- - Excluding the effects of the unusual or nonrecurring events and transactions described below, we achieved record profits. Underlying earnings from operations, net earnings applicable to common shareholders, and diluted net earnings per common share were $858 million, $509 million and $2.62 per share, respectively, representing increases over 1997 of 16%, 18%, and 16%, respectively.
Our consolidated medical care ratio increased to 87.2% in 1998 from 84.3% in 1997. The year-over-year increase includes the effects of the AARP business on our medical care ratio. We experience a medical care ratio of approximately 92% related to our portion of the AARP insurance offerings, which we began delivering on January 1, 1998. Excluding the AARP business, on a year-over-year basis, the medical care ratio increased to 85.8%.
PREMIUM REVENUES During 1997, consolidated premium revenues totaled $10.1 billion, representing an increase of $1.6 billion, or 19%, compared to 1996. Excluding the effects of acquisitions, premium revenues in 1997 increased by 17% over 1996.
INFLATION Although the general rate of inflation has remained relatively stable and health care cost inflation has stabilized in recent years, the national health care cost inflation rate still exceeds the general inflation rate. We use various strategies to mitigate the negative effects of health care cost inflation, including setting commercial premiums based on anticipated health care costs, risk-sharing arrangements with various health care providers, and other health care cost containment measures. Specifically, health plans try to control medical and hospital costs through contracts with independent providers of health care services. Through these contracted care providers, our health plans emphasize preventive health care and appropriate use of specialty and hospital services.
Premium revenues are recognized in the period enrolled members are entitled to receive health care services. Premium payments received from our customers prior to such period are recorded as unearned premiums. Management services and fee revenues are recognized in the period the related services are performed. Premium revenues related to Medicare and Medicaid programs as a percentage of total premium revenues were 20% in 1998, 22% in 1997, and 19% in 1996.
Retrospective rate credit reserves represent premiums we received in excess of claims and expenses charged under eligible contracts. Reserves established for closed policy years are based on actual experience, while reserves for open years are based on estimates of premiums, claims and expenses incurred.
Customer balances consist principally of deposit accounts and reserves that have accumulated under certain experience-rated contracts. At the customer's option, these balances may be returned to the customer or may be used to pay future premiums or claims under eligible contracts.
A reconciliation of MetraHealth restructuring activities for the years ended December 31 is as follows (in millions):
In November 1998, we issued $650 million of unsecured notes payable at a weighted-average interest rate of 6.0%. The debt placement consisted of $400 million in unsecured notes due December 1, 1999, with an interest rate of 5.65% and $250 million in unsecured notes due December 1, 2003, with an interest rate of 6.65%.
To determine compensation cost under the fair value method, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model.
In June 1996 and November 1995, we entered into separate 10-year contracts with nonaffiliated third parties for information technology services. Under the terms of the contracts, the third parties assumed responsibility for certain data center operations and support. In September 1996, we entered into a 10-year contract with a third party for certain data network and voice communication services. Future payments under all of these contracts are estimated to be $1.3 billion; however, the actual timing and amount of payments will vary based on usage. Expenses incurred in connection with these agreements were $162 million in 1998, $125 million in 1997, and $70 million in 1996.
Six suits assert claims under the United States securities laws against UnitedHealth Group and certain of its current and former officers and directors. The plaintiffs are shareholders of the Company who purport to sue on behalf of a class of purchasers of the Company's common shares during the period February 12, 1998, through August 5, 1998 (the "Class Period"). Each complaint was filed in the United States District Court for the District of Minnesota. Each of the six actions claims violations of Sections 10(b) and 20(a) of the Securities Exchange Act and SEC Rule 10b-5. In substance, the complaints allege that the Company made materially false or misleading statements about the profitability and performance of the Company's Medicare business during the Class Period. Two of the complaints also allege that the Company made materially false statements about its medical costs and the expenses related to its realignment. The complaints also allege that the statements were made with the intention of deceiving members of the investing public and with the intention that the price of the Company's shares would rise, making it possible for insiders at the Company to profit by selling shares at a time when they knew the Company's true financial condition, but the investing public did not. The complaints allege that once the Company's true financial condition was revealed on August 6, 1998, the price of its common shares fell from a closing price of $52 7/8 per share on August 5, 1998, to a closing price of $37 7/8 per share on August 6, 1998. The complaints seek compensatory damages in unspecified amounts.
Additionally, the health care industry is highly competitive and has seen significant consolidation over the past few years. The current competitive markets in certain areas may limit our ability to price products at appropriate levels. These competitive factors may adversely affect our consolidated financial results.
Investments in financial instruments such as marketable securities and commercial premiums receivable may subject UnitedHealth Group to concentrations of credit risk. Our investments in marketable securities are managed by professional investment managers within an investment policy authorized by the board of directors. This policy limits the amounts that may be invested in any one issuer. Concentrations of credit risk with respect to commercial premiums receivable are limited to the large number of employer groups that comprise our customer base. As of December 31, 1998, there were no significant concentrations of credit risk.
We have audited the accompanying consolidated balance sheets of UnitedHealth Group and its corporate entity, United HealthCare Corporation (a Minnesota Corporation), and Subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of UnitedHealth Group and Subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles.