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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, 2000
/ / 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
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
THOUSAND OAKS, CA 91362
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (818) 234-4000
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 16, 2001: $5,830,412,304 (based on the last
reported sale price of $93.01 per share on March 16, 2001, on the New York Stock
Exchange).
Common Stock, $0.01 par value of Registrant outstanding as of March 16,
2001: 63,096,476 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 2001 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......... 27
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........................................................ 43
Item 8. Financial Statements and Supplementary Data................. 46
Item 9. Changes and Disagreements with Accountants on Accounting and
Financial Disclosure........................................ 47
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 47
Item 11. Executive Compensation...................................... 47
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 47
Item 13. Certain Relationships and Related Transactions.............. 47
PART IV
Item 14. Exhibits, Financial Statements Schedules and Reports on Form
8-K......................................................... 47
SIGNATURES............................................................. 52
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, 2000, WellPoint had approximately 7.9 million medical members and
approximately 40.3 million specialty members. As a result of the March 2001
completion of the Company's acquisition of Cerulean Companies, Inc.
("Cerulean"), the Company's medical membership has increased to approximately
9.7 million medical 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 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, in Georgia primarily under the name Blue Cross Blue Shield
of Georgia and in other states primarily under the name UNICARE. Historically,
the Company's primary market for its managed care products has been California.
On March 15, 2001, the Company completed its acquisition of Cerulean, the parent
company of Blue Cross and Blue Shield of Georgia, Inc. ("Georgia Blue"), which
served approximately 1.8 million medical members in the state of Georgia as of
December 31, 2000. The Company holds the exclusive right in California to market
its products under the Blue Cross name and mark and in Georgia to market its
products under the Blue Cross Blue Shield name and mark. The Company's 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. One element of the Company's acquisition strategy has
been 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 2001 the Company
completed its acquisition of Cerulean. 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.
As of December 31, 2000, the Company's primary internal business divisions
were 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
1
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. As the Company begins its integration of the Georgia Blue
operations, it will assess the effect of the transaction on its reportable
business segments.
RECENT TRANSACTIONS
ACQUISITION OF CERULEAN
On March 15, 2001, the Company completed its acquisition of Cerulean.
WellPoint and Cerulean had originally entered into an Agreement and Plan of
Merger (as later amended and restated, the "Merger Agreement"). The Merger
Agreement provided for the merger (the "Merger") of Water Polo Acquisition
Corp., a wholly owned subsidiary of WellPoint, with and into Cerulean. As a
result of the Merger, Cerulean has now become a wholly owned subsidiary of
WellPoint. WellPoint now holds the exclusive license to use the Blue Cross and
Blue Shield names and marks in the state of Georgia. At the effective time of
the Merger, the shareholders of Cerulean became entitled to receive aggregate
cash consideration of $700 million. As of December 31, 2000, Cerulean, through
Georgia Blue and its various other subsidiaries, served approximately
1.8 million medical members in the state of Georgia.
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 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 was approximately $204 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 health care professionals to deliver health care
at favorable rates that incorporate health care utilization management and other
measures that encourage the delivery of medically necessary care 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 physicians 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
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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.
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 other closed-access 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 generally distributed on a regional basis by independent
sales agents in the various localized markets in which UNICARE operates. The
Company's Blue Cross and Blue Shield of Georgia products are also distributed by
independent sales agents working in conjunction with the Company's internal
sales staff. 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
3
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 AND OTHER PLANS. The Company's PPO products, which are generally
marketed in California under the name "Prudent Buyer," in Georgia under the name
"Blue Choice PPO" 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, 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 health care professionals, 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. In January 2001, the Company introduced its
PlanScape family of individual PPO plans in California. The PlanScape plans are
marketed towards purchasers with varying price preferences and offer a variety
of coverage options and premium amounts.
Georgia Blue introduced its first PPO in Georgia in the mid-1980s and began
offering the Blue Choice PPO product in 1995. Georgia Blue introduced its first
PPO for the individual market in February 1999. Georgia Blue also offers a
traditional fee-for-service product for both individual and small employer
groups. Traditional indemnity products may also use the statewide networks that
Georgia Blue has established for physicians, hospitals and pharmacies. An
important component of the Company's growth strategy is to introduce new
products aimed for the individual and small employer group markets in Georgia.
Outside of California and Georgia, 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 introduced 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 services from health care professionals 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
4
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.
Upon completion of the Cerulean acquisition, the Company now offers HMO
products in the state of Georgia. As of December 31, 2000, Georgia Blue (through
its affiliate Blue Cross Blue Shield Healthcare Plan of Georgia, Inc.) had
approximately 606,000 HMO members, primarily in the greater Atlanta area. Since
1993, Georgia Blue's HMO and point-of-service products have been Georgia Blue's
fastest-growing products. Georgia Blue is licensed and operational as an HMO in
eight separate locations in Georgia, including Atlanta, Augusta, Columbus and
Savannah. As result of the Rush Prudential acquisition, the Company also 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
During the last several years, WellPoint's large employer group business has
experienced considerable growth. The Company attributes this growth primarily to
the strength of the California economy as well as 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 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 employee population. In 1999, the Company
introduced its Blue Cross Preferred PPO product in California, 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 acquisitions of
Cerulean and Rush Prudential, the Company is able to offer a mix of products,
including HMO and PPO products, to customers in Georgia and 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 areas.
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 five years as a result of the MMHD, GBO and Cerulean acquisitions. These
businesses are comprised of a higher percentage of administrative services
business than the Company's traditional California business. Georgia Blue
currently provides administrative services for several accounts sponsored by the
state of Georgia. These accounts comprise in excess of 25% of Georgia Blue's
membership.
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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, 2000, WellPoint served
self-insured health plans covering approximately 2.5 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, 2000, these Medicare supplemental plans served
approximately 194,000 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, 2000 Blue Cross Senior Secure HMO plans served over
37,000 members. Georgia Blue also has a Medicare + Choice contract with HCFA,
which allows it to offer an HMO plan in nine Georgia counties in the greater
Atlanta area. This product, "Blue Choice Platinum," became operational in April
1997 and had approximately 26,000 members as of December 31, 2000.
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, 2000, approximately 753,000 members were enrolled
in WellPoint's Medi-Cal managed care programs in various California counties and
in other state-sponsored programs. In 2000, the Company formed a newly licensed
health maintenance organization, UNICARE Health Plan of Oklahoma, Inc., which
has obtained a contract with the Oklahoma Health Care Authority to cover
SoonerCare Plus Medicaid members in central Oklahoma, primarily the Oklahoma
City area. Operations began on July 1, 2000 and as of December 31, 2000, the
plan had approximately 18,000 Oklahoma Medicaid SoonerCare Plus members. In
2000, the Company entered into a joint venture with Medical Card Systems, Inc.,
a Puerto Rico-based group health and life insurer, to pursue contracts under the
Health Reform Program in Puerto Rico.
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 Quality Assurance Division. Because
of the different market positions of the Company's Blue Cross of
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California and UNICARE tradenames, the Company's health care networks and
provider relations are different in California than 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. WellPoint uses its
large California membership to negotiate physician contracts at favorable rates
that promote delivery of quality care and encourage effective utilization
management. Under these contracts, physicians 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 physicians 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. There were approximately 3.4 million members (including
administrative services members) enrolled in WellPoint's California PPO health
care plans as of December 31, 2000, approximately 36% 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 health
care professionals, and requiring participation in the Company's various medical
management programs. In addition, WellPoint manages costs through pricing and
product design decisions intended to influence the behavior of both members and
health care professionals.
WellPoint's California PPO plans provide for the delivery of specified
health care services to members by contracting with physicians, hospitals and
other health care professionals. Hospital 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 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 professionals that are part of its network. Rates are
generally negotiated on an annual or multi-year basis with hospitals. 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 2.2 million
members as of December 31, 2000.
The physician network of PMGs is comprised of both multi-specialty medical
group practices and individual practice associations ("IPAs"). 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 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. 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
7
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.
BLUE CROSS BLUE SHIELD OF GEORGIA
In 1995, Cerulean began using jointly owned integrated delivery systems for
managed healthcare products, with community health partnership networks
("CHPNs") as the cornerstone of this strategy. CHPNs are locally based equity
ventures between Georgia Blue and a local physician group or hospital. The
physician or hospital joint ventures, as well as other health care professionals
with which the CHPN maintains contracts, provide clinical services. Georgia Blue
provides sales, management and administrative services, including information
systems and data management services. Georgia Blue's HMO affiliate collects
premium and fee revenues from subscribers and retains a flat percentage for
administration and as a contribution to surplus. After deduction of premium
taxes, the CHPN uses remaining premium revenue for payment of medical expenses
and contributions to its retained earnings. As of December 31, 2000, two CHPNs
were active and operational, one in the greater Atlanta area and one in the
Augusta market. The HMO membership in the CHPNs accounts for significant
percentage of Georgia Blue's HMO membership.
Outside of Atlanta and Augusta, Georgia Blue has developed extensive
physician and hospital networks that serve Georgia Blue's PPO Plans and certain
of its indemnity products. For these products, Georgia Blue uses a variety of
reimbursement methods, including per diem payments, maximum allowable charge,
case rates, discounted fee-for-service and fee schedules.
UNICARE
Due to the more recent development of the Company's national operations, the
Company's relations with health care professionals outside of California are
more varied than in California. During 2000, the Company continued its UNICARE
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, UNICARE's proprietary networks in Georgia and Texas
are substantially completed.
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 part of the MMHD acquisition, the
Company also acquired a majority ownership interest in a PPO entity, UNICARE
National Capital Preferred Provider Organization ("UNICARE NCPPO"), which
operates in the Maryland/Virginia area and is a joint venture with local health
care providers.
A large number of UNICARE members are currently served by third-party
provider networks, which generally lack the 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 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.
8
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
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 processes 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 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. CCI products
include a disease state management program, a high-risk pregnancy identification
and management program and a nurse health information line. Certain of the
Company's plans in California also feature similar programs. In September 1999,
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. Additionally, in February 2000, CCI received a
two-year accreditation from URAC for its health information line program.
In 2000, the National Committee for Quality Assurance ("NCQA") awarded Blue
Cross Blue Shield Healthcare Plan of Georgia, Inc. its second full, three-year
accreditation. Georgia Blue's PPO organization was the first PPO in Georgia to
receive accreditation from URAC.
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, Georgia and
9
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 business is overseen by the
Company's Quality Management Department and is designed to ensure that necessary
care is provided by qualified personnel. Depending on the local markets, quality
management encompasses plan level quality performance, provider credentialing,
provider and member grievance monitoring and resolution, medical group auditing,
monitoring medical group compliance with Company 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. 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. In December 2000, the Company completed its acquisition of a
mail-order pharmacy facility, which now operates under the name PrecisionRx. The
Company believes that PrecisionRx will enhance the competitiveness of its
pharmacy benefit management services. As of December 31, 2000, WellPoint had
approximately 29 million risk and non-risk pharmacy members and approximately
54,000 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, a dental PPO, and
traditional indemnity plans. 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, 2000,
served approximately 2.2 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, GBO and Cerulean acquisitions have expanded
the Company's life insurance business both inside and outside of California. As
of December 31, 2000, the Company provided life insurance products to
approximately 2.0 million persons.
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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. In addition, approximately 307 employee
assistance and behavioral managed care programs have been implemented for a wide
variety of businesses throughout the United States. As of December 31, 2000,
there were approximately 4.4 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.
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, 2000, the Company
had approximately 2.1 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, 2000, the
Company provided long-term or short-term disability coverage to approximately
569,000 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 $61.8 million,
$40.8 million and $43.3 million on advertising for the years ended December 31,
2000, 1999 and 1998, respectively.
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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
health care professionals, 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."
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 NCQA and 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 Managed Health Care (the "DMHC") under the Knox-Keene Health Care
Service Plan Act of 1975 (the "Knox-Keene Act"). 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 DMHC
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 DMHC. 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
12
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.
RECENT CALIFORNIA HEALTH CARE LEGISLATION
In September 1999, the California Legislature enacted a number of health
care reform measures. The following is a summary of the material terms of the
most significant of these new laws.
The Managed Health Care Insurance Accountability Act of 1999 ("SB 21"),
which became 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 DMHC 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 physicians, 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. Under the statute, the DMHC was 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.
Assembly Bill 78 ("AB 78") provides for the creation of the DMHC into which
has been transferred the health care service plan operations of the DOC. The
DMHC is advised by an advisory committee consisting of 22 members, 11 of whom
are appointed by the Governor, 10 of whom are 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 is the Director of the
Department (who is 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
13
DMHC. Under the legislation, the new DMHC has been 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 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. The DMHC has issued emergency regulations. 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 became 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 has 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, President Clinton
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 ostensibly
expanded the managed health plan options available to Medicare enrollees to
include PPO, POS and high deductible health plans intended for
14
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 regarding the provision of health care in the United States. No
legislation has been adopted as a result of its recommendations. In
February 1998, President Clinton 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
now been issued. These regulations could have the effect of increasing the
Company's expenses.
On August 21, 1996, President Clinton signed into law the Health Insurance
Portability and Accountability Act of 1996 ("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 December 2000, the Department of Health and Human
Services promulgated final regulations regarding the privacy of "protected
health information." The 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. Final regulations
regarding the standard formats for the transmission of health care information
have also been released, with an effective date of October 2002. The privacy and
standardization regulations 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
15
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 and Georgia, 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.
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 unaffiliated 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, Rush
Prudential and Cerulean 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,
one of the Company's principal operating subsidiaries outside of California),
Georgia, 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, Georgia, Illinois, Texas
and various other states will have greater potential effect on the Company's
financial condition, cash flows or results of operations. 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 Consumers' Insurance Advocate with authority to review
and comment upon matters pending before the Department of Insurance
Commissioner. Over the past few years, there has also been an increase in other
states in proposed legislation regarding, among other things, mandated benefits,
health plan liability, third-party review of health plan coverage determinations
and health plan relationships with
16
providers. The Company expects that this trend of increased legislation will
continue. These laws may have the effect of increasing the Company's claims
expense.
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 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, BC Life, Georgia Blue, Blue Cross Blue
Shield Healthcare Plan of Georgia, Inc. and Greater Georgia Life Insurance
Company 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 (the Blue Cross and Blue Shield name and mark in Georgia)
with respect to WellPoint's HMO and PPO network-based plans. 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, 2000, WellPoint and its subsidiaries employed approximately
10,900 persons. Approximately 140 of the Company's employees are presently
covered by a collective bargaining agreement with the Office and Professional
Employees International Union, Local 29. Approximately 174 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. As of
December 31, 2000, Cerulean and its subsidiaries employed approximately 2,900
persons. WellPoint believes that its relations with its employees are good, and
it has not experienced any work stoppages.
