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 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, 1997 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 and AMS medical products.
(2) Includes dividends on preferred stock of subsidiary of $2,449,000 in 1993 and 1994, and $204,000 in 1996.
(1) Medical and other benefits as a percentage of premium revenue. The AMS medical loss ratios exclude non-recurring charges in 1997 and 1996. (2) Selling, general and administrative expenses as a percentage of premium revenue. (3) Net income as a percentage of total revenues.
The Company's revenues are derived primarily from premiums, while medical benefits constitute the majority of expenses. Profitability is directly affected by many factors including, among others, premium rate adequacy, estimates of medical benefits, health care utilization, effective administration of benefit payments, operating efficiency, investment returns and federal and state laws and regulations.
Total revenues in 1997 increased 38.9% to $1.6 billion from $1.2 billion in 1996. Total revenues in 1996 increased 12.0% from $1.0 billion in 1995. These increases were due primarily to increased health services revenues (premium and other revenue) as a result of the AMS Merger, as discussed further below.
HEALTH SERVICES REVENUES -- HMO health services revenues in 1997 increased 13.7% to $479.2 million from $421.3 million in 1996. HMO health services revenues in 1996 increased 4.9% from $401.7 million in 1995. Average HMO medical premium per member in 1997 increased 2.2% from 1996. Average HMO medical premium per member in 1996 increased 2.9% from 1995. The average number of HMO medical members in 1997 increased 10.8% to 287,534 from 259,507 in 1996. The average number of HMO medical members in 1996 increased 1.6% from 255,471 in 1995.
INVESTMENT RESULTS -- Investment results include investment income and realized gains (losses) on investments. Investment results in 1997 increased 6.2% to $46.3 million from $43.6 million in 1996. Investment results in 1996 increased 6.8% from $40.8 million in 1995. Average annual investment yields, excluding net realized gains, were 6.4%, 5.9% and 5.7% for 1997, 1996 and 1995, respectively. Investment results in 1997 included $1.8 million of mutual fund distributions which were favorably impacted by currency hedging and were recorded as investment income in December 1997. Investment gains are realized in the normal investment process in response to market opportunities. Average invested assets in 1997 decreased 5.1% to $496.5 million from $523.1 million in 1996. The decrease in average invested assets is due primarily to the decrease in medical and other benefits payable resulting from the membership decline for AMS products over the past year. Average invested assets in 1996 increased 9.0% from $479.9 million in 1995.
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 1997 was 9.3%, compared with 9.3% in 1996 and 9.2% in 1995.
The SGA expense ratio for AMS medical products in 1997 was 22.3%, compared with 23.6% in 1996 and 24.1% in 1995. The SGA expense ratio for AMS life products in 1997 was 29.8%, compared with 32.0% in 1996 and 32.8% in 1995. AMS products are sold exclusively through independent agents who are compensated through commissions. Over time, renewal business has gradually represented a larger proportion of the total AMS medical and life business. Since renewal commissions are typically lower than commissions on new sales, this has contributed to the decrease in the expense ratios. AMS also continues to focus on efforts to improve operating efficiency through process re-engineering and to align staff commensurate with gross premium revenue.
Profit sharing on joint ventures was $3.4 million in 1997, compared with $13.6 million in 1996 and $15.2 million in 1995. Of these balances, $3.6 million, $2.8 million and $2.6 million in 1997, 1996 and 1995, respectively, represent profit sharing expenses related primarily to the Unity and Valley joint ventures, and $10.7 million and $12.4 million in 1996 and 1995, respectively, were due to investment income and realized investment gains on funds held by the Company on behalf of an insurance subsidiary of AMS. Following the AMS Merger, the reinsurance agreement, which gave rise to this funds held balance, was terminated effective December 31, 1996.
In 1995, the Company granted an executive officer of the Company an option to purchase 7,113 shares of common stock of AMSG owned by the Company which, upon completion of the AMS Merger, were converted into options to purchase shares of Common Stock. Upon conversion, the Company recorded compensation expense of $2.1 million.
Historically, the Company has generated positive cash flow from operations. For 1997, however, net cash provided by or used in operating activities amounted to a use of $32.9 million, compared with $8.1 million used in 1996 and $49.1 million provided in 1995. The decrease in cash flow from operations in 1997 and 1996 was due primarily to the decrease in medical and other benefits payable resulting from the membership decline for AMS products over the past year. Due to periodic cash flow requirements of certain subsidiaries, the Company made
borrowings under its bank line of credit ranging up to $8.5 million during 1997 to meet short-term cash needs. No balance was outstanding at December 31, 1997.
