Health care services expense primarily comprises payments to physicians, hospitals and other health care providers under fully insured health care business and includes an estimated amount for incurred but not reported or paid claims ("IBNR"). The Company estimates IBNR expense based on a number of factors, including prior claims experience. The ultimate payment of unpaid claims attributable to any period may be more or less than the amount of IBNR reported. The Company's results for the year ended December 31, 1998 were adversely affected by additions to the Company's reserves for IBNR in the second and fourth quarters. See "Liquidity and Capital Resources".
The Company's results for 1999 and 1998 were adversely affected by significant restructuring charges, and results for 1998 and 1997 were adversely affected by write-downs of strategic investments. Additionally, 1999 includes a charge of $24 million for the purchase of insurance policies for litigation matters. Net income for 1999 was favorably affected by the reversal of $225 million of deferred tax valuation allowances.
The following table provides certain statement of operations data expressed as a percentage of total revenues and the medical loss ratio for the years indicated:
(1) The medical loss ratios for 1998 and 1997 reflect significant additions to the Company's reserves recorded in each year. A portion of the reserve additions in 1998 and 1997 represent revisions to estimates for claims incurred in prior years. Accordingly, the medical loss ratios on an incurred basis would be different from those shown above.
During the third quarter of 1999, the Company recorded pretax restructuring charges totaling $19.9 million ($11.3 million after income tax benefits, or $0.13 per diluted share) in connection with additional steps taken under the Company's plan (the "Turnaround Plan") to improve operations and restore the Company's profitability. These charges included estimated costs related to: (i) $8.7 million for severance costs associated with work force reductions; (ii) $7.4 million of costs associated with additional consolidation of the Company's office facilities inclusive of the net write-off of $6.4 million in fixed assets, consisting primarily of leasehold improvements; (iii) $4.3 million for the write-off of certain computer equipment; and (iv) $1.7 million related to leases for equipment no longer used in operations. These charges were partially offset by a pretax gain of $2.5 million related to the disposal of the Company's minority investment in Ralin Medical, Inc., which was written down in value as part of the Company's 1998 restructuring charge.
The Company believes that the remaining restructuring reserves as of December 31, 1999 are adequate and that no revisions of estimates are necessary at this time.
As part of its Turnaround Plan, the Company decided to withdraw from noncore markets by selling or closing its HMO and insurance businesses in Pennsylvania, Illinois, Florida and New Hampshire. Total premium revenue for these businesses in 1998 was approximately $170.4 million, with operating losses totaling approximately $37 million. In addition, the Company decided to close its specialty management initiatives and to sell or close certain other health care services operations and investments in noncore businesses. Restructuring reserves were established relating to estimated losses associated with premium deficiencies in the HMO and insurance
During the third quarter of 1999, the Company recorded an increase of $3 million to this reserve for the net costs associated with relocating its corporate headquarters and the cessation of operations at its Ireland facility. Additionally, as a result of revisions in the estimates related to the 1998 reserves, $1.6 million was added to the reserves in the fourth quarter of 1999. The Company's related lease obligations for these properties extend to July 2005.
The 1997 charges resulted from a reduction in the level of future investment in expansion markets and, accordingly, the Company wrote down its investments in its Florida and Illinois subsidiaries and one affiliate. These write downs have been shown as write-downs of strategic investments in the accompanying financial statements and are summarized as follows:
During 1998, in connection with the Company's attempts to reduce administrative costs under the Turnaround Plan, the Company decided to consolidate operations and reduce its occupied square footage from approximately 2 million square feet under lease to approximately 1.2 million square feet. The Company has attempted to dispose of property and equipment as it vacated the facilities. The 1998 estimate for write-down of property and equipment included provisions for the estimated losses related to vacating certain facilities in connection with the Company's Turnaround Plan. The 1998 charge included an estimated provision for loss related to leasehold improvements ($12.5 million), office furniture ($11.8 million), computers and office equipment ($4 million) and software ($1 million). In determining the estimated fair values, the Company reviewed detailed asset listings for each location to be vacated. Based upon the asset classification, acquisition date and anticipated net proceeds, if any, upon disposition, as determined by the Company, the assets were written down to their estimated fair value. The fair values were determined based on the best information available in the circumstances, including prior experience in disposing of similar assets and discussions with potential purchasers of the assets. The Company completed the disposition or sale of these assets during 1999. Additionally, the Company anticipated and experienced a reduction in workforce of over 1,000 employees as a result of this consolidation and its administrative expense reduction plan.
