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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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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 Warburg and Franklin totaling $47.1 million, including
interest, into 4,709,545 shares of Series A redeemable convertible preferred
stock ("preferred stock") at a price of $10 per share. The preferred stock is
subject to mandatory redemption at a price of $10 per share, plus accrued
dividends, in an amount equal to one-third of the shares outstanding on May 15,
2002, 2003 and 2004. The stock is carried at its fair value, which equals both
its redemption value and liquidation value as of December 31, 1999 and will
accrue dividends only if the Board of Directors declares dividends on common
stock. The dividends (per share) on the preferred stock would be equal to the
dividends on the common stock. The preferred stock may be converted at any time
at the holders' option into shares of common stock at a conversion price equal
to the closing market price of the Company's common stock on the date of
conversion, if the closing market price is less than $10 per share. If the
closing market price of the Company's common stock is greater than $10 per
share, the preferred stock is convertible to common stock on a share for share
basis. The preferred stock is callable by the Company if the market price of
the Company's common stock exceeds certain agreed upon targets.
Projected capital investments in 2000 of approximately $15.0 million
consist primarily of computer hardware, software and related equipment costs
associated with the development and implementation of improved operational and
communications systems.
The Company believes that cash flows generated from operations, cash
on hand and investments, and excess funds in certain of its regulated
subsidiaries will be sufficient to fund continuing operations through December
31, 2000.
SHARE REPURCHASE PROGRAM
On December 20, 1999, the Company announced a program to purchase up to
5% of its outstanding common stock. Stock repurchases may be made from time to
time at prevailing prices in the open market, by block purchase or in private
transactions. Coventry had approximately 64.2 million diluted shares of common
stock outstanding as of December 31, 1999.
As part of a program previously authorized by the Board of Directors, as
of March 23, 2000, the Company purchased approximately 826,200, 55,396 and
439,560 shares of its common stock in 2000, 1999 and 1997, respectively, for the
treasury at an aggregate cost of $6.4 million, $0.4 million and $5.0 million in
2000, 1999 and 1997, respectively.
LEGISLATION AND REGULATION
Numerous proposals have been introduced in the United States Congress
and various state legislatures relating to health care reform. Some proposals,
if enacted, could among other things, restrict the Company's ability to raise
prices and to contract independently with employers and providers. Certain
reform proposals favor the growth of
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managed health care, while others would adversely affect managed care. Although
the provisions of any legislation adopted at the state or federal level cannot
be accurately predicted at this time, management of the Company believes that
the ultimate outcome of currently proposed legislation would not have a material
adverse effect on the Company and its results of operations in the short-term.
LITIGATION AND INSURANCE
The Company may be subject to certain types of litigation, including
medical malpractice claims, claim disputes pertaining to contracts and other
arrangements with providers, employer groups and their employees and individual
members, and disputes relating to HMO denials of coverage for certain types of
medical procedures or treatments. In addition, the Company has contingent
litigation risk in connection with certain discontinued operations. Such
litigation may result in losses to the Company. The Company maintains insurance
coverage in amounts it believes to be adequate, including professional liability
(medical malpractice) and general liability insurance. Contracting physicians
are required to maintain professional liability insurance. In addition, the
Company carries "stop-loss" reinsurance to reimburse it for costs resulting from
catastrophic injuries or illnesses to its members. Nonetheless, no assurance can
be given as to the future availability or cost of such insurance and reinsurance
or that litigation losses will not exceed the limits of the insurance coverage
and reserves. In the opinion of management and based on the facts currently
known, the outcome of these actions should not have a material adverse effect on
the financial position or results of operations of the Company.
NEW ACCOUNTING STANDARDS
The Financial Accounting Standards Board ("FASB") has issued Statement
of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share", which
became effective for both interim and annual reporting periods that ended after
December 15, 1997. The Company adopted the new standard in its reporting for the
quarter and the year ended December 31, 1997, including required restatement of
prior periods. The adoption of this standard did not have a material impact on
earnings per share.
The FASB has also issued SFAS No. 130, "Reporting Comprehensive
Income," which became effective for fiscal years that began after December 15,
1997. SFAS No. 130 requires that changes in the amounts of certain items,
including unrealized gains and losses on certain securities, be reflected in the
financial statements. The Company adopted SFAS 130 effective January 1, 1998.
The adoption of this standard did not have a material effect on the Company's
consolidated financial statements.
The FASB has also issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." This standard requires that a public
business enterprise report financial and descriptive information about its
reportable operating segments. Operating segments are components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance. SFAS No. 131 also requires that
all public business enterprises report information about the revenues derived
from the enterprise's products or services (or groups of similar products and
services), about the countries in which the enterprise earns revenues and holds
assets and about major customers regardless of whether that information is used
in making operating decisions. Effective December 31, 1998, the Company adopted
SFAS 131.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS 133 requires companies to record
derivatives on the balance sheet as assets or liabilities, measured at fair
value. Gains or losses resulting from changes in the values of the derivatives
would be accounted for depending on the use of the derivatives and whether they
qualify for hedge accounting. In June 1999, the FASB also issued SFAS No. 137
("SFAS 137"), which defers the effective date of SFAS 133 until fiscal years
beginning after June 15, 2000. The Company does not believe that adoption of
SFAS 133 (as amended by SFAS 137) will have a material effect on its future
results of operations.
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 98-1 ("SOP 98-1"), "Accounting for the
Costs of Computer Software Developed or Obtained for Internal
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Use." SOP 98-1 provides authoritative guidance for the capitalization of certain
costs related to computer software developed or obtained for internal
applications, such as external direct costs of materials and services, payroll
costs for employees and certain interest costs. Costs incurred during the
preliminary project stage, as well as training and data conversion costs, are to
be expensed as incurred. SOP 98-1 is effective for fiscal years that began after
December 15, 1998. The Company adopted SOP 98-1 effective January 1, 1999. The
adoption of SOP 98-1 did not have a material effect on the Company's
consolidated financial statements.
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INFLATION
Health care cost inflation has exceeded the general inflation rate and
the Company has implemented cost control measures and risk sharing arrangements,
which seek to reduce the effect of health care cost inflation. During 1999, the
Company implemented increases in premium rates which exceeded inflationary cost
increases while maintaining competitive rates within its markets.
QUARTERLY RESULTS OF OPERATIONS
The unaudited quarterly consolidated results of operations of the Company
are summarized in Item 6: Selected Consolidated Financial Data, Supplementary
Financial Information.
2000 OUTLOOK
The Company's membership in January 2000 was approximately 1,485,000
members, an increase of 6.3% over January 1999. The increase was primarily
attributable to the acquisitions in North Carolina and West Virginia. Of the
January 2000 membership, approximately 1,246,000 were risk members and
approximately 239,000 were non-risk members.
The Company operates in highly competitive markets, but generally
believes that the pricing environment is improving in its existing markets, thus
creating the opportunity for reasonable price increases. However, there is no
assurance that the Company will be able to increase premiums at rates equal to
or in excess of increases in its health care costs.
For 2000, the Company continues to pursue ways to improve its
underwriting processes and oversight in both risk and management services
products with the objective of increasing premium yields and profitable growth
in its markets. The Company's migration of certain of its operating activities
(e.g., customer service, claims processing, billing and enrollment) to regional
service centers is expected to be completed by the end of the fourth quarter of
2000. The Company expects that the regional service centers will allow it to
provide improved levels of service in a more cost effective manner. The
integration of the PHC health plans has allowed the Company to strengthen its
balance sheet and gain entry into additional markets. Management believes that
existing markets have potential for growth for the Company's commercial and
governmental products. Management believes that the foregoing should result in
progressive improvements in 2000, although realization is dependent upon a
variety of factors, some of which may be outside the control of the Company.
E-COMMERCE INITIATIVES
The Company is launching several e-commerce initiatives. Each initiative
is intended to reach a segment of our core business customers: providers,
brokers, employers and members, and will have a distinct e-commerce solution.
PROVIDER CHANNEL. In February 2000, the Company entered into a three-year
agreement with Healtheon/WebMD, the first end-to-end Internet healthcare company
connecting physicians and consumers to the entire healthcare industry.
Initially, the Company will use Healtheon/WebMD's Internet services to manage
the electronic submission and processing of eligibility determination, referrals
and authorizations, claims submission, claim status, and reporting. Upon
completion of the roll-out, Healtheon/WebMD will also provide administrative
services to the providers in the Company's health plans' networks who have
signed up for WebMD Practice. It is expected that this relationship will
significantly improve service to our members and reduce administrative costs.
BROKER/EMPLOYER CHANNEL. In February 2000, the Company entered into a two-year
agreement with Workscape, Inc. ("Workscape"), which specializes in the
development of Internet solutions for the insurance industry. Workscape will
focus on automating the full broker/small employer relationship, including
enrolling customers, providing benefits information, generating customized
proposals, registering agents, processing applications, underwriting
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risk, and calculating rates. The Company will initially implement this
initiative in its Pittsburgh and Harrisburg, Pennsylvania markets, and then into
its other markets.
MEMBER CHANNEL. In March 2000, the Company announced a one-year agreement with
GeoAccess to implement GeoAccess' online healthcare directory technology. This
technology makes information about health plan providers available to members.
The online directories will be available in all the Company's health plans.
ProviderLookup Online uses GeoAccess' proprietary distance-calculation
technology, which provides precise results about the providers located closest
to an individual's address. The Company's members will be able to search for
providers by name, geographic proximity or specific criteria.
YEAR 2000
The Company has been aware of the "Year 2000" issue that has the
potential to affect products and systems that were not designed to properly
handle the transition between the twentieth and twenty-first centuries. The
Company recognized the need to ensure that its business operations would not be
adversely impacted by the Year 2000, and it implemented a Year 2000 readiness
program to facilitate the necessary readiness preparations. Through December 31,
1999, the Company incurred approximately $13.1 million in its Year 2000
assessment and remediation program, and it does not expect to incur significant
further costs in this program. Prior to the end of 1999, the Company completed
its readiness assessment and its implementation of all plans for handling
anticipated readiness risks. The Company's transition from 1999 to 2000 occurred
without any major business disruption. With the transition into the Year 2000
complete, the Year 2000 issue has not had, and the Company believes it will not
have, a material impact on the Company's business, financial condition or
results of operations.
RISK FACTORS
The risks described below are not the only ones that we face. Additional
risks not presently known to us or that we currently deem immaterial may also
impair our business operations.
Our business, financial condition or results of operations could be
materially adversely affected by any of these risks. Further, the trading price
of our common stock could decline due to any of these risks, and you may lose
all or part of your investment.
HEALTH CARE COSTS MAY RISE FASTER THAN OUR ABILITY TO INCREASE OUR PREMIUM
RATES, CAUSING OUR PROFIT MARGINS TO SHRINK WHICH MAY IN TURN REDUCE OUR NET
INCOME AND ADVERSELY AFFECT THE VALUE OF YOUR INVESTMENT IN COVENTRY.
In the future, the costs of health care services and supplies that we
provide to our membership may rise faster than our ability to increase premium
rates. If costs rise and we are unable to increase premium rates, our profit
margins will shrink. Shrinking profit margins may reduce our net income and
adversely affect the value of your investment in Coventry. Premium rates for
managed care plans generally have increased in recent months, but we could
experience unforeseen decreases or severely limited increases in future premium
rates. Also, 27.5% of our premium revenues through February 29, 2000 were
derived from governmental programs, including Medicare and Medicaid. The
government generally fixes these premium rates and we cannot adjust them based
on our anticipated costs. Recent legislation has limited Medicare premium rate
increases substantially as compared to increases permitted in prior years. As a
result, in the future the total costs of our government programs could exceed
the total premiums that we receive from these programs.
IF WE ARE UNABLE TO INCREASE OUR REVENUES AND OUR PROFIT MARGINS SHRINK, OUR NET
INCOME MAY DECREASE AND THE VALUE OF YOUR INVESTMENT IN COVENTRY MAY DECLINE.
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In the future, we may not be able to increase or maintain our current
revenues. Since we no longer receive revenues under our agreements with
Principal Life, which expired on December 31, 1999, there is a risk that we may
not be able to replace the revenues generated from these fees. We recognized
revenues from these agreements of $25.5 million in 1999 and $23.0 million in
1998. We may also be unable to reduce our costs or increase our premium
rates. If we are faced with shrinking profit margins and are unable to
increase our revenues, we will have a decline in net income, which could
adversely affect the value of your investment in Coventry.
Increases in our revenues will be generally dependent upon our ability
to increase premiums and membership. In addition to the loss of revenues
generated from the Principal Life fees, there are several factors that may
affect our ability to maintain or increase revenues including:
- - rising costs
- - loss of membership to our competitors
- - failure to attract new members
- - inability to increase premiums due to regulatory restrictions
- - loss of membership due to increased premium rates
- - withdrawal from unprofitable markets
- - consumer preferences for lower priced health care options
- - price competition
OUR FAILURE TO ACCURATELY ESTIMATE FUTURE HEALTH CARE COSTS MAY RESULT IN
PREMIUMS THAT ARE NOT SUFFICIENT TO COVER MEDICAL COSTS, WHICH MAY NEGATIVELY
AFFECT OUR OPERATING RESULTS AND REDUCE THE VALUE OF YOUR INVESTMENT IN
COVENTRY.
If we underestimate the costs of health care services and supplies that
we provide to our members, we may set our premium rates too low. Low premiums
may result in an inability to generate revenues that are sufficient to pay
future health care costs. This shortfall could significantly change our results
of operations, affect profitability and adversely affect the value of your
investment in Coventry. While we attempt to base the premiums we charge, at
least in part on our estimate of expected health care costs over the fixed
premium period, other factors may limit our ability to fully base premiums on
estimated costs and could cause actual health care costs to exceed estimated
health care costs. These factors could include:
- - the increased cost of individual health care services
- - the type and number of individual health care services delivered
exceeding our expectations
- - the occurrence of catastrophes or epidemics
- - seasonality and trends
- - general inflation
- - new mandated benefits or other regulatory changes that increase our costs
- - operational issues
- - insured population characteristics
- - competitive pressures
- - other unforeseen occurrences
FAILURE TO OBTAIN COST-EFFECTIVE AGREEMENTS WITH A SUFFICIENT NUMBER OF
PROVIDERS MAY RESULT IN HIGHER MEDICAL COSTS AND LOSS OF MEMBERSHIP, WHICH COULD
CAUSE A DECLINE IN THE VALUE OF YOUR INVESTMENT IN COVENTRY.
We expect that substantially all of our members will be served by
providers contracting with us to provide the requisite medical care. Our ability
to contract successfully with a sufficiently large number of providers in a
given geographic market will impact the relative attractiveness of managed care
products in those markets. In addition, the terms of those provider contracts
also have a material impact on our medical costs and our ability to control
these costs.
WE MAY NOT BE ABLE TO REACH COST-EFFECTIVE AGREEMENTS WITH CERTAIN MAJOR MARKET
PROVIDERS WHICH COULD REDUCE COVENTRY'S NET INCOME AND CAUSE A DECLINE IN THE
VALUE OF YOUR INVESTMENT IN COVENTRY.
In some of our markets, there are provider systems that have a major
presence. Our product offerings and profitability may be adversely affected if
these provider systems refuse to contract with us, place us at a competitive
disadvantage or use their market position to negotiate contracts that are
unfavorable to us.
THERE IS A RISK THAT PROVIDERS WITH WHOM WE HAVE CAPITATION CONTRACTS MAY BE
FINANCIALLY UNABLE OR UNWILLING TO FULFILL THEIR PAYMENT OR MEDICAL CARE
OBLIGATIONS UNDER CAPITATION AGREEMENTS AND THAT OUR MEMBERS MAY PREFER TO
UTILIZE OTHER PROVIDERS WITH WHOM WE DO NOT HAVE CAPITATION CONTRACTS.
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Among the medical cost control techniques we have utilized are
capitation agreements with providers pursuant to which we pay providers a fixed
dollar amount per member per month, with the provider obligated to provide all
of a particular type of medical service required by the members, and global
capitation agreements pursuant to which a single integrated hospital-physician
provider system provides substantially all hospital and medical services to a
large number of members for a fixed percentage of the premium we charge with
respect to those members. While these systems may shift to the contracting
provider system the risk that medical costs will exceed the amounts anticipated,
we will be exposed to the risks that the provider systems are financially unable
or unwilling to fulfill their payment or medical care obligations under the
capitation agreements. In addition, it is possible that members may prefer other
providers in the market with whom we do not have capitation agreements. If our
members choose to utilize providers with whom we do not have capitation
agreements, we may incur higher costs. These higher costs may reduce our net
income and negatively impact the value of your investment in Coventry.
PRINCIPAL LIFE AND ITS AFFILIATES' ABILITY TO EXERCISE CONTROL OVER COVENTRY
COULD ADVERSELY AFFECT THE VALUE OF YOUR INVESTMENT IN COVENTRY.
As a result of our acquisition of the Principal Health Care plans,
Principal Life owns approximately 40% of our common stock, on a fully diluted
basis. Due to previously agreed upon limitations that are effective through
April 2003, Principal Life may purchase additional shares of our common stock,
but only to maintain its 40% ownership of our fully diluted common stock.
In addition to its ownership position, Principal Life has designated
4 members of our 10 member Board of Directors in correspondence with its
percentage ownership of our common stock. As long as Principal Life owns at
least 10% of our common stock, it can designate one member of our Board of
Directors for each 6% ownership of our common stock. Accordingly, Principal Life
has the right to designate up to six members of our Board.
Principal Life's ownership position and its representation on our
Board of Directors, allow it to exert significant influence over the direction
and operations of Coventry. In some instances, this influence could be used in a
manner that is contrary to the best interests of our other stockholders, and may
accordingly decrease the value of your investment in Coventry.
It should be noted, however, that prior to April 2003, Principal
Life has agreed to vote its shares in favor of any acquisition required to be
approved by our shareholders, that a Special Committee of our Board of Directors
has recommended, and that a majority of our shareholders, other than Principal
Life, have approved. The Special Committee will consist of members of our Board
of Directors that are neither management, nor designees of Principal Life.
Additionally, prior to April 2003, Principal Life has agreed to vote
its shares for the election of directors nominated by the nominating committee
of the Board of Directors, and not to oppose or seek removal of any person
nominated by this nominating committee.
Once the previously agreed upon limitations imposed on Principal
Life expire in April 2003, Principal Life may acquire additional shares of our
common stock to the point that it exercises complete control over the Company.
If Principal Life were to acquire over 50% of our common stock, it would have
actual control over us, and would have a controlling vote in all actions
involving a shareholder vote. As the majority shareholder, Principal Life could
block transactions that were advantageous to our minority shareholders.
Accordingly, the value of your investment in Coventry could decline as future
investors may not consider our common stock to be an attractive stock due to
the percentage of our common stock held by Principal Life.
FUTURE AND EXISTING LAWS AND RULES GOVERNING COVENTRY MAY IMPACT OUR BUSINESS
AND NEGATIVELY AFFECT OUR PROFITABILITY.
Coventry'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 force us to change how we do
business and may restrict our revenue and/or enrollment growth and/or increase
our health care and administrative costs. Regulatory approvals must be
obtained and maintained to market many of our products and services. Delays in
obtaining or failing to obtain or maintain such approvals could adversely
affect our revenue or the number of our covered lives, or could increase our
costs.
OUR CONTRACTS WITH FEDERAL AND STATE GOVERNMENT AGENCIES ARE SUBJECT TO PERIODIC
AUDITS THAT COULD HAVE AN ADVERSE RESULT THAT MAY LEAD TO A DECLINE IN THE VALUE
OF YOUR INVESTMENT IN COVENTRY.
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Coventry contracts with various federal and state governmental agencies
to provide managed health care services. These agencies include the United
States Office of Personnel Management that contracts with us to provide managed
health care services for federal employees under the Federal Employees Health
Benefits Program; the U. S. Health Care Financing Administration that contracts
with us to provide a Medicare product to eligible beneficiaries; and certain
states that contract with us to provide a Medicaid product to eligible
recipients. These contracts and applicable federal and state regulations, among
other requirements, establish premium rating requirements or fixed premiums per
member per month. These governmental agencies and states may periodically audit
us to verify our compliance with their contracts and applicable federal and
state laws and regulations. Such audits could result in material adjustments. An
adverse audit of our contracts with governmental agencies could result in the
loss of licensure, the loss of the right to participate in certain programs, the
imposition of fines, penalties, and other sanctions and could negatively affect
our reputation in various markets and make it more difficult for us to sell our
products and services.
IN THE FUTURE, WE MAY NOT BE ABLE TO MEET CERTAIN MINIMUM CAPITALIZATION LIMITS
THAT MAY BE ADOPTED BY STATES IN WHICH WE DO BUSINESS.
The National Association of Insurance Commissioners has proposed that
states adopt risk-free capital standards that, if implemented, would generally
require higher minimum capitalization limits for health care coverage provided
by HMOs and other risk-bearing health care entities. To date, no state where
Coventry has HMO operations has adopted those standards. We do not expect this
legislation to have a material impact on our consolidated financial position in
the near future. We believe that cash flows from operations will be sufficient
to fund any additional regulatory risk-based capital.
COSTS ASSOCIATED WITH LITIGATION MAY RESULT IN LOSSES TO US THAT COULD
NEGATIVELY IMPACT THE VALUE OF YOUR INVESTMENT IN COVENTRY.
We are susceptible to litigation and insurance risks, including
medical malpractice liability, disputes relating to the denial of coverage and
the adequacy of "stop-loss" reinsurance for costs resulting from catastrophic
injuries or illnesses. Coventry has contingent litigation risk with certain
discontinued operations. Such litigation may result in losses to us that could
have a material adverse effect on our operations, financial performance, cash
flows or future prospects and adversely affect the value of your investment in
Coventry.
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET RISK
The Company's only material risk in investments in financial
instruments is in its debt securities portfolio. The Company invests primarily
in marketable state and municipal, U.S. Government and agencies, corporate, and
mortgage-backed debt securities. As of December 31, 1999, the Company has not
invested in financial instruments of a hedging or derivative nature.
The Company has established policies and procedures to manage its
exposure to changes in the fair value of its investments. These policies include
an emphasis on credit quality, management of portfolio duration, maintaining or
increasing investment income through high coupon rates and actively managing
profile and security mix depending upon market conditions. The Company has
classified all of its investments as available-for-sale. The fair value of the
Company's investments in debt securities at December 31, 1999 was $374.5
million. Debt securities at December 31, 1999 mature according to their
contractual terms, as follows (actual maturities may differ because of call or
prepayment rights):
1999 AMORTIZED COST FAIR VALUE
---- -------------- ----------
Maturities:
Within 1 year $102,126 $102,045
1 to 5 years 114,850 113,517
6 to 10 years 68,382 66,373
Over 10 years 93,726 92,592
----------------- -----------------
Total short-term and long-term securities $379,084 $374,527
================= =================
The Company believes its investment portfolio is diversified and
expects no material loss to result from the failure to perform by the issuer of
the debt securities it holds. The mortgage-backed securities are insured by GNMA
and FNMA.
The Company's projections of hypothetical net losses in fair value of
the Company's market rate sensitive instruments, should potential changes in
market rates occur, are presented below. While the Company believes that the
potential market rate change is reasonably possible, actual results may differ.
Based on the Company's debt securities portfolio and interest rates at
December 31, 1999, a 100 basis point increase in interest rates would result in
a decrease of $7.9 million or 2.1%, in the fair value of the portfolio. Changes
in interest rates may affect the fair value of the debt securities portfolio and
may result in unrealized gains or losses. Gains or losses would be realized upon
the sale of the investments.
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ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE BOARD OF DIRECTORS
OF COVENTRY HEALTH CARE, INC.:
We have audited the accompanying consolidated balance sheets of
Coventry Health Care, Inc. (a Delaware corporation and successor-in-interest to
Coventry Corporation) and subsidiaries as of December 31, 1999 and 1998, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1999. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards
generally accepted in the United States. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Coventry Health
Care, Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1999 in conformity with accounting principles generally
accepted in the United States.
Baltimore, Maryland
February 21, 2000
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COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
December 31, December 31,
1999 1998
----------- -----------
ASSETS
Cash and cash equivalents $ 240,076 $ 405,323
Short-term investments 88,365 46,714
Accounts receivable, net of allowance of $5,548 and $12,023 as
of December 31, 1999 and 1998, respectively 53,173 43,466
Other receivables, net 42,304 23,126
Deferred income taxes 56,157 65,583
Other current assets 3,330 6,993
----------- -----------
Total current assets 483,405 591,205
Long-term investments 286,162 162,546
Property and equipment, net 37,863 35,780
Goodwill and intangible assets, net 268,289 295,966
Other assets 5,864 5,731
----------- -----------
Total assets $ 1,081,583 $ 1,091,228
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Medical claim liabilities $ 308,095 $ 330,743
Other medical liabilities 54,691 73,079
Accounts payable and other accrued liabilities 110,186 115,716
Deferred revenue 49,914 46,414
----------- -----------
Total current liabilities 522,886 565,952
Convertible exchangeable subordinated notes - 45,538
Long-term debt - 781
Other long-term liabilities 31,217 42,418
----------- -----------
Total liabilities 554,103 654,689
Redeemable convertible preferred stock, $.01 par value; Series A, 47,095 -
6,000,000 shares authorized; 4,709,545
shares issued and outstanding in 1999
Stockholders' equity:
Common stock, $.01 par value; 200,000,000 shares
authorized; 59,643,753 shares issued and 59,148,797
outstanding in 1999; and 59,274,370 shares issued
and 58,834,810 outstanding in 1998 596 593
Additional paid-in capital 480,792 476,430
Accumulated other comprehensive (loss) income (2,780) 794
Retained earnings (accumulated deficit) 7,157 (36,278)
Treasury stock, at cost, 494,956 and 439,560 shares as of December 31, 1999
and 1998, respectively (5,380) (5,000)
----------- -----------
Total stockholders' equity 480,385 436,539
----------- -----------
Total liabilities and stockholders' equity $ 1,081,583 $ 1,091,228
=========== ===========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
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COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31,
--------------------------------------------------
1999 1998 1997
-------------- --------------- ---------------
Operating revenues:
Managed care premiums $ 2,082,075 $ 2,033,372 $ 1,208,149
Management services 80,297 77,011 20,202
--------------------------------------------------
Total operating revenues 2,162,372 2,110,383 1,228,351
--------------------------------------------------
Operating expenses:
Health benefits 1,792,652 1,767,374 1,039,860
Selling, general and administrative 297,922 291,919 170,017
Depreciation and amortization 28,205 25,793 12,735
Plan shutdown expense 2,020 - -
AHERF charge (6,282) 55,000 -
Merger costs - 6,492 -
--------------------------------------------------
Total operating expenses 2,114,517 2,146,578 1,222,612
--------------------------------------------------
Operating earnings (loss) 47,855 (36,195) 5,739
Other income, net 29,906 27,251 24,880
Interest expense (1,761) (8,566) (10,275)
--------------------------------------------------
Earnings (loss) before income taxes and minority interest 76,000 (17,510) 20,344
Provision for (benefit from) income taxes 32,565 (5,769) 8,422
Minority interest in earnings of
consolidated subsidiary, net of income tax - - 19
--------------------------------------------------
Net earnings (loss) $ 43,435 $ (11,741) $ 11,903
==================================================
Net earnings (loss) per share:
Basic $ 0.74 $ (0.22) $ 0.36
==================================================
Diluted $ 0.69 $ (0.22) $ 0.35
==================================================
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
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COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 (IN THOUSANDS)
ACCUMULATED RETAINED
ADDITIONAL OTHER EARNINGS TOTAL
COMMON PAID-IN COMPREHENSIVE (ACCUMULATED TREASURY STOCKHOLDERS'
STOCK CAPITAL INCOME (LOSS) DEFICIT) STOCK, AT COST EQUITY
----------------------------------------------------------------------------------------
Balance, December 31, 1996 $330 $136,142 $395 $(36,440) $- $100,427
Comprehensive income:
Net earnings 11,903 11,903
Unrealized gain on securities, net
of reclassifications 197 197
-----------------
Comprehensive income: 12,100
Issuance of common stock,
including exercise of options and
warrants 7 7,722 (5,000) 2,729
Issuance of warrants 2,353 2,353
Tax benefit of stock options exercised 209 209
- -------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 337 146,426 592 (24,537) (5,000) 117,818
Comprehensive (loss) income:
Net loss (11,741) (11,741)
Unrealized gain on securities,
net of reclassifications 202 202
-----------------
Comprehensive loss: (11,539)
Issuance of common stock, including
exercise of options and warrants 256 304,888 305,144
Issuance of warrants 25,000 25,000
Tax benefit of stock options exercised 116 116
- -------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 593 476,430 794 (36,278) (5,000) 436,539
Comprehensive income (loss):
Net earnings 43,435 43,435
Unrealized loss on securities,
net of reclassifications (3,574) (3,574)
-----------------
Comprehensive income: 39,861
Issuance of common stock, including
exercise of options and warrants 3 3,931 (380) 3,554
Tax benefit of stock options exercised 431 431
- -------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 $596 $480,792 $(2,780) $7,157 $(5,380) $480,385
===============================================================================================================================
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
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COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------
1999 1998 1997
---------------- ------------------ --------------------
Cash flows from operating activities:
Net earnings (loss) $43,435 $(11,741) $11,903
Adjustments to reconcile net earnings (loss) to cash provided
by operating activities:
Depreciation and amortization 28,205 25,793 12,735
Deferred income tax provision (benefit) 14,038 (19,439) (11,701)
Loss on sales of medical offices & property disposals 287 (399) (13,338)
Non-cash interest on convertible debt 1,557 3,496 2,042
Other 100 3,631 (383)
Changes in assets and liabilities, net of effects of the
purchase of subsidiaries:
Accounts receivable (7,357) 14,163 (2,432)
Other receivables (17,265) 12,677 715
Prepaid expenses and other current assets 388 (424) 2,013
Other assets (133) 2,373 2,874
Medical claims liabilities (41,982) 36,184 (28,060)
Other medical liabilities (20,007) 73,079 -
Accounts payable and other accrued liabilities (7,139) (70,741) 26,000
Deferred revenue 3,012 516 24,205
Other long-term liabilities (8,269) (724) (4,312)
-----------------------------------------------------------
Net cash (used in) provided by operating activities (11,130) 68,444 22,261
-----------------------------------------------------------
Cash flows from investing activities:
Capital expenditures, net (14,717) (3,196) (7,218)
Sales of investments 253,489 122,871 37,329
Purchases of investments & other (425,109) (141,577) (34,137)
Payments for acquisitions (10,133) - -
Proceeds from sales of subsidiaries & medical offices - 99,277 53,977
Proceeds from sale of Renewal Rights Agreement 19,850 - -
Cash acquired in conjunction with acquisitions 19,730 148,600 -
-----------------------------------------------------------
Net cash (used in) provided by investing activities (156,890) 225,975 49,951
-----------------------------------------------------------
Cash flows from financing activities:
Proceeds from issuance of convertible exchangeable notes - - 40,000
Payments on long-term debt (781) (44,491) (48,961)
Net proceeds from issuance of stock 3,554 1,416 2,729
Proceeds from issuance of stock warrants - - 2,353
-----------------------------------------------------------
Net cash provided by (used in) financing activities 2,773 (43,075) (3,879)
-----------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (165,247) 251,344 68,333
Cash and cash equivalents at beginning of period 405,323 153,979 85,646
-----------------------------------------------------------
Cash and cash equivalents at end of period $240,076 $405,323 $153,979
===========================================================
Supplemental disclosure of cash flow information:
Cash paid for interest $ - $3,386 $7,572
Income taxes paid (refunded), net $40,210 $9,487 $(4,456)
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
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Coventry Health Care, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 1998 AND 1997
A. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Coventry Health Care, Inc. (together with its subsidiaries, the
"Company", "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. The Company was incorporated under the laws of the
state of Delaware on December 17, 1997.
