Systems are highly dependent upon the efforts of certain key personnel, particularly Robert J. Bossart, Jonathan R. Wagner, and Richard T. Kurth. The loss of the services of any of these individuals could have a material adverse effect on the operations of the Company. The Company or one of its subsidiaries has employment agreements with each of these individuals.
As discussed in Note 14 to the financial statements, at December 31, 1997, the Company's HMO subsidiary did not meet minimum statutory net worth and admitted asset requirements as established by the Ohio Department of Insurance.
A. DESCRIPTION OF OPERATIONS: Health Power, Inc. (the Company) is a Delaware holding company that operates Health Power HMO, Inc., a health maintenance organization (HMO) in and around the Columbus, Cincinnati, Dayton, Cleveland and Youngstown, Ohio, areas for Medicaid recipients primarily enrolled in the Ohio Works First/Healthy Start (OWF) programs, as well as for commercial members. The HMO has a one-year accreditation from the National Committee for Quality Assurance (NCQA), which expires March 26, 1999. The Company also provides full-service workers' and unemployment compensation consulting services through its CompManagement, Inc. (CompManagement) subsidiary (see Note 2) to employers in the State of Ohio. Effective March 1, 1997, CompManagement Health Systems, Inc., a subsidiary of CompManagement, began operations as a managed care organization for the Ohio Bureau of Workers' Compensation (OBWC).
Primary care and physician-related costs and hospital costs include management's estimate of services provided but not reported at year-end and expected future losses on contracts in effect at year-end. The Company recognizes expected future contract losses when it is probable that expected future health care costs and maintenance costs under a group of existing contracts will exceed anticipated future premiums and stop-loss insurance recoveries on those contracts. The reserve for expected future contract losses is approximately $11,853 and $266,175 as of December 31, 1997 and 1996, respectively, and
is included with health care costs payable. The methods of making such estimates and for establishing the resulting liabilities are continually reviewed and updated based on current circumstances, and any adjustments resulting therefrom are currently reflected in operations. It is reasonably possible that circumstances impacting these estimates may change in the near term.
H. INCOME TAXES: Deferred income tax assets and liabilities are recognized for the tax consequences of "temporary differences" by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect on deferred tax assets and liabilities of a change in tax rates recognized as income or expense in the period that includes the enactment date.
I. MEMBERSHIP ACQUISITION COSTS: Effective June 30, 1996, the HMO acquired by assignment from ChoiceCare Health Plans, Inc., an Ohio corporation (ChoiceCare), certain contract rights with respect to ChoiceCare's provider agreement with the ODHS. Under that provider agreement, ChoiceCare previously provided health care services to OWF Medicaid recipients residing in Hamilton County, Ohio. Through its acquisition of such contract rights, approximately 12,000 OWF Medicaid recipients previously served by ChoiceCare were enrolled in the Company's HMO effective July 1, 1996. The purchase price for the contract rights assigned to the Company's HMO was $5 million and was charged to operations in 1996.
K. USE OF ESTIMATES: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
L. NEW ACCOUNTING PRONOUNCEMENTS: Effective December 31, 1997, Health Power, Inc., adopted SFAS No. 128, Earnings Per Share. The statement specifies the computation, presentation and disclosure requirements for earnings per share for entities with publicly held common stock (see Note 17). All reported prior period earnings per share information has been restated in accordance with SFAS No. 128.
On July 21, 1995, CompManagement was merged with and into the Company, and 634,878 shares of the Company's common stock were issued in exchange for all the outstanding common stock of CompManagement. The merger has been accounted for as a pooling of interests, and the financial statements for 1995 have been restated to include CompManagement.
Accounts receivable from primary care providers primarily represent amounts due for referral claims paid by the Company on behalf of capitated Medicaid primary care providers. Premium receivables include these amounts primarily due from commercial contracts billed during 1997 and 1996, respectively. Contract receivables primarily represent amounts due from the OBWC
for incentive and bonus earned of approximately $2,558,500 in the fourth quarter of 1997. The Company maintains an allowance for doubtful accounts when the receivable is deemed uncollectible.
In 1997 and 1996, the Company's HMO provided incentives to capitated primary care providers to promote appropriate utilization and control of hospital and ancillary medical costs. These incentives included withholds and risk-sharing funds. Risk-sharing funds were established using budgeted amounts and shared with providers based on actual utilization and health care cost experience.
The Company's HMO withholds 10%-20% of fees due certain commercial primary care providers and 10% of fees due Medicaid primary care providers as a reserve for potential excessive utilization. The balances in these reserve accounts were retained by the Company or remitted to the providers at the end of the year at the discretion of the Company.
Effective January 1, 1997, the HMO entered into an agreement to outsource the claims adjudication and payment process and other administrative functions related to the HMO's Medicaid and commercial members with a third-party administrator. The HMO incurred approximately $1,358,000 of operating expenses under this agreement as of December 31, 1997. In November 1997, the HMO terminated the original agreement and contracted a new third-party administrator in December 1997. The new administrative and claim processing agreement is for five years beginning on May 1, 1998 and the fees are subject to adjustment at the end of each twelve-month period. The operating expenses to be incurred under these agreements for 1998 is approximately $1,764,000 and for the years 1999 to 2002, at a minimum of approximately $600,000 per year.
The significant components of the deferred tax benefit (expense) for the years ended December 31, 1997, 1996 and 1995 were as follows:
The Company engages in transactions with medical centers and companies controlled by certain shareholders and directors of the Company and its subsidiaries, which are herein referred to as affiliates or affiliated providers, as follows:
The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for grants in 1997, 1996 and 1995, respectively: no dividend yield for all years; risk-free interest rates are different for each grant and range from 5.44% to 7.06%; the expected lives of options are estimated to be five years; and a volatility of 41.97% for 1997 grants and 54.73% for 1996 and 1995 grants.
d. MedOhio Stock Options: During 1996, the Company entered into a management agreement with Med Ohio Health, Inc., and Med Ohio Health Plan, Inc., to offer a managed care product. In connection with this agreement, MedOhio was granted the option to purchase 25,000 shares of common stock of the Company. Each option has an exercise price of $6.50 per share. This option vests based on performance over the four-year period beginning with the year closing on June 30, 1997 and ending with the year closing on June 30, 2000. At the end of each year within this period, 6,250 options will vest if a predetermined number of new members are added by MedOhio for the year (otherwise, the 6,250 options are forfeited). At June 30, 1997, all 6,250 options were forfeited.
current status of the Company and MedOhio's performance (number of new members added) to date, the Company has determined that it is likely that the 1997 options will not vest. As a consequence and in accordance with SFAS 123, the Company has not yet recognized any expense for these options. Outstanding options at December 31, 1997 was 18,750 and have a remaining contractual life of five and one-half years and an exercise price of $6.50 per share. In February 1998, the agreement with Med Ohio Health, Inc. was terminated and all available options were forfeited.
As of December 31, 1997, Ohio law required HMO's providing both basic and supplemental health care services to maintain statutory net worth in an amount such that admitted assets were equal to at least one hundred and ten percent of liabilities, but in no event less than $500,000. At December 31, 1997, the statutory net worth of the Company's HMO was $577,350, which did not meet these minimum statutory net worth requirements. This failure will cause the Company's HMO to submit a corrective action plan to the Department.
Management will provide its corrective action plan to the Department. Additionally, the board of directors has adopted a resolution authorizing and directing the officers of the Company and its subsidiaries to take appropriate action, as may be directed or approved by the Department of Insurance, to increase the HMO's statutory net worth to meet the new minimum net worth requirements.
Identifiable assets by segment are those assets that are used in the Company's operations in each segment. Corporate assets are principally cash, prepaids and property, plant and equipment.
Condensed balance sheets of Health Power, Inc. (parent company only) as of December 31, 1997 and 1996 and the condensed statements of operations and cash flows for the years ended December 31, 1997, 1996 and 1995 are as follows: