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
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO _________
For the Fiscal Year ended DECEMBER 31, 2002 Commission File Number 001-31513
WELLCHOICE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 71-0901607
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
11 WEST 42ND STREET
NEW YORK, NEW YORK 10036
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 476-7800
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
------------------- -----------------------------------------
COMMON STOCK, $0.01 PAR VALUE THE NEW YORK STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of 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. [X]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The aggregate market value of the Common Stock, par value $.01 per
share, held by non-affiliates based upon the reported last sale price of the
Common Stock on February 21, 2003 was approximately $466,324,506, assuming
1
solely for the purposes of this calculation that The New York Public Asset Fund
and all directors and executive officers of the registrant are "affiliates." The
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
The number of shares outstanding of the registrant's common stock, as
of March, 5, 2003 was 83,490,477 shares of common stock, $0.01 par value, and
one share of Class B common stock, $0.01 par value per share.
DOCUMENTS INCORPORATED BY REFERENCE
Some of the information required by Part III (Items 10, 11, 12 and
13) is incorporated by reference from the registrant's definitive proxy
statement, in connection with the registrant's 2003 Annual Meeting of
Stockholders, to be filed with the Securities and Exchange Commission (the
"Commission") pursuant to Regulation 14A no later than April 30, 2003 (the
"Proxy Statement").
2
WELLCHOICE, INC.
INDEX TO FORM 10-K
PAGE
PART I
Item 1 - Business.........................................................................................................4
Item 2 - Properties......................................................................................................43
Item 3 - Legal Proceedings.............................................................................................. 43
Item 4 - Submission of Matters to a Vote of Security Holders.............................................................45
PART II
Item 5 - Market for Registrant's Common Equity and Related Stockholder Matters...........................................47
Item 6 - Selected Financial Data.........................................................................................48
Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations........................................................................51
Item 7A - Quantitative and Qualitative Disclosures About Market Risk.....................................................67
Item 8 - Financial Statements and Supplementary Data ....................................................................69
Item 9 - Changes and Disagreements with Accountants on
Accounting and Financial Disclosure........................................................................69
PART III
Item 10 - Directors and Executive Officers of the Registrant.............................................................69
Item 11 - Executive Compensation.........................................................................................69
Item 12 -Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters.............................................................69
Item 13 - Certain Relationships and Related Transactions.................................................................69
Item 14 -Controls and Procedures.........................................................................................70
Item 15 - Exhibits, Financial Statement Schedules, and Reports on Form 8-K...............................................70
Signatures .................................................................................... .........................73
Section 302 Certifications...............................................................................................76
Index to Consolidated Financial Statements and Supplemental Schedules...................................................F-1
Index to Exhibits.......................................................................................................E-1
3
PART I
ITEM 1. BUSINESS.
In this report, "WellChoice," "company," "registrant," "we," "us,"
and "our" refer to WellChoice, Inc., a Delaware corporation, and as the context
requires, its subsidiaries.
This report contains forward-looking statements (within the meaning
of the Private Securities Litigation Reform Act of 1995) that include
information about possible or assumed future sales, results of operations,
developments, regulatory approvals or other circumstances. Statements that use
the terms "believe," "expect," "plan," "intend," "estimate," "anticipate,"
"project," "may," "will," "shall," "should" and similar expressions, whether in
the positive or negative, are intended to identify forward-looking statements.
All forward-looking statements in this report are based on management's
estimates, assumptions and projections and are subject to significant risks and
uncertainties, many of which are beyond our control. Important risk factors
could cause actual future results and other future events to differ materially
from those estimated by management. Those risks and uncertainties include but
are not limited to: our ability to accurately predict health care costs and to
manage those costs through underwriting criteria; quality initiatives and
medical management; product design and negotiation of favorable provider
reimbursement rates; our ability to maintain or increase our premium rates;
possible reductions in enrollment in our health insurance programs or changes in
membership; the regional concentration of our business; and the impact of health
care reform and other regulatory matters. For a more detailed discussion of
these and other important factors that may materially affect WellChoice, please
see our existing and future filings with the Commission, including the risk
factors set forth in "Item 1. Business - Additional Factors That May Affect
Future Results of Operations" and those contained in "Item 7. - Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
elsewhere in this report. Except as required by applicable law, including the
securities laws of the United States, we do not intend to update or revise any
forward-looking statements.
COMPANY OVERVIEW
We are the largest health insurance company in the State of New York
based on preferred provider organization, or PPO, and health maintenance
organization, or HMO, membership. At December 31, 2002, we served over 4.6
million members through our service areas. Our service areas include 10
downstate New York counties comprising the New York City metropolitan area,
where we hold a leading market position covering over 20% of the population,
upstate New York and New Jersey. We offer a broad portfolio of managed care and
insurance products primarily to private and public employers. Our managed care
product offerings include:
o health maintenance organizations, or HMOs;
o preferred provider organizations, or PPOs; and
o exclusive provider organizations, or EPOs.
We offer our products to our customers through a variety of funding
arrangements, including insured and self-funded, or administrative services only
(ASO). In addition, we have a broad customer base. Among our customers are large
groups of more than 500 employees, which include employees of New York State and
New York City as well as labor unions; middle-market groups, ranging from 51 to
500 employees; small groups, ranging from two to 50 employees; and individuals.
We also serve over one million members through our national accounts, which
include Fortune 500 companies.
4
We have the exclusive right to use the Blue Cross and Blue Shield
names and marks for all of our health benefits products in ten counties in the
New York City metropolitan area and in six counties in upstate New York and the
non-exclusive right to use these names and marks in one upstate New York county.
In addition, we have an exclusive right to use only the Blue Cross names and
marks in seven counties in our upstate New York service area and a nonexclusive
right to use only the Blue Cross names and marks in an additional four upstate
New York counties. Our membership in the Blue Cross Blue Shield Association also
enables us to provide our PPO, EPO and indemnity members access to the national
network of providers through the BlueCard program. This program allows these
members to access in-network benefits through the networks of Blue Cross Blue
Shield plans throughout the United States and over 200 foreign countries and
territories.
We have a long tradition of serving health insurance needs in New
York, having operated in the state for 69 years. We believe that our extensive
history, experience and understanding of operating in this unique marketplace,
combined with our strong relationships with providers and customers in our
service areas gives us a distinct competitive advantage in marketing our
products.
We have the largest hospital and physician networks of any health
insurer or HMO in our New York State service areas. Our provider networks
consist of many of the most well-recognized provider organizations.
We adhere to strict underwriting standards that have been proven
effective through our long experience in our principal markets. We continually
review and test our underwriting and pricing guidelines on a product-by-product
and customer group-by-group basis to ensure that our products remain competitive
in terms of both quality of service and price.
Our dedication to customer service is reflected in our efforts to
make meaningful information available to our customers, brokers and providers
and to address their inquiries in an efficient and prompt manner. Our telephone
inquiry satisfaction rate, which we currently measure on a daily and monthly
basis through surveys of members, has improved from approximately 70% during the
first quarter of 1996, to approximately 88% during the fourth quarter of 2002.
In addition, we utilize technology to deliver more useful and practical
information to our customers and providers. We have introduced member, employer,
broker and provider Internet portals. For example, our physicians are now able
to submit their claims via the Internet and have these claims adjudicated in
real-time. We also pay medical claims promptly, building loyalty with our
providers and members.
We have demonstrated our commitment to quality care. We have in place
a number of wellness, disease prevention and health education programs. We
employ early intervention programs that aim to identify potential issues in
physician-recommended treatments, such as adverse drug interactions, skipped
preventive screenings or overlooked tests as well as analyze information to
identify and recommend treatment of high-risk members before more significant
medical problems occur and expensive treatment is needed. We also participate in
initiatives to rate and report on hospital quality in order to eliminate
preventable medical errors and improve clinical outcomes.
We have been successful in enhancing and consolidating our
information technology and implementing innovative technologies. We have
consolidated multiple claims, membership and billing systems into two platforms
and intend to further consolidate these two platforms into one. Our success in
these initiatives has allowed us to eliminate inconsistencies and operational
inefficiencies. For example, our "first-pass rate," or the rate at which a claim
is properly approved for payment after the first time it is processed by our
system without requiring human intervention, for physician claims, improved from
71.6% in 1998 to 87.8% in the second half 2002 and, for hospital claims,
improved from 43.8% in 1998 to 72.1% in the second half of 2002.
5
INDUSTRY OVERVIEW
The managed healthcare industry has experienced significant change.
The increasing focus on health care costs by employers, the government and
consumers has led to the growth of alternatives to traditional indemnity health
insurance. HMO, PPO and EPO plans are among the various forms of managed care
products that have developed. Through these products and other innovative
programs, participants in the health care industry have incentives to provide
plan members with high quality and cost-efficient care. The cost of health care
is contained, in part, by negotiating contracts with hospitals, physicians and
other providers to deliver care at favorable rates and adopting programs to
ensure that appropriate and cost-effective care is provided.
In addition, economic factors and greater consumer awareness have
resulted in the increasing popularity of products that offer larger, more
extensive networks, more member choice related to coverage and the ability to
self-refer within those networks. There is also a growing preference for greater
flexibility to assume larger deductibles and co-payments in exchange for lower
premiums. At the same time, organizations and individuals are placing an
increased focus on the quality of health care and the level of sophistication
and customer service in delivering service. Groups and providers are also
demanding prompt and accurate payment of claims, including automated claims
payment options.
The Blue Cross Blue Shield Association and its member plans have also
undergone significant change. Historically, most states had at least one Blue
Cross (hospital coverage) and a separate Blue Shield (physician coverage)
company. Prior to the mid-1980s, there were more than 125 separate Blue Cross or
Blue Shield companies. Many of these organizations have merged, reducing the
number of independent licensees to 42 as of December 2002. We expect this trend
to continue, with plans merging or affiliating to address capital needs and
other competitive pressures. At the same time, the number of people enrolled in
Blue Cross Blue Shield plans has been steadily increasing, from 65.6 million in
1995 to 84.9 million at September 30, 2002.
The Blue Cross Blue Shield plans work together in a number of ways
that create significant market advantages, especially when competing for very
large, multi-state employer groups. For example, all Blue Cross Blue Shield
plans participate in the BlueCard program, which effectively creates a national
"Blue" network. Each plan is able to take advantage of other Blue Cross Blue
Shield plans' broad provider networks and negotiated provider reimbursement
rates where a member covered by a policy in one state lives or travels outside
of the state in which the policy under which he or she is covered is written.
This makes it possible for individual Blue Cross Blue Shield plans to compete
for national accounts business with other non-"Blue" plans with nationwide
networks.
OUR STRATEGY
Our goal is to be the leading health insurer in the New York
marketplace and surrounding areas. During the past several years, we have
implemented strategic changes to achieve this goal, including shifting our
membership base from purchasers of mainly traditional indemnity products to more
innovative managed care products, standardizing our product offerings and
consolidating our networks and claims payment systems. We plan to continue to
maintain and improve our market position and financial performance by executing
the following strategy:
6
o Capitalize on Growth Opportunities.
-- Offer a broad spectrum of managed care products in our
local markets. We intend to continue to grow our business,
particularly in the profitable middle-market customer
segment, by maintaining, developing and offering the broad
continuum of managed care products that the New York market
demands. Generally, the breadth and flexibility of our
benefit plan options are designed to appeal to a variety of
employer groups and individuals with differing product and
service preferences. We believe that customer needs will
continue to change, requiring us to increase the variety of
products we offer. These will include closely managed HMO
products, a broad PPO network that contains nearly every
hospital and offers the broadest physician network in the
market and an EPO product with no out-of-network benefit.
We are also developing a point of service, or POS, product,
to be offered to our small and middle market HMO accounts
later this year. Product variations will include freedom in
selecting providers, cost sharing, scope of coverage and
degree of medical management.
-- Grow our national accounts business. We view national
accounts as an attractive growth opportunity, as this group
represents approximately 38% of employed persons in the
United States. We believe our position in the New York City
metropolitan area, where a significant number of national
businesses have offices, provides us with a competitive
advantage in our efforts to grow the business. In addition,
we intend to continue to grow national accounts business
through the promotion of the BlueCard program.
-- Expand geographically. We also intend to pursue
expansion opportunities, especially those in or adjacent to
our current service areas. We believe that we have
developed an expertise in systems migration, network
development, marketing, underwriting and cost control that
is transferable to attractive markets within and outside
New York and which positions us to take advantage of
opportunities that may arise as the consolidation of the
health insurance industry continues.
o Leverage the Strength of the Blue Cross and Blue Shield
Brands. We believe that our license to use the Blue Cross and Blue
Shield names and marks gives us a significant competitive advantage
in New York, and we intend to continue to promote the value of these
brands to attract additional customers and members.
o Continue to Promote the Use of Medical Information to Offer
Innovative Products and Services to Members and Providers. We intend
to be a leader in the use of medical information to facilitate and
enhance communications and delivery of service among employers,
employees and other health care providers. We believe that our
members will increasingly desire and demand ready access to a
repository of comprehensive, accurate and secure medical and
health-related information that can be transmitted by the member to
physicians and medical institutions.
o Reduce Costs through Operational Excellence. We are seeking to
achieve operational excellence by improving delivery of service,
customer satisfaction and financial results through zero defects,
rapid turnaround times and lower operating costs. We have identified
three key areas that reduce medical and administrative costs:
administrative performance; quality of care and medical management
initiatives; and technology enhancements. We are executing a number
of initiatives that we believe will enable us to realize benefits in
each of these areas. For example, we recently entered into a
collaboration with IBM to modernize our legacy systems applications.
7
OUR NEW YORK REGIONAL MARKETS
New York is the third most populous state in the United States, with
a total population of approximately 19.2 million, according to the most recent
U.S. census estimates. We believe we can significantly increase our market share
through focused market efforts on a cost effective basis, given the high
population density in selected markets such as the New York City metropolitan
area. The New York marketplace is also comprised of a diverse customer base
requiring a broad range of product offerings and we believe our extensive
experience, understanding of and history of operating in this unique marketplace
combined with our leading market share and brand recognition provides us with a
distinct competitive advantage.
We operate in 28 counties in New York, including ten counties in the
New York City metropolitan area, and 16 counties in New Jersey. In our New York
service areas, we provide our products and services through our indirect, wholly
owned subsidiaries, Empire HealthChoice Assurance, or Empire, a New York
licensed accident and health insurer, and Empire HealthChoice HMO, a New York
and New Jersey licensed HMO. The following table demonstrates our service areas
by region (including in New Jersey), population (based on the 2000 census),
membership by residence (as of December 31, 2002) and branding:
REGION COUNTIES POPULATION MEMBERSHIP (1) BRANDING
------ --------------------------------------- ---------- -------------- --------
IN THOUSANDS IN THOUSANDS
New York City New York, Bronx, Richmond, Queens, Kings, 12,068 2,466 Exclusive licenses to use
Metropolitan area Nassau, Suffolk, Westchester, Rockland, Blue Cross and Blue Shield
Putnam names and marks
Upstate New York Dutchess, Orange, Sullivan, Ulster, 985 255 Exclusive licenses to use
Columbia, Greene the Blue Cross and Blue
Shield names and marks
Delaware 48 6 Non-exclusive licenses to
use the Blue Cross and Blue
Shield names and marks
Albany, Rensselaer, Saratoga, Schenectady, 950 176 Exclusive license to use
Achoharie, Warren, Washington only the Blue Cross names
and marks
Clinton, Essex, Fulton, Montgomery 224 36 Non-exclusive license to use
only the Blue Cross names
and marks
New Jersey Bergen, Burlington, Camden, Essex, Hudson, 7,124 234 (2) WellChoice
Hunterdon, Mercer, Middlesex, Monmouth,
Morris, Ocean, Passaic, Somerset, Sussex,
Union, Warren
(1) Excludes 1.4 million members who reside outside of our service
areas but includes the portion of our 1.0 million national account members who
reside in any of our New York or New Jersey service areas.
(2) Includes members who are employed by customers of our New York
State operations.
Our New Jersey operations are operated under the WellChoice brand
comprised of WellChoice Insurance of New Jersey and Empire HealthChoice HMO
8
d/b/a WellChoice HMO of New Jersey, which engages in managed care business in
New Jersey. Our New Jersey operations were launched in 1998 and offer a
comprehensive network of providers across Northern and Central New Jersey and we
expanded our New Jersey service area in 2001 to include the Southern New Jersey
counties of Burlington, Camden and Ocean.
We also market our Blue Cross Blue Shield products and services to
national accounts customers, generally large, multi-state employers. As of
December 31, 2002, approximately 22% of our members were covered under national
accounts. The national accounts are generally self-funded employers to which we
provide our products on an ASO basis with their employees having access to a
nationwide network of providers through the BlueCard program.
Substantially all of our revenue is derived from group accounts that
have an office in our service areas in New York State or from individual members
who reside in the state.
HEALTH CARE BENEFITS, PRODUCTS AND SERVICES
We offer a wide range of health insurance products. Our offerings
include managed care products consisting of HMO, PPO and EPO plans and
traditional indemnity products. Our principal health products are offered both
on an insured and, except with respect to our HMO products, self-funded, or ASO,
basis and, in some instances, in a combination of insured and self-funded.
The following table illustrates our health benefits membership by
product as of December 31, 2002:
MEMBERSHIP PERCENTAGE
---------------- --------------
(IN THOUSANDS)
Commercial managed care:
Group PPO, HMO, EPO and other(1)(2) 2,019 43.8%
New York City and New York State PPO 1,786 38.8
------------ -----------
Total commercial managed care 3,805 82.6
Other insurance products and services:
Indemnity 567 12.3
Individual 236 5.1
------------ -----------
Total other insurance products and services 803 17.4
------------ -----------
Overall total 4,608 100.0%
------------ -----------
________________
(1) Our HMO product includes Medicare+Choice. As of December 31,
2002, we had approximately 55,000 members enrolled in
Medicare+Choice.
(2) "Other" principally consists of our members enrolled in dental
only coverage.
Revenues from external customers, investment income and realized
gains, other revenue and income from continuing operations before income tax
expense attributable to each of our reportable segments are set forth in Note 18
to the Consolidated Financial Statements, which are included elsewhere in this
report. Assets are not allocated to the segments. We do not have intersegment
sales or expenses.
9
COMMERCIAL MANAGED CARE PRODUCTS
Managed care generally refers to a method of integrating the
financing and delivery of health care within a system that manages the cost,
accessibility and quality of care. Managed care products can be further
differentiated by the types of provider networks offered, the ability to use
providers outside such networks and the scope of the medical management and
quality assurance programs. Our members receive medical care from our networks
of providers in exchange for premiums paid by the individuals or their employers
and, in some instances, a co-payment by the member. We reimburse the providers
according to pre-established fee arrangements and other contractual agreements
that encourage use of the most appropriate care.
We currently offer three types of managed care plans: an HMO product,
a PPO product and an EPO product.
HMO. Our HMO plan provides members and their dependent family members
with all necessary health care for a fixed monthly premium in addition to
applicable member co-payments. Health care services can include emergency care,
inpatient hospital and physician care, outpatient medical services and
supplemental services, such as dental, behavioral health and prescription drugs.
Under our standard HMO product, members must select a primary care physician
within the network to provide and assist in managing care, including referrals
to specialists. We also offer a Direct Connection HMO product, which offers all
the advantages of our standard HMO product, but allows our members to seek care
from in-network specialists without a referral. We also provide services to
Medicare recipients through our Medicare+Choice product, which covers all
Medicare covered services, Medicare deductibles and coinsurance and certain
additional services. Members receive all covered medical care through physicians
selected from the applicable provider network.
PPO. Similar to an HMO, a PPO managed care plan provides members and
their dependent family members with health care coverage in exchange for a fixed
monthly premium. Our PPO provides its members with a larger network of providers
than our HMO. These providers represent a broad spectrum of medical specialties,
and members do not have to obtain any referrals from primary care providers in
order to obtain access to these specialists. A PPO differs from a standard HMO
in that members are not required to select a primary care physician or obtain a
referral to utilize in-network specialists and also provides coverage for
members who access providers outside of the network. Out-of-network benefits are
usually subject to a deductible and coinsurance. Our PPO also offers national
in-network coverage to its members through the BlueCard program. For our New
York State and New York City accounts we provide a hospital-only network
benefit.
EPO. Our EPO plan is similar to our PPO managed care plan but does
not cover out-of-network care. Members may choose any provider from our EPO
network in our New York service area and do not need to select a primary care
physician. Outside of our service area in New York State, EPO members may use
the BlueCard program to secure in-network benefits nationally. We currently
offer an EPO product only to New York State employers and to national accounts
on a self-funded basis. For national accounts needing coverage in jurisdictions
where the EPO product is prohibited, we offer a variation of this product that
requires a 50% coinsurance payment for out-of-network services.
BLUECARD
For our members who purchase our PPO, EPO and indemnity products
under a Blue Cross Blue Shield plan, we offer the BlueCard program. The BlueCard
program offers members in-network benefits through the networks of the other
Blue Cross Blue Shield plans in other states and regions. In addition, the
BlueCard program offers our members in-network coverage in over 200 countries
and territories. We believe that the national and international coverage
provided by this program allows us to compete effectively with large national
insurers, without compromising our focus and concentration in our geographical
region. We derive administrative fees from other Blue Cross Blue Shield plans
10
when their members receive medical care from providers in our service areas. In
2002, approximately 367,000 members of other Blue Cross Blue Shield plans
utilized our provider networks through the BlueCard programs. We also pay other
Blue Cross Blue Shield plans administrative fees when our members receive
medical care from providers in those other plans' service areas.
OTHER INSURANCE PRODUCTS AND SERVICES
TRADITIONAL HOSPITAL ONLY AND INDEMNITY
We provide indemnity health insurance, which generally reimburses the
insured for a portion of actual costs of health care services rendered by
physicians, hospitals and other providers. Persons with indemnity insurance are
not restricted to receiving professional medical services from a specified
provider network. Our indemnity products include hospital-only coverage and
comprehensive hospital and medical coverage.
INDIVIDUAL PRODUCTS
We also offer a number of individual products, including Child Health
Plus, Medicare supplemental, Healthy New York (whether purchased by groups or by
individuals), Direct Pay hospital-only and the New York State-mandated, direct
pay HMO and HMO based point of service products. Child Health Plus provides a
managed care product similar to our HMO products to children under the age of
nineteen who are ineligible for Medicaid and not otherwise insured. Our Medicare
supplemental insurance policy, also referred to as a Medigap policy, is designed
to supplement Medicare by paying hospital, medical and surgical expenses as well
as, in some cases, prescription drug for a portion of the fees not covered by
Medicare. Direct Pay hospital-only is a low-cost policy that covers primarily
inpatient services on an indemnity basis and Healthy New York is a
state-mandated HMO product. We also serve as fiscal intermediary for the
Medicare Part A program and a carrier for the Medicare Part B program, for which
we receive reimbursement of certain costs and expenses at predetermined levels.
In addition, we offer dental coverage on a PPO basis and other dental managed
care products.
ADMINISTRATIVE SERVICES ONLY
In addition to our insured plans, we also offer selected products,
including PPO, EPO and traditional benefit designs, on a self-funded, or ASO,
basis where we provide claims processing and other administrative services to
employers. Employers choosing to purchase our products on an ASO basis fund
their own claims but their employees are able to access our provider network at
our negotiated discounted rates. We administer the payment of claims to the
providers but we do not bear any insurance risk in connection with claims costs
because we are reimbursed in full by the employer. The administrative fee
charged to self-funded groups is generally based on the size of the group and
services provided. Our primary ASO customers are large national accounts and
large local groups (over 500 employees).
MARKETING AND DISTRIBUTION
Our marketing activities concentrate on promoting our strong brands,
quality care, customer service efforts, the size and quality of our provider
networks, our financial strength and the breadth of our product offerings. We
distribute our products through several different channels, including our
salaried and commission-based internal sales force, independent brokers and
telemarketing staff. We also use our Website to market our products.
11
Branding and Marketing. Our branding and marketing efforts include
"brand advertising," which focuses on the Blue Cross and Blue Shield names and
marks, "acquisition marketing," which focuses on attracting new customers, and
"institutional advertising," which focuses on our overall corporate image. We
believe that the strongest element of our brand identity is the "Cross and
Shield." We seek to leverage what we believe to be the high name recognition and
comfort level that many existing and potential customers associate with this
brand. Also, the BlueCard program is an important component of our Blue Cross
Blue Shield marketing strategy as it enables us to compete for large multi-state
employer groups. Acquisition marketing consists of business to business
marketing efforts which are used to generate leads for brokers and our sales
force as well as direct to consumer marketing which is used to add new customers
to our direct pay businesses. Institutional advertising is used to promote key
corporate interests and overall company image. We believe these efforts support
and further our competitive brand advantage. Our strategy will be to continue
utilizing the Blue Cross and Blue Shield brands for all products and services in
our service areas in New York and to continue to establish the WellChoice brand
outside of New York.
Distribution. We employ our sales force through our wholly owned
subsidiary, EHC Benefits Agency, Inc. As of January 7, 2003, our sales force
consisted of over 100 people. We also utilize the services of approximately
4,200 independent brokers in New York and approximately 1,600 in New Jersey. In
addition, we employ 18 general agents to distribute our products in New Jersey,
as well as five general agents to distribute our products to middle-market and
large groups in New York. Several account representatives and managers are
dedicated exclusively to maintaining our relationships with our national
accounts and labor union customers. We rely on independent brokers to market our
products to small and middle-market groups. Our telemarketing division and our
direct sale divisions are primarily responsible for marketing our managed health
care plans to small groups. We believe that each of these marketing methods is
optimally suited to address the specific health insurance needs of the customer
base to which it is assigned.
We compete for qualified brokers and agents to distribute our
products. Strong competition exists among health insurance companies and health
benefits plans for brokers and agents with demonstrated ability to secure new
business and maintain existing accounts. The basis of competition for the
services of such brokers and agents are commission structure, support services,
reputation and prior relationships, the ability to retain clients and the
quality of products. We believe that our brokers gain significant benefits from
our broker Internet portal, which enables brokers to obtain quotes for our small
group products over the Internet. We believe that we have good relationships
with our brokers and agents, and that our products, support services and
commission structure are highly competitive in the marketplace.
12
CUSTOMERS
The following chart shows our membership by customer group at
December 31, 2002:
MEMBERSHIP PERCENTAGE
-------------------- --------------------
(IN THOUSANDS)
Large group 2,903 63.0%
Small group and middle market 394 8.6
Individuals 290 6.2
National accounts 1,021 22.2
-------------------- --------------------
Total 4,608 100.0%
-------------------- --------------------
We sell products to customers ranging in size from large national
institutional accounts to individuals. We continually seek to obtain an optimal
and balanced portfolio of business across all of our customer segments.
Large Groups. This customer base consists of large organizations with
operations in our service areas that have more than 500 employees and includes
New York State, New York City and local governmental employers and labor unions.
Our large corporate accounts purchase our products on both an insured and ASO
basis. We sell our products to New York State and New York City in their
capacity as employers. As of December 31, 2002, New York State and New York City
employees covered under our PPO product represented 21.4% and 17.4%,
respectively, of our total membership enrollment and labor unions represented
11.7% of our membership enrollment. The pricing of our PPO products provided to
New York State and New York City historically have been renegotiated annually.
Effective January 1, 2003, we agreed to new pricing with New York State covering
a three-year period through December 31, 2005, though each party retains the
right to terminate the contract on six months' notice. The New York City account
is currently under renegotiation based upon a competitive bid process that is
open to us and to third parties. The contract awarded to the winner of this
competitive bid process is expected to commence July 1, 2003. We had rates in
place through December 31, 2002 with respect to our PPO products with the New
York City account. We are currently negotiating the pricing of our PPO products
with New York City for the first six months of 2003. The loss of one or both of
the New York City and New York State accounts would result in reduced membership
and revenue and require us to reduce, reallocate or absorb administrative
expenses associated with these accounts.
Small Group and Middle Market. This customer base consists of smaller
(two to 50 employees) and mid-sized (51 to 500 employees) companies. Our smaller
groups have tended to purchase HMO products, while our middle market groups are
covered by a mix of our HMO, PPO and EPO products. Our middle and small market
groups are our most profitable customer base and we intend to continue to grow
our business in these key markets. To build our business in the middle and small
markets, we will continue to develop and release new products and services based
on portfolio analyses and market research. Among other things, we are developing
a point of service, or POS, product for this market. POS plans have all the
features of an HMO, except that enrollees can also use out-of-network providers
in return for deductibles and/or co-insurance. We anticipate that the POS
product will be available to our small group HMO accounts in New York in
mid-2003 and that the POS product will be available to larger HMO accounts later
this year.
13
Individuals. This customer base consists principally of members who
utilize our government-related products including Child Health Plus, Medicare
supplemental, Medicare+Choice, Healthy New York, Direct Pay hospital-only and
two New York State-mandated direct pay HMO and HMO based point of service
products.
National Accounts. National accounts consist of large multi-state
employers for whom technology, flexibility, access to the BlueCard program and
single-point accountability are important factors. National accounts often
engage consultants to work with our in-house sales staff to tailor benefits to
their needs. Substantially all of our national accounts purchase our products on
an ASO basis. In order to provide ASO services and access to the BlueCard
program to customers that are headquartered outside of our licensed areas, we
are required under our Blue Cross and Blue Shield licenses to obtain the consent
of the Blue Cross Blue Shield plan licensed in the service area in which the
customer is headquartered, a process referred to as "ceding."
UNDERWRITING AND PRICING
Disciplined underwriting and appropriate pricing are core strengths
of our business and we believe are an important competitive advantage. We
continually review our underwriting and pricing guidelines on a
product-by-product basis in order to maintain competitive rates in a manner that
is consistent with our long-term commitment to quality care. As a result of our
disciplined approach to underwriting and pricing, we have attained consistent
profitability in our insured book of business.
Our claims database enables us to establish rates based on our own
experience and provides us with important insights about the risks in our
service areas. We tightly manage the overall rating process and have processes
in place to ensure that underwriting decisions are made by properly qualified
personnel. In addition, we have developed and implemented a sophisticated
process to detect fraudulent groups and employees.
Our rating policies in New York differ by group size product offerings.
Our middle-market and large group accounts for EPO, PPO and indemnity products
are experience rated. This means that our premium rate for each of these
accounts is calculated based upon demographic criteria such as age, gender,
industry and region and experience criteria, referring to the actual cost of
providing health care to that group during a period of coverage. For
middle-market groups, the rates are set prospectively. For large groups with
PPO, EPO or traditional benefit designs, we employ prospective and retrospective
ratings. Our New York City and New York State accounts are retrospectively
rated. In retrospective rating, a premium rate is determined at the beginning of
the policy period. Once the policy period has ended, the actual experience is
reviewed. If the experience is positive (actual claim costs and other expenses
are less than those expected), then a refund may be credited to the policy. If
the experience is negative, then under most of our contracts the deficit is
recovered from future years' refunds, but if the customer elects to terminate
coverage, deficits cannot be recovered. Other contracts, however, allow us to
call in additional premiums to cover a portion or all of the deficit
immediately.
Our HMO products sold in New York State, as well as all other insured
products purchased by small groups and individuals, are community rated. The
premiums for community rated products are set according to our expected costs of
providing medical benefits to the community pool as a whole, rather than to any
customer or sub-group of customers within the community. We cannot factor in
other criteria in rating our premiums for these products, other than Medicare
eligibility. We use a variation of community rating in New Jersey for all small
group products. All of our community rated products in New Jersey are determined
for a community pool according to the age, sex and county of residence of the
members.
14
Both the New York and New Jersey community rated products are set
prospectively, meaning that a fixed premium rate is determined at the beginning
of the policy period. Unanticipated increases in cost of benefits provided may
not be able to be recovered in that current policy year. However, prior
experience, in the aggregate, is considered in determining premium rates for
future periods.
With respect to our Medicare+Choice plan, we have a contract with the
Centers for Medicare and Medicaid Services, or CMS, to provide HMO
Medicare+Choice coverage to Medicare beneficiaries who choose health care
coverage through our HMO program in New York City and Nassau, Suffolk, Rockland
and Westchester counties in New York State. Under this annual contract, CMS pays
us a set rate based on membership that is adjusted for demographic factors. In
addition, the Medicare product offered by us in Nassau, Suffolk, Rockland and
Westchester counties requires a supplemental premium to be paid by the member.
QUALITY INITIATIVES AND MEDICAL MANAGEMENT
Our approach to quality initiatives and medical management seeks to
ensure that high quality care is provided to our members. For purposes of our
quality programs, we segment our membership into four health categories and
allocate our resources to facilitate the delivery of quality health care
appropriate for each segment. Our quality initiatives and medical management
approach seeks to improve member health, to avoid health risks and to lower
costs. We use sophisticated healthcare information technologies to identify
those members who incur a disproportionate amount of health care costs for
treatment and hospitalization. We use this information to work with physicians
to develop appropriate intervention programs intended to improve member health
and thereby minimize future claims expenditures.
As of June 30, 2002, approximately 8% of our insured commercial
managed care customers who had both medical and hospital coverage accounted for
63% of our medical claims expenses for that customer group during that period.
We are focusing on controlling these costs by using innovative technology,
including sophisticated databases that can identify and monitor specific members
who have the potential for high costs of benefits provided. Our programs are
built upon nationally recognized guidelines. We use statistical modeling
techniques to identify members in high-risk populations. In addition, our SARA
initiative, which is offered to our ASO accounts and some insured groups and
provided to HMO members, serves as an early intervention program with a goal of
identifying potential issues in physician-recommended treatments. These tools
provide identification and monitoring. We then use the information to develop
and align treatment programs for individual members.
We use our technology infrastructure to implement our quality of care
and medical management initiatives. Our current claims system feeds data into
both our process to identify high risk members and our SARA program. The SARA
program analyzes medical, laboratory, pharmacy and hospital claims data with the
goal of identifying patients at risk of potentially serious medical conditions
and alerting providers of identified risks, such as adverse drug reactions,
skipped preventive screenings and overlooked tests. These members are also
alerted online in the secure site in their SARA messaging center.
In addition, we have developed and provide a variety of services and
programs for the acute, chronic and complex populations as well as online and
offline educational materials to help keep members healthy. These include
pre-certification and concurrent review hospital discharge services for acute
patients, as well as disease management programs, such as asthma, congestive
heart failure and end stage renal disease, for the chronic care population and
nurse case managers for complex population members. These programs seek to
enhance quality by eliminating inappropriate hospitalizations or services and
eliminating possible complications of procedures performed in hospitals.