Total revenues for the year ended December 31, 1999 were $4.2 billion, down 11.1% from $4.7 billion in the prior year. Net income attributable to common stock in 1999 totaled $274.4 million, or $3.26 per diluted share compared to a net loss of $624.4 million, or $7.79 per share, in 1998. Results of operations in 1999 were adversely affected by net restructuring charges of $19.9 million related to additional steps taken in the Company's Turnaround Plan and a charge of $24 million for litigation insurance coverage. Net income for 1999 was favorably affected by the reversal of $225 million of deferred tax valuation allowances. Results of operations in 1998 were adversely affected by significantly higher medical costs in the Company's commercial group business, Medicare, Medicaid and New York Individual Plans. Additionally, 1998 included approximately $113.7 million of restructuring charges, a $31.8 million premium deficiency reserve for losses on government contracts and $38.3 million of write-downs of strategic investments. See "Liquidity and Capital Resources" and "Overview".
Total commercial premiums earned for the year ended December 31, 1999 decreased 0.2% to $3.3 billion compared with $3.4 billion in the prior year. This decrease is primarily attributable to a 7.9% decrease in member months in the Company's commercial health care programs, primarily due to a 7.2% member months decrease in the Freedom Plan. Average premium yields of commercial programs were 8.4% higher in 1999, when compared with 1998. In response to higher medical costs incurred in 1998 in the Company's core commercial business, the Company increased its premium rates based on estimates of future medical costs. The Company's 1999 commercial revenue as compared to 1998 was adversely affected by the Company's disposition or withdrawal from noncore commercial markets in Pennsylvania, Illinois, Florida and New Hampshire. In addition, the Company experienced attrition of commercial members in its core commercial markets in 1999 and
Health care service expense stated as a percentage of premium revenues (the "medical loss ratio") was 82.1% for 1999 compared with 94.4% for 1998. Overall per member per month revenue in 1999 increased 6.2% to $212.12 from $199.82 in 1998 due primarily to a 9.1% increase in premium yields for the Company's Freedom and Liberty Plans and lesser increases for the Company's Medicare programs. Overall per member per month health care services expenses decreased 7.7% to $174.10 in 1999 from $188.61 in 1998. Health care service expenses benefited from initiatives to improve health care utilization and reduce costs as well as a change in membership mix whereby government program membership was reduced. Health care service expense in 1999 included the favorable development of prior period estimates of medical costs of approximately $28.7 million in 1999. Excluding this favorable development, the medical loss ratio was 82.8% for 1999.
In 1999 and 1998 the Company expensed a total of $73.9 million and $76.4 million, respectively, for graduate medical education and a total of $41.9 million and $54.8 million, respectively, for hospital bad debt and charity care. Health care services expense in 1998 included a provision of $25 million related to valuation reserves established in respect of provider advances. See "Liquidity and Capital Resources".
Year Ended December 31, 1998 Compared with Year Ended December 31, 1997
Health care services expense stated as a percentage of premium revenues (the "medical loss ratio") was 94.4% for the year 1998 compared with 94.0% for the year 1997. Overall per member per month revenue in 1998 was $199.82 compared to $193.06 in 1997, however, overall per member per month health care services expenses increased 4.0% to $188.61 in 1998 from $181.38 in 1997. Software and hardware problems experienced in the conversion of a portion of the Company's computer system in prior periods resulted in significant delays in the Company's payment of provider claims and adversely affected payment accuracy during 1997. Medical costs for 1997 reflect additions to the Company's reserves for IBNR in the third quarter of 1997 aggregating $88 million and in the fourth quarter of 1997 aggregating $239 million. Of the total 1997 reserve additions of $327 million, approximately $90 million related to incurred costs for periods prior to 1997. These reserve additions represent revisions to estimates of the Company's incurred medical costs based on information gained in the process of reviewing and reconciling previously delayed claims and claims paid or denied in error. These revised estimates resulted from significant increases in medical costs in prior periods in the Company's commercial, Medicare, Medicaid and New York Individual plans that exceeded prior estimates. Health care services expense for 1998 and 1997 also included provisions of $25 million and $10 million, respectively, related to valuation reserves established in respect of provider advances.
As part of its Turnaround Plan, the Company decided to restructure its Medicare arrangements and/or withdraw from Medicare in the counties where the Medicare business was not profitable and to withdraw from the Medicaid business entirely. Premium deficiency reserves totaling $51 million were established in the second quarter of 1998 and charged to health care services expense. Based on the Company's decision to restructure or withdraw from these businesses by the end of 1998, the reserves were determined by estimating the premium deficiency for the remainder of 1998.