The Company's investment portfolio consists primarily of investment grade bonds and has a limited exposure to equity securities. At December 31, 1997, $398.6 million or 92.5% of the Company's total investment portfolio was invested in bonds. At December 31, 1996, $407.4 million or 87.2% of the Company's total investment portfolio was invested in bonds. The bond portfolio had an average quality rating of Aa3 at both December 31, 1997 and December 31, 1996 by Moody's Investor Service, and the majority of the bond portfolio was classified as available for sale. In accordance with Statement of Financial Accounting Standards 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 investment portfolio, which includes stocks and bonds, exceeded amortized cost by $8.8 million and $10.1 million at December 31, 1997 and 1996, 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, non-publicly traded securities (except for principal only strips of U. S. Government securities), real estate held for investment or financial derivatives.
In addition to internally generated funds and periodic borrowings on its bank line of credit, the Company believes that additional financing to facilitate long-term growth could be obtained through equity offerings, debt offerings, financings from BCBSUW or bank borrowings, as market conditions may permit or dictate.
ACCOUNTING FOR STOCK-BASED COMPENSATION - In October 1995, the FASB issued Statement of Financial Accounting Standards (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 12 of the Notes to Consolidated Financial Statements.
REPORTING COMPREHENSIVE INCOME - In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income", which establishes new rules for the reporting and display of comprehensive income and its components in a complete set of general-purpose financial statements and interim period financial statements. The Company will adopt SFAS No. 130 in 1998.
DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION - In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information", which establishes standards for public companies to report financial and descriptive information about their operating segments in annual financial statements and interim financial reports. The Company will adopt SFAS No. 131 in 1998.
The Company has initiated formal communications with its systems processing vendor and all large customers using electronic interfaces to determine the extent to which the Company's interface systems are vulnerable to those third parties' failure to remediate their own Year 2000 Issues.
The Company will utilize both internal and external resources to reprogram, or replace, and test the software for the Year 2000 modifications. The Company anticipates completing the Year 2000 project within one year but not later than December 31, 1998, which is prior to any anticipated impact on its operating systems. A number of repairs to current systems are covered by existing maintenance agreements and by normal operational upgrades and do not present incremental additional expense. Costs related to modification of existing computer hardware and software are expensed as incurred. Purchases of new hardware or software in replacement of non-compliant hardware or software is being capitalized in accordance with the Company's standard accounting practices.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 1997 and 1996, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, 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 therein.
The consolidated financial statements include the accounts of the Company and all of its majority-owned subsidiaries. Significant intercompany accounts and transactions have been eliminated. The Company is affiliated with Blue Cross & Blue Shield United of Wisconsin (BCBSUW) through certain common officers and directors. At December 31, 1997, BCBSUW owns approximately 38% of the Company's common stock.
Health services premiums are recognized as revenue in the period in which enrollees are entitled to care.
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. Processing costs are accrued as operating expenses based on an estimate of the costs necessary to process these claims. These unpaid claim estimates are based on historical payment patterns using actuarial techniques. The Company's year-end claim liabilities are substantially satisfied through claim payments in the subsequent year. Any adjustments to prior period estimates are reflected in the current period. The liability for non-HMO medical and other benefits payable, excluding reinsurance recoverables, of $177,773,000 and $104,962,000 at December 31, 1996 and 1995, developed favorably in the subsequent year by $4,147,000 and $13,970,000, respectively, due primarily to lower than anticipated medical costs and utilization. The liability for non-HMO medical and other benefits payable, excluding reinsurance recoverables, of $67,172,000 at December 31, 1994, developed unfavorably in the subsequent year by $6,255,000 due to higher than expected medical inflation. 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. The long-term portion of medical and other benefits payable pertaining to long-term disability, workers' compensation and certain life insurance products of $21,471,000 and $20,933,000 at December 31, 1997 and 1996, respectively, is included in other noncurrent liabilities.
Certain reclassifications have been made to the consolidated financial statements for 1996 and 1995 to conform with the 1997 presentation.
In conjunction with the merger, $150,018,000 of goodwill and other intangibles and $22,173,000 of related deferred tax liabilities were recorded in the consolidated balance sheet and are being amortized over 3 to 40 years using the straight-line method. Upon merger, the U&C Real Estate Partnership (the U&C Partnership), a partnership between the Company and AMSG, became wholly owned by the Company and is consolidated.
