Revenues and Earnings, Financial Position and per common share information set forth below for each year in the five-year period ended December 31, 2002, has been derived from the consolidated financial statements of the Company. The information below is qualified by reference to and should be read in conjunction with the audited consolidated financial statements and related notes and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included herein.
Defined as health care services expense as a percentage of premiums earned.
Defined as marketing, general and administrative expense as a percentage of operating revenues. Excludes litigation charge for estimated settlement, net, of $151.3 million in 2002.
The Company’s revenues consist primarily of commercial premiums derived from its HMO, POS and PPO plans. Revenues also include reimbursements under government contracts relating to its Medicare+Choice (“Medicare”) plans, third-party administration fee revenue for self-funded plans (which is stated net of direct expenses such as third-party reinsurance premiums) and investment and other income. Since the Company provides coverage under its insured and managed care products on a prepaid basis, with premium levels fixed for one-year periods, unexpected cost increases during the annual contract period cannot be passed on to employer groups or members.
Health care services expense primarily comprises payments to physicians, hospitals and other health care providers under fully insured health care business and includes an estimated amount for incurred but not reported or paid claims (“IBNR”). The Company estimates IBNR based on a number of factors, including prior claims experience. The ultimate payment of unpaid claims attributable to any period may be more or less than the amount of IBNR recorded. See “Liquidity and Capital Resources”.
The Company’s results of operations are dependent, in part, on its ability to predict and manage health care costs (through, among other things, benefit design, utilization review and case management programs, analytic tools, delegation, capitation, risk-transfer and other payment arrangements with providers or groups of providers or other parties including, without limitation, arrangements with vendors related to certain types of diagnostic testing, professional services and disease management and arrangements with hospitals and physician groups) while providing members with coverage for the health care benefits provided under their contracts. However, the Company’s ability to contain such costs may be adversely affected by various factors, including, but not limited to: changes in the historical patterns of health care utilization and/or unit costs generally and directly or indirectly related to the war on terrorism or the concerns of members or providers due to the threat of terrorism, new technologies and health care practices, hospital costs, changes in demographics and trends, expansion into new markets, changes in laws and regulations, mandated benefits or practices, selection biases, increases in unit costs paid to providers, termination of provider arrangements, termination of, or disputes under, delegation, capitation, or risk-transfer arrangements, major epidemics, catastrophes, acts of terrorism or war, inability to establish or maintain acceptable compensation agreements with providers or groups of providers, operational and regulatory issues which could delay, prevent or impede those arrangements, higher utilization of medical services, including, without limitation, higher out-of-network utilization, operational and regulatory issues and numerous other factors may affect the Company’s ability to control such costs. The Company attempts to use its medical cost-containment capabilities, such as claim auditing systems, with a view to reducing the rate of increase in health care service expense.
On March 1, 2002, the Company acquired all of the outstanding stock of MedSpan, a Connecticut managed health care organization, for cash of approximately $18.2 million, subject to adjustment for certain items. Net earnings attributable to MedSpan were not material for the year ended December 31, 2002.
The following tables show plan revenues earned, membership by product and certain other selected information:
Net investment and other income for the year ended December 31, 2002 decreased 0.4% to $94.7 million from $95 million in the prior year. Net investment income decreased $2.2 million or 2.3% to $91.4 million in 2002 compared with $93.6 million in 2001. The decrease was primarily due to the other than temporary impairment charge related to the Company’s investment in MedUnite of $11 million during the second quarter of 2002 and lower investment income, the result of lower investment yields. Partially offsetting this
decline was an increase in capital gains realized ($26.9 million for 2002 compared with $20.8 million for 2001) and the recognition of previously unearned revenue from the Company’s pharmacy benefit agreement of approximately $15.2 million. Due to interest rate and bond market dynamics during the past year, the overall pre-tax yield on the portfolio declined to 4.01% for 2002 compared with 4.47% in the prior year. See “Liquidity and Capital Resources”.
Health care service expense stated as a percentage of premium revenues (the “medical loss ratio”) was 79.3% for 2002 compared with 78.9% for 2001. Health care services expense benefited from initiatives to improve health care utilization and reduce costs as well as a change in membership mix. Overall per member per month revenue in 2002 increased 7% to $265.10 from $247.80 in 2001 due primarily to an approximate 10% increase in premium yields (excluding the impact of MedSpan), for the Company’s commercial products and lesser increases for the Company’s Medicare programs. Overall per member per month health care services expenses increased 7.6% to $210.33 in 2002 from $195.45 in 2001 (inclusive of prior period estimate changes of costs and reserves). Included in health care services expense for the year ended December 31, 2002 are a reduction to estimated reserves for New York Stabilization Pools of approximately $20.8 million for 2001 and prior years, an increase of approximately $1.2 million in estimated recoveries for 2001 New York Stop Loss Pools and net favorable development of prior period medical cost estimates of approximately $33.3 million, resulting primarily from ongoing incremental improvements in processes such that the level of completion of claims was, in retrospect, slightly higher than assumed for 2001. For the year ended December 31, 2001, net favorable development of prior period medical cost estimates, other reserve adjustments and recoveries from the New York Stabilization Pools approximated $15 million. For the years ended December 31, 2002 and 2001, pursuant to the Health Care Reform Act in New York (“HCRA”), the Company expensed $57.1 million and $59 million, respectively, for Graduate Medical Education and $51.9 million and $43.3 million, respectively, for hospital Bad Debt and Charity Care. The Company believes it has made adequate provision for incurred medical costs as of December 31, 2002. Changes to estimates of incurred medical costs are recorded in the period they arise. See “Liquidity and Capital Resources”.
The income tax expense recorded for the year ended December 31, 2001 includes the reversal of $21 million of deferred tax valuation allowances established during 1998 when the Company incurred substantial net losses. The remaining valuation allowance at December 31, 2002 of approximately $3.1 million relates primarily to the recognition of certain restructuring related and property and equipment deferred tax assets. Management believes that the Company will obtain the full benefit of the net deferred tax assets recorded at December 31, 2002.
Year Ended December 31, 2001 Compared with Year Ended December 31, 2000
Total commercial premiums earned for the year ended December 31, 2001 were $3.65 billion, compared with $3.35 billion in the prior year. Average premium yield increases were 8.3% and member months increased 0.9% for commercial products during 2001. Overall commercial membership increased by 2.6% at December 31, 2001 compared with the prior year primarily due to growth in the Company’s Freedom Plan group of products.
Premiums earned from the Company’s Medicare programs decreased 2.7% to $659.3 million in 2001 compared with $677.5 million in 2000. The overall decrease was attributable to a 7.6% decrease in member months of Medicare programs, due to the withdrawal from certain New Jersey counties in January 2001. The member month decline was partially offset by a 5.3% increase in premium yields as a result of annual rates of increase from CMS and the county-specific mix of membership.
Net investment and other income for the year ended December 31, 2001 increased 30.2% to $95 million from $73 million in the prior year. Net investment income increased $16.1 million or 20.8% to $93.6 million in 2001 compared with $77.4 million in 2000. The improvement is due primarily to a $20.5 million increase in capital gains realized during the year, partially offset by a decrease in interest income due to lower investment yields. Included in other income for the year ended December 31, 2000 are losses on the sale of fixed assets of approximately $5.4 million, investment valuation losses of approximately $1.5 million and gains on asset disposals of $1.6 million. See “Liquidity and Capital Resources”.
Health care service expense stated as a percentage of premium revenues (the “medical loss ratio”) was 78.9% for 2001 compared with 77.5% for 2000. Overall per member per month revenue in 2001 increased 6.8% to $247.80 from $231.96 in 2000 due primarily to a 8.3% increase in premium yields for the Company’s commercial products and lesser increases for the Company’s Medicare programs. Overall per member per month health care services expenses increased 8.8% to $195.45 in 2001 from $179.67 in 2000. For the year ended December 31, 2001, net favorable development of prior period medical cost estimates, other reserve adjustments and recoveries from the New York Stabilization Pools approximated $15 million. For the year ended December 31, 2000, health care services expense benefited from favorable development of prior period estimates of medical costs of approximately $47.7 million, claim recoveries of approximately $13.2 million and additional New York Stabilization Pool recoveries applicable to 1997 and 1998 of approximately $25.1 million. Excluding these items, the medical loss ratio would have been 79.0% for 2001 and 79.6% for 2000. Health care services expense benefited from initiatives to improve health care utilization and reduce costs as well as a change in membership mix whereby government program membership was reduced.
Marketing, general and administrative expenses increased $12.7 million, or 2.7%, to $489.1 million for 2001 compared with $476.4 million for 2000. Marketing, general and administrative expenses as a percent of operating revenue improved to 11.3% in 2001 compared with 11.8% in 2000. The increase in dollars spent in 2001 when compared with the prior year is primarily due to increased information technology spending and broker commissions. Broker commissions and premium taxes were approximately 26.3% of marketing, general and administrative expenses in 2001 compared with approximately 23.6% in 2000. Partially offsetting these increases were lower payroll, benefits and occupancy costs, the result of reduced staffing levels, and lower depreciation charges. During 2001, the Company recorded a charge of $10 million for estimated legal expenses related to the securities class action pending against the Company that may not be recoverable from one of the Company’s primary director’s and officer’s insurance carriers due to its insolvency. Included in marketing, general and administrative expenses for 2001 and 2000 are severance charges of approximately $6.4 million and $7.5 million, respectively.
The Company incurred interest and other financing charges of $15.6 million and $29.4 million in 2001 and 2000, respectively, related to bank debt. Interest on bank debt decreased in part during 2001 due to the repayment in full of the Term Loan during the second quarter of 2000. During December 2000, the Company completed a capital restructuring whereby all outstanding Senior Notes were repurchased or tendered and replaced with new senior bank facilities totaling $250 million, $175 million of which is a 5 1/2 year term loan (the “New Term Loan”) and $75 million of which is a 5 year revolving credit facility (the “Revolver”, together with the New Term Loan, the “Senior Credit Facilities”). In addition, the Company repaid approximately $21.9 million of its New Term Loan during the year ended December 31, 2001. See “Liquidity and Capital Resources - Financing”. The Company’s average interest rate on bank debt was 8% in 2001 compared with 12.1% in 2000. Interest expense on capital leases approximated $0.9 million in 2000. Interest expense on delayed claims totaled $3.4 million in 2001 compared with $4 million in 2000, reflecting more timely payment of claims and lower levels of older claims outstanding.
mitigate the effects of inflation on its operations. There is no assurance that the Company’s efforts to reduce the impact of inflation will be successful or that the Company will be able to increase premiums to offset cost increases associated with providing health care.
Capital expenditures totaled approximately $19 million during 2002 compared with $21.4 million in 2001. This amount was used primarily for computer equipment and software. The Company currently anticipates that capital expenditures in 2003 will be within a range of approximately $25 million to $30 million, a significant portion of which will be devoted to management information systems. In March 2002, the Company acquired MedSpan, the parent company of a Connecticut health maintenance organization, for cash of approximately $18.2 million, subject to certain adjustments. MedSpan’s network serves approximately 32,700 commercial members and 10,800 self-funded members in Connecticut at December 31, 2002, and had total commercial HMO revenues of approximately $87.7 million in 2002. Effective January 2003, the assets and liabilities of MedSpan were transferred and assumed by Oxford CT pursuant to an assumption reinsurance agreement. In May 2001, the Company purchased all of the outstanding shares of Investors Guaranty Life Insurance Company (“IGL”), a California insurance company, for approximately $11.8 million, net of cash acquired. The acquisition is intended to allow the Company to, among other things, expand offerings of its various health plans to New York, New Jersey and Connecticut based employers with employees outside the tri-state area. In the fourth quarter of 2002, the Company sold its investment in MedUnite, a company originally founded by certain healthcare payors to create an Internet-based health care transaction system, in exchange for nominal consideration. The Company had made investments in MedUnite of approximately $11.4 million, including $1.4 million in 2002, which investment was fully reserved prior to sale.