17
EXECUTIVE OFFICERS
Leonard D. Schaeffer, age 55, 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, 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. and Providian
Financial Corporation.
D. Mark Weinberg, age 48, has been Executive Vice President, Individual and
Small Group Division 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.
Joan E. Herman, age 47, joined the Company in June 1998 as Executive Vice
President, Specialty Division. 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 Division. 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.
David S. Helwig, age 44, has been Executive Vice President, Large Group
Division of the Company since March 2001. From May 2000 until March 2001,
Mr. Helwig was Senior Vice President, Western Region, Large Group Businesses of
the Company and from March 1999 until May 2000, Mr. Helwig served as Senior Vice
President and Chief Actuary for the Company. From 1995 until March 1999,
Mr. Helwig served as Senior Vice President of Individual and Small Group
Services for the Company and from May 1994 until 1995, Mr. Helwig was Senior
Vice President of Consumer Services for CaliforniaCare Health Plans, a
subsidiary of the Company. From 1991 to May 1994, Mr. Helwig was Senior Vice
President and Chief Actuary of Blue Cross of California and from February 1993
until May 1994, Mr. Helwig also served as Chief Financial Officer and Treasurer
of Blue Cross of California.
Rebecca Kapustay, age 49, has been Executive Vice President, Blue Cross and
Blue Shield of Georgia since March 2001. From 1979 until 1992, Ms. Kapustay held
various positions with Blue Cross of California of increasing responsibility in
both operations and data processing. From 1993 until April 1994, Ms. Kapustay
was General Manager of the Company and from May 1994 until 2000, Ms. Kapustay
held various positions with the Company including Senior Vice President,
California Operations and more recently Senior Vice President, Large Group
Services.
David C. Colby, age 47, 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
18
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 50, 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, Bridgett, Marcus, Vlahos & Stromberg as an
associate in March 1979 and became a partner in the firm, leaving in May 1985.
Woodrow A. Myers, Jr., M.D., age 47, has been Executive Vice President,
Chief Medical Officer of the Company since September 2000. From 1995 until
September 2000, he served as Director, Healthcare Management of Ford Motor
Company. From 1991 until 1995, Dr. Myers served as Senior Vice President and
Corporate Medical Director of The Associated Group (now known as Anthem Blue
Cross Blue Shield). From 1990 to 1991, Dr. Myers was the Commissioner of Health
for the City of New York. Dr. Myers serves as a director of Somnus Medical
Technologies.
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. As
of January 2001, the Foundation ceased to own any shares of WellPoint Common
Stock.
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."
At the time of the Recapitalization, pursuant to an agreement with the
BCBSA, the Company's Certificate of Incorporation included an "OwnershipLimit"
with respect to the Company's voting securities. At such time, 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 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
19
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, 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 OPERATIONS
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,
20
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, GBO and Cerulean
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. From time to time, the
Company and its subsidiaries receive requests for information from regulatory
agencies or are notified that such agencies or other officials are conducting
reviews, investigations or other proceedings with respect to certain of the
Company's activities. 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 DMHC 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 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
21
increases due to governmental budgetary issues. Future actions by any regulatory
agencies may have a material adverse effect on the Company's business.
As a result of the Precision Rx transaction completed in December 2000, one
of the Company's subsidiaries conducts business as a mail order pharmacy. The
pharmacy business is subject to extensive federal, state and local regulations
which are in many instances different from those under which the Company's
traditional health care businesses operate. The failure to properly adhere to
these and other applicable regulations could result in the imposition of civil
and criminal penalties, which could adversely affect the Company's result of
operations or financial condition. In addition, pharmacies are exposed to risks
inherent in the packaging and distribution of pharmaceuticals and other health
care products. Although the Company intends to maintain professional liability
insurance, there can be no assurances that the coverage limits under such
insurance programs will be adequate to protect against future claims or that the
Company will be able to maintain insurance on acceptable terms in the future.
INDEBTEDNESS FROM CERULEAN ACQUISITION
In connection with the Cerulean transaction, the Company incurred
significant additional indebtedness to fund the cash payments made to Cerulean
shareholders. This new indebtedness may result in a significant percentage of
the Company's cash flow being applied to the payment of interest, and there can
be no assurance that the Company's operations will generate sufficient future
cash flow to service this indebtedness. This indebtedness, as well as any
indebtedness that the Company may incur in the future (such as indebtedness
incurred to fund repurchases of its Common Stock), may adversely affect the
Company's ability to finance its operations and could limit the Company's
ability to pursue business opportunities that may be in the best interests of
the Company and its stockholders.
CLASS ACTION LAWSUITS AND OTHER EVOLVING THEORIES OF RECOVERY
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 the 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.
In June 2000, the California Medical Association filed a lawsuit in U.S.
district court in San Francisco against BCC. The lawsuit alleges that BCC
violated the RICO Act through various misrepresentations to and inappropriate
actions against health care providers. 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 plan members. In August 2000, the
Company was added as a party to SHANE V. HUMANA, ET AL., a class-action lawsuit
brought on behalf of health care providers nationwide. In addition to the RICO
claims brought in the California Medical Association lawsuit, this lawsuit also
alleges violations of ERISA, federal and state "prompt pay" regulations and
certain common law claims. In October 2000, the federal Judicial Panel on
Multidistrict Litigation issued an order consolidating the California Medical
Association lawsuit, the SHANE lawsuit and various other pending managed care
class-action lawsuits against other companies before District Court Judge
Federico Moreno in the Southern District of Florida for purposes of the pretrial
proceedings. In March 2001, Judge Moreno dismissed the plaintiffs' claims based
on violation of the RICO Act, although the dismissal was made without prejudice
to the plaintiffs' ability to subsequently refile their claims. Judge Moreno
also dismissed, with prejudice, the plaintiffs' federal prompt pay law claims.
The Company currently expects that a hearing
22
on the plaintiffs' motion to certify a class will be held in early May 2001. On
March 26, 2001, the California Medical Association filed an amended complaint in
its lawsuit, alleging, among other things, revised RICO claims and violations of
California law. 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.
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. In connection with the introduction of its
PlanScape individual PPO plans in California, the Company has announced that it
will not raise premiums to certain members during portions of 2001. 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, the Rush Prudential acquisition in March 2000 and the Cerulean
acqusition in March 2001. 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
completed significant work on the integration of the Rush Prudential businesses.
The Company expects to begin its integration of Cerulean during the remainder of
2001. 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. Due to the complex nature of the merger
integration process, particularly the information systems designed to serve
these businesses, the Company may temporarily experience 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
23
assurances can be given regarding the ultimate success of the integration of
these acquisitions into the Company's business.
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 Georgia, and the Company will
not have the benefit of the Blue Cross mark which are important components of
its success in California. The Company no longer has the benefit of the
MassMutual, John Hancock or Rush Prudential trade names. 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. 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 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 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 35% of WellPoint's total
premium revenue for the year ended December 31, 2000. WellPoint has experienced
increasing
24
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."
CALIFORNIA ENERGY CRISIS AND EFFECT ON CALIFORNIA ECONOMY
As a result of various factors, including the deregulation of certain parts
of the California energy market, certain locations in California have recently
experienced sporadic periods of electricity outages. This condition is expected
to continue into the future and may worsen during periods of peak energy
consumption in summer months. As part of the Company's disaster-recovery
planning, the Company has installed backup power generators for certain of its
facilities and will continue to evaluate the need for backup power supplies for
other facilities. Any prolonged interruption in power supplied to the Company's
facilities could affect the Company's ability to conduct its normal operations
(including the processing of claims) and could have a material adverse effect on
the Company's results of operations, cash flows or financial condition. The
California energy crisis could result in, or exacerbate, a downturn in the
overall California economy. Because the Company's business remains concentrated
in California (even after the Cerulean acquisition), any disruptions in the
California economy could have a material adverse effect on the Company's results
of operations, cash flows or financial condition.
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.
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 (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
25
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. 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 Atlanta and Columbus, Georgia;
Springfield, Massachusetts; Charlestown, Massachusetts; the greater Chicago,
Illinois area; Dearborn, Michigan; and Plano, Texas. As a result of the
PrecisionRx acquisition, the Company now owns an approximately 79,000 square
foot mail-order pharmacy distribution facility in the greater Fort Worth, Texas
area.
ITEM 3. LEGAL PROCEEDINGS.
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 the 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.
In June 2000, the California Medical Association filed a lawsuit in U.S.
district court in San Francisco against BCC. The lawsuit alleges that BCC
violated the RICO Act through various misrepresentations to and inappropriate
actions against health care providers. 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 plan members. In August 2000, the
Company was added as a party to SHANE V. HUMANA, ET. AL., a class-action lawsuit
brought on behalf of health care providers nationwide. In addition to the RICO
claims brought in the California Medical Association lawsuit, this lawsuit also
alleges violations of ERISA, federal and state "prompt pay" regulations and
certain common law claims. In October 2000, the federal Judicial Panel on
Multidistrict Litigation issued an order consolidating the California Medical
Association lawsuit, the SHANE lawsuit and various other pending managed care
class-action lawsuits against other companies before District Court Judge
Federico Moreno in the Southern District of Florida for purposes of the pretrial
proceedings. In March 2001, Judge Moreno dismissed the plaintiffs' claims based
on violation of the RICO Act, although the dismissal was made without prejudice
to the plaintiffs' ability to subsequently refile their claims. Judge Moreno
also dismissed, with prejudice, the plaintiffs' federal prompt pay law claims.
The Company currently expects that a hearing on the plaintiffs' motion to
certify a class will be held in early May 2001. On March 26, 2001, the
California Medical Association filed an amended complaint in its lawsuit,
alleging, among other things, revised RICO claims and violations of California
law. 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.
26
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
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, 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
Year Ended December 31, 2000
First Quarter............................................. 78 1/2 56 15/16
Second Quarter............................................ 79 7/8 66 3/4
Third Quarter............................................. 96 3/8 70 3/8
Fourth Quarter............................................ 121 1/2 91 9/16
On March 16, 2001 the closing price on the New York Stock Exchange for the
Company's Common Stock was $93.01 per share. As of March 16, 2001, there were
approximately 660 holders of record of Common Stock.
The Company did not pay any dividends on its Common Stock in 1999 or 2000.
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 2001.
27
ITEM 6. SELECTED FINANCIAL DATA.
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
2000 1999 1998 1997 1996
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA, MEMBERSHIP DATA AND
OPERATING STATISTICS)
CONSOLIDATED INCOME STATEMENTS(A)(B)
Revenues:
Premium revenue......................................... $8,583,663 $6,896,857 $5,934,812 $5,068,947 $3,699,337
Management services revenue............................. 451,847 429,336 433,960 377,138 147,911
Investment income....................................... 193,448 159,234 109,578 196,153 123,584
---------- ---------- ---------- ---------- ----------
9,228,958 7,485,427 6,478,350 5,642,238 3,970,832
Operating Expenses:
Health care services and other benefits................. 6,935,398 5,533,068 4,776,345 4,087,420 2,825,914
Selling expense......................................... 394,217 328,619 280,078 249,389 202,318
General and administrative expense...................... 1,265,155 1,075,449 975,099 836,581 543,541
Nonrecurring costs...................................... -- -- -- 14,535 --
---------- ---------- ---------- ---------- ----------
8,594,770 6,937,136 6,031,522 5,187,925 3,571,773
---------- ---------- ---------- ---------- ----------
Operating Income.......................................... 634,188 548,291 446,828 454,313 399,059
Interest expense........................................ 23,978 20,178 26,903 36,658 36,628
Other expense, net...................................... 45,897 40,792 27,939 31,301 25,195
---------- ---------- ---------- ---------- ----------
Income from Continuing Operations before provision for
income taxes, extraordinary gain and cumulative effect
of accounting change.................................... 564,313 487,321 391,986 386,354 337,236
Provision for Income Taxes.............................. 222,026 190,110 72,438 156,917 138,718
---------- ---------- ---------- ---------- ----------
Income from Continuing Operations before extraordinary
gain and cumulative effect of accounting change......... 342,287 297,211 319,548 229,437 198,518
Income (Loss) from Discontinued Operations.............. -- -- (88,268) (2,028) 3,484
Extraordinary gain from early extinguishment of debt,
net of tax............................................ -- 1,891 -- -- --
Cumulative effect of accounting change, net of tax...... -- (20,558) -- -- --
---------- ---------- ---------- ---------- ----------
Net Income................................................ $ 342,287 $ 278,544 $ 231,280 $ 227,409 $ 202,002
========== ========== ========== ========== ==========
Per Share Data(A)(C)(D):
Income from Continuing Operations before extraordinary
gain and cumulative effect of accounting change:
Earnings Per Share.................................... $ 5.47 $ 4.50 $ 4.63 $ 3.33 $ 2.99
Earnings Per Share Assuming Full Dilution............. $ 5.29 $ 4.38 $ 4.55 $ 3.30 $ 2.99
Extraordinary gain:
Earnings Per Share.................................... $ -- $ 0.03 $ -- $ -- $ --
Earnings Per Share Assuming Full Dilution............. $ -- $ 0.02 $ -- $ -- $ --
Cumulative 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
Earnings Per Share Assuming Full Dilution............. $ -- $ -- $ (1.26) $ (0.03) $ 0.05
Net Income:
Earnings Per Share.................................... $ 5.47 $ 4.22 $ 3.35 $ 3.30 $ 3.04
Earnings Per Share Assuming Full Dilution............. $ 5.29 $ 4.10 $ 3.29 $ 3.27 $ 3.04
OPERATING STATISTICS(A)(E):
Loss ratio................................................ 80.8% 80.2% 80.5% 80.6% 76.4%
Selling expense ratio..................................... 4.4% 4.5% 4.4% 4.6% 5.3%
General and administrative expense ratio.................. 14.0% 14.7% 15.3% 15.4% 14.1%
Net income ratio.......................................... 3.8% 3.8% 3.6% 4.2% 5.3%
DECEMBER 31,
--------------------------------------------------------------
2000 1999 1998 1997 1996
---------- ---------- ---------- ---------- ----------
BALANCE SHEET DATA(A):
Cash and investments...................................... $3,780,050 $3,258,666 $2,764,302 $2,560,537 $1,849,814
Total assets.............................................. $5,504,706 $4,593,234 $4,225,834 $4,234,124 $3,149,378
Long-term debt............................................ $ 400,855 $ 347,884 $ 300,000 $ 388,000 $ 625,000
Total equity.............................................. $1,644,417 $1,312,700 $1,315,223 $1,223,169 $ 870,459
Cash dividends declared per common share(F)............... -- -- -- -- $ 10.00
MEDICAL MEMBERSHIP(G)....................................... 7,869,119 7,300,003 6,892,000 6,638,000 4,485,000
- ----------------------------------
(A) Financial information prior to 1998 has been restated to present workers'
compensation business as a discontinued operation.
