Financial Highlights should be read together with the accompanying Financial Review and Consolidated Financial Statements and Notes.
(1) Excluding the operational realignment and other charges of $725 million, $175 million of charges related to contract losses associated with certain Medicare markets and other increases to commercial and Medicare medical costs payable estimates and the $20 million convertible preferred stock redemption premium from 1998 results, earnings from operations and net earnings applicable to common shareholders would have been $858 million and $509 million, or $2.62 diluted net earnings per common share.
(2) Excluding the merger costs associated with the acquisition of HealthWise of America, Inc. of $15 million ($9 million after tax, or $0.05 diluted net earnings per common share) and the provision for future losses on two large 28 contracts of $45 million ($27 million after tax, or $0.15 diluted net earnings per common share), 1996 earnings from operations and net earnings would have been $641 million and $392 million, or $1.96 diluted net earnings per common share.
(5) In May 1994, the Company sold Diversified Pharmaceutical Services, Inc. for $2.3 billion in cash and recognized an extraordinary gain after transaction costs and income tax effects of $1.4 billion, or $7.86 diluted net earnings per common share.
- - Record cash flows of more than $1.0 billion were generated from operating activities, a 57% increase over 1997.
- - We embarked on a major realignment of our operations into independent but strategically linked businesses, each focused on performance, growth and shareholder value. As a result of our evaluation of each business's strategic fit and contributions, analysis of our profitability in certain markets, and the adequacy of our medical costs payable estimates, we took actions that resulted in special operating charges of $900 million.
The following table summarizes our results for each of the last three years ended December 31 (in millions, except per share amounts).
(1) Excluding the effects of $725 million of operational realignment and other charges, $175 million of charges related to contract losses associated with certain Medicare markets and other increases to commercial and Medicare medical costs payable estimates, and the $20 million convertible preferred stock redemption premium, earnings from operations, net earnings applicable to common shareholders, and diluted net earnings per common share would have been $858 million, $509 million, and $2.62 per share, respectively.
- - Our second quarter 1998 medical costs include $120 million related to contract losses and other increases to medical costs payable estimates in UnitedHealthcare's Medicare markets and $55 million related to increases to medical costs payable estimates associated with increased commercial medical costs in certain health plans.
1998 was a record year for UnitedHealth Group, with consolidated revenues of $17.4 billion, an increase of $5.6 billion, or 47%, over 1997. Our revenue growth was primarily derived from successful implementation of our $3.5 billion Medicare supplement insurance program with the AARP and same-store enrollment growth in our UnitedHealthcare business. On a year-over-year same-store basis, UnitedHealthcare's total revenues increased by $1.7 billion, or 16%, over 1997.
The following table summarizes enrollment in all of our product offerings as of December 31:
(1) Enrollment information includes growth resulting from our 1998 acquisition of HealthPartners of Arizona, Inc. (509,000 members). Additionally, the fee-based lives served by United HealthCare Administrators, Inc. are included in 1996 (666,000 members). We sold United HealthCare Administrators, Inc. on June 30, 1997.
The discussion that follows provides an analysis of our 1998 revenue trends for each of our three revenue components.
Consolidated premium revenues in 1998 totaled $15.5 billion, an increase of $5.4 billion, or 53%, compared to 1997. On January 1, 1998, our Ovations business began delivering Medicare supplement insurance and other medical insurance coverage to approximately 4 million AARP members. Premium revenues from our portion of the AARP insurance offerings during 1998 were $3.5 billion.
Excluding the AARP business, 1998 consolidated premium revenues totaled $12.0 billion, an increase of 19% over 1997. This increase is primarily the result of growth in our UnitedHealthcare business. On a year-over-year same-store basis, UnitedHealthcare's premium revenues increased $1.7 billion, or 18%, during 1998. The increase reflects same-store commercial health plan enrollment growth of 10% and average year-over-year premium yield increases on renewing commercial health plan groups of approximately 5% to 6%.
The combination of our pricing strategy and medical management efforts is reflected in the medical care ratio (medical costs as a percentage of premium revenues). The following table summarizes our medical care ratio by product line for the years ended December 31:
We are addressing our Medicare medical care ratio by altering benefit designs, recontracting with providers, and aggressively increasing both contemporaneous and retrospective claim management activities. We also are continuing to evaluate the markets we serve and products we offer. In addition, we will curtail activities or exit markets where we believe near term prospects are unacceptable.
To that end, in October 1998, we announced our decision to withdraw Medicare product offerings from 86 of the 206 counties we then served. The decision, effective January 1, 1999, affected approximately 60,000, or 13%, of our Medicare members. We will continue to offer Medicare products in strong and economically viable markets. Annual revenues for 1998 from Medicare counties we exited were approximately $225 million.
Despite increasing commercial medical cost trends in certain health plan markets, UnitedHealthcare's overall commercial medical care ratio improved slightly to 85.3% in 1998 from 85.7% in 1997.
OPERATIONAL REALIGNMENT AND OTHER CHARGES In conjunction with our operational realignment, we developed and, in the second quarter of 1998, approved a comprehensive plan (the Plan) to implement our operational realignment. We recognized corresponding charges to operations of $725 million, which reflect the estimated costs we will incur under the Plan. The charges included costs associated with asset impairments; employee terminations; disposing of or discontinuing business units, product lines and contracts; and consolidating and eliminating certain processing operations and associated real estate obligations. These activities will result in a net reduction of more than 4,000 positions, affecting 6,000 people in various locations. Through December 31, 1998, we have eliminated approximately 2,000 positions pursuant to the Plan.
The table below summarizes realignment activities for the year ended December 31, 1998 (in millions):
We have included in asset impairments the write off of $68 million of purchased in-process research and development associated with the acquisition of Medicode, Inc. The in-process projects were focused on the continued development and evolution of next generation medical databases and software solutions including clinical editing software, benchmarking databases and technologies. These technologies upon completion will enable both healthcare payers and providers to use the same data generated in the treatment documentation process to then be used in the financial transaction process, which involves provider compensation, care utilization review, trend analysis and management reporting. As of the date of acquisition, Medicode had invested $8.5 million in the in-process projects identified above. We estimate that it will be necessary to dedicate approximately $2.2 million over the next sixteen months in order to successfully complete these projects.
We believe the aggregate reduction in our overall cost structure from our realignment and other cost reduction activities will approximate $300 million annually by the end of the year 2000. We expect to realize approximately $75 million of these reductions in 1999.
The operational realignment charges do not cover certain aspects of the Plan, including new information systems, data conversions, process re-engineering and employee relocation and training. These costs will be charged to expense as incurred or capitalized, as appropriate.
The increase in premium revenues in 1997 was primarily due to growth in year-over-year same-store commercial health plan revenues of $1.5 billion, or 25%. The increase reflected same-store commercial health plan enrollment growth of 13% and
The 1997 year-over-year increase in premium revenues from commercial and Medicare products was partially offset by a $220 million decrease from non-network-based indemnity products. Nearly $60 million of this decrease resulted because we discontinued our relationship with a broker who sold and administered small group indemnity business on our behalf, which led to the loss of 30,000 indemnity members effective July 1, 1997. The remaining decrease was from declining enrollment in these products, which is attributed to average rate increases of 10% to 20% that started in 1996 and continued into 1997, as well as other business factors.
MEDICAL COSTS During 1997, the medical care ratio increased slightly from 84.0% in 1996 (before nonrecurring charges) to 84.3%. The 1997 increase in the medical care ratio was the result of several factors:
- - Several markets had recently introduced Medicare products, which had been well received and were growing rapidly. We generally experience higher medical care ratios during the early stage of Medicare product introductions.
- - Medicaid premiums did not increase and, in fact, decreased in several markets.
OPERATING EXPENSES During 1997, our SG&A ratio improved from 21.5% in 1996 to 20.0%. The improvement in the 1997 SG&A ratio reflected ongoing operating efficiencies as well as our diligence in managing operating expenses. On an absolute dollar basis, selling, general and administrative costs increased $199 million in 1997, or 9%, over 1996. This increase reflects the additional infrastructure needed to support the $1.6 billion increase in premium-based business, as well as the additional investment in new Medicare markets and increased support for our growing Specialized Care Services businesses.
