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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
/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: 1-12718
FOUNDATION HEALTH SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 95-4288333
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
21650 OXNARD STREET, WOODLAND HILLS, CA 91367
(Address of principal executive offices) (Zip Codes)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (818) 676-6978
Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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Class A Common Stock, $.001 par value New York Stock Exchange, Inc.
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: None
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 this Form 10-K or any amendment to this
Form 10-K. ( )
The aggregate market value of the voting stock held by non-affiliates of the
registrant at March 29, 1999 was $1,325,343,786 (which represents 119,805,088
shares of Class A Common Stock held by such non-affiliates multiplied by
$11.0625, the closing sales price of such stock on the New York Stock Exchange
on March 29, 1999).
The number of shares outstanding of the registrant's Class A Common Stock as
of March 12, 1999 was 120,319,926 (excluding 3,194,374 shares held as treasury
stock), and 5,047,642 shares of the registrant's Class B Common Stock were
outstanding as of such date.
DOCUMENTS INCORPORATED BY REFERENCE:
Part II of this Form 10-K incorporates by reference certain information from
the registrant's Annual Report to Stockholders for the year ended December 31,
1998 ("Annual Report to Stockholders"). Part III of this Form 10-K incorporates
by reference certain information from the registrant's definitive proxy
statement to be filed with the Securities and Exchange Commission within 120
days after the close of the year ended December 31, 1998.
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PART I
ITEM 1. BUSINESS
Foundation Health Systems, Inc. (the "Company" or "FHS") is an integrated
managed care organization which administers the delivery of managed health care
services. The Company's health maintenance organizations ("HMOs"), insured
preferred provider organizations ("PPOs"), and government contracts subsidiaries
provide health benefits to 5.8 million individuals in 21 states through group,
individual, Medicare risk, Medicaid, and Civilian Health and Medical Program of
the Uniformed Services ("CHAMPUS") programs. The Company's subsidiaries also
offer managed health care products related to behavioral health, dental and
vision services, and offer managed health care product coordination for
multi-region employers and administrative services for medical groups and
self-funded benefits programs. The Company operates and conducts its HMO and
other businesses through its subsidiaries.
The Company currently operates within two segments of the managed health
care industry: Health Plan Services and Government Contracts/Specialty Services.
For a portion of 1998, the Company also operated a risk-assuming workers'
compensation insurance business, which represented a separate segment of
business. Such risk-assuming workers' compensation business was sold in December
1998, and is reported as "Discontinued Operations and Anticipated Divestitures."
During 1998, the Health Plan Services segment consisted of four regional
divisions: Arizona (Arizona and Utah), California (encompassing only the state
of California), Central (Colorado, Florida, Idaho, Louisiana, New Mexico, Ohio,
Oklahoma, Oregon, Pennsylvania, Texas, Washington and West Virginia) and
Northeast (Connecticut, New Jersey and New York). Effective January 1, 1999, the
Company slightly reorganized such divisions and moved the Ohio, Pennsylvania and
West Virginia operations from the Central Division to the Northeast Division.
The Company is one of the largest managed health care companies in the United
States, with approximately 4.2 million full-risk and administrative services
only ("ASO") members in its Health Plan Services segment. The Company also
operates PPO networks providing access to health care services to over 4 million
individuals in 37 states and owns six health and life insurance companies
licensed to sell insurance in 33 states and the District of Columbia.
The Company's HMOs market traditional HMO products to employer groups and
Medicare and Medicaid products to employer groups and directly to individuals.
Health care services that are provided to the Company's commercial and
individual members include primary and specialty physician care, hospital care,
laboratory and radiology services, prescription drugs, dental and vision care,
skilled nursing care, physical therapy and mental health. The Company's HMO
service networks include approximately 43,000 primary care physicians and
108,000 specialists.
The Company's Government Contracts/Specialty Services segment consists of
the Government Contracts Division and the Specialty Services Division. The
Company's Government Contracts Division oversees the provision of contractual
services to federal government programs such as CHAMPUS. The Company receives
revenues for administrative and management services and, under most of its
contracts, also accepts financial responsibility for a portion of the health
care costs. The Company's Specialty Services Division oversees the provision of
supplemental programs to enrollees in the Company's HMOs, as well as to members
whose basic medical coverage is provided by non-FHS companies, including vision
coverage, dental coverage, managed behavioral health programs and a prescription
drug program. The Specialty Services Division consists both of operations in
which the Company assumes underwriting risk in return for premium revenue, and
operations in which the Company provides administrative services only, including
certain of the behavioral health and pharmacy benefits management programs. Such
Division also provides certain bill review and third party administrative
services as described elsewhere in this Annual Report. The Company has entered
into a definitive agreement for the sale of certain of its pharmacy benefit
processing services. See "Discontinued Operations and Anticipated Divestitures."
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The Company continues to evaluate the profitability realized or likely to be
realized by its existing businesses and operations, and the opportunities to
expand its businesses in profitable markets. The Company is reviewing the
strategic importance of each of its businesses and operations, focusing its
resources on its core and strong-performing businesses, and divesting itself of
certain non-core and lesser-performing operations. Accordingly, in 1998 the
Company sold its risk-assuming workers' compensation operations and certain
member support center operations located in Philadelphia, and entered into a
definitive agreement to sell its HMO operations in Louisiana, Oklahoma and
Texas. In February 1999, the Company also entered into a definitive agreement
for the sale of certain of its pharmacy benefit processing services. In
addition, in March of 1999, the Company entered into a definitive agreement to
sell its New Mexico operations, and signed a letter of intent to sell its
Colorado operations. The Company has also undertaken to purchase the remaining
minority interests of FOHP, Inc., a majority-owned subsidiary of the Company
which owns a managed health care company in New Jersey. See "Discontinued
Operations and Anticipated Divestitures" and "Other Information--Recent
Developments."
The Company was incorporated in 1990. The current operations of the Company
are the result of the April 1, 1997 merger transaction (the "FHS Combination")
involving Health Systems International, Inc. ("HSI") and Foundation Health
Corporation ("FHC"). Pursuant to the Agreement and Plan of Merger (the "Merger
Agreement") that evidenced the FHS Combination, FH Acquisition Corp., a
wholly-owned subsidiary of HSI, merged with and into FHC and FHC survived as a
wholly-owned subsidiary of HSI, which changed its name to "Foundation Health
Systems, Inc." and thereby became the Company. Under the Merger Agreement, FHC
stockholders received 1.3 shares of the Company's Class A Common Stock for every
share of FHC common stock held. The shares of the Company's Class A Common Stock
issued to FHC's stockholders in the FHS Combination constituted approximately
61% of the outstanding stock of the Company after the FHS Combination and the
shares held by the Company's stockholders prior to the FHS Combination (i.e.,
the prior stockholders of HSI) constituted approximately 39% of the outstanding
stock of the Company after the FHS Combination.
The FHS Combination was accounted for as a pooling of interests for
accounting and financial reporting purposes. The pooling of interests method of
accounting is intended to present, as a single interest, two or more common
stockholder interests which were previously independent and assumes that the
combining companies have been merged from inception. Consequently, the Company's
consolidated financial statements incorporated by reference into this Annual
Report on Form 10-K have been prepared and/or restated as though HSI and FHC
always had been combined on a calendar year basis.
Prior to the FHS Combination, the Company was the successor to the business
conducted by Health Net, now the Company's HMO subsidiary in California, which
became a subsidiary of the Company in 1992, and HMO and PPO networks operated by
QualMed, Inc. ("QualMed"), which combined with the Company in 1994 to create
HSI. FHC was incorporated in Delaware in 1984. The executive offices of the
Company are located at 21650 Oxnard Street, Woodland Hills, CA 91367. Except as
the context otherwise requires, the term the "Company" refers to FHS and its
subsidiaries.
HEALTH PLAN DIVISIONS
HMO AND PPO OPERATIONS. The Company's HMOs offer members a comprehensive
range of health care services, including ambulatory and outpatient physician
care, hospital care, pharmacy services, eye care, behavioral health and
ancillary diagnostic and therapeutic services. The Company offers a full
spectrum of managed health care products.
The integrated health care programs offered by the Company's HMOs include
products offered through both traditional Network Model HMOs (in which the HMOs
contract with individual physicians, physician groups and independent or
individual practice associations ("IPAs")) and IPA Model HMOs (in which the HMOs
contract with one or more IPAs that in turn subcontract with individual
physicians to provide HMO patient services) which offer quality care, cost
containment and comprehensive coverage; a
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matrix package which allows employees to select their desired coverage from
alternatives that have interchangeable outpatient and inpatient co-payment
levels; point-of-service programs which offer a multi-tier design that provides
both conventional HMO and indemnity-like (in-network and out-of-network) tiers;
a PPO-like tier which allows members to self-refer to the network physician of
their choice; and a managed indemnity plan which is provided for employees who
reside outside of their HMO service areas. The Company's PPO subsidiaries
consist of networks of health care providers which offer their services to
health care third-party payors, such as insurers and self-funded employers.
The Company's strategy is to offer a wide range of managed health care
products and services to employers to assist them in containing health care
costs. The pricing of the products offered is designed to provide incentives to
both employers and employees to select and enroll in the products with greater
managed health care and cost containment elements. In general, the Company's HMO
subsidiaries provide comprehensive health care coverage for a fixed fee or
premium that does not vary with the extent or frequency of medical services
actually received by the member. PPO enrollees choose their medical care from
among the various contracting providers or choose a non-contracting provider and
are reimbursed on a traditional indemnity plan basis after reaching an annual
deductible. The Company assumes both underwriting and administrative expense
risk in return for the premium revenue it receives from its HMO and PPO
products. The HMOs and PPOs have contractual relationships with health care
providers for the delivery of health care to the Company's enrollees. While a
majority of the Company's members are covered by conventional HMO products, the
Company is continuing to expand its other product lines, thereby enabling it to
offer flexibility to an employer and to tailor its products to an employer's
particular needs.
The following table contains certain information relating to commercial HMO
and PPO members, Medicare members and employer groups under contract as of
December 31, 1998 in each region in which the Company operated (excluding
point-of-service):
ARIZONA CALIFORNIA CENTRAL NORTHEAST
DIVISION DIVISION DIVISION DIVISION
--------- ---------- --------- -----------
Commercial HMO and PPO Members.................. 294,032 1,534,961 514,786 782,403
Medicare Members (risk only).................... 51,280 150,650 61,756 58,486
Medicaid Members................................ -- 438,942 61,671 84,820
In addition, the following sets forth certain data regarding the Company's
employer groups in its commercial managed care operations of its Health Plan
Divisions as of December 31, 1998:
Number of Employer Groups........................................... 63,729
Largest Employer Group as % of enrollment........................... 4.8%
10 largest Employer Groups as % of enrollment....................... 17.6%
ARIZONA DIVISION
In Arizona, the Company believes that its commercial managed care operations
rank it second largest both as measured by total membership and by size of
provider network. The Company's commercial HMO membership in Arizona was 286,540
as of December 31, 1998. The Company's Medicare risk membership in Arizona was
51,280 as of December 31, 1998 which represented an increase of 8% during 1998.
The Company's commercial HMO membership in Utah was 7,492 as of December 31,
1998. The Arizona Division also oversees the Company's six health and life
insurance companies licensed to sell insurance in 33 states and the District of
Columbia.
4
CALIFORNIA DIVISION
The California market is characterized by a concentrated population. In mid
1998, the Company merged the operations of two of its California HMO
subsidiaries, Health Net and Foundation Health, a California Health Plan. The
resulting HMO, Health Net, is believed by the Company to be the third-largest
HMO in the state of California in terms of membership and the largest in terms
of size of provider network. The Company's commercial HMO membership in
California as of December 31, 1998 was 1,534,961, which represented a decrease
of 7% during 1998. The Company's Medicare risk membership in California as of
December 31, 1998 was 150,650, which represented a decrease of 1% during 1998.
The Company's Medicaid membership in California as of December 31, 1998 was
438,942 members.
CENTRAL DIVISION.
During 1998, the Central Division included Health Plan operations in
Colorado, Florida, Idaho, Louisiana, New Mexico, Ohio, Oklahoma, Oregon,
Pennsylvania, Texas, Washington and West Virginia. As of January 1, 1999, the
Health Plan operations in Ohio, Pennsylvania and West Virginia were moved to the
Northeast Division.
The Company believes that its Colorado HMO is the fifth largest HMO in the
state of Colorado as measured by total membership and second largest as measured
by size of provider network. The Company's commercial HMO membership in Colorado
was 77,269 as of December 31, 1998, which represented an increase of 1% during
1998. The Company's Medicare membership in Colorado was 10,324 as of December
31, 1998, which represented a decrease of 15% during 1998. As noted below in the
section of this Annual Report on Form 10-K entitled "Discontinued Operations and
Anticipated Divestitures," the company has entered into a letter of intent to
sell its Colorado HMO operations.
The Company believes its Florida HMO and PPO operations make it the ninth
largest HMO managed care provider in terms of membership and fifth largest HMO
in terms of size of provider network in the state of Florida. The Company's
commercial HMO membership in Florida was 84,508 as of December 31, 1998, which
represented a decrease of 9% during 1998. The Company's Medicare risk membership
in Florida was 24,891 as of December 31, 1998, which represented an increase of
4% during 1998. The Company's Medicaid membership in Florida was 28,318 as of
December 31, 1998, a 21% increase in 1998.
In New Mexico, the Company believes that its ranks sixth largest as measured
by total membership and tenth largest as measured by size of provider network.
The Company's commercial HMO membership in New Mexico was 29,924 as of December
31, 1998, which represented a decrease of 12% during 1998. The Company's
Medicare risk membership in New Mexico was 3,595 as of December 31, 1998, which
represented an increase of 55% during 1998. As noted below in the section of
this Annual Report on Form 10-K entitled "Discontinued Operations and
Anticipated Divestitures," the Company has entered into a definitive agreement
to sell its New Mexico HMO operations.
The Company's commercial HMO membership in eastern Pennsylvania was 47,990
as of December 31, 1998, which represented a decrease of 28% during 1998. The
Company's Medicare risk membership in eastern Pennsylvania was 14,033 as of
December 31, 1998, which represented a decrease of 7% during 1998. Collectively,
the Company's commercial HMO membership in Ohio, western Pennsylvania and West
Virginia was approximately 20,200 as of December 31, 1998. The Company's
Medicare risk membership in Ohio, western Pennsylvania and West Virginia was
approximately 2,600 collectively as of December 31, 1998.
The Company's Washington HMO services Seattle and Spokane and also services
a limited number of residents who reside in the state of Idaho. The Company's
Oregon HMO services Portland and its vicinity. In addition, an increasing
percentage of the population in each of these areas has enrolled in HMOs in the
last several years. In Washington and Oregon, the Company believes that it ranks
third and sixth,
5
respectively, with respect to total membership; the Company believes that it
ranks first in Washington and third in Oregon with respect to the size of its
primary care physician and specialist networks. The Company's commercial HMO and
PPO membership in Oregon was 131,889 as of December 31, 1998. At year end 1997,
the Company had 163,406 commercial members in Oregon. The Company's commercial
HMO and PPO membership in Washington was 105,372 as of December 31, 1998, which
represented an increase of 10% during 1998. The Company's Medicare risk
membership in Washington was 2,641 as of December 31, 1998, which represented a
decrease of 20% during 1998. The Company's Medicaid membership in Washington was
30,658 as of December 31, 1998, which represented an increase of 23% during
1998.
Collectively, the Company's commercial HMO membership in Texas, Oklahoma,
and Louisiana was 29,752 as of December 31, 1998. As noted below in the section
of this Annual Report on Form 10-K entitled "Discontinued Operations and
Anticipated Divestitures", the Company has entered into a definitive agreement
to sell these three HMOs.
NORTHEAST DIVISION.
During 1998, the Northeast Division included Company operations in
Connecticut, New Jersey and New York. As referenced above, effective January 1,
1999, the Company's operations in the states of Ohio, Pennsylvania and West
Virginia were moved from the Central Division to the Northeast Division.
In the Company's Northeast Division, the Company and The Guardian Life
Insurance Company of America ("The Guardian") together offer both HMO and
indemnity products through a joint venture doing business as "Healthcare
Solutions." In general, the Company and The Guardian share equally in the
profits of the joint venture, subject to certain terms of the joint venture
arrangement related to expenses. The Guardian is a mutual insurer (owned by its
policy owners) which offers financial products and services, including
individual life and disability income insurance, employee benefits, pensions and
401(k) products. The Guardian is headquartered in New York and has more than
2,000 agents distributing its products nationwide.
The Company believes its Connecticut HMO and PPO operations make it the
largest HMO managed care provider in terms of membership and size of provider
network in the state of Connecticut. The Company's commercial HMO membership in
Connecticut was 356,113 as of December 31, 1998 (including 48,415 members under
The Guardian arrangement), an increase of approximately 5% since the end of
1997. The Company's Medicare risk membership in Connecticut was 44,627 as of
December 31, 1998, which represented an increase of 70% during 1998, and the
Company's Medicaid membership in Connecticut was 62,649 as of December 31, 1998,
which represented an increase of 33% during 1998.
The Company believes its New Jersey HMO and PPO operations make it the third
largest HMO managed care provider in terms of membership and the largest in
terms of size of provider network in the state of New Jersey. The Company's
commercial HMO membership in New Jersey was 231,281 as of December 31, 1998
(including 77,260 members under The Guardian arrangement). The Company's
Medicare risk membership in New Jersey was 2,695 as of December 31, 1998 and the
Company's Medicaid membership in New Jersey was 22,171 as of December 31, 1998.
In New York, the Company had 187,285 members as of December 31, 1998, which
represented an increase of 25% during 1998. Such membership includes 88,164
members under The Guardian arrangement. The Company believes its New York HMO
and PPO operations make it the fifth largest HMO managed care provider in terms
of membership and the second largest in terms of size of provider network in the
state of New York.
MEDICARE RISK. The Company expanded its Medicare risk business in 1998 and,
as of December 31, 1998, the Company's Medicare risk plans had a combined
membership of approximately 322,171 compared to 309,333 as of December 31, 1997.
6
The Company offers its Medicare risk products directly to individuals and to
employer groups. To enroll in a Company Medicare risk plan, covered persons must
be eligible for Medicare. Health care services normally covered by Medicare are
provided or arranged for by the Company, in conjunction with a broad range of
preventive health care services. The federal Health Care Financing
Administration ("HCFA") pays to the Company for each enrolled member a monthly
fee based, in part, upon the "Adjusted Average Per Capita Cost," as determined
by HCFA's analysis of fee-for-service costs related to beneficiary demographics.
Depending on plan design and other factors, the Company may charge a member a
premium or prepaid charge.
The Company's California Medicare risk product, Seniority Plus, was licensed
and certified to operate in 25 California counties as of December 31, 1998. The
Company's other HMOs are licensed and certified to offer Medicare risk plans in
25 counties in Colorado, 10 counties in New Mexico, 6 counties in Washington, 9
counties in Pennsylvania, 34 counties in Oregon, 8 counties in Connecticut, 6
counties in Arizona, 3 counties in Florida, 21 counties in New Jersey and 11
counties in New York.
MEDICAID PRODUCTS. As of December 31, 1998, the Company had an aggregate of
approximately 585,500 Medicaid members, principally in California. To enroll in
these Medicaid products, an individual must be eligible for Medicaid benefits
under the appropriate state regulatory requirements. The respective HMOs offer,
in addition to standard Medicaid coverage, certain additional services including
dental and vision benefits. The applicable state agency pays the Company's HMOs
a monthly fee for each Medicaid member enrolled on a percentage of
fee-for-service costs. The Company has Medicaid members and operations in
California, Connecticut, Florida, New Jersey, New York and Washington.
ADMINISTRATIVE SERVICES ONLY BUSINESS. The Company also provides
third-party administrative services to large employer groups throughout its
service areas. Under these arrangements, the Company provides claims processing,
customer service, medical management and other administrative services without
assuming the risk for medical costs. The Company is generally compensated for
these services on a fixed per member per month basis.
INDEMNITY INSURANCE PRODUCTS. The Company offers indemnity products as
"stand-alone" products and as part of multiple option products in various
markets. These products are offered by the Company's six health and life
insurance subsidiaries which are licensed to sell insurance in 33 states and the
District of Columbia. Through these subsidiaries, the Company also offers HMO
members certain auxiliary non-health products such as group life and accidental
death and disability insurance.
Although the Arizona Division oversees the Company's health and life
insurance operations, such operations' products are provided throughout most of
the Company's service areas. The following table contains certain information
relating to such health and life insurance companies' insured PPO, point of
service ("POS"), indemnity and group life products as of December 31, 1998 in
each of the four Health Plan Divisions in which the Company operates:
ARIZONA CALIFORNIA CENTRAL NORTHEAST
DIVISION DIVISION DIVISION DIVISION
----------- ----------- ----------- -----------
Insured PPO Members................................ 0 28,955 32,721 18,888
Point of Service Members........................... 0 96,209 30,899 214,199(a)
Indemnity Members.................................. 9,142 9,213 1,039 0
Group Life Members................................. 3,364 34,923 23,594 0
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(a) Represents members under the Company's arrangement with The Guardian
described elsewhere in this Annual Report on Form 10-K.
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GOVERNMENT CONTRACTS DIVISION
CHAMPUS. The Company's wholly-owned subsidiary, Foundation Health Federal
Services, Inc. ("Federal Services"), administers large, multi-year managed care
federal contracts for the United States Department of Defense ("DoD").
Federal Services currently administers health care contracts for DoD's
TRICARE program covering 1.6 million eligible individuals under CHAMPUS. Through
the federal government's TRICARE program, Federal Services provides CHAMPUS
families with improved access to primary health care, lower out-of-pocket
expenses and fewer claims forms. Federal Services currently administers three
TRICARE contracts for five regions that cover the following states:
- Region 11: Washington, Oregon and part of Idaho
- Region 6: Texas, Arkansas, Oklahoma and part of Louisiana
- Regions 9, 10 and 12: California, Hawaii, Alaska and part of Arizona
During 1998, enrollment of CHAMPUS beneficiaries in the HMO option of the
TRICARE program for the Region 11 contract increased by 16% to 131,782 while the
total estimated number of eligible beneficiaries, based on DoD data, increased
by 5% to 248,928. During 1998, enrollment of CHAMPUS beneficiaries in the HMO
option of the TRICARE program for the Region 6 contract increased by 22% to
325,586 while the total estimated number of eligible beneficiaries, based on DoD
data, decreased by 1% to 619,688. During 1998, enrollment of CHAMPUS
beneficiaries in the HMO option of the TRICARE program for the Regions 9, 10 and
12 contract increased by 9% to 362,958 while the total estimated number of
eligible beneficiaries, based on DoD data and excluding Alaska, decreased by 15%
to 647,334 due to base realignments and closures.
Under the TRICARE contracts, Federal Services shares health care cost risk
with DoD for both gains and losses. Federal Services subcontracts to affiliated
and unrelated third parties for the administration and health care risk of parts
of these contracts. If all option periods are exercised by DoD and no extensions
of the performance period are made, health care delivery ends on February 29,
2000 for the Region 11 contract, on October 31, 2000 for the Region 6 contract,
and on March 31, 2001 for the Regions 9, 10 and 12 contract. The DoD
Authorization Act for government fiscal year 1999 authorized DoD to extend the
term of the current TRICARE contracts for two years. Federal Services and DoD
are currently negotiating modifications to the contracts for Region 11 and
Region 6 to add additional option periods which, if exercised, could extend the
period of health care delivery to February 28, 2002 for the Region 11 contract
and October 31, 2002 for the Region 6 contract. Federal Services expects to
negotiate a similar extension to the Regions 9, 10 and 12 contract. Federal
Services also expects to compete for the rebid of those contracts.
Federal Services protested to the U.S. General Accounting Office (the "GAO")
concerning the awards of TRICARE contracts for Region 1 (northeast states) and
for Regions 2 and 5 (mid-Atlantic and midwest states) to competitors of Federal
Services. The GAO sustained the protests and recommended that DoD conduct
another round of competition for these contracts. DoD filed petitions for
reconsideration of the protest decision by the GAO. The GAO denied DoD's
petition for reconsideration of the Regions 2 and 5 decision and DoD will
re-open competition for that contract on approximately April 1, 1999. Federal
Services expects to compete for the rebid of the contract for Regions 2 and 5.
Prior to the GAO deciding DoD's petition for reconsideration of the Region 1
protest decision, Federal Services entered into a litigation settlement
agreement with DoD and the Region 1 contractor whereby Federal Services agreed
not to seek the re-opening of competition for the Region 1 contract in exchange
for certain financial considerations from both the Region 1 contractor and DoD.
MEDICARE AND MEDICAID. During 1998, Federal Services administered contracts
with the states of Massachusetts, New Jersey, Georgia and Maryland to enroll
Medicaid eligible individuals in managed care
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programs within those states. Federal Services is not at risk for the provision
of any health care services under those contracts. Federal Services entered into
an agreement with MAXIMUS, Inc., effective December 24, 1997, to sell the
contracts for Massachusetts, New Jersey, Georgia, and Maryland. The contract
with the state of Maryland expired on June 30, 1998. The contracts with New
Jersey and Georgia have been novated to MAXIMUS, Inc., and novation of the
contract with Massachusetts is pending.
SPECIALTY SERVICES DIVISION
The Company's Specialty Services Division offers behavioral health, dental,
vision and pharmacy benefit management products and services as well as managed
care products related to bill review, administration and cost containment for
hospitals, health plans and other entities.
DENTAL AND VISION. Through DentiCare of California, Inc. ("DentiCare"), the
Company operates a dental HMO in California and Hawaii and performs dental
administrative services for an affiliate company in California and Colorado,
serving in the aggregate approximately 575,000 enrollees as of December 31,
1998. This enrollment includes 143,000 enrollees who are beneficiaries under
Medicaid dental programs, of which 42,000 enrollees are beneficiaries of
Hawaii's Medicaid program, and 184,000 enrollees who are also enrollees of
affiliated Health Plan companies. DentiCare is also a participant in
California's Healthy Families Program, with initial beneficiary enrollment and
service delivery commencing in July 1998. Acquired by the Company in 1991,
DentiCare has grown from total revenues in 1992 of $24 million to $46 million
for the year ended December 31, 1998.
Operating on administrative and information system platforms in common with
DentiCare is Foundation Health Vision Services, Inc., d.b.a. AVP Vision Services
("AVP"). AVP operates in California and Arizona and provides at-risk and
administrative services under various programs that result in the delivery of
vision benefits to over 636,000 enrollees. Total revenues from AVP operations
for the year ended December 31, 1998 exceeded $11 million. Since its acquisition
by the Company in 1992, AVP has grown from 30,000 covered enrollees to 374,000
enrollees in full-risk products and 262,000 enrollees covered under
administrative services contracts as of December 31, 1998.
Both DentiCare and AVP are licensed in California under the Knox-Keene
Health Care Service Plan Act of 1975, as amended (the "Knox-Keene Act"), as
Specialized Health Care Service Plans and compete with other HMOs, traditional
insurance companies, self-funded plans, PPOs and discounted fee-for-service
plans. The two companies share a common strategy to maximize the value and
quality of managed dental and vision care services while appropriately balancing
financial risk assumption among providers, enrollees and other entities to
achieve the effective and efficient use of available resources.
BEHAVIORAL HEALTH. Effective July 1, 1998, the Company's behavioral health
subsidiaries, Managed Health Network and Foundation Health Psychcare Services,
Inc. (collectively, "MHN"), each licensed in California under the Knox-Keene Act
as Specialized Health Care Service Plans, received regulatory approval of their
merger. MHN, directly and through Specialty Services affiliates, offers
behavioral health, substance abuse and employee assistance programs ("EAPs") on
an insured and self-funded basis to employers, governmental entities and other
payors in various states.
MHN provides managed behavioral health programs to employers, governmental
agencies and public entitlement programs, such as CHAMPUS and Medicaid. Employer
group sizes range from Fortune 100 to mid-sized companies with 200 employees.
MHN's strategy is to continue its market share achievement in the Fortune 500,
health plan and CHAMPUS markets through a combination of direct and consultant/
broker sales. MHN intends to achieve additional market share by capitalizing on
competitor consolidation, remaining CHAMPUS procurement opportunities and the
growing state and county Medicaid behavioral carve-outs, funded on either a risk
or administrative-services-only ("ASO") basis.
These products and services were provided to over 8.8 million individuals in
the year ended December 31, 1998, with approximately 3.6 million individuals
under risk-based programs, approximately
9
1.5 million individuals under self-funded programs, and approximately 3.9
million individuals under EAP programs.
WORKERS' COMPENSATION ADMINISTRATIVE SERVICES. The Company's subsidiaries
organized under WC Division, Inc. provide a full range of managed care
administrative services to insurers, self-funded employers, third-party claims
administrators and public agencies. These services include automated bill
review, telephonic claims reporting, automated utilization management, field and
telephonic case management, and PPO network access and administration. The
Company also offers ASO claims services as well as vocational rehabilitation and
temporary employee placement and recruitment services. Certain of these
operations were previously part of the Company's workers' compensation business,
the risk-based operations of which the Company sold on December 10, 1998. See
"Discontinued Operations and Anticipated Divestitures." WC Division, Inc. is in
the process of changing its name to Employer & Occupational Services Group, Inc.
PHARMACY BENEFIT MANAGEMENT. On February 26, 1999, the Company entered into
a definitive agreement to sell to Advance Paradigm, Inc. ("Advance Paradigm")
certain pharmacy benefit processing services, which it expects to complete on
March 31, 1999. The Company's pharmacy benefit management business consists of
claims processing, retail pharmacy network management, drug manufacturer rebate
management, mail service pharmacy and payment of claims with respect to pharmacy
benefits. As part of the sale, the Company and Advance Paradigm entered into a
services agreement, whereby Advance Paradigm will provide to the Company's
Health Plan Divisions at competitive rates the pharmacy management services
being sold. See "Discontinued Operations and Anticipated Divestitures."
PROVIDER RELATIONSHIPS AND RESPONSIBILITIES
PHYSICIAN RELATIONSHIPS. Upon enrollment in most of the Company's HMO
plans, each member selects a participating physician group ("PPG") or primary
care physician from the HMO's provider panel. The primary care physicians and
PPGs assume overall responsibility for the care of members. Medical care
provided directly by such physicians includes the treatment of illnesses not
requiring referral, as well as physical examinations, routine immunizations,
maternity and child care, and other preventive health services. The primary care
physicians and PPGs are responsible for making referrals (approved by the HMO's
or PPG's medical director) to specialists and hospitals. Certain Company HMOs
offer enrollees "open panels" under which members may access any physician in
the network without first consulting a primary care physician.
The following table sets forth the number of primary care and specialist
physicians with whom the Company's HMOs (and certain of such HMOs' PPGs)
contracted as of December 31, 1998 in each of the four Health Plan Divisions of
the Company:
ARIZONA CALIFORNIA CENTRAL NORTHEAST
DIVISION DIVISION DIVISION DIVISION
----------- ----------- ----------- -----------
Primary Care Physicians............................ 1,054 8,758 20,772 12,453
Specialist Physicians.............................. 2,708 49,472 29,419 27,152
Total.............................................. 3,762 58,230 50,191 39,605
PPG and physician contracts are generally for a period of at least one year
and are automatically renewable unless terminated, with certain requirements for
maintenance of good professional standing and compliance with the Company's
quality, utilization and administrative procedures. In California and Arizona,
PPGs generally receive a monthly "capitation" fee for every member served. The
capitation fee represents payment in full for all medical and ancillary services
specified in the provider agreements. The non-physician component of all
hospital services is covered by a combination of capitation and/or per diem
charges. In such capitated arrangements, in cases where the capitated provider
cannot provide the health care services needed, such providers generally
contract with specialists and other ancillary service providers
10
to furnish the requisite services pursuant to capitation agreements or
negotiated fee schedules with specialists. Many of the Company's HMOs outside
California and Arizona reimburse physicians according to a discounted
fee-for-service schedule, although several HMOs have commenced capitation
arrangements with certain providers and provider groups in their market areas.
HOSPITAL RELATIONSHIPS. The Company's HMOs arrange for hospital care
primarily through contracts with selected hospitals in their service areas. Such
hospital contracts generally provide for multi-year terms and provide for
payments on a variety of bases, including capitation, per diem rates, case
rates, and discounted fee-for-service schedules.
Covered inpatient hospital care for a member is comprehensive; it includes
the services of physicians, nurses and other hospital personnel, room and board,
intensive care, laboratory and x-ray services, diagnostic imaging, and generally
all other services normally provided by acute-care hospitals. HMO or PPG nurses
and medical directors are actively involved in discharge planning and case
management, which often involves the coordination of community support services,
including visiting nurses, physical therapy, durable medical equipment and home
intravenous therapy.
The Company owns and operates a 128-bed hospital located in Los Angeles,
California, the East Los Angeles Doctors Hospital, and a 200-bed hospital
located in Gardena, California, the Memorial Hospital of Gardena. As noted below
in the section of this Annual Report on Form 10-K entitled "Discontinued
Operations and Anticipated Divestitures," the Company is reviewing the
possibility of divesting its ownership of these hospitals.
COST CONTAINMENT. In most HMO plan designs, the primary care physician or
PPG is responsible for authorizing all needed medical care except for emergency
medical services. By coordinating care through such physicians in cases where
reimbursement includes risk-sharing arrangements, the Company believes that
inappropriate use of medical resources is reduced and efficiencies are achieved.
To limit possible abuse in utilization of hospital services in non-emergency
situations, a certification process precedes the inpatient admission of each
member, followed by continuing review during the member's hospital stay. In
addition to reviewing the appropriateness of hospital admissions and continued
hospital stay, the Company plays an active role in evaluating alternative means
of providing care to members and encourages the use of outpatient care, when
appropriate, to reduce the cost that would otherwise be associated with an
inpatient admission.
QUALITY ASSESSMENT. Quality assessment is a continuing priority for the
Company. Most of the Company's HMOs have a quality assessment plan administered
by a committee comprised of medical directors and primary care and specialist
physicians. The committees' responsibilities include periodic review of medical
records, development and implementation of standards of care based on current
medical literature and community standards, and the collection of data relating
to results of treatment. All of the Company's HMOs also have a subscriber
grievance procedure and/or a member satisfaction program designed to respond
promptly to member grievances. Aspects of such member service programs take
place both within the PPGs and within the Company's HMOs. Set forth under the
heading "National Committee for Quality Assurance" below is information
regarding certain quality assessment accreditations received by the Company's
subsidiaries.
The Company's quality initiatives department also implements various
programs to attempt to enhance access to quality health care and services for
the Company's members. The mission of such department is to improve the health
status and quality of life of the Company's members through the development and
implementation of various programs including disease management programs, health
assessment and member satisfaction surveys, data collection and tracking for the
Health Plan Employer Data and Information Set ("HEDIS") initiative, and
assistance with performance-based contracting with provider groups.
11
In December 1998, the Company sold the clinical content of its member
support center services located in Philadelphia for approximately $36.3 million
in net proceeds. The member support center is a telecommunications center
staffed by nurses who respond to member calls through the retrieval of detailed
clinical and demographic data regarding plan members and provider information
and the use of clinical algorithms to guide members to the most appropriate
level of care for their condition. As part of the sale, the Company's members
who had access to the support center prior to the sale will continue to have
access to similar services provided by the purchaser of the center for a period
of up to ten years. See "Discontinued Operations and Anticipated Divestitures"
below.
MANAGEMENT INFORMATION SYSTEMS
Effective information technology systems are critical to the Company's
operation. The Company's information technology systems include several computer
systems, each utilizing a combination of packaged and customized software and a
network of on-line terminals. The information technology systems gather and
store data on the Company's members and physician and hospital providers. The
systems contain all of the Company's necessary membership and claims-processing
capabilities as well as marketing and medical utilization programs. These
systems provide the Company with an integrated and efficient system of billing,
reporting, member services and claims processing, and the ability to examine
member encounter information for the optimization of clinical outcomes.
The Company also recognizes that the arrival of the Year 2000 poses a
challenge to the ability of computer systems to recognize the date change from
1999 to 2000 (the "Year 2000 Issue") and is in the process of modifying its
computer applications and business processes to provide for their continued
functionality given the Year 2000 Issue. The Year 2000 Issue is the result of
computer programs being written using two digits rather than four to define the
applicable year. Any of the Company's computer programs (both external and
internal) that have date/time sensitive software may recognize a date using "00"
as the year 1900 rather than the year 2000. This could result in a system
failure or material miscalculations causing disruptions of operations,
including, among other things, the inability to process transactions, prepare
invoices or engage in normal business activities.
The costs of the Company's Year 2000 Issue projects and the timetable in
which the Company plans to complete the Year 2000 Issue compliance requirements
are set forth under the heading "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in the Company's 1998 Annual
Report to Stockholders attached as an exhibit to this Annual Report on Form 10-K
and are based on estimates derived utilizing numerous assumptions of future
events including the continued availability of certain resources, third party
modification plans and other factors. There can be no assurance that these
estimates will be achieved and actual results could differ materially from these
plans and estimates.
DISCONTINUED OPERATIONS AND ANTICIPATED DIVESTITURES
RISK-BASED WORKERS' COMPENSATION OPERATIONS. In 1997, the Company revised
its strategy of maintaining a presence in the workers' compensation insurance
business as a result of various factors, including adverse developments arising
in the workers' compensation insurance business, primarily related to the
workers' compensation claims environment in California. In 1997 the Company
adopted a plan to completely discontinue this segment of its business, through
divestiture of its workers' compensation risk-assuming insurance subsidiaries.
On December 10, 1998, the Company consummated the sale of Business Insurance
Group, Inc. ("BIG"), its risk-based workers' compensation subsidiary. As part of
the transaction, the Company funded the purchase of third party reinsurance to
cover up to $175 million in adverse loss development related to BIG and its
subsidiaries. The Company received approximately $200 million in cash for the
sale, net of its costs and expenses for the transaction. Certain of the
Company's subsidiaries entered into agreements with the buyer to continue to
provide certain administrative services related to such operations for a period
of five years.
12
LOUISIANA, OKLAHOMA AND TEXAS HMO OPERATIONS. On November 4, 1998, the
Company entered into a definitive agreement for the sale of its HMO operations
in the states of Texas, Louisiana and Oklahoma to AmCareco, Inc. As part of the
transaction, the Company will receive convertible preferred stock of the buyer.
The Company is pursuing a divestiture of these HMOs due to, among other reasons,
inadequate returns on invested capital. Although the Company has entered into a
definitive agreement for the foregoing sale, consummation of the sale is subject
to numerous conditions and certain regulatory approvals.
ALABAMA HMO OPERATIONS. In December 1997, the Company entered into a
definitive agreement to sell its non-operational HMO license in Alabama to an
unaffiliated third party, which sale was consummated in January 1998.
PHARMACY BENEFITS MANAGEMENT SERVICES. In February 1999, the Company
entered into a definitive agreement to sell to Advance Paradigm the capital
stock of Foundation Health Pharmaceutical Services, Inc., and certain pharmacy
benefit processing services of Integrated Pharmaceutical Services, Inc., for
approximately $70 million in cash. In addition, the Company and Advance Paradigm
entered into a services agreement, whereby Advance Paradigm will provide to the
Company's Health Plan Divisions at competitive rates claims processing, retail
network management, and payment of claims pharmacy benefits services. Advance
Paradigm will also provide pharmacy mail service to the Health Plan Divisions.
For a period of five years, the Company may not compete with respect to such
services in any market in which Advance Paradigm conducts business, subject to
certain exceptions. It is anticipated that the sale will be consummated on March
31, 1999.
MEMBER SUPPORT CENTER OPERATIONS. During 1998, the Company operated a
regional member support center located in Philadelphia. The support center was a
telecommunications center staffed by nurses who responded to member calls
through the retrieval of detailed clinical and demographic data regarding plan
members and provider information, and the use of clinical algorithms to guide
members to the most appropriate level of care for their condition. In December
1998, the Company sold the clinical content used in its member support center
operations to Access Health, Inc. ("Access Health") for approximately $36.3
million in cash net proceeds. In addition, the Company entered into a long-term
services agreement with Access Health pursuant to which all members who had
access to the support center at the time of sale will continue to have such
access for a period of ten years, with available annual extensions by the
Company. In addition, as part of the transaction the Company agreed not to
compete in such services for a period commencing on the closing date and ending
two years after members cease to have access to the support center.
SOUTHERN CALIFORNIA HOSPITALS. The Company is reviewing the possibility of
divesting its ownership of two Southern California hospitals, a 128-bed hospital
located in Los Angeles, California, the East Los Angeles Doctors Hospital, and a
200-bed hospital located in Gardena, California, the Memorial Hospital of
Gardena. The Company is presently responding to inquiries of parties which have
expressed an interest in the purchase of such businesses.
GEM INSURANCE COMPANY. Since October of 1997, Gem Insurance Company
("Gem"), a subsidiary of the Company, has implemented a restructuring plan to
reduce operating losses and its in-force insurance risk. In 1997, Gem initiated
a withdrawal from the Nevada insurance markets, and began restructuring its
insurance products in Utah and then in certain other markets. Gem also reduced
commissions to market-level rates and terminated certain general agents. Gem
continued to implement such restructuring plan in 1998. As a result, the number
of Gem's insureds dropped from over 100,000 at the start of 1998 to
approximately 2,500 at December 31, 1998. Gem has filed notices of intention to
withdraw from Nebraska and the small group market in Colorado. Currently,
Foundation Health Systems Life and Health Insurance Company, a subsidiary of the
Company, services Gem's insureds through an administrative services agreement
between the companies. The Company is reviewing the possibility of winding up
the operations
13
of Gem or merging such operations into another insurance subsidiary of the
Company. Upon completion of its current withdrawals, Gem will be licensed in
only five states.
COLORADO OPERATIONS. In March 1999, the Company entered into a letter of
intent to sell the capital stock of QualMed Plans for Health of Colorado, Inc.,
the Company's HMO subsidiary in the state of Colorado, to Wellpoint Health
Networks Inc. The Company anticipates closing the sale in the first half of
1999. Although the Company has entered into a letter of intent for the foregoing
sale, consummation of the sale is subject to execution of a definitive agreement
mutually satisfactory to the parties and satisfaction of all conditions to be
set forth therein, including obtaining certain regulatory approvals. In
addition, the Company has decided to close its regional service center in
Pueblo, Colorado in the first half of 1999.
NEW MEXICO OPERATIONS. In March 1999, the Company also entered into a
definitive agreement to sell the capital stock of QualMed Plans for Health,
Inc., the Company's HMO subsidiary in the state of New Mexico, to Health Care
Horizons, Inc. Although the Company has entered into a definitive agreement for
the foregoing sale, consummation of the sale is subject to numerous conditions
and certain regulatory approvals.
CERTAIN OTHER OPERATIONS. The Company continues to evaluate the
profitability realized or likely to be realized by its existing businesses and
operations, and is reviewing from a strategic standpoint which of such
businesses or operations should be divested.
ADDITIONAL INFORMATION CONCERNING THE COMPANY'S BUSINESS
MARKETING AND SALES. Marketing for group Health Plan business is a two-step
process in which the Company first markets to employer groups and then provides
information directly to employees once the employer has selected a Company HMO.
The Company typically uses its internal sales staff to serve the large employer
groups while independent brokers work with the Company's internal sales staff to
develop business with smaller employer groups. Once selected by an employer, the
Company solicits enrollees from the employee base directly. In 1998, the Company
marketed its programs and services primarily through its direct sales staff and
independent brokers, agents and consultants. During "open enrollment" periods
when employees are permitted to change health care programs, the Company uses
direct mail, work day and health fair presentations, telemarketing, outdoor
print, radio and television advertisements to attract new enrollees. The
Company's sales efforts are supported by its marketing division which includes
research and product development, corporate communications, public relations and
marketing services.
Premiums for each employer group are generally contracted for on a yearly
basis, payable monthly. Numerous factors are considered by the Company in fixing
its monthly premiums, including employer group needs and anticipated health-care
utilization rates as forecasted by the Company's management based on the
demographic composition of, and the Company's prior experience in, its service
areas. Premiums are also affected by applicable regulations that prohibit
experience rating of group accounts (i.e., setting the premium for the group
based on its past use of health care services) and by state regulations
governing the manner in which premiums are structured.
The Company believes that the importance of the ultimate health care
consumer (or member) in the health care product purchasing process is likely to
increase in the future. Accordingly, the Company intends to focus its marketing
strategies on the development of distinct brand identities and innovative
product service offerings that will appeal to potential Health Plan members.
COMPETITION. HMOs operate in a highly competitive environment in an
industry currently subject to significant changes from business consolidations,
new strategic alliances, legislative reform, and market pressures brought about
by a better informed and better organized customer base. The Company's HMOs face
substantial competition from for-profit and nonprofit HMOs, PPOs, self-funded
plans (including self-insured employers and union trust funds), Blue Cross/Blue
Shield plans, and traditional indemnity
14
insurance carriers, some of which have substantially larger enrollments and
greater financial resources than the Company. The Company believes that the
principal competitive features affecting its ability to retain and increase
membership include the range and prices of benefit plans offered, provider
network, quality of service, responsiveness to user demands, financial
stability, comprehensiveness of coverage, diversity of product offerings, and
market presence and reputation. The relative importance of each of these
features and key competitors vary by market. The Company believes that it
competes effectively with respect to all of these factors.
Kaiser Foundation Health Plan ("Kaiser") is the largest HMO in California
and in the United States and is a competitor of the Company in the California
HMO industry. In addition to Kaiser, the Company's other HMO competitors include
PacifiCare of California, California Care (Blue Cross), Blue Shield, Aetna and
CIGNA Healthplans of California, Inc. In addition, there are a number of other
types of competitors including self-directed plans, traditional indemnity
insurance plans, and other managed care plans.
The Company also competes in California against a variety of PPOs. The
establishment of PPOs has been encouraged by legislation in California that
enables insurance companies to negotiate fees with health care providers and to
extend economic incentives to insureds to utilize such providers without
significant legal restrictions. But the California Department of Corporations
(the "DOC"), which regulates all California HMOs, has interpreted California law
to prohibit California PPOs that lack an HMO license from compensating providers
on a capitated or other prepaid or periodic basis unless those providers
themselves have an HMO license. Thus, only HMOs may legally enter into such
financial arrangements with providers, while PPOs are limited to fee-for-service
arrangements.
The Company's Colorado HMO competes primarily against other HMOs including
Kaiser, United Healthcare, and PacifiCare of Colorado, as well as with a Blue
Cross/Blue Shield HMO, other commercial carriers, and various hospital or
physician-owned HMOs. The Company's largest competitor in New Mexico is
Presbyterian Health Plan. The Company's New Mexico HMO also competes with
Lovelace Health Plan (an HMO owned by CIGNA Corporation) and Blue Cross/Blue
Shield. The Company's largest competitor in Arizona is Health Partners. The
Company's Arizona HMO also competes with CIGNA, PacifiCare, Aetna, and Blue
Cross/Blue Shield. In Utah, the Company competes with Intermountain Health Plan
and PacifiCare, among other companies.
The Company's Oregon HMO competes primarily against other HMOs including
Kaiser, PacifiCare of Oregon, The Good Health Plan, Blue Cross Lifewise and Blue
Shield Regions, and with various PPOs. The Company's Washington HMO competes
primarily with Group Health Cooperative of Puget Sound, Kaiser, HealthPlus (Blue
Cross), and with commercial carriers, self-funded plans, and other Blue Cross/
Blue Shield organizations.
The Company's HMOs in Connecticut compete for business with commercial
insurance carriers, Blue Cross and Blue Shield of Connecticut, Aetna/U.S.
Healthcare, and more than ten other HMOs. The Company's main competitors in
Pennsylvania, New York, and New Jersey are Aetna/U.S. Healthcare, Independence
Blue Cross, Empire Blue Cross, Oxford Health Plans, AmeriHealth, and Keystone
East. The Company's HMO operations in Florida compete for business with Humana
Medical Plan, United HealthCare, Health Options, and Prudential HealthCare,
among others.
GOVERNMENT REGULATION. The Company believes it is in compliance in all
material respects with all current state and federal regulatory requirements
applicable to the business to be conducted by its subsidiaries. Certain of these
requirements are discussed below.
FEDERAL HMO STATUTES. Under the Federal Health Maintenance Organization Act
of 1973 (the "HMO Act"), services to members must be provided substantially on a
fixed, prepaid basis without regard to the actual degree of utilization of
services. Although premiums established by an HMO may vary from account to
account through composite rate factors and special treatment of certain broad
classes of members, traditional experience rating of accounts (i.e.,
retrospective adjustments for a group account
15
based on that group's past use of health care services) is not permitted under
the HMO Act; prospective rating adjustments are, however, allowed. Several of
the Company's HMOs are federally qualified in certain parts of their respective
service areas under the HMO Act and are therefore subject to the requirements of
such act to the extent federally qualified products are offered and sold.
Additionally, there are a number of proposed federal laws currently before
Congress to further regulate managed health care. The Company cannot predict the
ultimate fate of any of these legislative proposals. The Company's Medicare risk
contracts are subject to regulation by HCFA. 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. The
Company's Medicaid business is also subject to regulation by HCFA, as well as
state agencies.
CALIFORNIA HMO REGULATIONS. California HMOs such as Health Net and certain
of the Company's specialty plans are subject to state regulation, principally by
the DOC under the Knox-Keene Act. Among the areas regulated by the Knox-Keene
Act are: (i) adequacy of administrative operations, (ii) the scope of benefits
required to be made available to members, (iii) manner in which premiums are
structured, (iv) procedures for review of quality assurance, (v) enrollment
requirements, (vi) composition of policy making bodies to assure that plan
members have access to representation, (vii) procedures for resolving
grievances, (viii) the interrelationship between HMOs and their health care
providers, (ix) adequacy and accessibility of the network of health care
providers, (x) provider contracts, and (xi) initial and continuing financial
viability. Any material modifications to the organization or operations of
Health Net are subject to prior review and approval by the DOC. This approval
process can be lengthy and there is no certainty of approval. Other significant
changes require filing with the DOC, which may then comment and require changes.
In addition, under the Knox-Keene Act, Health Net and certain other Company
subsidiaries must file periodic reports with, and are subject to periodic review
by, the DOC.
The DOC has also required the Company and its Knox-Keene licensed
subsidiaries to provide the DOC with a number of undertakings in connection with
the FHS Combination and the merger of the Company's two California, full-service
HMOs. These undertakings obligate the affected companies to certain requirements
not applicable to licensees generally, or prohibit or require regulatory
approval preceding the institution of certain changes. While the Company has
been permitted to withdraw a number of these undertakings, others remain in
effect and constrain the Company's flexibility of operations. The Company does
not believe, however, that the remaining undertakings have a material adverse
effect on the Company and its licensees taken as a whole.
Currently, the California legislature is considering a number of significant
managed health care measures which could materially alter California's
regulatory environment. Among such measures are proposals to establish an
entirely new regulatory structure for managed care, in lieu of the DOC. Other
legislative proposals focus on medical care dispute resolution mechanisms,
medical malpractice liability, and mandated benefits, such as mental health
coverage. The Company cannot predict the ultimate fate of any of these
legislative proposals in California.
OTHER HMO REGULATIONS. In each state in which the Company does business,
HMOs must file periodic reports with, and their operations are subject to
periodic examination by, state licensing authorities. In addition, each HMO must
meet numerous state licensing criteria and secure the approval of state
licensing authorities before implementing certain operational changes, including
the development of new product offerings and, in some states, the expansion of
service areas. To remain licensed, each HMO must continue to comply with state
laws and regulations and may from time to time be required to change services,
procedures or other aspects of its operations to comply with changes in
applicable laws and regulations. HMOs are required by state law to meet certain
minimum capital and deposit and/or reserve requirements in each state and may be
restricted from paying dividends to their parent corporations under certain
circumstances from time to time. Several states have increased minimum capital
requirements, pursuant to proposals by the National Association of Insurance
Commissioners to institute risk-based
16
capital requirements. Regulations in these and other states may be changed in
the future to further increase equity requirements. Such increases could require
the Company to contribute additional capital to its HMOs. Any adverse change in
governmental regulation or in the regulatory climate in any state could
materially impact the HMOs operating in that state. The HMO Act and state laws
place various restrictions on the ability of HMOs to price their products
freely. The Company must comply with certain provisions of certain state
insurance and similar laws, especially as it seeks ownership interests in new
HMOs, PPOs and insurance companies, or otherwise expands its geographic markets
or diversifies its product lines.
INSURANCE REGULATIONS. State departments of insurance (the "DOIs") regulate
insurance and third-party administrator business conducted by certain
subsidiaries of the Company (the "Insurance Subsidiaries") pursuant to various
provisions of state insurance codes and regulations promulgated thereunder. The
Insurance Subsidiaries are subject to various capital reserve and other
financial requirements established by the DOIs. The Insurance Subsidiaries must
also file periodic reports regarding their activities regulated by the DOIs and
are subject to periodic reviews of those activities by the DOIs. The Company
must also obtain approval from, or file copies with, the DOIs for all of its
group and individual policies prior to issuing those policies. The Company does
not believe that the requirements imposed by the DOIs will have a material
impact on the ability of the Insurance Subsidiaries to conduct their business
profitably.
NATIONAL COMMITTEE FOR QUALITY ASSURANCE ("NCQA"). NCQA is an independent,
non-profit organization that reviews and accredits HMOs and assesses an HMO's
quality improvement, utilization management, credentialing process, commitment
to members' rights, and preventive health services. HMOs that comply with NCQA's
review requirements and quality standards receive NCQA accreditation. After an
NCQA review is completed, NCQA will issue one of four designations. These are
(i) accreditation for three years; (ii) accreditation for one year; (iii)
provisional accreditation for twelve to eighteen months to correct certain
problems with a follow-up review to determine qualification for accreditation;
and (iv) not accredited. Foundation Health, A Florida Health Plan, Inc.; Health
Net, the Company's HMO in California; Intergroup Prepaid Health Services of
Arizona, Inc., the Company's HMO in Arizona; and QualMed Washington Health Plan,
Inc. (Spokane region), have all received NCQA accreditations for three years.
QualMed Plans for Health, Inc. (Pennsylvania), QualMed Plans for Health of
Colorado, Inc. and QualMed Washington Health Plan, Inc. (Seattle region) have
all received one year accreditation from NCQA. Certain of the Company's other
Health Plan subsidiaries are in the process of applying for NCQA accreditation.
SERVICE MARKS
The Company's service marks and/or trademarks include, among others: THE
ACUTE CARE ALTERNATIVE-Registered Trademark-, Alliance 2000(sm) Alliance
1000(sm), Asthmawise(sm), AVP(sm), AVP Vision Plans(sm), BabyWell(sm), BEING
WELL-Registered Trademark-, CARECAID-Registered Trademark-,
CMP-Registered Trademark-, COMBINED CARE-Registered Trademark-, COMBINED CARE
PLUS(sm), COMMUNITY MEDICAL PLAN, INC. and design-Registered Trademark-, A CURE
FOR THE COMMON HMO-Registered Trademark-, Feetbeat Worksite Walking Program(sm),
FIRM SOLUTIONS-Registered Trademark-, FLEX ADVANTAGE-Registered Trademark-, FLEX
NET(sm), FOUNDATION HEALTH and design-Registered Trademark-, FOUNDATION HEALTH
GOLD-Registered Trademark-, Foundation Health Systems(sm), GOOD HEALTH IS JUST
AROUND THE CORNER-Registered Trademark-, HANK-Registered Trademark-, HANK and
design-Registered Trademark-, HEALTH NET-Registered Trademark-, Health Net
ACCESS(sm), Health Net Comp.24(sm), Health Net ELECT(sm), Health Net
INSIGHT(sm), Health Net OPTIONS(sm), Health Net SELECT(sm), Health Net Seniority
Plus(sm), Health Smart and design(sm), Healthworks (stylized)(sm), Heart &
Soul(sm), IMET and design-Registered Trademark-, Indian
design-Registered Trademark-, INDIVIDUAL PREFERRED PPO-Registered Trademark-,
InterCare(sm), InterComp(sm), InterFlex(sm), Inter Mountain Employers Trust(sm),
InterPlus(sm), LIFE WITH DIGNITY AND HOPE-Registered Trademark-, MAKING QUALITY
HEALTH CARE AFFORDABLE-Registered Trademark-, M.D. Health Plan Personal Medical
Management(sm), On the Road to Good Health(sm), PHYSICIANS HEALTH
SERVICES-Registered Trademark-, Premier Medical Network(sm), Premier Medical
Network It's Your Choice(sm), QUALASSIST-Registered Trademark-,
QUALADMIT-Registered Trademark-, QUALCARE-Registered Trademark-, QUALCARE
PREFERRED-Registered Trademark-, QUAL-MED-Registered Trademark-, QUALMED(sm),
QUALMED HEALTH & LIFE INSURANCE COMPANY-Registered Trademark-, QUALMED PLANS FOR
HEALTH-Registered Trademark-, Rapid Access(sm), SENIOR
SECURITY-Registered Trademark-, SENIOR VALUE-Registered Trademark-, Someone at
Your Side(sm), Sun/Mountain design-Registered Trademark-,The Final Piece
17
of the Healthcare Puzzle(sm), VitalLine(sm), VITALTEAM-Registered Trademark-,
WELL MANAGED CARE RIGHT FROM THE START-Registered Trademark-, WELL
REWARDS-Registered Trademark-, Well Woman(sm), Wise Choice(sm), WORKING WELL
TOGETHER-Registered Trademark-, and Your Partner in Healthy Living(sm), and
certain designs related to the foregoing.
The Company utilizes these and other marks in connection with the marketing
and identification of products and services. The Company believes such marks are
valuable and material to its marketing efforts.
EMPLOYEES
The Company currently employs approximately 14,000 employees, excluding
temporary employees. Such employees perform a variety of functions, including
administrative services for employers, providers, and members, negotiation of
agreements with physician groups, hospitals, pharmacies, and other health care
providers, handling claims for payment of hospital and other services, and
providing data processing services. The Company's employees are not unionized
and the Company has not experienced any work stoppage since its organization.
The Company considers its relations with its employees to be very good.
In connection with the FHS Combination, the Company adopted a significant
restructuring plan which provides for a workforce reduction, the consolidation
of employee benefit plans and the consolidation of certain office locations,
which the Company has been effectuating.
ITEM 2. PROPERTIES
The Company owns certain of its offices in Pueblo, Colorado and leases
office space for its principal executive offices in Woodland Hills and its
offices in Rancho Cordova, California.
The Woodland Hills facility, with approximately 410,000 square feet, is
leased pursuant to two leases, the earliest of which expires in December 2001
with respect to 300,000 square feet. The aggregate rent for the two leases for
1998 totaled approximately $11.7 million. The Company's principal executive
offices are located in the Woodland Hills facility, and such facility contains
much of the Company's California HMO operations.
The Company and its subsidiaries also lease an aggregate of approximately
515,000 square feet of office space in Rancho Cordova, California. The Company's
aggregate rent obligations under these leases were approximately $7.2 million in
1998. These leases expire at various dates through July 2002. The Rancho Cordova
facilities serve as a regional data processing center.
The Pueblo facility consists of approximately 311,000 square feet of office
space. The facility is subject to a mortgage in the aggregate principal amount
of approximately $280,000 as of December 31, 1998. The Pueblo facility includes
three properties which the Company renovated in 1998. The Company has received
public funds for certain of such properties' renovation from the City and County
of Pueblo in return for certain employment commitments. In addition, the Company
leases approximately 34,000 square feet of office space in Pueblo pursuant to
three leases, the earliest of which expires in August 1999, at an aggregate rent
of approximately $330,000 per year. As set forth elsewhere in this Annual Report
on Form 10-K the Company has decided to close its regional services center in
Pueblo in the first half of 1999.
In addition to the Company's office space in Pueblo, Woodland Hills and
Rancho Cordova, the Company and its subsidiaries lease approximately 165 sites
in 26 states, comprising roughly 1.7 million square feet of space.
The Company owns in total approximately 1.6 million square feet of space.
The Company owns approximately 375,000 aggregate square feet of space for health
care centers in California and Arizona and approximately 250,000 square feet of
space for two hospitals in Southern California. The Company also owns
approximately one dozen office buildings located in Arizona, California,
Colorado and Connecticut, which collectively encompass approximately 960,000
square feet of space.
18
Management believes that its ownership and rental costs are consistent with
those available for similar space in the applicable local area. The Company's
properties are well maintained, considered adequate and are being utilized for
their intended purposes.
The Company is currently considering the sale of certain care centers and
unimproved real estate owned by the Company, and the sale and leaseback of
certain of its occupied facilities in Arizona, California and Connecticut.
ITEM 3. LEGAL PROCEEDINGS
MEDAPHIS CORPORATION
On November 7, 1996, the Company's predecessor, HSI, filed a lawsuit against
Medaphis Corporation ("Medaphis") and its former Chairman and Chief Executive
Officer Randolph G. Brown, entitled HEALTH SYSTEMS INTERNATIONAL, INC. V.
MEDAPHIS CORPORATION, RANDOLPH G. BROWN AND DOES 1-50, case number BC 160414,
Superior Court of California, County of Los Angeles. The lawsuit arises out of
the acquisition of Health Data Sciences Corporation ("HDS") by Medaphis. In July
1996, HSI, the owner of 1,234,544 shares of Series F Preferred Stock of HDS,
representing over sixteen percent of the total outstanding equity of HDS, voted
its shares in favor of the acquisition of HDS by Medaphis. HSI received as the
result of the acquisition 976,771 shares of Medaphis Common Stock in exchange
for its Series F Preferred Stock. Pursuant to the Merger Agreement, the Company
succeeded to the interests of HSI in the Medaphis lawsuit, and the Company has
been substituted for HSI as plaintiff in the suit.
In its complaint, the Company alleges that Medaphis was actually a poorly
run company with sagging earnings in its core business, and had artificially
maintained its stock prices through a series of acquisitions and accounting
maneuvers which provided the illusion of growth while hiding the reality of its
weakening financial and business condition. The Company alleges that Medaphis,
Brown and other insiders deceived the Company by presenting materially false
financial statements and by failing to disclose that Medaphis would shortly
reveal a "write off" of up to $40 million in reorganization costs and would
lower its earnings estimate for the following year, thereby more than halving
the value of the Medaphis shares received by the Company. The Company alleges
that these false and misleading statements were contained in oral communications
with the Company, as well as in the registration statement and the prospectus
provided by Medaphis to all HDS shareholders in connection with the HDS
acquisition. Further, despite knowing of the Company's discussions to form a
strategic alliance of its own with HDS, Medaphis and the individual defendants
wrongfully interfered with that prospective business relationship by proposing
to acquire HDS using Medaphis stock whose market price was artificially inflated
by false and misleading statements. The Company alleges that the defendants'
actions constitute violations of both federal and state securities laws, as well
as fraud and other torts under state law. The Company is seeking either
rescission of the transaction or damages in excess of $38 million. The
defendants have denied the allegations in the complaint, and the Company is
vigorously pursuing its claims against Medaphis.
The Company moved to disqualify the law firm representing certain of the
individual defendants. The trial court granted the Company's motion, and the law
firm and its clients appealed such decision. In addition, the trial court
granted a stay of the case in order to permit the law firm to appeal. On
November 30, 1998, the Appellate Court affirmed the trial court's decision. New
counsel has been substituted in as counsel for certain of the individual
defendants. The court ordered stay has been lifted and, therefore, discovery is
now permitted to resume. The case is in the early stages of discovery.
MONACELLI VS. GEM INSURANCE COMPANY
On December 29, 1994, a lawsuit entitled MARIO AND CHRISTIAN MONACELLI V.
GEM INSURANCE COMPANY, ET AL (Case No. CV94-20715) was initiated in Maricopa
County (Arizona) Superior Court against Gem Insurance Company, a subsidiary of
the Company ("Gem"), for bad faith and misrepresentation. Plaintiffs
subsequently asserted claims in the same action against their insurance agent,
Mark Davis, for negligence
19
and misrepresentation. The Plaintiffs' claims arose from the rescission of their
health insurance policy based on their alleged failure to disclose an X-ray,
taken one year before the Plaintiffs filled out their insurance application,
which revealed an undiagnosed mass on Mr. Monacelli's lung. Plaintiffs incurred
approximately $70,000 in medical expenses in connection therewith. Prior to
trial, the agent recanted certain portions of his deposition testimony and
admitted that the Plaintiffs had told him that Mr. Monacelli had undergone
certain tests which were not revealed on the application. Based on this new
information, Gem paid the Plaintiffs' medical expenses with interest.
The case went to trial in April of 1997 against Gem and the agent. A jury
verdict was ultimately rendered awarding the Plaintiffs $1 million in
compensatory damages and assessing fault 97% to Gem and 3% to the agent, Mark
Davis. In addition, the jury awarded $15 million in punitive damages against
Gem. Thereafter, the Plaintiffs filed a motion seeking to recover an additional
$4 million in attorneys' fees, and Gem filed post-trial motions for judgment
notwithstanding the verdict, for a new trial and for remittitur of the jury
verdict. Gem's motion for judgment notwithstanding the verdict was denied. The
court granted Gem's motion for remittitur and remitted the jury verdict to an
award of $1 million in compensatory damages and $2 million in punitive damages.
Gem planned to appeal the verdict, but the parties agreed to settle the matter
in May 1998 and avoid the uncertainties and cost of an appeal.
In addition, on July 15, 1997 Gem filed a complaint against Mr. Davis and
his spouse in Maricopa County (Arizona) Superior Court (Case No. CV97-13053)
asserting a claim for indemnity against Mr. Davis with respect to the Monacelli
case. Gem agreed to settle its claims against Mr. and Mrs. Davis in December
1998.
FPA MEDICAL MANAGEMENT, INC.
Since May 1998, several complaints (the "FPA Complaints") have been filed in
federal and state courts seeking an unspecified amount of damages on behalf of
an alleged class of persons who purchased shares of common stock, convertible
into debentures and options to purchase common stock of FPA Medical Management,
Inc. ("FPA") at various times between February 3, 1997 and May 15, 1998. The FPA
Complaints name as defendants FPA, certain of FPA's auditors, the Company and
certain of the Company's former officers. The FPA Complaints allege that the
Company and such former officers violated federal and state securities laws by
misrepresenting and failing to disclose certain information about a 1996
transaction between the Company and FPA, about FPA's business and about the
Company's 1997 sale of FPA common stock held by the Company. The Company has
filed a motion to dismiss all claims asserted against it in the consolidated
federal class actions but has not formally responded to the other complaints.
Management believes these suits against the Company and its former officers
are without merit and intends to defend the actions vigorously.
MISCELLANEOUS PROCEEDINGS
The Company and certain of its subsidiaries are also parties to various
legal proceedings, many of which involve claims for coverage encountered in the
ordinary course of its business. Based in part on advice from litigation counsel
to the Company and upon information presently available, management of the
Company is of the opinion that the final outcome of all such proceedings should
not have a material adverse effect upon the Company's results of operations or
financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the security holders of the
Company, either through solicitation of proxies or otherwise, during the fourth
quarter of the year ended December 31, 1998.
20
OTHER INFORMATION
REVOLVING CREDIT FACILITY
The Company has an unsecured, five-year $1.5 billion revolving credit
facility pursuant to a Credit Agreement dated July 8, 1997 (the "Credit
Agreement") with the banks identified in the Credit Agreement (the "Banks") and
Bank of America National Trust and Savings Association ("Bank of America") as
Administrative Agent. All previous revolving credit facilities were terminated
and rolled into the Credit Agreement. The Credit Agreement contains customary
representations and warranties, affirmative and negative covenants, and events
of default. Specifically, Section 7.11 of the Credit Agreement provides that the
Company and its subsidiaries may, so long as no event of default exists: (i)
declare and distribute stock as a dividend; (ii) purchase, redeem, or acquire
its stock, options, and warrants with the proceeds of concurrent public
offerings; and (iii) declare and pay dividends or purchase, redeem, or otherwise
acquire its capital stock, warrants, options, or similar rights with cash
subject to certain specified limitations.
Under the Credit Agreement, as amended pursuant to the First Amendment and
Waiver to Credit Agreement dated as of April 6, 1998, the Second Amendment to
Credit Agreement dated as of July 31, 1998, the Third Amendment to Credit
Agreement dated as of November 6, 1998 and the Fourth Amendment to Credit
Agreement dated March 26, 1999 (collectively, the "Amendments") with the Banks,
the Company is: (i) obligated to maintain certain covenants keyed to the
Company's financial condition and performance (including a Total Leverage Ratio
and Fixed Charge Ratio); (ii) obligated to limit liens; (iii) subject to
customary covenants, including (A) disposition of assets only in the ordinary
course and generally at fair value and (B) restrictions on acquisitions,
mergers, consolidations, loans, leases, joint ventures, contingent obligations,
and certain transactions with affiliates; (iv) permitted to sell the Company's
workers' compensation insurance business, provided that the net proceeds shall
be applied towards repayment of the outstanding Loans under the Credit Agreement
(which sale the Company completed on December 10, 1998); and (v) permitted to
incur additional indebtedness in an aggregate amount not to exceed
$1,000,000,000 upon certain terms and conditions, including mandatory prepayment
of the outstanding Loans with a certain portion of the proceeds from the
issuance of such indebtedness, resulting in a permanent reduction of the
aggregate amount of commitments under the Credit Agreement by the amount so
prepaid. The Amendments also provided for an increase in the interest and
facility fees under the Credit Agreement.
SHAREHOLDER RIGHTS PLAN
On May 20, 1996, the Board of Directors of the Company declared a dividend
distribution of one right (a "Right") for each outstanding share of the
Company's Class A Common Stock and Class B Common Stock (collectively, the
"Common Stock"), to stockholders of record at the close of business on July 31,
1996 (the "Record Date"). The Board of Directors of the Company also authorized
the issuance of one Right for each share of Common Stock issued after the Record
Date and prior to the earliest of the Distribution Date (as defined below), the
redemption of the Rights, and the expiration of the Rights, and in certain other
circumstances. Rights will attach to all Common Stock certificates representing
shares then outstanding and no separate Rights certificates will be distributed.
Subject to certain exceptions contained in the Rights Agreement dated as of June
1, 1996 by and between the Company and Harris Trust and Savings Bank, as Rights
Agent (the "Rights Agreement"), the Rights will separate from the Common Stock
in the event any person acquires 15% or more of the outstanding Class A Common
Stock, the Board of Directors of the Company declares a holder of 10% or more to
the outstanding Class A Common Stock to be an "Adverse Person," or any person
commences a tender offer for 15% or more of the Class A Common Stock (each event
causing a "Distribution Date").
Except as set forth below and subject to adjustment as provided in the
Rights Agreement, each Right entitles its registered holder, upon the occurrence
of a Distribution Date, to purchase from the Company one one-thousandth of a
share of Series A Junior Participating Preferred Stock, at a price of $170.00
per
21
one-thousandth share. However, in the event any person acquires 15% or more of
the outstanding Class A Common Stock, or the Board of Directors of the Company
declares a holder of 10% or more of the outstanding Class A Common Stock to be
an "Adverse Person," the Rights (subject to certain exceptions contained in the
Rights Agreement) will instead become exercisable for Class A Common Stock
having a market value at such time equal to $340.00 per share. The Rights are
redeemable under certain circumstances at $.01 per Right and will expire, unless
earlier redeemed, on July 31, 2006.
A copy of the Rights Agreement has been filed with the Securities and
Exchange Commission as Exhibit 99.1 to the Company's Registration Statement on
Form 8-A (File No. 001-12718). In connection with its execution of the Merger
Agreement for the FHS Combination, the Company entered into Amendment No. 1 (the
"Rights Amendment") to the Rights Agreement to exempt the Merger Agreement and
related transactions from triggering the Rights. In addition, the Rights
Amendment modifies certain terms of the Rights Agreement applicable to the
determination of certain "Adverse Persons," which modifications became effective
upon consummation of the transactions provided for under the Merger Agreement.
This summary description of the Rights does not purport to be complete and is
qualified in its entirety by reference to the Rights Agreement.
THE CALIFORNIA WELLNESS FOUNDATION
Pursuant to the Amended Foundation Shareholder Agreement, dated as of
January 28, 1992 (the "CWF Shareholder Agreement"), by and among the Company,
the California Wellness Foundation (the "CWF"), and certain stockholders (the
"HNMH Stockholders") of HN Management Holdings, Inc. (a predecessor to the
Company) ("HNMH") named therein, the CWF was subject to various volume and
manner of sale restrictions specified in the CWF Shareholder Agreement which
limited the number of shares of Class B Common Stock that the CWF could dispose
of prior to December 31, 1998. The CWF and the Company are also party to a
Registration Rights Agreement dated as of March 2, 1995 (the "CWF Registration
Rights Agreement") pursuant to which the CWF has the right to demand
registration for sale in underwritten public offerings of up to 8,026,298 shares
of Class B Common Stock.
Under the relevant provisions of California law, when a corporation converts
from nonprofit to for-profit corporate status, the equivalent of the fair market
value of the nonprofit corporation must be contributed to a successor charity
that has a charitable purpose consistent with the purposes of the nonprofit
entity. The CWF was formed to be the charitable recipient of the conversion
settlement when Health Net (a subsidiary of the Company) effected a conversion
from nonprofit to for-profit status, which occurred in February 1992 (the
"Conversion"). In connection with the Conversion, Health Net issued to the CWF
promissory notes in the original principal amount of $225 million (the "CWF
Notes") and shares of Class B Common Stock (which immediately prior to the
business combination involving HNMH and QualMed, Inc. were split to become
25,684,152 shares of Class B Common Stock then held by the CWF). While such
shares are held by the CWF, they are entitled to the same economic benefit as
Class A Common Stock, but are non-voting in nature. If the CWF sells or
transfers such shares to an unrelated third party, they automatically convert to
Class A Common Stock.
Pursuant to certain agreements with the CWF, the Company redeemed 4,550,000
shares of Class B Common Stock from the CWF on June 27, 1997. The CWF has also
sold shares of Class B Common Stock to unrelated third parties, which shares of
common stock automatically converted into shares of Class A Common Stock at the
time of such sales.
On February 25, 1998, the CWF notified the Company of its intention to sell
up to 8,026,000 shares of Class B Common Stock pursuant to the CWF Registration
Rights Agreement in an underwritten public offering. Pursuant to the terms of
the CWF Registration Rights Agreement, the Company upon receipt of a
notification under such agreement must prepare and file a registration statement
with respect to such shares with the Securities and Exchange Commission as
expeditiously as possible but in no event later than 90 days following receipt
of the notice, subject to certain exceptions. Pursuant to the terms of a letter
22
agreement dated June 1, 1998 between the CWF and the Company (the "Letter
Agreement"), the Company provided its consent under the CWF Registration Rights
Agreement to permit the CWF to sell certain shares of Class B Common Stock in
private sales transactions (subject to the terms and conditions set forth in the
Letter Agreement) in lieu of such underwritten public offering. Effective June
18, 1998, the CWF sold 5,250,000 shares of Class B Common Stock to unrelated
third parties in accordance with the Letter Agreement, which shares of Class B
Common Stock sold by the CWF automatically converted on a one-for-one basis into
shares of Class A Common Stock. Pursuant to the terms of the Letter Agreement,
all of such 5,250,000 shares sold reduced the number of shares subject to
registration under the CWF Registration Rights Agreement on a one-for-one basis.
As a result of such sales, the CWF currently holds 5,047,642 shares of Class B
Common Stock and CWF Notes in the principal amount of approximately $17,646,000.
CAUTIONARY STATEMENTS
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, the Company is hereby filing cautionary
statements identifying important risk factors that could cause the Company's
actual results to differ materially from those projected in forward-looking
statements of the Company made by or on behalf of the Company.
The Company wishes to caution readers that these factors, among others,
could cause the Company's actual financial or enrollment results to differ
materially from those expressed in any projected, estimated, or forward-looking
statements relating to the Company. The following factors should be considered
in conjunction with any discussion of operations or results by the Company or
its representatives, including any forward-looking discussion, as well as
comments contained in press releases, presentations to securities analysts or
investors, or other communications by the Company.
In making these statements, the Company is not undertaking to address or
update each factor in future filings or communications regarding the Company's
business or results, and is not undertaking to address how any of these factors
may have caused changes to discussions or information contained in previous
filings or communications. In addition, certain of these matters may have
affected the Company's past results and may affect future results.
HEALTH CARE COSTS. A large portion of the revenue received by the Company
is expended to pay the costs of health care services or supplies delivered to
its members. The total health care costs incurred by the Company are affected by
the number of individual services rendered and the cost of each service. Much of
the Company's premium revenue is set in advance of the actual delivery of
services and the related incurring of the cost, usually on a prospective annual
basis. While the Company attempts to base the premiums it charges at least in
part on its estimate of expected health care costs over the fixed premium
period, competition, regulations, and other circumstances may limit the
Company's ability to fully base premiums on estimated costs. In addition, many
factors may and often do cause actual health care costs to exceed those costs
estimated and reflected in premiums. These factors may include increased
utilization of services, increased cost of individual services, catastrophes,
epidemics, seasonality, new mandated benefits or other regulatory changes, and
insured population characteristics.
The managed health care industry is labor intensive and its profit margin is
low. Hence, it is especially sensitive to inflation. Health care industry costs
have been rising annually at rates higher than the Consumer Price Index.
Increases in medical expenses without corresponding increases in premiums could
have a material adverse effect on the Company.
PHARMACEUTICAL COSTS. The costs of pharmaceutical products and services are
increasing faster than the costs of other medical products and services. Thus,
the Company's HMOs face ever higher pharmaceutical expenses. The inability to
manage pharmaceutical costs could have an adverse effect on the Company's
financial condition.
23
MEDICAL MANAGEMENT. The Company's profitability is dependent, to a large
extent, upon its ability to accurately project and manage health care costs,
including without limitation, appropriate benefit design, utilization review and
case management programs, and its risk sharing arrangements with providers,
while providing members with quality health care. For example, high
out-of-network utilization of health care providers and services may have
significant adverse affects on the Company's ability to manage health care costs
and member utilization of health care. There can be no assurance that the
Company through its medical management programs will be able to continue to
manage medical costs sufficiently to restore and/or maintain profitability in
all of its product lines.
MARKETING. The Company markets its products and services through both
employed sales people and independent sales agents. Although the Company has a
number of such sales employees and agents, if certain key sales employees or
agents or a large subset of such individuals were to leave the Company, its
ability to retain existing customers and members could be impaired. In addition,
certain of the Company's customers or potential customers consider rating,
accreditation, or certification of the Company by various private or
governmental bodies or rating agencies necessary or important. Certain of the
Company's health plans or other business units may not have obtained or may not
desire or be able to obtain or maintain such accreditation or certification
which could adversely affect the Company's ability to obtain or retain business
with such customers.
The managed health care industry has recently received a significant amount
of negative publicity. Such general publicity, or any negative publicity
regarding the Company in particular, could adversely affect the Company's
ability to sell its products or services or could create regulatory problems for
the Company. Furthermore, the managed care industry recently has experienced
significant merger and acquisition activity. Speculation or uncertainty about
the Company's future could adversely affect the ability of the Company to market
its products.
COMPETITION. The Company competes with a number of other entities in the
geographic and product markets in which it operates, some of which other
entities may have certain characteristics or capabilities which give them an
advantage in competing with the Company. These competitors include HMOs, PPOs,
self-funded employers, insurance companies, hospitals, health care facilities,
and other health care providers. The Company believes there are few barriers to
entry in these markets, so that the addition of new competitors can readily
occur. Certain of the Company's customers may decide to perform for themselves
functions or services currently provided by the Company, which could result in a
decrease in the Company's revenues. Certain of the Company's providers may
decide to market products and services to Company customers in competition with
the Company. In addition, significant merger and acquisition activity has
occurred in the industry in which the Company operates as well as in industries
which act as suppliers to the Company such as the hospital, physician,
pharmaceutical, and medical device industries. This activity may create stronger
competitors and/or result in higher health care costs. Provider service
organizations may be created by health care providers to offer competing managed
care products. To the extent that there is strong competition or that
competition intensifies in any market, the Company's ability to retain or
increase customers, its revenue growth, its pricing flexibility, its control
over medical cost trends, and its marketing expenses may all be adversely
affected.
PROVIDER RELATIONS. One of the significant techniques the Company uses to
manage health care costs and utilization and to monitor the quality of care
being delivered is to contract with physicians, hospitals, and other providers.
Because of the large number of providers with which the Company's health plans
contract, the Company currently believes it has a limited exposure to provider
relations issues. In any particular market, however, providers could refuse to
contract with the Company, demand higher payments or take other actions which
could result in higher health care costs, less desirable products for customers
and members, insufficient provider access for current members or to support
growth, or difficulty in meeting regulatory or accreditation requirements.
24
In some markets, certain providers, particularly hospitals,
physician/hospital organizations or multi-specialty physician groups, may have
significant market positions or even monopolies. Many of these providers may
compete directly with the Company. If such providers refuse to contract with the
Company or utilize their market position to negotiate favorable contracts or
place the Company at a competitive disadvantage, the Company's ability to market
products, or to be profitable in those areas could be adversely affected.
The Company contracts with providers in California and Arizona, and to a
lesser degree in other areas, primarily through capitation fee arrangements.
Under a capitation fee arrangement, the Company pays the provider a fixed amount
per member on a regular basis and the provider accepts the risk of the frequency
and cost of member utilization of services. Providers who enter into such
arrangements generally contract with specialists and other secondary providers
to provide services not offered by the primary provider. The inability of
providers to properly manage costs under capitation arrangements can result in
financial instability of such providers and the termination of their
relationship with the Company. In addition, payment or other disputes between
the primary provider and specialists with whom it contracts can result in a
disruption in the provision of services to the Company's members or a reduction
in the services available. A primary provider's financial instability or failure
to pay secondary providers for services rendered could lead secondary providers
to demand payment from the Company, even though the Company has made its regular
capitated payments to the primary provider. There can be no assurance that
providers with whom the Company contracts will properly manage the costs of
services, maintain financial solvency or avoid disputes with secondary
providers, the failure of any of which could have an adverse effect on the
provision of services to members and the Company's operations.
ADMINISTRATION AND MANAGEMENT. The level of administrative expense is a
partial determinant of the Company's profitability. While the Company attempts
to effectively manage such expenses, increases in staff-related and other
administrative expenses may occur from time to time due to business or product
start-ups or expansions, growth or changes in business, acquisition, regulatory
requirements, or other reasons. Such expense increases are not clearly
predictable and increases in administrative expenses may adversely affect
results.
The Company currently believes it has a relatively experienced, capable
management staff. Loss of certain managers or a number of such managers could
adversely affect the Company's ability to administer and manage its business.
FEDERAL AND STATE LEGISLATION. There are numerous legislative proposals
currently before Congress and the state legislatures which, if enacted, could
materially affect the managed health care industry and the regulatory
environment. Recent financial troubles of certain health care service providers
could alter or increase legislative consideration of these or additional
proposals. The Company cannot predict the outcome of any of these legislative
proposals, nor the extent to which the Company may be affected by the enactment
of any such legislation. Legislation which causes the Company to change its
current manner of operation could have a material adverse effect on the
Company's results of operations and ability to compete.
RESTRUCTURING COSTS. During 1998, the Company initiated the consolidation
and centralization of its corporate functions and continued its workforce
reduction in selected health plans. In addition, the Company initiated a formal
plan to dispose of certain Central Division health plans included in the
Company's Health Plan Services segment during the fourth quarter of 1998. It is
anticipated that the divestiture of these plans will be completed during the
first half of 1999. The Company evaluated the carrying values of the assets of
these health plans and determined that the carrying value exceeded estimated
fair values. The Company had previously recorded charges in the second and third
quarters of 1998 related to management's best estimate of recovery for the real
estate and the impairment of notes receivable and other Company assets due to
the bankruptcy filing of FPA in July 1998.
25
During the second and third quarters of 1998, the Company recorded $78.1
million related to FPA's bankruptcy and $146.9 million of restructuring and
other charges. These charges were primarily related to severance costs of $21.2
million related to staff reduction in selected health plans and corporate
centralization and consolidation; other special charges totaling $38.7 million
related to the adjustment of amounts due from a hospital system that filed
bankruptcy totaling $18.6 million, premium deficiency reserves for certain of
the Company's non-core health plans totaling $12.0 million, and $8.1 million
related to other items. Other charges totaling $87.0 million were mostly related
to contractual adjustments and were primarily included in health care costs
within the consolidated statement of operations. As of December 31, 1998,
approximately $27.5 million is expected to require future outlays of cash.
As a direct consequence of the Company's evaluation of the estimated fair
value of its anticipated divestitures and other items, the Company recorded
asset impairment and other charges amounting to $185.9 million in the fourth
quarter of 1998. Of this amount, approximately $112.4 million related to the
carrying value of health plans anticipated to be divested; approximately $54.9
million primarily related to bad debts, claims and premium deficiency reserves;
and approximately $18.6 million primarily related to litigation in the normal
course of business. Of the charges in the fourth quarter, approximately $6
million resulted in cash outlays. The Company anticipates future cash outlays
from the charges of approximately $50.1 million. The cash generated from the
divestitures, however, is expected to exceed the cash impact of all such charges
in both 1998 and 1999 combined. Although the Company continually seeks to
integrate new operations and restructure existing operations efficiently,
unforeseen difficulties could delay or substantially impede any one or more of
the Company's restructuring efforts causing a material adverse effect on the
Company's future profitability. There can be no assurance that the anticipated
divestitures which are essential to the restructuring will be consummated.
MANAGEMENT INFORMATION SYSTEMS. The Company's business is significantly
dependent on effective information systems. The information gathered and
processed by the Company's management information systems assists the Company
in, among other things, pricing its services, monitoring utilization and other
cost factors, processing provider claims, billing its customers on a timely
basis, and identifying accounts for collection. The Company's customers and
providers also depend upon the Company's information systems for membership
verification, claims status, and other information. The Company has many
different information systems for its various businesses. Moreover, the merger,
acquisition and divestiture activity of the Company requires frequent
transitions to or from, and the integration of, various information management
systems. The Company is in the process of attempting to reduce the number of
systems and also to upgrade and expand its information systems capabilities. Any
difficulty associated with or failure to successfully implement such updated
management information systems, or any inability to expand processing capability
in the future in accordance with its business needs, could result in a loss of
existing customers and difficulty in attracting new customers, customer and
provider disputes, regulatory problems, increases in administrative expenses, or
other adverse consequences. In addition, the Company may, from time-to-time,
obtain significant portions of its systems-related or other services or
facilities from independent third parties which may make the Company's
operations vulnerable to such third parties' failure to perform adequately.
The Company also recognizes that the arrival of the Year 2000 poses a unique
worldwide challenge to the ability of virtually all computer systems to
recognize the date change from 1999 to 2000 and has substantially completed its
assessment of the Year 2000 Issue and is in the process of implementing remedial
measures. The Year 2000 Issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of the
Company's computer programs (both external and internal) that have date/time
sensitive software may recognize a date using "00" as the year 1900 rather than
the year 2000. This could result in a system failure or material miscalculations
causing disruptions of operations, including, among other things, the inability
to process transactions, prepare invoices, or engage in normal business
activities.
26
There can be no assurance that the systems of the Company or of other
companies on which the Company's systems rely will be timely converted and/or
modified, and such failure could have a material adverse effect on the Company
and its operations. The costs of the Company's Year 2000 Issue projects and the
timetable in which the Company plans to complete the Year 2000 Issue compliance
requirements set forth under the heading "Management's Discussion and Analysis
of Financial Condition and Results of Operations" in the Company's 1998 Annual
Report to Stockholders attached as an exhibit to this Annual Report on Form 10-K
are based on estimates derived utilizing numerous assumptions of future events
including the continued availability of certain resources, third party
modification plans, and other factors. There can be no assurance that these
estimates will be achieved and actual results could differ materially from these
plans and estimates.
The Company is also assessing the extent to which, if at all, the Company's
existing insurance policies cover these potential Year 2000 Issue liabilities.
MANAGEMENT OF GROWTH. The Company has made several large acquisitions in
recent years, and continues to explore acquisition opportunities. Failure to
effectively integrate acquired operations could result in increased
administrative costs or customer confusion or dissatisfaction. The Company may
also not be able to manage this growth effectively, including not being able to
continue to develop processes and systems to support its growing operations.
There can be no assurance that the Company will be able to maintain its
historical growth rate.
POTENTIAL DIVESTITURES. The Company continues to evaluate the profitability
realized or likely to be realized by its existing businesses and operations, and
is reviewing from a strategic standpoint which of its businesses or operations
should be divested. In this regard the Company (i) has entered into definitive
agreements to sell its HMOs in the states of New Mexico, Texas, Louisiana and
Oklahoma, (ii) has entered into a letter of intent to sell its HMO operations in
the state of Colorado, (iii) is considering divestiture of its ownership of two
southern California hospitals, (iv) has entered into a definitive agreement to
sell certain pharmacy benefit processing services, which sale is anticipated to
be consummated on March 31, 1999 and (v) is reviewing the possibility of
divesting its ownership of certain non-core operations. There can be no
assurance that the Company will complete any of these transactions. Further,
entering into, evaluating or consummating these transactions may entail certain
risks and uncertainties in addition to those which may result from any such
change in the Company's business operations, including but not limited to
extraordinary transaction costs, unknown indemnification liabilities or
unforeseen administrative needs, any of which could result in reduced revenues,
increased charges, post transaction administrative costs or could otherwise have
a material adverse effect on the Company's business, financial condition or
results of operations. See "Item 1. Business--Discontinued Operations and
Anticipated Divestitures."
GOVERNMENT PROGRAMS AND REGULATION. The Company's business is subject to
extensive federal and state laws and regulations, including, but not limited to,
financial requirements, licensing requirements, enrollment requirements, and
periodic examinations by governmental agencies. The laws and rules governing the
Company's business and interpretations of those laws and rules are subject to
frequent change. For example, as described earlier in this Annual Report on Form
10-K, in the section entitled "California HMO Regulations," the California
legislature may in 1999 make significant changes in the laws regulating HMOs
operating in that state, particularly in light of the bankruptcy of FPA in July
1998 and the state installation of a conservator over MedPartners Provider
Network, a California health plan, in March 1999. Existing or future laws and
rules could force the Company to change how it does business and may restrict
the Company's revenue and/or enrollment growth and/or increase its health care
and administrative costs. In particular, the Company's HMO and insurance
subsidiaries are subject to regulations relating to cash reserves, minimum net
worth, premium rates, and approval of policy language and benefits. Although
such regulations have not significantly impeded the growth of the Company's
business to date, there can be no assurance that the Company will be able to
continue to obtain or maintain required governmental approvals or licenses or
that regulatory changes will not have a material adverse
27
effect on the Company's business. Delays in obtaining or failure to obtain or
maintain such approvals, or moratoria imposed by regulatory authorities, could
adversely affect the Company's revenue or the number of its members, could
increase costs, or could adversely affect the Company's ability to bring new
products to market as forecasted. In addition, efforts to enact changes to
Medicare could impact the structure of the Medicare program, benefit designs and
reimbursement. Changes to the current operation of the Company's Medicare
services could have a material adverse affect on the Company's results of
operations.
A significant portion of the Company's revenues relate to federal, state,
and local government health care coverage programs, such as Medicare and
Medicaid programs. Such contracts carry certain risks such as higher comparative
medical costs, government regulatory and reporting requirements, the possibility
of reduced or insufficient government reimbursement in the future, and higher
marketing and advertising costs per member as a result of marketing to
individuals as opposed to groups. Such risk contracts also are generally subject
to frequent change including changes which may reduce the number of persons
enrolled or eligible, reduce the revenue received by the Company or increase the
Company's administrative or health care costs under such programs. In the event
government reimbursement were to decline from projected amounts, the Company's
failure to reduce the health care costs associated with such programs could have
a material adverse effect upon the Company's business. Changes to such
government programs in the future may also affect the Company's willingness to
participate in such programs.
The Company is also subject to various governmental audits and
investigations. Such activities could result in the loss of licensure or the
right to participate in certain programs, or the imposition of fines, penalties
and other sanctions. In addition, disclosure of any adverse investigation or
audit results or sanctions could negatively affect the Company's reputation in
various markets and make it more difficult for the Company to sell its products
and services.
The amount of government receivables represents the Company's best estimate
of the government's liability. As of December 31, 1998, the Company's government
receivables were $321.4 million. The receivables are generally subject to
government audit and negotiation and the final amounts actually received may be
greater or less than the amounts recognized by the Company.
LOSS RESERVES. The Company's loss reserves are estimates of future costs
based on various assumptions. The accuracy of these estimates may be affected by
external forces such as changes in the rate of inflation, the regulatory
environment, the judicious administration of claims, medical costs, and other
factors. Included in the loss reserves are estimates for the costs of services
which have been incurred but not reported ("IBNR"). Estimates are continually
monitored and reviewed and, as settlements are made or estimates adjusted,
differences are reflected in current operations. Such estimates are subject to
the impact of changes in the regulatory environment and economic conditions.
Given the inherent variability of such estimates, the actual liability could
differ significantly from the amounts provided. Moreover, if the assumptions on
which the estimates are based prove to be incorrect and reserves are inadequate
to cover the Company's actual experience, the Company's profitability could be
adversely affected.
LITIGATION AND INSURANCE. The Company is subject to a variety of legal
actions to which any corporation may be subject, including employment and
employment discrimination-related suits, employee benefit claims, breach of
contract actions, tort claims, shareholder suits, including for securities
fraud, and intellectual property related litigation. In addition, because of the
nature of its business, the Company incurs and likely will continue to incur
potential liability for claims related to its business, such as failure to pay
for or provide health care, poor outcomes for care delivered or arranged,
provider disputes, including disputes over withheld compensation, and claims
related to self-funded business. In some cases, substantial non-economic or
punitive damages may be sought. While the Company currently has insurance
coverage for some of these potential liabilities, others may not be covered by
insurance (such as punitive damages), the insurers may dispute coverage or the
amount of insurance may not be enough to cover the damages awarded. In addition,
insurance coverage for all or certain forms of liability may become unavailable
or prohibitively expensive in the future.
28
STOCK MARKET. Recently, the market prices of the securities of certain of
the publicly-held companies in the industry in which the Company operates have
shown volatility and sensitivity in response to many factors, including public
communications regarding managed care, legislative or regulatory actions, health
care cost trends, pricing trends, competition, earning or membership reports of
particular industry participants, and acquisition activity. There can be no
assurances regarding the level of stability of the Company's share price at any
time or the impact of these or any other factors on the share price.
RECENT DEVELOPMENTS
FOHP. In 1997, the Company purchased convertible debentures (the "FOHP
Debentures") of FOHP, Inc., a New Jersey corporation ("FOHP"), in the aggregate
principal amount of approximately $80.7 million and converted approximately
$70.6 million principal amount of the FOHP Debentures into shares of Common
Stock of FOHP. As a result, the Company owned approximately 98% of the
outstanding shares of FOHP common stock.
Effective December 31, 1997, the Company purchased nonconvertible debentures
in the amount of $24 million from FOHP. The debentures mature on December 31,
2002. The debentures were issued to the Company in consideration for additional
capital contributions made by the Company pursuant to the Amended and Restated
Securities Purchase Agreement, dated February 10, 1997, and as amended March 13,
1997, among the Company, FOHP, and First Option Health Plan of New Jersey, Inc.
("FOHP-NJ"), a wholly-owned subsidiary of FOHP (collectively, the "Definitive
Agreements"). Pursuant to the Definitive Agreements, at any time during the 1999
calendar year, the Company may acquire any remaining shares of FOHP not owned by
the Company pursuant to a tender offer, merger, combination or other business
combination transaction for consideration (to be paid in cash or stock of the
Company) equal to the value of such FOHP stock based on appraiser
determinations.
Pursuant to an Agreement and Plan of Merger dated as of October 26, 1998,
Physicians Health Services of New Jersey, Inc., a New Jersey HMO wholly-owned by
the Company, merged with and into FOHP-NJ on January 1, 1999 and FOHP-NJ changed
its name to Physicians Health Services of New Jersey, Inc. ("PHS-NJ"). On
December 31, 1998, the Company converted $1,197,183 principal amount of its
remaining convertible debentures of FOHP into common stock of FOHP. As a result,
the Company now owns approximately 99.6% of the outstanding equity of FOHP. The
minority shareholders of FOHP are physicians, hospitals and other health care
providers.
Pursuant to an Agreement and Plan of Merger dated as of November 16, 1998, a
wholly-owned subsidiary of the Company will merge into FOHP and FOHP will become
a wholly-owned subsidiary of the Company. The merger is anticipated to occur in
the second quarter of 1999. In connection with the merger, the current minority
shareholders of FOHP will be entitled to either the value of their shares as of
December 31, 1998 as determined by an appraiser or payment rights which entitle
the holders to receive not less than $15.00 per payment right on or about July
1, 2001, provided that, with respect to the payment rights (i) for a provider
shareholder, such shareholder agrees to remain a provider to PHS-NJ until
December 31, 2001 and a specified number of hospital providers in the provider
network does not leave the network prior to December 31, 2001, (ii) for a
hospital provider shareholder, such payment rights will be subject to additional
conditions to payment relating to reimbursement rates, enrollment of hospital
employees in PHS-NJ health plans, and payments of premiums to PHS-NJ and (iii)
for a non-provider shareholder, such shareholder will be entitled to receive
additional consideration of $2.25 per payment right and a pro rata portion of a
bonus to be funded by monies forfeited by provider shareholders, provided that
PHS-NJ achieves certain annual returns on common equity.
FOHP (headquartered in Neptune, New Jersey) is the sole shareholder of
PHS-NJ, a New Jersey corporation. PHS-NJ is a managed health care company
providing commercial products for businesses and individuals, along with
Medicare, Medicaid and workers' compensation programs. PHS-NJ currently has more
than 250,000 members in New Jersey enrolled in its commercial, Medicare,
Medicaid and PPO programs.
29
QUALMED PLANS FOR HEALTH OF PENNSYLVANIA, INC. Effective December 31, 1998,
the Company purchased the minority interests in QualMed Plans for Health of
Pennsylvania, Inc. ("QualMed-PA"), a then majority-owned subsidiary of the
Company, for approximately $2 million. Previously, the Company owned
approximately 83% of the common stock of QualMed-PA. In January 1999, the
Company transferred the assets of QualMed-PA, including the assets relating to
its preferred provider organization ("MaxNet-Registered Trademark-") and managed
workers' compensation ("CompTek-Registered Trademark-") business and operations,
to Preferred Health Network, Inc., another wholly-owned subsidiary of the
Company.
MEDPARTNERS PROVIDER NETWORK, INC. On March 11, 1999, MedPartners Provider
Network, Inc. ("MPN"), a Knox-Keene licensed entity and a subsidiary of
MedPartners, Inc., a publicly-held physician practice and pharmacy benefit
management company, was placed into conservatorship by the State of California
under Section 1393(c) of the California Health and Safety Code. The conservator
immediately filed a petition under Chapter 11 of the Bankruptcy Code on behalf
of MPN. MPN and various provider groups and clinics affiliated with MedPartners,
Inc. provide health care services to approximately 215,000 enrollees of the
Company's Health Net HMO subsidiary.
The Company continues to monitor the situation closely and has been involved
in discussions with various parties to attempt to maintain continuity of care
and to minimize the impact that MPN's conservatorship and bankruptcy could have
on affected Health Net members. The Company understands from various public
statements made by MedPartners, Inc. that it intends to divest its California
clinic operations.
Although at this time the Company is unable to fully assess the potential
financial implications of the foregoing actions, management of the Company
believes that such actions will not have a material adverse effect on either the
financial or operating condition of the Company.
CONSOLIDATION. In a continuing effort to streamline its operations, the
Company effectuated numerous consolidation transactions among its subsidiaries
in 1998. In January 1998, Midwest Business Medical Association, Ltd., a PPO
subsidiary of the Company, merged into Preferred Health Network, Inc. In May
1998, Foundation Health Medical Group Florida, Inc., a holding company whose
assets had been previously sold, merged into its immediate parent company
Foundation Health, A Florida Health Plan, Inc. In July 1998, the Company merged
two subsidiaries operating in managed behavioral health services: Foundation
Health Psychcare Services, Inc. and Managed Health Network, Inc. Intergroup
Healthcare Corporation of Utah, a holding company which owns the Company's Utah
HMO, merged into its immediate parent company, Foundation Health Corporation, in
July 1998. Also in July 1998, Foundation Health, A California Health Plan, Inc.
merged into Health Net, thereby consolidating the Company's California HMO
plans. In December 1998, the Company merged its Connecticut health plans, M.D.
Health Plan, Inc. and Physicians Health Services of Connecticut, Inc. Also in
December 1998, Preferred Health Providers, Inc., a PPO subsidiary of the
Company, merged into Foundation Health, A Florida Health Plan. In 1998, the
Company also completed the integration of its Colorado health plans, Foundation
Health, A Colorado Health Plan, Inc. and QualMed Plans for Health of Colorado,
Inc., which merged in August 1997.
INSURANCE SUBSIDIARIES. The Company is in the process of restructuring its
insurance subsidiaries to merge Foundation Health National Life Insurance
Company ("FHNL") and Foundation Health Systems Life and Health Insurance Company
("FHS Life") under a newly-formed holding company subsidiary of the Company, FHS
Life Holdings Company, Inc.
RISK-BASED WORKERS' COMPENSATION OPERATIONS. In 1997, the Company revised
its strategy of maintaining a presence in the workers' compensation insurance
business as a result of various factors, including adverse developments arising
in the workers' compensation insurance business, primarily related to the
workers' compensation claims environment in California. In 1997 the Company
adopted a plan to completely discontinue this segment of its business, through
divestiture of its workers' compensation
30
risk-assuming insurance subsidiaries. On December 10, 1998, the Company
consummated the sale of Business Insurance Group, Inc. ("BIG"), its risk-based
workers' compensation subsidiary. As part of the transaction, the Company funded
the purchase of third party reinsurance to cover up to $175 million in adverse
loss development related to BIG and its subsidiaries. The Company received
approximately $200 million in cash for the sale, net of its costs and expenses
for the transaction. Certain of the Company's subsidiaries entered into
agreements with the buyer to continue to provide certain administrative services
related to such operations for a period of five years.
LOUISIANA, OKLAHOMA AND TEXAS HMO OPERATIONS. On November 4, 1998, the
Company entered into a definitive agreement for the sale of its HMO operations
in the states of Texas, Louisiana and Oklahoma to AmCareco, Inc. As part of the
transaction, the Company will receive convertible preferred stock of the buyer.
The Company is pursuing a divestiture of these HMOs due to, among other reasons,
inadequate returns on invested capital. Although the Company has entered into a
definitive agreement for the foregoing sale, consummation of the sale is subject
to numerous conditions and certain regulatory approvals.
ALABAMA HMO OPERATIONS. In December 1997, the Company entered into a
definitive agreement to sell its non-operational HMO license in Alabama to an
unaffiliated third party, which sale was consummated in January 1998.
PHARMACY BENEFITS MANAGEMENT SERVICES. In February 1999, the Company
entered into a definitive agreement to sell to Advance Paradigm the capital
stock of Foundation Health Pharmaceutical Services, Inc., and certain pharmacy
benefit processing services of Integrated Pharmaceutical Services, Inc., for
approximately $70 million in cash. In addition, the Company and Advance Paradigm
entered into a services agreement, whereby Advance Paradigm will provide to the
Company's Health Plan Divisions at competitive rates claims processing, retail
network management and payment of claims pharmacy benefits services. Advance
Paradigm will also provide pharmacy mail service to the Health Plan Divisions.
For a period of five years, the Company may not compete with respect to such
services in any market in which Advance Paradigm conducts business, subject to
certain exceptions. It is anticipated that the sale will be consummated on March
31, 1999.
MEMBER SUPPORT CENTER OPERATIONS. During 1998, the Company operated a
regional member support center located in Philadelphia. The support center was a
telecommunications center staffed by nurses who responded to member calls
through the retrieval of detailed clinical and demographic data regarding plan
members and provider information, and the use of clinical algorithms to guide
members to the most appropriate level of care for their condition. In December
1998, the Company sold the clinical content used in its member support center
operations to Access Health, Inc. ("Access Health") for approximately $36.3
million in cash net proceeds. In addition, the Company entered into a long-term
services agreement with Access Health pursuant to which all members who had
access to the support center at the time of sale will continue to have such
access for a period of ten years, with available annual extensions by the
Company. In addition, as part of the transaction the Company agreed not to
compete in such services for a period commencing on the closing date and ending
two years after members cease to have access to the support center.
SOUTHERN CALIFORNIA HOSPITALS. The Company is reviewing the possibility of
divesting its ownership of two Southern California hospitals, a 128-bed hospital
located in Los Angeles, California, the East Los Angeles Doctors Hospital, and a
200-bed hospital located in Gardena, California, the Memorial Hospital of
Gardena. The Company is presently responding to inquiries of parties which have
expressed an interest in the purchase of such businesses.
GEM INSURANCE COMPANY. Since October of 1997, Gem Insurance Company
("Gem"), a subsidiary of the Company, has implemented a restructuring plan to
reduce operating losses and its in-force insurance risk. In 1997, Gem initiated
a withdrawal from the Nevada insurance markets, and began restructuring its
31
insurance products in Utah and then in certain other markets. Gem also reduced
commissions to market-level rates and terminated certain general agents. Gem
continued to implement such restructuring plan in 1998. As a result, the number
of Gem's insureds dropped from over 100,000 at the start of 1998 to
approximately 2,500 at December 31, 1998. Gem has filed notices of intention to
withdraw from Nebraska and the small group market in Colorado. Currently,
Foundation Health Systems Life and Health Insurance Company, a subsidiary of the
Company, services Gem's insured through an administrative services agreement
between the companies. The Company is reviewing the possibility of winding up
the operations of Gem or merging such operations into another insurance
subsidiary of the Company. Upon completion of its current withdrawals, Gem will
be licensed in only five states.
COLORADO OPERATIONS. In March 1999, the Company entered into a letter of
intent to sell the capital stock of QualMed Plans for Health of Colorado, Inc.,
the Company's HMO subsidiary in the state of Colorado, to Wellpoint Health
Networks Inc. The Company anticipates closing the sale in the first half of
1999. Although the Company has entered into a letter of intent for the foregoing
sale, consummation of the sale is subject to executing a definitive agreement
mutually satisfactory to the parties and satisfaction of all conditions to be
set forth therein, including obtaining regulatory approvals. In addition, the
Company has decided to close its regional service center in Pueblo, Colorado in
the first half of 1999.
NEW MEXICO OPERATIONS. In March 1999, the Company also entered into a
definitive agreement to sell the capital stock of QualMed Plans for Health,
Inc., the Company's HMO subsidiary in the state of New Mexico, to Health Care
Horizons, Inc. Although the Company has entered into a definitive agreement for
the foregoing sale, consummation of the sale is subject to numerous conditions
and certain regulatory approvals.
CERTAIN OTHER OPERATIONS. The Company continues to evaluate the
profitability realized or likely to be realized by its existing businesses and
operations, and is reviewing from a strategic standpoint which of such
businesses or operations should be divested.
32
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
The following table sets forth the high and low sales prices of the
Company's Class A Common Stock, par value $.001 per share (the "Class A Common
Stock"), on The New York Stock Exchange, Inc. ("NYSE") since January 2, 1996.
HIGH LOW
--------- ---------
Calendar Quarter--1996
First Quarter.................................................................................. 37 1/8 30 3/8
Second Quarter................................................................................. 37 1/8 26 7/8
Third Quarter.................................................................................. 28 7/8 19 3/8
Fourth Quarter................................................................................. 29 1/8 22 5/8
Calendar Quarter--1997
First Quarter.................................................................................. 30 3/4 23 1/8
Second Quarter................................................................................. 33 24 1/4
Third Quarter.................................................................................. 33 15/16 29 11/16
Fourth Quarter................................................................................. 33 3/8 22 1/16
Calendar Quarter--1998
First Quarter.................................................................................. 29 1/16 22 1/4
Second Quarter................................................................................. 32 5/8 25 3/8
Third Quarter.................................................................................. 26 7/8 9
Fourth Quarter................................................................................. 15 3/4 5 7/8
Calendar Quarter--1999
First Quarter (through March 29, 1999)......................................................... 12 7/16 7 11/16
On March 29, 1999, the last reported sales price per share of the Class A
Common Stock was $11.0625 per share.
DIVIDENDS
No dividends have been paid by the Company during the preceding two fiscal
years. The Company has no present intention of paying any dividends on its
Common Stock.
The Company is a holding company and, therefore, its ability to pay
dividends depends on distributions received from its subsidiaries, which are
subject to regulatory net worth requirements and certain additional state
regulations which may restrict the declaration of dividends by HMOs, insurance
companies and licensed managed health care plans. The payment of any dividend is
at the discretion of the Company's Board of Directors and depends upon the
Company's earnings, financial position, capital requirements and such other
factors as the Company's Board of Directors deems relevant.
Under the Credit Agreement entered into on July 8, 1997 with Bank of America
as agent, the Company cannot declare or pay cash dividends to its stockholders
or purchase, redeem or otherwise acquire shares of its capital stock or
warrants, rights or options to acquire such shares for cash except to the extent
permitted under such Credit Agreement as described elsewhere in this Annual
Report on Form 10-K.
HOLDERS
As of March 29, 1999, there were approximately 2,000 holders of record of
Class A Common Stock. The California Wellness Foundation (the "CWF") is the only
holder of record of the Company's Class B
33
Common Stock, par value $.001 per share (the "Class B Common Stock"), which
constitutes approximately 4% of the Company's aggregate equity. Under the
Company's Fourth Amended and Restated Certificate of Incorporation, shares of
the Company's Class B Common Stock have the same economic benefits as shares of
the Company's Class A Common Stock, but are non-voting. Upon the sale or other
transfer of shares of Class B Common Stock by the CWF to an unrelated third
party, such shares automatically convert into Class A Common Stock.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item is set forth in the Company's Annual
Report to Stockholders on page 1, and is incorporated herein by reference and
made a part hereof.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information required by this Item is set forth in the Company's Annual
Report to Stockholders on pages 17 through 27, and is incorporated herein by
reference and made a part hereof.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this Item is set forth in the Company's Annual
Report to Stockholders on pages 27 through 28, and is incorporated herein by
reference and made a part hereof.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is set forth in the Company's Annual
Report to Stockholders on pages 29 through 56, and is incorporated herein by
reference and made a part hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is set forth in the Company's
definitive proxy statement, which will be filed with the Securities and Exchange
Commission within 120 days of December 31, 1998. Such information is
incorporated herein by reference and made a part hereof.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is set forth in the Company's
definitive proxy statement, which will be filed with the Securities and Exchange
Commission within 120 days of December 31, 1998. Such information is
incorporated herein by reference and made a part hereof.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is set forth in the Company's
definitive proxy statement, which will be filed with the Securities and Exchange
Commission within 120 days of December 31, 1998. Such information is
incorporated herein by reference and made a part hereof.
34
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is set forth in the Company's
definitive proxy statement, which will be filed with the Securities and Exchange
Commission within 120 days of December 31, 1998. Such information is
incorporated herein by reference and made a part hereof.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K
(A) FINANCIAL STATEMENTS, SCHEDULES AND EXHIBITS
1. FINANCIAL STATEMENTS
The following consolidated financial statements are incorporated by
reference into this Annual Report on Form 10-K from pages 29 to 56 of the
Company's Annual Report to Stockholders for the year ended December 31, 1998:
Report of Deloitte & Touche LLP
Consolidated balance sheets at December 31, 1998 and 1997
Consolidated statements of operations for each of the three years in the
period ended December 31, 1998
Consolidated statements of stockholders' equity for each of the three
years in the period ended December 31, 1998
Consolidated statements of cash flows for each of the three years in the
period ended December 31, 1998
Notes to consolidated financial statements
35
2. FINANCIAL STATEMENT SCHEDULES
The following financial statement schedules are filed as a part of this
Annual Report on Form 10-K:
Schedule I--Condensed Financial Information of Registrant
All other schedules are omitted because they are not applicable, not
required or because the required information is included in the consolidated
financial statements or notes thereto which are incorporated by reference into
this Annual Report on Form 10-K from the Company's 1998 Annual Report to
Stockholders.
3. EXHIBITS
The following exhibits are filed as part of this Annual Report on Form 10-K
or are incorporated herein by reference:
2.1 Agreement and Plan of Merger, dated October 1, 1996, by and among Health Systems
International, Inc., FH Acquisition Corp. and Foundation Health Corporation (filed
as Exhibit 2.5 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1996, which is incorporated by reference herein).
2.2 Agreement and Plan of Merger, dated May 8. 1997, by and among the Company, PHS
Acquisition Corp. and Physicians Health Services, Inc. (filed as Exhibit 2.2 to the
Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997, which
is incorporated by reference herein).
2.3 Amendment No. 1 to Agreement and Plan of Merger, dated October 20, 1997, by and
among the Company, PHS Acquisition Corp. and Physicians Health Services, Inc.
(filed as Exhibit 2.3 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1997, which is incorporated by reference herein).
3.1 Fourth Amended and Restated Certificate of Incorporation of the Registrant (filed
as Exhibit 4.1 to the Company's Registration Statement on Form S-8 (File No.
333-24621), which is incorporated by reference herein).
3.2 Fifth Amended and Restated Bylaws of the Registrant (filed as Exhibit 3.2 to the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which
is incorporated by reference herein).
4.1 Form of Class A Common Stock Certificate (included as Exhibit 4.2 to the Company's
Registration Statements on Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01,
respectively) which is incorporated by reference herein).
4.2 Form of Class B Common Stock Certificate (included as Exhibit 4.3 to the Company's
Registration Statements on Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01,
respectively) which is incorporated by reference herein).
4.3 Rights Agreement dated as of June 1, 1996 by and between the Company and Harris
Trust and Savings Bank, as Rights Agent (filed as Exhibit 99.1 to the Company's
Registration Statement on Form 8-A (File No. 001-12718) which is incorporated by
reference herein).
4.4 First Amendment to the Rights Agreement dated as of October 1, 1996, by and between
the Company and Harris Trust and Savings Bank, as Rights Agent (filed as Exhibit
10.40 to the Company's Annual Report on Form 10-K for the year ended December 31,
1996, which is incorporated by reference herein).
36
10.1 Letter Agreement dated June 1, 1998 between The California Wellness Foundation and
the Company (filed as Exhibit 10.75 to the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1998, which is incorporated by reference herein).
*10.2 Employment Agreement, dated August 28, 1993, by and among QualMed, Inc., HN
Management Holdings, Inc. and Dale T. Berkbigler, M.D. (filed as Exhibit 10.20 to
the Company's Registration Statements on Forms S-1 and S-4 (File nos. 33-72892 and
33-72892-01, respectively) which is incorporated by reference herein).
*10.3 Amendment No. 1 to Employment Agreement dated as of April 27, 1994, by and among
the Company, QualMed, Inc. and Dale T. Berkbigler, M.D. (filed as Exhibit 10.17 to
the Company's Annual Report on Form 10-K for the year ended December 31, 1994,
which is incorporated by reference herein).
*10.4 Letter Agreement dated June 25, 1998 between B. Curtis Westen and the Company
(filed as Exhibit 10.73 to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1998, which is incorporated by reference herein).
*10.5 Letter Agreement dated July 31, 1998 between Michael P. White and the Company
(filed as Exhibit 10.74 to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1998 which is incorporated by reference herein).
*10.6 Amended and Restated Employment Agreement, dated March 10, 1997, by and between the
Company and Malik M. Hasan, M.D. (filed as Exhibit 10.3 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1996, which is incorporated by
reference herein).
*10.7 Early Retirement Agreement dated August 6, 1998 between the Company and Malik M.
Hasan, M.D. (filed as Exhibit 10.77 to the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1998).
*10.8 Employment Letter Agreement dated July 3, 1996 between Jay M. Gellert and the
Company (filed as Exhibit 10.37 to the Company's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1996, which is incorporated by reference herein).
*10.9 Amended Letter Agreement between the Company and Jay M. Gellert dated as of August
22, 1997 (filed as Exhibit 10.69 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1997, which is incorporated by reference herein).
*10.10 Employment Letter Agreement between the Company and Dale Terrell dated December 31,
1997 (filed as Exhibit 10.71 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1997, which is incorporated by reference herein).
*10.11 Employment Letter Agreement between the Company and Steven P. Erwin dated March 11,
1998 (filed as Exhibit 10.72 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1997, which is incorporated by reference herein).
*10.12 Employment Agreement between the Company and Maurice Costa dated December 31, 1997
(filed as Exhibit 10.71 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1997, which is incorporated by reference herein).
*+10.13 Employment Letter Agreement between the Company and Gary S. Velasquez dated May 1,
1996, a copy of which is filed herewith.
*+10.14 Employment Agreement between Foundation Health Corporation and Edward J. Munno
dated November 8, 1993, a copy of which is filed herewith.
37
*+10.15 Amendment Number One to Employment Agreement between Foundation Health Corporation
and Edward J. Munno dated May 1, 1996, a copy of which is filed herewith.
*+10.16 Employment Letter Agreement between the Company and Cora Tellez dated November 16,
1998, a copy of which is filed herewith.
*+10.17 Employment Letter Agreement between the Company and Karen Coughlin dated March 12,
1998, a copy of which is filed herewith.
*+10.18 Employment Letter Agreement between the Company and J. Robert Bruce dated September
22, 1998, a copy of which is filed herewith.
*+10.19 Employment Letter Agreement between the Company and Robert Natt dated December 31,
1997 (filed as Exhibit 10.74 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1997, which is incorporated by reference herein).
*+10.20 Waiver and Release of Claims between the Company and Robert Natt, a copy of which
is filed herewith.
*+10.21 Form of Severance Payment Agreement dated December 4, 1998 by and between the
Company and various of its executive officers, a copy of which is filed herewith.
*10.22 Severance Payment Agreement, dated as of April 25, 1994, among the Company,
QualMed, Inc. and B. Curtis Westen (filed as Exhibit 10.10 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1994, which is incorporated by
reference herein).
*+10.23 Severance Payment Agreement between the Company and J. Robert Bruce dated September
15, 1998, a copy of which is filed herewith
*+10.24 Severance Payment Agreement between the Company and Maurice Costa dated April 6,
1998, a copy of which is filed herewith.
*10.25 The Company's Second Amended and Restated 1991 Stock Option Plan (filed as Exhibit
10.30 to Registration Statement on Form S-4 (File No. 33-86524) which is
incorporated by reference herein).
*10.26 The Company's Second Amended and Restated Non-Employee Director Stock Option Plan
(filed as Exhibit 10.31 to Registration Statement on Form S-4 (File No. 33-86524)
which is incorporated by reference herein).
*10.27 The Company's Employee Stock Purchase Plan (filed as Exhibit 10.33 to the Company's
Registration Statements on Forms S-1 and S-4 (File nos. 33-72892 and 33-72892-01,
respectively) which is incorporated by reference herein).
*10.28 The Company's Performance-Based Annual Bonus Plan (filed as Exhibit 10.35 to
Registration Statement on Form S-4 (File No. 33-86524) which is incorporated by
reference herein).
*10.29 Deferred Compensation Agreement dated as of March 3, 1995, by and among Malik M.
Hasan, M.D., the Company and the Compensation and Stock Option Committee of the
Board of Directors of the Company (filed as Exhibit 10.31 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1994, which is incorporated by
reference herein).