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.
These pro forma results are not necessarily indicative of those that would have occurred had the merger taken place on January 1, 1995, or future results of operations for the combined companies.
Unrealized gains (losses) are computed as the difference between estimated fair value and amortized cost for debt securities or cost for equity securities. A summary of the net increase (decrease) in unrealized gains, less deferred income taxes, is as follows:
The amortized cost and estimated fair values of debt securities at December 31, 1997, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations.
At December 31, 1997, the insurance subsidiaries had debt securities and cash equivalents on deposit with various state insurance departments with carrying values of approximately $11,248,000, which are included in investments held to maturity on the balance sheet.
Certain subsidiaries of the Company provide health, life and other insurance benefits to the employees of BCBSUW. Premium revenue received from BCBSUW totaled $4,537,000, $4,370,000 and $4,568,000 in 1997, 1996 and 1995, respectively.
The Company has loans and advances receivable from employees, agents and joint venture partners of $2,376,000 and $2,639,000 at December 31, 1997 and 1996, respectively.
The Company reports assets and liabilities related to reinsured contracts on a gross basis.
The Company had a net federal income tax payable of $409,000 and a net federal income tax receivable of $4,858,000 at December 31, 1997 and 1996, 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 federal net operating loss carryforwards totaling $789,000 which expire in the year 2011. The Company and its subsidiaries have state net business loss carryforwards totaling $44,837,000 at December 31, 1997, which expire in the years 2006 through 2012. Federal and state income tax payments, net of refunds, totaled $6,999,000, $8,935,000 and $2,472,00 in 1997, 1996 and 1995, respectively.
The federal deferred benefit arising from the deductibility of state deferred tax is included as a component of other federal deferred taxes. The net deferred tax assets and liabilities are included in other current or other noncurrent assets and liabilities, as applicable.
In 1992, the Board of Directors designated 25,000 shares of the Company's authorized but unissued preferred stock as Series A Adjustable Rate Nonconvertible Preferred Stock to be used as the employers' matching contribution under the 401(k) plan covering salaried and nonunion hourly employees of the Company and BCBSUW. On January 3, 1995, the Company redeemed all of the outstanding shares of Series A Preferred Stock and discontinued its use as the employer's matching contribution to the 401(k) plan.
State insurance regulations also require the maintenance of a minimum compulsory surplus based on a percentage of premiums written. At December 31, 1997, the Company's insurance subsidiaries were in compliance with these compulsory regulatory requirements.
Dividends paid by the insurance subsidiaries to the Company are limited by state insurance regulations. The insurance regulator in the state of domicile may disapprove any dividend which, together with other dividends paid by an insurance company in the prior twelve months, exceeds the regulatory maximum as computed for the insurance company based on its statutory surplus and net income.
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 (a "Cash Balance" formula). The resulting reduction in the projected benefit obligation is included in the funded status of the pension plans at December 31, 1997 and 1996, and was also considered in the calculation of the 1996 pension credit.
The pension plans' assets are comprised primarily of debt, equity and other marketable securities.
Assumptions used in developing the projected benefit obligation are as follows:
After giving effect to all administrative expense allocations between the Company and BCBSUW, the pension credit was $945,000, $1,288,000 and $435,000 in 1997, 1996 and 1995, respectively.
The Company and certain of its subsidiaries participate with BCBSUW in postretirement benefit plans to provide certain medical, dental and vision benefits and life insurance for certain groups of retired employees. Such plans were amended in 1997 to limit the Company's financial contribution in future periods. No benefit will be provided for individuals hired after the effective dates of these amendments.
The Company and certain of its subsidiaries participate in defined contribution plans whereby the employer contributes a percentage of participants' qualifying compensation up to certain limits, as defined by the plans. The Company also participates with BCBSUW in various other profit sharing and bonus programs. Expenses related to all of these plans, after giving effect to all administrative expense allocations between the Company and BCBSUW, totaled $2,042,000, $2,932,000 and $1,838,000 in 1997, 1996 and 1995, respectively.
In May 1995, the shareholders of the Company approved the 1995 Director Stock Option Plan which permits the grant of NQSOs. As of December 31, 1997, 42,000 shares are available for grant.
Selected quarterly financial data for the years ended December 31, 1997 and 1996 are as follows: