TROVER SOLUTIONS INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934

(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM ____________TO ____________

Commission File Number 0-22585

TROVER SOLUTIONS, INC.
(Exact Name of Registrant as Specified in its Charter)

DELAWARE 61-1141758
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)

1600 WATTERSON TOWER
LOUISVILLE, KENTUCKY 40218
(Address of principal executive offices) (Zip Code)
(502) 454-1340
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act

NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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None

Securities registered pursuant to Section 12(g) of the Act:

TITLE OF CLASS
Common Stock, par value $.001 per share
(including rights attached thereto)

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 the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendments to this Form 10-K. [ ]

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X].

The aggregate market value of Registrant's Common Stock held by
non-affiliates of the Registrant as of the last day of the Registrant's most
recently completed second fiscal quarter was approximately $54,059,712 (based on
the last sale price of a share of Common Stock as of June 28, 2002 ($5.90)), as
reported by The Nasdaq National Market.

As of March 18, 2003, 8,451,229 shares of the Registrant's Common Stock,
$0.001 par value, were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Proxy Statement for the Annual Meeting of
Stockholders to be held on May 9, 2003 are incorporated herein by reference in
Part III.
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TABLE OF CONTENTS

THIS FORM 10-K AND OTHER STATEMENTS ISSUED OR MADE FROM TIME TO TIME BY THE
COMPANY OR ITS MANAGEMENT TEAM CONTAIN STATEMENTS WHICH MAY CONSTITUTE
"FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF THE SECURITIES ACT OF 1933,
AS AMENDED, AND THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED BY THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995, 15 U.S.C.A. SECTIONS 77Z-2 AND 78U-5
(SUPP. 1996). THOSE STATEMENTS INCLUDE STATEMENTS REGARDING THE INTENT, BELIEF
OR CURRENT EXPECTATIONS OF THE COMPANY AND MEMBERS OF ITS MANAGEMENT TEAM, AS
WELL AS THE ASSUMPTIONS ON WHICH SUCH STATEMENTS ARE BASED. PROSPECTIVE
INVESTORS ARE CAUTIONED THAT ANY SUCH FORWARD-LOOKING STATEMENTS ARE NOT
GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE RISKS AND UNCERTAINTIES, AND THAT
ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CONTEMPLATED BY SUCH
FORWARD-LOOKING STATEMENTS. IMPORTANT FACTORS CURRENTLY KNOWN TO MANAGEMENT THAT
COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN FORWARD-LOOKING
STATEMENTS ARE SET FORTH IN THE SAFE HARBOR COMPLIANCE STATEMENT FOR
FORWARD-LOOKING STATEMENTS INCLUDED AS EXHIBIT 99.1 TO THIS FORM 10-K, AND ARE
HEREBY INCORPORATED HEREIN BY REFERENCE. THE COMPANY UNDERTAKES NO OBLIGATION TO
UPDATE OR REVISE FORWARD-LOOKING STATEMENTS TO REFLECT CHANGED ASSUMPTIONS OR
CIRCUMSTANCES, THE OCCURRENCE OF UNANTICIPATED EVENTS OR CHANGES TO FUTURE
OPERATING RESULTS OVER TIME.

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PART I

ITEM 1. BUSINESS

GENERAL

Trover Solutions, Inc. (hereinafter referred to as the "Company"), a
Delaware corporation, believes it is a leading independent provider of
outsourcing of subrogation and certain other medical claims recovery and cost
containment services to the private healthcare payor industry in the United
States, based on the Company's experience and assessment of its market. The
Company's primary business is medical claims recovery, and its primary product
is subrogation recovery, which generally entails the identification,
investigation and recovery of accident-related medical benefits incurred by its
clients on behalf of their insureds, but for which other persons or entities
have primary responsibility. The Company's clients' rights to recover the value
of these medical benefits, arising by law or contract, are generally known as
the right of subrogation and are generally paid from the proceeds of liability
or workers' compensation insurance. The Company's other medical claims recovery
services include (1) the auditing of the bills of medical providers,
particularly hospitals, for accuracy, correctness and compliance with contract
terms ("provider bill audit"), (2) the recovery of overpayments attributable to
duplicate payments, failures to coordinate benefits and similar errors in
payment ("overpayments"), and (3) the auditing of physician evaluation and
management claims for consistency with medical records, in accordance with
federal guidelines ("MD audit"). The Company offers its healthcare recovery
services on a nationwide basis to health maintenance organizations ("HMOs"),
indemnity health insurers, self-funded employee health plans, companies that
provide claims administration services to self-funded plans (referred to as
"third-party administrators"), Blue Cross and Blue Shield organizations and
provider organized health plans. Current clients include Humana Inc., Kaiser
Permanente, Wellpoint Health Network Inc. and The Principal Financial Group. The
Company had 41.6 million and 49.1 million lives under contract from its
clientele at December 31, 2002 and 2001, respectively.

The Company has three segments: (1) Healthcare Recovery Services, which
encompasses its four healthcare recovery products: healthcare subrogation,
provider bill audit, overpayment recovery, and physician bill audit ("MD
Audit"); (2) Property and Casualty Recovery Services, which includes subrogation
recovery services for property and casualty insurers, which the Company sells
under the brand name "TransPaC Solutions"; and (3) Software, which includes the
sale of subrogation recovery software in a browser-based application service
provider (ASP) form. See Item 7. "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Healthcare Recovery Services",
"-- Property and Casualty Recovery Services", "--Software" and Item 8.
"Financial Statements and Supplementary Information -- Note 17 -- Segment
Information" for financial information about the Company's segments.

ORGANIZATIONAL STRUCTURE

The Company, which was co-founded by its present Chief Executive Officer,
was incorporated on June 30, 1988 under the laws of the State of Delaware. The
Company became publicly held as a result of an initial public offering in May
1997 and is traded on The Nasdaq National Market under the symbol "TROV".

STRATEGY

The Company intends to pursue a two-fold growth strategy. First, with
respect to its existing healthcare recovery services business, the Company will
focus on (i) servicing its existing client base, (ii) selling and installing the
additional lives covered by contracts with existing clients and (iii) selling
and installing new clients and cross-selling expanded product offerings. During
2000, the Company placed in service and began to earn revenue from an internally
developed service that offers its clients the ability to detect, audit and
recover a variety of claims overpayments. During 2002, the Company began a new
division that audits physician evaluation and management claims. The Company
will continue to explore, from time to time, strategic acquisitions which meet
its selection criteria and to develop new service products internally.

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Under the second aspect of its growth strategy, the Company intends to
extend its systems-driven, process-oriented approach, through acquisitions and
internal development, to outsourcing opportunities in the insurance industry,
including both healthcare and property and casualty. The defining
characteristics of the Company's business model are (i) the ability to automate
clerical and administrative tasks, using sophisticated and proprietary computer
applications; and (ii) the ability to standardize and scale work using process
management and classical work measurement techniques. Using this model, the
Company believes that it can dramatically increase the productivity of the
skilled knowledge workers who make up its labor force, and successfully
implement pricing strategies that will reward the Company for those productivity
gains. See "-- Business Developments".

The Company believes that any future development opportunities are likely
to be characterized by outsourcing business services that will produce
predictable and recurring revenue streams; competitive advantages from effective
process management, proprietary systems and the provision of knowledge-rich
services; the development of niche markets; value-based pricing; and a
non-exclusive focus on healthcare information services.

INDUSTRY

GENERAL

The Company's main focus of business is the provision, through its three
segments, of cost containment services and software for the insurance industry.
The first of these segments, Healthcare Recovery Services, offers four recovery
services on an outsourcing basis to healthcare payors, specifically indemnity
insurers, managed care and health maintenance organizations, and self-funded
employers. The second segment, Property and Casualty Recovery Services, provides
subrogation recovery services to the property and casualty ("P&C") industry,
with a focus on full outsourcing. With respect to its healthcare recovery
services and P&C recovery services, the Company believes that in recent years
businesses have increasingly delegated ("outsourced") non-core specialized
business functions to third parties. Because of expertise and economies of
scale, companies that provide specialized services are often able to deliver the
requisite service at lower costs or with greater effectiveness than could be
achieved by their clients. The Company's third segment is Software, which offers
to healthcare payors and P&C insurers an on-line subrogation recovery system in
an application service provider ("ASP") model.

HEALTHCARE RECOVERY SERVICES

Overview of the Healthcare Recovery Services Operations; Outsourcing

Since the late 1980s, healthcare payors have experienced increasing (i)
price competition, (ii) regulatory complexity and related administrative
burdens, (iii) costs of healthcare claims, and (iv) average age of the insured
population. These factors, resulting from the rapid growth of managed care,
improvements in medical technology, consumer-oriented political pressure and an
aging U.S. population, tend to result in healthcare payors concentrating their
resources on their core business. This, in turn, provides on-going opportunities
for enterprises, like the Company, which are able to perform non-core business
functions on behalf of healthcare payors.

The recovery process is complex and although many healthcare payors operate
internal recovery departments, the Company believes that these departments are
not generally as effective per insured life as the Company's operations. The
Company believes that (i) the relatively small size of recoverable funds as a
percentage of claims paid, (ii) the need for healthcare payors to focus on core
competencies and (iii) the complexity of the recovery process and economies of
scale will continue to provide opportunities for growth of the Company.

The industry conditions described above have contributed to the growing
need for a cost-effective provider of subrogation and other recovery products
and services. The Company believes that it is a leading independent provider of
outsourcing of subrogation and certain other related medical claims recovery and
cost containment services to the private healthcare payor industry in the United
States. The Company's success is

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a result of the implementation of its recovery processes, the skill and
knowledge of its employees, its approach to sales and marketing, its client
base, and its proprietary information management systems, all as described
below.

The Company utilizes recovery processes to implement its cost containment
services, which include subrogation, provider bill audit, overpayments, and
physician bill audit recovery services. The Company uses proprietary and other
software and various business processes to identify those claims that have
recovery potential. Client-specific threshold dollar amounts are utilized to
identify files where its clients may have a recovery right for subrogation for
the medical benefits provided. In the case of provider bill audit services, the
Company utilizes specific threshold dollar amounts to investigate proper payment
for medical procedures. To identify overpayment recovery opportunities,
typically all paid claims for a fixed period are analyzed on a rolling quarterly
basis. Physician bill audit services uses payment claims from doctors for their
patient evaluation and management visits to initiate the process of identifying
potential billing errors.

Following the identification and investigation of identified claims, the
Company proceeds to recover from the financially responsible party the value of
those covered medical benefits provided. The Company has automated this complex
processing of all raw data and the management, follow-up and generation of
correspondence. The use of automated processes substantially increases
productivity and enables specially trained personnel to focus more intensely on
matters requiring their professional judgment and expertise. The automated
processes also allow the Company to pursue claims that would otherwise be deemed
too small to pursue economically. The Company believes that its ability to
effectively recover a broad range of claim sizes is an important competitive
advantage in the market. In addition to automating the recovery processes, the
Company's proprietary software and other systems generate significant operations
and management information, which enables the Company to employ production and
quality standards in the context of providing specialized services.

The Company dedicates staff with specialized skills to individual services
to optimize recoveries. The recovery process for each healthcare recovery
service is described below.

Healthcare Subrogation Services

Subrogation Recovery Rights of Healthcare Payors. By contract and state
law, healthcare payors are generally entitled to certain rights with respect to
paid healthcare claims that may be the primary obligation of other insurance
carriers. For example, an HMO may pay the hospitalization and related health
expenses of a member who is injured in an automobile accident. However, the
party responsible for the accident is generally liable to the injured person for
the damages arising from the injury, which include lost wages, property loss,
pain and suffering and medical benefits. The responsible party usually has a
liability insurance policy that will pay covered damages, including medical
benefits, upon the acceptance of the injured party's claim. The healthcare payor
actually providing or paying for the medical benefits conferred on the injured
party (in this example, an HMO) may have a variety of rights through which it is
entitled to recover the value of such medical benefits from the responsible
party and the responsible party's liability insurer.

These recovery rights include:

(i) the right of subrogation, which allows the healthcare payor to
recover accident-related medical claims directly from the responsible party
or the responsible party's insurance carrier;

(ii) the right of reimbursement, which allows the healthcare payor to
recover from the injured party any payment received by him or her from the
responsible party or the responsible party's insurance carrier relating to
this injury;

(iii) the right of reimbursement for medical benefits provided for
work-related injuries, which are typically excluded from the healthcare
insurer's coverage; and

(iv) other recovery rights against automobile insurers and other
liability insurers arising from coordination of benefits provisions in
healthcare and property and casualty insurance coverages.

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Automated Identification of Claims with Recovery Potential. The Company's
specialty is using systematic identification methods to determine which files to
pass on to the investigation stage. The automated selection, analysis and
processing of raw claims data are handled primarily through the Company's
proprietary selection software. Information regarding diagnoses, the cost of
treatments, insured demographics (names, addresses and telephone numbers, etc.)
and related claims is provided to the Company electronically by the healthcare
payor. The automated systems include direct connections to the Company's
clients' claims information systems, subject to various security controls to
limit access internally. The Company's trained staff identifies, sorts, vets and
organizes raw claims data into usable form, essentially engaging in "data
mining".

The primary vehicle for the identification of injured insureds is an
automated analysis of the clients' claims data. This system identifies
potentially recoverable claims and, using client-specific protocols, opens an
on-line electronic file for such claims. After files are opened, the systems
automatically track the addition of medical expenses to these files, so that
they are updated as additional expenses are paid. Since its inception, the
Company has automatically opened over 52 million of such on-line files.

Investigation of Potentially Recoverable Claims. By focusing
investigations only on those cases with the greatest potential for recovery, the
Company minimizes member contacts and maximizes recovery potential. Subrogation
recoveries are typically related to accidental injuries. Claims may involve
automobile accidents, property and premises injuries, workers' compensation,
product liability or medical malpractice. When a file of claims reaches a value
predetermined by the Company, the system automatically generates a series of
inquiry letters that are sent to the injured insured. These individuals respond
by calling the Company's customer service department to provide the facts of the
accident. The Company also initiates phone calls if the insured does not respond
to the inquiry letters in a reasonable period of time. Historically,
approximately 90% of the injured insureds ultimately respond to the Company's
inquiries and approximately 16% of the claims investigated by customer service
representatives are classified as recoverable. Once a file of related claims is
identified as recoverable, the system updates the backlog and assigns the file
to the appropriate recovery person who begins the assertion and management of
recoverable claims. Since its inception, the Company has investigated over 9.1
million accidents.

Assertion and Management of Potentially Recoverable Claims. The workflow
performed by the various recovery personnel is directed and guided step-by-step
by the Company's proprietary and other software. The Company's systems document
activity on the claim files and provide an interconnected record of
correspondence and notes taken by the recovery personnel with respect to each
file. The Company's recovery personnel annotate the files on-line, as necessary,
to document progress, developments and status and otherwise maintain the history
of each claim. Approximately 25% of these healthcare subrogation recovery
personnel perform their work on Troveris, the internally-developed recovery
software that replaces the legacy subrogation system. The transition of the
remainder of the healthcare subrogation recovery personnel is currently expected
to be complete by the third quarter of 2003. See "-- Software".

Once a file of claims is classified as recoverable, the Company's recovery
personnel, who receive extensive training, proceed to assert the recovery rights
of the Company's clients and track the claims' history and development. The
employees contact all necessary parties to inform them of the existence and
value of the recovery claim. These parties generally include the liability
insurer for the responsible party, the insured and the insured's attorney, if
any, in conjunction with the claim. Recovery personnel maintain contact with the
parties involved, including the responsible party (or insurance carrier), until
the claim is settled. Settlement may not occur until several years after the
claim was originally paid. During this phase of the recovery process,
approximately 42% of the amounts initially entered into backlog (the dollar
amount of potentially recoverable claims that the Company is pursuing) as
recoverable are rejected, in which case further activity is terminated and
backlog is reduced.

Negotiation and Settlement of Claims. The recovery process culminates in
the negotiation and settlement of claim files. Within the settlement guidelines
established by each client and the Company's standard operating procedures,
recovery personnel close recoverable files and remove them from backlog by
making recoveries or by rejecting files and terminating recovery efforts. Once a
settlement is made and

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recorded in the system, receipt of cash is anticipated and monitored by the
responsible employee. Cash receipts are posted to the credit of the appropriate
client.

Claims remain the property of the Company's clients and litigation is
commenced solely at their written direction. Similarly, clients may terminate
litigation or other recovery efforts at any time for any reason. The Company
customarily bears the cost of legal services as part of the services to its
clients. The Company has established what it believes are cost-effective
relationships with providers of legal services, including its relationship with
Sharps & Associates, PSC, a law firm solely owned by Douglas R. Sharps, the
Company's Executive Vice President -- Finance and Administration, Chief
Financial Officer and Secretary. This arrangement exists solely for the benefit
of the Company and its purpose is to minimize the costs of legal services
purchased by the Company on behalf of its clients. This law firm employs 28
attorneys, 14 paralegals and 1 administrative assistant at its offices in
Louisville, Kentucky; Pleasanton, California; Chicago, Illinois; Tampa, Florida;
Dallas, Texas; Milwaukee, Wisconsin; and Locust Grove, Virginia. Mr. Sharps
receives no financial or other personal benefits from his ownership of the firm,
and the Audit Committee of the Company's Board of Directors reviews and approves
all payments to Sharps & Associates, PSC. See Item 8. "Financial Statements and
Supplementary Data -- Note 5 -- Related Party Transactions".

Although some healthcare subrogation recoveries will be made during the
first year of service, the average time to make a recovery is 18 to 24 months
from installation, with substantially all recoveries made by the sixth year. The
timing of recoveries is driven by the P&C payment cycle of claims (which is the
source of recoveries made by the Company) and circumstances specific to each
claim (e.g., identification of responsible party, responsiveness of responsible
party, cooperation of parties involved, factual complexity and litigation). The
amount of claims recoveries made by the Company on behalf of a client is
generally less than the amount of backlog generated on behalf of such client.
This is for a number of reasons, including (i) the inadequacy of insurance
coverage or other available source of funds to pay the claim; (ii) the absence
of third-party liability; or (iii) the settlement of the claim for less than
full value in accordance with the Company's established policies.

Historically, approximately 65% of the Company's recoveries on behalf of
clients involved automobile liability insurance, 15% involved premises liability
insurance, 10% involved workers' compensation insurance and 10% involved product
liability or other insurance.

Provider Bill Audit Services

Provider Bill Audit Rights of Healthcare Payors. By contract, healthcare
payors are generally entitled to certain audit rights with respect to healthcare
claims presented to them for payment by medical providers. Providers may bill
healthcare payors under a variety of pricing regimes, including standard
fee-for-service charges, discounted fee-for-service charges, case rates, per
diem rates, and charges based on stop-loss insurance thresholds. In addition,
Medicare risk claims that are paid under a variety of arrangements, including
federally mandated payment methodologies, are also generally subject to audit by
the payor.

Automated Identification of Claims with Recovery Potential. The Company's
database of information captures over 500 data elements of financial,
demographic and clinical data from members, providers and payors. The Company
utilizes this data to project potential savings outcomes and pre-screen claims
for its various audit services. Provider contract terms are also programmed into
the system, which then reviews claims against the specific contract provisions
to identify discrepancies. The database of statistical information is refined to
include the results of each completed audit. Provider bill claims are selected
for audit based upon statistical analysis and a comparison to previously audited
claims. Typically, claims with billed charges greater than specified thresholds
are selected for audit. Every claim is automatically reviewed in a complete,
focused audit to refine selection criteria.

Investigation of Potentially Recoverable Claims. The Company's provider
bill audit service is a process for establishing accurate billing based on the
care and services documented by healthcare professionals and ordered by the
physician in the medical record as compared to the itemized billed charges. When
a claim is identified, it is automatically assigned to a nurse auditor who will
conduct an audit of all the line items that

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make up the claim at the site of the provider. Based on historical experience,
approximately 91% of reviewed claims generate recoveries.

Assertion and Management of Potentially Recoverable Claims. The workflow
performed by the various audit personnel is directed and guided step-by-step by
the Company's proprietary and other software. Registered nurses review provider
bills line by line to determine if inaccuracies exist. This review is completed
on-site at the provider facility where the medical record exists. These audits
benefit any health plan that pays a portion of a claim based on a percent of
billed charges. Nurse auditors review the total claim file to compare the
medical record to the line item bill to ascertain that a physician ordered the
service performed, the supplies billed were actually used and the medication
billed was actually administered. The nurse auditor also verifies that the
billing is in compliance with the provider contract and that stoploss or outlier
provisions are correctly billed. Historically, provider bill audits have
resulted in savings of approximately 5% to 6% of the aggregate amount of billed
charges audited.

Negotiation and Settlement of Claims. Once the audit is completed, the
Company reviews its findings with a provider representative to reach agreement.
If there is no response from the provider within forty-five days, the audit
results are considered final and the claim is closed. The savings are reported
to the client for recoupment or the Company will collect them from the provider.

Overpayment Recovery Services

Automated Identification of Claims with Recovery Potential. Healthcare
payors are generally entitled to recover from contract providers amounts that
have been paid in error or where the payor's obligation is secondary to that of
another payor (i.e., coordination of benefits). Examples of errors include
payment of claims outside the coverage contract, duplicate payments, and
payments on claims for persons no longer covered by the payor. The automated
selection, analysis and processing of raw claims data are handled primarily
through the Company's proprietary selection software. This software identifies
potential claims adjudication errors based on the provisions contained in the
clients' various health plan and provider contracts.

Investigation of Potentially Recoverable Claims. Suspected overpayments
are identified and classified by type, then reviewed and researched by
experienced claims analysts, who specialize in particularly complex types of
overpayments, including coordination of benefits and Medicare. Based on
historical experience, approximately 10% of reviewed claims generate recoveries.

Assertion and Management of Potentially Recoverable Claims. The workflow
performed by the claims recovery personnel is directed and guided step-by-step
by the Company's proprietary and other software. Suspected overpayments are
verified based upon the claims analysts' research.

Negotiation and Settlement of Claims. Once an overpayment is verified it
is forwarded to a unit specializing in collections for recovery. Historically,
approximately 80% of verified overpayments have been collected. The Company
recovers the money for its clients through its collection function or reports
the overpayments to the client for recoupment from claims paid to that provider
prospectively, where the right of off-set is present in the payor's contract.

Physician Bill Audit Services

Automated Identification of Claims with Recovery Potential. The physician
bill audit product ("MD Audit") involves a review of physician claims in order
to identify instances of potential over-billing of evaluation and management
("E&M") claims. E&M claims represent physician requests for payment based on the
components of care rendered in connection with office and hospital visits. In
general, physicians charge for E&M visits based on the intensity level and
location (i.e., office vs. hospital) of the services, and bill using a
standardized method for ranking the intensity level that is susceptible to
error. Healthcare payors are generally entitled to review the claims from
physicians and the associated patient medical records and to seek correction of
billing errors. The Company has created proprietary software that automates the
selection of appropriate E&M claims for review and assists in the management of
the audit process.

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Investigation of Potentially Recoverable Claims. Certified Professional
Coders, using the Company's on-line operational software, audit the relevant
patient medical records in order to verify any billing errors. The audit process
involves applying standardized descriptions of the five intensity levels for E&M
claims, derived from federal evaluation and management guidelines, to the
physicians' own records of such visits.

Negotiation and Settlement of Claims. Once a physician overcharge is
verified, at the client's option, it can be either referred back to the client
for recovery or it can be retained by the Company for collection.

PROPERTY AND CASUALTY RECOVERY SERVICES

Overview of Property and Casualty Recovery Services Operations; Outsourcing

The Company operates in the subrogation outsourcing market that serves
property and casualty ("P&C") insurers. The Company offers its services to the
P&C market under the brand name "TransPaC Solutions".

The Company believes that the market for P&C subrogation outsourcing in the
United States is substantial and that the potential savings from subrogation
recoveries will vary depending upon the P&C line of business. The Company
believes that total potential subrogation recoveries in the automobile insurance
market exceed $6 billion per year. Based on its research and early experience,
the Company believes that there is an opportunity to increase total subrogation
recoveries across a wide spectrum of automobile insurers. The Company's
marketing strategy is to offer its services to automobile insurers and
multi-line carriers that lack the resources to maximize subrogation recoveries.

The Company believes that it has an opportunity to leverage its healthcare
subrogation expertise and resources to provide service to the P&C markets. The
primary difference between the two markets is in the acquisition of claims data
for investigation of subrogation potential. The P&C industry does not have
standard data definitions regarding claims as does the health insurance
industry. Nevertheless, the Company used its healthcare subrogation expertise to
build data interfaces with several of its P&C customers, and it has created
proprietary business processes to acquire paper-based and/or imaged claims data
from its customers' claims adjusting offices and archives.

Subrogation Recovery Rights of P&C Insurers. By contract and law, P&C
insurers typically have a standard set of subrogation rights that are recognized
in court proceedings or in arbitration. These rights may lie against the persons
causing the damages directly or against the insurers of those persons. The
Company is primarily engaged in making subrogation recoveries for its clients on
automobile physical damage and premises damage claims.

P&C Subrogation Recovery Process. The recovery process has been refined to
four major, interrelated steps: (i) acquisition of claims data on potential
subrogation claims from clients; (ii) investigation of potentially recoverable
subrogation claims; (iii) assertion and management of potentially recoverable
subrogation claims; and (iv) negotiation and settlement of claims.

The Company dedicates staff with specialized skills to individual services
to optimize recoveries. The workflow performed by the various recovery personnel
is directed and guided step-by-step by the Company's proprietary and other
software. The Company's systems document activity on the claim files and provide
an interconnected record of correspondence and notes taken by the recovery
personnel with respect to each file. The Company's recovery personnel annotate
the files on-line, as necessary, to document progress, developments and status
and otherwise maintain the history of each claim.

Once a file of claims is classified as recoverable, the Company's recovery
personnel, who undergo extensive training, proceed to assert the recovery rights
of the Company's clients and track the claims' history and development. The
employees contact all necessary parties to inform them of the existence and
value of the recovery claim. These parties generally include the liability
insurer for the responsible party or the responsible party itself when it is
uninsured. Recovery personnel maintain contact with the parties involved,
including the responsible party (or insurance carrier), until the claim is
settled. Settlement may not occur until several years after the claim was
originally paid.

7

The recovery process culminates in the negotiation and settlement of claim
files. Within the settlement guidelines established by each client and the
Company's standard operating procedures, recovery personnel close recoverable
files and remove them from backlog by making recoveries or by rejecting files
and terminating recovery efforts. Once a settlement is made and recorded in the
system, receipt of cash is anticipated and monitored by the responsible
employee. Cash receipts are posted to the credit of the appropriate client.

Claims remain the property of the Company's clients and litigation is
commenced solely at their written direction. Similarly, clients may terminate
litigation or other recovery efforts at any time for any reason.

Although some subrogation recoveries will be made during the first year of
service, the average time to make a recovery is 18 to 24 months from
installation, with substantially all recoveries made within 36 months. The
timing of recoveries is driven by the P&C payment cycle of claims (which is the
source of recoveries made by the Company) and circumstances specific to each
claim (e.g., identification of responsible party, responsiveness of responsible
party, cooperation of parties involved, factual complexity and litigation). The
amount of claims recoveries made by the Company on behalf of a client is
generally less than the amount of backlog generated on behalf of such client.
This is for a number of reasons, including (i) the inadequacy of insurance
coverage or other available source of funds to pay the claim; (ii) the absence
of third-party liability; or (iii) the settlement of the claim for less than
full value in accordance with the clients' settlement guidelines and the
Company's established operating policies.

SOFTWARE

The Company has developed a web-enabled subrogation software application.
The Company sells this product as an application service provider ("ASP"), under
the trade name "Troveris", to participants in both the health insurance and
benefits market and the P&C market which historically have not outsourced
subrogation recoveries. The Company currently estimates that 40% to 50% of the
private health insurance and health benefits markets do not outsource
subrogation recoveries. Public sector markets, such as Medicaid and Medicare,
have virtually no outsourcing of subrogation recoveries. These programs
typically rely on their claims administration contractors to provide subrogation
services as part of a bundled service contract. The Company believes that, like
the health insurance market, certain participants in the P&C insurance market
are less likely to outsource subrogation services. The Company believes mutual
insurers have organizational and cultural biases against outsourcing and larger
P&C insurers have sufficient resources to develop relatively sophisticated
internal departments. In June 2002, the Company made its first sale of the
Troveris software to an outside client (United Medical Resources). Additionally,
the Company has received indications of interest from other potential
purchasers.

The Troveris marketing strategy combines the opportunity for an internal
subrogation department to gain operating efficiency through the functionality of
state-of-the-art desktop software and to leverage its ability to produce
recoveries through the purchase of unbundled components of the Company's
traditional subrogation outsourcing services. The Troveris software application
allows the Company to administer these customized relationships using the same
proprietary processes as it uses for those customers who purchase turnkey
subrogation outsourcing services. An additional benefit of the Troveris software
application is that the Company believes that it will substantially reduce
future expenses for maintaining software applications that it has historically
used to provide turnkey outsourcing services.

In addition to being offered for sale as an on-line subrogation recovery
system in an ASP-model, Troveris also constitutes the systems platform for the
Company's recovery operations. All of those operations are currently conducted
on Troveris except healthcare subrogation. The Company began to migrate its
internal healthcare subrogation operations to a version of Troveris during the
fourth quarter of 2001, at which time it anticipated reducing its technology
expense, net of the expense of maintaining the Troveris application, by at least
$600,000 per year. At present, substantially all of that expense reduction has
been captured and is impounded in the Company's guidance for 2003 financial
results. The Company currently expects to complete the migration to Troveris in
the third quarter of 2003, and shortly thereafter to abandon its legacy
subrogation system. Given the complexities of software development and change
management, the Company may

8

lengthen this schedule in order to assure that there is no disruption in
operations. If the Company does lengthen the transition schedule, the Company
believes that such a change will have no adverse financial consequence for the
Company or its clients. The Troveris application also enables the Company to
expand its ability to manage its knowledge workers via telecommuting
arrangements. While the Company believes it can achieve the foregoing transition
and corresponding reduction of expenses in the outlined timeframe, future facts
and circumstances could change these estimates. See "Safe Harbor Compliance
Statement for Forward-Looking Statements" included as Exhibit 99.1.

EMPLOYEES

The Company employs, and facilitates the development of, skilled
knowledge-workers. The Company maintains an extensive in-house training program,
which it believes is attractive to employees and essential in developing the
necessary industry-specific skills. Because the Company employs specialized
labor in its recovery activities, it believes that a tight labor market for any
of those specialties could affect future hiring. The Company employed 666
persons as of December 31, 2002 and 698 persons as of December 31, 2001.

The Company requires all employees to enter into confidentiality and
nondisclosure agreements, which generally prohibit them from divulging
confidential information and trade secrets after employment is terminated.
Employees are also required to enter into non-compete agreements, preventing
them from working for a competitor during the first year after employment is
terminated. In addition, the Company's customers generally agree not to employ
the Company's employees during the client's contract term plus a specified
period.

The Company's employees are not represented by a labor union or a
collective bargaining agreement. The Company regards its employee relations as
good.

MARKETING, SALES AND CLIENT SERVICE

The Company primarily markets its healthcare recovery services and
healthcare subrogation software to and contracts with healthcare payors,
including HMOs, other types of managed healthcare plans, indemnity health
insurers, self-funded employee health plans, insured healthcare plans,
third-party administrators, Blue Cross and Blue Shield organizations and
provider organized health plans.

The Company primarily markets its P&C subrogation recovery service and P&C
subrogation software to P&C insurers that are personal lines automobile carriers
or that are multi-lines carriers which focus on automobile coverage. Although
its focus is on selling full outsource subrogation recovery services, the
Company does provide referral services and closed claims services, both of which
are more limited in scope and revenue potential than is the full outsourcing
product.

The Company employs a staff of sales managers, a marketing manager and
client services managers for its healthcare recovery services and healthcare
subrogation software and a separate staff of sales managers and client services
managers for its P&C subrogation recovery service and P&C subrogation software.
Sales are made directly through contacts with prospective clients, trade show
presentations and employer seminars. Additional business is also generated from
existing clients, which have expanded their business by growth or acquisitions
or which have business segments not already under contract with the Company.

Due to the nature of its outsourcing businesses, the operating cycle for
some of its products and the industries to which it markets its products, the
sales process is lengthy and involves demonstrating to prospective clients that
the Company's economies of scale, proprietary processes and value-added services
allow (i) the Company to generate and return to the clients a greater dollar
amount of recoveries than the clients' in-house recovery department and (ii) the
clients to focus greater resources on core business functions. New customer
relationships can also be established through pilot programs, which have
typically lasted 12 to 18 months.

Complementing the technical aspects of the recovery process, the client
support function is primarily responsible for communications with clients and
problem resolution. To facilitate strong working relationships, individual
members of the client services staff are assigned to specific clients. The
Company believes that its
9

investment in resources to resolve a wide variety of business issues with
clients is an important factor in obtaining customers and maintaining good
business relationships.

During the year ended December 31, 2002, clients terminated healthcare
recovery services covering 8.5 million lives; certain of these same clients,
however, kept in place or bought from the Company other healthcare recovery
services with respect to 2.2 million lives. During the three-year period ended
December 31, 2002, clients terminated healthcare recovery services covering 16.9
million lives; these same clients, however, kept in place or bought from the
Company other healthcare recovery services covering 2.6 million lives. The
terminations occurred due to, among other things, consolidations of healthcare
payors, bankruptcy, the selection of another vendor, or because the process was
taken in-house. See Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Healthcare Recovery Services -- Results
of Operations -- Key Operating Indicators".

During the year ended December 31, 2002, the Company lost one property and
casualty client. The termination occurred due to the process being taken
in-house. See Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Property and Casualty Recovery
Services -- Results of Operations -- Key Operating Indicators".

CLIENT BASE

Healthcare Recovery Services. The Company provides services to healthcare
plans that as of December 31, 2002 covered approximately 41.6 million lives. The
Company's clients are national and regional healthcare payors, large third-party
administrators or self-insured corporations.

Major healthcare recovery services clients include the following:

HealthNet The Principal Financial Group
Humana Inc. Kaiser Permanente
General American Life Insurance Wellpoint Health Network Inc.
Group Health, Inc. FIRST HEALTH

The Company has two clients that individually comprise more than 10% of the
Company's revenue. The Company's largest source of revenue is UnitedHealth Group
("UHG"). For the years ended December 31, 2002, 2001 and 2000, UHG generated
28%, 27% and 24% of the Company's revenues, respectively. Wellpoint Health
Network Inc. accounted for 14%, 11% and 7% of the Company's revenues in the
years ended December 31, 2002, 2001 and 2000, respectively.

The Company's revenues are earned under written contracts with its clients
that generally provide for contingency fees from recoveries under a variety of
pricing regimes. The pricing arrangements offered by the Company to its clients
include a fixed fee percentage, a fee percentage that declines as the number of
lives covered by the client and subject to the Company's service increases and a
fee percentage that varies with the Company's recovery performance.

The Company performs its recovery services on a reasonable efforts basis
and does not obligate itself to deliver any specific result. Contracts with its
customers are generally terminable on 60 to 180 days' notice by either party,
although in a few cases the contracts extend over a period of years. The
Company's contracts generally provide that in the event of termination, the
Company is entitled to complete the recovery process on the existing backlog or
to receive a cash payment designed to approximate the gross margin that would
otherwise have been earned from the recovery on the backlog of the terminating
client. On December 31, 2002 and 2001, the Company had Healthcare Recovery
Services backlog of $1,559.0 million and $1,414.8 million, respectively.

During 2002, UHG management informed the Company of its intention to
terminate subrogation services with respect to all but 1.8 million lives of the
9.7 million lives then subject to the Company's services under a contract with
UHG. UHG's termination of these services resulted from its decision to bring
subrogation recovery services back inside UHG, where they will be performed by
its Ingenix strategic business unit. The Company expects to continue recovering
on the backlog as to which UHG terminated the Company's services,

10

a process that the Company expects will be completed in 5 to 6 years. The
Company's contract with UHG expired in accordance with its terms on February 1,
2003 except with respect to 1.8 million lives as to which the Company continues
to provide healthcare subrogation recovery services.

Property and Casualty Recovery Services. As of December 31, 2002, the
Company provides services to 15 P&C insurers, of which three are clients for
full outsourcing with the remainder being clients for either referral services,
in which the Company supplements the capacity of an internal recovery unit, or
closed claims reviews, in which the Company recovers subrogation claims missed
or ignored by an internal recovery unit. Three of the Company's P&C Recovery
Services clients account for greater than 70% of this segment's backlog at
December 31, 2002.

The Company's P&C Recovery Services revenues are earned under written
contracts with its clients that generally provide for contingency fees from
recoveries. The pricing arrangements offered by the Company to its clients also
include tiered pricing based on the Company's service levels.

The Company performs its recovery services on a reasonable efforts basis
and does not obligate itself to deliver any specific result. Contracts with its
customers are generally terminable on 60 to 180 days' notice by either party.
The Company's contracts generally provide that in the event of termination, the
Company is entitled to complete the recovery process on the existing backlog. On
December 31, 2002, the Company had P&C Recovery Services backlog of $15.3
million.

Software. As of December 31, 2002, the Company had one software client, a
Cincinnati-based third party administrator of healthcare claims for self-funded
employers. The Software segment earns software revenues based on an external
client's level of utilization, and from the Healthcare Recovery Services and P&C
Recovery Services segments based on their use of the Troveris software.
Moreover, the Software segment may also earn commission revenue from the
Healthcare Recovery Services and the P&C Recovery Services segments on any
revenue that the Company derives from healthcare subrogation services or P&C
subrogation services that are delivered by such segments to an external client
through Troveris.

COMPETITION

Healthcare Recovery Services. The Company competes primarily with the
internal recovery departments of potential customers and other outsource
healthcare recovery service vendors. To the Company's knowledge, there are four
smaller, but significant, independent providers of healthcare subrogation
recovery services in addition to the Company. There are three different vendors
that provide competitive overpayment recovery outsourcing services, as well as
three national companies that provide competing provider bill auditing services.

Property and Casualty Recovery Services. The Company has assessed the
competitive environment for P&C subrogation outsourcing and believes that the
competition is fragmented and characterized by claims adjusting companies that
operate on a local or regional basis and by law firms that specialize in a low
volume of legally complex subrogation claims. The Company has identified four
competitors that attempt to serve a national market. Three of these competitors
are owned and controlled by P&C insurers, and the Company believes that this
fact may deter potential buyers of these competitors' services if those
potential buyers also compete against the competitors' parent organizations.

With respect to both its healthcare recovery services and its P&C recovery
services, the Company believes that there are barriers to entry in the bulk of
its market, including process expertise, capital requirements necessitated by
the unusually long revenue cycle in the recovery industry, assembling and
training a qualified and productive employee base possessing appropriate
industry expertise, and an information processing system designed to aid
investigators and examiners engaged in the recovery process. However, there are
participants in the healthcare, insurance, transaction processing and software
development industries that possess sufficient capital, and managerial and
technical expertise to develop competitive services.

Software. The Company is not aware of any competition in subrogation
software in an ASP model for the healthcare payor industry, and it has
identified only one large competitor in the P&C insurance industry.

11

This competitor is partially owned and controlled by a major P&C insurer, and
the Company believes that this relationship will reduce the ability of the
competitor to sell its services to other P&C insurers.

With respect to its software segment, the Company believes that there are
barriers to entry in its market, including process expertise. However, there are
participants in the healthcare, insurance, transaction processing and software
development industries that possess sufficient capital and managerial and
technical expertise to develop competitive software.

PROPRIETARY INFORMATION MANAGEMENT SYSTEMS

General. The Company's computer systems consist of inter-related
proprietary software programs that function as automated data and process
management systems. The Company holds a copyright on certain of its software and
has applied to the United States Patent Office for patents on certain inventions
contained in the Troveris software.

Quality and Management Controls. The computer systems control, measure and
generate reports on the recovery processes. From data recorded in these systems,
a series of financial reports are generated for clients that allow them to
monitor the Company's success in making recoveries on their behalf. The data
used for financial reports are also used to produce a wide array of accounting
and management information used by the Company to operate its business. The
Company employs a variety of quality control techniques to ensure consistently
high-quality service.

LEGAL AND REGULATORY ENVIRONMENT

The healthcare industry is subject to numerous regulations, which may
adversely affect the Company's business. In addition to laws and regulations
affecting healthcare and insurance, changes in federal fair debt collection
regulations may also adversely affect the Company's business.

General. From time to time, legislation is introduced in Congress and in
various state legislatures which would materially affect the Company's business.
The most significant legislation, laws and regulations may, for clarity, be
grouped into three categories: (i) legislation that would substantially limit
the ability of healthcare insurers to recover from third-parties
accident-related medical benefits incurred by injured insureds ("Health
Insurance Primacy Laws"); (ii) legislation that would substantially limit the
Company's ability to receive and utilize individual claim information from
healthcare insurers ("Confidentiality Laws"); and (iii) other federal and state
laws and certain legal doctrines. The following identifies specific risks in
these three categories:

Health Insurance Primacy Laws

Auto Choice Reform Act. During May 2001, Congress proposed legislation
known as the Auto Choice Reform Act of 2001 (the "Proposed Act"). Similar bills
were introduced but not enacted in each of the two previous Congresses. Under
the Proposed Act, in those states not opting out of its provisions, individual
drivers would be able to choose to be covered by an auto insurance system in
which healthcare insurers, with some exceptions, may be unable to recover for
healthcare costs incurred by those injured in automobile accidents.
Consequently, even if the insured's injuries were caused by the negligence of
another driver, the healthcare insurer might have no rights of recovery against
the negligent party or that party's liability insurer. Revenue generated from
recoveries against automobile liability insurers historically has represented
approximately 65% of the Company's revenues. Should similar legislation be
enacted, it could have a material adverse effect on the Company's business,
results of operations and financial condition.

Proponents of the Proposed Act asserted that (i) the costs of operating a
motor vehicle are excessive due to legal and administrative costs associated
with the processing of claims under the fault-based liability system; and (ii)
the costly fault-based liability insurance system often fails to provide
compensation commensurate with loss and takes too long to pay benefits. Even if
the Proposed Act is not introduced in Congress again in the future, these policy
reasons may result in future legislation designed to significantly alter the
fault-based liability system used in most states, eliminate recovery rights of
healthcare insurers and materially adversely affect the Company's business.

12

Certain No Fault Insurance Systems. Certain states have adopted versions
of automobile "no fault" insurance systems in which the injured party's health
insurance carrier or provider is primarily responsible for healthcare related
expenses (and not the responsible party and his or her insurer or the injured
insured's automobile liability insurer). In 1996, California voters rejected a
no-fault automobile insurance measure, Proposition 200, which would have
required drivers with bodily injuries to be compensated by their healthcare
insurers. Although Proposition 200 was rejected by the voters, there can be no
assurance that similar measures will not again be presented in a ballot
initiative or as legislation in California or elsewhere in the future. Growth in
the number of states adopting similar systems could significantly reduce the
amounts otherwise recoverable by the Company in connection with automobile
injuries in such states.

Confidentiality Laws

Confidentiality Provisions of the Health Insurance Portability and
Accountability Act of 1996 and Related Regulations. The Company's activities
involve the receipt and use of confidential health information from or on behalf
of its clients. On December 28, 2000, the Secretary (the "Secretary") of Health
and Human Services ("HHS") promulgated the Standards for Privacy of Individually
Identifiable Health Information. 45 C.F.R. Parts 160 and 164 (as modified, the
"Privacy Rule"). The Secretary modified certain provisions of the Privacy Rule
in August 2002. The Privacy Rule, which deals with the use and disclosure of
health information, implements certain requirements of the Administrative
Simplification subtitle of the Health Insurance Portability and Accountability
Act of 1996 ("HIPAA"). The Privacy Rule became effective on April 14, 2001.
Health plans, health care clearinghouses, and certain health care providers
covered by the Privacy Rule ("Covered Entities") generally have to comply by
April 14, 2003. The Privacy Rule prescribes the manner in which Covered Entities
are permitted or required to use and disclose individually identifiable health
information subject to the Privacy Rule's requirements, known as "protected
health information". The Privacy Rule also requires Covered Entities to
implement certain "administrative" requirements, such as establishing relevant
policies and procedures, designating a privacy official responsible for the
development and implementation of the policies and procedures, and training
affected members of the workforce regarding the policies and procedures. The
Privacy Rule establishes a complex regulatory framework on a variety of
subjects, including, but not limited to, (a) disclosures and uses of protected
health information that require patient consent or authorization, (b)
individuals' rights to access, amendment, and accounting regarding their
protected health information, and (c) individuals' rights to receive notice of
Covered Entities' practices with respect to protected health information.

The Privacy Rule affects other entities, that are not necessarily Covered
Entities under the Privacy Rule, who perform certain functions or activities on
behalf of Covered Entities. Entities performing certain functions or activities
on behalf of a Covered Entity are treated as "business associates" of a Covered
Entity under the Privacy Rule. The Company's activities will make it a business
associate of customers that are Covered Entities, such as health plans. The
Privacy Rule requires the Covered Entity and its business associates to enter
into contracts that meet certain requirements. Therefore, although a business
associate to a Covered Entity is not directly subject to the Privacy Rule, it
will be subject to certain similar requirements imposed through its business
associate contracts. Significantly, however, the Privacy Rule does not require
business associate contracts to obligate business associates to implement
certain organizational requirements the Privacy Rule imposes upon Covered
Entities, such as appointing a privacy officer or establishing and distributing
a notice of privacy practices. The business associate provisions of the Privacy
Rule do require a Covered Entity that becomes aware of a pattern of activity or
practice of a business associate that constitutes a material violation of the
business associate's obligations under the contract to take reasonable steps to
end the violation and, if such steps are not successful, terminate the contract
with the business associate, if feasible.

In August 2000, HHS issued pursuant to HIPAA, a final rule establishing
transaction standards and code sets for the electronic transmission of health
information. 45 C.F.R. Part 162 (the "Transactions Standard"). The Transactions
Standard adopts uniform standards that must be used if one health care provider
or health plan conducts certain electronic transactions with another health care
provider or health plan. Moreover, the Transactions Standard establishes certain
code sets to be used in connection with the standard transactions.

13

Although the Transactions Standard had a compliance deadline of October 16,
2002, the Secretary granted a one-year extension upon submission of a plan to
come into compliance.

In addition to the Privacy Rule and the Transactions Standard, in February
2003 HHS published, pursuant to HIPAA, a final rule governing the security of
health information maintained or transmitted electronically by health plans and
certain clearinghouses and providers (the "Security Standards"). The Security
Standards impose extensive additional administrative, physical, technological,
and organizational requirements on Covered Entities and their business
associates. As noted above, certain of the Company's activities make it a
business associate of the Company's clients; therefore the Company will have
some contractual obligations related to the Security Standards. The Security
Standards have a compliance date of April 21, 2005.

HIPAA, the Privacy Rule, the Transactions Standard and the Security
Standard (collectively, the "Rules") could impair the Company's subrogation
recovery practices by creating administrative burdens (for example, by requiring
business associates of Covered Entities to amend health information in certain
circumstances or to restrict subsequent uses of protected health information) or
liability risks that lead health plans to voluntarily restrict their subrogation
recovery practices. The provisions of the Rules or of future federal legislation
and regulations could impair or prevent the acquisition and use by the Company
of claims and insurance information necessary to process recovery claims on
behalf of its clients. However, the Company believes that it will be able to
comply fully with the Rules on a timely basis and without material adverse
effect.

In addition to the federal protection of health information, state laws
governing privacy of medical or insurance records and related matters may
significantly affect the Company's business. Most states have enacted health
care information confidentiality laws that limit the disclosure of confidential
medical information. The Rules do not preempt state laws regarding health
information privacy that are more restrictive than the Rules. The costs and
efforts associated with compliance with the various state laws could increase in
the future if states begin to enact additional and more comprehensive privacy
legislation and may have a material adverse effect on the Company.

Other Federal and State Laws

Changes in a variety of laws could also affect the Company's business. One
such area is insurance law, which comprises a complex network of state and
federal laws, such as the Employee Retirement Income Security Act of 1974
(ERISA), the regulations and orders promulgated under those laws, and the
pertinent case law created by state and federal courts. Similarly, federal or
state laws that would bar or impair healthcare subrogation or an injured party's
ability to collect insured damages (that is, an injured person would be
prevented from recovering from the wrongdoer damages for accident-related
medical benefits covered by health insurance) could similarly adversely affect
the Company's business. Existing debt collection laws also may be amended or
interpreted in a manner that could adversely affect the Company's business.
Additionally, although the Company does not believe that it engages in the
unauthorized practice of law, changes in the law or a judicial or administrative
decision defining some of the Company's activities as the practice of law, could
have a material adverse effect on the Company's business.

Certain Legal Doctrines

With respect to recoverable claims, the rights of healthcare subrogation
and reimbursement may be limited in some cases by three principles of general
application. The first of these is the "made whole doctrine", which subordinates
the healthcare provider's ability to recover to that of the injured party when
the settlement damage award received by the injured party is inadequate to cover
the injured party's damages. The second is the "common fund doctrine", which
permits plaintiff's attorneys to deduct their fees for the claim based on the
entire amount covered by a damage award and may, in some cases, proportionally
diminish the amount recoverable by the Company on behalf of the healthcare payor
out of that damage award. Finally, federal courts have in some venues begun to
apply a doctrine under ERISA that prevents health plans (and their recovery
agents) from bringing healthcare reimbursement actions in federal court.

14

BUSINESS DEVELOPMENTS

Acquisition Activities

The Company, from time to time, considers acquisition opportunities to
provide additional growth in revenues and net income. The Company's acquisition
strategy is two-fold. First, it may acquire additional claims recovery services
that it can sell into its installed base of health insurers, managed care
companies, benefits administrators, and P&C insurers. This will allow the
Company to leverage its sales and marketing resources and to acquire the
necessary core knowledge workers to provide service.

Second, the Company may acquire businesses that offer knowledge-based
services into market segments not currently served by the Company. The Company
believes that these types of acquisitions will enable it to sell its existing
services to current customers of the acquired business and create an opportunity
to serve new customers in that market segment.

The Company evaluates all acquisition opportunities in light of its ongoing
stock repurchase plan, which it regards as a competing use of capital.

ITEM 2. PROPERTIES

As of December 31, 2002, the Company leased property at the following four
locations: (i) approximately 105,718 square feet of space for its executive
offices and main operations in Louisville, Kentucky, under a lease agreement and
amendment expiring in 2009; (ii) approximately 10,206 square feet at a regional
operating office in Pittsburgh, Pennsylvania, under a lease agreement expiring
in 2006; (iii) approximately 8,125 square feet at its Encino, California
location under a lease agreement expiring in 2004; and (iv) approximately 20,500
square feet at its New Berlin, Wisconsin location under a 5-year term expiring
in 2006. In July 2002, the Company terminated a lease agreement for 4,670 square
feet for a regional operating office in Atlanta, Georgia, which was to have
expired in 2005.

ITEM 3. LEGAL PROCEEDINGS

The Company is engaged in the business of identifying and recovering
subrogation and related claims of its clients, many of which arise in the
context of personal injury lawsuits. As such, the Company operates in a
litigation-intensive environment. Consequently, since its founding in 1988 the
Company has been involved with many litigation matters related to its
subrogation business, sometimes as a defendant and sometimes through its
defendant client. The plaintiffs' attorneys attempting to defeat the clients'
subrogation liens often threaten litigation against the Company and its clients
as a negotiating tactic. Most of the lawsuits that have been filed against the
Company or its clients concern the entitlement to recover a specific, individual
subrogation claim or the amount of the subrogation claim. Typically, these
actions do not ask for punitive damages, are not pled as class actions, and do
not have wide implications with respect to the Company's ongoing business
practices.

To date, however, the Company has encountered eight noteworthy instances in
addition to the pending lawsuits described under "-- Current Litigation", in
which lawsuits were filed against it or its clients that sought punitive
damages, were pled as class actions, or otherwise made claims or requested
relief that could have materially affected the Company's business practices. The
risk profile for this sort of business practices litigation includes not only
the usual considerations of the potential amount, effect, and likelihood of
loss, but also specifically the potential for punitive damages and class
certification, the possible effects of an adverse verdict on the Company's
business practices, and the likelihood of specific plaintiffs' attorneys
bringing similar actions in other jurisdictions.

Each of these cases has been completely resolved, by decision of a court or
settlement by the parties, but prior to resolution the Company did not regard
all of these cases as being material in and of themselves. In management's
opinion, these eight cases share a common profile with each other and with the
lawsuits described below under the caption "-- Current Litigation".

15

Five of the eight lawsuits named the Company as a defendant and were pled
as class actions. Two of these five cases, one in federal court and the other in
state court, alleged that the Company violated state and federal laws on fair
debt collection practices. In the state court action, the court granted the
Company's motion for summary judgment on all claims in the complaint, which the
court of appeals affirmed. In the federal court action, the Company settled the
matter, prior to the court's ruling on the Company's motion for summary
judgment, for a nominal amount.

Three of those five lawsuits naming the Company as a defendant were filed
in federal court and charged the Company with a variety of violations of laws
and sought punitive damages. The complaints alleged, among other things, that
the Company committed negligence, fraud and breach of its duties under ERISA by
attempting to recover and actually recovering, by subrogation, the reasonable
value of medical benefits which were provided by the Company's clients under
capitation or discounted-fee-for-service arrangements. One of these lawsuits was
dismissed in a ruling on the merits. Another was settled, after the court denied
class certification, for a nominal amount paid by the Company's client, a
co-defendant in the case. The third case, DeGarmo et al. v. Healthcare
Recoveries, Inc., was concluded in mid-July 2001 for a settlement payment of $3
million and nonmonetary terms that management regards as immaterial to the
Company's ongoing business.

Three of the eight lawsuits did not name the Company as a defendant. These
three lawsuits did, however, involve the Company's clients and implicate
important Company business practices. The complaints in these cases alleged,
among other things, violation of state law with respect to the payment of
plaintiffs' attorneys' fees and unfair trade practices, violation of the federal
Health Maintenance Organization Act of 1973, misrepresentation of the rightful
amounts of subrogation claims, and impermissible enforcement of recovery rights.
Two of these cases resulted in judgments in favor of the Company's clients after
litigation of the merits before trial and appellate courts. The other case was
settled for an immaterial amount.

Management believes that the lawsuits described above will not, as a
general matter, have precedential value for either the cases described below
under the caption "-- Current Litigation" or for any future litigation matters
(all these cases being referred to as the "Pending and Potential Cases").
Indeed, the courts hearing the Pending and Potential Cases may not even become
aware of the outcomes in the eight lawsuits described above. Management expects
that each of the Pending and Potential Cases will be decided on its own merits
under the relevant state and federal laws, which will vary from case to case and
jurisdiction to jurisdiction. The descriptions of the outcomes in the eight
cases dealing with business practices are included here in order to describe the
contexts for this kind of litigation and the Company's relative successes in
handling past business practices litigation, but are not necessarily predictive
of the outcomes of any of the Pending and Potential Cases.

Moreover, there can be no assurance that the Company will not be subject to
further class action litigation similar to that described below under the
caption "-- Current Litigation", that existing and/or future class action
litigation against the Company and its clients will not consume significant
management time and/or attention or that the cost of defending and resolving
such litigation will not be material.

CURRENT LITIGATION

Conte v. Healthcare Recoveries

Conte v. Healthcare Recoveries, Inc., was settled for a nominal amount in
late 2002 after the court denied class certification and dismissed all but one
of the plaintiff's claims. A summary procedural history of the case is described
below.

In October 1999, a First Amended Class Action Complaint ("Amended
Complaint") was filed against the Company in the United States District Court
for the Southern District of Florida, in a putative class action brought by
William Conte and Aaron Gideon, individually and on behalf of all others
similarly situated. In that complaint, Conte v. Healthcare Recoveries, Inc., No.
99-10062, the plaintiffs asserted that the Company's subrogation recovery
efforts on behalf of its clients violated a number of state and federal laws,
including the Fair Debt Collection Practices Act and the Florida Consumer
Collection Practices Act. The Amended

16

Complaint also sought a declaratory judgment that the Company, as the
subrogation agent for various healthcare payors, was not entitled to assert and
recover upon subrogation or reimbursement liens it asserted on settlements
obtained from third party tortfeasors when the settlement was in an amount less
than the amount required to fully compensate (or "make whole") the injured party
for all elements of damage caused by the tortfeasor. The plaintiffs purported to
represent a class consisting of all participants or beneficiaries of ERISA plans
nationwide whose net recovery of damages through judgments, settlements or
otherwise against liable third parties has been reduced or potentially reduced
by the Company's alleged assertion and/or recovery of unlawful
subrogation/reimbursement rights of its clients. Each count of the Amended
Complaint sought compensatory and/or statutory damages as well as exemplary and
punitive damages. The plaintiffs also sought injunctive relief, prejudgment
interest, costs and attorneys' fees.

In November 1999, the Company filed a motion to dismiss the Amended
Complaint. In June 2001, the court issued a decision dismissing plaintiffs'
common law claims for fraud and unjust enrichment as well as plaintiffs' claims
under the federal Fair Debt Collection Practices Act and the Florida Consumer
Collection Practices Act. The court did not, however, dismiss the remaining
count of the Amended Complaint ("Count I"), which seeks a declaratory judgment
and damages under ERISA based on the Company's alleged violation of the "make
whole" rule. The Company then filed an answer with respect to Count I of the
Amended Complaint.

The plaintiffs' motion to certify a nationwide class, which the Company
opposed, was submitted to the court in September 2000. On June 5, 2002, the
court entered an order denying the plaintiffs' motion for class certification
and the plaintiffs did not appeal that order.

In October 2002, the Company and the two named plaintiffs reached an
agreement in principle to settle all claims in the lawsuit under terms that
would not require any payment by the Company and would not impact the Company's
operations in any respect. The parties subsequently entered into a formal
written settlement embodying the agreement in principle, pursuant to which the
named plaintiffs released all claims against the Company. On February 6, 2003,
the Court entered an order dismissing the action with prejudice.

Cajas et al. v. Prudential Health Care Plan and Healthcare Recoveries

On October 28, 1999, a class action plaintiff's Original Petition
("Petition") was filed against the Company and one of the Company's clients in
the District Court for the 150th Judicial District, Bexar County, Texas, Joseph
R. Cajas, on behalf of himself and all others similarly situated v. Prudential
Health Care Plan, Inc. and Healthcare Recoveries, Inc. The plaintiff asserts
that the Company's subrogation recovery efforts on behalf of its client
Prudential Health Care Plan, Inc. ("Prudential") violated a number of common law
duties, as well as the Texas Insurance Code and the Texas Business and Commerce
Code. The Petition alleges that the Company, as the subrogation agent for
Prudential, made fraudulent misrepresentations in the course of unlawfully
pursuing subrogation and reimbursement claims that the plaintiffs assert are
unenforceable because (1) prepaid medical service plans may not exercise rights
of subrogation and reimbursement; (2) the subrogation and reimbursement claims
asserted by the Company are not supported by contract documents that provide
enforceable recovery rights and/or do not adequately describe the recovery
rights; and (3) the sums recovered pursuant to such claims unlawfully exceed the
amount Prudential paid for medical goods and services. The Company was served
with the Petition in November 1999, and has answered, denying all allegations.
The court has not yet addressed the question of whether to certify the putative
class. After the defendants filed a motion for summary judgment in January 2002,
the plaintiff moved the court to delay consideration of the motion until the
plaintiff could complete additional discovery. The plaintiff's motion to delay
consideration was granted. On October 25, 2002, the plaintiff filed an amended
petition naming one additional plaintiff as a purported class representative.
The amended petition does not add any new claims. The defendants filed a motion
for summary judgment on January 24, 2003 and the plaintiffs filed a cross motion
for summary judgment. On February 25, 2003, a state court judge denied the
defendants' motion for summary judgment that the defendants were entitled to
enforce the terms of Prudential's policies. The same judge granted the
plaintiffs' motion for summary judgment to the extent that Prudential could not
recover more than its costs.

17

Franks et al. v. Prudential Health Care Plan and Healthcare Recoveries

Franks et al. v. Prudential Health Care Plan and Healthcare Recoveries,
Inc., was settled for a nominal amount in February 2003. A summary procedural
history of the case is described below.

In late 1999, the Cajas plaintiff's counsel filed two lawsuits in Texas and
South Carolina that raise issues similar to those in the Cajas lawsuit. On
December 7, 1999, a class action complaint ("Complaint") was filed against the
Company and one of the Company's clients in the United States District Court for
the Western District of Texas, San Antonio Division, Timothy Patrick Franks, on
behalf of himself and similarly situated persons v. Prudential Health Care Plan,
Inc. and Healthcare Recoveries, Inc. The Complaint asserted claims on behalf of
members of ERISA governed health plans and alleged that the Company's
subrogation recovery efforts on behalf of its client Prudential violated a
number of common law duties, as well as the terms of certain ERISA plan
documents, RICO, the federal Fair Debt Collection Practices Act, the Texas
Insurance Code and the Texas Business and Commerce Code. The Complaint alleged
that the Company, as the subrogation agent for Prudential, made fraudulent
misrepresentations in the course of unlawfully pursuing subrogation and
reimbursement claims that the plaintiffs assert are unenforceable because (1)
prepaid medical service plans may not exercise rights of subrogation and
reimbursement; (2) the subrogation and reimbursement claims asserted by the
Company are not supported by contract documents that provide enforceable
recovery rights and/or do not adequately describe the recovery rights; and (3)
the sums recovered pursuant to such claims unlawfully exceed the amount
Prudential paid for medical goods and services. The Complaint further alleged
that the Company unlawfully pursued subrogation and reimbursement claims by (1)
failing to pay pro rata attorney's fees to attorneys who represented purported
class members with respect to tort claims underlying the subrogation and
reimbursement claims; and (2) recovering subrogation and reimbursement claims
from purported class members who have not been fully compensated for their
injuries. The plaintiffs, on behalf of the purported class, demanded
compensatory damages, punitive damages, and treble damages under RICO, costs and
reasonable attorneys' fees. In January 2000, the defendants filed a motion to
dismiss the Complaint.

In response to the defendants' motion, in February 2001, the court rendered
its opinion and entered an order dismissing all of the plaintiff's claims with
the exception of the plaintiff's claim for attorney fees. In March 2001, the
Company filed an answer to the Complaint denying all of the plaintiff's
allegations. Also in March 2001, the plaintiff filed a motion to alter or amend
the court's ruling on the motion to dismiss. On July 15, 2002, the court denied
the plaintiff's motion to alter or amend the court's ruling on the motion to
dismiss. On February 18, 2003, the defendants served an offer of judgment in the
amount of $21,000 pursuant to Rule 68 of the Federal Rules of Civil Procedure.
That offer was accepted by the plaintiff Timothy Franks in February 2003 and in
March 2003 the court approved dismissal of the case with prejudice.

Martin et al. v. Companion Health Care and Healthcare Recoveries

In December 1999, a purported class action complaint ("Complaint") was
filed against the Company and one of the Company's clients in the Court of
Common Pleas of Richland County, South Carolina, Estalita Martin et al. vs.
Companion Health Care Corp., and Healthcare Recoveries, Inc. In January 2000,
the defendant Companion Healthcare Corp. ("CHC") filed an Answer and
Counterclaim and the plaintiff Martin filed a First Amended Complaint ("Amended
Complaint"). The Amended Complaint asserts that the Company's subrogation
recovery efforts on behalf of its client, CHC, violated a number of common law
duties, as well as the South Carolina Unfair Trade Practices Act. The Amended
Complaint alleges that the Company, as the subrogation agent for CHC, made
fraudulent misrepresentations in the course of unlawfully pursuing subrogation
and reimbursement claims that the plaintiffs assert are unenforceable because
(1) prepaid medical service plans may not exercise rights of subrogation and
reimbursement; (2) the subrogation and reimbursement claims asserted by the
Company are not supported by contract documents that provide enforceable
recovery rights and/or do not adequately describe the recovery rights; and (3)
the sums recovered pursuant to such claims unlawfully exceed the amount CHC was
entitled to collect for such medical goods and services. The Amended Complaint
further alleges that the Company and CHC unlawfully pursued subrogation and
reimbursement claims by (1) failing to pay pro rata costs and attorney's fees to
attorneys who represented purported class members with respect to tort claims
underlying the subrogation and reimburse-
18

ment claims; and (2) failing to include in subrogation and reimbursement claims
all applicable discounts that CHC received for such medical goods and services.
The plaintiffs, on behalf of the purported class, demand compensatory damages,
punitive damages, and treble damages, disgorgement of unjust profits, costs,
prejudgment interest and attorneys' fees. The Company was served with the
original Complaint in late December 1999 and answered denying all allegations.
The Company filed a motion to dismiss in August 2000 and in June 2001 the court
granted the Company's motion to dismiss. The plaintiffs filed a notice of appeal
in July 2001. All parties have filed briefs, but the appellate court has not yet
ruled on the plaintiffs' appeal of the dismissal, nor has oral argument been
scheduled.

Hamilton v. Healthcare Recoveries

On March 12, 2001, a Complaint ("Complaint") was filed against the Company
in the United States District Court for the Eastern District of Louisiana, in a
putative class action brought by Kyle M. Hamilton. In that action, Hamilton v.
Healthcare Recoveries, Inc., No. 01-650, the plaintiff asserts that the
Company's subrogation recovery efforts on behalf of its clients violate certain
Louisiana state laws, the federal Fair Debt Collection Practices Act and the
Louisiana Unfair Trade Practices Act. The Complaint alleges that the Company
intentionally and negligently interfered with the plaintiff's and the putative
class members' rights to settle certain personal injury claims. The Complaint
further alleges that the Company unlawfully pursued subrogation and
reimbursement claims that the plaintiff asserts are unenforceable because the
clauses in the Company's clients' coverage documents that create such recovery
rights are rendered null and void by Louisiana statutes that generally prohibit
coordination of benefits with individually underwritten insurance coverages. The
plaintiff purports to represent a class consisting of all persons covered under
group health policies that were issued or delivered in the State of Louisiana
and who received any communication from the Company attempting to enforce any
clauses that allegedly were rendered null and void by Louisiana law. The
plaintiff seeks on behalf of the purported class compensatory and statutory
damages, interest, costs, attorneys' fees and such additional damages and relief
as may be allowed by any applicable law. In July 2001, the court granted a
motion for summary judgment filed by the Company as concerned the plaintiff's
Fair Debt Collection Practices Act ("FDCPA") claim, dismissing those claims with
prejudice. The court denied the Company's motion for summary judgment, without
prejudice to the right of the Company to reassert its motion, with respect to
the plaintiff's state law claims. The court ordered that the parties submit
memoranda addressing whether the court still had subject matter jurisdiction,
given dismissal of the federal claim. In August 2001, the court ruled that it
lacked subject matter jurisdiction, thus dismissing the remaining claims,
without prejudice. The plaintiff filed an appeal to the United States Fifth
Circuit Court of Appeals. On November 1, 2002, the Court of Appeals rendered its
opinion reversing the dismissal of the FDCPA claims. The court also affirmed the
trial court's determination that diversity jurisdiction did not exist in the
case. The court remanded the case to the federal district court for further
proceedings. The time in which the Company may seek further appeal has not
expired, and the Company is now reviewing the opinion. The Company disputes the
plaintiff's allegations regarding the applicability of the FDCPA and intends to
vigorously defend its position in this case.

In addition to filing the appeal in federal court, the Hamilton plaintiff
in October 2001 filed a new complaint in the Civil District Court for the Parish
of Orleans, Louisiana, in a putative class action styled Hamilton v. Healthcare
Recoveries, Inc., 2001-15989. This state court action asserts claims
substantially similar to those in the federal court action. In November 2001,
the Company filed preliminary exceptions to this new complaint.

Rogalla v. Christie Clinic, PersonalCare Health Management and Healthcare
Recoveries

On December 14, 2001, Valerie Rogalla, the plaintiff in a putative class
action against a health care provider, amended her complaint to add Healthcare
Recoveries, Inc. as a defendant in Valerie Rogalla v. Christie Clinic, P.C.,
PersonalCare Health Management, Inc. and Healthcare Recoveries, Inc., No.
01-L-203, Circuit Court of the Sixth Judicial Circuit, Champaign County,
Illinois. In her complaint, the plaintiff makes allegations on behalf of herself
and all others similarly situated. The complaint asserts that the Company, as
subrogation agent for PersonalCare Health Management, made fraudulent
misrepresentations in the course of

19

unlawfully pursuing subrogation and reimbursement claims. The complaint seeks
recovery from the Company for compensatory damages, punitive damages and costs.
The Company disputes the plaintiff's allegations and intends to vigorously
defend its position in this case. Each defendant filed a motion to dismiss the
action. On October 2, 2002, the Court granted each of the defendants' motions
and dismissed the Plaintiff's action entirely. On October 22, 2002, the
plaintiff filed her notice of appeal. A hearing has not yet been scheduled on
the plaintiff's appeal.

Chan v. Trover Solutions

On November 19, 2002, a Complaint ("Complaint") was filed against the
company in the Superior Court of the State of California for the County of Los
Angeles in a putative class action brought by Roger Chan. In that action, Roger
Chan v. Healthcare Recoveries, Inc. and Trover Solutions, Inc. and Does 1
through 100, inclusive, No. CV 03-0465 FMC, the plaintiff asserts that the
Company's subrogation recovery efforts violate California's unfair trade
practices statute by pursuing recovery from ERISA members' personal injury
recoveries when case law allegedly held that ERISA plans could not enforce their
recovery rights. The Company timely removed the action to federal court and
filed a motion to dismiss. The plaintiff filed a motion to remand the case back
to the state court. On March 3, 2003 the Court entered an order denying the
plaintiff's motion to remand and denying the defendant's motion to dismiss. The
Company disputes the plaintiff's allegations and intends to vigorously defend
its position in this case.

Bruun et al. v. Prudential Health Care Plan, Prudential Insurance Company of
America, Aetna, Inc. and Trover Solutions

On October 30, 2002, the Cajas and Franks plaintiff's counsel filed a class
action lawsuit in the United States District Court for the District of New
Jersey on behalf of two Texas residents against the Company, one of the
Company's clients, Prudential Insurance Company, a subsidiary of the client,
PruCare HMO, and a company who had acquired the business of the client company,
Aetna. The complaint was served on the Company on February 27, 2003.

In the complaint, plaintiffs Kimberly Bruun and Ashley Emanis, on behalf of
themselves and similarly situated persons, asserted claims on behalf of a
nationwide class of persons who were members of PruCare HMO health plans
governed by ERISA from whom the Company, under its contract with the client,
recovered reimbursement. The complaint alleged that reimbursement recoveries
made by PruCare HMO and the Company violate the terms of the standard PruCare
HMO plan documents, and that reimbursement recoveries violate the Conformity
with Law provision in the standard plan documents because subrogation and
reimbursement are prohibited under the federal HMO Act. The complaint further
alleged that the defendants' subrogation and reimbursement recoveries resulted
in a double recovery to PruCare HMO because PruCare HMO did not account for
subrogation and reimbursement recoveries as offsets to expenses when setting
premium rates. The complaint further alleged that the defendants improperly
recovered in subrogation or reimbursement for services provided by capitated
providers, or that in the alternative, the defendants improperly recovered more
for capitated services than was paid for the services, or alternatively, that
the defendants improperly collected amounts that exceeded the reasonable cash
value of capitated services. The plaintiffs allege that PruCare HMO, Prudential,
Aetna and the Company are fiduciaries and that they each have breached their
fiduciary duty to plaintiffs. Alternatively, the plaintiffs allege that if
Aetna, Prudential and the Company are not fiduciaries, that they knowingly
participated in PruCare HMO's breach of fiduciary duty.

The plaintiffs, on behalf of the class, demand enforcement of the plan
documents under certain sections of ERISA. The plaintiffs also demand
restitution and disgorgement of sums recovered by defendants and the
establishment of a constructive trust. The plaintiffs also demand an accounting
of PruCare HMO's and Aetna's rate documents, the subrogation and reimbursement
claims for capitated services, and/or the actual costs paid by PruCare HMO and
Aetna for the capitated services.

The Company has retained counsel and will vigorously defend itself against
these allegations.

20

Godair v. American Home Assurance Company, Trover Solutions, and HMO Partners

On March 14, 2003, Lawrence Godair, the plaintiff in a putative class
action against a motor vehicle insurer, amended his complaint to add the
Company, and a client of the company, HMO Partners, as defendants in Lawrence
Godair v. American Home Assurance Company, Trover Solutions, Inc. and HMO
Partners, Inc., No. 4:02 CV 00407 SMR, United States District Court for the
Eastern District of Arkansas, Western Division. In the amended complaint (the
"Amended Complaint"), the plaintiff makes allegations on behalf of himself and a
purported class of others similarly situated. The complaint asserts that the
Company, as subrogation agent for HMO Partners, unlawfully demanded payment of a
subrogation claim against proceeds of a medical payments insurance policy issued
to the plaintiff by American Home. The Amended Complaint also alleges that the
Company was unjustly enriched because the plaintiff was not fully compensated
("made whole") for his injuries in violation of the Arkansas no-fault motor
vehicle insurance statute and because the payment constituted a double recovery
to the Company and to HMO Partners, in violation of the Arkansas Health
Maintenance Organizations Act. The Amended Complaint further alleges that in
recovering the subrogation claim the Company acted negligently, that it
interfered with the plaintiff's contractual relationship with the motor vehicle
insurer and that the Company may be directly or vicariously liable for the acts
of other defendants. The Amended Complaint demands relief on behalf of a
purported class of persons who purchased medical payments coverage as required
by the Arkansas no-fault motor vehicle insurance statute and who were entitled
to but did not receive benefits under such policies due to the payment of those
benefits to third parties, including the Company and HMO Partners. The Amended
Complaint demands compensatory and punitive damages, 12% statutory penalties,
costs, expenses, interest and attorney's fees.

The Company was served with the Amended Complaint on March 18, 2003 and has
not yet filed a response. The Company intends to retain counsel and to
vigorously defend itself against these allegations.

The Cajas, Martin or Bruun lawsuits, or any one of them, if successful,
could prevent the Company from recovering the "reasonable value" of medical
treatment under discounted fee for service ("DFS"), capitation and other payment
arrangements. The Cajas, Martin, Hamilton, Rogalla, Chan and Bruun lawsuits, or
any one or more of them, if successful, could require the Company to refund, on
behalf of its clients, recoveries in a material number of cases. In addition, an
adverse outcome in any of the above referenced lawsuits could impair materially
the Company's ability to assert subrogation or reimbursement claims on behalf of
its clients in the future. Based on the current disposition of these lawsuits,
the Company regards such an adverse outcome to be a remote possibility.

In terms of the Company's business practices and the allegations underlying
the Cajas, Martin and Bruun cases, at the end of 1993 the Company had ceased the
practice of recovering the "reasonable value" of medical treatment provided by
medical providers under DFS arrangements with the Company's clients. From that
date, the Company's policy has been not to recover the "reasonable value" of
medical treatment in DFS arrangements. However, the Company historically and
currently recovers the "reasonable value" of medical treatment provided under
capitation arrangements and other payment arrangements with medical providers on
behalf of those clients that compensate medical providers under these payment
mechanisms, to the extent that these benefits are related to treatment of the
injuries as to which clients have recovery rights. The Company believes that its
clients' contracts, including the contracts that provide for recovery under DFS,
capitation and other payment arrangements are enforceable under the laws
potentially applicable in these cases. As a result, and taking into account the
underlying facts in each of these cases, the Company believes it has meritorious
grounds to defend these lawsuits, it intends to defend the cases vigorously, and
it believes that the defense and ultimate resolution of the lawsuits should not
have a material adverse effect upon the business, results of operations or
financial condition of the Company. Nevertheless, if any of these lawsuits or
one or more other lawsuits seeking relief under similar theories were to be
successful, it is likely that such resolution would have a material adverse
effect on the Company's business, results of operations and financial condition.

Management of the Company has observed that, in parallel with
widely-reported legislative concerns with the healthcare payment system, there
also has occurred an increase in litigation, actual and threatened, including
class actions brought by nationally prominent attorneys, directed at healthcare
payors and related

21

parties. As a result of the foregoing, there can be no assurance that the
Company will not be subject to further class action litigation, that existing
and/or future class action litigation against the Company and its clients will
not consume significant management time and/or attention or that the cost of
defending and resolving such litigation will not be material.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

SUPPLEMENTARY ITEM. CERTAIN RISK FACTORS

See "Safe Harbor Compliance Statement for Forward-Looking Statements,"
included as Exhibit 99.1 to this Form 10-K and incorporated herein by reference.

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS

The Company's Common Stock is traded on The Nasdaq National Market under
the symbol "TROV". The following tables set forth the high and low closing
prices for the Company's Common Stock for the periods indicated, as reflected in
The Nasdaq National Market.

On March 18, 2003, there were approximately 42 holders of record of the
Company's Common Stock.

The Company has paid no cash dividends since the sale of the Company by
Medaphis Corporation in May 1997. Any future determination to pay cash dividends
will be at the discretion of the Board of Directors (the "Board") and will be
dependent upon the Company's financial condition, results of operations, credit
agreements, capital requirements and such other factors as the Board deems
relevant. The Company's current credit facility limits its ability to pay
dividends on its Common Stock. See Item 7. "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Liquidity and Capital
Resources".

22

ITEM 6. SELECTED FINANCIAL DATA

STATEMENTS OF INCOME DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

STATEMENTS OF INCOME AS A PERCENTAGE OF CLAIMS REVENUES

23

BALANCE SHEET DATA
(DOLLARS IN THOUSANDS)

- ---------------

(1) The increase in working capital, including cash and cash equivalents, is
primarily attributable to the $19.2 million of proceeds received by the
Company from the exercise of the underwriters' over-allotment option granted
by the Company in connection with the May 1997 initial public offering.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

OVERVIEW OF COMPANY

The Company believes it is a leading independent provider of outsourcing of
subrogation and certain other medical claims recovery and cost containment
services to the private healthcare payor industry in the United States, based on
the Company's experience and assessment of its market. The Company's primary
business is medical claims recovery and its primary product is subrogation
recovery, which generally entails the identification, investigation and recovery
of accident-related medical benefits incurred by its clients on behalf of their
insureds, but for which other persons or entities have primary responsibility.
The Company's clients' rights to recover the value of these medical benefits,
arising by law or contract, are known generally as the right of subrogation and
are generally paid from the proceeds of liability or workers' compensation
insurance. The Company's other medical claims recovery services include (1) the
auditing of the bills of medical providers, particularly hospitals, for
accuracy, correctness and compliance with contract terms ("provider bill
audit"), (2) the recovery of overpayments attributable to duplicate payments,
failures to coordinate benefits and similar errors in payment ("overpayments"),
and (3) the auditing of physician evaluation and management claims for
consistency with medical records, in accordance with federal guidelines ("MD
audit"). The Company offers its healthcare recovery services on a nationwide
basis to health maintenance organizations ("HMOs"), indemnity health insurers,
self-funded employee health plans, companies that provide claims administration
services to self-funded plans (referred to as "third-party administrators"),
Blue Cross and Blue Shield organizations and provider organized health plans.
Current clients include Humana Inc., Kaiser Permanente, Wellpoint Health Network
Inc. and The Principal Financial Group. The Company had 41.6 million and 49.1
million lives under contract from its clientele at December 31, 2002 and 2001,
respectively.

The Company has three segments: (1) Healthcare Recovery Services, which
encompasses its four healthcare recovery products: healthcare subrogation,
provider bill audit, overpayment recovery and physician bill audit ("MD Audit");
(2) Property and Casualty Recovery Services, which includes subrogation recovery
services for property and casualty insurers, which the Company sells under the
brand name "TransPaC Solutions"; and (3) Software, which includes the sale of
subrogation recovery software in a browser-based application service provider
(ASP) form.

ACQUISITIONS

On January 25, 1999, the Company acquired the assets and certain
liabilities of Subro-Audit, Inc., a Wisconsin corporation ("SAI"), and a related
entity, O'Donnell Leasing Co., LLP, a Wisconsin limited liability partnership
("ODL" and, together with SAI, "Subro Audit"), for approximately $24.4 million
(the "Subro Audit Acquisition"), using available unrestricted cash. The Company
paid an additional $5.3 million pursuant to an earn-out arrangement. The final
amount of $2.5 million was paid on June 7, 2001, and $2.8 million was paid on
May 18, 2000. Approximately $4.7 million was held in escrow for the potential
earn-

24

out and was included in restricted cash at December 31, 2000. SAI is based in
Wisconsin and provides subrogation recovery services with respect to an
installed base of lives, which are covered by insurers, HMOs and employer-funded
plans, throughout the United States of America. The Subro Audit Acquisition was
accounted for using the purchase method of accounting.

On February 15, 1999, the Company acquired the assets and certain
liabilities of MedCap Medical Cost Management, Inc., a California corporation
("MedCap"), for approximately $10 million, using available unrestricted cash and
borrowed funds (the "MedCap Acquisition" and, together with the Subro Audit
Acquisition, the "Acquisitions"). The Company paid approximately $4.8 million
from February 15, 2000 through January 15, 2001 pursuant to an amendment to the
original earn-out agreement. MedCap provides a variety of medical cost
management services to health insurers and HMOs, primarily in California. These
services include provider bill auditing, contract compliance review,
identification of certain other payments, and cost management consulting
services. The MedCap Acquisition was accounted for using the purchase method of
accounting.

CRITICAL ACCOUNTING POLICIES

This discussion and analysis of financial condition and results of
operations is based upon the Company's financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
the use of estimates and judgments that affect the reported amounts and related
disclosures of commitments and contingencies. The Company relies on historical
experience, established fact-gathering procedures, and various assumptions that
the Company believes to be reasonable under the circumstances to make judgments
about the carrying values of assets and liabilities that are not readily
apparent from other sources. Actual results may dif