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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
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, 1996
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-11628
WELLPOINT HEALTH NETWORKS INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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CALIFORNIA 95-3760980
(State of incorporation) (I.R.S. Employer Identification No.)
21555 OXNARD STREET
WOODLAND HILLS, CALIFORNIA 91367
(Address of principal executive (Zip Code)
offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (818) 703-4000
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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. /X/ Yes / / 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.
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State the aggregate market value of the voting stock held by non-affiliates
of the Registrant as of March 19, 1997: $1,273,420,698 (based on the last
reported sale price of $45.38 per share on March 19, 1997, on the New York Stock
Exchange).
Common Stock, $0.01 par value of Registrant outstanding as of March 19,
1997: 66,570,263 shares.
DOCUMENTS INCORPORATED BY REFERENCE
NONE.
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WELLPOINT HEALTH NETWORKS INC.
1996 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business....................................................................................... 1
Item 2. Properties..................................................................................... 17
Item 3. Legal Proceedings.............................................................................. 17
Item 4. Submission of Matters to a Vote of Security Holders............................................ 18
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters...................... 19
Item 6. Selected Financial Data........................................................................ 20
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.......... 21
Item 8. Financial Statements and Supplementary Data.................................................... 31
Item 9. Changes and Disagreements with Accountants on Accounting and Financial Disclosure.............. 31
PART III
Item 10. Directors and Executive Officers of the Registrant............................................. 32
Item 11. Executive Compensation......................................................................... 35
Item 12. Security Ownership of Certain Beneficial Owners and Management................................. 43
Item 13. Certain Relationships and Related Transactions................................................. 45
PART IV
Item 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K............................... 47
SIGNATURES
INDEX TO FINANCIAL STATEMENTS
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 with
approximately 4.5 million medical members, 11.5 million pharmacy members and 1.6
million dental members as of December 31, 1996. The Company offers a diversified
mix of managed care products, including health maintenance organizations
("HMOs"), preferred provider organizations ("PPOs") and point-of-service ("POS")
and other hybrid plans, and indemnity plans. The Company offers a continuum of
managed health care plans while providing incentives to members and employers to
select more intensively managed plans. Such plans are typically offered at a
lower cost in exchange for additional cost-control measures, such as limited
flexibility in choosing non-network providers. The Company believes that it is
better able to predict and control its health care costs as its members select
more intensively managed health care plans. The Company also provides a broad
array of specialty products, including pharmacy, dental, life, workers'
compensation, disability, behavioral health, COBRA and flexible benefits account
administration. In addition, the Company offers managed care services for
self-funded employers, including underwriting, actuarial services, network
access, medical cost management and claims processing. WellPoint's diversified
mix of products and services has been developed to meet the needs of a broad
range of individuals, employer groups and their employees.
The Company's operations, with the exception of specialty products, are
organized into two internal business units with a geographic focus. The Company
markets its products in California primarily under the name Blue Cross of
California and outside of California primarily under the name UNICARE.
Historically, the Company's primary market for its managed care products has
been California. The Company holds the exclusive right in California to market
its products under the Blue Cross name and mark. The Company is diversified in
its California customer base, with extensive membership among small employer
groups, individuals and large employer groups, and a growing presence in the
Medicare and Medicaid markets.
Over the past decade, 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. The Company's acquisition
strategy focuses on large employer group plans that offer indemnity and other
health insurance products that are less intensively managed than the Company's
current products. In addition, the Company focuses on acquiring businesses that
provide significant concentrations of members in strategic locations outside of
California. The Company believes that such acquisitions will provide its UNICARE
operations with sufficient scale to begin development of proprietary provider
network systems in key geographic areas which will enable the Company to offer a
broad range of managed care products. The Company intends to use these new
networks to introduce individual, small group and senior products in these
markets. 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 ("John Hancock") (discussed in the following section), the
Company has significantly expanded its operations outside of California.
The Company is also exploring opportunities to work with other BlueCross
BlueShield entities. The Company currently provides pharmacy benefits management
services to other BlueCross BlueShield entities and intends to market additional
specialty products to and to pursue other relationships with BlueCross
BlueShield plans in the future.
1
RECENT DEVELOPMENT--GBO ACQUISITION
On March 1, 1997, the Company completed its acquisition of the GBO (the "GBO
Acquisition"). The purchase price for the acquisition was $86.7 million, subject
to adjustment upon completion of a post-closing audit.
As of December 31, 1996, the GBO provided benefits to approximately 1.3
million medical members, most of which were in health plans that are self-funded
by employers. The GBO offers indemnity and PPO plans, and also provides life,
dental and disability coverage to a variety of employer groups. The GBO focuses
on the largest employer groups, accounts with greater than 5,000 employees. A
majority of the GBO members are located in California, Texas, Georgia, the
Mid-Atlantic/Washington, D.C. area, Massachusetts, the New York/Tri-State area,
Ohio, Illinois and Michigan. In addition to the medical members, as of December
31, 1996, the GBO served approximately 270,000 pharmacy members, approximately
1.5 million dental members, approximately 1.0 million life insurance members and
covered approximately 940,000 members through disability products. The GBO
Acquisition also included Cost Care, Inc. ("CCI"), a wholly owned subsidiary of
John Hancock, which provides medical management services.
The closing of the GBO Acquisition was postponed from January 31, 1997 due
to the granting of an injunction on January 30, 1997 in favor of SelectCare Inc.
("SelectCare"), a network manager in Michigan used by John Hancock to serve
certain GBO members. In its complaint for an injunction, SelectCare had alleged,
among other things, that the completion of the acquisition would violate the
confidentiality provisions of John Hancock's agreements with SelectCare. The
case was brought by SelectCare in the federal District Court in Michigan. The
acquisition was completed on March 1, 1997 in a manner that the Company believes
complies with the terms of the injunction.
MANAGED HEALTH CARE INDUSTRY OVERVIEW
An increasing focus on costs 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 (such as POS
plans), develop health care provider networks by entering into contracts with
hospitals, physicians and other providers to deliver health care at favorable
rates that incorporate health care utilization management, network
credentialing, quality assurance and other cost-control measures. HMO, PPO and
POS members generally are charged periodic, prepaid premiums, and co-payments 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 at the time of enrollment one primary care physician from a
network who is responsible for coordinating health care services for the member,
while PPOs generally allow members to select physicians without coordination
through a primary care physician. Hybrid plans, such as POS plans, typically
involve the selection of primary care physicians similar to HMOs, but allow
members to choose non-network providers at higher out-of-pocket costs, similar
to PPOs.
THE CALIFORNIA MARKET. The desire of California-based employers for a range
of health care choices that promote effective cost controls and quality care has
led to substantial market acceptance of managed health care in California, where
the total penetration of managed health care companies is higher than the
national average. While the Company is a market leader in offering managed
health care plans to individuals and small employer groups in California, the
Company has experienced increased competition in this market over the last
several years. However, the Company believes that there will continue to be
opportunities for growth in its small group membership because small employers
are the primary source of job growth in California. WellPoint's large group
business, which historically lagged the performance of its small group and
individual business, has experienced favorable growth since 1994 with the
rebound of the California economy and the enhancement of the Company's
reputation for customer service and value, especially among established
companies.
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OTHER STATES. The market acceptance of managed health care varies widely
outside of California. In many states, members are typically offered a spectrum
of health care choices which are more focused on traditional indemnity health
insurance than in California. Indemnity insurance usually allows members
substantial freedom of choice in selecting health care providers but without
financial incentives or cost-control measures typical of managed care plans.
Health care providers are reimbursed on a retrospective basis and there are few,
if any, incentives or measures to control health care costs. 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. PPO coverage
offered by health plans outside of California is often typified by broad-based,
third-party provider networks which do not incorporate the cost-control measures
or discounts typical of the Company's proprietary provider networks in
California. The Company believes the higher costs generally associated with such
third-party PPO networks and traditional indemnity health insurance will
continue to cause employers and members to seek out managed health care
solutions similar to those offered by the Company in California.
THE BLUE CROSS OF CALIFORNIA BUSINESS
Due in part to the MMHD and GBO Acquisitions, the Company's operations, with
the exception of stand-alone specialty products, are organized into two internal
business units with a geographic focus. Most of the Company's California
operations are conducted through the Blue Cross of California Business.
MARKETING AND PRODUCTS
WellPoint's products are marketed in California primarily under the Blue
Cross mark through four major business units focusing on specific customer
segments: Group Services ("GS"), Individual and Small Group Services ("ISG"),
Senior Services and Medi-Cal. GS provides products to large employers with 51 or
more employees, educational and public entities, federal employee health and
benefit programs and national employers; ISG provides products to individual
purchasers and small groups and products for state-run programs including high
risk and underserved markets. Senior Services provides the Company's Medicare
risk products and supplemental coverage for Medicare recipients. The Medi-Cal
division provides products for Medicaid recipients. Each business unit is
responsible for enrolling, underwriting and servicing its respective customers.
Sales representatives are generally assigned to a specific geographic region of
California to allow WellPoint to tailor its marketing efforts to the particular
health care needs of each regional market. Each business unit also uses
advertising, public relations, promotion and marketing research to support its
efforts. Consistent with the Company's focus on offering a continuum of
products, the Company believes that having distinct business units segmented by
employer size and geographic region better enables it to develop benefit plans
and services to meet the needs of specific markets. The GS sales staff markets
WellPoint's managed health care plans to large employers in California by
working with a broker or consultant to develop a package of managed health care
benefits specifically tailored to meet the employer's needs. ISG markets
WellPoint's managed health care plans in California primarily through sales
managers in both Comprehensive Integrated Marketing Services, Inc. ("CIMS"), a
wholly owned subsidiary of the Company, and ISG's sales department, who oversee
independent agents and brokers.
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 copayments (small per-visit charges). Members choose
a primary care physician from the HMO network who is responsible for
coordinating health care services for the member. Certain plans permit members
to receive health care services from providers that are not a part of the
Company's HMO network at a substantial out-of-pocket cost to members which
includes a deductible and higher copayment obligations. To enhance the
marketability of
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its plans, in 1996 the Company introduced its CaliforniaCare Saver HMO product,
which introduces deductible obligations for certain hospital and outpatient
benefits.
PPO PLANS. The Company's PPO products, which are marketed under the name
"Prudent Buyer," are designed to address the specific needs of different
customer segments. The Company's PPO plans require periodic, prepaid premiums
and 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 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 providers, typically at substantially higher
out-of-pocket costs to members. To improve the attractiveness of its PPO plans
to small groups and individual buyers, in 1996 the Company introduced its
Prudent Buyer Co-Pay product, which replaces annual deductible obligations with
HMO-like co-payments while maintaining the member choice typical of PPO plans.
In March 1997, the Company introduced new high-deductible health plans intended
for use with medical savings accounts ("MSAs").
SENIOR PLANS. WellPoint offers numerous Medicare supplemental plans, which
typically pay the difference between health care costs incurred and amounts paid
by Medicare, using existing PPO and HMO provider networks. 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, 1996, the
Medicare supplemental plans served approximately 162,000 members. WellPoint also
offers Senior CaliforniaCare, an HMO plan operating in defined geographic areas,
under a Medicare risk 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 include prescription drugs, routine physical exams, hearing tests,
immunizations, eye examinations, counseling and health education services.
MEDICAID PLANS. The California Department of Health Services ("DHS")
administers Medi-Cal, California's Medicaid program. WellPoint has been awarded
contracts to administer Medi-Cal managed care programs in several California
counties. Under these programs, WellPoint provides health care coverage to
Medi-Cal program members and DHS pays WellPoint a fixed payment per member per
month. As of December 31, 1996, approximately 111,029 members were enrolled in
WellPoint's Medi-Cal managed care programs in Sacramento, Orange, Riverside, San
Bernardino, San Francisco, Alameda, Santa Clara, Fresno and Kern counties.
WellPoint is a participating plan partner with the Local Initiative Health
Authority for Los Angeles County, although no enrollment had begun as of
December 31, 1996.
MANAGED HEALTH CARE NETWORKS AND PROVIDER RELATIONS
WellPoint's extensive managed health care provider networks in California
include its HMO, PPO and specialty managed care networks. These provider
relationships are monitored regularly in order to control the cost of health
care while providing access to quality providers. As a result of this
network-monitoring process as well as member and provider financial incentives,
WellPoint reduces or eliminates the need to use out-of-network providers that
are not subject to WellPoint's cost and performance controls.
WellPoint uses its large California membership to negotiate provider
contracts at favorable rates that require utilization management and other
cost-control measures. Pursuant to these contracts, physician providers are paid
either a fixed per member monthly amount (known as a capitation payment) or on
the basis of a fixed fee schedule. In selecting providers for its networks,
WellPoint uses its credentialing
4
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 HMO and PPO networks.
HMO NETWORK. Membership in CaliforniaCare has grown to approximately
1,058,000 members as of December 31, 1996 from 123,000 members as of December
31, 1987. As of December 31, 1996, the HMO network included approximately 24,600
primary care and specialist physicians and approximately 410 hospitals
throughout California. The physician network of participating medical groups
("PMGs") is comprised of both multi-specialty medical group practices and
individual practice associations.
Substantially all primary care physicians or PMGs in the Company's HMO
network are reimbursed on a capitated basis that incorporates financial
incentives to control health care costs. 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 reduced
risk to WellPoint. Generally, HMO network hospital provider contracts are on a
nonexclusive basis and provide for a per diem (a fixed fee schedule where the
daily rate is based on the type of service), which is substantially below the
hospitals' standard billing rates.
Contractual arrangements with PMGs typically include provisions under which
WellPoint provides limited stop-loss protection. If the PMG's actual charges for
medical services provided to a member exceed an agreed-upon threshold amount,
WellPoint will pay the group a portion of the excess amount. Provider rates are
generally negotiated annually with PMGs and hospitals. To encourage PMGs to
contain costs for claims for non-capitated services such as inpatient hospital,
outpatient surgery, hemodialysis, emergency room, skilled nursing facility,
ambulance, home health and alternative birthing center services, WellPoint's PMG
agreements provide for a settlement payment to the PMG based upon the PMG's
effective utilization of such non-capitated services. Amounts that remain in the
pool after payment of such claims are shared between WellPoint and the PMGs.
PMGs are also eligible for additional incentive payments based upon satisfaction
of quality criteria.
PPO NETWORK. The PPO network, WellPoint's largest network, included
approximately 40,400 physicians and 430 hospitals throughout California as of
December 31, 1996. There were approximately 2.5 million members (including
administrative services members) enrolled in WellPoint's California PPO health
care plans as of such date, approximately 45% of whom were individuals or
employees of small groups.
WellPoint endeavors to manage and control costs for its PPO plans by
negotiating favorable arrangements with physicians, hospitals and other
providers, which include utilization management and other cost-control measures.
In addition, WellPoint controls costs through pricing and product design
decisions intended to influence the behavior of both providers and members.
Like WellPoint's HMO plans, WellPoint's PPO plans provide for the delivery
of specified health care services to members by contracting with physicians,
hospitals and other providers. Hospital provider contracts are on a nonexclusive
basis and are generally paid per diem amounts that provide for rates that are
substantially below the hospitals' standard billing rates. Physician provider
contracts are also on a nonexclusive basis and specify fixed fee schedules that
are significantly below standard billing rates. WellPoint is able to obtain
prices for hospitals and physician services significantly below standard billing
rates because of the volume of business it offers to health care providers that
are part of its network. Provider rates are generally negotiated on an annual or
multi-year basis with hospitals. In 1996, the Company concluded an extensive
recontracting process with hospitals in its provider network, whereby certain
hospitals that demonstrated designated quality and other criteria were given a
preferred status in exchange for, among other things, lower negotiated rates.
Provider rates for physicians in the Company's PPO network are set from time to
time by the Company.
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UTILIZATION MANAGEMENT. WellPoint also manages health care costs in its
provider networks by adopting utilization management systems and guidelines that
are intended to reduce unnecessary procedures, admissions and other medical
costs. The utilization management systems seek to ensure that medical services
provided are based on medical necessity and that all final decisions are made by
physicians. In its HMO, WellPoint permits PMGs to oversee most utilization
management for their particular medical group under these guidelines. Currently,
substantially all of the PMGs in WellPoint's HMO network have established
committees to oversee utilization management. For its PPO network, WellPoint
uses treatment guidelines, requires pre-admission approvals of hospital stays
and concurrent review of all admissions and retrospectively reviews physician
practice patterns. Utilization management also includes an outpatient program,
with pre-authorization and retrospective review, ongoing supervision of
inpatient and outpatient care of members, case management and discharge planning
capacity. Review of practice patterns may result in modifications and
refinements to the PPO plan offerings, treatment guidelines and network
contractual arrangements. In addition, WellPoint manages health care costs by
periodically reviewing cost and utilization trends within its provider networks.
Cases are reviewed in the aggregate to identify a high volume of a particular
type of service to determine whether costs for these treatments can be more
effectively managed. In addition, the highest cost services are identified to
determine if costs in the aggregate can be reduced by using new, cost-effective
technologies or by creating additional networks, such as networks of home health
agencies.
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 California
legislation affecting the individual and small employer group market. See
"--Government Regulation."
QUALITY MANAGEMENT. Quality management for most of the Company's California
business is overseen by the Company's Quality Management Department and is
designed to ensure that necessary care is provided by qualified personnel.
Quality management encompasses plan level quality performance, physician
credentialing, provider and member grievance monitoring and resolution, medical
group auditing, monitoring medical group compliance with Blue Cross of
California standards for medical records and medical offices, physician peer
review and an active quality management committee.
THE UNICARE BUSINESS
The Company believes that its success in the highly competitive California
managed care market is attributable to its broad range of managed care products
that target the differing needs of specific market segments. The Company's
acquisition strategy has focused on large employer group plans which offer
indemnity and other health care products that are less intensively managed than
the Company's current products. In addition, the Company focuses on acquiring
businesses that provide significant concentrations of members in strategic
locations outside of California. As of December 31, 1996, the Company had
approximately 1.0 million members covered under its UNICARE health plans
(including approximately 141,000 members in California). Approximately 50% of
UNICARE medical membership as of such date was concentrated in seven states:
California, New York, Texas, Georgia, Massachusetts, Illinois and Virginia. The
acquired MMHD operations, as well as the GBO, are now conducted by the Company's
indirect wholly owned subsidiary UNICARE Life & Health Insurance Company.
MARKETING AND PRODUCTS
WellPoint's products are marketed outside of California under the UNICARE
brand name through business units which are organized on a customer-segment
basis. The large employer group businesses acquired in the MMHD and GBO
Acquisitions have a national focus as a result of the multi-state needs of
employers in those customer segments. Other business units, such as those
focusing on the individual and small employer group, senior and Medicaid
markets, have a more regional focus as a result of the more
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localized nature of customers in these segments. Similar to the Company's Blue
Cross of California business units, each UNICARE business unit is responsible
for marketing, enrolling, underwriting and servicing its specific customers.
Outside of California, the Company offers PPO products that use third-party
provider networks as well as traditional fee-for-service products. As WellPoint
develops proprietary provider network systems in these 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.
MANAGED HEALTH CARE NETWORKS AND PROVIDER RELATIONS
Due to the recent development of the Company's national operations, the
Company's relations with health care providers outside of California are more
varied than in California. The Company currently contracts with a number of
third-party provider networks, which generally lack the provider selectivity and
discounts typical of the Company's California networks. One of the Company's
strategies for the expansion of its UNICARE operations is to build proprietary
provider network systems similar to the Company's networks in California, 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.
The Company offers managed health care products and services in Texas
through certain subsidiaries. One of the Company's indirect subsidiaries,
UNICARE of Texas Health Plans, Inc., is currently licensed as an HMO in the
Houston area. This HMO began marketing operations to large employer groups in
October 1996. The Company expects to begin marketing the HMO product in the
individual and small group markets in the second half of 1997. The Company has
developed an HMO network of approximately 3,000 primary care and specialist
physicians and 20 hospitals in the Houston area as of December 31, 1996. The
Company intends to seek approval to extend this HMO product to the Dallas,
Austin, San Antonio, Corpus Christi and Beaumont metropolitan areas. The Company
has commenced start-up activities in Georgia and intends to begin building HMO
and PPO networks in the greater Atlanta and Savannah areas. The Company
currently expects that it will begin commercial marketing operations in Georgia
in the second half of 1997.
As part of the MMHD Acquisition, the Company also acquired majority
ownership interests in a start-up HMO, National Capital Health Plan ("NCHP"),
and an existing PPO, National Capital Preferred Provider Organization ("NCPPO").
Both entities operate in the greater Washington, D.C. metropolitan area and are
joint ventures with local health care providers. The NCPPO network included
approximately 5,800 primary care and specialist physicians and 47 hospitals as
of December 31, 1996. WellPoint anticipates that NCHP will commence commercial
operations in 1997.
UTILIZATION MANAGEMENT. For the Company's UNICARE managed care health
plans, utilization management is provided both by UNICARE and third-party
provider networks. As part of the GBO Acquisition, the Company also acquired
CCI, which provides medical management services. The Company expects that over
time CCI will become the primary platform for the provision of utilization
review services to UNICARE members.
UNDERWRITING. As with the Company's Blue Cross of California operations,
the UNICARE underwriting activities use criteria based upon accumulated
actuarial data, with adjustments for factors such as claims experience, member
mix and industry differences to evaluate anticipated health care costs. Due to
the administrative services only component of the Company's national membership,
most of the UNICARE business involves no underwriting risk to the Company.
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."
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SPECIALTY MANAGED HEALTH CARE AND OTHER PLANS
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 HMO, PPO and POS plans and help in
attracting employer groups and other members that are increasingly seeking a
wider variety of options and services. One of WellPoint's strategies is to
expand its specialty business by marketing these plans to the approximately 4.5
million members of its medical plans, as well as using these specialty products
to attract new members. WellPoint also markets these specialty products on a
stand-alone basis to other health plans and other payors.
PHARMACY PRODUCTS
WellPoint offers pharmacy services to its California members through its
subsidiary WellPoint Pharmacy Plan and offers pharmacy benefit management
services nationwide through its subsidiary Professional Claim Services, Inc.
("Pro-Serv"). WellPoint Pharmacy Plan and Pro-Serv incorporate features such as
drug formularies (a WellPoint-developed listing of preferred, cost-effective
drugs), a pharmacy network and maintenance of a prescription drug database and
mail order capabilities. Moreover, pharmacy benefit management services provided
by WellPoint Pharmacy Plan and Pro-Serv include management of drug utilization
through outpatient prescription drug formularies, retrospective review and drug
education for physicians, pharmacists and members. As of December 31, 1996,
WellPoint Pharmacy Plan and Pro-Serv had more than 11.5 million risk and
non-risk members and approximately 45,500 participating pharmacies.
DENTAL PLANS
WellPoint's dental plans include Dental Net, its California dental HMO, with
a provider network of approximately 2,000 dentists reimbursed on a capitated
basis, a dental PPO, with a network of approximately 9,600 dentists, and
traditional indemnity plans. The dental plans provide primary and specialty
dental services, including orthodontic services, and as of December 31, 1996,
served approximately 1.6 million dental members.
LIFE INSURANCE
The Company offers primarily term-life insurance to employers, generally in
conjunction with the Company's health plans. As of December 31, 1996, the
Company had approximately 723,000 life insurance members.
MENTAL HEALTH PLANS
WellPoint offers a specialized mental health and substance abuse program.
The plan covers mental health and substance abuse treatment services on both an
inpatient and an outpatient basis, through a network of approximately 3,300
contracting providers. In addition, approximately 257 employee assistance and
behavioral managed care programs have been implemented for a wide variety of
businesses throughout the United States. As of December 31, 1996, there were
approximately 502,000 members covered under WellPoint's mental health plans.
WORKERS' COMPENSATION
One of the Company's indirect operating subsidiaries, UNICARE Insurance
Company ("UIC"), underwrites workers' compensation insurance primarily in
California and is also licensed in 33 other states. UIC historically focused on
insuring large accounts, working with a select group of large property and
casualty insurance brokers. In August 1994, the Company introduced "UNICARE
Integrated," an integrated managed care product for workers' compensation and
medical benefits. Under UNICARE Integrated, WellPoint has combined its existing
HMO and PPO networks with a workers' compensation
8
occupational medical network of physicians and clinics. UNICARE Integrated
offers single point-of-service and account management for the employer and
provides employees access to existing HMO and PPO networks. WellPoint believes
that, by integrating managed care and workers' compensation, medical treatment
costs and workers' compensation costs can be reduced.
DISABILITY PLANS
As a result of the MMHD Acquisition, the Company now provides long-term and
short-term disability coverage. As of December 31, 1996, the Company provided
long-term and/or short-term disability coverage to approximately 107,000
individuals.
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.
MANAGED CARE SERVICES
WellPoint provides administrative services to large group employers that
maintain self-funded health plans. In California, the Company often has been
able to transition these customers into other lines of business by subsequently
introducing WellPoint's underwritten managed care products. 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 California PPO, POS and HMO 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, 1996, WellPoint serviced
self-insured health plans covering approximately 1.2 million medical members, of
which approximately 640,000 were attributable to the large employer group
operations acquired in the MMHD Acquisition. Management services revenue for
these services was $147.9 million, $61.2 million and $36.3 million for the years
ended December 31, 1996, 1995 and 1994, respectively.
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 $34.8 million, $21.2
million and $17.7 million on advertising for the years ended December 31, 1996,
1995 and 1994, respectively.
COMPETITION
The managed health care industry in California is competitive on both a
regional and statewide basis. In addition, in recent years there has been a
trend of increasing consolidation among both national and California-based
health care companies, which may further increase competitive pressures.
WellPoint competes with other companies that offer similar managed health care
plans, some of which have greater resources than WellPoint. The large employer
group market is especially competitive, as employers continue to demand
increasing variety and flexibility from their health plans while trying to limit
increases in premiums. 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 is lower than that for its large employer group business.
As a result, a larger portion
9
of WellPoint's profitability 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 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 the National Committee for
Quality Assurance ("NCQA")) and financial stability. WellPoint believes that it
competes effectively against other health care industry participants.
RECAPITALIZATION
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, Old WellPoint and BCC entered into a Recapitalization
Agreement dated as of March 31, 1995 regarding certain transactions between Old
WellPoint and BCC. On February 20, 1996, Old WellPoint, BCC and two newly
created nonprofit foundations, the California HealthCare Foundation (the
"Foundation") and the California Endowment (the "Endowment"), executed an
Amended and Restated Recapitalization Agreement (the "Amended Recapitalization
Agreement"). On May 20, 1996, BCC and Old WellPoint concluded a recapitalization
(the "Recapitalization"). Pursuant to the Amended Recapitalization Agreement,
(a) Old WellPoint distributed an aggregate of $995.0 million by means of a
special dividend of $10.00 per share of its common stock, and BCC, as a
California nonprofit public benefit corporation and the holder of all
outstanding Old WellPoint Class B Common Stock, thereupon immediately donated
its portion thereof ($800 million) to the Endowment; (b) BCC donated its assets,
other than BCC's Old WellPoint Class B Common Stock and its commercial
operations (the "BCC Commercial Operations") to the Foundation; (c) BCC changed
its status to a California for-profit business corporation (the "BCC
Conversion") and issued to the Foundation 53,360,000 shares of Common Stock; and
(d) Old WellPoint merged with and into BCC (the "Merger") and the surviving
entity changed its name to WellPoint Health Networks Inc. In the Merger, (i)
each outstanding share of Old WellPoint Class A Common Stock was converted into
0.667 shares of the Company's Common Stock, (ii) the outstanding shares of the
Company's Common Stock held by the Foundation prior to the Merger were converted
into 53,360,000 shares of the post-Merger Company's Common Stock and a cash
payment of $235.0 million to reflect the value of the BCC Commercial Operations
and the value of the Blue Cross mark and (iii) the outstanding shares of Old
WellPoint Class B Common Stock were canceled. The Company and the Foundation
subsequently amended the terms of the Recapitalization to provide for the
substitution by the Company of $7.0 million in cash for the capital stock of
certain entities owning the real estate surrounding the Company's headquarters
building.
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
10
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 connection with the Recapitalization, BCC relinquished its rights under
the Blue Cross License Agreement date January 1, 1991, between Blue Cross of
California and the BlueCross BlueShield Association ("BCBSA"). The BCBSA and the
Company entered into a new License Agreement effective as of May 20, 1996 (the
"License Agreement"), pursuant to which the Company has become the exclusive
licensee for the right to use the Blue Cross name and related service marks in
California and has become a member of the BCBSA. See "--Service Marks."
The License Agreement required that the Foundation enter into a voting trust
agreement (the "Voting Trust Agreement"), pursuant to which the Foundation
deposited into a voting trust (the "Voting Trust") the number of shares of the
Company's Common Stock sufficient to reduce the Foundation's holdings outside
such Voting Trust to a level not in excess of 50% of the voting power of the
outstanding shares of the Company's Common Stock. The shares held by the trustee
under the Voting Trust Agreement (the "Voting Trust Shares") generally will be
voted (i) with respect to elections and removal of directors, calling of
shareholder meetings and amendment of the Company's Articles of Incorporation
and Bylaws, where such action are opposed by the Board of Directors, to support
the position of the Board of Directors, (ii) with certain exceptions, on matters
requiring a vote of at least an absolute majority of all outstanding shares of
Common Stock, as the majority of non-Voting Trust Shares vote, and (iii) on all
other matters, in the identical proportion in favor of or in opposition to such
matters as non-Voting Trust Shares vote. In addition, the Voting Trust Agreement
requires that the Foundation, through sales (which may involve additional
exercises of its registration rights discussed below) or additional deposits
into the Voting Trust, reduce its holdings outside the Voting Trust to 20% and
5% of the outstanding Common Stock on and after three and five years,
respectively, from May 20, 1996.
With respect to those shares held by the Foundation in excess of the
"Ownership Limit" (which is defined in the Company's Articles of Incorporation
as one share less than 5% of the Company's outstanding voting securities) that
are not subject to the Voting Trust Agreement, the Foundation has also entered
into a voting agreement (the "Voting Agreement"). The Voting Agreement provides
among other things, that the Foundation, during the period that it continues to
own in excess of the Ownership Limit, will vote all shares of the Company's
Common Stock owned by it in excess of 5% of the outstanding shares (except those
shares held pursuant to the Voting Trust Agreement) in favor of each nominee to
the Board of Directors of the Company who has been nominated by the Nominating
Committee of the Board of Directors, or under certain circumstances, other
subsets of the board, all as set forth in the Company's Bylaws. With respect to
the removal of directors, calling of shareholder meetings and amendment of the
Company's Articles of Incorporation and Bylaws, where such actions are opposed
by the Board of Directors, the Foundation has also agreed under the Voting
Agreement to support the position of the Board of Directors.
In connection with the Recapitalization, the Company and the Foundation also
entered into a registration rights agreement (the "Registration Rights
Agreement") with respect to the shares of the Company held by the Foundation.
The Registration Rights Agreement grants the Foundation (and certain transferees
of the shares covered by the Registration Rights Agreement), certain demand and
"piggyback" registration rights. The undertakings made by Old WellPoint in order
to secure the DOC's approval of the Recapitalization required the Foundation to
make certain minimum annual distributions beginning in 1997. In order to fund
such required distributions, the Foundation may make additional sales of shares
of the Company's Common Stock pursuant to the exercise of its rights under the
Registration Rights Agreement.
11
GOVERNMENT REGULATION
CALIFORNIA
DOC REGULATION. WellPoint offers its managed health care services in
California through subsidiaries, Blue Cross of California (previously known as
CaliforniaCare Health Plans), WellPoint Dental Plan and WellPoint Pharmacy Plan,
which, along with WellPoint, are subject to regulation principally by the
California Department of Corporations (the "DOC") under the Knox-Keene Health
Care Service Plan Act of 1975 (the "Knox-Keene Act"). Under the Knox-Keene Act,
WellPoint's managed health care plans are each subject to various minimum
tangible net equity ("TNE"), deposit and other financial requirements. The DOC
also regulates the ability of WellPoint to issue capital stock or to pay
dividends, and of its subsidiaries to pay dividends or to diversify and
implement changes in their products, and the ability to effect intercompany
transactions. WellPoint's managed health care programs are also subject to
extensive DOC regulation regarding minimum benefit and coverage levels,
WellPoint's contractual and business relationships with health care providers,
administrative capacity, marketing and advertising, procedures for quality
assurance and subscriber and enrollee grievance resolution. WellPoint must file
periodic financial reports with the DOC and is subject to periodic reviews of
those activities by the DOC. In addition, the DOC must approve all forms of
individual and group subscriber contracts. Any material modifications to the
organization or operations of WellPoint are subject to prior review and approval
by the DOC. The approval process can be lengthy and there is no certainty of
approval by the DOC. The failure to comply with DOC regulations can subject the
Company to various penalties, including fines or the imposition of restrictions
on the conduct of its operations. The Company is currently undergoing a
triennial DOC medical survey of the Company and each of its subsidiaries
licensed under the Knox-Keene Act. The results of these surveys are expected to
be received some time in 1997.
DOI REGULATION. The California Department of Insurance (the "California
DOI") regulates the insurance business, including the managed care services and
workers' compensation activities, conducted by BC Life & Health Insurance
Company ("BC Life," formerly known as WellPoint Life Insurance Company) and UIC.
BC Life and UIC are subject to various capital reserve and other financial
requirements established by the California DOI. BC Life and UIC must also file
periodic reports regarding their activities regulated by the California DOI and
are subject to periodic reviews of those activities by the California DOI. BC
Life must also 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. CIMS, which operates a general insurance agency, is also
subject to regulation by the California DOI. There can be no assurance that any
future regulatory action by the California DOI will not have an adverse impact
on the ability of BC Life, UIC and CIMS to conduct their business profitably.
CALIFORNIA HEALTH CARE LEGISLATION. From time to time, new California
legislation is enacted and regulatory interpretations are adopted that adversely
affect WellPoint. For example, California's various small group reforms require
that coverage be offered to certain small groups, limit rate increases and
exclusions based on pre-existing conditions, limit waivers (temporary exclusion
for individuals with specifically identified preexisting conditions) and impose
other requirements designed to increase the availability of coverage for small
groups. This legislation has resulted in increased claims expense for the
Company. In addition, in 1996 WellPoint voluntarily removed certain temporary
exclusions, including a temporary exclusion for maternity services, which has
resulted in increased claims expense for the Company. Further California
legislation addresses the practice of "freezing," or discontinuing the offering
of certain benefit plans, by health care service plans and insurance carriers.
There can be no assurance that compliance with the legislation discussed above
will not adversely affect WellPoint's financial condition or results of
operations. The legislation described above and any similar legislation in
California or other states may result in increased claims expense.
FEDERAL
RECENT FEDERAL HEALTH CARE LEGISLATION. On August 21, 1996, the President
signed into law the Health Insurance Portability and Accountability Act of 1996
(originally known in the Senate as the Kennedy-
12
Kassebaum bill) ("HIPAA"). HIPAA imposes new obligations for issuers of health
insurance coverage and health benefit plan sponsors. Most of the insurance
reform provisions of HIPAA become effective for "plan years" beginning July 1,
1997.
HIPAA requires health plans in the small group market (generally 50 or fewer
employees) to accept every employer, employee and family member, subject to
certain prescribed exceptions. Plans must apply any restriction uniformly and
without regard to health status. HIPAA also guarantees the renewability of
coverage, regardless of the health status of any member of a group. Access to
coverage in the individual market is guaranteed to people who lose their group
coverage (due to loss of employment, change of jobs or other reasons), subject
to certain limited exceptions. Alternatively, states may develop programs to
assure that comparable coverage is available to these people. The coverage will
be available without regard to health status, and renewal will be guaranteed.
HIPAA further prohibits health plans from establishing enrollment
eligibility rules or premiums for individuals based on specified "health status"
related factors. An exception to this policy of nondiscrimination is provided
with respect to premium discounts or rebates, or modified copayments and
deductibles related to health promotion and disease prevention programs.
HIPAA provides parameters for the use of pre-existing condition limits by
health plans. Plans may limit or exclude benefits for a pre-existing condition
only if the exclusion is limited to 12 months for conditions diagnosed or
treated in the previous six months. The pre-existing condition exclusion period
is reduced or credited for each month of prior continuous coverage. Insurers
cannot impose new pre-existing condition exclusions for workers with previous
coverage. Health plans only may use an affiliation period of up to two months.
On September 26, 1996 the President signed maternity length of stay and
mental health parity benefits measures into law. 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 are covered if deemed necessary by
the mother or her physician (in consultation with the mother). Health plans will
be barred from offering financial incentives for early discharges. The mental
health parity provision will require health plans that provide mental health
benefits to set the same level of yearly and lifetime coverage for mental health
benefits as for physical ones. The maternity length of stay and mental health
parity measures will be effective for plan years beginning January 1, 1998.
Approximately 30 states already guarantee minimum hospital stays for mothers and
newborns. In many regions, the maternity length of stay provisions reflect the
existing average length of stay. As a result of these factors, it is unclear
what implications, if any, these measures will have on WellPoint's result of
operations.
WellPoint intends to take action to bring its operations into compliance
with the two new laws described above. There can be no assurance that compliance
with this legislation will not result in an increased claims expense for
WellPoint.
MEDICARE LEGISLATION. WellPoint's health benefits programs include products
that are marketed to Medicare beneficiaries as a supplement to their Medicare
coverage. These products are subject to Federal regulations intended to provide
Medicare supplement customers with standard minimum benefits and levels of
coverage and full disclosure of coverage terms and assure that fair sales
practices are employed in the marketing of Medicare supplement coverage.
In California, WellPoint provides a senior plan product under a Medicare
risk 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. WellPoint's senior plan is not
permitted to account for more than one-half of WellPoint's total HMO members in
each of WellPoint's geographic markets in California. HCFA has the right to
audit HMOs operating under
13
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, including
national health care reform, have been made at the Federal and state levels.
Certain of these proposals would require all employers to purchase health care
coverage for their employees, either from private providers or from a
government-sponsored program that would also make available coverage to the
uninsured or underinsured. Certain of these proposals would further restrict
coverage decisions or prohibit exclusions or denials of coverage for
pre-existing conditions and would provide for "community rating" of risks. To
help meet the needs of the uninsured, in 1994 WellPoint offered guaranteed
coverage in California to individuals, including those with pre-existing
conditions. To control medical costs, proposed legislation may also set or limit
fees of health care providers, which may be established through a governmental
board.
WellPoint is unable to evaluate what legislation may be proposed and when or
whether any legislation will be enacted and implemented. However, certain of the
proposals, if adopted, could have a material adverse effect on WellPoint's
financial condition 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 and workers' compensation insurance. As a result of
the MMHD and GBO Acquisitions, the Company and certain of its subsidiaries are
also subject to regulation by the DOI in Delaware (which is the state of
incorporation of the Company's wholly owned subsidiary UNICARE Life & Health
Insurance Company) and in all other states. Most of the products and plans
offered by WellPoint in Texas are regulated by the Texas Department of
Insurance. As the Company offers a broad range of managed care products in new
geographic locations, it will be subject to additional regulation by
governmental agencies applicable to the provision of health care services. The
Company believes it is in compliance in all material respects with all current
state regulatory requirements applicable to its business as presently conducted.
However, changes in government regulations could affect the level of services
which the Company is required to provide or the rates which the Company can
charge for its health care products and services. As the Company continues to
expand its operations outside of California, new legislative and regulatory
developments in Delaware, Texas, Georgia and various other states will have
greater potential effect on the Company's financial condition or results of
operations.
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 approximately 32,000 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
"CaliforniaCare," "Prudent Buyer Plan" and "UNICARE" are registered service
marks of WellPoint. In addition to these marks, WellPoint has filed for
registration of and maintains several other service marks, trademarks and trade
names at the Federal level and in California. WellPoint and one of its principal
operating subsidiaries, Blue Cross of California, are currently parties to
license agreements with the BCBSA which allow them to use the Blue Cross name
and mark in California with respect to WellPoint's HMO and PPO network-based
plans. 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 license requires payment of a fee to the BCBSA and compliance with various
requirements established by the BCBSA, including the maintenance of a specified
level (the "Minimum BCBSA Capital") of the BCBSA's base capital requirements.
The failure to meet the Minimum BCBSA Capital requirements can subject the
Company to certain corrective action, while the
14
failure to meet a lower specified level of capital can result in termination of
the Company's license agreement with the BCBSA. See "--Factors That May Affect
Future Results of Operations." 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, 1996, WellPoint and its subsidiaries employed approximately
6,600 people (excluding the approximately 2,900 employees of the GBO).
Approximately 120 of the Company's employees are presently covered by a
collective bargaining agreement with the Office and Professional Employees
International Union, Local 29. As a result of the GBO Acquisition, approximately
225 of the Company's office clerical employees in the greater Detroit area are
presently covered by a collective bargaining agreement with the International
Brotherhood of Teamsters, Chauffeurs, Warehousemen and Helpers of America, Local
No. 614. WellPoint believes that its relations with its employees are good, and
it has not experienced any work stoppages.
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 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, as amended). 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.
HEALTH CARE REGULATIONS; LEGISLATIVE REFORM
WellPoint's operations are subject to substantial regulation by Federal,
state and local agencies. As a result of the MMHD and GBO Acquisitions,
WellPoint is now subject to the authority of state regulatory agencies in all 50
states. There can be no assurance that any future regulatory action by any such
agencies will not have a material adverse effect on the profitability or
marketability of WellPoint's health plans or on its financial condition or
results of operations.
The health care industry has become the subject of greater legislative and
media scrutiny in recent years. In 1996, the President signed HIPAA into law as
well as maternity length of stay and mental health parity measures. The
maternity length of stay and mental health parity measures will take effect
January 1, 1998. See "--Government Regulation." Various states have passed
similar legislation, some providing for more extensive benefits than those
required by HIPAA. Numerous proposals are being considered by the United States
Congress and state legislatures relating to health care reform. 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, its financial
condition or results of operations.
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, health care practices, inflation, new
technologies, clusters of high-cost cases, the regulatory environment 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 or results of operations. In addition to the
challenge of controlling health care costs, the Company faces competitive
pressure to contain premium prices. Fiscal concerns regarding the continued
viability of programs such as Medicare and Medicaid may cause decreasing
reimbursement rates for government-
15
sponsored programs. WellPoint's financial condition or results of operations
would be adversely affected by any limitation on the Company's ability to
increase or maintain its premium levels.
INTEGRATION OF RECENT ACQUISITIONS; GEOGRAPHIC EXPANSION STRATEGY
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 and the GBO Acquisition in March
1997. The consolidation of these recently acquired operations into the
operations of the Company has required and will continue to require considerable
expenditures and a significant amount of management time. The success of these
acquisitions will also require the integration of a significant number of the
employees into the Company's existing operations, as well as the integration of
separate information systems. No assurances can be given regarding the ultimate
success of the integration of these acquisitions into the Company's business,
due in part to the large size and multi-state nature of their businesses.
Both the acquired MMHD operations and the GBO have some indemnity-based
insurance operations, with a significant number of members outside of
California. Each of these operations experienced varying profitability or losses
in recent periods. In addition, the Company expects that it will experience
material membership attrition as it pursues its strategy of motivating
traditional indemnity health insurance members to select managed care products.
There can be no assurances that a sufficient number of these members will accept
managed care health plans or that the Company will be able to continue existing
relationships with provider networks currently serving those members or develop
satisfactory proprietary provider networks in these geographic areas. The
development of such networks will require considerable expenditures by the
Company.
COMPETITION
Managed health care organizations operate in a highly competitive
environment that is subject to significant change from business consolidations,
new strategic alliances, legislative reform, aggressive marketing practices by
other managed health care organizations and other market pressures. The
Company's operations remain heavily concentrated 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 as a result of completed and pending
transactions. Outside of California, the Company faces substantial 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 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 45% WellPoint's total
premium revenue for the year ended December 31, 1996. WellPoint has experienced
increasing competition in the individual and small employer group market over
the past several years, which could adversely affect WellPoint's loss ratio and
future financial condition or results of operations. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations."
EVOLVING THEORIES OF RECOVERY
WellPoint, like HMOs and health insurers generally, excludes certain health
care services from coverage under its HMO, PPO and other plans. In the ordinary
course of business, WellPoint is subject to the claims of its members from
decisions to restrict reimbursement for certain treatments. The loss of even
16
one such claim, if it were to result in a significant punitive damage award,
could have a material adverse effect on WellPoint's financial condition or
results of operations. In addition, the risk of potential liability under
punitive damage theories may significantly increase the difficulty of obtaining
reasonable settlements of coverage claims. The financial and operational impact
that such evolving theories of recovery may have on the managed care industry
generally, or WellPoint in particular, is presently unknown.
MINIMUM BCBSA CAPITAL REQUIREMENTS
The failure to meet the Minimum BCBSA Capital requirement can subject the
Company to certain corrective actions, while the failure to meet a lower
specified level of capital can result in termination of the Company's license
agreement with the BCBSA. The BCBSA's Minimum Capital requirement increased as
of December 31, 1996. In order to address an anticipated shortfall in the
Company's capital under these more stringent requirements, on December 30, 1996
the Company borrowed $50 million under its $200 million subordinated debt
facility (the "Subordinated Credit Agreement"). As of December 31, 1996, the
Company's TNE (which is also its capital for BCBSA purposes) was approximately
$388 million and the Minimum BCBSA Capital was approximately $364 million. The
Company's required TNE for DOC purposes was approximately $17 million as of such
date. On March 17, 1997, the Company borrowed an additional $150 million under
the Subordinated Credit Agreement in part to meet increased capital needs as a
result of the GBO Acquisition. The Company intends to present a proposal at its
1997 Annual Meeting of Shareholders to form a new Delaware holding company
structure, which would have the effect of greatly increasing the Company's
capital for BCBSA purposes. There can be no assurances that such a proposal will
be adopted or that, whether or not such a proposal is adopted, that the
Company's net income in future periods will be sufficient to continue to satisfy
the Minimum BCBSA Capital requirement or that, if necessary, the Company will be
able to obtain additional subordinated indebtedness to meet this requirement.
ITEM 2. PROPERTIES.
Effective as of January 1, 1996, the Company entered into a new lease for
its Woodland Hills, California headquarters facility, which provides for a term
expiring in December 2019 with two options to extend the term for up to two
additional five-year terms. Rent expense under the new lease was approximately
$5.3 million during 1996. The Company, as well as the GBO, have additional
offices in California and various other states.
ITEM 3. LEGAL PROCEEDINGS.
NCQA LAWSUIT. On October 20, 1995, a lawsuit was filed in the United States
District Court for the District of Columbia by CaliforniaCare Health Plans
("CaliforniaCare," which is now known as Blue Cross of California) against the
NCQA. The NCQA is an organization that reviews and accredits HMOs and managed
care plans and, in October 1995, NCQA denied accreditation to CaliforniaCare.
CaliforniaCare's lawsuit alleged, among other things, that in its accreditation
review of CaliforniaCare and in its subsequent decision to deny accreditation to
CaliforniaCare, NCQA: (1) failed to follow its own policies, procedures and
guidelines; (2) failed to afford CaliforniaCare fair and due process; (3)
breached its contractual obligations with CaliforniaCare; and (4) that
CaliforniaCare suffered substantial damage as a result of the denial of
accreditation. The complaint sought a declaratory judgement against NCQA, as
well as a permanent injunction prohibiting NCQA from implementing, acting upon,
or disseminating further its accreditation decision, and compensatory damages.
In January 1996, CaliforniaCare and NCQA began court-ordered mediation in an
attempt to resolve the lawsuit. On March 1, 1996, the parties agreed to extend
the mediation and stayed the litigation proceedings until September 30, 1996
(subsequently extended to December 16, 1996) while the parties continued to seek
a resolution through mediation. As a result of this mediation, CaliforniaCare
and NCQA jointly agreed that NCQA would conduct another accreditation review of
CaliforniaCare. On December 19, 1996, CaliforniaCare announced that it had been
17
awarded a one-year accreditation by NCQA. On December 24, 1996, CaliforniaCare
filed a dismissal of its lawsuit against NCQA.
STOCKHOLDER LITIGATION. On November 26, 1996, the Superior Court of the
State of California for Los Angeles County approved the settlement (the
"Settlement") of four substantially identical actions that had been filed
against WellPoint, certain of WellPoint's officers and directors, and Blue Cross
of California in March and April of 1995. The complaints in Gollomp and Gober,
et al. v. Schaeffer, Williams, Rich, Weinberg, et al.; Greenberg, et al. v.
Schaeffer, Williams, Rich, Weinberg, et al.; Freed, et al. v Schaeffer,
Williams, Rich, Weinberg, et al.; and Kaiser v. WellPoint Health Networks Inc.,
Blue Cross of California, et al., alleged that the defendants breached fiduciary
duties to WellPoint's public stockholders by, among other things, pursuing a
business combination with Health Systems International and allegedly rejecting
certain other proposals without due consideration.
All of the Settlement documentation is on file with the Los Angeles County
Superior Court. The principal terms of the Settlement require: (1) certain
continuing obligations regarding the structure and operation of future
independent committees of the Company that may be formed to investigate or
evaluate potential mergers, acquisitions, financial restructurings or exchange
transactions; (2) certain limitations on the Company's ability to make "change
in control" or "golden parachute" payments to officers and directors; (3) the
Company's Board of Directors must consider and adopt a policy and/or
recommendations regarding payment of dividends to its shareholders on an annual
basis; and (4) the payment of $1,850,000 in attorneys' fees and costs to
plaintiffs' counsel.
The obligations summarized in items 1-3 above will continue in effect for a
minimum of five (5) years. Under the terms of the Settlement, WellPoint, BCC and
the individual defendants did not admit, and expressly denied, all claims and
liability asserted against them. The Settlement also included a release of all
claims alleged in the actions.
MISCELLANEOUS PROCEEDINGS. WellPoint and certain of its subsidiaries are
parties to various legal proceedings, many of which involve claims for coverage
encountered in the ordinary course of its business. WellPoint, like HMOs and
health insurers generally, excludes certain health care services from coverage
under its HMO, PPO and other plans. In the ordinary course of its business,
WellPoint is subject to the claims of its enrollees arising out of decisions to
restrict reimbursement for certain treatments. The loss of even one such claim,
if it resulted in a significant punitive damage award, could have a material
adverse effect on WellPoint. In addition, the risk of potential liability under
punitive damage theories may increase significantly the difficulty of obtaining
reasonable settlements of coverage claims. However, the financial and
operational impact that such evolving theories of recovery will have on the
managed care industry generally, or WellPoint in particular, is at present
unknown.
Certain of such legal proceedings are or may be covered under insurance
policies or indemnification agreements. Based upon information presently
available, the Company believes that the final outcome of all such proceedings
should not have a material adverse effect upon WellPoint's results of operations
or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
18
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. For periods prior to the consummation of
the Recapitalization on May 20, 1996, the information given below is with
respect to Old WellPoint Class A Common Stock, without adjustment for the
two-for-three exchange occurring as part of the Recapitalization. In connection
with the Recapitalization, Old WellPoint paid a special dividend of $10.00 per
share to its stockholders of record as of May 15, 1996.
PRE-RECAPITALIZATION:
Year Ended December 31, 1995 HIGH LOW
--------- ---------
First Quarter............................................. $ 37 $ 27
Second Quarter............................................ 34 3/8 27 3/8
Third Quarter............................................. 31 27 7/8
Fourth Quarter............................................ 33 3/8 29 1/8
Year Ended December 31, 1996
First Quarter............................................. $ 36 $ 31 7/8
Second Quarter (through May 20, 1996)..................... 36 5/8 26
POST-RECAPITALIZATION:
Second Quarter (May 21, 1996 to June 30, 1996)............ $ 39 1/8 $ 31 1/8
Third Quarter............................................. 33 3/4 23 3/8
Fourth Quarter............................................ 35 1/2 28 1/4
On March 19, 1997 the closing price on the New York Stock Exchange for the
Company's Common Stock was $45.38 per share. As of March 14, 1997, there were
approximately 1,200 holders of record of Common Stock.
The Company did not pay any dividends on its Common Stock in 1995 or 1996,
other than the payment of the $995 million special dividend in connection with
the Recapitalization. Management currently expects that all of WellPoint's
future income will be used to expand and develop its business. The Board of
Directors has determined to retain its net earnings during 1997.
19
ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
1996 1995 1994 1993 1992
--------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA, MEMBERSHIP
DATA AND OPERATING STATISTICS)
CONSOLIDATED INCOME STATEMENTS
Revenues:
Premium revenue................................... $3,879,806 $2,910,622 $2,647,951 $2,355,980 $2,161,216
Management services revenue....................... 147,948 61,151 36,274 18,121 17,952
Investment income................................. 142,028 135,306 107,447 75,074 95,987
--------- --------- --------- --------- ---------
4,169,782 3,107,079 2,791,672 2,449,175 2,275,155
Operating Expenses:
Health care services and other benefits........... 3,003,117 2,199,953 1,927,954 1,719,853 1,591,725
Selling expense................................... 224,453 190,161 169,483 147,097 128,653
General and administrative expense................ 545,942 344,427 334,206 266,295 263,263
Nonrecurring costs................................ -- 57,074 -- -- --
--------- --------- --------- --------- ---------
3,773,512 2,791,615 2,431,643 2,133,245 1,983,641
--------- --------- --------- --------- ---------
Operating Income.................................... 396,270 315,464 360,029 315,930 291,514
Interest expense.................................. 36,628 -- -- -- --
Other expense, net................................ 20,134 12,677 8,008 2,901 2,419
--------- --------- --------- --------- ---------
Income before Provision for Income Taxes and
Cumulative Effect of Accounting Changes........... 339,508 302,787 352,021 313,029 289,095
Provision for income taxes........................ 137,506 122,798 138,851 126,385 114,337
--------- --------- --------- --------- ---------
Income before Cumulative Effect of Accounting
Changes........................................... 202,002 179,989 213,170 186,644 174,758
Cumulative Effect of Accounting Changes--Adoption
of SFAS Nos. 106 and 109........................ -- -- -- (21,260) --
--------- --------- --------- --------- ---------
Net Income.......................................... $ 202,002 $ 179,989 $ 213,170 $ 165,384 $ 174,758
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Earnings Per Share(A)
Income before Cumulative Effect of Effect of
Accounting Changes................................ $ 3.04 $ 2.71 $ 3.21 $ 2.81 $ 2.63
Cumulative Effect of Accounting Changes--Adoption
of SFAS Nos. 106 and 109........................ -- -- -- (0.32) --
--------- --------- --------- --------- ---------
Net Income.......................................... $ 3.04 $ 2.71(B) $ 3.21 $ 2.49 $ 2.63
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
OPERATING STATISTICS(C)
Loss ratio.......................................... 77.4% 75.6% 72.8% 73.0% 73.6%
Selling expense ratio............................... 5.6% 6.4% 6.3% 6.2% 5.9%
General and administrative expense ratio............ 13.6% 11.6% 12.5% 11.2% 12.1%
Net income ratio.................................... 5.0% 6.1% 7.9% 7.0% 8.0%
DECEMBER 31,
-----------------------------------------------------
1996 1995 1994 1993 1992
--------- --------- --------- --------- ---------
BALANCE SHEET DATA
Cash and investments................................ $2,165,492 $2,257,269 $1,973,388 $1,779,495 $1,039,106
Total assets........................................ $3,405,542 $2,679,257 $2,385,636 $1,921,832 $1,155,883
Long-term debt...................................... $ 625,000 -- -- -- --
Total equity........................................ $ 870,459 $1,670,226 $1,418,919 $1,233,190 $ 507,483
Cash dividends declared per common share(D)......... $ 10.00 -- -- -- --
Medical Membership(E)................................. 4,485,000 2,797,000 2,617,000 2,322,000 2,162,000
(A) Earnings per share for all periods presented prior to 1996 has been
recomputed using 66,366,500 shares, the number of shares outstanding
immediately following completion of the Recapitalization. Earnings per share
for the year ended December 31, 1996 has been calculated using such
66,366,500 shares, plus the weighted average number of shares issued during
1996 after completion of the Recapitalization.
(B) Earnings per share for the year ended December 31, 1995 includes
nonrecurring costs of $0.52 per share.
(C) 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.
(D) 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.
(E) 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.
20
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 such 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 with approximately 4.5 million medical members, 11.5 million
pharmacy members and 1.6 million dental members as of December 31, 1996. The
Company offers a diversified mix of managed care products, including HMOs, PPOs,
POS and other hybrid plans and traditional indemnity products. The Company also
offers a broad array of specialty products, including pharmacy, dental, life,
workers' compensation, disability, behavioral health, COBRA and flexible
benefits account administration. In addition, WellPoint offers managed care
services for self-funded employers, including claims processing, actuarial
services, underwriting assistance, network access, medical cost management and
other administrative services. The Company's primary market for its managed care
products is California.
In March 1996, the Company completed the MMHD Acquisition through the
acquisition of MMHD's parent, MassMutual Holding Company Two, Inc. The acquired
MMHD operations now conduct business under the name UNICARE Life & Health
Insurance Company. The purchase price was $402.2 million which was funded with
$340.2 million in cash and a Series A term note for $62.0 million, of which
$20.0 million remained outstanding at December 31, 1996. During 1996, the
Company incurred approximately $13.0 million of costs relating to the MMHD
Acquisition. During 1997 and 1998, the Company expects to incur approximately
$15.0 million of additional costs related to the MMHD Acquisition. As a result
of the MMHD Acquisition, WellPoint serves medical members in 50 states.
Approximately 50% of MMHD's medical membership is concentrated in seven states:
California, New York, Texas, Georgia, Massachusetts, Illinois and Virginia. The
acquired MMHD operations also provide specialty products, including dental,
life, pharmacy and disability, to members throughout the United States.
On May 20, 1996, the Company completed the Recapitalization, including the
acquisition of the BCC Commercial Operations for $235.0 million in cash. The
Recapitalization included the payment of a $995.0 million special dividend
funded by $775.0 million in revolving debt and the remainder in cash (see Note 2
to the Consolidated Financial Statements for a description of the
Recapitalization).
On March 1, 1997, the Company completed the GBO Acquisition. The purchase
price was $86.7 million, subject to adjustment upon completion of a post-closing
audit. The purchase method of accounting will be used to account for the
acquisition of the GBO. The GBO targets employers with 5,000 or more employees
and currently provides benefits to approximately 1.3 million medical members, of
which most are in health plans that are self-funded by employers. The GBO offers
indemnity and PPO plans and also provides life, dental and disability coverage
to a variety of employer groups. Although most of the GBO business involves the
provision of administrative services to self-funded employer plans, the
indemnity-based portions of the GBO have experienced a higher overall loss ratio
than the Company's core business. The GBO has historically experienced a higher
administrative expense ratio due to its higher percentage of management services
business, which may contribute to an increase in the Company's overall
administrative expense ratio in future periods. The Company expects to incur
approximately $50.0 million of costs relating to this acquisition during 1997
and 1998, a portion of which is expected to be reflected in the Company's
results of operations. The Company expects that it will experience material
membership attrition of up to 30% of the GBO members as it pursues its strategy
of motivating traditional indemnity health insurance members to select managed
care products.
21
In order to implement the Company's regional expansion strategy, the Company
will need to develop satisfactory provider network and information systems,
which will require additional expenditures by the Company. A portion of these
expenditures will be reflected in the Company's results of operations.
Prior to their acquisitions by WellPoint, the MMHD large employer group
operations, the GBO and BCC Commercial Operations each experienced a higher
overall loss ratio than the Company and, as the Company integrates these
acquisitions, the Company's overall loss ratio may increase. There can be no
assurance that the Company will be able to successfully integrate these recent
acquisitions into its business or take appropriate measures to control the loss
ratio associated with their operations. In addition, the Company's overall loss
ratio may increase as the Company expands its California large group and
Medicaid businesses, both of which generally have higher loss ratios than the
Company's overall business.
A variety of health care reform measures are currently pending or have been
recently enacted at the Federal and state levels. Recent Federal legislation
seeks, among other things, to insure the portability of health coverage and
mandates minimum maternity hospital stays. These and other proposed measures may
have the effect of dramatically altering the regulation of the provision of
health care and of increasing the Company's loss ratio.
RESULTS OF OPERATIONS
WellPoint's revenues are generated from premiums earned for 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. WellPoint's 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; and income taxes.
The Company's consolidated results of operations for the year ended December
31, 1996 include the results of MMHD and the BCC Commercial Operations from
March 31, 1996 and May 20, 1996, respectively, the effective 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,
----------------------------------
1996 1995 1994
---------- ---------- ----------
Operating Revenues:
Premium revenue ratio.......................................... 96.3% 97.9% 98.7%
Management services revenue ratio.............................. 3.7 2.1 1.3
----- ----- -----
100.0 100.0 100.0
Operating Expenses:
Health care services and other benefits loss ratio............. 77.4 75.6 72.8
Selling expense ratio.......................................... 5.6 6.4 6.3
General and administrative expense ratio....................... 13.6 11.6 12.5
22
MEMBERSHIP
The following table sets forth membership data and the percent change in
membership:
AS OF DECEMBER 31,
---------------------- PERCENT
1996 1995 CHANGE
---------- ---------- -----------
MEDICAL MEMBERSHIP:
CALIFORNIA
Group Services:
HMO....................................................................... 677,850 619,907 9.3%
PPO and Other(a).......................................................... 1,298,359 765,145 69.7%
---------- ----------
Total(b)................................................................ 1,976,209 1,385,052 42.7%
---------- ----------
Individual, Small Group and Senior:
HMO....................................................................... 269,495 214,076 25.9%
PPO and Other............................................................. 1,197,306 1,152,657 3.9%
---------- ----------
Total................................................................... 1,466,801 1,366,733 7.3%
---------- ----------
Medi-Cal HMO Programs....................................................... 111,029 40,508 174.1%
---------- ----------
Total California Medical Membership(c)........................................ 3,554,039 2,792,293 27.3%
---------- ----------
OUT-OF-STATE
Group Services:
HMO....................................................................... 2,506 -- N/A
PPO and Other(a).......................................................... 898,601 743 N/A
---------- ----------
Total(b)................................................................ 901,107 743 N/A
---------- ----------
Individual, Small Group and Senior:
PPO and Other............................................................. 29,555 4,326 N/A
---------- ----------
Total Out-of-State Medical Membership......................................... 930,662 5,069 N/A
---------- ----------
TOTAL MEDICAL MEMBERSHIP...................................................... 4,484,701 2,797,362 60.3 %
---------- ----------
---------- ----------
HMO......................................................................... 1,060,880 874,491 21.3 %
PPO and Other............................................................... 3,423,821 1,922,871 78.1 %
---------- ----------
TOTAL MEDICAL MEMBERSHIP...................................................... 4,484,701 2,797,362 60.3 %
---------- ----------
---------- ----------
- ------------------------
(a) California and Out-of-State include 665,454 and 563,854 management services
members, respectively, as of December 31, 1996. Of the 665,454 California
management services members, 76,385 are from the acquired MMHD operations.
California and Out-of-State include 482,572 and 2,886 management services
members, respectively, as of December 31, 1995.
(b) As of December 31, 1996, total MMHD medical membership was approximately
1,042,000, of which approximately 141,300 were California members and
approximately 900,700 were Out-of-State members.
(c) As of December 31, 1996, total BCC Commercial Operations medical membership
was approximately 264,500, all of which were California members. The
majority of these members are included in Group Services.
23
AS OF DECEMBER 31,
------------------------ PERCENT
1996 1995 CHANGE
------------ ---------- -----------
SPECIALTY MEMBERSHIP:
Pharmacy........................................................ 11,516,824 9,882,560 16.5%
Dental.......................................................... 1,559,391 537,868 189.9%
Disability...................................................... 107,350 -- N/A
Behavioral Health............................................... 502,212 381,955 31.5%
Life............................................................ 722,964 326,590 121.4%
The 1996 specialty membership includes the acquired MMHD operations which
had approximately 0.5 million pharmacy members, 0.9 million dental members, 0.1
million disability members and 0.4 million life members as of December 31, 1996.
COMPARISON OF RESULTS FOR THE YEAR ENDED DECEMBER 31, 1996 TO THE YEAR ENDED
DECEMBER 31, 1995
Premium revenue increased 33.3% to $3,879.8 million for the year ended
December 31, 1996 from $2,910.6 million for the year ended December 31, 1995.
Premium revenue for 1996 of $523.4 million and $200.2 million was attributable
to MMHD and the BCC Commercial Operations, respectively. Also
contributing to increased premium revenue in 1996 was a 9.8% increase in medical
membership, excluding management services members and the acquired members of
MMHD and the BCC Commercial Operations. Workers' compensation premium revenue
increased 34.6% in 1996 from 1995, due to a large increase in the number of
insured employer groups, primarily in the small employer and California school
districts workers' compensation markets. In addition, an increase in premium
revenue resulted from moderate increases in the premiums per member in the
individual, senior and small group markets.
Management services revenue increased $86.7 million to $147.9 million for
the year ended December 31, 1996 from $61.2 million for the year ended December
31, 1995. The increase was primarily due to $62.9 million of management services
revenue from MMHD. Also contributing to the increase were a 31.7% membership
increase in the California large group market, excluding the acquired members of
MMHD and the BCC Commercial Operations, new pharmacy and clinical management
accounts and revenue from the BCC Commercial Operations.
Investment income increased to $142.0 million for the year ended December
31, 1996 compared to $135.3 million for the year ended December 31, 1995.
Interest and dividend income increased to $127.5 million in 1996 from $122.1
million in 1995. The increase in interest and dividend income was primarily due
to MMHD interest income of $21.6 million and slightly higher yields in 1996 over
1995, offset by the foregone interest earned on cash and investments used to
finance the MMHD and BCC Commercial Operations acquisitions, the
Recapitalization, and cash used for repayment of indebtedness under the
Company's senior credit facility.
Health care services and other benefits expense increased 36.5% to $3,003.1
million in 1996 from $2,200.0 million in 1995. Of the $803.1 million increase,
$412.2 million was attributable to MMHD and $189.9 million was attributable to
the BCC Commercial Operations. Excluding MMHD and the BCC Commercial Operations,
increased health care services expense also resulted from medical membership
growth. In addition, mix and product design changes, for example, the
elimination of deductibles for some PPO plans and pharmacy products, contributed
to an increase in health care expenses. Growth in the workers' compensation
business also contributed to the increase. These increases were partially offset
by savings from hospital recontracting, which was implemented in late 1995.
Additional savings were realized by savings from specialist and laboratory
recontracting, which was implemented during the third quarter of 1996.
The loss ratio for 1996 increased to 77.4% compared to 75.6% in 1995 due to
the PPO benefits changes described above, an increase in the loss and loss
adjustment expense reserves related to a portion of the Company's workers'
compensation business and the incremental effect of the MMHD Acquisition
24
and the BCC Commercial Operations on the Company's overall results. The acquired
MMHD operations and the BCC Commercial Operations have traditionally experienced
a higher loss ratio than the Company. The increase in the loss ratio was
partially offset by the Company's continuing cost containment efforts, such as
the hospital recontracting program. Excluding the Company's workers'
compensation business and the acquisitions of the MMHD operations and the BCC
Commercial Operations, the loss ratio would have been 74.7% for the year ended
December 31, 1996. The loss ratio for 1995, also excluding the workers'
compensation business, was 75.2%.
Selling expense consists of commissions paid to outside brokers and agents
representing the Company. Selling expense for the year ended December 31, 1996
increased 18.0% to $224.5 million compared to $190.2 million in 1995,
corresponding with continued overall premium revenue growth and an additional
$21.4 million in selling expense attributable to MMHD. The selling expense ratio
for 1996 decreased to 5.6% from 6.4% for the prior year, largely due to the
acquisition of MMHD, which has a lower selling expense ratio than the Company's
existing business, and the BCC Commercial Operations, which has no selling
expense. Excluding the acquisitions, the selling expense ratio would have been
6.3% for the year ended December 31, 1996, consistent with the prior year.
General and administrative expense for the year ended December 31, 1996
increased 58.5% to $545.9 million from $344.4 million for the same period in
1995. Of the $201.5 million increase, $153.3 million resulted from the MMHD
Acquisition. The administrative expense ratio increased to 13.6% for 1996
compared to 11.6% in 1995, primarily due to the increased administrative expense
associated with the Company's continued investment in geographic expansion and
the MMHD Acquisition. MMHD has historically had a higher administrative expense
ratio due to its higher percentage of management services business. The Company
also incurred additional expenses in 1996 for network development costs. The
above increases were partially offset by the BCC Commercial Operations' lower
administrative expense ratio. Excluding MMHD and the BCC Commercial Operations,
the administrative expense ratio would have been 11.9% in 1996.
Interest expense was $36.6 million for the year ended December 31, 1996. The
Company had no interest expense in 1995. The interest expense in 1996 related
primarily to $775.0 million drawn under the Company's revolving credit facility
on May 15, 1996 to fund a special dividend paid in connection with the
Recapitalization, as well as interest on amounts payable to MassMutual,
including a Series A term note of $62.0 million issued in connection with the
MMHD Acquisition. At December 31, 1996, the Company's outstanding long-term
indebtedness was $625.0 million. The weighted average interest rate for all debt
for the year ended December 31, 1996 was 5.9%.
WellPoint's net income for the year ended December 31, 1996 was $202.0
million or $3.04 per share compared to $180.0 million or $2.71 per share for the
year ended December 31, 1995. Earnings per share for the years ended December
31, 1996 and 1995 are based on 66.4 million shares, the number of shares
outstanding immediately following the Recapitalization, plus for 1996 the
weighted average number of shares issued since the Recapitalization. Earnings
per share is determined by dividing net income by the weighted average number of
common shares outstanding. Earnings per share for the year ended December 31,
1995 included nonrecurring costs of $0.52 per share (which are discussed in the
1995 results which follow).
COMPARISON OF RESULTS FOR THE YEAR ENDED DECEMBER 31, 1995 TO THE YEAR ENDED
DECEMBER 31, 1994
Premium revenue increased 9.9% to $2,910.6 million for the year ended
December 31, 1995 from $2,648.0 million for the year ended December 31, 1994.
This increase was primarily due to a 4.7% increase in medical members, excluding
management services members, to 2.3 million as of December 31, 1995 from 2.2
million members as of December 31, 1994. The increase in premium revenue due to
membership growth was partially offset by the conversion of some PPO Cost Plus
members to management services
25
arrangements. This conversion was principally due to regulatory actions taken by
the California Department of Corporations (the "DOC") related to licensure
requirements. In addition, increased premium revenues resulted from a shift to
certain HMO products that generate a higher premium per member than the
Company's PPO products and from membership growth in specialty products.
Management services revenue increased $24.9 million to $61.2 million for the
year ended December 31, 1995 from $36.3 million in 1994. The increase was due to
a number of factors, including new pharmacy and clinical management accounts and
the acquisitions of Professional Claim Services, Inc. ("Pro-Serv") in August of
1994 and AHI Healthcare Corporation ("AHI") in February of 1995. The conversion
of PPO Cost Plus members to management services arrangements also contributed to
the increase. This transfer, which was completed in December 1995, did not have
a material impact on net income.
Investment income increased to $135.3 million for the year ended December
31, 1995 as compared to $107.4 million in 1994 due in part to 1995 pretax net
gains on the sales of investment securities of $15.4 million as compared to
pretax net gains in 1994 of $5.0 million. As discussed below under the heading
"Liquidity and Capital Resources", there were increased sales of investment
securities in 1995 in anticipation of the 1996 cash requirements for the
Company's Recapitalization and the MMHD Acquisition. The increase also reflected
a higher average yield on a larger average portfolio balance, resulting in
interest income of $120.1 million for the year ended December 31, 1995 compared
to $102.0 million for the prior year.
Health care services and other benefits expense increased 14.1% to $2,200.0
million for the year ended December 31, 1995 from $1,928.0 million in 1994. The
loss ratio for 1995 increased to 75.6% compared to 72.8% in 1994 due to several
factors. Membership as a percentage of total medical membership in the Company's
large group business, which has a higher loss ratio than the Company's small
group and individual business, increased in 1995. In addition, moderately higher
medical cost trends, a continued competitive pricing environment and the
elimination through new regulations of mandatory minimum premiums ("open
rating") in the workers' compensation market also contributed to the higher loss
ratio in 1995.
Selling expense for the year ended December 31, 1995 increased 12.2% to
$190.2 million compared to $169.5 million for 1994, corresponding with continued
overall premium revenue growth. The selling expense ratio increased slightly in
1995 to 6.4% from 6.3% in 1994, largely due to an increase in selling expenses
for the Company's workers' compensation products. The commission rates for the
Company's workers' compensation products increased due to increased competition
resulting from the new California regulations which require open rating.
Excluding selling expenses for the Company's workers' compensation products, the
selling expense ratio would have decreased from 6.3% in 1994 to 6.2% in 1995.
General and administrative expense for the year ended December 31, 1995
increased 3.1% to $344.4 million from $334.2 million for 1994 due in part to
increased personnel service costs consistent with the increases in medical and
specialty membership, as well as the acquisition of AHI. The administrative
expense ratio decreased to 11.6% for the year ended December 31, 1995 compared
to 12.5% in 1994 due to a decrease in policyholder dividends resulting from the
open rating environment in the workers' compensation industry. Excluding the
conversion of PPO Cost Plus members to management services, the administrative
expense ratio would have been 11.1% in 1995, reflecting the Company's continued
focus on reducing its administrative costs.
During the fourth quarter of 1995, the operating results of the Company
included charges of $57.1 million ($34.5 million net of a $22.6 million tax
benefit) for nonrecurring costs. Approximately $29.8 million resulted from
costs, primarily professional fees, associated with the proposed acquisition of
Health Systems International which was terminated in December 1995. In addition,
the Company recorded a charge of $27.3 million for the impairment of intangible
assets associated with its pharmaceutical benefits management business based on
the Company's analysis evaluating the impairment of long-lived assets in
accordance with Company policy. The impairment reflected an anticipated
reduction in future claims
26
processing fees. The anticipated reduced fees result from an industry-wide
market shift whereby pharmaceutical manufacturing companies had purchased
pharmaceutical benefits management companies to market their products and
thereby reducing claims processing fees. These conditions resulted as the
pharmaceutical companies reduced processing fees to increase market share.
WellPoint's net income for the year ended December 31, 1995 was $180.0
million or $2.71 per share compared to $213.2 million or $3.21 per share for
1994. Net income for the year ended December 31, 1995 excluding nonrecurring
costs was $214.5 million or $3.23 per share. The number of shares of Common
Stock outstanding for the years ended December 31, 1995 and 1994 has been
recomputed to 66.4 million, the number of shares outstanding immediately
following the Recapitalization, to give effect to the two-for-three share
exchange that occurred in connection with the Recapitalization.
FINANCIAL CONDITION
The Company's consolidated assets increased by $726.2 million to $3.4
billion as of December 31, 1996. This represents a 27.1% increase from $2,679.3
million as of December 31, 1995 and resulted primarily from the acquisitions of
MMHD and the BCC Commercial Operations as well as cash flows generated from
operations. Cash and investments were $2.2 billion as of December 31, 1996, or
63.6% of total assets.
As of December 31, 1996, $625.0 million was outstanding under the Company's
long-term debt facilities incurred primarily for payment of a special dividend
to the stockholders of the Company's predecessor ("Old WellPoint") in connection
with the Recapitalization and the MMHD Acquisition. The Company had no long-term
borrowings outstanding as of December 31, 1995.
Equity totaled $870.5 million as of December 31, 1996, a decrease of $799.8
million from December 31, 1995. The decrease resulted primarily from the $995.0
million special dividend paid to the stockholders of Old WellPoint and a $11.8
million decrease in the unrealized valuation adjustment on investment
securities, net of deferred taxes, due to an increase in market interest rates
in 1996 compared to 1995. The decrease was partially offset by net income of
$202.0 million in 1996 and additional stock issuances in 1996 totaling $5.0
million under the Company's stock option/award plan and employee stock purchase
plan.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of cash are premiums 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 of
long-term debt, interest expense, broker and agent commissions and
administrative expenses. In addition to the foregoing, prospective uses of cash
will include costs of provider network and systems development, costs associated
with the integration of acquired businesses and capital expenditures. The
Company 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. As of December 31,
1996, the Company's investment portfolio consisted primarily of fixed maturity
securities (which are primarily rated "A" or better by rating agencies) and
equity securities.
Net cash flow provided by operating activities was $410.9 million for the
year ended December 31, 1996, compared with $150.4 million in 1995. The 1996
increase in positive cash flow from operations is mainly due to improvement in
continuing operations from increased membership growth in the individual,
senior, small group and Medi-Cal segments as well as additional revenue
generated through the acquisitions of MMHD and the BCC Commercial Operations and
increased liabilities associated with this growth and the acquisitions. The cash
provided by these activities was partially offset by the payment of $30 million
in the first quarter of 1996 in connection with a new lease for the Company's
headquarters
27
building. The lower operating cash flow in 1995 resulted primarily from
nonrecurring costs and the timing of payment of settlements related to
experience rated policies.
Net cash used by investing activities in 1996 totaled $736.2 million,
compared with net cash provided by investing activities of $712.1 million in
1995. The cash used in 1996 was attributable primarily to the acquisition of
MMHD and the BCC Commercial Operations and investment purchases, net of
investments sold and matured of $239.8 million. In 1995, cash provided by
investing activities was primarily due to the net proceeds from the sale and
maturities of investments which were invested in cash equivalents in
anticipation of the cash requirements for the acquisitions of MMHD and the BCC
Commercial Operations as well as the special dividend paid in connection with
the Recapitalization.
The MMHD operations were acquired for a total purchase price of $402.2
million. The $402.2 million was funded with $340.2 million in cash and a Series
A term note for $62.0 million, of which $20.0 million was outstanding at
December 31, 1996. MMHD cash acquired was $27.3 million. The BCC Commercial
Operations were acquired during the second quarter of 1996 for a purchase price
of $235.0 million. Cash acquired from the BCC Commercial Operations was $118.1
million, resulting in net cash used for the acquisition of $116.9 million.
Net cash used by financing activities totaled $431.0 million in 1996
compared to $43.7 million provided by financing activities in 1995. The net cash
used in 1996 primarily resulted from $995.0 million for the special dividend
paid in connection with the Recapitalization funded in part with long-term debt
of $775.0 million and cash. Repayments on long-term debt totaled $262.0 million
in 1996.
In connection with the Recapitalization, the Company entered into a $1.25
billion unsecured 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 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, 2001, although it may be
extended for two additional one-year periods 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 $555.0 million as of December
31, 1996. The weighted average interest rate from May 15, 1996, the initial draw
date, through December 31, 1996 was 5.9%.
In order to limit its exposure to interest rate increases, in August 1996
the Company entered into a swap agreement for a notional amount of $100.0
million bearing a fixed interest rate of 6.45% and having a maturity date of
August 17, 1999. In September 1996, the Company entered into two additional swap
agreements for notional amounts of $150.0 million each, bearing fixed interest
rates of 6.99% and 7.05%, respectively, and having maturity dates of October 17,
2003 and October 17, 2006, respectively.
The Company is required to maintain minimum TNE by the Company's primary
regulator, the DOC, and is required to meet minimum capital requirements
prescribed by the BCBSA. In measuring capital for the BCBSA, the Company is
required to use the method prescribed by the DOC. The failure to meet the
Minimum BCBSA Capital requirement can subject the Company to certain corrective
actions, while the failure to meet a lower specified level can result in
termination of the Company's license agreement with the BCBSA. The Minimum BCBSA
Capital requirement, which is more restrictive than DOC requirements, increased
as of December 31, 1996. As of December 31, 1996, the Company's TNE (which is
also its capital for BCBSA purposes) was approximately $388 million and its
Minimum BCBSA Capital was approximately $364 million. As of such date, its
required TNE for DOC purposes was approximately $17.0 million.
28
In order to address an anticipated shortfall in the Company's capital as a
result of the increased BCBSA capital requirement and the pending acquisition of
the GBO, in November 1996, the Company entered into a subordinated term loan
agreement with a bank for a two-year unsecured subordinated term loan facility
(the "Subordinated Credit Agreement") of $200.0 million, which could be drawn
down through March 17, 1997. On December 30, 1996, the Company borrowed $50.0
million, of which approximately $24.0 million was required in order to meet the
increased BCBSA capital requirements. The DOC regulations permit the Company to
include in TNE (and thus in capital for BCBSA purposes) any indebtedness
subordinated to the Company's obligation to maintain the DOC's required minimum
TNE. In March 1997, the Company incurred $150 million in additional indebtedness
under the Subordinated Credit Agreement in part as a result of the GBO
Acquisition in order to maintain the DOC's required minimum TNE. The Company
intends to repay outstanding indebtedness under its senior credit facility with
such borrowing. Such borrowings bear interest at interest rates determined by
reference to the bank's base rate or to LIBOR plus a margin determined by
reference to the Company's leverage ratio or the then-current rating of the
Company's unsecured long-term debt by specified rating agencies. The applicable
margin will increase with respect to any borrowings outstanding as of July 1,
1997. Interest is paid quarterly. Quarterly principal amortization payments will
be due beginning March 31, 1998, and all remaining outstanding borrowings under
the Subordinated Credit Agreement will become due on December 31, 1998. The
Subordinated Credit Agreement requires compliance with certain financial ratio
and other requirements similar to those in the Company's senior credit facility;
however, the repayment of borrowings has been subordinated to the Company's
requirements to maintain the required minimum TNE under DOC regulations. The
Subordinated Credit Agreement also requires that the net proceeds of certain
sales of capital stock or subordinated debt issued by the Company be used to
repay outstanding amounts under the Subordinated Credit Agreement.
In July 1996, the Company filed a registration statement relating to the
issuance of $1.0 billion of senior or subordinated unsecured indebtedness. As of
December 31, 1996, no indebtedness had been issued pursuant to this registration
statement.
The Company believes that cash flow generated by operations, its cash and
investment balances, its existing credit facility, its debt registration
statement and the subordinated indebtedness will be sufficient to fund
continuing operations and expected capital requirements for the foreseeable
future.
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
Certain statements contained herein, such as statements concerning potential
or future loss ratios, expected membership attrition as the Company continues to
integrate its recently acquired operations 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 now operates.
Many of these agencies have increased their scrutiny of managed health care
companies in recent periods. Future regulatory actions by any such agencies may
have a material adverse affect on the Company's business.
The Company's future results will depend in large part on accurately
predicting health care costs and upon the Company's ability to control future
health care costs through underwriting criteria, utilization management and
negotiation of favorable provider contracts. Changes in utilization rates,
demographic characteristics, health care practices, inflation, new technologies,
clusters of high-cost cases, the regulatory environment and numerous other
factors are beyond the control of any health plan and may adversely affect the
Company's ability to predict and control health care costs and claims, as well
as the Company's
29
financial condition or results of operations. Additionally, the Company faces
competitive pressure to contain premium prices. Fiscal concerns regarding the
continued viability of government sponsored programs such as Medicare and
Medicaid may cause decreasing reimbursement rates for these programs. Any
limitation on the Company's ability to increase or maintain its premium levels
may adversely affect the Company's financial condition or results of operations.
As part of the Company's business strategy, the Company has recently
acquired significant operations in new geographic markets. These businesses,
which include substantial indemnity-based insurance operations, have experienced
varying profitability or losses in recent periods. While the integration of
these businesses into the Company has begun, 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
these businesses as the Company pursues its strategy of motivating the acquired
members to select managed care products. In order to implement this strategy,
the Company will, among other things, need to develop satisfactory provider
networks and information systems, which will require considerable expenditures
by the Company in addition to the costs associated with the integration of these
acquisitions.
Managed care organizations, both inside and outside California, operate in a
highly competitive environment that has undergone significant change in recent
periods 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 or results of operations.
The Company's two primary products ([a] managed care products and [b]
management services products, including specialty managed care services) are
marketed through two internal business units which are organized on a geographic
basis, Blue Cross of California and UNICARE. The geographic business units are
divided further into individual and small group businesses versus larger
employers because of the distinctive differences in the focus needed in
targeting each of these markets. The combined cost ratios (medical costs and
expenses) for the small group and individual businesses and the large group
business vary due primarily to differing product mix between the managed care
and management services products and different distribution costs. A greater
percentage of small group and individual membership is comprised of higher risk
managed care products, which tend to be more profitable than the lower risk
managed care and management services products as a result of higher deductibles
and co-payments and increased profit margins generally associated with increased
underwriting risks. The group services membership is comprised primarily of
capitated managed care products and management services products which result in
lower margins as a result of the lower level of underwriting risk related to the
capitated products and the non-risk nature of the management services products.
However, over the past three years, margin erosion has been greater in the
individual and small group business than in the large group business primarily
as a result of slower growth in membership, product mix change and greater
competitive pressure on premium increases. The spread between the profitability
of the individual and small group business and large group business in
California was 6.2%, 6.5% and 9.4% for the years ended December 31, 1996, 1995
and 1994, respectively.
30
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The location in this Form 10-K of the Company's Consolidated Financial
Statements is set forth in the "Index" on page 55 hereof.
SELECTED QUARTERLY FINANCIAL INFORMATION
(UNAUDITED)
FOR THE QUARTER ENDED
(IN THOUSANDS, EXCEPT PER SHARE DATA --------------------------------------------------------------------
AND MEMBERSHIP DATA) MARCH 31, 1996 JUNE 30, 1996 SEPTEMBER 30, 1996 DECEMBER 31, 1996
-------------- ------------- ------------------ -----------------
Total revenues............................. $ 817,582 $ 1,065,459 $ 1,130,686 $ 1,156,055
Operating income........................... 104,057 100,754 94,181 97,278
Income before provision for income taxes... 101,045 83,662 75,859 78,942
Net income................................. $ 60,113 $ 49,772 $ 45,101 $ 47,016
-------------- ------------- ------------------ -----------------
-------------- ------------- ------------------ -----------------
Earnings per share(A):
Net income............................... $ 0.91 $ 0.75 $ 0.68 $ 0.71
-------------- ------------- ------------------ -----------------
-------------- ------------- ------------------ -----------------
Medical membership......................... 3,926,820 4,243,673 4,387,510 4,484,701
-------------- ------------- ------------------ -----------------
-------------- ------------- ------------------ -----------------
FOR THE QUARTER ENDED
--------------------------------------------------------------------
MARCH 31, 1995 JUNE 30, 1995 SEPTEMBER 30, 1995 DECEMBER 31, 1995
-------------- ------------- ------------------ -----------------
Total revenues............................. $ 768,132 $ 788,456 $ 771,830 $ 778,661
Operating income........................... 103,015 96,016 90,448 25,985(B)
Income before provision for income taxes... 99,894 93,254 87,486 22,153(B)
Net income................................. $ 59,470 $ 55,440 $ 51,800 $ 13,279(B)
-------------- ------------- ------------------ -----------------
-------------- ------------- ------------------ -----------------
Earnings per share(A):
Net income............................... $ 0.90 $ 0.84 $ 0.78 $ 0.20(B)
-------------- ------------- ------------------ -----------------
-------------- ------------- ------------------ -----------------
Medical membership......................... 2,757,387 2,772,065 2,778,130 2,797,362
-------------- ------------- ------------------ -----------------
-------------- ------------- ------------------ -----------------
(A) Earnings per share for all periods presented prior to the quarter ended June
30, 1996 has been recomputed using 66,366,500 shares, the number of shares
outstanding immediately following completion of the Recapitalization.
Earnings per share for the quarters ended June 30, September 30 and December
31, 1996 has been calculated using such 66,366,500 shares, plus the weighted
average number of shares issued since the Recapitalization.
(B) Includes nonrecurring costs of $57.1 million ($34.5 million net of a $22.6
million tax benefit) or $0.52 per share.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
31
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The directors and executive officers of the Company are as follows:
NAME AGE POSITION
- ---------------------------- --- --------------------------------------------------------------------
Leonard D. Schaeffer........ 51 Chairman of the Board of Directors and Chief Executive Officer
David R. Banks.............. 60 Director
W. Toliver Besson........... 52 Director
Roger E. Birk............... 66 Director
Stephen L. Davenport........ 64 Director
Julie A. Hill............... 50 Director
Robert T. Knight............ 59 Director
Elizabeth A. Sanders........ 51 Director
Sheila P. Burke............. 46 Director (effective as of April 1, 1997)
D. Mark Weinberg............ 44 Executive Vice President, UNICARE Businesses
Ronald A. Williams.......... 47 Executive Vice President, Blue Cross of California Businesses
Howard G. Phanstiel......... 48 Executive Vice President, Finance and Information Services
Thomas C. Geiser............ 46 Executive Vice President, General Counsel and Secretary
S. Louise McCrary........... 38 Vice President, Chief Accounting Officer and Controller
LEONARD D. SCHAEFFER has been Chairman of the Board of Directors and Chief
Executive Officer of the Company since August 1992. From 1989 until May 1996,
Mr. Schaeffer was also Chairman of the Board of Directors and, from 1986, Chief
Executive Officer of BCC. From 1982 to 1986, Mr. Schaeffer served as President
of Group Health, Inc., an HMO in the midwestern United States. Prior to joining
Group Health, Inc., Mr. Schaeffer was the Executive Vice President and Chief
Operating Officer of the Student Loan Marketing Association ("Sallie Mae"), a
financial institution that provides a secondary market for student loans, from
1980 to 1981. From 1978 to 1980, Mr. Schaeffer was the Administrator of HCFA.
HCFA administers the Federal Medicare, Medicaid and Peer Review Organization
programs. Mr. Schaeffer serves as a director of Allergan, Inc. and Metra
Biosystems.
DAVID R. BANKS has been a director of the Company since April 1993. He has
been Chairman and Chief Executive Officer of Beverly Enterprises since September
1979. Beverly Enterprises operates health care facilities in 34 states and the
District of Columbia. Mr. Banks serves as a director of Ralston Purina and
Nationwide Health Properties. Mr. Banks serves on the Nominating and
Compensation Committees of the Board and is Chairperson of the Compensation
Committee.
W. TOLIVER BESSON has been a director of the Company since May 1996, was an
independent director of BCC from April 1994 until May 1996 and prior to that
served as an advisory director of BCC from 1989. He has been a partner at the
law firm of Paul, Hastings, Janofsky & Walker since 1978. He served on its
national management committee from 1985 to 1990 and served on the Board of
Governors of the California State Bar from 1979 to 1980. He currently serves as
a member of the management committee of Cross Country Ventures (a venture
capital limited partnership). Pursuant to an undertaking with the DOC, Mr.
Besson has effectively agreed to not serve as a director beyond April 2003. Mr.
Besson serves on the Audit Committee of the Board.
ROGER E. BIRK has been a director of the Company since April 1993. Mr. Birk
served as President of the Federal National Mortgage Association ("Fannie Mae")
from 1987 to 1992 and as Chairman and Chief
32
Executive Officer of Merrill Lynch & Co., Inc. from 1982 to 1986. Mr. Birk
serves as a director of Penske Transportation, Fannie Mae, and Mutual of America
Capital Corp. and Golden Bear Golf, Inc. Mr. Birk serves as the Chairperson of
the Audit Committee of the Board.
STEPHEN L. DAVENPORT has been a director of the Company since May 1996, was
an independent director of BCC from 1991 until May 1996 and prior to that served
as an advisory director of BCC from 1989. He is retired. From 1980 to 1995 he
was president of D/A Financial Group. Prior to that he was Senior Vice President
of Provident Mutual Life Insurance Company. He currently serves on the board of
directors of Tinsley Laboratories, Inc. Pursuant to an undertaking with the DOC,
Mr. Davenport has effectively agreed to not serve as a director beyond April
2002. Mr. Davenport serves on the Compensation Committee of the Board.
JULIE A. HILL has been a director of the Company since March 1994. She has
been President and Chief Executive Officer of Costain Homes Inc. ("Costain")
since January 1991, having joined Costain in 1988 as Vice President of Sales and
Marketing. Costain is a division of London-based Costain Group PLC and builds
single-family detached residential communities. Ms. Hill serves on the
Compensation and Nominating Committees of the Board.
ROBERT T. KNIGHT has been a director of the Company since May 1996, was an
independent director of BCC from 1988 until May 1996 and prior to that served as
an advisory director of BCC from 1986. He was Chairman of Digital Sound
Corporation from January 1995 to May 1996 and prior to that had been President
and Chief Executive Officer of Digital Sound Corporation since 1992. He had
previously been a Senior Vice President of Xerox Corporation in Stamford,
Connecticut since 1986. He currently serves on the boards of directors of
Picture Tel Corporation, Blue Sky Research, Inc. and Data Dimensions Inc.
Pursuant to an undertaking with the DOC, Mr. Knight has effectively agreed to
not serve as a director beyond April 1997. Mr. Knight serves as the Chairperson
of the Nominating Committee of the Board.
ELIZABETH A. SANDERS has been a director of the Company since May 1996 and
has been a consultant to executive management and served as Vice President and
General Manager of Nordstrom, Inc. from 1978 to 1990. Ms. Sanders is a founder
of the National Bank of Southern California and was on its board of directors
from 1983 to 1990. She currently serves on the following boards of directors: H.
F. Ahmanson & Company, Wal-Mart Stores, Inc., Wolverine Worldwide, Inc. and the
Flagstar Companies, Inc. Ms. Sanders serves on the Audit Committee of the Board.
SHEILA P. BURKE has been elected to become a director of the Company
effective as of April 1, 1997 upon the resignation of Robert T. Knight. Since
December 1996, Ms. Burke has been the Executive Dean of the John F. Kennedy
School of Government, Harvard University. Previously in 1996, Ms. Burke was a
senior advisor to the Dole for President Campaign. From 1986 until June 1996,
Ms. Burke was the chief of staff for the Office of the Republican Leader of the
United States Senate. Ms. Burke currently serves on the Board of Directors of
Chubb Corp. Ms. Burke will be subject to reelection at the Company's 1997 Annual
Meeting of Shareholders which is expected to occur in June 1997.
D. MARK WEINBERG has been Executive Vice President, UNICARE Businesses of
the Company since October 1995. From August 1992 until May 1996, Mr. Weinberg
served as a director of the Company. From February 1993 to October 1995, Mr.
Weinberg was Executive Vice President, Consumer and Specialty Services of the
Company. Prior to February 1993, Mr. Weinberg was Executive Vice President of
BCC's Consumer Services Group from December 1989 to February 1993 and was Senior
Vice President of Individual and Senior Services of BCC from April 1987 to
December 1989. From 1981 to 1987, Mr. Weinberg held a variety of positions at
Touche Ross & Co. From 1976 to 1981, Mr. Weinberg was general manager for the
CTX Products Division of PET, Inc.
RONALD A. WILLIAMS has been Executive Vice President, Blue Cross of
California Businesses of the Company since October 1995. From August 1992 until
May 1996, Mr. Williams served as a director of the Company. From February 1993
to October 1995, Mr. Williams was Executive Vice President, Group and
33
Network Services of the Company. Prior to February 1993, Mr. Williams was
Executive Vice President of BCC's Group Services from May 1992 to February 1993.
Prior to that time, Mr. Williams served as Executive Vice President of BCC's
Health Services and Products Group from December 1989 to May 1992 and as BCC's
Senior Vice President of Marketing and Related Products from November 1988 to
December 1989. From May 1987 to November 1988 he was Vice President of Corporate
Services of BCC. From July 1984 to May 1987 he was Senior Vice President of
Vista Health Corporation, an alternative delivery system for outpatient
psychological and substance abuse services of which he was also a co-founder.
HOWARD G. PHANSTIEL has been Executive Vice President, Finance and
Information Services since December 1994. Prior to joining the Company, he was
Managing Director in the Finance Group of Prudential Securities Incorporated in
New York City and a member of the firm's Operating Council. He also served as
Chairman of Prudential-Bache International Bank. Prior to joining Prudential in
1989, Mr. Phanstiel was Chief Financial Officer and Executive Vice President of
Marine Midland Bank.
THOMAS C. GEISER 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.
S. LOUISE MCCRARY has been Vice President, Chief Accounting Officer and
Controller of the Company since December 1996. From 1985 until November 1996,
Ms. McCrary was with the accounting firm of Coopers & Lybrand L.L.P., most
recently as a partner.
BOARD OF DIRECTORS
The WellPoint Articles of Incorporation provide that the Board of Directors
is divided into three classes, currently with three directors in each class.
Directors in each class serve for a three-year term and the current composition
of the classes is as follows: Class I directors (whose terms expire in 1997)
consist of Ms. Sanders and Messrs. Birk and Knight; Class II directors (whose
terms expire in 1998) consist of Messrs. Banks and Davenport (with one vacancy);
and Class III directors (whose terms expire in 1999) consist of Ms. Hill and
Messrs. Besson and Schaeffer.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), requires the Company's directors, executive officers and
holders of more than ten percent of the Company's Common Stock to file reports
of ownership and changes in ownership with the Securities and Exchange
Commission ("SEC"). Officers, directors and greater than ten percent
shareholders are required by SEC regulations to furnish the Company with copies
of all Section 16(a) forms they file.
Based solely on a review of the copies of such forms received by it, or
written representations from certain reporting persons, the Company believes
that, during the year ended December 31, 1996, the Company's officers, directors
and greater than ten percent beneficial owners complied with all applicable
filing requirements, except W. Toliver Besson, who reported one transaction in
1996 late, and D. Mark Weinberg, who reported two transactions in 1996 late.
34
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION OF DIRECTORS
All non-employee directors of the Company are entitled to the following
compensation: (i) $23,000 per year paid in quarterly installments; and (ii)
$1,300 per Board meeting and $650 per committee meeting, with the chairperson of
the committee receiving $850 per committee meeting. Non-employee directors may
elect to defer receipt of a portion or all of their fees. Deferred amounts are
credited with interest quarterly.
On the last business day of the second quarter of each fiscal year of the
Company, continuing non-employee directors who have served for at least six full
calendar months automatically receive 333 shares of Common Stock (which has been
adjusted to reflect the change in the Company's Common Stock as a result of the
two-for-three share exchange occurring in connection with the Recapitalization)
pursuant to the Company's 1994 Stock Option/Award Plan.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee of the Board of Directors is comprised of David
R. Banks, Stephen L. Davenport and Julie A. Hill. The Company's Compensation
Committee does not include any present or former officers or employees of the
Company or any of its subsidiaries.
SUMMARY OF CERTAIN COMPENSATION
The following table provides certain summary information concerning
compensation paid or accrued by the Company and its subsidiaries to or on behalf
of the Company's Chief Executive Officer and each of the four other most highly
compensated executive officers of the Company determined as of December 31, 1995
(the "Named Executive Officers") for the years ended December 31, 1994, 1995 and
1996:
35
SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION
-----------------------------------------
ANNUAL COMPENSATION AWARDS
--------------------------------------- -------------------------- PAYOUTS
OTHER ANNUAL SECURITIES -------------
NAME AND PRINCIPAL COMPENSATION RESTRICTED UNDERLYING LTIP
POSITION YEAR SALARY ($) BONUS($) ($) STOCK ($) OPTIONS (#) PAYOUTS ($)(1)
- ------------------------- --------- ----------- ----------- ------------- ----------- ------------- -------------
Leonard D. Schaeffer 1996 $ 744,524 $ 532,440 $ 12,908 -- 437,700 $ 5,475,049
Chairman and Chief 1995 636,005 305,280 -- -- -- 136,913
Executive Officer(3) 1994 629,082 283,020 -- -- -- 806,756
D. Mark Weinberg 1996 $ 456,285 $ 234,000 $ 206,987(4) -- 240,931 $ 1,976,199
Executive Vice 1995 407,075 157,538 172,490(4) -- -- 42,736
President, UNICARE 1994 395,134 173,414 -- -- -- 345,210
Businesses
Ronald A. Williams 1996 $ 430,888 $ 238,743 $ 157,463(4) -- 230,511 $ 1,866,031
Executive Vice 1995 371,612 143,814 125,970(4) -- -- 39,043
President, Blue Cross of 1994 360,710 165,572 -- -- -- 316,443
California Businesses
Howard G. Phanstiel 1996 $ 358,077 $ 294,000(6) $ 30,000(9) -- 131,947 $ 1,042,658
Executive Vice 1995 350,000 148,000(7) 244,161(10) -- -- 10,288
President, Finance and 1994 22,885 100,000(8) 10,198(11) -- -- --
Information Services(5)
Thomas C. Geiser 1996 $ 321,002 $ 155,000 $ 35,989(12) $ 159,750(14) 128,348 $ 1,007,791
Executive Vice 1995 269,170 105,235 220,730(13) -- -- 27,963
President, General 1994 255,508 126,438 -- -- -- 74,796
Counsel and Secretary
ALL OTHER
NAME AND PRINCIPAL COMPENSATION
POSITION ($)(2)
- ------------------------- -------------
Leonard D. Schaeffer $ 245,777
Chairman and Chief 93,818
Executive Officer(3) 96,368
D. Mark Weinberg $ 136,473
Executive Vice 51,097
President, UNICARE 39,286
Businesses
Ronald A. Williams $ 134,256
Executive Vice 47,741
President, Blue Cross of 37,272
California Businesses
Howard G. Phanstiel $ 80,859
Executive Vice 18,366
President, Finance and 1,030
Information Services(5)
Thomas C. Geiser $ 63,085
Executive Vice 20,965
President, General 17,167
Counsel and Secretary
- ------------------------------
(1) For the year ended December 31, 1996, the amounts shown include the
following payments made in May 1996 upon completion of the Recapitalization
and termination of the Special Performance Units ("SPUs") and Performance
Units previously issued under the Company's 1994 Long Term Incentive Plan:
Leonard D. Schaeffer, $3,848,184; D. Mark Weinberg, $1,436,867; Ronald A.
Williams, $1,364,112; Howard G. Phanstiel, $767,218; and Thomas C. Geiser,
$739,860. For Mr. Schaeffer, this amount was paid 50% in cash, with the
remaining 50% allocated to deferred share units which will be received by
Mr. Schaeffer upon termination of his employment. See "Employment Contracts,
Termination of Employment and Change in Control Arrangements." For Messrs.
Weinberg, Williams, Phanstiel and Geiser, these amounts were paid 50% in
cash and 50% in unrestricted Common Stock. These amounts represented the
existing value of such SPUs and Performance Units as of the time of their
termination, but did not constitute regular compensation payments for 1996.
For the year ended December 31, 1996, the amounts shown also include the
following payments made under Special Performance Units that matured on
January 31, 1996: Leonard D. Schaeffer, $1,375,000; D. Mark Weinberg,
$426,250; Ronald A. Williams, $398,750; Howard G. Phanstiel, $220,000; and
Thomas C. Geiser, $206,250. For each year shown, the LTIP payouts also
include payments attributable to the three-year performance period ending in
that year, but that were made in the following year.
(2) For the year ended December 31, 1994, "All Other Compensation" includes the
following (i) contributions on behalf of Leonard D. Schaeffer, D. Mark
Weinberg, Ronald A. Williams and Thomas C. Geiser in the amount of $5,544,
$6,930, $6,930 and $6,930, respectively, to the Company's 401(k) Plan to
match 1994 pre-tax elective deferral contributions (included under Salary)
made by each to such plan, (ii) deferred compensation for Leonard D.
Schaeffer, D. Mark Weinberg, Ronald A. Williams, Howard G. Phanstiel and
Thomas C. Geiser of $64,489, $30,185, $26,378, $1,030 and $7,730,
respectively, and (iii) life insurance premiums paid on behalf of Leonard D.
Schaeffer, D. Mark Weinberg, Ronald A. Williams and Thomas C. Geiser in the
amount of $26,335, $2,171, $3,964 and $2,507, respectively. For the year
ended December 31, 1995, "All Other Compensation" includes the following:
(i) contributions of behalf of Leonard D. Schaeffer, D. Mark Weinberg,
Ronald A. Williams, Howard G. Phanstiel and Thomas C. Geiser in the amount
of $5,544, $5,940, $5,940, $5,315 and $5,940, respectively, to the Company's
401(k) Plan to match 1995 pre-tax elective deferral contributions (included
under Salary) made by each to such plan, (ii) deferred compensation for
Leonard D. Schaeffer, D. Mark Weinberg, Ronald A. Williams, Howard G.
