The Company owns a 380,000 square foot office building in Green Bay, Wisconsin which houses employees who service the small group business. The Company also occupies common facilities with BCBSUW and is charged a proportionate share of the cost of such facilities under the Service Agreement. The Company's corporate headquarters are principally located in Milwaukee, Wisconsin in a 235,000 square foot building leased by BCBSUW. The Company also utilizes space in a Milwaukee regional office leased by BCBSUW, which has approximately 299,000 square feet of office and warehouse space. In addition, the Company's business is sold and serviced in four other Wisconsin regional offices leased by BCBSUW and a 40,000 square foot facility in Sauk City, Wisconsin owned by Unity.
The following selected financial data as of and for each of the five years in the period ended December 31, 1996 have been derived from the Company's consolidated financial statements, which have been audited by Ernst & Young, LLP, independent auditors. The following data should be read in conjunction with the Company's consolidated financial statements, the related notes thereto, and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
(1) Ratios are based on premium revenues and related expenses for HMO products. See Management's Discussion and Analysis of Financial Condition and Results of Operations.
Total revenues in 1996 increased 12.0% to $1.16 billion from $1.04 billion in 1995. Total revenues in 1995 increased 34.7% from $770.7 million in 1994. These increases were due primarily to increased premium revenue.
Premium and other revenue from specialty managed care products and services in 1996 increased 14.8% to $124.1 million from $108.1 million in 1995. Premium and other revenue in 1995 increased 34.4% from $80.4 million in 1994. The increase in 1996 was due to (i) an increase in premium revenues of $6.4 million, including an increase of $2.2 million for life and disability products and an increase of $3.6 million for dental products, driven by increases in contracts, and (ii) an increase in other revenues of $9.6 million due primarily to increased managed care and consulting services and a gain on the sale of the vision line of business. The increase in 1995 was due to (i) an increase in premium revenues of $15.1 million, including an increase of $2.6 million for life and disability products and an increase of $2.2 million for dental products, driven by increases in contracts, an increase of $5.1 million in workers' compensation premiums, and an increase of $4.7 million in premiums assumed under certain federal and state reinsurance programs, and (ii) an increase in other revenues of $12.6 million due primarily to increased managed care and consulting services.
MEDICAL LOSS RATIO -- The combined medical loss ratio for HMO and AMS products was 84.4% in 1996 compared with 85.4% in 1995 and 77.1% in 1994. The increase in the combined medical loss ratio in 1995 was due to increases in both the HMO and AMS component loss ratios. In 1996, both the HMO and AMS component loss ratios decreased, as discussed below.
The medical loss ratio for HMO products in 1996 was 89.8%, compared with 91.1% in 1995 and 88.0% in 1994. The 1995 increase is attributed to the competitive market conditions in southeastern Wisconsin, where pricing pressures coupled with increased utilization have had an adverse impact on Compcare's loss ratio. The Company has taken steps to lower the medical loss ratio for HMO products, including, among other actions, renegotiation of provider contracts, selectively increasing premium rates, review of underwriting practices, review of managed care procedures, and selective product design changes.
The medical loss ratio for AMS products in 1996 was 80.3%, compared with 80.5% in 1995 and 68.3% in 1994. The increase in the medical loss ratio for AMS products since 1994 was due primarily to higher than expected incurred claims, beginning in the fourth quarter of 1994 and accelerating into the first and second quarters of 1995. During 1995, management determined that the liability for unpaid insured medical claims at December 31, 1994 was deficient by approximately $5.6 million, net of amounts allocated to an insurance subsidiary of AMS. This deficiency was charged to operations during the first six months of 1995, which increased the reported medical loss ratio for 1995 by approximately 1.2 percentage points. Products sold by AMS, which are more sensitive to changes in health care costs than the Company's other products, have been adversely affected since the first quarter of 1995 by an increase in the rate of health care inflation. The rate of change for health care costs for the small group managed care products on a per contract basis experienced a significant increase in late 1994 and early 1995. Since the second quarter of 1995, the rate of change in health care costs for insured medical products sold by AMS has steadily decreased from approximately 14% to approximately 8% currently. This stability in the rate of inflation has allowed the Company to better estimate health care costs in the pricing of its products.