15
We have created a pilot program in support of patient safety, in
conjunction with IBM, PepsiCo, Inc., Verizon Communications, Inc. and Xerox
Corporation (four of our national accounts). Using what is known as Leapfrog
Group standards, this program aims to improve patient safety in hospitals by
giving consumers information to make more informed hospital choices. The
Leapfrog Group is sponsored by the Business Roundtable, a national association
of Fortune 500 companies. The goals of our pilot program are to provide a
Web-based tool that allows easy access and review of the Leapfrog patient safety
data, on a hospital-by-hospital basis, for our employees and for employees of
our key customers participating in the pilot, and to provide financial rewards
to hospitals that meet the patient safety standards identified with the help of
national patient safety experts by The Leapfrog Group.
We also encourage the prescription of formulary and generic drugs,
instead of non-formulary equivalent drugs, through member and physician
interactions. In addition, through arrangements with our prescription benefit
manager, AdvancePCS, we are able to obtain discounts on certain medications
through bulk purchasing and rebates.
We have integrated medical policies, which we derive from CMS and
commercial and industry standard sources into our claims processing systems.
This integration substantially enhances the quality and accuracy of our claims
adjudication process.
INFORMATION SYSTEMS AND TELECOMMUNICATIONS INFRASTRUCTURE
The development and enhancement of our information technology systems
and integrated voice and data capabilities has been, and continues to be, a key
component of our strategy of operational excellence. We have spent significant
time and resources enhancing the capabilities of our customer service systems.
We have consolidated multiple claims systems into two platforms and are in the
process of migrating our national accounts claims, which have been processed by
National Accounts Service Company, LLC, or NASCO, into our other claims
platform. To this end, we have commenced negotiations to terminate our claims
processing agreement with NASCO, a company in which we have a 25.1% ownership
interest. In addition, we have implemented innovative voice and data
technologies that link most of our office locations, allowing us to broadcast
and communicate real-time right to our employees' desktops. These initiatives
and innovations have allowed us to:
o increase our "first pass rate" for physician claims, from 71.6% in
1998 to 87.8% in the second half of 2002, and, for hospital claims,
from 43.8% in 1998 to 72.1% in the second half of 2002;
o enable physicians to submit claims via the Internet and to have these
claims adjudicated in real-time; and
o improve the timeliness and ease of financial and other reporting.
We believe that our success in enhancing and consolidating our
information systems provides us with a distinct competitive advantage that will
allow us to grow our business organically as well as through potential strategic
acquisitions. We believe our experience in this area will allow the integration
of other information technologies and processes into our own in a timely and
efficient manner.
COLLABORATIONS
In addition to developing technological and managerial capabilities
internally, we also collaborate with third parties to develop new systems,
technologies and capabilities. These collaborations allow us to leverage the
core strengths of third parties to create better quality of service for our
16
customers as well as to increase efficiencies of our internal systems and
processes. We are currently involved in a major collaboration that we believe
will serve to substantially enhance our technological capabilities and cost
efficiencies.
IBM. Through a technology alliance with IBM, we plan to continue to
enhance our information systems and processes as well as to transition our
technology systems to new state-of-the-art platforms and technologies. A key
component of our agreement with IBM is to acquire or develop new systems, which
are built on open architectures. Open architectures employ a common set of
business rules, programming codes and processes which are developed using the
same standards so that new functionality can be quickly and efficiently built or
integrated.
The IBM agreement became effective in June 2002 and is for a term of
ten years. Under the agreement, IBM is responsible for operating our data
center, applications development and technical help desk. In connection with
these services, IBM has sublet our data center facility in Staten Island, New
York. Under the agreement, a significant portion of our information systems
staff have become employees of IBM and work on applications development for us.
We have, however, retained approximately 140 information systems personnel who
will continue to be responsible for and who will oversee the further enhancement
of the systems that they were responsible for prior to the IBM agreement. In
order to maintain the continuity, consistency and quality of our operations
after these operations have transitioned to IBM, the agreement includes mutually
developed performance, quality and pricing benchmarks that must be maintained by
IBM. We also have the flexibility to adjust our requirements to respond to
dynamic shifts in the industry, such as:
o reductions in membership for a particular product;
o customary advances in technology or improvements in the methods of
delivering services which modify, reduce or eliminate our need for a
particular service from IBM; or
o a substantial increase or reduction in our actual usage of a resource
provided under the agreement.
Pursuant to the IBM agreement, we will work jointly with IBM to
modernize our systems applications. Some of the systems application software
development will be done overseas from IBM's offices in Bangalore, India or, in
the event this facility becomes unavailable during the life of the agreement,
services will be provided from a replacement facility. These applications
include technological enhancements based on the ongoing requirements of our
business and solutions developed based upon our specifications.
The systems applications will be integrated with a new claims payment
system being developed by deNovis, in coordination with IBM, which will be
licensed to us when it is completed. deNovis is a privately held startup claims
payment systems developer. The system is expected to be ready for acceptance by
us in accordance with its specifications no earlier than 2005. We will own the
software developed by IBM under the agreement, other than the claims payment
system.
Subject to the successful completion and acceptance of the claims
payment system, we will pay $50.0 million for a perpetual license granted by
IBM, which includes custom development fees. Under the agreement with IBM, we
are scheduled to pay $25.0 million of this fee in four equal installments upon
the achievement of specified milestones, the last of which is our acceptance of
the claims payment system. The remaining $25.0 million will be paid one year
following the date we accept the claims payment system. Following the expiration
of the one year warranty period that begins upon the payment of the final
installment, we will pay IBM an annual fee of $10.0 million for maintenance and
support services.
17
In connection with IBM's modernization of our other systems, we have
contracted to purchase $65.0 million in integration and modernization services
from IBM over a four year period beginning in 2002 with a target purchase rate
of $7.3 million, $28.3 million, $19.0 million, $7.2 million and $3.2 million
during 2002, 2003, 2004, 2005 and 2006, respectively. We may defer the purchase
of services beyond the target date, provided that, to the extent we delay
purchases more than one year beyond the target year, we will pay a premium to
IBM of 10% per annum of the contract price. The amount that we will actually
spend for these integration and modernization services could be less or greater
than the annual target purchase rate. Through December 31, 2002, we purchased
$4.2 million of integration and modernization services under this agreement.
Our outsourcing agreement with IBM contains standard indemnification
clauses, which reduce the risk associated with a variety of claims and actions,
including certain failures of IBM to perform under the agreement. We have the
right to terminate certain services if IBM fails to meet our quality and
performance benchmarks and we may terminate our relationship with IBM in its
entirety upon the occurrence of material breaches under the agreement, IBM's
entrance into the health insurance business, changes of control and certain
other events which are damaging to us. We can terminate the outsourcing
agreement without cause after July 1, 2004, or at any time within twelve months
following a change of control of WellChoice by paying a termination fee to IBM.
The termination fee includes a lump sum payment that will decrease over the life
of the agreement. For any WellChoice termination without cause, the lump sum
decreases from $25.0 million beginning in June 2004 to $0.9 million in January
2012. We have the right to pay only a portion of this lump sum payment if we
choose to terminate only certain discrete portions of IBM's services rather than
the entire agreement. Any termination following a change of control of
WellChoice requires a similar one-time payment which decreases over the life of
the agreement and which is approximately 80% of the payment described in the
previous sentence, although we do not have the similar right to terminate only
portions of IBM's services, as allowed with a termination without cause. The
termination fee additionally includes, above the required one time payment,
reimbursement of certain of IBM's costs, subject to reduction to the extent we
purchase equipment, assume licenses and leases and hire employees used by IBM to
provide the services. We also have the right to terminate the agreement for no
cost within six months following a change of control of IBM.
Aware Dental. We have outsourced much of the management of our dental
products to Aware Dental Services, LLC of Minnesota. Aware Dental Services, a
joint venture between De Care International and Blue Cross and Blue Shield of
Minnesota, provides dental development, management and administrative services
in connection with dentist networks. Under this arrangement, Aware Dental is
responsible for customer service, underwriting and pricing, provider
contracting, claims processing and utilization management. We retain
responsibility for membership and billing services, and we share joint
responsibility with respect to the marketing and sales of our products,
information technology, product development and design and regulatory filings.
PROVIDER ARRANGEMENTS
Our relationships with health care providers, physicians, hospitals,
other facilities and ancillary health care providers are guided by state and
national standards established by applicable regulatory authorities for network
development, reimbursement and contract methodologies. In contrast to some for
health services provided to our members health benefits companies, it is
generally our philosophy not to delegate full financial responsibility for
health services provided to our members to our providers in the form of
capitation-based reimbursement. For some ancillary services, such as behavioral
health services, we have entered into capitation arrangements with entities that
offer broad based services through their own contracts with providers. We
attempt to provide market-based reimbursement along industry standards. We seek
to ensure that providers in our networks are paid in a timely manner. We seek to
18
maintain broad provider networks to ensure member choice while implementing
effective management programs designed to improve the quality of care received
by our members.
To build our provider networks, we compete with other health benefits
plans for contracts with hospitals, physicians and other providers. We believe
that physicians and other providers primarily consider member volume,
reimbursement rates, timeliness of reimbursement and administrative service
capabilities when deciding whether to contract with a health benefits plan.
Hospitals. We generally contract for hospital services to be paid on
a per diem basis or, for some services and in some areas, on a case rate basis
when beneficial. We have multi-year reimbursement arrangements with
approximately 70% of the hospitals in our New York network subject to early
termination pursuant to notice periods generally ranging from 90 to 180 days.
The remainder of our New York network hospitals have the right to renegotiate
rates annually. It is our goal to enter into multi-year reimbursement
arrangements with all network hospitals. The hospital industry in New York is
well organized, with a significant amount of bargaining power. A large physician
network is a competitive strength in competing with other health insurers for
contracts with hospitals. We believe that the size of our physician network and
our strong relationship with physicians in our market coupled with our extensive
operating history in our service areas, is sufficient to preserve a competitive
advantage. Our responsive reimbursement methodology, revised cost and
utilization management review process and our open channels of communication are
key components of our relationship and credibility with hospitals.
Physicians. Fee-for-service is our predominant reimbursement
methodology for physicians. Our physician rate schedules applicable to services
provided by in-network physicians are pegged to a resource-based relative value
system fee schedule and then adjusted for competitive rates in the market. This
structure is similar to reimbursement methodologies developed and used by the
federal Medicare system and other major payers.
With respect to Blue Cross and Blue Shield branded products, in our
New York service areas and counties that are contiguous to these areas, services
are provided to our members through our network providers with whom we contract
directly. Members seeking medical treatment outside of these areas are served by
providers in these areas through the BlueCard program. With respect to our New
Jersey operations, we contract directly with physicians in our New Jersey
service area and provide members outside of New Jersey with coverage through a
third party national provider network.
Subcontracting. We subcontract our behavioral healthcare and pharmacy
services through contracts with third parties. Our behavioral health care is
provided through Magellan Behavioral Health, Inc. which arranges through care
managers and a network of behavioral health care providers for a continuum of
behavioral health services focusing on access to appropriate providers and
settings for behavioral health care. Our contract with Magellan is multi-year
and capitation based. In addition, we have a five-year agreement with AdvancePCS
expiring December 31, 2005, pursuant to which AdvancePCS provides pharmacy
benefit management services to our members. These services include member
services, retail pharmacy network contracting and management, claims processing,
payment of claims to participating pharmacies and drug rebate negotiations with
manufacturers. We retain primary responsibility for formulary management and
compliance, utilization management and pharmacy clinical policies and programs.
In addition, a number of other ancillary service providers, including
laboratory service providers, home health agency providers and intermediate and
long-term care providers, are contracted with to provide access to a wide range
of services. These providers are normally paid on either a fee schedule,
fixed-per-day or per case basis.
19
COMPETITION
The health insurance industry is highly competitive, both nationally
and in New York and New Jersey. Competition has intensified in recent years due
to more aggressive marketing and pricing, a proliferation of new products and
increased quality awareness and price sensitivity among customers.
Industry participants compete for customers based on the ability to
provide a total value proposition which we believe includes quality of service
and flexibility of benefit designs, access to and quality of provider networks,
brand recognition and reputation, price and financial stability.
We believe that our competitive strengths, including the size and
quality of our provider network, the broad range of our product offerings and
our Blue Cross Blue Shield license position us well to satisfy these competitive
requirements.
Competitors in our markets include national health benefits companies
and local and regional for-profit and not-for-profit health insurance or managed
care plans. Our markets for managed care products are generally more competitive
than our markets for other products, including indemnity products. Our largest
competitors in the New York City metropolitan area include national health
benefits companies, such as UnitedHealthcare and Aetna, and regional local
health insurers, such as Oxford Health Plans, Health Insurance Plan of Greater
New York and Group Health Incorporated. We compete in upstate New York with
other "Blue" plans, including HealthNow New York Inc., as well as other
non-"Blue" plans, such as Capital District Physicians Health Plan and MVP Health
Plan. Our major competitors for national accounts customers include other "Blue"
plans as well as UnitedHealthcare, Cigna and Aetna. In New Jersey, we compete
with several national health benefits companies and Horizon Blue Cross Blue
Shield.
BLUE CROSS BLUE SHIELD LICENSE
We have the exclusive right to use the Blue Cross and Blue Shield
names and marks for all of our health benefits products in all ten counties in
the New York City metropolitan area and in six counties in upstate New York and
a non-exclusive right to use those names and marks in one upstate New York
county. In addition, we have an exclusive right to use only the Blue Cross names
and marks in seven counties in our upstate New York service area and a
non-exclusive right to use only the Blue Cross names and marks in an additional
four counties in upstate New York. We refer to these 28 counties in New York as
our Blue Cross Blue Shield licensed territory. We do not have any rights to use
the Blue Cross and/or Blue Shield names and marks in New Jersey or elsewhere to
market our products and services. We believe that the Blue Cross and Blue Shield
names and marks are valuable identifiers of our products and services in the
marketplace. The license agreements, which have a perpetual term (but which are
subject to termination under circumstances described below), contain reserve
requirements, discussed below under "Government Regulation --Capital and Reserve
Requirements," and other requirements and restrictions regarding our operations
and our use of the Blue Cross and Blue Shield names and marks.
Upon the occurrence of any event causing termination of the license
agreements, we would cease to have the right to use the Blue Cross and Blue
Shield names and marks in the Blue Cross Blue Shield licensed territory. We also
would no longer have access to the Blue Cross Blue Shield Association networks
of providers and BlueCard program. We would expect to lose a significant portion
of our membership if we lose these licenses. Loss of these licenses could
significantly harm our ability to compete in our markets and could require
payment of significant monetary penalties to the Blue Cross Blue Shield
Association. Furthermore, the Blue Cross Blue Shield Association would be free
to issue a license to use the Blue Cross and Blue Shield names and marks in the
counties in New York in which we had previously used the Blue Cross and/or Blue
Shield name and mark to another entity, which would have a material adverse
affect on our business, financial condition and results of operations.
20
Events which could result in termination of our license agreements
include:
o failure to maintain our total adjusted capital at 200% of authorized
control level risk based capital, as defined by the NAIC risk based
capital (RBC) model act;
o failure to maintain liquidity of greater than one month of
underwritten claims and administrative expenses, as defined by the
Blue Cross Blue Shield Association, for two consecutive quarters;
o failure to satisfy state-mandated statutory net worth requirements;
o impending financial insolvency; and
o a change of control not otherwise approved by the Blue Cross Blue
Shield Association or a violation of the Blue Cross Blue Shield
Association ownership limitations on our capital stock.
The Blue Cross Blue Shield Association license agreements and
membership standards specifically permit a licensee to operate as a for-profit,
publicly traded stock company, subject to governance and ownership requirements.
Pursuant to the rules and license standards of the Blue Cross Blue
Shield Association, we guarantee our and our subsidiaries' contractual and
financial obligations to respective customers. In addition, pursuant to the
rules and license standards of the Blue Cross Blue Shield Association, we have
agreed to indemnify the Blue Cross Blue Shield Association against any claims
asserted against it resulting from our contractual and financial obligations.
Each license requires an annual fee to be paid to the Blue Cross Blue
Shield Association. The fee is determined based on premiums earned from products
using the Blue Cross and Blue Shield names and marks and from a per-contract
charge for self-funded membership. During 2002, 2001 and 2000, we paid fees to
the Blue Cross Blue Shield Association in the amount of $3.2 million, $3.4
million and $3.5 million, respectively. The Blue Cross Blue Shield Association
is a national trade association of Blue Cross Blue Shield licensees, the primary
function of which is to promote and preserve the integrity of the Blue Cross
Blue Shield names and marks, as well as to provide certain coordination among
the member plans. Each Blue Cross Blue Shield licensee is an independent legal
organization and is not responsible for obligations of other Blue Cross Blue
Shield Association member organizations. Subject to the "ceding" rules discussed
below, we have no right to market products and services using the Blue Cross
Blue Shield names and marks outside our Blue Cross Blue Shield licensed
territory.
Ceding. The rules and license standards of the Blue Cross Blue Shield
Association set forth procedures with respect to the provision of insurance or
administrative services to national accounts with employees located in numerous
jurisdictions. With respect to insured products, a Blue Cross Blue Shield
licensee may sell its products to national accounts covering members located
outside of its licensed area, provided that the account has some operations in
the insurer's licensed area and, if the account is headquartered in another Blue
Cross Blue Shield insurer's licensed area, the other Blue Cross Blue Shield
insurer must first "cede" the right to sell the insured product to the selling
Blue Cross Blue Shield insurer. The duration of the ceding arrangement is
determined by the two plans. With respect to products purchased on an ASO basis,
Blue Cross Blue Shield licensees may offer this service to accounts outside of
their licensed areas regardless of whether the customer has a presence in the
licensed area, provided that the other Blue Cross Blue Shield licensee holding
the Blue Cross Blue Shield license in the area in which the customer is
headquartered cedes its right to the selling Blue Cross Blue Shield licensee. At
December 31, 2002, membership attributable to all national accounts ceded by
21
other plans to us represented approximately 41.8% (427,000 members) of our total
national account membership, or approximately 9.3% of overall membership. Most
of our ceding arrangements have a three-year term and are subject to renewal.
BlueCard. Under the rules and license standards of the Blue Cross
Blue Shield Association, other Blue Cross Blue Shield Association plans must
provide health care to members of the BlueCard program in a manner and scope as
consistent as possible to what such member would be entitled to in his or her
home region. The Blue Cross Blue Shield Association requires us to pay
administrative fees to any host Blue Cross Blue Shield Association member plan
that provides these claims and other services to our members who receive care in
their service area. Similarly, we are paid administrative fees for providing
claims and other services to members of other Blue Cross Blue Shield plans who
receive care in our service area.
CLAIM RESERVES
Medical benefits for claims occurring during any accounting period
are paid upon receipt of claim and adjudication. We are required to estimate the
ultimate amount of claims which have not been reported, or which have been
received but not yet adjudicated, during any accounting period. These estimates,
referred to as claim reserves, are recorded as liabilities on our balance sheet.
We estimate claim reserves in accordance with Actuarial Standards of
Practice promulgated by the Actuarial Standards Board, the committee of the
American Academy of Actuaries that establishes the professional guidelines and
standards for actuaries to follow. A degree of judgment is involved in
estimating reserves. We make assumptions regarding the propriety of using
existing claims data as the basis for projecting future payments. Factors we
consider include medical cost trends, the mix of products and benefits sold,
internal processing changes and the amount of time it took to pay all of the
benefits for claims from prior periods. Differences between actual experience
and the assumptions made in establishing the claim reserves may lead to actual
costs of benefits provided to be greater or less than the estimated costs of
benefits provided. The change in the claim reserve estimate during the
accounting period is reported as a change in medical expense.
EMPLOYEES
At January 20, 2003, we employed approximately 5,700 employees in our
offices in New York City, Albany, Middletown, Yorktown Heights, Melville,
Syracuse and Bohemia, New York, as well as Harrisburg, Pennsylvania, and several
other smaller locations. Twenty-five employees in our internal sales division
are subject to a collective bargaining agreement with the Office and
Professional Employees International Union. No other employees are subject to
collective bargaining agreements. Overall, we believe that our relations with
our employees are good, and we have not experienced any work stoppages.
GOVERNMENT REGULATION
The business operations of our subsidiary health insurance companies
and health maintenance organizations are subject to comprehensive and detailed
state regulation in New York and New Jersey, as well as federal regulation.
Supervisory agencies, including state health and insurance departments and, in
some instances, the state attorney general, have broad authority to:
o grant, suspend and revoke licenses to transact business;
o regulate many aspects of the products and services we offer;
o assess fines, penalties and/or sanctions;
22
o monitor our solvency and adequacy of our financial reserves; and
o regulate our investment activities on the basis of quality,
diversification and other quantitative criteria, within the parameters
of a list of permitted investments set forth in applicable insurance
laws and regulations.
Our operations and accounts are subject to examination at regular
intervals by these agencies. In addition, the federal and state governments
continue to consider and enact many legislative and regulatory proposals that
have impacted, or would materially impact, various aspects of the health care
system. Many of these changes are described below. While certain of these
measures could adversely affect us, at this time we cannot predict the extent of
this impact.
The federal government and the governments of the states in which we
conduct our health care operations have adopted laws and regulations that govern
our business activities in various ways. These laws and regulations may restrict
how we conduct our business and may result in additional burdens and costs to
us. Areas of governmental regulation include:
o licensure;
o policy forms, including plan design and disclosures;
o premium rates and rating methodologies;
o underwriting rules and procedures;
o benefit mandates;
o eligibility requirements;
o geographic service areas;
o market conduct;
o utilization review;
o payment of claims, including timeliness and accuracy of payment;
o special rules in contracts to administer government programs;
o transactions with affiliated entities;
o limitations on the ability to pay dividends;
o transactions resulting in a change of control;
o member rights and responsibilities;
o sales and marketing activities;
o quality assurance procedures;
23
o privacy of medical and other information and permitted disclosures;
o rates of payment to providers of care;
o surcharges on payments to providers;
o provider contract forms;
o delegation of financial risk and other financial arrangements in rates
paid to providers of care;
o agent licensing;
o financial condition (including reserves);
o corporate governance; and
o permissible investments.
These laws and regulations are subject to amendments and changing
interpretations in each jurisdiction. Failure to comply with existing or future
laws and regulations could materially and adversely affect our operations,
financial condition and prospects.
The Company is also subject to federal and state laws, rules and
regulations generally applicable to public corporations, including, but not
limited to, those governed by the Commission, the Internal Revenue Service and
state corporate and taxation departments. The Company is also subject to the
listing standards of the New York Stock Exchange, or NYSE. The federal
government, certain states and the NYSE and other self-regulatory organizations
have recently passed or proposed new laws, rules or regulations generally
applicable to corporations, including the Sarbanes-Oxley Act of 2002, that
affect or could affect the Company. These changes will increase the company's
costs and complexity of doing business and may expose the Company to additional
potential liability.
STATE REGULATION
Generally. New York state laws and regulations contain requirements
relating specifically to, among other things, Empire's financial condition,
financial reserve requirements, premium rates, contract forms, utilization
review procedures and rights to internal and external appeals, and the periodic
filing of reports with the Department of Insurance. Empire is also subject to
periodic examination by the Department of Insurance. WellChoice Insurance of New
Jersey is a credit, life, accident and health insurance company licensed in New
Jersey by the New Jersey Department of Banking and Insurance to operate in its
16-county service area, and is subject to similar regulation and oversight under
New Jersey insurance law.
Empire HealthChoice HMO has a certificate of authority issued by the
Department of Health to operate as an HMO in its 28-county service area in New
York State. Applicable state statutes and regulations require Empire
HealthChoice HMO to file periodic reports with the Department of Health and the
Department of Insurance and contain requirements relating to, among others,
operations, premium rates and covered benefits, financial condition and
marketing practices. These state agencies, together or individually, also
exercise oversight regarding our provider networks, medical care delivery and
quality assurance programs and reporting requirements, contract forms, including
risk-sharing contracts, claims payment standards, compliance with benefit
mandates, utilization review standards, including internal and external appeals,
and financial condition. Empire HealthChoice HMO is also subject to periodic
24
financial and market conduct examinations by the Department of Insurance and the
Department of Health. In New Jersey, Empire HealthChoice HMO (operating as
WellChoice HMO of New Jersey) is licensed as an HMO in its 16-county service
area, and is subject to similar oversight by the New Jersey Department of
Banking and Insurance and Department of Health and Senior Services.
Underwriting and Rating Limitations. Health insurers in New York, and
health insurers and HMOs in New Jersey, are required to offer coverage on a
community rated, open enrollment basis to all small groups seeking coverage and
may not utilize medical underwriting. HMOs in New York are also required to
offer coverage on a community rated, open enrollment basis to essentially all
groups seeking coverage and may not utilize medical underwriting. None of these
may decline to accept individuals within a group based on health-related
factors. All HMOs operating in New York are required to make coverage available
to individuals on a non-group basis, without underwriting and on a community
rated basis, through two standard policies with broad, comprehensive coverage.
In addition, all HMOs are required to offer a standard product called Healthy
New York to individuals and certain qualifying small groups. These requirements
apply exclusively to HMOs, and not to accident and health insurers. Insurers and
HMOs in New Jersey may opt to community rate small group business by class, so
that rates may vary based on certain demographic factors, such as age and sex as
well as location. In New Jersey, we have secured an exemption from offering
direct pay coverage by paying an assessment to the State, but we do issue the
standardized small group products required under New Jersey law.
New York insurers may experience-rate insurance coverage for large
groups (over 50 employees) and may apply medical underwriting rules to large
groups, but the rates applicable to each member of the group cannot vary based
on the individual's medical condition. In New York, Empire HealthChoice HMO must
offer almost all coverage on a community rated basis, although we may
distinguish between large groups, small groups and individuals for purposes of
establishing rates. Experience rating is permitted for certain large group HMO
products that include a point-of-service feature providing coverage out of the
network. New Jersey insurers and HMOs may experience-rate insurance and HMO
coverage for large groups.
Insurers and HMOs cannot terminate coverage of an employer group
based on the medical conditions existing within that group. In fact, they can
cancel business for groups or individuals for only a limited number of reasons,
such as fraud and default in payment of premium. Insurers and HMOs cannot
exclude coverage for a pre-existing condition of a new employee of an existing
employer group if that employee had previously satisfied a pre-existing
condition waiting period with the prior insurer and if that person maintained
continuous coverage. These limitations mirror the federal requirements
established by the Health Insurance Portability and Accountability Act of 1996,
or HIPAA.
Initial rates and rating formulae for all new products in New York
require the prior approval of the Department of Insurance. Initial rates for all
small group and individual products in New Jersey require the prior approval of
the New Jersey Department of Banking and Insurance. In New Jersey, large group
rates and rating methodologies are not filed with the New Jersey Department of
Banking and Insurance. Instead, a differential test is filed on a triennial
basis, which shows that the value of the in-network and out-of-network benefits
(including copayments and deductibles) cannot differ by more than 30% or, under
certain circumstances, 40%.
Rate increases on experience-rated products in either state do not
require prior approval, but in New York, must be consistent with the formula
filed with the Department of Insurance. Rate increases on community rated
products in New York generally can be implemented on a file and use basis which
does not require the prior approval of the Department of Insurance. With respect
to rate changes for community rated products, the New Jersey Department of
Banking and Insurance has 60 days from the date of receipt of a rate filing to
25
disapprove the filing. Unless the filing is disapproved, the insurer or HMO may
use the form on the effective date specified within the filing.
As part of the plan of conversion, we agreed to several restrictions
on premium rate increases relating to three categories of our individual
members. A discussion of these restrictions is described under "Item 1 -
Business - The Plan of Conversion--The Legislation and the Plan."
New York State Hospital Reimbursement. New York hospital rates are
governed by the Health Care Reform Act, which was adopted in 1997. The Health
Care Reform Act eliminated New York's former state rate-setting system and
allows hospitals and health insurance companies to negotiate reimbursement
rates. The Act also provides certain funding streams for public goods, including
graduate medical expenses and charity care. Graduate medical education expenses
are subsidized through a monthly per covered life assessment on insurers, HMOs
and self-insured plans. Compensation for bad debts and charity care and certain
other programs are funded by an 8.18% surcharge on hospital services. We pay the
surcharge directly to a State-run pool. The New York Governor's proposed
2003-2004 fiscal budget would increase the covered life assessment by
approximately 5% and increase the 8.18% bad debt and charity care surcharge to
8.85%. The impact of these increases, if adopted, will be to increase our
expenses.
Market Stabilization and Stop Loss Pools. In connection with our
participation in the small group and individual markets in New York, we are
required to participate in the Market Stabilization Pool established by the
Department of Insurance. In addition, we participate in certain Stop Loss Pools
established by the state of New York created under the HealthCare Reform Act of
New York. The Market Stabilization and Stop Loss Pools are collectively referred
to as the "Pools." These Pools are discussed more fully in Note 2 to the
Consolidated Financial Statements.
Other Legislation. During the past several years, New Jersey and New
York have enacted significant additional legislation relating to managed care
plans. These recent legislative acts have contained provisions relating to,
among other things, consumer disclosure, utilization review, removal of
providers from the network, appeals processes for both providers and members,
mandatory benefits and products, state funding pools, and provider contract
requirements. New York and New Jersey also passed legislation governing the
prompt payment of claims that require, among other things, that health plans pay
claims within certain prescribed time periods or pay interest and fines. We have
not incurred significant fines for prompt pay violations since those laws became
effective.
Other recently adopted state laws, which govern our business and
significantly affect our operations include, among others:
o A law in New York, which became effective on January 1, 2003, that
mandates that health insurance plans provide or expand coverage for
certain health care services. The law requires that plans provide
coverage for primary and preventive obstetrical and gynecological
care, more frequent annual mammogram screenings, cervical cytology
screenings, bone density testing and treatment, and contraceptive
coverage. While we have previously provided many of these benefits to
our insured members, we expect that the impact of this law will be to
increase our medical costs for these services.
o A law passed in New Jersey in 2001 which allows members to sue their
health insurance plan for injuries caused by negligence, including
delay, in making coverage decisions. Such litigation could be costly
to us and could have a significant effect on our results of
operations.
o Legislation in New Jersey giving the State Attorney General the
authority to regulate the process by which physicians may jointly
negotiate with health plans over fees and other contractual provisions
26
which was passed into law in January 2002 and will expire in April
2008. The effectiveness of the law is subject to the issuance of
regulations by the Attorney General. We cannot predict the ultimate
impact this law will have on our business and results of operations in
future periods.
Foreign Laws and Regulations. We may be subject to the laws of states
other than those in which we are licensed with respect to persons we cover who
reside in those states. We may also be subject to scrutiny from regulatory
agencies in those states. We do not believe the costs related to compliance with
such laws will have an adverse impact on our business, financial condition or
results of operations.
INSURANCE AND HMO HOLDING COMPANY LAWS
WellChoice is regulated as an insurance holding company system and is
subject to the insurance holding company laws and regulations of New York and
New Jersey as well as similar provisions included in the New York Department of
Health regulations. These laws and regulations generally require that insurers
or HMOs within an insurance holding company system register with the insurance
or health department of each state where they are licensed to do business and to
file with those states reports describing capital structure, ownership,
financial condition, certain intercompany transactions and general business
operations. In addition, various notice and reporting requirements generally
apply to transactions between insurance companies or HMOs and their affiliates
within an insurance holding company system, depending on the size and nature of
the transactions. These laws and regulations also require prior regulatory
approval by domestic regulators or prior notice of certain material intercompany
transfers of assets as well as certain transactions between insurance companies,
HMOs, their parent holding companies or affiliates.
Additionally, the holding company laws and regulations of New York
and New Jersey and the Department of Health regulations in New York restrict the
ability of any person to acquire control of an insurance company or HMO without
prior regulatory approval. Applicable New York statutes and regulations require
the prior approval of the Commissioner of Health for any acquisition of control
of Empire HealthChoice HMO, Empire or WellChoice, and the prior approval of the
Superintendent of Insurance for any acquisition of control of Empire or
WellChoice. Similarly, New Jersey law requires the prior approval of the
Commissioner of Banking and Insurance for any acquisition of control of
WellChoice, Empire, Empire HealthChoice HMO or WellChoice Insurance of New
Jersey. Under those statutes and regulations, without such approval (or an
exemption), no person may acquire any voting security of a domestic insurance
company or HMO, or an insurance holding company that controls a domestic
insurance company or HMO, or merge with such a holding company, if as a result
of such transaction such person would "control" a domestic insurance company or
HMO. "Control" is generally defined by state insurance laws as the direct or
indirect power to direct or cause the direction of the management and policies
of a person and is presumed to exist if a person directly or indirectly owns or
controls 10% or more of the voting securities of another person.
27
DIVIDEND RESTRICTIONS
The amount of dividends paid by insurance companies and HMOs are
limited by applicable state law and regulations in both New York and New Jersey.
Any proposed dividend to WellChoice from Empire, which, together with other
dividends paid within the preceding twelve month period, exceeds the lesser of
10% of its surplus to policyholders or 100% of adjusted net investment income
will be subject to approval by the New York Department of Insurance. Dividends
must also be paid out of earned surplus. The New Jersey dividend restriction
differs slightly from New York's in that any proposed dividend to Empire from
WellChoice Insurance of New Jersey, which, together with other dividends paid
within the preceding twelve month period, exceeds the greater of 10% of its
surplus to policyholders or net income not including realized capital gains will
be subject to approval by the Department of Banking and Insurance. Dividends
from both Empire and WellChoice Insurance of New Jersey must be paid from earned
surplus. Dividends from Empire HealthChoice HMO to Empire in excess of 10% of
the admitted assets of Empire HealthChoice HMO will be subject to review and
approval by the New York Department of Insurance, the New York Department of
Health and the New Jersey Department of Banking and Insurance.
CAPITAL AND RESERVE REQUIREMENTS
Empire is subject to capital and surplus requirements under the New
York insurance laws and the capital and surplus licensure requirement
established by the Blue Cross Blue Shield Association. Each of these standards
is based on the NAIC's RBC Model Act. These capital and surplus requirements are
intended to assess the capital adequacy of life and accident and health
insurers, taking into account the risk characteristics of an insurer's
investments and products. The RBC Model Act sets forth the formula for
calculating the risk-based capital requirements, which are designed to take into
account insurance risks, interest rate risks and other relevant risks with
respect to an individual insurance company's business. In general, under these
laws, an insurance company must submit a report of its risk-based capital level
to the insurance commissioner of its state of domicile as of the end of the
previous calendar year.