Phanstiel and Thomas C. Geiser of $72,116, $43,606, $38,142, $10,435, and
$12,978, respectively, and (iii) life insurance premiums paid on behalf of
Leonard D. Schaeffer, D. Mark Weinberg, Ronald A. Williams, Howard G.
Phanstiel and Thomas C. Geiser in the amount of $16,158, $1,551, $3,659,
$2,616, and $2,047, respectively. For the year ended December 31, 1996, "All
Other Compensation" includes the following: (i) contributions on behalf of
Leonard D. Schaeffer, D. Mark Weinberg, Ronald A. Williams, Howard G.
Phanstiel and Thomas C. Geiser in the amount of $5,924, $6,750, $6,750,
$6,750 and $4,774, respectively, to the Company's 401(k) Plan to match 1996
pre-tax elective deferral contribution (included under Salary) made by each
to such plan, (ii) deferred compensation for Leonard D. Schaeffer, D. Mark
Weinberg, Ronald A. Williams, Howard G. Phanstiel and Thomas C. Geiser of
$221,986, $126,277, $117,388, $68,761 and $56,264, respectively, and (iii)
life insurance premiums paid on
36
behalf of Leonard D. Schaeffer, D. Mark Weinberg, Ronald A. Williams, Howard
G. Phanstiel and Thomas C. Geiser in the amount of $17,867, $3,446, $10,118,
$5,348 and $2,047, respectively.
(3) Prior to May 20, 1996, Mr. Schaeffer also received compensation from BCC for
his services as Chief Executive Officer of BCC. For 1994, 1995 and such
period in 1996, amounts shown represent an allocation to the Company of the
amounts payable under Mr. Schaeffer's prior employment agreement with BCC
(which has been replaced by the employment agreement described below) and
are based on the estimated time spent by Mr. Schaeffer on the Company's
affairs.
(4) Represents a retention bonus paid pursuant to a management retention
agreement. See "Employment Contracts, Termination of Employment and Change
in Control Arrangements."
(5) Mr. Phanstiel joined the Company on December 1, 1994.
(6) Includes a $150,000 sign-on bonus paid to Mr. Phanstiel in 1996 and
conditioned, in part, on service in 1996.
(7) Includes a $50,000 sign-on bonus paid to Mr. Phanstiel in 1995 and
conditioned, in part, on service in 1995.
(8) Includes a $100,000 sign-on bonus paid to Mr. Phanstiel upon his joining the
Company.
(9) Represents forgiveness of $30,000 of a relocation loan.
(10) Represents forgiveness of $30,000 of a relocation loan and reimbursement
for relocation expenses.
(11) Represents reimbursement for relocation expenses.
(12) Includes forgiveness of $25,000 of a relocation loan.
(13) Represents a special relocation bonus of $50,000, forgiveness of a $50,000
relocation loan and reimbursement for relocation expenses.
(14) Represents a restricted share right grant of 4,500 shares that vests in
equal installments on June 1, 1997, 1998 and 1999. As of December 31, 1996,
the shares underlying this grant (none of which were vested) had a fair
market value of approximately $154,688, not accounting for vesting
restrictions. Dividends will not be paid on any shares prior to the lapsing
of vesting restrictions.
37
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth certain information with respect to stock
options granted to the Named Executive Officers during 1996. No stock
appreciation rights were granted in 1996.
INDIVIDUAL GRANTS
------------------------------------------------------------------------------------------
NUMBER OF SHARES PERCENTAGE OF TOTAL
UNDERLYING OPTIONS EXERCISE EXPIRATION GRANT DATE
NAME OPTIONS GRANTED GRANTED TO EMPLOYEES PRICE DATE PRESENT VALUE(1)
- --------------------------- ----------------- ------------------------- ------------- ----------- ----------------
Leonard D. Schaeffer....... 24,066 0.8% $ 39.675 1/1/04 $ 394,435
300,825 9.6 39.675 1/5/05 4,930,432
112,809 3.6 39.675 3/4/06 1,848,906
D. Mark Weinberg........... 19,997 0.6 39.675 1/1/04 $ 327,745
165,038 5.3 39.675 1/5/05 2,704,923
55,896 1.8 39.675 3/4/06 916,119
Ronald A. Williams......... 19,987 0.6 39.675 1/1/04 $ 327,581
154,562 4.9 39.675 1/5/05 2,533,225
55,962 1.8 39.675 3/4/06 917,200
Howard G. Phanstiel........ 10,417 0.3 39.675 1/1/04 $ 170,732
85,472 2.7 39.675 1/5/05 1,400,860
36,058 1.1 39.675 3/4/06 590,980
Thomas C. Geiser........... 12,033 0.4 39.675 1/1/04 $ 197,217
80,217 2.6 39.675 1/5/05 1,314,733
36,098 1.1 39.675 3/4/06 591,636
- ------------------------
(1) Grant date present values were calculated using the Black-Scholes option
valuation model with the following assumptions:
Five
Expected life of options......................................... years
Exercise price................................................... $39.675
Volatility....................................................... 35.68%
Dividend yield................................................... 0%
Risk-free interest rate.......................................... 6.40%
The actual value, if any, which a Named Executive Officer may realize will
be based upon the difference between the market price of the Company's Common
Stock on the date of exercise and the exercise price. There is no assurance that
the actual realized value, if any, will be at or near the value estimated by the
Black-Scholes model.
The grants made to the Named Executive Officers in 1996 were made under the
Company's 1994 Stock Option/Award Plan (the "Stock Option/Award Plan"). The
majority of such awards were made in replacement of terminated SPUs and
Performance Units that had been granted prior to 1996. Prior to the completion
of the Recapitalization, the Company had not been permitted by the DOC to
implement the Stock Option/Award Plan. A portion of the options granted in 1996
were exercisable as of the date of grant, with the remainder of the grants
vesting in varying amounts on January 1, January 5 and March 4, 1997, January 5
and March 4, 1998 and March 4, 1999 (or earlier, in full, upon the occurrence of
a change-in-control).
AGGREGATED OPTION/SAR EXERCISES AND YEAR-END OPTION/SAR VALUES
The following table sets forth certain information with respect to exercises
by the Named Executive Officers of stock options and stock appreciation rights
("SARs") during 1996 and the value of all
38
unexercised employee stock options and SARs as of December 31, 1996 held by the
named executive officers. No SARs were granted in 1996.
NUMBER OF SHARES VALUE OF UNEXERCISED IN- THE-MONEY
UNDERLYING UNEXERCISED
OPTIONS/SARS OPTIONS/SARS AT FISCAL YEAR-END(1)
SHARES ACQUIRED VALUE -------------------------- ----------------------------------
NAME ON EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ----------------------------------- --------------- ------------- ----------- ------------- --------------- -----------------
Leonard D. Schaeffer............... -0- -0- 16,044 421,656 -0- -0-
D. Mark Weinberg................... -0- -0- 13,331 227,600 -0- -0-
Ronald A. Williams................. -0- -0- 13,325 217,186 -0- -0-
Howard G. Phanstiel................ -0- -0- 6,945 125,002 -0- -0-
Thomas C. Geiser................... -0- -0- 8,022 120,326 -0- -0-
- ------------------------
(1) The actual amount realized from unexercised options is dependent upon the
price of the Company's Common Stock at the time shares obtained upon
exercise of such options are sold and, as to unexercisable options, whether
restrictions upon exercise of such options lapse.
LONG-TERM INCENTIVE PLAN
Prior to completion of the Recapitalization and the implementation of the
Stock Option/Award Plan, long-term incentive awards to the Named Executive
Officers were made under the 1994 Long-Term Incentive Plan. The Company's 1994
Long-Term Incentive Plan provided for three types of awards: Value Units,
Performance Units and Special Performance Units. Only Performance Units were
granted in March 1996 to the officers set forth below. Performance Units focused
on building share value and providing incentives based on the increase in the
value of the Common Stock over a three-year period. The Performance Units
granted in March 1996 were subsequently terminated in May 1996 upon completion
of the Company's Recapitalization and replaced by the option grants listed in
the Summary Compensation Table. The column "LTIP Payouts" in such table included
the amounts paid to such officers in 1996 attributable to the termination of
such Performance Units. Cash awards paid to the Named Executive Officers under
the Company's previous long-term incentive award program are reported in the
Summary Compensation Table for the last year of the award period; provided that,
with respect to Mr. Schaeffer, only the portion allocated to the Company has
been included.
LONG-TERM INCENTIVE PLAN -- AWARDS IN LAST FISCAL YEAR
PERFORMANCE OR OTHER
PERIOD UNTIL
NAME NUMBER OF UNITS(1) MATURATION OR PAYOUT
- ------------------------------------------------- ------------------ ----------------------
Leonard D. Schaeffer............................. 150,000 3/4/97 - 3/4/99
D. Mark Weinberg................................. 70,000 3/4/97 - 3/4/99
Ronald A. Williams............................... 70,000 3/4/97 - 3/4/99
Howard G. Phanstiel.............................. 45,000 3/4/97 - 3/4/99
Thomas C. Geiser................................. 45,000 3/4/97 - 3/4/99
- ------------------------
(1) Performance Units were cash awards vesting in three equal, annual
installments on March 4, 1997, 1998 and 1999. The awards provided for
payments based on the difference between (i) the "Base Price," which was
$33.63 with respect to such grants, and (ii) the fair market value of Common
Stock on the date the Performance Units were paid. Performance Units were
subject to accelerated vesting upon involuntary termination following a
change in control.
39
PENSION PLANS
PENSION PLAN
The Company sponsors the WellPoint Health Networks Inc. (formerly Blue Cross
of California) Pension Accumulation Plan (the "Pension Plan"), a cash balance
plan that is designed to be a qualified defined benefit pension plan under the
Internal Revenue Code of 1986, as amended (the "Internal Revenue Code"). The
benefit payable under the Pension Plan is generally equal to the amount of
annual annuity that could be purchased at age 65 (based on certain actuarial
assumptions) with the balance of an account that is credited with the following
amounts for each calendar year after 1986; (i) 3% of the participant's
compensation for that year, PLUS (ii) 1% of the participant's compensation for
that year, if the participant has at least 10 years of service, PLUS (iii) 1% of
the participant's compensation for that year if the participant has at least 20
years service, PLUS, (iv) interest on the balance of such account at a rate
equal to the 5-year Treasury Bill average yield for the immediately preceding
December (but not less than 2 1/2%). The Pension Plan became effective on
January 1, 1987 as a successor plan to the Non-Contributory Retirement Program
for Certain Employees of Blue Cross of California (the "Prior Plan"). Certain
participants in the Pension Plan are also eligible to receive retirement
benefits under the Prior Plan.
The Company also sponsors the Supplemental Pension Plan (the "Supplemental
Plan") of WellPoint Health Networks Inc. (formerly Blue Cross of California)
which provides additional benefits payable out of general corporate assets to
certain employees equal to the benefits these employees cannot receive under the
Pension Plan because of Internal Revenue Service limits on benefits and
restrictions on participation by highly compensated employees.
The estimated annual benefit payable upon retirement at age 65 under the
Pension Plan and the Supplemental Plan for named executive officers as of
December 31, 1996 based on service and compensation to such date and as
projected at age 65 is: Leonard D. Schaeffer $38,868 and $74,858; D. Mark
Weinberg, $54,756 and $184,253; Ronald A. Williams $42,800 and $137,864; Howard
G. Phanstiel, $19,985 and $51,156; and Thomas C. Geiser, $27,170 and $65,636.
Mr. Schaeffer is also entitled to an additional annual annuity of $5,135 from
the Prior Plan.
SPECIAL EXECUTIVE RETIREMENT PLAN
BCC established a Special Executive Retirement Plan ("SERP") with respect to
Mr. Schaeffer effective December 30, 1986. The SERP was amended and restated
effective January 1, 1993. The Company assumed the SERP upon completion of the
Recapitalization. The SERP provides that, within 30 days of his retirement, Mr.
Schaeffer will begin receiving an annual benefit equal to two-thirds of his then
current "Target Annual Compensation," reduced by the benefits provided by the
Pension Plan, the Prior Plan and Supplemental Plan described above. Target
Annual Compensation is defined as base salary plus target annual incentive. The
benefit will be reduced by 6 1/4% per year for retirement before age 60. The
earliest date a retirement benefit will be payable under the SERP is age 52.
This retirement benefit is to be paid in monthly installments for the greater of
Mr. Schaeffer's lifetime or a ten-year period, with payments, if any, made to
Mr. Schaeffer's designated beneficiary after Mr. Schaeffer's death. On Mr.
Schaeffer's death (or, if later, after retirement payments have been made for
ten years), the SERP provides for a survivor benefit to be paid to his spouse
for her lifetime equal to 50% of the benefit that he would receive. The SERP
also provides for a termination benefit payable on termination prior to age 52
as a lump sum that would be sufficient to fund his benefit if he were to retire
at age 65 (age 60 in the case of certain involuntary terminations) or, if
greater, a portion of the amount in the trust, attributable to benefits accrued
before 1993. The Company's obligations under the SERP are secured by a trust to
which the Company makes annual, irrevocable contributions. Based upon fiscal
1996 base salary and target annual incentive levels, the estimated annual
benefit payable to Mr. Schaeffer under the amended SERP upon retirement at age
65 is $787,806.
40
EMPLOYMENT CONTRACTS, TERMINATION OF EMPLOYMENT AND
CHANGE IN CONTROL ARRANGEMENTS
EMPLOYMENT AGREEMENT WITH LEONARD D. SCHAEFFER
In January 1997, Leonard D. Schaeffer, Chairman of the Board and Chief
Executive Officer, entered into an employment agreement with the Company which
covers a five-year period that expires in January 2002, but which will be
extended automatically on January 22 of each year for an additional year unless
the Board of Directors elects to cease such automatic extension. Under Mr.
Schaeffer's employment agreement, Mr. Schaeffer is entitled to receive an annual
base salary of not less than $850,000, which can be adjusted upward as
determined by the Board of Directors; provided, however, that the base salary in
each successive year may not be less than the base salary in the preceding year.
Mr. Schaeffer's base salary as of March 15, 1997 was $900,000.
The employment agreement with Mr. Schaeffer also provides that the Company
will provide long-term disability benefits that will maintain Mr. Schaeffer's
after-tax income at a level equal to his then current base salary for up to the
later of two years or until he reaches age 55 if he continues to be considered
disabled during such period.
In addition, Mr. Schaeffer's employment agreement provides that in the event
that he is constructively terminated or the Company terminates his employment
other than for cause, he will receive, in addition to payments under the SERP
described above, a lump sum payment equal to 2.99 times his then annual base
salary plus an amount equal to 2.99 times his then-current annual target
incentive compensation. Mr. Schaeffer's annual target incentive compensation for
1997 is $630,000. In the event of such termination, he will continue to receive
certain fringe benefits for 48 months. In addition, Mr. Schaeffer will be
entitled to a pro rata portion of any bonus pursuant to the Company's bonus
programs, and any options granted to Mr. Schaeffer on or after January 22, 1997
will immediately become exercisable. If the Company agrees to a change of
control, the employment agreement with Mr. Schaeffer provides that rights and
privileges under the agreement may not be affected. Mr. Schaeffer may elect to
terminate his employment with the Company upon 90 days' written notice to the
Company. In such event, Mr. Schaeffer will continue to receive his salary during
the 90-day notification period. In addition, Mr. Schaeffer will continue to
receive health, dental and life insurance and disability benefits for a
six-month period.
The above-described employment agreement with Mr. Schaeffer replaces
previous employment agreements with the Company's predecessor, Blue Cross of
California, and the Company. At the time of the execution of Mr. Schaeffer's
current employment agreement, the Company also agreed that Mr. Schaeffer will
receive 8,821 shares of the Company's Common Stock upon termination of Mr.
Schaeffer's employment with the Company for any reason. At the time of the
termination of outstanding SPUs and Performance Units in May 1996, the Company
granted Mr. Schaeffer deferred share rights with respect to 55,366 shares of the
Company's Common Stock, which will be issued to Mr. Schaeffer upon his
termination from the Company.
MANAGEMENT RETENTION AGREEMENTS
WellPoint has entered into management retention agreements with D. Mark
Weinberg and Ronald A. Williams which provide incentives for them to remain with
the Company through April 1, 1997. The management retention agreements provide
for the payment of bonuses to Messrs. Weinberg and Williams if they remain with
WellPoint for two, three and four years following April 1, 1993 or if they are
involuntarily terminated (without cause) or constructively discharged before
payment, as defined in the Company's Change in Control Plan, described below.
The bonus amounts payable to Mr. Weinberg for each respective year would be 50%,
60% and 75% of his current base salary, and the bonus amounts payable to Mr.
Williams for each respective year would be 40%, 50% and 65% of his current base
salary. The Company has the right to substitute stock options in place of unpaid
bonuses under these agreements.
41
OFFICER SEVERANCE AGREEMENTS
D. Mark Weinberg and Ronald A. Williams have each entered into an officer
severance agreement with the Company that provides a lump sum-payment, if either
is involuntarily terminated (other than for cause), equal to 24 months salary
and 200% of the previous fiscal year's target bonus, plus continuation for 24
months of health, dental, vision and life insurance premiums paid by the
Company.
Howard G. Phanstiel has entered into an officer severance agreement with the
Company that provides a lump sum payment, if his employment is involuntarily
terminated (other than for cause), equal to 12 months salary and 100% of the
previous fiscal year's target bonus, plus continuation for 12 months of health,
dental, vision and life insurance premiums paid by Company.
Thomas C. Geiser has entered into an officer severance agreement with the
Company that provides a lump sum payment, if he is involuntarily terminated
(other than for cause), equal to 18 months salary and 150% of the previous
fiscal year's target bonus, plus continuation for 18 months of health, dental,
vision and life insurance premiums paid by the Company.
RELOCATION LOANS AND BENEFITS
In connection with Thomas C. Geiser's purchase of a residence, the Company
made an interest-free loan of $125,000 to Mr. Geiser in 1995, forgivable in five
annual installments of $25,000, so long as he remains employed by the Company.
Should he terminate employment before the entire balance of the loan is
forgiven, the remaining unpaid, unforgiven balance would become due. Mr. Geiser
was also entitled to a relocation bonus of $50,000, paid in 1995.
In connection with Howard G. Phanstiel's relocation, the Company made an
interest-free loan of $150,000 to Mr. Phanstiel in 1994, forgivable in five
annual installments of $30,000, so long as he remains employed by the Company.
Should he terminate employment before the entire balance of the loan is
forgiven, the remaining unpaid, unforgiven balance would become due. Mr.
Phanstiel was also entitled to a special bonus, payable $100,000 in December
1994, $50,000 in March 1995 and $150,000 in March 1996.
CHANGE IN CONTROL
The Company has adopted the WellPoint Health Networks Inc. Officer Change in
Control Plan ("Change in Control Plan") effective January 1, 1994 to provide
selected officers of WellPoint and affiliates controlled by WellPoint who are
notified of their participation by the CEO of WellPoint with benefits in the
event of a Change in Control. The Change in Control Plan defines a Change in
Control as (i) a reduction in the Foundation's (or a qualifying successor's)
ownership of WellPoint to less than a majority of the outstanding voting
securities, if another person owns 30% or more of the combined voting power of
WellPoint's then-outstanding securities, (ii) a merger, consolidation,
liquidation, sale of stock or assets or other reorganization ("reorganization")
to which the Foundation or a qualifying successor is a party and as a
consequence of which the members of the Foundation's (or the qualifying
successor's) board of directors immediately before the reorganization or event
constitute less than two-thirds of the directors of such entity immediately
after the reorganization or event so long as the Foundation or the qualifying
successor continues to own 30% or more of the combined voting power of
WellPoint's then-outstanding securities, (iii) a reorganization to which the
Foundation, a qualifying successor or WellPoint is a party if, as a result
thereof, the members of WellPoint's directors immediately before the
reorganization will not constitute at least two-thirds of the directors of
WellPoint immediately after the reorganization or (iv) any other transaction,
acquisition of securities or other action or event that at least two-thirds of
the Foundation's (or a qualifying successor's) directors or at least a majority
of the independent directors of WellPoint determine will constitute a Change in
Control of BCC or WellPoint, respectively. However, the Compensation Committee
may determine that any such event will not be deemed a Change in Control for
purposes of the Change in Control Plan if it concludes that such event does not
pose a material risk to the operation of WellPoint's business.
42
Certain selected officers may be eligible to receive Change in Control Plan
severance benefits if an Affiliate (as defined in the plan) involuntarily
terminates (other than for cause) or constructively discharges the officer
within 36 months after a Change in Control. An officer is deemed constructively
discharged for purposes of the Change in Control Plan if, after a Change in
Control, any Affiliate significantly reduces the officer's duties,
responsibilities, status, titles or offices, reduces the officer's aggregate
salary and target bonus by more than 10%, or requests the officer to relocate
further than 35 miles from the officer's place of employment. Severance payments
will consist of a base amount plus an outplacement benefit. The base amount is
2.00 to 2.75 times base salary plus 2.00 to 2.75 times target annual bonus in
effect for the officer's position for an Executive Vice President, 1.75 to 2.50
times base salary plus 1.75 to 2.50 times target annual bonus for a Senior Vice
President and 1.25 to 2.00 times base salary plus 1.25 to 2.00 times target
annual bonus for a Vice President. The outplacement benefit consists of
outplacement services from a firm selected by WellPoint for up to the cost of
one month's base salary. The severance benefit payable to any officer is reduced
by the amount of any retention benefit previously paid to the officer under the
Change in Control Plan. Mr. Weinberg, Mr. Williams, Mr. Phanstiel and Mr. Geiser
participate in the Change in Control Plan.
Certain selected officers will also be entitled to annual retention payments
for three years following a Change in Control (other than a change in the
directors of the Foundation or a qualifying successor), with such payments to
cease if the officer terminates employment other than by involuntary termination
(other than for cause) or constructive discharge. The amount of each annual
payment will be one-third of the amount of the severance payment (excluding any
outplacement benefit) that would be paid to such officer under the Change in
Control Plan upon involuntary termination or constructive discharge. Mr.
Weinberg, Mr. Williams, Mr. Phanstiel and Mr. Geiser are entitled to annual
retention payments.
Payments under the Change in Control Plan are reduced to the extent
necessary to ensure that those payments do not constitute excess parachute
payments within the meaning of Section 280G of the Internal Revenue Code.
An officer who is to receive other severance benefits from an Affiliate will
not receive benefits under the Change in Control Plan unless the other severance
benefit plan so provides or the officer waives benefits under the other
severance benefit plan. The Compensation Committee may amend or terminate the
Change in Control Plan at any time except that, after a change in control, the
plan may not be amended or terminated to reduce or eliminate benefits that would
otherwise be payable under the Change in Control Plan to those who were
participants on the date of the Change in Control.
The Compensation Committee has determined that the Recapitalization did not
constitute a Change in Control.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the beneficial ownership of Common Stock of
the Company, as of March 19, 1997, by (a) each person known by the Company to
own beneficially more than 5% of the outstanding Common Stock; (b) the Chief
Executive Officer of the Company; (c) each of the four other
43
Named Executive Officers; (d) each current and proposed director of the Company;
and (e) all directors and executive officers as a group.
TOTAL SHARES
NUMBER OF BENEFICIALLY
NUMBER OF SHARES SHARES AND
BENEFICIALLY PERCENT OF SUPPLEMENTALLY SUPPLEMENTALLY PERCENT OF
NAME AND ADDRESS OWNED(1) CLASS(2) OWNED OWNED CLASS
- ----------------------------------- -------------------- ----------- --------------- -------------- -----------
California Health Care 38,410,000 57.7% -- 38,410,000 57.7%
Foundation .......................
21560 Oxnard Street
Woodland Hills, CA 91367(3)
Wilmington Trust Company(4) . 5,233,054 7.9 -- 5,233,054 7.9
Rodney Square North
1100 North Market Street
Wilmington, DE 19890
Leonard D. Schaeffer............... 212,963(5) * 64,187(6) 277,150 *
D. Mark Weinberg................... 142,268(7) * -- 142,268 *
Ronald A. Williams................. 139,885(8) * -- 139,885 *
Howard G. Phanstiel................ 82,763(9) * 121(10) 82,884 *
Thomas C. Geiser................... 75,125(11) * 4,500(12) 79,625 *
David R. Banks..................... 1,000(13) * -- 1,000 *
W. Toliver Besson.................. 1,333(14) * -- 1,333 *
Roger E. Birk...................... 10,335 * -- 10,335 *
Stephen L. Davenport............... 1,253 * -- 1,253 *
Julie A. Hill...................... 333 * -- 333 *
Robert T. Knight................... 1,133(15) * -- 1,133 *
Elizabeth A. Sanders............... -- * -- -- *
Sheila P. Burke.................... -- * -- -- *
All executive officers and 668,391(16) 1.0 69,308(17) 737,699 1.1
directors as a group
(14 persons)......................
- ------------------------
* Less than one percent.
(1) Except as indicated in footnotes to this table, the shareholders named in
this table are known to the Company to have sole voting and investment power
with respect to all shares of Common Stock shown as beneficially owned by
them, subject to community property laws where applicable. Shares shown as
beneficially owned by any person have been determined in accordance with the
requirements of Rule 13d-3 promulgated under the Securities Exchange Act of
1934, as amended.
(2) Calculation based on 66,570,263 shares of Common Stock outstanding as of
March 19, 1997.
(3) As of February 28, 1997, 29,860,923 shares and 5,232,254 shares were held
pursuant to the Voting Agreement and Voting Trust Agreement, respectively.
These agreements contain provisions with respect to the voting of shares
subject to them on certain specified matters. See "Item 1. Business --
Recapitalization."
(4) Of such shares, 5,232,254 are held in the capacity of trustee under the
Voting Trust Agreement. With respect to such shares, Wilmington Trust
Company has shared voting power with the Foundation.
44
(5) Includes 400 shares held in a Keogh account, 200 shares held in an IRA
account and 339 shares held in a 401(k) account for the benefit of Mr.
Schaeffer. Includes 206,081 shares subject to presently exercisable options
or options that become exercisable within 60 days.
(6) Represents deferred share units. The Company has agreed to issue such
shares to Mr. Schaeffer upon termination of his employment with the Company.
See "Item 11. Executive Compensation."
(7) Includes 3,100 shares held in a 401(k) account for the benefit of Mr.
Weinberg and 121,148 shares subject to presently exercisable options or
options that become exercisable within 60 days.
(8) Includes 59 shares held in a 401(k) account for the benefit of Mr.
Williams, 115,922 shares subject to presently exercisable options or options
that become exercisable within 60 days.
(9) Includes 4,000 shares held in a 401(k) account, 1,667 shares held in an IRA
account for the benefit of Mr. Phanstiel and 65,172 shares subject to
presently exercisable options or options that become exercisable within 60
days.
(10) Represents deferred rights to shares held under a deferred compensation
arrangement for the benefit of Mr. Phanstiel.
(11) Includes 58 shares held in a 401(k) account for the benefit of Mr. Geiser
and 64,173 shares subject to presently exercisable options or options that
become exercisable within 60 days.
(12) Represents a restricted share right grant made to Mr. Geiser that vests in
equal installments on June 1, 1997, 1998 and 1999.
(13) Includes 500 shares held in a Keogh account for the benefit of Mr. Banks.
(14) Includes 900 shares owned by the W. Toliver Besson Retirement Plan, of
which Mr. Besson is trustee. Includes 100 shares owned by Mr. Besson's wife.
(15) All shares are owned by Mr. Knight and his wife.
(16) Includes 572,496 shares subject to presently exercisable options or options
that become exercisable within 60 days.
(17) Includes a restricted share right grant of 500 shares made to an executive
officer in December 1996.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Prior to the Recapitalization, BCC owned approximately 80% of the
outstanding capital stock of the Company. At the time of the formation of the
Company in 1992, BCC, the Company and certain of the Company's subsidiaries
entered into an Administrative Services and Product Marketing Agreement (the
"Administrative Services Agreement"). Pursuant to the Administrative Services
Agreement, BCC provided office space and certain administrative and support
services, including computerized data processing and management information
systems, telecommunications systems and other management services, to WellPoint.
The expenses for these services were allocated to and paid by the Company in an
amount equal to the direct and indirect costs and expenses incurred in
furnishing the services. In addition, the Company provided services to BCC which
included health plan support services, financial management services and certain
provider contracting services, all of which were reimbursed on a basis that
approximated cost.
In 1996 prior to the Recapitalization, the Company incurred intercompany
charges of approximately $13,601,000 for services rendered by BCC pursuant to
the Administrative Services Agreement and BCC incurred intercompany charges of
approximately $3,931,000 for services rendered by WellPoint pursuant to the
Administrative Service Agreement.
As required by the DOC, prior to the Recapitalization, non-contract provider
services under the Company's and BCC's jointly marketed Prudent Buyer and
Medicare supplement products were required
45
to be provided by BCC and revenues attributable to such non-contract provider
services were therefore not included in the Company' financial statements. BCC
recorded a portion of the premium revenue for these products based on the
estimated costs of providing these non-contract provider health care services,
plus an underwriting margin equal to the greater of 2.0% or the average
percentage of underwriting gain among BCBSA member plans. Such aggregate premium
revenue recognized by BCC related to the non-contract provider services for
these products for the period from January 1, 1996 through May 20, 1996 was
$59,300,000. Operating income recognized by BCC on such non-contract provider
services for these products for the period from January 1, 1996 through May 20,
1996 was estimated at $1,200,000.
Mr. Besson, is a partner in the law firm of Paul, Hastings, Janofsky &
Walker. Paul, Hastings, Janofsky & Walker was previously retained as counsel to
Ms. Elizabeth Sanders to advise her with respect to her designation as a
director of the Company. Pursuant to the engagement letter for such services,
WellPoint agreed to pay the fees and expenses relating to such representation.
Mr. Besson was not involved in, did not work on, and was not aware of any issues
on which advice was given to Ms. Sanders. In addition, Paul, Hastings, Janofsky
& Walker has been retained by the Company to advise it on a variety of other
matters. During 1996, a total of $60,855 was paid by WellPoint to such firm for
legal fees and disbursements.
Pursuant to the requirements of the BCBSA pertaining to the issuance of the
new license to WellPoint covering the use of the Blue Cross name and related
service marks by WellPoint in California, the Common Stock owned by the
Foundation is subject to the terms of the Voting Trust Agreement and the Voting
Agreement. Pursuant to the Voting Trust Agreement, the voting power of the
Foundation is limited to less than 5% of the voting power of WellPoint.
WellPoint Common Stock owned by the Foundation above such limit is required to
be held in a voting trust and will be voted by the voting trustee (i) with
respect to elections and removal of directors, calling of shareholder meetings
and amendments of the WellPoint charter and bylaws, to support the position of
the Board of Directors, and (ii) with respect to other matters, generally to
support the vote of the other shareholders. Shares in excess of the Ownership
Limit (as defined in the Company's Articles of Incorporation) are subject to the
Voting Agreement, which contains provisions similar to the Voting Trust
Agreement with respect to elections and removal of directors, calling of
shareholder meetings and amendment of WellPoint charter and bylaws. See "Item 1.
Business--Recapitalization."
In connection with the Recapitalization, the Company and the Foundation also
entered into the Registration Rights Agreement. Under certain circumstances and
subject to certain limitations, the Registration Rights Agreement requires
WellPoint to effect under applicable securities laws the registration of shares
of WellPoint Common Stock held by the Foundation for sale to the public, as well
as permit the Foundation to participate in certain of such registrations which
WellPoint effects on its own initiative. The undertakings which the Foundation
made to the DOC in order to secure the DOC's approval of the Recapitalization
include annual distribution of approximately 5% of the value of its investment
assets beginning in 1997. In order to fund such required distributions, the
Foundation may sell shares of WellPoint. In November 1996, the Company effected
a registration pursuant to which the Foundation sold 14,950,000 shares of
WellPoint Common Stock to the public. While the Registration Rights Agreement
contains provisions restricting the times at which shares may be registered and
the number of shares that may be included in any registration, there can be no
assurance that sales of WellPoint Common Stock pursuant to such registrations
will not adversely affect the market price of WellPoint Common Stock.
46
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 55 hereof.
a. 2) FINANCIAL STATEMENT SCHEDULES
All of the financial statements 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
On October 4, 1996, the Company filed a Current Report on Form 8-K dated
October 2, 1996, which reported the resignation of Yon Y. Jorden, the Company's
Chief Financial Officer, effective as of December 31, 1996.
On October 25, 1996, the Company filed a Current Report on Form 8-K dated
October 9, 1996, which reported that the Company had entered into definitive
agreement to acquire the GBO of John Hancock for an aggregate purchase price of
$86.7 million. An amendment thereto on Form 8-K/A was filed on November 18,
1996. In connection with such filings, the Company provided the following
historical financial statements with respect to the GBO:
(i) Unaudited Combined Statement of Assets and Liabilities as of
September 30, 1996;
(ii) Unaudited Combined Statement of Operations and Changes in Net Asset
Balance for the nine months ended September 30, 1996;
(iii) Unaudited Combined Statement of Cash Flows for the nine months
ended September 30, 1996;
(iv) Combined Statements of Assets and Liabilities as of December 31,
1995 and 1994;
(v) Combined Statements of Operations and Changes in Net Asset Balance
for the years ended December 31, 1995 and 1994; and
(vi) Combined Statements of Cash Flows for the years ended December 31,
1995 and 1994.
In connection therewith, the Company also filed the following pro forma
financial statements:
(i) Unaudited Combined Condensed Balance Sheet as of September 30, 1996;
(ii) Unaudited Combined Condensed Income Statement for the nine months
ended September 30, 1996; and
(iii) Unaudited Combined Condensed Income Statement for the year ended
December 31, 1995.
On December 12, 1996, the Company filed a Current Report on Form 8-K dated
November 21, 1996, which reported that the Company had entered into a
Subordinated Term Loan Agreement dated as of November 21, 1996 (the
"Subordinated Credit Agreement"), by and between the Company and Bank of America
National Trust & Savings Association. The Subordinated Credit Agreement provided
for an unsecured facility in the aggregate amount of $200 million. The Company
reported that the Superior Court of the State of California for Los Angeles
County had approved the Settlement, which is described in "Item 3. Legal
Proceedings." The Company also reported that the public offering of 14,950,000
shares of the Company's Common Stock held by the Foundation had been completed
on November 27, 1996. The
47
Current Report on Form 8-K also attached a general description of the business
operations of the Company and its subsidiaries as of September 30, 1996.
On January 2, 1997, the Company filed a Current Report on Form 8-K dated
December 19, 1996 which reported that CaliforniaCare had been awarded a one-year
accreditation by the National Committee of Quality Assurance ("NCQA"). The
Company also reported that, on December 30, 1996, CaliforniaCare had agreed to a
dismissal of its lawsuit previously filed in the United States District Court
for the District of Columbia against NCQA.
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, WellPoint Health Partnership and Western Foundation for Health Improvements,
incorporated by reference to Exhibit 2.1 of Registrant's Form S-4 dated April 8, 1996
2.02 Purchase and Sale Agreement, dated as of January 5, 1996, by and among the Registrant and Massachusetts
Mutual Life Insurance Company, incorporated by reference to Exhibit 2.1 of Registrant's 8-K dated
January 5, 1996
2.03 Purchase and Sale Agreement, dated as of October 10, 1996, by and between the Registrant and John
Hancock Mutual Life Insurance Company ("John Hancock"), incorporated by reference to Exhibit 2.1 of
Registrant's Current Report on Form 8-K dated October 9, 1996
3.01 Amended and Restated Articles of Incorporation of the Registrant, incorporated by reference to Exhibit
3.1 of Registrant's Form 8-K dated May 20, 1996
3.02 Bylaws of the Registrant, incorporated by reference to Exhibit 3.2 of Registrant's Form 8-K dated May
20, 1996
3.03 Agreement of Merger dated as of May 20, 1996, by and among the Registrant, WellPoint Health Networks
Inc., a Delaware corporation, Western Health Partnerships and Western Foundation for Health
Improvement, incorporated by reference to Exhibit 3.3 of Registrant's Form 8-K dated May 20, 1996
4.01 Specimen of common stock certificate of WellPoint Health Networks Inc., incorporated by reference to
Exhibit 4.4 of Registrant's Registration Statement on Form S-3, Registration No. 33-14885
9.01 Voting Trust Agreement dated as of May 20, 1996, by and between the Registrant, Western Health
Partnerships and Wilmington Trust Company, incorporated by reference to Exhibit 99.2 of Registrant's
Form 8-K dated May 20, 1996
10.01 Line of Business Assignment and Assumption Agreement dated as of February 1, 1993, among the Registrant,
its subsidiaries and BCC, incorporated by reference to Exhibit 10.01 of Registrant's Form 10-K for the
fiscal year ended December 31, 1992
10.02 Administrative Services and Product Marketing Agreement dated as of February 1, 1993, among the
Registrant, its subsidiaries and BCC, incorporated by reference to Exhibit 10.02 of Registrant's Form
10-K for the fiscal year ended December 31, 1992
10.03 Master Subscriber Agreements dated as of January 27, 1993, between the Registrant's subsidiaries and
BCC, incorporate by reference to Exhibit 10.03 of Registrant's Form 10-K for the fiscal year ended
December 31, 1992
10.04 Tax Allocation Agreement dated as of February 1, 1993, among the Registrant, its subsidiaries and BCC
and its subsidiaries, incorporated by reference to Exhibit 10.04 of Registrant's Form 10-K for the
fiscal year ended December 31, 1992
48
EXHIBIT
NUMBER EXHIBIT
- --------- --------------------------------------------------------------------------------------------------------
10.05 Office Space Lease for Oakland, CA offices, dated December 10, 1985, between BCC and Webster Street
Partners, Ltd., incorporated by reference to Exhibit 10.06 of the Registrant's Form S-1 Registration
Statement No. 33-54898
10.06 Office Space Lease for Westlake, CA offices, dated October 29, 1986, between BCC and Westlake Business
Park, Ltd., incorporated by reference to Exhibit 10.07 of the Registrant's Form S-1 Registration
Statement No. 33-54898
10.07 Administrative Agreement, dated as of June 1, 1988, between BCC and INSURx, Inc., incorporated by
reference to Exhibit 10.08 of the Registrant's Form S-1 Registration Statement No. 33-54898
10.08 Undertakings dated January 7, 1993, by BCC, the Registrant and the Registrant's subsidiaries to the
California Department of Corporations, incorporated by reference to Exhibit 10.24 of Registrant's Form
S-1 Registration Statement No. 33-54898
10.09 Office Space Lease for Newbury Park, CA offices, dated January 13, 1993, between BCC and Metropolitan
Life Insurance Company, incorporated by reference to Exhibit 10.12 of Registrant's Form 10-K for the
fiscal year ended December 31, 1992
10.10 Office Space Lease for Calabasas, CA offices, dated August 26, 1992, between BCC and Lost Hills Office
Partners, First Amendment to Office Lease between Lost Hills Office Partners and BCC, dated November
1, 1992, and Subordination, Non-Disturbance and Attornment Agreement, dated January 7, 1993, between
BCC and DAG Management, incorporated by reference to Exhibit 10.13 of Registrant's Form 10-K for the
fiscal year ended December 31, 1992
10.11 WellPoint Health Networks Inc. Officer Change in Control Plan, incorporated by reference to Exhibit
10.14 of Registrant's Form 10-K for the fiscal year ended December 31, 1993
10.12 Supplemental Pension Plan of Blue Cross of California, incorporated by reference to Exhibit 10.15 of
Registrant's Form 10-K for the fiscal year ended December 31, 1992
10.13 Blue Cross of California Deferred Compensation Plan, incorporated by reference to Exhibit 10.13 of the
Registrant's Form S-1 Registration Statement No. 33-54898
10.14 Form of Supplemental Life and Disability Insurance Policy, incorporated by reference to Exhibit 10.14 of
the Registrant's Form S-1 Registration Statement No. 33-54898
10.15 Special Executive Retirement Plan dated as of March 29, 1993, among BCC, the Registrant and Leonard D.
Schaeffer, incorporated by reference to Exhibit 10.19 of the Registrant's Form 10-K for the fiscal
year ended December 31, 1992
10.16 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
10.17 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 Form 10-K for the fiscal year ended
December 31, 1993
10.18 First Amendment to Special Executive Retirement Plan dated as of March 29, 1993, among BCC, the
Registrant and Leonard D. Schaeffer (Exhibit 10.19), effective January 1, 1993, incorporated by
reference to Exhibit 10.25 of the Registrant's Form 10-K for the fiscal year ended December 31, 1993
10.19 Executive Benefiting You Highlights Brochure, incorporated by reference to Exhibit 10.29 of
Registrants's Form 10-K for the fiscal year ended December 31, 1993
49
EXHIBIT
NUMBER EXHIBIT
- --------- --------------------------------------------------------------------------------------------------------
10.20 WellPoint Health Networks Inc. Officer Change in Control Plan as amended January 5, 1995, incorporated
by reference to Exhibit 10.33 of the Registrant's Form 10-K for the fiscal year ended December 31,
1994
10.21 Form of Officer Severance Agreement of the Registrant, incorporated by reference to Exhibit 10.32 of the
Registrant's Form 10-K for the fiscal year ended December 31, 1994
10.22 WellPoint Health Networks Inc. Management Retention Agreement between the Registrant and Ronald A.
Williams, amended and restated effective as of January 5, 1995, incorporated by reference to Exhibit
10.35 of the Registrant's Form 10-K for the fiscal year ended December 31, 1994
10.23 WellPoint Health Networks Inc. Management Retention Agreement between the Registrant and D. Mark
Weinberg, amended and restated effective as of January 5, 1995, incorporated by reference to Exhibit
10.36 of the Registrant's Form 10-K for the fiscal year ended December 31, 1994
10.24 Amendment to Administrative Services and Product Marketing Agreement dated as of February 1, 1993, among
the Registrant, its subsidiaries and BCC (Exhibit 10.02), amended as of January 1, 1995, incorporated
by reference to Exhibit 10.39 of Registrant's Form 10-K for the fiscal year ended December 31, 1994
10.25 Amendment to Administrative Services and Product Marketing Agreement dated as of February 1, 1993, among
the Registrant, its subsidiaries and BCC (Exhibit 10.02), amended as of February 1, 1995, incorporated
by reference to Exhibit 10.40 of Registrant's Form 10-K for the fiscal year ended December 31, 1994
10.26 Agreement of Purchase and Sale and Escrow Instructions, dated as of December 16, 1994, between
Registrant and Pardee Construction Company, incorporated by reference to Exhibit 10.41 of Registrant's
Form 10-K for the fiscal year ended December 31, 1994
10.27 Credit Agreement, dated as of October 19, 1994, among the Registrant, Bank of America, National Trust
and Savings Association, Chemical Bank and Other Financial Institutions, incorporated by reference to
Exhibit 10.43 of Registrant's Form 10-K for the fiscal year ended December 31, 1994
10.28 First Amendment to Credit Agreement, dated as of March 7, 1995, among the Registrant, Bank of America
National Trust and Savings Association, and other Financial Institutions, incorporated by reference to
Exhibit 10.44 of Registrant's Form 10-K for the fiscal year ended December 31, 1994
10.29 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 Form 10-Q for the quarter ended September
30, 1995
10.30 Second Amendment to Credit Agreement, dated as of October 16, 1995, among the Registrant, Bank of
America National Trust and Savings Associations and other Financial Institutions, incorporated by
reference to Exhibit 10.48 of Registrant's Form 10-Q for the quarter ended September 30, 1995
10.31 WellPoint Health Networks Inc. Stock Option/Award Plan, incorporated by reference to Exhibit 10.45 of
Registrant's Form 10-K for the fiscal year ended December 31, 1995
10.32 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 Form 10-K for the fiscal
year ended December 31, 1995
50
EXHIBIT
NUMBER EXHIBIT
- --------- --------------------------------------------------------------------------------------------------------
10.33 Letter, dated November 13, 1995, from the Registrant to Ronald A. Williams regarding severance benefits,
together with underlying Officer Severance Agreement, incorporated by reference to Exhibit 10.47 of
Registrant's Form 10-K for the fiscal year ended December 31, 1995
10.34 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 Form 10-K for the fiscal year ended December 31, 1995
10.35 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 Form 10-K for the fiscal year ended
December 31, 1995
10.36 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
10.37 Senior Series A Term Note dated March 31, 1996, between the Registrant and Massachusetts Mutual Life
Insurance Company, incorporated by reference to Exhibit 10.53 of the Registrant's Form 10-Q for the
quarter ended March 31, 1996
10.38 Voting Agreement dated as of May 8, 1996, by and among the Registrant and Western Health Partnerships,
incorporated by reference to Exhibit 99.3 of Registrant's Form 8-K dated May 20, 1996
10.39 Share Escrow Agent Agreement dated as of May 20, 1996, by and between the Registrant and U.S. Trust
Company of California, N.A., incorporated by reference to Exhibit 99.4 of Registrant's Form 8-K dated
May 20, 1996
10.40 Registration Rights Agreement dated as of May 20, 1996, by and between the Registrant and Western Health
Partnerships, incorporated by reference to Exhibit 99.5 of Registrant's Form 8-K dated May 20, 1996
10.41 Blue Cross License Agreement effective as of May 20, 1996, by and among the Blue Cross and Blue Shield
Association and the Registrant (supersedes Exhibit 10.09), incorporated by reference to Exhibit 99.6
of Registrant's Form 8-K dated May 20, 1996
10.42 California Blue Cross License Addendum effective as of May 20, 1996, by and between the Blue Cross and
Blue Shield Association and the Registrant, incorporated by reference to Exhibit 99.7 of Registrant's
Form 8-K dated May 20, 1996
10.43 Blue Cross Affiliated License Agreement effective as of May 20, 1996, by and between the Blue Cross and
Blue Shield Association and CaliforniaCare Health Plans, incorporated by reference to Exhibit 99.8 of
Registrant's Form 8-K dated May 20, 1996
10.44 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 Registrant's Form 8-K dated May 20, 1996
10.45 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 Registrant's Form 8-K dated May 20, 1996
10.46 WellPoint Health Networks Inc. Employee Stock Option Plan, incorporated by reference to the Registrant's
Registration Statement on Form S-8 (Registration No. 33-05111)
51
EXHIBIT
NUMBER EXHIBIT
- --------- --------------------------------------------------------------------------------------------------------
10.47 WellPoint Health Networks Inc. Employee Stock Purchase Plan, incorporated by reference to the
Registrant's Registration Statement on Form S-8 (Registration No. 333-05111)
10.48 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 Form 10-Q for the quarter ended
September 30, 1996
10.49 Subordinated Term Loan Agreement dated as of November 21, 1996, by and among the Registrant, Bank of
America and the other parties named therein, incorporated by reference to Exhibit 99.1 to the
Registrant's Current Report on Form 8-K filed December 12, 1996
10.50 Employment Agreement dated as of January 22, 1997, by and between the Registrant and Leonard D.
Schaeffer
10.51 Modification Agreement dated as of November 26, 1996 by and between the Registrant and California
HealthCare Foundation
10.52 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
10.53 Administration Agreement dated as of March 1, 1997 between John Hancock and UNICARE, incorporated by
reference to Exhibit 99.3 of Registrant's Current Report on Form 8-K filed March 14, 1997
10.54 Amendment No. 1 dated as of February 11, 1997 to Registrant's Subordinated Term Loan Agreement dated as
of November 21, 1996
10.55 Blue Cross Affiliate License Agreement by and between BC Life & Health Insurance Company and the BCBSA
10.56 Blue Cross Controlled Affiliate License Agreement Applicable to Life Insurance Companies by and between
BC Life & Health Insurance Company and the BCBSA
21 List of Subsidiaries of the Registrant
23.1 Consent of Independent Accountants
23.2 Consent of Sheila P. Burke, Director-designate effective as of April 1, 1997
24 Power of Attorney (included on Signature Page).
27.1 Financial Data Schedule
52
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 19, 1997
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 and 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 dated 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
- ------------------------------ -------------------------- -------------------
Chairman of the Board of
/s/ LEONARD D. SCHAEFFER Directors and Chief
- ------------------------------ Executive Officer March 19, 1997
Leonard D. Schaeffer (Principal Executive
Officer)
Executive Vice President,
/s/ HOWARD G. PHANSTIEL Finance and Information
- ------------------------------ Services (Principal March 19, 1997
Howard G. Phanstiel Financial Officer)
53
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
Vice President, Controller
/s/ S. LOUISE MCCRARY and Chief Accounting
- ------------------------------ Officer (Principal March 19, 1997
S. Louise McCrary Accounting Officer)
/s/ DAVID R. BANKS
- ------------------------------ Director March 19, 1997
David R. Banks
/s/ W. TOLIVER BESSON
- ------------------------------ Director March 19, 1997
W. Toliver Besson
/s/ ROGER E. BIRK
- ------------------------------ Director March 19, 1997
Roger E. Birk
/s/ STEPHEN L. DAVENPORT
- ------------------------------ Director March 19, 1997
Stephen L. Davenport
/s/ JULIE A. HILL
- ------------------------------ Director March 19, 1997
Julie A. Hill
/s/ ROBERT T. KNIGHT
- ------------------------------ Director March 19, 1997
Robert T. Knight
/s/ ELIZABETH A. SANDERS
- ------------------------------ Director March 19, 1997
Elizabeth A. Sanders
54
INDEX TO FINANCIAL STATEMENTS
WELLPOINT HEALTH NETWORKS INC.
PAGE
---------
Report of Independent Accountants......................................................................... F-1
Consolidated Balance Sheets as of December 31, 1996 and 1995.............................................. F-2
Consolidated Income Statements for the Three Years Ended December 31, 1996................................ F-3
Consolidated Statements of Changes in Stockholders' Equity for the Three Years Ended December 31, 1996.... F-4
Consolidated Statements of Cash Flows for the Three Years Ended December 31, 1996......................... F-5
Notes to Consolidated Financial Statements................................................................ F-6
55
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors
WellPoint Health Networks Inc.
We have audited the accompanying consolidated balance sheets of WellPoint
Health Networks Inc. and subsidiaries (the "Company") as of December 31, 1996
and 1995, and the related consolidated income statements and consolidated
statements of changes in stockholders' equity and cash flows for each of the
three years in the period ended December 31, 1996. 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 in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of WellPoint
Health Networks Inc. and subsidiaries as of December 31, 1996 and 1995, and the
consolidated results of their operations and cash flows for each of the three
years in the period ended December 31, 1996 in conformity with generally
accepted accounting principles.
COOPERS & LYBRAND L.L.P.
Los Angeles, California
February 14, 1997, except Note 18 as to
which the date is March 17, 1997
F-1
WELLPOINT HEALTH NETWORKS INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
DECEMBER 31,
------------------------
(IN THOUSANDS, EXCEPT SHARE DATA) 1996 1995
----------- -----------
Current Assets:
Cash and cash equivalents............................................................. $ 313,256 $ 1,069,631
Investment securities, at market value................................................ 1,728,305 1,174,974
Receivables, net...................................................................... 401,300 149,081
Deferred tax assets................................................................... 67,147 42,969
Other current assets.................................................................. 28,463 25,651
----------- -----------
Total Current Assets................................................................ 2,538,471 2,462,306
Property and equipment, net............................................................. 82,720 42,964
Intangible assets....................................................................... 552,279 124,956
Long-term investments................................................................... 123,931 12,664
Deferred tax assets..................................................................... 57,830 36,367
Other non-current assets................................................................ 50,311 --
----------- -----------
Total Assets........................................................................ $ 3,405,542 $ 2,679,257
----------- -----------
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Medical claims payable................................................................ $ 667,540 $ 362,881
Loss and loss adjustment expense reserves............................................. 102,152 66,489
Unearned premiums..................................................................... 160,036 132,298
Accounts payable and accrued expenses................................................. 251,480 111,005
Experience rated and other refunds.................................................... 146,882 93,478
Income taxes payable.................................................................. 99,086 31,466
Other current liabilities............................................................. 118,303 42,731
----------- -----------
Total Current Liabilities........................................................... 1,545,479 840,348
Accrued postretirement benefits......................................................... 61,086 50,158
Loss and loss adjustment expense reserves, non-current.................................. 131,079 107,000
Reserves for future policy benefits..................................................... 104,508 --
Long-term debt.......................................................................... 625,000 --
Other non-current liabilities........................................................... 67,931 11,525
----------- -----------
Total Liabilities................................................................... 2,535,083 1,009,031
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, 66,526,985 issued and
outstanding at December 31, 1996.................................................... 665 --
Class A Common Stock--$0.01 par value, 200,000,000 shares authorized, 19,500,000
issued and outstanding at December 31, 1995......................................... -- 195
Class B Common Stock--$0.01 par value 100,000,000 shares authorized, 80,000,000 issued
and outstanding at December 31, 1995................................................ -- 800
Additional paid-in capital............................................................ 761,879 1,100,288
Unrealized valuation adjustment....................................................... (9,994) 1,820
Retained earnings..................................................................... 117,909 567,123
----------- -----------
Total Stockholders' Equity.......................................................... 870,459 1,670,226
----------- -----------
Total Liabilities and Stockholders' Equity........................................ $ 3,405,542 $ 2,679,257
----------- -----------
----------- -----------
See the accompanying notes to the consolidated financial statements.
