The Company owns five office buildings. These buildings are located in Rockville and Frederick, Maryland and total approximately 321,000 square feet of office and warehouse space. The Company's headquarters is located at 4 Taft Court, Rockville, Maryland 20850.
In addition, the Company leases approximately 212,000 square feet of office space and approximately 5,200 square feet of warehouse space in various locations within its service areas to support sales and administrative operations.
4. Days include acute and non-acute, skilled nursing, neonatal intensive care and psychiatric inpatient care.
2. The possibility of state budget related mandates that reduce premiums for Medicaid recipients.
5. The possibility that the Company is not able to increase its market share at the anticipated premium rates.
During the three year period ended December 31, 1998, the Company experienced modest membership expansion. While membership in certain products continues to grow, others have shown decreases when compared with 1997. The Company has achieved its overall size by continually expanding its product lines which include point-of-service, small group, indemnity health, hybrid products, Medicaid and Medicare, group term-life and through expansion into new geographic markets. Premium rates during this time have remained at or near competitive levels for the Company's marketplace. During 1998, after consideration of non-recurring adjustments, the Company's consolidated operating margin showed increased profits over 1997. The Company achieved 1998's results, in part, by implementing product price increases and reducing membership in products or effectively terminating groups that had the potential for continued unprofitability. The Company anticipates that it will continue to increase premium rates during 1999. This is a forward-looking statement. See "Forward-Looking Information" above for a description of those risk factors.
The Company generally receives a fixed premium amount per member per month while the majority of medical expenses are variable and significantly affected by spontaneous member utilization. Even with managed care controls, unusual medical conditions can occur, such as an outbreak of influenza or a higher than normal incidence of high cost cases (such as premature births, complex surgeries, or rare diseases). As a result, the Company's quarterly results can be materially affected and irregular. However, over the longer business cycle, the Company believes that its managed care control systems, underwriting procedures (when allowed) and network of providers should result in continued profitability.
Due to the continued escalation of health care costs and the inability of many individuals to obtain health care insurance, numerous proposals relating to health care reform have been made and put into effect, and additional proposals may be introduced, in the United States Congress and the legislatures of the states in which the Company operates or may seek to operate.
In 1997, the "Health Insurance Portability and Accountability Act of 1996, Public Law 104- 191", commonly called ("HIPAA"), was enacted. This bill establishes certain Federal requirements for large group, small group, and individual health benefit plans, and applies not only to insurers and HMOs but also to ERISA plans.
HIPAA is intended to make coverage more portable and available by limiting pre-existing condition requirements; providing special enrollment periods for employees who lose other coverage or whose family status changes; prohibiting group plans from denying an individual coverage or charging a higher premium based on the individual's health status or history; and by guaranteeing coverage availability and renewability in certain circumstances in the small group and individual markets. HIPAA also allows for the establishment of Medical Savings Accounts; increases the penalties for health care fraud and abuse; and calls for standardized health care information in order to reduce administrative costs.
Most of the provisions of HIPAA took effect on July 1, 1997, but some, like the provisions pertaining to Medical Savings Accounts, took effect earlier and others, like administrative simplification, took effect later.
In recent years, state legislatures in the HMOs service area and the U.S. Congress have considered legislation, (1) to amend civil tort law so as to extend "enterprise liability" to HMOs, and/or (2) to amend regulatory requirements to establish additional rules governing HMO internal and external appeals and grievances. Neither the Congress nor any state legislature in the HMOs service area has enacted laws, which would expand an HMO's liability in tort action.
States in the HMOs service area have enacted laws regarding internal and external appeals and grievances. Under these laws, persons covered by HMOs are given a right to seek a fast and fair review of adverse utilization review decisions, first internally by a medical director of the HMO and then by an independent review organization or by a State regulator. Maryland, North Carolina and Pennsylvania have enacted laws, which became effective January 1, 1999 or earlier in 1998, and which require HMOs to have an appeals and grievance process meeting certain requirements and to submit adverse decisions to independent outside review in certain circumstances. The District of Columbia is expected to enact similar legislation, which would become effective on January 1, 2000.
