Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One) X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996
OR
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: 1-8865
SIERRA HEALTH SERVICES, INC.
(Exact name of Registrant as specified in its charter)
NEVADA
(State or other jurisdiction of
incorporation or organization)
88-0200415
(I.R.S. Employer Identification Number)
2724 NORTH TENAYA WAY
LAS VEGAS, NEVADA 89128
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (702) 242-7000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange on
which registered
Common Stock, par value $.005
New York Stock Exchange
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. [ X ]
The aggregate market value of the voting stock held by non-affiliates
of the registrant on March 14, 1997 was $405,166,000.
The number of shares of the registrant's common stock outstanding on March 14,
1997 was 17,865,000.
DOCUMENTS INCORPORATED BY REFERENCE
DOCUMENT WHERE INCORPORATED
Registrant's Current Report on Form 8-K dated Part I
March 28,1997. Part II, Item 7
Portions of the registrant's definitive proxy statement for Part III
its 1997 annual meeting to be filed with the SEC not later
than 120 days after the end of the fiscal year.
SIERRA HEALTH SERVICES, INC.
1996 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
PART I
Item 1. Business ................................................... 1
Item 2. Properties.................................................. 14
Item 3. Legal Proceedings........................................... 14
Item 4. Submission of Matters to a Vote of Security Holders......... 14
PART II
Item 5. Market for Registrant's Common Stock and
Related Stockholder Matters.............................. 15
Item 6. Selected Financial Data..................................... 16
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operation................................. 17
Item 8. Financial Statements and Supplementary Data................. 26
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure...................... 54
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 54
Item 11. Executive Compensation...................................... 54
Item 12. Security Ownership of Certain Beneficial Owners
and Management............................................ 54
Item 13. Certain Relationships and Related Transactions.............. 54
PART IV
Item 14. Exhibits, Financial Statement Schedules
and Reports on Form 8-K................................... 55
i
PART I
ITEM 1. BUSINESS
GENERAL
Sierra Health Services, Inc. ("Sierra") and its subsidiaries (collectively
referred to as the "Company"), is a managed health care organization that
provides and administers the delivery of comprehensive health care and workers'
compensation programs with an emphasis on quality care and cost management. The
Company's strategy has been to develop and offer a portfolio of managed health
care and workers' compensation products to employer groups and individuals. The
Company's broad range of managed health care services is provided through its
federally qualified and non-qualified health maintenance organizations ("HMOs"),
insurance companies, managed indemnity plans, a third-party administrative
services program for employer-funded health benefit plans and workers'
compensation medical management programs. Ancillary products and services that
complement the Company's managed health care and workers' compensation product
lines are also offered.
In June 1996, the Civilian Health and Medical Program of the Uniformed
Services ("CHAMPUS") granted a 5-year contract to provide health services to
Regions 7 and 8, which includes a total of 17 states, to a consortium consisting
of Sierra and 13 other health care companies. In April 1997, this consortium
will begin providing health care to approximately 700,000 individuals, of which
Sierra will be responsible for providing care to approximately 93,000
individuals in Nevada and Missouri.
In November 1996, the Company acquired the remaining ownership interests of
HMO Texas for $5.0 million. The Company had previously held a 50 percent
interest in the Houston-based health plan which had approximately 12,700 members
at the end of 1996.
Effective December 31, 1996, the Company purchased Prime Holdings, Inc.
("Prime") for approximately $31.2 million in cash. At December 31, 1996, Prime
operated MedOne Health Plan, Inc., a 12,800 member HMO, and also served 215,000
people through preferred provider organizations ("PPOs"), workers' compensation
programs and administrative services products for self-insured employers and
union welfare funds primarily in the state of Nevada.
The principal executive offices of the Company are located at 2724 North
Tenaya Way, Las Vegas, Nevada 89128, and its telephone number is (702) 242-7000.
Managed Care Products and Services
The Company's primary types of health care coverage are HMO plans, HMO
Point of Service ("POS") plans, and managed indemnity plans, which include a PPO
option. As of December 31, 1996, the Company provided HMO products to
approximately 177,000 members. Of these HMO members, approximately 92% reside in
Nevada. The POS products allow members to choose one of the various coverage
options when medical services are required instead of one plan for the entire
year. The Company also provides managed indemnity products to approximately
46,000 members, Medicare supplement products to approximately 23,000 members,
and administrative services to approximately 501,000 members, of whom a
significant portion are employees covered through workers' compensation
products. Medical premiums account for approximately 67% of total revenues, 87%
of which are derived from southern Nevada.
1
Health Maintenance Organizations. The Company operates a mixed group
network model HMO in Nevada, and a network model HMO in Texas, as well as
managed indemnity PPO plans. Most of its managed health care services in Nevada
are provided through its networks of over 1,800 providers and 17 hospitals.
These networks include the Company's multi-specialty medical group, which
provides medical services to approximately 74% of the Company's Nevada HMO
members and employs over 134 primary care and other providers in various medical
specialties. The Company directly provides home health care, hospice care and
behavioral health care services. In addition, the Company operates two 24-hour
urgent care centers, a radiology department, a vision department, an
occupational medicine department and two free-standing, state-licensed and
Medicare-approved ambulatory surgery centers. The Company believes that this
vertical integration of its health care delivery system provides a competitive
advantage as it has helped it to manage health care costs effectively while
delivering quality care. As of December 31, 1996, the Texas HMO members were
served by approximately 1,600 contracted providers and 33 hospitals. Contracted
primary care physicians and specialists for the HMOs are compensated on a
capitation or modified fee-for-service basis. Contracts with their primary
hospitals are on a capitation or discounted per diem basis. Members receive a
wide range of coverage after paying a nominal co-payment and are eligible for
preventive care coverage. The HMOs do not require deductibles, co-insurance or
claim forms.
In addition to its commercial HMO plan, which involves traditional HMO
benefits and Point of Service benefits, the Company offers prepaid health care
programs for Medicare-eligible beneficiaries called Senior Dimensions in Nevada
and Golden Choice in Texas. Senior Dimensions is marketed directly to Medicare-
eligible beneficiaries in the Company's Nevada service area. Federal legislation
has been enacted which allows delivery of health care to Medicare beneficiaries
through HMOs. Such legislation provides that the federal government will
reimburse HMOs for health care services to Medicare beneficiaries in an amount
equal to 95% of the Medicare payments to fee-for-service providers in a defined
service area. As of December 31, 1996, approximately 29,000, or 17%, of the
Company's total Nevada HMO members were enrolled in Senior Dimensions. The
Senior Dimensions plan enables Medicare beneficiaries to reduce their
out-of-pocket expenses and receive additional benefits not covered by Medicare.
In July 1996 the Company's Texas HMO received approval to offer a Medicare risk
product and by the end of the year 11% of the Company's HMO Texas members were
enrolled in Golden Choice.
Social Health Maintenance Organization. Effective November 1, 1996, the
Company entered into a three year Social HMO contract pursuant to which a large
portion of the Company's Medicare risk enrollees will receive certain expanded
benefits. The Company expects to receive additional revenues for providing these
expanded benefits. The additional revenues will be determined based on health
care assessments that will be performed on the Company's eligible Medicare risk
members. The additional benefits include, among other things, assisting the
eligible Medicare risk members with typical daily living functions such as
bathing, dressing, walking and shopping. These members, as identified in the
health care assessments, are ones who currently have difficulty performing such
daily living functions because of a health or physical problem. The additional
reimbursement will be subject to adjustment based on the number of beneficiaries
who need assistance with the social problems noted above and their individual
health care assessments. The ultimate payment received from the Health Care
Financing Administration ("HCFA") will be based on these and other factors and
is expected to exceed the current reimbursement rate from HCFA. At this time,
however, there can be no assurance as to what the final per member reimbursement
will be.
Preferred Provider Organizations. The Company also offers health insurance
through its PPO. The Company's managed indemnity plans generally offer insureds
the option of receiving their medical care from either non-contracted or
contracted providers. Insureds pay higher deductibles and co-insurance or
co-payments when they receive care from non-contracted providers. Out-of-pocket
costs are lowered by utilizing contracted providers who are part of the
Company's Nevada PPO network, consisting of approximately 3,000 providers and 32
hospitals. As of December 31, 1996, approximately 46,000 persons were enrolled
in Sierra's managed indemnity plans.
2
The Company currently provides managed indemnity and Medicare supplement
services to individuals in Nevada, Arizona, Colorado, Texas, California, New
Mexico, Missouri, and Mississippi. The Company is also exploring further
expansion in certain other states. During 1996 the Company adopted a plan to
restructure certain insurance operations to allow the Company to focus on more
favorable operating markets. This plan significantly reduced the Company's
presence in Arizona and Colorado for certain managed indemnity products.
Workers' Compensation Subsidiary. On October 31, 1995, the Company acquired
CII Financial, Inc. ("CII") for approximately $76.3 million of common stock in a
transaction accounted for as a pooling of interests. CII writes workers'
compensation insurance in the states of California, Colorado, Kansas, Nebraska,
New Mexico, Texas, and Utah. CII has licenses in 24 states and the District of
Columbia. California and Colorado represent approximately 87% and 10%,
respectively, of CII's fully insured workers' compensation insurance premiums in
1996. Workers' compensation insurance premiums account for approximately 21% of
the Company's total revenue. In conjunction with the acquisition a supplemental
indenture was filed modifying CII's 7 1/2% convertible subordinated debentures
(the "Debentures"). As a result each $1,000 in principal is now convertible into
16.921 shares of Sierra's common stock at a conversion price of $59.097 per
share.
Administrative Services. The Company's administrative services products
provide, among other things, utilization review and PPO services to large
employer groups that are usually self-insured. As of December 31, 1996,
approximately 289,000 persons were enrolled in the Company's administrative
services plans. The Company also provides workers' compensation medical
management services to employers in Nevada. As of December 31, 1996, enrollment
in this program was approximately 212,000.
Ancillary Medical Services. Among the ancillary medical services offered by
the Company are outpatient surgical care, diagnostic tests, medical and surgical
procedures, inpatient and outpatient laboratory tests, x-ray, CAT scans and
nuclear medicine services. The Company also provides home health care services,
a hospice program and mental health and substance abuse services. These services
are provided to members of the Company's HMO, managed indemnity and
administrative services plans as well as to approximately 99,000 participants
from non-affiliated employer groups and an insurance company.
Ongoing Initiatives. During 1995, the Company entered the bidding process
to provide health services for military dependents and retirees in Nevada and a
portion of Missouri. In June 1996, the Office of the Civilian Health and Medical
Program of the Uniformed Services ("OCHAMPUS") granted a 5-year contract to
provide these services to Regions 7 and 8, which includes a total of 17 states,
to a consortium consisting of Sierra and 13 other health care companies. This
consortium will begin providing health care to approximately 700,000 individuals
in April 1997 of which the Company will be providing care to approximately
93,000. In addition, the Company has submitted a proposal as the prime
contractor to CHAMPUS to provide managed health care coverage to CHAMPUS
eligible beneficiaries in Region 1. This region includes approximately 665,000
individuals in Connecticut, Delaware, Maine, Maryland, Massachusetts, New
Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, Vermont, northern
Virginia and Washington, D.C. The Company expects to incur expenses of
approximately $8.0 to $10.0 million during the Region 1 contract proposal
process. The Company anticipates learning of the status of its bid in the second
quarter of 1997.
3
Marketing
The Company's marketing efforts for its commercial managed care products
involve a two-step process. The Company first makes presentations to employers
and then provides information directly to employees once the employer has
decided to offer the Company's products. Once a relationship with a group is
established and a group agreement is negotiated and signed, the Company's
marketing efforts focus on individual employees. During a designated "open
enrollment" period each year, usually the month preceding the annual renewal of
the agreement with the group, employees choose whether to remain with, join or
terminate their membership with a specific health plan offered by the employer.
New employees decide whether to join one of the employers' health insurance
options at the time of their employment. Although contracts with employers are
generally terminable on 60 days notice, changes in membership occur primarily
during open enrollment periods. Medicare risk products are primarily marketed by
the HMO's sales employees. Retention of employer groups and membership growth is
accomplished through print advertising directed to employers and through
consumer media campaigns. Media communications convey the Company's emphasis on
preventive care, ready access to health care providers and quality service.
Other communications to customers include employer and member newsletters,
member education brochures, prenatal information packets, employer/broker
seminars and direct mail advertising to clients. Members' satisfaction with
Company benefits and services is monitored by customer surveys. Results from
these surveys and other primary and secondary research guide the sales and
advertising efforts throughout the year.
The Company's workers' compensation insurance policies are sold primarily
through independent insurance agents and brokers, who may also represent other
insurance companies. The Company believes that independent insurance agents and
brokers choose to market the Company's insurance policies primarily because of
the price the Company charges. Additional considerations include the quality of
service that the Company provides and the commissions the Company pays. The
Company employs full-time employees as marketing representatives to make
personal contacts with agents and brokers, to maintain regular communication
with them, to advise them of the Company's services and products, and to recruit
additional agents and brokers. As of December 31, 1996, the Company had
relationships with approximately 420 agents and 30 brokers and paid its agents
and brokers commissions based on a percentage of the gross written premium
produced by such agents and brokers. The Company also utilizes a number of
promotional media, including advertising in publications and at trade fairs, to
support the efforts of its independent agents.
Membership
Period End Membership:
Years Ended December 31,
1996 1995 1994 1993 1992
HMO:
Commercial.............................. 147,000 116,000 107,000 89,000 82,000
Medicare................................ 30,000 25,000 20,000 15,000 14,000
Managed Indemnity........................... 46,000 31,000 24,000 30,000 30,000
Medicare Supplement......................... 23,000 15,000 9,000 4,000 2,000
Administrative Services..................... 501,000 211,000 144,000 59,000 59,000
Total Membership........................ 747,000 398,000 304,000 197,000 187,000
For the years ended December 31, 1996 and 1995, the Company received
approximately 24.2% and 23.9%, respectively, of its total revenues pursuant to
its contract with the HCFA to provide health care services to Medicare
enrollees. The Company's contract with HCFA is subject to annual renewal at the
election of HCFA and requires the Company to comply with federal HMO and
Medicare laws and
4
regulations and may be terminated if the Company fails to so comply. The
termination of the Company's contract with HCFA would have a material adverse
effect on the Company's business. In addition, there have been, and the Company
expects that there will continue to be, a number of legislative proposals to
limit Medicare reimbursements and to require additional benefits. Future levels
of funding of the Medicare program by the federal government cannot be predicted
with certainty.
The Company's ability to obtain and maintain favorable group benefit
agreements with employer groups affects the Company's profitability. The
agreements are generally renewable on an annual basis but are subject to
termination on 60 days prior notice. For the fiscal year ended December 31,
1996, the Company's ten largest HMO employer groups were, in the aggregate,
responsible for approximately 11% of the Company's total revenues. Although none
of such employer groups accounted for more than 3% of total revenues during that
period, the loss of one or more of the larger employer groups would, if not
replaced with similar membership, have a material adverse effect upon the
Company's business. The Company has generally been successful in retaining these
employer groups. However, there can be no assurance that the Company will be
able to renew its agreements with such employer groups in the future or that it
will not experience a decline in enrollment within its employer groups.
Additionally, revenues received under certain government contracts are subject
to audit and retroactive adjustment.
Provider Arrangements and Cost Management
HMO and Managed Indemnity Products. A significant distinction between the
Company's health care delivery system and that of many other managed care
providers is the fact that approximately 74% of the Company's Nevada HMO members
receive primary health care through the Company's own multi-specialty medical
group. The Company makes health care available through providers employed by the
multi-specialty medical group and an independently contracted network of
physicians, hospitals and other providers.
Under the Company's HMOs, the member selects a primary care physician who
provides or authorizes any non-emergency medical care given to that member.
These primary care physicians and some specialists are compensated to a limited
extent on the basis of how well they coordinate appropriate medical care. The
Company has a system of incentive risk arrangements and utilization management
with respect to its independently contracted primary care physicians. The
Company compensates its independently contracted primary care physicians and
specialists by using both capitation and modified fee-for-service payment
methods. Under both the capitation and modified fee-for-service methods, an
incentive risk arrangement is established for institutional services. Additional
amounts may be made available to certain capitated physicians if hospital costs
are less than anticipated for the Company's HMO members. For those primary care
physicians receiving payments on a modified fee-for-service basis, portions of
the payments otherwise due the physicians are withheld. The amounts withheld are
available for payment to the physicians if, at year-end, the expenditures for
both institutional and non-institutional medical services are within
predetermined, contractually agreed upon ranges. It is believed that this method
of incentive risk payment is advantageous to the physician, the Company and the
members because all share in the benefits of managing health care costs. The
Company has, however, negotiated capitation agreements with certain specialists
who do not participate in the incentive risk arrangements. The Company monitors
health care utilization, including evaluation of elective surgical procedures,
quality of care and financial stability of its capitated providers to facilitate
access to service and to ensure member satisfaction.
The Company also believes that it has negotiated favorable rates with its
contracted hospitals. The Company's contracts with its primary hospital
providers typically renew automatically with both parties granted the right to
terminate after a notice period varying from between three and twelve months.
Reimbursement arrangements with hospitals and other health care providers,
including pharmacies, are generally negotiated annually and are based on several
different payment methods, including per diems (where the reimbursement rate
varies and is based on a per day of service charge for specified types of care),
capitation or modified fee-for-service arrangements. To the extent possible,
when negotiating non-physician provider arrangements, the Company solicits
competitive bids.
5
The Company provides, or negotiates discounted contracts with hospitals for
the provision of, inpatient and outpatient hospital care, including room and
board, diagnostic tests and medical and surgical procedures. The Company
believes that it currently has a favorable contract with its primary southern
Nevada contracted hospital, Columbia Sunrise Hospital. Subject to certain
limitations, the contract provides, among other things, guaranteed contracted
per diem rate increases on an annual basis after December 31, 1997. Since a
majority of the Company's southern Nevada hospital days are at Columbia Sunrise
Hospital, this contract assists the Company in managing a significant portion of
its medical costs. The contract expires in the year 2012. The Company has
negotiated a capitation arrangement with Columbia Hospital, Inc. for hospital
services provided in Houston to members of the Company's Texas HMO.
The Company utilizes two reimbursement methods for health care providers
rendering services under the Company's indemnity plans. For services to members
utilizing a PPO plan, the Company reimburses participating physicians on a
modified fee-for-service basis which incorporates a limited fee schedule and
reimburses hospitals on a per diem or discounted fee-for-service basis. For
services rendered under a standard indemnity plan, pursuant to which a member
may select a non-plan provider, the Company reimburses non-contracted physicians
and hospitals at pre-established rates, less deductibles and co-insurance
amounts.
The Company also manages health care costs through its large case
management program, home health care agency, 24-hour urgent care centers and its
hospice which helps to minimize hospital admissions and lengths of stay. In
addition, the Company educates its members on how and when to use the services
of its plans and how to manage chronic disease conditions, and audits hospital
bills to identify inappropriate charges.
Risk Management
The Company maintains general and professional liability, property and
fidelity insurance coverage in amounts that it believes are adequate for its
operations. The Company's multi-specialty medical group maintains excess
malpractice insurance for the providers presently employed by the group. The
Company has, however, assumed the risk for the first $250,000 per malpractice
case, not to exceed $1.5 million in the aggregate per contract year up to its
limits of coverage. In addition, the Company requires all of its independently
contracted provider physician groups, individual practice physicians,
specialists, dentists, podiatrists and other health care providers (with the
exception of certain hospitals) to maintain professional liability coverage.
Certain of the hospitals with which the Company contracts are self-insured. The
Company also maintains stop-loss insurance that reimburses the Company between
50% and 90% of hospital charges for each individual member of its HMO or managed
indemnity plans whose hospital expenses exceed $75,000 during the contract year
and up to $2.0 million per member per lifetime. Workers' compensation claims are
reinsured between $350,000 and $60.0 million per occurrence. In the ordinary
course of its business, however, the Company is subject to claims that are not
insured, principally claims for punitive damages.
Information System
The Company has in place certain data systems which assist the Company in,
among other things, pricing its services, monitoring utilization and other cost
factors, providing bills on a timely basis, identifying accounts for collection
and handling various accounting and reporting functions. Its imaging and
workflow systems are used to process and track claims and coordinate customer
service. Where it is cost efficient, the Company's system is connected to large
provider groups, doctors' offices, payors and brokers to enable efficient
transfer of information and communication. The Company views its information
systems capability as critical to the performance of ongoing administrative
functions and integral to quality assurance and to the coordination of patient
care across care sites. The Company is continually modifying or improving its
information systems capabilities in an effort to improve operating efficiencies.
6
Quality Assurance and Improvement
The Company has developed programs to help ensure that the health care
services provided by its HMO and managed indemnity plans meet the professional
standards of care established by the medical community. The Company believes
that its emphasis on quality allows it to increase and retain its members. The
Company monitors and evaluates the availability and quality of the medical care
rendered by the providers in its HMO and insurance plans and periodically audits
selected diagnoses, problems and referrals to determine adherence to appropriate
standards of medical care. In addition, the Company has medical directors who,
supported by a professional medical staff, monitor the quality and
appropriateness of health care by analyzing a physician's utilization of
diagnostic tests, laboratory and radiology procedures, specialty referrals,
prescriptions and hospitals. Physicians and hospitals selected to provide
services to the Company's members are subject to the Company's quality assurance
programs including a formal credentialing process of all physicians.
The Company also has internal quality assurance and improvement review
committees that meet on a regular basis to review specialist referrals, monitor
the performance of physicians and review practice patterns, complaints and other
patient issues. Staff members regularly visit hospitals to review medical
records, meet with patients and review treatment programs and discharge plans
with attending physicians. In addition, the Company solicits information from
both existing and former members as to their satisfaction with the care
delivered. Complaints and grievances are responded to on both an informal and
formal basis, depending on the nature of the complaint.
With the increasing significance of managed care in the health care
industry, several independent organizations have been formed for the purpose of
responding to external demands for accountability over the managed care
industry. The organizations utilized by the Company are the National Committee
on Quality Assurance (the "NCQA") and the Joint Commission on Accreditation of
Healthcare Organizations ("JCAHO"). The NCQA performs site reviews of standards
established for quality assurance, credentialing, utilization management,
medical records, preventive services and member rights and responsibilities. The
JCAHO reviews rights, responsibilities and ethics, continuum of care, education
and communication, leadership, management of information and human resources and
network performance. In 1995, the Nevada HMO voluntarily applied for
accreditation from the NCQA with respect to its operations in southern Nevada,
which was denied. The Company has addressed most of the NCQA's findings for
Nevada and has recently gone through an NCQA site visit. The results are still
pending. The Company's Nevada multi-specialty clinic has received a full
three-year accreditation from the American Association for Ambulatory Health
Care -- the highest accreditation issued to ambulatory care facilities. The
clinic is the only multi-specialty site in Nevada to be awarded this
accreditation. Also, the Nevada HMO, along with the Company's managed indemnity
subsidiary, have received "excellent" ratings from the A.M. Best Company, an
independent insurance industry rating organization. The Company's workers'
compensation subsidiaries have received "very good" ratings from the A.M. Best
Company. There can be no assurance, however, that the Company will receive or
maintain NCQA or other accreditations in the future and there is no basis to
predict what effect, if any, the lack of NCQA or other accreditations will have
on the Nevada HMO's competitive position in southern Nevada.
7
Underwriting
HMO. The Company structures premium rates for its various health plans
primarily through community rating and community rating by class method. Under
the community rating method, all costs of basic benefit plans for the Company's
entire membership population are aggregated. These aggregated costs are
calculated on a "per member per month" basis and converted to premium rates for
coverage types, such as single or family coverage. The community rating by class
method is based on the same principles as community rating, except that
actuarial adjustments to premium rates are made for various employer groups
based on the average age and sex of their employees. All employees of an
employer group are charged the same premium rate if the same coverage is
selected.
In addition to those premium charges paid by the employers with whom the
Company's HMOs contract, members also pay co-payments at the time certain
services are provided. The Company believes that such co-payments encourage
appropriate utilization of health care services while allowing the Company to
offer competitive premium rates. The Company also believes that the capitation
method of provider compensation encourages physicians to provide only medically
necessary and appropriate care.
Managed Indemnity. Premium charges for the Company's managed indemnity
products are set in a manner similar to the community rating by class method
described above. This rate calculation utilizes age, sex and industry factors to
develop group-specific adjustments from a given base rate by plan. Actual health
claims experience is used to develop premium rates for larger insurance member
groups. This process includes the use of utilization experience, adjustments for
incurred but not reported claims, inflationary factors, credibility and specific
reinsurance pooling levels for large claims.
Workers' Compensation. Prior to insuring a particular risk, the Company
reviews, among other factors, the employer's prior loss experience and premium
payment history. Additionally, the Company determines whether the employer's
employment classifications are among the classifications that the Company has
elected to insure generally and if the amounts of the premiums for the
classifications are within the Company's guidelines. The Company reviews these
classifications periodically to evaluate whether they are profitable. A member
of the Company's loss control department may conduct an on-site safety
inspection before the Company insures the employer. The Company generally
initiates this inspection for enterprises with manufacturing or construction
classifications. The Company may also initiate inspections if the enterprise
previously has had a high loss ratio or frequent losses. If the on-site
inspection reveals hazards that can be corrected, and an agreement can be
reached with the employer that these hazards will be corrected in a time frame
established by the Company's underwriting department, the Company may issue a
policy subject to correction of those hazards. In the event the Company has
issued a policy where no previous inspection has been conducted, and
subsequently learns through an inspection the employer has hazards that must be
corrected, the Company will request that the employer correct the hazards within
a specified period of time. If these hazards are not corrected, the Company may
cancel the policy for non-compliance of the hazard correction. With regard to
new business, the agent or broker will usually submit the claims history on the
prospective account. In those situations where the claims history is not
supplied by the agent or broker, other sources (such as the prior insurer) are
used to obtain the appropriate claims history if possible.
In California, under open rating as it became effective for policyholders
in 1995, the Company has subdivided many of the standard classifications. These
subclassifications have been determined on the Company's perception of
differences in risk exposure. As a result, different rates have been filed for
each of these subclassifications. The use of these subclassifications requires
more detailed information than was required prior to open rating. The Company
ascertains characteristics of various employers through the use of
questionnaires and telephone inquiries by underwriters to determine the proper
subclassification. Subclassifications are subject to verification by loss
control and premium audits.
8
Competition
HMO and Managed Indemnity. Managed care companies and HMOs operate in a
highly competitive environment. The Company's major competition in Las Vegas is
from self-funded employer plans, PPO networks, other HMOs, such as Humana Care
Plus and Pacificare, Inc., and traditional indemnity carriers, such as Blue
Cross/Blue Shield. Many of the Company's competitors have substantially larger
total enrollments, have greater financial resources and offer a broader range of
products than the Company. Additional competitors with greater financial
resources than the Company may enter the Company's market in the future. The
Company believes that the most important competitive factors are the delivery of
reasonably priced, quality medical benefits to members and the adequacy and
availability of health care delivery services and facilities. The Company
depends on a large PPO network and flexible benefit plans to attract new
members. Competitive pressures are expected to limit the Company's ability to
increase premium rates and, to a lesser extent, to result in declining premium
rates. Accordingly, the profitability of the Company will, to a large extent,
depend on the Company's ability to manage the costs of providing health care
benefits to its members. The inability of the Company to manage these costs
would have an adverse impact on the Company's future results of operations by
reducing margins. In addition, competitive pressures may also result in reduced
membership levels. Any such reductions could materially affect the Company's
results of operations.
Workers' Compensation. The Company's workers' compensation business is
concentrated in California, a state where the workers' compensation insurance
industry is extremely competitive. Based upon data provided by the Workers'
Compensation Insurance Rating Bureau ("WCIRB"), for the year ended December 31,
1995, which is the latest data available, there were approximately 225 insurance
companies writing workers' compensation insurance in California. Many of the
Company's competitors have been in business longer, have a larger volume of
business, offer a more diversified line of insurance coverage, have greater
financial resources and have greater distribution capability than the Company.
The largest writer of workers' compensation insurance in California is the State
Compensation Insurance Fund. Prior to 1995, the Company concentrated on insuring
workers' compensation accounts in the small- to medium-size range. Under the
current open rating environment, the Company is actively pursuing accounts of
all sizes.
In all states in which the Company is currently writing business,
competition for workers' compensation insurance is primarily driven by price and
secondarily by services provided to insureds and agents. In states other than
California, commissions are normally not a dominant competitive factor. In those
other states, the National Council on Compensation Insurance ("NCCI") is usually
the designated rating organization. Like the WCIRB in California, the NCCI
accumulates statistical information and recommends pure loss costs to the
state's Department of Insurance. As in California under the open rating
environment, the Company then adds loss cost multipliers or expense loads to
derive premium rates. Rating plans in those states are more "standardized" and
are usually based on plans developed by the NCCI. Unlike California, where the
Company has developed subclasses, the Company will use standard classes in the
other states.
Losses and Loss Adjustment Expenses
Often, in workers' compensation insurance, several years may elapse between
the occurrence of a loss and the final settlement of the loss. To recognize
liabilities for unpaid losses, the Company establishes reserves, which are
balance sheet liabilities representing estimates of future amounts needed to pay
claims and related expenses for insured events, including reserves for events
that have occurred but have not yet been reported to the Company ("IBNR").
9
When a claim is reported, the Company's claims personnel initially
establish reserves on a case-by-case basis for the estimated amount of the
ultimate payment. These estimates reflect the judgment of the claims personnel
based on their experience and knowledge of the nature and value of the specific
type of claim and the available facts at the time of reporting as to severity of
injury and initial medical prognosis. Included in these reserves are estimates
of the expenses of settling claims, including legal and other fees, and the
general expenses of administering the claims adjustment process. Claims
personnel adjust the amount of the case reserves as the claim develops and as
the facts warrant.
IBNR reserves are established for unreported claims and loss development
relating to current and prior accident years. In the event that a claim that
occurred during a prior accident year was not reported until the current
accident year, the case reserve for such claim typically will be established out
of previously established IBNR reserves for that prior accident year.
The Company reviews the adequacy of its reserves on a monthly basis and
considers external forces such as changes in the rate of inflation, the
regulatory environment, the judicial administration of claims, medical costs and
other factors that could cause actual losses and loss adjustment expenses
("LAE") to change. Reserves are reviewed with the Company's independent actuary
at least annually. The actuarial projections include a range of estimates
reflecting the uncertainty of projections. Management evaluates the reserves in
the aggregate, based upon the actuarial indications and makes adjustments where
appropriate. The consolidated financial statements of the Company provide for
reserves based on the anticipated ultimate cost of losses.
Once an employer is insured by the Company, the Company's loss control
department may assist the insured in developing and maintaining safety programs
and procedures to minimize on-the-job injuries and industrial health hazards.
The safety programs and procedures vary from insured to insured. The Company's
loss control department may recommend to the employer that a safety committee
consisting of members of the employer's management staff and its general labor
force be established. The Company's loss control department may then assist the
committee members in isolating safety hazards, advising the committee on how to
correct the hazards and assisting the employer in establishing procedures to
enforce the corrections. The Company's loss control department may also revisit
the employer to determine whether the recommended corrections and procedures
have been implemented. Depending upon the size, classifications, and loss
experience of the employer, the Company's loss control department will
periodically inspect the employer's places of business and may recommend changes
that could prevent industrial accidents. In addition, severe or recurring
injuries may also warrant on-site inspections. In certain instances, members of
the Company's loss control department may conduct special educational training
sessions for insured employees to assist in the prevention of on-the-job
injuries. For example, employers engaged in manufacturing may be offered a
training session on how to prevent back injuries or employers engaged in
contracting may be offered a training session on general first aid and
prevention of injuries that may result from specific work exposures.
Government Regulation and Recent Legislation
HMOs and Managed Indemnity. Federal and state governments have enacted
statutes extensively regulating the activities of HMOs. In addition, growing
government concerns over increasing health care costs could result in new or
additional state or federal legislation that could affect health care providers,
including HMOs, PPOs and other health insurers. Among the areas regulated by
federal and state law are the scope of benefits available to members, premium
structure, procedures for review of quality assurance, enrollment requirements,
the relationship between an HMO and its health care providers, licensing and
financial condition.
10
The Company must file periodic reports with, and is subject to periodic
review and audit by, federal and state licensing authorities. The Company has
HMO licenses in Nevada and Texas and is subject to regulation by the Nevada
Division of Insurance, the Nevada Division of Health and the Texas Department of
Insurance. The Company's health insurance subsidiary is domiciled and
incorporated in California and is licensed in 26 states, with current operations
in Nevada, Arizona, Colorado, Texas, California, New Mexico, Missouri and
Mississippi. It is subject to licensing by and other regulations of the
California Department of Insurance as well as the insurance departments of other
states in which it operates or holds licenses. The Company's premium rate
increases are subject to various state insurance department approvals. The
Company's HMO and insurance subsidiaries are also required by state regulatory
agencies to maintain certain deposits and must also meet certain net worth and
reserve requirements. The Company also has certain other deposit requirements.
The Company has restricted assets on deposit in various states ranging from
$20,000 to $2.2 million and totalling $13.6 million at December 31, 1996. The
Company's HMO and insurance subsidiaries meet requirements to maintain minimum
stockholder's equity ranging from $200,000 to $5.2 million. The Company's Nevada
HMO and health insurance subsidiaries currently maintain home offices and a
regional home office, respectively, in Las Vegas and, accordingly, are eligible
for certain premium tax credits in Nevada.
The Company's HMO subsidiaries are also restricted by state law as to the
amount of dividends that can be declared and paid. Moreover, insurance companies
and HMOs domiciled in Texas, Nevada and California generally may not pay
extraordinary dividends without providing the state insurance commissioner with
30 days prior notice, during which period the commissioner may disapprove the
payment. An "extraordinary dividend" is generally defined as a dividend whose
fair market value together with that of other dividends or distributions made
within the preceding 12 months exceeds the lesser of (i) ten percent of the
insurer's surplus as of the preceding December 31 or (ii) the net gain from
operations of such insurer, not including realized capital gains, for the
12-month period ending on the preceding December 31. The Company is not in a
position to assess the likelihood of obtaining future approval for the payment
of "extraordinary dividends" or dividends other than those specifically allowed
by law in each of its subsidiaries' states of domicile. No prediction can be
made as to whether any legislative proposals relating to dividend rules in the
domiciliary states of the Company's subsidiaries will be made or adopted in the
future, whether the insurance departments of such states will impose either
additional restrictions in the future or a prohibition on the ability of the
Company's regulated subsidiaries to declare and pay dividends or as to the
effect of any such proposals or restrictions on the Company's regulated
subsidiaries.
The Company is subject to the Federal HMO Act and the regulations
promulgated thereunder. Of the Company's three subsidiary HMOs, only MedOne
Health Plan, acquired at the end of 1996, is not federally- qualified under this
Act. In order to obtain federal qualification, an HMO must, among other things,
provide its members certain services on a fixed, prepaid fee basis and set its
premium rates in accordance with certain rating principles established by
federal law and regulation. The HMO must also have quality assurance programs in
place with respect to its health care providers. Furthermore, an HMO may not
refuse to enroll an employee, in most circumstances, because of such person's
health, and may not expel or refuse to re-enroll individual members because of
their health or their need for health services.
Under the "corporate practice of medicine" doctrine, in most states,
business organizations, other than those authorized to do so, are prohibited
from providing, or holding themselves out as providers of, medical care. Some
states, including Nevada, exempt HMOs from this doctrine. The laws relating to
this doctrine are subject to numerous conflicting interpretations. Although the
Company seeks to structure its operations to comply with corporate practice of
medicine laws in all states in which it operates, there can be no assurance
that, given the varying and uncertain interpretations of those laws, the Company
would be found to be in compliance with those laws in all states. A
determination that the Company is not in compliance with applicable corporate
practice of medicine laws in any state in which it operates could have a
material adverse effect on the Company if it were unable to restructure its
operations to comply with the laws of that state.
11
Medicare and Medicaid antifraud and abuse provisions are codified at 42
U.S.C. Sections 1320a-7(b) (the "Anti-kickback Statute") and 1395nn (the "Stark
Amendments"). Many states have similar anti-kickback and anti-referral laws.
These statutes prohibit certain business practices and relationships involving
the referral of patients for the provision of health care items or services
under certain circumstances. Sanctions for violations of the Anti-kickback
Statute and the Stark Amendments include criminal penalties and civil sanctions,
including fines and possible exclusion from the Medicare and Medicaid programs.
Similar penalties are provided for violation of state anti-kickback and
anti-referral laws. The Department of Health and Human Services ("HHS") has
issued regulations establishing "safe harbors" with respect to the Anti-
kickback Statute. The Office of the Inspector General recently proposed new
rules to clarify those safe harbors. HHS has also proposed to establish certain
safe harbors under the Stark Amendments. The Company believes that its business
arrangements and operations are in compliance with the Anti-kickback Statute and
the Stark Amendments and the exceptions set forth therein, regardless of the
availability of regulatory safe harbor protection with respect to those
statutes. There can, however, be no assurance that (i) government officials
charged with responsibility for enforcing the prohibitions of the Anti-kickback
Statute and the Stark Amendments will not assert that the Company or certain
transactions in which it is involved are in violation of those statutes and (ii)
such statutes will ultimately be interpreted by the courts in a manner
consistent with the Company's interpretation.
As a result of the continued escalation of health care costs and the
inability of many individuals to obtain health care insurance, numerous
proposals relating to health care reform have been or may be introduced in the
United States Congress and state legislatures. Any proposals affecting
underwriting practices, limiting rate increases, requiring new or additional
benefits or affecting contracting arrangements (including proposals to require
HMOs and PPOs to accept any health care providers willing to abide by an HMO's
or PPO's contract terms) may have a material adverse effect on the Company's
business.
For example, recent news reports indicate that President Clinton may submit
a budget proposal to Congress that will reduce Medicare spending by $100 billion
and impose certain limits on Medicaid spending. Although neither the present
administration's health care reform proposals nor alternative health care reform
proposals introduced by certain members of Congress were previously adopted, the
Health Insurance Portability and Accountability Act of 1996 (the "Accountability
Act") was passed by Congress and signed into law by President Clinton on August
21, 1996 and will generally take effect beginning July 1, 1997. While the
Accountability Act contains provisions regarding health insurance or health
plans, such as portability and limitations on pre-existing condition exclusions,
guaranteed availability and renewability, it also contains several anti-fraud
measures that significantly change health care fraud and abuse provisions. Some
of the provisions include (i) creation of an anti-fraud and abuse trust fund and
coordination of fraud and abuse efforts by federal, state and local authorities,
(ii) extension of the criminal anti-kickback statues to all federal health
programs, (iii) expansion of and increase in the amount of civil monetary
penalties and establishment of a knowledge standard for individuals or entities
potentially subject to civil monetary penalties, and (iv) revisions to current
sanctions for fraud and abuse, including mandatory and permissive exclusion from
participation in the Medicare or Medicaid programs. The Company does not believe
that the Accountability Act should have a material adverse effect on the
Company's operations, but is unable to predict the ultimate impact of any
federal or state restructuring of the health care financing and delivery system,
which ultimately could have a material adverse impact on the operations,
financial condition and prospects of the Company.
Workers' Compensation. The Company is subject to extensive governmental
regulation and supervision in each state in which it conducts workers'
compensation business. The primary purpose of such regulation and supervision is
to provide safeguards for policyholders and injured workers rather than protect
the interests of shareholders. The extent and form of the regulation may vary,
but generally has its source in statutes that establish regulatory agencies and
delegate to the regulatory agencies broad regulatory, supervisory and
administrative authority. Typically, state regulations extend to such matters as
licensing companies; restricting the types or quality of investments; requiring
triennial financial examinations
12
and market conduct surveys of insurance companies; licensing agents; regulating
aspects of a company's relationship with its agents; restricting use of some
underwriting criteria; regulating rates, forms and advertising; limiting the
grounds for cancellation or nonrenewal of policies, solicitation and replacement
practices; and specifying what might constitute unfair practices. Moreover, the
payment of dividends and the making of other distributions to the Company by its
workers' compensation insurance company subsidiaries are contingent upon the
earnings of those subsidiaries and are subject to various business
considerations, applicable state corporate laws and regulations, the terms of
agreements to which they may become a party and government regulations, which
restrict in certain circumstances the payment of dividends and distributions and
the transfer of assets to the Company.
In the normal course of business, the Company and the various state
agencies that regulate the activities of the Company may disagree on
interpretations of laws and regulations, policy wording and disclosures or other
related issues. These disagreements, if left unresolved, could result in
administrative hearings and/or litigation. The Company attempts to resolve all
issues with the regulatory agencies, but is willing to litigate issues where it
believes it has a strong position. The ultimate outcome of these disagreements
could result in sanctions and/or penalties and fines assessed against the
Company. Currently, there are no litigation matters pending with any department
of insurance.
Typically, states mandate participation in insurance guaranty associations,
which assess solvent insurance companies in order to fund claims of
policyholders of insolvent insurance companies. Under this arrangement, insurers
can be assessed up to 1% (or 2% in certain states) of premiums written for
workers' compensation insurance in that state each year to pay losses and LAE on
covered claims of insolvent insurers. In California and certain other states,
insurance companies are allowed to recoup such assessments from policyholders
while several states allow an offset against premium taxes. Potential assessment
expenses, net of recoupment, if any, for insolvencies are not accrued until
after an insolvency has occurred since the likelihood and the amount of the
assessment expense cannot be reasonably determined or estimated. In California,
there have been no new assessments for insolvent workers' compensation insurance
companies since 1990.
California's Insurance Holding Company Act regulates the payment of
shareholder dividends by insurance companies. To date, the workers' compensation
insurance subsidiaries have not paid dividends to the Company.
General. Besides state insurance laws, the Company is subject to general
business and corporation laws, federal and state securities laws, consumer
protection laws, fair credit reporting acts and other laws regulating the
conduct and operation of its subsidiaries.
Employees
The Company had approximately 2,600 employees on December 31, 1996. None of
these employees are covered by a collective bargaining agreement. The Company
believes that its relations with its employees are good.
13
ITEM 2. PROPERTIES
The Company owns several administrative facilities in southern Nevada
totalling approximately 221,000 square feet. Such facilities include an
approximate 134,000 square foot six-story home office building and an
approximate 43,000 square foot two-story corporate administrative headquarters.
These buildings are subject to liens securing a $7.8 million loan balance from
Bank of America. The Company also owns several clinical facilities in the
southern Nevada area totalling approximately 319,000 square feet and consisting
primarily of six medical clinics and two surgery centers. Certain clinical space
is subject to a $3.2 million mortgage in favor of GE Capital Asset Management
Corporation. The Company leases additional office and clinical space in Nevada
totalling approximately 137,000 and 59,000 square feet, respectively. The
Company owns real estate and a building in Park City, Utah purchased in 1996 to
provide entertainment and a meeting environment for significant current and
prospective clients, brokers and others who assist in the Company's marketing
efforts. In connection with its workers' compensation insurance subsidiary, the
Company leases approximately 141,000 square feet of office space in California.
The Company also leases approximately 42,000 square feet of office space in
various states as needed for other regional operations, including the Texas HMO.
The Company has begun construction of an approximately 59,000 square foot
medical facility in Las Vegas with an estimated total cost of $7.3 million.
Completion is expected in the fourth quarter of 1997. The Company believes that
current and planned clinical space will be adequate for its present needs.
Additional clinical space may be required, however, if membership continues to
expand in southern Nevada. The Company has also begun construction of an
additional administrative building of approximately 180,000 square feet. Costs
are expected to be approximately $35.0 million, and completion is scheduled for
the fourth quarter of 1997. The land was purchased for approximately $2.0
million in December 1995.
ITEM 3. LEGAL PROCEEDINGS
On March 18, 1997, the Company announced it had terminated its merger
agreement with Physician Corporation of America ("PCA"). The original agreement
had been entered into in November 1996. On March 18, 1997, prior to termination
of the merger agreement, PCA filed a lawsuit against the Company in the United
States District Court for the Southern District of Florida (the "District
Court"), seeking, among other things, specific performance of the merger
agreement and monetary damages. While the Company believes the PCA lawsuit is
without merit, there can be no assurance as to the outcome of the PCA lawsuit.
The Company has filed a motion in the District Court seeking a dismissal of the
PCA lawsuit for lack of diversity jurisdiction. The Company has also initiated a
lawsuit in the Court of Chancery of the State of Delaware seeking a declaratory
judgment as well as other remedies. The Company intends to vigorously pursue all
remedies available to it, however, there can be no assurance that the Company
will prevail in such litigation or that PCA will have sufficient funds to pay
any damages that the Company may be awarded.
The Company is subject to various claims and other litigation in the
ordinary course of business. Such litigation includes claims of medical
malpractice, claims for coverage or payment for medical services rendered to HMO
members and claims by providers for payment for medical services rendered to HMO
members. Also included in such litigation are claims for workers' compensation
and claims by providers for payment for medical services rendered to injured
workers. In the opinion of the Company's management, the ultimate resolution of
pending legal proceedings should not have a material adverse effect on the
Company's financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
14
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS
Market Information
The Company's common stock, par value $.005 per share (the "Common Stock"),
has been listed on the New York Stock Exchange under the symbol SIE since April
26, 1994 and, prior to that, was listed on the American Stock Exchange since the
Company's initial public offering on April 11, 1985. The following table sets
forth the high and low sales prices for the Common Stock on the respective
exchanges for each quarter of 1996 and 1995.
Period High Low
1996
First Quarter........................................ $36 $29 7/8
Second Quarter....................................... 35 7/8 29
Third Quarter........................................ 34 7/8 25 1/4
Fourth Quarter....................................... 34 3/8 22 3/8
1995
First Quarter........................................ $32 7/8 $27 3/8
Second Quarter....................................... 33 5/8 22 1/8
Third Quarter........................................ 29 23
Fourth Quarter....................................... 33 1/8 24 1/8
On March 14, 1997, the closing sale price of the common stock was $26 1/2 per
share.
Holders
The number of record holders of Common Stock at March 14, 1997 was 318.
Based upon information available to it, the Company believes there are several
thousand beneficial holders of the Common Stock.
Dividends
No cash dividends have been paid on the Common Stock since the Company's
inception. The Company currently intends to retain its earnings for use in its
business and does not anticipate paying any cash dividends in the foreseeable
future. As a holding company, the Company's ability to declare and to pay
dividends is dependent upon cash distributions from its operating subsidiaries.
The ability of the Company's HMO and insurance subsidiaries to declare and to
pay dividends is limited by state regulations applicable to the maintenance of
minimum deposits, reserves and net worth. (See Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources.) The declaration of any future dividends will be at the
discretion of the Company's Board of Directors and will depend on, among other
things, future earnings, debt covenants, operations, capital requirements and
the financial condition of the Company and upon general business conditions.
15
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data of Sierra Health
Services, Inc., and subsidiaries (the "Company"), for each of the fiscal years
in the five-year period ended December 31, 1996 should be read in conjunction
with the Consolidated Financial Statements and the related Notes thereto,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and other information which appears elsewhere in this Annual Report
on Form 10-K. The selected consolidated financial data below has been derived
from the audited Consolidated Financial Statements of the Company.
Years Ended December 31,
1996 1995 1994 1993 1992
(Amounts in thousands, except per share data)
Statement of Operations Data (1):
OPERATING REVENUES:
Medical Premiums............................................. $386,968 $319,475 $269,382 $240,691 $217,624
Specialty Product Revenue.................................... 133,324 102,807 101,287 113,714 107,229
Professional Fees............................................ 28,836 19,417 12,331 11,254 10,206
Investment and Other Revenue................................. 26,283 25,310 19,081 17,771 15,397
Total...................................................... 575,411 467,009 402,081 383,430 350,456
OPERATING EXPENSES:
Medical Expenses............................................. 315,915 245,135 200,229 178,526 166,495
Specialty Product Expenses................................... 130,758 102,859 96,600 118,868 156,042
General, Administrative and Marketing Expenses............... 72,237 63,562 53,671 50,715 44,176
Acquisition, Restructuring and Other Expenses (2) ........... 12,064 11,614
Total...................................................... 530,974 423,170 350,500 348,109 366,713
OPERATING INCOME (LOSS) ........................................ 44,437 43,839 51,581 35,321 (16,257)
OTHER INCOME (EXPENSE):
Minority Interests .......................................... 2,065 2,471 (113) (179) (249)
Interest Expense and Other, Net.............................. (4,888) (6,208) (6,288) (4,258) (4,641)
Litigation Settlement........................................ (784)
Total...................................................... (2,823) (3,737) (6,401) (4,437) (5,674)
Income (Loss) from Continuing Operations
Before Income Taxes ....................................... 41,614 40,102 45,180 30,884 (21,931)
Provision for Income Taxes...................................... 10,471 12,198 8,236 8,435 7,045
Income (Loss) from Continuing Operations........................ 31,143 27,904 36,944 22,449 (28,976)
Loss from Discontinued Operations .............................. (6,600) (2,501) (404)
Extraordinary Gain ............................................. 457
Cumulative Effect of Adopting FAS 109........................... 5,250
NET INCOME (LOSS)............................................... $ 31,143 $ 21,304 $ 34,443 $ 27,295 $(28,519)
EARNINGS PER COMMON SHARE (3)
Income (Loss) from Continuing Operations
Per Share ................................................. $1.76 $1.60 $2.36 $1.50 $ (1.98)
Loss Per Share from Discontinued Operations ................. (.38) (.16) (.02)
Extraordinary Gain Per Share ................................ .03
Cumulative Effect of Adopting FAS 109. ...................... .35
Net Income (Loss) Per Share ................................. $1.76 $1.22 $2.20 $1.83 $ (1.95)
Weighted Average Number of Common
Shares Outstanding ........................................ 17,726 17,414 15,678 14,939 14,601
16
Years Ended December 31,
1996 1995 1994 1993 1992
(Amounts in thousands)
Balance Sheet Data:
Working Capital ............................................. $ 76,530 $ 18,157 $ 71,337 $ 21,323 $ 10,578
Total Assets................................................. 629,462 575,146 535,487 445,510 373,848
Long-term Debt (Net of Current Maturities)................... 66,189 71,257 75,209 72,802 64,461
Cash Dividends Per Common Share.............................. NONE NONE NONE NONE NONE
Stockholders' Equity......................................... 234,482 207,715 168,157 84,708 54,380
(1) The Company's consolidated financial statements have been restated to
reflect the results of acquisitions accounted for in accordance with
pooling of interests method of accounting. See Note 1 of Notes to the
Consolidated Financial Statements.
