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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBER 001-13803
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WELLPOINT HEALTH NETWORKS INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 95-4635504
(State of incorporation) (I.R.S. Employer Identification No.)
1 WELLPOINT WAY 91362
THOUSAND OAKS, CA (Zip Code)
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (818) 703-4000
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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Common Stock, $0.01 par value New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
None
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Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment to this
Form 10-K. / /
State the aggregate market value of the voting stock held by non-affiliates
of the Registrant as of March 15, 2000: $3,865,930,171 (based on the last
reported sale price of $62 13/16 per share on March 17, 2000, on the New York
Stock Exchange).
Common Stock, $0.01 par value of Registrant outstanding as of March 17,
2000: 61,911,003 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Annual Report on Form 10-K incorporates by reference
information from the Registrant's definitive proxy statement for its 2000 Annual
Meeting of Stockholders.
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WELLPOINT HEALTH NETWORKS INC.
FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 26
Item 3. Legal Proceedings........................................... 26
Item 4. Submission of Matters to a Vote of Security Holders......... 26
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters....................................... 27
Item 6. Selected Financial Data..................................... 28
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 29
Item 7a. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 44
Item 8. Financial Statements and Supplementary Data................. 47
Item 9. Changes and Disagreements with Accountants on Accounting and
Financial Disclosure...................................... 47
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 48
Item 11. Executive Compensation...................................... 48
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 48
Item 13. Certain Relationships and Related Transactions.............. 48
PART IV
Item 14. Exhibits, Financial Statements Schedules and Reports on
Form 8-K.................................................. 49
SIGNATURES............................................................ 54
INDEX TO FINANCIAL STATEMENTS......................................... F-1
PART I
ITEM 1. BUSINESS
GENERAL
WellPoint Health Networks Inc. (the "Company" or "WellPoint") is one of the
nation's largest publicly traded managed health care companies. As of
December 31, 1999, WellPoint had approximately 7.3 million medical members and
approximately 32.0 million specialty members. The Company offers a broad
spectrum of quality network-based managed care plans. WellPoint provides these
plans to the large and small employer, individual, Medicaid and senior markets.
The Company's managed care plans include preferred provider organizations
("PPOs"), health maintenance organizations ("HMOs") and point-of-service ("POS")
and other hybrid plans and traditional indemnity plans. In addition, the Company
offers managed care services, including underwriting, actuarial services,
network access, medical cost management and claims processing. The Company
offers a continuum of managed health care plans while providing incentives to
members and employers to select more intensively managed plans. The Company also
provides a broad array of specialty and other products, including pharmacy,
dental, utilization management, life insurance, preventive care, disability
insurance, behavioral health, COBRA and flexible benefits account
administration.
The Company markets its products in California primarily under the name Blue
Cross of California and outside of California primarily under the name UNICARE.
Historically, the Company's primary market for its managed care products has
been California. The Company holds the exclusive right in California to market
its products under the Blue Cross name and mark. The Company's California
customer base is diversified, with extensive membership among large and small
employer groups and individuals and a growing presence in the Medicare and
Medicaid markets.
In 1996, the Company began pursuing a nationwide expansion strategy through
selective acquisitions and start-up activities in key geographic areas. With the
acquisitions in March 1996 of the Life & Health Benefits Management division
("MMHD") of Massachusetts Mutual Life Insurance Company (the "MMHD Acquisition")
and in March 1997 of certain portions of the health and related life group
benefit operations (the "GBO") of John Hancock Mutual Life Insurance Company
(the "GBO Acquisition"), the Company has significantly expanded its operations
outside of California. The Company's acquisition strategy has focused in part on
large employer group plans that offer indemnity and other health insurance
products that are less intensively managed than the Company's products in
California. Since 1987, the Company has transitioned substantially all of its
California indemnity insurance customers to managed care products. An element of
the Company's geographic expansion strategy is to replicate its experience in
California in motivating traditional indemnity members to transition to the
Company's broad range of managed care products.
In addition, the Company focuses on acquiring businesses that provide
significant concentrations of members in strategic locations outside of
California. In connection with this strategy, in March 2000 the Company acquired
Rush Prudential Health Plans, which offers HMO and other medical products in
Illinois, primarily in the greater Chicago area. The Company believes that its
current UNICARE medical membership provides its UNICARE operations with
sufficient scale to begin development of proprietary provider network systems in
key geographic areas, which will enable the Company over time to begin offering
a broader range of managed care products. The Company has used and intends to
continue to use these new networks to introduce individual, small group and
senior products in these markets. Outside California, the Company has developed
or is actively developing proprietary networks in Texas, Georgia, Illinois,
Indiana, Maryland, Ohio and Virginia and has introduced new managed care
products in, among other states, Texas, Georgia, Illinois, Indiana and Virginia.
Prior to the MMHD and GBO Acquisitions, the Company's significant operations
were primarily confined to the State of California. As a result of these
acquisitions, during 1996, 1997 and 1998, the Company's operations, with the
exception of stand-alone specialty products, were organized generally into
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two internal business units with a geographic focus. Effective as of April 1,
1999, the Company effected a modification of its internal business divisions. As
a result of this change, the Company's primary internal business divisions are
focused on large employer group business, individual and small employer group
business, and senior and specialty business. Revenues (with sales to external
customers and sales or transfers to other segments shown separately), operating
profit or loss and identifiable assets attributable to each of the Company's
reportable segments are set forth in Note 20 to the Consolidated Financial
Statements, which are included elsewhere in this Annual Report on Form 10-K.
PENDING TRANSACTIONS AND OTHER RECENT DEVELOPMENTS
PENDING TRANSACTION WITH CERULEAN
On July 9, 1998, WellPoint entered into an Agreement and Plan of Merger (the
"Merger Agreement") with Cerulean Companies, Inc. ("Cerulean"). Upon completion
of this transaction (the "Merger"), Cerulean will become a wholly owned
subsidiary of WellPoint. Cerulean currently holds the exclusive license to use
the Blue Cross and Blue Shield names and marks in the state of Georgia. Cerulean
is the parent company of Blue Cross Blue Shield of Georgia, which served
approximately 1.7 million medical members in the state of Georgia as of
December 31, 1999. At the effective time of the Merger, the shareholders of
Cerulean will receive WellPoint Common Stock with a market value of $500 million
(subject to certain adjustments provided in the Merger Agreement). Certain
shareholders of Cerulean will have the option to receive cash in lieu of
WellPoint Common Stock, subject to a maximum aggregate limit of $225 million.
The transaction is intended to qualify as a tax-free reorganization for Cerulean
shareholders that elect to receive WellPoint Common Stock. The closing of the
transaction is subject to the approval of the shareholders of Cerulean and to a
number of regulatory and other approvals. The Company currently expects the
transaction to close during 2000.
In September 1998, a class action lawsuit was filed in Richmond County,
Georgia on behalf of certain current and former policyholders of Blue Cross Blue
Shield of Georgia (the "Conversion Litigation"). The claims brought in the
Conversion Litigation relate to the conversion of Blue Cross Blue Shield of
Georgia from a non-profit entity to a for-profit entity in October 1996 (the
"Conversion"). At the time of the Conversion, each eligible Blue Cross Blue
Shield of Georgia subscriber was offered five shares of Cerulean Class A stock.
In order to receive such shares, each eligible subscriber had to return certain
election forms prepared by Cerulean. At the time of the Conversion,
approximately 90,000 of the 160,000 eligible subscribers did not return their
election forms. The litigation sought to compel Cerulean to issue five
additional shares of its Class A Common Stock to each of the 90,000 subscribers.
On December 17, 1998, the Superior Court judge in the Conversion Litigation
issued an order in favor of the plaintiffs. On May 3, 1999, the Georgia Supreme
Court reversed the ruling of the Superior Court, holding that the Superior Court
erred in considering and ruling upon the plaintiffs' claims. The Georgia Supreme
Court's ruling did not affect pending derivative and fraud claims brought by the
plaintiffs.
The plaintiffs in this litigation subsequently filed a petition with the
Georgia Department of Insurance, arguing substantially the same claims made in
the Richmond County litigation. This petition was denied by the Georgia
Department of Insurance, and the plaintiffs brought an appeal in the Richmond
County Superior Court. On September 23, 1999, the Superior Court judge ruled in
favor of the plaintiffs and effectively overturned the denial of the plaintiffs'
petition by the Georgia Department of Insurance. The Superior Court judge ruled
that the Conversion was not carried out in accordance with the terms of the
order issued in 1996 by the Georgia Department of Insurance and that, as a
result, the plaintiffs were entitled to be issued five shares each of Cerulean
Class A Common Stock. The judge's order directed the Georgia Department of
Insurance to vacate its earlier order denying the plaintiffs' petition and to
enter an order in their favor. At the same time, the judge also denied a motion
by Cerulean to intervene in the plaintiffs' appeal. The Georgia Department of
Insurance and Cerulean each filed motions with the Georgia Supreme Court for
appeal of these orders and, on November 12, 1999, the Georgia Supreme
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Court transferred the appeals to the Georgia Court of Appeals, Georgia's
intermediate level court. The Georgia Court of Appeals held oral arguments on
the case on March 22, 2000.
On June 25, 1999, Cerulean held a special meeting of shareholders, at which
the Cerulean shareholders approved the plan of merger with the Company. In order
to complete the Merger, a number of other conditions must be satisfied,
including approval by the Georgia Department of Insurance after a public hearing
and the absence of pending material litigation. The plaintiffs in the Richmond
County litigation have been granted the right to intervene in the public hearing
as policyholders of Blue Cross Blue Shield of Georgia.
The Merger Agreement between the Company and Cerulean originally provided
that either party could terminate the Merger Agreement if all conditions to
closing were not satisfied on or before July 9, 1999. The Company and Cerulean
have agreed to an extension of this date until December 31, 2000.
The Company intends to continue to explore opportunities to work with other
Blue Cross Blue Shield entities. The Company currently provides pharmacy
benefits management services to certain Blue Cross Blue Shield entities
(including Blue Cross Blue Shield of Georgia) and may market additional
specialty products to and pursue additional relationships with other Blue Cross
Blue Shield plans in the future.
ACQUISITION OF RUSH PRUDENTIAL HEALTH PLANS
On December 9, 1999, WellPoint entered into a Purchase Agreement (the
"Purchase Agreement") with The Prudential Insurance Company of America and
Rush-Presbyterian-St. Luke's Medical Center to acquire Rush Prudential Health
Plans. WellPoint completed this transaction on March 1, 2000. The purchase price
for the acquisition is approximately $200 million, subject to certain
post-closing adjustments. As of December 31, 1999, Rush Prudential Health Plans
served approximately 300,000 medical members, primarily in the Chicago area.
MANAGED HEALTH CARE OVERVIEW
An increasing focus on costs by employers and consumers over the last decade
has spurred the growth of HMO, PPO, POS and other forms of managed care plans as
alternatives to traditional indemnity health insurance. Typically, HMOs and
PPOs, as well as hybrid plans incorporating features of each (such as POS
plans), develop health care provider networks by entering into contracts with
hospitals, physicians and other providers to deliver health care at favorable
rates that incorporate health care utilization management and other cost-control
measures as well as network credentialing and quality assurance. HMO, PPO and
POS members generally are charged periodic, prepaid premiums, and copayments or
deductibles. PPOs, POS plans and a number of HMOs allow out-of-network usage,
typically at substantially higher out-of-pocket costs to members. HMO members
generally select one primary care physician from a network who is responsible
for coordinating health care services for the member, while PPOs and other "open
access" plans generally allow members to select physicians without coordination
through a primary care physician. Hybrid plans, such as POS plans, typically
involve the selection of primary care physicians similar to HMOs, but allow
members to choose non-network providers at higher out-of-pocket costs similar to
PPOs.
THE CALIFORNIA MARKET. The desire of California-based employers for a range
of health care choices that promote effective cost controls and quality care has
contributed to substantial market acceptance of managed health care in
California, where the total penetration of managed health care companies is
generally higher than the national average. Initial developments in California
with respect to managed care were focused on HMOs and other tightly controlled
plans. Over the last few years, this emphasis has decreased as consumers and
media scrutiny have generally criticized the reduced choice typical of HMO plans
and as greater regulatory restrictions have been placed on HMO offerings. The
Company believes that this movement towards PPOs and other open access plans
will continue in the future.
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OTHER STATES. Outside of California, the past decade has seen significant
transformations in the health care sector. Although market acceptance of the
array of managed health care plans continues to grow throughout the United
States, it still varies widely from state to state. In some states, especially
larger population centers, members are offered health care choices focused on
HMO or POS plans. In other states, members are typically offered a spectrum of
health care choices which are more focused on PPOs or traditional indemnity
health models than in California. Indemnity insurance usually allows members
substantial freedom of choice in selecting health care providers but without
significant financial incentives or cost-control measures typical of managed
care plans. Indemnity insurance plans typically require annual deductible
obligations of members. Upon satisfaction of the deductible, the member is
reimbursed for health care expenses on a full or partial basis of the indicated
charges. Health plan reimbursement is often limited to the health plan's
assessment of the reasonable and customary charges prevailing in a region for
the particular health care procedure. As in California, initial developments in
managed care in other states have generally focused on more restrictive plans.
More recently, consumer and general public sentiment has shifted towards open
access plans.
CUSTOMER SEGMENTATION
WellPoint's products are developed and marketed with an emphasis on the
differing needs of various customer segments. In particular, the Company's
product development and marketing efforts take into account the differing
characteristics between the various customer groups served by the Company,
including individuals and small employers, large employers (generally with 51 or
more employees), seniors and Medicaid recipients, as well as the unique needs of
educational and public entities, federal employee health and benefit programs,
national employers and state-run programs servicing high-risk and under-served
markets. Individual business units are responsible for enrolling, underwriting
and servicing customers in specific segments. The Company believes that one of
the keys to its success has been its focus on distinct customer groups defined
generally by employer size and geographic region, which better enables the
Company to develop benefit plans and services that meet the needs of these
distinct markets. Although the Company has experienced increased competition
over the last several years, the Company has long been a market leader in the
California individual and small employer group market.
INDIVIDUAL AND SMALL GROUP BUSINESSES
MARKETING
Sales representatives are generally assigned to a specific geographic region
to allow WellPoint to tailor its marketing efforts to the particular health care
needs of each regional market. Individual and small employer group products are
marketed in California primarily through independent agents and brokers, who are
overseen by WellPoint's sales departments, and through sales managers in
Comprehensive Integrated Marketing Services, Inc. ("CIMS"), a wholly owned
indirect subsidiary of the Company. UNICARE's individual and small employer
group products are also generally distributed on a regional basis by independent
sales agents in the various localized markets in which UNICARE operates. The
Company expects that, over time, the development of Internet-based distribution
methods may affect the sales and marketing process in the individual and small
employer group market. In this regard, in 1999 the Company entered into sales
distribution arrangements with certain Internet-based sales agents and
introduced its Agent Connect program, which allows individual agents and brokers
to create customized Internet websites and incorporate basic information
regarding the Company's health plan offerings.
PRODUCTS
PPO PLANS. The Company's PPO products, which are generally marketed in
California under the name "Prudent Buyer" and elsewhere under the name
"UNICARE," are designed to address the specific needs of different customer
segments. The Company's PPO plans require periodic, prepaid premiums and may
have copayment obligations for services rendered by network providers that are
often similar to the copayment obligations of its HMO plans. Unlike WellPoint's
HMO and other "closed-access" plans,
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members are not required to select a primary care physician who is responsible
for coordinating their care and may be subject to annual deductible
requirements. PPO members have the option to receive health care services from
non-network providers, typically at substantially higher out-of-pocket costs to
members. Among the Company's various PPO plans are its Prudent Buyer and UNICARE
Co-Pay products, which replace annual deductible obligations with HMO-like
co-payments while maintaining the member choice typical of PPO plans, and
high-deductible health plans intended for use with medical savings accounts
("MSAs"). In 1998, the Company introduced its unique Employee Elect product,
which allows small employers to offer their employees a menu of PPO and HMO
options.
Outside of California, the Company offers PPO and other open access products
(using proprietary networks and third-party provider networks), as well as
traditional fee-for-service products. As WellPoint continues to develop or
acquire proprietary provider network systems in key geographic areas, the
Company intends to offer more intensively managed products to the existing
members of acquired businesses and to new individual, small group and senior
customers outside of California.
The Company believes that an important growth opportunity in the individual
market lies in the development of products that are priced attractively for
previously uninsured people. In 2000, the Company is introducing its PPO Saver
product in California and selected other locations. The PPO Saver product offers
significantly lower premiums in exchange for certain limited benefits that still
offer primary care physician visits and preventive care benefits and provide
catastrophic coverage.
HMO PLANS. The Company offers a variety of HMO products to the members of
its California HMO, CaliforniaCare. CaliforniaCare members are generally charged
periodic, prepaid premiums that do not vary based on the amount of services
rendered, as well as modest co-payments (small per-visit charges). Members
choose a primary care physician from the HMO network who is responsible for
coordinating health care services for the member. Certain plans permit members
to receive health care services from providers that are not a part of the
Company's HMO network at a substantial out-of-pocket cost to members which
includes a deductible and higher copayment obligations. To enhance the
marketability of its plans, in 1996 the Company introduced its CaliforniaCare
Saver HMO product, which has deductible obligations for certain hospital and
outpatient benefits. In response to consumer demand for easier access to
specialists, in 1997 the Company introduced the Ready Access program in its
CaliforniaCare HMO. The program expedites the referral process to specialists
within a member's participating medical group ("PMG"). In addition, the program
also allows members of certain PMGs to self-refer to designated frequently used
specialists.
As a result of the Rush Prudential acquisition, the Company now offers HMO
products in the greater Chicago area. An element of the Company's expansion
strategy with respect to this business is to introduce a greater variety of
products similar to those offered to CaliforniaCare members.
LARGE GROUP BUSINESSES
WellPoint's large employer group business, which historically lagged the
performance of its individual and small group business, has experienced
considerable growth since 1994. The Company attributes this growth to the
rebound of the California economy and the enhancement of the Company's
reputation for customer service and value, especially among large, established
companies.
MARKETING AND PRODUCTS
WellPoint's managed health care plans to large employers in California are
generally sold by WellPoint sales personnel, in conjunction with an employer's
broker or consultant, to develop a package of managed health care benefits
specifically tailored to meet the employer's needs. WellPoint believes that a
key component of its success in this market segment is the Company's strength in
developing complex, highly customized benefits packages that respond to the
diverse needs of larger employers and their
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employee population. In 1999, the Company introduced its Blue Cross Preferred
PPO product, which provides certain enhanced benefits desired by high-technology
companies in competitive labor markets.
Many of WellPoint's HMO and PPO products offered to individuals and small
employer groups are also offered to large employer groups. In addition to
competitive pricing and exemplary customary service, a key competitive factor in
the sale of large employer group products is the ability to offer a spectrum of
health plan choices. With the completion of the Company's acquisition of Rush
Prudential, the Company is able to offer a mix of products, including HMO and
PPO products, to customers in the greater Chicago area. One component of the
Company's expansion strategy outside of California is to evaluate acquisition
opportunities that will allow the Company to complement its product offerings in
selected target markets.
MANAGEMENT SERVICES
In addition to fully insured products, WellPoint provides administrative
services to large group employers that maintain self-funded health plans. In
California, the Company often has been able to capitalize on this relationship
by subsequently introducing WellPoint's underwritten managed care products. The
Company's managed care services revenues have expanded considerably during the
last four years as a result of the MMHD and GBO Acquisitions. These businesses,
especially the GBO, are comprised of a higher percentage of administrative
services business than the Company's traditional California business. WellPoint
offers managed care services, including underwriting, actuarial services,
medical cost management, claims processing and administrative services for
self-funded employers. WellPoint also enables employers with self-funded health
plans to use WellPoint's provider networks and to realize savings through
WellPoint's favorable provider arrangements, while allowing employers the
ability to design certain health benefit plans in accordance with their own
requirements and objectives. As of December 31, 1999, WellPoint serviced
self-insured health plans covering approximately 2.6 million medical members.
SENIOR PLANS
WellPoint offers numerous Medicare supplement plans, which typically pay the
difference between health care costs incurred by a beneficiary and amounts paid
by Medicare. One such product is Medicare Select, a PPO-based product that
offers supplemental Medicare coverage. WellPoint also offers Medicare Select II,
a hybrid product which allows seniors over the age of 65 to maintain their full
Medicare benefits for any out-of-network benefits while enrolled in a
supplemental plan that allows them to choose their own physician with a
copayment. As of December 31, 1999, these Medicare supplemental plans served
approximately 208,000 members. WellPoint also offers Blue Cross Senior Secure,
an HMO plan operating in defined geographic areas, under a Medicare + Choice
contract with the Health Care Financing Administration ("HCFA"). This contract
entitles WellPoint to a fixed per-member premium from HCFA which is subject to
adjustment annually by HCFA based on certain demographic information relating to
the Medicare population and the cost of providing health care in a particular
geographic area. In addition to physician care, hospitalization and other
benefits covered by Medicare, the benefits under this plan (which vary by
county) typically include prescription drugs, routine physical exams, hearing
tests, immunizations, eye examinations, counseling and health education
services. As of December 31, 1999 Blue Cross Senior Secure HMO plans served over
28,000 members.
MEDICAID PLANS AND OTHER STATE-SPONSORED PROGRAMS
The California Department of Health Services ("DHS") administers Medi-Cal,
California's Medicaid program. WellPoint has been awarded contracts to offer
Medi-Cal managed care programs in various California counties. Under these
programs, WellPoint provides health care coverage to Medi-Cal program members
and DHS (or a delegated local agency) pays WellPoint a fixed payment per member
per month. As of December 31, 1999, approximately 710,000 members were enrolled
in WellPoint's Medi-Cal managed care programs in Los Angeles, Sacramento,
Orange, San Francisco, Alameda, Santa Clara,
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Fresno, Kern, Stanislaus, Contra Costa, San Diego, Tulare and San Joaquin
counties and in other state-sponsored programs.
MANAGED HEALTH CARE NETWORKS AND PROVIDER RELATIONS
While the Company's product development and marketing efforts are organized
by distinct customer segments, the Company believes that its interactions with
hospitals and physicians are best facilitated through a single coordinated
effort handled by the Company's Health Care Services Division. Because of the
different market positions of the Company's Blue Cross of California and UNICARE
tradenames, the Company's health care networks and provider relations are
different in California than in other states.
BLUE CROSS OF CALIFORNIA
WellPoint's extensive managed health care provider networks in California
include its HMO, PPO and specialty managed care networks. These provider
relationships are monitored regularly in order to help control the cost of
health care while providing access to quality providers. As a result of this
network-monitoring process as well as member and provider financial incentives,
WellPoint reduces or eliminates the need to use out-of-network providers that
are not subject to WellPoint's cost and performance controls.
WellPoint uses its large California membership to negotiate provider
contracts at favorable rates that encourage effective utilization management.
Under these contracts, physician providers are paid either a fixed per member
monthly amount (known as a capitation payment) or on the basis of a fixed fee
schedule. In selecting providers for its networks, WellPoint uses its
credentialing programs to evaluate the applicant's professional qualifications
and experience, including license status, malpractice claims history and
hospital affiliations.
The following is a more detailed description of the principal features of
WellPoint's California PPO and HMO networks.
PPO NETWORK. The California PPO network included approximately 48,000
physicians and 440 hospitals throughout California as of December 31, 1999.
There were approximately 3.1 million members (including administrative services
members) enrolled in WellPoint's California PPO health care plans as of such
date, approximately 37% of whom were individuals or employees of small groups.
WellPoint endeavors to manage and control costs for its PPO plans by
negotiating favorable arrangements with physicians, hospitals and other
providers, which arrangements include utilization management and other
cost-control measures. In addition, WellPoint manages costs through pricing and
product design decisions intended to influence the behavior of both providers
and members.
WellPoint's California PPO plans provide for the delivery of specified
health care services to members by contracting with physicians, hospitals and
other providers. Hospital provider contracts are on a nonexclusive basis and
generally provide for per diem payments (a fixed fee schedule where the daily
rate is based on the type of service) that provide for rates that are below the
hospitals' standard billing rates. Physician provider contracts are also on a
nonexclusive basis and specify fixed fee schedules that are below standard
billing rates. WellPoint is able to obtain prices for hospitals and physician
services below standard billing rates because of the volume of business it
offers to health care providers that are part of its network. Provider rates are
generally negotiated on an annual or multi-year basis with hospitals. Provider
rates for physicians in the Company's PPO network are set from time to time by
the Company.
HMO NETWORK. Membership in CaliforniaCare was approximately 2.0 million
members as of December 31, 1999. As of December 31, 1999, the HMO network
included approximately 31,000 primary care and specialist physicians and
approximately 427 hospitals throughout California. The physician network of PMGs
is comprised of both multi-specialty medical group practices and individual
practice associations ("IPAs").
7
Substantially all primary care physicians or PMGs in the Company's
California HMO network are reimbursed on a capitated basis. These arrangements
specify fixed per member per month payments to providers and may result in a
marginally higher medical loss ratio than a non-capitated arrangement, but
significantly reduce risk to WellPoint. Generally, HMO network hospital provider
contracts are on a nonexclusive basis and provide for a per diem payment, which
is below the hospitals' standard billing rates.
Contractual arrangements with PMGs typically include provisions under which
WellPoint provides limited stop-loss protection. If the PMG's actual charges for
medical services provided to a member exceed an agreed-upon threshold amount,
WellPoint will pay the group a portion of the excess amount. Provider rates are
generally negotiated with PMGs and hospitals on an annual or multi-year basis.
To encourage PMGs to contain costs for claims for non-capitated services such as
inpatient hospital, outpatient surgery, hemodialysis, emergency room, skilled
nursing facility, ambulance, home health and alternative birthing center
services, WellPoint's PMG agreements provide for a settlement payment to the PMG
based upon the PMG's effective utilization of such non-capitated services. PMGs
are also eligible for additional incentive payments based upon their
satisfaction of quality criteria and management of outpatient prescription
drugs.
UNICARE
Due to the more recent development of the Company's national operations, the
Company's relations with health care providers outside of California are more
varied than in California. During 1999, the Company continued its significant
network development efforts in various states, including Georgia, Illinois,
Indiana, Maryland, Ohio, Texas and Virginia. Some of these network development
activities involved start-up activities, while others involved supplementing
existing networks acquired in the MMHD and GBO acquisitions. As a result of the
Company's extensive efforts, the Company's proprietary networks in Georgia and
Texas are substantially completed. As of December 31, 1999, UNICARE's
proprietary networks included approximately 92,700 primary care and specialist
physicians and 870 hospitals.
As a result of the Rush Prudential acquisition completed in March 2000,
UNICARE has now added Rush Prudential's existing networks to its proprietary
networks in the greater Chicago area. As of December 31, 1999, these networks
included approximately 10,300 primary care and specialty physicians and
approximately 94 hospitals.
As part of the MMHD Acquisition, the Company also acquired a majority
ownership interest in a PPO entity, National Capital Preferred Provider
Organization ("UNICARE NCPPO"), which operates in the Maryland/Virginia area and
is a joint venture with local health care providers. The UNICARE NCPPO network
included approximately 10,700 primary care and specialist physicians and 57
hospitals as of December 31, 1999.
A large number of UNICARE members are currently served by third-party
provider networks, which generally lack the provider selectivity and discounts
typical of the Company's proprietary networks. One of the Company's strategies
for the expansion of its UNICARE operations is to continue building and
acquiring proprietary provider network systems in certain geographies similar to
the Company's networks in California and Texas, which provide a continuum of
managed care products to various customer segments. As the Company expands its
out-of-state operations, it intends to build or acquire such network operations
and, as appropriate, to replace or supplement the current third-party network
arrangements. Additionally, the Company has begun a process to consolidate its
third-party network relationships in an effort to further contain its
administrative expenses.
ANCILLARY NETWORKS
WellPoint evaluates current and emerging high volume or high cost services
to determine whether developing an ancillary service network will yield cost
control benefits. In establishing these ancillary service networks, WellPoint
seeks to enter into capitation or fixed fee arrangements with providers of these
8
services. WellPoint regularly collects and analyzes industry data on high cost
or high volume unmanaged services to identify the need for specialty managed
care networks. For example, WellPoint has created Centers of Expertise for
certain transplant services.
UTILIZATION MANAGEMENT
In order to better manage quality in its proprietary provider networks,
WellPoint adopts utilization management systems and guidelines that are intended
to reduce unnecessary procedures, admissions and other medical costs. The
utilization management systems seek to provide quality care to WellPoint's
members by ensuring that medical services provided are based on medical
necessity and that all final decisions are made by physicians. In its California
HMO, WellPoint permits PMGs to oversee most utilization management for their
particular medical group under WellPoint's guidelines. Currently, substantially
all of the PMGs in WellPoint's California HMO network have established
committees to oversee utilization management. For its California PPO network,
WellPoint uses treatment guidelines, requires pre-admission approvals of
hospital stays and concurrent review of all admissions and retrospectively
reviews physician practice patterns. Utilization management also includes an
outpatient program, with pre-authorization and retrospective review, ongoing
supervision of inpatient and outpatient care of members, case management and
discharge planning capacity. Review of practice patterns may result in
modifications and refinements to the PPO plan offerings, treatment guidelines
and network contractual arrangements. In addition, WellPoint manages health care
costs by periodically reviewing cost and utilization trends within its provider
networks. Cases are reviewed in the aggregate to identify a high volume of a
particular type of service to identify the most effective method of treatment
while more effectively managing costs. In addition, the Company reviews
high-cost procedures in an effort to provide new quality, cost-effective
treatment by utilizing new technologies or by creating additional networks, such
as its networks of home health agencies.
For the Company's UNICARE managed care health plans, utilization management
is provided by UNICARE through the Company's subsidiary CostCare, Inc. ("CCI").
As part of the GBO Acquisition, the Company acquired CCI, which provides medical
management services. The Company has integrated CCI's traditional utilization
management and case management services into UNICARE offerings and is increasing
membership in CCI's newer medical management products. These products include a
disease state management program, a high-risk pregnancy identification and
management program and a nurse health information line. In December 1997, CCI
(which operates as UNICARE/Cost Care) received a two-year accreditation for its
utilization management program from the Utilization Review Accreditation
Commission ("URAC"), a private organization providing voluntary accreditation of
utilization review entities. CCI is currently undergoing a re-accreditation by
URAC. Additionally, in February 2000, CCI received a two-year accreditation from
URAC for its health information line program.
UNDERWRITING
In establishing premium rates for its health care plans, WellPoint uses
underwriting criteria based upon its accumulated actuarial data, with
adjustments for factors such as claims experience, member mix and industry
differences to evaluate anticipated health care costs. WellPoint's underwriting
practices in the individual and small group market are subject to legislation in
California and other states affecting the individual and small employer group
market. Because UNICARE's members are in every state, the Company's underwriting
practices, especially in the individual and small group market, are subject to a
variety of legislative and regulatory requirements and restrictions. See
"Government Regulation."
QUALITY MANAGEMENT
Quality management for most of the Company's California business is overseen
by the Company's Quality Management Department and is designed to ensure that
necessary care is provided by qualified personnel. Quality management
encompasses plan level quality performance, provider credentialing,
9
provider and member grievance monitoring and resolution, medical group auditing,
monitoring medical group compliance with Blue Cross of California standards for
medical records and medical offices, physician peer review and a quality
management committee.
SPECIALTY MANAGED HEALTH CARE AND OTHER PLANS AND SERVICES
WellPoint offers a variety of specialty managed health care and other
services. WellPoint believes that these specialty networks and plans complement
and facilitate the marketing of WellPoint's medical plans and help in attracting
employer groups and other members that are increasingly seeking a wider variety
of options and services. WellPoint also markets these specialty products on a
stand-alone basis to other health plans and other payors.
PHARMACY PRODUCTS
WellPoint offers pharmacy services and pharmacy benefit management services
to its members. WellPoint's pharmacy services incorporate features such as drug
formularies (a WellPoint-developed listing of preferred, cost-effective drugs),
a pharmacy network and maintenance of a prescription drug database and mail
order capabilities. Moreover, pharmacy benefit management services provided by
WellPoint include management of drug utilization through outpatient prescription
drug formularies, retrospective review and drug education for physicians,
pharmacists and members. As of December 31, 1999, WellPoint had approximately 22
million risk and non-risk pharmacy members and approximately 53,000
participating pharmacies.
DENTAL PLANS
WellPoint's California dental plans include Dental Net, its California
dental HMO, and Blue Cross Dental Select HMO, a hybrid plan, with provider
networks of approximately 2,100 dentists reimbursed on a capitated basis, a
dental PPO, with a network of approximately 11,200 dentists, and traditional
indemnity plans. As of December 31, 1999, the Company's dental networks outside
of California included approximately 22,000 dentists. The Company's dental
products outside of California currently include a dental PPO in Texas, Georgia
and almost all of the other states in which the Company operates. As a result of
the MMHD and GBO acquisitions, the Company has acquired significant additional
dental membership outside of California. The Company's dental plans provide
primary and specialty dental services, including orthodontic services, and as of
December 31, 1999, served approximately 2.5 million dental members.
LIFE INSURANCE
The Company offers primarily term-life and accidental death and
dismemberment ("AD&D") insurance to employers, generally in conjunction with the
Company's health plans. The MMHD and GBO acquisitions expanded the Company's
life insurance business both inside and outside of California. As of
December 31, 1999, the Company provided life insurance products to approximately
2.1 million persons.
MENTAL HEALTH PLANS
WellPoint offers specialized mental health and substance abuse programs. The
plans cover mental health and substance abuse treatment services on both an
inpatient and an outpatient basis, through a network of approximately 6,400
contracting providers. In addition, approximately 300 employee assistance and
behavioral managed care programs have been implemented for a wide variety of
businesses throughout the United States. As of December 31, 1999, there were
approximately 2.2 million members covered under WellPoint's mental health plans.
The Company believes the implementation of new mental health parity laws
(described in "Government Regulation") will provide a growth opportunity for the
Company because many plans currently provide for limited mental health benefits.
10
UTILIZATION MANAGEMENT
In connection with the GBO Acquisition, the Company acquired CCI. CCI, which
now operates under the trade name UNICARE/CostCare, provides stand-alone
utilization management and other medical management services to other health
plans and self-funded employers. CCI utilization management services are also
integrated into UNICARE product offerings. As of December 31, 1999, the Company
had approximately 2.7 million utilization management members.
DISABILITY PLANS
The Company offers short-and long-term disability programs, usually in
conjunction with the Company's health plans. As of December 31, 1999, the
Company provided long-term or short-term disability coverage to approximately
600,000 individuals.
LONG-TERM CARE INSURANCE
In November 1997, the Company began offering a group of long-term care
insurance products to its California members through its indirect wholly owned
subsidiary BC Life & Health Insurance Company ("BC Life"). These plans, which
are marketed under the Blue Cross Long Term Care trade name, involve six
different products. The Company's long-term care products include tax-qualified
and non-tax qualified versions of a skilled nursing home care plan and
comprehensive policies covering skilled, intermediate and custodial long-term
care and home health care services.
WORKERS' COMPENSATION MANAGED CARE SERVICES
In California, the Company offers workers' compensation managed care
services, including bill review, network access, medical cost management and
utilization management, to employers who self-insure their workers' compensation
coverage, as well as to workers' compensation carriers.
MARKET RESEARCH AND ADVERTISING
WellPoint conducts market research and advertising programs to develop
products and marketing techniques tailored specifically to customer segments.
WellPoint uses print and broadcast advertising to promote its health care plans.
In addition, the Company engages in promotional activities with agents, brokers
and consultants. WellPoint incurred costs of approximately $40.8 million, $43.3
million and $36.5 million on advertising for the years ended December 31, 1999,
1998 and 1997, respectively.
COMPETITION
The managed health care industry in California is competitive on both a
regional and statewide basis. In addition, in recent years there has been a
trend of increasing consolidation among both national and California-based
health care companies, which may further increase competitive pressures.
WellPoint competes with other companies that offer similar managed health care
plans, some of which have greater resources than WellPoint. In addition, the
development and growth of companies offering Internet-based connections between
providers, employers and members, along with a variety of services, may create
additional competitors. Currently, WellPoint is a market leader in offering
managed health care plans to individuals and small employer groups in
California. The medical loss ratio attributable to WellPoint's individual and
small group business has historically been lower than that for its large
employer group business. As a result, a larger portion of WellPoint's
profitability on a per-member basis is due to the individual and small group
business. WellPoint has experienced increased competition in this market over
the last several years, which could adversely affect its medical loss ratio and
future financial condition, cash flows or results of operations. See "Factors
That May Affect Future Results of Operations."
11
The markets in which the Company operates outside of California are also
highly competitive. Because of the many different markets in which the Company
now serves members, the Company faces unique competitive pressures in regional
markets as well as on a national basis. The Company competes with other
companies that offer managed health care plans as well as traditional indemnity
insurance products. Many of these companies have greater financial and other
resources than the Company and greater market share on either a regional or
national basis. As the Company continues to geographically expand its
operations, it will be subject to national competitive factors as well as unique
competitive conditions that may affect the more localized markets in which the
Company operates.
WellPoint believes that significant factors in the selection of a managed
health care plan by employers and individual members include price, the extent
and depth of provider networks, flexibility and scope of benefits, quality of
services, market presence, reputation (which may be affected by public rankings
or accreditation by voluntary organizations such as the National Committee for
Quality Assurance ("NCQA") and the URAC) and financial stability. WellPoint
believes that it competes effectively against other health care industry
participants.
GOVERNMENT REGULATION
CALIFORNIA
DOC AND DOI REGULATION. WellPoint offers its managed health care services
in California principally through its wholly owned indirect subsidiary Blue
Cross of California, which is currently subject to regulation by the California
Department of Corporations (the "DOC") under the Knox-Keene Health Care Service
Plan Act of 1975 (the "Knox-Keene Act"). This regulatory structure will be
significantly altered when newly adopted legislation (described below) becomes
effective. The insurance business conducted by the Company's subsidiary BC Life
& Health Insurance Company ("BC Life") is regulated by the California Department
of Insurance (the "California DOI"). Each entity is subject to various minimum
capital and other requirements, such as restrictions on the payment of dividends
or the issuance of capital stock, established by its respective regulatory
authority. Blue Cross of California's managed health care programs are also
subject to extensive DOC regulation regarding benefit and coverage levels,
relationships with health care providers, administrative capacity, marketing and
advertising, procedures for quality assurance and subscriber and enrollee
grievance resolution. Any material modifications to the organization or
operations of Blue Cross of California are subject to prior review and approval
by the DOC. BC Life must obtain approval from the California DOI for all of its
group insurance policies and certain aspects of its individual policies prior to
issuing those policies, as well as certain other material actions which BC Life
may propose to take. The failure to comply with applicable regulations can
subject BCC or BC Life to various penalties, including fines or the imposition
of restrictions on the conduct of its operations.
In 1997, the DOC conducted triennial medical surveys of the Company and each
of its subsidiaries licensed under the Knox-Keene Act. The Company received a
final report of the DOC with respect to the surveys and has provided responses
to the final report. In February 2000, the DOC conducted its next regularly
scheduled triennial medical survey of the Company. The Company has not yet
received any results of this survey from the DOC. The Company does not expect
any material impact on its operations as a result of the surveys. In addition,
the DOC conducted a routine examination of fiscal and administrative affairs of
Blue Cross of California for the quarter ended March 31, 1998. The Company has
received a final report of the results of this audit from the DOC and has
responded to each item noted therein.
RECENT CALIFORNIA HEALTH CARE LEGISLATION
In September 1999, the California Legislature enacted and the California
Governor subsequently signed into law a number of health care reform measures.
The following is a summary of the material terms of the most significant of
these new laws.
12
The Managed Health Care Insurance Accountability Act of 1999 ("SB 21"),
which becomes effective for health care services rendered after January 1, 2001,
establishes an explicit duty on managed care entities to exercise ordinary care
in arranging for the provision of medically necessary health care services to
their subscribers and imposes liability for all harm legally caused by the
failure to exercise such ordinary care. Managed care entities may be held liable
if their failure to exercise ordinary care results in the denial, delay or
modification of a health care service recommended for or furnished to the
subscriber and the subscriber suffers "substantial harm." For purposes of the
statute, "substantial harm" is defined as the loss of life, loss of or
significant impairment of a limb or bodily function, significant disfigurement,
severe and chronic pain or significant financial loss. Liability may be
established for health care services regardless of whether the recommending
health care provider is a contracting provider with the managed care entity.
Managed care plans may not seek indemnity from a health care provider for the
liability imposed by the statute. A cause of action may not be maintained under
the statute against a managed care entity unless the subscriber has exhausted
independent medical review procedures, except in instances where substantial
harm has occurred or will imminently occur prior to the completion of the
independent medical review.
Assembly Bill 55 ("AB 55") establishes an independent medical review system
effective as of January 1, 2001. Every health plan enrollee, whether currently
under the regulatory supervision of the DOC or the California DOI, must be
provided with an opportunity to seek an independent medical review whenever
health care services have been denied, modified or delayed by a managed care
entity or one of its contracting providers, if this decision was based on a
finding that the proposed services are not medically necessary. Under AB 55,
there is no minimum dollar level for claims to be subject to the independent
review process and the enrollee will not have any responsibility for the payment
of any application or processing fee. An enrollee's provider may assist and
advocate in the review. All health plan contracts issued or renewed after
January 1, 2000 must provide an opportunity to seek an independent review
effective as of January 1, 2001. The statute does not apply to decisions by a
health plan that health care services are not covered under the plan issued to
the subscriber. The newly established Department of Managed Care (which is
described below) is instructed to contract with one or more medical review
organizations by January 1, 2001.
Assembly Bill 88 ("AB 88") requires that any health care service plan
contract or disability insurance policy issued or renewed on or after July 1,
2000 must provide coverage for the diagnosis and medically necessary treatment
of severe mental illness under the same terms and conditions applied to other
medical conditions. Many of the plans offered by the Company currently provide
for limited mental health benefits.
Assembly Bill 78 ("AB 78") provides for the creation of a Department of
Managed Care into which will be transferred the existing health care service
plan operations of the DOC. This will become operative on the earlier of
July 1, 2000 or the issuance of an executive order by the California Governor.
The Department of Managed Care will be advised by an advisory committee
consisting of 22 members, 11 of whom will be appointed by the Governor, 10 of
whom will be appointed by the joint recommendation of the Governor, the Speaker
of the California Assembly and the California Senate Committee on Rules and one
of whom will be the Director of the Department (who will be appointed by the
Governor). This advisory committee will issue an annual report, which will
include a report card issued to the public on the comparative performance of
managed care organizations. This bill also establishes an Office of Patient
Advocate, who will be appointed by the California Governor, to represent the
interest of enrollees. The Office of Patient Advocate will be charged with the
responsibility of helping enrollees secure health care services and will have
access to the records of the Department of Managed Care. Under the legislation,
the new Department of Managed Care will be granted expanded powers, including
the ability to order the discontinuance of "unsafe or injurious practices."
Senate Bill 260 ("SB 260") establishes a Financial Solvency Standards Board
(the "Board") comprised of the Director of the Department of Managed Care (the
"Director") and seven members appointed by the Director. The Board will review
financial solvency matters affecting the delivery of health care services and
recommend financial solvency requirements relating to plan operations,
plan-affiliate operations and
13
transactions, plan-provider contractual relationships and provider-affiliate
operations and transactions. Effective January 1, 2001, every contract between a
health care service plan and a risk-bearing organization (i.e., any provider
group that provides services in exchange for fixed capitation payments) must
include a requirement that the risk-bearing organization furnish financial
information to the health care service plan. In addition, the health care
service plan must disclose information to the risk-bearing organization that
enables the organization to be informed regarding its financial risk. Plans must
provide payment of all risk arrangements, excluding capitation payments, within
180 days after the close of each fiscal year. On or before June 30, 2000, the
Director must adopt regulations providing for a process of reviewing and grading
risk-bearing organizations based on criteria regarding financial responsibility,
estimates for incurred but not reported claims ("IBNR"), tangible net equity and
level of working capital. Risk-bearing organizations may not be at financial
risk for the provision of health care services unless a particular contract
provision allocating such risk has first been negotiated and agreed to between
the health care service plan and the risk-bearing organization. In addition, no
contract between a health care service plan and a risk-bearing organization may
include any provision that requires a health care provider to accept rates or
methods of payments unless the provisions have first has been negotiated and
agreed to between the plan and the risk-bearing organization.
Senate Bill 559 ("SB 559"), which is effective July 1, 2000, imposes certain
disclosure obligations and other limitations on health care plans, such as the
Company, that make their networks of contracted providers available to other
entities. Under SB 559, health care plans must disclose to contracting providers
that they intend to make their health care networks, and the negotiated
discounts, available to other payors such as self-insured employers or workers'
compensation insurance companies. Providers may decline to be included in any
list of contracted providers made available to any payor entity that does not
provide financial incentives to, or otherwise actively encourage, the payor's
members to use the list of contracting providers when obtaining medical care.
The California Legislature also adopted new legislation that imposes
restrictions on the categories of persons that may be involved in medical
management activities and on the conduct of such activities. Various other newly
adopted bills mandate coverage for certain benefits, such as the provision of
oral contraceptives, and place further limitations on health plan operations.
Although it is too early to determine the effects of the recently enacted
legislation, the Company expects that this legislation and any other legislation
adopted in the future will increase the Company's cost of operations and may
have the effect of increasing the Company's loss ratio or decreasing the
affordability of its products. As a result, this legislation could have a
material adverse effect on the Company's results of operations, financial
condition and cash flows.
FEDERAL
RECENT FEDERAL HEALTH CARE LEGISLATION. In August 1997, the President
signed into law the Balanced Budget Act of 1997 (the "Balanced Budget Act"). The
Balanced Budget Act included a number of measures affecting the provision of
health care. The act placed restrictions on the variation in Medicare
reimbursement amounts (so-called "risk adjusters") between counties. HCFA has
released proposed risk adjusters, which are currently expected to be implemented
in phases through the year 2005. In addition, the Balanced Budget Act expanded
the managed health plan options available to Medicare enrollees to include PPO,
POS and high deductible health plans intended for MSAs. Regulations regarding
these changes were adopted in June 1998. Finally, the Balanced Budget Act
implemented certain changes with respect to Medicare supplement programs,
including guaranteed coverage issues. Certain of the changes under the Balanced
Budget Act could have the result of increasing the Company's costs.
In November 1997, the Advisory Commission on Consumer Protection and Quality
in the Health Care Industry (the "Clinton Quality Commission"), which had been
appointed by President Clinton to formulate recommendations regarding health
care quality and the protection of consumers, released a "Consumer Bill of
Rights and Responsibilities" containing a number of general and specific
recommendations
14
regarding the provision of health care in the United States. No legislation has
yet been adopted as a result of its recommendations. In February 1998, the
President issued an executive order to the government administrators of each of
the government-sponsored health programs directing them to take appropriate
actions to insure compliance with some or all of the recommendations made in the
Consumer Bill of Rights by various dates on or before December 31, 1999.
Compliance with the President's executive order is likely to increase health
plan costs associated with these government-sponsored programs. In 1998, the
Department of Labor also issued proposed regulations regarding a mandated health
plan grievance and appeal process. These regulations would apply to all plans
subject to the Employee Retirement and Income Security Act of 1974 ("ERISA"),
including employer-funded plans. Final regulations have not yet been issued.
These regulations, if adopted, could have the effect of increasing the Company's
expenses.
On August 21, 1996, the President signed into law the Health Insurance
Portability and Accountability Act of 1996 (originally known in the Senate as
the Kennedy-Kassebaum bill) ("HIPAA"). HIPAA and the implementing regulations
that have thus far been adopted impose new obligations for issuers of health
insurance coverage and health benefit plan sponsors. HIPAA requires certain
guaranteed issuance and renewability of health coverage for individuals and
small groups (generally 50 or fewer employees) and limits exclusions based on
preexisting conditions. Most of the insurance reform provisions of HIPAA became
effective for "plan years" beginning July 1, 1997.
HIPAA also establishes new requirements regarding the confidentiality of
patient health information and regarding standard formats for the transmission
of health care data. In November 1999, the Department of Health and Human
Services released proposed regulations regarding the privacy of "protected
health information" for electronic records. The proposed rules would, among
other things, require that health plans give patients a clear written
explanation of how they intend to use, keep and disclose patient health
information, prohibit health plans from conditioning payment or coverage on a
patient's agreement to disclose health information for other purposes, and
create federal criminal penalties for health plans, providers and claims
clearinghouses that knowingly and improperly disclose information or obtain
information under false pretenses. Proposed regulations regarding the standard
formats for the transmission of health care information have also been released,
although no final regulations have yet been adopted. The privacy and
standardization regulations, if adopted, could have the effect of increasing the
Company's expenses.
Maternity length of stay and mental health parity benefits measures became
effective for plan years beginning January 1, 1998. The maternity stay provision
requires health plans to cover the cost of a 48-hour hospital stay (96 hours
following a Caesarian section). This measure does not mandate the length of
hospital stays but requires that longer stays be covered if deemed necessary by
the mother or her physician (in consultation with the mother). Although many
states already guarantee minimum hospital stays for mothers and newborns, these
measures have further increased WellPoint's claims expense.
MEDICARE LEGISLATION. WellPoint's health benefits programs include products
that are marketed to Medicare beneficiaries as a supplement to their Medicare
coverage. These products are subject to Federal regulations intended to provide
Medicare supplement customers with standard minimum benefits and levels of
coverage and full disclosure of coverage terms and assure that fair sales
practices are employed in the marketing of Medicare supplement coverage.
In California, WellPoint provides a senior plan product under a Medicare +
Choice contract that is subject to regulation by HCFA. Under this contract and
HCFA regulations, if WellPoint's premiums received for Medicare-covered health
care services provided to senior plan Medicare members are more than the
Company's projected costs associated with the provision of health care services
provided to senior plan members, then WellPoint must provide its senior plan
members with additional benefits beyond those required by Medicare or reduce its
premiums, or deductibles or co-payments, if any. HCFA has the right to audit
HMOs operating under Medicare contracts to determine the quality of care being
rendered and the degree of compliance with HCFA's contracts and regulations.
15
FUTURE HEALTH CARE REFORM. A number of legislative proposals have been made
at the Federal and state levels over the past several years. These proposals
would, among other things, mandate benefits with respect to certain diseases or
medical procedures, require plans to offer an independent external review of
certain coverage decisions or establish health plan liability in a manner
similar to the California legislation discussed above or the Georgia and Texas
legislation discussed in the following section. The United States Congress is
currently considering a number of alternative health care reform measures that
would, among other things, mandate external review of treatment denial
decisions, provide for managed care liability and allow for collective
bargaining by physicians groups. There have also been proposals made at the
Federal level to implement greater restrictions on employer-funded health plans,
which are generally exempted from state regulation by ERISA.
WellPoint is unable to evaluate what legislation may be proposed and when or
whether any legislation will be enacted and implemented. However, many of the
proposals, if adopted, could have a material adverse effect on WellPoint's
financial condition, cash flows or results of operations, while others, if
adopted, could potentially benefit WellPoint's business.
OTHER STATES
The Company's activities in other states are subject to state regulation
applicable to the provision of managed health care services and the sale of
traditional health indemnity insurance. As a result of the MMHD, GBO and Rush
Prudential acquisitions, the Company and certain of its subsidiaries are also
subject to regulation by the DOI in Delaware (which is the state of
incorporation and domicile of UNICARE Life & Health Insurance Company, the
Company's principal operating subsidiary outside of California), Illinois,
Indiana and in all other states. As the Company expands its offering of managed
care products in new geographic locations, it will be subject to additional
regulation by governmental agencies applicable to the provision of health care
services. The Company believes it is in compliance in all material respects with
all current state regulatory requirements applicable to its business as
presently conducted. However, changes in government regulations could affect the
level of services which the Company is required to provide or the rates which
the Company can charge for its health care products and services.
As the Company continues to expand its operations outside of California, new
legislative and regulatory developments in Delaware, Texas, Georgia (especially
after the expected completion of the Cerulean transaction), Illinois and various
other states will have greater potential effect on the Company's financial
condition, cash flows or results of operations. Over the past few years, there
has been an increase throughout the United States in proposed state legislation
regarding, among other things, mandated benefits, health plan liability,
third-party review of health plan coverage determinations and health plan
relationships with providers. The Company expects that this trend of increased
legislation will continue. In this regard, in 1999 the Georgia Legislature
adopted several new bills, including one that requires managed care plans to
offer coverage for services rendered by out-of-network providers and one that
establishes a "consumer advocate" with authority to review and comment upon
matters pending before the Department of Insurance Commissioner. These laws may
have the effect of increasing the Company's claims expense, especially after the
anticipated completion of the Cerulean transaction.
In 1997, the Texas legislature adopted SB 386 which, among other things,
purports to make managed care organizations ("MCOs") such as the Company liable
for the failure by the MCO, its employees or agents to exercise ordinary care
when making "health care treatment decisions" (as defined in the legislation).
The legislation was effective as of September 1, 1997. In September 1998, the
United States District Court for the Southern District of Texas ruled, in part,
that the MCO liability provisions of SB 386 are not preempted by ERISA. To date,
this legislation has not adversely affected the Company's results of operations.
However, although the Company maintains insurance covering such liabilities, to
the extent that this legislation (or similar legislation that may be
subsequently adopted at the Federal or state level) effectively expands the
scope of liability of MCOs, such as the Company, it may have a material adverse
effect on the Company's results of operations, financial condition and cash
flows. Even if the Company is
16
not held liable under any litigation, the existence of potential MCO liability
may cause the Company to incur greater costs in defending such litigation.
In connection with the GBO Acquisition, the Company has entered into a
reinsurance arrangement, on a 100% coinsurance basis, of the insured business of
the GBO. This business includes a small number of insured persons in Canada
covered by group policies issued to U.S.-based employers. As a result, the
Company may be subject to certain rules and regulations of applicable Canadian
regulatory agencies.
SERVICE MARKS
WellPoint and its subsidiaries have filed for registration of and maintain
several service marks, trademarks and trade names at the Federal level and in
California, including "Prudent Buyer Plan," "CaliforniaCare" and "UNICARE."
WellPoint, Blue Cross of California and BC Life are currently parties to license
agreements with the Blue Cross Blue Shield Association (the "BCBSA") which allow
them to use the Blue Cross name and mark in California with respect to
WellPoint's HMO and PPO network-based plans. Cerulean has also been granted
similar BCBSA licenses for the state of Georgia, which licenses are expected to
be transferred to WellPoint at the closing of the Cerulean transaction. The
BCBSA is a national trade association of Blue Cross and Blue Shield licensees,
the primary function of which is to promote the Blue Cross and Blue Shield
names. Each licensee is an independent legal organization and is not responsible
for the obligations of other BCBSA member organizations. A Blue Cross or Blue
Shield license requires payment of a fee to the BCBSA and compliance with
various requirements established by the BCBSA, including the maintenance of
specified minimum capital. The failure to meet such capital requirements can
subject the Company to certain corrective action, while the failure to meet a
lower specified level of capital can result in termination of the Company's
license agreement with the BCBSA. WellPoint considers the licensed Blue Cross
name and its registered service marks, trademarks and trade names important in
the operation of its business.
EMPLOYEES
At December 31, 1999, WellPoint and its subsidiaries employed approximately
10,600 persons. Approximately 142 of the Company's employees are presently
covered by a collective bargaining agreement with the Office and Professional
Employees International Union, Local 29. Approximately 198 of the Company's
office clerical employees in the greater Detroit area are presently covered by a
collective bargaining agreement with the International Brotherhood of Teamsters,
Chauffeurs, Warehousemen and Helpers of America, Local No. 614. WellPoint
believes that its relations with its employees are good, and it has not
experienced any work stoppages.
EXECUTIVE OFFICERS
Leonard D. Schaeffer, age 54, has been Chairman of the Board of Directors
and Chief Executive Officer of the Company since August 1992. Mr. Schaeffer has
also been Chief Executive Officer of BCC since 1986 and Chairman of the Board of
Directors since 1989. From 1982 to 1986, Mr. Schaeffer served as President of
Group Health, Inc., an HMO in the midwestern United States. Prior to joining
Group Health, Inc., Mr. Schaeffer was the Executive Vice President and Chief
Operating Officer of the Student Loan Marketing Association ("Sallie Mae"), a
financial institution that provides a secondary market for student loans, from
1980 to 1981. From 1978 to 1980, Mr. Schaeffer was the Administrator of HCFA.
HCFA administers the Federal Medicare, Medicaid and Peer Review Organization
programs. Mr. Schaeffer serves as a director of Allergan, Inc.
17
D. Mark Weinberg, age 47, has been Executive Vice President, Individual and
Small Group Businesses of the Company since April 1999. From October 1995 until
March 1999, he served as Executive Vice President, UNICARE Businesses of the
Company. From August 1992 until May 1996, Mr. Weinberg served as a director of
the Company. From February 1993 to October 1995, Mr. Weinberg was Executive Vice
President, Consumer and Specialty Services of the Company. Prior to February
1993, Mr. Weinberg was Executive Vice President of BCC's Consumer Services Group
from December 1989 to February 1993 and was Senior Vice President of Individual
and Senior Services of BCC from April 1987 to December 1989. From 1981 to 1987,
Mr. Weinberg held a variety of positions at Touche Ross & Co. From 1976 to 1981,
Mr. Weinberg was general manager for the CTX Products Division of PET, Inc.
Ronald A. Williams, age 50, has been Executive Vice President, Large Group
Businesses of the Company since April 1999. From October 1995 until March 1999,
he served as Executive Vice President, Blue Cross of California Businesses of
the Company. From August 1992 until May 1996, Mr. Williams served as a director
of the Company. From February 1993 to October 1995, Mr. Williams was Executive
Vice President, Group and Network Services of the Company. Prior to February
1993, Mr. Williams was Executive Vice President of BCC's Group Services from May
1992 to February 1993. Prior to that time, Mr. Williams served as Executive Vice
President of BCC's Health Services and Products Group from December 1989 to May
1992 and as BCC's Senior Vice President of Marketing and Related Products from
November 1988 to December 1989. From May 1987 to November 1988 he was Vice
President of Corporate Services of BCC. From July 1984 to May 1987 he was Senior
Vice President of Vista Health Corporation, an alternative delivery system for
outpatient psychological and substance abuse services of which he was also a
co-founder. Mr. Williams also serves as a director of Syncor International
Corporation.
Joan E. Herman, age 46, joined the Company in June 1998 as Executive Vice
President, Specialty Businesses. From April 1999 until March 2000, Ms. Herman
was Executive Vice President, Senior and Specialty Businesses. Since March 2000,
Ms. Herman has been Executive Vice President, Senior Specialty and
State-Sponsored Programs Businesses. From 1982 until joining the Company,
Ms. Herman was with Phoenix Home Life Mutual Insurance Company, a mutual
insurance company, most recently serving as Senior Vice President. Ms. Herman is
a member of the Society of Actuaries and American Academy of Actuaries.
Clifton R. Gaus, age 57, joined the Company in March 1999 as Executive Vice
President and Chief Administrative Officer. From March 1998 until joining the
Company, Mr. Gaus was Senior Vice President, Research and Development of Kaiser
Permanente, a managed health care firm. From March 1997 to 1998, Mr. Gaus was a
health care consultant. From February 1993 until March 1997, Mr. Gaus worked in
the United States Department of Health and Human Services, where he served in
various positions, including the Administrator of the Agency for Health Care
Policy and Research and senior advisor for the Office of Assistant Secretary.
Mr. Gaus was the founder and initial President of the Association for Health
Services Research.
David C. Colby, age 46, joined the Company in September 1997 as Executive
Vice President and Chief Financial Officer. From April 1996 until joining the
Company, Mr. Colby was Executive Vice President, Chief Financial Officer and
Director of American Medical Response, Inc., a health care services company
focusing on ambulance services and emergency physician practice management. From
July 1988 until March 1996, Mr. Colby was with Columbia/HCA Healthcare
Corporation, most recently serving as Senior Vice President and Treasurer. From
September 1983 until July 1988, Mr. Colby was Senior Vice President and Chief
Financial Officer of The Methodist Hospital in Houston, Texas.
Thomas C. Geiser, age 49, has been Executive Vice President, General Counsel
and Secretary of the Company since May 1996. From July 1993 until May 1996,
Mr. Geiser held the position of Senior Vice President, General Counsel and
Secretary. Prior to joining the Company, he was a partner in the law firm of
Brobeck, Phleger & Harrison from June 1990 to June 1993 and a partner in the law
firm of Epstein Becker Stromberg & Green from May 1985 to May 1990. Mr. Geiser
joined the law firm of Hanson,
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Bridgett, Marcus, Vlahos & Stromberg as an associate in March 1979 and became a
partner in the firm, leaving in May 1985.
MAY 1996 RECAPITALIZATION AND RESTRICTIONS ON OWNERSHIP AND TRANSFER OF
SECURITIES
The Company's predecessor, WellPoint Health Networks Inc., a Delaware
corporation ("Old WellPoint"), was organized in 1992 as a public for-profit
subsidiary of Blue Cross of California ("BCC"), to own and operate substantially
all of the managed health care businesses of BCC. In order to fulfill BCC's
public benefit obligations to the State of California arising out of the
creation of Old WellPoint, BCC and Old WellPoint undertook a recapitalization
(the "Recapitalization") which was concluded on May 20, 1996. As a result of the
Recapitalization, among other things, Old WellPoint merged into BCC, a special
dividend of $995.0 million was made to the shareholders of Old WellPoint and the
California HealthCare Foundation (the "Foundation") became the holder of
53,360,000 shares, or approximately 80%, of the surviving WellPoint entity.
In connection with the Recapitalization, BCC relinquished its rights under
the Blue Cross License Agreement dated January 1, 1991, between Blue Cross of
California and the BCBSA. The BCBSA and the Company entered into a new License
Agreement (the "License Agreement"), pursuant to which the Company became the
exclusive licensee for the right to use the Blue Cross name and related service
marks in California and became a member of the BCBSA. See "Service Marks."