The Company entered into an agreement to dispose of its remaining Medicaid business in the fourth quarter of 1998, completed two Medicare risk transfer agreements late in the third quarter of 1998 and notified HCFA in the fourth quarter of 1998 of its intention to withdraw from Medicare in certain counties effective January 1, 1999. Under the two risk sharing arrangements the Company transferred a substantial portion of the medical cost risk associated with the provision of medical services to certain of the Company's Medicare members to a network management company in one case and an integrated health care system in the other. These risk transfer agreements had five year terms and provided for delegation of certain claims payment and utilization management functions, subject to oversight by the Company. The providers agreed to provide or arrange for providing all covered health care services for this membership in return for payment by the Company of a fixed per member per month payment based on a percentage of premium received by the Company. In the event the providers fail to fulfill their obligations under the risk transfer agreements, the Company remains primarily liable to pay the cost of covered services. Losses in these programs amounted to $31.8 million in the second half of 1998 and were charged against the reserves established in the second quarter of 1998. As a result of the Company's early completion of this portion of its Turnaround Plan, the remaining reserve balance of $19.2 million was reversed as a reduction of health care services expense in the fourth quarter of 1998, which reduced the net loss by $0.24 per share.
Although the rate of inflation has remained relatively stable in recent years, health care costs have generally been rising at a higher rate than the consumer price index. Through 1998, the Company has experienced significant increases in medical costs in its commercial, Medicare and New York Individual Plans. The Company employs various means to reduce the negative effects of inflation. The Company has increased overall commercial premium rates when practicable in order to attempt to maintain margins. The Company's cost-control measures and risk-sharing arrangements with various health care providers as well as its withdrawal from participation in state Medicaid programs may mitigate the effects of inflation on its operations. There is no assurance that the Company's efforts to reduce the impact of inflation will be successful or that the Company will be able to increase premiums to offset cost increases associated with providing health care.
Cash provided by operations was $35.5 million in 1999 versus cash used by operations of $46.5 million in 1998. The improvement is primarily attributable to the increase in net earnings and reductions in premiums receivable.
Cash and investments aggregating $61.6 million at December 31, 1999 have been segregated as restricted investments to comply with federal and state regulatory requirements. The amount includes $5.2 million as collateral for certain advances made by the Company's New Jersey subsidiary. The Company expects to have the restriction on the New Jersey funds removed during 2000. With respect to the Company's New York subsidiaries, the minimum amount of surplus required is based on a formula established by NYSID. These statutory surplus requirements amounted to approximately $133.3 million and $130 million at December 31 1999 and 1998, respectively. In addition, the Company's subsidiaries are subject to certain restrictions on their abilities to make dividend payments, loans or other transfers of cash to the parent company. These restrictions limit the ability of the Company to use cash generated by subsidiary operations to pay the obligations of the parent, including debt service and other financing costs.
The New Jersey State legislature has passed legislation that includes a $50 million assessment on HMOs in the state based on market share and to be collected over a three-year period. Although the Company does not anticipate that this assessment will have a material impact on its operations, the assessment may result in the necessity of making a capital contribution to Oxford NJ in an amount up to approximately $5 million.
In an effort to control increasing medical costs in its Medicare programs, the Company has an agreement with North Shore-Long Island Jewish Health Systems ("North Shore") pursuant to which it has transferred to North Shore a substantial portion of the medical cost risk associated with its approximately 22,000 Medicare members in certain New York counties where it had experienced substantial losses. The Company and North Shore have made progress in resolving certain initial operational difficulties. The Company bears the risk of nonperformance or default by North Shore, and the failure of the North Shore arrangement could have a material adverse effect on the Company's results of operations. A similar agreement covering New Jersey Medicare members was terminated in July 1999. The Company is currently in arbitration proceedings to resolve the New Jersey agreement. See "Legal Proceedings".
In the first quarter of 1998, the Company issued $200 million of senior secured increasing rate notes due February 6, 1999 ("Bridge Notes") pursuant to an agreement between the Company and an affiliate of Donaldson Lufkin & Jenrette Securities Corporation. The Company used the proceeds of the Bridge Notes to make a portion of the above described contributions to its HMO subsidiaries, to pay expenses in connection with the issuance of the Bridge Notes and for general corporate purposes. The Bridge Notes were redeemed as part of the financing arrangements described below.
Company prior to May 13, 2003. Thereafter, subject to certain conditions, the Series A and Series B Preferred Stock were each redeemable at the option of the Company at a redemption price of $1,000 per share (in each case, plus accrued and unpaid dividends), and were subject to mandatory redemption at the same price on May 13, 2008. The Series A Warrants and the Series B Warrants expire on the earlier of May 13, 2008 or redemption of the related series of Preferred Stock. The Warrants are detachable from the Preferred Stock. With respect to dividend rights, the Series A and Series B Preferred Stock rank on a parity with each other and prior to the Company's common stock.
On August 28, 1998, the Company held its annual shareholders meeting at which its shareholders approved the vesting of voting rights in respect of the Series B Preferred Stock and the issuance, subject to adjustment, of up to 6,730,000 shares of common stock upon exercise of the Series B Warrants. This approval resulted in the reduction of the dividend on the Series B Preferred Stock to 8% (8.243216% prior to May 13, 2000) and an increase in the voting rights of TPG to 22.1% of the combined voting power of the Company's outstanding common stock and Series A and Series B Preferred Stock.
245,000 shares of Series A Preferred Stock were exchanged for 260,146.909 shares of a new Series D Preferred Stock (the "Series D Preferred Stock"), and the 105,000 shares of Series B Preferred Stock were exchanged for 111,820.831 shares of a new Series E Preferred Stock (the "Series E Preferred Stock"). In the exchange, (1) a holder received in exchange for each share of Series A Preferred Stock, one share of Series D Preferred Stock, plus 0.061824118367 share of Series D Preferred Stock representing dividends on the Series A Preferred Stock accrued and unpaid through February 13, 1999, and (2) a holder received in exchange for each share of Series B Preferred Stock, one share of Series E Preferred Stock, plus 0.064960295238 share of Series E Preferred Stock representing dividends on the Series B Preferred Stock accrued and unpaid through February 13, 1999. As a result of the exchange, the holders hold only Series D Preferred Stock and Series E Preferred Stock. On March 9, 1999, the Company filed Certificates of Elimination for the Series A Preferred Stock and the Series B Preferred Stock that have the effect of eliminating from the Certificate of Incorporation all matters with respect to the Series A Preferred Stock and the Series B Preferred Stock. The terms of the shares of the Series D Preferred Stock are identical to the terms of the Series A Preferred Stock, except that the Series D Preferred Stock accumulates cash dividends at the rate of 5.12981% per annum, payable quarterly, provided that prior to May 13, 2000, the Series D Preferred Stock accumulates dividends at a rate of 5.319521% per annum, payable annually in cash or additional shares of Series D Preferred Stock, at the option of the Company. The terms of the shares of the Series E Preferred Stock are identical to the terms of the shares of the Series B Preferred Stock, except that the Series E Preferred Stock accumulates cash dividends at a rate of 14.00% per annum, payable quarterly, provided that prior to May 13, 2000, the Series E Preferred Stock accumulates dividends at a rate of 14.589214% per annum, payable annually in cash or additional shares of Series E Preferred Stock, at the option of the Company. In addition, prior to May 13, 2000, the holders of the Series D Preferred Stock may not use the Series D Preferred Stock in connection with the exercise of the Warrants unless they use a percentage of the total amount of Series D Preferred Stock issued on February 13, 1999 that does not exceed the percentage of the total number of shares of Series E Preferred Stock issued on February 13, 1999 that have been redeemed, repurchased or retired by the Company, or used as consideration in connection with the exercise of the Warrants by the holders. With respect to dividend rights, the Series D Preferred Stock and Series E Preferred Stock rank on a parity with each other and prior to the Company's common stock.
The aggregate cost to the Company of dividends on the Series D Preferred Stock and Series E Preferred Stock is the same as the aggregate cost to the Company of dividends on the Series A Preferred Stock and Series B Preferred Stock. The respective voting rights of the holders of the Series A Preferred Stock and Series B Preferred Stock have not changed as the result of the exchange of such shares for shares of Series D Preferred Stock and Series E Preferred Stock. The exchange had no effect on the consolidated balance sheet as the issuance of additional redeemable preferred stock effected the in-kind payment of the accrued redeemable preferred stock dividend which had previously been credited to redeemable preferred stock. In the Company's view, there was no difference in the aggregate fair value between the redeemable preferred stock issued in the exchange and the redeemable preferred stock canceled in the exchange.
The Company completed its assessment, planning, remediation and testing of its computer programs associated with its mission critical systems that could be affected by the "Year 2000" date issue. The Year 2000 problem was the result of computer programs being written using two digits rather than four to define the applicable year. The Company did not experience any significant interruption of business operations or any other system failures or disruptions as a result of the failure of any of its business systems or those of its material vendors as a result of the Year 2000 issue.
See Index to Consolidated Financial Statements and Schedules on page 49.