The Company occupies common facilities with BCBSUW and is charged a proportionate share of the cost of such facilities under the Service Agreements. The Company's corporate headquarters are 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 217,000 square feet of office and warehouse space. In addition, the Company's 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. Intercare and Ladd both lease facilities including 9,900 square feet in Hartford, Wisconsin and 10,000 combined square feet at two locations in Michigan, respectively.
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, including Compcare Health Services Insurance Corporation ("Compcare"), Valley Health Plan, Inc. ("Valley"), Unity Health Plans Insurance Corporation ("Unity") and certain point-of-service ("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, pharmaceutical management, managed behavioral health services, case management and receivables management, sold throughout the United States. Operating results and statistics for these product groups are presented below for the periods indicated.
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 new corporation originally was named Newco/UWS, Inc. and was subsequently renamed United Wisconsin Services, Inc. The spin off resulted in the distribution on September 25, 1998 ("Spin off date") of one share of common stock of the Company 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, the Company and their shareholders.
(2) Selling, general and administrative expenses (associated with premium revenue) as a percentage of premium revenue.
All financial data in the Results of Operations section are gross numbers and, therefore, are not net of intercompany eliminations. For this reason, some of the financial data does not precisely match the data in the financial tables.
PREMIUM REVENUE-HMO premium revenue in 1998 increased 8.2% to $518.7 million from $479.2 million in 1997. HMO premium revenue in 1997 increased 13.8% from $421.2 million in 1996. The increases in both years are primarily due to increases in average HMO premium revenue per member and increases in the average number of HMO medical members. Average HMO medical premium per member in 1998 increased 4.3% from 1997 and increased 3.0% in 1997 from 1996, due to premium increases, partially offset by benefit reductions. The average number of HMO medical members in 1998 increased 3.5% to 297,737 from 287,534 in 1997. The average number of HMO medical members in 1997 increased 10.8% from 259,507 in 1996. This increase in 1997 was due in part to the elimination of a key provider from the network of one of Compcare's competitors, resulting in a shift of members to Compcare.
Premium revenue for specialty managed care products and services in 1998 increased 11.5% to $93.4 million from $83.8 million in 1997. This increase was due primarily to an increase of $8.4 million in
the life and disability products and $1.4 million in dental premiums. Premium revenue in 1997 increased 13.6% from $73.8 million in 1996. The increase was due primarily to an increase of $2.7 million in disability premiums, an increase of $2.7 million in dental premiums and an increase of $1.9 million in workers' compensation premiums. The increases in life and disability premiums were driven by membership increases of 24.1% and 11.2% in 1998 and 1997, respectively. The increase in workers' compensation premiums in 1997 was due primarily to a change in the reinsurance agreement related to this business. In 1998 and 1997, the Company ceded 40% of the workers' compensation premiums written by United Heartland to a third-party reinsurer while the percentage ceded to the outside reinsurer was 50% in 1996.
INVESTMENT RESULTS-Investment results include investment income and realized gains on the sale of investments. Investment results in 1998 decreased 14.4% to $19.0 million from $22.2 million in 1997. Investment results in 1997 increased 16.8% from $19.0 million in 1996. Average annual investment yields, excluding net realized gains, were 5.53%, 5.75% and 5.90% for 1998, 1997 and 1996, respectively. Average invested assets in 1998 increased 3.2% to $185.2 million from $179.5 million in 1997. Average invested assets in 1997 decreased 0.1% from $180.7 million in 1996. Changes in levels of average invested assets relate to ongoing operations, including collection of receivables and timing of claim payments. Investment results in 1997 also included $1.8 million of mutual fund distributions which were recorded as investment income in December 1997. Net realized investment gains decreased to $9.1 million in 1998 from $11.9 million in 1997. Net realized investment gains in 1997 increased from $8.4 million in 1996. Investment gains are realized in the normal investment process in response to market opportunities. In addition, a portion of the gains realized during the second half of 1997 were achieved as part of a portfolio restructuring to reduce the overall level of equity investments.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE RATIO-The Selling, General and Administrative ("SGA") expense ratio includes commissions, administrative expenses, and premium taxes and other assessments. The SGA expense ratio for HMO products in 1998 was 9.6%, compared with 9.3% in 1997 and 9.3% in 1996. During 1998, Compcare incurred higher costs as a result of a major system conversion and related training costs. A new claims administrative system was necessary to replace the previous system for which the service agreement expired, provide improved functionality and resolve the Year 2000 Issue.
Profit sharing on provider arrangements was $2.8 million in 1998, compared with $3.4 million in 1997 and $2.9 million in 1996, 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 sharing expenses related to the Unity and Valley provider arrangements were $3.2 million, $4.0 million and $3.0 million in 1998, 1997 and 1996, respectively. Income from the workers' compensation agreements was $0.4 million, $0.6 million and $0.1 million in 1998, 1997 and 1996, respectively.
Interest expense of $1.4 million was incurred in 1998 as a result of the assumption of $70 million in debt owed to BCBSUW as of September 11, 1998.
Amortization of goodwill and other intangibles was $0.5 million for 1998 compared with $0.8 for 1997 and 1996. The reduction in 1998 is due to full amortization of certain intangibles.
Consolidated net income in 1998 increased 14.5% to $18.1 million from $15.8 million in 1997. Consolidated net income in 1997 decreased 3.1% from $16.3 million in 1996.
On an historical basis, the Company has generated positive cash flow from operations. For 1998, net cash provided by operating activities amounted to $21.9 million, compared with $1.6 million for 1997. The increase in cash flows from operations in 1998 compared to 1997 was due primarily to an increase in
operating income and an increase in medical and other benefits payable and premium advances. Due to periodic cash flow requirements of certain subsidiaries, the Company made borrowings under its bank line of credit ranging up to $10.0 million during 1998 and $8.0 million during 1997 to meet short-term cash needs. No balance was outstanding at December 31, 1998, 1997 or 1996.
The Company's investment portfolio consists primarily of investment grade bonds, Government securities and has a limited exposure to equity securities. At December 31, 1998, $133.1 million or 80.0% of the Company's total investment portfolio was invested in bonds compared with $127.9 million or 80.1% at December 31, 1997. The bond portfolio had an average quality rating by Moody's Investor Service of Aa3 at December 31, 1998 and 1997. The majority of the bond portfolio was classified as available for sale. The market value of the total investment portfolio, which includes stocks and bonds, exceeded amortized cost by $1.9 million and $4.8 million at December 31, 1998 and 1997, 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. The Company has no investments in mortgage loans, no non-publicly traded securities, or financial derivatives.
The amount of dividends which may be paid to the Company from insurance subsidiaries are 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.
The Company is party to certain provider arrangements in conjunction with Unity and Valley as further described below.
Effective October 1, 1994, the Company acquired all of the outstanding common stock of HMO-W, Inc. for cash approximating $7,482,000 representing the net assets of HMO-W, Inc. as negotiated by the Company. HMO-W, Inc. owned all of the outstanding common stock of HMOW.
Effective October 1, 1994, the Company acquired all of the assets of U-Care and certain assets from an affiliate of U-Care for cash approximating $3,772,000, representing net assets plus $500,000 as negotiated by the Company.
Pursuant to the HMO-W, Inc. and U-Care purchase agreements, options to repurchase the net assets of HMO-W, Inc. and U-Care were issued to the respective primary provider groups, at prices determined by the formula used in computing the purchase prices paid by the Company, effective on November 1, 1999 or 2004. The U-Care and HMO-W, Inc. acquisitions were accounted for under the purchase method of accounting. The accompanying consolidated financial statements include the results of operations of U-Care and HMOW which have been merged to form Unity.
The Company's plan to resolve the Year 2000 Issue involves the following four phases: assessment, remediation, testing, and implementation. To date, the Company has fully completed its assessment of all systems that could be significantly affected by the Year 2000 Issue. The completed assessment indicated that most of the Company's significant information technology systems could be affected, particularly the general ledger, billing and processing of medical claims. That assessment also indicated that software and hardware (embedded chips) used in building operations and office equipment (hereafter also referred to as non-IT systems) also are at risk. The Company does not believe that the Year 2000 Issue presents a material exposure as it relates to the Company's non-IT systems. In addition, the Company has inquired and gathered information about the Year 2000 readiness status of its significant suppliers and vendors and continues to monitor their readiness.
The Company outsources and relies extensively on third party systems to process selected payroll, membership and claims processing functions, among others. The Company is in the process of working with third party vendors to ensure that their systems are Year 2000 ready. Several third party systems are currently not Year 2000 ready. Compcare utilizes a membership system that is expected to complete its upgrades and testing by March 31, 1999. UWG is expected to be Year 2000 ready by September 30, 1999 for its administrative, claims and billing systems. Based on discussions with these key vendors, the Company is of the understanding that the vendor systems utilized are or will be Year 2000 ready.
The Company has surveyed its significant suppliers and subcontractors (external agents) that do not share information systems with the Company. To date, the Company is not aware of any external agent with a Year 2000 Issue that would materially impact the Company's results of operations, liquidity or capital resources. However, the Company has no means of ensuring that external agents will be Year 2000 ready. The inability of external agents to complete their Year 2000 resolution process in a timely fashion could materially impact the Company. The effect of non-compliance by external agents is not determinable.
The Company has utilized both internal and external resources to reprogram or replace, test and implement the software and non-IT systems for the Year 2000 modifications. The total direct costs of the Year 2000 project is estimated at $1.5 million and is being funded through operating cash flows. To date, the Company has incurred $0.9 million of identifiable costs related to all phases of the Year 2000 project. Remaining costs, to be incurred to complete the Year 2000 project, are estimated to approximate $0.6 million. In addition, the Company has capitalized $2.7 million related to other functionality enhancing system upgrades which also provide Year 2000 readiness. A number of other repairs to current systems are covered by existing maintenance agreements and by normal upgrades and do not present incremental additional expense.
BCBSUW leases the claims, membership and general ledger software programs and subleases the use of these systems to the Company under the service agreement. BCBSUW capitalized $16.5 million of implementation and system enhancement costs that were incurred to replace these systems primarily as a result of a service agreement expiration and for improved functionality. These replacements also included Year 2000 readiness but were not the result of acceleration due to Year 2000 Issues. Approximately 24% of the amortized costs are allocated to the Company.
Costs related to maintenance of existing computer hardware and software are expensed as incurred. Purchases of new hardware or software in replacement of non-compliant hardware or software and reprogramming costs are being capitalized in accordance with the Company's standard accounting practices.
We have audited the accompanying consolidated balance sheets of United Wisconsin Services, Inc. (the Company) as of December 31, 1998 and 1997, and the related statements of income, changes in shareholders' equity and comprehensive income and cash flows for each of the three years in the period ended December 31, 1998. Our audits also include the financial statement schedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 1998 and 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth herein.
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 and receivables management, sold throughout the United States.
The consolidated financial statements present the Company's financial position, operations and cash flows as if the Company had been an independent, public company for all years presented. The Company consolidates majority owned subsidiaries that are
controlled by the Company. All material intercompany transactions have been eliminated. For those subsidiaries for which repurchase options exist (see Note 2), the Company consolidates those subsidiaries 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 as 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.
Investments are classified as either held to maturity or available for sale. Investments which the Company has the intent and ability to hold to maturity are designated as held to maturity and are stated at amortized cost. All other investments are classified as available for sale and are stated at fair value based on quoted market prices, with unrealized gains and losses excluded from earnings and reported in accumulated other comprehensive income, net of income tax effects. Realized gains and losses from the sale of available for sale debt securities and equity securities are based on the first-in, first-out basis.
Receivables are stated at net realizable value, net of allowances of $727,000 and $394,000 at December 31, 1998 and 1997, respectively, based upon historical collection trends and management's judgment of the ultimate collectibility. In late December 1998, Compcare Health Services Insurance Corporation ("Compcare") provided $13,421,000 of interest bearing notes to certain contracted health care providers primarily due in full on April 1, 1999. The Company retained the ability to offset claim payments to these health care providers after April 1, 1999 and has included the advances in other receivables on the consolidated balance sheet.
The Company periodically evaluates whether events and circumstances have occurred which may affect the estimated useful life or the recoverability of the remaining balance of its intangibles. At December 31, 1998, the Company's management believed that no material impairment of goodwill or other intangible assets existed.
Medical and other benefits expense consists principally of capitation expenses, health and disability claims and life insurance benefits. 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. The estimates of reported and unreported claims and accrued capitation fees and adjustments, which are unpaid as of the balance sheet date, are based on historical payment patterns using actuarial techniques. Processing costs are accrued as operating expenses based on an estimate of the costs necessary to process these claims.
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.
(1) Pro forma calculations for dilutive securities for the period January 1, 1996 thru September 25, 1998, assume that the price of the stock and the strike price of the options is the same for the periods prior to the Spin off date.
(2) EPS on net income as reported are computed by dividing net income as reported, by the pro forma weighted average number of common shares outstanding. There is no dilutive effect on securities for the period prior to the Spin off date (1).
(3) EPS on pro forma net income are computed by dividing pro forma net income by the pro forma weighted average number of common shares outstanding. There is no dilutive effect on securities for the period prior to the Spin off date (1).
At December 31, 1998, the Company adopted SFAS 131, "Disclosures about Segments of an Enterprise and Related Information". SFAS 131 establishes new rules for identification and disclosure of segment information.
At December 31, 1998, the Company adopted SFAS 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits". SFAS 132 establishes new rules for the disclosure of pension plan information.
Pursuant to the Unity related purchase agreements, options to repurchase the net assets of the acquired companies were issued to the sellers effective as of November 1, 1999 or 2004. One seller has the option to repurchase a portion of Unity's business at a price equal to the net assets of such business plus $500,000. The other seller has the option to repurchase the remainder of the Unity business at a price equal to the net assets of such business.
Proceeds from sales of stocks during 1998 was $73,156,000. Proceeds from sales of bonds classified as available for sale during 1998, excluding maturities, was $160,818,000.
As of December 31, 1998, the Company and several subsidiaries participate with BCBSUW in a bank line of credit, which permits aggregate borrowings up to $10,000,000 for UWS and its subsidiaries. Prior to this date the line of credit permitted aggregate borrowings up to $30,000,000. Periodic borrowings have been made on these lines of credit. There was no balance outstanding at December 31, 1998 and 1997.
Certain subsidiaries of the Company provide health, life and other insurance benefits to the employees of BCBSUW. Premium revenue received from BCBSUW totaled $4,547,000, $4,537,000 and $4,370,000 in 1998, 1997 and 1996, respectively.
The Company has an agreement with United Wisconsin Life Insurance Company ("UWLIC"), a subsidiary of AMSG, whereby United Wisconsin Insurance Company ("UWIC") underwrites certain small group health care and life, dental, drug and disability products in Minnesota as UWLIC products have not yet been approved for sale in Minnesota. The Company ceded to UWLIC 100% of the premium revenue of these products sold in Minnesota. The ceded premium revenue approximated $26,875,000, $27,014,000 and $24,739,000 in 1998, 1997 and 1996, respectively.
The Company has an agreement with UWLIC whereby UWLIC underwrites certain life and disability products on behalf of United Heartland Life Insurance Company ("UHLIC"). The Company also had agreements with UWLIC, through September 30, 1998, whereby UWLIC underwrote certain health care, dental and pharmaceutical products on behalf of Compcare, Heartland Dental Plan, Inc., and CNR Health, Inc. The Company assumes 100% of the premium revenues on these products from UWLIC. The assumed premium revenue approximated $23,295,000, $36,177,000 and $30,573,000 in 1998, 1997 and 1996, respectively.
Amounts due from/to affiliates are related primarily to operating expenses and reinsurance arrangements. The amounts due from/to affiliates are generally settled on a monthly basis for operating expenses and are settled in accordance with industry practice for reinsurance agreements. The amounts due from/to affiliates are typically less than $10,000,000 at any point in time during the fiscal year, excluding the $70,000,000 note obligation due to BCBSUW.
Income tax expense has been calculated as if the Company filed separate federal income tax returns. Prior to the spin off, the Company has been included in the consolidated federal income tax return filed by AMSG, except as noted below. UHLIC has filed separate federal income tax returns due to specific provisions of the Internal Revenue Code of 1986, as amended, related to consolidation of life insurance entities. The entities included in these consolidated financial statements file separate state franchise, income and premium tax returns as applicable.
The Company had a net federal income tax payable of $1,650,000, included in other current liabilities, and a net federal income tax receivable of $436,000, included in other current assets, at December 31, 1998 and 1997, respectively. Federal and state income tax payments, net of refunds, totaled $2,327,000, $3,243,000 and $1,545,000 in 1998, 1997 and 1996, respectively.
The components of deferred income tax expense (benefit) are as follows:
The Company and certain of its subsidiaries participate with BCBSUW in two multiple employer defined benefit pension plans. The plans provide retirement benefits to covered employees based primarily on compensation and years of service. Since the plans are overfunded, no contributions were made in 1998, 1997 or 1996.
Prior to December 31, 1998, separate salaried and hourly pension plans existed. These plans were merged into a single plan in an effort to reduce administrative expenses and streamline communication with plan participants. The merger had no material effect on pension assets, liabilities or funding levels.
Effective January 1, 1997, the Company amended the salaried pension plan and the hourly pension plan with respect to non-union participants, which include expansion of the lump-sum payment provisions and changes in the methods and formulae used for the calculation of benefit accruals.
The following table summarizes the change in the pension plan's benefit obligation:
Weighted-average assumptions used as of September 30, 1998 and 1997, the measurement date, in developing the projected benefit obligation are as follows:
The unrecognized net asset is being amortized over the remaining estimated service lives of participating employees at January 1, 1986: 15.4 years for salaried employees and 16.9 years for hourly employees.
After giving effect to all administrative expense allocations between the Company and BCBSUW, the pension credit was $622,000, $945,000 and $1,288,000 in 1998, 1997 and 1996, respectively.
As of December 31, 1998, the Company has a stock-based compensation plan covering employees and directors that allows for granting of options for up to 4,625,000 shares of common stock as incentive or nonqualified stock options ("NQSOs").
In 1992, certain executive officers of AMSG were awarded stock appreciation rights ("SARs") in AMSG. At the Spin off date, 67,500 AMSG SARs were converted into SARs of the Company to provide equivalent value.
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:
In determining compensation cost pursuant to SFAS 123, the fair value for the options granted subsequent to the Spin off date were estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for 1998: risk-free interest rate of 4.62%; dividend yield of 0.70%; volatility factor of the expected market price of the Company's common stock of 0.45; and a weighted average expected life of the options of 6.00 years. 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 $3.34 per share for 1998.
Selected quarterly financial data for the years ended December 31, 1998 and 1997 are as follows: