In an effort to pursue the expansion of the Company's business outside the state of California, the Company acquired two businesses in 1996 and 1997, the Life and Health Benefits Management Division of Massachusetts Mutual Life Insurance Company and the Group Benefits Operations (the "GBO") of John Hancock Mutual Life Insurance Company. The acquisitions of Rush Prudential Health Plans and a mail-order pharmacy, which now does business as PrecisionRx, in 2000 and the acquisition of Cerulean in 2001 were also components of this expansion strategy. In 2001, the Company entered into definitive agreements to expand into the Midwest with its acquisition of RightCHOICE, which closed on January 31, 2002, and into the Mid-Atlantic region with the pending acquisition of CareFirst. On April 30, 2002, the Company completed its acquisition of MethodistCare.
As a result of these completed acquisitions, the Company has significantly expanded its operations outside of California. In order to integrate its acquired businesses and implement the Company's
In response to rising medical and pharmacy costs, the Company has from time to time implemented premium increases with respect to certain of its products. The Company will continue to evaluate the need for further premium increases, plan design changes and other appropriate actions in the future in order to maintain or restore profit margins. There can be no assurances, however, that the Company will be able to take subsequent pricing or other actions or that any actions previously taken or implemented in the future will be successful in addressing any concerns that may arise with respect to the performance of certain businesses.
(b)Classification between states for employer groups is determined by the zip code of the subscriber.
(f)Central Region Large Group membership includes network access services members, primarily from HealthLink, of 1,469,769 and 380,294 as of December 31, 2002 and December 31, 2001, respectively.
(h)Medi-Cal membership is included in California-Large Group. Medicaid membership for Virginia, Puerto Rico and Other are included in Other States-Large Group. Healthy Families, MRMIP (Major Risk Medical Insurance Program) /AIM (Access for Infants and Mothers) / IHRP (Interim High Risk Program) and California Kids membership is included in California-Large Group.
Comparison of Results for the Year Ended December 31, 2002 to the Year Ended December 31, 2001
Premium revenue increased 40.0%, or $4,629.0 million, to $16,206.2 million for the year ended December 31, 2002 from $11,577.2 million for the year ended December 31, 2001. The RightCHOICE and Cerulean acquisitions accounted for $2,146.1 million or 46.4% of the increase. Of the $2,146.1 million increase related to the RightCHOICE and Cerulean acquisitions, $2,119.2 million was attributable to the Health Care segment and $26.9 million to the Specialty segment. Excluding these acquisitions (which acquisitions included $1,824.5 million of premium revenue attributable to the acquired Cerulean business for the year ended December 31, 2001), premium revenue would have increased 25.5% for the year ended December 31, 2002. The increase, excluding these acquisitions, was primarily due to a 12.4% increase in insured member months and the implementation of premium increases overall. The majority of the increase is attributable to the California region.
Management services and other revenue increased 34.2%, or $208.7 million, to $818.4 million for the year ended December 31, 2002 from $609.7 million for the year ended December 31, 2001. The increase was primarily due to an increase of $194.9 million of management services and other revenue from the RightCHOICE and Cerulean acquisitions, $189.7 million of which was attributable to the Health Care segment and $5.2 million of which was attributable to the Specialty segment. Excluding these acquisitions (which acquisitions included $123.6 million of management services and other revenue attributable to the acquired Cerulean business for the year ended December 31, 2001), management services and other revenue would have increased 2.8% for the year ended December 31, 2002 due primarily to an increase in pharmacy benefit management services revenues.
The medical care ratio for the year ended December 31, 2002 of 81.5% remained unchanged from the year ended December 31, 2001. The medical care ratio attributable to the Health Care segment was 81.9% for the year ended December 31, 2002 (for which health care services and other benefits expense attributable to the Health Care segment was $12,865.7 million), compared to 82.0% for the year ended December 31, 2001 (for which health care services and other benefits expense attributable to the Health Care segment was $9,105.3 million). The medical care ratio attributable to the Specialty segment was 68.4% for the year ended December 31, 2002 (for which health care services and other benefits expense attributable to the Specialty segment was $345.4 million), compared to 70.4% for the year ended December 31, 2001 (for which health care services and other benefits expense attributable to the Specialty segment was $331.0 million). The acquired RightCHOICE business has a slightly lower medical care ratio than the Company's core businesses, while the acquired Cerulean business has experienced a higher medical care ratio than the Company's core businesses due to Cerulean's higher
Selling expense consists of commissions paid to outside brokers and agents representing the Company. The selling expense ratio for the year ended December 31, 2002 decreased to 4.0%, compared to 4.1% for the year ended December 31, 2001. The acquired Cerulean business has experienced a lower selling expense ratio due primarily to its lower percentage of individual and small employer group business. The acquired RightCHOICE business also experienced a slightly lower selling expense ratio than the Company's core businesses. Selling expense attributable to the acquired RightCHOICE and Cerulean business for the year ended December 31, 2002 was $134.5 million and selling expense attributable to the acquired Cerulean business for the year ended December 31, 2001 was $51.4 million. Excluding these acquisitions, the selling expense ratio would have decreased to 4.3% for the year ended December 31, 2002 from 4.4% for the year ended December 31, 2001.
The general and administrative expense ratio decreased to 12.7% for the year ended December 31, 2002 from 13.7% for the year ended December 31, 2001. The acquired RightCHOICE business experienced a higher general and administrative expense ratio than the Company's core businesses for the year ended December 31, 2002 due to integration expenses, its higher concentration of administrative services business and certain other transaction-related expenses. The acquired Cerulean business experienced an improved general and administrative expense ratio for the year ended December 31, 2002 over the year ended December 31, 2001. General and administrative expense attributable to the acquired RightCHOICE and Cerulean businesses for the year ended December 31, 2002 was $569.9 million and general and administrative expense attributable to the acquired Cerulean business for the year ended December 31, 2001 was $279.4 million. Excluding these acquisitions, the general and administrative expense ratio decreased to 12.5% for the year ended December 31, 2002, compared to 13.6% for the year ended December 31, 2001, due to administrative efficiencies from technology investments and systems convergence efforts and fixed administrative costs spread over a larger membership base.
Other expense, net decreased $19.6 million to $55.1 million for the year ended December 31, 2002, compared to $74.7 million for the year ended December 31, 2001. The decrease resulted from lower amortization of goodwill and other intangible assets due to the implementation of Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142") which accounted for $41.3 million of the decrease in amortization expense, an increase in income from the Company's share of its investments in joint ventures of $4.4 million and a decrease in minority interest expense of $3.9 million related to an equity interest in the Atlanta CHPN. (See "Item 1. Business-Managed Health Care Networks and Provider Relations-Blue Cross Blue Shield of Georgia.") These decreases were partially offset by the following items: (i) an increase in amortization of intangible assets with definite useful lives of $16.2 million, primarily due to recent acquisitions, (ii) an increase in losses on the disposition of fixed assets of $5.7 million and (iii) an increase in net operating expenses of $7.9 million from an insurance general agency subsidiary owned by the Company.
The Company's net income for the year ended December 31, 2002 was $703.1 million, compared to $414.7 million for the year ended December 31, 2001. Net income for the year ended December 31, 2002 included net realized investment gains of $33.3 million, net of tax, as discussed earlier and a net gain for two extraordinary items, a gain related to the acquisition of MethodistCare, partially offset by a loss on early redemption of debt. The extraordinary gain amounted to $8.9 million, or $0.06 per diluted share, and was due to an excess of the fair value of net assets over acquisition costs. The extraordinary loss was $3.8 million, net of tax, or $0.03 per diluted share, which resulted from the early redemption of certain of the Company's Zero Coupon Convertible Subordinated Debentures due 2019. (See Note 9 to the Consolidated Financial Statements.) Net income for the year ended December 31, 2002, excluding net realized investment gains of $33.3 million and a net gain for extraordinary items, was $664.7 million, or $4.42 per diluted share. For the year ended December 31, 2001, adjusted for the SFAS No. 142 impact of $32.2 million, net income would have been $446.9 million or $3.39 per diluted share. (See Note 7 to the Consolidated Financial Statements.)
Comparison of Results for the Year Ended December 31, 2001 to the Year Ended December 31, 2000
Premium revenue increased 34.9%, or $2,993.5 million, to $11,577.2 million for the year ended December 31, 2001 from $8,583.7 million for the year ended December 31, 2000. The Cerulean and Rush Prudential acquisitions accounted for $1,905.2 million, or 63.6%, of the increase. Of the $1,905.2 million increase related to the Cerulean and Rush Prudential acquisitions, $1,846.9 million was attributable to the Health Care segment and $58.3 million was attributable to the Specialty segment. Excluding these acquisitions, premium revenue would have increased 12.7% for the year ended December 31, 2001 over the year ended December 31, 2000, primarily attributable to the California region's Health Care business, resulting from a 5.8% increase of insured member months and the implementation of premium increases overall.
Investment income was $241.8 million for the year ended December 31, 2001, compared to $193.4 million for the year ended December 31, 2000, an increase of 25.0%, or $48.4 million. The Cerulean and Rush Prudential acquisitions represented $24.9 million, or 51.4%, of the increase. Excluding these acquisitions, investment income would have increased $23.5 million, or 12.2%. The increase excluding these acquisitions was primarily due to lower net realized investment losses in 2001 of $3.0 million, compared to net realized investment losses in 2000 of $21.6 million. Additionally, gross investment income, net of investment expenses, excluding these acquisitions, increased $6.4 million to $220.3 million for the year ended December 31, 2001, compared to $213.9 million for the year ended December 31, 2000. The increase resulted from higher average investment balances during the year ended December 31, 2001 as compared with the year ended December 31, 2000.
The medical care ratio for the year ended December 31, 2001 increased to 81.5%, compared to 80.8% for the year ended December 31, 2000, due in part to the incremental effect of the Cerulean acquisition on the Company's overall results. The acquired Cerulean business has traditionally experienced a higher medical care ratio than the Company's core businesses due to its higher percentage of large employer group business and fewer managed care offerings. Excluding Cerulean, the medical care ratio increased slightly to 80.9% for the year ended December 31, 2001. Including Cerulean, the medical care ratio for the Health Care segment for the years ended December 31, 2001 and 2000 was 82.0% and 81.5%, respectively. Health care services and benefits expense attributable to the Health Care segment was $9,105.3 million for the year ended December 31, 2001 and $6,653.6 million for the year ended December 31, 2000. Health care services and benefits expense attributable to the Specialty segment was $331.0 million for the year ended December 31, 2001 and $281.8 million for the year ended December 31, 2000. The medical care ratio attributable to the Health Care segment was 82.0% for the year ended December 31, 2001, compared to 81.5% for the year ended December 31, 2000. The medical care ratio attributable to the Specialty segment was 70.4% for the year ended December 31, 2001, compared to 67.9% for the year ended December 31, 2000.
Interest expense increased $25.9 million to $49.9 million for the year ended December 31, 2001, compared to $24.0 million for the year ended December 31, 2000. The increase in interest expense was related to the higher average debt balance for the year ended December 31, 2001 in comparison to the debt balance for the year ended December 31, 2000, primarily due to the Cerulean acquisition. The weighted average interest rate for all debt for the years ended December 31, 2001 and 2000, including the fees associated with the Company's borrowings and interest rate swap agreements, was 6.7% and 6.2% respectively.
The Company's net income for the year ended December 31, 2001 was $414.7 million, compared to $342.3 million for the year ended December 31, 2000. Earnings per share totaled $3.27 and $2.74 for the years ended December 31, 2001 and 2000, respectively. Earnings per share assuming full dilution totaled $3.15 and $2.64 for years ended December 31, 2001 and 2000, respectively.
