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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 quarter ended September 30, 1996
Commission File Number 0-19506
UNITED WISCONSIN SERVICES, INC.
(Exact name of registrant as specified in its charter)
WISCONSIN 39-1431799
(State of Incorporation) (I.R.S. Employer
Indentification No.)
401 WEST MICHIGAN STREET, MILWAUKEE, WISCONSIN 53203-2896
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (414) 226-6900
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
---
Number of shares of Common Stock outstanding as of October 31, 1996 was
12,599,715.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
UNITED WISCONSIN SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
1996 1995
------------- ------------
(In thousands)
ASSETS
Investments:
Bonds available for sale, at market $ 395,023 $ 461,915
Bonds held to maturity, at amortized cost 10,659 9,850
---------- ----------
Total bonds 405,682 471,765
Stocks, at market 63,468 71,582
---------- ----------
Total investments 469,150 543,347
Cash and cash equivalents 24,273 38,290
Receivables:
Due from affiliates 1,238 14,789
Other receivables 77,153 73,265
---------- ----------
Total receivables 78,391 88,054
Other assets 60,500 51,598
---------- ----------
Total assets $ 632,314 $ 721,289
---------- ----------
---------- ----------
See Notes to Interim Consolidated Financial Statements
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UNITED WISCONSIN SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
LIABILITIES AND SHAREHOLDERS' EQUITY 1996 1995
-------------- ------------
(In thousands)
Liabilities:
Medical and other benefits payable $ 228,571 $ 245,118
Advance premiums 49,202 41,456
Due to affiliates 19,067 71,508
Funds held on behalf of affiliated reinsurers 34,473 60,041
Other liabilities 46,867 45,857
Subordinated notes 44,888 44,898
---------- ----------
Total liabilities 423,068 508,878
Shareholders' equity:
Common stock (no par value, $1 stated value,
50,000,000 shares authorized, 12,599,715 shares
issued and outstanding at September 30, 1996 and
December 31, 1995) 12,600 12,600
Paid-in capital 86,902 86,902
Retained earnings 106,604 103,361
Unrealized gains on investments 3,140 9,548
---------- ----------
Total shareholders' equity 209,246 212,411
---------- ----------
Total liabilities and shareholders'equity $ 632,314 $ 721,289
---------- ----------
---------- ----------
See Notes to Interim Consolidated Financial Statements
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UNITED WISCONSIN SERVICES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
-------------------------- --------------------------
1996 1995 1996 1995
----------- ----------- ----------- -----------
(In thousands, except per share data)
<S> <C> <C> <C> <C>
Revenues:
Premium revenue $ 261,160 $ 247,696 $ 786,929 $ 715,608
Other revenue 7,124 5,407 21,232 18,137
Investment income 7,823 6,909 22,578 19,587
Realized investment gains 1,549 7,909 9,033 10,878
----------- ----------- ----------- -----------
Total revenues 277,656 267,921 839,772 764,210
Expenses:
Medical and other benefits 212,743 202,233 650,449 598,472
Commission expenses 16,489 16,409 51,420 47,299
Administrative expenses 34,356 29,583 100,762 87,595
Premium taxes and other assessments 3,228 3,442 10,269 9,288
Interest and profit sharing on joint ventures 2,919 5,593 11,312 11,037
Interest expense on subordinated notes 870 871 2,609 2,613
Dividends on preferred stock of subsidiary 0 0 0 204
----------- ----------- ----------- -----------
Total expenses 270,605 258,131 826,821 756,508
----------- ----------- ----------- -----------
Income before income tax expense 7,051 9,790 12,951 7,702
Income tax expense 2,760 3,494 5,173 2,919
----------- ----------- ----------- -----------
Net income $ 4,291 $ 6,296 $ 7,778 $ 4,783
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Earnings per common share $ 0.34 $ 0.50 $ 0.62 $ 0.37
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
See Notes to Interim Consolidated Financial Statements
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UNITED WISCONSIN SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine months ended
September 30,
-------------------------------
1996 1995
----------- -----------
(In thousands)
<S> <C> <C>
Operating activities:
Net income $ 7,778 $ 4,783
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Bond and other amortization 1,677 1,781
Realized investment gains (9,033) (10,878)
Deferred income tax expense 2,145 122
Changes in other operating accounts:
Medical and other benefits payable (16,547) 54,057
Advance premiums 7,746 6,544
Due to/from affiliates 26,110 (12,293)
Other receivables (3,888) (26,896)
Funds held on behalf of affiliated reinsurers (22,653) (3,710)
Other - net (5,978) (4,690)
----------- -----------
Net cash provided by (used in) operating activities (12,643) 8,820
Investing activities:
Purchases of available for sale investments (453,516) (453,079)
Proceeds from sale of available for sale investments 471,040 368,075
Proceeds from maturity of available for sale investments 51,125 64,144
Purchases of held to maturity investments (3,989) (2,408)
Proceeds from maturity of held to maturity investments 3,296 1,010
Change in investment in unconsolidated affiliates (116) 505
Purchases of other investments (336) (1,272)
----------- -----------
Net cash provided by (used in) investing activities 67,504 (23,025)
Financing activities:
Capital contribution - 716
Cash dividends paid (4,535) (4,650)
Redemption of preferred stock of subsidiary - (30,000)
Redemption of redeemable preferred stock - (2,007)
Common stock issuance - 16,628
Repayment of subordinated notes (10) (10)
Net borrowings under line of credit agreement 667 -
Payment on surplus note with affiliate (65,000) -
----------- -----------
Net cash used in financing activities (68,878) (19,323)
----------- -----------
Cash and cash equivalents:
Decrease during period (14,017) (33,528)
Balance at beginning of year 38,290 84,717
----------- -----------
Balance at end of period $ 24,273 $ 51,189
----------- -----------
----------- -----------
</TABLE>
See Notes to Interim Consolidated Financial Statements
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UNITED WISCONSIN SERVICES, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION - The accompanying consolidated financial statements
for United Wisconsin Services, Inc. (the Company) have been prepared in
accordance with generally accepted accounting principles. The financial
information included herein has been prepared by management without audit by
independent certified public accountants.
The unaudited financial statements include all adjustments and accruals
consisting only of normal recurring accrual adjustments which are, in the
opinion of management, necessary for a fair presentation of the consolidated
financial position and results of operations for the interim periods. The
results of operations for any interim period are not necessarily indicative
of results for the full year. The unaudited interim consolidated financial
statements should be read in conjunction with the consolidated financial
statements and notes thereto for the year ended December 31, 1995,
incorporated by reference or included in the Company's Form 10-K, as filed
with the Securities and Exchange Commission.
EARNINGS PER COMMON SHARE - Earnings per common share are computed by
dividing net income, after reduction for dividends and discounts on
redeemable preferred stock, by the weighted average number of common shares
outstanding. Weighted average common shares outstanding were 12,599,715 for
the three months ended September 30, 1996 and 1995, and 12,599,715 and
12,534,050 for the nine months ended September 30, 1996 and 1995,
respectively.
RECLASSIFICATIONS - Certain reclassifications have been made to the
consolidated financial statements for 1995 to conform with the 1996
presentation.
2. SUBSEQUENT EVENT
On October 30, 1996, the shareholders of the Company voted to approve the
merger of American Medical Security Group, Inc. (AMS) with and into the
Company pursuant to an Agreement and Plan of Merger between AMS, Blue Cross
& Blue Shield United of Wisconsin, the Company, Wallace J. Hilliard and
Ronald A. Weyers. The merger will become effective as soon as all necessary
regulatory approvals have been received. Upon effectiveness of the merger,
all shares of AMS stock issued and outstanding immediately prior to the
merger (other than shares held by the Company and shares with respect to
which
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dissenters' rights are exercised) will be exchanged for an aggregate
of approximately $67.0 million in cash and 3,694,280 newly issued shares of
the Company's common stock. All outstanding options to purchase shares of
AMS stock will be converted into the right to receive options of equivalent
value to acquire Company common stock. The Company will borrow
approximately $70.0 million from Blue Cross & Blue Shield United
of Wisconsin to finance this transaction. See Part II. Item 5. for
further discussion of this transaction.
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Item 2.
Management's Discussion and Analysis
of Financial Condition and Results of Operations
OVERVIEW
United Wisconsin Services, Inc. (the Company) is a leading provider of
managed health care services and employee benefit products. The Company's three
primary product lines are (i) Health Maintenance Organization (HMO) products,
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 and Valley; (ii) small group preferred provider organization (PPO)
products and other non-PPO products sold through American Medical Security
Group, Inc. (AMS), the Company's joint venture partner in the marketing and
administration of low-cost health insurance primarily to employer groups of 50
or fewer employees on behalf of the Company; and (iii) specialty managed care
products and services, including dental, life, disability and workers'
compensation products, managed care consulting, electronic claim submission,
pharmaceutical management and managed mental health services. These three
product groups represented the following percentages of the Company's premium
and other revenue and the following amounts of income (loss) before income tax
expense for the periods noted.
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1996 1995 1996 1995
---- ---- ---- ----
Premium and other revenue (As a percentage of the total)
- -------------------------
<S> <C> <C> <C> <C>
HMO products 39.2% 39.9% 38.9% 40.9%
Small group PPO products 48.6 48.6 48.9 47.2
Specialty managed care
products and services 13.5 12.3 13.2 12.8
Intercompany eliminations (1.3) (0.8) (1.0) (0.9)
----- ----- ----- -----
Total 100.0% 100.0% 100.0% 100.0%
----- ----- ----- -----
----- ----- ----- -----
Income (loss) before income
tax expense (In millions of dollars)
- ---------------------------
HMO products $ 3.2 $ 1.2 $ 5.4 $ 2.2
Small group PPO products (0.8) 1.0 (9.9) (10.6)
Specialty managed care
products and services 5.7 8.8 20.3 19.3
Holding company expenses (1.0) (1.2) (2.8) (3.2)
----- ----- ----- -----
Total $ 7.1 $ 9.8 $ 13.0 $ 7.7
----- ----- ----- -----
----- ----- ----- -----
</TABLE>
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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 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.
RESULTS OF OPERATIONS
TOTAL REVENUES
Total revenues for the three months ended September 30, 1996 increased 3.6%
to $277.7 million from $267.9 million for the three months ended September 30,
1995, due to an increase in premium revenue of $13.5 million, an increase in
other revenue of $1.7 million and an increase in investment income of $0.9
million, partially offset by a decrease in realized investment gains of $6.4
million. On a year-to-date basis, total revenues increased 9.9% to $839.8
million from $764.2 million for the same period in the prior year, due to an
increase in premium revenue of $71.3 million, an increase in investment income
of $3.0 million and an increase in other revenue of $3.1 million, partially
offset by a decrease in realized investment gains of $1.8 million.
PREMIUM AND OTHER REVENUE -- HMO premiums for the three months ended
September 30, 1996 increased 4.2% to $105.2 million from $101.0 million for the
same period in the prior year. Average HMO medical premium per member increased
by 2.2% from the third quarter of 1995 to the third quarter of 1996. The
average number of HMO medical members for the three months ended September 30,
1996 increased 1.1% to 258,346 from 255,484 for the same period in the prior
year.
HMO premiums for the nine months ended September 30, 1996 increased 4.9% to
$314.5 million from $299.7 million for the same period in the prior year.
Average HMO medical premium per member increased by 2.8% for the nine months
ended September 30, 1996, compared with the same period in the prior year. The
average number of HMO medical members for the nine months ended September 30,
1996 increased 2.0% to 259,389 from 254,420 for the same period in the prior
year.
Small group PPO premiums for the three months ended September 30, 1996
increased 6.0% to $130.3 million from $122.9 million for the same period in the
prior year, due in part to growth in the average number of insured medical
contracts outstanding, which increased 1.8% to 312,190 for the third quarter of
1996 from 306,538 for the third quarter of 1995. Average small group PPO
insured medical premium per insured medical contract increased by
6.5% from the third quarter of 1995 to the third quarter of 1996.
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Small group PPO premiums for the nine months ended September 30, 1996
increased 14.3% to $395.5 million from $346.0 million for the same period in the
prior year, due primarily to growth in the average number of insured medical
contracts outstanding, which increased 10.5% to 318,398 for the nine months
ended September 30, 1996, compared with 288,013 for the same period in the prior
year. Average small group PPO insured medical premium per insured medical
contract increased by 6.1% for the nine months ended September 30, 1996,
compared with the same period in the prior year. See "Expense Ratio - Medical
Loss Ratio" for a further discussion of pricing actions on small group PPO
products.