Cash used by financing activities totaled $273.7 million for the year ended December 31, 2002, compared with $364.6 million in 2001. During 2002, the Company repurchased 6.8 million shares of its common stock in open market transactions at a cost of approximately $251.5 million, repaid approximately $27.1 million of its New Term Loan (as defined in “Financing” below) and other notes and paid approximately $24.1 million related to minimum tax withholdings on option exercises. Partially offsetting these amounts were proceeds received from option exercises of approximately $31.5 million. Proceeds from the exercise of stock options were approximately $29.5 million during 2001 and $64.6 million in 2000. In 2001, the Company’s Board of Directors approved a share repurchase program for up to $500 million of the Company’s outstanding common stock through September 2003. In September 2002, the Company’s Board of Directors approved an increase of $250 million to its existing share repurchase program and extended the program through December 2003. The program authorizes the Company to purchase shares on the open market and in privately negotiated transactions from time to time depending on general market conditions. Through December 31, 2002, the Company has repurchased approximately 19.8 million of its common shares at an aggregate cost of approximately $617.4 million. The Company has remaining repurchase authority of approximately $132.6 million as of December 31, 2002. The Company paid cash dividends on the then outstanding Preferred Stock of approximately $13.8 million during 2000.
The Company has senior credit facilities that include a term loan of $175 million, of which approximately $126.9 million was outstanding at December 31, 2002, and a revolving credit facility of $75 million, which has not been drawn. Under the terms of the senior credit facilities, the Company must make scheduled payments and reductions in the revolving credit facility and must prepay the term loan or reduce the revolving credit facility upon the occurrence of certain events, as defined. See “Liquidity and Capital Resources - Financing”.
Cash and investments aggregating $56.4 million at December 31, 2002 have been segregated as restricted investments to comply with state regulatory requirements. With respect to the Company’s HMO and insurance subsidiaries, the minimum amount of surplus required is based on formulas established by the state insurance departments. At December 31, 2002, the Company’s HMO and insurance subsidiaries had statutory surplus of approximately $551 million, as compared with approximately $448.3 million at December 31, 2001, or approximately $338 million in excess of current regulatory requirements. The Company manages its statutory surplus primarily against National Association of Insurance Commissioners (“NAIC”) Company Action Level (“CAL”) Risk Based Capital (“RBC”), although RBC standards are not yet applicable to all of the Company’s operating subsidiaries. At December 31, 2002, the Company’s statutory surplus was approximately 200% of CAL RBC. The Company’s subsidiaries are subject to certain restrictions on their ability to make dividend payments, loans or other transfers of cash to the parent company. These restrictions limit the ability of the Company to use cash generated by subsidiary operations to pay the obligations of the parent, including debt service and other financing costs. During 2002 and 2001, the Company’s HMO subsidiaries paid dividends to the parent company of approximately $235 million and $328.4 million, respectively. In addition, a dividend of approximately $87.3 million was approved and paid in the first quarter of 2002 from the Company’s indemnity insurance company to its parent company, Oxford’s New York HMO. The Company intends to continue to seek additional dividends from most of its regulated subsidiaries during 2003, and currently estimates that such amounts will be in excess of $250 million. Although the Company received dividends from its HMO subsidiaries in 2002 and 2001, there can be no assurances that such dividend payments will be made in future periods. With regard to MedSpan, the Company contributed $24 million in April 2002, increasing statutory surplus in that subsidiary to approximately 165% of CAL RBC at that time.
