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1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For fiscal year ended DECEMBER 31, 1998
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 1-13340
Mid Atlantic Medical Services, Inc.
(Exact name of registrant as specified in its charter)
Delaware 52-1481661
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4 Taft Court, Rockville, Maryland 20850
(Address of principal executive offices) (Zip Code)
(301) 294-5140
(Registrant's telephone number, including area code) Securities registered
pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
- ------------------- ---------------------
Common Stock, $0.01 par value The New York Stock
per share. Exchange, Inc.
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 (Sec. 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of the 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.
[ ]
Aggregate market value of voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the common equity was
sold, or the average bid and asked price of such common equity March 4, 1999:
Approximately $405 million.
APPLICABLE ONLY TO CORPORATE REGISTRANTS:
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date.
51,134,162 shares of common stock as of March 4, 1999
2
DOCUMENTS INCORPORATED BY REFERENCE
The Proxy Statement for the Registrant's annual meeting of shareholders to be
held on April 26, 1999 is incorporated by reference into Part III of this Form
10-K.
3
FORM 10-K
INDEX
ITEM NO. DISCLOSURE REQUIRED PAGE
PART I
Item 1 Business .............................................. 4
Item 2 Properties ............................................ 17
Item 3 Legal Proceedings ..................................... 17
Item 4 Submission of Matters to a Vote of Security Holders ... 18
PART II
Item 5 Market for Registrant's Common Equity and Related
Stockholder Matters ................................ 19
Item 6 Selected Financial Data .............................. 20
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations ................ 21
Item 7A Quantitative and Qualitative Disclosures About
Market Risk ........................................ 29
Item 8 Financial Statements and Supplementary Data .......... 30
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure ................ 55
PART III
Item 10 Directors and Executive Officers of the Registrant ... 56
Item 11 Executive Compensation ............................... 56
Item 12 Security Ownership of Certain Beneficial Owners
and Management ..................................... 56
Item 13 Certain Relationships and Related Transactions ....... 56
PART IV
Item 14 Exhibits, Financial Statement Schedules
and Reports on Form 8-K ............................ 57
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PART I
ITEM 1. BUSINESS
Mid Atlantic Medical Services, Inc. is a holding company for subsidiaries active
in managed health care and other life and health insurance related activities.
Mid-Atlantic Medical Services, Inc. and its subsidiaries (the "Company" or
"MAMSI") have developed a broad range of managed health care and related
ancillary products and deliver these services through health maintenance
organizations ("HMOs"), preferred provider organizations ("PPOs"), a life and
health insurance company, a home health care company, a pharmaceutical services
company and a hospice company. The Company also has a partnership interest in an
outpatient surgery center.
GENERAL DEVELOPMENT OF BUSINESS
Mid-Atlantic Medical Services, Inc. was incorporated in Delaware in 1986 to
serve as a holding company for MD - Individual Practice Association, Inc. ("M.D.
IPA") and Physicians Health Plan of Maryland, Inc. ("PHP-MD"). MAMSI made an
exchange offer for all of the issued and outstanding shares of common stock of
M.D. IPA and PHP-MD in 1987.
M.D. IPA, a Federally qualified HMO, was organized as a nonstock corporation in
1979. M.D. IPA operated as a non-profit organization until 1985 when it amended
its articles of incorporation and was reorganized into a stock corporation.
PHP-MD, an individual practice association ("IPA"), was organized as a nonstock
corporation in 1979 to provide physician and other medical services to M.D. IPA
enrollees. PHP-MD operated as a non-stock organization until it amended its
articles of incorporation and was reorganized into a stock corporation in 1984.
MANAGED HEALTH ORGANIZATIONS
MAMSI's primary business is providing access to and managing health care through
its HMOs and its life and health insurance company. MAMSI currently offers HMO
coverage through four licensed HMO subsidiaries - M.D. IPA, Optimum Choice, Inc.
("OCI"), Optimum Choice of the Carolinas, Inc. ("OCCI") and Optimum Choice, Inc.
of Pennsylvania ("OCIPA") (hereinafter M.D. IPA, OCI, OCCI and OCIPA will be
collectively referred to as the "HMOs" or "MAMSI HMOs") and offers life and
health insurance through MAMSI Life and Health Insurance Company ("MAMSI Life").
M.D. IPA became a licensed HMO in Maryland in 1981 and in Virginia in 1985. M.D.
IPA's present service area (which includes all geographic areas where the HMO
has received regulatory approval to provide health care services) includes the
entire state of Maryland, the District of Columbia and most counties and cities
in Virginia including the Northern Virginia, Richmond/Tidewater and Roanoke
areas ("HMO Service Area"). In addition to serving governmental entities such as
the Office of Personnel Management of the United States Government under the
Federal Employees Health Benefit Plan, M.D. IPA generally provides coverage to
the larger commercial group market.
OCI, a non-Federally qualified HMO, became a licensed HMO in Maryland in 1988,
in Virginia in 1990, in Delaware in 1993 and in West Virginia in 1994. OCI
generally operates within the small and large business market segment, which is
comprised of both small and large group employers and also covers Medicaid and
Medicare recipients. OCI's present commercial service area includes the entire
states of Maryland and Delaware, the District of Columbia, most counties and
cities in Virginia, and 49 counties in West Virginia. For the Medicare Program,
OCI is licensed in Northern Virginia, Maryland, Delaware and the District of
Columbia. OCI withdrew from the Medicare risk program effective January 1, 1999.
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OCCI, a non-Federally qualified HMO, became a licensed HMO in North Carolina in
1995 and South Carolina in 1996. OCCI operates in both the small and large group
commercial market as well as Medicaid. OCCI's present service area includes
certain areas of North Carolina and South Carolina. OCCI has yet to market its
products in South Carolina as a provider network is still being developed.
OCIPA, a non-Federally qualified HMO, became a licensed HMO in Pennsylvania in
1996. OCIPA operates in both the small and large group commercial market.
OCIPA's present service area includes eleven counties in south-central
Pennsylvania.
MAMSI Life, a life and health insurance company, is licensed in 31 states and
the District of Columbia and actively markets in the states in which the Company
has licensed HMO's. MAMSI Life sells group health insurance as well as a
preferred point of service product to large and small employers and individuals.
MAMSI Life also sells group term life insurance as well as short-term disability
insurance and worker's compensation.
GENERAL
HMOs typically provide or arrange for the provision of comprehensive medical
care (including physician and hospital care) to enrollees for a fixed, prepaid
premium regardless of the amount of care provided. Enrollees generally receive
care from participating primary care physicians ("PCPs") who, as required, refer
enrollees to participating specialists and hospitals. HMOs require patients to
utilize participating physicians and other participating health care providers.
This allows HMOs to negotiate favorable rates and control utilization to a
greater extent than traditional health insurers, while monitoring and enhancing
the quality of care provided to enrollees.
The goal of an HMO is to combine quality health care with management controls
designed to encourage efficient and economical use of health care services. Such
controls include monitoring physician services, hospital admissions and lengths
of stay and maximizing the use of non-hospital based medical services. Because
an HMO generally receives fixed monthly premiums from its enrollees regardless
of the health care services provided, an HMO has an incentive to maintain the
health of its enrollees, while carefully monitoring expenses through the
implementation of various cost control strategies and effective management.
The Company's HMO provider network is organized as an Individual Practice
Association ("IPA"). Under the IPA model, the HMO contracts with a broadly
dispersed group of physicians to provide medical services to enrollees in the
physicians' own offices and in hospitals; the physicians are generally paid on a
capitated or a negotiated fee maximum basis. Physicians may contract directly
with the HMO or through a designated organization that, in turn, contracts with
the HMO.
MAMSI'S HMO PRODUCTS
MAMSI's HMOs offer a range of benefit plans for providing health care coverage
to enrollees. Generally, enrollees arrange for coverage through their employer.
However, in certain circumstances, group enrollees can convert their coverage to
an individual contract upon separation from their employer. There is no
assurance that employers will renew their HMO agreements annually or that,
within each employer group, the HMO will not experience disenrollment by
individual enrollees. MAMSI's HMOs also offer individual coverage to the
commercial, Medicaid and Medicare markets in some of its service area. The
Company will no longer participate in the Medicare program effective January 1,
1999.
Under traditional HMO coverage, the enrollee selects a PCP from the HMO's
provider network. Most medical care provided to the enrollee must be authorized
and coordinated by the PCP. Generally, the enrollee pays a copayment for all PCP
and specialist office visits and may also be required to pay a copayment for
hospital admissions and emergency room services.
6
Except in emergencies, enrollees are generally required to utilize only those
participating professional and institutional health care providers that have
contracted with the IPA (see further discussion under "HMO Arrangements with
Physician and Institutional Providers").
MAMSI's HMOs, in cooperation with MAMSI Life (except North Carolina which is
offered through OCCI), a wholly owned subsidiary of MAMSI, also offer
point-of-service coverage (the "preferred plan"), which is marketed to appeal to
the following customers:
1. Individuals who will not consider a closed delivery system. These
individuals prefer the flexibility of the traditional indemnity plan but are
also seeking a lower-cost alternative such as an HMO.
2. Small to mid-sized employers who are looking to limit the number of health
care plan options. In this case, the HMO would seek to be offered as an
exclusive health care provider.
In the preferred plan, enrollees have the choice of seeking care from the PCP or
from any physician of their choice (point-of-service option). Whenever care is
provided under the point-of-service option and the enrollee visits a provider
outside of the HMO network, MAMSI Life, which underwrites this indemnity
benefit, generally covers the lesser of 80% of the requested charges or 100% of
a preestablished fee for the service provided. The enrollee is responsible for
the remainder of the charge.
Additionally, MAMSI, through its subsidiaries, offers hybrid products to large
employer groups. These products offer the ability to tailor employee health care
offerings by varying benefit designs, funding methods and insurance risk. Hybrid
products generally compete in the so-called "self-funded" employer plan
marketplace. A typical MAMSI hybrid product combines the use of capitated PCPs
to serve as gatekeepers, employer funding of specialist and institutional claims
on an "as paid" basis and MAMSI's underwriting of risk of loss on a specific
and/or aggregate stop loss basis.
OCI offers HMO coverage to recipients of Title XIX Medical Assistance
("Medicaid") in certain states. The Medicaid plan operates in a manner similar
to the traditional HMO plan. The participating states pay a monthly premium
based upon the age, sex and geographic location of the recipients for which OCI
provides comprehensive medical coverage. At December 31, 1998, MAMSI's Medicaid
service area includes certain areas of Virginia, fifteen counties in West
Virginia and twelve counties in North Carolina.
Under all coverage options, enrollees receive the following basic benefits:
primary and specialist physician services; hospital services such as diagnostic
tests, x-rays, drugs, medication, nursing and maternity services; outpatient
diagnostic tests such as laboratory tests, x-rays, and allergy testing and
injections.
Through December 31, 1998, OCI offered health coverage to Title XVIII Medicare
recipients. Under a contractual arrangement with the United States Health Care
Financing Administration ("HCFA"), OCI received a monthly premium based upon
age, sex, county of residence and enrollment status for which OCI provides
comprehensive medical coverage to those individuals. Effective January 1, 1999,
OCI will no longer participate in the Medicare program. This decision was
primarily motivated by insufficient reimbursement rates. The reimbursement OCI
was receiving was insufficient to fund the direct cost of care being provided by
OCI. It is anticipated that these changes will reduce MAMSI's membership by
approximately 7,000 members.
7
The Company's total health plan (managed care full risk and hybrid, ASO and
indemnity health insurance) membership in the HMOs and MAMSI Life increased to
approximately 731,000 at December 31, 1998 from 682,000 at December 31, 1997, an
increase of 7.2 percent.
The following table sets forth information relevant to MAMSI's HMO and indemnity
health plans as of December 31, 1998:
Employer Groups Served 25,000
Population of Aggregate HMO
Service Area 33,500,000
Service Area Penetration 28%
Primary Care Physicians 6,700
Specialist Physicians 15,400
Other Affiliated Health
Care Providers 8,600
Hospitals and Outpatient
Facilities 2,900
Pharmacies 11,400
A significant portion of the Company's premium revenue is derived from Federal,
state and local government agencies including governmental employees and
Medicaid and Medicare recipients. For the years ended December 31, 1998, 1997
and 1996, approximately 11% of premium revenue was derived from Federal
government agencies which is included in the Medicare and Risk segments, and
approximately 18%, 25% and 26%, respectively, was derived from state and local
government agencies located in the Company's service area which is included in
the Risk segment.
HMO ARRANGEMENTS WITH PHYSICIAN AND INSTITUTIONAL PROVIDERS
M.D. IPA and OCI contract with PHP-MD to provide physician services to their
enrollees while OCCI (North Carolina and South Carolina) and OCIPA
(Pennsylvania) generally contract directly with providers. The HMOs are
ultimately responsible for ensuring that an adequate number of physicians and
other health care providers are maintained in order to service enrollees.
The Company contracts with many different kinds of health care providers,
including primary care and specialist physicians, dentists, social workers,
psychologists, physical therapists and podiatrists. PCPs are paid a monthly
capitation payment for each enrollee who has chosen that PCP. This capitation
payment varies according to the age and sex of the enrollee and according to the
primary care designation of the provider chosen by the enrollee. The primary
care designations on which premiums are based fall into one of two types: (1)
family and general practice, pediatrics and internal medicine, and (2)
obstetrics and gynecology.
PCPs may receive, in addition to capitation payments, fees for specified
procedures and an annual payment that is based on a Quality Review
Reconciliation. This payment generally does not exceed 3 percent of their annual
capitation payments. The reconciliation evaluates the physician's practice
performance as well as quality issues such as grievance rates from members,
sanctions by a MAMSI HMO, and member transfer rate. As part of the Quality
Review Reconciliation, the Company provides a quarterly report to each PCP that
compares the physician's practice performance based on outpatient and inpatient
expenses to those of his/her peers and allows the PCP not only to monitor the
number of referrals consistent with quality medical standards, but also to
evaluate the most cost-effective consultants and facilities within each
specialty area. The Company compensates specialist providers and participating
non-physician providers using the Medicare Resource Based Relative Value Scale
methodology of provider reimbursement.
8
The HMOs have contractual arrangements with a combined total of 2,900
facilities, consisting of 300 hospitals and 2,600 non-hospital facilities, as of
December 31, 1998. These facilities are located in the Company's HMO Service
Area. Contracts with facilities are renewable annually.
HMO ARRANGEMENTS FOR OTHER SERVICES
The HMOs have contracted with a number of entities to arrange for the provision
of other services:
EMERGENCY CARE - Enrollees may receive urgent care services as an alternative to
hospital emergency room treatment. Enrollees can use local urgent care centers
and any hospital emergency room in emergency situations.
HOME HEALTH CARE - A number of medical care providers are engaged to provide
health care services (such as nursing, pediatric, neonatal, orthopedic,
psychiatric, geriatric, dialysis treatments, physical therapy, speech therapy
and respiratory therapy) at the home of the enrollee. MAMSI's home health care
subsidiary, HomeCall, Inc. ("HomeCall"), provides these services throughout much
of the Company's service area.
PHARMACEUTICAL ASSISTANCE - The Company has arrangements with participating
pharmacies so that an enrollee is only responsible for the deductibles and/or
copayments that are indicated on his or her enrollment card. The Company's
pharmaceutical subsidiary, HomeCall Pharmaceutical Services, Inc. provides home
infusion, delivery of drugs to physician offices and mail order prescription
services to its HMO and Indemnity members and other payors.
LABORATORY TESTING - The Company has an arrangement with a laboratory that
conducts much of the laboratory work required by HMO providers. Enrollees in
MAMSI's PPO's are similarly referred to this laboratory for testing.
DENTAL - The Company has several dental products available including a dental
indemnity product available from MAMSI Life, subcontracted capitated
arrangements with a dental HMO, and a discount dental services network through a
dental PPO.
QUALITY ASSESSMENT/IMPROVEMENT
MAMSI conducts a multidisciplinary approach to its Quality Assessment/Quality
Improvement ("QA/QI") Program, utilizing the resources of all of its
subsidiaries to ensure the provision of quality health care and services to its
HMO enrollees in an appropriate and cost-efficient manner.
MAMSI recognizes the importance of a Continuous Quality Improvement Program to
determine and allocate appropriate resources that will have the greatest impact
for members. The QA/QI Program is designed to meet and serve the needs of
employers, members and providers as well as to monitor the timeliness,
appropriateness and effectiveness of services via ongoing and systematic reviews
of key indicators and aspects of care. The QA/QI Program conducts member
satisfaction surveys, identifies opportunities for improvements in providing
care, adopts strategies to improve outcomes and monitors the improvement to
report progress.
9
MAMSI's QI Committee, which operates under the direction and oversight of
MAMSI's Board of Directors, includes administrative, clinical and provider
representation. The Committee evaluates numerous quality related issues and
outcomes measuring overall services provided to enrollees.
In addition, MAMSI utilizes several cost control and quality review mechanisms.
Provider applications are reviewed by a Credentials Committee in order to
determine whether the applicant meets MAMSI's criteria, including Board
Certification or eligibility.
MAMSI maintains a physician review process to determine whether the needed
levels of medical service are being provided in a timely and efficient manner.
The Company conducts medical reviews to monitor the quality of care provided.
The Company also monitors hospital and out- of-plan referrals issued by primary
care providers.
In most situations, prior authorization must be obtained for non-emergency
hospital admissions. Failure to secure prior authorization for non-emergency
hospital admissions of enrollees may cause claims to be denied, and in some
situations, providers may be sanctioned. Prior to admission for non-emergency
hospital services, MAMSI applies certain medical criteria to authorize the
admission.
After admission of an HMO enrollee, MAMSI monitors the course of hospital
treatment and coordinates discharge planning with the physician and hospital
utilization department. The Utilization Management staff is working with a
physician during the course of treatment. If the physician needs to extend an
enrollee's stay beyond the expected length of stay, the physician provides
medical justification for the necessity of such proposed action in order to
obtain specific approval.
The HMOs have established a grievance procedure to respond to enrollee and
provider complaints. Persons covered by HMOs are given a right to seek a fast
and fair review of adverse utilization review decisions, first internally by a
medical director of the HMO and then by an independent review organization or by
a State regulator. Enrollees are encouraged to use this procedure. There is a
similar grievance procedure for physician complaints.
In 1993, MAMSI invited the National Committee for Quality Assurance ("NCQA"), a
private, non-profit organization, to evaluate the Company's methodologies in an
effort to receive NCQA accreditation. NCQA accreditation is a voluntary process.
In the 1993 review, the Company did not meet certain of NCQA's criteria and,
therefore, did not receive NCQA accreditation. In response, MAMSI adopted
methodologies and programs designed to respond to concerns and questions raised
in NCQA's assessment. The Company requested the NCQA to perform another
accreditation review which took place in December of 1996. In May, 1997, NCQA
informed the Company that its flagship HMOs received one year accreditation. In
May, 1998 NCQA completed its most recent accreditation review and in September,
1998 NCQA informed the Company that M.D. IPA and OCI received full accreditation
through May, 2000. The Company has implemented the Health Plan and Employer Data
and Information Set ("HEDIS") 3.0 which represents a core set of performance
measures developed by NCQA to serve the employer as a purchaser. In addition, in
October, 1998 the Maryland Health Care Access and Cost Commission released the
results of Maryland's statewide HMO report card. MAMSI's Maryland HMOs exceeded
the state wide average in several key areas. In another survey of member
satisfaction taken by the U.S. Office of Personnel Management, federal employees
expressed satisfaction with the Company's federally qualified HMO which resulted
in M.D. IPA be designated as a "Top Rated Plan".
The Company's home health care, home infusion, and home hospice subsidiaries
underwent voluntary reaccreditation review by the Joint Commission on
Accreditation of Healthcare Organizations ("JCAHO") in November, 1998. Full
accreditation status was awarded as a result of this process.
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COMPETITION AND MARKETING STRATEGY
The health care industry is characterized by intense competition. MAMSI
recognizes the possibility that other entities with greater resources may enter
into competition with MAMSI in the future by either entering its HMO Service
Area or by designing alternative health care delivery systems. HMOs compete not
only with other HMOs and managed care organizations such as provider sponsored
organizations, but also with insurance companies that offer indemnity insurance
products.
MAMSI's HMOs compete with approximately 29 HMOs or other prepaid alternative
health care delivery systems that have a presence in MAMSI's significant service
areas (Maryland, Virginia, Delaware, District of Columbia, North Carolina and
West Virginia). The following table sets forth MAMSI's best estimate of 1998
enrollment of HMOs operating in its significant HMO Service Areas.
Approximate
Number
HMO Plan Type of Enrollees
- ------------- --------- ------------
AETNA/U.S. Healthcare***....................... IPA 822,000
Kaiser Permanente Health Plan ................. Group 675,000
Mid Atlantic Medical Services, Inc.* .......... IPA 562,000
FreeState Health Plan** ....................... IPA 407,000
United Healthcare ............................. IPA 325,000
Trigon ........................................ IPA 273,000
Health Source North Carolina................... IPA 244,000
Optima ........................................ IPA 222,000
Cigna Healthcare............................... IPA 216,000
Blue Cross/Blue Shield of North Carolina....... IPA 206,000
Partners Healthplan of North Carolina.......... IPA 185,000
Qualchoice of Virginia......................... IPA 107,000
* - Includes individuals covered by the Company's HMOs only.
** - This company is owned by Blue Cross/Blue Shield of Maryland.
*** - Includes NYLCARE and Prudential membership.
MAMSI's HMOs compete with other HMOs and insurance companies on the basis of
price, network and range of services offered to enrollees. PHP-MD competes with
the same entities and with other IPAs for physician services. PHP-MD believes
that its capitation payments to PCPs and the fee for service payments to
specialists are competitive with other HMOs. MAMSI believes that the freedom
IPA-model HMOs offer their enrollees in choosing from a greater number of
physicians constitutes a competitive advantage over group or staff model HMOs.
The ability to retain and attract enrollees will depend, in part, on how present
enrollees assess their benefit packages, quality of service, provider network,
rates and the HMOs' responsiveness to enrollee needs.
MAMSI subsidiaries employed approximately 383 full-time individuals who provide
marketing services for the Company's products as of December 31, 1998. MAMSI's
marketing strategy includes identifying and contacting employers in its HMO
Service Area. In addition, the Company employs prospecting, telemarketing,
employer group consultation, referrals by consultants, and the use of a minimum
number of selected brokers to acquire new accounts. Since 1994, the Company's
strategy has included reducing the use of brokers for new business while
increasing its internal sales force. New members acquired by the Company's
dedicated sales force accounted for 45 percent of total large group new members
and 98 percent of total small group new members in 1998.
11
RISK MANAGEMENT
With the exception of certain small group markets, OCI uses underwriting
criteria as a part of its risk management efforts. Underwriting is the process
of analyzing the risk of enrolling employer groups in order to establish an
appropriate premium rate. OCI's use of underwriting techniques is restricted in
certain situations by state small group reform legislation (see further
discussion under "Government Regulation").
The Company maintains professional, directors and officers, errors and
omissions, general liability and property insurance coverage in amounts believed
to be adequate. The Company requires participating hospitals to maintain
professional liability coverage and physicians to have malpractice insurance. A
professional liability insurance policy provides coverage in the event that
legal action is taken against any entity as a result of medical malpractice
committed by a physician.
In addition, MAMSI's HMOs reduce the financial impact of catastrophic losses by
maintaining reinsurance coverage for hospital costs. The reinsurer indemnifies
either 90% of the approved per diem or fixed charge per procedure, or 80% of the
eligible in and out of service area medical expenses in excess of $200,000 per
enrollee per year up to a lifetime maximum of $2,000,000 in eligible medical
costs.
GOVERNMENT REGULATION
MAMSI's HMOs are subject to state and, in some instances, Federal regulation.
Among the areas regulated are: (i) premium rate setting; (ii) benefits provided;
(iii) marketing; (iv) provider contracts; (v) quality assurance and utilization
review programs; (vi) adherence to confidentiality and medical records
requirements; (vii) enrollment requirements; and (viii) financial reserves and
other fiscal solvency requirements; (ix) appeals and grievances.
Under applicable law, HMOs must generally provide services to enrollees
substantially on a fixed, prepaid basis without regard to the actual degree of
utilization of services. The HMOs generally fix the premiums charged to
employers for a 12 month period and revises the premium with each renewal. In
setting premiums, the HMOs forecast health care utilization rates based on the
relevant demographics and also considers competitive conditions and the average
number of enrollees in the employer group. In addition to these premiums, HMO
enrollees also make copayments to providers as required.
Although premiums established may vary from account to account through composite
rate factors and special treatment of certain broad classes of enrollees,
Federal regulations generally prohibit Federally qualified HMOs from traditional
experience rating of accounts on a retrospective basis. Consistent with the
practices of other Federally qualified HMOs, M.D. IPA, in some situations, bases
the premiums it charges employers in part on the age, sex and geographic
location of the enrolled employees. M.D. IPA believes that its premiums are
competitive with other HMOs and health insurers and its health coverage is a
better value for members because of the range of physician and hospital
selection and other benefits provided.
M.D. IPA contracts with the Office of Personnel Management ("OPM") to provide or
arrange health services under the Federal Employee Health Benefit Program
("FEHBP"). The contract with OPM and applicable government regulations establish
premium rating requirements for the FEHBP. The premiums established under the
OPM contract are subject to periodic review and audit to determine if they were
established in compliance with the community rating and other requirements under
the program.
12
In September, 1998, a pretax charge of approximately $16.5 million was
recognized in the Company's financial statements in anticipation of negotiations
relating to potential governmental claims for contracts with OPM related to an
audit conducted by the Office of Inspector General concerning the Company's
participation in FEHBP for the years 1992-1997 related to findings for years
1992-1994. In the normal course of business, OPM audits health plans with which
it contracts to, among other things, verify that the premiums calculated and
charged to OPM are established in compliance with the best price 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
two to three years.
In addition to claims made by the OPM auditors as part of the normal audit
process, OPM may also refer their results to the United States Department of
Justice ("DOJ") for potential legal action under the False Claims Act. The DOJ
has the authority to file a claim under the False Claims Act if it believes that
the health plan knowingly overcharged the government or otherwise submitted
false documentation or certifications. In False Claims Act actions, the
government may impose trebled damages and a civil penalty of not less than
$5,000 nor more than $10,000 for each separate alleged false claim.
The Company intends to negotiate with OPM on all matters to attain a mutually
satisfactory result. There can be no assurance that these negotiations will be
concluded satisfactorily, that the audit will not be referred to the DOJ, or
that additional, possibly material, liability will be not be incurred. The
Company believes that any ultimate liability in excess of amounts accrued would
not materially affect the Company's consolidated financial position. However,
such liability could have a material affect on results of operations or cash
flows of a future period if resolved unfavorably.
MAMSI's HMOs must file periodic reports with, and are subject to periodic review
by, state regulatory authorities. Although MAMSI's HMOs are not regulated
specifically as insurance companies, they must comply with certain provisions of
state insurance laws as well as other laws specifically enacted to regulate
HMOs.
MAMSI Life, the Company's insurance subsidiary, is domiciled in Maryland and is
licensed in 31 states and the District of Columbia. MAMSI Life is subject to
regulation by the department of insurance in each state in which it is licensed.
These regulations subject MAMSI Life to extensive review of the terms,
administration and marketing of insurance products offered and minimum net worth
and deposit requirements. In addition, MAMSI Life is required to file periodic
reports and is subject to periodic audits and continuing oversight. The offering
of certain new insurance products may require the approval of regulatory
agencies.
The Company's home health care subsidiaries are regulated principally in four
areas: home health care licensing; certification for participation in private
insurance and government reimbursement programs; employee licensure and training
requirements; and Federal occupational safety guidelines. The Company believes
that it is in compliance with all applicable regulations, which include
possessing the required Certificates of Need in all locations in which such
certificates are required. Additionally, the Company's infusion and mail order
prescription businesses have obtained the necessary licenses and permits to
operate as a full service retail pharmacy.
13
MAMSI's customers include employee health benefit plans subject to the Employee
Retirement Income Security Act of 1974 ("ERISA"). To the extent that the Company
has discretionary authority in the operation of these plans, the Company could
be considered a plan fiduciary under ERISA. Plan fiduciaries are barred from
engaging in various prohibited transactions, including self-dealing. They are
also required to conduct the operations of employee benefit plans in accordance
with each plan's terms.
Due to the continued increase in health care costs and the inability of many
individuals to obtain health care insurance, numerous proposals relating to
health care reform have been made, and additional proposals may be introduced,
in the United States Congress and the legislatures of the states in which the
Company operates or may seek to operate.
In 1997, the "Health Insurance Portability and Accountability Act of 1996,
Public Law 104- 191", commonly called ("HIPAA"), was enacted. This bill
establishes certain Federal requirements for large group, small group, and
individual health benefit plans, and applies not only to insurers and HMOs but
also to ERISA plans.
HIPAA is intended to make coverage more portable and available by limiting
pre-existing condition requirements; providing special enrollment periods for
employees who lose other coverage or whose family status changes; prohibiting
group plans from denying an individual coverage or charging a higher premium
based on the individual's health status or history; and by guaranteeing coverage
availability and renewability in certain circumstances in the small group and
individual markets. HIPAA also allows for the establishment of Medical Savings
Accounts; increases the penalties for health care fraud and abuse; and calls for
standardized health care information in order to reduce administrative costs.
The effect of HIPAA differs from state to state. In the group market, state laws
remain in effect unless they prevent the application of the new federal
requirements, and in the individual market, state laws govern if the Health and
Human Services Secretary determines that they provide an "acceptable alternative
mechanism" to the federal requirement. This means that in those states, like
Maryland, where state reforms have already been enacted, the legislation has
little, if any, effect in the small group market, but may have some effect in
the individual market. In other states, the legislation has a greater effect.
Most of the provisions of HIPAA took effect on July 1, 1997, but some, like the
provisions pertaining to Medical Savings Accounts, took effect earlier and
others, like administrative simplification, took effect later.
In recent years, state legislatures in the HMO's service area and the U.S.
Congress have considered legislation, (1) to amend civil tort law so as to
extend "enterprise liability" to HMOs, and/or (2) to amend regulatory
requirements to establish additional rules governing HMO internal and external
appeals and grievances. Neither the Congress nor any state legislature in the
HMO's service area has enacted laws, which would expand an HMO's liability in
tort action.
States in the HMOs service area have enacted laws regarding internal and
external appeals and grievances. Under these laws, persons covered by HMOs are
given a right to seek a fast and fair review of adverse utilization review
decisions, first internally by a medical director of the HMO and then by an
independent review organization or by a State regulator. Maryland, North
Carolina and Pennsylvania have enacted laws, which became effective January 1,
1999 or earlier in 1998, and which require HMOs to have an appeals and grievance
process meeting certain requirements and to submit adverse decisions to
independent outside review in certain circumstances. The District of Columbia is
expected to enact similar legislation, which would become effective on January
1, 2000.
14
The District of Columbia, which has not previously regulated HMOs, enacted
legislation effective July 1, 1997, providing for regulatory oversight similar
to that currently provided by other states.
The Company believes that the current political environment in which it operates
will result in continued legislative scrutiny of health care reform and may lead
to additional legislative initiatives. The Company is unable to predict the
ultimate impact on the Company of any Federal or state restructuring of the
health care delivery or health care financing systems, but such changes could
have a material adverse impact on the operations and financial condition of the
Company.
PREFERRED PROVIDER ORGANIZATIONS
MAMSI offers PPO coverage through two subsidiaries: Alliance PPO, LLC
("Alliance") and Mid Atlantic Psychiatric Services, Inc. ("MAPSI").
PPOs allow enrollees to receive care from participating physicians at
contractually negotiated rates. A PPO is different from an HMO in that a PPO
does not assume any financial risk from medical utilization nor does it
typically process claims payments to providers. All medical charges are paid
directly by the payor, which can be a self-funded employer, a third party
administrator, a health benefits trust fund or another health insurance company.
In return for access to the PPO's network, the PPO charges the payor either a
per employee rate or a percentage of the savings of actual claims processed for
the services accessed. MAMSI's PPOs provide access to substantially the same
provider network as MAMSI's HMOs.
A PPO operates by being incorporated into an employer's current benefit program,
and offers some or all of the following: access to physician, hospital and
facility services; utilization management and claims screening and repricing.
The employer determines the level of the benefits and any applicable copayments.
Alliance is marketed primarily to and through insurance companies, insurance
brokers, consultants, third party administrators ("TPAs"), self-insured
employers and union health and benefit trusts. The advantages of a TPA marketing
approach are minimized marketing costs and maximized market coverage through
established TPA-employer relationships. Alliance also works directly with
employers and unions that are self-insured and uses direct marketing efforts.
The major competition comes from other PPOs and individual insurance carriers.
At
December 31, 1998, Alliance had contracts with approximately 31,700 employer
groups that had access to an entire PHP-MD provider network.
The MAPSI PPO is comprised of providers specializing in mental health and
substance abuse care. MAPSI's products are marketed directly to TPAs,
self-insured groups, brokers, indemnity plans, union funds and consultants. In
addition, MAPSI contracts with indemnity insurers that want to offer groups a
managed care mental health product. MAPSI believes it has a competitive
advantage with its unique mental health screening process that offers the
employer the benefit of enhanced coordinated treatment for employees as well as
increased cost savings. MAPSI's major competitors include Merit Behavioral
Health, Inc., Green Spring Mental Health and MCC Inc. At December 31, 1998,
MAPSI had a provider network of approximately 4,000 psychiatrists,
psychologists, social workers, and other affiliated licensed mental health
providers.
Alliance and MAPSI are most often marketed jointly and the prospective purchaser
may also purchase the MAPSI PPO if the Alliance PPO is purchased. A total of
approximately 1,060,000 lives were covered under one or both of these PPO
products as of December 31, 1998.
15
PPOs are not subject to HMO regulations by virtue of their business. However,
PPOs are subject to certain state regulations governing the provision of PPO
services such as mandatory state registration. It is possible that PPOs may be
subject to increased regulatory oversight in the future.
OTHER PRODUCTS
MAMSI Life currently underwrites the indemnity coverage of the HMOs preferred
plans, except OCCI, in addition to offering stand-alone indemnity health and
dental insurance, aggregate and specific stop loss insurance for self-insured
groups, and group life, accidental death and short-term disability policies. In
addition, in 1995 MAMSI Life began providing an administrative services only
("ASO") product to the State of Maryland. ASO business consists of allowing
access to MAMSI's provider network, without gatekeeper PCPs, and the payment of
claims. MAMSI has no insurance risk on this product. MAMSI Life holds insurance
licenses in 31 states and the District of Columbia including Maryland, Virginia,
West Virginia, Delaware and North Carolina. MAMSI Life also became licensed in
Pennsylvania in 1995.
In October, 1994, MAMSI acquired all of the outstanding stock of HomeCall and
its wholly owned subsidiary, FirstCall, Inc. ("FirstCall"), for approximately
$10 million, including direct expenses. HomeCall is a state licensed, Medicare
certified home health agency. The combined operations of HomeCall and FirstCall
include 17 branch locations that serve virtually all of Maryland, the District
of Columbia, Northern Virginia and the Panhandle area of West Virginia. HomeCall
achieved full accreditation from the Joint Commission of Accreditation of
Healthcare Organizations ("JCAHO"), following its survey of all services in
November, 1995. The Company achieved reaccreditation in November, 1998.
Also during 1994, the Company formed a home infusion services company, HomeCall
Pharmaceutical Services, Inc. ("HCPS"), which received its pharmacy license in
1994, its Federal license from the Drug Enforcement Agency in 1995, and JCAHO
accreditation in 1995 and 1998 for its infusion services.
HomeCall, FirstCall and HCPS provide services that are generally lower cost
alternatives to institutional treatment and care. The Company believes that it
can provide better care to its members and reduce its medical costs by
substituting, where medically appropriate, in- home medical treatment for
treatment in an institutional setting.
Medical services provided by HomeCall, FirstCall and HCPS include skilled
nursing, advanced nursing in support of infusion therapy, maternal/infant
nursing, physical, speech and occupational therapy, medical social work,
nutrition consultation and home health care aides. Services provided by HCPS
include a comprehensive range of in home drug infusion therapies, the delivery
of infusion ready drugs for physician office based infusion therapy, mail order
pharmacy (as described below) and some hospice (as described below).
In April, 1996, HCPS started a mail-order pharmacy, HomeCall Mail Rx, which
received its pharmacy license and its Federal license in 1996. HomeCall Mail Rx
fills and delivers prescription oral medications via common carrier to patients
in their homes. Approximately 13,500 prescriptions are filled each month.
In November, 1996, the Company started HomeCall Hospice Services, Inc.
("Hospice"), which received its Maryland state license to operate a general
hospice care program on December 3, 1996 and its Virginia hospice license on
June 26, 1998. Based in Columbia, Maryland, Hospice was organized to address the
needs of terminally ill patients and their families. The hospice program
provides services to individuals in the comfort of their homes. Hospice
underwent a voluntary accreditation review by JCAHO in November, 1998 and
received full accreditation.
16
Hospice currently serves the Baltimore, Washington, D.C. and Northern Virginia
metropolitan areas. It is the goal of Hospice to extend its service delivery
area to all geographical areas served by MAMSI. The addition of hospice services
complements MAMSI's other home care products by having a full range of services
available to its members.
In addition to providing in-home medical care to the Company's members,
HomeCall, FirstCall, Hospice and HCPS will continue to provide services to other
payors, including insurance companies, other HMOs and individuals.
The Company also has an equity interest in an ambulatory surgery center located
in Rockville, Maryland. The surgery center conducts outpatient surgery and
services to HMO enrollees and other patients.
A summary of MAMSI's membership enrollment in all product lines is as follows:
MEMBERSHIP DATA AT DECEMBER 31
---------------------------------
PRODUCT LINE 1996 1997 1998
- ------------ ---------------------------------
(in thousands)
Commercial HMO (1) 430.8 389.1 424.9
Hybrid HMO (2) 106.7 103.5 99.4
Medicaid 82.5 34.0 30.9
Medicare 14.4 11.2 7.0
Indemnity 99.2 132.7 157.5
ASO (3) 11.0 11.0 11.0
------- ------- -------
744.6 681.5 730.7
PPO (4) 935.0 1,006.0 1,060.0
------- ------- -------
Total Membership 1,679.6 1,687.5 1,790.7
======= ======= ========
(1) Commercial HMO includes traditional HMO and point-of-service members.
(2) Hybrid HMO includes any business that uses MAMSI's network and gatekeeper
PCPs, utilization management services, claims adjudication and payment services
and that has a self-funded component. Generally, these products include specific
and/or aggregate stop loss provisions.
(3) ASO includes administrative services only business without gatekeeper PCPs
and no assumption of insurance risk by any MAMSI affiliate.
(4) PPO includes all business whereby access is granted to MAMSI's provider
network. MAMSI assumes no insurance risk and does not provide claims payment
services on this business.
INVESTMENTS
The majority of the Company's investments are held by its state regulated
subsidiaries to provide capital for those subsidiaries' operations and to
satisfy capital, surplus and deposit requirements of the HMO and insurance laws
of the various states in which the Company is licensed. HMO and insurance laws
generally protect consumers of insurance products with one of the principal
focuses being on financial solvency of the companies that underwrite insurance
risk. These laws and regulations limit the types of investments that can be made
by the regulated entities with appropriate investments being deemed "admitted
assets." Admitted assets are those assets that can be used to fulfill capital
and surplus requirements. The Company's current investment policy generally
prohibits investments that would be "non-admitted" for statutory reporting
purposes. The Company has no investments in derivative financial instruments and
has no current intention of owning such investments.
17
EMPLOYEES
As of December 31, 1998, the Company had a total of 2,674 employees, including
2,293 full-time and 381 part-time employees. MAMSI's home health care subsidiary
employed 607 of these employees (400 on a full-time basis and 207 on a part-time
basis). None of the Company's employees are covered by a collective bargaining
agreement and the Company has not experienced any work stoppage since its
inception.
SEGMENT INFORMATION
Segment information is included in Item 8 "Financial Statements and
Supplementary Data" on pages 49 thru 50.
ITEM 2. PROPERTIES
The Company owns five office buildings. These buildings are located in Rockville
and Frederick, Maryland and total approximately 321,000 square feet of office
and warehouse space. The Company's headquarters is located at 4 Taft Court,
Rockville, Maryland 20850.
In addition, the Company leases approximately 212,000 square feet of office
space and approximately 5,200 square feet of warehouse space in various
locations within its service areas to support sales and administrative
operations.
ITEM 3. LEGAL PROCEEDINGS
The Company has been named as the defendant in a suit filed by certain medical
providers on March 26, 1997 in the Circuit Court for Anne Arundel County,
Maryland, which alleges that the Company improperly reduced payments to
participating providers in the form of "withhold". It is the plaintiffs'
allegation that certain payments should not have been reduced in this manner and
seek unspecified damages. This matter has been filed as a class action against
the Company. On August 18, 1997, the court stayed further proceedings in the
litigation pending plaintiff's pursuit of arbitration as provided for under the
contract. The parties are in active arbitration proceedings at this time.
Management believes that the ultimate outcome of this matter will not have a
material adverse effect on the Company's financial statements.
On December 2, 1998, a minority of the MAMSI Board of Directors filed a lawsuit
in the Delaware Court of Chancery against George Jochum, CEO, President and
Chairman of the Board, and the Company. The suit concerns an evenly divided
Board of Directors' vote concerning Mr. Jochum's continued tenure. There was a
dispute as to whether the Board of Directors' vote operates to terminate Mr.
Jochum's employment. The suit sought removal of Mr. Jochum from his position
with the Company and expedited prosecution temporarily restraining Mr. Jochum
from conducting all but the most ministerial of actions and enjoining any change
in the composition of the Board of Directors and restitution from Mr. Jochum to
the Company for any damages. A trial date on the merit of the case was scheduled
for February 4, 1999. On January 8, 1999 the complaint was dismissed and Mr.
Jochum resigned as Chairman, CEO and President.
During the quarter ended March 31, 1998, the Company became involved in a
dispute with the Maryland Insurance Administration ("MIA") concerning the
construction and application of Section 15-1008 of the Maryland Insurance
Article. The law limits the time within which a carrier may retroactively
collect money owed by providers to the carrier by using the device of offsetting
future payments to providers with the amount owed by the provider to the
carrier. The law does not affect the right of carriers to otherwise recover
monies owed. The Company construed the law to be applicable to claims paid on or
after October 1, 1997. The MIA construed the law to apply to retroactive
adjustments made on or after October 1, 1997 and the MIA has ordered the Company
to abide by its construction of the law. The Company has not yet decided whether
to appeal. Management believes that the ultimate outcome
18
of this matter will not have a material adverse effect on the Company's
financial statements as the MIA's current position affects the method of
collection of the claims reversals, rather than the Company's legal right to the
refunds.
On February 18, 1999, certain providers filed a class action lawsuit in the
Circuit Court for Anne Arundel County, Maryland concerning the construction and
application of Section 15-1008 of the Maryland Insurance Article. The complaint
requests an accounting of claims' payments, injunctive relief and punitive
damages. Management believes that the ultimate outcome of this matter will not
have a material adverse effect on the Company's financial statements as the
MIA's current position affects the method of collection of the claims reversals,
rather than the Company's legal right to the refunds.
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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted for shareholder vote in the fourth quarter of
1998.
19
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is currently listed on The New York Stock Exchange,
Inc. ("NYSE") under the trading symbol MME. The following table sets forth for
the indicated periods the high and low reported sale prices of the common stock
as furnished by the NYSE.
1998 1997
----------------- -----------------
HIGH LOW HIGH LOW
----------------- -----------------
First Quarter $13.88 $ 9.25 $15.25 $10.75
Second Quarter 13.88 11.50 15.56 10.25
Third Quarter 11.19 5.00 17.00 13.88
Fourth Quarter 10.69 4.44 16.75 10.81
The Company has never paid any cash dividends on its common stock and presently
anticipates that no cash dividends will be declared in the foreseeable future.
Any dividends will depend on future earnings, the financial condition of the
Company and regulatory requirements. See Note 13 to the Consolidated Financial
Statements.
As of March 4, 1999, there were approximately 775 stockholders of record of the
Company's common stock.
20
ITEM 6. SELECTED FINANCIAL DATA
Year Ended December 31,
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
(in thousands except share amounts, key ratios and operating data)
SELECTED INCOME STATEMENT DATA
Revenue $1,187,901 $1,111,653 $1,133,742 $ 954,907 $ 749,898
Expense 1,175,665 1,090,213 1,138,677 858,567 663,343
Income (loss) before income taxes 12,236 21,440 (4,935) 96,340 86,555
Net income (loss) 9,045 14,489 (2,768) 61,124 54,530
Earnings (loss) per common share (1):
Basic $0.20 $0.31 ($0.06) $1.33 $1.21
Diluted $0.20 $0.31 ($0.06) $1.28 $1.15
Weighted Average Shares
Basic 45,407,006 46,273,484 45,978,864 46,127,112 45,030,113
Diluted 45,473,995 46,885,666 45,978,864 47,908,379 47,370,211
Dividends --- --- --- --- ---
SELECTED BALANCE SHEET DATA (AT DECEMBER 31)
Working capital $ 123,138 $ 128,065 $ 118,870 $ 153,668 $ 91,983
Total assets 362,775 345,959 334,719 354,182 268,522
Long-term debt 14 74 134 194 5,331
Stockholders' equity 191,218 208,307 184,400 217,216 141,326
Cash dividends per common share (2) --- --- --- --- ---
KEY RATIOS
Medical loss ratio 88.8% 89.4% 92.4% 81.9% 80.8%
Administrative expense ratio 11.3% 11.7% 10.7% 10.5% 9.4%
Net income margin 0.8% 1.3% (.2%) 6.4% 7.3%
OPERATING DATA
Annualized hospital days per
1,000 enrollees:
All products and health services (4) 265 297 331 313 312
HMO only (3) 191 192 203 222 238
Medicare (4) 2,425 2,566 2,698 2,531 ---
Medicaid (4) 375 552 454 405 466
Annualized hospital admissions per
1,000 enrollees (4) 72 78 77 80 76
HMO, hybrid, ASO and indemnity
health enrollees at year end 731,000 682,000 745,000 658,000 508,000
PPO enrollees at year end 1,060,000 1,006,000 935,000 825,000 698,000
Participating providers at year end 33,600 28,400 24,300 21,077 16,950
Notes
1. Earnings (loss) per common share have been adjusted to reflect stock
dividends on a retroactive basis and to reflect adoption of Financial Accounting
Standards No. 128. All previously reported earnings per share amounts have been
restated to reflect the adoption of this statement. See Note 1 to the
Consolidated Financial Statements.
2. MAMSI has not declared or paid cash dividends on its common stock.
3. Days are presented exclusive of skilled nursing, neonatal intensive care and
psychiatric inpatient care.
4. Days include acute and non-acute, skilled nursing, neonatal intensive care
and psychiatric inpatient care.
21
ITEM 7. 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 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 market
place.
2. The possibility of state budget related mandates that reduce premiums for
Medicaid recipients.
3. The potential for increased medical expenses due to: - Increased utilization
by the Company's membership. - Inflation in provider and pharmaceutical
costs.
- Federal or state mandates that increase benefits or limit the Company's
oversight ability.
4. The possibility that the Company is not able to expand its service territory
as planned due to regulatory delays and/or inability to contract with
appropriate providers.
5. The possibility that the Company is not able to increase its market share at
the anticipated premium rates.
6. The possibility that one of the Company's vendors will experience year 2000
problems that disrupt the Company's operating or administrative systems.
GENERAL
During the three year period ended December 31, 1998, the Company experienced
modest membership expansion. While membership in certain products continues to
grow, others have shown decreases when compared with 1997. The Company has
achieved its overall size by continually expanding its product lines which
include point-of-service, small group, indemnity health, hybrid products,
Medicaid and Medicare, group term-life and through expansion into new geographic
markets. Premium rates during this time have remained at or near competitive
levels for the Company's marketplace. During 1998, after consideration of
non-recurring adjustments, the Company's consolidated operating margin showed
increased profits over 1997. The Company achieved 1998's results, in part, by
implementing product price increases and reducing membership in products or
effectively terminating groups that had the potential for continued
unprofitability. The Company anticipates that it will continue to increase
premium rates during 1999. This is a forward-looking statement. See
"Forward-Looking Information" above for a description of those risk factors.
The Company generally receives a fixed premium amount per member per month while
the majority of medical expenses are variable and significantly affected by
spontaneous member utilization. Even with managed care controls, unusual medical
conditions can occur, such as an outbreak of influenza or a higher than normal
incidence of high cost cases (such as premature births, complex surgeries, or
rare diseases). As a result, the Company's quarterly results can be materially
affected and irregular. However, over the longer business cycle, the Company
believes that its managed care control systems, underwriting procedures (when
allowed) and network of providers should result in continued profitability.
22
Due to the continued escalation of health care costs and the inability of many
individuals to obtain health care insurance, numerous proposals relating to
health care reform have been made and put into effect, and additional proposals
may be introduced, in the United States Congress and the legislatures of the
states in which the Company operates or may seek to operate.
In 1997, the "Health Insurance Portability and Accountability Act of 1996,
Public Law 104- 191", commonly called ("HIPAA"), was enacted. This bill
establishes certain Federal requirements for large group, small group, and
individual health benefit plans, and applies not only to insurers and HMOs but
also to ERISA plans.
HIPAA is intended to make coverage more portable and available by limiting
pre-existing condition requirements; providing special enrollment periods for
employees who lose other coverage or whose family status changes; prohibiting
group plans from denying an individual coverage or charging a higher premium
based on the individual's health status or history; and by guaranteeing coverage
availability and renewability in certain circumstances in the small group and
individual markets. HIPAA also allows for the establishment of Medical Savings
Accounts; increases the penalties for health care fraud and abuse; and calls for
standardized health care information in order to reduce administrative costs.
