As of December 31, 1997, the company owned or leased the following facilities which the company considers material to its operations:
Corporate Headquarters St. Louis, MO 343,017 Leased Document Storage Warehouse St. Louis, MO 69,152 Leased HealthLink, Inc. Headquarters St. Louis, MO 20,550 Owned HealthLink, Inc. Administrative Office St. Louis, MO 19,500 Leased Southwest Regional Office Springfield, MO 30,000 Owned Southwest Claims Office Expansion Springfield, MO 4,750 Leased Southeast Claims Office Cape Giardeau, MO 42,000 Leased Central Marketing Office Columbia, MO 5,000 Leased
Year ended December 31, Consolidated Statements of Income data 1997 1996 1995 1994 1993 (in thousands, except per share data)
Revenues $719,411 $653,375 $591,880 $583,580 $575,615 Operating expenses 780,411 666,954 572,847 556,943 550,501 Operating (loss) income (61,000) (13,579) 19,033 26,637 25,114 Investment income, net 33,184 17,532 18,344 15,764 23,288 Other, net (5,739) (5,320) (3,327) (640) (859) Net (loss) income (24,034) (2,027) 23,570 26,584 19,998(c) Basic and diluted (loss) earnings per share $(1.29) $(0.11) $1.26 Pro forma data: (a) Pro forma operating income $23,712 $20,747 Pro forma net income 24,683 17,159(c) Pro forma earnings per share (b) $1.49 $.94(c)
Consolidated Balance Sheet data December 31, 1997 1996 1995 1994 1993 (in thousands, except per share data)
Total assets $506,363 $532,144 $516,388 $433,605 $354,491 Long-term obligations 88,845 86,776 89,060 31,013 25,136 Shareholders' equity 140,865 172,954 173,221 135,425 82,247 Available cash and investments (d) 8,279 48,472 56,753 72,854 Book value per share $7.54 $9.26 $9.27 $7.25 Tangible book value per share 3.36 4.76 4.93 7.10
(a) Prior to its initial public offering in August 1994, the company was not subject to premium taxes levied by the State of Missouri. Pro forma data reflect the premium taxes that would have been recorded, net of income tax, had the company been subject to such premium taxes.
(d) Amounts represent cash and investments available for general corporate use without regulatory approval.
The following discussion should be read in conjunction with the accompanying Consolidated Financial Statements and Notes thereto and the information set forth under the captions "Safe Harbor" statement and "Factors that May Affect Future Results of Operations, Financial Condition or Business" of Part I, Item I hereof.
496,167 489,864 1.3 Self-funded: PPO 89,300 110,001 (18.8) HMO 13,825 16,551 (16.5) ASO (includes HealthLink): Workers' Compensation 344,712 310,891 10.9 Other ASO* 1,013,303 925,941 9.4
Premium revenue increased $59.3 million to $654.3 million in 1997 from $595.0 million in 1996. As described below, components of premium revenue were affected by shifts in product mix, rate increases, and other factors; and as a result, such changes may not be indicative of future periods. The company will continue to strive to establish its premium rates based on anticipated health care costs. Depending on the level of future competition, customer acceptance of the company's premium increases, future health care cost trends or other factors, there can be no assurance that the company will be able to price its products consistent with health care cost trends.
PPO premium revenue increased $11.8 million in 1997 -- $17.2 million due to a 3.6 percent increase in net premium rates. This increase was partially offset by a $5.4 million decrease resulting primarily from product mix shifts within the PPO product family, such as the continued shift in membership to AllianceChoice, a lower cost, non-gatekeeper point-of-service (POS) product. Alliance PPO member months decreased by 539,300 in 1997 compared to 1996 while AllianceChoice POS member months increased by 544,800 in 1997 as compared to 1996. Net rates increased due in part to the company's targeted general rate increases averaging 7 percent to 18 percent during enrollment periods during 1997. Net rate increases are lower than the targeted range due in part to changes in deductibles, the timing of group renewals throughout the year, and product mix changes. The company also began offering its PPO product in Illinois at the end of the first quarter of 1997. Included in the Alliance PPO member count in the company's membership table are 2,200 PPO Illinois members at December 31, 1997. The company anticipates future enrollment gains in the central and southern regions of Illinois as the company plans to intensify marketing efforts during 1998.
Premium revenue from Medicare supplement decreased by $0.9 million in 1997. Member months decreased by 8.6 percent partially offset by an 8.4 percent increase in net premium rates. Membership declines are partially attributable to members shifting to BlueCHOICE Senior, a Medicare-risk program, which provides medical benefits at least as comprehensive as Medicare benefits for persons eligible to receive Medicare (parts A and B) at no additional cost to the member.
Managed indemnity premium revenue decreased by $3.9 million due to a 27.8 percent decline in member months in keeping with the company's strategy to move toward more highly managed products.
Revenue from other specialty services, which include certain of the company's drug and dental health care benefit plans, increased $8.2 million due to a 12.6 percent increase in member months and a 12.4 percent increase in net premium rates. The company's drug product, AllianceRx, continued to gain momentum with revenues increasing $7.4 million due primarily to a 13.7 percent increase in member months in 1997 as compared to 1996.
Fees and other income from administrative services only/self- funded and network services increased in 1997 by $6.8 million. ASO revenues from HealthLink increased by $10.1 million in 1997 as compared to 1996. HealthLink's 1997 and 1996 revenues include $7.5 million and $2.7 million of revenues, respectively from HealthLink HMO, Inc. (HealthLink HMO), which was only 50 percent owned by HealthLink (and not consolidated with the company's operations) prior to its May 31, 1996, acquisition from a subsidiary of Blue Cross and Blue Shield of Kansas City. HealthLink's revenues also increased due to membership gains in its PPO products of approximately 10.7 percent or 71,900 members from December 31, 1996, to December 31, 1997. HealthLink's increases to fees and other income were partially offset by two main factors - decreases to revenue caused by a decline in the HMO self-funded membership of 2,700 members from December 31, 1996, to December 31, 1997, and a decline in the overall PPO self-funded membership of 20,700 members over the same time period.
The company expects further declines in its self-funded membership as three large self-funded group cancellations are effective as of January 1, 1998. As of December 31, 1997, these three groups encompassed approximately 72,000 members, approximately 30,000 of which have enrolled in HealthLink's self- funded ASO plans in 1998.
Depreciation and amortization expenses increased to $23.1 million in 1997 from $15.0 million in 1996. The primary cause for this $8.1 million increase is an additional $4.9 million of IOS amortization expense incurred in 1997 as compared to 1996. See "Outlook - Information Strategies" for more information related to the IOS project. In addition, the company amortized an additional $2.6 million in 1997 compared to 1996 for prepaid reinsurance payments associated with the company's reinsurance agreements with Blue Cross and Blue Shield of Kansas City.
Premium revenue increased $56.6 million to $595.0 million in 1996 from $538.4 million in 1995. As described below, components of premium revenue were affected by product mix shifts, new product introductions, and other factors as the company continued the positioning of its managed care product portfolio; and, as a result, such changes may not be indicative of future periods.
PPO premium revenue increased $15.1 million -- $21.8 million due to a 9.8 percent increase in member months and a $6.7 million decrease in revenue resulting from a 4.2 percent net decrease in premium rates. Rates decreased slightly due to two main factors. First, in November 1994, the company introduced a new managed care drug product, AllianceRx, which is sold to members on a separate product basis; prior to this, the drug benefit was typically included as part of the basic PPO medical program. The resulting shift in revenue from the PPO products to other specialty services is more pronounced in 1996 than in the prior year due to the gradual penetration of AllianceRx throughout 1995 and 1996. Second, the company experienced a shift in membership to AllianceChoice, a lower cost, non-gatekeeper point- of-service (POS) product. As evidence of this shift, Alliance PPO membership decreased by 32,700 members in 1996 while AllianceChoice POS membership increased by 54,000 over the same time period.
Premium revenue from Medicare supplement decreased by $6.4 million in 1996, due to a 10.3 percent decrease in member months, partially offset by a 4.7 percent increase in premium rates.
Managed indemnity premium revenue decreased by $6.6 million due primarily to a 33.3 percent decline in member months, consistent with the company's strategy to focus membership growth in more intensely managed products.
Revenue from other specialty services, which include certain of the company's drug and dental health care benefit plans, increased $11.0 million due primarily to a 52.1 percent increase in member months. These increases are primarily attributable to the aforementioned selling of the company's drug product separate from PPO major medical products. Member months in the company's drug product increased by 73.6 percent in 1996 as compared to 1995.
The overall medical loss ratio increased by 6.5 percent to 82.6 percent in 1996 from 76.1 percent in 1995 primarily as a result of (1) the company's lower margin BlueCHOICE Senior, Medicaid and AllianceChoice products, (2) competitive pricing to enhance selected enrollment growth, (3) higher drug and outpatient utilization, and (4) growth in regions outside of the metropolitan St. Louis area that have less cost efficient networks.
General and administrative expenses increased $3.5 million, or 2.5 percent in 1996. Excluding the effects of HealthLink, Epoch, and a third-party accrual, discussed below, comparable 1996 general and administrative expenses decreased by $1.1 million. HealthLink accounted for $20.9 million of general and administrative expenses in 1996. HealthLink expenses incurred in 1995 subsequent to its August acquisition were $6.6 million. Thus, HealthLink accounts for a net 1996 increase of $14.3 million to general and administrative expenses. Offsetting this net increase to expense is the reduction of expenses related to the company's aforementioned TPA subsidiaries that were combined to form Epoch in December 1995. The results of operations of Epoch (50 percent owned by the company) are not consolidated with the company's operations. General and administrative expenses in 1995 include $11.1 million of TPA subsidiary general and administrative expenses. General and administrative expenses in 1996 also increased due to an accrual of $1.4 million related to a third-party contract.
Non-recurring charges in 1996 include $4.5 million related to costs associated with the relocation of the company's St. Louis- based claims, customer service, billing, and provider services functions to its Springfield, Missouri, facility and a new facility in Cape Girardeau, Missouri. Non-recurring charges in 1995 include $2.0 million of one-time integration charges related to the company's acquisition of HealthLink in August 1995 and $1.5 million relating to the settlement of a class action lawsuit. The lawsuit stemmed from the company's claims paying practices and negotiated discounts with providers; the company agreed to settle the lawsuit by establishing a rebate program for all affected subscribers. See Note 13 entitled "Contingencies - Litigation with DOI and Attorney General, Litigation relating to the Market Conduct Study and Copayment Calculations" of Part II, Item 8 for recent information relating to this issue.
Operating income decreased from $19.0 million in 1995 to a loss of $13.6 million in 1996. Excluding non-recurring charges, operating income was $22.5 million in 1995 compared to a loss of $9.0 million in 1996.
Net investment income includes investment income in the form of interest and dividend income and net realized gains from the sale of portfolio securities. Net investment income of $17.5 million in 1996 represents a 4.4 percent decrease from $18.3 million in 1995 inclusive of a $0.2 million decrease in realized gains, net.
The company's net income for 1995 was $23.6 million as compared to a net loss of $2.0 million for 1996. Excluding non-recurring charges on an after-tax basis, net income for 1995 was $25.8 million as compared to net income of $0.9 million for 1996.
The company's working capital as of December 31, 1997, was $69.7 million, a decrease of $39.1 million from December 31, 1996. The decrease is partially attributable to a $15.0 million repayment of a portion of the $62.0 million of funds that were borrowed in August 1995 from the company's reducing revolving credit facility in conjunction with the company's acquisition of HealthLink. Also, the company's charge to accrue a loss reserve related to MCHCP resulted in a current liability as of December 31, 1997 of $9.1 million. In addition, the company capitalized $18.5 million of property and equipment purchases, $17.2 million of which related to capitalized IOS development costs (see "Outlook - Information and operations strategy" section below). The company's unrealized net appreciation of investments available for sale decreased by $8.0 million in 1997 as most of the unrealized gains existing at December 31, 1996, were realized in 1997 as the company liquidated equity securities and company-owned life insurance policies.
