The table below provides selected consolidated financial data of WellPoint. The information has been derived from our consolidated financial statements for each of the years in the five year period ended December 31, 2005. You should read this selected consolidated financial data in conjunction with the audited consolidated financial statements and notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Form 10-K.
Net income and net income per share for the year ended December 31, 2001 on a pro forma basis as if FAS 142 had been adopted January 1, 2001, is as follows:
References to the terms “we”, “our”, or “us” used throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, refer to WellPoint, Inc. (name changed from Anthem, Inc. effective November 30, 2004), an Indiana holding company, and unless the context otherwise requires, its direct and indirect subsidiaries.
The structure of our Management’s Discussion and Analysis of Financial Condition and Results of Operations is as follows:
We are the largest health benefits company in terms of membership in the United States, serving approximately 34 million medical members as of December 31, 2005. We are an independent licensee of the Blue Cross Blue Shield Association, or BCBSA, an association of independent health benefit plans. We serve our members as the Blue Cross licensee in California and as the Blue Cross and Blue Shield licensee for: Colorado, Connecticut, Georgia, Indiana, Kentucky, Maine, Missouri (excluding 30 counties in the Kansas City area), Nevada, New Hampshire, New York (as BCBS in 10 New York City metropolitan counties, and as Blue Cross or BCBS in selected upstate counties only), Ohio, Virginia (excluding the immediate suburbs of Washington, D.C.), and Wisconsin. We also serve customers throughout various parts of the country as UniCare. We are licensed to conduct insurance operations in all 50 states through our subsidiaries and in Puerto Rico through an affiliate.
No other health benefits company has leading local market presence in so many geographic areas. This market position offers advantages in attracting physicians and hospitals to our networks at attractive rates and in helping to keep our products affordable. While we hold the leading position in these markets, all have additional room for expansion.
We intend to continue expanding through a combination of organic growth and strategic acquisitions in both existing and new markets. Our growth strategy is designed to enable us to take advantage of the additional economies of scale provided by increased overall membership as well as providing us access to new and evolving technologies and products. In addition, we believe geographic diversity reduces our exposure to local or regional regulatory, economic and competitive pressures and provides us with increased opportunities for growth. While we have achieved strong growth as a result of strategic mergers and acquisitions, we have also achieved organic growth in our existing markets by providing excellent service, offering competitively priced products and effectively capitalizing on the brand strength of the Blue Cross and Blue Shield names and marks.
Our Other segment is comprised of our Medicare processing business, including AdminaStar Federal and United Government Services; Arcus Enterprises, which works to develop innovative means to promote quality care, well being and education; intersegment revenue and expense eliminations; and corporate expenses not allocated to our Health Care or Specialty segments. Effective December 31, 2005, Empire Medical Services, the Medicare processing company of the former WellChoice, was also included in our Other segment.
Our operating revenue consists of premiums, administrative fees and other revenue. Premium revenue comes from fully-insured contracts where we indemnify our policyholders against costs for covered health and life benefits. Administrative fees come from contracts where our customers are self-insured, or where the fee is based on either processing of transactions or a percent of network discount savings realized. Additionally, we earn administrative fee revenues from our Medicare processing business and from other health-related businesses including disease management programs. Other revenue is principally generated from member co-payments and deductibles associated with the mail-order sale of drugs by our pharmacy benefit management companies.
Our cost of drugs consists of the amounts we pay to pharmaceutical companies for the drugs we sell via mail order through our pharmacy benefit management companies, or PBM. This amount excludes the cost of drugs
Our results of operations depend in large part on our ability to accurately predict and effectively manage health care costs through effective contracting with providers of care to our members and our medical management programs. Several economic factors related to health care costs, such as regulatory mandates of coverage and direct-to-consumer advertising by providers and pharmaceutical companies, have a direct impact on the volume of care consumed by our members. The potential effect of escalating health care costs as well as any changes in our ability to negotiate competitive rates with our providers may impose further risks to our ability to profitably underwrite our business, and may have a material impact on our results of operations.
This MD&A should be read in conjunction with our audited consolidated financial statements for the year ended December 31, 2005 included in this Form 10-K.
On December 28, 2005 (December 31, 2005 for accounting purposes), WellPoint and WellChoice, Inc., or WellChoice, completed their previously announced merger. The acquisition of WellChoice strengthened our leadership in providing health benefits to National Accounts and provided us with a strategic presence in New York City, the headquarters of more Fortune 500 companies than any other U.S. city. Under the terms of the merger agreement, the stockholders of WellChoice (other than subsidiaries of WellPoint) received consideration of $38.25 in cash and 0.5191 of a share of WellPoint common stock for each share of WellChoice common stock outstanding. In addition, WellChoice stock options and other awards were converted to WellPoint awards in accordance with the merger agreement. The purchase price including cash, fair value of stock and stock awards and estimated transaction costs was approximately $6.5 billion.
On July 11, 2005, we announced that an agreement was reached with representatives of more than 700,000 physicians nationwide involved in two multi-district class-action lawsuits against us and other health benefits companies. As part of the agreement, we have agreed to pay $135.0 million to physicians and to contribute $5.0 million to a not-for-profit foundation whose mission is to promote higher quality health care and to enhance the delivery of care to the disadvantaged and underserved. In addition, up to $58.0 million will be paid in legal fees. As a result of the agreement, we incurred a pre-tax expense of $103.0 million during the year ended December 31, 2005, or $0.10 EPS, which represents the final settlement amount of the agreement that was not previously accrued.
2005 received one additional share of WellPoint common stock for each share of common stock held on that date. The additional shares of common stock were distributed to shareholders of record in the form of a stock dividend on May 31, 2005. All historical weighted average share and per share amounts and all references to stock compensation data and market prices of our common stock for all periods presented in this MD&A have been adjusted to reflect this two-for-one stock split.
State Sponsored membership represents eligible members with state sponsored managed care alternatives in Medicaid and State Children’s Health Insurance programs.
The following table presents our medical membership by customer type, funding arrangement and geographical region as of December 31, 2005 and 2004. Also included below are key metrics from our Specialty segment, including prescription volume for our PBM and membership by product. The membership data presented is unaudited and in certain instances includes estimates of the number of members represented by each contract at the end of the period.
Represents membership at December 31, 2005, resulting from the WellChoice acquisition. Medical membership is shown net of overlapping BlueCard host membership.
WellPoint without WellChoice membership was calculated by subtracting membership resulting from the WellChoice acquisition from WellPoint, Inc.’s reported membership at December 31, 2005.
Represents annual PBM prescription volume for mail order and retail prescriptions for the full years ended December 31, 2005 and 2004.
During the twelve months ended December 31, 2005, total medical membership increased approximately 6,128,000, or 22%, primarily due to our acquisition of WellChoice and organic growth in all customer types. Excluding the impact of the WellChoice acquisition: BlueCard membership increased 545,000, or 16%, representing membership growth in other Blue Cross and Blue Shield licensees with members who reside in or travel to our licensed areas; National Accounts membership increased 329,000, or 10%, primarily due to new sales, as well as, in-group increases in membership and members acquired from the acquisition of Lumenos; Large Group membership increased 204,000, or 2% primarily due to our acquisition of Lumenos as well as new sales throughout the year; State Sponsored membership increased 148,000, or 9% due to new sales, primarily in the West region; and ISG membership increased 97,000, or 2%, primarily due to the introduction of new, more affordable product designs and an overall increase in consumer awareness of our wide variety of quality products and services as well as efforts to market products to the uninsured.