Earnings per share for the year ended December 31, 2001 is based upon weighted average shares outstanding of 126.9 million, excluding potential Common Stock, and 132.4 million shares, assuming full dilution. Earnings per share for the year ended December 31, 2000 is based on 125.1 million shares, excluding potential Common Stock, and 130.2 million shares, assuming full dilution. Earnings per share and weighted average shares above reflect the two-for-one stock split that occurred on March 15, 2002.
The Company's consolidated assets increased by $3,830.4 million, or 51.3%, to $11,302.5 million as of December 31, 2002 from $7,472.1 million as of December 31, 2001. The increase in total assets was primarily due to the acquisition of RightCHOICE, which accounted for $2,013.0 million, or 52.6%, of the increase. Excluding RightCHOICE, the increase in total assets was primarily due to growth in cash and investments of $1,432.2 million as a result of strong operating cash flows and an increase in receivables of $231.4 million due to timing of pending securities settlements. Cash and investments totaled $6.8 billion as of December 31, 2002, or 59.9% of total assets.
As of December 31, 2002, the Company's long-term indebtedness was $1,011.6 million, of which $462.8 million was related to the Company's 63/8% Notes due 2006 (which includes a fair value adjustment of $13.6 million), $349.0 million was related to the Company's 63/8% Notes due 2012 and $199.8 million was related to the commercial paper program described below. The 63/8% Notes due 2012, with an aggregate principal amount at maturity of $350.0 million, were issued to partially finance the RightCHOICE acquisition. The Company's revolving credit facility indebtedness of $235.0 million at December 31, 2001 was repaid during the year ended December 31, 2002, with $200.0 million obtained through the commercial paper program and operating cash of $35.0 million. As of December 31, 2001, the Company had $153.9 million (based upon the original issue price plus accreted interest) of Zero Coupon Convertible Subordinated Debentures due 2019 (the "Debentures") outstanding. As of December 31, 2002, no Debentures were outstanding due to Debentureholders exercising their option to convert the Debentures into the Company's Common Stock and the Company's election to redeem the remaining balance outstanding as of October 28, 2002. (See Note 9 to the Consolidated Financial Statements.)
The Company generally receives premium revenue in advance of anticipated claims for related health care services and other benefits. The Company's investment policies are designed to provide safety and preservation of capital, sufficient liquidity to meet cash flow needs, the integration of investment strategy with the business operations and objectives of the Company and attainment of a competitive after-tax total return.
financial stability and net worth requirements, including license requirements of the Blue Cross and Blue Shield Association.
Cash flow provided by operating activities was $1,401.0 million for the year ended December 31, 2002, compared with $806.2 million for the year ended December 31, 2001. Cash flow from operations for the year ended December 31, 2002 was due primarily to net income before extraordinary items of $697.9 million, an increase in medical claims payable of $312.4 million due to membership growth and higher provider contract rates and an increase in accounts payable and accrued expenses of $258.7 million resulting from the timing of liability payments.
Net cash used in investing activities for the year ended December 31, 2002 totaled $1,306.5 million, compared with $857.2 million for the year ended December 31, 2001. The net cash used in 2002 was primarily attributable to the purchase of investments of $6.5 billion, and of property and equipment, net of sales proceeds, of $94.7 million and the purchases of RightCHOICE and MethodistCare, net of acquired cash, of $349.0 million. Proceeds from investments sold and matured totaled $5.6 billion, partially offsetting the aforementioned purchases.
including restrictions on the incurrence of additional indebtedness and the granting of certain liens, limitations on acquisitions and investments and limitations on changes in control (see Note 9 to the Consolidated Financial Statements). As of December 31, 2002, there were no amounts outstanding under the revolving credit facility. The Company currently expects to negotiate an amendment to the $250.0 million facility that would, among other things, extend the availability of the commitments thereunder to March 26, 2004.
On June 15, 2001, the Company issued $450.0 million aggregate principal amount at maturity of 63/8% Notes due June 15, 2006 (the "2006 Notes"). The net proceeds of this offering totaled approximately $449.0 million. The net proceeds from the sale of the 2006 Notes were used to repay indebtedness under the Company's revolving credit facilities, which indirectly financed a portion of the Cerulean acquisition. The 2006 Notes bear interest at a rate of 63/8% per annum, payable semi-annually in arrears on June 15 and December 15 of each year commencing December 15, 2001. Interest is computed on the basis of a 360-day year of twelve 30-day months.
