SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------
FORM 8-K
Current Report Pursuant
to Section 13 or 15(d) of the
Securities Exchange Act of 1934
March 15, 2000
SIERRA HEALTH SERVICES, INC.
(Exact Name of Registrant as Specified in Its Charter)
Nevada 1-8865 88-0200415
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(State or Other Jurisdiction (Commission File Number) (IRS Employer
of Incorporation) Identification No.)
2724 North Tenaya Way
Las Vegas, Nevada 89128
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (702) 242-7000
<PAGE>
Item 5. Other Events
The following discussion contains certain cautionary statements regarding Sierra
Health Services, Inc.'s ("Sierra" or the "Company") business and results of
operations, which should be considered by the Company's stockholders. This
discussion is intended to take advantage of the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995. The following factors should
be considered in conjunction with any discussion of operations or results by the
Company, or its representatives, including any forward-looking discussion, as
well as comments contained in press releases, presentations to securities
analysts or investors, and all other communications by the Company or its
representatives.
In making these statements, the Company is not undertaking to address or update
each factor in future filings or communications regarding the Company's business
or results, and is not undertaking to address how any of these factors may have
caused changes to discussions or information contained in previous filings or
communications. In addition, any of the matters discussed below may have
affected the Company's past results and may affect future results, so that the
Company's actual results may differ materially from those expressed herein and
in prior or subsequent communications.
Risks Associated with Managed Health Care Class Action Lawsuits. A number of
companies in the managed health care industry have recently become involved in
several purported class action lawsuits targeting the conduct of business by
managed health care companies. These complaints seek various forms of relief for
alleged violations of the Employee Retirement Income Security Act of 1974
("ERISA"), the Racketeering Influenced and Corrupt Organizations Act and for
alleged misrepresentations and omissions relating to the adequacy of disclosures
of providers' compensation arrangements in literature that is made available to
actual or prospective members. The Company is currently not the target of any
such purported class action. There can be no assurance that the Company will not
be named to such a suit or that the affect of such a suit will not have a
material adverse impact to the results of operations, liquidity or financial
position.
Risks Associated with Goodwill Recoverability. At December 31, 1999, the
Company had a net amortized balance of goodwill of $159.5 million.
Approximately $126.8 million of this balance is attributable to the acquisition
of certain assets of Kaiser Foundation Health Plan of Texas ("Kaiser-Texas") in
October 1998. This goodwill is being amortized over 40 years from the date of
acquisition. In addition, approximately $27.4 million of goodwill is
attributable to the acquisition in December 1996 of Prime Holdings, Inc., which
operated MedOne Health Plan, Inc., a Nevada-based HMO. This goodwill is being
amortized over 25 years from the date of acquisition.
The Company periodically evaluates the carrying value of its intangible assets.
The Company utilizes the discounted cash flow method for evaluating the
recoverability of goodwill. Future cash flows are estimated based on Company
projections and are discounted based on interest rates approximating long-term
bond yields. There can be no assurance that the current projections used by the
Company will become an actuality. Any significant variations in the projections
to actual, or in future interest rates, could result in an impairment of
goodwill and could adversely impact the results of operations and financial
position.
Risks Associated with Government Contracts. In June 1996, the Department of
Defense ("DoD") awarded a triple-option health benefits ("TRICARE") managed care
support contract to TriWest Healthcare Alliance ("TriWest"), a consortium
consisting of Sierra and 13 other health care companies, to provide health
services to Regions 7 and 8, which include a total of 16 states. In April 1997,
TriWest began providing health care to approximately 700,000 individuals, of
which Sierra is responsible for providing care to approximately 93,000
beneficiaries in Nevada and Missouri.
During the third quarter of 1997, Sierra Military Health Services, Inc.
