WellCare's executive offices are located in two adjacent buildings, at Hurley Avenue Extension, Kingston, New York, which provide approximately 38,600 square feet of office space. The Company also owns four other buildings that were purchased through its wholly-owned subsidiary, WellCare Development, Inc. in 1994. Three of the buildings are located in Kingston and provide approximately 40,200 square feet of office space utilized by the Company's communication, information and member service divisions. The fourth building is located in Saugerties, New York and provides approximately 10,000 square feet of office suites that are leased to two health care providers and a laboratory at annual rental incomes of approximately $111,500, $31,600 and $9,200, respectively.
In 1996, the Company leased 5,000 square feet of office space in North Haven, Connecticut, at an annual rental expense of approximately $67,200 for WellCare of Connecticut, Inc., a wholly-owned subsidiary. In addition, between April and September of 1996, the Company leased additional space in New York City at a cost of $104,300.
The Company seeks to control medical expenses through capitation arrangements with the Alliances and with non-Alliance primary care physicians, capitation arrangements with certain specialty providers, and through its quality improvement programs, utilization management and review of hospital inpatient and outpatient services, and educational programs on effective managed care for its providers.
Effective October 1, 1994, WCNY changed its capitation arrangements with the majority of its providers from capitating primary care physicians with attendant risk-sharing to capitating the Alliances comprised of the specialists and previously-capitated primary care physicians. The Alliances have operated at a deficit since inception but have recently instituted measures designed to reduce these deficits and achieve profitability. The Alliance could request additional funding beyond the contractual increases described in Notes 1a and 17a of "Notes to Consolidated Financial Statements", from the Company, which management does not believe should be required and, if requested by the Alliances, does not intend to provide. (On March 13, 1997, the Alliances received a $1.0 million cash infusion and a commitment for up to an additional $3.0 million cash infusion from an unrelated third-party.)
In an effort to improve profitability of the Company and the Alliances, effective September 1, 1996, WCNY entered into a letter of understanding with the Alliances to restructure the capitation arrangements. WCNY reassumed risk for certain previously capitated services, with a corresponding reduction in rates. At December 31, 1996, WCNY capitated the Alliances for all physician services, both primary care and specialty services, on a PMPM basis for each HMO member associated with an Alliance except for physician services for certain diagnostics and mental health, which are capitated through regional integrated delivery systems. This restructuring had a minimal impact on medical expenses in 1996, but is expected to result in savings for the Company in future periods. (See Note 1a and 17a of "Notes to Consolidated Financial Statements").
Certain statements in the Form 10-K are forward-looking statements and are not based on historical facts but are management's projections or best estimates. Actual results may differ from these projections due to risks and uncertainties. These risks and uncertainties include a variety of factors. The Company's results of operations depend in large part on accurately predicting and effectively managing medical costs and other operating expenses. A variety of factors, including competition, changes in health care practices, changes in federal or state laws and regulations or the interpretations thereof, inflation, provider contract changes, new technologies, government-imposed surcharges, taxes or assessments, reductions in provider payments by governmental payors (including Medicare, whereby such reductions may cause providers to seek high payments from private payor), major epidemics, disasters and numerous other factors affecting the delivery and cost of health care, such as major health care providers' inability to maintain their operations and reduce or eliminate their accumulated deficits, may in the future affect the Company's ability to control its medical costs and other operating expenses. Governmental action (including downward adjustments to premium rates requested by the Company, which could result in adjusted rates lower than premium rates then in effect) or business conditions (including intensification of competition and the other factors described above) could result in premium revenues not increasing to thus offset any increases in medical costs and other operating expenses. Once set, premiums are generally fixed for one year periods and, accordingly, unanticipated costs during such periods cannot be recovered through higher premiums. The expiration, suspension or termination of contracts to provide health coverage for governmental entities or other significant customers would also negatively impact the Company. Due to these factors and risks, no assurance can be given with respect to the Company's premium levels or its ability to control its medical costs.
(Loss)/income before income taxes (12.3) 1.8 4.8 (Benefit)/provision for income taxes (5.0) 0.7 2.0
Statistical Data: HMO member months enrollment 1,077,774 1,046,559 918,542 Medical loss ratio(1) 86.5% 80.0% 81.7% General and administrative ratio(2) 24.4% 19.8% 12.7%
(1) Medical expenses as a percentage of premiums earned; reflects the combined rates for commercial, Medicaid, Full Risk Medicare and Medicare supplemental members.