The effect of HIPAA differs from state to state. In the group market, state laws
remain in effect unless they prevent the application of the new federal
requirements, and in the individual market, state laws govern if the Health and
Human Services Secretary determines that they provide an "acceptable alternative
mechanism" to the federal requirement. This means that in those states, like
Maryland, where state reforms have already been enacted, the legislation has
little, if any, effect in the small group market, but may have some effect in
the individual market. In other states, the legislation has a greater effect.
Most of the provisions of HIPAA took effect on July 1, 1997, but some, like the
provisions pertaining to Medical Savings Accounts, took effect earlier and
others, like administrative simplification, took effect later.
In recent years, state legislatures in the HMOs service area and the U.S.
Congress have considered legislation, (1) to amend civil tort law so as to
extend "enterprise liability" to HMOs, and/or (2) to amend regulatory
requirements to establish additional rules governing HMO internal and external
appeals and grievances. Neither the Congress nor any state legislature in the
HMOs service area has enacted laws, which would expand an HMO's liability in
tort action.
States in the HMOs service area have enacted laws regarding internal and
external appeals and grievances. Under these laws, persons covered by HMOs are
given a right to seek a fast and fair review of adverse utilization review
decisions, first internally by a medical director of the HMO and then by an
independent review organization or by a State regulator. Maryland, North
Carolina and Pennsylvania have enacted laws, which became effective January 1,
1999 or earlier in 1998, and which require HMOs to have an appeals and grievance
process meeting certain requirements and to submit adverse decisions to
independent outside review in certain circumstances. The District of Columbia is
expected to enact similar legislation, which would become effective on January
1, 2000.
The District of Columbia, which has not previously regulated HMOs, enacted
legislation effective July 1, 1997, providing for regulatory oversight similar
to that currently provided by other states.
23
The Company believes that the current political environment in which it operates
will result in continued legislative scrutiny of health care reform and may lead
to additional legislative initiatives. The Company is unable to predict the
ultimate impact on the Company of any Federal or state restructuring of the
health care delivery or health care financing systems, but such changes could
have a material adverse impact on the operations and financial condition of the
Company.
- -----------------------------------------------------------------------------
THE YEAR ENDED DECEMBER 31, 1998 COMPARED TO THE YEAR ENDED DECEMBER 31, 1997
- -----------------------------------------------------------------------------
RESULTS OF OPERATIONS
Consolidated net income of the Company was $9,045,000 and $14,489,000 in 1998
and 1997, respectively. Diluted earnings per share was $.20 in 1998 as compared
to $.31 in 1997. This decrease in earnings is primarily attributable to a
$16,500,000 non-recurring item related to the results of an audit conducted in
connection with the Company's participation in the Federal Employee Health
Benefit Program. The audit covered the periods 1992 - 1997 with the audit
findings related to years 1992 - 1994. There were no findings for years 1995 -
1997.
The Company has priced its health products competitively in order to increase
its membership base and thereby enhance its strategic position in its market
place. 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.)
Revenue for the year ended December 31, 1998 increased approximately $76.2
million or 6.9 percent over the year ended December 31, 1997. Revenue for year
ended December 31, 1998 includes $5.7 million related to the sale of certain
Company owned real estate no longer required in its operations. Excluding these
sales, year-over-year revenue increased 6.4 percent. A 2 percent increase in net
average HMO and indemnity enrollment resulted in an increase of approximately
$21.2 million in health premium revenue while a 4.8 percent increase in average
monthly premium per enrollee, combined for all products, resulted in a $51.1
million increase in health premium revenue. The increase in HMO and indemnity
enrollment is principally due to increases in the Company's commercial
membership. Management believes that commercial health premiums should continue
to increase over the next twelve months as the Company continues to increase its
commercial membership and as new and renewing groups are charged higher premium
rates due to legislatively mandated benefit enhancements and general price
increases initiated by the Company. 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 cannot be initiated until a contract reaches its
renewal date. Therefore, price increases cannot be made across the Company's
membership at the same time. Commercial premium rate increases are expected to
continue in 1999 in the range of 6% to 8%. Management believes that these rate
increases may have the effect of slowing the Company's future membership growth.
In addition, management reevaluated premium reimbursement rates with regard to
its Medicare and Medicaid programs. Specifically, effective January 1, 1998, the
Company withdrew from participation in certain areas of the Virginia Medicaid
program. On January 1, 1998, the Company also modified certain benefits for
enrollees in its Medicare program and began to charge additional premiums in
certain areas.
24
In the third quarter of 1998, three HMOs with large Medicare membership in the
Mid-Atlantic area announced that effective January 1, 1999 they would not
continue their Medicare risk contract with the Health Care Financing
Administration ("HCFA"). In response to the Company's perception of increased
risk related to these HMOs' departure, the Company requested a change to its
already filed rates which were to be effective January 1, 1999. HCFA responded
that they would not allow the Company to change its filed rates. Based on HCFA's
response, the Company terminated its Medicare contract effective January 1,
1999. At December 31, 1998 the Company had approximately 7,000 Medicare Risk
members.
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, increased competition in the Company's service
area and changes in state mandated enrollment in Medicaid HMO programs in which
the Company participates. Enrollment may also decrease if the Company determines
that premium reimbursement rates related to certain state Medicaid programs are
inadequate, which would cause the Company to voluntarily withdraw from
participation.
Fee and other income increased from $18.4 million in 1997 to $20.5 million in
1998, principally due to increased membership in the Company's PPO product.
Revenue from life and short-term disability products contributed $6.9 million in
revenue in 1998 as compared with $5.3 in 1997. The increase is mainly due to the
products' continued popularity with customers looking for one carrier to provide
all of their employee benefit needs.
Service revenue from non-MAMSI affiliated entities earned by the Company's home
health care subsidiaries decreased and contributed approximately $20.0 million
in revenue in 1998 as compared with $21.0 million in 1997. This decrease is due
to an increasing volume of business conducted for MAMSI HMO and indemnity
members which is eliminated in consolidation.
In the third quarter of 1998, the National Committee for Quality Assurance
("NCQA") announced that OCI and M.D. IPA received three year, full
accreditation. Full accreditation is granted to those plans that have excellent
programs for continuous quality improvement and meet NCQA's rigorous standards.
Medical expenses as a percentage of health premium revenue ("medical loss
ratio") decreased to 88.8 percent for 1998 compared to 89.4 percent for 1997. On
a per member, per month basis, medical expenses increased 4.0 percent. Included
in the year ended December 31, 1997 are the results of the Company's
identification of certain claims which were overpaid. These overpayments were
caused, in large part, by a combination of factors including the ever increasing
complexity of the claims paying process as well as providers enhancing their
ability to maximize charges. In connection with these overpayments, during 1997
the Company recorded, as a reduction of medical expenses, approximately $12
million relating to claims paid in 1996. The Company believes that it has taken
the appropriate action and implemented the appropriate controls to insure that
future claims are paid at the appropriate amount. These initiatives should help
to control the Company's medical loss ratio. The statements in this paragraph
and the preceding paragraphs regarding cost containment initiatives, total
medical costs and future increases in health premiums 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 loss ratio.
25
Administrative expenses as a percentage of revenue ("administrative expense
ratio") decreased to 11.3 percent for 1998 as compared to 11.7 in 1997. Adjusted
to exclude the effect of the $5.7 million gain on sale of real estate, the
administrative expense ratio was 11.4 percent for 1998. Management believes that
the administrative expense ratio will likely remain near the current level of
11.4 percent in 1999. 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, development of the
Company's expansion areas and increased administrative activity related to
business volume.
M.D. IPA contracts with the Office of Personnel Management ("OPM") to provide or
arrange health services under the Federal Employee Health Benefit Program
("FEHBP"). The contract with OPM and applicable government regulations establish
premium rating requirements for the FEHBP. The premiums established under the
OPM contract are subject to periodic review and audit to determine if they were
established in compliance with the community rating and other requirements under
the program.
In September, 1998, a pretax charge of approximately $16.5 million was
recognized in the Company's financial statements in anticipation of negotiations
relating to potential governmental claims for contracts with OPM related to an
audit conducted by the Office of Inspector General concerning the Company's
participation in FEHBP for the years 1992-1997 related to findings for
1992-1994. 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 price 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
two to three years.
In addition to claims made by the OPM auditors as part of the normal audit
process, OPM may also refer their results to the United States Department of
Justice ("DOJ") for potential legal action under the False Claims Act. The DOJ
has the authority to file a claim under the False Claims Act if it believes that
the health plan knowingly overcharged the government or otherwise submitted
false documentation or certifications. In False Claims Act actions, the
government may impose trebled damages and a civil penalty of not less than
$5,000 nor more than $10,000 for each separate alleged false claim.
The Company intends to negotiate with OPM on all matters to attain a mutually
satisfactory result. There can be no assurance that these negotiations will be
concluded satisfactorily, that the audit will not be referred to the DOJ, or
that additional, possibly material, liability will be not be incurred. The
Company believes that any ultimate liability in excess of amounts accrued would
not materially affect the Company's consolidated financial position. However,
such liability could have a material effect on results of operations or cash
flows of a future period if resolved unfavorably.
Also reflected in the Company's 1998 results is a $4.8 million write down of
certain computer and computer related assets that the Company had identified as
being no longer of use and which were discarded or sold.
Investment income decreased $4.4 million due to a decrease in realized gains on
sales of marketable equity securities of $5.3 million offset by an increase in
interest income due to higher investable balances.
Income tax expense as a percent of pretax income decreased from 32.4 percent in
1997 to 26.1 percent in 1998, in large part due to the relative increase of tax
exempt interest income as a percent of pretax income.
26
The net margin rate decreased from 1.3 percent in 1997 to .8 percent in 1998.
This decrease is primarily due to the non-recurring item related to the
Company's participation in the FEHBP.
- -----------------------------------------------------------------------------
THE YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE YEAR ENDED DECEMBER 31, 1996
- -----------------------------------------------------------------------------
RESULTS OF OPERATIONS
Consolidated net income (loss) of the Company was $14,489,000 and $(2,768,000)
in 1997 and 1996, respectively. Diluted net earnings (loss) per share was $.31
in 1997 as compared to $(.06) in 1996. The increase in earnings is primarily
attributable to a decrease in the medical loss ratio for commercial products.
The medical loss ratio decreased primarily due to increased efforts by the
Company to control medical costs.
Revenue for the year ended December 31, 1997 decreased approximately $22.1
million or 2.0 percent over the year ended December 31, 1996. A 4.4 percent
decrease in net average HMO and indemnity enrollment resulted in a decrease of
approximately $47.5 million in health premium revenue while a 2.0 percent
increase in the average monthly premium per enrollee combined for all products
resulted in a $20.2 million increase in health premium revenue.
Service revenue from non-MAMSI affiliated entities earned by the Company's home
health care subsidiaries contributed $21.0 million in revenue in 1997 as
compared to $20.5 million for 1996. This increase is the result of increasing
business volume for these subsidiaries, particularly in the home infusion area,
which is largely offset by an increasing relative percentage of business
conducted for MAMSI HMO and indemnity members which is eliminated in
consolidation. Revenue from life and short-term disability products contributed
$5.3 million in 1997 as compared to $3.2 million in 1996.
Medical expenses as a percentage of health premium revenue ("medical loss
ratio") decreased to 89.4 percent in 1997 as compared to 92.4 percent for 1996
and, on a per member per month basis, medical expenses decreased 1.4 percent.
This decrease is due to a combination of factors including continuing efforts by
the Company to implement product specific cost containment controls, expanded
activity in specialized subrogation areas and claims review for dual health
coverage, the adoption of regionalized and product specific fee maximums for
specialists from the delivery network following a continuing intensified peer
review analysis. In addition, during 1997, the Company identified certain claims
which had been overpaid and recorded as a reduction of medical expenses
approximately $12 million relating to claims incurred and paid in 1996.
The administrative expense ratio for 1997 increased to 11.7 percent from 10.7
percent in 1996. This increase is due primarily to increased salaries and
expenses in certain administrative areas of the Company, including utilization
management claims audit and customer service departments, as well as reduced
revenue in 1997.
The net margin rate increased from (.2) percent in 1996 to 1.3 percent in 1997.
This increase is primarily due to the decrease in the medical loss ratio.
LIQUIDITY AND CAPITAL RESOURCES
The Company's business is not capital intensive and the majority of the
Company's expenses are payments to health care providers, 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 be sufficient in the
future.
27
Accounts receivable decreased from $87.9 million at December 31, 1997 to $79.3
million at December 31, 1998. This decrease is primarily due to a reduction in
amounts due from the Federal government and a reduction in receivables from
customers offset somewhat by increased medical recoverables.
Prepaid expenses, advances and other current assets increased from $19.3 million
at December 31, 1997 to $27.0 million at December 31, 1998, principally due to
an increase in income taxes receivable and an increase in hospital working
capital advances.
Property and equipment decreased from $57.0 million at December 31, 1997 to
$45.0 million at December 31, 1998 due to the sale of two office buildings no
longer required in the Company's operations and the disposal of certain computer
equipment no longer needed.
Short-term investments are marked to market at the end of every quarter and the
resulting unrealized gain or loss is reflected in the ending stockholders'
equity balance. Accordingly, stockholders' equity at December 31, 1998 reflects
an unrealized gain of $1.3 million, net of tax, on the Company's short-term
investments.
Medical claims payable increased from $98.3 million at December 31, 1997 to
$129.3 million at December 31, 1998 primarily due to increased membership and
increased medical expense per member.
Additional paid-in capital decreased from $162.9 million at December 31, 1997 to
$138.2 million at December 31, 1998, principally due to activity in the
Company's stock compensation trust. This trust is used to provide shares of the
Company's stock to meet its stock option plan obligations.
Treasury stock increased from $41.2 million at December 31, 1997 to $75.6
million at December 31, 1998 due to the purchase of approximately 5 million
additional shares by the Company.
Deferred tax assets are recognized for deductible temporary differences that, in
management's opinion, are more likely than not to be realized in the current or
future periods. The Company's history of operating revenue and income growth,
and expectation of future operating income, provides strong positive evidence
that these deferred tax assets will be realized. A valuation allowance has been
recorded for net operating loss carryforwards generated by certain subsidiaries
that are not deductible on the Company's consolidated tax return. Management
intends to continue to monitor the realizability of deferred tax assets in light
of future circumstances and assess the reasonableness of the valuation
allowance.
The Company currently has access to total revolving credit facilities of $29.0
million, which is used to provide short-term capital resources for routine cash
flow fluctuations. At December 31, 1998, approximately $1.9 million was drawn
against these facilities. In addition, the Company maintains a $12 million
letter of credit for the benefit of the North Carolina Insurance Department in
support of operations of MAMSI Life and Health Company and a $300,000 letter of
credit for the Company's home health subsidiary. While no amounts have been
drawn against these letters of credit, they are a reduction of the Company's
credit line availability.
28
Following is a schedule of the short-term capital resources available to the
Company:
December 31
(in thousands) 1998 1997
--------------------
Cash and cash equivalents $ 9,787 $ 3,570
Short-term investments 174,325 152,080
Working capital advances to Maryland hospitals 12,261 9,186
-------- --------
Total available liquid assets 196,373 164,836
Credit line availability 14,855 21,526
-------- --------
Total short-term capital resources $211,228 186,362
======== ========
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 sold an office building in April, 1998 at a
price of approximately $3 million. In July, 1998, the Company sold another of
its office buildings for approximately $9.4 million. The Company's purchase of
an approximately 208,000 square foot office building in Frederick, Maryland in
1997, and the resulting consolidation of its service departments in this new
facility, made the previously owned buildings unnecessary for the Company's
operations.
In 1997, the Company began the process of identifying, evaluating and
implementing changes to computer programs necessary to address the year 2000
issue ("Y2K"). This issue affects computer systems that have time-sensitive
programs that may not properly recognize the year 2000. This could result in
major system failures or miscalculations. The Company is currently addressing
its internal year 2000 issue with modifications to existing programs. As a part
of the Company's initial assessment, 1,300 software programs were identified for
Y2K review. Of those 1,300, 182 programs were identified as needing modification
of which 145 were modified and 37 were determined to be obsolete. To date, the
Company has modified the majority of the programs with internal resources
diverted from other projects, none of which are critical to the Company's daily
operations. Testing and validation of the modified programs is complete. The
Company has incurred less than $500,000 to date and does not anticipate
significant additional costs to bring the Y2K compliance program to completion.
Approximately two-thirds of the Company's critical vendors have indicated Y2K
compliance and the Company anticipates completion of this evaluation in the
second quarter of 1999. The Company is actively pursuing the remainder for
confirmation of Y2K compliance. Based upon the work completed to date, the
Company does not anticipate any future material impact on its financial
statements. With regard to the Company's most reasonably likely worst case
scenario, the Company believes that such scenario involves the possibility that
a small number of reports will display incorrect data, a small number of
programs may give unusual data and a small number of vendors will not be Y2K
compliant. In terms of a contingency plan, the Company believes it has
sufficient internal resources to be able to correct such report errors and
address non-compliant vendors within a relatively short time frame. If internal
resources prove to be insufficient, the Company will engage outside resources.
