Our facilities are in good working condition, are well maintained and are adequate for our present and currently anticipated needs. We believe that we can rent additional space at competitive rates when current leases expire, or if we need additional space.
- - In November 1999, we entered a definitive agreement to purchase Harris Methodist Texas Health Plan, Inc. and Harris Methodist Health Insurance Company, Inc., a health plan and insurance company in Texas with approximately 250,000 commercial and 50,000 Medicare members. We completed the acquisition effective February 1, 2000 once we had received all necessary approvals from the regulators. See Note 12 of the Notes to Consolidated Financial Statements.
- - In September 1999, we acquired ANTERO Health Plans in Colorado and in February 1999, we acquired 15,000 commercial members in Texas. See Note 4 of the Notes to Consolidated Financial Statements.
- - In June 1999, we submitted our 2000 proposed Secure Horizons benefit plan changes to HCFA for approval. These changes were designed to enable us to maintain our Medicare margins in 2000. The changes, which were effective January 1, 2000, included increasing our members' monthly premiums and copayments or reducing benefits where the government provided insufficient reimbursement. We expect disenrollments as a result of these premium and benefit adjustments. In addition, we exited Secure Horizons operations in 12 counties in Ohio, Washington, California and Oregon effective January 1, 2000. These county exits did not result in a significant loss of our Secure Horizons members. See "Forward-Looking Information under the Private Securities Litigation Act of 1995."
- - In May 1999, we entered into a stock purchase agreement with UniHealth Foundation to repurchase up to 5.9 million shares of our common stock held by UniHealth Foundation. At our June 24, 1999 annual meeting, our Class A and Class B common stockholders approved an amended and restated certificate of incorporation, which combined and reclassified PacifiCare's Class A and Class B common stock into a single class of voting common stock. We paid UniHealth Foundation $60 million when our stockholders approved the amended and restated certificate of incorporation on June 24, 1999. This payment was recorded as a reduction of stockholders' equity. To date we have not repurchased any of the shares held by UniHealth Foundation because our stock price has been substantially below the $75 per share price at which UniHealth Foundation may agree to sell the stock. See Note 6 of the Notes to Consolidated Financial Statements.
Commercial membership increased approximately three percent at December 31, 1999 compared to membership at December 31, 1998 due to:
- - Membership increases in California primarily due to improved sales efforts, and in Colorado as a result of the acquisition of ANTERO Health Plans; partially offset by
- - The sale of our Utah HMO and workers' compensation subsidiaries; partially offset by
- - The improved efficiencies of our regional customer service operations.
OPERATING INCOME. Factors contributing to the increase in operating income are discussed above.
- - The shift of more portfolio holdings to tax-exempt investments that have lower interest rates.
PROVISION FOR INCOME TAXES. The effective income tax rate was 42.2 percent in 1999, compared with 47.5 percent in 1998. The rate declined significantly because:
- - Nondeductible goodwill amortization was a smaller percentage of pretax income;
- - We benefited from certain tax strategies, in particular the legal reorganization of PacifiCare and its subsidiaries, which resulted in lower state income taxes;
MEMBERSHIP. Total membership decreased seven percent to approximately 3.5 million members at December 31, 1998 from approximately 3.8 million members at December 31, 1997.
- --------------- (1) The government program represents the Medicare line of business.
(2) The government program represents the Medicare and Medicaid lines of business.
Government membership decreased approximately three percent at December 31, 1998 compared to the membership at the end of the prior year primarily as a result of the sale of our Utah HMO and our exit from certain rural counties.
Commercial membership decreased approximately eight percent at December 31, 1998 compared to the membership at the end of the prior year due to:
- - Our continued focus on renewing commercial contracts with sufficient price increases to improve gross margin, primarily in California.
OTHER INCOME. Other income increased in 1998 from the prior year due primarily to higher revenues from our pharmacy benefit management company and SHUSA.
CONSOLIDATED MEDICAL CARE RATIO AND PROVIDER RESERVES. The 1998 consolidated medical care ratio declined 0.7 percent compared to 1997.
Reserves for the FPA Medical Management, Inc. bankruptcy totaled $57 million, with $41 million attributable to our Nevada HMO. Reserves for other providers totaled $38 million. Approximately $17 million of the reserves recognized in the third and fourth quarters related to Caremark Rx, Inc. (formerly MedPartners, Inc.), who ceased paying claims in Nevada and Arizona. The membership was transitioned to other providers between December 1998 and January 1999. The remaining $21 million was the estimated liability for smaller bankrupt providers and potentially insolvent providers, primarily in California.
GOVERNMENT MEDICAL CARE RATIO. The government medical care ratio for the year ended December 31, 1998 increased 0.9 percent compared to the prior year because we recognized $62 million of provider reserves. Government provider reserves for FPA were $40 million, with the majority of these charges recognized in the second and third quarters. Other provider reserves of $22 million were recorded primarily in the fourth quarter. Higher costs incurred for FPA membership shifting into new provider relationships were offset by the disposition of Utah in September 1998. Excluding government provider reserves, the 1998 government medical care ratio was 85.4 percent.
OPERATING CASH FLOWS. PacifiCare's consolidated cash, equivalents and marketable securities increased to $1.8 billion at December 31, 1999 from $1.6 billion at December 31, 1998. The combined increase in cash, equivalents and marketable securities occurred primarily due to the large draws on our line of credit to repurchase shares in the open market. In addition, the Medicare payment received from HCFA in December 1999 for January 2000 was higher than the amount received in December 1998 for January 1999.
FINANCING ACTIVITIES. For the year ended December 31, 1999, we used $194 million of cash for financing activities compared to $393 million used for the same period of the prior year. The decrease was primarily related to fewer credit facility payments. The changes were as follows:
- - We borrowed under the credit facility to repurchase shares of our outstanding common stock. Borrowings were $400 million in 1999 and $30 million in 1998;
- - We paid $75 million in principal on our credit facility during 1999 in comparison to $391 million in principal in 1998. Principal payments declined as we used available cash to fund our stock repurchases;
- - We paid $5 million in preferred stock dividends in 1998. No preferred dividends were paid in 1999 because all of the outstanding preferred stock was converted or redeemed in 1998.
GOODWILL AND INTANGIBLE ASSETS, NET. Goodwill and intangible assets decreased $69 million from 1998 as follows:
- - $14 million decrease attributable to the impairment of the Ohio HMO's goodwill; partially offset by
- - $21 million increase attributable to membership acquisitions in Texas and Colorado.
- - $12 million net decrease in provider insolvency reserves, consisting of $24 million in payments primarily to Nevada providers, other net changes in estimates totaling $3 million; partially offset by $15 million in additional provisions; and
ACCRUED LIABILITIES. Accrued liabilities decreased $81 million from December 31, 1998 primarily due to income taxes payable. The decrease was attributable to higher estimated tax payments, partially offset by the income tax provision on 1999 income.
COMMERCIAL PREMIUMS. Commercial premiums increased approximately two percent or $19 million for the three months ended December 31, 1999 compared to the three months ended September 30, 1999 due to:
OTHER INCOME. Other income increased for the three months ended December 31, 1999 compared to the three months ended September 30, 1999 due to increased mail-service revenues from our pharmacy benefit management company, where we, rather than the network retail pharmacies, collect the member copayments.
CONSOLIDATED MEDICAL CARE RATIO. The consolidated medical care ratio for the three months ended December 31, 1999 was comparable to the consolidated medical care ratio for the three months ended September 30, 1999.
COMMERCIAL MEDICAL CARE RATIO. The commercial medical care ratio includes the specialty HMOs and indemnity insurance results. The commercial medical care ratio increased for the three months ended December 31, 1999 compared to the three months ended September 30, 1999 due to:
- - Increased pharmacy utilization and higher prescription drug costs; partially offset by
PROVISION FOR INCOME TAXES. The effective income tax rate was 42.1 percent for the three months ended December 31, 1999 compared with 43.8 percent for the three months ended September 30, 1999. The sequential decrease was primarily due to the nondeductible Ohio goodwill impairment charges recognized in the third quarter. See Note 9 of the Notes to Consolidated Financial Statements.
DILUTED EARNINGS PER SHARE. For the three months ended December 31, 1999, net income was $66 million or $1.59 diluted earnings per share compared to net income of $69 million or $1.54 diluted earnings per share for the three months ended September 30, 1999. The change was due to the following:
- --------------- (1) This represents the income tax rate impact for the fourth quarter 1999 as a result of the change in the income tax rate due to the impairment, disposition, restructuring, and other (credit) charges recognized in the third quarter 1999.
This document contains forward-looking statements that involve risks and uncertainties. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology including, "may," "will," "could," "should," "intend," "expect," "plan," "anticipate," "believe," "estimate," "predict," "potentially," "continue," or "opportunity" or the negative of these terms or other comparable terminology. The statements about our plans, strategies, intentions, expectations and prospects contained throughout the document are forward-looking and are based on current expectations. Actual results may differ materially from those predicted as of the date of this report in the forward-looking statements. In addition, past financial performance is not necessarily a reliable indicator of future performance and investors should not use historical performance to anticipate results or future period trends. In evaluating these statements, you should specifically consider factors, including the risks described below and in other parts of this annual report.
The expectations discussed below include QualMed membership assumed during the first quarter of 2000 and the February 1, 2000 acquisition of Harris. See Note 12 of the Notes to Consolidated Financial Statements.