ADMINISTRATIVE EXPENSE RATIO -- The administrative expense ratio for AMS medical and life products combined has remained relatively steady at 10.2% in 1996, compared with 10.1% in 1995 and 10.0% in 1994. Prior to the AMS Merger, the Company paid a negotiated fee to a third party administrator (TPA) subsidiary of AMS to administer the business underwritten by the Company, which contributed to the stability of this ratio. Following the AMS Merger, any profit or loss of AMS' TPA subsidiary will be recorded on the books of the Company. AMS has taken steps recently to reduce administrative expenses related to the processing of AMS medical and life products, including recent staff reductions and an ongoing intensive review of operating expenses for every department within AMS.
The administrative expense ratio for HMO products was 8.4% in 1996, 7.9% in 1995, and 8.9% in 1994. The decrease in 1995 was due primarily to a reduction in expenses related to the Company's profit sharing and bonus programs for employees due to the lower profits in 1995.
Interest and profit sharing on joint ventures was $13.6 million in 1996, compared with $15.2 million in 1995 and $7.6 million in 1994. Of these balances, $2.8 million, $2.6 million and $1.4 million in 1996, 1995 and 1994, respectively, represent profit sharing expenses related to the Unity and Valley acquisitions, and $10.7 million, $12.4 million and $6.1 million in 1996, 1995 and 1994, respectively, were due to investment income and realized investment gains on funds held by the Company on behalf of an insurance subsidiary of AMS. The gross funds held balance, which includes amounts for both medical and other benefits payable and undistributed profits subject to allocation of investment returns, increased during the three-year period from $88.7 million at the beginning of 1994 to $121.7 million at November 30, 1996, just prior to the AMS Merger. Following the AMS Merger, the funds held balance is eliminated in consolidation. See "Investment Income and Realized Gains" for a discussion of the increase in realized gains in 1996.
The Company's effective tax rate was 40.2% in 1996, compared with 31.9% in 1995 and 33.6% in 1994. The increase in the effective tax rate in 1996 was due primarily to a higher proportion of the Company's income being generated by its HMO subsidiaries, which record higher effective tax rates than the Company's other subsidiaries due to state tax implications.
AMS products recorded a pre-tax loss of $2.9 million in 1996, compared with a pre-tax loss of $7.6 million in 1995 and pre-tax income of $34.6 million in 1994. The improvement in 1996 is due primarily to an increase of $6.1 million in investment income and realized gains, net of amounts allocated to an insurance subsidiary of AMS prior to the AMS Merger. This increase in investment income is due to the reallocation of capital in 1996 to support this line of business. The decrease in pre-tax income in 1995 is due to the increase in the medical loss ratio. See "Expense Ratios - Medical Loss Ratio." Following the AMS Merger, pre-tax income for AMS products includes 100% of the profit or loss on the business sold by AMS, as well as interest expense and amortization of goodwill and other intangibles recorded in conjunction with the AMS Merger, as discussed previously. In addition, pre-tax income for AMS products includes the financial results for all other AMS subsidiaries acquired in the AMS Merger. The financial results of these other subsidiaries were not material to the 1996 financial statements.
Pre-tax income for specialty managed care products and services in 1996 increased 10.3% to $21.0 million from $19.0 million in 1995, due primarily to an increase of $3.5 million in the net underwriting gain related to life and disability products, a $1.6 million gain recorded on the sale of the vision line of business, partially offset by a decrease of $2.1 million in investment income and realized gains related to all specialty products and services due to the capital reallocation to support AMS products. Pre-tax income for specialty managed care products and services in 1995 increased 83.5% from $10.4 million in 1994, due primarily to an increase of $7.6 million in investment income and realized gains related to all specialty products and services, and an increase of $1.1 million in the net underwriting gain related to workers' compensation products.
Historically, the Company has generated positive cash flow from operations. For 1996, however, net cash provided by or used in operating activities amounted to a use of $9.9 million, compared with $48.7 million provided in 1995 and $94.3 million provided in 1994. The decrease in cash flow from operations in 1996 and 1995 was due primarily to a reduction in the funds held on behalf of American Medical Security Insurance Company (AMSIC) due to the reduced profitability on the business sold by AMS and cash payments to AMSIC totaling $17.0 million during
Prior to the AMS Merger, the Company held funds in accordance with the AMS joint venture agreement. Investment income and realized investment gains or losses were credited to AMSIC on the funds held balance at the Company's average portfolio rate. The Company held $121.7 million of funds on behalf of AMSIC at November 30, 1996, just prior to the AMS Merger. Following the AMS Merger, the funds held balance was eliminated in consolidation. The Company held $143.7 million of funds on behalf of AMSIC at December 31, 1995, of which $83.4 million was utilized to offset reinsurance recoverable balances from AMSIC on the Company's balance sheet in accordance with SFAS No. 113.