The Company began operations in 1987 with the acquisition of the American
Service Companies ("ASC") entities, including the Coventry Health and Life
Insurance Company ("CHLIC"). In 1988, the Company acquired HealthAmerica
Pennsylvania, Inc. ("HAPA"), a Pennsylvania HMO. In 1990, the Company acquired
Group Health Plan, Inc. ("GHP"), a St. Louis, Missouri HMO. Southern Health
Services, Inc. ("SHS"), a Richmond, Virginia HMO, was acquired by the Company in
1994. In 1995, the Company acquired HealthCare USA, Inc. ("HCUSA"), a
Jacksonville, Florida-based Medicaid managed care company. In 1998, the Company
acquired certain assets of Principal Health Care, Inc. ("PHC") from Principal
Mutual Life Insurance Company, now known as Principal Life Insurance Company
("Principal Life"). On October 1, 1999, the Company acquired Carelink Health
Plans ("Carelink") from Camcare, Inc. 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 commercial membership. See
Notes B and C to consolidated financial statements.
Principles of Consolidation - The consolidated financial statements
include the accounts of the Company and its subsidiaries. All significant
intercompany transactions have been eliminated. Interests of other investors in
the Company's majority owned (or otherwise effectively-controlled) subsidiaries
are accounted for as minority interests and are included in other long-term
liabilities for financial reporting purposes.
Use of Estimates - The preparation of financial statements in conformity
with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Cash and Cash Equivalents - Cash and cash equivalents consist principally
of overnight repurchase agreements, money market funds, commercial paper and
certificates of deposit. The Company considers all highly liquid securities
purchased with an original maturity of three months or less to be cash
equivalents. The carrying amounts of cash and cash equivalents reported in the
accompanying consolidated balance sheets approximate fair value.
Investments - The Company accounts for investments in accordance with
Statement of Financial Accounting Standards No. 115 ("SFAS 115"), "Accounting
for Certain Investments in Debt and Equity Securities." The Company considers
all of its investments as available-for-sale, and accordingly, records
unrealized gains and losses, net of deferred income taxes, as a separate
component of stockholders' equity. Realized gains and losses on the sale of
these investments are determined on a specific identification basis.
Investments with original maturities in excess of three months and less
than one year are classified as short-term investments and generally consist of
time deposits, U.S. Treasury Notes, and obligations of various states and
municipalities. Long-term investments have original maturities in excess of one
year and primarily consist of debt securities.
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43
Other Receivables - Other receivables include interest receivable,
reinsurance claims receivable, receivables from providers and suppliers and any
other receivables that do not relate to premiums.
Property and Equipment - Property and equipment are recorded at cost.
Depreciation is computed using the straight-line method over the estimated lives
of the related assets or, if shorter, over the terms of the respective leases.
Long-Lived Assets - The Company has adopted Statement of Financial
Accounting Standards No. 121 ("SFAS 121"), "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of." In accordance
with SFAS 121, the Company evaluates long-lived assets to be held for events or
changes in circumstances that would indicate that the carrying value may not be
recoverable. In making that determination, the Company considers a number of
factors, including undiscounted future cash flows, prior to interest expense.
The Company measures an impairment loss by comparing the fair value of the
assets to their carrying value. Fair values are determined by using market
prices for similar assets, if available, or discounted future estimated cash
flows, prior to interest expense. Assets held for sale are recorded at the lower
of the carrying amount or fair value, less any cost of disposition.
Goodwill and Intangible Assets - Goodwill and intangible assets consist
of costs in excess of the fair value of the net assets of subsidiaries or
operations acquired. Goodwill is amortized using the straight-line method over
periods ranging from 15 to 35 years. The remaining unamortized goodwill and
intangible asset balances at December 31, 1999 are as follows (in thousands):
ESTIMATED ACCUMULATED
DESCRIPTION USEFUL LIFE AMOUNT AMORTIZATION NET BOOK VALUE
- -----------------------------------------------------------------------------------------------------------
Customer Lists 5 years $ 11,700 $ 8,450 $ 3,250
HMO Licenses 15-20 years 10,700 1,202 9,498
Goodwill 15-35 years 314,240 58,699 255,541
------- ------ -------
Total $336,640 $68,351 $268,289
======== ======= ========
Amortization expense for the years ended December 31, 1999, 1998 and
1997 was approximately $14.6 million, $13.6 million and $3.8 million,
respectively. In accordance with SFAS 121 and Accounting Principles Board
("APB") Opinion No.17, the Company periodically evaluates the realizability of
goodwill and intangible assets and the reasonableness of the related lives in
light of factors such as industry changes, individual market competitive
conditions, and operating income.
Other Assets - Other assets consist of loan acquisition costs, assets
related to the supplemental executive retirement plan (See Note P to
consolidated financial statements), restricted assets, deferred charges and
certain costs incurred to develop new service areas and new products prior to
the initiation of revenues. Loan acquisition costs are amortized over the term
of the related debt while the other assets are amortized over their expected
periods of benefit, where applicable. Loan acquisition costs were fully
amortized in 1999. The preoperational new service area and new product costs
were amortized over their expected period of benefit up to eight years.
Effective April 1, 1997, the Company adopted a one-year period for amortization
of new service area and new product costs. $2.7 million of expense was included
in selling, general and administrative expense due to this change. These costs
were fully amortized at December 31, 1997. Accumulated amortization of other
assets was approximately $3.5 million and $3.4 million at December 31, 1999 and
1998, respectively.
Medical Claims Liabilities - Medical claims liabilities consist of
actual claims reported but not paid and estimates of health care services
incurred but not reported. The estimated claims incurred but not reported are
based on historical data, current enrollment, health service utilization
statistics, and other related information. Although considerable variability is
inherent in such estimates, management believes that the liability is adequate.
The Company also establishes reserves, if required, for the probability that
anticipated future health care costs and contract maintenance costs under the
group of existing contracts will exceed anticipated future premiums and
reinsurance recoveries on those contracts. These accruals are continually
monitored and reviewed, and as
41
44
settlements are made or accruals adjusted, differences are reflected in current
operations. Changes in assumptions for medical costs caused by changes in actual
experience could cause these estimates to change in the near term.
Revenue Recognition - Managed care premiums are recorded as revenue in
the month in which members are entitled to service. Premiums collected in
advance are recorded as deferred revenue. Employer contracts are typically on an
annual basis, subject to cancellation by the employer group or the Company upon
thirty days written notice. Management services revenues are recognized in the
period in which the related services are performed. Premiums for services to
federal employee groups are subject to audit and review by the Office of
Personnel Management ("OPM") on a periodic basis. Such audits are usually a
number of years in arrears. The Company provides reserves, on an estimated basis
annually, based on the appropriate guidelines. Any differences between actual
results and estimates are recorded in the year the audits are finalized.
Significant Customers - For the years ended 1999, 1998, and 1997, the
Company received 16.0%, 15.2%, and 14.0%, respectively, of its revenue from the
Federal Medicare program throughout the Company's various markets.
Reinsurance - Premiums paid to reinsurers are reported as health
benefits expense and the related reinsurance recoveries are reported as
deductions from health benefits expense.
Income Taxes - The Company files a consolidated tax return for the
Company and its wholly owned consolidated subsidiaries. The Company accounts for
income taxes in accordance with Statement of Financial Accounting Standards No.
109 ("SFAS 109"). The deferred tax assets and/or liabilities are determined by
multiplying the differences between the financial reporting and tax reporting
bases for assets and liabilities by the enacted tax rates expected to be in
effect when such differences are recovered or settled. The effect on deferred
taxes of a change in tax rates is recognized in income in the period that
includes the enactment date. See Note I for disclosures related to income taxes.
Minority Interest - For 1997, the minority interest represents a joint
venture interest of 51% in Pennsylvania HealthMate, Inc. ("HealthMate").
Stock-based Compensation - The Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standards No. 123 ("SFAS
123"), "Accounting for Stock-Based Compensation." As permitted by SFAS 123, the
Company has elected to continue to account for stock-based compensation to
employees under APB Opinion No. 25, and complies with the disclosure
requirements for SFAS 123. See Note L for disclosures related to stock-based
compensation.
Earnings per Share - In the fourth quarter of 1997, the Company adopted
Statement of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings per
Share." SFAS 128 establishes new standards for computing and presenting earnings
per share ("EPS"), replacing primary EPS with "basic EPS." Basic EPS excludes
dilution and is computed by dividing income available to common stockholders by
the weighted-average number of common shares outstanding for the period. The
adoption of SFAS 128 did not have a material effect on the Company's earnings
per share. All prior periods were previously restated to comply with SFAS 128.
See Note S for calculation of EPS.
Comprehensive Earnings - Effective January 1, 1998, the Company adopted
Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting
Comprehensive Income." SFAS 130 requires that changes in the amounts of certain
items, including unrealized gains and losses on certain securities, be shown in
the financial statements as part of comprehensive earnings. The adoption of this
standard did not have a material effect on the Company's consolidated financial
statements.
Segment reporting - Effective December 31, 1998, the Company adopted
Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures
about Segments of an Enterprise and Related Information." This standard requires
that a public business enterprise report financial and descriptive information
about its reportable operating segments. Operating segments are components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources
42
45
and in assessing performance. SFAS 131 also requires that all public business
enterprises report information about the revenues derived from the enterprise's
products or services (or groups of similar products and services), about the
countries in which the enterprise earns revenues and holds assets and about
major customers regardless of whether that information is used in making
operating decisions. The Company has two reportable segments: Commercial
products and Government products. The products are provided to a cross section
of employer groups through the Company's health plans in the Midwest,
Mid-Atlantic, and Southeastern United States.
Commercial products include HMO, PPO, and POS products. HMO products
provide comprehensive health care benefits to enrollees through a primary care
physician. PPO and POS products permit members to participate in managed care
but allow them the flexibility to utilize out of network providers in exchange
for an increase in out-of-pocket costs to the member.
Governmental products include Medicare Risk, Medicare Cost, and
Medicaid. The Company provides comprehensive health benefits to members
participating in government programs and receives premium payments from federal
and state governments. The Company evaluates the performance of its operating
segments and allocates resources based on gross margin. Assets are not allocated
to specific products and, accordingly, cannot be reported by segment. See Note U
for disclosures on segment reporting.
Derivative Instruments - In June 1998, the FASB issued Statement of
Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative
Instruments and Hedging Activities." SFAS 133 requires companies to record
derivatives on the balance sheet as assets or liabilities, measured at fair
value. Gains or losses resulting from changes in the values of the derivatives
would be accounted for depending on the use of the derivatives and whether they
qualify for hedge accounting. In June 1999, the FASB also issued Statement of
Financial Accounting Standards No. 137 ("SFAS 137"), which defers the effective
date of SFAS 133 until fiscal years beginning after June 15, 2000. The Company
does not believe that adoption of SFAS 133 (as amended by SFAS 137) will have a
material effect on its future results of operations.
