UWS occupies common facilities with BCBSUW and is charged a proportionate share of the cost of such facilities under the Service Agreements. UWS' corporate headquarters are located in Milwaukee, Wisconsin in a 235,000 square foot building leased by BCBSUW. UWS also occupies 45,000 square feet of leased office space located in New Berlin, Wisconsin, approximately 12,000 square feet located in Platteville, Wisconsin, and 32,000 combined square feet at two locations in Waukesha, Wisconsin. In addition, UWS' business is sold and serviced in five other Wisconsin regional offices leased by BCBSUW. Unity owns a 40,000 square foot facility in Sauk City, Wisconsin. IRG and CRG both lease facilities including 9,900 square feet in Pewaukee, Wisconsin and 12,500 combined square feet at three locations in Michigan, respectively.
The following selected financial data are derived from the consolidated financial statements of UWS. The data should be read in conjunction with UWS' consolidated financial statements, the related
notes thereto, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other financial information included herein.
(1)Earnings per share data have been omitted since UWS was not an independent, publicly owned company with a capital structure of its own for the entire year. UWS became publicly owned on September 28, 1998.
UWS is a leading provider of managed health care services and employee benefit products. UWS' two primary product lines are: (i) HMO products sold primarily in Wisconsin, including Compcare, Valley, Unity and certain POS and other related products managed by Compcare, Valley and Unity; and (ii) specialty managed care products and services, including dental, life, disability and workers' compensation products, managed care consulting, electronic claim submission services, pharmaceutical management, managed behavioral health services, case management and receivables management services, sold throughout the United States. Operating results and statistics for these product groups are presented below for the periods indicated.
(1)Medical and other benefits as a percentage of premium revenue. (2)Selling, general and administrative expenses as a percentage of premium revenue. (3)Operating expense as a percentage of other revenue.
UWS' revenues are derived primarily from premiums, while medical benefits constitute the majority of expenses. Profitability is directly affected by many factors including, among others, premium rate adequacy, estimates of medical benefits, health care utilization, effective administration of benefit payments, operating efficiency, investment returns and federal and state laws and regulations.
Health services revenue for specialty managed care products and services in 2000 increased 20.1% to $186.3 million from $155.1 million in 1999. This was the result of additional covered lives for managed behavioral health services, increases in premium rates on insurance products, a decrease in the percentage of workers' compensation business ceded and a significant increase in the volume of workers' compensation business written. In the second quarter of 2000, UWS expanded its specialty service business through the acquisition of Seltzer/Delman, Inc. ("Seltzer"), a workers' compensation case management company, resulting in an increase in health services revenues of $0.6 million in 2000. Also, under a "quota share" arrangement, the amount of business ceded to the workers' compensation reinsurer was reduced from 30% in 1999 to 20% in 2000, representing a revenue increase of $3.2 million in 2000. Quota share reinsurance is a contractual arrangement whereby the reinsurer assumes an agreed percentage of certain risks insured by the ceding insurer and shares premium revenue and losses proportionately. UWS' quota share reinsurance treaties allocate the total amount of business subject to the treaties between UWS and the respective parties to the treaties.
Health services revenue for specialty managed care products and services in 1999 increased 12.6% from $137.7 million in 1998. This was the result of increases in covered lives for managed behavioral health services and premium rates on insurance products, a decrease in the percentage of workers' compensation business ceded and additional revenue of $4.5 million from recent acquisitions. During the third quarter of 1999, UWS formed Innovative Resources Group, Inc. ("IRG"), which is comprised of three of UWS' recent acquisitions and two existing specialty managed care subsidiaries. IRG provides medical and behavioral health management services, case management, employee assistance
programs, and workers' compensation case management and pharmacy management services. Health services revenues in 1998 included an increase of $8.4 million relative to life and disability products, an increase of $1.4 million in dental premiums and an increase in managed behavioral health and managed care consulting. The increases in life and disability premiums were driven by membership increases of 24.1% in 1998. In addition, acquisitions during 1998 provided $1.0 million of additional revenue.
Investment gains and losses are realized when investments are liquidated to fund operations and in the normal investment process in response to market opportunities. Net realized losses in 2000 were $0.9 million, compared to net realized gains of $2.1 million in 1999. Net realized gains in 1999 decreased from $9.1 million in 1998.
Loss Ratio. The consolidated loss ratio represents the ratio of medical and other benefits to premium revenue on an aggregate basis, and is therefore a blended ratio for medical, life, dental, disability and other product lines. The consolidated loss ratio was 92.0% in 2000 compared with 95.5% in 1999 and 85.3% in 1998. The 2000 consolidated loss ratio is influenced by the component loss ratios for each of UWS' primary product lines, as discussed below.
The medical loss ratio for HMO products for 2000 was 95.1%, compared with 99.8% for 1999 and 88.8% for 1998. The improvement in 2000 is primarily attributable to $7.8 million in prior year favorable reserve development, premium rate increases on group renewals and exiting the Medicaid business. The increase in the 1999 medical loss ratio, compared to 1998, for HMO products is primarily attributable to $15.6 million in prior year adverse reserve development and a $0.9 million of premium deficiency reserve for anticipated future losses related to the Medicaid business. Although the claims inventory remained stable following UWS' conversion to a Year 2000 compliant computer system, actuarial data indicate an increase in the lag between the time some HMO services were provided and the date the claims for those services were submitted by providers for payment. The increase in claim reserves is intended to cover the higher level of outstanding claims. The lower loss ratio in 1998 is also attributable to higher premium rate increases and a favorable development in the reserves. In general, the medical loss ratio in any quarter will be impacted by the development of prior period reserves, which are evaluated each quarter.
Heartland, Inc.'s workers' compensation block of business achieved better-than-expected results, while the 1999 results represent an increased loss ratio that is more in line with industry and targeted results.
Selling, General, and Administrative Expense Ratio. The selling, general and administrative ("SGA") expense ratio includes commissions, administrative expenses, premium taxes and other assessments. The SGA expense ratio for HMO products in 2000 was 9.6%, compared with 10.4% in 1999 and 9.6% in 1998. The improvement in 2000 over 1999 was due to an increase in membership and premium rates in combination with reduced costs over the prior year, offset by $1.3 million in transition costs related to the takeover of the insurance operations of FHP. Costs in 1999 were higher than 1998 as a result of additional costs incurred to reduce Compcare's claim backlog and process claims adjustments, which were attributed to the system conversion as part of UWS' implementation of its Year 2000 readiness program, and due to increased customer service demands.
The SGA expense ratio related to the risk products within specialty managed care products and services in 2000 was 23.3%, compared with 25.1% in 1999 and 24.8% in 1998. Costs in 1999 were higher than in 2000 and in 1998 due to UWS incurring costs attributable to the implementation of its Year 2000 readiness program.
Profit (loss) sharing expenses on joint ventures in 2000 was $0.5 million, compared with $(4.1) million in 1999 and $2.8 million in 1998, 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 $0.3 million, $(2.4) million and $3.2 million in 2000, 1999 and 1998, respectively. The change in profit (loss) sharing in 2000 resulted from a final settlement relative to Valley's prior joint venture agreement. UWS is a party to certain provider arrangements in conjunction with Unity and Valley, which include profit-sharing payments to certain providers and repurchase provisions. The Unity and Valley provider agreements were renegotiated at the end of 1999 and the profit-sharing provisions for Unity were eliminated beginning in 2000, except for certain limited profit-sharing provisions with a provider. In October 1999, UWS formed a joint venture with Health Care Service Corporation, a mutual legal reserve company doing business as Blue Cross Blue Shield of Illinois ("HCSC"). UWS shares equally in all profits and losses on this newly-formed joint venture, United Heartland of Illinois, Inc., which provides workers' compensation administration services.
Consolidated net income (loss) from operations in 2000 improved by $12.6 million to $(16.4) million from $(29.0) million in 1999. Consolidated net loss in 1999 decreased from income of $18.1 million in 1998. The reduced loss in 2000 demonstrates improvement in operating results over the prior year, which includes $7.8 million of prior year favorable reserve development. The improving operating trends are attributable to decreases in the medical loss and SGA ratios, partially offset by a reduction in investment income and transition costs related to the takeover of the insurance operations of FHP. The decrease in 1999 was impacted primarily by $15.6 million in prior year adverse reserve development and an increase of $12.6 million in the allowance for doubtful accounts largely resulting from the financial condition of CPN. In addition to these charges, 2000 included $1.3 million of costs associated with the combination of UWS and BCBSUW, and 1999 included $2.8 million of charges for various transactions and reorganization costs. The charges are included in other operations.
UWS' cash flow improved over the previous year. In 2000, net cash provided by operating activities was $29.1 million, compared with net cash used in operating activities of $45.2 million in 1999. This improvement was due to a significant increase in the volume of business written as a result of an improved market, increases in medical and other benefits payable resulting from fewer capitated provider arrangements, decreases in other receivables as a result of collecting on outstanding customer receivables and receiving federal tax refunds. Due to periodic short-term cash flow needs of certain subsidiaries, UWS made borrowings under its bank line of credit ranging up to $24.6 million during 2000, compared with $20.2 million during 1999. The amount drawn on the line of credit at December 31, 2000 was $13.5 million, compared to $11.6 million at December 31, 1999.
As a Larger Controlled Affiliate Licensee of the Blue Cross Association (the "Association"), Compcare is required to maintain a prescribed liquidity ratio of certain liquid assets to average monthly expenses, as defined, in accordance with licensure requirements of the Association.
UWS' investment portfolio consists primarily of investment grade bonds and U.S. Government securities, and has a limited exposure to equity securities. At December 31, 2000, $117.4 million, or 91.5%, of UWS' total investment portfolio was invested in bonds, compared with $119.5 million, or 88.6%, at December 31, 1999. The bond portfolio had an average quality rating by Moody's Investor
The amount of dividends that may be paid to UWS 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. Based upon the financial results of UWS' combined insurance subsidiaries for the year ended December 31, 2000, there are no dividend payments available from insurance subsidiaries for 2001 to UWS without regulatory approval.
In addition to internally generated funds and periodic borrowings on its bank line of credit, UWS 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.
Total revenues subject to repurchase options, pursuant to the various acquisition agreements, totaled $239.3 million, $220.2 million and $207.0 million for 2000, 1999 and 1998, respectively. Profit (loss) sharing expenses related to these provider arrangements are calculated based on the profitability of the HMO subsidiary and totaled $0.3 million, $(2.4) million and $3.2 million in 2000, 1999 and 1998, respectively. Net income (loss) subject to repurchase options, pursuant to the various acquisition agreements, totaled $(3.2) million, $(1.1) million and $2.4 million for 2000, 1999 and 1998, respectively. Total assets and total net assets subject to repurchase options were $52.2 million and $18.1 million, respectively, at December 31, 2000 and $39.4 million and $17.0 million, respectively, at December 31, 1999.
Due to these alternative uses of capital, the potential buy back arrangements do not represent material claims against UWS' liquidity and capital resources.
Health care costs have been rising and are expected to continue to rise at a rate that exceeds the consumer price index. UWS' cost control measures, risk-sharing incentive arrangements with medical care providers, and premium rate increases are designed to reduce the adverse effect of medical cost inflation on its operations. In addition, UWS utilizes its ability to apply appropriate underwriting criteria in selecting groups and individuals and in controlling the utilization of health care services. However, there can be no assurance that UWS' efforts will fully offset the impact of inflation or that premium revenue increases will equal or exceed increasing health care costs.
United Wisconsin Services, Inc. (the "Company") is a leading provider of managed health care services and employee benefit products. The Company's two primary product lines are (i) health maintenance organization ("HMO") products, sold primarily in Wisconsin, and (ii) specialty managed care products and services, including dental, life, disability and workers' compensation products, managed care consulting, electronic claim submission, pharmaceutical management, managed behavioral health services, case management and receivables management, sold throughout the United States.
On May 27, 1998, the Board of Directors of American Medical Security Group, Inc. ("AMSG") (formerly United Wisconsin Services, Inc.) approved a formal plan to spin off its managed care companies and specialty business to its shareholders. The Spin-off involved the creation of a new corporation originally named Newco/UWS, Inc., subsequently renamed United Wisconsin Services, Inc. ("UWS"). The Spin-off resulted in the distribution of one share of common stock of UWS on September 25, 1998 ("Spin-off date") for each share of AMSG common stock held as of September 11, 1998. AMSG received a private letter ruling from the Internal Revenue Service that the Spin-off is tax free to AMSG, UWS and their shareholders. A further description of the Spin-off and certain transactions with AMSG is included in Notes 1, 6, 7 and 10.
intercompany transactions have been eliminated. The Company consolidates subsidiaries for which repurchase options exist (see Note 2) when control is deemed to be other than temporary. Management believes that control of Unity Health Plans Insurance Corporation ("Unity") and Valley Health Plan, Inc. ("Valley") is not temporary because exercise of the repurchase options is not probable. Any repurchase would not provide a substantial economic benefit to the option holders and would require regulatory approval pursuant to change of control regulations.