Prior to the Company's announcement of its election to redeem the Debentures, Debentureholders in 2002 converted $18.0 million in aggregate principal amount at maturity of the Company's Debentures with a carrying value (including accreted interest) of $12.6 million. In lieu of delivering shares of Common Stock upon conversion of these Debentures, the Company elected to pay cash of $18.9 million, which resulted in an extraordinary after-tax loss of $3.8 million, as shown on the Company's Consolidated Income Statements.
As a part of a hedging strategy to limit its exposure to variable interest rate increases, the Company has from time to time entered into interest rate swap agreements in order to reduce the volatility of interest expense resulting from changes in interest rates. The swap agreements are contracts to exchange variable-rate interest payments (weighted average rate for the year ended December 31, 2002 of 2.25%) for fixed-rate interest payments (weighted average rate for the year ended December 31, 2002 of 7.08%) without the exchange of the underlying notional amounts. The Company had entered into $200.0 million of fixed-rate swap agreements, which consisted of a $150.0 million notional amount swap agreement at 6.99% maturing on October 17, 2003 and a $50.0 million notional amount swap agreement at 7.06% maturing on October 17, 2006. In September 2002, the Company terminated these two fixed-rate swap agreements with an aggregate cash settlement of $17.6 million, of which $1.8 million was accrued interest and the remaining $15.8 million represented the fair value of the swap agreements at the time of termination. (See Note 16 to the Consolidated Financial Statements.)
In order to reduce the interest expense associated with the 2006 Notes, the Company, on January 15, 2002, entered into a $200.0 million notional amount interest rate swap agreement, which matures on June 15, 2006. The swap agreement is a contract to exchange a fixed 63/8% rate for a LIBOR-based floating rate (weighted average variable rate of 3.02% for the year ended December 31, 2002).
the remaining hedges. (See Note 16 to the Consolidated Financial Statements.) Subsequent to the implementation of Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," all gains and losses from both effective and ineffective forward exchange contracts have been reported in investment income offset by the related gains and losses on the Company's available-for-sale foreign securities.
Certain of the Company's subsidiaries are required to maintain minimum capital requirements prescribed by various regulatory agencies, including the California Department of Managed Health Care and the Departments of Insurance in various states, including Georgia, Missouri and Delaware. As of December 31, 2002 (or the most recent date with respect to which compliance is required), those subsidiaries of the Company were in compliance with all minimum capital requirements.
The Company enters into operating leases primarily for office space, electronic data processing and office equipment. As of December 31, 2002, minimum annual rental commitments on operating leases having initial or remaining noncancellable lease terms in excess of one year during the years 2003 through 2007 were $96.1 million, $73.5 million, $52.0 million, $38.9 million and $30.1 million, respectively, with $227.6 million in minimum commitments thereafter.
The Company's obligations relating to debt and leases at December 31, 2002 were as follows:
(A)As of December 31, 2002, outstanding borrowings under the commercial paper program totaled approximately $199.8 million, with an average maturity of 54 days. The commercial paper may be issued with varying maturities up to a maximum of 270 days from the date of issuance. The Company intends to maintain commercial paper borrowings of at least the amount outstanding at December 31, 2002 for more than one year. Accordingly, for financial reporting purposes, the commercial paper has been classified under non-current liabilities in the Consolidated Financial Statements.
The Company's committed credit availability as of December 31, 2002 was as follows:
The Company believes that cash flow generated by operations and its cash and investment balances, supplemented by the Company's ability to borrow under its existing revolving credit facility, commercial paper program or through public or private financing sources, will be sufficient to fund continuing operations and expected capital requirements for the foreseeable future.
