As of December 31, 2001, we leased approximately 114,000 aggregate square feet of space for our principal corporate headquarters and executive offices in Costa Mesa and Santa Ana, California. In connection with our operations, as of December 31, 2001, we leased approximately 2.0 million aggregate square feet for office space, subsidiary operations, customer service centers and space for computer facilities. Such space corresponds to areas in which our HMOs or specialty managed care products and services operate, or where we have satellite administrative offices. Our leases expire at various dates from 2002 through 2011.
We own six buildings encompassing approximately 328,000 aggregate square feet of space. Two of the buildings, representing approximately 225,000 aggregate square feet of space, are primarily used for administrative operations and are located in California and Guam. The remaining four buildings are medical office buildings, all of which are leased to third parties under a master lease agreement. All four medical buildings are being marketed for sale. We also own one parcel of vacant land for a total of two acres, which is being marketed for sale.
Overview. We sell managed care and other health insurance products to employer groups and Medicare beneficiaries in eight Western states and Guam. We also offer a variety of specialty products and services that employers can purchase to supplement our basic commercial plans, or as stand-alone products. These specialty products include pharmacy benefit management, behavioral health services, life and health insurance and dental and vision services.
Events significant to our business and actual or future operating results that occurred in 2001 and to date have included the following:
In January 2002, we announced a 10-year 	outsourcing arrangement with International Business Machines, or 	IBM, and Keane, Inc., or Keane, which we have estimated will 	result in approximately $380 to $400 million in savings 	over 10 years. IBM will provide information technology, or 	IT, services and day-to-day management of our IT infrastructure, 	including data center operations, support services and 	information distribution, while Keane will provide software 	applications maintenance and enhancement services. See 	Note 5 of the Notes to Consolidated Financial Statements.
In August 2001, we executed an amendment to our 	existing senior credit facility with our lenders to extend its 	maturity date. The amended and restated credit facility matures 	on January 2, 2003, and
Effective May 1, 2001, we withdrew our 	commercial HMO and point-of-service, or POS, products from 	15 Colorado counties. This withdrawal affected 	approximately 25,000 commercial HMO and POS members. We 	retained our commercial HMO products in other Colorado counties 	where the vast majority of our members reside. Qualified 	employers may apply for our preferred provider organization, or 	PPO, which is not affected by this service area change.
Generally, since the Balanced Budget Act of 1997 went into effect, annual premium increases for Medicare+Choice members have not kept pace with increases in the costs of health care. CMS recently announced that federal payments to Medicare+Choice managed care organizations are projected to increase only 2%, the guaranteed minimum required by law, in calendar year 2003. Such shortfalls in Medicare+Choice premiums compared to our health care service expenses in some of our operating areas contributed to our decision to cease offering, close enrollment, or obtain capacity limits in our Medicare+Choice plans in various counties in 2002, 2001 and 2000. These premium trends also contributed to changes in our benefits, copayments and deductibles. The following table provides information on the number of counties where we did offer or currently offer our Medicare+Choice plans for new member enrollment as of the dates indicated. Additionally, it provides information on the number of counties for which we contracted with CMS to offer our Medicare+Choice plans, as of the beginning of each calendar year indicated.
Other Income. Other income consists of revenue we receive from administrative services we offer through our specialty products and services companies. For example, PacifiCare Life and Health Insurance is paid
care costs that we did not fully anticipate in our pricing and underwriting decisions when we designed and priced our products for 2001 and 2000. In 2002, we expect this trend to continue, but at a slower pace. We expect commercial hospital risk-based contracts to cover approximately 56% of our membership and commercial physician risk-based contracts to cover approximately 23% of our membership by December 31, 2002. We expect Medicare hospital risk-based contracts to cover approximately 46% of our membership and Medicare physician risk-based contracts to cover approximately 25% of our membership by December 31, 2002.
Pharmacy benefit management PacifiCare HMO 	membership represents members that are in our commercial or 	Medicare HMO. All of these members either have a prescription 	drug benefit or are able to purchase their prescriptions 	utilizing our retail network contracts or our mail service.
Dental and behavioral health PacifiCare HMO 	membership represents members that are in our commercial HMO 	that are also enrolled in our dental or behavioral health plan.
During 2002, we expect commercial HMO membership to decline by approximately 150,000, primarily due to exits of unprofitable markets and products, and stricter underwriting standards.
Decrease of 1,800 members in Texas due to member 	disenrollments in anticipation of reduced benefits that were 	effective January 1, 2002; partially offset by an
Increase of 1,500 members in Arizona primarily 	due to competitor exits in areas where Secure Horizons remained.
During 2002, we expect Medicare HMO membership to decline by approximately 130,000 primarily due to county exits, increased premiums and benefit reductions.
PacifiCare behavioral health HMO membership at December 31, 2001 decreased approximately 10% compared to the prior year primarily due membership losses in Arizona, Colorado and Texas. Behavioral health unaffiliated membership at December 31, 2001 increased approximately 13% compared to prior year primarily due to additional membership in Oregon.
Net Investment Income. Net investment income increased approximately 3% to $111 million for the year ended December 31, 2001 compared to the prior year primarily due to higher overall net realized gains compared to the prior year.
Consolidated Medical Loss Ratio. The consolidated medical loss ratio (health care services as a percentage of premium revenue) changed for the year ended December 31, 2001 compared to the prior year as follows:
Commercial Medical Loss Ratio. The commercial medical loss ratio includes results from our specialty HMO and indemnity insurance operations. The commercial medical loss ratio for the year ended December 31, 2001 increased compared to the prior year due to:
Higher inpatient, physician, outpatient and out 	of area service utilization under fee-for-service or risk-based 	contracts; partially offset by
Medicare Medical Loss Ratio. The Medicare medical loss ratio increased for the year ended December 31, 2001 compared to the prior year due to:
Premium rate increases including the Benefits 	Improvement and Protection Act of 2000 (effective March 1, 	2001), and supplemental member premiums.
For the year ended December 31, 2001, our increases in Medicare health care costs slightly outpaced premium rate increases. At our Texas HMO more members accessed more services, at a higher cost, from providers with whom we have shared-risk, rather than capitation contracts. Additionally, our Texas HMO experienced increased health care costs because we paid hospitals and doctors for expenses that were otherwise the obligations of our contracted providers and for which we previously paid capitation. See Note 10 of the Notes to Consolidated Financial Statements. Substantial premium rate increases at our Colorado HMO and Washington HMO partially offset increased health care costs. In 2002, we expect our Medicare medical loss ratio to be in the range of 89% to 90%, based on current CMS reimbursement levels. We expect the slight decrease to result from benefit reductions, and the positive effect on utilization of our medical and disease management investments.
Selling, general and administrative expenses as a 	percentage of operating revenue (excluding net investment income)
Impairment, Disposition, Restructuring, OPM and Other Charges (Credits). We recognized net pretax charges of $61 million ($39 million or $1.13 diluted loss per share, net of tax) for the year ended December 31, 2001. See Note 9 of the Notes to Consolidated Financial Statements.
Operating Income. Operating income decreased 65% to $127 million for the year ended December 31, 2001, compared to the prior year. Factors contributing to the change are discussed above.
Reconciliation of Reported Results to Pro Forma Results. In our fourth quarter 2001 earnings announcement, we disclosed pro forma results as described in the following table. See Note 9 of the Notes to Consolidated Financial Statements.
Membership. Total HMO membership increased approximately 10%, to 4.0 million members at December 31, 2000 from approximately 3.7 million members at December 31, 1999. Our total HMO membership excludes employer self-funded and PPO, indemnity and Medicare supplement members.
Commercial HMO membership increased approximately 12% at December 31, 2000 compared to the prior year due to:
PacifiCare dental HMO membership as of December 31, 2000 decreased approximately 4% compared to the prior year primarily due to membership losses in California and Colorado. Dental unaffiliated membership as of December 31, 2000 decreased approximately 10% compared to the prior year due to membership losses in California.
Consolidated Medical Loss Ratio. The consolidated medical loss ratio (health care services as a percentage of premium revenue) changed for the year ended December 31, 2000 compared to the prior year as follows:
Commercial Medical Loss Ratio. The commercial medical loss ratio includes results from our specialty HMO and indemnity insurance operations. The commercial medical loss ratio for the year ended December 31, 2000 increased compared to the prior year due to:
Higher physician, inpatient, outpatient and 	emergency service utilization under fee-for-service or 	risk-based contracts; and
Medicare Medical Loss Ratio. The Medicare medical loss ratio increased for the year ended December 31, 2000 compared to the prior year due to:
Premium rate increases, which include Medicare 	rates and supplemental member premiums.
Interest Expense. Interest expense increased approximately 85% to $80 million for the year ended December 31, 2000 compared to the prior year due to:
Increased borrowings on our credit facility to 	fund our share repurchase program; and
Higher short-term interest rates combined with a 	higher interest fee structure in the credit facility agreement.
Provision for Income Taxes. The effective income tax rate was 44.1% for the year ended December 31, 2000, compared with 42.2% in 1999. Because of lower 2000 earnings, the non-deductible goodwill amortization expense is a higher percentage of pretax income, increasing our 2000 effective tax rate.
Operating Cash Flows. Our consolidated cash, equivalents and marketable securities decreased $76 million or 4% to $2.0 billion at December 31, 2001, from $2.1 billion at December 31, 2000.
Investing Activities. For the year ended December 31, 2001, we used $261 million for investing activities compared to $72 million provided during the year ended December 31, 2000. We purchased $208 million of marketable securities in 2001 to obtain longer-duration securities with higher yields during a period of falling interest rates, compared to $170 million of marketable securities sold in the prior year to provide cash to fund the Harris acquisition and share repurchases.
We paid a net $30 million on our credit 	facility in 2001 compared to a net $138 million in 2000;
We paid a total of $13 million in amendment 	fees and expenses in 2001 in connection with the extension of 	our credit facility;
We paid $9 million to three minority 	stockholders for all outstanding stock of our consolidated 	minority subsidiary compared to $8 million received from 	one minority stockholder that invested in our consolidated 	minority subsidiary in 2000. See Note 2 of the Notes to 	Consolidated Financial Statements.
In August 2001, we executed an amendment to our existing senior credit facility with our lenders to extend its maturity date. The amended and restated credit facility provided for a $650 million term loan and a $150 million revolving line of credit, and will mature on January 2, 2003. As of December 31, 2001, there was $705 million outstanding under the credit facility, including the $650 million term loan and $55 million under the revolving line of credit. Included in the amount outstanding as of December 31, 2001 under the revolving line of credit are letters of credit equal to $29 million, which left us with $66 million for additional borrowing under the revolving line of credit as of that date. On January 2, 2002, we paid and permanently retired $25 million of the outstanding balance on our term loan with proceeds we received from computer equipment sold to IBM.
The interest rates per annum applicable to amounts outstanding under the term loan and revolving line of credit are, at our option, either the administrative agent’s publicly announced “prime rate” (or, if greater, the Federal Funds Rate plus 0.5%) plus a margin of 2.5% per annum, or the rate of Eurodollar borrowings for the applicable interest period plus a margin of 3.5% per annum. These margins will increase by 1% per annum if we do not permanently pay down the term loan by at least $250 million by March 31, 2002. We do not intend to pay down the term loan to avoid this margin increase. Based on our outstanding balance under the credit facility at December 31, 2001, our average overall interest rate, excluding the facility fee, was 5.7% per annum.
We also have $88 million in senior notes outstanding that we assumed when we acquired FHP in 1997. These notes mature on September 15, 2003, and bear interest at 7% payable semiannually. In September 2001, we retired $12 million of the FHP senior notes by exchanging approximately 0.8 million shares of common stock for those notes. We reissued treasury stock to provide the common stock used in the exchange. The note retirements resulted in a pretax extraordinary gain of $2 million ($0.9 million or $0.02 diluted earnings per share, net of tax), and a net equity increase of $10 million. The FHP notes share in the security granted under our amended and restated credit facility.
In December 2001, we entered into an arrangement with Acqua Wellington North American Equities Fund Ltd., or Acqua Wellington, an institutional investor, for the purchase by Acqua Wellington of up to 6.9 million shares or $150 million in our common stock. We have the ability to call the equity commitment for an 18-month period beginning December 26, 2001, the effective date of our registration
statement relating to the equity commitment, at a price per share equal to the daily volume weighted average price of our common stock on each of the 18 consecutive trading days in a draw down period that the weighted average price is above the threshold price we determine for the applicable draw down, less a discount ranging from 3.2% to 4.7% that is based on the threshold price. We have the sole discretion to present up to 15 draw down notices to Acqua Wellington. Each draw down notice sets the threshold price and the dollar value of shares Acqua Wellington may be obligated to purchase during a draw down period. The threshold price we choose cannot be less than $11.00 per share. The threshold price we select determines the maximum dollar value of shares and the discount to the market price based upon a predetermined schedule. As funds are drawn, proceeds will be used to reduce our outstanding bank term debt.
We expect to fund our working capital requirements and capital expenditures during the next twelve months from our cash flow from operations. We have taken a number steps to increase our cash flow from operations, including premium increases, increased marketing for specialty product lines and the introduction of new products as well as exits from unprofitable markets and cost savings initiatives, including our restructuring announced in December 2001 and our outsourcing of our IT infrastructure and software maintenance. If our cash flows are less than we expect due to one or more of the risk factors described in “Forward-Looking Statements,” or our cash flow requirements increase for reasons we do not currently foresee, then we may need to draw down our remaining available funds ($66 million as of December 31, 2001) on our senior revolving credit facility which matures in January 2003. A failure to comply with any covenant in the senior credit facility could make these funds unavailable. We also may be required to take additional actions to reduce our cash flow requirements, including the deferral of planned investments aimed at reducing our selling, general and administrative expenses. The deferral or cancellation of any investments could have a material adverse impact on our ability to meet our short-term business objectives.
In addition, we do not expect to retire our senior credit facility from internally generated cash flows prior to its maturity in January 2003. Accordingly, we will seek to extend or refinance all or a portion of the senior credit facility. In addition, we may also seek to refinance the $88 million in senior notes that mature in September 2003. In late 2000, during 2001 and to date, the agencies that assign ratings to our long-term debt have downgraded our credit ratings. As of March 2002, Moody’s rating of our long-term debt was B2, with a negative outlook, Standard and Poors’ rating was BB- with a stable outlook and Fitch IBCA’s rating was BB- with an evolving outlook. Because we no longer qualify for an investment grade rating, our ability to refinance our debt in capital markets is limited to non-investment grade debt and equity or equity-linked instruments. We may not be able to refinance all or any portion of this debt or do so on terms favorable to us. We may need to draw upon our $150 million equity line of credit and/or raise additional capital to retire a portion of our debt, and additional capital may not be available on terms favorable to us. Any issuance of equity or equity-linked securities may result in substantial dilution to our stockholders.
$17 million decrease in provider 	receivables, primarily due to a reduction in provider incentive 	and capitation receivables; partially offset by
$4 million increase in other receivables, 	due primarily to the timing of interest income.
Long-Term Debt and Stockholders’ Equity. In September 2001, we retired $12 million of the FHP senior notes by exchanging approximately 0.8 million shares of common stock for those notes. We reissued treasury stock to provide the common stock used in the exchange. The retirements resulted in a pretax extraordinary gain of $2 million ($0.9 million or $0.02 diluted earnings per share, net of tax), and a net equity increase of $10 million. See Note 5 of the Notes to Consolidated Financial Statements.
New Accounting Pronouncements. See Note 2 of the Notes to Consolidated Financial Statements for a discussion of future application of accounting standards.
Incurred But Not Reported or Paid Claims Reserves. We estimate the amount of our reserves for incurred but not reported or not paid, or IBNR, claims submitted under our risk-based provider contracts, primarily using standard actuarial methodologies based on historical data. These standard actuarial methodologies include, among other factors, the average interval between the date services are rendered and the date claims are received and/or paid, denied claims activity, expected health care cost inflation, utilization, seasonality patterns and changes in membership. The estimates for submitted claims and IBNR are made on an accrual basis and adjusted, based on actual claims data, in future periods as required. For new products, such as our PPO products, estimates are initially based on health care cost data provided by third parties. This data includes assumptions for member age, gender and geography. The models that we use to prepare estimates for each product are adjusted as we accumulate actual claims data. Such estimates could materially understate or overstate our actual liability for medical claims and benefits payable. In addition, if our claims processing system is unable to handle increased claims volume, the data we use for our IBNR estimates could be incomplete and our ability to estimate claims liabilities and establish adequate reserves could be adversely affected.
Provider Insolvency Reserves. We maintain insolvency reserves with respect to our capitated contracts with providers that include estimates for potentially insolvent providers, where conditions indicate claims are not being paid or have slowed considerably. These insolvency reserves include write-offs of certain uncollectable receivables from providers and the estimated cost of unpaid health care claims that were previously the responsibility of the capitated provider. Depending on states’ laws, we may be held liable for unpaid health care claims that were previously the responsibility of the capitated provider and for which we have already paid capitation. Such estimates could materially understate or overstate our actual liability for medical claims and benefits payable.
For further discussion of risk factors associated with these accounting estimates, read “Forward Looking Statements - Risk Factors.”
Some of the statements contained in this report are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or Exchange Act, and are subject to the safe harbor created by the Securities Litigation Reform Act of 1995. These forward-looking statements relate to future events or our future financial and/or operating performance and can generally be identified as such because the context of the statement will include words such as “may,” “will,” “intends,” “plans,” “believes,” “anticipates,” “expects,” “estimates,” “predicts,” “potential,” “continue,” or “opportunity,” the negative of these words or words of similar import. Similarly, statements that describe our reserves and our future plans, strategies, intentions, expectations, objectives, goals or prospects are also forward-looking statements. These forward-looking statements are based largely on our expectations and projections about future events and future trends affecting our business, and so are subject to risks and uncertainties, including the risks and uncertainties set forth under “Risk Factors,” that could cause actual results to differ materially from those anticipated as of the date of this report. In addition, past financial and/or operating performance is not necessarily a reliable indicator of future performance and you should not use our historical performance to anticipate results or future period trends. In evaluating these statements, you should specifically consider the risks described below and in other parts of this report.
Of our commercial business, more than 50% of our membership renews on January 1 of each year, with premiums that are generally fixed for a one-year period. In addition, each of our subsidiaries that offers Medicare+Choice products must submit adjusted community rate proposals, generally by county or service area, to CMS by July 1 for each such product that will be offered in a subsequent year. As a result, increases in the costs of health care services in excess of the estimated future health care costs reflected in the premiums or the adjusted community rate proposals generally cannot be recovered in the applicable contract year through higher premiums or benefit designs. Many factors, including health care costs that rise faster than premium increases, increases in utilization and regulatory changes, could cause actual health care costs to exceed what was estimated and reflected in premiums. To the extent that such excesses occur, our results of operations will be adversely affected.
If we do not continue to enhance our underwriting capabilities, our abilities to appropriately price our commercial products in light of the risk we assume and assess the profitability of our different markets could be materially and adversely affected.
Our financial and operating performance could be adversely affected by a reduction in revenue caused by membership losses or lower-than-expected premiums.
We expect our revenues to decline approximately 6%, or approximately $700 million during 2002, compared to 2001 revenues. We expect to lose approximately 150,000 commercial members and 130,000 Medicare members during 2002, primarily as a result of our exits of unprofitable markets and products and increased premiums and benefit reductions, and we expect our membership declines to more than offset our premium increases. A loss of profitable membership, an inability to increase commercial membership in targeted markets, including unaffiliated membership in our PBM and other specialty businesses, including our PPO and Medicare supplement products, an inability to gain market acceptance and expected membership in new product lines, including our PPO and Medicare supplement products, or an inability to achieve expected premium increases could negatively affect our financial position, results of operations or cash flows. Factors that could contribute to the loss of membership, failure to gain new members in targeted markets or new product lines, or lower premiums include:
the inability of our marketing and sales plans to 	attract new customers or retain existing customers for existing 	products and new products;
Our profitability has been adversely affected, and will continue to be significantly impacted, by our ability to control our health care costs under risk-based contracts.
We have experienced a significant increase in our health care costs as a greater proportion of our membership was covered through risk-based hospital and physician contracts. For percentages of membership by contract type, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations, Expenses - Commercial and Medicare Health Care Services.” We expect this shift to risk-based contracts to continue, primarily as a result of planned transitions in Arizona, California, Oklahoma and Texas. To the extent that we have entered into and may continue to increasingly enter into risk-based contracts with hospitals and physicians, our ability to control our health care costs and profitability will increasingly depend on our ability to accurately predict member utilization of health care services and claims costs, and proportionately less on our ability to control health care costs under capitated contracts. Our inability to control health care costs under risk-based contracts could have a material adverse effect on our financial condition and results of operations.
Under risk-based contracts, we risk incurring higher than expected health care costs due to increased utilization of hospital and physician services. To reduce the risk of higher than medically warranted utilization, we have developed medical management programs to manage health care costs, and are investing in the development of systems to monitor and manage the utilization of health care services, while maintaining quality of care, and renegotiating provider contracts to reduce costs. Our consolidated medical loss ratio could continue to increase if our programs for controlling utilization are not successful and we are not able to increase premiums appropriately to offset the cost of such utilization increases.
In 2001, the Texas legislature adopted changes to legislation that may affect contracts that our Texas subsidiary enters into or renews with its delegated network providers after January 1, 2002. State regulators may take the position that this legislation provides that HMOs are liable for paying individual provider claims that are otherwise the financial responsibility of the capitated physician group if the HMO does not
comply with the oversight requirements of the legislation. See “Item 3. Legal Proceedings, State of Texas Litigation.” We cannot predict whether the financial condition of our Texas providers will continue to deteriorate. To the extent that we do not accurately estimate the timing, amount or outcome of claims asserted against us based on providers with whom we have capitated contracts and who become insolvent, our results of operations or cash flows for a future period could be materially and adversely affected.
We estimate the amount of our reserves for IBNR claims primarily using standard actuarial methodologies based upon historical data. These standard actuarial methodologies include, among other factors, the average interval between the date services are rendered and the date claims are received and/or paid, denied claims activity, expected health care cost inflation, utilization, seasonality patterns and changes in membership. The estimates for submitted claims and IBNR are made on an accrual basis and adjusted in future periods as required. Such estimates could understate or overstate our actual liability for claims and benefits payable. Any increases to such prior estimates could adversely affect our results of operations in future periods.
our need for additional investments in medical 	management, underwriting and actuarial resources and technology;
the necessity to comply with regulatory 	requirements, including the Health Insurance Portability and 	Accountability Act of 1996, or HIPAA;
our ability to estimate costs for our retention 	for medical malpractice claims; and
our inability to achieve efficiency goals and 	resulting cost savings from announced restructuring or other 	initiatives.
In addition, our selling, general and administrative expenses as a percentage of our revenue could increase due to changes in our product mix between Medicare and commercial products and expected declines in our revenue, and could be adversely affected if we exit Medicare+Choice markets without replacing our revenue from those markets with revenue from other sources, such as our new Medicare supplement product offerings. If we do not generate expected cash flow from operations, we could be forced to postpone or cancel some of these planned investments, which would adversely affect our ability to meet our short term strategic plan.
We may not accurately estimate the amounts we will need to spend to comply with HIPAA, which may adversely affect our ability to execute portions of our business strategy or our expenses.
We are subject to several lawsuits brought by health care providers and members alleging that we engage in a number of improper practices. Depending upon their outcome, these lawsuits could result in material liabilities to us or cause us to incur material costs, to change our operating procedures or comply with increased regulatory requirements.
lawsuits brought by health care providers allege that HMOs’ claims processing systems automatically and impermissibly alter codes included on providers’ reimbursement/claims forms to reduce the amount of reimbursement, and that HMOs impose unfair contracting terms on health care providers, impermissibly delay making capitated payments under their capitated contracts, and negotiate capitation payments that are inadequate to cover the costs of health care services provided. The lawsuits brought by members allege that HMOs engage in a number of purportedly undisclosed practices designed to limit the amount and cost of health care services provided to members. These alleged practices include:
making determinations that established procedures 	and treatments for certain diseases, illnesses or injuries are 	experimental or investigational and so not provided for under 	HMOs’ coverage.
Our adjusted community rate proposals for the contract year 2002 have been filed and approved. In the normal course of business, all information submitted as part of the adjusted community rate process is subject to audit and approval. We cannot be certain that any ongoing and future audits will be concluded satisfactorily. We may incur additional, possibly material, liability as a result of these audits. The incurrence of such liability could have a material adverse effect on our financial position, results of operations or cash flows.
Recently enacted or proposed legislation, regulations and initiatives could materially and adversely affect our business by increasing our operating costs, reducing our membership or subjecting us to additional litigation.
proposed legislation to provide payment and 	administrative relief for the Medicare+Choice program and 	regulate drug pricing by the state and federal government could 	include provisions that impact our Medicare+Choice products;
new and proposed “patients’ bill of 	rights” legislation at the state level that would hold HMOs 	liable for medical malpractice, including legislation enacted in 	Arizona, California, Oklahoma, Texas and Washington, may 	increase the likelihood of lawsuits against HMOs for malpractice 	liability. The proposed federal “patients’ bill of 	rights” has passed both the Senate and the House of 	Representatives but conference action is still pending at this 	time. This legislation would remove or limit the federal 	preemption set forth in the Employee Retirement Income Security 	Act of 1974, or ERISA, that precludes most individuals from 	suing their employer-sponsored health benefit plans for causes 	of action based upon state law and enable members to challenge 	coverage/ benefits decisions in state and federal courts;
new and increased initiatives at the DOJ, the OIG 	of the DHHS, the OIG and the various enforcement divisions of 	the state regulatory agencies governing health care programs 	that pursue both civil and criminal investigations against 	physicians, hospitals, payers, and pharmaceutical companies for 	misconduct relating to potential health care fraud and abuse, 	false claims, ERISA violations, violations of the Medicare 	program, overbilling of government programs, incorrect reporting 	of data, and improper denial or mismanagement of care;
existing state legislation and regulation that 	may require increases in minimum capital, reserves, and other 	financial liability requirements and proposed state legislation 	that may limit the admissibility of certain assets;
During 2002, we will perform the first of the required goodwill impairment tests as of January 1, 2002. The tests for measuring goodwill impairment under SFAS No. 142 are more stringent than the existing tests required by SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. Under SFAS No. 121, we applied an undiscounted cash flow model when assessing the possible impairment of our reporting units, which did not result in the recognition of goodwill impairment in 2001. Under SFAS No. 142, we will be required to use a fair value methodology when assessing the possible impairment of our reporting units, which will likely result in impairment charges. We will record such impairment charges as the cumulative effect of a change in accounting principle as of January 1, 2002. Impairment charges will have a material adverse effect on our financial position, but will not impact operating income or cash flows.
will rise to at least 11.5%, primarily as a result of $80 million that we expect to spend for IT investments, PBM expansion and a branding advertising campaign. We plan to fund these expenditures in part through savings that result from the restructuring program that we began in the fourth quarter of 2001. We expect EBITDA, defined as net income plus interest expense, provision for income taxes and depreciation and amortization expense, before impairment, disposition, restructuring and other charges (credits) and Office of Personnel Management credits, for 2002 to approximate $375 million. Due to the risks described above and throughout other parts of this report, particularly those relating to our membership and our ability to control health care costs, we may not achieve our expected operating results. Our results may also be impacted by other factors beyond our control, such as returns on our investment portfolio and interest rates on our senior credit facility.
We have a significant amount of indebtedness and it is approaching maturity, which could adversely affect our operations.
We will seek to extend or refinance, rather than retire, all or a portion of our amended and restated senior secured credit facility prior to its maturity on January 2, 2003. As of December 31, 2001, we had outstanding borrowings of $705 million under that facility. We may also seek to refinance $88 million of senior notes that we have outstanding prior to their maturity on September 15, 2003. In late 2000 and during 2001 and to date in 2002, the agencies that assign ratings to our long-term debt downgraded our credit ratings. Because we no longer qualify for an investment grade rating, we will only be able to refinance our debt in capital markets transactions by issuing non-investment grade debt or equity or equity-linked securities. Any non-investment grade debt securities that we issue to refinance our debt will likely carry interest rates that increase our already significant debt service requirements.
Our significant indebtedness and its approaching maturity poses risks to our business, including the risks that:
we will use a substantial portion of our 	consolidated cash flow from operations to pay principal and 	interest on our debt, thereby reducing the funds available for 	working capital, capital expenditures, acquisitions and other 	general corporate purposes, including executing our business 	strategy of diversifying our product offerings and making 	planned investments in our branding campaign, the marketing of 	our specialty products and technology initiatives for further 	streamlining our operations;
insufficient cash flow from operations may force 	us to sell assets, or seek additional capital, which we may be 	unable to do at all or on terms favorable to us;
our debt service obligations increase our 	vulnerabilities to competitive pressures, as many of our 	competitors are less leveraged than we are.
See “Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.”