The Company's investment portfolio consists primarily of investment grade bonds and has a limited exposure to equity securities. At December 31, 1996, $407.4 million or 87.2% of the Company's total investment portfolio was invested in bonds. At December 31, 1995, $471.8 million or 86.8% of the Company's total investment portfolio was invested in bonds. At December 31, 1996 and 1995, the bond portfolio had an average quality rating of Aa3 by Moody's Investor Service, and the majority of the bond portfolio was classified as available for sale. In accordance with SFAS No. 115, bonds classified as available for sale are recorded on the Company's balance sheet at market value. The market value of the total bond portfolio exceeded amortized cost by $1.4 million and $10.6 million at December 31, 1996 and 1995, respectively. Unrealized holding gains and losses on bonds classified as available for sale are included as a component of shareholders' equity, net of applicable deferred taxes and amounts attributable to funds held on behalf of an affiliated reinsurer. See Notes 1 and 4 to Notes to Consolidated Financial Statements for a discussion of the accounting treatment of unrealized holding gains and losses on bonds classified as available for sale. The Company has no investments in mortgage loans, non-publicly traded securities (except for principal only strips of U. S. Government securities), real estate held for investment or financial derivatives.
In July 1994, the Company completed a public offering of 1,000,000 shares of Common Stock. In conjunction with this offering, BCBSUW sold 1,566,200 shares of Common Stock and the United Wisconsin Services Foundation, Inc. sold 100,000 shares of Common Stock. Net proceeds to the Company, after estimated offering expenses, totaled $26.1 million. In February 1995, the Company completed a public offering of 484,500 shares of Common Stock, and BCBSUW sold 930,000 shares of Common Stock. Net proceeds to the Company, after offering
The Company's anticipated expansion of its business requires capital levels sufficient to support premium growth. The Company's compound annual growth rate in premium revenue for the five years ended December 31, 1996 was 28.8%, due principally to the growth of AMS products. While the future rate of growth is uncertain, growth in premium revenue is expected to continue.
In compliance with applicable state insurance regulations, certain insurance subsidiaries have deposited securities with various states aggregating $5.8 million at December 31, 1996. In addition, HMOs are required to maintain a deposit with the State of Wisconsin for future assessments for HMO insolvencies. As of December 31, 1996, the combined deposit for the Company's consolidated HMOs was $4.7 million. States in which the insurance subsidiaries are licensed to do business independently establish deposit requirements. Increases in deposit levels, resulting in the segregation of certain investments, may adversely affect the Company's liquidity.
The National Association of Insurance Commissioners (NAIC) has adopted risk-based capital guidelines for both life and health insurers and for property and casualty insurers. These guidelines currently apply only to certain of the Company's subsidiaries. Those subsidiaries exceed the company action level for NAIC risk-based capital guidelines. The NAIC is also developing risk-based capital guidelines for health organizations, which would apply to other of the Company's subsidiaries. In addition, the OCI and other state regulators have the authority to establish capital and surplus requirements for individual companies and may propose stricter capital and surplus requirement.
The Company believes that internally generated funds and periodic borrowings on its bank line of credit will be sufficient to finance planned growth for the foreseeable future. In the event the Company seeks additional financing to facilitate long-term growth, the Company believes that such financing could be obtained through equity offerings, debt offerings, financings from BCBSUW or other bank borrowings, as market conditions may permit or dictate.
Health care costs have been rising and are expected to continue to rise at a rate that exceeds the consumer price index. The Company's 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, the Company 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 the Company's efforts will fully offset the impact of inflation or that premium revenue increases will equal or exceed increasing health care costs.
The Financial Accounting Standards Board (FASB) recently issued the following accounting standard. A brief description of the standard follows, along with a discussion of the estimated impact of the adoption of the standard on the Company's consolidated financial statements.
ACCOUNTING FOR STOCK-BASED COMPENSATION -- In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-based Compensation'" which became effective for the Company in 1996. As allowed by SFAS No. 123, the Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related Interpretations in accounting for its employee stock options. Under APB 25, when the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recorded. The required pro forma information regarding net income and earnings per share has been included in Note 16 of the Notes to Consolidated Financial Statements.