(2) In connection with certain acquisitions and restructurings, the Company
recorded certain non-recurring incremental costs. See Note 13 of Notes to
the Consolidated Financial Statements.
(3) Adjusted to account for a two-for-one stock split of the Company's common
stock in 1992.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion and analysis provides information which management
believes is relevant for assessment and understanding of the Company's
consolidated financial condition and results of operations. The discussion
should be read in conjunction with the Condensed Consolidated Financial
Statements and Related Notes thereto. Any forward-looking information contained
in this Management's Discussion and Analysis of Financial Condition and Results
of Operations and any other sections of this 1996 Annual Report on Form 10-K
should be considered in connection with certain cautionary statements contained
in the Company's Current Report on Form 8-K filing dated March 28, 1997. Such
cautionary statements are made pursuant to the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995 and identify important risk
factors that could cause the Company's actual results to differ from those
expressed in any projected, estimated or forward-looking statements relating to
the Company.
Acquisitions
Effective December 31, 1996, the Company purchased Prime for approximately
$32.2 million in cash. At December 31, 1996, Prime operated MedOne Health Plan,
Inc., a 12,800 member HMO, and also served 215,000 people through preferred
provider organizations, workers' compensation programs, and administrative
services products for self-insured employers and union welfare funds, primarily
in the state of Nevada. The acquisition of Prime has been accounted for as a
purchase and, therefore, none of Prime's prior operations have been included in
the information contained in this discussion and analysis; however, all of the
acquired assets and liabilities have been reflected in the Company's ending
consolidated balance sheet, along with the associated goodwill.
In November 1996, the Company acquired the remaining ownership interests of
HMO Texas for $5.0 million. The Company had previously held a 50 percent
interest in the Houston-based health plan which had approximately 12,700 members
at the end of 1996.
On October 31, 1995, the Company acquired CII Financial, Inc., a workers'
compensation insurance holding company, for approximately $76.3 million of
common stock, in a transaction accounted for as a pooling of interests. The
information contained in this discussion and analysis has been restated to
include the results of CII for all periods presented.
17
Overview
The Company derives revenues from its health maintenance organizations,
managed indemnity and workers' compensation insurance subsidiaries. To a lesser
extent, the Company also derives additional specialty product revenues from
non-HMO and insurance products (consisting of fees for workers' compensation
administration, utilization management services and ancillary products),
professional fees (consisting primarily of fees for providing health care
services to non-members and co-payment fees received from members), and
investment and other revenue. Medical premium revenues accounted for
approximately 67.3%, 68.4%, and 67.0% of the Company's total revenues for 1996,
1995 and 1994, respectively. Continued medical premium revenue growth is
principally dependent upon continued enrollment in the Company's products and
upon competitive and regulatory factors which are expected to limit the
Company's ability to implement annual premium rate increases.
The Company's principal expenses consist of medical expenses, specialty
product expenses, and general, administrative and marketing expenses. Medical
expenses represent the aggregate expenses of operating the Company's
multi-specialty medical group and other provider subsidiaries as well as
capitation fees and other fee-for-service payments paid to independently
contracted physicians, hospitals and other health care providers. As a provider
of managed care services, the Company seeks to manage medical expenses by
employing or contracting with physicians, hospitals and other health care
providers at negotiated price levels, by adopting quality assurance programs, by
monitoring and managing utilization of physicians and hospital services and by
providing incentives to use cost-effective providers. Specialty product expenses
primarily consist of losses and loss adjustment expenses, and underwriting
expenses associated with the Company's workers' compensation insurance
subsidiaries. General, administrative and marketing expenses generally represent
operational costs other than those associated with the delivery of health care
services and specialty product services.
Acquisition, restructuring and other expenses represent the non-recurring
incremental costs the Company has incurred in connection with various mergers,
acquisitions and planned dispositions.
18
Results of Operations
The following table sets forth selected operating data as a percentage of
revenues for the periods indicated:
Years Ended December 31,
1996 1995 1994
OPERATING REVENUES:
Medical Premiums........................................ 67.3% 68.4% 67.0%
Specialty Product Revenue............................... 23.2 22.0 25.2
Professional Fees....................................... 5.0 4.2 3.1
Investment and Other Revenue............................ 4.5 5.4 4.7
Total................................................ 100.0 100.0 100.0
OPERATING EXPENSES:
Medical Expense......................................... 54.9 52.5 49.8
Specialty Product Expense............................... 22.7 22.0 24.0
General, Administrative and Marketing Expenses.......... 12.6 13.6 13.4
Acquisition, Restructuring and Other Expenses .......... 2.1 2.5
Total................................................ 92.3 90.6 87.2
OPERATING INCOME ............................................ 7.7 9.4 12.8
OTHER INCOME (EXPENSE):
Minority Interests ..................................... 0.4 0.5
Interest Expense and Other, Net......................... (0.9) (1.3) (1.6)
Total................................................ (0.5) (0.8) (1.6)
INCOME FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES .................................... 7.2 8.6 11.2
PROVISION FOR INCOME TAXES................................... 1.8 2.6 2.0
INCOME FROM CONTINUING OPERATIONS ........................... 5.4 6.0 9.2
NET OPERATING LOSS ON DISCONTINUED
OPERATIONS .............................................. (.4) (.6)
NET LOSS ON DISPOSAL OF
DISCONTINUED OPERATIONS .................................. (1.0)
NET INCOME................................................... 5.4% 4.6% 8.6%
19
1996 Compared to 1995
Revenues. The Company's total operating revenues for 1996 increased 23.2%
to $575.4 million from $467.0 million for 1995. The increase was primarily due
to medical premium revenue increases of approximately $67.5 million, or 21.1%,
from the Company's HMO and managed indemnity insurance subsidiaries. Such
premium growth resulted principally from a 19.6% increase in member months. The
Company experienced an overall rate increase for its Medicare members due to an
approximate 2.9% increase in its capitation rate established by HCFA.
Additionally, the Company realized minimal rate changes for the HMO subsidiary's
commercial groups and managed indemnity insurance subsidiary. The Company's
specialty product revenue increased $30.5 million, or 29.7%, to $133.3 million
in 1996 from $102.8 million in 1995. Such increases were primarily from workers'
compensation premiums in California. Professional fees increased $9.4 million,
or 48.5%, over 1995 to $28.8 million. This increase is due primarily to the
acquisition of a medical facility in the fourth quarter of 1995 as well as
expanded services at the Company's existing medical facilities. Investment and
other revenue increased $1.0 million, or 3.8%, over the prior year due to
changes in the investment balances and market yield fluctuations.
Medical and Specialty Product Expenses. Total medical expenses increased by
$70.8 million in 1996 compared to 1995. This 28.9% increase resulted from the
consolidated member month growth discussed above, as well as the clinical
expansions and increases associated with professional fee growth. These factors,
as well as an increase in Medicare members as a percentage of total members,
increased the Company's medical loss ratio to 76.0% for the twelve months ended
December 31, 1996, from 72.3% for the comparable twelve months in 1995. The cost
of providing medical care to Medicare members generally requires a greater
percentage of the premium revenue received. Specialty product expenses increased
$27.9 million, or 27.1%, over 1995. This increase is due primarily to the
increase in workers' compensation premiums noted above, offset in part by the
Company's ability to overlay managed care techniques on the management and
payment of certain workers' compensation claims. In addition, specialty product
expenses for 1996 and 1995 were impacted by the loss development on prior
accident years. During the year, the Company had net favorable loss development
on prior accident years of $15.3 million, compared to net favorable loss
development of $20.1 million for the comparable prior year period. The majority
of the favorable loss development occurred on the 1992 through 1994 accident
years. The favorable development on the 1992 accident year appears to be
primarily due to the Company's aggressive actions to resolve claims. The
favorable development on the 1993 and 1994 accident years appears to have been
aided by the workers' compensation reforms that were enacted in July 1993 to
combat the abuses in the California workers' compensation system. There can be
no assurances that favorable development, or the magnitude of the development,
will continue in the future. See Note 6 of Notes to Consolidated Financial
Statements.
General, Administrative and Marketing Expenses. General, administrative and
marketing ("G&A") costs increased $8.7 million, or 13.6%, for the twelve months
ended December 31, 1996 compared to the twelve months ended December 31, 1995.
As a percentage of revenues, however, G&A costs for the twelve months ended
December 31, 1996 decreased to 12.6% from 13.6% during the comparable period in
1995. Of the $8.7 million increase in G&A, $3.3 million is in compensation costs
primarily resulting from additional employees supporting expanded services, $3.8
million is from percent of premium costs such as broker commissions and premium
taxes, and the remaining $1.6 million is made up of various changes which
individually are insignificant.
Acquisition, Restructuring and Other Expenses. During 1995, as part of the
Company's clinical expansion and growth efforts, the Company acquired a medical
facility in Mohave County, Arizona, across the border from Laughlin, Nevada.
This medical facility included a small 12 bed hospital. During 1996 the Company
implemented a plan to exit the hospital business and has actively pursued buyers
for this business. As a result of this plan, the Company took a charge of $3.8
million ($2.8 million after tax) in the fourth quarter of 1996, primarily to
recognize the estimated costs to dispose of the hospital.
20
As a result of higher than expected claim and administrative costs relative
to premium rates that can be obtained in certain regional insurance operations
and the Company's inability to negotiate adequate provider contracts due to its
limited presence in some of these markets, the Company adopted a plan to
restructure certain insurance operations during the third quarter of 1996 and
recorded a charge of $8.3 million. The plan included the sale or closure of
certain regional operations in California, Arizona, and Colorado. The plan will
allow the Company to focus on more favorable operating markets and improve
operating efficiencies. The Company believes that this restructuring, over time,
will result in improved cash flow and operating cost savings in excess of the
amount of the charge.
As a result of these restructurings, the Company recorded expenses of $12.1
million. These costs included cancellation of certain contractual obligations of
$6.0 million, lease termination costs of $1.5 million, and $4.6 million of other
costs including the estimated costs to dispose of the hospital. As of December
31, 1996, approximately $4.1 million of these costs had been paid or otherwise
charged against the accrual and the Company estimates that most of the remaining
cash expenditures will be paid over the next twelve months.
Income Taxes. The Company's effective tax rate for the year ended December
31, 1996 was 25.2%, compared to 30.4% in 1995, or 25.4% after taking into
account the non-deductible merger costs incurred in 1995. The difference between
the Company's effective tax rate and the current federal tax rate is due
primarily to a $2.7 million tax benefit recorded as a result of a reduction of
the deferred tax valuation allowance and the Company's significant portfolio of
tax preferred investments. See Note 8 of Notes to Consolidated Financial
Statements.
Net Income. Net income for 1996 increased $9.8 million, or 46.2%, over
1995. This increase was impacted in part by several non-recurring items
including the restructurings in 1996 and discontinued operations and merger
costs in 1995. Excluding non-recurring items and the related tax effects, income
from ongoing operations for 1996 increased $2.6 million, or 6.9%.
1995 Compared to 1994
Revenues. The Company's total operating revenues for 1995 increased 16.1%
to $467.0 million from $402.1 million for 1994. The increase was primarily due
to medical premium revenue increases of approximately $50.1 million, or 18.6%
from the Company's HMO and managed indemnity insurance subsidiaries. Such
premium growth resulted principally from a 12.5% increase in member months. The
Company experienced an overall rate increase for its Medicare members due to an
approximate 7.5% increase in its capitation rate established by HCFA.
Additionally, the Company realized minimal rate changes for the HMO subsidiary's
commercial groups and managed indemnity insurance subsidiary. The Company's
specialty product revenue increased slightly to $102.8 million in 1995 from
$101.3 million in 1994. Specialty product revenue increased by $1.7 million in
Nevada and $2.0 million in all other states excluding California. Such increases
were offset by a $2.2 million decrease in the amount of specialty product
revenue earned in California. The decrease in California specialty product
revenues is primarily due to the abolishment of minimum premium rates in the
California workers' compensation market and the commencement of open rating
effective January 1, 1995, as well as a 16% rate decrease which had occurred
October 1, 1994. Professional fees increased by $7.1 million, or 57.5% over 1994
due principally to the opening of three new medical clinics (one in the latter
part of 1994 and two in 1995), a new surgery center, and the acquisition of a
medical facility. Investment and other revenue increased $6.2 million, or 32.6%,
primarily due to increased investment balances from the Company's common stock
offering completed in October 1994.
21
Medical and Specialty Product Expense. Total medical expenses increased by
approximately $44.9 million in 1995 compared to 1994. This 22.4% increase
resulted from the consolidated member month growth discussed above, as well as
the clinical expansions and increases associated with professional fee growth.
These factors, as well as an increase in Medicare members as a percentage of
total members, increased the Company's medical loss ratio to 72.3% for the
twelve months ended December 31, 1995, from 71.1% for the comparable twelve
months in 1994. The cost of providing medical care to Medicare members generally
requires a greater percentage of the premium revenue received. Specialty product
expenses increased by 6.5% over 1994. This increase is primarily the result of a
higher loss ratio in 1995 due to the decrease in premium rates discussed above,
offset in part by favorable development during 1995 in reserves for prior
accident years. During the year, the Company had net favorable loss development
on prior accident years of $20.1 million, compared to net favorable loss
development of $14.0 million for the comparable prior year period. The majority
of the favorable loss development occurred on the 1992 and 1993 accident years.
The favorable development on the 1992 accident year appears to be primarily due
to the Company's aggressive actions to resolve claims. The favorable development
on the 1993 accident year appears to have been aided by the workers'
compensation reforms that were enacted in July 1993 to combat the abuses in the
California workers' compensation system. There can be no assurances that
favorable development, or the magnitude of the development, will continue in the
future.
See Note 6 of Notes to Consolidated Financial Statements.
General, Administrative and Marketing Expenses. General, administrative and
marketing ("G&A") costs increased 18.4% to $63.6 million for the twelve months
ended December 31, 1995 compared to the twelve months ended December 31, 1994.
As a percentage of revenues, however, G&A costs for the twelve months ended
December 31, 1995 increased to 13.6% from 13.3% during the comparable period in
1994. Excluding the operations of HMO Texas, however, G&A as a percentage of
revenue for 1995 decreased to 12.6%. Of the $9.9 million increase in G&A,
approximately $4.8 million was due to the HMO Texas operations. Additional
increases include $3.2 million of compensation costs primarily resulting from
additional employees supporting expanded services, and $1.6 million in
additional marketing and related fees.
Income Tax. The Company's effective income tax rate for the year ended
December 31, 1995, was 30.4% compared to 18.2% for the year ended 1994. This
change is primarily due to the non-deductibility of a significant portion of the
merger costs incurred in 1995 and a $4.0 million tax benefit recorded as part of
the 1994 provision as a result of a reduction of the deferred tax valuation
allowance. See Note 8 of Notes to Consolidated Financial statements.
Discontinued Operations. During 1995, CII sold its interest in an
unprofitable subsidiary for approximately $1.0 million in cash and securities.
This disposal resulted in a loss on discontinued operations, net of tax effects,
of $6.6 million in 1995 compared to losses of $2.5 million from the discontinued
operations in 1994.
Net Income. Net income for 1995 decreased to $21.3 million, from $34.4
million in 1994. This decrease is primarily due to the non-recurring items
previously discussed, discontinued operations, merger and integration expenses,
and the change in the deferred tax valuation allowance. Excluding non-recurring
items and the related tax effects, income from ongoing operations for 1995
increased 11.9% to $36.8 million from $32.9 million in 1994.
22
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents increased by $46.5 million to
$103.6 million at December 31, 1996, from $57.0 million at December 31, 1995. At
December 31, 1996, the Company had working capital of $76.5 million. The primary
source of cash received during the year ended December 31, 1996, was operations.
The Company's cash flow from operating activities resulted in $52.4 million
of cash flow for the twelve months ended December 31, 1996. This cash flow was
primarily generated from net income of $31.1 million, $10.5 million in
depreciation and amortization, and a net change in operating assets and
liabilities, excluding cash and cash equivalents, of $10.8 million. The increase
in cash from fluctuations in such operating assets and liabilities is
principally due to increases in the reserve for losses and loss adjustment
expense, other liabilities and medical claims payable, as well as a decrease in
reinsurance recoverable. These increases in cash were offset by increases in
accounts receivable and other assets.
In 1996 the Company spent $36.3 million on the acquisition, net of cash
acquired, of Prime and the remaining interests of HMO Texas and $17.9 million in
capital expenditures. Capital expenditures were primarily for new facilities as
well as the expansion of existing medical facilities and include the
construction costs of a 59,000 square foot medical facility in Las Vegas with
completion expected in the fourth quarter of 1997, medical equipment for the
Breast Care Center and 23 hour recovery unit, remodeling of certain existing
medical space and construction costs on an additional administrative
headquarters building of approximately 180,000 square feet. Such facilities
accounted for $8.5 million of the total capital expenditures. Other capital
expenditures were primarily for business expansion of the HMO and insurance
operations, along with general corporate expansion. Such amounts include $3.2
million in computer hardware and software. In addition, the Company reduced debt
obligations by $9.6 million in 1996. Most of this debt reduction was a result of
the Company paying off a mortgage on one of the clinics. These cash outflows
were offset through the net change of marketable securities, as well as $3.6
million received in connection with the purchase of stock through the Company's
employee stock plans.
In April 1996, the Company obtained a $50.0 million unsecured line of
credit from Bank of America National Trust & Savings Association ("BofA") for a
term of five years at an interest rate equal to the London InterBank Offering
Rate ("LIBOR") plus 32 basis points. Such rate would have been 5.875% at
December 31, 1996 if the line of credit had been drawn upon.
In September 1991, CII issued convertible subordinated debentures (the
"Debentures") due September 15, 2001. The Debentures bear interest at 7 1/2%
which is due semi-annually on March 15 and September 15. Each $1,000 in
principal is convertible into 16.921 shares of the Company's common stock at a
conversion price of $59.097 per share. Unamortized issuance costs of $1.1
million are included in other assets on the balance sheet and are being
amortized over the life of the Debentures. The Debentures are general unsecured
obligations of CII only and are not guaranteed by Sierra. During the twelve
months ended December 31, 1996, the Company purchased $2.3 million of the
Debentures on the open market. At December 31, 1996, CII had total assets of
$315.9 million, consisting primarily of investments, and total liabilities of
$271.0 million, consisting primarily of reserves for losses and loss adjustment
expense and the debentures. For the year ended December 31, 1996, CII had net
premiums earned of $121.0 million and investment and other revenue of $18.7
million, and total operating expenses of $128.9 million.
The Company has a 1997 capital budget of approximately $45.0 million,
primarily for the completion of the construction on the new 59,000 square-foot
medical facility and 180,000 square foot six-story corporate headquarters
building and accompanying five-story parking structure, computer hardware and
software, furniture and equipment, and other requirements due to the Company's
projected growth and expansion. Completion of the medical facility is expected
in the fourth quarter of 1997 at an estimated cost
23
of $7.3 million. Completion of the additional building at the corporate
headquarters complex is expected in the fourth quarter of 1997 at an estimated
cost of $35.0 million, of which $3.5 million was spent in 1996. The Company's
liquidity needs over the next 12 months will primarily be for the capital items
noted above to support growing membership in Nevada, as well as debt service and
expansion of the Company's operations. The Company believes that existing
working capital, operating cash flow and, if necessary, mortgage financing and
equipment leasing, and amounts available under its credit facility will be
sufficient to fund its capital expenditures, debt service and any expansion
activities during the next 12 months. Additionally, subject to unanticipated
cash requirements, the Company believes that its existing working capital and
operating cash flow and, if necessary, its access to new credit facilities, will
enable it to meet its liquidity needs on a longer term basis.
