Effective as of January 1, 1996, the Company entered into a new lease for its Woodland Hills, California headquarters facility, which provides for a term expiring in December 2019 with two options to extend the term for up to two additional five-year terms. Rent expense under the new lease was approximately $7.8 million during 1997. In 1997, the Company entered into a lease, which expires in December 2019, for a new facility to be located in Thousand Oaks, California that will consolidate many corporate and UNICARE functions. The Company and its subsidiaries have additional offices in the greater Los Angeles and Ventura County area. As a result of the MMHD and GBO acquisitions and the Company's continuing national expansion efforts, the Company maintains offices in various other locations, including Springfield, Massachusetts; Charlestown, Massachusetts; Schaumburg, Illinois; Dearborn, Michigan; and Plano, Texas.
(B) Per share data includes nonrecurring costs of $0.13 per share and $0.52 per share for 1997 and 1995, respectively.
(C) Per share data for periods prior to 1997 has been restated to reflect the adoption of SFAS No. 128, "Earnings Per Share."
(F) Membership numbers are approximate and include some estimates based upon the number of contracts at the relevant date and an actuarial estimate of the number of members represented by each contract.
The Company is one of the nation's largest publicly traded managed health care companies with approximately 6.6 million medical members and approximately 22 million specialty members as of December 31, 1997. The Company offers a diversified mix of managed care products, including health maintenance organizations ("HMOs"), preferred provider organizations ("PPOs"), point of service ("POS") plans, other hybrid plans and traditional indemnity products. In addition, WellPoint offers managed care services for self-funded employers under management services contracts, including claims processing, actuarial services, network access, medical cost management and other administrative services. The Company also offers a broad array of specialty and other products, including pharmacy, dental, utilization management, life, integrated workers' compensation, preventive care, disability, behavioral health, COBRA and flexible benefits account administration.
On March 1, 1997, the Company completed its acquisition of certain portions of the health and related life group benefits operations (the "GBO") of the John Hancock Life Insurance Company. The purchase price was $89.7 million, subject to adjustment upon completion of a post-closing audit (which is still pending). The purchase method of accounting has been used to account for the acquisition of the GBO. The GBO, with an associated 1.3 million acquired members, targets large employers with 5,000 or more employees and a majority of the medical members it serves are in health plans that are self-funded by employers. The GBO offers indemnity and PPO plans and also provides life, dental, pharmacy, utilization management and disability coverage to a variety of employer groups. The GBO has historically experienced a higher administrative expense ratio than the Company's traditional California business due to the GBO's higher percentage of management services business. The higher administrative expense ratio of the GBO has contributed and may continue to contribute to an increase in the Company's overall administrative expense ratio in current and future periods.
The Company expects to incur approximately $21 to $25 million of costs relating to the GBO acquisition during 1998, a portion of which is expected to be reflected in the Company's results of operations. At the time that the GBO Acquisition was consummated, the Company expected that it would experience material membership attrition of up to 30% as it integrated the GBO operations and implemented its strategy of motivating traditional indemnity insurance members to select managed care products through, among other things, product design and premium increases. Premium increases implemented in the second and third quarters of 1997 did not result in the expected membership attrition. The Company is currently unable to determine if and to what extent the Company may experience additional membership attrition as it continues to integrate this acquired business.
On March 31, 1996, the Company acquired the Life and Health Benefits Management Division ("MMHD") of Massachusetts Mutual Life Insurance Company (the "MMHD Acquisition"). The acquired MMHD operations focus on employers with 250 to 5,000 employees and provide administrative services, PPO and indemnity insurance products. The Company has experienced membership attrition of approximately 18% through December 31, 1997 on acquired membership, a portion of which is the result of recently instituted premium increases with respect to certain accounts. The Company expects that it will experience some level of further membership attrition of its acquired MMHD members as it pursues its strategy of motivating members to select managed care products.
On May 20, 1996, the Company completed the Recapitalization, including the acquisition of the commercial operations of BCC (the "BCC Commercial Operations") for $235.0 million in cash. The Recapitalization included the payment of a $995.0 million special dividend funded by $775.0 million in revolving debt and the remainder in cash (see Note 2 to the Consolidated Financial Statements for a description of the Recapitalization).
As a result of the GBO and MMHD acquisitions, the Company has significantly expanded its operations outside of California. In order to implement the Company's regional expansion strategy, the Company will need to continue its development of satisfactory provider and sales networks and successfully convert these books of business to the Company's existing information systems, which will require additional expenditures by the Company.
The Company has begun to assemble survey data from health care providers, health care transaction clearing houses, employers, agents and brokers and other parties with which it communicates electronically to determine the compliance efforts being undertaken by these parties and to assess WellPoint's potential business exposure to any non-compliant systems operated by these parties. Although the Company is implementing programs and procedures designed to mitigate the aforementioned risks, there can be no assurances that all potential problems may be mitigated by these procedures.
(b) Membership as of December 31, 1997 includes the acquired GBO medical membership (approximately 1.3 million members as of the date of acquisition).