This report contains certain forward looking statements with respect to the financial condition, results of operations and business of the Company. Such forward looking statements are subject to inherent risks and uncertainties that may cause actual results to differ materially from those contemplated by such forward looking statements. Factors that may cause actual results to differ materially from those contemplated by such forward
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. Form 10-K Page Number ----------- Report of Independent Auditors.................................... 30
Consolidated Statements of Income for the years ended December 31, 1996, 1995 and 1994................................. 33
As discussed in Note 1 to the consolidated financial statements, in 1994 the Company changed its method of accounting for certain investments in debt and equity securities.
Bonds held to maturity, at amortized cost 12,823 9,850 -------- -------- Total bonds 407,438 471,765
Receivables: Due from affiliates 2,641 14,789 Other receivables 74,167 73,265 -------- -------- Total receivables 76,808 88,054
Property and equipment - net 53,103 10,037 Goodwill and other intangibles (net of accumulated amortization of $2,397,000 and $996,000) 155,458 6,851 Other assets 32,482 34,710 -------- -------- Total assets $836,120 $721,289 -------- -------- -------- --------
DECEMBER 31, ------------------ LIABILITIES AND SHAREHOLDERS' EQUITY 1996 1995 -------- -------- (In thousands)
Shareholders' equity: Preferred stock (no par value, 475,000 shares authorized, none issued or outstanding) -- --
Common stock (no par value, $1 stated value, 50,000,000 shares authorized, 16,293,995 and 12,599,715 shares issued and outstanding at December 31, 1996 and 1995, respectively) 16,294 12,600
The accompanying notes are an integral part of the Consolidated Financial Statements.
The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles (GAAP). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Significant intercompany accounts and transactions have been eliminated.
ORGANIZATION - The Company is a leading provider of managed health care products and services. The Company's three primary product lines are (i) Health Maintenance Organization (HMO) products, sold primarily in Wisconsin; (ii) American Medical Security (AMS) products, including small group preferred provider organization (PPO) products and life products, sold throughout the United States; and (iii) specialty managed care products and services, including dental, life, disability, workers' compensation, managed care consulting, electronic claims processing, pharmaceutical services and managed mental health services, sold throughout the United States.
INVESTMENTS - The Company adopted Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities," on January 1, 1994 resulting in an increase in shareholders' equity of $2,650,000. Bonds are divided into two categories: held to maturity and available for sale. Bonds which the Company has the intent and ability to hold to maturity are designated as held to maturity and are stated at amortized cost.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents include operating cash and short-term investments with original maturities of three months or less. These amounts are recorded at cost, which approximates market.
MEDICAL AND OTHER BENEFITS - Medical and other benefits expense consists principally of capitation expenses, health and disability claims and life insurance benefits. Capitation represents monthly fees to participating physicians and other medical specialists as compensation for providing comprehensive health or dental care services. In addition, certain subsidiaries have risk-sharing and bonus arrangements with certain providers. Amounts are paid to or collected from these providers based on their performance in controlling health care costs. These amounts are estimated using formulae defined in the provider's contract and are accrued during the contract period based upon current experience.
In addition to actual paid claims and capitation, these expenses include the change in estimates of reported and unreported claims and accrued capitation fees and adjustments, which are unpaid as of the balance sheet date. These unpaid claim estimates are based on statistical analyses and are revised as additional information becomes available. Any adjustments resulting from these revisions are reflected in earnings currently. See Note 5.
INCOME TAXES - Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial statement purposes and the amounts used for income tax purposes. A valuation allowance is recorded on deferred tax assets that more likely than not will not be realized.
RECLASSIFICATIONS - Certain reclassifications have been made to the consolidated financial statements for 1994 and 1995 to conform with the 1996 presentation.
The Company completed the following merger and acquisitions during 1994 through 1996.
CNR HEALTH, INC. - Effective May 26, 1994, the Company acquired 53% of the outstanding common stock of CNR Health, Inc. (CNR) for $1,498,000 in cash and 45,234 shares of the Company's common stock with a market value at the date of acquisition of $1,402,000, for a total purchase price of $2,900,000. CNR manages mental health, substance abuse and medical benefits.
