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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, 1998
/ / 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.)
ONE WELLPOINT WAY 91362
THOUSAND OAKS, CA (Zip Code)
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (805) 557-6110
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE ON WHICH
TITLE OF EACH CLASS REGISTERED
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Common Stock, $0.01 par value New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
None
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Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment to this
Form 10-K. / /
State the aggregate market value of the voting stock held by non-affiliates
of the Registrant as of March 15, 1999: $3,922,112,194 (based on the last
reported sale price of $79 5/8 per share on March 19, 1999, on the New York
Stock Exchange).
Common Stock, $0.01 par value of Registrant outstanding as of March 19,
1999: 67,439,029 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 1999 Annual
Meeting of Stockholders.
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WELLPOINT HEALTH NETWORKS INC.
FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business....................................................................................... 1
Item 2. Properties..................................................................................... 23
Item 3. Legal Proceedings.............................................................................. 23
Item 4. Submission of Matters to a Vote of Security Holders............................................ 23
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters...................... 24
Item 6. Selected Financial Data........................................................................ 25
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.......... 26
Item 8. Financial Statements and Supplementary Data.................................................... 44
Item 9. Changes and Disagreements with Accountants on Accounting and Financial Disclosure.............. 44
PART III
Item 10. Directors and Executive Officers of the Registrant............................................. 45
Item 11. Executive Compensation......................................................................... 45
Item 12. Security Ownership of Certain Beneficial Owners and Management................................. 45
Item 13. Certain Relationships and Related Transactions................................................. 45
PART IV
Item 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K............................... 45
SIGNATURES
INDEX TO FINANCIAL STATEMENTS
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PART I
ITEM 1. BUSINESS
GENERAL
WellPoint Health Networks Inc. (the "Company" or "WellPoint") is one of the
nation's largest publicly traded managed health care companies. As of December
31, 1998, WellPoint had approximately 6.9 million medical members and
approximately 25 million specialty members. The Company offers a broad spectrum
of quality network-based managed care plans. WellPoint provides these plans to
the large and small employer, individual and senior markets. The Company's
managed care plans include preferred provider organizations ("PPOs"), health
maintenance organizations ("HMOs") and point-of-service ("POS") and other hybrid
plans and traditional indemnity plans. In addition, the Company offers managed
care services, including underwriting, actuarial services, network access,
medical cost management and claims processing. The Company offers a continuum of
managed health care plans while providing incentives to members and employers to
select more intensively managed plans. The Company typically offers such plans
at a lower cost in exchange for additional cost-control measures, such as
limited flexibility in choosing physician and hospitals that are not included in
the Company's provider networks. 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, including pharmacy, dental, utilization management, life
insurance, preventive care, disability insurance, behavioral health, COBRA and
flexible benefits account administration.
The Company markets its products in California primarily under the name Blue
Cross of California and outside of California primarily under the name UNICARE.
Historically, the Company's primary market for its managed care products has
been California. The Company holds the exclusive right in California to market
its products under the Blue Cross name and mark. The Company's California
customer base is diversified, with extensive membership among large and small
employer groups and individuals and a growing presence in the Medicare and
Medicaid markets.
In 1996, the Company began pursuing a nationwide expansion strategy through
selective acquisitions and start-up activities in key geographic areas. With the
acquisitions in March 1996 of the Life & Health Benefits Management division
("MMHD") of Massachusetts Mutual Life Insurance Company (the "MMHD Acquisition")
and in March 1997 of certain portions of the health and related life group
benefit operations (the "GBO") of John Hancock Mutual Life Insurance Company
(the "GBO Acquisition"), the Company has significantly expanded its operations
outside of California. The Company's acquisition strategy has focused on large
employer group plans that offer indemnity and other health insurance products
that are less intensively managed than the Company's products in California.
Since 1987, the Company has transitioned substantially all of its California
indemnity insurance customers to managed care products. An element of the
Company's geographic expansion strategy is to replicate its experience in
California in motivating traditional indemnity members to transition to the
Company's broad range of managed care products. In addition, the Company focuses
on acquiring businesses that provide significant concentrations of members in
strategic locations outside of California. The Company believes that its current
UNICARE medical membership provides its UNICARE operations with sufficient scale
to begin development of proprietary provider network systems in key geographic
areas, which will enable the Company over time to begin offering a broader range
of managed care products. The Company has used and intends to continue to use
these new networks to introduce individual, small group and senior products in
these markets. The Company has developed or is actively developing proprietary
networks in Texas, Georgia, Illinois, Maryland, Ohio and Virginia and has
introduced new managed care products in, among other states, Texas, Georgia and
Illinois.
Prior to the MMHD and GBO Acquisitions, the Company's significant operations
were primarily confined to the State of California. As a result of these
acquisitions, during 1996, 1997 and 1998, the Company's operations, with the
exception of stand-alone specialty products, were organized generally into
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two internal business units with a geographic focus. Revenues (with sales to
external customers and sales or transfers to other segments shown separately),
operating profit or loss and identifiable assets attributable to each of the
Company's segments are set forth in Note 21 to the Consolidated Financial
Statements, which are included elsewhere in this Annual Report on Form 10-K.
Effective as of April 1, 1999, the Company intends to effect a modification of
its internal business divisions. Upon completion of this change, the Company
expects that its primary internal business divisions will be focused on large
employer group business, individual and small employer group business and senior
and specialty business.
RECENT DEVELOPMENTS
PENDING TRANSACTION WITH CERULEAN
On July 9, 1998, WellPoint entered into an Agreement and Plan of Merger (the
"Merger Agreement") with Cerulean Companies, Inc. ("Cerulean"). Upon completion
of this transaction (the "Merger"), Cerulean will become a wholly owned
subsidiary of WellPoint. Cerulean currently holds the exclusive license to use
the Blue Cross and Blue Shield names and marks in the state of Georgia. Cerulean
is the parent company of Blue Cross Blue Shield of Georgia, which served
approximately 1.6 million medical members in the state of Georgia as of December
31, 1998. At the effective time of the Merger, the shareholders of Cerulean will
receive WellPoint Common Stock with a market value of $500 million (subject to
certain adjustments provided in the Merger Agreement). Certain shareholders of
Cerulean will have the option to receive cash in lieu of WellPoint Common Stock,
subject to a maximum aggregate limit of $225 million. The transaction is
intended to qualify as a tax-free organization for Cerulean shareholders that
elect to receive WellPoint Common Stock. The closing of the transaction is
subject to the approval of the shareholders of Cerulean and to a number of
regulatory and other approvals. The Company currently expects the transaction to
close during the second half of 1999.
In September 1998, a class action lawsuit was filed in Richmond County,
Georgia on behalf of certain current and former policyholders of Blue Cross Blue
Shield of Georgia (the "Conversion Litigation"). The claims brought in the
Conversion Litigation relate to the conversion of Blue Cross Blue Shield of
Georgia from a non-profit entity to a for-profit entity in October 1996 (the
"Conversion"). At the time of the Conversion, each eligible Blue Cross Blue
Shield of Georgia subscriber was offered five shares of Cerulean Class A stock.
In order to receive such shares, each eligible subscriber had to return certain
election forms prepared by Cerulean. At the time of the Conversion,
approximately 90,000 of the 160,000 eligible subscribers did not return their
election forms. The litigation sought to compel Cerulean to issue five
additional shares of its Class A Common Stock to each of the 90,000 subscribers.
On December 17, 1998, the Superior Court judge in the Conversion Litigation
issued an order in favor of the plaintiffs. Cerulean is pursuing an appeal of
the judge's decision before the Georgia Supreme Court, which held oral arguments
with respect to the matter on March 8, 1999.
The Company intends to continue to explore opportunities to work with other
Blue Cross Blue Shield entities. The Company currently provides pharmacy
benefits management services to certain Blue Cross Blue Shield entities
(including Blue Cross Blue Shield of Georgia) and may market additional
specialty products to and pursue additional relationships with other Blue Cross
Blue Shield plans in the future.
SALE OF WORKERS' COMPENSATION BUSINESS
On July 29, 1998, WellPoint entered into a Stock Purchase Agreement (the
"Stock Purchase Agreement") with Fremont Indemnity Company ("Fremont"). Pursuant
to the Stock Purchase Agreement, Fremont acquired all of the outstanding capital
stock of UNICARE Specialty Services, Inc. a wholly owned subsidiary of WellPoint
("UNICARE Specialty"). The transaction was completed on September 1, 1998. The
principal asset of UNICARE Specialty was the capital stock of UNICARE Workers'
Compensation Insurance Company ("UNICARE Workers' Compensation"). The purchase
price for the acquisition was approximately $110.0 million. Pursuant to the
Stock Purchase Agreement, the purchase price for the
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acquisition was the statutory surplus (adjusted in accordance with the terms of
the Stock Purchase Agreement) of UNICARE Workers' Compensation as of the date of
closing. As part of the transaction, the Company and Fremont entered into a
joint marketing agreement with respect to workers' compensation and medical
insurance products in the small employer group market.
MANAGED HEALTH CARE 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 copayments or deductibles. PPOs, POS
plans and a number of HMOs allow out-of-network usage, typically at
substantially higher out-of-pocket costs to members. HMO members generally
select one primary care physician from a network who is responsible for
coordinating health care services for the member, while PPOs and other "open
access" plans generally allow members to select physicians without coordination
through a primary care physician. Hybrid plans, such as POS plans, typically
involve the selection of primary care physicians similar to HMOs, but allow
members to choose non-network providers at higher out-of-pocket costs similar to
PPOs.
THE CALIFORNIA MARKET. The desire of California-based employers for a range
of health care choices that promote effective cost controls and quality care has
contributed to substantial market acceptance of managed health care in
California, where the total penetration of managed health care companies is
higher than the national average. Although the Company has experienced increased
competition over the last several years, the Company remains a market leader in
offering managed health care plans to individuals and small employer groups in
California. 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. Initial developments in California with
respect to managed care were generally focused on HMOs and other tightly
controlled plans. Over the last few years, this emphasis has decreased, as
consumers and media scrutiny have generally criticized the reduced choice
typical of HMO plans and as greater regulatory restrictions have been placed on
HMO offerings. The Company believes that this movement towards PPOs and other
open access plans will continue in the future.
OTHER STATES. Outside of California, the past few years have seen
significant transformations in the health care sector. Although market
acceptance of the array of managed health care plans continues to grow
throughout the United States, it still varies widely from state to state. In
some states, especially larger population centers, members are offered health
care choices focused on HMO or POS plans. In other states, members are typically
offered a spectrum of health care choices which are more focused on PPOs or
traditional indemnity health models than in California. Indemnity insurance
usually allows members substantial freedom of choice in selecting health care
providers but without significant financial incentives or cost-control measures
typical of managed care plans. Indemnity insurance plans typically require
annual deductible obligations of members. Upon satisfaction of the deductible,
the member is reimbursed for health care expenses on a full or partial basis of
the indicated charges. Health plan reimbursement is often limited to the health
plan's assessment of the reasonable and customary charges prevailing in a region
for the particular health care procedure. 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 and Texas. The
Company believes the higher costs generally associated with such third-party PPO
networks and traditional
3
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 and Texas.
BLUE CROSS OF CALIFORNIA
Most of the Company's California operations are conducted under the trade
name Blue Cross of California.
MARKETING
WellPoint's Blue Cross of California products are developed and marketed in
California with an emphasis on the differing needs of various customer segments.
In particular, the Company's product development and marketing efforts take into
account the differing characteristics between the various customer groups served
by the Company, including large employers (generally with 51 or more employees),
individuals and small employers, seniors and California Medicaid recipients, as
well as the unique needs of educational and public entities, federal employee
health and benefit programs, national employers and state-run programs servicing
high-risk and under-served markets. Individual business units are responsible
for enrolling, underwriting and servicing customers in specific segments. 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. For example,
in 1998 the Company introduced its unique Employee Elect program, which allows
small employers to offer their employees a menu of PPO and HMO options.
WellPoint's managed health care plans to large employers in California are
generally sold in conjunction with an employer's broker or consultant to develop
a package of managed health care benefits specifically tailored to meet the
employer's needs. 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 indirect subsidiary of the
Company, and WellPoint's sales department, who oversee independent agents and
brokers.
PRODUCTS
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 may have copayment obligations for services rendered by network
providers that are often similar to the copayment obligations of its HMO plans.
Unlike WellPoint's HMO and other "closed-access" plans, members are not required
to select a primary care physician who is responsible for coordinating their
care and may be subject to annual deductible requirements. PPO members have the
option to receive health care services from non-network providers, typically at
substantially higher out-of-pocket costs to members. Among the Company's various
PPO plans are 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, and high-deductible health plans intended for use with
medical savings accounts ("MSAs").
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
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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.
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, 1998, approximately 474,000 members were enrolled in
WellPoint's Medi-Cal managed care programs in Los Angeles, Sacramento, Orange,
San Francisco, Alameda, Santa Clara, Fresno, Kern, Stanislaus, Contra Costa and
San Diego counties and in the state-sponsored Healthy Families program. In
addition, the Company has been awarded a contract to administer the Medi-Cal
managed care program in Tulare County, although no enrollment had occurred as of
December 31, 1998.
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, 1998, the
Medicare supplemental plans served approximately 179,000 members. WellPoint also
offers Blue Cross Senior Secure, an HMO plan operating in defined geographic
areas, under a Medicare + Choice contract with the Health Care Financing
Administration ("HCFA"). This contract entitles WellPoint to a fixed per-member
premium from HCFA which is subject to adjustment annually by HCFA based on
certain demographic information relating to the Medicare population and the cost
of providing health care in a particular geographic area. In addition to
physician care, hospitalization and other benefits covered by Medicare, the
benefits under this plan (which vary by county) typically include prescription
drugs, routine physical exams, hearing tests, immunizations, eye examinations,
counseling and health education services. As of December 31, 1998, Blue Cross
Senior Secure HMO plans served over 17,000 members.
UNICARE
OVERVIEW
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, 1998, the Company
had approximately 2.2 million members covered under its UNICARE health plans
(including approximately 62,000 members in California). Approximately 50% of
UNICARE medical membership as of such date was concentrated in six states:
Illinois, Texas, Massachusetts, Ohio, 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 ("UL&H") under the trade name UNICARE.
Upon completion of the Cerulean Merger, the Company intends to operate primarily
under the Blue Cross Blue Shield name and mark in the state of Georgia.
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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. As with the Company's Blue Cross of
California products, UNICARE's individual and small employer group products are
generally distributed by independent sales agents, while large group products
are distributed by the Company's internal sales force or in conjunction with
third-party brokers and consultants.
Outside of California, the Company offers PPO and other open access products
(using proprietary networks and third-party provider networks), as well as
traditional fee-for-service products. As WellPoint continues to develop
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. In 1998, UNICARE began offering in certain markets its
unique Planscape product. Planscape has been designed to address the differing
needs of consumers. The Planscape product allows individual family members to
select different plan options based upon that particular individual's health
needs. In addition, Planscape incorporates a personal needs assessment ("PNA")
which is designed to help each individual family member choose the Planscape
option most appropriate for that individual. In the event that an individual's
health needs change (for example, due to a significant illness), Planscape also
has an "opt up" feature allowing a particular individual, during certain times
of the year, to transfer to a Planscape option providing greater benefits and
incorporating more tightly managed care features.
Consistent with the Company's strategy of developing open access programs
that offer members greater choice, in December 1998 UNICARE's Texas HMO
subsidiary, UNICARE of Texas Health Plans, Inc. ("UTHP"), made the decision to
withdraw from the Texas marketplace. As of December 31, 1998, the Company had
approximately 2,620 members served by its UTHP subsidiary. The Company
anticipates that UTHP will cease active operations no later than the end of the
second quarter of 1999. The Company expects that existing UTHP members will be
offered a replacement PPO or similar plan from UL&H.
MANAGED HEALTH CARE NETWORKS AND PROVIDER RELATIONS
BLUE CROSS OF CALIFORNIA
WellPoint's extensive managed health care provider networks in California
include its HMO, PPO and specialty managed care networks. These provider
relationships are monitored regularly in order to 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. Under these contracts, physician providers are paid
either a fixed per member monthly amount (known as a capitation payment) or on
the basis of a fixed fee schedule. In selecting providers for its networks,
WellPoint uses its credentialing programs to evaluate the applicant's
professional qualifications and experience, including license status,
malpractice claims history and hospital affiliations.
The following is a more detailed description of the principal features of
WellPoint's California PPO and HMO networks.
PPO NETWORK. The California PPO network included approximately 46,000
physicians and 440 hospitals throughout California as of December 31, 1998.
There were approximately 2.9 million members
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(including administrative services members) enrolled in WellPoint's California
PPO health care plans as of such date, approximately 41% of whom were
individuals or employees of small groups.
WellPoint endeavors to manage and control costs for its PPO plans by
negotiating favorable arrangements with physicians, hospitals and other
providers, which arrangements include utilization management and other
cost-control measures. In addition, WellPoint manages costs through pricing and
product design decisions intended to influence the behavior of both providers
and members.
WellPoint's California PPO plans provide for the delivery of specified
health care services to members by contracting with physicians, hospitals and
other providers. Hospital provider contracts are on a nonexclusive basis and
generally provide for per diem payments (a fixed fee schedule where the daily
rate is based on the type of service) that provide for rates that are below the
hospitals' standard billing rates. Physician provider contracts are also on a
nonexclusive basis and specify fixed fee schedules that are below standard
billing rates. WellPoint is able to obtain prices for hospitals and physician
services below standard billing rates because of the volume of business it
offers to health care providers that are part of its network. Provider rates are
generally negotiated on an annual or multi-year basis with hospitals. Provider
rates for physicians in the Company's PPO network are set from time to time by
the Company.
HMO NETWORK. Membership in CaliforniaCare was approximately 1.8 million
members as of December 31, 1998. As of December 31, 1998, the HMO network
included approximately 30,000 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, which is below the
hospitals' standard billing rates.
Contractual arrangements with PMGs typically include provisions under which
WellPoint provides limited stop-loss protection. If the PMG's actual charges for
medical services provided to a member exceed an agreed-upon threshold amount,
WellPoint will pay the group a portion of the excess amount. Provider rates are
generally negotiated with PMGs and hospitals on an annual or multi-year basis.
To encourage PMGs to contain costs for claims for non-capitated services such as
inpatient hospital, outpatient surgery, hemodialysis, emergency room, skilled
nursing facility, ambulance, home health and alternative birthing center
services, WellPoint's PMG agreements provide for a settlement payment to the PMG
based upon the PMG's effective utilization of such non-capitated services. PMGs
are also eligible for additional incentive payments based upon their management
of outpatient prescription drugs and satisfaction of quality criteria.
UNICARE
Due to the more recent development of the Company's national operations, the
Company's relations with health care providers outside of California are more
varied than in California. During 1998, the Company continued its significant
network development efforts in various states, including Georgia, Illinois,
Maryland, Ohio, Texas and Virginia. Some of these network development activities
involved start-up activities, while others involved supplementing existing
networks acquired in the MMHD and GBO acquisitions. As a result of the Company's
extensive efforts, the Company's proprietary networks in Georgia and Texas are
substantially completed. As of December 31, 1998, UNICARE's proprietary networks
included approximately 53,600 primary and specialist physicians and 600
hospitals.
As part of the MMHD Acquisition, the Company also acquired a majority
ownership interest in a PPO entity, National Capital Preferred Provider
Organization ("UNICARE NCPPO"), which operates in the Maryland/Virginia area and
is a joint venture with local health care providers. The UNICARE NCPPO
7
network included approximately 8,100 primary care and specialist physicians and
50 hospitals as of December 31, 1998.
A large number of UNICARE members are currently served by third-party
provider networks, which generally lack the provider selectivity and discounts
typical of the Company's proprietary networks. One of the Company's strategies
for the expansion of its UNICARE operations is to continue building proprietary
provider network systems in certain geographies similar to the Company's
networks in California and Texas, which provide a continuum of managed care
products to various customer segments. As the Company expands its out-of-state
operations, it intends to build or acquire such network operations and, as
appropriate, to replace or supplement the current third-party network
arrangements. Additionally, the Company has begun a process to consolidate its
third-party network relationships in an effort to further contain its
administrative expenses.
ANCILLARY NETWORKS
WellPoint evaluates current and emerging high volume or high cost services
to determine whether developing an ancillary service network will yield cost
control benefits. In establishing these ancillary service networks, WellPoint
seeks to enter into capitation or fixed fee arrangements with providers of these
services. WellPoint regularly collects and analyzes industry data on high cost
or high volume unmanaged services to identify the need for specialty managed
care networks. For example, WellPoint has created Centers of Expertise for
certain transplant services.
UTILIZATION MANAGEMENT
In order to better manage quality in its proprietary provider networks,
WellPoint adopts utilization management systems and guidelines that are intended
to reduce unnecessary procedures, admissions and other medical costs. The
utilization management systems seek to provide quality care to WellPoint's
members by ensuring that medical services provided are based on medical
necessity and that all final decisions are made by physicians. In its California
HMO, WellPoint permits PMGs to oversee most utilization management for their
particular medical group under WellPoint's guidelines. Currently, substantially
all of the PMGs in WellPoint's California HMO network have established
committees to oversee utilization management. For its California PPO network,
WellPoint uses treatment guidelines, requires pre-admission approvals of
hospital stays and concurrent review of all admissions and retrospectively
reviews physician practice patterns. Utilization management also includes an
outpatient program, with pre-authorization and retrospective review, ongoing
supervision of inpatient and outpatient care of members, case management and
discharge planning capacity. Review of practice patterns may result in
modifications and refinements to the PPO plan offerings, treatment guidelines
and network contractual arrangements. In addition, WellPoint manages health care
costs by periodically reviewing cost and utilization trends within its provider
networks. Cases are reviewed in the aggregate to identify a high volume of a
particular type of service to identify the most effective method of treatment
while more effectively managing costs. In addition, the Company reviews
high-cost procedures in an effort to provide new quality, cost-effective
treatment by utilizing new technologies or by creating additional networks, such
as its networks of home health agencies.
For the Company's UNICARE managed care health plans, utilization management
is provided both by UNICARE (through the Company's subsidiary CostCare, Inc.
("CCI")) and third-party provider networks. As part of the GBO Acquisition, the
Company acquired 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.
8
UNDERWRITING
In establishing premium rates for its health care plans, WellPoint uses
underwriting criteria based upon its accumulated actuarial data, with
adjustments for factors such as claims experience, member mix and industry
differences to evaluate anticipated health care costs. WellPoint's underwriting
practices in the individual and small group market are subject to legislation in
California and other states affecting the individual and small employer group
market. Because UNICARE's members are in every state, the Company's underwriting
practices, especially in the individual and small group market, are subject to a
variety of legislative and regulatory requirements and restrictions. See
"--Government Regulation."
QUALITY MANAGEMENT
Quality management for most of the Company's California business is overseen
by the Company's Quality Management Department and is designed to ensure that
necessary care is provided by qualified personnel. Quality management
encompasses plan level quality performance, provider credentialing, provider and
member grievance monitoring and resolution, medical group auditing, monitoring
medical group compliance with Blue Cross of California standards for medical
records and medical offices, physician peer review and a quality management
committee.
SPECIALTY MANAGED HEALTH CARE AND OTHER PLANS AND SERVICES
WellPoint offers a variety of specialty managed health care and other
services. WellPoint believes that these specialty networks and plans complement
and facilitate the marketing of WellPoint's medical plans and help in attracting
employer groups and other members that are increasingly seeking a wider variety
of options and services. WellPoint also markets these specialty products on a
stand-alone basis to other health plans and other payors.
PHARMACY PRODUCTS
WellPoint offers pharmacy services and pharmacy benefit management services
to its members. WellPoint's pharmacy services incorporate features such as drug
formularies (a WellPoint-developed listing of preferred, cost-effective drugs),
a pharmacy network and maintenance of a prescription drug database and mail
order capabilities. Moreover, pharmacy benefit management services provided by
WellPoint include management of drug utilization through outpatient prescription
drug formularies, retrospective review and drug education for physicians,
pharmacists and members. As of December 31, 1998, WellPoint had more than 15.0
million risk and non-risk pharmacy members and approximately 52,000
participating pharmacies.
DENTAL PLANS
WellPoint's California dental plans include Dental Net, its California
dental HMO, with a provider network of approximately 2,100 dentists reimbursed
on a capitated basis, a dental PPO, with a network of approximately 11,000
dentists, and traditional indemnity plans. As of December 31, 1998, the
Company's dental networks outside of California included approximately 20,000
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, 1998, served
approximately 3.1 million dental members.
LIFE INSURANCE
The Company offers primarily term-life insurance to employers, generally in
conjunction with the Company's health plans. The MMHD and GBO acquisitions
expanded the Company's life insurance business both inside and outside of
California. As of December 31, 1998, the Company provided life insurance
products to approximately 2.2 million persons.