FINANCIAL CONDITION AND LIQUIDITY AS OF DECEMBER 31, 1998 During 1998, we generated more than $1.0 billion in cash from operating activities. We continued to maintain a strong financial condition and liquidity position, with cash and investments of $4.4 billion at December 31, 1998, an increase of $400 million over December 31, 1997. Our long-term investments, $2.6 billion as of December 31, 1998, are classified as available for sale and are periodically sold prior to their maturity date to fund working capital or for other purposes.
- - We established a $600 million commercial paper program, which provides increased flexibility in managing our capital structure. At December 31, 1998, there were $59 million in commercial paper borrowings outstanding at an average interest rate of 5.3%.
In support of our commercial paper program, we entered into a $600 million credit arrangement with a group of banks. The agreement is comprised of a $300 million five-year revolving credit facility and a $300 million 364-day credit facility. No borrowings were outstanding under the credit facilities as of December 31, 1998.
- - In January 1998, we filed a shelf registration statement with the Securities and Exchange Commission (SEC) to sell up to $200 million of debt securities and preferred or common shares. The shelf filing registered the securities and allows us to sell them from time to time in the event we need financing. Proceeds from sales of these securities may be used for a variety of general corporate purposes, including working capital, securities repurchases and acquisitions. In October 1998, we filed another shelf registration statement to sell up to $1.05 billion of debt securities, preferred stock, common stock, depository shares, warrants and trust preferred securities. These securities may not be sold until the SEC declares the registration statement effective.
As further described under "Regulatory Capital and Dividend Restrictions," many of our subsidiaries are subject to various government regulations. After taking into account these regulations, approximately $500 million of our $4.4 billion of cash and investments at December 31, 1998, was available for general corporate use, including working capital needs.
Certain proposed changes in Medicare and Medicaid programs may improve opportunities to enroll people under products developed for these populations. Other proposed changes could limit available reimbursement and increase competition in those programs, with adverse effects on our financial results. Also, it could be more difficult for us to control costs if federal and state bodies continue to consider and enact significant and onerous managed care laws and regulations. Among the legislative proposals are proposals that could expand health plan liability or increase medical expenses.
Health care fraud and abuse has become a top priority for the nation's law enforcement entities, which have focused on participants in federal government health care programs such as Medicare, Medicaid and the Federal Employees Health Benefits Program (FEHBP). We participate extensively in these programs.
We also are subject to governmental investigations and enforcement actions. Included are actions relating to ERISA, which regulates insured and self-insured health coverage plans offered by employers; the FEHBP; Medicare and Medicaid; federal and state fraud and abuse laws; and laws relating to care management and health care delivery. Government actions could result in assessment of damages, civil or criminal fines or penalties, or other sanctions, including exclusion from participation in government programs. We currently are involved in various government investigations and audits, but we do not believe the results will have a material adverse effect on our financial position or results of operations.
As of December 31, 1998, the Company's regulated subsidiaries had aggregate statutory capital and surplus of approximately $1.4 billion, compared with their aggregate minimum statutory capital and surplus requirements of $390 million. The amount of dividends that may be paid to the Company or United HealthCare Services, Inc., by their insurance and HMO subsidiaries at December 31, 1998, without prior approval by state regulatory authorities, is limited to approximately $120 million. There are no such restrictions on distributions from United HealthCare Services, Inc. to the Company or on distributions from the Company to its shareholders.
The National Association of Insurance Commissioners has adopted rules which, to the extent that they are implemented by the states, will set new minimum capitalization requirements for insurance companies, HMOs and other entities bearing risk for health care coverage. The requirements take the form of risk-based capital rules. The change in rules for insurance companies was effective December 31, 1998. The new HMO rules are subject to state-by-state adoption, but few states had adopted the rules as of December 31, 1998. The HMO rules, if adopted by the states in their proposed form, would significantly increase the capital required for certain of our subsidiaries. However, we believe we can redeploy capital among our regulated entities to minimize the need for incremental capital investment of general corporate financial resources into regulated subsidiaries. As such, we do not anticipate a significant impact on our aggregate capital or investments in regulated subsidiaries.