F-2
WELLPOINT HEALTH NETWORKS INC.
CONSOLIDATED INCOME STATEMENTS
YEAR ENDED DECEMBER 31,
----------------------------------------
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE) 1996 1995 1994
------------ ------------ ------------
Revenues:
Premium revenue....................................................... $ 3,879,806 $ 2,910,622 $ 2,647,951
Management services revenue........................................... 147,948 61,151 36,274
Investment income..................................................... 142,028 135,306 107,447
------------ ------------ ------------
4,169,782 3,107,079 2,791,672
Operating Expenses:
Health care services and other benefits............................... 3,003,117 2,199,953 1,927,954
Selling expense....................................................... 224,453 190,161 169,483
General and administrative expense.................................... 545,942 344,427 334,206
Nonrecurring costs.................................................... -- 57,074 --
------------ ------------ ------------
3,773,512 2,791,615 2,431,643
------------ ------------ ------------
Operating Income........................................................ 396,270 315,464 360,029
Interest expense...................................................... 36,628 -- --
Other expense, net.................................................... 20,134 12,677 8,008
------------ ------------ ------------
Income before Provision for
Income Taxes.......................................................... 339,508 302,787 352,021
Provision for income taxes............................................ 137,506 122,798 138,851
------------ ------------ ------------
Net Income.............................................................. $ 202,002 $ 179,989 $ 213,170
------------ ------------ ------------
------------ ------------ ------------
Earnings Per Share...................................................... $ 3.04 $ 2.71 $ 3.21
------------ ------------ ------------
------------ ------------ ------------
See the accompanying notes to the consolidated financial statements.
F-3
WELLPOINT HEALTH NETWORKS INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
CLASS B
CLASS A COMMON
COMMON STOCK COMMON STOCK STOCK
PREFERRED ------------------------ ---------------------- ---------
STOCK SHARES AMOUNT SHARES AMOUNT SHARES
------------- ----------- ----------- --------- ----------- ---------
(IN THOUSANDS)
Balance as of December 31, 1993.................. $ -- -- $ -- 19,500 $ 195 80,000
Net income.....................................
Change in unrealized valuation adjustment on
investment securities, net of tax............
Additional capital contributed by Blue Cross of
California (utilization of AMT credit).......
----- ----------- ----- --------- ----- ---------
Balance as of December 31, 1994.................. -- -- -- 19,500 195 80,000
Net income.....................................
Change in unrealized valuation adjustment on
investment securities, net of tax............
----- ----------- ----- --------- ----- ---------
Balance as of December 31, 1995.................. -- -- -- 19,500 195 80,000
Net income.....................................
Recapitalization
Dividends....................................
Share exchange............................... 66,367 664 (19,500) (195) (80,000)
Stock grants to employees and directors........ 117 1
Stock issued for employee stock purchase
plan......................................... 43
Change in unrealized valuation adjustment on
investment securities, net of tax............
----- ----------- ----- --------- ----- ---------
Balance as of December 31, 1996.................. $ -- 66,527 $ 665 -- $ -- --
----- ----------- ----- --------- ----- ---------
----- ----------- ----- --------- ----- ---------
ADDITIONAL UNREALIZED
PAID-IN VALUATION RETAINED
AMOUNT CAPITAL ADJUSTMENT EARNINGS TOTAL
----------- ----------- ----------- ----------- ---------
Balance as of December 31, 1993.................. $ 800 $1,056,588 $ 1,643 $ 173,964 $1,233,190
Net income..................................... 213,170 213,170
Change in unrealized valuation adjustment on
investment securities, net of tax............ (71,141) (71,141)
Additional capital contributed by Blue Cross of
California (utilization of AMT credit)....... 43,700 43,700
----- ----------- ----------- ----------- ---------
Balance as of December 31, 1994.................. 800 1,100,288 (69,498) 387,134 1,418,919
Net income..................................... 179,989 179,989
Change in unrealized valuation adjustment on
investment securities, net of tax............ 71,318 71,318
----- ----------- ----------- ----------- ---------
Balance as of December 31, 1995.................. 800 1,100,288 1,820 567,123 1,670,226
Net income..................................... 202,002 202,002
Recapitalization
Dividends.................................... (343,784) (651,216) (995,000)
Share exchange............................... (800) 331
Stock grants to employees and directors........ 4,082 4,083
Stock issued for employee stock purchase
plan......................................... 962 962
Change in unrealized valuation adjustment on
investment securities, net of tax............ (11,814) (11,814)
----- ----------- ----------- ----------- ---------
Balance as of December 31, 1996.................. $ -- $ 761,879 $ (9,994) $ 117,909 $ 870,459
----- ----------- ----------- ----------- ---------
----- ----------- ----------- ----------- ---------
See the accompanying notes to the consolidated financial statements.
F-4
WELLPOINT HEALTH NETWORKS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
---------------------------------------
1996 1995 1994
------------ ----------- ------------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income........................................................... $ 202,002 $ 179,989 $ 213,170
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization, net of accretion.................... 37,739 22,034 20,292
Gains on sales of assets, net...................................... (15,677) (14,510) (4,000)
Benefit for deferred income taxes.................................. (22,341) (17,973) (5,970)
Amortization of deferred gain on sale of building.................. (2,582) -- --
Writedown for impairment of intangible assets...................... -- 27,316 --
(Increase) decrease in certain assets, net of acquisitions:
Receivables, net................................................. 14,812 (37,508) 6,763
Other current assets............................................. 46,929 (4,907) (12,383)
Other non-current assets......................................... (47,552) -- --
Increase (decrease) in certain liabilities, net of acquisitions:
Medical claims payable........................................... (9,805) (4,422) 4,267
Loss and loss adjustment expense reserves........................ 59,742 25,581 14,689
Reserves for future policy benefits.............................. (492) -- --
Unearned premiums................................................ 20,382 4,935 (7,961)
Accounts payable and accrued expenses............................ 74,320 3,711 38,545
Experience rated and other refunds............................... 11,043 (34,910) 23,383
Income taxes payable and other current liabilities............... 48,752 (3,304) (38,973)
Accrued postretirement benefits.................................. (1,600) 4,352 7,101
Other non-current liabilities.................................... (4,772) -- --
------------ ----------- ------------
Net cash provided by operating activities...................... 410,900 150,384 258,923
------------ ----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investments purchased................................................ (1,220,370) (706,792) (1,084,809)
Proceeds from investments sold....................................... 899,080 771,074 1,012,726
Proceeds from matured investments.................................... 81,448 686,221 75,112
Property and equipment purchased, net................................ (43,327) (25,223) (22,004)
Purchase of subsidiaries, net of cash acquired....................... (453,068) (13,177) (215,813)
------------ ----------- ------------
Net cash provided by (used in) investing activities............ (736,237) 712,103 (234,788)
------------ ----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of UniCARE Financial Corp.'s long-term note................ -- -- (15,000)
Proceeds from long-term debt......................................... 825,000 -- --
Repayment of long-term debt.......................................... (262,000) -- --
Dividends paid in connection with the Recapitalization............... (995,000) -- --
Proceeds from the issuance of stock.................................. 962 -- --
Additional capital contributed by Blue Cross of California........... -- 43,700 42,767
------------ ----------- ------------
Net cash provided by (used in) financing activities............ (431,038) 43,700 27,767
------------ ----------- ------------
Net increase (decrease) in cash and cash equivalents................... (756,375) 906,187 51,902
Cash and cash equivalents at beginning of year......................... 1,069,631 163,444 111,542
------------ ----------- ------------
Cash and cash equivalents at end of year............................... $ 313,256 $ 1,069,631 $ 163,444
------------ ----------- ------------
------------ ----------- ------------
See the accompanying notes to the consolidated financial statements.
F-5
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
WellPoint Health Networks Inc. (the "Company" or "WellPoint"), one of the
nation's largest publicly traded managed health care companies, is organized
under the laws of California and holds the exclusive license for the right to
use the Blue Cross name and related service marks in California. The Company has
medical members in all 50 states and the District of Columbia.
The Company offers a comprehensive array of managed care health plans to
both the large employer and the individual, senior and small employer markets.
These plans are marketed through health maintenance organizations ("HMOs"),
preferred provider organizations ("PPOs"), point-of-service ("POS"), and
specialty managed care networks. The Company's managed care plans incorporate a
full range of financial incentives and cost controls for both members and
providers. The Company also provides a broad array of specialty products,
including pharmacy, dental, life, integrated workers' compensation, preventive
care, disability, behavioral health, COBRA and flexible benefits account
administration. In addition, the Company provides underwriting, actuarial
service, network access, medical cost management, claims processing and
administrative services to self-funded employers. The Company serves the health
care needs of approximately 4.5 million medical members in HMOs, PPOs, POS and
management services plans and approximately 11.5 million pharmacy members and
1.6 million dental members as of December 31, 1996. The Company's primary market
for managed care products and services is the State of California.
2. ACQUISITIONS AND RECAPITALIZATION
PURCHASE OF MASSACHUSETTS MUTUAL LIFE INSURANCE COMPANY'S LIFE AND HEALTH
BENEFITS MANAGEMENT DIVISION
On March 31, 1996, the Company completed its acquisition of the Life and
Health Benefits Management Division ("MMHD") of Massachusetts Mutual Life
Insurance Company ("MassMutual"), which conducts business under the name UNICARE
Life & Health Insurance Company, through the acquisition of its parent
MassMutual Holding Company Two, Inc. The acquired operations are included in the
Company's results of operations from the date of acquisition. The purchase price
was $402.2 million which was funded with $340.2 million in cash and a Series A
term note for $62.0 million, of which $20.0 million was outstanding at December
31, 1996.
The purchase method of accounting has been used to account for the MMHD
acquisition. The excess purchase price over net assets acquired was
approximately $233.4 million and is being amortized on a straight-line basis
over 35 years.
As of December 31, 1996, the acquired MMHD operations provided medical
services to approximately 1.0 million members, focusing on the large employer
market (groups of 251 to 5,000), and had medical members in all 50 states. In
addition, the acquired MMHD operations also had approximately 0.9 million dental
members, 0.4 million life insurance members, 0.5 million pharmacy members and
0.1 million disability members.
RECAPITALIZATION AND PURCHASE OF BCC COMMERCIAL OPERATIONS
On May 20, 1996, the Company concluded a series of transactions
(collectively, the "Recapitalization") to recapitalize its publicly traded,
majority-owned subsidiary, WellPoint Health Networks Inc., a Delaware
corporation ("Old WellPoint"), pursuant to the Amended and Restated
Recapitalization Agreement dated as of March 31, 1995 (the "Amended
Recapitalization Agreement"), by and among Old
F-6
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. ACQUISITIONS AND RECAPITALIZATION (CONTINUED)
WellPoint, the company formerly known as Blue Cross of California ("BCC"), the
California HealthCare Foundation (the "Foundation") and the California Endowment
(the "Endowment"). In connection with the Recapitalization, (a) Old WellPoint
distributed an aggregate of $995.0 million by means of a special dividend of
$10.00 per share to the record holders of its Class A and Class B Common Stock
as of May 15, 1996, (b) BCC, the sole shareholder of Old WellPoint's Class B
Common Stock, donated its portion of such dividend ($800.0 million) to the
Endowment, (c) BCC donated its assets, other than the shares of the Old
WellPoint Class B Common Stock held by BCC and its commercial operations (the
"BCC Commercial Operations"), to the Foundation, (d) BCC changed its status from
a California nonprofit public benefit corporation to a California for-profit
business corporation, in conformity with the terms and orders of the California
Department of Corporations (the "DOC"), immediately following which BCC issued
to the Foundation 53,360,000 shares of its common stock and (e) Old WellPoint
merged with and into BCC (the "Merger"), with the resulting entity changing its
name to WellPoint Health Networks Inc. In connection with the Merger, (i) each
outstanding share of Old WellPoint's Class A Common Stock was converted into
0.667 shares of the Company's Common Stock, (ii) the outstanding shares of the
Company's common stock issued to the Foundation prior to the Merger were
converted into 53,360,000 shares of the post-merger Company's Common Stock and a
cash payment of $235.0 million was made to the Foundation to reflect the value
of the BCC Commercial Operations and the value of the Blue Cross mark (iii) the
outstanding shares of Old WellPoint's Class B Common Stock were canceled. The
BCC Commercial Operations consisted of, among other things, the health care
lines of business conducted by BCC, substantially all agreements with health
care providers that provided services to enrollees of BCC and all of the cash
and securities of BCC on hand at the time of closing of the Recapitalization. In
November 1996, the Company and the Foundation amended the terms of the
Recapitalization to provide for the substitution by the Company of $7.0 million
in cash for the capital stock of certain entities owning the real estate parcel
surrounding the Company's headquarters building.
By virtue of the Merger and the exchange of shares of Old WellPoint for
those of the Company, as of May 20, 1996 (the effective date of the Merger),
there were a total of 66,366,500 shares of the Company's Common Stock
outstanding, of which 53,360,000 shares (or approximately 80.4%) were held
beneficially by the Foundation.
On November 21, 1996 the Foundation sold approximately 15 million shares of
the Company's Common Stock through a secondary stock offering. Following the
offering the Foundation owned 38,410,000 shares (or approximately 57.8%) of the
outstanding shares.
The purchase method of accounting has been used to account for the
acquisition of the BCC Commercial Operations. The excess purchase price over
assets acquired was approximately $206.7 million and is being amortized on a
straight-line basis over 40 years.
See Note 17 for unaudited pro forma combined condensed financial statements
for the above acquisitions.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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 generally accepted accounting principles and have been
consistently applied. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and
F-7
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 intangible assets, medical claims payable, loss and loss adjustment
expense reserves, reserves for future policy benefits, experience rated refunds
and contingent liabilities. While management believes that the carrying value of
such assets and liabilities are adequate as of December 31, 1996 and 1995,
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.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash investments,
investment securities and interest rate swaps. The Company invests its excess
cash primarily in commercial paper and money market funds. Although a majority
of the cash accounts exceed the federally insured deposit amount, management
does not anticipate nonperformance by financial institutions and reviews the
financial viability of these institutions on a periodic basis. The Company
attempts to limit its risk in investment securities by maintaining a diversified
portfolio. The components of investment securities are shown in Note 4.
INVESTMENTS
Investment securities consist primarily of U.S. Treasury and agency
securities, mortgage-backed securities, investment grade corporate bonds and
equity securities. The Company has determined that its investment securities are
available for use in current operations and, accordingly, has classified such
investment securities as current without regard to contractual maturity dates.
Long-term investments consist primarily of restricted assets, real estate,
mortgages, and other equity investments. Restricted assets included in long-term
investments at December 31, 1996 and 1995 were $93.7 million and $0.4 million,
respectively, and consist of deposits required by the DOC. These deposits
consist primarily of U.S. Treasury bonds and notes.
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 the stockholders' equity section of the balance sheet, 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 computing the cost of debt and equity securities sold.
F-8
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 and depreciated on the
straight-line method over the estimated useful lives of the assets. Leasehold
improvements are amortized over a period not exceeding the term of the lease.
INTANGIBLE ASSETS
Intangible assets represent the cost in excess of fair value of the net
assets (including tax attributes) acquired in purchase transactions. Intangible
assets are amortized on a straight-line basis over periods ranging from 25 to 40
years. Amortization charged to operations was $12.8 million, $5.6 million and
$3.2 million for the years ended December 31, 1996, 1995 and 1994, respectively.
Accumulated amortization as of December 31, 1996 and 1995 was $21.6 million and
$8.8 million, respectively.
The Company periodically evaluates whether events or circumstances have
occurred that may affect the estimated useful life or the recoverability of the
remaining balance of goodwill and other identifiable intangible assets.
Impairment of an intangible asset is triggered when the estimated future
undiscounted cash flows (excluding interest charges) do not exceed the carrying
amount of the intangible asset. If the events or circumstances indicate that the
remaining balance of the intangible assets may be permanently impaired, such
potential impairment will be measured based upon the difference between the
carrying amount of the intangible asset 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 yet 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 to physicians, certain other medical service
providers and hospitals in the Company's HMO networks as retainers for providing
continuing medical care. The Company maintains various programs that provide
incentives to physicians, certain other medical service providers and hospitals
participating in its HMO networks through the use of risk-sharing agreements and
other programs. Payments under such agreements are 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.
F-9
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
The estimated liabilities for loss and loss adjustment expenses relate to
the Company's workers' compensation business and include the accumulation of
estimates for losses and claims reported prior to the balance sheet dates,
estimates (based upon historical information) of claims incurred but not yet
reported and estimates of expenses for investigating and adjusting all incurred
and unadjusted claims. Amounts reported are estimates of the ultimate net cost
of settlement which is subject to the impact of future changes in economic and
social conditions. Such amounts are not discounted for interest. Reserves are
continually monitored and reviewed, and as settlements are made or reserves
adjusted, differences are reflected in current operations.
RESERVES FOR FUTURE POLICY BENEFITS
The estimated reserves for future policy benefits relate to the life and
disability business and are based on the following assumptions. Reserves for
future extended benefit coverage are based on projections of past experience.
Reserves for future policy and contract benefits for single premium immediate
annuity contracts, group disabled life reserves, long-term disability reserves
and group paid-up life reserves 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.
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.
INCOME TAXES
For 1996, the Company will file a consolidated income tax return with its
subsidiaries. For 1995 and 1994, the operating results of Old WellPoint were
included in the consolidated income tax returns filed by BCC for those years.
The income tax provisions for 1995 and 1994 were calculated separately for the
Company without the benefit of any special tax provisions applicable to BCC or
its other subsidiaries. The Company's provision for income taxes is 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.
RECOGNITION OF PREMIUM REVENUE AND MANAGEMENT SERVICES REVENUE
For most health care and life 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. For other contracts, revenue is
recognized based on claims paid, estimated outstanding claims and related
administrative fees. Premium revenue is adjusted by a provision for experience
rated refunds which is estimated for certain group contracts based on historical
and current claims experience.
F-10
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Workers' compensation insurance premiums are based upon the payroll of the
insured. Premiums are earned on a pro rata basis over the term of the policy,
generally one year. The ultimate premiums on retrospectively rated policies are
estimated and, if necessary, adjusted for current claims experience.
Premiums applicable to the unexpired contractual coverage periods are
reflected in the accompanying consolidated balance sheets 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.
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 workers' compensation, 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 $34.8
million, $21.2 million and $17.7 million for the years ended December 31, 1996,
1995 and 1994, respectively.
EARNINGS PER SHARE
Earnings per share is determined by dividing net income by the weighted
average number of shares outstanding during the period. The number of shares
outstanding for the years ended December 31, 1995 and 1994 have been recomputed
to 66.4 million shares, the number of shares outstanding immediately following
the Recapitalization, to give effect to the two-for-three share exchange that
occurred as part of the Recapitalization. Earnings per share for the year ended
December 31, 1996 has been calculated using 66.4 million shares, the shares
outstanding upon completion of the Recapitalization, plus the weighted average
number of shares issued since the Recapitalization. For 1996, common stock
equivalents do not have a dilutive effect on the weighted average number of
shares issued. There were no common stock equivalents in 1995 and 1994.
STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," effective in 1996 encourages, but does not require,
companies to record compensation cost for stock-based employee compensation
plans at fair value. The Company has chosen to continue to account for stock-
based compensation using the intrinsic method prescribed in Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. Accordingly, compensation cost for
stock options under existing plans is measured as the excess, if any, of the
quoted market price of the Company's stock at the date of the grant over the
amount an employee must pay to acquire the stock.
F-11
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECLASSIFICATIONS
Certain amounts in the prior year consolidated financial statements have
been reclassified to conform to the 1996 presentation.
NEW PRONOUNCEMENT
The Financial Accounting Standards Board recently issued Statement of
Financial Accounting Standards ("SFAS") No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." This
statement is to be applied prospectively to transactions occurring after
December 31, 1996. At this time, the Company does not expect this statement to
have a material impact on the Company's results of operations.
4. INVESTMENTS
INVESTMENT SECURITIES
The Company's investment securities consist of the following (in thousands):
DECEMBER 31, 1996
------------------------------------------------
GROSS UNREALIZED
AMORTIZED -------------------- ESTIMATED
COST GAINS LOSSES FAIR VALUE
------------ --------- --------- ------------
U.S. Treasury and agency............................... $ 831,497 $ 578 $ 14,558 $ 817,517
Mortgage-backed securities............................. 154,249 433 2,751 151,931
Corporate and other securities......................... 650,788 3,309 3,559 650,538
------------ --------- --------- ------------
Total debt securities................................ 1,636,534 4,320 20,868 1,619,986
Equity securities...................................... 109,955 2,519 4,155 108,319
------------ --------- --------- ------------
Total investment securities........................ $ 1,746,489 $ 6,839 $ 25,023 $ 1,728,305
------------ --------- --------- ------------
------------ --------- --------- ------------
DECEMBER 31, 1995
------------------------------------------------
GROSS UNREALIZED
AMORTIZED -------------------- ESTIMATED
COST GAINS LOSSES FAIR VALUE
------------ --------- --------- ------------
U.S. Treasury and agency............................... $ 633,396 $ 3,646 $ 1,249 $ 635,793
Mortgage-backed securities............................. 205,361 131 4,124 201,368
Corporate and other securities......................... 273,997 1,474 8,271 267,200
------------ --------- --------- ------------
Total debt securities................................ 1,112,754 5,251 13,644 1,104,361
Equity securities...................................... 70,362 2,350 2,099 70,613
------------ --------- --------- ------------
Total investment securities........................ $ 1,183,116 $ 7,601 $ 15,743 $ 1,174,974
------------ --------- --------- ------------
------------ --------- --------- ------------
The amortized cost and estimated fair value of debt securities as of
December 31, 1996, based on contractual maturity dates are summarized below (in
thousands). Expected maturities for mortgage-
F-12
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. INVESTMENTS (CONTINUED)
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..................................................... $ 102,940 $ 102,899
Due after one year through five years....................................... 811,801 805,340
Due after five years through ten years...................................... 568,373 558,992
Due after ten years......................................................... 153,420 152,755
------------ ------------
Total debt securities................................................... $ 1,636,534 $ 1,619,986
------------ ------------
------------ ------------
For the years ended December 31, 1996, 1995 and 1994, proceeds from the
sales and maturities of debt securities were $647.5 million, $1,253.0 million
and $1,023.8 million, respectively. Gross gains of $2.3 million and gross losses
of $3.0 million were realized on the sales of debt securities for the year ended
December 31, 1996. For 1995, gross realized gains and gross realized losses from
sales of debt securities were $2.2 million and $5.2 million, respectively. In
1994, gross realized gains and gross realized losses from sales of debt
securities were $6.2 million and $2.7 million, respectively.
For the years ended December 31, 1996, 1995 and 1994, proceeds from the
sales of equity securities were $333.0 million, $204.3 million and $64.0
million, respectively. Gross gains of $19.1 million and gross losses of $2.5
million were realized on the sales of equity securities in 1996. For 1995, gross
realized gains and gross realized losses on the sales of equity securities were
$21.1 million and $2.7 million, respectively. In 1994, gross realized gains and
gross realized losses on the sales of equity securities were $6.1 million and
$4.6 million, respectively.
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. Securities on loan are included in the Company's 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. Transactions
under the securities lending program are in accordance with Board-approved
investment policies and are monitored by the Company's Corporate Treasury
Department. The balances of securities on loan as of December 31, 1996 and 1995
were $691.5 million and $1,345.5 million, respectively, and income earned on
security lending transactions for the years ended December 31, 1996, 1995 and
1994 was $2.2 million, $1.2 million and $0.4 million, respectively.
F-13
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, 1996
------------------------------------------------
GROSS UNREALIZED
AMORTIZED ------------------------ ESTIMATED
COST GAINS LOSSES FAIR VALUE
---------- ----------- ----------- ----------
U.S. Treasury and agency securities.................. $ 93,718 $ 23 $ 389 $ 93,352
Corporate and other securities....................... 228 -- 16 212
---------- --- ----- ----------
Total debt securities............................ 93,946 23 405 93,564
Equity investments................................... 30,367 -- 30,367
---------- --- ----- ----------
Total long-term investments...................... $ 124,313 $ 23 $ 405 $ 123,931
---------- --- ----- ----------
---------- --- ----- ----------
DECEMBER 31, 1995
------------------------------------------------
GROSS UNREALIZED
AMORTIZED ------------------------ ESTIMATED
COST GAINS LOSSES FAIR VALUE
---------- ----------- ----------- ----------
U.S. Treasury and agency securities.................. $ 419 $ 10 $ -- $ 429
Equity investments................................... 12,235 -- 12,235
---------- --- ----- ----------
Total long-term investments...................... $ 12,654 $ 10 $ $ 12,664
---------- --- ----- ----------
---------- --- ----- ----------
The total debt securities discussed above all have contractual maturity
dates due after one year and through five years.
5. RECEIVABLES, NET
Receivables consist of the following (in thousands):
DECEMBER 31,
----------------------
1996 1995
---------- ----------
Premiums receivable................................................... $ 301,897 $ 81,112
Investment income and other receivables............................... 121,060 81,371
---------- ----------
422,957 162,483
Less allowance for doubtful accounts.................................. 21,657 13,402
---------- ----------
Receivables, net...................................................... $ 401,300 $ 149,081
---------- ----------
---------- ----------
F-14
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,
---------------------
1996 1995
---------- ---------
Furniture and fixtures................................................. $ 37,869 $ 23,064
Equipment.............................................................. 109,302 36,743
Leasehold improvements................................................. 24,486 12,602
---------- ---------
171,657 72,409
Less accumulated depreciation and amortization......................... 88,937 29,445
---------- ---------
Property and equipment, net............................................ $ 82,720 $ 42,964
---------- ---------
---------- ---------
Depreciation and amortization expense for the years ended December 31, 1996,
1995 and 1994 was $19.9 million, $16.3 million and $11.7 million, respectively.
7. LONG-TERM DEBT
NOTES PAYABLE
In connection with the MMHD acquisition, the Company issued a Series A term
note for $62.0 million on March 31, 1996. At December 31, 1996, $20.0 million
was outstanding under this note. The Series A note will mature on March 31,
1999. Interest is paid quarterly and the interest rate is equal to the Company's
average cost on the revolving credit facility, as described below.
REVOLVING CREDIT FACILITY
In May 1996, the Company entered into an agreement with a consortium of
financial institutions for a five-year revolving credit facility which provides
a line of credit up to $1.25 billion through May 2001 with extension options
through May 2003. In May 1996, $775.0 million was drawn on this facility for the
payment of a special dividend to the stockholders of Old WellPoint in connection
with the Recapitalization. At December 31, 1996, $555.0 million was outstanding
under this facility.
F-15
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. LONG-TERM DEBT (CONTINUED)
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 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. Interest is
determined using whichever of these methods is the most favorable to the Company
(5.9% at December 31, 1996). 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.
SUBORDINATED DEBT
In November, 1996, the Company entered into a subordinated term loan
agreement with a bank for a $200 million two-year unsecured subordinated term
loan facility, which has been extended to be drawn down through March 17, 1997
and which matures on December 31, 1998. On December 30, 1996, the Company
borrowed $50.0 million in order to meet increased capital requirements of the
BlueCross BlueShield Association ("BCBSA"), which borrowing was outstanding on
December 31, 1996.
The agreement provides for interest at rates determined by reference to the
bank's base rate or to the LIBOR plus a margin determined by reference to the
Company's leverage ratio 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 and will be paid
quarterly (6.2% at December 31, 1996). Quarterly principal amortization payments
will be due beginning March 31, 1998. The repayment of borrowings have been
subordinated to the Company's requirements to maintain the required minimum
tangible net equity under DOC regulations. The subordinated debt facility also
requires that the proceeds of certain sales of capital stock or subordinated
debt issued by the Company be used to repay outstanding amounts under the
subordinated debt facility.
In July 1996, the Company filed a registration statement relating to the
issuance of $1.0 billion of senior or subordinated unsecured indebtedness. As of
December 31, 1996, no indebtedness had been issued pursuant to this registration
statement.
MATURITIES
The Company's long-term debt maturities are as follows: 1997--zero;
1998--$50 million; 1999--$20 million; 2000--zero; 2001--$555 million.
DEBT COVENANTS
The Company's revolving credit facility and subordinated debt agreements
require the maintenance of certain financial ratios and contain 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, 1996, the
Company was in compliance with the requirements outlined in these agreements.
F-16
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. LONG-TERM DEBT (CONTINUED)
INTEREST RATE SWAPS
During the third quarter of 1996, the Company entered into three interest
rate swap agreements to manage interest costs and risks associated with changing
interest rates. These agreements effectively convert underlying variable-rate
debt (average rate 5.9%) into fixed-rate debt (average rate 6.8%). The
agreements mature at various dates through 2006. As of December 31, 1996, the
total notional amount outstanding under the three agreements was $400.0 million.
The interest rate swap agreements subject the Company to financial risk that
will vary during the life of this agreement in relation to market interest
rates. The Company does not anticipate any material adverse effect on its
financial position or results of operations resulting from its involvement in
these agreements, nor does it anticipate non-performance by any of its
counterparties.
INTEREST PAID
Interest paid on long-term debt for the year ended December 31, 1996 was
$30.3 million. No interest was paid for the years ended December 31, 1995 and
1994.
8. INCOME TAXES
The components of the provision (benefit) for income taxes are as follows
(in thousands):
YEAR ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
---------- ---------- ----------
Current:
Federal................................................ $ 129,317 $ 111,814 $ 115,001
State.................................................. 30,530 28,957 29,820
---------- ---------- ----------
159,847 140,771 144,821
---------- ---------- ----------
Deferred:
Federal................................................ (17,813) (14,998) (4,791)
State.................................................. (4,528) (2,975) (1,179)
---------- ---------- ----------
(22,341) (17,973) (5,970)
---------- ---------- ----------
Provision for income taxes............................... $ 137,506 $ 122,798 $ 138,851
---------- ---------- ----------
---------- ---------- ----------
The overall effective tax rate differs from the statutory federal tax rate
as follows (percent of pretax income):
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------
Tax provision based on the federal statutory rate................ 35.0% 35.0% 35.0%
State income taxes, net of federal benefit....................... 5.0 5.6 5.3
Tax exempt income................................................ (1.0) (1.3) (1.2)
Non-deductible expenses.......................................... 1.6 0.8 0.7
Other, net....................................................... (0.1) 0.5 (0.4)
--------- --------- ---------
Effective tax rate............................................... 40.5% 40.6% 39.4%
--------- --------- ---------
--------- --------- ---------
F-17
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES (CONTINUED)
Net deferred tax assets are comprised of the following (in thousands):
DECEMBER 31,
---------------------
1996 1995
---------- ---------
Gross deferred tax assets:
Market valuation on investment securities............................ $ 5,536 $ 250
Vacation and holiday accruals........................................ 7,046 3,770
Incurred claim reserve discounting................................... 16,255 15,353
Provision for doubtful accounts...................................... 13,665 11,561
Unearned premium reserve............................................. 11,583 10,393
State income taxes................................................... 9,316 4,548
Postretirement benefits.............................................. 25,073 19,844
Policyholder dividends............................................... 796 4,787
Deferred gain on building............................................ 10,748 --
Deferred compensation................................................ 6,182 63
Expenses not currently deductible.................................... 21,450 --
Intangible asset impairment.......................................... 9,263 10,850
Other, net........................................................... 3,972 3,925
---------- ---------
Total gross deferred tax assets.................................... 140,885 85,344
---------- ---------
Gross deferred tax liabilities:
Depreciation and amortization........................................ (6,972) (1,263)
Bond discount and basis differences.................................. (7,146) (3,185)
Other, net........................................................... (1,790) (1,560)
---------- ---------
Total gross deferred tax liabilities............................... (15,908) (6,008)
---------- ---------
Net deferred tax assets................................................ $ 124,977 $ 79,336
---------- ---------
---------- ---------
The deferred tax assets recorded above are comprised of temporary
differences that are short-term in nature, except for the postretirement
benefits which will reverse over 30 years, deferred compensation which will
reverse over 10 years, deferred building gain which will reverse over 5 years,
intangible asset impairment which will reverse over the next 14 years and
depreciation and amortization differences which will reverse over 40 years.
Management believes that the deferred tax assets listed above are fully
recoverable and, accordingly, no valuation allowance has been recorded. Expenses
not currently deductible include various financial statement charges and
expenses that will be deductible for income tax purposes in future periods.
In 1994 and 1995, in accordance with the tax allocation agreement among BCC
and certain subsidiaries of BCC (including the Company and its subsidiaries), a
portion of BCC's consolidated alternative minimum tax ("AMT") credit was
allocated to the Company based on the respective tax liabilities in the years
that the AMT credits were utilized in the consolidated federal income tax
return. The tax benefits associated with the AMT credits were reflected as
capital contributions from BCC based on the Company's contribution to
consolidated taxable income. The 1993 capital contribution of $42.8 million was
received in 1994. The remaining AMT credit of $43.7 million was reflected as a
capital contribution in 1994 and was received in 1995.
F-18
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES (CONTINUED)
Income taxes paid for the years ended December 31, 1996, 1995 and 1994 were
$90.0 million, $79.0 million and $101.9 million, respectively.
9. PENSION AND POSTRETIREMENT BENEFITS
The BCC pension and postretirement plans were assumed by the Company as a
result of the Recapitalization.
PENSION BENEFITS
The Company covers substantially all employees through two non-contributory
defined benefits pension plans. One plan covers bargaining unit employees, while
the second plan, which was established on January 1, 1987, covers all eligible
exempt and administrative employees meeting certain age and employment
requirements. Plan assets are invested primarily in pooled income funds. The
Company's policy is to fund its plans according to the applicable Employee
Retirement Income Security Act of 1974 and income tax regulations. The Company
uses the unit credit method of cost determination.
The funded status of the plans is as follows (in thousands):
NON-BARGAINING BARGAINING
UNIT EMPLOYEES UNIT EMPLOYEES
DECEMBER 31, DECEMBER 31,
-------------------- --------------------
1996 1995 1996 1995
--------- --------- --------- ---------
Actuarial present value of projected benefit
obligations:
Vested........................................... $ 34,704 $ 29,923 $ 7,962 $ 8,261
Non-vested....................................... 2,546 2,326 72 94
--------- --------- --------- ---------
Accumulated benefit obligation..................... 37,250 32,249 8,034 8,355
Provision for future salary increases.............. 2,798 2,543 550 578
--------- --------- --------- ---------
Projected benefit obligation....................... 40,048 34,792 8,584 8,933
Less plan assets at fair value..................... 35,712 28,540 9,111 8,496
--------- --------- --------- ---------
Projected benefit obligation in excess of (less
than) plan assets................................ 4,336 6,252 (527) 437
Unrecognized prior service benefit................. 91 106 204 251
Unrecognized net loss.............................. (4,842) (7,149) (956) (2,053)
Unrecognized net transition asset.................. -- -- 15 41
Adjustment to recognize minimum liability.......... 1,953 4,499 -- --
--------- --------- --------- ---------
Accrued pension liability (asset).................. $ 1,538 $ 3,708 $ (1,264) $ (1,324)
--------- --------- --------- ---------
--------- --------- --------- ---------
Major Assumptions:
Discount rate.................................... 7.75% 7.25% 7.75% 7.25%
Rate of increase in compensation levels.......... 5.50% 5.50% 5.50% 5.50%
Expected long-term rate of return on plan
assets......................................... 8.50% 8.50% 8.50% 8.50%
F-19
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. PENSION AND POSTRETIREMENT BENEFITS (CONTINUED)
Net periodic pension expense (benefit) for the Company's defined benefit
pension plans includes the following components (in thousands):
NON-BARGAINING UNIT EMPLOYEES BARGAINING UNIT EMPLOYEES
YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
------------------------------- -------------------------------
1996 1995 1994 1996 1995 1994
--------- --------- --------- --------- --------- ---------
Service cost -- benefits earned during the
year........................................... $ 4,143 $ 3,084 $ 3,531 $ 108 $ 76 $ 112
Interest cost on projected benefits
obligations.................................... 2,896 2,402 2,048 642 589 607
Actual (return) loss on plan assets............. (3,723) (5,417) 319 (956) (1,062) 235
Net amortization and deferral................... 1,754 3,878 (1,270) 266 342 (945)
--------- --------- --------- --------- --------- ---------
Net periodic pension expense (benefit).......... $ 5,070 $ 3,947 $ 4,628 $ 60 $ (55) $ 9
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
Prior to the Recapitalization in 1996, BCC allocated pension expense to Old
WellPoint based on the number of employees. Management believed this to be a
reasonable and appropriate method of allocation. For the years ended December
31, 1996, 1995 and 1994, the pension expense was $5.1 million, $3.6 million and
$4.1 million, respectively.
The Company has a Salary Deferral (401(k)) Savings Program (the "Plan").
Employees over 18 years of age are eligible to participate in the Plan if they
meet certain length of service requirements. Under this plan, employees may
contribute a percentage of their pre-tax earnings to the Plan. After one year of
service, employee contributions up to 6% are matched by up to a 75% employer
contribution which is immediately vested. The employer contribution is 85% for
employees with ten to nineteen years of service as of January 1, 1997 and 100%
for employees with twenty or more years of service as of such date. Company
expenses related to the Plan totaled $8.2 million, $6.1 million and $4.3 million
for the years ended December 31, 1996, 1995 and 1994, respectively.
POSTRETIREMENT BENEFITS
The Company provides certain health care and life insurance benefits to
eligible retirees and their dependents. The Company's employees are fully
eligible for retiree benefits upon attaining ten 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 forward
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-20
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. PENSION AND POSTRETIREMENT BENEFITS (CONTINUED)
The accumulated postretirement benefit obligation ("APBO") and the accrued
postretirement benefits as of December 31, 1996 and 1995 are as follows (in
thousands):
DECEMBER 31,
--------------------
1996 1995
--------- ---------
Actives not eligible.............................................................. $ 23,312 $ 20,411
Actives fully eligible............................................................ 221 152
Retirees and dependents........................................................... 24,333 22,750
--------- ---------
Accumulated postretirement benefits obligation.................................... 47,866 43,313
Unrecognized net gain from accrued postretirement benefit cost.................... 13,220 6,845
--------- ---------
Accrued postretirement benefits................................................... $ 61,086 $ 50,158
--------- ---------
--------- ---------
The above actuarially determined APBO was calculated using discount rates of
7.75% and 7.25% as of December 31, 1996 and 1995, respectively. The medical
trend rate is assumed to decline gradually from 13% (under age 65) and 11% (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 percentage in each year would increase the APBO as of
December 31, 1996 by $7.3 million and would increase service and interest costs
by $1.0 million. For life insurance benefit calculations, a compensation
increase of 5.5% was assumed.
Net periodic postretirement benefit cost includes the following components
(in thousands):
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------
Service cost............................................................... $ 2,047 $ 1,691 $ 2,207
Interest cost.............................................................. 3,490 3,216 3,004
Net amortization and deferral.............................................. (438) -- --
--------- --------- ---------
Net periodic postretirement benefit cost................................... $ 5,099 $ 4,907 $ 5,211
--------- --------- ---------
--------- --------- ---------
10. COMMON STOCK
STOCK OPTION PLANS
In May 1996, all eligible employees were granted options to purchase common
stock under the Company's Employee Stock Option Plan (the "Employee Option
Plan") adopted in 1996. The exercise price of such grants is the fair market
value of the Common Stock on the day of the grant. Each option granted has a
maximum term of ten years. The options granted in 1996 vest ratably over a
three-year period. The maximum number of shares of Common Stock issuable under
the Employee Option Plan is 2.0 million shares, subject to adjustment for
certain changes in the Company's capital structure.
In 1996, the Company also implemented its Stock Option/Award Plan (the
"Stock Option/Award Plan") for key employees, officers and directors. The
exercise price per share is fixed by the 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 number of shares that may be issued under the Stock
Option/Award Plan will not exceed 2.6 million shares, subject to adjustment in
accordance with the terms of the plan. The maximum term for an option is ten
years.
F-21
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. COMMON STOCK (CONTINUED)
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, phantom stock and stock appreciation rights.
The following summarizes activity in the Company's stock option plans for
the year ended December 31, 1996:
WEIGHTED AVERAGE
EXERCISE PRICE
SHARES UNDER OPTION SHARES PER SHARE
- -------------------------------------------------------------- ---------- -----------------
Outstanding at January 1, 1996................................ -- $ --
Granted....................................................... 3,273,089 39.27
Canceled...................................................... (108,093) 39.68
Exercised..................................................... -- --
----------
Outstanding at December 31, 1996.............................. 3,164,996 39.26
----------
Exerciseable at December 31, 1996............................. 135,548
The options outstanding at December 31, 1996 have exercise prices ranging
from $25.16 to $39.68 per share.
STOCK PURCHASE PLAN
On May 18, 1996, the Company's stockholders approved the Company's Employee
Stock Purchase Plan (the "ESPP"). The ESPP allows eligible employees to purchase
Common Stock at the lower of 85% of the market price of the stock at the
beginning or end of each offering period. The aggregate amount of common stock
that may be issued pursuant to the ESPP shall not exceed 400,000 shares, subject
to adjustment pursuant to the terms of the ESPP. As of December 31, 1996,
approximately 43,000 shares of common stock were purchased under the ESPP at a
purchase price of $22.53 per share. Shares issued under the ESPP will generally
be subject to a one-year holding period.
SFAS 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
F-22
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. COMMON STOCK (CONTINUED)
the year ended December 31, 1996 would have been reduced to the pro forma
amounts indicated in the table which follows (in millions, except per share
amounts:)
1996
---------
Net income--as reported.............................................................. $ 202.0
Net income--pro forma................................................................ $ 190.9
Earnings per share--as reported...................................................... $ 3.04
Earnings per share--pro forma........................................................ $ 2.87
ASSUMPTIONS OFFICERS EMPLOYEES
- -------------------------------------------------------------- ------------- ---------------
Expected dividend yield....................................... -- --
Risk-free interest rate....................................... 6.40% 6.21%
Expected stock price volatility............................... 35.68% 37.16%
Expected life of options...................................... five years three years
The above pro forma disclosures may not be representative of the effects on
reported net income for future years. The weighted average fair value of options
granted during 1996 is $15.74 per share.
11. LEASES
Effective January 1, 1996, the Company entered into a new lease agreement
for a 24-year period for its 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, the Company has to pay a contingent amount, beginning in
January 1997, based upon annual changes in the consumer price index. The Company
has paid $30 million to the owner of the building in connection with the new
lease agreement. This 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 ten years with 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, 1996 are as follows (in thousands):
YEAR ENDING DECEMBER 31,
- ----------------------------------------------------------------------------------
1997.............................................................................. $ 19,470
1998.............................................................................. 16,374
1999.............................................................................. 13,837
2000.............................................................................. 11,678
2001.............................................................................. 9,517
Thereafter........................................................................ 131,652
----------
Total payments required....................................................... $ 202,528
----------
----------
Rental expense for the years ended December 31, 1996, 1995 and 1994 for all
operating leases was $18.3 million, $18.7 million and $17.5 million,
respectively. Contingent rentals included in the above rental
F-23
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. LEASES (CONTINUED)
expense for the years ended December 31, 1995 and 1994 were $2.0 million and
$1.3 million, respectively. There were no contingent rentals for the year ended
December 31, 1996.
12. RELATED PARTY TRANSACTIONS
Prior to the Recapitalization in May 1996, and pursuant to the
Administrative Services and Product Marketing Agreement, BCC provided office
space and certain administrative and support services, including computerized
data processing and management information systems, telecommunications systems
and other management services to the Company. These expenses were allocated to
and paid by the Company in an amount equal to the direct and indirect costs and
expenses incurred in furnishing these services. In addition, the Company
provided services to BCC which included health plan services, claims processing
related to such plans, other financial management services and provider
contracting (excluding hospitals and other institutional health care providers)
which were reimbursed on a basis that approximated cost. Management of both the
Company and BCC considered the allocation methodologies and cost approximations
reasonable and appropriate.
Intercompany charges between the Company and BCC for the respective periods
prior to the Recapitalization are as follows (in thousands):
YEAR ENDED DECEMBER
31,
JANUARY 1 TO ----------------------
MAY 20, 1996 1995 1994
------------ ---------- ----------
Services provided by BCC................................ $ 13,601 $ 17,418 $ 37,313
Services provided to BCC................................ (3,931) (11,592) (13,013)
------------ ---------- ----------
Net intercompany charges included in general and
administrative expense................................ $ 9,670 $ 5,826 $ 24,300
------------ ---------- ----------
------------ ---------- ----------
As required by the DOC prior to the Recapitalization, non-contract provider
services under the Company and BCC's jointly marketed Prudent Buyer and Medicare
supplement products were required to be provided by BCC, and revenues
attributable to such non-contract provider services were, therefore, not
included in the Company's consolidated financial statements prior to May 20,
1996. BCC recorded a portion of premium revenue for these products based on the
estimated cost of providing these non-contract provider health care services,
plus an underwriting margin equal to the greater of 2.0% or the average
percentage of underwriting gain among member plans of the BCBSA (which included
BCC). For the period January 1, 1996 through May 20, 1996, the underwriting
margin was estimated at 2.0%. For each of the years ended December 31, 1995 and
1994, the underwriting margin was estimated at 2.0% and 2.5%, respectively. Such
aggregate premium revenue recognized by BCC related to the non-contract provider
services for these products for the period from January 1, 1996 through May 20,
1996 and for the years ended December 31, 1995 and 1994 was $59.3 million,
$163.4 million and $172.6 million, respectively. Operating income recognized by
BCC on such non-contract provider services for the period from January 1, 1996
through May 20, 1996 and for the years ended December 31, 1995 and 1994 was $1.2
million, $3.2 million and $4.3 million, respectively. In conjunction with the
Recapitalization of May 20, 1996, the DOC approved the Company to offer
non-contract provider services, and, therefore revenues attributable to such
services are included in the Company's 1996 consolidated financial statements
subsequent to the Recapitalization date.
F-24
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. 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.
LONG-TERM DEBT. The carrying amount for long-term debt approximates fair
value as the underlying instruments have variable interest rates at
market value.
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.
The carrying amounts and estimated fair values of the Company's financial
instruments as of December 31, 1996 are summarized below (in thousands):
CARRYING ESTIMATED
AMOUNT FAIR VALUE
------------ ------------
Cash and cash equivalents......................................... $ 313,256 $ 313,256
Investment securities............................................. 1,728,305 1,728,305
Long-term investments............................................. 123,931 123,931
Long-term debt.................................................... 625,000 625,000
Interest rate swaps............................................... 400,000 390,712
14. CONTINGENCIES
From time to time, the Company and certain of its subsidiaries are parties
to various legal proceedings, many of which involve claims for coverage
encountered in the ordinary course of business. The Company, like HMOs and
health insurers generally, excludes certain health care services from coverage
under its HMO, PPO and other plans. The Company is, in its ordinary course of
business, subject to the claims of its enrollees arising out of decisions to
restrict treatment or reimbursement for certain services. The loss of even one
such claim, if it results in a significant punitive damage award, could have a
material adverse affect 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. However, the
financial and operational impact that such 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 or financial condition.
F-25
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. NONRECURRING COSTS
During the fourth quarter of 1995, the operating results of the Company
included charges of $57.1 million ($34.5 million net of a $22.6 million tax
benefit) for nonrecurring costs. Of the total, $29.8 million resulted from
costs, primarily professional fees, associated with the terminated acquisition
of Health Systems International. In addition, the Company recorded a charge of
$27.3 million for the impairment of its pharmaceutical benefits management
business based on the Company's analysis evaluating impairment of long-lived
assets in accordance with Company policy. The impairment reflected an
anticipated dramatic reduction in future claims processing fees. The anticipated
reduced fees resulted from an industry market shift whereby pharmaceutical
manufacturing companies had purchased pharmaceutical benefits management
companies to market their products by reducing claims processing fees.
16. REGULATORY REQUIREMENTS
The Company and certain 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, 1996, the Company and its regulated
subsidiaries were in compliance with these requirements.
17. UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS
In accordance with the requirements of APB Opinion No. 16, Business
Combinations, the following unaudited pro forma summary combines the
consolidated results of operations of WellPoint, MMHD and the BCC Commercial
Operations as if the acquisitions had occurred as of the beginning of each
period presented after giving effect to pro forma adjustments. The columns
entitled WellPoint, BCC and MMHD represent results of operations for these
entities as if the acquisitions and the Recapitalization had not occurred. The
pro forma adjustments represent interest expense on long-term debt incurred to
fund the acquisitions and the Recapitalization, amortization of intangible
assets, foregone interest on the net cash used for the acquisitions and a
portion of the Recapitalization and the related income tax effect from the
beginning of each period presented through the effective dates of the
acquisitions. The pro forma financial information is presented for informational
purposes only and may not be indicative of the results of operations as they
would have been if WellPoint, MMHD and the BCC Commercial Operations had been a
single entity during the years ended December 31, 1996 and 1995, nor is it
necessarily indicative of the
F-26
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
results of operations which may occur in the future. Pro forma earnings per
share is calculated based on 66.4 million shares of common stock outstanding
during all periods presented.
PRO FORMA
YEAR ENDED DECEMBER 31, 1996
---------------------------------------------------------
WELLPOINT BCC MMHD ADJUSTMENTS TOTAL
--------- --------- --------- ------------- ---------
(IN MILLIONS, EXCEPT EARNINGS PER SHARE)
Revenues................................................. $ 3,364.8 $ 393.0 $ 795.6 $ (14.3) $ 4,539.1
Net Income............................................... $ 222.7 $ (5.3) $ 5.5 $ (35.3) $ 187.6
Earnings Per Share....................................... $ 2.82
PRO FORMA
YEAR ENDED DECEMBER 31, 1995
---------------------------------------------------------
WELLPOINT BCC MMHD ADJUSTMENTS TOTAL
--------- --------- --------- ------------- ---------
(IN MILLIONS, EXCEPT EARNINGS PER SHARE)
Revenues................................................. $ 3,107.1 $ 448.5 $ 888.5 $ (43.7) $ 4,400.4
Net Income............................................... $ 180.0 $ 4.2 $ 49.5 $ (73.6) $ 160.1
Earnings Per Share....................................... $ 2.41
18. SUBSEQUENT EVENTS (UNAUDITED)
PURCHASE OF GROUP BENEFITS OPERATIONS OF JOHN HANCOCK MUTUAL LIFE INSURANCE
COMPANY
On March 1, 1997, the Company completed its acquisition of certain portions
of the health and related life group benefits operations (the "GBO") of John
Hancock Mutual Life Insurance Company for approximately $86.7 million in cash.
The GBO focuses on the large employer segment (employers with 5,000 or more
employees) and provides medical, life, dental, and disability services to some
of the largest employers in the nation. This transaction will be accounted for
under the purchase method of accounting. On March 17, 1997, the Company borrowed
an additional $150.0 million under the subordinated debt facility to meet
increased capital needs as a result of the GBO acquisition.
F-27