The RBC Model Act requires increasing degrees of regulatory oversight
and intervention as an insurance company's risk-based capital declines. The
level of regulatory oversight ranges from requiring the insurance company to
inform and obtain approval from the domiciliary insurance commissioner of a
comprehensive financial plan for increasing its risk-based capital to mandatory
regulatory intervention requiring an insurance company to be placed under
regulatory control, in a rehabilitation or liquidation proceeding. The RBC Model
Act provides for four different levels of regulatory oversight depending on the
ratio of the company's total adjusted capital (defined as the total of its
statutory capital, surplus, asset valuation reserve and dividend liability) to
its risk-based capital. The "company action level" is triggered if a company's
total adjusted capital is less than 200%, but greater than or equal to 150%, of
its risk-based capital. At the company action level, a company must submit a
comprehensive plan to the regulatory authority which discusses proposed
corrective actions to improve its capital position. A company whose total
adjusted capital is between 250% and 200% of its risk-based capital is subject
to a trend test. The trend test calculates the greater of any decrease in the
margin (i.e., the amount in dollars by which a company's adjusted capital
exceeds its risk-based capital) between the current year and the prior year and
between the current year and the average of the past three years, and assumes
that the decrease could occur again in the coming year. If a similar decrease in
margin in the coming year would result in a risk-based capital ratio of less
than 190%, then company action level regulatory action will occur.
The "regulatory action level" is triggered if a company's total
adjusted capital is less than 150% but greater than or equal to 100% of its
risk-based capital. At the regulatory action level, the regulatory authority
will perform a special examination of the company and issue an order specifying
corrective actions that must be followed. The "authorized control level" is
triggered if a company's total adjusted capital is less than 100% but greater
than or equal to 70% of its risk-based capital, at which level the regulatory
28
authority may take any action it deems necessary, including placing the company
under regulatory control. The "mandatory control level" is triggered if a
company's total adjusted capital is less than 70% of its risk-based capital, at
which level the regulatory authority must place the company under its control.
Empire currently exceeds the New York minimum risk-based capital level and meets
the Blue Cross Blue Shield Association risk-based capital level licensure
requirement.
Capital and surplus requirements for Empire HealthChoice HMO, Inc.,
our HMO subsidiary which is directly owned by Empire, are regulated under a
different method set forth in the New York Department of Health's HMO
regulations. The regulations require that Empire HealthChoice HMO currently
maintain reserves of five percent of its annual New York-based premium income.
Empire HealthChoice HMO, with respect to its operations in New York, meets the
financial reserve standards of the New York Department of Health. The Department
of Health is currently redrafting its regulations and proposes to increase the
required reserves gradually over the next six years to twelve and one half
percent of annual premium income. If that requirement changes it will affect all
HMOs and we expect we will meet those revised standards. In November 2002,
Empire HealthChoice HMO received a $50.0 million capital contribution from
Empire, which was made in connection with the transfer of our New York HMO
business from Empire HealthChoice, or HealthChoice, to Empire HealthChoice HMO
during 2002 in order to ensure compliance with New York capital and surplus
requirements. HealthChoice was our parent company prior to our initial public
offering in November 2002. Empire HealthChoice HMO is also licensed in New
Jersey and there are minimum net worth standards established under New Jersey
laws and regulations. Empire HealthChoice HMO, with respect to its operations in
New Jersey, meets the minimum net worth standards established under New Jersey
law. Empire HealthChoice HMO is also subject to the Blue Cross Blue Shield
Association capital and surplus licensure requirement which is applicable to
Empire and satisfies that requirement.
Our New Jersey operations are not subject to the Blue Cross Blue
Shield Association capital and surplus licensure requirement. At December 31,
2002, WellChoice Insurance of New Jersey met the minimum capital and surplus
requirements of the New Jersey Department of Banking and Insurance. During 2002,
Empire made cash capital contributions of approximately $15.0 million to
WellChoice Insurance of New Jersey.
Regulation of financial reserves for insurers and HMOs is a frequent
topic of legislative and regulatory scrutiny and proposals for change. It is
possible that the method of measuring the adequacy of our financial reserves
could change and that could affect our financial condition. However, any such
change is likely to affect all companies in the state.
GUARANTY FUND ASSESSMENTS
New York does not have an insolvency or guaranty association law
under which health insurance companies such as Empire or Empire HealthChoice HMO
can be assessed for amounts paid by guaranty funds for member losses incurred
when an insurance company or HMO becomes insolvent. New York does have a law
providing that providers of care may not bring collection or litigation actions
against consumers for bills unpaid by an insolvent HMO.
However, under Blue Cross Blue Shield Association guidelines, Empire
and Empire HealthChoice HMO are required to establish a mechanism which ensures
payment of certain claim liabilities and continuation of coverage in the event
of insolvency. Empire and Empire HealthChoice HMO maintain a deposit agreement
with the Blue Cross Blue Shield Association for out-of-area services to provide
such assurance. The amount of the deposit is approximately 17% of Empire's and
Empire HealthChoice HMO's unpaid claim reserves for out-of-area services. At
December 31, 2002, the market value and amortized cost of the investment on
deposit were $8.4 million and $7.9 million, respectively.
29
WellChoice Insurance of New Jersey participates in the New Jersey
Life and Health Insurance Guaranty Association, under which it may be required
to pay assessments to the State of New Jersey to provide funds to ensure that
the liabilities arising under an impaired insurer's policies or contracts are
paid when due. The assessments are due only in the event another carrier is
impaired. Since its inception, WellChoice Insurance of New Jersey has not been
assessed any payments.
Empire HealthChoice HMO is subject to a New Jersey law that requires
New Jersey HMOs to contribute over a three-year period to a fund established to
meet unpaid contractual obligations of insolvent New Jersey HMOs. To date,
Empire HealthChoice HMO has paid assessments of approximately $190,000 as
required under this law.
CODIFICATION OF NAIC STANDARDS
The NAIC adopted the Codification of Statutory Principles, or the
Codification, in March 1998. The effective date for the statutory accounting
guidance was January 1, 2001. Our domiciliary states have adopted the
Codification with certain modifications, and we have made the necessary changes
in our statutory accounting and reporting required for implementation. The
overall impact of applying the new standards in 2001 resulted in an aggregate
reduction in HealthChoice's statutory surplus of $8.6 million. In 2002, New York
State passed legislation modifying the adopted Codification which would permit
us to recognize certain deferred tax assets. This legislation took effect on
December 31, 2002 and the impact of applying the new standard resulted in an
increase in Empire's statutory surplus of $52.9 million.
FEDERAL REGULATION
ERISA. The provision of services to certain employee health benefit
plans is subject to ERISA, a complex set of laws and regulations subject to
interpretation and enforcement by the federal Department of Labor. ERISA
regulates certain aspects of the relationships between us and employers who
maintain employee benefit plans subject to ERISA. Some of our administrative
services and other activities may also be subject to regulation under ERISA. Of
particular application are the regulations recently adopted by the Department of
Labor that revise claims procedures for employee benefit plans governed by ERISA
(insured and self-insured), effective for claims filed on or after July 1, 2002.
Given that the state insurance laws in New York and New Jersey, as well as many
other states, already contain stringent claim appeal process requirements, the
rules have not significantly impacted our operations. However, we cannot predict
the ultimate impact on its business and results of operations in future periods.
HIPAA. HIPAA required the adoption of regulations accomplishing three
things:
o ensuring the privacy of personally identifiable health
information;
o ensuring the security of personally identifiable health
information; and
o standardizing the way certain health care transactions such as
claims are handled when they are conducted electronically, and
establishing national identifiers for providers, health plans and
employers.
The federal Department of Health and Human Services adopted final rules on these
topics. The final security standards became effective on February 20, 2003. We
must comply with the security standards by April 21, 2005.
30
The HIPAA privacy rules require health plans, clearinghouses and
providers to:
o comply with a variety of requirements concerning their use and
disclosure of individuals' protected health information;
o establish rigorous internal procedures to protect health
information;
o enter into business associate contracts with those companies to
whom protected health information is disclosed; and
o establish procedures to allow individuals to access and amend
records maintained by Empire, receive an accounting of certain
disclosures, and to establish grievance processes for individuals
to make inquiries or complaints regarding the privacy of their
records.
We must comply with the privacy rules by April 14, 2003 and we expect that we
will be in compliance by that date.
In accordance with the final rules standardizing electronic
transactions between health plans, providers and clearinghouses, those parties
are required to conform their electronic and data processing systems with
HIPAA's electronic transaction requirements. The compliance date for these rules
has been delayed until October 2003 for those plans, including the Company, that
filed an extension request by October 2002. We are on schedule to be fully
compliant by October 2003. States may adopt more stringent requirements for
health care information privacy and security than the standards set by HIPAA.
In addition, provisions of the federal Gramm-Leach-Bliley Act
generally require insurers to protect the privacy of consumers' and customers'
non-public personal information and authorize state regulators to enact and
enforce privacy standards that meet at least the federal minimum requirements.
Like HIPAA, this law sets a "floor" standard, allowing states to adopt more
stringent requirements governing privacy protection. In compliance with the
Gramm-Leach-Bliley Act, the New York State Department of Insurance issued
privacy and security regulations affording New York consumers and customers
privacy protections and notice rights. New Jersey already had laws regulating
the collection, use and disclosure of information that met or exceeded the
Gramm-Leach-Bliley Act requirements, and therefore the New Jersey Department of
Banking and Insurance stated that compliance with state law by insurers
transacting business in New Jersey is deemed to be compliance with the
requirements of the Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act also
gives banks and other financial institutions the ability to affiliate with
insurance companies, which may lead to new competitors in the insurance and
health benefits fields.
The cost of complying with HIPAA is likely to be significant. Our
costs for HIPAA compliance were $4.1 million in 2002. We anticipate these costs
to approximate $3.8 million in 2003 and anticipate we will incur additional
costs in 2004 and beyond. We cannot predict the ultimate impact HIPAA will have
on our business and results of operations in future periods.
MEDICARE
Empire HealthChoice HMO operates a Medicare+Choice plan pursuant to a
contract with CMS under the federal Department of Health and Human Services, and
that contract is subject to the applicable federal laws and regulations. Our
Medicare+Choice members receive their Medicare benefits from our HMO rather than
directly from the federal government under the standard Medicare Part A and Part
B programs. CMS has the right to audit health plans operating under Medicare
contracts to determine their compliance with CMS's contracts and regulations and
the quality of care being rendered to the health plan's Medicare members.
31
In 1997, the federal government passed legislation related to
Medicare+Choice that, among other things, provides for a minimum annual premium
increase of two percent. The legislation also requires us to pay a user fee to
reimburse CMS for costs incurred to disseminate enrollment information. The
federal government also announced in 1999 that it planned to begin to phase in
risk adjustments to its premium payments which will occur over several years.
Congress has subsequently lengthened this timetable to allow the risk adjusted
mechanism to be fully implemented by 2007. These changes have had the effect of
reducing reimbursement to us in our New York service areas, forcing us to adjust
the Medicare+Choice package of covered benefits. These changes have decreased
the attractiveness of the product to consumers, although there is currently
federal legislation under consideration that would increase the funding level
for our Medicare+Choice product. Reduction in traditional Medicare payments to
hospitals and physicians has resulted in increasing monetary pressures from our
participating hospitals. Some hospitals have decided to cease their
participation with us for this particular program, while many of the remaining
hospitals have sought to renegotiate for higher rates. In addition, this program
is annually the subject of legislation in Congress and we cannot predict what
additional rules and requirements may be enacted that will impact our business.
The contract to participate in the Medicare+Choice program could also, under
certain circumstances, be terminated by the federal government or by us.
We also serve as a fiscal intermediary for the Medicare Part A
program and a carrier for the Medicare Part B program. Fiscal intermediaries and
carriers for these programs act as agents under contract to the federal
government to process and pay claims for one or more designated regions of the
United States under the Medicare Part A program for hospital care and the
Medicare Part B program for physician and other care. Our contract with the
federal government is cost-based which means we receive reimbursement for
certain costs and expenditures from the federal government, which is subject to
adjustment upon audit by CMS. The laws and regulations governing fiscal
intermediaries and carriers for the Medicare program are complex and subject to
interpretation and can expose an intermediary to penalties for non-compliance.
Fiscal intermediaries and carriers may be subject to criminal fines, civil
penalties or other sanctions as a result of such audits or reviews. While we
believe we are currently in compliance in all material respects with the
regulations governing fiscal intermediaries and carriers, there are ongoing
reviews by the federal government of our activities under certain of our
Medicare fiscal intermediary and carrier contracts. The contract could, under
certain circumstances, be terminated either by the federal government or by us.
OTHER GOVERNMENT PROGRAMS
New York State mandates and/or sponsors several health benefit
products for persons who might otherwise be uninsured or require assistance in
paying premiums. These include the Child Health Plus, Healthy New York and other
state-mandated direct pay products. All HMOs are mandated by law to participate
in the Healthy New York and other state-mandated direct pay products and Empire
HealthChoice HMO participates in all of these programs. The Child Health Plus
program has extensive rules regarding participation and the contract to
participate could, under certain circumstances, be terminated by the State
government or by us. In New Jersey, insurers are required to offer certain
standard products in the small group market. As noted above, we have obtained an
exemption from the requirement that we offer direct pay (non-group) coverage in
New Jersey by virtue of an assessment paid to the State.
In addition, we participate in the Federal Employee Health Benefits
Program (FEP) through a contract with the Blue Cross Blue Shield Association.
Currently, other FEP contractors are required to comply with federal Cost
Accounting Standards. The Blue Cross Blue Shield Association has a waiver from
compliance with these standards which must be renewed annually. Failure to renew
this waiver could adversely impact this program, and could result in the Blue
Cross Blue Shield Association's withdrawal from the program, although
regulations are currently being drafted that could make the waiver permanent.
32
LEGISLATIVE AND REGULATORY INITIATIVES
There has been a continuing trend of increased health care regulation
at both the federal and state levels. The federal government and many states,
including New York and New Jersey, are considering additional legislation and
regulations related to health care plans, including, among other things:
o increasing the funding levels for Medicare+Choice products;
o enhancing preventative health care benefits under the Medicare
program;
o requiring coverage of experimental procedures and drugs and
liberalized definitions of medical necessity;
o limiting utilization review and cost management and cost control
initiatives of our managed care subsidiaries;
o requiring, at the New York State level, that mental health
benefits be treated the same as medical benefits in addition to
the existing federal law that imposes requirements relating to
parity of mental health benefits;
o exempting physicians from the antitrust laws that prohibit price
fixing, group boycotts and other horizontal restraints on
competition; o regulating premium rates, including prior approval
of rate changes by regulatory authorities;
o changing the government programs for the uninsured or those who
need assistance in paying premiums, including potential mandates
that all HMOs or insurers must participate;
o implementing a state-run single payer system that would partially
or largely obviate the current role of private health insurers or
HMOs;
o restricting or eliminating the use of formularies for
prescription drugs; and
o increasing premium taxes, surcharges and assessments that health
insurers would be required to pay , and transferring certain
early intervention services from state sponsored programs to
private insurers, under the New York State Governor's proposed
2003-2004 fiscal budget.
At the federal level, Congress is currently considering a
comprehensive package of requirements on managed care plans called the "Patient
Protection Act" which largely mirrors the "Patients' Bill of Rights" legislation
considered by Congress in 2002. However, the current legislation would not
subject managed care plans to liability for personal injuries. States such as
New York are also considering such proposals. We cannot predict whether these
proposals will be enacted or what form such laws might take.
Congress is also considering significant changes to the Medicare
program. In addition, long-term structural changes to the Medicare program,
including the addition of a prescription drug benefit, are currently being
considered by Congress and the current White House administration.
In addition, Congress is considering legislation authorizing
association health plans or AHPs to offer health insurance coverage to small
groups without state oversight. Specifically, AHPs would be exempt from state
insurance laws and subject to minimal federal rules and oversight. State
33
regulated health plans would remain subject to state rules and oversight, thus
requiring them to compete with largely unregulated entities for business.
The proposed regulatory and legislative changes described above, if
enacted, could increase health care costs and administrative expenses, reduce
Medicare reimbursement rates and otherwise adversely affect our business,
financial condition and results of operations. We cannot predict whether any of
the proposed legislation will be enacted.
THE PLAN OF CONVERSION
BACKGROUND
On September 26, 1996, HealthChoice announced its intention to
restructure to a for-profit company, based on significant changes in both the
regulatory environment and the marketplace affecting the health insurance
industry.
In July 1999, HealthChoice filed a proposed plan of restructuring
with the Department of Insurance, which was revised in November 1999 following
public hearings. On December 29, 1999, the Superintendent of Insurance approved
the plan with some modification. This plan was never implemented.
THE LEGISLATION AND THE PLAN
In January 2002, the Governor of the State of New York signed into
law Chapter One of the New York Laws of 2002, which we refer to as the
Conversion Legislation, providing an express statutory basis for HealthChoice's
right to convert to a for-profit company. Prior to our initial public offering,
HealthChoice was our parent company. The Conversion Legislation, specifically
Section 4301(j) and Section 7317 of the New York Insurance Law, clarified the
statutory authority for the Superintendent of Insurance's review and approval of
a conversion plan. Accordingly, on June 18, 2002, HealthChoice filed an amended
plan of conversion seeking the Superintendent's approval to convert under the
terms of the Conversion Legislation. HealthChoice also requested and obtained
approvals from the Superintendent and, where necessary, from the New York
Commissioner of Health, the New Jersey Department of Banking and Insurance, CMS
and the Blue Cross Blue Shield Association for certain transactions related to
the plan of conversion. On August 6 and 7, 2002, public hearings took place in
New York City and Albany, respectively, with respect to the plan of conversion.
HealthChoice further amended and refiled the plan of conversion on September 26,
2002 in response to various issues raised at the public hearings. On October 8,
2002, the Superintendent issued an Opinion and Decision approving the plan of
conversion and concluding that the conversion is in compliance with the
Conversion Legislation and does not violate any applicable laws or regulations.
The approval and conclusions were subject to several conditions, including the
approval by the Superintendent, the Commissioner and CMS of certain of the
agreements that we entered into in connection with the conversion, all of which
were satisfied.
The plan of conversion, as required by the Conversion Legislation,
provided for:
o safeguards to ensure consumers' continued or increased access to
coverage and consumer outreach;
o the method for the transfer of contract forms to ensure that
current members were not adversely affected by the conversion and
had uninterrupted coverage;
o the conversion of HealthChoice from a not-for-profit corporation
into a for-profit corporation; and
34
o the procedures which we were required to take in completing our
conversion, including the series of transactions that resulted in
The New York Public Asset Fund, or the Fund, and The New York
Charitable Asset Foundation, or the Foundation, initially owning
all of our shares. The Fund and the Foundation were established
by New York State under the Conversion Legislation to receive the
value of HealthChoice as part of HealthChoice's conversion to a
for-profit company.
As contemplated by the plan, following HealthChoice's conversion into
a for-profit corporation and prior to the effectiveness of our initial public
offering, the converted HealthChoice transferred 95% and 5% of its capital stock
to the Fund and the Foundation, respectively. The Fund and the Foundation then
transferred their shares in the converted HealthChoice to WellChoice Holdings of
New York, Inc., or Holdings, a then newly formed wholly owned, for-profit
subsidiary and the parent company of our principal insurance operating
subsidiaries, in exchange for a corresponding amount of our common stock.
Consequently, immediately prior to the completion of the offering, WellChoice
was 95% owned by the Fund and 5% owned by the Foundation. As part of these
transactions, the converted HealthChoice merged with Empire HealthChoice
Assurance, Inc., HealthChoice's indirect, wholly owned subsidiary and existing
for-profit insurer, with HealthChoice surviving as "Empire HealthChoice
Assurance, Inc." That entity then transferred its administrative and managerial
functions to us. In connection with the transactions described in this
paragraph, the Fund obtained an exemption from acquisition of control
requirements from the Superintendent and the Commissioner in order to hold 10%
or more of the outstanding shares of our common stock.
As a result of these transactions, WellChoice became an insurance
holding company with Holdings owning our insurance operating subsidiaries. As
required by the Conversion Legislation, immediately following the conversion,
95% of the fair market value of HealthChoice, by virtue of the proceeds from
their respective sale of shares and the ownership of their remaining initial
shares of WellChoice, was held by the Fund and 5% by the Foundation.
In connection with the conversion, HealthChoice transferred and
assigned, and WellChoice received and assumed, certain assets and liabilities,
including leases and contracts associated with the provision of administrative
and management services to our insurance/HMO subsidiaries.
WellChoice was incorporated in Delaware in August 2002. Prior to the
completion of the conversion and our initial public offering, WellChoice did not
engage in any operations.
As part of the plan of conversion, we agreed to several restrictions
on premium rate increases relating to three categories of our individual
members. The first category is a small group of members who currently are
covered under a comprehensive individual indemnity policy that is no longer sold
by us. This group of members is eligible for Medicare by reason of disability
and would not be eligible to purchase comparable coverage if their policies were
terminated. Current law applicable to us and the Conversion Legislation
prohibits us from discontinuing these policies. There are fewer than 300
individuals covered under these policies and new enrollment is prohibited. We
agreed in the plan of conversion that we will not discontinue these policies and
that we will not increase rates on these policies by more than 10% (or such
lesser amount as may be required if the current statute is amended to provide a
lower maximum for "file and use" rates) in any 12-month period without the
Superintendent's prior approval, which may only be granted following a public
hearing.
The second category relates to members covered by our individual
Medicare supplemental policies and the third category relates to our individual
Direct Pay voluntary indemnity policies. Currently, we offer three standard
Medicare supplemental packages, A, B and H, and approximately 118,000
individuals are covered under these policies and approximately 19,000 members
35
are covered under our individual Direct Pay voluntary indemnity policies. We
agreed that, with respect to the premium rates applicable to our individual
Medicare supplemental policies and our individual Direct Pay voluntary indemnity
policies, we will comply with certain provisions of the New York Insurance Law
in effect on December 31, 1999 relating to premium rate increases for persons
covered under policies issued by Article 43 (not-for-profit) insurers for a
period of five years and three years, respectively, following the effective date
of the conversion. Specifically, for rate increases applicable to individual
Medicare supplemental policies and individual Direct Pay voluntary indemnity
policies during the five-year and three-year periods, respectively:
o we may utilize the "file and use" rate methodology (filed rates
will be deemed approved 30 days after submission) for rate
increases of up to 10% annually, or such lower amount as may be
required if the current statute is amended to provide a lower
maximum for file and use rates (provided that the policies do not
have a medical loss ratio less than a minimum of 80%); and
o the Superintendent's prior approval following a public hearing
will be required for increases that exceed 10% annually.
In addition, we agreed that with respect to our Medicare supplemental
policies, rate increases during the sixth, seventh and eighth years following
November 7, 2002, the effective date of the conversion, may be implemented upon
filing under the "file and use" methodology, provided we have a medical loss
ratio of at least 80% (the ratio otherwise applicable to not-for-profit
insurers), in contrast to the 75% minimum that is applicable to Medicare
supplemental policies issued by for-profit health insurers. During this period,
any application for Medicare Supplemental policy rate increases with a medical
loss ratio below 80% will require the prior approval of the Superintendent
following a public hearing. At the end of the eighth year following the
effective date of the conversion, the premium rates for these policies will be
subject to the rules applicable to all other for-profit health insurers.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
OUR INABILITY TO ADDRESS HEALTH CARE COSTS AND IMPLEMENT INCREASES IN PREMIUM
RATES COULD NEGATIVELY AFFECT OUR PROFITABILITY.
Our profitability depends in large part on accurately predicting
health care costs and on our ability to manage future health care costs through
underwriting criteria, quality initiatives and medical management, product
design and negotiation of favorable provider reimbursement rates. The following
includes factors that are beyond our control and may adversely affect our
ability to predict and manage health care costs:
36
o higher than expected utilization of services; o changes in healthcare practices;
o an increase in the number of high-cost cases; o cost of prescription drugs and direct to
consumer marketing by pharmaceutical
o changes in the population or demographic companies;
characteristics of members served, including
aging of the population; o the introduction of new medical technology
and pharmaceuticals, and
o medical cost inflation;
o the enactment of legislation that requires
us to expand the delivery of required
benefits
In addition to the challenge of managing health care costs, we face
pressure to contain prices for our products. Our customer contracts may be
subject to renegotiations as customers seek to contain their costs.
Alternatively, our customers may move to a competitor to obtain more favorable
prices. A limitation on our ability to increase or maintain our prices could
result in reduced revenues and earnings which could have an adverse impact on
the trading prices of our common stock and the value of your investment.
A REDUCTION IN ENROLLMENT IN OUR HEALTH INSURANCE PROGRAMS COULD AFFECT OUR
BUSINESS AND PROFITABILITY.
A reduction in the number of members in our health insurance programs
could reduce our revenues and profitability. Factors that could contribute to a
reduction in membership include:
o failure to obtain new customers or retain existing customers;
o premium increases and benefit changes;
o failure to successfully implement our growth strategy;
o failure to provide innovative products that meet the needs of our
customers or potential customers;
o our exit from a specific market;
o reductions in workforce by existing customers;
o negative publicity and news coverage; and
o a general economic downturn that results in business failures.
REGIONAL CONCENTRATION OF OUR BUSINESS MAY SUBJECT US TO ECONOMIC DOWNTURNS IN
NEW YORK STATE AND, IN PARTICULAR, THE NEW YORK CITY METROPOLITAN AREA.
We operate in 28 counties in New York State and substantially all of
our revenue is derived from group accounts that have an office in our service
areas in New York State or from individual members who reside in the state. This
concentration of business in New York exposes us to potential losses resulting
from a downturn in the economy of New York State and, in particular, New York
City. The events of September 11, 2001 and the economic recession have had a
negative economic impact on business in New York City as well as New York State.
In addition, a nationwide economic downturn could have an adverse impact on our
37
national accounts business. If economic conditions continue to deteriorate, we
may experience a reduction in existing and new business, which may have an
adverse effect on our business, financial condition and results of operations.
In addition, as a high profile, diverse and highly populated city,
New York City could be the target of future terrorist attacks, including
bioterrorism and other public health threats, which could significantly increase
the risks of our business, such as the risk of significant increases in costs of
benefits provided following such an event. For example, a bioterrorism attack
could cause increased utilization of healthcare services, including physician
and hospital services, high-cost prescription drugs and other services.
SIGNIFICANT COMPETITION FROM OTHER HEALTH CARE COMPANIES COULD NEGATIVELY AFFECT
OUR ABILITY TO MAINTAIN OR INCREASE OUR PROFITABILITY.
Our business operates in a highly competitive environment, both in
the states of New York and New Jersey as well as nationally. Competition in our
industry has intensified in recent years, due to more aggressive marketing and
pricing practices by other health care organizations, a customer base which
focuses on quality while still being price-sensitive and the introduction of new
products for which health insurance companies must compete for members. This
environment has produced, and will likely continue to produce, significant
pressures on the profitability of health insurance companies. Concentration in
our industry also has created an increasingly competitive environment, both for
customers and for potential acquisition targets, which may make it difficult for
us to grow our business. Some of our competitors are larger and have greater
financial and other resources than we do. We may have difficulty competing with
larger health insurance companies, which can create downward price pressures on
provider rates through economies of scale. We may not be able to compete
successfully against current and future competitors. In addition, in recent
years, the nature and means by which participants in the health care and health
insurance industries market products and deliver services have changed rapidly.
We believe this trend will continue, requiring us to continue to respond to new
and, possibly, unanticipated competitive developments. Competitive pressures
faced by us may adversely affect our business, financial condition and results
of operations.
MEDICARE PREMIUMS MAY NOT KEEP UP WITH THE COST OF HEALTH CARE SERVICES WE
PROVIDE UNDER OUR MEDICARE+CHOICE PRODUCT.
We offer a Medicare+Choice product through our New York HMO
operations. Under the Medicare+Choice program, Medicare beneficiaries have the
option of receiving their care through an HMO instead of the traditional
Medicare fee-for-service program. In connection with this product, we receive a
fixed per member per month, or PMPM, capitation payment from CMS, the federal
agency that administers the Medicare program. The capitation payment is
established annually based on a legislatively mandated formula that, in general,
provides for a 2% annual increase. In addition, we have the ability to change
our program on an annual basis. These changes may include a premium payment that
is charged to enrolled members and/or reductions in the level of covered
services. We currently require that members in some counties contribute toward
the cost of their coverage. We bear the risk that the actual cost of covered
health services may exceed the amount we receive from CMS and our members. This
can happen if the utilization of health care services increases at a faster rate
than we expect or if our hospitals and providers demand larger increases than we
anticipated. Hospitals, hospital systems and providers that render services to
our Medicare+Choice members may decide to cease to participate with us in this
particular program or demand increases from us in order to receive a level of
reimbursement that is consistent with the reimbursement rates they receive under
the traditional Medicare fee-for-service program. As these factors increase
costs beyond the 2% annual increase we receive from CMS, we may need to either
increase the premium rates charged to our members or decrease covered benefits.
These changes may make our product less attractive to Medicare beneficiaries
and, as a result, our Medicare+Choice membership could decrease. Our membership
38
could also decrease as a result of our departure from certain counties that we
currently serve. In addition, this program is annually the subject of
legislation in Congress and we cannot predict what additional rules and
requirements may be enacted that will impact our business. The contract to
participate in the Medicare+Choice program could also, under certain
circumstances, be terminated by the federal government or by us.
AS A MEDICARE FISCAL INTERMEDIARY, WE ARE SUBJECT TO COMPLEX REGULATIONS. IF WE
FAIL TO COMPLY WITH THESE REGULATIONS, WE MAY BE EXPOSED TO CRIMINAL SANCTIONS
AND SIGNIFICANT CIVIL PENALTIES.
Empire is a fiscal intermediary for the Medicare Part A program and a
carrier for the Medicare Part B program, which provide hospital and physician
coverage to persons 65 years or older. As a fiscal intermediary, we serve as an
administrative agent for the traditional Medicare fee-for-service program and
receive reimbursement for certain costs and expenditures, which are subject to
adjustment upon audit by CMS. The laws and regulations governing fiscal
intermediaries for the Medicare program are complex, subject to interpretation
and can expose a fiscal intermediary to penalties for non-compliance. Fiscal
intermediaries may be subject to criminal fines, civil penalties or other
sanctions as a result of such audits or reviews. However, there can be no
assurance that our compliance program will be adequate or that regulatory
changes or other developments which occur in the future will not result in
infractions of the CMS requirements.
WE ARE DEPENDENT ON THE SUCCESS OF OUR RELATIONSHIP WITH IBM FOR A SIGNIFICANT
PORTION OF OUR INFORMATION SYSTEM RESOURCES.
In June 2002, we entered into an agreement with International
Business Machines Corporation, or IBM, pursuant to which IBM will assist us in
modernizing our information systems. In addition, under this agreement, a
portion of our core applications staff and our data center operations will be
outsourced to IBM for a period of ten years. Also under this agreement, IBM,
through a relationship with deNovis, Inc., a claims payment systems developer,
will develop a new claims payment system which will be licensed to us in
perpetuity. deNovis, Inc. is a privately held startup company. We will
materially rely on these developments and improvements of our core technology
operations on a going-forward basis. Strategic relationships such as the one we
have with IBM can be difficult to implement and maintain, and may not succeed
for various reasons including:
o changes in strategic direction by one or both companies;
o technical obstacles to developing the technologies;
o the insolvency, merger or change of control of one of the
parties;
o difficulties in coordinating joint development efforts;
o difficulties in structuring and maintaining revenue sharing
arrangements; and
o operating differences between the companies and their respective
employees.
If our relationship with IBM is terminated for any reason or if we
are unable to successfully develop and implement the technological improvements
and innovations contemplated by the agreement with IBM, we may not be able to
find an alternative partner in a timely manner or on acceptable financial terms
with whom we will be able to pursue our strategy. As a result, we may not be
able to meet the demands of our customers and, in turn, our business, financial
condition and results of operations may be harmed.
39
In addition, we intend to fund the modernization expenses incurred in
connection with this collaboration with IBM in part through the cost savings we
expect to realize as a result of the outsourcing of this project to IBM. Any
substantial increase in these expenses, or inability to achieve our anticipated
cost savings, could have an adverse effect on our profitability, financial
condition and results of operations. We do not expect to realize cost savings
from these improvements in the early years of the project. If we are
unsuccessful in implementing these improvements or if these improvements do not
meet our customers' requirements, we may not be able to recoup these costs and
expenses and effectively compete in our industry.
Some of the risks associated with the collaboration with IBM are
anticipated and covered through termination rights clauses and indemnification
clauses included under our outsourcing agreement. Nevertheless, we may not be
adequately indemnified against all possible losses through the terms and
conditions of the agreement. In addition, some of our termination rights are
contingent upon payment of a fee, which may be significant.
A SUBSTANTIAL LEGAL LIABILITY OR A SIGNIFICANT REGULATORY ACTION AGAINST US
COULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS, RESULTS OF OPERATIONS AND
FINANCIAL CONDITION.
We are, and may in the future be, a party to a variety of legal
actions that affect any business, such as employment and employment
discrimination-related suits, employee benefit claims, breach of contract
actions, tort claims and intellectual property related litigation. In addition,
because of the nature of our business, we are subject to a variety of legal and
regulatory actions relating to our business operations or to our industry,
including the design, management and offering of our products and services.
Recent court decisions and legislative activity may increase our
exposure for litigation claims. In some cases, substantial non-economic, treble
or punitive damages may be sought. The loss of even one claim, if it resulted in
a significant punitive damages award, could significantly worsen our financial
condition or results of operations. This risk of potential liability may make
reasonable settlements of claims more difficult to obtain.
We currently have insurance coverage for some of these potential
liabilities. Other potential liabilities may not be recovered by insurance,
insurers may dispute coverage or the amount of insurance may not be enough to
cover the damages awarded. In addition, certain types of damages, such as
punitive damages, may not be covered by insurance and insurance coverage for all
or certain forms of liability may become unavailable or prohibitively expensive
in the future.
In September 1999, a group of plaintiffs' trial lawyers publicly
announced that they were targeting the managed care industry by way of class
action litigation. Since that time, two actions, one purporting to be a class
action on behalf of providers and the other brought by the Medical Society of
the State of New York, have been commenced against us generally challenging
managed care practices, including cost containment mechanisms, disclosure
obligations and payment methodologies. We intend to defend vigorously all of
these cases. We will incur defense costs and we cannot predict the outcome of
these cases. Certain potential liabilities may not be covered by insurance, and
a large judgment against us or a settlement could adversely affect our business,
financial condition and results of operations.