Investment income increased $73.3 million to $215.3 million for the year ended December 31, 1997, compared to $142.0 million for the year ended December 31, 1996. Net realized gains from equity securities increased $45.5 million to $62.0 million for the year ended December 31, 1997 in comparison to $16.5 million for the year ended December 31, 1996. The year ended December 31, 1997 included a gain of $30.3 million related to the stock-for-stock exchange of the Company's interest in Health Partners, Inc. ("HPI"), a physician practice management company, for the common stock of FPA Medical Management, Inc. ("FPA") as a result of HPI's October 1997 merger with FPA. See Note 4 to the Notes to Consolidated Financial Statements. Net interest and dividend income increased $25.9 million to $153.4 million for the year ended December 31, 1997 in comparison to $127.5 million for the year ended December 31, 1996, primarily due to increased interest income on the investment portfolios of GBO and MMHD acquired businesses and slightly higher yields in 1997 over 1996, partially offset by the foregone interest from cash and investments used to finance the GBO, MMHD and BCC Commercial Operations acquisitions, the Recapitalization and cash used for repayment of indebtedness under the Company's senior credit facility.
Health care services and other benefits expense increased 41.4%, or $1,242.2 million, to $4,245.3 million for the year ended December 31, 1997 from $3,003.1 million for the year ended December 31,
1996. The acquisition of the GBO accounted for 32.9% of the increase, or $408.2 million. The inclusion of MMHD and the BCC Commercial Operations for a full twelve months in 1997 accounted for an aggregate of 22.0% of the increase and resulted in increased health care expense of $133.9 million and $139.1 million, respectively. Additionally, the Company's health care benefits and other expenses for the year ended December 31, 1997 increased in comparison to the prior year as a result of the aforementioned increase in insured member months of 12.9%.
General and administrative expense for the year ended December 31, 1997 increased 56.2%, or $307.1 million, to $853.1 million from $546.0 million for the same period in 1996. The increase was primarily due to $196.9 million of general and administrative expense related to the Company's acquisition of the GBO in 1997 and $46.0 million and $8.0 million, respectively, of incremental increase in general and administrative expense related to the Company's acquisitions of MMHD and the BCC Commercial Operations in 1996.
Interest expense increased for the year ended December 31, 1997 to $36.7 million, from $36.6 million for the year ended December 31, 1996. The increase is primarily due to interest on debt incurred as a result of the Recapitalization in May 1996 being included in the results of operations for the entire year
ended December 31, 1997 in comparison to a shorter period of time in the year ended December 31, 1996, partially offset by debt repayments during 1997. The weighted average interest rate for all debt for the year ended December 31, 1997, including the fees associated with the borrowings and interest rate swaps, was 7.45%. See "--Liquidity and Capital Resources."
The Company's net income for the year ended December 31, 1997 was $227.4 million, compared to $202.0 million for the year ended December 31, 1996. Earnings per share totaled $3.30 and $3.04 for the years ended December 31, 1997 and 1996, respectively. Earnings per share assuming full dilution totaled $3.27 and $3.04 for the years ended December 31, 1997 and 1996, respectively. Earnings per share for the year ended December 31, 1997 included nonrecurring costs of $0.13 per share. Earnings per share for all periods presented has been calculated in accordance with Statement of Financial Accounting Standards No. 128, Earnings Per Share ("SFAS No. 128").
Investment income increased to $142.0 million for the year ended December 31, 1996 compared to $135.3 million for the year ended December 31, 1995. Interest and dividend income increased to $127.5 million in 1996 from $122.1 million in 1995. The increase in interest and dividend income was primarily due to MMHD interest income of $21.6 million and slightly higher yields in 1996 over 1995, offset by the foregone interest earned on cash and investments used to finance the MMHD and BCC Commercial Operations acquisitions, the Recapitalization, and cash used for repayment of indebtedness under the Company's senior credit facility.
The loss ratio for 1996 increased to 77.4% compared to 75.6% in 1995 due to the PPO benefits changes described above, an increase in the loss and loss adjustment expense reserves related to a portion of the Company's workers' compensation business and the incremental effect of the MMHD Acquisition and the BCC Commercial Operations on the Company's overall results. The acquired MMHD operations and the BCC Commercial Operations have traditionally experienced a higher loss ratio than the Company. The increase in the loss ratio was partially offset by the Company's continuing cost containment efforts, such as the hospital recontracting program. Excluding the Company's workers' compensation business and the acquisitions of the MMHD operations and the BCC Commercial Operations, the loss ratio would have been 74.7% for the year ended December 31, 1996. The loss ratio for 1995, also excluding the workers' compensation business, was 75.2%.
Interest expense was $36.6 million for the year ended December 31, 1996. The Company had no interest expense in 1995. The interest expense in 1996 related primarily to $775.0 million drawn under the Company's revolving credit facility on May 15, 1996 to fund a special dividend paid in connection with the Recapitalization, as well as interest on amounts payable to MassMutual, including a Series A term note of $62.0 million issued in connection with the MMHD Acquisition. At December 31, 1996, the Company's outstanding long-term indebtedness was $625.0 million. The weighted average interest rate for all debt for the year ended December 31, 1996 was 5.9%.
The Company's net income for the year ended December 31, 1996 was $202.0 million or $3.04 per share compared to $180.0 million or $2.71 per share for the year ended December 31, 1995. Earnings per share for the years ended December 31, 1996 and 1995 are based on 66.4 million shares, the number of shares outstanding immediately following the Recapitalization, plus the weighted average number of shares issued in 1996 subsequent to the Recapitalization. The number of shares outstanding prior to the Recapitalization were adjusted to reflect the two-for-three share exchange that occurred in connection with the Recapitalization. Earnings per share is determined by dividing net income by the weighted
The Company's consolidated assets increased by $1,127.9 million from $3,405.5 million as of December 31, 1996 to $4,533.4 million as of December 31, 1997. This represents a 33.1% increase and resulted primarily from the GBO acquisition as well as cash flows generated from operations. Cash and investments were $2,939.4 million as of December 31, 1997, or 64.8% of total assets.
Equity totaled $1,223.2 million as of December 31, 1997, an increase of $352.7 million from $870.5 million as of December 31, 1996. The increase resulted primarily from the net income of $227.4 million for the year ended December 31, 1997, $110.3 million and $9.9 million in additional paid-in capital from the Company's public offering of three million shares of common stock and stock issuances under the Company's stock option and stock purchase plans, respectively, and $4.9 million change in net unrealized valuation adjustments on investment securities, net of tax.
As part of a hedging strategy to limit exposure to interest rate increases, in August 1996 the Company entered into a swap agreement for a notional amount of $100.0 million bearing a fixed interest rate of 6.45% and having a maturity date of August 17, 1999. In September 1996, the Company entered into two additional swap agreements for notional amounts of $150.0 million each, bearing fixed interest rates of 6.99% and 7.05%, respectively, and having maturity dates of October 17, 2003 and October 17, 2006, respectively.
Certain of the Company's subsidiaries are required to maintain minimum capital requirements prescribed by various regulatory agencies, including the California Department of Corporations and the Department of Insurance in various states. As of December 31, 1997, those subsidiaries of the Company were in compliance with all minimum capital requirements.
In July 1996, the Company filed a registration statement relating to the issuance of $1.0 billion of senior or subordinated unsecured indebtedness. As of December 31, 1997, no indebtedness had been issued pursuant to this registration statement.
The Company believes that cash flow generated by operations, its cash and investment balances, supplemented by the Company's ability to borrow under its existing revolving credit facility or to conduct a
The Company is presently assessing the presentation and effect of SFAS Nos. 130, 131 and 132 on the financial statements of the Company.
Certain statements contained herein, such as statements concerning potential or future loss ratios, expected membership attrition as the Company continues to integrate its recently acquired operations and other statements regarding matters that are not historical facts, are forward-looking statements (as such term is defined in the Securities Exchange Act of 1934). Such statements involve a number of risks and uncertainties that may cause actual results to differ from those projected. Factors that can cause actual results to differ materially include, but are not limited to, those discussed below and those discussed from time to time in the Company's various filings with the Securities and Exchange Commission. See also "Item 1. Business--Factors That May Affect Future Results of Operations."
As part of the Company's business strategy, the Company has recently acquired substantial operations in new geographic markets. These businesses, which include substantial indemnity-based insurance operations, have experienced varying profitability or losses in recent periods. During 1997, the Company worked extensively on the integration of these businesses, which will be continuing in 1998; however, there can be no assurances regarding the ultimate success of the Company's integration efforts or regarding the ability of the Company to maintain or improve the results of operations of these businesses as the Company pursues its strategy of motivating the acquired members to select managed care products. In order to implement this strategy, the Company has and will, among other things, need to continue to incur considerable expenditures for provider networks and information systems in addition to the costs associated with the integration of these acquisitions. The integration of these complex businesses may result in, among other things, temporary increases in claims inventory or other service-related issues. The Company's results of operations could be adversely affected in the event that the Company experiences such problems or is otherwise unable to implement fully its expansion strategy.
Substantially all of the Company's investment assets are in yielding securities of varying maturities. The value of such securities are highly sensitive to fluctuations in short-and long-term interest rates, with the value decreasing as such rates increase or increasing as such rates decrease. Changes in the value of the Company's investment assets, as a result of interest rate fluctuations, can impact the Company's total assets and stockholders' equity and can also result in gains or losses which impact the Company's results of operations. There can be no assurance that interest rate fluctuations will not have a material adverse affect on the results of operations or financial condition of the Company.
The location in this Form 10-K of the Company's Consolidated Financial Statements is set forth in the "Index" on page 45 hereof.
SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED) IN THOUSANDS, EXCEPT PER SHARE DATA AND MEMBERSHIP DATA
(C) Per share data for all periods presented prior to the quarter ended June 30, 1996 has been recomputed using 66,366,500 shares, the number of shares outstanding immediately following completion of the Recapitalization. Per share data for the quarters ended June 30, September 30 and December 31, 1996 has been calculated using such 66,366,500 shares, plus the weighted average number of shares issued subsequent to the Recapitalization.