YEAR 2000 ACTIVITIES Our business depends significantly on effective information systems, and we have many different information systems for our various businesses. Our information systems require ongoing enhancements to keep pace with the continuing changes in information technology, evolving industry standards, and customer preferences. We have been modifying our computer systems to accommodate the Year 2000. The Year 2000 problem exists throughout the global marketplace, as many computer systems and applications were developed to recognize the year as a two-digit number, with the digits "00" being recognized as the year 1900.
MAINFRAME TECHNOLOGY In conjunction with our two vendors that provide support for our data center operations, we have completed, tested and certified 99% of our remediation efforts for the hardware, operating system and supporting software remediation efforts on our two primary mainframe computer systems. In addition, we are in the process of reviewing some of our smaller mainframe systems and making modifications as necessary. We expect to be 100% complete with all mainframe hardware and software technology Year 2000 modifications by March 31, 1999. We also have installed separate test environments (both mainframe and distributed) to test our business applications in a simulated Year 2000 environment.
DESKTOP HARDWARE AND SOFTWARE We have inventoried all of our desktop hardware and software-- more than 40,000 computing devices of multiple makes and models. All noncompliant desktop hardware and software have been identified and are being modified or replaced with compliant systems by September 30, 1999.
CRITICAL SOFTWARE APPLICATIONS We use 500 different software applications that include more than 80 million lines of computer code. We have surveyed our software applications and have identified systems that will not be used after December 31, 1999, and systems that will be modified for Year 2000 compliance. We have determined that 36% of our software applications will not be used after December 31, 1999, due to conversions, consolidations and software replacements. Of the remaining applications, over 90% have been made Year 2000 compliant, tested and certified or are scheduled to be certified for compliance. The balance of the applications are yet to be tested. We expect all critical Year 2000 software modifications to be completed by March 31, 1999, with further testing and certification during the remainder of 1999.
NON-INFORMATION TECHNOLOGY SYSTEMS We have approximately 300 owned or leased facilities throughout the world. We have contacted all of our facility managers regarding Year 2000 compliance issues. In addition, we have contracted with a real estate management company to assist in our Year 2000 compliance efforts. All facilities are scheduled to be Year 2000 compliant by September 1, 1999.
The projected costs of our Year 2000 compliance efforts and the date on which we plan to complete the necessary Year 2000 remediation efforts are based on management's best estimates, which were derived using various assumptions of future events. However, there can be no guarantee that these estimates will be achieved, and actual results could differ significantly from our current plans. Specific factors that might cause significant differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct the relevant computer codes, and the ability of our significant vendors, providers, customers, and others with whom we conduct business to identify and resolve their own Year 2000 issues.
Each area of our Year 2000 compliance effort is currently developing contingency plans to mitigate the risk of failure, and to provide for a speedy recovery from possible failures associated with the century change. The contingency plans detail strategies to implement in 1999 to prepare for the century rollover, and actions to execute if problems emerge. The target date for completion of the initial contingency plans is April 1, 1999. Contingency plans will be final by July 31, 1999.
We are also involved in other legal actions that arise in the ordinary course of business. Although we cannot predict the outcomes of legal actions, it is our opinion that the resolution of all currently pending or threatened actions, including the class action lawsuit described above, will not have an adverse effect on our consolidated financial position or results of operations.
UnitedHealth Group ("the Company," "we," "us," "our") is a national leader in offering health care coverage and related services to help people achieve improved health and well-being through all stages of life. We provide a broad spectrum of products and services and operate in all 50 states, the District of Columbia and Puerto Rico, as well as internationally.
These financial statements include some amounts that are based on our best estimates and judgments. The most significant estimates relate to medical costs payable and other policy liabilities, intangible asset valuations and useful lives, integration reserves relating to acquisitions, and liabilities and asset impairments relating to our operational realignment activities. These estimates may be adjusted as more current information becomes available, and any adjustment could be significant.
Under our 10-year agreement with the AARP, we are administering certain aspects of the AARP's insurance program that were transferred from the program's previous carrier (see Note 7). Pursuant to our agreement with the AARP, the associated assets are managed separately from our general investment portfolio and are used to fund expenditures associated with the AARP program. The assets are invested at our discretion, within certain investment guidelines approved by the AARP. At December 31, 1998, the assets were invested in marketable debt securities. Interest earnings and realized investment gains and losses on these assets accrue to the AARP policyholders and, as such, are not included in our determination of earnings. Assets under management are reported at their amortized cost. Unrealized gains and losses are included in the reserve stabilization fund associated with the AARP program (see Note 7). At December 31, 1998, the AARP investment portfolio included unrealized gains of $12 million.
Other policy liabilities principally relate to experience-rated indemnity products and primarily include retrospective rate credit reserves and customer balances.
The useful lives of goodwill and other intangible assets have been assigned based on our best judgment. We periodically evaluate whether certain circumstances may affect the estimated useful lives or the recoverability of the unamortized balance of goodwill or other intangible assets.
Deferred income tax assets and liabilities are recognized for the differences between the financial and income tax reporting bases of assets and liabilities based on enacted tax rates and laws. The deferred income tax provision or benefit generally reflects the net change in deferred income tax assets and liabilities during the year. The current income tax provision reflects the tax consequences of revenues and expenses currently taxable or deductible on various income tax returns for the year reported.
We use the intrinsic value method for determining stock-based compensation expenses. Under the intrinsic value method, we do not recognize compensation expense when the exercise price of an employee stock option equals or exceeds the fair market value of the stock on the date the option is granted. Information on what our stock-based compensation expenses would have been had we calculated those expenses using the fair market values of granted stock options is included in Note 12.
Comprehensive income and its components is reported in the Consolidated Statements of Changes in Shareholders' equity. Comprehensive income is defined as changes in the equity of our business excluding changes resulting from investments by and distributions to our shareholders.
In June 1998, a new standard on accounting for derivative financial instruments and hedging activities was issued. This new standard will not materially affect our financial results or disclosures based upon our current investment portfolio.
In October 1998, our UnitedHealthcare business acquired HealthPartners of Arizona, Inc. (HPA), with 509,000 members as of the acquisition date. We paid $235 million in cash in exchange for all outstanding shares of HPA. We accounted for the acquisition using the purchase method of accounting, which means the purchase price was allocated to assets and liabilities acquired based on their estimated fair values at the date of acquisition and only the post-acquisition results of HPA are included in our consolidated financial statements. The purchase price and costs associated with the acquisition exceeded the preliminary estimated fair value of net assets acquired by $223 million, which has been assigned to goodwill. The pro forma effects of the HPA acquisition on our consolidated financial statements were not material.
During 1998, our Ingenix business segment acquired Kern-McNeill International (KMI), a New Jersey-based contract research organization, and St. Anthony Publishing, Inc. (St. Anthony), a leader in the health care coding and reimbursement publications market. In the aggregate, we paid $188 million in cash and assumed liabilities of $17 million in exchange for all of the common stock of KMI and St. Anthony. We accounted for these acquisitions using the purchase method of accounting. The purchase price and costs associated with these acquisitions exceeded the preliminary estimated fair value of net assets acquired by $205 million, which has preliminarily been assigned to identifiable intangible assets and goodwill. The pro forma effects of these acquisitions on our consolidated financial statements were not material.
In April 1996, we completed the acquisition of HealthWise of America, Inc. (HealthWise). HealthWise owned or operated health plans in Maryland, Kentucky, Tennessee and Arkansas that served 154,000 members at the time of acquisition. We issued 4.3 million shares of common stock in exchange for all outstanding shares of HealthWise. We accounted for the acquisition as a pooling of interests; however, we did not restate our historical financial results because the effects of this acquisition on our consolidated financial statements were not material. In connection with the HealthWise acquisition, we incurred merger costs of $15 million.
In March 1996, we completed the acquisition of PHP, Inc. (PHP), a North Carolina-based health plan that served 132,000 members at the time of acquisition. We issued 2.3 million shares of common stock, with a fair value of $140 million, in exchange for all outstanding shares of PHP. We accounted for the acquisition using the purchase method of accounting. The purchase price and costs associated with the acquisition exceeded the estimated fair value of net assets acquired by $115 million, which has been assigned to goodwill. The pro forma effects of the PHP acquisition on our consolidated financial statements were not material.