Medical expenses increased 17.4%, or $17.1 million, to $115.6 million in 1995 representing a 3.1% increase on a per member per month basis, but decreased as a percentage of premiums earned (the "medical loss ratio") from 81.7% in 1994 to 80.0% in 1995. The decrease in the medical loss ratio resulted, in part, from a 5.4% weighted average increase in premium rates. As a result of a prior period restatement, medical expenses in 1994 were increased $4.7 million with a corresponding reduction to medical expenses in 1995 in the amount of $1.7 million.
General and administrative ("G&A") expenses increased 94.1%, or $14.7 million, to $30.3 million in 1995, and increased as a percentage of total revenue from 12.7% in 1994 to 19.8% in 1995. The increase in G&A expenses resulted primarily from the reserve established for the note and other receivables due from the buyer of WellCare Medical Management, Inc. (See Note 4 of "Notes to Consolidated Financial Statements"), increased staffing related to service area and product line expansion, non-payroll (contracted) services, marketing and tele-communications related activities, and an increase in the doubtful account reserve for trade accounts receivable.
Depreciation and amortization increased by approximately $700,000 to $2.3 million in 1995 as a result of amortization of preoperational costs associated with service area and product line expansion.
The Company's requirements for working capital are principally for funding geographic and product expansion for HMO operations, maintaining necessary regulatory reserves, potential acquisitions and strategic partnerships and marketing and product expansion of other managed care operations.
New York State certified HMOs are required to maintain a cash reserve equal to the greater of 5% of expected annual medical costs or $100,000. Additionally, WCNY is required to maintain a contingent reserve which must be increased annually by an amount equal to at least 1% of premiums earned limited, in total, to a maximum of 5% of premiums earned for the most recent calendar year and which may be offset by the cash reserve. The cash reserve is calculated at December 31 of each year and is maintained throughout the following calendar year. At December 31, 1996, WellCare had required cash reserves of $6.7 million and a contingent reserve of $5.9 million which was fully offset by the cash reserve. In the event the contingent reserve exceeds the required cash reserve, the excess of the contingent reserve over the required cash reserve would be required to be maintained.
At December 31, 1996, the Company has total mortgage indebtedness of $6.2 million outstanding on four of its office buildings, of which approximately $780,000 is due February 1, 1999, approximately $4.3 million is due on January 1, 2000, approximately $795,000 is due on March 1, 2000 and approximately $325,000 is due on March 1, 2001.
In view of the Buyer's operating losses and advances to the Alliances, the Company has obtained from certain of the Buyer's equity holders personal guarantees of the original note and pledges of collateral to secure these guarantees. Nevertheless, in view of the Buyer's financial condition and difficulties inherent in the collection of personal guarantees and realization of collateral, and the Buyer's default on the payments of the notes, the Company fully reserved in 1995 the original $5.1 million note receivable, plus the $.7 million advanced in 1995. In 1996, the Company established a net reserve of $1.9 million for the additional note, interest accrued on the notes, and advances receivable, net of the deferred gain on the original sale.
On February 19, 1997, the Buyer executed a promissory note in the amount of $2.1 million, evidencing the $2.1 million payable to WellCare. The note bears interest at the rate of prime plus 2% (10.25% at December 31, 1996), with repayment of the principal over 36 months, starting upon the occurrence of certain events explained below. Subsequently, on February 26, 1997, the Buyer entered into an Option Agreement with a potential investor (the "Investor"), whereby the Investor agreed to lend the Buyer $4,000,000 and received an option to merge with the Buyer, exercisable during the period from March 15, 1998 through March 15, 1999. Concurrently, WellCare entered into an agreement with the Buyer whereby WellCare agreed to forbear on the collection of principal and interest on the note for $5.1 million, and on the collection of principal of the $2.1 million note, in exchange for the right to convert the $5.1 million note into 43% of the Common Stock of the company resulting from the merger of the Investor and the Buyer. In the event the Investor merges with the Buyer, the $2.1 million note would be payable immediately. At the earlier of the Buyer relinquishing its option to merge, or March 14, 1999, the forbearance will be rescinded and the original payment terms of the $5.1 million note reinstated. The Buyer would continue to pay monthly interest on the $2.1 million note, with principal payments over a thirty-six month period to commence upon rescission of the forbearance. The notes are subordinated to the Investor's and Key Bank's security interests.
The Company adopted Statements of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") and SFAS No. 121 "Accounting for Impairment of Long-Lived Assets to be Disposed Of ("SFAS 121"), which became effective for fiscal years beginning after December 15, 1995. The adoption of SFAS 123 and SFAS 121 did not have an impact on the Company's consolidated financial position or results of operations.