We expect the rate of commercial membership growth to range from 13 percent to 18 percent for the year ended December 31, 2000. The majority of the growth will be a result of acquisitions. We expect to increase membership by approximately 175,000 by the end of 2000 as a result of the Harris acquisition. We also expect to assume approximately 25,000 to 29,000 members in Colorado and approximately 24,000 members in Washington by the end of 2000, as a result of the agreements signed with QualMed. In addition, we expect growth in California, where we plan to focus our marketing efforts on membership retention and renewal of national and major employer accounts.
PREMIUMS. HCFA premium rate increases combined with supplemental member premiums are expected to be approximately three percent to five percent in 2000. We instituted or increased member-paid supplemental premiums for approximately 45 percent of our Secure Horizons members for the first time in certain markets, and increased premiums in other markets, to offset lower annual HCFA premium rate increases. Commercial HMO premium rate increases are expected to range from seven percent to nine percent in 2000. We expect our commercial premium revenue to increase 22 percent to 26 percent as a result of these rate increases combined with our expected commercial membership growth. In addition, in the second half of the year we plan to implement higher premium rate increases in California to cover the cost of new mental health coverage mandated under state and federal laws.
- - The inability of our marketing and sales plans to attract new customers or retain existing customers;
- - The loss of our key employees in sales and marketing.
OTHER INCOME. In 2000, we expect other income to increase, primarily related to increased pharmacy mail-service revenues.
HEALTH CARE COSTS. Our profitability depends, in part, on our ability to control health care costs while providing quality care. Our primary focus is securing cost-effective physician, hospital and other health care provider contracts to maintain our qualified network of providers in each geographic area we serve. Through December 31, 1999, consolidated medical and hospital costs were trending between one and five percent higher. Other costs, the majority of which is prescription drugs, were trending between 12 percent and 16 percent higher. These health care cost trends are expected to be slightly higher in 2000.
85 percent at the end of 1998 to approximately 75 percent to 80 percent at the end of 1999. We expect the percentage of capitated hospital contracts to continue to decrease in 2000 to between 70 percent and 75 percent, particularly in markets where providers face less competition. We expect to increase the capitation rates we pay some of our medical and hospital providers to improve the network stability of our capitated providers. To offset these increases, we have reduced benefits, increased copayments and instituted or increased member-paid supplemental premiums in certain markets for our Secure Horizons members. We have also begun to implement initiatives intended to improve performance of our provider contracts, including our medical management redesign initiative. See "Health Care Costs and Provider Relationships -- Medical Management Redesign." Members in contracts that are capitated for professional risk were approximately 95 percent at December 31, 1999 and are not expected to change in 2000.
Formularies are lists of physician-recommended drugs in different therapeutic classes that have been reviewed for safety, efficacy and value. These lists help ensure that members get the right prescription at the right time in the right dose, avoiding potential adverse effects. Formularies also ensure that the costs are effectively managed; if two medications have the same effect, the less expensive option (often a generic alternative) is recommended. Medically necessary drugs not included in the formulary can be obtained through our authorization process. We continue to conduct member and physician education programs to provide information on the appropriate use of generic drugs, over the counter drugs and antibiotics. Many of our medical groups share the financial risk for prescription drugs to find the most effective and cost-efficient treatments for our members. Prescription drug benefit changes for Secure Horizons members have been implemented in almost all our geographic areas for 2000 as a way of controlling this health care cost component.
CONSOLIDATED MEDICAL CARE RATIO. We manage premium increases to offset health care cost increases to maintain long term stability in our medical care ratio. Our "same store" business is expected to have a consolidated medical care ratio comparable to 1999. Our acquisition of Harris is expected to slightly increase the consolidated medical care ratio.
GOVERNMENT MEDICAL CARE RATIO. We expect the 2000 government medical care ratio to increase compared to the December 31, 1999 medical care ratio. We expect increases in capitation rates and higher claims under shared-risk arrangements to cause an increase in the medical care ratio. To partially offset these rising health care costs, we plan to charge member-paid supplemental premiums, reduce benefits and increase our hospital utilization management.
COMMERCIAL MEDICAL CARE RATIO. We expect the 2000 commercial medical care ratio to slightly increase due to the number of fee-for-service provider contracts and the more extensive drug formulary, both obtained as a result of the Harris acquisition. In addition, we also expect increases in costs resulting from higher pharmacy costs and increased utilization under our shared-risk contracts. These increases will be partially offset by premium rate increases and cost savings from hospital utilization management.