We acquired MetraHealth in October 1995. MetraHealth was formed in January 1995 by combining the group health care insurance operations of Metropolitan Life Insurance Company and The Travelers Insurance Group. We accounted for the acquisition using the purchase method of accounting. The excess purchase price over the fair value of net assets acquired of $1.2 billion was assigned to identifiable intangibles of $635 million in the Indemnity, Administrative Services Only and Specialty businesses consisting of employer group contracts and the supporting infrastructure, distribution networks and institutional knowledge being amortized over periods ranging from 10 to 40 years, with the remaining $560 million assigned to goodwill being amortized over 40 years.
In conjunction with our operational realignment initiatives, we developed and, in the second quarter of 1998, approved a comprehensive plan (the Plan) to implement our operational realignment. We recognized corresponding charges to operations of $725 million in the quarter, which reflect the estimated costs we will incur under the Plan. The charges included costs associated with asset impairments; employee terminations; disposing of or discontinuing business units, product lines and contracts; and consolidating and eliminating certain processing operations and associated real estate obligations. These activities will result in a net reduction of more than 4,000 positions affecting 6,000 people in various locations. Through December 31, 1998, we have eliminated approximately 2,000 positions pursuant to the Plan.
The operational realignment charges do not cover certain aspects of the Plan, including new information systems, data conversions, process re-engineering, and employee relocation and training. These costs will be charged to expense as incurred or capitalized, as appropriate.
The $101 million of contract losses were incurred in 13 of our 24 Medicare markets. These plans contribute half of our annual Medicare premiums of $2.4 billion. Six of these markets are generally newer markets where we have been unable to achieve the scale of operations necessary to achieve profitability. In numerous counties in the seven other markets, we experienced high medical costs which exceeded the fixed Medicare premiums that only increased 2.5% on average. We incurred $38 million of these Medicare losses during the second quarter and accrued $63 million at June 30, 1998, to cover estimated future losses to be incurred in the third and fourth quarters. We actually incurred $73 million of losses in the third and fourth quarters, and we recorded the additional $10 million as medical costs in the fourth quarter.
In conjunction with ongoing integration efforts, we modified the Plan during 1996. The restructuring reserves established with the original Plan were an accurate estimation of the costs incurred; however, we needed to reallocate the reserve estimates among the associated activities as the original Plan evolved.
In the second quarter of 1996, we recorded a provision to medical costs of $45 million to cover estimated losses we expected to incur through the remaining terms of two large 28 contracts in our St. Louis health plan. One of the contracts expired in December 1998 and contained a premium rate increase cap of 2.5% per year. The other contract expires in December 2000 and generally limits premium rate increases to annual Consumer Price Index adjustments. As of December 31, 1998, there were approximately 35,000 members under this contract.
We believe the remaining balance in the accrual for future losses of $13 million, which is included in medical costs payable in the accompanying Consolidated Balance Sheets, will be sufficient to cover expected future losses from the remaining contract.
Mortgage-backed securities that do not have a single maturity date have been presented in the above tables based on their estimated maturity dates.
Gross realized gains of $31 million, $24 million, and $10 million and gross realized losses of $5 million, $11 million, and $6 million were recognized in 1998, 1997 and 1996, respectively, and are included in investment and other income in the accompanying Consolidated Statements of Operations.
In December 1998, we also established a $600 million commercial paper program, thereby providing increased flexibility in managing our capital structure. At December 31, 1998, we had $59 million in commercial paper borrowings outstanding at an average interest rate of 5.3%.
The Company's debt arrangements and credit facilities contain various covenants, the most restrictive of which place limitations on secured and unsecured borrowings and require the Company to exceed minimum interest coverage levels. As of December 31, 1998, we are well within the requirements of all debt covenants.
Maturities of debt for the years ending December 31, are as follows (in millions):
In December 1998, we redeemed all 500,000 outstanding shares of 5.75% Series A Convertible Preferred Stock (the Preferred Stock). The Preferred Stock was issued to certain former shareholders of MetraHealth as a portion of the total consideration of our 1995 acquisition of MetraHealth. The redemption price per share of stock was $1,040 per share, or $520 million in the aggregate, which included a redemption premium of $40 per share, or $20 million in the aggregate. The redemption premium of $20 million is deducted from net earnings (loss) to arrive at net earnings (loss) applicable to common shareholders in the accompanying Consolidated Statements of Operations.
