This Financial Review should be read in conjunction with the accompanying Consolidated Financial Statements and notes thereto.
/3/ Amounts include both fully insured and self-funded enrollment. End of year self-funded enrollment was as follows: Commercial Health Plan Product -- 243,000 in 1995, 123,000 in 1994, and 62,000 in 1993; Other Network-Based Products -- 5,038,000 in 1995 and 67,000 in 1994; Indemnity Products --
Premium revenues in 1994 were $3.38 billion, a 21% increase over 1993, reflecting year-over-year enrollment growth of 18% and an average premium rate increase on renewing commercial groups of approximately 4%.
Commercial premium rates are established by the Company based on anticipated health care costs. The Company has been able to effectively manage health care costs and maintain the effective rate at which its health care costs have grown within the commercial line of business to low single-digit percentage increases. Following this strategy, the Company currently expects premium rate increases on renewing commercial groups in 1996 to increase slightly over those realized in 1995.
Competition for commercial enrollment in certain of the Company's health plan markets has increased in recent years. However, the Company has continued to follow its strategy of pricing its commercial products in accordance with anticipated health care costs. Depending on the level of future competition or other external factors beyond the Company's control, there can be no assurance that the Company's recent enrollment growth trends will continue or that the Company will be able to maintain pricing consistent with health care cost trends.
Management services and fee revenues in 1995 of $579.7 million more than doubled over 1994 comparable revenues. Prior to the MetraHealth acquisition, these revenues were primarily comprised of administrative fees relating to services performed on behalf of the Company's managed health plans and fees generated by the Company's specialty managed care services.
The Company had approximately 8,666,000 enrollees in self-funded products at December 31, 1995, most of which related to the former MetraHealth business. Under these funding arrangements, the Company receives a fee for the provision of administrative services and generally assumes no financial responsibility for health care costs associated with these products. The Company recorded $216.2 million in management services and fee revenues in the fourth quarter of 1995 related to the former MetraHealth self-funded products.
Investment and other income was $159.8 million in 1995, $118.0 million in 1994, and $62.8 million in 1993. Investment and other income increased each year primarily due to the investment of cash generated from operations and, from May 1994, the investment of the net proceeds from the Diversified sale.
Selling, general and administrative expenses as a percent of total revenues (the SG&A ratio) followed a similar trend. The SG&A ratio improved from 15.8% in 1993 to 14.7% in 1994, and then increased to 18.2% in 1995. The SG&A ratio actually decreased through the first nine months of 1995 to 14.4% from 15.2% for the comparable 1994 period. Contributing to this decrease from the 1994 period was a change in the terms of the Company's management agreement with the Minneapolis, Minnesota, based Medica health plan in August 1994. Under the new Medica agreement, the Company transferred cost responsibility for certain management contract expenses and employees to Medica. The Company's selling, general and administrative expenses decreased accordingly, matched with a corresponding decrease in management services revenues. With the MetraHealth acquisition, the SG&A ratio substantially increased in the fourth quarter of 1995 because a greater proportion of the former MetraHealth business consists of fee-based, self-funded products rather than products which generate full premium revenue.
Depreciation and amortization was $94.5 million in 1995, $64.1 million in 1994, and $50.6 million in 1993. Depreciation and amortization increased each year due to higher levels of capital expenditures in support of the growth in business and, in 1995, amortization of goodwill and other intangible assets related to the acquisition of GenCare, Group Sales and MetraHealth.
The charges reflect management's best estimates of the cost to be incurred in executing the restructuring plan. These estimates will continue to be refined until the plan is complete.
Although the general rate of inflation has remained relatively stable and health care cost inflation has declined in recent years, the total health care cost inflation rate still exceeds the general inflation rate. The Company uses various strategies to mitigate the negative effects of health care cost inflation, including setting commercial premiums based on its anticipated health care costs, risk-sharing arrangements with the Company's various health care providers, and other health care cost containment measures. Specifically, the Company's health plans attempt to control medical and hospital costs through contractual arrangements primarily with independent providers of health care services. Cost-effective delivery of health care services by such health care providers is achieved by the reduction of unnecessary hospitalizations, appropriate use of specialty referral services, and emphasizing preventive health services. While the Company currently believes its strategies to mitigate health care cost inflation will continue to be successful, competitive pressures, demands from providers and customers, applicable regulations or other factors may adversely affect the Company's ability to control the impact of health care cost increases. In addition, certain non-network-based products of the former MetraHealth business do not have similar health care cost containment measures as the Company's network-based managed care products. As a result, the Company is subject to more health care cost inflation risk with these products.