The holding company may receive dividends from its HMO and insurance
subsidiaries which generally must be approved by certain state insurance
departments. The Company's HMO and insurance subsidiaries are required by state
regulatory agencies to maintain certain deposits and must also meet certain net
worth and reserve requirements. The HMO and insurance subsidiaries had
restricted assets on deposit in various states totaling $13.6 million and $12.5
million, as of December 31, 1996 and December 31, 1995, respectively. The HMO
and insurance subsidiaries also meet requirements to maintain minimum
stockholder's equity ranging from $200,000 to $5.2 million. Of the cash and cash
equivalents held at December 31, 1996, $85.2 million is designated for use only
by the regulated subsidiaries. Such amounts are available for transfer to the
holding company from the HMO and insurance subsidiaries only to the extent that
they can be remitted in accordance with terms of existing management agreements
and by dividends. Remaining amounts are available on an unrestricted basis. The
holding company will not receive dividends from its HMO or insurance
subsidiaries that would cause violation of statutory net worth and reserve
requirements.
On March 18, 1997, the Company announced it had terminated its merger
agreement with PCA. During the first quarter of 1997, the Company intends to
record certain costs and expenses incurred as a result of the terminated merger.
See Item 3. Legal Proceedings for discussion on associated litigation.
On January 10, 1997, the Company and PCA entered into a credit and share
pledge agreement (the "PCA Loan") pursuant to which the Company made a demand
loan to PCA in the amount of $16.8 million with an 8.25% fixed rate of interest.
The proceeds of the PCA Loan were used by PCA to make a principal payment under
PCA's existing credit facility in which Citibank N.A. is the agent ("PCA Credit
Facility"). The PCA Loan is subordinated as to payment of principal and interest
to the amount due under the PCA Credit Facility (estimated to be in excess of
$100 million) and is secured by a lien on the stock of certain of PCA's
subsidiaries, second in priority to the lien securing the PCA Credit Facility.
The PCA Loan provides that the Company will not take any action to collect
payment until the earlier of the PCA Credit Facility being paid in full or six
months from the date the Company notifies Citibank N.A., as agent, that it
intends to take such action. On March 20, 1997 the Company notified Citibank
N.A. of its intent to demand payment. There can be no assurance that PCA will
have sufficient funds to pay the PCA Credit Facility and the PCA Loan in full.
The Company has submitted a proposal as the prime contractor to OCHAMPUS to
provide managed health care coverage to CHAMPUS eligible beneficiaries in Region
1. This region includes approximately 665,000 individuals in Connecticut,
Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York,
Pennsylvania, Rhode Island, Vermont, northern Virginia and Washington, D.C. The
Company expects to incur expenses of approximately $8.0 to $10.0 million during
the Region 1 contract proposal process. The Company submitted its final bid on
February 14, 1997 and anticipates learning of the result of its bid in the
second quarter of 1997. The contract, if awarded to the Company, will result in
approximately $1.8 billion in estimated revenues over the term of the contract.
24
Inflation
Health care costs generally continue to rise at a faster rate than the
Consumer Price Index. The Company has been able to lessen somewhat the impact of
inflation by managing medical costs. There can be no assurance, however, that,
in the future, the Company's ability to manage medical costs will not be
negatively impacted by items such as technological advances, utilization changes
and catastrophic items, which could, in turn, result in medical cost increases
equaling or exceeding premium increases.
Health Care Reform
As a result of the continued escalation of health care costs and the
inability of many individuals to obtain health care insurance, numerous
proposals relating to health care reform have been or may be introduced in the
United States Congress and state legislatures. Any proposals affecting
underwriting practices, limiting rate increases, requiring new or additional
benefits or affecting contracting arrangements (including proposals to require
HMOs and PPOs to accept any health care providers willing to abide by an HMO's
or PPO's contract terms) may have a material adverse effect on the Company's
business.
For example, recent news reports indicate that President Clinton may submit
a budget proposal to Congress that will reduce Medicare spending by $100 billion
and impose certain limits on Medicaid spending. Although neither the present
administration's health care reform proposals nor alternative health care reform
proposals introduced by certain members of Congress were previously adopted, the
Health Insurance Portability and Accountability Act of 1996 (the "Accountability
Act") was passed by Congress and signed into law by President Clinton on August
21, 1996 and will generally take effect beginning July 1, 1997. While the
Accountability Act contains provisions regarding health insurance or health
plans, such as portability and limitations on pre-existing condition exclusions,
guaranteed availability and renewability, it also contains several anti-fraud
measures that significantly change health care fraud and abuse provisions. Some
of the provisions include (i) creation of an anti-fraud and abuse trust fund and
coordination of fraud and abuse efforts by federal, state and local authorities,
(ii) extension of the criminal anti-kickback statues to all federal health
programs, (iii) expansion of and increase in the amount of civil monetary
penalties and establishment of a knowledge standard for individuals or entities
potentially subject to civil monetary penalties, and (iv) revisions to current
sanctions for fraud and abuse, including mandatory and permissive exclusion from
participation in the Medicare or Medicaid programs. The Company does not believe
that the Accountability Act should have a material adverse effect on the
Company's operations, but is unable to predict the ultimate impact of any
federal or state restructuring of the health care financing and delivery system,
which ultimately could have a material adverse impact on the operations,
financial condition and prospects of the Company.
25
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
Page
Management Report on Consolidated Financial Statements.................. 27
Independent Auditors' Report............................................ 28
Consolidated Balance Sheets at December 31, 1996 and 1995............... 29
Consolidated Statements of Operations for the Years Ended
December 31, 1996, 1995, and 1994.................................... 30
Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended December 31, 1996, 1995 and 1994................. 31
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996, 1995, and 1994.................................... 32
Notes to Consolidated Financial Statements.............................. 33
26
MANAGEMENT REPORT ON CONSOLIDATED FINANCIAL STATEMENTS
The management of Sierra Health Services, Inc., is responsible for the integrity
and objectivity of the accompanying Consolidated Financial Statements. The
statements have been prepared in conformity with generally accepted accounting
principles applied on a consistent basis and are not misstated due to fraud or
material error. The statements include some amounts that are based upon the
Company's best estimates and judgment.
The accounting systems and controls of the Company are designed to provide
reasonable assurance that transactions are executed in accordance with
management's authorization, that the financial records are reliable for
preparing financial statements and maintaining accountability for assets, and
that assets are safeguarded against losses from unauthorized use or disposition.
Management believes that for the year ended December 31, 1996, such systems and
controls were adequate to meet the objectives discussed herein.
The accompanying Consolidated Financial Statements have been audited by
independent certified public accountants, whose audits thereof were made in
accordance with generally accepted auditing standards and included a review of
internal accounting controls to the extent necessary to design audit procedures
aimed at gathering sufficient evidence to provide a reasonable basis for their
opinion on the fairness of presentation of the Consolidated Financial Statements
taken as a whole.
The Audit Committee of the Board of Directors, comprised solely of directors
from outside the Company, meets regularly with management and the independent
auditors to review the work procedures of each. The independent auditors have
free access to the Audit Committee, without management being present, to discuss
the results of their opinions on the adequacy of the Company's accounting
controls and the quality of the Company's financial reporting. The Board of
Directors, upon the recommendation of the Audit Committee, appoints the
independent auditors, subject to stockholder ratification.
Anthony M. Marlon, M.D.
Chairman and
Chief Executive Officer
James L. Starr
Vice President,
Chief Financial Officer
and Treasurer
27
INDEPENDENT AUDITORS' REPORT
Board of Directors
Sierra Health Services, Inc.:
We have audited the consolidated balance sheets of Sierra Health Services, Inc.,
and its subsidiaries as of December 31, 1996 and 1995, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 1996. Our audits also
included the financial statement schedules listed in the index at Item 14
(a)(2). These financial statements and financial statement schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and financial statement schedules based on
our audits. The consolidated financial statements give retroactive effect to the
merger of Sierra Health Services, Inc., and its subsidiaries, and CII Financial,
Inc., and its subsidiaries, which has been accounted for as a pooling of
interests as described in Note 1 to the consolidated financial statements. We
did not audit the statements of operations, stockholders' equity, and cash flows
of CII Financial, Inc., and its subsidiaries, for the year ended December 31,
1994, which statements reflect total revenues of $106,280,000 for the year ended
December 31, 1994. These statements were audited by other auditors whose report
has been furnished to us, and our opinion, insofar as it relates to the amounts
included for CII Financial, Inc., and its subsidiaries, for 1994 is based solely
on the report of such other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of the other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors, the
consolidated financial statements present fairly, in all material respects, the
financial position of Sierra Health Services, Inc. and its subsidiaries at
December 31, 1996 and 1995, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1996 in
conformity with generally accepted accounting principles. Also, in our opinion,
such financial statement schedules when considered in relation to the basic
consolidated financial statements taken as a whole, present fairly in all
material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Las Vegas, Nevada
February 21, 1997
(March 28, 1997 as to Note 14)
28
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1996 and 1995
ASSETS
1996 1995
CURRENT ASSETS:
Cash and Cash Equivalents.............................................. $103,587,000 $ 57,044,000
Short-term Investments................................................. 83,688,000 72,579,000
Accounts Receivable (Less: Allowance for Doubtful
Accounts 1996 - $7,324,000; 1995 - $5,000,000)..................... 31,849,000 21,723,000
Current Portion of Deferred Tax Asset ................................. 13,713,000 7,629,000
Prepaid Expenses and Other Current Assets.............................. 20,098,000 16,442,000
Total Current Assets............................................... 252,935,000 175,417,000
PROPERTY AND EQUIPMENT, NET................................................ 99,804,000 91,176,000
LONG-TERM INVESTMENTS...................................................... 160,482,000 234,698,000
RESTRICTED CASH AND INVESTMENTS............................................ 13,648,000 12,482,000
REINSURANCE RECOVERABLE, Net of Current Portion............................ 14,721,000 24,952,000
GOODWILL .................................................................. 44,602,000 8,351,000
OTHER ASSETS............................................................... 43,270,000 28,070,000
TOTAL ASSETS............................................................... $629,462,000 $575,146,000
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accrued Liabilities.......