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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-11628
WELLPOINT HEALTH NETWORKS INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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CALIFORNIA 95-3760980
(State of incorporation) (I.R.S. Employer Identification No.)
21555 OXNARD STREET
WOODLAND HILLS, CALIFORNIA 91367
(Address of principal executive (Zip Code)
offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (818) 703-4000
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH
- -------------------------------------- REGISTERED
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Common Stock, $0.01 par value New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) of the Act:
None
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Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. /X/ Yes / / No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment to this
Form 10-K.
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State the aggregate market value of the voting stock held by non-affiliates
of the Registrant as of March 19, 1997: $1,273,420,698 (based on the last
reported sale price of $45.38 per share on March 19, 1997, on the New York Stock
Exchange).
Common Stock, $0.01 par value of Registrant outstanding as of March 19,
1997: 66,570,263 shares.
DOCUMENTS INCORPORATED BY REFERENCE
NONE.
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WELLPOINT HEALTH NETWORKS INC.
1996 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business....................................................................................... 1
Item 2. Properties..................................................................................... 17
Item 3. Legal Proceedings.............................................................................. 17
Item 4. Submission of Matters to a Vote of Security Holders............................................ 18
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters...................... 19
Item 6. Selected Financial Data........................................................................ 20
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.......... 21
Item 8. Financial Statements and Supplementary Data.................................................... 31
Item 9. Changes and Disagreements with Accountants on Accounting and Financial Disclosure.............. 31
PART III
Item 10. Directors and Executive Officers of the Registrant............................................. 32
Item 11. Executive Compensation......................................................................... 35
Item 12. Security Ownership of Certain Beneficial Owners and Management................................. 43
Item 13. Certain Relationships and Related Transactions................................................. 45
PART IV
Item 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K............................... 47
SIGNATURES
INDEX TO FINANCIAL STATEMENTS
PART I
ITEM 1. BUSINESS
GENERAL
WellPoint Health Networks Inc. (the "Company" or "WellPoint") is one of the
nation's largest publicly traded managed health care companies with
approximately 4.5 million medical members, 11.5 million pharmacy members and 1.6
million dental members as of December 31, 1996. The Company offers a diversified
mix of managed care products, including health maintenance organizations
("HMOs"), preferred provider organizations ("PPOs") and point-of-service ("POS")
and other hybrid plans, and indemnity plans. The Company offers a continuum of
managed health care plans while providing incentives to members and employers to
select more intensively managed plans. Such plans are typically offered at a
lower cost in exchange for additional cost-control measures, such as limited
flexibility in choosing non-network providers. The Company believes that it is
better able to predict and control its health care costs as its members select
more intensively managed health care plans. The Company also provides a broad
array of specialty products, including pharmacy, dental, life, workers'
compensation, disability, behavioral health, COBRA and flexible benefits account
administration. In addition, the Company offers managed care services for
self-funded employers, including underwriting, actuarial services, network
access, medical cost management and claims processing. WellPoint's diversified
mix of products and services has been developed to meet the needs of a broad
range of individuals, employer groups and their employees.
The Company's operations, with the exception of specialty products, are
organized into two internal business units with a geographic focus. The Company
markets its products in California primarily under the name Blue Cross of
California and outside of California primarily under the name UNICARE.
Historically, the Company's primary market for its managed care products has
been California. The Company holds the exclusive right in California to market
its products under the Blue Cross name and mark. The Company is diversified in
its California customer base, with extensive membership among small employer
groups, individuals and large employer groups, and a growing presence in the
Medicare and Medicaid markets.
Over the past decade, the Company has transitioned substantially all of its
California indemnity insurance customers to managed care products. An element of
the Company's geographic expansion strategy is to replicate its experience in
California in motivating traditional indemnity members to transition to the
Company's broad range of managed care products. The Company's acquisition
strategy focuses on large employer group plans that offer indemnity and other
health insurance products that are less intensively managed than the Company's
current products. In addition, the Company focuses on acquiring businesses that
provide significant concentrations of members in strategic locations outside of
California. The Company believes that such acquisitions will provide its UNICARE
operations with sufficient scale to begin development of proprietary provider
network systems in key geographic areas which will enable the Company to offer a
broad range of managed care products. The Company intends to use these new
networks to introduce individual, small group and senior products in these
markets. With the acquisitions in March 1996 of the Life & Health Benefits
Management division ("MMHD") of Massachusetts Mutual Life Insurance Company (the
"MMHD Acquisition") and in March 1997 of certain portions of the health and
related life group benefit operations (the "GBO") of John Hancock Mutual Life
Insurance Company ("John Hancock") (discussed in the following section), the
Company has significantly expanded its operations outside of California.
The Company is also exploring opportunities to work with other BlueCross
BlueShield entities. The Company currently provides pharmacy benefits management
services to other BlueCross BlueShield entities and intends to market additional
specialty products to and to pursue other relationships with BlueCross
BlueShield plans in the future.
1
RECENT DEVELOPMENT--GBO ACQUISITION
On March 1, 1997, the Company completed its acquisition of the GBO (the "GBO
Acquisition"). The purchase price for the acquisition was $86.7 million, subject
to adjustment upon completion of a post-closing audit.
As of December 31, 1996, the GBO provided benefits to approximately 1.3
million medical members, most of which were in health plans that are self-funded
by employers. The GBO offers indemnity and PPO plans, and also provides life,
dental and disability coverage to a variety of employer groups. The GBO focuses
on the largest employer groups, accounts with greater than 5,000 employees. A
majority of the GBO members are located in California, Texas, Georgia, the
Mid-Atlantic/Washington, D.C. area, Massachusetts, the New York/Tri-State area,
Ohio, Illinois and Michigan. In addition to the medical members, as of December
31, 1996, the GBO served approximately 270,000 pharmacy members, approximately
1.5 million dental members, approximately 1.0 million life insurance members and
covered approximately 940,000 members through disability products. The GBO
Acquisition also included Cost Care, Inc. ("CCI"), a wholly owned subsidiary of
John Hancock, which provides medical management services.
The closing of the GBO Acquisition was postponed from January 31, 1997 due
to the granting of an injunction on January 30, 1997 in favor of SelectCare Inc.
("SelectCare"), a network manager in Michigan used by John Hancock to serve
certain GBO members. In its complaint for an injunction, SelectCare had alleged,
among other things, that the completion of the acquisition would violate the
confidentiality provisions of John Hancock's agreements with SelectCare. The
case was brought by SelectCare in the federal District Court in Michigan. The
acquisition was completed on March 1, 1997 in a manner that the Company believes
complies with the terms of the injunction.
MANAGED HEALTH CARE INDUSTRY OVERVIEW
An increasing focus on costs has spurred the growth of HMO, PPO, POS and
other forms of managed care plans as alternatives to traditional indemnity
health insurance. Typically, HMOs and PPOs, as well as hybrid plans (such as POS
plans), develop health care provider networks by entering into contracts with
hospitals, physicians and other providers to deliver health care at favorable
rates that incorporate health care utilization management, network
credentialing, quality assurance and other cost-control measures. HMO, PPO and
POS members generally are charged periodic, prepaid premiums, and co-payments or
deductibles. PPOs, POS plans and a number of HMOs allow out-of-network usage,
typically at substantially higher out-of-pocket costs to members. HMO members
generally select at the time of enrollment one primary care physician from a
network who is responsible for coordinating health care services for the member,
while PPOs generally allow members to select physicians without coordination
through a primary care physician. Hybrid plans, such as POS plans, typically
involve the selection of primary care physicians similar to HMOs, but allow
members to choose non-network providers at higher out-of-pocket costs, similar
to PPOs.
THE CALIFORNIA MARKET. The desire of California-based employers for a range
of health care choices that promote effective cost controls and quality care has
led to substantial market acceptance of managed health care in California, where
the total penetration of managed health care companies is higher than the
national average. While the Company is a market leader in offering managed
health care plans to individuals and small employer groups in California, the
Company has experienced increased competition in this market over the last
several years. However, the Company believes that there will continue to be
opportunities for growth in its small group membership because small employers
are the primary source of job growth in California. WellPoint's large group
business, which historically lagged the performance of its small group and
individual business, has experienced favorable growth since 1994 with the
rebound of the California economy and the enhancement of the Company's
reputation for customer service and value, especially among established
companies.
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OTHER STATES. The market acceptance of managed health care varies widely
outside of California. In many states, members are typically offered a spectrum
of health care choices which are more focused on traditional indemnity health
insurance than in California. Indemnity insurance usually allows members
substantial freedom of choice in selecting health care providers but without
financial incentives or cost-control measures typical of managed care plans.
Health care providers are reimbursed on a retrospective basis and there are few,
if any, incentives or measures to control health care costs. Indemnity insurance
plans typically require annual deductible obligations of members. Upon
satisfaction of the deductible, the member is reimbursed for health care
expenses on a full or partial basis of the indicated charges. PPO coverage
offered by health plans outside of California is often typified by broad-based,
third-party provider networks which do not incorporate the cost-control measures
or discounts typical of the Company's proprietary provider networks in
California. The Company believes the higher costs generally associated with such
third-party PPO networks and traditional indemnity health insurance will
continue to cause employers and members to seek out managed health care
solutions similar to those offered by the Company in California.
THE BLUE CROSS OF CALIFORNIA BUSINESS
Due in part to the MMHD and GBO Acquisitions, the Company's operations, with
the exception of stand-alone specialty products, are organized into two internal
business units with a geographic focus. Most of the Company's California
operations are conducted through the Blue Cross of California Business.
MARKETING AND PRODUCTS
WellPoint's products are marketed in California primarily under the Blue
Cross mark through four major business units focusing on specific customer
segments: Group Services ("GS"), Individual and Small Group Services ("ISG"),
Senior Services and Medi-Cal. GS provides products to large employers with 51 or
more employees, educational and public entities, federal employee health and
benefit programs and national employers; ISG provides products to individual
purchasers and small groups and products for state-run programs including high
risk and underserved markets. Senior Services provides the Company's Medicare
risk products and supplemental coverage for Medicare recipients. The Medi-Cal
division provides products for Medicaid recipients. Each business unit is
responsible for enrolling, underwriting and servicing its respective customers.
Sales representatives are generally assigned to a specific geographic region of
California to allow WellPoint to tailor its marketing efforts to the particular
health care needs of each regional market. Each business unit also uses
advertising, public relations, promotion and marketing research to support its
efforts. Consistent with the Company's focus on offering a continuum of
products, the Company believes that having distinct business units segmented by
employer size and geographic region better enables it to develop benefit plans
and services to meet the needs of specific markets. The GS sales staff markets
WellPoint's managed health care plans to large employers in California by
working with a broker or consultant to develop a package of managed health care
benefits specifically tailored to meet the employer's needs. ISG markets
WellPoint's managed health care plans in California primarily through sales
managers in both Comprehensive Integrated Marketing Services, Inc. ("CIMS"), a
wholly owned subsidiary of the Company, and ISG's sales department, who oversee
independent agents and brokers.
HMO PLANS. The Company offers a variety of HMO products to the members of
its California HMO, CaliforniaCare. CaliforniaCare members are generally charged
periodic, prepaid premiums that do not vary based on the amount of services
rendered, as well as modest copayments (small per-visit charges). Members choose
a primary care physician from the HMO network who is responsible for
coordinating health care services for the member. Certain plans permit members
to receive health care services from providers that are not a part of the
Company's HMO network at a substantial out-of-pocket cost to members which
includes a deductible and higher copayment obligations. To enhance the
marketability of
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its plans, in 1996 the Company introduced its CaliforniaCare Saver HMO product,
which introduces deductible obligations for certain hospital and outpatient
benefits.
PPO PLANS. The Company's PPO products, which are marketed under the name
"Prudent Buyer," are designed to address the specific needs of different
customer segments. The Company's PPO plans require periodic, prepaid premiums
and have copayment obligations for services rendered by network providers that
are often similar to the copayment obligations of its HMO plans. Unlike
WellPoint's HMO plans, members are not required to select a primary care
physician who is responsible for coordinating their care and may be subject to
annual deductible requirements. PPO members have the option to receive health
care services from non-network providers, typically at substantially higher
out-of-pocket costs to members. To improve the attractiveness of its PPO plans
to small groups and individual buyers, in 1996 the Company introduced its
Prudent Buyer Co-Pay product, which replaces annual deductible obligations with
HMO-like co-payments while maintaining the member choice typical of PPO plans.
In March 1997, the Company introduced new high-deductible health plans intended
for use with medical savings accounts ("MSAs").
SENIOR PLANS. WellPoint offers numerous Medicare supplemental plans, which
typically pay the difference between health care costs incurred and amounts paid
by Medicare, using existing PPO and HMO provider networks. One such product is
Medicare Select, a PPO-based product that offers supplemental Medicare coverage.
WellPoint also offers Medicare Select II, a hybrid product which allows seniors
over the age of 65 to maintain their full Medicare benefits for any
out-of-network benefits while enrolled in a supplemental plan that allows them
to choose their own physician with a copayment. As of December 31, 1996, the
Medicare supplemental plans served approximately 162,000 members. WellPoint also
offers Senior CaliforniaCare, an HMO plan operating in defined geographic areas,
under a Medicare risk contract with the Health Care Financing Administration
("HCFA"). This contract entitles WellPoint to a fixed per-member premium from
HCFA which is subject to adjustment annually by HCFA based on certain
demographic information relating to the Medicare population and the cost of
providing health care in a particular geographic area. In addition to physician
care, hospitalization and other benefits covered by Medicare, the benefits under
this plan include prescription drugs, routine physical exams, hearing tests,
immunizations, eye examinations, counseling and health education services.
MEDICAID PLANS. The California Department of Health Services ("DHS")
administers Medi-Cal, California's Medicaid program. WellPoint has been awarded
contracts to administer Medi-Cal managed care programs in several California
counties. Under these programs, WellPoint provides health care coverage to
Medi-Cal program members and DHS pays WellPoint a fixed payment per member per
month. As of December 31, 1996, approximately 111,029 members were enrolled in
WellPoint's Medi-Cal managed care programs in Sacramento, Orange, Riverside, San
Bernardino, San Francisco, Alameda, Santa Clara, Fresno and Kern counties.
WellPoint is a participating plan partner with the Local Initiative Health
Authority for Los Angeles County, although no enrollment had begun as of
December 31, 1996.
MANAGED HEALTH CARE NETWORKS AND PROVIDER RELATIONS
WellPoint's extensive managed health care provider networks in California
include its HMO, PPO and specialty managed care networks. These provider
relationships are monitored regularly in order to control the cost of health
care while providing access to quality providers. As a result of this
network-monitoring process as well as member and provider financial incentives,
WellPoint reduces or eliminates the need to use out-of-network providers that
are not subject to WellPoint's cost and performance controls.
WellPoint uses its large California membership to negotiate provider
contracts at favorable rates that require utilization management and other
cost-control measures. Pursuant to these contracts, physician providers are paid
either a fixed per member monthly amount (known as a capitation payment) or on
the basis of a fixed fee schedule. In selecting providers for its networks,
WellPoint uses its credentialing
4
programs to evaluate the applicant's professional qualifications and experience,
including license status, malpractice claims history and hospital affiliations.
The following is a more detailed description of the principal features of
WellPoint's California HMO and PPO networks.
HMO NETWORK. Membership in CaliforniaCare has grown to approximately
1,058,000 members as of December 31, 1996 from 123,000 members as of December
31, 1987. As of December 31, 1996, the HMO network included approximately 24,600
primary care and specialist physicians and approximately 410 hospitals
throughout California. The physician network of participating medical groups
("PMGs") is comprised of both multi-specialty medical group practices and
individual practice associations.
Substantially all primary care physicians or PMGs in the Company's HMO
network are reimbursed on a capitated basis that incorporates financial
incentives to control health care costs. These arrangements specify fixed per
member per month payments to providers and may result in a marginally higher
medical loss ratio than a non-capitated arrangement, but significantly reduced
risk to WellPoint. Generally, HMO network hospital provider contracts are on a
nonexclusive basis and provide for a per diem (a fixed fee schedule where the
daily rate is based on the type of service), which is substantially below the
hospitals' standard billing rates.
Contractual arrangements with PMGs typically include provisions under which
WellPoint provides limited stop-loss protection. If the PMG's actual charges for
medical services provided to a member exceed an agreed-upon threshold amount,
WellPoint will pay the group a portion of the excess amount. Provider rates are
generally negotiated annually with PMGs and hospitals. To encourage PMGs to
contain costs for claims for non-capitated services such as inpatient hospital,
outpatient surgery, hemodialysis, emergency room, skilled nursing facility,
ambulance, home health and alternative birthing center services, WellPoint's PMG
agreements provide for a settlement payment to the PMG based upon the PMG's
effective utilization of such non-capitated services. Amounts that remain in the
pool after payment of such claims are shared between WellPoint and the PMGs.
PMGs are also eligible for additional incentive payments based upon satisfaction
of quality criteria.
PPO NETWORK. The PPO network, WellPoint's largest network, included
approximately 40,400 physicians and 430 hospitals throughout California as of
December 31, 1996. There were approximately 2.5 million members (including
administrative services members) enrolled in WellPoint's California PPO health
care plans as of such date, approximately 45% of whom were individuals or
employees of small groups.
WellPoint endeavors to manage and control costs for its PPO plans by
negotiating favorable arrangements with physicians, hospitals and other
providers, which include utilization management and other cost-control measures.
In addition, WellPoint controls costs through pricing and product design
decisions intended to influence the behavior of both providers and members.
Like WellPoint's HMO plans, WellPoint's PPO plans provide for the delivery
of specified health care services to members by contracting with physicians,
hospitals and other providers. Hospital provider contracts are on a nonexclusive
basis and are generally paid per diem amounts that provide for rates that are
substantially below the hospitals' standard billing rates. Physician provider
contracts are also on a nonexclusive basis and specify fixed fee schedules that
are significantly below standard billing rates. WellPoint is able to obtain
prices for hospitals and physician services significantly below standard billing
rates because of the volume of business it offers to health care providers that
are part of its network. Provider rates are generally negotiated on an annual or
multi-year basis with hospitals. In 1996, the Company concluded an extensive
recontracting process with hospitals in its provider network, whereby certain
hospitals that demonstrated designated quality and other criteria were given a
preferred status in exchange for, among other things, lower negotiated rates.
Provider rates for physicians in the Company's PPO network are set from time to
time by the Company.
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UTILIZATION MANAGEMENT. WellPoint also manages health care costs in its
provider networks by adopting utilization management systems and guidelines that
are intended to reduce unnecessary procedures, admissions and other medical
costs. The utilization management systems seek to ensure that medical services
provided are based on medical necessity and that all final decisions are made by
physicians. In its HMO, WellPoint permits PMGs to oversee most utilization
management for their particular medical group under these guidelines. Currently,
substantially all of the PMGs in WellPoint's HMO network have established
committees to oversee utilization management. For its PPO network, WellPoint
uses treatment guidelines, requires pre-admission approvals of hospital stays
and concurrent review of all admissions and retrospectively reviews physician
practice patterns. Utilization management also includes an outpatient program,
with pre-authorization and retrospective review, ongoing supervision of
inpatient and outpatient care of members, case management and discharge planning
capacity. Review of practice patterns may result in modifications and
refinements to the PPO plan offerings, treatment guidelines and network
contractual arrangements. In addition, WellPoint manages health care costs by
periodically reviewing cost and utilization trends within its provider networks.
Cases are reviewed in the aggregate to identify a high volume of a particular
type of service to determine whether costs for these treatments can be more
effectively managed. In addition, the highest cost services are identified to
determine if costs in the aggregate can be reduced by using new, cost-effective
technologies or by creating additional networks, such as networks of home health
agencies.
UNDERWRITING. In establishing premium rates for its health care plans,
WellPoint uses underwriting criteria based upon its accumulated actuarial data,
with adjustments for factors such as claims experience, member mix and industry
differences to evaluate anticipated health care costs. WellPoint's underwriting
practices in the individual and small group market are subject to California
legislation affecting the individual and small employer group market. See
"--Government Regulation."
QUALITY MANAGEMENT. Quality management for most of the Company's California
business is overseen by the Company's Quality Management Department and is
designed to ensure that necessary care is provided by qualified personnel.
Quality management encompasses plan level quality performance, physician
credentialing, provider and member grievance monitoring and resolution, medical
group auditing, monitoring medical group compliance with Blue Cross of
California standards for medical records and medical offices, physician peer
review and an active quality management committee.
THE UNICARE BUSINESS
The Company believes that its success in the highly competitive California
managed care market is attributable to its broad range of managed care products
that target the differing needs of specific market segments. The Company's
acquisition strategy has focused on large employer group plans which offer
indemnity and other health care products that are less intensively managed than
the Company's current products. In addition, the Company focuses on acquiring
businesses that provide significant concentrations of members in strategic
locations outside of California. As of December 31, 1996, the Company had
approximately 1.0 million members covered under its UNICARE health plans
(including approximately 141,000 members in California). Approximately 50% of
UNICARE medical membership as of such date was concentrated in seven states:
California, New York, Texas, Georgia, Massachusetts, Illinois and Virginia. The
acquired MMHD operations, as well as the GBO, are now conducted by the Company's
indirect wholly owned subsidiary UNICARE Life & Health Insurance Company.
MARKETING AND PRODUCTS
WellPoint's products are marketed outside of California under the UNICARE
brand name through business units which are organized on a customer-segment
basis. The large employer group businesses acquired in the MMHD and GBO
Acquisitions have a national focus as a result of the multi-state needs of
employers in those customer segments. Other business units, such as those
focusing on the individual and small employer group, senior and Medicaid
markets, have a more regional focus as a result of the more
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localized nature of customers in these segments. Similar to the Company's Blue
Cross of California business units, each UNICARE business unit is responsible
for marketing, enrolling, underwriting and servicing its specific customers.
Outside of California, the Company offers PPO products that use third-party
provider networks as well as traditional fee-for-service products. As WellPoint
develops proprietary provider network systems in these key geographic areas, the
Company intends to offer more intensively managed products to the existing
members of acquired businesses and to new individual, small group and senior
customers outside of California.
MANAGED HEALTH CARE NETWORKS AND PROVIDER RELATIONS
Due to the recent development of the Company's national operations, the
Company's relations with health care providers outside of California are more
varied than in California. The Company currently contracts with a number of
third-party provider networks, which generally lack the provider selectivity and
discounts typical of the Company's California networks. One of the Company's
strategies for the expansion of its UNICARE operations is to build proprietary
provider network systems similar to the Company's networks in California, which
provide a continuum of managed-care products to various customer segments. As
the Company expands its out-of-state operations, it intends to build or acquire
such network operations and, as appropriate, to replace or supplement the
current third-party network arrangements.
The Company offers managed health care products and services in Texas
through certain subsidiaries. One of the Company's indirect subsidiaries,
UNICARE of Texas Health Plans, Inc., is currently licensed as an HMO in the
Houston area. This HMO began marketing operations to large employer groups in
October 1996. The Company expects to begin marketing the HMO product in the
individual and small group markets in the second half of 1997. The Company has
developed an HMO network of approximately 3,000 primary care and specialist
physicians and 20 hospitals in the Houston area as of December 31, 1996. The
Company intends to seek approval to extend this HMO product to the Dallas,
Austin, San Antonio, Corpus Christi and Beaumont metropolitan areas. The Company
has commenced start-up activities in Georgia and intends to begin building HMO
and PPO networks in the greater Atlanta and Savannah areas. The Company
currently expects that it will begin commercial marketing operations in Georgia
in the second half of 1997.
As part of the MMHD Acquisition, the Company also acquired majority
ownership interests in a start-up HMO, National Capital Health Plan ("NCHP"),
and an existing PPO, National Capital Preferred Provider Organization ("NCPPO").
Both entities operate in the greater Washington, D.C. metropolitan area and are
joint ventures with local health care providers. The NCPPO network included
approximately 5,800 primary care and specialist physicians and 47 hospitals as
of December 31, 1996. WellPoint anticipates that NCHP will commence commercial
operations in 1997.
UTILIZATION MANAGEMENT. For the Company's UNICARE managed care health
plans, utilization management is provided both by UNICARE and third-party
provider networks. As part of the GBO Acquisition, the Company also acquired
CCI, which provides medical management services. The Company expects that over
time CCI will become the primary platform for the provision of utilization
review services to UNICARE members.
UNDERWRITING. As with the Company's Blue Cross of California operations,
the UNICARE underwriting activities use criteria based upon accumulated
actuarial data, with adjustments for factors such as claims experience, member
mix and industry differences to evaluate anticipated health care costs. Due to
the administrative services only component of the Company's national membership,
most of the UNICARE business involves no underwriting risk to the Company.
Because UNICARE's members are in every state, the Company's underwriting
practices, especially in the individual and small group market, are subject to a
variety of legislative and regulatory requirements and restrictions. See
"--Government Regulation."
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SPECIALTY MANAGED HEALTH CARE AND OTHER PLANS
WellPoint offers a variety of specialty managed health care and other
services. WellPoint believes that these specialty networks and plans complement
and facilitate the marketing of WellPoint's HMO, PPO and POS plans and help in
attracting employer groups and other members that are increasingly seeking a
wider variety of options and services. One of WellPoint's strategies is to
expand its specialty business by marketing these plans to the approximately 4.5
million members of its medical plans, as well as using these specialty products
to attract new members. WellPoint also markets these specialty products on a
stand-alone basis to other health plans and other payors.
PHARMACY PRODUCTS
WellPoint offers pharmacy services to its California members through its
subsidiary WellPoint Pharmacy Plan and offers pharmacy benefit management
services nationwide through its subsidiary Professional Claim Services, Inc.
("Pro-Serv"). WellPoint Pharmacy Plan and Pro-Serv incorporate features such as
drug formularies (a WellPoint-developed listing of preferred, cost-effective
drugs), a pharmacy network and maintenance of a prescription drug database and
mail order capabilities. Moreover, pharmacy benefit management services provided
by WellPoint Pharmacy Plan and Pro-Serv include management of drug utilization
through outpatient prescription drug formularies, retrospective review and drug
education for physicians, pharmacists and members. As of December 31, 1996,
WellPoint Pharmacy Plan and Pro-Serv had more than 11.5 million risk and
non-risk members and approximately 45,500 participating pharmacies.
DENTAL PLANS
WellPoint's dental plans include Dental Net, its California dental HMO, with
a provider network of approximately 2,000 dentists reimbursed on a capitated
basis, a dental PPO, with a network of approximately 9,600 dentists, and
traditional indemnity plans. The dental plans provide primary and specialty
dental services, including orthodontic services, and as of December 31, 1996,
served approximately 1.6 million dental members.
LIFE INSURANCE
The Company offers primarily term-life insurance to employers, generally in
conjunction with the Company's health plans. As of December 31, 1996, the
Company had approximately 723,000 life insurance members.
MENTAL HEALTH PLANS
WellPoint offers a specialized mental health and substance abuse program.
The plan covers mental health and substance abuse treatment services on both an
inpatient and an outpatient basis, through a network of approximately 3,300
contracting providers. In addition, approximately 257 employee assistance and
behavioral managed care programs have been implemented for a wide variety of
businesses throughout the United States. As of December 31, 1996, there were
approximately 502,000 members covered under WellPoint's mental health plans.
WORKERS' COMPENSATION
One of the Company's indirect operating subsidiaries, UNICARE Insurance
Company ("UIC"), underwrites workers' compensation insurance primarily in
California and is also licensed in 33 other states. UIC historically focused on
insuring large accounts, working with a select group of large property and
casualty insurance brokers. In August 1994, the Company introduced "UNICARE
Integrated," an integrated managed care product for workers' compensation and
medical benefits. Under UNICARE Integrated, WellPoint has combined its existing
HMO and PPO networks with a workers' compensation
8
occupational medical network of physicians and clinics. UNICARE Integrated
offers single point-of-service and account management for the employer and
provides employees access to existing HMO and PPO networks. WellPoint believes
that, by integrating managed care and workers' compensation, medical treatment
costs and workers' compensation costs can be reduced.
DISABILITY PLANS
As a result of the MMHD Acquisition, the Company now provides long-term and
short-term disability coverage. As of December 31, 1996, the Company provided
long-term and/or short-term disability coverage to approximately 107,000
individuals.
ANCILLARY NETWORKS
WellPoint evaluates current and emerging high volume or high cost services
to determine whether developing an ancillary service network will yield cost
control benefits. In establishing these ancillary service networks, WellPoint
seeks to enter into capitation or fixed fee arrangements with providers of these
services. WellPoint regularly collects and analyzes industry data on high cost
or high volume unmanaged services to identify the need for specialty managed
care networks. For example, WellPoint has created Centers of Expertise for
certain transplant services.
MANAGED CARE SERVICES
WellPoint provides administrative services to large group employers that
maintain self-funded health plans. In California, the Company often has been
able to transition these customers into other lines of business by subsequently
introducing WellPoint's underwritten managed care products. WellPoint offers
managed care services, including underwriting, actuarial services, medical cost
management, claims processing and administrative services for self-funded
employers. WellPoint also enables employers with self-funded health plans to use
WellPoint's California PPO, POS and HMO provider networks and to realize savings
through WellPoint's favorable provider arrangements, while allowing employers
the ability to design certain health benefit plans in accordance with their own
requirements and objectives. As of December 31, 1996, WellPoint serviced
self-insured health plans covering approximately 1.2 million medical members, of
which approximately 640,000 were attributable to the large employer group
operations acquired in the MMHD Acquisition. Management services revenue for
these services was $147.9 million, $61.2 million and $36.3 million for the years
ended December 31, 1996, 1995 and 1994, respectively.
MARKET RESEARCH AND ADVERTISING
WellPoint conducts market research and advertising programs to develop
products and marketing techniques tailored specifically to customer segments.
WellPoint uses print and broadcast advertising to promote its health care plans.
In addition, the Company engages in promotional activities with agents, brokers
and consultants. WellPoint incurred costs of approximately $34.8 million, $21.2
million and $17.7 million on advertising for the years ended December 31, 1996,
1995 and 1994, respectively.
COMPETITION
The managed health care industry in California is competitive on both a
regional and statewide basis. In addition, in recent years there has been a
trend of increasing consolidation among both national and California-based
health care companies, which may further increase competitive pressures.
WellPoint competes with other companies that offer similar managed health care
plans, some of which have greater resources than WellPoint. The large employer
group market is especially competitive, as employers continue to demand
increasing variety and flexibility from their health plans while trying to limit
increases in premiums. Currently, WellPoint is a market leader in offering
managed health care plans to individuals and small employer groups in
California. The medical loss ratio attributable to WellPoint's individual and
small group business is lower than that for its large employer group business.
As a result, a larger portion
9
of WellPoint's profitability is due to the individual and small group business.
WellPoint has experienced increased competition in this market over the last
several years, which could adversely affect its medical loss ratio and future
financial condition or results of operations. See "--Factors That May Affect
Future Results of Operations."
The markets in which the Company operates outside of California are also
highly competitive. Because of the many different markets in which the Company
now serves members, the Company faces unique competitive pressures in regional
markets as well as on a national basis. The Company competes with other
companies that offer managed health care plans as well as traditional indemnity
insurance products. Many of these companies have greater financial and other
resources than the Company and greater market share on either a regional or
national basis. As the Company continues to geographically expand its
operations, it will be subject to national competitive factors as well as unique
competitive conditions that may affect the more localized markets in which the
Company operates.
WellPoint believes that significant factors in the selection of a managed
health care plan by employers and individual members include price, the extent
and depth of provider networks, flexibility and scope of benefits, quality of
services, market presence, reputation (which may be affected by public rankings
or accreditation by voluntary organizations such as the National Committee for
Quality Assurance ("NCQA")) and financial stability. WellPoint believes that it
competes effectively against other health care industry participants.
RECAPITALIZATION
The Company's predecessor, WellPoint Health Networks Inc., a Delaware
corporation ("Old WellPoint"), was organized in 1992 as a public for-profit
subsidiary of Blue Cross of California ("BCC"), to own and operate substantially
all of the managed health care businesses of BCC. In order to fulfill BCC's
public benefit obligations to the State of California arising out of the
creation of Old WellPoint, Old WellPoint and BCC entered into a Recapitalization
Agreement dated as of March 31, 1995 regarding certain transactions between Old
WellPoint and BCC. On February 20, 1996, Old WellPoint, BCC and two newly
created nonprofit foundations, the California HealthCare Foundation (the
"Foundation") and the California Endowment (the "Endowment"), executed an
Amended and Restated Recapitalization Agreement (the "Amended Recapitalization
Agreement"). On May 20, 1996, BCC and Old WellPoint concluded a recapitalization
(the "Recapitalization"). Pursuant to the Amended Recapitalization Agreement,
(a) Old WellPoint distributed an aggregate of $995.0 million by means of a
special dividend of $10.00 per share of its common stock, and BCC, as a
California nonprofit public benefit corporation and the holder of all
outstanding Old WellPoint Class B Common Stock, thereupon immediately donated
its portion thereof ($800 million) to the Endowment; (b) BCC donated its assets,
other than BCC's Old WellPoint Class B Common Stock and its commercial
operations (the "BCC Commercial Operations") to the Foundation; (c) BCC changed
its status to a California for-profit business corporation (the "BCC
Conversion") and issued to the Foundation 53,360,000 shares of Common Stock; and
(d) Old WellPoint merged with and into BCC (the "Merger") and the surviving
entity changed its name to WellPoint Health Networks Inc. In the Merger, (i)
each outstanding share of Old WellPoint Class A Common Stock was converted into
0.667 shares of the Company's Common Stock, (ii) the outstanding shares of the
Company's Common Stock held by the Foundation prior to the Merger were converted
into 53,360,000 shares of the post-Merger Company's Common Stock and a cash
payment of $235.0 million to reflect the value of the BCC Commercial Operations
and the value of the Blue Cross mark and (iii) the outstanding shares of Old
WellPoint Class B Common Stock were canceled. The Company and the Foundation
subsequently amended the terms of the Recapitalization to provide for the
substitution by the Company of $7.0 million in cash for the capital stock of
certain entities owning the real estate surrounding the Company's headquarters
building.
In connection with the Recapitalization, BCC received a ruling from the IRS
that, among other things, the BCC Conversion qualified as a tax-free transaction
and that no gain or loss was recognized by BCC for
10
Federal income tax purposes. The Foundation and the Company have entered into an
Indemnification Agreement which provides, with certain exceptions, that the
Foundation will indemnify WellPoint against the net tax liability as a result of
a revocation or modification, in whole or in part, of the ruling by the IRS or a
determination by the IRS that the BCC Conversion constitutes a taxable
transaction for Federal income tax purposes.
In connection with the Recapitalization, BCC relinquished its rights under
the Blue Cross License Agreement date January 1, 1991, between Blue Cross of
California and the BlueCross BlueShield Association ("BCBSA"). The BCBSA and the
Company entered into a new License Agreement effective as of May 20, 1996 (the
"License Agreement"), pursuant to which the Company has become the exclusive
licensee for the right to use the Blue Cross name and related service marks in
California and has become a member of the BCBSA. See "--Service Marks."
The License Agreement required that the Foundation enter into a voting trust
agreement (the "Voting Trust Agreement"), pursuant to which the Foundation
deposited into a voting trust (the "Voting Trust") the number of shares of the
Company's Common Stock sufficient to reduce the Foundation's holdings outside
such Voting Trust to a level not in excess of 50% of the voting power of the
outstanding shares of the Company's Common Stock. The shares held by the trustee
under the Voting Trust Agreement (the "Voting Trust Shares") generally will be
voted (i) with respect to elections and removal of directors, calling of
shareholder meetings and amendment of the Company's Articles of Incorporation
and Bylaws, where such action are opposed by the Board of Directors, to support
the position of the Board of Directors, (ii) with certain exceptions, on matters
requiring a vote of at least an absolute majority of all outstanding shares of
Common Stock, as the majority of non-Voting Trust Shares vote, and (iii) on all
other matters, in the identical proportion in favor of or in opposition to such
matters as non-Voting Trust Shares vote. In addition, the Voting Trust Agreement
requires that the Foundation, through sales (which may involve additional
exercises of its registration rights discussed below) or additional deposits
into the Voting Trust, reduce its holdings outside the Voting Trust to 20% and
5% of the outstanding Common Stock on and after three and five years,
respectively, from May 20, 1996.
With respect to those shares held by the Foundation in excess of the
"Ownership Limit" (which is defined in the Company's Articles of Incorporation
as one share less than 5% of the Company's outstanding voting securities) that
are not subject to the Voting Trust Agreement, the Foundation has also entered
into a voting agreement (the "Voting Agreement"). The Voting Agreement provides
among other things, that the Foundation, during the period that it continues to
own in excess of the Ownership Limit, will vote all shares of the Company's
Common Stock owned by it in excess of 5% of the outstanding shares (except those
shares held pursuant to the Voting Trust Agreement) in favor of each nominee to
the Board of Directors of the Company who has been nominated by the Nominating
Committee of the Board of Directors, or under certain circumstances, other
subsets of the board, all as set forth in the Company's Bylaws. With respect to
the removal of directors, calling of shareholder meetings and amendment of the
Company's Articles of Incorporation and Bylaws, where such actions are opposed
by the Board of Directors, the Foundation has also agreed under the Voting
Agreement to support the position of the Board of Directors.
In connection with the Recapitalization, the Company and the Foundation also
entered into a registration rights agreement (the "Registration Rights
Agreement") with respect to the shares of the Company held by the Foundation.
The Registration Rights Agreement grants the Foundation (and certain transferees
of the shares covered by the Registration Rights Agreement), certain demand and
"piggyback" registration rights. The undertakings made by Old WellPoint in order
to secure the DOC's approval of the Recapitalization required the Foundation to
make certain minimum annual distributions beginning in 1997. In order to fund
such required distributions, the Foundation may make additional sales of shares
of the Company's Common Stock pursuant to the exercise of its rights under the
Registration Rights Agreement.
11
GOVERNMENT REGULATION
CALIFORNIA
DOC REGULATION. WellPoint offers its managed health care services in
California through subsidiaries, Blue Cross of California (previously known as
CaliforniaCare Health Plans), WellPoint Dental Plan and WellPoint Pharmacy Plan,
which, along with WellPoint, are subject to regulation principally by the
California Department of Corporations (the "DOC") under the Knox-Keene Health
Care Service Plan Act of 1975 (the "Knox-Keene Act"). Under the Knox-Keene Act,
WellPoint's managed health care plans are each subject to various minimum
tangible net equity ("TNE"), deposit and other financial requirements. The DOC
also regulates the ability of WellPoint to issue capital stock or to pay
dividends, and of its subsidiaries to pay dividends or to diversify and
implement changes in their products, and the ability to effect intercompany
transactions. WellPoint's managed health care programs are also subject to
extensive DOC regulation regarding minimum benefit and coverage levels,
WellPoint's contractual and business relationships with health care providers,
administrative capacity, marketing and advertising, procedures for quality
assurance and subscriber and enrollee grievance resolution. WellPoint must file
periodic financial reports with the DOC and is subject to periodic reviews of
those activities by the DOC. In addition, the DOC must approve all forms of
individual and group subscriber contracts. Any material modifications to the
organization or operations of WellPoint are subject to prior review and approval
by the DOC. The approval process can be lengthy and there is no certainty of
approval by the DOC. The failure to comply with DOC regulations can subject the
Company to various penalties, including fines or the imposition of restrictions
on the conduct of its operations. The Company is currently undergoing a
triennial DOC medical survey of the Company and each of its subsidiaries
licensed under the Knox-Keene Act. The results of these surveys are expected to
be received some time in 1997.
DOI REGULATION. The California Department of Insurance (the "California
DOI") regulates the insurance business, including the managed care services and
workers' compensation activities, conducted by BC Life & Health Insurance
Company ("BC Life," formerly known as WellPoint Life Insurance Company) and UIC.
BC Life and UIC are subject to various capital reserve and other financial
requirements established by the California DOI. BC Life and UIC must also file
periodic reports regarding their activities regulated by the California DOI and
are subject to periodic reviews of those activities by the California DOI. BC
Life must also obtain approval from the California DOI for all of its group
insurance policies and certain aspects of its individual policies prior to
issuing those policies. CIMS, which operates a general insurance agency, is also
subject to regulation by the California DOI. There can be no assurance that any
future regulatory action by the California DOI will not have an adverse impact
on the ability of BC Life, UIC and CIMS to conduct their business profitably.
CALIFORNIA HEALTH CARE LEGISLATION. From time to time, new California
legislation is enacted and regulatory interpretations are adopted that adversely
affect WellPoint. For example, California's various small group reforms require
that coverage be offered to certain small groups, limit rate increases and
exclusions based on pre-existing conditions, limit waivers (temporary exclusion
for individuals with specifically identified preexisting conditions) and impose
other requirements designed to increase the availability of coverage for small
groups. This legislation has resulted in increased claims expense for the
Company. In addition, in 1996 WellPoint voluntarily removed certain temporary
exclusions, including a temporary exclusion for maternity services, which has
resulted in increased claims expense for the Company. Further California
legislation addresses the practice of "freezing," or discontinuing the offering
of certain benefit plans, by health care service plans and insurance carriers.
There can be no assurance that compliance with the legislation discussed above
will not adversely affect WellPoint's financial condition or results of
operations. The legislation described above and any similar legislation in
California or other states may result in increased claims expense.
FEDERAL
RECENT FEDERAL HEALTH CARE LEGISLATION. On August 21, 1996, the President
signed into law the Health Insurance Portability and Accountability Act of 1996
(originally known in the Senate as the Kennedy-
12
Kassebaum bill) ("HIPAA"). HIPAA imposes new obligations for issuers of health
insurance coverage and health benefit plan sponsors. Most of the insurance
reform provisions of HIPAA become effective for "plan years" beginning July 1,
1997.
HIPAA requires health plans in the small group market (generally 50 or fewer
employees) to accept every employer, employee and family member, subject to
certain prescribed exceptions. Plans must apply any restriction uniformly and
without regard to health status. HIPAA also guarantees the renewability of
coverage, regardless of the health status of any member of a group. Access to
coverage in the individual market is guaranteed to people who lose their group
coverage (due to loss of employment, change of jobs or other reasons), subject
to certain limited exceptions. Alternatively, states may develop programs to
assure that comparable coverage is available to these people. The coverage will
be available without regard to health status, and renewal will be guaranteed.
HIPAA further prohibits health plans from establishing enrollment
eligibility rules or premiums for individuals based on specified "health status"
related factors. An exception to this policy of nondiscrimination is provided
with respect to premium discounts or rebates, or modified copayments and
deductibles related to health promotion and disease prevention programs.