(B) The Company's consolidated results of operations for the years presented
above include the results of several acquisitions which are components of
the Company's national expansion strategy. (See "Item 7. Management's
Discussion and Analysis Of Financial Condition And Results Of Operations.")
(C) Per share data for the year ended December 31, 1996 has been calculated
using 66,366,500 shares, the number of shares outstanding immediately
following completion of the Company's May 1996 recapitalization plus the
weighted average number of shares issued during 1996 after such transaction.
(D) Per share data includes nonrecurring costs of $0.13 per share for 1997.
(E) 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.
(F) 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.
(G) 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, 2000, WellPoint had approximately
7.9 million medical members and approximately 40.3 million specialty members. As
a result of the March 15, 2001 closing of the Cerulean transaction, the
Company's medical membership increased to 9.7 million. 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 primarily under the name Blue Cross of California, in
Georgia primarily under the name Blue Cross Blue Shield of Georgia and in other
states primarily under the name UNICARE. Historically, the Company's primary
market for managed care products has been California. The Company holds the
exclusive right to market its products under the Blue Cross name and mark in
California and under the Blue Cross Blue Shield name and mark in Georgia.
ACQUISITION OF RUSH PRUDENTIAL
On March 1, 2000, the Company completed its acquisition of Rush Prudential
Health Plans ("Rush Prudential") (See Note 2 to the Consolidated Financial
Statements). Rush Prudential offers a broad array of products and services
ranging from HMO products to traditional PPO products, which has been primarily
integrated into the Company's existing Large Employer Group Business. Rush
Prudential has historically experienced a higher loss ratio than the Company's
core business, which may result in an increase in the Company's overall loss
ratio. The acquisition has significantly increased the Company's Illinois
medical membership to over 537,000 members as of December 31, 2000. Subsequent
to the acquisition, the acquired business has been operated as UNICARE Health
Plans. The transaction, which was financed with cash from operations and debt
from the Company's existing revolving credit facility, is valued at
approximately $204 million, subject to certain post-closing adjustments. This
acquisition was accounted for under the purchase method of accounting.
ACQUISITION OF PRECISIONRX
On December 5, 2000, the Company completed its acquisition of a mail order
pharmacy fulfillment facility. The facility, located in Fort Worth Texas, now
operates under the new name of PrecisionRx. The acquisition was accounted for
under the purchase method of accounting.
ACQUISITION OF CERULEAN
On July 9, 1998, the Company entered into an Agreement and Plan of Merger
with Cerulean (See Note 23 to the Consolidated Financial Statements). On
March 15, 2001, the Company completed this transaction, pursuant to which
Cerulean has become a wholly owned subsidiary of the Company. The transaction,
which was financed with cash from operations and debt from the Company's
existing revolving credit facility is valued at approximately $700 million.
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
29
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 Employer 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.
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 Cerulean, Rush Prudential and
PrecisionRx acquisitions are each components of this expansion strategy.
As a result of these 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 successfully convert acquired books of business to the Company's existing
information systems, which will require continued investments by the Company.
In January 2001, the Company introduced new benefit plans (known as
PlanScape) to all of its individual PPO members in California. All of the
Company's existing individual PPO plans were converted into newly designed
plans, offering an array of premium levels, deductibles, cost sharing features
and out-of-pocket limits. Although the precise effects of these plans will not
be known until some time after they are introduced, the Company expects that
this portion of its business will be subject to less seasonality than
traditionally experienced. In connection with the introduction of these plans,
the Company has announced that it will not increase premiums for certain members
during portions of 2001. These plan changes will not affect any of the Company's
PPO plans under employer-sponsored arrangements.
In response to rising medical and pharmacy costs, the Company has from time
to time 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
30
taken or implemented in the future will be successful in addressing any concerns
that may arise with respect to the performance of certain businesses. In this
regard, as mentioned in the previous paragraph, the Company has committed that
it will not increase premiums for certain California individual PPO members for
certain periods during 2001.
LEGISLATION
Federal legislation enacted during the last five years seeks, among other
things, to insure the portability of health coverage and mandates minimum
maternity hospital stays. California legislation enacted since 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.
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 the year ended
December 31, 2000 include the results of Rush Prudential from March 1, 2000 and
PrecisionRx from December 5, 2000, their respective dates of acquisition.
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,
------------------------------------
2000 1999 1998
-------- -------- --------
Operating Revenues:
Premium revenue.................................. 95.0% 94.1% 93.2%
Management services revenue...................... 5.0% 5.9% 6.8%
----- ----- -----
100.0% 100.0% 100.0%
Operating Expenses:
Health care services and other benefits (loss
ratio)......................................... 80.8% 80.2% 80.5%
Selling expense.................................. 4.4% 4.5% 4.4%
General and administrative expense............... 14.0% 14.7% 15.3%
31
MEMBERSHIP
The following table sets forth membership data and the percent change in
membership:
AS OF DECEMBER 31,
--------------------- PERCENT
2000 1999 CHANGE
--------- --------- -------------
Medical Membership(a)(b)(c):
Large Employer Group(d)
California
HMO..................................................... 1,800,932 1,650,350 9.1%
PPO and Other........................................... 1,982,474 1,790,671 10.7%
--------- ---------
Total California...................................... 3,783,406 3,441,021 10.0%
--------- ---------
Texas..................................................... 197,037 170,435 15.6%
Georgia................................................... 43,160 53,237 (18.9)%
Illinois.................................................. 459,282 247,027 85.9%
Other States.............................................. 1,205,883 1,298,688 (7.1)%
--------- ---------
Total Large Employer Group............................ 5,688,768 5,210,408 9.2%
--------- ---------
Individual and Small Employer Group
California
HMO..................................................... 355,400 336,315 5.7%
PPO and Other........................................... 1,228,230 1,167,959 5.2%
--------- ---------
Total California...................................... 1,583,630 1,504,274 5.3%
--------- ---------
Texas..................................................... 167,845 168,517 (0.4)%
Georgia................................................... 34,185 30,100 13.6%
Illinois.................................................. 67,550 35,417 90.7%
Other States.............................................. 96,546 115,221 (16.2)%
--------- ---------
Total Individual and Small Employer Group............. 1,949,756 1,853,529 5.2%
--------- ---------
Senior(e)
California
HMO..................................................... 34,930 28,207 23.8%
PPO and Other........................................... 173,311 168,059 3.1%
--------- ---------
Total California...................................... 208,241 196,266 6.1%
--------- ---------
Texas(f).................................................. 222 22,224 (99.0)%
Georgia................................................... 1,050 516 103.5%
Illinois.................................................. 10,936 4,381 149.6%
Other States.............................................. 10,146 12,679 (20.0)%
--------- ---------
Total Senior.......................................... 230,595 236,066 (2.3)%
--------- ---------
Total Medical Membership.................................... 7,869,119 7,300,003 7.8%
========= =========
Membership by Network(g)
Proprietary Networks...................................... 6,246,519 5,485,769 13.9%
Affiliate Networks........................................ 994,166 1,043,865 (4.8)%
Non-Network............................................... 628,434 770,369 (18.4)%
--------- ---------
Total Medical Membership.................................... 7,869,119 7,300,003 7.8%
========= =========
Management Services Membership
California................................................ 1,309,994 1,217,176 7.6%
Other States.............................................. 1,233,405 1,382,390 (10.8)%
--------- ---------
Total Management Services Membership........................ 2,543,399 2,599,566 (2.2)%
========= =========
- ------------------------------
(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.
(c) Medical membership includes management services members, which are primarily
included in the Large Employer Group segment.
(d) Large Employer Group membership includes 813,468 and 709,598 state-sponsored
program members as of December 31, 2000 and 1999, respectively.
(e) Senior membership includes members covered under both Medicare risk and
Medicare supplement products.
(f) In the fourth quarter of 1999, the Company's UNICARE Life & Health Insurance
Company subsidiary made a strategic decision to discontinue its offering of
Medicare supplement products primarily in the state of Texas.
(g) Proprietary networks consist of California, Texas and other
WellPoint-developed or WellPoint-controlled networks. Affiliate networks
consist of third-party networks 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. Membership in both
periods shown reflects a restatement to include in proprietary network
membership members of WellPoint-controlled networks which were previously
reflected as affiliate network members.
32
SPECIALTY MEMBERSHIP
AS OF DECEMBER 31,
----------------------- PERCENT
2000 1999 CHANGE
---------- ---------- -------------
Pharmacy..................................... 29,038,815 21,979,758 32.1%
Dental....................................... 2,245,490 2,452,727 (8.4)%
Utilization Management....................... 2,103,396 2,664,566 (21.1)%
Life......................................... 2,020,069 2,125,214 (4.9)%
Disability................................... 569,266 598,129 (4.8)%
Behavioral Health(a)......................... 4,352,988 2,156,642 101.8%
- ------------------------
(a) Behavioral health membership as of December 31, 2000 reflects an
addition of 1.6 million members over December 31, 1999 due to the mental
health parity requirements in the State of California, which became
effective in the third quarter of 2000.
COMPARISON OF RESULTS FOR THE YEAR ENDED DECEMBER 31, 2000 TO THE YEAR ENDED
DECEMBER 31, 1999
The following table depicts premium revenue by business segment:
YEAR ENDED DECEMBER 31,
-----------------------
2000 1999
---------- ----------
(IN THOUSANDS)
Large Employer Group................................. $5,011,562 $3,889,032
Individual and Small Employer Group.................. 3,030,503 2,551,961
Corporate and Other.................................. 541,598 455,864
---------- ----------
Consolidated......................................... $8,583,663 $6,896,857
========== ==========
Premium revenue increased 24.5%, or $1,686.8 million, to $8,583.7 million
for the year ended December 31, 2000 from $6,896.9 million for the year ended
December 31, 1999. The Rush Prudential acquisition contributed $378.1 million or
22.4% of the overall premium revenue increase. Also contributing to increased
premium revenue was an increase in insured member months of 12.5% in the Large
Employer Group and Individual and Small Employer Group business segments, in
addition to the implementation of premium increases in both segments.
The following table depicts management services revenue by business segment:
YEAR ENDED DECEMBER 31,
------------------------
2000 1999
--------- ---------
(IN THOUSANDS)
Large Employer Group................................. $379,142 $367,060
Individual and Small Employer Group.................. 2,865 4,579
Corporate and Other.................................. 69,840 57,697
-------- --------
Consolidated......................................... $451,847 $429,336
======== ========
Management services revenue increased approximately $22.5 million to
$451.8 million for the year ended December 31, 2000 from $429.3 million for the
year ended December 31, 1999. The Rush Prudential acquisition contributed
$4.2 million, or 18.6% of the overall increase. Also contributing to the
increased management services revenue was the implementation of price increases,
partially offset by a decrease in non-insured member months of approximately
0.9%, related to attrition of previously acquired businesses.
Investment income was $193.4 million for the year ended December 31, 2000
compared to $159.2 million for the year ended December 31, 1999, an increase of
21.5%, or $34.2 million. The Rush
33
Prudential acquisition accounted for $5.3 million or 15.4% of the increase. An
increase in net interest and dividend income of $16.2 million to $212.7 million
for the year ended December 31, 2000 in comparison to $196.5 million for the
year ended December 31, 1999 also contributed to the overall net increase in
investment income. This increase was primarily due to higher average investment
balances in 2000 versus 1999, partially offset by a reduction in other interest
income related to interest income received in 1999 related to the Company's
refund from the Internal Revenue Service ("IRS"). See "-- Liquidity and Capital
Resources." Net realized losses on investment securities totaled $21.6 million
for the year ended December 31, 2000 in comparison to losses of $33.8 million
for the year ended December 31, 1999.
The loss ratio attributable to managed care and related products for the
year ended December 31, 2000 increased to 80.8% compared to 80.2% for the year
ended December 31, 1999, due in part to the incremental effect of the Rush
Prudential acquisition on the Company's overall results. The acquired Rush
Prudential business has traditionally experienced a higher loss ratio than the
Company's core business. Excluding the acquired operations of Rush Prudential,
the loss ratio would have been 80.5%. The increase in the loss ratio excluding
Rush Prudential was primarily due to growth in the Company's Large Employer
Group business segment which has historically experienced a higher loss ratio
than the Company's Individual and Small Employer Group business.
Selling expense consists of commissions paid to outside brokers and agents
representing the Company. The selling expense ratio decreased slightly to 4.4%
for the year ended December 31, 2000 from 4.5% for the year ended December 31,
1999.
The administrative expense ratio decreased to 14.0% for the year ended
December 31, 2000 from 14.7% for the year ended December 31, 1999. The overall
decline is primarily attributable to savings from the integration of information
systems centers related to acquired businesses on the Company's information
systems platform, a reduction in Year 2000 remediation expense from 1999 levels,
economies of scale associated with premium revenue growth in relation to fixed
corporate administrative expenses in addition to technology investments made by
the Company (e.g., electronic claims submission, internet self-service and
interactive voice response).
Interest expense increased $3.8 million to $24.0 million for the year ended
December 31, 2000 compared to $20.2 million for the year ended December 31,
1999. The increase in interest expense was related to the higher average debt
balance due to the Rush Prudential, which was partially offset by a decrease in
the effective interest rate due to the issuance of the Company's Zero Coupon
Convertible Subordinated Debentures (the "Debentures") in July 1999. The
weighted average interest rate for all debt for the year ended December 31,
2000, including the fees associated with the Company's borrowings and interest
rate swap agreements, was 6.16%.
The Company's income from continuing operations, before extraordinary gain
and the cumulative effect of accounting change, for the year ended December 31,
2000 was $342.3 million, compared to $297.2 million for the year ended
December 31, 1999. Earnings per share from continuing operations before
extraordinary gain and cumulative effect of accounting change totaled $5.47 and
$4.50 for the years ended December 31, 2000 and 1999, respectively. Earnings per
share from continuing operations before extraordinary gain and cumulative effect
of accounting change assuming full dilution totaled $5.29 and $4.38 for years
ended December 31, 2000 and 1999, respectively.