Our cost of care trends are calculated by comparing the year-over-year change in average per member per month claim costs for which we are responsible, which excludes member co-payments and deductibles. While our cost of care trend varies by geographic location, our aggregate cost of care was less than 8.5% for the full year 2005.
Costs for outpatient and inpatient services are the primary drivers of overall cost trends, with outpatient trends moderating from 2004 levels. Cost trend increases for outpatient services were primarily driven by higher per visit costs as more procedures are being performed during each visit to outpatient providers, particularly emergency room visits, as well as the impact of price increases included within certain provider contracts. However, we are seeing the positive impact of our radiology management programs on our outpatient trends. These programs were implemented over most of our East and Central regions in late 2004 and early 2005 and are designed to ensure appropriate use of radiology services by our members. We are currently expanding these programs to our other regions. Inpatient trends have been driven primarily by unit cost, a reflection of negotiated contract increases with hospitals. Utilization (admissions per 1,000 members) remains flat, while average length of hospital stay and hospital days per 1,000 members have both decreased slightly.
We discuss our operations using “comparable basis” information, which is presented in order to provide a more meaningful prior-year comparison to the current year, due to the merger with WHN. Comparable basis information is not calculated in accordance with U.S. generally accepted accounting principles, or GAAP, and is not intended to represent or be indicative of the results of WellPoint, Inc. had the merger been completed as of January 1, 2004. Comparable basis information for the year ended December 31, 2004 was calculated by adding the reclassified historical statements of income for the former WHN for the 11 months ended November 30, 2004 to the reported results of WellPoint, Inc. for the year ended December 31, 2004, which includes one month of the former WHN. Comparable basis information contains no intercompany eliminations or pro forma adjustments resulting from the November 30, 2004 merger.
Premiums increased $22,445.1 million, or 120%, to $41,216.7 million in 2005. On a comparable basis, premium increased $2,649.9 million, or 7%, primarily due to premium rate increases in our Large Group, ISG and Senior businesses and membership gains in our ISG, State Sponsored and Senior membership types. Partially offsetting the impact of premium rate increases was the conversion of some Large Group customers from fully-insured contracts to self-funded arrangements and the non-renewal of certain fully-insured accounts.
Other revenue is comprised principally of co-payments and deductibles associated with the sale of mail-order drugs by our PBM companies, which provides services to members of our Health Care segment and third party clients. Other revenue increased $314.1 million, or 124%, to $566.5 million in 2005. On a comparable basis, other revenue increased $43.3 million, or 8%, primarily due to additional mail-order prescription revenue and increased prices of prescription drugs sold by our PBM companies. Increased mail-order prescription volume resulted from both membership increases and additional utilization of our PBM’s mail-order pharmacy option.
Includes operations of the former WellPoint Health Networks Inc. for the one month period ended December 31, 2004 and the former Anthem, Inc. for the year ended December 31, 2004.
In 2005, net realized gains and losses from the sale of fixed maturity and equity securities was primarily due to restructuring of our portfolio as a result of integration activities related to our merger with WHN. Net gains or losses on investments are influenced by market conditions when an investment is sold, and will vary from year to year.
Other-than-temporary impairments in 2005 were approximately equal between equity securities and fixed maturity securities, while in 2004, other-than-temporary impairments were substantially related to equity securities. Other-than-temporary impairments in both 2005 and 2004 are primarily due to the length of time that such securities’ fair value had been less than cost.
Amortization of other intangible assets increased $177.5 million, or 289%, to $238.9 million in 2005, primarily due to a full year of additional amortization expense related to identifiable intangible assets with finite lives resulting from the WHN merger.
We use operating gain to evaluate the performance of our reportable segments, as described in FAS 131, Disclosure About Segments of an Enterprise and Related Information. Operating gain is calculated as total
Our segments’ operating revenue and operating gain for the year ended December 31, 2004 on a comparable basis are as follows. Comparable basis information was calculated as discussed above and is presented in order to provide investors with a more meaningful prior-year comparison to the current year, due to the merger with WHN. Comparable basis information is not calculated in accordance with GAAP and is not intended to represent or be indicative of the results of WellPoint, Inc. had the merger been completed as of January 1, 2004.
Our Health Care segment’s summarized results of operations for the year ended December 31, 2005 and 2004 are as follows:
contributing to premium revenue growth was higher membership, primarily in our ISG and State Sponsored businesses. Administrative fees also increased primarily due to additional self-funded membership in National Accounts and Large Group businesses.
Operating revenue increased $1,627.9 million, or 132%, to $2,863.1 million. On a comparable basis operating revenue increased $228.9 million or 9%, primarily due to increases in PBM operating revenue driven by improved pharmaceutical contracting and increased script volume, particularly due to mail-order script volume. This increase was partially offset by decreases in behavioral health revenue due to the standardization in funding arrangements between Health Care and Specialty segments.
Operating gain increased $287.2 million, or 285%, to $388.1 million. On a comparable basis operating gain increased $55.2 million or 17%, primarily due to an increase in PBM, behavioral health and dental businesses. On a comparable basis, PBM operating gain increased due to higher script volume and improved pharmaceutical contracting. In addition, operating gain from behavioral health increased as we standardized funding arrangements between the Health Care and Specialty segments. Finally, membership growth, driven primarily by the transition of 1.9 million behavioral health members from an outside vendor, also contributed to the improved results in Specialty segment. These gains are partially offset by decreased rates on workers’ compensation insurance in California driven by unfavorable legislation.
Our summarized results of operations for our Other segment for the years ended December 31, 2005 and 2004 are as follows:
The following table presents our medical membership by customer type, funding arrangement and geographical region as of December 31, 2004 and 2003. Also included below are key metrics from our Specialty segment, including prescription volume for our PBM and membership by product. The membership data presented is unaudited and in certain instances includes estimates of the number of members represented by each contract at the end of the period, rounded to the nearest thousand.
During the twelve months ended December 31, 2004, total comparable medical membership increased approximately 1,678,000, or 6%, primarily in our National Accounts, BlueCard, and ISG businesses. Our National Accounts comparable membership increased 544,000, or 20%, primarily due to recognition of the value of Blue Cross and Blue Shield networks and the discounts we can secure, the breadth of our product offerings, and our distinctive customer service. BlueCard comparable membership increased 532,000, or 18%, representing increased sales by other Blue Cross and Blue Shield licensees to accounts with members who reside in or travel to our licensed areas. ISG comparable membership increased 332,000, or 7%, primarily due to the introduction of new, more affordable product designs and an overall increase in consumer awareness of our wide variety of quality products and services as well as efforts to market products to the uninsured.
Self-funded comparable medical membership increased 1,289,000, or 11%, primarily due to increases in our National Accounts and BlueCard businesses. Fully-insured comparable membership increased by 389,000 members, or 3%, primarily in our ISG business.