HMO-W, INCORPORATED - Effective October 1, 1994, the Company acquired all of the outstanding common stock of HMO-W, Incorporated for cash approximating $7,569,000.
U-CARE HMO, INC. - Effective October 1, 1994, the Company acquired all of the assets of U-Care HMO, Inc. (U-Care) and certain assets from University Health Care, Inc., an affiliate of U-Care, for cash approximating $3,774,000.
Effective December 3, 1996, the Company acquired the remaining 88% of AMSG. The acquisition was accomplished through the merger of AMSG with and into the Company pursuant to the terms of an Agreement and Plan of Merger dated July 31, 1996, by and between AMSG, BCBSUW, the Company and the two primary shareholders of AMSG. The Company is the surviving corporation in the merger.
The following unaudited pro forma information presents the consolidated results of operations for 1996 and 1995 assuming the 1996 merger had occurred on January 1, 1995, after giving effect to certain adjustments arising from the recording of the transaction, including amortization of goodwill and other intangibles, reduction of investment income due to cash payments, interest expense on debt and intercompany eliminations.
Years ended December 31, ----------------------- 1996 1995 ----------- ---------- (In thousands,except per share data)
In conjunction with several recent acquisitions, the Company has included profit sharing and repurchase provisions in the acquisition agreements. Profit sharing expense related to these acquisitions totaled $2,827,000, $2,625,000 and $1,438,000 in 1996, 1995 and 1994, respectively, and is recorded as interest and profit sharing on joint ventures. Total revenues subject to repurchase options, pursuant to the various acquisition agreements, totaled $191,342,000, $160,003,000 and $65,870,000 for 1996, 1995 and 1994, respectively. Total assets and total net assets subject to repurchase options were $56,281,000 and $22,475,000, respectively, at December 31, 1996 and $44,820,000 and $20,175,000, respectively, at December 31, 1995.
Interest on bonds $28,986 $23,736 $19,976 Dividends on stocks 1,841 2,058 713
Unrealized gains (losses) on investments, which are reflected as a component of shareholders' equity, are as follows:
$ 6,269 $ 9,548 $(13,473) ------- ------- -------- ------- ------- --------
At December 31, 1996: Available for sale: U.S. Treasury securities $ 87,170 $ 966 $ (651) $ 87,485 State and municipal securities 4,614 43 (14) 4,643 Foreign government securities 16,249 259 (121) 16,387 Corporate securities 189,822 2,120 (1,061) 190,881 Government agency mortgage-backed securities 95,478 608 (867) 95,219 --------- ---------- ---------- --------- 393,333 3,996 (2,714) 394,615
Bonds held to maturity: Due in one year or less $ 4,570 $ 4,565 Due after one through five years 5,235 5,347 Due after five through ten years 3,018 3,020 --------- --------- $ 12,823 $ 12,932 --------- --------- --------- ---------
The cost of stocks at December 31, 1996 and 1995 totaled $50,975,000 and $61,573,000, respectively.
At December 31, 1996, the insurance subsidiaries had bonds and cash equivalents on deposit with various state insurance departments with carrying values of approximately $12,080,000.
Land and land improvements $ 4,271 $ 683 Building and building improvements 26,787 5,843 Computer equipment and software 16,854 5,315 Furniture and other equipment 18,163 3,962 --------- --------- 66,075 15,803 Less accumulated depreciation (12,972) (5,766) --------- --------- $ 53,103 $ 10,037 --------- --------- --------- ---------
The estimated useful lives are as follows: land improvements - 20-30 years; building and building improvements - 10-40 years; computer equipment and software - 3-5 years; and furniture and other equipment - 3-10 years.
Balance as of January 1 $ 245,118 $ 162,933 $ 114,248 Less: HMO benefits payable (39,087) (31,503) (21,976) Reinsurance recoverables (101,069) (64,258) (43,952) --------- --------- --------- Net balance at January 1 104,962 67,172 48,320
The liability for medical and other benefits payable at December 31, 1995 developed favorably in 1996 due primarily to lower than anticipated medical costs and utilization. The liability for medical and other benefits payable at December 31, 1994 developed unfavorably in 1995 due to higher than expected medical inflation beginning in late 1994. The unfavorable development was reflected in earnings when it became known. The liability for medical and other benefits payable at December 31, 1993 developed favorably in 1994 due primarily to lower than anticipated medical costs and utilization.
