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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 1999
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 000-21949
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PACIFICARE HEALTH SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 95-4591529
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
3120 LAKE CENTER DRIVE, SANTA ANA, CALIFORNIA 92704
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) (714) 825-5200
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $0.01
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Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of common stock held by non-affiliates of the
Registrant on February 29, 2000 was approximately $927,600,000.
The number of shares of common stock outstanding at February 29, 2000 was
approximately 35,900,000.
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PACIFICARE HEALTH SYSTEMS, INC.
INDEX TO ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1999
PAGE
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 13
Item 3. Legal Proceedings........................................... 13
Item 4. Submission of Matters to a Vote of Security Holders......... 14
PART II
Item 5. Market for the Company's Common Equity and Related
Stockholders Matters........................................ 15
Item 6. Selected Financial Data..................................... 15
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 18
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 37
Item 8. Consolidated Financial Statements and Supplementary Data.... 37
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 37
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 38
Item 11. Executive Compensation...................................... 43
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 51
Item 13. Certain Relationships and Related Transactions.............. 53
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 54
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PART I
ITEM 1. BUSINESS
HMOS AND HMO-RELATED PRODUCTS AND SERVICES. PacifiCare Health Systems, Inc. is
one of the nation's leading managed health care services companies, serving
approximately 3.7 million members in nine states and Guam as of December 31,
1999. We operate health maintenance organizations ("HMOs") and offer HMO-related
products and services.
Our commercial plans offer a comprehensive range of products to employer groups
and individuals, including HMO, Preferred Provider Organization ("PPO") and
Point of Service ("POS") plans. An HMO is a health care organization that
combines aspects of a health care insurer with those of a health care provider
by arranging health care services for its members through a defined provider
network at a reduced deductible or nominal copayment. A PPO is a selected group
of providers, such as medical groups, that offers discounted fee-for-service
health care. POS plans combine the features of an HMO with the features of a
traditional indemnity insurance product, allowing members to choose from a
network of providers at a lower cost, or from other physicians at a higher
deductible or copayment. Our Medicare program and commercial plans are designed
to deliver quality health care and customer service to members at cost-effective
prices. We also offer a variety of specialty HMO managed care and HMO-related
products and services that employers can purchase as a supplement to our basic
commercial plans or as stand-alone products. These products include life and
health insurance, behavioral health services, dental and vision services and
pharmacy benefit management. We generally provide these specialty services
through subcontracts or referral relationships with other health care providers.
BUSINESS OPERATIONS
In September 1999, we announced that we had organized our company in three
divisions: Health Plans, Specialty Products and a Seniors division. This
realignment, effective in 2000, will allow each division to focus on its
customers, markets and growth opportunities. Our Medicare and commercial HMO
health plans and life and health insurance companies, which operate in nine
states and serve 3.7 million members, fall within the Health Plans division.
This new division integrates services that had been operated through regional
and local offices with the programs operated through the corporate headquarters.
The goal of this integration is to bring cost savings and synergies to our HMO
operations.
Our behavioral health, dental and vision and pharmacy benefit management
subsidiaries operate within the Specialty Products division to focus on growth
opportunities. The third division, a Seniors division, researches and develops
health, lifestyle and ancillary products and services marketed to older adults.
We will take advantage of our experience in this growing market segment through
our 14 years of experience with SecureHorizons(R), our Medicare+Choice HMO
program.
HEALTH PLANS DIVISION
PacifiCare's government and commercial membership at December 31, 1999 was as
follows:
GOVERNMENT(1) COMMERCIAL TOTAL PERCENT OF TOTAL
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Arizona................................... 89,300 105,000 194,300 5.3%
California................................ 608,100 1,720,000 2,328,100 63.7
Colorado.................................. 78,200 318,300 396,500 10.9
Guam...................................... -- 41,500 41,500 1.1
Nevada.................................... 28,500 35,100 63,600 1.7
Ohio...................................... 16,500 42,700 59,200 1.6
Oklahoma.................................. 29,000 84,300 113,300 3.1
Oregon.................................... 36,500 109,000 145,500 4.0
Texas..................................... 64,100 112,600 176,700 4.8
Washington................................ 64,400 74,900 139,300 3.8
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Total membership................ 1,014,600 2,643,400 3,658,000 100.0%
========= ========= ========= =====
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(1) The government program represents the Medicare line of business.
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SECURE HORIZONS PROGRAM
GENERAL. For Medicare beneficiaries, we offer health care services through our
Secure Horizons program. The Secure Horizons program is the largest
Medicare+Choice program in the United States (as measured by membership). Secure
Horizons membership has grown from approximately 0.4 million members at December
31, 1994 to approximately 1.0 million members at December 31, 1999. Beginning
January 1, 1999, the new Medicare+Choice program replaced the Medicare risk
program and all of our Medicare HMO operations qualified and continue to provide
services to Medicare beneficiaries under this program.
PREMIUMS. Our Medicare+Choice contracts entitle us to per-member per-month
payments on behalf of each enrolled Medicare beneficiary. In addition, we, and
all participants in the Medicare+Choice program, are subject to periodic
adjustments to premiums based upon retroactive changes in members' status such
as Medicaid eligibility. These periodic adjustments can be positive or negative.
In 1999, our payments from the Health Care Financing Administration ("HCFA")
were based on a mix of the average annual cost of providing traditional
fee-for-service Medicare benefits to the Medicare population in each county and
nationally. The payment was also adjusted for each individual based upon
demographic factors including the age, gender, zip code, Medicaid status as well
as certain health status information relating to each enrollee. Effective
January 1, 2000, HCFA further began adjusting payments based upon health status.
Under HCFA's new risk-adjusted methodology, plans with enrollees who were
hospitalized for more than one day in the previous year for select disease
conditions including certain cancers, cardiovascular problems, diabetes, and
neurological disorders will be paid more for those enrollees than for enrollees
without those conditions. The higher payments are determined from data that we
and all other Medicare+Choice contracting organizations have supplied to HCFA.
In addition, payments from HCFA are subject to annual limits on the growth of
overall payments to Medicare+Choice contracting organizations. See "Government
Regulation and Proposed Legislation -- HCFA" and "Government Regulation and
Proposed Legislation -- Adjusted Community Rate Filings."
The per-member revenue we receive from the government for enrollees in the
Secure Horizons program has been and will continue to be more than three times
higher than the per-member revenue we receive from enrollees in our commercial
plans primarily because of the higher medical and administrative costs of
serving a Medicare member. As a result, the Secure Horizons program accounted
for approximately 60 percent of our consolidated premium revenue for the year
ended December 31, 1999, even though it represented only 28 percent of our total
membership.
Our Medicare+Choice contracts are renewed every 12 months unless we or HCFA
elect to terminate them. HCFA may also terminate our Medicare+Choice contracts
if we fail to continue to meet compliance standards. Termination of our
Medicare+Choice contracts would have a material effect on our financial
position, results of operations or cash flows of a future period. We have had
these contracts in some states for at least 14 years and we have no reason to
believe that such terminations would occur.
COMMERCIAL PLANS
GENERAL. For the commercial employer market, we offer a range of products and
benefit plan designs that vary in the amount of member copayments. These options
allow employers flexibility in selecting cost-effective benefit packages for
their employees. Our commercial membership has grown from approximately 1.0
million members at December 31, 1994 to 2.7 million members at December 31,
1999. Our commercial plans offer a comprehensive range of products to employer
groups and individuals, including HMO, Preferred Provider Organization ("PPO")
and Point of Service ("POS") plans. A PPO is a selected group of providers, such
as medical groups, that offers discounted fee-for-service health care. POS plans
combine the features of an HMO with the features of a traditional indemnity
insurance product, allowing members to choose from a network of providers at a
lower cost, or from other physicians at a higher deductible or copayment.
PREMIUMS. In our commercial plan pricing, we use underwriting criteria as an
integral part of our commercial risk management efforts. Underwriting is the
process by which a health plan assesses the risk of enrolling employer groups
(or individuals) and establishes appropriate or necessary premium rates. The
setting of
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premium rates directly affects a health plan's profitability and marketing
success. See "Health Care Costs and Provider Relationships." We cannot employ
underwriting techniques for the Secure Horizons program because of regulations
that require us to accept nearly all Medicare beneficiaries.
FEDERAL EMPLOYEES. Our HMOs also have commercial contracts with the United
States Office of Personnel Management ("OPM") to provide managed health care
services to approximately 171,000 members under the Federal Employee Health
Benefits Program ("FEHBP") for federal employees, annuitants and their
dependents as of December 31, 1999. See "Government Regulation and Proposed
Legislation -- OPM" and Note 10 of the Notes to Consolidated Financial
Statements.
COMMERCIAL RETIREE PRODUCTS. In response to the needs of employers to provide
cost-effective health care coverage to their retired employees who may or may
not be currently entitled to Medicare, we offer the Secure Horizons retiree
product. This product draws on our Medicare expertise by offering provider
networks that are similar to those offered to our Secure Horizons enrollees. We
set our premiums generally based on the same revenue requirements needed to
provide services to Secure Horizons members. The retiree product gives us access
to individuals who, once familiar with our services and delivery system, may
enroll in Secure Horizons when they become eligible for Medicare benefits.
LIFE AND HEALTH INSURANCE. We are licensed through our subsidiaries, PacifiCare
Life and Health Insurance Company and PacifiCare Life Assurance Company, to
issue life and health care insurance in 38 states, including each of the states
where our HMOs operate, the District of Columbia and Guam. Under our new
structure, when our sales and marketing representatives promote our HMO
commercial product line, they will offer managed health care insurance products
to employer groups at the same time. This allows us to form multi-option health
benefits programs, including our PPO and POS plans. In addition, other
supplementary insurance products offered to employer groups include group term
life, indemnity dental and indemnity behavioral health benefits.
SPECIALTY PRODUCTS DIVISION
In addition to our HMO operations, we provide a range of specialty managed care
products that supplement our HMO products and are primarily sold in our
commercial plans. These products have been organized as one division and
include:
BEHAVIORAL HEALTH SERVICES. PacifiCare Behavioral Health of California, Inc. is
a California licensed specialized health care service plan that provides
behavioral health care services, including chemical dependency benefit programs,
primarily to our California and other HMO commercial members. Outside of
California, PacifiCare Behavioral Health, Inc. contracts with our HMOs and
employers to manage their respective mental health and chemical dependency
benefit programs.
DENTAL AND VISION SERVICES. PacifiCare Dental, a California licensed HMO dental
plan, and PacifiCare Dental & Vision Administrators, a third-party administrator
of indemnity and PPO dental and vision plans, provide HMO, PPO and
fee-for-service dental and PPO vision benefits directly to individuals and
employer groups and indirectly to seniors through Secure Horizons. We currently
offer these products in five states: California, Colorado, Nevada, Oregon and
Washington.
PHARMACY BENEFIT MANAGEMENT. PacifiCare Pharmacy Centers, Inc., dba Prescription
Solutions(R), is one of the industry's largest pharmacy benefit management
companies. Prescription Solutions offers pharmacy benefit management services to
HMOs, including our HMOs, and employer groups that are self-insured for
prescription drugs. Clients of Prescription Solutions have access to a pharmacy
provider network that features independent and chain pharmacies and a variety of
cost and quality management capabilities. Prescription Solutions also provides
its clients with an array of fully integrated services, including mail order
distribution, an extensive network of retail pharmacies, claims processing and
sophisticated drug utilization reporting. Prescription Solutions launched its
e-commerce initiative this year as a means of improving member services and
moving more medications to its mail service operation. We will continue to
enhance the services available in this area, including the offering of
non-prescription items such as over-the-counter medications and durable medical
equipment supplies.
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SENIORS DIVISION
Our newly formed Seniors division researches and develops health, lifestyle and
ancillary products and services marketed to older adults. As we define our
business opportunities and strategies, we will take advantage of our experience
in this growing market segment through our 14 years of experience through Secure
Horizons. Currently, the division is comprised of:
MEDICARE+CHOICE MANAGEMENT. Formed to promote our expertise in the
Medicare+Choice area, Secure Horizons USA, Inc., ("SHUSA") licenses the Secure
Horizons name and provides management services to HMOs and health care delivery
systems that seek participation in the Medicare+Choice program. SHUSA's
management services include marketing, provider contracting and administrative
services. The fee charged by SHUSA is generally based on a percentage of a
licensee's revenue. SHUSA has agreements in New Mexico with Presbyterian
Healthcare Services, Inc. and in New England with Tufts Associated Health
Maintenance Organization, Inc.
BUSINESS STRATEGY
PacifiCare's objective is to be the leading health plan in the western United
States and to gain new growth opportunities in our specialty products and the
older adult market. To achieve these objectives, we intend to pursue the
following strategies:
PURSUE MARKET LEADERSHIP IN THE WESTERN UNITED STATES TO ACHIEVE OPERATING
EFFICIENCIES AND REDUCE DEPENDENCE ON MEDICARE BUSINESS. Our Health Plans
division intends to pursue primarily commercial membership growth within the
following states that we are targeting as our primary HMO market: Arizona,
California, Colorado, Guam, Nevada, Oklahoma, Oregon, Texas and Washington. We
believe that by gaining market leadership within the western region, we can more
effectively enhance our brand recognition and gain additional operating
efficiencies, including in our provider contracting. By focusing on commercial
membership growth, we intend to reduce our exposure to risks associated with our
Medicare business, including the government's evolving reimbursement policies.
We will target our marketing efforts at large and medium size employers in these
states, focusing on potential growth opportunities. To reduce membership
acquisition costs, we will use the Internet, in addition to our other marketing
efforts, to target individuals and small employers (with fewer than 50
employees) in California. We plan to introduce similar Internet strategies for
individuals and small employers in markets outside of California by the end of
2000.
IMPLEMENT NEW INITIATIVES TO IMPROVE OPERATING PERFORMANCE. Our Health Plans
division has completed an efficiency and effectiveness review of all of its
operations and identified potential savings and synergies. These initiatives
include streamlining provider contracting and reorganizing our sales and
marketing teams and human resources department. We expect to implement the
initial initiatives within the next twelve months. As an ongoing process, we
intend to continue to seek out opportunities for new sources of efficiency and
cost savings.
PURSUE GROWTH THROUGH STRATEGIC ACQUISITIONS. As part of our commercial growth
strategy, we intend to purchase smaller health plans in our target markets. As
of January 1, 1999, there were more than 80 health plans with fewer than 100,000
members operating within the states of our target market. Consistent with this
strategy, in 1999 we acquired 15,000 commercial members in Texas as well as
ANTERO Health Plans in Colorado, which added approximately 32,000 commercial
members and 4,000 Medicare members. In February 2000, we acquired Harris
Methodist Texas Health Plan and Harris Methodist Health Insurance Company in
Texas, adding approximately 250,000 commercial members and 50,000 Medicare
members. During the first quarter of 2000, we will assume from the QualMed Plans
approximately 25,000 to 28,000 commercial members in Colorado and approximately
24,000 commercial members in Washington.
EXPAND OUR SPECIALTY PRODUCTS AND SENIORS DIVISIONS. We intend to expand our
marketing activities for our specialty products to grow the division's revenues.
For example, Prescription Solutions is expanding its mail order capacity so that
it can service more business that is independent of the services we provide to
our HMO businesses. We intend to market these services to other health plans
within the states of our target HMO market. The Specialty Products division will
also continue to develop competencies to better serve
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customers outside of our HMO business, as well as increase the synergies between
our core businesses. The Seniors division will research and develop products and
services that are not HMO-based that can be marketed to older adults.
COMPETITION
The health care industry is highly competitive, both nationally and in
PacifiCare's HMO and specialty product markets. Consolidation in the health care
industry has resulted in fewer but larger competitors, including insurance
carriers, other HMOs, employer self-funded programs and PPOs, some of which have
substantially larger enrollments or greater financial resources than PacifiCare.
As a result of this consolidation, we have become one of the larger HMOs in the
country with a concentration in the western United States.
PacifiCare competes with CIGNA Corporation, Aetna Inc. and UnitedHealth Group
for membership from national employers. We also compete with regional HMOs which
vary depending on the geographic market. Regional competitors include Kaiser
Foundation Health Plan, Foundation Health Care Systems, WellPoint Health
Networks Inc., and Humana, Inc. We also offer a regional alternative for
national employers who are willing to support multiple health plans to maintain
plans that best suit the needs of employees within a specific region. PacifiCare
has the highest Medicare membership in the nation, both in absolute terms and as
a percentage of overall membership, offering significant competitive advantages
and economies of scale in the Medicare+Choice market. Many health plans have
exited the Medicare HMO market due to changes in federal law, beginning with the
Balanced Budget Act of 1997 ("BBA"), that reduced Medicare reimbursement rates.
While we have benefited in certain regions from our competitors' market exits,
the long-term impact of the BBA on enrollment trends in Medicare+Choice HMO
programs is uncertain.
Other competitors include hospitals, health care facilities and other health
care providers. These competitors have combined to form their own networks to
contract directly with employer groups, and other prospective customers for the
delivery of health care services. We face competition in all our markets from
national HMOs, insurance carriers, local HMOs, PPOs and other local health care
providers.
Our behavioral health and dental and vision products supplement our HMO products
and are sold primarily as part of our commercial plans. Our pharmacy benefit
management product, Prescription Solutions, is an integral part of our
commercial and Medicare products; however, Prescription Solutions is also sold
as a stand-alone product. Competitors include Merck-Medco Managed Care,
WellPoint Pharmacy Management, PCS Health Systems, Med Impact, Express Scripts
and Advance Paradigm.
We believe that to retain our health plans' competitive advantages we should
continue to focus on building market share in our existing markets, as well as
develop additional products and services. Other factors that we believe give us
competitive advantages are:
- - Strong underwriting and pricing practices and staff;
- - Significant market position in certain geographic areas;
- - Financial strength;
- - Long-term operating experience in managed care;
- - A generally favorable marketplace reputation with providers, members and
employers;
- - An extensive provider network;
- - A primary reimbursement model that allows physicians, rather than HMO
administrators, to make decisions regarding medical care;
- - A relatively stable cost structure;
- - A focus on the Medicare+Choice market, creating significant purchasing power;
- - A strong brand identity;
- - Emphasis on providing high quality customer service; and
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- - An effort to continually improve the quality of care provided to our members.
HEALTH CARE COSTS AND PROVIDER RELATIONSHIPS
GENERAL. The cost of drugs and medical services have been rising in the past few
years and we expect that they will continue to rise, causing HMO insurance
premiums to increase. The reasons for the increases have been numerous,
including:
- - An aging population, which has greater medical needs;
- - The availability of more costly diagnostic and therapeutic procedures;
- - New laws and regulations specifying covered services;
- - Increased prices for medications and the introduction of more expensive
medications;
- - Defensive medical practices due to physician fear of lawsuits;
- - Significant investments by pharmaceutical companies in advertising campaigns;
- - Growth in the number of hospitals and medical specialists, resulting in
increased use of services; and
- - Consumer demand for easy access to providers, low out-of-pocket costs and
coverage of lifestyle drugs.
Our profitability depends on our ability to successfully implement premium
increases that will keep pace with the rising costs of health care. Also
impacting our profitability is our ability to control health care costs while
providing quality care. Our focus is both securing cost-effective physician,
hospital and other health care provider contracts to maintain our qualified
network of providers in each geographic area we serve, as well as improving the
medical management of health services.
PROVIDER CONTRACTING ARRANGEMENTS. We use contracting processes that include
analysis and modeling of underlying cost and utilization assumptions. Through
these processes, we expect to enhance provider performance under PacifiCare
contracts and identify strategies to increase the likelihood of provider
success. Some of our provider contracts have one-year terms. However, we have
entered into a number of multiple-year contracts with physician groups to ensure
the quality and stability of our provider network. We believe improved business
consultation and management tools, including more thorough data reporting and
financial analysis of expected performance of our contracts, will enable us to
create more financially successful provider networks.
- - Capitation Arrangements. PacifiCare typically contracts with physician
organizations as well as most hospitals and ancillary providers on a prepaid,
capitated fixed-fee per-member-per month, regardless of the services provided
to each member. Capitation payments to providers may be based on a percentage
of the premium we receive, which is especially true for our Secure Horizons
contracts, or a fixed per-member per-month amount that is adjusted to reflect
membership age, sex and benefit variation. Under capitation arrangements, the
physician group influences medical utilization and controls costs through
referrals, hospitalization and other services. At December 31, 1999,
approximately 95 percent of our members were in contracts that are capitated
for professional risk. Medical groups may potentially assume delegated
administration functions, including medical management and claims processing
to support management of health care services under PacifiCare's capitation
contracts:
-- Provider Delegated Administration. Approximately 80 percent of our
capitated provider networks have qualified through our assessment
processes to perform some or all of the delegated, administrative
functions associated with operating in a capitated environment. In those
situations, we provide support for their administrative functions to help
them achieve greater levels of efficiency while promoting the health
status of our members. We believe one of our core competencies is our
ability to manage delegated provider relationships.
-- HMO Direct Administration. Other provider groups do not have the
capability to manage the administrative functions associated with
operating in a capitated environment. With such providers, we perform all
the direct management functions, such as paying claims and providing
medical
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management on their behalf. In addition, we work with those providers to
assist them in developing the capability to assume a greater share of the
administrative functions. We continue to develop our own expertise in
this area to ensure that we can continue to build strong provider
networks for our members in existing and new markets where providers may
not be capable of performing these functions.
- - Fee-for-Service Arrangements. We contract with other hospitals and ancillary
providers, as well as some individual physicians or physician organizations,
to receive payments based on billed charges, often discounted, for the
service provided.
- - Direct Physician Management Model ("DPM"). Where the provider community is
not organized around aggregate physician groups or requires more extensive
medical management and/or administrative service, PacifiCare contracts with
physicians directly through its DPM model. DPM allows individual physicians
to serve our members through a program that generally compensates physicians
on a discounted fee-for-service basis and incorporates some elements of
risk-sharing, while PacifiCare performs all administrative functions required
for effective management of quality, medical costs and claims payment. We
designed the DPM model to be user friendly and efficient in the delivery of
administrative services.
- - Incentive Arrangements. Our HMOs share the risk of certain health care costs
through both capitation and DPM. We provide additional incentives to the
physicians or medical groups for improving quality, as well as the
appropriate utilization of hospital inpatient, outpatient surgery and
emergency room services.
HEALTH CARE COST TRENDS. Since the end of 1998, we have seen a trend of hospital
providers electing not to renew capitated contracts and opting for either
fee-for-service or shared-risk hospital arrangements. As a result of this trend,
the percentage of consolidated members under capitated arrangements for hospital
contracts has decreased from 85 percent at the end of 1998 to 75 percent to 80
percent at the end of 1999. As hospital capitation arrangements decrease, we
bear more risk for higher costs and utilization.
MEDICAL MANAGEMENT REDESIGN. We continue to believe that delegation of certain
functions empowers our providers to provide quality service and care. We are
seeking to reduce our exposure to provider insolvency by using more rigorous
standards to determine whether a provider can have delegated status or maintain
its status. We currently delegate to fewer providers than we have in the past
for medical management and claims payment, a trend we expect to continue through
the next few years. We upgraded our tracking and assessment tools to enable more
proactive identification of potential provider stability and solvency issues.
The tools are deployed on an ongoing basis to detect problems and avoid network
disruptions for our members and to minimize our financial risk. Provider
assessments focus on indicators of solvency problems, including liquidity and
cash management, underlying cost and utilization patterns, and operational and
management deficiencies. When our delegated providers require assistance, we
provide clinical and management tools, clinical and operational best practices
and performance benchmarks.
We are exploring new strategies for improving medical management core
competencies we put in place. Examples of such strategies include automating the
pre-certification and concurrent review process based on objective criteria,
auto-adjudicating claims based on prior authorization, investing in decision
support software, investing in improved training and needs assessment of
internal staff to assure consistent determinations of coverage and management
issues, and re-engineering workflows to maximize efficiencies. To support our
vision of provider success, we will make the tools and best practices we develop
available to all our providers.
NETWORK STABILITY. We believe improved business consultation and management
tools, including more thorough data reporting and financial analysis of expected
performance of our contracts, will enable us to create more financially
successful provider networks. We work closely with our provider partners to
ensure the strength and quality of our network. Under fee-for-service contracts,
PacifiCare has no insolvency risk; however, we do have increased utilization
risk. Under our capitated arrangements, we face the risk of a provider becoming
insolvent. Depending on state law, we may be held liable for unpaid health care
claims that were the responsibility of the capitated provider. Regardless, our
business consultation services, including
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on-site financial and operational audits of medical groups, provider profiles,
and corrective action plans, provide monitors and management tools to maximize
network stability.
QUALITY IMPROVEMENT
GENERAL. We are convinced that providing our members access to continually
improved health care services leads to improved health for our members. To
assure this, we focus on provider peer review procedures, member quality
initiatives and national industry measures.
PROVIDER PEER REVIEW PROCEDURES. We have established a comprehensive peer review
procedure at each HMO, governed by a quality improvement committee. The medical
director for each HMO chairs that HMO's committee. Each committee consists of
health plan clinical professionals and physician representatives from the
contracted physician groups. All physicians are initially credentialed and
approved by that HMO's quality improvement committee. The quality assessment
includes evaluating the performance of that physician, as well as the quality of
the providers' medical facilities, medical records, laboratory and x-ray
licenses and its capacity to handle membership demands. We also engage in
ongoing quality reviews of our existing providers to ensure that members are
receiving quality medical care. A highlight of our physician management program
is our provider profile which measures medical group performance quarterly
across 59 indicators of clinical quality, service quality, utilization
management, and administrative services to assist medical groups in improving
results. In addition, the provider profile serves as the data source for the
Quality Index, which is a public report card of medical groups measured in 28
areas. Our member information materials highlight best performing medical
groups, so that members have credible and relevant information by which to
select physicians. We plan to implement this report in all the PacifiCare
regions by the fall of 2000.
MEMBER QUALITY INITIATIVES. To improve the quality of service and health for our
members, we have developed a comprehensive quality improvement program that
includes:
- - Offering independent external review programs to members in which members can
have a service or treatment denial of coverage decision reviewed by a
physician or panel of physicians outside their health plan;
- - Training our contracting provider groups to decrease inappropriate denials
and improve the appeals process for our members;
- - Standardizing and streamlining our specialty provider referral process;
- - Resolving claims issues more efficiently and reducing turnaround times, with
the goal of improving member satisfaction;
- - Launching our "JustOne/Ready Reply" initiative in California, Oklahoma and
Texas designed to resolve members' issues and answer questions with a single
phone call by the member. PacifiCare handles all necessary contact between
the plan, physicians, hospitals and medical groups through the final
resolution of the issue, and reports the outcome to the member;
- - Monitoring member satisfaction through surveys and internal operational
report cards compared to our current established benchmarks;
- - Offering highly effective health management programs, including chronic care
management initiatives in diabetes, congestive heart failure, cardiovascular
risk reduction, and depression;
- - Conducting preventive health programs, smoking cessation, and senior health
risk assessments; and
- - Providing members free access to in-depth health information on thousands of
topics via the internet at www.pacificare.com.
NATIONAL INDUSTRY MEASURES. The National Committee for Quality Assurance
("NCQA") is an independent, non-profit organization that reviews and accredits
HMOs. Our HMOs provide quality and service information under NCQA's Health Plan
Employer Data Information Set program. NCQA also
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performs site reviews to determine if an HMO complies with standards it has
established for quality improvement, utilization management, provider
credentialing, a commitment to members' rights and preventive health services.
HMOs that comply with NCQA's review requirements and quality standards receive
NCQA accreditation. We have improved our NCQA scores by implementing the
membership and provider quality initiatives described above. At December 31,
1999, our HMOs in Arizona, California, Colorado, Nevada, Oklahoma and Oregon
(covering approximately 89 percent of our membership) have received
"commendable" three-year NCQA accreditation. Our Texas plan will receive its
NCQA accreditation status in March 2000, and the Washington plan will be
reviewed by NCQA in June 2000.
RISK MANAGEMENT
We shift part of our risk of catastrophic losses by maintaining reinsurance
coverage for certain hospital costs incurred in the treatment of catastrophic
illnesses. We require contracting physicians, physician groups and hospitals to
maintain individual malpractice insurance coverage. We also maintain general
liability, property and medical malpractice insurance coverage in amounts that
we believe to be adequate.
MARKETING
We have reorganized our sales and marketing teams by function rather than by
geographic regions. We believe the new structure will allow us to increase sales
growth and add value for our members and providers. We established three
strategic areas for marketing leadership, as follows:
- - Secure Horizons;
- - Commercial national, major, mid-size, group retiree, labor and trust
accounts; and
- - Commercial individual and small group accounts.
We believe this focus will allow us to satisfy customer expectations, create
enterprise-wide solutions, streamline operations, optimize efficiencies and
quality improvements and leverage our growth opportunities.
SECURE HORIZONS MARKETING. We market our Secure Horizons programs to Medicare
beneficiaries primarily through direct mail, telemarketing, our website,
television, radio and community based events with participating medical groups.
Most Secure Horizons members enroll directly in a plan, generally without the
involvement of insurance brokers, except when enrolling as part of an employer
group retiree offering. See "Business Operations -- Secure Horizons Program" and
"Business Operations -- Commercial Plans."
COMMERCIAL NATIONAL, MAJOR, MID-SIZE, GROUP RETIREE, LABOR AND TRUST ACCOUNTS
MARKETING. Commercial marketing is a two-step process in which we first market
to employer groups, then provide information directly to employees once the
employer has selected our HMO. We use various techniques to attract commercial
members, including work site presentations, direct mail, medical group tours and
local advertising. We also use television, radio, billboard and print media to
market our programs. Insurance brokers and consultants represent many employer
groups under contract with PacifiCare. These brokers and consultants work
directly with employers to recommend or design employee benefits packages. We
pay insurance brokers commissions over the life of the contract, while employers
generally pay consultants directly. Our commercial membership growth is a result
of in-market acquisitions as well as greater penetration in existing employer
groups. With each open enrollment, we identify our specific approach with
certain employer groups to increase our penetration.
COMMERCIAL INDIVIDUAL AND SMALL GROUP ACCOUNTS MARKETING. A small group is an
employer with fewer than 50 employees. We now consider small groups as a single
market throughout all of our regions, not as separate markets managed
independently and differently in each state as in the past. Since September
1999, we have had a partnership with InsWeb Corporation which is accessible from
more than 115 sites on the Internet to provide free health insurance quotes. We
currently offer individual health products at InsWeb in California, with plans
to expand to individual and small group offerings in our other states by the end
of 2000. In February 2000, we announced the launch of our Premier plans, a new
line of small group products sold through the Internet. This product's pricing
reflects the reduced distribution costs of doing business online.
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The Premier plans are currently available to our California customers through
electronic brokers via online insurance channels, PacifiCare's website
(www.pacificare.com/need insurance) and through traditional insurance brokers.
We plan to introduce similar Internet strategies for small employers in markets
outside of California by the end of 2000.
MANAGEMENT INFORMATION SYSTEMS
GENERAL. PacifiCare uses computer-based management information systems for
various purposes, including marketing and sales tracking, underwriting, billing,
claims processing, medical management, medical cost and utilization trending,
financial and management accounting, reporting, planning and analysis. These
systems also support member, group and provider service functions, including
on-line access to membership verification, claims and referral status and
information regarding hospital admissions and lengths of stay. In addition,
these systems support extensive analyses of cost and outcome data.
We continually enhance and upgrade our computer information systems to preserve
our investment in existing systems, embrace new technologies, improve the cost
effectiveness and quality of our services and introduce new products. Ongoing
system enhancements include upgrading system platforms, enhancing existing
software, implementing purchased software, selectively outsourcing some
technical functions and migrating to more suitable software database
environments. Simplification, integration and expansion of the systems servicing
our business are important components of controlling health care and
administrative expenses and improving member and provider satisfaction. We have
recovery plans in place to mitigate the effect of information systems outages,
if necessary. To the extent that these systems fail to operate, however, it
could have a material effect on results of operations or cash flows of a future
period.
GOVERNMENT REGULATION AND PROPOSED LEGISLATION
GENERAL. PacifiCare's HMOs are subject to extensive federal and state regulation
that govern the scope of benefits provided to its members, financial solvency
requirements, quality assurance and utilization review procedures, member
grievance procedures, provider contracts, marketing and advertising. Certain
federal and state regulatory agencies also require our HMOs to maintain
restricted cash reserves represented by interest-bearing investments that are
held by trustees or state regulatory agencies. These requirements, which limit
the ability of our subsidiaries to transfer funds, may limit their ability to
pay dividends. From time to time, we advance funds to our subsidiaries to assist
them in satisfying federal or state financial requirements. Our behavioral
health, dental and insurance subsidiaries are also subject to extensive federal
and state regulation.
HCFA. PacifiCare's Secure Horizons program is subject to regulations by HCFA,
the United States Department of Health and Human Services ("HHS") and certain
state agencies. These agencies govern the benefits provided, premiums paid,
quality assurance procedures, marketing and advertising. See "Business
Operations -- Secure Horizons Program." Congress enacted the Balanced Budget Act
of 1997, which required the creation of the Medicare+Choice program as a
replacement to the Medicare Risk program. HCFA has since promulgated
regulations, operational policy letters and contracts implementing
Medicare+Choice, including the Balanced Budget Refinement Act of 1999. These
contracts and regulations establish new and expanded requirements for
Medicare+Choice organizations. They also establish new or expanded standards for
quality assurance, beneficiary protection, coordinated open enrollment, program
payment and audits, information disclosure and provider participation.
Compliance with and implementation of the new Medicare+Choice regulations has
and will continue to increase our Medicare administration costs. We continue to
evaluate the operational and financial impact of the new Medicare+Choice
program.
The Balanced Budget Act also revised the formula used by HCFA to calculate
payments to Medicare health plans. The BBA established minimum payment levels,
limiting annual increases and the overall rate of payment growth. Further, as
authorized by the BBA, HCFA has developed a health risk-adjusted payment
methodology that it began to implement on January 1, 2000. See "Secure Horizons
Program -- Premiums." Effective January 1, 2000, 10 percent of the payment
amount is subject to risk adjustment in 2000. Under the Balanced Budget
Refinement Act of 1999, the phase-in schedule for risk adjusted payments was
modified to 10 percent in 2001 and 20 percent in 2002. It had previously been
set at 30 percent in 2001 and 55 percent in
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2002. Currently, HCFA is basing its assessment of health risk solely on the
prior year's hospital utilization statistics relating to each member. Managed
care organizations, such as PacifiCare, have succeeded in part because of
programs designed to avoid unnecessary, extended and risky hospitalizations. We
have achieved lower inpatient utilization through the use of other, less costly
processes for providing and managing health care. We anticipate that, beginning
in 2004, as much as 100 percent of the payments to Medicare health plans may be
subject to a risk adjustment factor.
It is possible that future legislation may create additional changes in the
payment formula or modify risk adjustment. However, it is not certain that
efforts to revise either will succeed. The loss of Medicare contracts or changes
in the program could have a material effect on our financial position, results
of operations or cash flows of a future period.
ADJUSTED COMMUNITY RATE FILINGS. As a result of the Balanced Budget Act of 1997
and related HCFA rules and regulations, our HMO subsidiaries are required to
submit separate adjusted community rate ("ACR") proposals for every
Medicare+Choice plan they offer to Medicare beneficiaries. These rates are based
upon our average commercial rate (for non-Medicare enrollees) modified by a
factor that represents the difference in utilization characteristics between
Medicare and non-Medicare enrollees within each geographic area. In effect, our
benefits structure for Secure Horizons is established based upon these rates.
Each of our subsidiaries must submit the ACR proposals, generally by county or
service area, to HCFA by July 1st for each Medicare+Choice plan offered in the
subsequent year. In the normal course of business, all information submitted as
part of the ACR process is subject to audit by HCFA or any person or
organization designated by HCFA. Beginning in January 2000, HCFA contracted with
the Office of Inspector General of the United States Department of Health and
Human Services to conduct more comprehensive audits on one-third of all ACR
filings as mandated by law. We cannot be certain that any ongoing and future
audits will be concluded satisfactorily. We may incur additional, possibly
material, liability as a result of these audits. We believe that any ultimate
liability would not materially affect our consolidated financial position.
However, the incurrence of such liability could have a material effect on
results of operations or cash flows of a future period.
EMPLOYEE RETIREMENT INCOME SECURITY ACT OF 1974 ("ERISA"). Pursuant to ERISA,
the federal government regulates insured and self-insured health coverage plans
offered by employers. There have been recent highly publicized legislative
attempts to amend ERISA to remove the current limitation on the ability of
states to regulate employer health plans and the limitations on an employee's
ability to sue a health plan under state law. If such proposals were enacted,
they may permit greater state regulation of other aspects of those business
operations, and they might increase our exposure under state law claims that
relate to employee health benefits.
HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996 ("HIPAA"). HIPAA's
federal standards apply to both the group and individual health insurance
markets. HIPAA includes certain mandates including guarantees of the
availability and renewability of health insurance for certain employers,
employees and individuals, limits on the use of preexisting condition
exclusions, disclosure of prior coverage, prohibitions against discriminating on
the basis of health status, and requirements that make it easier to continue
coverage in cases where an employee is terminated or changes employers.
PacifiCare believes that it is in substantial compliance with the mandates
required by HIPAA. HIPAA also includes administrative simplification provisions
directed at simplifying electronic data interchange through standardizing
transactions, establishing uniform health care provider, payer and employer
identifiers and seeking protections for confidentiality and security of patient
data. Proposed rules under HIPAA administrative simplification are expected to
be released as final rules during 2000 for full implementation within two years
from the date of each release. The administrative simplification portion of
HIPAA as currently proposed would require health plans, health care providers,
health care clearing houses and additional third parties such as business
partners to communicate electronically using standardized formats. We are
proceeding as if the proposed rules will be adopted as currently proposed and
will be assessing where our current systems diverge from the requirements of
administrative simplification. We are unable at this time to assess the cost of
implementation of the administrative simplification requirements of HIPAA.
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Both federal and state regulators have enforcement responsibilities for HIPAA.
As a result, we may encounter different interpretations of HIPAA's provisions in
the different states, as well as varying enforcement philosophies in states
where we operate HMOs. These differences may inhibit our ability to standardize
our products and services across state lines. Ultimately, under HIPAA and other
state laws, cost control through provider contracting and coordinating care may
become more important, and we believe our experience in these areas will allow
us to compete effectively.
OPM. Our HMO subsidiaries have commercial contracts with OPM to provide managed
health care services to federal employees, annuitants and their dependents under
the FEHBP. Rather than negotiating rates with HMOs, OPM requires HMOs to provide
the FEHBP with rates comparable to the rates charged to the two employer groups
with enrollment closest in size to the FEHBP in the applicable state after
adjusting for differences in benefits, enrollment demographics, and coordination
of costs with Medicare. OPM further requires that every HMO certify each year
that its rates meet these requirements. Approximately every three to five years,
OPM's Office of Inspector General ("OIG") audits each HMO to verify that the
premiums charged are calculated and charged in compliance with these rating
regulations and guidelines. Each audit encompasses a period of up to six years.
Following the government's initial on-site audit, OPM will provide the HMO with
a post-audit briefing indicating its preliminary results. Because these are
actuarial calculations, interpretations of the rating regulations and audit
findings often raise complex issues. The final resolution and settlement of
audits have historically taken more than three years and as many as seven years.
During the audit process, OPM may refer its findings to the United States
Department of Justice ("DOJ") if it believes that the health plan knowingly
overcharged the government or otherwise submitted false documentation or
certifications in violation of the False Claims Act. Under the False Claims Act,
an action can be considered knowingly committed if the government contractor
acted with actual knowledge, or with reckless disregard or deliberate ignorance
of the government's rules and regulations. If the government were to win a False
Claims Act lawsuit against an HMO, the government could obtain trebled damages,
a civil penalty of not less than $5,000 nor more than $10,000 for each separate
alleged false claim, and the government could permanently disqualify the HMO
from participating in all federal government programs.
Prior to our acquisition of FHP International Corporation ("FHP"), the FHP HMO
subsidiary, TakeCare of California, was audited by the OIG auditors. The OIG
issued a draft audit report in September 1996 alleging that TakeCare overcharged
the FEHBP by approximately $24 million including lost investment income.
TakeCare responded to this draft audit in January 1997, questioning many of the
auditors' calculations and assumptions. When we purchased FHP in February 1997,
we were aware of the government's claims, and we reserved for potential
liabilities in accordance with our accounting policies. In August 1999, we were
notified that the auditors had referred certain allegations to the DOJ for
review of potential claims under the False Claims Act. We are negotiating with
the DOJ to resolve all outstanding issues relating to the TakeCare of California
audit amicably. We do not agree with the auditors' interpretations of the
applicable rules and guidelines or their method of calculating rates for the
applicable period, and we do not believe there is any evidence that TakeCare of
California ever engaged in intentional wrongdoing or any action that would
violate the False Claims Act.
In July 1999, we received a request from the OIG for documentation regarding all
of the contracts between OPM and any of the HMOs owned by FHP that related to
the contract years 1990 through 1997. The majority of these contract years have
already been audited, but are not yet settled. We have complied with this
request.
OPM has conducted an audit of our Oregon HMO subsidiary for the years 1991
through 1996. We have recently been notified that the auditors had referred
certain allegations to the DOJ for review of potential claims under the False
Claims Act. We intend to negotiate with the DOJ to resolve any potential claims
amicably.
We intend to negotiate with OPM on any existing or future unresolved matters to
attain a mutually satisfactory result. We cannot be certain that any ongoing and
future negotiations will be concluded satisfactorily, that additional audits
will not be referred to the DOJ, or that additional, possibly material,
liabilities will not be incurred. We believe that any ultimate liability,
including any lost investment income, in
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excess of amounts accrued would not materially affect our consolidated financial
position. However, such liability could have a material effect on results of
operations or cash flows of a future period if resolved unfavorably.
In late 1997, we established a formal corporate compliance program to
specifically address potential issues that may arise from the FEHBP rating
process, to work with OPM to understand its interpretation of the rules and
guidelines prior to completion of the rating process, to standardize the FEHBP
rating process among all of our HMOs, and to help reduce the likelihood that
future government audits will result in any significant findings. Based upon the
results of a limited number of audits that have been conducted for contract
years 1998 and later, we believe that this program has been effective.
TRADEMARKS
PacifiCare owns the federally registered service marks PacifiCare and
SecureHorizons(R). These service marks are material to our business.
EMPLOYEES
At February 29, 2000, PacifiCare had approximately 8,800 full and part-time
employees. None of our employees is presently covered by a collective bargaining
agreement. We consider relations with our employees to be good and have never
experienced any work stoppage.
ITEM 2. PROPERTIES
As of December 31, 1999, PacifiCare leased approximately 201,000 aggregate
square feet of space for its principal corporate headquarters and executive
offices in Santa Ana and Costa Mesa, California. In connection with our
operations, as of December 31, 1999, we leased approximately 1.8 million
aggregate square feet for office space, subsidiary operations, customer service
centers and space for computer facilities. Such space corresponds to areas in
which our HMOs or specialty managed care products and services operate, or where
we have satellite administrative offices. Our leases expire at various dates
from 2000 through 2009.
We own 13 buildings encompassing approximately 445,000 aggregate square feet of
space. Three of the buildings, representing approximately 244,000 aggregate
square feet of space, are primarily used for administrative operations and are
located in California and Guam. The remaining 10 buildings are medical office
buildings, of which nine are leased to third parties under a master lease
agreement. All 10 medical buildings are being marketed for sale. We also own
three parcels of vacant land for a total of 18 acres, all of which are being
marketed for sale.
Our facilities are in good working condition, are well maintained and are
adequate for our present and currently anticipated needs. We believe that we can
rent additional space at competitive rates when current leases expire, or if we
need additional space.
ITEM 3. LEGAL PROCEEDINGS
On November 2, 1999, Jose Cruz filed a class action complaint against
PacifiCare, our California subsidiary and FHP in San Francisco Superior Court.
On November 9, 1999, Cruz filed a first amended class action complaint that
omitted FHP as a defendant. The amended complaint relates to the period from
November 2, 1995 to the present and purports to be filed on behalf of all
enrollees in our health care plans other than Medicare and Medicaid enrollees.
The amended complaint alleges that we have engaged in unfair business acts in
violation of California law, engaged in false, deceptive and misleading
advertising in violation of California law and violated the California Consumer
Legal Remedies Act. It also alleges that we have received unjust payments as a
result of our conduct. The amended complaint seeks injunctive and declaratory
relief, an order requiring the defendants to inform and warn all California
consumers regarding our financial compensation programs, unspecified monetary
damages for restitution of premiums and disgorgement of improper profits,
attorneys' fees and interest. On December 2, 1999, we removed the action to the
United
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States District Court for the Northern District of California on the grounds
that the amended complaint was completely preempted by the Employee Retirement
Income Security Act of 1974 or ERISA. We also moved to compel arbitration. The
plaintiff sought to have the case returned to state court. The court held a
hearing on these motions in February 2000 and has not ruled on the motions. We
deny all material allegations in the amended complaint and intend to defend the
action vigorously.
On November 22, 1999, Debbie Hitsman filed a class action complaint against
PacifiCare in the United States District Court for the Southern District of
Mississippi, Hattiesburg Division. The complaint relates to the period from
November 22, 1995 to the present and purports to be on behalf of all enrollees
in our health care plans other than Medicare and Medicaid enrollees. The
complaint alleges causes of action for violations of the Racketeer-Influenced
and Corrupt Organizations Act and ERISA. The complaint seeks an unspecified
amount of compensatory and treble damages, injunctive and restitutionary relief,
attorneys' fees, the imposition of a constructive trust and interest. On January
13, 2000, we filed a motion to compel arbitration and a motion to dismiss or, in
the alternative, to transfer the case for lack of personal jurisdiction and
improper venue. On January 25, 2000, the court stayed the action pending
resolution by the Multi-District Litigation or MDL Panel as to whether to
consolidate and transfer this and other similar actions to the MDL Panel. We
deny all material allegations and intend to defend the action vigorously.
In 1997, Tim Brady and other individuals filed a class action suit against
PacifiCare, several PacifiCare officers and several former officers of FHP in
the United States District Court for the Central District of California. In
addition, in 1997, Brady and other individuals filed class action against
PacifiCare and several PacifiCare officers and several former officers of FHP in
the Orange County Superior Court. Finally, in 1997, William Madruga and another
individual filed a class action suit against PacifiCare and several of its
directors and officers in the United States District Court for the Central
District of California. Each of the complaints related to the period from the
date of proxy statement for the FHP acquisition through our November 1997
announcement that earnings for the fourth quarter of 1997 would be lower than
expected. These complaints primarily alleged that we previously omitted and/or
misrepresented material facts with respect to our costs, earnings and profits.
The trial courts dismissed the Brady cases, brought on behalf of former FHP
shareholders, but the cases are now on appeal. The Madruga case, brought on
behalf of our stockholders, was dismissed with permission for the plaintiffs to
amend the complaint. The plaintiffs filed an amended complaint in November 1999
and we moved to dismiss the amended complaint in February 2000. The court has
scheduled a hearing on April 17, 2000 to consider our motion to dismiss. We deny
all material allegations and intend to defend the actions vigorously.
We are involved in legal actions in the normal course of business, some of which
seek monetary damages, including claims for punitive damages which are not
covered by insurance. Based on current information and review, including
consultation with our lawyers, we believe any ultimate liability that may arise
from these actions (including all purported class actions) would not materially
affect our consolidated financial position, results of operations, cash flows or
business prospects. However, our evaluation of the likely impact of these
actions could change in the future and an unfavorable outcome, depending upon
the amount and timing, could have a material effect on the results of operations
or cash flows of a future period.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the three months
ended December 31, 1999.
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PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PacifiCare's common stock is listed on the Nasdaq National Market under the
symbol PHSY. The following table indicates the high and low reported sale prices
per share as furnished by Nasdaq.
HIGH LOW
---- ---
YEAR ENDED DECEMBER 31, 1999
First Quarter(1).......................................... 82 7/8 63 1/2
Second Quarter(1)......................................... 100 3/8 60 1/2
Third Quarter............................................. 72 1/8 42
Fourth Quarter............................................ 59 31 1/8
YEAR ENDED DECEMBER 31, 1998(1)
First Quarter............................................. 75 5/8 49
Second Quarter............................................ 89 3/8 69 7/16
Third Quarter............................................. 93 1/4 55 5/8
Fourth Quarter............................................ 84 3/4 58 1/4
- ---------------
(1) At our June 24, 1999 annual meeting, our Class A and Class B common
stockholders approved an amended and restated certificate of incorporation,
which combined and reclassified our Class A and Class B common stock into a
single class of voting common stock. The 1999 first and second quarter
information and 1998 information listed above indicate the high and low
reported sales price per share for the Class B common stock. See Note 6 of
the Notes to Consolidated Financial Statements.
PacifiCare has never paid cash dividends on its common stock. We do not expect
to declare dividends on our common stock in the future, retaining all earnings
for business development. Any possible future dividends will depend on our
earnings, financial condition, and regulatory requirements. If we decide to
declare common stock dividends in the future, such dividends may only be made in
shares of PacifiCare's common stock, according to the terms of our credit
facility. See Note 6 of the Notes to Consolidated Financial Statements.
As of March 13, 2000 there were 328 stockholders of record of our common stock.
As of March 13, 2000 there were approximately 18,373 beneficial holders of our
common stock.
ITEM 6. SELECTED FINANCIAL DATA
In February 1997, PacifiCare's board of directors approved a change in our
fiscal year end from September 30 to December 31. This resulted in a transition
period for October 1, 1996 through December 31, 1996. The following selected
financial and operating data are derived from our audited consolidated financial
statements, or from our unaudited internal financial data. For clarity of
presentation and comparability, the following selected financial and operating
data includes the unaudited period for the twelve months ended December 31,
1996. The selected financial and operating data should be read in conjunction
with "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations," and also with "Item 8. Consolidated Financial Statements
and Supplementary Data."
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INCOME STATEMENT DATA
(TRANSITION
(UNAUDITED) PERIOD)
TWELVE THREE
YEAR ENDED YEAR ENDED YEAR ENDED MONTHS ENDED MONTHS ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
1999(1) 1998(2) 1997(3) 1996(4) 1996 1996(4) 1995
------------ ------------ ------------ ------------ ------------ ------------- -------------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
Operating revenue......... $9,989,090 $9,521,482 $8,982,680 $4,807,856 $1,234,875 $4,637,305 $3,731,022
---------- ---------- ---------- ---------- ---------- ---------- ----------
Expenses:
Health care services.... 8,368,690 8,002,260 7,658,879 4,017,383 1,039,345 3,872,747 3,077,135
Other operating
expenses.............. 1,181,773 1,166,011 1,125,299 605,546 154,996 585,081 505,644
Impairment, disposition,
restructuring and
other (credits)
charges............... (2,233) 15,644 154,507 75,840 -- 75,840 --
Office of Personnel
Management (credits)
charges............... -- (4,624) -- 25,000 -- 25,000 --
---------- ---------- ---------- ---------- ---------- ---------- ----------
Operating income.......... 440,860 342,191 43,995 84,087 40,534 78,637 148,243
Net investment income and
interest expense........ 41,049 43,383 16,129 44,696 12,302 44,143 33,857
---------- ---------- ---------- ---------- ---------- ---------- ----------
Income before income
taxes................... 481,909 385,574 60,124 128,783 52,836 122,780 182,100
Provision for income
taxes................... 203,365 183,147 81,825 53,052 21,079 50,827 74,005
---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income (loss)......... $ 278,544 $ 202,427 $ (21,701) $ 75,731 $ 31,757 $ 71,953 $ 108,095
========== ========== ========== ========== ========== ========== ==========
Preferred dividends....... -- (5,259) (8,792) -- -- -- --
---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income (loss)
available to common
stockholders............ $ 278,544 $ 197,168 $ (30,493) $ 75,731 $ 31,757 $ 71,953 $ 108,095
========== ========== ========== ========== ========== ========== ==========
Basic earnings (loss) per
share(5)................ $ 6.26 $ 4.50 $ (0.75) $ 2.43 $ 1.01 $ 2.31 $ 3.69
========== ========== ========== ========== ========== ========== ==========
Diluted earnings (loss)
per share(5)............ $ 6.23 $ 4.40 $ (0.75) $ 2.39 $ 1.00 $ 2.27 $ 3.62
========== ========== ========== ========== ========== ========== ==========
OPERATING STATISTICS
Medical care ratio (health
care services as a
percentage of premium
revenue)
Consolidated............ 84.8% 85.0% 85.7% 84.5% 85.1% 84.4% 83.6%
Government.............. 86.9% 86.5% 85.6% 85.6% 85.5% 85.4% 84.3%
Commercial.............. 81.7% 82.8% 85.8% 82.8% 84.4% 83.1% 82.5%
Marketing, general and
administrative expenses
as a percentage of
operating revenue....... 11.1% 11.4% 11.7% 12.4% 12.4% 12.4% 13.4%
Operating income as a
percentage of operating
revenue................. 4.4% 3.6% 0.5% 1.7% 3.3% 1.7% 4.0%
Effective tax rate(6)..... 42.2% 47.5% 136.1% 41.2% 39.9% 41.4% 40.6%
Return on average
stockholders' equity.... 13.2% 9.4% (1.5)% 9.3% 3.9% 9.3% 18.9%
See footnotes following "Balance Sheet Data."
Continued on next page.
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FINANCIAL STATEMENT CHANGE STATISTICS
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1997(7) 1996 1995
------------ ------------ ------------ ------------- -------------
Operating revenue.................................... 4.9% 6.0% 86.8% 24.3% 29.0%
Net income (loss).................................... 37.6% 1,032.8% (128.7)% (33.4)% 19.8%
Earnings (loss) per share............................ 41.6% 686.7% (131.4)% (37.3)% 12.4%
Total assets......................................... 5.5% (6.7)% 217.8% (6.2)% 25.3%
Total stockholders' equity........................... (11.6)% 8.5% 139.8% 12.5% 77.1%
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1997 1996 1996 1995
------------ ------------ ------------ ------------ ------------- -------------
MEMBERSHIP DATA
Government (Medicare & Medicaid)...... 1,014,600 972,800 1,001,100 593,600 596,200 541,000
Commercial............................ 2,643,400 2,554,100 2,790,000 1,451,500 1,434,500 1,216,100
---------- ---------- ---------- ---------- ---------- ----------
Total membership...................... 3,658,000 3,526,900 3,791,100 2,045,100 2,030,700 1,757,100
========== ========== ========== ========== ========== ==========
Percentage change in membership....... 3.7% (7.0)% 85.4% 0.7% 15.6% 29.4%
========== ========== ========== ========== ========== ==========
BALANCE SHEET DATA
(AMOUNTS IN THOUSANDS)
Cash and equivalents and marketable
securities.......................... $1,848,258 $1,600,189 $1,545,382 $ 962,482 $ 700,093 $ 811,525
Total assets.......................... $4,884,021 $4,630,944 $4,963,046 $1,561,472 $1,299,462 $1,385,372
Medical claims and benefits payable... $ 795,200 $ 645,300 $ 721,500 $ 282,500 $ 268,000 $ 288,400
Long-term debt, due after one year.... $ 975,000 $ 650,006 $1,011,234 $ 1,370 $ 5,183 $ 11,949
Stockholders' equity.................. $1,977,719 $2,238,096 $2,062,187 $ 860,102 $ 823,224 $ 732,024
- ---------------
(1) The 1999 results include impairment, disposition, restructuring and other
net pretax credits totaling $2 million ($2 million or $0.04 diluted loss per
share, net of tax). The after tax and per share amounts were losses because
the goodwill impairment was not deductible for income tax purposes. See Note
9 of the Notes to Consolidated Financial Statements. Operating income before
pretax credits and charges as a percentage of operating revenue was 4.4
percent. Return on average stockholders' equity before pretax credits and
charges was 13.3 percent.
(2) The 1998 results include $11 million of net pretax charges ($6 million or
$0.12 diluted loss per share, net of tax) for the disposal of unprofitable
subsidiaries and potential OPM claims. See Note 9 of the Notes to
Consolidated Financial Statements. Operating income before pretax credits
and charges as a percentage of operating revenue was 3.7 percent. Return on
average stockholders' equity before pretax credits and charges was 9.7
percent.
(3) The 1997 results include the results of operations for the FHP International
Corporation acquisition from February 14, 1997. The 1997 results also
include $155 million of pretax charges ($129 million or $3.18 diluted loss
per share, net of tax) for the impairment of long-lived assets,
restructuring and certain other charges. See Note 9 of the Notes to
Consolidated Financial Statements. Operating income before pretax charges as
a percentage of operating revenue was 2.2 percent. Return on average
stockholders' equity before pretax charges was 6.9 percent.
(4) The 1996 results include $101 million of pretax charges ($62 million or
$1.96 diluted loss per share, net of tax for the fiscal year ended September
30 and $1.97 diluted loss per share for the twelve months ended December 31)
for the impairment of long-lived assets, potential government claims,
dispositions and certain restructuring charges. Operating income before
pretax charges as a percentage of operating revenue for 1996 was 3.8 percent
for the fiscal year ended September 30 and 3.9 percent for the twelve months
ended December 31. Return on average stockholders' equity before pretax
charges for the fiscal year ended September 30 was 17.2 percent and 17.0
percent for the twelve months ended December 31.
(5) Earnings per share were restated to conform with the provisions of Statement
of Financial Accounting Standards No. 128, "Earnings per Share."
(6) Effective income tax rate includes the effect of nondeductible pretax
charges.
(7) Changes compared to the unaudited period for the twelve months ended
December 31, 1996.
17
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
OVERVIEW. PacifiCare sells HMO and HMO-related products primarily to members in
two groups: the Secure Horizons program for Medicare beneficiaries and the
commercial plans for members of employer groups and individuals. Our specialty
managed care HMOs and HMO-related products and services supplement our
commercial and Secure Horizons programs. These include life and health
insurance, behavioral health services, dental and vision services, pharmacy
benefit management and Medicare+Choice management services.
Events significant to our business in 1999 include the following:
- - In November 1999, we entered a definitive agreement to purchase Harris
Methodist Texas Health Plan, Inc. and Harris Methodist Health Insurance
Company, Inc., a health plan and insurance company in Texas with
approximately 250,000 commercial and 50,000 Medicare members. We completed
the acquisition effective February 1, 2000 once we had received all necessary
approvals from the regulators. See Note 12 of the Notes to Consolidated
Financial Statements.
- - In October 1999, our board of directors approved a stock repurchase program
that allows us to repurchase up to 12 million shares of our outstanding
common stock, including any shares purchased from UniHealth Foundation. From
November 8, 1999, through December 31, 1999, we repurchased 6.3 million
shares under this authorization. This repurchase program supersedes the stock
repurchase program approved in January 1998, under which we purchased 3.2
million shares. Included in this 3.2 million shares were 2.5 million shares
repurchased in 1999. We also obtained an amendment to our existing credit
facility that increased the maximum allowable amount of share repurchases to
$1 billion from $500 million. See Note 6 of the Notes to Consolidated
Financial Statements.
- - We signed transition agreements with QualMed Washington Health Plans, Inc.,
in October 1999 and with QualMed Plans for Health of Colorado, Inc. in
September 1999, each a subsidiary of Foundation Health Systems, Inc. During
the first quarter of 2000 we will assume approximately 25,000 to 29,000
members in Colorado and approximately 24,000 members in Washington. See Note
12 of the Notes to Consolidated Financial Statements.
- - In September 1999, we acquired ANTERO Health Plans in Colorado and in
February 1999, we acquired 15,000 commercial members in Texas. See Note 4 of
the Notes to Consolidated Financial Statements.
- - In June 1999, we submitted our 2000 proposed Secure Horizons benefit plan
changes to HCFA for approval. These changes were designed to enable us to
maintain our Medicare margins in 2000. The changes, which were effective
January 1, 2000, included increasing our members' monthly premiums and
copayments or reducing benefits where the government provided insufficient
reimbursement. We expect disenrollments as a result of these premium and
benefit adjustments. In addition, we exited Secure Horizons operations in 12
counties in Ohio, Washington, California and Oregon effective January 1,
2000. These county exits did not result in a significant loss of our Secure
Horizons members. See "Forward-Looking Information under the Private
Securities Litigation Act of 1995."
- - In May 1999, we entered into a stock purchase agreement with UniHealth
Foundation to repurchase up to 5.9 million shares of our common stock held by
UniHealth Foundation. At our June 24, 1999 annual meeting, our Class A and
Class B common stockholders approved an amended and restated certificate of
incorporation, which combined and reclassified PacifiCare's Class A and Class
B common stock into a single class of voting common stock. We paid UniHealth
Foundation $60 million when our stockholders approved the amended and
restated certificate of incorporation on June 24, 1999. This payment was
recorded as a reduction of stockholders' equity. To date we have not
repurchased any of the shares held by UniHealth Foundation because our stock
price has been substantially below the $75 per share price at which UniHealth
Foundation may agree to sell the stock. See Note 6 of the Notes to
Consolidated Financial Statements.
18
21
1999 COMPARED WITH 1998
MEMBERSHIP. Total membership increased four percent to approximately 3.7 million
members at December 31, 1999 from approximately 3.5 million members at December
31, 1998.
AT DECEMBER 31, 1999 AT DECEMBER 31, 1998
-------------------------------------- --------------------------------------
MEMBERSHIP DATA GOVERNMENT(1) COMMERCIAL TOTAL GOVERNMENT(1) COMMERCIAL TOTAL
--------------- ------------- ---------- --------- ------------- ---------- ---------
Arizona......................... 89,300 105,000 194,300 86,500 107,100 193,600
California...................... 608,100 1,720,000 2,328,100 599,800 1,595,000 2,194,800
Colorado........................ 78,200 318,300 396,500 58,500 296,600 355,100
Guam............................ -- 41,500 41,500 -- 39,800 39,800
Nevada.......................... 28,500 35,100 63,600 22,900 38,900 61,800
Ohio............................ 16,500 42,700 59,200 16,600 44,000 60,600
Oklahoma........................ 29,000 84,300 113,300 26,900 96,300 123,200
Oregon.......................... 36,500 109,000 145,500 39,300 114,700 154,000
Texas........................... 64,100 112,600 176,700 61,900 127,100 189,000
Washington...................... 64,400 74,900 139,300 60,400 94,600 155,000
--------- --------- --------- ------- --------- ---------
Total membership................ 1,014,600 2,643,400 3,658,000 972,800 2,554,100 3,526,900
========= ========= ========= ======= ========= =========
- ---------------
(1) The government program represents the Medicare line of business.
Government membership increased four percent at December 31, 1999 compared to
membership at December 31, 1998 due to:
- - Competitor exits in markets where Secure Horizons will remain, primarily
Colorado, Nevada, Washington and Arizona; and
- - The positive results of retention programs initiated during 1998 in
California.
Commercial membership increased approximately three percent at December 31, 1999
compared to membership at December 31, 1998 due to:
- - Membership increases in California primarily due to improved sales efforts,
and in Colorado as a result of the acquisition of ANTERO Health Plans;
partially offset by
- - Membership losses attributable to our continued focus on renewing commercial
contracts with sufficient price increases to improve gross margin, primarily
in Washington and Texas.
GOVERNMENT PREMIUMS. Government premiums increased five percent or $289 million
for the year ended December 31, 1999 compared to premiums in the prior year as
follows:
YEAR ENDED
DECEMBER 31, 1999
---------------------
(AMOUNTS IN MILLIONS)
Premium rate increases that averaged approximately three
percent for the year ended December 31, 1999............ $205
Net membership increases (excluding Utah), primarily due
to competitors' exits in markets where Secure Horizons
will remain............................................. 131
Membership losses resulting from the disposition of
Utah.................................................... (47)
----
Increase over prior year.................................. $289
====
Government premium rates on a per member basis increased due to higher HCFA
premiums received, changes in membership demographics and health status, higher
retiree supplemental premiums and the exit of the Utah Medicaid business.
19
22
COMMERCIAL PREMIUMS. Commercial premiums increased four percent or $171 million
for the year ended December 31, 1999 compared to premiums in the prior year as
follows:
YEAR ENDED
DECEMBER 31, 1999
---------------------
(AMOUNTS IN MILLIONS)
Premium rate increases that averaged approximately six
percent for the year ended December 31, 1999............ $ 228
Net membership increases (excluding Utah), primarily in
California.............................................. 62
Membership losses resulting from the disposition of
Utah.................................................... (100)
Discontinued indemnity and workers' compensation
products................................................ (19)
-----
Increase over prior year.................................. $ 171
=====
OTHER INCOME. Other income increased for the year ended December 31, 1999
compared to the prior year. The increase was primarily due to increased
mail-service revenues from our pharmacy benefit management company, where we,
rather than network retail pharmacies, collect the member copayments.
CONSOLIDATED MEDICAL CARE RATIO. The 1999 consolidated medical care ratio
(health care services as a percentage of premium revenue) declined slightly
compared to 1998 primarily because current year provider reserves were
significantly less than in 1998.
YEAR ENDED
DECEMBER 31
------------
1999 1998
---- ----
Medical care ratio:
Consolidated.............................................. 84.8% 85.0%
Government................................................ 86.9% 86.5%
Commercial................................................ 81.7% 82.8%
Excluding 1998 net provider reserves, the increase in the 1999 consolidated
medical care ratio compared to 1998 was primarily due to higher contracted
physician costs, increased pharmacy utilization, pharmacy benefit enhancements
and higher prescription drug costs for our Secure Horizons members. See "1998
Compared with 1997 -- Consolidated Medical Care Ratio and Provider Reserves" for
further discussion of provider reserves.
GOVERNMENT MEDICAL CARE RATIO. The government medical care ratio for the year
ended December 31, 1999 increased compared to the prior year due to:
- - Higher contracted physician costs;
- - Increased pharmacy utilization, pharmacy benefit enhancements and higher
prescription drug costs; partially offset by
- - Higher premiums; and
- - Reduced hospital expenses, primarily because current year provider reserves
were significantly less than in 1998.
COMMERCIAL MEDICAL CARE RATIO. The commercial medical care ratio includes the
specialty HMOs and indemnity insurance results. The commercial medical care
ratio for the year ended December 31, 1999 decreased compared to the prior year
due to the following:
- - Premium rate increases;
- - The sale of our Utah HMO and workers' compensation subsidiaries; partially
offset by
- - Higher contracted physician costs.
20
23
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. For the year ended December 31,
1999 compared to 1998, marketing, general and administrative expenses as a
percentage of operating revenue decreased because of:
- - Higher operating revenues;
- - The Utah HMO disposition; and
- - The improved efficiencies of our regional customer service operations.
YEAR ENDED
DECEMBER 31
------------
1999 1998
---- ----
Marketing, general and administrative expenses as a
percentage of operating revenue........................... 11.1% 11.4%
IMPAIRMENT, DISPOSITION, RESTRUCTURING AND OTHER (CREDITS) CHARGES. We
recognized impairment, disposition, restructuring and other pretax credits in
1999 totaling $2 million (after tax charges of $2 million or $0.04 diluted loss
per share). The after tax and per-share amounts were losses because the goodwill
impairment was not deductible for income tax purposes. See Note 9 of the Notes
to Consolidated Financial Statements.
OPERATING INCOME. Factors contributing to the increase in operating income are
discussed above.
YEAR ENDED
DECEMBER 31
------------
1999 1998
---- ----
Operating income as a percentage of operating revenue....... 4.4% 3.6%
NET INVESTMENT INCOME. Net investment income decreased approximately 19 percent
for the year ended December 31, 1999 compared to the prior year due to the
following:
- - Fewer realized gains on sales of marketable securities in the current year;
and
- - The shift of more portfolio holdings to tax-exempt investments that have
lower interest rates.
INTEREST EXPENSE. Interest expense decreased approximately 29 percent for the
year ended December 31, 1999 compared to the prior year due to the reduction in
outstanding borrowings until December 1999, when we borrowed $400 million to
fund our share repurchase program, and lower overall average interest rates paid
on our credit facility.
PROVISION FOR INCOME TAXES. The effective income tax rate was 42.2 percent in
1999, compared with 47.5 percent in 1998. The rate declined significantly
because:
- - Nondeductible goodwill amortization was a smaller percentage of pretax
income;
- - We benefited from certain tax strategies, in particular the legal
reorganization of PacifiCare and its subsidiaries, which resulted in lower
state income taxes;
- - The 1998 effective tax rate included an increase related to nondeductible
losses recognized for the dispositions of the Utah HMO and workers'
compensation subsidiaries; and
- - 1999 investment strategies resulted in increased tax-exempt earnings.
21
24
DILUTED EARNINGS PER SHARE. For the year ended December 31, 1999, net income was
$279 million or $6.23 diluted earnings per share. For the year ended December
31, 1998, net income was $202 million or $4.40 diluted earnings per share. The
change was due to the following:
YEAR ENDED
DECEMBER 31
-----------
Diluted earnings per share -- December 31, 1998............. $ 4.40
Impairment, disposition, restructuring, OPM and other
charges................................................... 0.12
------
Diluted earnings per share before impairment, disposition,
restructuring, OPM and other charges -- December 31,
1998...................................................... 4.52
Change attributable to operations:
Commercial medical care ratio performance................. 0.99
Government medical care ratio performance................. 0.22
Marketing, general and administrative expenses............ (0.21)
Other income performance.................................. 0.10
Amortization of goodwill and intangible assets............ 0.01
------
Total change attributable to operations................ 1.11
Net investment income and interest expense.................. (0.03)
Income tax rate decrease.................................... 0.54
Accretive impact of share repurchases due to 8.8 million
shares repurchased in 1999................................ 0.13
------
Diluted earnings per share before impairment, disposition,
restructuring and other (credits) charges -- December 31,
1999...................................................... 6.27
Impairment, disposition, restructuring, and other (credits)
charges................................................... (0.04)
------
Diluted earnings per share -- December 31, 1999............. $ 6.23
======
1998 COMPARED WITH 1997
MEMBERSHIP. Total membership decreased seven percent to approximately 3.5
million members at December 31, 1998 from approximately 3.8 million members at
December 31, 1997.
AT DECEMBER 31, 1998 AT DECEMBER 31, 1997
-------------------------------------- --------------------------------------
MEMBERSHIP DATA GOVERNMENT(1) COMMERCIAL TOTAL GOVERNMENT(2) COMMERCIAL TOTAL
--------------- ------------- ---------- --------- ------------- ---------- ---------
Arizona......................... 86,500 107,100 193,600 88,700 109,500 198,200
California...................... 599,800 1,595,000 2,194,800 605,300 1,650,000 2,255,300
Colorado........................ 58,500 296,600 355,100 52,600 286,700 339,300
Guam............................ -- 39,800 39,800 -- 42,800 42,800
Nevada.......................... 22,900 38,900 61,800 24,200 40,700 64,900
Ohio............................ 16,600 44,000 60,600 13,200 54,200 67,400
Oklahoma........................ 26,900 96,300 123,200 26,200 108,700 134,900
Oregon.......................... 39,300 114,700 154,000 40,600 116,500 157,100
Texas........................... 61,900 127,100 189,000 68,600 128,400 197,000
Utah............................ -- -- -- 25,000 154,200 179,200
Washington...................... 60,400 94,600 155,000 56,700 98,300 155,000
------- --------- --------- --------- --------- ---------
Total membership............ 972,800 2,554,100 3,526,900 1,001,100 2,790,000 3,791,100
======= ========= ========= ========= ========= =========
- ---------------
(1) The government program represents the Medicare line of business.
(2) The government program represents the Medicare and Medicaid lines of
business.
Government membership decreased approximately three percent at December 31, 1998
compared to the membership at the end of the prior year primarily as a result of
the sale of our Utah HMO and our exit from certain rural counties.
22
25
Commercial membership decreased approximately eight percent at December 31, 1998
compared to the membership at the end of the prior year due to:
- - The sale of our Utah HMO; and
- - Our continued focus on renewing commercial contracts with sufficient price
increases to improve gross margin, primarily in California.
GOVERNMENT PREMIUMS. Government premiums increased seven percent or $380 million
for the year ended December 31, 1998 compared to premiums in the prior year as
follows:
YEAR ENDED
DECEMBER 31, 1998
---------------------
(AMOUNTS IN MILLIONS)
The inclusion of six additional weeks of results in 1998
from the FHP acquisition.............................. $ 301
Premium rate increases that averaged approximately four
percent for the year ended December 31, 1998.......... 208
Net membership losses caused by our exit of certain
rural geographic areas and the Medicaid line of
business, primarily in California, Utah and Texas..... (129)
-----
Increase over prior year................................ $ 380
=====
COMMERCIAL PREMIUMS. Commercial premiums increased three percent or $95 million
for the year ended December 31, 1998 compared to premiums in the prior year as
follows:
YEAR ENDED
DECEMBER 31, 1998
---------------------
(AMOUNTS IN MILLIONS)
The inclusion of six additional weeks of results in 1998
from the FHP acquisition................................ $ 231
Premium rate increases that averaged approximately five
percent for the year ended December 31, 1998............ 130
Net membership losses primarily in California, Oklahoma
and Ohio, and from the disposition of Utah.............. (224)
Discontinued indemnity and workers' compensation
products................................................ (42)
-----
Increase over prior year.................................. $ 95
=====
OTHER INCOME. Other income increased in 1998 from the prior year due primarily
to higher revenues from our pharmacy benefit management company and SHUSA.
CONSOLIDATED MEDICAL CARE RATIO AND PROVIDER RESERVES. The 1998 consolidated
medical care ratio declined 0.7 percent compared to 1997.
YEAR ENDED
DECEMBER 31
------------
1998 1997
---- ----
Medical care ratio:
Consolidated.............................................. 85.0% 85.7%
Government................................................ 86.5% 85.6%
Commercial................................................ 82.8% 85.8%
23
26
The improved commercial product performance was partially offset by increased
provider reserves. Excluding these reserves, the consolidated medical care ratio
was 84.0 percent. Provider reserves were immaterial in 1997 and totaled $95
million in 1998 as follows:
QUARTER GOVERNMENT COMMERCIAL TOTAL
------- ---------- ---------- -----
(AMOUNTS IN MILLIONS)
First................................. $ 3 $ 3 $ 6
Second................................ 25 10 35
Third................................. 14 6 20
Fourth................................ 20 14 34
--- --- ---
Total............................ $62 $33 $95
=== === ===
The majority of the provider reserves related to specific provider bankruptcies.
However, the estimate also included reserves for potentially insolvent
providers, where conditions indicated claims were not being paid or had slowed
considerably. Provider charges include the write-off of uncollectable
receivables from providers and the estimated cost of unpaid health care claims
covered by our capitation payments. Depending on state law, we may be held
liable for unpaid health care claims that were the responsibility of the
capitated provider.
Reserves for the FPA Medical Management, Inc. bankruptcy totaled $57 million,
with $41 million attributable to our Nevada HMO. Reserves for other providers
totaled $38 million. Approximately $17 million of the reserves recognized in the
third and fourth quarters related to Caremark Rx, Inc. (formerly MedPartners,
Inc.), who ceased paying claims in Nevada and Arizona. The membership was
transitioned to other providers between December 1998 and January 1999. The
remaining $21 million was the estimated liability for smaller bankrupt providers
and potentially insolvent providers, primarily in California.
GOVERNMENT MEDICAL CARE RATIO. The government medical care ratio for the year
ended December 31, 1998 increased 0.9 percent compared to the prior year because
we recognized $62 million of provider reserves. Government provider reserves for
FPA were $40 million, with the majority of these charges recognized in the
second and third quarters. Other provider reserves of $22 million were recorded
primarily in the fourth quarter. Higher costs incurred for FPA membership
shifting into new provider relationships were offset by the disposition of Utah
in September 1998. Excluding government provider reserves, the 1998 government
medical care ratio was 85.4 percent.
COMMERCIAL MEDICAL CARE RATIO. The commercial medical care ratio includes the
specialty HMOs and indemnity insurance results. The commercial medical care
ratio for the year ended December 31, 1998 decreased due to the following:
- - Improved provider contracts;
- - Premium rate increases;
- - Improved performance from the specialty HMOs;
- - Sale of our Utah HMO and workers' compensation subsidiaries; offset by
- - Provider reserves of $33 million.
Commercial provider reserves for FPA totaled $17 million, primarily recognized
in the second and third quarters. Other provider reserves of $16 million were
recognized in the fourth quarter and related to Arizona, California, Nevada,
Texas and Washington. Excluding commercial provider reserves, the 1998
commercial medical care ratio was 82.0 percent.
24
27
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. For the year ended December 31,
1998 compared to 1997, marketing, general and administrative expenses as a
percentage of operating revenue decreased because we realized the benefits of
restructuring and a full year of synergies as a result of the FHP acquisition.
YEAR ENDED
DECEMBER 31
-------------
1998 1997
----- ----
Marketing, general and administrative expenses as a
percentage of operating revenue........................... 11.4% 11.7%
IMPAIRMENT, DISPOSITION, RESTRUCTURING, OPM AND OTHER CHARGES. We recognized $11
million of net pretax charges in 1998, primarily for dispositions of
unprofitable operations. Favorable OPM settlements in the fourth quarter
partially offset increased reserves recognized in the third quarter. In 1997, we
recognized $155 million of pretax charges primarily related to our impairment of
our Utah and Washington HMOs and our workers' compensation subsidiary.
Restructuring reserves recognized in 1997 were paid in 1998. See Note 9 of the
Notes to Consolidated Financial Statements.
OPERATING INCOME. Factors contributing to the increase in operating income are
discussed above.
YEAR ENDED
DECEMBER 31
------------
1998 1997
---- ----
Operating income as a percentage of operating revenue....... 3.6% 0.5%
NET INVESTMENT INCOME. Net investment income increased approximately 29 percent
in 1998 compared to the prior year, due primarily to gains on sales of
marketable securities experienced throughout 1998 and more efficient investment
through account consolidation.
INTEREST EXPENSE. Interest expense decreased approximately six percent in 1998
compared to the prior year, due to continued repayment of our credit facility
and declining interest rates. The decrease was partially offset by interest on
the FHP acquisition borrowings that were outstanding for six weeks longer in
1998.
PROVISION FOR INCOME TAXES. The effective income tax rate was 47.5 percent in
1998, compared with 136.1 percent in 1997. The rate declined significantly for
two reasons:
- - The 1997 effective rate was disproportionately high because most of the
pretax charges recorded in the fourth quarter of 1997 were not deductible for
tax purposes. The 1997 effective income tax rate without the effect of the
pretax charges was approximately 50 percent.
- - We had a smaller percentage of nondeductible goodwill amortization as part of
our expenses.
DILUTED EARNINGS PER SHARE. For the year ended December 31, 1998, net income was
$202 million or $4.40 diluted earnings per share. For the year ended December
31, 1997, the net loss was $22 million or $0.75 diluted loss per share.
LIQUIDITY AND CAPITAL RESOURCES
OPERATING CASH FLOWS. PacifiCare's consolidated cash, equivalents and marketable
securities increased to $1.8 billion at December 31, 1999 from $1.6 billion at
December 31, 1998. The combined increase in cash, equivalents and marketable
securities occurred primarily due to the large draws on our line of credit to
repurchase shares in the open market. In addition, the Medicare payment received
from HCFA in December 1999 for January 2000 was higher than the amount received
in December 1998 for January 1999.
INVESTING ACTIVITIES. For the year ended December 31, 1999, we used $251 million
of cash for investing activities, compared to $19 million used in 1998. We
purchased more marketable securities and property, plant and equipment in 1999,
resulting in the majority of the net increase over the prior year. Property,
plant and equipment purchases were primarily related to internally developed
software and computer equipment.
25
28
FINANCING ACTIVITIES. For the year ended December 31, 1999, we used $194 million
of cash for financing activities compared to $393 million used for the same
period of the prior year. The decrease was primarily related to fewer credit
facility payments. The changes were as follows:
- - We repurchased 8.8 million shares of our common stock in 1999 for $480
million compared to 0.8 million shares of our common stock in 1998 for $45
million under our stock repurchase programs;
- - We borrowed under the credit facility to repurchase shares of our outstanding
common stock. Borrowings were $400 million in 1999 and $30 million in 1998;
- - We paid $75 million in principal on our credit facility during 1999 in
comparison to $391 million in principal in 1998. Principal payments declined
as we used available cash to fund our stock repurchases;
- - In consideration for UniHealth Foundation's vote for the reclassification of
our stock and in consideration for the agreements and covenants contained in
the stock purchase agreement between PacifiCare and UniHealth Foundation, we
paid UniHealth Foundation $60 million on June 24, 1999, when our stockholders
approved the amended and restated certificate of incorporation. We incurred
$2 million of expenses related to the reclassification of our common stock
and the registration of the shares held by UniHealth Foundation. See Note 4
of the Notes to Consolidated Financial Statements;
- - We received cash for the issuance of common stock totaling $23 million for
the year ended December 31, 1999 compared to $18 million for year ended
December 31, 1998; and
- - We paid $5 million in preferred stock dividends in 1998. No preferred
dividends were paid in 1999 because all of the outstanding preferred stock
was converted or redeemed in 1998.
OTHER BALANCE SHEET CHANGE EXPLANATIONS
RECEIVABLES, NET. Receivables, net increased $31 million from December 31, 1998
primarily due to increases in provider receivables as a result of our higher
proportion of shared-risk hospital contracts. In shared-risk contracts,
PacifiCare shares the risk of certain health care costs not covered by
capitation arrangements and we provide additional incentives to the physicians
or groups for appropriate utilization of hospital inpatient, outpatient surgery
and emergency room services. In some cases, the utilization of the hospital
health care costs is above the budgeted percentage as specified in the contract.
As a result, the hospital or medical group shares the liability for these costs
with PacifiCare.
GOODWILL AND INTANGIBLE ASSETS, NET. Goodwill and intangible assets decreased
$69 million from 1998 as follows:
- - $76 million decrease attributable to goodwill and intangible amortization
expense;
- - $14 million decrease attributable to the impairment of the Ohio HMO's
goodwill; partially offset by
- - $21 million inc