Computer Software - Effective January 1, 1999, the Company adopted
Statement of Position 98-1 ("SOP 98-1"), "Accounting for the Cost of Computer
Software Developed or Obtained for Internal Use" issued by the American
Institute of Certified Public Accountants ("AICPA"). SOP 98-1 provides
authoritative guidance for the capitalization of certain costs related to
computer software developed or obtained for internal applications, such as
external direct costs of materials and services, payroll costs for employees and
certain interest costs. Costs incurred during the preliminary project stage, as
well as training and data conversion costs, are to be expensed as incurred. The
adoption of SOP 98-1 did not have a material effect on the Company's
consolidated financial statements.
Reclassifications - Certain 1997 and 1998 amounts have been
reclassified to conform to the 1999 presentation.
B. PHC ACQUISITIONS AND DISPOSITIONS
Effective April 1, 1998, the Company completed its acquisition of
certain PHC health plans from 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
the Company's consolidated financial statements since the date of acquisition.
The purchase price consisted of 25,043,704 shares of the Company'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 the Company'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 the Company's common stock to
increase its ownership percentage above 40%.
Coincident with the closing of the transaction, the Company 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 the Company does business and, on December 31, 1999, to offer to
renew such policies in force at that time. Effective June 1, 1999, the Company
amended these agreements with Principal Life
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46
and waived its rights to reinsure and renew Principal Life's health insurance
indemnity business located in the Company's service area. The Company 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, the Company also entered into a Marketing Services
Agreement and a Management Services Agreement with Principal Life. Both
agreements expired on December 31, 1999. Pursuant to the agreements, the Company
recognized revenue of approximately $25.5 million and $23.0 million for the
years ended December 31, 1999 and 1998, respectively.
As a result of the acquisition, the Company assumed an agreement with
Principal Life, whereby Principal Life paid a fee for access to the Company'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, the Company 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, the Company 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, the Company 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 the Company'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 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, the Company 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, the Company 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, the Company 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, the Company recorded a reserve of
$2.0 million in the fourth quarter of 1999. The Company plans to close the
health plan by the end of the fourth quarter 2000 and has expended approximately
$0.4 million as of December 31, 1999.
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The purchase price for certain of the PHC plans was allocated to the
assets, including the identifiable intangible assets, and liabilities based on
estimated fair values. The $174.0 million excess of purchase price over the net
identified tangible assets acquired was allocated to identifiable intangible
assets and goodwill. The allocated amounts, net of the Florida and Illinois
health plans and net of the impact of waiving the Renewal Rights and Coinsurance
Agreements and the expiration of the Marketing Services Agreement, Management
Services Agreement and PPO access agreement, and their related useful lives are
as follows:
AMOUNT ESTIMATED
DESCRIPTION (IN THOUSANDS) USEFUL LIFE
----------- -------------- -----------
Customer Lists 7,233 5 years
HMO Licenses 10,000 20 years
Goodwill 156,795 35 years
-------
Total $174,028
========
The following unaudited pro-forma condensed consolidated results of
operations assumes the PHC acquisition and the sales of the Florida and Illinois
health plans occurred on January 1, 1998 and 1997 and excludes the non-recurring
charge to merger costs of $6.5 million, see Note F:
(IN THOUSANDS, EXCEPT PER SHARE DATA)
DECEMBER 31, DECEMBER 31,
1998 1997
---------------------------- ---------------------------
(UNAUDITED) (UNAUDITED)
Operating revenues $2,021,580 $1,875,411
Net loss (32,165) (22,694)
Loss per share, basic (0.55) (0.39)
C. 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 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 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.
On November 1, 1999, the Company's subsidiary, Coventry Health Care of
the Carolinas, Inc., acquired Kaiser Foundation Health Plan of North Carolina's
("KFHPNC") commercial membership in Charlotte, North Carolina. The total
purchase price was approximately $1.8 million including transaction costs.
D. MEDICAL OFFICE DISPOSITIONS
Effective March 31, 1997, the Company completed its 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 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 globally capitated
membership in western Pennsylvania to approximately 250,000 members. Under the
agreement, the provider organization receives a fixed percentage of premiums to
cover all of the medical treatment
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the globally capitated members receive. 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 Note E for AHERF Charge.
Effective May 1, 1997, the Company completed its 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 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 and the transaction resulted in a
pretax loss 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.
E. AHERF CHARGE
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 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.
The lawsuit also included additional claims for monetary damages. In response,
the hospitals filed a counterclaim alleging that the Company's subsidiary,
HealthAmerica Pennsylvania, Inc., was liable to the hospitals for payment of
these medical services.
As a result, the Company, which is 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 fulfil 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 of 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.
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F. MERGER COSTS
In connection with the acquisition of the PHC health plans, the Company
relocated its corporate headquarters from Nashville, Tennessee to Bethesda,
Maryland. As a result, the Company established a one-time reserve in 1998 of
approximately $6.5 million for the incurred and anticipated costs related to the
relocation of the corporate office and other direct merger related costs. The
reserve is primarily comprised of severance costs related to involuntary
terminations, relocation costs for management personnel, and lease costs, net of
sublease income, related to the unused space remaining at the old headquarters
location. As of December 31, 1999, the Company expended approximately $6.0
million and expects to make payments through March 2003 related to these
charges.
G. PROPERTY AND EQUIPMENT
Property and equipment is comprised of the following (in thousands):
DECEMBER 31,
1999 1998
-------------------- -----------------
Land $350 $481
Buildings and leasehold improvements 14,310 11,922
Equipment 62,567 54,313
------ ------
77,227 66,716
Less accumulated depreciation and amortization (39,364) (30,936)
-------- --------
Property and equipment, net $37,863 $35,780
======= =======
Depreciation expense for the years ended December 31, 1999, 1998, and
1997 was approximately $13.6 million, $12.2 million, and $8.9 million,
respectively.
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H. INVESTMENTS IN DEBT SECURITIES
The Company considers all of its investments as available-for-sale
securities and, accordingly, records unrealized gains and losses, as other
comprehensive earnings, in the stockholders' equity section of its consolidated
balance sheets. As of December 31, 1999 and 1998, stockholders' equity was
decreased by approximately $5.9 million and increased by $0.3 million,
respectively, netted by a deferred tax benefit of approximately $2.3 million and
deferred tax cost of $0.1 million, respectively, to reflect the net unrealized
investment loss/ gain on securities.
The amortized cost, gross unrealized gain or loss and estimated fair
value of short-term and long-term investments by security type were as follows
at December 31, 1999 and 1998 (in thousands):
1999 AMORTIZED COST UNREALIZED GAIN UNREALIZED LOSS FAIR VALUE
- --------------------------------------------- ----------------- ------------------- ------------------ -----------------
State and municipal bonds $107,821 $97 $(1,369) $106,549
Asset-backed securities 16,383 6 (172) 16,217
Mortgage-backed securities 63,577 424 (1,021) 62,980
US Treasury & agencies securities 34,046 23 (1,148) 32,921
Other debt securities 157,257 128 (1,525) 155,860
================= =================== ================== =================
$379,084 $678 $(5,235) $374,527
================= =================== ================== =================
1998 AMORTIZED COST UNREALIZED GAIN UNREALIZED LOSS FAIR VALUE
- --------------------------------------------- ----------------- ------------------- ------------------ -----------------
State and municipal bonds $55,355 $548 $(290) $55,613
Asset-backed securities 10,728 71 (174) 10,625
Mortgage-backed securities 50,626 455 (141) 50,940
US Treasury & agencies securities 51,246 661 (316) 51,591
Other debt securities 40,003 529 (41) 40,491
================= =================== ================== =================
$207,958 $2,264 $(962) $209,260
================= =================== ================== =================
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51
The amortized cost and estimated fair value of short-term and long-term
investments by contractual maturity were as follows at December 31, 1999 and
December 31, 1998 (in thousands):
1999 AMORTIZED COST FAIR VALUE
--------------------------------------------------------
Maturities:
Within 1 year $102,126 $102,045
1 to 5 years 114,850 113,517
6 to 10 years 68,382 66,373
Over 10 years 93,726 92,592
--------------------------------------------------------
Total short-term and long-term securities $379,084 $374,527
========================================================
1998 AMORTIZED COST FAIR VALUE
--------------------------------------------------------
Maturities:
Within 1 year $50,773 $50,416
1 to 5 years 57,362 57,949
6 to 10 years 29,382 29,423
Over 10 years 70,441 71,472
--------------------------------------------------------
Total short-term and long-term securities $207,958 $209,260
========================================================
Proceeds from the sale and maturities of investments were
approximately $253.5 million and $122.9 million for the years ended December 31,
1999 and 1998, respectively. Gross investment gains of approximately $1.0
million and gross investment losses of approximately $1.2 million were realized
on these sales for the year ended December 31, 1999 compared to gross investment
gains of approximately $0.9 million and no gross investment losses on these
sales for the year ended December 31, 1998.
I. INCOME TAXES
The provision (benefit) for income taxes consists of the following (in
thousands):
YEAR ENDED DECEMBER 31,
1999 1998 1997
--------------------------------------------------------------
Current provision:
Federal $15,606 $12,907 $16,439
State 2,921 763 3,684
Deferred provision (benefit):
Federal 11,092 (14,695) (9,943)
State 2,946 (4,744) (1,758)
--------------------------------------------------------------
$32,565 $(5,769) $8,422
==============================================================
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52
The expected tax provision based on the statutory rate of 35% differs
from the Company's effective tax rate as a result of the following:
YEAR ENDED DECEMBER 31,
-----------------------
1999 1998 1997
--------------------------------------------------------------------
Statutory federal tax rate 35.00% (35.00%) 35.00%
- -------------------------- --------------------------------------------------------------------
Effect of:
State income taxes, net of federal benefit 4.00% (4.04%) 6.15%
Amortization of goodwill 4.72% 18.60% 5.98%
Tax exempt interest income (1.51%) (13.77%) (5.54%)
Other 0.64% 1.27% (0.19%)
--------------------------------------------------------------------
Income tax provision (benefit) 42.85% (32.94%) 41.40%
====================================================================
The effect of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1999 and 1998 are presented below (in thousands):
DECEMBER 31,
1999 1998
-----------------------------------------
Deferred tax assets:
Deferred revenue $3,005 $2,804
Medical liabilities 4,748 5,799
Accounts receivable 4,749 7,921
Deferred compensation 4,525 4,211
Other accrued liabilities 3,254 6,487
Other assets 8,363 8,419
Contingent liabilities 29,289 31,173
Net operating loss carryforward 3,769 3,769
--------------------------------------------------------------------------------------------
Gross deferred tax assets 61,702 70,583
Less valuation allowance (3,252) (3,252)
--------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------
Deferred tax asset 58,450 67,331
--------------------------------------------------------------------------------------------
Deferred tax liabilities:
Property and equipment (5,000) (982)
Intangibles (2,650) (12,562)
Other - (508)
--------------------------------------------------------------------------------------------
Gross deferred tax liabilities (7,650) (14,052)
--------------------------------------------------------------------------------------------
Net deferred tax asset $50,800 $53,279
============================================================================================
The valuation allowance for deferred tax assets as of December 31, 1999 and 1998
is $3.3 million due to the Company's belief that the realization of the deferred
tax asset resulting from federal and state net operating loss carryforwards
associated with certain acquisitions is doubtful.
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53
J. CONVERTIBLE EXCHANGEABLE SUBORDINATED NOTES AND REDEEMABLE CONVERTIBLE
PREFERRED STOCK
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 the Company'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 the Company's or
Warburg's option for shares of redeemable convertible preferred stock.
During the second and third quarters of 1999, the Company converted all
Coventry Notes held by Warburg and Franklin totaling $47.1 million, including
interest, into 4,709,545 shares of Series A redeemable convertible preferred
stock ("preferred stock") at a price of $10 per share. The preferred stock is
subject to mandatory redemption at a price of $10 per share, plus accrued
dividends, in an amount equal to one-third of the shares outstanding on May 15,
2002, 2003 and 2004. The stock is carried at its fair value, which equals both
its redemption value and liquidation value as of December 31, 1999 and will
accrue dividends only if the Board of Directors declares dividends on common
stock. The dividends (per share) on the preferred stock would be equal to the
dividends on the common stock. The preferred stock may be converted at any time
at the holders' option into shares of common stock at a conversion price equal
to the closing market price of the Company's common stock on the date of
conversion, if the closing market price is less than $10 per share. If the
closing market price of the Company's common stock is greater than $10 per
share, the preferred stock is convertible to common stock on a share for share
basis. The preferred stock is callable by the Company if the market
price of the Company's common stock exceeds certain agreed upon targets.
K. LONG-TERM DEBT
At December 31, 1998, long-term debt of $781,000, payable to the U. S.
Department of Health and Human Services, represented obligations which were
assumed in the acquisition of HAPA. Under the terms of the notes, principal was
payable in various annual installments through June 30, 2000 with interest
payable semi-annually at rates ranging from 7.75% to 9.125%. The notes were
secured by certain assets of the Company. These notes were paid in full in May
1999.
Interest expense for the year ended December 31, 1999 was $1.6 million,
substantially all of which related to the Coventry Notes.
The fair value of the Company's long-term borrowings is based on quoted
market rates. The carrying amount of the Company's borrowings approximates fair
value.
L. STOCK OPTIONS, WARRANTS AND EMPLOYEE STOCK PURCHASE PLAN
As of December 31, 1999, the Company had one stock incentive plan, the
Amended and Restated 1998 Stock Incentive Plan (the "1998 Plan"), with an
aggregate of 7 million shares of common stock authorized for issuance thereunder
to key employees, consultants and directors in the form of stock options,
restricted stock and other stock-based awards. At April 1, 1998, the 1998 Plan
assumed the obligations of six stock option plans of Coventry Corporation with
total outstanding options representing 3,322,714 shares, and one stock option
plan of Principal Health Care, Inc. with total outstanding options representing
750,000 shares, as a result of the acquisition of the PHC plans. Under the 1998
Plan, the terms and conditions of grants are established on an individual basis
with the exercise price of the options being equal to not less than 100% of the
market value of the underlying stock at the date of grant. Options generally
become exercisable after one year in 20% to 25% increments per year and expire
ten years from the date of grant. The 1998 Plan is authorized to grant either
incentive stock options or nonqualified stock options at the discretion of the
Compensation and Benefits Committee of the Board of Directors.
51
54
As of September 10, 1998, employees of the Company were offered an
opportunity to exchange their existing options (issued at a higher exercise
price) for a reduced number of new options (issued at a lower exercise price)
equivalent to the same value as their existing options, based upon a
Black-Scholes equal valuation model. Employees could choose to decline the offer
of new options and keep their existing options. As a result, the Company
canceled approximately 4,370,100 options, and reissued re-priced options equal
to approximately 3,714,182 shares. The options canceled were at exercise prices
ranging from a high of $22.750 to a low of $6.3750. The options were reissued in
accordance with an exchange formula (using the Black-Scholes equal valuation
model) that issued one-half of the new options at an exercise price of the then
current market value ($5.00) and the remaining one-half at 150% of the then
current market value ($7.50). The resulting value of the repriced options was
the same as the exchanged options.
During 1997, the Company adopted the 1997 Stock Incentive Plan (the "1997
Plan"). Under the 1997 Plan, the Company may grant options and other rights with
respect to the Company's common stock to officers, other key employees,
consultants and outside directors of the Company. A total of 1,600,000 shares of
common stock was reserved for this issuance.
The Company follows APB No. 25, under which no compensation cost has been
recognized in connection with stock option grants. Had compensation cost for
these plans been determined consistent with SFAS 123, the Company's net income
and earnings per share would have been reduced to the following pro forma
amounts (in thousands, except per share data):
FOR THE YEAR ENDED DECEMBER 31,
1999 1998 1997
------------------------------------------------------
Net income (loss): As Reported $ 43,435 $(11,741) $11,903
Pro Forma 40,098 (14,224) 8,790
EPS, basic As Reported 0.74 (0.22) 0.36
EPS, diluted As Reported 0.69 (0.22) 0.35
EPS, basic Pro Forma 0.68 (0.27) 0.26
EPS, diluted Pro Forma 0.64 (0.27) 0.26
Because the SFAS 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting pro forma compensation cost may
not be representative of that to be expected in future years.
Transactions with respect to the plans for the three years ended December
31, 1999 were as follows (shares in thousands):
1999 1998 1997
-------------------------------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
-------------------------------------------------------------------------------------------
Outstanding at beginning of year 5,441 $8 3,261 $13 2,858 $13
Granted 2,339 9 7,627 8 1,584 $15
Exercised (344) 9 (110) 12 (166) $12
Canceled (1,259) 11 (5,337) 13 (1,015) $14
-------------------------------------------------------------------------------------------
Outstanding at end of year 6,177 $8 5,441 $8 3,261 $13
-------------------------------------------------------------------------------------------
Exercisable at end of year 1,655 $8 837 $11 819 $13
-------------------------------------------------------------------------------------------
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55
The following table summarizes information about stock options
outstanding at December 31, 1999 (shares in thousands):
OPTIONS OUTSTANDING OPTIONS EXCERCISABLE
--------------------------------------------------------------------------------------------------
WEIGHTED
NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED
RANGE OF EXERCISE OUTSTANDING AT REMAINING AVERAGE EXERCISABLE AT AVERAGE EXERCISE
PRICES 12/31/99 CONTRACTUAL LIFE EXERCISE PRICES 12/31/99 PRICE
- ----------------------------------------------------------------------------------------------------------------------------
$ 5 - $ 7 2,910 8.6 $ 6 752 $ 5
$ 7 - $ 8 1,247 7.4 8 530 8
$ 8 - $ 11 1,449 9.4 10 43 9
$ 11 - $ 21 567 7.5 14 326 14
$ 21 - $ 25 4 5.0 25 4 25
----- --- ---- ----- ----
$ 5 - $ 25 6,177 8.4 $ 8 1,655 $ 8
===== === ==== ===== ====
The fair value of the stock options included in the pro forma amounts shown
above was estimated as of the grant date using the Black-Scholes option-pricing
model with the following weighted-average assumptions:
1999 1998 1997
---- ---- ----
Dividend yield 0 % 0% 0%
Expected volatility 74 % 73% 64%
Risk-free interest rate 6 % 5% 6%
Expected life 4 years 4 years 5 years
The weighted-average grant date fair values for options granted in 1999,
1998 and 1997 were $5.29, $4.53, and $8.77, respectively.
At December 31, 1999, the Company had outstanding warrants granting
holders the right to purchase 5,690,188 shares of common stock. In July 1995,
100,000 warrants were issued at a price of $14.125 and expire in July 2000.
During the first half of 1996, warrants for 170,000 shares were exercised at a
price of $6.75 per share.
On July 7, 1997, the Company finalized the sale of $40 million of
Coventry Convertible Exchangeable Subordinated Notes, together with warrants to
purchase 2,352,941 shares at $10.625 per share of common stock. The purchase
price for the warrants was $1.00 per share, valued by the Company and the
purchaser. The warrants expire seven years from the purchase date.
On April 1, 1998, the Company issued a warrant to PHC (the "Principal
Warrant") to purchase that number of shares of common stock equal to 66-2/3% of
the total number of shares of common stock actually issued upon the exercise or
conversion of the Company's employee stock options and warrants issued and
outstanding at March 31, 1998, on the same terms and conditions as set forth in
the respective options and warrants. The subsequent repricing of outstanding
employee stock options on September 10, 1998 (see above) did not affect the
Principal Warrant. Options and warrants that terminated or expired and are not
exercised, are also canceled in the Principal Warrant. At March 31, 1998, the
Company had options and warrants outstanding for 5,800,480 shares of common
stock, representing the right to purchase 3,866,986 shares under the Principal
Warrant. On May 21, 1999 and November 11, 1999, PHC exercised a portion of the
Principal Warrant pursuant to exercises of the underlying options and purchased
1,335 and 10,915 shares of common stock, respectively. At December 31, 1999, the
Principal Warrant represented the right to purchase 3,017,183 shares, taking
into account exercises and cancellations.
53
56
On May 1, 1997, the Company issued warrants to certain providers to
purchase a total of 24,825 shares of common stock at an exercise price of
$12.625 per share, expiring in 2002. On May 18, 1998, the Company issued
warrants to four individual consultants to purchase a total of 40,000 shares of
common stock at an exercise price of $13.625 per share, expiring in 2003. On
October 22, 1998, the Company issued warrants to certain providers to purchase a
total of 10,000 shares of common stock at an exercise price of $7.625 per share,
expiring in 2003. On December 21, 1998, the Company issued a warrant to an
individual in connection with the acquisition of a health plan to purchase
85,239 shares of common stock at an exercise price of $8.32 per share, expiring
in 2003. On December 21, 1998, the Company issued a warrant to an individual in
connection with legal services to purchase 50,000 shares of common stock at an
exercise price of $7.625 per share, expiring in 2009. On April 19, 1999, the
Company issued a warrant to an individual in recognition of years served on the
Company's Board of Directors to purchase 10,000 shares of common stock at an
exercise price of $7.625 per share, expiring in 2004.
The Company implemented an Employee Stock Purchase Plan in 1994, which
allows substantially all employees who meet length of service requirements to
set aside a portion of their salary for the purchase of the Company's common
stock. At the end of each plan year, the Company will issue the stock to
participating employees at an issue price equal to 85% of the lower of the stock
price at the end of the plan year or the average stock price, as defined. The
Company has reserved 1.0 million shares of stock for this plan and has issued
11,416, 15,016, and 7,074, shares in 1999, 1998, and 1997 respectively.
M. REINSURANCE
Throughout 1997, 1998 and the first quarter of 1999, the Company had
reinsurance agreements, through its subsidiary CHLIC, with American Continental
Insurance Company and Continental Assurance Company for portions of the risk it
has underwritten through its products. Beginning in April 1999, the Company
entered into new reinsurance agreements with Continental Assurance Company and
American Continental Insurance Company with greater coverages. Reinsurance
premiums for the years ended December 31, 1999, 1998 and 1997 were
approximately $9.9 million, $1.0 million and $0.7 million respectively.
Reinsurance recoveries, including amounts receivable, for the same periods were
approximately $5.9 million, $0.6 million and $0.4 million.
These reinsurance agreements do not release the Company from its primary
obligations to its membership. The Company remains liable to its membership if
the reinsurers are unable to meet their contractual obligations under the
reinsurance agreements. All reinsurance agreements are subject to certain limits
on hospital costs per patient-day. To minimize its exposure to significant
losses from reinsurer insolvencies, the Company evaluates the financial
condition of its reinsurers on an annual basis. American Continental Insurance
Company and Continental Assurance Company are both currently A rated by the A.M.
Best Company.
Medicaid risk exposures in Missouri are reinsured through the State of
Missouri mandated program. Reinsurance recoveries for the years ended December
31, 1999, 1998 and 1997 were approximately $3.1 million, $2.1 million and $3.6
million, respectively.
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N. COMMITMENTS
The Company operates primarily in leased facilities with original lease
terms of up to ten years with options for renewal. The Company also leases
computer equipment with lease terms of approximately three years. Leases that
expire generally are expected to be renewed or replaced by other leases.
The minimum rental commitments payable and minimum sublease rentals to be
received by the Company during each of the next five years ending December 31
and thereafter for noncancellable operating leases are as follows (in
thousands):
RENTAL SUBLEASE
YEAR COMMITMENTS INCOME
---------- ----------- ------------
2000 $ 15,314 $ 4,491
2001 14,342 4,367
2002 12,727 3,878
2003 9,902 3,252
2004 8,657 3,216
Thereafter 7,795 3,157
---------- -----------
$ 68,737 $ 22,361
========== ===========
Total rent expense was approximately $14.5 million, $14.6 million and
$8.3 million for the years ended December 31, 1999, 1998 and 1997, respectively.
O. CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of cash and cash equivalents,
investments in marketable securities and accounts receivable. The Company
invests its excess cash in interest bearing deposits with major banks,
commercial paper, and money market funds. Investments in marketable securities
are managed within guidelines established by the Board of Directors which
emphasize investment-grade fixed income securities and limit the amount that may
be invested in any one issuer. The fair value of the Company's financial
instruments is substantially equivalent to their carrying value and, although
there is some credit risk associated with these instruments, the Company
believes this risk to be minimal.
As discussed in Notes D and E to the consolidated financial statements,
the Company entered into long-term global capitation arrangements with two
integrated provider organizations. 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. To the extent that the Company becomes a party to
global capitation agreements with a single provider organization serving
substantial membership, the Company becomes exposed to credit risk with respect
to such organizations. The Company may utilize the following to manage such
risk: 1) contract with providers with significant net worth and cash reserves;
2) require letters of credit or cash to be reserved for claims payment and 3)
monitor the providers' financial condition in regard to the Company membership.
Concentration of credit risk with respect to accounts receivable is
limited due to the large number of customers comprising the Company's customer
base and their breakdown among geographical locations. See Note A for additional
information with respect to accounting policies for accounts receivable.
The Company believes the allowance for doubtful collections adequately
provides for estimated losses as of December 31, 1999. The Company has a risk of
incurring loss if such allowances are not adequate.
As discussed in Note M to consolidated financial statements, the Company
has reinsurance agreements with major insurance companies. The Company monitors
the insurance companies' financial ratings to determine compliance with
standards set by state law. The Company has a credit risk associated with these
reinsurance agreements to the extent the reinsurers are unable to pay valid
reinsurance claims of the Company.
55
58
P. BENEFIT PLANS
On July 1, 1994, Coventry Corporation adopted an employee defined
contribution retirement plan qualifying under IRC Section 401(k), the Coventry
Corporation Retirement Savings Plan (the "Plan"), which covered substantially
all employees of Coventry Corporation and its subsidiaries who meet certain
requirements as to age and length of service and who elect to participate in the
Plan. Similar retirement savings plans offered by (1) both HAPA and GHP and (2)
both Coventry Healthcare Management Corporation ("CHMC") and HCUSA were merged
into the Plan effective July 1, 1994 and January 1, 1996, respectively.
Effective March 31, 1998, the Company was formed as the parent company of an
affiliated group of companies that includes Coventry Corporation. The Company,
with the approval of Coventry Corporation, adopted and became sponsor of the
Plan effective April 1, 1998. On April 1, 1998, the Coventry Health Care, Inc.
Retirement Savings Plan (the "New Plan") was adopted and any prior PHC and
certain affiliated participant account balances included in the assets of the
former PHC qualified retirement plan were rolled over into the New Plan at the
election of the former PHC employees. Effective October 1, 1998, the Plan was
merged with the New Plan. All employees that were participants under the Plan
became participants in the New Plan. On October 1, 1998, the assets of the Plan
were merged and transferred to: (1) Principal Life Insurance Company, as funding
agent of the assets held under the terms of the Flexible Investment Annuity
Contract with Coventry Health Care, Inc., (2) Delaware Charter Guarantee and
Trust Company, as custodial trustee of the mutual funds and (3) Bankers Trust
Company, as custodial trustee of the New Plan's participant loans and the
Coventry Health Care, Inc. Common Stock. Effective October 1, 1999, pursuant to
the merger of Coventry Health Plan of West Virginia, Inc. (CHC-WV), a
wholly-owned subsidiary of the Company, and Carelink Health Plans, Inc.
(Carelink) whereby Carelink was the surviving entity, Carelink became an
adopting employer of the New Plan.
Prior to 1998, under the Plan, participants were able to defer up to 15%
of their compensation, limited by the maximum compensation deferral amount
permitted by applicable law. The Company made matching contributions equal to
100% of the participant's contribution on the first 3% of the participant's
compensation deferral and equal to 50% of the participant's contribution on the
second 3% of the participant's compensation deferral. Prior to 1998,
participants vested in the Company's matching contributions in 20% increments
annually over a period of 5 years, based on length of service with the Company
and/or its subsidiaries. Effective January 1, 1998, under the Plan and the New
Plan, participants may defer up to 15% of their compensation, limited by the
maximum compensation deferral amount permitted by applicable law. The Company
makes matching contributions in the Company's common stock equal to 100% of the
participant's contribution on the first 3% of the participant's compensation
deferral and equal to 50% of the participant's contribution on the second 3% of
the participant's compensation deferral. Participants will vest in the Company's
matching contributions in 50% increments annually over a period of 2 years,
based on length of service with the Company and/or its subsidiaries. All costs
of the Plan and the New Plan are funded by the Company and participants as they
are incurred.