MEDICAL CARE RATIO RISK FACTORS. An increase in our consolidated medical care ratio could have an adverse effect on our profitability. Uncertainties that could have a negative impact on our medical care ratio include:
- - Medical and prescription drug costs that rise faster than premium increases;
- - Increases in utilization and costs of medical and hospital services;
- - The effect of federal and/or state legislation on our ability to secure cost-effective contracts with providers;
- - Termination of provider contracts, provider instability or renegotiations of such contracts at less favorable rates or terms of payment; and
MARKETING, GENERAL AND ADMINISTRATIVE RISK FACTORS. The following factors could have an adverse impact on marketing, general and administrative expenses:
- - Our need for additional unanticipated investments in medical management resources and technology;
- - Integration costs for Harris and other acquisitions that exceed our expectations;
- - Our inability to achieve the anticipated efficiencies and resulting cost savings.
RESTRUCTURING. In January 2000, we announced a restructuring that will allow us to develop plans to strengthen our operations through planned productivity enhancements and technology improvements to further our competitive advantages and growth opportunities. As a result of these changes, we will record a restructuring charge of approximately $7 million to $8 million in the first quarter of 2000. The restructuring charge includes severance and related employee benefits. In January 2000, we reduced our workforce by 90 employees. During the twelve months ending December 31, 2000, an additional 160 employees are in transition, which will result in further reductions in workforce. In addition, 200 other positions will be eliminated through attrition and cancellation of certain open positions.
HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996 ("HIPAA"). HIPAA includes administrative simplification provisions directed at simplifying electronic data interchange through standardizing transactions, establishing uniform health care provider, payer and employer identifiers and seeking protections for confidentiality and security of patient data. Proposed rules under HIPAA administrative simplification are expected to be released as final rules during 2000 for full implementation within two years from the date of each release. The administrative simplification portion of HIPAA as currently proposed would require health plans, health care providers, health care clearing houses and additional third parties such as business partners to communicate electronically using standardized formats. We are proceeding as if the proposed rules will be adopted as currently proposed. We will be undertaking an assessment of our current systems to determine where they diverge from the requirements of administrative simplification. We expect to begin this analysis by the end of the first quarter and believe we will be able to determine the cost of implementation of the administrative simplification requirements of HIPAA by the beginning of the third quarter. Currently, we are unable to assess the cost of implementation of the administrative simplification requirements of HIPAA or predict the results of the system analysis.
INTEREST EXPENSE. In 2000, we expect interest expense will significantly increase compared to 1999 primarily due to increased borrowings on our credit facility to fund our share repurchase program. In addition, the reduction in our credit rating by the credit rating agencies, combined with a higher interest fee structure in the credit facility amendment and rising market interest rates, will result in higher interest rates in 2000.
LIQUIDITY AND CAPITAL RESOURCES. The terms of our credit facility permit us to repurchase up to $1 billion of our outstanding common stock. We plan to fund repurchases through a combination of cash flow and borrowings under our credit facility. Our ability to repay amounts owed under the credit facility depends on dividends from our subsidiaries. Nearly all of the subsidiaries are subject to HMO regulations or insurance regulations and may be subject to substantial supervision by one or more HMO or insurance regulators. Subsidiaries subject to regulation must meet or exceed various capital standards imposed by HMO or insurance regulations, which may from time to time impact the amount of funds the subsidiaries can pay to us. Our subsidiaries are not obligated to make funds available to us and creditors of our subsidiaries have superior claim to our subsidiaries' assets. Additionally, from time to time, we advance funds in the form of a loan or capital contribution to our subsidiaries to assist them in satisfying federal or state financial requirements. If a federal or state regulator has concerns about the financial position of a subsidiary, a regulator may impose additional financial requirements on the subsidiary, which may require additional funding from us. We believe that cash flows from operations, existing cash equivalents, marketable securities and other financing sources will be sufficient to meet the requirements of the credit facility, stock repurchases and our business operations during the next twelve months.
limits for health care coverage provided by HMOs and other risk-bearing health care entities. To date, Colorado and Washington are the only states where we have HMO operations that have adopted these standards. We do not expect this legislation to have a material impact on our consolidated financial position in the near future if other states where we operate HMOs adopt these standards. We believe that cash flows from operations will be sufficient to fund any additional 2000 risk-based capital requirements. Further borrowings under the credit facility could be used for risk-based capital requirements, if necessary.
- - New and proposed legislation that would hold HMOs liable for medical malpractice (including proposed federal legislation that would remove the federal preemption set forth in ERISA that precludes most individuals from suing their employer based health plan for causes of action based upon state law). To date, both California and Texas have adopted regulations that may increase the likelihood of lawsuits against HMOs for malpractice liability;
- - New state and proposed federal laws mandating benefits including those that mandate equal coverage for mental health benefits ("mental health parity");
- - Proposed federal regulations that place new restrictions and administrative requirements on the use of, the electronic retention of, the transmission of and the disclosure of personally identifiable health information;
- - Increases in minimum capital, reserves, and other financial liability requirements.
We cannot assure the level or stability of our share price at any time, or the impact of the foregoing or any other factors may have on our share price. The market price of our common stock may decline significantly if our earnings results for any quarter are below the expectations of industry research analysts.