9
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 4,200
contracting providers. In addition, approximately 388 employee assistance and
behavioral managed care programs have been implemented for a wide variety of
businesses throughout the United States. As of December 31, 1998, there were
approximately 740,000 members covered under WellPoint's mental health plans.
UTILIZATION MANAGEMENT
In connection with the GBO Acquisition, the Company acquired CCI, a wholly
owned subsidiary of John Hancock Mutual Life Insurance Company. CCI, which now
operates under the trade name UNICARE/CostCare, provides stand-alone utilization
management and other medical management services to other health plans and
self-funded employers. CCI utilization management services are also integrated
into UNICARE product offerings. As of December 31, 1998, the Company had
approximately 2.9 million utilization management members.
DISABILITY PLANS
The Company offers short- and long-term disability programs, usually in
conjunction with the Company's health plans. As of December 31, 1998, the
Company provided long-term or short-term disability coverage to approximately
800,000 individuals.
LONG-TERM CARE INSURANCE
In November 1997, the Company began offering a group of long-term care
insurance products to its California members through its indirect wholly owned
subsidiary BC Life & Health Insurance Company ("BC Life"). These plans, which
are marketed under the Advantage Blue trade name, involve six 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, including home health care services.
WORKERS' COMPENSATION MANAGED CARE SERVICES
In California, the Company offers workers' compensation managed care
services, including bill review, network access, medical cost management and
utilization management, to employers who self-insure their workers' compensation
coverage, as well as to workers' compensation carriers.
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 capitalize on this relationship by subsequently introducing WellPoint's
underwritten managed care products. The Company's managed care services revenues
have expanded considerably during the last three years as a result of the MMHD
and GBO Acquisitions. These businesses, especially the GBO, are comprised of a
higher percentage of administrative services business than the Company's
traditional California business. WellPoint offers managed care services,
including underwriting, actuarial services, medical cost management, claims
processing and administrative services for self-funded employers. WellPoint also
enables employers with self-funded health plans to use WellPoint's 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, 1998, WellPoint serviced self-insured health
plans covering approximately 2.6 million medical members.
10
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 $43.3 million, $36.5
million and $33.7 million on advertising for the years ended December 31, 1998,
1997 and 1996, 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, cash flows or results of operations. See "--Factors That
May Affect Future Results of Operations."
The markets in which the Company operates outside of California are also
highly competitive. Because of the many different markets in which the Company
now serves members, the Company faces unique competitive pressures in regional
markets as well as on a national basis. The Company competes with other
companies that offer managed health care plans as well as traditional indemnity
insurance products. Many of these companies have greater financial and other
resources than the Company and greater market share on either a regional or
national basis. As the Company continues to geographically expand its
operations, it will be subject to national competitive factors as well as unique
competitive conditions that may affect the more localized markets in which the
Company operates.
WellPoint believes that significant factors in the selection of a managed
health care plan by employers and individual members include price, the extent
and depth of provider networks, flexibility and scope of benefits, quality of
services, market presence, reputation (which may be affected by public rankings
or accreditation by voluntary organizations such as the National Committee for
Quality Assurance ("NCQA") and the URAC) and financial stability. WellPoint
believes that it competes effectively against other health care industry
participants.
GOVERNMENT REGULATION
CALIFORNIA
DOC AND DOI REGULATION. WellPoint offers its managed health care services
in California principally through its wholly owned indirect subsidiary Blue
Cross of California, which is subject to regulation by the California Department
of Corporations (the "DOC") under the Knox-Keene Health Care Service Plan Act of
1975 (the "Knox-Keene Act"). The insurance business conducted by BC Life is
regulated by the California Department of Insurance (the "California DOI"). Each
entity is subject to various minimum capital and other requirements, such as
restrictions on the payment of dividends or the issuance of capital stock,
established by its respective regulatory authority. Blue Cross of California's
managed health care programs are also subject to extensive DOC regulation
regarding benefit and coverage levels, relationships with health care providers,
administrative capacity, marketing and advertising, procedures for quality
assurance and subscriber and enrollee grievance resolution. Any material
modifications to the organization or operations of Blue Cross of California are
subject to prior review and approval by the DOC. BC Life must obtain approval
from the California DOI for all of its group insurance policies and certain
aspects of its individual policies prior to issuing those policies, as well as
certain other material actions which BC Life
11
may propose to take. The failure to comply with applicable regulations can
subject BCC or BC Life to various penalties, including fines or the imposition
of restrictions on the conduct of its operations.
In 1997, the DOC conducted a triennial medical survey of the Company and
each of its subsidiaries licensed under the Knox-Keene Act. During 1998, the
Company received a preliminary report of the DOC with respect to the surveys.
The Company has provided responses to the preliminary report. Based upon this
preliminary report, the Company does not expect any material impact on its
operations as a result of the surveys. In addition, the DOC conducted a regular
triennial audit during 1998 and early 1999. To date, the Company has not
received any results of this audit from the DOC.
CALIFORNIA HEALTH CARE LEGISLATION. From time to time, new California
legislation is enacted and regulatory interpretations are adopted that adversely
affect WellPoint. For example, California's various small group laws require
that coverage be offered to certain small groups, limit rate increases and
exclusions based on pre-existing conditions, limit waivers (a temporal
limitation of coverage) 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. There can be no assurance that
compliance with existing or future legislation will not adversely affect
WellPoint's financial condition, cash flows or results of operations.
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, which was
comprised of appointees chosen by then-California Governor Wilson and by the
Legislature, issued a preliminary report in 1998. The task force's report
included 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. After providing
its recommendations to Governor Wilson and the California Legislature, the task
force disbanded in 1998. As a result of the task force's recommendations, the
California Legislature did enact new laws in 1998 concerning direct access by
patients to obstetrician/gynecologists, hospital length of stay for mastectomies
and disclosure requirements to members in the individual and small group
markets. During 1998, the California Legislature also enacted new laws, among
others, mandating coverage for prostate cancer screening and certain
reconstructive surgery and requiring health plans under certain circumstances to
continue to cover services rendered by a provider who is not part of the health
plan's provider network.
In December 1998, BCC, along with several other managed care companies and
the California Association of Health Plans, announced an intention to
voluntarily adopt an independent external review program by the end of 1999. BCC
is still in the process of developing the specifics of this program, but it is
anticipated that it will provide members with the opportunity to appeal certain
medical necessity decisions. Since July 1998, BCC has allowed independent
external review of medical necessity decisions involving certain types of
life-threatening illnesses or experimental treatments.
During 1999, the Company expects that legislation may be proposed in
California regarding independent external review, health plan liability and
individual liability of health plan medical directors as well as additional
regulation of the individual market and a variety of other topics. As a result
of the November 1998 California elections, the California governor is now a
member of the same political party as a majority of the members of both houses
of the California Legislature, thereby increasing the likelihood of the passage
of health care reform legislation. While it is still too early to determine if
any additional legislation will be enacted into law, such legislation could have
a material adverse effect on the Company's results of operations, cash flows or
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
12
reimbursement amounts (so-called "risk adjusters") between counties. HCFA has
released proposed risk adjusters for year 2000 implementation. In addition, the
Balanced Budget Act expanded the managed health plan options available to
Medicare enrollees to include PPO, POS and high deductible health plans intended
for MSAs. Regulations regarding these changes were adopted in June 1998.
Finally, the Balanced Budget Act implemented certain changes with respect to
Medicare supplement programs, including guaranteed coverage issues. Certain of
the changes under the Balanced Budget Act could have the result of increasing
the Company's costs.
In November 1997, the Advisory Commission on Consumer Protection and Quality
in the Health Care Industry (the "Clinton Quality Commission"), which had been
appointed by President Clinton to formulate recommendations regarding health
care quality and the protection of consumers, released a "Consumer Bill of
Rights and Responsibilities" containing a number of general and specific
recommendations regarding the provision of health care in the United States. No
legislation has yet been adopted as a result of its recommendations. In February
1998, the President issued an executive order to the government administrators
of each of the government-sponsored health programs directing them to take
appropriate actions to insure compliance with some or all of the recommendations
made in the Consumer Bill of Rights by various dates on or before December 31,
1999. Compliance with the President's executive order is likely to increase
health plan costs associated with these government-sponsored programs. In 1998,
the Department of Labor also issued proposed regulations regarding a mandated
health plan grievance and appeal process. These regulations would apply to all
plans subject to the Employee Retirement and Income Security Act of 1974
("ERISA"), including employer-funded plans. These regulations, if adopted, could
have the effect of increasing the Company's expenses.
On August 21, 1996, the President signed into law the Health Insurance
Portability and Accountability Act of 1996 (originally known in the Senate as
the Kennedy-Kassebaum bill) ("HIPAA"). HIPAA and the implementing regulations
that have been subsequently adopted impose new obligations for issuers of health
insurance coverage and health benefit plan sponsors. HIPAA requires certain
guaranteed issuance and renewability of health coverage for individuals and
small groups (generally 50 or fewer employees) and limits exclusions based on
preexisting conditions. Most of the insurance reform provisions of HIPAA became
effective for "plan years" beginning July 1, 1997.
Maternity length of stay and mental health parity benefits measures became
effective for plan years beginning January 1, 1998. The maternity stay provision
requires health plans to cover the cost of a 48-hour hospital stay (96 hours
following a Caesarian section). This measure does not mandate the length of
hospital stays but requires that longer stays be covered if deemed necessary by
the mother or her physician (in consultation with the mother). Although many
states already guarantee minimum hospital stays for mothers and newborns, these
measures have further increased WellPoint's claims expense.
MEDICARE LEGISLATION. WellPoint's health benefits programs include products
that are marketed to Medicare beneficiaries as a supplement to their Medicare
coverage. These products are subject to Federal regulations intended to provide
Medicare supplement customers with standard minimum benefits and levels of
coverage and full disclosure of coverage terms and assure that fair sales
practices are employed in the marketing of Medicare supplement coverage.
In California, WellPoint provides a senior plan product under a Medicare +
Choice contract that is subject to regulation by HCFA. Under this contract and
HCFA regulations, if WellPoint's premiums received for Medicare-covered health
care services provided to senior plan Medicare members are more than the
Company's projected costs associated with the provision of health care services
provided to senior plan members, then WellPoint must provide its senior plan
members with additional benefits beyond those required by Medicare or reduce its
premiums, or deductibles or co-payments, if any. HCFA has the right to audit
HMOs operating under Medicare contracts to determine the quality of care being
rendered and the degree of compliance with HCFA's contracts and regulations.
FUTURE HEALTH CARE REFORM. A number of legislative proposals have been made
at the Federal and state levels over the past several years. These proposals
would, among other things, mandate benefits with
13
respect to certain diseases or medical procedures, require plans to offer an
independent external review of certain coverage decisions or establish health
plan liability in a manner similar to the Texas legislation discussed in the
following section. 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 ERISA.
WellPoint is unable to evaluate what legislation may be proposed and when or
whether any legislation will be enacted and implemented. However, many of the
proposals, if adopted, could have a material adverse effect on WellPoint's
financial condition, cash flows or results of operations, while others, if
adopted, could potentially benefit WellPoint's business.
OTHER STATES
The Company's activities in other states are subject to state regulation
applicable to the provision of managed health care services and the sale of
traditional health indemnity insurance. As a result of the MMHD 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 and
domicile of UL&H) and in all other states. As the Company expands its offering
of managed care products in new geographic locations, it will be subject to
additional regulation by governmental agencies applicable to the provision of
health care services. The Company believes it is in compliance in all material
respects with all current state regulatory requirements applicable to its
business as presently conducted. However, changes in government regulations
could affect the level of services which the Company is required to provide or
the rates which the Company can charge for its health care products and
services.
As the Company continues to expand its operations outside of California, new
legislative and regulatory developments in Delaware, Texas, Georgia (especially
after the expected completion of the Cerulean transaction) and various other
states will have greater potential effect on the Company's financial condition,
cash flows or results of operations. Over the past few years, there has been an
increase throughout the United States in proposed state legislation regarding,
among other things, mandated benefits, health plan liability, third-party review
of health plan coverage determinations and health plan relationships with
providers. The Company expects that this trend of increased legislation will
continue. In this regard, in early 1999 several bills have been introduced in
the Georgia Legislature, including one that would require managed care plans to
offer coverage for services rendered by out-of-network providers and one that
would establish a "consumer advocate" with authority to review and comment upon
matters pending before the Department of Insurance Commissioner. These laws, if
passed, could have the effect of increasing the Company's claims expense,
especially after the anticipated completion of the Cerulean transaction.
In 1997, the Texas legislature adopted SB 386 which, among other things,
purports to make managed care organizations ("MCOs") such as the Company liable
for the failure by the MCO, its employees or agents to exercise ordinary care
when making "health care treatment decisions" (as defined in the legislation).
The legislation was effective as of September 1, 1997. In September 1998, the
United States District Court for the Southern District of Texas ruled, in part,
that the MCO liability provisions of SB 386 are not preempted by ERISA. To date,
this legislation has not adversely affected the Company's results of operations.
However, although the Company maintains insurance covering such liabilities, to
the extent that this legislation (or similar legislation that may be
subsequently adopted at the Federal or state level) effectively expands the
scope of liability of MCOs, such as the Company, it may have a material adverse
effect on the Company's results of operations and financial condition. Even if
the Company is not held liable under any litigation, the existence of potential
MCO liability may cause the Company to incur greater costs in defending such
litigation.
In connection with the GBO Acquisition, the Company has entered into a
reinsurance arrangement, on a 100% coinsurance basis, of the insured business of
the GBO. This business includes 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.
14
SERVICE MARKS
WellPoint and its subsidiaries have filed for registration of and maintain
several service marks, trademarks and trade names at the Federal level and in
California, including "Prudent Buyer Plan," "CaliforniaCare" and "UNICARE."
WellPoint, Blue Cross of California and BC Life are currently parties to license
agreements with the Blue Cross Blue Shield Association ("BCBSA") which allow
them to use the Blue Cross name and mark in California with respect to
WellPoint's HMO and PPO network-based plans. Cerulean has also been granted
similar BCBSA licenses for the state of Georgia, which licenses are expected to
be transferred to WellPoint at the closing of the Cerulean transaction. The
BCBSA is a national trade association of Blue Cross and Blue Shield licensees,
the primary function of which is to promote the Blue Cross and Blue Shield
names. Each licensee is an independent legal organization and is not responsible
for the obligations of other BCBSA member organizations. A Blue Cross or Blue
Shield license requires payment of a fee to the BCBSA and compliance with
various requirements established by the BCBSA, including the maintenance of
specified capital. The failure to meet such capital requirements can subject the
Company to certain corrective action, while the failure to meet a lower
specified level of capital can result in termination of the Company's license
agreement with the BCBSA. WellPoint considers the licensed Blue Cross name and
its registered service marks, trademarks and trade names important in the
operation of its business.
EMPLOYEES
At December 31, 1998, WellPoint and its subsidiaries employed approximately
10,600 people. Approximately 140 of the Company's employees are presently
covered by a collective bargaining agreement with the Office and Professional
Employees International Union, Local 29. As a result of the GBO Acquisition,
approximately 209 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 53, 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 46, has been appointed Executive Vice President,
Individual and Small Group Businesses of the Company to be effective April 1999.
From October 1995 until March 1999, he has served as Executive Vice President,
UNICARE Businesses of the Company. From August 1992 until May 1996, Mr. Weinberg
served as a director of the Company. From February 1993 to October 1995, Mr.
Weinberg was Executive Vice President, Consumer and Specialty Services of the
Company. Prior to February 1993, Mr. Weinberg was Executive Vice President of
BCC's Consumer Services Group from December 1989 to February 1993 and was Senior
Vice President of Individual and Senior Services of BCC from April 1987 to
December 1989. From 1981 to 1987, Mr. Weinberg held a variety of positions at
Touche Ross & Co. From 1976 to 1981, Mr. Weinberg was general manager for the
CTX Products Division of PET, Inc.
Ronald A. Williams, age 49, has been appointed Executive Vice President,
Large Group Businesses of the Company to be effective April 1999. From October
1995 until March 1999, he has served as Executive Vice President, Blue Cross of
California Businesses of the Company. From August 1992 until May 1996, Mr.
Williams served as a director of the Company. From February 1993 to October
1995, Mr. Williams was
15
Executive Vice President, Group and Network Services of the Company. Prior to
February 1993, Mr. Williams was Executive Vice President of BCC's Group Services
from May 1992 to February 1993. Prior to that time, Mr. Williams served as
Executive Vice President of BCC's Health Services and Products Group from
December 1989 to May 1992 and as BCC's Senior Vice President of Marketing and
Related Products from November 1988 to December 1989. From May 1987 to November
1988 he was Vice President of Corporate Services of BCC. From July 1984 to May
1987 he was Senior Vice President of Vista Health Corporation, an alternative
delivery system for outpatient psychological and substance abuse services of
which he was also a co-founder. Mr. Williams also serves as a director of Syncor
International Corporation.
Joan E. Herman, age 45, joined the Company in June 1998 as Executive Vice
President, Specialty Businesses. Effective April 1999, Ms. Herman is Executive
Vice President, Senior and Specialty Businesses. From 1982 until joining the
Company, Ms. Herman was with Phoenix Home Life Mutual Insurance Company, a
mutual insurance company, most recently serving as Senior Vice President. Ms.
Herman is a member of the Society of Actuaries and American Academy of
Actuaries.
Clifton R. Gaus, age 56, joined the Company in March 1999 as Executive Vice
President and Chief Administrative Officer. From March 1997 until joining the
Company, Mr. Gaus was Senior Vice President, Research and Development of Kaiser
Permanente, a managed health care firm. Mr. Gaus was the owner and president of
a privately owned company, Potomac Valley Landscaping, Inc., from March 1997 to
1998. From February 1992 until March 1997, Mr. Gaus worked in the United States
Department of Health and Human Services, where he served in various positions,
including the Administrator of the Agency for Health Care Policy and Research
and senior advisor for the Office of Assistant Secretary. Mr. Gaus was the
founder and initial President of the Association for Health Services Research.
David C. Colby, age 45, joined the Company in September 1997 as Executive
Vice President and Chief Financial Officer. From April 1996 until joining the
Company, Mr. Colby was Executive Vice President, Chief Financial Officer and
Director of American Medical Response, Inc., a health care services company
focusing on ambulance services and emergency physician practice management. From
July 1988 until March 1996, Mr. Colby was with Columbia/HCA Healthcare
Corporation, most recently serving as Senior Vice President and Treasurer. From
September 1983 until July 1988, Mr. Colby was Senior Vice President and Chief
Financial Officer of The Methodist Hospital in Houston, Texas.
Thomas C. Geiser, age 48, 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
16
Company entered into a new License Agreement (the "License Agreement"), pursuant
to which the Company became the exclusive licensee for the right to use the Blue
Cross name and related service marks in California and became a member of the
BCBSA. See "--Service Marks."
The License Agreement required that the Foundation enter into a voting trust
agreement (the "Voting Trust Agreement"), pursuant to which the Foundation
deposited into a voting trust (the "Voting Trust") the number of shares of the
Company's Common Stock sufficient to reduce the Foundation's holdings outside
such Voting Trust to a level not in excess of 50% of the voting power of the
outstanding shares of the Company's Common Stock. The shares held by the trustee
under the Voting Trust Agreement (the "Voting Trust Shares") generally must be
voted (i) with respect to elections of directors, where the nominees have been
selected by the Nominating Committee (or, in certain instances, subsets of the
Board) in conformity with procedures set forth in the Company's Bylaws, to
support the position of the Board of Directors, (ii) with certain exceptions, on
matters requiring a vote of at least an absolute majority of all outstanding
shares of Common Stock, as the majority of non-Voting Trust Shares vote, and
(iii) on all other matters, in the identical proportion in favor of or in
opposition to such matters as non-Voting Trust Shares vote. With respect to the
removal of directors, calling of stockholder meetings and amendments of the
Company's Certificate of Incorporation and Bylaws, where such actions are
opposed by the Board of Directors, the Foundation has also agreed under the
Voting Trust Agreement to support the position of the Board of Directors. 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 June 12,
1998 and June 12, 1999, respectively. As of March 15, 1999, approximately
4,426,818 shares held by the Foundation were subject to the provisions of the
Voting Trust Agreement. As of March 15, 1999, the Foundation owned 17,910,000
shares of WellPoint Common Stock, or approximately 26.6% of the outstanding
Common Stock.
With respect to those shares held by the Foundation in excess of the
"Ownership Limit" (as defined in the Company's Certificate of Incorporation and
discussed further in the following paragraph) that are not subject to the Voting
Trust Agreement, the Foundation has also entered into a voting agreement (the
"Voting Agreement"). The Voting Agreement provides among other things, that the
Foundation, during the period that it continues to own in excess of the
Ownership Limit, will vote all shares of the Company's Common Stock owned by it
in excess of 5% of the outstanding shares (except those shares held pursuant to
the Voting Trust Agreement) in favor of each nominee to the Board of Directors
of the Company who has been nominated by the Nominating Committee of the Board
of Directors, or under certain circumstances, other subsets of the board, all as
set forth in the Company's Bylaws. With respect to the removal of directors,
calling of shareholder meetings and amendment of the Company's Articles of
Incorporation and Bylaws, where such actions are opposed by the Board of
Directors, the Foundation has also agreed under the Voting Agreement to support
the position of the Board of Directors. As of March 15, 1999, approximately
10,112,384 shares held by the Foundation were subject to the Voting Agreement.
At the time of the Recapitalization, the "Ownership Limit" was established
as one share less than 5% of the Company's outstanding voting securities. In
December 1997, the Company and the BCBSA, in accordance with the provisions of
Article VII, Section 14(f)(2) of the Company's Certificate of Incorporation,
agreed to modify the Ownership Limit to be the following: (i) for any
"Institutional Investor," one share less than 10% of the Company's outstanding
voting securities; and (ii) for any "Noninstitutional Investor," other than the
Foundation, one share less than 5% of the Company's outstanding voting
securities. For these purposes, "Institutional Investor" means any person if
(but only if) such person is (1) a broker or dealer registered under Section 15
of the Securities Exchange Act of 1934 (the "Exchange Act"), (2) a bank as
defined in Section 3(a)(6) of the Exchange Act, (3) an insurance company as
defined in Section 3(a)(19) of the Exchange Act, (4) an investment company
registered under Section 8 of the Investment Company Act of 1940, (5) an
investment adviser registered under Section 203 of the Investment Advisers Act
of 1940, (6) an employee benefit plan, or pension fund which is subject to the
provisions of the Employee Retirement Income Security Act of 1974 or an
endowment fund, (7) a parent
17
holding company, provided the aggregate amount held directly by the parent, and
directly and indirectly by its subsidiaries which are not persons specified in
paragraphs (1) through (6), does not exceed one percent of the securities of the
subject class, or (8) a group, provided that all the members are persons
specified in paragraphs (1) through (7). In addition, every filing made by such
person with the SEC under Regulation 13D-G (or any successor Regulation) under
the Exchange Act with respect to such person's beneficial ownership must contain
a certification (or a substantially similar one) that the WellPoint Common Stock
acquired by such person was acquired in the ordinary course of business and was
not acquired for the purpose of and does not have the effect of changing or
influencing the control of WellPoint and was not acquired in connection with or
as a participant in any transaction having such purpose or effect. For such
purposes, "Noninstitutional Investor" means any person that is not an
Institutional Investor.
In 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. Each
of the material agreements (other than the Indemnification Agreement) entered
into in connection with the Recapitalization was amended and restated on
substantially similar terms at the time of the reincorporation.
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATION
Certain statements contained in "Item 1. Business," such as statements
concerning the Company's geographic expansion and other business strategies, the
effect of recent health care reform legislation 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
Exchange Act). 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
18
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, cash
flows or result of operations.
In addition to capital requirements imposed by the California Department of
Corporations and Department of Insurance, the Company and its BCBSA-licensed
affiliates are required to maintain certain levels of capital to satisfy BCBSA
requirements. During 1998, the National Association of Insurance Commissioners
(the "NAIC"), the trade association representing state insurance regulators,
adopted a risk-based capital formula for licensed managed care organizations
called Managed Care Organization Risk-Based Capital ("MCORBC"). The NAIC also
approved an accompanying Risk-Based Capital for Health Organizations Model Act
(the "Model Act"), which will serve as a model for states considering enacting
new legislation. The BCBSA is expected to transition to the MCORBC formula
effective as of December 31, 1999. If adopted by states, the minimum capital
requirements under the Model Act are not expected to have a material impact on
the Company, although there can be no assurances that new minimum capital
requirements will not increase the Company's capital requirements in the future.
The health care industry has become the subject of greater legislative and
media scrutiny in recent years. In 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, cash flows 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
and other provider contracts, coupled with continued consolidation of physician,
hospital and other provider groups, may result in increased health care costs or
limit the Company's ability to negotiate favorable rates. Recently, large
physician practice management companies have experienced extreme financial
difficulties (including bankruptcy), which may subject the Company to increased
credit risk related to provider groups.
19
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.
PENDING TRANSACTION WITH CERULEAN
WellPoint has entered into the Merger Agreement with Cerulean pursuant to
which Cerulean will become a wholly owned subsidiary of the Company. (See
"--Recent Developments--Pending Transaction with Cerulean.") Completion of the
Merger is subject to the satisfaction of a number of conditions, including
approval by the Georgia Department of Insurance. There can be no assurances that
the required approvals will be obtained. In addition, the timing of the
resolution of the Conversion Litigation could delay the closing. If all
conditions to closing are not met on or before July 8, 1999, each of WellPoint
and Cerulean will have the right to terminate the Merger Agreement. As a result,
there can be no assurances that the transaction will be consummated.
As a condition to approval of the transaction, regulatory agencies may
impose requirements or limitations on the way that the combined company conducts
its business. If WellPoint or Cerulean were to agree to any material
requirements or limitations in order to obtain approvals, such requirements or
limitations or additional costs associated therewith could adversely affect
WellPoint's ability to intergrate the operations of Cerulean with those of
WellPoint. Accordingly, a material adverse effect on WellPoint's revenues and
results of operations following the merger could result.
INTEGRATION OF ACQUISITIONS; GEOGRAPHIC EXPANSION STRATEGY; FUTURE ACQUISITIONS
One component of the Company's business strategy has been to diversify into
new geographic markets, particularly through strategic acquisitions. The Company
completed the MMHD acquisition in March 1996 and the GBO acquisition in March
1997. During 1997 and 1998, the Company worked extensively on the integration of
these acquired businesses, 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. Assuming the acquisition of Cerulean is consummated,
WellPoint will then undertake similar integration efforts for this acquired
business. Due to the complex nature of the merger integration process,
particularly the information systems designed to serve these businesses, the
Company may temporarily experience increases in claims inventory or other
service-related issues that may negatively affect the Company's relationship
with its customers and contribute to increased attrition of such customers. The
success of these acquisitions will, among other things, also require the
integration of a significant number of the employees into the Company's existing
operations and the completion of the integration of separate information
systems. No assurances can be given regarding the ultimate success of the
integration of these acquisitions into the Company's business.
Both the acquired MMHD operations and the GBO have some indemnity-based
insurance operations, with a significant number of members outside of
California. Each of these operations experienced varying profitability or losses
in recent periods. As anticipated at the time of acquisition, the Company has
experienced material membership attrition related to these businesses in 1998
and the early part of 1999 and expects to continue to experience membership
attrition during 1999 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
20
members or develop satisfactory proprietary provider networks in these
geographic areas. The development of such networks will require considerable
expenditures by the Company.
As the Company pursues its geographic expansion strategy, the Company's
market share in new markets will not be as significant, and its provider
networks not as extensive, as in California, and the Company will not have the
benefit of the Blue Cross mark (except in Georgia after completion of the
Cerulean transaction), which are important components of its success in
California. 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. Except with respect to Cerulean, the Company currently has no
existing agreements or commitments to effect any material acquisition.
Accordingly, there can be no assurance that the Company will be able to identify
additional acquisition candidates available for sale at reasonable prices or
consummate any acquisition or that any discussions will result in an
acquisition. Any such acquisitions may require significant additional capital
resources and there can be no assurance that the Company will have access to
adequate capital resources to effect such future acquisitions. To the extent
that the Company consummates acquisitions, there can be no assurance that such
acquisitions will be successfully integrated into the Company or that such
acquisitions will not adversely affect the Company's results of operations, cash
flows and financial condition.
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 significant changes in recent
years, including substantial consolidation. Outside of California, the Company
faces competition from other regional and national companies, many of which have
(or due to future consolidation, may have) significantly greater financial and
other resources and market share than the Company. If competition were to
further increase in any of its markets, WellPoint's financial condition, cash
flows or results of operations could be materially adversely affected.
A substantial portion of WellPoint's California business is in the
individual and small employer group market, where the loss ratio is
significantly lower than in the large employer group market. The individual and
small employer group business constituted approximately 34% of WellPoint's total
premium revenue for the year ended December 31, 1998. 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 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
21
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 and other information
technology personnel. 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 Company has developed and is in the midst of executing a comprehensive
plan designed to address the year 2000 issue for its information technology
("IT") and non-information technology systems and applications ("non-IT
systems"). With respect to IT systems, during 1997 the Company completed a
detailed risk assessment of its various computer systems, business applications
and other affected systems, formulated a plan for specific remediation efforts
and began certain of such remediation efforts. During 1998 and the first quarter
of 1999, the Company completed its remediation efforts and undertook internal
testing of its systems and applications. In the second quarter of 1999, the
Company expects to undergo third-party review of certain of its year 2000
remediation efforts. This third party review will include an assessment of
certain procedures undertaken by the Company as well as a computer software test
of select portions of the Company's computer code. With respect to non-IT
systems, the Company is currently in the process of completing the replacement
or renovation of Company-owned systems to address year 2000 issues. The Company
is also completing an assessment and, where appropriate, obtaining
certifications, from property owners that non-IT systems in leased facilities
will be remediated or replaced on a timely basis. The Company currently expects
that its year 2000 remediation efforts and third-party review with respect to
non-IT systems will be completed in the second quarter of 1999. 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, cash flows 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
22
the BCC Conversion is treated as a taxable transaction is currently estimated to
be approximately $696 million, plus interest (and possibly penalties). BCC and
the Foundation entered into an Indemnification Agreement that provides, with
certain exceptions, that the Foundation will indemnify WellPoint against the net
tax liability as a result of a revocation or modification, in whole or in part,
of the ruling by the IRS or a determination by the IRS that the BCC Conversion
constitutes a taxable transaction for Federal income tax purposes. In the event
a tax liability should arise against which the Foundation has agreed to
indemnify WellPoint, there can be no assurance that the Foundation will have
sufficient assets to satisfy the liability in full, in which case WellPoint
would bear all or a portion of the cost of the liability, which could have a
material adverse effect on WellPoint's financial condition.
ITEM 2. PROPERTIES.
Effective as of January 1, 1996, the Company entered into a lease for Blue
Cross of California's Woodland Hills, California headquarters facility, which
provides for a term expiring in December 2019 with two options to extend the
term for up to two additional five-year terms. Rent expense under the lease was
approximately $8.4 million during 1998. In 1997, the Company entered into a
lease, which expires in December 2019, for its new headquarters facility located
in Thousand Oaks, California. This facility was completed in January 1999. The
Company and its subsidiaries have additional offices in the greater Los Angeles
and Ventura County area. As a result of the 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. Further, legislation that would establish the
liability of health plans for medical decisions is pending in various states.
See "Item 1. Business--Government Regulation." The financial and operational
impact that such evolving theories of recovery will have on the managed care
industry generally, or WellPoint in particular, is at present unknown. Certain
of such legal proceedings are or may be covered under insurance policies or
indemnification agreements. Based upon information presently available, the
Company believes that the final outcome of all such proceedings should not have
a material adverse effect upon WellPoint's results of operations, cash flows or
financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
23
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock has been traded on the New York Stock Exchange
under the symbol "WLP" since the Company's initial public offering on January
27, 1993. The following table sets forth for the periods indicated the high and
low sale prices for the Common Stock.
HIGH LOW
------- -------
Year Ended December 31, 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
Year Ended December 31, 1998
First Quarter............................................................... 70 1/16 42 1/4
Second Quarter.............................................................. 74 61 15/16
Third Quarter............................................................... 74 11/16 51 1/4
Fourth Quarter.............................................................. 87 51 7/16
On March 15, 1999 the closing price on the New York Stock Exchange for the
Company's Common Stock was $73 13/16 per share. As of March 15, 1999, there were
approximately 209 holders of record of Common Stock.
The Company did not pay any dividends on its Common Stock in 1997 or 1998.
Management currently expects that all of WellPoint's future income will be used
to expand and develop its business. The Board of Directors currently intends to
retain the Company's net earnings during 1999.
24
ITEM 6. SELECTED FINANCIAL DATA.
YEAR ENDED DECEMBER 31,
(IN THOUSANDS, EXCEPT PER SHARE DATA, MEMBERSHIP ---------------------------------------------------------------
DATA AND OPERATING STATISTICS) 1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
CONSOLIDATED INCOME STATEMENTS(A)
Revenues:
Premium revenue.............................. $ 5,934,812 $ 5,068,947 $ 3,699,337 $ 2,776,760 $ 2,564,371
Management services revenue.................. 433,960 377,138 147,911 61,151 36,253
Investment income............................ 109,578 196,153 123,584 120,913 92,188
----------- ----------- ----------- ----------- -----------
6,478,350 5,642,238 3,970,832 2,958,824 2,692,812
Operating Expenses:
Health care services and other benefits...... 4,776,345 4,087,420 2,825,914 2,090,036 1,865,887
Selling expense.............................. 280,078 249,389 202,318 177,058 161,596
General and administrative expense........... 975,099 836,581 543,541 327,951 320,417
Nonrecurring costs........................... -- 14,535 -- 57,074 --
----------- ----------- ----------- ----------- -----------
6,031,522 5,187,925 3,571,773 2,652,119 2,347,900
----------- ----------- ----------- ----------- -----------
Operating Income............................... 446,828 454,313 399,059 306,705 344,912
Interest expense............................. 26,903 36,658 36,628 -- --
Other expense, net........................... 27,939 31,301 25,195 9,718 5,504
----------- ----------- ----------- ----------- -----------
Income from Continuing Operations before
Provision for Income Taxes................... 391,986 386,354 337,236 296,987 339,408
Provision for Income Taxes................... 72,438 156,917 138,718 122,232 137,149
----------- ----------- ----------- ----------- -----------
Income from Continuing Operations 319,548 229,437 198,518 174,755 202,259
Income (Loss) from Discontinued Operations... (88,268) (2,028) 3,484 5,234 10,911
----------- ----------- ----------- ----------- -----------
Net Income..................................... $ 231,280 $ 227,409 $ 202,002 $ 179,989 $ 213,170
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Per Share Data(A)(B)(C):
Income from Continuing Operations:
Earnings Per Share......................... $ 4.63 $ 3.33 $ 2.99 $ 2.63 $ 3.05
Earnings Per Share Assuming Full
Dilution................................. $ 4.55 $ 3.30 $ 2.99 $ 2.63 $ 3.05
Income (Loss) from Discontinued Operations:
Earnings Per Share......................... $ (1.28) $ (0.03) $ 0.05 $ 0.08 $ 0.16
Earnings Per Share Assuming Full
Dilution................................. $ (1.26) $ (0.03) $ 0.05 $ 0.08 $ 0.16
Net Income:
Earnings Per Share......................... $ 3.35 $ 3.30 $ 3.04 $ 2.71 $ 3.21
Earnings Per Share Assuming Full
Dilution................................. $ 3.29 $ 3.27 $ 3.04 $ 2.71 $ 3.21
OPERATING STATISTICS (A)(D):
Loss ratio..................................... 80.5% 80.6% 76.4% 75.3% 72.8%
Selling expense ratio.......................... 4.4% 4.6% 5.3% 6.2% 6.2%
General and administrative expense ratio....... 15.3% 15.4% 14.1% 11.6% 12.3%
Net income ratio............................... 3.6% 4.2% 5.3% 6.3% 8.2%
DECEMBER 31,
---------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
BALANCE SHEET DATA(A):
Cash and investments........................... $ 2,764,302 $ 2,560,537 $ 1,849,814 $ 1,981,532 $ 1,724,026
Total assets................................... $ 4,225,834 $ 4,234,124 $ 3,149,378 $ 2,471,360 $ 2,185,950
Long-term debt................................. $ 300,000 $ 388,000 $ 625,000 -- --
Total equity................................... $ 1,315,223 $ 1,223,169 $ 870,459 $ 1,670,226 $ 1,418,919
Cash dividends declared per common share(E).... -- -- $ 10.00 -- --
MEDICAL MEMBERSHIP(F)............................ 6,892,000 6,638,000 4,485,000 2,797,000 2,617,000
25
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(A) Financial information prior to 1998 has been restated to present the
workers' compensation business as a discontinued operation.
(B) Per share data for all periods presented prior to 1996 have been recomputed
using 66,366,500 shares, the number of shares outstanding immediately
following completion of the Recapitalization. Per share data for the year
ended December 31, 1996 has been calculated using such 66,366,500 shares,
plus the weighted average number of shares issued since the
Recapitalization.
(C) Per share data includes nonrecurring costs of $0.13 per share and $0.52 per
share for 1997 and 1995, respectively.
(D) The loss ratio represents health care services and other benefits as a
percentage of premium revenue. All other ratios are shown as a percentage of
premium revenue and management services revenue.
(E) The Company paid a $995.0 million special dividend in conjunction with the
Recapitalization which occurred on May 20, 1996. Management currently
expects that all of the Company's future income will be used to expand and
develop its business.
(F) Membership numbers are approximate and include some estimates based upon the
number of contracts at the relevant date and an actuarial estimate of the
number of members represented by each contract.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This discussion contains forward-looking statements which involve risks and
uncertainties. The Company's actual results may differ materially from those
anticipated in these forward-looking statements as a result of certain factors
including, but not limited to, those set forth under "Factors That May Affect
Future Results of Operations."
GENERAL
The Company is one of the nation's largest publicly traded managed health
care companies. As of December 31, 1998, WellPoint had approximately 6.9 million
medical members and approximately 25 million specialty members. The Company
offers a broad spectrum of network-based managed care plans. WellPoint provides
these plans to the large and small employer, individual and senior markets. The
Company's managed care plans include HMOs, PPOs, POS plans, other hybrid plans
and traditional indemnity plans. In addition, WellPoint offers managed care
services, including underwriting, claims processing, actuarial services, network
access and medical cost management. The Company also provides a broad array of
specialty and other products, including pharmacy, dental, utilization
management, life insurance, preventive care, disability insurance, behavioral
health, COBRA and flexible benefits account administration.
As discussed in Note 11 to the Consolidated Financial Statements, during
1998, the Company discontinued its workers' compensation operations. All
financial information presented herein has been restated in both current and
prior periods to exclude the workers' compensation operations and the discussion
and analysis that follows has been modified accordingly.
In accordance with Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of a Business Enterprise," the Company was organized
into two primary segments, the California and National business segments, during
the year ended December 31, 1998. Effective April 1, 1999, the Company intends
to modify its internal business operations. It is anticipated that the impact of
this internal change will also affect the disclosures of the Company's segments
from that presented as of December 31, 1998. The Company is currently evaluating
the effect of this proposed change and expects that future filings under the
Securities Exchange Act of 1934 on or after the effective date of this
reorganization will reflect such modified segments.
26
SALE OF WORKERS' COMPENSATION SEGMENT
On July 29, 1998, WellPoint entered into a Stock Purchase Agreement (the
"Stock Purchase Agreement") by and between WellPoint and Fremont Indemnity
Company ("Fremont"). Pursuant to the Stock Purchase Agreement, Fremont acquired
all of the outstanding capital stock of UNICARE Specialty Services, Inc., a
wholly owned subsidiary of WellPoint ("UNICARE Specialty"). The transaction was
completed on September 1, 1998. The principal asset of UNICARE Specialty was the
capital stock of UNICARE Workers' Compensation Insurance Company ("UNICARE
Workers' Compensation"). The purchase price for the acquisition was the
statutory surplus (adjusted in accordance with the terms of the Purchase
Agreement) of UNICARE Workers' Compensation as of the date of the closing. The
purchase price based upon adjusted statutory surplus of UNICARE Workers'
Compensation as of September 1, 1998, the closing date of the transaction, was
approximately $110.0 million. Subsequent to September 1, 1998, the Company and
Fremont are jointly marketing integrated workers' compensation and medical
insurance products in the small employer group market.
NATIONAL EXPANSION AND OTHER RECENT DEVELOPMENTS
In an effort to pursue the expansion of the Company's National business
segment, during the past three years the Company has completed the acquisition
of two businesses outside the state of California, the Life and Health Benefits
Management Division ("MMHD") of Massachusetts Mutual Life Insurance Company and
the Group Benefits Operations (the "GBO") of John Hancock Mutual Life Insurance
Company. The purchase method of accounting has been used to account for both of
the aforementioned transactions. The excess purchase price over net assets
acquired was approximately $172.5 million for the GBO and $251.0 million for
MMHD. During the fourth quarter of 1998, the Company re-evaluated the useful
life of the intangible assets and goodwill related to these acquisitions and
reduced such composite lives from 35 to 20 years. The Company's pending
transaction with Cerulean Companies, Inc. is also a component of this expansion.
On March 1, 1997, the Company completed its acquisition of the GBO. The
purchase price was $89.7 million, subject to the resolution of certain items
related to the post-closing audit. 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.
As a result of the GBO and MMHD acquisitions, the Company has significantly
expanded its operations outside of California. In order to integrate its
acquired businesses and implement the Company's regional expansion strategy, the
Company will need to develop satisfactory 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.
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. In September 1998, the Company
received a private letter ruling from the Internal Revenue Service with respect
to the treatment of certain payments in conjunction with the Recapitalization
and acquisition of the BCC Commercial Operations. The ruling allows the Company
to deduct as an ordinary and necessary business expense an $800 million cash
payment made by Blue Cross of California in May 1996 to one of two newly formed
charitable foundations. As a result of such private letter ruling, the Company
reduced the remaining intangible asset related to its acquisition of the BCC
Commercial Operations to zero. (See Note 8 to the Consolidated Financial
Statements.)
The Company has acquired certain businesses over the last three years which
historically experienced a higher overall loss ratio than the Company. These
acquired businesses have contributed to an increase in the Company's overall
loss ratio. In order to control the respective loss ratios and reduce the
financial risk
27
of these acquired businesses, the Company has undertaken a variety of measures,
including significant premium increases and changes in product design. The GBO
and MMHD businesses have historically also experienced a higher administrative
expense ratio than the Company's traditional California business due to the
higher percentage of management services business. These higher administrative
expense ratios have contributed to an increase in the Company's overall
administrative expense ratio since the respective dates of acquisition.
PENDING ACQUISITION OF CERULEAN
On July 9, 1998, the Company entered into an Agreement and Plan of Merger
with Cerulean Companies Inc. ("Cerulean") (See Note 23 to the Consolidated
Financial Statements). Cerulean, principally through its Blue Cross Blue Shield
of Georgia subsidiary, offers insured and administrative services products
primarily in the State of Georgia. Cerulean has historically experienced a
higher administrative expense ratio than the Company's core businesses due to
its higher concentration of administrative services business. Cerulean has also
historically experienced a higher loss ratio than the Company's core businesses
due to its higher percentage of large group business, which generally reduces
the Company's overall risk and also underwriting margins. Accordingly, it is
expected that Cerulean's higher loss and administrative expense ratios will
ultimately contribute to an increase in those ratios for the Company after the
transaction is completed. This transaction is expected to be completed in the
second half of 1999.
LEGISLATION
A variety of health care reform measures are currently pending or have been
recently enacted at the Federal, state and local levels. Federal legislation
enacted during the last two years 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
decreasing the affordability of the Company's products. In May 1997, the Texas
Legislature adopted Senate Bill No. 386 ("SB 386"). Among other things, this
legislation 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 was effective as of September 1, 1997. In September 1998,
the United States District Court for the Southern District of Texas ruled, in
part, that the MCO liability provisions of SB 386 are not preempted by the
Federal Employee Retirement Income Security Act of 1974 ("ERISA"). To date, this
legislation has not adversely affected the Company's results of operations.
Similar legislation is currently pending in both the California and Georgia
legislatures. Although the Company maintains insurance covering such
liabilities, to the extent that this legislation (or similar legislation that
may be subsequently adopted at the Federal or state level) effectively expands
the scope of liability of MCOs such as the Company, it may have a material
adverse effect on the Company's results of operations, financial condition or
cash flows. Even if the Company is not held to be liable under any litigation,
the existence of potential MCO liability may cause the Company to incur greater
costs in defending such litigation.
YEAR 2000
The Company is substantially dependent on its computer systems, business
applications and other information technology systems ("IT systems"), due to the
nature of its managed health care business and the increasing number of
electronic transactions in the industry. Historically, many IT systems were
developed to recognize the year as a two-digit number, with the digits "00"
being recognized as the year 1900. The year 2000 presents a number of potential
problems for such systems, including potentially significant processing errors
or failure. Given the Company's reliance on its computer systems, the Company's
results of operations could be materially adversely affected by any significant
errors or failures. Additionally, the year 2000 presents potential problems for
other systems and applications containing date-
28
dependent embedded microprocessors ("non-IT systems"), such as elevators and
heating and ventilation equipment.
The Company has developed and is in the midst of executing a comprehensive
plan designed to address the "year 2000" issue for its IT and non-IT systems and
applications. With respect to IT systems, during 1997 the Company completed a
detailed risk assessment of its various computer systems, business applications
and other affected systems, formulated a plan for specific remediation efforts
and began certain of such remediation efforts. During 1998 and the first quarter
of 1999, the Company completed its remediation efforts and undertook internal
testing of its systems and applications. In the second quarter of 1999, the
Company expects to undergo third-party review of certain of its year 2000
remediation efforts. This third party review will include an assessment of the
procedures undertaken by the Company as well as a computer software test of
selected portions of the Company's computer code. With respect to non-IT
systems, the Company is currently in the process of completing the replacement
or renovation of Company-owned systems to address year 2000 issues. The Company
is also undertaking a review of non-IT systems in leased facilities and, where
appropriate, obtaining certifications from the property owners that non-IT
systems in leased facilities will be remediated or replaced on a timely basis.
The Company currently expects that its year 2000 remediation efforts and
third-party review with respect to non-IT systems will be completed by the
second quarter of 1999.
The Company currently estimates that its costs related to year 2000
compliance remediation for Company-owned IT systems and applications will be
approximately $6 to $7 million in 1999. The amounts expected to be expended
during 1999 represent less than 5% of the Company's IT systems budget. During
the year ended December 31, 1998, the Company expended approximately $16.9
million and $1.3 million for remediation of its IT software systems and
applications and for renovation or replacement of its telecommunications
equipment, respectively. The Company currently estimates that its total costs in
1999 with respect to non-IT systems and applications will be approximately $1.0
million. The Company's expenditures with respect to non-IT systems will include
the acquisition of back-up power supplies for the Company's headquarters and
data center facilities. The Company expenses year 2000 remediation costs as
incurred and expects to fund these costs through cash flow from operations.
While the immediacy of year 2000 compliance measures has caused the Company to
defer or cancel certain IT projects, the Company does not expect such actions to
have a material effect on the Company's results of operations, cash flows or
financial condition. Assuming the Company's pending acquisition of Cerulean is
consummated (see Note 23 to the Consolidated Financial Statements), similar
remediation and testing efforts with respect to Cerulean-owned IT and non-IT
systems and applications may increase the Company's total expenditures.
The Company is currently formulating detailed contingency plans in the event
that its various systems and applications do not achieve year 2000 compliance in
a timely fashion. The contingency plans are focused on identifying potential
failure scenarios for the Company's IT and non-IT systems and those of third
parties with which the Company interacts and on ensuring the continuation of
critical business operations. During the first half of 1999, the Company expects
to integrate each of these contingency plans into a Company-wide contingency
plan.
The Company continues to assemble survey data from health care transaction
clearing houses, third party vendors and certain other parties with which the
Company communicates electronically to determine the compliance efforts being
undertaken by these parties and to assess the Company's potential business
exposure to any non-compliant systems operated by these parties. Health care
claims submitted electronically to the Company are usually submitted through
clearing houses on behalf of health care providers. Based on the survey data and
other information compiled by the Company to date, the Company has not
identified any third parties that the Company expects will suffer year
2000-related problems which are likely to have a significant adverse effect on
the Company's operations. However, many of these third parties are currently in
the process of implementing the critical portions of their own year 2000
compliance measures. As a result, at the current time the Company does not have
sufficient information to determine whether its external relationships will be
materially adversely affected by year 2000 compliance problems.
29
If the Company's year 2000 issues were not completely resolved prior to the
end of 1999, the Company could be subject to a number of potential consequences,
including, among other things, an inability to timely and accurately process
health care claims, collect customers' premiums or administrative fees, verify
subscriber eligibility, assess utilization trends or compile accurate financial
data for use by management. In particular, the Company may experience a decrease
in electronic health claims submission, which could cause the Company's claims
inventory to increase on a temporary basis. An increase in claims inventory
could prevent the Company from identifying emerging utilization trends quickly
and taking appropriate actions to mitigate such trends through pricing actions,
benefit redesign or other actions. The Company is attempting to limit its
exposure to year 2000 issues by closely monitoring its own year 2000 remediation
efforts, assessing the year 2000 compliance efforts of various third parties
with which it interacts and developing contingency plans addressing potential
problems that could have a material adverse effect on the Company's results of
operations. Although the Company intends to put into place programs and
procedures designed to mitigate the aforementioned risks, there can be no
assurances that all potential problems may be mitigated by these procedures.
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, 1998 include a full year of earnings for each of its acquired businesses.
The results of operations for the year ended December 31, 1997 include ten
months of earnings for the GBO, from the date of its acquisition. 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,
-------------------------------
1998 1997 1996
--------- --------- ---------
Operating Revenues:
Premium revenue.................................................. 93.2% 93.1% 96.2%
Management services revenue...................................... 6.8 6.9 3.8
--------- --------- ---------
100.0 100.0 100.0
Operating Expenses:
Health care services and other benefits loss..................... 80.5 80.6 76.4
Selling expense.................................................. 4.4 4.6 5.3
General and administrative expense............................... 15.3 15.4 14.1
30
MEMBERSHIP
The following table sets forth membership data and the percent change in
membership:
AS OF DECEMBER 31,
--------------------------- PERCENT
1998 1997 CHANGE
------------ ------------ ---------
MEDICAL MEMBERSHIP (A):
CALIFORNIA (B)
Group Services:
HMO................................. 947,797 812,180 16.7%
PPO and Other....................... 1,589,506 1,475,360 7.7%
------------ ------------
Total............................. 2,537,303 2,287,540 10.9%
------------ ------------
Individual, Small Group and Senior:
HMO................................. 350,939 316,350 10.9%
PPO and Other....................... 1,324,193 1,282,511 3.3%
------------ ------------
Total............................. 1,675,132 1,598,861 4.8%
------------ ------------
Medi-Cal HMO Programs................. 474,429 284,281 66.9%
------------ ------------
Total California Medical Membership..... 4,686,864 4,170,682 12.4%
------------ ------------
TEXAS
Group Services........................ 162,880 202,239 (19.5)%
Individual, Small Group and Senior.... 114,254 74,261 53.9%
------------ ------------
Total............................. 277,134 276,500 0.2%
------------ ------------
GEORGIA
Group Services........................ 88,533 91,070 (2.8)%
Individual, Small Group and Senior.... 16,739 8,139 105.7%
------------ ------------
Total............................. 105,272 99,209 6.1%
------------ ------------
OTHER STATES
Group Services........................ 1,798,697 2,083,122 (13.7)%
Individual, Small Group and Senior.... 23,636 8,644 173.4%
------------ ------------
Total............................. 1,822,333 2,091,766 (12.9)%
------------ ------------
Total National Medical Membership (b)... 2,204,739 2,467,475 (10.6)%
------------ ------------
TOTAL MEDICAL MEMBERSHIP (C)............ 6,891,603 6,638,157 3.8%
------------ ------------
------------ ------------
NETWORKS (D)
Proprietary Networks.................. 4,537,000 3,941,220 15.1%
Other Networks........................ 1,411,097 1,560,276 (9.6)%
Non-Network........................... 943,506 1,136,661 (17.0)%
------------ ------------
TOTAL MEDICAL MEMBERSHIP................ 6,891,603 6,638,157 3.8%
------------ ------------
------------ ------------
- ------------------------
(a) Membership numbers are approximate and include some estimates based upon the
number of contracts at the relevant date and an actuarial estimate of the
number of members represented by the contract.
(b) Classification between California and National membership for employer
groups is determined by the state of the employer's corporate office. The
state designation within National is determined by the zip code of the
subscriber.
(c) Medical membership includes 2,580,119 and 2,765,856 management services
members as of December 31, 1998 and 1997, respectively, of which management
services members outside of California were 1,600,616 and 1,792,151 as of
December 31, 1998 and 1997, respectively.
(d) 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.
31
AS OF DECEMBER 31,
----------------------------- PERCENT
SPECIALTY MEMBERSHIP: 1998 1997 CHANGE
------------- ------------- ---------
Pharmacy.............................. 15,003,377 12,290,221 22.1%
Dental................................ 3,148,528 3,183,477 (1.1)%
Utilization Management................ 2,908,383 2,750,767 5.7%
Life.................................. 2,155,805 1,757,881 22.6%
Disability............................ 778,860 1,125,571 (30.8)%
Behavioral Health..................... 743,507 721,350 3.1%
COMPARISON OF RESULTS FOR THE YEAR ENDED DECEMBER 31, 1998 TO THE YEAR ENDED
DECEMBER 31, 1997
Premium revenue increased 17.1%, or $865.9 million, to $5,934.8 million for
the year ended December 31, 1998 from $5,068.9 million for the year ended
December 31, 1997. The overall increase was primarily due to an increase in
insured member months of 12.1%, primarily in the Company's California business
segment, and the implementation of price increases throughout the California
market. Excluding the impact of the additional two months of premium revenue in
1998 related to the GBO of $80.1 million, the National business segment
experienced a decline in overall premium revenue due to attrition on acquired
MMHD membership and, to a lesser extent, the GBO membership, a portion of which
was the result of recently instituted premium increases with respect to certain
under-priced customer accounts. The Company expects that it will experience some
level of further membership attrition of its acquired MMHD and GBO members
during the first half of 1999 as it continues to increase prices and pursues its
strategy of motivating members to select managed care products.
Management services revenue increased 15.1%, or $56.9 million, to $434.0
million for the year ended December 31, 1998 from $377.1 million for the year
ended December 31, 1997. The increase was primarily due to a 14.7% increase in
management services member months, primarily in the California business
segment's large employer group business. Also contributing to the increase was
the incremental impact of the addition of a management services contract in the
National business segment with the State of Illinois effective as of July 1,
1997. Excluding the impact of the additional two months of management services
revenue in 1998 related to the GBO operations of $22.3 million, the National
business segment experienced a decline in overall management services revenue
due to attrition on acquired MMHD membership and, to a lesser extent, the GBO
membership.
Investment income decreased $86.6 million to $109.6 million for the year
ended December 31, 1998, compared to $196.2 million for the year ended December
31, 1997. The decline was primarily attributable to recognition in 1998 of an
"other than temporary" decline in value of $48.7 million relating to the
Company's equity holdings in FPA Medical Management, Inc. ("FPA"), which
subsequently filed for bankruptcy. Further contributing to the decrease between
years was the initial gain of $30.3 million recognized in 1997 related to the
exchange of Health Partners Inc. ("HPI") stock for FPA. Excluding the effects of
both the "other than temporary" decline in value in 1998 and the gain related to
the stock-for-stock merger with FPA in 1997, investment income would have been
$158.3 million and $165.9 million, for 1998 and 1997, respectively. Including
the loss on FPA in 1998, and the gain on HPI in 1997, the net realized loss on
investment securities for the year ended December 31, 1998 was $32.0 million
compared to a net realized gain of $64.3 million for the year ended December 31,
1997. Net interest and dividend income increased $11.3 million to $145.2 million
for the year ended December 31, 1998 in comparison to $133.9 million for the
year ended December 31, 1997, primarily due to increased interest income
resulting from the investment portfolios of the acquired GBO businesses
partially offset by lower yields on invested assets in 1998 versus 1997. Net
investment income also included a loss of approximately $4.5 million in 1998
related to the Company's interest rate swap agreements.
Health care services and other benefits expense increased 16.9%, or $688.9
million, to $4,776.3 million for the year ended December 31, 1998 from $4,087.4
million for the year ended December 31, 1997. The overall increase was primarily
due to the aforementioned increase in insured member months of 12.1%,
32
primarily in the Company's California business segment. Excluding the impact of
the additional two months in 1998 related to the GBO of $91.4 million, the
National business segment experienced a decline in overall claims expense due to
attrition on acquired MMHD membership and, to a lesser extent, the acquired GBO
membership.
The loss ratio attributable to managed care and related products for the
year ended December 31, 1998 decreased slightly to 80.5% compared to 80.6% for
the year ended December 31, 1997. Excluding the GBO for the period prior to its
acquisition for the year ended December 31, 1998, the loss ratio would have been
80.0%. The decline is primarily due to the aforementioned membership attrition
related to underperforming MMHD and GBO acquired accounts in the Company's
National business segment combined with the growth in the Company's Medi-Cal
business that experienced a lower loss ratio, partially offset by increases in
California large group business.
Selling expense consists of commissions paid to outside brokers and agents
representing the Company. Selling expense for the year ended December 31, 1998
increased 12.3% to $280.1 million, compared to $249.4 million for the year ended
December 31, 1997, generally corresponding with continued overall premium
revenue growth. The selling expense ratio for the year ended December 31, 1998
decreased to 4.4% from 4.6% for the year ended December 31, 1997, largely due to
the acquisition of the GBO in the Company's National business segment, which has
a lower selling expense ratio than the Company's existing business due to the
use of an internal sales force. Excluding the GBO for the period prior to its
acquisition for the year ended December 31, 1998, the selling expense ratio
would have been 4.5%. The California business segment's growth in Medi-Cal and
large employer group medical products had a further impact on lowering the
selling expense ratio as a result of the lower selling costs associated with
these products in comparison to the Company's other products.
General and administrative expense for the year ended December 31, 1998
increased 16.6%, or $138.5 million, to $975.1 million from $836.6 million for
the year ended December 31, 1997. The additional two months of the GBO in 1998
compared to 1997 in the National business segment accounted for 24.5%, or $34.0
million, of the overall increase. The remainder of the increase was primarily
due to an increase in California member months of 15.9%, including management
services members, and to costs associated with the Company's national expansion
related to the integration of the acquired businesses to the Company's
information systems. The Company's systems have been enhanced to accommodate the
more complex products offered by those businesses. Costs associated with year
2000 compliance efforts also contributed to the increase. The Company incurred
approximately $26.0 million of costs relating to the integration of acquired
businesses during 1998.
The administrative expense ratio decreased slightly to 15.3% for 1998
compared to 15.4% for 1997. The GBO has historically experienced a higher
administrative expense ratio than the Company's traditional California-based
businesses due to the GBO's higher percentage of management services business.
The administrative expense ratio, excluding the GBO for the period prior to its
acquisition for the year ended December 31, 1998, was 15.0%. This decline in
comparison to the previous year is primarily due to savings from the
consolidation of various National regional offices and the integration of
information system centers related to acquired businesses onto the Company's
information systems platform, in addition to economies of scale associated with
premium revenue growth in relation to fixed corporate administrative expenses.
Interest expense decreased for the year ended December 31, 1998 to $26.9
million, from $36.7 million for the year ended December 31, 1997. The decrease
is primarily related to the repayment of indebtedness as the effective interest
rate paid by the Company remained relatively stable as a result of its interest
rate swaps. The Company's long-term indebtedness at December 31, 1998 was $300.0
million compared to $388.0 million at December 31, 1997. The weighted average
interest rate for all debt for the year ended December 31, 1998, including the
cost associated with the fee on the Company's credit agreements and its interest
rate swaps was 7.6%. See "--Liquidity and Capital Resources."
33
The provision for income taxes decreased $84.5 million or 53.9%, to $72.4
million for the year ended December 31, 1998. The decline was primarily due to
the effect of the private letter ruling received from the IRS in September 1998,
which resulted in a decrease in income tax expense of $85.5 million. (See Note 8
to the Consolidated Financial Statements.) Excluding the ruling, the provision
for income taxes would have been $157.9 million, representing an overall tax
rate consistent with the prior period.
The Company's income from continuing operations for the year ended December
31, 1998 was $319.5 million, compared to $229.4 million for the year ended
December 31, 1997. Earnings per share from continuing operations totaled $4.63
and $3.33 for the years ended December 31, 1998 and 1997, respectively. Earnings
per share from continuing operations assuming full dilution totaled $4.55 and
$3.30 for the years ended December 31, 1998 and 1997, respectively. Earnings per
share from continuing operations for the year ended December 31, 1997 included
non-recurring costs of $0.13 per share (See Note 18 to the Consolidated
Financial Statements).
Earnings per share for the year ended December 31, 1998 is based upon
weighted average shares outstanding of 69.1 million, excluding common stock
equivalents, and 70.3 million shares assuming full dilution. Earnings per share
for the year ended December 31, 1997 has been calculated using 68.8 million,
excluding common stock equivalents, and 69.5 million shares, assuming full
dilution. For the year ended December 31, 1998, the increase in weighted average
shares outstanding primarily relates to common stock issued through the
Company's stock option plans and the incremental impact in 1998 of the public
offering of 3.0 million shares of the Company's common stock in April 1997,
partially offset by the repurchase of 3.5 million shares during the latter part
of 1998.
COMPARISON OF RESULTS FOR THE YEAR ENDED DECEMBER 31, 1997 TO THE YEAR ENDED
DECEMBER 31, 1996
Premium revenue increased 37.0%, or $1,369.6 million, to $5,068.9 million
for the year ended December 31, 1997 from $3,699.3 million for the year ended
December 31, 1996. The 1997 acquisition of the GBO contributed $419.4 million,
or 30.6% 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 22.7% of the total
increase. Also, contributing to increased premium revenue in 1997 was an
increase in insured member months of 12.9% primarily in the Company's California
business segment, 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 155.0%, or $229.2 million, to $377.1
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 92.8% 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 in the Company's National business segment with the state of Illinois
on July 1, 1997.
Investment income increased $72.6 million to $196.2 million for the year
ended December 31, 1997, compared to $123.6 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 HPI for the common stock of FPA. Net interest and dividend
income increased $24.0 million to $133.9 million for the year ended December 31,
1997 in comparison to $109.9 million for the year ended December 31, 1996,
primarily due to increased interest income resulting from the investment
portfolios of GBO and MMHD
34
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 44.6%, or $1,261.5
million, to $4,087.4 million for the year ended December 31, 1997 from $2,825.9
million for the year ended December 31, 1996. The acquisition of the GBO
accounted for 32.4% 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 21.6% 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%, primarily in the
Company's California business segment.
The loss ratio for 1997 increased to 80.6% compared to 76.4% 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 78.5%. The increase in loss
ratio excluding acquired operations was due to a loss ratio increase in the
Company's California business segment, primarily due to slightly higher medical
utilization for certain managed care products and increased pharmacy costs.
Selling expense for the year ended December 31, 1997 increased 23.3% to
$249.4 million, compared to $202.3 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 5.3% for the year ended December
31, 1996, largely due to the acquisition 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 5.3%, respectively.
General and administrative expense for the year ended December 31, 1997
increased 53.9%, or $293.1 million, to $836.6 million from $543.5 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, of incremental increase in
general and administrative expense related to the Company's acquisitions of MMHD
and the BCC Commercial Operations, respectively in 1996.
The administrative expense ratio increased to 15.4% for 1997 compared to
14.1% 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 13.1%.
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 California business segment's dental
practice management operations and discontinuance of the California business
segment'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.
35
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 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%.
The Company's income from continuing operations for the year ended December
31, 1997 was $229.4 million, compared to $198.5 million for the year ended
December 31, 1996. Earnings per share from continuing operations totaled $3.33
and $2.99 for the years ended December 31, 1997 and 1996, respectively. Earnings
per share from continuing operations assuming full dilution totaled $3.30 and
$2.99 for the years ended December 31, 1997 and 1996, respectively. Earnings per
share for 1996 has been calculated in accordance with Statement of Financial
Accounting Standards No. 128, Earning Per Share ("SFAS No. 128").
Earnings per share for the year ended December 31, 1997 is based upon
weighted average shares outstanding, excluding common stock equivalents, of 68.8
million 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.
FINANCIAL CONDITION
The Company's consolidated assets decreased by $8.3 million from $4,234.1
million as of December 31, 1997 to $4,225.8 million as of December 31, 1998.
This represents a 0.2% decrease which resulted from the net impact of a number
of offsetting factors such as: the sale of the workers' compensation business,
which held net assets at December 31, 1997 of $209.2 million partially offset by
proceeds from its sale of $101.4 million; the purchase of $193.3 million of
treasury stock from available cash; the effect of the tax benefit related to the
BCC tax ruling which resulted in an income tax recoverable of $95.9 million,
offset by a related decrease in intangible assets of $194.5 million; and cash
flow from continuing operating activities of $394.6 million. Cash and
investments were $2.8 billion as of December 31, 1998, or 65.4% of total assets.
Overall claims liabilities increased $14.7 million, or 1.1%, from $1,305.9
million at December 31, 1997 to $1,320.6 million at December 31, 1998. This
increase is due to the increase in membership offset by several factors. In
1998, the Company reduced its medical claims payable as it continued to reduce
claims inventory related to its acquired MMHD business that was converted to the
Company's information systems platform. The timing of pharmacy payments made at
the end of 1998 further contributed to the reduction in overall claims
liability. Finally, the Company experienced membership attrition in its acquired
MMHD and GBO membership in its National business segment, which had higher
average per member reserves compared to the average per member reserves for its
California business, which experienced significant membership growth.
As of December 31, 1998, $300.0 million was outstanding under the Company's
long-term debt facilities, compared to $388.0 million at December 31, 1997. Debt
repayments during 1998 were primarily funded from cash flow from continuing
operating activities.
36
Stockholders' equity totaled $1,315.2 million as of December 31, 1998, an
increase of $92.0 million from $1,223.2 million as of December 31, 1997. The
increase resulted primarily from the net income of $231.3 million for the year
ended December 31, 1998, $39.4 million in stock issuances under the Company's
stock option and stock purchase plans, a $14.6 million increase in net
unrealized valuation adjustments on investment securities, net of tax, offset by
treasury stock repurchases totaling $193.3 million.
During the year ended December 31, 1998, the Company's Board of Directors
approved a stock repurchase plan of up to eight million shares. At December 31,
1998, approximately 4.5 million shares remained available for repurchase under
that plan.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of cash are premium and management services
revenues received and investment income. The primary uses of cash include health
care claims and other benefits, capitation payments, income taxes, repayment of
long-term debt, interest expense, broker and agent commissions, administrative
expenses, common stock repurchases and capital expenditures. In addition, to the
foregoing, other uses of cash include costs of provider networks and systems
development, and costs associated with the integration of acquired businesses.
The Company receives premium revenue in advance of anticipated claims for
related health care services and other benefits. The Company's investment
policies are designed to provide liquidity, preserve capital and maximize total
return on invested assets. Cash and investment balances maintained by the
Company are sufficient to meet applicable regulatory financial stability and net
worth requirements. As of December 31, 1998, the Company's investment portfolio
consisted primarily of fixed-maturity securities and equity securities.
Net cash flow provided by continuing operating activities was $394.6 million
for the year ended December 31, 1998, compared with $496.1 million in 1997. Cash
flow from continuing operations for the year ended December 31, 1998 is due
primarily to income from continuing operations of $319.5 million, increased
medical claims payable of $23.8 million and increased other current liabilities
of $35.4 million, offset by an increase in other current assets of $20.1
million.
Net cash used in continuing investing activities in 1998 totaled $21.6
million, compared with $376.4 million in 1997. The cash used in 1998 was
attributable primarily to the purchase of investments for $2,843.1 million and
net purchases of property and equipment totaling $52.7 million, offset by the
proceeds from investments sold and matured of $2,772.8 million, and proceeds
from the sale of the workers' compensation business totaling $101.4 million.
Net cash used in financing activities totaled $241.9 million in 1998,
compared to $116.6 million in 1997. The net cash used in financing activities in
1998 was primarily due to the repurchase of stock during the year totaling
$193.3 million, which was financed partially by the proceeds from the sale of
the Company's workers' compensation business, and repayments of long-term debt
totaling $88.0 million, partially offset by proceeds of $39.4 million from the
issuance of common stock through the Company's employee stock purchase and
option plans.
The Company has a $1.0 billion unsecured revolving credit facility.
Borrowings under the credit facility bear interest at rates determined by
reference to the bank's base rate or to the London Interbank Offered Rate
("LIBOR") plus a margin determined by reference to the Company's leverage ratio
(as defined in the credit agreement) or the then-current rating of the Company's
unsecured long-term debt by specified rating agencies. Borrowings under the
credit facility are made on a committed basis or pursuant to an auction-bid
process. The credit facility expires as of May 15, 2002, although it may be
extended for an additional one-year period under certain circumstances. The
credit agreement requires the Company to maintain certain financial ratios and
contains restrictive covenants, including restrictions on the occurrence
37
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 $280.0 million and $368.0
million as of December 31, 1998 and 1997, respectively. The weighted average
interest rate for the year ended December 31, 1998, including the facility and
other fees and the effect of the interest rate swaps discussed in the following
paragraph, was 7.6%.
As a part of a hedging strategy to limit its exposure to interest rate
increases, in August 1996 the Company entered into a swap agreement for a
notional amount of $100.0 million bearing a fixed interest rate of 6.45% and
having a maturity date of August 17, 1999. In September 1996, the Company
entered into two additional swap agreements for notional amounts of $150.0
million each, bearing fixed interest rates of 6.99% and 7.05%, respectively, and
having maturity dates of October 17, 2003 and October 17, 2006, respectively.
The total notional amount of the outstanding swaps exceeded the Company's
long-term debt balance at December 31, 1998. The swaps that are considered
hedges for currently outstanding debt are the $150 million swap at 7.05%
maturing October 17, 2006 and the $150 million swap which bears a fixed interest
rate of 6.99% and matures October 17, 2003.
The Company has entered into foreign currency forward exchange contracts for
each of the fixed maturity securities on hand as of December 31, 1998
denominated in foreign currencies in order to hedge asset positions with respect
to these securities. The unrealized gains and losses from such forward exchange
contracts are reflected in other comprehensive income. In addition, the Company
has entered into forward exchange contracts to hedge the foreign currency risk
between the trade date and the settlement date. Gains and losses from these
contracts are recognized in income.
During the quarter ended September 30, 1998, the Company received a private
letter ruling from the Internal Revenue Service. The Company expects its future
liquidity to be positively affected by the anticipated receipt of a $200 million
tax refund and a decrease in future income tax payments of approximately $80
million (See Note 8 to the Consolidated Financial Statements).
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 Departments of Insurance in various
states. See Note 19 to the Consolidated Financial Statements. As of December 31,
1998, 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, 1998, no indebtedness had been issued pursuant to this registration
statement.
The Company believes that cash flow generated by operations and its cash and
investment balances, supplemented by the Company's ability to borrow under its
existing revolving credit facility or to conduct a public offering under its
debt registration statement, will be sufficient to fund continuing operations
and expected capital requirements for the foreseeable future.
NEW ACCOUNTING PRONOUNCEMENTS
In April 1998, the AICPA issued Statement of Position ("SOP") No. 98-5,
"Reporting on the Costs of Start-Up Activities." SOP No. 98-5 provides guidance
on the accounting for start-up costs and organization costs. It requires these
costs to be expensed as incurred and, with certain exceptions, requires the
initial application to be reported as a cumulative effect of a change in
accounting principle. This SOP is effective for fiscal years beginning after
December 15, 1998. During the first quarter of 1999, the Company expects to
recognize an after-tax charge of approximately $20.4 million related to the
cumulative effect of the implementation of this pronouncement.
38
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
No. 133"). SFAS No. 133 establishes the accounting and reporting standards for
derivative instruments and for hedging activities. Upon adoption of SFAS No.
133, all derivatives must be recognized on the balance sheet at their then fair
value. Any stand-alone deferred gains and losses remaining on the balance sheet
under previous hedge accounting rules must be removed from the balance sheet and
all hedging relationships must be designated anew and documented pursuant to the
new accounting rules. The new standard will be effective in the first quarter of
2000. The Company is presently assessing the effect of SFAS No. 133 on the
financial statements of the Company.
RISK MANAGEMENT AND MARKET-SENSITIVE INSTRUMENTS
The Company regularly evaluates its asset and liability interest rate risks
as well as the appropriateness of investments relative to its internal
investment guidelines. The Company operates within these guidelines by
maintaining a well-diversified portfolio, both across and within asset classes.
The Company has retained an independent consultant to advise the Company on the
appropriateness of its investment policy and the compliance therewith.
Asset interest rate risk is managed within a duration band tied to the
Company's liability interest rate risk. Credit risk is managed by maintaining
high average quality ratings and a well-diversified portfolio.
The Company's use of derivative instruments is generally limited to hedging
purposes and has principally consisted of forward exchange contracts intended to
minimize the portfolio's exposure to currency volatility associated with certain
foreign bond holdings. The Company's investment policy prohibits the use of
derivatives for leveraging purposes as well as the creation of risk exposures
not otherwise allowed within the policy.
In 1996, the Company entered into interest rate swap agreements by
exchanging the floating debt payments due under its outstanding indebtedness for
fixed rate payments. The Company believes that this allows it to better
anticipate its interest payments while helping to manage the asset-liability
relationship.
INTEREST RATE RISK
As of December 31, 1998, approximately 80% of the Company's investment
portfolio consisted of fixed income securities (maturing in more than one year),
the value of which generally varies inversely with changes in interest rates.
However, the Company's risk of fluctuation in the value of its fixed income
portfolio due to changes in interest rates is partially mitigated by the
Company's existing interest rate swap agreements.
The Company has evaluated the net impact to the fair value of its fixed
income investments and interest rate swap agreements resulting from a
hypothetical change in all interest rates of 100, 200 and 300 basis points
("bp"). In doing so, optionality was addressed through Monte Carlo simulation of
the price behavior of securities with embedded options. Changes in the fair
value of the investment portfolio are reflected in the balance sheet through
stockholders' equity. Changes in the fair value of the interest rate swap
agreements, to the extent they serve as effective hedges, are not currently
reflected on the balance sheet. Under the requirements of SFAS No. 133,
effective January 1, 2000, all derivative financial instruments will be
reflected on the balance sheet at fair value. The terms of the Company's
interest rate
39
swap agreements are discussed in greater detail in Note 16 to the Consolidated
Financial Statements. The results of this analysis as of December 31, 1998 are
reflected in the table below.
INCREASE (DECREASE) IN FAIR
VALUE GIVEN AN INTEREST RATE
INCREASE OF:
--------------------------------
100 BP 200 BP 300 BP
--------- --------- ----------
(In millions)
Fixed Income Portfolio........................................................... ($ 80.4) ($ 161.4) ($ 240.2)
Valuation of Interest Rate Swap Agreements....................................... 16.3 31.6 46.0
--------- --------- ----------
($ 64.1) ($ 129.8) ($ 194.2)
--------- --------- ----------
--------- --------- ----------
The Company believes that an interest rate shift in a 12-month period of 100
bp represents a moderately adverse outcome, while a 200 bp shift is
significantly adverse and a 300 bp shift is unlikely given historical
precedents. Although the Company holds its bonds as "available for sale" for
purposes of SFAS No. 115, the Company's cash flows and the short duration of its
investment portfolio should allow it to hold securities to maturity, thereby
avoiding the recognition of losses, should interest rates rise significantly.
INTEREST RATE SWAP AGREEMENTS
The Company has entered into interest rate swap agreements in order to
reduce the volatility of interest expense resulting from changes in interest
rates. As of December 31, 1998, the Company had entered into $400 million of
floating to fixed rate swap agreements and also had $300 million of LIBOR-based
floating rate debt outstanding. The Company also receives a LIBOR-based payment
as a result of its swap arrangements, thereby eliminating the payment exposure
to changes in interest rates on that $300 million of outstanding debt. The
marginal $100 million of interest rate swaps in which the Company has agreed to
pay a fixed rate in exchange for receiving a LIBOR-based floating interest rate
does expose the Company to receiving a lower interest payment in the event of
declining interest rates. Should LIBOR decline by 100 bp, the Company would
receive $1 million less in annual pre-tax interest income as a result of its
swap arrangement. Rate declines of 200 bp and 300 bp would result in lower
annual pre-tax interest income of approximately $2 million and $3 million,
respectively.
EQUITY PRICE RISK
The Company's equity securities are comprised primarily of domestic stocks
as well as certain foreign holdings. Assuming an immediate decrease of 10% in
equity prices, as of December 31, 1998, the hypothetical loss in fair value of
stockholders' equity is estimated to be approximately $27.4 million.
FOREIGN EXCHANGE RISK
The Company has generally hedged the foreign exchange risk associated with
its fixed income portfolio. The Company generally uses short-term foreign
exchange contracts to hedge the risk associated with certain fixed income
securities denominated in foreign currencies. Therefore, the Company believes
that there is minimal risk to the fixed-income portfolio due to currency
exchange rate fluctuations. The Company's hedging program related to its foreign
currency denominated investments is described in Note 16 to the Consolidated
Financial Statements.
The Company does not hedge its foreign exchange risk arising from equity
investments denominated in foreign currencies. Assuming a foreign exchange loss
of 10% across all foreign equity investments, the net hypothetical pre-tax loss
in fair value as of December 31, 1998 is estimated to be $5.5 million.
40
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
Certain statements contained herein, such as statements concerning potential
or future loss ratios, expected membership attrition as the Company continues to
integrate its recently acquired operations, the pending transaction with
Cerulean and other statements regarding matters that are not historical facts,
are forward-looking statements (as such term is defined in the Securities
Exchange Act of 1934). Such statements involve a number of risks and
uncertainties that may cause actual results to differ from those projected.
Factors that can cause actual results to differ materially include, but are not
limited to, those discussed below and those discussed from time to time in the
Company's various filings with the Securities and Exchange Commission.
Completion of the Company's pending transaction with Cerulean is contingent
upon, among other things, receipt of necessary approvals from certain federal
and state agencies. Broad latitude in administering the applicable regulations
is given to the agencies from which WellPoint and Cerulean must seek these
approvals. There can be no assurance that these approvals will be obtained. As a
condition to approval of the transaction, regulatory agencies may impose
requirements or limitations or costs on the way that the combined company
conducts business after consummation of the transaction. If the Company or
Cerulean were to agree to any material requirements or limitations in order to
obtain any approvals required to consummate the transaction, such requirements
or limitations or additional costs associated therewith could adversely affect
WellPoint's ability to integrate the operations of Cerulean with those of
WellPoint. A material adverse effect on WellPoint's revenues and results of
operations following completion of the transaction could result.
The Company intends to incur debt to finance some or all of the cash
payments to be made to Cerulean shareholders in connection with the pending
acquisition. In addition, WellPoint has received authorization to, and is
currently in the process of, repurchasing shares of WellPoint stock to offset
shares that are expected to be issued in connection with the transaction. The
Company has made significant purchases of treasury stock for this purpose
utilizing excess cash as well as the incurrence of additional debt. Upon
completion of the Cerulean transaction, WellPoint could incur significant
additional indebtedness to fund not only the cash portion of the transaction but
to fund any further repurchase of shares of WellPoint stock. Such additional
indebtedness may require that a significant amount of the Company's cash flow be
applied to the payment of interest, and there can be no assurance that the
Company's operations will generate sufficient cash flow to service the
indebtedness. Any additional indebtedness may adversely affect the Company's
ability to finance its operations and could limit its ability to pursue business
opportunities that may be in the best interests of the Company and its
stockholders.
As part of the Company's business strategy, over the past three years the
Company has acquired substantial operations in new geographic markets. The
Company has also recently entered into a merger agreement with Cerulean,
pursuant to which Cerulean will become a wholly owned subsidiary of the Company.
These businesses, which include substantial indemnity-based insurance
operations, have experienced varying profitability or losses in recent periods.
Since the relevant dates of acquisition of MMHD and GBO, the Company has
continued to work extensively on the integration of these businesses; however,
there can be no assurances regarding the ultimate success of the Company's
integration efforts or regarding the ability of the Company to maintain or
improve the results of operations of the businesses of completed or pending
transactions as the Company pursues its strategy of motivating the acquired
members to select managed care products. In order to implement this business
strategy, the Company has and will, among other things, need to continue to
incur considerable expenditures for provider networks, distribution channels and
information systems in addition to the costs associated with the integration of
these acquisitions. The integration of these complex businesses may result in,
among other things, temporary increases in claims inventory or other
service-related issues that may negatively affect the Company's relationship
with its customers and contribute to increased attrition of such customers. The
Company's results of operations could be adversely affected in the event that
the Company experiences such problems or is otherwise unable to implement fully
its expansion strategy.
41
The Company's operations are subject to substantial regulation by Federal,
state and local agencies in all jurisdictions in which the Company operates.
Many of these agencies have increased their scrutiny of managed health care
companies in recent periods. The Company also provides insurance products to
Medi-Cal beneficiaries in various California counties under contracts with the
California Department of Health Services and provides administrative services to
the Health Care Finance Administration ("HCFA") in various capacities. There can
be no assurance that acting as a government contractor in these circumstances
will not increase the risk of heightened scrutiny by such government agencies
and that profitability from this business will not be adversely affected through
inadequate premium rate increases due to governmental budgetary issues. Future
actions by any regulatory agencies may have a material adverse effect on the
Company's business.
The Company and certain of its subsidiaries are subject to capital
requirements by the California Department of Corporations, various other state
departments of insurance and the Blue Cross Blue Shield Association. Although
the Company is currently in compliance with all applicable requirements, there
can be no assurances that such requirements will not be increased in the future.
The Company's future results will depend in large part on accurately
predicting health care costs incurred on existing business and upon the
Company's ability to control future health care costs through product and
benefit design, underwriting criteria, utilization management and negotiation of
favorable provider contracts. Changes in mandated benefits, utilization rates,
demographic characteristics, health care practices, provider consolidation,
inflation, new pharmaceuticals/technologies, clusters of high-cost cases, the
regulatory environment and numerous other factors are beyond the control of any
health plan provider and may adversely affect the Company's ability to predict
and control health care costs and claims, as well as the Company's financial
condition, cash flows or results of operations. Periodic renegotiation of
hospital and other provider contracts, coupled with continued consolidation of
physician, hospital and other provider groups, may result in increased health
care costs and limit the Company's ability to negotiate favorable rates.
Recently, large physician practice management companies have experienced extreme
financial difficulties (including bankruptcy), which may subject the Company to
increased credit risk related to provider groups. Additionally, the Company
faces competitive pressure to contain premium prices. Fiscal concerns regarding
the continued viability of government-sponsored programs such as Medicare and
Medicaid may cause decreasing reimbursement rates for these programs. Any
limitation on the Company's ability to increase or maintain its premium levels,
design products, select underwriting criteria or negotiate competitive provider
contracts may adversely affect the Company's financial condition, cash flows or
results of operations.
Managed care organizations, both inside and outside California, operate in a
highly competitive environment that has undergone significant change in recent
years as a result of business consolidations, new strategic alliances,
aggressive marketing practices by competitors and other market pressures.
Additional increases in competition could adversely affect the Company's
financial condition, cash flows or results of operations.
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 management services products and those managed care products
where the Company is able to shift risks to employer groups. Individuals and
small employer groups are more likely to purchase the Company's higher-risk
managed care products
42
because such purchasers are generally unable or unwilling to bear greater
liability for health care expenditures. Typically, government-sponsored programs
involve the Company's higher-risk managed care products. Over the past few
years, the Company has experienced greater margin erosion in its higher-risk
managed care products than in its lower-risk managed care and management
services products. This margin erosion is attributable to product mix change,
product design, competitive pressure and greater regulatory restrictions
applicable to the small employer group market. In 1998, the Company implemented
price increases in certain of its managed care businesses. In response to higher
than anticipated utilization with respect to certain co-payment products offered
to the Company's individual and small group customers in California, the Company
has recently implemented premium increases with respect to such products. While
these price increases are intended to improve profitability, there can be no
assurance that this will occur. Subsequent unfavorable changes in the relative
profitability between the Company's various products could have a material
adverse effect on the Company's results of operations and on the continued
feasibility of the Company's geographic expansion strategy.
Substantially all of the Company's investment assets are in
interest-yielding debt securities of varying maturities or equity securities.
The value of fixed income securities is highly sensitive to fluctuations in
short- and long-term interest rates, with the value decreasing as such rates
increase or increasing as such rates decrease. In addition, the value of equity
securities can fluctuate significantly with changes in market conditions.
Changes in the value of the Company's investment assets, as a result of interest
rate fluctuations, can affect the Company's stockholders' equity. There can be
no assurances that interest rate fluctuations will not have a material adverse
effect on the financial condition of the Company.
The Company is dependent on retaining existing employees and attracting
additional qualified employees to meet its future needs. The Company faces
intense competition for qualified personnel, especially qualified computer
programmers, actuaries and other professional and technical employees. There can
be no assurances that an inability to retain existing employees or attract
additional employees will not have a material adverse effect on the Company's
results of operations.
43
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 53 hereof.
FOR THE QUARTER ENDED
-----------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA AND MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
MEMBERSHIP DATA) 1998(A) 1998 1998 1998
----------- ----------- ------------- ------------
Total revenues...................................... $ 1,584,216 $ 1,561,819(B) $ 1,628,739 $1,703,576
Operating income.................................... 125,743 68,717(B) 124,651 127,717
Income before provision for income taxes............ 112,058 54,353(B) 112,304 113,271
Income from continuing operations................... 67,192 32,752(B) 152,208(C) 67,396
Loss from discontinued operations................... (8,678) (79,590) -- --
----------- ----------- ------------- ------------
Net income (loss)................................... $ 58,514 $ (46,838) $ 152,208 $ 67,396
----------- ----------- ------------- ------------
----------- ----------- ------------- ------------
Per Share Data:
Earnings Per Share................................ $ 0.96 $ 0.47(B) $ 2.20(C) $ 1.01
----------- ----------- ------------- ------------
----------- ----------- ------------- ------------
Earnings Per Share Assuming Full Dilution......... $ 0.95 $ 0.45(B) $ 2.16(C) $ 0.99
----------- ----------- ------------- ------------
----------- ----------- ------------- ------------
Medical membership.................................. 6,727,586 6,783,224 6,828,512 6,891,603
----------- ----------- ------------- ------------
----------- ----------- ------------- ------------
FOR THE QUARTER ENDED
-----------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA AND MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
MEMBERSHIP DATA) 1997(A) 1997(A) 1997(A) 1997(A)
----------- ----------- ------------- ------------
Total revenues...................................... $ 1,221,620 $ 1,440,716 $ 1,465,921 $1,513,981
Operating income.................................... 102,896(D) 96,464(D) 108,024 146,929
Income before provision for income taxes............ 84,887(D) 82,195(D) 93,711 125,561
Income from continuing operations................... 49,992(D) 48,575(D) 55,682 75,188
Income (loss) from discontinued operations.......... 763 688 (114) (3,365)
----------- ----------- ------------- ------------
Net income.......................................... $ 50,755 $ 49,263 $ 55,568 $ 71,823
----------- ----------- ------------- ------------
----------- ----------- ------------- ------------
Per Share Data:
Earnings Per Share................................ $ 0.75(D) $ 0.70(D) $ 0.80 $ 1.08
----------- ----------- ------------- ------------
----------- ----------- ------------- ------------
Earnings Per Share Assuming Full Dilution......... $ 0.75(D) $ 0.69(D) $ 0.79 $ 1.07
----------- ----------- ------------- ------------
----------- ----------- ------------- ------------
Medical membership.................................. 5,914,726 6,067,966 6,473,467 6,638,157
----------- ----------- ------------- ------------
----------- ----------- ------------- ------------
- --------------------------
(A) Financial information for quarters prior to June 30, 1998 has been restated
to include the workers' compensation business as a discontinued operation.
(B) The second quarter of 1998 includes a charge of $48.7 million, before tax,
$29.0 million, after tax, or $0.26 per basic and diluted share related to
the write off of the Company's investment in FPA Holdings, Inc.
(C) The third quarter of 1998 includes a tax benefit of $85.5 million, or $1.24
per basic and $1.21 per diluted share related to a favorable IRS ruling
regarding the deductibility of a cash payment made by the Company's former
parent company at the time of its May 20, 1996 Recapitalization.
(D) The first and second quarters of 1997 include nonrecurring costs of $6.5
million and $8.0 million, before tax, $3.8 million and $4.8 million, after
tax, or $0.06 per share and $0.07 per basic and diluted share, respectively.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
44
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 1999 Annual Meeting of Stockholders and is
incorporated herein by reference.
B. Executive Officers of the Company
Information regarding the Company's executive officers is contained in Part
I above under the caption "Item 1. Business."
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is contained in the Company's proxy
statement for its 1999 Annual Meeting of Stockholders and is incorporated herein
by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is contained in the Company's proxy
statement for its 1999 Annual Meeting of Stockholders and is incorporated herein
by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is contained in the Company's proxy
statement for its 1999 Annual Meeting of Stockholders and is incorporated herein
by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K.
A. 1) FINANCIAL STATEMENTS
The consolidated financial statements are contained herein as listed on the
"Index" on page 53 hereof.
2) FINANCIAL STATEMENT SCHEDULES
All of the financial statement schedules for which provision is made in the
applicable accounting regulations of the Commission are not required under the
applicable instructions or are not applicable and therefore have been omitted.
B. REPORTS ON FORM 8-K
There were no Current Reports on Form 8-K filed by the Company during the
quarter ended December 31, 1998 that have not been previously reported in the
Company's Quarterly Reports on Form 10-Q.
45
C. EXHIBITS
EXHIBIT
NUMBER EXHIBIT
- --------- --------------------------------------------------------------------------------------------------------
2.01 Amended and Restated Recapitalization Agreement dated as of March 31, 1995, by and among the Registrant,
Blue Cross of California, Western Health Partnerships and Western Foundation for Health Improvement
incorporated by reference to Exhibit 2.1 of Registrant's Registration Statement on Form S-4 dated April
8, 1996
2.02 Agreement and Plan of 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
2.03 Agreement and Plan of Merger dated as of July 9, 1998, by and among Cerulean Companies, Inc., the
Registrant and Water Polo Acquisition Corp., incorporated by reference to Exhibit 2.4 to the
Registrant's Registration Statement on Form S-4 (Registration No. 333-64955)
2.04 Stock Purchase Agreement dated as of July 29, 1998, by and between the Registrant and Fremont Indemnity
Company, incorporated by reference to Exhibit 2.1 to the Registrant's Current Report on Form 8-K dated
September 1, 1998
2.05 First Amendment to the Stock Purchase Agreement dated as of November 5, 1998, by and between the
Registrant and Fremont Indemnity Company
2.06 Second Amendment to the Stock Purchase Agreement dated as of February 1, 1999, by and between the
Registrant and Fremont Indemnity Company
3.01 Restated Certificate of Incorporation of the Registrant, incorporated by reference to Exhibit 3.1 of the
Registrant's Current Report on Form 8-K filed on August 5, 1997.
3.02 Bylaws of the Registrant
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 between the California
HealthCare Foundation (the "Foundation") and Wilmington Trust Company, incorporated by reference to
Exhibit 99.2 of Registrant's Current Report on Form 8-K filed on August 5, 1997
9.02 Amendment No. 1 dated as of June 12, 1998 to the Amended and Restated Voting Trust Agreement by and
among the Foundation, the Registrant and Wilmington Trust Company, incorporated by reference to Exhibit
99.2 of the Registrant's Current Report on Form 8-K filed on June 15, 1998
10.01 Undertakings dated January 7, 1993, by the Registrant, Blue Cross of California and certain subsidiaries
to the California Department of Corporations, incorporated by reference to Exhibit 10.24 of the
Registrant's Form S-1 Registration Statement No. 33-54898
10.02* Supplemental Pension Plan of Blue Cross of California, incorporated by reference to Exhibit 10.15 of the
Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992
10.03* Form of Supplemental Life and Disability Insurance Policy, incorporated by reference to Exhibit 10.14 of
the Registrant's Form S-1 Registration Statement No. 33-54898
46
EXHIBIT
NUMBER EXHIBIT
- --------- --------------------------------------------------------------------------------------------------------
10.04* Form of Indemnification Agreement between the Registrant and its Directors and Officers, incorporated by
reference to Exhibit 10.17 of the Registrant's Form S-1 Registration Statement No. 33-54898
10.05* Officer Severance Agreement, dated as of July 1, 1993, between the Registrant and Thomas C. Geiser,
incorporated by reference to Exhibit 10.24 of the Registrant's Annual Report on Form 10-K for the fiscal
year ended December 31, 1993
10.06* 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
10.07 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
10.08 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
10.09* 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
10.10* 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
10.11* 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
10.12 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
10.13 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
10.14 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
10.15 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
10.16* 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
47
EXHIBIT
NUMBER EXHIBIT
- --------- --------------------------------------------------------------------------------------------------------
10.17 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
10.18 Coinsurance Agreement dated as of March 1, 1997 between John Hancock and UNICARE Life & Health Insurance
Company ("UNICARE"), incorporated by reference to Exhibit 99.2 of Registrant's Current Report on Form
8-K filed March 14, 1997
10.19 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
10.20 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
10.21 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
10.22 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
10.23 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
10.24 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
10.25 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
10.26 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
10.27 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
10.28 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
10.29 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.
48
EXHIBIT
NUMBER EXHIBIT
- --------- --------------------------------------------------------------------------------------------------------
10.30 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
10.31* 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
10.32* Amendment No. 1 to Employment Agreement by and between the Registrant and Leonard D. Schaeffer,
incorporated by reference to Exhibit 10.72 to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1997
10.33* 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
10.34* 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
10.35* 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).
10.36* WellPoint Health Networks Inc. Employee Stock Option Plan, as amended through February 24, 1999
10.37* WellPoint Officer Benefit Enrollment Guide Brochure
10.38 Office Lease dated as of December 2, 1997 by and among the Registrant and Westlake Business Park, Ltd.,
incorporated by reference to Exhibit 10.48 to Registrant's Annual Report on Form 10-K for the year ended
December 31, 1997
10.39 Fifth Amendment dated as of May 1, 1998 to the Registrant's Credit Agreement dated as of May 15, 1996,
incorporated by reference to Exhibit 10.01 to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1998
10.40* Amendment No. 2 dated May 1, 1998 to the Employment Agreement by and between the Registrant and Leonard
D. Schaeffer incorporated by reference to Exhibit 10.02 to the Registrant's Quarterly Report on Form
10-Q for the quarter ended March 31, 1998
10.41* Amendment No. 1 to the Salary Deferral Savings Program of WellPoint Health Networks Inc., incorporated
by reference to Exhibit 10.03 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended
March 31, 1998
10.42 California Blue Cross License Addendum (amended and restated as of June 12, 1998), by and among the
Registrant, Blue Cross of California and the Blue Cross Blue Shield Association, incorporated by
reference to Exhibit 99.1 to the Registrant's Current Report on Form 8-K filed on June 15, 1998
10.43 Amendment No. 1 dated as of June 12, 1998 to the Amended and Restated Share Escrow Agent Agreement by
and between the Registrant and U.S. Trust Company of California, N.A., incorporated by reference to
Exhibit 99.3 to the Registrant's Current Report on Form 8-K filed on June 15, 1998
10.44* Promissory Note dated as of June 23, 1998 made by Joan Herman in favor of the Registrant, incorporated
by reference to Exhibit 10.04 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1998
49
EXHIBIT
NUMBER EXHIBIT
- --------- --------------------------------------------------------------------------------------------------------
10.45* Stock Option/Award Plan, as amended through October 27, 1998, incorporated by reference to Exhibit 10.01
to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998
10.46* WellPoint Health Networks Inc. Officer Change-in-Control Plan (as amended and restated through October
27, 1998), incorporated to the Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1998
10.47* WellPoint Health Networks Inc. Officer Severance Plan (as adopted October 27, 1998), incorporated by
reference to Exhibit 10.03 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1998
10.48 Letter Agreement dated July 8, 1998 by and between the Registrant and the Foundation, incorporated by
reference to Exhibit 10.04 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1998
10.49* WellPoint Health Networks Inc. Management Bonus Plan, incorporated by reference to Exhibit 10.05 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998
10.50* Amendment No. 3 dated as of October 27, 1998 to the Employment Agreement by and between the Registrant
and Leonard D. Schaeffer
10.51* Amendment No. 2 to the Salary Deferral Savings Program of WellPoint Health Networks Inc.
10.52* Board of Directors Deferred Compensation Plan of WellPoint Health Networks Inc.
10.53 Stock Purchase Agreement dated as of November 20, 1998 by and between the Registrant and the Foundation
10.54* Amendment No. 3 to the Salary Deferral Savings Program of WellPoint Health Networks Inc.
21 List of Subsidiaries of the Registrant
23.1 Consent of Independent Accountants
24 Power of Attorney (included on Signature Page).
27.1 Financial Data Schedule
- ------------------------
* Management contract or compensatory plan or arrangement
50
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 26, 1999 WELLPOINT HEALTH NETWORKS INC.
By: /s/ LEONARD D. SCHAEFFER
-----------------------------------------
Leonard D. Schaeffer
CHAIRMAN OF THE BOARD OF DIRECTORS AND
CHIEF EXECUTIVE OFFICER
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS:
That the undersigned officers and directors of WellPoint Health Networks
Inc. do hereby constitute and appoint Leonard D. Schaeffer and Thomas C. Geiser,
and each of them, the lawful attorney and agent or attorneys and agents with
power and authority to do any and all acts and things and to execute any and all
instruments which said attorneys and agents, or either of them, determine may be
necessary or advisable or required to enable WellPoint Health Networks Inc. to
comply with the Securities Exchange Act of 1934, as amended, and any rules or
regulations or requirements of the Securities and Exchange Commission in
connection with this Annual Report on Form 10-K. Without limiting the generality
of the foregoing power and authority, the powers granted include the power and
authority to sign the names of the undersigned officers and directors in the
capacities indicated below to this Annual Report on Form 10-K or amendment or
supplements thereto, and each of the undersigned hereby ratifies and confirms
all that said attorneys and agent, or either of them, shall do or cause to be
done by virtue hereof. This Power of Attorney may be signed in several
counterparts.
IN WITNESS WHEREOF, each of the undersigned has executed this Power of
Attorney as of the date indicated opposite his or her name.