The Company believes that the current political environment in which it operates will result in continued legislative scrutiny of health care reform and may lead to additional legislative initiatives. The Company is unable to predict the ultimate impact on the Company of any Federal or state restructuring of the health care delivery or health care financing systems, but such changes could have a material adverse impact on the operations and financial condition of the Company.
The Company has priced its health products competitively in order to increase its membership base and thereby enhance its strategic position in its market place. The Company currently has one of the largest HMO and managed care enrollments and also the largest network of contract providers of medical care in its service area (which includes the entire states of Maryland and Delaware, the District of Columbia, most counties and cities in Virginia and certain areas of West Virginia, North Carolina and Pennsylvania.)
Revenue for the year ended December 31, 1998 increased approximately $76.2 million or 6.9 percent over the year ended December 31, 1997. Revenue for year ended December 31, 1998 includes $5.7 million related to the sale of certain Company owned real estate no longer required in its operations. Excluding these sales, year-over-year revenue increased 6.4 percent. A 2 percent increase in net average HMO and indemnity enrollment resulted in an increase of approximately $21.2 million in health premium revenue while a 4.8 percent increase in average monthly premium per enrollee, combined for all products, resulted in a $51.1 million increase in health premium revenue. The increase in HMO and indemnity enrollment is principally due to increases in the Company's commercial membership. Management believes that commercial health premiums should continue to increase over the next twelve months as the Company continues to increase its commercial membership and as new and renewing groups are charged higher premium rates due to legislatively mandated benefit enhancements and general price increases initiated by the Company. This is a forward-looking statement. See "Forward-Looking Information" above for a description of the risk factors that may effect health premiums per member.
The Company has implemented increased premium rates across essentially all of its commercial products. As the Company's contracts are generally for a one year period, increased pricing cannot be initiated until a contract reaches its renewal date. Therefore, price increases cannot be made across the Company's membership at the same time. Commercial premium rate increases are expected to continue in 1999 in the range of 6% to 8%. Management believes that these rate increases may have the effect of slowing the Company's future membership growth. In addition, management reevaluated premium reimbursement rates with regard to its Medicare and Medicaid programs. Specifically, effective January 1, 1998, the Company withdrew from participation in certain areas of the Virginia Medicaid program. On January 1, 1998, the Company also modified certain benefits for enrollees in its Medicare program and began to charge additional premiums in certain areas.
Service revenue from non-MAMSI affiliated entities earned by the Company's home health care subsidiaries decreased and contributed approximately $20.0 million in revenue in 1998 as compared with $21.0 million in 1997. This decrease is due to an increasing volume of business conducted for MAMSI HMO and indemnity members which is eliminated in consolidation.
Medical expenses as a percentage of health premium revenue ("medical loss ratio") decreased to 88.8 percent for 1998 compared to 89.4 percent for 1997. On a per member, per month basis, medical expenses increased 4.0 percent. Included in the year ended December 31, 1997 are the results of the Company's identification of certain claims which were overpaid. These overpayments were caused, in large part, by a combination of factors including the ever increasing complexity of the claims paying process as well as providers enhancing their ability to maximize charges. In connection with these overpayments, during 1997 the Company recorded, as a reduction of medical expenses, approximately $12 million relating to claims paid in 1996. The Company believes that it has taken the appropriate action and implemented the appropriate controls to insure that future claims are paid at the appropriate amount. These initiatives should help to control the Company's medical loss ratio. The statements in this paragraph and the preceding paragraphs regarding cost containment initiatives, total medical costs and future increases in health premiums are forward-looking statements. See "Forward-Looking Information" above for a description of risk factors that may affect medical expenses per member and the medical loss ratio.
Administrative expenses as a percentage of revenue ("administrative expense ratio") decreased to 11.3 percent for 1998 as compared to 11.7 in 1997. Adjusted to exclude the effect of the $5.7 million gain on sale of real estate, the administrative expense ratio was 11.4 percent for 1998. Management believes that the administrative expense ratio will likely remain near the current level of 11.4 percent in 1999. Management's expectation concerning the administrative expense ratio is a forward-looking statement. The administrative expense ratio is affected by changes in health premiums and other revenues, development of the Company's expansion areas and increased administrative activity related to business volume.