40
OUR PROFITABILITY MAY BE ADVERSELY AFFECTED IF WE ARE UNABLE TO MAINTAIN OUR
CURRENT PROVIDER AGREEMENTS AND TO ENTER INTO OTHER APPROPRIATE AGREEMENTS.
Our profitability is dependent in part upon our ability to contract
on favorable terms with hospitals, physicians and other health benefits
providers. Our agreements with these providers generally have fixed terms which
require that we renegotiate them periodically. The failure to maintain or secure
new cost-effective health care provider contracts may result in a loss in
membership or higher costs of benefits provided. In addition, our inability to
contract with providers on favorable terms, or the inability of providers to
provide cost-effective care, could adversely affect our business. Large groups
of physicians, hospitals and other providers have in recent years begun to
collectively renegotiate their contracts with health insurance companies like
us. In addition, physicians, hospitals and other provider groups continue to
consolidate to create hospital networks. This cooperation and/or consolidation
among providers increases their bargaining positions and allows the providers to
negotiate for higher reimbursement rates from us. Demands for higher
reimbursement rates may lead to increased premium rates, the loss of beneficial
hospitals and physicians and a disruption of service for our members, which in
turn could cause a decrease in existing and new business. If this practice
increases or continues for an extended period of time, it could have an adverse
affect on our business, financial condition and results of operations.
In addition, we have capitated arrangements for mental health and
substance abuse services with Magellan Behavioral Health Inc., which has
announced that it is exploring refinancing its debt and a comprehensive capital
restructuring. The failure of Magellan to continue the current arrangement could
result in increased costs for these services as well as the need to obtain
another network for these services outside our service area.
OUR BUSINESS IS HEAVILY REGULATED AND CHANGES IN STATE AND FEDERAL REGULATIONS
MAY ADVERSELY AFFECT THE PROFITABILITY OF OUR BUSINESS, OUR FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
We are subject to extensive regulation and supervision by the New York
State Department of Insurance, or Department of Insurance, and the New York
State Department of Health, or Department of Health, with respect to our New
York operations, the New Jersey Department of Banking and Insurance, with
respect to our New Jersey operations, as well as to regulation by federal
agencies with respect to our federal programs. These laws and regulations are
subject to amendments and changing interpretations in each jurisdiction.
Our insurance subsidiaries are also subject to insurance laws that
establish supervisory agencies with broad administrative powers to grant and
revoke licenses to transact business and otherwise regulate sales, policy forms
and rates, financial reporting, solvency requirements, investments and other
practices. Future regulatory action by state insurance authorities could have an
adverse effect on the profitability or marketability of our health benefits or
managed care products or on our and our subsidiaries' business, financial
condition and results of operations. In addition, because of our participation
in government-sponsored programs, such as Medicare, changes in government
regulations or policies with respect to, among other things, reimbursement
levels, could also adversely affect our and our subsidiaries' business,
financial condition and results of operations.
Moreover, state legislatures and the United States Congress continue
to focus on health care issues. Congress is considering various forms of
Patients' Bill of Rights legislation which, if adopted, could fundamentally
alter the treatment of coverage decisions under the Employee Retirement Income
Security Act of 1974, or ERISA. Additionally, there recently have been
legislative attempts to limit ERISA's preemptive effect on state laws. If
adopted, such limitations could increase our liability exposure and could permit
greater state regulation of our operations. Other proposed bills and regulations
41
at state and federal levels may impact certain aspects of our business,
including agent licensing, corporate governance, permissible investments, market
conduct, provider contracting, claims payments and processing and
confidentiality of health information. In addition, the New York Governor's
proposed 2003-2004 fiscal budget would increase assessments and surcharges
imposed on insurers, increase premium taxes payable on insured business written
in New York, and transfer some early intervention services from state sponsored
programs to private insurers. While we cannot predict if any of these
initiatives will ultimately become effective or, if enacted, what their terms
will be, their enactment could increase our costs, expose us to expanded
liability or require us to revise the ways in which we conduct business.
ACQUISITIONS OR INVESTMENTS THAT WE MAY MAKE COULD TURN OUT TO BE UNSUCCESSFUL.
As part of our growth strategy, we may in the future pursue
acquisitions of and/or investments in businesses, products and services. The
negotiation of potential acquisitions or investments as well as the integration
of an acquired or jointly developed business, service or product could result in
a substantial diversion of management resources. We could be competing with
other firms, many of which have greater financial and other resources, to
acquire attractive companies. Acquisitions could result in potentially dilutive
issuances of equity securities, the incurrence or assumption of debt and
contingent liabilities, amortization of certain identifiable intangible assets,
write-offs and other acquisition-related expenses. In addition, we may also fail
to successfully integrate acquired businesses with our operations or
successfully realize the intended benefits of any acquisition or investment.
LITIGATION CHALLENGING THE CONVERSION LEGISLATION COULD ADVERSELY AFFECT THE
TERMS OF THE PLAN OF CONVERSION AND THE PRICE OF OUR COMMON STOCK.
Litigation may be filed challenging the Conversion Legislation on the
ground that the legislation is unconstitutional. The Conversion Legislation
provides that any such litigation must receive expedited judicial review.
However, a substantial period of time could be required to reach a
determination. On August 21, 2002, Consumers Union of U.S., Inc., the New York
Statewide Senior Action Council and several other groups and individuals filed a
lawsuit in New York Supreme Court challenging the Conversion Legislation on
several constitutional grounds, including that it impairs the plaintiffs'
contractual rights, impairs the plaintiffs' property rights without due process
of law, and constitutes an unreasonable taking of property. In addition, the
lawsuit alleges that HealthChoice has violated Section 510 of the New York
Not-For-Profit Corporation Law and that the directors of HealthChoice breached
their fiduciary duties, among other things, in approving the plan of conversion.
The complaint seeks a permanent injunction enjoining the conversion or portions
of the conversion. On September 20, 2002, we responded to this complaint by
moving to dismiss the plaintiffs' complaint in its entirety on several grounds.
On November 6, 2002, pursuant to a motion filed by plaintiffs, the New York
Supreme Court issued a temporary restraining order temporarily enjoining and
restraining the transfer of the proceeds of the sale of common stock by the
selling stockholders in this offering to the Fund or the Foundation or to the
State or any of its agencies or instrumentalities. The court also ordered that
such proceeds be deposited with The Comptroller of the State of New York pending
the outcome of this action. The court did not enjoin WellChoice, HealthChoice or
the other defendants from completing the conversion or our initial public
offering. A court conference was held on November 26, 2002, at which time the
motion to dismiss and the motion to convert the temporary restraining order into
a preliminary injunction were deemed submitted. On March 6, 2003, the court
delivered its decision dated February 28, 2003, in which it dismissed all of the
plaintiffs' claims in the complaint. The decision grants two of the plaintiffs,
Consumers Union and one other group, leave to replead the complaint, if they so
choose, within 30 days of the decision to allege that the Conversion Legislation
violates the State Constitution on the ground that it applies exclusively to
HealthChoice. Pending this 30-day period, the temporary restraining order
remains in effect and the plaintiffs' motion for a preliminary injunction is
deferred. If the plaintiffs are successful in this litigation, there could be
substantial uncertainty as to the terms and effectiveness of the plan of
conversion, including the conversion of HealthChoice into a for-profit
42
corporation, the issuance of the shares of our common stock in the conversion,
or the sale of our common stock in the initial public offering. In addition, new
litigation challenging the Conversion Legislation could also be filed. Such
developments could have an adverse impact on our ability to conduct our business
and could have an adverse impact on prevailing market prices of our common
stock.
ITEM 2. PROPERTIES.
We lease approximately 162,000 square feet of office space at 11
West 42nd Street in New York City, where our corporate headquarters are located.
This lease expires in December 2015, although the lease for approximately
one-third of this space terminates in September 2003 and March 2004. We lease
approximately 275,000 additional square feet throughout New York City for our
operations, information technology, administration and sales and marketing
staff, including our 73,000 square feet data center which IBM has sublet
pursuant to our outsourcing and modernization arrangements with them. The
expiration of these leases range from June 2003 to June 2009, with the exception
of our data center sublease which expires in May 2020. We also lease
approximately one million square feet throughout New York State and New Jersey
where we house, among others, our customer service, operations, administration,
sales and Medicare administration staff. The leases for these facilities expire
between June 2004 and February 2012. We have entered into a lease agreement to
rent 392,500 square feet at Nine Metrotech Center in Brooklyn, New York
beginning in 2003. This space will replace, for the most part, our existing
leases for space in New York City expiring during 2003 and 2004.
The average annual rental obligations for these facilities for the
next five years is approximately $43.0 million. We believe that these facilities
will be sufficient to meet our needs for the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS.
Medical Society of the State of New York. We and several of our
affiliates have been named as defendants in a class action lawsuit brought by
five physicians on behalf of a purported class of all members of the Medical
Society of the State of New York. The suit, Cheng v. Empire, was filed on or
about August 16, 2001 in the Supreme Court of the State of New York, New York
County. The plaintiffs allege that the defendants are engaged in various
activities in violation of statute or contract, including "bundling" for payment
separate healthcare services that occurred on the same date, unjustifiably
denying increased levels of reimbursement for complicated medical cases,
improperly employing software programs to automatically "downcode" claims for
procedures and use of inappropriate medical necessity guidelines, failure to
employ adequate staff so as to frustrate payments, failure to pay interest as
required by law on past due claims and forcing physicians to enter into
one-sided managed care physician agreements. The plaintiffs seek an award of
compensatory or actual damages.
A second action was also commenced on or about August 16, 2001,
captioned Medical Society of the State of New York v. Empire in the Supreme
Court of the State of New York, New York County. This case makes allegations
virtually identical to those in the Cheng case. The Medical Society seeks,
however, a declaration that the challenged practices violate various provisions
of state law and a permanent injunction prohibiting HealthChoice from engaging
in the conduct alleged in the complaint.
On December 4, 2001, these cases were removed from state court to the
United States District Court for the Southern District of New York, and
plaintiffs have moved to remand these cases to state court. We are awaiting
decisions on these actions.
Consumers Union of the U.S., Inc. et. al. On August 21, 2002,
Consumers Union of the U.S., Inc., the New York Statewide Senior Action Council
and several other groups and individuals filed a lawsuit in New York Supreme
43
Court against the State of New York, the Superintendent, the Fund, HealthChoice
and its board of directors, among others, challenging the Conversion Legislation
on several constitutional grounds, including that it impairs the plaintiffs'
contractual rights, it impairs the plaintiffs' property rights without due
process of law, and constitutes an unreasonable taking of property. In addition,
the lawsuit alleges that HealthChoice has violated Section 510 of the New York
Not-For-Profit Corporation Law and that the directors of HealthChoice breached
their fiduciary duties, among other things, in approving the plan of conversion.
The complaint seeks a permanent injunction against the conversion or portions
thereof, including a redirection of the proceeds received from the sale of
shares by our largest stockholder, The New York Public Asset Fund, to uses that
are charitable in nature.
By a motion dated September 20, 2002, we and the State defendants moved
on several grounds to dismiss plaintiffs' complaint in its entirety. In our
motion, we argued first, that plaintiffs' entire complaint should be dismissed
because the issue of how best to use HealthChoice's value to advance the
public's health and welfare raised by the complaint is a non-justiciable
political question that is the sole province of the Legislature and beyond
review by the courts. Second, we argued that plaintiffs' constitutional claims
based upon violations of the contracts, due process, and takings clauses should
be dismissed because plaintiffs failed to allege a state action, a cognizable
property or contractual right, or that the procedures pursuant to which any
conversion would take place do not comport with due process safeguards. We
argued further that plaintiffs' state law claims should be dismissed because the
Conversion Legislation supersedes any state provisions allegedly violated;
plaintiffs failed to plead that our board of director's decision to pursue the
conversion constitutes a breach of fiduciary duty; plaintiffs did not plead all
of the elements of constructive trust against any defendant; and plaintiffs'
allegation that the Conversion Legislation does not apply to HealthChoice is
contradicted by the statute itself and by the decision of the New York
Superintendent of Insurance to approve the plan of conversion, which allegation
plaintiffs seek to withdraw.
On November 6, 2002, pursuant to a motion filed by plaintiffs, the
New York Supreme Court issued a temporary restraining order enjoining and
restraining the transfer of the proceeds of the sale of common stock by the
selling stockholders in our initial public offering to The New York Public Asset
Fund or The New York Charitable Asset Foundation or to the State or any of its
agencies or instrumentalities. The court also ordered that such proceeds be
deposited with the Comptroller of the State of New York pending the outcome of
this action. The court did not enjoin WellChoice, HealthChoice or the other
defendants from completing the conversion or the initial public offering or the
receipt by WellChoice of the net proceeds from its issuance and sale of shares
in the initial public offering. A court conference was held on November 26,
2002, at which time the motion to dismiss and the motion to convert the
temporary restraining order into a preliminary injunction were deemed submitted.
On March 6, 2003, the court delivered its decision dated February 28, 2003, in
which it dismissed all of the plaintiffs' claims in the complaint. The decision
grants two of the plaintiffs, Consumers Union and one other group, leave to
replead the complaint, if they so choose, within 30 days of the decision to
allege that the Conversion Legislation violates the State Constitution on the
ground that it applies exclusively to HealthChoice. Pending this 30-day period,
the temporary restraining order remains in effect and the plaintiffs' motion for
a preliminary injunction is deferred.
Other. We are also party to additional litigation and are, from time
to time, named as co-defendants in legal actions brought against governmental
healthcare bodies. At present, we are not party to any additional litigation
which, if concluded in a manner adverse to us, would have a material adverse
impact on us or our business.
44
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT:
Our executive officers are as follows:
NAME AGE POSITION
- ---- --- --------
Michael A. Stocker, M.D. 60 Chief Executive Officer, President and Director
Bryan D. Birch 37 Senior Vice President, Chief Sales Officer
Deborah Loeb Bohren 48 Senior Vice President, Communications
David A. Florman 50 Senior Vice President, Medical Delivery Systems and Medicare Risk
Jason N. Gorevic 31 Senior Vice President, Chief Marketing Officer
Kenneth O. Klepper 49 Senior Vice President, Systems, Technology and Infrastructure
Robert W. Lawrence 51 Senior Vice President, Human Resources and Services
Gloria M. McCarthy 50 Senior Vice President, Operations, Managed Care and Medicare Services
John W. Remshard 55 Senior Vice President, Chief Financial Officer
Linda V. Tiano 45 Senior Vice President, General Counsel
Michael A. Stocker, M.D. has served as Chief Executive Officer and
director of WellChoice since August 2002 and as its President since January 3,
2003. Dr. Stocker has served as Chief Executive Officer and Director of
HealthChoice since October 1994 and served as President of HealthChoice from
October 1994 to March 2001. From February 1993 to October 1994, Dr. Stocker was
the President of CIGNA Healthplans. Dr. Stocker has also served as Executive
Vice President, General Manager for the Greater New York Market of U.S.
Healthcare.
Bryan D. Birch has served as Senior Vice President, Chief Sales
Officer of WellChoice since September 2002 and of HealthChoice since June 2000.
From January 1999 to June 2000, Mr. Birch was an Executive Vice President and
Founder of iHealth Technologies, a claims editing company. From July 1995 to
January 1999, Mr. Birch was the Chief Executive Officer of Oxford Health Plans'
Connecticut Division. From August 1992 to July 1995, Mr. Birch was the Corporate
Director of Medical Delivery for Oxford Health Plans responsible for all
contracting initiatives. Prior to serving at Oxford, Mr. Birch worked for an
issuer of tax-exempt revenue bonds in New Jersey for six years. Mr. Birch serves
on the board of directors for both Consortium Health Plans and the National
Account Executive Committee, a Blue Cross Blue Shield Association workgroup.
Deborah Loeb Bohren has served as Senior Vice President,
Communications of WellChoice since January 2003. Ms. Bohren was Vice President,
Public Affairs of WellChoice from October 2002 to December 2002 and of
HealthChoice from October 1998 to October 2002. Prior thereto, Ms. Bohren served
as Assistant Vice President, Media Relations for HealthChoice from February 1997
to October 1998 and as HealthChoice's Director of Media Relations from February
1996 to February 1997.
David A. Florman has served as Senior Vice President, Medical
Delivery Systems and Medicare Risk of WellChoice since September 2002 and of
HealthChoice since March 2001. From September 2000, until February 2001, Mr.
Florman was Senior Vice President and the head of national medical management
strategy of Aetna (formerly U.S. HealthCare), a health insurance company. From
October 1997 until August 2000, he led corporate medical cost management at
Aetna. From December 1995 until September 1997, Mr. Florman was Senior Vice
President and General Manager of Aetna's Long Island Market. From 1990 until
45
September 1997, Mr. Florman served in various positions at Aetna, which included
senior level responsibility for network development and medical cost management.
Jason N. Gorevic has served as the Senior Vice President, Chief
Marketing Officer of WellChoice since February 2003. Prior thereto, Mr. Gorevic
served as Acting Chief Marketing Officer of WellChoice from November 2002 to
February 2003, and was Vice President, Local Group Commercial Markets of
WellChoice from September 2002 to November 2002 and of HealthChoice from
February 2002 to November 2002. From July 2000 until December 2001, Mr. Gorevic
was Chief Executive Officer of LuxuryGems, Inc. d/b/a Gemfinity, an electronic
marketplace and purchasing aggregator. From July 1999 to July 2000, Mr. Gorevic
was General Manager of Business Messaging at Mail.com, Inc., a provider of
Internet messaging services, and from April 1998 until June 1999, he served as
Mail.com's Vice President of Operations. Between 1993 and 1998, Mr. Gorevic
worked at Oxford Health Plans, Inc., where he held a variety of positions in
marketing, medical management and operations.
Kenneth O. Klepper has served as Senior Vice President of Systems,
Technology and Infrastructure of WellChoice since September 2002 and of
HealthChoice since August 1999. Prior thereto, Mr. Klepper served HealthChoice
as Senior Vice President and Process Champion of Corporate Development from
March 1999 until August 1999 and as Senior Vice President and Process Champion
of Medical Cost Control from March 1998 until March 1999. He joined HealthChoice
in 1995 as Senior Vice President, Process Champion, Customer Service, and also
held the position of Senior Vice President of Planning and Strategic Initiatives
during 1997. From 1992 until 1995, Mr. Klepper was the Assistant Vice President,
Provider Process Champion for CIGNA Healthcare in Nashville, where he had
national responsibility for provider process management. He currently serves on
the board of the National Accounts Services Company, LLC, an entity in which we
hold a 25% interest.
Robert W. Lawrence has served as Senior Vice President, Human
Resources and Services of WellChoice since September 2002 and of HealthChoice
since June 2002. Mr. Lawrence joined HealthChoice in November 1999 as Vice
President, Compensation, Benefits and HRIC. Prior to joining HealthChoice, he
served as Vice President, Human Resources of Philipp Brothers Chemicals, Inc., a
recycling company for agricultural and industrial chemicals, from August to
November 1999, and as Director, Human Resources for the Genlyte Thomas Group,
LLC, a manufacturer of lighting fixtures and control devices, from July 1993 to
May 1999. Prior thereto, Mr. Lawrence served in various human resources
positions for US WEST Financial Services, Inc. and the American National Can
Company.
Gloria M. McCarthy has served as the Senior Vice President,
Operations, Managed Care and Medicare Services of WellChoice since September
2002 and of HealthChoice since March 1997. She has held a variety of other
positions at HealthChoice since 1974.
John W. Remshard has been the Senior Vice President, Chief Financial
Officer of WellChoice since August 2002 and of HealthChoice since March 1996.
From July 1995 until March 1996, Mr. Remshard was the Senior Vice President of
Auditing of HealthChoice. Prior to joining HealthChoice, from 1978 until 1995,
Mr. Remshard was a Vice President in the Finance Division of CIGNA Corporation.
Linda V. Tiano has been the Senior Vice President, General Counsel of
WellChoice since August 2002 and of HealthChoice since September 1995. Prior
thereto, from 1992 until 1995, Ms. Tiano served as Vice President for Legal and
Government Affairs and General Counsel for MVP Health Plan, an HMO located in
upstate New York. From 1990 until 1992, Ms. Tiano was a stockholder of Epstein
Becker and Green, P.C., and for nine years prior thereto, an associate of that
firm, where she specialized in providing legal advice and assistance to a wide
variety of healthcare entities, primarily in the managed care industry.
46
***
As disclosed in the Company's Form 10-Q for the quarter ended
September 30, 2002, the Company's Chief Executive Officer, Michael A. Stocker,
M.D., is being treated for prostate cancer. He will continue performing all of
his regular duties and does not expect to take any extended leave of absence in
connection with his condition.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Since November 8, 2002, the first day of trading following the
effectiveness of our initial public offering, the Company's common stock has
been traded on The New York Stock Exchange under the symbol "WC." There is no
established market for the one share of Class B Common Stock outstanding.
The following table sets forth the high and low sales prices for the
Company's Common Stock, as reported by The New York Stock Exchange, since
November 8, 2002 for each calendar quarter indicated:
High Low
---- ---
2002: Fourth Quarter (commencing November 8, 2002).....$28.50 $22.15
2003: First Quarter (through March 5, 2003)............$24.00 $17.65
On February 21, 2003, the Company had 14 holders of record of its Common
Stock, which did not include beneficial owners of shares registered in nominee
or street name, and one holder of its Class B Common Stock.
No cash dividends have been declared on the Common Stock or Class B
Common Stock. We do not expect to pay cash dividends for the foreseeable future.
We currently intend to retain future earnings, if any, to finance operations and
the expansion of our business.
Our ability to pay dividends is dependent on cash dividends from our
subsidiaries. Our subsidiaries are subject to regulatory surplus requirements
and additional regulatory requirements, which may restrict their ability to
declare and pay dividends or distributions to us. Any proposed dividend to
WellChoice from Empire, which, together with other dividends paid within the
preceding twelve month period, exceeds the lesser of 10% of its surplus to
policyholders or 100% of adjusted net investment income, will be subject to
approval by the Department of Insurance. Any proposed dividend to Empire from
WellChoice Insurance of New Jersey, which, together with other dividends paid
within the preceding twelve month period, exceeds the greater of 10% of its
surplus to policyholders or net income not including realized capital gains will
be subject to approval by the New Jersey Department of Banking and Insurance.
Dividends from both Empire and WellChoice Insurance of New Jersey must be paid
from earned surplus. Dividends from Empire HealthChoice HMO to Empire in excess
of 10% of the admitted assets of Empire HealthChoice HMO will also be subject to
review and approval by the New York Department of Insurance and Department of
Health and the New Jersey Department of Banking and Insurance. These dividends
can only be paid from earned surplus.
In November 2002, HealthChoice obtained the consent of the Superintendent
to pay a dividend of $225.0 million to WellChoice simultaneously with the
effectiveness of our initial public offering.
47
At December 31, 2002, the Company did not have any compensation plans
(including individual compensation arrangements) under which equity securities
of the Company are authorized. Under the Plan of Conversion, the Company agreed
not to make any grants of any stock awards or stock options to employees or
directors prior to November 7, 2003, the first anniversary of the Company's
initial public offering.
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth selected financial data and other
operating information of WellChoice, Inc. and its subsidiaries. The selected
financial data in the table are derived from the consolidated financial
statements of WellChoice, Inc. The data should be read in conjunction with the
consolidated financial statements, related notes, and other financial
information included herein.
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------
2002 2001 2000 1999 1998
REVENUE:
Premiums earned $ 4,628.0 $ 4,246.2 $ 3,876.9 $ 3,362.3 $ 3,064.4
Administrative service fees 396.2 322.0 264.9 238.9 171.2
Investment income, net 64.8 69.3 65.5 58.7 55.6
Net realized investment gains
(losses) 2.6 (12.4) 22.1 0.2 3.8
Other income, net 14.0 6.1 4.3 4.8 3.0
-------- -------- -------- -------- --------
Total revenue 5,105.6 4,631.2 4,233.7 3,664.9 3,298.0
EXPENSES:
Cost of benefits provided 3,947.4 3,738.8 3,426.4 2,944.6 2,721.5
Administrative expenses 833.1 742.8 686.2 587.3 533.2
Conversion and IPO expenses 15.4 2.0 0.6 3.7 2.3
-------- -------- -------- -------- --------
Total expenses 4,795.9 4,483.6 4,113.2 3,535.6 3,257.0
-------- -------- -------- -------- --------
Income from continuing
operations before income
taxes 309.7 147.6 120.5 129.3 41.0
Income tax benefit (expense)(1) 67.9 (0.1) 74.5 (9.1) 1.0
-------- -------- -------- -------- --------
Income from continuing
operations 377.6 147.5 195.0 120.2 42.0
Loss from discontinued
operations, net of tax (1.1) (16.5) (4.6) -- --
-------- -------- -------- -------- --------
NET INCOME $376.5 $ 131.0 $ 190.4 $ 120.2 $ 42.0
-------- -------- -------- -------- --------
PER SHARE DATA
Proforma basic and diluted
earnings per share(2) $4.51 $ 1.57 $ 2.28 $ 1.44 $ 0.50
48
DECEMBER 31,
----------------------------------------------------------------------
2002 2001 2000 1999 1998
ADDITIONAL DATA - FOR THE YEAR
ENDED:
Medical loss ratio(3) 85.3% 88.1% 88.4% 87.6% 88.8%
Medical loss ratio, excluding
New York City and New York
State PPO(4) 81.8% 86.0% 85.9% 85.1% 86.6%
Administrative expense ratio(5) 16.9% 16.3% 16.6% 16.4% 16.6%
Administrative expense
ratio--premium equivalent
basis(6) 11.5% 11.7% 12.6% 12.7% N/A
Members (000's at end of
period)(7) 4,608 4,383 4,135 4,161 4,119
BALANCE SHEET DATA:
Cash and investments 1,783.0 1,604.3 1,400.6 1,330.2 1,184.0
Premium related receivables 358.8 403.5 447.5 404.7 399.3
Total assets 2,777.5 2,449.6 2,252.5 1,987.4 1,837.3
Unpaid claims and claims
adjustment expense 559.9 634.1 672.4 591.0 597.2
Obligations under capital lease 47.7 50.1 52.0 53.5 54.5
Total liabilities 1,541.2 1,620.3 1,577.8 1,484.7 1,457.8
Stockholders' equity (8) 1,236.3 829.3 674.7 502.7 379.5
_________
(1) The valuation allowance at December 31, 2001 was approximately $195.7
million. At December 31, 2002, we have eliminated the valuation
allowance on our deferred tax assets, based on approval of the
conversion and continued, current and projected positive taxable
income. As a result of the conversion, WellChoice is a for-profit
entity and is subject to state and local taxes as well as federal
income taxes at the statutory rate of 35% for the year ended December
31, 2002. As of December 31, 2000, we reduced our valuation allowance
on our deferred tax assets by $71.9 million based on continued,
current and projected positive taxable income.
(2) Pro forma basic and diluted earnings per share is calculated using
income from continuing operations and net income for each period
presented. Shares used to compute pro forma earnings per share are
shares outstanding at December 31, 2002 of 83,490,477. Net loss and
basic and diluted net loss per common share based on the weighted
average shares outstanding for the period from November 7, 2002 (date
of initial public offering) to December 31, 2002 were $38.5 million
and $0.46, respectively.
(3) Medical loss ratio represents cost of benefits provided as a
percentage of premiums earned.
(4) We present medical loss ratio, excluding New York City and New York
State PPO because these accounts differ from our standard PPO product
in that they are hospital-only accounts which have lower premiums
relative to administrative expense and are retrospectively rated with
a guaranteed administrative service fee. In addition, the size of
these accounts distorts our performance when the total medical loss
ratios are presented.
(5) Administrative expense ratio represents administrative and conversion
and IPO expenses as a percentage of premiums earned and administrative
service fees.
(6) Premium equivalents are obtained by adding to our administrative
service fees the amount of paid claims attributable to these service
fees, which include our non-Medicare, self-funded (or ASO) health
business pursuant to which we provide a range of customer services,
including claims administration and billing and membership services.
Administrative expense ratio--premium equivalent basis is determined
by dividing administrative and conversion and IPO expenses by premium
equivalents plus premiums earned for the relevant periods.
49
(7) Enrollment as of December 31, 2002 includes 175,000 New York State
PPO account members who reside in New York State but outside of our
service areas. Prior to this time, these members were enrolled in the
New York Blue Cross Blue Shield plan licensed in the area where the
members resided and, accordingly, the membership was reported by
these plans and not by us. Starting in 2002, in accordance with a
change to the contract with New York State under which we administer
the entire plan, we began including those members enrolled outside of
our service area, and all members were therefore enrolled in, and
reported by, HealthChoice. New York State PPO account members who
reside in New York State but outside of our service areas are
excluded from enrollment totals for all other periods presented.
(8) Prior to the conversion, this line item was captioned "Total reserves
for policyholders' protection."
50
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis presents a review of
WellChoice, Inc. and its subsidiaries (collectively, the "Company") for the
three-year period ended December 31, 2002. This review should be read in
conjunction with the consolidated financial statements and other data presented
herein.
The statements contained in this Annual Report on Form 10-K,
including those set forth in "Item 1 - Business - Company Overview," "--Our
Strategy," "--Customers," "--Information Systems and Telecommunications
Infrastructure," "--Collaborations," "Item 7 - Management's Discussion and
Analysis of Financial Condition and Results of Operations" and elsewhere in this
report include forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995, or the PSLRA. When used in this Annual
Report on Form 10-K and in future filings by the Company with the Commission, in
our press releases, presentations to securities analysts or investors, and in
oral statements made by or with the approval of one of our executive officers,
the words or phrases "believes," "anticipates," "intends," "will likely result,"
"estimates," "projects" or similar expressions are intended to identify such
forward-looking statements. Any of these forward-looking statements involve
risks and uncertainties that may cause our actual results to differ materially
from the results discussed in the forward-looking statements.
The discussion of risks described in "Item 1 - Business" and "Item 7
- - Management's Discussion and Analysis of Financial Condition and Results of
Operations" of this report and the following discussion contain certain
cautionary statements regarding our business that investors and others should
consider. These discussions are intended to take advantage of the "safe harbor"
provisions of the PSLRA. Except to the extent otherwise required by federal
securities laws, in making these cautionary statements, we are not undertaking
to address or update each factor in future filings or communications regarding
our business or operating results, and are not undertaking to address how any of
these factors may have caused results to differ from discussions or information
contained in previous filings or communications. In addition, any of the matters
discussed below may have affected our past, as well as current, forward-looking
statements about future results. Any or all forward-looking statements in this
report and in any other public statements we make may turn out to be wrong. They
can be affected by inaccurate assumptions we might make or by known or unknown
risks and uncertainties. Many factors discussed below will be important in
determining future results. Consequently, no forward-looking statement can be
guaranteed. Actual future results may vary materially from those expressed in
our communications.
OVERVIEW
We are the largest health insurance company in the State of New York
based on total preferred provider organization, or PPO, and health maintenance
organization, or HMO, membership, which includes members under our insured and
administrative services only, or ASO, plans. We offer managed care and
traditional indemnity products to over 4.6 million members. We have licenses
with the Blue Cross Blue Shield Association which entitle us to the exclusive
use of the Blue Cross and Blue Shield names and marks in ten counties in the New
York City metropolitan area and in six counties in upstate New York, the
non-exclusive right to use the Blue Cross and Blue Shield names and marks in one
upstate New York county, the exclusive right to only the Blue Cross name and
mark in seven upstate New York counties and the non-exclusive right to only the
Blue Cross name in four upstate New York counties. We market our products and
services using these names and marks in our New York service areas. We also
market our managed care products in 16 counties in New Jersey under the
WellChoice brand.
We offer our products and services to a broad range of customers,
including large groups of more than 500 employees; middle market groups, ranging
from 51 to 500 employees; small groups, ranging from two to 50 employees and
51
individuals. Over one million of our members are covered through our national
accounts, which include Fortune 500 companies.
Our revenue primarily consists of premiums earned and administrative
service fees derived from the sale of managed care and traditional indemnity
health benefits products to employer groups and individuals. Premiums are
derived from insured contracts and administrative service fees are derived from
self-funded contracts, under which we provide a range of customer services,
including claims administration and billing and membership services. Revenue
also includes administrative service fees earned under the BlueCard program for
providing members covered by other Blue Cross and Blue Shield plans with access
to our network providers, reimbursements under our government contracts with the
Centers for Medicare and Medicaid Services, or CMS, to act as a fiscal
intermediary for Medicare Part A program beneficiaries and a carrier for
Medicare Part B program beneficiaries, and investment income.
Our cost of benefits provided expense consists primarily of claims
paid and claims in process and pending to physicians, hospitals and other
healthcare providers and includes an estimate of amounts incurred but not yet
reported. Administrative expenses consist primarily of compensation expenses,
commission payments to brokers and other overhead business expenses.
We report our operating results as two business segments: commercial
managed care and other insurance products and services. Our commercial managed
care segment accounted for 82.6% of our membership as of December 31, 2002. Our
commercial managed care segment includes group PPO, HMO (including
Medicare+Choice), EPO, and other products (principally dental-only coverage) as
well as our PPO business under our accounts with New York City and New York
State. Our other insurance products and services segment consists of our
indemnity and individual products. Our indemnity products include traditional
indemnity products and government contracts with CMS to act as a fiscal
intermediary and carrier. Our individual products include Medicare supplemental,
state sponsored plans, government mandated individual plans and individual
hospital-only. We allocate administrative expenses, investment income and other
income, but not assets, to our segments. Except when otherwise specifically
stated or where the context requires, all references in this document to our
membership include both our insured and ASO membership. Our New York City and
New York State account members are covered under insured plans.
Our future results of operations will depend in part on our ability
to predict and control health care costs through underwriting criteria,
utilization management, product design and negotiation of favorable provider and
hospital contracts. Our ability to contain such costs may be adversely affected
by changes in utilization rates, demographic characteristics, the regulatory
environment, health care practices, inflation, new technologies, clusters of
high-cost cases, continued consolidation of physician, hospital and other
provider groups, acts of terrorism and bioterrorism or other catastrophes,
including war, and numerous other factors. The inability to mitigate any or all
of the above-listed or other factors may adversely affect our future
profitability.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The following is an explanation of our accounting policies considered
most significant by management. These accounting policies require us to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Such estimates and assumptions could change
in the future as more information is known. Actual results could differ
materially from those estimates.
52
REVENUE RECOGNITION
Our membership contracts generally have one year terms and are
subject to cancellation upon 60 days written notice. Premiums are generally due
monthly and are recognized as revenue during the period in which we are
obligated to provide services to our members. We record premiums received prior
to such periods as unearned premiums. We record premiums earned net of an
allowance for doubtful accounts. Premiums recorded for groups with certain
funding arrangements are based upon the actual and estimated claims experience
of these groups. Future adjustments to the claims experience of these groups
will result in changes in premium revenue. Our estimated claim experience is
based on a number of factors, including prior claims experience. These estimates
are continually reviewed and adjusted based on actual claims experience. Any
changes in these estimates are included in current period results. Funds
received from these groups in excess of premiums recorded are reflected as
liabilities on our balance sheet.
We recognize administrative service fees during the period the
related services are performed. Administrative service fees consist of revenues
from the performance of administrative services for self-funded contracts,
reimbursements from our contracts with CMS under which we serve as an
intermediary for the Medicare Part A program and a carrier for the Medicare Part
B program, and fees earned under the BlueCard program. The revenue earned under
our contracts with CMS is recorded net of an allowance for an estimate of
disallowed expenses.
COST OF BENEFITS PROVIDED
Cost of benefits provided includes claims paid, claims in process and
pending, and an estimate for unreported claims for charges for healthcare
services for enrolled members during the period. We are required to estimate the
total amount of claims that have not been reported or that have been received,
but not yet adjudicated, during any accounting period. These estimates, referred
to as unpaid claims on our balance sheet, are recorded as liabilities.
We estimate claim reserves in accordance with Actuarial Standards of
Practice promulgated by the Actuarial Standards Board, the committee of the
American Academy of Actuaries that establishes the professional guidelines and
standards for actuaries to follow. A degree of judgment is involved in
estimating reserves. We make assumptions regarding the propriety of using
existing claims data as the basis for projecting future payments. Factors we
consider include medical cost trends, the mix of products and benefits sold,
internal processing changes and the amount of time it took to pay all of the
benefits for claims from prior periods. To the extent the actual amount of these
claims is greater than the estimated amount based on our underlying assumptions,
such differences would be recorded as additional cost of benefits provided in
subsequent accounting periods and our future earnings would be adversely
affected. To the extent the claims experience is less than estimated based on
our underlying assumptions, such differences would be recorded as a reduction in
cost of benefits provided in subsequent accounting periods.
TAXES
We account for income taxes using the liability method. Accordingly,
deferred tax assets and liabilities are recognized for the future tax
consequences attributable to the difference between the financial reporting and
tax basis of assets and liabilities. We record a valuation allowance to reduce
our deferred tax asset to the amount we believe is more likely than not to be
realized. This determination, which requires considerable judgment, is based on
a number of assumptions including an estimate of future taxable income. If
future taxable income or other factors are not consistent with our expectations,
an adjustment to our deferred tax asset may be required in the future. Any such
adjustment would be charged or credited to income in the period such
determination was made.
53
THE CONVERSION
The conversion has been accounted for as a reorganization using the
historical carrying values of HealthChoice's assets and liabilities. Immediately
following the conversion, HealthChoice's unassigned reserves were reclassified
to par value of common stock and additional paid-capital. Concurrently,
HealthChoice became a wholly owned subsidiary of WellChoice. The costs of the
conversion were recognized as an expense when incurred. We started incurring
conversion-related expenses in 1998 when HealthChoice first began paying fees
and expenses of advisors to the New York State Superintendent of Insurance, or
Superintendent, in connection with the New York State Department of Insurance's
consideration of our original draft plan of conversion. From inception of the
conversion process through the completion of our initial public offering in
December 2002, we incurred conversion and offering expenses of $23.9 million.
We have benefited from certain favorable tax attributes over the
years. HealthChoice has reported its income for tax purposes using certain
beneficial rules afforded Blue Cross and Blue Shield plans under Section 833 of
the Internal Revenue Code, or the Code. Among other provisions of the Code,
these plans were granted a special deduction, the 833(b) deduction, for regular
tax calculation purposes. As a result of this deduction, HealthChoice has
incurred no regular tax liability but, in profitable years, has paid taxes at
the alternative minimum tax rate of 20%. The 833(b) deduction is calculated as
the excess of 25% of the incurred claim and claim adjustment expenses for the
tax year over adjusted surplus, as defined, but limited to taxable income. The
amount of 833(b) deductions utilized in each tax year is accumulated in an
adjusted surplus balance. Once the cumulative adjusted surplus balance exceeds
the 833(b) deduction for the current taxable year, the deduction is eliminated.
During the fourth quarter of 2002, we reevaluated our tax position for financial
statement purposes related to HealthChoice's ability to utilize the Section
833(b) deduction and determined that when HealthChoice converted to a for-profit
entity, its ability to utilize the Section 833(b) deduction was uncertain. No
authority directly addresses whether a conversion transaction will render the
833(b) deduction unavailable. We are aware, however, that the IRS has taken the
position related to other Blue Cross Blue Shield plans that a conversion could
result in the inability of a Blue Cross Blue Shield plan to utilize the 833(b)
deduction. In light of the absence of governing authority, while we intend to
continue to take the deduction on its tax returns after the conversion, we will
assume, for financial statement reporting purposes, that the deduction will be
disallowed. Accordingly, our income tax provision for 2002 assumes the
utilization of approximately $145.0 million regular operating loss carryforwards
for financial reporting purposes in excess of those utilized for tax purposes.
Because the conversion occurred in the fourth quarter and the tax provisions for
the first three quarters had assumed the availability of the section 833(b)
deduction, we recorded additional tax expense of $50.7 million in the fourth
quarter representing the utilization of regular operating loss carryforwards
rather than the 833(b) deduction.
We have substantial tax loss and credit carryovers. At December 31,
2002, our regular tax loss carryforwards were approximately $310.0 million and
our alternative minimum tax credit carryforward was approximately $134.0
million. We recently received a ruling from the Internal Revenue Service that
our conversion was not viewed as a change in control and therefore did not
result in limitations in the use of our net regular tax operating loss
carryforwards and alternative minimum tax credits. However, subsequent sales of
shares of our common stock, including sales by the Fund and/or Foundation, could
result in such a limitation, which would have an impact on our cash flow.
ADDITIONAL STATE AND LOCAL TAXES
As a result of the conversion, we became a for-profit entity and are
subject to New York state and local taxes that we were not previously required
to pay. These include premium taxes on most non-HMO insured business and sales
and use taxes (which are recorded as administrative expenses), as well as state
and local income taxes.
54
DISCONTINUED OPERATIONS
In February 2002, we discontinued the operations of NexxtHealth, Inc., a
development stage subsidiary formed in March 2000 to develop Internet portal
software to market to other health benefit companies. We discontinued these
operations as part of our overall strategy to outsource certain technology
functions.
CAPITATED PROVIDER ARRANGEMENTS
Our cost of benefits provided under capitated arrangements is not
significant. Payments under capitated arrangements totaled $88.7 million for the
year ended December 31, 2002, representing 2.3% of total cost of benefits
provided for each period.
We currently maintain a single global capitation arrangement to provide
hospital and medical benefits for approximately 1,000 members enrolled in our
Medicare+Choice product. Payments made under this arrangement totaled $7.5
million for the year ended December 31, 2002, respectively. The premiums earned
in excess of costs of benefits provided under this arrangement was approximately
$1.3 million for the year ended December 31, 2002.
We also have capitated arrangements with service providers for certain
disease management programs and utilization management services. At December 31,
2002, we had approximately 55,000 members under a capitated utilization
management program for eye care services and 851,000 members under capitated
disease management programs.
Other capitated arrangements are in place to manage and assume risk for
certain benefits covered under specific products. The following sets forth the
membership and respective benefits under these capitated arrangements at
December 31, 2002:
BENEFIT MEMBERSHIP
------------------------------------------------------- ----------
(IN THOUSANDS)
Mental health 1,550
Laboratory services 385
Vision 345
Hearing 133
Dental 100
Approximately 34.0% of our membership is provided one or more benefits
under a capitated program.
55
SELECTED MEMBERSHIP DATA AND RESULTS OF OPERATIONS
The following table sets forth selected membership data as of the dates
set forth below:
DECEMBER 31,
---------------------------
(MEMBERS IN THOUSANDS) 2002 2001 2000
PRODUCTS AND SERVICES:
COMMERCIAL MANAGED CARE:
Group PPO, HMO, EPO and other(1)(2) 2,019 1,752 1,432
New York City and New York State PPO(3) 1,786 1,563 1,512
------- ------ -----
TOTAL COMMERCIAL MANAGED CARE 3,805 3,315 2,944
------- ------ -----
OTHER INSURANCE PRODUCTS AND SERVICES:
Indemnity 567 804 906
Individual 236 264 285
------- ------ -----
TOTAL OTHER INSURANCE PRODUCTS AND SERVICES 803 1,068 1,191
------- ------ -----
OVERALL TOTAL 4,608 4,383 4,135
------- ------ -----
CUSTOMERS:
Large group(3) 2,903 2,695 2,686
Small group and middle market 394 366 272
Individuals 290 323 326
National accounts 1,021 999 851
------- ------ -----
OVERALL TOTAL 4,608 4,383 4,135
------- ------ -----
FUNDING TYPE:
COMMERCIAL MANAGED CARE:
Insured(3) 2,597 2,441 2,312
Self-funded 1,208 874 632
------- ------ -----
TOTAL COMMERCIAL MANAGED CARE 3,805 3,315 2,944
------- ------ -----
OTHER INSURANCE PRODUCTS AND SERVICES:
Insured 463 691 838
Self-funded 340 377 353
------- ------ -----
TOTAL OTHER INSURANCE PRODUCTS AND SERVICES 803 1,068 1,191
OVERALL TOTAL 4,608 4,383 4,135
------- ------ -----
______________
(1) Our HMO product includes Medicare+Choice. As of December 31, 2002, 2001 and
2000, we had approximately 55,000, 59,000 and 41,000 members, respectively,
enrolled in Medicare+Choice.
(2) "Other" principally consists of our members enrolled in dental only
coverage.
(3) Enrollment as of December 31, 2002 includes 175,000 New York State PPO
account members who reside in New York State but outside of our service areas.
Prior to January 1, 2002, these members were enrolled in the New York Blue Cross
Blue Shield plan licensed in the area where the members resided, and,
accordingly, the membership was reported by these plans and not by us. Beginning
January 1, 2002, in accordance with a change to the contract with New York State
under which we administer the entire plan, we began including those members
enrolled outside of our service area, and all members were therefore enrolled
56
in, and reported by, WellChoice. New York State PPO account members who reside
in New York State but outside of our service areas are excluded from enrollment
totals for all other periods presented.
The following table sets forth results of operations for each of our
segments for the periods set forth below:
(IN MILLIONS)
YEAR ENDED DECEMBER 31,
-----------------------
2002 2001 2000
---- ---- ----
COMMERCIAL MANAGED CARE:
Total revenue $4,000.6 $ 3,448.3 $ 2,948.8
Income from continuing operations before
income tax expense $ 253.4 $ 121.1 $ 95.0
Medical loss ratio:
Commercial managed care total 86.0% 88.6% 89.1%
Commercial managed care, excluding New York
City and New York State PPO(1) 81.6% 85.8% 85.5%
Administrative expense ratio 13.9% 13.0% 12.6%
Administrative expense ratio - premium equivalent
basis 9.7% 10.0% 10.4%
OTHER INSURANCE PRODUCTS AND SERVICES:
Total revenue $1,105.0 $ 1,182.9 $ 1,284.9
Income from continuing operations before
income tax expense $ 56.3 $ 26.5 $ 25.5
Medical loss ratio 82.4% 86.2% 86.4%
Administrative expense ratio 27.8% 25.0% 24.6%
Administrative expense ratio - premium equivalent
basis 17.4% 15.9% 16.4%
______________
(1) We present commercial managed care medical loss ratio, excluding New York
City and New York State PPO, because these accounts differ from our standard PPO
product in that they are hospital-only accounts which have lower premiums
relative to administrative expense and are retrospectively rated with a
guaranteed administrative service fee. In addition, the size of these accounts
distorts our performance when the total medical loss ratios are presented.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
As of December 31, 2002, total enrollment was 4.6 million members and
commercial managed care enrollment was 3.8 million members (82.6% of total
enrollment). If we add to the December 31, 2001 enrollment the 167,000 New York
State PPO account members who reside in New York State but outside of our
service areas, total enrollment and commercial managed care enrollment increased
1.3% and 9.3%, respectively, from December 31, 2001 to December 31, 2002.
Enrollment in our group PPO, HMO, EPO and other products increased 15.2%, or
267,000 members. This growth was attributable to the migration of members
enrolled in our indemnity products to our commercial managed care products, new
large group and national accounts business in our PPO and EPO products and
increased enrollment by small group and middle market customers in our Direct
Connection HMO (our HMO product which allows members to seek care from
in-network specialists without a referral) and EPO products. The enrollment
57
growth in self-funded products of 23.7% was the result of both new membership
and the migration from insured business, most noticeably in the large group PPO
and national EPO membership. Enrollment in other insurance products and services
declined 24.8% to approximately 0.8 million members due, in part, to the
continued migration of members to commercial managed care products.
As of December 31, 2002, our New York State account covered
approximately 985,000 members, or 21.4% of our total membership and 25.9% of our
commercial managed care membership, and our New York City account covered
approximately 801,000 members, or 17.4% of our total membership and 21.1% of our
commercial managed care membership. The pricing of our products provided to New
York State and New York City historically have been renegotiated annually.
Effective January 1, 2003, we agreed to new pricing with New York State covering
a three-year period through December 31, 2005, though both parties retain the
right to terminate the contract on six months' notice. The New York City account
is currently under renegotiation based upon a competitive bid process that is
open to us and to third parties and involves renegotiation with respect to
rates. The contract awarded to the winner of this competitive bid process is
expected to commence July 1, 2003. We had rates in place through December 31,
2002 with respect to our PPO products with the New York City account. We are
currently negotiating the pricing of our PPO products with New York City for the
first six months of 2003. The loss of one or both of the New York City and New
York State accounts would result in reduced membership and revenue and require
us to reduce, reallocate or absorb administrative expenses associated with these
accounts.
Total revenue increased 10.2%, or $474.4 million, to $5,105.6 million
for the year ended December 31, 2002, from $4,631.2 million for the year ended
December 31, 2001 primarily due to an increase in premium and administrative
service fee revenue.
Premium revenue increased $381.8 million, or 9.0%, to $4,628.0
million for the year ended December 31, 2002, from $4,246.2 million for the year
ended December 31, 2001. The increase in premium revenue was primarily due to
growth in our commercial managed care segment. Commercial managed care premium
revenue was $3,723.0 million for the year ended December 31, 2002, a 14.6%
increase compared to the year ended December 31, 2001. The increase in
commercial managed care premium revenue was attributable to enrollment growth
and premium rate increases, particularly in our HMO and PPO products. Premium
revenue growth was partially offset by the anticipated decline in our other
insurance products and services enrollment, the cancellation of unprofitable EPO
contracts and the migration of insured EPO national and large group indemnity
contracts to self-funded contracts. On a per member per month, or PMPM basis,
premium for the year ended December 31, 2002 increased 7.2%, to $124.65, from
$116.29 for the year ended December 31, 2001. Commercial managed care PMPM
premium increased to $120.90 for the year ended December 31, 2002, from $115.22
for the year ended December 30, 2001. Excluding the New York City and New York
State PPO, commercial managed care PMPM premium increased to $250.72 for the
year ended December 31. 2002, compared to $226.59 for the year ended December
31, 2001.
Administrative service fee revenue increased 23.0%, or $74.2 million,
to $396.2 million for the year ended December 31, 2002, from $322.0 million for
the year ended December 31, 2001. The increase was primarily due to growth in
self-funded group PPO, HMO, EPO and other membership, expanded volume of
services provided under our CMS contract for Medicare Part A and Part B programs
and increased BlueCard fees. Approximately $52.7 million of the increase was
driven by the migration of approximately 45,000 members from insured EPO
national account contracts and approximately 137,000 insured large group
indemnity contracts to self-funded contracts and approximately 69,000 members
from new national and large group customers. Administrative service fee revenue
from our CMS contracts increased 10.6%, or $12.2 million to $127.3 million for
the year ended December 31, 2002, from $115.1 million for the year ended
December 31, 2001. Total BlueCard fees increased 26.3%, or $9.3 million, to
$44.6 million for the year ended December 31, 2002, from $35.3 million for the
year ended December 31, 2001 due to an increase in transaction volume.
58
Investment income, net of investment expenses, decreased 6.5%, or
$4.5 million, to $64.8 million for the year ended December 31, 2002, from $69.3
million for the year ended December 31, 2001 due to lower interest rates. Net
realized gains of $2.6 million for the year ended December 31, 2002 was
primarily the result of net gains on government and corporate bond sales and the
sale of a portion of our WebMD Corp. common stock. The net realized loss of
$12.4 million for the year ended December 31, 2001 was primarily due to a $10.5
million impairment loss recorded on our holdings of WebMD Corp. common stock.
Other income, net of $14.0 million for the year ended December 31,
2002 consisted primarily of a gain of $8.0 million resulting from insurance
settlements in excess of estimated recoveries recorded as of December 31, 2001
for property and equipment lost at our World Trade Center headquarters, $5.4
million related to the recovery of amounts previously recorded against net
income, interest received on outstanding hospital advances of $1.9 million and
late payment fee income of $0.7 million. Other income, net of $6.1 million for
the year ended December 30, 2001 primarily consisted of a gain of $6.8 million
resulting from insurance recovery estimates in excess of book values for
property and equipment lost at our World Trade Center headquarters, $1.6 million
from the demutualization of MetLife, Inc., the life insurance carrier for our
employees, late payment fee income of $0.6 million and interest income earned on
advances to hospitals of $1.2 million, offset in part by a charge of $3.7
million due to the restructuring of an outstanding provider note receivable and
other miscellaneous expenses of $0.4 million.
Total cost of benefits provided increased 5.6%, or $208.6 million, to
$3,947.4 million for the year ended December 31, 2002, from $3,738.8 million for
the year ended December 31, 2001, reflecting a 1.7% increase in member months
and a 3.8% increase in PMPM benefit costs. The increase in benefit costs was due
to increases in unit costs, offset in part by decreases in utilization. Cost of
benefits provided for the year ended December 31, 2002 included a $3.3 million
premium deficiency reserve charge related to our New Jersey PPO business, offset
in part by net litigation reserve related activity of $13.7 million. Overall,
benefit expense on a PMPM basis for the year ended December 31, 2002 increased
to $106.32, from $102.39 for the year ended December 31, 2001.
The total medical loss ratio decreased to 85.3% for the year ended
December 31, 2002, from 88.1% for the year ended December 31, 2001. This
decrease was attributable to, in part, $40.1 million of prior period reserve
development on the at-risk book of business. Excluding prior period development
and the litigation reserve release, the total medical loss ratio for the year
ended December 31, 2002, was 86.3%. The medical loss ratio in our commercial
managed care segment decreased to 86.0% for the year ended December 31, 2002,
from 88.6% for the year ended December 31, 2001. Excluding New York City and New
York State PPO, the medical loss ratio in our commercial managed care segment
decreased to 81.6% for the year ended December 31, 2002, from 85.8% for the year
ended December 31, 2001 due to better than anticipated claim experience. The
medical loss ratio for other insurance products and services decreased to 82.4%
for the year ended December 31, 2002, from 86.2% for the year ended December 31,
2001.
Administrative expenses increased 12.2%, or $90.3 million, to $833.1
million for the year ended December 31, 2002, from $742.8 million for the year
ended December 31, 2001. This increase was attributable to increased broker
commissions of $18.8 million due to premium revenue growth in small group and
middle market customers, increased employee benefit expense of $15.6 million,
increased professional services related to our technology outsourcing strategy
of $23.1 million, increased premium taxes of $6.2 million, employee-related
transition costs of $9.5 million incurred as part of our outsourcing agreement
with IBM in June 2002, restructuring charges of $13.7 million related to our
plan to streamline operations and other miscellaneous expenses. This increase
was offset in part by a gain of $19.3 million resulting from the settlement of
our business property protection and blanket earnings and extra expense
59
insurance claim related to the loss of our headquarters located at the World
Trade Center. Conversion and IPO expenses increased $13.4 million to $15.4
million for the year ended December 31, 2002, from $2.0 million for the year
ended December 31, 2001 due to the increased conversion and IPO related
activities as we reached the effective date of the conversion and completed our
initial public offering.
In 2003, we plan to transition from several leased properties, which
temporarily replaced our World Trade Center office, to a long-term leased
facility. During the transition period (June through December 2003), we will
incur rent expense for both our temporary leased facilities and our long-term
leased facility. As a result, we will incur approximately $9.8 million in
incremental rent costs in 2003. In addition, in 2003 we estimate that we will
incur $8.6 million in depreciation and start-up costs related to our long-term
leased facility. We will continue to incur additional facility costs beyond 2003
due to the increased costs associated with our long-term leased facility when
compared to the cost of our World Trade Center facility.
Income from continuing operations before income taxes increased
109.8%, or $162.1 million, to $309.7 million for the year ended December 31,
2002, from $147.6 million for the year ended December 31, 2001. This improvement
was primarily driven by increased commercial managed care membership and
improved underwriting performance. The tax benefit of $67.9 million increased
income from continuing operations to $377.6 million for the year ended December
31, 2002. The tax expense of $0.1 million reduced income from continuing
operations to $147.5 million for the year ended December 31, 2001. Taking into
account our loss from discontinued operations, our net income for the year ended
December 31, 2002 was $376.5 million and for year ended December 31, 2001 was
$131.0 million.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Total enrollment grew 6.0%, or 248,000 members, to 4.4 million
members as of December 31, 2001, compared to 4.1 million members as of December
31, 2000. Commercial managed care enrollment increased 12.6%, or 371,000, to 3.3
million members, representing 75.6% of total enrollment. Enrollment in our group
PPO, HMO, EPO and other products increased 22.3%, or 320,000 members. This
growth was attributable to new large group and national accounts business in our
PPO and EPO products, increased enrollment by small group and middle market
customers in our commercial managed care HMO products and individuals enrolled
in our Medicare+Choice product. Membership in New York City and New York State
PPO increased 3.4%, or 51,000 members, with enrollment gains reported in both
the New York City and New York State plans. Other insurance products and
services enrollment decreased 10.3% for the year due to a continued shift to
commercial managed care programs.
Premium revenue increased $369.3 million, or 9.5%, to $4,246.2
million for the year ended December 31, 2001, from $3,876.9 million for the year
ended December 31, 2000 as a result of enrollment growth in commercial managed
care products, partially offset by anticipated enrollment declines in other
insurance products and services. Premium revenue for New York City and New York
State PPO increased as a result of enrollment growth. Group PPO, HMO, EPO and
other premium revenue increased 26.8% due to enrollment growth in all products.
PMPM premiums in 2001 increased 10.2%, or $10.81, to $116.29, from $105.48 in
2000. The PMPM premium increase was primarily due to an increase in premium
revenue from higher premium products as a percentage of total premium revenue.
Administrative service fee revenue increased 21.6%, or $57.1 million,
to $322.0 million for the year ended December 31, 2001, from $264.9 million for
the year ended December 31, 2000 due to new national accounts business and
BlueCard fees. Approximately $51.4 million of the increase was driven by the
enrollment of approximately 148,000 new self-funded PPO members. BlueCard fees
increased 19.3%, or $5.7 million to $35.3 million for the year ended December
31, 2001, from $29.6 million for the year ended December 31, 2000.
60
Investment income, net of investment expenses, increased 5.8%, or
$3.8 million, to $69.3 million for the year ended December 31, 2001, from $65.5
million for the year ended December 31, 2000. The increase was due to higher
average invested balances offset by lower interest rates. The net realized loss
of $12.4 million for the year ended December 31, 2001 is primarily due to a
$10.5 million impairment loss recorded on our holdings of WebMD Corp. common
stock. The net realized gain of $22.1 million for the year ended December 31,
2000 is primarily due to a series of transactions related to our investment
interest in The Health Information Network, LLC, or THINC. In January 2000,
CareInsite, Inc. purchased our investment interest in THINC for warrants in
CareInsite common stock. We exercised our warrants and recognized a gain of
$13.2 million. In February 2000, CareInsite was acquired by WebMD and we
received WebMD common stock in exchange for our investment in CareInsite. As a
result of this transaction, we recognized an additional gain of $7.8 million.
Other income increased 41.9%, or $1.8 million, to $6.1 million for
the year ended December 31, 2001, from $4.3 million for the year ended December
31, 2000. Other income in 2001 primarily consisted of a gain of $6.8 million
resulting from insurance recovery estimates in excess of book values for
property and equipment lost at our World Trade Center headquarters, late payment
fee income of $0.6 million and interest income earned on advances to hospitals
of $1.2 million, offset in part by a charge of $3.7 million due to the
restructuring of an outstanding provider note receivable. Other income in 2000
primarily consisted of real estate rental income.
Total revenue increased 9.4%, or $397.5 million, to $4,631.2 million
for the year ended December 31, 2001, from $4,233.7 million for the year ended
December 31, 2000 primarily due to an increase in premium revenue.
Total cost of benefits provided increased 9.1%, or $312.4 million, to
$3,738.8 million for the year ended December 31, 2001, from $3,426.4 million for
the year ended December 31, 2000 primarily due to increased utilization of
physician, outpatient services and prescription drugs and higher unit costs,
partially offset by a decrease in utilization of inpatient hospital services.
Overall PMPM benefit expense for the year ended December 31, 2001 increased
9.5%, to $102.39, from $93.48 for the year ended December 31, 2000 due to higher
costs for healthcare services.
The total medical loss ratio decreased to 88.1% for the year ended
December 31, 2001, from 88.4% for the year ended December 31, 2000. The medical
loss ratio in our commercial managed care segment decreased to 88.6% for the
year ended December 31, 2001, from 89.1% for the year ended December 31, 2000.
Excluding New York City and New York State PPO, the medical loss ratio in our
commercial managed care segment increased to 85.8% in 2001 from 85.5% in 2000
due to healthcare cost increases in excess of premium rate increases. The higher
healthcare costs were driven by increased utilization, primarily in outpatient
and physician services, as well as higher inpatient and drug unit costs.
The medical loss ratio for other insurance products and services
decreased to 86.2% for the year ended December 31, 2001, from 86.4% for the year
ended December 31, 2000, due to an improvement in the small and large group
indemnity products and Medicare supplemental plans, partially offset by higher
claims cost as a percentage of premium with respect to the New York
State-mandated direct pay products.
Administrative and conversion expenses increased 8.4%, or $58.0
million, to $744.8 million for the year ended December 31, 2001, from $686.8
million for the year ended December 31, 2000. This increase was attributable to
increased broker commissions of $10.1 million incurred to support continued
growth in our small group and middle market customers and higher general
administrative expenses of $47.9 million to service increased commercial managed
care enrollment.
61
Income from continuing operations before income taxes increased $27.1
million, or 22.5%, to $147.6 million for the year ended December 31, 2001, from
$120.5 million for the year ended December 31, 2000. Income tax expense was $0.1
million for the year ended December 31, 2001 compared to income tax benefit of
$74.5 million for the year ended December 31, 2000. The 2000 benefit is the
result of management's conclusion that based on continued, current and projected
positive taxable income and the expected timing of the reversal of other tax
deductible temporary differences, our deferred tax valuation allowance could be
significantly reduced by $71.9 million. Income from continuing operations
decreased 24.4%, or $47.5 million, to $147.5 million for the year ended December
31, 2001, from $195.0 million for the year ended December 31, 2000. Taking into
account our loss from discontinued operations, our net income for the year ended
December 31, 2001 was $131.0 million and for the year ended December 31, 2000
was $190.4 million.
LIQUIDITY AND CAPITAL RESOURCES
WellChoice is a holding company and depends on its subsidiaries for
cash and working capital to pay expenses. WellChoice receives cash from its
subsidiaries from administrative and management service fees, as well as tax
sharing payments and dividends. On November 7, 2002, the Superintendent approved
the payment of a dividend to WellChoice from its subsidiary, Empire, in the
amount of $225.0 million, which was paid on November 8, 2002. This dividend has
been accounted for as an equity transfer from a subsidiary to the parent of a
consolidated group. On November 20, 2002, we received net proceeds of
approximately $28.0 million, after deducting the underwriting discount, from the
exercise of the underwriters' over-allotment option in our initial public
offering. We used these proceeds from the exercise of the over-allotment option
to pay offering and conversion expenses and for general corporate purposes.
Our subsidiaries' primary source of cash is from premiums and fees
received and investment income. The primary uses of cash include healthcare
benefit expenses, brokers' and agents' commissions and administrative expenses.
We generally receive premium revenues in advance of anticipated claims for
related healthcare services.
Our investment policies are designed to provide liquidity to meet
anticipated payment obligations and to preserve principal. We believe the
composition of our marketable investment portfolio is conservative, consisting
primarily of high-rated, fixed income securities with the objective of producing
a consistently growing income stream and maximizing risk-adjusted total return.
The fixed income portfolio is comprised of U.S. government securities, corporate
bonds, asset-backed bonds and mortgage-related securities. The average credit
rating of our fixed income portfolio as of December 31, 2002 was "AA." A portion
of the fixed income portfolio is designated as short-term and is intended to
cover near-term cash flow needs. Our marketable equity portfolio as of December
31, 2002 consisted of an investment in a mutual fund indexed to the S&P 500, our
common stock investment in WebMD and our investment in non-redeemable preferred
stock of several companies. As of December 31, 2002, our marketable equity
portfolio was 3.5% of the total marketable investment portfolio, compared to
2.0% as of December 31, 2001.
On October 17, 2002, we entered into a credit and guaranty agreement,
effective as of November 7, 2002, with The Bank of New York, as Issuing Bank and
Administrative Agent, and several other financial institutions as agents and
lenders, which will provide us with a credit facility. We are able to borrow
under the credit facility for general working capital purposes. The total
outstanding amounts (including the amount of the letter of credit) under the
credit facility cannot exceed $100.0 million. The facility has a term of 364
days, subject to extension for additional periods of 364 days with the consent
of the lenders. Borrowings under the facility will bear interest, at our option,
at The Bank of New York's prime commercial rate (or, if greater, 0.50% plus the
federal funds rate) as in effect from time to time plus a margin of between zero
and 1.0%, or LIBOR plus a margin of between 1.125% and 2.250%, with the
62
applicable margin to be determined based on our financial strength rating. As of
December 31, 2002, there were no funds drawn against this line of credit.
The credit facility contains covenants that limit our ability to
issue any equity interest which is not issued on a perpetual basis or in respect
of which we shall become liable to purchase, redeem, retire or otherwise acquire
any such interest, including any class of redeemable preferred stock. However,
the credit facility does not restrict us from paying dividends on our common
stock or repurchasing or redeeming shares of our common stock. Covenants under
the credit facility also impose limitations on the incurrence of secured debt,
creation of liens, mergers, asset sales, transactions with affiliates and
material amendments of material agreements, as defined in the credit facility
without the consent of the lenders. In addition, the credit facility contains
certain financial covenants. Failure to comply with any of these covenants will
result in an event of default, which could result in the termination of the
credit facility.
We believe that cash flow from our operations and our cash and
investment balances, including the proceeds of the dividend mentioned above,
will be sufficient to fund continuing operations and capital expenditures for at
least the next twelve months.
Year ended December 31, 2002 compared to year ended December 31, 2001
Cash from operating activities decreased $31.6 million to $182.7 million
as of December 31, 2002, from $214.3 million as of December 31, 2001. The
decrease in cash from operating activities is principally due to a $75.8 million
return of advanced premium held related to our New York State account compared
to an increase of premium held of approximately $24.4 million in 2001 and an
increase of $74.0 million in taxes paid. This decrease was partially offset by
$46.5 million in World Trade Center insurance proceeds, net of recovery expense
and positive operating results net of non-cash items. Some of the non-cash items
impacting net income include the net deferred income tax benefit of $151.4
million, litigation reserve releases of $15.4 related to the settlement of a
large case and prior year "at risk" claim reserve adjustments, offset in part by
depreciation and amortization expense of $34.5 million and accrued restructuring
expenses of $20.9 million.
Net cash used in investing activities of $129.5 million for the year
ended December 31, 2002, was consistent with cash used in investing activities
of $129.3 million for the year ended December 31, 2001.
Net cash provided by financing activities of $25.6 million includes
net proceeds from the sale of common stock in the initial public offering of
$28.0 million and payments made on capital lease obligations of $2.4 million for
the year ended December 31, 2002. Cash used in financing activities of $1.9
million for the year ended December 31, 2001 reflects payments for capital lease
obligations.
Year ended December 31, 2001 compared to year ended December 31, 2000
Cash from operating activities increased $98.3 million to $214.3
million for the year ended December 31, 2001, from $116.0 million for the year
ended December 31, 2000. The increase in cash from operating activities is
principally due to premium collection increases in excess of increases in paid
claims and a decrease in disbursements related to the settlement of outstanding
group and contract liabilities.
Net cash used in investing activities decreased $8.6 million to
$129.3 million in 2001, from $137.9 million in 2000. Cash used in investing
activities in 2001 was impacted by a strategic decision to maintain cash flow
generated by operations in cash and cash equivalents to cover business needs
related to the recovery of our World Trade Center operations.
63
CONTRACTUAL OBLIGATIONS
We are contractually obligated to make future minimum payments as
follows:
2003 2004 2005 2006 2007 THEREAFTER
---- ---- ---- ---- ---- ----------
Lease Commitments:
Operating Leases $ 49.9 $ 43.8 $ 39.9 $ 33.4 $ 31.1 $ 357.6
Capital Leases 11.1 11.4 11.7 12.0 12.2 36.0
Operating lease terms generally range from one to 27 years with certain
early termination or renewal provisions. We anticipate that we will incur
leasehold improvement costs and related capital expenditures of approximately
$55.4 million at our Brooklyn, New York facility in 2003. These expenditures
will be funded using internal cash. The schedule above includes rent commitments
for our Staten Island facility. However, as part of the information technology
outsourcing agreement with IBM, we entered into a sublease agreement with IBM
for this property. The Company expects to receive net sublease income of
approximately $1.0 million per year for the next ten years.