In the fourth quarter of 1997, the company amended its revolving credit facility (the Credit Facility), the material terms of which are as follows: (1) the borrowings under the Credit Facility will bear interest at 2.75 percent above the one month floating London Interbank Offered Rate (LIBOR), (2) certain financial covenant calculations were modified and the financial covenant requirements were adjusted, (3) the maximum commitment of the Credit Facility was reduced to $50 million as of October 1, 1997 with $1.25 million quarterly reductions through 1998 and subsequent $2.5 million quarterly reductions through June 30, 2000, with the remaining $30 million commitment under the Credit Facility terminating on August 10, 2000, (4) mandatory reductions to the commitment, together with prepayments, are required upon the happening of certain extraordinary events, (5) stricter limits were placed on the company's ability to incur additional debt, and (6) stricter limits were placed on capital expenditures as well as the company's ability to make investments and acquisitions.
The company primarily invests positive cash flow in fixed income securities. The company's investment policies are designed to preserve principal, maximize yield, and provide liquidity to meet anticipated obligations. The company's investment portfolio consists primarily of U.S. government and agency securities, corporate bonds, and notes.
On August 29, 1997, the company reported the commencement of the litigation with MCHCP and estimated losses (giving effect to all possible renewal terms of the MCHCP contract without requested rate increases) in the range of $30 million to $40 million. As discussed under Note 13 entitled "Contingencies -- Litigation with MCHCP" of Part II, Item 8, Financial Statements and Supplementary Data, the trial court made certain rulings adverse to the company on summary judgment. In the third quarter of 1997, the company took a pre-tax charge of $29.5 million, which was based on actuarial estimates, including projected limited rate increases, and projected enrollment and medical cost trends accounted for through the year 2000 in accordance with generally accepted accounting principles. The company was advised by the Missouri Department of Insurance (DOI) in March, 1998, that the entire amount of the reserve for the MCHCP contract recorded by the company for projected losses under the contract through the year 2000, must, for statutory accounting purposes, be recorded by the company's subsidiary, HMO Missouri, Inc. (BlueCHOICE), on its statutory filings with the DOI. With the prior regulatory approval of the DOI, BlueCHOICE issued surplus notes to the company in the amount of $29 million to ensure the statutory solvency of BlueCHOICE. While management of the company believes the current provision for losses is adequate, if the actual public entity membership in MCHCP grows at a rate in excess of the rate used in the actuarial estimates, or if the projected limited rate increases and medical cost trends should differ materially from those assumed in the actuarial estimates, then the amount of the reserve recorded to date could be insufficient to cover all future losses which may be associated with the MCHCP contract, and such losses could have a material adverse effect on the company and the market for the company's stock. In addition, the company's Credit Agreement described elsewhere herein provides that the company's subsidiaries, including BlueCHOICE, may not issue surplus notes to the company in an aggregate principal amount in excess of $40 million. As the aggregate principal amount of surplus notes issued by such subsidiaries to the company currently approximates $40 million, any additional funding required by any subsidiaries of the company, including BlueCHOICE, as a result of additional losses or reserves associated with the MCHCP contract, or otherwise, must, absent approval of the lenders under the Credit Agreement, be funded from sources other than surplus notes.
Other than continued investment in information technology and debt repayment, the company currently has no definitive material commitments for future use of its current or expected levels of available cash resources; however, management continually evaluates opportunities to expand the company's specialty managed care services and health plan operations. The company's expansion options may include additional acquisitions and internal development of new products and programs. The company's available cash resources will remain in interest- bearing investments until they are utilized for such purposes.