Other receivables are stated at net realizable value, net of allowances for uncollectible amounts of $678,000 and $965,000 at December 31, 2000 and 1999, respectively, based upon historical collection trends and management's best estimate of the ultimate collectibility.
Health services premiums and managed behavioral health fees are recognized as revenue in the period in which enrollees are entitled to care. Managed care consulting revenues are generally recognized when services are rendered. Case management revenues are recognized when services are billed. Receivables management revenues are recognized when cash is received, which is in accordance with generally accepted accounting principles for the industry.
The Company's year-end claim liabilities are substantially satisfied through claim payments in the subsequent year. Any adjustments to prior period estimates are reflected in the current period. Capitation represents fixed payments on a per member per month basis to participating physicians, other medical specialists and hospital systems as compensation for providing comprehensive health or dental care services. In addition, certain subsidiaries have risk-sharing, stop-loss, and bonus arrangements with certain providers. Estimated settlements relating to these arrangements are developed based on historical payment patterns using standard actuarial techniques. The portion of other benefits payable pertaining to long-term disability, workers' compensation and certain life insurance products, which is estimated to be paid more than one year from the balance sheet date, is included in noncurrent liabilities on the accompanying balance sheets.
Premium deficiency reserves are recognized when it is probable that the future costs associated with a group of existing contracts will exceed the anticipated future premiums on those contracts. The Company calculates expected premium deficiency reserves based on budgeted revenues and expenses, excluding investment income. Premium deficiency reserves are evaluated quarterly for adequacy.
The Company has reinsurance recoverable amounts outstanding of $21,299,000 and $18,356,000 as of December 31, 2000 and 1999, respectively. These balances are included in other current and other noncurrent assets based on the expected settlements.
Historical EPS has been omitted for 1998 on the Consolidated Statements of Operations because the Company was not a separate entity with its own capital structure.
Pro forma net income per common share is calculated as if the Spin-off had occurred at the beginning of fiscal year 1998, and is adjusted for additional interest expense, net of related income tax. Pro forma EPS is based on the pro forma weighted average number of shares of outstanding Company common stock, giving effect to the distribution of one share of Company stock for each share of AMSG common stock. Pro forma dilutive common equivalent shares are stated at the historical AMSG dilutive common equivalent share level.
The following table sets forth the pro forma computation of basic and diluted EPS for the year ended December 31, 1998:
Certain reclassifications have been made to the consolidated financial statements for 1999 and 1998 to conform with the 2000 presentation.
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 (as well as the legal entity) at a price equal to the net assets of such business.
Total revenues subject to repurchase options, pursuant to the various acquisition agreements, totaled $239,306,000, $220,235,000 and $207,014,000 for 2000, 1999 and 1998, respectively. Profit (loss) sharing expenses related to these provider arrangements is calculated based on the profitability of the HMO subsidiary and totaled $347,000, $(2,366,000) and $3,171,000 in 2000, 1999 and 1998, respectively. Total net income (loss) subject to repurchase options, pursuant to the various acquisition agreements, totaled $(3,156,000), $(1,071,000) and $2,358,000 for 2000, 1999 and 1998, respectively. Total assets and total net assets subject to repurchase options were $52,182,000 and $18,068,000, respectively, at December 31, 2000 and $39,409,000 and $16,970,000, respectively, at December 31, 1999.
Proceeds from sales of stocks during 2000, 1999 and 1998 were $6,998,000, $65,031,000 and $73,156,000, respectively. Proceeds from sales of bonds classified as available-for-sale during 2000, 1999 and 1998, excluding maturities, were $24,468,000, $78,730,000 and $160,818,000, respectively.
The amortized cost and estimated fair values of debt securities at December 31, 2000, 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, 2000, the insurance subsidiaries had debt securities and cash equivalents on deposit with various state insurance departments with carrying values of approximately $9,677,000, which are included in investments held-to-maturity on the balance sheet.
credit. The interest expense on the line of credit was $990,000, $441,000 and $53,000 in 2000, 1999 and 1998, respectively. The 2000 weighted average interest rate on the line-of-credit was 7.8%.
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; 8.06% as of December 31, 2000. On October 13, 1999, the maturity date of the principal balance was extended from October 30, 1999 to April 30, 2001. The Company and BCBSUW intend to refinance this $70,000,000 note obligation with a maturity date subsequent to December 31, 2001. BCBSUW's board of directors has authorized the renegotiation of the note and the extension of the maturity date beyond December 31, 2001, pending approval of the Office of the Commissioner of Insurance. As a result, this obligation has been classified as noncurrent in the 2000 balance sheet. Interest expense and interest paid totaled $5,494,000, $4,804,000 and $1,411,000 in 2000, 1999 and 1998, respectively.
UWIC has an agreement with BCBSUW whereby UWIC underwrites BCBSUW's United Dairy Trust insured product. UWIC cedes 100% of the premium revenue of these products to BCBSUW. The ceded premium revenue was $3,497,000, $1,843,000 and $6,122,000 in 2000, 1999 and 1998, respectively.
The Company and its subsidiaries, except UHLIC, file a consolidated federal tax return. Income tax expense has been calculated as if the Company filed separate federal income tax returns. Prior to the Spin-off, the Company was included in the consolidated federal income tax return filed by AMSG. The entities included in these consolidated financial statements file separate state franchise, income and premium tax returns, as applicable.
The Company has operating leases for office space, EDP equipment, automobiles, software and terminal lines. Future minimum lease payments under noncancelable operating leases with initial or remaining lease terms in excess of one year at December 31, 2000 were $22,180,000 in total. Individually, the lease payments are $2,572,000, $2,636,000, $2,426,000, $2,247,000, $2,346,000 and $9,953,000 for the years ended December 31, 2001, 2002, 2003, 2004, 2005 and thereafter, respectively. Rental expense totaled $2,888,000, $1,934,000 and $2,547,000 for 2000, 1999 and 1998, respectively.
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.
State insurance regulations also require the maintenance of a minimum compulsory surplus based on a percentage of premiums written. As of December 31, 2000, statutory compulsory excess surplus and regulatory minimum compulsory surplus, as calculated and permitted by OCI, were $25,685,000 and $31,181,000, respectively. In addition, the Company's insurance subsidiaries are subject to risk-based capital ("RBC") requirements promulgated by the NAIC. The RBC requirements establish minimum levels of capital and surplus based upon the insurer's operations. The Company intends to make capital contributions on an ongoing basis or take other steps necessary to satisfy all promulgated capital and surplus requirements. In addition, Compcare is required to maintain certain capital and liquidity levels in conjunction with the licensing of certain products by the Blue Cross Association
The pension and postretirement plans' assets are comprised primarily of debt, equity and other marketable securities, including 700,000 shares of UWS stock with a fair value of $2,363,000 at December 31, 2000. The plan received dividends on UWS stock in the amount of $35,000 during 2000.
The effect of a 1% increase or decrease in the medical trend rate would be an approximate increase or decrease of $75,000 in the benefit obligation as of September 30, 2000.
The components of the pension credit and postretirement benefit cost, which are included in selling, general and administrative expenses, for the years ended December 31, 2000, 1999 and 1998 are as follows:
At the Spin-off date, certain of the options to purchase AMSG common stock held by the Company's employees were converted to Company stock options. AMSG options totaling 2,232,334 were converted into an equal amount of Company and AMSG options, including 1,000,000 options related to an acquisition. The options were converted at exercise prices that maintained the amount of unrealized stock appreciation that existed immediately prior to the Spin-off date. The vesting dates and expiration periods of the options were not affected by the conversion.
The Company follows Accounting Principles Board Opinion No. 25 under which no compensation expense is recorded when the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant. The Company's pro forma information, as if the options granted subsequent to the Spin-off date had been expensed in accordance with SFAS 123, "Accounting for Stock-Based Compensation", is as follows:
(1)When the Company reports a net loss, potentially dilutive securities are not included in the calculation of earnings per share ("EPS") because their inclusion would have an antidilutive effect. 12. Segment Reporting
The Company has two reportable business segments: HMO products sold primarily in Wisconsin, and specialty managed care products and services, including dental, life, disability and workers' compensation products, managed care consulting, electronic claim submission, pharmaceutical management, managed behavioral health services, case management and receivables management, sold throughout the United States.
FHP's 2000 results of operations prior to the acquisition of its insurance operations by the Company included revenues of $140,639,000 and a net loss of $8,295,000. On a pro forma basis, the net loss per share was $1.46. Operating results for FHP for the year ended December 31, 1999 included revenues of $171,274,000 and a net loss of $17,009,000. On a pro forma basis, the net loss per share for 1999 was $2.73. Average enrollment through October 2000 and through December 1999 was approximately 76,000 and 89,000, respectively.