On November 20, 2001, WellPoint entered into a definitive agreement to acquire CareFirst, which agreement was amended and restated as of January 24, 2003. The amended and restated merger agreement with CareFirst provides, among other things, that the purchase price of $1.37 billion for the transaction will consist solely of cash, if stock and other non-cash consideration are not allowed under any applicable law or regulation. If the purchase price is paid solely in cash, the agreement allows up to $850.0 million of the purchase price to be financed by debt or equity offerings by the Company. If applicable law allows non-cash consideration, the purchase price will be paid in cash and stock or notes. Consummation of the CareFirst acquisition is subject to a number of conditions, including the conversion of CareFirst from a not-for-profit corporation into for-profit, stock corporation. This conversion requires the approval of insurance regulators in Maryland, Delaware and the District of Columbia, as well as other approvals. On March 5, 2003, the Maryland insurance commissioner issued an order disapproving the conversion of CareFirst to a for-profit entity. The Maryland legislature has 90 days to review the matter and has the power to veto the commissioner's decision. The Company has 30 days from the date of the commissioner's order to appeal the order. See "Item 1. Business-Recent Completed Transactions and Pending Transactions-Pending Acquisition of CareFirst."
In connection with the Recapitalization (see "Item 1. Business-May 1996 Recapitalization and Restrictions on Ownership and Transfer of Securities"), BCC received a ruling from the IRS that, among other things, the BCC Conversion qualified as a tax-free transaction and that no gain or loss was recognized by BCC for federal income tax purposes. If the ruling were to be subsequently revoked, modified or not honored by the IRS (due to a change in law or for any other reason), WellPoint, as the successor to BCC, could be subject to federal income tax on the difference between the value of BCC at the time of the BCC Conversion and BCC's tax basis in its assets at the time of the BCC Conversion. The potential tax liability to WellPoint if the BCC Conversion is treated as a taxable transaction is currently estimated to be approximately $696 million, plus interest (and possibly penalties). WellPoint and the California HealthCare Foundation (the "California Foundation") entered into an Indemnification Agreement that provides, with certain exceptions, that the California Foundation will indemnify WellPoint against the net tax liability as a result of a revocation or modification, in whole or in part, of the ruling by the IRS or a determination by the IRS that the BCC Conversion constitutes a taxable transaction for federal income tax purposes. In the event a tax liability should arise against which the California Foundation has agreed to indemnify WellPoint, there can be no assurance that the California Foundation will have sufficient assets to satisfy the liability in full, in which case WellPoint would bear all or a portion of the cost of the liability, which could have a material adverse effect on WellPoint's financial condition.
During the quarter ended September 30, 1998, the Company received a private letter ruling from the IRS with respect to the treatment of certain payments made at the time of the Recapitalization and the acquisition of the commercial operations of BCC. The ruling allowed the Company to deduct as an ordinary and necessary business expense the $800.0 million cash payment made by BCC in May 1996 to one of two newly formed charitable foundations. As a result of and in reliance on the ruling, the Company experienced a reduction in its income tax expense of $85.5 million and the Company reduced its goodwill resulting from the Recapitalization by $194.5 million during the year ended December 31, 1998. The Company filed for refund claims of approximately $198.6 million of previous year income tax payments and reduced income tax payments during 1998 and 1999 by approximately $81.4 million. In August 1999, the Company received a cash refund (including applicable accrued interest) of approximately $183.0 million, which was reflected in the statement of cash flows for such year. The Company has refund claims pending of approximately $39.3 million.