HIPAA provides parameters for the use of pre-existing condition limits by
health plans. Plans may limit or exclude benefits for a pre-existing condition
only if the exclusion is limited to 12 months for conditions diagnosed or
treated in the previous six months. The pre-existing condition exclusion period
is reduced or credited for each month of prior continuous coverage. Insurers
cannot impose new pre-existing condition exclusions for workers with previous
coverage. Health plans only may use an affiliation period of up to two months.
On September 26, 1996 the President signed maternity length of stay and
mental health parity benefits measures into law. The maternity stay provision
requires health plans to cover the cost of a 48-hour hospital stay (96 hours
following a Caesarian section). This measure does not mandate the length of
hospital stays but requires that longer stays are covered if deemed necessary by
the mother or her physician (in consultation with the mother). Health plans will
be barred from offering financial incentives for early discharges. The mental
health parity provision will require health plans that provide mental health
benefits to set the same level of yearly and lifetime coverage for mental health
benefits as for physical ones. The maternity length of stay and mental health
parity measures will be effective for plan years beginning January 1, 1998.
Approximately 30 states already guarantee minimum hospital stays for mothers and
newborns. In many regions, the maternity length of stay provisions reflect the
existing average length of stay. As a result of these factors, it is unclear
what implications, if any, these measures will have on WellPoint's result of
operations.
WellPoint intends to take action to bring its operations into compliance
with the two new laws described above. There can be no assurance that compliance
with this legislation will not result in an increased claims expense for
WellPoint.
MEDICARE LEGISLATION. WellPoint's health benefits programs include products
that are marketed to Medicare beneficiaries as a supplement to their Medicare
coverage. These products are subject to Federal regulations intended to provide
Medicare supplement customers with standard minimum benefits and levels of
coverage and full disclosure of coverage terms and assure that fair sales
practices are employed in the marketing of Medicare supplement coverage.
In California, WellPoint provides a senior plan product under a Medicare
risk contract that is subject to regulation by HCFA. Under this contract and
HCFA regulations, if WellPoint's premiums received for Medicare-covered health
care services provided to senior plan Medicare members are more than the
Company's projected costs associated with the provision of health care services
provided to senior plan members, then WellPoint must provide its senior plan
members with additional benefits beyond those required by Medicare or reduce its
premiums, or deductibles or co-payments, if any. WellPoint's senior plan is not
permitted to account for more than one-half of WellPoint's total HMO members in
each of WellPoint's geographic markets in California. HCFA has the right to
audit HMOs operating under
13
Medicare contracts to determine the quality of care being rendered and the
degree of compliance with HCFA's contracts and regulations.
FUTURE HEALTH CARE REFORM. A number of legislative proposals, including
national health care reform, have been made at the Federal and state levels.
Certain of these proposals would require all employers to purchase health care
coverage for their employees, either from private providers or from a
government-sponsored program that would also make available coverage to the
uninsured or underinsured. Certain of these proposals would further restrict
coverage decisions or prohibit exclusions or denials of coverage for
pre-existing conditions and would provide for "community rating" of risks. To
help meet the needs of the uninsured, in 1994 WellPoint offered guaranteed
coverage in California to individuals, including those with pre-existing
conditions. To control medical costs, proposed legislation may also set or limit
fees of health care providers, which may be established through a governmental
board.
WellPoint is unable to evaluate what legislation may be proposed and when or
whether any legislation will be enacted and implemented. However, certain of the
proposals, if adopted, could have a material adverse effect on WellPoint's
financial condition or results of operations, while others, if adopted, could
potentially benefit WellPoint's business.
OTHER STATES
The Company's activities in other states are subject to state regulation
applicable to the provision of managed health care services and the sale of
traditional health indemnity and workers' compensation insurance. As a result of
the MMHD and GBO Acquisitions, the Company and certain of its subsidiaries are
also subject to regulation by the DOI in Delaware (which is the state of
incorporation of the Company's wholly owned subsidiary UNICARE Life & Health
Insurance Company) and in all other states. Most of the products and plans
offered by WellPoint in Texas are regulated by the Texas Department of
Insurance. As the Company offers a broad range of managed care products in new
geographic locations, it will be subject to additional regulation by
governmental agencies applicable to the provision of health care services. The
Company believes it is in compliance in all material respects with all current
state regulatory requirements applicable to its business as presently conducted.
However, changes in government regulations could affect the level of services
which the Company is required to provide or the rates which the Company can
charge for its health care products and services. As the Company continues to
expand its operations outside of California, new legislative and regulatory
developments in Delaware, Texas, Georgia and various other states will have
greater potential effect on the Company's financial condition or results of
operations.
In connection with the GBO Acquisition, the Company has entered into a
reinsurance arrangement, on a 100% coinsurance basis, of the insured business of
the GBO. This business includes approximately 32,000 insured persons in Canada
covered by group policies issued to U.S.-based employers. As a result, the
Company may be subject to certain rules and regulations of applicable Canadian
regulatory agencies.
SERVICE MARKS
"CaliforniaCare," "Prudent Buyer Plan" and "UNICARE" are registered service
marks of WellPoint. In addition to these marks, WellPoint has filed for
registration of and maintains several other service marks, trademarks and trade
names at the Federal level and in California. WellPoint and one of its principal
operating subsidiaries, Blue Cross of California, are currently parties to
license agreements with the BCBSA which allow them to use the Blue Cross name
and mark in California with respect to WellPoint's HMO and PPO network-based
plans. The BCBSA is a national trade association of Blue Cross and Blue Shield
licensees, the primary function of which is to promote the Blue Cross and Blue
Shield names. Each licensee is an independent legal organization and is not
responsible for the obligations of other BCBSA member organizations. A Blue
Cross license requires payment of a fee to the BCBSA and compliance with various
requirements established by the BCBSA, including the maintenance of a specified
level (the "Minimum BCBSA Capital") of the BCBSA's base capital requirements.
The failure to meet the Minimum BCBSA Capital requirements can subject the
Company to certain corrective action, while the
14
failure to meet a lower specified level of capital can result in termination of
the Company's license agreement with the BCBSA. See "--Factors That May Affect
Future Results of Operations." WellPoint considers the licensed Blue Cross name
and its registered service marks, trademarks and trade names important in the
operation of its business.
EMPLOYEES
At December 31, 1996, WellPoint and its subsidiaries employed approximately
6,600 people (excluding the approximately 2,900 employees of the GBO).
Approximately 120 of the Company's employees are presently covered by a
collective bargaining agreement with the Office and Professional Employees
International Union, Local 29. As a result of the GBO Acquisition, approximately
225 of the Company's office clerical employees in the greater Detroit area are
presently covered by a collective bargaining agreement with the International
Brotherhood of Teamsters, Chauffeurs, Warehousemen and Helpers of America, Local
No. 614. WellPoint believes that its relations with its employees are good, and
it has not experienced any work stoppages.
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
Certain statements contained in "Item 1. Business," such as statements
concerning the Company's geographic expansion and other business strategies, the
effect of recent health care reform legislation and small group membership
growth and other statements contained herein regarding matters that are not
historical facts, are forward-looking statements (as such term is defined in the
Securities Exchange Act of 1934, as amended). Such statements involve a number
of risks and uncertainties that may cause actual results to differ from those
projected. Factors that can cause actual results to differ materially include,
but are not limited to, those discussed below. Readers are cautioned not to
place undue reliance on these forward-looking statements, which speak only as of
the date hereof.
HEALTH CARE REGULATIONS; LEGISLATIVE REFORM
WellPoint's operations are subject to substantial regulation by Federal,
state and local agencies. As a result of the MMHD and GBO Acquisitions,
WellPoint is now subject to the authority of state regulatory agencies in all 50
states. There can be no assurance that any future regulatory action by any such
agencies will not have a material adverse effect on the profitability or
marketability of WellPoint's health plans or on its financial condition or
results of operations.
The health care industry has become the subject of greater legislative and
media scrutiny in recent years. In 1996, the President signed HIPAA into law as
well as maternity length of stay and mental health parity measures. The
maternity length of stay and mental health parity measures will take effect
January 1, 1998. See "--Government Regulation." Various states have passed
similar legislation, some providing for more extensive benefits than those
required by HIPAA. Numerous proposals are being considered by the United States
Congress and state legislatures relating to health care reform. There can be no
assurance that compliance with recently enacted or future legislation will not
have a material adverse impact on WellPoint's claims expense, its financial
condition or results of operations.
HEALTH CARE COSTS AND PREMIUM PRICING PRESSURES
WellPoint's future profitability will depend in part on accurately
predicting health care costs and on its ability to control future health care
costs through underwriting criteria, utilization management, product design and
negotiation of favorable provider and hospital contracts. Changes in utilization
rates, demographic characteristics, health care practices, inflation, new
technologies, clusters of high-cost cases, the regulatory environment and
numerous other factors affecting health care costs may adversely affect
WellPoint's ability to predict and control health care costs as well as
WellPoint's financial condition or results of operations. In addition to the
challenge of controlling health care costs, the Company faces competitive
pressure to contain premium prices. Fiscal concerns regarding the continued
viability of programs such as Medicare and Medicaid may cause decreasing
reimbursement rates for government-
15
sponsored programs. WellPoint's financial condition or results of operations
would be adversely affected by any limitation on the Company's ability to
increase or maintain its premium levels.
INTEGRATION OF RECENT ACQUISITIONS; GEOGRAPHIC EXPANSION STRATEGY
One component of the Company's business strategy has been to diversify into
new geographic markets, particularly through strategic acquisitions. The Company
completed the MMHD Acquisition in March 1996 and the GBO Acquisition in March
1997. The consolidation of these recently acquired operations into the
operations of the Company has required and will continue to require considerable
expenditures and a significant amount of management time. The success of these
acquisitions will also require the integration of a significant number of the
employees into the Company's existing operations, as well as the integration of
separate information systems. No assurances can be given regarding the ultimate
success of the integration of these acquisitions into the Company's business,
due in part to the large size and multi-state nature of their businesses.
Both the acquired MMHD operations and the GBO have some indemnity-based
insurance operations, with a significant number of members outside of
California. Each of these operations experienced varying profitability or losses
in recent periods. In addition, the Company expects that it will experience
material membership attrition as it pursues its strategy of motivating
traditional indemnity health insurance members to select managed care products.
There can be no assurances that a sufficient number of these members will accept
managed care health plans or that the Company will be able to continue existing
relationships with provider networks currently serving those members or develop
satisfactory proprietary provider networks in these geographic areas. The
development of such networks will require considerable expenditures by the
Company.
COMPETITION
Managed health care organizations operate in a highly competitive
environment that is subject to significant change from business consolidations,
new strategic alliances, legislative reform, aggressive marketing practices by
other managed health care organizations and other market pressures. The
Company's operations remain heavily concentrated in California, where the
managed health care industry is especially competitive. In addition, the managed
health care industry in California has undergone significant changes in recent
years, including substantial consolidation as a result of completed and pending
transactions. Outside of California, the Company faces substantial competition
from other regional and national companies, many of which have (or due to future
consolidation, may have) significantly greater financial and other resources and
market share than the Company. If competition were to further increase in any of
its markets, WellPoint's financial condition or results of operations could be
materially adversely affected.
A substantial portion of WellPoint's California business is in the
individual and small employer group market, where the loss ratio is
significantly lower than in the large employer group market. The individual and
small employer group business constituted approximately 45% WellPoint's total
premium revenue for the year ended December 31, 1996. WellPoint has experienced
increasing competition in the individual and small employer group market over
the past several years, which could adversely affect WellPoint's loss ratio and
future financial condition or results of operations. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations."
EVOLVING THEORIES OF RECOVERY
WellPoint, like HMOs and health insurers generally, excludes certain health
care services from coverage under its HMO, PPO and other plans. In the ordinary
course of business, WellPoint is subject to the claims of its members from
decisions to restrict reimbursement for certain treatments. The loss of even
16
one such claim, if it were to result in a significant punitive damage award,
could have a material adverse effect on WellPoint's financial condition or
results of operations. In addition, the risk of potential liability under
punitive damage theories may significantly increase the difficulty of obtaining
reasonable settlements of coverage claims. The financial and operational impact
that such evolving theories of recovery may have on the managed care industry
generally, or WellPoint in particular, is presently unknown.
MINIMUM BCBSA CAPITAL REQUIREMENTS
The failure to meet the Minimum BCBSA Capital requirement can subject the
Company to certain corrective actions, while the failure to meet a lower
specified level of capital can result in termination of the Company's license
agreement with the BCBSA. The BCBSA's Minimum Capital requirement increased as
of December 31, 1996. In order to address an anticipated shortfall in the
Company's capital under these more stringent requirements, on December 30, 1996
the Company borrowed $50 million under its $200 million subordinated debt
facility (the "Subordinated Credit Agreement"). As of December 31, 1996, the
Company's TNE (which is also its capital for BCBSA purposes) was approximately
$388 million and the Minimum BCBSA Capital was approximately $364 million. The
Company's required TNE for DOC purposes was approximately $17 million as of such
date. On March 17, 1997, the Company borrowed an additional $150 million under
the Subordinated Credit Agreement in part to meet increased capital needs as a
result of the GBO Acquisition. The Company intends to present a proposal at its
1997 Annual Meeting of Shareholders to form a new Delaware holding company
structure, which would have the effect of greatly increasing the Company's
capital for BCBSA purposes. There can be no assurances that such a proposal will
be adopted or that, whether or not such a proposal is adopted, that the
Company's net income in future periods will be sufficient to continue to satisfy
the Minimum BCBSA Capital requirement or that, if necessary, the Company will be
able to obtain additional subordinated indebtedness to meet this requirement.
ITEM 2. PROPERTIES.
Effective as of January 1, 1996, the Company entered into a new lease for
its Woodland Hills, California headquarters facility, which provides for a term
expiring in December 2019 with two options to extend the term for up to two
additional five-year terms. Rent expense under the new lease was approximately
$5.3 million during 1996. The Company, as well as the GBO, have additional
offices in California and various other states.
ITEM 3. LEGAL PROCEEDINGS.
NCQA LAWSUIT. On October 20, 1995, a lawsuit was filed in the United States
District Court for the District of Columbia by CaliforniaCare Health Plans
("CaliforniaCare," which is now known as Blue Cross of California) against the
NCQA. The NCQA is an organization that reviews and accredits HMOs and managed
care plans and, in October 1995, NCQA denied accreditation to CaliforniaCare.
CaliforniaCare's lawsuit alleged, among other things, that in its accreditation
review of CaliforniaCare and in its subsequent decision to deny accreditation to
CaliforniaCare, NCQA: (1) failed to follow its own policies, procedures and
guidelines; (2) failed to afford CaliforniaCare fair and due process; (3)
breached its contractual obligations with CaliforniaCare; and (4) that
CaliforniaCare suffered substantial damage as a result of the denial of
accreditation. The complaint sought a declaratory judgement against NCQA, as
well as a permanent injunction prohibiting NCQA from implementing, acting upon,
or disseminating further its accreditation decision, and compensatory damages.
In January 1996, CaliforniaCare and NCQA began court-ordered mediation in an
attempt to resolve the lawsuit. On March 1, 1996, the parties agreed to extend
the mediation and stayed the litigation proceedings until September 30, 1996
(subsequently extended to December 16, 1996) while the parties continued to seek
a resolution through mediation. As a result of this mediation, CaliforniaCare
and NCQA jointly agreed that NCQA would conduct another accreditation review of
CaliforniaCare. On December 19, 1996, CaliforniaCare announced that it had been
17
awarded a one-year accreditation by NCQA. On December 24, 1996, CaliforniaCare
filed a dismissal of its lawsuit against NCQA.
STOCKHOLDER LITIGATION. On November 26, 1996, the Superior Court of the
State of California for Los Angeles County approved the settlement (the
"Settlement") of four substantially identical actions that had been filed
against WellPoint, certain of WellPoint's officers and directors, and Blue Cross
of California in March and April of 1995. The complaints in Gollomp and Gober,
et al. v. Schaeffer, Williams, Rich, Weinberg, et al.; Greenberg, et al. v.
Schaeffer, Williams, Rich, Weinberg, et al.; Freed, et al. v Schaeffer,
Williams, Rich, Weinberg, et al.; and Kaiser v. WellPoint Health Networks Inc.,
Blue Cross of California, et al., alleged that the defendants breached fiduciary
duties to WellPoint's public stockholders by, among other things, pursuing a
business combination with Health Systems International and allegedly rejecting
certain other proposals without due consideration.
All of the Settlement documentation is on file with the Los Angeles County
Superior Court. The principal terms of the Settlement require: (1) certain
continuing obligations regarding the structure and operation of future
independent committees of the Company that may be formed to investigate or
evaluate potential mergers, acquisitions, financial restructurings or exchange
transactions; (2) certain limitations on the Company's ability to make "change
in control" or "golden parachute" payments to officers and directors; (3) the
Company's Board of Directors must consider and adopt a policy and/or
recommendations regarding payment of dividends to its shareholders on an annual
basis; and (4) the payment of $1,850,000 in attorneys' fees and costs to
plaintiffs' counsel.
The obligations summarized in items 1-3 above will continue in effect for a
minimum of five (5) years. Under the terms of the Settlement, WellPoint, BCC and
the individual defendants did not admit, and expressly denied, all claims and
liability asserted against them. The Settlement also included a release of all
claims alleged in the actions.
MISCELLANEOUS PROCEEDINGS. WellPoint and certain of its subsidiaries are
parties to various legal proceedings, many of which involve claims for coverage
encountered in the ordinary course of its business. WellPoint, like HMOs and
health insurers generally, excludes certain health care services from coverage
under its HMO, PPO and other plans. In the ordinary course of its business,
WellPoint is subject to the claims of its enrollees arising out of decisions to
restrict reimbursement for certain treatments. The loss of even one such claim,
if it resulted in a significant punitive damage award, could have a material
adverse effect on WellPoint. In addition, the risk of potential liability under
punitive damage theories may increase significantly the difficulty of obtaining
reasonable settlements of coverage claims. However, the financial and
operational impact that such evolving theories of recovery will have on the
managed care industry generally, or WellPoint in particular, is at present
unknown.
Certain of such legal proceedings are or may be covered under insurance
policies or indemnification agreements. Based upon information presently
available, the Company believes that the final outcome of all such proceedings
should not have a material adverse effect upon WellPoint's results of operations
or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
18
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
The Company's Common Stock has been traded on the New York Stock Exchange
under the symbol "WLP" since the Company's initial public offering on January
27, 1993. The following table sets forth for the periods indicated the high and
low sale prices for the Common Stock. For periods prior to the consummation of
the Recapitalization on May 20, 1996, the information given below is with
respect to Old WellPoint Class A Common Stock, without adjustment for the
two-for-three exchange occurring as part of the Recapitalization. In connection
with the Recapitalization, Old WellPoint paid a special dividend of $10.00 per
share to its stockholders of record as of May 15, 1996.
PRE-RECAPITALIZATION:
Year Ended December 31, 1995 HIGH LOW
--------- ---------
First Quarter............................................. $ 37 $ 27
Second Quarter............................................ 34 3/8 27 3/8
Third Quarter............................................. 31 27 7/8
Fourth Quarter............................................ 33 3/8 29 1/8
Year Ended December 31, 1996
First Quarter............................................. $ 36 $ 31 7/8
Second Quarter (through May 20, 1996)..................... 36 5/8 26
POST-RECAPITALIZATION:
Second Quarter (May 21, 1996 to June 30, 1996)............ $ 39 1/8 $ 31 1/8
Third Quarter............................................. 33 3/4 23 3/8
Fourth Quarter............................................ 35 1/2 28 1/4
On March 19, 1997 the closing price on the New York Stock Exchange for the
Company's Common Stock was $45.38 per share. As of March 14, 1997, there were
approximately 1,200 holders of record of Common Stock.
The Company did not pay any dividends on its Common Stock in 1995 or 1996,
other than the payment of the $995 million special dividend in connection with
the Recapitalization. Management currently expects that all of WellPoint's
future income will be used to expand and develop its business. The Board of
Directors has determined to retain its net earnings during 1997.