CONTRACTUAL COMMITMENTS TO IBM
In June 2002, we entered into a ten-year agreement with IBM to
modernize our systems applications and operate our data center and technical
help desk. Our payments to IBM for operating our data center and technical help
desk will be based upon actual utilization of services billed at the rates
established in the agreement. We estimate that our payments to IBM for operating
our data center and technical help desk will total approximately $681.0 million
over the remaining term of the agreement, which we anticipate to be less than
the costs we would have otherwise incurred had we continued to operate the data
center and technical help desk ourselves. Under the terms of the contract, we
will work jointly with IBM to modernize our systems applications, centered
around a new claims payment system being developed by deNovis, Inc., a privately
held startup company, in coordination with IBM and which will be licensed to us
in perpetuity. The system is expected to be ready for acceptance by us in
accordance with its specifications no earlier than 2005. Subject to the
successful completion and acceptance of the claims payment system, we will pay
$50.0 million for a perpetual license granted by IBM, which includes custom
development fees. Under the agreement with IBM, we are scheduled to pay $25.0
million of this fee in four equal installments upon the achievement of specified
milestones, the last of which is our acceptance of the claims payment system.
The remaining $25.0 million will be paid one year following the date we accept
the claims payment system. Following the expiration of the one year warranty
period which begins upon the payment of the final installment, we will pay IBM
an annual fee of $10.0 million for maintenance and support services.
The agreement also provides for IBM to assist us in modernizing our
other systems. In connection with these services, we have agreed to purchase up
to $65.0 million in modernization services from IBM for a four year period
beginning in 2002, with a target purchase rate of $7.3 million, $28.3 million,
$19.0 million, $7.2 million and $3.2 million during 2002, 2003, 2004, 2005 and
2006, respectively. We may defer the purchase of services beyond the target
date, provided that to the extent we delay purchases more than one year beyond
the target year, we shall pay a premium to IBM of 10% per annum of the contract
price. The amount that we will actually spend for these integration and
modernization services could be less or greater than the annual target purchase
rate, though over the term we anticipate that the amount we will actually spend
for these services could be significantly greater than those contractual
minimums. We will own all software developed by IBM under the agreement, other
than the claims payment system. Actual expenses incurred related to these
purchases were $4.2 million for the year ended December 31, 2002.
64
We intend to fund the modernization expenses incurred in connection
with this collaboration with IBM in part through the cost savings we expect to
realize as a result of the outsourcing of our applications development
functions, data center and help desk to IBM. Any substantial increase in these
expenses or inability to achieve our anticipated cost savings could have an
adverse effect on our profitability, financial condition and results of
operations. We do not expect to realize significant cost savings from this
contract in the early years of the project.
Our outsourcing agreement with IBM contains standard indemnification
clauses which reduce the risks associated with a variety of claims and actions,
including certain failures of IBM to perform under the agreement. We have the
right to terminate certain services if IBM fails to meet our quality and
performance benchmarks and we may terminate our relationship with IBM in its
entirety upon the occurrence of material breaches under the agreement, IBM's
entrance into the health insurance business, changes of control and certain
other events which are damaging to us. We can terminate the outsourcing
agreement without cause after June 1, 2004, or at any time within twelve months
following a change of control of WellChoice, provided that we pay IBM a
termination fee. The termination fee includes a lump sum payment which decreases
over the life of the agreement. For any WellChoice termination without cause,
the lump sum decreases from $25.0 million beginning in June 2004 to $0.9 million
in January 2012. We have the right to pay only a portion of this lump sum
payment if we choose not to terminate the entire agreement but only certain
discrete portions of IBM's services. Any termination following a change of
control of WellChoice requires a similar lump sum payment which decreases over
the life of the agreement and which is approximately 80% of the payment
described in the previous sentence, although we do not have the similar right to
terminate only portions of IBM's services, as allowed with a termination without
cause. In addition, upon termination we must reimburse certain of IBM's costs,
subject to reduction to the extent we purchase equipment, assume licenses and
leases and hire employees used by IBM to provide the services. We also have the
right to terminate the agreement at no cost within six months following a change
of control of IBM.
REGULATORY AND OTHER DEVELOPMENTS
Empire is subject to capital and surplus requirements under the New
York insurance laws and the capital and surplus licensure requirements
established by the Blue Cross Blue Shield Association. Each of these standards
is based on the NAIC's RBC Model Act, which provides for four different levels
of regulatory attention depending on the ratio of a company's total adjusted
capital (defined as the total of its statutory capital, surplus, asset valuation
reserve and dividend liability) to its risk-based capital. The capital and
surplus level required to meet the minimum requirements under the New York
insurance laws and Blue Cross Blue Shield Association licensure requirements
applicable to Empire is 200% of Risk-Based Capital Authorized Control Level.
Empire exceeds the New York minimum capital and surplus requirements and the
Blue Cross Blue Shield Association capital and surplus licensure requirements.
Capital and surplus requirements for Empire HealthChoice HMO, Inc.,
our HMO subsidiary which is directly owned by Empire, are regulated under a
different method set forth in the New York Department of Health's HMO
regulations. The regulations require that Empire HealthChoice HMO currently
maintain reserves of five percent of its annual premium income. Empire
HealthChoice HMO, with respect to its operations in New York, meets the
financial reserve standards of the New York Department of Health. The Department
of Health is currently redrafting its regulations and proposes to increase the
required reserves gradually over the next six years to twelve and one half
percent of annual premium income. If that requirement changes it will affect all
HMOs and we expect we will meet those revised standards. In November 2002,
Empire HealthChoice HMO received a $50.0 million capital contribution from
Empire, which was made in connection with the transfer of our New York HMO
business from HealthChoice to Empire HealthChoice HMO during 2002 in order to
ensure compliance with New York capital and surplus requirements. Empire
HealthChoice HMO is also licensed in New Jersey and there are minimum net worth
standards established under New Jersey laws and regulations. Empire HealthChoice
HMO, with respect to its operations in New Jersey, meets the minimum net worth
65
standards established under New Jersey law. Empire HealthChoice HMO is also
subject to the Blue Cross Blue Shield Association capital and surplus licensure
requirement which is applicable to Empire and satisfies that requirement.
Our New Jersey operations are not subject to the Blue Cross Blue
Shield Association capital and surplus licensure requirement. At December 31,
2002, WellChoice Insurance of New Jersey met the minimum capital and surplus
requirements of the New Jersey Department of Banking and Insurance.
Regulation of financial reserves for insurers and HMOs is a frequent
topic of legislative and regulatory scrutiny and proposals for change. It is
possible that the method of measuring the adequacy of our financial reserves
could change and that could affect our financial condition. However, any such
change is likely to affect all companies in the state.
The ability of our insurance and HMO subsidiaries to pay dividends to
us is subject to regulatory requirements, including state insurance laws and
health department regulations and regulatory surplus or admitted asset
requirements, respectively. These laws and regulations require the approval of
the applicable state insurance department or health regulators in order to pay
any proposed dividend over a certain amount. For example, any proposed dividend
to WellChoice from Empire, which, together with other dividends paid within the
preceding twelve month period, exceeds the lesser of 10% of its surplus to
policyholders or 100% of adjusted net investment income will be subject to
approval by the New York Department of Insurance. The provisions of our Blue
Cross and Blue Shield licenses also may limit our ability to obtain dividends or
other cash payments from our subsidiaries as they require our licensed
subsidiaries to retain certain levels of minimum surplus and liquidity.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2002, the Financial Accounting Standards Board issued SFAS 146,
Accounting for Costs Associated with Exit or Disposal Activities, which
supersedes Emerging Issues Task Force (EITF) Issue 94-3, Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring). SFAS 146 requires that a
liability for costs associated with exit or disposal activities first be
recognized when the liability is irrevocably incurred rather than at the date of
management's commitment to an exit or disposal plan. The provisions of the new
standard are effective prospectively for exit or disposal activities initiated
after December 31, 2002. We do not anticipate that the adoption of SFAS 146 will
materially affect our financial statements.
INVESTMENTS
We classify all of our fixed maturity and marketable equity
investments as available for sale and, accordingly, they are carried at fair
value. The fair value of investments in fixed maturities and marketable equity
securities are based on quoted market prices. Unrealized gains and losses are
reported as a separate component of other comprehensive income, net of deferred
income taxes. The amortized cost of fixed maturities, including certain trust
preferred securities, is adjusted for amortization of premiums and accretion of
discounts to maturity, which is included in investment income. Amortization of
premiums and discounts on collateralized mortgage obligations are adjusted for
prepayment patterns using the retrospective method. Investment income is shown
net of investment expenses. The cost of securities sold is based on the specific
identification method. When the fair value of an investment is lower than its
cost and such a decline is determined to be other than temporary, the cost of
the investment is written down to fair value and the amount of the write down is
charged to net income as a realized loss.
66
Short-term investments are carried at fair value, and consist
principally of U.S. treasury bills, commercial paper and money market
investments. We consider securities with maturities greater than three months
and less than one year at the date of purchase as short-term investments. The
fair value of short-term investments is based on quoted market prices.
Other long-term equity investments include joint ventures and
warrants. Joint ventures are accounted for under the equity method. Our warrants
are considered derivatives and are carried at fair value. Our warrants are not
classified as hedging instruments. Fair values of warrants are determined using
the Black Scholes Options Valuation Model. Changes in the fair values of
warrants are recorded as realized gains or losses.
We are subject to state laws and regulations that require
diversification of our investment portfolios and limit the amount our insurance
company subsidiaries may invest in certain investment categories, such as
below-investment-grade fixed income securities, mortgage loans, real estate and
equity investments. Failure to comply with these laws and regulations might
cause investments exceeding regulatory limitations to be treated as non-admitted
assets for purposes of measuring statutory surplus and risk-based capital and,
in some instances, require the sale of those investments.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Our fixed maturity and marketable equity securities are subject to the
risk of potential losses from adverse market conditions. To manage the potential
for economic losses, we regularly evaluate certain risks, as well as the
appropriateness of the investments, to ensure the portfolio is managed within
its risk guidelines. The result is a portfolio that is well diversified. Our
primary risk exposures are changes in market interest rates, credit quality and
changes in equity prices. The market value of our investments varies from time
to time depending on economic and market conditions. Our investment portfolio is
not significantly concentrated in any particular industry or geographic region.
Interest Rate Risk
Interest rate risk is defined as the potential for economic losses on
fixed-rate securities due to an adverse change in market interest rates. Our
fixed maturity portfolio consists exclusively of U.S. dollar-denominated assets,
invested primarily in U.S. government securities, corporate bonds, asset-backed
bonds and mortgage-related securities, all of which represent an exposure to
changes in the level of market interest rates. We manage interest rate risk by
maintaining a duration commensurate with our insurance liabilities and
policyholders' surplus. Further, we do not engage in the use of derivatives to
manage interest rate risk. A hypothetical increase in interest rates of 100
basis points would result in an estimated decrease in the fair value of the
fixed income portfolio at December 31, 2002 of approximately $44.3 million.
Credit Quality Risk
Credit quality risk is defined as the risk of a credit downgrade to
an individual fixed income security and the potential loss attributable to that
downgrade. We manage this risk through our investment policy, which establishes
credit quality limitations on the overall portfolio as well as dollar limits for
individual issuers. The result is a well-diversified portfolio of fixed income
securities, with an average credit rating of approximately "AA."
67
Fixed Maturity Securities Quality Distribution
The following chart shows the quality distribution of our fixed maturity
securities portfolio as of December 31, 2002 and December 31, 2001 (at fair
value):
DECEMBER 31, PERCENT DECEMBER 31 PERCENT
2002 OF TOTAL 2001 OF TOTAL
---- -------- ---- --------
(DOLLARS IN MILLIONS)
Total fixed maturity
Aaa $ 892.3 72.9% $ 793.4 69.3%
Aa 70.7 5.8 85.5 7.5
A 251.3 20.6 262.6 22.9
Baa 8.5 0.7 3.6 0.3
Total fixed maturity $ 1,222.8 100.0% $ 1,145.1 100.0%
Total fixed maturity corporate securities:
Industrial $ 37.2 10.1% $ 52.7 12.2%
Finance 251.3 68.2 254.9 59.2
Utility 20.4 5.5 47.7 11.1
Asset-backed securities 30.0 8.2 35.8 8.3
Other 29.5 8.0 39.7 9.2
Total fixed maturity corporate securities $ 368.4 100.0% $ 430.8 100.0%
Total mortgage-related securities:
Mortgage pass through certificates $ 12.0 6.9% $ 15.7 8.6%
Collateralized mortgage obligations 162.6 93.1 167.1 91.4
Total mortgage-related securities $ 174.6 100.0% $ 182.8 100.0%
Equity Price Risk
Equity price risk for stocks is defined as the potential for economic
losses due to an adverse change in equity prices. Equity risk exposure is
managed through our investment in an indexed mutual fund. Specifically, we are
invested in the ML S&P 500 Index LLC, which is an S&P 500 index mutual fund,
resulting in a well-diversified and liquid portfolio that replicates the risk
and performance of the broad U.S. stock market. We also hold a direct common
stock investment in WebMD and investments in non-redeemable preferred stock of
several companies. Our investment in non-redeemable preferred stock is managed
in conjunction with our fixed maturity portfolio. We estimate our equity price
risk from a hypothetical 10% decline in the S&P 500 and the relative effect of
that decline in the value of our marketable equity portfolio at December 31,
2002 to be a decrease in fair value of $2.9 million.
68
Fixed Income Securities
Our fixed income strategy is to construct and manage a high quality,
diversified portfolio of securities. Additionally, our investment policy
establishes minimum quality and diversification requirements resulting in an
average credit rating of approximately "AA." The average duration of our
portfolio as of December 31, 2002 was 1.6 years.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See Index to Consolidated Financial Statements and Supplemental
Schedules on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by Item 10, as to (a) directors of the
registrant and (b) compliance with Section 16(a) of the Securities Exchange Act
of 1934, is incorporated by reference from the information under the headings
"Nominees for the Board of Directors" and "Section 16A Beneficial Ownership
Reporting Compliance" in the Proxy Statement.
Certain information regarding the registrant's executive officers is
included in Part I immediately following Item 4 above.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by Item 11 is incorporated by reference from
the information under the headings "Compensation of Directors," "Executive
Compensation," and "Certain Relationships and Related Transactions" in the Proxy
Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
At December 31, 2002, the registrant did not have any compensation
plans (including individual compensation arrangements) under which equity
securities of the registrant are authorized. All other information required by
Item 12 is incorporated by reference from the information under the headings
"Questions and Answers - Does any stockholder own more than 5% of WellChoice's
Common Stock," and "Stock Ownership of Management" in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by Item 13 is incorporated by reference from
the information under the heading "Certain Relationships and Related
Transactions" in the Proxy Statement.
69
ITEM 14. CONTROLS AND PROCEDURES.
(a) We maintain disclosure controls and procedures that are designed
to ensure that information required to be disclosed in our filings under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the periods specified in the rules and forms of the Commission. Such
information is accumulated and communicated to our management, including the
principal executive officer and principal financial officer, as appropriate, to
allow timely decisions regarding required disclosure. Our management, including
the principal executive officer and the principal financial officer, recognizes
that any set of controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives.
(b) Within 90 days prior to the filing date of this Annual Report on
Form 10-K, we have carried out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures. Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures are effective.
(c) There have been no significant changes in our internal controls
or in other factors, which could significantly affect the internal controls
subsequent to the date of their evaluation in connection with the preparation of
this Annual Report on Form 10-K.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) (1) Financial Statements and Supplemental Schedules
(2) The consolidated financial statements and Supplemental
Schedules of the registrant listed in the "Index of
Consolidated Financial Statements and Supplemental
Schedules" on page F-1 together with the report of Ernst &
Young LLP, independent auditors, are filed as part of this
report.
(3) Exhibits:
The following exhibits are filed as part of this report:
Exhibit
Number Description
2.1 New York State Superintendent of Insurance's Opinion and
Decision approving Plan Of Conversion, dated October 8, 2002
(1)
2.2 Form of Transfer and Exchange Agreement between the Fund and
WellChoice, Inc. (1)
2.3 Form of Transfer and Exchange Agreement between the
Foundation and WellChoice, Inc. (1)
2.4 Transfer Agreement between WellChoice,
Inc. as transferee, and Empire HealthChoice, Inc., as
transferor (1)
3.1 Amended and Restated Certificate of Incorporation of
WellChoice, Inc. (2)
3.2 Amended and Restated Bylaws of WellChoice, Inc., as amended
as of December 18, 2002 (2)
4.1 Specimen Common Stock certificate (1)
4.2 Registration Rights Agreement dated as of November 7, 2002,
by and among WellChoice, Inc., The New York Public Asset
Fund and The New York Charitable Asset Foundation (2)
70
9.1 Voting Trust and Divestiture Agreement dated as of November
7, 2002, by and among WellChoice Inc., The New York Public
Asset Fund and The Bank of New York, as trustee (2)
10.1* Empire HealthChoice, Inc. Annual Executive Incentive
Compensation Plan -- 2000 Plan Description (1)
10.2* Empire HealthChoice, Inc. Annual Executive Incentive
Compensation Plan -- 2001 Plan Description (1)
10.3* Empire HealthChoice, Inc. Annual Executive Incentive
Compensation Plan -- 2002 Plan Description (1)
10.4* Empire HealthChoice, Inc. Executive Savings Plan, as Amended
and Restated effective January 1, 1999 (1)
10.5* Empire HealthChoice, Inc., 1998-2000 Long-Term Incentive
Compensation Plan (1)
10.6* Empire HealthChoice, Inc., 1999-2001 Long-Term Incentive
Compensation Plan (1)
10.7* Empire HealthChoice, Inc., 2000-2002 Long-Term Incentive
Compensation Plan (1)
10.8* WellChoice, Inc. Long-Term Incentive Compensation Plan (1)
10.9* Letter Agreement, dated July 21, 2000, between Empire
HealthChoice, Inc. and Kenneth Klepper
10.10 Form of Blue Cross License Agreement (1)
10.11 Form of Blue Shield License Agreement (1)
10.12 (+) Master Services Agreement, dated June 1, 2002, between
Empire HealthChoice, Inc. and International Business
Machines Corporation (1)
10.13 Software License and Support Agreement, dated June 1, 2002,
between Empire HealthChoice, Inc. and International Business
Machines Corporation (1)
10.14 Agreement of Lease, dated January 17, 2002, between Forest
City Myrtle Associates, LLC as Landlord and Empire
HealthChoice, Inc. d/b/a/ Blue Cross Blue Shield as Tenant
(1) 10.15 Credit and Guaranty Agreement, dated as of October
17, 2002 (1)
10.16 Form of Empire Blue Cross Blue Shield License Addendum to
Blue Cross and Blue Shield License Agreements (1)
10.17 Form of Amendment No. 1 to Credit and Guaranty Agreement (1)
10.18* Change in Control Retention Agreement, dated December 18,
2002, between WellChoice, Inc. and Michael A. Stocker, M.D.
(3)
10.19* Change in Control Retention Agreement dated December 23,
2002, between WellChoice, Inc. and Kenneth O. Klepper (3)
10.20* Change in Control Retention Agreement, dated December 23,
2002, between WellChoice, Inc. and John Remshard (3)
10.21* Change in Control Retention Agreement, dated December 23,
2002, between WellChoice, Inc. and Gloria M. McCarthy (3)
71
10.22* WellChoice, Inc. Annual Executive Incentive Compensation
Plan - 2003 Plan Description.+
10.23* Separation Agreement and General Release, dated January 3,
2003, between WellChoice, Inc. and David B. Snow, Jr.+ 21
Subsidiaries of the Registrant.+
24 Power of Attorney+
99.1 Certification of CEO Pursuant to Section 906 of
Sarbanes-Oxley Act of 2002+
99.2 Certification of CFO Pursuant to Section 906 of
Sarbanes-Oxley Act of 2002+
___________
+ Filed herewith.
(+) Omits information for which confidential treatment has been
granted.
* Management contracts, compensatory plans or arrangements.
(1) Previously filed as the same numbered exhibit to the
Registrant's Registration Statement on Form S-1 (File No.
333-99051) and incorporated herein by reference thereto.
(2) Previously filed as the same numbered exhibit to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 2002 and incorporated herein by
reference thereto.
(3) Previously filed as the same numbered exhibit to the
Registrant's Current Report on Form 8-K filed January 21,
2003 and incorporated herein by reference thereto.
(b) Reports on Form 8-K:
During the fourth quarter of the fiscal year ended December
31, 2002, the registrant filed no reports on Form 8-K.
(c) Refer to Item 15(b)(3) of this report.
(d) Refer to Item 15 (b)(2) of this report.
72
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: March 7, 2003 WELLCHOICE, INC.
(Registrant)
By: /s/ Michael A. Stocker, M.D.
-----------------------------
Michael A. Stocker, M.D.
Chief Executive Officer and
President
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on dates indicated.
Signature and Title Date
- ------------------- ----
/s/ Michael A. Stocker, M.D. March 7, 2003
- -----------------------------
Michael A. Stocker, M.D.
Chief Executive Officer, President
and Director
(Principal Executive Officer)
/s/ John W. Remshard March 7, 2003
- ----------------------
John W. Remshard
Senior Vice President and
Chief Financial Officer
(Principal Financial and Accounting
Officer)
/s/ Philip Briggs*
-------------------
Philip Briggs
Chairman of the Board of Directors
- ----------------------
Hermes L. Ames, III
Director
73
Signature and Title Date
- -------------------
/s/ John R. Gunn*
------------------
John R. Gunn
Director
/s/ William T. Lee*
- --------------------
William T. Lee
Director
/s/ Edward J. Malloy*
- ---[------------------
Edward J. Malloy
Director
/s/ John F. McGillicuddy*
- --------------------------
John F. McGillicuddy
Director
/s/ Robert R. McMilan*
- ------------------------
Robert R. McMillan
Director
- ------------------
Robert D. Paul
Director
/s/ Veronica C. Santilli*
- --------------------------
Veronica C. Santilli, M.D.
Director
/s/ Stephen S. Scheidt, M.D.*
- ------------------------------
Stephen S. Scheidt, M.D.
Director
/s/ Frederick O. Terrell*
- --------------------------
Frederick O. Terrell
Director
74
Signature and Title Date
- ------------------- ----
/s/ Faye Wattleton*
- --------------------
Faye Wattleton
Director
/s/ John E. Zuccotti*
- ----------------------
John E. Zuccotti
Director
_______
*Executed this 7th day of March 2003, on behalf of the indicated Directors by
Linda V. Tiano, duly appointed attorney-in-fact.
/s/ Linda V. Tiano
- --------------------
Linda V. Tiano
Attorney-in-Fact
75
CERTIFICATIONS
CHIEF EXECUTIVE OFFICER'S SECTION 302 CERTIFICATION
I, Michael A. Stocker, M.D., Chief Executive Officer of WellChoice,
Inc., certify that:
1. I have reviewed this Annual Report on Form 10-K of WellChoice, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
(c) Presented in this annual report our conclusions based upon the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 7, 2003 /s/ Michael A. Stocker, M.D.
----------------------------------
Michael A. Stocker, M.D.
Chief Executive Officer
76
CHIEF FINANCIAL OFFICER'S SECTION 302 CERTIFICATION
I, John W. Remshard, Chief Financial Officer of WellChoice, Inc., certify that:
1. I have reviewed this Annual Report on Form 10-K of WellChoice, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
(c) Presented in this annual report our conclusions based upon the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 7, 2003 /s/ John W. Remshard
------------------------------
John W. Remshard
Chief Financial Officer
77
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTAL SCHEDULES
WellChoice, Inc. and Subsidiaries
Consolidated Financial Statements
Years ended December 31, 2002, 2001 and 2000
Report of Independent Auditors......................................................................................F-2
Consolidated Balance Sheets.........................................................................................F-3
Consolidated Statements of Income...................................................................................F-5
Consolidated Statements of Changes in Stockholders' Equity..........................................................F-6
Consolidated Statements of Cash Flows...............................................................................F-7
Notes to Consolidated Financial Statements..........................................................................F-8
Supplemental Schedules.............................................................................................F-45
F-1
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors of
WellChoice, Inc.
We have audited the accompanying consolidated balance sheets of WellChoice, Inc.
and subsidiaries as of December 31, 2002 and 2001, and the related consolidated
statements of income, changes in stockholders' equity and cash flows for each of
the three years in the period ended December 31, 2002. Our audits also included
the financial statement schedules listed in the Index at Item 15(a). These
financial statements and schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of WellChoice, Inc.
and subsidiaries at December 31, 2002 and 2001, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2002, in conformity with accounting principles generally
accepted in the United States. Also, in our opinion, the related financial
statement schedules, when considered in relation to the basic financial
statements taken as a whole, present fairly in all material respects the
information set forth therein.
/s/ Ernst & Young LLP
New York, New York
February 3, 2003
F-2
WellChoice, Inc. and Subsidiaries
Consolidated Balance Sheets
DECEMBER 31
2002 2001
-----------------------------------------
(In thousands, except share and per
share data)
ASSETS
Investments:
Fixed maturities, at fair value (amortized cost: $846,617 and $909,497) $ 863,290 $ 919,864
Marketable equity securities, at fair value (cost: $47,022 and $23,482) 44,548 23,418
Short-term investments 359,490 225,298
Other long-term equity investments 28,220 27,157
-----------------------------------------
Total investments 1,295,548 1,195,737
Cash and cash equivalents 487,431 408,588
-----------------------------------------
Total investments and cash and cash equivalents 1,782,979 1,604,325
Receivables:
Billed premiums, net 111,082 135,965
Accrued premiums 247,729 267,583
Other amounts due from customers, net 94,475 68,453
Notes receivable, net 12,059 10,449
Advances to hospitals, net 124 1,613
Accrued investment income 9,829 9,446
Insurance proceeds receivable - 13,716
Miscellaneous, net 70,644 49,358
-----------------------------------------
Total receivables 545,942 556,583
Property, equipment and information systems, net of accumulated depreciation 100,790 102,949
Prepaid pension expense 45,209 39,253
Deferred taxes, net 268,948 118,904
Other 33,587 27,573
-----------------------------------------
Total assets $ 2,777,455 $2,449,587
=========================================
See notes to consolidated financial statements.
F-3
DECEMBER 31
2002 2001
------------------------------------------
(In thousands, except share and per
share data)
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Unpaid claims and claims adjustment expense $ 559,924 $ 634,130
Unearned premium income 127,503 120,182
Managed cash overdrafts 170,270 174,602
Accounts payable and accrued expenses 111,842 114,713
Advance deposits 137,762 211,256
Group and other contract liabilities 112,870 96,554
Postretirement benefits other than pensions 143,736 138,206
Obligations under capital lease 47,700 50,079
Other 129,586 80,620
------------------------------------------
Total liabilities 1,541,193 1,620,342
Stockholders' equity:
Class A common stock, $0.01 per share value, 225,000,000 shares authorized;
83,490,477 shares issued and outstanding
835 -
Class B common stock, $0.01 per share value, one share authorized; one share
issued and outstanding - -
Preferred stock, $0.01 per share value, 25,000,000 shares authorized; none
issued and outstanding - -
Additional paid-in capital 1,255,566 -
Retained deficit (38,542) -
Unassigned reserves - 813,310
Accumulated other comprehensive income 18,403 15,935
------------------------------------------
Total stockholders' equity 1,236,262 829,245
------------------------------------------
Total liabilities and stockholders' equity $ 2,777,455 $ 2,449,587
==========================================
F-4
WellChoice, Inc. and Subsidiaries
Consolidated Statements of Income
YEAR ENDED DECEMBER 31
2002 2001 2000
-------------------------------------------------------------
(In thousands, except share
and per share data)
Revenue:
Premiums earned $ 4,628,035 $ 4,246,168 $ 3,876,927
Administrative service fees 396,203 321,984 264,927
Investment income, net 64,806 69,356 65,497
Net realized investment gains (losses) 2,604 (12,403) 22,035
Other income, net 14,012 6,101 4,298
-------------------------------------------------------------
Total revenue 5,105,660 4,631,206 4,233,684
Expenses:
Cost of benefits provided 3,947,382 3,738,821 3,426,417
Administrative expenses 833,160 742,777 686,214
Conversion and IPO expenses 15,350 2,043 566
-------------------------------------------------------------
Total expenses 4,795,892 4,483,641 4,113,197
Income from continuing operations before
income taxes 309,768 147,565 120,487
Income tax benefit (expense) 67,847 (135) 74,540
-------------------------------------------------------------
Income from continuing operations 377,615 147,430 195,027
Loss from discontinued operations, net of taxes of $0 (1,056) (16,452) (4,647)
-------------------------------------------------------------
Net income $ 376,559 $ 130,978 $ 190,380
=============================================================
Net loss for the period from November 7, 2002 (date of conversion and $ (38,542)
initial public offering) to December 31, 2002
Basic and diluted net loss per common share for the period from November 7, 2002
(date of conversion and initial public offering)
to December 31, 2002 $ (0.46)
Shares used to compute earnings per share, based on weighted average
shares outstanding November 7, 2002 (date of conversion and
initial public offering) to December 31, 2002 83,333,244
See notes to consolidated financial statements.
F-5
WellChoice, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity
(In thousands, except share and per share data)
COMMON STOCK ADDITIONAL
NUMBER OF PAR PAID IN UNASSIGNED
SHARES VALUE CAPITAL RESERVES
-------------------------------------------------------------------------
Balance at January 1, 2000 $ 491,952
Net income 190,380
Other comprehensive loss
Comprehensive income
------------------------------------------------------------------------
Balance at December 31, 2000 682,332
Net income 130,978
Other comprehensive income
Comprehensive income
------------------------------------------------------------------------
Balance at December 31, 2001 813,310
Initial public offering of common stock (2) 83,490,478 $835 $1,255,566 (1,228,411)
Net income (loss) 415,101
Other comprehensive income
Comprehensive income
------------------------------------------------------------------------
Balance at December 31, 2002 83,490,478 $835 $1,255,566 $ -
========================================================================
(1) Prior years represent Reserve for Policyholders' Protection prior to for
profit conversion
(2) Represents 83,490,477 shares of class A common stock and
one share class B common stock
See notes to consolidated financial statements.
** TABLE CONTINUED **
F-6
ACCUMULATED
OTHER TOTAL
RETAINED COMPREHENSIVE INCOME STOCKHOLDERS'
DEFICIT (LOSS) EQUITY (1)
-----------------------------------------------------------
Balance at January 1, 2000 $ 10,669 $ 502,621
Net income 190,380
Other comprehensive loss (18,323) (18,323)
----------------------
Comprehensive income 172,057
-------------------------------------------------------------
Balance at December 31, 2000 (7,654) 674,678
Net income 130,978
Other comprehensive income 23,589 23,589
----------------------
Comprehensive income 154,567
-------------------------------------------------------------
Balance at December 31, 2001 15,935 829,245
Initial public offering of common stock (2) 27,990
Net income (loss) $(38,542) 376,559
Other comprehensive income 2,468 2,468
----------------------
Comprehensive income 379,027
----------------------
-------------------------------------------------------------
Balance at December 31, 2002 $ (38,542) $ 18,403 $ 1,236,262
===============================================================
** TABLE COMPLETE **
F-6
WellChoice, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
YEAR ENDED DECEMBER 31
2002 2001 2000
--------------------------------------------------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 376,559 $ 130,978 $ 190,380
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 34,502 26,741 14,189
Net realized (gain) loss on sales of investments (2,604) 12,403 (22,035)
Provision (credit) for doubtful accounts 1,284 (1,702) 6,534
Accretion of discount, net (2,733) (5,005) (2,797)
Equity in earnings of other long-term equity investments 229 571 6,378
Deferred income tax benefit (151,372) (34,828) (86,902)
Insurance recovery gain - 8,943 -
Other (5,763) (8,428) (73)
Changes in assets and liabilities:
Billed and accrued premiums receivable 43,372 42,328 (58,117)
Other customer receivable (24,956) 2,787 (1,221)
Notes receivable (1,610) (3,102) 1,061
Advances to hospitals 1,757 3,920 12,058
Accrued investment income (383) 3,523 (1,722)
Insurance proceeds receivable 13,716 (13,716) -
Miscellaneous receivables (8,212) 10,390 (12,401)
Other assets (6,207) (5,976) (23,897)
Unpaid claims and claims adjustment expenses (74,205) (38,289) 81,469
Unearned premium income 7,321 14,441 3,573
Managed cash overdrafts (4,332) 8,686 28,496
Accounts payable and accrued expenses (9,608) 34,350 4,655
Advance deposits (73,494) 24,427 20,706
Group and other contract liabilities 16,315 (8,971) (51,454)
Postretirement benefits other than pensions 5,530 1,888 696
Other liabilities 47,584 7,938 6,399
--------------------------------------------------
Net cash provided by operating activities 182,690 214,297 115,975
--------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, equipment and information systems (33,691) (33,822) (44,410)
Proceeds from sale of property, equipment and
information systems 1,349 - -
Purchases of available for sale investments (1,757,657) (818,465) (520,362)
Proceeds from sales and maturities of available
for sale investments 1,660,541 722,951 426,827
--------------------------------------------------
Net cash used in investing activities (129,458) (129,336) (137,945)
--------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Decrease in capital lease obligations (2,379) (1,933) (1,469)
Net proceeds from common stock issued in the
initial public offering 27,990 - -
--------------------------------------------------
Net cash provided by (used in) financing activities 25,611 (1,933) (1,469)
--------------------------------------------------
Net change in cash and cash equivalents 78,843 83,028 (23,439)
Cash and cash equivalents at beginning of period 408,588 325,560 348,999
--------------------------------------------------
Cash and cash equivalents at end of period $ 487,431 $ 408,588 $ 325,560
==================================================
Supplemental disclosure: $ 84,000 $ 13,349 $ 14,195
Income taxes paid
==================================================
See notes to consolidated financial statements.
F-7
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
1. ORGANIZATION AND FOR-PROFIT CONVERSION
WellChoice, Inc. ("WellChoice") was formed in August 2002 as a Delaware
Corporation to be the for-profit parent holding company for Empire HealthChoice,
Inc. ("EHC") following the conversion. WellChoice owns a Health Maintenance
Organization ("HMO") and two health insurance companies through its investment
in WellChoice Holdings of New York, Inc. ("WellChoice Holdings").
