<PAGE> 1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K/A
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (date of earliest event reported): FEBRUARY 1, 2000
PACIFICARE HEALTH SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 000-21949 95-4591529
(State or other jurisdiction of (Commission (IRS Employer
incorporation or organization) File Number) 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
================================================================================
<PAGE> 2
ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS.
On February 1, 2000, PacifiCare Health Plan Administrators, Inc. ("PHPA"),
acquired (the "Acquisition") all of the issued and outstanding stock of Harris
Methodist Texas Health Plan, Inc. ("Harris HMO") and Harris Methodist Insurance
Company, Inc. ("Harris Indemnity") (collectively, "Harris"), for a purchase
price of approximately $121 million. The Acquisition was made pursuant to the
Purchase Agreement dated November 1, 1999, as amended by the First Amendment,
dated February 1, 2000, by and among Harris Methodist Health Plan, Inc., Texas
Health Resources and PHPA. PHPA is a wholly owned subsidiary of PacifiCare
Health Systems, Inc. ("PacifiCare"). The Acquisition was funded using cash from
PacifiCare operations and will be accounted for by PacifiCare as a purchase.
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS.
(a) Financial Statements of Business Acquired.
1. Financial statements for Harris Methodist Texas Health Plan, Inc.
a. Audited financial statements for the year ended December 31,
1999, presented herein according to the index at page F-1.
2. Financial statements for Harris Methodist Health Insurance
Company.
a. Audited financial statements for the year ended December 31,
1999, presented herein according to the index at page F-1.
(b) Pro Forma Financial Information.
The following Unaudited Pro Forma Condensed Consolidated Statement of Operations
for the year ended December 31, 1999 presents results for PacifiCare as if the
Acquisition occurred on January 1, 1999. The following Unaudited Pro Forma
Condensed Consolidated Balance Sheet as of December 31, 1999 gives effect to the
Acquisition as if it occurred on December 31, 1999.
We will account for the Acquisition under the purchase method of accounting.
Accordingly, the acquisition cost will be allocated to Harris assets acquired
and liabilities assumed based on their estimated fair values. We have
preliminarily allocated the excess of such acquisition cost over the estimated
fair value of such assets and liabilities to goodwill. We may adjust this
allocation when we complete the final valuations of Harris' assets and
liabilities; we do not expect the effect of such adjustments, if any, to be
significant. The Unaudited Pro Forma Condensed Consolidated Statement of
Operations and Balance Sheet do not give effect to any synergies that we may
realize as a result of the Acquisition. Additionally, except as indicated in the
accompanying notes, the Unaudited Pro Forma Condensed Consolidated Statement of
Operations and Balance Sheet do not reflect any nonrecurring restructuring
charges that we may incur as a result of the integration of Harris. We cannot
reasonably estimate the amount of such charges at this time.
We have provided the Unaudited Pro Forma Condensed Consolidated Statement of
Operations and Balance Sheet for informational purposes only. These statements
do not purport to present the financial position or results of PacifiCare's
operations had the acquisition occurred on the dates specified, nor are they
necessarily indicative of the results of operations that we expect in the
future.
The Unaudited Pro Forma Condensed Consolidated Statement of Operations and
Balance Sheet should be read in conjunction with such historical financial
statements, and the accompanying notes, that are included in or incorporated by
reference in this Form 8-K/A.
1
<PAGE> 3
PACIFICARE HEALTH SYSTEMS, INC.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1999
(In thousands, except per-share data)
<TABLE>
<CAPTION>
Harris Historical
----------------------------------
PacifiCare Harris Harris Pro Forma PacifiCare,
Historical Harris HMO Indemnity Total Adjustments Pro Forma
---------- ---------- --------- ------ ----------- -----------
(1)
<S> <C> <C> <C> <C> <C> <C>
Total operating revenue $ 9,989,090 $ 675,066 $ 75,879 $ 750,945 $ -- $ 10,740,035
Expenses:
Health care services 8,368,690 631,346 69,830 701,176 -- 9,069,866
Marketing, general and administrative
expenses 1,105,816 98,090 17,470 115,560 (2,310)(2) 1,219,066
Amortization of goodwill and
intangible assets 75,957 -- -- -- 5,796 (3) 81,753
Impairment, disposition, restructuring
and other credits (2,233) -- -- -- -- (2,233)
----------- --------- -------- --------- -------- ------------
Operating income (loss) 440,860 (54,370) (11,421) (65,791) (3,486) 371,583
Net investment income (loss) 84,050 5,855 1,448 7,303 (9,730)(4) 81,623
Interest expense (43,001) (77) -- (77) -- (43,078)
----------- --------- -------- --------- -------- ------------
Income (loss) before income taxes 481,909 (48,592) (9,973) (58,565) (13,216) 410,128
Provision for income taxes (benefit) 203,365 -- -- -- (28,425)(5) 174,940
----------- --------- -------- --------- -------- ------------
Net income (loss) $ 278,544 $ (48,592) $ (9,973) $ (58,565) $ 15,209 $ 235,188
=========== ========= ======== ========= ======== ============
Weighted average common shares and
equivalents outstanding used to
calculate basic earnings per share 44,506 44,506
=========== ============
Basic earnings per share $ 6.26 $ 5.28
=========== ============
Weighted average common shares and
equivalents outstanding used to
calculate diluted earnings per share 44,717 44,717
=========== ============
Diluted earnings per share $ 6.23 $ 5.26
=========== ============
</TABLE>
See Notes to Unaudited Pro Forma Condensed Consolidated Statement of Operations
and Balance Sheet.
2
<PAGE> 4
PACIFICARE HEALTH SYSTEMS, INC.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1999
(In thousands)
<TABLE>
<CAPTION>
Harris Historical
----------------------------------------
PacifiCare Harris Pro Forma PacifiCare,
Historical Harris HMO Indemnity Harris Total Adjustments Pro Forma
---------- ---------- --------- ------------- ----------- -----------
(1)
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Current assets
Cash and equivalents $ 849,064 $ 125,785 $ 13,156 $ 149,408 $ -- $ 988,005
Marketable securities 999,194 -- 10,467 -- (121,475)(6) 888,186
Receivables, net 306,652 8,669 1,868 10,537 -- 317,189
Prepaid expenses and other
current assets 48,412 6,963 212 7,175 -- 55,587
Deferred income taxes 141,169 -- -- -- -- 141,169
----------- --------- --------- --------- ----------- -----------
Total current assets 2,344,491 141,417 25,703 167,120 (121,475) 2,390,136
----------- --------- --------- --------- ----------- -----------
Property, plant and equipment, net 177,521 6,607 -- 6,607 (5,217)(7) 178,911
Marketable securities, restricted 86,471 -- -- -- -- 86,471
Goodwill and intangible assets, net 2,244,243 -- -- -- 95,421 (8) 2,339,664
Other assets 31,295 -- -- -- -- 31,295
----------- --------- --------- --------- ----------- -----------
$ 4,884,021 $ 148,024 $ 25,703 $ 173,727 $ (31,271) $ 5,026,477
=========== ========= ========= ========= =========== ===========
LIABILITIES AND STOCKHOLDERS'
EQUITY
Current liabilities:
Medical claims and benefits
payable $ 795,200 $ 59,862 $ 11,294 $ 71,156 $ (10,535)(9) $ 855,821
Accounts payable and accrued
liabilities 425,171 39,371 1,217 40,588 8,413 (10) 474,172
Unearned premium revenue 565,815 25,027 1,694 26,721 -- 592,536
----------- --------- --------- --------- ----------- -----------
Total current liabilities 1,786,186 124,260 14,205 138,465 (2,122) 1,922,529
----------- --------- --------- --------- ----------- -----------
Long-term debt due after one year 975,000 -- -- -- -- 975,000
Deferred income taxes 127,469 -- -- -- -- 127,469
Other liabilities 17,314 6,113 -- 6,113 -- 23,427
Minority interest 333 -- -- -- -- 333
Stockholders' equity:
Common stock 468 -- 700 700 (700)(11) 468
Additional paid-in capital 1,597,485 160,157 37,954 198,111 (198,111)(11) 1,597,485
Accumulated other comprehensive
(loss) income (24,396) -- (25) (25) 25 (11) (24,396)
Retained earnings (deficit) 928,152 (142,506) (27,131) (169,637) 169,637 (11) 928,152
Treasury stock (523,990) -- -- -- -- (523,990)
----------- --------- --------- --------- ----------- -----------
Total stockholders' equity 1,977,719 17,651 11,498 29,149 (29,149) 1,977,719
----------- --------- --------- --------- ----------- -----------
$ 4,884,021 $ 148,024 $ 25,703 $ 173,727 $ (31,271) $ 5,026,477
=========== ========= ========= ========= =========== ===========
</TABLE>
See Notes to Unaudited Pro Forma Condensed Consolidated Statement of Operations
and Balance Sheet.
3
<PAGE> 5
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO UNAUDITED PRO FORMA CONDENSED
CONSOLIDATED STATEMENT OF OPERATIONS
PRO FORMA STATEMENT OF OPERATIONS ADJUSTMENTS
(1) Harris Acquisition. Pro forma adjustments to reflect the effects of the
Acquisition. The Unaudited Pro Forma Condensed Consolidated Statement
of Operations and Balance Sheet do not reflect an effect, if any, of
the allocation adjustments resulting from final valuation of Harris'
assets and liabilities, or any nonrecurring restructuring charges, that
we may incur as a result of the integration of Harris.
(2) Marketing, General and Administrative Expenses. Pro forma adjustment to
reflect reduced depreciation expense, because certain property, plant
and equipment acquired from Harris is deemed to be impaired.
(3) Amortization of Goodwill and Intangible Assets. Pro forma adjustment to
reflect amortization on approximately $95 million of the excess of the
purchase price over the estimated fair value of the net assets
acquired, using a range of estimated useful lives for identifiable
intangible assets of 1 to 10 years, and a 30-year useful life for
provider networks and goodwill, resulting in a 16-year weighted-average
useful life. See goodwill calculation at Note (8), Goodwill and
Intangible Assets.
(4) Net Investment Income. Pro forma adjustment to reflect reduced net
investment income, assuming liquidation of marketable securities to
fund the Acquisition. We used a weighted-average net investment income
rate of 8.0 percent.
(5) Income Taxes. Pro forma adjustment to reflect the tax effects of the
Acquisition at the statutory rates in effect for the year ended
December 31, 1999.
(In thousands)
Pro forma adjustments to income before income taxes $(13,216)
Harris pretax operating losses (58,565)
--------
(71,781)
--------
Statutory tax rate 39.6%
--------
Pro forma income tax benefit adjustment $(28,425)
========
4
<PAGE> 6
PACIFICARE HEALTH SYSTEMS, INC.
NOTES TO UNAUDITED PRO FORMA CONDENSED
CONSOLIDATED BALANCE SHEET
PRO FORMA BALANCE SHEET ADJUSTMENTS
(6) Marketable Securities. Pro forma adjustment to reflect the assumed
liquidation of marketable securities to fund the Acquisition.
(7) Property, Plant and Equipment. Pro forma adjustment to reflect the
impairment of certain of Harris' property, plant and equipment.
(8) Goodwill and Intangible Assets. Pro forma adjustment to record the
Acquisition and reflect the excess of the purchase price over the net
assets acquired based on currently available information.
<TABLE>
<CAPTION>
(In thousands)
<S> <C> <C>
Purchase price $120,289
Direct transaction costs 1,186
--------
Acquisition cost 121,475
Less carrying value of net assets acquired:
Common stock 700
Additional paid-in capital 198,111
Accumulated other comprehensive loss (25)
Retained deficit (169,637)
--------
29,149
--------
92,326
Plus purchase accounting fair value adjustments:
Premium deficiency reserve decrease (see Note (9)) (10,535)
Impairment of long-lived assets (see Note (7)) 5,217
Severance accrual 9,450
Legal reserves reduction (1,037)
--------
3,095
--------
Acquisition cost in excess of net assets acquired $ 95,421
========
Allocation of acquisition cost in excess of net assets acquired:
Employer groups 16,344
Provider networks 4,500
Goodwill 74,577
--------
Acquisition cost in excess of net assets acquired $ 95,421
========
</TABLE>
(9) Medical Claims and Benefits Payable. Pro forma adjustment to reverse
premium deficiency reserves on long-term provider contracts
renegotiated during the acquisition.
(10) Accounts Payable and Accrued Liabilities. Pro forma adjustment to
reflect estimated transaction costs and a reduction of legal reserves
indemnified in the purchase agreement.
(11) Stockholders' Equity. Pro forma adjustments to eliminate Harris' equity
accounts.
5
<PAGE> 7
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS (CONTINUED).
(c) Exhibits.
2.1 Purchase Agreement, dated November 1, 1999, by and among
PacifiCare Health Plan Administrators, Inc., Harris Methodist
Health Plan, Inc. and Texas Health Resources. Incorporated by
reference herein from the PacifiCare Health Systems, Inc.
Current Report on Form 8-K filed on February 11, 2000.
2.2 First Amendment to Purchase Agreement, dated February 1, 2000,
by and among PacifiCare Health Plan Administrators, Inc.,
Harris Methodist Health Plan, Inc. and Texas Health Resources.
Incorporated by reference herein from the PacifiCare Health
Systems, Inc. Current Report on Form 8-K filed on February 11,
2000.
23.1 Consent of Arthur Andersen LLP, independent auditors.
23.2 Consent of Arthur Andersen LLP, independent auditors.
99.1 Press release of January 31, 2000. Incorporated by reference
herein from the PacifiCare Health Systems, Inc. Current Report
on Form 8-K filed on February 11, 2000.
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
PACIFICARE HEALTH SYSTEMS, INC.
-------------------------------
(Registrant)
Date: April 14, 2000 By: /s/ MARY LANGSDORF
------------------ -----------------------------------
Mary C. Langsdorf
Senior Vice President
of Finance, Corporate Controller
and Interim Chief Financial Officer
6
<PAGE> 8
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS.
(a) Index to Financial Statements of Business Acquired:
PAGE
----
HARRIS METHODIST TEXAS HEALTH PLAN, INC.
Balance sheet - December 31, 1999 F-4
Statement of operations for the year ended December 31, 1999 F-5
Statement of shareholders' equity for the year ended December 31, 1999 F-6
Statement of cash flows for the year ended December 31, 1999 F-7
Notes to financial statements F-8
HARRIS METHODIST HEALTH INSURANCE COMPANY
Balance sheet - December 31, 1999 F-19
Statement of operations for the year ended December 31, 1999 F-20
Statement of shareholders' equity for the year ended December 31, 1999 F-21
Statement of cash flows for the year ended December 31, 1999 F-22
Notes to financial statements F-23
F-1
<PAGE> 9
HARRIS METHODIST TEXAS HEALTH PLAN, INC.
Financial Statements
As Of December 31, 1999
Together With Report Of Independent Public Accountants
F-2
<PAGE> 10
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Harris Methodist Texas Health Plan, Inc.:
We have audited the accompanying balance sheet of Harris Methodist Texas Health
Plan, Inc. (the "Health Plan," a Texas corporation and a wholly owned subsidiary
of Harris Methodist Health Plan, Inc.) as of December 31, 1999, and the related
statements of operations and comprehensive loss, changes in shareholder's
equity, and cash flows for the year then ended. These financial statements are
the responsibility of the Health Plan's management. Our responsibility is to
express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of the Health Plan as of December
31, 1999, and the results of its operations and its cash flows for the year then
ended in conformity with accounting principles generally accepted in the United
States.
ARTHUR ANDERSEN LLP
Dallas, Texas,
February 14, 2000
F-3
<PAGE> 11
HARRIS METHODIST TEXAS HEALTH PLAN, INC.
BALANCE SHEET - DECEMBER 31,1999
ASSETS
<TABLE>
<S> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 125,534,934
Restricted cash 250,000
Premiums receivable, net of allowance for doubtful accounts of $1,298,928 5,740,066
Due from affiliates, net 2,928,996
Accrued investment income 566,166
Other current assets 6,396,225
-------------
Total current assets 141,416,387
PROPERTY AND EQUIPMENT, net of accumulated
depreciation and amortization of $11,958,604 6,607,266
-------------
Total assets $ 148,023,653
=============
LIABILITIES AND SHAREHOLDER'S EQUITY
CURRENT LIABILITIES:
Medical claims and benefits payable $ 59,862,436
Current portion of accrued premium deficiency on loss contracts 24,575,589
Unearned premiums 25,027,446
Deposit funds held 5,121,702
Accrued expenses 4,374,491
Accrued compensation and employee benefits 3,720,066
Accrued premium taxes 1,155,217
Accounts payable 422,470
-------------
Total current liabilities 124,259,417
ACCRUED PREMIUM DEFICIENCY ON LOSS CONTRACTS,
net of current portion (Note 6) 6,113,214
-------------
Total liabilities 130,372,631
-------------
COMMITMENTS AND CONTINGENCIES (Note 10)
SHAREHOLDER'S EQUITY:
Common stock, $.01 par value; 6,000,000 shares authorized, 100
shares issued and outstanding 1
Paid-in-surplus 160,157,170
Retained deficit (142,506,149)
-------------
Total shareholder's equity 17,651,022
-------------
Total liabilities and shareholder's equity $ 148,023,653
=============
</TABLE>
The accompanying notes are an integral part of this financial statement.
F-4
<PAGE> 12
HARRIS METHODIST TEXAS HEALTH PLAN, INC.
STATEMENT OF OPERATIONS AND COMPREHENSIVE LOSS
FOR THE YEAR ENDED DECEMBER 31, 1999
<TABLE>
<S> <C>
OPERATING REVENUE:
Commercial premiums earned $ 391,667,399
Government premiums earned 278,207,240
Other revenue 5,191,525
-------------
Total operating revenue 675,066,164
-------------
OPERATING EXPENSES:
Health care services-
Commercial 371,150,253
Government 260,195,676
-------------
Total health care services expense 631,345,929
Purchased services 14,136,279
Other marketing, general and administrative expenses 83,954,089
-------------
Total operating expenses 729,436,297
-------------
OPERATING LOSS (54,370,133)
NET INVESTMENT INCOME 5,855,123
INTEREST EXPENSE (77,152)
-------------
LOSS BEFORE PROVISION FOR INCOME TAXES (48,592,162)
PROVISION FOR INCOME TAXES --
-------------
NET LOSS $ (48,592,162)
=============
COMPREHENSIVE LOSS:
Net loss $ (48,592,162)
Change in unrealized gains on fixed maturity investments (62,575)
-------------
COMPREHENSIVE LOSS $ (48,654,737)
=============
</TABLE>
The accompanying notes are an integral part of this financial statement.
F-5
<PAGE> 13
HARRIS METHODIST TEXAS HEALTH PLAN, INC.
STATEMENT OF CHANGES IN SHAREHOLDER'S EQUITY
FOR THE YEAR ENDED DECEMBER 31, 1999
<TABLE>
<CAPTION>
Accumulated
Common Stock Other
---------------- Paid-In Comprehensive Retained
Shares Amount Surplus Income (Loss) Deficit Total
------ ------ ------------ ------------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1998 100 $1 $108,798,753 $ 62,575 $ (93,913,987) $ 14,947,342
Net loss -- - -- -- (48,592,162) (48,592,162)
Capital contribution - cash -- - 47,358,417 -- -- 47,358,417
Capital contribution -
qualifying receivable -- - 4,000,000 -- -- 4,000,000
Change in unrealized gains
on fixed maturity
investments -- - -- (62,575) -- (62,575)
--- -- ------------ -------- ------------- ------------
BALANCE, December 31, 1999 100 $1 $160,157,170 $ -- $(142,506,149) $ 17,651,022
=== == ============ ======== ============= ============
</TABLE>
The accompanying notes are an integral part of this financial statement.
F-6
<PAGE> 14
HARRIS METHODIST TEXAS HEALTH PLAN, INC.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1999
<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (48,592,162)
Adjustments to reconcile net loss to net cash used in
operating activities-
Depreciation and amortization 2,932,366
Accretion of fixed maturity investments (108,534)
Net gain on sale of investments (1,521,455)
Unrealized losses on equity securities 717,995
Purchases of equity securities (490,188)
Sales of equity securities 4,893,483
Decrease in net premiums receivable 3,262,572
Decrease in net due from affiliates 7,982,845
Increase in accrued investment income (186,052)
Increase in other current assets (2,581,973)
Increase in medical claims and benefits payable 10,251,882
Decrease in accrued premium deficiency on loss contracts (18,765,573)
Increase in unearned premiums 4,179,527
Increase in deposit funds held 5,121,702
Decrease in accounts payable and accrued expenses (2,281,618)
Decrease in accrued compensation and employee benefits (414,330)
Decrease in accrued premium taxes (183,625)
-------------
Net cash used in operating activities (35,783,138)
-------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sales or maturities of fixed maturity investments 18,245,000
Purchases of property and equipment (1,674,802)
-------------
Net cash provided by investing activities 16,570,198
-------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Capital contribution - cash 47,358,417
Capital contribution - receipt of qualifying receivable from 1998 49,454,375
-------------
Net cash provided by financing activities 96,812,792
-------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 77,599,852
CASH AND CASH EQUIVALENTS, beginning of year 47,935,082
-------------
CASH AND CASH EQUIVALENTS, end of year $ 125,534,934
=============
NONCASH INVESTING AND FINANCING ACTIVITIES:
Capital contribution - qualifying receivable $ 4,000,000
Change in unrealized gains on fixed maturity investments (62,575)
</TABLE>
The accompanying notes are an integral part of this financial statement.
F-7
<PAGE> 15
HARRIS METHODIST TEXAS HEALTH PLAN, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
1. ORGANIZATION:
Harris Methodist Texas Health Plan, Inc., d.b.a. Harris Methodist Health Plan
and Summit Administrative Services (the "Health Plan"), is a for-profit,
federally qualified health maintenance organization (HMO) subject to regulation
by the Texas Department of Insurance (TDI). The Health Plan is a wholly owned
subsidiary of Harris Methodist Health Plan, Inc. (HMHPI), a Delaware corporation
and a controlled affiliate of Texas Health Resources (THR). The Health Plan
began operations as an HMO on March 1, 1996, when it became the successor to the
business interests of Harris Health Plan, Inc., a not-for-profit HMO and a
controlled affiliate of Harris Methodist Health System. The Health Plan provides
comprehensive health benefits to its enrollees in the state of Texas for a
predetermined, prepaid monthly fee. The Health Plan also provides contracted
services to certain self-insured clients on an administrative fee basis.
The Health Plan recorded a net loss of approximately $48,592,000 and had
negative cash flow from operations of approximately $35,783,000 for the year
ended December 31, 1999. As a result of its liquidity issues, the Health Plan
has been dependent upon capital contributions from THR. Without such
contributions, the Health Plan would not have sufficient liquidity to settle its
obligations in the ordinary course of business (see Note 14).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Cash and Cash Equivalents
- -------------------------
Cash and cash equivalents include bank account balances and money market
accounts with original maturities of three months or less and are reflected at
cost, which approximates market.
Restricted Cash
- ---------------
The Health Plan maintains $250,000 in two one-year certificates of deposit to
meet restricted fund requirements of the TDI. These investments are carried at
amortized cost, which approximates market.
Equity Securities
- -----------------
Equity securities previously owned consisted of common stocks and were stated at
fair value. All equity securities were classified by the Health Plan as trading
securities under the provisions of Statement of Financial Accounting Standards
(SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," and all unrealized holding gains and losses were reflected in net
investment income in the accompanying statement of operations and comprehensive
loss.
Market value was determined by the most recently traded price of the security at
the balance sheet date. Net realized gains or losses were determined on the FIFO
cost method. All such equity securities were liquidated during 1999.
F-8
<PAGE> 16
-2-
Fixed Maturity Investments
- --------------------------
Fixed maturity investments are generally designated as available-for-sale under
the provisions of SFAS No. 115. Accordingly, these investments were carried at
fair value, and unrealized gains or losses, net of applicable income taxes, were
recorded as accumulated other comprehensive income. Market values of these
investments were determined by the most recently traded price of the security at
the balance sheet date. Realized gains and losses were recorded based on the
specific identification method. All fixed maturity investments were liquidated
during 1999.
Fair Value of Financial Instruments
- -----------------------------------
The carrying amounts of cash and cash equivalents, net premiums receivable, and
current liabilities in the financial statements approximate the fair value for
these financial instruments because of the relatively short period of time
between origination of the instruments and their expected realization.
Property and Equipment
- ----------------------
Property and equipment are recorded at cost, less accumulated depreciation.
Repairs and maintenance are charged to expense as incurred. Depreciation is
recorded using the straight-line method over the estimated useful lives of the
assets, which range from 3 to 15 years. The cost of disposed assets and the
related accumulated depreciation are eliminated from the respective accounts at
the time of disposition, and any resulting gain or loss is included in other
revenue in the accompanying statement of operations and comprehensive loss.
Medical Claims and Benefits Payable
- -----------------------------------
The liability for medical claims and benefits payable is based on the Health
Plan's estimate of the total reported and unreported claims attributable to
services rendered in the current reporting period, net of portions ceded to
reinsurers.
The liability for medical claims and benefits payable is continually reviewed,
and changes to estimates are reflected in the current accounting period. The
liability, which is net of portions ceded to reinsurers, is based upon estimates
for claims reported and claims incurred but not reported based upon past
experience. In analyzing the appropriate level of liability, the Health Plan
considers many factors influencing the determination of such liability. However,
amounts ultimately paid in settlement of such reserves may be more or less than
the liability as presented in the financial statements.
Accrued Medical Incentive Pool
- ------------------------------
During 1999, the Health Plan had contracts with certain providers which
established incentives for performance against certain quality and/or cost
targets. The Health Plan recorded approximately $113,000 in net medical
incentive recoveries in 1999 as a reduction to health care services expenses.
The Health Plan had net incentive receivables at December 31, 1999, due from
providers totaling approximately $28,000 which are netted against medical claims
and benefits payable in the accompanying financial statements.
F-9
<PAGE> 17
-3-
Accrued Premium Deficiency on Loss Contracts
- --------------------------------------------
The profitability of contracts to provide health care services to members is
assessed when current operating results or forecasts indicate probable future
losses. Anticipated premiums are compared to health care related costs,
including estimated payments to providers, commissions and the cost of
collecting premiums and processing claims. If the anticipated future costs
exceed the premiums, a premium deficiency on loss contracts is recognized in the
accompanying financial statements.
Reinsurance
- -----------
In the normal course of business, the Health Plan seeks to reduce the loss that
may arise from catastrophic claims that cause unfavorable underwriting results
by reinsuring certain levels of risk in various areas of exposure with other
insurers. Amounts recoverable from reinsurers are estimated in a manner
consistent with the claim liability associated with the reinsured policy. The
effects of subsequent changes in estimated or actual reinsurance recoveries are
recorded as a charge or credit to health care services expense. Reinsurance
premiums, net of recoveries, are included in healthcare services expense in the
accompanying statement of operations and comprehensive loss.
Recognition of Premium Revenue and Related Expenses
- ---------------------------------------------------
Commercial premiums are determined on a combination of experience and class
rating bases. Government premiums are determined based on rates specified by the
Health Care Financing Administration for Medicare members and contractually
defined rates that vary by state-defined member category for Medicaid members.
Prepaid health care premiums are reported as revenue in the month that the
member is entitled to receive health care. Premiums received in advance are
reported as unearned premiums. Medical and administrative expenses are charged
to expense as incurred.
Taxes
- -----
The payment of premium taxes is required by the state of Texas based on a
percentage of collected premiums. These taxes are recorded in other marketing,
general and administrative expenses, and totaled approximately $6,854,000 in
1999.
Deferred income tax assets and liabilities are recognized for the expected
future tax consequences of events that have been included in the financial
statements or tax returns. Deferred tax assets and liabilities are determined
based on differences between the financial reporting and tax bases of assets and
liabilities. Deferred tax assets and liabilities are measured by applying
enacted tax rates and laws to taxable years in which such differences are
expected to reverse (see Note 7). The Health Plan files a consolidated tax
return with its parent, HMHPI.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period. Actual
results could differ from those estimates.
F-10
<PAGE> 18
-4-
3. INVESTMENTS:
Net investment income by investment category is summarized for 1999 as follows:
<TABLE>
<S> <C>
U.S. government agency obligations $ 477,902
Common stock 839,816
Cash and cash equivalents 4,537,405
----------
Net investment income $5,855,123
==========
</TABLE>
Proceeds from sales and maturities of investments in equity securities and fixed
maturity investments were approximately $23,138,000 for the year ended December
31, 1999. Gross gains of approximately $1,772,000 and gross losses of
approximately $250,000 were realized on those sales during 1999.
4. PROPERTY AND EQUIPMENT:
Property and equipment at December 31, 1999 are summarized as follows:
<TABLE>
<S> <C>
Leasehold improvements $ 193,728
Furniture, fixtures, and movable equipment 18,372,142
------------
18,565,870
Less- Accumulated depreciation and amortization (11,958,604)
------------
Property and equipment, net $ 6,607,266
============
</TABLE>
Depreciation and amortization expense for property and equipment for the year
ended December 31, 1999, was approximately $2,920,000.
5. MEDICAL CLAIMS AND BENEFITS PAYABLE:
Activity in the liability for medical claims and benefits payable is summarized
as follows:
<TABLE>
<S> <C>
Balance, January 1, 1999 $ 49,610,554
-------------
Incurred related to-
Current year 656,772,013
Prior years (10,375,387)
-------------
Total incurred 646,396,626
-------------
Paid related to-
Current year (597,103,459)
Prior years (39,041,285)
-------------
Total paid (636,144,744)
-------------
Balance, December 31, 1999 $ 59,862,436
=============
</TABLE>
Total incurred medical claims above do not reflect reinsurance premiums paid
(see Note 10) and net changes in premium deficiency (see Note 6). As a result of
changes in estimates of claims incurred in prior years, health care services
expense decreased by approximately $10,375,000 in 1999. This decrease reflects
actual utilization and medical costs that were less than estimated amounts.
F-11
<PAGE> 19
-5-
6. ACCRUED PREMIUM DEFICIENCY ON LOSS CONTRACTS:
The Health Plan recorded an accrual for premium deficiency on loss contracts of
approximately $49,454,000 as of December 31, 1998. The loss contracts were ones
on which the anticipated future health care costs, commissions, and costs of
collecting premiums and processing claims exceeded anticipated future premiums.
During 1999, the Health Plan recorded amortization and additional charges
relating to the accrual, resulting in net credits to health care services
expense and other marketing, general, and administrative expenses of
approximately $16,325,000 and $2,440,000, respectively, and yielding a balance
in the accrual for premium deficiency of approximately $30,689,000 at December
31, 1999.
The accrued premium deficiency will be amortized over the remaining term of the
contracts generating the premium deficiency. Approximately $24,576,000 and
$6,113,000 of amortization is projected for 2000 and 2001, respectively. An
estimate of accrued premium deficiency on loss contracts will be recalculated
each quarter with adjustments recorded through charges or credits to health care
services expense and other marketing, general and administrative expenses.
7. INCOME TAXES:
As of December 31, 1999, the Health Plan has approximately $86,300,000 in
deferred tax assets, against which a 100% valuation allowance has been recorded.
The deferred tax assets are comprised of approximately $22,200,000 of tax
deductible intangibles, approximately $10,400,000 related to accrued premium
deficiency on loss contracts, approximately $2,600,000 of various net deductible
differences and approximately $51,100,000 related to benefits associated with
net operating loss carryforwards. The Health Plan has approximately $150,300,000
in net operating loss carryforwards, which will expire between 2011 and 2014, if
unused.
There is no provision or benefit for income taxes for the year ended December
31, 1999. The difference between the effective tax rate and the statutory rate
of 34% is primarily attributable to the uncertainty regarding the realizability
of a net operating loss tax benefit as a result of the Health Plan's operating
performance.
The valuation allowance increased by approximately $13,000,000 for the year
ended December 31, 1999, to fully reserve for tax deductible differences and the
additional net operating loss carryforwards generated during the period.
Management periodically assesses the need for a valuation allowance considering
both positive and negative factors, including the historical losses generated by
the Health Plan. The 100% valuation allowance reflects management's belief that
the realization of the deferred tax assets is not assured as of December 31,
1999.
F-12
<PAGE> 20
-6-
The tax effects of the major items recorded as deferred tax assets and
liabilities are as follows:
<TABLE>
<S> <C>
Current deferred tax assets:
Unearned premiums $ 1,125,855
Medical claims and benefit payable 405,088
Accrued expenses 937,083
Accrued premium deficiency on loss contracts 8,355,700
Allowance for bad debts 488,929
------------
Total current deferred tax assets 11,312,655
------------
Non-current deferred tax assets (liabilities):
Software amortization $ 22,223,156
Depreciation (457,654)
Franchise tax (175)
Organization costs 5,420
Accrued premium deficiency on loss contracts 2,078,493
Net operating losses 51,093,671
------------
Total non-current deferred tax assets 74,942,911
------------
Total net deferred tax assets 86,255,566
Valuation allowance (86,255,566)
------------
Net deferred tax assets $ --
============
</TABLE>
Provision for income taxes computed using the federal statutory rate of 34% are
reconciled to the Health Plan's actual provision for income taxes as follows for
the year ended December 31, 1999:
<TABLE>
<S> <C>
Benefit computed at statutory rate $(16,521,335)
Business meals and entertainment 32,326
Loss on related party contract 1,904,000
Goodwill amortization (1,159,851)
Unused net operating losses 15,744,860
------------
Provision for income taxes $ --
============
</TABLE>
8. EMPLOYEE BENEFIT PLAN:
Health Plan employees participate in the Texas Health 401(k) Retirement Plan,
which was established for the benefit of employees of THR. Under the plan, THR
is required to match contributions of eligible employees, defined as
participants who contribute at least 2% of their eligible compensation, as
defined, to the plan. The amount of the THR matching contribution varies based
on the employee's length of service. The maximum match is generally 6% of
eligible compensation. In 1999, Health Plan contributions totaled approximately
$1,286,000.
F-13
<PAGE> 21
-7-
9. STATUTORY ACCOUNTING AND DIVIDEND RESTRICTIONS:
Under the laws of the state of Texas, the Health Plan is required to maintain a
minimum net worth of $900,000 and to maintain a cash or security deposit of
$100,000. The Health Plan was in compliance with these requirements at December
31, 1999, and throughout the period to the date of this report. Texas state law
also provides that dividends or other distributions may be paid only to the
extent of net worth in excess of $900,000. The Health Plan paid no dividends in
1999.
Statutory net worth of the Health Plan as reported to regulatory authorities as
of December 31, 1999, totaled $10,761,570. Statutory net loss of the Health Plan
as reported to regulatory authorities for the year ended December 31, 1999,
totaled $54,585,364. The major difference between statutory net worth and net
loss and GAAP results from changes in premium deficiency and treatment of
unrealized losses on equity securities.
The NAIC has adopted model regulations that establish minimum capitalization
requirements using a risk-based capital (RBC) formula. Texas legislation was
passed during 1999 requiring TDI to draft administrative rules for the adoption
of the NAIC RBC formula. TDI has drafted Texas Administrative Code Title 28,
Section 11.809. The original draft of this section adopts the NAIC RBC
calculation by reference and requires Texas HMOs to calculate and file an RBC
report for informational purposes only for the period ending December 31, 1999.
The Health Plan has complied with the RBC calculation and filing requirements
contained in the draft administrative code section.
10. COMMITMENTS AND CONTINGENCIES:
Reinsurance Agreement
- ---------------------
The Health Plan cedes insurance to other insurers under various contracts that
cover individual risk and entire classes of business. The ceding of insurance
does not discharge the Health Plan from primary liability to policyholders in
the event any reinsurer might be unable to meet its obligations assumed under
the reinsurance agreements. Failure of reinsurers to honor their obligations
could result in losses to the Health Plan; consequently, allowances are
established for amounts deemed uncollectible. To minimize credit risk, the
Health Plan monitors the financial condition of its reinsurers.
Effective October 1, 1998, the Health Plan renegotiated its reinsurance contract
to set its retention limit for acceptance of risk on a per-member basis at
$250,000 per year (annual deductible) for its Commercial and Point of Service
members, $50,000 for its Medicare members, and $75,000 for its Medicaid members.
The Health Plan is generally reimbursed 60% to 90% of eligible services per
member, depending on the nature of the claim, in excess of the annual
deductible. The Health Plan also maintains insolvency protection insurance with
its reinsurance carrier. Total reinsurance premiums paid were approximately
$1,275,000 in 1999 and are included in healthcare services expense in the
accompanying statement of operations and comprehensive loss. Total reinsurance
recoveries of approximately $893,000 are deducted from healthcare services
expense in 1999.
Estimated amounts recoverable from reinsurers on paid losses of approximately
$80,000 have been included in other current assets in the accompanying balance
sheet.
F-14
<PAGE> 22
-8-
Operating Leases
- ----------------
The Health Plan leases office space and equipment under operating leases
expiring in 2000. Future minimum rental payments under noncancelable operating
leases for the year ended December 31, 2000, are approximately $13,000. Total
rent expense for operating leases in 1999 was approximately $3,381,000.
Capitation
- ----------
The Health Plan capitates certain providers for medical expenses under various
contracts. The capitation of medical expense does not discharge the Health Plan
from primary liability to covered members in the event any provider might be
unable to meet its obligations assumed under the capitation agreements. The
Health Plan has not recorded medical claims and benefits payable for medical
services rendered to members covered by these capitated contracts since there is
no indication that any capitated provider will be unable to honor its
obligations.
The Health Plan has contracts to provide claims processing services on behalf of
certain capitated provider groups. In connection with these contracts, the
Health Plan holds deposit funds for payment of claims on behalf of these third
parties. At December 31, 1999, the funds on deposit with the Health Plan totaled
approximately $5,122,000.
11. RELATED-PARTY TRANSACTIONS:
The Health Plan is a wholly owned subsidiary of HMHPI, a Delaware corporation
and a controlled affiliate of THR.
In a contract dated September 1, 1997, THR agreed to assume liability for
obligations incurred under certain participant and health care provider
contracts to the extent permissible by law.
The Health Plan contracts with various THR affiliates to provide healthcare
services to employees who select Health Plan coverage. Included in commercial
premiums earned are total premiums received from THR affiliates of approximately
$36,109,000 for 1999.
During 1999, the Health Plan purchased certain administrative functions
including information technology, human resources, tax management, and legal
management from THR. The administrative costs for these purchased services were
approximately $ 9,937,000 in 1999.
The Health Plan contracts with various THR affiliates for the provision of
facility and ancillary medical services to Health Plan members. Approximately
$117,443,000 of healthcare costs in 1999 were related to charges incurred at THR
affiliated entities.
The Health Plan recorded a receivable of $4,000,000 from THR in connection with
a capital contribution from HMHPI as of December 31, 1999. This amount was
received by the Health Plan in January 2000.
F-15
<PAGE> 23
-9-
12. CONCENTRATION OF CREDIT RISK:
The Health Plan conducts its business activities exclusively in the state of
Texas. Further, the Health Plan maintains accounts with cash and cash
equivalents in excess of the amount insured by the Federal Deposit Insurance
Corporation. The Health Plan monitors the financial stability of its depository
institutions regularly, and management does not believe excessive risk of
depository institution failure exists.
13. TERMINATION OF MEDICAID CONTACT:
In late August 1999, the Health Plan terminated its contact with the Texas
Department of Health for participation in the state program to provide health
maintenance coverage to Medicaid recipients. Coverage to Medicaid recipients
under this contract expired November 30, 1999.
14. SUBSEQUENT EVENT:
On February 1, 2000, PacifiCare Health Plan Administrators, Inc. ("PHPA")
acquired 100% of the outstanding common stock of the Health Plan from HMHPI.
Subsequent to the change in control, the officers and directors of the Health
Plan were replaced by officers and directors of PacifiCare of Texas, Inc., a
wholly owned subsidiary of PHPA. The accompanying financial statements do not
include adjustments, if any, resulting from the acquisition of the Health Plan
by PHPA. The Health Plan expects to receive working capital support from PHPA
throughout 2000 to meet its obligations in the ordinary course of business.
F-16
<PAGE> 24
HARRIS METHODIST HEALTH INSURANCE COMPANY
Financial Statements
As Of December 31, 1999
Together With Report Of Independent Public Accountants
F-17
<PAGE> 25
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Harris Methodist Health Insurance Company:
We have audited the accompanying balance sheet of Harris Methodist Health
Insurance Company ("HMHIC", a Texas for-profit corporation, and wholly owned
subsidiary of Harris Methodist Health Plan, Inc.), as of December 31, 1999, and
the related statements of operations and comprehensive loss, changes in
shareholder's equity, and cash flows for the year then ended. These financial
statements are the responsibility of HMHIC's management. Our responsibility is
to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of HMHIC as of December 31, 1999,
and the results of its operations and its cash flows for the year then ended in
conformity with accounting principles generally accepted in the United States.
ARTHUR ANDERSEN LLP
Dallas, Texas,
February 14, 2000
F-18
<PAGE> 26
HARRIS METHODIST HEALTH INSURANCE COMPANY
BALANCE SHEET--DECEMBER 31, 1999
ASSETS
<TABLE>
<S> <C>
CASH AND INVESTMENTS:
Cash and cash equivalents $ 13,155,961
Fixed maturity investments, at fair value 10,466,649
------------
Total cash and investments 23,622,610
PREMIUMS RECEIVABLE, net of allowance for doubtful
accounts of $194,083 189,411
ACCRUED INVESTMENT INCOME 212,005
OTHER RECEIVABLES 273,611
REINSURANCE RECEIVABLES 1,405,753
------------
Total assets $ 25,703,390
============
LIABILITIES AND SHAREHOLDER'S EQUITY
LIABILITIES:
Policy and contract claims payable $ 9,493,918
Due to affiliates, net 532,032
Unearned premiums 1,694,327
Accrued premium taxes 282,810
Accounts payable and accrued expenses 402,745
Reserve for loss contracts 1,800,000
------------
Total liabilities 14,205,832
------------
COMMITMENTS AND CONTINGENCIES (Note 5)
SHAREHOLDER'S EQUITY:
Common stock, $1 par value, 1,400,000 shares authorized,
700,000 shares issued and outstanding 700,000
Paid-in surplus 37,954,000
Accumulated other comprehensive loss (25,195)
Retained deficit (27,131,247)
------------
Total shareholder's equity 11,497,558
------------
Total liabilities and shareholder's equity $ 25,703,390
============
</TABLE>
The accompanying notes are an integral part of this financial statement.
F-19
<PAGE> 27
HARRIS METHODIST HEALTH INSURANCE COMPANY
STATEMENT OF OPERATIONS AND COMPREHENSIVE LOSS
FOR THE YEAR ENDED DECEMBER 31, 1999
<TABLE>
<S> <C>
OPERATING REVENUE:
Premiums earned (net of premiums ceded totaling $1,416,500) $ 75,771,748
Net investment income 1,448,557
Other revenue 107,119
------------
Total operating revenue 77,327,424
------------
OPERATING EXPENSES:
Life, accident, and health benefits (net of reinsurance recoveries
totaling $1,467,719) 68,029,589
Taxes, licenses, and fees 1,369,257
Commission expense 4,438,199
Purchased administrative services 10,488,360
Other administrative expenses 1,174,749
Provision for loss contracts 1,800,000
------------
Total operating expenses 87,300,154
------------
LOSS BEFORE INCOME TAX PROVISION (9,972,730)
PROVISION FOR INCOME TAXES --
------------
NET LOSS $ (9,972,730)
============
COMPREHENSIVE LOSS:
Net loss $ (9,972,730)
Change in unrealized gains on fixed maturity investments (64,018)
------------
COMPREHENSIVE LOSS $(10,036,748)
============
</TABLE>
The accompanying notes are an integral part of this financial statement.
F-20
<PAGE> 28
HARRIS METHODIST HEALTH INSURANCE COMPANY
STATEMENT OF CHANGES IN SHAREHOLDER'S EQUITY
FOR THE YEAR ENDED DECEMBER 31, 1999
<TABLE>
<CAPTION>
Accumulated
Common Stock Other
------------------- Paid-In Comprehensive Retained
Shares Amount Surplus Income (Loss) Deficit Total
------- -------- ----------- -------------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1998 700,000 $700,000 $33,240,000 $ 38,823 $(17,158,517) $ 16,820,306
Net loss -- -- -- -- (9,972,730) (9,972,730)
Capital contribution -- -- 4,714,000 -- -- 4,714,000
Change in unrealized
gains on fixed maturity
investments -- -- -- (64,018) -- (64,018)
------- -------- ----------- -------- ------------ ------------
BALANCE, December 31, 1999 700,000 $700,000 $37,954,000 $(25,195) $(27,131,247) $ 11,497,558
======= ======== =========== ======== ============ ============
</TABLE>
The accompanying notes are an integral part of this financial statement.
F-21
<PAGE> 29
HARRIS METHODIST HEALTH INSURANCE COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1999
<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (9,972,730)
Adjustments to reconcile net loss to net cash used in operating activities-
Amortization of premium on fixed maturity investments (45,747)
Provision for loss contracts 1,800,000
Decrease in net premiums receivable 1,150,831
Increase in accrued investment income (63,162)
Increase in other receivables (82,827)
Decrease in federal income tax receivable 332,084
Increase in reinsurance receivables (223,832)
Decrease in policy and contract claims payable (3,833,173)
Decrease in net due to affiliates (1,073,110)
Increase in unearned premiums 270,614
Decrease in accrued premium taxes (395,220)
Increase in accounts payable and accrued expenses 149,096
------------
Net cash used in operating activities (11,987,176)
------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments (7,498,086)
Maturities of investments 7,025,000
------------
Net cash used in investing activities (473,086)
------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Capital contribution 4,714,000
------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (7,746,262)
CASH AND CASH EQUIVALENTS, beginning of year 20,902,223
------------
CASH AND CASH EQUIVALENTS, end of year $ 13,155,961
============
NONCASH INVESTING ACTIVITIES:
Change in unrealized gains on fixed maturity investments $ (64,018)
============
</TABLE>
The accompanying notes are an integral part of this financial statement.
F-22
<PAGE> 30
HARRIS METHODIST HEALTH INSURANCE COMPANY
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
1. ORGANIZATION:
Harris Methodist Health Insurance Company (HMHIC) is a wholly owned subsidiary
of Harris Methodist Health Plan, Inc. (HMHPI). HMHPI is a Delaware corporation
and a controlled affiliate of Texas Health Resources (THR). HMHIC is a Texas
domiciled insurer and sells life, health, dental, Medicare supplement, and
accidental death and dismemberment insurance products to employer groups and
individuals in the state of Texas.
HMHIC recorded a net loss of approximately $9,973,000 and had negative cash flow
from operations of approximately $11,987,000 for the year ended December 31,
1999. As a result of its liquidity issues, HMHIC has been dependent upon capital
contributions from THR. Without such contributions, HMHIC would not have
sufficient liquidity to settle its obligations in the ordinary course of
business (see Note 12).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Cash and Cash Equivalents
- -------------------------
Cash and cash equivalents include bank account balances and money market
accounts purchased with original maturities of three months or less and are
reflected at cost, which approximates fair value.
Fixed Maturity Investments
- --------------------------
All fixed maturity investments are designated as available-for-sale under the
provisions of Statement of Financial Accounting Standards No. 115, "Accounting
for Certain Investments in Debt and Equity Securities." Accordingly, these
investments are carried at fair value, and unrealized gains or losses, net of
applicable income taxes, are recorded as accumulated other comprehensive income.
Realized gains and losses are recorded based on the specific identification
method.
Fair Value of Financial Instruments
- -----------------------------------
The carrying amounts of cash and cash equivalents, receivables, and accounts
payable and accrued expenses in the financial statements approximate the fair
value for these financial instruments because of the relatively short period of
time between origination of the instruments and their expected realization.
Fixed maturity investments are carried at fair value in the financial
statements, determined based on the most recent trade price of the security at
the balance sheet date.
F-23
<PAGE> 31
Reinsurance
- -----------
In the normal course of business, HMHIC seeks to reduce the loss that may arise
from catastrophic claims that cause unfavorable underwriting results by
reinsuring certain levels of risk in various areas of exposure with other
insurers. Reinsurance receivables are estimated in a manner consistent with the
claim liability associated with the reinsured policy. The effects of subsequent
changes in estimated or actual reinsurance recoveries are recorded as a charge
or credit to life, accident, and health benefits expense.
Policy and Contract Claims
- --------------------------
The liability for policy and contract claims is based on HMHIC's estimate of the
total reported and unreported claims attributable to services rendered in the
current reporting period, but unpaid at the balance sheet date. The liability
for policy and contract claims is continually reviewed, and changes to the
estimates are reflected in the current accounting period. The liability is based
upon estimates for claims reported and claims incurred but not reported based
upon past experience. In analyzing the appropriate level of liability, HMHIC
considers many factors influencing the determination of such liability. However,
amounts ultimately paid in settlement of such reserves may be more or less than
the liability presented in the financial statements.
Recognition of Premium Revenue and Related Expenses
- ---------------------------------------------------
Premiums are determined on a combination of experience and class rating bases.
Premiums are reported as revenue in the month that the member is entitled to
receive coverage. Premiums received in advance are reported as unearned
premiums. Life, accident, and health benefits and administrative expenses are
charged to expense as incurred.
Taxes
- -----
The payment of premium taxes is required by the state of Texas based on a
percentage of collected premiums. These taxes are recorded as taxes, licenses,
and fees in the accompanying statement of operations and comprehensive loss and
totaled approximately $1,369,000 in 1999.
Deferred income tax assets and liabilities are recognized for the expected
future tax consequences of events that have been included in the financial
statements or tax returns. Deferred tax assets and liabilities are determined
based on differences between the financial reporting and tax bases of assets and
liabilities. Deferred tax assets and liabilities are measured by applying
enacted tax rates and laws to taxable years in which such differences are
expected to reverse (see Note 6). HMHIC files a consolidated tax return with its
parent HMHPI.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period. Actual
results could differ from those estimates.
F-24
<PAGE> 32
3. FIXED MATURITY INVESTMENTS:
The amortized cost and estimated fair value of fixed maturity investments at
December 31, 1999, are as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
U.S. government agency obligations $ 8,008,775 $ -- $(25,195) $ 7,983,580
Corporate obligations 2,483,069 -- -- 2,483,069
----------- ------ -------- -----------
Total fixed maturity investments $10,491,844 $ -- $(25,195) $10,466,649
=========== ====== ======== ===========
</TABLE>
The U.S. government agency obligations and corporate obligations owned at
December 31, 1999, are contractually due in one year or less. Actual maturities
may differ from contractual maturities because certain issuers may have the
right to call or prepay obligations with or without call or prepayment
penalties.
Net investment income by investment category is summarized for the year ended
December 31, 1999, as follows:
<TABLE>
<S> <C>
U.S. government agency obligations $ 478,024
Corporate obligations 865
Cash and cash equivalents 969,668
----------
Net investment income $1,448,557
==========
</TABLE>
Proceeds from maturities of fixed maturity investments were approximately
$7,025,000 for the year ended December 31, 1999. No gains or losses were
realized on maturities during 1999.
F-25
<PAGE> 33
4. POLICY AND CONTRACT CLAIMS:
Activity in the liability for policy and contract claims for 1999 is summarized
as follows:
<TABLE>
<S> <C>
Claim liability as of January 1, 1999 $ 13,327,091
Less- Reinsurance receivables --
------------
Net balance, January 1, 1999 13,327,091
------------
Incurred related to-
Current year 71,430,164
Prior years (3,400,575)
------------
Total incurred 68,029,589
------------
Paid related to-
Current year (62,944,312)
Prior years (9,843,409)
------------
Total paid (72,787,721)
------------
Net balance, December 31, 1999 8,568,959
Reinsurance receivables 924,959
------------
Balance, December 31, 1999 $ 9,493,918
============
</TABLE>
As a result of changes in estimates of claims incurred in prior years, life,
accident, and health benefits expense decreased by approximately $3,401,000 in
1999. This decrease reflects actual utilization and medical costs that were less
than estimated amounts.
5. COMMITMENTS AND CONTINGENCIES:
Reinsurance Agreements
- ----------------------
HMHIC cedes insurance to other insurers under various contracts that cover
individual risk and entire classes of business. The ceding of insurance does not
discharge HMHIC from primary liability to policyholders in the event any
reinsurer might be unable to meet its obligations assumed under the reinsurance
agreements. Failure of reinsurers to honor their obligations could result in
losses to HMHIC; consequently, allowances are established for amounts deemed
uncollectable. To minimize credit risk, HMHIC continually monitors the financial
condition of reinsurers.
HMHIC maintains reinsurance agreements for group term life and accidental death
and dismemberment (AD&D) insurance, health insurance, and self-funded employers'
stop loss insurance. One reinsurance agreement provides that HMHIC and the
reinsurer share 50% of the risk and premiums for group term life claims. HMHIC
cedes 100% of the risk and premiums for AD&D claims. HMHIC also maintains an
agreement with a reinsurer that cedes 100% of the risk greater than $150,000 per
occurrence for life insurance claims with more than three deaths in a common
event, not to exceed $2,000,000.
HMHIC maintains a reinsurance contract with a reinsurer under which that company
reinsures 60% to 90% of Eligible Hospital Services risks, as defined in the
contract, after the occurrence of the first $75,000 in liability, not to exceed
$1,000,000. HMHIC also maintains insolvency protection insurance with that
company.
F-26
<PAGE> 34
Finally, HMHIC issues stop loss insurance as the insurer for excess loss
protection for self-funded employers' health funds. HMHIC retains 10% of the
risk and premiums and cedes the remaining 90% to a reinsurer.
Reinsurance receivables include the following as of December 31, 1999:
<TABLE>
<S> <C>
Amounts recoverable from reinsurers on paid losses $ 480,794
Estimated amounts receivable from reinsurers on unpaid claims
and claims incurred but not reported 924,959
----------
$1,405,753
==========
</TABLE>
The effect of reinsurance on premiums written and earned is as follows for the
year ended December 31, 1999:
<TABLE>
<CAPTION>
Written Earned
------------ ------------
<S> <C> <C>
Direct $ 78,609,693 $ 77,188,248
Ceded (1,416,500) (1,416,500)
------------ ------------
Net premiums $ 77,193,193 $ 75,771,748
============ ============
</TABLE>
6. FEDERAL INCOME TAXES:
As of December 31, 1999, HMHIC has a total of approximately $9,300,000 in
deferred tax assets, against which a 100% valuation allowance has been recorded.
The deferred tax assets are comprised of approximately $1,100,000 of various net
deductible differences relating primarily to differences in the treatment of
loss contract reserves, policy acquisition costs, unearned premiums and
discounted losses for financial reporting and tax reporting purposes and
approximately $8,200,000 related to benefits associated with net operating loss
carryforwards. HMHIC has approximately $24,400,000 in net operating loss
carryforwards which will expire between 2012 and 2014, if unused.
The difference between the 0% effective tax rate and the statutory rate of 34%
is primarily due to the net operating losses generated in 1999.
The valuation allowance increased approximately $3,400,000 for the year ended
December 31, 1999, to fully reserve for the net tax deductible differences and
the additional net operating loss carryforwards generated during the period.
Management periodically assesses the need for a valuation allowance considering
both positive and negative factors, including the historical losses generated by
HMHIC. The 100% valuation allowance reflects management's belief that the
realization of the deferred tax assets is not assured as of December 31, 1999.
F-27
<PAGE> 35
The tax effects of the major items recorded as deferred tax assets and
liabilities are as follows:
<TABLE>
<S> <C>
Net operating losses $ 8,281,277
Reserve for loss contracts 612,000
Unearned premiums 113,040
Discounted policy and contract claims 196,184
Amortization (46,234)
Allowance for bad debts 90,540
Deferred acquisition costs 99,150
Deferred life and uncollected premiums 18
-----------
Total net deferred tax assets 9,345,975
Valuation allowance (9,345,975)
-----------
Net deferred tax assets $ --
===========
</TABLE>
7. STATUTORY ACCOUNTING AND DIVIDEND RESTRICTIONS:
Under the laws of the state of Texas, HMHIC is required to maintain a minimum
net worth of $700,000. HMHIC was in compliance with this requirement at December
31, 1999, and throughout the year then ended.
Texas state law also limits the payment of dividends to stockholders by life and
health insurance companies. The maximum dividend that may be paid without prior
approval of the Commissioner of Insurance is limited to the greater of prior
year net income or 10% of prior year statutory capital and surplus. HMHIC paid
no dividends and issued no additional stock in 1999.
Statutory capital and surplus of HMHIC as reported to regulatory authorities at
December 31, 1999, totaled $13,314,356. Statutory net loss of HMHIC as reported
to regulatory authorities for the year ended December 31, 1999, totaled
$8,172,730. The major difference between statutory capital and surplus and net
loss and GAAP results from the recognition of the reserve for loss contracts
under GAAP.
The National Association of Insurance Commissioners has adopted model
regulations that establish minimum capitalization requirements using a
risk-based capital (RBC) formula. At December 31, 1999, and as of the date of
this report, HMHIC had capital and surplus in excess of RBC minimum
capitalization requirements.
8. RELATED-PARTY TRANSACTIONS:
During 1999, HMHIC purchased certain administrative functions including the
billing and collection of premiums, claims processing, customer service, data
processing, marketing, integrated care management, and network management from
Harris Methodist Texas Health Plan, Inc. d/b/a Harris Methodist Health Plan (the
"Health Plan"), a wholly owned subsidiary of HMHPI and a controlled affiliate of
THR. HMHIC paid approximately $10,488,000 in 1999 for these services. HMHIC had
net amounts due to affiliates of approximately $532,000 at December 31, 1999.
F-28
<PAGE> 36
9. CONCENTRATIONS OF CREDIT RISK:
HMHIC conducts its business activities exclusively in the state of Texas.
Further, HMHIC maintains accounts with cash and cash equivalents in excess of
the amount insured by the Federal Deposit Insurance Corporation. HMHIC monitors
the financial stability of its depository institutions regularly, and management
does not believe excessive risk of depository institution failure exists.
10. RESERVE FOR LOSS CONTRACTS:
HMHIC recorded a reserve for loss contracts of $1,800,000 as of December 31,
1999, for contracts on which the anticipated future health care costs,
commissions, and costs of collecting premiums and processing claims exceed
anticipated future premiums. Estimates of the reserve for loss contracts will be
recalculated each quarter with any adjustments recorded through charges or
credits to the provision for loss contracts. Amortization of approximately
$1,800,000 is projected for 2000.
11. WITHDRAWAL FROM CERTAIN LINES OF BUSINESS:
In November 1999, HMHIC made a strategic decision to discontinue its Small Group
and Individual and Family Preferred Provider Organization (PPO) product lines.
HMHIC notified TDI of its intent to no longer issue or renew small employer
health benefit plans, and Small Group PPO policy holders were notified that
their coverage would cease effective June 2000. HMHIC filed the required
withdrawal plan for the Individual and Family PPO product line with TDI. New
sales of this product ceased, and members were notified that their coverage
would cease effective July 2000.
12. SUBSEQUENT EVENT:
On February 1, 2000, PacifiCare Health Plan Administrators, Inc. ("PHPA")
acquired 100% of the outstanding common stock of HMHIC from HMHPI. Subsequent to
the change in control, the officers and directors of HMHIC were replaced by
officers and directors of PacifiCare of Texas, Inc., a wholly owned subsidiary
of PHPA. The accompanying financial statements do not include adjustments, if
any, resulting from the acquisition of HMHIC by PHPA. HMHIC expects to receive
working capital support from PHPA throughout 2000 to meet its obligations in the
ordinary course of business.
F-29
<PAGE> 37
EXHIBIT INDEX
Exhibit
No. Description
-------- ------------
2.1 Purchase Agreement, dated November 1, 1999, by and among
PacifiCare Health Plan Administrators, Inc., Harris Methodist
Health Plan, Inc. and Texas Health Resources. Incorporated by
reference herein from the PacifiCare Health Systems, Inc.
Current Report on Form 8-K filed on February 11, 2000.
2.2 First Amendment to Purchase Agreement, dated February 1, 2000,
by and among PacifiCare Health Plan Administrators, Inc.,
Harris Methodist Health Plan, Inc. and Texas Health Resources.
Incorporated by reference herein from the PacifiCare Health
Systems, Inc. Current Report on Form 8-K filed on February 11,
2000.
23.1 Consent of Arthur Andersen LLP, independent auditors.
23.2 Consent of Arthur Andersen LLP, independent auditors.
99.1 Press release of January 31, 2000. Incorporated by reference
herein from the PacifiCare Health Systems, Inc. Current Report
on Form 8-K filed on February 11, 2000.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our report
for Harris Methodist Texas Health Plan, Inc. dated February 14, 2000, in this
Form 8-K/A.
ARTHUR ANDERSEN LLP
Dallas, Texas,
April 12, 2000
<PAGE> 1
EXHIBIT 23.2
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our report
for Harris Methodist Health Insurance Company dated February 14, 2000, in this
Form 8-K/A.
ARTHUR ANDERSEN LLP
Dallas, Texas,
April 12, 2000