19
ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
1996 1995 1994 1993 1992
--------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA, MEMBERSHIP
DATA AND OPERATING STATISTICS)
CONSOLIDATED INCOME STATEMENTS
Revenues:
Premium revenue................................... $3,879,806 $2,910,622 $2,647,951 $2,355,980 $2,161,216
Management services revenue....................... 147,948 61,151 36,274 18,121 17,952
Investment income................................. 142,028 135,306 107,447 75,074 95,987
--------- --------- --------- --------- ---------
4,169,782 3,107,079 2,791,672 2,449,175 2,275,155
Operating Expenses:
Health care services and other benefits........... 3,003,117 2,199,953 1,927,954 1,719,853 1,591,725
Selling expense................................... 224,453 190,161 169,483 147,097 128,653
General and administrative expense................ 545,942 344,427 334,206 266,295 263,263
Nonrecurring costs................................ -- 57,074 -- -- --
--------- --------- --------- --------- ---------
3,773,512 2,791,615 2,431,643 2,133,245 1,983,641
--------- --------- --------- --------- ---------
Operating Income.................................... 396,270 315,464 360,029 315,930 291,514
Interest expense.................................. 36,628 -- -- -- --
Other expense, net................................ 20,134 12,677 8,008 2,901 2,419
--------- --------- --------- --------- ---------
Income before Provision for Income Taxes and
Cumulative Effect of Accounting Changes........... 339,508 302,787 352,021 313,029 289,095
Provision for income taxes........................ 137,506 122,798 138,851 126,385 114,337
--------- --------- --------- --------- ---------
Income before Cumulative Effect of Accounting
Changes........................................... 202,002 179,989 213,170 186,644 174,758
Cumulative Effect of Accounting Changes--Adoption
of SFAS Nos. 106 and 109........................ -- -- -- (21,260) --
--------- --------- --------- --------- ---------
Net Income.......................................... $ 202,002 $ 179,989 $ 213,170 $ 165,384 $ 174,758
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Earnings Per Share(A)
Income before Cumulative Effect of Effect of
Accounting Changes................................ $ 3.04 $ 2.71 $ 3.21 $ 2.81 $ 2.63
Cumulative Effect of Accounting Changes--Adoption
of SFAS Nos. 106 and 109........................ -- -- -- (0.32) --
--------- --------- --------- --------- ---------
Net Income.......................................... $ 3.04 $ 2.71(B) $ 3.21 $ 2.49 $ 2.63
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
OPERATING STATISTICS(C)
Loss ratio.......................................... 77.4% 75.6% 72.8% 73.0% 73.6%
Selling expense ratio............................... 5.6% 6.4% 6.3% 6.2% 5.9%
General and administrative expense ratio............ 13.6% 11.6% 12.5% 11.2% 12.1%
Net income ratio.................................... 5.0% 6.1% 7.9% 7.0% 8.0%
DECEMBER 31,
-----------------------------------------------------
1996 1995 1994 1993 1992
--------- --------- --------- --------- ---------
BALANCE SHEET DATA
Cash and investments................................ $2,165,492 $2,257,269 $1,973,388 $1,779,495 $1,039,106
Total assets........................................ $3,405,542 $2,679,257 $2,385,636 $1,921,832 $1,155,883
Long-term debt...................................... $ 625,000 -- -- -- --
Total equity........................................ $ 870,459 $1,670,226 $1,418,919 $1,233,190 $ 507,483
Cash dividends declared per common share(D)......... $ 10.00 -- -- -- --
Medical Membership(E)................................. 4,485,000 2,797,000 2,617,000 2,322,000 2,162,000
(A) Earnings per share for all periods presented prior to 1996 has been
recomputed using 66,366,500 shares, the number of shares outstanding
immediately following completion of the Recapitalization. Earnings per share
for the year ended December 31, 1996 has been calculated using such
66,366,500 shares, plus the weighted average number of shares issued during
1996 after completion of the Recapitalization.
(B) Earnings per share for the year ended December 31, 1995 includes
nonrecurring costs of $0.52 per share.
(C) The loss ratio represents health care services and other benefits as a
percentage of premium revenue. All other ratios are shown as a percentage of
premium revenue and management services revenue.
(D) The Company paid a $995.0 million special dividend in conjunction with the
Recapitalization which occurred on May 20, 1996. Management currently
expects that all of the Company's future income will be used to expand and
develop its business.
(E) Membership numbers are approximate and include some estimates based upon the
number of contracts at the relevant date and an actuarial estimate of the
number of members represented by each contract.
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This discussion contains forward-looking statements which involve risks and
uncertainties. The Company's actual results may differ materially from those
anticipated in such forward-looking statements as a result of certain factors
including, but not limited to, those set forth under "Factors That May Affect
Future Results of Operations."
GENERAL
The Company is one of the nation's largest publicly traded managed health
care companies with approximately 4.5 million medical members, 11.5 million
pharmacy members and 1.6 million dental members as of December 31, 1996. The
Company offers a diversified mix of managed care products, including HMOs, PPOs,
POS and other hybrid plans and traditional indemnity products. The Company also
offers a broad array of specialty products, including pharmacy, dental, life,
workers' compensation, disability, behavioral health, COBRA and flexible
benefits account administration. In addition, WellPoint offers managed care
services for self-funded employers, including claims processing, actuarial
services, underwriting assistance, network access, medical cost management and
other administrative services. The Company's primary market for its managed care
products is California.
In March 1996, the Company completed the MMHD Acquisition through the
acquisition of MMHD's parent, MassMutual Holding Company Two, Inc. The acquired
MMHD operations now conduct business under the name UNICARE Life & Health
Insurance Company. The purchase price was $402.2 million which was funded with
$340.2 million in cash and a Series A term note for $62.0 million, of which
$20.0 million remained outstanding at December 31, 1996. During 1996, the
Company incurred approximately $13.0 million of costs relating to the MMHD
Acquisition. During 1997 and 1998, the Company expects to incur approximately
$15.0 million of additional costs related to the MMHD Acquisition. As a result
of the MMHD Acquisition, WellPoint serves medical members in 50 states.
Approximately 50% of MMHD's medical membership is concentrated in seven states:
California, New York, Texas, Georgia, Massachusetts, Illinois and Virginia. The
acquired MMHD operations also provide specialty products, including dental,
life, pharmacy and disability, to members throughout the United States.
On May 20, 1996, the Company completed the Recapitalization, including the
acquisition of the BCC Commercial Operations for $235.0 million in cash. The
Recapitalization included the payment of a $995.0 million special dividend
funded by $775.0 million in revolving debt and the remainder in cash (see Note 2
to the Consolidated Financial Statements for a description of the
Recapitalization).
On March 1, 1997, the Company completed the GBO Acquisition. The purchase
price was $86.7 million, subject to adjustment upon completion of a post-closing
audit. The purchase method of accounting will be used to account for the
acquisition of the GBO. The GBO targets employers with 5,000 or more employees
and currently provides benefits to approximately 1.3 million medical members, of
which most are in health plans that are self-funded by employers. The GBO offers
indemnity and PPO plans and also provides life, dental and disability coverage
to a variety of employer groups. Although most of the GBO business involves the
provision of administrative services to self-funded employer plans, the
indemnity-based portions of the GBO have experienced a higher overall loss ratio
than the Company's core business. The GBO has historically experienced a higher
administrative expense ratio due to its higher percentage of management services
business, which may contribute to an increase in the Company's overall
administrative expense ratio in future periods. The Company expects to incur
approximately $50.0 million of costs relating to this acquisition during 1997
and 1998, a portion of which is expected to be reflected in the Company's
results of operations. The Company expects that it will experience material
membership attrition of up to 30% of the GBO members as it pursues its strategy
of motivating traditional indemnity health insurance members to select managed
care products.
21
In order to implement the Company's regional expansion strategy, the Company
will need to develop satisfactory provider network and information systems,
which will require additional expenditures by the Company. A portion of these
expenditures will be reflected in the Company's results of operations.
Prior to their acquisitions by WellPoint, the MMHD large employer group
operations, the GBO and BCC Commercial Operations each experienced a higher
overall loss ratio than the Company and, as the Company integrates these
acquisitions, the Company's overall loss ratio may increase. There can be no
assurance that the Company will be able to successfully integrate these recent
acquisitions into its business or take appropriate measures to control the loss
ratio associated with their operations. In addition, the Company's overall loss
ratio may increase as the Company expands its California large group and
Medicaid businesses, both of which generally have higher loss ratios than the
Company's overall business.
A variety of health care reform measures are currently pending or have been
recently enacted at the Federal and state levels. Recent Federal legislation
seeks, among other things, to insure the portability of health coverage and
mandates minimum maternity hospital stays. These and other proposed measures may
have the effect of dramatically altering the regulation of the provision of
health care and of increasing the Company's loss ratio.
RESULTS OF OPERATIONS
WellPoint's revenues are generated from premiums earned for health care and
specialty services provided to its members, fees for administrative services,
including claims processing and access to provider networks for self-insured
employers, and investment income. WellPoint's operating expenses include health
care services and other benefits expenses, consisting primarily of payments for
physicians, hospitals and other providers for health care and specialty products
claims; selling expenses for broker and agent commissions; general and
administrative expenses; interest expense; and income taxes.
The Company's consolidated results of operations for the year ended December
31, 1996 include the results of MMHD and the BCC Commercial Operations from
March 31, 1996 and May 20, 1996, respectively, the effective dates of
acquisition.
The following table sets forth selected operating ratios. The loss ratio for
health care services and other benefits is shown as a percentage of premium
revenue. All other ratios are shown as a percentage of premium revenue and
management services revenue combined.
YEAR ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
---------- ---------- ----------
Operating Revenues:
Premium revenue ratio.......................................... 96.3% 97.9% 98.7%
Management services revenue ratio.............................. 3.7 2.1 1.3
----- ----- -----
100.0 100.0 100.0
Operating Expenses:
Health care services and other benefits loss ratio............. 77.4 75.6 72.8
Selling expense ratio.......................................... 5.6 6.4 6.3
General and administrative expense ratio....................... 13.6 11.6 12.5
22
MEMBERSHIP
The following table sets forth membership data and the percent change in
membership:
AS OF DECEMBER 31,
---------------------- PERCENT
1996 1995 CHANGE
---------- ---------- -----------
MEDICAL MEMBERSHIP:
CALIFORNIA
Group Services:
HMO....................................................................... 677,850 619,907 9.3%
PPO and Other(a).......................................................... 1,298,359 765,145 69.7%
---------- ----------
Total(b)................................................................ 1,976,209 1,385,052 42.7%
---------- ----------
Individual, Small Group and Senior:
HMO....................................................................... 269,495 214,076 25.9%
PPO and Other............................................................. 1,197,306 1,152,657 3.9%
---------- ----------
Total................................................................... 1,466,801 1,366,733 7.3%
---------- ----------
Medi-Cal HMO Programs....................................................... 111,029 40,508 174.1%
---------- ----------
Total California Medical Membership(c)........................................ 3,554,039 2,792,293 27.3%
---------- ----------
OUT-OF-STATE
Group Services:
HMO....................................................................... 2,506 -- N/A
PPO and Other(a).......................................................... 898,601 743 N/A
---------- ----------
Total(b)................................................................ 901,107 743 N/A
---------- ----------
Individual, Small Group and Senior:
PPO and Other............................................................. 29,555 4,326 N/A
---------- ----------
Total Out-of-State Medical Membership......................................... 930,662 5,069 N/A
---------- ----------
TOTAL MEDICAL MEMBERSHIP...................................................... 4,484,701 2,797,362 60.3 %
---------- ----------
---------- ----------
HMO......................................................................... 1,060,880 874,491 21.3 %
PPO and Other............................................................... 3,423,821 1,922,871 78.1 %
---------- ----------
TOTAL MEDICAL MEMBERSHIP...................................................... 4,484,701 2,797,362 60.3 %
---------- ----------
---------- ----------
- ------------------------
(a) California and Out-of-State include 665,454 and 563,854 management services
members, respectively, as of December 31, 1996. Of the 665,454 California
management services members, 76,385 are from the acquired MMHD operations.