Our consolidated results of operations for the years ended December 31, 2004 and 2003 are as follows:
Premiums increased $3,603.9 million, or 24%, to $18,771.6 million in 2004, due to the impact of the merger with WHN, and premium rate increases in our Large Group and ISG businesses. Also contributing to premium
Administrative fees increased $276.7 million, or 24%, to $1,436.9 million in 2004, primarily due to increased revenues from self-funded membership, principally in National businesses, and also due to the impact of the merger with WHN. These increases were partially offset by decreased administrative fees from AdminaStar Federal’s 1-800 Medicare Help Line contract with Centers for Medicare & Medicaid Services, or CMS, which was substantially completed by June 30, 2003.
Benefit expense increased $3,133.3 million, or 26%, to $15,387.8 million in 2004. Benefit expense increased due to the impact of the merger with WHN, and also due to increased cost of care, which was driven primarily by higher costs in outpatient services and drug costs. Included in the 2003 results was a $31.7 million net favorable prior year reserve development recorded during the second quarter of 2003 and a $24.5 million favorable adjustment for resolution of a litigation matter in our Health Care segment in the first quarter of 2003. Our benefit expense ratio increased 120 basis points from 80.8% in 2003 to 82.0% in 2004, increasing from lower than anticipated cost of care trends in 2003 and returning to more sustainable levels.
Selling, general and administrative expense increased $380.2 million, or 12%, to $3,477.7 million in 2004, primarily due to the impact of the merger with WHN, and also due to increases in volume-sensitive costs such as higher commissions, premium taxes and other expenses associated with growth in our business and higher salary and benefits costs. These increases were partially offset by a decrease in incentive compensation in 2004, and $20.0 million of contributions to our charitable foundation made by our Health Care segment in 2003 which did not recur in 2004. Our selling, general and administrative expense ratio decreased 180 basis points to 17.0% in 2004, primarily due to our growth in operating revenue and the leveraging of costs over these higher revenues.
The loss on repurchase of debt incurred in 2004 related to our tender offer for our high coupon surplus notes. Due to the high coupon on this debt and time remaining until stated maturity, the debt was repurchased at a significant premium over book value, which was the driver of the loss.
Income tax expense increased $45.6 million, or 10%, to $483.2 million in 2004. Included in 2004 was $44.8 million in tax benefits associated with a change in Indiana laws governing the state’s high-risk health insurance pool recorded during the first quarter of 2004.
Our Health Care segment’s summarized results of operations for the years ended December 31, 2004 and 2003 are as follows:
Operating loss decreased $41.5 million, or 28%, to $105.8 million in 2004, primarily due to lower incentive compensation expenses.
We prepare our consolidated financial statements in conformity with U.S. generally accepted accounting principles, or GAAP. Application of GAAP requires management to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes and within this Management’s Discussion and Analysis. We consider some of our most important accounting policies that require estimates and management judgment to be those policies with respect to liabilities for medial claims payable, income taxes, goodwill and other intangible assets, investments and retirement benefits, which are discussed below. Our significant accounting policies are summarized in Note 2 to our audited consolidated financial statements for the year ended December 31, 2005 included in this Form 10-K.
The most judgmental accounting estimate in our consolidated financial statements is our liability for medical claims payable. At December 31, 2005, this liability was $4,923.4 million and represented 19% of our total consolidated liabilities. We record this liability and the corresponding benefit expense for pending claims and claims that are incurred but not reported, including the estimated costs of processing such claims. Pending claims are those received by us but not yet processed through our systems. Liabilities for both incurred but not reported and reported but not yet paid claims are determined employing actuarial methods that are commonly used by health insurance actuaries and meet Actuarial Standards of Practice. Actuarial Standards of Practice require that the claim liabilities be adequate under moderately adverse circumstances. We determine the amount of the liability for incurred but not reported claims by following a detailed actuarial process that entails using both historical claim payment patterns as well as emerging medical cost trends to project our best estimate of claim liabilities. Under this process, historical data of paid claims is formatted into “claim triangles,” which compare claim incurred dates to the dates of claim payments. This information is analyzed to create “completion factors” that represent the average percentage of total incurred claims that have been paid through a given date after being incurred. Completion factors are applied to claims paid through the financial statement date to estimate the ultimate claim expense incurred for the current period. Actuarial estimates of claim liabilities are then determined by subtracting the actual paid claims from the estimate of the ultimate incurred claims.
As described above, the completion factors and trend factors can have a significant impact on the claim liability. The following example provides the estimated impact to our December 31, 2005 unpaid claims liability assuming hypothetical changes in the completion and trend factors:
Assumes (decrease) increase in the claims trend factors for the most recent two months
In addition, assuming a hypothetical 1% total difference between our December 31, 2005 estimated claims liability and the actual claims paid, net income for the year ended December 31, 2005 would increase or decrease by $32.0 million, while basic and diluted net income per share would increase or decrease by $0.05 per share.
As summarized below, Note 10 to our audited consolidated financial statements for the year ended December 31, 2005 included in this Form 10-K provides historical information regarding the accrual and payment of our medical claims liability. Components of the total incurred claims for each year include amounts accrued for current year estimated claims expense as well as adjustments to prior year estimated accruals. In Note 10 to our audited consolidated financial statements, the line labeled “incurred related to prior years” accounts for those adjustments made to prior year estimates. The impact of any reduction of “incurred related to prior years” claims may be offset as we establish the estimate of “incurred related to current year”. Our reserving practice is to consistently recognize the actuarial best estimate of our ultimate liability for our claims. When we recognize a release of the redundancy, we disclose the amount that is not in the ordinary course of business, if material. We believe we have consistently applied our methodology in determining our best estimate for unpaid claims liability at each reporting date.
The ratio of current year paid as a percent of current year incurred was 88.2% for 2005, 81.3% for 2004, and 85.6% for 2003. The 2004 ratio was impacted by having only one month of medical claims incurred and paid during 2004 for the former WHN. If the former WHN had not been included during 2004, current year medical claims paid would have been $12,170.8 million, current year net incurred medical claims would have been $13,942.8 million and the adjusted ratio would have been approximately 87.3% for 2004. Comparison of the 2005 ratio of 88.2%, the adjusted 2004 ratio of 87.3% and the 2003 ratio of 85.6% indicate that we are paying claims faster. The increase is primarily attributable to improved processes and electronic connectivity with our provider networks. The result of these changes is an enhanced ability to adjudicate and pay claims more quickly.
We calculate the percentage of prior year redundancies in the current period to net incurred medical claims recorded in each prior year in order to demonstrate the development of the prior year reserves. This metric was
The following table shows the variance between total net incurred medical claims as reported in the above table for each of 2004 and 2003 and the incurred claims for such years had it been determined retrospectively (computed as the difference between “net incurred medical claims-current year” for the year shown and “net incurred medical claims - prior years (redundancies)” for the immediately following year):
During 2004 and 2003, we recorded additional tax liabilities of $44.1 million and $81.9 million, respectively, offsetting the reduction in valuation allowances discussed above. These additional liabilities were recorded for uncertainty on several tax issues, including the lack of clear guidance from the Internal Revenue Service, or IRS, on various tax issues relating to our conversion in 1986 from tax exempt to tax paying status.
As a result of legislation enacted in Indiana on March 16, 2004, we recorded deferred tax assets and liabilities, with a corresponding net tax benefit in our income statement of $44.8 million, or $0.15 per basic share and $0.14 per diluted share, for the year ended December 31, 2004. The legislation eliminated the creation of tax credits resulting from the payment of future assessments to the Indiana Comprehensive Health Insurance Association, or ICHIA. ICHIA is Indiana’s high-risk health insurance pool. Our historical ICHIA assessment payments far exceeded our Indiana income tax liability. Thus, the recognition of a state deferred tax asset was not warranted, as a future Indiana tax liability was unlikely. Under the new legislation, ICHIA tax credits are limited to any unused ICHIA assessment paid prior to December 31, 2004. FAS 109 requires that deferred assets or liabilities be established in the period a change in law is enacted. These deferred tax assets and liabilities reflect temporary differences, net operating loss carryforwards and tax credits relating to our Indiana income tax filings. Following guidance in FAS 109, a valuation allowance of $5.6 million was established for the portion of the deferred tax asset, which we believe will likely not be utilized. There is no carryforward limitation on the tax credits and the net operating loss carryforwards do not begin to expire until 2018. We believe we will have sufficient taxable income in future years to offset these carryforwards; therefore, no additional valuation allowance was recorded.
We, like other companies, frequently face challenges from tax authorities regarding the amount of taxes due. These challenges include questions regarding the timing and amount of deductions that we have taken on our tax returns. In evaluating any additional tax liability associated with various positions taken in our tax return filings, we record additional tax liability for potential adverse tax outcomes. Based on our evaluation of our tax positions, we believe we have appropriately accrued for tax exposures. To the extent we prevail in matters we have accrued for, our future effective tax rate would be reduced and net income would increase. If we are required to pay more than accrued, our future effective tax rate would increase and net income would decrease. Our effective tax rate and net income in any given future period could be materially impacted.
While we believe we have appropriately allocated the purchase price of our acquisitions, this allocation requires many assumptions to be made regarding the fair value of assets and liabilities acquired. In addition, the annual impairment testing required under FAS 142 requires us to make assumptions and judgments regarding the estimated fair value of our goodwill and intangibles. Such assumptions include the discount factor used to determine the fair value of a reporting unit, which is ultimately used to identify potential goodwill impairment. Such estimated fair values might produce significantly different results if other reasonable assumptions and estimates were to be used. If we are unable to support a fair value estimate in future annual goodwill impairment tests or if significant impairment indicators are noted relative to other intangible assets subject to amortization, we may be required to record impairment losses against future income.
For additional information, see Note 4 to our audited consolidated financial statements as of and for the year ended December 31, 2005 included in this Form 10-K.
Current and long term available-for-sale investment securities were $17,388.0 million at December 31, 2005 and represented 34% of our total consolidated assets at December 31, 2005. In accordance with Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities, our fixed maturity and equity securities are classified as “available-for-sale” securities and are reported at fair value. We have determined that all available-for-sale investments in our portfolio, with the exception of certain securities held for contractual or regulatory purposes, are available to support current operations, and accordingly, have classified such securities as current assets. Investment income is recorded when earned, and realized gains or losses, determined by specific identification of investments sold, are included in income when the securities are sold.
In addition to available-for-sale investment securities, we held other long-term investments of $207.8 million, or 0.4% of total consolidated assets, at December 31, 2005. These long-term investments consist primarily of real estate and certain other investments. Due to their less liquid nature, these investments are classified as long-term.
An impairment review of securities to determine if declines in fair value below cost are other-than-temporary is subjective and requires a high degree of judgment. We evaluate our investment securities on a quarterly basis, using both quantitative and qualitative factors, to determine whether a decline in value is other-than-temporary. Such factors considered include the length of time and the extent to which a security’s market value has been less than its cost, financial condition and near term prospects of the issuer, recommendations of investment advisors, and forecasts of economic, market or industry trends. If any declines are determined to be other-than-temporary, we charge the losses to income when that determination is made. We have a committee made up of certain accounting and investment associates and management responsible for managing the impairment review process. The current economic environment and recent volatility of securities markets increase the difficulty of determining fair value and assessing investment impairment. The same influences tend to increase the risk of potential impairment of these assets. We recorded charges for other-than-temporary impairment of securities of $14.8 million, $0.8 million and $24.4 million, respectively, for the years ended December 31, 2005, 2004 and 2003. The $24.4 million impairment for the year ended December 31, 2003 included a $22.3 million charge for other-than-temporary impairment of our equity securities; primarily due to the length of time that such securities’ fair value had been less than cost.
The Company participates in securities lending programs whereby marketable securities in its investment portfolio are transferred to independent brokers or dealers based on, among other things, their creditworthiness in exchange for collateral initially equal to at least 102% of the value of the securities on loan and is thereafter maintained at a minimum of 100% of the market value of the securities loaned. The market value of the securities on loan to each borrower is monitored daily and the borrower is required to deliver additional collateral if the
market value of the collateral falls below 100% of the market value of the securities on loan. The fair value of the collateral amounted to $1,389.9 million and $658.5 million, which represents 102% and 102% of the carrying value at December 31, 2005 and 2004, respectively. Under the guidance provided in FAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, the Company recognizes the collateral as an asset, which is reported as “securities lending collateral” on its balance sheet and the Company records a corresponding liability for the obligation to return the collateral to the borrower, which is reported as “securities lending payable”. The securities on loan are reported in the applicable investment category on the balance sheet.
We have audited the accompanying consolidated balance sheets of WellPoint, Inc. as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of WellPoint, Inc. at December 31, 2005 and 2004, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of WellPoint, Inc.’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 15, 2006 expressed an unqualified opinion thereon.
Per share data for each period presented reflects the two-for-one stock split, which was approved by the Board of Directors on April 25, 2005. All shareholders of record on May 13, 2005 received one additional share of WellPoint common stock for each share of common stock held on that date. The additional shares of common stock were distributed to shareholders of record in the form of a stock dividend on May 31, 2005.
WellPoint, Inc. (“WellPoint”), which name changed from Anthem, Inc. (“Anthem”) effective November 30, 2004, is the largest publicly traded commercial health benefits company in terms of membership in the United States, serving approximately 34 million members as of December 31, 2005. WellPoint and its consolidated subsidiaries (the “Company”) offer a broad spectrum of network-based managed care plans to large and small employers, individual, Medicaid and senior markets. The Company’s managed care plans include preferred provider organizations (“PPOs”), health maintenance organizations (“HMOs”), point-of-service (“POS”) plans, consumer-driven health plans (“CDHPs”), other hybrid plans and traditional indemnity plans. In addition, the Company provides a broad array of managed care services to self-funded customers, including claims processing, underwriting, stop loss insurance, actuarial services, provider network access, medical cost management and other administrative services. The Company also provides an array of specialty and other products and services including pharmacy benefit management, group life and disability insurance benefits, dental, vision, behavioral health benefits, workers compensation and long-term care insurance. The Company has licenses in all 50 states.
Basis of Presentation: The accompanying consolidated financial statements of the Company include the accounts of WellPoint and its subsidiaries and have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”). All significant intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates: The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
record in the form of a stock dividend on May 31, 2005. All historical weighted average share and per share amounts and all references to stock compensation data and market prices of WellPoint’s common stock for all periods presented have been adjusted to reflect this two-for-one stock split.
The Company uses the equity method of accounting for investments in companies in which its ownership interest of the voting shares of an investee company enables the Company to influence the operating or financial decisions of the investee company, but the Company is without a controlling financial interest. The Company’s proportionate share of equity in net income of these unconsolidated affiliates is reported with net investment income.
Derivative Financial Instruments: All investments in derivatives are recorded at fair value. A derivative is typically defined as an instrument whose value is “derived” from an underlying instrument, index or rate, has a notional amount, requires little or no initial investment and can be net settled. WellPoint typically invests in the following types of derivative financial instruments: interest rate swaps, call options, embedded derivatives and warrants. Derivatives embedded within non-derivative instruments (such as options embedded in convertible fixed maturity securities) are bifurcated from the host instrument when the embedded derivative is not clearly and closely related to the host instrument.
The Company has exposure to economic losses due to interest rate risk arising from changes in the level or volatility of interest rates. The Company attempts to mitigate its exposure to interest rate risk through active portfolio management, which includes rebalancing its existing portfolios of assets and liabilities, as well as changing the characteristics of investments to be purchased or sold in the future. In addition, derivative financial instruments are used to modify the interest rate exposure of certain liabilities. These strategies include the use of interest rate swaps and forward contracts. These instruments are generally used to lock interest rates or to hedge (on an economic basis) interest rate risks associated with variable rate debt. The Company has used these types of instruments as designated hedges against specific liabilities.
Premium and Self-Funded Receivables: Premium and self-funded receivables include the uncollected amounts from insured and self-funded groups, and are reported net of an allowance for doubtful accounts of $96.0 and $78.1 at December 31, 2005 and 2004, respectively. The allowance for doubtful accounts is based on historical collection trends and management’s judgment regarding the ability to collect specific accounts.
Other Receivables: Other receivables include proceeds due from brokers on investment trades, government programs, pharmacy sales, reinsurance, claim recoveries and other miscellaneous amounts due to the Company. These receivables have been reduced by an allowance for uncollectible amounts of $90.9 and $84.6 at December 31, 2005 and 2004, respectively, which is based on historical collection trends and management’s judgment regarding the ability to collect specific accounts.
Goodwill and Other Intangible Assets: The Company follows FAS 141, Business Combinations, and FAS 142, Goodwill and Other Intangible Assets. FAS 141 requires business combinations to be accounted for using the purchase method of accounting and it also specifies the types of acquired intangible assets that are required to be recognized and reported separately from goodwill. Under FAS 142, goodwill and other intangible assets with indefinite lives are not amortized but are tested for impairment at least annually. Goodwill represents the excess of cost of acquisition over the fair value of net assets acquired. Other intangible assets represent the values assigned to subscriber bases, provider and hospital networks, Blue Cross and Blue Shield trademarks, licenses, non-compete and other agreements. Goodwill and other intangible assets are allocated to reportable segments based on membership.
Retirement Benefits: Pension benefits are recorded in accordance with FAS 87, Employers’ Accounting for Pensions. Prepaid pension benefits represent prepaid costs related to defined benefit pension plans and are reported with other noncurrent assets. Liabilities for pension benefits are reported with other noncurrent liabilities.
The “Medicare Prescription Drug, Improvement and Modernization Act of 2003” became law in December 2003 and expanded Medicare, primarily adding a prescription drug benefit for Medicare-eligible retirees starting January 1, 2006. The Company anticipates that the retiree medical benefits it pays in 2006 and beyond will be lower as a result of the new Medicare provisions. During 2004, the Company adopted accounting guidance under Financial Accounting Standards Board Staff Position (“FSP”) 106-1 and 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003. The impact of adopting FSP 106-1 and 106-2, while accretive to earnings, is not material to the consolidated financial statements for the years ended December 31, 2005 and 2004.
Reserves for Future Policy Benefits: Reserves for future policy benefits include liabilities for life and long-term disability insurance policy benefits based upon interest, mortality and morbidity assumptions from published actuarial tables, modified based upon the Company’s experience. Future policy benefits also include liabilities for insurance policies for which some of the premiums received in earlier years are intended to pay anticipated benefits to be incurred in future years. Future policy benefits are continually monitored and reviewed, and when reserves are adjusted, differences are reflected in benefit expense. The current portion of reserves for future policy benefits relates to the portion of such reserves that the Company expects to pay within one year. The Company believes that its liabilities for future policy benefits, along with future premiums received, are adequate to satisfy its ultimate benefit liability; however, these estimates are inherently subject to a number of variable circumstances. Consequently, the actual results could differ materially from the amounts recorded in the consolidated financial statements of the Company.
Federal Income Taxes: The Company files a consolidated income tax return. Deferred income tax assets and liabilities are recognized for temporary differences between the financial statement and tax return bases of assets and liabilities based on enacted tax rates and laws. The deferred tax benefits of the deferred tax assets are recognized to the extent realization of such benefits is more likely than not. Deferred income tax expense or
The Company adopted FAS 123R on January 1, 2006, using the modified prospective transition method. Under the modified prospective transition method, fair value accounting and recognition provisions of FAS 123R are applied to share-based awards granted or modified subsequent to the date of adoption and prior periods presented are not restated. In addition, for awards granted prior to the effective date, the unvested portion of the awards shall be recognized in periods subsequent to the adoption based on the grant date fair value determined for recognition or pro forma disclosure purposes under FAS 123. The overall impact of adopting FAS 123R will reduce 2006 earnings by approximately 3% to 5% given the Company’s current stock-based compensation programs and will reduce operating cash flows for the excess tax benefits that must be shown as cash flows from financing activities. The Company does not expect that the adoption of FAS 123R will have a material impact on its financial position.
Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share includes the dilutive effect of stock options, restricted stock and purchase contracts included in Equity Security Units, using the treasury stock method. The treasury stock method assumes exercise of stock options, vesting of restricted stock and conversion of stock purchase rights under purchase contracts included in Equity Security Units, with the assumed proceeds used to purchase common stock at the average market price for the period. The difference between the number of shares assumed issued and number of shares assumed purchased represents the dilutive shares. The purchase contracts included in Equity Security Units were settled in November 2004, and the common stock issued is included in the basic earnings per share calculation at December 31, 2004 and thereafter. Under long-term incentive plans, when cumulative net income, as defined, met or exceeded threshold targets, contingently issuable shares were dilutive to earnings per share.
Under the merger agreement, WellChoice stockholders received thirty-eight dollars and twenty-five cents ($38.25) in cash and 0.5191 of a share of WellPoint common stock for each share of WellChoice common stock outstanding. The value of the transaction is estimated to be approximately $6,452.0, including cash of $3,126.4, the issuance of 42.4 shares of common stock, valued at $3,180.8, 0.3 shares of WellChoice restricted stock and stock units converted to WellPoint stock, valued at $19.8, WellChoice stock options converted to WellPoint stock options, valued at $113.4, and $11.6 of estimated transaction costs. The fair value of common stock issued was based on $74.97 per share, which represents the average closing price of the Company’s common stock for the five trading days ranging from two days before to two days after September 27, 2005, the date the merger was announced.
In accordance with FAS 141 the purchase price was allocated to the fair value of WellChoice assets acquired and liabilities assumed, including identifiable intangible assets. The excess of purchase price over the fair value of net assets acquired resulted in $3,445.2 of non-tax deductible goodwill which was allocated to the Health Care segment. The purchase price allocation is preliminary and is subject to change as fair value estimates and opening balance sheet liabilities, including those related to employee terminations and other merger-related exit activities, are refined.
The estimated fair values of WellChoice assets acquired and liabilities assumed at the date of the merger are summarized as follows:
On June 9, 2005, the Company completed its acquisition of Lumenos, Inc. (“Lumenos”), a market leader in consumer-driven health programs. The total consideration for the acquisition was approximately $185.0 in cash paid to the stockholders of Lumenos. The acquisition was accounted for using the purchase method of accounting, and was deemed effective June 1, 2005 for accounting purposes. Accordingly, the results of
operations for Lumenos are included in the Company’s consolidated financial statements for periods following June 1, 2005. In accordance with FAS 141, the purchase price was allocated to the fair value of Lumenos assets acquired and liabilities assumed, including identifiable intangible assets, and the excess of purchase price over the fair value of net assets acquired resulted in $119.5 of non-tax deductible goodwill, which was allocated to the Health Care segment. The purchase price allocation is preliminary and additional refinements may occur. The pro forma effects of this acquisition were not material to the Company’s consolidated results of operations.
In connection with the WHN merger, the Company executed certain undertakings with the California Department of Managed Health Care, the California Department of Insurance (“California DOI”), and the Georgia Department of Insurance (“Georgia DOI”), which contained various commitments by the Company. Expenses for merger related undertakings of $61.5 were recorded in 2004 for certain obligations under these agreements with the California DOI and the Georgia DOI. Under these obligations, during 2005, WellPoint donated $35.0 to community clinics in California and $15.0 for a program to be conducted through California community colleges to support the training of new nurses in California. Further, Blue Cross and Blue Shield of Georgia, Inc. and Blue Cross and Blue Shield Healthcare Plan of Georgia, Inc., started to fund the establishment and administration of a telemedicine network to benefit health care in rural Georgia under the $11.5 commitment established in connection with the WHN merger.
Goodwill acquired in 2005 included $3,445.2 related to the merger with WellChoice, $119.5 related to the acquisition of Lumenos and $0.9 related to other acquisitions. Goodwill adjustments of $72.1 in 2005 relate primarily to adjustments for costs associated with employee terminations and costs for exiting certain activities in connection with the WHN merger. The Company recorded an estimate of these liabilities at the merger date, which resulted in an increase to goodwill. For a period of time after the merger date, adjustments to these initial estimates are recorded as an adjustment to goodwill. Subsequent to this purchase price allocation period, any additional changes are recorded as a charge to current operations, except for adjustments to income taxes, which will continue to be adjusted to goodwill. Goodwill adjustments in 2005 also include reductions of $25.4 related to other purchase accounting adjustments related to the WHN merger and $161.1 related to the tax benefit on the exercise of stock options issued as part of the WHN and Trigon Healthcare, Inc. (“Trigon”) acquisitions.
The following table represents a reconciliation of employee termination and other exit costs recorded in connection with the WHN merger:
As required by FAS 142, the Company completed its annual impairment tests of existing goodwill and other intangible assets with indefinite lives during the fourth quarters of 2005, 2004 and 2003. These tests involved the use of estimates related to the fair value of the reporting unit to which the goodwill and other intangible assets with indefinite lives are allocated. There were no impairment losses recorded during 2005, 2004 and 2003.
The Company’s fixed maturity investment portfolio is sensitive to interest rate fluctuations, which impact the fair value of individual securities. Unrealized losses reported above were generally caused by the effect of a rising interest rate environment on certain securities with stated interest rates currently below market rates. The Company has the ability and intent to hold these securities until their full cost can be recovered. Therefore, the Company does not believe the unrealized losses represent an other-than-temporary impairment as of December 31, 2005.
The amortized cost and fair value of fixed maturity securities at December 31, 2005, by contractual maturity, are shown below. Expected maturities may be less than contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.
Net realized investment (losses) gains and net change in unrealized (depreciation) appreciation in investments for the years ended December 31, were as follows:
A primary objective in the management of the fixed maturity and equity portfolios is to maximize total return relative to underlying liabilities and respective liquidity needs. In achieving this goal, assets may be sold to take advantage of market conditions or other investment opportunities as well as tax considerations. Sales will produce realized gains and losses.
A significant judgment in the valuation of investments is the determination of when an other-than-temporary decline in value has occurred. The Company follows a consistent and systematic process for impairing securities that sustain other-than-temporary declines in value. The Company has established a committee responsible for the impairment review process.
The carrying value of fixed maturity investments that did not produce income during 2005 and 2004 was $4.7 and $0.0 at December 31, 2005 and 2004, respectively.
As of December 31, 2005 the Company had committed approximately $22.6 to future capital calls from various third-party limited partnership investments in exchange for an ownership interest in the related partnerships.
At December 31, 2005 and 2004, securities with carrying values of approximately $227.9 and $210.2 were deposited by the Company’s insurance subsidiaries under requirements of regulatory authorities.
A summary of the aggregate contractual or notional amounts and estimated fair values related to derivative financial instruments at December 31 is as follows:
percentage rate based on the Company’s credit rating at the date of utilization, or (ii) a base rate as defined in the facility agreement. The weighted-average interest rate on the bridge loan at December 31, 2005 was 7.250%. The bridge loan has been classified as long-term debt at December 31, 2005 in accordance with FAS 6, Classification of Short-Term Obligations Expected to Be Refinanced (“FAS 6”), as this short-term borrowing was replaced with a long-term borrowing on January 10, 2006.
due 2010 and $174.9 of 9.000% notes due 2027. The Company recorded a loss of $146.1 which has been recorded as loss on repurchase of debt securities in the statement of income for the year ended December 31, 2004.
Fair values are disclosed for all financial instruments, for which it is practicable to estimate fair value, whether or not such values are recognized in the consolidated balance sheets. Management attempts to obtain quoted market prices for these disclosures. Where quoted market prices are not available, fair values are estimated using present value or other valuation techniques. These techniques are significantly affected by management’s assumptions, including discount rates and estimates of future cash flows. Potential taxes and other transaction costs have not been considered in estimating fair values. The estimates presented herein are not necessarily indicative of the amounts that the Company would realize in a current market exchange.
Non-financial instruments such as real estate, property and equipment, deferred income taxes and intangibles, and certain financial instruments such as policy liabilities are excluded from the fair value disclosures. Therefore, the fair value amounts cannot be aggregated to determine the underlying economic value of the Company.
Other notes: The fair value of other notes is based on quoted market prices for the same or similar debt, or, if no quoted market prices were available, on the current rates estimated to be available to the Company for debt of similar terms and remaining maturities.
Equity warrants: The fair value of equity warrants are based on quoted market prices, where available. For securities not actively traded, fair values were estimated using values obtained from independent pricing services or quoted market prices of comparable instruments.
The carrying values and estimated fair values of the Company’s financial instruments at December 31 are as follows:
Property and equipment includes assets purchased under noncancelable capital leases of $54.7 and $25.7 at December 31, 2005 and 2004, respectively. Total accumulated amortization on leased assets at December 31, 2005 and 2004 was $17.0 and $5.9, respectively. Depreciation expense for 2005, 2004 and 2003 was $102.7, $81.7 and $77.3, respectively. Amortization expense on leased assets, software and leasehold improvements for 2005, 2004 and 2003 was $125.9, $54.0 and $50.5, respectively. Capitalized costs related to the internal development of software of $409.9 and $330.9 at December 31, 2005 and 2004, respectively, are reported with computer software.
The Company reinsures certain of its risks with other companies and assumes risk from other companies and such reinsurance is accounted for as a transfer of risk. The Company remains primarily liable to policyholders under ceded insurance contracts and is contingently liable for amounts recoverable from reinsurers in the event that such reinsurers do not meet their contractual obligations.
A summary of net premiums written and earned for the Company’s segments for the years ended December 31 is as follows:
In accordance with the Stock Plan, options to purchase shares of common stock at an amount equal to the fair market value of the stock at the date of grant were granted to eligible employees and non-employee directors during 2005, 2004 and 2003. Options vest and expire over terms as set by the Compensation Committee at the time of grant. In 2005, the Company changed the vesting provisions of newly granted options to six equal semi-annual vesting tranches. Options granted prior to 2005 vested in three equal annual tranches. All options expire ten years from the grant date. Certain grants contain provision whereby the employee continues to vest in the award subsequent to termination due to retirement. The Company’s expense attribution methodology ignores such vesting provisions and the fair value of the awards is amortized over the stated vesting periods. Effective with the adoption of FAS 123R, the Company will change its attribution method and will then consider all vesting provisions in determining the requisite service period over which the fair value of the awards will be recognized.
A summary of stock option activity for the years ended December 31 is as follows:
Information about stock options outstanding and exercisable as of December 31, 2005 is summarized as follows:
The Company has registered 6.0 shares of common stock for the Employee Stock Purchase Plan (“Stock Purchase Plan”) which is intended to provide a means to encourage and assist employees in acquiring a stock ownership interest in WellPoint. The Stock Purchase Plan was initiated in June 2002 and any employee that meets the eligibility requirements, as defined, may participate. No employee will be permitted to purchase more than $25,000 (actual dollars) worth of stock in any calendar year, based on the fair market value of the stock at the beginning of each plan quarter. Employees become participants by electing payroll deductions from 1% to 15% of gross compensation. Payroll deductions are accumulated during each quarter and applied toward the purchase of stock on the last trading day of each quarter. Once purchased, the stock is accumulated in the employee’s investment account. The purchase price per share is 85% of the lower of the fair market value of a share of common stock on either the first or last trading day of the quarter. Employee purchases under the Stock Purchase Plan were $52.2, $21.9 and $18.4, respectively, resulting in the issuance of approximately 1.0, 0.6 and 0.6 shares during 2005, 2004 and 2003, respectively. As of December 31, 2005, there were approximately 3.4 shares of common stock available for issuance under the Stock Purchase Plan.
The pro forma information regarding net income and earnings per share presented in Note 2 has been determined as if the Company accounted for its stock-based compensation using the fair value method. The Company has historically used a Black-Scholes option pricing model to estimate the fair value of stock options. The inputs for volatility and expected term of the options were primarily based on historical information.
In 2005, the Company began using a binomial lattice valuation model to estimate the fair value of all future stock options granted. The binomial lattice model is deemed to provide a more accurate estimate of the fair values of employee stock options as it incorporates the impact of employee exercise behavior and allows for the input of a range of assumptions. Expected volatilities utilized in the lattice model are based on an analysis of implied volatilities of publicly traded options on WellPoint stock and historical volatility of WellPoint’s stock price. The risk-free interest rate is derived from the U.S. Treasury strip rates at the time of the grant. The expected term of the options was derived from the outputs of the lattice model, which incorporates post-vesting forfeiture assumptions based on an analysis of historical data. The dividend yield was based on the Company’s estimate of future dividend yields. Groups of employees that have similar exercise behavior are considered separately for valuation purposes. The Company utilizes the multiple-grant approach for recognizing
compensation cost associated with the vesting tranches of the option grant. The following weighted-average assumptions were used to estimate the fair values of options. In 2005, the expected life represents the fair value calculated by the binomial lattice model as the model does not require the input of an expected life assumption:
credits resulting from the payment of future assessments to the Indiana Comprehensive Health Insurance Association (“ICHIA”), Indiana’s high-risk health insurance pool. Under the new legislation, ICHIA tax credits are limited to any unused ICHIA assessment paid prior to December 31, 2004. A valuation allowance of $5.6 was established for the portion of the deferred tax asset, which the Company believes will likely not be utilized. There is no carryforward limitation on the tax credits and the net operating loss carryforwards do not begin to expire until 2018.
The Company sponsors various non-contributory defined benefit plans covering most employees.
During the fourth quarter of 2005, the Company announced that effective January 1, 2006, it would curtail the benefits under the Plan. Most participants will no longer have pay credits added to their accounts, but will continue to earn interest on existing account balances. Participants will continue to earn years of pension service for vesting. Employees hired on or after January 1, 2006, will not be eligible to participate in the Plan. Certain participants will be “grandfathered” into the Plan based on age and years of service in previously merged plans. Grandfathered participants will continue to receive pay credits under the Plan formula. The Company expects to record a curtailment gain in the first quarter of 2006, which is not anticipated to be material to the consolidated operating results.
All of the plans’ assets consist primarily of common stocks, fixed maturity securities, investment funds and short-term investments. The funding policies for all plans are to contribute amounts at least sufficient to meet the
The Company uses a September 30 measurement date for determining benefit obligations and fair value of plan assets. However, all pre-merger WellChoice plans were determined using a December 31 measurement date. The Company will begin using a September 30 measurement date for pre-merger WellChoice plans in 2006.
The effect of acquisitions on the consolidated benefit obligation and plan assets is reflected through the business combination lines of the tables below.
The weighted average assumed health care cost trend rates to be used for next year to measure the expected cost of other benefits is 9.00% with a gradual decline to 4.9% by the year 2011. These estimated trend rates are subject to change in the future. The health care cost trend rate assumption has a significant effect on the amounts reported. For example, an increase in the assumed health care cost trend rate of one percentage point would increase the postretirement benefit obligation as of December 31, 2005 by $51.5 and would increase service and interest costs by $3.5. Conversely, a decrease in the assumed health care cost trend rate of one percentage point would decrease the postretirement benefit obligation by $43.5 as of December 31, 2005 and would decrease service and interest costs by $2.9.
equity securities, interest rates, inflation and asset allocations are considered in the assumption. The assumption includes an estimate of the additional return expected from active management of the investment portfolio. Peer data and historical returns are also reviewed for appropriateness of the selected assumption. The expected long-term rate of return is calculated by the geometric averaging method, which calculates an expected multi-period return, reflecting volatility drag on compound returns.
The Company’s current funding strategy is to fund an amount at least equal to the minimum required funding as determined under ERISA with consideration of factors such as the minimum pension liability requirement and maximum tax deductible amounts. The Company may elect to make discretionary contributions up to the maximum amount deductible for income tax purposes. For the year ended December 31, 2005, no contributions were required under ERISA, however, the Company made tax deductible discretionary contributions of $117.8 to the defined benefit pension plans. Employer contributions related to other benefits represent payments to retirees for current benefits. Contributions to the VEBA are generally not material. The Company may elect to make discretionary contributions, including on a quarterly basis, up to the maximum amount deductible for income tax purposes.
In May 2003, in a case titled Kenneth Thomas, M.D., et al., v. Blue Cross Blue Shield Association, et al., (the “Thomas Litigation”) several medical providers filed suit in federal district court in Miami, Florida against the BCBSA and Blue Cross and Blue Shield plans across the country, including the Company and WellChoice. The suit alleges that the BCBSA and the Blue Cross and Blue Shield plans violated RICO and challenges many of the same practices as the CMA Litigation and the Shane Litigation.
On June 27, 2002, in a case titled Academy of Medicine of Cincinnati and Luis Pagani, M.D. v. Aetna Health, Inc., Humana Health Plan of Ohio, Inc., Anthem Blue Cross and Blue Shield, and United Health Care of Ohio, Inc., No. A02004947 filed in the Court of Common Pleas, Hamilton County, Ohio and a case titled Academy of Medicine of Cincinnati and A. Lee Greiner, M.D., Victor Schmelzer, M.D., and Karl S. Ulicny, Jr., M.D. v. Aetna Health, Inc., Humana, Inc., Anthem Blue Cross and Blue Shield, and United Health Care, Inc., No. 02-CI-903 filed in the Boone County, Kentucky Circuit Court, the Academy and certain physicians allege that the defendants acted in combination and collusion with one another to reduce the reimbursement rates paid to physicians in the area. On September 30, 2005, the Company entered into a settlement agreement to resolve the litigation. The settlement agreement has three components. First, the Company will increase the total annual reimbursement to physicians in the twelve county area (six counties each in Ohio and Kentucky) by $35.0 in 2005, an additional $20.0 in 2006 and an additional $15.0 in 2007. The increases will be measured against the total reimbursement amount for the same area in 2004. Second, the Company will pay $2.8 to plaintiffs, with approximately $0.6 for payments to retired doctors and incentive awards to the named plaintiffs and the remainder going to a charitable foundation to improve health care in the affected area. Third, the Company will pay $9.6 in attorneys’ fees to the plaintiffs’ class counsel. Both the Ohio court and the Kentucky court preliminarily approved the settlement on September 30, 2005. A final fairness hearing was held on November 21, 2005. Both courts issued orders giving final approval of the settlement on November 21, 2005. The attorneys’ fees, incentive awards to plaintiffs, payments to retired doctors and charitable donation were paid out December 27, 2005. The final terms of the settlement agreement did not have a significant impact on the financial results of the Company for the year ended December 31, 2005.
Prior to WHN’s acquisition of the group benefit operations (“GBO”) of John Hancock Mutual Life Insurance Company (“John Hancock”), John Hancock entered into a number of reinsurance arrangements, including with respect to personal accident insurance and the occupational accident component of workers’ compensation insurance, a portion of which was originated through a pool managed by Unicover Managers, Inc. Under these arrangements, John Hancock assumed risks as a reinsurer and transferred certain of such risks to other companies. Similar reinsurance arrangements were entered into by John Hancock following WHN’s acquisition of the GBO of John Hancock. These various arrangements have become the subject of disputes, including a number of legal proceedings to which John Hancock is a party. The Company is currently in arbitration with John Hancock regarding these arrangements. The Company believes that it has a number of defenses to avoid any ultimate liability with respect to these matters and believes that such liabilities were not transferred to the Company as part of the GBO acquisition. However, if the Company were to become subject to such liabilities, the Company could suffer losses that might have a material adverse effect on its financial condition, results of operations or cash flows.
In addition to the lawsuits described above, the Company is also involved in other pending and threatened litigation of the character incidental to the business transacted, arising out of its operations and its 2001 demutualization, and is from time to time involved as a party in various governmental investigations, audits, reviews and administrative proceedings. These investigations, audits and reviews include routine and special investigations by state insurance departments, state attorneys general and the U.S. Attorney General. Such investigations could result in the imposition of civil or criminal fines, penalties and other sanctions. The Company believes that any liability that may result from any one of these actions, or in the aggregate, is unlikely to have a material adverse effect on its consolidated financial position or results of operations.
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents, investment securities, premium receivables and instruments held through hedging activities. All investment securities are managed by professional investment managers within policies authorized by the Board of Directors. Such policies limit the amounts that may be invested in any one issuer and prescribe certain investee company criteria. Concentrations of credit risk with respect to premium receivables are limited due to the large number of employer groups that constitute the Company’s customer base in the geographic regions in which it conducts business. As of December 31, 2005, there were no significant concentrations of financial instruments in a single investee, industry or geographic location.
The Company has three reportable segments: Health Care, Specialty, and Other. The Health Care segment is an aggregation of various operating segments, principally differentiated only by geography. These Health Care operating segments have similar economic, product, distribution, customer and regulatory characteristics, and meet the aggregation criteria as defined under paragraph 17 of FAS 131, Disclosures About Segments of an Enterprise and Related Information (“FAS 131”).
product offerings where the Company provides claims adjudication and other administrative services to the customer, but the customer principally bears the insurance risk.
Anthem Foundation, Inc. (the “Foundation”) is an Indiana non-profit organization exempt from federal taxation under Section 501(c)(3) of the Internal Revenue Code, which was formed to conduct, support and assist charitable, health-related, educational, and other community-based programs and projects. The officers of the Foundation are also officers of the Company. These officers receive no compensation for the management services performed for the Foundation but are reimbursed for any cash expenditures incurred on behalf of the Foundation. The Foundation is not a subsidiary of the Company and the financial results of the Foundation are not consolidated with the Company’s financial statements. For 2005, the Company made no contributions to the Foundation. For 2004 and 2003, the Company contributed $3.0 and $24.0, respectively, to the Foundation. The Company has no current legal obligations for future commitments to the Foundation.
WellPoint Foundation is a non-profit organization exempt from federal taxation under Section 501(c)(3) of the Internal Revenue Code, which was formed to improve the health and well-being of individuals in the communities served by the former WHN. Certain officers of WellPoint Foundation were also officers of WHN prior to the merger. As of December 31, 2005 and 2004, the officers of WellPoint Foundation are also officers of the Company. For the year ended December 31, 2005 and for the period from December 1, 2004 to December 31, 2004, the Company made no contributions to WellPoint Foundation. The Company has no current legal obligations for future commitments to WellPoint Foundation.
WellPoint’s insurance subsidiaries are subject to risk-based capital requirements. Risk-based capital is a method developed by the NAIC to determine the minimum amount of statutory capital appropriate for an insurance company to support its overall business operations in consideration of its size and risk profile. The formula for determining the amount of risk-based capital specifies various factors, weighted based on the perceived degree of risk, which are applied to certain financial balances and financial activity. Below minimum risk-based capital requirements are classified within certain levels, each of which requires specified corrective action. As of December 31, 2005 and 2004, all of WellPoint’s insurance subsidiaries exceeded the minimum risk-based capital requirements.
Statutory-basis capital and surplus for WellPoint’s insurance subsidiaries was $7,487.0 and $6,094.9 at December 31, 2005 and 2004, respectively. Statutory-basis net income of WellPoint’s insurance subsidiaries was $2,385.1, $1,545.9 and $565.0 for 2005, 2004 and 2003, respectively. Statutory-basis net income includes WellChoice and WHN statutory results for the full year ended December 31, 2005 and WHN statutory results for the full year ended December 31, 2004.