On November 30, 2000, RightCHOICE completed a reorganization (the "RightCHOICE Recapitalization") with its majority stockholder, RightCHOICE Managed Care, Inc., a Missouri corporation ("Old RightCHOICE"). As part of the RightCHOICE Recapitalization, The Missouri Foundation For Health (the "Missouri Foundation") became the holder of approximately 80% of RightCHOICE common stock. In connection with the RightCHOICE Recapitalization, the predecessor of Old RightCHOICE, Blue Cross and Blue Shield of Missouri, received a ruling from the IRS that, among other things, the conversion of Blue Cross and Blue Shield of Missouri from a non-profit corporation to a for-profit corporation qualified as a reorganization under the Internal Revenue Code and that Blue Cross and Blue Shield of Missouri recognized no gain or loss for federal income tax purposes. If the IRS subsequently revokes, modifies or decides not to honor the ruling due to a change in law or for any other reason, RightCHOICE, as the successor to Old RightCHOICE, could be subject to federal income tax on the difference between the value of each of Blue Cross and Blue Shield of Missouri's assets at the time of the RightCHOICE Recapitalization and its tax basis in its assets at the time of the RightCHOICE Recapitalization. RightCHOICE is now a wholly owned subsidiary of WellPoint. RightCHOICE and the Missouri Foundation entered into an indemnification agreement that provides, with certain exceptions, that the Missouri Foundation will indemnify RightCHOICE against the tax liability as a result of the IRS's revocation or modification, in whole or in part, of its ruling, or an IRS determination that RightCHOICE's conversion was a taxable transaction for federal income tax purposes. If a tax liability should arise against which the Missouri Foundation has agreed to indemnify RightCHOICE, the Missouri Foundation may not have sufficient assets to pay the liability. RightCHOICE would then bear all or a portion of the liability, which could have a material adverse effect on the financial condition of RightCHOICE and the Company.
The critical accounting policies described below are those that the Company believes are important to the portrayal of the Company's financial condition and results of operations, and which require management to make difficult, subjective and/or complex judgments. Critical accounting policies cover accounting matters that are inherently uncertain because the future resolution of such matters is unknown. The Company believes that critical accounting policies include medical claims payable, reserves for future policy benefits, intangible assets and goodwill and investments.
Medical claims payable include claims in process as well as provisions for the estimate of incurred but not reported claims and provisions for disputed claims obligations. Such estimates are developed using actuarial principles and assumptions that consider, among other things, contractual requirements, historical utilization trends and payment patterns, benefits changes, medical inflation, product mix, seasonality, membership and other relevant factors. In developing its best estimate of medical claims payable, the Company consistently applies the principles and assumptions listed above from year to year, while also giving due consideration to the potential variability of these factors. Because medical claims payable includes various actuarially developed estimates, the Company's actual health care services expense may be more or less than the Company's previously developed estimates. Claim processing expenses are also accrued based on an estimate of expenses necessary to process such claims. Such reserves are continually monitored and reviewed, with any adjustments reflected in current operations.
Capitation costs represent monthly fees paid one month in advance to physicians, certain other medical service providers and hospitals in the Company's HMO networks as retainers for providing continuing medical care. The Company maintains various programs that provide incentives to physicians, certain other medical service providers and hospitals participating in its HMO networks through the use of risk-sharing agreements and other programs. Payments under such agreements are made based on the providers' performance in controlling health care costs while providing quality health care. Expenses related to these programs, which are based in part on estimates, are recorded in the period in which the related services are rendered. The Company believes that its reserves for medical claims payable are adequate to satisfy its ultimate claim liability. However, these estimates are inherently subject to a number of highly variable circumstances. Consequently, the actual results could differ materially from the amount recorded in the consolidated financial statements.
arrangement with the CHPN. As of December 31, 2002, 2001 and 2000, approximately 535,000, 479,000 and 424,000 members, respectively, were covered by this arrangement.
The Company's future results of operations will depend in part on its ability to predict and control health care costs through underwriting criteria, medical management, product design and negotiation of favorable provider and hospital contracts. The Company's ability to contain such costs may be adversely affected by changes in utilization rates, demographic characteristics, the regulatory environment, health care practices, inflation, new technologies, clusters of high-cost cases, continued consolidation of physician, hospital and other provider groups, acts of terrorism and bioterrorism or other catastrophes, including war and numerous other factors. The inability to mitigate any or all of the above-listed or other factors may adversely affect the Company's future profitability.