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
Chairman of the Board of
/s/ LEONARD D. SCHAEFFER Directors and Chief
- ------------------------------ Executive Officer March 26, 1999
Leonard D. Schaeffer (Principal Executive
Officer)
Executive Vice President
/s/ DAVID C. COLBY and Chief Financial
- ------------------------------ Officer (Principal March 26, 1999
David C. Colby Financial Officer)
51
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
Senior Vice President,
/s/ S. LOUISE MCCRARY Controller and Chief
- ------------------------------ Accounting Officer March 26, 1999
S. Louise McCrary (Principal Accounting
Officer)
/s/ W. TOLIVER BESSON
- ------------------------------ Director March 26, 1999
W. Toliver Besson
/s/ ROGER E. BIRK
- ------------------------------ Director March 26, 1999
Roger E. Birk
/s/ SHEILA P. BURKE
- ------------------------------ Director March 26, 1999
Sheila P. Burke
/s/ STEPHEN L. DAVENPORT
- ------------------------------ Director March 26, 1999
Stephen L. Davenport
/s/ JULIE A. HILL
- ------------------------------ Director March 26, 1999
Julie A. Hill
/s/ ELIZABETH A. SANDERS
- ------------------------------ Director March 26, 1999
Elizabeth A. Sanders
52
INDEX TO FINANCIAL STATEMENTS
WELLPOINT HEALTH NETWORKS INC.
PAGE
-----
Report of Independent Accountants.......................................................................... F-1
Consolidated Balance Sheets as of December 31, 1998 and 1997............................................... F-2
Consolidated Income Statements for the Three Years Ended December 31, 1998................................. F-3
Consolidated Statements of Changes in Stockholders' Equity for the Three Years Ended December 31, 1998..... F-4
Consolidated Statements of Cash Flows for the Three Years Ended December 31, 1998.......................... F-5
Notes to Consolidated Financial Statements................................................................. F-6
53
REPORT OF INDEPENDENT ACCOUNTANTS
February 11, 1999
To the Stockholders and Board of Directors
WellPoint Health Networks Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated income statements and consolidated statements of changes in
stockholders' equity and cash flows present fairly, in all material respects,
the financial position of WellPoint Health Networks Inc. and its subsidiaries
(the "Company") at December 31, 1998 and 1997, and the results of their
operations and cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these financial statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
Los Angeles, California
F-1
WELLPOINT HEALTH NETWORKS INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
DECEMBER 31,
---------------------------
(IN THOUSANDS, EXCEPT SHARE DATA) 1998 1997
------------ ------------
Current Assets:
Cash and cash equivalents....................... $ 410,875 $ 269,067
Investment securities, at market value.......... 2,250,174 2,188,651
Receivables, net................................ 485,259 502,880
Deferred tax assets............................. 121,881 68,279
Income taxes recoverable........................ 95,902 --
Other current assets............................ 70,349 50,262
------------ ------------
Total Current Assets.......................... 3,434,440 3,079,139
Property and equipment, net....................... 131,459 112,526
Intangible assets, net............................ 93,937 295,680
Goodwill, net..................................... 336,155 325,067
Long-term investments, at market value............ 103,253 102,819
Deferred tax assets............................... 79,976 61,078
Other non-current assets.......................... 46,614 48,592
------------ ------------
Total Non-Current Assets...................... 791,394 945,762
------------ ------------
Net assets of discontinued operations held for
sale............................................ -- 209,223
------------ ------------
Total Assets................................ $ 4,225,834 $ 4,234,124
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Medical claims payable.......................... $ 946,502 $ 922,658
Reserves for future policy benefits............. 55,024 51,189
Unearned premiums............................... 215,058 196,205
Accounts payable and accrued expenses........... 342,713 347,316
Experience rated and other refunds.............. 249,685 255,495
Income taxes payable............................ -- 105,052
Other current liabilities....................... 373,882 302,032
------------ ------------
Total Current Liabilities..................... 2,182,864 2,179,947
Accrued postretirement benefits................... 67,058 63,891
Reserves for future policy benefits,
non-current..................................... 319,056 332,033
Long-term debt.................................... 300,000 388,000
Other non-current liabilities..................... 41,633 47,084
------------ ------------
Total Liabilities............................. 2,910,611 3,010,955
Stockholders' Equity:
Preferred Stock--$0.01 par value, 50,000,000
shares authorized, none issued and
outstanding................................... -- --
Common Stock--$0.01 par value, 300,000,000
shares authorized, 70,620,657 and 69,778,086
issued in 1998 and 1997, respectively......... 706 698
Treasury stock, at cost, 3,501,556 and 4,571
shares in 1998 and 1997, respectively......... (193,435) (103)
Additional paid-in capital...................... 921,747 882,312
Retained earnings............................... 576,598 345,318
Accumulated other comprehensive income.......... 9,607 (5,056)
------------ ------------
Total Stockholders' Equity.................... 1,315,223 1,223,169
------------ ------------
Total Liabilities and Stockholders'
Equity..................................... $ 4,225,834 $ 4,234,124
------------ ------------
------------ ------------
See the accompanying notes to the consolidated financial statements.
F-2
WELLPOINT HEALTH NETWORKS INC.
CONSOLIDATED INCOME STATEMENTS
YEAR ENDED DECEMBER 31,
------------------------------------------
1998 1997 1996
------------ ------------ ------------
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
Revenues:
Premium revenue............................ $ 5,934,812 $ 5,068,947 $ 3,699,337
Management services revenue................ 433,960 377,138 147,911
Investment income.......................... 109,578 196,153 123,584
------------ ------------ ------------
6,478,350 5,642,238 3,970,832
Operating Expenses:
Health care services and other benefits.... 4,776,345 4,087,420 2,825,914
Selling expense............................ 280,078 249,389 202,318
General and administrative expense......... 975,099 836,581 543,541
Nonrecurring costs......................... -- 14,535 --
------------ ------------ ------------
6,031,522 5,187,925 3,571,773
------------ ------------ ------------
Operating Income............................. 446,828 454,313 399,059
Interest expense........................... 26,903 36,658 36,628
Other expense, net......................... 27,939 31,301 25,195
------------ ------------ ------------
Income from Continuting Operations before
Provision for Income Taxes................. 391,986 386,354 337,236
Provision for income taxes................. 72,438 156,917 138,718
------------ ------------ ------------
Income from Continuing Operations............ 319,548 229,437 198,518
Discontinued Operations:
Income (Loss) from Workers' Compensation
Segment, net of tax benefit of $6,959,
$2,126 and $1,212, respectively.......... (12,592) (2,028) 3,484
Loss on disposal of Workers' Compensation
Segment, net of tax benefit of $33,022... (75,676) -- --
------------ ------------ ------------
Income (Loss) from Discontinued Operations... (88,268) (2,028) 3,484
------------ ------------ ------------
Net Income................................... $ 231,280 $ 227,409 $ 202,002
------------ ------------ ------------
------------ ------------ ------------
Earnings Per Share:
Income from continuing operations.......... $ 4.63 $ 3.33 $ 2.99
Income (loss) from discontinued
operations............................... (1.28) (0.03) 0.05
------------ ------------ ------------
Net income................................. $ 3.35 $ 3.30 $ 3.04
------------ ------------ ------------
------------ ------------ ------------
Earnings Per Share Assuming Full Dilution:
Income from continuing operations.......... $ 4.55 $ 3.30 $ 2.99
Income (loss) from discontinued
operations............................... (1.26) (0.03) 0.05
------------ ------------ ------------
Net income................................. $ 3.29 $ 3.27 $ 3.04
------------ ------------ ------------
------------ ------------ ------------
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 COMMON STOCK
ISSUED IN TREASURY
PREFERRED ---------------------- ----------- ----------------------
(IN THOUSANDS) STOCK SHARES AMOUNT AMOUNT SHARES AMOUNT
---------- ---------- ---------- ----------- ---------- ----------
BALANCE AS OF JANUARY 1, 1996........... $ -- -- $ -- $ -- 19,500 $ 195
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
Comprehensive income
Net income............................
Other comprehensive income, net of tax
Change in unrealized valuation
adjustment on investment
securities, net of
reclassification adjustment.......
Total comprehensive income..............
---------- ---------- ---------- ----------- ---------- ----------
BALANCE AS OF DECEMBER 31, 1996......... -- 66,527 665 -- -- --
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)
Comprehensive income
Net income............................
Other comprehensive income, net of tax
Change in unrealized valuation
adjustment on investment
securities, net of
reclassification adjustment.......
Total comprehensive income..............
---------- ---------- ---------- ----------- ---------- ----------
BALANCE AS OF DECEMBER 31, 1997......... -- 69,778 698 (103) -- --
Stock grants to employees and
directors............................. 6
Stock issued for employee stock option
and stock purchase plans.............. 837 8
Stock repurchased, 3,496,985 shares at
cost.................................. (193,332)
Comprehensive income
Net income............................
Other comprehensive income, net of tax
Change in unrealized valuation
adjustment on investment
securities, net of
reclassification adjustment.......
Total comprehensive income..............
---------- ---------- ---------- ----------- ---------- ----------
BALANCE AS OF DECEMBER 31, 1998......... $ -- 70,621 $ 706 $ (193,435) -- $ --
---------- ---------- ---------- ----------- ---------- ----------
---------- ---------- ---------- ----------- ---------- ----------
CLASS B COMMON STOCK ACCUMULATED
ADDITIONAL OTHER
---------------------- PAID-IN RETAINED COMPREHENSIVE
(IN THOUSANDS) SHARES AMOUNT CAPITAL EARNINGS INCOME TOTAL
---------- ---------- ---------- ---------- ------------- ----------
BALANCE AS OF JANUARY 1, 1996........... 80,000 $ 800 $1,100,288 $ 567,123 $ 1,820 $1,670,226
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
Comprehensive income
Net income............................ 202,002 202,002
Other comprehensive income, net of tax
Change in unrealized valuation
adjustment on investment
securities, net of
reclassification adjustment....... (11,814) (11,814)
---------- ------------- ----------
Total comprehensive income.............. 202,002 (11,814) 190,188
---------- ------------- ----------
---------- ---------- ----------
---------- ------------- ----------
BALANCE AS OF DECEMBER 31, 1996......... -- -- 761,879 117,909 (9,994) 870,459
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)
Comprehensive income
Net income............................ 227,409 227,409
Other comprehensive income, net of tax
Change in unrealized valuation
adjustment on investment
securities, net of
reclassification adjustment....... 4,938 4,938
---------- ------------- ----------
Total comprehensive income.............. 227,409 4,938 232,347
---------- ------------- ----------
---------- ---------- ----------
---------- ------------- ----------
BALANCE AS OF DECEMBER 31, 1997......... -- -- 882,312 345,318 (5,056) 1,223,169
Stock grants to employees and
directors............................. 399 399
Stock issued for employee stock option
and stock purchase plans.............. 39,036 39,044
Stock repurchased, 3,496,985 shares at
cost.................................. (193,332)
Comprehensive income
Net income............................ 231,280 231,280
Other comprehensive income, net of tax
Change in unrealized valuation
adjustment on investment
securities, net of
reclassification adjustment....... 14,663 14,663
---------- ------------- ----------
Total comprehensive income.............. 231,280 14,663 245,943
---------- ------------- ----------
---------- ---------- ----------
---------- ------------- ----------
BALANCE AS OF DECEMBER 31, 1998......... -- $ -- $ 921,747 $ 576,598 $ 9,607 $1,315,223
---------- ---------- ---------- ---------- ------------- ----------
---------- ---------- ---------- ---------- ------------- ----------
See accompanying notes to the consolidated financial statements.
F-4
WELLPOINT HEALTH NETWORKS INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
----------------------------------
(IN THOUSANDS) 1998 1997 1996
---------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Income from continuing operations........................................... $ 319,548 $ 229,437 $ 198,518
Adjustments to reconcile income from continuing operations to net cash
provided by continuing operating activities:
Depreciation and amortization, net of accretion........................... 54,590 51,239 31,971
(Gains) losses on sales of assets, net.................................... 34,679 (59,168) (16,270)
Provision (benefit) for deferred income taxes............................. (83,261) 20,699 (21,261)
Amortization of deferred gain on sale of building......................... (4,425) (4,426) (2,582)
(Increase) decrease in certain assets:
Receivables, net........................................................ 17,621 (11,315) 19,053
Income taxes recoverable................................................ 15,099 -- --
Other current assets.................................................... (20,087) (30,536) 46,119
Other non-current assets................................................ 1,978 1,719 (47,552)
Increase (decrease) in certain liabilities:
Medical claims payable.................................................. 23,844 170,728 (9,585)
Reserves for future policy benefits..................................... (9,142) 407 (492)
Unearned premiums....................................................... 18,853 14,072 24,113
Accounts payable and accrued expenses................................... (6,415) 102,662 68,563
Experience rated and other refunds...................................... (5,810) 17,726 12,029
Other current liabilities............................................... 35,398 3,745 52,480
Accrued postretirement benefits......................................... 3,167 2,805 (1,600)
Other non-current liabilities........................................... (1,027) (13,698) 3,795
---------- ---------- ----------
Net cash provided by continuing operating activities.................. 394,610 496,096 357,299
---------- ---------- ----------
Income (loss) from discontinued operations.................................. (12,592) (2,028) 3,484
Adjustment to derive cash flows from discontinued operating activities:
Change in net operating assets............................................ 7,410 59,012 43,806
---------- ---------- ----------
Net cash provided by (used in) discontinued operating activities............ (5,182) 56,984 47,290
---------- ---------- ----------
Net cash provided by operating activities............................. 389,428 553,080 404,589
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investments purchased..................................................... (2,843,102) (2,641,752) (1,089,838)
Proceeds from investments sold............................................ 2,666,355 1,836,541 812,402
Proceeds from investments matured......................................... 106,436 143,218 75,018
Property and equipment purchased.......................................... (78,431) (58,619) (44,150)
Proceeds from property and equipment sold................................. 25,721 503 291
Proceeds from sale of Workers' Compensation business...................... 101,413 -- --
Additional investment in subsidiaries..................................... -- (18,317) --
Purchase of subsidiaries, net of cash acquired............................ -- 361,977 (453,068)
---------- ---------- ----------
Net cash used in continuing investing activities...................... (21,608) (376,449) (699,345)
---------- ---------- ----------
Net cash provided by (used in) discontinued investing activities............ 15,877 (76,149) (36,892)
---------- ---------- ----------
Net cash used in investing activities................................. (5,731) (452,598) (736,237)
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt.............................................. -- 150,000 825,000
Repayment of long-term debt............................................... (88,000) (387,000) (262,000)
Net proceeds from common stock offering................................... -- 110,340 --
Proceeds from the issuance of common stock................................ 39,443 10,126 962
Common stock repurchased.................................................. (193,332) (103) --
Dividends paid in connection with the Recapitalization.................... -- -- (995,000)
---------- ---------- ----------
Net cash used in financing activities................................. (241,889) (116,637) (431,038)
---------- ---------- ----------
Net increase (decrease) in cash and cash equivalents........................ 141,808 (16,155) (762,686)
Cash and cash equivalents at beginning of year.............................. 269,067 285,222 1,047,908
---------- ---------- ----------
Cash and cash equivalents at end of year.................................... $ 410,875 $ 269,067 $ 285,222
---------- ---------- ----------
---------- ---------- ----------
See 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"), is one of the
nation's largest publicly traded managed health care companies. As of December
31, 1998, WellPoint had approximately 6.9 million medical members and
approximately 25 million specialty members. The Company offers a broad spectrum
of network-based managed care plans. WellPoint provides these plans to the large
and small employer, individual and senior markets. The Company's managed care
plans include preferred provider organizations ("PPOs"), health maintenance
organizations ("HMOs"), point-of-service ("POS") plans, other hybrid plans and
traditional indemnity plans. In addition, the Company offers managed care
services, including underwriting, actuarial service, network access, medical
cost management and claims processing. The Company offers a continuum of managed
health care plans while providing incentives to members and employers to select
more intensively managed plans. The Company typically offers such plans at a
lower cost in exchange for additional cost-control measures, such as limited
flexibility in choosing physicians and hospitals that are not included in the
Company's provider networks. 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 insurance, preventive care, disability, behavioral health,
COBRA and flexible benefits account administration.
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.
F-6
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. ORGANIZATION (CONTINUED)
The purchase method of accounting has been used to account for the
acquisition of the BCC Commercial Operations. The Company paid $206.7 million
for the Blue Cross trademark and was amortizing this intangible asset on a
straight-line basis over 40 years. The entire intangible asset balance related
to the BCC Commercial Operations purchase was written-off during 1998 (See Note
8 to the Consolidated Financial Statements).
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, April 10, 1997 and April
16, 1998 the Foundation sold approximately 15.0, 8.5 and 12.0 million shares,
respectively, of the Company's Common Stock through public offerings. Upon
completion of the April 1998 offering, the Foundation owned 17.9 million shares
(or approximately 26.7%) of the Company's outstanding shares.
As more fully described in Note 11, on September 1, 1998, the Company
completed the sale of its workers' compensation segment. Such sale was accounted
for as a discontinued operation, with prior period results restated to exclude
the workers' compensation segment from continuing operations.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
As a managed health care organization, the Company derives the majority of
its revenues from premiums received for providing prepaid health services and
prepares its financial statements in accordance with the AICPA Audit and
Accounting Guide for "Health Care Organizations." The following is a summary of
significant accounting policies used in the preparation of the accompanying
consolidated financial statements. Such policies are in accordance with
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
goodwill and intangible assets, medical claims payable, reserves for future
policy benefits, experience rated refunds and contingent liabilities. While
management believes that the carrying value of such assets and liabilities are
adequate as of December 31, 1998 and 1997, actual results could differ from the
estimates upon which the carrying values were based.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All significant intercompany transactions and accounts
have been eliminated in consolidation.
CASH EQUIVALENTS
The Company considers cash equivalents to include highly liquid debt
instruments purchased with an original remaining maturity of three months or
less.
F-7
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash investments,
investment securities, foreign currency denominated forward exchange contracts
and interest rate swaps. The Company invests its excess cash primarily in
commercial paper and money market funds. Although a majority of the cash
accounts exceed the federally insured deposit amount, management does not
anticipate nonperformance by financial institutions and reviews the financial
viability of these institutions on a periodic basis. The Company attempts to
limit its risk in investment securities by maintaining a diversified portfolio.
The components of investment securities are shown in Note 3.
INVESTMENTS
Investment securities consist primarily of U.S. Treasury and agency
securities, foreign currency denominated bonds, mortgage-backed securities,
investment grade corporate bonds and equity securities. The Company has
determined that its investment securities are available for use in current
operations and, accordingly, has classified such investment securities as
current without regard to contractual maturity dates.
Long-term investments consist primarily of restricted assets, equity and
other investments. Restricted assets, at market value, included in long-term
investments at December 31, 1998 and 1997 were $96.6 million and $94.2 million,
respectively, and consisted of investments on deposit with the DOC. These
deposits consisted primarily of U.S. Treasury bonds and notes. Due to their
restricted nature, such investments are classified as long-term without regard
to contractual maturity.
The Company has determined that its debt and equity securities are available
for sale. Debt and equity securities are carried at estimated fair value based
on quoted market prices for the same or similar instruments. Unrealized gains
and losses are computed on the basis of specific identification and are included
in other comprehensive income, net of applicable deferred income taxes. Realized
gains and losses on the disposition of investments are included in investment
income. The specific identification method is used in determining the cost of
debt and equity securities sold.
The Company participates in a securities lending program whereby marketable
securities in the Company's portfolio are transferred to an independent broker
or dealer in exchange for collateral equal to at least 102% of the market value
of securities on loan.
In order to mitigate foreign currency risk for certain investments on the
foreign currency denominated bonds within the Company's investment portfolio,
the Company has entered into two types of foreign currency derivative
instruments. The first type is a forward exchange contract which is entered into
to hedge the foreign currency risk between the trade date and the settlement
date of a foreign currency investment transaction. Gains and losses related to
such instruments are recognized in the Company's income statement. The Company
has also entered into foreign currency contracts for each of the fixed maturity
securities owned as of December 31, 1998 to hedge asset positions denominated in
other currencies. The unrealized gains and losses, net of deferred taxes, from
such forward contracts and the related hedged investments are reflected in other
comprehensive income.
F-8
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PREMIUMS RECEIVABLE
Premiums receivable are shown net of an allowance based on historical
collection trends and management's judgment on the collectibility of these
accounts. These collection trends, as well as prevailing and anticipated
economic conditions, are routinely monitored by management, and any adjustments
required are reflected in current operations.
PROPERTY AND EQUIPMENT, NET
Property and equipment are stated at cost, net of depreciation, and are
depreciated on the straight-line method over the estimated useful lives of the
assets. Leasehold improvements are stated net of amortization and are amortized
over a period not exceeding the term of the lease.
Computer software costs that are incurred in the preliminary project stage
are expensed as incurred. Direct consulting costs, payroll and payroll related
cost for employees who are directly associated with each project are capitalized
and amortized over a five-year period when placed into production.
INTANGIBLE ASSETS AND GOODWILL
Intangible assets and goodwill represent the cost in excess of fair value of
the net assets, net of the related tax impact, acquired in purchase
transactions. Intangible assets and goodwill are being amortized, utilizing a
composite useful life, on a straight-line basis over periods ranging from 20 to
25 years. (See Note 6 for a more complete discussion of the Company's intangible
assets and goodwill.)
The Company periodically evaluates whether events or circumstances have
occurred that may affect the estimated useful life or the recoverability of the
remaining balance of goodwill and other identifiable intangible assets.
Impairment of an intangible asset is triggered when the estimated future
undiscounted cash flows (excluding interest charges) do not exceed the carrying
amount of the intangible asset and related goodwill. If the events or
circumstances indicate that the remaining balance of the intangible asset and
goodwill may be permanently impaired, such potential impairment will be measured
based upon the difference between the carrying amount of the intangible asset
and goodwill and the fair value of such asset determined using the estimated
future discounted cash flows (excluding interest charges) generated from the use
and ultimate disposition of the respective acquired entity.
MEDICAL CLAIMS PAYABLE
The liability for medical claims payable includes claims in process and a
provision for incurred but not reported claims, which is actuarially determined
based on historical claims payment experience and other statistics. Claim
processing expenses are also accrued based on an estimate of expenses necessary
to process such claims. Such reserves are continually monitored and reviewed
with any adjustments reflected in current operations. Capitation costs represent
monthly fees paid one month in advance to physicians, certain other medical
service providers and hospitals in the Company's HMO networks as retainers for
providing continuing medical care. The Company maintains various programs that
provide incentives to physicians, certain other medical service providers and
hospitals participating in its HMO networks through the use of risk-sharing
agreements and other programs. Payments under such agreements are made based on
the providers' performance in controlling health care costs while providing
quality health care. Expenses related to these programs, which are based in part
on estimates, are recorded in the period in which the related services are
rendered.
F-9
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RESERVES FOR FUTURE POLICY BENEFITS
The estimated reserves for future policy benefits relate to life and
disability policies written in connection with health care contracts. Reserves
for future extended benefit coverage are based on projections of past
experience. Reserves for future policy and contract benefits for certain
long-term disability products and group paid-up life products are based upon
interest, mortality and morbidity assumptions from published actuarial tables,
modified based upon the Company's experience. Reserves are continually monitored
and reviewed, and as settlements are made or reserves adjusted, differences are
reflected in current operations. The current portion of reserves for future
policy benefits relates to the portion of such reserves which management expects
to pay within one year.
POSTRETIREMENT BENEFITS
The Company currently provides certain health care and life insurance
benefits to eligible retirees and their dependents under plans administered by
the Company. The Company accrues the estimated costs of retiree health and other
postretirement benefits during the periods in which eligible employees render
service to earn the benefits.
INTEREST RATE SWAP AGREEMENTS
The Company utilizes interest rate swap agreements to manage interest rate
exposures. The principal objective of such contracts is to minimize the risks
and/or costs associated with financial activities. The counterparties to these
contractual arrangements are major financial institutions with which the Company
also has other financial relationships. These counterparties expose the Company
to credit loss in the event of nonperformance. However, the Company does not
anticipate nonperformance by the counterparties.
The Company entered into interest rate swap agreements to reduce the impact
of changes in interest rates on its floating rate debt under its revolving
credit facility. The swap agreements are contracts to exchange floating interest
rate payments for fixed interest rate payments periodically over the life of the
agreements without the exchange of the underlying notional amounts. The notional
amounts of the interest rate swap agreements are used to measure interest to be
paid. For interest rate instruments that effectively hedge interest rate
exposures, the net cash amounts paid on the agreements are accrued and
recognized as an adjustment to interest expense. If an agreement no longer
qualifies as a hedge instrument, then it is marked to market and carried on the
balance sheet at fair value. The change in fair value of these instruments are
included in investment income.
INCOME TAXES
The Company files a consolidated income tax return with its subsidiaries.
The Company's provision for income taxes reflects the current and future tax
consequences of all events that have been recognized in the financial statements
as measured by the provision of currently enacted tax laws and rates applicable
to future periods.
RECOGNITION OF PREMIUM REVENUE AND MANAGEMENT SERVICES REVENUE
For most health care and life insurance contracts, premiums are billed in
advance of coverage periods and are recognized as revenue over the period in
which services or benefits are obligated to be provided. Premiums include
revenue from other contracts, which principally relate to minimum premium
contracts,
F-10
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
where revenue is recognized based upon the ultimate loss experience of the
contract. These contracts obligate the Company to arrange for the provision of
health care for the members covered by the related contract and expose the
Company to financial risk based upon its ability to manage health care costs
below a contractual fixed attachment point. Premium revenue includes an
adjustment for experience rated refunds based on an estimate of incurred claims.
Experience rated refunds are paid based on contractual requirements.
The Company's group life and disability insurance contracts are traditional
insurance contracts which are typically issued only in conjunction with a health
care contract. Additionally, WellPoint has a limited number of indemnity health
insurance contracts principally acquired from the Life and Health Benefits
Management Division of the Massachusetts Mutual Life Insurance Company ("MMHD")
and the Group Benefits Operations of the John Hancock Mutual Life Insurance
Company ("GBO"). All of these contracts provide insurance protection for a fixed
period ranging from one month to a year. The Company has the ability at a
minimum to cancel the contract or adjust the provisions of the contract at the
end of the contract period. As a result, the Company's insurance contracts are
considered short-duration contracts.
Premiums applicable to the unexpired contractual coverage periods are
reflected in the accompanying consolidated balance sheet as unearned premiums.
Management services revenue is earned as services are performed and consists
of administrative fees for services provided to third parties, including
management of medical services, claims processing and access to provider
networks. Under administrative service contracts, self-funded employers retain
the full risk of financing benefits. Funds received from employers are equal to
amounts required to fund benefit expenses and pay earned administrative fees.
Because benefits expenses are not the obligation of the Company, premium revenue
and benefits expense for these contracts are not included in the Company's
financial statements. Administrative service fees received from employer groups
are included in the Company's revenues.
LOSS CONTRACTS
The Company monitors its contracts for the provision of medical care and
recognizes losses on those contracts when it is probable that expected future
health care and maintenance costs, under a group of existing contracts, will
exceed anticipated future premiums on those contracts. The estimation of future
health care medical costs includes all costs related to the provision of health
care to members covered by the related group of contracts. In determining
whether a loss has been incurred, the Company reviews contracts either
individually or collectively, depending upon the Company's method of
establishing premium rates for such contracts.
The Company further monitors its life insurance contracts and recognizes
losses on those contracts for which estimated future claims costs and
maintenance costs exceed the related unearned premium.
HEALTH CARE SERVICES AND OTHER BENEFITS
Health care services and other benefits expense includes the costs of health
care services, capitation expenses and expenses related to risk sharing
agreements with participating physicians, medical groups and hospitals and
incurred losses on the disability and life products. The costs of health care
services are accrued as services are rendered, including an estimate for claims
incurred but not yet reported.
F-11
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ADVERTISING COSTS
The Company uses print and broadcast advertising to promote its products.
The cost of advertising is expensed as incurred and totaled approximately $43.3
million, $36.5 million and $33.7 million for the years ended December 31, 1998,
1997 and 1996, respectively.
EARNINGS PER SHARE
Earnings per share is computed both including and excluding the impact of
common stock equivalents.
STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," encourages, but does not require, companies to record
compensation cost for stock-based employee compensation plans at fair value. The
Company has chosen to continue to account for stock-based compensation using the
intrinsic method prescribed in Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees," and related interpretations.
Accordingly, compensation cost for stock options, under existing plans is
measured as the excess, if any, of the quoted market price of the Company's
stock at the date of the grant over the amount an employee must pay to acquire
the stock.
COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted the provisions of Statement
of Financial Accounting Standards No. 130, "Comprehensive Income" ("SFAS No.
130"). Comprehensive income encompasses all changes in stockholders' equity
(except those arising from transactions with stockholders) and includes net
income and net unrealized gains or losses on available-for-sale securities.
Comprehensive income is net of reclassification adjustments to adjust for items
currently included in net income, such as realized gains on investment
securities. The 1997 and 1996 consolidated financial statements have been
reclassified to reflect the provisions of this statement.
RECLASSIFICATIONS
Certain amounts in the prior year consolidated financial statements have
been reclassified to conform to the 1998 presentation. All amounts have been
restated from the original 1997 and 1996 presentations to exclude the
discontinued workers' compensation segment from continuing operations, and from
assets and cash flows as discussed in Note 11.
NEW ACCOUNTING PRONOUNCEMENTS
In April 1998, the AICPA issued Statement of Position ("SOP") No. 98-5,
"Reporting on the Costs of Start-Up Activities." SOP No. 98-5 provides guidance
on the accounting for start-up costs and organization costs. It requires these
costs to be expensed as incurred and, with certain exceptions, requires the
initial application to be reported as a cumulative effect of a change in
accounting principle. This SOP is effective for fiscal years beginning after
December 15, 1998. During the first quarter of 1999, the Company expects to
recognize an after-tax charge of approximately $20.4 million related to the
cumulative effect of the implementation of this pronouncement.
F-12
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
No. 133"). SFAS No. 133 establishes the accounting and reporting standards for
derivative instruments and for hedging activities. Upon adoption of SFAS No.
133, all derivatives must be recognized on the balance sheet at their then fair
value. Any stand-alone deferred gains and losses remaining on the balance sheet
under previous hedge accounting rules must be removed from the balance sheet and
all hedging relationships must be designated anew and documented pursuant to the
new accounting rules. The new standard will be effective in the first quarter of
2000. The Company is presently assessing the effect of SFAS No. 133 on the
financial statements of the Company.
3. INVESTMENTS
INVESTMENT SECURITIES
The Company's investment securities consist of the following (in thousands):
DECEMBER 31, 1998
------------------------------------------------
GROSS UNREALIZED
AMORTIZED -------------------- ESTIMATED
COST GAINS LOSSES FAIR VALUE
------------ --------- --------- ------------
U.S. Treasury and agency........................................ $ 274,004 $ 4,546 $ 894 $ 277,656
Foreign government securities................................... 88,332 2,413 1,046 89,699
Mortgage-backed securities...................................... 598,529 8,517 688 606,358
Corporate and other securities.................................. 995,596 17,810 10,661 1,002,745
------------ --------- --------- ------------
Total debt securities......................................... 1,956,461 33,286 13,289 1,976,458
Equity and other investments.................................... 278,229 20,705 25,218 273,716
------------ --------- --------- ------------
Total investment securities................................. $ 2,234,690 $ 53,991 $ 38,507 $ 2,250,174
------------ --------- --------- ------------
------------ --------- --------- ------------
DECEMBER 31, 1997
------------------------------------------------
GROSS UNREALIZED
AMORTIZED -------------------- ESTIMATED
COST GAINS LOSSES FAIR VALUE
------------ --------- --------- ------------
U.S. Treasury and agency........................................ $ 359,016 $ 2,168 $ 299 $ 360,885
Mortgage-backed securities...................................... 721,816 8,370 2,229 727,957
Corporate and other securities.................................. 911,589 11,657 4,064 919,182
------------ --------- --------- ------------
Total debt securities......................................... 1,992,421 22,195 6,592 2,008,024
Equity and other investments.................................... 206,616 8,411 34,400 180,627
------------ --------- --------- ------------
Total investment securities................................. $ 2,199,037 $ 30,606 $ 40,992 $ 2,188,651
------------ --------- --------- ------------
------------ --------- --------- ------------
The amortized cost and estimated fair value of debt securities as of
December 31, 1998, based on contractual maturity dates are summarized below (in
thousands). Expected maturities for mortgage-
F-13
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENTS (CONTINUED)
backed securities will differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call or prepayment
penalties.
AMORTIZED ESTIMATED
COST FAIR VALUE
------------ ------------
Due in one year or less........................................... $ 146,152 $ 144,408
Due after one year through five years............................. 564,138 565,335
Due after five years through ten years............................ 653,285 663,107
Due after ten years............................................... 592,886 603,608
------------ ------------
Total debt securities............................................. $ 1,956,461 $ 1,976,458
------------ ------------
------------ ------------
For the years ended December 31, 1998, 1997 and 1996, proceeds from the
sales and maturities of debt securities were $2,569.1 million, $1,566.1 million
and $554.4 million, respectively. Gross gains of $28.2 million and gross losses
of $10.8 million were realized on the sales of debt securities for the year
ended December 31, 1998. For 1997, gross realized gains and gross realized
losses from sales of debt securities were $9.5 million and $7.2 million,
respectively. In 1996, gross realized gains and gross realized losses from sales
of debt securities were $1.2 million and $2.9 million, respectively.
For the years ended December 31, 1998, 1997 and 1996, proceeds from the
sales of equity securities were $203.7 million, $413.7 million and $333.0
million, respectively. Gross gains of $15.5 million and gross losses of $64.9
million were realized on the sales of equity securities in 1998. For 1997, gross
realized gains and gross realized losses on the sales of equity securities were
$68.5 million and $6.5 million, respectively. In 1996, gross realized gains and
gross realized losses on the sales of equity securities were $19.1 million and
$2.5 million, respectively.
Securities on loan under the Company's securities lending program are
included in its cash and investment portfolio shown on the accompanying
consolidated balance sheets. Under this program, broker/ dealers are required to
deliver substantially the same security to the Company upon completion of the
transaction. The balance of securities on loan as of December 31, 1998 and 1997
was $262.8 million and $499.3 million, respectively, and income earned on
security lending transactions for the years ended December 31, 1998, 1997 and
1996 was $1.0 million, $2.0 million and $2.2 million, respectively.
LONG-TERM INVESTMENTS
The Company's long-term investments consist of the following (in thousands):
DECEMBER 31, 1998
------------------------------------------------
GROSS UNREALIZED
AMORTIZED ------------------------ ESTIMATED
COST GAINS LOSSES FAIR VALUE
---------- ----------- ----------- ----------
U.S. Treasury and agency securities...................................... $ 94,131 $ 408 $ 29 $ 94,510
Equity and other investments............................................. 8,743 -- -- 8,743
---------- ----- --- ----------
Total long-term investments............................................ $ 102,874 $ 408 $ 29 $ 103,253
---------- ----- --- ----------
---------- ----- --- ----------
F-14
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENTS (CONTINUED)
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
---------- ----- --- ----------
---------- ----- --- ----------
At December 31, 1998, the Company's debt securities had contractual maturity
dates: due in one year or less, amortized cost of $94.1 million and market value
of $94.5 million.
In 1997, the Company owned an interest in the stock of Health Partners Inc.
("HPI") which was accounted for under the equity method. In October 1997, HPI
entered into a business combination with FPA Medical Management Inc. ("FPA"), a
publicly traded company, which was accounted for as a pooling of interests. As a
result of the transaction, the Company exchanged its HPI stock for FPA stock and
recognized a pre-tax gain of $30.3 million at the date of the transaction. At
December 31, 1997, the Company's investment in FPA was held in its investment
portfolio at estimated fair value.
In 1998, the Company's investment in FPA experienced an "other than
temporary" decline in market value. As a result, the Company recognized a
pre-tax loss of $48.7 million. This investment was sold in 1998 for an amount
that approximated its written down value.
4. RECEIVABLES, NET
Receivables consist of the following (in thousands):
DECEMBER 31,
----------------------
1998 1997
---------- ----------
Premiums receivable................................................... $ 362,225 $ 339,618
Investment income and other receivables............................... 168,614 193,720
---------- ----------
530,839 533,338
Less allowance for doubtful accounts.................................. 45,580 30,458
---------- ----------
Receivables, net...................................................... $ 485,259 $ 502,880
---------- ----------
---------- ----------
F-15
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. PROPERTY AND EQUIPMENT, NET
Property and equipment, at cost, consist of the following (in thousands):
DECEMBER 31,
----------------------
1998 1997
---------- ----------
Furniture and fixtures................................................ $ 50,412 $ 44,079
Software.............................................................. 44,747 21,934
Equipment............................................................. 117,762 128,123
Leasehold improvements................................................ 41,543 32,125
---------- ----------
254,464 226,261
Less accumulated depreciation and amortization........................ 123,005 113,735
---------- ----------
Property and equipment, net........................................... $ 131,459 $ 112,526
---------- ----------
---------- ----------
Depreciation and amortization expense for the years ended December 31, 1998,
1997 and 1996 was $36.8 million, $32.6 million and $19.5 million, respectively.
6. INTANGIBLE ASSETS AND GOODWILL
The intangible asset balance consists of the following components (in
thousands):
DECEMBER 31,
----------------------
1998 1997
---------- ----------
Tradename and service mark............................................ $ -- $ 206,683
Employer group relationships.......................................... 77,991 77,991
Self-developed software............................................... 7,280 7,280
Provider contracts.................................................... 9,208 9,208
Miscellaneous intangible assets....................................... 5,728 5,728
---------- ----------
100,207 306,890
Less accumulated amortization......................................... 6,270 11,210
---------- ----------
Intangible assets, net................................................ $ 93,937 $ 295,680
---------- ----------
---------- ----------
The goodwill balance consists of the following components (in thousands):
DECEMBER 31,
----------------------
1998 1997
---------- ----------
Goodwill.............................................................. $ 368,310 $ 349,478
Less accumulated amortization......................................... 32,155 24,411
---------- ----------
Goodwill, net......................................................... $ 336,155 $ 325,067
---------- ----------
---------- ----------
During the fourth quarter of 1998, the Company re-evaluated the useful life
of the intangible assets and goodwill related to its acquisitions of the GBO and
MMHD and reduced such composite lives from 35 to 20 years.
F-16
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. INTANGIBLE ASSETS AND GOODWILL (CONTINUED)
Amortization charged to operations was $19.9 million, $17.9 million and $9.8
million for the years ended December 31, 1998, 1997 and 1996, respectively.
As discussed in Note 8, in 1998 the Company received from the Internal
Revenue Service a favorable private letter ruling concerning the deductibility
of an $800 million payment made during the Company's May 1996 Recapitalization.
As a result of such private letter ruling in the third quarter of 1998, the
Company reduced the remaining intangible assets of $194.5 million related to its
acquisition of the BCC Commercial Operations to zero.
7. LONG-TERM DEBT
NOTES PAYABLE
In connection with the MMHD acquisition, the Company issued a Series A term
note for $62.0 million on March 31, 1996. At December 31, 1998 and 1997, $20
million was outstanding under this note. The Series A note will mature on March
31, 1999 and is expected to be refinanced utilizing the Company's revolving
credit facility. 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, 1998 and 1997, $280.0 million and $368.0 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 (5.6% at December 31, 1998). 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.
SHELF REGISTRATION STATEMENT
In July 1996, the Company filed a registration statement relating to the
issuance of $1.0 billion of senior or subordinated unsecured indebtedness. As of
December 31, 1998, no indebtedness had been issued pursuant to this registration
statement.
MATURITIES
At December 31, 1998, the Company's long-term debt maturities are as
follows: 1999--$20 million; 2000--zero; 2001--zero; 2002--$280 million.
F-17
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. LONG-TERM DEBT (CONTINUED)
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, 1998, the Company was in compliance with
the requirements outlined in these agreements.
INTEREST RATE SWAPS
As described in Note 16, the Company is a party to three separate interest
rate swap agreements which convert underlying variable-rate debt into fixed-rate
debt.
INTEREST PAID
Interest paid on long-term debt for the years ended December 31, 1998, 1997
and 1996 was $25.9 million, $38.9 million and $30.3 million, respectively.
8. INCOME TAXES
The components of the provision (benefit) for income taxes are as follows
(in thousands):
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Current:
Federal..................................... $ 97,231 $ 107,695 $ 129,413
State....................................... 30,929 28,523 30,566
--------- --------- ---------
128,160 136,218 159,979
--------- --------- ---------
Deferred:
Federal..................................... (51,398) 19,041 (16,733)
State....................................... (4,324) 1,658 (4,528)
--------- --------- ---------
(55,722) 20,699 (21,261)
--------- --------- ---------
Provision for income taxes from continuing
operations.................................. $ 72,438 $ 156,917 $ 138,718
--------- --------- ---------
--------- --------- ---------
F-18
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES (CONTINUED)
The overall effective tax rate differs from the statutory federal tax rate
as follows (percent of pretax income from continuing operations):
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Tax provision based on the federal statutory rate....... 35.0% 35.0% 35.0%
State income taxes, net of federal benefit.............. 4.4 5.1 5.0
Non-deductible expenses................................. 0.9 0.1 0.7
Tax benefit from IRS ruling in excess of noncurrent
intangible assets related to business combination..... (21.8) -- --
Other, net.............................................. -- 0.4 0.4
--------- --- ---
Effective tax rate...................................... 18.5% 40.6% 41.1%
--------- --- ---
--------- --- ---
Net deferred tax assets are comprised of the following (in thousands):
DECEMBER 31,
--------------------
1998 1997
--------- ---------
Gross deferred tax assets:
Market valuation on investment securities............. $ -- $ 5,530
Vacation and holiday accruals......................... 8,521 7,388
Incurred claim reserve discounting.................... 10,726 11,451
Provision for doubtful accounts....................... 16,619 14,987
Unearned premium reserve.............................. 15,852 13,499
State income taxes.................................... 10,707 9,904
Postretirement benefits............................... 27,332 26,033
Deferred gain on building............................. 7,063 8,867
Deferred compensation................................. 11,349 8,553
Expenses not currently deductible..................... 44,791 44,615
Intangible asset impairment........................... 7,940 8,189
Capital loss carryover................................ 11,247 --
Alternative Minimum Tax credit carryover.............. 46,616 --
Other, net............................................ 8,599 6,119
--------- ---------
Total gross deferred tax assets..................... 227,362 165,135
--------- ---------
Gross deferred tax liabilities:
Market valuation on investment securities............. (5,757) --
Depreciation and amortization......................... (11,313) (11,267)
Bond discount and basis differences................... (6,682) (21,240)
Other, net............................................ (1,753) (3,271)
--------- ---------
Total gross deferred tax liabilities................ (25,505) (35,778)
--------- ---------
Net deferred tax assets................................. $ 201,857 $ 129,357
--------- ---------
--------- ---------
F-19
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES (CONTINUED)
Management believes that the deferred tax assets listed above are fully
recoverable and, accordingly, no valuation allowance has been recorded. Expenses
not currently deductible include various financial statement charges and
expenses that will be deductible for income tax purposes in future periods.
Income taxes paid for the years ended December 31, 1998, 1997 and 1996 were
$103.0 million, $121.2 million and $90.0 million, respectively.
INCOME TAXES
In September 1998, the Company received a private letter ruling from the
Internal Revenue Service with respect to the treatment of certain payments made
at the time of WellPoint's 1996 Recapitalization and acquisition of the BCC
Commercial Operations. The ruling allows the Company to deduct as an ordinary
and necessary business expense an $800 million cash payment made by BCC in May
1996 to one of two newly formed charitable foundations. As a result of the
ruling in 1998, the Company reduced the remaining intangible asset of $194.5
million arising from the acquisition of certain assets and liabilities of BCC
Commercial Operations at the time of the Recapitalization and recognized a
reduction in its income tax expense of $85.5 million. As a result, the Company
filed amended tax returns for prior years requesting a refund of approximately
$200 million and anticipates that current and future income tax payments will be
reduced by approximately $80 million and has, therefore, recognized an income
tax recoverable and a deferred tax asset, respectively, in its financial
statements for the year ended December 31, 1998.
As the result of the sale of its workers' compensation segment and its
investment in FPA, the Company has a Federal capital loss carryforward of $14.0
million and a California capital loss carryforward of $111.2 million. The
carryforward amounts expire on December 31, 2003. The federal alternative
minimum tax credit is available to offset future regular tax payments, on an
indefinite basis.
9. PENSION AND POSTRETIREMENT BENEFITS
The BCC pension and postretirement plans were assumed by the Company as a
result of the Recapitalization in 1996.
In 1998, the Company adopted SFAS No. 132, "Employers Disclosures about
Pensions and Other Postretirement Benefits." This statement requires the
disclosure of reconciliations of beginning and ending balances of plan benefit
obligations as well as the fair value of plan assets. It also requires the
disclosure of the effect a one percentage-point change (increase and decrease)
in the rate change of health care costs on the service and interest costs
components of net periodic postretirement health care benefit costs and on the
accumulated postretirement benefit obligation for health care benefits. It
eliminates the disclosures for plan descriptions, types of benefit formulas and
funding policies. The Company has restated prior period information to conform
to the required disclosures.
PENSION BENEFITS
The Company covers substantially all employees through two non-contributory
defined benefit pension plans. One plan covers employees of a bargaining unit,
bargaining unit employees, while the second plan, which was established on
January 1, 1987, covers all other eligible exempt and administrative employees
meeting certain age and employment requirements. Plan assets are invested
primarily in pooled income funds. The Company's policy is to fund its plans
according to the applicable Employee Retirement Income Security Act of 1974 and
income tax regulations. The Company uses the unit credit method of cost
determination.
F-20
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. PENSION AND POSTRETIREMENT BENEFITS (CONTINUED)
The funded status of the plans is as follows:
DECEMBER 31,
----------------------
1998 1997
---------- ----------
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year.............................. $ 63,554 $ 48,632
Service cost......................................................... 8,045 6,510
Interest cost........................................................ 5,183 4,353
Amendments........................................................... -- 714
Actuarial loss....................................................... 4,736 5,742
Benefits paid........................................................ (4,015) (2,397)
---------- ----------
Benefit obligation at end of year.................................... $ 77,503 $ 63,554
---------- ----------
---------- ----------
CHANGE IN PLAN ASSETS
Fair value at beginning of year...................................... $ 55,173 $ 45,239
Actual return on fair value.......................................... 5,024 7,681
Employer contributions............................................... 9,617 4,650
Benefits paid........................................................ (4,015) (2,397)
---------- ----------
Fair value at end of year............................................ $ 65,799 $ 55,173
---------- ----------
---------- ----------
Funded status........................................................ $ (11,703) $ (8,381)
Unrecognized prior service cost...................................... 401 410
Unrecognized actuarial loss.......................................... 11,668 7,244
---------- ----------
Net amount recognized................................................ $ 366 $ (727)
---------- ----------
---------- ----------
Amounts recognized in the Balance Sheet consist of:
Prepaid benefit cost............................................... $ 1,146 $ 1,240
Accrued benefit liability.......................................... (780) (1,967)
---------- ----------
Net amount recognized................................................ $ 366 $ (727)
---------- ----------
---------- ----------
WEIGHTED AVERAGE ASSUMPTIONS
Discount rate........................................................ 7.00% 7.25%
Expected return on plan assets....................................... 8.50% 8.50%
Rate of compensation increases....................................... 5.00% 5.50%
F-21
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. PENSION AND POSTRETIREMENT BENEFITS (CONTINUED)
Net periodic pension expense for the Company's defined benefit pension plans
includes the following components:
YEAR ENDED DECEMBER 31,
-------------------------------
(IN THOUSANDS) 1998 1997 1996
--------- --------- ---------
Service cost--benefits earned during the year..... $ 8,045 $ 6,510 $ 4,251
Interest cost on projected benefits obligations... 5,183 4,353 3,538
Expected return on plan assets.................... (4,908) (3,992) (3,255)
Amortization of prior service cost................ 9 9 (62)
Amortization of transition obligation............. -- (15) (26)
Recognized net actuarial loss..................... 196 191 684
--------- --------- ---------
Net periodic pension expense...................... $ 8,525 $ 7,056 $ 5,130
--------- --------- ---------
--------- --------- ---------
For the years ended December 31, 1998 and 1997, the pension expense was $8.5
million and $7.1 million, respectively. 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 year ended December 31, 1996, the pension expense was $5.1
million.
The Company sponsors The WellPoint (401(k)) Retirement Savings Plan (the
"401(k) Plan"). Employees over 18 years of age are eligible to participate in
the 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% on the employee's contribution. Matching
contributions are immediately vested. Effective January 1, 1998, 33.3% of the
employer contribution was in the Company's common stock for all plan
participants. The employer contribution is 85% for only those employees with ten
to nineteen years of service as of January 1, 1997 and 100% for only those
employees with twenty years or more of service as of such date. Company expense
related to the 401(k) Plan totaled $13.0 million, $11.8 million and $8.2 million
for the years ended December 31, 1998, 1997 and 1996, respectively.
POSTRETIREMENT BENEFITS
The Company provides certain health care and life insurance benefits to
eligible retirees and their dependents. Certain employees acquired as a result
of the MMHD acquisition and all employees hired after January 1, 1997 are not
covered under the Company's postretirement benefit plan. All other Company
employees are fully eligible for retiree benefits upon attaining 10 years of
service and a minimum age of 55. The plan in effect for those retiring prior to
September 1, 1994 provides for Company-paid life insurance for all retirees
based on age and a percent of salary. In addition, the majority of retirees from
age 62 or greater currently receive fully paid health benefit coverage for
themselves and their dependents. For employees retiring on or after September 1,
1994, the Company currently subsidizes health benefit coverage based on the
retiree's years of service at retirement and date of hire. Life insurance
benefits for retirees hired on or after May 1, 1992 are set at $10,000 upon
retirement and are reduced to $5,000 at age 70.
F-22
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, 1998 and 1997 are as follows (in
thousands):
DECEMBER 31,
--------------------
1998 1997
--------- ---------
Benefit obligation at the beginning of the year........... $ 54,687 $ 47,866
Service cost.............................................. 1,780 1,980
Interest cost............................................. 3,843 3,783
Actuarial loss (gain)..................................... (2,080) 3,395
Benefits paid............................................. (1,906) (2,337)
--------- ---------
Accumulated postretirement benefits obligation............ 56,324 54,687
Unrecognized net gain from accrued postretirement benefit
cost.................................................... 10,734 9,204
--------- ---------
Accrued postretirement benefits........................... $ 67,058 $ 63,891
--------- ---------
--------- ---------
The Company currently pays for its postretirement benefit obligations as
they are incurred. As such, there are no plan assets.
The above actuarially determined APBO was calculated using discount rates of
7.00% and 7.25% as of December 31, 1998 and 1997, respectively. The medical
trend rate is assumed to decline gradually from 11% (under age 65) and 9% (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, 1998 by $8.3 million and would increase service and interest costs by $1.0
million. Conversely, a decrease in the assumed health care trend rate of one
percent in each year would decrease the APBO as of December 31, 1998 by $7.2
million and would decrease service and interest costs by $0.9 million. For life
insurance benefit calculations, a compensation increase of 5.0% was assumed.
Net periodic postretirement benefit cost includes the following components
(in thousands):
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
Service cost........................................ $ 1,780 $ 1,980 $ 2,047
Interest cost....................................... 3,843 3,783 3,490
Net amortization and deferral....................... (550) (621) (438)
--------- --------- ---------
Net periodic postretirement benefit cost............ $ 5,073 $ 5,142 $ 5,099
--------- --------- ---------
--------- --------- ---------
10. COMMON STOCK
STOCK OPTION PLANS
In 1996, the Company adopted an Employee Stock Option Plan (the "Employee
Option Plan"). In May 1996, all eligible employees were granted options to
purchase common stock under the Employee Option Plan. The exercise price of
options granted under the Employee Option Plan is the fair market value of the
Common Stock on the date of the grant. Each option granted has a maximum term of
F-23
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. COMMON STOCK (CONTINUED)
10 years. The options granted in 1998, 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 2.3 million shares, subject to adjustment for
certain changes in the Company's capital structure.
In 1996, the Company also implemented a Stock Option/Award Plan (the "Stock
Option/Award Plan") for key employees, officers and directors. The exercise
price per share is fixed by the committee appointed by the Board of Directors to
administer the Stock Option/Award Plan, but for any incentive stock option, the
exercise price will not be less than the fair market value on the date of grant.
The number of shares that may be issued under the Stock Option/Award Plan will
not exceed 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 and
phantom stock.
The following summarizes activity in the Company's stock option plans for
the years ended December 31, 1998, 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
----------
Granted........................................................ 1,533,908 56.86
Canceled....................................................... (296,993) 43.66
Exercised...................................................... (836,400) 37.67
----------
Outstanding at December 31, 1998............................... 4,499,238 44.23
----------
----------
Exercisable at:
December 31, 1996.............................................. 135,548 39.68
December 31, 1997.............................................. 1,077,221 39.32
December 31, 1998.............................................. 1,801,311 40.65
F-24
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. COMMON STOCK (CONTINUED)
The options outstanding at December 31, 1998 have exercise prices ranging
from $26.85 to $82.25 per share.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------- --------------------------
WEIGHTED WEIGHTED
NUMBER WEIGHTED AVERAGE AVERAGE NUMBER AVERAGE
ACTUAL RANGE OUTSTANDING REMAINING EXERCISE OUTSTANDING EXERCISE
OF EXERCISE PRICES AT 12/31/98 CONTRACTUAL LIFE PRICE AT 12/31/98 PRICE
- ------------------------------ ----------- ----------------- ------------- ----------- -------------
$26.85-39.68.................. 2,810,612 7.3 $ 37.17 1,603,718 $ 38.61
$42.31-62.19.................. 1,630,908 9.0 $ 55.28 159,415 $ 52.28
$65.00-82.25.................. 57,718 8.7 $ 75.51 38,178 $ 77.53
----------- -----------
4,499,238 7.9 $ 44.23 1,801,311 $ 40.65
----------- -----------
----------- -----------
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. During the years ended December
31, 1998, 1997 and 1996, approximately 99,300, 50,700 and 43,000 shares of
common stock were purchased under the ESPP. Beginning in 1998, there are two
offering periods for the first half and second half of the year, and
accordingly, two purchase prices of $35.91 and $57.35 per share. For the years
ended December 31, 1997 and 1996, purchase prices totaled $29.22 and $22.53 per
share, respectively.
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, 1998, 1997 and 1996 would
have been reduced to the pro forma amounts indicated in the table which follows:
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS) 1998 1997 1996
--------- --------- ---------
Net income--as reported.............................................................. $ 231.3 $ 227.4 $ 202.0
Net income--pro forma................................................................ $ 218.6 $ 218.2 $ 190.9
Earnings per share--as reported...................................................... $ 3.35 $ 3.30 $ 3.04
Earnings per share--pro forma........................................................ $ 3.16 $ 3.17 $ 2.87
Earnings per share assuming full dilution--as reported............................... $ 3.29 $ 3.27 $ 3.04
Earnings per share assuming full dilution--pro forma................................. $ 3.11 $ 3.14 $ 2.87
F-25
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. COMMON STOCK (CONTINUED)
1998
ASSUMPTIONS OFFICERS EMPLOYEES
------------ ------------
Expected dividend yield................. -- --
Risk-free interest rate................. 5.38% 5.35%
Expected stock price volatility......... 37.00% 37.00%
Expected life of options................ four years three years
1997
ASSUMPTIONS OFFICERS EMPLOYEES
------------ ------------
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
ASSUMPTIONS OFFICERS EMPLOYEES
------------ ------------
Expected dividend yield................. -- --
Risk-free interest rate................. 6.40% 6.21%
Expected stock price volatility......... 35.68% 37.16%
Expected life of options................ five years three years
The above pro forma disclosures may not be representative of the effects on
reported pro forma net income for future years. The weighted average fair value
of options granted during 1998, 1997 and 1996 is $18.72, $13.72 and $15.74 per
share, respectively.
During the year ended December 31, 1998, the Company was authorized to
repurchase eight million shares of its common stock. This treasury stock
acquisition was executed in anticipation of the pending Cerulean transaction in
which Cerulean stockholders will receive cash and WellPoint Common Stock with an
aggregate market value of $500 million. As of December 31, 1998, 3.5 million
shares of common stock were repurchased pursuant to this authorization.
11. DISCONTINUED OPERATIONS
During 1998, the Company discontinued its workers' compensation business
segment. On July 29, 1998, the Company entered into an agreement to sell its
workers' compensation business to Fremont Indemnity Company for approximately
$110.0 million. The Company received proceeds of $101.4 million as of the
closing date, representing the initial purchase price as defined in the
agreement. The transaction closed on September 1, 1998. Accordingly, the
consolidated financial statements for all periods presented have been restated.
Revenues for the workers' compensation segment totaled $24.0 million for the
period beginning July 1, 1998, the measurement date, through the date of sale,
and $94.6 million for the period beginning January 1, 1998 through the date of
sale. Revenues totaled $184.2 million and $199.0 million for the years ended
December 31, 1997, and 1996, respectively.
F-26
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. 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 earning per share ("EPS"). There were no antidilutive
securities in any of the three periods presented.
YEAR ENDED DECEMBER 31,
----------------------------------
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE) 1998 1997 1996
---------- ---------- ----------
Income from continuing operations............................................ $ 319,548 $ 229,437 $ 198,518
Income (loss) from discontinued operations................................... (88,268) (2,028) 3,484
---------- ---------- ----------
Net Income................................................................... $ 231,280 $ 227,409 $ 202,002
---------- ---------- ----------
---------- ---------- ----------
Weighted average shares outstanding.......................................... 69,099 68,811 66,433
Net effect of dilutive stock options......................................... 1,160 651 --
---------- ---------- ----------
Fully diluted weighted average shares outstanding............................ 70,259 69,462 66,433
---------- ---------- ----------
---------- ---------- ----------
EARNINGS PER SHARE:
Income from continuing operations............................................ $ 4.63 $ 3.33 $ 2.99
Income (loss) from discontinued operations................................... (1.28) (0.03) 0.05
---------- ---------- ----------
Net Income................................................................... $ 3.35 $ 3.30 $ 3.04
---------- ---------- ----------
---------- ---------- ----------
EARNINGS PER SHARE ASSUMING FULL DILUTION:
Income from continuing operations............................................ $ 4.55 $ 3.30 $ 2.99
Income (loss) from discontinued operations................................... (1.26) (0.03) 0.05
---------- ---------- ----------
Net Income................................................................... $ 3.29 $ 3.27 $ 3.04
---------- ---------- ----------
---------- ---------- ----------
The number of shares outstanding for the year ended December 31, 1996 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, plus the weighted
average number of shares issued during 1996 after completion of the
Recapitalization.
13. LEASES
Effective January 1, 1996, the Company entered into a new lease agreement
for a 24-year period for Blue Cross of California's Woodland Hills, California
Headquarters facility, 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 22 years with certain
options to renew. Certain lease agreements provide for escalation of payments
which are based on fluctuations in certain published cost-of-living indices.
Future minimum rental payments under operating leases utilized by the Company
F-27
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. LEASES (CONTINUED)
having initial or remaining noncancellable lease terms in excess of one year at
December 31, 1998 are as follows:
(IN THOUSANDS)
YEAR ENDING DECEMBER 31,
- ----------------------------------------------------------------------------------
1999.............................................................................. $ 42,528
2000.............................................................................. 39,891
2001.............................................................................. 33,953
2002.............................................................................. 18,803
2003.............................................................................. 14,615
Thereafter........................................................................ 240,347
----------
Total payments required......................................................... $ 390,137
----------
----------
Rental expense for the years ended December 31, 1998, 1997 and 1996 for all
operating leases was $43.4 million, $33.3 million and $16.1 million,
respectively. Contingent rentals included in the above rental expense for the
years ended December 31, 1998 and 1997 were $0.6 million and $0.3 million,
respectively. There were no contingent rentals for the year ended December 31,
1996.
14. RELATED PARTY TRANSACTIONS
Prior to the Recapitalization in May 1996, and pursuant to the
Administrative Services and Product Marketing Agreement between 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 reasonable and appropriate.
Intercompany charges between the Company and BCC for the respective period
prior to the Recapitalization were as follows:
JANUARY 1,
TO
(IN THOUSANDS) MAY 20, 1996
------------
Services provided by BCC........................................................ $ 13,601
Services provided to BCC........................................................ (3,931)
------------
Net intercompany charges included in general and administrative expense......... $ 9,670
------------
------------
As required by the DOC prior to the Recapitalization, non-contract provider
services under the Company and BCC's jointly marketed Prudent Buyer and Medicare
supplement products were required to be provided by BCC, and revenues
attributable to such non-contract provider services were, therefore, not
included in the Company's consolidated financial statements prior to May 20,
1996. BCC recorded a
F-28
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. RELATED PARTY TRANSACTIONS (CONTINUED)
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 Blue Cross Blue Shield Association ("BCBSA")
(which included BCC). For the period January 1, 1996 through May 20, 1996, 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 was $59.3
million.
Operating income recognized by BCC on such non-contract provider services
for the period from January 1, 1996 through May 20, 1996 was $1.2 million. 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 1998, 1997 and 1996
consolidated financial statements subsequent to the Recapitalization date.
15. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value
of each class of financial instrument:
CASH AND CASH EQUIVALENTS. The carrying amount approximates fair value,
based on the short-term maturities of these instruments.
INVESTMENT SECURITIES. The carrying amount approximates fair value,
based on quoted market prices for the same or similar instruments.
LONG-TERM INVESTMENTS. The carrying amount approximates fair value,
based on quoted market prices for the same or similar instruments and at
cost for certain equity investments.
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 quoted market prices by the financial institutions which are the
counterparties to the swaps.
FOREIGN CURRENCY CONTRACTS. The fair value of the foreign currency
contracts is based on quoted market prices by the financial institutions
which are the counterparties to the contracts.
The carrying amounts and estimated fair values of the Company's financial
instruments as of December 31, 1998 are summarized below:
CARRYING ESTIMATED
(IN THOUSANDS) AMOUNT FAIR VALUE
------------ ------------
Cash and cash equivalents......................................... $ 410,875 $ 410,875
Investment securities............................................. 2,250,174 2,250,174
Long-term investments............................................. 103,253 103,253
Long-term debt.................................................... 300,000 300,000
Interest rate swaps............................................... (4,477) (29,128)
Foreign currency contracts........................................ 1,052 1,052
F-29
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
16. HEDGING ACTIVITIES
The Company utilizes interest rate swap agreements and foreign currency
contracts to manage interest rate and foreign currency exposures. The principal
objective of such contracts is to minimize the risks and/or costs associated
with financial and investing activities. The Company does not utilize financial
instruments for trading or speculative purposes. The counterparties to these
contractual arrangements are major financial institutions with which the Company
also has other financial relationships. These counterparties expose the Company
to credit loss in the event of non-performance. However, the Company does not
anticipate non-performance by the other parties.
INTEREST RATE SWAP AGREEMENTS: In 1996, the Company entered into three
interest rate swap agreements to reduce the impact of changes in interest rates
on its floating rate debt under its revolving credit facility. The swap
agreements are contracts to exchange variable-rate (weighted average rate for
1998 of 5.8%) for fixed-rate interest payments (weighted average rate for 1998
of 7.1%) without the exchange of the underlying notional amounts. The agreements
mature at various dates through 2006.
The notional amounts of the interest rate swap agreements are used to
measure interest to be paid and do not represent the amount of exposure to
credit loss. For interest rate instruments that effectively hedge interest rate
exposures, the net cash amounts paid on the agreements are accrued and
recognized as an adjustment to interest expense. If an agreement no longer
qualifies as a hedge instrument, then it is marked to market and carried on the
balance sheet at fair value. For the year ended December 31, 1998, the Company
recognized a charge of $4.5 million for the market value decrease on the
interest rate swap agreements not serving as a hedge. As of December 31, 1998,
the notional amount of such contracts was $100 million.
As of December 31, 1998 the Company had the following interest rate swap
agreements in effect (notional amount in thousands):
NOTIONAL AMOUNT STRIKE RATE EXPIRATION DATE
- -------------------------------------------------------------------------------- ------------- -------------------
$100,000........................................................................ 6.45% August 17, 1999
$150,000........................................................................ 6.99% October 17, 2003
$150,000........................................................................ 7.05% October 17, 2006
FOREIGN EXCHANGE CONTRACTS: As part of the Company's investment strategy to
diversify and obtain a higher rate of return on its investment portfolio, the
Company has invested in certain fixed maturity securities denominated in foreign
currencies. In order to mitigate the foreign currency risk, the Company has
entered into two types of foreign currency derivative instruments. The first
type of instrument is a forward exchange contract which is entered into to hedge
the currency risk of a foreign currency investment transaction between the trade
date and the settlement date. Gains and losses related to such instruments are
recognized in the Company's income statement. For the year ended December 31,
1998, recognized a gain from such hedging activities of $0.5 million. No such
hedging activity occurred during the years ended December 31, 1997 and 1996.
The Company has also entered into foreign currency contracts for each of the
fixed maturity securities owned as of December 31, 1998 to hedge asset positions
denominated in other currencies. As of
F-30
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
16. HEDGING ACTIVITIES (CONTINUED)
December 31, 1998, the Company had the following foreign currency contracts in
effect (notional amount in thousands of U. S. dollars):
NOTIONAL AMOUNT SETTLEMENT DATE
-------------------- --------------------
CURRENCY BUY SELL BUY SELL
- -------------------------------------------------- --------- --------- --------- ---------
British pound..................................... $ 3,843 02/01/99
German mark....................................... $ 8,130 $ 37,904 02/22/99 02/22/99
Danish kroner..................................... $ 7,932 02/19/99
French franc...................................... $ 108 $ 15,879 02/19/99 02/19/99
The unrealized gains and losses from effective forward exchange contracts
are reflected in other comprehensive income. As of December 31, 1998, the
unrealized losses arising from the above forward exchange contracts amounted to
$1.7 million. As of December 31, 1997, the Company had no such hedges
outstanding. The unrealized gains and losses from ineffective foreign currency
contracts are reflected in the Company's income statement. For the year ended
December 31, 1998, the Company recognized a gain from such hedging activities of
$2.7 million. No such hedging activity occurred during the years ended December
31, 1997 and 1996.
17. 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, cash flows or financial condition.
18. 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.
F-31
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
19. 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, 1998, the Company and its regulated
subsidiaries were in compliance with these requirements.
The ability of the Company's licensed insurance company subsidiaries to pay
dividends is limited by the department of insurance in their respective states
of domicile. Generally, dividends in any 12-month period are limited to the
greater of the prior year's statutory net income or 10% of statutory surplus.
Larger dividends, classified as extraordinary, require a special request of the
respective department of insurance. The maximum dividend payable in 1999 without
prior approval by WellPoint's licensed insurance company subsidiaries is $74.9
million.
20. FISCAL INTERMEDIARY FUNCTION
Under an agreement with the BCBSA, the Company has contracted to administer
Part A of Title XVIII of the Social Security Act (Medicare) in certain regions
or for certain health care providers. The agreement is renewable annually unless
terminated by the parties involved. As fiscal intermediary under the agreement,
the Company makes disbursements to providers for medical care from funds
provided by the Federal Government and is reimbursed for these expenses incurred
under the agreement. The Company disbursed approximately $8.5 billion, $8.4
billion and $4.6 billion and received administrative fees of approximately $34.3
million, $29.9 million and $16.4 million for the years ended December 31, 1998,
1997 and 1996, respectively. The reimbursement is treated as a direct recovery
of general and administrative expenses.
21. BUSINESS SEGMENT INFORMATION
The Company adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" in the fourth quarter of 1998.
The Company has two reportable segments: the California business segment and
the National business segment. The California and National business segments
both provide a broad spectrum of network-based health plans, including health
maintenance organizations, preferred provider organizations, point of service
plans, other hybrid plans and traditional indemnity products to large and small
employers, individuals and seniors.
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies and are consistent with generally
accepted accounting principles with the exception of the exclusion of allocated
corporate overhead to the reportable segments.
The Company's management identified its reportable segments based upon the
following factors: (1) The Company's organizational structure contains Division
Presidents that oversee each of these segments, (2) The Company's Chief
Operating Decision Maker (Chief Executive Officer) reviews the results of
operations for each of the following segments and holds each Division President
accountable for results, and (3) A Division President's overall compensation is
based upon the related segment's results.
F-32
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
21. BUSINESS SEGMENT INFORMATION (CONTINUED)
The following tables present segment information for the California and
National Divisions as of and for the years ended December 31, 1998, 1997 and
1996:
1998
CORPORATE &
(IN THOUSANDS) CALIFORNIA NATIONAL OTHER CONSOLIDATED
------------- ------------- ---------------- ------------------
Premium revenue......................... $ 4,832,704 $ 1,102,108 $ -- $ 5,934,812
Managment services revenue.............. 113,204 293,020 27,736 433,960
------------- ------------- ---------------- ------------------
Total revenue from external customers... 4,945,908 1,395,128 27,736 6,368,772
Intercompany revenue.................... 13,922 -- (13,922) --
Investment income....................... 76,451 65,913 (32,786) 109,578
Interest expense........................ -- 26,838 65 26,903
Depreciation and amortization expense... 25,451 23,876 7,354 56,681
Income tax expense (benefit)............ 209,481 15,531 (152,574) 72,438
Loss from discontinued operations....... (83,410) (942) (3,916) (88,268)
Segment net income (loss)............... 229,588 19,369 (17,677) 231,280
------------- ------------- ---------------- ------------------
------------- ------------- ---------------- ------------------
Segment assets.......................... $ 1,663,343 $ 1,563,318 $ 999,173 $ 4,225,834
------------- ------------- ---------------- ------------------
------------- ------------- ---------------- ------------------
1997
CORPORATE &
(IN THOUSANDS) CALIFORNIA NATIONAL OTHER CONSOLIDATED
------------- ------------- ---------------- ------------------
Premium revenue......................... $ 4,000,241 $ 1,068,706 $ -- $ 5,068,947
Managment services revenue.............. 75,779 277,308 24,051 377,138
------------- ------------- ---------------- ------------------
Total revenue from external customers... 4,076,020 1,346,014 24,051 5,446,085
Intercompany revenue.................... 39,510 -- (39,510) --
Investment income....................... 70,259 59,254 66,640 196,153
Interest expense........................ 1,099 34,322 1,237 36,658
Depreciation and amortization expense... 22,843 21,568 6,199 50,610
Income tax expense (benefit)............ 181,918 4,918 (29,919) 156,917
Income (loss) on discontinued
operations............................ (8,203) (2,414) 8,589 (2,028)
Segment net income (loss)............... 255,969 8,485 (37,045) 227,409
------------- ------------- ---------------- ------------------
------------- ------------- ---------------- ------------------
Segment assets.......................... $ 1,473,811 $ 1,708,038 $ 1,052,275 $ 4,234,124
------------- ------------- ---------------- ------------------
------------- ------------- ---------------- ------------------
F-33
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
21. BUSINESS SEGMENT INFORMATION (CONTINUED)
1996
CORPORATE &
(IN THOUSANDS) CALIFORNIA NATIONAL OTHER CONSOLIDATED
------------- ------------- ---------------- ------------------
Premium revenue......................... $ 3,169,662 $ 529,675 $ -- $ 3,699,337
Managment services revenue.............. 54,724 93,187 -- 147,911
------------- ------------- ---------------- ------------------
Total revenue from external customers... 3,224,386 622,862 -- 3,847,248
Intercompany revenue.................... 16,894 -- (16,894) --
Investment income....................... 66,322 24,251 33,011 123,584
Interest expense........................ -- 19,407 17,221 36,628
Depreciation and amortization expense... 17,410 9,688 2,223 29,321
Income tax expense (benefit)............ 168,437 908 (30,627) 138,718
Income (loss) on discontinued
operations............................ (9,493) (1,677) 14,654 3,484
Segment net income (loss)............... 191,803 499 9,700 202,002
------------- ------------- ---------------- ------------------
------------- ------------- ---------------- ------------------
RECONCILIATIONS
(IN THOUSANDS)
DECEMBER 31,
--------------------------
ASSETS (1) 1998 1997
- ---------------------------------------------------------------------- ------------ ------------
Total assets from reportable segments................................. $ 3,226,661 $ 3,181,849
Corporate and other assets............................................ 999,173 853,863
Goodwill not allocated to segments (corporate)........................ -- 198,412
------------ ------------
Consolidated total.................................................. $ 4,225,834 $ 4,234,124
------------ ------------
------------ ------------
- ------------------------
(1) Segment balance sheet data for 1996 is not presented as it is impracticable
to do so.
22. COMPREHENSIVE INCOME
The following summarizes comprehensive income reclassification adjustments
included in the statements of changes in stockholders' equity:
DECEMBER 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
Holding gain (loss) on investment securities arising during the period (net of
tax expense of $24,218, and tax benefit of $20,581, and $14,519,
respectively)............................................................... $ 35,579 $ (30,236) $ (21,330)
Add: reclassification adjustment for realized gains (losses) on investment
securities (net of tax benefit of $14,237, and tax expense of $23,942 and
$6,478, respectively)....................................................... (20,916) 35,174 9,516
---------- ---------- ----------
Net gain recognized in other comprehensive income (net of tax expense of
$9,981, $3,361, and a tax benefit of $8,041, respectively).................. $ 14,663 $ 4,938 $ (11,814)
---------- ---------- ----------
---------- ---------- ----------
F-34
WELLPOINT HEALTH NETWORKS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
23. PENDING TRANSACTIONS
On July 9, 1998, the Company entered into an Agreement and Plan of Merger
(the "Merger Agreement") with Cerulean Companies, Inc. ("Cerulean"). Upon
completion of this transaction (the "Merger"), Cerulean will become a wholly
owned subsidiary of WellPoint. Cerulean currently holds the exclusive license to
use the Blue Cross and Blue Shield names and marks in the state of Georgia.
Cerulean is the parent company of Blue Cross and Blue Shield of Georgia, Inc.,
which serves approximately 1.6 million members in the State of Georgia as of
December 31, 1998. At the effective time of the Merger, the shareholders of
Cerulean will receive WellPoint Common Stock with a market value of $500 million
(subject to certain adjustments provided in the merger agreement). Certain
shareholders of Cerulean will have the option to receive cash in lieu of
WellPoint Common Stock in the Merger, subject to a maximum aggregate limit of
$225 million. The transaction is intended to qualify as a tax-free
reorganization for Cerulean shareholders that elect to receive WellPoint Common
Stock.
F-35