NOTE PAYABLE - On October 30, 1996, the Company borrowed $70,000,000 from BCBSUW to fund the cash consideration for the AMSG merger. The Company pledged the common stock of certain subsidiaries as collateral for the loan. Interest is payable quarterly at a rate equal to the London Interbank Offered Rate plus 1.25%, adjusted quarterly. The principal balance is due on October 30, 1999. Interest expense on this note totaled $564,000 in 1996.
SUBORDINATED NOTES - In July 1993, the Company issued $45,000,000 of Subordinated Notes (Notes) bearing interest at a rate of 7.75% per year until maturity or earlier redemption. The Notes will mature on July 1, 2000 and are currently redeemable at the option of the Company at 100% of the principal amount, plus accrued interest. The Notes are subordinated in right of payment to all existing and future Senior Indebtedness of the Company and are junior to the claims of any secured obligations on specific assets of the Company's subsidiaries. Certain covenants exist which, among other matters, restrict the ability of the Company to incur additional indebtedness, limit future cash dividends and transfers of assets and require the maintenance of a minimum consolidated tangible net worth. At December 31, 1996, the Company was in compliance with these covenants.
MORTGAGE PAYABLE - The Company had two mortgages on an office building. Prior to the merger of AMSG and the Company in December 1996, these mortgages were a liability of the Partnership. In December 1996, the Company repaid the outstanding balance of $9,083,000 on one of the mortgages.
The remaining mortgage of $10,900,000 requires monthly principal payments of $100,000 plus interest through December 1, 2003. On January 1, 2004, the outstanding principal balance and any unpaid interest are due. The mortgage bears interest at a fixed rate of 9.05%. Interest expense on these mortgages totaled $282,000 in 1996.
The Company provides marketing, underwriting, actuarial and certain administrative services for BCBSUW. In addition, BCBSUW provides health insurance to the employees of the Company and provides office space to the Company. These activities are reimbursed at amounts approximating cost, which resulted in receipts to the Company of $13,315,000, $10,028,000 and $10,964,000 in 1996, 1995 and 1994, respectively, and payments to BCBSUW of $7,474,000, $4,368,000 and $4,102,000 in 1996, 1995 and 1994, respectively. These amounts are included in administrative expenses.
Prior to December 3, 1996, the Company had a joint venture agreement with AMSG, whereby the Company underwrote all of the small group health care products and life, dental, drug and disability business sold by AMSG. Amounts related to this agreement, prior to ceded reinsurance (see Note 10), are as follows:
The Company limits the maximum net loss that can arise from certain lines of business by reinsuring (ceding) a portion of these risks with other insurance organizations (reinsurers), principally on a quota share basis. The ceding company is contingently liable on reinsurance ceded in the event that the reinsurers do not meet their contractual obligations.
Since July 1, 1994, the Company and most of its subsidiaries file a consolidated federal income tax return. Certain subsidiaries of the Company file separate federal income tax returns. The Company and its subsidiaries file separate state franchise, income and premium tax returns as applicable. Prior to July 1, 1994, the Company was included in the consolidated federal income tax return of BCBSUW.
The Internal Revenue Service (IRS) has completed its examinations of the tax returns of BCBSUW, the Company and its subsidiaries through 1992. Reserves for federal income tax and interest have been established in an amount which the Company believes is adequate to provide for any future settlements.
The Company had a net federal income tax receivable of $4,858,000 and a net federal income tax payable of $320,000 at December 31, 1996 and 1995, respectively. These amounts include $1,887,000 due to BCBSUW for taxes incurred while the Company was included in BCBSUW's consolidated federal income tax return. This amount will be settled in full upon final IRS examination of the consolidated federal income tax returns. The Company and its subsidiaries have state net business loss carryforwards totaling $22,112,000 at December 31, 1996, which expire in the years 2006 through 2011. Federal and state income tax payments, net of refunds, totaled $8,935,000, $2,472,000 and $23,573,000 in 1996, 1995 and 1994, respectively.