The estimate of reserves for future policy benefits relates to life and disability insurance policies written in connection with health care contracts. Reserves for future life benefit coverage are based on projections of past experience. Reserves for future policy and contract benefits for certain long-term disability products and group paid-up life products are based upon interest, mortality and morbidity assumptions from published actuarial tables, modified based upon the Company's experience. Reserves are continually monitored and reviewed, and as settlements are made or reserves adjusted, differences are reflected in current operations. The current portion of reserves for future policy benefits relates to the portion of such reserves that the Company expects to pay within one year. The Company believes that its reserves for future policy benefits are adequate to satisfy its ultimate benefit liability. However, these estimates are inherently subject to a number of highly variable circumstances. Consequently, the actual results could differ materially from the amount recorded in the consolidated financial statements. As of December 31, 2002 and 2001, the reserves for future policy benefits were $283.2 million and $285.1 million, respectively.
In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS No. 141") and Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"). SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for using the purchase method. The provisions of SFAS No. 141 also apply to all business combinations consummated after June 30, 2001. SFAS No. 142, which became effective for fiscal years beginning after December 15, 2001, eliminates amortization of goodwill and other intangible assets with indefinite useful lives. Rather, these assets are subject to impairment tests at least annually. The Company is required to make estimates of fair value and apply certain assumptions, such as a discount factor in applying these annual impairment tests. Such estimates could produce significantly different results if other assumptions, which could also be considered reasonable, were to be used. Intangible assets with definite useful lives are being amortized using a straight-line basis or the timing of related cash flows over periods ranging from five to 25 years. An intangible asset subject to amortization must be reviewed for impairment
pursuant to Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."
The Company adopted SFAS No. 142 on January 1, 2002 and, accordingly, no longer amortizes goodwill and other intangible assets with indefinite useful lives. In accordance with SFAS No. 142, the Company completed the transitional evaluation of its goodwill and other intangible assets at January 1, 2002 and the annual evaluation at December 31, 2002, and determined that there was no impairment loss. As of December 31, 2002 and 2001, total goodwill and other intangible assets were $2.4 billion and $1.1 billion, respectively. (See Note 7 to the Consolidated Financial Statements for further discussion of the Company's goodwill and other intangible assets.)
The Company regularly evaluates the appropriateness of investments relative to its internal investment guidelines. The Company operates within these guidelines by maintaining a well-diversified portfolio, both across and within asset classes. The Company has from time to time retained an independent consultant to advise the Company on the appropriateness of its investment policy. The Company performs a quarterly evaluation of its investment securities, using both quantitative and qualitative factors to determine whether a decline in investment value is other-than-temporary. When a decline in an investment's fair value is determined to be other-than-temporary, a loss is recorded against investment income. When determining whether a decline in an investment's fair value is other-than-temporary, the Company considers the extent and duration to which a security's market value has been less than its cost, the financial condition and future earnings potential of the issuer, recommendations and opinions from outside investment managers and the current economic environment. For the years ended December 31, 2002, 2001 and 2000, the Company recorded investment losses that the Company believed to be other-than-temporary of approximately $41.9 million, $21.1 million and $18.3 million, respectively. The Company believes that it has performed an adequate review for impairment of the investment portfolio and that investments are carried at fair value. Changing economic and market conditions in the future, however, may cause the Company to reassess its judgment regarding impairment, which could result in realized losses relating to other-than-temporary declines being charged against future income.
As of December 31, 2002 and 2001, net unrealized gains from the Company's fixed-maturity securities totaled $184.5 million and $56.0 million, respectively, primarily resulting from a general decrease in interest rates. The Company had a net unrealized loss in its equity securities portfolio as of December 31, 2002 of $49.5 million and an unrealized gain of $70.0 million as of December 31, 2001. The Company believes that these fluctuations are temporary as a result of current market conditions.
(A)Medical membership numbers as of March 31, 2002 as reported in the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2002 have been revised to exclude 164,493 behavioral health members, 9,345 flexible spending account members and 3,205 dental members associated with the RightCHOICE acquisition. The revised medical membership numbers also reflect a reduction of 12,607 behavioral health members from two Company-owned rental networks. All of these members were previously reported as medical members.
(B)Per share data for each period presented has been restated to reflect the two-for-one stock split in the form of a 100% stock dividend that occurred on March 15, 2002.