The Company's cash and investments increased from $2.77 billion at December 31, 1994, to $3.08 billion at December 31, 1995. The increase in cash and investments is primarily the result of cash generated from operations of $434.3 million, offset by cash used for the purchases of GenCare ($515.4 million), Group Sales ($22.0 million) and MetraHealth ($1.09 billion), net of cash and investments of $1.49 billion assumed with these acquisitions.
The Company generally invests a large portion of its cash resources in high quality, long-term investments. At December 31, 1994, the Company had working capital of $1.24 billion, a current ratio of 2.9, as a substantial portion of the Diversified proceeds remained invested in short-term instruments while the Company evaluated longer-term investment opportunities. As a result of the 1995 acquisitions and the application of the Company's investment strategy, the Company's working capital decreased to $433.1 million at December 31, 1995, a current ratio of 1.2.
Under applicable state regulations, certain of the Company's subsidiaries are required to retain cash generated from their operations. After giving effect to these restrictions, the Company had approximately $745.2 million in cash and investments available for general corporate use at December 31, 1995.
In connection with the Company's acquisition of MetraHealth, the former owners of MetraHealth are eligible to receive up to an additional $350.0 million if MetraHealth achieves certain 1995 operating results, as defined. Any consideration payable for this 1995 earnout may, at the Company's sole discretion, be in the form of cash, convertible debt, convertible preferred stock, or straight debt. Moreover, if the Company's post-acquisition combined net earnings for 1996 and 1997 reaches certain specified levels, certain of MetraHealth's former owners will be eligible to receive up to an additional $175.0 million in cash for each of those years.
These financial statements include some amounts that are based on management's best estimates and judgments. The most significant estimates relate to medical costs payable and other policy liabilities, intangible asset valuations and integration and restructuring reserves relating to the Company's recent acquisitions. These estimates are subject to adjustment as more accurate information becomes available and any such adjustment could be significant.
Medical costs includes claims paid, claims in process and pending, and estimated unreported claims and charges by physicians, hospitals and other health care providers for services rendered to enrolled members during the period. Medical cost adjustments to prior period estimates are reflected in the current period.
Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS No.115). The cumulative effect of adopting this statement was not significant.
Customer balances consist principally of deposit accounts and reserves which have accumulated under certain experience-rated contracts. At the customer's option, these balances may be returned to the customer or may be used to pay future premiums or claims under certain eligible contracts.
Effective December 31, 1995, the Company adopted Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" (SFAS No. 121). Following the criteria set forth in SFAS No. 121, long-lived assets to be held are reviewed by the Company for events or changes in circumstances which would indicate that the carrying value may not be recoverable. In making this determination, the Company considers a number of factors, including estimated future undiscounted cash flows associated with the long-lived asset. Assets held for sale are recorded at the lower of the carrying amount or fair value, less any costs associated with its disposition. The principles of SFAS No. 121 were applied in determining the restructuring charges recorded in the fourth quarter of 1995 (see Note 4).
Property and equipment is stated at cost. Depreciation is provided using the straight-line method over the estimated useful life of the respective assets ranging from 3 to 30 years.
Deferred income tax assets and liabilities are recognized for the differences between financial and income tax reporting basis of assets and liabilities based on enacted tax rates and laws. The deferred income tax provision or benefit generally reflects the net change in deferred income tax assets and liabilities during the year. The current income tax provision reflects the tax consequences of revenues and expenses currently taxable or deductible on the Company's various income tax returns for the year reported.
Certain 1994 and 1993 amounts in the consolidated financial statements have been reclassified to conform with the 1995 presentation. These reclassifications had no effect on net earnings or shareholders' equity as previously reported.
The Company acquired MetraHealth on October 2, 1995. MetraHealth was formed in January 1995 by combining the group health care operations of Metropolitan Life Insurance Company and The Travelers Insurance Group. At the time of acquisition, MetraHealth served over 10 million individuals, including 5.9 million in network-based care programs, 469,000 of whom were health plan members. The acquisition was accounted for using the purchase method of accounting, whereby the purchase price has been allocated to assets and liabilities based on their estimated fair values at the date of acquisition. The purchase price and costs associated with the acquisition exceeded the estimated fair value of net assets acquired by $992.2 million which have been allocated to certain identified intangible assets and goodwill. These identified intangible assets and goodwill are being amortized on a straight-line basis over useful lives deemed appropriate by management based on their best current judgment. The purchase price allocation and the useful lives assigned to intangible assets and goodwill may be adjusted upon completion of the final valuations of MetraHealth's assets and liabilities and the effect of any such adjustment could be significant.
On January 3, 1995, the Company completed its acquisition of GenCare Health Systems, Inc. (GenCare), a health plan based in St. Louis, Missouri, which served 230,000 members at the time of acquisition. The total purchase price of the acquisition was $515.4 million in cash. The acquisition was accounted for using the purchase method of accounting. The purchase price and costs associated with the acquisition exceeded the estimated fair value of net assets acquired by $476.0 million.
In connection with the Complete Health and Ramsay acquisitions, the Company incurred nonrecurring, non-operating merger costs of $35.9 million. Each acquisition was accounted for as a pooling of interests and, accordingly, the Company's consolidated financial statements and notes thereto include the results of Complete Health and Ramsay for all periods presented.
On May 27, 1994, the Company completed the sale of 100% of the outstanding common stock of Diversified Pharmaceutical Services, Inc. (Diversified), then a wholly owned subsidiary of the Company, to SmithKline Beecham Corporation (SmithKline), the U.S. operating subsidiary of London-based SmithKline Beecham plc., a pharmaceutical manufacturer. In connection with the sale, the Company received $2.3 billion in cash and recognized a $1.38 billion extraordinary gain after transaction costs and income taxes. Under a six-year management services agreement, SmithKline will pay the Company a management fee for certain administrative and management services to be provided by the Company to Diversified and for exclusive rights among pharmaceutical and medical diagnostic companies to access certain data utilized in Diversified's ongoing business. During the same six-year period, Diversified and SmithKline also will provide the Company, subject to competitive cost and quality considerations, the Diversified drug benefit management services that the Company requires in its health plan and other operations. At the end of the six-year period, the parties will consider continuation of the contract.
At the option of the shareholders, the Preferred Stock may be redeemed anytime after October 1, 1998, at certain defined redemption rates. Each shareholder has the right to convert the Preferred Stock into shares of the Company's common stock at predetermined conversion prices at any time. The Preferred Stock is subject to mandatory redemption no later than October 1, 2005.
The Company's regulated subsidiaries must comply with certain minimum capital or tangible net equity requirements in each of the states in which they operate. As of December 31, 1995, all of the Company's regulated subsidiaries were in compliance with these requirements.
The Company recorded $28.6 million, $44.5 million and $30.3 million in 1995, 1994 and 1993, respectively, to additional paid-in capital to reflect the tax benefit received by the Company upon the exercise of non-qualified stock options and the vesting of restricted stock.
The Company's consolidated income tax returns for fiscal years 1993, 1992 and 1991 are currently under examination by the Internal Revenue Service. The Company believes any adjustments which may result from this examination would not have a significant impact on its consolidated operating results or financial position.
The Company leases facilities, computer hardware and other equipment under long-term operating leases which are noncancellable and expire on various dates through 2011. Rent expense under all operating leases was $61.0 million, $41.4 million and $33.0 million for 1995, 1994 and 1993.
At December 31, 1995, future minimum annual lease payments under all noncancellable operating leases are as follows (in thousands):
On November 16, 1995, a subsidiary of the Company signed a 10-year contract with a third party for information technology services. Under terms of the contract the third party will assume responsibility for the subsidiary's data center operations and support. Future payments under the contract are estimated to be $540.0 million; however, the actual timing and amount of payments will vary based on usage.
Certain factors relating to the industry in which the Company operates and the Company's business should be carefully considered. The Company's primary business, offering health care coverage and health care management services, is heavily regulated at both the federal and state levels. While the Company is unable to predict what regulatory changes may occur or the impact on the Company of any particular change, the Company's operations and financial results could be negatively affected.
Recent trends in health care prices and utilization have moderated, but there can be no assurance that they will not again increase at a more rapid pace. If health care costs do begin to increases more rapidly, there can be no assurance that the Company will be able to meet its goal of maintaining price increases at least sufficient to cover increases in health care costs.
Also, the Company operates in a highly competitive industry which has seen significant consolidation over the past few years. The current competitive markets in certain areas may limit the Company's ability to price its products at levels the Company believes appropriate. These competitive factors could adversely affect the Company's financial results.
The following is a summary of unaudited quarterly results of operations (in thousands, except per share data) for the years ended December 31, 1995 and 1994:
The management of United HealthCare Corporation is responsible for the integrity and objectivity of the consolidated financial statements and other financial information contained in this annual report. The consolidated financial statements and related information were prepared in accordance with generally accepted accounting principles and include some amounts that are based on management's best estimates and judgments.