Except for the historical information contained herein, this Annual Report contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements typically, but not exclusively, are identified by the inclusion of phrases such as "the company anticipates," "the company believes," "the company expects," "the company plans," "the company intends," and other phrases of similar meaning. Such forward-looking statements involve known and unknown risks, uncertainties, contingencies and other factors that may cause the company's actual results of operations, financial condition or business performance to be materially different from the results of operation, financial condition or business performance expressed or implied by such forward- looking statements. Factors that could cause or contribute to such differences include, but are not limited to: the Office of Personnel Management audit of BlueCHOICE, pending litigation including the subscriber class action litigation, litigation with Missouri Department of Insurance and Missouri Attorney General, administrative action initiated by the Department of Insurance, the outcome of litigation with Missouri Consolidated Health Care Plan, other litigation, potential loss of "Blue Cross" and "Blue Shield" licenses by BCBSMo, the company and its controlled affiliates, government regulation and health care reform, market competition and consolidation, escalating health care costs, dependence on sales to individuals, recontracting efforts and potential nonrenewal of subscriber and provider agreements, voting control by BCBSMo, changes in key management, variability of operating results and stock price, Credit Facility restrictions, the year 2000 issue, and other factors discussed in the section entitled "Factors that May Affect Future Results of Operations, Financial Condition or Business" included in Part I, Item 1 of this Annual Report on Form 10-K for the fiscal year ended December 31, 1997, as well as those discussed elsewhere in the company's SEC reports.
In 1995, the company implemented a comprehensive information and operations strategy (IOS) to assist the company in implementing its managed care strategy of delivering the lowest cost medical care consistent with quality outcomes. The company believes that controlling medical costs in the future will be highly dependent on readily accessing both member and provider medical information at a detail level that provides real-time analytical support. The company receives capital expenditure authorizations from the Board of Directors to expend funds for the project subject to periodic review by an ad hoc committee of the board. In 1997, the company incurred capitalized expenditures of $17.2 million on this project. Cumulatively, since 1995, the company has incurred capitalized expenditures of $39.0 million. The company anticipates that it will expend approximately $10 million for capitalized costs associated with the IOS project in 1998 and $9 million for capitalized costs in subsequent years to complete the project. While management believes that the IOS project will initially be dilutive to earnings per share, it is believed that opportunities exist for significant medical and administrative savings, which will provide a payback and contribute to earnings per share over the long term. The company anticipates funding these expenditures through positive future operating cash flows.
The Health Insurance Portability and Accountability Act of 1996 requires private health insurance coverage to be "portable" by employees from job to job and eliminates coverage limitations for pre-existing health conditions. Additionally, the State of Missouri has recently passed legislation that mandates various lengths of stay for maternity patients and imposes a number of new restrictions on managed care organizations, which include, among others, health maintenance organizations, health insurers, and utilization review organizations. Although the impact of the provisions of this recent legislation and any future legislation cannot be fully predicted at this time, management of the company believes that the ultimate outcome will not have a material adverse effect on the company. However, there can be no assurance that the company will be able to obtain or maintain required governmental approvals or licenses or that any current or proposed federal and state legislation or other regulatory reform imposed on the company and its subsidiaries, will not have a material adverse effect on the company's business or results of operations in the future.
Health care costs in the United States have increased more rapidly than the national consumer price index in recent years, and that trend is expected to continue. The company believes that it has reduced the impact of such increases by expanding its provider networks, establishing risk-sharing agreements and enhancing its underwriting standards. However, there can be no assurance that the company's efforts to reduce the impact of inflation will be effective or that premium increases will equal or exceed increasing health care costs.
The following statements are based on short-term expectations. The statements are forward-looking and actual results may differ materially. Reference is made to the information set forth under the captions "Safe Harbor" Statement and "Factors that May Affect Future Results of Operations, Financial Condition or Business" of Part I, Item 1 hereof. The company expects that 1998 will be a transitional year with targeted improvements and the expectation of entering 1999 with a strong operating base.
See description under the same caption in Note 13 of the Notes to Consolidated Financial Statements of Part II, Item 8, of which is incorporated herein by reference.
Index to Financial Statements: Page Consolidated Balance Sheets, December 31, 1997 and 1996 48 Consolidated Statements of Income for the years ended December 31, 1997, 1996 and 1995 49 Consolidated Statement of Shareholders' Equity for the years ended December 31, 1997, 1996 and 1995 50 Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995 51 Notes to Consolidated Financial Statements 52 Reports of Independent Accountants 73 Financial Statement Schedule- Condensed Financial Information of Registrant 76