As of December 31, 1998, the Company's regulated subsidiaries had aggregate statutory capital and surplus of approximately $1.4 billion, compared with their aggregate minimum statutory capital and surplus requirements of $390 million. The amount of dividends that may be paid to the Company or United HealthCare Services, Inc. by their insurance and HMO subsidiaries at December 31, 1998, without prior approval by state regulatory authorities, is limited to approximately $120 million. There are no such restrictions on distributions from United HealthCare Services, Inc. to the Company or on distributions from the Company to its shareholders.
Pursuant to a board of directors' authorization, we are operating an 18.7 million share common stock repurchase program. These repurchases may be made from time to time at prevailing prices, subject to certain restrictions on volume, pricing and timing. During 1998, we repurchased 11.3 million shares for an aggregate cost of $436 million, an average cost of approximately $40 per share.
We have stock and incentive plans (the Stock Plans) for the benefit of eligible employees. As of December 31, 1998, the Stock Plans allowed for the future granting of up to 5 million shares as incentive or non-qualified stock options, stock appreciation rights, restricted stock awards, and performance awards to employees.
Stock options are generally granted at an exercise price not less than the fair market value of the common stock at the date of grant. They may be exercised over varying periods up to 10 years from the date of grant.
We increased additional paid-in capital $47 million in 1998, $37 million in 1997, and $15 million in 1996 to reflect the tax benefit we received upon the exercise of non-qualified stock options.
We do not recognize compensation expense in connection with stock option grants because we grant stock options at exercise prices that equal or exceed the fair market value of the stock at the time options are granted. If we had determined compensation expense using fair market values for stock options granted, net earnings (loss) would have been reduced to the following pro forma amounts:
We have a non-leveraged Employee Stock Ownership Plan (the ESOP) for the benefit of all eligible employees. Company contributions to the ESOP are made at the discretion of the board of directors. We made contributions to the ESOP of $4 million in 1998, $4 million in 1997, and $3 million in 1996.
Reconciliation of the Tax Provision at the U.S. Federal Statutory Rate to the Provision for Income Taxes
Valuation allowances are provided when it is considered unlikely that deferred tax assets will be realized. The valuation allowance relates to future tax benefits on certain purchased domestic and foreign net operating losses.
We paid income taxes of $245 million in 1998, $124 million in 1997, and $96 million in 1996.
At December 31, 1998, future minimum annual lease payments under all noncancelable operating leases were as follows (in millions):
On January 19, 1999, we received a consolidated amended complaint (In re United HealthCare Corporation Securities Litigation, No. 98-1888 in the United States District Court for the District of Minnesota) for the six suits which essentially restates the allegations made in the earlier complaints.
We are also involved in other legal actions that arise in the ordinary course of business. Although we cannot predict outcomes of legal actions, it is our opinion that the resolution of all currently pending or threatened actions, including the class action lawsuit described above, will not have an adverse effect on our consolidated financial position or results of operations.
(2) Includes $20 million convertible preferred stock redemption premium. Excluding the effects of the convertible preferred stock redemption premium, net earnings applicable to common shareholders would have been $125 million, or $0.67 diluted net earnings per common share.
The management of UnitedHealth Group is responsible for the integrity and objectivity of the consolidated financial information contained in this annual report. The consolidated financial statements and related information were prepared according to generally accepted accounting principles and include some amounts that are based on management's best estimates and judgements. To meet its responsibility, management depends on its accounting systems and related internal accounting controls. These systems are designed to provide reasonable assurance, at an appropriate cost, that financial records are reliable for use in preparing financial statements and that assets are safeguarded. Qualified personnel throughout the organization maintain and monitor these internal accounting controls on an ongoing basis. Internal auditors review the accounting practices, systems of internal control and compliance with these practices and controls. The Audit Committee of the board of directors, composed entirely of directors who are not employees of the Company, meets periodically and privately with the Company's independent public accountants and its internal auditors, as well as management, to review accounting, auditing, internal control, financial reporting and other matters.