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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 001-13803
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WELLPOINT HEALTH NETWORKS INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 95-4635504
(State of incorporation) (I.R.S. Employer Identification No.)
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. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment to this
Form 10-K. / /
State the aggregate market value of the voting stock held by non-affiliates
of the Registrant as of March 13, 1998: $2,661,288,721 (based on the last
reported sale price of $66 5/8 per share on March 13, 1998, on the New York
Stock Exchange).
Common Stock, $0.01 par value of Registrant outstanding as of March 13,
1998: 69,971,937 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Annual Report on Form 10-K incorporates by reference
information from the Registrant's definitive proxy statement for its 1998 Annual
Meeting of Stockholders.
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WELLPOINT HEALTH NETWORKS INC.
1997 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business....................................................................................... 1
Item 2. Properties..................................................................................... 21
Item 3. Legal Proceedings.............................................................................. 21
Item 4. Submission of Matters to a Vote of Security Holders............................................ 22
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters...................... 23
Item 6. Selected Financial Data........................................................................ 24
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.......... 25
Item 8. Financial Statements and Supplementary Data.................................................... 37
Item 9. Changes and Disagreements with Accountants on Accounting and Financial Disclosure.............. 37
PART III
Item 10. Directors and Executive Officers of the Registrant............................................. 38
Item 11. Executive Compensation......................................................................... 38
Item 12. Security Ownership of Certain Beneficial Owners and Management................................. 38
Item 13. Certain Relationships and Related Transactions................................................. 38
PART IV
Item 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K............................... 38
SIGNATURES
INDEX TO FINANCIAL STATEMENTS
i
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 6.6 million medical members and approximately 22 million specialty
members as of December 31, 1997. The Company offers a broad spectrum of
network-based managed care products, including preferred provider organizations
("PPOs"), health maintenance organizations ("HMOs") and point-of-service ("POS")
and other hybrid plans and indemnity plans to the large and small employer,
individual and senior markets. In addition, the Company offers managed care
services for self-funded employers, including underwriting, actuarial services,
network access, medical cost management and claims processing. The Company
offers a continuum of managed health care plans while providing incentives to
members and employers to select more intensively managed plans. 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 and other products and
services, including pharmacy, dental, utilization management, life, integrated
workers' compensation, preventive care, disability, behavioral health, COBRA and
flexible benefits account administration.
The Company markets its products in California primarily under the name Blue
Cross of California and outside of California primarily under the name UNICARE.
Historically, the Company's primary market for its managed care products has
been California. The Company holds the exclusive right in California to market
its products under the Blue Cross name and mark. The Company is diversified in
its California customer base, with extensive membership among large and small
employer groups and individuals and a growing presence in the Medicare and
Medicaid markets.
In 1996, the Company began pursuing a nationwide expansion strategy through
selective acquisitions and start-up activities in key geographic areas. With the
acquisitions in March 1996 of the Life & Health Benefits Management division
("MMHD") of Massachusetts Mutual Life Insurance Company (the "MMHD Acquisition")
and in March 1997 of certain portions of the health and related life group
benefit operations (the "GBO") of John Hancock Mutual Life Insurance Company
(the "GBO Acquisition"), the Company has significantly expanded its operations
outside of California. The Company's acquisition strategy to date has focused 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 California. 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. In addition,
the Company focuses on acquiring businesses that provide significant
concentrations of members in strategic locations outside of California. The
Company believes that its current UNICARE medical membership provides its
UNICARE operations with sufficient scale to begin development of proprietary
provider network systems in key geographic areas which will enable the Company
over time to begin offering a broader range of managed care products. The
Company intends to use these new networks to introduce individual, small group
and senior products in these markets. The Company has developed or is actively
developing proprietary networks in Texas, Georgia, Illinois, Indiana, Michigan,
Maryland and Virginia and has introduced new managed care products in, among
other states, Texas, Georgia and Illinois.
The Company also intends to explore opportunities to work with other Blue
Cross Blue Shield entities. The Company currently provides pharmacy benefits
management services to certain Blue Cross Blue Shield entities and may market
additional specialty products to and pursue additional relationships with other
Blue Cross Blue Shield plans in the future.
1
MANAGED HEALTH CARE INDUSTRY OVERVIEW
An increasing focus on costs by employers and consumers has spurred the
growth of HMO, PPO, POS and other forms of managed care plans as alternatives to
traditional indemnity health insurance. Typically, HMOs and PPOs, as well as
hybrid plans incorporating features of each (such as POS plans), develop health
care provider networks by entering into contracts with hospitals, physicians and
other providers to deliver health care at favorable rates that incorporate
health care utilization management and other cost-control measures as well as
network credentialing and quality assurance. HMO, PPO and POS members generally
are charged periodic, prepaid premiums, and 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 one primary care physician from a network who is responsible for
coordinating health care services for the member, while PPOs or other "open
access" plans generally allow members to select physicians without coordination
through a primary care physician. Hybrid plans, such as POS plans, typically
involve the selection of primary care physicians similar to HMOs, but allow
members to choose non-network providers at higher out-of-pocket costs similar to
PPOs.
THE CALIFORNIA MARKET. The desire of California-based employers for a range
of health care choices that promote effective cost controls and quality care has
contributed to substantial market acceptance of managed health care in
California, where the total penetration of managed health care companies is
higher than the national average. The Company is a market leader in offering
managed health care plans to individuals and small employer groups in
California, but has experienced increased competition in this market over the
last several years. WellPoint's large group business, which historically lagged
the performance of its small group and individual business, has experienced
considerable 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.
OTHER STATES. Although market acceptance of managed health care continues
to grow throughout the United States, it currently varies widely from state to
state. In some 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 significant 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. Health plan reimbursement is often
limited to the health plan's assessment of the reasonable and customary charges
prevailing in a region for the particular health care procedure. 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.
BLUE CROSS OF CALIFORNIA
Prior to the MMHD and GBO Acquisitions, the Company's significant operations
were primarily confined to the State of California. Most of the Company's
California operations are conducted under the trade name Blue Cross of
California.
MARKETING AND PRODUCTS
WellPoint's Blue Cross of California products are developed and marketed in
California with an emphasis on four distinct customer groups: large employers
with 51 or more employees, individuals and
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small employers, seniors and Medi-Cal recipients. Medi-Cal is California's
Medicaid program. In addition, the Company's products are marketed to
educational and public entities, federal employee health and benefit programs
and national employers and in conjunction with state-run programs servicing
high-risk and underserved markets. Individual business units are responsible for
enrolling, underwriting and servicing customers in specific segments. 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. Individual business units also use
advertising, public relations, promotion and marketing research to support their
efforts. The Company believes that one of the keys to its success in California
has been its focus on distinct customer groups defined generally by employer
size and geographic region, which better enables the Company to develop benefit
plans and services that meet the needs of these distinct markets. WellPoint's
managed health care plans to large employers in California are generally sold in
conjunction with a broker or consultant to develop a package of managed health
care benefits specifically tailored to meet the employer's needs. Individual and
small employer group products are marketed in California primarily through sales
managers in both Comprehensive Integrated Marketing Services, Inc. ("CIMS"), a
wholly owned subsidiary of the Company, and WellPoint'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 its plans, in 1996 the Company introduced its CaliforniaCare
Saver HMO product, which has deductible obligations for certain hospital and
outpatient benefits. In response to consumer demand for easier access to
specialists, in 1997 the Company introduced the Ready Access program in its
CaliforniaCare HMO. The program expedites the referral process to specialists
within a member's participating medical group ("PMG"). In addition, the program
also allows members of certain PMGs to self-refer to designated frequently used
specialists.
PPO PLANS. The Company's PPO products, which are generally 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 and other "closed-access" plans, members are not required
to select a primary care physician who is responsible for coordinating their
care and may be subject to annual deductible requirements. PPO members have the
option to receive health care services from non-network 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").
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 various 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, 1997, approximately 284,000 members were enrolled in
WellPoint's Medi-Cal managed care programs in Los Angeles, Sacramento, Orange,
Riverside, San Bernardino, San Francisco, Alameda, Santa Clara, Fresno, Kern and
Stanislaus counties.
3
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, 1997, the
Medicare supplemental plans served approximately 166,000 members. WellPoint also
offers Blue Cross Senior Secure, 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. As of December 31, 1997, Blue Cross Senior Secure HMO plans served
over 10,000 members.
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 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 1.4
million members as of December 31, 1997 from 123,000 members as of December 31,
1987. As of December 31, 1997, the HMO network included approximately 28,000
primary care and specialist physicians and approximately 430 hospitals
throughout California. The physician network of PMGs is comprised of both
multi-specialty medical group practices and individual practice associations
("IPAs").
Substantially all primary care physicians or PMGs in the Company's
California HMO network are reimbursed on a capitated basis 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
reduce risk to WellPoint. Generally, HMO network hospital provider contracts are
on a nonexclusive basis and provide for a per diem payment (a fixed fee schedule
where the daily rate is based on the type of service), which is below the
hospitals' standard billing rates.
Contractual arrangements with PMGs typically include provisions under which
WellPoint provides limited stop-loss protection. If the PMG's actual charges for
medical services provided to a member exceed an agreed-upon threshold amount,
WellPoint will pay the group a portion of the excess amount. Provider rates are
generally negotiated with PMGs and hospitals on an annual or multi-year basis.
To encourage PMGs to contain costs for claims for non-capitated services such as
inpatient hospital, outpatient surgery, hemodialysis, emergency room, skilled
nursing facility, ambulance, home health and alternative birthing
4
center services, WellPoint's PMG agreements provide for a settlement payment to
the PMG based upon the PMG's effective utilization of such non-capitated
services. PMGs are also eligible for additional incentive payments based upon
their management of outpatient prescription drugs and satisfaction of quality
criteria.
PPO NETWORK. The California PPO network included approximately 42,000
physicians and 440 hospitals throughout California as of December 31, 1997.
There were approximately 2.8 million members (including administrative services
members) enrolled in WellPoint's California PPO health care plans as of such
date, approximately 47% 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 manages costs through pricing and product design
decisions intended to influence the behavior of both providers and members.
Like WellPoint's HMO plans, WellPoint's California PPO plans provide for the
delivery of specified health care services to members by contracting with
physicians, hospitals and other providers. Hospital provider contracts are on a
nonexclusive basis and are generally paid per diem amounts that provide for
rates that are below the hospitals' standard billing rates. Physician provider
contracts are also on a nonexclusive basis and specify fixed fee schedules that
are below standard billing rates. WellPoint is able to obtain prices for
hospitals and physician services below standard billing rates because of the
volume of business it offers to health care providers that are part of its
network. Provider rates are generally negotiated on an annual or multi-year
basis with hospitals. 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.
UTILIZATION MANAGEMENT. In order to better manage quality in its
proprietary provider networks WellPoint adopts utilization management systems
and guidelines that are intended to reduce unnecessary procedures, admissions
and other medical costs. The utilization management systems seek to provide
quality care to WellPoint's members by ensuring that medical services provided
are based on medical necessity and that all final decisions are made by
physicians. In its 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 California 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 identify the most effective method of treatment
while more effectively managing costs. In addition, the Company reviews
high-cost procedures in an effort to provide new quality, cost-effective
treatment, by utilizing new technologies or by creating additional networks,
such as its networks of home health agencies.
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."
5
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 a quality management committee.
UNICARE
In 1996, the Company began pursuing a nationwide expansion strategy through
selective acquisitions and start-up activities in key geographic areas. 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 to date has focused on large employer group plans that
offer indemnity and other health care products that are less intensively managed
than the Company's current products. In addition, the Company has focused on
acquiring businesses that provide significant concentrations of members in
strategic locations outside of California. As of December 31, 1997, the Company
had approximately 2.4 million members covered under its UNICARE health plans
(including approximately 57,000 members in California). Approximately 55% of
UNICARE medical membership as of such date was concentrated in eight states:
Illinois, Texas, Massachusetts, Ohio, Michigan, New York, Georgia and Indiana.
Most of the Company's non-California business is conducted by the Company's
wholly owned subsidiary UNICARE Life & Health Insurance Company.
MARKETING AND PRODUCTS
Similar to the Company's Blue Cross of California products, WellPoint's
UNICARE products are developed and marketed outside of California with a focus
on specific customer groups. The large employer group businesses that were
previously part of the MMHD and GBO operations have a national focus as a result
of the multi-state needs of such employers. UNICARE's individual and smaller
employer group and senior products are marketed on a more regional basis as a
result of the more localized nature of these customer segments and the agent and
broker communities that serve them. Similar to the Company's Blue Cross of
California business units, individual UNICARE business units are responsible for
marketing, enrolling, underwriting and servicing their respective customers.
Outside of California, the Company offers HMO products in Texas and PPO and
other open access products (using proprietary networks and third-party provider
networks), as well as traditional fee-for-service products. As WellPoint
continues to develop proprietary provider network systems in key geographic
areas, the Company intends to offer more intensively managed products to the
existing members of acquired businesses and to new individual, small group and
senior customers outside of California. The Company offers managed health care
products and services in Texas through certain subsidiaries including UNICARE of
Texas Health Plans, Inc., which is currently licensed as an HMO in the Houston,
Dallas/ Forth Worth and Austin areas. Although the regulatory requirements vary
from state to state, many states require that HMO products be offered by an
entity incorporated and domiciled in that state.
MANAGED HEALTH CARE NETWORKS AND PROVIDER RELATIONS
Due to the more recent development of the Company's national operations, the
Company's relations with health care providers outside of California are more
varied than in California. During 1997, the Company undertook significant
network development efforts in various states, including Georgia, Illinois,
Indiana, Ohio, Texas and Virginia. Some of these network development activities
involved start-up activities, while others involved supplementing existing
networks acquired in the MMHD and GBO acquisitions. As of December 31, 1997,
UNICARE's proprietary networks included approximately 42,000 primary and
specialist physicians and 350 hospitals. These networks included approximately
15,000 primary care and specialist physicians and 150 hospitals in the Company's
Texas HMO network.
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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 entity, National Capital Preferred Provider Organization
("NCPPO"). Both entities operate in the Maryland/Virginia area and are joint
ventures with local health care providers. The NCPPO network included
approximately 6,700 primary care and specialist physicians and 50 hospitals as
of December 31, 1997.
A large number of UNICARE members are currently served by third-party
provider networks, which generally lack the provider selectivity and discounts
typical of the Company's California proprietary networks. One of the Company's
strategies for the expansion of its UNICARE operations is to continue building
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.
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
CostCare, Inc. ("CCI"), which provides medical management services. The Company
has integrated CCI utilization management services into UNICARE offerings. In
December 1997, CCI (which operates as UNICARE/Cost Care) received a two-year
accreditation from the Utilization Review Accreditation Commission ("URAC"), a
private organization providing voluntary accreditation of utilization review
entities.
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. Because
a significant portion of UNICARE's business is the provision of administrative
services to self-funded employer plans, 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."
SPECIALTY MANAGED HEALTH CARE AND OTHER PLANS AND SERVICES
WellPoint offers a variety of specialty managed health care and other
services. WellPoint believes that these specialty networks and plans complement
and facilitate the marketing of WellPoint's medical plans and help in attracting
employer groups and other members that are increasingly seeking a wider variety
of options and services. WellPoint also markets these specialty products on a
stand-alone basis to other health plans and other payors.
PHARMACY PRODUCTS
WellPoint offers pharmacy services and pharmacy benefit management services
to its members. WellPoint's pharmacy services incorporate features such as drug
formularies (a WellPoint-developed listing of preferred, cost-effective drugs),
a pharmacy network and maintenance of a prescription drug database and mail
order capabilities. Moreover, pharmacy benefit management services provided by
WellPoint include management of drug utilization through outpatient prescription
drug formularies, retrospective review and drug education for physicians,
pharmacists and members. As of December 31, 1997, WellPoint had more than 12.3
million risk and non-risk members and approximately 49,000 participating
pharmacies.
DENTAL PLANS
WellPoint's California 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 11,000
dentists, and traditional indemnity plans. As part of the Company's national
expansion efforts, the Company has developed or is developing dental provider
networks in 40 states
7
outside of California. As of December 31, 1997, the Company's dental networks
outside of California included 18,900 dentists. The Company's dental products
outside of California currently include a dental PPO in Texas and Georgia. As a
result of the MMHD and GBO acquisitions, the Company has acquired significant
additional dental membership outside of California. The Company's dental plans
provide primary and specialty dental services, including orthodontic services,
and as of December 31, 1997, served approximately 3.2 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, 1997, the
Company provided life insurance products to approximately 1.8 million persons.
MENTAL HEALTH PLANS
WellPoint offers specialized mental health and substance abuse programs. The
plans cover mental health and substance abuse treatment services on both an
inpatient and an outpatient basis, through a network of approximately 3,800
contracting providers. In addition, approximately 280 employee assistance and
behavioral managed care programs have been implemented for a wide variety of
businesses throughout the United States. As of December 31, 1997, there were
approximately 700,000 members covered under WellPoint's mental health plans.
WORKERS' COMPENSATION
One of the Company's 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 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. As of December 31, 1997, approximately 275,000 members were covered
under WellPoint's workers' compensation programs.
UTILIZATION MANAGEMENT
In connection with the GBO Acquisition, the Company acquired CCI, a wholly
owned subsidiary of John Hancock. CCI, which now operates under the trade name
UNICARE/Cost Care, provides stand-alone utilization management and other medical
management services to other health plans and self-funded employers. CCI
utilization management services are also integrated into UNICARE product
offerings. In December 1997, CCI received a two-year accreditation from URAC. As
of December 31, 1997, the Company had approximately 2.8 million utilization
management members.
DISABILITY PLANS
As of December 31, 1997, the Company provided long-term and/or short-term
disability coverage to approximately 1.1 million individuals.
LONG-TERM CARE INSURANCE
In November 1997, the Company began offering a group of long-term care
insurance products to its California members through its indirect wholly owned
subsidiary BC Life & Health Insurance Company ("BC Life"). These plans, which
are marketed under the Advantage Blue trade name, involve three
8
different products. The Company's long-term care products include both a skilled
nursing home care plan and comprehensive policies covering skilled, intermediate
and custodial long-term care.
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.
MANAGEMENT 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 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, 1997, WellPoint serviced
self-insured health plans covering approximately 2.7 million medical members.
Management services revenue for these services was $383.2 million, $147.9
million and $61.2 million for the years ended December 31, 1997, 1996 and 1995,
respectively. The Company's managed care services revenues have expanded
considerably during the last two years as a result of the MMHD and GBO
Acquisitions.
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 $36.6 million, $34.8
million and $21.2 million on advertising for the years ended December 31, 1997,
1996 and 1995 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. Currently, WellPoint
is a market leader in offering managed health care plans to individuals and
small employer groups in California. The medical loss ratio attributable to
WellPoint's individual and small group business has historically been lower than
that for its large employer group business. As a result, a larger portion of
WellPoint's profitability 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
9
greater market share on either a regional or national basis. As the Company
continues to geographically expand its operations, it will be subject to
national competitive factors as well as unique competitive conditions that may
affect the more localized markets in which the Company operates.
WellPoint believes that significant factors in the selection of a managed
health care plan by employers and individual members include price, the extent
and depth of provider networks, flexibility and scope of benefits, quality of
services, market presence, reputation (which may be affected by public rankings
or accreditation by voluntary organizations such as the National Committee for
Quality Assurance ("NCQA") and the Utilization Review Accreditation Commission
("URAC")) and financial stability. WellPoint believes that it competes
effectively against other health care industry participants.
GOVERNMENT REGULATION
CALIFORNIA
DOC REGULATION. WellPoint offers its managed health care services in
California through Blue Cross of California which is 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, Blue Cross of California is subject to various minimum
tangible net equity ("TNE"), deposit and other financial requirements. The DOC
also regulates the ability of Blue Cross of California 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. Blue Cross of California's managed health care programs are also
subject to extensive DOC regulation regarding minimum benefit and coverage
levels, Blue Cross of California's contractual and business relationships with
health care providers, administrative capacity, marketing and advertising,
procedures for quality assurance and subscriber and enrollee grievance
resolution. Blue Cross of California 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 Blue
Cross of California 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. In 1997, the DOC conducted a triennial medical survey
of the Company and each of its subsidiaries licensed under the Knox-Keene Act.
The Company has received preliminary reports from the DOC with respect to three
surveys and is currently in the process of responding to the preliminary
reports. Prior to the Company's August 1997 reincorporation in Delaware, the
Company and two subsidiaries other than Blue Cross of California were Knox-Keene
licensees.
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 and UIC. BC Life and UIC
are subject to various capital reserve and other financial requirements
established by the California DOI. The DOI also regulates the ability of the
Company's subsidiaries to issue capital stock, to pay dividends, to diversify
and implement changes in their products, and the ability to effect intercompany
transactions. 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
10
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.
In 1997, the California Legislature established the Managed Health Care
Improvement Task Force to study and make recommendations regarding managed
health care issues in the state of California. The task force deliberated in
1997 and issued a preliminary report in January 1998. The task force was
comprised of appointees chosen by California Governor Pete Wilson and by the
Legislature and included representatives from health plans, employer groups,
consumer groups and health care providers. The task force's report includes a
broad range of recommendations to restructure managed health care in California,
including changes in patient confidentiality requirements, quality-of-care
issues, mandated benefit coverage and the restructuring of California regulatory
oversight of managed health care plans. The task force's recommendations have
been provided to Governor Wilson and the California Legislature. No legislation
has yet been implemented as a result of the task force's recommendations. While
it is still too early to determine if any additional legislation will be adopted
as a result of the task force's work, changes recommended by the task force, if
enacted into law, could have a material adverse affect on the Company's results
of operations and financial condition.
FEDERAL
RECENT FEDERAL HEALTH CARE LEGISLATION. In August 1997, the President
signed into law the Balanced Budget Act of 1997 (the "Balanced Budget Act"). The
Balanced Budget Act included a number of measures affecting the provision of
health care. The act placed restrictions on the variation in Medicare
reimbursement amounts between counties. In addition, the Balanced Budget Act
expanded the managed health plan options available to Medicare enrollees to
include PPO, POS and high deductible health plans intended for MSAs. No
regulations regarding this change have yet been adopted. Finally, the Balanced
Budget Act implemented certain changes with respect to Medicare supplement
programs, including guaranteed coverage issues. Certain of the changes under the
Balanced Budget Act could have the result of increasing the Company's costs.
In March 1997, President Clinton appointed the Advisory Commission on
Consumer Protection and Quality in the Health Care Industry (the "Clinton
Quality Commission") to advise the President on changes occurring in the health
care system and to formulate recommendations regarding health care quality and
the protection of consumers. The commission is comprised of representatives from
government, consumer groups, business groups and health care providers. In
November 1997, the Clinton Quality Commission released a "Consumer Bill of
Rights and Responsibilities" containing a number of general and specific
recommendations regarding the provision of health care in the United States. The
Commission's recommendations have been put forth for consideration by the United
States Congress. No legislation has yet been adopted as a result of its
recommendations. In February 1998, the President issued an executive order to
the government administrators of each of the government-sponsored health
programs directing them to take appropriate actions to insure compliance with
some or all of the recommendations made in the Consumer Bill of Rights by
various dates on or before December 31, 1999. Compliance with the President's
executive order is likely to increase health plan costs associated with these
government-sponsored programs.
11
On August 21, 1996, the President signed into law the Health Insurance
Portability and Accountability Act of 1996 (originally known in the Senate as
the Kennedy-Kassebaum bill) ("HIPAA"). HIPAA 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 individual member 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 in the small group market from
establishing enrollment eligibility rules or premiums 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 are 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.
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, although this rule is
currently scheduled to be terminated on or before January 1, 1999. HCFA has the
right to audit HMOs operating under Medicare contracts to
12
determine the quality of care being rendered and the degree of compliance with
HCFA's contracts and regulations.
FUTURE HEALTH CARE REFORM. A number of legislative proposals have been made
at the Federal and state levels over the past five years. Certain of these
proposals would restrict coverage decisions or prohibit exclusions or denials of
coverage for pre-existing conditions and would provide for "community rating" of
risks. Certain of these proposals would impose new restrictions or standards on
health plans, including restrictions on incentive payments to providers, and
would require health plans to provide greater information and disclosure to
consumers. There have been proposals made at the Federal level to implement
greater restrictions on employer-funded health plans, which are generally
exempted from state regulation by the Employee Retirement Income Security Act of
1974 ("ERISA"). 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 UNICARE Life & Health Insurance Company) and in all other
states. 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. Over the past few years, there has been an increase throughout the
United States in proposed state legislation regarding, among other things,
mandated benefits, health plan liability, third-party review of health plan
coverage determinations and health plan relationships with providers. The
Company expects that this trend of increased legislation will continue.
In May 1997, the Texas legislature adopted SB 386 which, among other things,
purports to make managed care organizations ("MCOs") such as the Company liable
for the failure by the MCO, its employees or agents to exercise ordinary care
when making "health care treatment decisions" (as defined in the legislation).
The legislation was effective as of September 1, 1997. It is too early to
determine what effect, if any, this legislation will ultimately have on the
Company. However, to the extent that this legislation (or similar legislation
that may be subsequently adopted at the Federal or state level) effectively
expands the scope of liability of MCOs, such as the Company, it may have a
material adverse effect on the Company's results of operations and financial
condition.
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 125 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.
13
SERVICE MARKS
WellPoint and its subsidiaries have filed for registration of and maintain
several service marks, trademarks and trade names at the Federal level and in
California, including "Prudent Buyer Plan," "CaliforniaCare" and "UNICARE."
WellPoint, Blue Cross of California and BC Life are currently parties to license
agreements with the 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 base capital
requirements. The failure to meet such capital requirements can subject the
Company to certain corrective action, while the failure to meet a lower
specified level of capital can result in termination of the Company's license
agreement with the BCBSA. WellPoint considers the licensed Blue Cross name and
its registered service marks, trademarks and trade names important in the
operation of its business.
EMPLOYEES
At December 31, 1997, WellPoint and its subsidiaries employed approximately
10,100 people. Approximately 115 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 260 of the Company's office clerical employees in the greater
Detroit area are presently covered by a collective bargaining agreement with the
International Brotherhood of Teamsters, Chauffeurs, Warehousemen and Helpers of
America, Local No. 614. WellPoint believes that its relations with its employees
are good, and it has not experienced any work stoppages.
EXECUTIVE OFFICERS
Leonard D. Schaeffer, age 52, 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.
D. Mark Weinberg, age 45, 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, age 48, 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 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
14
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.
David C. Colby, age 44, joined the Company in September 1997 as Executive
Vice President and Chief Financial Officer. From April 1996 until joining the
Company, Mr. Colby was Executive Vice President, Chief Financial Officer and
Director of American Medical Response, Inc., a health care services company
focusing on ambulance services and emergency physician practice management. From
July 1988 until March 1996, Mr. Colby was with Columbia/HCA Healthcare
Corporation, most recently serving as Senior Vice President and Treasurer. From
September 1983 until July 1988, Mr. Colby was Senior Vice President and Chief
Financial Officer of The Methodist Hospital in Houston, Texas. Mr. Colby also
serves as a director of 2 Connect Express, Inc. and OMNIS Technology
Corporation.
Thomas C. Geiser, age 47, 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.
MAY 1996 RECAPITALIZATION AND AUGUST 1997 REINCORPORATION
The Company's predecessor, WellPoint Health Networks Inc., a Delaware
corporation ("Old WellPoint"), was organized in 1992 as a public for-profit
subsidiary of Blue Cross of California ("BCC"), to own and operate substantially
all of the managed health care businesses of BCC. In order to fulfill BCC's
public benefit obligations to the State of California arising out of the
creation of Old WellPoint, BCC and Old WellPoint undertook a recapitalization
(the "Recapitalization") which was concluded on May 20, 1996. As a result of the
Recapitalization, among other things, Old WellPoint merged into BCC, a special
dividend of $995.0 million was made to the shareholders of Old WellPoint and the
California HealthCare Foundation (the "Foundation") became the holder of
53,360,000 shares, or approximately 80%, of the surviving WellPoint entity.
In connection with the Recapitalization, BCC relinquished its rights under
the Blue Cross License Agreement date January 1, 1991, between Blue Cross of
California and the BCBSA. The BCBSA and the Company entered into a new License
Agreement (the "License Agreement"), pursuant to which the Company became the
exclusive licensee for the right to use the Blue Cross name and related service
marks in California and became a member of the BCBSA. See "--Service Marks."
The License Agreement required that the Foundation enter into a voting trust
agreement (the "Voting Trust Agreement"), pursuant to which the Foundation
deposited into a voting trust (the "Voting Trust") the number of shares of the
Company's Common Stock sufficient to reduce the Foundation's holdings outside
such Voting Trust to a level not in excess of 50% of the voting power of the
outstanding shares of the Company's Common Stock. The shares held by the trustee
under the Voting Trust Agreement (the "Voting Trust Shares") generally must be
voted (i) with respect to elections and removal of directors, calling of
shareholder meetings and amendment of the Company's Certificate of Incorporation
and Bylaws, where such actions 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
15
vote. In addition, the Voting Trust Agreement requires that the Foundation,
through sales (which may involve 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. As a result of sales of
its Common Stock holdings, as of March 15, 1998, no shares held by the
Foundation were subject to the provisions of the Voting Trust Agreement. As of
March 15, 1998, the Foundation owned 29,910,000 shares of WellPoint Common
Stock, or approximately 42.7% of the outstanding Common Stock.
Pursuant to an addendum to the License Agreement, the Foundation's Board of
Directors was required to consist of a majority of persons that served as
directors of BCC on or before May 17, 1996 (the "Original Blue Cross
Directors"). In March 1998, the Company, the BCBSA and the Foundation
tentatively agreed to modify this restriction. Pursuant to a proposed amendment
to the Voting Trust Agreement (the "Amended Voting Trust Agreement"), in the
event that the number of Original Blue Cross Directors were to become equal to
the number of non-Original Blue Cross Directors (such occurrence being known as
the "Even Division Date"), the Foundation would be required to immediately make
deposits into the Voting Trust to reduce its holdings outside the Voting Trust
to 20% of the outstanding Common Stock and make additional deposits into the
Voting Trust within one year thereafter to reduce its holdings outside of the
Voting Trust to 5% of the outstanding Common Stock. The Foundation has indicated
to the Company that an Even Division Date may occur in April 1998. In order for
a change in composition of the Foundation Board to be permitted, the Foundation
must obtain the approval of the California Attorney General and the California
Department of Corporations. There can be no assurance that such approvals will
be obtained or that the Amended Voting Trust Agreement will be executed.
With respect to those shares held by the Foundation in excess of the
"Ownership Limit" (as defined in the Company's Certificate of Incorporation and
discussed further in the following paragraph) that are not subject to the Voting
Trust Agreement, the Foundation has also entered into a voting agreement (the
"Voting Agreement"). The Voting Agreement provides among other things, that the
Foundation, during the period that it continues to own in excess of the
Ownership Limit, will vote all shares of the Company's Common Stock owned by it
in excess of 5% of the outstanding shares (except those shares held pursuant to
the Voting Trust Agreement) in favor of each nominee to the Board of Directors
of the Company who has been nominated by the Nominating Committee of the Board
of Directors, or under certain circumstances, other subsets of the board, all as
set forth in the Company's Bylaws. With respect to the removal of directors,
calling of shareholder meetings and amendment of the Company's Articles of
Incorporation and 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.
At the time of the Recapitalization, the "Ownership Limit" was established
as one share less than 5% of the Company's outstanding voting securities. In
December 1997, the Company and the BCBSA, in accordance with the provisions of
Article VII, Section 14(f)(2) of the Company's Certificate of Incorporation,
agreed to modify the Ownership Limit to be the following: (i) for any
"Institutional Investor," one share less than 10% of the Company's outstanding
voting securities; and (ii) for any "Noninstitutional Investor," other than the
Foundation, one share less than 5% of the Company's outstanding voting
securities. For these purposes, "Institutional Investor" means any person if
(but only if) such person is (1) a broker or dealer registered under Section 15
of the Securities Exchange Act of 1934 (the "Exchange Act"), (2) a bank as
defined in Section 3(a)(6) of the Exchange Act, (3) an insurance company as
defined in Section 3(a)(19) of the Exchange Act, (4) an investment company
registered under Section 8 of the Investment Company Act of 1940, (5) an
investment adviser registered under Section 203 of the Investment Advisers Act
of 1940, (6) an employee benefit plan, or pension fund which is subject to the
provisions of the Employee Retirement Income Security Act of 1974 or an
endowment fund, (7) a parent holding company, provided the aggregate amount held
directly by the parent, and directly and indirectly by its subsidiaries which
are not persons specified in paragraphs (1) through (6), does not exceed one
percent of the securities of the subject class, or (8) a group, provided that
all the members are persons specified in
16
paragraphs (1) through (7). In addition, every filing made by such person with
the SEC under Regulation 13D-G (or any successor Regulation) under the Exchange
Act with respect to such person's beneficial ownership must contain a
certification (or a substantially similar one) that the WellPoint Common Stock
acquired by such person was acquired in the ordinary course of business and was
not acquired for the purpose of and does not have the effect of changing or
influencing the control of WellPoint and was not acquired in connection with or
as a participant in any transaction having such purpose or effect. For such
purposes, "Noninstitutional Investor" means any person that is not an
Institutional Investor.
In 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 sales from time to time of
shares of the Company's Common Stock pursuant to the exercise of its rights
under the Registration Rights Agreement.
In connection with the Recapitalization, BCC also received a ruling from the
IRS that, among other things, the conversion of BCC from a nonprofit public
benefit corporation to a for-profit entity (the "BCC Conversion") qualified as a
tax-free transaction and that no gain or loss was recognized by BCC for Federal
income tax purposes. The Foundation and the Company have entered into an
Indemnification Agreement which provides, with certain exceptions, that the
Foundation will indemnify WellPoint against the net tax liability as a result of
a revocation or modification, in whole or in part, of the ruling by the IRS or a
determination by the IRS that the BCC Conversion constitutes a taxable
transaction for Federal income tax purposes.
In August 1997, pursuant to approval by the stockholders at the Company's
1997 Annual Meeting, the Company reincorporated in the state of Delaware. See
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations--General." Each of the material agreements (other than the
Indemnification Agreement) entered into in connection with the Recapitalization
was amended and restated on substantially similar terms at the time of the
reincorporation.
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
Certain statements contained in "Item 1. Business," such as statements
concerning the Company's geographic expansion and other business strategies, the
effect of recent health care reform legislation 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.
FEDERAL AND STATE HEALTH CARE REGULATION; LEGISLATIVE REFORM; ACTIVITIES AS
GOVERNMENT CONTRACTOR
WellPoint's operations are subject to substantial regulation by Federal,
state and local agencies. As a result of the MMHD and GBO Acquisitions,
WellPoint is now subject to the authority of state regulatory agencies in all 50
states. Such regulation may either relate to the Company's business operations
or to the financial condition of regulated subsidiaries. With regard to the
former, regulation typically covers prescribed benefits, relationships with
providers, marketing, advertising, quality assurance and member grievance
resolution. With regard to the latter, regulation typically governs the amount
of capital required to be retained in regulated subsidiaries and the ability of
such subsidiaries to pay dividends. There can be
17
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, the Company's ability to access capital from the
operations of its regulated subsidiaries or on its financial condition or result
of operations.
In addition to capital requirements imposed by the California Department of
Corporations, the Company and its BCBSA-licensed affiliates are required to
maintain certain levels of capital to satisfy BCBSA requirements. The National
Association of Insurance Commissioners (the "NAIC") is currently considering
adopting new capital requirements for licensed HMOs called Health Organization
Risk Based Capital ("HORBC"). When and if adopted by the NAIC, the BCBSA may
adopt HORBC as the basis for its capital requirements. There can be no
assurances that such new minimum capital requirements will not increase the
Company's capital requirements in the future.
The health care industry has become the subject of greater legislative and
media scrutiny in recent years. In 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 took effect as of
January 1, 1998. See "--Government Regulation." Various states have passed
similar legislation, some providing for more extensive benefits than those
required by HIPAA. An increasing number of proposals are being considered by the
United States Congress and state legislature relating to health care reform and
the Company expects that some of such proposals will be enacted. There can be no
assurance that compliance with recently enacted or future legislation will not
have a material adverse impact on WellPoint's claims expense, its financial
condition or results of operations.
The Company provides administrative services for Medi-Cal for the DHS in
various California counties. The Company also provides similar services for HCFA
in various capacities, including certain Medicare programs and under its Blue
Cross Senior Secure plan. There can be no assurance that acting as a government
contractor in these circumstances will not increase the risk of heightened
scrutiny by such government agencies, particularly in light of governmental
concern with increasing health care costs. Further, there can be no assurance
any such heightened scrutiny will not have a material adverse effect on the
Company either through negative publicity about the Company or through an
adverse impact on the Company's results of operations.
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, continued consolidation of physician,
hospital and other provider groups, 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. Periodic renegotiation of hospital
contracts and continued consolidation of physician, hospital and other provider
groups may result in increased health care costs or limit the Company's ability
to control such costs.
In addition to the challenge of controlling health care costs, the Company
faces competitive pressure to contain premium prices. While health plans compete
on the basis of many factors, including service and the quality and depth of
provider networks, the Company expects that price will continue to be a
significant basis of competition. Fiscal concerns regarding the continued
viability of programs such as Medicare and Medicaid may cause decreasing
reimbursement rates for government-sponsored programs. WellPoint's financial
condition or results of operations would be adversely affected by significant
premium decreases by any of its major competitors or by any limitation on the
Company's ability to increase or maintain its premium levels.
18
INTEGRATION OF RECENT ACQUISITIONS; GEOGRAPHIC EXPANSION STRATEGY; FUTURE
ACQUISITIONS
One component of the Company's business strategy has been to diversify into
new geographic markets, particularly through strategic acquisitions. The Company
completed the MMHD acquisition in March 1996 and the GBO acquisition in March
1997. During 1997, the Company worked extensively on the integration of these
acquired businesses (especially MMHD), including consolidating existing
operations sites and converting certain accounts to the Company's information
systems. The Company is continuing the consolidation of these recently acquired
operations into its operations, which will require considerable expenditures and
a significant amount of management time. Due to the complex nature of the merger
integration process (especially the information systems designed to serve these
businesses), the Company may temporarily experience increases in claims
inventory, difficulties in determining member eligibility and service and other
issues. The success of these acquisitions will, among other things, also require
the integration of a significant number of the employees into the Company's
existing operations and the completion of the integration of separate
information systems. No assurances can be given regarding the ultimate success
of the integration of these acquisitions into the Company's business, 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 has experienced and expects to
continue to 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.
As the Company pursues its geographic expansion strategy, the Company's
market share in new markets will not be as significant, and its provider
networks not as extensive, as in California, and the Company will not have the
benefit of the Blue Cross mark, which are important components of its success in
California. After an initial transition period, the Company will also no longer
have the benefit of the MassMutual or John Hancock trade names under which these
acquired operations were previously conducted. There can be no assurance that
the absence of one or more of these elements will not adversely affect the
success of the Company's geographic expansion strategy.
The Company actively considers acquisition opportunities on a regular basis,
both in connection with its geographic expansion strategy and its California
operations. The Company currently has no existing agreements or commitments to
effect any such acquisition. Accordingly, there can be no assurance that the
Company will be able to identify suitable acquisition candidates available for
sale at reasonable prices or consummate any acquisition or that any discussions
will result in an acquisition. Any such acquisitions may require significant
additional capital resources and there can be no assurance that the Company will
have access to adequate capital resources to effect such future acquisitions. To
the extent that the Company consummates acquisitions, there can be no assurance
that such acquisitions will be successfully integrated into the Company or that
such acquisitions will not adversely affect the Company's results of operations
and financial condition.
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. A
significant portion of the Company's operations are in California, where the
managed health care industry is especially competitive. In addition, the managed
health care industry in California has undergone
19
significant changes in recent years, including substantial consolidation.
Outside of California, the Company faces competition from other regional and
national companies, many of which have (or due to future consolidation, may
have) significantly greater financial and other resources and market share than
the Company. If competition were to further increase in any of its markets,
WellPoint's financial condition 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 34% of WellPoint's total
premium revenue for the year ended December 31, 1997. 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 one
such claim, if it were to result in a significant punitive damage award, could
have a material adverse effect on WellPoint's financial condition or results of
operations. In addition, the risk of potential liability under punitive damage
theories may significantly increase the difficulty of obtaining reasonable
settlements of coverage claims. The financial and operational impact that such
evolving theories of recovery may have on the managed care industry generally,
or WellPoint in particular, is presently unknown. See "--Government Regulation."
DEPENDENCE ON INDEPENDENT AGENTS AND BROKERS
The Company is dependent on the services of independent agents and brokers
in the marketing of its health care plans, particularly with respect to
individual and small employer group members. Such independent agents and brokers
are typically not exclusively dedicated to the Company and may frequently also
market health care plans of the Company's competitors. The Company faces intense
competition for the services and allegiance of independent agents and brokers.
EMPLOYEE MATTERS
The Company is dependent on retaining existing employees and attracting and
retaining additional qualified employees to meet its future needs. The Company
faces intense competition for qualified employees, particularly during the
present economic environment of low unemployment, and there can be no assurance
that the Company will be able to attract and retain such employees or that such
competition among potential employers will not result in increasing salaries.
There can be no assurance that an inability to retain existing employees or
attract additional employees will not have a material adverse effect on the
results of operations of the Company. The Company is especially dependent on
attracting and retaining qualified computer programmers. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Year 2000."
EFFECT OF YEAR 2000 ON COMPUTER SYSTEMS AND APPLICATIONS
The year 2000 presents a number of potential problems for computer systems
and applications, including significant processing errors or failures. In order
to address these problems for its systems and applications, the Company has
developed and is in the midst of executing a comprehensive plan designed to
address the year 2000 issue. During 1997, the Company completed a detailed risk
assessment of its various computer systems and applications, formulated a plan
for specific remediation efforts and began
20
certain of such remediation efforts. During 1998 and the first quarter of 1999,
the Company expects to continue and complete its remediation efforts and to
undertake internal testing of its systems and applications. In the second
quarter of 1999, the Company expects to undergo third-party testing of its
applications and systems. See "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations--Year 2000" for a more
comprehensive discussion of the year 2000 issue, the steps being taken by the
Company to address it and the potential effects on the Company's results of
operations and financial condition of this issue.
TAX ISSUES RELATING TO THE RECAPITALIZATION
In connection with the Recapitalization, BCC received a ruling from the IRS
that, among other things, the BCC Conversion qualified as a tax-free transaction
and that no gain or loss was recognized by BCC for Federal income tax purposes.
If the ruling were subsequently revoked, modified or not honored by the IRS (due
to a change in law or for any other reason), WellPoint, as the successor to BCC,
could be subject to Federal income tax on the difference between the value of
BCC at the time of the BCC Conversion and BCC's tax basis in its assets at the
time of the BCC Conversion. The potential tax liability to WellPoint if the BCC
Conversion is treated as a taxable transaction is currently estimated to be
approximately $696 million, plus interest (and possibly penalties). BCC and the
Foundation entered into the Indemnification Agreement that provides, with
certain exceptions, that the Foundation will indemnify WellPoint against the net
tax liability as a result of a revocation or modification, in whole or in part,
of the ruling by the IRS or a determination by the IRS that the BCC Conversion
constitutes a taxable transaction for Federal income tax purposes. In the event
a tax liability should arise against which the Foundation has agreed to
indemnify WellPoint, there can be no assurance that the Foundation will have
sufficient assets to satisfy the liability in full, in which case WellPoint
would bear all or a portion of the cost of the liability, which could have a
material adverse effect on WellPoint's financial condition. See "--May 1996
Recapitalization."
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
$7.8 million during 1997. In 1997, the Company entered into a lease, which
expires in December 2019, for a new facility to be located in Thousand Oaks,
California that will consolidate many corporate and UNICARE functions. The
Company and its subsidiaries have additional offices in the greater Los Angeles
and Ventura County area. As a result of the MMHD and GBO acquisitions and the
Company's continuing national expansion efforts, the Company maintains offices
in various other locations, including Springfield, Massachusetts; Charlestown,
Massachusetts; Schaumburg, Illinois; Dearborn, Michigan; and Plano, Texas.
ITEM 3. LEGAL PROCEEDINGS.
WellPoint and certain of its subsidiaries are parties to various legal
proceedings, many of which involve claims for coverage encountered in the
ordinary course of its business. WellPoint, like health plans generally,
excludes certain health care services from coverage under its HMO, PPO and other
plans. In the ordinary course of its business, WellPoint is subject to the
claims of its enrollees arising out of decisions to restrict reimbursement for
certain treatments. The loss of even one such claim, if it resulted in a
significant punitive damage award, could have a material adverse effect on
WellPoint. In addition, the risk of potential liability under punitive damage
theories may increase significantly the difficulty of obtaining reasonable
settlements of coverage claims. 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.
21
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.
22
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.
HIGH LOW
------- -------
PRE-RECAPITALIZATION:
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
Year Ended December 31, 1997
First Quarter................................................................ $45 7/8 $32 7/8
Second Quarter............................................................... 51 37 3/4
Third Quarter................................................................ 60 1/2 46 1/4
Fourth Quarter............................................................... 58 13/16 38 13/16
On March 13, 1998 the closing price on the New York Stock Exchange for the
Company's Common Stock was $66 5/8 per share. As of March 13, 1998, there were
approximately 1,117 holders of record of Common Stock.
The Company did not pay any dividends on its Common Stock in 1996 or 1997,
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 1998.
23
ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA, MEMBERSHIP
DATA AND OPERATING STATISTICS)
CONSOLIDATED INCOME STATEMENTS
Revenues:
Premium revenue............................................. $5,227,904 $3,879,806 $2,910,622 $2,647,951 $2,355,980
Management services revenue................................. 383,238 147,948 61,151 36,274 18,121
Investment income........................................... 215,302 142,028 135,306 107,447 75,074
--------- --------- --------- --------- ---------
5,826,444 4,169,782 3,107,079 2,791,672 2,449,175
Operating Expenses:
Health care services and other benefits..................... 4,245,281 3,003,117 2,199,953 1,927,954 1,719,853
Selling expense............................................. 260,523 224,453 190,161 169,483 147,097
General and administrative expense.......................... 853,100 545,942 344,427 334,206 266,295
Nonrecurring costs.......................................... 14,535 -- 57,074 -- --
--------- --------- --------- --------- ---------
5,373,439 3,773,512 2,791,615 2,431,643 2,133,245
--------- --------- --------- --------- ---------
Operating Income.............................................. 453,005 396,270 315,464 360,029 315,930
Interest expense............................................ 36,658 36,628 -- -- --
Other expense, net.......................................... 34,147 20,134 12,677 8,008 2,901
--------- --------- --------- --------- ---------
Income before Provision for Income Taxes and Cumulative Effect
of Accounting Changes....................................... 382,200 339,508 302,787 352,021 313,029
Provision for income taxes.................................. 154,791 137,506 122,798 138,851 126,385
--------- --------- --------- --------- ---------
Income before Cumulative Effect of Accounting Changes......... 227,409 202,002 179,989 213,170 186,644
Cumulative Effect of Accounting Changes--Adoption of SFAS
Nos. 106 and 109.......................................... -- -- -- -- (21,260)
--------- --------- --------- --------- ---------
Net Income.................................................... $ 227,409 $ 202,002 $ 179,989 $ 213,170 $ 165,384
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Per Share Data(A)(B)(C)
Income before Cumulative Effect of Accounting Changes:
Earnings Per Share.......................................... $ 3.30 $ 3.04 $ 2.71 $ 3.21 $ 2.81
Earnings Per Share Assuming Full Dilution................... $ 3.27 $ 3.04 $ 2.71 $ 3.21 $ 2.81
Cumulative Effect of Accounting Changes--Adoption of SFAS
Nos. 106 and 109:
Earnings Per Share.......................................... -- -- -- -- (0.32)
Earnings Per Share Assuming Full Dilution................... -- -- -- -- (0.32)
Net Income:
Earnings Per Share.......................................... $ 3.30 $ 3.04 $ 2.71 $ 3.21 $ 2.49
Earnings Per Share Assuming Full Dilution................... $ 3.27 $ 3.04 $ 2.71 $ 3.21 $ 2.49
OPERATING STATISTICS(D)
Loss ratio.................................................. 81.2% 77.4% 75.6% 72.8% 73.0%
Selling expense ratio....................................... 4.6% 5.6% 6.4% 6.3% 6.2%
General and administrative expense ratio.................... 15.2% 13.6% 11.6% 12.5% 11.2%
Net income ratio............................................ 4.1% 5.0% 6.1% 7.9% 7.0%
DECEMBER 31,
-----------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
BALANCE SHEET DATA
Cash and investments.......................................... $2,939,445 $2,165,492 $2,257,269 $1,973,388 $1,779,495
Total assets.................................................. $4,533,415 $3,405,542 $2,679,257 $2,385,636 $1,921,832
Long-term debt................................................ $ 388,000 $ 625,000 -- -- --
Total equity.................................................. $1,223,169 $ 870,459 $1,670,226 $1,418,919 $1,233,190
Cash dividends declared per common share(E)................... -- $ 10.00 -- -- --
Medical Membership(F)......................................... 6,638,000 4,485,000 2,797,000 2,617,000 2,322,000
- ------------------------------
(A) Per share data for all periods presented prior to 1996 have been recomputed
using 66,366,500 shares, the number of shares outstanding immediately
following completion of the Recapitalization. Per share data for the year
ended December 31, 1996 has been calculated using such 66,366,500 shares,
plus the weighted average number of shares issued since the
Recapitalization.
(B) Per share data includes nonrecurring costs of $0.13 per share and $0.52 per
share for 1997 and 1995, respectively.
(C) Per share data for periods prior to 1997 has been restated to reflect the
adoption of SFAS No. 128, "Earnings Per Share."
(D) The loss ratio represents health care services and other benefits as a
percentage of premium revenue. All other ratios are shown as a percentage of
premium revenue and management services revenue.
(E) The Company paid a $995.0 million special dividend in conjunction with the
Recapitalization which occurred on May 20, 1996. Management currently
expects that all of the Company's future income will be used to expand and
develop its business.
(F) Membership numbers are approximate and include some estimates based upon the
number of contracts at the relevant date and an actuarial estimate of the
number of members represented by each contract.
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This discussion contains forward-looking statements which involve risks and
uncertainties. The Company's actual results may differ materially from those
anticipated in these forward-looking statements as a result of certain factors
including, but not limited to, those set forth under "Factors That May Affect
Future Results of Operations."
GENERAL
The Company is one of the nation's largest publicly traded managed health
care companies with approximately 6.6 million medical members and approximately
22 million specialty members as of December 31, 1997. The Company offers a
diversified mix of managed care products, including health maintenance
organizations ("HMOs"), preferred provider organizations ("PPOs"), point of
service ("POS") plans, other hybrid plans and traditional indemnity products. In
addition, WellPoint offers managed care services for self-funded employers under
management services contracts, including claims processing, actuarial services,
network access, medical cost management and other administrative services. The
Company also offers a broad array of specialty and other products, including
pharmacy, dental, utilization management, life, integrated workers'
compensation, preventive care, disability, behavioral health, COBRA and flexible
benefits account administration.
RECENT ACQUISITIONS AND MAY 1996 RECAPITALIZATION
On March 1, 1997, the Company completed its acquisition of certain portions
of the health and related life group benefits operations (the "GBO") of the John
Hancock Life Insurance Company. The purchase price was $89.7 million, subject to
adjustment upon completion of a post-closing audit (which is still pending). The
purchase method of accounting has been used to account for the acquisition of
the GBO. The GBO, with an associated 1.3 million acquired members, targets large
employers with 5,000 or more employees and a majority of the medical members it
serves are in health plans that are self-funded by employers. The GBO offers
indemnity and PPO plans and also provides life, dental, pharmacy, utilization
management and disability coverage to a variety of employer groups. The GBO has
historically experienced a higher administrative expense ratio than the
Company's traditional California business due to the GBO's higher percentage of
management services business. The higher administrative expense ratio of the GBO
has contributed and may continue to contribute to an increase in the Company's
overall administrative expense ratio in current and future periods.
The Company expects to incur approximately $21 to $25 million of costs
relating to the GBO acquisition during 1998, a portion of which is expected to
be reflected in the Company's results of operations. At the time that the GBO
Acquisition was consummated, the Company expected that it would experience
material membership attrition of up to 30% as it integrated the GBO operations
and implemented its strategy of motivating traditional indemnity insurance
members to select managed care products through, among other things, product
design and premium increases. Premium increases implemented in the second and
third quarters of 1997 did not result in the expected membership attrition. The
Company is currently unable to determine if and to what extent the Company may
experience additional membership attrition as it continues to integrate this
acquired business.
On March 31, 1996, the Company acquired the Life and Health Benefits
Management Division ("MMHD") of Massachusetts Mutual Life Insurance Company (the
"MMHD Acquisition"). The acquired MMHD operations focus on employers with 250 to
5,000 employees and provide administrative services, PPO and indemnity insurance
products. The Company has experienced membership attrition of approximately 18%
through December 31, 1997 on acquired membership, a portion of which is the
result of recently instituted premium increases with respect to certain
accounts. The Company expects that it will experience some level of further
membership attrition of its acquired MMHD members as it pursues its strategy of
motivating members to select managed care products.
25
On May 20, 1996, the Company completed the Recapitalization, including the
acquisition of the commercial operations of BCC (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).
As a result of the GBO and MMHD acquisitions, the Company has significantly
expanded its operations outside of California. In order to implement the
Company's regional expansion strategy, the Company will need to continue its
development of satisfactory provider and sales networks and successfully convert
these books of business to the Company's existing information systems, which
will require additional expenditures by the Company.
Prior to their acquisitions by WellPoint, each of the GBO, MMHD and the BCC
Commercial Operations experienced a higher overall loss ratio than the Company.
The inclusion of these acquisitions has contributed to an increase in the
Company's overall loss ratio. In order to control the respective loss ratios and
reduce the financial risk of these acquired businesses, the Company has
undertaken a variety of measures, including the imposition of significant
premium increases and changes in product design. The Company also implemented a
series of price increases for certain of its California managed care businesses
in response to an increased loss ratio in the second and third quarters of 1997.
The Company will continue to evaluate the need for further price increases, plan
design changes and other appropriate actions in the future. There can be no
assurances, however, that the Company will be able to take subsequent pricing or
other actions or that any actions previously taken or implemented in the future
will be successful in addressing any concerns that may arise with respect to the
performance of certain businesses.
LEGISLATION
A variety of health care reform measures are currently pending or have been
recently enacted at the Federal, state and local 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 health
care and of increasing the Company's loss ratio or decrease the affordability of
the Company's products. In May 1997, the Texas Legislature adopted Senate Bill
No. 386 ("SB 386"), which purports to make managed care organizations ("MCOs"),
such as the Company, liable for the failure by the MCO, its employees or agents
to exercise ordinary care when making "health care treatment decisions" (as
defined in SB 386). The legislation became effective as of September 1, 1997. It
is too early to determine what effect, if any, this legislation may have on the
Company. However, to the extent that this legislation (or similar legislation
that may be subsequently adopted at the Federal or state level) effectively
expands the scope of liability of MCOs such as the Company, it may have a
material adverse effect on the Company's results of operations and financial
condition. See "Business--Government Regulation."
YEAR 2000
The Company is substantially dependent on its computer systems and
applications due to the nature of its managed health care business and the
increasing number of electronic transactions in the industry. Historically, some
computer systems and applications were developed to recognize the year as a
two-digit number, with the digits "00" being recognized as the year 1900. The
year 2000 presents a number of potential problems for such systems, including
potentially significant processing errors or failure. In order to address these
problems, the Company has developed and is in the midst of executing a
comprehensive plan designed to address the "year 2000" issue for its computer
systems and applications. During 1997, the Company completed a detailed risk
assessment of its various computer systems and applications, formulated a plan
for specific remediation efforts and began certain of such remediation efforts.
During 1998 and the first quarter of 1999, the Company expects to continue and
complete its remediation efforts and to undertake internal testing of its
systems and applications. In the second quarter of 1999, the Company
26
expects to undergo third-party testing of its applications and systems. The
Company currently estimates that its costs related to year 2000 compliance
remediation for Company-owned systems and applications will be approximately $20
million in 1998 and approximately $2 million in 1999. The Company expects that
these costs will be expensed as incurred and will be funded through cash flow
from operations.
The Company has begun to assemble survey data from health care providers,
health care transaction clearing houses, employers, agents and brokers and other
parties with which it communicates electronically to determine the compliance
efforts being undertaken by these parties and to assess WellPoint's potential
business exposure to any non-compliant systems operated by these parties.
Although the Company is implementing programs and procedures designed to
mitigate the aforementioned risks, there can be no assurances that all potential
problems may be mitigated by these procedures.
DELAWARE REINCORPORATION
On August 4, 1997, the Company completed a reincorporation in Delaware (the
"Reincorporation") through the formation of a new holding company structure. The
Reincorporation involved a merger among the Company, WellPoint Health Networks
Inc., a California corporation ("WellPoint California"), and WLP Acquisition
Corp. (the "Merger Subsidiary"), a wholly owned subsidiary of the Company.
Merger Subsidiary was merged with and into WellPoint California, and WellPoint
California's shareholders became stockholders of the Company. As a result of
such merger, WellPoint California became a wholly owned subsidiary of the
Company. The principal purpose of the Reincorporation was to allow a
restructuring of the Company and its various subsidiaries in order to improve
the Company's capital as measured for BCBSA purposes.
RESULTS OF OPERATIONS
WellPoint's revenues are primarily generated from premiums earned for
risk-based health care and specialty services provided to its members, fees for
administrative services, including claims processing and access to provider
networks for self-insured employers, and investment income. 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;
depreciation and amortization expense; and income taxes.
The Company's consolidated results of operations for the year ended December
31, 1997 include a full year of earnings for MMHD and BCC Commercial Operations,
and ten months of earnings for the GBO. The results of operations for the year
ended December 31, 1996 include the results of MMHD for the period from April 1,
1996 (its date of acquisition) to December 31, 1996 and BCC Commercial
Operations for the period from May 20, 1996 (its date of acquisition) to
December 31, 1996.
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,
-------------------------------
1997 1996 1995
--------- --------- ---------
Operating Revenues:
Premium revenue.................................................... 93.2% 96.3% 97.9%
Management services revenue........................................ 6.8% 3.7% 2.1%
--------- --------- ---------
100.0% 100.0% 100.0%
Operating Expenses:
Health care services and other benefits............................ 81.2% 77.4% 75.6%
Selling expense.................................................... 4.6% 5.6% 6.4%
General and administrative expense................................. 15.2% 13.6% 11.6%
27
MEMBERSHIP
The following table sets forth membership data and the percent change in
membership:
AS OF DECEMBER 31,
-------------------------- PERCENT
MEDICAL MEMBERSHIP: 1997 1996 CHANGE
- ------------------------------------------------------- ------------ ------------ ---------
CALIFORNIA
Group Services:
HMO................................................ 812,180 677,850 19.8%
PPO and Other...................................... 1,475,360 1,298,359 13.6%
------------ ------------
Total............................................ 2,287,540 1,976,209 15.8%
------------ ------------
Individual, Small Group and Senior:
HMO................................................ 316,350 269,495 17.4%
PPO and Other...................................... 1,282,511 1,197,306 7.1%
------------ ------------
Total............................................ 1,598,861 1,466,801 9.0%
------------ ------------
Medi-Cal HMO Programs.............................. 284,281 111,029 156.0%
------------ ------------
Total California Medical Membership.................. 4,170,682 3,554,039 17.4%
------------ ------------
TEXAS
Group Services....................................... 202,239 77,254 161.8%
Individual, Small Group and Senior................... 74,261 29,095 155.2%
------------ ------------
Total............................................ 276,500 106,349 160.0%
------------ ------------
GEORGIA
Group Services....................................... 91,070 50,713 79.6%
Individual, Small Group and Senior................... 8,139 460 1,669.3%
------------ ------------
Total............................................ 99,209 51,173 93.9%
------------ ------------
OTHER STATES
Group Services....................................... 2,083,122 773,140 169.4%
Individual, Small Group and Senior................... 8,644 -- N/A
------------ ------------
Total............................................ 2,091,766 773,140 170.6%
------------ ------------
Total National Medical Membership.................... 2,467,475 930,662 165.1%
------------ ------------
TOTAL MEDICAL MEMBERSHIP(A)(B)....................... 6,638,157 4,484,701 48.0%
------------ ------------
------------ ------------
NETWORKS(B)(C)
Proprietary Networks............................... 3,941,220 3,324,331 18.6%
Other Networks..................................... 1,560,276 774,719 101.4%
Non-Network........................................ 1,136,661 385,651 194.7%
------------ ------------
TOTAL MEDICAL MEMBERSHIP............................. 6,638,157 4,484,701 48.0%
------------ ------------
------------ ------------
- ------------------------
(a) Medical membership includes 2,765,856 and 1,229,308 management services
members as of December 31, 1997 and 1996, respectively, of which those
management services members outside of California were 1,792,151 and
563,854, as of December 31, 1997 and 1996, respectively.
(b) Membership as of December 31, 1997 includes the acquired GBO medical
membership (approximately 1.3 million members as of the date of
acquisition).
(c) Proprietary networks consist of California, Texas and other
WellPoint-developed networks. Other networks consist of third-party networks
and networks owned by the Company as a result of acquisitions that
incorporate provider discounts and some basic managed care elements.
Non-network consists of fee for service and percentage-of-billed charges
contracts with providers.
28
AS OF DECEMBER 31,
-------------------------- PERCENT
1997 1996 CHANGE
------------ ------------ ---------
SPECIALTY MEMBERSHIP:
Pharmacy................................................. 12,290,221 11,516,824 6.7%
Dental................................................... 3,183,477 1,559,391 104.1%
Utilization Management................................... 2,750,767 -- N/A
Life Insurance........................................... 1,757,881 722,964 143.1%
Disability............................................... 1,125,571 107,350 948.5%
Behavioral Health........................................ 721,350 502,212 43.6%
The specialty membership as of December 31, 1997 includes the acquired GBO
operations, which had approximately 0.3 million pharmacy members, 1.5 million
dental members, 2.7 million utilization management members, 0.9 million life
insurance members and 1.0 million disability members at the date of acquisition.
COMPARISON OF RESULTS FOR THE YEAR ENDED DECEMBER 31, 1997 TO THE YEAR ENDED
DECEMBER 31, 1996
Premium revenue increased 34.7%, or $1,348.1 million, to $5,227.9 million
for the year ended December 31, 1997 from $3,879.8 million for the year ended
December 31, 1996. The 1997 acquisition of the GBO contributed $419.4 million,
or 31.1% of this increase. The 1996 acquisitions of MMHD and the BCC Commercial
Operations contributed an incremental increase in 1997 premium revenue of $163.0
million and $147.7 million, respectively, or an aggregate of 23.0% of the total
increase. Also, contributing to increased premium revenue in 1997 was an
increase in insured member months of 12.9%, excluding the GBO from both periods
and excluding MMHD and BCC Commercial Operations from the periods prior to their
respective dates of acquisition in both periods. Additionally, there was an
increase in the per member per month revenues as a result of premium increases
associated with several of the Company's medical products.
Management services revenue increased 159.1%, or $235.3 million, to $383.2
million for the year ended December 31, 1997 from $147.9 million for the year
ended December 31, 1996. The increase was primarily due to $189.9 million of
management services revenue related to the 1997 acquisition of the GBO and $18.9
million and $3.9 million, respectively, of incremental increase in management
services revenue related to the acquisitions of MMHD and the BCC Commercial
Operations in 1996, which together represented 90.4% of the increase. Also
contributing to the increase was an increase in the California large group
management services membership and the addition of a management services
contract with the state of Illinois on July 1, 1997.
Investment income increased $73.3 million to $215.3 million for the year
ended December 31, 1997, compared to $142.0 million for the year ended December
31, 1996. Net realized gains from equity securities increased $45.5 million to
$62.0 million for the year ended December 31, 1997 in comparison to $16.5
million for the year ended December 31, 1996. The year ended December 31, 1997
included a gain of $30.3 million related to the stock-for-stock exchange of the
Company's interest in Health Partners, Inc. ("HPI"), a physician practice
management company, for the common stock of FPA Medical Management, Inc. ("FPA")
as a result of HPI's October 1997 merger with FPA. See Note 4 to the Notes to
Consolidated Financial Statements. Net interest and dividend income increased
$25.9 million to $153.4 million for the year ended December 31, 1997 in
comparison to $127.5 million for the year ended December 31, 1996, primarily due
to increased interest income on the investment portfolios of GBO and MMHD
acquired businesses and slightly higher yields in 1997 over 1996, partially
offset by the foregone interest from cash and investments used to finance the
GBO, 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 41.4%, or $1,242.2
million, to $4,245.3 million for the year ended December 31, 1997 from $3,003.1
million for the year ended December 31,
29
1996. The acquisition of the GBO accounted for 32.9% of the increase, or $408.2
million. The inclusion of MMHD and the BCC Commercial Operations for a full
twelve months in 1997 accounted for an aggregate of 22.0% of the increase and
resulted in increased health care expense of $133.9 million and $139.1 million,
respectively. Additionally, the Company's health care benefits and other
expenses for the year ended December 31, 1997 increased in comparison to the
prior year as a result of the aforementioned increase in insured member months
of 12.9%.
The loss ratio for 1997 increased to 81.2% compared to 77.4% in 1996. The
acquired MMHD operations, the GBO and the BCC Commercial Operations have
traditionally experienced a higher loss ratio than the Company. Additionally,
the MMHD operations experienced an increase in loss ratio for the year ended
December 31, 1997 in comparison to 1996 due to higher actual claims incurred as
a result of higher cost trends. Excluding the effects of the acquired
businesses, the loss ratio in 1997 would have been 79.2%. The increase in loss
ratio excluding acquired operations is due to a loss ratio increase in the
Company's California businesses, primarily due to slightly higher medical
utilization for certain managed care products and increased pharmacy costs.
Selling expense consists of commissions paid to outside brokers and agents
representing the Company. Selling expense for the year ended December 31, 1997
increased 16.0% to $260.5 million, compared to $224.5 million for the year ended
December 31, 1996, corresponding with continued overall premium revenue growth
and an additional $7.2 million in selling expense attributable to the GBO and
the incremental impact in 1997 of the MMHD acquisition. The selling expense
ratio for the year ended December 31, 1997 decreased to 4.6% from 5.6% for the
year ended December 31, 1996, largely due to the acquisitions of the GBO and
MMHD, which have lower selling expense ratios than the Company's existing
business, and the BCC Commercial Operations, which has no selling expense.
Excluding the effects of the acquisitions for the years ended December 31, 1997
and 1996, the selling expense ratio would have been 5.4% and 5.6%, respectively.
This decrease is due to lower selling costs, in comparison to the Company's
other products, for Medi-Cal and large employer group medical products which
experienced higher growth in premium revenue in 1997.
General and administrative expense for the year ended December 31, 1997
increased 56.2%, or $307.1 million, to $853.1 million from $546.0 million for
the same period in 1996. The increase was primarily due to $196.9 million of
general and administrative expense related to the Company's acquisition of the
GBO in 1997 and $46.0 million and $8.0 million, respectively, of incremental
increase in general and administrative expense related to the Company's
acquisitions of MMHD and the BCC Commercial Operations in 1996.
The administrative expense ratio increased to 15.2% for 1997 compared to
13.6% for 1996, primarily due to the increased administrative expense associated
with the Company's continued investment in national expansion and the
acquisition of the GBO. The GBO has historically experienced a higher
administrative expense ratio than the Company's traditional California-based
businesses due to the GBO's higher percentage of management services business.
The increase was partially offset by the BCC Commercial Operations' lower
administrative expense ratio. The administrative expense ratio for the year
ended December 31, 1997, excluding the effect of the GBO acquisition in 1997 and
the incremental effect in 1997 of MMHD and BCC Commercial Operations, was 13.0%.
The Company recorded $14.5 million of nonrecurring costs for the year ended
December 31, 1997, of which $8.0 million recorded in the second quarter of 1997
related primarily to the write-down of the Company's dental practice management
operations and discontinuance of the Company's medical practice management
operations. In addition, the Company incurred $6.5 million in the first quarter
related to severance and retention payments associated with the GBO acquisition.
Interest expense increased for the year ended December 31, 1997 to $36.7
million, from $36.6 million for the year ended December 31, 1996. The increase
is primarily due to interest on debt incurred as a result of the
Recapitalization in May 1996 being included in the results of operations for the
entire year
30
ended December 31, 1997 in comparison to a shorter period of time in the year
ended December 31, 1996, partially offset by debt repayments during 1997. The
weighted average interest rate for all debt for the year ended December 31,
1997, including the fees associated with the borrowings and interest rate swaps,
was 7.45%. See "--Liquidity and Capital Resources."
The Company's net income for the year ended December 31, 1997 was $227.4
million, compared to $202.0 million for the year ended December 31, 1996.
Earnings per share totaled $3.30 and $3.04 for the years ended December 31, 1997
and 1996, respectively. Earnings per share assuming full dilution totaled $3.27
and $3.04 for the years ended December 31, 1997 and 1996, respectively. Earnings
per share for the year ended December 31, 1997 included nonrecurring costs of
$0.13 per share. Earnings per share for all periods presented has been
calculated in accordance with Statement of Financial Accounting Standards No.
128, Earnings Per Share ("SFAS No. 128").
Earnings per share for the year ended December 31, 1997 is based upon
weighted average shares outstanding of 68.8 million, excluding common stock
equivalents, and 69.5 million shares, assuming full dilution. Earnings per share
for the year ended December 31, 1996 has been calculated using 66.4 million
shares for both measures. Common stock equivalents did not have a dilutive
effect on earnings per share in 1996. The 1996 weighted average reflects the
number of shares outstanding immediately following the Recapitalization, plus
the weighted average number of shares issued in 1996 subsequent to the
Recapitalization. For the year ended December 31, 1997, the increase in weighted
average shares outstanding primarily relates to the public offering of 3,000,000
shares of the Company's common stock in April 1997 and, on a diluted basis, the
inclusion of 651,000 common stock equivalents related to the Company's stock
option plans.
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 for the year ended December 31, 1996 from $2,200.0 million for the year
ended December 31, 1995. Of the $803.1 million increase, $412.2 million was
attributable to MMHD and $189.9 million was attributable to the BCC
31
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 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 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%.
The Company'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 the weighted
average number of shares issued in 1996 subsequent to the Recapitalization. The
number of shares outstanding prior to the Recapitalization were adjusted to
reflect the two-for-three share exchange that occurred in connection with the
Recapitalization. Earnings per share is determined by dividing net income by the
weighted
32
average number of common shares outstanding. Earnings per share for the year
ended December 31, 1995 included nonrecurring costs of $0.52 per share. For the
year ended December 31, 1995, there were no stock options outstanding and, for
the year ended December 31, 1996, stock options did not have a dilutive effect
on weighted average shares outstanding. Therefore, for 1995 and 1996 there is no
difference between earnings per share and earnings per share assuming full
dilution as calculated under SFAS No. 128.
FINANCIAL CONDITION
The Company's consolidated assets increased by $1,127.9 million from
$3,405.5 million as of December 31, 1996 to $4,533.4 million as of December 31,
1997. This represents a 33.1% increase and resulted primarily from the GBO
acquisition as well as cash flows generated from operations. Cash and
investments were $2,939.4 million as of December 31, 1997, or 64.8% of total
assets.
As of December 31, 1997, $388.0 million was outstanding under the Company's
long-term debt facilities, compared to $625.0 million at December 31, 1996. Debt
repayments were funded from the proceeds from the Company's April 1997 common
stock offering and from cash flow from operations.
Equity totaled $1,223.2 million as of December 31, 1997, an increase of
$352.7 million from $870.5 million as of December 31, 1996. The increase
resulted primarily from the net income of $227.4 million for the year ended
December 31, 1997, $110.3 million and $9.9 million in additional paid-in capital
from the Company's public offering of three million shares of common stock and
stock issuances under the Company's stock option and stock purchase plans,
respectively, and $4.9 million change in net unrealized valuation adjustments on
investment securities, net of tax.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of cash are premium and management services
revenues received and investment income. The primary uses of cash include health
care claims and other benefits, capitation payments, income taxes, repayment of
long-term debt, interest expense, broker and agent commissions, administrative
expenses and capital expenditures. In addition to the foregoing, other uses of
cash include costs of provider networks and systems development, and costs
associated with acquisitions and the integration of acquired businesses. 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,
1997, 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 $539.8 million for the
year ended December 31, 1997, compared with $410.9 million in 1996. The positive
cash flow from operations is due primarily to net income of $227.4 million,
adjusted for certain operating liabilities such as increased medical claims
payable of $170.7 million and accounts payable and accrued expenses of $116.9
million.
Net cash used in investing activities in 1997 totaled $452.6 million,
compared with net cash used in investing activities of $736.2 million in 1996.
The cash used in 1997 was attributable primarily to the purchase of investments
for $2,747.2 million partially offset by the proceeds from investments sold and
matured of $2,009.4 million and the net cash acquired from the GBO purchase of
$362.0 million. The GBO was acquired for a total purchase price of $89.7
million, all of which was funded with cash. GBO net cash acquired was $451.7
million.
Net cash used in financing activities totaled $116.6 million in 1997,
compared to net cash used in financing activities of $431.0 million in 1996. The
net cash used in financing activities in 1997 was primarily due to borrowings
and repayments on long-term debt which totaled $150.0 million and $387.0
million, respectively, partially offset by net proceeds from common stock
offering of $110.3 million.
33
The Company has a $1.0 billion unsecured revolving credit facility.
Borrowings under the credit facility bear interest at rates determined by
reference to the bank's base rate or to the London Interbank Offered Rate
("LIBOR") plus a margin determined by reference to the Company's leverage ratio
(as defined in the credit agreement) or the then-current rating of the Company's
unsecured long-term debt by specified rating agencies. Borrowings under the
credit facility are made on a committed basis or pursuant to an auction-bid
process. The credit facility expires as of May 15, 2002, although it may be
extended for an additional one-year period under certain circumstances. The
credit agreement requires the Company to maintain certain financial ratios and
contains restrictive covenants, including restrictions on the occurrence of
additional indebtedness and the granting of certain liens, limitations on
acquisitions and investments and limitations on changes in control. The total
amount outstanding under the credit facility was $368.0 million and $555.0
million as of December 31, 1997 and 1996, respectively. The weighted average
interest rate for the year ended December 31, 1997, including the facility and
other fees and the effect of the interest rate swaps discussed in the following
paragraph, was 7.45%.
As part of a hedging strategy to limit 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.
Prior to the Reincorporation, the Company held a license as a health care
service plan under the Knox-Keene Act. See "Item 1. Business--Government
Regulation." As such, the Company was required to maintain minimum tangible net
equity ("TNE") by the DOC, in addition to meeting minimum capital requirement
prescribed by the BCBSA. As a DOC licensee, the Company used TNE in measuring
capital for the BCBSA. The failure to meet a specified level (the "BCBSA Minimum
Capital") of the BCBSA's base capital requirement can subject the Company to
certain corrective actions, while the failure to meet a lower specified level
can result in the termination of the Company's license agreement with BCBSA. As
a result of the Reincorporation, the Company is no longer licensed under the
Knox-Keene Act (Blue Cross of California remains a DOC licensee) and, as a
result, its capital for BCBSA purposes is measured based on GAAP equity. As of
December 31, 1997, the Company's GAAP equity was in excess of the BCBSA's
Minimum Capital requirement. A principal purpose of the Reincorporation was to
allow restructuring of the Company and its various subsidiaries in order to
improve the Company's capital as measured for BCBSA purposes.
In November 1996, in order to address an anticipated shortfall in its
capital for BCBSA purposes, the Company entered into a subordinated debt
agreement for $200 million. On March 17, 1997, prior to the Reincorporation, the
Company borrowed $150.0 million under its subordinated debt agreement to ensure
compliance with the Company's BCBSA capital requirements, bringing its total
indebtedness under the facility to $200 million at that date. The Company used
the proceeds of its April 1997 public offering of 3,000,000 shares of its common
stock to pay down outstanding indebtedness under the Company's subordinated debt
agreement. On July 1, 1997, the Company repaid the remaining $90.0 million
outstanding under the subordinated debt agreement with borrowings under the
revolving credit facility.
Certain of the Company's subsidiaries are required to maintain minimum
capital requirements prescribed by various regulatory agencies, including the
California Department of Corporations and the Department of Insurance in various
states. As of December 31, 1997, those subsidiaries of the Company were in
compliance with all minimum capital requirements.
In July 1996, the Company filed a registration statement relating to the
issuance of $1.0 billion of senior or subordinated unsecured indebtedness. As of
December 31, 1997, no indebtedness had been issued pursuant to this registration
statement.
The Company believes that cash flow generated by operations, its cash and
investment balances, supplemented by the Company's ability to borrow under its
existing revolving credit facility or to conduct a
34
public offering under its debt registration statement will be sufficient to fund
continuing operations and expected capital requirements for the foreseeable
future.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("SFAS No. 130"). SFAS No. 130 will require companies to present all
non-owner changes in equity, (e.g., market value adjustments to investments and
adjustments to the minimum pension liability) that are currently included as a
component of stockholders' equity as a component of comprehensive income. The
new disclosures will be effective beginning in the first quarter of 1998.
In June 1997, the FASB also issued Statement of Financial Accounting
Standards No. 131, "Disclosures About Segments of an Enterprise and Related
Information" ("SFAS No. 131"). SFAS No. 131 requires that companies disclose
"operating segments" based on the way management disaggregates the company for
making internal operating decisions. The new disclosures will be effective for
the Company's fiscal year ending on December 31, 1998. Abbreviated quarterly
disclosure will be required beginning with the period ending March 31, 1999,
with comparative information required for the corresponding period in the prior
fiscal year.
In February 1998, the FASB issued Statement of Financial Accounting
Standards No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits" ("SFAS No. 132"). SFAS No. 132 standardizes the
disclosure requirements of pension and other postretirement benefits under
previous guidance. In addition, SFAS No. 132 requires additional disclosures
regarding changes in the benefit obligations and fair values of plan assets,
eliminates certain disclosures no longer deemed useful, permits aggregation of
information about certain plans and revises disclosure about defined
contribution plans. The new disclosures are required for year-end financial
statements for the year ending December 31, 1998.
The Company is presently assessing the presentation and effect of SFAS Nos.
130, 131 and 132 on the financial statements of the Company.
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
Certain statements contained herein, such as statements concerning potential
or future loss ratios, expected membership attrition as the Company continues to
integrate its recently acquired operations 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. See also "Item 1. Business--Factors That May Affect Future Results
of Operations."
As part of the Company's business strategy, the Company has recently
acquired substantial operations in new geographic markets. These businesses,
which include substantial indemnity-based insurance operations, have experienced
varying profitability or losses in recent periods. During 1997, the Company
worked extensively on the integration of these businesses, which will be
continuing in 1998; however, there can be no assurances regarding the ultimate
success of the Company's integration efforts or regarding the ability of the
Company to maintain or improve the results of operations of 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 has and
will, among other things, need to continue to incur considerable expenditures
for provider networks and information systems in addition to the costs
associated with the integration of these acquisitions. The integration of these
complex businesses may result in, among other things, temporary increases in
claims inventory or other service-related issues. The Company's results of
operations could be adversely affected in the event that the Company experiences
such problems or is otherwise unable to implement fully its expansion strategy.
35
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, provider consolidation,
inflation, new technologies, clusters of high-cost, 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 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, design products, or select
underwriting criteria may adversely affect the Company's financial condition or
results of operations.
Managed care organizations, both inside and outside California, operate in a
highly competitive environment that has undergone significant change in recent
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.
As a result of the Company's recent acquisitions, the Company now operates
on a national basis and offers a spectrum of health care and specialty products
through various risk sharing arrangements. The Company's health care products
include a variety of managed care offerings as well as traditional fee-for-
service coverage. With respect to product type, fee-for-service products are
generally less profitable than managed care products. A critical component of
the Company's expansion strategy is to transition over time the traditional
insurance members of the Company's acquired businesses to more managed care
products. With respect to the risk-sharing nature of products, managed care
products that involve greater potential risk to the Company generally tend to be
more profitable than those managed care products where the Company is able to
shift risks to employer groups and management services products. Individuals and
small employer groups are more likely to purchase the Company's higher-risk
managed care products because such purchasers are generally unable or unwilling
to bear greater liability for health care expenditures. Over the past few years,
the Company has experienced greater margin erosion in its higher risk managed
care products than in its lower-risk managed care and management services
products. This margin erosion is attributable to product mix change, competitive
pressure and greater regulatory restrictions applicable to the small employer
group market. The Company has implemented price increases in certain of its
managed care businesses. While these price increases are intended to improve
profitability, there can be no assurance that this will occur. Subsequent
unfavorable changes in the relative profitability between the Company's various
products could have a material adverse effect on the Company's results of
operations and on the continued feasibility of the Company's geographic
expansion strategy.
Substantially all of the Company's investment assets are in yielding
securities of varying maturities. The value of such securities are highly
sensitive to fluctuations in short-and long-term interest rates, with the value
decreasing as such rates increase or increasing as such rates decrease. Changes
in the value of the Company's investment assets, as a result of interest rate
fluctuations, can impact the Company's total assets and stockholders' equity and
can also result in gains or losses which impact the Company's results of
operations. There can be no assurance that interest rate fluctuations will not
have a material adverse affect on the results of operations or financial
condition of the Company.
36
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 45 hereof.
SELECTED QUARTERLY FINANCIAL INFORMATION
(UNAUDITED)
IN THOUSANDS, EXCEPT PER SHARE DATA AND MEMBERSHIP DATA
FOR THE QUARTER ENDED
-------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1997 1997 1997 1997
------------ ------------ ------------- ------------
(IN THOUSANDS, EXCEPT PER SHARE DATA AND MEMBERSHIP
DATA)
Total revenues...................................... $ 1,271,632 $ 1,485,609 $ 1,511,580 $1,557,623
Operating income.................................... 103,916(A) 97,858(A) 108,415 142,816
Income before provision for income taxes............ 85,279(A) 82,818(A) 93,383 120,720
Net income.......................................... $ 50,755(A) $ 49,263(A) $ 55,568 $ 71,823
------------ ------------ ------------- ------------
------------ ------------ ------------- ------------
Per Share Data(B):
Earnings Per Share................................ $ 0.76(A) 0.71(A) $ 0.80 $ 1.03
------------ ------------ ------------- ------------
------------ ------------ ------------- ------------
Earnings Per Share Assuming Full Dilution......... $ 0.76(A) 0.70(A) $ 0.79 $ 1.02
------------ ------------ ------------- ------------
------------ ------------ ------------- ------------
Medical membership.................................. 5,914,726 6,067,966 6,473,467 6,638,157
------------ ------------ ------------- ------------
------------ ------------ ------------- ------------
FOR THE QUARTER ENDED
-------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1996 1996 1996 1996
------------ ------------ ------------- ------------
(IN THOUSANDS, EXCEPT PER SHARE DATA AND MEMBERSHIP
DATA)
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.............................................. $ 60,133 $ 49,772 $ 45,101 $ 47,016
------------ ------------ ------------- ------------
------------ ------------ ------------- ------------
Per Share Data(B)(C):
Earnings Per Share.................................... $ 0.91 $ 0.75 $ 0.68 $ 0.71
------------ ------------ ------------- ------------
------------ ------------ ------------- ------------
Earnings Per Share Assuming Full Dilution............. $ 0.91 $ 0.75 $ 0.68 $ 0.71
------------ ------------ ------------- ------------
------------ ------------ ------------- ------------
Medical membership...................................... 3,926,820 4,243,673 4,387,510 4,484,701
------------ ------------ ------------- ------------
------------ ------------ ------------- ------------
- --------------------------
(A) The first and second quarters of 1997 include nonrecurring costs of $6.5
million and $8.0 million, before taxes, $3.8 million and $4.8 million, after
tax, or $0.06 and $0.07 per share on a basic and diluted basis,
respectively.
(B) Per share data for all periods prior to the fourth quarter of 1997 has been
restated to reflect the adoption of SFAS No. 128.
(C) Per share data 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. Per
share data 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 subsequent to the Recapitalization.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
37
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
A. Directors of the Company.
Information regarding the directors of the Company is contained in the
Company's proxy statement for its 1998 Annual Meeting of Stockholders filed with
the SEC on March 27, 1998 and is incorporated herein by reference.
B. Executive Officers of the Company
Information Regarding the Company's executive officers is contained in Part
I above under the caption "Item 1. Business."
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is contained in the Company's proxy
statement for its 1998 Annual Meeting of Stockholders filed with the SEC on
March 27, 1998 and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is contained in the Company's proxy
statement for its 1998 Annual Meeting of Stockholders filed with the SEC on
March 27, 1998 and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is contained in the Company's proxy
statement for its 1998 Annual Meeting of Stockholders filed with the SEC on
March 27, 1998 and is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K.
A. 1) FINANCIAL STATEMENTS
The consolidated financial statements are contained herein as listed on
the "Index" on page 45 hereof.
2) FINANCIAL STATEMENT SCHEDULES
All of the financial statement schedules for which provision is made in
the applicable accounting regulations of the Commission are not required
under the applicable instructions or are not applicable and therefore have
been omitted.
B. REPORTS ON FORM 8-K
A Current Report on Form 8-K was filed on December 31, 1997 which
reported that the Company and the BCBSA had entered into an amended and
restated California Blue Cross License Addendum modifying the "Ownership
Limit" contained in the Company's Restated Certificate of Incorporation.
38
C) EXHIBITS
EXHIBIT
NUMBER EXHIBIT
- --------- --------------------------------------------------------------------------------------------------------
2.01 Amended and Restated Recapitalization Agreement dated as of March 31, 1995, by and among the Registrant,
Blue Corss 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 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
2.03 Agreement and Plan of Reorganization dated as of July 22, 1997 by and among the Registrant, WellPoint
Health Networks Inc., a California corporation ("WellPoint California"), and WLP Acquisition Corp.,
incorporated by reference to Exhibit 99.1 of Registrant's Current Report on Form 8-K filed on August
5, 1997
3.01 Restated Certificate of Incorporation of the Registrant, incorporated by reference to Exhibit 3.1 of
Registrant's Current Report on Form 8-K filed on August 5, 1997.
3.02 Bylaws of the Registrant, incorporated by reference to Appendix B to WellPoint California's Schedule 14A
filed on May 8, 1997, File No. 333-03292-01
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 8-B, Registration No. 001-13083
4.02 Restated Certificate of Incorporation of the Registrant (included in Exhibit 3.01)
4.03 Bylaws of the Registrant (included in Exhibit 3.02)
9.01 Amended and Restated Voting Trust Agreement dated as of August 4, 1997 by and among the California
HealthCare Foundation (the "Foundation") and Wilmington Trust Company, incorporated by reference to
Exhibit 99.2 of Registrant's Current Report on Form 8-K filed on August 5, 1997
10.01 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 Annual Report on Form 10-K for the
fiscal year ended December 31, 1992
10.02 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 Annual Report on Form
10-K for the fiscal year ended December 31, 1992
10.03 Undertakings dated January 7, 1993, by the Registrant, Blue Cross of California and certain subsidiaries
to the California Department of Corporations, incorporated by reference to Exhibit 10.24 of the
Registrant's Form S-1 Registration Statement No. 33-54898
10.04* Supplemental Pension Plan of Blue Cross of California, incorporated by reference to Exhibit 10.15 of
Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992
10.05* 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
10.06* 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
10.07* Officer Severance Agreement, dated as of July 1, 1993, between the Registrant and Thomas C. Geiser,
incorporated by reference to Exhibit 10.24 of the Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 1993
10.08* Form of Officer Severance Agreement of the Registrant, incorporated by reference to Exhibit 10.32 of the
Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994
39
EXHIBIT
NUMBER EXHIBIT
- --------- --------------------------------------------------------------------------------------------------------
10.09 Orders Approving Notice of Material Modification and Undertakings dated September 7, 1995, by BCC, the
Registrant and the Registrant's subsidiaries to the California Department of Corporations,
incorporated by reference to Exhibit 10.47 of Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1995
10.10 Lease Agreement, dated as of January 1, 1996, by and between TA/Warner Center Associates II, L.P., and
the Registrant, incorporated by reference to Exhibit 10.46 of Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1995
10.11* Letter, dated November 13, 1995, from the Registrant to Ronald A. Williams regarding severance benefits,
together with underlying Officer Severance Agreement, incorporated by reference to Exhibit 10.47 of
Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1995
10.12* Letter, dated November 13, 1995, from the Registrant to D. Mark Weinberg regarding severance benefits,
together with underlying Officer Severance Agreement, incorporated by reference to Exhibit 10.48 of
Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1995
10.13* Letter, dated November 13, 1995, from the Registrant to Thomas C. Geiser regarding severance benefits,
incorporated by reference to Exhibit 10.49 of Registrant's Annual Report on Form 10-K for the fiscal
year ended December 31, 1995
10.14 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
10.15 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 Quarterly Report on
Form 10-Q for the quarter ended March 31, 1996
10.16 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 Current Report on Form 8-K dated May 20, 1996
10.17 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 Current Report on Form 8-K dated
May 20, 1996
10.18 Amendment No. 1 dated as of June 28, 1996, to the Registrant's Credit Agreement dated as of May 15,
1996, incorporated by reference to Exhibit 10.65 of Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1996
10.19 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
10.20* Employment Agreement dated as of January 22, 1997, by and between the Registrant and Leonard D.
Schaeffer, incorporated by reference to Exhibit 10.50 to Registrant's Annual Report on Form 10-K for
the year ended December 31, 1996
10.21 Modification Agreement dated as of November 26, 1996 by and between the Registrant and California
HealthCare Foundation, incorporated by reference to Exhibit 10.51 to Registrant's Annual Report on
Form 10-K for the year ended December 31, 1996
10.22 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
40
EXHIBIT
NUMBER EXHIBIT
- --------- --------------------------------------------------------------------------------------------------------
10.23 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
10.24 Amendment No. 1 dated as of February 11, 1997 to Registrant's Subordinated Term Loan Agreement dated as
of November 21, 1996, incorporated by reference to Exhibit 10.54 to Registrant's Annual Report on Form
10-K for the year ended December 31, 1996
10.25 Second Amendment dated as of April 21, 1997 to Registrant's Credit Agreement dated as of May 15, 1996,
incorporated by reference to Exhibit 10.55 of Registrant's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1997
10.26 Third Amendment dated as of April 21, 1997 to Registrant's Credit Agreement dated as of May 15, 1996,
incorporated by reference to Exhibit 10.56 of Registrant's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1997
10.27 Second Amendment dated as of April 21, 1997 to Registrant's Subordinated Term Loan Agreement dated as of
November 21, 1996, incorporated by reference to Exhibit 10.57 of Registrant's Quarterly Report on Form
10-Q for the quarter ended March 31, 1997
10.28 Amended and Restated Voting Agreement dated as of August 4, 1997 by and among the Registrant, WellPoint
California and the Foundation, incorporated by reference to Exhibit 99.3 of the Registrant's Current
Report on Form 8-K filed on August 5, 1997
10.29 Amended and Restated Share Escrow Agent Agreement dated as of August 4, 1997 by and between the
Registrant and U.S. Trust Company of California, N.A., incorporated by reference to Exhibit 99.4 of
the Registrant's Current Report on Form 8-K filed on August 5, 1997
10.30 Amended and Restated Registration Rights Agreement dated as of August 4, 1997 by and among the
Registrant, WellPoint California and the Foundation incorporated by reference to Exhibit 99.5 of
Registrant's Form 8-K filed on August 5, 1997
10.31 Blue Cross License Agreement Effective as of August 4, 1997 by and among the Registrant and the Blue
Cross Blue Shield Association (the "BCBSA"), incorporated by reference to Exhibit 99.6 of Registrant's
Form 8-K filed on August 5, 1997
10.32 Blue Cross Controlled Affiliate License Agreement effective as of August 4, 1997 by and between the
BCBSA and Blue Cross of California, incorporated by reference to Exhibit 99.8 of Registrant's Form 8-K
filed on August 5, 1997
10.33 Blue Cross Affiliate License Agreement effective as of August 4, 1997 by and between the BCBSA and BC
Life & Health Insurance Company, incorporated by reference to Exhibit 99.9 of Registrant's Form 8-K
filed on August 5, 1997
10.34 Blue Cross Controlled Affiliate License Agreement Applicable to Life Insurance Companies effective as of
August 4, 1997 by and between the BCBSA and BC Life & Health Insurance Company, incorporated by
reference to Exhibit 99.10 of Registrant's Form 8-K filed on August 5, 1997
10.35 Fourth Amendment to Credit Agreement and Consent dated as of July 21, 1997 by and among the Registrant,
WellPoint California, Bank of America National Trust and Savings Association, as Administrative Agent,
NationsBank of Texas, N.A., as Syndication Agent, and Chase Manhattan Bank, as Documentation Agent,
and the other financial institutions named therein, incorporated by reference to Exhibit 99.11 to
Registrant's Current Report on Form 8-K filed on August 5, 1997.
10.36 Undertakings dated July 31, 1997 by the Registrant, WellPoint California and WellPoint California
Services, Inc. to the California Department of Corporations, incorporated by reference to Exhibit
99.12 to Registrant's Current Report on Form 8-K filed on August 5, 1997
41
EXHIBIT
NUMBER EXHIBIT
- --------- --------------------------------------------------------------------------------------------------------
10.37* WellPoint Health Networks Inc. Stock Option/Award Plan, as amended through January 15, 1997 incorporated
by reference to Exhibit 99.1 to the Registrant's Registration Statement on Form S-8, File No.
333-33013
10.38* WellPoint Health Networks Inc. Employee Stock Purchase Plan (as amended and restated effective January
1, 1998), incorporated by reference to Exhibit 10.71 of Registrant's Form 10-Q for the quarter ended
June 30, 1997)
10.39* Amendment No. 1 to Employment Agreement by and between the Registrant and Leonard D. Schaeffer,
incorporated by reference to Exhibit 10.72 to Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1997
10.40* Amended and Restated Special Executive Retirement Plan effective as of September 1, 1997 by and between
the Registrant and Leonard D. Schaeffer, incorporated by reference to Exhibit 10.73 to Registrant's
Quarterly Report on Form 10-Q for the quarter ended September 30, 1997
10.41* Salary Deferral Savings Program of WellPoint Health Networks Inc., as amended through October 1, 1997,
incorporated by reference to Exhibit 10.74 to Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1997
10.42* WellPoint Health Networks Inc. Comprehensive Executive Non-Qualified Retirement Plan, incorporated by
reference to Exhibit 4.6 to the Registrant's Registration Statement on S-8 (File No. 333-42073).
10.43 California Blue Cross License Addendum, as amended and restated as of December 30, 1997, between the
Registrant, Blue Cross of California and the BCBSA, incorporated by reference to Exhibit 99.1 of the
Registrant's Current Report on Form 8-K filed December 31, 1997
10.44* WellPoint Health Networks Inc. Officer Change-in-Control Plan as amended and restated February 12, 1998.
10.45 WellPoint Health Networks Inc. Employee Stock Option Plan, as amended through February 12, 1998
10.46* WellPoint Officer Benefit Enrollment Guide Brochure
10.47* Description of WellPoint Health Networks Corporate Incentive Plan
10.48 Office Lease dated as of December 2, 1997 by and among the Registrant and Westlake Business Park, Ltd.
10.49* WellPoint Health Networks Inc. Stock Option/Award Plan, as amended through February 12, 1998
21 List of Subsidiaries of the Registrant
23.1 Consent of Independent Accountants
24 Power of Attorney (included on Signature Page).
27.1 Financial Data Schedule
27.2 Restated Financial Data Schedule for the three months ended March 31, 1996
27.3 Restated Financial Data Schedule for the six months ended June 30, 1997
27.4 Restated Financial Data Schedule for the nine months ended September 30, 1997
- ------------------------
* Management contract or compensatory plan or arrangement
42
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 30, 1998 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 30, 1998
Leonard D. Schaeffer (Principal Executive
Officer)
Executive Vice President
/s/ DAVID C. COLBY and Chief Financial
- ------------------------------ Officer (Principal March 30, 1998
David C. Colby Financial Officer)
Senior Vice President,
/s/ S. LOUISE MCCRARY Controller and Chief
- ------------------------------ Accounting Officer March 30, 1998
S. Louise McCrary (Principal Accounting
Officer)
/s/ DAVID R. BANKS
- ------------------------------ Director March 30, 1998
David R. Banks
43
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
/s/ W. TOLIVER BESSON
- ------------------------------ Director March 30, 1998
W. Toliver Besson
/s/ ROGER E. BIRK
- ------------------------------ Director March 30, 1998
Roger E. Birk
/s/ SHEILA A. BURKE
- ------------------------------ Director March 30, 1998
Sheila A. Burke
/s/ STEPHEN L. DAVENPORT
- ------------------------------ Director March 30, 1998
Stephen L. Davenport
/s/ JULIE A. HILL
- ------------------------------ Director March 30, 1998
Julie A. Hill
/s/ ELIZABETH A. SANDERS
- ------------------------------ Director March 30, 1998
Elizabeth A. Sanders
44
INDEX TO FINANCIAL STATEMENTS
WELLPOINT HEALTH NETWORKS INC.
PAGE
-----
Report of Independent Accountants.......................................................................... F-1
Consolidated Balance Sheets as of December 31, 1997 and 1996............................................... F-2
Consolidated Income Statements for the Three Years Ended December 31, 1997................................. F-3
Consolidated Statements of Changes in Stockholders' Equity for the Three Years Ended December 31, 1997..... F-4
Consolidated Statements of Cash Flows for the Three Years Ended December 31, 1997.......................... F-5
Notes to Consolidated Financial Statements................................................................. F-6
45
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders 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, 1997
and 1996, 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, 1997. 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, 1997 and 1996, and the
consolidated results of their operations and cash flows for each of the three
years in the period ended December 31, 1997 in conformity with generally
accepted accounting principles.
Coopers & Lybrand L.L.P.
Los Angeles, California
February 2, 1998
F-1
WELLPOINT HEALTH NETWORKS INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
------------------------
1997 1996
----------- -----------
(IN THOUSANDS, EXCEPT
SHARE DATA)
ASSETS
Current Assets:
Cash and cash equivalents............................................................ $ 283,851 $ 313,256
Investment securities, at market value............................................... 2,552,775 1,728,305
Receivables, net..................................................................... 537,454 401,300
Deferred tax assets.................................................................. 79,733 67,147
Other current assets................................................................. 52,004 28,463
----------- -----------
Total Current Assets............................................................. 3,505,817 2,538,471
Property and equipment, net............................................................ 115,193 82,720
Intangible assets...................................................................... 698,507 552,279
Long-term investments.................................................................. 102,819 123,931
Deferred tax assets.................................................................... 62,487 57,830
Other non-current assets............................................................... 48,592 50,311
----------- -----------
Total Assets..................................................................... $ 4,533,415 $ 3,405,542
----------- -----------
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Medical claims payable............................................................... $ 922,658 $ 667,540
Loss and loss adjustment expense reserves............................................ 115,325 102,152
Reserves for future policy benefits.................................................. 51,189 13,001
Unearned premiums.................................................................... 210,337 160,036
Accounts payable and accrued expenses................................................ 372,441 251,480
Experience rated and other refunds................................................... 255,625 146,882
Income taxes payable................................................................. 107,018 99,086
Other current liabilities............................................................ 309,712 118,303
----------- -----------
Total Current Liabilities........................................................ 2,344,305 1,558,480
Accrued postretirement benefits........................................................ 63,891 61,086
Loss and loss adjustment expense reserves, non-current................................. 134,933 131,079
Reserves for future policy benefits, non-current....................................... 332,033 91,507
Long-term debt......................................................................... 388,000 625,000
Other non-current liabilities.......................................................... 47,084 67,931
----------- -----------
Total Liabilities................................................................ 3,310,246 2,535,083
Stockholders' Equity:
Preferred stock--$0.01 par value, 50,000,000 shares authorized, none issued and
outstanding........................................................................ -- --
Common stock--$0.01 par value, shares authorized 300,000,000; issued 69,778,086 and
66,526,985 in 1997 and 1996, respectively.......................................... 698 665
Treasury stock, at cost, 4,571 shares in 1997........................................ (103) --
Additional paid-in capital........................................................... 882,312 761,879
Unrealized valuation adjustment...................................................... (5,056) (9,994)
Retained earnings.................................................................... 345,318 117,909
----------- -----------
Total Stockholders' Equity....................................................... 1,223,169 870,459
----------- -----------
Total Liabilities and Stockholders' Equity..................................... $ 4,533,415 $ 3,405,542
----------- -----------
----------- -----------
See the accompanying notes to the consolidated financial statements.
F-2
WELLPOINT HEALTH NETWORKS INC.
CONSOLIDATED INCOME STATEMENTS
YEAR ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
(IN THOUSANDS, EXCEPT EARNINGS PER
SHARE)
Revenues:
Premium revenue....................................................... $ 5,227,904 $ 3,879,806 $ 2,910,622
Management services revenue........................................... 383,238 147,948 61,151
Investment income..................................................... 215,302 142,028 135,306
------------ ------------ ------------
5,826,444 4,169,782 3,107,079
Operating Expenses:
Health care services and other benefits............................... 4,245,281 3,003,117 2,199,953
Selling expense....................................................... 260,523 224,453 190,161
General and administrative expense.................................... 853,100 545,942 344,427
Nonrecurring costs.................................................... 14,535 -- 57,074
------------ ------------ ------------
5,373,439 3,773,512 2,791,615
------------ ------------ ------------
Operating Income........................................................ 453,005 396,270 315,464
Interest expense...................................................... 36,658 36,628 --
Other expense, net.................................................... 34,147 20,134 12,677
------------ ------------ ------------
Income before Provision for
Income Taxes.......................................................... 382,200 339,508 302,787
Provision for income taxes............................................ 154,791 137,506 122,798
------------ ------------ ------------
Net Income.............................................................. $ 227,409 $ 202,002 $ 179,989
------------ ------------ ------------
------------ ------------ ------------
Earnings Per Share...................................................... $ 3.30 $ 3.04 $ 2.71
------------ ------------ ------------
------------ ------------ ------------
Earnings Per Share Assuming Full Dilution............................... $ 3.27 $ 3.04 $ 2.71
------------ ------------ ------------
------------ ------------ ------------
See the accompanying notes to the consolidated financial statements.
F-3
WELLPOINT HEALTH NETWORKS INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
COMMON STOCK
---------------------------------------
CLASS A
ISSUED IN TREASURY COMMON STOCK
PREFERRED ------------------------ ------------- ----------------------
(IN THOUSANDS) STOCK SHARES AMOUNT AMOUNT SHARES AMOUNT
- ------------------------------------------------ ------------- ----------- ----------- ------------- --------- -----------
Balance as of January 1, 1995................... $ -- -- $ -- $ -- 19,500 $ 195
Net income....................................
Change in unrealized valuation adjustment on
investment securities, net of tax...........
----- ----------- ----- ----- --------- ---
Balance as of December 31, 1995................. -- -- -- -- 19,500 195
Net income....................................
Recapitalization
Dividends...................................
Share exchange.............................. 66,367 664 (19,500) (195)
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 -- -- --
Net income....................................
Net proceeds from common stock offering....... 3,000 30
Stock grants to employees and directors....... 6
Stock issued for employee stock option and
stock purchase plans........................ 245 3
Stock repurchased, 4,571 shares at cost....... (103)
Change in unrealized valuation adjustment on
investment securities, net of tax...........
----- ----------- ----- ----- --------- ---
Balance as of December 31, 1997................. $ -- 69,778 $ 698 $ (103) -- $ --
----- ----------- ----- ----- --------- ---
----- ----------- ----- ----- --------- ---
CLASS B
COMMON STOCK ADDITIONAL UNREALIZED
---------------------- PAID-IN VALUATION RETAINED
(IN THOUSANDS) SHARES AMOUNT CAPITAL ADJUSTMENT EARNINGS TOTAL
- ------------------------------------------------ --------- ----------- ----------- ----------- --------- ---------
Balance as of January 1, 1995................... 80,000 $ 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................. 80,000 800 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.............................. (80,000) (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
Net income.................................... 227,409 227,409
Net proceeds from common stock offering....... 110,310 110,340
Stock grants to employees and directors....... 270 270
Stock issued for employee stock option and
stock purchase plans........................ 9,853 9,856
Stock repurchased, 4,571 shares at cost....... (103)
Change in unrealized valuation adjustment on
investment securities, net of tax........... 4,938 4,938
--------- --- ----------- ----------- --------- ---------
Balance as of December 31, 1997................. -- $ -- $ 882,312 $ (5,056) $ 345,318 $1,223,169
--------- --- ----------- ----------- --------- ---------
--------- --- ----------- ----------- --------- ---------
See the accompanying notes to the consolidated financial statements.
F-4
WELLPOINT HEALTH NETWORKS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
---------------------------------------
1997 1996 1995
------------ ------------ -----------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................................. $ 227,409 $ 202,002 $ 179,989
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization, net of accretion...................... 57,100 37,739 22,034
Gains on sales of assets, net........................................ (59,168) (15,677) (14,510)
Provision (benefit) for deferred income taxes........................ 22,042 (22,341) (17,973)
Amortization of deferred gain on sale of building.................... (4,426) (2,582) --
Writedown for impairment of intangible assets........................ -- -- 27,316
(Increase) decrease in certain assets, net of acquisitions:
Receivables, net................................................... (16,884) 14,812 (37,508)
Other current assets............................................... (29,536) 46,929 (4,907)
Other non-current assets........................................... 1,719 (47,552) --
Increase (decrease) in certain liabilities, net of acquisitions:
Medical claims payable............................................. 170,728 (9,805) (4,422)
Loss and loss adjustment expense reserves.......................... 17,027 59,742 25,581
Reserves for future policy benefits................................ 407 (492) --
Unearned premiums.................................................. 15,798 20,382 4,935
Accounts payable and accrued expenses.............................. 116,926 74,320 3,711
Experience rated and other refunds................................. 20,954 11,043 (34,910)
Income taxes payable and other current liabilities................. 13,350 48,752 (3,304)
Accrued postretirement benefits.................................... 2,805 (1,600) 4,352
Other non-current liabilities...................................... (16,421) (4,772) --
------------ ------------ -----------
Net cash provided by operating activities........................ 539,830 410,900 150,384
------------ ------------ -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investments purchased.................................................. (2,747,205) (1,220,370) (706,792)
Proceeds from investments sold......................................... 1,854,987 899,080 771,074
Proceeds from matured investments...................................... 154,402 81,448 686,221
Property and equipment purchased, net.................................. (58,442) (43,327) (25,223)
Additional investment in subsidiaries.................................. (18,317) -- --
Purchase of subsidiaries, net of cash acquired......................... 361,977 (453,068) (13,177)
------------ ------------ -----------
Net cash provided by (used in) investing activities.............. (452,598) (736,237) 712,103
------------ ------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt........................................... 150,000 825,000 --
Repayment of long-term debt............................................ (387,000) (262,000) --
Net proceeds from common stock offering................................ 110,340 -- --
Proceeds from the issuance of common stock............................. 10,126 962 --
Common stock repurchased............................................... (103) -- --
Dividends paid in connection with the Recapitalization................. -- (995,000) --
Additional capital contributed by Blue Cross of California............. -- -- 43,700
------------ ------------ -----------
Net cash provided by (used in) financing activities.............. (116,637) (431,038) 43,700
------------ ------------ -----------
Net increase (decrease) in cash and cash equivalents..................... (29,405) (756,375) 906,187
Cash and cash equivalents at beginning of year........................... 313,256 1,069,631 163,444
------------ ------------ -----------
Cash and cash equivalents at end of year................................. $ 283,851 $ 313,256 $ 1,069,631
------------ ------------ -----------
------------ ------------ -----------
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 Delaware 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.
On August 4, 1997, the Company completed its plan, which was approved by
shareholders, to reincorporate in Delaware (the "Reincorporation") through the
formation of a new holding company structure. The Reincorporation involved a
merger among the Company, WellPoint Health Networks Inc., a California
corporation ("WellPoint California") and WLP Acquisition Corp. (the "Merger
Subsidiary"), a wholly owned subsidiary of the Company. The Merger Subsidiary
was merged with and into WellPoint California, and WellPoint California's
shareholders became the stockholders of the Company. As a result of such merger,
WellPoint California became a wholly owned subsidiary of the Company and changed
its name to Blue Cross of California. A principal purpose of the Reincorporation
was to allow a restructuring of the Company and its various subsidiaries in
order to improve the Company's capital as measured for purposes of the Blue
Cross Blue Shield Association ("BCBSA") which owns the rights to the Blue Cross
name and mark.
The Company offers a broad spectrum of quality network-based health plans,
including health maintenance organizations ("HMOs"), preferred provider
organizations ("PPOs"), point-of-service ("POS") plans, other hybrid plans and
traditional indemnity products to large and small employers, individuals and
seniors. The Company's managed care plans incorporate a full range of financial
incentives and cost controls for both members and providers. In addition, the
Company provides underwriting, actuarial service, network access, medical cost
management, claims processing and administrative services to self-funded
employers under management services contracts. The Company also provides a broad
array of specialty and other products and services, including pharmacy, dental,
utilization management, life, integrated workers' compensation, preventive care,
disability, behavioral health, COBRA and flexible benefits account
administration.
2. ACQUISITIONS AND RECAPITALIZATION
PURCHASE OF GROUP BENEFITS OPERATIONS OF JOHN HANCOCK MUTUAL LIFE INSURANCE
COMPANY AND LIFE AND HEALTH BENEFITS MANAGEMENT DIVISION OF MASSACHUSETTS
MUTUAL LIFE INSURANCE COMPANY
On March 1, 1997, the Company completed its acquisition of certain portions
of the group benefits operations (the "GBO") of John Hancock Mutual Life
Insurance Company for approximately $89.7 million in cash, subject to adjustment
upon completion of a post-closing audit. The GBO, which is now part of the
Company's wholly owned subsidiary, UNICARE Life & Health Insurance Company,
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.
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. 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, 1997.
The purchase method of accounting has been used to account for both of the
above acquisitions. The acquired operations are included in the Company's
results of operations from their respective date of
F-6
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. ACQUISITIONS AND RECAPITALIZATION (CONTINUED)
acquisition. The excess purchase price over net assets acquired was
approximately $148.8 million for the GBO and $251.0 million for MMHD and is
being amortized on a straight-line basis over 35 years for both the GBO and
MMHD.
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 California
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 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, (iii) a cash payment of $235.0 million was
made to the Foundation to reflect the value of the BCC Commercial Operations and
(iv) 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 in Woodland Hills,
California.
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.
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 and April 10, 1997, the
Foundation sold approximately 15.0 and 8.5 million shares, respectively, of the
Company's Common Stock through public offerings. Upon completion of the April
1997 offering, the Foundation owned 29.9 million shares (or approximately 43.0%)
of the Company's outstanding shares.
F-7
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. ACQUISITIONS AND RECAPITALIZATION (CONTINUED)
See Note 19 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 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, 1997 and 1996,
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, equity and
other investments. Restricted assets included in long-term investments at
December 31, 1997 and 1996 were $94.2 million and $93.7 million, respectively,
and consist of deposits required by the DOC. These deposits consist primarily of
U.S.
F-8
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Treasury bonds and notes. Due to their restricted nature, such investments are
classified as long-term without regard to contractual maturity.
The Company has determined that its debt and equity securities are available
for sale. Debt and equity securities are carried at estimated fair value based
on quoted market prices for the same or similar instruments. Unrealized gains
and losses are computed on the basis of specific identification and are included
in stockholders' equity, net of applicable deferred income taxes. Realized gains
and losses on the disposition of investments are included in investment income.
The specific identification method is used in determining the cost of debt and
equity securities sold.
The Company participates in a securities lending program whereby marketable
securities in the Company's portfolio are transferred to an independent broker
or dealer in exchange for collateral equal to at least 102% of the market value
of securities on loan.
PREMIUMS RECEIVABLE
Premiums receivable are shown net of an allowance based on historical
collection trends and management's judgment on the collectibility of these
accounts. These collection trends, as well as prevailing and anticipated
economic conditions, are routinely monitored by management, and any adjustments
required are reflected in current operations.
PROPERTY AND EQUIPMENT, NET
Property and equipment are stated at cost, net of depreciation, and are
depreciated on the straight-line method over the estimated useful lives of the
assets. Leasehold improvements are stated net of amortization and are amortized
over a period not exceeding the term of the lease.
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 $20.9 million, $12.8 million and
$5.6 million for the years ended December 31, 1997, 1996 and 1995, respectively.
Accumulated amortization as of December 31, 1997 and 1996 was $41.9 million and
$21.6 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 asset 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.
F-9
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
MEDICAL CLAIMS PAYABLE
The liability for medical claims payable includes claims in process and a
provision for incurred but not reported claims, which is actuarially determined
based on historical claims payment experience and other statistics. Claim
processing expenses are also accrued based on an estimate of expenses necessary
to process such claims. Such reserves are continually monitored and reviewed
with any adjustments reflected in current operations. Capitation costs represent
monthly fees paid 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.
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
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. The current portion
of loss and loss adjustment expense reserves relates to the portion of such
reserves which management expects to pay within one year.
RESERVES FOR FUTURE POLICY BENEFITS
The estimated reserves for future policy benefits relate to the life and
disability business. Reserves for future extended benefit coverage are based on
projections of past experience. Reserves for future policy and contract benefits
for certain long-term disability products and group paid-up life products are
based upon interest, mortality and morbidity assumptions from published
actuarial tables, modified based upon the Company's experience. Reserves are
continually monitored and reviewed, and as settlements are made or reserves
adjusted, differences are reflected in current operations. The current portion
of reserves for future policy benefits relates to the portion of such reserves
which management expects to pay within one year.
POSTRETIREMENT BENEFITS
The Company currently provides certain health care and life insurance
benefits to eligible retirees and their dependents under plans administered by
the Company. The Company accrues the estimated costs of retiree health and other
postretirement benefits during the periods in which eligible employees render
service to earn the benefits.
F-10
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
Beginning in 1996, the Company filed a consolidated income tax return with
its subsidiaries. For 1995, the operating results of Old WellPoint were included
in the consolidated income tax returns filed by BCC. The income tax provision
for 1995 was 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 reflects the current and future tax
consequences of all events that have been recognized in the financial statements
as measured by the provision of currently enacted tax laws and rates applicable
to future periods.
RECOGNITION OF PREMIUM REVENUE AND MANAGEMENT SERVICES REVENUE
For most health care and life insurance contracts, premiums are billed in
advance of coverage periods and are recognized as revenue over the period in
which services or benefits are obligated to be provided. 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 are estimated for certain group contracts based
on historical and current claims experience.
Workers' compensation insurance premiums are based upon the payroll of the
employer. 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 $36.6
million, $34.8 million and $21.2 million for the years ended December 31, 1997,
1996 and 1995, respectively.
EARNINGS PER SHARE
The Company has adopted Statement of Financial Accounting Standards No. 128,
"Earnings Per Share," effective for fiscal years ending on or after December 31,
1997. Earnings per share are now presented in a dual format, computed both
including and excluding the impact of common stock equivalents. Prior year
information has been restated in order to provide comparable disclosure.
F-11
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
RECLASSIFICATIONS
Certain amounts in the prior year consolidated financial statements have
been reclassified to conform to the 1997 presentation.
4. INVESTMENTS
INVESTMENT SECURITIES
The Company's investment securities consist of the following (in thousands):
DECEMBER 31, 1997
------------------------------------------------
GROSS UNREALIZED
AMORTIZED -------------------- ESTIMATED
COST GAINS LOSSES FAIR VALUE
------------ --------- --------- ------------
U.S. Treasury and agency.................... $ 384,250 $ 2,361 $ 299 $ 386,312
Mortgage-backed securities.................. 721,816 8,370 2,229 727,957
Corporate and other securities.............. 1,248,984 14,679 5,784 1,257,879
------------ --------- --------- ------------
Total debt securities..................... 2,355,050 25,410 8,312 2,372,148
Equity and other investments................ 206,616 8,411 34,400 180,627
------------ --------- --------- ------------
Total investment securities............. $ 2,561,666 $ 33,821 $ 42,712 $ 2,552,775
------------ --------- --------- ------------
------------ --------- --------- ------------
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 and other investments................ 109,955 2,519 4,155 108,319
------------ --------- --------- ------------
Total investment securities............. $ 1,746,489 $ 6,839 $ 25,023 $ 1,728,305
------------ --------- --------- ------------
------------ --------- --------- ------------
The amortized cost and estimated fair value of debt securities as of
December 31, 1997, 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 may 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........................................... $ 128,499 $ 127,395
Due after one year through five years............................. 866,409 870,574
Due after five years through ten years............................ 764,562 770,004
Due after ten years............................................... 595,580 604,175
------------ ------------
Total debt securities........................................... $ 2,355,050 $ 2,372,148
------------ ------------
------------ ------------
For the years ended December 31, 1997, 1996 and 1995, proceeds from the
sales and maturities of debt securities were $1,595.7 million, $647.5 million
and $1,253.0 million, respectively. Gross gains of $9.6 million and gross losses
of $7.2 million were realized on the sales of debt securities for the year ended
December 31, 1997. For 1996, gross realized gains and gross realized losses from
sales of debt securities were $2.3 million and $3.0 million, respectively. In
1995, gross realized gains and gross realized losses from sales of debt
securities were $2.2 million and $5.2 million, respectively.
For the years ended December 31, 1997, 1996 and 1995, proceeds from the
sales of equity securities were $413.7 million, $333.0 million and $204.3
million, respectively. Gross gains of $68.5 million and gross losses of $6.5
million were realized on the sales of equity securities in 1997. For 1996, gross
realized gains and gross realized losses on the sales of equity securities were
$19.1 million and $2.5 million, respectively. In 1995, gross realized gains and
gross realized losses on the sales of equity securities were $21.1 million and
$2.7 million, respectively.
Securities on loan under its securities lending program 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. The balance of securities on loan as of December 31, 1997 and 1996
was $499.3 million and $691.5 million, respectively, and income earned on
security lending transactions for the years ended December 31, 1997, 1996 and
1995 was $2.0 million, $2.2 million and $1.2 million, respectively.
LONG-TERM INVESTMENTS
The Company's long-term investments consist of the following (in thousands):
DECEMBER 31, 1997
------------------------------------------------
GROSS UNREALIZED
AMORTIZED -------------------- ESTIMATED
COST GAINS LOSSES FAIR VALUE
------------ --------- --------- ------------
U.S. Treasury and agency securities......... $ 92,957 $ 214 $ -- $ 93,171
Equity and other investments................ 9,648 -- -- 9,648
------------ --------- --------- ------------
Total long-term investments............. $ 102,605 $ 214 $ -- $ 102,819
------------ --------- --------- ------------
------------ --------- --------- ------------
F-13
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. INVESTMENTS (CONTINUED)
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 and other investments................ 30,367 -- -- 30,367
------------ --------- --------- ------------
Total long-term investments............. $ 124,313 $ 23 $ 405 $ 123,931
------------ --------- --------- ------------
------------ --------- --------- ------------
At December 31, 1997, the Company's debt securities have contractual
maturity dates: due in one year or less, amortized cost of $26.7 million and
market value of $26.8 million and due after one year and through five years,
amortized cost of $66.2 million and market value of $66.4 million.
In 1997 and 1996, the Company owned an interest in the stock of Health
Partners, Inc. ("HPI") which was accounted for under the equity method. In
October 1997, HPI entered into a business combination with FPA Medical
Management, Inc. ("FPA"), a publicly traded company, which was accounted for as
a pooling of interests. As a result of the transaction, the Company exchanged
its HPI stock for FPA stock and recognized a gain of $30.3 million at the date
of the transaction. At December 31, 1997, the Company's investment in FPA is
held in its investment portfolio at estimated fair value. Fluctuation in the
market price of FPA since the date of the transaction is reflected in
stockholders' equity, net of tax.
5. RECEIVABLES, NET
Receivables consist of the following (in thousands):
DECEMBER 31,
----------------------
1997 1996
---------- ----------
Premiums receivable................................................... $ 357,814 $ 301,897
Investment income and other receivables............................... 212,227 121,060
---------- ----------
570,041 422,957
Less allowance for doubtful accounts.................................. 32,587 21,657
---------- ----------
Receivables, net...................................................... $ 537,454 $ 401,300
---------- ----------
---------- ----------
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,
----------------------
1997 1996
---------- ----------
Furniture and fixtures................................................ $ 48,715 $ 37,869
Equipment............................................................. 154,878 109,302
Leasehold improvements................................................ 32,227 24,486
---------- ----------
235,820 171,657
Less accumulated depreciation and amortization........................ 120,627 88,937
---------- ----------
Property and equipment, net........................................... $ 115,193 $ 82,720
---------- ----------
---------- ----------
Depreciation and amortization expense for the years ended December 31, 1997,
1996 and 1995 was $33.2 million, $19.9 million and $16.3 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, 1997 and 1996, $20
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 to provide a
line of credit up to $1.25 billion. 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. In April 1997 the Company
amended this facility to decrease the maximum amount which could be borrowed to
$1.0 billion. The facility expires as of May 15, 2002, although it may be
extended for an additional one-year period under certain circumstances. At
December 31, 1997 and 1996, $368.0 million and $555.0 million, respectively, was
outstanding under this facility.
The agreement provides for interest on committed advances at rates
determined by reference to the bank's base rate or to the London Interbank
Offered Rate ("LIBOR") plus a margin determined by reference to the Company's
leverage ratio (as defined in the credit agreement) or the then-current rating
of the Company's unsecured long-term debt by specified rating agencies. Interest
is determined using whichever of these methods is the most favorable to the
Company (6.1% at December 31, 1997). Borrowings under the credit facility are
made on a committed basis or pursuant to an auction-bid process. A facility fee
based on the facility amount, regardless of utilization, is payable quarterly.
The facility fee rate is also determined by the unsecured debt ratings or the
leverage ratio of the Company.
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, maturing on December 31, 1998. The
F-15
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. LONG-TERM DEBT (CONTINUED)
agreement provided 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 was determined using whichever of
these methods was the most favorable to the Company and was paid quarterly. On
December 30, 1996, the Company borrowed $50 million in order to meet increased
capital requirements of the BCBSA, which borrowing was outstanding on December
31, 1996. All amounts outstanding under the subordinated term loan agreement
were repaid as of April 1997, and the agreement has expired.
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, 1997, no indebtedness had been issued pursuant to this registration
statement.
MATURITIES
At December 31, 1997, the Company's long-term debt maturities are as
follows: 1998--zero; 1999-- $20 million; 2000--zero; 2001--zero; 2002--$368
million.
DEBT COVENANTS
The Company's revolving credit facility requires the maintenance of certain
financial ratios and contains other restrictive covenants, including
restrictions on the occurrence of additional indebtedness and the granting of
certain liens, limitations on acquisitions and investments and limitations on
changes in control. As of December 31, 1997, the Company was in compliance with
the requirements outlined in these agreements.
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 (weighted average rate for 1997 of 6.1%) into fixed-rate debt (weighted
average rate for 1997 of 6.9%). The agreements mature at various dates through
2006. As of December 31, 1997 and 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. The weighted average interest rate
for the year ended December 31, 1997, including the facility and other fees and
the effect of the interest rate swaps, was 7.45%.
INTEREST PAID
Interest paid on long-term debt for the years ended December 31, 1997 and
1996 was $38.9 million and $30.3 million, respectively. No interest was paid for
the year ended December 31, 1995.
F-16
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES
The components of the provision (benefit) for income taxes are as follows
(in thousands):
YEAR ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
---------- ---------- ----------
Current:
Federal................................................ $ 104,258 $ 129,317 $ 111,814
State.................................................. 28,491 30,530 28,957
---------- ---------- ----------
132,749 159,847 140,771
---------- ---------- ----------
Deferred:
Federal................................................ 20,384 (17,813) (14,998)
State.................................................. 1,658 (4,528) (2,975)
---------- ---------- ----------
22,042 (22,341) (17,973)
---------- ---------- ----------
Provision for income taxes............................... $ 154,791 $ 137,506 $ 122,798
---------- ---------- ----------
---------- ---------- ----------
The overall effective tax rate differs from the statutory federal tax rate
as follows (percent of pretax income):
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Tax provision based on the federal statutory rate...................... 35.0% 35.0% 35.0%
State income taxes, net of federal benefit............................. 5.1 5.0 5.6
Tax exempt income...................................................... (0.6) (1.0) (1.3)
Non-deductible expenses................................................ 0.5 1.6 0.8
Other, net............................................................. 0.5 (0.1) 0.5
--- --- ---
Effective tax rate..................................................... 40.5% 40.5% 40.6%
--- --- ---
--- --- ---
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,
----------------------
1997 1996
---------- ----------
Gross deferred tax assets:
Market valuation on investment securities........................... $ 5,004 $ 5,536
Vacation and holiday accruals....................................... 7,986 7,046
Incurred claim reserve discounting.................................. 21,686 16,255
Provision for doubtful accounts..................................... 15,733 13,665
Unearned premium reserve............................................ 14,479 11,583
State income taxes.................................................. 9,893 9,316
Postretirement benefits............................................. 26,033 25,073
Policyholder dividends.............................................. -- 796
Deferred gain on building........................................... 8,867 10,748
Deferred compensation............................................... 8,555 6,182
Expenses not currently deductible................................... 44,615 21,450
Intangible asset impairment......................................... 8,189 9,263
Other, net.......................................................... 5,460 3,972
---------- ----------
Total gross deferred tax assets................................... 176,500 140,885
---------- ----------
Gross deferred tax liabilities:
Depreciation and amortization....................................... (11,382) (6,972)
Bond discount and basis differences................................. (20,895) (7,146)
Other, net.......................................................... (2,003) (1,790)
---------- ----------
Total gross deferred tax liabilities.............................. (34,280) (15,908)
---------- ----------
Net deferred tax assets............................................... $ 142,220 $ 124,977
---------- ----------
---------- ----------
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 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. An AMT credit of $43.7 million was reflected as a
capital contribution in 1994 and was received in 1995.
