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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____ to____
Commission file number: 1-8865
SIERRA HEALTH SERVICES, INC.
(Exact name of Registrant as specified in its charter)
NEVADA 88-0200415
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
2724 NORTH TENAYA WAY
LAS VEGAS, NEVADA 89128
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (702) 242-7000
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
Common Stock, par value $.005 New York Stock Exchange
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
---
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant on March 18, 2002 was $291,259,000.
The number of shares of the registrant's common stock outstanding on March 18,
2002 was 28,111,000.
DOCUMENTS INCORPORATED BY REFERENCE
DOCUMENT WHERE INCORPORATED
-------- ------------------
Portions of the registrant's definitive proxy Part III
statement for Part III its 2001 annual meeting
to be filed with the SEC not later than 120 days
after the end of the fiscal year.
SIERRA HEALTH SERVICES, INC.
2001 Form 10-K
TABLE OF CONTENTS
Page
----
PART I
Item 1. Description of Business .................................................................. 1
Item 2. Description of Properties................................................................. 20
Item 3. Legal Proceedings......................................................................... 20
Item 4. Submission of Matters to a Vote of Security Holders....................................... 20
PART II
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters............................................................ 21
Item 6. Selected Financial Data................................................................... 22
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations ............................................................. 24
Item 7a. Quantitative and Qualitative Disclosures about Market Risk ............................... 45
Item 8. Financial Statements and Supplementary Data............................................... 46
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.................................................... 84
PART III
Item 10. Directors and Executive Officers of the Registrant........................................ 84
Item 11. Executive Compensation.................................................................... 84
Item 12. Security Ownership of Certain Beneficial Owners and Management............................ 84
Item 13. Certain Relationships and Related Transactions............................................ 84
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K........................... 85
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Unless otherwise indicated, "Sierra," "we," "us," and "our" refer to Sierra
Health Services, Inc. and its subsidiaries.
We are a managed health care organization that provides and administers the
delivery of comprehensive health care and workers' compensation programs with an
emphasis on quality care and cost management. Our strategy has been to develop
and offer a portfolio of managed health care and workers' compensation products
to employer groups and individuals. Our broad range of managed health care
services is provided through the following:
o federally qualified health maintenance organizations or HMOs
o managed indemnity plans
o a third-party administrative services program for employer-funded health
benefit plans
o workers' compensation medical management and fully insured program
o ancillary products and services that complement our managed health care
and workers' compensation product lines
o a subsidiary that administers a managed care federal contract for the
Department of Defense's TRICARE program in Region 1
Operating results and cash flows from continuing operations for fiscal year 2001
reflected significant improvement over the prior year. Fiscal year 2000 was a
difficult year for us. In the first and second quarters of 2000, we evaluated
and then announced and adopted restructuring plans related primarily to our
Texas HMO health care operations. This restructuring involved a reduction in
staff and the closing of some of our Texas clinic facilities, which resulted in
our recording the write off of a significant portion of our goodwill and fixed
asset impairment and other charges totaling approximately $220 million.
Throughout 2001, we continued to focus on making the Texas HMO health care
operations profitable. Significant premium rate increases were made on renewing
membership and during the third quarter we embarked on a recontracting effort to
reduce medical costs. It was during this recontracting effort that unsustainable
cost increases were identified, including the fact that the operations' primary
hospital contract if renewed, would be at a substantially higher rate than was
previously indicated by the hospital.
Although considerable efforts had been made to achieve profitability in our
Texas HMO health care operations, it was determined that under the current
operating environment, we would not be able to turn around the operating results
and the best course of action was to exit the market as soon as possible to
limit future losses and exposure. As part of our plan to exit Texas, in the
third quarter of 2001, we recorded a charge of $17.1 million for premium
deficiency costs, the write down of certain assets, legal and restitution costs,
and various other exit related costs. We will cease providing HMO health care
coverage in Texas on April 17, 2002.
We have elected to early adopt Statement of Financial Accounting Standards No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets" or SFAS
No. 144, effective January 1, 2001. In accordance with SFAS No. 144 our Texas
HMO health care operations have been reclassified and presented as discontinued
operations. Unless otherwise indicated, information presented in this 2001 Form
10-K is for continuing operations and excludes the discontinued Texas HMO health
care operations.
Revolving Credit Facility. As a result of the asset impairment and other changes
in estimate charges, we were not in compliance with the revolving credit
facility financial covenants at June 30, 2000. On December 15, 2000, we entered
into an amended and restated credit agreement, which terminates on September 30,
2003, and are now in compliance with all covenants of the amended agreement. The
amended agreement was further amended in April 2001 to allow for the completion
of the debenture exchange offer and again in October 2001 to provide a limited
waiver for covenants affected by exiting the Texas HMO health care market. The
availability under the credit facility has been reduced to $117 million at
December 31, 2001 from $135 million at the end of 2000 due to required
reductions in the agreement. We have $28 million available under the credit
facility; however, the total availability will be reduced by $6.0 million on
June 30, 2002 and December 31, 2002 and finally by $10.0 million on June 30,
2003. The amount available under the credit facility can be further reduced by
80% of net proceeds from certain asset sales and annual excess cash flows, as
well as 100% of the net proceeds of any new debt or equity issuance, excluding
any issuance by CII, as defined in the amended and restated credit agreement.
The amended and restated credit agreement restricts the amount of funds that can
be transferred to the Texas and Sierra Military Health Services, Inc., or SMHS,
operations. The amount outstanding under the credit facility fluctuates with our
working capital needs.
Debentures. At September 30, 2000, CII Financial, our wholly-owned workers'
compensation subsidiary, had outstanding approximately $47.1 million of
subordinated debentures that were due on September 15, 2001. These subordinated
debentures were neither assumed nor guaranteed by Sierra and were subordinated
to Sierra's credit facility debt. In December 2000, CII Financial commenced an
offer to exchange the subordinated debentures for cash and/or new debentures. On
May 7, 2001, CII Financial closed its exchange offer on $42.1 million of its
outstanding subordinated debentures. CII Financial purchased $27.1 million in
principal amount of subordinated debentures for $20.0 million in cash and issued
$15.0 million in new 9 1/2% senior debentures, due September 15, 2004, in
exchange for $15.0 million in subordinated debentures. The transaction was
accounted for as a restructuring of debt; therefore all future cash payments,
including interest, related to the debentures will be reductions of the carrying
amount of the debentures and no future interest expense will be recognized.
Accordingly, the new 9 1/2% senior debentures have a carrying amount of $19.2
million, which consists of principal of $15.0 million and $4.2 million in future
accrued interest.
In September 2001, the California Department of Insurance gave approval to
California Indemnity, one of CII Financial's insurance subsidiaries, to pay a
dividend of $5.0 million to CII Financial. CII Financial used these funds to pay
the remaining $5.0 million in subordinated debentures at maturity. CII Financial
expects to service the new 9 1/2% senior debentures from future cash flows,
primarily from dividends that will be paid by its insurance subsidiaries from
their future earnings.
Other. Our principal executive offices are located at 2724 North Tenaya Way, Las
Vegas, Nevada 89128, and our telephone number is (702) 242-7000.
Our fiscal year period is the same as the calendar year and unless otherwise
indicated, any year designated will refer to the year ended December 31.
Managed Care Products and Services
Our primary types of health care coverage are HMO plans, HMO Point of Service,
or POS plans, and managed indemnity plans, which include a preferred provider
organization, or PPO option. The POS products allow members to choose one of the
various coverage options when medical services are required instead of one plan
for the entire year. As of December 31, 2001, we provided HMO products to
approximately 247,000 members in Nevada. We also provide managed indemnity
products to approximately 29,000 members, Medicare supplement products to
approximately 23,000 members, and administrative services to approximately
289,000 members. Medical premiums account for approximately 56% of total
revenues.
Health Maintenance Organizations. We operate a mixed model HMO in Las Vegas,
Nevada, which means that we use our own specialty medical group as well as a
network of independently contracted providers. We also operate a network model
HMO in Reno, Nevada. Our network model HMO, in Dallas, Texas, will operate
through April 17, 2002. Independently contracted primary care physicians and
specialists for the HMOs are compensated on a capitation or modified
fee-for-service basis. Contracts with our primary hospitals are on a discounted
per diem basis. Members receive a wide range of coverage after paying a nominal
co-payment and are eligible for preventive care coverage. The HMOs do not
require deductibles or claim forms when the member receives HMO benefits. We
have over 50% of the Las Vegas HMO market share.
Most of our managed health care services in Nevada are provided through our
independently contracted network of approximately 2,000 providers and 13
hospitals. These Nevada networks include our affiliated multi-specialty medical
group, which provides medical services to approximately 75% of our southern
Nevada HMO members and employs over 180 primary care and other providers in
various medical specialties. Through our affiliates, the following services are
offered:
o three urgent care centers
o home health care
o hospice care
o behavioral health care
o home infusion, oxygen and durable medical equipment
o a free-standing, state-licensed and Medicare-approved ambulatory surgery
center
o radiology
o vision
o occupational medicine
We believe that this vertical integration of our health care delivery system in
southern Nevada provides a competitive advantage as it helps us to effectively
manage health care costs while delivering quality care.
On October 24, 2000, Texas Health Choice, L.C., or TXHC, entered into an
agreement with AmCare Health Plans of Texas, Inc., or AmCare, for the sale and
transfer of TXHC's membership in Houston. Effective December 1, 2000, AmCare
assumed the risk associated with the commercial HMO and Medicare+Choice, or M+C,
member contracts under an assumption reinsurance agreement with TXHC. We did not
receive material sales proceeds from this transaction.
On October 1, 2001 TXHC entered into another agreement with AmCare to offer
replacement coverage to all small and large groups covered by TXHC. The offer
applied to approximately 30,000 members and currently, we believe approximately
8,000 members have, or will, accept the AmCare replacement coverage. We do not
expect to receive material sales proceeds from this transaction.
Our commercial plans offer traditional HMO benefits and POS benefits. At
December 31, 2001, we had approximately 175,000 commercial members in Nevada.
We offer a Medicare risk product for Medicare-eligible beneficiaries called
Senior Dimensions. Senior Dimensions is marketed directly to Medicare-eligible
beneficiaries. The monthly payment received from the Centers for Medicare and
Medicaid Services, or CMS, formerly known as the Health Care Financing
Administration, or HCFA, for Medicare members is determined by formula
established by Federal law.
As of December 31, 2001, we had approximately 45,000 Medicare members in Nevada.
Approximately 39,000 of the Medicare members were enrolled in the Social HMO,
which is discussed below.
In addition, as of December 31, 2001, we had approximately 27,000 members
enrolled in our Nevada HMO Medicaid risk products. To enroll in these products,
an individual must be eligible for Medicaid benefits in the state of Nevada. We
are paid a monthly fee for each Medicaid member enrolled by the state's managed
care division.
Social Health Maintenance Organization. Effective November 1, 1996, we entered
into a Social HMO II contract with CMS pursuant to which a large portion of our
Nevada Medicare risk enrollees will receive certain expanded benefits. We are
one of six HMOs nationally to be awarded this contract and are the only company
to have the program implemented as of December 31, 2001. We receive additional
revenues for providing these expanded benefits. The additional revenues are
determined based on health risk assessments that have been, and will continue to
be, performed on our eligible Medicare risk members. The additional benefits
include, among other things, assisting the eligible Medicare risk members with
typical daily living functions such as bathing, dressing and walking. These
members, as identified in the health risk assessments, are those who currently
have difficulty performing daily living functions because of a health or
physical problem. CMS may consider adjusting the reimbursement factors for the
Social HMO members in the future. At this time, however, the final reimbursement
per member for 2003 has not been determined and there is no guaranty that the
Social HMO contract will be renewed beyond 2003. It should be noted that
Congress has in the past agreed to extend the contract. If the reimbursement for
these members decreases significantly and related benefit changes are not made
timely, there could be a materially adverse effect on our business.
Preferred Provider Organizations. Our managed indemnity plans generally offer
members a PPO option of receiving their medical care from either contracted or
non-contracted providers. Members pay higher deductibles and co-insurance or
co-payments when they receive care from non-contracted providers. Out-of-pocket
costs are lowered by utilizing contracted providers who are part of our PPO
network. As of December 31, 2001, approximately 29,000 members were enrolled in
our managed indemnity plans.
During 2001, we provided managed indemnity, accidental death and disability and
Medicare supplement services to individuals in Arizona, California, Colorado,
Iowa, Louisiana, Maryland, Nevada, New Mexico and Texas. As of December 31,
2001, our managed indemnity subsidiary was licensed in a total of 43 states and
the District of Columbia.
Ancillary Medical Services. Among the ancillary medical services we offer in
Nevada are the following:
o outpatient surgical care
o diagnostic testing
o medical and surgical procedures
o x-ray
o CAT scans
o mental health and substance abuse services
o home health care services
o hospice program
o vision services
o home infusion
o oxygen
o durable medical equipment services
These services are provided to members of our HMO, managed indemnity and
administrative service plans. Mental health and substance abuse services are
also provided to approximately 152,000 participants from non-affiliated employer
groups and insurance companies.
Administrative Services. Our administrative services products provide, among
other things, utilization review and PPO services to large employer groups that
are usually self-insured. As of December 31, 2001, approximately 289,000 members
were enrolled in our administrative services plans. The results of operations
for these services are included in specialty product revenues and expenses in
the Consolidated Statements of Operations.
Military Contract Services
Sierra Military Health Services, Inc. On September 30, 1997, the Department of
Defense, or DoD, awarded us a triple-option health benefits contract, known as
TRICARE, to provide managed health care coverage to eligible beneficiaries in
Region 1. This region has approximately 639,000 eligible individuals in
Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New
Jersey, New York, Pennsylvania, Rhode Island, Vermont, Virginia, West Virginia
and Washington, D.C. SMHS completed an eight month implementation phase in May
1998 and began providing health care benefits on June 1, 1998 under the TRICARE
contract.
Under the TRICARE contract, SMHS provides health care services to dependents of
active duty military personnel and military retirees and their dependents
through subcontractor partnerships and individual providers. We also perform
specific administrative services, including health care appointment scheduling,
enrollment, network management and health care management services. We perform
these services using DoD information systems. If all five option periods are
exercised by the DoD and no extensions of the performance period are made,
health care delivery will end on May 31, 2003, followed by an additional eight
month phase out of the Region 1 managed care support contract. The DoD has
extended expiring TRICARE contracts in other regions and SMHS has recently begun
negotiations with the DoD about a possible extension to the base contract.
In June 1996, the DoD awarded a TRICARE contract to TriWest Health Care
Alliance, a consortium consisting of Sierra and 13 other health care companies,
to provide health services to Regions 7 and 8, which include a total of 16
states. During the first quarter of 2000, we sold our interest in TriWest Health
Care Alliance in exchange for a $3.7 million note, which approximated the
carrying value of our investment. The note was completely paid by the first
quarter of 2001.
Workers' Compensation Operations
Workers' Compensation Subsidiary. On October 31, 1995, we acquired CII
Financial, Inc., or CII, for approximately $76.3 million of common stock in a
transaction accounted for as a pooling of interests. Through CII's insurance
subsidiaries, we write workers' compensation insurance in California, Colorado,
Kansas, Missouri, Nebraska, Nevada, New Mexico, Texas and Utah. CII's insurance
subsidiaries have licenses in 36 states and the District of Columbia and have
applications pending for licenses in other states. California, Colorado and
Nevada represent approximately 72%, 9%, and 10%, respectively, of CII's fully
insured workers' compensation insurance premiums in 2001. Workers' compensation
insurance premiums account for approximately 14% of our total revenue. The
workers' compensation subsidiary applies the discipline of managed care concepts
to its operations. These concepts include, but are not limited to, the use of
specialized preferred provider networks, utilization reviews by an employed
board certified occupational medicine physician as well as nurse case managers,
medical bill reviewers and job developers who facilitate early return to work.
Marketing
The marketing and sales of our commercial managed care products typically
involve a multi-step process involving our sales representatives, a
consultant/broker appointed by the client and the client. Once a relationship
with a group has been established and a group agreement is negotiated and
signed, we focus our marketing efforts on individual employees. During a
designated "open enrollment" period each year, usually the month preceding the
annual renewal of the agreement with the group, employees choose whether to
remain with, join or terminate their membership with a specific health plan
offered by the employer. New employees decide whether to join one of the
employers' heath insurance options at the time of their employment. Although
contracts with employers are generally terminable on 60 days notice, changes in
membership occur primarily during open enrollment periods.
Media communications convey our emphasis on access to our broad health care
provider network and services at a reasonable price. Other communications to
customers include employer and member newsletters, member education brochures,
prenatal information packets, employer/broker seminars, certain Internet
information and direct mail advertising to clients. Members' satisfaction with
our benefits and services is monitored by customer surveys. Results from these
surveys and other primary and secondary research guide the sales and advertising
efforts throughout the year.
Medicare risk products are primarily marketed by the HMOs' sales employees.
Retention of employer groups and membership growth is accomplished through print
advertising directed to employers and through consumer media campaigns.
Our workers' compensation insurance policies are sold through independent
insurance agents and brokers, who may also represent other insurance companies.
We believe that independent insurance agents and brokers choose to market our
insurance policies primarily because of the price we charge, the quality of
service that we provide and the commissions we pay. As of December 31, 2001, we
had relationships with approximately 756 agents and paid our agents commissions
based on a percentage of the gross written premium they produced. We also have
various agency incentive programs that enable certain agents to earn additional
compensation if certain premium production and/or agency loss ratio goals are
met. We utilize a number of promotional media, including advertising in
publications to support the efforts of our independent agents.
SMHS administers marketing initiatives in accordance with the TRICARE Region 1
managed care support contract. SMHS' dedicated marketing division uses a
multi-faceted marketing approach to ensure that beneficiaries within Region 1
have the opportunity to learn about the health care benefits under TRICARE and
have the opportunity to make health care choices that best fit their specific
needs. Marketing initiatives include direct beneficiary briefings, direct mail,
newspaper advertising, newsletters and Internet web page briefs.
Membership
Period End Membership:
At December 31,
2001 2000 1999 1998 1997
-------- -------- -------- ------- --------
Continuing Operations:
- ----------------------
HMO:
Commercial.............................. 175,000 140,000 149,000 146,000 139,000
Medicare................................ 45,000 42,000 42,000 37,000 33,000
Medicaid................................ 27,000 15,000 11,000 5,000 2,000
Managed Indemnity........................... 29,000 31,000 37,000 41,000 64,000
Medicare Supplement......................... 23,000 28,000 28,000 26,000 25,000
Administrative Services..................... 289,000 273,000 298,000 318,000 328,000
TRICARE Eligibles........................... 639,000 621,000 610,000 606,000
--------- --------- --------- --------- -------
Total Membership,
Continuing Operations.............. 1,227,000 1,150,000 1,175,000 1,179,000 591,000
========= ========= ========= ========= =======
Discontinued Operations:
- ------------------------
HMO:
Commercial.............................. 43,000 73,000 114,000 126,000 15,000
Medicare................................ 12,000 8,000 11,000 10,000 3,000
------ ------ ------- ------- ------
Total Membership,
Discontinued Operations............ 55,000 81,000 125,000 136,000 18,000
====== ====== ======= ======= ======
During 2001, 2000 and 1999, we received approximately 23.6%, 23.1% and 23.4%,
respectively, of our total revenues from our contract with CMS to provide health
care services to Medicare enrollees. Our contract with CMS is subject to annual
renewal at the election of CMS and requires us to comply with federal HMO and
Medicare laws and regulations and may be terminated if we fail to comply. The
termination of our contract with CMS could have a material adverse effect on our
business. In addition, there have been, and we expect that there will continue
to be, a number of legislative proposals to limit Medicare reimbursements and to
require additional benefits. Future levels of funding of the Medicare program by
the federal government cannot be predicted with certainty. (See Government
Regulation and Recent Regulation).
Our ability to obtain and maintain favorable group benefit agreements with
employer groups affects our profitability. The agreements are generally
renewable on an annual basis but are subject to termination on 60 days prior
notice. For the fiscal year ended December 31, 2001, our ten largest HMO
employer groups were, in the aggregate, responsible for less than 10% of our
total revenues. Although none of our employer groups accounted for more than 2%
of total revenues during that period, the loss of one or more of the larger
employer groups could, if not replaced with similar membership, have a material
adverse effect upon our business. We have generally been successful in retaining
these employer groups in Nevada. However, there can be no assurance that we will
be able to renew our agreements with our employer groups in the future or that
we will not experience a decline in enrollment within our employer groups.
Additionally, revenues received under certain government contracts are subject
to audit and retroactive adjustment.
Provider Arrangements and Cost Management
HMO and Managed Indemnity Products. A significant distinction between our health
care delivery system and that of many other managed care providers is the fact
that approximately 75% of our southern Nevada HMO members receive primary health
care through our own multi-specialty medical group. We make health care
available through independently contracted providers employed by the
multi-specialty medical group and other independently contracted networks of
physicians, hospitals and other providers.
Under our HMOs, the member selects a primary care physician who provides or
authorizes any non-emergency medical care given to that member. These primary
care physicians and some specialists are compensated to a limited extent on the
basis of how well they coordinate appropriate medical care. We have a system of
limited incentive risk arrangements and utilization management with respect to
our independently contracted primary care physicians. We compensate our
independently contracted primary care physicians and specialists by using both
capitation and modified fee-for-service payment methods. In Nevada, under the
modified fee-for-service method, a limited incentive risk arrangement is
established for institutional services. Additional amounts may be made available
to certain capitated physicians if hospital costs are less than anticipated for
our HMO members. For those primary care physicians receiving payments on a
modified fee-for-service basis, portions of the payments otherwise due the
physicians are withheld. The amounts withheld are available for payment to the
physicians if, at year-end, the expenditures for both institutional and
non-institutional medical services are within established ranges. It is believed
that this method of limited incentive risk payment is advantageous to the
physician, our company and the members because all share in the benefits of
managing health care costs. We have, however, negotiated capitation and reduced
fee-for-service agreements with certain specialists and primary care providers
who do not participate in the incentive risk arrangements. We monitor certain
health care utilization, including evaluation of elective surgical procedures,
quality of care and financial stability of our capitated providers, to
facilitate access to service and to ensure member satisfaction.
We provide or negotiate discounted contracts with hospitals for inpatient and
outpatient hospital care, including room and board, diagnostic tests and medical
and surgical procedures. We believe that we currently have a favorable contract
with our primary southern Nevada contracted hospitals, Sunrise Hospital and
Medical Center and Mountain View Hospital. Subject to certain limitations, the
contract provides, among other things, guaranteed contracted per diem rate
increases on an annual basis. The per diem rate increased 4% in 2001 and is
scheduled to increase approximately 8% for commercial members in 2002. The
scheduled rate increase for 2002 has been factored into our 2002 premium rate
increases. Our contract with Sunrise Hospital and Medical Center and Mountain
View Hospital contains a clause which requires them to provide us with their
best rates in the market place. Since a majority of our southern Nevada hospital
days are at these facilities, this contract assists us in managing a significant
portion of our medical costs. We can be and have been affected by these
hospital's limited capacity and have had to place our members in other
facilities, some with a higher cost to us, due to a shortage of beds at these
hospitals. In general, our other hospital contracts in Las Vegas are based on a
fixed per diem rate structure.
We believe that we have negotiated favorable rates with our contracted
hospitals. For hospitals other than Sunrise and Mountain View Hospitals, our
contracts with our hospital providers typically renew automatically with both
parties granted the right to terminate after a notice period ranging from three
to twelve months. We are currently in negotiations with one Las Vegas hospital
that has given us notice of their intent to terminate the contract effective
October 23, 2002. Reimbursement arrangements with other health care providers,
including pharmacies, generally renew automatically or are negotiated annually
and are based on several different payment methods, including per diems (where
the reimbursement rate is based on a per day of service charge for specified
types of care), capitation or modified fee-for-service arrangements. To the
extent possible, when negotiating non-physician provider arrangements, we
solicit competitive bids.
We utilize two reimbursement methods for health care providers rendering
services under our indemnity plans. For services to members utilizing a PPO
plan, we reimburse participating physicians on a modified fee-for-service basis,
which incorporates a limited fee schedule and reimburses hospitals on a per diem
or discounted fee-for-service basis. For services rendered under a standard
indemnity plan, pursuant to which a member may select a non-plan provider, we
reimburse non-contracted physicians and hospitals at pre-established rates, less
deductibles and co-insurance amounts.
We manage health care costs through our large case management program,
utilization review, monitoring care in the appropriate setting and by educating
our members on how and when to use the services of our plans and how to manage
chronic disease conditions. We audit hospital bills and review hospital and high
volume providers' claims to ensure appropriate billing and utilization patterns.
We also monitor the referral process from the primary care physician to the
specialty network for appropriateness. Further, in Nevada, we utilize our home
health care agency and our hospice, which help to minimize hospital admissions
and the length of stay.
Military Contract Services. Under the TRICARE contract, dependents of active
duty military personnel and military retirees and their dependents choose one of
three option plans available to them for health care services: (i) TRICARE Prime
(an HMO style option with a self-selected primary care manager and no
deductibles), (ii) TRICARE Extra (a PPO style option with deductibles and cost
shares) or (iii) TRICARE Standard (an indemnity style option with deductibles
and cost shares). Approximately 36% of eligible beneficiaries receive their
primary care through existing military treatment facilities. SMHS negotiated
discounted contracts with approximately 32,000 individual providers, 2,000
institutions and 8,000 pharmacies to provide supplemental network access for
TRICARE Prime and Extra beneficiaries. SMHS' contracts with providers are
primarily on a discounted fee-for-service basis with renewal and termination
terms similar to our commercial practice. SMHS is at-risk for and manages the
health care service cost of all TRICARE Extra and Standard beneficiaries as well
as a small percentage of TRICARE Prime beneficiaries.
SMHS implemented the TRICARE Senior Pharmacy Program, or Senior RX, on April 1,
2001. The Senior RX program enables Military Health Services Medicare eligible
beneficiaries, age 65 and over, to obtain prescription drugs, and the supplies
necessary for the administration of pharmaceuticals, from a network retail
pharmacy, non-network retail pharmacy or through the National Mail Order
Pharmacy. SMHS does not assume any risk under this new program.
On October 1, 2001, SMHS implemented the TRICARE for Life program. This new DoD
program provides continued TRICARE coverage to military family retirees over the
age of 65 as a supplement to Medicare. SMHS does not assume any risk under this
new program.
Risk Management
We maintain general and professional liability and property and fidelity
insurance coverage in amounts that we believe are adequate for our operations.
Effective June 15, 2001 our health care organization and provider liability
policy, combined with our managed care organization errors and omissions
liability policy, provides insurance for professional, managed care, general and
employee benefit exposures with a self insured retention of $500,000 per claim
and a liability limit of $10 million per claim. Our combined self insured
retention aggregate limit on this policy is $15 million. We also have an excess
professional liability policy which insures these risks for an additional $15
million per claim and in the aggregate. Acts of liability prior to June 15, 2001
were insured as follows: Nevada and Arizona liabilities for medical malpractice
were insured per claim and in the aggregate with a total limit of $20 million
(less any previous claims against the aggregate) with a self insured retention
of $250,000 per claim with an aggregate retention of $1.5 million. Prior to June
15, 2001, medical malpractice liability in Texas had a total limit of $30
million (less any previous claims against the aggregate) with first dollar
coverage. All managed care risks prior to June 15, 2001 was insured to a $25
million liability limit (less any previous claims against the aggregate) with a
$15,000 deductible per claim. In addition, we require all of our independently
contracted provider physician groups, individual practice physicians,
specialists, dentists, podiatrists and other health care providers (with the
exception of certain hospitals) to maintain professional liability coverage.
Certain of the hospitals with which we contract are self-insured. We also
maintain stop-loss insurance that reimburses us between 50% and 90% of hospital
charges for each individual member of our HMO or managed indemnity plans whose
hospital expenses exceed, depending on the contract, $75,000 to $200,000, during
the contract year and up to $2.0 million per member per lifetime.
We also maintain excess catastrophic coverage for one of our wholly-owned HMOs,
Health Plan of Nevada, Inc., or HPN, that reimburses us for amounts by which the
ultimate net loss exceeds $400,000, but does not exceed the annual maximum of
$19.6 million per occurrence and $39.2 million per contract. In the ordinary
course of business, we are subject to claims that are not insured, principally
claims for punitive damages.
Effective July 1, 1998, all workers' compensation claims with dates of injury
occurring on or after that date were reinsured under a quota share and excess of
loss agreement, which we refer to as "low level" reinsurance, with Travelers
Indemnity Company of Illinois, or Travelers. Travelers is rated AA and A++ by
Fitch Ratings and the A.M. Best Company, respectively. The low level reinsurance
provided quota share protection for 30% of the first $10,000 of each loss, and
excess of loss protection of 75% of the next $40,000 of each loss, and 100% of
the next $450,000 on a per occurrence basis. The maximum net loss retained on
any one claim ceded under this treaty was $17,000. This agreement continued
until June 30, 2000, when we exercised an option for a twelve month extension
relating to the run-off of policies in force as of June 30, 2000, which covered
claims arising under such policies during the term of the extension.
In addition to the low level reinsurance, effective January 1, 2000 we entered
into a reinsurance contract that provides statutory (unlimited) coverage for
workers' compensation claims in excess of $500,000 per occurrence. The contract
is in effect for claims occurring on or after January 1, 2000 through December
31, 2002. There is a twelve month run out provision in the contract which we
intend to execute. The reinsurer, National Union Fire Insurance Company, is
rated AAA and A++ by Fitch Ratings and the A.M. Best Company, respectively.
When the low level reinsurance agreement expired on June 30, 2000, as a result
of a general tightening of the reinsurance market as well as the impact of the
increased loss experience in California, a comparable type of reinsurance
program was unavailable in the market and those reinsurers which were offering
other forms of lower retention programs were charging premiums that we believed
were not cost justified. Therefore, effective July 1, 2000, we entered into a
reinsurance contract with National Union Fire Insurance Company that provided
$250,000 of coverage for workers' compensation claims in excess of $250,000 per
occurrence. The contract was in effect for claims occurring on policies with
effective dates beginning July 1, 2000 and thereafter and for claims incurred
prior to July 1, 2001. As a result of the general tightening of the reinsurance
market, we expect all of our insurance costs to increase significantly upon
renewal.
Information Systems
We use information systems to support, among other things, pricing our services,
monitoring utilization and other cost factors, providing bills on a timely
basis, identifying accounts for collection, processing claims for reimbursement,
delivering customer service and handling various accounting and reporting
functions. In 2001, we upgraded some of our core application systems to more
current releases to ensure that we maintain the vendors' support for ongoing
maintenance and enhancements. We also expanded our secure Internet-based access
to basic eligibility, benefits and claims information to health care providers,
covered members, group customers and brokers. We view our information systems
capability as critical to the performance of ongoing administrative functions
and integral to quality assurance and the coordination of patient care. We are
continually modifying or improving our information systems capabilities in an
effort to improve operating efficiencies and service levels.
Quality Assurance and Improvement
We promote continuous improvement in the quality of member care and service
through our quality programs. Our quality programs are a combination of quality
assurance activities, including the retrospective monitoring and problem solving
associated with the quality of care delivered and continuous quality improvement
activities including the trending and analysis of ongoing aggregate data for
purposes of prospective planning.
Our quality assurance methodology is based on (i) reviews of adverse health
outcomes as well as appropriateness and quality of care; (ii) focused reviews of
high volume/high risk diagnoses or procedures; (iii) monitoring for trends; (iv)
peer review of the clinical process of care; (v) development and implementation
of corrective action plans, as appropriate; (vi) monitoring compliance/adherence
to corrective action plans; and (vii) assessment of the effectiveness of the
corrective action plans.
Our quality improvement methodology is based on (i) collection and analysis of
data; (ii) analysis of barriers to achieving goals and/or benchmarks; (iii)
development and implementation of interventions to address barriers; (iv)
remeasurement of data to assess effectiveness of interventions; (v) development
and implementation of new or additional interventions, as appropriate; and (vi)
follow-up remeasurement of data to assess effectiveness or sustained impact.
Several independent organizations have been formed for the purpose of responding
to external demands for accountability in the health care industry. We have
voluntarily elected to be evaluated by two of these external organizations, the
National Committee for Quality Assurance, or NCQA, and the American
Accreditation Healthcare Commission, or URAC. NCQA is an independent,
not-for-profit organization that evaluates managed care organizations. URAC is a
non-profit charitable organization founded in 1990 to establish standards for
the managed care industry.
The NCQA accreditation process includes rigorous evaluations conducted by a team
of physicians and managed care experts. According to NCQA officials, the
standards are purposely set high to encourage health plans to continuously
enhance their quality. No comparable evaluation exists for fee-for-service
health care. NCQA evaluates plans on approximately 50 quality standards that
fall into six categories: quality management and improvement; physician
credentials; members' rights and responsibilities; preventive health services;
utilization management; and medical records. In 2000, HPN earned an "Accredited"
status from the NCQA for its HMO and Medicare products.
HPN, Sierra Health and Life Insurance Co. Inc., or SHL, Sierra Healthcare
Options, Inc. and Behavioral Healthcare Options, Inc. utilization management
operations were "Fully Accredited" by URAC, under URAC's "Health Utilization
Management, or UM, Standards" program. URAC's health UM accreditation program is
the largest and most recognized program of its type in the United States. The
health UM standards are meant to ensure organizations follow a process that is
clinically sound, promotes quality care and respects members' rights. The health
UM standards address eight categories including the following: confidentiality,
staff qualifications, program qualifications, information upon which
organizations conduct UM, procedures for review determination and procedures for
appeals of determinations not to certify (expedited and standard appeals). Once
the review team is satisfied that the organization is in compliance with the
Standards, the accreditation application is forwarded to the URAC Accreditation
committee. This Committee consists of representatives from the URAC member
organizations and industry experts. Final approval for accreditation is made by
URAC's executive committee. URAC accreditation is awarded for two years, we
received our latest accreditation in 2001.
There can be no assurance, however, that we will maintain NCQA or other
accreditations in the future and there is no basis to predict what effect, if
any, the lack of NCQA or other accreditations could have on HPN's competitive
position in Nevada.
Underwriting
HMO. We structure premium rates for our various health plans primarily through a
community rating by class method. Under the community rating by class method,
all costs of basic benefit plans for our entire membership population are
aggregated. These aggregated costs are calculated on a "per member per month"
basis and converted to premium rates for various coverage types, such as single
or family coverage. Actuarial adjustments to premium rates are made for
demographic variations specific to each employer group including the average age
and sex of their employees, group size and industry. All employees of an
employer group are charged the same premium rate if the same coverage is
selected.
In addition to premiums paid by employers, members also pay co-payments at the
time certain services are provided. We believe that co-payments encourage
appropriate utilization of health care services while allowing us to offer
competitive premium rates. We also believe that the capitation method of
provider compensation encourages physicians to provide only medically necessary
and appropriate care.
Managed Indemnity. Premium charges for our managed indemnity products are set in
a manner similar to the community rating by class method described above. This
rate calculation utilizes similar demographic adjustment factors including age,
sex and industry factors to develop group-specific adjustments from a given per
member per month base rate by plan. Actual health claim experience is used in
whole or in part to develop premium rates for larger insurance member groups.
This process includes the use of utilization experience, adjustments for
incurred but not reported claims, inflationary factors, credibility and specific
reinsurance pooling levels for large claims.
Workers' Compensation. Prior to insuring a particular risk, we review, among
other factors, the employer's prior loss experience and other pertinent
underwriting information. Additionally, we determine whether the employer's
employment classifications are among the classifications that we have elected to
insure and if the amounts of the premiums for the classifications are within our
guidelines. We review these classifications periodically to evaluate whether
they are profitable. Of the approximately 500 employment classifications in
California, we are willing to insure approximately one-half. The remaining
classifications are either excluded by our reinsurance treaty or are believed by
us to be too hazardous or not profitable. In addition, we increase our
requirements for certain classifications to increase the likelihood of
profitability.
Once an employer has been insured by us, our loss control department may assist
the insured in developing and maintaining safety programs and procedures to
minimize on-the-job injuries and industrial health hazards. The safety programs
and procedures vary from insured to insured. Depending upon the size,
classifications and loss experience of the employer, our loss control department
will periodically inspect the employer's place of business and may recommend
changes that could prevent industrial accidents. In addition, severe or
recurring injuries may also warrant on-site inspections. In certain instances,
members of our loss control department may conduct special educational training
sessions for insured employees to assist in the prevention of on-the-job
injuries. For example, employers engaged in contracting may be offered a
training session on general first aid and prevention of injuries from specific
work exposures.
Competition
HMO and Managed Indemnity. Managed care companies and HMOs operate in a highly
competitive environment. Our major competition is from self-funded employer
plans, PPO networks, other HMOs, such as Nevada Care, Inc., Pacificare Health
Systems, Inc., and Aetna and traditional indemnity carriers, such as Blue
Cross/Blue Shield. Many of our competitors have substantially larger total
enrollments, greater financial resources and offer a broader range of products.
Additional competitors with greater financial resources may enter our markets in
the future. We believe that the most important competitive factors are the
delivery of reasonably priced, quality medical benefits to members and the
adequacy and availability of health care delivery services and facilities. We
depend on a large PPO network and flexible benefit plans to attract new members.
Competitive pressures may result in reduced membership levels. Any reductions
could materially affect our results of operations.
Workers' Compensation. Our workers' compensation business is concentrated in
California, a state where the workers' compensation insurance industry is
extremely competitive. When open rating became effective for policyholders in
1995, there were substantial reductions in premiums. Starting in the latter part
of 1999 however, we and other carriers began increasing rates. In 2000 and 2001,
we received increases on policies renewed in California of 26% and 38%,
respectively. Based on public information, other California workers'
compensation companies issued year 2001 policies at rates averaging 22% in
excess of the expiring rates. For the first two months of 2002, the average
renewal rate increase for our California policies was approximately 33%.
Approximately 160 companies wrote workers' compensation insurance in California
in 2001, including the State Compensation Insurance Fund, which is the largest
writer in California. Many of our competitors have been in business longer, have
a larger volume of business, offer a more diversified line of insurance coverage
and have greater financial resources and distribution capability than we do.
Losses and Loss Adjustment Expenses
In workers' compensation insurance, several years may elapse between the
occurrence of a loss and the final settlement of the loss. To recognize
liabilities for unpaid losses, we establish reserves, which are balance sheet
liabilities representing estimates of future amounts needed to pay claims and
related expenses for insured events, including reserves for events that have
been incurred but not reported or IBNR.
When a claim is reported, our claims personnel initially establish reserves on a
case-by-case basis for the estimated amount of the ultimate payment. These
estimates reflect the judgment of the claims personnel based on their experience
and knowledge of the nature and value of the specific type of claim and the
available facts at the time of reporting as to severity of injury and initial
medical prognosis. Included in these reserves are estimates of the expenses of
settling claims, including legal and other fees. Claims personnel adjust the
amount of the case reserves as the claim develops and as the facts warrant.
IBNR reserves are established for unreported claims and loss development
relating to current and prior accident years. In the event that a claim that
occurred during a prior accident year was not reported until the current
accident year, the case reserve for the claim typically will be established out
of previously established IBNR reserves for that prior accident year.
Unallocated loss adjustment expense reserves are established for the estimated
costs related to the general administration of the claims adjustment process.
The National Association of Insurance Commissioners requires that we submit a
formal actuarial opinion concerning loss reserves with each statutory annual
report. The annual report must be filed with each applicable state department of
insurance on or before March 1st of the succeeding year. The actuarial opinion
must be signed by a qualified actuary as determined by the applicable state
insurance regulators. We retain the services of a qualified independent actuary
to periodically review our loss reserves.
We review the adequacy of our reserves on a periodic basis and consider external
forces including changes in the rate of inflation, the regulatory environment,
the judicial administration of claims, medical costs and other factors that
could cause actual losses and loss adjustment expenses, or LAE to change.
Reserves are reviewed with our independent actuary at least annually and usually
twice a year. The actuarial projections include a range of estimates reflecting
the uncertainty of projections. We evaluate the reserves in the aggregate, based
upon the actuarial indications, and make adjustments where appropriate. Our
consolidated financial statements provide for reserves based on the anticipated
ultimate cost of losses. We also supplement our analyses by comparing our paid
losses and incurred losses to similar data provided by the Workers' Compensation
Insurance Rating Bureau of California for all California workers' compensation
insurance companies.
Government Regulation and Recent Legislation
HMOs and Managed Indemnity. Federal and state governments have enacted statutes
that extensively regulate the activities of HMOs. Among the areas regulated by
federal and state law are the scope of benefits available to members, grievances
and appeals, prompt payment of claims, premium structure, procedures for review
of quality assurance, enrollment requirements, the relationships between an HMO
and its health care providers and members, licensing and financial condition.
Government concerns regarding increasing health care costs and quality of care
could result in new or additional state or federal legislation that would impact
health care companies, including HMOs, PPOs and other health insurers.
Government regulation of health care coverage products and services is a dynamic
area of law that varies from jurisdiction to jurisdiction. Amendments to
existing laws and regulations are continually being considered and
interpretation of the existing laws and rules changes from time to time.
Regulatory agencies generally exercise broad discretion in interpreting laws and
promulgating regulations to enforce their interpretations.
While we are unable to predict what legislative or regulatory changes may occur
or the impact of any particular change, our operations and financial results
could be negatively affected by any legislative or regulatory requirements. For
example, any proposals to eliminate or reduce the Employee Retirement Income
Security Act, or ERISA, which regulates insured and self-insured health care
coverage plans offered by employers, pre-emption of state laws that would
increase litigation exposure, affect underwriting practices, limit rate
increases, require new or additional benefits or affect contracting arrangements
(including proposals to require HMOs and PPOs to accept any health care provider
willing to abide by an HMO's or PPO's contract terms) may have a material
adverse effect on our business. The continued consideration and enactment of
"anti-managed care" laws and regulations by federal and state bodies may make it
more difficult for us to manage medical costs and may adversely affect financial
results.
The Secretary of the U.S. Department of Health and Human Services, or HHS, has
established a committee on regulatory reform. This committee will help guide
HHS' efforts to streamline unnecessarily burdensome and inefficient regulations
for the Medicare and Medicaid populations, both of which we arrange services for
under our managed care programs.
In addition to changes in existing laws and regulations, we are subject to
audits, investigations and enforcement actions. These include possible
government actions relating to ERISA, the Federal Employees Health Benefit Plan,
federal and state fraud and abuse laws and laws relating to utilization
management and the delivery and payment of health care. In addition, our
Medicare business is subject to Medicare regulations promulgated by CMS.
Violation of government laws and regulations may result in an assessment of
damages, civil or criminal fines or penalties, or other sanctions, including
exclusion from participation in government programs. In addition, disclosure of
any adverse investigation or audit results or sanctions could negatively affect
our reputation in various markets and make it more difficult for us to sell our
products and services.
There has been Congressional activity in Washington D.C. relative to Medicare
and the Medicare+Choice programs. Unfortunately, Congress concluded the 2001
legislative session without taking final action on issues of importance to us,
including increased funding for the Medicare+Choice programs and repeal or delay
of the "lock-in" requirement.
The "lock-in" provisions become effective January 1, 2002. Under the "lock-in"
provisions of the Medicare+Choice program, beneficiaries may elect plans
(including other plans offered by a Medicare+Choice Organization (M+CO) or the
original Medicare plan) only during the Annual Election Period (AEP) in November
or once during the Open Enrollment Period (OEP) from January through the end of
June. Starting in 2003, the OEP extends only from January through the end of
March. With a few exceptions, a Medicare beneficiary cannot enroll in or
disenroll from a Medicare+Choice plan, or return to the original Medicare plan,
at any other time of the year.
We have HMO licenses in Nevada, Texas and Arizona. Our HMO operations are
subject to regulation by the Nevada Division of Insurance, the Nevada State
Board of Health, the Texas Department of Insurance and the Arizona Department of
Insurance. In May 2001, we terminated our HMO operations in Arizona and filed a
withdrawal plan with the Department of Insurance in Texas to terminate our Texas
HMO operations effective on April 17, 2002 for business reasons. As part of the
withdrawal plan from Texas, we terminated our CMS Medicare+Choice and Federal
Employees Health Benefits Program contracts at the end of 2001.
Our HMOs are federally qualified under the Federal HMO Act and are subject to
the Act and its regulations. In order to obtain federal qualification, an HMO
must, among other things, provide its members certain services on a fixed,
prepaid fee basis and set its premium rates in accordance with certain rating
principles established by federal law and regulation. The HMO must also have
quality assurance programs in place with respect to our health care providers.
Furthermore, an HMO may not refuse to enroll an employee, in most circumstances,
because of a person's health, and may not expel or refuse to re-enroll
individual members because of their health or their need for health services.
Our managed indemnity health insurance subsidiary is domiciled and incorporated
in California and is licensed in 43 states and the District of Columbia. It is
subject to licensing and other regulations of the California Department of
Insurance as well as the insurance departments of the other states in which it
operates or holds licenses.
Our HMO and health insurance subsidiary insurance premium rate increases are
subject to various state insurance department approvals.
Our Nevada HMO and managed indemnity health insurance subsidiary currently
maintain a home office and a regional home office, respectively, in Las Vegas
and, accordingly, are eligible for certain premium tax credits in Nevada. We
intend to take all necessary steps to continue to comply with eligibility
requirements for these credits. The elimination or reduction of the premium tax
credit would have a material adverse effect on our results of operations.
Under the "corporate practice of medicine" doctrine, in most states, business
organizations, other than those authorized to do so, are prohibited from
providing, or holding themselves out as providers of, medical care. Some states,
including Nevada, exempt HMOs from this doctrine. The laws relating to this
doctrine are subject to numerous conflicting interpretations. Although we seek
to structure our operations to comply with corporate practice of medicine laws
in all states in which we operate, there can be no assurance that, given the
varying and uncertain interpretations of those laws, we would be found to be in
compliance with those laws in all states. A determination that we are not in
compliance with applicable corporate practice of medicine laws in any state in
which we operate could have a material adverse effect on us if we were unable to
restructure our operations to comply with the laws of that state.
Certain Medicare and Medicaid antifraud and abuse provisions are codified at 42
U.S.C. Sections 1320a-7(b) (the Anti-kickback Statute) and 1395nn (the Stark
Amendments). Many states have similar anti-kickback and anti-referral laws.
These statutes prohibit certain business practices and relationships involving
the referral of patients for the provision of health care items or services
under certain circumstances. Violations of the Anti-kickback Statute and the
Stark Amendments may result in criminal penalties, civil sanctions, fines and
possible exclusion from the Medicare, Medicaid and other federal health care
programs. Similar penalties are provided for violation of state anti-kickback
and anti-referral laws. HHS has issued regulations establishing and defining
"safe harbors" with respect to the Anti-kickback Statute and the Stark
Amendments. We believe that our business arrangements and operations are in
compliance with the Anti-kickback Statute and the Stark Amendments as defined by
the relevant safe harbors. However, there can be no assurance that (i)
government officials charged with responsibility for enforcing the prohibitions
of the Anti-kickback Statute and the Stark Amendments or Qui Tam relators
purporting to act on behalf of the Government will not assert that we, or
certain conduct in which we are involved, are in violation of those statutes;
and (ii) such statutes will ultimately be interpreted by the courts in a manner
consistent with our interpretation.
We participate in a consortium of health plans whose work includes seeking
legislative permanency for the Social HMO programs. The Social HMO is a
Medicare+Choice demonstration program that enables our Nevada HMO to offer
extended benefits to seniors will expire at the end of 2003. The majority of our
Medicare members are enrolled in the Social HMO program and the discontinuation
of the program may negatively impact our operating results or financial
condition.
The Federal Health Insurance Portability and Accountability Act of 1996, or
HIPAA, contains provisions that impact us and will require operational changes
as various federal departmental regulations required by the Act are promulgated.
With certain conditions imposed, the compliance date of the regulation that
establishes standards for electronic transactions and code sets has been delayed
one year to October 1, 2003. One of the conditions of the delay is that health
plans must request an extension of time by filing a summary report of their
implementation plans with HHS by October 16, 2002. We intend on requesting an
extension of time by filing a summary report prior to the October deadline. The
health information privacy rule component of HIPAA requires compliance by April
14, 2003.
Work is underway to meet the requirements of all HIPAA related regulations
impacting us. Failure to comply with the standards and implementation
specifications of HIPAA regulations could result in investigation by the Office
of Civil Rights of HHS and the imposition of criminal penalties and civil
sanctions, including fines. At this time, we cannot quantify the cost of
compliance or the impact it will have on our business. There can be no assurance
that the costs to implement and to comply will not adversely affect our
operating results or financial condition.
In November 2000, the Department of Labor published the final regulation on
ERISA claims procedures, the first major revision of the existing claims
procedure requirements since 1977. The regulation applies to all employee
benefit plans governed by ERISA, whether the benefits are provided through
insurance products or are self-funded. This regulation impacts our third party
administrator services and potentially other operations and will apply to all
claims filed on or after January 1, 2002.
Workers' Compensation. We are subject to extensive governmental regulation and
supervision in each state in which we conduct workers' compensation business.
The primary purpose of the regulation and supervision is to provide safeguards
for policyholders and injured workers rather than protect the interests of
shareholders. The extent and form of the regulation may vary, but generally it
has its source in statutes that establish regulatory agencies and delegate to
the regulatory agencies broad regulatory, supervisory and administrative
authority. Typically, state regulations extend to matters such as licensing
companies; restricting the types or quality of investments; requiring triennial
financial examinations and market conduct surveys of insurance companies;
licensing agents; regulating aspects of a company's relationship with its
agents; restricting use of some underwriting criteria; regulating premium rates,
forms and advertising; limiting the grounds for cancellation or nonrenewal of
policies; solicitation and replacement practices; and specifying what might
constitute unfair practices.
Typically, states mandate participation in insurance guaranty associations,
which assess solvent insurance companies in order to fund claims of
policyholders of insolvent insurance companies. Under this arrangement, insurers
can be assessed up to 1%, or 2% in certain states, of premiums written for
workers' compensation insurance in that state each year to pay losses and LAE on
covered claims of insolvent insurers. In certain states, insurance companies are
allowed to recoup such assessments from policyholders while several states allow
an offset against premium taxes. In California, insurance companies are required
to recoup guaranty fund assessments from policyholders. California assessments
are recorded as an asset and all other assessments are expensed as incurred.
Starting in 2000, the California Insurance Guarantee Association, or CIGA,
issued assessments as a result of the insolvency of the insurers owned by
Superior National Insurance Group and other insolvent workers' compensation
insurance companies. The assessments are initially made on direct premiums
written reported in the prior year and are subsequently adjusted to the actual
direct premiums written in the following year. For example, CIGA issued an
assessment in 2000 using the 1999 direct premiums written as the initial
assessment. We began recouping the assessment on policies effective January 1,
2001. Our initial assessment will be adjusted to our actual premiums written in
2001. Any difference between the actual and initial premiums written would be
either refunded to the member insurer, in the case of lower actual premiums, or
an additional assessment imposed, in the case of higher actual premiums. In
addition, any excess assessments that we recoup would have to be paid to CIGA.
The CIGA assessments are recorded as an asset, which is reduced as we recoup the
assessments. On an on-going basis, we evaluate the asset for impairment. In
2000, CIGA assessed us 1% of the 1999 direct premiums written for $1.2 million.
In 2001, CIGA assessed us 2% of the 2000 direct premiums written for $3.1
million. In January 2002, CIGA assessed an additional 2% of the 2000 direct
written premiums for $3.1 million. These assessments are being recouped starting
with policies effective January 1, 2001 through December 31, 2003.
There were no assessments by non-California states in 2000 and total assessments
by all other states were less than $300,000 in 2001. It is likely that guarantee
fund assessments related to insolvent workers' compensation insurance companies
will continue for the next several years.
General. Besides state insurance laws, we are subject to general business and
corporation laws, federal and state securities laws, consumer protection laws,
fair credit reporting acts and other laws regulating the conduct and operation
of our subsidiaries.
In the normal course of business, we may disagree with various government
agencies that regulate our activities on interpretations of laws and
regulations, policy wording and disclosures or other related issues. These
disagreements, if left unresolved, could result in administrative hearings
and/or litigation. We attempt to resolve all issues with the regulatory
agencies, but are willing to litigate issues where we believe we have a strong
position. The ultimate outcome of these disagreements could result in sanctions
and/or penalties and fines assessed against us. Currently, there are no
litigation matters pending with any government agencies.
Deposits. Our HMO and insurance subsidiaries are required by state regulatory
agencies to maintain certain deposits and must also meet certain net worth and
reserve requirements. The HMO and insurance subsidiaries had restricted assets
on deposit in various states totaling $26.0 million at December 31, 2001. The
HMO and insurance subsidiaries must also meet requirements to maintain minimum
stockholders' equity, on a statutory basis, as well as minimum risk-based
capital requirements, which are determined annually. Additionally, in
conjunction with the Kaiser-Texas acquisition, TXHC entered into a letter
agreement with the Texas Department of Insurance whereby TXHC agreed to maintain
a net worth of $20.0 million, on a statutory basis, until certain income levels
are achieved. In conjunction with the exit from the Texas HMO health care
market, the Texas Department of Insurance approved a plan of withdrawal and TXHC
is now required to maintain deposits and net worth of $3.5 million. We believe
we are in compliance with our regulatory requirements.
Dividends. Our HMO and insurance subsidiaries are restricted by state law as to
the amount of dividends or distributions that can be declared and paid.
Moreover, insurance companies and HMOs domiciled in Texas, Nevada and California
generally may not pay extraordinary dividends or distributions without providing
the state insurance commissioner with 30 days prior notice, during which period
the commissioner may disapprove the payment. An "extraordinary dividend or
distribution" is generally defined as a dividend or distribution whose fair
market value together with that of the other dividends or distributions made
within the preceding 12 months exceeds the greater of (i) ten percent of the
insurer's surplus as of the preceding December 31 or (ii) net gain from
operations of an insurer, if a life insurer, or net income if not a life
insurer, for the 12-month period ending on the preceding December 31.
In addition, our California domiciled insurance subsidiaries may not pay a
dividend without the prior approval of the state insurance commissioner to the
extent the cumulative amount of dividends or distributions paid or proposed to
be paid in any year exceeds the amount shown as unassigned funds (reduced by any
unrealized gains included in any such amount) on the insurer's statutory
statement as of the previous December 31.
In 2001, California Indemnity Insurance Company received prior approval to pay
an aggregate of $10 million in dividends, all of which was used to purchase or
retire the subordinated debentures.
We are not in a position to assess the likelihood of obtaining future approval
for the payment of dividends other than those specifically allowed by law in
each of our subsidiaries' state of domicile.
No prediction can be made as to whether any legislative proposals relating to
dividend rules in the domicilliary states of our subsidiaries will be made or
adopted in the future, whether the insurance departments of such states will
impose either additional restrictions in the future or a prohibition on the
ability of our regulated subsidiaries to declare and pay dividends or as to the
effect of any such proposals or restrictions on our regulated subsidiaries.
Employees
We had approximately 3,600 employees as of March 15, 2002. None of our employees
are covered by a collective bargaining agreement. We believe that our relations
with our employees are good.
Note on Forward-Looking Statements and Risk Factors
Forward-Looking Statements
This annual report on Form 10-K contains "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, both as amended.
The forward looking statements regarding Sierra Health Services, Inc.'s business
and results of operations should be considered by our stockholders or any reader
of our business or financial information along with the risk factors discussed
below. All statements other than statements of historical fact are
forward-looking statements for purposes of federal and state securities laws.
The cautionary statements are made pursuant to the "safe harbor" provisions of
the Private Securities Litigation Reform Act of 1995, as amended, and identify
important factors that could cause our actual results to differ materially from
those expressed in any projected, estimated or forward-looking statements
relating to us. These forward-looking statements are identified by their use of
terms and phrases such as "anticipate," "believe," "could," "estimate,"
"expect," "hope," "intend," "may," "plan," "predict," "project," "seeks,"
"will," "continue," and other similar terms and phrases, including references to
assumptions. Such forward-looking statements may be contained in the sections
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business," among other places.
Although we believe that the expectations reflected in any of our
forward-looking statements are reasonable, actual results could differ
materially from those projected or assumed in any of our forward-looking
statements.
In making these statements, we disclaim any intention or obligation to address
or update each factor in future filings or communications regarding our business
or results, and we do not undertake to address how any of these factors may have
caused changes to discussions or information contained in previous filings or
communications. In addition, any of the matters discussed below may have
affected our past results and may affect future results, so that our actual
results may differ materially from those expressed here and in prior or
subsequent communications.
We urge you to review carefully the section below, "Risk Factors," in this 2001
Form 10-K for a more complete discussion of the risks associated with an
investment in our securities.
Risk Factors
We are exiting the Texas health care market and we will cease providing coverage
on April 17, 2002. We have recorded reserves and accrued expenses for all
anticipated exit-related costs but unanticipated expenses could result in
additional losses during the run-out period.
We are exiting the Texas health care market and will stop providing health care
services on April 17, 2002. Unanticipated expenses, primarily related to legal
matters and provider settlements, could result in additional losses. In
addition, we are limited by our credit facility in the amount of funds we can
provide to our Texas health care operations. Should we exceed our limits, then
we would need approval by our banks to waive or amend this covenant or we would
be in default.
A variety of factors beyond our control could affect our results of operations.
Our results of operations can be adversely affected by the following:
o Loss of health care premium and workers' compensation insurance
premium revenues due to heightened competition;
o Inadequate premium revenues due to heightened competition,
miscalculations of underlying healthcare and workers' compensation
costs and other factors in our rate filings and in underwriting
accounts;
o Significant reductions in retaining accounts and members;
o Inability or delays in making timely changes to health care benefits
to offset the impact of inadequate premium rates;
o Loss of Medicare, Medicaid or TRICARE contracts;
o Inability to timely and fairly negotiate TRICARE change orders or
contract bid price adjustments with the Department of Defense;
o Inability to effectively manage the TRICARE contract and our at-risk
members;
o Loss of or significant changes in our health care provider contracts;
o Inability or unwillingness of our contracted providers to provide
health care services to our members;
o Significantly higher costs of medical malpractice insurance, reduced
coverage that increases our risk exposure or the unavailability of
coverage that either affect us or our contracted providers;
o Terrorist acts that directly affect the operation of our business or
our customers, policyholders and members;
o A sustained and severe economic recession, especially in Nevada or
California;
o Adverse loss development on healthcare payables and workers'
compensation insurance reserves resulting from unanticipated increases
or changes in our claims costs;
o Inability or unwillingness of our reinsurers to honor their
contractual obligations;
o Adverse legal judgments that are not covered by insurance or that
indirectly impact our ability to obtain insurance in the future at
reasonable costs;
o Significant declines in investment rates;
o New legislation, regulations or their interpretations, including the
impact of new legislation enacted in California in 2002 that will
increase benefits to injured workers starting January 1, 2003, which
increase our costs and exposure to lawsuits without a corresponding
increase in revenues;
o Inability to implement HIPAA privacy rules on a timely, accurate and
cost effective basis;
o A ratings downgrade from insurance rating agencies, such as A.M. Best
Company and Fitch Ratings, and from health care quality rating
organizations, such as the National Committee for Quality Assurance;
o Inability to maintain or enhance, as required, our management
information systems;
o Inability to expand our e-business initiatives on a timely basis and
in compliance with government regulations; or
o Power interruptions in California, where our workers' compensation
operations' main computer systems reside.
Our reinsurance costs may significantly increase or coverage may be limited,
which could adversely impact us.
Due to the September 11, 2001 terrorist acts, the reinsurance market has
contracted and reinsurance premium rates have significantly increased. We also
expect that reinsurers will try to limit their future exposure to terrorist
acts. If we are unable to adequately increase our premiums to cover the
anticipated increase in our reinsurance costs or the increase in risk exposure,
our operating results and financial condition may be materially affected.
If we are unable to comply with the terms of our credit facility, our borrowing
costs could increase and if we cannot refinance or pay the outstanding
indebtedness under the credit facility at maturity, our business could be
adversely affected.
We entered into an amended $185 million credit facility with the banks on
December 15, 2000, and this credit facility is guaranteed by our subsidiaries.
As of December 31, 2001, the outstanding balance under our credit facility was
$89 million and the credit facility limit was reduced to $117 million. The total
availability will be reduced by $6.0 million on June 30, 2002 and December 31,
2002 and finally by $10.0 million on June 30, 2003. There is no assurance that
we will be able to obtain future waivers if we are unable to meet the covenant
requirements or to cure a default on a timely basis. Failure to obtain a waiver
or to cure a default on a timely basis could result in significantly higher
borrowing costs and/or a demand for payment of the principal. The credit
facility matures on September 30, 2003 and there is no assurance that we can
successfully refinance or pay this debt when it matures. In addition, the loans
bear interest at a fluctuating rate, which could result in significantly higher
borrowing costs.
We are limited under our credit facility in the amount of funds we can transfer
to our discontinued Texas HMO health care operations. If we transfer more funds
during the run-out period then we are allowed, we would be out of compliance
with our credit facility. If additional funds are needed by our discontinued
Texas HMO health care operations and we do not transfer such funds, they may be
in violation of certain insurance regulations.
Under the terms of our credit facility agreement, after September 30, 2001 we
can invest an additional $5.0 million in the Texas operations and replace the
Texas real estate assets with cash and notes up to $46 million. Under the terms
of the amended and restated agreement, the use of Sierra funds to pay the
outstanding Texas mortgage note of $29.2 million is not considered an investment
in the Texas operations. During the fourth quarter of 2001, we invested in Texas
the full $5.0 million allowed under the amended and restated agreement. If we
had to invest more than we are allowed, we would be required to get a waiver or
an amendment to our agreement or be out of compliance. If additional funds are
needed by our discontinued Texas HMO health care operations and we do not
transfer such funds, they may be in violation of certain insurance regulations
and we may be required to get a waiver or an amendment to our agreement or be
out of compliance. There is no assurance that if we needed a bank waiver or
amendment that we would be able to obtain it. Failure to obtain a waiver or
amendment could result in significantly higher borrowing costs and/or a demand
for payment of the principal.
If we fail to qualify for the Nevada home office tax credit, our tax costs will
increase.
Under existing Nevada law, a 50% premium tax credit is generally available to
HMOs and insurers that own and substantially occupy home offices or regional
home offices within Nevada. In connection with the settlement of a prior dispute
concerning the premium tax credit, the Nevada Department of Insurance
acknowledged in November 1993 that our HMO and insurance subsidiaries met the
statutory requirements to qualify for this tax credit. We intend to take all
necessary steps to continue to comply with these requirements. The elimination
or reduction of the premium tax credit, or our failure to qualify for the
premium tax credit, would have a material adverse effect on our results of
operations.
We depend on our management for our success and the loss of our founder,
Chairman of the Board and Chief Executive Officer could have a material adverse
effect on our business.
Our success has been dependent to a large extent upon the efforts of Anthony M.
Marlon, M.D., our founder, Chairman of the Board and Chief Executive Officer,
who has an employment agreement with us. Although we believe that the
development of our management staff has made us less dependent on Dr. Marlon,
the loss of Dr. Marlon could still have a material adverse effect on our
business.
The price of our common stock has been volatile and we cannot assure you as to
the price at which our common stock will trade in the future.
There has been significant volatility in the market prices of securities of
companies in the health care industry, including the price of our common stock.
Many factors, including medical cost increases, research analysts' comments,
announcements of new legislative and regulatory proposals or laws relating to
health care reform, investor expectations, the trading volume of our common
stock, litigation and general economic and market conditions, will influence the
trading price of our common stock.
ITEM 2. DESCRIPTION OF PROPERTIES
On December 28, 2000, we finalized a sale-leaseback transaction that included
the majority of our administrative and clinical properties in Las Vegas totaling
approximately 478,000 square feet. The lease is for a term of fifteen years and
we have the option of five 5-year renewal periods. We lease additional office
and clinical space in Nevada totaling approximately 142,000 and 36,000 square
feet, respectively. HPN and SHL have retained ownership of a 134,000 square foot
administrative building at their Las Vegas headquarters, which serves as the
home office and a regional home office for our Nevada HMO and health insurance
subsidiaries, respectively.
In conjunction with the Kaiser-Texas acquisition, we purchased eight medical and
office facilities with approximately 323,000 square feet of clinical facilities
and approximately 175,000 square feet of administrative facilities. These
buildings are subject to a deed of trust note with an original balance of $35.2
million and a remaining principal balance of $22.7 million at December 31, 2001.
Approximately 47,000 square feet of the clinical and 60,000 square feet of the
administrative space are leased by outside parties. The Texas assets have been
written down to market value and are included in the assets of discontinued
operations. We are actively seeking a buyer for the assets and anticipate
selling them by the end of 2002.
The workers' compensation subsidiary is headquartered in Nevada and subleases
space from us in one of the buildings included in the sale-leaseback transaction
as well as an additional approximately 75,000 square feet of leased office space
in California, Colorado and Texas.
We lease approximately 125,000 square feet of office space in other various
states as needed for the military subsidiary's administrative headquarters,
TRICARE service centers and other regional operations.
We believe that current and planned clinical space will be adequate for our
present needs. However, additional clinical space may be required if membership
expands in southern Nevada.
ITEM 3. LEGAL PROCEEDINGS
We are subject to various claims and other litigation in the ordinary course of
business. Such litigation includes, for example, claims of medical malpractice,
claims for coverage or payment for medical services rendered to HMO members and
insureds and claims by providers for payment for medical services rendered to
HMO members. Also included in such litigation are claims for workers'
compensation and claims by providers for payment of medical services rendered to
injured workers. In the opinion of our management, the ultimate resolution of
pending legal proceedings should not have a material adverse effect on our
financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Market Information
Our common stock, par value $.005 per share (the "Common Stock"), has been
listed on the New York Stock Exchange under the symbol SIE since April 26, 1994
and, prior to that, had been listed on the American Stock Exchange since our
initial public offering on April 11, 1985. The following table sets forth the
high and low sales prices for the Common Stock for each quarter of 2001 and
2000.
Period High Low
------ ---- ---
2001
First Quarter........................................ $ 6.70 $3.59
Second Quarter....................................... 7.04 4.06
Third Quarter........................................ 10.97 6.35
Fourth Quarter....................................... 9.75 6.97
2000
First Quarter........................................ $ 8.25 $4.31
Second Quarter....................................... 5.13 2.75
Third Quarter........................................ 4.75 2.44
Fourth Quarter....................................... 6.00 2.75
On March 18, 2002, the closing sale price of Common Stock was $11.62 per share.
Holders
The number of record holders of Common Stock at March 15, 2002 was 211. Based
upon information available to us, we believe there are approximately 6,200
beneficial holders of the Common Stock.
Dividends
No cash dividends have been paid on the Common Stock since our inception. We
currently intend to retain our earnings for use in our business and do not
anticipate paying any cash dividends in the foreseeable future. As a holding
company, our ability to declare and to pay dividends is dependent upon cash
distributions from our operating subsidiaries. The ability of our HMOs and our
insurance subsidiaries to declare and pay dividends is limited by state
regulations applicable to the maintenance of minimum deposits, reserves and net
worth. The declaration of any future dividends will be at the discretion of our
Board of Directors and will depend on, among other things, future earnings, debt
covenants, operations, capital requirements, our financial condition and general
business conditions.
ITEM 6. SELECTED FINANCIAL DATA
The table below presents our selected consolidated financial information for the
years indicated. The table should be read in conjunction with the Consolidated
Financial Statements and the related Notes thereto, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and other information
which appears elsewhere in this 2001 Form 10-K. The selected consolidated
financial data below has been derived from our audited Consolidated Financial
Statements.
Years Ended December 31,
2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ----------
(In thousands, except per share data)
Statements of Operations Data:
OPERATING REVENUES:
Medical Premiums......................................... $ 718,994 $ 637,769 $ 594,966 $ 528,759 $481,449
Military Contract Revenues............................... 338,918 330,352 287,398 204,838 4,346
Specialty Product Revenues............................... 183,306 135,844 94,221 148,368 146,211
Professional Fees........................................ 28,985 33,102 42,069 43,609 31,238
Investment and Other Revenues............................ 21,298 22,513 20,411 28,898 25,912
--------- --------- --------- -------- -------
Total.................................................. 1,291,501 1,159,580 1,039,065 954,472 689,156
--------- --------- --------- -------- -------
OPERATING EXPENSES:
Medical Expenses......................................... 608,757 576,738 534,606 440,265 391,507
Military Contract Expenses............................... 331,621 323,265 276,493 196,625 4,193
Specialty Product Expenses............................... 188,574 152,733 96,487 142,258 143,082
General, Administrative and Marketing Expenses........... 117,717 105,314 94,428 95,633 87,164
Asset Impairment, Restructuring,
Reorganization and Other Costs (1).................... 33,836 7,808 13,851 29,350
---------- --------- --------- -------- -------
Total.................................................. 1,246,669 1,191,886 1,009,822 888,632 655,296
--------- --------- --------- -------- -------
OPERATING INCOME (LOSS) FROM
CONTINUING OPERATIONS................................... 44,832 (32,306) 29,243 65,840 33,860
INTEREST EXPENSE AND OTHER, NET............................. (18,563) (19,362) (16,511) (7,021) (3,873)
--------- --------- --------- -------- -------
INCOME (LOSS) FROM CONTINUING
OPERATIONS BEFORE INCOME TAXES.......................... 26,269 (51,668) 12,732 58,819 29,987
(PROVISION) BENEFIT FOR INCOME TAXES........................ (8,803) 12,875 (2,209) (13,796) (3,234)
--------- --------- --------- -------- -------
NET INCOME (LOSS) FROM
CONTINUING OPERATIONS.................................... 17,466 (38,793) 10,523 45,023 26,753
LOSS FROM DISCONTINUED OPERATIONS........................... (13,980) (161,122) (15,154) (5,427) (2,512)
--------- --------- --------- -------- -------
NET INCOME (LOSS)........................................... $ 3,486 $ (199,915) $ (4,631) $ 39,596 $ 24,241
========= ========= ========= ======== =======
EARNINGS PER COMMON SHARE (2):
Net Income (Loss) From Continuing Operations............. $0.63 $(1.43) $0.39 $1.65 $0.99
Loss from Discontinued Operations........................ (0.50) (5.94) (0.56) (0.20) (0.09)
----- ----- ----- ------ -----
Net Income (Loss)........................................ $0.13 $(7.37) $(0.17) $1.45 $0.90
==== ===== ===== ==== ====
Weighted Average Number of Common
Shares Outstanding..................................... 27,685 27,142 26,927 27,391 27,013
====== ====== ====== ====== ======
EARNINGS PER COMMON SHARE ASSUMING DILUTION (2):
Net Income (Loss) From Continuing Operations............. $0.61 $(1.43) $0.39 $1.63 $0.97
Loss from Discontinued Operations........................ (0.49) (5.94) (0.56) (0.20) (0.09)
----- ----- ----- ----- -----
Net Income (Loss)........................................ $0.12 $(7.37) $(0.17) $1.43 $0.88
==== ===== ===== ==== ====
Weighted Average Number of Common
Shares Outstanding Assuming Dilution................... 28,509 27,142 26,996 27,747 27,426
====== ====== ====== ====== ======
December 31,
2001 2000 1999 1998 1997
---------- ---------- ----------- ---------- --------
(In thousands)
Balance Sheet Data:
Working Capital..................................... $ 106,119 $ 78,317 $ 264,973 $ 176,775 $219,975
Total Assets........................................ 1,069,962 1,165,100 1,130,112 1,045,120 723,936
Long-term Debt (Net of Current Portion)............. 181,759 224,970 224,076 206,948 90,841
Cash Dividends Per Common Share..................... none none none none none
Stockholders' Equity................................ 96,519 90,473 278,412 303,714 265,682
(1) We recorded certain identifiable asset impairment, restructuring,
reorganization and other costs. See Note 17 of Notes to the Consolidated
Financial Statements.
(2) Adjusted to account for three-for-two stock split of our common stock to
stockholders of record as of May 18, 1998.
- -----------------
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis provides information which management
believes is relevant for an assessment and understanding of our consolidated
financial condition and results of operations. The discussion should be read in
conjunction with the Consolidated Financial Statements and related Notes
thereto. The information contained below may be subject to risk factors. We urge
you to review carefully the section "Risk Factors" in this 2001 Form 10-K for a
more complete discussion of the risks associated with an investment in our
securities. See "Note on Forward-Looking Statements and Risk Factors" under Item
1.
Overview
We derive revenues from our health maintenance organizations, managed indemnity,
military health care services and workers' compensation insurance subsidiaries.
To a lesser extent, we also derive additional specialty product revenues from
non-HMO and insurance products (consisting of fees for workers' compensation
administration, utilization management services and ancillary products),
professional fees (consisting primarily of fees for providing health care
services to non-members and co-payment fees received from members), and
investment and other revenue.
Our principal expenses consist of medical expenses, military contract expenses,
specialty product expenses, and general, administrative and marketing expenses.
Medical expenses represent capitation fees and other fee-for-service payments
paid to independently contracted physicians, hospitals and other health care
providers to cover members, as well as the aggregate expenses to operate and
manage our wholly owned multi-specialty medical group and other provider
subsidiaries. As a provider of health care management services, we seek to
positively affect quality of care and expenses by contracting with physicians,
hospitals and other health care providers at negotiated price levels, by
adopting quality assurance programs, monitoring and managing utilization of
physicians and hospital services and providing incentives to use cost-effective
providers. Military contract expenses represent payments to providers for health
care services rendered under the TRICARE program, as well as administrative
costs to operate the military health care subsidiary. Specialty product expenses
primarily consist of losses and loss adjustment expenses, policy acquisition
expenses and other general and administrative expenses associated with our
workers' compensation insurance subsidiaries. General, administrative and
marketing expenses generally represent operational costs other than those
directly associated with the delivery of health care services, military contract
services and specialty products.
Texas HMO Health Care Operations
During 2001, we made significant premium rate increases on renewing membership
in our Texas HMO health care operations. In the third quarter, we embarked on a
recontracting effort to reduce medical costs. It was during this recontracting
effort that unsustainable cost increases were revealed, including the
operation's primary hospital contract. Although considerable efforts were made
to achieve profitability in Texas, it was determined that under the current
operating environment, we would not be able to turn around the operating
results. At the end of the third quarter, we announced a plan to exit the Texas
HMO health care market and subsequently recorded exit-related charges of $17.1
million. We received formal approval from the Texas Department of Insurance to
withdraw our operations and we will cease providing HMO health care coverage in
Texas on April 17, 2002. In accordance with SFAS No. 144, the Texas HMO health
care operations have been reclassified as discontinued operations.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Critical Accounting Policies and Estimates
Our consolidated financial statements have been prepared in conformity with
accounting principles generally accepted in the United States of America. In
preparing these financial statements, we are required to make judgments,
assumptions and estimates, which we believe are reasonable and prudent based on
the available facts and circumstances. These judgments, assumptions and
estimates affect certain of our revenues and expenses and their related balance
sheet accounts and in disclosing our contingent assets and liabilities. We base
our assumptions and estimates primarily on historical experience and trends and
factor in known and projected trends. On an on-going basis, we re-evaluate our
selection of assumptions and the method of calculating our estimates. Actual
results, however, may differ from our calculated estimates and this difference
would be reported in our current operations. The following discusses our most
critical accounting policies and estimates.
Military contract revenue is recorded based on the contract price as agreed to
by the federal government. The contract was based on prior years' data provided
by the government along with assumptions of future trends. The contract contains
provisions that adjust the contract price based on actual experience, which we
call the bid price adjustment, or BPA, and for government-directed change
orders. As the data becomes available from the government, we compare the actual
results to the contract assumptions and the estimated effects of these
adjustments are recognized on a monthly basis. In addition, we record revenue
based on estimates of the earned portion of any contract change orders not
originally specified in the contract. The BPA and government-directed change
orders are subject to negotiation and we must use our judgment in making our
estimates. The actual negotiated price could be substantially different from
what we had originally estimated. Any difference would be reported in current
operations.
Military contract health care costs are recorded in the period when services are
provided to eligible beneficiaries, including estimates for provider costs which
have been incurred as of the balance sheet date but not reported to us. We use a
variety of actuarial projection methods to make these estimates and we must use
our judgment in selecting development factors and assumed trends. Our
assumptions, which are in large part related to the same assumptions we use in
estimating military contract revenues, could be affected by unanticipated
changes, such as new interpretations of contract provisions that result in our
having to provide new or extended benefits and changes in our health care
delivery system or costs. We must also factor into our assumptions the limited
risk sharing that we have with the government in providing health care services.
Any substantial errors in our estimates are to a large degree mitigated by the
risk-sharing contract provision. Any subsequent changes in an estimate for a
prior year would be reflected in the current year's operating results.
Health care medical expenses are recorded in the period when services are
provided to enrolled members, including estimates for provider costs which have
been incurred as of the balance sheet date but not yet reported to us. We use a
variety of actuarial projection methods to make these estimates and we must use
our judgment in selecting development factors and assumed trends. Our
assumptions could be affected by unanticipated changes, such as adverse legal
outcomes, legislative or regulatory changes, new interpretations of existing
laws or regulations or disputed contract provisions that result in our having to
provide new or extended benefits and changes in our health care delivery system
or costs. Any subsequent changes in an estimate for a prior year would be
reflected in the current year's operating results.
Specialty product workers' compensation insurance losses and loss adjustment
expenses, or LAE, are based upon the accumulation of cost estimates for reported
claims occurring during the period as well as an estimate for losses that have
occurred but have not yet been reported. Similar to the health care medical
expenses, we use a variety of actuarial projection methods to make these
estimates and we must use our judgment in selecting development factors and
assumed trends. Unlike health care medical expenses, where the cost to provide
health care services is substantially completed within one year, workers'
compensation claims can be paid out over a substantial number of years due to
certain lifetime benefits. In addition, the period between when a claim is
reported to us and when the injury occurred could be longer than one year and
when we are no longer insuring the account. Loss and LAE reserves have a
significant degree of uncertainty when related to their subsequent payments.
Although our reserves are established on the basis of a reasonable estimate, it
is not only possible but probable that our reserves will differ from their
related subsequent developments. Underlying causes for this uncertainty include,
but are not limited to, uncertainty in development patterns, unanticipated
inflationary trends affecting the services covered by the insurance contract,
adverse legal outcomes and new interpretations of laws or regulations or of
disputed contract provisions that result in our having to provide new or
extended benefits. This uncertainty can result in both adverse as well as
favorable development of actual subsequent activity when compared to the reserve
established. Any subsequent change in loss and LAE reserves established in a
prior year would be reflected in the current year's operating results.
Reinsurance recoverable primarily represents the estimated amount of unpaid
workers' compensation loss and LAE reserves that would be recovered from our
reinsurers and, to a lesser extent, amounts billed to the reinsurers for their
portion of paid losses and LAE and health care claims. Reinsurance receivable
for ceded paid claims is recorded in accordance with the terms of the agreements
and reinsurance recoverable for unpaid losses and LAE and medical claims payable
is estimated in a manner consistent with the claim liability associated with the
reinsurance policy. Any significant changes in the underlying claim liability
could directly affect the amount of reinsurance recoverable. Reinsurance
recoverable, including amounts related to paid and unpaid losses, are reported
as assets rather than a reduction of the related liabilities. Reinsurance
contracts do not relieve us from our obligations to enrollees, injured workers
or policyholders. If our reinsurers were to fail to honor their obligations
because of insolvency or disputed contract provisions, we could incur
significant losses. We evaluate the financial condition of our reinsurers to
minimize our exposure to significant losses from reinsurer insolvencies.
Deferred income tax assets and liabilities result from temporary differences
between the tax basis of assets and liabilities and the reported amounts in the
consolidated financial statements that will result in taxable or deductible
amounts in future years. Our temporary differences arise principally from
certain net operating losses, accrued expenses, reserves that are discounted for
tax return purposes, depreciation and impairment charges. We regularly review
our deferred tax assets for recoverability based on historical taxable income,
projected future taxable income and the expected timing of the reversals of the
existing temporary differences.
In addition to the most critical accounting policies and estimates discussed
above, other areas requiring us to use judgment, assumptions and estimates
include, but are not limited to, allowance for retroactive health care premium
revenue adjustments, workers' compensation earned but unbilled premiums,
contractual discounts on professional fee revenue, allowances for doubtful
receivables, litigation and legal settlement costs and accruals, other accrued
liabilities, accrued payroll and taxes, unearned premium revenue and contingent
assets and liabilities.
For a more extensive discussion of our accounting policies, see Note 2, Summary
of Significant Accounting Policies, in the Notes to the Consolidated Financial
Statements. Review the section "Risk Factors" in this 2001 Form 10-K for a more
complete discussion of the risks associated with an investment in our
securities.
Results of Operations
The following table sets forth selected operating data as a percentage of
revenues for the periods indicated:
Years Ended December 31,
2001 2000 1999
---------- ---------- ---------
OPERATING REVENUES:
Medical Premiums........................................ 55.7% 55.0% 57.3%
Military Contract Revenues.............................. 26.2 28.5 27.7
Specialty Product Revenues ............................. 14.2 11.7 9.1
Professional Fees....................................... 2.2 2.9 4.0
Investment and Other Revenues .......................... 1.7 1.9 1.9
----- ----- -----
Total................................................ 100.0 100.0 100.0
----- ----- -----
OPERATING EXPENSES:
Medical Expenses........................................ 47.1 49.7 51.5
Military Contract Expenses ............................. 25.7 27.9 26.6
Specialty Product Expenses.............................. 14.6 13.2 9.3
General, Administrative and Marketing Expenses.......... 9.1 9.1 9.1
Asset Impairment, Restructuring,
Reorganization and Other Costs....................... 2.9 .7
----- ----- -----
Total................................................... 96.5 102.8 97.2
----- ----- -----
OPERATING INCOME (LOSS) FROM CONTINUING
OPERATIONS.............................................. 3.5 (2.8) 2.8
INTEREST EXPENSE AND OTHER, NET.............................. (1.4) (1.7) (1.6)
----- ----- -----
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES .................................... 2.1 (4.5) 1.2
(PROVISION) BENEFIT FOR INCOME TAXES........................ (0.7) 1.2 (0.2)
----- ----- -----
NET INCOME (LOSS) FROM CONTINUING OPERATIONS................. 1.4 (3.3) 1.0
LOSS FROM DISCONTINUED OPERATIONS............................ (1.1) (13.9) (1.4)
----- ----- -----
NET INCOME (LOSS)............................................ 0.3% (17.2)% (0.4)%
===== ===== =====
Year Ended December 31, 2001 Compared to 2000
Total Operating Revenues for 2001 increased approximately 11.4% to $1.29 billion
from $1.16 billion for 2000. Medical premium revenues accounted for
approximately 55.7% and 55.0% of our total revenues for the years ended December
31, 2001 and 2000, respectively.
The change in operating revenues was comprised of the following:
o An increase in medical premiums of $81.2 million
o An increase in military contract revenues of $8.6 million
o An increase in specialty product revenues of $47.5 million
o A decrease in professional fees of $4.2 million
o A decrease in investment and other revenues of $1.2 million
Medical Premiums from our HMO and managed indemnity insurance subsidiaries
increased $81.2 million or 12.7%. The $81.2 million increase in premium revenue
reflects a 7.9% increase in Medicare member months (the number of months
individuals are enrolled in a plan) and a 10.9% increase in commercial member
months. The growth in Medicare member months contributes significantly to the
increase in premium revenues as the Medicare per member premium rates are over
three times higher than the average commercial premium rate. HMO premium rates
for commercial groups increased approximately 6.6%, managed indemnity rates
increased approximately 14.6% and Medicare rates increased approximately 4.0%.
Over 97% of our Las Vegas, Nevada Medicare members are enrolled in the Social
HMO Medicare program. The Centers for Medicare and Medicaid Services, or CMS,
formerly known as the Health Care Financing Administration, or HCFA, may
consider adjusting the reimbursement factor or changing the program for the
Social HMO members in the future. If the reimbursement for these members
decreases significantly and related benefit changes are not made timely, there
could be a material adverse effect on our business. Continued medical premium
revenue growth is principally dependent upon continued enrollment in our
products and upon competitive and regulatory factors.
Military Contract Revenues increased $8.6 million or 2.6%. The increase in
revenue is primarily the result of additive change order work and is
significantly offset by increased military contract expenses associated with
those change orders. The Congressionally approved DoD fiscal year 2001 budget
included several sweeping changes to the TRICARE program. In April 2001, SMHS
began implementation of a prescription drug program for beneficiaries over age
65 and the implementation of a waiver of co-payments for active duty family
members. Both of these program modifications resulted from Congressional changes
to the program. Likewise, in October 2001, SMHS implemented TRICARE for Life
which is a comprehensive health care benefit to those retired military
beneficiaries over age 65. SMHS only administers the expanded benefits to the
over age 65 retiree military population. SMHS does not directly fund claims
payment or bear any risk for the actual level of health care service
utilization. Revenues associated with these new programs will carry forward into
2002.
If all five option periods of the contract with the DoD are exercised and no
extensions of the performance period are made, health care delivery will end on
May 31, 2003, followed by an additional eight month phase out of the Region 1
managed care support contract. The DoD has extended expiring TRICARE contracts
in other regions and SMHS has recently begun negotiations with the DoD about a
possible extension to the base contract.
Specialty Product Revenues increased $47.5 million or 34.9%. Revenue increased
in the workers' compensation insurance segment by $48.4 million, which was
offset by a slight decrease in administrative services revenue of $900,000. The
increase in the workers' compensation insurance segment was primarily due to a
lower amount of ceded reinsurance premiums.
Workers' compensation net earned premiums are the end result of direct written
premiums, plus the change in unearned premiums, less premiums ceded to
reinsurers. Direct written premiums decreased by 7.9% due primarily to a 29%
decrease in premium production that was partially offset by a 31% increase in
composite premium rates. Ceded reinsurance premiums decreased by 82.7% due to
the expiration of our low level reinsurance agreement on June 30, 2000 and a new
reinsurance agreement with lower ceded premiums. Direct written premiums
decreased from $203.3 million in 2000 to $187.1 million in 2001.
As compared to the low level reinsurance agreement that expired on June 30,
2000, the new reinsurance agreement results in higher net earned premium
revenues, as we retain more of the premium dollars, but also leads to our
keeping more of the incurred losses. This resulted in a higher loss and loss
adjustment expense ratio, or LAE ratio, as the percentage increase in the
additional incurred losses was greater than the percentage increase in the
additional premiums retained. The effect on the balance sheet of the new
reinsurance agreement compared to the low level agreements will eventually
result in a lower amount of reinsurance recoverables, and due to the length of
time over which claims expenses are typically paid, we expect to see an increase
in future operating cash flow and amounts available to be invested.
Professional Fees decreased $4.2 million or 12.4% due primarily to the closing
of our affiliated medical group in Arizona during 2000.
Investment and Other Revenues decreased $1.2 million or 5.4% due primarily to a
decrease in the average investment yield during the period offset by an increase
in the average invested balance.
Medical Expenses increased $32.0 million or 5.6%. Excluding the effects of
changes in estimate charges for 2000, medical expenses increased approximately
$58.0 million or 10.5%. Medical expenses as a percentage of medical premiums and
professional fees decreased from 82.1% to 81.4%, excluding changes in estimate
charges as described below. The improvement is primarily due to the closing of
our rural Nevada clinical operation with a higher medical care ratio and premium
yields in excess of cost increases.
Medical expenses reported in the first quarter of 2000 included $1.0 million of
prior period reserve strengthening. In the second quarter of 2000, we recorded
changes in estimate charges of $15.5 million for reserve strengthening primarily
due to adverse development on prior years' medical claims and $9.5 million of
other non-recurring medical costs primarily relating to the write-down of
certain medical subsidiary assets.
Military Contract Expenses increased $8.4 million or 2.6%. The increase is
consistent with the increase in revenues discussed previously. Health care
delivery expense consists primarily of costs to provide managed health care
services to eligible beneficiaries in accordance with Sierra's TRICARE contract.
Under the contract, SMHS provides health care services to approximately 639,000
dependents of active duty military personnel and military retirees under the age
of 65 and their dependents through a network of nearly 50,000 health care
providers and certain other subcontractor partnerships. Also included in
military contract expenses are costs incurred to perform specific administrative
services, such as health care appointment scheduling, enrollment, network
management and health care advice line services, and other administrative
functions of the military health care subsidiary. These administrative services
are performed for active duty personnel and family members as well as retired
military families.
Specialty Product Expenses increased $35.8 million or 23.5%. Expenses increased
in the workers' compensation operations by approximately $38.3 million as a
direct result of the costs associated with the increase in workers' compensation
premiums and associated loss and loss adjustment expenses. This increase was
offset by a decrease in administrative services expense of $2.5 million.
The increase in the workers' compensation insurance segment expenses is
primarily due to the following:
o Approximately $32.9 million in additional loss and LAE related to the
increase in net earned premiums in 2001 compared to 2000.
o In 2001, we recorded $8.7 million of net adverse loss development for
prior accident years compared to net adverse loss development of $23.3
million recorded in 2000. The net adverse development recorded was
largely attributable to higher costs per claim, or claim severity, in
California. Higher claim severity has had a negative impact on the
entire California workers' compensation industry.
o We established a higher loss and LAE ratio for the 2001 accident year,
which has resulted in an increase of approximately $12.5 million. The
majority of the increase is due to the termination of the low level
reinsurance agreement on June 30, 2000, which results in a higher risk
exposure on policies effective after that date and a higher amount of
net incurred loss and LAE.
o A net increase in underwriting expenses, policyholders' dividends and
other operating expenses of $7.5 million related primarily to the
increase in net earned premiums.
The net adverse loss development on prior accident years included those years
that were covered by our low level reinsurance agreement. This results in an
increase in the reinsurance recoverable balance which is then reduced by amounts
collected from reinsurers. Net reinsurance recoverable decreased by $29.1
million in 2001 while they increased by $115.3 million in 2000.
The higher loss ratio we recorded for the 2001 accident year is in light of the
lower premium rates on policies in prior years, inflationary trends in health
care costs, the fact that we have seen our reserves develop adversely for the
past three years and that projecting ultimate reserves cannot be done with 100%
accuracy. We believed it prudent to establish reserves at a higher loss ratio to
mitigate any future adverse loss development that may occur.
In February 2002, California enacted Assembly Bill 749. This new legislation
will increase benefits paid to injured workers starting January 1, 2003. The
Workers' Compensation Insurance Rating Organization of California, or WCIRB, has
preliminarily estimated that the new legislation will increase the loss costs
for accident year 2003 by approximately 7%. Increased loss costs, such as
benefit increases, are normally built into the rating-making process so that
premiums are increased to cover the increase in costs. Although we intend to
increase our premiums, there is no assurance that our increase will be
sufficient or that the WCIRB's estimate is accurate.
The loss and LAE reserves recorded as of December 31, 2001 reflect our best
estimate of the ultimate loss costs for reported and unreported claims occurring
in accident year 2001 as well as those occurring in accident years prior to 2001
and is slightly in excess of our independent actuary's estimate. Workers'
compensation claim payments are made over several years from the date of the
claim. Until the final payments for reported claims are made, reserves are
invested to generate investment income.
Under our low level reinsurance agreement, we reinsured 30% of the first $10,000
of each claim, 75% of the next $40,000 and 100% of the next $450,000. The
maximum net loss retained on any one claim ceded under this agreement was
$17,000. This agreement covered all policies in force at July 1, 1998 and
continued until June 30, 2000, when we exercised an option to extend coverage to
all policies in force as of June 30, 2000. The termination of the low level
agreement will result in our keeping more retained losses and LAE. However, our
California premium rates have been increasing, which we believe will largely
mitigate the loss of this favorable reinsurance protection. The premium rate
increases on policies renewed in California during 2001 were approximately 38%.
For policies effective from July 1, 2000, we obtained excess of loss reinsurance
for 100% of the losses above $250,000 and less than $500,000. This agreement
terminated on June 30, 2001 and only covered claims with dates of injury
occurring by that date. We already had an existing excess of loss reinsurance
agreement that covered 100% of the losses above $500,000. The latter reinsurance
agreement is a fixed rate multi-year contract that will expire December 31,
2002. We intend to execute an option to extend the coverage for all policies in
force as of December 31, 2002 until they expire.
In the wake of the events of September 11, 2001 and the ensuing hardening of the
reinsurance market, we expect our future reinsurance costs to increase and our
coverage limits to decrease. We cannot currently estimate what the impact to our
operating results will be when we obtain replacement coverage in January 2003.
However, any increases in our reinsurance costs, including our retaining more of
the risk, will most likely be factored into our premium rates.
Reinsurance contracts do not relieve us from our obligations to enrollees or
policyholders. At December 31, 2001, we had over $220.1 million in reinsurance
recoverable. We evaluate the financial condition of our reinsurers to minimize
our exposure to significant losses from reinsurer insolvencies. At December 31,
2001, all of our reinsurers were rated AA and A+ or better by Fitch Ratings and
the A.M. Best Company, respectively. Should these companies be unable to perform
their obligations to reimburse us for ceded losses, we would experience
significant losses.
The combined ratio is a measurement of the workers' compensation underwriting
profit or loss and is the sum of the loss and LAE ratio, underwriting expense
ratio and policyholders' dividend ratio. A combined ratio of less than 100%
indicates an underwriting profit. Our combined ratio was 106.1% compared to
115.8% for 2000. The decrease was primarily due to significantly higher prior
year adverse loss development recorded during 2000. Excluding adverse loss
development, the combined ratio would have been 101.1% for 2001 and 97.3% for
2000. The increase in the accident year loss and LAE ratio was primarily due to
the run off of the low level reinsurance, which is resulting in our retaining
more of the incurred losses. The underwriting expense ratio decreased primarily
due to higher retained net earned premiums.
General, Administrative and Marketing Expenses, or G&A, increased $12.4 million
or 11.8%. As a percentage of revenues, G&A expenses were 9.1% for both periods.
As a percentage of medical premium revenue, G&A expenses were 16.4% for 2001
compared to 16.5% for 2000.
Asset Impairment, Restructuring, Reorganization and Other Costs. We did not
record any asset impairment, restructuring, reorganization and other costs in
2001. For a discussion of the costs recorded in 2000 and 1999 see the asset
impairment, restructuring, reorganization and other costs section for the year
ended December 31, 2000 compared to December 31, 1999.
Interest Expense and Other, Net decreased $799,000 or 4.1%. Interest expense
related to the revolving credit facility decreased $13.3 million due to a
decrease in the average balance of outstanding debt during the period offset by
an increase in the weighted average cost of borrowing. Our average revolving
credit facility balance was $61 million in 2001 compared to $183 million in
2000. Our average interest rate on the revolving credit facility, including the
amortization of deferred financing fees and our interest rate swap agreement,
was 10.6% in 2001 compared to 9.9% in 2000. Our average interest rate on the
revolving credit facility, excluding the amortization of deferred financing fees
and our interest rate swap agreement was 8.1% in 2001 compared to 9.8% in 2000.
CII debenture interest decreased by $2.4 million in 2001, primarily as a result
of the restructuring of the debentures. The decreases were offset by an increase
in interest expense of $9.2 million related to the net financing obligations
associated with the sale-leaseback transaction that was completed in December
2000. In 2001, we recorded a loss of $2.4 million on the sale of our Arizona
properties compared to a net gain on sale of various assets of $1.1 million in
2000.
Provision for Income Taxes was recorded at $8.8 million for 2001 compared to a
tax benefit of $12.9 million for 2000. The effective tax rate for 2001 was 33.5%
compared to 24.9% for 2000. The effective tax rate for 2000 reflects the
non-deductibility of certain portions of goodwill impairment expense recorded
during the period. Excluding the effect of the goodwill impairment expense, the
effective tax rate for both periods was approximately 33.5%. Our ongoing
effective tax rate is less than the statutory rate due primarily to tax
preferred investments.
Discontinued Operations consist entirely of our Texas HMO health care
operations. See Note 10 of the Notes to the Consolidated Financial Statements.
We elected to early adopt Statement of Financial Accounting Standards No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets", or SFAS No.
144, effective January 1, 2001. In the third quarter of 2001, we decided to exit
the Texas HMO health care market and received approval from the Texas Department
of Insurance in mid-October 2001. We will cease providing HMO health care
coverage on April 17, 2002. In accordance with SFAS No. 144, our Texas HMO
health care operations are now reclassified as a discontinued operation. The net
loss from discontinued operations was $14.0 million in 2001 compared to $161.1
million in 2000. Included in the 2001 loss are estimated costs to exit the Texas
HMO health care market of $17.1 million. Included in the 2000 loss were the
following: (a) asset impairment charges of $126.4 million for impaired goodwill;
(b) $36.5 million for impaired real estate and other fixed assets; (c) medical
expenses of $14.7 million, primarily for adverse development on prior periods'
medical claims; (d) $15.5 million for premium deficiency medical costs; (e)
$10.4 million for premium deficiency maintenance costs; and (f) other
restructuring, reorganization and other costs of $13.3 million. The utilization
of prior premium deficiency reserves were $23.3 million in 2001 and $32.4
million in 2000.
Year Ended December 31, 2000 Compared to 1999
Total Operating Revenues for 2000 increased approximately 11.6% to $1.16 billion
from $1.04 billion for 1999. Medical premium revenues accounted for
approximately 55.0% and 57.3% of our total revenues for the years ended December
31, 2000 and 1999, respectively. The decrease in medical premiums as a
percentage of total revenues in 2000 is primarily due to the increase in
specialty product and military contract revenues.
The change in operating revenues was comprised of the following:
o An increase in medical premiums of $42.8 million
o An increase in military contract revenues of $43.0 million
o An increase in specialty product revenues of $41.6 million
o A decrease in professional fees of $9.0 million
o An increase in investment and other revenues of $2.1 million
Medical Premiums from our HMO and managed indemnity insurance subsidiaries
increased $42.8 million or 7.2%. The $42.8 million increase in premium revenue
reflects a 1.2% increase in Medicare member months (the number of months
individuals are enrolled in a plan) offset by a 1.2% decrease in commercial
member months. The growth in Medicare member months contributes significantly to
the increase in premium revenues as the Medicare per member premium rates are
over three times higher than the average commercial premium rate. HMO premium
rates for commercial groups increased approximately 4% in Nevada. Our managed
indemnity rates increased approximately 12% and Medicare rates increased
approximately 2%.
Military Contract Revenues increased $43.0 million or 14.9%. The increase was
primarily attributable to additional accrued bid price adjustment revenues
related to a true-up of prior periods' information received from the government
in the third quarter of 2000. Partially offsetting this was a decrease recorded
in the first quarter for a reduction in the at-risk health care population of
beneficiaries as additional beneficiaries enrolled with military treatment
facility primary care managers. We are not at-risk for those TRICARE eligibles
and receive less revenue related to them from the government.
Specialty Product Revenues increased $41.6 million or 44.2%. Revenue increased
in the workers' compensation insurance segment by $42.7 million, which was
offset by a slight decrease in administrative services revenue of $1.1 million.
The increase in the workers' compensation insurance segment was primarily due to
a larger amount of direct written premiums with an 18% composite increase in
premium rates for all states and a 24% increase in production growth.
Net earned premiums are the end result of direct written premiums, plus the
change in unearned premiums, less premiums ceded to reinsurers. Direct written
premiums increased by 37% due primarily to growth in California and Nevada.
Partially offsetting the growth in direct written premiums was an increase in
premiums ceded to reinsurers, which increased by 22%. The growth in ceded
reinsurance premiums was lower than the growth in direct written premiums
primarily due to the expiration of our low level reinsurance agreement on June
30, 2000 and new lower cost reinsurance agreements, all of which reduced the
percentage of premiums being ceded. Direct written premiums increased from
$148.8 million in 1999 to $203.3 million in 2000.
As compared to the low level reinsurance agreement that expired on June 30,
2000, the new lower cost reinsurance agreements result in higher net earned
premium revenues, as we retain more of the premium dollars, but also leads to
our keeping more of the incurred losses. This may result in a higher loss and
loss adjustment expense, or LAE, ratio if the percentage increase in the
additional incurred losses should be greater than the percentage increase in the
additional premiums we retained. The effect on the balance sheet will result in
a lower amount of reinsurance recoverables. However, due to the length of time
that it typically takes to fully pay a claim, we should see an increase in
operating cash flow and amounts available to be invested.
Professional Fees decreased $9.0 million or 21.3%. The revenue for 1999 included
the inpatient operations at the Mohave Valley Hospital until they were closed
during the first quarter of 1999. The fees in 2000 also reflect staffing
reductions and subsequent closure of our affiliated medical group in Arizona.
Investment and Other Revenues increased $2.1 million or 10.3% due primarily to
an increase in the average invested balance during the year.
Medical Expenses increased $42.1 million or 7.9%. Excluding the effects of
changes in estimate charges, medical expenses increased approximately $38.2
million or 7.5%. Medical expenses as a percentage of medical premiums and
professional fees increased from 80.5% to 82.1%, excluding changes in estimate
charges and premium deficiency as described below. The increase is primarily due
to an increase in Medicare members as a percentage of fully-insured members. The
cost of providing medical care to Medicare members generally requires a greater
percentage of the premiums received.
Medical expenses reported in the first quarter of 2000 included $1.0 million of
prior period reserve strengthening. In the second quarter of 2000, we recorded
changes in estimate charges of $15.5 million for reserve strengthening primarily
due to adverse development on prior years' medical claims and $9.5 million of
other non-recurring medical costs primarily related to the write-down of medical
subsidiary assets.
During 1999, we reported a premium deficiency medical charge of $8.1 million
related to losses in under-performing markets primarily in Arizona and rural
Nevada, all of which was used during 1999. Also recorded in medical expenses
during the fourth quarter was $7.2 million primarily related to an adjustment to
the estimate for medical expenses recorded in previous years, and $6.8 million
primarily related to contractual settlements with providers of medical services.
Military Contract Expenses increased $46.8 million or 16.9%. The increase is
consistent with the increase in revenues discussed previously. Also, included in
military contract expenses are costs incurred to perform specific administrative
services, such as health care appointment scheduling, enrollment, network
management and health care advice line services, and other administrative
functions of the military health care subsidiary.
Specialty Product Expenses increased $56.2 million or 58.3%. Of the increase,
approximately $32.1 million is a direct result of the costs associated with the
increase in workers' compensation premiums and associated loss and loss
adjustment expenses.
We recorded net adverse loss development for prior accident years of $23.3
million in 2000 compared to $9.9 million in 1999. The net adverse development
recorded in 1999 and 2000 for prior accident years was largely attributable to
higher costs per claim, or claim severity, in California. Higher claim severity
has had a negative impact on the entire California workers' compensation
industry. The majority of the adverse loss development occurred on accident
years that were not covered by our low level reinsurance agreement. While the
low level reinsurance agreement was in run-off effective July 1, 2000,
California premium rates have been increasing, which we believe will largely
mitigate the loss of this very favorable reinsurance protection. The premium
rate increases on policies renewed in California during the year ended December
31, 2000 were approximately 26% and for the second half of the year alone,
averaged approximately 36%.
We recorded a higher loss and LAE ratio for the 2000 accident year, which
resulted in an increase of approximately $8.6 million in specialty product
expense. The majority of the increase is due to the termination of the low level
reinsurance agreement on June 30, 2000, which results in a higher risk exposure
on policies effective after that date and a higher amount of net incurred loss
and LAE. In addition, in light of the lower premium rates on policies written in
1999, inflationary trends in health care costs, the fact that we have seen our
reserves develop adversely for the past two years and that projecting ultimate
reserves cannot be done with 100% accuracy, we believed it prudent to establish
reserves at a higher loss ratio to mitigate any future adverse loss development
that may occur.
The loss and LAE reserves recorded as of December 31, 2000 reflect our best
estimate of the ultimate loss costs for reported and unreported claims occurring
in accident year 2000 as well as those occurring in accident years prior to 2000
and was slightly in excess of our independent actuary's estimate. Workers'
compensation claim payments are made over several years from the date of the
claim. Until the final payments for reported claims are made, reserves are
invested to generate investment income.
Under our low level reinsurance agreement, we reinsured 30% of the first $10,000
of each claim, 75% of the next $40,000 and 100% of the next $450,000. The
maximum net loss retained on any one claim ceded under this agreement was
$17,000. This agreement covered all policies in force at July 1, 1998 and
continued until June 30, 2000 when we exercised an option to extend coverage to
all policies in force as of June 30, 2000. For policies effective from July 1,
2000, we obtained excess of loss reinsurance for 100% of the losses above
$250,000 and less than $500,000. We already had an existing excess of loss
reinsurance agreement that covered 100% of the losses above $500,000. (See Note
6 of Notes to the Consolidated Financial Statements).
The combined ratio is a measurement of the workers' compensation underwriting
profit or loss and is the sum of the loss and LAE ratio, underwriting expense
ratio and policyholders' dividend ratio. A combined ratio of less than 100%
indicates an underwriting profit. Our combined ratio was 115.8% compared to
105.5% for 1999. The increase was primarily due to a higher loss and LAE ratio
of 13.4 percentage points and policyholders' dividend ratio of 1.6 percentage
points, offset slightly by a decrease in the underwriting expense ratio of 4.7
percentage points. The increase in the loss and LAE ratio was due to an increase
in net adverse loss development, which represents 6.6 percentage points of the
change in the loss and LAE ratio, and a higher loss and LAE ratio on the 2000
accident year of $8.6 million, which represents 6.8 percentage points of the
change in the loss and LAE ratio.
General, Administrative and Marketing Expenses, or G&A, increased $10.9 million
or 11.5%. As a percentage of revenues, G&A costs were 9.1% for both periods. As
a percentage of medical premium revenue, G&A costs increased from 15.9% for 1999
to 16.5% for 2000.
Asset Impairment, Restructuring, Reorganization and Other Costs for 1999 and
2000 are discussed below.
Asset Impairments. During the first quarter of 1999, we closed all inpatient
operations at Mohave Valley Hospital, a 12-bed acute care facility in Bullhead
City, Arizona, and terminated over 40 employees. We recorded a charge of $3.5
million for the write-off of goodwill associated with these operations.
Management adopted a plan in the second quarter of 2000 to discontinue medical
delivery operations in Mohave County, Arizona and to sell the real estate assets
located there, as well as an underperforming medical clinic in Las Vegas. In
connection with the restructuring plans adopted and announced by us in the
second quarter of 2000, we re-evaluated the recoverability of certain long-live
assets, in accordance with Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of", or SFAS No. 121, and Accounting Principles Board Opinion No.
17, "Intangible Assets", or APB No. 17, and determined that the carrying values
of certain goodwill and other long-lived assets were impaired.
In assessing the asset impairment of the long-lived assets, we first allocated a
portion of related goodwill to the fixed assets to be disposed of, in accordance
with SFAS No. 121. The fixed assets were then written down to estimated fair
value less costs to sell, which was determined from independent valuations. The
remainder of the related goodwill was then assessed for recoverability in
accordance with APB No. 17 based on projected discounted cash flows.
The charges recorded for the write-off of goodwill totaled $15.1 million related
primarily to the Prime Holdings, Inc. acquisition. The charges recorded for
fixed asset impairment totaled $9.5 million for the Arizona and Nevada
operations.
During the second quarter of 2000, we wrote-off capitalized costs of $3.0
million related to the application development of an information system software
project for the workers' compensation operations, which was canceled because the
vendor was unable to fulfill its contractual obligations. The amounts written
off included software and consulting costs of $1.6 million and capitalized
internal personnel costs of $1.4 million.
Restructuring and Reorganization. In the first quarter of 1999, we incurred
$450,000 for certain legal and contractual settlements and $400,000 to provide
for our portion of the write-off of start-up costs at our equity investee,
TriWest Healthcare Alliance.
In the second quarter of 2000, we adopted a plan and announced additional
restructuring of the Arizona managed health care operations. As a result of this
restructuring, we recorded charges in accordance with Emerging Issues Task Force
Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (Including Certain Costs Incurred in a
Restructuring)" of approximately $2.0 million. Of the costs recorded, $1.2
million was for severance, $400,000 was related to clinic closures and lease
termination and $400,000 was for other costs.
Other:
The $3.4 million of charges in the fourth quarter of 1999 consisted primarily of
legal and contractual settlements.
The $4.3 million of costs recorded in the second quarter of 2000 relate
primarily to the write-down of certain receivables as well as an accrual for
certain legal settlements.
The table below presents a summary of asset impairment, restructuring,
reorganization and other costs for the years indicated.
Restructuring
Asset and
(In thousands) Impairment Reorganization Other Total
---------- -------------- ----- -----
Balance, January 1, 1999 $ 2,819 $ 2,819
Charges recorded............................... $ 3,509 $ 850 3,449 7,808
Cash used...................................... (850) (2,819) (3,669)
Noncash activity............................... (3,509) (3,509)
Changes in estimate............................ -
------- ------ ------ -------
Balance, December 31, 1999..................... - - 3,449 3,449
Charges recorded............................... 27,553 1,983 4,300 33,836
Cash used...................................... (1,389) (302) (1,691)
Noncash activity............................... (27,553) (3,000) (30,553)
Changes in estimate............................ -
------- ------ ------ -------
Balance, December 31, 2000..................... - 594 4,447 5,041
Charges recorded...............................
Cash used...................................... (594) (594)
Noncash activity...............................
Changes in estimate............................ -
------- ------ ------ -------
Balance, December 31, 2001..................... $ - $ - $ 4,447 $ 4,447
======= ====== ====== =======
The remaining other costs of $4.4 million are primarily related to legal claims.
Management believes that the remaining reserves as of December 31, 2001 are
adequate and that no revisions to the estimates are necessary at this time.
Interest Expense and Other, Net increased $2.9 million or 17.3% due primarily to
an increase in the average balance of outstanding debt and an increase in the
average cost of borrowing. Our average credit facility debt balance was $183
million in 2000 compared to $164 million in 1999 and our average interest rate
on the credit facility was 9.9% in 2000 compared to 7.8% in 1999.
Benefit for Income Taxes was $12.9 million for 2000 compared to tax expense of
$2.2 million for 1999. The effective tax rate for 2000 was 24.9% compared to
17.3% for 1999. The effective tax rates for 2000 and 1999 reflect the
non-deductibility of certain portions of goodwill impairment expense recorded
during the periods. In addition, during 1999, due to a change in tax law, we
were able to utilize a $1.6 million net operating loss carryover that had
previously not been recognized in the financial statements due to uncertainty
about its realization. Excluding the effect of the items described above, the
effective tax rate for both periods was approximately 33.5%. Our ongoing
effective tax rate is less than the statutory rate due to tax preferred
investments offset by state income taxes.
Discontinued Operations consist entirely of our Texas HMO health care operations
as previously discussed and described in Note 10 of the Notes to Consolidated
Financial Statements. The net loss from discontinued operations was $161.1
million in 2000 compared to $15.2 million in 1999. Included in the 2000 loss
were the following: (a) asset impairment charges of $126.4 million for impaired
goodwill; (b) $36.5 million for impaired real estate and other fixed assets; (c)
medical expenses of $14.7 million, primarily for adverse development on prior
periods' medical claims; (d) $15.5 million for premium deficiency medical costs;
(e) $10.4 million for premium deficiency maintenance costs; and (f) other
restructuring, reorganization and other costs of $13.3 million. Included in the
1999 loss was a premium deficiency medical charge of $14.0 million and $11.0
million in premium deficiency maintenance costs. The utilization of prior
premium deficiency reserves were $32.4 million in 2000 and $18.2 million in
1999.
LIQUIDITY AND CAPITAL RESOURCES
We had cash flows from operating activities for continuing operations of $124.5
million for the year ended December 31, 2001 compared to $25.2 million in 2000.
We used the majority of the cash flows to make cash payments for debt reductions
of $81.0 million. Overall, discontinued operations used cash of $34.0 million in
2001 compared to providing cash of $11.6 million in 2000. The improvement in
continuing operations over 2000 is primarily attributable to cash from earnings
and the change in assets and liabilities.
The cash flow resulting from the change in assets and liabilities of $77.5
million was primarily due to the following:
o a source of cash due to the decrease in reinsurance recoverable of
$31.6 million primarily from our workers' compensation business
o a source of cash due to the increase in the reserve for losses and
loss adjustment expense of $11.2 million
o a source of cash due to the decrease in the military accounts
receivable balance of $32.4 million
o a source of cash due to the increase in medical claims payable of $7.3
million
o a use of cash due to the decrease in military health care payable of
$7.6 million
o various other changes in assets and liabilities accounting for the
remaining source of cash of $2.6 million
SMHS receives monthly cash payments equivalent to one-twelfth of its annual
contractual price with the Department of Defense, or DoD. SMHS accrues health
care revenue on a monthly basis for any monies owed above its monthly cash
receipt based on the number of at-risk eligible beneficiaries and the level of
military direct care system utilization. The contractual bid price adjustment,
or BPA, process serves to adjust the DoD's monthly payments to SMHS, because the
payments are based in part on 1996 DoD estimates for beneficiary population and
beneficiary population baseline health care cost, inflation and military direct
care system utilization. As actual information becomes available for the above
items, quarterly adjustments are made to SMHS' monthly health care payment in
addition to lump sum adjustments for past months. In addition, SMHS accrues
change order revenue for DoD directed contract changes. During the second,
third, and fourth quarters of 2001, SMHS received $22.2 million, $9.9 million
and $4.6 million, respectively, as partial payments from the BPA process
covering the period June 1, 1999 through August 31, 2001. As a result of
preliminary data accumulated from the BPA process, SMHS received a partial
upward adjustment of approximately $4.1 million to its monthly DoD payments for
January 2001 through December 2001. Our business and cash flows could be
adversely affected if the timing or amount of the BPA and change order
reimbursements vary significantly from our expectations.
On November 16, 2001, SMHS entered into a securitization arrangement with
General Electric Capital Corporation. The arrangement provides for the sale of
SMHS' Federal Government accounts receivable to SMHS Funding, LLC. SMHS Funding
is a special purpose limited liability company owned by SMHS and was formed for
the purpose of purchasing all receivables of SMHS. This entity is fully
consolidated into SMHS. SMHS Funding, LLC may sell an undivided interest in
certain of the receivables to a subsidiary of General Electric Capital
Corporation in the event that additional financing by SMHS is warranted. This
securitization arrangement was not utilized in 2001 and we do not anticipate
utilizing it in 2002. (See Note 1 of Notes to the Consolidated Financial
Statements).
Net cash used from continuing operations for investing activities during 2001
included $9.5 million in capital expenditures associated with continued
implementation of new computer systems, as well as facilities, furniture,
equipment and other capital needs to support our growth, offset by net proceeds
of $7.3 million for property and equipment dispositions. The net cash change in
investments for the year was an increase of $51.1 million as investments were
purchased with available funds.
Cash used in financing activities during 2001 included payments of $81.0 million
on debt related items offset by $2.1 million in cash received related to the
sale of stock through our employee stock purchase plan. The year 2000 included
net proceeds from long-term borrowings (proceeds less payments) of $48.8 million
and proceeds of $1.6 million related to the sale of stock through our employee
stock purchase plan.
On December 28, 2000, we sold the majority of our Las Vegas real estate holdings
in a sale-leaseback transaction. The transaction was recorded as a financing
obligation of $113.7 million offset by mortgage notes receivable of $22.2
million and a payoff of related real estate mortgages of $9.9 million. From the
proceeds, we made a permanent reduction on our revolving credit facility of $50
million for a net increase in liabilities of $31.6 million. During 2001, we
received full payment on the outstanding mortgage notes receivable associated
with three of the medical clinics. This allowed these clinics to qualify as a
sale. The impact of the sale of the three clinics was a net reduction of $13.4
million in property and equipment, a $14.6 million net reduction in the
associated financing obligation and a deferred gain of $6.1 million. The
deferred gain will be recognized over the remaining 14 years of the lease term.
(See Note 4 of Notes to the Consolidated Financial Statements).
Revolving Credit Facility
Our revolving credit facility balance decreased from $135 million to $89 million
during the year. As a result of the asset impairment and other changes in
estimate charges, we were not in compliance with our financial covenants at June
30, 2000. On December 15, 2000, we entered into an amended and restated credit
agreement, which terminates on September 30, 2003, and are now in compliance
with all covenants of the amended agreement. The restated agreement was amended
in April 2001 to allow for the completion of the CII debenture exchange offer
and again in October 2001 to provide a limited waiver for covenants affected by
exiting the Texas HMO health care market. The availability under the credit
facility has been reduced to $117 million at December 31, 2001 from $135 million
at the end of 2000 due to reductions required in the agreement. At December 31,
2001, we had $28 million available under the credit facility, however the total
availability will be reduced by $6.0 million on June 30, 2002 and December 31,
2002 and finally by $10.0 million on June 30, 2003.
Interest under the amended and restated credit agreement is variable and based
on the Bank of America "prime rate" adjusted for a margin. The rate was 5.375%
at December 31, 2001, which is a combination of the prime rate of 4.75% plus a
margin of .625%. The margin will be reduced by 1.0% at the end of the first
quarter of 2002 since we exceeded certain ratio requirements as of December 31,
2001. We can further reduce the margin in the future by completing certain
transactions and meeting certain financial ratios. Of the outstanding balance,
$25 million is covered by an interest-rate swap agreement. To mitigate the risk
of interest rate fluctuation on the credit facility, we entered into a five-year
$50 million interest-rate swap agreement during the fourth quarter of 1998. The
intent of the agreement was to keep our interest rate on $50 million of the
borrowing relatively fixed. In the fourth quarter of 2000, $25 million of the
swap agreement was terminated. In accordance with Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" we recorded the interest-rate swap agreement to fair market value as
of December 31, 2001. The fair market value indicated that we would need to pay
$685,000 to terminate the swap agreement.
The average cost of borrowing on the credit facility for 2001, including the
amortization of deferred financing fees and the impact of the swap agreement,
was 10.6%. The terms of the amended and restated credit agreement contain
certain covenants including a minimum fixed charge coverage ratio, a minimum
interest coverage ratio, a maximum leverage ratio, maximum loss ratios and
maximum capital expenditure amounts. We believe that we are in compliance with
these covenants at December 31, 2001.
Going forward, under certain circumstances, we will be required to make
prepayments on the credit facility and the amount available to us under the
credit facility will be further reduced. For example, 80% of any excess cash
flow that we have in each year must be applied to a repayment of the credit
facility. In addition, if we or one of our subsidiaries (other than a regulated
subsidiary and other specified subsidiaries) engage in an asset sale or a
sale-leaseback transaction (with the exception of assets specified in the
amended credit agreement), 80% of the net cash proceeds must be applied to a
repayment of the credit facility and a reduction of the amount available under
the credit facility. In addition, 100% of the net cash proceeds of a debt
issuance (excluding issuances by CII Financial, a wholly-owned subsidiary) must
be applied to a repayment of the credit facility and a reduction in the amount
available under the credit facility.
We are also limited in the amount of funds we can invest in our Texas and
Military operations. The maximum we can invest in the Military operations is $5
million. We have not invested any of the $5 million as of December 31, 2001.
After September 30, 2001, we can invest an additional $5.0 million in the Texas
operations and replace the Texas real estate assets with cash and notes up to
$46 million. Under the terms of the amended and restated agreement, the use of
Sierra funds to pay the outstanding Texas mortgage note of $29.2 million is not
considered an investment in the Texas operations. During the fourth quarter of
2001, we invested in Texas the full $5.0 million allowed under the amended and
restated agreement. If we had to invest more than we are allowed, we would be
required to get a waiver or an amendment to our agreement or be out of
compliance. If additional funds are needed by our discontinued Texas HMO health
care operations and we do not transfer such funds they may be in violation of
certain insurance regulations and we may be required to get a waiver or an
amendment to our agreement or be out of compliance. There is no assurance that
if we needed a bank waiver or amendment that we would be able to obtain it.
Based on the current estimated Texas HMO healthcare run-out costs and recorded
reserves, we believe we have adequate funds available and the ability to invest
adequate funds in Texas to meet the anticipated obligations.
Subject to normal qualifications and exceptions, Sierra and CII Financial have
covenants that, among other things, restrict our ability to dispose of assets,
incur indebtedness, pay dividends, make investments, loans or advances, make
acquisitions, engage in mergers or consolidations, or make capital expenditures
and which otherwise restrict certain corporate activities. At January 31, 2002,
our credit facility had outstanding borrowings of $81 million. Unused credit
facility balances are primarily reserved for our working capital purposes. Any
availability under the credit facility generated from our excess cash flow must
be converted annually to permanent reductions in accordance with the terms of
the credit facility.
Debentures
At September 30, 2000, CII Financial, Inc. had approximately $47.1 million of
subordinated debentures that were due on September 15, 2001. These subordinated
debentures were neither assumed nor guaranteed by Sierra and were subordinated
to Sierra's credit facility debt. In December 2000, CII Financial commenced an
offer to exchange the subordinated debentures for cash and/or new debentures. On
May 7, 2001, CII Financial closed its exchange offer on $42.1 million of its
outstanding subordinated debentures. CII Financial purchased $27.1 million in
principal amount of subordinated debentures for $20.0 million in cash and issued
$15.0 million in new 9 1/2% senior debentures, due September 15, 2004, in
exchange for $15.0 million in subordinated debentures. The transaction was
accounted for as a restructuring of debt; therefore all future cash payments,
including interest, related to the debentures will be reductions of the carrying
amount of the debentures and no future interest expense will be recognized.
Accordingly, the new 9 1/2% senior debentures have a carrying amount of $19.2
million consisting of principal of $15.0 million and $4.2 million in future
accrued interest.
In September 2001, the California Department of Insurance gave approval to
California Indemnity, one of CII Financial's insurance subsidiaries, to pay a
dividend of $5.0 million to CII Financial. CII Financial used these funds to pay
the remaining $5.0 million in subordinated debentures at maturity.
The new 9 1/2% senior debentures pay interest, which is due semi-annually on
March 15 and September 15 of each year, commencing on September 15, 2001. The
new 9 1/2% senior debentures rank senior to outstanding notes payable from CII
Financial to Sierra and CII Financial's guarantee of Sierra's revolving credit
facility. The new 9 1/2% senior debentures may be redeemed by CII Financial at
any time at premiums starting at 110% and declining to 100% for redemptions
after April 1, 2004. In the event of a change in control of CII Financial, the
holders of the new 9 1/2% senior debentures may require that CII Financial
repurchase them at the then applicable redemption price, plus accrued and unpaid
interest.
CII is a holding company and its only significant asset is its' investment in
California Indemnity. Of the $8.6 million in cash and cash equivalents it held
at December 31, 2001, approximately $8.1 million was designated for use only by
the regulated insurance companies. CII has limited sources of cash and is
dependent upon dividends paid by California Indemnity. California Indemnity may
only pay a dividend without the prior approval of the state insurance
commissioner to the extent the cumulative amount of dividends or distributions
paid or proposed to be paid in any year does not exceed the amount shown as
unassigned funds (reduced by any unrealized gains or losses included in any such
amount) on its statutory statement as of the previous December 31. In 2002,
California Indemnity can pay dividends of up to $2.1 million without the prior
approval of the state insurance commissioner. In 2001, California Indemnity
received prior approval to pay an aggregate of $10 million in dividends. We are
not in a position to assess the likelihood of obtaining future approval for the
payment of dividends other than those specifically allowed by law in each of our
subsidiaries' state of domicile.
Statutory Capital and Deposit Requirements
Our HMO and insurance subsidiaries are required by state regulatory agencies to
maintain certain deposits and must also meet certain net worth and reserve
requirements. The HMO and insurance subsidiaries had restricted assets on
deposit in various states totaling $26.0 million at December 31, 2001. The HMO
and insurance subsidiaries must also meet requirements to maintain minimum
stockholders' equity, on a statutory basis, as well as minimum risk-based
capital requirements, which are determined annually. Additionally, in
conjunction with the Kaiser-Texas acquisition, TXHC entered into a letter
agreement with the Texas Department of Insurance whereby TXHC agreed to maintain
a net worth of $20.0 million, on a statutory basis, until certain income levels
were achieved. In conjunction with the exit from the Texas HMO health care
market, the Texas Department of Insurance approved a plan of withdrawal and TXHC
is now required to maintain deposits and net worth of at least $3.5 million. We
believe we are in compliance with our regulatory requirements. We are limited by
our credit facility in the amount of funds we can invest in our Texas operations
as previously discussed.
Of the $115.8 million in cash and cash equivalents held at December 31, 2001,
$84.1 million was designated for use only by the regulated subsidiaries. Amounts
are available for transfer to the holding company from the HMO and insurance
subsidiaries only to the extent that they can be remitted in accordance with the
terms of existing management agreements and by dividends. The holding company
will not receive dividends from its regulated subsidiaries if such dividend
payment would cause violation of statutory net worth and reserve requirements.
Obligations and Commitments
The following schedule represents our obligations and commitments for long-term
debt, capital leases and operating leases. With the exception of our revolving
credit facility, the amounts below represent the entire payment, principal and
interest, on our outstanding obligations. Based on the outstanding balance of
the revolving credit facility of $89 million as of December 31, 2001, we are not
required to make any principal payments until the balance is due in 2003.
Long-Term Capital Operating
Debt Leases Leases Total
-------------- ------------ ----------- ---------
(In thousands)
Continuing Operations
Payments due in less than 1 year................ $ 11,781 $115 $ 8,805 $ 20,701
Payments due in 1 to 3 years.................... 127,841 204 12,685 140,730
Payments due in 4 to 5 years.................... 21,646 61 9,899 31,606
Payments due after 5 years...................... 105,996 184 26,965 133,145
------- --- ------ -------
Total Continuing Operations................ $ 267,264 $564 $58,354 $326,182
======= === ====== =======
Discontinued Operations
Payments due in less than 1 year................ $188 $ 188
Payments due in 1 to 3 years.................... $ 5,065 47 5,112
Payments due in 4 to 5 years.................... 24,124 24,124
Payments due after 5 years...................... -
------- --- ------
Total Discontinued Operations.............. $ 29,189 $235 $ 29,424
======= === ======
Included in long-term debt payments for continuing operations is $158.2 million
for our net financing obligation related to the sale-leaseback transaction. We
expect the transaction will qualify as a sale by the end of 2002 at which time
the future payments due will be categorized as operating leases. In conjunction
with the remainder of the transaction qualifying as a sale, we will receive
proceeds of $21.2 million, primarily from notes receivable due to us. See Note 4
and Note 8 of Notes to the Consolidated Financial Statements for a more detailed
discussion of the sale-leaseback transaction.
The amount included in long-term debt payments for discontinued operations is
for a mortgage loan secured by certain underlying real estate assets of the
discontinued operations. We are actively seeking a buyer for the assets and
anticipate selling them by the end of 2002. As the assets are sold, we are
required to make reductions on the mortgage note and completely satisfy the
obligation once all of the assets have been sold.
Other
We have a 2002 capital budget of $16.1 million and we are limited to $19.6
million by our revolving credit facility. The planned expenditures are primarily
for the purchase of computer hardware and software, furniture and equipment and
other normal capital requirements. Our liquidity needs over the next 12 months
will primarily be for the capital items noted above, debt service and funds
required to exit the Texas HMO health care market. We believe that our existing
working capital, operating cash flow and, if necessary, equipment leasing,
divestitures of certain non-core assets and amounts available under our credit
facility should be sufficient to fund our capital expenditures and debt service.
Additionally, subject to unanticipated cash requirements, we believe that our
existing working capital and operating cash flow should enable us to meet our
liquidity needs on a long-term basis.
We have a $25 million interest-rate swap agreement that allows us to mitigate
the risk of interest rate fluctuation on our credit facility. The intent of the
agreement was to keep our interest rate on $25 million of the credit facility
relatively fixed. In accordance with Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" we
recorded the interest-rate swap agreement to fair market value as of December
31, 2001. The fair market value indicated that we would need to pay $685,000 to
terminate the swap agreement. If the prime rate were to decrease by 1%, we
estimate our maximum increase in annual expense associated with the swap to be
approximately $250,000.
In the second quarter of 1997, our Board of Directors authorized a $3.0 million
loan from us to our Chief Executive Officer, or CEO. In April 2000, our Board of
Directors authorized an additional $2.5 million loan from us to the CEO. The
entire principal balance along with accrued interest is due on June 30, 2002.
During 2001, the CEO made payments of $898,000 and at the end of 2001, the
aggregate principal balance outstanding and accrued interest for both
instruments was $5.0 million. All amounts borrowed bear interest at a rate equal
to the rate at which we could have borrowed funds under our revolving credit
facility at the time of the borrowing plus 10 basis points. The amounts
outstanding are collateralized by certain of the CEO's assets and rights to
compensation from us.
Inflation
Health care costs continue to rise at a rate faster than the Consumer Price
Index. We use various strategies to mitigate the negative effects of health care
cost inflation, including setting commercial premiums based on our anticipated
health care costs, risk-sharing arrangements with our various health care
providers and other health care cost containment measures including member
co-payments. There can be no assurance, however, that in the future, our ability
to manage medical costs will not be negatively impacted by items such as
technological advances, competitive pressures, applicable regulations, increases
in pharmacy costs, utilization changes and catastrophic items, which could, in
turn, result in medical cost increases equaling or exceeding premium increases.
Government Regulation
Our business, offering health care coverage, health care management services,
workers' compensation programs and, to a lesser extent, the delivery of medical
services, is heavily regulated at both the federal and state levels.
Government regulation of health care coverage products and services is a
changing area of law that varies from jurisdiction to jurisdiction. Changes in
applicable laws and regulations are continually being considered, including
legislative proposals to eliminate or reduce ERISA pre-emption of state laws,
that would increase potential litigation exposure and interpretation of existing
laws and rules also may change from time to time. Regulatory agencies generally
exercise broad discretion in promulgating regulations and in interpreting and
enforcing laws and regulations.
While we are unable to predict what regulatory changes may occur or the impact
on us of any particular change, our operations and financial results could be
negatively affected by regulatory changes. For example, any proposals affecting
underwriting practices, limiting rate increases, increasing litigation exposure,
requiring new or additional benefits or affecting contracting arrangements
(including proposals to require HMOs and PPOs to accept any health care
providers willing to abide by an HMO's or PPO's contract terms) may have a
material adverse effect on our business. The continued consideration and
enactment of "anti-managed care" laws and regulations by federal and state
bodies may make it more difficult for us to manage medical costs and may
adversely affect financial results.
In addition to changes in applicable laws and regulations, we are subject to
various audits, investigations and enforcement actions. These include possible
government actions relating to ERISA, which regulates insured and self-insured
health coverage plans offered by employers, the Federal Employees Health Benefit
Plan, federal and state fraud and abuse laws, and laws relating to utilization
management and the delivery of health care. Any such government action could
result in assessment of damages, civil or criminal fines or penalties, or other
sanctions, including exclusion from participation in government programs. In
addition, disclosure of any adverse investigation or audit results or sanctions
could negatively affect our reputation in various markets and make it more
difficult for us to sell our products and services.
In addition to the items described above, we urge you to review carefully the
section "Risk Factors" in this 2001 Form 10-K for a more complete discussion of
the risks associated with an investment in our securities. See "Note on
Forward-Looking Statements and Risk Factors" under Item 1.
Recently Issued Accounting Standards
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
142, "Goodwill and Other Intangible Assets", or SFAS No. 142, which is effective
January 1, 2002. SFAS No. 142 requires, among other things, the discontinuance
of goodwill amortization. In addition, the pronouncement includes provisions for
the reclassification of certain existing recognized intangibles as goodwill,
reassessment of the useful lives of existing recognized intangibles,
reclassification of certain intangibles out of previously reported goodwill and
the identification of reporting units for purposes of assessing potential future
impairments of goodwill. SFAS No. 142 also requires us to complete a
transitional goodwill impairment test six months from the date of adoption. The
net amortized goodwill balance at December 31, 2001 was $14.8 million and
goodwill amortization during the year was $805,000 and would have been
approximately the same amount in 2002 under current accounting standards. We
have performed an evaluation of the impact of SFAS No. 142 on our operations and
have determined that our recorded goodwill will not be impaired under the
guidelines of the pronouncement.
In October 2001, the FASB issued Statement of Financial Accounting Standards No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets", or SFAS
No. 144, which is effective for fiscal years beginning after December 15, 2001
with early adoption recommended. SFAS No. 144 requires that long-lived assets
that are to be sold within one year must be separately identified and carried at
the lower of carrying value or fair value less costs to sell. Long-lived assets
expected to be held longer than one year are subject to depreciation and must be
written down to fair value upon impairment. Long-lived assets no longer expected
to be sold within one year, such as foreclosed real estate, must be written down
to the lower of current fair value or fair value at the date of foreclosure
adjusted to reflect depreciation since acquisition. As discussed in Note 4 of
Notes to the Consolidated Financial Statements, we have elected to adopt SFAS
No. 144 effective January 1, 2001.
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk for the impact of interest rate changes and
changes in the market value of our investments. We have not utilized derivative
financial instruments in our investment portfolio.
Our exposure to market risk for changes in interest rates relates primarily to
our investment portfolio and our long-term debt. As of December 31, 2001, we
have approximately $411.0 million in cash and cash equivalents and current,
long-term and restricted investments. Of the investments, approximately $281.4
million is classified as available-for-sale and $13.8 million is classified as
held-to-maturity. These investments are primarily in fixed income, investment
grade securities. Our investment policy emphasizes return of principal and
liquidity and is focused on fixed returns that limit volatility and risk of
principal. Because of our investment policies, the primary market risk
associated with our portfolio is interest rate risk.
Assuming interest rates were to increase by a factor of 1.1, the net
hypothetical loss in fair value of stockholders' equity related to financial
instruments is estimated to be approximately $4.9 million after tax (5.1% of
total stockholders' equity). We believe that such an increase in interest rates
would not have a material impact on future earnings or cash flows, as it is
unlikely that we would need or choose to substantially liquidate our investment
portfolio.
The effect of interest rate risk on potential near-term net income, cash flow
and fair value was determined based on commonly used interest rate sensitivity
analyses. The models project the impact of interest rate changes on a wide range
of factors, including duration and prepayment. Fair value was estimated based on
the net present value of cash flows or duration estimates, assuming an immediate
10% increase in interest rates. Because duration is estimated, rather than a
known quantity, for certain securities, other market factors may impact security
valuations and there can be no assurance that our portfolio would perform in
line with the estimated values.
As of December 31, 2001, we had $89 million in borrowings outstanding under a
revolving credit facility. The average cost of borrowing on this credit facility
for 2001, including the amortization of deferred financing fees and the impact
of the interest-rate swap agreement, was 10.6%. If the average cost of borrowing
on the amount outstanding as of December 31, 2001 were to increase by a factor
of 1.1, our annual income before tax would decrease by approximately $900,000.
As of December 31, 2001, CII had $15.0 million in senior debentures outstanding.
The debentures trade on the New York Stock Exchange. The fair market value of
the outstanding debentures was estimated to be approximately $13.0 million at
December 31, 2001, based on the last trade in 2001. If interest rates were to
fluctuate by a factor of 1.1, we do not anticipate a material change in the fair
value of the debentures based on the current market for them.
Our outstanding financing obligations related to the sale-leaseback transaction
are not publicly traded and are not subject to fluctuations in interest rates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
Page
----
Management Report on Consolidated Financial Statements.................................................... 47
Independent Auditors' Report.............................................................................. 48
Consolidated Balance Sheets at December 31, 2001 and 2000................................................. 49
Consolidated Statements of Operations for the Years Ended
December 31, 2001, 2000 and 1999....................................................................... 50
Consolidated Statements of Stockholders' Equity
for the Years Ended December 31, 2001, 2000 and 1999................................................... 51
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2001, 2000 and 1999....................................................................... 52
Notes to Consolidated Financial Statements................................................................ 53
MANAGEMENT REPORT ON CONSOLIDATED FINANCIAL STATEMENTS
The management of Sierra Health Services, Inc. is responsible for the integrity
and objectivity of the accompanying consolidated financial statements. The
statements have been prepared in conformity with accounting principles generally
accepted in the United States of America applied on a consistent basis and are
not misstated due to fraud or material error. The statements include some
amounts that are based upon the Company's best estimates and judgment.
The accounting systems and controls of the Company are designed to provide
reasonable assurance that transactions are executed in accordance with
management's authorization, that the financial records are reliable for
preparing financial statements and maintaining accountability for assets, and
that assets are safeguarded against losses from unauthorized use or disposition.
Management believes that for the year ended December 31, 2001, such systems and
controls were adequate to meet the objectives discussed herein.
The accompanying consolidated financial statements have been audited by
independent certified public accountants, whose audits thereof were made in
accordance with auditing standards generally accepted in the United States of
America and included a review of internal accounting controls to the extent
necessary to design audit procedures aimed at gathering sufficient evidence to
provide a reasonable basis for their opinion on the fairness of presentation of
the consolidated financial statements taken as a whole.
The Audit Committee of the Board of Directors, comprised solely of directors
from outside the Company, meets regularly with management and the independent
auditors to review the work procedures of each. The independent auditors have
free access to the Audit Committee, without management being present, to discuss
the results of their opinions on the adequacy of the Company's accounting
controls and the quality of the Company's financial reporting. The Board of
Directors, upon the recommendation of the Audit Committee, appoints the
independent auditors, subject to stockholder ratification.
Anthony M. Marlon, M.D.
Chairman and Chief Executive Officer
Paul H. Palmer
Vice President, Finance
Chief Financial Officer and Treasurer
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Sierra Health Services, Inc.:
We have audited the accompanying consolidated balance sheets of Sierra Health
Services, Inc. and its subsidiaries as of December 31, 2001 and 2000, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2001. Our
audits also included the financial statement schedules listed in the Index at
Item 14 (a)(2). These financial statements and financial statement schedules are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements and financial statement schedules based
on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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, such consolidated financial statements present fairly, in all
material respects, the financial position of Sierra Health Services, Inc. and
its subsidiaries at December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001 in conformity with accounting principles generally accepted in
the United States of America. Also, in our opinion, such financial statement
schedules, when considered in relation to the basic consolidated financial
statements taken as a whole, present fairly in all material respects the
information set forth therein.
DELOITTE & TOUCHE LLP
Las Vegas, Nevada
January 30, 2002
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2001 and 2000
(In thousands, except per share data)
ASSETS
2001 2000
---------- -----------
CURRENT ASSETS:
Cash and Cash Equivalents............................................... $ 115,754 $ 157,564
Investments............................................................. 260,762 206,935
Accounts Receivable (Less: Allowance for Doubtful
Accounts 2001 - $12,655; 2000 - $12,587)........................... 26,003 26,661
Military Accounts Receivable (Less: Allowance for Doubtful
Accounts 2001 - $0; 2000 - $1,212)................................. 40,166 71,390
Current Portion of Deferred Tax Asset .................................. 35,869 46,702
Current Portion of Reinsurance Recoverable.............................. 96,762 91,477
Other Current Receivables............................................... 16,821 15,703
Prepaid Expenses and Other Current Assets............................... 14,819 15,209
Assets Held for Sale.................................................... 3,458
Assets of Discontinued Operations....................................... 28,404 36,192
--------- ---------
Total Current Assets............................................... 635,360 671,291
PROPERTY AND EQUIPMENT, NET................................................... 141,451 171,032
LONG-TERM INVESTMENTS......................................................... 8,434 18,093
RESTRICTED CASH AND INVESTMENTS............................................... 26,011 24,461
REINSURANCE RECOVERABLE (Less Current Portion)................................ 123,383 160,227
GOODWILL (Less: Accumulated Amortization
2001 - $6,972; 2000 - $6,167).......................................... 14,782 15,587
DEFERRED TAX ASSET (Less Current Portion)..................................... 77,036 68,253
OTHER ASSETS.................................................................. 43,505 36,156
--------- ---------
TOTAL ASSETS.................................................................. $1,069,962 $1,165,100
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accrued Liabilities....................................................... $ 53,546 $ 48,423
Trade Accounts Payable.................................................... 21,578 28,411
Accrued Payroll and Taxes................................................. 14,390 16,089
Medical Claims Payable.................................................... 81,662 74,404
Current Portion of Reserve for
Losses and Loss Adjustment Expenses.................................. 142,342 134,676
Unearned Premium Revenue.................................................. 52,919 41,499
Military Health Care Payable.............................................. 77,261 84,859
Current Portion of Long-term Debt......................................... 1,612 53,993
Liabilities of Discontinued Operations.................................... 83,931 110,620
--------- ---------
Total Current Liabilities............................................ 529,241 592,974
RESERVE FOR LOSSES AND
LOSS ADJUSTMENT EXPENSE (Less Current Portion)............................ 243,363 239,878
LONG-TERM DEBT (Less Current Portion)......................................... 181,759 224,970
OTHER LIABILITIES............................................................. 19,080 16,805
--------- ---------
TOTAL LIABILITIES............................................................. 973,443 1,074,627
---------- ---------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred Stock, $.01 Par Value, 1,000
Shares Authorized; None Issued or Outstanding
Common Stock, $.005 Par Value, 60,000 Shares Authorized;
Shares Issued: 2001 - 29,648; 2000 - 28,815.......................... 148 144
Additional Paid-In Capital................................................ 181,076 177,493
Deferred Compensation..................................................... (1,058)
Treasury Stock: 2001 and 2000 - 1,523 Common Stock Shares................. (22,789) (22,789)
Accumulated Other Comprehensive Loss...................................... (5,636) (5,667)
Accumulated Deficit....................................................... (55,222) (58,708)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY.................................................... 96,519 90,473
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................................... $1,069,962 $1,165,100
========= =========
See the accompanying notes to consolidated financial statements.
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December 31, 2001, 2000 and 1999
(In thousands, except per share data)
2001 2000 1999
---------- ---------- -----------
OPERATING REVENUES:
Medical Premiums..................................................... $ 718,994 $ 637,769 $ 594,966
Military Contract Revenues........................................... 338,918 330,352 287,398
Specialty Product Revenues........................................... 183,306 135,844 94,221
Professional Fees.................................................... 28,985 33,102 42,069
Investment and Other Revenues ....................................... 21,298 22,513 20,411
--------- --------- ---------
Total............................................................. 1,291,501 1,159,580 1,039,065
--------- --------- ---------
OPERATING EXPENSES:
Medical Expenses..................................................... 608,757 576,738 534,606
Military Contract Expenses........................................... 331,621 323,265 276,493
Specialty Product Expenses........................................... 188,574 152,733 96,487
General, Administrative and Marketing Expenses....................... 117,717 105,314 94,428
Asset Impairment, Restructuring,
Reorganization and Other Costs.................................. 33,836 7,808
--------- --------- ---------
Total............................................................. 1,246,669 1,191,886 1,009,822
--------- --------- ---------
OPERATING INCOME (LOSS) FROM CONTINUING
OPERATIONS........................................................... 44,832 (32,306) 29,243
INTEREST EXPENSE AND OTHER, NET...................................... (18,563) (19,362) (16,511)
--------- --------- ---------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES.................................................. 26,269 (51,668) 12,732
(PROVISION) BENEFIT FOR INCOME TAXES................................. (8,803) 12,875 (2,209)
--------- --------- ---------
NET INCOME (LOSS) FROM CONTINUING OPERATIONS......................... 17,466 (38,793) 10,523
LOSS FROM DISCONTINUED OPERATIONS
(net of income tax benefit of $7,046, $61,350 and $8,144)....... (13,980) (161,122) (15,154)
--------- --------- ---------
NET INCOME (LOSS).................................................... $ 3,486 $ (199,915) $ (4,631)
========= ========= =========
EARNINGS PER COMMON SHARE:
Net Income (Loss) From Continuing Operations..................... $0.63 $(1.43) $ 0.39
Loss from Discontinued Operations................................ (0.50) (5.94) (0.56)
----- ----- -----
Net Income (Loss)................................................ $0.13 $(7.37) $(0.17)
==== ===== ====
EARNINGS PER COMMON SHARE ASSUMING DILUTION:
Net Income (Loss) From Continuing Operations..................... $0.61 $(1.43) $ 0.39
Loss from Discontinued Operations................................ (0.49) (5.94) (0.56)
----- ----- -----
Net Income (Loss)................................................ $0.12 $(7.37) $(0.17)
==== ===== ====
See the accompanying notes to consolidated financial statements.
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the Years Ended December 31, 2001, 2000 and 1999
(In thousands)
Addi-
tional Deferred
Common Stock Paid-In Compen- Treasury
Shares Amount Capital sation Stock
------ ------ -------- -------- --------
BALANCE, JANUARY 1, 1999....... 28,236 $141 $173,583 - $(14,821)
Comprehensive Income:
Net Loss....................
Other Comprehensive Loss, Net of Tax:
Unrealized Holding Loss on Available-
for-sale Investments.
Reclassification Adjustment for
Losses Included in Net Loss
Comprehensive Loss.............
Common Stock Issued in Connection
with Stock Plans............ 164 1 2,331
Purchase of Treasury Stock..... (7,968)
Income Tax Benefit Realized Upon
Exercise of Stock Options... 1
------ --- ------- ------ -------
BALANCE, DECEMBER 31, 1999..... 28,400 142 175,915 - (22,789)
Comprehensive Income:
Net Loss....................
Other Comprehensive Loss, Net of Tax:
Unrealized Holding Gain on Available-
for-sale Investments.
Reclassification Adjustment for
Gains Included in Net Loss
Comprehensive Loss.............
Common Stock Issued in Connection
with Stock Plans............ 415 2 1,578
------ --- ------ ------ -------
BALANCE, DECEMBER 31, 2000..... 28,815 144 177,493 - (22,789)
Comprehensive Income:
Net Income
Other Comprehensive Loss, Net of Tax:
Unrealized Holding Gain on Available-
for-sale Investments
Reclassification Adjustment for
Gains Included in Net Loss
Comprehensive Income...........
Issuance of Restricted Stock... 244 1 1,399 $(1,400)
Amortization of Deferred Compensation 342
Common Stock Issued in Connection
with Stock Plans............ 589 3 2,087
Income Tax Benefit Realized Upon
Exercise of Stock Options... 97
------ --- ------- ------ -------
BALANCE, DECEMBER 31, 2001..... 29,648 $148 $181,076 $(1,058) $(22,789)
====== === ======= ====== =======
See the accompanying notes to consolidated financial statements.
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the Years Ended December 31, 2001, 2000 and 1999
(In thousands)
Accumu-
lated
Other
Compre- Compre- Retained Total
hensive hensive Earnings Stock-
(Loss) (Loss) (Accumulated holders'
Income Income Deficit) Equity
-------- ------ ------------ -------
BALANCE, JANUARY 1, 1999......... $ (1,027) $ 145,838 $ 303,714
Comprehensive Income:
Net Loss.................... $ (4,631) (4,631) (4,631)
Other Comprehensive Loss, Net of Tax:
Unrealized Holding Loss on Available-
for-sale Investments... (15,295) (15,295) (15,295)
Reclassification Adjustment for
Losses Included in Net Loss 259 259 259
-------
Comprehensive Loss............. $(19,667)
=======
Common Stock Issued in Connection
with Stock Plans............ 2,332
Purchase of Treasury Stock..... (7,968)
Income Tax Benefit Realized Upon
Exercise of Stock Options... 1
------- -------- -------
BALANCE, DECEMBER 31, 1999..... (16,063) 141,207 278,412
Comprehensive Income:
Net Loss.................... $(199,915) (199,915) (199,915)
Other Comprehensive Loss, Net of Tax:
Unrealized Holding Gain on Available-
for-sale Investments 11,092 11,092 11,092
Reclassification Adjustment for
Gains Included in Net Loss (696) (696) (696)
--------
Comprehensive Loss............. $(189,519)
========
Common Stock Issued in Connection
with Stock Plans............ 1,580
-------- -------- -------
BALANCE, DECEMBER 31, 2000..... (5,667) (58,708) 90,473
Comprehensive Income:
Net Income................... $ 3,486 3,486 3,486
Other Comprehensive Loss, Net of Tax:
Unrealized Holding Gain on Available-
for-sale Investments 243 243 243
Reclassification Adjustment for
Gains Included in Net Loss (212) (212) (212)
--------
Comprehensive Income........... $ 3,517
========
Issuance of Restricted Stock...
Amortization of Deferred Compensation 342
Common Stock Issued in Connection
with Stock Plans............ 2,090
Income Tax Benefit Realized Upon
Exercise of Stock Options... 97
-------- -------- -------
BALANCE, DECEMBER 31, 2001..... $ (5,636) (55,222) $ 96,519
======== ======== =======
See the accompanying notes to consolidated financial statements.
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2001, 2000 and 1999
(In thousands)
2001 2000 1999
---------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (Loss)......................................... $ 3,486 $(199,915) $ (4,631)
Adjustments to Reconcile Net Income (Loss) to Net Cash
Provided by (Used for) Operating Activities:
Loss from Discontinued Operations..................... 13,980 161,122 15,154
Depreciation and Amortization......................... 25,547 25,495 20,675
Deferred Compensation Expense......................... 342
Provision for Doubtful Accounts....................... 1,232 1,594 7,131
Provision for Asset Impairment........................ 39,079
Loss on Property and Equipment Dispositions........... 2,418
Change in Assets and Liabilities:
Other Assets.......................................... (1,863) 1,451 (4,328)
Deferred Tax Asset.................................... 2,029 (53,573) (30,363)
Reinsurance Recoverable............................... 31,559 (115,036) (69,791)
Reserve for Losses and Loss Adjustment Expenses....... 11,151 130,160 32,131
Other Liabilities..................................... 2,646 11,313 29,671
Accounts Receivable................................... (1,786) 1,278 (14,889)
Other Current Assets.................................. (639) 6,065 (4,328)
Military Accounts Receivable.......................... 32,436 (11,462) 8,857
Military Health Care Payable.......................... (7,598) 34,028 (2,989)
Medical Claims Payable................................ 7,258 9,146 6,051
Other Current Liabilities.............................. 2,275 (15,563) 6,168
-------- -------- ---------
Net Cash Provided by (Used for)
Continuing Operations............................... 124,473 25,182 (5,481)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital Expenditures...................................... (9,462) (15,513) (49,629)
Property and Equipment Dispositions....................... 7,293 10,558 981
Purchase of Available-for-Sale Investments................ (849,061) (209,234) (358,281)
Proceeds from Sales/Maturities of
Available-for-Sale Investments........................ 790,611 226,980 358,792
Purchase of Held-to-Maturity Investments.................. (1,265) (1,662) (7,133)
Proceeds from Maturities of Held-to-Maturity Investments.. 8,585 5,466 36,077
-------- -------- --------
Net Cash (Used for) Provided by Continuing Operations. (53,299) 16,595 (19,193)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from Long-term Borrowing......................... 91,459 79,000
Payments on Debt and Capital Leases....................... (81,041) (42,686) (62,419)
Purchase of Treasury Stock................................ (7,968)
Exercise of Stock in Connection with Stock Plans.......... 2,090 1,580 2,332
-------- -------- --------
Net Cash (Used for) Provided by Continuing Operations. (78,951) 50,353 10,945
-------- -------- --------
NET CASH (USED FOR) PROVIDED
BY DISCONTINUED OPERATIONS............................... (34,033) 11,567 (3,918)
-------- -------- --------
NET (DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS.............................................. (41,810) 103,697 (17,647)
CASH AND CASH EQUIVALENTS AT BEGINNING
OF YEAR.................................................. 157,564 53,867 71,514
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR........................ $ 115,754 $ 157,564 $ 53,867
======== ======== ========
See the accompanying notes to consolidated financial statements.
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2001, 2000 and 1999
1. BUSINESS
Business. The consolidated financial statements include the accounts of Sierra
Health Services, Inc. and its subsidiaries (collectively referred to as "Sierra"
or the "Company"). Sierra is a managed health care organization that provides
and administers the delivery of comprehensive health care and workers'
compensation programs with an emphasis on quality care and cost management.
Sierra's broad range of managed health care services is provided through its
health maintenance organizations ("HMOs"), managed indemnity plans, military
health services programs, third-party administrative services programs for
employer-funded health benefit plans and its workers' compensation insurance and
medical management programs. Ancillary products and services that complement the
Company's managed health care product lines are also offered.
During the third quarter of 2001, the Company announced its plan to exit the
Texas HMO health care market and received formal approval from the Texas
Department of Insurance to withdraw its HMO operations in mid-October. The
Company will cease providing HMO health care coverage in Texas on April 17,
2002. In accordance with Statement of Financial Accounting Standards No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No.
144"), the Company's Texas HMO health care operations have been reclassified as
discontinued operations. The individual line items on the consolidated balance
sheets have been presented net of discontinued operations with the total assets
and liabilities of the discontinued operations presented on one line within
current assets and current liabilities, respectively. The results of operations
from discontinued operations have been reported net of tax as a separate
component of income on the consolidated statements of operations. The cash flows
from discontinued operations have been reported as a separate component on the
consolidated statements of cash flows. See Note 10 for disclosure on and a
description of the discontinued operations.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation. All significant intercompany transactions and
balances have been eliminated. Sierra's consolidated subsidiaries include:
Health Plan of Nevada, Inc. ("HPN") and Texas Health Choice, L.C. ("TXHC"),
which are licensed HMOs; Sierra Health and Life Insurance Company, Inc. ("SHL"),
a health and life insurance company; Southwest Medical Associates, Inc. ("SMA"),
a multi-specialty medical provider group; Sierra Military Health Services, Inc.,
and its subsidiary, ("SMHS"), a company that provides and administers managed
care services to certain TRICARE eligible beneficiaries; CII Financial, Inc.
("CII"), a holding company primarily engaged in writing workers' compensation
insurance through its wholly-owned subsidiaries; administrative services
companies; a home health care agency; a hospice; a home medical products
subsidiary; and a company that provides and manages mental health and substance
abuse services. TXHC is reported as part of discontinued operations.
Medical Premiums. Membership contracts are generally established on an annual
basis subject to cancellation by the employer group or Sierra generally upon 60
days written notice. Premiums, including premiums from both commercial and
governmental programs, are due monthly and are recognized as revenue during the
period in which Sierra is obligated to provide services to members and are net
of estimated retroactive terminations of members and groups. Non-Medicare member
enrollment is represented principally by employer groups. HPN offers a prepaid
health care program to Medicare recipients. Revenues associated with Medicare
recipients were approximately $304,734,000, $267,851,000 and $242,753,000 in
2001, 2000 and 1999, respectively. Unearned premium revenue includes payments
under prepaid Medicare contracts with the Centers for Medicare and Medicaid
Services ("CMS") and prepaid HPN commercial and SHL indemnity premiums.
Military Contract Revenues. Revenue under the Department of Defense TRICARE
contract is recorded based on the contract price as agreed to by the federal
government. The contract also contains provisions which adjust the contract
price based on actual experience and for government-directed change orders. The
estimated effects of these adjustments are recognized on a monthly basis. In
addition, the Company records revenue based on estimates of the earned portion
of any contract change orders not originally specified in the contract.
Specialty Product Revenues. These revenues consist primarily of workers'
compensation premiums. Premiums are calculated by formula such that the premium
written is earned pro rata over the term of the policy. Also included in
specialty product revenues are administrative services fees and certain
ancillary product revenues. Such revenues are recognized in the period in which
the service is performed or the period that coverage for services is provided.
Premiums written in excess of premiums earned are recorded as an unearned
premium revenue liability. Premiums earned include an estimate for earned but
unbilled premiums.
Professional Fees. Revenue for professional medical services is recorded on the
accrual basis in the period in which the services are provided. Such revenue is
recorded at established rates, net of provisions for estimated contractual
allowances.
Medical Expenses. The Company contracts with hospitals, physicians and other
independently contracted providers of health care under capitated or discounted
fee-for-service arrangements including hospital per diems to provide medical
care services to enrollees. Capitated providers are at risk for the cost of
medical care services provided to the Company's enrollees in the relevant
geographic areas; however, the Company is ultimately responsible for the
provision of services to its enrollees should the capitated provider be unable
to provide the contracted services. Health care costs are recorded in the period
when services are provided to enrolled members, including estimates for provider
costs which have been incurred as of the balance sheet date but not reported to
the Company. Any subsequent changes in estimate for a prior year would be
reflected in the current year's operating results.
Military Contract Expenses. This expense consists primarily of costs to provide
managed health care services to eligible beneficiaries in accordance with the
Company's TRICARE contract. Under the contract, SMHS provides health care
services to approximately 639,000 dependents of active duty military personnel
and military retirees and their dependents through subcontractor partnerships
and individual providers. Health care costs are recorded in the period when
services are provided to eligible beneficiaries including estimates for provider
costs which have been incurred as of the balance sheet date but not reported to
the Company. Also included in military contract expenses are costs incurred to
perform specific administrative services, such as health care appointment
scheduling, enrollment, network management and health care advice line services
and other administrative functions of the military health care subsidiary.
Specialty Product Expenses. This expense consists primarily of losses and loss
adjustment expense ("LAE"), policy acquisition costs and other general and
administrative expenses associated with issued workers' compensation policies.
Losses and LAE are based upon the accumulation of cost estimates for reported
claims occurring during the period as well as an estimate for losses that have
occurred but have not yet been reported. Policy acquisition costs consist of
commissions, premium taxes and other underwriting costs, which are directly
related to the production and retention of new and renewal business and are
deferred and amortized as the related premiums are earned. Should it be
determined that future policy revenues and earnings on invested funds relating
to existing insurance contracts will not be adequate to cover related costs and
expenses, deferred costs are expensed. Also included in specialty product
expenses are costs associated with administrative services and certain ancillary
products. These costs are recorded when incurred.
Loss and LAE reserves have a significant degree of uncertainty when related to
their subsequent payments. Although reserves are established on the basis of a
reasonable estimate, it is not only possible but probable that reserves will
differ from their related subsequent developments. Underlying causes for this
uncertainty include, but are not limited to, uncertainty in development patterns
and unanticipated inflationary trends affecting the services covered by the
insurance contract. This uncertainty can result in both adverse as well as
favorable development of actual subsequent activity when compared to the reserve
established. Any subsequent change in loss and LAE reserves established in a
prior year would be reflected in the current year's operating results.
Cash and Cash Equivalents. The Company considers cash and cash equivalents as
all highly liquid instruments with a maturity of three months or less at time of
purchase. The carrying amount of cash and cash equivalents approximates fair
value because of the short maturity of these instruments.
Investments. Investments consist principally of U.S. Government and its agencies
securities and municipal bonds, as well as corporate and mortgage-backed
securities. All non-restricted investments that are designated as
available-for-sale are classified as current assets. These investments are
available for use in the current operations regardless of contractual maturity
dates. Non-restricted investments designated as held-to-maturity are classified
as current assets if expected maturity is within one year of the balance sheet
date. Otherwise, they are classified as long-term investments. Realized gains
and losses are calculated using the specific identification method and are
included in net income. Unrealized holding gains and losses on
available-for-sale securities are included as a separate component of
stockholders' equity until realized.
Restricted Cash and Investments. Certain subsidiaries are required by state
regulatory agencies to maintain deposits and must also meet net worth and
reserve requirements. The Company believes its subsidiaries are in compliance
with the applicable minimum regulatory and capital requirements.
Military Accounts Receivable. Amounts receivable under government contracts are
comprised primarily of estimates of adjustments under the contract based on
actual experience and estimates of the earned portion of any change orders not
originally specified in the contract.
During 2001, SMHS adopted SFAS No. 140, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities", which provides
accounting and reporting standards for securitizations and other transfers of
financial assets and extinguishments of liabilities. On November 16, 2001, SMHS
entered into a securitization arrangement with General Electric Capital
Corporation. The arrangement provides for the sale of SMHS' Federal Government
accounts receivable to SMHS Funding, LLC. SMHS Funding is a special purpose
limited liability company owned by SMHS and was formed for the purpose of
purchasing all receivables of SMHS. This entity is fully consolidated into SMHS.
SMHS Funding, LLC may sell an undivided interest in certain of the receivables
to a subsidiary of General Electric Capital Corporation in the event that
additional financing by SMHS is warranted.
As of and for the year ended December 31, 2001, SMHS has not utilized the
facility and is currently incurring an unused facility fee of 0.5% per annum
calculated daily and payable monthly in arrears on the unused portion of the
maximum purchase limit of $32 million. As the servicer, SMHS receives servicing
fees at the rate of 1.0% per annum on the capital investment.
Reinsurance Recoverable. In the normal course of business, the Company seeks to
reduce the effects of catastrophic and other events that may cause unfavorable
underwriting results by reinsuring certain levels of risk with other reinsurers.
Reinsurance recoverable for ceded paid claims is recorded in accordance with the
terms of the agreements and reinsurance recoverable for unpaid losses and LAE
and medical claims payable is estimated in a manner consistent with the claim
liability associated with the reinsurance policy. Reinsurance receivables,
including amounts related to paid and unpaid losses, are reported as assets
rather than a reduction of the related liabilities.
Property and Equipment. Property and equipment are stated at cost less
accumulated depreciation. Maintenance and repairs that do not significantly
improve or extend the life of the respective assets are charged to operations.
Depreciation and amortization is computed using the straight-line method over
the estimated service lives of the assets or terms of leases if shorter.
Estimated useful lives are as follows:
Buildings and Improvements 10 - 30 years
Leasehold Improvements 3 - 10 years
Furniture, Fixtures and Equipment 3 - 5 years
Data Processing Hardware and Software 3 - 10 years
Goodwill. Goodwill has been recorded primarily as a result of various business
acquisitions by the Company. Amortization has been recorded on a straight line
basis over periods not exceeding 40 years. The Company has periodically
evaluated the carrying value of its intangible assets. The Company utilized the
discounted cash flow method for evaluating the recoverability of goodwill.
Future cash flows are estimated based on Company projections and are discounted
based on the interest rates approximating long-term bond yields.
In connection with the restructuring plans adopted and announced by the Company
in the second quarter of 2000, the Company re-evaluated the recoverability of
certain long-lived assets, primarily those associated with the Texas HMO health
care operations, in accordance with Statement of Financial Accounting Standards
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of" ("SFAS No. 121") and Accounting Principles Board
Opinion No. 17, "Intangible Assets" ("APB No. 17"), and determined that the
carrying value of certain goodwill was impaired. In assessing the asset
impairment of the long-lived assets, the Company first allocated a portion of
related goodwill to the fixed assets to be disposed of, in accordance with SFAS
No. 121. The remainder of the related goodwill was then assessed for
recoverability in accordance with APB No. 17 based on projected discounted cash
flows and an impairment of $141,506,000 was recorded. Of the total impairment,
$126,387,000 was related to and has been recorded as part of discontinued
operations. See Note 10 and Note 17 for a description of the primary facts and
circumstances related to the impairment.
Starting in 2002, goodwill will be evaluated in accordance with Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets"
("SFAS No. 142"), which is effective January 1, 2002. In accordance with SFAS
No. 142, the Company will no longer amortize its goodwill. Amortization expense,
from continuing operations, associated with goodwill was $805,000, $1,131,000
and $1,463,000 for the years ended December 31, 2001, 2000 and 1999,
respectively.
Medical Claims Payable and Military Health Care Payable. Medical claims payable
and military health care payable include the estimated cost for unpaid claims
for which health care services have been provided to enrollees and to TRICARE
eligibles. Such provisions include an estimate for the costs of claims that have
been incurred but have not been reported.
Premium Deficiency Reserves. Premium deficiency expenses are recognized when it
is probable that the future costs associated with a group of existing contracts
will exceed the anticipated future premiums on those contracts. The Company
calculates expected premium deficiency expense based on budgeted revenues and
expenses. Premium deficiency reserves are evaluated quarterly for adequacy. See
Note 10 and Note 16 for a description of premium deficiency expenses and
balances for the years ended December 31, 2001, 2000 and 1999. The premium
deficiency accruals as of December 31, 2001 and 2000 were related to the
discontinued operations.
Reserve for Losses and Loss Adjustment Expense. The reserve for workers'
compensation losses and LAE consists of estimated costs of each unpaid claim
reported to the Company prior to the close of the accounting period, as well as
those incurred but not yet reported. The methods for establishing and reviewing
such liabilities are continually reviewed and adjustments are reflected in
current operations. The Company does not discount its losses and LAE reserves.
Income Taxes. The Company accounts for income taxes using the liability method.
Deferred income tax assets and liabilities result from temporary differences
between the tax basis of assets and liabilities and the reported amounts in the
consolidated financial statements that will result in taxable or deductible
amounts in future years. The Company's temporary differences arise principally
from certain net operating losses, accrued expenses, reserves, depreciation and
impairment charges.
Concentration of Credit Risk. The Company's financial instruments that are
exposed to credit risk consist primarily of investments and accounts receivable.
The Company maintains cash and cash equivalents and investments with various
financial institutions. These financial institutions are located in many
different regions and company policy is designed to limit exposure with any one
institution.
Credit risk with respect to accounts receivable is generally diversified due to
the large number of entities comprising the Company's customer base and their
dispersion across many different industries. These customers are primarily
located in the states in which the Company operates and are principally in
California, Nevada and Texas. However, the Company is licensed and does business
in several other states. As of December 31, 2001, the Company had receivables
outstanding from the federal government related to its TRICARE contract in the
amount of $40.2 million. The Company also has receivables from its reinsurers.
Reinsurance contracts do not relieve the Company from its obligations to
enrollees or policyholders. Failure of reinsurers to honor their obligations
could result in losses to the Company. The Company evaluates the financial
condition of its reinsurers to minimize its exposure to significant losses from
reinsurer insolvencies. All reinsurers with whom the Company has reinsurance
contracts are rated AA and A+ or better by Fitch Ratings and the A.M. Best
Company, respectively.
Derivatives. The Company's only derivative instrument is an interest rate swap
agreement used to minimize interest rate risk. As of January 1, 2001, the
Company implemented Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133").
The implementation did not result in an adjustment. At December 31, 2001 we
recorded the swap agreement to its fair market value. The fair market value was
determined based on what the Company would need to pay, $685,000, to terminate
the swap agreement at December 31, 2001. Sierra accounts for derivative
instruments on the balance sheet at fair value with changes in fair values
reported as part of net income.
Recently Issued Accounting Standards. In July 2001, the FASB issued SFAS No. 142
which is effective January 1, 2002. SFAS No. 142 requires, among other things,
the discontinuance of goodwill amortization. In addition, the pronouncement
includes provisions for the reclassification of certain existing recognized
intangibles as goodwill, reassessment of the useful lives of existing recognized
intangibles, reclassification of certain intangibles out of previously reported
goodwill and the identification of reporting units for purposes of assessing
potential future impairments of goodwill. SFAS No. 142 also requires us to
complete a transitional goodwill impairment test six months from the date of
adoption. The net amortized goodwill balance at December 31, 2001 was $14.8
million and goodwill amortization expense during the year was $805,000 and would
have been approximately the same amount in 2002 under current accounting
standards. The Company has performed an evaluation of the impact of SFAS No. 142
on our operations and has determined that the recorded goodwill was not impaired
under the guidelines of the pronouncement.
In October 2001, the FASB issued SFAS No. 144 which is effective for fiscal
years beginning after December 15, 2001 with early adoption recommended. SFAS
No. 144 requires that long-lived assets that are to be sold within one year must
be separately identified and carried at the lower of carrying value or fair
value less costs to sell. Long-lived assets expected to be held longer than one
year are subject to depreciation and must be written down to fair value upon
impairment. Long-lived assets no longer expected to be sold within one year,
such as foreclosed real estate, must be written down to the lower of current
fair value or fair value at the date of foreclosure adjusted to reflect
depreciation since acquisition. As discussed in Note 4 of Notes to the
Consolidated Financial Statements the Company elected to adopt early SFAS No.
144 effective January 1, 2001 and present the Texas HMO health care operations
as discontinued.
Use of Estimates and Assumptions in the Preparation of Financial Statements. The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Management must exercise its judgment taking into
consideration the facts and circumstances in selecting assumptions and other
factors in calculating its estimates. On an on-going basis, management
re-evaluates its assumptions and the methods of calculating its estimates.
Estimates and assumptions include, but are not limited to, medical and specialty
product expenses, military revenue and expenses and goodwill recoverability.
Actual results may materially differ from estimates.
Reclassifications. Certain amounts in the Consolidated Financial Statements for
the years ended December 31, 2000 and 1999 have been reclassified to conform
with the current year presentation.
3. EARNINGS PER SHARE
The following table provides a reconciliation of basic and diluted earnings per
share ("EPS"):
(In thousands, except per share data) Years ended December 31,
2001 2000 1999
---- ---- ----
Income (loss) from continuing operations........................ $ 17,466 $ (38,793) $ 10,523
Loss from discontinued operations............................... (13,980) (161,122) (15,154)
------- -------- -------
Net income (loss)............................................... $ 3,486 $ (199,915) $ (4,631)
======= ======== =======
Earnings per common share:
Income (loss) from continuing operations........................ $ 0.63 $ (1.43) $ 0.39
Loss from discontinued operations............................... (0.50) (5.94) (0.56)
------ ------- -------
Net income (loss).............................................. $ 0.13 $ (7.37) $ (0.17)
====== ======= =======
Earnings per common share assuming dilution:
Income (loss) from continuing operations....................... $ 0.61 $ (1.43) $ 0.39
Loss from discontinued operations............................... (0.49) (5.94) (0.56)
------ -------- -------
Net income (loss)............................................... $ 0.12 $ (7.37) $ (0.17)
====== ======== =======
Weighted average common shares outstanding...................... 27,685 27,142 26,927
Weighted average common shares outstanding
assuming dilution...................................... 28,509 27,142 26,996
Options to purchase 4,250,000 shares of common stock were outstanding at
December 31, 2000 but were not included in the computation of diluted earnings
per share because the Company had a net operating loss for the year and their
inclusion would have been anti-dilutive.
CII issued convertible subordinated debentures (the "Debentures") due September
15, 2001. Each $1,000 in principal was convertible into 25.382 shares of the
Company's common stock at a conversion price of $39.398 per share. The
Debentures were paid off in September 2001 and they have not been included in
the computation of EPS during the years presented because their effect would be
anti-dilutive.
4. PROPERTY AND EQUIPMENT
Property and equipment at December 31, consists of the following:
(In thousands) 2001 2000
---------- -----------
Land................................................... $ 11,263 $ 14,218
Buildings and Improvements............................. 101,822 118,879
Furniture, Fixtures and Equipment...................... 39,565 39,975
Data Processing Equipment and Software................. 96,405 88,439
Software in Development and Construction
in Progress......................................... 2,424 5,816
Less: Assets Held for Sale............................. (3,458)
Accumulated Depreciation ..................... (110,028) (92,837)
-------- -------
Property and Equipment, Net........................ $ 141,451 $171,032
======== =======
The following is an analysis of property and equipment under capital lease by
classification as of December 31:
(In thousands): 2001 2000
---------- -----------
Data Processing Equipment and Software ................ $ 333 $ 6,571
Furniture, Fixtures and Equipment...................... 3,783
Buildings.............................................. 245 245
Less: Accumulated Depreciation......................... (316) (5,552)
---- ------
Property and Equipment, Net......................... $ 262 $ 5,047
==== ======
The Company capitalizes interest expense as part of the cost of construction of
facilities and the implementation of computer systems. Interest expense
capitalized in 2001, 2000 and 1999 was $29,000, $67,000 and $2,140,000,
respectively. Depreciation expense, from continuing operations, in 2001, 2000
and 1999 was $24,742,000, $23,847,000 and $18,961,000, respectively.
Assets held for sale on the balance sheet at December 31, 2000 consisted of real
estate in Arizona which the Company sold during 2001.
Sale-Leaseback. On December 28, 2000, the Company sold the majority of its Las
Vegas, Nevada administrative and medical clinic real estate holdings in a
sale-leaseback transaction. As part of the transaction, the Company financed a
portion of the sales price with mortgage notes receivable of $22.2 million and
provided deposits of $4.3 million. The mortgages and deposits constitute
continuing involvement as defined in Statement of Financial Accounting Standards
No. 98, "Accounting for Leases" ("SFAS No. 98"), and as such the transaction did
not qualify as a sale. In accordance with SFAS No. 98, the Company recorded the
transaction as a financing obligation of $113,659,000, offset by the mortgage
notes receivable of $22,200,000. The net book value of the assets included in
the transaction was $86,890,000 at December 31, 2000. For assets that do not
qualify for sale treatment, depreciation expense and interest expense are
recognized on the net book value of the assets and net financing obligation
outstanding, respectively.
During 2001, the Company received full payment on the outstanding mortgage notes
receivable associated with three of the medical clinics. This cured the
continuing involvement criteria from SFAS No. 98 and the clinics then qualified
as a sale. To record the sale, the Company retired the assets and their
associated accumulated depreciation and financing obligation and recorded a
deferred gain to be recognized over the remaining 14 year term of the lease. The
impact of the sale of the three clinics was a net reduction of $13.4 million in
property and equipment, a net reduction of $14.6 million in the associated
financing obligation and a deferred gain of $6.1 million. As of December 31,
2001, the remaining financing obligation was $90,810,000, offset by mortgage
notes receivable of $16,862,000.
The Company expects that the remaining mortgages and deposits will be repaid to
Sierra by the end of 2002, at which time the rest of the transaction will
qualify as a sale.
5. CASH AND INVESTMENTS
Investments that the Company has the intention and ability to hold to maturity
are stated at amortized cost and categorized as held-to-maturity. The remaining
investments have been categorized as available-for-sale and are stated at their
fair value. Fair value is estimated primarily from published market values as of
the balance sheet date. Gross realized gains on investments for 2001, 2000 and
1999 were $1,098,000, $494,000 and $334,000, respectively. Gross realized losses
on investments for 2001, 2000 and 1999 were $771,000, $1,566,000 and $733,000,
respectively.
The following table summarizes the Company's current, long-term and restricted
investments as of December 31, 2001:
Gross Gross
Amortized Unrealized Unrealized Fair
(In thousands) Cost Gains Losses Value
-------------- ------------- ------------- -----------
Available-for-Sale Investments:
Classified as Current:
U.S. Government
and its Agencies........................... $210,949 $1,129 $ 7,494 $204,584
Municipal Obligations......................... 16,274 31 394 15,911
Corporate Bonds............................... 29,572 81 2,110 27,543
Other......................................... 851 851
------- ----- ------ -------
Total Debt Securities...................... 257,646 1,241 9,998 248,889
Preferred Stock............................... 8,884 40 50 8,874
------- ----- ------ -------
Total Current.............................. 266,530 1,281 10,048 257,763
------- ----- ------ -------
Classified as Restricted:
U.S. Government
and its Agencies........................... 17,677 352 317 17,712
Municipal Obligations......................... 2,326 38 2,364
Corporate Bonds............................... 1,495 35 1,530
Other......................................... 2,029 2,029
------- ----- ------ -------
Total Restricted................................. 23,527 425 317 23,635
------- ----- ------ -------
Total Available-for-Sale................ $290,057 $1,706 $10,365 $281,398
======= ===== ====== =======
Held-to-Maturity Investments:
Classified as Current:
Corporate Bonds................................ $ 2,999 $ 22 $ 3,021
------- ----- -------
Classified as Long-term:
U.S. Government
and its Agencies........................... 5,608 $ 258 5,350
Municipal Obligations......................... 328 15 313
Corporate Bonds............................... 2,498 175 2,673
------- ----- ------ -------
Total Long-term ................................. 8,434 175 273 8,336
------- ----- ------ -------
Classified as Restricted:
U.S. Government
and its Agencies........................... 626 24 650
Municipal Obligations.......................... 636 29 607
Corporate Bonds............................... 1,114 42 1,156
------- ----- ------ -------
Total Restricted ................................. 2,376 66 29 2,413
------- ----- ------ -------
Total Held-to-Maturity.................. $ 13,809 $ 263 $ 302 $ 13,770
======= ===== ====== =======
The following table summarizes the Company's current, long-term and restricted
investments as of December 31, 2000:
Gross Gross
Amortized Unrealized Unrealized Fair
(In thousands) Cost Gains Losses Value
-------------- ------------- ------------- -----------
Available-for-Sale Investments:
Classified as Current:
U.S. Government
and its Agencies........................... $145,610 $284 $6,761 $139,133
Municipal Obligations......................... 20,303 41 549 19,795
Corporate Bonds............................... 41,040 62 1,659 39,443
------- --- ----- -------
Total Debt Securities............................. 206,953 387 8,969 198,371
Preferred Stock............................... 7,957 50 231 7,776
------- --- ----- -------
Total Current .................................... 214,910 437 9,200 206,147
------- --- ----- -------
Classified as Restricted:
U.S. Government
and its Agencies........................... 15,862 69 207 15,724
Municipal Obligations......................... 2,637 49 27 2,659
Corporate Bonds............................... 1,192 16 16 1,192
Other......................................... 2,509 2,509
------- --- ----- -------
Total Restricted .......................... 22,200 134 250 22,084
------- --- ----- -------
Total Available-for-Sale ............... $237,110 $571 $9,450 $228,231
======= === ===== =======
Held-to-Maturity Investments:
Classified as Current:
U.S. Government
and its Agencies........................... $ 283 $ 3 $ 286
Municipal Obligations......................... 505 12 517
------- --- -------
Total Current..................................... 788 15 803
------- --- -------
Classified as Long-term:
U.S. Government
and its Agencies........................... 11,230 262 $ 689 10,803
Municipal Obligations......................... 2,381 53 2,434
Corporate Bonds............................... 4,482 117 160 4,439
------- --- ----- -------
Total Long-term ................................. 18,093 432 849 17,676
------- --- ----- -------
Classified as Restricted:
U.S. Government
and its Agencies........................... 1,263 14 1,277
Corporate Bonds ................................. 499 23 522
Other.......................................... 615 615
------- --- -------
Total Restricted........................... 2,377 37 2,414
------- --- ----- -------
Total Held-to-Maturity.................. $ 21,258 $484 $ 849 $ 20,893
======= === ===== =======
The contractual maturities of available-for-sale investments at December 31,
2001 are shown below. Expected maturities may differ from contractual maturities
because borrowers may have the right to call or prepay obligations.
Amortized
Cost Fair Value
--------------- --------------
(In thousands)
Due in one year or less...................................... $ 13,590 $ 13,609
Due after one year through five years........................ 39,511 39,865
Due after five years through ten years....................... 34,345 34,263
Due after ten years through fifteen years.................... 19,399 19,295
Due after fifteen years...................................... 174,328 165,492
------- -------
Total................................................... $281,173 $272,524
======= =======
The contractual maturities of held-to-maturity investments at December 31, 2001
are shown below. Expected maturities may differ from contractual maturities
because borrowers may have the right to call or prepay obligations.
Amortized
Cost Fair Value
--------------- --------------
(In thousands)
Due in one year or less...................................... $ 4,065 $ 4,111
Due after one year through five years........................ 3,171 3,389
Due after five years through ten years.......................
Due after ten years through fifteen years....................
Due after fifteen years...................................... 6,573 6,270
------ ------
Total................................................... $13,809 $13,770
====== ======
Of the cash and cash equivalents and current investments that total $376.5
million in the accompanying Consolidated Balance Sheet at December 31, 2001,
$341.3 million is limited for use only by the Company's regulated subsidiaries.
Such amounts are available for transfer to Sierra from the regulated
subsidiaries only to the extent that they can be remitted in accordance with
terms of existing management agreements and by dividends, which customarily must
be approved by regulating state insurance departments. The remainder is
available to Sierra on an unrestricted basis.
6. REINSURANCE
The Company is covered under medical reinsurance agreements that provide
coverage for 50% - 90% of hospital and other costs in excess of, depending on
the contract, $75,000 to $200,000 per case, up to a maximum of $2,000,000 per
member per lifetime for both the managed indemnity and HMO subsidiaries. In
addition, certain of the Company's HMO members are covered by an excess
catastrophe reinsurance contract and SHL maintains reinsurance on certain of its
insurance products. Reinsurance premiums of $1,680,000, $2,433,000 and
$1,835,000, net of reinsurance recoveries of $1,760,000, $1,945,000 and
$1,761,000, are included in medical expenses for 2001, 2000 and 1999,
respectively.
CII has reinsurance agreements or treaties in effect with unrelated entities.
Effective July 1, 1998, all claims with dates of injury occurring on or after
that date were reinsured under a quota share and excess of loss agreement, "low
level reinsurance", with Travelers Indemnity Company of Illinois ("Travelers").
Travelers is rated AA and A++ by Fitch Ratings and the A.M. Best Company,
respectively. The low level reinsurance provided quota share protection for 30%
of the first $10,000 of each loss, and excess of loss protection of 75% of the
next $40,000 of each loss, and 100% of the next $450,000 on a per occurrence
basis. The maximum net loss retained on any one claim ceded under this treaty
was $17,000. This agreement continued until June 30, 2000, when CII exercised an
option for a twelve month extension relating to the run-off of policies in force
as of June 30, 2000, which covered claims arising under such policies during the
term of the extension.
In addition to the low level reinsurance, effective January 1, 2000 CII entered
into a reinsurance contract that provides statutory (unlimited) coverage for
workers' compensation claims in excess of $500,000 per occurrence. The contract
is in effect for claims occurring on or after January 1, 2000 through December
31, 2002. There is a twelve month run out provision in the contract which the
Company intends to exercise. The reinsurer, National Union Fire Insurance
Company, is rated AAA and A++ by Fitch Ratings and the A.M. Best Company,
respectively.
Effective July 1, 2000, CII entered into a reinsurance contract with National
Union Fire Insurance Company that provided $250,000 of coverage for workers'
compensation claims in excess of $250,000 per occurrence. The contract was in
effect for claims occurring on policies with effective dates beginning July 1,
2000 and thereafter and for claims incurred prior to July 1, 2001.
The low level reinsurance agreement was consummated early in the fourth quarter
of 1998 but coverage was made retroactive to July 1, 1998. Therefore, this
agreement contained both retroactive (covering claims occurring in the third
calendar quarter of 1998) and prospective reinsurance coverage (covering claims
occurring after September 30, 1998). In accordance with Statement of Financial
Accounting Standards No. 113, "Accounting and Reporting for Reinsurance of
Short-Duration and Long-Duration Contracts" ("SFAS No. 113"), the Company
bifurcated the low level reinsurance agreement between the retroactive and
prospective components due to the different accounting treatments for each
respective piece. The amount by which the estimated ceded liabilities exceeded
the amount paid for the retroactive coverage was reported as a deferred gain and
is amortized to income as a reduction of incurred losses over the estimated
remaining settlement period using the interest method. Any subsequent changes in
estimated or actual cash flows related to the retroactive coverage are accounted
for by adjusting the previously recorded deferred gain to the balance that would
have existed had the revised estimate been available at the inception of the
reinsurance transactions, with a corresponding charge or credit to income. The
Company recorded an adjustment to increase its deferred gain related to
retroactive reinsurance coverage by $2,996,000, $3,662,000 and $4,615,000 in
2001, 2000 and 1999, respectively. For the years ended December 31, 2001, 2000
and 1999, the Company amortized deferred gains of $2,696,000, $5,199,000 and
$3,850,000, respectively. Such amortization is included as a credit to specialty
product expense on the accompanying consolidated statements of operations.
In accordance with SFAS No. 113, losses ceded under prospective reinsurance
reduce direct incurred losses and amounts recoverable are reported as an asset.
At December 31, 2001 and 2000, the amount of reinsurance recoverable under
prospective reinsurance contracts for unpaid loss and LAE was $187,453,000 and
$218,757,000, respectively. At December 31, 2001 and 2000, the amount of
reinsurance recoverable under the retroactive reinsurance contract was
$8,781,000 and $10,863,000, respectively. The amount of reinsurance receivable
for paid loss and LAE was $21,845,000 and $17,585,000 at December 31, 2001 and
2000, respectively.
Reinsurance contracts do not relieve the Company from its obligations to
enrollees or policyholders. Failure of reinsurers to honor their obligations
could result in losses to the Company. The Company evaluates the financial
condition of its reinsurers to minimize its exposure to significant losses from
reinsurer insolvencies.
All of the reinsurance recoverables are due from reinsurers rated AA and A+ by
Fitch Ratings and the A.M. Best Company, respectively, and all amounts are
considered to be collectible.
The following table provides workers' compensation prospective reinsurance
information for the three years ended December 31, 2001:
Change in
Recoveries Recoverable
on Paid on Unpaid Premiums
Losses/LAE Losses/LAE Ceded
---------- ------------ -----
(In thousands)
Year Ended December 31, 2001:
Low level reinsurance carrier................. $80,932 $(40,430) $ 9,136
Excess of loss reinsurance carriers........... 4,407 9,125 4,244
------ ------- -------
Total ........................................ $85,339 $(31,305) $13,380
====== ======= ======
Year Ended December 31, 2000:
Low level reinsurance carrier................... $53,408 $100,240 $74,071
Excess of loss reinsurance carriers............. 2,324 8,428 3,449
------ ------- -------
Total .......................................... $55,732 $108,668 $77,520
====== ======= ======
Year Ended December 31, 1999:
Low level reinsurance carrier.................. $21,941 $ 69,104 $60,702
Excess of loss reinsurance carriers.............. 1,730 3,188 3,025
------ ------- -------
Total ........................................ $23,671 $ 72,292 $63,727
====== ======= ======
7. LOSSES AND LOSS ADJUSTMENT EXPENSES
The following table provides a reconciliation of the beginning and ending
reserve balances for workers' compensation unpaid losses and LAE. The loss
estimates are subject to change in subsequent accounting periods and any change
to the current reserve estimates would be accounted for in future results of
operations in the period when the change occurs.
While management of the Company believes that current estimates are reasonable,
significant adverse or favorable loss development could occur in the future.
Year ended December 31,
2001 2000 1999
---------- ---------- -----------
(In thousands)
Net Beginning Losses and LAE Reserve ..................... $155,797 $134,305 $174,467
------- ------- -------
Net Provision for Insured Events Incurred in:
Current Year .......................................... 131,923 86,587 51,541
Prior Years............................................ 8,691 23,293 9,920
------- ------- -------
Total Net Provision.................................. 140,614 109,880 61,461
------- ------- -------
Net Payments for Losses and LAE
Attributable to Insured Events Incurred in:
Current Year .......................................... 28,560 26,867 21,207
Prior Years............................................ 69,599 61,521 80,416
------- ------- -------
Total Net Payments .................................. 98,159 88,388 101,623
------- ------- -------
Net Ending Losses and LAE Reserve ........................ 198,252 155,797 134,305
Reinsurance Recoverable .................................. 187,453 218,757 110,089
------- ------- -------
Gross Ending Losses and LAE Reserve ...................... $385,705 $374,554 $244,394
======= ======= =======
During the years ended December 31, 2001 and 2000, the Company experienced prior
year net adverse loss development of $8.7 million and $23.3 million,
respectively. Estimated losses and LAE incurred in accident years 1996 to 1999
have developed significantly primarily due to the continuation of increasing
claim severity patterns on the Company's California book of business. Many
workers' compensation insurance carriers in California are also experiencing
high claim severity. Factors influencing the higher claim severity include
rising average temporary disability costs, the increase in the number of major
permanent disability claims, medical inflation and adverse court decisions
related to medical control of a claimant's treatment. See Note 6 for a
description of our reinsurance coverage.
For the year ended December 31, 1999, the Company recorded net adverse loss
development on prior accident years of $9.9 million, primarily for accident
years 1996 to 1998.
8. LONG-TERM DEBT
Long-term debt at December 31, consists of the following:
2001 2000
---------- -----------
(In thousands)
Revolving Credit Facility............................................ $ 89,000 $135,000
Net Financing Obligations............................................ 73,948 91,253
7 1/2% Convertible Subordinated Debentures........................... 47,041
9 1/2% Senior Debentures............................................. 19,187
Other................................................................ 1,236 5,669
------- -------
Total.............................................................. 183,371 278,963
Less Current Portion................................................. (1,612) (53,993)
------- -------
Long-term Debt....................................................... $181,759 $224,970
======= =======
Revolving Credit Facility. On October 31, 1998, the Company replaced its prior
line of credit with a $200 million credit facility. As a result of the asset
impairment and other changes in estimate charges, the Company was not in
compliance with its financial covenants at June 30, 2000. On December 15, 2000,
the Company entered into an amended and restated credit agreement, which
terminates on September 30, 2003. The Company believes it is now in compliance
with all covenants of the amended agreement. The restated agreement was
subsequently amended in April 2001 to allow for the completion of the CII
debenture exchange offer and again in October 2001 to provide a limited waiver
for covenants affected by exiting the Texas HMO health care market.
The maximum availability under the amended and restated credit agreement has
been reduced to $117 million at December 31, 2001 from $135 million at the end
of 2000 due to required reductions in the agreement. At December 31, 2001, the
Company has $28 million available under the agreement; however, the total
availability will be reduced by $6.0 million on June 30, 2002 and December 31,
2002 and finally by $10.0 million on June 30, 2003. The amount available under
the credit facility can be further reduced by 80% of net proceeds from certain
asset sales and excess cash flow, as well as 100% of the net proceeds of any new
debt or equity issuance, excluding any issuance by CII, as defined in the
amended and restated credit agreement.
Subject to normal qualifications and exceptions, Sierra has covenants that,
among other things, restrict its ability to dispose of assets, incur
indebtedness, pay dividends, make investments, loans or advances, make
acquisitions, engage in mergers or consolidations, or make capital expenditures
and which otherwise restrict certain corporate activities. Any availability
under the credit facility generated from excess cash flow must be converted
annually to permanent reductions in accordance with the terms of the credit
facility.
The amended and restated credit agreement restricts the amount of funds that can
be invested in the Texas and SMHS operations. The maximum we can invest in the
Military operations is $5 million, we have not invested any of the $5 million as
of December 31, 2001. After September 30, 2001, we can invest an additional $5.0
million in the Texas operations and replace the Texas real estate assets with
cash and notes up to $46 million. Under the terms of the amended and restated
agreement, the use of Sierra funds to pay the outstanding Texas mortgage note of
$29.2 million is not considered an investment in the Texas operations. During
the fourth quarter of 2001, we invested in Texas the full $5.0 million allowed
under the amended and restated agreement. If we had to invest more than we are
allowed, we would be required to get a waiver or an amendment to our agreement
or be out of compliance. If additional funds are needed by our discontinued
Texas HMO health care operations and we do not transfer such funds they may be
in violation of certain insurance regulations and we may be required to get a
waiver or an amendment to our agreement or be out of compliance. There is no
assurance that if we needed a bank waiver or amendment that we would be able to
obtain it. Based on the current estimated Texas HMO healthcare run-out costs and
recorded reserves, we believe we have adequate funds available and the ability
to invest adequate funds in Texas to meet the anticipated obligations.
We are not allowed to pay or declare any cash dividends on our common stock
under the terms of our amended and restated credit agreement. We have not paid
or declared any cash dividends since inception. We anticipate that future
earnings will be retained for our current operations; therefore, we do not plan
to pay or declare any dividends on our common stock in the foreseeable future.
Interest under the amended and restated credit agreement is variable and based
on the Bank of America "prime rate" adjusted for a margin. The rate was 5.375%
at December 31, 2001, which is a combination of the prime rate of 4.75% plus a
margin of .625%. The Company can reduce the margin in the future by completing
certain transactions and meeting certain financial ratios. Of the outstanding
balance, $25 million is covered by an interest-rate swap agreement. To mitigate
the risk of interest rate fluctuation on the credit facility, the Company
entered into a five-year $50 million interest-rate swap agreement during the
fourth quarter of 1998. The intent of the agreement was to keep the Company's
interest rate on $50 million of the borrowing relatively fixed. In the fourth
quarter of 2000, $25 million of the swap agreement was terminated. The interest
rate swap is a derivative as described in SFAS No.133 and the Company recorded a
liability for the interest-rate swap agreement at its fair market value of
$685,000 as of December 31, 2001. Previously, the fair value of the asset or
liability related to the swap was immaterial. The fair market value is the cost
that the Company would need to pay to terminate the swap agreement as of
December 31, 2001.
The average cost of borrowing on the credit facility for 2001, including the
amortization of deferred financing fees and the impact of the swap agreement,
was 10.6%. The terms of the amended and restated credit agreement contain
certain covenants including a minimum fixed charge coverage ratio, a minimum
interest coverage ratio, a maximum leverage ratio, maximum loss ratios and
maximum capital expenditure amounts. The Company believes it is in compliance
with these covenants at December 31, 2001.
Net Financing Obligations represent amounts recorded as a financing obligation
of $90.8 million offset by notes receivable of $16.9 million as part of the
sale-leaseback transaction described in Note 4. Amounts were recorded as a
financing obligation as required by SFAS No. 98 using the interest method with
effective interest rates of 8.16% to 8.53%. The balance outstanding under the
net financing obligations was reduced by $14.6 million as described in Note 4
and by $2.7 million from the principal portion of the lease payments made during
2001.
Debentures. At September 30, 2000, CII Financial, Inc. had approximately $47.1
million of subordinated debentures outstanding that were due on September 15,
2001. These subordinated debentures were neither assumed nor guaranteed by
Sierra and were subordinated to Sierra's credit facility debt. In December 2000,
CII Financial commenced an offer to exchange the subordinated debentures for
cash and/or new debentures. On May 7, 2001, CII Financial closed its exchange
offer on $42.1 million of its outstanding subordinated debentures. CII Financial
purchased $27.1 million in principal amount of subordinated debentures for $20.0
million in cash and issued $15.0 million in new 9 1/2% senior debentures, due
September 15, 2004, in exchange for $15.0 million in subordinated debentures.
The remaining $5.0 million in subordinated debentures were paid at maturity.
The transaction was accounted for as a restructuring of debt; therefore all
future cash payments, including interest, related to the debentures will be
reductions of the carrying amount of the debentures and no future interest
expense will be recognized. Accordingly, the new 9 1/2% senior debentures have a
carrying amount of $19.2 million, which consists of principal amount of $15.0
million and $4.2 million in future accrued interest.
The new 9 1/2% senior debentures pay interest, which is due semi-annually on
March 15 and September 15 of each year, commencing on September 15, 2001. The
new 9 1/2% senior debentures rank senior to outstanding notes payable from CII
Financial to Sierra and CII Financial's guarantee of Sierra's revolving credit
facility. The new 9 1/2% senior debentures may be redeemed by CII Financial at
any time at premiums starting at 110% and declining to 100% for redemptions
after April 1, 2004. In the event of a change in control of CII Financial, the
holders of the new 9 1/2% senior debentures may require that CII Financial
repurchase them at the then applicable redemption price, plus accrued and unpaid
interest.
Other. The Company has obligations under capital leases with interest rates from
8.0% to 12.2%. In addition, the Company has term loans with the City of
Baltimore and the State of Maryland. Scheduled maturities of the Company's notes
payable, net financing obligations and future minimum payments under capital
leases, together with the present value of the net minimum lease payments at
December 31, 2001, are as follows:
Obligations
(In thousands) Notes Under Capital
Years ending December 31, Payable Leases
---------------------------------------------------- ----------- -------------------
2002................................................. $ 1,533 $115
2003................................................. 92,171 121
2004................................................. 21,304 83
2005 ................................................ 4,011 31
2006................................................. 4,526 30
Thereafter........................................... 59,437 184
------- ----
Total............................................. $182,982 564
=======
Less: Amounts Representing Interest................. (175)
----
Present Value of Minimum Lease Payments.............. $ 389
====
The fair value of long-term debt, including the current portion, is estimated to
be approximately $192,392,000 based on the borrowing rates currently available
to the Company.
9. INCOME TAXES
A summary of the provision for income taxes for the years ended December 31, is
as follows:
(In thousands) 2001 2000 1999
---------- ---------- -----------
Provision (Benefit) for Income Taxes:
Current..................................... $(1,131) $ (795) $ 0
Deferred.................................... 9,934 (12,080) 2,209
------ ------- -----
Total....................................... $ 8,803 $(12,875) $2,209
====== ======= =====
The following reconciles the difference between the reported and statutory
provision (benefit) for income taxes, including discontinued operations, for the
years ended December 31:
2001 2000 1999
------------ ------------ ------------
Statutory Rate.............................. 35% (35)% 35%
State Income Taxes.......................... (1) 1 9
Tax Preferred Investments................... (2) (1) (10)
Change in Valuation Allowance .............. - - (12)
Intangible Amortization..................... 1 11 4
Other....................................... 1 (1) (9)
-- --- ---
Provision (Benefit) for Income Taxes........ 34% (25)% 17%
== === ===
The tax effects of significant items comprising the Company's net deferred tax
assets are as follows at December 31:
2001 2000
------------ -------------
(In thousands)
Deferred Tax Assets:
Medical and Losses and LAE Reserves....................... $ 10,506 $ 18,880
Accruals Not Currently Deductible......................... 16,542 14,628
Compensation Accruals..................................... 9,974 9,732
Bad Debt Allowances....................................... 4,061 6,916
Loss Carryforwards and Credits............................ 59,756 26,741
Depreciation and Amortization............................. 5,038 30,444
Unearned Premiums......................................... 1,757 1,954
Deferred Reinsurance Gains................................ 2,022 1,917
Unrealized Investment Losses.............................. 3,033 3,051
Other..................................................... 216 692
------- -------
Total................................................... 112,905 114,955
------- -------
Deferred Tax Liabilities:
Deferred Policy Acquisition Costs......................... 741 655
Other..................................................... 947 290
------- -------
Total................................................... 1,688 945
------- -------
Net Deferred Tax Asset.................................... $111,217 $114,010
======= =======
At December 31, 2001, the Company had approximately $154,942,000 of regular tax
net operating loss carryforwards. The net operating loss carryforwards can be
used to reduce future taxable income until they expire through the year 2020. In
addition to the net operating loss carryforwards, the Company has alternative
minimum tax credits of approximately $4,258,000, which can be used to reduce
regular tax liabilities in future years. There is no expiration date for the
alternative minimum tax credits.
The Company does not have a valuation allowance at December 31, 2001 or 2000.
Included in other current receivables in the December 31, 2001 and 2000 balance
sheets are income tax receivables of $2,265,000 and $1,326,000, respectively.
10. DISCONTINUED OPERATIONS
Throughout 2001, the Company continued to focus on making the Texas HMO health
care operations profitable. Significant premium rate increases were made on
renewing membership and during the third quarter the Company embarked on a
recontracting effort to reduce medical costs. It was during this recontracting
effort that unsustainable cost increases were identified, including the fact
that the operations' primary hospital contract, if renewed, would be at a
substantially higher rate than was previously indicated by the hospital.
Although considerable efforts had been made to achieve profitability in Texas,
it was determined that under the current operating environment, the Company
would not be able to turn around the operating results and the best course of
action was to exit the market as soon as possible to limit future losses and
exposure. During the third quarter of 2001, the Company announced its plan to
exit the Texas HMO health care market and received formal approval from the
Texas Department of Insurance to withdraw its HMO operations in mid-October. The
Company intends to cease providing HMO health care coverage in Texas on April
17, 2002.
The Company has elected to early adopt SFAS No. 144 effective January 1, 2001.
In accordance with SFAS No. 144, the Company's Texas HMO health care operations
have been reclassified as discontinued operations. The Company has received a
limited waiver under its revolving credit facility agreement for covenants
affected by exiting the Texas HMO health care market.
The following are condensed statements of operations of the discontinued Texas
HMO health care operations:
Year Ended December 31
(In thousands) 2001 2000 1999
---- ---- ----
Operating Revenues.............................................. $181,132 $ 233,398 $244,746
------- -------- -------
Medical Expenses................................................ 175,333 233,652 215,191
General, Administrative and Marketing Expenses.................. 29,607 31,346 43,384
Asset Impairment, Restructuring,
Reorganization and Other Costs............................... (1,250) 186,604 11,000
Interest Expense and Other, Net................................. (1,532) 4,268 (1,531)
------- -------- -------
Loss from Discontinued Operations Before Tax.................... (21,026) (222,472) (23,298)
Income Tax Benefit.............................................. 7,046 61,350 8,144
------- -------- -------
Net Loss from Discontinued Operations........................... $(13,980) $(161,122) $(15,154)
======= ======== =======
All of the discontinued Texas HMO health care operations were a component of the
"managed care and corporate operations" segment.
Based on the Company's Texas HMO health care operations financial projections
for 2000, the Company recorded a $21.0 million premium deficiency at the end of
1999. Of this amount, $10.0 million was recorded in medical expenses and $11.0
million was recorded in asset impairment, restructuring, reorganization and
other costs. The $11.0 million was an estimate of general and administrative
costs, in excess of those covered by premiums, the Company expected to be
incurred to service the Dallas/Ft. Worth contracts. Also recorded in medical
expenses during the fourth quarter of 2000 was $4.0 million primarily related to
an adjustment to the estimate for medical expenses recorded in previous years.
Included in the Texas HMO health care operations medical expenses for the year
ended December 31, 2000 are $14.7 million, primarily for adverse development on
prior periods' medical claims, and $15.5 million in premium deficiency medical
expense related to under-performing markets in the Dallas/Ft. Worth and Houston
areas. The recorded premium deficiency reflected anticipated costs after
restructuring and reorganization actions taken in the first six months of 2000.
During the second quarter of 2001, management revised their estimates of premium
deficiency reserves and reclassified $7.8 million from premium deficiency
maintenance reserve to premium deficiency medical reserve. This reclassification
was based on the latest available medical cost trends, which did not become
evident until late in the second quarter of 2001, and is reflected as an
increase in medical expense and a decrease in general, administrative and
marketing expenses on the condensed statements of operations of the discontinued
Texas HMO health care operations.
Asset impairment, restructuring, reorganization and other costs for the year
ended December 31, 2000 include the following: (a) asset impairment charges of
$126.4 million for impaired goodwill; (b) $36.5 million for impaired real estate
and other fixed assets; (c) $10.4 million for premium deficiency maintenance
costs; and (d) other restructuring, reorganization and other costs of $13.3
million.
As part of the Company's plan to exit Texas, the Company recorded charges of
$10.6 million for premium deficiency medical costs, $1.6 million to write down
certain Texas furniture and equipment, $2.0 million in lease and other
termination costs, $1.8 million in legal and restitution costs, $500,000 in
various other exit related costs and $570,000 in premium deficiency maintenance.
The table below presents a summary of discontinued Texas HMO health care
operations' asset impairment, restructuring, reorganization and other cost
activity for the periods indicated.
Restructuring Premium
Asset and Deficiency
(In thousands) Impairment Reorganization Maintenance Other Total
---------- -------------- ----------- ----- -----
Balance, January 1, 1999........... -
Charges recorded................... $ 11,000 $ 11,000
Cash used..........................
Noncash activity................... -
Changes in estimate................ -
-------- ------ ------- ----- --------
Balance, December 31, 1999......... - - 11,000 - 11,000
Charges recorded................... $ 162,937 $11,509 10,358 $1,800 186,604
Cash used.......................... (7,754) (12,080) (200) (20,034)
Noncash activity................... (162,937) (800) (163,737)
Changes in estimate................ -
-------- ------ ------- ----- --------
Balance, December 31, 2000......... - 3,755 9,278 800 13,833
Charges recorded................... 1,600 4,380 570 6,550
Cash used.......................... (3,716) (1,478) (800) (5,994)
Noncash activity................... (1,600) (125) (1,725)
Changes in estimate................ (7,800) (7,800)
-------- ------ ------- ----- --------
Balance, December 31, 2001......... $ - $ 4,294 $ 570 $ - $ 4,864
======== ====== ======= ===== ========
The remaining restructuring and reorganization costs of $4.3 million are
primarily related to legal and restitution costs, lease and other termination
costs, the cost to provide malpractice insurance on our discontinued affiliated
medical groups and various other exit related costs. Management believes that
the remaining reserves, as of December 31, 2001, are appropriate and that no
revisions to the estimates are necessary at this time.
The following are the assets and liabilities of the discontinued Texas HMO
health care operations:
December 31 December 31
(In thousands) 2001 2000
---- ----
ASSETS
Cash and Cash Equivalents.................................. $ 0 $ 3,742
Accounts Receivable, Net................................... 1,402 6,433
Other Assets............................................... 6,895 4,534
Property and Equipment, Net................................ 20,107 21,483
------- -------
TOTAL ASSETS............................................... 28,404 36,192
------- -------
LIABILITIES
Accounts Payable and Other Liabilities................. 16,407 17,158
Medical Claims Payable..................................... 36,567 37,892
Unearned Premium Revenue................................... 68 6,874
Premium Deficiency Reserve................................. 1,700 14,466
Mortgage Loan.............................................. 29,189 34,230
------- -------
TOTAL LIABLIITIES.......................................... 83,931 110,620
------- -------
NET LIABILITIES OF DISCONTINUED OPERATIONS................. $(55,527) $(74,428)
======= =======
Property and equipment consists mainly of real estate properties located in the
Dallas/Fort Worth metroplex areas. TXHC acquired these properties from Kaiser
Foundation Health Plan of Texas ("Kaiser-Texas"), for $44 million as part of the
acquisition of certain assets of Kaiser-Texas in October 1998. In June 2000, as
part of its restructuring and reorganization of the Texas HMO health care
operations, the Company announced its intentions to sell these properties. The
real estate was written down to its estimated fair value and the Company took an
asset impairment charge of $27 million. The real estate is encumbered by a
mortgage loan to Kaiser-Texas.
During 2001, Sierra participated in negotiations with Kaiser-Texas relative to
the real estate properties and associated mortgage loan to Kaiser-Texas along
with other matters. Sierra reached an agreement with Kaiser-Texas, effective
December 31, 2001, whereby Kaiser-Texas forgave $8.5 million of the outstanding
principal balance of the mortgage loan and extended the maturity from November
1, 2003 to November 1, 2006. In exchange for the consideration by Kaiser-Texas,
Sierra agreed to an unconditional guaranty of the mortgage loan. In conjunction
with the agreement, Sierra applied a $2.5 million outstanding receivable from
Kaiser-Texas to the outstanding balance of the mortgage loan on December 31,
2001.
The agreement included concessions by Kaiser-Texas, including a reduction of
principal and an extension of the maturity. In accordance with accounting
principles generally accepted in the United States of America, the agreement was
accounted for as a restructuring of debt. In the transaction, total future cash
payments (interest and principal) were less than the balance of the mortgage
loan at the time of the agreement. Accordingly, a gain on restructuring was
recognized for the difference and the carrying amount of the mortgage loan is
equal to the total future cash payments. Costs incurred in connection with the
agreement were offset against the gain on restructuring. At December 31, 2001,
the mortgage loan has a carrying value of $29.2 million, which consists of a
principal balance of $22.7 million and $6.5 million in future accrued interest.
Effective January 1, 2002, all future cash payments, including interest, related
to the mortgage loan will be reductions of the carrying amount; therefore, no
future interest expense will be recognized. The transaction resulted in an
immaterial gain.
11. COMMITMENTS AND CONTINGENCIES
Leases. The Company is the lessee under several operating leases, most of which
relate to office facilities and equipment. The rentals on these leases are
charged to expense over the lease term as the Company becomes obligated for
payment and, where applicable, provide for rent escalations based on certain
costs and price index factors. The following is a schedule, by year, of the
future minimum lease payments under existing operating leases:
(In thousands)
Years Ending December 31,
-------------------------------------------------
2002................................................... $ 8,805
2003................................................... 6,834
2004................................................... 5,851
2005................................................... 5,348
2006................................................... 4,551
Thereafter............................................. 26,965
------
Total............................................. $58,354
======
Rent expense totaled $9,430,000, $8,788,000 and $7,725,000 for the years ended
December 31, 2001, 2000 and 1999, respectively.
The Company is a guarantor on a mortgage loan which has a carrying value of
$29.2 million, consisting of a principal balance of $22.7 million and $6.5
million in future accrued interest. The mortgage loan is related to the property
of the discontinued operations as described in Note 10.
Litigation and Legal Matters. The Company is subject to various claims and other
litigation in the ordinary course of business. Such litigation, for example,
includes claims of medical malpractice, claims for coverage or payment for
medical services rendered to HMO members and insureds and claims by providers
for payment for medical services rendered to HMO members. Also included in such
litigation are claims for workers' compensation and claims by providers for
payment for medical services rendered to injured workers. In the opinion of the
Company's management, the ultimate resolution of pending legal proceedings
should not have a material adverse effect on the Company's operations or
financial condition.
12. RELATED PARTY TRANSACTIONS
During 1997, the Company's Board of Directors authorized a $3.0 million loan
from the Company to its Chief Executive Officer ("CEO"). In April 2000, the
Company's Board of Directors authorized an additional $2.5 million loan from the
Company to the CEO which, along with accrued interest, is due on June 30, 2002.
During 2001, the CEO made payments of $898,000 and at the end of 2001, the
aggregate principal balance outstanding and accrued interest for both
instruments was $5.0 million. All amounts borrowed bear interest at a rate equal
to the rate at which the Company could have borrowed funds under the revolving
credit facility at the time of the borrowing plus 10 basis points. The amounts
outstanding are collateralized by certain of the CEO's assets and rights to
compensation from the Company.
The Company incurred legal fees of $38,000, $4,000 and $289,000 in the years
ended December 31, 2001, 2000 and 1999, respectively, with a Nevada law firm of
which a non-employee Board of Director member is a shareholder.
13. EMPLOYEE BENEFIT PLANS
Defined Contribution Plan. The Company has a defined contribution pension and
401(k) plan (the "Plan") for its employees. The Plan covers all employees who
meet certain age and length of service requirements. For the six months ended
June 30, 1999, the Company contributed a maximum of 2% of eligible employees'
compensation and matched 50% of a participant's elective deferral up to a
maximum of either 10% of an employee's compensation or the maximum allowable
under current IRS regulations. Effective July 1, 1999, the Plan was modified
such that the Company matches 50%-100% of an employee's elective deferral up to
a maximum of 6% of a participant's annual compensation, subject to IRS limits.
The Plan does not require additional Company contributions. Expense under the
plan totaled $4.8 million, $4.7 million and $6.7 million for the years ended
December 31, 2001, 2000 and 1999, respectively.
Supplemental Retirement Plans. The Company has Supplemental Retirement Plans
(the "SRPs") for certain officers, directors and highly compensated employees.
The SRPs are non-qualified deferred compensation plans through which
participants may elect to postpone the receipt and taxation of all or a portion
of their salary and bonuses received from the Company. Until July 1, 1999 the
Company matched 50% of those contributions that participants are restricted from
deferring, if any, under the Company's pension and 401(k) plan. As contracted
with the Company, the participants or their designated beneficiaries may begin
to receive benefits under the SRPs upon a participant's death, disability,
retirement, termination of employment or certain other circumstances including
financial hardship.
Executive Life Insurance Plan. The Company has split dollar life insurance
agreements with certain officers and key executives (selected and approved by
the Sierra Board of Directors). The premiums paid by the Company will be
reimbursed upon the occurrence of certain events as specified in the contract.
Supplemental Executive Retirement Plan ("SERP"). The Company has a defined
benefit retirement plan covering certain key employees. The Company is funding
the benefits through the purchase of life insurance policies. Benefits are based
on, among other things, the employee's average earnings over the five-year
period prior to retirement or termination, and length of service. Benefits
attributable to service prior to the adoption of the plan are amortized over the
estimated remaining service period for those employees participating in the
plan. During 2001, one participant began to receive benefits earlier than
originally estimated. The effect of this change is included in actuarial losses
(gains) in the reconciliation below.
A reconciliation of ending year balances is as follows:
Years Ended December 31,
2001 2000 1999
---------- ---------- -----------
(In thousands)
Change in Benefit Obligation:
Projected Benefit Obligation at Beginning of Period.... $13,693 $12,808 $14,198
Service Cost .......................................... 322 365 365
Interest Cost ......................................... 1,162 887 829
Plan Amendments........................................ 335 166
Actuarial Losses (Gains)............................... 4,410 (340) (2,391)
Benefits Paid ......................................... (784) (193) (193)
------ ------ ------
Benefit Obligation at End of Period.................... $19,138 $13,693 $12,808
====== ====== ======
Change in Plan Assets:
Fair Value of Plan Assets at Beginning of Period....... $ 8,439 $ 7,295 $ 4,493
Actual Return on Plan Assets .......................... (802) (445) 123
Company Contributions ................................. 2,678 1,589 2,679
------ ------ ------
Fair Value of Plan Assets at End of Period............. $10,315 $ 8,439 $ 7,295
====== ====== ======
Funded Status of the Plan ............................. $(8,823) $(5,254) $(5,513)
Unrecognized Actuarial Change.......................... 3,399 (851) (532)
Unrecognized Prior Service Credit ..................... 7,062 7,652 8,412
Unrecognized Net Loss ................................. 4,117 2,326 1,150
------ ------ ------
Total Recognized ...................................... $ 5,755 $ 3,873 $ 3,517
====== ====== ======
Total Recognized Amounts in the Financial
Statements Consist of:
Accrued Benefit Liability ............................. $(6,134) $(1,912) $(2,439)
Intangible Asset ...................................... 11,889 5,785 5,956
------ ------ ------
Total ................................................. $ 5,755 $ 3,873 $ 3,517
====== ====== ======
Assumptions:
Discount Rate ......................................... 7.0% 7.0% 7.0%
Expected Return on Plan Assets ........................ 8.0% 8.0% 8.0%
Rate of Compensation Increase ......................... 3.0% 3.0% 3.0%
Components of Net Periodic Benefit Cost:
Service Cost........................................... $ 322 $ 365 $ 365
Interest Cost ......................................... 1,162 887 829
Expected Return on Plan Assets......................... (987) (733) (525)
Amortization of Prior Service Credits.................. 925 925 922
Recognized Actuarial Loss (Gain)....................... 159 (20) (1)
------- ------ ------
Net Periodic Benefit Cost.............................. $ 1,581 $ 1,424 $ 1,590
====== ====== ======
14. CAPITAL STOCK PLANS
Stockholders' Rights Plan. Each share of Sierra common stock, par value $.005
per share, contains one right (a "Right"). Each Right entitles the registered
holder to purchase from Sierra a unit consisting of one one-hundredth (.001) of
a share of the Sierra Series A Junior Participating Preferred Shares (a "Unit"),
par value $.01 per share, or a combination of securities and assets of
equivalent value, at a purchase price of $100.00 per Unit, subject to
adjustment. The Rights have certain anti-takeover effects. The Rights will cause
substantial dilution to a person or group that attempts to acquire Sierra on
terms not approved by Sierra's Board of Directors, except pursuant to an offer
conditioned on a substantial number of Rights being acquired. The Rights should
not interfere with any merger or other business combination approved by the
Board of Directors since Sierra may redeem the Rights at the price of $.02 per
Right prior to the time that a person or group has acquired beneficial ownership
of 20% or more of Sierra common stock.
Stock Option Plans. The Company has several plans that provide common
stock-based awards to employees and to non-employee directors. The plans provide
for the granting of options, stock, and other stock-based awards. Awards are
granted by a committee appointed by the Board of Directors. Options become
exercisable at such times and in such installments as set by the committee. The
exercise price of each option equals the market price of the Company's stock on
the date of grant. Stock options generally vest at a rate of 20% - 33% per year.
Options expire from one to seven years after the end of the vesting period.
The following table reflects the activity of the stock option plans:
Number of Option Weighted
Shares Price Average Price
--------------- ----------- -------------
(Number of shares in thousands)
Outstanding January 1, 1999 2,730 $ 6.31 - $24.83 $18.89
Granted..................................... 1,436 6.69 - 21.00 9.44
Exercised................................... (2) 6.31 - 12.08 9.41
Canceled.................................... (260) 11.71 - 24.83 19.65
------
Outstanding December 31, 1999.................. 3,904 6.31 - 24.69 15.37
Granted..................................... 2,458 3.13 - 7.19 3.87
Canceled.................................... (2,112) 3.75 - 24.69 18.17
------
Outstanding December 31, 2000.................. 4,250 3.13 - 24.69 7.31
Granted..................................... 2,218 4.24 - 8.93 6.57
Exercised................................... (72) 3.75 - 8.00 5.25
Canceled.................................... (393) 3.19 - 24.69 10.98
------
Outstanding December 31, 2001.................. 6,003 3.13 - 24.69 6.81
======
Exercisable at December 31, 2001............... 1,391 3.13 - 24.69 8.94
======
Available for Grant at
December 31, 2001 .......................... 2,225
=======
The following table summarizes information about stock options outstanding at
December 31, 2001:
(Number of options in thousands)
Weighted Average Weighted Average
Range of Exercise Contractual Life Options Exercise Price
Prices Remaining in Days Outstanding Exercisable Outstanding Exercisable
--------------------- ----------------- ----------- ----------- ----------- -----------
$ 3.13 - $ 5.73 3,215 3,635 576 $ 4.53 $ 4.40
6.19 - 9.91 2,339 1,875 457 8.15 7.76
10.36 - 18.00 1,377 190 166 12.40 12.29
19.08 - 24.69 1,160 303 192 22.28 22.49
Employee Stock Purchase Plans. The Company has an employee stock purchase plan
(the "Purchase Plan") whereby employees may purchase newly issued shares of
common stock through payroll deductions at 85% of the fair market value of such
shares on specified dates as defined in the Purchase Plan. During 2001, a total
of 517,000 shares were purchased at prices of $2.92 and $3.60 per share. During
January 2002, 203,000 shares were purchased by employees at $6.02 per share in
connection with the Purchase Plan. At December 31, 2001, the Company had 531,000
shares reserved for purchase under the Purchase Plan.
Restricted Stock Units. The Company issued 244,000 restricted stock units
("units"), to certain executives during 2001. The first half of the units vest
in 2003 with the remainder vesting in 2004. Each unit represents a
nontransferable right to receive one share of Sierra stock and there is no cost
by the recipient to exercise the units. The units are included in total
outstanding common shares. In the calculation of earnings per share, the units
are not included in the common shares outstanding but are included in the
calculation of common shares outstanding assuming dilution. The transaction was
recorded by including the value of the units as common stock and additional
paid-in capital offset by a contra-equity account, deferred compensation. The
value of the transaction was based on the number of units issued and the Company
stock price on the date of issuance, which was $5.73. Compensation expense will
be recognized over the period of vesting. Total expense associated with the plan
for 2001 was $342,000.
Accounting for Stock-Based Compensation. The Company uses the intrinsic value
method in accounting for its stock-based compensation plans. Accordingly, no
compensation cost has been recognized for its employee stock option plans nor
the Purchase Plan. Had compensation cost for the Company's stock-based
compensation plans been determined based on the fair value at the grant dates
for awards under those plans, the Company's net income and earnings per share
for the years ended December 31, would have been reduced to the pro forma
amounts indicated below:
Years Ended December 31,
2001 2000 1999
---------- ---------- ----------
(In thousands, except per share data)
Net Income (Loss) As reported $3,486 $(199,915) $(4,631)
Pro forma (1,268) (203,293) (9,204)
Net Income (Loss) Per Share As reported $ .13 $ (7.37) $ (.17)
Pro forma (.05) (7.49) (.34)
Net Income (Loss) Per Share
Assuming Dilution As reported $ .12 $ (7.37) $ (.17)
Pro forma (.04) (7.49) (.34)
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions used for grants in 2001, 2000 and 1999, respectively: dividend yield
of 0% for all years; expected volatility of 83%, 52% and 43%; risk-free interest
rates of 4.34%, 6.60% and 5.87%; and expected lives of three to five years. The
weighted average fair value of options granted in 2001, 2000 and 1999 was $5.58,
$2.72 and $3.77, respectively.
The fair value of the look-back option implicit in each offering of the Purchase
Plans is estimated on the date of grant using the Black-Scholes option pricing
model with the following weighted average assumptions used for grants in 2001,
2000 and 1999, respectively: dividend yield of 0% for all years; expected
volatility of 85%, 46% and 45%; risk-free interest rates of 4.36%, 5.79% and
4.66%; and expected lives of six months for all years.
During 1999, the Company extended by three years the expiration date for
1,035,000 options covering shares that would have expired in 1999 and 2000. The
exercise price per share for these options ranges from $10.92 to $20.50. No
expense was recognized in the consolidated statement of operations related to
these options. Expense of $1,445,000 is included in the Pro forma information
presented.
Due to the fact that the Company's stock option programs vest over many years
and additional awards are made each year, the above pro forma numbers are not
indicative of the financial impact had the disclosure provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" been applicable to all years of previous option grants. The above
numbers do not include the effect of options granted prior to 1995.
15. CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTAL INFORMATION
Supplemental statements of cash flows information is presented below:
Years ended December 31,
2001 2000 1999
------------ ------------ -------------
(In thousands)
Cash Paid During the Year for Interest
(Net of Amount Capitalized)......................... $21,566 $26,848 $15,583
Cash Received During the Year
for Income Taxes.................................... (221) (10,608) (4,900)
Non-cash Investing and Financing Activities:
Retired Sale-Leaseback Assets, Liabilities
and Financing Obligations......................... 14,552
Note Received for Sale of Investment................ 3,700
Stock Issued for Exercise of Options
and Related Tax Benefits.......................... 97 1
Additions to Capital Leases......................... 1,835
Debentures Exchanged................................ 19,692
16. CERTAIN MEDICAL EXPENSES
During 1999, the Company reported a premium deficiency medical charge of $8.1
million related to losses in under-performing markets primarily in Arizona and
rural Nevada, all of which was used during 1999. Also recorded in medical
expenses during the fourth quarter was $7.2 million primarily related to an
adjustment to the estimate for medical expenses recorded in previous years and
$6.8 million primarily related to contractual settlements with providers of
medical services.
In the first quarter of 2000, the Company recorded $1.0 million of adverse
development related to prior years' medical claims. Included in reported medical
expenses for the second quarter of 2000 are changes in estimate charges of $15.5
million of reserve strengthening primarily due to adverse development on prior
periods' medical claims. In addition, the Company recorded $9.5 million of other
non-recurring medical costs primarily relating to the write-down of medical
subsidiary assets.
17. ASSET IMPAIRMENT, RESTRUCTURING, REORGANIZATION AND OTHER COSTS
Asset Impairments:
In the first quarter of 1999, the Company recorded a charge of $3.5 million
related to the write-off of goodwill associated with the Mohave Valley
operations. During the first quarter of 1999, the Company closed all inpatient
operations at Mohave Valley Hospital, a 12-bed acute care facility in Bullhead
City, Arizona, and terminated approximately 45 employees.
Management adopted a plan in the second quarter of 2000 to discontinue medical
delivery operations in Mohave County, Arizona and to sell the real estate assets
located there, as well as an underperforming medical clinic in Las Vegas.
In connection with the restructuring plans adopted and announced by the Company
in the second quarter of 2000, the Company re-evaluated the recoverability of
certain long-lived assets, in accordance with SFAS No. 121 and APB No. 17 and
determined that the carrying values of certain goodwill and other long-lived
assets were impaired.
In assessing the asset impairment of the long-lived assets, the Company first
allocated a portion of related goodwill to the fixed assets to be disposed of,
in accordance with SFAS No. 121. The fixed assets were then written down to
estimated fair value less costs to sell, which was determined from independent
valuations. The remainder of the related goodwill was then assessed for
recoverability in accordance with APB No. 17 based on projected discounted cash
flows.
The charges recorded for the write-off of goodwill totaled $15.1 million and
related primarily to the Prime Holdings, Inc. acquisition. The charges recorded
for fixed asset impairment totaled $9.5 million for the Arizona and Nevada
operations.
During the second quarter of 2000, the Company wrote-off capitalized costs of
$3.0 million related to the application development of an information system
software project for the workers' compensation operations, which was canceled
because the vendor was unable to fulfill its contractual obligations. The
amounts written off included software and consulting costs of $1.6 million and
capitalized internal personnel costs of $1.4 million.
Restructuring and Reorganization:
In the first quarter of 1999, the Company incurred $450,000 for certain legal
and contractual settlements and $400,000 to provide for the Company's portion of
the write-off of start-up costs at the Company's equity investee, TriWest
Healthcare Alliance.
In the second quarter of 2000, the Company adopted a plan and announced
additional restructuring of the Arizona managed health care operations. As a
result of this restructuring, the Company recorded charges in accordance with
Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (Including
Certain Costs Incurred in a Restructuring)" of approximately $2.0 million. Of
the costs recorded, $1.2 million was for severance, $400,000 was related to
clinic closures and lease termination and $400,000 was for other costs.
Other:
The $3.4 million of charges in the fourth quarter of 1999 consisted primarily of
legal and contractual settlements.
The $4.3 million of costs recorded in the second quarter of 2000 relate
primarily to the write-down of certain receivables as well as an accrual for
legal settlements.
The table below presents a summary of asset impairment, restructuring and other
costs for the years indicated.
Restructuring
Asset and
(In thousands) Impairment Reorganization Other Total
---------- -------------- ----- -----
Balance, January 1, 1999....................... $ 2,819 $ 2,819
Charges recorded............................... $ 3,509 $ 850 3,449 7,808
Cash used...................................... (850) (2,819) (3,669)
Noncash activity............................... (3,509) (3,509)
Changes in estimate............................
------- ------ ------ -------
Balance, December 31, 1999..................... - - 3,449 3,449
Charges recorded............................... 27,553 1,983 4,300 33,836
Cash used...................................... (1,389) (302) (1,691)
Noncash activity............................... (27,553) (3,000) (30,553)
Changes in estimate............................
------- ----- ------ -------
Balance, December 31, 2000..................... - 594 4,447 5,041
Charges recorded...............................
Cash used...................................... (594) (594)
Noncash activity...............................
Changes in estimate............................
------- ----- ------ -------
Balance, December 31, 2001..................... $ - $ - $ 4,447 $ 4,447
======= ====== ====== =======
The remaining other costs of $4.4 million are primarily related to legal claims.
Management believes that the remaining reserves as of December 31, 2001 are
adequate and that no revisions to the estimates are necessary at this time.
18. UNAUDITED QUARTERLY INFORMATION
(In thousands, except per share data)
March June September December
31 30 30 31
--------------- --------------- --------------- ----------------
Year Ended December 31, 2001 (1):
Operating Revenues.................................... $303,228 $318,327 $330,854 $339,092
Operating Income from Continuing Operations........... 10,062 11,391 10,758 12,621
Net Income from Continuing Operations................. 3,466 3,777 4,572 5,651
Net Income (Loss)..................................... 3,205 2,795 (7,554) 5,040
Basic earnings per share:
Income from Continuing Operations.................. $ 0.13 $ 0.14 $ 0.16 $ 0.20
Net Income (Loss).................................. 0.12 0.10 (0.27) 0.18
Diluted earnings per share:
Income from Continuing Operations.................. $ 0.13 $ 0.13 $ 0.16 $ 0.19
Net Income (Loss).................................. 0.12 0.10 (0.26) 0.17
Year Ended December 31, 2000 (1):
Operating Revenues.................................... $265,591 $278,228 $315,300 $300,461
Operating Income (Loss) from
Continuing Operations.............................. 11,263 (64,976) 10,103 11,304
Net Income (Loss) from Continuing operations.......... 4,327 (50,484) 3,541 3,823
Net Income (Loss)..................................... 1,556 (206,717) 2,669 2,577
Basic earnings per share:
Income from Continuing Operations.................. $ 0.16 $ (1.87) $ 0.13 $ 0.14
Net Income (Loss).................................. 0.06 (7.64) 0.10 0.09
Diluted earnings per share:
Income from Continuing Operations.................. $ 0.16 $ (1.87) $ 0.13 $ 0.14
Net Income (Loss).................................. 0.06 (7.64) 0.10 0.09
(1) The Company early adopted SFAS No. 144 effective January 1, 2001. All
quarterly amounts have been reclassified to reflect the adoption of SFAS
No. 144.
19. SEGMENT REPORTING
The Company has three reportable segments based on the products and services
offered: managed care and corporate operations, military health services
operations and workers' compensation operations. The managed care segment
includes managed health care services provided through HMOs, managed indemnity
plans, third-party administrative services programs for employer-funded health
benefit plans, multi-specialty medical groups, other ancillary services and
corporate operations. The military health services segment administers a
five-year, managed care federal contract for the Department of Defense's TRICARE
program in Region 1. The workers' compensation segment assumes workers'
compensation claims risk in return for premium revenues and third party
administrative services.
The Company evaluates each segment's performance based on segment operating
profit. The accounting policies of the operating segments are the same as those
described in the summary of significant accounting policies (except as described
in the notes below). Certain changes in estimate charges for the years ended
December 31, 2000 and 1999 have been reclassified to segment operation profit to
conform with the current year presentation.
Information concerning the operations of the reportable segments is as follows:
(In thousands)
Managed Care Military Workers'
and Corporate Health Services Compensation
Operations Operations Operations Total
-------------------- ------------------- ------------------ ------------
Year Ended December 31, 2001
Medical Premiums.............................. $718,994 $ 718,994
Military Contract Revenues.................... $338,918 338,918
Specialty Product Revenues.................... 7,875 $175,431 183,306
Professional Fees............................. 28,985 28,985
Investment and Other Revenues................. 2,790 2,404 16,104 21,298
------- ------- ------- ---------
Total Revenue.............................. $758,644 $341,322 $191,535 $1,291,501
======= ======= ======= =========
Segment Operating Profit (1).................. $ 28,529 $ 9,701 $ 6,602 $ 44,832
Interest Expense and Other.................... (16,758) 11 (1,816) (18,563)
------- -------- ------- ---------
Net Income from Continuing Operations
Before Income Taxes...................... $ 11,771 $ 9,712 $ 4,786 $ 26,269
======= ======= ======= =========
Segment Assets................................ $401,686 $117,302 $522,570 $1,041,558
Capital Expenditures.......................... 5,763 1,377 2,322 9,462
Depreciation and Amortization................. 20,125 4,025 1,397 25,547
Year Ended December 31, 2000
Medical Premiums.............................. $637,769 $ 637,769
Military Contract Revenues.................... $330,352 330,352
Specialty Product Revenues.................... 8,822 $127,022 135,844
Professional Fees............................. 33,102 33,102
Investment and Other Revenues................. 7,091 905 14,517 22,513
------- ------- ------- ---------
Total Revenue.............................. $686,784 $331,257 $141,539 $1,159,580
======= ======= ======= =========
Segment Operating Profit (1).................. $ 24,514 $ 7,992 $ 11,535 $ 44,041
Interest Expense and Other.................... (16,177) (611) (2,574) (19,362)
Changes in Estimate Charges (2)............... (26,011) (16,500) (42,511)
Asset Impairment, Restructuring,
Reorganization and Other Costs........... (30,836) (3,000) (33,836)
------- ------- ------- ---------
Net (Loss) Income from Continuing Operations
Before Income Taxes...................... $(48,510) $ 7,381 $(10,539) $ (51,668)
======= ======= ======= =========
Segment Assets................................ $479,786 $115,520 $533,602 $1,128,908
Capital Expenditures.......................... 13,957 717 839 15,513
Depreciation and Amortization................. 21,031 2,926 1,538 25,495
Year Ended December 31, 1999
Medical Premiums.............................. $594,966 $ 594,966
Military Contract Revenues.................... $287,398 287,398
Specialty Product Revenues.................... 9,869 $ 84,352 94,221
Professional Fees............................. 42,069 42,069
Investment and Other Revenues................. 4,285 706 15,420 20,411
------- ------- ------- ---------
Total Revenue.............................. $651,189 $288,104 $ 99,772 $1,039,065
======= ======= ======= =========
Segment Operating Profit (1).................. $ 28,153 $ 11,612 $ 11,171 $ 50,936
Interest Expense and Other.................... (12,345) (910) (3,256) (16,511)
Changes in Estimate Charges (2)............... (13,885) (13,885)
Asset Impairment, Restructuring,
Reorganization and Other Costs........... (7,808) (7,808)
------- ------- ------- ---------
Net (Loss) Income from Continuing Operations
Before Income Taxes...................... $ (5,885) $ 10,702 $ 7,915 $ 12,732
======= ======= ======= =========
Segment Operating Assets...................... $446,379 $ 76,187 $403,420 $ 925,986
Capital Expenditures.......................... 44,858 570 4,201 49,629
Depreciation and Amortization................. 16,487 2,758 1,430 20,675
(1) The segment operating profit excludes the effects of asset impairment,
restructuring, reorganization and other costs.
(2) Represents changes in estimate charges in the current year for services or
liabilities of a prior year that are reclassified to either Medical
Expenses or Specialty Product Expenses for presentation in accordance with
accounting principles generally accepted in the United States of America.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information set forth under the caption "Election of Directors" in Sierra's
Proxy Statement for its 2001 Annual Meeting of Stockholders, is incorporated
herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information set forth under the caption "Compensation of Executive Officers"
in Sierra's Proxy Statement for its 2001 Annual Meeting of Stockholders, is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information set forth under the caption "Security Ownership of Certain
Beneficial Owners and Management" in Sierra's Proxy Statement for its 2001
Annual Meeting of Stockholders, is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information set forth under the caption "Certain Relationships and Related
Transactions" in Sierra's Proxy Statement for its 2001 Annual Meeting of
Stockholders, is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) The following consolidated financial statements are included in Part II,
Item 8 of this Report:
Page
----
Independent Auditors' Report............................................................. 48
Consolidated Balance Sheets at December 31, 2001 and 2000................................ 49
Consolidated Statements of Operations for the Years Ended
December 31, 2001, 2000 and 1999...................................................... 50
Consolidated Statements of Stockholders' Equity
for the Years Ended December 31, 2001, 2000 and 1999.................................. 51
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2001, 2000 and 1999...................................................... 52
Notes to Consolidated Financial Statements............................................... 53
(a)(2) Financial Statement Schedules:
Schedule I - Condensed Financial Information of Registrant................... S-1
Schedule V - Supplemental Information Concerning
Property-Casualty Insurance .................................. S-5
Other Information:
Section 403.04 b - Exhibit of Redundancies (Deficiencies) ......................... S-6
All other schedules are omitted because they are not applicable, not required,
or because the required information is in the consolidated financial statements
or notes thereto.
(a)(3) The following exhibits are filed as part of, or incorporated by reference
into, this Report as required by Item 601 of Regulation S-K:
(3.1)Articles of Incorporation, together with amendments thereto to date,
incorporated by reference to Exhibit 4 (b) to the Registrant's
Registration Statement on Form S-8 (No. 33-41543) effective July 3,
1991.
(3.2)Certificate of Division of Shares into Smaller Denominations of the
Registrant.
(3.3)Amended and Restated Bylaws of the Registrant, as amended through
March 21, 2002.
(3.4)Certificant pursuant to NRS Section 78.207 increasing the number of
authorized shares of common stock to 60,000,000 pursuant to the
Company's stock split on May 18, 1998.
(4.1)Rights Agreement, dated as of June 14, 1994, between the Registrant
and Continental Stock Transfer & Trust Company, incorporated by
reference to Exhibit 3.4 to the Registrant's Registration Statement on
Form S-3 effective October 11, 1994 (Reg. No. 33-83664).
(4.2)Rights Agreement, dated as of June 14, 1994, amended as of August 10,
2000, between the Registrant and Wells Fargo Bank Minnesota, N.A.
(4.3) Specimen Common Stock Certificate.
(10.1) Form of Contract With Eligible Medicare+Choice Organization and the
Centers for Medicare and Medicaid Services for the period January 1,
2001 to December 31, 2001.
(10.2) Amended and Restated Credit Agreement dated as of December 15, 2000,
among Sierra Health Services, Inc. as Borrower, Bank of America
National Trust and Savings Association as Administrative Agent and
Issuing Bank, First Union National Bank as Syndication Agent, and the
Other Financial Institutions Party Thereto, incorporated by reference
to Exhibit 1 to the Registrant's Current Report on Form 8-K filed
December 22, 2000.
(10.3) Form of Indenture for 91/2% senior debentures due September 15, 2004
from CII Financial, Inc. to Wells Fargo Bank Minnesota, N.A., as
Trustee, incorporated by reference to Exhibit 4.3 to CII Financial's
Registration Statement on Form S-4 (File No. 333-52726)
(10.4) Specimen 91/2% senior debenture due September 15, 2004 of CII
Financial (included in Exhibit 10.3 hereto)
(10.5) Compensatory Plans, Contracts and Arrangements.
(1) Employment Agreement with Jonathon W. Bunker dated November
16, 2000, incorporated by reference to Exhibit 10.5 to
Registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 2000.
(2) Employment Agreement with Frank E. Collins dated November
16, 2000, incorporated by reference to Exhibit 10.5 to
Registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 2000.
(3) Employment Agreement with William R. Godfrey dated December
10, 1999, incorporated by reference to Exhibit 10.8 to
Registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 1999.
(4) Employment Agreement with Laurence S. Howard dated December
10, 1999 incorporated by reference to Exhibit 10.8 to
Registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 1999.
(5) Employment Agreement with Anthony M. Marlon, M.D. dated
November 16, 2000, incorporated by reference to Exhibit 10.5
to Registrant's Annual Report on Form 10-K for the fiscal
year ended December 31, 2000.
(6) Employment Agreement with Erin E. MacDonald dated June 1,
2001, incorporated by reference to Exhibit 10.1 to
Registrant's Quarterly Report on Form 10-Q for the fiscal
quarter ended June 30, 2001.
(7) Employment Agreement with Michael A. Montalvo dated November
16, 2000, incorporated by reference to Exhibit 10.5 to
Registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 2000.
(8) Employment Agreement with Marie H. Soldo dated November 16,
2000, incorporated by reference to Exhibit 10.5 to
Registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 2000.
(9) Employment Agreement with Paul H. Palmer dated December 1,
2001.
(10) Form of Split Dollar Life Insurance Agreement effective as
of August 25, 1998, by and between Sierra Health Services,
Inc., and Jonathon W. Bunker, Ria Marie Carlson, Frank E.
Collins, William R. Godfrey, Laurence S. Howard, Erin E.
MacDonald, Anthony M. Marlon, M.D., Kathleen M. Marlon,
Michael A. Montalvo, John A. Nanson, M.D., Paul H. Palmer
and Marie H. Soldo, incorporated by reference to Exhibit
10.5 to the Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 2000.
(11) Sierra Health Services, Inc. Deferred Compensation Plan
effective May 1, 1996 as Amended and Restated Effective
January 1, 2001, incorporated by reference to Exhibit 10.5
to the Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 2000.
(12) Sierra Health Services, Inc. Supplemental Executive
Retirement Plan effective July 1, 1997, as Amended and
Restated January 1, 2001, incorporated by reference to
Exhibit 10.5 to the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 2000.
(13) Sierra Health Services, Inc. Supplemental Executive
Retirement Plan effective as of March 1, 1998, incorporated
by reference to Exhibit 10 to the Registrant's Quarterly
Report on Form 10-Q for the fiscal quarter ended March 31,
1998.
(14) The Registrant's Second Amended and Restated 1986 Stock
Option Plan as amended to date, incorporated by reference to
Exhibit 4 (a) to the Registrant's Registration Statement on
Form S-8 (No. 33-41543) effective July 3, 1991.
(15) Amendment No. 1 to The Registrant's Second Amended and
Restated 1986 Stock Option Plan as amended to November 11,
1992.
(16) Amendment No. 2 to The Registrant's Second Amended and
Restated 1986 Stock Option Plan as amended to March 16,
1993.
(17) Sierra Health Services, Inc. Management Incentive
Compensation Plan incorporated by reference to Exhibit 10.8
to the Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 1999.
(18) Sierra Health Services, Inc. 1995 Long-Term Incentive Plan,
as amended and restated through December 11, 2001.
(19) Sierra Health Services, Inc. 1995 Non-Employee Directors'
Stock Plan, as amended and restated through August 10, 2000,
incorporated by reference to Exhibit 10.7 to the
Registrant's Quarterly Report on Form 10-Q for the fiscal
quarter ended September 30, 2000.
(10.6) Loan Agreement dated August 11, 1997 between the Company and Anthony
M. Marlon for a revolving credit facility in the maximum aggregate
amount of $3,000,000, incorporated by reference to the Registrant's
Quarterly Report on Form 10-Q for the fiscal quarter ended September
30, 1997.
(10.7) Amendment No. 1 to Loan Agreement dated August 11, 1997 between the
Company and Anthony M. Marlon for a revolving credit facility in the
maximum aggregate amount of $3,000,000, incorporated by reference to
Exhibit 10.8 to the Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 2000.
(10.8)Amendment No. 2 to Loan Agreement dated August 11, 1997 between the
Company and Anthony M. Marlon for a revolving credit facility in the
maximum aggregate amount of $3,000,000, incorporated by reference to
Exhibit 10.9 to the Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 2000.
(10.9)Loan Agreement dated April 10, 2000 between the Company and Anthony
M. Marlon for a term loan of $2,500,000, incorporated by reference to
Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the
fiscal quarter ended June 30, 2000.
(10.10)Collateral Assignment of Rights dated April 10, 2000 between the
Company and Anthony M. Marlon, incorporated by reference to Exhibit
10.2 to the Registrant's Quarterly Report on Form 10-Q for the fiscal
quarter ended June 30, 2000.
(10.11)Purchase and Sale Agreement dated December 1, 2000 between Sierra
Health Services, Inc., Health Plan of Nevada, Inc., Sierra Health and
Life Insurance Company, Inc., 2716 North Tenaya Way Limited
Partnership and CB Richard Ellis Corporate Partners, LLC and
amendments one through seven thereof, incorporated by reference to
Exhibit 10.16 to the Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 2000.
(10.12)Purchase and Sale Agreement dated December 1, 2000 between Sierra
Health Services, Inc., Southwest Medical Associates, Inc., Health Plan
of Nevada, Inc., 2314 West Charleston Partnership and CB Richard Ellis
Corporate Partners, LLC and amendments one through seven thereof,
incorporated by reference to Exhibit 10.17 to the Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 2000.
(10.13)Settlement Agreement and Release of Claims between Kaiser Foundation
Health Plan of Texas and Sierra Health Services, Inc. and certain
subsidiaries.
(21) Subsidiaries of the Registrant (listed herein):
There is no parent of the Registrant. The following is a listing
of the active subsidiaries of the Registrant:
Jurisdiction of
Incorporation
-----------------
Sierra Health and Life Insurance Company, Inc. California
Health Plan of Nevada, Inc. Nevada
Sierra Health-Care Options, Inc. Nevada
Behavioral Healthcare Options, Inc. Nevada
Family Health Care Services Nevada
Family Home Hospice, Inc. Nevada
Southwest Medical Associates, Inc. Nevada
Sierra Medical Management, Inc. and Subsidiaries Nevada
Southwest Realty, Inc. Nevada
Sierra Health Holdings, Inc. (Texas Health Choice, L.C.) Nevada (Texas)
CII Financial, Inc., and Subsidiaries California
Northern Nevada Health Network, Inc. Nevada
Intermed, Inc. Arizona
Sierra Military Health Services, Inc. Delaware
Sierra Home Medical Products, Inc. Nevada
Nevada Administrators, Inc. Nevada
(23.1) Consent of Deloitte & Touche LLP
All other Exhibits are omitted because they are not applicable.
(b) Reports on Form 8-K
Current Report on Form 8-K, filed November 13, 2001, with the Securities
and Exchange Commission in connection with the announcement of the
Company's participation in a health care conference on November 14, 2001.
Current Report on Form 8-K, filed January 4, 2002, with the Securities and
Exchange Commission in connection with the announcement of the Company's
participation in a health care conference on January 8, 2002.
Current Report on Form 8-K, filed February 1, 2002, with the Securities and
Exchange Commission in connection with the announcement of the Company's
participation in a health care conference on February 5, 2002.
Current Report on Form 8-K, filed February 21, 2002, with the Securities
and Exchange Commission in connection with the announcement of the
Company's participation in a health care conference on February 27, 2002.
(d) Financial Statement Schedules
The Exhibits set forth in Item 14 (a)(2) are filed herewith.
- ---------------------
*The agreements contain certain schedules and exhibits which were not included
in this filing. The Company will furnish supplementally a copy of any omitted
schedule or exhibit to the Commission upon request.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has caused this report to be signed on its behalf by
the undersigned thereto duly authorized.
SIERRA HEALTH SERVICES, INC.
By: /s/ Anthony M. Marlon, M.D.
----------------------------
Anthony M. Marlon, M.D.
Date: March 29, 2002
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
/s/ Anthony M. Marlon, M.D. Chief Executive Officer March 29, 2002
- ---------------------------------
Anthony M. Marlon, M.D. and Chairman of the Board
(Chief Executive Officer)
/s/ Paul H. Palmer Vice President of Finance, March 29, 2002
- ---------------------------------
Paul H. Palmer Chief Financial Officer,
and Treasurer
(Chief Accounting Officer)
/s/ Erin E. MacDonald Director March 29, 2002
- ---------------------------------
Erin E. MacDonald
/s/ Charles L. Ruthe Director March 29, 2002
- ---------------------------------
Charles L. Ruthe
/s/ William J. Raggio Director March 29, 2002
- ---------------------------------
William J. Raggio
/s/ Thomas Y. Hartley Director March 29, 2002
- ---------------------------------
Thomas Y. Hartley
/s/ Albert L. Greene Director March 29, 2002
- ---------------------------------
Albert L. Greene
/s/ Michael E. Luce Director March 29, 2002
- ---------------------------------
Michael E. Luce
/s/ Anthony L. Watson Director March 29, 2002
- ---------------------------------
Anthony L. Watson
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS - Parent Company Only
(In thousands)
December 31,
2001 2000
---------------- ---------------
CURRENT ASSETS:
Cash and Cash Equivalents .......................................... $ 15,230
Short-term Investments.............................................. $ 1,585 358
Current Portion of Deferred Tax Asset............................... 15,301 25,803
Prepaid Expenses and Other Current Assets........................... 31,966 8,672
------- -------
Total Current Assets.......................................... 48,852 50,063
PROPERTY AND EQUIPMENT - NET ............................................ 109,658 134,394
EQUITY IN NET ASSETS OF SUBSIDIARIES .................................... 50,582 83,734
NOTES RECEIVABLE FROM SUBSIDIARIES ...................................... 9,345 9,435
GOODWILL .............................................................. 2,154 2,259
DEFERRED TAX ASSET....................................................... 67,829 63,829
OTHER ................................................................... 27,532 29,126
------- -------
TOTAL ASSETS ............................................................ $315,952 $372,840
======= =======
CURRENT LIABILITIES:
Accounts Payable and Other Accrued Liabilities ..................... $ 22,836 $ 30,864
Current Portion of Long-term Debt .................................. 3,728 8,883
------- -------
Total Current Liabilities .................................... 26,564 39,747
LONG-TERM DEBT (Less Current Portion).................................... 177,981 229,804
OTHER LIABILITIES ....................................................... 14,888 12,816
------- -------
TOTAL LIABILITIES ....................................................... 219,433 282,367
------- -------
STOCKHOLDERS' EQUITY:
Capital Stock ...................................................... 148 144
Additional Paid-in Capital.......................................... 181,076 177,493
Deferred Compensation............................................... (1,058)
Treasury Stock ..................................................... (22,789) (22,789)
Accumulated Other Comprehensive Income.............................. (5,636) (5,667)
(Accumulated Deficit) Retained Earnings ............................ (55,222) (58,708)
------- -------
Total Stockholders' Equity ................................... 96,519 90,473
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY............................... $315,952 $372,840
======= =======
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
CONDENSED STATEMENT OF OPERATIONS - Parent Company Only
(In thousands)
Year Ended December 31,
2001 2000 1999
------------ ------------ -------------
OPERATING REVENUES:
Management Fees........................................ $ 69,603 $ 61,101 $ 52,109
Subsidiary Dividends................................... 10,000 5,137 9,700
Investment and Other Income............................ 5,250 7,320 4,600
------- -------- -------
Total Operating Revenues............................... 84,853 73,558 66,409
------- -------- -------
GENERAL AND ADMINISTRATIVE EXPENSES:
Depreciation.......................................... 14,125 10,650 6,311
Other................................................. 36,478 32,546 34,250
Asset Impairment, Restructuring,
Reorganization and Other Costs................... 8,454 7,808
------- -------- -------
Total General and Administrative...................... 50,603 51,650 48,369
INTEREST EXPENSE AND OTHER, NET............................ (9,065) (15,945) (12,741)
EQUITY IN UNDISTRIBUTED
(LOSS) EARNINGS OF SUBSIDIARIES....................... 15,456 (267,755) (26,744)
------- -------- -------
INCOME (LOSS) BEFORE INCOME TAXES.......................... 40,641 (261,792) (21,445)
BENEFIT (PROVISION) FOR
INCOME TAXES......................................... (37,155) 61,877 16,814
------- -------- -------
NET INCOME (LOSS).......................................... $ 3,486 $(199,915) $ (4,631)
======= ======== =======
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
CONDENSED STATEMENTS OF CASH FLOWS - Parent Company Only
(In thousands)
Year Ended December 31,
2001 2000 1999
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (Loss).................................................... $ 3,486 $(199,915) $ (4,631)
Adjustments to Reconcile Net Income (Loss) to Net Cash
(Used for) Provided by Operating Activities:
Depreciation and Amortization.................................... 14,231 10,755 6,398
Provision for Property Impairment ............................... 3,604
Equity in Undistributed Earnings (Loss) of Subsidiaries.......... (15,456) 267,755 26,744
Change in Assets and Liabilities................................. (10,650) (78,511) (30,788)
------- -------- -------
Net Cash (Used for) Provided by Operating Activities...... (8,389) 3,688 (2,277)
------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital Expenditures ................................................ (3,915) (5,527) (31,804)
Property and Equipment Dispositions.................................. 5,356 9,920
(Increase) Decrease in Investments................................... (1,247) 836 2,655
Dividends from Subsidiaries.......................................... 10,000 5,137 9,700
Acquisitions, Net of Cash Acquired .................................. (3,000)
(Decrease) Increase in Net Assets in Subsidiaries.................... 39,772 (69,800) (7,080)
------- -------- -------
Net Cash Provided by (Used for) Investing Activities ............ 49,966 (59,434) (29,529)
------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from Long-term Borrowing ................................... 7,500 91,520 79,000
Reductions in Long-term Obligations and
Payments on Capital Leases....................................... (49,926) (22,400) (49,469)
Notes Receivable from Subsidiaries................................... (16,910) 82 160
Purchase of Treasury Stock .......................................... (7,968)
Exercise of Stock in Connection with Stock Plans..................... 2,529 1,580 2,332
------- -------- -------
Net Cash (Used for) Provided by Financing Activities............. (56,807) 70,782 24,055
------- -------- -------
Net (Decrease) Increase in Cash and Cash Equivalents....................... (15,230) 15,036 (7,751)
Cash and Cash Equivalents at Beginning of Year............................. 15,230 194 7,945
------- -------- -------
Cash and Cash Equivalents at End of Year................................... $ $ 15,230 $ 194
======= ======== =======
Supplemental condensed statements of cash flows information:
Cash Paid During the Year for Interest
(Net of Amount Capitalized).......................................... $22,075 $ 21,734 $ 11,210
Cash Received During the Year for Income Taxes............................. (80) (11,286) (4,702)
Noncash Investing and Financing Activities:
Stock Issued for Exercise of Options
and Related Tax Benefits......................................... 97 1
Retired Sale-Leaseback Assets, Liabilities
and Financing Obligations........................................ 14,552
Addition to capital leases........................................... 1,835
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
NOTES TO CONDENSED INFORMATION OF REGISTRANT
For the Years Ended December 31, 2001 and 2000
1. LONG-TERM DEBT
Scheduled maturities of long-term debt, including the principal portion of
obligations under capital leases, are as follows:
(In thousands)
Year Ending December 31,
---------------------------------------------------------
2002............................................................. $ 3,728
2003............................................................. 92,161
2004............................................................. 11,059
2005............................................................. 3,978
2006............................................................. 4,492
Thereafter....................................................... 66,291
-------
Total........................................................ $181,709
=======
2. OTHER
Reclassifications. Amounts related to our discontinued operations have been
reclassified to conform with the current year presentation in the Condensed
Financial Information of Registrant for the years ended December 31, 2000
and 1999.
Management Fees. Sierra Health Services, Inc. receives monthly management
fees from certain wholly-owned subsidiaries for services performed. The
majority of the fees are from Health Plan of Nevada, Inc. under an
administrative services agreement that has been approved by the Nevada
Division of Insurance. The fees have been recorded as reveneue in the
Condensed Financial Information of Registrant for the three years ended
December 31, 2001.
SIERRA HEALTH SERVICES, INC.
SUPPLEMENTAL INFORMATION
CONCERNING PROPERTY - CASUALTY INSURANCE
(In thousands)
Gross Claims & Claim
Reserves Adjustment Amortization
Deferred for Unpaid Expenses Incurred of Deferred Paid Claims
Policy Claims and Discount if any Gross Net Related to Policy and Claims Direct
Acquisition Adjustment Deducted in Unearned Earned Investment (1) (2) Acquisition Adjustment Premiums
Affiliation With Registrant Costs Expenses Column C Premiums Premiums Income Current Prior Year Costs Expenses Written
Column A Column B Column C Column D Column E Column F Column G Year Column H Column I Column J Column K
- -------- -------- -------- -------- -------- -------- -------- ---------- -------- -------- -------- --------
Consolidated Property and
Casualty Entities of CII
Financial, Inc. for
Years Ended:
December 31, 2001......... $2,236 $385,705 $0 $14,327 $186,296 $15,475 $131,923 $ 8,691 $29,272 $ 98,159 $187,129
December 31, 2000......... 2,015 374,554 0 13,493 203,075 15,074 86,587 23,293 21,386 88,388 203,268
December 31, 1999......... 2,378 244,394 0 13,300 146,682 15,776 51,541 9,920 11,260 101,623 148,824
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
SECTION 403.04.b
EXHIBIT OF REDUNDANCIES (DEFICIENCIES)
(In thousands)
Year ended December 31,
---------------------------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------- ---------
Losses and LAE
Reserve......... $385,705 $374,554 $244,394 $212,264 $202,699 $187,776 $182,318 $190,962 $200,356 $178,460 $112,749
Less Reinsurance
Recoverables (1) 187,453 218,757 110,089 37,797 21,056 15,676 25,871 29,342 25,841 20,207
------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Net Loss and LAE
Reserves........ 198,252 155,797 134,305 174,467 181,643 172,100 156,447 161,620 174,515 158,253
Net Reserve
Re-estimated as of:
1 Year Later ... 164,488 157,598 184,386 172,000 163,130 141,163 139,741 160,562 154,388 140,815
2 Years Later .. 171,136 204,029 173,596 146,987 132,193 125,279 141,100 147,167 142,447
3 Years Later .. 218,626 186,794 140,563 113,766 117,792 126,483 134,747 143,433
4 Years Later .. 198,403 146,266 102,652 102,955 122,517 132,193 137,143
5 Years Later .. 153,423 104,249 95,997 114,443 131,112 135,249
6 Years Later .. 108,208 95,954 112,284 127,258 135,299
7 Years Later .. 98,482 111,883 125,936 133,729
8 Years Later .. 113,929 125,907 132,696
9 Years Later .. 127,225 132,836
10 Years Later.. 132,425
Cumulative Redundancy
(Deficiency).... (8,691) (36,381) (44,159) (16,760) 18,677 48,239 63,138 60,586 31,028 (20,676)
Cumulative Net Paid
as of:
1 Year Later.... 69,599 61,522 80,416 71,933 56,977 45,731 44,519 50,210 50,360 57,611
2 Years Later... 103,855 124,191 117,794 91,765 70,854 68,619 79,788 84,465 89,177
3 Years Later... 159,335 143,369 113,054 83,674 80,645 94,865 104,569 108,849
4 Years Later... 164,584 125,024 91,115 86,381 102,395 114,293 120,539
5 Years Later... 135,421 95,609 89,601 106,012 119,462 126,100
6 Years Later... 100,365 91,676 107,850 122,000 129,060
7 Years Later... 93,789 109,201 123,291 130,649
8 Years Later... 110,743 124,220 131,346
9 Years Later... 125,147 131,898
10 Years Later.. 132,506
Net Reserve......... 198,252 155,797 134,305 174,467 181,643 172,100 156,447 161,620 174,515
Reins. Recoverables. 187,453 218,757 110,089 37,797 21,056 15,676 25,871 29,342 25,841
------- ------- ------- ------- ------- ------- ------- ------- -------
Gross Reserve ...... $385,705 374,554 244,394 212,264 202,699 187,776 182,318 190,962 200,356
======= ------- ------- ------- ------- ------- ------- ------- -------
Net Re-estimated
Reserve .......... 164,488 171,136 218,626 198,403 153,423 108,208 98,482 113,929
Re-estimated Reins.
Recoverables ... 248,856 146,890 49,260 22,910 16,847 26,989 30,037 26,092
------- ------- ------- ------- ------- ------- ------- -------
Gross Re-estimated
Reserve ........ 413,344 318,026 267,886 221,313 170,270 135,197 128,519 140,021
------- ------- ------- ------- ------- ------- ------- -------
Gross Cumulative
Redundancy
(Deficiency).. $(38,790) $(73,632) $(55,622) $(18,614) $ 17,506 $ 47,121 $ 62,443 $ 60,335
======= ======= ======= ======= ======= ======= ======= =======
(1) Amounts reflect reinsurance recoverable under prospective reinsurance
contracts only. The Company adopted Financial Accounting Standards
Board Statement No. 113 ("FAS 113"), "Accounting and Reporting for
Short-Duration and Long-Duration Reinsurance Contracts" for the year
ended December 31, 1992. As permitted, prior financial statements have
not been restated. Reinsurance recoverables on unpaid losses and LAE
are shown as an asset on the balance sheets at December 31, 2001 and
2000. However, for purposes of the reconciliation and development
tables, loss and LAE information are shown net of reinsurance.