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United States
Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Period Ended September 30, 1999
Commission File Number 1-14177
UNITED WISCONSIN SERVICES, INC.
(Exact name of registrant as specified in its charter)
Wisconsin (State of incorporation) |
39-1931212 (I.R.S. Employer Identification No.) |
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401 West Michigan Street, Milwaukee, Wisconsin (Address of principal executive offices) |
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53203-2896 (Zip Code) |
(414) 226-6900
(Registrant's telephone number, including area code)
Indicate by check mark whether registrant (1) has filed all documents and 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 the number of shares outstanding of each of the issuer's classes of common tock, as of the latest practical date:
Common stock outstanding as of October 31, 1999 was 16,845,509.
UNITED WISCONSIN SERVICES, INC.
INDEX TO
QUARTERLY REPORT ON FORM 10-Q
For the Period Ended September 30, 1999
PART I | ||
Financial Statements and Supplementary Data | ||
Management's Discussion and Analysis of Financial Condition and Results of Operations | ||
Quantitative and Qualitative Disclosures about Market Risk | ||
PART II | ||
Other Information | ||
Signature Page |
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
United Wisconsin Services, Inc.
Consolidated Balance Sheets
(Unaudited)
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September 30, 1999 |
December 31, 1998 |
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(In thousands) |
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ASSETS | ||||||
Current Assets: | ||||||
Cash and cash equivalents | $ | 7,932 | $ | 26,385 | ||
Investmentsavailable for sale | 128,536 | 158,463 | ||||
Other receivables | 70,993 | 65,464 | ||||
Prepaid and other current assets | 24,879 | 6,778 | ||||
Total Current Assets | 232,340 | 257,090 | ||||
Investmentsheld to maturity |
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9,060 |
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7,710 |
Property and equipment, net | 9,467 | 8,963 | ||||
Goodwill and other intangible assets, net | 10,752 | 7,751 | ||||
Other noncurrent assets | 21,245 | 16,694 | ||||
Total Assets | $ | 282,864 | $ | 298,208 | ||
LIABILITIES AND SHAREHOLDERS' EQUITY |
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Current Liabilities: | ||||||
Medical and other benefits payable | $ | 51,407 | $ | 70,659 | ||
Advance premiums | 29,778 | 30,584 | ||||
Note payable to affiliate | | 70,000 | ||||
Due to affiliatesother | 8,962 | 7,513 | ||||
Payables and accrued expenses | 21,756 | 19,129 | ||||
Other current liabilities | 18,091 | 10,527 | ||||
Total Current Liabilities | 129,994 | 208,412 | ||||
Other noncurrent liabilities |
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102,232 |
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25,337 |
Total Liabilities | 232,226 | 233,749 | ||||
Shareholders' Equity: |
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|
|
|
|
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Preferred stock (no par value, 1,000,000 shares authorized) Common stock (no par value, no stated value, 50,000,000 shares authorized, 16,845,404 and 16,812,081 issued and outstanding at September 30, 1999 and December 31, 1998, respectively) | 13,663 | 13,378 | ||||
Retained earnings | 40,062 | 50,088 | ||||
Unrealized gains (losses) on investments, net of taxes | (3,087 | ) | 993 | |||
Total Shareholders' Equity | 50,638 | 64,459 | ||||
Total Liabilities and Shareholders' Equity | $ | 282,864 | $ | 298,208 | ||
See Notes to Interim Consolidated Financial Statements.
United Wisconsin Services, Inc.
Consolidated Statements of Income
(Unaudited)
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Three months ended September 30, |
Nine months ended September 30, |
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1999 |
1998 |
1999 |
1998 |
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(In thousands, except share data) |
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Revenues: | ||||||||||||
Health services revenue: | ||||||||||||
Premium revenue | $ | 163,007 | $ | 153,738 | $ | 484,207 | $ | 452,340 | ||||
Other revenue | 9,212 | 7,775 | 29,477 | 22,153 | ||||||||
Investment results | 3,022 | 3,580 | 9,509 | 13,540 | ||||||||
Total Revenues | 175,241 | 165,093 | 523,193 | 488,033 | ||||||||
Expenses: | ||||||||||||
Medical and other benefits | 149,519 | 132,194 | 441,505 | 385,902 | ||||||||
Selling, general and administrative expenses | 32,708 | 25,255 | 95,492 | 75,929 | ||||||||
Profit (loss) sharing on provider arrangements | (540 | ) | 674 | (820 | ) | 2,087 | ||||||
Interest expense | 1,355 | 254 | 3,780 | 254 | ||||||||
Amortization of goodwill and other intangibles | 211 | 112 | 571 | 327 | ||||||||
Total Expenses | 183,253 | 158,489 | 540,528 | 464,499 | ||||||||
Income (Loss) before Income Taxes | (8,012 | ) | 6,604 | (17,335 | ) | 23,534 | ||||||
Income Tax Expense (Benefit) | (3,299 | ) | 2,513 | (7,309 | ) | 9,028 | ||||||
Net Income (Loss) | $ | (4,713 | ) | $ | 4,091 | $ | (10,026 | ) | $ | 14,506 | ||
Basic and Diluted Earnings (Loss) Per Common Share (1998 pro forma) | $ | (0.28 | ) | $ | 0.21 | $ | (0.60 | ) | $ | 0.74 | ||
See Notes to Interim Consolidated Financial Statements.
United Wisconsin Services, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
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Nine months ended September 30, |
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1999 |
1998 |
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(In thousands) |
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Operating Activities: | |||||||
Net Income (Loss) | $ | (10,026 | ) | $ | 14,506 | ||
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | |||||||
Depreciation and amortization | 2,652 | 1,848 | |||||
Realized investment gains | (2,539 | ) | (6,340 | ) | |||
Deferred income tax expense (benefit) | (1,777 | ) | 149 | ||||
Changes in operating accounts: | |||||||
Other receivables | (4,287 | ) | (5,397 | ) | |||
Due from clinics and providers | (2,101 | ) | 2,899 | ||||
Medical and other benefits payable | (16,428 | ) | 7,174 | ||||
Advance premiums | (806 | ) | 6,961 | ||||
Due to/from affiliates | 1,146 | (4,091 | ) | ||||
Other, net | (8,914 | ) | (3,487 | ) | |||
Net Cash Provided by (Used in) Operating Activities | (43,080 | ) | 14,222 | ||||
Investing Activities: | |||||||
Acquisition of subsidiaries (net of cash and cash equivalents acquired of $253,000) | (3,605 | ) | | ||||
Purchases of available for sale investments | (108,500 | ) | (164,753 | ) | |||
Proceeds from sale of available for sale investments | 125,388 | 164,573 | |||||
Proceeds from maturity of available for sale investments | 8,650 | 5,575 | |||||
Purchases of held to maturity investments | (1,359 | ) | (313 | ) | |||
Proceeds from maturity of held to maturity investments | | 335 | |||||
Additions to property and equipment | (1,960 | ) | (2,860 | ) | |||
Net Cash Provided by Investing Activities | 18,614 | 2,557 | |||||
Financing Activities: | |||||||
Issuances of common stock | 5 | | |||||
Proceeds from line of credit | 6,565 | | |||||
Repayment of debt | (557 | ) | | ||||
Decrease in investments by and advances from AMSG | | (6,133 | ) | ||||
Net Cash Provided by (Used in) Financing Activities | 6,013 | (6,133 | ) | ||||
Cash and Cash Equivalents: | |||||||
Increase (decrease) during period | (18,453 | ) | 10,646 | ||||
Balance at beginning of year | 26,385 | 17,033 | |||||
Balance at End of Period | $ | 7,932 | $ | 27,679 | |||
See Notes to Interim Consolidated Financial Statements.
United Wisconsin Services, Inc.
Notes to Interim Consolidated Financial Statements
(Unaudited)
September 30, 1999
Note A. Basis of Presentation
The accompanying unaudited interim consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of only normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three-month and nine-month periods ended September 30, 1999 are not necessarily indicative of the results that may be expected for the year ending December 31, 1999. These interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 1998 and footnotes thereto included in United Wisconsin Services, Inc. (the "Company") Form 10-K, as filed with the Securities and Exchange Commission.
The accompanying unaudited interim consolidated financial statements present the consolidated financial position, consolidated results of operations and cash flows as if the Company had been an independent, publicly owned company for all periods presented prior to the spin off ("Spin off" or "Distribution") from American Medical Security Group, Inc. ("AMSG", formerly United Wisconsin Services, Inc.) on September 25, 1998 ("Spin off date"). Certain estimates, assumptions and allocations were made to facilitate the preparation of the unaudited interim consolidated financial statements.
Note B. Net Income (Loss) Per Share
Basic earnings per common share are computed by dividing net income (loss) by the weighted average number of common shares outstanding. Diluted earnings per common share are computed by dividing net income by the weighted average number of common shares outstanding, adjusted for the effect of dilutive securities for employee and board of director stock options. When the Company reports a net loss, potentially dilutive securities are not included in the calculation of Earnings Per Share ("EPS") because their inclusion would have an antidilutive effect.
The weighted average number of common shares outstanding used in the calculation of both basic and diluted EPS are 16,845,337 and 16,837,976 for the three months and nine months ended September 30, 1999, respectively.
Options to purchase 2,361,714 and 2,486,792 common shares during the three months and nine months ended September 30, 1999, respectively, were not included in the computation of diluted earnings per common share since the options' exercise prices were greater than the average market price of the outstanding common shares. In addition, 400,900 and 421,811 potentially dilutive common shares for the three months and nine months ended September 30, 1999, respectively, were not included because the Company had a net loss in the periods presented for 1999 and their inclusion would have been antidilutive.
Note C. Pro Forma Financial Information
In conjunction with the distribution of assets pursuant to the Spin off, the Company assumed a $70 million note obligation to Blue Cross & Blue Shield United of Wisconsin ("BCBSUW"). The assumption of debt was effective September 11, 1998. The unaudited pro forma results presented on the interim consolidated statement of income and below, have been prepared for informational purposes only. These results include the adjustment to historical results, based on additional interest expense for the three month and nine month periods ended September 30, 1998, net of related income tax. Pro forma calculations for dilutive securities for the third quarter and year-to-date 1998, assume that the price of the common shares and the strike price of the options are the same during the periods.
The following unaudited pro forma information presents a summary of the effect on net income as if the Spin off had occurred at the beginning of the period:
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Three months ended September 30, 1998 |
Nine months ended September 30, 1998 |
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(In thousands, except share data) |
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Net income as reported | $4,091 | $14,506 | ||
Pro forma adjustmentinterest expense, net of taxes | 634 | 2,215 | ||
Pro forma net income | $3,457 | $12,291 | ||
Pro forma basic and diluted weighted average common shares | 16,571,502 | 16,544,721 | ||
Pro forma basic and diluted earnings per common share | $0.21 | $0.74 | ||
The unaudited pro forma financial information presented on the consolidated statement of income and above, do not purport to be indicative of the results of operations which actually would have resulted had the transactions occurred at the beginning of the periods presented or of the future results of operations.
Note D. Related Party
On August 17, 1999, BCBSUW completed its purchase of 1.4 million of the Company's shares in the open market as a result of the previously disclosed plan for BCBSUW to increase its ownership in the Company. The ownership by BCBSUW, in combination with the 401(K) and pension plans ownership of the Company, will allow Compcare Health Services Insurance Corporation, a wholly owned subsidiary of the Company, to use the Blue Cross and Blue Shield brand on its products.
BCBSUW's Board of Directors announced in June of 1999 its intention to convert BCBSUW from a service insurance corporation to a stockholder-owned corporation. The conversion is authorized under existing state law and would occur following the required approval by Wisconsin regulators, including the Office of the Commissioner of Insurance. In conjunction with the planned change in corporate structure of BCBSUW, the Company plans to pursue opportunities for a possible merger or other business combination with BCBSUW. Any merger or other business combination is not expected to occur before the end of the second quarter of 2000.
Note E. Comprehensive Income
A reconciliation from net income (loss) reported in the Consolidated Statements of Income to comprehensive income (loss) is stated below:
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Three months ended September 30, |
Nine months ended September 30, |
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1999 |
1998 |
1999 |
1998 |
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(In thousands) |
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Net income (loss) per Consolidated Statements of Income | $ | (4,713 | ) | $ | 4,091 | $ | (10,026 | ) | $ | 14,506 | |||
Unrealized gains (losses) on investments, net of taxes | (2,323 | ) | (1,337 | ) | (4,080 | ) | (3,301 | ) | |||||
Comprehensive income (loss) | $ | (7,036 | ) | $ | 2,754 | $ | (14,106 | ) | $ | 11,205 | |||
Comprehensive income (loss) is defined as all changes in equity during the period except those resulting from shareholder equity contributions and distributions. The accumulated effect of comprehensive income (loss) was a reduction of $3.1 million and an increase of $1.0 million as of September 30, 1999 and December 31, 1998, respectively.
Note F. Segment Reporting
The Company has two reportable business segments: Health Maintenance Organization ("HMO") products sold primarily in Wisconsin, and specialty managed care products and services, including dental, life, disability and workers' compensation products, managed care consulting, electronic claim submission, pharmaceutical management, managed behavioral health services, case management and receivables management sold throughout the United States.
"Other Operations" includes operations not directly related to the business segments, unallocated corporate items (i.e. interest expense on corporate debt, amortization of goodwill and intangibles, unallocated overhead expenses and one-time transaction and reorganization costs) and intercompany eliminations. The Company evaluates segment performance based on profit or loss from operations before income taxes. The accounting policies of the reportable segments are the same as those described in the December 31, 1998 audited financial statements in the summary of significant accounting policies.
Financial data by segment is as follows:
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Three months ended September 30, |
Nine months ended September 30, |
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1999 |
1998 |
1999 |
1998 |
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(In thousands) |
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Health services revenue: | |||||||||||||
HMO products | $ | 137,721 | $ | 131,721 | $ | 412,636 | $ | 386,423 | |||||
Specialty managed care products and services | 38,694 | 34,885 | 113,334 | 101,076 | |||||||||
Other operations | (4,196 | ) | (5,093 | ) | (12,286 | ) | (13,006 | ) | |||||
Total consolidated | $ | 172,219 | $ | 161,513 | $ | 513,684 | $ | 474,493 | |||||
Investment results: | |||||||||||||
HMO products | $ | 669 | $ | 2,045 | $ | 4,129 | $ | 6,083 | |||||
Specialty managed care products and services | 2,302 | 1,470 | 5,288 | 7,172 | |||||||||
Other operations | 51 | 65 | 92 | 285 | |||||||||
Total consolidated | $ | 3,022 | $ | 3,580 | $ | 9,509 | $ | 13,540 | |||||
Income (loss) before income tax expense: | |||||||||||||
HMO products | $ | (7,895 | ) | $ | 3,514 | $ | (16,614 | ) | $ | 11,910 | |||
Specialty managed care products and services | 2,450 | 3,357 | 7,637 | 12,592 | |||||||||
Other operations | (2,567 | ) | (267 | ) | (8,358 | ) | (968 | ) | |||||
Total consolidated | $ | (8,012 | ) | $ | 6,604 | $ | (17,335 | ) | $ | 23,534 | |||
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September 30, 1999 |
December 31, 1998 |
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(In thousands) |
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Total assets: | ||||||
HMO products | $ | 108,832 | $ | 138,272 | ||
Specialty managed care products and services | 162,391 | 151,845 | ||||
Other operations | 11,641 | 8,091 | ||||
Total consolidated | $ | 282,864 | $ | 298,208 | ||
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Three months ended September 30, |
Nine months ended September 30, |
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1999 |
1998 |
1999 |
1998 |
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(In thousands) |
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Health services revenue from transactions with other operating segments: | ||||||||||||
HMO products | $ | 483 | $ | 440 | $ | 1,471 | $ | 1,406 | ||||
Specialty managed care products and services | 4,110 | 4,653 | 10,814 | 11,603 |
Note G. Reclassifications
Certain reclassifications have been made to the consolidated financial statements for 1998 to conform with the 1999 presentation.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
United Wisconsin Services, Inc. (the "Company") is a Wisconsin corporation organized in May of 1998 for the purpose of owning and operating the managed care companies and specialty businesses of the Company's predecessor, American Medical Security Group, Inc. ("AMSG") (formerly United Wisconsin Services, Inc.). On September 25, 1998, the Company was spun off (the "Spin off") from its former parent AMSG.
The Company is a leading provider of managed health care services and employee benefit products. The Company's two primary product lines are: (i) Health Maintenance Organization ("HMO") products sold primarily in Wisconsin, including Compcare Health Services Insurance Corporation ("Compcare"), Valley Health Plan, Inc. ("Valley"), Unity Health Plans Insurance Corporation ("Unity") and certain point-of-service ("POS") and other related products managed by Compcare, Valley and Unity, and (ii) specialty managed care products and services, including dental, life, disability and workers' compensation products, managed care consulting, electronic claim submission, pharmaceutical management, managed behavioral health services, case management and receivables management, sold throughout the United States. Operating results and statistics for these product groups are presented below for the periods indicated.
The following Management's Discussion and Analysis should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 1998 and footnotes thereto included in the Company's Form 10-K.
Results of Operations
Total Revenues
Total revenues for the three months ended September 30, 1999 increased 6.1% to $175.2 million from $165.1 million for the three months ended September 30, 1998. For the nine months ended September 30, 1999, total revenues increased 7.2% to $523.2 million from $488.0 million for the nine months ended September 30, 1998. These increases were due primarily to increased membership in most of the major product lines, general premium and rate increases and acquisitions of specialty businesses since July of 1998.
Health Services RevenuesHMO health services revenues for the three months ended September 30, 1999 increased 4.6% to $137.7 million from $131.7 million for the three months ended September 30, 1998. Average insured HMO medical premium per member for the three months ended September 30, 1999 increased 3.8% from the same period in the prior year. The average number of insured HMO medical members for the three months ended September 30, 1999 increased 0.7% to 296,798 from 294,658 for the three months ended September 30, 1998.
HMO health services revenues for the nine months ended September 30, 1999 increased 6.8% to $412.6 million from $386.4 million for the nine months ended September 30, 1998. Average insured HMO medical premium per member for the nine months ended September 30, 1999 increased 4.5% from the same period in the prior year. The average number of insured HMO medical members for the nine months ended September 30, 1999 increased 2.2% to 297,095 from 290,627 for the nine months ended September 30, 1998.
Health services revenues for specialty managed care products and services for the three months ended September 30, 1999 increased 10.9% to $38.7 million from $34.9 million for the three months ended September 30, 1998. Health services revenues for specialty managed care products and services for the nine months ended September 30, 1999 increased 12.1% to $113.3 million from $101.1 million for the nine months ended September 30, 1998. This was the result of a decrease in the percentage of ceded reinsurance, along with increases in covered lives, premium rates on insurance products and additional revenue of $5.3 million for the nine months ended September 30, 1999 from recent acquisitions. During the third quarter of 1999, the Company formed Innovative Resources Group, Inc. ("IRG"), which is comprised of three of the Company's recent acquisitions and two existing specialty managed care subsidiaries. IRG provides medical and behavioral health management services, case management, employee assistance programs, workers' compensation case management and pharmacy management services.
Net Investment ResultsInvestment results include investment income and realized gains on investments. Investment results for the three months ended September 30, 1999 decreased 16.7% to $3.0 million from $3.6 million for the three months ended September 30, 1998. Average annual investment yields, excluding net realized gains, were 6.2% for the three months ended September 30, 1999 and 5.3% for the three months ended September 30, 1998. Investment results for the nine months ended September 30, 1999 decreased 29.6% to $9.5 million from $13.5 million for the nine months ended September 30, 1998. Average annual investment yields, excluding net realized gains, were 5.6% for the nine months ended September 30, 1999 and 5.5% for the nine months ended September 30, 1998. The decrease in investment income during 1999 is the result of fewer invested assets.
Average invested assets for the three months ended September 30, 1999 decreased 17.3% to $150.0 million from $181.3 million for the three months ended September 30, 1998. Average invested assets for the nine months ended September 30, 1999 decreased 7.4% to $167.9 million from $181.4 million for the nine months ended September 30, 1998. The decrease in the average invested assets during 1999 is the result of cash requirements necessary to fund operating losses and a reduction in medical and other benefits payable.
Investment gains are realized in the normal investment process in response to market opportunities. Realized gains for the three months ended September 30, 1999 were $0.8 million, compared to $1.3 million for the three months ended September 30, 1998. Realized gains for the nine months ended September 30, 1999 were $2.5 million, compared to $6.3 million for the nine months ended September 30, 1998.
Expense Ratios
Loss RatioThe consolidated loss ratio represents the ratio of medical and other benefits to premium revenue on a consolidated basis, and is therefore a blended ratio for medical, life, dental, disability and other product lines. The consolidated loss ratio was 91.7% for the three months ended September 30, 1999, compared with 86.0% for the three months ended September 30, 1998. The consolidated loss ratio was 91.2% for the nine months ended September 30, 1999, compared with 85.3% for the nine months ended September 30, 1998. The 1999 consolidated loss ratios were influenced by increases in the component loss ratios for each of the Company's primary product lines, as discussed below.
The medical loss ratio for HMO products for the three months ended September 30, 1999 was 96.1%, compared with 89.4% for the three months ended September 30, 1998. The medical loss ratio for HMO products for the nine months ended September 30, 1999 was 94.8%, compared with 88.7% for the nine months ended September 30, 1998. The increase for the three months ended September 30, 1999 is primarily the result of $1.9 million in prior year adverse reserve development, along with $1.5 million in current year reserve development. Included in the nine months ended September 30, 1999, is $14.6 million of adverse reserve development which relates to 1998 and prior.
The loss ratio for the risk products within specialty managed care products and services for the three months ended September 30, 1999 was 73.9%, compared with 71.3% for the three months ended September 30, 1998. The loss ratio for the risk products within specialty managed care products and services for the nine months ended September 30, 1999 was 75.2%, compared with 70.7% for the nine months ended September 30, 1998. The loss ratios principally relate to the life, disability, workers' compensation and dental product lines of business. These products represent relatively small blocks of business, and as a result, the loss ratio can exhibit significant volatility due to varying levels of claim frequency and severity. Despite the higher loss ratio in the third quarter, this is an improvement over the second quarter of 1999 in which the loss ratio was 77.7%. Generally, the anticipated aggregate loss ratio for specialty risk products should range between 70% and 75%. The higher loss ratios in 1999 are attributable to an increase in the life and disability claims, along with lower premium and rate increases in 1999 given the competitive marketplace conditions for disability and workers' compensation products. In addition, United Heartland, Inc. workers' compensation block of business had achieved better than expected results during 1998, while the 1999 results represent an increased loss ratio that is more in line with industry and targeted results.
Selling, General, and Administrative Expense RatioThe selling, general and administrative ("SGA") expense ratio includes commissions, administrative expenses, and premium taxes and other assessments. The SGA expense ratio for HMO products for the three months ended September 30, 1999 was 10.5%, compared with 9.0% for the three months ended September 30, 1998. The SGA expense ratio for HMO products for the nine months ended September 30, 1999 was 10.4%, compared with 9.2% for the nine months ended September 30, 1998. The majority of the increase in the SGA expense ratio continues to relate to costs incurred to reduce Compcare's claim backlog and process claim adjustments, which were attributed to the system conversion as part of the Company's implementation of its Year 2000 readiness program and to increase customer service demands.
SGA expense ratio related to the risk products within specialty managed care products and services for the three months ended September 30, 1999, remained stable with the comparable period at 25.0%. SGA expense ratio related to the risk products within specialty managed care products and services for the nine months ended September 30, 1999 was 25.1%, compared with 25.4% for the nine months ended September 30, 1998. This improvement was primarily due to higher volumes in life premiums on the insured group and assumed reinsurance business.
The operating expense ratio related to the service products within specialty managed care products and services for the three months ended September 30, 1999 was 100.1%, compared with 91.2% for the three months ended September 30, 1998. The operating expense ratio related to the service products within specialty managed care products and services for the nine months ended September 30, 1999 was 92.8%, compared with 91.5% for the nine months ended September 30, 1998. This deterioration is due to an increase of $0.4 million in allowance for doubtful accounts, along with a reduction in assets of $0.9 million to more appropriately reflect deferred acquisition costs.
Other Expenses
Profit (loss) sharing on joint ventures was $(0.5) million for the three months ended September 30, 1999 compared with $0.7 million for the three months ended September 30, 1998. Profit (loss) sharing on joint ventures was $(0.8) million for the nine months ended September 30, 1999, compared with $2.1 million for the nine months ended September 30, 1998. These balances are related to the Unity and Valley provider arrangements and reflect the relative profitability of these entities.
Amortization of goodwill and other intangibles for the three months ended September 30, 1999 was $0.2 million, compared with $0.1 million for the three months ended September 30, 1998. Amortization of goodwill and other intangibles for the nine months ended September 30, 1999 was $0.6 million, compared with $0.3 million for the nine months ended September 30, 1998. The increase is due to goodwill arising from recent acquisitions.
Included in other operations for the nine months ended September 30, 1999 is $3.5 million of interest expense, which relates to the $70 million note obligation to BCBSUW. This compares to $0.3 million for the nine months ended September 30, 1998. This note obligation was assumed on September 11, 1998 in conjunction with the Spin off.
Net Income From Operations
Net income (loss) from operations for the three months ended September 30, 1999 decreased to $(4.7) million from $4.1 million for the three months ended September 30, 1998. In summary, the third quarter includes current and prior year reserve developments, an increase to the allowance for doubtful accounts and a reduction in assets to more appropriately reflect deferred acquisition costs. Net income (loss) from operations for the nine months ended September 30, 1999 decreased to $(10.0) million from $14.5 million for the nine months ended September 30, 1998. In addition to the third quarter charges, the nine month period also includes an additional $12.3 million in adverse reserve development and $2.8 million of one-time charges for various transaction and reorganization costs. The one-time charges are included in other operations.
The Company's effective tax rate was 41.2% for the three months ended September 30, 1999, compared with 38.1% for the three months ended September 30, 1998. The Company's effective tax rate was 42.2% for the nine months ended September 30, 1999, compared with 38.4% for the nine months ended September 30, 1998. This rate fluctuates based upon the relative profitability of the Company's two reportable business segments and the differing effective tax rates for each subsidiary within those reportable segments. The effective tax rates range from 32% to 46%.
Summary of Operating Results and Statistics
Operating results and statistics for the two primary product groups are presented below for the periods indicated.
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September 30, |
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1999 |
1998 |
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Members at end of period: | ||||
HMO members by business unit: | ||||
Compcare | 175,755 | 174,027 | ||
Valley | 41,978 | 40,752 | ||
Unity | 86,749 | 86,604 | ||
Total HMO members | 304,482 | 301,383 | ||
HMO members by product type: | ||||
Commercial | 182,738 | 189,756 | ||
Point of Service | 75,312 | 66,160 | ||
Medicaid | 39,903 | 41,028 | ||
Total insured members | 297,953 | 296,944 | ||
Self-insured members | 6,529 | 4,439 | ||
Total HMO members | 304,482 | 301,383 | ||
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September 30, |
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1999 |
1998 |
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Members at end of period: | ||||
Specialty managed care products and services: | ||||
UWG Life/AD&D | 165,362 | 150,811 | ||
DentalHMO | 175,900 | 168,528 | ||
DentalIndemnity | 13,982 | 12,160 | ||
Disability | 120,046 | 106,727 | ||
Behavioral Health | 971,535 | 969,892 | ||
Workers' Compensation | 53,677 | 53,365 | ||
Total Specialty managed care products and services members | 1,500,502 | 1,461,483 | ||
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Three Months Ended September 30, |
Nine Months Ended September 30, |
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1999 |
1998 |
1999 |
1998 |
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Health services revenues (as a percentage of the total): | |||||||||
HMO products | 80.0 | % | 81.6 | % | 80.3 | % | 81.4 | % | |
Specialty managed care products and services | |||||||||
Service Products | 7.4 | 7.0 | 7.8 | 6.8 | |||||
Risk Products | 15.0 | 14.6 | 14.3 | 14.5 | |||||
Intercompany eliminations | (2.4 | ) | (3.2 | ) | (2.4 | ) | (2.7 | ) | |
Total | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | |
Operating statistics: |
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HMO products: | |||||||||
Medical loss ratio(1) | 96.1 | % | 89.4 | % | 94.8 | % | 88.7 | % | |
Selling, general, & administrative expense ratio(2) | 10.5 | 9.0 | 10.4 | 9.2 | |||||
Combined loss and expense ratio | 106.6 | 98.4 | 105.2 | 97.9 | |||||
Specialty managed care products and services: |
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Service products: | |||||||||
Operating expense ratio* | 100.1 | % | 91.2 | % | 92.8 | % | 91.5 | % | |
Risk products: | |||||||||
Loss ratio(1) | 73.9 | 71.3 | 75.2 | 70.7 | |||||
Selling, general, & administrative expense ratio(2) | 25.0 | 25.0 | 25.1 | 25.4 | |||||
Combined loss and expense ratio | 98.9 | 96.3 | 100.3 | 96.1 | |||||
Consolidated: | |||||||||
Loss ratio(1) | 91.7 | % | 86.0 | % | 91.2 | % | 85.3 | % | |
Net income (loss) margin(3) | (2.7 | ) | 2.5 | (1.9 | ) | 3.0 |
The Company's revenues are derived primarily from premiums, while medical benefits constitute the majority of expenses. Profitability is directly affected by many factors including, among others, premium rate adequacy, estimates of medical benefits, health care utilization, effective administration of benefit payments, operating efficiency, investment returns and federal and state laws and regulations.
Liquidity and Capital Resources
The Company's sources of cash flow consist primarily of health services revenues and investment income. The primary uses of cash include medical and other benefits and operating expense payments. Positive cash flows are invested pending future payments of medical and other benefits and other operating expenses. The Company's investment policies are designed to maximize yield, preserve principal and provide liquidity to meet anticipated payment obligations.
The Company has generated positive cash flow from operations in prior years. However, for the nine months ended September 30, 1999, net cash was used in operating activities in the amount of $43.1 million, compared with net cash provided by operating activities of $14.2 million for the nine months ended September 30, 1998. In addition to the net loss from operations, the decrease in cash flows from operations in 1999 was due primarily to the significant reductions in medical and other benefits payable. Due to periodic short term cash flow needs of certain subsidiaries, the Company made borrowings under its bank line of credit ranging up to $14.8 million during the first nine months of 1999, compared to $10.0 million during the first nine months of 1998. The outstanding balance on the line of credit at September 30, 1999 was $6.1 million compared with no outstanding balance at December 31, 1998.
The Company's investment portfolio consists primarily of investment grade bonds and Government securities, and has a limited exposure to equity securities. At September 30, 1999, $123.5 million or 89.8% of the Company's total investment portfolio was invested in bonds compared with $132.8 million or 79.9% at December 31, 1998. The bond portfolio had an average quality rating by Moody's Investor Service of Aa3 at September 30, 1999 and December 31, 1998. The majority of the bond portfolio was classified as available for sale. The market value of the total investment portfolio, which includes stocks and bonds, was less than amortized cost by $4.8 million at September 30, 1999 and greater than amortized cost by $1.9 million at December 31, 1998. As of September 30, 1999, the Company had no investments in mortgage loans, non-publicly traded securities (except for principal-only strips of U. S. Government securities), real estate held for investment or financial derivatives.
From time to time, capital contributions are made to the subsidiaries to assist them in maintaining appropriate levels of capital and surplus for regulatory and rating purposes. Insurance subsidiaries are required to maintain certain levels of capital and surplus under the National Association of Insurance Commissioners ("NAIC") and the state of Wisconsin requirements. In Wisconsin, where a large percentage of the Company's premium is written, these levels are based upon the amount and type of premiums written and are calculated separately for each subsidiary. As of the balance sheet dates presented, capital and surplus for each of these insurance subsidiaries exceeded NAIC and statutory required levels.
In conjunction with the Spin off, the Company assumed a $70 million note obligation to BCBSUW that originally matured on October 30, 1999. The assumption of debt was effective September 11, 1998. On October 13, 1999, the Company extended the maturity of the note obligation to April 30, 2001.
In addition to internally generated funds and periodic borrowings on its bank line of credit, the Company believes that additional financing to facilitate long-term growth could be obtained through equity offerings, debt offerings, financings from BCBSUW or bank borrowings, as market conditions may permit or dictate.
Year 2000 Issues
General Description of the Year 2000 Issue and the Nature and Effects of the Year 2000 on Information Technology (IT) and Non-IT Systems
The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs that have time-sensitive software or embedded chips may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities.
The Company has identified required modifications or replacements of its software and certain hardware so that those systems will properly utilize dates beyond December 31, 1999. The Company presently believes that with these modifications or replacements of existing software and certain hardware, the Year 2000 Issue can be mitigated and will not pose significant operational problems. However, if such modifications and conversions are not made or are not completed timely, the Year 2000 Issue could have a material impact on the operations of the Company.
The Company's plan to resolve the Year 2000 Issue involves the following four phases: assessment, remediation, testing, and implementation. To date, the Company has fully completed its assessment of all systems that could be significantly affected by the Year 2000 Issue. The completed assessment indicated that most of the Company's significant information technology systems could be affected, particularly the general ledger, billing and processing of medical claims. That assessment also indicated that software and hardware (embedded chips) used in building operations and office equipment (hereafter referred to as non-IT systems) are at risk. The Company does not believe that the Year 2000 Issue presents a material exposure as it relates to the Company's non-IT systems. In addition, the Company has inquired and gathered information about the Year 2000 readiness status of its significant suppliers and vendors and continues to monitor their readiness.
Status of Progress in Becoming Year 2000 Compliant, Including Timetable for Completion of Each Remaining Phase
As of September 30, 1999, all of the Company's subsidiaries except United Wisconsin Insurance Company and United Heartland Life Insurance Company have completed the remediation phase for their information technology exposures. Software for all systems have been reprogrammed or replaced and the subsidiaries have completed all testing and implementation phases as they relate to Year 2000 Issues.
United Wisconsin Group ("UWG"), which includes the Company's wholly owned subsidiaries of United Wisconsin Insurance Company and United Heartland Life Insurance Company, is approximately 80% complete in the remediation, testing and implementation phases of its administrative, claims and billing systems. At the completion of the remaining remediation phase, UWG will then finalize the testing and implementation phases. UWG expects to complete the remediation, testing and implementation by November 30, 1999.
The remediation, testing and implementation phases of a majority of the non-IT systems are complete and ready for immediate use.
Nature and Level of Importance of Third Parties and their Exposure to the Year 2000
The Company outsources and relies extensively on third party systems to process selected payroll, membership and claims processing functions, among others. The Company has worked with third party vendors to ensure that their systems are Year 2000 ready. Third party systems have been upgraded and tested and are Year 2000 ready. Based on discussions with external consultants and vendors, the Company is of the understanding that all vendor systems utilized, including UWG, will be Year 2000 ready.
The Company has initiated formal communications with its systems processing vendors, government agencies and all large customers and providers using electronic interfaces to determine the extent to which the Company's interface systems are vulnerable to the failure of third parties to remediate Year 2000 Issues. The Company is not aware of any significant interface issues.
The Company has surveyed its significant suppliers and subcontractors (external agents) that do not share information systems with the Company. To date, the Company is not aware of any external agent with a Year 2000 Issue that would materially impact the Company's results of operations, liquidity or capital resources. However, the Company has no means of ensuring that external agents will be Year 2000 ready. The inability of external agents to complete their Year 2000 resolution process in a timely fashion could materially impact the Company. The effect of non-compliance by external agents is not determinable.
Cost of the Year 2000 Project
The Company has utilized both internal and external resources to assess, remediate, test and implement the software and non-IT systems for the Year 2000 modifications. The total estimated direct costs of the Year 2000 project increased during the past quarter as a result of additional consulting costs deemed necessary to ensure Year 2000 readiness for the administrative, claims and billing systems of UWG. The estimate was increased to $3.5 million, which will be expensed and funded through operating cash flows. To date, the Company has incurred $2.7 million of identifiable costs related to all phases of the Year 2000 project. Remaining costs to be incurred to complete the Year 2000 project are estimated to approximate $0.8 million.
In addition, the Company has also capitalized $2.6 million related to other functionality enhancing system upgrades or new systems that also provide Year 2000 readiness. A number of other modifications to current systems are covered by existing maintenance agreements and by normal upgrades and do not present incremental additional expense.
BCBSUW leases the claims, membership and general ledger software programs, and subleases the use of these systems to the Company under a service agreement. BCBSUW capitalized $17.2 million of implementation and system enhancement costs that were incurred to replace these systems, primarily as a result of a service agreement expiration and for improved functionality. These replacements also included Year 2000 readiness but were not the result of acceleration due to Year 2000 Issues. Approximately 24% of the amortized costs were allocated to the Company.
Costs related to maintenance of existing computer hardware and software are expensed as incurred. Purchases of new hardware or software in replacement of non-compliant hardware or software and reprogramming costs are being capitalized in accordance with the Company's standard accounting practices.
Risks Associated with Year 2000
Company management believes it has an effective program in place to resolve the Year 2000 Issue in a timely manner. As noted above for the two remaining subsidiaries, the Company has not yet completed all necessary phases of the Year 2000 program. In the event that the Company is unable to complete the remaining phases, the Company would selectively be unable to bill and collect premiums, adjudicate medical and other claims, manage the utilization of medical services or perform actuarial determinations. In addition, disruptions in the economy generally resulting from Year 2000 issues could also materially adversely affect the Company. The Company could be subject to litigation on a loss of business in the event it failed to complete certain of the remaining remediation and implementation steps. The amount of any potential liability and lost revenue cannot be reasonably estimated at this time. No provision for any such liability or lost revenue has been recorded.
Contingency Plans
The Company is developing contingency plans for certain critical applications and is working on such plans with internal staff, external consultants and major data center vendors. These contingency plans are being developed in the event the system conversions and their functionality or their readiness for Year 2000 are not completed on a timely basis. These contingency plans involve, among other actions, manual workarounds, reducing claim inventories prior to December 31, 1999, and adjusting staffing strategies.
Forward Looking Statements
This report contains certain forward looking statements with respect to the financial condition, results of operation and business of the Company. Such forward looking statements are subject to inherent risks and uncertainties that may cause actual results or events to differ materially from those contemplated by such forward looking statements. Forward-looking statements may include, but are not limited to, projections of revenues, income or losses, capital expenditures, plans for future operations, financing needs or plans, compliance with financial covenants in loan agreements, plans relating to products or services of the Company, assessments of materiality, predictions of future events, the ability to obtain additional financing, the Company's ability to meet obligations as they become due, as well as assumptions relating to the foregoing. In addition, when used in this discussion, the words "anticipates," "believes," "estimates," "expects," "intends," "plans" and similar expressions are intended to identify forward-looking statements. Factors that may cause actual results to differ materially from those contemplated by such forward looking statements include, among others, rising health care costs, economic and business conditions and competition in the managed care industry, development of claims reserves, developments in health care reform and other regulatory issues.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The information called for by this item is provided under the caption 'Liquidity and Capital Resources' under Item 2Management's Discussion and Analysis of Financial Condition and Results of Operations.
Because of the Company's investment policies, the primary market risks associated with the Company's portfolio are interest rate risk, credit risk, and the risk related to fluctuations in equity prices. With respect to interest rate risk, a reasonably near-term rise in interest rates could negatively affect the fair value of the Company's bond portfolio; however, because the Company considers it unlikely that the Company would need to choose to substantially liquidate its portfolio, the Company believes that such an increase in interest rates would not have a material impact on future earnings or cash flows. In addition, the Company is exposed to the risk of loss related to changes in credit spreads. Credit spread risk arises from the potential that changes in an issuer's credit rating or credit perception may affect the value of financial instruments.
The overall goal of the investment portfolios is to support the ongoing operations of the Company's business units. The Company's philosophy is to actively manage assets to maximize total return over a multiple-year time horizon, subject to appropriate levels of risk. The Company manages these risks by establishing gain and loss tolerances, targeting asset-class allocations, diversifying among asset classes and segments within various asset classes, and using performance measurement and reporting.
The Company uses a sensitivity model to assess the inherent rate risk of its fixed income investments. The model includes all fixed income securities held and incorporates assumptions regarding the impact of changing interest rates on expected cash flows for certain financial assets with prepayment features, such as callable bonds and mortgage-backed securities. No significant changes have occurred in the determination of the reduction in the fair value of the Company's modeled financial assets as a result of a hypothetical instantaneous 100 basis point since last reported as of June 30, 1999.
PART II. OTHER INFORMATION
United Wisconsin Services, Inc.
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
None
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 thereunto duly authorized.
DATE: 11/11/99 | |||
UNITED WISCONSIN SERVICES, INC. | |||
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By: |
/s/ GAIL L. HANSON Gail L. Hanson Vice President and Chief Financial Officer (Principal Financial Officer and Chief Accounting Officer) |
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