On November 7, 2002, EHC converted from a not-for-profit health service
corporation to a for-profit accident and health insurer under the New York State
insurance laws and the converted EHC issued all its authorized capital stock to
the New York Public Asset Fund (the "Fund") and The New York Charitable Asset
Foundation (the "Foundation"). The Fund and the Foundation then received their
respective shares of WellChoice common stock in exchange for the transfer of all
the outstanding shares of EHC to WellChoice Holdings. Pursuant to the plan of
conversion, WellChoice issued 82,300,000 shares to the Fund and the Foundation
and completed an initial public offering of 19,199,000 shares of common stock,
consisting of 18,008,523 shares that were sold by the Fund and Foundation and
1,190,477 newly issued shares of common stock sold by WellChoice. After
deducting the underwriting discount, net proceeds to WellChoice were
approximately $27,990.
WellChoice Holdings is a non-insurance holding company which wholly-owns Empire
HealthChoice Assurance Inc. ("EHCA") dba, Empire Blue Cross Blue Shield. In
connection with EHC's conversion to a for-profit entity, EHC merged with EHCA.
EHCA wholly-owns Empire HealthChoice HMO, Inc. ("EHC HMO") and WellChoice
Insurance of New Jersey, Inc. ("WCINJ"). EHC HMO is an HMO licensed under
Article 44 of the New York Public Health Law and is also licensed to operate an
HMO in the State of New Jersey. WCINJ is a credit, life, accident and health
insurance company licensed in eleven states, which currently writes business
only in New Jersey. Prior to its dissolution in February 2002, NexxtHealth, Inc.
was a wholly-owned subsidiary of EHC primarily engaged in the development of
software to link health care systems to the Internet.
F-8
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
1. ORGANIZATION AND FOR-PROFIT CONVERSION (CONTINUED)
EHCA and its subsidiaries offer a comprehensive array of insurance products to
employer groups and individuals. Products include traditional comprehensive
indemnity health coverage and managed care products and services offered through
an HMO, preferred provider organization ("PPO") and exclusive provider
organization ("EPO"). EHCA and its subsidiaries also process claims for
self-insured employers and government programs. EHCA and EHC HMO are members of
the Blue Cross Blue Shield Association ("BCBSA") which provides EHCA and EHC HMO
the ability to participate with other Blue Cross Blue Shield plans in BCBSA
sponsored programs and entitles it to use the Blue Cross and Blue Shield names
and marks in the New York City metropolitan area and one or both of these names
and marks in select upstate New York counties.
WellChoice also owns Empire National Accounts Services Corporation ("ENASCO").
ENASCO has a 24.975% interest in National Accounts Service Company, LLC
("NASCO"), a limited liability company, which processes national account claims
for the Company and other Blue Cross Blue Shield plans.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements have been prepared in conformity with
accounting principles generally accepted in the United States ("GAAP"). The
consolidated financial statements include the accounts of WellChoice and its
wholly-owned subsidiaries (collectively, the "Company"). All significant
intercompany transactions have been eliminated.
The preparation of financial statements requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Such estimates and assumptions could change in the future as
more information becomes known, which could impact the amounts reported and
disclosed herein.
F-9
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CONVERSION
The conversion was accounted for as a reorganization using the historical
carrying values of EHC and its subsidiaries assets and liabilities. Immediately
following the conversion, EHC's unassigned reserves were reclassified to par
value of common stock and additional paid-in capital. The costs of the
conversion were recognized as an expense.
INVESTMENTS-FIXED MATURITIES AND MARKETABLE EQUITY SECURITIES
The Company has classified all of its fixed maturity and marketable equity
security investments as available for sale and, accordingly, they are carried at
fair value. The fair value of investments in fixed maturities and marketable
equity securities are based on quoted market prices. Unrealized gains and losses
are reported as a separate component of other comprehensive income, net of
deferred income taxes. The amortized cost of fixed maturities, including certain
trust preferred securities, is adjusted for amortization of premiums and
accretion of discounts to maturity, which is included in investment income.
Amortization of premiums and discounts on collateralized mortgage obligations
are adjusted for prepayment patterns using the retrospective method. Investment
income is shown net of investment expenses. The cost of securities sold is based
on the specific identification method. When the fair value of an investment is
lower than its cost and such a decline is determined to be other than temporary,
the cost of the investment is written down to fair value and the amount of the
write down is charged to net income as a realized loss.
SHORT-TERM INVESTMENTS
Short-term investments are carried at fair value, and consist principally of
U.S. treasury bills, commercial paper and money market investments. The Company
considers securities with maturities greater than three months and less than one
year at the date of purchase as short-term investments. The fair value of
short-term investments is based on quoted market prices.
F-10
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
OTHER LONG-TERM EQUITY INVESTMENTS
Other long-term equity investments include joint ventures and warrants. Joint
ventures are accounted for under the equity method. The Company's warrants are
considered derivatives and are carried at fair value. The warrants are not
classified as hedging instruments. Fair values of warrants are determined using
the Black Scholes Options Valuation Model. Changes in the fair values of
warrants are recorded as realized gains or losses.
CASH AND CASH EQUIVALENTS
The Company considers all bank deposits, highly liquid securities and
certificates of deposit with maturities of three months or less at the date of
purchase to be cash equivalents. These cash equivalents are carried at cost
which approximates fair value.
PHARMACEUTICAL REBATE SHARING PROGRAM
The Company participates in pharmaceutical rebate sharing programs with drug
manufacturers through a third party pharmacy benefit manager. Rebates for fully
insured groups are recorded as a reduction to the cost of benefits provided.
Rebates for self-funded groups are recorded as administrative service fee
revenue. The Company records an estimate for pharmacy rebates earned but not yet
received. These estimates are adjusted as new information becomes known and such
adjustments are included in current period operations. Pharmacy rebates included
in miscellaneous receivables were $19,004 and $10,912 at December 31, 2002 and
2001, respectively.
MARKET STABILIZATION AND STOP LOSS POOLS
The Company is required to participate in Market Stabilization and Stop Loss
Pools ("Pools") as established by the State of New York. Contributions and
recoveries under the Pools are estimated based on interpretations of applicable
regulations and are recorded as an addition or a reduction to cost of benefits
provided. These estimates are adjusted as new information becomes known and such
adjustments are included in current period operations. Pool recoverables
included in miscellaneous receivables were $18,390 and $18,310 at December 31,
2002 and 2001, respectively.
F-11
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECEIVABLES
Receivables are reported net of allowance for doubtful accounts of $13,724 and
$12,440 at December 31, 2002 and 2001, respectively.
PROPERTY, EQUIPMENT AND INFORMATION SYSTEMS
Property, equipment and information systems are reported at cost less
accumulated depreciation. Depreciation is computed using the straight-line
method over the estimated useful lives of the assets, which are not greater than
twenty-one years for property and improvements and three to ten years for
equipment and furniture. Purchased software is capitalized and depreciated for a
period not to exceed three years. The Company capitalizes certain costs incurred
during the application development stage related to developing internal use
software. These capitalized costs are amortized over a three-year period
beginning when the software is placed into production. Computer software costs
that are incurred in the preliminary project stages and
post-implementation/operation stages, are expensed as incurred.
UNPAID CLAIMS AND CLAIMS ADJUSTMENT EXPENSES
The cost of unpaid claims, both for reported claims and claims incurred but not
yet reported to the Company, is calculated based upon claim history, claim
inventory, number of claims received, changes in product mix, number of
contracts in force, recent trend experience, unit costs and the regulatory
environment. The estimated expense of processing these claims is also included
in the consolidated financial statements as a component of administrative
expense. These estimates are subject to the effects of medical claim trends and
other uncertainties. Although considerable variability is inherent in such
estimates, management believes that the reserves for claims and claims
adjustment expenses are adequate. The estimates are continually reviewed and
adjusted as experience develops or new information becomes known. Such
adjustments are included in current period operations.
F-12
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ADVANCE DEPOSITS
Under certain funding arrangements, customers are contractually obligated to
remit funds on a paid claims basis. Funds received prior to payment of claims
are classified as advance deposits.
REVENUE
Membership contracts are generally for a period of one year and are subject to
cancellation by the employer group upon 60 days written notice. Premiums are
normally due monthly and are recognized as revenue during the period in which
the Company is obligated to provide services to members. Premiums received prior
to such periods are recorded as unearned premiums. Premiums on retrospectively
rated group contracts are accrued by making estimates based on past claims
experience on such contracts. Premiums collected on retrospectively rated group
contracts in excess of premiums earned are classified as group and other
contract liabilities.
Administrative service fees are recognized in the period the related services
are performed. All benefit payments under these programs are excluded from
revenue and cost of benefits provided.
COST OF BENEFITS PROVIDED
Cost of benefits provided includes claims paid, claims in process and pending,
and an estimate of unreported claims for healthcare service provided to enrolled
members during the period. Costs of benefits are reported net of pharmacy
rebates, coordination of benefits and pool recoveries.
ACQUISITION COSTS
Marketing and other costs associated with the acquisition of membership
contracts are expensed as incurred.
F-13
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
The Company accounts for income taxes using the liability method. Accordingly,
deferred tax assets and liabilities are recognized for the future tax
consequences attributable to the difference between the financial reporting and
tax bases of assets and liabilities.
PREMIUM DEFICIENCY
A premium deficiency reserve is established when expected claim payments or
incurred costs, claim adjustment expenses and administrative costs exceed the
premiums to be collected for the remainder of a contract period. For purposes of
determining if a premium deficiency reserve exists, contracts are grouped in a
manner consistent with how policies are marketed, serviced and measured.
Anticipated investment income is not utilized in the premium deficiency reserve
calculation. For the years ended December 31, 2002 and 2001, a premium
deficiency reserve of $3,300 and $0, respectively, is included in group and
other contract liabilities.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2002, the Financial Accounting Standards Board issued SFAS 146,
Accounting for Costs Associated with Exit or Disposal Activities, which
supersedes Emerging Issues Task Force (EITF) Issue 94-3, Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring). SFAS 146 requires that a
liability for costs associated with exit or disposal activities first be
recognized when the liability is irrevocably incurred rather than at the date of
management's commitment to an exit or disposal plan. The provisions of the new
standard are effective prospectively for exit or disposal activities initiated
after December 31, 2002. The Company does not anticipate that the adoption of
SFAS 146 will materially affect the financial statements.
F-14
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
3. INVESTMENTS
Available-for-sale investments are as follows:
COST OR AMORTIZED GROSS UNREALIZED GROSS UNREALIZED FAIR
COST GAINS LOSSES VALUE
------------------------------------------------------------------------
AT DECEMBER 31, 2002
Fixed maturities:
U.S. Treasury Notes $ 76,042 $ 2,081 $ - $ 78,123
U.S. Government Agency obligations 234,300 2,011 (156) 236,155
U.S. Government Agency mortgage-
backed securities 129,522 1,299 (127) 130,694
Public utility bonds 20,000 368 (4) 20,364
Corporate securities 386,753 13,059 (1,858) 397,954
------------------------------------------------------------------------
Total fixed maturities 846,617 18,818 (2,145) 863,290
Marketable equity securities:
Common stock 31,966 - (2,724) 29,242
Non-redeemable preferred stock 15,056 250 - 15,306
------------------------------------------------------------------------
Total marketable equity securities 47,022 250 (2,724) 44,548
------------------------------------------------------------------------
Total fixed maturities and marketable equity securities $ 893,639 $ 19,068 $ (4,869) $ 907,838
investments
========================================================================
F-15
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
3. INVESTMENTS (CONTINUED)
COST OR AMORTIZED GROSS UNREALIZED GROSS UNREALIZED FAIR
COST GAINS LOSSES VALUE
------------------------------------------------------------------------
AT DECEMBER 31, 2001
Fixed maturities:
U.S. Treasury Notes $ 95,757 $ 2,142 $ - $ 97,899
U.S. Government Agency obligations 243,808 1,212 (2,922) 242,098
U.S. Government Agency
mortgage-backed securities 80,893 1,328 (366) 81,855
Public utility bonds 37,128 772 (150) 37,750
Corporate securities 451,911 10,745 (2,394) 460,262
------------------------------------------------------------------------
Total fixed maturities 909,497 16,199 (5,832) 919,864
Marketable equity securities:
Common stock 8,426 - - 8,426
Non-redeemable preferred stock 15,056 - (64) 14,992
------------------------------------------------------------------------
Total marketable equity securities 23,482 - (64) 23,418
------------------------------------------------------------------------
Total fixed maturities and marketable $ 932,979 $ 16,199 $ (5,896) $ 943,282
equity securities investments ========================================================================
The amortized cost and fair value of fixed maturities, by contractual maturity,
are shown below:
DECEMBER 31, 2002
-----------------------------------
AMORTIZED COST FAIR VALUE
-----------------------------------
Due in 1 year or less $ 29,222 $ 29,561
Due after 1 year through 5 years 246,979 256,825
Due after 5 years through 10 years 54,408 56,124
Due after 10 years 516,008 520,780
-----------------------------------
Total $ 846,617 $ 863,290
===================================
Mortgage-backed securities do not have a single maturity date and have been
included in the above table based on the year of final maturity. Expected
maturities may differ from contractual maturities because borrowers may have the
right to call or prepay obligations with or without call or prepayment
penalties.
F-16
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
3. INVESTMENTS (CONTINUED)
Proceeds from sales of available for sale securities for the years ended
December 31, 2002, 2001 and 2000 were $231,840, $154,137 and $181,900,
respectively. The Company's investment portfolio is not significantly
concentrated in any particular industry or geographic region.
Investment income, net is summarized as follows:
YEAR ENDED DECEMBER 31
2002 2001 2000
----------------------------------------------------
Fixed maturities $57,507 $61,690 $62,282
Marketable equity securities 1,081 1,200 1,198
Short-term investments and cash equivalents 7,775 15,583 19,952
Other long-term equity investments 117 - -
----------------------------------------------------
Interest and dividend income 66,480 78,743 83,432
Equity in earnings (losses) of joint ventures (229) (571) (6,378)
Less investment expenses including interest on advance deposits
(1,445) (8,546) (11,557)
----------------------------------------------------
Investment income, net $64,806 $69,356 $65,497
====================================================
F-17
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
3. INVESTMENTS (CONTINUED)
Realized and unrealized gains and losses on investments were as follows:
YEAR ENDED DECEMBER 31
2002 2001 2000
-----------------------------------------------------
Realized gains:
Fixed maturities $ 4,447 $ 2,351 $ 1,457
Equity securities 375 - 20,993
Short-term investments and cash equivalents 6 3,994 -
-----------------------------------------------------
Total realized gains 4,828 6,345 22,450
Realized losses:
Fixed maturities (1,747) (2,402) (415)
Equity securities (476) (10,816) -
Short-term investments and cash equivalents (1) (5,530) -
-----------------------------------------------------
Total realized losses (2,224) (18,748) (415)
Net realized gains (losses) 2,604 (12,403) 22,035
Changes in unrealized gains (losses):
Fixed maturities 6,305 23,249 43,893
Equity securities (2,531) 11,193 (70,304)
Short-term investments 23 (9) 67
-----------------------------------------------------
Net unrealized gains (losses) 3,797 34,433 (26,344)
-----------------------------------------------------
Total realized and unrealized gains (losses) $ 6,401 $ 22,030 $ (4,309)
=====================================================
F-18
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
3. INVESTMENTS (CONTINUED)
The components of other comprehensive income are as follows:
YEAR ENDED DECEMBER 31
2002 2001 2000
-------------------------------------------------------
Unrealized gains (losses) from investments, net of taxes of $ 4,059 $ 15,527
$(2,186), $(6,503) and $309 $ (4,000)
Reclassification adjustment for (gains) losses included
in net income, net of taxes of $857, $(4,341) and
$7,711 (1,591) 8,062 (14,323)
-------------------------------------------------------
Other comprehensive income (loss) $ 2,468 $ 23,589 $ (18,323)
=======================================================
In 2001 the Company participated in a securities lending program, whereby
certain securities from its portfolio are loaned to qualified brokers in
exchange for cash collateral, equal to at least 102% of the market value of the
securities loaned. The securities lending agent indemnified the Company against
loss in the event of default by the borrower. Income generated by the securities
lending program is reported as a component of net investment income. As of
December 31, 2001, $321,421 of fixed maturity securities were loaned under the
program. In November 2002, the Company transferred its investment portfolio to a
new custodial agent and is in the process of entering into a similar securities
lending agreement. As of December 31, 2002 the terms of the agreement were not
finalized as such no fixed securities were on loan.
The Company is required by BCBSA to maintain a deposit for the benefit and
security of out-of-state policyholders. At December 31, 2002, the fair value and
amortized cost of the investment on deposit were $8,364 and $7,919,
respectively. The Company also maintains a deposit to satisfy the requirements
of its workers' compensation insurance carrier. At December 31, 2002, the fair
value and amortized cost of the investment on deposit were $1,848 and $1,846,
respectively.
4. INVESTMENT IN WEBMD
The Health Information Network Connection, LLC ("THINC") was organized as a 20%
owned joint venture. In January 1999, CareInsite, Inc. ("CareInsite"), a
publicly-held company, acquired a 20% ownership interest in THINC in exchange
for cash and a warrant to purchase CareInsite common stock. In January 2000,
CareInsite agreed to
F-19
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
4. INVESTMENT IN WEBMD (CONTINUED)
acquire the remainder of THINC. The Company received its pro rata portion of the
warrant to purchase shares of CareInsite held by THINC and a new warrant to
purchase additional shares of CareInsite stock. Pursuant to a cashless exercise,
the Company exercised its warrants and received 918,004 unregistered shares of
CareInsite common stock. The Company recognized a realized gain of $13,157 in
2000, on this transaction.
In September 2000, Healtheon/WebMD Corp. ("WebMD"), a publicly-held company,
purchased CareInsite and its parent, Medical Manager Corp. and the Company
received 1,193,535 shares of WebMD common stock. The Company recognized a
realized gain of $7,836 in 2000 on this transaction. At December 31, 2000, the
Company recorded an unrealized loss of $9,473 on its investment in WebMD common
stock. In 2001, the Company recorded a realized loss of $10,521 due to
management's determination that the decline in WebMD common stock was other than
temporary. For the year ended December 31, 2002, the Company's unrealized gain
in WebMD common stock was $1,470. During December 2002, 206,900 shares were sold
resulting in a gain of $375.
5. PROPERTY AND EQUIPMENT
Property and equipment, including capitalized lease arrangements, are as
follows:
DECEMBER 31
2002 2001
-------------------------------
Buildings and improvements $102,600 $ 91,576
Equipment and furniture 52,575 41,497
Software systems 57,807 46,728
------------------------------
Total property and equipment 212,982 179,801
Less accumulated depreciation and amortization 112,192 76,852
-------------------------------
Net property and equipment $100,790 $ 102,949
===============================
F-20
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
5. PROPERTY AND EQUIPMENT (CONTINUED)
All property and equipment is used by the Company for its operations and
includes two facilities leased under agreements which are accounted for as
capital leases. Depreciation expense, including depreciation on properties held
under capital leases totaled $33,270, $27,332 and $14,189 for the years ended
December 31, 2002, 2001 and 2000, respectively.
For the year ended December 31, 2002, the cost and accumulated depreciation of
assets retired were $2,278 and $1,077, respectively. Of these retirements, cost
and accumulated depreciation of $2,213 and $1,036, respectively, was for
information system equipment and personal computers.
For the year ended December 31, 2001, the cost and accumulated depreciation of
assets retired were $16,463 and $6,770, respectively. Of these, the cost and
accumulated depreciation of the World Trade Center assets that were written-off
were $14,703 and $5,761, respectively. The cost and accumulated depreciation of
all other assets retired, all of which was for information systems equipment and
personal computers, was $1,760 and $1,009, respectively.
For the year ended December 31, 2000, the cost and accumulated depreciation of
assets retired were $50,626 and $50,374, respectively. Of these retirements,
cost and accumulated depreciation of $27,621 and $27,541, respectively, was for
information system equipment and personal computers.
F-21
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
6. CLAIM RESERVES
Activity in unpaid claims and certain claim adjustment expenses is summarized as
follows:
YEAR ENDED DECEMBER 31
2002 2001 2000
---------------------------------------------------------------------
Balance as of January 1 $ 634,130 $ 672,419 $ 590,950
Incurred related to:
Current period 3,993,607 3,792,241 3,445,559
Prior periods (46,225) (53,420) (19,142)
---------------------------------------------------------------------
Total incurred 3,947,382 3,738,821 3,426,417
---------------------------------------------------------------------
Paid related to:
Current period 3,493,244 3,257,090 2,863,345
Prior periods 525,044 520,020 481,603
---------------------------------------------------------------------
Total paid 4,018,288 3,777,110 3,344,948
---------------------------------------------------------------------
Balance at end of periods $ 563,224* $ 634,130 $ 672,419
=====================================================================
*Includes $3,300 of premium deficiency reserve in WCINJ recorded in group
and other contract liabilities.
The provision for claims and claim adjustment expenses attributable to prior
year incurrals had a favorable development of $46,225 in 2002, $53,420 in 2001,
and $19,142 in 2000 due to health care trends being lower than anticipated when
the reserves were established. Moreover, actual claim payment lags were shorter
than assumed in determining the reserves, due to continued improvement in the
claim adjudication process. Additionally, the development of the prior years'
claim liability impacts premiums for retrospectively rated contracts.
Accordingly, the Company's favorable (unfavorable) development of ($1,532),
$46,416 and ($13,919) in 2002, 2001, and 2000, respectively, on such contracts,
was largely offset by decreases (increases) in premiums.
F-22
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
7. INCOME TAXES
The significant components of the provision for income tax benefit (expense) are as follows:
YEAR ENDED DECEMBER 31
2002 2001 2000
---------------------------------------------------
Current tax expense $(83,526) $ (34,963) $ (12,362)
Deferred tax benefit 151,373 34,828 86,902
---------------------------------------------------
Income tax benefit (expense) $ 67,847 $ (135) $ 74,540
===================================================
A reconciliation of income tax computed at the federal statutory tax rate of 35%
to total income tax is as follows:
YEAR ENDED DECEMBER 31
2002 2001 2000
---------------------------------------------------------
Income tax at prevailing corporate tax rate
applied to pre-tax income $(108,049) $ (45,890) $ (40,544)
Increase (decrease):
Change in valuation allowance 195,698 1,147 71,860
IRC Sec. 833(b) special deduction - 54,249 36,427
State and local income taxes, net of
federal income tax benefit (5,077) (88) (88)
Other (14,725) (9,553) 6,885
---------------------------------------------------------
Income tax benefit (expense) $ 67,847 $ (135) $ 74,540
=========================================================
WellChoice and its subsidiaries file a consolidated federal income tax return.
WellChoice currently has a tax sharing agreement in place with all of its
subsidiaries. In accordance with the Company's tax sharing agreement, the
Company's subsidiaries pay federal income taxes to WellChoice based on a
separate company calculation.
F-23
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
7. INCOME TAXES (CONTINUED)
Prior to 2002, EHC maintained a valuation allowance on its regular tax net
operating loss carryforwards and certain other temporary differences due to
uncertainty in its ability to utilize these assets within an appropriate period.
The use of these assets was largely dependent on the conversion and future
positive taxable income. Because the approval of EHC's plan of conversion by the
New York State Insurance Department (the "Department"), removed the uncertainty
of the conversion, the Company concluded in the third quarter that the valuation
allowance related to these assets was no longer necessary. Accordingly, the
income tax benefit for 2002 includes the reversal of the valuation allowance of
$174,977 related to the Company's regular tax operating loss carryforwards.
Because EHC converted to a for-profit insurer in 2002, the Company adjusted its
deferred tax assets for temporary differences related to EHCA's liability for
state and local taxes which resulted in the recognition of a $5,374 deferred tax
benefit.
Prior to January 1, 1987, EHC was exempt from federal income taxes. With the
enactment of the Tax Reform Act of 1986, EHC, and all other Blue Cross and Blue
Shield plans, became subject to federal income tax. Among other provisions of
the Internal Revenue Code, these plans were granted a special deduction (the
"833(b) deduction") for regular tax calculation purposes. EHC's position with
regard to ordering is that the special deduction must be taken before any
regular tax loss carryforward deduction. This is consistent with recent Internal
Revenue Service ("IRS") rulings. The Company has followed this position and the
related deduction ordering methodology in all its federal income tax return
filings. As a result of the 833(b) deduction, EHC has incurred no regular tax
liability but in profitable years, has paid taxes at the alternative minimum tax
rate of 20%.
The 833(b) deduction is calculated as the excess of 25% of the incurred claim
and claim adjustment expenses for the tax year over adjusted surplus, as
defined, limited to taxable income. The amount of 833(b) deductions utilized in
each tax year is accumulated in an adjusted surplus balance. Once the cumulative
adjusted surplus balance exceeds the 833(b) deduction for the current taxable
year, the deduction is eliminated.
During the fourth quarter of 2002, the Company reevaluated its tax position for
financial statement purposes related to EHC's ability to utilize the Section
833(b) deduction and determined that when EHC converted to a for-profit entity,
its ability to utilize the
F-24
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
7. INCOME TAXES (CONTINUED)
Section 833(b) deduction was uncertain. No authority directly addresses whether
a conversion transaction will render the 833(b) deduction unavailable. The
Company is aware, however, that the IRS has taken the position related to other
Blue Cross Blue Shield plans that a conversion could result in the inability of
a Blue Cross Blue Shield plan to utilize the 833(b) deduction. In light of the
absence of governing authority, while the Company intends to continue to take
the deduction on its tax returns after the conversion, the Company will assume,
for financial statement reporting purposes, that the deduction will be
disallowed. Accordingly, the Company's income tax provision for 2002 assumes the
utilization of approximately $145,000 regular operating loss carryforwards for
financial reporting purposes in excess of those utilized for tax purposes.
Because the conversion occurred in the fourth quarter and the tax provisions for
the first three quarters had assumed the availability of the section 833(b)
deduction, the Company recorded additional tax expense of $50,744 in the fourth
quarter representing the utilization of regular operating loss carryforwards
rather than the 833(b) deduction.
F-25
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
7. INCOME TAXES (CONTINUED)
The Company's position with gross deferred tax assets and liabilities and the related
valuation allowance are as follows:
DECEMBER 31
2002 2001
---------------------------------------
Deferred tax assets:
Regular tax operating loss carryforwards $ 57,593 $ 174,977
Alternative minimum tax credit carryforward 134,064 68,010
Fixed assets 4,807 10,420
Loss reserve discounting 4,933 6,689
Post-retirement benefits other than pensions 50,308 48,372
Post-employment benefits 3,901 2,372
Bad debts 5,621 4,354
Deferred compensation 6,250 4,199
Unpaid expense accruals 10,858 11,054
Other temporary differences 21,366 11,218
---------------------------------------
Total deferred tax assets 299,701 341,665
Valuation allowance for deferred tax assets - (195,698)
---------------------------------------
Deferred tax assets, net of allowance 299,701 145,967
Deferred tax liabilities:
Unrealized gain on investments 12,339 11,521
Pension income adjustment 17,264 14,670
Bonds and bond discount 1,150 872
---------------------------------------
Total deferred tax liabilities 30,753 27,063
---------------------------------------
Net deferred tax assets $ 268,948 $ 118,904
=======================================
The Company's regular tax loss carryforwards for income tax purposes of $310,000
expire between the years 2003 and 2022. For financial reporting purposes, the
Company's regular net operating loss carryforwards are $165,000. The Company
fully utilized its remaining alternative minimum tax loss carryforward in 2000.
The Company's alternative minimum tax credit carryforward of $134,000 has no
expiration date.
F-26
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
7. INCOME TAXES (CONTINUED)
The Company completed a study of the intangible assets which existed at January
1, 1987 and has filed amended returns for 1989 and 1990 claiming a refund for
taxes paid. The Company is aware that the IRS and other Blue Cross Blue Shield
plans are currently in litigation to determine whether intangible assets that
existed at January 1, 1987 are entitled to tax basis and therefore are
deductible in future years' tax returns. If the Company prevails, these
potential future tax benefits of up to $100,000 will be available to the
Company. As of December 31, 2002 the Company has not recognized this potential
benefit in its financial statements.
The Company paid federal income taxes of $84,000, $13,349 and $14,195 in 2002,
2001 and 2000, respectively. Included in accounts payable and accrued expenses
are $917 and $18,863 of federal income taxes payable at December 31, 2002 and
December 31, 2001, respectively.
8. INFORMATION TECHNOLOGY OUTSOURCING
In June 2002, the Company entered into a ten-year outsourcing agreement with
International Business Machines Corporation ("IBM"). Under the terms of the
contract, IBM is responsible for operating the Company's data center, technical
help desk and applications development. IBM has entered into a separate
agreement to sublease the Company's data center. IBM's charges under the
contract include personnel, calculated as a function of IBM's cost for personnel
dedicated to the outsourcing; computer equipment, based on equipment usage
rates; space, based on actual usage rates; and certain other costs.
F-27
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
8. INFORMATION TECHNOLOGY OUTSOURCING (CONTINUED)
IBM is expected to invoice the Company approximately $681,000 over the remaining
term of the agreement for operating the Company's data center and technical help
desk as follows:
2003 $ 94,900
2004 84,900
2005 88,000
2006 74,800
2007 67,200
2008 65,200
2009 62,900
2010 60,400
2011 58,600
2012 24,100
---------------------
$ 681,000
=====================
The agreement provides for IBM to assist the Company in developing new IT
systems. In connection with these services, the Company is obligated to purchase
$60,823, in additional modernization services and equipment from IBM, with a
target purchase rate as follows:
2003 $31,423
2004 19,000
2005 7,200
2006 3,200
--------------------
Total $60,823
====================
The Company may defer the purchase of services beyond the target date, provided
that to the extent purchases are delayed more than one year beyond the target
year, the Company shall pay a premium to IBM of 10% per annum of the contract
price. At December 31, 2002 other liabilities include $11,143 of cash flow
concessions the Company has taken on monthly invoices from IBM. In accordance
with the terms of the IBM contract the Company is required to repay these
amounts in the future.
F-28
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
8. INFORMATION TECHNOLOGY OUTSOURCING (CONTINUED)
Additionally, IBM, in coordination with deNovis, Inc. ("deNovis"), has agreed to
develop a new claims payment software system and to license it to the Company.
Subject to the successful completion and acceptance of the claims payment
system, the Company will pay a development and license fee of $50,000. Under the
terms of the contract with IBM, the Company will pay $25,000 of this fee in four
equal installments upon the achievement of specified milestones, the last of
which is the Company's acceptance of the claims payment system. The achievement
of these milestones is anticipated to occur during 2004 and 2005. The remaining
$25,000 will be paid one year following the date the Company accepts the claims
payment system. Following the expiration of the one-year warranty period that
begins upon the payment of the final installment, the Company will pay IBM an
annual fee of $10,000 for maintenance and support services. Under the terms of
the contract, the Company is entitled to 2% of IBM's gross revenues from
licensing the claims payment system to third parties for the term of the IBM
outsourcing contract, including any extensions. The Company will have no
obligation to pay the development and license fee and the annual fee if the
successful completion and delivery of the claims payment system does not occur.
The Company will own all software developed by IBM under the agreement, other
than the claims payment system. All such software in which the Company will have
all rights, title and interest will be accounted for in accordance with SOP
98-1, "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use".
In connection with the agreement, the Company sold computer equipment with a net
book value of $1,736 to IBM. No gain or loss on the sale of the computer
equipment was recognized. Also in connection with the agreement, the Company
licensed to IBM its Internet portal technology for an upfront initial license
fee of $2,000. In accordance with SOP 98-1, the Company applied the proceeds
from the license of the Internet portal technology to the book value of the
assets and no gain or loss was recorded. Under the agreement, IBM has the right
to sublicense the Internet portal technology to third parties and the Company
will receive 4% of IBM's gross revenues from its licensing for fifteen years.
The Company received no licensing revenue in 2002.
F-29
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
8. INFORMATION TECHNOLOGY OUTSOURCING (CONTINUED)
The outsourcing agreement can be terminated by either the Company or IBM in
certain circumstances for cause without penalty. The Company can terminate the
contract without cause after two years or if it experiences a change in control
and, in such instances, would be obligated to pay certain termination costs,
which vary based on the duration of the contract but are significant in the
early years, to IBM.
During the second quarter of 2002, in connection with the IBM outsourcing, the
Company began the implementation of a restructuring plan relating to its
information technology personnel. Certain employees were involuntarily
terminated in accordance with a plan of termination, certain employees were
retained by the Company and certain employees were transitioned to IBM.
Severance and other costs accrued at June 30, 2002 relating to the plan of
termination were $5,351. Payments related to these costs of approximately $1,239
were made during the six months ended December 31, 2002. To help retain its
employees and to help IBM retain its newly transitioned employees, the Company
offered stay bonuses for these individuals. The estimated maximum cost of these
bonuses assuming all individuals remain with the Company or IBM through the
required dates, which range from 2003 to 2004, is approximately $8,518. At
December 31, 2002, approximately $3,716 was accrued for these bonuses. The
Company will recognize the cost of these stay bonuses in future periods as these
employees provide service.
9. RESTRUCTURING
In November 2002, as part of the Company's continuing focus on increasing
overall productivity, and in part as a result of the implementation of the
technology outsourcing strategy, the Company continued streamlining certain
operations and adopted a plan to terminate approximately 500 employees across
all segments of its business. Severance and other costs of $13,715 were accrued
relating to the plan. As of December 31, 2002, payments related to these costs
of $639 were made.
F-30
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
10. STATUTORY INFORMATION
Insurance companies, including HMOs are subject to certain Risk-Based Capital
("RBC") requirements as specified by the National Association of Insurance
Commissioners (the "NAIC"). Under those requirements, the amount of capital and
statutory-basis surplus maintained by an insurance company is to be determined
based on the various risk factors related to it. At December 31, 2002, EHCA and
each of its wholly-owned insurance subsidiaries met the RBC requirements.
EHCA and its subsidiaries are subject to minimum capital requirements under the
state insurance laws. Combined statutory-basis surplus of EHCA and its
subsidiaries at December 31, 2002 and 2001 of $819,756 and $610,779,
respectively, exceeded their respective requirements. Combined statutory-basis
net income of EHCA and its subsidiaries was $316,936, $114,462 and $73,971, for
the years ended December 31, 2002, 2001 and 2000, respectively.
In accordance with the rules of the Department, the maximum amount of dividends
which can be paid by the Company's subsidiaries without approval of the
Department is subject to restrictions relating to statutory surplus and adjusted
net income or adjusted net investment income.