In September, 1998, a pretax charge of approximately $16.5 million was recognized in the Company's financial statements in anticipation of negotiations relating to potential governmental claims for contracts with OPM related to an audit conducted by the Office of Inspector General concerning the Company's participation in FEHBP for the years 1992-1997 related to findings for 1992-1994. In the normal course of business, OPM audits health plans with which it contracts to verify, among other things, that the premiums calculated and charged to OPM are established in compliance with the best price community rating guidelines established by OPM. OPM typically audits plans once every five or six years, and each audit covers the prior five or six year period. While the government's initial on-site audits are usually followed by a post-audit briefing as well as a preliminary audit report in which the government indicates its preliminary results, final resolution and settlement of the audits can take two to three years.
Service revenue from non-MAMSI affiliated entities earned by the Company's home health care subsidiaries contributed $21.0 million in revenue in 1997 as compared to $20.5 million for 1996. This increase is the result of increasing business volume for these subsidiaries, particularly in the home infusion area, which is largely offset by an increasing relative percentage of business conducted for MAMSI HMO and indemnity members which is eliminated in consolidation. Revenue from life and short-term disability products contributed $5.3 million in 1997 as compared to $3.2 million in 1996.
Medical expenses as a percentage of health premium revenue ("medical loss ratio") decreased to 89.4 percent in 1997 as compared to 92.4 percent for 1996 and, on a per member per month basis, medical expenses decreased 1.4 percent. This decrease is due to a combination of factors including continuing efforts by the Company to implement product specific cost containment controls, expanded activity in specialized subrogation areas and claims review for dual health coverage, the adoption of regionalized and product specific fee maximums for specialists from the delivery network following a continuing intensified peer review analysis. In addition, during 1997, the Company identified certain claims which had been overpaid and recorded as a reduction of medical expenses approximately $12 million relating to claims incurred and paid in 1996.
Property and equipment decreased from $57.0 million at December 31, 1997 to $45.0 million at December 31, 1998 due to the sale of two office buildings no longer required in the Company's operations and the disposal of certain computer equipment no longer needed.
Short-term investments are marked to market at the end of every quarter and the resulting unrealized gain or loss is reflected in the ending stockholders' equity balance. Accordingly, stockholders' equity at December 31, 1998 reflects an unrealized gain of $1.3 million, net of tax, on the Company's short-term investments.
Additional paid-in capital decreased from $162.9 million at December 31, 1997 to $138.2 million at December 31, 1998, principally due to activity in the Company's stock compensation trust. This trust is used to provide shares of the Company's stock to meet its stock option plan obligations.
December 31 (in thousands) 1998 1997 -------------------- Cash and cash equivalents $ 9,787 $ 3,570 Short-term investments 174,325 152,080 Working capital advances to Maryland hospitals 12,261 9,186 -------- -------- Total available liquid assets 196,373 164,836 Credit line availability 14,855 21,526 -------- -------- Total short-term capital resources $211,228 186,362 ======== ========
The Company believes that cash generated from operations along with its current liquidity and borrowing capabilities are adequate for both current and planned expanded operations. The Company sold an office building in April, 1998 at a price of approximately $3 million. In July, 1998, the Company sold another of its office buildings for approximately $9.4 million. The Company's purchase of an approximately 208,000 square foot office building in Frederick, Maryland in 1997, and the resulting consolidation of its service departments in this new facility, made the previously owned buildings unnecessary for the Company's operations.