California and Out-of-State include 482,572 and 2,886 management services
members, respectively, as of December 31, 1995.
(b) As of December 31, 1996, total MMHD medical membership was approximately
1,042,000, of which approximately 141,300 were California members and
approximately 900,700 were Out-of-State members.
(c) As of December 31, 1996, total BCC Commercial Operations medical membership
was approximately 264,500, all of which were California members. The
majority of these members are included in Group Services.
23
AS OF DECEMBER 31,
------------------------ PERCENT
1996 1995 CHANGE
------------ ---------- -----------
SPECIALTY MEMBERSHIP:
Pharmacy........................................................ 11,516,824 9,882,560 16.5%
Dental.......................................................... 1,559,391 537,868 189.9%
Disability...................................................... 107,350 -- N/A
Behavioral Health............................................... 502,212 381,955 31.5%
Life............................................................ 722,964 326,590 121.4%
The 1996 specialty membership includes the acquired MMHD operations which
had approximately 0.5 million pharmacy members, 0.9 million dental members, 0.1
million disability members and 0.4 million life members as of December 31, 1996.
COMPARISON OF RESULTS FOR THE YEAR ENDED DECEMBER 31, 1996 TO THE YEAR ENDED
DECEMBER 31, 1995
Premium revenue increased 33.3% to $3,879.8 million for the year ended
December 31, 1996 from $2,910.6 million for the year ended December 31, 1995.
Premium revenue for 1996 of $523.4 million and $200.2 million was attributable
to MMHD and the BCC Commercial Operations, respectively. Also
contributing to increased premium revenue in 1996 was a 9.8% increase in medical
membership, excluding management services members and the acquired members of
MMHD and the BCC Commercial Operations. Workers' compensation premium revenue
increased 34.6% in 1996 from 1995, due to a large increase in the number of
insured employer groups, primarily in the small employer and California school
districts workers' compensation markets. In addition, an increase in premium
revenue resulted from moderate increases in the premiums per member in the
individual, senior and small group markets.
Management services revenue increased $86.7 million to $147.9 million for
the year ended December 31, 1996 from $61.2 million for the year ended December
31, 1995. The increase was primarily due to $62.9 million of management services
revenue from MMHD. Also contributing to the increase were a 31.7% membership
increase in the California large group market, excluding the acquired members of
MMHD and the BCC Commercial Operations, new pharmacy and clinical management
accounts and revenue from the BCC Commercial Operations.
Investment income increased to $142.0 million for the year ended December
31, 1996 compared to $135.3 million for the year ended December 31, 1995.
Interest and dividend income increased to $127.5 million in 1996 from $122.1
million in 1995. The increase in interest and dividend income was primarily due
to MMHD interest income of $21.6 million and slightly higher yields in 1996 over
1995, offset by the foregone interest earned on cash and investments used to
finance the MMHD and BCC Commercial Operations acquisitions, the
Recapitalization, and cash used for repayment of indebtedness under the
Company's senior credit facility.
Health care services and other benefits expense increased 36.5% to $3,003.1
million in 1996 from $2,200.0 million in 1995. Of the $803.1 million increase,
$412.2 million was attributable to MMHD and $189.9 million was attributable to
the BCC Commercial Operations. Excluding MMHD and the BCC Commercial Operations,
increased health care services expense also resulted from medical membership
growth. In addition, mix and product design changes, for example, the
elimination of deductibles for some PPO plans and pharmacy products, contributed
to an increase in health care expenses. Growth in the workers' compensation
business also contributed to the increase. These increases were partially offset
by savings from hospital recontracting, which was implemented in late 1995.
Additional savings were realized by savings from specialist and laboratory
recontracting, which was implemented during the third quarter of 1996.
The loss ratio for 1996 increased to 77.4% compared to 75.6% in 1995 due to
the PPO benefits changes described above, an increase in the loss and loss
adjustment expense reserves related to a portion of the Company's workers'
compensation business and the incremental effect of the MMHD Acquisition
24
and the BCC Commercial Operations on the Company's overall results. The acquired
MMHD operations and the BCC Commercial Operations have traditionally experienced
a higher loss ratio than the Company. The increase in the loss ratio was
partially offset by the Company's continuing cost containment efforts, such as
the hospital recontracting program. Excluding the Company's workers'
compensation business and the acquisitions of the MMHD operations and the BCC
Commercial Operations, the loss ratio would have been 74.7% for the year ended
December 31, 1996. The loss ratio for 1995, also excluding the workers'
compensation business, was 75.2%.
Selling expense consists of commissions paid to outside brokers and agents
representing the Company. Selling expense for the year ended December 31, 1996
increased 18.0% to $224.5 million compared to $190.2 million in 1995,
corresponding with continued overall premium revenue growth and an additional
$21.4 million in selling expense attributable to MMHD. The selling expense ratio
for 1996 decreased to 5.6% from 6.4% for the prior year, largely due to the
acquisition of MMHD, which has a lower selling expense ratio than the Company's
existing business, and the BCC Commercial Operations, which has no selling
expense. Excluding the acquisitions, the selling expense ratio would have been
6.3% for the year ended December 31, 1996, consistent with the prior year.
General and administrative expense for the year ended December 31, 1996
increased 58.5% to $545.9 million from $344.4 million for the same period in
1995. Of the $201.5 million increase, $153.3 million resulted from the MMHD
Acquisition. The administrative expense ratio increased to 13.6% for 1996
compared to 11.6% in 1995, primarily due to the increased administrative expense
associated with the Company's continued investment in geographic expansion and
the MMHD Acquisition. MMHD has historically had a higher administrative expense
ratio due to its higher percentage of management services business. The Company
also incurred additional expenses in 1996 for network development costs. The
above increases were partially offset by the BCC Commercial Operations' lower
administrative expense ratio. Excluding MMHD and the BCC Commercial Operations,
the administrative expense ratio would have been 11.9% in 1996.
Interest expense was $36.6 million for the year ended December 31, 1996. The
Company had no interest expense in 1995. The interest expense in 1996 related
primarily to $775.0 million drawn under the Company's revolving credit facility
on May 15, 1996 to fund a special dividend paid in connection with the
Recapitalization, as well as interest on amounts payable to MassMutual,
including a Series A term note of $62.0 million issued in connection with the
MMHD Acquisition. At December 31, 1996, the Company's outstanding long-term
indebtedness was $625.0 million. The weighted average interest rate for all debt
for the year ended December 31, 1996 was 5.9%.
WellPoint's net income for the year ended December 31, 1996 was $202.0
million or $3.04 per share compared to $180.0 million or $2.71 per share for the
year ended December 31, 1995. Earnings per share for the years ended December
31, 1996 and 1995 are based on 66.4 million shares, the number of shares
outstanding immediately following the Recapitalization, plus for 1996 the
weighted average number of shares issued since the Recapitalization. Earnings
per share is determined by dividing net income by the weighted average number of
common shares outstanding. Earnings per share for the year ended December 31,
1995 included nonrecurring costs of $0.52 per share (which are discussed in the
1995 results which follow).
COMPARISON OF RESULTS FOR THE YEAR ENDED DECEMBER 31, 1995 TO THE YEAR ENDED
DECEMBER 31, 1994
Premium revenue increased 9.9% to $2,910.6 million for the year ended
December 31, 1995 from $2,648.0 million for the year ended December 31, 1994.
This increase was primarily due to a 4.7% increase in medical members, excluding
management services members, to 2.3 million as of December 31, 1995 from 2.2
million members as of December 31, 1994. The increase in premium revenue due to
membership growth was partially offset by the conversion of some PPO Cost Plus
members to management services
25
arrangements. This conversion was principally due to regulatory actions taken by
the California Department of Corporations (the "DOC") related to licensure
requirements. In addition, increased premium revenues resulted from a shift to
certain HMO products that generate a higher premium per member than the
Company's PPO products and from membership growth in specialty products.
Management services revenue increased $24.9 million to $61.2 million for the
year ended December 31, 1995 from $36.3 million in 1994. The increase was due to
a number of factors, including new pharmacy and clinical management accounts and
the acquisitions of Professional Claim Services, Inc. ("Pro-Serv") in August of
1994 and AHI Healthcare Corporation ("AHI") in February of 1995. The conversion
of PPO Cost Plus members to management services arrangements also contributed to
the increase. This transfer, which was completed in December 1995, did not have
a material impact on net income.
Investment income increased to $135.3 million for the year ended December
31, 1995 as compared to $107.4 million in 1994 due in part to 1995 pretax net
gains on the sales of investment securities of $15.4 million as compared to
pretax net gains in 1994 of $5.0 million. As discussed below under the heading
"Liquidity and Capital Resources", there were increased sales of investment
securities in 1995 in anticipation of the 1996 cash requirements for the
Company's Recapitalization and the MMHD Acquisition. The increase also reflected
a higher average yield on a larger average portfolio balance, resulting in
interest income of $120.1 million for the year ended December 31, 1995 compared
to $102.0 million for the prior year.
Health care services and other benefits expense increased 14.1% to $2,200.0
million for the year ended December 31, 1995 from $1,928.0 million in 1994. The
loss ratio for 1995 increased to 75.6% compared to 72.8% in 1994 due to several
factors. Membership as a percentage of total medical membership in the Company's
large group business, which has a higher loss ratio than the Company's small
group and individual business, increased in 1995. In addition, moderately higher
medical cost trends, a continued competitive pricing environment and the
elimination through new regulations of mandatory minimum premiums ("open
rating") in the workers' compensation market also contributed to the higher loss
ratio in 1995.
Selling expense for the year ended December 31, 1995 increased 12.2% to
$190.2 million compared to $169.5 million for 1994, corresponding with continued
overall premium revenue growth. The selling expense ratio increased slightly in
1995 to 6.4% from 6.3% in 1994, largely due to an increase in selling expenses
for the Company's workers' compensation products. The commission rates for the
Company's workers' compensation products increased due to increased competition
resulting from the new California regulations which require open rating.
Excluding selling expenses for the Company's workers' compensation products, the
selling expense ratio would have decreased from 6.3% in 1994 to 6.2% in 1995.
General and administrative expense for the year ended December 31, 1995
increased 3.1% to $344.4 million from $334.2 million for 1994 due in part to
increased personnel service costs consistent with the increases in medical and
specialty membership, as well as the acquisition of AHI. The administrative
expense ratio decreased to 11.6% for the year ended December 31, 1995 compared
to 12.5% in 1994 due to a decrease in policyholder dividends resulting from the
open rating environment in the workers' compensation industry. Excluding the
conversion of PPO Cost Plus members to management services, the administrative
expense ratio would have been 11.1% in 1995, reflecting the Company's continued
focus on reducing its adminis