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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-19147
COVENTRY HEALTH CARE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 52-2073000
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
6705 ROCKLEDGE DRIVE, SUITE 900, BETHESDA, MARYLAND 20817
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (301) 581-0600
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
Common Stock purchase rights
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the registrant's voting Common Stock held
by non-affiliates of the registrant as of February 29, 2000 (computed by
reference to the closing sales price of such stock on The Nasdaq Stock Market on
such date) was $483,284,250.
As of February 29, 2000, there were 59,027,084 shares of the registrant's
voting Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the registrant's Proxy Statement for its 2000 Annual Meeting of
Shareholders to be filed subsequent to the filing of this Form 10-K Report are
incorporated by reference in items 10 through 13 of Part III hereof.
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COVENTRY HEALTH CARE, INC.
FORM 10-K
TABLE OF CONTENTS
PAGE
---------
PART I
Item 1: Business 3
Item 2: Properties 11
Item 3: Legal Proceedings 12
Item 4: Submission of Matters to a Vote of Security Holders 13
PART II
Item 5: Market for Registrant's Common Equity and Related Stockholder Matters 14
Item 6: Selected Consolidated Financial Data 14
Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations 16
Item 7A: Quantitative and Qualitative Disclosures About Market Risk 34
Item 8: Financial Statements and Supplementary Data 35
Item 9: Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 62
PART III
Item 10: Directors and Executive Officers of the Registrant 63
Item 11: Executive Compensation 63
Item 12: Security Ownership of Certain Beneficial Owners and Management 63
Item 13: Certain Relationships and Related Transactions 63
PART IV
Item 14: Exhibits, Financial Statement Schedules and Reports on Form 8-K 64
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PART I
The statements contained in this Form 10-K that are not historical are
forward-looking statements made pursuant to the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995, which are subject to risks and
uncertainties. These forward-looking statements may be affected by a number of
factors, including the "Risk Factors" contained in Management's Discussion and
Analysis of Financial Condition and Results of Operations in this Form 10-K, and
actual operations and results may differ materially from those expressed in this
Form 10-K. Among the factors that may materially affect the Company's business
are potential increases in medical costs, difficulties in increasing premiums
due to competitive pressures, price restrictions under Medicaid and Medicare,
imposition of regulatory restrictions, issues relating to marketing of products
or accreditation or certification of the products by private or governmental
bodies, difficulties in obtaining or maintaining favorable contracts with health
care providers, credit risks on global capitation arrangements, financing costs
and contingencies, litigation risk and substantial ownership of the Company's
common stock by Principal Life Insurance Company ("Principal Life").
ITEM 1: BUSINESS
GENERAL
Coventry Health Care, Inc. (together with its subsidiaries, the
"Company", "Coventry", "we", "our", or "us"), successor-in-interest to Coventry
Corporation, is a managed health care company operating health plans under the
names Coventry Health Care, HealthAmerica, HealthAssurance, HealthCare USA,
Group Health Plan, Southern Health, SouthCare and Carelink Health Plans. The
Company provides a full range of managed care products and services including
health maintenance organization ("HMO"), point of service ("POS") and preferred
provider organization ("PPO") products. The Company also administers
self-insured plans for large employer groups. Coventry was incorporated under
the laws of the state of Delaware on December 17, 1997.
As of December 31, 1999, in continuing operations, the Company had
1,202,304 members for whom it assumes underwriting risk ("risk members") and
237,635 members of self-insured employers for whom it provides management
services but does not assume underwriting risk. The following tables show the
total number of members as of December 31, 1999 and 1998 and the percentage
change in membership between these dates. The December 31, 1999 membership
figures for continuing operations reflect the acquisitions of Carelink and
Kaiser's North Carolina membership and the discontinuation of Coventry Health
Care of Indiana, Inc., all of which occurred in 1999.
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DECEMBER 31, PERCENTAGE
1999 1998 CHANGE
------------------- -------------------- --------------------
Membership by Market:
At-risk membership in continuing operations
Carolina 48,205 21,575 123.4%
Delaware 56,700 54,329 4.4%
Georgia 27,485 20,273 35.6%
Iowa 76,205 79,306 (3.9%)
Kansas City 66,753 51,993 28.4%
Louisiana 37,837 39,730 (4.8%)
Nebraska 26,927 34,598 (22.2%)
Pennsylvania 376,416 402,178 (6.4%)
Richmond 53,333 55,259 (3.5%)
St. Louis 314,298 320,179 (1.8%)
West Virginia 78,968 24,999 215.9%
Wichita 39,177 35,342 10.9%
------ ------ -----
Total at-risk membership by market 1,202,304 1,139,761 5.5%
Total non-risk membership 237,635 217,523 9.2%
------- ------- ----
Total membership in continuing operations 1,439,939 1,357,284 6.1%
========= ========= ====
Total membership in non-continuing operations
Indiana 23,434 28,030 (16.4%)
Total membership 1,463,373 1,385,314 5.6%
========= ========= ====
Membership by Product:
At-risk membership in continuing operations
Commercial 987,181 973,419 1.4%
Medicare 68,632 63,599 7.9%
Medicaid 146,491 102,743 42.6%
------- ------- -----
Total at-risk membership by product 1,202,304 1,139,761 5.5%
Total non-risk membership 237,635 217,523 9.2%
------- ------- ----
Total membership in continuing operations 1,439,939 1,357,284 6.1%
========= ========= ====
Total membership in non-continuing operations
Indiana 23,434 28,030 (16.4%)
Total membership 1,463,373 1,385,314 5.6%
========= ========= ====
PRODUCTS
Commercial
HEALTH MAINTENANCE ORGANIZATIONS
The Company's HMO products provide comprehensive health care benefits to
members, including ambulatory and inpatient physician services, hospitalization,
pharmacy, dental, optical, mental health, and ancillary diagnostic and
therapeutic services. In general, a fixed monthly enrollment fee covers all HMO
services although some benefit plans require copayments or deductibles in
addition to the basic enrollment fee. A primary care physician assumes overall
responsibility for the care of a member, including preventive and routine
medical care and referrals to specialists and consulting physicians. While an
HMO member's choice of providers is limited to those within the health plan's
HMO network, the HMO member is typically entitled to coverage of a broader range
of health care services than is covered by typical reimbursement or indemnity
policies.
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PREFERRED PROVIDER ORGANIZATIONS AND POINT OF SERVICE
The Company, through its health plans, offers flexible provider products,
including PPO and POS products. These products permit members to participate in
managed care but allow them to choose, at the time services are required, to use
providers not participating in the managed care network. If a non-participating
provider is utilized, deductibles and copayments are generally higher and
increase the out-of-pocket costs to the member. PPO/POS premiums are typically
lower than HMO premiums due to the increased out-of-pocket costs borne by the
members.
Governmental Programs
MEDICARE
In late 1995, the Company introduced a Medicare product, for which the
Company assumes risk, under the name "Advantra", in the St. Louis market. In
1996, the Company began marketing this product in its western Pennsylvania and
central Pennsylvania markets. The Company also marketed a Medicare risk product
in the Chicago, Illinois and Jacksonville, Florida markets. The Company
introduced a Medicare risk product in Kansas City and Delaware effective July 1,
1999 and January 1, 2000, respectively. In 1998, the Company exited the Medicare
program in several counties, in which it had approximately 18,000 members,
approximately 10,000 of whom were in the Illinois and Florida health plans that
were sold effective November 30, 1998 and December 31, 1998, respectively. The
remaining counties were exited because the reimbursement rates were not adequate
and/or the Company was not successful in its efforts to increase reimbursement
rates. Effective January 1, 2000, the Company exited three counties in central
Pennsylvania for similar reasons, representing less than 900 members.
Under a Medicare risk contract, the Company receives a county-specific
fixed premium per member per month from the U.S. Health Care Financing
Administration ("HCFA"), which reflects certain county-specific demographics of
the Medicare population of each region. However, the product also carries the
risk of higher utilization and related medical costs than commercial products
and the possibility of regulatory or legislative changes that may reduce
premiums or increase mandated benefits in the future. The Company is also
subject to increased government regulation and reporting requirements related to
the product.
The Company also offers Medicare cost and supplement products. Under a
Medicare cost contract, the Company is reimbursed by HCFA only for the cost of
services rendered to the plan members, including a portion of administrative
expenses. HCFA periodically audits the cost of services and, as a result, the
Company is at risk for less than full reimbursement. Medicare supplement members
enroll individually and pay a monthly premium for comprehensive health services
not covered under Medicare. A majority of the Company's former Medicare cost and
supplement members converted to the Company's Advantra product during 1996.
MEDICAID
The Company offers health care coverage to Medicaid recipients in the St.
Louis and central Missouri; Richmond, Virginia; Delaware; North Carolina; West
Virginia and Iowa markets. Medicaid recipients in the St. Louis, central
Missouri, North Carolina and Delaware markets are generally required to choose a
managed care provider. In Richmond, Virginia, West Virginia and Iowa, enrollment
in a Medicaid HMO is voluntary. Under a Medicaid risk contract, the
participating state pays a monthly premium per member based on the age, sex, and
eligibility category of the recipients enrolled in the Company's plans.
The Company determined, at the end of 1996, that its Florida operations
were not sufficiently profitable to justify a continued presence in the Florida
market and, as a result, the Company discontinued operations in the Florida
Medicaid HMO market on June 30, 1997. The Company also exited the western and
central Pennsylvania Medicaid markets for similar reasons effective December 31,
1997 and March 31, 1998, respectively.
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Management Services
The Company's health plans offer management services to large employers
who self-insure their employee health benefits. Under related contracts,
employers who fund their own health plans receive the benefit of provider
pricing arrangements from the health plan. The health plan also provides a
variety of administrative services such as claims processing, utilization review
and quality assurance for the employers. The health plan receives an
administrative fee for these services but does not assume the healthcare cost
underwriting risk. Certain of the Company's management services contracts
include performance and utilization management standards which affect the fees
received for these services. As a result of the acquisition of certain Principal
Health Care Inc. ("PHC") health plans from Principal Life, the Company
recognized revenue under a Marketing Services Agreement, Management Services
Agreement and PPO access agreement with Principal Life. The Company also offers
a PPO product to other third-party payors under which the Company provides
rental of and access to the Company's PPO network, claims repricing and
utilization review. The Company does not accept underwriting risk for this
product. Non-risk membership in the tables above do not reflect membership
attributable to this product.
DELIVERY SYSTEMS
The Company's health plans maintain provider networks that furnish health
care services through contractual arrangements with physicians, hospitals and
other health care providers, rather than providing reimbursement to the member
for the charges of such providers. Because the health plans receive the same
amount of revenue from their members irrespective of the cost of healthcare
services provided, they must manage both the utilization of services and the
unit cost of the services.
The Company's health plans' networks historically have utilized a variety
of physician care delivery systems that differed primarily in the
characterization of the relationship between the Company and the participating
physicians. Prior to 1997, the Company utilized staff models in the western and
central Pennsylvania and St. Louis markets to deliver primary care and certain
specialist services through physicians who were employed exclusively by the
health plan. The exclusive full-time employment of physicians in a staff model
generally enabled the health plan to predict costs more effectively, maintain
quality and respond quickly to consumer issues. However, staff model operations
also involved substantial investment in facilities and personnel that could not
be immediately adjusted to take into account changes in the membership or third
party payor pricing trends. In addition to providing health care to plan
members, these staff models also accepted non-member patients on a
fee-for-service basis in an effort to help cover the costs associated with the
medical offices.
The Company determined in late 1996 to dispose of the staff model
operations in Pittsburgh, Pennsylvania and St. Louis, Missouri. Effective March
31, 1997, the Company completed its sale of a majority of the medical offices in
Pittsburgh, Pennsylvania associated with Allegheny Health, Education and
Research Foundation ("AHERF"), a major provider organization in the Pittsburgh
market, for approximately $20 million. Upon the sale, the Company entered into a
long-term global capitation agreement with AHERF that increased the Company's
globally capitated membership in western Pennsylvania to approximately 250,000
members, which was 91% of the Company's commercial, Medicaid and Medicare
membership in western Pennsylvania. Under the arrangement, AHERF received a
fixed percentage of premium to cover all the medical costs provided to the
globally capitated members.
On July 21, 1998, AHERF filed for bankruptcy protection. As a result of
the bankruptcy, AHERF failed to pay for medical services under its global
capitation agreement with the Company covering approximately 250,000 Company
members in the western Pennsylvania market. Shortly after AHERF filed for
bankruptcy protection, the Company filed a lawsuit against AHERF's non-debtor,
affiliated hospitals seeking monetary damages and a declaratory judgment that
the Company was not obligated to pay in excess of $21.5 million to the hospitals
for medical services provided by them to the Company's members and the hospitals
filed a counterclaim for payment of these services. As a result, the Company,
which was ultimately responsible for medical costs delivered to its members,
notwithstanding the global capitation agreement, recorded a charge of $55.0
million in the second quarter of 1998 to establish a reserve for, among other
things, the medical costs incurred by its members under the AHERF global
capitation agreement at the time of the bankruptcy filing. On July 22, 1999, the
Company reached a settlement with the hospitals, including Allegheny General
Hospital, formerly owned by AHERF, and its new
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owner, Western Pennsylvania Health Care System ("West Penn"), whereby the
hospitals agreed that the Company would not be liable for the payment of certain
medical services rendered by the hospitals to the Company's members prior to
July 21, 1998, the date of AHERF's bankruptcy filing. Simultaneous with the
settlement, the Company signed a new three-year provider contract with West
Penn. The conditions to execute the settlement and the provider contract were
finalized in October 1999 and, as a result, all liability issues surrounding
AHERF's failure to fulfill its contractual obligations and the Company's
remaining obligations have been determined and all AHERF-related litigation has
been concluded. As of December 31, 1999, approximately $35.4 million of the
$55.0 million reserve had been paid for medical claims. As a result of the
settlement, the Company released $6.3 million from the reserve, which was
reflected as a gain in the fourth quarter and year-end 1999 results. The balance
of the reserve represents the Company's remaining obligations under the
settlement and will be expended through August 2007.
Effective May 1, 1997, the Company completed its sale of the medical
offices associated with Group Health Plan, Inc., its health plan in St. Louis,
Missouri, to BJC Health System ("BJC"), a major provider organization in the St.
Louis market, for approximately $26.9 million. Upon the sale, the Company
entered into a long-term global capitation agreement with BJC, since amended,
that covered approximately 33.3% of the risk membership in St. Louis at December
31, 1998. Under the agreement, BJC receives a fixed percentage of premium to
cover all of the medical treatment received by the globally capitated members.
Global capitation agreements limit the Company's exposure to the risk of
increasing medical costs, but expose the Company to risk as to the adequacy of
the financial and medical care resources of the provider organization. To the
extent that the respective provider organization faces financial difficulties or
otherwise is unable to perform its obligations under the global capitation
agreements, the Company, which is responsible for the coverage of its members
pursuant to its customer agreements, will be required to perform such
obligations, and may have to incur costs in doing so in excess of the amounts it
would otherwise have to pay under the global capitation agreements. Various
disputes alleging breaches have arisen under the BJC global capitation agreement
concerning the accuracy and timeliness of claims payments, and the accuracy of
membership reconciliations that would affect the amount of premiums paid to BJC
to provide its services under the agreement. BJC contends that these alleged
breaches entitles it to terminate the agreement. Although the parties are
obligated to arbitrate their disputes under the terms of the agreement, the
parties have agreed to attempt to negotiate a resolution of the various disputed
issues concurrent with arbitration. While the Company acknowledges certain
claims payment inaccuracies, the Company denies the remaining allegations and
vigorously disputes that any such claims constitute a material breach of the
agreement. Management does not believe that the outcome of these disputes will
have a material impact on the consolidated financial statements, although there
can be no assurance in this regard.
Effective September 30, 1997, the Company completed the sale of its
remaining five medical offices associated with HealthAmerica Pennsylvania, Inc.
("HealthAmerica") to ProMedCo Management Company. The agreement covered 21
physicians who serve approximately 12,000 members. The approximate $2.0 million
of proceeds from the sale roughly equaled the carrying value of the medical
offices.
All of the Company's health plans currently offer an open panel delivery
system. In an open panel structure, individual physicians or physician groups
contract with the health plans to provide services to members but also maintain
independent practices in which they provide services to individuals who are not
members of the Company's health plans.
HEALTH CARE PROVIDER COMPENSATION
Under most open panel contracts, each primary care physician is paid a
monthly fixed capitation fee for each enrollee selecting the physician and may
receive additional compensation from risk-sharing and other incentive
arrangements with the health plan to the extent that pre-established utilization
and quality goals are achieved. Contracting specialist physicians are
compensated under both discounted fee-for-service arrangements and capitation
arrangements. The majority of the Company's contracts with hospitals provide for
inpatient per diem or per case hospital rates, while outpatient services are
typically contracted on a discounted fee-for-service basis. The Company pays
many of its hospital and ancillary providers on a fixed fee schedule or a
monthly fixed capitation fee. In the western Pennsylvania and St. Louis markets,
the Company maintains risk sharing arrangements with integrated networks of
physicians and providers. The Company has credit and operating risk associated
with these arrangements. One of the risk sharing agreements in the St. Louis
market remains in arbitration over amounts in
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dispute. Additionally, the Company has significant membership covered by global
capitation agreements in St. Louis, as discussed above.
QUALITY ASSURANCE
The Company has established systems to monitor the availability,
appropriateness and effectiveness of the patient care it provides. Monitoring
the quantity of physicians and support personnel needed for the number of
enrollees served assists in determining and maintaining the availability of care
at appropriate levels. Utilization data, collected and disseminated in the
context of controlling costs, serves as a valuable indicator of over or under
utilization of services, and helps the Company's health plans provide
appropriate care for their members.
The Company's health plans also have internal quality assurance review
committees made up of practicing physicians and staff members whose
responsibilities include periodic review of medical records, development and
implementation of standards of care based on current medical literature and the
collection of data relating to results of treatment. Studies are regularly
conducted to discover possible adverse medical outcomes for both quality and
risk management purposes.
Appointment availability, member waiting times and environments are
monitored. A member services department is responsible for monitoring and
maintaining member satisfaction, and the Company's health plans periodically
conduct membership surveys of both existing and former members concerning
services furnished and suggestions for improvement.
UTILIZATION MANAGEMENT AND REVIEW
A managed care company's profitability is dependent on maintaining
effective controls over utilization of health care services consistent with the
provision of high quality care. Each of the Company's health plans either
employs physicians or contracts with physicians as Medical Directors who oversee
the delivery of medical services. The Medical Director supervises medical
managers (nurses) who review and approve requests by physicians to perform
certain diagnostic and therapeutic procedures, using nationally recognized
clinical guidelines. Medical managers also continually review the status of
hospitalized patients and compare their medical progress with established
clinical criteria, make hospital rounds to review patients' medical progress,
and perform quality assurance and utilization functions.
Medical directors also monitor the utilization of diagnostic services and
encourage use of outpatient surgery and testing where appropriate. Data showing
each physician's utilization profile for diagnostic tests, specialty referrals
and hospitalization are collected by each health plan and presented to the
health plan's physicians. These results are monitored by the medical directors
in an attempt to ensure the use of cost-effective, medically appropriate
services.
MARKETING
The Company's commercial health plans are marketed primarily to employer
groups as alternatives to conventional fee-for-service health care and indemnity
health insurance programs. Employers generally pay all or part of their
employees' health care premiums, and many continue to offer their employees a
conventional insurance plan even if one or more of the Company's products are
offered.
Commercial marketing is generally a two-step process in which
presentations are made first to employers and then directly to employees. Once
selected by an employer, the Company solicits members from the employee base
directly. During periodic "open enrollments," in which employees are permitted
to change health care programs, the Company uses direct mail, worksite
presentations, and radio and television advertisements to contact prospective
members. The Company also markets through independent insurance brokers, agents,
and employee benefits consultants. Virtually all of the Company's employer group
contracts are renewable annually, and enrollment is continuously affected by
employee turnover within employer groups.
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The Company's Medicaid products are marketed directly to individuals
while its Medicare products are marketed to both individuals and employer group
retirees. Individual marketing to Medicare beneficiaries is conducted through
use of a direct sales force and advertising efforts that include television,
radio, newspaper, billboards, and direct mail. The Company also markets Medicare
products through independent insurance brokers and agents. The Company's
Medicaid and Medicare contracts are renewable annually. Medicare enrollees may
disenroll monthly. Medicaid enrollees may disenroll, depending on the
jurisdiction, either monthly or annually.
Each of the Company's health plans employs a full-time marketing staff.
The marketing staff uses advertising and promotional material prepared by
advertising firms as well as market research programs.
The Company received 16% of its consolidated revenues in 1999 from the
Medicare program throughout its various markets. For the year ended December 31,
1999, HealthCare USA of Missouri, LLC ("HCUSA"), a subsidiary, received
approximately $128 million or 100% of its revenues from the State of Missouri
for Medicaid members. Also, the Company's health plan in Wichita received
approximately $38.5 million, or 61% of its revenues from one employer group.
COMPETITION
The Company's health plans operate in highly competitive environments and
compete with other HMOs, PPOs, indemnity insurance carriers and, most recently,
physician-hospital organizations. While competitive pressures in 1998 had an
adverse affect on premiums from the Company's commercial products, the
environment has generally improved in 1999, allowing the Company to implement
average rate increases of 10% in 1999 on commercial business. The favorable
pricing environment is expected to continue in 2000. In some cases, employer
groups have moved from the traditional commercial HMO plans toward the lower
premium flexible provider products.
The Company believes that the principal factors influencing an employer
group's decision to choose among health care options are the price of the
benefit plans offered, locations of the health care providers, reputation for
quality care, financial stability, comprehensiveness of coverage, and diversity
of product offerings.
The Company also competes with other managed care organizations and
indemnity insurance carriers in seeking to obtain and retain favorable contracts
with hospitals and other providers of services to the Company's health plans.
GOVERNMENT REGULATION
The Company's HMOs are required to file periodic reports with, and are
subject to periodic review by, state and federal licensing authorities that
regulate them. The HMOs are required by state law to meet certain minimum
capital and deposit and/or reserve requirements and may be restricted from
paying dividends under certain circumstances. They are also required to provide
their members with certain mandated benefits. The HMOs are required to have
quality assurance and education programs for their professionals and enrollees.
Certain states' laws further require that representatives of the HMOs' members
have a voice in policy making.
The Women's Health and Cancer Rights Act of 1998 ("WHCRA") was signed
into law on October 21, 1998. This law applies to group health plans and health
insurance issuers and became effective for plan years after October 21, 1998.
WHCRA requires group health plans and health insurance issuers providing
coverage for mastectomies to provide benefits for reconstructive surgery.
Specifically, the law mandates that if an enrollee elects reconstructive surgery
after a mastectomy, a group health plan or health insurance issuer must provide
benefits for reconstruction of the affected breast, surgery and reconstruction
of the other breast to produce a symmetrical appearance, prosthesis and
treatment of physical complications at all stages of the mastectomy, including
lymphedemas. This coverage may be subject to the same annual deductions and
coinsurance provisions as established for other plan benefits.
All of the Company's HMOs that contract with HCFA to provide services to
Medicare beneficiaries pursuant to a Medicare+Choice contract are subject to
federal laws and regulations. These HMOs may also be subject to state
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laws governing Medicare contracting. HCFA has the right to audit any health plan
operating under a Medicare+Choice contract to determine the plan's compliance
with federal law. The Company's HMOs with Medicare+Choice contracts must also
comply with the requirements established by peer review organizations ("PROs"),
which are organizations under contract with HCFA to monitor the quality of
health care received by Medicare beneficiaries and under contract with certain
states to monitor the quality of health care received by Medicaid recipients. In
addition, cost reimbursement reports are required with respect to Medicare cost
contracts and are subject to audit and revision.
On August 5, 1997, the President signed into law the Balanced Budget Act
of 1997 ("BBA"). This law made revisions to the Medicare program, including:
permitting provider-sponsored organizations to offer services to Medicare
beneficiaries; requiring managed care plans serving Medicare beneficiaries to
make medically necessary care available 24 hours a day, to provide coverage a
"prudent lay person" would deem necessary and to provide grievance and appeal
procedures; and prohibiting such plans from restricting providers' advice
concerning medical care. The BBA also revised the method of calculation of the
payments made to the Company's plan by Medicare and is expected to reduce the
annual increase in such payments from the amounts that would have been paid
under former calculation methods.
As a result of the Medicare+Choice and Medicaid products offered by
Coventry, Coventry is subject to regulatory and legislative changes in those two
government programs. The Balanced Budget Refinement Act of 1999 ("BBRA") was
enacted into law on November 29, 1999. This law modifies the BBA, which had made
the substantial revisions to the Medicare and Medicaid Programs. Specially, the
BBRA revised the Medicare+Choice Program's enrollment rules and risk adjustment
methodology. Additionally, the BBRA offers limited incentives to health plans to
participate in the Medicare+Choice Program by offering increased monthly
payments for Medicare+Choice plans in areas which currently do not have
Medicare+Choice plans. The BBRA also allows Medicare+Choice plans greater
flexibility in structuring benefit packages for enrollees in the same service
area. At this time, the management of Coventry does not believe that the BBRA
will have a material effect on the Company and its operations.
All of the Company's HMOs that contract with states to provide services
to Medicaid recipients are subject to state and federal laws and regulations.
HCFA and the appropriate state regulatory agency have the right to audit any
health plan operating under a Medicaid managed care contract to determine the
plan's compliance with state and federal law. In some instances, states engage
PROs to perform quality assurance and utilization review oversight of Medicaid
managed care plans. The Company's HMOs are required to abide by these PRO
requirements.
The Social Security Act imposes criminal and civil penalties for paying
or receiving remuneration (which is deemed to include a kickback, bribe or
rebate) in connection with any federal health care program including, but not
limited to, the Medicare, Medicaid and CHAMPUS programs. The law and the related
regulations have been interpreted to prohibit the payment, solicitation,
offering or receipt of any form of remuneration in return for the referral of
federal health care program patients or any item or service that is reimbursed,
in whole or in part, by any federal health care program. Similar anti-kickback
provisions have been adopted by many states, which apply regardless of the
source of reimbursement. In 1996, as part of the Health Insurance Portability
and Accountability Act of 1996, Congress adopted a statutory exception for
certain risk-sharing arrangements which has not yet been interpreted by the
Office of the Inspector General as no regulation, either proposed or final,
has yet been published. Nevertheless, the Department of Health and Human
Services ("DHHS") has adopted safe harbor regulations specifying certain
relationships and activities that are deemed not to violate the federal
anti-kickback statute. Specifically, DHHS has adopted safe harbor regulations
addressing: (i) HMOs' waivers of Medicare and Medicaid beneficiaries'
obligation to pay cost-sharing amounts or to provide other incentives in
order to attract Medicare and Medicaid enrollees; and (ii) certain discounts
offered to prepaid health plans by contracting providers. The Company
believes that the incentives offered by its HMOs to Medicare and Medicaid
beneficiaries and the discounts its plans receive from contracting health care
providers should satisfy the requirements of the safe harbor regulations.
However, failure to satisfy each criterion of the applicable safe harbor does
not mean that the arrangement constitutes a violation of the law; rather the
safe harbor regulations provide that the arrangement must be analyzed on the
basis of its specific facts and circumstances. The Company believes that its
arrangements do not violate the federal or similar state anti-kickback laws.
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11
The Company contracts with the United States Office of Personnel
Management ("OPM") to provide managed health care services under the Federal
Employees Health Benefits Program ("FEHBP"). These contracts with OPM and
applicable government regulations establish premium rating requirements for the
FEHBP. OPM conducts periodic audits of its contractors to, among other things,
verify that the premiums established under the OPM contracts are established in
compliance with the community rating and other requirements under FEHBP. Such
audits could result in material adjustments.
Numerous proposals have been introduced in the United States Congress and
various state legislatures relating to managed health care reform. Some
proposals, if enacted, could, among other things, limit Coventry's ability to
control medical costs, increase Coventry's exposure to liability to members for
coverage denials or delays, require certain coverages and impose other
requirements on managed care companies. Although the provisions of legislation
that may be adopted at the state level cannot be accurately and completely
predicated at this time, Coventry's management believes that the ultimate
outcome of currently proposed legislation and state legislation enacted to date
should not have a material effect on its operations. On the federal level,
Coventry expects that some form of managed health care reform may be enacted. At
this time, it is unclear when such legislation might be enacted as well as the
content of any new provisions. Coventry's management believes that the ultimate
outcome of such federal legislation should not have a material adverse effect on
its operations.
RISK MANAGEMENT
The HMOs maintain general liability and professional liability (medical
malpractice, managed care liability, and medical excess "stop loss") insurance
coverage in amounts the Company believes to be adequate. Contracting physicians
are also required to maintain professional liability coverage. No assurance can
be given as to the future availability or costs of such insurance or that the
liability will not exceed the limit of the insurance coverage.
EMPLOYEES
At March 3, 2000, the Company employed approximately 2,900 persons, none
of whom are covered by a collective bargaining agreement.
TRADEMARKS
The Company has the right in perpetuity to use the federally registered
name "HealthAmerica" in Illinois, Missouri, Pennsylvania and West Virginia. The
Company has federal and/or state registered service marks for "HealthAssurance,"
"GHP Access," "Healthcare USA," "Doc Bear," "CarePlus," "Coventry", "Advantra,"
"SouthCare" and "CareNet." The Company has pending applications for federal
registration of the service marks "Senior Life Management," "Southern Select,"
and "Neighborhood Housecall." Effective December 31, 1999, the Company ceased
using the names "Principal Health Care," "The Principal," "The Principal
Financial Group," "Principal Health Care 65," and "PrinChoice," pursuant to an
agreement entered into with Principal Life on May 19, 1999.
ITEM 2: PROPERTIES
As of December 31, 1999, the Company leased approximately 171,000
square feet of space for its corporate office in Bethesda, Maryland, the
majority of which is subleased. The Company also leased approximately 667,000
aggregate square feet for office space, subsidiary operations, and customer
service centers in the various markets where the Company's health plans operate.
The Company's leases expire at various dates from 2000 through 2009. The Company
also owns a building in Richmond, Virginia with approximately 45,000 square
feet, which is used for administrative services related to its health plan in
that market. The Company believes that its facilities are adequate for its
operations.
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ITEM 3: LEGAL PROCEEDINGS
SETTLEMENT WITH AHERF RELATED ENTITIES. The Company and certain
affiliated hospitals of Allegheny Health, Education and Research Foundation
("AHERF") were involved in litigation to determine if the Company had the
financial responsibility for medical services provided to the Company's members
by the hospitals as a consequence of the bankruptcy filed by AHERF on July 21,
1998. As a result of the bankruptcy, AHERF failed to pay for medical services
under its global capitation agreement with the Company covering approximately
250,000 Company members in the western Pennsylvania market.
Shortly after AHERF filed for bankruptcy protection, the Company filed a
lawsuit against AHERF's non-debtor, affiliated hospitals seeking monetary
damages and a declaratory judgment that the Company was not obligated to pay in
excess of $21.5 million to the hospitals for medical services provided by them
to the Company's members and the hospitals filed a counterclaim for payment of
these services.
As a result, the Company, which was ultimately responsible for medical
costs delivered to its members, notwithstanding the global capitation agreement,
recorded a charge of $55.0 million in the second quarter of 1998 to establish a
reserve for, among other things, the medical costs incurred by its members under
the AHERF global capitation agreement at the time of the bankruptcy filing.
On July 22, 1999, the Company reached a settlement with the hospitals,
including Allegheny General Hospital, formerly owned by AHERF, and its new
owner, Western Pennsylvania Health Care System ("West Penn"), whereby the
hospitals agreed that the Company would not be liable for the payment of certain
medical services rendered by the hospitals to the Company's members prior to
July 21, 1998, the date of AHERF's bankruptcy filing. Simultaneous with the
settlement, the Company signed a new three-year provider contract with West
Penn. The conditions to execute the settlement and the provider contract were
finalized in October 1999 and, as a result, all liability issues surrounding
AHERF's failure to fulfill its contractual obligations and Coventry's remaining
obligations have been determined and all AHERF-related litigation has been
concluded.
As of December 31, 1999, approximately $35.4 million of the $55.0 million
reserve had been paid for medical claims. As a result of the settlement,
Coventry released $6.3 million from the reserve, which was reflected as a gain
in the fourth quarter and year-end 1999 results. The balance of the reserve
represents Coventry's remaining obligations under the settlement and will be
expended through August 2007.
UNITY ARBITRATION. Group Health Plan, Inc. ("GHP"), a health plan
subsidiary of the Company, entered into an agreement, effective January 1, 1998,
with Unity Health Network, L.L.C. ("Unity") for Unity's provider network to
provide health care services to GHP's members in the southern and western areas
of St. Louis County, Missouri. The agreement contained risk sharing provisions.
Disputes arose under the agreement and the matter was submitted to arbitration
before the American Arbitration Association ("AAA"). GHP demanded payment from
Unity of $7.6 million and specific performance under the agreement. Unity
demanded payment from GHP of $14.5 million, specific performance of certain
provisions of the agreement and suspension of its payment obligations. On
December 23, 1999, the AAA tribunal of arbitrators awarded GHP the sum of $1.1
million for deficiencies in risk fund pools for 1998, and awarded Unity the sum
of $1.8 million as liquidated damages for GHP's failure to meet certain
administrative performance standards, and held Unity contractually liable for
funding any deficits in the risk fund pools for 1999. The only remaining issue
pending is the readjudication of certain disputed claims submitted subsequent to
June 30, 1999.
BJC. Effective May 1, 1997, the Company completed its sale of the medical
offices associated with Group Health Plan, Inc., its health plan in St. Louis,
Missouri, to BJC Health System ("BJC"), a major provider organization in the St.
Louis market, for approximately $26.9 million. Upon the sale, the Company
entered into a long-term global capitation agreement with BJC, since amended,
that covered approximately 33.3% of the risk membership in St. Louis at December
31, 1998. Under the agreement, BJC receives a fixed percentage of premium to
cover all of the medical treatment received by the globally capitated members.
Global capitation agreements limit the Company's exposure to the risk of
increasing medical costs, but expose the Company to risk as to the adequacy of
the financial and medical care resources of the provider organization. To the
extent that the respective provider
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organization faces financial difficulties or otherwise is unable to perform its
obligations under the global capitation agreements, the Company, which is
responsible for the coverage of its members pursuant to its customer agreements,
will be required to perform such obligations, and may have to incur costs in
doing so in excess of the amounts it would otherwise have to pay under the
global capitation agreements. Various disputes alleging breaches have arisen
under the BJC global capitation agreement concerning the accuracy and timeliness
of claims payments, and the accuracy of membership reconciliations that would
affect the amount of premiums paid to BJC to provide its services under the
agreement. BJC contends that these alleged breaches entitles it to terminate the
agreement. Although the parties are obligated to arbitrate their disputes under
the terms of the agreement, the parties have agreed to attempt to negotiate a
resolution of the various issues concurrent with arbitration. While the Company
acknowledges certain claims payment inaccuracies, the Company denies the
remaining allegations and vigorously disputes that any such claims constitute a
material breach of the agreement. Management does not believe that the outcome
of these disputes will have a material impact on the consolidated financial
statements, although there can be no assurance in this regard.
OTHER LEGAL ACTIONS. In the normal course of business, the Company has
been named as a defendant in various legal actions seeking payments for claims
denied by the Company, medical malpractice, and other monetary damages. The
claims are in various stages of proceedings and some may ultimately be brought
to trial. Incidents occurring through December 31, 1999 may result in the
assertion of additional claims. With respect to medical malpractice, the Company
carries professional malpractice and general liability insurance for each of its
operations on a claims-made basis for which the Company maintains reserves. In
the opinion of management, the outcome of these actions should not have a
material adverse effect on the financial position or results of operations of
the Company.
Other managed care companies have been sued recently in class action
lawsuits claiming violations of the federal racketeering act (RICO) and federal
employee benefits law (ERISA), and generally claiming that managed care
companies overcharge consumers and misrepresent that they deliver quality health
care. Although it is possible that the Company may be the target of a similar
suit, the Company believes there is no valid basis for such a suit.
The Company's industry is heavily regulated and the laws and rules
governing the industry and interpretations of those laws and rules are subject
to frequent change. Existing or future laws could have significant impact on the
Company's operations.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of the fiscal year 1999.
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PART II
ITEM 5: MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
PRICE RANGE OF COMMON STOCK
The Company's common stock is traded on the National Market of the
Nasdaq Stock Market(R) under the symbol "CVTY." The following tables set forth
the quarterly range of high and low closing sales prices of the common stock on
Nasdaq during the calendar period indicated:
1999 1998
- ------------------------------------------------------------------------------------------------------------------
HIGH LOW HIGH LOW
- ------------------------------------------------------------------------------------------------------------------
First Quarter $11.375 $7.500 $19.250 $12.375
Second Quarter 14.875 7.125 19.125 12.750
Third Quarter 11.500 9.500 16.000 3.875
Fourth Quarter 7.938 5.125 10.250 4.625
On March 17, 2000, the Company had approximately 487 shareholders of
record, not including beneficial owners of shares held in nominee name.
DIVIDENDS
The Company has not paid any cash dividends on its common stock and
expects for the foreseeable future to retain all of its earnings to finance the
development of its business. The Company's ability to pay dividends is also
restricted by insurance regulations applicable to its subsidiaries. Subject to
the terms of such insurance regulations, any future decision as to the payment
of dividends will be at the discretion of the Company's Board of Directors and
will depend on the Company's earnings, financial position, capital requirements
and other relevant factors. See Part II, Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources."
ITEM 6: SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
OPERATIONS STATEMENT DATA (1) DECEMBER 31,
---------------------------------------------------------------------------
1999 1998 1997 1996 1995
---------------------------------------------------------------------------
Operating revenues $2,162,372 $2,110,383 $1,228,351 $1,057,129 $ 852,390
Operating earnings (loss) 47,855 (36,195) 5,739 (91,346) (1,275)
Net earnings (loss) 43,435 (11,741) 11,903 (61,287) 18
Net earnings (loss) per share - basic (3) 0.74 (0.22) 0.36 (1.87) -
Net earnings (loss) per share - diluted (3) 0.69 (0.22) 0.35 (1.87) -
Weighted average common shares outstanding - basic (3) 59,025 52,477 33,210 32,818 31,526
Weighted average common shares outstanding - diluted (3) 64,159 52,477 33,912 32,818 32,150
BALANCE SHEET DATA (1) DECEMBER 31,
---------------------------------------------------------------------------
1999 1998 1997 1996 1995
---------------------------------------------------------------------------
Cash and investments $614,603 $614,583 $240,091 $168,423 $147,777
Total assets 1,081,583 1,091,228 487,182 448,945 385,675
Long-term obligations and notes
payable (including current maturities) 31,217 88,737 109,268 102,985 77,868
Redeemable convertible preferred stock 47,095 - - - -
Stockholders' equity and partners' capital (2) 480,385 436,539 117,818 100,427 153,851
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(1) Balance Sheet Data for 1998 reflect the acquisition of the Principal Life
Insurance Company health plans as of December 31, 1998 and Operations
Statement Data for 1998 include the results of operations of the acquired
PHC health plans beginning April 1, 1998, the date of acquisition.
(2) Predecessor company of a wholly owned subsidiary of the Company was an S
Corporation.
(3) Restated to comply with SFAS 128, "Earnings Per Share."
SUPPLEMENTARY FINANCIAL INFORMATION
The following is a summary of unaudited quarterly results of operations
(in thousands, except per share data) for the years ended December 31, 1999 and
1998.
QUARTER ENDED
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1999 1999 1999 1999 (1) (2)
-------------------- --------------------- ---------------------- -----------------------
Operating revenues $527,848 $531,831 $529,889 $572,804
Operating earnings 8,683 9,626 11,391 18,155
Net earnings 8,293 9,157 10,970 15,015
Net earnings per share - basic 0.14 0.16 0.19 0.25
Net earnings per share - diluted 0.14 0.15 0.17 0.24
QUARTER ENDED
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1998 1998 (3)(4) 1998 1998 (5)
-------------------- --------------------- ---------------------- -----------------------
Operating revenues $330,209 $583,804 $593,278 $603,092
Operating earnings (loss) 7,178 (51,238) 2,179 5,686
Net earnings (loss) 4,707 (27,756) 5,068 6,240
Net earnings (loss) per share - basic 0.14 (0.47) 0.09 0.11
Net earnings (loss) per share - diluted 0.13 (0.47) 0.09 0.11
(1) Coventry will close its subsidiary, Coventry Health Care of Indiana,
Inc., by the end of the fourth quarter 2000. As a result of the cost
associated with exiting the Indiana market, Coventry recorded a reserve
for $2.0 million in the fourth quarter of 1999.
(2) In October 1999, the Company reached a settlement with AHERF. As a result
of the settlement, the Company released $6.3 million of its AHERF
reserve, which was reflected as a gain in the fourth quarter.
(3) Effective April 1, 1998, the Company completed its acquisition of certain
assets of PHC from Principal Life. The acquisition was accounted for
using the purchase method of accounting and, accordingly, the operations
of PHC have been included in the Company's consolidated financial
statements since the date of acquisition. As a result of the merger, an
estimated reserve of $7.8 million was established for the costs related
to the relocation of the corporate office from Nashville, Tennessee to
Bethesda, Maryland and other merger related expenses.
(4) The second quarter 1998 operating results were affected by the
establishment of a reserve as a result of the bankruptcy filing by AHERF.
The establishment of the reserves resulted in a charge to earnings of
$55.0 million.
(5) The merger costs were less than the reserve established in the second
quarter of 1998, resulting in a credit to earnings of $1.3 million.
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ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
accompanying audited consolidated financial statements and notes thereto.
RESULTS OF OPERATIONS
The following table (in thousands, except percentages and membership
data) is provided to facilitate a more meaningful discussion regarding the
results of the Company's operations for each of the three years in the period
ended December 31, 1999.
1999 1998
----------------------------------------------- -----------------------------------------------
PERCENT OF PERCENT PERCENT OF PERCENT
OPERATING INCREASE OPERATING INCREASE
AMOUNT REVENUE (DECREASE) AMOUNT REVENUE (DECREASE)
---------------- -------------- --------------- ---------------- -------------- ---------------
Operating revenues:
Managed care premiums $2,082,075 96.3% 2.4% $2,033,372 96.4% 68.3%
Management services 80,297 3.7% 4.3% 77,011 3.6% 281.2%
------ ---- ---- ------ ---- ------
Total operating revenues 2,162,372 100.0% 2.5% 2,110,383 100.0% 71.8%
---------------- ----------------
Operating expenses:
Health benefits (1) 1,792,652 82.9% 1.4% 1,767,374 83.7% 70.0%
Selling, general and
administrative 297,922 13.8% 2.1% 291,919 13.8% 71.7%
Depreciation and
amortization 28,205 1.3% 9.4% 25,793 1.2% 102.5%
Plan shutdown expense 2,020 0.1% - - - -
AHERF charge (6,282) (0.3%) (111.4%) 55,000 2.6% -
Merger costs - - - 6,492 0.3% -
Operating earnings (loss) 47,855 2.2% (232.2%) (36,195) (1.7%) (730.7%)
Other income, net 29,906 1.4% 9.7% 27,251 1.3% 9.5%
Interest expense (1,761) (0.1%) (79.4%) (8,566) (0.4%) (16.6%)
------- ------ ------- ------- ------ -------
Earnings (loss) before
income taxes
and minority interest 76,000 3.5% (534.0%) (17,510) (0.8%) (186.1%)
------ ---- -------- -------- ------ --------
Net earnings (loss) $43,435 $(11,741)
================ ================
Membership at December 31:
Commercial 1,010,282 1,000,699
Governmental Programs 215,123 166,342
Non-risk 237,968 218,273
---------------- ----------------
1,463,373 1,385,314
================ ================
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1997
--------------------------------
PERCENT OF
OPERATING
AMOUNT REVENUE
---------------- ---------------
Operating revenues:
Managed care premiums $1,208,149 98.4%
Management services 20,202 1.6%
------ ----
Total operating revenues 1,228,351 100.0%
----------------
Operating expenses:
Health benefits (1) 1,039,860 84.7%
Selling, general and
administrative 170,017 13.8%
Depreciation and
amortization 12,735 1.0%
Plan shutdown expense - -
AHERF charge - -
Merger costs - -
Operating earnings 5,739 0.5%
Other income, net 24,880 2.0%
Interest expense (10,275) (0.8)%
-------- ------
Earnings before
income taxes
and minority interest 20,344 1.7%
------ ----
Net earnings $11,903
================
Membership at December 31:
Commercial 622,942
Governmental Programs 142,881
Non-risk 148,910
----------------
914,733
================
(1) The medical loss ratio (health benefits as a percentage of managed care
premiums) was 86.1%, 86.9%, and 86.1% in 1999, 1998 and 1997,
respectively.
GENERAL
OVERVIEW
Coventry Health Care, Inc. (together with its subsidiaries, the
"Company", "Coventry", "we", "our", or "us"), successor-in-interest to Coventry
Corporation, is a managed health care company operating health plans under the
names Coventry Health Care, HealthAmerica, HealthAssurance, HealthCare USA,
Group Health Plan, Southern Health, SouthCare and Carelink Health Plans. The
Company provides a full range of managed care products and services including
health maintenance organization ("HMO"), point of service ("POS") and preferred
provider organization ("PPO") products. The Company also administers
self-insured plans for large employer groups. Coventry was incorporated under
the laws of the state of Delaware on December 17, 1997.
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During the three years ended December 31, 1999, the Company experienced
substantial growth in operating revenues due primarily to membership increase.
Much of the growth was in 1998 and was attributable to the acquisition of the
Principal Health Care, Inc. ("PHC") plans effective April 1, 1998. Additional
membership growth was achieved through marketing efforts, acquisitions,
geographic expansion and increased product offerings.
The Company's commercial managed care premium revenues during the three
years in the period ended December 31, 1999 were comprised of premiums from its
commercial HMO products and flexible provider products, including PPO and POS
products for which the Company assumes full underwriting risk. Premiums for such
commercial PPO and POS products are typically lower than HMO premiums due to
medical underwriting and higher deductibles and copayments that are required
from the PPO and POS members. Premium rates for commercial HMO products are
reviewed by various state agencies based on rate filings. While the Company has
not had such filings modified, no assurance can be given that approvals for rate
submissions will continue.
The public sector managed care premium revenues consists of premiums
from the Company's Medicare risk, Medicare cost and Medicaid products. The
Company provides comprehensive health benefits to members participating in
government programs and receives premium payments from federal and state
governments. Premium rates for the Medicaid and Medicare risk products are
established by governmental regulatory agencies and may be reduced by regulatory
action.
The Company's management services revenues result from operations in
which the Company's health plans provide administrative and other services to
self-insured employers and to employer group beneficiaries that have elected HMO
coverage. The Company receives an administrative fee for these services, but
does not assume underwriting risk. In addition, the Company offers a PPO product
to other third party payors, under which it provides rental of and access to the
Company's PPO network, claims repricing and utilization review, and does not
assume underwriting risk. A significant portion of the Company's management
services revenue in 1999 and 1998 was a result of the acquisition of certain PHC
health plans from Principal Life Insurance Company ("Principal Life"). The
Company recognized revenue under a Marketing Services Agreement, Management
Services Agreement and PPO access agreement with Principal Life. These
agreements have either expired or have been terminated as of December 31, 1999.
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20
As of December 31, 1999, Coventry had 1,202,304 members for whom it
assumes underwriting risk ("risk members") and 237,635 members of self-insured
employers for whom it provides management services but does not assume
underwriting risk ("non-risk members") in continuing operations. The following
tables show the total number of members in continuing operations as of December
31, 1999 and 1998.
COMMERCIAL RISK GOVERNMENTAL RISK
----------------------------------- -----------------------------------
HMO PPO/POS MEDICARE MEDICAID NON-RISK TOTAL
- --------------------------------------- --------------- ----------------- --------------------------------------------------------
1999
- --------------------
Pennsylvania 172,221 181,371 22,824 - 102,808 479,224
St. Louis 104,773 69,748 42,317 97,460 28,872 343,170
Delaware 35,529 139 - 21,032 59,978 116,678
West Virginia 44,937 19,291 990 13,750 13,636 92,604
Iowa 73,901 - 686 1,618 12,145 88,350
Kansas City 64,893 45 1,815 - 1,844 68,597
Richmond 37,650 7,268 - 8,415 14,345 67,678
Carolina 43,989 - - 4,216 - 48,205
Wichita 39,177 - - - 299 39,476
Louisiana 37,837 - - - 57 37,894
Nebraska 26,927 - - - 3,651 30,578
Georgia 27,485 - - - - 27,485
--------------------------------------------------------------------------------------------------------------
Total 709,319 277,862 68,632 146,491 237,635 1,439,939
==============================================================================================================
1998
- --------------------
Pennsylvania 200,688 175,919 25,571 - 88,785 490,963
St. Louis 138,031 62,615 38,028 81,505 23,029 343,208
Delaware 37,500 - - 16,829 58,062 112,391
West Virginia 6,379 18,620 - - 14,503 39,502
Iowa 77,912 - - 1,394 10,778 90,084
Kansas City 51,993 - - - 5,526 57,519
Richmond 51,980 264 - 3,015 14,812 70,071
Carolina 21,575 - - - - 21,575
Wichita 35,342 - - - 399 35,741
Louisiana 39,730 - - - 161 39,891
Nebraska 34,598 - - - 720 35,318
Georgia 20,273 - - - 748 21,021
--------------------------------------------------------------------------------------------------------------
Total 716,001 257,418 63,599 102,743 217,523 1,357,284
==============================================================================================================
The Company experienced strong sales and renewals for January 2000,
adding about 30,000 members, excluding Indiana membership, to December 1999
results. Commercial membership grew by about 12,000 members despite pricing
increases in most markets. Medicare membership was essentially flat, even though
the Company exited three counties in Pennsylvania and reduced benefits and
increased premiums in remaining service areas. Medicaid membership increased by
about 17,000 members mainly due to the increase of membership in the Delaware
plan, as a result of another carrier exiting the Medicaid program effective
December 31, 1999. The remaining 1,000 member increase was a result of modest
growth in non-risk membership.
Coventry's operating expenses are primarily medical costs, including
medical claims under contractual relationships with a wide variety of providers,
and capitation payments. Medical claims expense also includes an estimate of
claims incurred but not reported ("IBNR"). Coventry currently believes that the
estimates for IBNR liabilities are adequate to satisfy its ultimate medical
claims liability after all medical claims have been reported. In determining the
Company's IBNR liabilities, Coventry employs plan by plan standard actuarial
reserve methods (specific to the plan's membership, product characteristics,
geographic territories and provider network) that consider utilization frequency
and unit costs of inpatient, outpatient, pharmacy and other medical costs, as
well as claim payment backlogs and the timing of provider reimbursements.
Reserve estimates are reviewed by underwriting, finance and accounting, and
other appropriate plan and corporate personnel and judgments are then made as to
the necessity for reserves in addition to the estimated amounts. Changes in
assumptions for medical costs caused by changes in actual experience, changes in
the delivery system, changes in pricing due to ancillary capitation and
fluctuations in the claims backlog could cause these estimates to change in the
near term. Coventry
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periodically monitors and reviews its IBNR reserves, and as actual settlements
are made or accruals adjusted, reflects these differences in current operations.
PHC Acquisitions and Dispositions
Effective April 1, 1998, Coventry completed its acquisition of certain
health plans of PHC from Principal Mutual Life Insurance Company, now known as
Principal Life, for a total purchase price of approximately $330.2 million
including transaction costs of approximately $5.7 million. The acquisition was
accounted for using the purchase method of accounting and, accordingly, the
operating results of PHC have been included in Coventry's consolidated financial
statements since the date of acquisition. The purchase price consisted of
25,043,704 shares of Coventry's common stock at an assigned value of $11.96 per
share. In addition, a warrant valued at $25.0 million ("the Warrant") was issued
that grants Principal Life the right to acquire additional shares of Coventry's
common stock in the event that its ownership percentage of such common stock is
diluted below 40%. The Warrant is included as a component of additional paid-in
capital in the accompanying consolidated financial statements. Through April
2003, Principal Life is restricted from buying additional shares of Coventry's
common stock to increase its ownership percentage above 40%. As of December 31,
1999, Principal Life had exercised the Warrant to purchase 12,250 shares of the
Company's common stock.
Coincident with the closing of the transaction, Coventry entered into a
Renewal Rights Agreement and a Coinsurance Agreement with Principal Life, to
manage certain of Principal Life's indemnity health insurance policies in the
markets where Coventry does business and, on December 31, 1999, to offer to
renew such policies in force at that time. Effective June 1, 1999, Coventry
amended these agreements with Principal Life and waived its rights to reinsure
and renew Principal Life's health insurance indemnity business located in
Coventry's service area. Coventry received $19.8 million in cash in exchange for
waiving these rights. At the date of the amendment, the Renewal Rights and
Coinsurance Agreements had a net book value of $19.7 million resulting in an
after tax gain of $0.1 million.
At the closing, Coventry also entered into a License Agreement, which
was amended effective June 1, 1999, a Marketing Services Agreement and a
Management Services Agreement with Principal Life. All three agreements expired
on December 31, 1999. Pursuant to the latter two agreements, Coventry recognized
revenue of approximately $25.5 million and $23.0 million for the years ended
December 31, 1999 and 1998, respectively. Coventry no longer receives revenue
under these agreements. In anticipation of the loss of these fees, Coventry
commenced reducing selling, general and administrative ("SG&A") costs through
cost savings from service center consolidation, headcount reductions and
across-the-board reductions in administrative expenses. In addition to SG&A
reductions, Coventry plans to increase its gross margin through acquisitions and
by implementing rate increases.
As a result of the acquisition, Coventry assumed an agreement with
Principal Life, whereby Principal Life pays a fee for access to Coventry's PPO
network based on a fixed rate per employee entitled to access the PPO network
and a percentage of savings realized by Principal Life. Effective June 1, 1999,
Coventry sold the Illinois portion of the PPO network back to Principal Life.
Under this agreement, Coventry recognized revenue of approximately $8.0 million
and $12.0 million for the years ended December 31, 1999 and 1998, respectively.
Effective November 30, 1998, Coventry sold its subsidiary, Principal
Health Care of Illinois, Inc., for $4.3 million in cash. The Illinois health
plan accounted for approximately 56,000 risk members and approximately 2,400
non-risk members as of November 30, 1998.
On December 31, 1998, Coventry sold its subsidiary, Principal Health
Care of Florida, Inc., for $95.0 million in cash. The Florida health plan
accounted for approximately 156,000 risk members and approximately 5,500
non-risk members as of December 31, 1998.
The proceeds from both sales were used to retire Coventry's credit
facility, to assist in improving the capital position of its regulated
subsidiaries, and for other general corporate purposes. Given the short time
period between the respective acquisition and sale dates and the lack of events
or other evidence which would indicate differing
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22
values, no gain or loss was recognized on the sales of the Florida and Illinois
health plans, as the sale prices were considered by management to be equivalent
to the fair values allocable to these plans at the date of their acquisition
from Principal Life in April 1998.
In connection with the acquisition of certain PHC health plans and the
sales of the Florida and Illinois plans, Coventry established reserves of
approximately $33.0 million for the estimated transition costs of the PHC health
plans. These reserves are primarily comprised of severance costs related to
involuntary terminations of former PHC employees, relocation costs of former PHC
personnel, lease termination costs and contract termination costs. Through
December 31, 1999, Coventry has expended approximately $29.7 million related to
these reserves and expects to make payments on the remaining reserves through
July 2002.
In the fourth quarter of 1999, Coventry notified the Indiana Department
of Insurance of its intention to close its subsidiary, Coventry Health Care of
Indiana, Inc. As of December 31, 1999, the health plan had approximately 23,000
members throughout the state. As a result of the cost associated with exiting
the Indiana market, Coventry recorded a reserve of $2.0 million in the fourth
quarter of 1999. Coventry has expended approximately $0.4 million as of December
31, 1999 and expects to close the plan by the end of the fourth quarter 2000.
The Indiana health plan was not operating profitably or demonstrating
good prospects for future growth. Although closing the plan will not have a
substantial impact on consolidated earnings, it will allow Coventry to focus
resources and management attention on its other markets. Coventry's transition
plan gives employers and members ample time to obtain health care coverage
through one of the many other companies operating in Indiana.
In the fourth quarter of 1999, the Company's PHC subsidiaries changed
the word Principal in their names to Coventry. All aspects of the health plans'
operations, such as member coverage and access, remain unchanged. After the
merger on April 1, 1998, the PHC plans continued to use the Principal brand name
under the terms of the License Agreement as amended, between the parties, even
though the Plans were no longer subsidiaries of Principal Life.
Other Acquisitions
Effective October 1, 1999, the Company acquired Carelink Health Plans
("Carelink"), the managed care subsidiary of Camcare, Inc., for a total purchase
price of approximately $8.3 million including transaction costs of approximately
$0.3 million. The acquisition was accounted for using the purchase method of
accounting, and accordingly the operating results of Carelink have been included
in the Company's consolidated financial statements since October 1, 1999, the
date of the acquisition. The purchase price for Carelink was allocated to the
assets, including the identifiable intangible assets, and liabilities based on
estimated fair values. The $4.7 million excess of purchase price over the net
identified tangible assets acquired was allocated to goodwill, which is being
amortized over a useful life of 25 years. The final purchase price may be
adjusted subject to the results of the final determination of the balance sheet
of Carelink as of October 1, 1999. Carelink is the market leader and has a broad
provider network in West Virginia with a service area covering the majority of
the state's population.
On November 1, 1999, the Company's subsidiary, Coventry Health Care of
the Carolinas, Inc., acquired Kaiser Foundation Health Plan of North Carolina,
Inc.'s (KFHPNC) commercial membership in Charlotte, North Carolina. The total
purchase price was approximately $1.8 million including transaction costs. The
transaction more than doubles Coventry's membership in the Charlotte market.
Effective February 1, 2000, the Company completed its acquisition of The
Anthem Company's West Virginia managed care subsidiary, PrimeONE, Inc.,
("PrimeONE"), for the total purchase price of approximately $3.9 million
including acquisition costs. The $1.5 million excess of purchase price over the
net identifiable tangible assets acquired was allocated to goodwill. The
acquisition expands Coventry's West Virginia service area and brings its total
membership in the state to over 109,000 members. This transaction combined with
the Carelink acquisition solidifies Coventry's market leadership position in
West Virginia.
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On February 3, 2000, Coventry completed the acquisition of Prudential
Health Care Plan, Inc.'s 11,800-member Medicaid business in St. Louis, Missouri
at approximately $100 per member. The acquisition brings Coventry's total
Medicaid membership in St. Louis to more than 106,000 members, expanding
Coventry's leading position in the market.
Medical Office Dispositions
Effective March 31, 1997, the Company completed the sale of the medical
offices associated with HealthAmerica Pennsylvania, Inc., ("HealthAmerica"), in
Pittsburgh, Pennsylvania, to a major health care provider organization. The
sales price was $20.0 million, resulting in a pretax gain to the Company of
approximately $6.0 million. Coincident with the sale, the Company entered into a
long-term global capitation agreement with the purchaser which increased the
Company's globally capitated membership in western Pennsylvania to approximately
250,000 members. Under the agreement, the provider organization received a fixed
percentage of premiums to cover all of the medical treatment the globally
capitated members received. The provider organization filed for bankruptcy
protection on July 21, 1998 and, as a result, the Company is no longer operating
under this agreement. See "Legal Proceedings - Settlement with AHERF Related
Entities."
Effective May 1, 1997, the Company completed the sale of the medical
offices associated with GHP, its health plan in St. Louis, Missouri, to a major
health care provider organization. The sales price was $26.9 million, resulting
in a pretax gain to the Company of approximately $9.6 million. Coincident with
the sale, the Company entered into a long-term global capitation agreement with
the purchaser covering approximately 83,000 members, pursuant to which the
provider organization receives a fixed percentage of premiums to cover all of
the medical treatment the globally capitated members receive.
In August 1997, the Company entered into agreements to sell certain
remaining medical offices associated with HealthAmerica in Harrisburg,
Pennsylvania. The sales price was $2.4 million, resulting in a pretax loss to
the Company of $0.6 million. All gains or losses resulting from medical office
sales are reflected in other income, net, in the accompanying Consolidated
Statement of Operations for the year ended December 31, 1997.