Earnings per share for the year ended December 31, 2000 is based upon
weighted average shares outstanding of 62.5 million, excluding potential common
stock, and 65.1 million shares, assuming full dilution. Earnings per share for
the year ended December 31, 1999 is based on 66.1 million shares, excluding
potential common stock, and 68.1 million shares, assuming full dilution. The
decrease in weighted average shares outstanding primarily resulted from of the
repurchase of approximately 2.5 million shares during the year ended
December 31, 2000. For weighted average shares outstanding
34
assuming full dilution, the decline was partially offset by the impact of the
assumed conversion of the Debentures.
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 and is now expensing these costs. The cumulative effect of
this change of $20.6 million, net of tax, was reflected in the results of
operations for the year ended December 31, 1999.
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 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
======== ========
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 was
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. 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
35
$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 was 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
historically experienced a higher loss ratio than the Company's other business.
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 was 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 was related to the higher average debt balance in 1999 (due to
significant share repurchases (See "--Liquidity and Capital Resources"))
compared to 1998, which was more than offset by a decrease in the effective
interest rate due to the issuance of the Company's 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.
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 two million shares of WellPoint Common Stock from the
California HealthCare Foundation. The extraordinary gain from this repurchase
was $1.9 million, after tax, and is reported in the results of operations for
the year ended December 31, 1999.
The Company's income from continuing operations, excluding extraordinary
gain and the cumulative effect of accounting change 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 extraordinary gain and the cumulative effect of
accounting change, totaled $4.50 and $4.63 for the years 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 resulted from the
repurchase of approximately
36
4.3 million shares during the year ended December 31, 1999. For weighted average
shares outstanding assuming full dilution, the decline was partially offset by
the impact of the assumed conversion of the Debentures.
FINANCIAL CONDITION
The Company's consolidated assets increased by $911.5 million, or 19.8%,
from $4,593.2 million as of December 31, 1999 to $5,504.7 million as of
December 31, 2000. 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 $3.8 billion as of December 31, 2000, or 68.7% of total assets. The Rush
Prudential acquisition accounted for $93.6 million or 10.3% of the increase.
Overall claims liabilities increased $401.0 million, or 26.9%, from
$1,491.2 million as of December 31, 1999 to $1,892.2 million as of December 31,
2000. This increase is primarily due to an increase in insured membership from
December 31, 1999, to December 31, 2000 of approximately 13.3% in the Company's
Large Employer Group and Individual and Small Employer Group business segments,
in addition to the timing of certain pharmacy claim payments. The Rush
Prudential acquisition accounted for $57.2 million or 14.3% of the increase.
As of December 31, 2000, the Company's long-term indebtedness was
$400.9 million, of which $150.9 million was related to the Company's Debentures
and $250.0 million was related to the Company's revolving credit facility. As of
December 31, 1999, the Company's long-term indebtedness was $347.9 million, of
which $200 million was related to the Company's revolving credit facility and
$147.9 million was related to the Company's Debentures.
Stockholders' equity totaled $1,644.4 million as of December 31, 2000, an
increase of $331.7 million from $1,312.7 million as of December 31, 1999. The
increase was primarily due to net income of $342.3 million for the year ended
December 31, 2000, an increase of $147.4 million of stock issuances under the
Company's stock option/purchase plans and an increase in net unrealized gains on
investment securities, net of tax, of $68.1 million. These increases were
partially offset by stock repurchases made during 2000 totaling $174.6 million,
funded primarily from income from operations. In addition, the Company
experienced net losses on the reissuance of the Company's Common Stock from
treasury of $51.5 million.
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, 2000,
approxmiately 2.4 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 yield. Cash and investment balances maintained by the Company are
sufficient to meet applicable regulatory financial stability and net worth
requirements,
37
including license requirements of the Blue Cross Blue Shield Association. As of
December 31, 2000, the Company's investment portfolio consisted primarily of
investment grade fixed-maturity securities.
Net cash flow provided by continuing operating activities was
$647.9 million for the year ended December 31, 2000, compared with
$829.4 million in 1999. Cash flow from continuing operations for the year ended
December 31, 2000 was due primarily to income from continuing operations, before
extraordinary gain and cumulative effect of accounting change, of
$342.3 million, and an increase in medical claims payable of $367.2 million,
which related to the growth of insured members, and the timing of other
operating liability payments. Cash flow from continuing operations was offset by
increases in receivables of $162.4 million. In addition, the change in cash flow
from continuing operations before extraordinary gain and cumulative effect
decreased from the prior year because the Company had received a cash refund
from the IRS of $183.0 million in 1999.
Net cash used in continuing investing activities in 2000 totaled
$557.4 million, compared with $531.1 million in 1999. The cash used in 2000 was
attributable primarily to the purchase of investments and property and
equipment, net of sales proceeds, of $3,427.5 million and $44.5 million,
respectively. In addition, during the year ended December 31, 2000, net cash
used in investing activities was affected by the purchase of Rush Prudential for
approximately $204.0 million less acquired cash of $61.2 million. This was
partially offset by the proceeds from investments sold and matured of
$3,066.3 million.
Net cash used in financing activities totaled $28.6 million in 2000,
compared to $204.1 million in 1999. During the year ended December 31, 2000, the
Company repurchased 2.5 million shares of the Company's Common Stock for an
aggregate $174.6 million and issued Common Stock for an aggregate of
$96.0 million pursuant to the Company's stock incentive and employee stock
purchase programs. Additionally, the Company increased indebtedness by
$50.0 million under its revolving credit facility.
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 $250.0 million and
$200.0 million as of December 31, 2000 and 1999, respectively. The weighted
average interest rate for the year ended December 31, 2000, including the
facility and other fees and the effect of the interest rate swap agreements
discussed in the following paragraph, was 7.57%.
As a part of a hedging strategy to limit its exposure to variable interest
rate increases, the Company entered into interest rate swap agreements in order
to reduce the volatility of interest expense resulting from changes in interest
rates. The swap agreements are contracts to exchange variable-rate interest
payments (weighted average rate for 2000 of 6.6%) for fixed-rate interest
payments (weighted average rate for 2000 of 5.6%) without the exchange of the
underlying notional amounts. The agreements mature at various dates through
2006. As of December 31, 2000, the Company had entered into $200 million of
fixed rate swap agreements, which consisted of a $150 million notional amount
swap agreement at 6.99% and a $50 million notional amount swap agreement at
7.06%.
The Company has entered into foreign currency forward exchange contracts for
each of the fixed maturity securities on hand as of December 31, 2000
denominated in foreign currencies in order to
38
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 accumulated 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 when a foreign
currency denominated bond is purchased. Gains and losses from these contracts
are recognized in income.
On March 15, 2001, WellPoint completed the acquisition of Cerulean. The
purchase price of $700 million was financed through $550 million of borrowings
under the Company's revolving credit facility and $150 million in operating
cash.
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 were available for general
corporate purposes. The Debentures accrue interest at a yield to maturity of
2.0% per year, compounded semi-annually. 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, 2000, 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 Managed Health Care, formerly the California Department
of Corporations, and the Departments of Insurance in various states. As of
December 31, 2000, those subsidiaries of the Company were in compliance with all
minimum capital requirements.
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 through public or private financing
sources, will be sufficient to fund continuing operations and expected capital
requirements for the foreseeable future.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133, as amended
by SFAS Nos. 137 and 138, 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 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. The new standard will be effective in the first quarter of 2001.
Based upon the Company's review of its operations, the adoption of SFAS No.
133 on January 1, 2001, resulted in an after tax increase to net income of
$0.2 million and an after-tax decrease to other comprehensive income of
$4.2 million.
39
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
Certain statements contained herein, such as statements concerning potential
or future loss ratios, the effects as the Company continues to integrate its
recently acquired operations 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 discussed below and those discussed from time to time in the
Company's various filings with the Securities and Exchange Commission.
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 or are expected to increase their scrutiny, as newly
passed legislation becomes effective. From time to time, the Company and its
subsidiaries receive requests for information from regulatory agencies or are
notified that such agencies are conducting reviews, investigations or other
proceedings with respect to certain of the Company's activities. 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 government agencies or that
such scrutiny will not have a material adverse effect on the Company, either
through negative publicity about the Company or through an adverse impact on the
Company's results of operations. In addition, profitability from this business
may 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.
In connection with the Cerulean transaction, WellPoint incurred significant
indebtedness to fund the transaction. This indebtedness may result in a
significant percentage of the Company's cash flow being 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. This indebtedness, as
well as any indebtedness the Company may incur in the future, 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, the Company has acquired
substantial operations in new geographic markets over the last five years. These
businesses, some of 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. The
Company has also begun its integration of the Rush Prudential business. The
Company expects to begin its integration of Cerulean during the remainder of
2001. 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.
40
The Company and certain of its subsidiaries are subject to capital surplus
requirements by the California Department of Managed Health Care, the Georgia
Department of Insurance, 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.
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.
In June 2000, the California Medical Association filed a lawsuit in U.S.
district court in San Francisco against BCC. The lawsuit alleges that BCC
violated the RICO Act through various misrepresentations to and inappropriate
actions against health care providers. 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 plan members. In August 2000, the
Company was added as a party to SHANE V. HUMANA, et al., a class-action lawsuit
brought on behalf of health care providers nationwide. In addition to the RICO
claims brought in the California Medical Association lawsuit, this lawsuit also
alleges violations of ERISA, federal and state "prompt pay" regulations and
certain common law claims. In October 2000, the federal Judicial Panel on
Multidistrict Litigation issued an order consolidating the California Medical
Association lawsuit, the Shane lawsuit and various other pending managed care
class-action lawsuits against other companies before District Court Judge
Federico Moreno in the Southern District of Florida for purposes of the pretrial
proceedings. In March 2001, Judge Moreno dismissed the plaintiffs' claims based
on violation of the RICO Act, although the dismissal was made without prejudice
to the plaintiffs' ability to subsequently refile their claims. Judge Moreno
also dismissed, with prejudice, the plaintiffs' federal prompt pay law claims.
The Company currently expects that a hearing on the plaintiffs' motion to
certify a class will be held in early May 2001. On March 26, 2001, the
California Medical Association filed an amended complaint in its lawsuit,
alleging, among other things, revised RICO claims and violations of California
law. 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.
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, 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 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 and cause the Company to incur
duplicative claims expense. Additionally, the Company faces competitive pressure
to contain premium prices. In connection with the introduction of new individual
PPO plans in California
41
in January 2001, the Company has announced that it will not raise premiums to
certain members during portions of 2001. 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,
implement underwriting criteria or negotiate competitive provider contracts may
adversely affect the Company's financial condition 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 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 a slight decline
in margins in its higher-risk managed care products and to a lesser extent on
its lower-risk managed care and management services products. This decline is
primarily attributable to product mix change, product design, competitive
pressure and greater regulatory restrictions applicable to the small employer
group market. From time to time, the Company has 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 merits 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 and 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 results of operations and
stockholders' equity. There can be no assurances that interest rate fluctuations
will not have a material adverse effect on the results of operations or
financial condition of the Company.
The Company's operations are dependent on retaining existing employees,
attracting additional qualified employees and achieving productivity gains from
the Company's investment in technology. 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.
42
In December 2000, a wholly-owned subsidiary of the Company completed its
acquisition of certain mail order pharmaceutical service assets and conducts
business as a mail order pharmacy. The pharmacy business is subject to extensive
federal, state and local regulations which are in many instances different from
those under which the Company currently operates. The failure to properly adhere
to these and other applicable regulations could result in the imposition of
civil and criminal penalties, which could adversely affect the Company's results
of operations or financial condition. In addition, pharmacies are exposed to
risks inherent in the packaging and distribution of pharmaceuticals and other
health care products. Although the Company intends to maintain professional
liability and errors and omissions liability insurance, there can be no
assurances that the coverage limits under such insurance programs will be
adequate to protect against future claims or that the Company will be able to
maintain insurance on acceptable terms in the future.
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 currency denominated 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, 2000, approximately 76% of the Company's investment
portfolio consisted of fixed income securities (maturing in more than one year).
Of the remainder, 11% was comprised of equities and 13% was comprised of cash,
which is not subject to interest rate risk, 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 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.
See"Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources--New
43
Accounting Pronouncements." The results of this analysis as of December 31, 2000
are reflected in the table below. The table reflects the change in valuation of
interest rate swap agreements for the year ended December 31, 2000 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......................... $(85.5) $(170.0) $(250.1)
Valuation of Interest Rate Swap Agreements..... 6.1 12.0 17.6
------ ------- -------
$(79.4) $(158.0) $(232.5)
====== ======= =======
Results as of December 31, 1999 are reflected in the table below. The table
reflects the change in valuation of interest rate swap agreements for the year
ended December 31, 1999 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......................... $(89.2) $(172.8) $(250.5)
Valuation of Interest Rate Swap Agreements..... 7.3 14.2 20.8
------ ------- -------
$(81.9) $(158.6) $(229.7)
====== ======= =======
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, 2000, the Company had entered into $200 million of
floating to fixed rate swap agreements, which consist of a $150 million notional
amount swap agreement at 6.99% and a $50 million notional amount swap agreement
at 7.06%. As of December 31, 2000, the Company also had $250 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 $250 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. This agreement matured
February 28, 2000.
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
market value, as of December 31, 2000
44
and 1999, the hypothetical loss in fair value of stockholders' equity is
estimated to be approximately $39.3 million and $31.4 million, respectively.
FOREIGN EXCHANGE RISK
The Company has generally hedged the foreign exchange risk associated with
its fixed income portfolio. The Company uses short-term foreign exchange
contracts to hedge the risk associated 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 16 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 pretax loss
in fair value as of December 31, 2000 and 1999, is estimated to be $8.1 million
and $8.9 million, respectively.
45
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The location in this Annual Report on 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,
2000 2000 2000 2000
----------- ----------- -------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA AND MEMBERSHIP DATA)
Total revenues............................... $2,145,246 $2,288,835 $2,353,324 $2,441,553
Operating income............................. 143,946 157,692 165,133 167,417
Income before provision for income taxes..... 130,615 137,194 146,727 149,777
Income from continuing operations............ 79,644 83,667 89,504 89,472
---------- ---------- ---------- ----------
Net income................................... $ 79,644 $ 83,667 $ 89,504 $ 89,472
========== ========== ========== ==========
Per Share Data:
Earnings Per Share......................... $ 1.27 $ 1.35 $ 1.43 $ 1.43
========== ========== ========== ==========
Earnings Per Share Assuming Full
Dilution................................. $ 1.23 $ 1.30 $ 1.38 $ 1.37
========== ========== ========== ==========
Medical membership........................... 7,541,027 7,617,773 7,742,973 7,869,119
========== ========== ========== ==========
FOR THE QUARTER ENDED
----------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1999 1999 1999 1999
----------- ----------- -------------- -------------
(IN THOUSANDS, EXCEPT PER SHARE DATA AND 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(A):
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
========== ========== ========== ==========
- ------------------------
(A) Per share data for all periods presented is based on income before
extraordinary gain and cumulative effect of accounting change.
46
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
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 2001 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 2001 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 2001 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 2001 Annual Meeting of Stockholders and is incorporated herein
by reference.
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, 2000.
47
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 Amended and Restated Agreement and Plan of Merger dated as
of November 29, 2000, by and among Cerulean Companies, Inc.,
the Registrant and Water Polo Acquisition Corp, incorporated
by reference to Exhibit 2.01 of the Registrant's Current
Report on Form 8-K dated March 15, 2001.
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)
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.
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 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
10.04* 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
10.05 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
10.06 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
10.07* 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
48
EXHIBIT
NUMBER EXHIBIT
- ------- ------------------------------------------------------------
10.08* 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
10.9 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
10.10 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
10.11 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
10.12 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
10.13 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
10.14 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
10.15 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
10.16 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
10.17 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
10.18 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
10.19 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
10.20 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
49
EXHIBIT
NUMBER EXHIBIT
- ------- ------------------------------------------------------------
10.21 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.
10.22 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
10.23* 401(k) Retirement Savings Program of WellPoint Health
Networks Inc., as amended through January 1, 2001
10.24* WellPoint Officer Benefit Enrollment Guide Brochure
10.25* 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
10.26* 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
10.27 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
10.28 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
10.29* 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
10.30* 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
10.31* 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
10.32* WellPoint Health Networks Inc. Management Bonus Plan
10.33* 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 year ended December 31, 1998.
10.34* 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.
10.35* 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.
50
EXHIBIT
NUMBER EXHIBIT
- ------- ------------------------------------------------------------
10.36* 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.
10.37* 1999 Stock Incentive Plan, as amended through December 6,
2000
10.38* 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.
10.39* WellPoint Health Networks Inc. Comprehensive Executive
Non-Qualified Retirement Plan (as amended through
February 1, 2001)
10.40* WellPoint Health Networks Inc. Employee Stock Purchase Plan
(as amended and restated effective April 1, 2000),
incorporated by reference to Annex I to the Registrant's
definitive Proxy Statement on Schedule 14A dated March 23,
2000.
10.41* WellPoint Health Networks Inc. 2000 Employee Stock Option
Plan, incorporated by reference to Exhibit 10.02 to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended March 31, 2000.
10.42* Amendment No. 1 to the Special Executive Retirement Plan for
Leonard D. Schaeffer, incorporated by reference to
Exhibit 10.01 to the Registrant's Quarterly Report on
Form 10-Q for the quarter ended June 30, 2000.
10.43* WellPoint Health Networks Inc. Supplemental Executive
Retirement Plan, incorporated by reference to Exhibit 10.02
to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2000.
10.44* Promissory Note made by Woodrow A. Myers, Jr., M.D. in favor
of the Registrant, incorporated by reference to
Exhibit 10.01 to the Registrant's Quarterly Report on
Form 10-Q for the quarter ended September 30, 2000.
21 List of Subsidiaries of the Registrant
23.1 Consent of Independent Accountants
24 Power of Attorney (included on Signature Page).
- ------------------------
* Management contract or compensatory plan or arrangement
51
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 28, 2001 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 and
------------------------------- Chief Executive Officer (Principal March 28, 2001
Leonard D. Schaeffer Executive Officer)
/s/ DAVID C. COLBY Executive Vice President and Chief
------------------------------- Financial Officer (Principal Financial March 28, 2001
David C. Colby Officer)
52
SIGNATURE TITLE DATE
--------- ----- ----
/s/ KENNETH C. ZUREK Senior Vice President, Controller and
------------------------------- Taxation (Principal Accounting Officer) March 28, 2001
Kenneth C. Zurek
/s/ W. TOLIVER BESSON Director
------------------------------- March 28, 2001
W. Toliver Besson
/s/ ROGER E. BIRK Director
------------------------------- March 28, 2001
Roger E. Birk
/s/ SHEILA P. BURKE Director
------------------------------- March 28, 2001
Sheila P. Burke
/s/ STEPHEN L. DAVENPORT Director
------------------------------- March 28, 2001
Stephen L. Davenport
/s/ JULIE A. HILL Director
------------------------------- March 28, 2001
Julie A. Hill
/s/ WARREN Y. JOBE Director
------------------------------- March 28, 2001
Warren Y. Jobe
/s/ ELIZABETH A. SANDERS Director
------------------------------- March 28, 2001
Elizabeth A. Sanders
53
INDEX TO FINANCIAL STATEMENTS
WELLPOINT HEALTH NETWORKS INC.
PAGE
--------
Report of Independent Accountants........................... F-2
Consolidated Balance Sheets as of December 31, 2000 and
1999...................................................... F-3
Consolidated Income Statements for the Three Years Ended
December 31, 2000......................................... F-4
Consolidated Statements of Changes in Stockholders' Equity
for the Three Years Ended December 31, 2000............... F-5
Consolidated Statements of Cash Flows for the Three Years
Ended December 31, 2000................................... F-6
Notes to Consolidated Financial Statements.................. F-7
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
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, 2000 and 1999, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
2000, in conformity with accounting principles generally accepted in the United
States of America. 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
statements in accordance with auditing standards generally accepted in the
United States of America, 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 our opinion.
As discussed in Note 3 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
January 31, 2001, except note 23 as to which the date is March 15, 2001
F-2
WELLPOINT HEALTH NETWORKS INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
---------------------------------
2000 1999
------------ ------------
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 566,889 $ 505,014
Investment securities, at market value.................... 3,096,350 2,645,372
Receivables, net.......................................... 699,868 513,079
Deferred tax assets....................................... 77,757 92,774
Other current assets...................................... 59,545 59,725
---------- ----------
Total Current Assets.................................... 4,500,409 3,815,964
Property and equipment, net................................. 151,031 125,917
Intangible assets, net...................................... 165,164 96,298
Goodwill, net............................................... 418,120 307,647
Long-term investments, at market value...................... 116,811 108,280
Deferred tax assets......................................... 92,982 84,063
Other non-current assets.................................... 60,189 55,065
---------- ----------
Total Assets............................................ $5,504,706 $4,593,234
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Medical claims payable.................................... $1,566,569 $1,142,183
Reserves for future policy benefits....................... 58,085 57,435
Unearned premiums......................................... 232,132 230,407
Accounts payable and accrued expenses..................... 513,637 440,412
Experience rated and other refunds........................ 249,725 223,066
Income taxes payable...................................... 53,898 84,026
Other current liabilities................................. 398,867 349,757
---------- ----------
Total Current Liabilities............................... 3,072,913 2,527,286
Accrued postretirement benefits............................. 71,510 68,903
Reserves for future policy benefits, non-current............ 267,552 291,626
Long-term debt.............................................. 400,855 347,884
Other non-current liabilities............................... 47,459 44,835
---------- ----------
Total Liabilities....................................... 3,860,289 3,280,534
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 issued at December 31, 2000 and
1999.................................................... 714 714
Treasury stock, at cost, 8,566,399 and 7,764,668 shares at
December 31, 2000 and 1999, respectively................ (536,524) (481,331)
Additional paid-in capital................................ 983,028 955,016
Retained earnings......................................... 1,145,464 854,642
Accumulated other comprehensive income.................... 51,735 (16,341)
---------- ----------
Total Stockholders' Equity.............................. 1,644,417 1,312,700
---------- ----------
Total Liabilities and Stockholders' Equity............ $5,504,706 $4,593,234
========== ==========
See the accompanying notes to the consolidated financial statements.
F-3
WELLPOINT HEALTH NETWORKS INC.
CONSOLIDATED INCOME STATEMENTS
YEAR ENDED DECEMBER 31,
------------------------------------------
2000 1999 1998
---------- ---------- ----------
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
Revenues:
Premium revenue........................................... $8,583,663 $6,896,857 $5,934,812
Management services revenue............................... 451,847 429,336 433,960
Investment income......................................... 193,448 159,234 109,578
---------- ---------- ----------
9,228,958 7,485,427 6,478,350
Operating Expenses:
Health care services and other benefits................... 6,935,398 5,533,068 4,776,345
Selling expense........................................... 394,217 328,619 280,078
General and administrative expense........................ 1,265,155 1,075,449 975,099
---------- ---------- ----------
8,594,770 6,937,136 6,031,522
---------- ---------- ----------
Operating Income............................................ 634,188 548,291 446,828
Interest expense.......................................... 23,978 20,178 26,903
Other expense, net........................................ 45,897 40,792 27,939
---------- ---------- ----------
Income from Continuing Operations before Provision for
Income Taxes, Extraordinary Gain and Cumulative Effect of
Accounting Change......................................... 564,313 487,321 391,986
Provision for income taxes................................ 222,026 190,110 72,438
---------- ---------- ----------
Income from Continuing Operations before Extraordinary Gain
and Cumulative Effect of Accounting Change................ 342,287 297,211 319,548
Discontinued Operations:
Loss from Workers' Compensation Segment, net of tax
benefit of $6,959....................................... -- -- (12,592)
Loss on disposal of Workers' Compensation Segment, net of
tax benefit of $33,022.................................. -- -- (75,676)
---------- ---------- ----------
Loss from Discontinued Operations........................... -- -- (88,268)
Extraordinary Gain from Early Extinguishment of Debt, net of
tax....................................................... -- 1,891 --
Cumulative Effect of Accounting Change, net of tax.......... -- (20,558) --
---------- ---------- ----------
Net Income.................................................. $ 342,287 $ 278,544 $ 231,280
========== ========== ==========
Earnings Per Share:
Income from continuing operations before extraordinary
gain and cumulative effect of accounting change......... $ 5.47 $ 4.50 $ 4.63
Loss from discontinued operations......................... -- -- (1.28)
Extraordinary gain from early extinguishment of debt, net
of tax.................................................. -- 0.03 --
Cumulative effect of accounting change, net of tax........ -- (0.31) --
---------- ---------- ----------
Net income................................................ $ 5.47 $ 4.22 $ 3.35
========== ========== ==========
Earnings Per Share Assuming Full Dilution:
Income from continuing operations before extraordinary
gain and cumulative effect of accounting change......... $ 5.29 $ 4.38 $ 4.55
Loss from discontinued operations......................... -- -- (1.26)
Extraordinary gain from early extinguishment of debt, net
of tax.................................................. -- 0.02 --
Cumulative effect of accounting change, net of tax........ -- (0.30) --
---------- ---------- ----------
Net income................................................ $ 5.29 $ 4.10 $ 3.29
========== ========== ==========
See the accompanying notes to the consolidated financial statements.
F-4
WELLPOINT HEALTH NETWORKS INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
COMMON STOCK
------------------------------------------
ISSUED IN TREASURY ADDITIONAL
PREFERRED ------------------- -------------------- PAID-IN RETAINED
STOCK SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS
--------- -------- -------- -------- --------- ---------- ----------
(IN THOUSANDS)
Balance as of January 1, 1998...... $ -- 69,778 $698 5 $ (103) $882,312 $ 345,318
Stock grants to employees and
directors........................ 6 399
Stock issued for employee stock
option and stock purchase
plans............................ 837 8 39,036
Stock repurchased, at cost......... 3,497 (193,332)
Comprehensive income
Net income....................... 231,280
Other comprehensive income, net
of tax
Change in unrealized valuation
adjustment on investment
securities, net of
reclassification
adjustment...................
----------
Total comprehensive income......... 231,280
------- ------- ---- ------ --------- -------- ----------
Balance as of December 31, 1998.... -- 70,621 706 3,502 (193,435) 921,747 576,598
Stock grants to employees and
directors........................ 75 1 (4) 172 3,051
Stock issued for employee stock
option and stock purchase
plans............................ 695 7 (66) 3,616 30,218
Stock repurchased, at cost......... 4,333 (291,684)
Net losses from treasury stock
reissued......................... (500)
Comprehensive income
Net income....................... 278,544
Other comprehensive income, net
of tax
Change in unrealized valuation
adjustment on investment
securities, net of
reclassification
adjustment...................
Foreign currency adjustments, net
of tax.........................
----------
Total comprehensive income......... 278,544
------- ------- ---- ------ --------- -------- ----------
Balance as of December 31, 1999.... -- 71,391 714 7,765 (481,331) 955,016 854,642
Stock grants to employees and
directors........................ (15) 1,013
Stock issued for employee stock
option and stock purchase
plans............................ (1,668) 118,396 28,012
Stock repurchased, at cost......... 2,484 (174,602)
Net losses from treasury stock
reissued......................... (51,465)
Comprehensive income
Net income....................... 342,287
Other comprehensive income, net
of tax
Change in unrealized valuation
adjustment on investment
securities, net of
reclassification
adjustment...................
Foreign currency adjustments,
net of tax...................
----------
Total comprehensive income......... 342,287
------- ------- ---- ------ --------- -------- ----------
Balance as of December 31, 2000.... $ -- 71,391 $714 8,566 $(536,524) $983,028 $1,145,464
======= ======= ==== ====== ========= ======== ==========
ACCUMULATED
OTHER
COMPREHENSIVE
INCOME TOTAL
-------------- ----------
(IN THOUSANDS)
Balance as of January 1, 1998...... $ (5,056) $1,223,169
Stock grants to employees and
directors........................ 399
Stock issued for employee stock
option and stock purchase
plans............................ 39,044
Stock repurchased, at cost......... (193,332)
Comprehensive income
Net income....................... 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......... 14,663 245,943
-------- ----------
Balance as of December 31, 1998.... 9,607 1,315,223
Stock grants to employees and
directors........................ 3,224
Stock issued for employee stock
option and stock purchase
plans............................ 33,841
Stock repurchased, at cost......... (291,684)
Net losses from treasury stock
reissued......................... (500)
Comprehensive income
Net income....................... 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......... (25,948) 252,596
-------- ----------
Balance as of December 31, 1999.... (16,341) 1,312,700
Stock grants to employees and
directors........................ 1,013
Stock issued for employee stock
option and stock purchase
plans............................ 146,408
Stock repurchased, at cost......... (174,602)
Net losses from treasury stock
reissued......................... (51,465)
Comprehensive income
Net income....................... 342,287
Other comprehensive income, net
of tax
Change in unrealized valuation
adjustment on investment
securities, net of
reclassification
adjustment................... 68,045 68,045
Foreign currency adjustments,
net of tax................... 31 31
-------- ----------
Total comprehensive income......... 68,076 410,363
-------- ----------
Balance as of December 31, 2000.... $ 51,735 $1,644,417
======== ==========
See the accompanying notes to the consolidated financial statements.