Years Ended December 31, --------------------------- 1996 1995 1994 ------- ------- ------- (In thousands)
Tax at federal statutory rate $ 5,967 $ 3,274 $17,264 Tax exempt interest and dividends received deduction (522) (1,013) (957) Small life deduction (9) -- (1,050) State income and franchise taxes, net of federal benefit 883 255 788 Reserve for federal tax and interest related to prior years 80 -- (520) Other, net 447 465 1,038 ------- ------- ------- $ 6,846 $ 2,981 $16,563 ------- ------- ------- ------- ------- -------
Alternative minimum tax credit $ -- $ -- $ 2,178 Depreciation and amortization (2,844) 107 46 Net operating loss carryforwards 2,248 (2,419) 44 Other, net 438 1,249 (154) ------- ------- ------- $ (158) $(1,063) $ 2,114 ------- ------- ------- ------- ------- -------
LONG-TERM CONTRACT - BCBSUW has an agreement with a service bureau extending through December 31, 1999, with an option to terminate upon one year's prior written notice, deliverable at any time. The service bureau provides BCBSUW and a subsidiary of the Company with the majority of the electronic data processing services used to operate their businesses. Processing charges are based on the volume of transactions processed. The Company recorded expenses related to this agreement of $3,456,000, $3,425,000 and $3,177,000 in 1996, 1995 and 1994, respectively.
In April and May 1995, suits were filed against the Company, BCBSUW and certain of the Company's officers, alleging that these parties violated federal securities laws by issuing false and misleading statements regarding the Company, its financial condition and operations. The suits seek class action status and were filed on behalf of purchasers of the Company's common stock between February 7, 1995 and April 18, 1995. These actions were consolidated on August 14, 1995. Motions to dismiss filed on behalf of the defendants are pending.
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.
Based upon the financial statements of the Company's insurance subsidiaries as of December 31, 1996, as filed with the insurance regulators, the aggregate amount available for dividends in 1997 without regulatory approval is $8,783,000.
PENSION BENEFITS - The Company and all of its subsidiaries, except certain recent acquisitions, participate with BCBSUW in two multiple-employer defined benefit pension plans. One plan covers salaried employees and one plan covers hourly employees. The salaried plan provides benefits based on compensation, years of service, year of birth and date of retirement. The hourly plan provides for benefit payments of stated amounts, based on number of hours worked and years of credited service. Since both plans were overfunded, no contributions were made in 1996, 1995 or 1994, and a pension credit was recorded in each year.
The Company has amended the salaried pension plan and the hourly pension plan with respect to nonunion participants, which include expansion of the lump-sum payment provisions and changes in the methods and formulae used for the calculation of benefit accruals (a "cash balance" formula). The amendments are effective January 1, 1997. The resulting reduction in the projected benefit obligation is included in the funded status of the pension plans at December 31, 1996 and 1995, and was also considered in the calculation of the 1996 pension credit.
The following table summarizes the combined funding status of the pension plans of the Company and the amounts recorded in the consolidated balance sheets:
Actuarial present value of benefit obligations: Vested benefits $(12,806) $(10,635) Nonvested benefits (2,923) (1,853) -------- --------- Total accumulated benefit obligations (15,729) (12,488) Adjustment for projected benefit obligations (52) (453) -------- --------- Projected benefit obligations (15,781) (12,941) Assets, at fair market value 29,309 26,509 -------- --------- Excess of assets over projected benefit obligations 13,528 13,568 Unrecognized net gains (122) (633) Unrecognized net asset (1,326) (1,600) Unrecognized prior service cost (6,836) (7,526) -------- --------- Prepaid pension expense in consolidated balance sheets $ 5,244 $ 3,809 -------- --------- -------- ---------
Discount rate 8% 8% Rate of increase in compensation 4.75% 4.75% Rate of return on plan assets 9% 9%
After July 1, 1994: Service cost - benefits earned during the period $ 829 $ 1,117 $ 601 Interest cost on benefit obligations 1,034 1,116 606 Actual return on plan assets (2,866) (4,136) (158) Net amortization and deferrals (432) 1,503 (1,132) -------- -------- -------- (1,435) (400) (83) Prior to July 1, 1994: Pension credit allocation for the six months ended June 30, 1994 -- -- (588) -------- -------- -------- Total pension credit $(1,435) $ (400) $ (671) -------- -------- -------- -------- -------- --------
The following table presents the funded status of the post-retirement welfare benefit plans, reconciled with the liability recognized in the consolidated balance sheets:
Funded status: Unrecognized prior service cost 1,080 1,160 Unrecognized net gains 356 392 -------- -------- Accrued liability for post-retirement benefits other than pensions - unfunded $ 3,728 $ 3,513 -------- -------- -------- --------
The employees of AMSH are included in a contributory defined contribution profit sharing plan covering all eligible salaried and hourly employees who meet minimum service requirements. Contributions are determined by AMSH's Board of Directors. There is no expense for this plan in 1996.