The statements in this paragraph regarding future effects of the year 2000 issue
is a forward- looking statement. See "Forward-Looking Information" for a
description of risk factors.
29
At its February, 1998 meeting, the Board of Directors authorized a $20 million
stock repurchase program which allowed the Company to purchase its stock on the
open market, through block trades, or in private transactions over the
succeeding 12 months. On August 3, 1998, the Executive Committee of the Board of
Directors (subsequently ratified by the Board of Directors) increased the
authorization to purchase up to $40 million of common stock prior to February
25, 1999. The program may be discontinued at any time. As of December 31, 1998,
the Company had repurchased 5,043,700 shares of its common stock for a total
cost of approximately $34.4 million under the stock repurchase program. On
February 25, 1999 the Board of Directors authorized a $20 million stock
repurchase program to extend through September 2, 1999.
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 impact the Company's financial position or cash flow. The Company has
no significant market risk with regard to liabilities.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by Item 305 of S-K is contained in Item 7 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".
30
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA PAGE
----
Consolidated Balance Sheets as of December 31, 1998 and 1997..... 31
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996............................... 32
Consolidated Statements of Changes in Stockholders' Equity
for the years ended December 31, 1998, 1997 and 1996........... 33
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996............................... 34
Notes to Consolidated Financial Statements....................... 35
Report of Ernst & Young LLP Independent Auditors................. 54
Selected Quarterly Financial Data for Fiscal Years 1998 and
1997 (Unaudited)............................................... 55
31
Mid Atlantic Medical Services, Inc.
Consolidated Balance Sheets
December 31,
(in thousands except share amounts) 1998 1997
-------- --------
ASSETS
Current assets
Cash and cash equivalents $ 9,787 $ 3,570
Short-term investments (Note 2) 174,325 152,080
Accounts receivable, net (Note 3) 79,258 87,855
Prepaid expenses, advances and other 26,955 19,294
Deferred income taxes (Note 7) 1,247 303
-------- --------
Total current assets 291,572 263,102
Property and equipment, net (Note 4) 44,961 56,964
Statutory deposits (Note 2) 14,906 14,854
Other assets 9,055 10,427
Deferred income taxes (Note 7) 2,281 612
-------- --------
Total assets $362,775 $345,959
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Notes payable (Note 5) $ 60 $ 60
Short-term borrowings (Note 5) 1,845 2,249
Accounts payable 19,071 16,878
Medical claims payable, net 129,265 98,328
Deferred premium revenue 17,167 15,722
Deferred income taxes (Note 7) 1,026 1,800
-------- --------
Total current liabilities 168,434 135,037
Notes payable (Note 5) 14 74
Deferred income taxes (Note 7) 3,109 2,541
-------- --------
Total liabilities 171,557 137,652
Stockholders' equity (Notes 10, 11 and 13)
Common stock, $0.01 par, 100,000,000 shares authorized,
56,772,502 issued and 49,634,162 outstanding at
December 31, 1998 and 54,677,862 outstanding at
December 31, 1997 567 567
Additional paid-in capital 138,247 162,892
Stock compensation trust (common stock held in trust) (68,926) (101,482)
Treasury stock, 7,138,340 shares at December 31, 1998;
2,094,640 shares at December 31, 1997 (75,623) (41,211)
Accumulated other comprehensive income (Note 16) 1,313 946
Retained earnings 195,640 186,595
-------- --------
Total stockholders' equity 191,218 208,307
-------- --------
Total liabilities and stockholders' equity $362,775 $345,959
======== ========
The accompanying notes are an integral part of these consolidated financial statements.
32
Mid Atlantic Medical Services, Inc.
Consolidated Statements of Operations
Year Ended December 31,
(in thousands except share amounts) 1998 1997 1996
---------- ---------- ---------
Revenue
Health premium $1,124,248 $1,051,923 $1,079,223
Fee and other 20,501 18,351 16,376
Life and short-term disability premium 6,876 5,313 3,240
Home health services 19,962 21,025 20,519
Investment 10,622 15,041 14,384
Gain on sale of real estate 5,692 0 0
---------- ---------- ----------
Total revenue 1,187,901 1,111,653 1,133,742
---------- ---------- ----------
Expense
Medical expense
Referral and ancillary care (Notes 8 and 9) 437,279 406,840 432,487
Hospitalization, net of coordination of benefits 342,852 323,435 349,445
Primary care (Notes 8 and 9) 81,166 83,183 100,692
Prescription drugs 136,767 127,187 115,544
Reinsurance premiums, net (Note 6) 192 (49) (600)
---------- ---------- ----------
998,256 940,596 997,568
---------- ---------- ----------
Life and short-term disability claims 3,760 2,811 2,314
---------- ---------- ----------
Home health patient services 17,755 16,808 17,141
---------- ---------- ----------
Administrative expense
Salaries and benefits 85,166 80,700 76,627
Promotion and advertising 3,939 3,543 4,182
Professional services 4,066 6,499 5,837
Facilities, maintenance and supplies 27,058 26,609 23,398
Other (including interest expense of $414, $540 and $691) 14,378 12,647 11,610
---------- ---------- ----------
134,607 129,998 121,654
---------- ---------- ----------
Loss on retirement of equipment 4,787 0 0
Federal Employee Health Benefit Program
Potential Settlement (Note 12) 16,500 0 0
---------- ---------- ----------
Total expense 1,175,665 1,090,213 1,138,677
---------- ---------- ----------
Income (loss) before income taxes 12,236 21,440 (4,935)
Income tax benefit (expense) (Note 7) (3,191) (6,951) 2,167
---------- ---------- ----------
Net income (loss) $ 9,045 $ 14,489 $ (2,768)
========== ========== ==========
Basic earnings (loss) per common share (Note 11) $ .20 $ .31 $ (.06)
========== ========== =========
Diluted earnings (loss) per common share (Note 11) $ .20 $ .31 $ (.06)
========== ========== =========
The accompanying notes are an integral part of these consolidated financial statements.
33
Mid Atlantic Medical Services, Inc.
Consolidated Statements of Changes in Stockholders' Equity
Accumulated
Additional Stock Other
Common Paid-In Compensation Treasury Comprehensive Retained
(in thousands except share amounts) Stock Capital Trust Stock Income Earnings Total
------ ---------- ------------ -------- ------------- -------- --------
Balance, December 31, 1995 $ 466 $ 40,374 $ (33) $ 1,535 $174,874 $217,216
Exercise of stock options for
1,011,175 shares of MAMSI
common stock 10 5,682 5,692
Stock option tax benefit 6,162 6,162
Establishment of Stock
Compensation Trust for
9,130,000 shares of MAMSI
common stock 91 130,011 $(130,102)
Exercise of stock options
for 109,300 shares released from
the Stock Compensation Trust (1,011) 1,557 546
Adjustment to market value
for shares held in Stock
Compensation Trust (7,893) 7,893
Repurchase of 2,048,700 shares of
MAMSI common stock (41,178) (41,178)
Comprehensive Income:
Net Loss (2,768) (2,768)
Other comprehensive income,
net of tax benefit of $830 (1,270) (1,270)
------ -------- --------- -------- -------- -------- --------
Total Comprehensive Income (4,038)
--------
Balance, December 31, 1996 567 173,325 (120,652) (41,211) 265 172,106 184,400
Exercise of stock options for
1,061,325 shares released from the
Stock Compensation Trust (10,265) 15,124 4,859
Stock option tax benefit 3,878 3,878
Adjustment to market value for shares
held in Stock Compensation Trust (4,046) 4,046
Comprehensive Income:
Net Income 14,489 14,489
Other comprehensive income,
net of tax of $444 681 681
------ -------- --------- -------- -------- -------- --------
Total Comprehensive Income 15,170
--------
Balance, December 31, 1997 567 162,892 (101,482) (41,211) 946 186,595 208,307
Exercise of stock options for
935,425 shares released from the
Stock Compensation Trust (7,914) 13,330 5,416
Stock option tax benefit 2,495 2,495
Adjustment to market value for shares
held in Stock Compensation Trust (19,226) 19,226
Repurchase of 5,043,700 shares of
MAMSI common stock (34,412) (34,412)
Comprehensive Income:
Net Income 9,045 9,045
Other comprehensive income
net of tax of $239 367 367
------ -------- --------- -------- -------- -------- --------
Total Comprehensive Income 9,412
Balance, December 31, 1998 $ 567 $138,247 $ (68,926) $(75,623) $ 1,313 $195,640 $191,218
====== ======== ========= ======== ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements.
34
Mid Atlantic Medical Services, Inc.
Consolidated Statements of Cash Flows
Year Ended December 31,
(in thousands) 1998 1997 1996
-------- -------- --------
Cash flows from operating activities:
Net income (loss) $ 9,045 $ 14,489 $ (2,768)
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization 10,796 10,179 7,874
Provision for bad debts 34 (187) 1,728
Provision for deferred income taxes (2,273) 7,260 2,261
Gain (loss) on sale and disposal of assets (833) 13
Decrease (increase) in accounts receivable 8,563 (10,626) (20,153)
Decrease (increase) in prepaid expenses, advances and other (7,661) 13,029 (23,349)
Increase (decrease) in accounts payable 2,193 (1,877) 3,680
Increase (decrease) in medical claims payable, net 30,937 (20,321) 10,159
Increase in deferred premium revenue 1,445 5,243 3,000
-------- -------- --------
Total adjustments 43,201 2,700 (14,787)
-------- -------- --------
Net cash provided by (used in) operating activities 52,246 17,189 (17,555)
-------- -------- --------
Cash flows (used in) provided by investing activities:
Purchases of short-term investments (329,400) (249,862) (338,943)
Sales and maturities of short-term investments 307,763 253,267 392,219
Purchases of property and equipment (9,008) (21,016) (13,469)
Purchases of statutory deposits (100) (8,761) (2,407)
Maturities of statutory deposits 10 1,824
Purchases of other assets (893) (406) (247)
Proceeds from sale of assets 12,574 131 435
-------- -------- --------
Net cash (used in) provided by investing activities (19,064) (26,637) 39,412
-------- -------- --------
Cash flows provided by (used in) financing activities:
Principal payments on notes payable (60) (60) (210)
Increase (decrease) in short-term borrowings (404) 276 322
Exercise of stock options 5,416 4,859 6,238
Stock option tax benefit 2,495 3,878 6,162
Purchase of treasury stock (34,412) (41,178)
-------- -------- --------
Net cash provided by (used in) financing activities (26,965) 8,953 (28,666)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 6,217 (495) (6,809)
Cash and cash equivalents at beginning of year 3,570 4,065 10,874
-------- -------- --------
Cash and cash equivalents at end of year $ 9,787 $ 3,570 $ 4,065
======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements.
35
Mid Atlantic Medical Services, Inc.
Notes to Consolidated Financial Statements
NOTE 1 - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Mid Atlantic Medical Services, Inc. ("MAMSI") 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 the "Company") have developed a broad range of managed health care and
related ancillary products and deliver these services through health maintenance
organizations ("HMOs"), preferred provider organizations ("PPOs"), a life and
health insurance company, home health care and home infusion services companies,
a hospice company, a mail-order pharmacy, and part ownership 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"), Optimum Choice of the Carolinas, Inc. ("OCCI") and Optimum Choice, Inc.
of Pennsylvania ("OCIPA") 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.
The following are other significant wholly owned subsidiaries of MAMSI:
Physicians Health Plan of Maryland, Inc. ("PHP-MD") is an individual practice
association ("IPA") that provides physician services to certain of the Company's
HMOs.
Alliance PPO, LLC ("Alliance") provides a delivery network of physicians (called
a preferred provider organization) to employers and insurance companies in
association with various health plans.
Mid Atlantic Psychiatric Services, Inc. ("MAPSI") provides psychiatric services
to third party payors or self-insured employer groups.
MAMSI Life and Health Insurance Company ("MAMSI Life") 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.
("HCPS") provide in-home medical care including skilled nursing, infusion and
therapy to MAMSI's HMO members and other payors. In addition, HCPS provides
mail-order pharmacy services to MAMSI's HMO members and other payors.
HomeCall Hospice Services, Inc. ("HCHS") began operations in December, 1996 and
provides services to terminally ill patients and their families.
The significant accounting policies followed by MAMSI and its subsidiaries are
described below.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of MAMSI and its
subsidiaries. All significant intercompany balances have been eliminated in
consolidation.
36
MAJOR CUSTOMERS
A significant portion of the Company's premium revenue is derived from federal,
state and local government agencies, including governmental employees and
Medicaid and Medicare recipients. For the years ended December 31, 1998, 1997
and 1996, approximately 11% of premium revenue was derived from federal
government agencies which is included in the Medicare and Risk segments, and
approximately 18%, 25% and 26%, respectively, was derived from state and local
government agencies which is included in the Risk segment.
CASH EQUIVALENTS
Floating rate municipal putable bonds, which possess an insignificant risk of
loss from changes in interest rates, are held less than three months, are
classified as cash equivalents.
SHORT-TERM INVESTMENTS
Short-term investments, consisting principally of marketable equity securities,
municipal bonds and tax-free bond funds, are classified as available-for-sale.
These securities are carried at fair market value plus accrued interest and any
unrealized gains and losses are reported in other comprehensive income, net of
the related tax effect. Gains and losses are reported in earnings when realized.
Gains and losses on sales of securities are computed using the specific
identification method.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost less accumulated depreciation.
Depreciation is provided on a straight-line basis over the estimated useful
lives of the property and equipment. Leasehold improvements are amortized on a
straight-line basis over the lesser of the life of the improvement or the term
of the related lease.
STATUTORY DEPOSITS
Statutory deposits, consisting principally of municipal bonds and treasury notes
held in custodial accounts by state regulatory agencies, are classified as
held-to-maturity. These securities are stated at amortized cost.
GOODWILL
The excess of cost over the fair value of net assets of the acquired company in
the 1994 purchase transaction is recorded as goodwill and is classified in the
consolidated balance sheets as an other asset. Goodwill is amortized on a
straight-line basis over 15 years.
HEALTH PREMIUM
Amounts charged for health care services are recognized as premium revenue in
the month for which enrollees are entitled to receive care. Included in premium
revenue are amounts due from customers that utilize the Company's capitated
primary care physician network, its medical utilization management services and
other services related to health management and who self-fund, generally up to
specified limits, certain elements of medical costs, such as hospitalization and
specialist physicians. Premium revenue received in advance is recorded as
deferred premium revenue.
37
FEE AND OTHER
Amounts charged to third party payors solely for use of the Company's provider
network and its discounted fee-for-service rate structure are recognized as fee
revenue. Amounts charged for administrative services only arrangements,
entailing only claims payment services and utilization of the provider network
without utilization of the Company's primary care physician network and
utilization management services, and for which the Company bears no insurance
risk, are recognized as fee revenue.
HOME HEALTH SERVICES
Amounts charged to patients, third party payors and others for home health
services are recorded at net realizable amounts, including retroactive
adjustments under cost reimbursement agreements with third party payors.
MEDICAL EXPENSE
Medical expense consists principally of medical claims and capitation costs.
Medical claims include payments to be made on claims reported as of the balance
sheet date and estimates of health care services incurred but not reported
("IBNR") to the Company as of the balance sheet date. The IBNR is estimated
using an expense forecasting model that is based on historical claims incurrence
patterns modified to consider current trends in enrollment, member utilization
patterns, timeliness of claims submissions and other factors. This estimate
includes medical costs to be incurred beyond the premium paying date that are
contractually required.
Capitation costs represent monthly fixed fees to participating physicians and
other medical providers as retainers for providing continuing medical care.
Medical claims reversals result from the determination that the Company has paid
claims in excess of contractually obligated amounts. Amounts recognized (through
specific identification or estimation) are recorded at their net realizable
value as a reduction of medical expense in the consolidated statements of
operations and as a reduction of medical claims payable in the consolidated
balance sheets.
The Company believes that its claims reserves are adequate to satisfy its
ultimate claims liabilities; however, the liability as established may vary
significantly from actual claims amounts, both negatively or positively, and as
such adjustments are deemed necessary, they are included in current operations.
Establishment of claims estimates is an inherently uncertain process and there
can be no certainty that currently established reserves will prove adequate to
cover actual ultimate expenses. Subsequent actual experience could result in
reserves being too high or too low which could positively or negatively impact
the Company's earnings in future periods.
COORDINATION OF BENEFITS
Coordination of benefits ("COB") results from the determination that the Company
has paid for medical claims expenses for which an enrollee has duplicate
coverage and for which another insurer is primarily liable. In the consolidated
statements of operations, such identified amounts are classified as a reduction
of hospitalization expense and, in the consolidated balance sheets, such amounts
are classified as a reduction of medical claims payable.
38
INCOME TAXES
The income tax provision includes Federal and state income taxes both currently
payable and deferred because of differences between financial reporting and tax
bases of assets and liabilities. Deferred tax assets and liabilities are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse.
EARNINGS (LOSS) PER COMMON SHARE
In 1997, the Company adopted Statement of Financial Accounting Standards No.
128, "Earnings Per Share", resulting in the restatement of earnings per share
for all prior periods. Basic earnings per common share are based upon the
weighted average shares outstanding. Outstanding stock options are treated as
common stock equivalents for purposes of computing diluted earnings per share.
Shares held in the Company's Stock Compensation Trust (see Note 11) are excluded
from the calculation of basic and diluted earnings per share.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosure about Fair
Value of Financial Instruments" ("Statement No. 107"), requires disclosure of
fair value information about financial instruments, whether or not recognized in
the balance sheet, for which it is practicable to estimate that value. Statement
No. 107 excludes certain financial instruments and all nonfinancial instruments
from its disclosure requirements. The following methods and assumptions were
used by the Company in estimating its fair value disclosures for financial
instruments:
Cash and cash equivalents - The carrying amount reported in the consolidated
balance sheets approximates fair value.
Short-term investments - Fair values are based on quoted market prices.
Statutory deposits - Fair values are based on quoted market prices.
Short-term borrowings - The carrying amount reported in the consolidated balance
sheets approximates fair value.
ESTIMATES
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that effect 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. Such estimates and assumptions could change in the future as
more information becomes known, which could impact the amounts reported and
disclosed herein.
STOCK OPTION PLANS
The Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for its stock option plans. Under APB 25, because
the exercise price of the Company's employee stock options equals the market
value of the underlying stock on the date of grant, no compensation expense is
recognized.
39
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income"
("Statement No. 130"), which establishes standards for reporting and display of
income and its components (revenue, expenses, gains and losses) in a full set of
general-purpose financial statements. The Company adopted Statement No. 130 as
of December 31, 1997 and has presented comprehensive income for all periods
presented in the Consolidated Statements of Changes in Stockholders' Equity.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosure about Segments of an
Enterprise and Related Information" ("Statement No. 131"), which changes the way
public companies report information about operating segments. Statement No. 131,
which is based on the management approach to segment reporting, establishes
requirements to report selected segment information quarterly and to report
entity-wide disclosures about products and services, major customers, and the
material countries in which the entity holds assets and reports revenue. The
Company adopted Statement No. 131 as of December 31, 1997.
In March 1998, the AICPA issued Statement of Position 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"),
which establishes guidelines for the accounting for the costs of all computer
software developed or obtained for internal use. SOP 98-1 is effective for years
beginning after December 15, 1998. The Company anticipates adopting this
statement in the first quarter of 1999 and anticipates that the adoption of SOP
98-1 will not have a material impact on the Company's consolidated financial
statements.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities" ("Statement No. 133"). Statement No. 133 is effective
for all fiscal quarters of all fiscal years beginning after June 15, 1999.
Statement No. 133 requires that all derivative instruments be recorded on the
balance sheet at their fair value. Changes in the fair value of derivatives are
recorded each period in current earnings or other comprehensive income,
depending on whether a derivative is designed as part of a hedge transaction
and, if it is, the type of hedge transaction. The Company does not expect that
the adoption of Statement No. 133 will have a material impact on its
consolidated financial statements because the Company does not currently hold
any derivative instruments.
RECLASSIFICATIONS
Certain balances in the 1997 financial statements have been reclassified to
conform to 1998 presentation.
NOTE 2 - INVESTMENTS
Investments are classified into two categories (available-for-sale or
held-to-maturity) and are valued based upon this designation. Securities
classified as available-for-sale, which include debt and equity securities that
the Company does not have the positive intent to hold to maturity, are marked to
market with the resulting unrealized gain or loss reflected in other
comprehensive income. Securities classified as held-to-maturity, which are debt
securities that the Company has both the positive intent and ability to hold to
maturity, are carried at amortized cost. The Company classifies its statutory
deposits as held-to-maturity with no effect on the recorded value. All other
investments are classified as available-for- sale. Management re-evaluates these
designations annually. During 1997, statutory deposit investments with an
amortized cost of $3,001,000 were released by state regulatory agencies and
transferred to the Company's short-term investment portfolio. The unrealized
gain at the date of transfer was $94,000.
40
The following is a summary of available-for-sale and held-to-maturity securities
at December 31, 1998 and 1997:
-----------------------------------------------------
1998
-----------------------------------------------------
Gross Gross Estimated
(in thousands) Unrealized Unrealized Fair
Cost Gains Losses Value
-----------------------------------------------------
AVAILABLE-FOR-SALE SECURITIES
Obligations of states and political subdivisions $ 84,072 $ 1,996 $ - $ 86,068
Municipal bond funds 81,468 1 81,469
Accrued interest 1,210 1,210
-------- ------- ------- --------
Debt securities 166,750 1,997 - 168,747
Equity securities 5,403 181 6 5,578
-------- ------- ------- --------
Short-term investments $172,153 $ 2,178 $ 6 $174,325
======== ======= ======= ========
HELD-TO-MATURITY SECURITIES
U.S. Treasury securities and obligations
of U.S. government agencies $ 3,426 $ 157 $ - $ 3,583
Obligations of states and political subdivisions 10,626 270 10,896
Other investments 854 854
-------- ------- ------- --------
Statutory deposits $ 14,906 $ 427 $ - $ 15,333
======== ======= ======= ========
-----------------------------------------------------
1997
-----------------------------------------------------
Gross Gross Estimated
(in thousands) Unrealized Unrealized Fair
Cost Gains Losses Value
-----------------------------------------------------
AVAILABLE-FOR-SALE SECURITIES
Obligations of states and political subdivisions $ 85,433 $ 1,615 $ 21 $ 87,027
Municipal bond funds 15,775 15,775
Other debt securities 462 46 508
Accrued interest 1,170 1,170
-------- ------- ------- --------
Debt securities 102,840 1,661 21 104,480
Equity securities 46,220 2,812 2,893 46,139
Mutual funds 1,456 5 1,461
-------- ------- ------- --------
Short-term investments $150,516 $ 4,478 $ 2,914 $152,080
======== ======= ======= ========
HELD-TO-MATURITY SECURITIES
U.S. Treasury securities and obligations
of U.S. government agencies $ 3,943 $ 85 $ 2 $ 4,026
Obligations of states and political subdivisions 10,661 187 10,848
Other investments 250 250
-------- ------- ------- --------
Statutory deposits $ 14,854 $ 272 $ 2 $ 15,124
======== ======= ======= ========
For the years ended December 31, 1998 and 1997, marketable equity
available-for-sale securities with a fair value at the date of sale of
$92,570,000 and $62,804,000, respectively, were sold. The gross realized gains
on such sales totaled $5,793,000 and $11,027,000, and the gross realized losses
totaled $3,001,000 and $2,935,000 for each of the
41
respective periods. Realized gains and losses are included in investment income.
Other sales of short-term investments consisted principally of redemptions from
municipal bond funds.
The amortized cost and estimated fair value of debt and marketable equity
securities at December 31, 1998, by contractual maturity, are shown below.
Actual maturities may differ from contractual maturities because the issuers of
the securities may have the right to prepay obligations without prepayment
penalties.
-------------------------
Estimated
Fair
(in thousands) Cost Value
-------------------------
AVAILABLE-FOR-SALE
Due in one year or less $ 89,634 $ 89,645
Due after one year through five years 39,444 40,370
Due after five years through ten years 23,356 24,003
Due after ten years 14,316 14,729
-------- --------
Debt securities 166,750 168,747
Equity securities 5,403 5,578
-------- --------
$172,153 $174,325
======== ========
HELD-TO-MATURITY
Due in one year or less $ 2,021 $ 2,029
Due after one year through five years 8,802 8,980
Due after five years through ten years 3,579 3,784
Due after ten years 504 540
-------- --------
$ 14,906 $ 15,333
======== ========
NOTE 3 - ACCOUNTS RECEIVABLE
Accounts receivable consists of the following at December 31:
-------------------------
(in thousands) 1998 1997
-------------------------
Premium and fee accounts $ 57,399 $ 68,643
Home health service accounts 5,909 5,466
Medical recoverables 16,204 11,726
Other 4,960 7,200
Less: allowance for doubtful accounts (5,214) (5,180)
-------- --------
$ 79,258 $ 87,855
======== ========
Medical recoverables consist of refunds identified on paid claims. This amount
has been recorded as a reduction of medical expense in the consolidated
statements of operations. Other receivables consist primarily of amounts due for
reinsurance recoveries and pharmacy rebates.
42
NOTE 4 - PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31:
------------------------
(in thousands) 1998 1997
------------------------
Land, buildings and improvements $28,684 $31,355
Computer equipment and software 28,826 38,757
Office furniture and equipment 19,498 17,267
Leasehold improvements 861 688
------- -------
77,869 88,067
Less: accumulated depreciation and
amortization (32,908) (31,103)
------- -------
$44,961 $56,964
======= =======
NOTE 5 - NOTES PAYABLE
Notes payable consists of the following at December 31:
------------------------
(in thousands) 1998 1997
------------------------
Notes payable $ 74 $ 134
Current portion (60) (60)
------- -------
Noncurrent portion $ 14 $ 74
======= =======
The noncurrent portion of notes at December 31, 1998 matures in the year 2000.
The Company has access to total line-of-credit and letter-of-credit facilities
of $29 million, which are subject to annual renewal. Borrowings bear interest at
a rate based on the Federal Funds rate plus .75% - 1.65% and are secured by
certain cash balances and short-term investments. At December 31, 1998,
approximately $1.85 million was outstanding on one of the lines-of-credit at an
interest rate of 6.45% and approximately $12.3 million was outstanding in
letters-of-credit.
Interest expense paid in cash during 1998, 1997 and 1996 was approximately
$188,000, $538,000 and $688,000, respectively.
NOTE 6 - REINSURANCE
M.D. IPA, OCI, OCCI, OCIPA and MAMSI Life maintain reinsurance coverage to
provide for reimbursement of claims in excess of certain limits. Reinsurance for
health claims generally covers 80% of all hospital costs in excess of a
deductible amount per enrollee per year (subject to a $2,000,000 maximum
lifetime reinsurance limit per person) but excludes coverage of costs in excess
of certain per diem rates. The deductible per enrollee is $200,000. Reinsurance
for life and accidental death claims generally covers all settlements in excess
of $50,000 per person subject to a $2,500,000 maximum recovery per person.
Reinsurance recoveries for the years ended December 31, 1998, 1997 and 1996 were
approximately $1,597,000, $2,045,000 and $2,288,000, respectively. In the
consolidated statements of operations, reinsurance premiums are shown net of the
related recoveries.
43
NOTE 7 - INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax liabilities and assets are as follows as of December
31:
--------------------------
(in thousands) 1998 1997
--------------------------
Deferred tax liabilities:
Accelerated depreciation $ 2,664 $ 3,422
Receivable valuation adjustments 4,460 3,314
Unrealized investment gains 859 618
------- -------
Total deferred tax liabilities 7,983 7,354
------- -------
Deferred tax assets:
Accrued medical expenses 3,429 3,259
Premium revenue adjustments 2,975 784
State net operating losses 2,449 256
Accrued pension expenses 1,263 915
Other (450) (224)
------- -------
Total deferred tax assets 9,666 4,990
Valuation allowance for deferred tax assets (2,290) (1,062)
------- -------
Net deferred tax assets 7,376 3,928
------- -------
$ (607) $(3,426)
======= =======
Included in the consolidated balance sheets:
Current assets - deferred income taxes $ 1,247 $ 303
Non-current assets - deferred income taxes 2,281 612
Current liabilities - deferred income taxes (1,026) (1,800)
Non-current liabilities - deferred
income taxes (3,109) (2,541)
------- -------
Net deferred tax liability $ (607) $(3,426)
======= =======
44
Significant components of the provision for income taxes attributable to
continuing operations are as follows for the years ended December 31:
---------------------------------------
(in thousands) 1998 1997 1996
---------------------------------------
Current:
Federal $ 4,105 $ (1,363) $ (4,239)
State 1,359 1,054 (189)
--------- --------- ---------
Total current 5,464 (309) (4,428)
--------- --------- ---------
Deferred:
Federal (1,250) 7,279 1,828
State (1,023) (19) 433
--------- --------- ---------
Total deferred (2,273) 7,260 2,261
--------- --------- ---------
$ 3,191 $ 6,951 $ (2,167)
========= ========= =========
The Company's tax provision differs from the statutory rate for Federal income
taxes for the years ended December 31 as follows:
-------------------------------------
(in thousands) 1998 1997 1996
-------------------------------------
Statutory rate (35%) $ 4,282 $ 7,504 (1,727)
Tax-exempt interest (1,369) (1,582) (1,912)
State income taxes, net of Federal benefit (580) 461 (254)
Increase in valuation allowance for
deferred tax assets 1,228 325 634
Other non-deductible items 526 575 785
Other, net (896) (332) 307
------- ------- -------
$ 3,191 $ 6,951 $(2,167)
======= ======= =======
Total tax deposits made by the Company in 1998, 1997 and 1996 were approximately
$6,870,000, $2,461,000 and $10,320,000, respectively.
NOTE 8 - RISK POOL WITHHOLDINGS
Prior to July 1, 1996, contracts with participating physicians allowed for
withholdings generally ranging from 5% to 15% from primary care physicians and
participating specialists on capitation and fee-for-service payments. The
withheld amounts ultimately paid back to providers is generally less than the
total amount withheld. Withheld liabilities and related medical expenses were
reduced by $14,535,000 in 1996 to reflect amounts not returned to providers.
Commencing July 1, 1996, the Company, pursuant to state law changes,
discontinued withholding from payments in substantially all areas of operations.
Amounts placed in such risk pools, in jurisdictions where it is still permitted,
were insignificant in 1998 and 1997.
45
NOTE 9 - RELATED PARTIES
For the years ended December 31, 1998, 1997 and 1996, certain members of the
Boards of Directors of MAMSI and subsidiary corporations who are also
participating physicians provided medical services to enrollees totaling
$4,430,000, $6,103,000 and $8,406,000, respectively, which represents
approximately 1% in 1998 and 1997, and 2% in 1996 of payments to all physicians.
Board members are remunerated at the same contractual level as all other
participating physicians and are selected by enrollees to render medical
services under the same guidelines as all other participating physicians.
NOTE 10 - EMPLOYEE BENEFIT PLANS
PENSION PLANS
The Company has a defined contribution 401(k) savings plan covering all
full-time employees. Employees are allowed to contribute up to 10% of their
pretax earnings annually and the Company makes a matching contribution of 50% on
the first 4% of contributions made by employees. Employees vest immediately in
the employee contributions and ratably over six years in the Company
contributions. During 1998, 1997 and 1996, the Company's contribution to the
401(k) plan aggregated $681,000, $577,000 and $540,000, respectively.
In accordance with a personal service contract negotiated by the Company, its
former Chairman is entitled to supplemental pension benefits based upon years of
service and attained salary levels. Expense recognized related to this plan was
$818,000 in 1996. During 1997, the service contract was renegotiated, at which
time the supplemental pension benefits package was amended to include a fixed
payment benefit of $450,000 per year for a fixed term of 15 years. The reduction
in pension expense recognized in 1997 related to this change was approximately
$1.1 million. During 1998, certain one-time elections which reduced the fixed
benefit payable to $250,000 per year, were made under the agreement which caused
1998 pension expense to be reduced by approximately $880,000.
STOCK OPTION PLANS
In October 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("Statement 123"). Statement 123 prescribes accounting and
reporting standards for all stock based compensation plans. Statement 123
requires that the Company either adopt the fair value method of accounting for
its stock option plans or continue to apply the existing accounting rules but
provide supplemental pro forma disclosures as if the new rules had been adopted.
The Company elected to follow the existing rules and make the required pro forma
disclosures for the first time, in its 1996 consolidated financial statements.
Although Statement 123 first became effective in 1996, it requires that the pro
forma disclosures include the effects of all awards granted in fiscal years
beginning after December 15, 1994, the majority of which were issued under the
Company's 1995-1998 stock option plans.
Pro forma information regarding net income and earnings per share are required
by Statement 123, and has been determined as if the Company had accounted for
its employee stock options under the fair value method of that statement. The
fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted-average
assumptions for 1998, 1997 and 1996, respectively: risk-free interest rates of
5.6%, 6.4%, and 6.3%; volatility factors of the expected market price of the
Company's common stock of .42, .42, and .47 and a weighted average life of the
options of 3 years. The Company anticipates that it will declare no dividends.
46
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the option's vesting period. The Company's pro
forma information follows (in thousands except share amounts):
1998 1997 1996
------ ------ -------
Pro forma net income (loss) $1,502 $9,007 $(8,409)
Pro forma basic earnings (loss) per share .03 .19 (.18)
Pro forma diluted earnings (loss) per share .03 .19 (.18)
In each year 1990 through 1996 and 1998, MAMSI implemented a non-qualified stock
option plan whereby options for the purchase of shares of common stock may be
granted to directors, officers and employees of the Company. Shares authorized
under the plans total 17,000,000. Options under the plans generally vest over a
three-year period and are exercisable at 100% of the fair market value per share
on the date the options are granted. The Company accounts for these stock option
grants in accordance with APB 25, and, accordingly, recognizes no compensation
expense for these stock option grants. Transactions relating to the 1990 - 1996
plans and the 1998 plan through 1998 are summarized as follows:
47
1998 1997 1996
----------------------- ----------------------- -----------------------
Weighted Weighted Weighted
Average Average Average
1998 Exercise 1997 Exercise 1996 Exercise
Shares Price Shares Price Shares Price
------ -------- ------ -------- ------ --------
Outstanding, January 1 8,099,231 $ 17.76 8,864,021 $ 17.02 7,400,405 $ 14.94
Granted 6,304,558 $ 14.77 1,128,500 $ 12.79 3,122,371 $ 17.72
Exercised (935,425) $ 5.79 (1,061,325) $ 4.58 (1,120,475) $ 5.57
Forfeited (5,555,240) $ 20.34 (831,965) $ 19.92 (538,280) $ 20.67
--------- --------- ---------
Outstanding, December 31 7,913,124 $ 14.98 8,099,231 $ 17.76 8,864,021 $ 17.02
========= ========= =========
Available for grant, end of year 1,766,751 1,188,744 1,494,829
Exercisable, end of year 1,608,139 4,887,992 4,107,450
Option price range for exercised
shares $4.54-$12.63 $3.29-14.75 $2.58-22.38
Option price range at end of year $5.00-$27.13 $4.54-28.50 $3.29-28.50
Weighted average fair value of
options granted during year $4.49 $4.26 $7.32
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ----------------------------------------------------------------------------- --------------------------------
Outstanding Weighted-Average Exercisable
Range of as of Remaining Weighted-Average as of Weighted-Average
Exercise Prices 12/31/1998 Contractual Life Exercise Price 12/31/1998 Exercise Price
- ------------------- ----------- ---------------- ---------------- ----------- ----------------
$5.00 - $10.00 236,337 4.7 $ 7.07 3,750 $ 9.56
$10.01 - $15.00 2,868,341 3.8 $12.70 990,000 $12.74
$15.01 - $20.00 4,609,546 2.4 $16.28 415,489 $18.31
$20.01 - $25.00 900 2.2 $23.75 900 $23.75
$25.01 - $27.13 198,000 0.3 $27.13 198,000 $27.13
--------- ------- ------ --------- ------
7,913,124 2.9 $14.98 1,608,139 $15.95
========= ======= ====== ========= ======
On April 15, 1998, the Stock Option Committee of the Company's Board of
Directors authorized a voluntary exchange ("Exchange") of all existing stock
options with an exercise price of $16.00 or more per share. Each stock option
that was voluntarily tendered was replaced with a newly issued stock option
priced at $16.00 per share. As a condition of the Exchange, option holders
agreed to extend the vesting period for one year. In addition, the newly issued
stock options are exercisable for one additional year beyond the current
expiration date. Approximately 4.3 million options were exchanged for a like
number of newly issued options.
The Company has an incentive compensation plan whereby managers receive bonuses
based upon the annual operating results of the Company. During 1998, incentive
compensation expense was approximately $800,000 which was paid to employees
below the level of Vice President. No management bonus was earned in 1997 or
1996. In addition, certain individuals receive a cash bonus based upon the
achievement of certain measurable criteria other than the annual operating
results of the Company. These bonus amounts are not significant.
48
NOTE 11 - COMMON STOCK
The following table sets forth the computation of basic and diluted earnings per
share:
-----------------------------------------
1998 1997 1996
-----------------------------------------
Numerator:
Net income (loss) $ 9,045,000 $14,489,000 $(2,768,000)
Denominator:
Denominator for basic earnings per share
- weighted average shares 45,407,006 46,273,484 45,978,864
Dilutive securities - employee stock options 66,989 612,182 0
Denominator for diluted earnings per share
- adjusted weighted average shares 45,473,995 46,885,666 45,978,864
On August 26, 1996, the Company established the MAMSI Stock Compensation Trust
("SCT") to fund its obligations arising from its various stock compensation
plans. MAMSI funded the SCT with 9,130,000 shares of newly issued MAMSI stock.
In exchange, the SCT has delivered a promissory note to MAMSI for approximately
$129.9 million which represents the purchase price of the shares. Amounts owed
by the SCT to MAMSI will be repaid by cash received by the SCT or will be
forgiven by MAMSI, which will result in the SCT releasing shares to satisfy
MAMSI obligations for stock compensation.
On January 11, 1999 the SCT purchased an additional 1,500,000 shares of the
Company's common stock for approximately $18,000,000. The existing promissory
note has been modified to reflect this purchase.
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 sheet. 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. At December 31,
1998, 1997 and 1996, the SCT held 7,023,950, 7,959,375 and 9,020,700 shares of
common stock at a fair market value of approximately $68.9, $101.5 and $120.7
million, respectively.
Shares held by the SCT are excluded from weighted average shares outstanding
used in the computation of income or loss per common share.
NOTE 12 - COMMITMENTS AND CONTINGENCIES
The Company leases certain equipment and office space under the terms of
noncancellable operating leases that expire at various dates through 2000. Rent
expense relating to these operating leases approximated $3,502,000, $3,552,000
and $3,316,000 in 1998, 1997 and 1996, respectively.
49
Future minimum lease commitments under non-cancelable operating leases are as
follows for the years ended December 31 (in thousands):
1999 $ 2,907
2000 1,505
2001 719
2002 397
2003 203
-------
$ 5,731
=======
During the quarter ended March 31, 1998, the Company became involved in a
dispute with the Maryland Insurance Administration ("MIA") concerning the
construction and application of Section 15-1008 of the Maryland Insurance
Article. The law limits the time within which a carrier may retroactively
collect money owed by providers to the carrier by using the device of offsetting
future payments to providers with the amount owed by the provider to the
carrier. The law does not affect the right of carriers to otherwise recover
monies owed. The Company construed the law to be applicable to claims paid on or
after October 1, 1997. The MIA construed the law to apply to retroactive
adjustments made on or after October 1, 1997 and the MIA has ordered the Company
to abide by its construction of the law. The Company has not yet decided whether
to appeal. Management believes that the ultimate outcome of this matter will not
have a material adverse effect on the Company's financial statements as the
MIA's current position affects the method of collection of the claims reversals,
rather than the Company's legal right to the refunds.
On February 18, 1999, certain providers filed a class action lawsuit in the
Circuit Court for Anne Arundel County, Maryland concerning the construction and
application of Section 15-1008 of the Maryland Insurance Article. The complaint
requests an accounting of claims' payments, injunctive relief and punitive
damages. Management believes that the ultimate outcome of this matter will not
have a material adverse effect on the Company's financial statements as the
MIA's current position affects the method of collection of the claims reversals,
rather than the Company's legal right to the refunds.
M.D. IPA contracts with the Office of Personnel Management ("OPM") to provide or
arrange health services under the Federal Employee Health Benefit Program
("FEHBP"). The contract with OPM and applicable government regulations establish
premium rating requirements for the FEHBP. The premiums established under the
OPM contract are subject to periodic review and audit to determine, if they were
established in compliance with the community rating and other requirements under
the program.
In September, 1998, a pretax charge of approximately $16.5 million which
includes approximately $4.4 million of interest, was recognized in the Company's
financial statements in anticipation of negotiations relating to potential
governmental claims for contracts with OPM related to an audit conducted by the
Office of Inspector General concerning the Company's participation in FEHBP for
the years 1992-1997 related to findings for years 1992-1994. 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 price 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 two to three
years.
50
In addition to claims made by the OPM auditors as part of the normal audit
process, OPM may also refer their results to the United States Department of
Justice ("DOJ") for potential legal action under the False Claims Act. The DOJ
has the authority to file a claim under the False Claims Act if it believes that
the health plan knowingly overcharged the government or otherwise submitted
false documentation or certifications. In False Claims Act actions, the
government may impose trebled damages and a civil penalty of not less than
$5,000 nor more than $10,000 for each separate alleged false claim.
The Company intends to negotiate with OPM on all matters to attain a mutually
satisfactory result. There can be no assurance that these negotiations will be
concluded satisfactorily, that the audit will not be referred to the DOJ, or
that additional, possibly material, liability will not be incurred. The Company
believes that any ultimate liability in excess of amounts accrued would not
materially affect the Company's consolidated financial position. However, such
liability could have a material effect on results of operations or cash flows of
a future period if resolved unfavorably.
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 any
ultimate liability that could arise from these other actions will not materially
effect the Company's consolidated financial position or results of operations.
NOTE 13 - STATUTORY REQUIREMENTS
M.D. IPA, OCI, OCCI and OCIPA are subject to insurance department regulations in
the states in which they are licensed. MAMSI Life is subject to insurance
department regulations in Maryland, its state of domicile.
Minimum required statutory net worth and actual statutory net worth are as
follows:
1998 1997
-------------------------- --------------------------
Minimum Actual Minimum Actual
---------- ----------- ---------- -----------
M.D. IPA $3,000,000 $42,000,000 $3,000,000 $43,300,000
OCI 3,000,000 56,000,000 3,000,000 49,800,000
MLH 500,000 34,500,000 500,000 28,300,000
OCCI 2,500,000 2,900,000 2,500,000 1,800,000
OCIPA 1,500,000 2,400,000 1,500,000 2,700,000
M.D. IPA, OCI, OCCI, OCIPA and MAMSI Life were in compliance with state
depository rules at December 31, 1998 and 1997. OCCI failed to meet its net
worth requirement of $2.5 million and working capital requirement of $1.6
million at December 31, 1997. In February, 1998, additional capital was provided
so that each of these requirements was met. MAMSI Life was in compliance with
the applicable risk-based capital requirements for life and health insurance
companies at December 31, 1998 and 1997, and M.D. IPA, OCI, OCCI and OCIPA were
in compliance with the applicable newly enacted risk-based capital requirements
at December 31, 1998. These MAMSI subsidiaries must notify state regulators
before the payment of any dividends to MAMSI and, in certain circumstances, must
receive positive affirmation prior to such payment.
NOTE 14 - RISK CONCENTRATIONS
Financial instruments that potentially subject the Company to credit risk
consist primarily of investments in marketable securities (including money
market funds, floating rate municipal putable bonds, intermediate term municipal
bonds, and common stocks) and premiums receivable. The Company receives advice
through or assigns direct management of short-term
51
investments in marketable securities to professional investment managers
selected for their expertise in various markets, within guidelines established
by the Board of Directors. These guidelines include broad diversification of
investments. Concentrations of credit risk and business volume with respect to
commercial premiums receivable are generally limited due to the large number of
employer groups comprising the Company's customer base. As of December 31, 1998,
approximately 16% of premium and home health service receivables were due from
federal government agencies. The Company performs ongoing credit evaluations of
customers and generally does not require collateral.
NOTE 15 - REPORTABLE SEGMENTS
Effective January 1, 1998, the Company adopted the Financial Accounting
Standards Board's Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information"
("Statement 131"). Statement 131 superseded FASB Statement No. 14, "Financial
Reporting for Segments of a Business Enterprise". Statement 131 establishes
standards for the way that public business enterprises report information about
operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments in interim
financial reports. The adoption of Statement 131 did not affect results of
operations or financial position, but did affect the disclosure of segment
information.
DESCRIPTION OF THE TYPES OF PRODUCTS AND SERVICES FROM WHICH EACH REPORTABLE
SEGMENT DERIVES ITS REVENUES
The Company has three reportable segments: Commercial risk products, Medicare
products and Preferred Provider Organizations (PPO). Commercial risk products
include traditional HMO and point of service health care plans as well as hybrid
products. Traditional products provide for the provision of comprehensive
medical care to enrollees for a fixed, prepaid premium regardless of the amount
of care provided. Hybrid products offer the ability to tailor employee health
care offerings by varying benefit designs, funding methods and insurance risk.
These products combine the use of capitated physicians to serve as gatekeepers,
employer funding of specialist and institutional claims on an "as paid" basis
with MAMSI's underwriting of risk on a specific and/or aggregate stop loss
basis. The Medicare product is health coverage offered to Title XVIII Medicare
recipients. Under a contractual arrangement with the United States Health Care
Financing Administration ("HCFA"), the Company receives a monthly premium for
which the Company provides comprehensive medical coverage to those individuals.
Effective January 1, 1999, the Company will no longer participate in the
Medicare program. The PPO product provides a delivery network of physicians to
employers and insurance companies in association with various health plans. PPOs
allow enrollees to receive care from participating physicians at contractually
negotiated rates. A PPO does not assume any financial risk from medical
utilization nor does it typically process claims payments to providers.
MEASUREMENT OF SEGMENT PROFIT OR LOSS
The Company evaluates performance and allocates resources based on profit or
loss from operations before income taxes, not including gains and losses on the
Company's investment portfolio. The accounting policies of the reportable
segments are the same as those described in the summary of significant
accounting policies.
Management does not allocate assets in the measurement of segment profit or
loss; therefore, jointly used assets are not allocated to the reportable
segments.
FACTORS MANAGEMENT USED TO IDENTIFY THE COMPANY'S REPORTABLE SEGMENTS
The Company's reportable segments are business units that offer different
products. The reportable segments are each managed separately because of the
range of benefit plans offered for providing health care coverage to enrollees.
52
REPORTABLE SEGMENTS
-----------------------------------------------------------------
(in thousands) Risk Medicare PPO All Other Totals
-----------------------------------------------------------------
Year ended December 31, 1998:
Revenue from external customers $1,040,701 $46,414 $20,501 $ 63,971 $1,171,587
Segment profit (loss) 13,251 (6,778) 10,748 519 17,740
-----------------------------------------------------------------
(in thousands) Risk Medicare PPO All Other Totals
-----------------------------------------------------------------
Year ended December 31, 1997:
Revenue from external customers $ 917,613 $53,665 $18,351 $106,983 $1,096,612
Segment profit (loss) 7,282 (14,799) 9,543 5,095 7,121
-----------------------------------------------------------------
(in thousands) Risk Medicare PPO All Other Totals
-----------------------------------------------------------------
Year ended December 31, 1996:
Revenue from external customers $ 878,060 $55,542 $16,376 $169,380 $1,119,358
Segment profit (loss) (743) (25,555) 9,171 (2,048) (19,175)
The sources of revenue included in the All Other category are composed primarily
of Medicaid and miscellaneous. All revenue is generated within the United
States.
--------------------------------------------
(in thousands) 1998 1997 1996
--------------------------------------------
Revenues
Total external revenues for reportable segments $1,107,616 $ 989,629 $ 949,978
Other revenues 63,971 106,983 169,380
Investment revenue not allocated 10,622 15,041 14,384
Gain on sale of real estate 5,692
---------- ---------- ----------
Total consolidated revenues $1,187,901 $1,111,653 $1,133,742
========== ========== ==========
Pretax Profit or Loss
Total profit or loss from reportable segments $ 17,221 $ 2,026 $ (17,127)
Other profit or loss 519 5,095 (2,048)
Net investment income not allocated 10,091 14,319 14,240
Gain on sale of real estate 5,692
Federal Employee Health Benefit Program
potential settlement (16,500)
Loss on retirement of equipment (4,787)
---------- ---------- ----------
Total consolidated pretax profit (loss) $ 12,236 $ 21,440 $ (4,935)
========== ========== ==========
53
NOTE 16 - COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted Statement 130, "Reporting
Comprehensive Income". Statement 130 establishes new rules for the reporting and
display of comprehensive income and its components; however, the adoption of
this statement had no impact on the Company's net income or stockholders'
equity. Statement 130 requires unrealized gains and losses on the Company's
available-for-sale securities, which prior to the adoption were reported
separately in the stockholders' equity to be included in other comprehensive
income. Prior year financial statements have been reclassified to conform to the
requirements of Statement 130.
Changes in accumulated other comprehensive income related to changes in
unrealized gains (losses) on securities net-of-tax were as follows:
-----------------------------------------
(in thousands) 1998 1997 1996
-----------------------------------------
Unrealized holding gains arising during period $ 2,055 $ 5,573 $ 2,296
Less: Reclassification adjustment for
net gains included in net income 1,688 4,892 3,566
------- ------- -------
Net unrealized gain (loss) recognized in
other comprehensive income $ 367 $ 681 $(1,270)
======= ======= =======
54
Report of Independent Auditors
Board of Directors and Stockholders
Mid Atlantic Medical Services, Inc.
We have audited the accompanying consolidated balance sheets of Mid Atlantic
Medical Services, Inc. and subsidiaries as of December 31, 1998 and 1997, and
the related consolidated statements of operations, changes in stockholders'
equity and cash flows for each of the three years in the period ended December
31, 1998. Our audits also included the financial statement schedule listed in
the Index at Item 14(a). These financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audits.
We have conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Mid
Atlantic Medical Services, Inc. and subsidiaries at December 31, 1998 and 1997,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule, when considered in relation to the financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
/s/ Ernst & Young LLP
----------------------
Ernst & Young LLP
Washington, D.C.
February 24, 1999
55
SELECTED QUARTERLY FINANCIAL DATA FOR FISCAL YEARS 1998 AND 1997
1998 1998 1998 1998 1997 1997 1997 1997
First Second Third Fourth First Second Third Fourth
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- ------- ------- ------- ------- ------- -------
(in thousands except share amounts)
(unaudited)
Revenue $289,502 $294,225 $299,546 $304,628 $283,165 $282,443 $269,875 $276,170
Expense 278,843 288,496 310,685 297,641 281,856 278,014 262,685 267,658
Income (loss) before income taxes 10,659 5,729 (11,139) 6,987 1,309 4,429 7,190 8,512
Net income (loss) 6,690 3,585 (6,743) 5,513 806 2,788 4,726 6,169
Basic earnings (loss) per share .14 .08 (.15) .13 .02 .06 .10 .13
Diluted earnings (loss) per share .14 .08 (.15) .13 .02 .06 .10 .13
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
56
Part III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is incorporated by reference to "Directors
and Executive Officers" in the Proxy Statement for MAMSI's annual meeting of
shareholders to be held on April 26, 1999.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to "Directors
and Executive Officers -- Directors' Compensation" and "Executive Management
Compensation" in the Proxy Statement for MAMSI's annual meeting of shareholders
to be held on April 26, 1999.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to "Stock
Owned by Management" and "Principal Stockholders" in the Proxy Statement for
MAMSI's annual meeting of shareholders to be held on April 26, 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to "Executive
Management Compensation" in the Proxy Statement for MAMSI's annual meeting of
shareholders to be held on April 26, 1999.
57
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1)
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PAGE
----
Consolidated Balance Sheets as of December 31, 1998 and 1997 ... 31
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996 ............................. 32
Consolidated Statements of Changes in Stockholders' Equity
for the years ended December 31, 1998, 1997 and 1996 ......... 33
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996 ............................. 34
Notes to Consolidated Financial Statements ..................... 35
Report of Ernst & Young LLP Independent Auditors ............... 54
(a)(2) and (d)
INDEX TO FINANCIAL STATEMENT SCHEDULE PAGE
----
II - Valuation and Qualifying Accounts as of December 31,
1998, 1997 and 1996 ..................................... 58
All other schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are omitted because they
are not required under the related instructions or are inapplicable.
58
Mid Atlantic Medical Services, Inc.
Schedule II - Valuation and Qualifying Accounts
(in thousands)
Additions
Balance at ------------------------------
Beginning Charged to Charged to Balance
of Costs Other Deductions- at End
Description Period and Expenses Accounts Write-Offs of Period
- ----------- ---------- ------------- ---------- ----------- ---------
DEDUCTED FROM ASSET ACCOUNTS:
YEAR ENDED DECEMBER 31, 1996
Allowance for doubtful accounts - accounts receivable
$ 3,638 $ $ 1,756(1) $ (28) $ 5,366
======== ======== ======== ======== ========
Valuation allowance - deferred tax assets
$ 128 $ $ 634 $ $ 762
======== ======== ======== ======== ========
YEAR ENDED DECEMBER 31, 1997
Allowance for doubtful accounts - accounts receivable
$ 5,366 $ $ (93)(1) $ (93) $ 5,180
======== ======== ======== ======== ========
Valuation allowance - deferred tax assets
$ 762 $ $ 325 $ (25) $ 1,062
======== ======== ======== ======== ========
YEAR ENDED DECEMBER 31, 1998
Allowance for doubtful accounts - accounts receivable
$ 5,180 $ 143 $ (309)(1) $ 200 $ 5,214
======== ======== ======== ======== =======
Valuation allowance - deferred tax assets
$ 1,062 $ 1,228 $ $ $ 2,290
======== ======== ======== ======== =======
(1) The changes to the allowance were charged to premium revenue.
59
(a)(3)
EXHIBITS
See the Exhibit Index on pages 62-63 of this Form 10-K.
(b)
REPORTS ON FORM 8-K
None.
60
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, the
registrant has caused this report to be signed on its behalf by undersigned
thereunto duly authorized.
MID ATLANTIC MEDICAL SERVICES, INC. ("MAMSI")
(Registrant)
By: /s/ Mark D. Groban, M.D. 3/29/99
--------------------------------------------------
Mark D. Groban, M.D. Date
Chairman of the Board and Director
Pursuant to the requirements of the Exchange Act, this report has been signed
below by the following persons on behalf of the registrant and in the capacities
and on the dates indicated.
By: /s/ Thomas P. Barbera 3/29/99
--------------------------------------------------
Thomas P. Barbera Date
Vice Chairman of the Board, President,Chief Executive Officer and
Director
By: /s/ Francis C. Bruno, M.D. 3/29/99
---------------------------------------------------
Francis C. Bruno, M.D. Date
Director
By: /s/ John H. Cook, III, M.D. 3/29/99
---------------------------------------------------
John H. Cook, III, M.D. Date
Director
By: /s/ Raymond H. Cypess, D.V.M., Ph.D. 3/29/99
---------------------------------------------------
Raymond H. Cypess, D.V.M., Ph.D. Date
Director
By: /s/ Stanley M. Dahlman, Ph.D. 3/29/99
--------------------------------------------------
Stanley M. Dahlman, Ph.D. Date
Director
By: /s/ Robert E. Foss 3/29/99
--------------------------------------------------
Robert E. Foss Date
Senior Executive Vice President and Chief Financial Officer and
Director
(Principal Financial Officer)
By: /s/ Mark D. Groban, M.D. 3/29/99
--------------------------------------------------
Mark D. Groban, M.D. Date
Chairman of the Board and Director
(Principal Executive Officer)
By: /s/ Christopher E. Mackail 3/29/99
--------------------------------------------------
Christopher E. Mackail Date
Senior Vice President, Controller and Chief Accounting Officer
(Principal Accounting Officer)
By: /s/ John P. Mamana, M.D. 3/29/99
--------------------------------------------------
John P. Mamana, M.D. Date
Director
61
By: /s/ William M. Mayer, M.D. 3/29/99
--------------------------------------------------
William M. Mayer, M.D. Date
Director
By: /s/ Edward J. Muhl 3/29/99
--------------------------------------------------
Edward J. Muhl Date
Director
By: /s/ Gretchen P. Murdza 3/29/99
--------------------------------------------------
Gretchen P. Murdza Date
Chief Executive Officer of Homecare and Pharmacy
Subsidiaries and Director
By: /s/ James A. Wild 3/29/99
--------------------------------------------------
James A. Wild Date
Director
62
(a)(3), (b) and (c) List of Exhibits.
EXHIBIT INDEX
Location of Exhibit
Exhibit in Sequential
Number Description of Document Numbering System
- ------- ----------------------- -------------------
3.1 Copy of Certificate of Incorporation of MAMSI dated
October 7, 1986..........................................................(1)
3.2 Copy of Certificate of Amendment of MAMSI Certificate of
Incorporation dated April 23, 1990.......................................(4)
3.3 Amended and Restated By-laws of MAMSI as of February 25, 1999............
3.4 Copy of Certificate of Amendment of MAMSI Certificate of
Incorporation dated June 2, 1994.........................................(4)
10.5 Copy of Agreement between M.D. IPA and the United States
Secretary of Health and Human Services dated December 20, 1985...........(1)
10.20 Copy of Amendments to Agreement between M.D. IPA and the United
States Secretary of Health and Human Services dated December 24, 1987....(3)
10.26 1990 Non-Qualified Stock Option Plan.....................................(4)
10.27 Copy of 1990 Non-Qualified Stock Option Letter sent to Key Employees.....(4)
10.32 Copy of Contract between George T. Jochum and M.D. IPA for the period
January 1, 1991 through January 1, 1994..................................(4)
10.35 1991 Non-Qualified Stock Option Plan.....................................(4)
10.36 Copy of 1991 Non-Qualified Stock Option Letter sent to Key Employees.....(4)
10.41 Copy of Agreement between M.D. IPA and Surgical Care Affiliates, Inc.,
dated April 22, 1985.....................................................(4)
10.44 1992 Non-Qualified Stock Option Plan.....................................(4)
10.45 Copy of 1992 Non-Qualified Stock Option Letter sent to Key Employees.....(4)
10.48 Equipment Term Loan Agreement with Signet Bank dated March 25, 1991......(4)
10.50 Amendment to Revolving Loan Agreement with Signet Bank dated
June 19, 1991............................................................(4)
10.53 Amendments to the Stock Option Plans effective May 15, 1991..............(4)
10.54 Summary Plan Description of the Employees Cash or Deferred Profit
Sharing (401k) Plan dated October, 1991..................................(4)
10.55 Defined Benefit Plan Agreement with the Principal Financial Group which
was approved September 12, 1991..........................................(4)
10.57 Mortgage and Loan Agreement with Aid Association for Lutherans dated
October 4, 1990..........................................................(4)
10.60 1993 Non-Qualified Stock Option Plan.....................................(11)
10.61 1993 Non-Qualified Stock Option Letter Sent to Key Employees.............(11)
10.62 1992 Amendment to Employment Agreement Between George T. Jochum and
the Company..............................................................(11)
10.65 Agreement to Purchase 2301 Research Boulevard dated September 30, 1993...(2)
10.66 1994 Management Bonus Program............................................(3)
10.67 1994 Non-Qualified Stock Option Plan.....................................(3)
10.68 1994 Non-Qualified Stock Option Letter sent to Key Employees.............(3)
10.69 Revolving Loan Agreement with Signet Bank dated September 30, 1993.......(3)
10.71 Agreement between OCI and the State of Maryland governing the Medical
Assistance Program ("Medicaid") dated August 5, 1993.....................(3)
10.72 List of States in which MAMSI Life is Licensed to Operate................(3)
10.73 1995 Management Bonus Program............................................(4)
10.74 1995 Non-Qualified Stock Option Plan.....................................(4)
10.75 1995 Non-Qualified Stock Option Plan letter sent to Key Employees........(4)
10.76 Agreement between OCI and the Commonwealth of Virginia governing the
Medical Assistance Program ("Medicaid") dated May 27, 1994...............(4)
10.77 1995 Amendment to Employment Agreement between George T. Jochum and
the Company..............................................................(5)
10.78 1996 Management Bonus Program............................................(5)
10.79 1996 Non-Qualified Stock Option Plan.....................................(5)
10.80 Form of Agreement between MAMSI and Employees Granting Options
under the 1996 Non-Qualified Stock Option Plan...........................(5)
10.81 Form of Agreement between MAMSI and George T. Jochum Granting Options
under the 1996 Non-Qualified Stock Option Plan...........................(5)
10.82 Form of Agreement between MAMSI and Non-Employee Directors Granting
Options under the 1996 Non-Qualified Stock Option Plan...................(5)
10 Amended and Restated Compensation Trust Agreement dated
December 20, 1996........................................................(7)
10.1 Amended and Restated Common Stock Purchase Agreement dated
December 20, 1996........................................................(7)
10.2 Replacement Promissory Note dated December 20, 1996......................(7)
10.83 1997 Management Bonus Program............................................(8)
63
10.84 Form of Non-Qualified Stock Option Agreement for Options Granted
under 1991, 1992, 1993, 1994 and 1995 Non-Qualified Stock Option Plan....(9)
10.85 Agreement of Purchase of Real Property by Mid-Atlantic
Medical Services, Inc....................................................(10)
10.86 1997 Amendment to Employment Agreement between George T. Jochum
and the Company..........................................................(11)
10.87 1998 Non-Qualified Stock Option Plan.....................................(11)
10.88 1998 Senior Management Bonus Plan........................................(11)
10.89 1998 Management Bonus Plan...............................................(11)
10.90 Amendment to 1994 Non-Qualified Stock Option Plan........................(11)
10.91 Amendment to 1995 Non-Qualified Stock Option Plan........................(11)
10.92 Amendment to 1996 Non-Qualified Stock Option Plan........................(11)
10.93 1999 Employment Agreement Between George T. Jochum and the Company.......(11)
10.94 Form of Agreement between MAMSI and Employees Granting Options
under the 1998 Non-Qualified Stock Option Plan...........................(12)
10.95 Form of Agreement between MAMSI and George T. Jochum Granting Options
under the 1998 Non-Qualified Stock Option Plan...........................(12)
10.96 Form of Agreement between MAMSI and Non-Employee Directors Granting
Options under the 1998 Non-Qualified Stock Option Plan...................(12)
10.97 Memorandum to Employees and Form for Election Of Exchange
and Repricing of Stock Options...........................................(12)
10.98 Agreement of Purchase and Sale of Real Estate............................(13)
10.981 1999 Non-Qualified Stock Option Plan.....................................
10.982 1999 Senior Management Bonus Plan........................................
10.983 1999 Management Bonus Plan...............................................
10.984 Amended and Restated Stock Compensation Trust Agreement
dated January 11, 1999...................................................
10.985 Common Stock Purchase Agreement dated January 11, 1999...................
10.986 Allonge to Replacement Promissory Note dated January 11, 1999............
10.987 Employment Agreement between the Company and Mark D. Groban..............
10.988 Employment Agreement between the Company and Thomas P. Barbera...........
10.989 Employment Agreement between the Company and Robert E. Foss..............
10.990 Form of Executive Employment Agreement between the Company
and Executive Staff......................................................
10.991 Form of Agreement between MAMSI and Employees Granting Options
under the 1999 Non-Qualified Stock Option Plan...........................
10.992 Form of Agreement between MAMSI and Non-Employee Directors Granting
Options under the 1999 Non-Qualified Stock Option Plan...................
21 Subsidiaries of the Company..............................................
23 Consent of Independent Auditors..........................................
27 Financial Data Schedule..................................................
(1) Incorporated by reference to exhibits filed with the Company's Registration
Statement filed under the Securities Act of 1933 on Form S-4 (Registration No.
33-9803).
(2) Incorporated by reference to exhibits filed with the Company's Quarterly
Report filed under the Securities Exchange Act of 1934 on Form 10-Q for the
Quarterly Period Ended September 30, 1993.
(3) Incorporated by reference to exhibits filed with the Company's Annual Report
filed under the Securities Exchange Act of 1934 on Form 10-K for the fiscal year
ended December 31, 1993.
(4) Incorporated by reference to exhibits filed with the Company's Annual Report
filed under the Securities Exchange Act of 1934 on Form 10-K for the fiscal year
ended December 31, 1994.
(5) Incorporated by reference to exhibits filed with the Company's Quarterly
Report filed under the Securities Exchange Act on Form 10-Q for the Quarterly
Period Ended March 31, 1995.
(6) Incorporated by reference to exhibits filed with the Company's Annual Report
filed under the Securities Exchange Act of 1934 on Form 10-K for the fiscal year
ended December 31, 1995.
(7) Incorporated by reference to exhibits filed with the Company's Quarterly
Report filed under the Securities Exchange Act on Form 10-Q/A for the Quarterly
Period Ended September 31, 1996.
(8) Incorporated by reference to exhibits filed with the Company's Annual Report
filed under the Securities Exchange Act of 1934 on Form 10-K for the fiscal year
ended December 31, 1996.
64
(9) Incorporated by reference to exhibits filed with the Company's Quarterly
Report filed under the Securities Exchange Act on Form 10-Q for the Quarterly
Period Ended March 31, 1997.
(10) Incorporated by reference to exhibits filed with the Company's Quarterly
Report filed under the Securities Exchange Act on Form 10-Q for the Quarterly
Period Ended June 30, 1997.
(11) Incorporated by reference to exhibits filed with the Company's Annual
Report filed under the Securities Exchange Act of 1934 on Form 10-K for the
fiscal year ended December 31, 1997.
(12) Incorporated by reference to exhibits filed with the Company's Quarterly
Report filed under the Securities Exchange Act on Form 10-Q for the quarterly
Period March 31, 1998.
(13) Incorporated by reference to exhibits filed with the Company's Quarterly
Report filed under the Securities Exchange Act on Form 10-Q for the Quarterly
Period Ended September 30, 1998.