On July 1, 1994, Coventry Corporation adopted a supplemental executive
retirement plan (the "SERP"), which covered employees of Coventry Corporation
and its subsidiaries who (1) meet certain requirements as to age and management
responsibilities and/or salary, (2) are designated as being eligible to
participate in the SERP by the Compensation and Benefits Committee of the Board
of Directors of the Company, and (3) elect to participate in the SERP and the
Plan. A similar supplemental executive retirement plan offered by HAPA was
merged into the SERP effective July 1, 1994. The Company, with the approval of
Coventry Corporation, adopted and became sponsor of the SERP effective April 1,
1998. Effective April 1, 1998, the SERP Plan name changed to the Coventry Health
Care, Inc. Supplemental Executive Retirement Plan. Under the SERP, participants
may defer up to 15% of their base salary, and up to 100% of any bonus awarded,
over and beyond the compensation deferral limits of the Plan. Effective January
1, 1999, the Company amended the SERP's definition of compensation to exclude
income or proceeds from the Company's Stock Incentive Plan and relocation
payments. The Company makes matching contributions equal to 100% of the
participant's contribution on the first 3% of the participant's compensation
deferral and 50% of the participant's contribution on the second 3% of the
participant's compensation deferral. Prior to January 1, 1998, participants
vested in the Company's matching contributions in 20% increments annually over a
period of 5 years, based on length of service with the Company and/or its
subsidiaries. Effective January 1, 1998, participants vest in the Company's
matching contributions ratably over two years, based on length of service. All
costs of the SERP are funded by the Company as they are incurred.
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59
The cost, principally employer matching contributions, of the benefit
plans charged to operations for 1999, 1998 and 1997 was approximately $3.6
million, $4.0 million and $1.8 million, respectively.
Q. STATUTORY INFORMATION
The Company's HMO subsidiaries are required by the respective domicile
states to maintain minimum statutory capital and surplus in aggregate of
approximately $80.7 million at December 31, 1999. Combined statutory capital and
surplus of the Company's HMOs was approximately $159.8 million. The states in
which the Company's HMOs operate require HMOs to maintain deposits with the
Department of Insurance. These deposits totaled $24.8 million at December 31,
1999.
The National Association of Insurance Commissioners has proposed that
states adopt risk-free capital standards that, if implemented, would generally
require higher minimum capitalization limits for health care coverage provided
by HMOs and other risk-bearing health care entities. To date, no state where
Coventry has HMO operations has adopted those standards.
CHLIC's authorized control level risk-based capital is approximately
$11.8 million. Total adjusted statutory capital and surplus of CHLIC as of
December 31, 1999 was approximately $38.6 million. Statutory deposits for CHLIC
as of December 31, 1999 totaled approximately $3.5 million.
R. OTHER INCOME
Other income for the years ended December 31, 1999, 1998, and 1997
includes investment income of approximately $30.3 million, $25.5 million, and
$10.8 million, respectively. As described in Note D, other income includes $15.0
million in 1997 from the sale of medical offices.
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60
S. EARNINGS PER SHARE
Basic earnings per share ("EPS") is based on the weighted average number
of common shares outstanding during the year. Diluted EPS, when applicable,
assumes the conversion of convertible notes and the exercise of all options,
warrants and redeemable convertible preferred stock using the treasury stock
method. Net earnings is increased for the assumed elimination of interest
expense on the convertible notes. In all cases, however, losses are not diluted.
The following table summarizes the earnings and the average number of
common shares used in the calculation of basic and diluted EPS (in thousands,
except for per share amounts):
1999
---------------------------------------------------------
EARNINGS SHARES
(NUMERATOR) (DENOMINATOR) PER SHARE AMOUNT
---------------------------------------------------------
Basic EPS $43,435 59,025 $0.74
Effect of Dilutive Securities
Options and warrants 498
Convertible notes 2,997
Redeemable convertible 1,639
preferred stock
Interest on convertible notes $848
--------------------------------------------------------------
Diluted EPS $44,283 64,159 $0.69
==============================================================
1998
--------------------------------------------------------------
LOSS SHARES
(NUMERATOR) (DENOMINATOR) PER SHARE AMOUNT
--------------------------------------------------------------
Basic EPS $(11,741) 52,477 $(0.22)
Effect of Dilutive Securities
Options and warrants
Convertible notes
--------------------------------------------------------------
Diluted EPS $(11,741) 52,477 $(0.22)
==============================================================
1997
--------------------------------------------------------------
LOSS SHARES
(NUMERATOR) (DENOMINATOR) PER SHARE AMOUNT
--------------------------------------------------------------
Basic EPS $11,903 33,210 $0.36
Effect of Dilutive Securities
Options and warrants 702
Convertible notes
--------------------------------------------------------------
Diluted EPS $11,903 33,912 $0.35
==============================================================
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T. LEGAL PROCEEDINGS
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 with varying deductibles 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.
UNITY ARBITRATION. 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.
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
while concurrently proceeding 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 no assurance in this regard.
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U. SEGMENT INFORMATION
FOR THE YEAR ENDED DECEMBER 31, 1999
(IN $000S)
COMMERCIAL GOVERNMENT PROGRAMS TOTAL
---------------------------------------------------------------------------
Revenues $1,541,786 540,289 2,082,075
Gross Margin 235,084 60,621 295,705
FOR THE YEAR ENDED DECEMBER 31, 1998
(IN $000S)
COMMERCIAL GOVERNMENT PROGRAMS TOTAL
---------------------------------------------------------------------------
Revenues $1,561,640 471,732 2,033,372
Gross Margin 165,299 45,699 210,998
FOR THE YEAR ENDED DECEMBER 31, 1997
(IN $000S)
COMMERCIAL GOVERNMENT PROGRAMS TOTAL
---------------------------------------------------------------------------
Revenues $886,237 321,912 1,208,149
Gross Margin 132,340 35,949 168,289
Following are reconciliations of reportable segment information to
financial statement amounts:
FOR THE YEARS ENDED DECEMBER 31,
1999 1998 1997
-------------------------------------------------------------------
Revenues
Reportable Segments $2,082,075 $2,033,372 $1,208,149
Management services 80,297 77,011 20,202
-------------------------------------------------------------------
Total revenues $2,162,372 $2,110,383 $1,228,351
===================================================================
Earnings (Loss) Before
Income Taxes:
Gross margin from reportable
segments $295,705 $210,998 $168,289
Management services 80,297 77,011 20,202
Selling, general and administrative (299,942) (291,919) (170,017)
Depreciation and amortization (28,205) (25,793) (12,735)
Merger costs - (6,492) -
Other income, net 29,906 27,251 24,880
Interest expense (1,761) (8,566) (10,275)
-------------------------------------------------------------------
Earnings (loss) before income
taxes and minority interest $76,000 $(17,510) $20,344
===================================================================
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V. QUARTERLY FINANCIAL DATA (UNAUDITED)
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) The Company 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, the Company 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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W. SUBSEQUENT EVENTS
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. PrimeONE
has approximately 18,000 commercial members and annual premium revenue of $32.0
million. The acquisition expands the Company's West Virginia service area and
brings its total membership in the state to over 109,000 members.
On February 3, 2000, the Company 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 the Company's total
Medicaid membership in St. Louis to more than 106,000 members.
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
NONE.
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PART III
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information set forth under the captions "Directors and Executive
Officers" and "Election of Directors" in the Company's Proxy Statement for its
2000 Annual Meeting of Shareholders, which the Company intends to file within
120 days after its fiscal year-end, is incorporated herein by reference.
ITEM 11: EXECUTIVE COMPENSATION.
The information set forth under the caption "Executive Compensation" in
the Company's Proxy Statement for its 2000 Annual Meeting of Shareholders, which
the Company intends to file within 120 days after its fiscal year-end, is
incorporated herein by reference.
ITEM 12: SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information set forth under the captions "Executive Compensation,"
"Voting Stock Outstanding and Shareholders," and "Voting Stock Ownership of
Principal Shareholders and Management" in the Company's Proxy Statement for its
2000 Annual Meeting of Shareholders, which the Company intends to file within
120 days after its fiscal year-end, is incorporated by reference herein.
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information set forth under the caption "Certain Transactions" in the
Company's Proxy Statement for its 2000 Annual Meeting of Shareholders, which the
Company intends to file within 120 days after its fiscal year-end, is
incorporated by reference herein.
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PART IV
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
FORM 10-K
PAGES
---------
Report of Independent Public Accountants 35
Consolidated Balance Sheets, December 31, 1999 and 1998 36
Consolidated Statements of Operations for the Years Ended December
31, 1999, 1998 and 1997 37
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 1999, 1998 and 1997 38
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1999, 1998 and 1997 39
Notes to Consolidated Financial Statements, December 31, 1999, 1998,
and 1997 40 - 62
2. Financial Statement Schedules
Report of Independent Public Accountants S-1
Schedule II - Valuation and Qualifying Accounts S-2
3. Exhibits Required to be Filed by Item 601 of Regulation S-K.
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
2.1 Capital Contribution and Merger Agreement dated as of November 3,
1997 ("Combination Agreement") by and among Coventry Corporation,
Coventry Health Care, Inc., Principal Mutual Life Insurance
Company, Principal Holding Company and Principal Health Care, Inc.
(Incorporated by reference to Exhibit 2.1 to Form S-4,
Registration Statement No. 333-45821, of Coventry Health Care,
Inc.).
2.2 Agreement and Plan of Merger by and among Coventry Corporation,
Coventry Health Care, Inc. and Coventry Merger Corporation
(Incorporated by reference to Exhibit 2.2 to Form S-4,
Registration Statement No. 333-45821 of Coventry Health Care,
Inc.).
3.1 Certificate of Incorporation of Coventry Health Care, Inc.
(Incorporated by reference to Exhibit 3.1 to Form S-4,
Registration Statement No. 333-45821 of Coventry Health Care,
Inc.).
3.2 Bylaws of Coventry Health Care, Inc. (Incorporated by reference to
Exhibit 3.2 to Form S-4, Registration Statement No. 333-45821 of
Coventry Health Care, Inc.).
4.1.1 Specimen Common Stock Certificate (Incorporated by reference to
Exhibit 4.1 to the Company's Current Report on Form 8-K dated
April 8, 1998).
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67
4.1.2 Specimen Series A Convertible Preferred Stock Certificate
(Incorporated by reference to Exhibit 4.1 of the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30,
1999).
4.2 Rights Agreement dated March 30, 1998 between Coventry Health
Care, Inc. and ChaseMellon Shareholder Services, L.L.C. as Rights
Agent (Incorporated by reference to Exhibit 4.2 to the Company's
Current Report on Form 8-K dated April 8, 1998).
4.3 Amendment No. 1 to Rights Agreement, dated as of December 18, 1998
by and between Coventry Health Care, Inc. and ChaseMellon
Shareholder Services, LLC (Incorporated by reference to Exhibit 2
to the Company's Current Report on Form 8-K dated December 21,
1998).
4.4 Amended and Restated Securities Purchase Agreement dated as of
April 2, 1997, by and among Coventry Corporation, Warburg, Pincus
Ventures, L.P. and Franklin Capital Associates III, L.P., together
with Exhibit A (Form of Convertible Note), Exhibit B (Form of
Warrant) and Exhibit C (Form of Certificate of Designation of
Series A Preferred Stock) (Incorporated by reference to Exhibit 10
to Coventry Corporation's Form 8-K dated May 7, 1997).
4.5 Amendment No. 1 to Amended and Restated Securities Purchase
Agreement dated August 1, 1998 between Coventry Health Care, Inc.
(successor by merger to Coventry Corporation) and Warburg, Pincus
Ventures, L.P. (Incorporated by reference to Exhibit 4.13 to the
Company's Quarterly Report on Form 10-Q for the period ended
September 30, 1998).
4.6 Amended Form of Convertible Note (Incorporated by reference to
Exhibit 4.5 of Coventry Corporation's Annual Report on Form 10-K
for the year ended December 31, 1997).
4.7 Consent to the Combination Agreement of Warburg, Pincus Ventures,
L.P. dated December 18, 1998 (Incorporated by reference to Exhibit
4.7 to the Company's Form 8-K dated April 8, 1998).
4.8 Common Stock Purchase Warrant dated as of April 1, 1998 issued to
Principal Health Care, Inc. pursuant to the Combination Agreement
(Incorporated by reference to Exhibit 4.5 to the Company's Form
8-K dated April 8, 1998).
4.9 Amendment No. 1 to Common Stock Purchase Warrant effective as of
October 29, 1998, issued to Principal Health Care, Inc.
(Incorporated by reference to Exhibit 4.9 of the Company's Annual
Report on Form 10-K for the year ended December 31, 1998).
4.10 Form of Common Stock Purchase Warrant, as amended, of Coventry
Corporation issued to Warburg, Pincus Ventures, L.P. (and also to
Franklin Capital Associates III, L.P. for 235,294 shares of common
stock) (assumed by the Company as of April 1, 1998) (Incorporated
by reference to Exhibit 4.6 to the Company's Form 8-K dated April
8, 1998).
4.11 Form of Common Stock Purchase Warrant.
4.12 Common Stock Purchase Warrant issued as of January 4, 1999 to John
W. Campbell (Incorporated by reference to Exhibit 10.2 to the
Company's Form 10-Q, Quarterly Report for the quarter ended June
30, 1999).
65
68
4.13 Shareholders' Agreement, dated as of April 1, 1998, by and among
Coventry Health Care, Inc., Principal Mutual Life Insurance
Company and Principal Health Care, Inc. (Incorporated by reference
to Exhibit 4.8 to the Company's Form 8-K dated April 8, 1998).
10.0 Agreement dated May 19, 1999 between the Company and Principal
Life Insurance Company (Incorporated by reference to Exhibit 10.2
to the Company's Form 10-Q, Quarterly Report for the quarter ended
June 30, 1999).
10.1 Form of Coinsurance Agreement executed as of April 1, 1998,
pursuant to the Combination Agreement (Incorporated by reference
to Exhibit 10.2 to Form S-4, Registration Statement No. 333-45821
of Coventry Health Care, Inc.).
10.2 Form of Renewal Rights Agreement executed as of April 1, 1998,
pursuant to the Combination Agreement (Incorporated by reference
to Exhibit 10.3 to Form S-4, Registration Statement No. 333-45821
of Coventry Health Care, Inc.).
10.3 Form of Transition Agreement executed as of April 1, 1998,
pursuant to the Combination Agreement (Incorporated by reference
to Exhibit 10.4 to Form S-4, Registration Statement No. 333-45821
of Coventry Health Care, Inc.).
10.4 Form of Management Services Agreement executed as of April 1,
1998, pursuant to the Combination Agreement (Incorporated by
reference to Exhibit 10.5 to Form S-4, Registration Statement No.
333-45821 of Coventry Health Care, Inc.).
10.5 Form of Tax Benefit Restitution Agreement executed as of April 1,
1998, pursuant to the Combination Agreement (Incorporated by
reference to Exhibit 10.7 to Form S-4, Registration Statement No.
333-45821 of Coventry Health Care, Inc.).
10.6 Form of License Agreement executed as of April 1, 1998, pursuant
to the Combination Agreement (Incorporated by reference to Exhibit
10.8 to Form S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
10.7 Form of Marketing Service Agreement executed as of April 1, 1998,
pursuant to the Combination Agreement (Incorporated by reference
to Exhibit 10.9 to Form S-4, Registration Statement No. 333-45821
of Coventry Health Care, Inc.).
10.8 Principal Health Care of Florida, Inc. Stock Purchase Agreement
dated as of October 14, 1998, by and among Coventry Health Care,
Inc., as Seller, Blue Cross and Blue Shield of Florida, Inc.,
Principal Health Care of Florida, Inc. and Health Options, Inc.,
as Buyer (Incorporated by reference to Exhibit 10.45 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1998).
10.9 Stock Purchase Agreement dated October 2, 1998, between Coventry
Health Care, Inc., as Seller, and First American Group of
Companies, Inc., as Buyer (Incorporated by reference to Exhibit
10.46 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998).
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69
10.10 Employment Agreement effective as of January 1, 1999, executed by
Allen F. Wise and the Company. (Incorporated by reference to
Exhibit 10.10 of the Company's Annual Report on Form 10-K for the
year ended December 31, 1998).
10.11 Employment Agreement dated December 30, 1996 executed by Dale B.
Wolf and Coventry Corporation (assumed by the Company as of April
1, 1998) (Incorporated by reference to Exhibit 10 (v) to Coventry
Corporation's Form 10-K for the fiscal year ended December 31,
1996, filed March 31, 1997).
10.12.1 Employment Agreement dated March 13, 1998 between Thomas McDonough
and Coventry Corporation (assumed by the Company as of April 1,
1998) (Incorporated by reference to Exhibit 10.33 to the Company's
Form 10-Q, Quarterly Report, for the quarter ended June 30, 1998).
10.12.2 Amendment to Employment Agreement dated July 12, 1999 between
Thomas McDonough and the Company (Incorporated by reference to
Exhibit 10.1 to the Company's Form 10-Q, Quarterly Report for the
quarter ended September 30, 1999).
10.13.1 Employment Letter dated May 22, 1998 between James E. McGarry and
Coventry Health Care, Inc. (Incorporated by reference to Exhibit
10.34 to the Company's Form 10-Q, Quarterly Report, for the
quarter ended June 30, 1998).
10.13.2 Employment Agreement effective as of June 17, 1999, executed by
James E. McGarry and Coventry Health Care, Inc. (Incorporated by
reference to Exhibit 10.3 to the Company's Form 10-Q Quarterly
Report for the quarter ended June 30, 1999).
10.14 Form of Company's Employment Agreement executed by the following
executives upon terms substantially similar, except as to
compensation, dates of employment, position, and as otherwise
noted: Claudia Bjerre, Janet M. Stallmeyer, Francis S. Soistman,
Jr., Harvey Pollack, Ronald M. Chaffin, Bernard J. Mansheim,
M. D., Thomas Davis (included executive's right to terminate and
receive severance if he is required to relocate other than to
Atlanta, Georgia or Bethesda, Maryland), J. Stewart Lavelle
(includes executive's right to terminate and receive severance if
there is a material reduction in position or compensation without
consent, a change of control or a requirement to relocate), and
Harvey C. DeMovick, Jr. (includes executive's right to terminate
and receive severance if there is a significant change in his
position or reporting relationship as a result of a change in
control) (Incorporated by reference to Exhibit 10.32 to the
Company's Form 10-Q, Quarterly Report, for the quarter ended June
30, 1998).
10.15 Form of Company's Agreement (for Key Executives) dated September
12, 1995 (executed by James R. Hailey, Jan H. Hodges, and Shirley
R. Smith) (Incorporated by reference to Exhibit (xxix) to Coventry
Corporation's Form 10-Q, Quarterly Report, for the quarter ended
September 30, 1995).
10.16 Separation Agreement and Release dated April 13, 1999 between
Richard H. Jones and the Company (Incorporated by reference to
Exhibit 10.1 to the Company's Form 10-Q, Quarterly Report for the
quarter ended June 30, 1999).
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70
10.17 Agreement and Release dated May 29, 1998 between Robert A. Mayer,
Coventry Corporation and HealthAmerica Pennsylvania, Inc.
(Incorporated by reference to Exhibit 10.35 to the Company's Form
10-Q, Quarterly Report, for the quarter ended June 30, 1998).
10.19 Agreement and Release dated June 30, 1998 between Kenneth J. Linde
and Coventry Health Care, Inc. (Incorporated by reference to
Exhibit 10.36 to the Company's Form 10-Q, Quarterly Report, for
the quarter ended June 30, 1998).
10.20 Second Amended and Restated 1987 Statutory-Nonstatutory Stock
Option Plan (Incorporated by reference to Exhibit 10.8.1 attached
to Annual Report on Coventry Corporation's Form 10-K for fiscal
year ended December 31, 1993).
10.21 Third Amended and Restated 1989 Stock Option Plan (Incorporated by
reference to Exhibit 10.8.2 attached to Coventry Corporation's
Annual Report on Form 10-K for the fiscal year ended December 31,
1993).
10.22 1993 Outside Directors Stock Option Plan (as amended)
(Incorporated by reference to Exhibit 10.8.3 attached to Coventry
Corporation's Annual Report on Form 10-K for the fiscal year ended
December 31, 1995).
10.23 1993 Stock Option Plan (as amended) (Incorporated by reference to
Exhibit 10.8.4 attached to the Coventry Corporation's Annual
Report on Form 10-K for the fiscal year ended December 31, 1995).
10.24 Coventry Corporation 1997 Stock Incentive Plan, as amended.
(Incorporated by reference to Exhibit 10.29 to Coventry
Corporation's Annual Report on Form 10-K for the fiscal year ended
December 31, 1997).
10.25 Coventry Health Care, Inc. Amended and Restated 1998 Stock
Incentive Plan (March 4, 1999) (Incorporated by reference to
Exhibit 10.25 of the Company's Annual Report on Form 10-K for the
year ended December 31, 1998).
10.26 Coventry Health Care 1999 Management Incentive Plan
(Incorporated by reference to Exhibit 10.26 of the Company's
Annual Report on Form 10-K for the year ended December 31, 1998).
10.27.1 Form of Coventry Health Care, Inc. Retirement Savings Plan,
effective April 1, 1998. (Incorporated by reference to Exhibit
10.27 of the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1998).
10.27.2 Amendment No. 1, Coventry Health Care, Inc. Retirement Savings
Plan, effective October 1, 1998.
10.28.1 Coventry Corporation Supplemental Executive Retirement ("SERP")
Plan effective July 1, 1994 (Incorporated by reference to Exhibit
4.2 to Coventry Corporation's Form S-8, Registration Statement No.
33-81358).
10.28.2 First Amendment to SERP dated December 31, 1996 (Incorporated by
reference to Exhibit 10.19 to Coventry Corporation's Annual Report
on Form 10-K for the fiscal year ended December 31, 1997).
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71
10.28.3 Second Amendment to SERP dated July 15, 1997 (Incorporated by
reference to Exhibit 10.20 to Coventry Corporation's Annual Report
on Form 10-K for the fiscal year ended December 31, 1997).
10.28.4 Third Amendment to SERP dated April 30, 1998 (Incorporated by
reference to Exhibit 10.32.1 of the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1998).
10.28.5 Fourth Amendment to SERP dated November 4, 1999.
10.32 Southern Health Management Corporation 1993 Stock Option Plan
(Incorporated by reference to Exhibit 10.8.5 to Coventry
Corporation's Annual Report on Form 10-K for the year ended
December 31, 1995).
10.33 Employment Agreement dated January 15, 1997 executed by Shirley R.
Smith (Incorporated by reference to Exhibit 10 (xxiv) to Coventry
Corporation's Form 10-K for the fiscal year ended December 31,
1996 filed March 31, 1997).
10.34 Employment Agreement dated January 1, 1997 executed by Jan H.
Hodges (Incorporated by reference to Exhibit 10 (xxvii) to
Coventry Corporation's Form 10-K for the fiscal year ended
December 31, 1996 filed March 31, 1997).
10.35 Global Capitation Agreement, dated March 12, 1997, by and among
Group Health Plan, Inc., HealthCare USA of Missouri, LLC and BJC
Health Systems. (Incorporated by reference to Exhibit 10.5 to
Coventry Corporation's Form 8-K/A dated March 12, 1998).*
10.36 Second Amendment to the Global Capitation Agreement by and between
Group Health Plan, Inc., HealthCare USA of Missouri, LLC, and BJC
Health System dated February 26, 1999 (Incorporated by reference
to the Company's Annual Report on Form 10-K for the year ended
December 31, 1998).*
11 Computation of Net Earnings Per Common and Common Equivalent Share
21 Subsidiaries of the Registrant
23 Consent of Arthur Andersen LLP (See Exhibit 23 attached to this
Report)
27 Financial Data Schedule (for SEC use only)
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the quarter ended December 31,
1999.
- ----------
* Portions of this exhibit have been omitted and have been accorded confidential
treatment pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as
amended.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
COVENTRY HEALTH CARE, INC.
By: /s/ ALLEN F. WISE President, Chief Executive Officer and
---------------------------------- Director
Allen F. Wise
Executive Vice President, Chief Financial
By: /s/ DALE B. WOLF Officer, Treasurer and Principal Accounting
---------------------------------- Officer
Dale B. Wolf
DATED: MARCH 30, 2000
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title (Principal Function) Date
/s/ JOHN H. AUSTIN, .M.D., M.P.H.
------------------------------------- Chairman of the Board and March 30, 2000
John H. Austin, M.D., M.P.H. Director
/s/ ALLEN F. WISE
------------------------------------- President, Chief Executive March 30, 2000
Allen F. Wise Officer and Director
/s/ DALE B. WOLF
------------------------------------- Executive Vice President, Chief
Dale B. Wolf Financial Officer, Treasurer and March 30, 2000
Principal Accounting Officer
/s/ LAWRENCE N. KUGELMAN
------------------------------------- Director March 30, 2000
Lawrence N. Kugelman
/s/ EMERSON D. FARLEY, JR., M.D.
------------------------------------- Director March 30, 2000
Emerson D. Farley, Jr., M.D.
/s/ JOEL ACKERMAN
------------------------------------- Director March 30, 2000
Joel Ackerman
------------------------------------- Director March 30, 2000
Elizabeth E. Tallett
------------------------------------- Director March 30, 2000
Thomas L. Blair
/s/ THOMAS J. GRAF
------------------------------------- Director March 30, 2000
Thomas J. Graf
/s/ DAVID J. DRURY
------------------------------------- Director March 30, 2000
David J. Drury
/s/ RODMAN W. MOORHEAD, III
------------------------------------- Director March 30, 2000
Rodman W. Moorhead, III
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ARTHUR ANDERSEN LLP
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE BOARD OF DIRECTORS OF
COVENTRY HEALTH CARE, INC:
We have audited in accordance with auditing standards generally accepted in the
United States, the consolidated financial statements of Coventry Health Care,
Inc. (a Delaware corporation and successor-in-interest to Coventry Corporation)
and subsidiaries included in this Form 10-K and have issued our report thereon
dated February 21, 2000. Our audits were made for the purpose of forming an
opinion on the basic consolidated financial statements taken as a whole. The
schedule listed under Item 14(a)(2) is the responsibility of the Company's
management and is presented for purposes of complying with the Securities and
Exchange Commission's rules and is not part of the basic consolidated financial
statements. This schedule has been subjected to the auditing procedures applied
in the audit of the basic consolidated financial statements and, in our opinion,
fairly states in all material respects the financial data required to be set
forth herein in relation to the basic consolidated financial statements taken as
a whole.
ARTHUR ANDERSEN LLP
BALTIMORE, MARYLAND
FEBRUARY 21, 2000
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SCHEDULE II
COVENTRY HEALTH CARE INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
ADDITIONS CHARGED TO
BALANCE AT COSTS AND EXPENSES DEDUCTIONS (CHARGE END OF
BEGINNING OF PERIOD (1) (2) OFFS) (1)(2) PERIOD
---------------------------------------------------------------------------------------
Year ended December 31, 1999:
Allowance for doubtful accounts $ 12,023 $ 4,562 $ (11,037) $ 5,548
Year ended December 31, 1998:
Allowance for doubtful accounts $ 7,378 $ 15,935 $ (11,290) $ 12,023
Year ended December 31, 1997:
Allowance for doubtful accounts $ 8,000 $ 2,748 $ (3,370) $ 7,378
(1) Additions to the allowance for doubtful accounts are included in selling,
general and administrative expense. All deductions or charge offs are
charged against the allowance for doubtful accounts.
(2) Additions to the allowance for retroactive terminations are included as
contra revenue.
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INDEX TO EXHIBITS
Reg. S-K
Item 601
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
2.1 Capital Contribution and Merger Agreement dated as of November 3,
1997 ("Combination Agreement") by and among Coventry Corporation,
Coventry Health Care, Inc., Principal Mutual Life Insurance
Company, Principal Holding Company and Principal Health Care, Inc.
(Incorporated by reference to Exhibit 2.1 to Form S-4,
Registration Statement No. 333-45821, of Coventry Health Care,
Inc.).
2.2 Agreement and Plan of Merger by and among Coventry Corporation,
Coventry Health Care, Inc. and Coventry Merger Corporation
(Incorporated by reference to Exhibit 2.2 to Form S-4,
Registration Statement No. 333-45821 of Coventry Health Care,
Inc.).
3.1 Certificate of Incorporation of Coventry Health Care, Inc.
(Incorporated by reference to Exhibit 3.1 to Form S-4,
Registration Statement No. 333-45821 of Coventry Health Care,
Inc.).
3.2 Bylaws of Coventry Health Care, Inc. (Incorporated by reference to
Exhibit 3.2 to Form S-4, Registration Statement No. 333-45821 of
Coventry Health Care, Inc.).
4.1.1 Specimen Common Stock Certificate (Incorporated by reference to
Exhibit 4.1 to the Company's Current Report on Form 8-K dated
April 8, 1998).
4.1.2 Specimen Series A Convertible Preferred Stock Certificate
(Incorporated by reference to Exhibit 4.1 of the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30,
1999).
4.2 Rights Agreement dated March 30, 1998 between Coventry Health
Care, Inc. and ChaseMellon Shareholder Services, L.L.C. as Rights
Agent (Incorporated by reference to Exhibit 4.2 to the Company's
Current Report on Form 8-K dated April 8, 1998).
4.3 Amendment No. 1 to Rights Agreement, dated as of December 18, 1998
by and between Coventry Health Care, Inc. and ChaseMellon
Shareholder Services, LLC (Incorporated by reference to Exhibit 2
to the Company's Current Report on Form 8-K dated December 21,
1998).
4.4 Amended and Restated Securities Purchase Agreement dated as of
April 2, 1997, by and among Coventry Corporation, Warburg, Pincus
Ventures, L.P. and Franklin Capital Associates III, L.P., together
with Exhibit A (Form of Convertible Note), Exhibit B (Form of
Warrant) and Exhibit C (Form of Certificate of Designation of
Series A Preferred Stock) (Incorporated by reference to Exhibit 10
to Coventry Corporation's Form 8-K dated May 7, 1997).
4.5 Amendment No. 1 to Amended and Restated Securities Purchase
Agreement dated August 1, 1998 between Coventry Health Care, Inc.
(successor by merger to Coventry Corporation) and Warburg, Pincus
Ventures,
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L.P. (Incorporated by reference to Exhibit 4.13 to the Company's
Quarterly Report on Form 10-Q for the period ended September 30,
1998).
4.6 Amended Form of Convertible Note (Incorporated by reference to
Exhibit 4.5 of Coventry Corporation's Annual Report on Form 10-K
for the year ended December 31, 1997).
4.7 Consent to the Combination Agreement of Warburg, Pincus Ventures,
L.P. dated December 18, 1998 (Incorporated by reference to Exhibit
4.7 to the Company's Form 8-K dated April 8, 1998).
4.8 Common Stock Purchase Warrant dated as of April 1, 1998 issued to
Principal Health Care, Inc. pursuant to the Combination Agreement
(Incorporated by reference to Exhibit 4.5 to the Company's Form
8-K dated April 8, 1998).
4.9 Amendment No. 1 to Common Stock Purchase Warrant effective as of
October 29, 1998, issued to Principal Health Care, Inc.
(Incorporated by reference to Exhibit 4.9 of the Company's Annual
Report on Form 10-K for the year ended December 31, 1998).
4.10 Form of Common Stock Purchase Warrant, as amended, of Coventry
Corporation issued to Warburg, Pincus Ventures, L.P. (and also to
Franklin Capital Associates III, L.P. for 235,294 shares of common
stock) (assumed by the Company as of April 1, 1998) (Incorporated
by reference to Exhibit 4.6 to the Company's Form 8-K dated April
8, 1998).
4.11 Form of Common Stock Purchase Warrant.
4.12 Common Stock Purchase Warrant issued as of January 4, 1999 to John
W. Campbell (Incorporated by reference to Exhibit 10.2 to the
Company's Form 10-Q, Quarterly Report for the quarter ended June
30, 1999).
4.13 Shareholders' Agreement, dated as of April 1, 1998, by and among
Coventry Health Care, Inc., Principal Mutual Life Insurance
Company and Principal Health Care, Inc. (Incorporated by reference
to Exhibit 4.8 to the Company's Form 8-K dated April 8, 1998).
10.0 Agreement dated May 19, 1999 between the Company and Principal
Life Insurance Company (Incorporated by reference to Exhibit 10.2
to the Company's Form 10-Q, Quarterly Report for the quarter ended
June 30, 1999).
10.1 Form of Coinsurance Agreement executed as of April 1, 1998,
pursuant to the Combination Agreement (Incorporated by reference
to Exhibit 10.2 to Form S-4, Registration Statement No. 333-45821
of Coventry Health Care, Inc.).
10.2 Form of Renewal Rights Agreement executed as of April 1, 1998,
pursuant to the Combination Agreement (Incorporated by reference
to Exhibit 10.3 to Form S-4, Registration Statement No. 333-45821
of Coventry Health Care, Inc.).
10.3 Form of Transition Agreement executed as of April 1, 1998,
pursuant to the Combination Agreement (Incorporated by reference
to Exhibit 10.4 to Form S-4, Registration Statement No. 333-45821
of Coventry Health Care, Inc.).
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10.4 Form of Management Services Agreement executed as of April 1,
1998, pursuant to the Combination Agreement (Incorporated by
reference to Exhibit 10.5 to Form S-4, Registration Statement No.
333-45821 of Coventry Health Care, Inc.).
10.5 Form of Tax Benefit Restitution Agreement executed as of April 1,
1998, pursuant to the Combination Agreement (Incorporated by
reference to Exhibit 10.7 to Form S-4, Registration Statement No.
333-45821 of Coventry Health Care, Inc.).
10.6 Form of License Agreement executed as of April 1, 1998, pursuant
to the Combination Agreement (Incorporated by reference to Exhibit
10.8 to Form S-4, Registration Statement No. 333-45821 of Coventry
Health Care, Inc.).
10.7 Form of Marketing Service Agreement executed as of April 1, 1998,
pursuant to the Combination Agreement (Incorporated by reference
to Exhibit 10.9 to Form S-4, Registration Statement No. 333-45821
of Coventry Health Care, Inc.).
10.8 Principal Health Care of Florida, Inc. Stock Purchase Agreement
dated as of October 14, 1998, by and among Coventry Health Care,
Inc., as Seller, Blue Cross and Blue Shield of Florida, Inc.,
Principal Health Care of Florida, Inc. and Health Options, Inc.,
as Buyer (Incorporated by reference to Exhibit 10.45 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1998).
10.9 Stock Purchase Agreement dated October 2, 1998, between Coventry
Health Care, Inc., as Seller, and First American Group of
Companies, Inc., as Buyer (Incorporated by reference to Exhibit
10.46 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998).
10.10 Employment Agreement effective as of January 1, 1999, executed by
Allen F. Wise and the Company. (Incorporated by reference to
Exhibit 10.10 of the Company's Annual Report on Form 10-K for the
year ended December 31, 1998).
10.11 Employment Agreement dated December 30, 1996 executed by Dale B.
Wolf and Coventry Corporation (assumed by the Company as of April
1, 1998) (Incorporated by reference to Exhibit 10 (v) to Coventry
Corporation's Form 10-K for the fiscal year ended December 31,
1996, filed March 31, 1997).
10.12.1 Employment Agreement dated March 13, 1998 between Thomas McDonough
and Coventry Corporation (assumed by the Company as of April 1,
1998) (Incorporated by reference to Exhibit 10.33 to the Company's
Form 10-Q, Quarterly Report, for the quarter ended June 30, 1998).
10.12.2 Amendment to Employment Agreement dated July 12, 1999 between
Thomas McDonough and the Company (Incorporated by reference to
Exhibit 10.1 to the Company's Form 10-Q, Quarterly Report for the
quarter ended September 30, 1999).
10.13.1 Employment Letter dated May 22, 1998 between James E. McGarry and
Coventry Health Care, Inc. (Incorporated by reference to Exhibit
10.34 to the Company's Form 10-Q, Quarterly Report, for the
quarter ended June 30, 1998).
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10.13.2 Employment Agreement effective as of June 17, 1999, executed by
James E. McGarry and Coventry Health Care, Inc. (Incorporated by
reference to Exhibit 10.3 to the Company's Form 10-Q, Quarterly
Report, for the quarter ended June 30, 1999).
10.14 Form of Company's Employment Agreement executed by the following
executives upon terms substantially similar, except as to
compensation, dates of employment, position, and as otherwise
noted: Claudia Bjerre, Janet M. Stallmeyer, Francis S. Soistman,
Jr., Harvey Pollack, Ronald M. Chaffin, Bernard J. Mansheim, M.D.,
Thomas Davis (included executive's right to terminate and receive
severance if he is required to relocate other than to Atlanta,
Georgia or Bethesda, Maryland), J. Stewart Lavelle (includes
executive's right to terminate and receive severance if there is a
material reduction in position or compensation without consent, a
change of control or a requirement to relocate), and Harvey C.
DeMovick, Jr. (includes executive's right to terminate and receive
severance if there is a significant change in his position or
reporting relationship as a result of a change in control)
(Incorporated by reference to Exhibit 10.32 to the Company's Form
10-Q, Quarterly Report, for the quarter ended June 30, 1998).
10.15 Form of Company's Agreement (for Key Executives) dated September
12, 1995 (executed by James R. Hailey, Jan H. Hodges, and Shirley
R. Smith) (Incorporated by reference to Exhibit (xxix) to Coventry
Corporation's Form 10-Q, Quarterly Report, for the quarter ended
September 30, 1995)
10.16 Separation Agreement and Release dated April 13, 1999 between
Richard H. Jones and the Company (Incorporated by reference to
Exhibit 10.1 to the Company's Form 10-Q, Quarterly Report for the
quarter ended June 30, 1999).
10.17 Agreement and Release dated May 29, 1998 between Robert A. Mayer,
Coventry Corporation and HealthAmerica Pennsylvania, Inc.
(Incorporated by reference to Exhibit 10.35 to the Company's Form
10-Q, Quarterly Report, for the quarter ended June 30, 1998).
10.19 Agreement and Release dated June 30, 1998 between Kenneth J. Linde
and Coventry Health Care, Inc. (Incorporated by reference to
Exhibit 10.36 to the Company's Form 10-Q, Quarterly Report, for
the quarter ended June 30, 1998).
10.20 Second Amended and Restated 1987 Statutory-Nonstatutory Stock
Option Plan (Incorporated by reference to Exhibit 10.8.1 attached
to Annual Report on Coventry Corporation's Form 10-K for fiscal
year ended December 31, 1993).
10.21 Third Amended and Restated 1989 Stock Option Plan (Incorporated by
reference to Exhibit 10.8.2 attached to Coventry Corporation's
Annual Report on Form 10-K for the fiscal year ended December 31,
1993).
10.22 1993 Outside Directors Stock Option Plan (as amended)
(Incorporated by reference to Exhibit 10.8.3 attached to Coventry
Corporation's Annual Report on Form 10-K for the fiscal year ended
December 31, 1995).
10.23 1993 Stock Option Plan (as amended) (Incorporated by reference to
Exhibit 10.8.4 attached to the Coventry
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Corporation's Annual Report on Form 10-K for the fiscal year ended
December 31, 1995).
10.24 Coventry Corporation 1997 Stock Incentive Plan, as amended.
(Incorporated by reference to Exhibit 10.29 to Coventry
Corporation's Annual Report on Form 10-K for the fiscal year ended
December 31, 1997).
10.25 Coventry Health Care, Inc. Amended and Restated 1998 Stock
Incentive Plan (March 4, 1999) (Incorporated by reference to
Exhibit 10.25 of the Company's Annual Report on Form 10-K for the
year ended December 31, 1998).
10.26 Coventry Health Care 1999 Management Incentive Plan -
(Incorporated by reference to Exhibit 10.26 of the Company's
Annual Report on Form 10-K for the year ended December 31, 1998).
10.27.1 Form of Coventry Health Care, Inc. Retirement Savings Plan,
effective April 1, 1998. (Incorporated by reference to Exhibit
10.27 of the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1998).
10.27.2 Amendment No. 1, Coventry Health Care, Inc. Retirement Savings
Plan, effective October 1, 1998.
10.28.1 Coventry Corporation Supplemental Executive Retirement
Plan ("SERP") effective July 1, 1994 (Incorporated by reference to
Exhibit 4.2 to Coventry Corporation's Form S-8, Registration
Statement No. 33-81358).
10.28.2 First Amendment to SERP dated December 31, 1996 (Incorporated by
reference to Exhibit 10.19 to Coventry Corporation's Annual Report
on Form 10-K for the fiscal year ended December 31, 1997).
10.28.3 Second Amendment to SERP dated July 15, 1997 (Incorporated by
reference to Exhibit 10.20 to Coventry Corporation's Annual Report
on Form 10-K for the fiscal year ended December 31, 1997).
10.28.4 Third Amendment to SERP dated April 30, 1998 (Incorporated by
reference to Exhibit 10.32.1 of the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1998).
10.28.5 Fourth Amendment to SERP dated November 4, 1999.
10.32 Southern Health Management Corporation 1993 Stock Option Plan
(Incorporated by reference to Exhibit 10.8.5 to Coventry
Corporation's Annual Report on Form 10-K for the year ended
December 31, 1995).
10.33 Employment Agreement dated January 15, 1997 executed by Shirley R.
Smith (Incorporated by reference to Exhibit 10 (xxiv) to Coventry
Corporation's Annual Report on Form 10-K for the fiscal year ended
December 31, 1996 filed March 31, 1997).
10.34 Employment Agreement dated January 1, 1997 executed by Jan H.
Hodges (Incorporated by reference to Exhibit 10 (xxvii) to
Coventry Corporation's Annual Report on Form 10-K for the fiscal
year ended December 31, 1996 filed March 31, 1997).
10.35 Global Capitation Agreement, dated March 12, 1997, by and among
Group Health Plan, Inc., HealthCare USA of Missouri, LLC and BJC
Health Systems. (Incorporated by reference to Exhibit 10.5 to
Coventry Corporation's Form 8-K/A dated March 12, 1998).*
10.36 Second Amendment to the Global Capitation Agreement by and between
Group Health Plan, Inc., HealthCare USA of
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Missouri, LLC, and BJC Health System dated February 26, 1999
(Incorporated by reference to the Company's Annual Report on Form
10-K for the year ended December 31, 1998).*
11 Computation of Net Earnings Per Common and Common Equivalent Share
21 Subsidiaries of the Registrant
23 Consent of Arthur Andersen LLP (See Exhibit 23 attached to this
Report)
27 Financial Data Schedule (for SEC use only)
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the quarter ended December 31,
1999.
- ----------
* Portions of this exhibit have been omitted and have been accorded confidential
treatment pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as
amended.
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