The License Agreement required that the Foundation enter into a voting trust
agreement (the "Voting Trust Agreement"), pursuant to which the Foundation
deposited into a voting trust (the "Voting Trust") the number of shares of the
Company's Common Stock sufficient to reduce the Foundation's holdings outside
such Voting Trust to a level not in excess of 50% of the voting power of the
outstanding shares of the Company's Common Stock. The shares held by the trustee
under the Voting Trust Agreement (the "Voting Trust Shares") generally must be
voted (i) with respect to elections of directors, where the nominees have been
selected by the Nominating Committee (or, in certain instances, subsets of the
Board) in conformity with procedures set forth in the Company's Bylaws, to
support the position of the Board of Directors, (ii) with certain exceptions, on
matters requiring a vote of at least an absolute majority of all outstanding
shares of Common Stock, as the majority of non-Voting Trust Shares vote, and
(iii) on all other matters, in the identical proportion in favor of or in
opposition to such matters as non-Voting Trust Shares vote. With respect to the
removal of directors, calling of stockholder meetings and amendments of the
Company's Certificate of Incorporation and Bylaws, where such actions are
opposed by the Board of Directors, the Foundation has also agreed under the
Voting Trust Agreement to support the position of the Board of Directors. As a
result of a subsequent amendment to the License Agreement, as of June 12, 1999
the Voting Trust Agreement requires that the Foundation, through sales (which
may involve exercises of its registration rights described below) or additional
deposits into the Voting Trust, reduce its holding outside the Voting Trust to
5% of the outstanding Common Stock. As of March 15, 2000, approximately
1,311,181 shares held by the Foundation were subject to the provisions of the
Voting Trust Agreement. As of March 15, 2000, the Foundation owned 4,410,000
shares of WellPoint Common Stock, or approximately 7.1% of the outstanding
Common Stock.
With respect to those shares held by the Foundation in excess of the
"Ownership Limit" (as defined in the Company's Certificate of Incorporation and
discussed further in the following paragraph) that are not subject to the Voting
Trust Agreement, the Foundation has also entered into a voting agreement (the
"Voting Agreement"). The Voting Agreement provides among other things, that the
Foundation, during the period that it continues to own in excess of the
Ownership Limit, will vote all shares of the Company's Common Stock owned by it
in excess of 5% of the outstanding shares (except those shares held pursuant to
the Voting Trust Agreement) in favor of each nominee to the Board of Directors
of the Company who has been nominated by the Nominating Committee of the Board
of Directors, or under certain circumstances, other subsets of the board, all as
set forth in the Company's Bylaws. With respect to the removal of directors,
calling of shareholder meetings and amendment of the Company's Articles of
Incorporation and
19
Bylaws, where such actions are opposed by the Board of Directors, the Foundation
has also agreed under the Voting Agreement to support the position of the Board
of Directors. As of March 15, 2000, no shares held by the Foundation were
subject to the Voting Agreement.
At the time of the Recapitalization, the "Ownership Limit" was established
as one share less than 5% of the Company's outstanding voting securities. In
December 1997, the Company and the BCBSA, in accordance with the provisions of
Article VII, Section 14(f)(2) of the Company's Certificate of Incorporation,
agreed to modify the Ownership Limit to be the following: (i) for any
"Institutional Investor," one share less than 10% of the Company's outstanding
voting securities; and (ii) for any "Noninstitutional Investor," other than the
Foundation, one share less than 5% of the Company's outstanding voting
securities. For these purposes, "Institutional Investor" means any person if
(but only if) such person is (1) a broker or dealer registered under Section 15
of the Securities Exchange Act of 1934 (the "Exchange Act"), (2) a bank as
defined in Section 3(a)(6) of the Exchange Act, (3) an insurance company as
defined in Section 3(a)(19) of the Exchange Act, (4) an investment company
registered under Section 8 of the Investment Company Act of 1940, (5) an
investment adviser registered under Section 203 of the Investment Advisers Act
of 1940, (6) an employee benefit plan, or pension fund which is subject to the
provisions of the Employee Retirement Income Security Act of 1974 or an
endowment fund, (7) a parent holding company, provided the aggregate amount held
directly by the parent, and directly and indirectly by its subsidiaries which
are not persons specified in paragraphs (1) through (6), does not exceed one
percent of the securities of the subject class, or (8) a group, provided that
all the members are persons specified in paragraphs (1) through (7). In
addition, every filing made by such person with the SEC under Regulation 13D-G
(or any successor Regulation) under the Exchange Act with respect to such
person's beneficial ownership must contain a certification (or a substantially
similar one) that the WellPoint Common Stock acquired by such person was
acquired in the ordinary course of business and was not acquired for the purpose
of and does not have the effect of changing or influencing the control of
WellPoint and was not acquired in connection with or as a participant in any
transaction having such purpose or effect. For such purposes, "Noninstitutional
Investor" means any person that is not an Institutional Investor.
In December 1997, the Company and the BCBSA also agreed that the License
Agreement would be subject to termination in the event that any entity other
than the Foundation became the beneficial owner of 20% or more of WellPoint's
then-outstanding Common Stock or other equity securities which (either by
themselves or in combination) represented an ownership interest of 20% or
greater. WellPoint also agreed that it would not issue any class or series of
securities other than shares of Common Stock, non-voting, non-convertible debt
securities or such other securities as WellPoint may approve, provided that
WellPoint will provide the BCBSA with at least 30 days advance notice of the
issuance of such securities and the BCBSA will have the authority to determining
how such securities will be treated for purposes of determine a particular
holder's beneficial ownership of Common Stock.
In July 1999, WellPoint issued an aggregate of $299 million in principal
amount at maturity of Zero Coupon Convertible Subordinated Debentures Due 2019
(the "Debentures"). The BCBSA has determined that it will treat a holder of
Debentures at a particular time as beneficially owning shares of Common Stock
equal to the greater of (i) the number of shares into which the Debentures could
be converted upon exercise of the conversion right of the Debentures at such
time, and (ii) the number of shares of Common Stock which the holder would
receive if WellPoint paid the holder in shares of Common Stock upon exercise of
the holder's redemption right (assuming redemption of the Debentures at a price
equal to the original issue price plus then-accrued original issue discount and
based on the then-current market price of the Common Stock). This deemed
beneficial ownership will be aggregated with a Debentureholder's other
beneficial ownership of Common Stock for purposes of determining if the
Ownership Limit provisions have been violated. Any Debentureholder's deemed
beneficial ownership of Common Stock will fluctuate as a result of changes in
the market price of the Common Stock.
In connection with the Recapitalization, the Company and the Foundation also
entered into a registration rights agreement (the "Registration Rights
Agreement") with respect to the shares of the Company held by the Foundation.
The Registration Rights Agreement grants the Foundation (and certain
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transferees of the shares covered by the Registration Rights Agreement), certain
demand and "piggyback" registration rights which generally continue as long as
the Foundation owns 5% or more of the Company's outstanding Common Stock. The
undertakings made by Old WellPoint in order to secure the DOC's approval of the
Recapitalization required the Foundation to make certain minimum annual
distributions beginning in 1997. In order to fund such required distributions,
the Foundation may make sales from time to time of shares of the Company's
Common Stock pursuant to the exercise of its rights under the Registration
Rights Agreement.
In connection with the Recapitalization, BCC also received a ruling from the
IRS that, among other things, the conversion of BCC from a nonprofit public
benefit corporation to a for-profit entity (the "BCC Conversion") qualified as a
tax-free transaction and that no gain or loss was recognized by BCC for Federal
income tax purposes. The Foundation and the Company have entered into an
Indemnification Agreement which provides, with certain exceptions, that the
Foundation will indemnify WellPoint against the net tax liability as a result of
a revocation or modification, in whole or in part, of the ruling by the IRS or a
determination by the IRS that the BCC Conversion constitutes a taxable
transaction for Federal income tax purposes.
In August 1997, pursuant to approval by the stockholders at the Company's
1997 Annual Meeting, the Company reincorporated in the state of Delaware. Each
of the material agreements (other than the Indemnification Agreement) entered
into in connection with the Recapitalization was amended and restated on
substantially similar terms at the time of the reincorporation.
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATION
Certain statements contained in "Item 1. Business," such as statements
concerning the Company's geographic expansion and other business strategies, the
effect of recent health care reform legislation, changes in the competitive
environment and small group membership growth and other statements contained
herein regarding matters that are not historical facts, are forward-looking
statements (as such term is defined in the Securities Exchange Act of 1934).
Such statements involve a number of risks and uncertainties that may cause
actual results to differ from those projected. Factors that can cause actual
results to differ materially include, but are not limited to, those discussed
below. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof.
FEDERAL AND STATE HEALTH CARE REGULATION; LEGISLATIVE REFORM; ACTIVITIES AS
GOVERNMENT CONTRACTOR
WellPoint's operations are subject to substantial regulation by Federal,
state and local agencies. As a result of the MMHD and GBO Acquisitions,
WellPoint is now subject to the authority of state regulatory agencies in all 50
states. Such regulation may either relate to the Company's business operations
or to the financial condition of regulated subsidiaries. With regard to the
former, regulation typically covers prescribed benefits, relationships with
providers, marketing, advertising, quality assurance and member grievance
resolution. With regard to the latter, regulation typically governs the amount
of capital required to be retained in regulated subsidiaries and the ability of
such subsidiaries to pay dividends. There can be no assurance that any past or
future regulatory action by any such agencies will not have a material adverse
effect on the profitability or marketability of WellPoint's health plans, the
Company's ability to access capital from the operations of its regulated
subsidiaries or on its financial condition, cash flows or result of operations.
In addition to capital requirements imposed by the DOC and certain
Departments of Insurance, the Company and its BCBSA-licensed affiliates are
required to maintain certain levels of capital to satisfy BCBSA requirements.
During 1998, the National Association of Insurance Commissioners (the "NAIC"),
the trade association representing state insurance regulators, adopted a
risk-based capital formula for licensed managed care organizations called
Managed Care Organization Risk-Based Capital ("MCORBC"). The NAIC also approved
an accompanying Risk-Based Capital for Health Organizations Model Act (the
"Model Act"), which will serve as a model for states considering enacting new
legislation. The BCBSA adopted the MCORBC formula effective as of December 31,
1999. If adopted by states, the
21
minimum capital requirements under the Model Act are not expected to have a
material impact on the Company, although there can be no assurances that new
minimum capital requirements will not increase the Company's capital
requirements in the future.
The health care industry has become the subject of greater legislative and
media scrutiny in recent years. In 1999, California adopted a considerable
number of health care reform measures, including legislation providing for
health plan liability and independent review of health plan decisions. See
"Government Regulation." An increasing number of proposals are being considered
by the United States Congress and state legislatures relating to health care
reform and the Company expects that some of such proposals will be enacted.
There can be no assurance that compliance with recently enacted or future
legislation will not have a material adverse impact on WellPoint's claims
expense, financial condition, cash flows or results of operations.
The Company provides insurance products to Medi-Cal beneficiaries in various
California counties under contracts with the DHS (or a delegated local agency).
The Company also provides administrative services for HCFA in various
capacities, including certain Medicare programs and under its Blue Cross Senior
Secure plan. There can be no assurance that acting as a government contractor in
these circumstances will not increase the risk of heightened scrutiny by such
government agencies, or that the profitability from this business will not be
adversely affected through inadequate premium rate increases due to governmental
budgetary issues. Future actions by any regulatory agencies may have a material
adverse effect on the Company's business.
PENDING TRANSACTION WITH CERULEAN
WellPoint has entered into the Merger Agreement with Cerulean pursuant to
which Cerulean will become a wholly owned subsidiary of the Company. (See
"Recent Developments--Pending Transaction with Cerulean.") Completion of the
Merger is subject to the satisfaction of a number of conditions, including
approval by the Georgia Department of Insurance. There can be no assurances that
the required approvals will be obtained. In addition, the timing of the
resolution of the Conversion Litigation could delay the closing. If all
conditions to closing are not met on or before December 31, 2000, each of
WellPoint and Cerulean will have the right to terminate the Merger Agreement. As
a result, there can be no assurances that the transaction will be consummated.
As a condition to approval of the transaction, regulatory agencies may
impose requirements or limitations on the way that the combined company conducts
its business. If WellPoint or Cerulean were to agree to any material
requirements or limitations in order to obtain approvals, such requirements or
limitations or additional costs associated therewith could adversely affect
WellPoint's ability to integrate the operations of Cerulean with those of
WellPoint. Accordingly, a material adverse effect on WellPoint's revenues,
results of operations and cash flows following the Merger could result.
The Company intends to incur debt to finance some or all of the cash
payments to be made to Cerulean shareholders in connection with the pending
acquisition. In addition, WellPoint has received authorization to and has
repurchased shares of its Common Stock to offset shares that are expected to be
issued in connection with the transaction. Since the purchase price is fixed at
$500 million, the number of shares required to be issued is dependent upon the
stock price over a specified period of time immediately prior the Closing Date.
WellPoint has made significant repurchases of its Common Stock for this purpose,
using excess cash as well as the issuance of additional indebtedness under the
Company's existing revolving credit facility. Upon completion of the Cerulean
transaction, WellPoint may incur significant additional indebtedness to fund not
only the cash portion of the transaction but any further repurchases of its
Common Stock. Such additional indebtedness may require that a significant amount
of the Company's cash flow be applied to the payment of interest, and there can
be no assurance that the Company's operations will generate sufficient cash flow
to service the indebtedness. Any additional indebtedness may adversely affect
the Company's ability to finance its operations and could limit its ability to
pursue additional business opportunities that may be in the best interests of
the Company and its stockholders.
22
CLASS ACTION LAWSUITS AND OTHER EVOLVING THEORIES OF RECOVERY
In late 1999, a number of class-action lawsuits were brought against several
of the Company's competitors alleging, among other things, various
misrepresentations regarding their health plans and breaches of fiduciary
obligations to health care members. The Company has not yet been made party to
any of such lawsuits.
In addition, WellPoint, like health insurers generally, excludes certain
health care services from coverage under its HMO, PPO and other plans. In the
ordinary course of business, WellPoint is subject to the claims of its members
from decisions to restrict reimbursement for certain treatments. The loss of
even one such claim, if it were to result in a significant punitive damage
award, could have a material adverse effect on WellPoint's financial condition
or results of operations. In addition, the risk of potential liability under
punitive damage theories may significantly increase the difficulty of obtaining
reasonable settlements of coverage claims. The financial and operational impact
that such evolving theories of recovery may have on the managed care industry
generally, or WellPoint in particular, is presently unknown. See "Government
Regulation."
HEALTH CARE COSTS AND PREMIUM PRICING PRESSURES
WellPoint's future profitability will depend in part on accurately
predicting health care costs and on its ability to control future health care
costs through underwriting criteria, utilization management, product design and
negotiation of favorable provider and hospital contracts. 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 and numerous
other factors affecting health care costs may adversely affect WellPoint's
ability to predict and control health care costs as well as WellPoint's
financial condition, results of operations or cash flows. Periodic
renegotiations of hospital and other provider contracts, coupled with continued
consolidation of physician, hospital and other provider groups, may result in
increased health care costs or limit the Company's ability to negotiate
favorable rates. In the past few years, large physician practice management
companies have experienced extreme financial difficulties (including
bankruptcy), which may subject the Company to increased credit risk related to
provider groups and cause the Company to incur duplicative claims expense.
In addition to the challenge of controlling health care costs, the Company
faces competitive pressure to contain premium prices. While health plans compete
on the basis of many factors, including service and the quality and depth of
provider networks, the Company expects that price will continue to be a
significant basis of competition. Fiscal concerns regarding the continued
viability of programs such as Medicare and Medicaid may cause decreasing
reimbursement rates for government-sponsored programs. WellPoint's financial
condition or results of operations would be adversely affected by significant
premium decreases by any of its major competitors or by any limitation on the
Company's ability to increase or maintain its premium levels.
INTEGRATION OF ACQUISITIONS; GEOGRAPHIC EXPANSION STRATEGY; FUTURE
ACQUISITIONS
One component of the Company's business strategy has been to diversify into
new geographic markets, particularly through strategic acquisitions. The Company
completed the MMHD acquisition in March 1996, the GBO acquisition in March 1997
and the Rush Prudential acquisition in March 2000. Since the relevant dates of
acquisition, the Company has worked extensively on the integration of the
acquired MMHD and GBO businesses, including consolidating existing operations
sites and converting certain accounts to the Company's information systems. The
Company has also begun its integration of the Rush Prudential businesses. The
Company is continuing the consolidation of these acquired operations into its
operations, which will require considerable expenditures and a significant
amount of management time. Assuming the acquisition of Cerulean is consummated,
WellPoint will then undertake similar integration efforts for this acquired
business. Due to the complex nature of the merger integration process,
particularly the information systems designed to serve these businesses, the
Company may temporarily experience
23
increases in claims inventory or other service-related issues that may
negatively affect the Company's relationship with its customers and contribute
to increased attrition of such customers. The success of these acquisitions
will, among other things, also require the integration of a significant number
of the employees into the Company's existing operations and the completion of
the integration of separate information systems. No assurances can be given
regarding the ultimate success of the integration of these acquisitions into the
Company's business.
Both the acquired MMHD operations and the GBO have some indemnity-based
insurance operations, with a significant number of members outside of
California. Each of these operations experienced varying profitability or losses
in recent periods. As anticipated at the time of acquisition, the Company has
experienced material membership attrition related to these businesses in 1998
and 1999 and expects to continue to experience membership attrition during 2000
as it pursues its strategy of motivating traditional indemnity health insurance
members to select managed care products. There can be no assurances that a
sufficient number of these members will accept managed care health plans or that
the Company will be able to continue existing relationships with provider
networks currently serving those members or develop satisfactory proprietary
provider networks in these geographic areas. The development of such networks
will require considerable expenditures by the Company.
As the Company pursues its geographic expansion strategy, the Company's
market share in new markets will not be as significant, and its provider
networks not as extensive, as in California, and the Company will not have the
benefit of the Blue Cross mark (except in Georgia after completion of the
Cerulean transaction), which are important components of its success in
California. The Company no longer has the benefit of the MassMutual or John
Hancock trade names and, after an initial transition period, will no longer have
the benefit of the Rush Prudential trade name. There can be no assurance that
the absence of one or more of these elements will not adversely affect the
success of the Company's geographic expansion strategy.
The Company actively considers acquisition opportunities on a regular basis,
both in connection with its geographic expansion strategy and its California
operations. Except with respect to Cerulean, the Company currently has no
existing agreements or commitments to effect any material acquisition.
Accordingly, there can be no assurance that the Company will be able to identify
additional acquisition candidates available for sale at reasonable prices or
consummate any acquisition or that any discussions will result in an
acquisition. Any such acquisitions may require significant additional capital
resources and there can be no assurance that the Company will have access to
adequate capital resources to effect such future acquisitions. To the extent
that the Company consummates acquisitions, there can be no assurance that such
acquisitions will be successfully integrated into the Company or that such
acquisitions will not adversely affect the Company's results of operations, cash
flows and financial condition.
Prior to the Company's acquisition of the GBO, John Hancock Mutual Life
Insurance Company ("John Hancock") entered into a number of reinsurance
arrangements with respect to personal accident insurance and the occupational
accident component of workers' compensation insurance, a portion of which was
originated through a pool managed by Unicover Managers, Inc. Under these
arrangements, John Hancock assumed risks as a reinsurer and transferred certain
of such risks to other companies. These arrangements have recently become the
subject of disputes, including a number of legal proceedings to which
John Hancock is a party. The Company believes that it has a number of defenses
to avoid any ultimate liability with respect to these matters and believes that
such liabilities were not transferred to the Company as part of the GBO
Acquisition. However, if the Company were to become subject to such liabilities,
the Company could suffer losses that might have a material adverse effect on its
financial condition, results of operations or cash flows.
COMPETITION
Managed health care organizations operate in a highly competitive
environment that is subject to significant change from legislative reform,
business consolidations, new strategic alliances, aggressive
24
marketing practices by other managed health care organizations, the development
of companies offering Internet-based connections between providers, employers
and members and other market pressures. A significant portion of the Company's
operations are in California, where the managed health care industry is
especially competitive. In addition, the managed health care industry in
California has undergone significant changes in recent years, including
substantial consolidation. Outside of California, the Company faces competition
from other regional and national companies, many of which have (or due to future
consolidation, may have) significantly greater financial and other resources and
market share than the Company. If competition were to further increase in any of
its markets, WellPoint's financial condition, cash flows or results of
operations could be materially adversely affected.
A substantial portion of WellPoint's California business is in the
individual and small employer group market, where the loss ratio is
significantly lower than in the large employer group market. The individual and
small employer group business constituted approximately 37% of WellPoint's total
premium revenue for the year ended December 31, 1999. WellPoint has experienced
increasing competition in the individual and small employer group market over
the past several years, which could adversely affect WellPoint's loss ratio and
future financial condition or results of operations. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations."
DEPENDENCE ON INDEPENDENT AGENTS AND BROKERS
The Company is dependent on the services of independent agents and brokers
in the marketing of its health care plans, particularly with respect to
individuals, seniors and small employer group members. Such independent agents
and brokers are typically not exclusively dedicated to the Company and may
frequently also market health care plans of the Company's competitors. The
Company faces intense competition for the services and allegiance of independent
agents and brokers.
EMPLOYEE MATTERS
The Company is dependent on retaining existing employees and attracting and
retaining additional qualified employees to meet its future needs. The Company
faces intense competition for qualified employees, particularly during the
present economic environment of low unemployment, and there can be no assurance
that the Company will be able to attract and retain such employees or that such
competition among potential employers will not result in increasing salaries.
There can be no assurance that an inability to retain existing employees or
attract additional employees will not have a material adverse effect on the
results of operations of the Company. The Company is especially dependent on
attracting and retaining qualified information technology personnel and other
skilled professionals.
EFFECT OF YEAR 2000 ON COMPUTER SYSTEMS AND APPLICATIONS
Beginning in 1997 and continuing throughout 1998 and 1999, the Company
developed and implemented a comprehensive plan designed to address the year 2000
issue for its information technology ("IT") and its non-information technology
systems and applications ("non-IT systems"). This plan included a detailed risk
assessment of its various computer systems, business applications and other
affected systems, the completion of remediation efforts, internal testing and
third-party review of certain of its year 2000 remediation efforts. To date, the
Company has not experienced any significant disruptions in its operations as a
result of year 2000 issues nor is the Company aware of any significant year
2000-related disruptions experienced by any other company with which WellPoint
interacts on a regular basis. See "Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations--Year 2000" for a more
comprehensive discussion of the year 2000 issue.
TAX ISSUES RELATING TO THE RECAPITALIZATION
In connection with the Recapitalization, BCC received a ruling from the IRS
that, among other things, the BCC Conversion qualified as a tax-free transaction
and that no gain or loss was recognized by BCC for Federal income tax purposes.
If the ruling were subsequently revoked, modified or not honored by the IRS
25
(due to a change in law or for any other reason), WellPoint, as the successor to
BCC, could be subject to Federal income tax on the difference between the value
of BCC at the time of the BCC Conversion and BCC's tax basis in its assets at
the time of the BCC Conversion. The potential tax liability to WellPoint if the
BCC Conversion is treated as a taxable transaction is currently estimated to be
approximately $696 million, plus interest (and possibly penalties). BCC and the
Foundation entered into an Indemnification Agreement that provides, with certain
exceptions, that the Foundation will indemnify WellPoint against the net tax
liability as a result of a revocation or modification, in whole or in part, of
the ruling by the IRS or a determination by the IRS that the BCC Conversion
constitutes a taxable transaction for Federal income tax purposes. In the event
a tax liability should arise against which the Foundation has agreed to
indemnify WellPoint, there can be no assurance that the Foundation will have
sufficient assets to satisfy the liability in full, in which case WellPoint
would bear all or a portion of the cost of the liability, which could have a
material adverse effect on WellPoint's financial condition.
ITEM 2. PROPERTIES.
Effective as of January 1, 1996, the Company entered into a lease for Blue
Cross of California's Woodland Hills, California headquarters facility, which
provides for a term expiring in December 2019 with two options to extend the
term for up to two additional five-year terms. Rent expense under the lease was
approximately $5.3 million during 1999. In 1997, the Company entered into a
lease, which expires in December 2019, for a new facility located in Thousand
Oaks, California housing certain corporate and specialty services. This facility
was completed in January 1999. The Company and its subsidiaries have additional
offices in the greater Los Angeles and Ventura County area. As a result of the
Company's continuing national expansion efforts, the Company maintains offices
in various other locations, including Springfield, Massachusetts; Charlestown,
Massachusetts; the greater Chicago, Illinois area; Dearborn, Michigan; and
Plano, Texas.
ITEM 3. LEGAL PROCEEDINGS.
WellPoint and certain of its subsidiaries are parties to various legal
proceedings, many of which involve claims for coverage encountered in the
ordinary course of its business. WellPoint, like health plans generally,
excludes certain health care services from coverage under its HMO, PPO and other
plans. In the ordinary course of its business, WellPoint is subject to the
claims of its enrollees arising out of decisions to restrict reimbursement for
certain treatments. The loss of even one such claim, if it resulted in a
significant punitive damage award, could have a material adverse effect on
WellPoint. In addition, the risk of potential liability under punitive damage
theories may increase significantly the difficulty of obtaining reasonable
settlements of coverage claims. Further, legislation that would potentially
establish the liability of health plans for medical decisions has been enacted
in California, Texas and Georgia and is pending in various states. See "Item 1.
Business Government Regulation." In late 1999, a number of class-action lawsuits
were brought against several of the Company's competitors alleging, among other
things, various misrepresentations regarding their health plans and breaches of
fiduciary obligations to health care members. The Company has not yet been made
party to any of such lawsuits. The financial and operational impact that such
evolving theories of recovery will have on the managed care industry generally,
or WellPoint in particular, is at present unknown. Certain of such legal
proceedings are or may be covered under insurance policies or indemnification
agreements. Based upon information presently available, the Company believes
that the final outcome of all such proceedings should not have a material
adverse effect upon WellPoint's results of operations, cash flows or financial
condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
26
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock has been traded on the New York Stock Exchange
under the symbol "WLP" since the Company's initial public offering on
January 27, 1993. The following table sets forth for the periods indicated the
high and low sale prices for the Common Stock.
HIGH LOW
----------- -----------
Year Ended December 31, 1998
First Quarter............................................. 70 1/16 42 1/4
Second Quarter............................................ 74 61 15/16
Third Quarter............................................. 74 11/16 51 1/4
Fourth Quarter............................................ 87 51 7/16
Year Ended December 31, 1999
First Quarter............................................. 87 13/16 69 3/8
Second Quarter............................................ 97 66 13/16
Third Quarter............................................. 86 11/16 54 3/4
Fourth Quarter............................................ 67 5/8 48 1/4
On March 15, 2000 the closing price on the New York Stock Exchange for the
Company's Common Stock was $63 1/2 per share. As of March 15, 2000, there were
approximately 555 holders of record of Common Stock.
The Company did not pay any dividends on its Common Stock in 1998 or 1999.
Management currently expects that all of WellPoint's future income will be used
to expand and develop its business. The Board of Directors currently intends to
retain the Company's net earnings during 2000.
During October and November 1999, the Company inadvertently sold
approximately 6,030 shares without registration under the Securities Act of 1933
to its employees participating in the Company's 401(k) Retirement Savings Plan.
These shares were sold for an aggregate of approximately $375,000.
27
ITEM 6. SELECTED FINANCIAL DATA.
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
1999 1998 1997 1996 1995
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA, MEMBERSHIP
DATA AND OPERATING STATISTICS)
CONSOLIDATED INCOME STATEMENTS(A)
Revenues:
Premium revenue......................................... $6,896,857 $5,934,812 $5,068,947 $3,699,337 $2,776,760
Management services revenue............................. 429,336 433,960 377,138 147,911 61,151
Investment income....................................... 159,234 109,578 196,153 123,584 120,913
---------- ---------- ---------- ---------- ----------
7,485,427 6,478,350 5,642,238 3,970,832 2,958,824
Operating Expenses:
Health care services and other benefits................... 5,533,068 4,776,345 4,087,420 2,825,914 2,090,036
Selling expense........................................... 328,619 280,078 249,389 202,318 177,058
General and administrative expense........................ 1,075,449 975,099 836,581 543,541 327,951
Nonrecurring costs........................................ -- -- 14,535 -- 57,074
---------- ---------- ---------- ---------- ----------
6,937,136 6,031,522 5,187,925 3,571,773 2,652,119
---------- ---------- ---------- ---------- ----------
Operating Income............................................ 548,291 446,828 454,313 399,059 306,705
Interest expense.......................................... 20,178 26,903 36,658 36,628 --
Other expense, net........................................ 40,792 27,939 31,301 25,195 9,718
---------- ---------- ---------- ---------- ----------
Income from Continuing Operations before provision for
income taxes, extraordinary gain and cumulative effect of
accounting change......................................... 487,321 391,986 386,354 337,236 296,987
Provision for income taxes................................ 190,110 72,438 156,917 138,718 122,232
---------- ---------- ---------- ---------- ----------
Income from Continuing Operations before extraordinary gain
and cumulative effect of accounting change................ 297,211 319,548 229,437 198,518 174,755
Income (loss) from discontinued operations................ -- (88,268) (2,028) 3,484 5,234
Extraordinary gain from early extinguishment of debt,
net of tax.............................................. 1,891 -- -- -- --
Cumulative effect of accounting change, net of tax........ (20,558) -- -- -- --
---------- ---------- ---------- ---------- ----------
Net Income.................................................. $ 278,544 $ 231,280 $ 227,409 $ 202,002 $ 179,989
========== ========== ========== ========== ==========
Per Share Data(A)(B)(C):
Income from Continuing Operations before extraordinary
gain and cumulative effect of accounting change:
Earnings Per Share...................................... $ 4.50 $ 4.63 $ 3.33 $ 2.99 $ 2.63
Earnings Per Share Assuming Full Dilution............... $ 4.38 $ 4.55 $ 3.30 $ 2.99 $ 2.63
Extraordinary Gain:
Earnings Per Share........................................ $ 0.03 -- -- -- --
Earnings Per Share Assuming Full Dilution................. $ 0.02 -- -- -- --
Cummulative Effect Of
Accounting Change......................................... $ (0.31) -- -- -- --
Earnings Per Share Assuming Full Dilution................. $ (0.30) -- -- -- --
Income (Loss) from Discontinued Operations:
Earnings Per Share...................................... -- $ (1.28) $ (0.03) $ 0.05 $ 0.08
Earnings Per Share Assuming Full Dilution............... -- $ (1.26) $ (0.03) $ 0.05 $ 0.08
Net Income:
Earnings Per Share...................................... $ 4.22 $ 3.35 $ 3.30 $ 3.04 $ 2.71
Earnings Per Share Assuming Full Dilution............... $ 4.10 $ 3.29 $ 3.27 $ 3.04 $ 2.71
OPERATING STATISTICS (A)(D):
Loss ratio................................................ 80.2% 80.5% 80.6% 76.4% 75.3%
Selling expense ratio..................................... 4.5% 4.4% 4.6% 5.3% 6.2%
General and administrative expense ratio.................. 14.7% 15.3% 15.4% 14.1% 11.6%
Net income ratio.......................................... 3.8% 3.6% 4.2% 5.3% 6.3%
DECEMBER 31,
--------------------------------------------------------------
1999 1998 1997 1996 1995
---------- ---------- ---------- ---------- ----------
BALANCE SHEET DATA(A):
Cash and investments...................................... $3,258,666 $2,764,302 $2,560,537 $1,849,814 $1,981,532
Total assets.............................................. $4,593,234 $4,225,834 $4,234,124 $3,149,378 $2,471,360
Long-term debt............................................ $ 347,884 $ 300,000 $ 388,000 $ 625,000 --
Total equity.............................................. $1,312,700 $1,315,223 $1,223,169 $ 870,459 $1,670,226
Cash dividends declared per common share(E)............... -- -- -- $ 10.00 --
MEDICAL MEMBERSHIP(F)....................................... 7,300,00 6,892,000 6,638,000 4,485,000 2,797,000
- ----------------------------------
(A) Financial information prior to 1998 has been restated to present the
workers' compensation business as a discontinued operation.
(B) Per share data for all periods presented prior to 1996 have been recomputed
using 66,366,500 shares, the number of shares outstanding immediately
following completion of the Recapitalization. Per share data for the year
ended December 31, 1996 has been calculated using such 66,366,500 shares,
plus the weighted average number of shares issued during 1996 after the
Recapitalization.
(C) Per share data includes nonrecurring costs of $0.13 and $0.52 per basic and
diluted share for 1997 and 1995, respectively.
(D) The loss ratio represents health care services and other benefits as a
percentage of premium revenue. All other ratios are shown as a percentage of
premium revenue and management services revenue.
(E) The Company paid a $995.0 million special dividend in conjunction with the
Recapitalization which occurred on May 20, 1996. Management currently
expects that all of the Company's future income will be used to expand and
develop its business.
(F) Membership numbers are approximate and include some estimates based upon the
number of contracts at the relevant date and an actuarial estimate of the
number of members represented by each contract.
28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This discussion contains forward-looking statements which involve risks and
uncertainties. The Company's actual results may differ materially from those
anticipated in these forward-looking statements as a result of certain factors
including, but not limited to, those set forth under "Factors That May Affect
Future Results of Operations."
GENERAL
The Company is one of the nation's largest publicly traded managed health
care companies. As of December 31, 1999, WellPoint had approximately 7.3 million
medical members and approximately 32 million specialty members. The Company
offers a broad spectrum of network-based managed care plans. WellPoint provides
these plans to the large and small employer, individual and senior markets. The
Company's managed care plans include HMOs, PPOs, POS plans, other hybrid medical
plans and traditional indemnity plans. In addition, the Company offers managed
care services, including underwriting, actuarial services, network access,
medical cost management and claims processing. The Company also provides a broad
array of specialty and other products, including pharmacy, dental, utilization
management, life insurance, preventive care, disability insurance, behavioral
health, COBRA and flexible benefits account administration. The Company markets
its products in California under the name Blue Cross of California and outside
of California under the name UNICARE. Historically, the Company's primary market
for managed care products has been California. The Company holds the exclusive
right in California to market its products under the Blue Cross name and mark.
SALE OF WORKERS' COMPENSATION SEGMENT
On July 29, 1998, WellPoint entered into a Stock Purchase Agreement (the
"Stock Purchase Agreement") by and between WellPoint and Fremont Indemnity
Company ("Fremont"). Pursuant to the Stock Purchase Agreement, Fremont acquired
all of the outstanding capital stock of UNICARE Specialty Services, Inc., a
wholly owned subsidiary of WellPoint ("UNICARE Specialty"). The transaction was
completed on September 1, 1998. The principal asset of UNICARE Specialty was the
capital stock of UNICARE Workers' Compensation Insurance Company ("UNICARE
Workers' Compensation"). The purchase price for the acquisition was the
statutory surplus (adjusted in accordance with the terms of the Purchase
Agreement) of UNICARE Workers' Compensation as of the date of the closing. The
purchase price based upon adjusted statutory surplus of UNICARE Workers'
Compensation as of September 1, 1998, the closing date of the transaction, was
approximately $110.0 million, after closing adjustments. Subsequent to
September 1, 1998, the Company and Fremont are jointly marketing integrated
workers' compensation and medical insurance products in the small employer group
market. Based upon the results of a post-closing audit, the Company made a
payment of approximately $6.7 million in final settlement of the purchase price.
NATIONAL EXPANSION AND OTHER RECENT DEVELOPMENTS
In an effort to pursue the expansion of the Company's business outside the
state of California, the Company acquired two businesses in 1996 and 1997, the
Life and Health Benefits Management Division ("MMHD") of Massachusetts Mutual
Life Insurance Company and the Group Benefits Operations (the "GBO") of John
Hancock Mutual Life Insurance Company. The Company's March 1, 2000 acquisition
of Rush Prudential Health Plans and its pending transaction with Cerulean
Companies, Inc. ("Cerulean") are also components of this expansion strategy.
As a result of the GBO and MMHD acquisitions, the Company has significantly
expanded its operations outside of California. In order to integrate its
acquired businesses and implement the Company's regional expansion strategy, the
Company will need to develop satisfactory networks of hospitals, physicians and
other health care service providers, develop distribution channels for its
products and
29
successfully convert acquired books of business to the Company's existing
information systems, which will require continued investments by the Company.
In response to rising medical and pharmacy costs the Company has recently
implemented premium increases with respect to certain of its products. The
Company will continue to evaluate the need for further premium increases, plan
design changes and other appropriate actions in the future in order to maintain
or restore profit margins. There can be no assurances, however, that the Company
will be able to take subsequent pricing or other actions or that any actions
previously taken or implemented in the future will be successful in addressing
any concerns that may arise with respect to the performance of certain
businesses.
ACQUISITION OF RUSH PRUDENTIAL
On March 1, 2000, the Company completed its acquisition of Rush Prudential
Health Plans ("Rush Prudential"). Rush Prudential offers a broad array of
products and services ranging from HMO products to traditional PPO products. The
acquisition has more than doubled the Company's current Illinois medical
membership to nearly 600,000 members. The transaction, which was financed with
cash, is valued at approximately $200 million, subject to certain post-closing
adjustments. This acquisition will be accounted for under the purchase method of
accounting.
PENDING ACQUISITION OF CERULEAN
On July 9, 1998, the Company entered into an Agreement and Plan of Merger
with Cerulean (See Note 22 to the Consolidated Financial Statements). Cerulean,
principally through its Blue Cross and Blue Shield of Georgia subsidiary, offers
insured and administrative services products primarily in the State of Georgia.
Cerulean has historically experienced a higher administrative expense ratio than
the Company's core businesses due to its higher concentration of administrative
services business. Cerulean has also historically experienced a higher medical
loss ratio than the Company's core businesses due to its higher percentage of
large group business and fewer managed care offerings. Accordingly, it is
expected that Cerulean's higher loss and administrative expense ratios will
ultimately contribute to an increase in those ratios for the Company after the
transaction is completed. The transaction is expected to be completed during
2000.
LEGISLATION
In September 1999, the California Legislature enacted and the California
Governor subsequently signed into law a number of health care reform measures.
Federal legislation enacted during the last four years seeks, among other
things, to insure the portability of health coverage and mandates minimum
maternity hospital stays. California legislation enacted during 1999, among
other things, establishes an explicit duty on managed care entities to exercise
ordinary care in arranging for the provision of medically necessary health care
services and establishes a system of independent medical review. In 1997, Texas
adopted legislation purporting to make managed care organizations such as the
Company liable for their failure to exercise ordinary care when making health
care treatment decisions. Similar legislation has also been enacted in Georgia.
These and other proposed measures may have the effect of dramatically altering
the regulation of health care and of increasing the Company's loss ratio and
administrative costs or decreasing the affordability of the Company's products.
YEAR 2000
The Company is substantially dependent on its computer systems, business
applications and other information technology systems ("IT systems"), due to the
nature of its managed health care business and the increasing number of
electronic transactions in the industry. Historically, many IT systems were
developed to recognize the year as a two-digit number, with the digits "00"
being recognized as the year
30
1900. As a result, the year 2000 presented a number of potential problems for
such systems, including potentially significant processing errors or failure.
Given the Company's reliance on its computer systems to process health care
transactions, the Company's results of operations could be materially adversely
affected by any significant errors or failures. Additionally, the year 2000
presented potential problems for other systems and applications containing
date-dependent embedded microprocessors ("non-IT systems"), such as elevators
and heating and ventilation equipment.
Beginning in 1997 and continuing throughout 1998 and 1999, the Company
developed and implemented a comprehensive plan designed to address the "year
2000" issue for its IT and non-IT systems and applications. This plan included a
detailed risk assessment of the Company's various computer systems, business
applications and other affected systems, the completion of remediation efforts,
on-going internal testing and third-party review of certain of its year 2000
remediation efforts.
As part of its year 2000 readiness efforts, the Company's various business
units formulated detailed contingency plans in order to address unexpected year
2000 readiness issues or issues beyond the Company's control. These contingency
plans focused on identifying potential failure scenarios for the Company's IT
and non-IT systems and those of third parties with which the Company interacts
and on ensuring the continuation of critical business operations.
During the year ended December 31, 1999, the Company spent approximately
$7.1 million for remediation of its IT software systems and applications,
approximately $1.0 million for renovation or replacement of its
telecommunications equipment. The Company expensed year 2000 remediation costs
as incurred and funded these costs through cash flow from operations.
To date, the Company has not experienced any significant disruptions in its
operations as a result of year 2000 issues nor is the Company aware of any
significant year 2000-related disruptions experienced by any other company with
which the Company interacts on a regular basis. The Company will continue to
monitor its IT and non-IT systems throughout 2000 with respect to year 2000
compliance issues.
If the Company were to experience any year 2000 issues, either as a result
of a failure of its own systems or those of third parties with which it
interacts, the Company could be subject to a number of potential consequences
including, among others, inability to timely and accurately process health care
claims, collect customers' premiums and administrative fees, verify subscriber
eligibility, assess utilization trends or compile accurate financial data for
use by management. The Company is attempting to limit its exposure to any year
2000 issues by closely monitoring its on-going year 2000 readiness efforts,
assessing the year 2000 readiness efforts of various third party with which it
interacts and developing contingency plans addressing potential problems that
could have a material adverse effect on the Company's results of operations.
RESULTS OF OPERATIONS
The Company's revenues are primarily generated from premiums earned for
risk-based health care and specialty services provided to its members, fees for
administrative services, including claims processing and access to provider
networks for self-insured employers and investment income. Operating expenses
include health care services and other benefits expenses, consisting primarily
of payments for physicians, hospitals and other providers for health care and
specialty products claims; selling expenses for broker and agent commissions;
general and administrative expenses; interest expense; depreciation and
amortization expense; and income taxes.
The Company's consolidated results of operations for each of the years ended
December 31, 1999 and 1998, include a full year of earnings for the MMHD and GBO
acquired businesses. The results of operations for the year ended December 31,
1997 include ten months of earnings for the GBO, from the date of its
acquisition.
31
The following table sets forth selected operating ratios. The loss ratio for
health care services and other benefits is shown as a percentage of premium
revenue. All other ratios are shown as a percentage of premium revenue and
management services revenue combined.
YEAR ENDED DECEMBER 31,
------------------------------------
1999 1998 1997
-------- -------- --------
Operating Revenues:
Premium revenue................................. 94.1% 93.2% 93.1%
Management services revenue..................... 5.9% 6.8% 6.9%
----- ----- -----
100.0% 100.0% 100.0%
Operating Expenses:
Health care services and other benefits (loss
ratio)........................................ 80.2% 80.5% 80.6%
Selling expense................................. 4.5% 4.4% 4.6%
General and administrative expense.............. 14.7% 15.3% 15.4%
32
MEMBERSHIP
The following table sets forth membership data and the percent change in
membership:
AS OF DECEMBER 31,
--------------------- PERCENT
1999 1998 CHANGE
--------- --------- --------
Medical Membership (a)(b):
Large Employer Group (c)
California
HMO..................................................... 1,650,350 1,416,569 16.5%
PPO and Other........................................... 1,790,671 1,422,340 25.9%
--------- ---------
Total California...................................... 3,441,021 2,838,909 21.2%
--------- ---------
Texas..................................................... 170,435 173,541 (1.8)%
Georgia................................................... 53,237 89,232 (40.3)%
Other States.............................................. 1,545,715 1,849,902 (16.4)%
--------- ---------
Total Large Employer Group............................ 5,210,408 4,951,584 5.2%
--------- ---------
Individual and Small Employer Group
California
HMO..................................................... 336,315 330,454 1.8%
PPO and Other........................................... 1,167,959 1,135,488 2.9%
--------- ---------
Total California...................................... 1,504,274 1,465,942 2.6%
--------- ---------
Texas..................................................... 168,517 100,610 67.5%
Georgia................................................... 30,100 22,156 35.9%
Other States.............................................. 150,638 137,425 9.6%
--------- ---------
Total Individual and Small Employer Group............. 1,853,529 1,726,133 7.4%
--------- ---------
Senior (d)
California
HMO..................................................... 28,207 17,143 64.5%
PPO and Other........................................... 168,059 159,005 5.7%
--------- ---------
Total California...................................... 196,266 176,148 11.4%
--------- ---------
Texas..................................................... 22,224 25,346 (12.3)%
Georgia................................................... 516 310 66.5%
Other States.............................................. 17,060 12,082 41.2%
--------- ---------
Total Senior.......................................... 236,066 213,886 10.4%
--------- ---------
Total Medical Membership.................................... 7,300,003 6,891,603 5.9%
========= =========
MEMBERSHIP BY NETWORK (E)
Proprietary Networks...................................... 5,342,740 4,537,000 17.8%
Affiliate Networks........................................ 1,189,813 1,411,097 (15.7)%
Non-Network............................................... 767,450 943,506 (18.7)%
--------- ---------
Total Medical Membership.................................... 7,300,003 6,891,603 5.9%
========= =========
California................................................ 1,217,176 886,000 37.4%
Other States.............................................. 1,382,390 1,694,119 (18.4)%
--------- ---------
TOTAL MANAGEMENT SERVICES MEMBERSHIP (F).................... 2,599,566 2,580,119 0.8%
========= =========
- ------------------------------
(a) Membership numbers are approximate and include some estimates based upon the
number of contracts at the relevant date and an actuarial estimate of the
number of members represented by the contract.
(b) Classification between states for employer groups is determined by the zip
code of the subscriber. Medical membership reflects a shift of 205,865
members as of December 31, 1998, representing employees (and their
dependents) of certain California-based companies who reside out of state
and were previously classified as California members.
(c) Large Employer Group membership includes 709,598 and 495,357 state-sponsored
program members as of December 31, 1999, and 1998, respectively.
(d) Senior membership includes members covered under both Medicare risk and
Medicare supplement products.
(e) Proprietary networks consist of California, Texas and other
WellPoint-developed networks. Affiliate networks consist of third-party
networks and networks owned by the Company as a result of acquisitions that
incorporate provider discounts and some basic managed care elements.
Non-network consists of fee for service and percentage-of-billed-charges
contracts with providers.
(f) Medical membership includes management services members which are primarily
included within the Large Employer Group segment.
33
SPECIALTY MEMBERSHIP
AS OF DECEMBER 31,
----------------------- PERCENT
1999 1998 CHANGE
---------- ---------- --------
Pharmacy(a).................................. 21,979,758 15,003,377 46.5%
Dental....................................... 2,452,727 3,148,528 (22.1)%
Utilization Management....................... 2,664,566 2,908,383 (8.4)%
Life......................................... 2,125,214 2,155,805 (1.4)%
Disability................................... 598,129 778,860 (23.2)%
Behavioral Health(b)......................... 2,156,642 743,507 190.1%
- ------------------------
(a) Effective January 1, 1999, WellPoint revised its methodology of counting
pharmacy members. As a result of this revision, pharmacy members for whom
WellPoint provides claims processing services are now counted separately
from pharmacy members for whom WellPoint provides clinical management
services. As of December 31, 1999, WellPoint provided both claims processing
services and clinical management services to approximately 4.4 million
members.
(b) The increase in behavioral health membership is due to approximately 1.4
million additional California large employer group and certain
state-sponsored program members whose behavioral health benefits were
formerly not counted separately from medical benefits.
COMPARISON OF RESULTS FOR THE YEAR ENDED DECEMBER 31, 1999 TO THE YEAR ENDED
DECEMBER 31, 1998
The following table depicts premium revenue by business segment:
YEAR ENDED DECEMBER 31,
-------------------------
1999 1998
----------- -----------
(IN THOUSANDS)
Large Employer Group................................. $3,889,032 $3,467,742
Individual and Small Employer Group.................. 2,551,961 2,114,094
Corporate and Other.................................. 455,864 352,976
---------- ----------
Consolidated......................................... $6,896,857 $5,934,812
========== ==========
Premium revenue increased 16.2%, or $962.1 million, to $6,896.9 million for
the year ended December 31, 1999 from $5,934.8 million for the year ended
December 31, 1998. The overall increase was due to an increase in insured member
months of 9.5% in the Large Employer Group and the Individual and Small Employer
Group business segments, and the implementation of price increases throughout
the Company's business segments. The Company expects that it will experience
some level of further membership dilution of its acquired MMHO and GBO members
during the first half of 2000 as it continues to increase prices and pursues its
strategy of motivating members to select managed care products.
The following table depicts management services revenue by business segment:
YEAR ENDED
DECEMBER 31,
-------------------
1999 1998
-------- --------
(IN THOUSANDS)
Large Employer Group.................................... $367,060 $388,301
Individual and Small Employer Group..................... 4,579 4,627
Corporate and Other..................................... 57,697 41,032
-------- --------
Consolidated............................................ $429,336 $433,960
======== ========
34
Management services revenue decreased 1.1% for the year ended December 31,
1999 in comparison to the same period in the prior year. The overall decline is
due to a 4.0% decline in management services member months, offset by the
implementation of price increases in the Large Employer Group business segment.
The decrease in management services member months was primarily related to
attrition on acquired MMHD membership and, to a lesser extent, the GBO
membership.
Investment income was $159.2 million for the year ended December 31, 1999
compared to $109.6 million for the year ended December 31, 1998, an increase of
$49.6 million. The increase was primarily due to an increase in net interest and
dividend income of $51.3 million to $196.5 million for the year ended
December 31, 1999 in comparison to $145.2 million for the year ended
December 31, 1998. This increase was primarily due to interest income of $23.8
million related to the Company's refund from the IRS (See "--Liquidity and
Capital Resources") and higher average investment balances in 1999 versus 1998.
Interest and dividend income for the year ended December 31, 1999 also included
a $1.3 million charge related to the partial termination of the Company's
interest rate swap agreements (See "--Liquidity and Capital Resources"). The
increase was also attributable to the recognition of an "other than temporary"
decline in value in accordance with SFAS No. 115 of $48.7 million in 1998
relating to the Company's equity holdings in FPA Medical Management Inc.
("FPA"). Net realized losses on investment securities totaled $33.8 million for
the year ended December 31, 1999 in comparison to a gain of $16.7 million for
the year ended December 31, 1998, excluding the FPA loss.
The loss ratio attributable to managed care and related products for the
year ended December 31, 1999 decreased to 80.2% compared to 80.5% for the year
ended December 31, 1998. The decline is primarily due to price increases
implemented throughout the year in the Company's Large Employer Group and
Individual and Small Employer Group business segments. In addition, the decline
was also attributable to membership attrition related to underperforming MMHD
and GBO acquired accounts in the Company's Large Employer Group business, which
have historically experienced a higher loss ratio than the Company's other
business.
Selling expense consists of commissions paid to outside brokers and agents
representing the Company. The selling expense ratio increased slightly to 4.5%
for the year ended December 31, 1999 from 4.4% from the year ended December 31,
1998.
The general and administrative expense ratio decreased to 14.7% for the year
ended December 31, 1999 from 15.3% for the year ended December 31, 1998. The
overall decline is primarily attributable to savings from the consolidation of
various offices outside of California, the integration of information systems
centers related to acquired businesses with the Company's information systems
and a reduction in Year 2000 remediation expense from 1998 levels, in addition
to economies of scale associated with membership and premium revenue growth in
relation to certain fixed general and administrative expenses.
Interest expense was $20.2 million for the year ended December 31, 1999
compared to $26.9 million for the year ended December 31, 1998. The decrease in
interest expense is related to the higher average debt balance in 1999 compared
to 1998, which was more than offset by a decrease in the effective interest rate
due to the issuance of the Company's Zero Coupon Convertible Subordinated
Debentures (the "Debentures"). The weighted average interest rate for all debt
for the year ended December 31, 1999, including the fees associated with the
Company's borrowings and interest rate swaps, was 7.04%.
The provision for income taxes increased $117.7 million, resulting in a tax
provision of $190.1 million for the year ended December 31, 1999. The increase
was primarily due to the effect of a private letter ruling received from the IRS
in September 1998, which resulted in a decrease in income tax expense of $85.5
million during 1998. Excluding the ruling, the provision for income taxes would
have been $157.9 million during the year ended December 31, 1998, representing
an overall tax rate consistent with the tax rate for 1999.
Effective January 1, 1999, the Company changed its method of accounting for
start-up costs related to the Company's provider network and distribution
channel development. The cumulative effect of this
35
change of $20.6 million, net of tax, was reflected in the results of operations
for the year ended December 31, 1999.
During the fourth quarter of 1999, the Board of Directors authorized the
repurchase of some or all of the Debentures, which were issued in July 1999 to
fund the purchase of 2 million WellPoint common shares from the California
HealthCare Foundation. The Company's income from continuing operations,
excluding the cumulative effect of accounting change and the extraordinary gain
for the year ended December 31, 1999 was $297.2 million, compared to $319.5
million for the year ended December 31, 1998. The decrease is primarily the
result of the impact of the private letter ruling received from the IRS in 1998.
Earnings per share from continuing operations, excluding the cumulative effect
of accounting change and the extraordinary gain, totaled $4.50 and $4.63 for the
year ended December 31, 1999 and 1998, respectively.
Earnings per share for the year ended December 31, 1999 is based upon
weighted average shares outstanding of 66.1 million, excluding potential common
stock, and 68.1 million shares, assuming full dilution. Earnings per share for
the year ended December 31, 1998 is based on 69.1 million shares excluding
potential common stock, and 70.3 million shares, assuming full dilution. The
decrease in weighted average shares outstanding primarily relates to the effect
of the repurchase of approximately 4.3 million shares during the year ended
December 31, 1999. In addition, for weighted average shares outstanding assuming
full dilution, the decline was partially offset by the impact of the assumed
conversion of the Debentures.
COMPARISON OF RESULTS FOR THE YEAR ENDED DECEMBER 31, 1998 TO THE YEAR ENDED
DECEMBER 31, 1997
The following table depicts premium revenue by business segment:
YEAR ENDED DECEMBER 31,
-------------------------
1998 1997
----------- -----------
(IN THOUSANDS)
Large Employer Group................................. $3,467,742 $2,999,422
Individual and Small Employer Group.................. 2,114,094 1,785,096
Corporate and Other.................................. 352,976 284,429
---------- ----------
Consolidated......................................... $5,934,812 $5,068,947
========== ==========
Premium revenue increased 17.1%, or $865.9 million, to $5,934.8 million for
the year ended December 31, 1998 from $5,068.9 million for the year ended
December 31, 1997. The overall increase was primarily due to an increase in
insured member months of 12.1%, in the Large Employer Group and Individual and
Small Employer Group business segments, in addition to the implementation of
price increases in both segments. The additional two months of premium revenue
in 1998 related to the GBO accounted for $80.1 million or 9.3% of the overall
increase, or 17.1% of the increase in the Large Employer Group business segment.
The following table depicts management services revenue by business segment:
YEAR ENDED
DECEMBER 31,
-------------------
1998 1997
-------- --------
(IN THOUSANDS)
Large Employer Group.................................... $388,301 $327,753
Individual and Small Employer Group..................... 4,627 3,613
Corporate and Other..................................... 41,032 45,772
-------- --------
Consolidated............................................ $433,960 $377,138
======== ========
36
Management services revenue increased 15.1%, or $56.9 million, to $434.0
million for the year ended December 31, 1998 from $377.1 million for the year
ended December 31, 1997. The increase was primarily due to a 14.7% increase in
management services member months, primarily in the Company's Large Employer
Group business segment. The additional two months of management services revenue
in 1998 related to the GBO accounted for $22.3 million or 39.2% of the overall
increase, or 36.9% of the increase in the Large Employer Group business segment.
Also contributing to the increase was the incremental impact of the addition of
a management services contract also in the Company's Large Employer Group
business segment with the State of Illinois effective as of July 1997.
Investment income decreased $86.6 million to $109.6 million for the year
ended December 31, 1998, compared to $196.2 million for the year ended
December 31, 1997. The decline was primarily attributable to recognition in 1998
of an "other than temporary" decline in value of $48.7 million relating to the
Company's equity holdings in FPA, which subsequently filed for bankruptcy.
Further contributing to the decrease between years was the initial gain of
$30.3 million recognized in 1997 related to the exchange of Health Partners Inc.
("HPI") stock for FPA. Excluding the effects of both the "other than temporary"
decline in value in 1998 and the gain related to the stock-for-stock merger with
FPA in 1997, investment income would have been $158.3 million and
$165.9 million, for 1998 and 1997, respectively. Including the loss on FPA in
1998, and the gain on HPI in 1997, the net realized loss on investment
securities for the year ended December 31, 1998 was $32.0 million compared to a
net realized gain of $64.3 million for the year ended December 31, 1997. Net
interest and dividend income increased $11.3 million to $145.2 million for the
year ended December 31, 1998 in comparison to $133.9 million for the year ended
December 31, 1997, primarily due to increased interest income resulting from the
investment portfolios of the acquired GBO businesses partially offset by lower
yields on invested assets in 1998 versus 1997. Net investment income also
included a loss of approximately $4.5 million in 1998 related to the Company's
interest rate swap agreements.
The loss ratio attributable to managed care and related products for the
year ended December 31, 1998 decreased slightly to 80.5% compared to 80.6% for
the year ended December 31, 1997. Excluding the GBO for the period prior to its
acquisition for the year ended December 31, 1998, the loss ratio would have been
80.0%. The decline is primarily due to membership attrition related to
underperforming MMHD and GBO acquired accounts, combined with the growth in the
Company's Medi-Cal business that experienced a lower loss ratio, primarily in
the Company's Large Employer Group business segment.
The selling expense ratio for the year ended December 31, 1998 decreased to
4.4% from 4.6% for the year ended December 31, 1997, largely due to the
acquisition of the GBO primarily in the Company's Large Employer Group business
segment, which has a lower selling expense ratio than the Company's existing
business due to the use of an internal sales force. Excluding the GBO for the
period prior to its acquisition for the year ended December 31, 1998, the
selling expense ratio would have been 4.5%. The Large Employer Group business
segment's growth in Medi-Cal and large employer group medical products had a
further impact on lowering the selling expense ratio as a result of the lower
selling costs associated with these products in comparison to the Company's
other products.
The general and administrative expense ratio decreased slightly to 15.3% for
1998 compared to 15.4% for 1997. The GBO has historically experienced a higher
administrative expense ratio than the Company's traditional California-based
businesses due to the GBO's higher percentage of management services business.
The administrative expense ratio, excluding the GBO for the period prior to its
acquisition for the year ended December 31, 1998, was 15.0%. This decline in
comparison to the previous year is primarily due to savings from the
consolidation of various regional offices outside of California and the
integration of information system centers related to acquired businesses with
the Company's information systems, in addition to economies of scale associated
with membership and premium revenue growth in relation to fixed corporate
general and administrative expenses.
37
Interest expense decreased for the year ended December 31, 1998 to $26.9
million, from $36.7 million for the year ended December 31, 1997. The decrease
is primarily related to the repayment of indebtedness as the effective interest
rate paid by the Company remained relatively stable as a result of its interest
rate swaps. The Company's long-term indebtedness at December 31, 1998 was $300.0
million compared to $388.0 million at December 31, 1997. The weighted average
interest rate for all debt for the year ended December 31, 1998, including the
cost associated with the fee on the Company's credit agreements and its interest
rate swap agreements, was 7.6%. See "--Liquidity and Capital Resources."
The provision for income taxes decreased $84.5 million, or 53.9%, to $72.4
million for the year ended December 31, 1998. The decline was primarily due to
the effect of the private letter ruling received from the IRS in September 1998,
which resulted in a decrease in income tax expense of $85.5 million. (See
Note 8 to the Consolidated Financial Statements.) Excluding the ruling, the
provision for income taxes would have been $157.9 million, representing an
overall tax rate consistent with the prior period.
The Company's income from continuing operations before extraordinary gain
and cumulative effect of accounting change for the year ended December 31, 1998
was $319.5 million, compared to $229.4 million for the year ended December 31,
1997. Earnings per share from continuing operations before extraordinary gain
and cumulative effect of accounting change totaled $4.63 and $3.33 for the years
ended December 31, 1998 and 1997, respectively. Earnings per share from
continuing operations before extraordinary gain and cumulative effect of
accounting change assuming full dilution totaled $4.55 and $3.30 for the years
ended December 31, 1998 and 1997, respectively. Earnings per share from
continuing operations before extraordinary gain and cumulative effect of
accounting change for the year ended December 31, 1997 included non-recurring
costs of $0.13 per share (See Note 17 to the Consolidated Financial Statements).
Earnings per share for the year ended December 31, 1998 is based upon
weighted average shares outstanding of 69.1 million, excluding potential common
stock, and 70.3 million shares assuming full dilution. Earnings per share for
the year ended December 31, 1997 has been calculated using 68.8 million,
excluding potential common stock, and 69.5 million shares, assuming full
dilution. For the year ended December 31, 1998, the increase in weighted average
shares outstanding primarily relates to common stock issued through the
Company's stock option plans and the incremental impact in 1998 of the public
offering of 3.0 million shares of the Company's common stock in April 1997,
partially offset by the repurchase of 3.5 million shares during the latter part
of 1998.
FINANCIAL CONDITION
The Company's consolidated assets increased by $367.4 million, or 8.7%, from
$4,225.8 million as of December 31, 1998 to $4,593.2 million as of December 31,
1999. The increase in total assets was primarily due to growth in cash and
investments as a result of operating cash flow. Cash and investments totaled
$3.3 billion as of December 31, 1999, or 70.9% of total assets. Income taxes
recoverable declined approximately $179.9 million, resulting in a net payable of
$84.0 million at December 31, 1999. The primary reason for the decrease was the
receipt in the third quarter of 1999 of the IRS refund (See "--Liquidity and
Capital Resources").
Overall claims liabilities increased $170.6 million, or 12.9%, from $1,320.6
million at December 31, 1998 to $1,491.2 million at December 31, 1999. This
increase was primarily due to an increase in insured membership from December
31, 1998 to December 31, 1999 of approximately 9.0% in the Company's Large
Employer Group and Individual and Small Employer Group businesses, in addition
to the timing of certain pharmacy claim payments.
As of December 31, 1999, $347.9 million was outstanding under the Company's
long-term debt facilities of which $147.9 million was related to the Company's
Debentures and $200.0 million was related to the Company's revolving credit
facility. As of December 31, 1998, $300.0 million was outstanding under the
Company's long-term debt facilities of which $280 million was related to the
Company's revolving
38
credit facility and $20 million was due under a term note issued in connection
with the MMHD acquisition. Debt repayments during 1999 were primarily funded
from cash flow from continuing operating activities.
Stockholders' equity totaled $1,312.7 million as of December 31, 1999, a
slight decrease of $2.5 million from $1,315.2 million as of December 31, 1998.
The decline related primarily to stock repurchases made during the year totaling
$291.7 million, funded principally from the proceeds from the Company's issuance
of the Debentures and from income from operations, and a $25.9 million increase
in net unrealized losses on investment securities, net of tax, partially offset
by net income of $278.5 million for the year ended December 31, 1999 and
$33.8 million of stock issuances under the Company's stock option and purchase
plans.
During the year ended December 31, 1998, the Company's Board of Directors
approved a stock repurchase plan of up to eight million shares. During the year
ended December 31, 1999, the Board of Directors amended the plan to approve the
repurchase of an additional 4.7 million shares. At December 31, 1999,
approximately 5.0 million shares remained available for repurchase under that
plan.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of cash are premium and management services
revenues received and investment income. The primary uses of cash include health
care claims and other benefits, capitation payments, income taxes, repayment and
repurchases of long-term debt, interest expense, broker and agent commissions,
administrative expenses, common stock repurchases and capital expenditures. In
addition to the foregoing, other uses of cash include costs of provider networks
and systems development, and costs associated with the integration of acquired
businesses.