F-5
WELLPOINT HEALTH NETWORKS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
---------------------------------------
2000 1999 1998
----------- ----------- -----------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Income from continuing operations before extraordinary
gain and cumulative effect of accounting change......... $ 342,287 $ 297,211 $ 319,548
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....... 75,402 68,767 54,590
Loss on sales of assets, net.......................... 24,170 31,898 34,679
Provision (benefit) for deferred income taxes......... (61,188) 41,087 (83,261)
Amortization of deferred gain on sale of building..... (4,426) (4,426) (4,425)
Accretion of interest on zero coupon convertible
subordinated debentures............................. 2,971 1,465 --
(Increase) decrease in certain assets:
Receivables, net.................................... (162,375) (29,263) 17,621
Income taxes recoverable............................ -- 191,079 15,099
Other current assets................................ 1,829 (26,169) (20,087)
Other non-current assets............................ (5,324) (8,451) 1,978
Increase (decrease) in certain liabilities:
Medical claims payable.............................. 367,189 195,681 23,844
Reserves for future policy benefits................. (23,424) (25,019) (9,142)
Unearned premiums................................... 1,460 15,349 18,853
Accounts payable and accrued expenses............... 61,856 107,086 (6,415)
Experience rated and other refunds.................. 26,659 (26,619) (5,810)
Income taxes payable................................ (30,070) -- --
Other current liabilities........................... 20,692 (5,227) 35,398
Accrued postretirement benefits..................... 2,607 1,845 3,167
Other non-current liabilities....................... 7,634 3,064 (1,027)
----------- ----------- -----------
Net cash provided by continuing operating
activities...................................... 647,949 829,358 394,610
----------- ----------- -----------
Loss from discontinued operations........................... -- -- (12,592)
Adjustment to derive cash flows from discontinued operating
activities
Change in net operating assets...................... -- -- 7,410
----------- ----------- -----------
Net cash used in discontinued operating activities.......... -- -- (5,182)
----------- ----------- -----------
Net cash provided by operating activities......... 647,949 829,358 389,428
CASH FLOWS FROM INVESTING ACTIVITIES:
Investments purchased............................... (3,427,465) (3,456,317) (2,843,102)
Proceeds from investments sold...................... 2,979,906 2,892,802 2,666,355
Proceeds from investments matured................... 86,412 83,404 106,436
Property and equipment purchased.................... (46,891) (38,516) (78,431)
Proceeds from property and equipment sold........... 2,358 1,925 25,721
Proceeds from sale of Workers' Compensation
business.......................................... -- -- 101,413
Settlement of sales price for sale of Workers'
Compensation business............................. -- (6,733) --
Acquisition of new businesses, net of cash
acquired.......................................... (151,748) (7,700) --
----------- ----------- -----------
Net cash used in continuing investing
activities...................................... (557,428) (531,135) (21,608)
----------- ----------- -----------
Net cash provided by investing activities of discontinued
operations................................................ -- -- 15,877
----------- ----------- -----------
Net cash used in investing activities............. (557,428) (531,135) (5,731)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of zero coupon convertible
subordinated debentures........................... -- 200,823 --
Net borrowing (repayment) of long-term debt under
the revolving credit facility..................... 50,000 (149,788) (88,000)
Proceeds from issuance of common stock.............. 95,956 36,565 39,443
Common stock repurchased............................ (174,602) (291,684) (193,332)
----------- ----------- -----------
Net cash used in financing activities............. (28,646) (204,084) (241,889)
----------- ----------- -----------
Net increase in cash and cash equivalents................... 61,875 94,139 141,808
Cash and cash equivalents at beginning of period............ 505,014 410,875 269,067
----------- ----------- -----------
Cash and cash equivalents at end of period.................. $ 566,889 $ 505,014 $ 410,875
=========== =========== ===========
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, 2000, WellPoint had approximately 7.9 million medical members and
approximately 40.3 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
medical 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 12, on September 1, 1998, the Company
completed the sale of its workers' compensation segment. Such sale was accounted
for as a discontinued operation.
2. ACQUISITIONS
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 significantly increased the Company's current Illinois medical
membership to over 537,000 members as of December 31, 2000. Subsequent to the
acquisition, the acquired business has been operated as UNICARE Health Plans.
The transaction, which was financed with both cash from operations and debt from
the Company's existing revolving credit facility, is valued at approximately
$204.0 million, subject to certain post-closing adjustments. This acquisition
was accounted for under the purchase method of accounting. Cash of
$104.0 million and debt totaling $100.0 million were used to purchase net assets
with a fair value of approximately $19.2 million, resulting in goodwill and
other intangibles totaling $217.1 million. The resulting goodwill includes
$32.3 million of deferred tax liabilities relating to preliminary identified
intangibles. The purchase price allocation between goodwill and identifiable
intangible assets had not been finalized as of December 31, 2000.
On December 5, 2000, the Company completed its acquisition of a mail order
pharmacy fulfillment facility from RxAmerica LLC ("RxAmerica"). RxAmerica is a
pharmacy benefits management joint venture between Albertson's, Inc. and Longs
Drugs Stores California, Inc. Subsequent to the acquisition, the business was
re-named PrecisionRx. This acquisition was accounted for under the purchase
method of accounting.
In accordance with the requirements of APB Opinion No. 16, "Business
Combinations," the following unaudited pro forma summary presents revenues,
income before extraordinary gain and cumulative effect of accounting change, net
income and per share data of WellPoint as if the acquisition of Rush Prudential
and Precision Rx had occurred on January 1, 1999. The pro forma information
includes the results of operations for the period prior to the acquisition,
adjusted for interest expense on long-term debt incurred to fund the acquisition
of Rush Prudential, amortization of goodwill and intangible assets and the
related income tax effects. The pro forma financial information is presented for
informational purposes only and may not be indicative of the results of
operations had
F-7
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. ACQUISITIONS (CONTINUED)
the Company been a single entity during the years ended December 31, 2000 and
1999, nor is it necessarily indicative of future results of operations. Pro
forma earnings per share assuming full dilution is based on 65.1 million and
68.1 million weighted average shares for the years ended December 31, 2000 and
1999, respectively.
YEAR ENDED
DECEMBER 31,
---------------------
2000 1999
--------- ---------
(IN MILLIONS, EXCEPT
EARNINGS PER SHARE)
Revenues................................................. $9,440.1 $8,138.7
Income before Extraordinary Gain and Cumulative Effect of
Accounting Change...................................... $ 337.9 $ 288.2
Net Income............................................... $ 337.9 $ 269.5
Earnings Per Share Assuming Full Dilution:
Income before Extraordinary Gain and Cumulative Effect
of Accounting Change................................. $ 5.19 $ 4.23
Net Income............................................. $ 5.19 $ 3.96
3. 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 of America 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, 2000 and 1999, 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-8
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. 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, bonds,
foreign currency denominated forward exchange contracts and interest rate swap
agreements. 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. The Company attempts to limit its risk in investment securities by
maintaining a diversified portfolio. The components of investment securities are
shown in Note 4.
INVESTMENTS
Investment securities consist primarily of U.S. Treasury and agency
securities, foreign currency denominated bonds, mortgage-backed securities,
investment grade and non-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, 2000 and 1999 were $104.1 million and
$100.0 million, respectively, and consisted of investments on deposit with the
California Department of Managed HealthCare ("DMHC"). These deposits consisted
primarily of U.S. Treasury and agency 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.
The Company utilizes derivative instruments, specifically forward exchange
contracts, to mitigate foreign currency risk associated with its foreign
currency denominated investment portfolio. Forward exchange contracts are used
to hedge the foreign currency risk between trade date and settlement date of
foreign currency investment transactions. Gains and losses from such instruments
are recognized in the Company's income statement at the settlement date.
Forward exchange contracts are also used to hedge asset positions in foreign
denominated currencies. The unrealized gains and losses, net of deferred taxes,
from such forward contracts and related hedging investments are reflected in
other comprehensive income at the balance sheet dates.
F-9
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. 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 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 1.5 to
25 years. (See Note 7 for a more complete discussion of the Company's intangible
assets and goodwill.)
The Company 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
F-10
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
agreements are 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 uses interest rate swap agreements to manage interest rate
exposures. The principal objective of such contracts is to minimize the risks
and 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'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-11
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. 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
exposes 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. 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-12
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. 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
$61.8 million, $40.8 million and $43.3 million for the years ended December 31,
2000, 1999 and 1998, 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
The Company accounts for stock-based compensation using the intrinsic
method. 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
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 and foreign
currency adjustments. 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 was $20.6 million, net of a tax benefit of $14.3 million
for the year ended December 31, 1999.
RECLASSIFICATIONS
Certain amounts in the prior years consolidated financial statements have
been reclassified to conform to the 2000 presentation.
F-13
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133, as amended
by SFAS Nos. 137 and 138, 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 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. The new standard will be effective in the first quarter of 2001.
Based upon the Company's review of its operations, the adoption of SFAS
No. 133 on January 1, 2001, resulted in an after tax increase to net income of
$0.2 million and an after-tax decrease to other comprehensive income of $4.2
million.
4. INVESTMENTS
INVESTMENT SECURITIES
The Company's investment securities consist of the following (in thousands):
DECEMBER 31, 2000
---------------------------------------------
COST OR GROSS UNREALIZED
AMORTIZED ------------------- ESTIMATED
COST GAINS LOSSES FAIR VALUE
---------- -------- -------- ----------
U.S. Treasury and agency.......................... $ 136,051 $ 3,852 $ 42 $ 139,861
Foreign government securities..................... 128,367 2,065 122 130,310
Mortgage-backed securities........................ 886,972 14,136 3,552 897,556
Corporate and other securities.................... 1,546,369 18,999 29,445 1,535,923
---------- -------- ------- ----------
Total debt securities........................... 2,697,759 39,052 33,161 2,703,650
Equity and other investments...................... 312,225 102,192 21,717 392,700
---------- -------- ------- ----------
Total investment securities................... $3,009,984 $141,244 $54,878 $3,096,350
========== ======== ======= ==========
DECEMBER 31, 1999
---------------------------------------------
COST OR 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
========== ======= ======= ==========
F-14
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. INVESTMENTS (CONTINUED)
The amortized cost and estimated fair value of debt securities as of
December 31, 2000, 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.............................. $ 131,265 $ 131,840
Due after one year through five years................ 1,099,514 1,099,293
Due after five years through ten years............... 612,545 615,188
Due after ten years.................................. 854,435 857,329
---------- ----------
Total debt securities................................ $2,697,759 $2,703,650
========== ==========
For the years ended December 31, 2000, 1999 and 1998, proceeds from the
sales and maturities of debt securities were $2,760.8 million, $2,713.8 million
and $2,569.1 million, respectively. Gross gains of $12.0 million and gross
losses of $28.8 million were realized on the sales of debt securities for the
year ended December 31, 2000. For 1999, gross realized gains and gross realized
losses from sales of debt securities were $16.2 million and $52.6 million,
respectively. In 1998, gross realized gains and gross realized losses from sales
of debt securities were $28.2 million and $10.8 million, respectively.
For the years ended December 31, 2000, 1999 and 1998, proceeds from the
sales of equity securities were $310.3 million, $262.4 million and
$203.7 million, respectively. Gross gains of $11.0 million and gross losses of
$15.3 million were realized on the sales of equity securities in 2000. For 1999,
gross realized gains and gross realized losses on the sales of equity securities
were $30.9 million and $26.5 million, respectively. In 1998, gross realized
gains and gross realized losses on the sales of equity securities were
$15.5 million and $64.9 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, 2000 and 1999
was $101.9 million and $127.2 million, respectively, and income earned on
security lending transactions for the years ended December 31, 2000, 1999 and
1998 was $0.3 million, $0.6 million and $1.0 million, respectively.
F-15
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. INVESTMENTS (CONTINUED)
LONG-TERM INVESTMENTS
The Company's long-term investments consist of the following (in thousands):
DECEMBER 31, 2000
------------------------------------------------------
COST OR GROSS UNREALIZED
AMORTIZED ----------------------- ESTIMATED
COST GAINS LOSSES FAIR VALUE
--------- -------- --------- ----------
Mortgage-backed securities............................ $ 95,950 $632 $ -- $ 96,582
Equity and other investments.......................... 20,229 -- -- 20,229
-------- ---- --------- --------
Total long-term investments..................... $116,179 $632 $ -- $116,811
======== ==== ========= ========
DECEMBER 31, 1999
------------------------------------------------------
COST OR 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
======== ========= ==== ========
At December 31, 2000 the Company's debt securities had contractual maturity
dates: due in one through five years, amortized cost of $95.9 million and market
value of $96.6 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 pretax loss of
$48.7 million.
5. RECEIVABLES, NET
Receivables consist of the following:
DECEMBER 31,
-------------------
2000 1999
-------- --------
(IN THOUSANDS)
Premiums receivable..................................... $373,616 $291,743
Investment income and other receivables................. 385,175 271,775
-------- --------
758,791 563,518
Less: allowance for doubtful accounts................... 58,923 50,439
-------- --------
Receivables, net........................................ $699,868 $513,079
======== ========
F-16
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. PROPERTY AND EQUIPMENT, NET
Property and equipment, at cost, consist of the following (in thousands):
DECEMBER 31,
-------------------
USEFUL LIFE 2000 1999
------------- -------- --------
Equipment................................ 5 years $123,994 $100,454
Software................................. 5 years 94,371 69,489
Leasehold improvements................... Term of Lease 67,931 63,263
Furniture and fixtures................... 8 years 58,338 49,990
Building................................. 30 years 3,373 --
Land..................................... 382 --
-------- --------
348,389 283,196
Less: accumulated depreciation and
amortization........................... 197,358 157,279
-------- --------
Property and equipment, net.............. $151,031 $125,917
======== ========
Depreciation and amortization expense for the years ended December 31, 2000,
1999 and 1998 was $38.5 million, $39.3 million and $36.8 million, respectively.
