financial statements, the related notes thereto, and "Management's Discussion and Analysis of Financial Condition and Results of Operations".
(1)Reflects pro forma adjustments for interest expense on assumed debt. See note 1 (Pro forma Earnings Per Common Share) in the accompanying Consolidated Financial Statements.
United Wisconsin Services, Inc. (the "Company") is a Wisconsin corporation organized in May of 1998 for the purpose of owning and operating the managed care companies and specialty businesses of the Company's predecessor, American Medical Security Group, Inc. ("AMSG") (formerly United Wisconsin Services, Inc.). On September 25, 1998, the Company was spun-off (the "Spin-off") from its former parent, AMSG.
(2)Selling, general and administrative expenses as a percentage of premium revenue.
Total revenues in 1999 increased 7.1% to $704.5 million from $657.6 million in 1998. Total revenues in 1998 increased 8.0% from $609.1 million in 1997. These increases were due primarily to increased membership in most of the major product lines, general premium and rate increases and acquisitions of specialty businesses since July of 1998.
Health Services Revenue-HMO health services revenue in 1999 increased 6.9% to $554.7 million from $518.7 million in 1998. HMO health services revenue in 1998 increased 8.2% from $479.2 million in 1997. The increases in both years are primarily due to increases in average HMO premium revenue per member and increases in the average number of HMO medical members. Average HMO medical premium per member in 1999 increased 4.7% from 1998 and increased 4.3% in 1998 from 1997, as a result of premium increases. The average number of HMO medical members in 1999 increased 2.8% to 306,007 from 297,737 in 1998. The average number of HMO medical members in 1998 increased 3.5% from 287,534 in 1997. This increase in 1998 was due in part to the elimination of a key provider from the network of one of Compcare's competitors, resulting in a shift of members to Compcare.
Average invested assets in 1999 decreased 12.6% to $161.9 million from $185.2 million in 1998. The decrease in average invested assets during 1999 is a result of cash requirements necessary to fund operating losses and increased cash payments relative to medical and other benefits payable. Average invested assets in 1998 increased 3.2% from $179.5 million in 1997. Changes in levels of average invested during 1998 assets relate to ongoing operations, including collection of receivables and timing of claim payments.
The loss ratio for the risk products within specialty managed care products and services in 1999 was 75.2%, compared with 70.9% in 1998 and 71.5% in 1997. The loss ratios principally relate to the life, disability, workers' compensation and dental product lines of business. These products represent relatively small blocks of business, and as a result, the loss ratio can exhibit significant volatility due to varying levels of claim frequency and severity. Generally, the anticipated aggregate loss ratio for specialty risk products should range between 70% and 75%. The higher loss ratios in 1999 are attributable to an increase in the life and disability claims, along with lower premium and rate increases in 1999 given the competitive marketplace conditions for disability and workers' compensation products. In addition, United Heartland, Inc. workers' compensation block of business had achieved better than expected results during 1998,
while the 1999 results represent an increased loss ratio that is more in line with industry and targeted results.
SGA expense ratio related to the risk products within specialty managed care products and services in 1999 was 25.1%, compared with 24.8% in 1998 and 23.3% in 1997. Increases in SGA expenses correlate to premium and other revenue increases which were 5.9% in 1999 compared with 1998 and 11.7% in 1998 compared with 1997. In addition, the Company incurred higher Year 2000 readiness expenses during 1999. The mix of business shifted between 1998 and 1997, as a result of greater growth in ancillary lines of business that have higher SGA expense ratios.
Profit (loss) sharing on provider arrangements was $(4.1) million in 1999, compared with $2.8 million in 1998 and $3.4 million in 1997, net of intercompany eliminations. Included in this caption is expense related to the Unity and Valley provider arrangements and income from the workers' compensation agreements. Profit (loss) sharing expenses related to the Unity and Valley provider arrangements are calculated based on the profitability of the HMO, which amounted to $(2.4) million, $3.2 million and $4.0 million in 1999, 1998 and 1997, respectively.
Included in other operations in 1999 is $5.3 million of interest expense compared to $1.4 million in 1998. The Company assumed a $70 million debt owed to BCBSUW as of September 11, 1998. Interest expense related to the $70 million debt was $4.8 million and $1.4 million in 1999 and 1998, respectively. The Company also participates with BCBSUW in a bank line-of-credit, which permits aggregate borrowings up to $30 million. Interest expense related to the bank line-of-credit was $0.5 million and $0.1 million in 1999 and 1998, respectively.
The Company's effective tax rate was 38.0% in 1999, compared with 39.4% in 1998 and 37.4% in 1997. The Company's effective tax rate fluctuates based upon the relative profitability of the Company's two
reportable business segments and the differing effective tax rates for each subsidiary within those reportable segments. The effective tax rates range from 32% to 46%.