The Company has risk-share agreements with two hospitals and a physician group covering approximately 22,650 and 21,100 Medicare members at December 31, 2002 and 2001, respectively. One such agreement was expanded in August 2001. Premium revenues for the Medicare members covered under these agreements totaled approximately $189 million and $149 million in 2002 and 2001, respectively. The increase in premium revenue under these agreements for the 2002 period compared with the 2001 period is the result of an increase in member months. Prior to January 1, 2002, the Company had transferred the medical cost risk for its Medicare members in certain New York counties to North Shore Long Island Jewish Health System (“North Shore”). The premium revenues recognized by the Company during the year ended December 31, 2001 for the approximately 16,600 Medicare members covered at that time pursuant to this agreement approximated $167 million. However, as of January 1, 2002, the Company exited the Medicare line of business in Long Island and discontinued the risk transfer agreement with North Shore in other counties. Although North Shore is obligated under the contract to pay all claims for dates of service through December 31, 2001, the Company is ultimately responsible for any claims not paid by North Shore.
The Company and certain of its former Officers and Directors are currently defendants in certain securities class actions. In the fourth quarter of 1999, the Company purchased Excess Insurance policies providing additional coverage of, among other things, certain judgments and settlements, if any, incurred by the Company and individual defendants in certain pending lawsuits and investigations, including among others, the securities class actions pending against the Company and certain of its former Officers and Directors and the pending stockholder derivative actions. Subject to the terms of the policies, the excess insurers have agreed to pay 90% of the amount, if any, by which covered costs exceed a retention amount (the “Retention”), provided that the aggregate amount of insurance under these policies is limited to $200 million. The Excess Insurance carriers have advised the Company that the Retention is currently $161.3 million. The Company believes that, under the terms of the policies, the Retention is currently $155 million, but the Excess Insurance carriers have not accepted this interpretation. The policies do not cover taxes, fines or penalties imposed by law or the cost to comply with any injunctive or other non-monetary relief or any agreement to provide any such relief. The coverage under the policies is in addition to approximately $25 million of coverage remaining under preexisting primary insurance that is not subject to the Retention applicable to the Excess Insurance policies. Of the remaining $25 million in primary insurance coverage, collectibility of some portion of $15 million is in doubt because one of the Company’s Directors and Officers insurance carriers, Reliance Insurance Company (“Reliance”), was placed in liquidation in October 2001 by the Commonwealth Court of Pennsylvania. Accordingly, during the third quarter of 2001, the Company recorded a charge of $10 million related to a provision for estimated insurance recoveries related to anticipated legal expenses that may not be recoverable from Reliance. Reliance also insured $20 million of the $200 million Excess Insurance. Due to the liquidation of Reliance, collectibility of some portion of $20 million of the Excess Insurance would also be in doubt if the Company makes a claim on that coverage.
On September 30, 2002, Judge Brieant agreed to hold a settlement conference on November 6, 2002 with parties to the securities class actions and the Excess Insurance carriers. In view of the inherent risks and uncertainties of litigation and the related time and expense, and in anticipation of the settlement conference,
The agreement governing the Senior Credit Facilities (the “Credit Agreement”), provides for scheduled quarterly repayments of principal of the New Term Loan with a final maturity of June 2006. The Credit Agreement provides for voluntary prepayments of principal and voluntary reductions in commitments under the Revolver without penalty of a minimum amount of $5 million and mandatory prepayments of principal from proceeds upon the occurrence of certain events. Mandatory prepayments of principal and/or reductions in the Revolver are required from (1) the net proceeds from the sale of assets, subject to certain exceptions; (2) 50% of the net proceeds from certain equity issuances; and (3) the net proceeds from the issuance of debt securities. The Credit Agreement also provides for mandatory prepayment of the entire amount outstanding under the Senior Credit Facilities at a 1% premium upon the occurrence of a change in control (as defined). The Credit Agreement (i) allows the Company to use unrestricted Parent Company cash to repurchase common stock and make other payments as defined in the Credit Agreement, subject to a minimum of $150 million of liquidity, (ii) allows the Company, subject to certain restrictions, to borrow an additional $300 million and (iii) allows the Company to pay up to $150 million related to a settlement or adverse judgment in the securities litigation in excess of insurance payments received by the Company.
The Company is contractually obligated to make payments as follows within the next five years:
The Company is subject to various contracts with certain health care providers, facilities and the federal government for the provision of health care services to its members. Such contracts involve payments to or
from the Company, generally on a monthly basis, in the ordinary course of business and are not included in the above table.
The Company evaluates the collectibility of its premiums receivable based on a combination of factors. These estimates are based on the Company’s assessment of the collectibility of specific accounts, the aging of premiums receivable, historical retroactivity trends, bad-debt write-offs and other known factors. If economic or industry trends change beyond the Company’s estimates or if there is a deterioration in financial condition of a major group or account, increases in the reserve for uncollectible accounts may result.
and arrangements relating to the Company’s Medicare business generally associated with specific hospitals. In determining the liability for medical costs payable, the Company accounts for the financial impact of the transfer of risk for certain members and the experience of risk-sharing providers (who may be entitled to credits from Oxford for favorable experience or subject to deductions for accrued deficits) as well as the impact of incentive arrangements and reserves for estimated settlements. Levels of unpaid claims may also vary based in part on working capital management.
Medical costs payable also reflects payments required by or anticipated benefits from certain state regulated risk allocation pools and state health care public policy initiatives. The risk allocation pools include the New York Market Stabilization Pool affecting small employer group and individual products, the New York Stop Loss Pools, the Connecticut Small Employer Reinsurance Pool and New Jersey assessments related to the individual product market. Certain of the risk allocation pools have, and in the future may be, amended in ways more or less favorable to the Company and may be the target of legal challenges by insurers or other parties.
Management believes that the amount of medical costs payable is adequate to cover the Company’s ultimate liability for unpaid claims as of December 31, 2002; however, actual claim payments and other items may differ from established estimates. Assuming a hypothetical 1% difference between the Company’s December 31, 2002 estimates of medical costs payable and actual costs payable, net earnings for the year ended December 31, 2002 would increase or decrease by approximately $3.6 million and diluted earnings per share would increase or decrease by approximately $0.04 per share.
Included in estimate changes are favorable development of prior years estimated medical costs of approximately $33.3 million, $8.4 million and $47.7 million for 2002, 2001 and 2000, respectively, estimate changes in New York market stabilization pool reserves and stop loss pool recoveries of approximately $22 million, $6.6 million and $25.1 million for 2002, 2001 and 2000, respectively, and claim recoveries of approximately $13.2 million in 2000.
Investments are classified as either available-for-sale or held-to-maturity. Investments that the Company has the intent and ability to hold to maturity are designated as held-to-maturity and are stated at amortized cost. The Company has determined that all other investments might be sold prior to maturity to support its investment strategies. Accordingly, these other investments are classified as available-for-sale and are stated at fair value based on quoted market prices. Unrealized gains and losses on available-for-sale investments are excluded from earnings and are reported in accumulated other comprehensive earnings (loss), net of income tax effects where applicable. Realized gains and losses are determined on a specific identification basis and are included in results of operations. Investment income is accrued when earned and included in investment and other income.
Because of the nature of the Company’s business, the Company is routinely involved in various other disputes, legal proceedings and governmental audits and investigations. Liabilities are recorded for estimates of probable costs resulting from these matters. These estimates are developed in consultation with outside counsel and are based upon an analysis of potential results, assuming a combination of litigation and settlement strategies and considering the Company’s insurance coverages for such matters. Management does not believe that any of such other matters currently threatened or pending will have a material adverse effect
on the Company’s consolidated financial position. It is possible, however, that future results of operations for any particular quarterly or annual period could be materially affected by changes in the Company’s assumptions or the effectiveness of the Company’s strategies related to these proceedings.
See Index to Consolidated Financial Statements and Schedule on page 52.