7. INTANGIBLE ASSETS AND GOODWILL
The intangible asset balance consists of the following components (in
thousands):
DECEMBER 31,
-------------------
2000 1999
-------- --------
Employer group relationships............................ $160,609 $ 85,691
Self-developed software................................. 7,280 7,280
Provider contracts...................................... 13,247 9,208
Miscellaneous intangible assets......................... 11,197 5,728
-------- --------
192,333 107,907
Less: accumulated amortization.......................... 27,169 11,609
-------- --------
Intangible assets, net.................................. $165,164 $ 96,298
======== ========
The goodwill balance consists of the following components (in thousands):
DECEMBER 31,
-------------------
2000 1999
-------- --------
Goodwill................................................ $492,804 $359,975
Less: accumulated amortization.......................... 74,684 52,328
-------- --------
Goodwill, net........................................... $418,120 $307,647
======== ========
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 Group
Benefits Operations of John Hancock Mutual Life Insurance Company ("GBO") and
the Life and Health Benefits Management Division of
F-17
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. INTANGIBLE ASSETS AND GOODWILL (CONTINUED)
the Massachusetts Mutual Life Insurance Company ("MMHD") and reduced such
composite lives from 35 to 20 years.
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 was originally being amortized over 3 years.
During the second quarter of 2000, the Company re-evaluated the useful life of
intangible assets related to its acquisition of Omni and reduced its related
useful life to 1.5 years.
On March 1, 2000, the Company completed its acquisition of Rush Prudential
Health Plans ("Rush Prudential"). Subsequent to the acquisition, the business
has operated under the name UNICARE Health Plans. The transaction is valued at
approximately $204 million, subject to certain post-closing adjustments. This
acquisition was accounted for under the purchase method of accounting. Cash of
$104.0 million and debt totaling $100.0 million were used to purchase net assets
with a fair value of approximately $19.2 million, resulting in goodwill and
other intangibles totaling $217.1 million. The resulting goodwill includes
$32.3 million of deferred tax liabilities relating to preliminary identified
intangibles. As of December 31, 2000 the purchase price allocation between
goodwill and identifiable intangible assets had not been finalized.
Amortization charged to operations was $38.1 million, $25.5 million and
$19.9 million for the years ended December 31, 2000, 1999 and 1998,
respectively.
8. LONG-TERM DEBT
REVOLVING CREDIT FACILITY
As of December 31, 2000, 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, 2000 and 1999,
$250.0 million and $200.0 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 6.87% at December 31, 2000. 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. Holders have the option to convert the Debentures into the
Company's
F-18
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. LONG-TERM DEBT (CONTINUED)
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.
On October 6, 1999, the Board of Directors authorized the repurchase of some
or all of the Company's Debentures for cash. The Company did not repurchase any
Debentures during the year ended December 31, 2000. During the year ended
December 31, 1999, the Company repurchased $81.0 million in aggregate principal
amount at maturity of the 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, 2000 and 1999, the Company had $150.9 million and
$147.9 million (based upon the original issue price plus accreted interest),
respectively, of Debentures outstanding. For the years ended December 31, 2000
and 1999, the Company accrued $3.1 million and $1.5 million, respectively, of
interest related to the Debentures.
MATURITIES
At December 31, 2000, the Company's long-term debt maturities were as
follows: 2001--zero; 2002--$250 million; 2003--zero; 2004--zero; 2005--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, 2000, the Company was in compliance with
the requirements in these agreements.
INTEREST RATE SWAPS
As described in Note 15, as of December 31, 2000, the Company is a party to
two separate interest rate swap agreements, which convert underlying
variable-rate debt into fixed-rate debt.
INTEREST PAID
Interest paid on long-term debt for the years ended December 31, 2000, 1999
and 1998 was $21.5 million, $22.1 million and $25.9 million, respectively.
F-19
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. INCOME TAXES
The components of the provision (benefit) for income taxes are as follows
(in thousands):
YEAR ENDED DECEMBER 31,
------------------------------
2000 1999 1998
-------- -------- --------
Current:
Federal..................................... $226,606 $106,036 $ 97,231
State....................................... 56,608 42,987 30,929
-------- -------- --------
283,214 149,023 128,160
-------- -------- --------
Deferred:
Federal..................................... (54,552) 43,968 (51,398)
State....................................... (8,383) (2,881) (4,324)
-------- -------- --------
(62,935) 41,087 (55,722)
-------- -------- --------
Valuation Allowance:.......................... 1,747 -- --
-------- -------- --------
Provision for income taxes from continuing
operations.................................. $222,026 $190,110 $ 72,438
======== ======== ========
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,
--------------------------------------
2000 1999 1998
-------- -------- --------
Tax provision based on the federal statutory rate... 35.0% 35.0% 35.0%
State income taxes, net of federal benefit.......... 5.6 5.3 4.4
Non-deductible expenses/non-taxable items........... (0.1) (0.4) 0.9
Tax benefit from IRS ruling in excess of noncurrent
intangible assets related to business
combination....................................... -- -- (21.8)
Change in valuation allowance....................... 0.3 -- --
Other, net.......................................... (1.5) (0.9) --
---- ---- -----
Effective tax rate.................................. 39.3% 39.0% 18.5%
==== ==== =====
F-20
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. INCOME TAXES (CONTINUED)
Net deferred tax assets are comprised of the following (in thousands):
DECEMBER 31,
-------------------
2000 1999
-------- --------
Gross deferred tax assets:
Net operating loss........................................ $ 4,420 $ --
Market valuation on investment securities................. -- 7,951
Vacation and holiday accruals............................. 6,224 9,549
Incurred claim reserve discounting........................ 23,038 13,237
Provision for doubtful accounts........................... 22,472 19,010
Unearned premium reserve.................................. 18,644 17,469
State income taxes........................................ 21,068 14,039
Postretirement benefits................................... 29,138 28,075
Deferred gain on building................................. 3,456 5,260
Deferred compensation..................................... 25,114 15,091
Expenses not currently deductible......................... 73,774 28,645
Intangible asset impairment............................... 6,439 7,190
Capital loss carryover.................................... 26,708 23,483
Start-up costs............................................ 4,327 6,114
Deferred acquisition costs................................ 8,904 --
Other, net................................................ 4,733 9,686
-------- --------
Total gross deferred tax assets......................... 278,459 204,799
-------- --------
Gross deferred tax liabilities:
Market valuation on investment securities................. (35,687) --
Depreciation and amortization............................. (5,582) (5,912)
Bond discount and basis differences....................... (6,947) (6,778)
Internally developed software............................. (13,119) (13,491)
Purchased intangibles of subsidiary stock................. (32,330) --
Lease expense............................................. (6,239) --
Other, net................................................ (1,728) (1,781)
-------- --------
Total gross deferred tax liabilities.................... (101,632) (27,962)
-------- --------
Valuation allowance:
Net operating loss carryover.............................. (4,341) --
Capital loss carryover.................................... (1,747) --
-------- --------
(6,088) --
-------- --------
Net deferred tax assets..................................... $170,739 $176,837
======== ========
For year ended December 31, 2000, a $32.3 million deferred tax liability and
a $7.4 million net deferred tax asset were recorded as a result of the Company's
acquisition of Rush Prudential. The result of these tax adjustments is an
increase to goodwill of approximately $25 million, which includes a valuation
allowance for an operating loss carryforward acquired in such transaction.
F-21
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. INCOME TAXES (CONTINUED)
In addition, management recorded a valuation allowance for its California
capital loss carryforward as discussed below. Management believes it is more
likely than not that the recorded deferred tax assets, net of valuation
allowance provided, will be realized.
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, 2000, 1999 and
1998 were $283.8 million, ($57.0) million and $103.0 million, respectively.
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 allowed 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.
As of December 31, 2000, the Company had a Federal capital loss carryforward
of $53.5 million and a California capital loss carryforward of $145.2 million.
The Company has established a valuation allowance of $1.8 million related only
to the California capital loss carryforward. The carryforward amounts begin to
expire on December 31, 2003.
In addition, as of December 31, 2000 the Company had a federal net operating
loss carryforward of $10.2 million and an Illinois net operating loss
carryforward of $16.6 million. The Company has established a valuation allowance
of $4.3 million related to these carryforwards. These carryforwards begin to
expire in year 2014.
Management believes that the ability to use the carryforward amounts may be
limited by federal and state statutes. As a result, the aforementioned valuation
allowances were established during 2000.
F-22
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. 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 employees (employees covered under a collective bargaining agreement
participate if the terms of the collective bargaining agreement permits) meeting
certain age and service 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.
The funded status of the plans is as follows:
DECEMBER 31,
-------------------
2000 1999
-------- --------
(IN THOUSANDS)
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year.................. $ 77,656 $77,503
Service cost............................................. 8,008 8,117
Interest cost............................................ 6,456 5,583
Actuarial gain........................................... (59) (8,643)
Benefits paid............................................ (5,381) (4,904)
-------- -------
Benefit obligation at end of year........................ $ 86,680 $77,656
======== =======
CHANGE IN PLAN ASSETS
Fair value at beginning of year.......................... $ 72,128 $65,799
Actual return on fair value.............................. (3,206) (949)
Employer contributions................................... 8,639 12,182
Benefits paid............................................ (5,381) (4,904)
-------- -------
Fair value at end of year................................ $ 72,180 $72,128
======== =======
Funded status............................................ $(14,500) $(5,528)
Unrecognized prior service cost.......................... 424 437
Unrecognized actuarial loss.............................. 20,252 10,447
-------- -------
Net amount recognized.................................... $ 6,176 $ 5,356
======== =======
Amounts recognized in the statement of financial position consist entirely
of prepaid benefit costs of $6.2 million and $5.4 million for the years ended
December 31, 2000 and 1999, respectively.
WEIGHTED AVERAGE ASSUMPTIONS
Discount rate............................................... 7.75% 7.75%
Expected return on plan assets.............................. 9.50% 9.50%
Rate of compensation increases.............................. 5.00% 5.00%
F-23
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. 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,
------------------------------
2000 1999 1998
-------- -------- --------
(IN THOUSANDS)
Service cost--benefits earned during the year..... $ 8,008 $ 8,117 $ 8,045
Interest cost on projected benefits obligations... 6,456 5,583 5,183
Expected return on plan assets.................... (6,946) (6,603) (4,908)
Amortization of prior service cost................ 15 14 9
Recognized net actuarial loss..................... 286 81 196
------- ------- -------
Net periodic pension expense...................... $ 7,819 $ 7,192 $ 8,525
======= ======= =======
The Company sponsors the WellPoint 401(k) Retirement Savings Plan (the
"401(k) Plan"). Employees (excluding temporary employees working less than
1,000 hours and leased 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. One third of the employer contribution is in the
Company's common stock. The employer contribution is 85% for those employees
with 10 to 19 years of service as of January 1, 1997 and 100% for those
employees with 20 years or more of service as of such date. Company expense
related to the 401(k) Plan totaled $16.5 million, $15.9 million and
$13.0 million for the years ended December 31, 2000, 1999 and 1998,
respectively.
POSTRETIREMENT BENEFITS
The Company currently provides certain health care and life insurance
benefits to eligible retirees and their dependents. Employees outside of
California and certain employees in California acquired as a result of the
acquisitions and all employees hired, rehired or reinstated 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-24
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. PENSION AND POSTRETIREMENT BENEFITS (CONTINUED)
The accumulated postretirement benefit obligation ("APBO") and the accrued
postretirement benefits as of December 31, 2000 and 1999 are as follows (in
thousands):
DECEMBER 31,
-------------------
2000 1999
-------- --------
Benefit obligation at the beginning of the year........... $54,932 $56,324
Service cost.............................................. 1,520 1,650
Interest cost............................................. 4,234 3,933
Actuarial (gain) loss..................................... 1,063 (3,655)
Benefits paid............................................. (2,458) (3,320)
------- -------
Accumulated postretirement benefits obligation............ 59,291 54,932
Unrecognized net gain from accrued postretirement benefit
cost.................................................... 12,219 13,971
------- -------
Accrued postretirement benefits........................... $71,510 $68,903
======= =======
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 a discount rate
of 7.75%. The medical trend rate is assumed to decline gradually from 8.5%
(under age 65) and 7% (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, 2000 by $6.7 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, 2000 by $5.8 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,
------------------------------
2000 1999 1998
-------- -------- --------
Service cost........................................ $1,520 $1,650 $1,780
Interest cost....................................... 4,234 3,933 3,843
Net amortization and deferral....................... (689) (418) (550)
------ ------ ------
Net periodic postretirement benefit cost............ $5,065 $5,165 $5,073
====== ====== ======
F-25
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. 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, it 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 Plan also allows the grant or award of
restricted stock, performance units and phantom stock. As of December 31, 2000
the maximum number of shares issuable under the Plan, subject to subsequent
adjustments for certain changes in the Company's capital structure, was
6.1 million shares in addition to the number of shares of Common Stock remaining
for issuance under the Predecessor Plans.
Effective as of February 17, 2000, the Company adopted the 2000 Employee
Stock Option Plan (the "2000 Employee Plan") for employees and non-executive
officers of the Company. The exercise price and maximum term of any stock option
granted under the 2000 Employee Plan are determined by the plan administrator.
Options granted will vest in accordance with the terms of each grant. The
maximum number of shares issuable under the 2000 Employee Plan, subject to
subsequent adjustments for certain changes in the Company's capital structure,
is 3 million shares.