("SMHS"), a wholly owned subsidiary of the Company, was notified that it had
been awarded a multi-year TRICARE managed care support contract by the DoD to
serve TRICARE eligible beneficiaries in Region 1. This region includes
approximately 610,000 TRICARE beneficiaries in 13 northeastern states and the
District of Columbia. SMHS began health care delivery under this contract on
June 1, 1998. The contract contains five option periods. While SMHS will begin
its third option period on June 1, 2000, there is no contract guarantee for
option years four and five.
SMHS subcontracts for health care delivery, including some of the risk, for
parts of the TRICARE contract. TRICARE contracts are generally issued at low
profit margins. There can be no assurance that health care expenses or
administrative expenses will not exceed contractual levels, which could have a
material adverse effect on the Company's results of operations, liquidity and
financial condition.
In addition, the DoD has the unilateral right to modify the contract to increase
or decrease specifications and associated workload. SMHS incurs costs related to
such change orders (and recognizes revenue using a percentage-of-completion
method of accounting) long before final negotiations and payment from DoD. As a
result, SMHS could experience health care revenue or administrative revenue
reduction adjustments for prior periods, which could have a material adverse
effect on the Company's results of operations, liquidity and financial
condition.
SMHS estimates and records revenues earned in part based on preliminary
statistical data provided by the DoD that estimates the beneficiary population
currently eligible to utilize SMHS's services. As the DoD and the Company
continue to gather and analyze this data, adjustments to previously estimated
revenues may be necessary. Such adjustments, if necessary, could have a material
adverse effect on the Company's results of operations and financial condition.
Finally, SMHS receives monthly cash payments equivalent to one-twelfth of its
annual contractual price with DoD. SMHS accrues health care revenue on a monthly
basis for any monies owed above its monthly cash receipt, based on the number of
estimated at-risk eligible beneficiaries and the estimated level of military
direct care system utilization. The contractual Bid Price Adjustment (BPA)
process serves to adjust the DoD's monthly payments to SMHS, because such
payments are based in part on 1996 DoD estimates for: beneficiary population,
beneficiary population baseline health care cost, inflation and military
direct care system utilization. As actual information is made available for
the above items, quarterly adjustments are made to SMHS' monthly health
care payment in addition to lump sum adjustments for past months. As a
result of this "true-up" process, the Company's business and cash flows
could be adversely affected if the timing and/or amount of the BPA
reimbursement should significantly vary from the Company's expectations.
Potential Adverse Impact of Government Regulation. The health care industry in
general, health maintenance organizations ("HMOs") and health insurance
companies in particular, are subject to substantial federal and state government
regulation, which may increase our exposure to lawsuits and/or penalties or
other regulatory actions for non-compliance. These regulations include, but are
not limited to: cash reserves; minimum net worth; licensing requirements;
approval of policy language and benefits; claims payment practices; mandatory
products and benefits; provider compensation arrangements; patient
confidentiality; premium rates; medical management tools; dividend payment; and
periodic examinations by state and federal agencies. As a result, a portion of
the Company's HMOs' and insurance companies' cash is essentially restricted by
various state regulatory or other requirements limiting certain of the Company's
subsidiaries' cash to use within their current operations. State and federal
government authorities are continually considering changes to laws and
regulations applicable to the Company and its subsidiaries. Many states in which
the Company operates are currently considering regulation relating to mandatory
benefits, provider compensation, disclosure and composition of physician
networks. The Company currently conducts operations, and is subject to state
regulation, in the following jurisdictions: Arizona, California, Colorado, Iowa,
Louisiana, Maryland, Mississippi, Missouri, Nevada, South Carolina and Texas. In
addition, the Company is licensed, and may be subject to state regulation, in
several other states in which it is currently not doing business.