38
*10.30 Trust Agreement for Deferred Compensation Arrangement for Malik M. Hasan, M.D.,
dated as of March 3, 1995, by and between the Company and Norwest Bank Colorado
N.A. (filed as Exhibit 10.32 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1994, which is incorporated by reference herein).
*+10.31 The Company's Deferred Compensation Plan Trust Agreement dated as of September 1,
1998 between the Company and Union Bank of California.
*10.32 The Company's 1995 Stock Appreciation Right Plan (filed as Exhibit 10.12 to the
Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995,
which is incorporated by reference herein).
*10.33 The Company's 401(k) Associate Savings Plan (filed as Exhibit 4.5 to the Company's
Registration Statement on Form S-8 filed on March 31, 1998).
*10.34 The Company's 1997 Stock Option Plan (filed as Exhibit 10.45 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which is
incorporated by reference herein).
*10.35 The Company's 1998 Stock Option Plan (filed as Exhibit 4.5 to the Company's
Registration Statement on Form S-8 filed on December 4, 1998).
*10.36 The Company's Employee Stock Purchase Plan (filed as Exhibit 10.47 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which is
incorporated by reference herein).
*10.37 The Company's Performance-Based Annual Bonus Plan (filed as Exhibit 10.48 to the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, which
is incorporated by reference herein).
*10.38 The Company's Third Amended and Restated Non-Employee Director Stock Option Plan
(filed as Exhibit 10.46 to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1997, which is incorporated by reference herein).
*10.39 1989 Stock Plan of Business Insurance Corporation (as Amended and Restated
Effective September 22, 1992) (filed as Exhibit 4.7 to the Company's Registration
Statement on Form S-8 (File No. 333-24621), which is incorporated by reference
herein).
*10.40 Managed Health Network, Inc. Incentive Stock Option Plan (filed as Exhibit 4.8 to
the Company's Registration Statement on Form S-8 (File No. 333-24621), which is
incorporated by reference herein).
*10.41 Managed Health Network, Inc. Amended and Restated 1991 Stock Option Plan (filed as
Exhibit 4.9 to the Company's Registration Statement on Form S-8 (File No.
333-24621), which is incorporated by reference herein).
*10.42 Foundation Health Corporation Employee Stock Purchase Plan (filed as Exhibit 4.3 to
the Company's Registration Statement on Form S-8 (File No. 333-24621), which is
incorporated by reference herein).
*10.43 Foundation Health Corporation Profit Sharing and 401(k) Plan (Amended and Restated
effective January 1, 1994) (filed as Exhibit 4.4 to the Company's Registration
Statement on Form S-8 (File No. 333-24621), which is incorporated by reference
herein).
*10.44 1990 Stock Option Plan of Foundation Health Corporation (filed as Exhibit 4.5 to
the Company's Registration Statement on Form S-8 (File No. 333-24621), which is
incorporated by reference herein).
39
*10.45 1992 Nonstatutory Stock Option Plan of Foundation Health Corporation (filed as
Exhibit 4.6 to the Company's Registration Statement on Form S-8 (File No.
333-24621), which is incorporated by reference herein).
*10.46 1993 Nonstatutory Stock Option Plan of Foundation Health Corporation (as amended
and restated September 7, 1995) (filed as Exhibit 4.10 to the Company's
Registration Statement on Form S-8 (File No. 333-24621), which is incorporated by
reference herein).
*10.47 FHC Directors Retirement Plan (filed as an exhibit to FHC's Form 10-K for the year
ended June 30, 1994 filed with the Commission on September 24, 1994, which is
incorporated by reference herein).
10.48 Participation Agreement dated as of May 25, 1995 among Foundation Health Medical
Services, as Construction Agent and Lessee, FHC, as Guarantor, First Security Bank
of Utah, N.A., as Owner Trustee, Sumitomo Bank Leasing and Finance, Inc., The Bank
of Nova Scotia and NationsBank of Texas, N.A., as Holders and NationsBank of Texas,
N.A., as Administrative Agent for the Lenders; and Guaranty Agreement dated as of
May 25, 1995 by FHC for the benefit of First Security Bank of Utah, N.A. (filed as
an exhibit to FHC's Form 10-K for the year ended June 30, 1995, filed with the
Commission on September 27, 1995, which is incorporated by reference herein).
*10.49 FHC's Deferred Compensation Plan, as amended and restated (filed as an exhibit to
FHC's Form 10-K for the year ended June 30, 1995, filed with the Commission on
September 27, 1995, which is incorporated by reference herein).
*10.50 FHC's Supplemental Executive Retirement Plan, as amended and restated (filed as an
exhibit to FHC's Form 10-K for the year ended June 30, 1995, filed with the
Commission on September 27, 1995, which is incorporated by reference herein).
*10.51 FHC's Executive Retiree Medical Plan, as amended and restated (filed as an exhibit
to FHC's Form 10-K for the year ended June 30, 1995, filed with the Commission on
September 27, 1995, which is incorporated by reference herein).
10.52 Stock and Note Purchase Agreement by and between FHC, Jonathan H., Schoff, M.D.,
FPA Medical Management, Inc., FPA Medical Management of California, Inc. and FPA
Independent Practice Association dated as of June 28, 1996 (filed as Exhibit 10.109
to FHC's Annual Report on Form 10-K for the year ended June 30, 1996, which is
incorporated by reference herein).
10.53 Credit Agreement dated July 8, 1997 among the Company, the banks identified therein
and Bank of America National Trust and Savings Association in its capacity as
Administrative Agent (providing for an unsecured $1.5 billion revolving credit
facility) (filed as Exhibit 10.23 to the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1997, which is incorporated by reference herein).
10.54 Guarantee Agreement dated July 8, 1997 between the Company and First Security Bank,
National Association (filed as Exhibit 10.24 to the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1997, which is incorporated by
reference herein).
10.55 First Amendment and Waiver to Credit Agreement dated April 6, 1998 among the
Company, Bank of America National Trust and Savings Association and the Banks (as
defined therein) (filed as Exhibit 10.64 to the Company's Quarterly Report on Form
10-Q for the quarter ended March 31, 1998, which is incorporated by reference
herein).
40
10.56 Second Amendment to Credit Agreement dated July 31, 1998 among the Company, Bank of
America National Trust and Savings Association and the Banks (as defined therein)
(filed as Exhibit 10.65 to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1998, which is incorporated by reference herein).
10.57 Third Amendment to Credit Agreement, dated November 6, 1998, among the Company,
Bank of America National Trust and Savings Association and the Banks (as defined
therein) (filed as Exhibit 10.65 to the Company's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1998, which is incorporated by reference herein).
10.58 Form of Credit Facility Commitment Letter, dated March 27, 1998, between the
Company and the Majority Banks (as defined therein) (filed as Exhibit 10.70 to the
Company's Annual Report on Form 10-K for the year ended December 31, 1997, which is
incorporated by reference herein).
10.59 Registration Rights Agreement dated as of March 2, 1995 between the Company and the
California Wellness Foundation (filed as Exhibit No. 28.2 to the Company's Current
Report on Form 8-K dated March 2, 1995, which is incorporated by reference herein).
10.60 Office Lease, dated as of January 1, 1992, by and between Warner Properties III and
Health Net (filed as Exhibit 10.23 to the Company's Registration Statements on
Forms S-1 and S-4 (File Nos. 33-72892 and 33-72892-01, respectively) which is
incorporated by reference herein).
10.61 Lease Agreement between HAS-First Associates and FHC dated August 1, 1998 and form
of amendment thereto (filed as an exhibit to FHC's Registration Statement on Form
S-1 (File No. 33-34963), which is incorporated by reference herein).
+10.62 Asset Purchase Agreement dated December 31, 1998 by and between the Company and
Access Health, Inc., a copy of which is filed herewith.
+10.63 Purchase Agreement dated February 26, 1999 by and among the Company, Foundation
Health Pharmaceutical Services, Inc., Integrated Pharmaceutical Services, Inc., and
Advance Paradigm, Inc., a copy of which is filed herewith.
+10.64 Fourth Amendment to Credit Agreement, dated as of March 26, 1999, among the
Company, Bank of America National Trust and Savings Association and the Banks (as
defined therein), a copy of which is filed herewith.
*+10.65 The Company's Supplemental Executive Retirement Plan effective as of January 1,
1996, a copy of which is filed herewith.
*+10.66 The Company's Deferred Compensation Plan effective as of May 1, 1998, a copy of
which is filed herewith.
11.1 Statement relative to computation per share earnings of the Company (included in
the notes to the Financial Statements, which are incorporated by reference from
pages to of the Annual Report to Stockholders for the year ended
December 31, 1998).
+13.1 1998 Annual Report to Stockholders, a copy of which is filed herewith.
+21.1 Subsidiaries of the Company, a copy which is filed herewith.
+23.1 Consent and Report on Schedule of Deloitte & Touche LLP, a copy of which is filed
herewith.
+27.1 Financial Data Schedule for 1998, a copy of which has been filed with the EDGAR
version of this filing.
41
99.1 Report of Deloitte & Touche LLP on the consolidated balance sheets of Foundation
Health Systems, Inc. as of December 31, 1998 and 1997, and the related statements
of operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1998, which is incorporated by reference from page 29
of the Annual Report to Stockholders for the fiscal year ended December 31, 1998.
- ------------------------
* Management contract or compensatory plan or arrangement required to be filed
(and/or incorporated by reference) as an exhibit to this Annual Report on
Form 10-K pursuant to Item 14(c) of Form 10-K.
+ A copy of the exhibit is being filed with this Annual Report on Form 10-K.
(b) Reports on Form 8-K
The following Current Report on Form 8-K was filed by the Company during the
quarterly period ended December 31, 1998:
A Current Report on Form 8-K dated December 23, 1998 announcing the
Company's completion of its sale of Business Insurance Group, Inc., a
wholly-owned subsidiary of the Company.
No other Current Reports on Form 8-K were filed by the Company during the
quarterly period ended December 31, 1998.
42
SUPPLEMENTAL SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
DECEMBER 31, DECEMBER 31,
1998 1997
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents.......................................................... $ 74,767 $ 16,740
Investments available for sale..................................................... 3,352 9,007
Other assets....................................................................... 6,654 46,902
Due from subsidiaries.............................................................. 597,321 473,431
Net assets from discontinued operations............................................ -- 267,713
------------ ------------
Total current assets................................................................. 682,094 813,793
Property and equipment, net.......................................................... 7,854 22,895
Investment in subsidiaries........................................................... 1,459,335 1,389,190
Other assets......................................................................... 65,881 70,342
------------ ------------
Total assets..................................................................... $2,215,164 $2,296,220
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Due to subsidiaries................................................................ 185,516 73,283
Other current liabilities.......................................................... 46,883 35,907
------------ ------------
Total current liabilities........................................................ 232,399 109,190
Notes payable........................................................................ 1,235,500 1,287,500
Other liabilities.................................................................... 3,223 3,556
------------ ------------
Total liabilities................................................................ 1,471,122 1,400,246
------------ ------------
Stockholders' equity:
Common stock and additional paid-in capital........................................ 641,945 628,735
Common stock held in treasury, at cost............................................. (95,831) (95,831)
Retained earnings.................................................................. 205,236 370,394
Accumulated other comprehensive loss............................................... (7,308) (7,324)
------------ ------------
Total stockholders' equity....................................................... 744,042 895,974
------------ ------------
Total liabilities and stockholders' equity..................................... $2,215,164 $2,296,220
------------ ------------
------------ ------------
See accompanying note to condensed financial statements.
43
SUPPLEMENTAL SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT--(CONTINUED)
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
------------------------------------
1998 1997 1996
----------- ----------- ----------
Investment and other income................................................. $ 11,366 $ 6,485 $ 5,171
Expenses:
General and administrative................................................ 27,480 17,288 11,879
Amortization and depreciation............................................. 2,197 1,315 1,155
Interest.................................................................. 91,717 42,118 22,063
Asset impairment, merger, restructuring and other charges................. 39,602 42,189 2,500
----------- ----------- ----------
160,996 102,910 37,597
----------- ----------- ----------
Loss from continuing operations before income taxes and equity in net income
of subsidiaries........................................................... (149,630) (96,425) (32,426)
Income tax benefit.......................................................... 61,333 39,533 11,861
Equity in net income (loss) of subsidiaries................................. (76,861) (10,938) 59,395
----------- ----------- ----------
Income (loss) from continuing operations.................................... (165,158) (67,830) 38,830
Discontinued operations:
Income (loss) from operations, net of tax................................. -- (30,409) 25,084
Gain (loss) on disposition, net of tax.................................... -- (88,845) 20,317
----------- ----------- ----------
Net income (loss)....................................................... $ (165,158) $ (187,084) $ 84,231
----------- ----------- ----------
----------- ----------- ----------
See accompanying note to condensed financial statements.
44
SUPPLEMENTAL SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT--(CONTINUED)
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
-----------------------------------
1998 1997 1996
---------- ----------- ----------
Net Cash Flows from Operating Activities..................................... $ (39,871) $ (521,154) $ 11,091
---------- ----------- ----------
Cash Flows from Investing Activities:
Sales or maturity of investments available for sale........................ 8,777 11,400 --
Purchases of investments available for sale................................ (6,264) (309) (20,160)
Sales of property and equipment............................................ 16,376 -- --
Purchases of property and equipment........................................ (3,532) (20,695) (3,273)
Other assets............................................................... 4,771 (130,755) (2,941)
Sale of net assets of discontinued operations.............................. 257,100 -- --
Acquisition of businesses.................................................. -- (293,625) (4,113)
---------- ----------- ----------
Net cash provided by (used in) investing activities.......................... 277,228 (433,984) (30,487)
---------- ----------- ----------
Cash Flows from Financing Activities:
Proceeds from exercise of stock options and employee stock purchases....... 13,209 21,506 17,483
Proceeds from sale of stock................................................ -- -- 95,831
Proceeds from issuance of notes payable.................................... 155,000 946,000 9,000
Principal payments on notes payable........................................ (207,000) (873) --
Redemption of common stock................................................. -- (111,334) (105,419)
Cash dividends received from subsidiaries.................................. 2,900 140,994 --
Capital contributions to subsidiaries...................................... (143,439) (33,875) (700)
---------- ----------- ----------
Net cash provided by (used in) financing activities.......................... (179,330) 962,418 16,195
---------- ----------- ----------
Net increase (decrease) in cash and cash equivalents......................... 58,027 7,280 (3,201)
Cash and cash equivalents, beginning of period............................... 16,740 9,460 12,661
---------- ----------- ----------
Cash and cash equivalents, end of period..................................... $ 74,767 $ 16,740 $ 9,460
---------- ----------- ----------
---------- ----------- ----------
See accompanying note to condensed financial statements.
45
SUPPLEMENTAL SCHEDULE I
CONDENSED FINANCIAL INFORMATION OF REGISTRANT--(CONTINUED)
FOUNDATION HEALTH SYSTEMS, INC.
NOTE TO CONDENSED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
NOTE 1--BASIS OF PRESENTATION
Foundation Health Systems, Inc.'s ("FHS") investment in subsidiaries is
stated at cost plus equity in undistributed earnings (losses) of subsidiaries.
FHS' share of net income (loss) of its unconsolidated subsidiaries is included
in consolidated income (loss) using the equity method. This condensed financial
information of registrant should be read in conjunction with the consolidated
financial statements of Foundation Health Systems, Inc. and subsidiaries.
46
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Company has duly caused this Report to be
signed on its behalf by the undersigned thereunto duly authorized, on the day
of March, 1999.
FOUNDATION HEALTH SYSTEMS, INC.
By: /s/ JAY M. GELLERT
-----------------------------------------
Jay M. Gellert
PRESIDENT AND CHIEF EXECUTIVE OFFICER
(PRINCIPAL EXECUTIVE OFFICER)
By: /s/ STEVEN P. ERWIN
-----------------------------------------
Steven P. Erwin
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
(PRINCIPAL ACCOUNTING AND FINANCIAL
OFFICER)
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Report has been signed below by the following persons on behalf of
the Company and in the capacities indicated on the day of March, 1999.
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------
/s/ J. THOMAS BOUCHARD Director
- ------------------------------ March 31, 1999
J. Thomas Bouchard
/s/ GEORGE DEUKMEJIAN Director
- ------------------------------ March 31, 1999
Gov. George Deukmejian
/s/ THOMAS T. FARLEY Director
- ------------------------------ March 31, 1999
Thomas T. Farley
/s/ PATRICK FOLEY Director
- ------------------------------ March 31, 1999
Patrick Foley
/s/ EARL B. FOWLER Director
- ------------------------------ March 31, 1999
Admiral Earl B. Fowler
/s/ JAY M. GELLERT Director
- ------------------------------ March 31, 1999
Jay M. Gellert
/s/ ROGER F. GREAVES Director
- ------------------------------ March 31, 1999
Roger F. Greaves
/s/ RICHARD W. HANSELMAN Director
- ------------------------------ March 31, 1999
Richard W. Hanselman
47
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------
/s/ RICHARD J. STEGEMEIER Director
- ------------------------------ March 31, 1999
Richard J. Stegemeier
/s/ RAYMOND S. TROUBH Director
- ------------------------------ March 31, 1999
Raymond S. Troubh
48