The Company generally receives premium revenue in advance of anticipated
claims for related health care services and other benefits. The Company's
investment policies are designed to provide liquidity, preserve capital and
maximize total return on invested assets. Cash and investment balances
maintained by the Company are sufficient to meet applicable regulatory financial
stability and net worth requirements. As of December 31, 1999, the Company's
investment portfolio consisted primarily of investment grade fixed-maturity
securities. Approximately 10% of the portfolio was invested in equity
securities.
Net cash flow provided by continuing operating activities was
$829.4 million for the year ended December 31, 1999, compared with
$394.6 million in 1998. Cash flow from continuing operations for the year ended
December 31, 1999 was due primarily to income from continuing operations, before
the extraordinary gain and cumulative effect of accounting change, of
$297.2 million, and the cash refund from the IRS of $183.0 million. In addition,
cash flow from continuing operations was affected by increases in medical claims
payable of $195.7 million related to the growth of insured members, and the
timing of other operating liability payments.
Net cash used in continuing investing activities in 1999 totaled $531.1
million, compared with $21.6 million in 1998. The cash used in 1999 was
attributable primarily to the purchase of investments and property, plant and
equipment, net of sales proceeds of $3,456.3 million and $36.6 million,
respectively, the first quarter 1999 adjustment of $6.7 million of the sales
price of the Company's workers' compensation business, which was sold in 1998,
in addition to the payment of approximately $7.7 million related to the
transition of Omni Healthcare members to the Company's health plans. This was
partially offset by the proceeds from investments sold and matured of
$2,976.2 million.
Net cash used in financing activities totaled $204.1 million in 1999,
compared to $241.9 million in 1998. Net cash used in financing activities in
1999 was primarily due to the repurchase of 4.3 million shares of the Company's
Common Stock totaling $291.7 million and repayments of long-term debt totaling
$149.8 million related to both the Company's revolving credit facility and
Debentures. These uses of cash were partially offset by the receipt of
approximately $201.0 million of proceeds related to the issuance of
39
the Debentures (See Note 7 to the Consolidated Financial Statements) in addition
to $36.6 million related to the issuance of Common Stock through the Company's
employee stock purchase and option plans.
The Company has a $1.0 billion unsecured revolving credit facility.
Borrowings under the credit facility bear interest at rates determined by
reference to the bank's base rate or to the London Interbank Offered Rate
("LIBOR") plus a margin determined by reference to the Company's leverage ratio
(as defined in the credit agreement) or the then-current rating of the Company's
unsecured long-term debt by specified rating agencies. Borrowings under the
credit facility are made on a committed basis or pursuant to an auction-bid
process. The credit facility expires as of May 15, 2002, although it may be
extended for an additional one-year period under certain circumstances. The
credit agreement requires the Company to maintain certain financial ratios and
contains restrictive covenants, including restrictions on the occurrence of
additional indebtedness and the granting of certain liens, limitations on
acquisitions and investments and limitations on changes in control. The total
amount outstanding under the credit facility was $200.0 million and $280.0
million as of December 31, 1999 and 1998, respectively. The weighted average
interest rate for the year ended December 31, 1999, including the facility and
other fees and the effect of the interest rate swap agreements discussed in the
following paragraph, was 7.04%.
As a part of a hedging strategy to limit its exposure to interest rate
increases, in 1996 the Company entered into three interest rate swap agreements.
During 1999, the Company's 6.45%, $100.0 million fixed interest rate swap
agreement matured. In addition, on September 22 and October 1, 1999, the Company
entered into partial termination agreements to reduce the notional amount of the
Company's 7.05%, $150.0 million swap agreement to $50.0 million. All of the
remaining terms and conditions of the swap agreement remained unchanged, with
the exception of the fixed interest rate which was 7.06% as of December 31,
1999. The swap agreements are contracts to exchange variable-rate interest
payments (weighted average rate for 1999 of 5.4%) for fixed-rate interest
payments (weighted average rate for 1999 of 6.3%) without the exchange of the
underlying notional amounts. The agreements mature at various dates through
2006. In 1999, the Company entered into an additional interest rate swap
agreement with a notional amount of $100.0 million to exchange three month LIBOR
(the index associated with the aforementioned swap) for one month LIBOR (the
index associated with the Company's revolving credit facility) in order to hedge
against rising interest rates at the end of the year. This agreement matured
February 28, 2000.
The Company has entered into foreign currency forward exchange contracts for
each of the fixed maturity securities on hand as of December 31, 1999
denominated in foreign currencies in order to hedge asset positions with respect
to currency fluctuations related to these securities. The unrealized gains and
losses from such forward exchange contracts are reflected in other comprehensive
income. In addition, the Company has entered into forward exchange contracts to
hedge the foreign currency risk between the trade date and the settlement date.
Gains and losses from these contracts are recognized in income.
During the quarter ended September 30, 1998, the Company received a private
letter ruling from the IRS with respect to the treatment of certain payments
made at the time of WellPoint's 1996 Recapitalization and the acquisition of the
commercial operations of its former majority stockholder. The ruling allows the
Company to deduct as an ordinary and necessary business expense the
$800 million cash payment made by such stockholder in May 1996 to one of two
newly formed charitable foundations. The Company's liquidity for 1999 was
positively affected by a reduction in income tax payments of approximately
$47.0 million. In August 1999, the Company received a cash refund (including
applicable accrued interest) of approximately $183.0 million, which is reflected
in the statement of cash flows for the year ended December 31, 1999. The Company
has also submitted a claim for refund with respect to an additional
$38.0 million.
40
In July 1999, the Company received proceeds of approximately $200.8 million
from the issuance of the Debentures. Of this amount, $162.0 million was used to
repurchase 2,000,000 shares of the Company's Common Stock from the California
HealthCare Foundation, and the remaining proceeds are available for general
corporate purposes. The Debentures accrue interest at a yield to maturity of
2.0% per year, compounded semi-annually. The Debentures will result in an
increase in accrued interest expense of approximately $3.1 million during the
one-year period immediately following their issuance, with such annual accrued
interest expense increasing until maturity. The Debentures may be converted into
Common Stock, at the option of the debentureholder, at a rate of 6.797 shares
per $1,000 principal amount at maturity. The Company may redeem the Debentures
for cash at any time after July 2, 2002. The applicable redemption price will be
the original issue price plus original issue discount accrued to the date of
redemption. The Debentureholders can cause the Company to repurchase the
Debentures on July 2, 2002, July 2, 2009 and July 2, 2014 at a price equal to
the original issue price plus original issue discount accrued to the date of
repurchase.
On October 6, 1999, the Board of Directors authorized the repurchase from
time to time of some or all of the Company's Debentures for cash. As of
December 31, 1999, the Company had repurchased $81.0 million aggregate principal
amount of the Debentures for a total purchase price of $49.8 million.
The Company intends to monitor its other cash needs before making additional
repurchases of its Debentures or its Common Stock under its current
authorizations.
Certain of the Company's subsidiaries are required to maintain minimum
capital requirements prescribed by various regulatory agencies, including the
California Department of Corporations, and the Departments of Insurance in
various states. As of December 31, 1999, those subsidiaries of the Company were
in compliance with all minimum capital requirements.
In July 1996, the Company filed a registration statement relating to the
issuance of $1.0 billion of senior or subordinated unsecured indebtedness. As of
December 31, 1999, no indebtedness had been issued pursuant to this registration
statement.
The Company believes that cash flow generated by operations and its cash and
investment balances, supplemented by the Company's ability to borrow under its
existing revolving credit facility or to conduct a public offering under its
debt registration statement, will be sufficient to fund continuing operations
and expected capital requirements (including the proposed merger with Cerulean)
for the foreseeable future.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
No. 133"). SFAS No. 133 establishes the accounting and reporting standards for
derivative instruments and for hedging activities. Upon adoption of SFAS No.
133, all derivatives must be recognized on the balance sheet at their then fair
value. Any stand-alone deferred gains and losses remaining on the balance sheet
under previous hedge accounting rules must be removed from the balance sheet and
all hedging relationships must be designated anew and documented pursuant to the
new accounting rules. The new standard will be effective in the first quarter of
2001. The Company is presently assessing the effect of SFAS No. 133 on the
financial statements of the Company.
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
Certain statements contained herein, such as statements concerning potential
or future loss ratios, expected membership attrition as the Company continues to
integrate its recently acquired operations, the pending transaction with
Cerulean and other statements regarding matters that are not historical facts,
are forward-looking statements (as such term is defined in the Securities
Exchange Act of 1934). Such statements involve a number of risks and
uncertainties that may cause actual results to differ from those projected.
Factors that can cause actual results to differ materially include, but are not
limited to, those
41
discussed below and those discussed from time to time in the Company's various
filings with the Securities and Exchange Commission.
Completion of the Company's pending transaction with Cerulean is contingent
upon, among other things, receipt of necessary approvals from certain federal
and state agencies on or before December 31, 2000. Broad latitude in
administering the applicable regulations is given to the agencies from which
WellPoint and Cerulean must seek these approvals. There can be no assurance that
these approvals will be obtained. As a condition to approval of the transaction,
regulatory agencies may impose requirements or limitations or costs on the way
that the combined company conducts business after consummation of the
transaction. If the Company or Cerulean were to agree to any material
requirements or limitations in order to obtain any approvals required to
consummate the transaction, such requirements or limitations or additional costs
associated therewith could adversely affect WellPoint's ability to integrate the
operations of Cerulean with those of WellPoint. A material adverse effect on
WellPoint's revenues and results of operations following completion of the
transaction could result.
The Company intends to incur debt to finance some or all of the cash
payments to be made to Cerulean shareholders in connection with the pending
acquisition. In addition, WellPoint has received authorization to, and is
currently in the process of, repurchasing shares of WellPoint stock to offset
shares that are expected to be issued in connection with the transaction. The
Company has made significant purchases of treasury stock for this purpose
utilizing excess cash as well as the incurrence of additional debt. Upon
completion of the Cerulean transaction, WellPoint could incur significant
additional indebtedness to fund not only the cash portion of the transaction but
to fund any further repurchase of shares of WellPoint stock. Such additional
indebtedness may require that a significant amount of the Company's cash flow be
applied to the payment of interest, and there can be no assurance that the
Company's operations will generate sufficient cash flow to service the
indebtedness. Any additional indebtedness may adversely affect the Company's
ability to finance its operations and could limit its ability to pursue business
opportunities that may be in the best interests of the Company and its
stockholders.
As part of the Company's business strategy, over the past four years the
Company has acquired substantial operations in new geographic markets. As
discussed above, the Company has entered into a merger agreement with Cerulean,
pursuant to which Cerulean will become a wholly owned subsidiary of the Company.
These businesses, which include substantial indemnity-based insurance
operations, have experienced varying profitability or losses in recent periods.
Since the relevant dates of acquisition of MMHD and GBO, the Company has
continued to work extensively on the integration of these businesses; however,
there can be no assurances regarding the ultimate success of the Company's
integration efforts or regarding the ability of the Company to maintain or
improve the results of operations of the businesses of completed or pending
transactions as the Company pursues its strategy of motivating the acquired
members to select managed care products. In order to implement this business
strategy, the Company has incurred and will, among other things, need to
continue to incur considerable expenditures for provider networks, distribution
channels and information systems in addition to the costs associated with the
integration of these acquisitions. The integration of these complex businesses
may result in, among other things, temporary increases in claims inventory or
other service-related issues that may negatively affect the Company's
relationship with its customers and contribute to increased attrition of such
customers. The Company's results of operations could be adversely affected in
the event that the Company experiences such problems or is otherwise unable to
implement fully its expansion strategy.
The Company's operations are subject to substantial regulation by Federal,
state and local agencies in all jurisdictions in which the Company operates.
Many of these agencies have increased their scrutiny of managed health care
companies in recent periods. The Company also provides insurance products to
Medi-Cal beneficiaries in various California counties under contracts with the
California Department of Health Services (or delegated local agencies) and
provides administrative services to the Health Care Finance Administration
("HCFA") in various capacities. There can be no assurance that acting as a
government contractor in these circumstances will not increase the risk of
heightened scrutiny by such
42
government agencies and that profitability from this business will not be
adversely affected through inadequate premium rate increases due to governmental
budgetary issues. Future actions by any regulatory agencies may have a material
adverse effect on the Company's business.
The Company and certain of its subsidiaries are subject to capital surplus
requirements by the California Department of Corporations, various other state
Departments of Insurance and the Blue Cross Blue Shield Association. Although
the Company believes that it is currently in compliance with all applicable
requirements, there can be no assurances that such requirements will not be
increased in the future.
The Company's future results will depend in large part on accurately
predicting health care costs incurred on existing business and upon the
Company's ability to control future health care costs through product and
benefit design, underwriting criteria, utilization management and negotiation of
favorable provider contracts. Changes in mandated benefits, utilization rates,
demographic characteristics, health care practices, provider consolidation,
inflation, new pharmaceuticals/technologies, clusters of high-cost cases, the
regulatory environment and numerous other factors are beyond the control of any
health plan provider and may adversely affect the Company's ability to predict
and control health care costs and claims, as well as the Company's financial
condition, cash flows or results of operations. Periodic renegotiation of
hospital and other provider contracts, coupled with continued consolidation of
physician, hospital and other provider groups, may result in increased health
care costs and limit the Company's ability to negotiate favorable rates.
Recently, large physician practice management companies have experienced extreme
financial difficulties (including bankruptcy), which may subject the Company to
increased credit risk related to provider groups. Additionally, the Company
faces competitive pressure to contain premium prices. Fiscal concerns regarding
the continued viability of government-sponsored programs such as Medicare and
Medicaid may cause decreasing reimbursement rates for these programs. Any
limitation on the Company's ability to increase or maintain its premium levels,
design products, select underwriting criteria or negotiate competitive provider
contracts may adversely affect the Company's financial condition, cash flows or
results of operations.
Managed care organizations, both inside and outside California, operate in a
highly competitive environment that has undergone significant change in recent
years as a result of business consolidations, new strategic alliances,
aggressive marketing practices by competitors and other market pressures.
Additional increases in competition could adversely affect the Company's
financial condition, cash flows or results of operations. Additional increases
in competition (including competition from market entrants offering
Internet-based products and services), could adversely affect the Company's
financial condition.
As a result of the Company's recent acquisitions, the Company operates on a
select geographic basis nationally and offers a spectrum of health care and
specialty products through various risk sharing arrangements. The Company's
health care products include a variety of managed care offerings as well as
traditional fee-for-service coverage. With respect to product type,
fee-for-service products are generally less profitable than managed care
products. A critical component of the Company's expansion strategy is to
transition over time the traditional insurance members of the Company's acquired
businesses to more managed care products.
With respect to the risk-sharing nature of products, managed care products
that involve greater potential risk to the Company generally tend to be more
profitable than management services products and those managed care products
where the Company is able to shift risks to employer groups. Individuals and
small employer groups are more likely to purchase the Company's higher-risk
managed care products because such purchasers are generally unable or unwilling
to bear greater liability for health care expenditures. Typically,
government-sponsored programs involve the Company's higher-risk managed care
products. Over the past few years, the Company has experienced greater margin
erosion in its higher-risk managed care products than in its lower-risk managed
care and management services products. This margin erosion is attributable to
product mix change, product design, competitive pressure and greater regulatory
restrictions applicable to the small employer group market. In response to
pressure on margins
43
in 1998 and again in 1999, the Company implemented price increases in certain of
its managed care businesses. While these price increases are intended to improve
profitability, there can be no assurance that this will occur. Subsequent
unfavorable changes in the relative profitability between the Company's various
products could have a material adverse effect on the Company's results of
operations and on the continued feasibility of the Company's geographic
expansion strategy.
Substantially all of the Company's investment assets are in
interest-yielding debt securities of varying maturities or equity securities.
The value of fixed income securities is highly sensitive to fluctuations in
short- and long-term interest rates, with the value decreasing as such rates
increase or increasing as such rates decrease. In addition, the value of equity
securities can fluctuate significantly with changes in market conditions.
Changes in the value of the Company's investment assets, as a result of interest
rate fluctuations, can affect the Company's stockholders' equity which could
impact leverage ratios, credit ratings or compliance with covenants of its
revolving credit facility. There can be no assurances that interest rate
fluctuations will not have a material adverse effect on the financial condition
of the Company.
The Company is dependent on retaining existing employees and attracting
additional qualified employees to meet its future needs. The Company faces
intense competition for qualified information technology personnel and other
skilled professionals. There can be no assurances that an inability to retain
existing employees or attract additional employees will not have a material
adverse effect on the Company's results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company regularly evaluates its asset and liability interest rate risks
as well as the appropriateness of investments relative to its internal
investment guidelines. The Company operates within these guidelines by
maintaining a well-diversified portfolio, both across and within asset classes.
The Company has retained an independent consultant to advise the Company on the
appropriateness of its investment policy and the compliance therewith.
Asset interest rate risk is managed within a duration band tied to the
Company's liability interest rate risk. Credit risk is managed by maintaining
high average quality ratings and a well-diversified portfolio.
The Company's use of derivative instruments is generally limited to hedging
purposes and has principally consisted of forward exchange contracts intended to
minimize the portfolio's exposure to currency volatility associated with certain
foreign demoninated bond holdings. The Company's investment policy prohibits the
use of derivatives for leveraging purposes as well as the creation of risk
exposures not otherwise allowed within the policy.
Since 1996, the Company has from time to time entered into interest rate
swap agreements primarily by exchanging the floating debt payments due under its
outstanding indebtedness for fixed rate payments. The Company believes that this
allows it to better anticipate its interest payments while helping to manage the
asset-liability relationship.
INTEREST RATE RISK
As of December 31, 1999, approximately 86% of the Company's investment
portfolio consisted of fixed income securities (maturing in more than one year),
the value of which generally varies inversely with changes in interest rates.
The Company has evaluated the net impact to the fair value of its fixed
income investments from a hypothetical change in all interest rates of 100, 200
and 300 basis points ("bp"). In doing so, optionality was addressed through
Monte Carlo simulation of the price behavior of securities with embedded
options. In addressing prepayments on mortgage backed securities, the model
follows the normal market practice of estimating a non-interest rate sensitive
component (primarily related to relocations) and an interest sensitive component
(primarily related to refinancings) separately. The model is based on
statistical techniques applied to historical prepayment and market data, and
then incorporates forward-looking
44
mortgage market research and judgments about future prepayment behavior. Changes
in the fair value of the investment portfolio are reflected in the balance sheet
through stockholders' equity. Under the requirements of SFAS No. 133, effective
January 1, 2001, all derivative financial instruments will be reflected on the
balance sheet at fair value. The results of this analysis as of December 31,
1999 are reflected in the table below.
INCREASE (DECREASE) IN FAIR VALUE
GIVEN AN INTEREST RATE INCREASE OF:
--------------------------------------
100 BP 200 BP 300 BP
-------- -------- --------
(IN MILLIONS)
Fixed Income Portfolio........................ ($83.5) ($161.9) ($234.6)
Results as of December 31, 1998 are reflected in the table below. The table
reflects the change in valuation of interest rate swap agreements for the year
ended December 31, 1998 to the extent that the notional amount of interest rate
swap agreements exceeded the principal balance of the Company's floating rate
indebtedness.
INCREASE (DECREASE) IN FAIR VALUE GIVEN
AN INTEREST RATE INCREASE OF:
-----------------------------------------
100 BP 200 BP 300 BP
--------- --------- ---------
(IN MILLIONS)
Fixed Income Portfolio........................ ($80.4) ($161.4) ($240.2)
Valuation of Interest Rate Swap Agreements.... 16.3 31.6 46.0
------ ------- -------
($64.1) ($129.8) ($194.2)
====== ======= =======
The Company believes that an interest rate shift in a 12-month period of 100
bp represents a moderately adverse outcome, while a 200 bp shift is
significantly adverse and a 300 bp shift is unlikely given historical
precedents. Although the Company holds its bonds as "available for sale" for
purposes of SFAS No. 115, the Company's cash flows and the short duration of its
investment portfolio should allow it to hold securities to maturity, thereby
avoiding the recognition of losses, should interest rates rise significantly.
INTEREST RATE SWAP AGREEMENTS
The Company has entered into interest rate swap agreements in order to
reduce the volatility of interest expense resulting from changes in interest
rates. As of December 31, 1999, the Company had entered into $200 million of
floating to fixed rate swap agreements and also had $200 million of LIBOR-based
floating rate debt outstanding. The Company also receives a LIBOR-based payment
as a result of its swap arrangements, thereby eliminating the payment exposure
to changes in interest rates on that $200 million of outstanding debt. In 1999,
the Company entered into an additional interest rate swap agreement with a
notional amount of $100 million to exchange three month LIBOR (the index
associated with the aforementioned swap) for one month LIBOR (the index
associated with the revolving credit facility) in order to hedge against rising
interest rates at the end of the year.
EQUITY PRICE RISK
The Company's equity securities are comprised primarily of domestic stocks
as well as certain foreign holdings. Assuming an immediate decrease of 10% in
equity prices, as of December 31, 1999 and 1998, the hypothetical loss in fair
value of stockholders' equity is estimated to be approximately $31.4 million and
$27.4 million, respectively.
FOREIGN EXCHANGE RISK
The Company has generally hedged the foreign exchange risk associated with
its fixed income portfolio. The Company generally uses short-term foreign
exchange contracts to hedge the risk associated
45
with certain fixed income securities denominated in foreign currencies.
Therefore, the Company believes that there is minimal risk to the fixed-income
portfolio due to currency exchange rate fluctuations. The Company's hedging
program related to its foreign currency denominated investments is described in
Note 15 to the Consolidated Financial Statements.
The Company does not hedge its foreign exchange risk arising from equity
investments denominated in foreign currencies. Assuming a foreign exchange loss
of 10% across all foreign equity investments, the net hypothetical pre-tax loss
in fair value as of December 31, 1999 and 1998, is estimated to be $8.9 million
and $5.5 million, respectively.
46
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The location in this Form 10-K of the Company's Consolidated Financial
Statements is set forth in the "Index" on Page F-1.
WELLPOINT HEALTH NETWORKS INC.
QUARTERLY SELECTED FINANCIAL INFORMATION
(UNAUDITED)
FOR THE QUARTER ENDED
------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
(IN THOUSANDS, EXCEPT PER SHARE DATA AND 1999 1999 1999 1999
MEMBERSHIP DATA) ---------- ---------- ------------- ------------
Total revenues...................................... $1,771,245 $1,856,773 $1,891,513 $1,965,896
Operating income.................................... 130,756 132,720 136,614 148,201
Income before provision for income taxes............ 116,571 116,563 125,014 129,173
Income before extraordinary gain and cumulative
effect of accounting change....................... 71,110 71,079 76,233 78,789
Extraordinary gain, net of tax...................... -- -- -- 1,891
Cumulative effect of accounting change, net of
tax............................................... (20,558) -- -- --
---------- ---------- ---------- ----------
Net income.......................................... $ 50,552 $ 71,079 $ 76,233 $ 80,680
========== ========== ========== ==========
Per Share Data:
Earnings Per Share................................ $ 1.06 $ 1.05 $ 1.16 $ 1.24
========== ========== ========== ==========
Earnings Per Share Assuming Full Dilution......... $ 1.04 $ 1.03 $ 1.11 $ 1.20
========== ========== ========== ==========
Medical membership.................................. 6,913,107 7,014,456 7,174,363 7,300,003
========== ========== ========== ==========
FOR THE QUARTER ENDED
------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
(IN THOUSANDS, EXCEPT PER SHARE DATA AND 1998(A) 1998 1998 1998
MEMBERSHIP DATA) ---------- ---------- ------------- ------------
Total revenues...................................... $1,584,216 $1,561,819(B) $1,628,739 $1,703,576
Operating income.................................... 125,743 68,717(B) 124,651 127,717
Income before provision for income taxes............ 112,058 54,353(B) 112,304 113,271
Income from continuing operations................... 67,192 32,752(B) 152,208(C) 67,396
Loss from discontinued operations................... (8,678) (79,590) -- --
---------- ---------- ---------- ----------
Net income (loss)................................... $ 58,514 $ (46,838) $ 152,208 $ 67,396
========== ========== ========== ==========
Per Share Data:
Earnings Per Share................................ $ 0.96 $ 0.47(B) $ 2.20(C) $ 1.01
========== ========== ========== ==========
Earnings Per Share Assuming Full Dilution......... $ 0.95 $ 0.45(B) $ 2.16(C) $ 0.99
========== ========== ========== ==========
Medical membership.................................. 6,727,586 6,783,224 6,828,512 6,891,603
========== ========== ========== ==========
- --------------------------
(A) Financial information for quarters prior to June 30, 1998 has been restated
to include the workers' compensation business as a discontinued operation.
(B) The second quarter of 1998 includes a charge of $48.7 million, before tax,
$29.0 million, after tax, or $.26 per basic and diluted share related to the
write off of the Company's investment in FPA Holdings, Inc.
(C) The third quarter of 1998 includes a tax benefit of $85.5 million, or $1.24
per basic and $1.21 per diluted share related to a favorable IRS ruling
regarding the deductibility of a cash payment made by the Company's former
parent company at the time of its May 20, 1996 Recapitalization.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
47
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
A. Directors of the Company.
Information regarding the directors of the Company is contained in the
Company's proxy statement for its 2000 Annual Meeting of Stockholders and is
incorporated herein by reference.
B. Executive Officers of the Company
Information regarding the Company's executive officers is contained in Part
I above under the caption "Item 1. Business."
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is contained in the Company's proxy
statement for its 2000 Annual Meeting of Stockholders and is incorporated herein
by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is contained in the Company's proxy
statement for its 2000 Annual Meeting of Stockholders and is incorporated herein
by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is contained in the Company's proxy
statement for its 2000 Annual Meeting of Stockholders and is incorporated herein
by reference.
48
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K.
a. 1) FINANCIAL STATEMENTS
The consolidated financial statements are contained herein as listed on the
"Index" on page F-1 hereof.
2) FINANCIAL STATEMENT SCHEDULES
All of the financial statement schedules for which provision is made in the
applicable accounting regulations of the Commission are not required under the
applicable instructions or are not applicable and therefore have been omitted.
b. REPORTS ON FORM 8-K
There were no Current Reports on Form 8-K filed by the Company during the
quarter ended December 31, 1999.
c. EXHIBITS
EXHIBIT
NUMBER EXHIBIT
- --------------------- -------
2.01 Amended and Restated Recapitalization Agreement dated as of
March 31, 1995, by and among the Registrant, Blue Cross of
California, Western Health Partnerships and Western
Foundation for Health Improvement incorporated by reference
to Exhibit 2.1 of Registrant's Registration Statement on
Form S-4 dated April 8, 1996
2.02 Agreement and Plan of Merger dated as of July 9, 1998, by
and among Cerulean Companies, Inc., the Registrant and Water
Polo Acquisition Corp., incorporated by reference to
Exhibit 2.4 to the Registrant's Registration Statement on
Form S-4 (Registration No. 333-64955)
2.03 Stock Purchase Agreement dated as of July 29, 1998, by and
between the Registrant and Fremont Indemnity Company,
incorporated by reference to Exhibit 2.1 to the Registrant's
Current Report on Form 8-K dated September 1, 1998
2.04 First Amendment to the Stock Purchase Agreement dated as of
November 5, 1998, by and between the Registrant and Fremont
Indemnity Company, incorporated by reference to
Exhibit 2.05 of the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1998
2.05 Second Amendment to the Stock Purchase Agreement dated as of
February 1, 1999, by and between the Registrant and Fremont
Indemnity Company, incorporated by reference to
Exhibit 2.06 of the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1998
2.06 First Amendment to the Agreement and Plan of Merger dated as
of July 9, 1999, by and among Cerulean Companies, Inc., the
Registrant and Water Polo Acquisition Corp., incorporated by
reference to Exhibit 2.07 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1999.
2.07 Second Amendment to the Agreement and Plan of Merger dated
as of December 31, 1999, by and among Cerulean
Companies, Inc., the Registrant and Water Polo Acquisition
Corp.
3.01 Restated Certificate of Incorporation of the Registrant,
incorporated by reference to Exhibit 3.1 of the Registrant's
Current Report on Form 8-K filed on August 5, 1997.
3.02 Bylaws of the Registrant, incorporated by reference to
Exhibit 4.2 of the Registrant's Registration Statement on
Form S-8 (Registration No. 333-90791)
49
EXHIBIT
NUMBER EXHIBIT
- --------------------- -------
4.01 Specimen of Common Stock certificate of WellPoint Health
Networks Inc., incorporated by reference to Exhibit 4.4 of
the Registrant's Registration Statement on Form 8-B,
Registration No. 001-13083
4.02 Restated Certificate of Incorporation of the Registrant
(included in Exhibit 3.01)
4.03 Bylaws of the Registrant (included in Exhibit 3.02)
4.04 Indenture dated as of July 2, 1999 by and between Registrant
and the Bank of New York, as trustee (including the Form of
Debenture attached as Exhibit A thereto), incorporated by
reference to Exhibit 4.04 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 30,
1999.
9.01 Amended and Restated Voting Trust Agreement dated as of
August 4, 1997, by and between the California HealthCare
Foundation (the "Foundation") and Wilmington Trust Company,
incorporated by reference to Exhibit 99.2 of Registrant's
Current Report on Form 8-K filed on August 5, 1997
9.02 Amendment No. 1 dated as of June 12, 1998 to the Amended and
Restated Voting Trust Agreement by and among the Foundation,
the Registrant and Wilmington Trust Company, incorporated by
reference to Exhibit 99.2 of the Registrant's Current Report
on Form 8-K filed on June 15, 1998
10.01 Undertakings dated January 7, 1993, by the Registrant, Blue
Cross of California and certain subsidiaries to the
California Department of Corporations, incorporated by
reference to Exhibit 10.24 of the Registrant's Form S-1
Registration Statement No. 33-54898
10.02* Supplemental Pension Plan of Blue Cross of California,
incorporated by reference to Exhibit 10.15 of the
Registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 1992
10.03* Form of Supplemental Life and Disability Insurance Policy,
incorporated by reference to Exhibit 10.14 of the
Registrant's Form S-1 Registration Statement No. 33-54898
10.04* Form of Indemnification Agreement between the Registrant and
its Directors and Officers, incorporated by reference to
Exhibit 10.17 of the Registrant's Form S-1 Registration
Statement No. 33-54898
10.05* Officer Severance Agreement, dated as of July 1, 1993,
between the Registrant and Thomas C. Geiser, incorporated by
reference to Exhibit 10.24 of the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1993
10.06 Orders Approving Notice of Material Modification and
Undertakings dated September 7, 1995, by BCC, the
Registrant and the Registrant's subsidiaries to the
California Department of Corporations, incorporated by
reference to Exhibit 10.47 of Registrant's Quarterly Report
on Form 10-Q for the quarter ended September 30, 1995
10.07 Lease Agreement, dated as of January 1, 1996, by and between
TA/Warner Center Associates II, L.P., and the Registrant,
incorporated by reference to Exhibit 10.46 of Registrant's
Annual Report on Form 10-K for the fiscal year ended
December 31, 1995
10.08* Letter, dated November 13, 1995, from the Registrant to
Ronald A. Williams regarding severance benefits, together
with underlying Officer Severance Agreement, incorporated by
reference to Exhibit 10.47 of Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 1995
10.09* Letter, dated November 13, 1995, from the Registrant to D.