Income taxes paid for the years ended December 31, 1997, 1996 and 1995 were
$121.2 million, $90.0 million and $79.0 million, respectively.
F-18
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. PENSION AND POSTRETIREMENT BENEFITS
The BCC pension and postretirement plans were assumed by the Company as a
result of the Recapitalization in 1996.
PENSION BENEFITS
The Company covers substantially all employees through two non-contributory
defined benefit 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:
NON-BARGAINING BARGAINING
UNIT EMPLOYEES UNIT EMPLOYEES
DECEMBER 31, DECEMBER 31,
-------------------- --------------------
1997 1996 1997 1996
--------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
Actuarial present value of projected benefit
obligations:
Vested........................................... $ 45,904 $ 34,704 $ 9,106 $ 7,962
Non-vested....................................... 3,834 2,546 80 72
--------- --------- --------- ---------
Accumulated benefit obligation..................... 49,738 37,250 9,186 8,034
Provision for future salary increases.............. 3,866 2,798 764 550
--------- --------- --------- ---------
Projected benefit obligation....................... 53,604 40,048 9,950 8,584
Less plan assets at fair value..................... 45,603 35,712 9,570 9,111
--------- --------- --------- ---------
Projected benefit obligation in excess of (less
than) plan assets................................ 8,001 4,336 380 (527)
Unrecognized prior service benefit................. (567) 91 156 204
Unrecognized net loss.............................. (6,860) (4,842) (1,776) (956)
Unrecognized net transition asset.................. -- -- -- 15
Adjustment to recognize minimum liability.......... 3,561 1,953 -- --
--------- --------- --------- ---------
Accrued pension liability (asset).................. $ 4,135 $ 1,538 $ (1,240) $ (1,264)
--------- --------- --------- ---------
--------- --------- --------- ---------
MAJOR ASSUMPTIONS:
Discount rate.................................... 7.25% 7.75% 7.25% 7.75%
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:
NON-BARGAINING UNIT EMPLOYEES BARGAINING UNIT EMPLOYEES YEAR
YEAR ENDED DECEMBER 31, ENDED DECEMBER 31,
------------------------------- -------------------------------
1997 1996 1995 1997 1996 1995
--------- --------- --------- --------- --------- ---------
(IN THOUSANDS)
Service cost--benefits earned
during the year................ $ 6,347 $ 4,143 $ 3,084 $ 163 $ 108 $ 76
Interest cost on projected
benefits obligations........... 3,675 2,896 2,402 678 642 589
Actual return on plan assets..... (5,538) (3,723) (5,417) (750) (956) (1,062)
Net amortization and deferral.... 2,548 1,754 3,878 (67) 266 342
--------- --------- --------- --------- --------- ---------
Net periodic pension expense
(benefit)...................... $ 7,032 $ 5,070 $ 3,947 $ 24 $ 60 $ (55)
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
For the year ended December 31, 1997, the pension expense was $7.1 million.
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 and 1995, the pension expense was $5.1 million and $3.6 million,
respectively.
The Company has a Salary Deferral (401(k)) Savings Program (the "401(k)
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 401(k) Plan. After
one year of service, employee contributions up to 6% are matched by an employer
contribution equal to 75% of the employee's contribution. Matching contributions
are immediately vested. Effective January 1, 1997, 25% of the employer
contribution was in the Company's common stock. 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 years or more of service as of such date. Company
expense related to the 401(k) Plan totaled $11.8 million, $8.2 million and $6.1
million for the years ended December 31, 1997, 1996 and 1995, respectively.
POSTRETIREMENT BENEFITS
The Company provides certain health care and life insurance benefits to
eligible retirees and their dependents. Employees acquired as a result of the
MMHD acquisition and all employees hired after January 1, 1997 are not covered
under the Company's postretirement benefit plan. All other Company employees are
fully eligible for retiree benefits upon attaining 10 years of service and a
minimum age of 55. The plan in effect for those retiring prior to September 1,
1994 provides for Company-paid life insurance for all retirees based on age and
a percent of salary. In addition, the majority of retirees age 62 or greater
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, 1997 and 1996 are as follows (in
thousands):
DECEMBER 31,
--------------------
1997 1996
--------- ---------
Actives not eligible.................................................... $ 29,545 $ 23,312
Actives fully eligible.................................................. 252 221
Retirees and dependents................................................. 24,890 24,333
--------- ---------
Accumulated postretirement benefits obligation.......................... 54,687 47,866
Unrecognized net gain from accrued postretirement benefit cost.......... 9,204 13,220
--------- ---------
Accrued postretirement benefits......................................... $ 63,891 $ 61,086
--------- ---------
--------- ---------
The above actuarially determined APBO was calculated using discount rates of
7.25% and 7.75% as of December 31, 1997 and 1996, respectively. The medical
trend rate is assumed to decline gradually from 12% (under age 65) and 10% (age
65 and over) to 6% by the year 2002. These estimated trend rates are subject to
change in the future. The medical trend rate assumption has a significant effect
on the amounts reported. For example, an increase in the assumed health care
trend rates of one percent in each year would increase the APBO as of December
31, 1997 by $7.8 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):
DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Service cost..................................................... $ 1,980 $ 2,047 $ 1,691
Interest cost.................................................... 3,783 3,490 3,216
Net amortization and deferral.................................... (621) (438) --
--------- --------- ---------
Net periodic postretirement benefit cost......................... $ 5,142 $ 5,099 $ 4,907
--------- --------- ---------
--------- --------- ---------
10. COMMON STOCK
STOCK OPTION PLANS
In 1996 the Company adopted its Employee Stock Option Plan (the "Employee
Option Plan"). In May 1996, all eligible employees were granted options to
purchase common stock under the Employee Option Plan. The exercise price of
options granted under the Employee Option Plan is the fair market value of the
Common Stock on the day of the grant. Each option granted has a maximum term of
ten years. The options granted in 1997 and 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
F-21
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. COMMON STOCK (CONTINUED)
of shares that may be issued under the Stock Option/Award Plan will not exceed
5.0 million shares, subject to adjustment in accordance with the terms of the
plan. The maximum term for an option is ten years. Options granted will vest in
accordance with the terms of each grant. The Stock Option/Award Plan also allows
the grant or award of restricted stock, performance units, phantom stock and
stock appreciation rights.
The following summarizes activity in the Company's stock option plans for
the year ended December 31, 1997 and 1996:
WEIGHTED
AVERAGE
EXERCISE
PRICE
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
Granted........................................................... 1,698,327 36.13
Canceled.......................................................... (572,511) 37.76
Exercised......................................................... (192,089) 39.61
----------
Outstanding at December 31, 1997.................................. 4,098,723 38.12
----------
----------
Exercisable at:
December 31, 1996................................................. 135,548 39.68
December 31, 1997................................................. 1,077,221 39.32
The options outstanding at December 31, 1997 have exercise prices ranging
from $25.16 to $60.20 per share.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------- ----------------------------
ACTUAL RANGE NUMBER WEIGHTED AVERAGE WEIGHTED NUMBER WEIGHTED
OF EXERCISE OUTSTANDING REMAINING AVERAGE OUTSTANDING AVERAGE
PRICES AT 12/31/97 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/97 EXERCISE PRICE
- ---------------- ----------- ------------------- --------------- ----------- ---------------
$25.16-35.27 1,415,854 9.1 $ 33.06 39,245 $ 30.10
$36.67-56.06 2,682,369 7.8 $ 40.79 1,037,976 $ 39.67
$60.20-60.20 500 9.7 $ 60.20 -- --
----------- -----------
4,098,723 8.2 $ 38.12 1,077,221 $ 39.32
----------- -----------
----------- -----------
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, 1997 and
1996, approximately 50,700
F-22
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. COMMON STOCK (CONTINUED)
and 43,000 shares of common stock were purchased under the ESPP at a purchase
price of $29.22 and $22.53 per share, respectively. Through 1997, shares issued
under the ESPP are generally subject to a one-year holding period. The Company
maintains the right to repurchase shares held in escrow upon termination of the
employee. Beginning in 1998, newly issued shares are no longer subject to such
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 the years ended December 31, 1997 and 1996 would have
been reduced to the pro forma amounts indicated in the table which follows:
1997 1996
--------- ---------
(IN MILLIONS, EXCEPT
PER SHARE AMOUNTS)
Net income--as reported.................................................... $ 227.4 $ 202.0
Net income--pro forma...................................................... $ 218.2 $ 190.9
Earnings per share--as reported............................................ $ 3.30 $ 3.04
Earnings per share--pro forma.............................................. $ 3.17 $ 2.87
Earnings per share assuming full dilution--as reported..................... $ 3.27 $ 3.04
Earnings per share assuming full dilution--pro forma....................... $ 3.14 $ 2.87
1997
-------------------------
OFFICERS EMPLOYEES
----------- ------------
ASSUMPTIONS
Expected dividend yield........................................... -- --
Risk-free interest rate........................................... 6.26% 6.13%
Expected stock price volatility................................... 37.00% 37.00%
Expected life of options.......................................... five years three years
1996
-------------------------
OFFICERS EMPLOYEES
----------- ------------
ASSUMPTIONS
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 pro forma net income for future years. The weighted average fair value
of options granted during 1997 and 1996 is $13.72 and $15.74 per share,
respectively.
F-23
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. EARNINGS PER SHARE
In accordance with Statement of Financial Accounting Standards No. 128, the
following is an illustration of the dilutive effect of the Company's common
stock equivalents on earnings per share ("EPS"). There were no antidilutive
securities for each of the three periods presented.
YEAR ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
---------- ---------- ----------
(IN THOUSANDS, EXCEPT
EARNINGS PER SHARE)
Net Income............................................... $ 227,409 $ 202,002 $ 179,989
Weighted average shares outstanding...................... 68,811 66,433 66,367
Net effect of dilutive stock options..................... 651 -- --
---------- ---------- ----------
Fully diluted weighted average shares outstanding........ 69,462 66,433 66,367
---------- ---------- ----------
---------- ---------- ----------
Earnings Per Share....................................... $ 3.30 $ 3.04 $ 2.71
---------- ---------- ----------
---------- ---------- ----------
Earnings Per Share Assuming Full Dilution................ $ 3.27 $ 3.04 $ 2.71
---------- ---------- ----------
---------- ---------- ----------
The number of shares outstanding for the year ended December 31, 1995 has
been calculated using 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. For the year ended
December 31, 1996, has been calculated using such 66.4 million shares, plus the
weighted average number of shares issued since the Recapitalization.
12. 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, beginning in January 1997, the Company must pay a
contingent amount based upon annual changes in the consumer price index. In
1996, the Company paid $30 million to the owner of the building in connection
with the new lease agreement. This prepayment 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 twenty-two years with
certain options to renew. Certain lease agreements provide for escalation of
payments which are based on fluctuations in certain published cost-of-living
indices.
F-24
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. LEASES (CONTINUED)
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, 1997 are as follows:
YEAR ENDING
DECEMBER 31,
--------------
(IN THOUSANDS)
1998.......................................................................... $ 35,373
1999.......................................................................... 35,462
2000.......................................................................... 31,340
2001.......................................................................... 26,197
2002.......................................................................... 16,250
Thereafter.................................................................... 257,123
--------------
Total payments required................................................... $ 401,745
--------------
--------------
Rental expense for the years ended December 31, 1997, 1996 and 1995 for all
operating leases was $34.8 million, $18.3 million and $18.7 million,
respectively. Contingent rentals included in the above rental expense for the
years ended December 31, 1997 and 1995 were $0.3 million and $2.0 million,
respectively. There were no contingent rentals for the year ended December 31,
1996.
13. RELATED PARTY TRANSACTIONS
Prior to the Recapitalization in May 1996, and pursuant to the
Administrative Services and Product Marketing Agreement by BCC and Old
WellPoint, 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 to be reasonable and
appropriate.
Intercompany charges between the Company and BCC for the respective periods
prior to the Recapitalization are as follows:
JANUARY 1 YEAR ENDED
TO MAY 20, DECEMBER 31,
1996 1995
----------- ------------
(IN THOUSANDS)
Services provided by BCC........................................... $ 13,601 $ 17,418
Services provided to BCC........................................... (3,931) (11,592)
----------- ------------
Net intercompany charges included in general and administrative
expense.......................................................... $ 9,670 $ 5,826
----------- ------------
----------- ------------
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
F-25
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. RELATED PARTY TRANSACTIONS (CONTINUED)
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 the year ended December 31, 1995, the
underwriting margin was estimated at 2.0%. 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
year ended December 31, 1995 was $59.3 million, and $163.4 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 year ended
December 31, 1995 was $1.2 million, and $3.2 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 1997 and 1996
consolidated financial statements subsequent to the Recapitalization date.
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value
of each class of financial instrument:
CASH AND CASH EQUIVALENTS. The carrying amount approximates fair value,
based on the short-term maturities of these instruments.
INVESTMENT SECURITIES. The carrying amount approximates fair value, based
on quoted market prices for the same or similar instruments.
LONG-TERM INVESTMENTS. The carrying amount approximates fair value, based
on quoted market prices for the same or similar instruments and at cost for
certain equity investments.
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
the 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, 1997 are summarized below:
CARRYING ESTIMATED
AMOUNT FAIR VALUE
------------ ------------
(IN THOUSANDS)
Cash and cash equivalents......................................... $ 283,851 $ 283,851
Investment securities............................................. 2,552,775 2,552,775
Long-term investments............................................. 102,819 102,819
Long-term debt.................................................... 388,000 388,000
Interest rate swaps............................................... -- (17,283)
F-26
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. CONTINGENCIES
From time to time, the Company and certain of its subsidiaries are parties
to various legal proceedings, many of which involve claims for coverage
encountered in the ordinary course of business. The Company, like HMOs and
health insurers generally, excludes certain health care services from coverage
under its HMO, PPO and other plans. The Company is, in its ordinary course of
business, subject to the claims of its enrollees arising out of decisions to
restrict treatment or reimbursement for certain services. The loss of even one
such claim, if it results in a significant punitive damage award, could have a
material adverse effect on the Company. In addition, the risk of potential
liability under punitive damage theories may increase significantly the
difficulty of obtaining reasonable settlements of coverage claims. 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.
16. NONRECURRING COSTS
The Company recorded $14.5 million of nonrecurring costs for the year ended
December 31, 1997, of which $8.0 million recorded in the second quarter of 1997
related primarily to the write-down related to the Company's dental practice
management operations and discontinuance of the Company's medical practice
management operations in Santa Barbara and San Luis Obispo. In addition, $6.5
million incurred in the first quarter of 1997 consisted of severance and
retention payments associated with the GBO acquisition.
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 pharmacy 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 pharmacy benefits management companies to market their
products by reducing claims processing fees.
17. REGULATORY REQUIREMENTS
Certain of the Company's regulated subsidiaries must comply with certain
minimum capital or tangible net equity requirements in each of the states in
which they operate. As of December 31, 1997, the Company's regulated
subsidiaries were in compliance with these requirements.
18. FISCAL INTERMEDIARY FUNCTION
Under an agreement with the BCBSA, the Company has contracted to administer
Part A of Title XVIII of the Social Security Act (Medicare) in certain regions
or for certain healthcare providers. The agreement is renewable annually unless
terminated by the parties involved. As fiscal intermediary under the agreement,
the Company makes disbursements to providers for medical care from funds
provided by
F-27
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
18. FISCAL INTERMEDIARY FUNCTION (CONTINUED)
the Federal Government and is reimbursed for these expenses incurred under the
agreement. The Company disbursed approximately $8.4 billion and $4.6 billion and
received administrative fees of approximately $29.9 million and $16.4 million
for the years ended December 31, 1997 and 1996, respectively. The reimbursement
is treated as a direct recovery of administrative expenses.
19. UNAUDITED PRO FORMA FINANCIAL INFORMATION
In accordance with APB No. 16, Business Combinations, the following
unaudited pro forma summary presents revenue, net income and per share data of
WellPoint as if the GBO acquisition had occurred as of the beginning of each
period presented. The pro forma adjustments made include the results of
operations for the GBO prior to its acquisition, amortization of intangible
assets and foregone interest on the net cash used for the acquisition and the
related income tax effects of such adjustments. For comparison purposes,
adjustments also include all pro forma adjustments necessary to reflect the MMHD
acquisition and the Recapitalization as if such transactions had been completed
as of January 1, 1996. 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, the GBO, MMHD and the BCC
Commercial Operations had been a single entity during the years ended December
31, 1997 and 1996, nor is it necessarily indicative of the results of operations
which may occur in the future. Pro forma earnings per share is calculated based
on 68.8 million and 66.4 million shares for the years ended 1997 and 1996,
respectively. Pro forma earnings per share assuming full dilution is calculated
based on 69.5 million and 66.4 million shares for the years ended 1997 and 1996,
respectively.
YEAR ENDED DECEMBER
31,
--------------------
1997 1996
--------- ---------
(IN MILLIONS, EXCEPT
EARNINGS PER SHARE)
Revenues............................................................... $ 5,953.2 $ 5,284.1
Net Income............................................................. $ 223.7 $ 192.0
Earnings Per Share..................................................... $ 3.25 $ 2.89
Earnings Per Share Assuming Full Dilution.............................. $ 3.22 $ 2.89
F-28