On November 7, 2002, the Department approved the payment of a dividend to
WellChoice from its subsidiary, EHCA, in the amount of $225,000, which was paid
on November 8, 2002. No dividends were received or paid during the years ended
December 31, 2001 and 2000.
EHCA made cash contributions to its HMO and insurance subsidiaries of
approximately $65,000, $10,000, and $1,000 during 2002, 2001, and 2000,
respectively. The capital contributions were made to ensure that each subsidiary
had sufficient surplus under applicable BCBSA and state licensing requirements.
11. CONTINGENCIES
The Company is subject to a number of lawsuits, investigations and claims, some
of which are class actions arising out of the conduct of its business. The
Company believes that it has meritorious defenses in all of these matters and
intends to vigorously defend its respective positions. The outcome of these
matters is not currently predictable and the damages, if any, are also
uncertain. The Company is also involved in and is subject to
F-31
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
11. CONTINGENCIES (CONTINUED)
numerous claims, contractual disputes and uncertainties in the ordinary course
of business. In the opinion of management, after consultation with legal
counsel, the ultimate disposition of these matters will not have a material
adverse effect on the Company's consolidated financial condition or results of
operations.
In June 2002, the Company settled a class action lawsuit for an estimated
$23,000 in claims and legal fees. During the period from June 2002 to September
2002, the members of the class were informed of their right to receive payment,
were required to respond, and the payments due to respondents were determined.
Based on the number of respondents to the class action mailing through August
24, 2002 and the Company's estimate of the number of late respondents to the
mailing, the Company has revised its best estimate of the ultimate liability for
this action to $14,600. This change in estimate has been recorded in the
consolidated financial statements for year ended December 31, 2002.
The Company entered into a credit and guaranty agreement, effective as of
November 7, 2002, with The Bank of New York, as Issuing Bank and Administrative
Agent, and several other financial institutions as agents and lenders, which
will provide the Company with a credit facility. The Company is able to borrow
under the credit facility for general working capital purposes. The total
outstanding amounts under the credit facility cannot exceed $100,000. The
facility has a term of 364 days, subject to extension for additional periods of
364 days with the consent of the lenders. Borrowings under the facility will
bear interest, at the Company's option, at The Bank of New York's prime
commercial rate (or, if greater, the federal funds rate plus 0.50%) as in effect
from time to time plus a margin of between zero and 1.0%, or LIBOR plus a margin
of between 1.125% and 2.250%, with the applicable margin to be determined based
on the Company's financial strength rating. As of December 31, 2002, there are
no funds drawn against this credit facility.
The Company also maintains a $607 secured letter of credit from HSBC Bank USA to
support its rental lease obligation with Digitas LLC.
F-32
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
12. COMMITMENTS
The Company leases office facilities and equipment under capital and operating
lease arrangements. Future minimum payments for capital leases and noncancelable
operating leases, including escalation clauses, as of December 31, 2002 are as
follows:
CAPITAL LEASES OPERATING LEASES
--------------------- -----------------
2003 $ 11,094 $ 49,881
2004 11,378 43,812
2005 11,663 39,903
2006 11,950 33,475
2007 12,240 31,116
Future years 36,069 357,558
--------------------- ---------------
Net minimum lease payment
94,394 $ 555,745
==================
Less:
Interest 31,590
Maintenance, taxes, etc. 15,104
------------------
Present value of minimum lease payments $ 47,700
==================
The average imputed interest rate on the capital leases was 14% in 2002. Rent
expense under operating leases was $54,082, $50,540 and $48,340 for the years
ended December 31, 2002, 2001 and 2000, respectively.
The schedule above includes rent commitments for the Company's Staten Island
facility. However, as part of the information technology outsourcing agreement
with IBM (see footnote 8), the Company entered into a sublease agreement with
IBM for this property. The Company expects to receive net sublease income of
approximately $1,000 per year for the next ten years.
F-33
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
13. RELATED PARTY TRANSACTIONS
Administrative expenses incurred related to NASCO services totaled $14,673,
$13,281 and $11,988 for the years ended December 31, 2002, 2001 and 2000,
respectively. Accounts payable for the year ended December 31, 2002 and 2001,
includes amounts due to NASCO of $3,515 and $2,634, respectively.
Active Health Management, Inc., ("AHM") an entity in which the Company has a
0.8% ownership interest, provides certain medical management services to the
Company. Administrative expenses incurred related to AHM services totaled
$5,882, $4,869 and $3,624 for the years ended December 31, 2002, 2001 and 2000,
respectively. Accounts payable for the year ended December 31, 2002 and 2001,
includes amounts due to AHM of $0 and $340, respectively.
A member of the Company's board of directors is an Executive Vice President of
a labor union account. For the years ended December 31, 2002, 2001 and 2000, the
Company earned premium revenue $18,030, $16,245, $13,250, respectively from the
union. Billed premiums receivable at December 31, 2002 and 2001 includes amounts
due from the union of $1,655 and $1,618, respectively. In addition, the Company
recorded administrative service fees revenue of $2,918, $2,834 and $2,111 for
the years ended December 31, 2002, 2001, and 2000. Other amounts due from
customers at December 31, 2002 and 2001 includes $1,074 and $1,372 for service
fees due from the union.
A member of the Company's board of directors is an Executive Vice President and
Chief Operating Officer of a provider in our network. For the years ended
December 31, 2002, 2001 and 2000, the Company made payments to the provider in
the amount of $97,936, $72,308 and $69,239 respectively for the reimbursement of
claims to this provider.
A member of the Company's board of directors is a physician in a group practice,
which is a provider in our network. For the years ended December 31, 2002, 2001
and 2000, the Company made payments in the amount of $1,180, $1,230 and $1,359,
respectively to this group practice for the reimbursement of claims.
F-34
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
13. RELATED PARTY TRANSACTIONS (CONTINUED)
A member of the Company's board of directors served as Chairman of the Board of
a provider in our network during 2000. For the year ended December 31, 2000 the
Company made payments to this provider in the amount of $90,700 for the
reimbursement of claims.
14. INSURANCE PROCEEDS
In December 2002, the Company and its insurance carrier settled the Company's
business property protection and blanket earnings and extra expense claim
related to loss of the Company's offices located at the World Trade Center for
$74,000. During 2002 and 2001, the Company recorded gains related to the
business property portion of the claim of $7,959 and $6,784, respectively, which
are included in other income. Administrative expense for the year ended December
31, 2002 includes a gain of $19,300 representing extra expense settlement
proceeds for items expensed in 2001 and extra expenses that have not yet been
incurred. Administrative expense for the year ended December 31, 2001 includes
expenses of $3,535 related to the Company's recovery efforts.
15. PENSION BENEFITS
The Company had several noncontributory, defined benefit pension plans covering
substantially all of its employees. In May 1998, the Company's Board of
Directors approved a consolidation of the Company's defined benefit pension
plans into one "cash balance" defined benefit plan (the "Cash Balance Plan").
The redesigned plan, effective January 1, 1999, provides employees with an
opening balance based on the previous benefits attributed to the employee under
prior plans with increases through contributions by the Company based on the
employee's age and length of service. The benefit provided at retirement is the
sum of all contributions and interest earned.
Prior to the redesign, the Company's pension benefits were provided through
three plans. Although the manner in which these plans were funded differed, the
benefits relating to each were similar.
F-35
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
15. PENSION BENEFITS (CONTINUED)
As part of the consolidation of the plans, the Cash Balance Plan assumed the
assets and benefit obligations of the previous plans, some of which were
previously retained by an insurer under an annuity purchase contract. As a
result of the consolidation of the plans, the Company is amortizing the amount
of the plan assets in excess of the benefit obligation assumed from the insurer,
$116,865 over the average remaining service life of plan participants (10.5
years).
The effect of the change in pension benefits reduced the benefit obligation by
$20,606 which will be amortized over the remaining service life of the Cash
Balance Plan members (13 years).
The Company also has an unfunded, nonqualified supplemental plan to provide
benefits in excess of ERISA limitations on recognized salary or benefits payable
from the qualified pension plans and the Company's Deferred Compensation Plan
and Executive Savings Plan. This supplemental plan is accounted for using the
projected unit credit actuarial cost method.
The following table sets forth the plans' change in the actuarially determined
benefit obligation, plan assets and information on the plan's funded status.
December 31
2002 2001
--------------------- ----------------------
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of period $ 368,042 $ 319,622
Service cost 15,977 14,443
Interest cost 26,144 23,783
Plan amendments 11 3,276
Actuarial loss 33,563 27,165
Benefits paid (43,469) (20,247)
--------------------- ----------------------
Benefit obligation at end of period 400,268 368,042
--------------------- ----------------------
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of period 467,523 417,352
Actual (loss) return on plan assets (10,523) 69,914
Employer contributions 182 504
Benefits paid (43,469) (20,247)
--------------------- ----------------------
Fair value of plan assets at end of period 413,713 467,523
F-36
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
15. PENSION BENEFITS (CONTINUED)
December 31
2002 2001
--------------------- ----------------------
INFORMATION ON FUNDED STATUS AND AMOUNTS RECOGNIZED
Funded status $ 13,445 $ 99,481
Unrecognized net transition asset (715) (905)
Unrecognized prior service credits (70,951) (83,646)
Unrecognized net loss from past experience different from that assumed 103,430 24,323
--------------------- ----------------------
Prepaid benefit cost $ 45,209 $ 39,253
===================== ======================
Actuarial assumptions used were as follows:
DECEMBER 31
2002 2001
------------------ -------------------
Discount rate 7.0% 7.5%
Rate of increase in future compensation levels 4.0% 4.0%
Expected long-term rate of return 8.0% 8.0%
Net pension income for the actuarially developed plans included the following
components:
YEAR ENDED DECEMBER 31
2002 2001 2000
----------------------------------------------------
Service cost $ 15,977 $ 14,443 $ 13,709
Interest cost on projected benefit obligation 26,144 23,783 22,195
Expected return on plan assets (36,054) (33,984) (33,616)
Net amortization and deferral (12,070) (12,894) (13,059)
----------------------------------------------------
Net pension income $ (6,003) $ (8,652) $ (10,771)
====================================================
F-37
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
15. PENSION BENEFITS (CONTINUED)
The Company administers two noncontributory defined contribution plans offering
employees the opportunity to accumulate funds for their retirement. The Deferred
Compensation Plan, which is closed to new contributions, and the Executive
Savings Plan are nonqualified plans designed to provide executives with an
opportunity to defer a portion of their base salary and/or incentive
compensation.
The Company also administers a contributory 401(k) Deferred Savings Plan which
is offered to all eligible employees. The Company matches contributions of
participating employees; 50% of the first 6% of employee contributions or
$5,921, $5,880 and $5,678 for the years ended December 31, 2002, 2001 and 2000,
respectively.
16. OTHER POSTRETIREMENT EMPLOYEE BENEFITS
In addition to pension benefits, the Company provides certain health care and
life insurance benefits for retired employees. Substantially all employees may
become eligible for those benefits if they reach retirement age while working
for the Company.
The change in benefit obligation, plan assets and information on the plans'
funded status and the components of the net periodic benefit cost are as
follows:
December 31
2002 2001
---------------------- ----------------------
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of period $ 124,481 $ 96,121
Service cost 1,500 1,639
Interest cost 7,686 8,434
Actuarial (gain) loss (7,154) 25,858
Benefits paid (5,787) (7,571)
---------------------- ----------------------
Benefit obligation at end of period 120,726 124,481
---------------------- ----------------------
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of period - -
Employer contributions 5,787 7,571
Benefits paid (5,787) (7,571)
---------------------- ----------------------
Fair value of plan assets at end of period - -
---------------------- ----------------------
F-38
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
16. OTHER POSTRETIREMENT EMPLOYEE BENEFITS (CONTINUED)
December 31
2002 2001
---------------------- ----------------------
INFORMATION ON FUNDED STATUS AND AMOUNTS RECOGNIZED
Funded status (120,726) (124,481)
Unrecognized net actuarial gain (66,027) (61,043)
Unrecognized transition obligation 43,017 47,318
---------------------- ----------------------
Accrued postretirement benefit cost $ (143,736) $ (138,206)
====================== ======================
December 31
2002 2001 2000
------------------- ------------------- ------------
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost $ 1,500 $ 1,639 $ 1,516
Interest cost 7,686 8,434 6,845
Amortization of transition obligation 4,301 4,302 4,302
Amortization of actuarial gain (4,699) (4,738) (5,923)
------------------- ------------------- ------------
Net periodic postretirement benefit cost $ 8,788 $ 9,637 $ 6,740
=================== =================== ============
Actuarial gains or losses for postretirement life and health benefits are
recorded separately when they exceed 10% of their respective accumulated
postretirement benefit obligations and, at that time, the entire amount of the
gain is amortized over the period in which eligibility requirements are
fulfilled (20 years).
F-39
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
16. OTHER POSTRETIREMENT EMPLOYEE BENEFITS (CONTINUED)
The actuarial assumptions used for determining the accumulated postretirement
benefit obligation as measured on December 31, 2002 and 2001 are as follows:
DECEMBER 31
2002 2001
------------------------ ----------------------
Weighted-average discount rate 7.0% 7.5%
Health care trend rates:
Participants under age 65 in EPO and PPO Plans 11.0%-4.5% 10.0%-4.5%
Participants under age 65 in other plans 11.0%-4.5% 10.0%-4.5%
Participants age 65 and over in Medicare HMOs 21.9%-4.5% 55.1%-4.5%
Participants age 65 and over in Indemnity Plans 10.0%-4.5% 13.0%-4.5%
Caps on Company paid portion of health care premiums for
participants who retire on or after May 1, 1996 (in whole
dollars):
Participants age 65 and older with Medicare Carve-out Plans $2,358 $2,358
Participants under age 65 with POS--Point of Service Plans $4,926 $4,926
The trend rate ranges shown indicate the trend rates will decrease 1.0%
annually, other than the Medicare HMO and the Indemnity Plan, until ultimately
leveling out at 4.5%. The annual trend rate for the Medicare HMO is 21.9%, 9.0%,
and 8.0% for the next three years and then decreases 1% annually until
ultimately leveling out at 4.5%. The annual trend rate for the Indemnity Plan is
10.0% and 9.0% for the next two years and then decreases 1.0% annually until
ultimately leveling out at 4.5%.
The health care cost trend rate assumptions have a significant effect on the
amounts reported. Increasing and decreasing the assumed health care cost trend
rates by one percentage point in each year would increase and decrease the
postretirement benefit obligation as of December 31, 2002 by $12,899 and $7,676,
respectively, and increase and decrease the service and interest cost components
of net periodic postretirement benefit cost for December 31, 2002 by $1,060 and
$556, respectively.
F-40
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
17. CONCENTRATION OF BUSINESS
The Company's business is concentrated in New York and New Jersey, with more
than 98% of its premium revenue received from New York business. As a result,
future acts of terrorism, changes in regulatory, market or healthcare provider
conditions in either of these states, particularly New York, could have a
material adverse effect on the Company's business, financial condition or
results of operations.
The Company earns revenue from its contracts with the Center for Medicare and
Medicaid Services (CMS), the federal agency that administers the Medicare
program. Specifically, the Company has a contract with CMS to provide HMO
Medicare+Choice coverage to Medicare beneficiaries in certain New York counties
and the Company has a contract to serve as fiscal intermediary for the Medicare
Part A program and a carrier for the Medicare Part B program (collectively,
referred to as "Medicare Services"). The Company's Medicare+Choice product and
Medicare Services represented 10% and 32% of total premium earned and
administrative service fee revenue, respectively, during 2002.
The Company's earns revenue from its contracts to provide healthcare services to
New York State and New York City employees. The New York State and New York City
account represented 17% and 13% of total premium earned, respectively, during
2002.
18. SEGMENT INFORMATION
Empire has two reportable segments: commercial managed care and other insurance
products and services. The commercial managed care segment includes group PPO,
HMO (including Medicare+Choice), EPO and other products as well as the Company's
New York City and New York State PPO business. The other insurance products and
services segment consists of the Company's traditional indemnity products,
Medicare supplemental, individual hospital only, state sponsored individual
plans, government mandated individual plans and government contracts with CMS to
act as a fiscal intermediary for Medicare Part A program beneficiaries and as a
carrier for Medicare Part B program beneficiaries.
F-41
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
18. SEGMENT INFORMATION (CONTINUED)
The reportable segments follow the Company's method of internal reporting by
products and services. The financial results of the Company's segment are
presented consistent with the accounting policies described in Note 2.
Administrative expenses, investment income, and other income, but not assets,
are allocated to the segments. There are no intersegment sales or expenses.
The following table presents information by reportable segment:
OTHER INSURANCE
COMMERCIAL PRODUCTS AND
MANAGED CARE SERVICES TOTAL
----------------- ------------------ -----------------
YEAR ENDED DECEMBER 31, 2002
Revenues from external customers $ 3,935,234 $ 1,089,004 $ 5,024,238
Investment income and net realized gains 54,047 13,363 67,410
Other revenue 11,272 2,740 14,012
Income from continuing operations before income tax expense 253,424 56,344 309,768
YEAR ENDED DECEMBER 31, 2001
Revenues from external customers $ 3,401,900 $ 1,166,252 $ 4,568,152
Investment income and net realized gains 41,704 15,249 56,953
Other revenue 4,667 1,434 6,101
Income from continuing operations before income tax expense 121,113 26,452 147,565
YEAR ENDED DECEMBER 31, 2000
Revenues from external customers 2,885,870 1,255,984 4,141,854
Investment income and net realized gains 59,861 27,671 87,532
Other revenue 3,089 1,209 4,298
Income from continuing operations before income tax expense 95,066 25,421 120,487
F-42
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
18. SEGMENT INFORMATION (CONTINUED)
The following table presents our revenue from external customers by products and
services:
YEAR ENDED DECEMBER 31
2002 2001 2000
--------------------- ----------------- ------------------
Revenues from external customers:
Commercial managed care:
Premiums earned:
PPO $ 2,349,911 $2,016,580 $1,908,591
HMO 1,133,637 948,865 664,463
EPO 234,112 250,651 179,468
Other 5,343 31,719 33,709
Administrative service fees 212,231 154,085 99,639
--------------------- ----------------- ------------------
Total commercial managed care 3,935,234 3,401,900 2,885,870
--------------------- ----------------- ------------------
Other insurance products and services
Premiums earned:
Indemnity 397,175 489,947 584,848
Individual 507,857 508,406 505,848
Administrative service fees 183,972 167,899 165,288
--------------------- ----------------- ------------------
Total other insurance products and services 1,089,004 1,166,252 1,255,984
--------------------- ----------------- ------------------
Total revenues from external customers $ 5,024,238 $4,568,152 $4,141,854
===================== ================= ==================
F-43
WELLCHOICE, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Dollars in thousands except per share data)
19. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following unaudited quarterly financial data are presented on a consolidated
basis for each of the years ended December 31, 2002 and 2001.
QUARTER ENDED
--------------------------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
----------------- ------------------ --------------------- ---------------
2002 DATA
Total revenues $1,280,100 $1,321,642 $1,221,204 $1,282,714
Income from continuing operations before income tax
expense 79,704 60,092 87,224 82,748
Income (loss) from continuing operations 79,681 60,095 254,409 (16,570)
Loss from discontinued operations (1,050) (6) - -
Net income (loss) 78,631 60,089 254,409 (16,570)
Net loss for the period from
November 7, 2002 (date of initial public offering)
to December 31,2002 $(38,542)
Basic and diluted net loss per common share for the
period from November 7, (date of initial public
offering) to December 31, 2002 $(0.46) Shares used to compute earnings per
share, based on
weighted average shares outstanding November 7, 2002
(date of conversion and initial public offering) to
December 31, 2002 83,333,244
2001 DATA
Total revenues 1,123,194 1,233,845 1,141,624 1,132,543
Income from continuing operations before income tax
expense 39,631 29,902 36,630 41,402
Income from continuing operations 39,586 29,899 36,540 41,405
Loss from discontinued operations (4,485) (2,526) (5,552) (3,889)
Net income 35,101 27,373 30,988 37,516
For the quarter ended September 30, 2002, income from continuing operations
includes a deferred tax benefit of $167,185 primarily resulting from the
reversal of the valuation allowance for deferred tax assets. For the quarter
ended December 31, 2002, loss from continuing operations includes income tax
expense of $99,318 primarily resulting from the elimination of the section
833(b) deduction that had previously been assumed during the first three
quarters of 2002. Refer to footnote 7.
F-44
SUPPLEMENTAL SCHEDULES
F-45
WELLCHOICE, INC. AND SUBSIDIARIES
SCHEDULE I
SUMMARY OF INVESTMENTS-OTHER THAN INVESTMENTS IN RELATED PARTIES
(DOLLARS IN THOUSANDS)
AMOUNT AT
WHICH SHOWN IN THE
TYPE OF INVESTMENT COST VALUE BALANCE SHEET
------------------ ---- ----- -------------
INVESTMENT AT DECEMBER 31,2002
Fixed maturities:
Bonds:
United States Government and
government authorities.............................. $ 439,256 $ 444,364 $ 444,364
Public Utilities...................................... 20,000 20,364 20,364
All other corporate bonds............................. 386,753 397,954 397,954
Certificates of Deposit.................................. 608 608 608
-------- -------- --------
Total fixed maturities.............................. 846,617 863,290 863,290
Equity securities:
Common stocks
Industrial, miscellaneous and all other .............. 31,966 29,242 29,242
Nonredeemable preferred stocks........................... 15,056 15,306 15,306
-------- -------- --------
Total equity securities............................. 47,022 $ 44,548 44,548
-------- ======== ========
Other long- term investments................................ 28,220 Xxx 28,220
Short-term investments...................................... 359,371 Xxx 359,490
-------
Total investments................................... $ 1,281,230 Xxx $ 1,295,548
========= =========
F-46
WELLCHOICE, INC. AND SUBSIDIARIES
SCHEDULE II CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEET
December 31, 2002
-----------------
(In thousands)
ASSETS
Investments:
Fixed maturities, at fair value (amortized cost: $31,902).................................. $ 31,904
Marketable equity securities, at fair value (cost: $47,022)................................ 44,548
Short-term investments..................................................................... 62,465
Other long-term equity investments......................................................... 16,357
--------
Total investments............................................................................. 155,274
Cash and cash equivalents..................................................................... 108,862
--------
Total investments and cash and cash equivalents............................................... 264,136
Receivables:
Other amounts due from customers, net...................................................... 2,336
Miscellaneous, net......................................................................... 3,773
Total receivables............................................................................. 6,109
Investment in subsidiaries.................................................................... 1,007,330
Property, equipment and information systems, net of accumulated
depreciation............................................................................... 100,788
Prepaid pension expense....................................................................... 45,209
Deferred taxes, net........................................................................... 96,533
Other......................................................................................... 16,903
--------
Total assets.................................................................................. $ 1,537,008
==========
F-47
WELLCHOICE, INC. AND SUBSIDIARIES
SCHEDULE II CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEET
December 31, 2002
-----------------
(In thousands, except share and
per share data)
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts payable and accrued expenses..................................................... $ 110,636
Capital lease obligations................................................................. 47,700
Other..................................................................................... 142,410
-----------
Total liabilities............................................................................ 300,746
Stockholders' equity:
Class A common stock, $0.01 per share value, 225,000,000 shares authorized;
83,490,477 shares
issued and outstanding................................................................. 835
Class B common stock, $0.01 per share value, one share authorized; one share issued and
outstanding............................................................................ -
Preferred stock, $0.01 per share value, 25,000,000 shares authorized; none issued and outstanding -
Additional paid-in capital................................................................ 1,255,566
Retained deficit.......................................................................... (38,542)
Accumulated other comprehensive income.................................................... 18,403
-----------
Total stockholders' equity................................................................... 1,236,262
-----------
Total liabilities and stockholders' equity................................................... $ 1,537,008
===========
F-48
WELLCHOICE, INC. AND SUBSIDIARIES
SCHEDULE II CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENT OF OPERATIONS
FOR THE PERIOD FROM NOVEMBER
7, 2002
(DATE OF FOR PROFIT
CONVERSION AND INITIAL PUBLIC
OFFERING) TO DECEMBER 31, 2002
------------------------------
(In thousands)
Equity in net loss of subsidiaries................................................................. $ (40,331)
Other income....................................................................................... 1,268
-----------
Loss from continuing operations before
income taxes ................................................................................... (39,063)
Income tax benefit................................................................................. 521
-----------
Net loss........................................................................................... $ (38,542)
===========
F-49
WELLCHOICE, INC. AND SUBSIDIARIES
SCHEDULE II CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENT OF CASH FLOWS
FOR THE PERIOD FROM NOVEMBER
7, 2002
(DATE OF FOR PROFIT
CONVERSION AND INITIAL PUBLIC
OFFERING) TO DECEMBER 31, 2002
------------------------------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss............................................................................................ $ (38,542)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization................................................................. 6,084
Equity in earnings of wholly-owned unconsolidated subsidiaries................................ 40,214
Deferred income tax benefit................................................................... (521)
Dividends received from Empire HealthChoice Assurance, Inc.................................... 91,038
Other......................................................................................... (1,167)
Changes in assets and liabilities:
Other amounts due from customers............................................................ (2,340)
Miscellaneous receivables................................................................... 3,353
Other assets................................................................................ (2,471)
Accounts payable and accrued expenses....................................................... 25,203
Other liabilities........................................................................... (91,821)
------------
Net cash provided by operating activities........................................................... 29,030
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, equipment and information systems............................................ (4,124)
Transfer of assets and liabilities from subsidiaries after for profit conversion.................... 50,519
Purchases of available for sale investments......................................................... 3,825
Proceeds from sales and maturities of available for sale investments................................ 1,977
------------
Net cash provided by investing activities........................................................... 52,197
CASH FLOWS FROM FINANCING ACTIVITIES
Decrease in capital lease obligations............................................................... (355)
Net proceed from common stock issued in the initial public offering................................. 27,990
------------
Net cash provided by financing activities........................................................... 27,635
------------
Change in cash and cash equivalents................................................................. 108,862
Cash and cash equivalents at beginning of period.................................................... -
-----------
Cash and cash equivalents at end of period.......................................................... $ 108,862
============
SUPPLEMENTAL DISCLOSURE
Dividend from Empire HealthChoice Assurance, Inc.
(a wholly-owned subsidiary):
Cash and cash equivalents..................................................................... $ 91,038
Investments................................................................................... 133,962
------------
Total dividend form Empire HealthChoice Assurance, Inc ............................................. $ 225,000
============
F-50
WELLCHOICE, INC. AND SUBSIDIARIES
SCHEDULE III
SUPPLEMENTARY INSURANCE INFORMATION
(Dollars in thousands)
UNPAID
CLAIMS
AND CLAIMS UNEARNED
EXPENSES PREMIUMS
-------- --------
SEGMENT
December 31,2002
Commercial managed care....................... $ 451,838 $ 67,709
Other insurance products and services......... 108,086 59,794
----------- -----------
Total.................................. $ 559,924 $ 127,503
=========== ===========
December 31,2001
Commercial managed care....................... $ 457,755 $ 64,046
Other insurance products and services......... 176,375 56,136
----------- ------------
Total.................................. $ 634,130 $ 120,182
=========== ============
NET COST OF OTHER
PREMIUMS INVESTMENT BENEFITS OPERATING PREMIUM
AND FEES INCOME PROVIDED EXPENSES WRITTEN
-------- ------ -------- -------- -------
SEGMENT
Year ended December 31,2002
Commercial Managed Care................... $ 3,935,234 $ 54,047 $ 3,201,752 $ 545,377 $ 3,726,666
Other insurance products and services..... 1,089,004 13,363 745,630 303,133 908,690
-------------- -------------- -------------- -------------- --------------
Total.............................. $ 5,024,238 $ 67,410 $ 3,947,382 $ 848,510 $ 4,635,356
Year ended December 31,2001
Commercial Managed Care................... $ 3,401,900 $ 41,704 $ 2,877,902 $ 449,256 $ 3,267,616
Other insurance products and services..... 1,166,252 15,249 860,919 295,564 992,993
-------------- -------------- -------------- -------------- --------------
Total.............................. $ 4,568,152 $ 56,953 $ 3,738,821 $ 744,820 $ 4,260,609
============== ============== ============== ============== ===============
Year ended December 31,2000
Commercial Managed Care....................$ 2,885,870 $ 59,861 $ 2,483,541 $ 370,212 $ 2,789,822
Other insurance products and services...... 1,255,984 27,671 942,876 316,568 1,090,678
-------------- -------------- -------------- -------------- --------------
Total...............................$ 4,141,854 $ 87,532 $ 3,426,417 $ 686,780 $ 3,880,500
============== ============== ============== ============== ===============
F-51
WELLCHOICE, INC. AND SUBSIDIARIES
SCHEDULE V
VALUATION AND QUALIFYING ACCOUNTS
(DOLLARS IN THOUSANDS)
CHARGED CHARGED
BALANCE AT (CREDITED) TO (CREDITED) OTHER BALANCE
BEGINNING OF COSTS AND TO OTHER (DEDUCTIONS) END
PERIOD EXPENSES ACCOUNTS RECOVERIES OF PERIOD
------ -------- -------- ---------- ---------
YEAR ENDED DECEMBER 31,2002
Allowance for doubtful accounts.................. $ 12,440 $ 773 $ - $ 511 $ 13,724
Deferred tax assets valuation
Allowance..................................... 195,698 (195,698) - - -
YEAR ENDED DECEMBER 31,2001
Allowance for doubtful accounts.................. $ 14,142 $ 1,542 $ - $ (3,244) $ 12,440
Deferred tax assets valuation
Allowance..................................... 196,845 (1,147) - - 195,698
YEAR ENDED DECEMBER 31,2000
Allowance for doubtful accounts.................. $ 19,190 $ 1,400 $ - $ (6,448) $ 14,142
Deferred tax assets valuation
Allowance..................................... 265,549 (68,704) - - 196,845
F-52
INDEX TO EXHIBITS
NUMBER DESCRIPTION
------ -----------
2.1 New York State Superintendent of Insurance's Opinion and
Decision approving Plan Of Conversion, dated October 8, 2002
(1)
2.2. Form of Transfer and Exchange Agreement between the Fund and
WellChoice, Inc. (1)
2.3 Form of Transfer and Exchange Agreement between the
Foundation and WellChoice, Inc. (1)
2.4 Transfer Agreement between WellChoice, Inc. as
transferee, and Empire HealthChoice, Inc., as transferor (1)
3.1 Amended and Restated Certificate of Incorporation of
WellChoice, Inc. (2)
3.2 Amended and Restated Bylaws of WellChoice, Inc., as amended
as of December 18, 2002 (2)
4.1 Specimen Common Stock certificate (1)
4.2 Registration Rights Agreement dated as of November 7, 2002,
by and among WellChoice, Inc., The New York Public Asset
Fund and The New York Charitable Asset Foundation (2)
9.1 Voting Trust and Divestiture Agreement dated as of November
7, 2002, by and among WellChoice Inc., The New York Public
Asset Fund and The Bank of New York, as trustee (2)
10.1* Empire HealthChoice, Inc. Annual Executive Incentive
Compensation Plan -- 2000 Plan Description (1)
10.2* Empire HealthChoice, Inc. Annual Executive Incentive
Compensation Plan -- 2001 Plan Description (1)
10.3* Empire HealthChoice, Inc. Annual Executive Incentive
Compensation Plan -- 2002 Plan Description (1)
10.4* Empire HealthChoice, Inc. Executive Savings Plan, as Amended
and Restated effective January 1, 1999 (1)
10.5* Empire HealthChoice, Inc., 1998-2000 Long-Term Incentive
Compensation Plan (1)
10.6* Empire HealthChoice, Inc., 1999-2001 Long-Term Incentive
Compensation Plan (1)
10.7* Empire HealthChoice, Inc., 2000-2002 Long-Term Incentive
Compensation Plan (1)
10.8* WellChoice, Inc. Long-Term Incentive Compensation Plan (1)
10.9* Letter Agreement, dated July 21, 2000, between Empire
HealthChoice, Inc. and Kenneth Klepper
10.10 Form of Blue Cross License Agreement (1)
10.11 Form of Blue Shield License Agreement (1)
10.12 (+ Master Services Agreement, dated June 1, 2002, between
Empire HealthChoice, Inc. and International Business
Machines Corporation (1)
10.13 Software License and Support Agreement, dated June 1, 2002,
between Empire HealthChoice, Inc. and International Business
Machines Corporation (1)
10.14 Agreement of Lease, dated January 17, 2002, between Forest
City Myrtle Associates, LLC as Landlord and Empire
HealthChoice, Inc. d/b/a/ Blue Cross Blue Shield as Tenant
(1)
10.15 Credit and Guaranty Agreement, dated as of October 17, 2002
(1)
E-1
10.16 Form of Empire Blue Cross Blue Shield License Addendum to
Blue Cross and Blue Shield License Agreements (1)
10.17 Form of Amendment No. 1 to Credit and Guaranty Agreement (1)
10.18* Change in Control Retention Agreement, dated December 18,
2002, between WellChoice, Inc. and Michael A. Stocker, M.D.
(3)
10.19* Change in Control Retention Agreement dated December 23,
2002, between WellChoice, Inc. and Kenneth O. Klepper (3)
10.20* Change in Control Retention Agreement, dated December 23,
2002, between WellChoice, Inc. and John Remshard (3)
10.21* Change in Control Retention Agreement, dated December 23,
2002, between WellChoice, Inc. and Gloria M. McCarthy (3)
10.22* WellChoice, Inc. Annual Executive Incentive Compensation
Plan - 2003 Plan Description.+
10.23* Separation Agreement and General Release, dated January 3,
2003, between WellChoice, Inc. and David B. Snow, Jr.+
21 Subsidiaries of the Registrant.+
24 Power of Attorney+
99.1 Certification of CEO Pursuant to Section 906 of
Sarbanes-Oxley Act of 2002+
99.2 Certification of CFO Pursuant to Section 906 of
Sarbanes-Oxley Act of 2002+
___________
+ Filed herewith.
( + ) Omits information for which confidential treatment has been
granted.
* Management contracts, compensatory plans or arrangements.
(1) Previously filed as the same numbered exhibit to the
Registrant's Registration Statement on Form S-1 (File No.
333-99051) and incorporated herein by reference thereto.
(2) Previously filed as the same numbered exhibit to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 2002 and incorporated herein by
reference thereto.
(3) Previously filed as the same numbered exhibit to the
Registrant's Current Report on Form 8-K filed January 21,
2003 and incorporated herein by reference thereto.
E-2