The table below provides selected consolidated financial data of Anthem. The information has been derived from our consolidated financial statements for each of the years in the five year period ended December 31, 2003, which have been audited by Ernst & Young LLP. You should read this selected consolidated financial data in conjunction with the audited consolidated financial statements and notes included in Part II, Item 8, of this Form 10-K and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Part II,
Our administrative expense consists of fixed and variable costs. Examples of fixed costs are depreciation and amortization and facilities expenses. Other costs are variable or discretionary in nature. Certain variable costs, such as broker and commission expenses and premium taxes, vary directly with premium volume. Other variable costs, such as salaries and benefits, do not vary directly with changes in premium, but are more aligned with changes in membership. The acquisition or loss of a significant block of business would likely impact staffing levels, and thus salary and benefit expense. Discretionary costs include professional and consulting expenses and advertising. Other factors can impact our administrative cost structure, including systems efficiencies, inflation and changes in productivity.
In response to increasing pharmacy benefit costs, we are implementing modified plan designs and we have recontracted with retail pharmacies in an effort to secure better pricing. We have also expanded several clinical initiatives designed to improve quality such as drug utilization review, programs to detect and prevent misuse of prescription drugs and programs designed to educate physicians and members about the appropriate use of antibiotics. In addition, we continually evaluate our drug formulary to ensure appropriate pharmaceutical therapies for our members. We have about two-thirds of our membership in three-tier drug programs and do not expect significant change from that level.
Income before income taxes and minority interest as a percentage of total revenue = income before income taxes and minority interest ÷ total revenue.
Other-than-temporary impairments recognized in 2003 were substantially related to our equity investments, primarily due to the length of time that the securities’ fair value had been less than cost. As of December 31, 2003, our equity securities had gross unrealized gains of $26.2 million. In 2002, we recorded a $3.1 million other-than-temporary impairment on a limited partnership.
Operating revenue increased $637.7 million, or 11%, to $6,689.1 million, primarily due to premium rate increases in our Local Large Group, Federal Employee Program and Small Group businesses. Also contributing to this growth were membership increases in our Individual and Small Group businesses. Operating revenue increases were partially offset by changes in the mix of our products with members selecting less rich benefit designs, resulting in lower priced products. Also offsetting the growth were shifts by certain National Accounts and Local Large Group customers to self-funded arrangements, resulting in lower revenues.
Operating loss increased $52.2 million, or 57%, to $(143.6) million in 2003, primarily due to additional technology expenses, incentive compensation not allocated to the operating segments associated with better than expected performance and legal fees and expenses paid in 2003. Partially offsetting these operating loss increases was the reduction in our carrying value of our investment in MedUnite in 2002.
During the year ended December 31, 2002, total membership increased approximately 3.2 million, or 40%, primarily due to our acquisition of Trigon, which became our Southeast segment. On a same-store basis, total membership increased 621,000, or 8%, primarily in National Accounts, Individual and Local Large Group businesses. The following discussion of membership changes between periods excludes our Southeast members, which are identified separately in the table above.
Cost increases for outpatient services were approximately 12% including the impact of our Trigon acquisition for both rolling 12-month periods, including periods prior to our July 31, 2002 acquisition. Excluding the impact of our Trigon acquisition, our outpatient services trend was approximately one percentage point higher. Drivers of this outpatient trend include a continuing shift of certain procedures such as certain cardiac care procedures previously performed in an inpatient setting to an outpatient setting and increased cost of emergency room services as more procedures are being performed at each emergency room visit. Costs are also increasing for outpatient surgery and radiology services.
Note 8 to our audited consolidated financial statements for the years ended December 31, 2003, 2002 and 2001 included in Part II, Item 8 of this Form 10-K provides historical information regarding the accrual and payment of our unpaid 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 8 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 within a level of confidence required by actuarial standards. Thus, only when the release of a prior year reserve is not offset with the same level of conservatism in estimating the current year reserve will the redundancy create a net reduction in current benefit expense. When we recognize a release of the redundancy, we disclose the amount that is not in the ordinary course of business. We believe we have consistently applied our methodology in determining our best estimate for unpaid claims liability at each reporting date.
For additional information, see Note 12 to our audited consolidated financial statements for the years ended December 31, 2003, 2002 and 2001 included in Part II, Item 8 of this Form 10-K.
On January 1, 2002, we adopted Statement of Financial Accounting Standards No. 141, Business Combinations, and Statement of Accounting Standards No. 142, Goodwill and Other Intangible Assets. FAS 141 requires business combinations completed after June 30, 2001 to be accounted for using the purchase method of accounting. It also specifies the types of acquired intangible assets that are required to be recognized and reported separately from goodwill.
On July 31, 2002, we completed our purchase of 100% of the outstanding stock of Trigon. In accordance with FAS 141, we allocated the purchase price to the fair value of assets acquired, including intangible assets, and liabilities assumed. This allocation process included the review of relevant information about the assets and liabilities, independent appraisals and other valuations to determine the fair value of assets acquired and liabilities assumed. The allocation resulted in $2,146.1 million of non-tax deductible goodwill and $1,172.7 million of acquired intangible assets.
An impairment review of securities to determine if declines in fair value are other-than-temporary is subjective and requires a high degree of judgement. 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. The current economic environment and recent
1 Amounts prior to the demutualization on November 2, 2001 represent “Policyholders’ surplus”.
Goodwill and Other Intangible Assets: On January 1, 2002, the Company adopted FAS 141, Business Combinations, and FAS 142, Goodwill and Other Intangible Assets. FAS 141 requires business combinations completed after June 30, 2001 to be accounted for using the purchase method of accounting. 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.
At December 31 the carrying value of long-term debt consists of the following:
Debentures included in Equity Security Units are obligations of Anthem and are unsecured and subordinated in right of payment to all of Anthem’s existing and future senior indebtedness. Each Equity Security Unit contains a purchase contract under which the holder agrees to purchase, for fifty dollars, shares of Anthem common stock on November 15, 2004, and a 5.95% subordinated debenture. In addition, Anthem will pay quarterly contract fee payments on the purchase contracts at the annual rate of 0.05% of the stated amount of fifty dollars per purchase contract, subject to Anthem’s rights to defer these payments. The applicable interest rate on the debentures outstanding on and after August 15, 2004 will be reset on the third business day preceding August 15, 2004, effective for interest accrued from August 15, 2004 to November 15, 2006. The reset rate will be the interest rate on the debentures determined by the reset agent to be sufficient to cause the then current aggregate market value of all then outstanding debentures to be equal to 100.5% of the re-marketing value. The debentures will mature on November 15, 2006.
Property and equipment includes noncancelable capital leases of $7.3 and $7.4 at December 31, 2003 and 2002, respectively. Total accumulated amortization on these leases at December 31, 2003 and 2002 was $4.6 and $4.3, respectively. The related lease amortization expense is included in depreciation and amortization expense. Depreciation and leasehold improvement amortization expense for 2003, 2002 and 2001 was $127.8, $108.1 and $89.6, respectively. Capitalized costs related to the internal development of software of $117.2 and $116.4 at December 31, 2003 and 2002, respectively, are reported with computer software.
Stock options, restricted stock awards, shares to be contingently issued under long term incentive plans and the purchase contracts included in the Equity Security Units are not considered outstanding in computing the
At December 31, 2003, the Company had unused federal tax net operating loss carryforwards of approximately $79.8 to offset future taxable income. The loss carryforwards expire in the years 2004 through 2021. During 2003, 2002 and 2001 federal income taxes paid totaled $303.3, $151.2 and $74.1, respectively.
Prior to December 31, 2003, Anthem Health Plans of Virginia, Inc. sponsored a plan that was a cash balance arrangement where participants had an account balance that earned a pay credit equal to three to ten percent of compensation. This plan covered all full- and part-time employees who had completed three months of service and there was no minimum age for participation. The pay credit was based on the sum of the participants’ age and years of service. In addition to the pay credit, participant accounts earned interest at a rate based on 30-year Treasury notes. This plan merged into the Anthem Insurance plan effective December 31, 2003.
The accumulated benefit obligation for the defined benefit pension plans was $863.3 and $772.8 at December 31, 2003 and 2002, respectively.
The change in the additional minimum pension liability included within other comprehensive income is as follows:
Certain executives are participants in the 2001 Long Term Incentive Plan (“2001 LTIP”). The 2001 LTIP operated during the three-year period from 2001 to 2003. At the beginning of the three-year period, the Compensation Committee of the Board of Directors established performance goals, which included specific strategic objectives of the Company. Each participant’s target award is established as a percentage ranging from 30% to 150% of annual base salary for each year of the three-year period. Awards under the 2001 LTIP in each three-year period become payable upon approval by the Compensation Committee and will be paid in 2004, with the executive having the option to defer payment. The 2001 LTIP will terminate after completion of the 2001 to 2003 performance period and payout of any awards. The award will be paid in cash, stock and restricted stock of the Company. The 2001 LTIP expense for 2003, 2002 and 2001 was $89.5, $73.7 and $44.9, respectively.