In addition to applicable laws and regulations, the Company is subject to
various audits, investigations and enforcement actions. These include possible
government actions relating to ERISA, which regulates insured and self-insured
health coverage plans offered by employers; the Federal Employees Health Benefit
Plan; the Health Care Financing Administration ("HCFA"), which regulates
Medicare programs; federal and state fraud and abuse laws; and laws relating to
utilization management and the delivery of health care and the timeliness of
payment or reimbursement. Any such government action could result in assessment
of damages, civil or criminal fines or penalties, or other sanctions, including
exclusion from participation in government programs. In addition, disclosure of
any adverse investigation or audit results or sanctions could negatively affect
the Company's reputation in various markets and make it more difficult for the
Company to sell its products and services.
Under the "corporate practice of medicine" doctrine, in most states, business
organizations, other than those authorized to do so, are prohibited from
providing, or holding themselves out as providers of, medical care. Some states,
including Nevada, exempt HMOs from this doctrine. The laws relating to this
doctrine are subject to numerous conflicting interpretations. Although the
Company seeks to structure its operations to comply with corporate practice of
medicine laws in all states in which it operates, there can be no assurance
that, given the varying and uncertain interpretations of those laws, the Company
would be found to be in compliance with those laws in all states. A
determination that the Company is not in compliance with applicable corporate
practice of medicine laws in any state in which it operates could have a
material adverse effect on the Company if it were unable to restructure its
operations to comply with the laws of that state.
Risk of Adverse Effect of Health Care Reform. As a result of the continued
escalation of health care costs and the inability of many individuals to obtain
health care insurance, numerous proposals relating to health care reform have
been or may be introduced in the United States Congress and state legislatures.
Any proposals affecting underwriting practices, limiting rate increases,
requiring new or additional benefits or affecting contracting arrangements
(including proposals to require HMOs and preferred provider organizations
("PPOs") to accept any health care providers willing to abide by an HMO's or
PPO's contract terms) may make it more difficult for the Company to control
medical costs and could have a material adverse effect on the Company's
business. In addition, proposed regulations relating to patient confidentiality
may result in significant costs to implement appropriate systems and other
safeguard features.
Potential Inability to Manage or Predict Future Health Care Costs. Much of the
Company's medical premium revenue is determined in advance of the actual
delivery of services and incurrence of the related costs. The Company's
profitability will continue to be dependent, in large part, on its ability to
predict and maintain effective management over health care costs through, among
other things, appropriate benefit design, utilization review and case management
programs and its contracting arrangements with providers while providing members
with quality health care. Factors such as utilization, new technologies and
changing health care practices, hospital costs, pharmacy costs, inflation,
epidemics, new mandated benefits or additional regulations, inability to
establish acceptable contracting arrangements with providers and numerous other
factors may affect the Company's ability to manage such costs. There can be no
assurance that the Company will be successful in predicting or mitigating the
effect of any of these factors.
Medical costs payable reflected in the Company's financial statements include
reserves for incurred but not reported claims ("IBNR") which are estimated by
the Company. The Company estimates the amount of such reserves using standard
actuarial methodologies based upon historical data including the average
interval between the date services are rendered and the date claims are paid,
expected medical cost inflation and utilization, seasonality patterns and
fluctuations in membership. The Company believes that its reserves for IBNR have
been fairly estimated. The adequacy of the reserve estimates, which are to a
large degree based on judgment, are sensitive to the Company's growth and
changes in utilization costs, claims payment patterns and medical cost trends,
all of which may affect its ability to rely on historical information in making
IBNR reserve estimates. Adverse development of medical cost trends and claim
payment patterns from the assumptions used to estimate reserves could cause
these reserves to change in the near term. There can be no assurance as to the
ultimate accuracy or completeness of such estimates or that adjustments to
reserves will not cause volatility in the Company's results of operations.
Pharmaceutical Costs. The costs of pharmaceutical products and services are
increasing faster than the costs of other medical products and services. Thus,
the Company's HMOs and PPOs face ever higher pharmaceutical expenses. Although
the Company attempts to effectively manage the pharmacy costs for its HMOs and
PPOs, there can be no assurances that the Company will be able to do so in the
face of rapidly rising prices. Also, statutory and regulatory changes may
significantly alter the Company's ability to manage pharmaceutical costs through
restricted formularies of products available to the Company's health plan
members.
Possible Volatility of Common Stock Price. Recently, there has been significant
volatility in the market prices of securities of companies in the health care
industry, including the price of the Sierra Common Stock. Many factors,
including medical cost increases, research analysts' comments, announcements of
new legislative and regulatory proposals or laws relating to health care reform,
the performance of, and investor expectations for, the Company, the trading
volume of the Sierra Common Stock, litigation, and general economic and market
conditions, will influence the trading price of Sierra Common Stock.
Accordingly, there can be no assurance as to the price at which Sierra's Common
Stock will trade in the future.
No Dividends. The Company has not paid or declared any cash dividends on the
Sierra Common Stock since inception and the Company anticipates that future
earnings will be retained to finance the continuing development of its business
for the foreseeable future.
Lack of Control Over Premium Structure; Lack of Control Over and
Unpredictability of Medical Costs. A substantial amount of the Company's
revenues are generated by premiums, including capitation payments from HCFA,
which represent fixed monthly payments for each person enrolled in the Company's
plans. If the Company is unable to obtain adequate premiums because of
competitive or regulatory considerations, the Company could incur decreased
margins or significant losses. Because a significant portion of the Company's
premium revenues are paid by the federal government in connection with the
Medicare program, to the extent Medicare premium rates do not keep pace with
rising medical costs, the Company's profitability could be materially adversely
affected. Historically, these rates have been subject to wide variations from
year to year and have decreased in certain years. The Company's Medicare
programs are subject to certain additional risks relative to commercial
programs, such as higher comparative medical costs and higher levels of
utilization. While the Company attempts to base commercial premiums at least in
part on estimates of future health costs, many factors, such as those discussed
above, may cause actual health care costs to exceed those cost estimates
reflected in premiums charged.
The Company also participates in the Nevada Medicaid program. Similar to the
federal Medicare program, the state government determines the premium levels it
will pay. If the state government reduces the premium levels or does not
increase premiums to keep pace with the Company's cost increases and the Company
is unable to offset them with changes in benefit plans, then the Company's
profitability could be adversely affected.
Dependence on Key Enrollment Contracts. For the year ended December 31, 1999,
the Company received approximately 23% of its total revenues from its contract
with HCFA to provide health care services to Medicare enrollees. The Company's
contract with HCFA is subject to annual renewal at the election of HCFA and
requires the Company to comply with federal HMO and Medicare laws and
regulations and may be terminated if the Company fails to so comply. The
termination of the Company's contract with HCFA would have a material adverse
effect on the Company's business. In addition, there have been, and the Company
expects that there will continue to be, a number of legislative proposals to
limit Medicare reimbursements. Future levels of funding of the Medicare program
by the federal government cannot be predicted with certainty.
Changes in the Company's mix of HMO and managed indemnity business can affect
profitability. If more employers switch to self-funded health plans or health
products with higher medical care ratios, then the Company's profitability could
be adversely affected. There can be no assurance that the Company will be able
to continue to renew existing members and attract new members.
For the year ended December 31, 1999, military contract revenue represented
approximately 22% of the Company's revenue. This TRICARE contract is currently
structured as five one-year option periods. The termination of the TRICARE
contract would have a material adverse effect on the Company's business. In
addition, the Company has contracts to provide medical services to federal
employees. The rates charged for such services are subject to annual reviews and
retroactive adjustments. The Company's ability to obtain and maintain favorable
group benefit agreements with employer groups also affects the Company's
profitability. The agreements are generally renewable on an annual basis but are
subject to termination on 60 days' prior notice. Although no employer group
accounts for more than 2% of total revenues, the loss of one or more of the
larger employer groups could have a material adverse effect upon the Company's
business.
Potential Adverse Impact of Social Health Maintenance Organization. Effective
November 1, 1996, Health Plan of Nevada, Inc. ("HPN") entered into a Social HMO
contract pursuant to which a large portion of the Company's Medicare risk
enrollees receive certain expanded benefits. HPN, a wholly-owned subsidiary,
receives additional revenues for providing these expanded benefits. The
additional revenues are determined based on health risk assessments that have
been, and will continue to be, performed on the Company's eligible Medicare risk
members. HCFA is considering adjusting the reimbursement factor for the Social
HMO members in the future. At this time however, there can be no assurance as to
what the final per member reimbursement will be or that the Social HMO contract
will be renewed. If the reimbursement for these members decreases significantly
and the related benefit changes are not made timely, there could be a material
adverse effect on the Company's profitability.
Potential Adverse Impact of Competition. Managed care companies and HMOs operate
in a highly competitive environment. The Company has numerous types of
competitors, including, among others, other HMOs, PPOs, self-insured employer
plans and traditional indemnity carriers, many of which have substantially
larger total enrollments, have greater financial resources and offer a broader
range of products than the Company. The Company has encountered the effects of
increased competition in the Nevada market and the Texas market is very
competitive. Certain competitive pressures have limited the Company's ability to
increase or in some instances maintain the premiums charged to certain employer
groups. The inability of the Company to manage costs effectively may have an
adverse impact on the Company's future results of operations by reducing profit
margins. In addition, competitive pressures may also result in reduced
membership levels or decreasing profit margins and there can be no assurance
that the Company will not incur increased pricing and enrollment pressure from
local and national competitors.
Management of Growth. The Company has made several acquisitions in recent years,
the most recent of which was the acquisition of certain assets of Kaiser
Foundation Health Plan of Texas ("Kaiser-Texas") in October 1998. Failure to
effectively integrate acquired operations could have a material adverse effect
on the Company's results of operations and financial condition.
The Kaiser-Texas operations incurred significant losses over the past several
years. Since the date of acquisition, the Company has worked extensively on the
integration of the Kaiser-Texas operations. However, there can be no assurances
regarding the ultimate success of the Company to improve the results of
operations of Kaiser-Texas. In order to integrate and improve the acquired
operations, the Company has incurred and may, among other things, need to
continue to incur considerable expenditures. The work plans to improve this
business may result in, among other things, temporary increases in claims
inventory or other service-related issues that may negatively affect the
Company's relationship with its customers. The Company's results of operations
could be adversely affected in the event that the Company experiences such
problems or is otherwise unable to implement fully and effectively its expansion
strategy.
For the year ended December 31, 1999, the Company recorded a premium deficiency
reserve of $21 million for estimated deficient premiums associated with
contracts in the Texas market. The amount was determined based on budgeted
revenues and expenses. Should the actual results exceed the budget amounts,
there could be a significant adverse impact to the Company's results of
operations, liquidity or financial position.
Risks Associated with Computer Conversions and Internet Initiatives. In 1999,
the Company converted the majority of its business operations to new computer
systems. As with many major system conversions, the Company encountered problems
that, to a degree, negatively affected member services, employers and providers.
None of the problems, however, were significant and alternative procedures were
used to mitigate the problems. In 2000, the Company is implementing an
internet-based health access system to serve its members, providers and
employers. The costs to develop and implement this electronic commerce
application are expected to be more than offset by future savings. However,
there is no assurance that these savings can be achieved or that the Company can
successfully implement its electronic commerce initiatives. Any significant
unanticipated hardware or software problems resulting from these conversions and
initiatives could have a significant adverse impact on the Company's business
processes, customer relationships, results of operations and financial
condition. There is no assurance that the Company will be able to develop
processes and systems to support its growing operations.
Geographic Concentration; Potential Adverse Impact of Current Expansion Program;
Limited Success of Previous Expansion Program. Through the third quarter of
1998, the majority of the Company's HMO operations were concentrated in southern
Nevada, with less significant HMO operations in Houston, Texas, northern Nevada
and Arizona. With the Kaiser-Texas acquisition in October 1998, the Company now
has significant HMO operations in Texas. Any adverse economic, regulatory or
other developments that may occur in Nevada or Texas may negatively impact the
Company's operations and financial condition. In the past, the Company has
attempted to expand its operations outside of southern Nevada. These activities
have met with limited success and, in some cases, resulted in the Company
incurring significant losses. Although the Company believes that it is now more
experienced, there can be no assurance that the Company will be able to recover
its initial investments or expand into other regions successfully and without
incurring losses.
Potential Loss of Nevada Home Office Tax Credit. Under existing Nevada law, a
50% premium tax credit is generally available to HMOs and insurers that own and
substantially occupy home offices or regional home offices within Nevada. In
connection with the settlement of a prior dispute concerning the premium tax
credit, the Nevada Department of Insurance acknowledged in November 1993 that
the Company's HMO and insurance subsidiaries meet the statutory requirements to
qualify for this tax credit. The Company intends to take all necessary steps to
continue to comply with these requirements. The elimination or reduction of the
premium tax credit, or any failure by the Company to qualify for the premium tax
credit, would have a material adverse effect on the Company's results of
operations.
Dependence Upon Health Care Providers. The Company's profitability is dependent,
in large part, upon its ability to contract favorably with hospitals, physicians
and other health care providers. The Company's contracts with its primary
providers are generally renewable annually, but certain contracts may be
terminated on 90 days' prior written notice by either party. There can be no
assurance that the Company will be able to continue to renew such contracts or
enter into new contracts enabling it to service its members profitably. The
Company expects that it will be required to expand its health care provider
network in order to service membership growth adequately; however, there can be
no assurance that it will be able to do so on a timely basis or under favorable
terms.
Capitation and Other Risk Sharing Arrangements. The Company contracts with
hospitals, physicians and other providers of health care and administrative
services under capitated or discounted fee-for-service arrangements. Capitated
providers are at risk for the cost of medical care and administrative services
provided to the Company's enrollees in the relevant geographic areas; however,
the Company is ultimately responsible for the provision of services to its
enrollees should the capitated provider be unable to provide the contracted
services. The inability of certain capitated providers to provide the contracted
service could have a material adverse effect on the Company's business.
Reinsurance Contracts. Reinsurance contracts do not relieve the Company from its
obligations to enrollees or policyholders. Failure of reinsurers to honor their
obligations could result in losses to the Company. The Company evaluates the
financial condition of its reinsurers to minimize its exposure to significant
losses from reinsurer insolvencies. All reinsurers that the Company has
reinsurance contracts with are rated A- or better by the A.M. Best Company.
Should these companies be unable to perform their obligations to reimburse the
Company for ceded losses, the Company could experience significant losses.
The Company's workers' compensation operations segment obtained a quota share
and excess of loss reinsurance agreement (referred to as "low level
reinsurance") effective July 1, 1998. This agreement is with a property-casualty
insurance company that is rated A+ by the A.M. Best Company and effectively
limits the Company's exposure to losses and allocated loss adjustment expenses
to a maximum of $17,000 per occurrence. The agreement expires June 30, 2000 and
has a provision for 12-month run-off coverage of policies in force at June 30,
2000. The reinsurer has declined to renew and the Company is in the process of
obtaining quotes to replace this coverage when it expires. There is no assurance
that the Company will be able to obtain replacement coverage or that the terms
will be materially the same. If the Company is unable to obtain replacement
coverage on terms similar to the current agreement, it could adversely impact
the Company's operating results.
Potential Litigation Against the Company and Inability to Obtain or Inadequacy
of Insurance. The Company is and will continue to be subject to certain types of
litigation, including medical malpractice claims and claim disputes pertaining
to its contracts and other arrangements with providers, employer groups and
their employees and individual members. The Company maintains general and
professional liability, property and fidelity insurance coverage and its
multi-specialty medical group maintains excess malpractice insurance for the
providers presently employed by the group. Additionally, the Company requires
all of its other independently contracted provider physician groups, individual
practice physicians, specialists, dentists, podiatrists and other health care
providers (with the exception of certain hospitals) to maintain professional
liability coverage. However, certain of the hospitals with which the Company
contracts are self-insured. The Company may incur losses not covered by
insurance, beyond the limits of its insurance coverage for its employed
physicians and staff, for acts or omissions by independent providers who do not
carry sufficient malpractice coverage or for other acts or omissions. In
addition, punitive damage awards are generally not covered by insurance.
Although the Company believes that it currently carries adequate insurance, no
assurance can be given that the Company's insurance coverage will be adequate in
amount or type, will be available in the future or that the cost of such
insurance will be reasonable.
Ongoing Modification of the Company's Management Information System. The
Company's management information system is critical to its current and future
operations. The information gathered and processed by the Company's management
information system assists the Company in, among other things, pricing its
services, monitoring utilization and other cost factors, processing provider
claims, providing bills on a timely basis and identifying accounts for
collection. The Company regularly modifies its management information system.
Any difficulty associated with or failure of such system, or any inability to
expand processing capability or to develop and maintain networking capability,
could have a material adverse effect on the Company's business.
Year 2000. The Year 2000 issue exists because many computer systems and
applications currently use two-digit date fields to designate a year. As the
century date change occurs, date-sensitive systems will recognize the year 2000
as 1900, or not at all. This inability to recognize or properly treat the Year
2000 may cause systems to process critical financial and operational information
incorrectly.
The Company replaced or remediated its mission critical computer systems and
applications, remediated data bases and validated the readiness of all computing
and non-computing systems. The Company also engaged in a thorough evaluation to
validate that all systems, computing and non-computing, were functioning. The
Company is unaware of any Year 2000-related problems. There can be no assurance
that the Company will not experience any Year 2000-related problems in the
future or that potential Year 2000 failures will not have a material adverse
impact on the Company's results of operations, liquidity or financial condition.
Revolving Credit Facility. On October 31, 1998, the Company obtained a $200
million credit facility under which it has $160 million in borrowings
outstanding as December 31, 1999. Interest under the credit facility is variable
and based on the London Interbank Offering Rate ("LIBOR") plus a margin
determined by reference to the Company's leverage ratio. Of the outstanding
balance, $50 million is covered by interest-rate swap agreements. The average
cost of borrowing on this line of credit for the year ended December 31, 1999,
including the impact of the swap agreements, was approximately 7.8%. The terms
of the credit facility contain a mandatory payment schedule that begins on June
30, 2001 and ends on September 30, 2003 if the principal balance exceeds certain
thresholds. The terms of the credit facility contain certain covenants including
a minimum fixed charge coverage ratio and a maximum leverage ratio.
For the quarter ended September 30, 1999, the Company exceeded the limits of
certain covenants. The Company was able to obtain a waiver and re-negotiate the
covenant limits. These negotiations resulted in a borrowing rate of LIBOR plus
2.375% through September 30, 2000. There is no assurance that the Company will
be able to obtain future waivers if the Company were unable to meet the covenant
requirements or to cure a default on a timely basis. Failure to obtain a waiver
or to cure a default on a timely basis could result in significantly higher
borrowing costs and/or a demand for payment of the principal. In addition, if
the LIBOR rate increases, it could result in significantly higher borrowing
costs.
Rating Agencies. Certain of the Company's subsidiaries are subject to scrutiny
by various credit agencies such as Standard & Poor's, and Moody's, and insurer
rating agencies such as A.M. Best and Duff & Phelps, as well as health care
rating agencies that rate the quality of service to members such as the National
Committee for Quality Assurance ("NCQA") and the Joint Commission on
Accreditation of Healthcare Organizations. Currently, Health Plan of Nevada has
a Commendable Accreditation rating from NCQA. Texas Health Choice has an
accredited rating that expires in April 2000. At this time, the Company has
voluntarily postponed its accreditation renewal process for TXHC and a scheduled
site examination visit of TXHC by the NCQA in the second quarter of 2000 was
cancelled. The Company expects to reschedule the site examination visit in the
first quarter of 2001, depending upon the NCQA's availability. A negative rating
or the lack of rating from such agencies could have an adverse effect on the
Company's ability to borrow funds or to compete with other health care or
workers' compensation insurance companies in attracting members and selling
policies, and ultimately an adverse affect on earnings and share price.
Dependence on Management. The success of the Company has been dependent to a
large extent upon the efforts of the Company's founder, Anthony M. Marlon, M.D.,
the Chairman of the Board and Chief Executive Officer of the Company, who has an
employment agreement with the Company. Although the Company believes that the
development of its management staff has made the Company less dependent on Dr.
Marlon, the loss of Dr. Marlon could still have a material adverse effect on the
Company's business.
Effect of Open Rating on the Company's California Workers' Compensation
Business. Through its property-casualty insurance subsidiaries, CII Financial,
Inc. ("CII"), a wholly-owned subsidiary of the Company, writes workers'
compensation insurance principally in California. Premium rates, which are
regulated by the Department of Insurance in California, have been under
significant pressure and, at times, been required to be reduced in the period
from 1992 through 1994. Pursuant to workers' compensation legislative reforms
enacted in 1993, "open rating" rules replaced "minimum rate" laws effective
January 1, 1995. Under minimum rate laws, insurers could not charge a premium
that was less than the published minimum rate and, therefore, competed primarily
on the basis of service to policyholders, the level of agent commissions and
policyholders' dividends. The open rating environment has resulted in lower
premium rates and lower net income to CII in 1995 and subsequent years and has
brought further uncertainties to premium revenues and continued operating
profits due to increased price competition and the risk of incurring adverse
loss experience over a smaller premium base.
For the year ended December 31, 1999, CII incurred net adverse loss development
on prior accident years of $9.9 million. The majority of this development was on
the 1996 through 1998 accident years and was primarily attributable to increased
California claim severity. Higher claim severity has had a negative impact on
the entire California workers' compensation industry. There can be no assurance
that CII will not incur adverse loss development in the future or that any such
development will not have a material impact on the results of operations or
financial position.
Although CII intends to underwrite each account taking into consideration the
insured's risk profile, prior loss experience, loss prevention plans and other
underwriting considerations, there can be no assurance that CII will be able to
operate profitably in the California workers' compensation industry,
particularly with open rating, or that future workers' compensation legislation
will not be adopted in California or other states which might adversely affect
CII's results of operations. For the fiscal year ended December 31, 1999,
approximately 81% of CII's direct written premiums were in California.
Consequently, CII's operating results are expected to be largely dependent upon
its ability to write profitable workers' compensation insurance in California.
Convertible Subordinated Debentures. CII has outstanding debentures (the
"Debentures") totaling $50.5 million at December 31, 1999. The ability of CII's
insurance company subsidiaries to transfer funds to CII to service the
Debentures is limited by certain regulatory restrictions and capital
requirements. Sierra has not directly assumed CII's payment obligations under
the CII Debentures or guaranteed their repayment. There can be no assurance that
Sierra will be in a position to prevent a default of the Debentures in the
future if CII's subsidiaries are unable to provide sufficient funds with which
to service the Debentures.
<PAGE>
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.
SIERRA HEALTH SERVICES, INC.
-------------------------------------
(Registrant)
Date: March 15, 2000 /S/ PAUL H. PALMER
---------------------------
Paul H. Palmer
Vice President
Chief Financial Officer and Treasurer
(Chief Accounting Officer)