F-26
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. COMMON STOCK (CONTINUED)
The following summarizes activity in the Company's stock option plans for
the years ended December 31, 2000, 1999 and 1998:
WEIGHTED AVERAGE
EXERCISE PRICE
SHARES PER SHARE
---------- ----------------
Outstanding at January 1, 1998.................... 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
----------
Granted........................................... 2,185,095 72.22
Canceled.......................................... (248,941) 67.46
Exercised......................................... (1,910,815) 46.42
----------
Outstanding at December 31, 2000.................. 5,326,099 65.46
==========
Exercisable at:
December 31, 1998................................. 1,801,311 40.65
December 31, 1999................................. 2,464,325 47.92
December 31, 2000................................. 2,462,112 61.97
The options outstanding at December 31, 2000 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 12/31/00 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/00 EXERCISE PRICE
- ---------------------- ----------- ---------------- -------------- ----------- --------------
$ 26.85 - 39.68 754,490 5.3 $ 38.19 754,490 $ 38.19
$ 42.31 - 62.19 894,571 7.0 $ 55.77 526,550 $ 55.42
$ 65.38 - 96.13 3,479,333 8.3 $ 71.33 993,267 $ 74.35
$100.56 - 123.63 197,705 7.7 $110.23 187,805 $110.43
---------- ---------
5,326,099 7.6 $ 65.46 2,462,112 $ 61.97
========== =========
STOCK PURCHASE PLAN
On May 18, 1996, the Company's stockholders approved the Company's Employee
Stock Purchase Plan (the "ESPP"). The stockholders approved an amendment and
restatement of the ESPP on May 9, 2000. 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 1,400,000 shares,
subject to adjustment pursuant to the terms of the ESPP. During the years ended
December 31, 2000, 1999 and
F-27
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. COMMON STOCK (CONTINUED)
1998, approximately 111,400, 93,400 and 99,300 shares of Common Stock were
purchased under the ESPP. 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, 2000, the purchase prices were $56.10 and $61.68 per share. 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.
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, 2000, 1999 and 1998 would
have been reduced to the pro forma amounts indicated in the table which follows:
2000 1999 1998
-------- -------- --------
(IN MILLIONS, EXCEPT
PER SHARE AMOUNTS)
Net income--as reported..................................... $342.3 $278.5 $231.3
Net income--pro forma....................................... $315.7 $256.3 $218.6
Earnings per share--as reported............................. $ 5.47 $ 4.22 $ 3.35
Earnings per share--pro forma............................... $ 5.05 $ 3.88 $ 3.16
Earnings per share assuming full dilution--as reported...... $ 5.29 $ 4.10 $ 3.29
Earnings per share assuming full dilution--pro forma........ $ 4.88 $ 3.76 $ 3.11
2000 OFFICERS EMPLOYEES
- ---- ---------- -----------
ASSUMPTIONS
Expected dividend yield.............................. -- --
Risk-free interest rate.............................. 6.38% 6.37%
Expected stock price volatility...................... 40.00% 40.00%
Expected life of options............................. four years three years
1999 OFFICERS EMPLOYEES
- ---- ---------- -----------
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
1998 OFFICERS EMPLOYEES
- ---- ---------- -----------
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-28
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. COMMON STOCK (CONTINUED)
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 2000, 1999 and 1998 is $26.18, $23.76, and $18.72 per
share, respectively.
TREASURY STOCK
As of December 31, 2000, the Company was authorized to repurchase
approximately 12.7 million shares of its Common Stock. As of December 31, 2000,
10.3 million shares of Common Stock had been repurchased pursuant to this
authorization.
12. 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.
F-29
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. 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,
------------------------------
2000 1999 1998
-------- -------- --------
(IN THOUSANDS, EXCEPT EARNINGS
PER SHARE)
BASIC EARNINGS PER SHARE CALCULATION:
NUMERATOR
Income from continuing operations before extraordinary gain
and cumulative effect of accounting change................ $342,287 $297,211 $319,548
Loss from discontinued operations........................... -- -- (88,268)
Extraordinary gain from early extinguishment of debt,
net of tax................................................ -- 1,891 --
Cumulative effect of accounting change, net of tax.......... -- (20,558) --
-------- -------- --------
Net Income.................................................. $342,287 $278,544 $231,280
======== ======== ========
DENOMINATOR
Weighted average shares outstanding......................... 62,531 66,070 69,099
======== ======== ========
EARNINGS PER SHARE
Income from continuing operations before extraordinary gain
and cumulative effect of accounting change................ $ 5.47 $ 4.50 $ 4.63
Loss from discontinued operations........................... -- -- (1.28)
Extraordinary gain from early extinguishment of debt, net of
tax....................................................... -- 0.03 --
Cumulative effect of accounting change, net of tax.......... -- (0.31) --
-------- -------- --------
Net Income.................................................. $ 5.47 $ 4.22 $ 3.35
======== ======== ========
EARNINGS PER SHARE ASSUMING FULL DILUTION CALCULATION:
NUMERATOR
Income from continuing operations before extraordinary gain
and cumulative effect of accounting change................ $342,287 $297,211 $319,548
Interest expense on zero coupon convertible subordinated
debentures, net of tax.................................... 1,890 930 --
-------- -------- --------
Adjusted income from continuing operations before
extraordinary gain and cumulative effect of accounting
change.................................................... 344,177 298,141 319,548
Loss from discontinued operations........................... -- -- (88,268)
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......................................... $344,177 $279,474 $231,280
======== ======== ========
DENOMINATOR
Weighted average shares outstanding......................... 62,531 66,070 69,099
Net effect of dilutive stock options........................ 1,097 1,077 1,160
Assumed conversion of zero coupon convertible subordinated
debentures................................................ 1,481 949 --
-------- -------- --------
Fully diluted weighted average shares outstanding........... 65,109 68,096 70,259
======== ======== ========
EARNINGS PER SHARE ASSUMING FULL DILUTION
Income from continuing operations before extraordinary gain
and cumulative effect of accounting change................ $ 5.29 $ 4.38 $ 4.55
Loss from discontinued operations........................... -- -- (1.26)
Extraordinary gain from early extinguishment of debt, net of
tax....................................................... -- 0.02 --
Cumulative effect of accounting change, net of tax.......... -- (0.30) --
-------- -------- --------
Net Income.................................................. $ 5.29 $ 4.10 $ 3.29
======== ======== ========
F-30
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. 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 19 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, 2000 are as follows:
YEAR ENDING DECEMBER 31, (IN THOUSANDS) OPERATING LEASES
- --------------------------------------- ----------------
2001........................................................ $ 75,387
2002........................................................ 62,850
2003........................................................ 46,396
2004........................................................ 34,202
2005........................................................ 29,245
Thereafter.................................................. 257,937
--------
Total minimum payments required........................... $506,017
========
Rental expense for the years ended December 31, 2000, 1999 and 1998 for all
operating leases was $47.5 million, $41.8 million and $43.4 million,
respectively. Contingent rentals included in the above rental expense for the
years ended December 31, 2000, 1999 and 1998 were $1.2 million, $0.9 million and
$0.6 million, respectively.
15. 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
quoted market prices. The carrying value is based on the face value adjusted
for accretion of original issue discount.
F-31
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
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, 2000 are summarized below:
CARRYING ESTIMATED
AMOUNT FAIR VALUE
---------- ----------
(IN THOUSANDS)
Cash and cash equivalents............................ $ 566,889 $ 566,889
Investment securities................................ 3,096,350 3,096,350
Long-term investments................................ 116,811 116,811
Revolving credit facility............................ 250,000 250,000
Convertible debt..................................... 150,855 165,612
Interest rate swaps.................................. -- (7,155)
Forward exchange contracts........................... (5,196) (5,196)
16. HEDGING ACTIVITIES
The Company uses 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 use 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.
INTEREST RATE SWAP AGREEMENTS: The Company uses 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 variable-rate (weighted average rate for 2000 of 6.6%) for
fixed-rate interest payments (weighted average rate for 2000 of 5.7%) without
the exchange of the underlying notional amounts. 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, 2000 and 1999, no such condition
existed.
F-32
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
16. HEDGING ACTIVITIES (CONTINUED)
As of December 31, 2000 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
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
$0.5 million and $1.9 million and a gain of $0.5 million from such hedging
activities for the years ended December 31, 2000, 1999 and 1998, respectively.
The Company has also entered into foreign currency contracts for each of the
fixed maturity securities owned as of December 31, 2000 to hedge asset positions
denominated in other currencies. As of December 31, 2000, 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
- -------- -------- -------- -------- --------
British pound........................... $8,321 $ 8,321 01/16/01 01/16/01
British pound........................... $ 8,291 03/27/01
Canadian dollar......................... $ 8,355 03/27/01
Danish kroner........................... $ 3,421 01/23/01
Euro dollar............................. $20,655 01/16/01
Euro dollar............................. $32,456 01/29/01
Euro dollar............................. $24,363 03/05/01
Japanese yen............................ $8,319 $25,482 01/16/01 01/16/01
Japanese yen............................ $ 4,247 02/09/01
Japanese yen............................ $10,727 03/05/01
The unrealized gains and losses from effective forward exchange contracts
are reflected in other comprehensive income. As of December 31, 2000, the
unrealized losses arising from the above forward exchange contracts amounted to
$1.8 million. 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, 2000, 1999 and 1998, the Company recognized gains
from such hedging activities of $2.7 million, $0.3 million and $2.7 million,
respectively.
F-33
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. CONTINGENCIES
From time to time in the ordinary course of business, the Company and
certain of its subsidiaries are parties to various legal proceedings, many of
which involve claims for coverage. 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
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.
In June 2000, the California Medical Association filed a lawsuit in U.S.
district court in San Francisco against the Company's subsidiary, Blue Cross of
California ("BCC"). The lawsuit alleges that BCC violated the federal
Racketeering Influenced and Corrupt Organizations ("RICO") Act through various
misrepresentations to and inappropriate actions against health care providers.
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 plan members. In August 2000, the Company was added as a
party to SHANE V. HUMANA, ET AL., a class-action lawsuit brought on behalf of
health care providers nationwide. In addition to the RICO claims brought in the
California Medical Association lawsuit, this lawsuit also alleges violations of
ERISA, federal and state "prompt pay" regulations and certain common law claims.
In October 2000, the federal Judicial Panel on Multidistrict Litigation issued
an order consolidating the California Medical Association lawsuit, the SHANE
lawsuit and various other pending managed care class-action lawsuits against
other companies before District Court Judge Federico Moreno in the Southern
District of Florida for purposes of the pretrial proceedings. In March 2001,
Judge Moreno dismissed the plaintiffs' claims based on violation of the RICO
Act, although the dismissal was made without prejudice to the plaintiffs'
ability to subsequently refile their claims. Judge Moreno also dismissed, with
prejudice, the plaintiffs' federal prompt pay law claims. The Company currently
expects that a hearing on the plaintiffs' motion to certify a class will be held
in early May 2001. On March 26, 2001, the California Medical Association filed
an amended complaint in its lawsuit, alleging, among other things, revised RICO
claims and violations of California law. 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.
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, 2000, 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
applicable Departments of Insurance. The maximum dividend payable in 2001
without prior approval by WellPoint's licensed insurance company subsidiaries is
estimated to be $112.9 million.
F-34
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
19. DISCONTINUATION OF MEDICARE FISCAL INTERMEDIARY ACTIVITIES IN CALIFORNIA
Under an agreement with the BCBSA, the Company's wholly-owned subsidiary
Blue Cross of California ("BCC") previously 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 was renewable annually unless
terminated by the parties involved. As fiscal intermediary under the agreement,
BCC made disbursements to providers for medical care from funds provided by the
Federal Government and was reimbursed for these expenses incurred under the
agreement. BCC disbursed approximately $7.6 billion, $8.8 billion and
$8.5 billion and received administrative fees of approximately $39.1 million,
$40.7 million and $34.3 million for the years ended December 31, 2000, 1999 and
1998, respectively. The reimbursement is treated as a direct recovery of general
and administrative expenses.
Effective December 1, 2000, BCC ceased to participate as a Medicare fiscal
intermediary. This action does not affect the Company's offering of Medicare
risk HMO and Medicare supplement products.
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 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.
The Company's senior and specialty businesses are included in the Corporate and
Other segment.
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.
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.
F-35
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
20. BUSINESS SEGMENT INFORMATION (CONTINUED)
The following tables present segment information for the Large Employer
Group and Individual and Small Employer Group for the years ended December 31,
2000, 1999 and 1998:
2000
LARGE INDIVIDUAL &
EMPLOYER SMALL EMPLOYER CORPORATE
GROUP GROUP & OTHER CONSOLIDATED
---------- -------------- ---------- ------------
(IN THOUSANDS)
Premium revenue............................. $5,011,562 $3,030,503 $ 541,598 $8,583,663
Management services revenue................. 379,142 2,865 69,840 451,847
---------- ---------- ---------- ----------
Total revenue from external customers....... 5,390,704 3,033,368 611,438 9,035,510
Intercompany revenues....................... 12,375 (583) (11,792) --
Investment income........................... 102,037 77,886 13,525 193,448
Interest expense............................ 23,244 310 424 23,978
Depreciation and amortization expense....... 38,167 17,014 20,221 75,402
Income tax expense (benefit)................ 176,342 131,027 (85,343) 222,026
Segment net income (loss)................... $ 210,221 $ 172,051 $ (39,985) $ 342,287
========== ========== ========== ==========
Segment Assets.............................. $2,323,129 $1,067,692 $2,113,885 $5,504,706
========== ========== ========== ==========
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
========== ========== ========== ==========
F-36
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
20. BUSINESS SEGMENT INFORMATION (CONTINUED)
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
========== ========== ========== ==========
21. COMPREHENSIVE INCOME
The following summarizes comprehensive income reclassification adjustments
included in the statements of changes in stockholders' equity:
YEAR ENDED DECEMBER 31,
------------------------------
2000 1999 1998
-------- -------- --------
(IN THOUSANDS)
Holding gain (loss) on investment securities arising during
the period (net of tax expense of $53,624, tax benefit of
$6,295 and tax expense of $24,218, respectively).......... $ 83,691 $ (9,847) $ 35,579
Holding gain (loss) related to foreign exchange transactions
(net of tax expense of $222 and tax benefit of $1,013,
respectively)............................................. 350 (1,584) --
Add:
Reclassification adjustment for realized losses on
investment securities (net of tax benefit of $10,004,
$10,442 and $14,237, respectively)........................ (15,646) (16,332) (20,916)
Reclassification adjustment related to foreign exchange
gains (losses) on investment securities (net of tax
benefit $204 and tax expense of $1,160, respectively)..... (319) 1,815 --
-------- -------- --------
Net gain (loss) recognized in other comprehensive income
(net of tax expense of $43,638, tax benefit of $16,590 and
tax expense of $9,981, respectively)...................... $ 68,076 $(25,948) $ 14,663
======== ======== ========
F-37
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
22. 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.
23. SUBSEQUENT EVENT
On March 15, 2001, WellPoint completed its acquisition of Cerulean
Companies, Inc., the parent company of Blue Cross and Blue Shield of
Georgia, Inc., which serves approximately 1.8 million persons in the State of
Georgia. Under the terms of the transaction, Cerulean shareholders received cash
of $700 million.
F-38