In 1997, the Company began the process of identifying, evaluating and implementing changes to computer programs necessary to address the year 2000 issue ("Y2K"). This issue affects computer systems that have time-sensitive programs that may not properly recognize the year 2000. This could result in major system failures or miscalculations. The Company is currently addressing its internal year 2000 issue with modifications to existing programs. As a part of the Company's initial assessment, 1,300 software programs were identified for Y2K review. Of those 1,300, 182 programs were identified as needing modification of which 145 were modified and 37 were determined to be obsolete. To date, the Company has modified the majority of the programs with internal resources diverted from other projects, none of which are critical to the Company's daily operations. Testing and validation of the modified programs is complete. The Company has incurred less than $500,000 to date and does not anticipate significant additional costs to bring the Y2K compliance program to completion. Approximately two-thirds of the Company's critical vendors have indicated Y2K compliance and the Company anticipates completion of this evaluation in the second quarter of 1999. The Company is actively pursuing the remainder for confirmation of Y2K compliance. Based upon the work completed to date, the Company does not anticipate any future material impact on its financial statements. With regard to the Company's most reasonably likely worst case scenario, the Company believes that such scenario involves the possibility that a small number of reports will display incorrect data, a small number of programs may give unusual data and a small number of vendors will not be Y2K compliant. In terms of a contingency plan, the Company believes it has sufficient internal resources to be able to correct such report errors and address non-compliant vendors within a relatively short time frame. If internal resources prove to be insufficient, the Company will engage outside resources. The statements in this paragraph regarding future effects of the year 2000 issue is a forward- looking statement. See "Forward-Looking Information" for a description of risk factors.
At its February, 1998 meeting, the Board of Directors authorized a $20 million stock repurchase program which allowed the Company to purchase its stock on the open market, through block trades, or in private transactions over the succeeding 12 months. On August 3, 1998, the Executive Committee of the Board of Directors (subsequently ratified by the Board of Directors) increased the authorization to purchase up to $40 million of common stock prior to February 25, 1999. The program may be discontinued at any time. As of December 31, 1998, the Company had repurchased 5,043,700 shares of its common stock for a total cost of approximately $34.4 million under the stock repurchase program. On February 25, 1999 the Board of Directors authorized a $20 million stock repurchase program to extend through September 2, 1999.
The Company is exposed to market risk through its investment in fixed and variable rate debt securities that are interest rate sensitive. The Company does not use derivative financial instruments. The Company places its investments in instruments that meet high credit quality standards, as specified in the Company's investment policy guidelines; the policy also limits the amount of credit exposure to any one issue, issuer, or type of instrument. A hypothetical ten percent change in market interest rates over the next year would not materially impact the Company's financial position or cash flow. The Company has no significant market risk with regard to liabilities.
Consolidated Balance Sheets as of December 31, 1998 and 1997..... 31
Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 1998, 1997 and 1996........... 33
Mid Atlantic Medical Services, Inc. ("MAMSI") is a holding company whose subsidiaries are active in managed health care and other life and health insurance related activities. MAMSI's principal markets currently include Maryland, Virginia, the District of Columbia, Delaware, West Virginia, North Carolina and Pennsylvania. MAMSI and its subsidiaries (collectively referred to as the "Company") have developed a broad range of managed health care and related ancillary products and deliver these services through health maintenance organizations ("HMOs"), preferred provider organizations ("PPOs"), a life and health insurance company, home health care and home infusion services companies, a hospice company, a mail-order pharmacy, and part ownership in an outpatient surgery center.
Mid Atlantic Psychiatric Services, Inc. ("MAPSI") provides psychiatric services to third party payors or self-insured employer groups.
HomeCall, Inc., FirstCall, Inc. and HomeCall Pharmaceutical Services, Inc. ("HCPS") provide in-home medical care including skilled nursing, infusion and therapy to MAMSI's HMO members and other payors. In addition, HCPS provides mail-order pharmacy services to MAMSI's HMO members and other payors.
The significant accounting policies followed by MAMSI and its subsidiaries are described below.
Short-term investments, consisting principally of marketable equity securities, municipal bonds and tax-free bond funds, are classified as available-for-sale. These securities are carried at fair market value plus accrued interest and any unrealized gains and losses are reported in other comprehensive income, net of the related tax effect. Gains and losses are reported in earnings when realized. Gains and losses on sales of securities are computed using the specific identification method.