The Company's sources of cash flow consist primarily of health services revenues and investment income. The primary uses of cash include medical and other benefits and operating expense payments. Positive cash flows are invested pending future payments of medical and other benefits and other operating expenses. The Company's investment policies are designed to maximize yield, preserve principal and provide liquidity to meet anticipated payment obligations.
The amount of dividends, which may be paid to the Company from insurance subsidiaries, is limited by state regulation. In the past, the insurance subsidiaries have been allowed, with prior notification to the OCI, to pay dividends in excess of the ordinary dividend levels prescribed by regulation.
In addition to internally-generated funds and periodic borrowings on its bank line-of-credit, the Company believes that additional financing to facilitate long-term growth could be obtained through equity offerings, debt offerings, financings from BCBSUW or bank borrowings, as market conditions may permit or dictate.
The Company is a party to certain provider arrangements in conjunction with Unity and Valley, wholly-owned HMO subsidiaries included in the Company's consolidated financial statements, which include profit-sharing payments to certain providers and repurchase provisions.
Should the buy back options be exercised, the Company would lose rights to the future profits on the HMO. The cash received by the Company pursuant to the exercise of the buy back option could be redeployed to support additional premium writings, acquire other businesses or be invested to earn a portfolio return. Due to these alternative uses of capital, the potential buy back arrangements do not represent material claims against the Company's liquidity and capital resources.
We have audited the accompanying consolidated balance sheets of United Wisconsin Services, Inc. (the "Company") as of December 31, 1999 and 1998, and the related statements of operations, changes in shareholders' equity and comprehensive income (deficit) and cash flows for each of the three years in the period ended December 31, 1999. Our audits also included the financial statement schedules listed in the index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 1999 and 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth herein.
Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income (Deficit)
Investments are classified as either held-to-maturity or available-for-sale. Investments which the Company has the intent and ability to hold to maturity are designated as held-to-maturity and are stated at amortized cost. All other investments are classified as available-for-sale and are stated at fair value based on quoted market prices, with unrealized gains and losses excluded from earnings and reported as a component of accumulated other comprehensive income (deficit), net of income tax effects. Realized gains and losses from the sale of available-for-sale debt and equity securities are calculated using the first-in, first-out basis.
Amounts due from clinics and providers are stated at net realizable value, net of an allowance for uncollectible amount of $7,015,000 at December 31, 1999 based upon management's judgment of the ultimate collectibility. In late December 1998, Compcare Health Services Insurance Corporation ("Compcare") issued interest-bearing notes to certain contracted health care providers. Notes outstanding to providers at December 31, 1999 and 1998 were $1,009,000 and $13,421,000, respectively, and are included in due from clinics and providers on the accompanying consolidated balance sheets.
Goodwill represents the excess of cost over the fair value of net assets acquired. Goodwill and other intangible assets are being amortized on a straight-line basis over a period of 15 years or less. Accumulated amortization was $2,951,000 and $2,006,000 at December 31, 1999 and 1998, respectively.
Medical and other benefits expense consists principally of capitation expenses, health and disability benefit claims and life insurance benefits. In addition to actual paid claims and capitation, medical and other benefits expense includes the change in estimates for reported and unreported claims and accrued capitation fees and adjustments, which are unpaid as of the balance sheet date. The estimates for reported and unreported claims and accrued capitation fees and adjustments, which are unpaid as of the balance sheet date, are based on historical payment patterns using standard actuarial techniques. Processing costs are accrued as operating expenses based on an estimate of the costs necessary to process these claims.
Amounts assumed from and ceded to other insurance companies are summarized as follows:
Historical earnings per share ("EPS") has been omitted for 1998 and 1997, since the Company was not a separate entity with its own capital structure.
Pro forma net income per common and common equivalent share is calculated as if the Spin-off had occurred at the beginning of fiscal year 1997, and is adjusted in 1998 and 1997 for additional interest expense, net of related income tax. Pro forma EPS are based on the pro forma weighted average number of shares of outstanding Company common stock and dilutive common equivalent shares from stock options, giving effect to the distribution of one share of Company stock for each share of AMSG common stock. Pro forma dilutive common equivalent shares from stock options are stated at the historical AMSG dilutive common equivalent share level.
(2)EPS on net income as reported are computed by dividing net income as reported, by the pro forma weighted average number of common shares outstanding. There is no dilutive effect on securities for the period prior to the Spin-off date (1).
Pursuant to the terms of the Unity purchase agreements, as amended, the sellers retained options to repurchase the net assets of the acquired companies as of December 31, 2004. One seller has the option to repurchase a portion of Unity's business for $500,000 plus the proportionate share of the net worth of such business less any unpaid amount of the maximum annual performance bonuses. The maximum annual performance bonuses are limited to $650,000 in total. The other seller has the option to repurchase the remainder of the Unity business at a price equal to the net assets of such business.
Unrealized gains (losses) are computed as the difference between estimated fair value and amortized cost for debt securities classified as available-for-sale or cost for equity securities. A summary of the change in unrealized gains/losses, less deferred income taxes, which is included in accumulated other comprehensive income (deficit), is as follows:
The amortized cost and estimated fair values of debt securities at December 31, 1999, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations.
At December 31, 1999, the insurance subsidiaries had debt securities and cash equivalents on deposit with various state insurance departments with carrying values of approximately $9,071,000, which are included in investments held-to-maturity on the balance sheet.
The Company participates with BCBSUW in a bank line of credit, which permits aggregate borrowings up to $30,000,000. Periodic borrowings have been made on these lines of credit. The Company's
As of September 11, 1998, the Company assumed a $70,000,000 note obligation to BCBSUW in connection with the Spin-off (see note 1). The Company pledged the common stock of certain subsidiaries as collateral for the note obligation. Interest is payable quarterly at a rate equal to the London Interbank Offered Rate plus 1.25%, adjusted quarterly, 7.33% as of December 31, 1999. On October 13, 1999, the maturity date of the principal balance was extended from October 30, 1999 to April 30, 2001; and therefore, it is classified as noncurrent in the 1999 consolidated balance sheet. Interest expense and interest paid totaled $4,804,000 and $1,411,000 in 1999 and 1998, respectively.
Certain subsidiaries of the Company provide health, life and other insurance benefits to the employees of BCBSUW. Premium revenue received from BCBSUW totaled $4,921,000, $4,547,000 and $4,537,000 in 1999, 1998 and 1997, respectively.
The Company has an agreement with United Wisconsin Life Insurance Company ("UWLIC"), a subsidiary of AMSG, whereby United Wisconsin Insurance Company ("UWIC") underwrites certain small group health care and life, dental, drug and disability products in Minnesota as UWLIC products have not yet been approved for sale in Minnesota. The Company ceded to UWLIC 100% of the premium revenue of these products sold in Minnesota. The ceded premium revenue approximated $15,562,000, $26,875,000 and $27,014,000 in 1999, 1998 and 1997, respectively.
The Company has an agreement with UWLIC whereby UWLIC underwrites certain life and disability products on behalf of United Heartland Life Insurance Company ("UHLIC"), a wholly-owned subsidiary. The Company also had agreements with UWLIC, through September 30, 1998, whereby UWLIC underwrote certain health care, dental and pharmaceutical products on behalf of Compcare, Heartland Dental Plan, Inc., and Innovative Resource Group, Inc., all wholly-owned subsidiaries. The Company assumes 100% of the premium revenues on these products from UWLIC. The assumed premium revenue approximated $18,182,000, $23,295,000 and $27,213,000 in 1999, 1998 and 1997, respectively.
Management believes all related-party activity has been entered into on a reasonable basis and includes all costs of doing business.
The Company is involved in various legal actions occurring in the normal course of its business. In the opinion of management, adequate provision has been made for losses which may result from these actions and, accordingly, the outcome of these proceedings is not expected to have a material adverse effect on the consolidated financial statements.
The Company has postretirement benefit plans to provide certain medical, dental, and vision benefits and life insurance for certain groups of retired employees. Such plans were amended in 1997 to limit the Company's financial contribution in future periods. No benefits will be provided for individuals hired after the effective dates of these amendments.
Weighted-average assumptions used as of September 30, 1999, the measurement date, in developing the projected benefit obligations are as follows:
The effect of a 1% increase in the medical trend rate would be a $93,000 increase in the benefit obligation as of September 30, 1999.
The Company and certain of its subsidiaries participate in defined contribution plans whereby the employer contributes a percentage of participants' qualifying compensation up to certain limits, as defined by the plans. The Company and certain of its subsidiaries also participates with BCBSUW in various other profit sharing and bonus programs. Expenses related to all of these plans, after giving effect to all administrative expense allocations between the Company and BCBSUW, totaled $1,356,000, $2,475,000 and $2,042,000 in 1999, 1998 and 1997, respectively.
The Company has a stock-based compensation plan covering employees and directors that allows for option grants of up to 4,500,000 shares of common stock as incentive or nonqualified stock options ("NQSOs").
Financial data by segment as of December 31, 1999 and 1998 and for the year ended December 31, 1999, 1998 and 1997 is as follows: