MID ATLANTIC MEDICAL SERVICES INC - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------

FORM 10-Q

[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934

For the quarterly period ended JUNE 30, 2003, or

[ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934

For the transition period from to

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COMMISSION FILE NUMBER 1-13340
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MID ATLANTIC MEDICAL SERVICES, INC.
(Exact name of registrant as specified in its charter)

DELAWARE
(State or other jurisdiction of
incorporation or organization)

52-1481661
(I.R.S. Employer Identification No.)

4 TAFT COURT, ROCKVILLE, MARYLAND
(Address of principal executive offices)

20850
(Zip code)

(301) 762-8205
(Registrant's telephone number, including area code)

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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).

Yes [X] No [ ]

The number of shares outstanding of each of the issuer's classes of common stock
was 48,267,622 shares of common stock, par value $.01, outstanding as of June
30, 2003.

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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MID ATLANTIC MEDICAL SERVICES, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS (Note 1)
(in thousands except share amounts)

(Unaudited) (Note)
June 30, 2003 December 31, 2002
------------ ------------

ASSETS
Current assets:
Cash and cash equivalents $ 10,221 $ 7,144
Investment securities 609,200 486,740
Accounts receivable, net of allowance of $7,346 and $7,068 143,687 118,050
Prepaid expenses, advances and other 34,027 37,104
Deferred income taxes 6,366 3,419
----------- -----------
Total current assets 803,501 652,457

Property and equipment, net of accumulated
depreciation of $76,201 and $70,123 81,826 82,683
Statutory deposits 21,517 21,541
Other assets 9,233 8,951
Deferred income taxes 9,042 7,396
----------- -----------
Total assets $ 925,119 $ 773,028
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowings $ 3,348 $ 3,219
Accounts payable 64,341 62,434
Claims payable, net 352,051 297,304
Income taxes payable - 12,751
Deferred premium revenue 38,674 33,901
Unearned revenue 25,477 14,592
Deferred income taxes 3,845 2,262
----------- -----------
Total liabilities 487,736 426,463
----------- -----------
Stockholders' equity
Common stock, $.01 par, 100,000,000 shares authorized; 67,772,502 issued
and 48,267,622 outstanding at June 30, 2003; 65,772,502 issued
and 46,987,122 outstanding at December 31, 2002 677 657
Additional paid-in capital 683,957 466,154
Stock compensation trust (common stock held in trust)
8,466,588 shares outstanding at June 30, 2003;
8,311,590 shares outstanding at December 31, 2002 (442,803) (269,296)
Treasury stock, 19,504,880 shares at June 30, 2003;
18,785,380 shares at December 31, 2002 (305,610) (276,205)
Accumulated other comprehensive income 11,949 9,279
Retained earnings 489,213 415,976
----------- -----------
Total stockholders' equity 437,383 346,565
----------- -----------
Total liabilities and stockholders' equity $ 925,119 $ 773,028
=========== ===========

Note: The balance sheet at December 31, 2002 has been extracted from the audited
financial statements at that date.

See accompanying notes to these financial statements.

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MID ATLANTIC MEDICAL SERVICES, INC.
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(in thousands except share amounts)
(Unaudited)

Three Months Ended
June 30, June 30,
2003 2002
------------ ------------

Revenue
Health premium $ 654,457 $ 558,615
Fee and other 5,992 5,735
Life and short-term disability premium 2,434 2,250
Home health services 6,086 4,976
Investment 4,177 3,687
----------- -----------
Total revenue 673,146 575,263
----------- -----------
Expense
Medical 537,473 480,321
Life and short-term disability claims 871 966
Home health patient services 5,673 5,963
Administrative (including interest expense of $407 and $158) 69,787 60,749
----------- -----------
Total expense 613,804 547,999
----------- -----------
Income before income taxes 59,342 27,264

Income tax expense (20,260) (8,841)
----------- -----------

Net income $ 39,082 $ 18,423
=========== ===========

Basic earnings per common share $ 1.00 $ .47
=========== ===========

Diluted earnings per common share $ .94 $ .44
=========== ===========

See accompanying notes to these financial statements.

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MID ATLANTIC MEDICAL SERVICES, INC.
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(in thousands except share amounts)
(Unaudited)

Six Months Ended
June 30, June 30,
2003 2002
------------ ------------

Revenue
Health premium $ 1,300,958 $ 1,092,625
Fee and other 11,865 11,290
Life and short-term disability premium 4,774 4,402
Home health services 11,741 10,220
Investment 8,184 6,889
----------- -----------
Total revenue 1,337,522 1,125,426
----------- -----------
Expense
Medical 1,075,909 935,765
Life and short-term disability claims 2,002 1,751
Home health patient services 11,327 10,737
Administrative (including interest expense of $596 and $317) 137,076 122,235
----------- -----------
Total expense 1,226,314 1,070,488
----------- -----------
Income before income taxes 111,208 54,938

Income tax expense (37,971) (17,662)
----------- -----------

Net income $ 73,237 $ 37,276
=========== ===========

Basic earnings per common share $ 1.88 $ .95
=========== ===========

Diluted earnings per common share $ 1.78 $ .89
=========== ===========

See accompanying notes to these financial statements.

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MID ATLANTIC MEDICAL SERVICES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(Unaudited)

Six Months
Ended
June 30, 2003
------------

Cash flows provided by operating activities:
Net income $ 73,237
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization $ 6,210
Provision for bad debts 278
Provision for deferred income taxes (4,448)
Loss on sale and disposal of assets 5
Stock option tax benefit 20,792
Increase in accounts receivable (25,915)
Decrease in prepaid expenses, advances, and other 3,077
Increase in accounts payable 1,907
Decrease in income taxes payable (12,751)
Increase in claims payable, net 54,747
Increase in deferred premium revenue 4,773
Increase in unearned revenue 10,885
-----------
Total adjustments 59,560
-----------
Net cash provided by operating activities 132,797

Cash flows used in investing activities:
Purchases of investment securities (471,556)
Sales of investment securities 353,205
Purchases of property and equipment (5,312)
Purchase of statutory deposits (3,800)
Maturity of statutory deposit 3,800
Purchases of other assets (348)
Proceeds from sale of assets 43
-----------
Net cash used in investing activities (123,968)

Cash flows used in financing activities:
Increase in short-term borrowings 129
Exercise of stock options 23,524
Purchase of treasury stock (29,405)
-----------
Net cash used in financing activities (5,752)
-----------
Net increase in cash and cash equivalents 3,077

Cash and cash equivalents at beginning of period 7,144
-----------
Cash and cash equivalents at end of period $ 10,221
===========

See accompanying notes to these financial statements.

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MID ATLANTIC MEDICAL SERVICES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(Unaudited)

Six Months
Ended
June 30, 2002
------------

Cash flows provided by operating activities:
Net income $ 37,276
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization $ 5,710
Provision for bad debts 274
Provision for deferred income taxes (8,048)
Loss on sale and disposal of fixed assets 19
Stock option tax benefit 13,987
Increase in accounts receivable (19,589)
Increase in prepaid expenses, advances, and other (3,794)
Increase in accounts payable 5,807
Decrease in income taxes payable (1,315)
Increase in claims payable, net 95,884
Decrease in deferred premium revenue (4,232)
Increase in unearned revenue 8,059
-----------
Total adjustments 92,762
-----------
Net cash provided by operating activities 130,038

Cash flows used in investing activities:
Purchases of investment securities (389,673)
Sales of investment securities 285,760
Purchases of property and equipment (8,547)
Purchases of statutory deposits (244)
Maturity of statutory deposits 100
Purchases of other assets (168)
Proceeds from sale of assets 94
-----------
Net cash used in investing activities (112,678)

Cash flows used in financing activities:
Decrease in short-term borrowings (453)
Exercise of stock options 24,229
Purchase of treasury stock (40,210)
-----------
Net cash used in financing activities (16,434)
-----------
Net increase in cash and cash equivalents 926

Cash and cash equivalents at beginning of period 4,510
-----------
Cash and cash equivalents at end of period $ 5,436
===========

See accompanying notes to these financial statements.

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MID ATLANTIC MEDICAL SERVICES, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

INTRODUCTION

Mid Atlantic Medical Services, Inc. is a holding company whose subsidiaries are
active in managed health care and other life and health insurance related
activities. MAMSI's principal markets currently include Maryland, Virginia, the
District of Columbia, Delaware, West Virginia, North Carolina and Pennsylvania.
MAMSI and its subsidiaries (collectively referred to as "MAMSI" or the
"Company") offer a broad range of health care coverage and related ancillary
products and deliver these services through health maintenance organizations
("HMOs"), a preferred provider organization ("PPO"), and a life and health
insurance company. MAMSI also owns a home health care company, a home infusion
services company, a hospice company, a coordination of benefits identification
and collections company and maintains a partnership interest in an outpatient
surgery center.

MAMSI delivers managed health care services principally through HMOs. The HMOs,
MD-Individual Practice Association, Inc. ("M.D. IPA"), Optimum Choice, Inc.
("OCI"), and Optimum Choice of the Carolinas, Inc. ("OCCI") arrange for health
care services to be provided to an enrolled population for a predetermined,
prepaid fee, regardless of the extent or nature of services provided to the
enrollees. The HMOs offer a full complement of health benefits, including
physician, hospital and prescription drug services.

Other MAMSI subsidiaries include Alliance PPO, LLC, which provides a delivery
network of physicians to employers and insurance companies in association with
various health plans, and provides psychiatric services principally to third
party payors or self-insured employer groups. MAMSI Life and Health Insurance
Company develops and markets indemnity health products and group life,
accidental death and short-term disability insurance. HomeCall, Inc., FirstCall,
Inc., and HomeCall Pharmaceutical Services, Inc. provide in-home medical care
including skilled nursing, infusion and therapy to MAMSI's HMO members and other
payors. HomeCall Hospice Services, Inc. provides services to terminally ill
patients and their families. Alliance Recovery Services, LLC provides
coordination of benefits identification and collection services to third party
administrators and insurance companies.

NOTE 1 - FINANCIAL STATEMENTS

The consolidated balance sheet of the Company as of June 30, 2003, the
consolidated statements of income for the three and six months ended June 30,
2003 and 2002, and the consolidated statements of cash flows for the six months
ended June 30, 2003 and 2002 have been prepared by MAMSI without audit. In the
opinion of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included.

Certain information and disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted. These financial statements should be read in conjunction
with the financial statements and notes there to included in the Company's
December 31, 2002 audited consolidated financial statements included in its
annual report on Form 10-K for the year ended December 31, 2002 ("2002 Form
10-K"). The results of operations for the three and six month periods ended June
30, 2003 are not necessarily indicative of the operating results for the full
year.

The Company has entered into certain long-term vendor contracts, some of which
include incentives or cost guarantees designed to provide savings to the Company
over several years. The Company typically accounts for the benefit derived from
these incentives or guarantees ratably over the contract period as a reduction
of medical expense. Because of the complexity of the Company's product offerings
as well as obligations imposed under the contracts, and the timing of settlement
of various contractual periods, disputes may arise as to the degree of
satisfaction of the various contractual obligations which could result in
material adjustments to the Company's financial statements. In the case of one
of these contracts, a dispute with the Company's pharmacy benefits manager,

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("PBM"), Medco Health Solutions, Inc., (formerly known as Merck-Medco Managed
Care, LLC), ("Merck"), arose over its 2000 guarantee which involved
approximately $41.0 million which had been recorded in the Company's financial
statements as a reduction of medical expense over the three years of the
contract. On April 24, 2002 the Company reached a settlement of its dispute with
Merck over its 2000 cost guarantee. Under the terms of the settlement, the
Company received payment of $41 million. In addition to the 2000 guarantee, the
Company's former PBM contract provided for a risk-sharing arrangement for the
years 2001 and 2002. There is also a risk sharing arrangement with the Company's
new PBM for 2003. The 2001 and 2002 risk-sharing arrangements are in the process
of being finalized and settled. As of June 30, 2003, the Company has recorded
what it believes to be a reasonable estimate of the results of these risk-share
arrangements.

NOTE 2 - COMMON STOCK

The following table sets forth the computation of basic and diluted earnings per
share (in thousands except share amounts):

Three Months Ended Six Months Ended
June 30, June 30, June 30, June 30,
2003 2002 2003 2002
---------- ---------- ---------- ----------

Numerator:
Net income $ 39,082 $ 18,423 $ 73,237 $ 37,276
Denominator:
Denominator for basic earnings per share
- weighted average shares 39,137,645 39,229,386 38,896,077 39,143,705
Dilutive securities - employee stock options 2,491,848 2,962,123 2,302,758 2,771,493
Denominator for diluted earnings per share
- adjusted weighted average shares 41,629,493 42,191,509 41,198,835 41,915,198

Options to purchase approximately 8,300 shares of common stock at various prices
were outstanding at June 30, 2003, but were not included in the computation of
diluted earnings per share because the option proceeds would exceed the average
market price and, therefore, the effect would be antidilutive.

During the first six months of 2003 and 2002, total comprehensive income
amounted to $75,907,000 and $41,284,000, respectively.

The Company maintains a stock compensation trust ("SCT") to fund its obligations
arising from its various stock option plans. Shares held by the SCT are excluded
from the denominator used in calculating basic and diluted earnings per common
share.

NOTE 3 - FEDERAL EMPLOYEES' HEALTH BENEFIT PROGRAM

M.D. IPA contracts with the Office of Personnel Management ("OPM") to provide or
arrange health services under the Federal Employees Health Benefits Program
("FEHBP"). The contract with OPM and applicable government regulations establish
premium rating requirements for the FEHBP. In the normal course of business, OPM
audits health plans with which it contracts to verify, among other things, that
the premiums calculated and charged to OPM are established in compliance with
the best community rating guidelines established by OPM. OPM typically audits
plans once every five or six years, and each audit covers the prior five or six
year period. While the government's initial on-site audits are usually followed
by a post-audit briefing as well as a preliminary audit report in which the
government indicates its preliminary results, final resolution and settlement of
the audits can take a minimum of two to three years. The results of these audits
could result in material adjustments to the Company's financial statements. The
Company has been audited through 1999. There were no significant findings
related to 1999. OPM has not yet audited 2000-2002.

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NOTE 4 - CLAIMS PAYABLE

The following table shows the components of claims payable at June 30, 2003 and
2002 (in thousands):

June 30, June 30,
2003 2002
-------- --------

Reserve for incurred but
not reported claims $278,597 $251,975

Claims received, not yet
paid and other items 73,454 55,919
-------- --------
Total claims payable $352,051 $307,894
======== ========

The following tables show the components of the change in claims payable for the
six months ended June 30, 2003 and 2002 for each period's Dates of Service
("DOS") (in thousands except for percentages):

For the Six Months Ended
June 30, 2003: Life & 2002 &
Medical STD Total 2003 DOS Prior DOS
----------------------------------------- -----------------------

Beginning of the year $ 295,721 $ 1,583 $ 297,304 $ - $ 297,304

Components of medical expense:
Estimated cost incurred 1,126,581 2,002 1,128,583 1,128,583 -
Estimated redundancy (50,672) - (50,672) - (50,672)
---------- -------- ---------- ---------- ---------
1,075,909 2,002 1,077,911 1,128,583 (50,672)

Payments for medical expense (1,020,933) (2,231) (1,023,164) (794,051) (229,113)
---------- -------- ---------- ---------- ---------
End of the period $ 350,697 $ 1,354 $ 352,051 $ 334,532 $ 17,519
========== ======== ========== ========== =========

Prior period redundancy as a percentage
of current period medical expense 4.71%

For the Six Months Ended
June 30, 2002: Life & 2001 &
Medical STD Total 2002 DOS Prior DOS
----------------------------------------- -----------------------

Beginning of the year $ 238,814 $ 1,310 $ 240,124 $ - $ 240,124

Components of medical expense:
Estimated cost incurred 965,858 1,751 967,609 967,609 -
Estimated redundancy (30,093) - (30,093) - (30,093)
---------- -------- --------- ---------- ---------
935,765 1,751 937,516 967,609 (30,093)

Payments for medical expense (868,020) (1,726) (869,746) (673,247) (196,499)
---------- -------- --------- ---------- ---------
End of the period $ 306,559 $ 1,335 $ 307,894 $ 294,362 $ 13,532
========== ======== ========= ========== =========

Prior period redundancy as a percentage
of current period medical expense 3.22%

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The Company does not track the redundancy/(deficiency) related to its life and
short-term disability business. Any actual redundancy/(deficiency) would be
immaterial to the tables above and the Company's financial statements.

NOTE 5 - REPORTABLE SEGMENTS

The Company's principal business is providing health insurance products. The
Company has two reportable segments: commercial risk products and preferred
provider organizations. The Company evaluates performance and allocates
resources based on profit or loss from operations before income taxes, not
including gains or losses on the Company's investment portfolio. Management does
not allocate assets in the measurement of segment profit or loss. The accounting
policies of the reportable segments are the same as those described in the
summary of significant accounting policies described in the Company's 2002 Form
10-K.

Three Months Ended Six Months Ended
June 30, June 30, June 30, June 30,
2003 2002 2003 2002
(In thousands) ------------ ------------ ------------ ------------

Revenues:
Commercial risk $ 654,457 $ 558,615 $ 1,300,958 $ 1,092,625
Preferred provider organizations 5,992 5,735 11,865 11,290
All other 8,520 7,226 16,515 14,622
----------- ----------- ----------- -----------
$ 668,969 $ 571,576 $ 1,329,338 $ 1,118,537
=========== =========== =========== ===========

Income before taxes:
Commercial risk $ 52,428 $ 22,873 $ 98,255 $ 45,378
Preferred provider organizations 2,517 2,868 4,984 5,646
All other 345 (2,053) 30 (2,768)
----------- ----------- ----------- -----------
$ 55,290 $ 23,688 $ 103,269 $ 48,256
=========== =========== =========== ===========

Reconciliations of segment data to the Company's consolidated data is as
follows:

Three Months Ended Six Months Ended
June 30, June 30, June 30, June 30,
2003 2002 2003 2002
(In thousands) ------------ ------------ ------------ ------------

Total profit from reportable segments $ 54,945 $ 25,741 $ 103,239 $ 51,024
Other profit (loss) 345 (2,053) 30 (2,768)
Unallocated amounts:
Investment income 4,052 3,576 7,939 6,682
----------- ----------- ----------- -----------
Income before taxes $ 59,342 $ 27,264 $ 111,208 $ 54,938
=========== =========== =========== ===========

NOTE 6 - STOCK-BASED COMPENSATION

In accordance with Statement of Financial Accounting Standards No. 148,
Accounting for Stock-Based Compensation - Transition and Disclosure ("SFAS No.
148"), the effect on net income and net income per share if the Company had
applied the fair value recognition provisions of SFAS No. 123, Accounting for
Stock-Based Compensation ("SFAS No. 123") to stock-based employee compensation
is as follows:

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Three Months Ended Six Months Ended
June 30, June 30, June 30, June 30,
2003 2002 2003 2002
(In thousands) ------------ ------------ ------------ ------------

Net income, as reported $ 39,082 $ 18,423 $ 73,237 $ 37,276
Deduct: Net stock-based employee
compensation expense determined
under fair value based method (3,054) (2,438) (5,899) (4,537)
----------- ----------- ----------- -----------
Pro forma net income $ 36,028 $ 15,985 $ 67,338 $ 32,739
=========== =========== =========== ===========

Earnings per share:
Basic - as reported $ 1.00 $ .47 $ 1.88 $ .95
Basic - pro forma $ .92 $ .41 $ 1.73 $ .84

Diluted - as reported $ .94 $ .44 $ 1.78 $ .89
Diluted - pro forma $ .87 $ .38 $ 1.64 $ .78

The effect of applying SFAS No. 123 on the three and six month periods ended
June 30, 2003 and 2002 pro forma net income and pro forma net income per share
as stated above, is not necessarily representative of the effects on reported
net income for future years, due to, among other things, (1) the vesting period
of stock options and (2) the fair value of additional stock options in future
years.

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MID ATLANTIC MEDICAL SERVICES, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING INFORMATION

All forward-looking information contained in this Management's Discussion and
Analysis of Financial Condition and Results of Operations is based on
management's current knowledge of factors, all with inherent risks and
uncertainties, affecting MAMSI's business. MAMSI's actual results may differ
materially if these assumptions prove invalid. Significant risk factors, while
not all-inclusive, are:

1. The possibility of increasing price competition in the Company's service
area.

2. The effect of a weak economy on the Company.

3. The effect on the Company due to the acts of terrorism and the threat of
future attacks.

4. The possibility that the Company is not able to increase its market share at
the anticipated premium rates.

5. The possibility of increased litigation, legislation or regulation (such as
the numerous class action lawsuits that have been filed against managed care
companies and the pending initiatives to increase health care regulation) that
might have the potential for increased costs, and/or increased regulation of
rates which might have the potential to decrease revenue.

6. The inability to predict and control medical expenses due to:
- Increased utilization by the Company's membership.
- Increased practitioner and pharmaceutical costs.
- Federal or state mandates that increase benefits or limit the Company's
oversight ability.
- The ultimate accuracy of the Company's estimate of the liability for
incurred but not reported claims.
- The potential for disputes under its risk-sharing arrangements, and the
Company's ability to maintain and renew these arrangements.

7. The possibility that the Company is not able to negotiate new or renewal
contracts with appropriate physicians, other health care practitioners,
hospitals and facilities.

The list of significant risk factors is not intended to be exhaustive. There may
be other risk factors that would preclude the Company from realizing the
predictions made in the forward-looking statements. While the Company may
periodically update this discussion of risk factors, the Company does not
undertake to update any forward-looking statement that may be made by or on
behalf of the Company prior to its next required filing with the Securities and
Exchange Commission.

CRITICAL ACCOUNTING POLICIES

MAMSI, through its 100% owned subsidiary companies, is predominately in the
business of selling various forms of health insurance. In 2003, approximately
97% of revenues were earned from the sale of health insurance products, mostly
to employers who purchase health insurance for their employees. Since premium
rates are generally fixed for a one year period, it is critical to the Company's
continued financial success that premiums are set at levels that will at least
cover the next policy year's medical costs for members plus administrative costs
to pay claims, provide member services, pay taxes, and cover other related
costs.

This means that we have to carefully evaluate data and estimate both future
utilization of medical services by our members and the cost of those services so
that we can set premiums at adequate levels. This is the single most important
factor in our business. Very simply, if our medical expenses are greater than
our premiums, we lose money.

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While MAMSI's business is somewhat complex from an insurance regulatory
standpoint, its consolidated balance sheet and income statement are
straightforward and the accounting policies and procedures that we use to
produce them are reasonable and appropriate. MAMSI does not own any special
purpose entities, does not have any complex or extraordinarily risky investments
nor does it have any off balance sheet financing arrangements. In fact, MAMSI
has almost no debt outstanding.

The buildings that the Company owns are either used in its operations or are
currently leased to other entities and do not have mortgages; they are owned
free and clear. The Company's funds are held in cash or invested in money market
accounts, tax exempt securities and other debt securities. All of the bonds we
own have investment ratings of "A" or better.

Certain of our accounting policies are extremely important to the fair
presentation of our results and financial position.

We think that the single most important accounting issue we have is the
recording, at the end of each reporting period, of an adequate liability and
corresponding expense for medical services that have been provided to our
members but for which we have not yet received a bill. This lag between date of
service and date of billing is normal in the insurance business and the
liability for these claims is called "liability for incurred, but not reported
claims" ("IBNR"). The IBNR liability is included within claims payable in our
balance sheet.

The determination of the Company's IBNR is a fairly complex process. The Company
employs its own actuary to aid in its determination. The primary method we use
to estimate IBNR is consistent from period to period and uses historical claims
data to develop the historical relationship of how many claims dollars have been
reported in any given month to what was received in total, once all claims were
received. This relationship gives us an indication of how much medical expense
has been incurred in months for which we have not yet received all claims. While
we use a consistent method in developing our IBNR estimate, considerable
judgment is required. Various factors such as timing of the receipt of claims,
seasonal utilization, and underlying cost inflation affect the ultimate
development of claims expense. To the extent that we over or under estimate our
IBNR at the end of any reporting period, the adjustment is included in the
future period's results. The table below indicates how much we believe we have
over-estimated our December 30, 2002 and 2001 IBNR liability for the six months
ended and expresses it as a percentage of the respective year to date medical
expense:

Six Months Over As a % of
Ended Estimated Medical Expense
------------ ----------- ---------------

June 2003 $50,672,000 4.71%
June 2002 $30,093,000 3.22%

If medical expense was annualized for 2003, the over-estimation as a percentage
of medical expense would be 2.4% for 2003. The over-estimation for 2002 as a
percentage of actual medical expense for 2002 would be 1.6%. This annualized
medical expense is not necessarily indicative of the medical expense for the
full year.

Another important accounting policy relates to our risk sharing contracts.
Certain of the Company's larger vendors offer various forms of "risk-sharing" or
"guarantees" as a part of their contractual relationship with us. These
arrangements are not significant in relation to the Company's financial
statements with one exception; the Company's risk-sharing arrangement with its
PBM. The Company's PBM is responsible for providing administrative and technical
support as well as providing the ability to process pharmacy transactions on a
real time basis. The Company's PBM through December 31, 2002 was Merck. As a
part of its contract with us, Merck agreed to a pharmacy cost guarantee related
to fiscal year 2000. We recorded the amount due under this guarantee over the
contract term of three years, which expired December 31, 2002. The total value
of the guarantee for financial statement purposes was approximately $41.0
million which has been recorded in our financial statements as a reduction of
medical expense over the three years of the contract. In April 2002, the Company
received payment of $41.0 million from Merck. At December 31, 2002, no amounts

14

related to the 2000 guarantee remained unrecognized. In addition to the 2000
guarantee, the Company's former PBM contract provided for a risk-sharing
arrangement for the years 2001 and 2002. There is also a risk sharing
arrangement with the Company's new PBM. The 2001 and 2002 risk-sharing
arrangements are in the process of being finalized and settled. As of June 30,
2003, the Company has recorded what it believes to be a reasonable estimate of
the results of these risk-share arrangements.

Another accounting policy that is very important to the fair presentation of our
financial results is the proper valuation of the Company's accounts receivable.
The Company bills the majority of its health insurance customers on a monthly
basis. The premium bill is typically sent out 15 days in advance of the month
being billed for, so that the Company can receive the cash at the start of the
month for which the insurance is being provided. The vast majority of our
customers pay in a timely fashion but some do not. After some communication, we
generally receive payment but we do not always collect what we are due. This can
happen for a variety of reasons such as customers having financial difficulties,
disputes regarding the amount of the bill or a customer failing to notify us
that they have obtained other health insurance. To properly value the accounts
receivable at its net realizable value we must determine an allowance for
doubtful accounts.

The allowance for doubtful accounts reduces the gross amount of accounts
receivable that are recorded, based on the bills sent, to the net amount that we
actually think we will receive. The allowance also reduces premium revenue by
the same amount. To determine how much to record as a reduction of the gross
accounts receivable, we prepare an accounts receivable aging. This aging
segments the total accounts receivable balance by category as to when it was due
to the Company. This allows us to evaluate how old our accounts receivable are.
We then prepare an evaluation based on historical collection percentages applied
to various categories of accounts. We also identify individual accounts that are
unlikely to pay due to financial or other problems and analyze them
individually. The aforementioned analyses are then summarized and an allowance
is developed and recorded. The Company applies this methodology on a consistent
basis from period to period.

RESULTS OF OPERATIONS

THE THREE MONTHS ENDED JUNE 30, 2003 COMPARED WITH THE THREE MONTHS ENDED JUNE
30, 2002

Consolidated net income of the Company was $39,082,000 and $18,423,000 for the
second quarters of 2003 and 2002, respectively. Diluted earnings per share were
$.94 and $.44 in the second quarters of 2003 and 2002, respectively. This
increase in earnings is attributable to an increase in members, an increase in
premiums per member, a reduction in medical expenses as a percentage of health
premium revenue ("medical care ratio"), and a reduction in administrative
expenses as a percentage of total revenue ("administrative expense ratio"). The
Company currently has one of the largest HMO and managed care enrollments and
also the largest network of contract providers of medical care in its service
area (which includes the entire states of Maryland and Delaware, the District of
Columbia, most counties and cities in Virginia and certain areas of West
Virginia, North Carolina and Pennsylvania).

Health premium revenue for the three months ended June 30, 2003 increased
approximately $95.8 million or 17.2 percent over the three months ended June 30,
2002. A 3.1 percent increase in net average HMO and indemnity enrollment
resulted in an increase of approximately $17.5 million in health premium
revenue, while a 13.6 percent increase in average monthly premium per enrollee,
combined for all products, resulted in a $78.3 million increase in health
premium revenue. Management believes that commercial health premiums should
continue to increase during 2003 as new and renewing groups are charged higher
premium rates. This is a forward-looking statement. See "Forward Looking
Information" above for a description of the risk factors that may effect health
premiums per member.

The Company has implemented increased premium rates across essentially all of
its commercial products. As the Company's contracts are generally for a one year
period, increased pricing generally cannot be initiated until a contract reaches
its renewal date. Therefore, price increases are not implemented across the
Company's membership at the same time. Overall, commercial premium rate
increases in 2003 are expected to be in the range of 13.0% to 13.25%, net of buy
downs. Management believes that these rate increases may have the effect of
slowing the Company's future membership growth.

15

The Company's future membership growth depends on several factors such as
relative premium prices and product availability, future increases or decreases
in the Company's service area, and increased competition in the Company's
service area.

The Company's home health operations contributed approximately $6.1 million in
revenue in the second quarter of 2003 as compared with $5.0 million in the
second quarter of 2002, reflecting an increase in services provided to
non-affiliated companies. Fee and other revenue increased to $6.0 million for
the quarter ended June 30, 2003 from $5.7 million for the quarter ended June 30,
2002, primarily due to an increase in rental income from company owned
facilities. Life and short-term disability products contributed $2.4 million in
revenue in the second quarter of 2003 as compared with $2.3 million for the
second quarter of 2002.

Investment income increased from $3.7 million for the second quarter of 2002 to
$4.2 million for the second quarter of 2003 due to higher levels of invested
balances partially offset by lower rates.

The medical care ratio decreased from 86.0% for the second quarter of 2002 to
82.1% for the second quarter of 2003. On a per member per month basis, medical
expenses increased 8.5%. The decrease in the medical care ratio is due to a
combination of factors including continuing efforts by the Company to implement
product specific cost containment controls, continued activity in specialized
subrogation areas and claims review for dual health coverage, lower than
expected utilization of medical services and also increased premiums per member.
The ongoing initiatives should help to control the Company's medical care ratio.
The medical expense trend is expected to be between 10.0% and 10.5% for 2003.
The statements in this paragraph and the preceding paragraphs regarding future
utilization rates, cost containment initiatives, total medical costs and trend
and future increases in health premiums per member are forward-looking
statements. See "Forward-Looking Information" above for a description of risk
factors that may affect medical expenses per member and the medical care ratio.

The administrative expense ratio decreased from 10.6 percent for the second
quarter of 2002 to 10.4 percent for the same period in 2003. The decrease in the
administrative expense ratio is principally due to increases in premium rates
and membership, management's efforts to control costs as the business volume
increases and technology and productivity gains which have allowed headcount to
remain stable. Management believes that the administrative expense ratio will be
approximately 10.3% to 10.7% for 2003. Management's expectation concerning the
administrative expense ratio is a forward-looking statement. The administrative
expense ratio is affected by changes in health premiums and other revenues and
increased administrative activity related to business volume and to price
increases from the Company's vendors.

The net margin rate increased from 3.2 percent in the second quarter of 2002 to
5.8 percent in the current quarter. This increase is consistent with the factors
previously described.

THE SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO THE SIX MONTHS ENDED JUNE 30,
2002

The Company's consolidated net income for the six months ended June 30, 2003
increased to $73,237,000 from $37,276,000 for the six months ended June 30,
2002. Diluted earnings per share on net income increased from $.89 in the first
six months of 2002 to $1.78 for the same period in 2003. The increase in
earnings is primarily attributable to increased premiums per member and
reduction in the medical care and administrative expense ratios.

Health premium revenue for the six months ended June 30, 2003 increased
approximately $208.3 million or 19.1 percent over the six months ended June 30,
2002. A 5.4 percent increase in net average HMO and indemnity enrollment
resulted in an increase in health premium revenue of approximately $58.9
million, while a 13.0 percent increase in monthly premium per enrollee, combined
for all products, resulted in a $149.4 million increase in health premium
revenue.

16

The Company's home health operations contributed approximately $11.7 million in
revenue in the first six months of 2003 as compared with $10.2 million in the
first six months of 2002, reflecting of an increase in services provided to
non-affiliated companies. Fee and other revenue increased to $11.9 million for
the six months ended June 30, 2003 from $11.3 million for the six months ended
June 30, 2002. Revenue from life and short-term disability products contributed
$4.8 million in revenue for the first six months of 2003 as compared to $4.4
million in the first six months of 2002.

Investment income increased from $6.9 million in the first six months of 2002 to
$8.2 million in the first six months of 2003 primarily due to higher investment
balances partially offset by lower rates.

The medical care ratio decreased to 82.7 percent for the six months ended June
30, 2003 as compared to 85.6 percent for the comparable period in 2002. The
reasons for this decrease are consistent with the items discussed in the
quarterly analysis.

The administrative expense ratio decreased to 10.2 percent for the first six
months of 2003 as compared to 10.9 percent for the comparable period in 2002.
The reasons for this decrease are consistent with the items discussed in the
quarterly analysis.

The net margin rate increased from 3.3 percent for the first six months of 2002
to 5.5 percent for the comparable period of 2003. This increase is consistent
with the factors previously described.

LIQUIDITY AND CAPITAL RESOURCES

The Company's business is not capital intensive and the majority of the
Company's expenses are payments to hospitals, physicians and other health care
practitioners, which generally vary in direct proportion to the health premium
revenues received by the Company. Although medical utilization rates vary by
season, the payments for such expenses lag behind cash inflow from premiums
because of the lag in provider billing procedures. In the past, the Company's
cash requirements have been met principally from operating cash flow and it is
anticipated that this source, coupled with the Company's operating
line-of-credit, will continue to be sufficient to meet the Company's cash
requirements in the future.

The Company's cash and investment securities increased $125.5 million from
$493.9 million at December 31, 2002 to $619.4 million at June 30, 2003,
primarily due to the timing of medical expense payments which traditionally lag
behind the receipt of increased premiums per member, a $27.2 million contractual
payment received from a vendor in February 2003, cash received from the exercise
of stock options and net income offset by the effect of treasury stock purchases
and other capital expenditures. Accounts receivable increased from $118.1
million at December 31, 2002 to $143.7 million at June 30, 2003, principally due
to the timing of customer payments and increased membership, and the
recharacterization of $11.4 million in amounts due from a vendor related to the
2002 contract year. Prepaid expenses, advances and other decreased from $37.1
million at December 31, 2002 to $34.0 million at June 30, 2003, primarily due to
the amortization of prepayments for insurance policies which cover the Company's
assets and business operations, offset by the prepayment of income taxes at June
30, 2003.

Net property and equipment decreased from $82.7 million at December 31, 2002 to
$81.8 million at June 30, 2003, due to depreciation expense exceeding capital
expenditures in 2003.

Claims payable increased from $297.3 million at December 31, 2002 to $352.1
million at June 30, 2003, primarily due to increased membership and an increase
in medical expenses per member, and the timing of payments to physicians and
health care practitioners. Deferred premium revenue increased from $33.9 million
at December 31, 2002 to $38.7 million at June 30, 2003, due to a increase in
cash payments received in advance of the premium coverage period. Unearned
revenue increased from $14.6 million at December 31, 2002 to $25.5 million at
June 30, 2003, primarily due to the receipt of contractual advances.

Additional paid-in capital increased from $466.2 million at December 31, 2002 to
$684.0 million at June 30, 2003, due to the exercise of employee stock options,
as well as an increase in the market value of the shares of the Company's stock
held in the SCT.

17

The value of the SCT increased from $269.3 million at December 31, 2002 to
$442.8 million at June 30, 2003, due to the increase in the market value of the
shares of the Company's stock held in the SCT, offset by the exercise of
employee stock options and the purchase of 2.0 million additional shares of the
Company's common stock held by the SCT. For financial reporting purposes, the
SCT is consolidated with MAMSI. The fair market value of the shares held by the
SCT is shown as a reduction to stockholders' equity in the Company's
consolidated balance sheets. All transactions between the SCT and MAMSI are
eliminated. The difference between the cost and fair value of common stock held
in the SCT is included in the consolidated financial statements as additional
paid-in capital.

Treasury stock increased from $276.2 million at December 31, 2002 to $305.6
million at June 30, 2003, due to the repurchase of 719,500 additional shares of
common stock by the Company at a total cost of $29.4 million. On June 30, 2003,
approximately $23.4 million of unspent authorization was available for future
purchases. During July 2003, the Company repurchased an additional 233,100
shares of its common stock for a total cost of approximately $12.3 million. On
August 5, 2003, the Board of Directors increased the outstanding unspent
authorization by $38.9 million to increase the total authorizations back up to
$50 million.

The Company currently has access to total revolving credit facilities of $29.0
million which are subject to annual renewal and collateral requirements, and are
used to provide short-term capital resources for routine cash flow fluctuations.
At June 30, 2003, the Company's investment security balances used as collateral,
which are parent company only investments, fell below the minimum collateral
requirements thereby reducing the credit line availability to $25.3 million. In
addition, at June 30, 2003, approximately $3.3 million was drawn against these
facilities, and approximately $614,000 in letters of credit were outstanding.
While no amounts have been drawn against these letters of credit, they reduce
the Company's credit line availability.

Following is a schedule of the short-term capital resources available to the
Company:

The Company believes that cash generated from operations along with its current
liquidity and borrowing capabilities are adequate for both current and planned
expanded operations.

The Company's major business operations are principally conducted through its
HMOs and its insurance company. HMOs and insurance companies are subject to
state regulations that, among other things, require those companies to maintain
certain levels of equity and Risk Based Capital ("RBC"), and restrict the amount
of dividends and other distributions that may be paid to their parent
corporation. As of June 30, 2003, those subsidiaries of the Company were in
compliance with all minimum capital requirements and exceeded all RBC - Company
Action Level requirements.

CONTRACTUAL OBLIGATIONS

There were no material changes in contractual obligations at June 30, 2003 when
compared with December 31, 2002.

18

MARKET RISK

The Company is exposed to market risk through its investment in fixed and
variable rate debt securities that are interest rate sensitive. The Company does
not use derivative financial instruments. The Company places its investments in
instruments that meet high credit quality standards, as specified in the
Company's investment policy guidelines; the policy also limits the amount of
credit exposure to any one issue, issuer, or type of instrument. A hypothetical
ten percent change in market interest rates over the next year would not
materially affect the Company's financial position or cash flow. The Company has
no significant market risk with regard to liabilities and does not use special
purpose entities. There are no material changes in market risk exposure at June
30, 2003 when compared with December 31, 2002.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information required by this Item is contained in Item 2 - "Management's
Discussion and Analysis of Financial Condition and Results of Operations".

ITEM 4. CONTROLS AND PROCEDURES

Based on the evaluation carried out under the supervision of the Chief Executive
Officer and Chief Financial Officer of the Company as of the end of the period
covered by this quarterly report, the Company's disclosure controls and
procedures are adequately designed to ensure that the information required to be
included in this report has been recorded, processed, summarized and reported on
a timely basis. There have not been any significant changes in the Company's
internal controls over financial reporting that have materially affected, or is
reasonably likely to materially affect the Company's internal controls over
financial reporting.

19

PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS

In September, 2000, the Company and other HMOs operating in Maryland were served
with similar class action lawsuits challenging the right of the Company to
subrogate against other insurance companies for injuries to members arising out
of third-party liabilities based on the provisions of the Maryland HMO Act, as
interpreted by the Maryland Court of Appeals in Reimer v. Columbia Medical Plan.
The action against the Company was filed in the Circuit Court for Montgomery
County, Maryland. The Company filed a motion for removal of the case to federal
court under the Employee Retirement Income Security Act of 1974 ("ERISA") which
was denied on February 4, 2003. The Company believes that its operations with
respect to the law are valid and is pursuing all available defenses. The Company
does not believe that, at this time, the ultimate outcome of this action will be
material to the Company's financial statements.

The Company is involved in other various legal actions arising in the normal
course of business, some of which seek substantial monetary damages. After
review, including consultation with legal counsel, management believes that any
ultimate liability that could arise from these other actions will not materially
effect the Company's consolidated financial position or results of operations.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

Exhibit Number Description of Document
- -------------- -----------------------

10.51 Common Stock Purchase Agreement dated June 25, 2003.

10.52 Allonge to Replacement Promissory Note dated
June 25, 2003.

31.1 Certification of Chief Executive Officer Pursuant to
Rule 13a-14(a)/15d-14(a), as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.

31.2 Certification of Chief Financial Officer Pursuant to
Rule 13a-14(a)/15d-14(a), as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.

32.1 Certification of Chief Executive Officer Pursuant to
Title 18, United States Code, Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.

32.2 Certification of Chief Financial Officer Pursuant to
Title 18, United States Code, Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.

(b) Reports on Form 8-K

In a report on Form 8-K dated May 8, 2003, the Company reported under Item
9, Regulation FD Disclosure, its financial results for the quarter ended
March 31, 2003.

20
SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by undersigned
thereto duly authorized.

MID ATLANTIC MEDICAL SERVICES, INC.
--------------------------------------------
(Registrant)

Date: August 14, 2003 /s/ Robert E. Foss
-------------------------------
Robert E. Foss
Senior Executive Vice President
and
Chief Financial Officer
(duly authorized officer and
principal financial officer)