Amounts charged for health care services are recognized as premium revenue in the month for which enrollees are entitled to receive care. Included in premium revenue are amounts due from customers that utilize the Company's capitated primary care physician network, its medical utilization management services and other services related to health management and who self-fund, generally up to specified limits, certain elements of medical costs, such as hospitalization and specialist physicians. Premium revenue received in advance is recorded as deferred premium revenue.
Medical expense consists principally of medical claims and capitation costs. Medical claims include payments to be made on claims reported as of the balance sheet date and estimates of health care services incurred but not reported ("IBNR") to the Company as of the balance sheet date. The IBNR is estimated using an expense forecasting model that is based on historical claims incurrence patterns modified to consider current trends in enrollment, member utilization patterns, timeliness of claims submissions and other factors. This estimate includes medical costs to be incurred beyond the premium paying date that are contractually required.
The Company believes that its claims reserves are adequate to satisfy its ultimate claims liabilities; however, the liability as established may vary significantly from actual claims amounts, both negatively or positively, and as such adjustments are deemed necessary, they are included in current operations. Establishment of claims estimates is an inherently uncertain process and there can be no certainty that currently established reserves will prove adequate to cover actual ultimate expenses. Subsequent actual experience could result in reserves being too high or too low which could positively or negatively impact the Company's earnings in future periods.
In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("Statement No. 130"), which establishes standards for reporting and display of income and its components (revenue, expenses, gains and losses) in a full set of general-purpose financial statements. The Company adopted Statement No. 130 as of December 31, 1997 and has presented comprehensive income for all periods presented in the Consolidated Statements of Changes in Stockholders' Equity.
In March 1998, the AICPA issued Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"), which establishes guidelines for the accounting for the costs of all computer software developed or obtained for internal use. SOP 98-1 is effective for years beginning after December 15, 1998. The Company anticipates adopting this statement in the first quarter of 1999 and anticipates that the adoption of SOP 98-1 will not have a material impact on the Company's consolidated financial statements.
Certain balances in the 1997 financial statements have been reclassified to conform to 1998 presentation.
Investments are classified into two categories (available-for-sale or held-to-maturity) and are valued based upon this designation. Securities classified as available-for-sale, which include debt and equity securities that the Company does not have the positive intent to hold to maturity, are marked to market with the resulting unrealized gain or loss reflected in other comprehensive income. Securities classified as held-to-maturity, which are debt securities that the Company has both the positive intent and ability to hold to maturity, are carried at amortized cost. The Company classifies its statutory deposits as held-to-maturity with no effect on the recorded value. All other investments are classified as available-for- sale. Management re-evaluates these designations annually. During 1997, statutory deposit investments with an amortized cost of $3,001,000 were released by state regulatory agencies and transferred to the Company's short-term investment portfolio. The unrealized gain at the date of transfer was $94,000.
The following is a summary of available-for-sale and held-to-maturity securities at December 31, 1998 and 1997:
respective periods. Realized gains and losses are included in investment income. Other sales of short-term investments consisted principally of redemptions from municipal bond funds.
The amortized cost and estimated fair value of debt and marketable equity securities at December 31, 1998, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.
Interest expense paid in cash during 1998, 1997 and 1996 was approximately $188,000, $538,000 and $688,000, respectively.
Total tax deposits made by the Company in 1998, 1997 and 1996 were approximately $6,870,000, $2,461,000 and $10,320,000, respectively.
In accordance with a personal service contract negotiated by the Company, its former Chairman is entitled to supplemental pension benefits based upon years of service and attained salary levels. Expense recognized related to this plan was $818,000 in 1996. During 1997, the service contract was renegotiated, at which time the supplemental pension benefits package was amended to include a fixed payment benefit of $450,000 per year for a fixed term of 15 years. The reduction in pension expense recognized in 1997 related to this change was approximately $1.1 million. During 1998, certain one-time elections which reduced the fixed benefit payable to $250,000 per year, were made under the agreement which caused 1998 pension expense to be reduced by approximately $880,000.
Pro forma information regarding net income and earnings per share are required by Statement 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1998, 1997 and 1996, respectively: risk-free interest rates of 5.6%, 6.4%, and 6.3%; volatility factors of the expected market price of the Company's common stock of .42, .42, and .47 and a weighted average life of the options of 3 years. The Company anticipates that it will declare no dividends.