Mark Weinberg regarding severance benefits, together with
underlying Officer Severance Agreement, incorporated by
reference to Exhibit 10.48 of Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 1995
50
EXHIBIT
NUMBER EXHIBIT
- --------------------- -------
10.10* Letter, dated November 13, 1995, from the Registrant to
Thomas C. Geiser regarding severance benefits, incorporated
by reference to Exhibit 10.49 of Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1995
10.11 Amended and Restated Undertakings dated March 5, 1996, by
BCC, the Registrant and the Registrant's subsidiaries to the
California Department of Corporations, incorporated by
reference to Exhibit 99.1 of the Registrant's Current Report
on Form 8-K dated March 5, 1996
10.12 Indemnification Agreement dated as of May 17, 1996, by and
among the Registrant, WellPoint Health Networks Inc., a
Delaware corporation, and Western Health Partnerships,
incorporated by reference to Exhibit 99.9 of the
Registrant's Current Report on Form 8-K dated May 20, 1996
10.13 Credit Agreement dated as of May 15, 1996, by and among the
Registrant, Bank of America National Trust and Savings
Association ("Bank of America"), as Administrative Agent,
NationsBank of Texas, N.A., as Syndication Agent, Chemical
Bank, as Documentation Agent, and the other financial
institutions named therein, incorporated by reference to
Exhibit 99.10 of the Registrant's Current Report on
Form 8-K dated May 20, 1996
10.14 Amendment No. 1 dated as of June 28, 1996, to the
Registrant's Credit Agreement dated as of May 15, 1996,
incorporated by reference to Exhibit 10.65 of Registrant's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996
10.15 Coinsurance Agreement dated as of March 1, 1997 between John
Hancock and UNICARE Life & Health Insurance Company
("UNICARE"), incorporated by reference to Exhibit 99.2 of
Registrant's Current Report on Form 8-K filed March 14, 1997
10.16 Second Amendment dated as of April 21, 1997 to the
Registrant's Credit Agreement dated as of May 15, 1996,
incorporated by reference to Exhibit 10.55 of Registrant's
Quarterly Report on Form 10-Q for the quarter ended
March 31, 1997
10.17 Third Amendment dated as of April 21, 1997 to Registrant's
Credit Agreement dated as of May 15, 1996, incorporated by
reference to Exhibit 10.56 of the Registrant's Quarterly
Report on Form 10-Q for the quarter ended March 31, 1997
10.18 Amended and Restated Voting Agreement dated as of August 4,
1997 by and among the Registrant, WellPoint California and
the Foundation, incorporated by reference to Exhibit 99.3 of
the Registrant's Current Report on Form 8-K filed on
August 5, 1997
10.19 Amended and Restated Share Escrow Agent Agreement dated as
of August 4, 1997 by and between the Registrant and U.S.
Trust Company of California, N.A., incorporated by reference
to Exhibit 99.4 of the Registrant's Current Report on
Form 8-K filed on August 5, 1997
10.20 Amended and Restated Registration Rights Agreement dated as
of August 4, 1997 by and among the Registrant, WellPoint
California and the Foundation incorporated by reference to
Exhibit 99.5 of Registrant's Form 8-K filed on August 5,
1997
10.21 Blue Cross License Agreement Effective as of August 4, 1997
by and among the Registrant and the Blue Cross Blue Shield
Association (the "BCBSA"), incorporated by reference to
Exhibit 99.6 of Registrant's Form 8-K filed on August 5,
1997
10.22 Blue Cross Controlled Affiliate License Agreement effective
as of August 4, 1997 by and between the BCBSA and Blue Cross
of California, incorporated by reference to Exhibit 99.8 of
Registrant's Form 8-K filed on August 5, 1997
10.23 Blue Cross Affiliate License Agreement effective as of
August 4, 1997 by and between the BCBSA and BC Life & Health
Insurance Company, incorporated by reference to
Exhibit 99.9 of Registrant's Form 8-K filed on August 5,
1997
51
EXHIBIT
NUMBER EXHIBIT
- --------------------- -------
10.24 Blue Cross Controlled Affiliate License Agreement Applicable
to Life Insurance Companies effective as of August 4, 1997
by and between the BCBSA and BC Life & Health Insurance
Company, incorporated by reference to Exhibit 99.10 of
Registrant's Form 8-K filed on August 5, 1997
10.25 Fourth Amendment to Credit Agreement and Consent dated as of
July 21, 1997 by and among the Registrant, WellPoint
California, Bank of America National Trust and Savings
Association, as Administrative Agent, NationsBank of Texas,
N.A., as Syndication Agent, and Chase Manhattan Bank, as
Documentation Agent, and the other financial institutions
named therein, incorporated by reference to Exhibit 99.11 to
Registrant's Current Report on Form 8-K filed on August 5,
1997.
10.26 Undertakings dated July 31, 1997 by the Registrant,
WellPoint California and WellPoint California
Services, Inc. to the California Department of Corporations,
incorporated by reference to Exhibit 99.12 to the
Registrant's Current Report on Form 8-K filed on August 5,
1997
10.27* WellPoint Health Networks Inc. Employee Stock Purchase Plan
(as amended and restated effective January 1, 1998),
incorporated by reference to Exhibit 10.71 of Registrant's
Form 10-Q for the quarter ended June 30, 1997
10.28* Salary Deferral Savings Program of WellPoint Health
Networks Inc., as amended through October 1, 1997,
incorporated by reference to Exhibit 10.74 to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1997
10.29* WellPoint Officer Benefit Enrollment Guide Brochure
10.30 Office Lease dated as of December 2, 1997 by and among the
Registrant and Westlake Business Park, Ltd., incorporated by
reference to Exhibit 10.48 to the Registrant's Annual Report
on Form 10-K for the year ended December 31, 1997
10.31 Fifth Amendment dated as of May 1, 1998 to the Registrant's
Credit Agreement dated as of May 15, 1996, incorporated by
reference to Exhibit 10.01 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended March 31, 1998
10.32* Amendment No. 1 to the Salary Deferral Savings Program of
WellPoint Health Networks Inc., incorporated by reference to
Exhibit 10.03 to the Registrant's Quarterly Report on
Form 10-Q for the quarter ended March 31, 1998
10.33 California Blue Cross License Addendum (amended and restated
as of June 12, 1998), by and among the Registrant, Blue
Cross of California and the Blue Cross Blue Shield
Association, incorporated by reference to Exhibit 99.1 to
the Registrant's Current Report on Form 8-K filed on June
15, 1998
10.34 Amendment No. 1 dated as of June 12, 1998 to the Amended and
Restated Share Escrow Agent Agreement by and between the
Registrant and U.S. Trust Company of California, N.A.,
incorporated by reference to Exhibit 99.3 to the
Registrant's Current Report on Form 8-K filed on June 15,
1998
10.35* Promissory Note dated as of June 23, 1998 made by Joan E.
Herman in favor of the Registrant, incorporated by reference
to Exhibit 10.04 to the Registrant's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1998
10.36* WellPoint Health Networks Inc. Officer Change-in-Control
Plan (as amended and restated through October 27, 1998),
incorporated to the Registrant's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1998
10.37* WellPoint Health Networks Inc. Officer Severance Plan (as
adopted October 27, 1998), incorporated by reference to
Exhibit 10.04 to the Registrant's Quarterly Report on
Form 10-Q for the quarter ended March 31, 1999
52
EXHIBIT
NUMBER EXHIBIT
- --------------------- -------
10.38 Letter Agreement dated July 8, 1998 by and between the
Registrant and the Foundation, incorporated by reference to
Exhibit 10.04 to the Registrant's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1998
10.39* WellPoint Health Networks Inc. Management Bonus Plan
10.40* Amendment No. 2 to the Salary Deferral Savings Program of
WellPoint Health Networks Inc., incorporated by reference to
Exhibit 10.51 to the Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 1998
10.41* Board of Directors Deferred Compensation Plan of WellPoint
Health Networks Inc., incorporated by reference to
Exhibit 10.52 to the Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 1998.
10.42 Stock Purchase Agreement dated as of November 20, 1998 by
and between the Registrant and the Foundation, incorporated
by reference to Exhibit 10.53 to the Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31,
1998.
10.43* Amendment No. 3 to the Salary Deferral Savings Program of
WellPoint Health Networks Inc., incorporated by reference to
Exhibit 10.54 to the Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 1998
10.44* Employment Agreement dated as of February 10, 1999 by and
between the Registrant and Leonard D. Schaeffer,
incorporated by reference to Exhibit 10.01 to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1999.
10.45* Promissory Note dated as of February 10, 1999 made by
Leonard D. Schaeffer in favor of the Registrant,
incorporated by reference to Exhibit 10.02 to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1999.
10.46* Special Executive Retirement Plan dated as of February 10,
1999 by and between the Registrant and Leonard D. Schaeffer,
incorporated by reference to Exhibit 10.03 to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1999.
10.47* 1999 Stock Incentive Plan, incorporated by reference to
Annex I to the Registrant's Proxy Statement on Schedule 14A
dated March 25, 1999.
10.48* 1999 Executive Officer Annual Incentive Plan, incorporated
by reference to Annex II to the Registrant's Proxy Statement
on Schedule 14A dated March 25, 1999.
10.49* Promissory Note dated as of April 5, 1999 made by Clifton R.
Gaus in favor or the Registrant, incorporated by reference
to Exhibit 10.03 to the Registrant's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1999.
10.50* Stock Purchase Agreement dated as of June 29, 1999 by and
between the Registrant and the Foundation, incorporated by
reference to Exhibit 10.04 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1999.
10.51* WellPoint Health Networks Inc. Comprehensive Executive
Non-Qualified Retirement Plan
10.52* Amendment No. 4 to the Salary Deferral Savings Program of
WellPoint Health Networks Inc.
21 List of Subsidiaries of the Registrant
23.1 Consent of Independent Accountants
24 Power of Attorney (included on Signature Page).
27.1 Financial Data Schedule
- ------------------------
* Management contract or compensatory plan or arrangement
53
SIGNATURES
Pursuant to the requirement 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 23, 2000 WELLPOINT HEALTH NETWORKS INC.
By: /s/ LEONARD D. SCHAEFFER
------------------------------------
Leonard D. Schaeffer
CHAIRMAN OF THE BOARD OF DIRECTORS
AND CHIEF EXECUTIVE OFFICER
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS:
That the undersigned officers and directors of WellPoint Health Networks
Inc. do hereby constitute and appoint Leonard D. Schaeffer and Thomas C. Geiser,
and each of them, the lawful attorney and agent or attorneys and agents with
power and authority to do any and all acts and things and to execute any and all
instruments which said attorneys and agents, or either of them, determine may be
necessary or advisable or required to enable WellPoint Health Networks Inc. to
comply with the Securities Exchange Act of 1934, as amended, and any rules or
regulations or requirements of the Securities and Exchange Commission in
connection with this Annual Report on Form 10-K. Without limiting the generality
of the foregoing power and authority, the powers granted include the power and
authority to sign the names of the undersigned officers and directors in the
capacities indicated below to this Annual Report on Form 10-K or amendment or
supplements thereto, and each of the undersigned hereby ratifies and confirms
all that said attorneys and agent, or either of them, shall do or cause to be
done by virtue hereof. This Power of Attorney may be signed in several
counterparts.
IN WITNESS WHEREOF, each of the undersigned has executed this Power of
Attorney as of the date indicated opposite his or her name.
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ LEONARD D. SCHAEFFER Chairman of the Board of Directors March 23, 2000
------------------------------------ and Chief Executive Officer
Leonard D. Schaeffer (Principal Executive Officer)
/s/ DAVID C. COLBY Executive Vice President and March 23, 2000
------------------------------------ Chief Financial Officer
David C. Colby (Principal Financial Officer)
/s/ S. LOUISE MCCRARY Senior Vice President, Controller March 23, 2000
------------------------------------ and Chief Accounting Officer
S. Louise McCrary (Principal Accounting Officer)
54
SIGNATURE TITLE DATE
--------- ----- ----
/s/ W. TOLIVER BESSON Director March 23, 2000
------------------------------------
W. Toliver Besson
/s/ ROGER E. BIRK Director March 23, 2000
------------------------------------
Roger E. Birk
/s/ SHEILA P. BURKE Director March 23, 2000
------------------------------------
Sheila P. Burke
/s/ STEPHEN L. DAVENPORT Director March 23, 2000
------------------------------------
Stephen L. Davenport
/s/ JULIE A. HILL Director March 23, 2000
------------------------------------
Julie A. Hill
/s/ ELIZABETH A. SANDERS Director March 23, 2000
------------------------------------
Elizabeth A. Sanders
55
INDEX TO FINANCIAL STATEMENTS
WELLPOINT HEALTH NETWORKS INC.
PAGE
--------
Report of Independent Accountants........................... F-2
Consolidated Balance Sheets as of December 31, 1999 and
1998...................................................... F-3
Consolidated Income Statements for the Three Years Ended
December 31, 1999......................................... F-4
Consolidated Statements of Changes in Stockholders' Equity
for the Three Years Ended December 31, 1999............... F-5
Consolidated Statements of Cash Flows for the Three Years
Ended December 31, 1999................................... F-6
Notes to Consolidated Financial Statements.................. F-7
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
January 31, 2000
To the Stockholders and Board of Directors
WellPoint Health Networks Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated income statements and consolidated statements of changes in
stockholders' equity and cash flows present fairly, in all material respects,
the financial position of WellPoint Health Networks Inc. and its subsidiaries
(the "Company") at December 31, 1999 and 1998, and the results of its operations
and cash flows for each of the three years in the period ended December 31,
1999, in conformity with accounting principles generally accepted in the United
States. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these financial
statements in accordance with auditing standards generally accepted in the
United States, which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
As discussed in Note 2 to the Consolidated Financial Statements, effective
January 1, 1999, the Company changed its method of accounting for start-up
costs.
PricewaterhouseCoopers LLP
Los Angeles, California
F-2
WELLPOINT HEALTH NETWORKS INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
-----------------------
1999 1998
(IN THOUSANDS, EXCEPT SHARE DATA) ---------- ----------
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 505,014 $ 410,875
Investment securities, at market value.................... 2,645,372 2,250,174
Receivables, net.......................................... 513,079 485,259
Deferred tax assets....................................... 92,774 121,881
Income taxes recoverable.................................. -- 95,902
Other current assets...................................... 59,725 70,349
---------- ----------
Total Current Assets.................................... 3,815,964 3,434,440
Property and equipment, net................................. 125,917 131,459
Intangible assets, net...................................... 96,298 93,937
Goodwill, net............................................... 307,647 336,155
Long-term investments, at market value...................... 108,280 103,253
Deferred tax assets......................................... 84,063 79,976
Other non-current assets.................................... 55,065 46,614
---------- ----------
Total Assets.......................................... $4,593,234 $4,225,834
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Medical claims payable.................................... $1,142,183 $ 946,502
Reserves for future policy benefits....................... 57,435 55,024
Unearned premiums......................................... 230,407 215,058
Accounts payable and accrued expenses..................... 440,412 342,713
Experience rated and other refunds........................ 223,066 249,685
Income taxes payable...................................... 84,026 --
Other current liabilities................................. 349,757 373,882
---------- ----------
Total Current Liabilities............................... 2,527,286 2,182,864
Accrued postretirement benefits............................. 68,903 67,058
Reserves for future policy benefits, non-current............ 291,626 319,056
Long-term debt.............................................. 347,884 300,000
Other non-current liabilities............................... 44,835 41,633
---------- ----------
Total Liabilities....................................... 3,280,534 2,910,611
Stockholders' Equity:
Preferred Stock--$0.01 par value, 50,000,000 shares
authorized, none issued and outstanding................. -- --
Common Stock--$0.01 par value, 300,000,000 shares
authorized, 71,390,971 and 70,620,657 issued in 1999 and
1998, respectively...................................... 714 706
Treasury stock, at cost, 7,764,668 and 3,501,556 shares in
1999 and 1998, respectively............................. (481,331) (193,435)
Additional paid-in capital................................ 955,016 921,747
Retained earnings......................................... 854,642 576,598
Accumulated other comprehensive income.................... (16,341) 9,607
---------- ----------
Total Stockholders' Equity.............................. 1,312,700 1,315,223
---------- ----------
Total Liabilities and Stockholders' Equity............ $4,593,234 $4,225,834
========== ==========
See the accompanying notes to the consolidated financial statements.
F-3
WELLPOINT HEALTH NETWORKS INC.
CONSOLIDATED INCOME STATEMENTS
YEAR ENDED DECEMBER 31,
------------------------------------
1999 1998 1997
---------- ---------- ----------
(IN THOUSANDS, EXCEPT EARNINGS PER
SHARE)
Revenues:
Premium revenue........................................... $6,896,857 $5,934,812 $5,068,947
Management services revenue............................... 429,336 433,960 377,138
Investment income......................................... 159,234 109,578 196,153
---------- ---------- ----------
7,485,427 6,478,350 5,642,238
Operating Expenses:
Health care services and other benefits................... 5,533,068 4,776,345 4,087,420
Selling expense........................................... 328,619 280,078 249,389
General and administrative expense........................ 1,075,449 975,099 836,581
Nonrecurring costs........................................ -- -- 14,535
---------- ---------- ----------
6,937,136 6,031,522 5,187,925
---------- ---------- ----------
Operating Income............................................ 548,291 446,828 454,313
Interest expense.......................................... 20,178 26,903 36,658
Other expense, net........................................ 40,792 27,939 31,301
---------- ---------- ----------
Income from Continuing Operations before Provision for
Income Taxes, Extraordinary Gain and Cumulative Effect
of Accounting Change.................................... 487,321 391,986 386,354
Provision for income taxes................................ 190,110 72,438 156,917
---------- ---------- ----------
Income from Continuing Operations before Extraordinary......
Gain and Cumulative Effect of Accounting Change........... 297,211 319,548 229,437
Discontinued Operations:
Loss from Workers' Compensation
Segment, net of tax benefit of $6,959 and $2,126,
respectively............................................ -- (12,592) (2,028)
Loss on disposal of Workers' Compensation
Segment, net of tax benefit of $33,022.................. -- (75,676) --
---------- ---------- ----------
Loss from Discontinued Operations........................... -- (88,268) (2,028)
Extraordinary Gain from Early Extinguishment of Debt, net of
tax....................................................... 1,891 -- --
Cumulative Effect of Accounting Change, net of tax.......... (20,558) -- --
---------- ---------- ----------
Net Income.................................................. $ 278,544 $ 231,280 $ 227,409
========== ========== ==========
Earnings Per Share:
Income from continuing operations before extraordinary
gain and cumulative effect of accounting change......... $ 4.50 $ 4.63 $ 3.33
Loss from discontinued operations......................... -- (1.28) (0.03)
Extraordinary gain from early extinguishment of debt, net
of tax.................................................. 0.03 -- --
Cumulative effect of accounting change, net of tax........ (0.31) -- --
---------- ---------- ----------
Net income................................................ $ 4.22 $ 3.35 $ 3.30
========== ========== ==========
Earnings Per Share Assuming Full Dilution:
Income from continuing operations before extraordinary
gain and cumulative effect of accounting change......... $ 4.38 $ 4.55 $ 3.30
Loss from discontinued operations......................... -- (1.26) (0.03)
Extraordinary gain from early extinguishment of debt, net
of tax.................................................. 0.02 -- --
Cumulative effect of accounting change, net of tax........ (0.30) -- --
---------- ---------- ----------
Net income................................................ $ 4.10 $ 3.29 $ 3.27
========== ========== ==========
See the accompanying notes to the consolidated financial statements.
F-4
WELLPOINT HEALTH NETWORKS INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS)
COMMON STOCK
--------------------------------- ACCUMULATED
ISSUED IN TREASURY ADDITIONAL OTHER
PREFERRED ------------------- ----------- PAID-IN RETAINED COMPREHENSIVE
STOCK SHARES AMOUNT AMOUNT CAPITAL EARNINGS INCOME TOTAL
--------- -------- -------- ----------- ---------- -------- -------------- ----------
BALANCE AS OF JANUARY 1,
1997...................... $ -- 66,527 $665 $ -- $761,879 $117,909 $ (9,994) $ 870,459
Net proceeds from common
stock offering............ 3,000 30 110,310 110,340
Stock grants to employees
and directors............. 6 270 270
Stock issued for employee
stock option and stock
purchase plans............ 245 3 9,853 9,856
Stock repurchased, 4,571
shares at cost............ (103) (103)
Comprehensive income
Net income................ 227,409 227,409
Other comprehensive
income, net of tax
Change in unrealized
valuation adjustment
on investment
securities, net of
reclassification
adjustment............ 4,938 4,938
-------- -------- ----------
Total comprehensive
income.................... 227,409 4,938 232,347
----- ------- ---- --------- -------- -------- -------- ----------
BALANCE AS OF DECEMBER 31,
1997...................... -- 69,778 698 (103) 882,312 345,318 (5,056) 1,223,169
Stock grants to employees
and directors............. 6 399 399
Stock issued for employee
stock option and stock
purchase plans............ 837 8 39,036 39,044
Stock repurchased, 3,496,985
shares at cost............ (193,332) (193,332)
Comprehensive income
Net income................ 231,280 231,280
Other comprehensive
income, net of tax
Change in unrealized
valuation adjustment
on investment
securities, net of
reclassification
adjustment............ 14,663 14,663
-------- -------- ----------
Total comprehensive
income.................... 231,280 14,663 245,943
----- ------- ---- --------- -------- -------- -------- ----------
BALANCE AS OF DECEMBER 31,
1998...................... -- 70,621 706 (193,435) 921,747 576,598 9,607 1,315,223
Stock grants to employees
and directors............. 75 1 172 3,051 3,224
Stock issued for employee
stock option and stock
purchase plans............ 695 7 3,616 30,218 33,841
Stock repurchased, 4,332,500
shares at cost............ (291,684) (291,684)
Net losses from treasury
stock reissued............ (500) (500)
Comprehensive income
Net income................ 278,544 278,544
Other comprehensive
income, net of tax
Change in unrealized
valuation adjustment
on investment
securities, net of
reclassification
adjustment............ (26,179) (26,179)
Foreign currency
adjustments, net of
tax................... 231 231
-------- -------- ----------
Total comprehensive
income.................... 278,544 (25,948) 252,596
----- ------- ---- --------- -------- -------- -------- ----------
BALANCE AS OF DECEMBER 31,
1999...................... $ -- 71,391 $714 $(481,331) $955,016 $854,642 $(16,341) $1,312,700
===== ======= ==== ========= ======== ======== ======== ==========
See the accompanying notes to the consolidated financial statements
F-5
WELLPOINT HEALTH NETWORKS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
---------------------------------------
1999 1998 1997
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Income from continuing operations before extraordinary gain
and cumulative effect of accounting change................ $ 297,211 $ 319,548 $ 229,437
Adjustments to reconcile income from continuing operations
before extraordinary gain and cumulative effect of
accounting change to net cash provided by continuing
operating activities:
Depreciation and amortization, net of accretion........... 68,767 54,590 51,239
(Gains) losses on sales of assets, net.................... 31,898 34,679 (59,168)
Provision (benefit) for deferred income taxes............. 41,087 (83,261) 20,699
Amortization of deferred gain on sale of building......... (4,426) (4,425) (4,426)
Accretion of interest on zero coupon convertible
subordinated debentures................................. 1,465 -- --
(Increase) decrease in certain assets:
Receivables, net........................................ (29,263) 17,621 (11,315)
Income taxes recoverable................................ 191,079 15,099 --
Other current assets.................................... (26,169) (20,087) (30,536)
Other non-current assets................................ (8,451) 1,978 1,719
Increase (decrease) in certain liabilities:
Medical claims payable.................................. 195,681 23,844 170,728
Reserves for future policy benefits..................... (25,019) (9,142) 407
Unearned premiums....................................... 15,349 18,853 14,072
Accounts payable and accrued expenses................... 107,086 (6,415) 102,662
Experience rated and other refunds...................... (26,619) (5,810) 17,726
Other current liabilities............................... (5,227) 35,398 3,745
Accrued postretirement benefits......................... 1,845 3,167 2,805
Other non-current liabilities........................... 3,064 (1,027) (13,698)
----------- ----------- -----------
Net cash provided by continuing operating
activities........................................... 829,358 394,610 496,096
----------- ----------- -----------
Loss from discontinued operations........................... -- (12,592) (2,028)
Adjustment to derive cash flows from discontinued operating
activities:
Change in net operating assets.......................... -- 7,410 59,012
----------- ----------- -----------
Net cash provided by (used in) discontinued operating
activities -- (5,182) 56,984
----------- ----------- -----------
Net cash provided by operating activities............. 829,358 389,428 553,080
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investments purchased..................................... (3,456,317) (2,843,102) (2,641,752)
Proceeds from investments sold............................ 2,892,802 2,666,355 1,836,541
Proceeds from investments matured......................... 83,404 106,436 143,218
Property and equipment purchased.......................... (38,516) (78,431) (58,619)
Proceeds from property and equipment sold................. 1,925 25,721 503
Proceeds from sale of Workers' Compensation business...... -- 101,413 --
Settlement of sales price for sale of Workers'
Compensation business................................... (6,733) -- --
Additional investment in subsidiaries..................... -- -- (18,317)
Acquisition of new businesses, net of cash acquired....... (7,700) -- 361,977
----------- ----------- -----------
Net cash used in continuing investing activities...... (531,135) (21,608) (376,449)
----------- ----------- -----------
Net cash provided by (used in) investing activities of
discontinued operations................................... -- 15,877 (76,149)
----------- ----------- -----------
Net cash used in investing activities................. (531,135) (5,731) (452,598)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt.............................. 200,823 -- 150,000
Repayment of long-term debt............................... (149,788) (88,000) (387,000)
Net proceeds from common stock offering................... -- -- 110,340
Proceeds from the issuance of common stock................ 36,565 39,443 10,126
Common stock repurchased.................................. (291,684) (193,332) (103)
----------- ----------- -----------
Net cash used in financing activities................. (204,084) (241,889) (116,637)
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents........ 94,139 141,808 (16,155)
Cash and cash equivalents at beginning of year.............. 410,875 269,067 285,222
----------- ----------- -----------
Cash and cash equivalents at end of year.................... $ 505,014 $ 410,875 $ 269,067
=========== =========== ===========
See the accompanying notes to the consolidated financial statements.
F-6
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
WellPoint Health Networks Inc. (the "Company" or "WellPoint"), is one of the
nation's largest publicly traded managed health care companies. As of
December 31, 1999, WellPoint had approximately 7.3 million medical members and
approximately 32 million specialty members. The Company offers a broad spectrum
of network-based managed care plans. WellPoint provides these plans to the large
and small employer, individual and senior markets. The Company's managed care
plans include preferred provider organizations ("PPOs"), health maintenance
organizations ("HMOs"), point-of-service ("POS") plans, other hybrid plans and
traditional indemnity plans. In addition, the Company offers managed care
services, including underwriting, actuarial service, network access, medical
cost management and claims processing. The Company offers a continuum of managed
health care plans while providing incentives to members and employers to select
more intensively managed plans. The Company also provides a broad array of
specialty and other products and services including pharmacy, dental,
utilization management, life insurance, preventive care, disability, behavioral
health, COBRA and flexible benefits account administration.
As more fully described in Note 11, on September 1, 1998, the Company
completed the sale of its workers' compensation segment. Such sale was accounted
for as a discontinued operation.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
As a managed health care organization, the Company derives the majority of
its revenues from premiums received for providing prepaid health services and
prepares its financial statements in accordance with the AICPA Audit and
Accounting Guide for "Health Care Organizations." The following is a summary of
significant accounting policies used in the preparation of the accompanying
consolidated financial statements. Such policies are in accordance with
accounting principles generally accepted in the United States and have been
consistently applied. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses for each reporting
period. The significant estimates made in the preparation of the Company's
consolidated financial statements relate to the assessment of the carrying value
of the goodwill and intangible assets, medical claims payable, reserves for
future policy benefits, experience rated refunds and contingent liabilities.
While management believes that the carrying value of such assets and liabilities
is adequate as of December 31, 1999 and 1998, actual results could differ from
the estimates upon which the carrying values were based.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All significant intercompany transactions and accounts
have been eliminated in consolidation.
CASH EQUIVALENTS
The Company considers cash equivalents to include highly liquid debt
instruments purchased with an original remaining maturity of three months or
less.
F-7
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash investments,
investment securities, foreign currency denominated forward exchange contracts
and interest rate swaps. The Company invests its excess cash primarily in
commercial paper and money market funds. Although a majority of the cash
accounts exceed the federally insured deposit amount, management does not
anticipate nonperformance by financial institutions and reviews the financial
viability of these institutions on a periodic basis. The Company attempts to
limit its risk in investment securities by maintaining a diversified portfolio.
The components of investment securities are shown in Note 3.
INVESTMENTS
Investment securities consist primarily of U.S. Treasury and agency
securities, foreign currency denominated bonds, mortgage-backed securities,
investment grade corporate bonds and equity securities. The Company has
determined that its investment securities are available for use in current
operations and, accordingly, has classified such investment securities as
current without regard to contractual maturity dates.
Long-term investments consist primarily of restricted assets, equity and
other investments. Restricted assets, at market value, included in long-term
investments at December 31, 1999 and 1998 were $100.0 million and
$96.6 million, respectively, and consisted of investments on deposit with the
California Department of Corporations ("DOC"). These deposits consisted
primarily of U.S. Treasury bonds and notes. Due to their restricted nature, such
investments are classified as long-term without regard to contractual maturity.
The Company has determined that its debt and equity securities are available
for sale. Debt and equity securities are carried at estimated fair value based
on quoted market prices for the same or similar instruments. Unrealized gains
and losses are computed on the basis of specific identification and are included
in other comprehensive income, net of applicable deferred income taxes. Realized
gains and losses on the disposition of investments are included in investment
income. The specific identification method is used in determining the cost of
debt and equity securities sold.
The Company participates in a securities lending program whereby marketable
securities in the Company's portfolio are transferred to an independent broker
or dealer in exchange for collateral equal to at least 102% of the market value
of securities on loan.
In order to mitigate foreign currency risk for certain investments on the
foreign currency denominated bonds within the Company's investment portfolio,
the Company has entered into two types of foreign currency derivative
instruments. The first type is a forward exchange contract which is entered into
to hedge the foreign currency risk between the trade date and the settlement
date of a foreign currency investment transaction. Gains and losses related to
such instruments are recognized in the Company's income statement at the
settlement date. The Company has also entered into foreign currency contracts
for each of the fixed maturity securities owned as of December 31, 1999 and 1998
to hedge asset positions denominated in other currencies. The unrealized gains
and losses, net of deferred taxes, from such forward contracts and the related
hedged investments are reflected in other comprehensive income at the balance
sheet dates.
F-8
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PREMIUMS RECEIVABLE
Premiums receivable are shown net of an allowance based on historical
collection trends and management's judgment on the collectibility of these
accounts. These collection trends, as well as prevailing and anticipated
economic conditions, are routinely monitored by management, and any adjustments
required are reflected in current operations.
PROPERTY AND EQUIPMENT, NET
Property and equipment are stated at cost, net of depreciation, and are
depreciated on the straight-line method over the estimated useful lives of the
assets. Leasehold improvements are stated net of amortization and are amortized
over a period not exceeding the term of the lease. Upon disposal of property,
plant and equipment, the cost of the asset and the related accumulated
depreciation are removed from the accounts while the resulting gain or loss is
reflected in current operations.
Computer software costs that are incurred in the preliminary project stage
are expensed as incurred. Direct consulting costs, payroll and payroll related
cost for employees, incurred during the development stage, who are directly
associated with each project are capitalized and amortized over a five-year
period when placed into production.
INTANGIBLE ASSETS AND GOODWILL, NET
Intangible assets and goodwill represent the cost in excess of fair value of
the net assets, net of the related tax impact, acquired in purchase
transactions. Intangible assets and goodwill are being amortized, utilizing a
composite useful life, on a straight-line basis over periods ranging from three
to 25 years. (See Note 6 for a more complete discussion of the Company's
intangible assets and goodwill.)
The Company periodically evaluates whether events or circumstances have
occurred that may affect the estimated useful life or the recoverability of the
remaining balance of goodwill and other identifiable intangible assets.
Impairment of an intangible asset is triggered when the estimated future
undiscounted cash flows (excluding interest charges) do not exceed the carrying
amount of the intangible asset and related goodwill. If the events or
circumstances indicate that the remaining balance of the intangible asset and
goodwill may be permanently impaired, such potential impairment will be measured
based upon the difference between the carrying amount of the intangible asset
and goodwill and the fair value of such asset determined using the estimated
future discounted cash flows (excluding interest charges) generated from the use
and ultimate disposition of the respective acquired entity.
MEDICAL CLAIMS PAYABLE
The liability for medical claims payable includes claims in process and a
provision for incurred but not reported claims, which is actuarially determined
based on historical claims payment experience and other statistics. Claim
processing expenses are also accrued based on an estimate of expenses necessary
to process such claims. Such reserves are continually monitored and reviewed
with any adjustments reflected in current operations. Capitation costs represent
monthly fees paid one month in advance to physicians, certain other medical
service providers and hospitals in the Company's HMO networks as retainers for
providing continuing medical care. The Company maintains various programs that
provide incentives to physicians, certain other medical service providers and
hospitals participating in its HMO networks through the use of risk-sharing
agreements and other programs. Payments under such agreements are
F-9
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
made based on the providers' performance in controlling health care costs while
providing quality health care. Expenses related to these programs, which are
based in part on estimates, are recorded in the period in which the related
services are rendered.
RESERVES FOR FUTURE POLICY BENEFITS
The estimated reserves for future policy benefits relate to life and
disability policies written in connection with health care contracts. Reserves
for future extended benefit coverage are based on projections of past
experience. Reserves for future policy and contract benefits for certain
long-term disability products and group paid-up life products are based upon
interest, mortality and morbidity assumptions from published actuarial tables,
modified based upon the Company's experience. Reserves are continually monitored
and reviewed, and as settlements are made or reserves adjusted, differences are
reflected in current operations. The current portion of reserves for future
policy benefits relates to the portion of such reserves which management expects
to pay within one year.
POSTRETIREMENT BENEFITS
The Company currently provides certain health care and life insurance
benefits to eligible retirees and their dependents under plans administered by
the Company. The Company accrues the estimated costs of retiree health and other
postretirement benefits during the periods in which eligible employees render
service to earn the benefits.
INTEREST RATE SWAP AGREEMENTS
The Company utilizes interest rate swap agreements to manage interest rate
exposures. The principal objective of such contracts is to minimize the risks
and/or costs associated with financial activities. The counterparties to these
contractual arrangements are major financial institutions with which the Company
also has other financial relationships. These counterparties expose the Company
to credit loss in the event of nonperformance. However, the Company does not
anticipate nonperformance by the counterparties.
The Company entered into interest rate swap agreements to reduce the impact
of changes in interest rates on its floating rate debt under its revolving
credit facility. The swap agreements are contracts to exchange floating interest
rate payments for fixed interest rate payments periodically over the life of the
agreements without the exchange of the underlying notional amounts. The notional
amounts of the interest rate swap agreements are used to measure interest to be
paid. For interest rate instruments that effectively hedge interest rate
exposures, the net cash amounts paid on the agreements are accrued and
recognized as an adjustment to interest expense. If an agreement no longer
qualifies as a hedge instrument, then it is marked to market and carried on the
balance sheet at fair value. The change in fair value of these instruments is
included in investment income.
INCOME TAXES
The Company files a consolidated income tax return with its subsidiaries.
The Company's provision for income taxes reflects the current and future tax
consequences of all events that have been recognized in the financial statements
as measured by the provision of currently enacted tax laws and rates applicable
to future periods.
F-10
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECOGNITION OF PREMIUM REVENUE AND MANAGEMENT SERVICES REVENUE
For most health care and life insurance contracts, premiums are billed in
advance of coverage periods and are recognized as revenue over the period in
which services or benefits are obligated to be provided. Premiums include
revenue from other contracts, which principally relate to minimum premium
contracts, where revenue is recognized based upon the ultimate loss experience
of the contract. These contracts obligate the Company to arrange for the
provision of health care for the members covered by the related contract and
expose the Company to financial risk based upon its ability to manage health
care costs below a contractual fixed attachment point. Premium revenue includes
an adjustment for experience rated refunds based on an estimate of incurred
claims. Experience rated refunds are paid based on contractual requirements.
The Company's group life and disability insurance contracts are traditional
insurance contracts which are typically issued only in conjunction with a health
care contract. Additionally, WellPoint has a limited number of indemnity health
insurance contracts principally acquired from the Life and Health Benefits
Management Division of the Massachusetts Mutual Life Insurance Company ("MMHD")
and the Group Benefits Operations of the John Hancock Mutual Life Insurance
Company ("GBO"). All of these contracts provide insurance protection for a fixed
period ranging from one month to a year.
The Company has the ability at a minimum to cancel the contract or adjust
the provisions of the contract at the end of the contract period. As a result,
the Company's insurance contracts are considered short-duration contracts.
Premiums applicable to the unexpired contractual coverage periods are
reflected in the accompanying consolidated balance sheet as unearned premiums.
Management services revenue is earned as services are performed and consists
of administrative fees for services provided to third parties, including
management of medical services, claims processing and access to provider
networks. Under administrative service contracts, self-funded employers retain
the full risk of financing benefits. Funds received from employers are equal to
amounts required to fund benefit expenses and pay earned administrative fees.
Because benefit expenses are not the obligation of the Company, premium revenue
and benefit expenses for these contracts are not included in the Company's
financial statements. Administrative service fees received from employer groups
are included in the Company's revenues.
LOSS CONTRACTS
The Company monitors its contracts for the provision of medical care and
recognizes losses on those contracts when it is probable that expected future
health care and maintenance costs, under a group of existing contracts, will
exceed anticipated future premiums on those contracts. The estimation of future
health care medical costs includes all costs related to the provision of health
care to members covered by the related group of contracts. In determining
whether a loss has been incurred, the Company reviews contracts either
individually or collectively, depending upon the Company's method of
establishing premium rates for such contracts.
The Company further monitors its life insurance contracts and recognizes
losses on those contracts for which estimated future claims costs and
maintenance costs exceed the related unearned premium.
F-11
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
HEALTH CARE SERVICES AND OTHER BENEFITS
Health care services and other benefits expense includes the costs of health
care services, capitation expenses and expenses related to risk sharing
agreements with participating physicians, medical groups and hospitals and
incurred losses on the disability and life products. The costs of health care
services are accrued as services are rendered, including an estimate for claims
incurred but not yet reported.
ADVERTISING COSTS
The Company uses print and broadcast advertising to promote its products.
The cost of advertising is expensed as incurred and totaled approximately $40.8
million, $43.3 million and $36.5 million for the years ended December 31, 1999,
1998 and 1997, respectively.
EARNINGS PER SHARE
Basic Earnings per share is computed excluding the impact of potential
common stock and earnings per share assuming full dilution is computed including
the impact of potential common stock.
STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," ("SFAS No. 123") encourages, but does not require,
companies to record compensation cost for stock-based employee compensation
plans at fair value. The Company has chosen to continue to account for
stock-based compensation using the intrinsic method prescribed in Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. Accordingly, compensation cost for
stock options, under existing plans is measured as the excess, if any, of the
quoted market price of the Company's stock at the date of the grant over the
amount an employee must pay to acquire the stock.
COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted the provisions of Statement
of Financial Accounting Standards No. 130, "Comprehensive Income". Comprehensive
income encompasses all changes in stockholders' equity (except those arising
from transactions with stockholders) and includes net income and net unrealized
gains or losses on available-for-sale securities. Comprehensive income is net of
reclassification adjustments to adjust for items currently included in net
income, such as realized gains on investment securities.
START-UP COSTS
Effective January 1, 1999, the Company changed its method of accounting for
start-up costs related to the Company's provider and sales network development
to comply with the AICPA Statement of Position No. 98-5, "Reporting on the Costs
of Start-Up Activities." The change involves expensing these costs as incurred,
rather than capitalizing and subsequently amortizing such costs. The total
amount of deferred start-up costs reported as a cumulative effect of a change in
accounting principle is $20.6 million, net of a tax benefit of $14.3 million.
F-12
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECLASSIFICATIONS
Certain amounts in the prior years consolidated financial statements have
been reclassified to conform to the 1999 presentation.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 establishes the
accounting and reporting standards for derivative instruments and for hedging
activities. Upon adoption of SFAS No. 133, all derivatives must be recognized on
the balance sheet at their then fair value. Any stand-alone deferred gains and
losses remaining on the balance sheet under previous hedge accounting rules must
be removed from the balance sheet and all hedging relationships must be
designated anew and documented pursuant to the new accounting rules. The new
standard will be effective in the first quarter of 2001. The Company is
presently assessing the effect of SFAS No. 133 on the financial statements of
the Company.
3. INVESTMENTS
INVESTMENT SECURITIES
The Company's investment securities consist of the following (in thousands):
DECEMBER 31, 1999
---------------------------------------------
GROSS UNREALIZED
AMORTIZED ------------------- ESTIMATED
COST GAINS LOSSES FAIR VALUE
---------- -------- -------- ----------
U.S. Treasury and agency........... $ 178,350 $ -- $ 2,091 $ 176,259
Foreign government securities...... 98,435 470 3,507 95,398
Mortgage-backed securities......... 783,736 957 19,133 765,560
Corporate and other securities..... 1,341,928 1,582 49,732 1,293,778
---------- ------- ------- ----------
Total debt securities............ 2,402,449 3,009 74,463 2,330,995
Equity and other investments....... 266,972 60,396 12,991 314,377
---------- ------- ------- ----------
Total investment securities...... $2,669,421 $63,405 $87,454 $2,645,372
========== ======= ======= ==========
DECEMBER 31, 1998
---------------------------------------------
GROSS UNREALIZED
AMORTIZED ------------------- ESTIMATED
COST GAINS LOSSES FAIR VALUE
---------- -------- -------- ----------
U.S. Treasury and agency........... $ 274,004 $ 4,546 $ 894 $ 277,656
Foreign government securities...... 88,332 2,413 1,046 89,699
Mortgage-backed securities......... 598,529 8,517 688 606,358
Corporate and other securities..... 995,596 17,810 10,661 1,002,745
---------- ------- ------- ----------
Total debt securities............ 1,956,461 33,286 13,289 1,976,458
Equity and other investments....... 278,229 20,705 25,218 273,716
---------- ------- ------- ----------
Total investment securities...... $2,234,690 $53,991 $38,507 $2,250,174
========== ======= ======= ==========
F-13
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENTS (CONTINUED)
The amortized cost and estimated fair value of debt securities as of
December 31, 1999, based on contractual maturity dates, are summarized below (in
thousands). Expected maturities for mortgage-backed securities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
AMORTIZED ESTIMATED
COST FAIR VALUE
---------- ----------
Due in one year or less.............................. $ 67,633 $ 67,484
Due after one year through five years................ 860,857 843,400
Due after five years through ten years............... 659,537 634,201
Due after ten years.................................. 814,422 785,910
---------- ----------
Total debt securities................................ $2,402,449 $2,330,995
========== ==========
For the years ended December 31, 1999, 1998 and 1997, proceeds from the
sales and maturities of debt securities were $2,713.8 million, $2,569.1 million
and $1,566.1 million, respectively. Gross gains of $16.2 million and gross
losses of $52.6 million were realized on the sales of debt securities for the
year ended December 31, 1999. For 1998, gross realized gains and gross realized
losses from sales of debt securities were $28.2 million and $10.8 million,
respectively. In 1997, gross realized gains and gross realized losses from sales
of debt securities were $9.5 million and $7.2 million, respectively.
For the years ended December 31, 1999, 1998 and 1997, proceeds from the
sales of equity securities were $262.4 million, $203.7 million and
$413.7 million, respectively. Gross gains of $30.9 million and gross losses of
$26.5 million were realized on the sales of equity securities in 1999. For 1998,
gross realized gains and gross realized losses on the sales of equity securities
were $15.5 million and $64.9 million, respectively. In 1997, gross realized
gains and gross realized losses on the sales of equity securities were
$68.5 million and $6.5 million, respectively.
Securities on loan under the Company's securities lending program are
included in its cash and investment portfolio shown on the accompanying
consolidated balance sheets. Under this program, broker/ dealers are required to
deliver substantially the same security to the Company upon completion of the
transaction. The balance of securities on loan as of December 31, 1999 and 1998
was $127.2 million and $262.8 million, respectively, and income earned on
security lending transactions for the years ended December 31, 1999, 1998 and
1997 was $0.6 million, $1.0 million and $2.0 million, respectively.
LONG-TERM INVESTMENTS
The Company's long-term investments consist of the following (in thousands):
DECEMBER 31, 1999
---------------------------------------------
GROSS
UNREALIZED
AMORTIZED -------------------- ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- --------- -------- ----------
U.S. Treasury and agency securities....... $ 24,500 $ -- $140 $ 24,360
Mortgage backed securities................ 71,450 -- 478 70,972
Equity and other investments.............. 12,948 -- -- 12,948
-------- --------- ---- --------
Total long-term investments............. $108,898 $ -- $618 $108,280
======== ========= ==== ========
F-14
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENTS (CONTINUED)
DECEMBER 31, 1998
--------------------------------------------
GROSS
UNREALIZED
AMORTIZED ------------------- ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- -------- -------- ----------
U.S. Treasury and agency securities....... $ 94,131 $408 $29 $ 94,510
Equity and other investments.............. 8,743 -- -- 8,743
-------- ---- --- --------
Total long-term investments............. $102,874 $408 $29 $103,253
======== ==== === ========
At December 31, 1999 the Company's debt securities had contractual maturity
dates: due in one to five years, amortized cost of $57.5 million and market
value of $57.1 million; due in five to ten years, amortized cost of $38.5
million and market value of $38.2 million. Expected maturities for mortgage-
backed securities will differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call or prepayment
penalties.
In 1997, the Company owned an interest in the stock of Health Partners Inc.
("HPI") which was accounted for under the equity method. In October 1997, HPI
entered into a business combination with FPA Medical Management Inc. ("FPA"), a
publicly traded company, which was accounted for as a pooling of interests. As a
result of the transaction, the Company exchanged its HPI stock for FPA stock and
recognized a gain of $30.3 million at the date of the transaction. In 1998, the
Company's investment in FPA experienced an "other than temporary" decline in
market value. As a result, the Company recognized a pre-tax loss of
$48.7 million.
4. RECEIVABLES, NET
Receivables consist of the following (in thousands):
DECEMBER 31,
-------------------
1999 1998
-------- --------
Premiums receivable..................................... $291,743 $362,225
Investment income and other receivables................. 271,775 168,614
-------- --------
563,518 530,839
Less allowance for doubtful accounts.................... 50,439 45,580
-------- --------
Receivables, net........................................ $513,079 $485,259
======== ========
F-15
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. PROPERTY AND EQUIPMENT, NET
Property and equipment, at cost, consist of the following (in thousands):
DECEMBER 31,
USEFUL -------------------
LIFE 1999 1998
------------- -------- --------
Furniture and fixtures................... 8 years $ 49,990 $ 50,412
Software................................. 5 years 69,489 44,747
Equipment................................ 5 years 100,454 117,762
Leasehold improvements................... Term of Lease 63,263 41,543
-------- --------
283,196 254,464
Less: accumulated depreciation and
amortization........................... 157,279 123,005
-------- --------
Property and equipment, net.............. $125,917 $131,459
======== ========
Depreciation and amortization expense for the years ended December 31, 1999,
1998 and 1997 was $39.3 million, $36.8 million and $32.6 million, respectively.
6. INTANGIBLE ASSETS AND GOODWILL, NET
The intangible assets balance consists of the following components (in
thousands)
DECEMBER 31,
-------------------
1999 1998
-------- --------
Employer group relationships............................ $ 85,691 $ 77,991
Self-developed software................................. 7,280 7,280
Provider contracts...................................... 9,208 9,208
Miscellaneous intangible assets......................... 5,728 5,728
-------- --------
107,907 100,207
Less: accumulated amortization.......................... (11,609) (6,270)
-------- --------
Intangible assets, net.................................. $ 96,298 $ 93,937
======== ========
The goodwill balance consists of the following components (in thousands):
DECEMBER 31,
-------------------
1999 1998
-------- --------
Goodwill................................................ $359,975 $368,310
Less: accumulated amortization.......................... (52,328) (32,155)
-------- --------
Goodwill, net........................................... $307,647 $336,155
======== ========
During the fourth quarter of 1998, the Company re-evaluated the useful life
of the intangible assets and goodwill related to its acquisitions of the GBO and
MMHD and reduced such composite lives from 35 to 20 years.
F-16
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. INTANGIBLE ASSETS AND GOODWILL, NET (CONTINUED)
In May 1999, the Company entered into an agreement with Omni Healthcare
("Omni"), a Sacramento, California based health plan to transition Omni members
to the Company's Blue Cross of California subsidiary. The Company paid $7.7
million, subject to adjustment in exchange for Omni's cooperation in
transferring its approximately 124,000 members. The entire amount has been
allocated to intangible assets and is being amortized over 3 years.
Amortization charged to operations was $25.5 million, $19.9 million and
$17.9 million for the years ended December 31, 1999, 1998 and 1997,
respectively.
7. LONG-TERM DEBT
NOTES PAYABLE
In connection with the MMHD acquisition, the Company issued a Series A term
note for $62.0 million on March 31, 1996. At December 31, 1998, $20.0 million
was outstanding under this note. The Series A term note matured on March 31,
1999 and was repaid by the Company.
REVOLVING CREDIT FACILITY
As of December 31, 1999, the Company has a $1.0 billion five-year revolving
credit facility with a consortium of financial institutions. The facility
expires as of May 15, 2002, although it may be extended for an additional
one-year period under certain circumstances. At December 31, 1999 and 1998,
$200.0 million and $280.0 million, respectively, was outstanding under this
facility.
The agreement provides for interest on committed advances at rates
determined by reference to the bank's base rate or to the London Interbank
Offered Rate ("LIBOR") plus a margin determined by reference to the Company's
leverage ratio (as defined in the credit agreement) or the then-current rating
of the Company's unsecured long-term debt by specified rating agencies. Interest
is determined using whichever of these methods is the most favorable to the
Company (The effective interest rate was 6.7% at December 31, 1999). Borrowings
under the credit facility are made on a committed basis or pursuant to an
auction-bid process. A facility fee based on the facility amount, regardless of
utilization, is payable quarterly. The facility fee rate is also determined by
the unsecured debt ratings or the leverage ratio of the Company.
ZERO COUPON CONVERTIBLE SUBORDINATED DEBENTURES
On July 2, 1999, the Company issued $299.0 million aggregate principal
amount at maturity of zero coupon convertible subordinated debentures due 2019
(the "Debentures"). The proceeds totaled approximately $200.8 million. The
Debentures accrue interest at a yield to maturity of 2.0% per year compounded
semi-annually. The Debentures will result in an increase in accrued interest
expense of approximately $3.1 million during the one-year period immediately
following their issuance, with such annual accrued interest expense increasing
until maturity. Holders have the option to convert the Debentures into the
Company's common stock at any time prior to maturity at a rate of 6.797 shares
per $1,000 principal amount at maturity. In lieu of delivering shares of common
stock upon conversion of any Debentures, the Company may elect to pay cash for
the Debentures in an amount equal to the last reported sales price of its common
stock on the trading day preceding the conversion date. The debentures are
subordinate in right of payment to all existing and future senior indebtedness.
F-17
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. LONG-TERM DEBT (CONTINUED)
On October 6, 1999, the Board of Directors authorized the repurchase of some
or all of the Company's Debentures for cash. During the year ended December 31,
1999, the Company repurchased $81.0 million in aggregate principal amount at
maturity of the Company's Debentures at a total purchase price of $49.8 million.
The gain on such repurchase is shown on the Company's income statement as an
extraordinary gain, net of applicable tax.
As of December 31, 1999, the Company had $147.9 million of Debentures
outstanding. For the year ended December 31, 1999, the Company accrued $1.5
million of interest related to the Debentures.
SHELF REGISTRATION STATEMENT
In July 1996, the Company filed a registration statement relating to the
issuance of $1.0 billion of senior or subordinated unsecured indebtedness. As of
December 31, 1999, no indebtedness had been issued pursuant to this registration
statement.
MATURITIES
At December 31, 1999, the Company's long-term debt maturities were as
follows: 2000--zero; 2001--zero; 2002--$200 million; 2003--zero; 2004--zero;
2019--$218 million.
DEBT COVENANTS
The Company's revolving credit facility requires the maintenance of certain
financial ratios and contains other restrictive covenants, including
restrictions on the occurrence of additional indebtedness and the granting of
certain liens, limitations on acquisitions and investments and limitations on
changes in control. As of December 31, 1999, the Company was in compliance with
the requirements outlined in these agreements.
INTEREST RATE SWAPS
As described in Note 15, as of December 31, 1999, the Company is a party to
three separate interest rate swap agreements two of which convert underlying
variable-rate debt into fixed-rate debt. The other converts three month LIBOR
for one month LIBOR.
INTEREST PAID
Interest paid on long-term debt for the years ended December 31, 1999, 1998
and 1997 was $22.1 million, $25.9 million and $38.9 million, respectively.
F-18
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES
The components of the provision (benefit) for income taxes are as follows
(in thousands):
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
Current:
Federal..................................... $106,036 $ 97,231 $107,695
State....................................... 42,987 30,929 28,523
-------- -------- --------
149,023 128,160 136,218
-------- -------- --------
Deferred:
Federal..................................... 43,968 (51,398) 19,041
State....................................... (2,881) (4,324) 1,658
-------- -------- --------
41,087 (55,722) 20,699
-------- -------- --------
Provision for income taxes from continuing
operations.................................. $190,110 $ 72,438 $156,917
======== ======== ========
The overall effective tax rate differs from the statutory federal tax rate
as follows (percent of pretax income from continuing operations):
YEAR ENDED DECEMBER 31,
------------------------------------
1999 1998 1997
-------- -------- --------
Tax provision based on the federal statutory rate... 35.0% 35.0% 35.0%
State income taxes, net of federal benefit.......... 5.3 4.4 5.1
Non-deductible expenses/non-taxable items........... (0.4) 0.9 0.1
Tax benefit from IRS ruling in excess of noncurrent
intangible assets related to business
combination....................................... -- (21.8) --
Other, net.......................................... (0.9) -- 0.4
---- ----- ----
Effective tax rate.................................. 39.0% 18.5% 40.6%
==== ===== ====
F-19
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES (CONTINUED)
Net deferred tax assets are comprised of the following (in thousands):
DECEMBER 31,
-------------------
1999 1998
-------- --------
Gross deferred tax assets:
Market valuation on investment securities............. $ 7,951 $ --
Vacation and holiday accruals......................... 9,549 8,521
Incurred claim reserve discounting.................... 13,237 10,726
Provision for doubtful accounts....................... 19,010 16,619
Unearned premium reserve.............................. 17,469 15,852
State income taxes.................................... 14,039 10,707
Postretirement benefits............................... 28,075 27,332
Deferred gain on building............................. 5,260 7,063
Deferred compensation................................. 15,091 11,349
Expenses not currently deductible..................... 28,645 44,791
Intangible asset impairment........................... 7,190 7,940
Capital loss carryover................................ 23,483 11,247
Alternative minimum tax credit carryover.............. -- 46,616
Start up costs........................................ 6,114 --
Other, net............................................ 9,686 8,599
-------- --------
Total gross deferred tax assets..................... 204,799 227,362
-------- --------
Gross deferred tax liabilities:
Market valuation on investment securities............. -- (5,757)
Depreciation and amortization......................... (5,912) (11,313)
Bond discount and basis differences................... (6,778) (6,682)
Internally developed software......................... (13,491) --
Other, net............................................ (1,781) (1,753)
-------- --------
Total gross deferred tax liabilities................ (27,962) (25,505)
-------- --------
Net deferred tax assets................................. $176,837 $201,857
======== ========
Management believes that the deferred tax assets listed above are fully
recoverable and, accordingly, no valuation allowance has been recorded. Expenses
not currently deductible include various financial statement charges and
expenses that will be deductible for income tax purposes in future periods.
Income taxes paid (refunded) for the years ended December 31, 1999, 1998 and
1997 were ($57.0) million, $103.0 million and $121.2 million, respectively.
F-20
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES (CONTINUED)
INCOME TAXES
In September 1998, the Company received a private letter ruling from the
Internal Revenue Service with respect to the treatment of certain payments made
at the time of WellPoint's 1996 Recapitalization and acquisition of the BCC
Commercial Operations. The ruling allows the Company to deduct as an ordinary
and necessary business expense an $800.0 million cash payment made by BCC in May
1996 to one of two newly formed charitable foundations. As a result of the
ruling in 1998, the Company reduced the remaining intangible asset of $194.5
million arising from the acquisition of certain assets and liabilities of BCC
Commercial Operations at the time of the Recapitalization and recognized a
reduction in its income tax expense of $85.5 million. As a result, the Company
filed amended tax returns for prior years requesting a refund of approximately
$200.0 million and anticipated that current and future income tax payments would
be reduced by approximately $80.0 million and, therefore, recognized an income
tax recoverable and a deferred tax asset, respectively, in its financial
statements for the year ended December 31, 1998. In August 1999, the Company
received a cash refund (including applicable accrued interest) of approximately
$183.0 million.
The Company has a Federal capital loss carryforward of $44.3 million and a
California capital loss carryforward of $139.1 million. The carryforward amounts
begin to expire on December 31, 2003.
9. PENSION AND POSTRETIREMENT BENEFITS
PENSION BENEFITS
The Company covers substantially all employees through two non-contributory
defined benefit pension plans. One plan covers employees of a bargaining unit,
while the second plan, which was established on January 1, 1987, covers all
eligible exempt and administrative employees meeting certain age and employment
requirements. Plan assets are invested primarily in pooled income funds. The
Company's policy is to fund its plans according to the applicable Employee
Retirement Income Security Act of 1974 and income tax regulations. The Company
uses the unit credit method of cost determination.
F-21
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. PENSION AND POSTRETIREMENT BENEFITS (CONTINUED)
The funded status of the plans is as follows:
DECEMBER 31,
-------------------
1999 1998
-------- --------
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year..................... $77,503 $ 63,554
Service cost................................................ 8,117 8,045
Interest cost............................................... 5,583 5,183
Actuarial loss (gain)....................................... (8,643) 4,736
Benefits paid............................................... (4,904) (4,015)
------- --------
Benefit obligation at end of year........................... $77,656 $ 77,503
======= ========
CHANGE IN PLAN ASSETS
Fair value at beginning of year............................. $65,799 $ 55,173
Actual return on fair value................................. (949) 5,024
Employer contributions...................................... 12,182 9,617
Benefits paid............................................... (4,904) (4,015)
------- --------
Fair value at end of year................................... $72,128 $ 65,799
======= ========
Funded status............................................... $(5,528) $(11,703)
Unrecognized prior service cost............................. 437 401
Unrecognized actuarial loss................................. 10,447 11,668
------- --------
Net amount recognized....................................... $ 5,356 $ 366
======= ========
Amounts recognized in the statement of financial position
consists of:
Prepaid benefit cost...................................... $ 5,356 $ 1,146
Accrued benefit liability................................. -- (780)
------- --------
Net amount recognized....................................... $ 5,356 $ 366
======= ========
WEIGHTED AVERAGE ASSUMPTIONS
Discount rate............................................... 7.75% 7.00%
Expected return on plan assets.............................. 9.50% 8.50%
Rate of compensation increases.............................. 5.00% 5.00%
F-22
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. PENSION AND POSTRETIREMENT BENEFITS (CONTINUED)
Net periodic pension expense for the Company's defined benefit pension plans
includes the following components:
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
(IN THOUSANDS)
Service cost--benefits earned during the year............... $ 8,117 $ 8,045 $ 6,510
Interest cost on projected benefits obligations............. 5,583 5,183 4,353
Expected return on plan assets.............................. (6,603) (4,908) (3,992)
Amortization of prior service cost.......................... 14 9 9
Amortization of transition obligation....................... -- -- (15)
Recognized net actuarial loss............................... 81 196 191
------- ------- -------
Net periodic pension expense................................ $ 7,192 $ 8,525 $ 7,056
======= ======= =======
For the years ended December 31, 1999, 1998 and 1997, the pension expense
was $7.2 million, $8.5 million and $7.1 million, respectively.
The Company sponsors the WellPoint 401(k) Retirement Savings Plan (the
"401(k) Plan"). Employees over 18 years of age are eligible to participate in
the 401(k) Plan if they meet certain length of service requirements. Under this
plan, employees may contribute a percentage of their pre-tax earnings to the
401(k) Plan. After one year of service, employee contributions up to 6% of
eligible compensation are matched by an employer contribution equal to 75% on
the employee's contribution. Matching contributions are immediately vested.
Effective January 1, 1998, 33.3% of the employer contribution was in the
Company's common stock. The employer contribution is 85% for those employees
with ten to nineteen years of service as of January 1, 1997 and 100% for those
employees with twenty years or more of service as of such date. Company expense
related to the 401(k) Plan totaled $15.9 million, $13.0 million and $11.8
million for the years ended December 31, 1999, 1998 and 1997, respectively.
POSTRETIREMENT BENEFITS
The Company currently provides certain health care and life insurance
benefits to eligible retirees and their dependents. Certain employees acquired
as a result of the MMHD acquisition and all employees hired after January 1,
1997 are not covered under the Company's postretirement benefit plan. All other
Company employees are fully eligible for retiree benefits upon attaining 10
years of service and a minimum age of 55. The plan in effect for those retiring
prior to September 1, 1994 provides for Company-paid life insurance for all
retirees based on age and a percent of salary. In addition, the majority of
retirees from age 62 or greater currently receive fully paid health benefit
coverage for themselves and their dependents. For employees retiring on or after
September 1, 1994, the Company currently subsidizes health benefit coverage
based on the retiree's years of service at retirement and date of hire. Life
insurance benefits for retirees hired on or after May 1, 1992 are set at $10,000
upon retirement and are reduced to $5,000 at age 70.
F-23
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. PENSION AND POSTRETIREMENT BENEFITS (CONTINUED)
The accumulated postretirement benefit obligation ("APBO") and the accrued
postretirement benefits as of December 31, 1999 and 1998 are as follows (in
thousands):
DECEMBER 31,
-------------------
1999 1998
-------- --------
Benefit obligation at the beginning of the year............. $56,324 $54,687
Service cost................................................ 1,650 1,780
Interest cost............................................... 3,933 3,843
Actuarial gain.............................................. (3,655) (2,080)
Benefits paid............................................... (3,320) (1,906)
------- -------
Accumulated postretirement benefits obligation.............. 54,932 56,324
Unrecognized net gain from accrued postretirement benefit
cost...................................................... 13,971 10,734
------- -------
Accrued postretirement benefits............................. $68,903 $67,058
======= =======
The Company currently pays for its postretirement benefit obligations as
they are incurred. As such, there are no plan assets.
The above actuarially determined APBO was calculated using discount rates of
7.75% and 7.00% as of December 31, 1999 and 1998, respectively. The medical
trend rate is assumed to decline gradually from 10% (under age 65) and 8% (age
65 and over) to 6% by the year 2002. These estimated trend rates are subject to
change in the future. The medical trend rate assumption has a significant effect
on the amounts reported. For example, an increase in the assumed health care
trend rates of one percent in each year would increase the APBO as of December
31, 1999 by $6.2 million and would increase service and interest costs by $0.8
million. Conversely, a decrease in the assumed health care trend rate of one
percent in each year would decrease the APBO as of December 31, 1999 by $5.4
million and would decrease service and interest costs by $0.7 million. For life
insurance benefit calculations, a compensation increase of 5.0% was assumed.
Net periodic postretirement benefit cost includes the following components
(in thousands):
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
Service cost................................................ $1,650 $1,780 $1,980
Interest cost............................................... 3,933 3,843 3,783
Net amortization and deferral............................... (418) (550) (621)
------ ------ ------
Net periodic postretirement benefit cost.................... $5,165 $5,073 $5,142
====== ====== ======
F-24
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. COMMON STOCK
STOCK OPTION PLANS
In 1996, the Company adopted an Employee Stock Option Plan (the "Employee
Option Plan"). In May 1996, all eligible employees were granted options to
purchase common stock under the Employee Option Plan. The exercise price of
options granted under the Employee Option Plan is the fair market value of the
Common Stock on the date of the grant. Each option granted has a maximum term of
10 years. Options granted under the Employee Option Plan vest in accordance with
the terms of the applicable grant.
In 1996, the Company also implemented a Stock Option/Award Plan (the "Stock
Option/Award Plan") for key employees, officers and directors. The exercise
price per share is fixed by a committee appointed by the Board of Directors to
administer the Stock Option/Award Plan, but for any incentive stock option, the
exercise price will not be less than the fair market value on the date of grant.
The maximum term for an option is ten years. Options granted will vest in
accordance with the terms of each grant. The Stock Option/Award Plan also allows
the grant or award of restricted stock, performance units and phantom stock.
On May 11, 1999, the stockholders of the Company approved a new Stock
Incentive Plan (the "Plan") for key employees, officers and directors. This new
plan serves as the successor to the Company's Stock Option/Award Plan and
Employer Stock Option Plan (the "Predecessor Plans"). All options granted under
the Predecessor Plans and outstanding on the Plan's effective date were
incorporated into the Plan and treated as outstanding awards under the Plan. The
exercise price is determined by the plan administrator, however, will generally
not be less than the fair market value on the date of grant. The maximum term
for an option is ten years. Options granted will vest in accordance with the
terms of each grant. The Stock Incentive Plan also allows the grant or award of
restricted stock, performance units and phantom stock. The maximum number of
shares issuable under the Plan, subject to subsequent adjustments for certain
changes in the Company's capital structure, is 5.2 million shares in addition to
the number of shares of common stock remaining for issuance under the
Predecessor Plans.
F-25
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. COMMON STOCK (CONTINUED)
The following summarizes activity in the Company's stock option plans for
the years ended December 31, 1999, 1998 and 1997:
WEIGHTED
AVERAGE
EXERCISE PRICE
SHARES PER SHARE
---------- --------------
Outstanding at January 1, 1997...................... 3,164,996 $39.26
Granted............................................. 1,698,327 36.13
Canceled............................................ (572,511) 37.76
Exercised........................................... (192,089) 39.61
----------
Outstanding at December 31, 1997.................... 4,098,723 38.12
----------
Granted............................................. 1,533,908 56.86
Canceled............................................ (296,993) 43.66
Exercised........................................... (836,400) 37.67
----------
Outstanding at December 31, 1998.................... 4,499,238 44.23
----------
Granted............................................. 1,957,605 73.85
Canceled............................................ (141,604) 52.58
Exercised........................................... (1,014,479) 39.08
----------
Outstanding at December 31, 1999.................... 5,300,760 55.94
==========
Exercisable at:
December 31, 1997................................... 1,077,221 39.32
December 31, 1998................................... 1,801,311 40.65
December 31, 1999................................... 2,464,325 47.92
The options outstanding at December 31, 1999 have exercise prices ranging
from $26.85 to $123.63 per share.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------- ----------------------------
NUMBER WEIGHTED AVERAGE WEIGHTED NUMBER WEIGHTED
ACTUAL RANGE OUTSTANDING REMAINING AVERAGE OUTSTANDING AVERAGE
OF EXERCISE PRICES AT 12/31/99 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/99 EXERCISE PRICE
- --------------------- ----------- ---------------- -------------- ----------- --------------
$ 26.85-39.68 1,895,085 6.3 $ 37.53 1,530,704 $38.53
$ 42.31-62.19 1,450,333 8.0 $ 55.36 569,969 $54.77
$ 65.63-83.88 1,869,760 8.7 $ 72.40 363,652 $76.75
$103.49-123.63 85,582 9.1 $113.56 -- $ --
--------- ---------
5,300,760 7.6 $ 55.94 2,464,325 $47.92
========= =========
STOCK PURCHASE PLAN
On May 18, 1996, the Company's stockholders approved the Company's Employee
Stock Purchase Plan (the "ESPP"). The ESPP allows eligible employees to purchase
Common Stock at the lower of 85% of the market price of the stock at the
beginning or end of each offering period. The aggregate amount of common stock
that may be issued pursuant to the ESPP shall not exceed 400,000 shares, subject
to
F-26
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. COMMON STOCK (CONTINUED)
adjustment pursuant to the terms of the ESPP. During the years ended December
31, 1999, 1998 and 1997, approximately 93,400, 99,300 and 50,700 shares of
common stock were purchased under the ESPP. Beginning in 1998, there are
offering periods for the first half and second half of the year and accordingly,
two purchase prices. For the year ended December 31, 1999, the purchase prices
were $72.14 and $56.05 per share. For the year ended December 31, 1998, the
purchase prices were $35.91 and $57.35 per share. For the year ended December
31, 1997, the purchase price totaled $29.22.
SFAS NO. 123 DISCLOSURE
In accordance with the provisions of SFAS No. 123, the Company applies APB
Opinion No. 25 and related interpretations in accounting for its stock option
plans and, accordingly, does not recognize compensation cost. If the Company had
elected to recognize the compensation cost based on the fair value of the
options granted at grant date as prescribed by SFAS No. 123, net income and
earnings per share for the years ended December 31, 1999, 1998 and 1997 would
have been reduced to the pro forma amounts indicated in the table which follows:
1999 1998 1997
-------- -------- --------
(IN MILLIONS, EXCEPT
PER SHARE AMOUNTS)
Net income--as reported..................................... $278.5 $231.3 $227.4
Net income--pro forma....................................... $256.3 $218.6 $218.2
Earnings per share--as reported............................. $ 4.22 $ 3.35 $ 3.30
Earnings per share--pro forma............................... $ 3.88 $ 3.16 $ 3.17
Earnings per share assuming full dilution--as reported...... $ 4.10 $ 3.29 $ 3.27
Earnings per share assuming full dilution--pro forma........ $ 3.76 $ 3.11 $ 3.14
OFFICERS EMPLOYEES
---------- -----------
1999
ASSUMPTIONS
Expected dividend yield.............................. -- --
Risk-free interest rate.............................. 5.02% 4.86%
Expected stock price volatility...................... 38.00% 38.00%
Expected life of options............................. four years three years
OFFICERS EMPLOYEES
---------- -----------
1998
ASSUMPTIONS
Expected dividend yield.............................. -- --
Risk-free interest rate.............................. 5.38% 5.35%
Expected stock price volatility...................... 37.00% 37.00%
Expected life of options............................. four years three years
F-27
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. COMMON STOCK (CONTINUED)
OFFICERS EMPLOYEES
---------- -----------
1997
ASSUMPTIONS
Expected dividend yield.............................. -- --
Risk-free interest rate.............................. 6.26% 6.13%
Expected stock price volatility...................... 37.00% 37.00%
Expected life of options............................. five years three years
The above pro forma disclosures may not be representative of the effects on
reported pro forma net income for future years. The weighted average fair value
of options granted during 1999, 1998 and 1997 is $23.76, $18.72, $13.72 per
share respectively.
TREASURY STOCK
As of December 31, 1999, the Company was authorized to repurchase
approximately 12.7 million shares of its common stock. A portion of this
authorization was approved in anticipation of the pending Cerulean transaction
in which Cerulean stockholders will receive cash and WellPoint Common Stock with
an aggregate market value of $500 million. As of December 31, 1999, 7.8 million
shares of common stock had been repurchased pursuant to this authorization.
11. DISCONTINUED OPERATIONS
During 1998, the Company discontinued its workers' compensation business
segment. On July 29, 1998, the Company entered into an agreement to sell its
workers' compensation business to Fremont Indemnity Company ("Fremont") for
approximately $110.0 million. The Company received proceeds of $101.4 million as
of the closing date, representing the initial purchase price as defined in the
agreement. The transaction closed on September 1, 1998. In the first quarter of
1999, the Company paid Fremont $6.7 million, representing the settlement of the
sales price.
Revenues for the workers' compensation segment totaled $24.0 million for the
period beginning July 1, 1998, the measurement date, through the date of sale,
and $94.6 million for the period beginning January 1, 1998 through the date of
sale. Revenues totaled $184.2 million for the year ended December 31, 1997.
F-28
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. EARNINGS PER SHARE
The following is an illustration of the dilutive effect of the Company's
potential common stock on earnings per share ("EPS"). There were no antidilutive
securities in any of the three periods presented.
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
BASIC EARNINGS PER SHARE CALCULATION:
NUMERATOR
Income from continuing operations before extraordinary gain
and cumulative effect of accounting change................ $297,211 $319,548 $229,437
Loss from discontinued operations........................... -- (88,268) (2,028)
Extraordinary gain from early extinguishment of debt, net of
tax....................................................... 1,891 -- --
Cumulative effect of accounting change, net of tax.......... (20,558) -- --
-------- -------- --------
Net Income.................................................. $278,544 $231,280 $227,409
======== ======== ========
DENOMINATOR
Weighted average shares outstanding......................... 66,070 69,099 68,811
======== ======== ========
EARNINGS PER SHARE
Income from continuing operations before extraordinary gain
and cumulative effect of accounting change................ $ 4.50 $ 4.63 $ 3.33
Loss from discontinued operations........................... -- (1.28) (0.03)
Extraordinary gain from early extinguishment of debt, net of
tax....................................................... 0.03 -- --
Cumulative effect of accounting change, net of tax.......... (0.31) -- --
-------- -------- --------
Net Income.................................................. $ 4.22 $ 3.35 $ 3.30
======== ======== ========
EARNINGS PER SHARE ASSUMING FULL DILUTION CALCULATION:
NUMERATOR
Income from continuing operations before extraordinary gain
and cumulative effect of accounting change................ $297,211 $319,548 $229,437
Interest expense on zero coupon convertible subordinated
debentures, net of tax.................................... 930 -- --
-------- -------- --------
Adjusted income from continuing operations before
extraordinary gain and cumulative effect of accounting
change.................................................... 298,141 319,548 229,437
Loss from discontinued operations........................... -- (88,268) (2,028)
Extraordinary gain from early extinguishment of debt, net of
tax....................................................... 1,891 -- --
Cumulative effect of accounting change, net of tax.......... (20,558) -- --
-------- -------- --------
Adjusted Net Income......................................... $279,474 $231,280 $227,409
======== ======== ========
DENOMINATOR
Weighted average shares outstanding......................... 66,070 69,099 68,811
Net effect of dilutive stock options........................ 1,077 1,160 651
Assumed conversion of zero coupon convertible subordinated
debentures................................................ 949 -- --
-------- -------- --------
Fully diluted weighted average shares outstanding........... 68,096 70,259 69,462
======== ======== ========
F-29
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. EARNINGS PER SHARE (CONTINUED)
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
EARNINGS PER SHARE ASSUMING FULL DILUTION
Income from continuing operations before extraordinary gain
and cumulative effect of accounting change................ $ 4.38 $ 4.55 $ 3.30
Loss from discontinued operations........................... -- (1.26) (0.03)
Extraordinary gain from early extinguishment of debt, net of
tax....................................................... 0.02 -- --
Cumulative effect of accounting change, net of tax.......... (0.30) -- --
-------- -------- --------
Net Income.................................................. $ 4.10 $ 3.29 $ 3.27
======== ======== ========
13. LEASES
Effective January 1, 1996, the Company entered into a new lease agreement
for a 24-year period for its former corporate headquarters, expiring in December
2019, with two options to extend the term for up to two additional five-year
terms. In addition to base rent, beginning in January 1997, the Company must pay
a contingent amount based upon annual changes in the consumer price index. The
Company paid $30 million to the owner of the building in connection with this
lease agreement which is being amortized on a straight-line basis over the life
of the new lease.
The Company's other lease terms range from one to 20 years with certain
options to renew. Certain lease agreements provide for escalation of payments
which are based on fluctuations in certain published cost-of-living indices.
Future minimum rental payments under operating leases utilized by the
Company having initial or remaining noncancellable lease terms in excess of one
year at December 31, 1999 are as follows:
YEAR ENDING DECEMBER 31,
- ------------------------ (IN THOUSANDS)
2000........................................................ $ 57,515
2001........................................................ 53,592
2002........................................................ 36,202
2003........................................................ 24,157
2004........................................................ 17,843
Thereafter.................................................. 245,277
--------
Total payments required................................. $434,586
========
Rental expense for the years ended December 31, 1999, 1998 and 1997 for all
operating leases was $41.8 million, $43.4 million and $33.3 million,
respectively. Contingent rentals included in the above rental expense for the
years ended December 31, 1999, 1998 and 1997 were $0.9 million, $0.6 million and
$0.3 million, respectively.
F-30
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value
of each class of financial instrument:
CASH AND CASH EQUIVALENTS. The carrying amount approximates fair value,
based on the short-term maturities of these instruments.
INVESTMENT SECURITIES. The carrying amount approximates fair value, based
on quoted market prices for the same or similar instruments.
LONG-TERM INVESTMENTS. The carrying amount approximates fair value, based
on quoted market prices for the same or similar instruments and at cost
for certain equity investments.
REVOLVING CREDIT FACILITY. The carrying amount for the revolving credit
facility approximates fair value as the underlying instruments have
variable interest rates at market value.
CONVERTIBLE DEBT. The fair value for the convertible debt is based upon
the last price paid by the Company to repurchase the debt. The carrying
value is based on the face value adjusted for accretion of original issue
discount.
INTEREST RATE SWAPS. The fair value of the interest rate swaps is based
on its quoted market prices by the financial institutions which are the
counterparties to the swaps.
FORWARD EXCHANGE CONTRACTS. The carrying value for forward exchange
contracts represents the fair value of such contracts that exceed the
fair value of the related foreign denominated bond position. The fair
value of such contracts is determined by the counterparties to the
contracts.
The carrying amounts and estimated fair values of the Company's financial
instruments as of December 31, 1999 are summarized below:
CARRYING ESTIMATED
AMOUNT FAIR VALUE
---------- ----------
(IN THOUSANDS)
Cash and cash equivalents............................ $ 505,014 $ 505,014
Investment securities................................ 2,645,372 2,645,372
Long-term investments................................ 108,280 108,280
Revolving credit facility............................ 200,000 200,000
Convertible debt..................................... 147,884 136,795
Interest rate swaps.................................. (562) (1,134)
Forward exchange contracts........................... 2,793 2,793
15. HEDGING ACTIVITIES
The Company utilizes interest rate swap agreements and foreign currency
contracts to manage interest rate and foreign currency exposures. The principal
objective of such contracts is to minimize the risks and/or costs associated
with financial and investing activities. The Company does not utilize financial
instruments for trading or speculative purposes. The counterparties to these
contractual arrangements are major financial institutions with which the Company
also has other financial relationships. These counterparties expose the Company
to credit loss in the event of non-performance. However, the Company does not
anticipate non-performance by the other parties.
F-31
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. HEDGING ACTIVITIES (CONTINUED)
INTEREST RATE SWAP AGREEMENTS: In 1996, the Company entered into three
interest rate swap agreements to reduce the impact of changes in interest rates
on its floating rate debt under its revolving credit facility. During 1999, the
Company's 6.45%, $100.0 million fixed interest rate swap agreement matured. In
addition, on September 22 and October 1, 1999, the Company entered into partial
termination agreements to reduce the notional amount of the Company's 7.05%,
$150.0 million swap agreement to $50.0 million. All of the remaining terms and
conditions of the swap agreement remained unchanged, with the exception of the
fixed interest rate which was revised to 7.06%. The swap agreements are
contracts to exchange variable-rate (weighted average rate for 1999 of 5.4%) for
fixed-rate interest payments (weighted average rate for 1999 of 6.3%) without
the exchange of the underlying notional amounts. The agreements mature at
various dates through 2006. In 1999, the Company entered into an additional
interest rate swap agreement with a notional amount of $100.0 million to
exchange three month LIBOR (the index associated with the aforementioned swap)
for one month LIBOR (the index associated with the Company's revolving credit
facility), in order to hedge against rising interest rates at the end of the
year. This agreement matured February 28, 2000.
The notional amounts of the interest rate swap agreements are used to
measure interest to be paid and do not represent the amount of exposure to
credit loss. For interest rate instruments that effectively hedge interest rate
exposures, the net cash amounts paid on the agreements are accrued and
recognized as an adjustment to interest expense. If an agreement no longer
qualifies as a hedge instrument, then it is marked to market and carried on the
balance sheet at fair value. As of December 31, 1999, no such condition existed.
For the year ended December 31, 1998, the Company recognized a charge of $4.5
million for the market value decrease on the interest rate swap agreements not
serving as a hedge.
As of December 31, 1999 the Company had the following interest rate swap
agreements in effect (notional amount in thousands):
NOTIONAL AMOUNT STRIKE RATE EXPIRATION DATE
- --------------- ------------------ -----------------
$150,000 6.99% October 17, 2003
$ 50,000 7.06% October 17, 2006
$100,000 One Month LIBOR February 28, 2000
FOREIGN EXCHANGE CONTRACTS: As part of the Company's investment strategy to
diversify and obtain a higher rate of return on its investment portfolio, the
Company has invested in certain fixed maturity securities denominated in foreign
currencies. In order to mitigate the foreign currency risk, the Company has
entered into two types of foreign currency derivative instruments. The first
type of instrument is a forward exchange contract which is entered into to hedge
the currency risk of a foreign currency investment transaction between the trade
date and the settlement date. Gains and losses related to such instruments are
recognized in the Company's income statement. The Company recognized a loss of
$1.9 million and a gain of $0.5 million from such hedging activities for the
years ended December 31, 1999 and 1998, respectively. No such hedging activity
occurred during the year ended December 31, 1997.
The Company has also entered into foreign currency contracts for each of the
fixed maturity securities owned as of December 31, 1999 to hedge asset positions
denominated in other currencies. As of
F-32
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. HEDGING ACTIVITIES (CONTINUED)
December 31, 1999, the Company had the following foreign currency contracts in
effect (notional amount in thousands of U. S. dollars):
NOTIONAL AMOUNT SETTLEMENT DATE
------------------- -------------------
CURRENCY BUY SELL BUY SELL
- -------- -------- -------- -------- --------
Australian dollar....................................... $ 7,263 05/08/00
Danish kroner........................................... $ 6,585 02/23/00
Japanese yen............................................ $ 3,478 03/08/00
Euro dollar............................................. $1,104 $20,412 02/07/00 02/07/00
Euro dollar............................................. $15,340 02/25/00
Euro dollar............................................. $14,422 03/15/00
Euro dollar............................................. $11,486 04/06/00
The unrealized gains and losses from effective forward exchange contracts
are reflected in other comprehensive income. As of December 31, 1999, the
unrealized gains arising from the above forward exchange contracts amounted to
$1.5 million. As of December 31, 1998, the unrealized losses arising from the
above forward exchange contracts amounted to $1.7 million. The unrealized gains
and losses from ineffective foreign currency contracts are reflected in the
Company's income statement. For the years ended December 31, 1999 and 1998, the
Company recognized gains from such hedging activities of $0.3 million and $2.7
million, respectively. No such hedging activity occurred during the years ended
December 31, 1997.
16. CONTINGENCIES
From time to time, the Company and certain of its subsidiaries are parties
to various legal proceedings, many of which involve claims for coverage
encountered in the ordinary course of business. The Company, like HMOs and
health insurers generally, excludes certain health care services from coverage
under its HMO, PPO and other plans. The Company is, in its ordinary course of
business, subject to the claims of its enrollees arising out of decisions to
restrict treatment or reimbursement for certain services. The loss of even one
such claim, if it results in a significant punitive damage award, could have a
material adverse effect on the Company. In addition, the risk of potential
liability under punitive damage theories may increase significantly the
difficulty of obtaining reasonable settlements of coverage claims. Recently, a
number of class-action lawsuits have been brought against several of the
Company's competitors alleging, among other things, various misrepresentations
regarding their health plans and breaches of fiduciary obligations to health
plan members. The Company has not yet been made a party to any of such lawsuits.
The financial and operational impact that these and other evolving theories of
recovery will have on the managed care industry generally, or the Company in
particular, is at present unknown.
Certain of such legal proceedings are or may be covered under insurance
policies or indemnification agreements. Based upon information presently
available, management of the Company believes that the final outcome of all such
proceedings should not have a material adverse effect on the Company's results
of operations, cash flows or financial condition.
17. NONRECURRING COSTS
The Company recorded $14.5 million of nonrecurring costs for the year ended
December 31, 1997, of which $8.0 million recorded in the second quarter of 1997
related primarily to the write-down related to
F-33
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. NONRECURRING COSTS (CONTINUED)
the Company's dental practice management operations and discontinuance of the
Company's medical practice management operations in Santa Barbara and San Luis
Obispo. In addition, $6.5 million incurred in the first quarter of 1997
consisted of severance and retention payments associated with the GBO
acquisition.
18. REGULATORY REQUIREMENTS
Certain of the Company's regulated subsidiaries must comply with certain
minimum capital or tangible net equity requirements in each of the states in
which they operate. As of December 31, 1999, the Company and its regulated
subsidiaries were in compliance with these requirements.
The ability of the Company's licensed insurance company subsidiaries to pay
dividends is limited by the Departments of Insurance in their respective states
of domicile. Generally, dividends in any 12-month period are limited to the
greater of the prior year's statutory net income or 10% of statutory surplus.
Larger dividends, classified as extraordinary, require a special request of the
respective Departments of Insurance. The maximum dividend payable in 2000
without prior approval by WellPoint's licensed insurance company subsidiaries is
estimated to be $86.3 million.
19. FISCAL INTERMEDIARY FUNCTION
Under an agreement with the BCBSA, the Company has contracted to administer
Part A of Title XVIII of the Social Security Act (Medicare) in certain regions
or for certain health care providers. The agreement is renewable annually unless
terminated by the parties involved. As fiscal intermediary under the agreement,
the Company makes disbursements to providers for medical care from funds
provided by the Federal Government and is reimbursed for these expenses incurred
under the agreement. The Company disbursed approximately $8.8 billion, $8.5
billion and $8.4 billion and received administrative fees of approximately $40.7
million, $34.3 million and $29.9 million for the years ended December 31, 1999,
1998 and 1997, respectively. The reimbursement is treated as a direct recovery
of general and administrative expenses.
20. BUSINESS SEGMENT INFORMATION
Effective April 1, 1999, the Company effected a modification of its internal
business operations. As a result of this modification, the Company has two
reportable segments: the Large Employer Group business segment and the
Individual and Small Employer Group business segment. The Large Employer Group
and Individual and Small Employer Group segments both provide a broad spectrum
of network-based health plans, including HMOs, PPOs, POS plans, other hybrid
plans and traditional indemnity products to large and small employers and
individuals. Included in Corporate and Other is the Company's Senior business
and Specialty business.
The Company's management identified its reportable segments based upon the
following factors: (1) The Company's organizational structure contains Senior
Executives that oversee each of these segments, (2) The Company's Chief
Operating Decision Maker (Chief Executive Officer) reviews the results of
operations for each of the following segments and holds each Division President
accountable for results, and (3) A Division President's overall compensation is
based upon the related segment's results.
F-34
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
20. BUSINESS SEGMENT INFORMATION (CONTINUED)
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies and are consistent with generally
accepted accounting principles with the exception of the exclusion of allocated
corporate overhead to the reportable segments.
The following tables present segment information for the Large Employer
Group and Individual and Small Employer Group for the years ended December 31,
1999, 1998 and 1997:
1999
LARGE INDIVIDUAL &
EMPLOYER SMALL EMPLOYER CORPORATE &
GROUP GROUP OTHER CONSOLIDATED
---------- -------------- ------------ ------------
(IN THOUSANDS)
Premium revenue............................. $3,889,032 $2,551,961 $ 455,864 $6,896,857
Management services revenue................. 367,060 4,579 57,697 429,336
---------- ---------- ---------- ----------
Total revenue from external customers....... 4,256,092 2,556,540 513,561 7,326,193
Intercompany revenues....................... 19,941 2,500 (22,441) --
Investment income........................... 98,410 53,627 7,197 159,234
Interest expense............................ 20,949 278 (1,049) 20,178
Depreciation and amortization expense....... 36,829 14,641 13,328 64,798
Income tax expense (benefit)................ 145,973 105,347 (61,210) 190,110
Extraordinary gain / cumulative effect...... (12,328) (7,685) 1,346 (18,667)
Segment net income (loss)................... $ 167,435 $ 134,828 $ (23,719) $ 278,544
========== ========== ========== ==========
Segment Assets.............................. $2,300,056 $ 998,060 $1,295,118 $4,593,234
========== ========== ========== ==========
1998
LARGE INDIVIDUAL &
EMPLOYER SMALL EMPLOYER CORPORATE &
GROUP GROUP OTHER CONSOLIDATED
---------- -------------- ----------- ------------
(IN THOUSANDS)
Premium revenue............................. $3,467,742 $2,114,094 $ 352,976 $5,934,812
Management services revenue................. 388,301 4,627 41,032 433,960
---------- ---------- ---------- ----------
Total revenue from external customers....... 3,856,043 2,118,721 394,008 6,368,772
Intercompany revenues....................... 13,922 -- (13,922) --
Investment income........................... 91,284 43,281 (24,987) 109,578
Interest expense............................ 26,471 351 81 26,903
Depreciation and amortization expense....... 34,773 11,511 10,397 56,681
Income tax expense (benefit)................ 118,915 87,517 (133,994) 72,438
Loss from discontinued operations........... (44,526) (39,827) (3,915) (88,268)
Segment net income (loss)................... $ 138,514 $ 91,249 $ 1,517 $ 231,280
========== ========== ========== ==========
Segment Assets.............................. $2,299,178 $ 783,505 $1,143,151 $4,225,834
========== ========== ========== ==========
F-35
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
20. BUSINESS SEGMENT INFORMATION (CONTINUED)
1997
LARGE INDIVIDUAL & CORPORATE
EMPLOYER SMALL EMPLOYER &
GROUP GROUP OTHER CONSOLIDATED
---------- -------------- ---------- ------------
(IN THOUSANDS)
Premium revenue................................ $2,999,422 $1,785,096 $ 284,429 $5,068,947
Management services revenue.................... 327,753 3,613 45,772 377,138
---------- ---------- ---------- ----------
Total revenue from external customers.......... 3,327,175 1,788,709 330,201 5,446,085
Intercompany revenues.......................... 39,510 -- (39,510) --
Investment income.............................. 85,602 38,124 72,427 196,153
Interest expense............................... 35,033 379 1,246 36,658
Depreciation and amortization expense.......... 31,408 9,975 9,227 50,610
Income tax expense (benefit)................... 99,167 78,238 (20,488) 156,917
Loss from discontinued operations.............. (13,276) 2,673 8,575 (2,028)
Segment net income (loss)...................... $ 131,408 $ 107,858 $ (11,857) $ 227,409
========== ========== ========== ==========
Segment Assets................................. $2,397,814 $ 777,029 $1,059,281 $4,234,124
========== ========== ========== ==========
RECONCILIATIONS
DECEMBER 31,
------------------------------------
1999 1998 1997
---------- ---------- ----------
(IN THOUSANDS)
Total assets for reportable segments........................ $3,298,116 $3,082,683 $3,174,843
Corporate and other assets.................................. 1,295,118 1,143,151 860,869
Goodwill not allocated to segments (corporate).............. -- -- 198,412
---------- ---------- ----------
Consolidated total........................................ $4,593,234 $4,225,834 $4,234,124
========== ========== ==========
21. COMPREHENSIVE INCOME
The following summarizes comprehensive income reclassification adjustments
included in the statements of changes in stockholders' equity:
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
(IN THOUSANDS)
Holding gain (loss) on investment securities arising during
the period (net of tax benefit of $6,295 and tax expense
of $24,218 and tax benefit of $20,581, respectively)...... $ (9,847) $35,579 $(30,236)
Holding loss related to foreign exchange transactions (net
of tax benefit of $1,013)................................. (1,584) -- --
Add:
Reclassification adjustment for realized gains (losses) on
investment securities (net of tax benefit of $10,442,
$14,237, and tax expense of $23,942, respectively)........ (16,332) (20,916) 35,174
Reclassification adjustment related to foreign exchange
gains on investment securities (net of tax expense of
$1,160)................................................... 1,815 -- --
-------- ------- --------
Net gain (loss) recognized in other comprehensive income
(net of tax benefit of $16,590 and tax expense of $9,981
and $3,361, respectively)................................. $(25,948) $14,663 $ 4,938
======== ======= ========
F-36
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
22. PENDING TRANSACTIONS
On July 9, 1998, the Company entered into an Agreement and Plan of Merger
(the "Merger Agreement") by and among the Company, Cerulean Companies, Inc.
("Cerulean") and Water Polo Acquisition Corp., a wholly owned subsidiary of the
Company (the "Merger Sub"). Pursuant to the Merger Agreement, Cerulean will
merge with and into Merger Sub (the "Merger"). Cerulean is the parent company of
Blue Cross and Blue Shield of Georgia, Inc., which served approximately
1.7 million persons in the State of Georgia as of December 31, 1999. At the
effective time of the Merger, the shareholders of Cerulean will receive
WellPoint Common Stock with a market value of $500.0 million (subject to certain
adjustments). Certain shareholders of Cerulean will have the option to receive
cash in lieu of WellPoint Common Stock in the Merger, subject to a maximum
aggregate limit of $225.0 million. The transaction is intended to qualify as a
tax-free reorganization for Cerulean shareholders that elect to receive
WellPoint Common Stock. On June 25, 1999, the shareholders of Cerulean approved
the plan of merger with the Company. In order to complete the transaction, the
Company must obtain the approval of the Georgia Department of Insurance after a
public hearing
23. EXTRAORDINARY GAIN
On October 6, 1999, the Board of Directors authorized the repurchase of some
or all of the Company's Debentures for cash. During the year ended December 31,
1999, the Company repurchased $81.0 million aggregate principal amount at
maturity of the Company's Debentures at a total purchase price of $49.8 million.
This repurchase resulted in an extraordinary gain of $1.9 million, or $0.02 per
share assuming full dilution, net of tax expense totaling $1.2 million.
24. SUBSEQUENT EVENT (UNAUDITED)
On March 1, 2000, the Company completed its acquisition of Rush Prudential
Health Plans ("Rush Prudential"). Rush Prudential offers a broad array of
products and services ranging from HMO products to traditional PPO products. The
acquisition has more than doubled the Company's current Illinois medical
membership to nearly 600,000 members. The transaction, which was financed with
cash, is valued at approximately $200 million, subject to certain post-closing
adjustments. The acquisition will be accounted for under the purchase method of
accounting.
F-37