The Company also participates with BCBSUW in various other bonus programs covering certain management employees. Expenses related to these programs, after giving effect to all administrative expense allocations between the Company and BCBSUW, totaled $926,000, $483,000 and $477,000 in 1996, 1995 and 1994, respectively.
STOCK APPRECIATION RIGHTS PLAN - In December 1991, the Board of Directors of the Company authorized a Stock Appreciation Rights Plan (SAR Plan) for certain employees of the Company, which became effective on January 1, 1992. The aggregate number of stock appreciation rights (SARs) which may be granted may not exceed 150,000.
UWS EQUITY INCENTIVE PLAN - In May 1993, the Board of Directors of the Company authorized the UWS Equity Incentive Plan, which permits the grant of Nonqualified Stock Options (NQSOs), Incentive Stock Options, SARs, Restricted Stock, Performance Units and Performance Shares. No awards may be granted on or after February 24, 2003. The total number of shares available for grant, as defined in the UWS Equity Incentive Plan, as amended, may not exceed 2,750,000.
NQSOs have been granted to certain employees of the Company under this plan. The NQSOs are exercisable in whole or in part and at such times as specified in the grant. The rights of grantees vest over various periods up to four years after the date of the grant. The options lapse if not exercised within various periods up to twelve years of the grant date.
DIRECTOR STOCK OPTION PLAN - In May 1995, the shareholders of the Company approved the 1995 Director Stock Option Plan which permits the grant of NQSOs. The total number of shares available for grant may not exceed 75,000.
Exercisable at end of year 2,029,557 54,937 Available for grant at end of year 580,541 280,596
WEIGHTED AVERAGE EXERCISE PRICE OF NQSOS: Outstanding at beginning of year $26.36 $27.94 Granted - exercise price equals market price on grant date 24.26 25.18 Granted - exercise price is less than market price on grant date 11.05 -- Granted - exercise price exceeds market price on grant date 32.83 -- Forfeited 27.78 28.07 Outstanding at end of year 25.00 26.36 Exercisable at end of year 25.02 27.67
Range of exercise prices $18.13-$26.00 $22.38-$26.00 Weighted average exercise price $22.33 $25.08 Weighted average remaining contractual life 11.07 11.63 Exercisable at end of year 657,895 15,625 Weighted average exercise price of options exercisable at end of year $22.25 $26.00
In October 1995, the Financial Accounting Standards Board (the FASB) issued SFAS No. 123, "Accounting for Stock-based Compensation," which became effective for the Company in 1996. As allowed by SFAS No. 123, the Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related Interpretations in accounting for its employee stock options for the reasons discussed below. Under APB 25, when the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recorded.
Pro forma information regarding net income and earnings per share is required by SFAS No. 123, and has been determined as if the Company had accounted for its NQSOs under the fair value method prescribed by SFAS No. 123. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for 1996 and 1995, respectively: risk-free interest rates of 5.66% and 5.47%; dividend yields of 5.14% and 1.91%; volatility factors of the expected market price of the Company's common stock of 0.34 and 0.34; and a weighted average expected life of the options of 3.61 and 5.12 years.
For purposes of pro forma disclosures, the estimated fair values of the options are amortized to expense over the options' respective vesting periods. As calculated using the Black-Scholes model, the weighted average, grant-date fair value of options granted in which the exercise price equaled the market price on the date of the grant was $7.77 per share for 1996 and $8.27 per share for 1995. The weighted average, grant-date fair value of options granted in which the exercise price was less than the market price on the date of the grant was $1.29 per share for 1996. The Company's pro forma information, as if these options had been expensed in accordance with SFAS No. 123, is as follows:
Selected quarterly financial data for the years ended December 31, 1996 and 1995 are as follows:
QUARTER -------------------------------------- FIRST SECOND THIRD FOURTH TOTAL -------- -------- -------- -------- ---------- (In thousands, except per share data) 1996: ----- Total revenues $281,404 $280,712 $277,656 $323,539 $1,163,311 Income before income tax expense 839 5,061 7,051 4,098 17,049 Net income 292 3,195 4,291 2,425 10,203 Earnings per common share (1) 0.02 0.26 0.34 0.18 0.79