Legal Proceedings
SETTLEMENT WITH AHERF RELATED ENTITIES. The Company and certain
affiliated hospitals of Allegheny Health, Education and Research Foundation
(AHERF) were involved in litigation to determine if the Company had the
financial responsibility for medical services provided to the Company's members
by the hospitals as a consequence of the bankruptcy filed by AHERF on July 21,
1998. As a result of the bankruptcy, AHERF failed to pay for medical services
under its global capitation agreement with the Company covering approximately
250,000 Company members in the western Pennsylvania market. Shortly after AHERF
filed for bankruptcy protection, the Company filed a lawsuit against AHERF's
non-debtor, affiliated hospitals seeking monetary damages and a declaratory
judgment that the Company was not obligated to pay in excess of $21.5 million to
the hospitals for medical services provided by them to the Company's members and
the hospitals filed a counterclaim for payment of these services. As a result,
the Company, which was ultimately responsible for medical costs delivered to its
members, notwithstanding the global capitation agreement, recorded a charge of
$55.0 million in the second quarter of 1998 to establish a reserve for, among
other things, the medical costs incurred by its members under the AHERF global
capitation agreement at the time of the bankruptcy filing. On July 22, 1999, the
Company reached a settlement with the hospitals, including Allegheny General
Hospital, formerly owned by AHERF, and its new owner, Western Pennsylvania
Health Care System ("West Penn"), whereby the hospitals agreed that the Company
would not be liable for the payment of certain medical services rendered by the
hospitals to the Company's members prior to July 21, 1998, the date of AHERF's
bankruptcy filing. Simultaneous with the settlement, the Company signed a new
three-year provider contract with West Penn. The conditions to execute the
settlement and the provider contract were finalized in October 1999 and, as a
result, all liability issues surrounding AHERF's failure to fulfill its
contractual obligations and Coventry's remaining obligations have been
determined and all AHERF-related litigation has been concluded. As of December
31, 1999, approximately $35.4 million of the $55.0 million reserve had been paid
for medical claims. As a result of the settlement, Coventry released $6.3
million from the reserve, which was reflected as a gain in the fourth quarter
and year-end 1999 results. The balance of the reserve represents
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Coventry's remaining obligations under the settlement and will be expended
through August 2007.
UNITY ARBITRATION. Group Health Plan, Inc. ("GHP"), a health plan
subsidiary of the Company, entered into an agreement, effective January 1, 1998,
with Unity Health Network, L.L.C. ("Unity") for Unity's provider network to
provide health care services to GHP's members in the southern and western areas
of St. Louis County, Missouri. The agreement contained risk sharing provisions.
Disputes arose under the agreement and the matter was submitted to arbitration
before the American Arbitration Association ("AAA"). GHP demanded payment from
Unity of $7.6 million and specific performance under the agreement. Unity
demanded payment from GHP of $14.5 million, specific performance of certain
provisions of the agreement and suspension of its payment obligations. On
December 23, 1999, the AAA tribunal of arbitrators awarded GHP the sum of $1.1
million for deficiencies in risk fund pools for 1998, and awarded Unity the sum
of $1.8 million as liquidated damages for GHP's failure to meet certain
administrative performances standards, and held Unity contractually liable for
funding any deficits in the risk fund pools for 1999. The only remaining issue
pending is the readjudication of certain disputed claims submitted subsequent to
June 30, 1999.
BJC. Effective May 1, 1997, the Company completed its sale of the
medical offices associated with Group Health Plan, Inc., its health plan in St.
Louis, Missouri, to BJC Health System ("BJC"), a major provider organization in
the St. Louis market, for approximately $26.9 million. Upon the sale, the
Company entered into a long-term global capitation agreement with BJC, since
amended, that covered approximately 33.3% of the risk membership in St. Louis at
December 31, 1998. Under the agreement, BJC receives a fixed percentage of
premium to cover all of the medical treatment received by the globally capitated
members. Global capitation agreements limit the Company's exposure to the risk
of increasing medical costs, but expose the Company to risk as to the adequacy
of the financial and medical care resources of the provider organization. To the
extent that the respective provider organization faces financial difficulties or
otherwise is unable to perform its obligations under the global capitation
agreements, the Company, which is responsible for the coverage of its members
pursuant to its customer agreements, will be required to perform such
obligations, and may have to incur costs in doing so in excess of the amounts it
would otherwise have to pay under the global capitation agreements. Various
disputes alleging breaches have arisen under the BJC global capitation agreement
concerning the accuracy and timeliness of claims payments, and the accuracy of
membership reconciliations that would affect the amount of premiums paid to BJC
to provide its services under the agreement. BJC contends that these alleged
breaches entitles it to terminate the agreement. Although the parties are
obligated to arbitrate their disputes under the terms of the agreement, the
parties have agreed to attempt to negotiate a resolution of the various issues
concurrent with arbitration. While the Company acknowledges certain claims
payment inaccuracies, the Company denies the remaining allegations and
vigorously disputes that any such claims constitute a material breach of the
agreement. Management does not believe that the outcome of these disputes
will have a material impact on the consolidated financial statements, although
there can be no assurances in this regard.
OTHER LEGAL ACTIONS. In the normal course of business, the Company has
been named as a defendant in various legal actions seeking payments for claims
denied by the Company, medical malpractice, and other monetary damages. The
claims are in various stages of proceedings and some may ultimately be brought
to trial. Incidents occurring through December 31, 1999 may result in the
assertion of additional claims. With respect to medical malpractice, the Company
carries professional malpractice and general liability insurance for each of its
operations on a claims-made basis for which the Company maintains reserves. In
the opinion of management, the outcome of these actions should not have a
material adverse effect on the financial position or results of operations of
the Company.
Other managed care companies have been sued recently in class action
lawsuits claiming violations of the federal racketeering act (RICO) and federal
employee benefits law (ERISA), and generally claiming that managed care
companies overcharge consumers and misrepresent that they deliver quality health
care. Although it is possible that the Company may be the target of a similar
suit, the Company believes there is no valid basis for such a suit.
The Company's industry is heavily regulated and the laws and rules
governing the industry and interpretations of those laws and rules are subject
to frequent change. Existing or future laws could have significant impact on the
Company's operations.
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COMPARISON OF 1999 TO 1998
Managed care premiums increased $48.7 million in 1999, or 2.4%, over
1998. The increase is primarily attributable to the additional revenue
associated with the acquisitions of Carelink and the KFHPNC membership in the
fourth quarter of 1999 and also due to the increase in Medicare risk and
Medicaid membership of 34,345, or 20.6%, in continuing markets. In addition to
the increase in risk membership, premiums increased by an average of $9.0, or
6.3%, over 1998 on a per member per month ("PMPM") basis, to $150.8 PMPM, as a
result of rate increases. The Medicare Risk and Medicaid programs continue to
grow in existing markets through recently expanded programs. On a same store
basis, the increase in Medicare risk and Medicaid membership was offset by a
decrease in commercial membership of 57,321, or 5.7%. The decrease in commercial
membership occurred primarily in the western Pennsylvania market, attributable
to the disruption caused by the AHERF bankruptcy filing and the conversion of a
large group from a commercial risk product to a self-funded product. Membership
also decreased in other markets due to Coventry's efforts to adhere to a strict
pricing discipline. Coventry will continue to be diligent in attempting to
obtain adequate premium increases and expects premium rates to increase 8% to
10% for renewals in the first quarter of 2000.
Management services revenue increased $3.3 million in 1999, or 4.3%,
from the prior year. The increase in management service revenue is primarily
attributable to an increase in self-funded membership of 19,695, or 9.0%,
including the conversion of a large group from a commercial risk product to a
self-funded product.
Health benefits expense increased $25.3 million, or 1.4%, in 1999,
compared to 1998 due primarily to the additional expenses associated with the
acquisitions of Carelink and KFHPNC membership. Exclusive of the Carelink and
KFHPNC transactions, health benefits expense decreased $4.0 million. Coventry's
medical loss ratio decreased slightly to 86.1% from 86.9% in 1998 due to premium
rate increases which were a result of Coventry's efforts to maintain a strict
pricing discipline.
Medical claim liability accruals are periodically monitored and reviewed
with differences for actual settlements from reserves reflected in current
operations. In addition to the procedures for determining reserves as discussed
above, the Company reviews the actual payout of claims relating to prior period
accruals, which may take up to six months to fully develop. Medical costs are
affected by a variety of factors, including the severity and frequency of
claims, that are difficult to predict and may not be entirely within the
Company's control. The Company continually refines its reserving practices to
incorporate new cost events and trends.
SG&A expense increased $6.0 million, or 2.1%, from 1998. SG&A expense,
as a percent of revenue, remained unchanged at 13.8% in 1999, compared to 1998.
The increase in SG&A expense was primarily attributable to additional expense
associated with the acquired Carelink health plan and Coventry's consolidation
of eighteen service centers into three regional service centers. In an effort to
control costs and improve customer service, Coventry is in the process of
transferring certain of its operating activities (e.g., customer service, claims
processing, billing and enrollment) to regional service centers. All activities
are expected to be fully transferred by the end of the fourth quarter of 2000.
Depreciation and amortization increased $2.4 million, or 9.4%, compared
to the prior year primarily as a result of the depreciation related to the net
capital expenditures of $14.7 million in 1999 and the additional amortization
related to the intangibles recorded as part of the acquisition of the PHC health
plans in April 1998.
Other income, net of interest expense, increased $9.5 million, or 50.6%,
in 1999 from 1998, primarily due to the reduction of interest expense from the
reduction of debt and increased investment income resulting from the increase in
invested assets subsequent to the acquisition of the PHC health plans.
Earnings from operations increased $84.1 million, or 232.2% in 1999,
compared to 1998. Excluding charges related to AHERF, plan shutdown expense and
the relocation of the corporate office, operating earnings increased $18.3
million, or 72.3%, attributable to the various factors described above.
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26
Coventry's net income was $43.4 million in 1999 compared to a loss of
$11.7 million in 1998. Net income per diluted share was $0.69 in 1999 compared
to a net loss per diluted share of $0.22 in 1998. Excluding the AHERF charge,
plan shutdown expense and merger costs, Coventry would have reported earnings
per diluted share of $0.65 and $0.49 in 1999 and 1998, respectively. The
weighted average common shares outstanding were approximately 64,159,000 and
52,477,000 on a diluted basis for the years ended December 31, 1999 and 1998,
respectively.
COMPARISON OF 1998 TO 1997
Managed care premiums increased $825.2 million, or 68.3%, in 1998
compared to 1997. The PHC plans accounted for approximately $697.7 million, or
84.6%, of the increase. Exclusive of the PHC plans, the Medicare risk membership
increased by 25,285 members, or 66.0%. Medicare risk membership has a
significantly higher per member per month premium (approximately three times)
when compared to commercial risk membership and represented an increase in
premiums, exclusive of the PHC plans, of $117.9 million from $161.1 million in
1997 to $279.0 million in 1998. The increase in Medicare risk membership was
offset by a 20,047 decrease in Medicaid risk membership primarily resulting from
the Company's decision to exit the Medicaid market in Pennsylvania in the first
quarter of 1998. In addition, revenues per member per month, exclusive of the
PHC plans, increased by 3.3% for HMO members, 8.3% for PPO/POS members and 5.5%
for Medicaid members in 1998 over 1997. Excluding Medicaid membership, risk
membership grew by 25,885, or 3.9%. The Company implemented rate increases that
averaged approximately 7.0% in the fourth quarter of 1998.
The Company has exited the Medicare program in several counties
representing approximately 18,000 members as of December 31, 1998. Approximately
10,000 of those members were in the Illinois and Florida health plans that were
sold effective November 30, 1998 and December 31, 1998, respectively.
Management services revenue increased $56.8 million for the year ended
December 31, 1998, or 281.2%, from the prior year. Management services and
marketing services agreements that were entered into coincident with the
acquisition of the PHC plans accounted for approximately $23.0 million, or
40.5%, of the increase. Approximately $30.5 million, or 53.7%, of the increase
is primarily attributable to the PHC Administrative Services Only ("ASO")
operations and PPO access fees. Exclusive of the PHC plans and the related
agreements with Principal Life, management services revenue increased
approximately $3.3 million, or 5.8%, attributable to transition services related
to global capitation agreements and rate increases to ASO customers.
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MEMBERSHIP
COMMERCIAL RISK GOVERNMENTAL RISK
------------------------------------------------------------------
HMO PPO/POS MEDICARE MEDICAID NON-RISK TOTAL
--------------------------------------------------------------------------------------------------------
1998
- ----------------------
Pennsylvania (1) 207,067 194,539 25,571 - 103,288 530,465
St. Louis (2) 138,031 62,615 38,028 81,505 23,029 343,208
Richmond 51,980 264 - 3,015 14,812 70,071
Nebraska 34,598 - - - 720 35,318
Kansas City 51,993 - - - 5,526 57,519
Wichita 35,342 - - - 399 35,741
Louisiana 39,730 - - - 161 39,891
Delaware 37,500 - - 16,829 58,062 112,391
Iowa 77,912 - - 1,394 10,778 90,084
Indiana 27,280 - - - 750 28,030
Georgia 20,273 - - - 748 21,021
Carolina 21,575 - - - - 21,575
--------------------------------------------------------------------------------------------------------
Total 743,281 257,418 63,599 102,743 218,273 1,385,314
========================================================================================================
1997
- ----------------------
Pennsylvania (1) 238,122 174,157 12,141 23,683 111,087 559,190
St. Louis 103,456 52,932 26,173 78,323 21,281 282,165
Richmond 54,095 180 - 2,561 16,542 73,378
--------------------------------------------------------------------------------------------------------
Total 395,673 227,269 38,314 104,567 148,910 914,733
========================================================================================================
(1) Pennsylvania includes West Virginia membership in 1998 and 1997.
(2) St. Louis includes PHC of St. Louis membership in 1998.
Health benefits expense increased $727.5 million for the year ended
December 31, 1998, or 70.0%, compared to 1997. The PHC plans accounted for
approximately $612.5 million, or 84.2%, of the increase. The Company's medical
loss ratio increased slightly to 86.9% from 86.1% in the previous year,
primarily as a result of increases in Medicare membership.
As previously discussed, in July 1998, AHERF, the global capitation
provider organization in western Pennsylvania, filed for bankruptcy protection
under Chapter 11. On July 22, 1999, the Company reached a settlement with the
non debtor, affiliated hospitals, including Allegheny General Hospital (AGH),
formerly owned by AHERF, and its new owner, Western Pennsylvania Health Care
System ("West Penn"), whereby the hospitals agreed that the Company would not be
liable for the payment of certain medical services rendered by the hospitals to
the Company's members prior to July 21, 1998, the date of AHERF's bankruptcy
filing. Simultaneous with the settlement, the Company signed a new three-year
provider contract with West Penn. The conditions to execute the settlement and
the provider contract were finalized in October 1999 and, as a result, all
liability issues surrounding AHERF's failure to fulfill its contractual
obligations and Coventry's remaining obligations have been determined and all
AHERF-related litigation has been concluded.
SG&A expense for the year ended December 31, 1998 increased $121.9
million, or 71.7%, compared to 1997. The PHC plans accounted for approximately
$92.8 million, or 76.1%, of the increase. The remainder of the increase in SG&A
is primarily attributable to the increased costs relating to administrative
processes, particularly in claims processing, associated with the growth of the
Medicare product in certain markets. SG&A expense as a percent of revenue
remained at 13.8% for the year ended 1998. In an effort to control costs and
improve customer service, the Company started the process of migrating certain
of its operating activities (e.g., customer service, claims processing, billing
and enrollment) to regional service centers.
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Depreciation and amortization for the year ended December 31, 1998
increased $13.1 million, or 102.5%, compared to 1997. Depreciation expense from
the PHC plans accounted for approximately $2.3 million, or 17.6%, of the
increase. The remainder of the increase is attributable to the amortization of
intangibles and goodwill recorded in connection with the acquisition of the PHC
plans.
Loss from operations was $36.2 million for the year ended December 31,
1998. Excluding the $61.5 million of charges associated with the AHERF
bankruptcy and the relocation of the corporate headquarters and other merger
related costs, operating earnings were $25.3 million for the year ended December
31, 1998 compared to $5.7 million for the corresponding period in 1997. The
increase in the operating earnings, exclusive of the $61.5 million of charges in
1998, is attributable to various factors as previously described.
Other income, net of interest expense, increased $4.1 million for the
year ended December 31, 1998, or 27.9%, from the corresponding period in the
prior year. Other income, net of interest expense, related to the PHC plans
accounted for approximately $10.1 million, or 246.3%, of the increase. Exclusive
of the PHC plans, other income, net of interest expense, decreased by $6.0
million. This reduction was primarily attributable to a $15.0 million pre-tax
gain related to the sale of medical offices that was recognized in the prior
year, offset by increased investment income resulting from the increase in
invested assets subsequent to the acquisition of the PHC plans.
The Company's net loss was $11.7 million for the year ended December
31, 1998. Net loss per common and common equivalent share was $0.22 for the year
ended December 31, 1998 compared to earnings per common and common equivalent
share of $0.35 for the corresponding period in 1997. Excluding the $61.5 million
of charges associated with the AHERF bankruptcy and the relocation of the
corporate headquarters and other merger related costs, the Company reported
basic earnings per common and common equivalent share of $0.50 in 1998. The
weighted average number of common shares outstanding were approximately
52,477,000 and 33,912,000 for the years ended December 31, 1998 and 1997,
respectively. The increase in the weighted average number of shares outstanding
in 1998 was primarily attributable to the shares issued in April 1998 related to
the acquisition of the PHC plans. Effective in the fourth quarter of 1997, the
Company adopted SFAS 128, "Earnings Per Share." Accordingly, prior periods have
been restated.
LIQUIDITY AND CAPITAL RESOURCES
The Company's total cash and investments, excluding deposits of $24.8
million restricted under state regulations, decreased $8.5 million to $589.8
million at December 31, 1999 from $598.3 million at December 31, 1998. This
decrease was primarily a result of approximately $55.6 million that was used to
pay the amount of medical claims for Principal Health Care of Florida, Inc. and
Principal Health Care of Illinois, Inc., the two plans that were sold effective
December 31, 1998 and November 30, 1998, respectively. The decrease is also
attributable to the Company's efforts to reduce medical claims inventory in
1999.
The Company's investment guidelines emphasize investment grade fixed
income instruments in order to provide short-term liquidity and minimize the
risk to principal. The Company believes that since its long-term investments are
available-for-sale, the amount of such investments should be added to current
assets when assessing the Company's working capital and liquidity; on such
basis, current assets plus long-term investments available-for-sale less
short-term liabilities increased to $246.7 million at December 31, 1999 from
$187.8 million at December 31, 1998.
The Company's HMOs and its insurance company subsidiary, Coventry Health
and Life Insurance Company ("CHLIC"), are required by state regulatory agencies
to maintain minimum surplus balances, thereby limiting the dividends the Company
may receive from its HMOs and its insurance company subsidiary. After giving
effect to these statutory reserve requirements, the Company's HMO subsidiaries
had surplus in excess of statutory requirements of approximately $102.6 million
and $93.4 million at December 31, 1999 and December 31, 1998, respectively.
CHLIC had surplus in excess of statutory requirements of approximately $15.0
million and $7.8 million at December 31, 1999 and 1998, respectively. Excluding
funds held by entities subject to regulation, the Company had cash and
investments of approximately $61.1 million and $96.8 million at December 31,
1999 and
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December 31, 1998, respectively, which are available to pay intercompany
balances to regulated subsidiaries and for general corporate purposes. The
Company also has entered into agreements with certain of its regulated
subsidiaries to provide additional capital if necessary to prevent the
subsidiary's insolvency.
On December 29, 1997, the Company entered into a credit agreement with
a group of banks (the "Credit Facility"), which replaced a prior credit
agreement. Using a portion of the proceeds received from the sale of its Florida
health plan, the Company retired the Credit Facility and the $42.2 million
balance then outstanding effective December 31, 1998. On December 31, 1998, the
effective interest rate on the indebtedness retired was 7.0625%.
During the quarter ended June 30, 1997, the Company entered into a
securities purchase agreement ("Warburg Agreement") with Warburg, Pincus
Ventures, L.P. ("Warburg") and Franklin Capital Associates III, L.P.
("Franklin") for the purchase of $40.0 million of Coventry's 8.3% Convertible
Exchangeable Senior Subordinated Notes ("Coventry Notes"), together with
warrants to purchase 2.35 million shares of the Company's common stock for
$42.35 million. The original amount of the Coventry Notes, $36.0 million held by
Warburg and $4.0 million held by Franklin, were exchangeable at Coventry's or
Warburg's option for shares of redeemable convertible preferred stock.
During the second and third quarters of 1999, Coventry converted all
Coventry Notes held by Warbu