On April 15, 1998, the Stock Option Committee of the Company's Board of Directors authorized a voluntary exchange ("Exchange") of all existing stock options with an exercise price of $16.00 or more per share. Each stock option that was voluntarily tendered was replaced with a newly issued stock option priced at $16.00 per share. As a condition of the Exchange, option holders agreed to extend the vesting period for one year. In addition, the newly issued stock options are exercisable for one additional year beyond the current expiration date. Approximately 4.3 million options were exchanged for a like number of newly issued options.
The Company has an incentive compensation plan whereby managers receive bonuses based upon the annual operating results of the Company. During 1998, incentive compensation expense was approximately $800,000 which was paid to employees below the level of Vice President. No management bonus was earned in 1997 or 1996. In addition, certain individuals receive a cash bonus based upon the achievement of certain measurable criteria other than the annual operating results of the Company. These bonus amounts are not significant.
For financial reporting purposes, the SCT is consolidated with MAMSI. The fair market value of the shares held by the SCT is shown as a reduction to stockholders' equity in the Company's consolidated balance sheet. All transactions between the SCT and MAMSI are eliminated. The difference between the cost and fair value of common stock held in the SCT is included in the consolidated financial statements as additional paid-in capital. At December 31, 1998, 1997 and 1996, the SCT held 7,023,950, 7,959,375 and 9,020,700 shares of common stock at a fair market value of approximately $68.9, $101.5 and $120.7 million, respectively.
The Company leases certain equipment and office space under the terms of noncancellable operating leases that expire at various dates through 2000. Rent expense relating to these operating leases approximated $3,502,000, $3,552,000 and $3,316,000 in 1998, 1997 and 1996, respectively.
Future minimum lease commitments under non-cancelable operating leases are as follows for the years ended December 31 (in thousands):
1999 $ 2,907 2000 1,505 2001 719 2002 397 2003 203 ------- $ 5,731 =======
The Company intends to negotiate with OPM on all matters to attain a mutually satisfactory result. There can be no assurance that these negotiations will be concluded satisfactorily, that the audit will not be referred to the DOJ, or that additional, possibly material, liability will not be incurred. The Company believes that any ultimate liability in excess of amounts accrued would not materially affect the Company's consolidated financial position. However, such liability could have a material effect on results of operations or cash flows of a future period if resolved unfavorably.
The Company is involved in other various legal actions arising in the normal course of business, some of which seek substantial monetary damages. After review, including consultation with legal counsel, management believes any ultimate liability that could arise from these other actions will not materially effect the Company's consolidated financial position or results of operations.
1998 1997 -------------------------- -------------------------- Minimum Actual Minimum Actual ---------- ----------- ---------- ----------- M.D. IPA $3,000,000 $42,000,000 $3,000,000 $43,300,000 OCI 3,000,000 56,000,000 3,000,000 49,800,000 MLH 500,000 34,500,000 500,000 28,300,000 OCCI 2,500,000 2,900,000 2,500,000 1,800,000 OCIPA 1,500,000 2,400,000 1,500,000 2,700,000
Effective January 1, 1998, the Company adopted the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("Statement 131"). Statement 131 superseded FASB Statement No. 14, "Financial Reporting for Segments of a Business Enterprise". Statement 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. The adoption of Statement 131 did not affect results of operations or financial position, but did affect the disclosure of segment information.
As of January 1, 1998, the Company adopted Statement 130, "Reporting Comprehensive Income". Statement 130 establishes new rules for the reporting and display of comprehensive income and its components; however, the adoption of this statement had no impact on the Company's net income or stockholders' equity. Statement 130 requires unrealized gains and losses on the Company's available-for-sale securities, which prior to the adoption were reported separately in the stockholders' equity to be included in other comprehensive income. Prior year financial statements have been reclassified to conform to the requirements of Statement 130.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Mid Atlantic Medical Services, Inc. and subsidiaries at December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the financial statements taken as a whole, presents fairly in all material respects the information set forth therein.