Premium and other revenue from specialty managed care products and services
for the three months ended September 30, 1996 increased 16.2% to $36.3 million
from $31.2 million for the third quarter of 1995. This increase is due
primarily to (i) a $1.1 million increase in assumed premiums under certain
federal and state reinsurance programs; (ii) a $0.5 million increase in dental
premiums due to contract growth; and (iii) a $1.6 million increase in other
revenue for managed mental health services, resulting from increased sales of
services.
Premium and other revenue from specialty managed care products and services
for the nine months ended September 30, 1996 increased 14.2% to $106.9 million
from $93.6 million for the same period in the prior year. This increase is due
primarily to (i) a $3.0 million increase in assumed premiums under certain
federal and state reinsurance programs; (ii) a $1.6 million increase in dental
premiums due to contract growth; (iii) a $3.8 million increase in other revenue
for managed mental health services, resulting from increased sales of services;
and (iv) a gain on the sale of the vision line of business of $1.6 million.
INVESTMENT INCOME AND REALIZED GAINS -- Investment income for the three
months ended September 30, 1996 increased 13.2% to $7.8 million from $6.9
million for the three months ended September 30, 1995. On a year-to-date basis,
investment income increased 15.3% to $22.6 million from $19.6 million for the
same period in the prior year. These increases are due primarily to an
increased level of invested assets due to growth in premiums and recent capital
raising activities, including $16.6 million from a public offering of the
Company's common stock in February 1995. In December of 1995, Blue Cross & Blue
Shield United of Wisconsin (BCBSUW) loaned $65.0 million to United Wisconsin
Insurance Company (UWIC) under a Surplus Note Agreement, which was guaranteed by
the Company. During the first nine months of 1996, the entire $65.0 million was
repaid on this Surplus Note. See "Liquidity and Capital Resources." Investment
income on the proceeds of the Surplus Note is offset by the related interest
expense on the Surplus Note, which is netted against investment income on the
Company's statement of income for the first nine months of 1996.
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Average invested assets, excluding the proceeds of the Surplus Note, for
the three months ended September 30, 1996 increased 6.7% to $507.7 million from
$475.8 million for the three months ended September 30, 1995. On a year-to-date
basis, average invested assets increased 11.3% to $520.7 million from $467.9
million for the first nine months of the prior year. The average annual
investment yield, excluding net realized gains, was 6.2% for the three months
ended September 30, 1996, compared with 5.5% for the three months ended
September 30, 1995. The average annual investment yield, excluding net realized
gains, was 5.9% for the nine months ended September 30, 1996, compared with 5.4%
for the same period in the prior year.
Net realized investment gains for the third quarter of 1996 decreased to
$1.5 million, compared with a gain of $7.9 million for the third quarter of
1995. For the nine months ended September 30, 1996, realized investment gains
decreased to $9.0 million from $10.9 million for the same period in the prior
year. Investment gains are realized in the normal investment process in
response to market opportunities. In addition, during the first three quarters
of 1996 securities were sold as funds were transferred from UWIC to United
Wisconsin Life Insurance Company (UWLIC) associated with the transfer of claim
reserves on the small group PPO business and to effect capital contributions
totaling $70.0 million from the Company to UWLIC to provide UWLIC with
sufficient capital to support the transfer from UWIC to UWLIC of the small group
PPO business sold by AMS. The transfer of the small group PPO business and
supporting capital from UWIC to UWLIC is related to the Company's acquisition of
the remaining interest in AMS. See "Liquidity and Capital Resources." The
source of funds for these capital contributions was an extraordinary dividend
from subsidiaries in December of 1995, which was substantially collected from
UWIC.
In connection with the AMS joint venture, the Company holds funds on behalf
of affiliated reinsurers. Investment income and realized gains attributable to
those funds are included in their respective captions on the statements of
income and are offset by amounts reported as a component of interest and profit
sharing on joint ventures on the Company's statements of income.
EXPENSE RATIOS
MEDICAL LOSS RATIO -- The combined medical loss ratio for HMO and small
group PPO products for the three months ended September 30, 1996 increased to
83.8% from 83.5% for the same period in the prior year, due to an increase in
the small group PPO component loss ratio. On a year-to-date basis, the combined
medical loss ratio decreased to 84.9% from 85.2% for the first nine months of
1995.
The medical loss ratio for HMO products for the three months
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ended September 30, 1996 decreased to 88.7% from 90.5% for the same period in
the prior year. On a year-to-date basis, the medical loss ratio for HMO
products decreased to 89.8% from 90.6% for the first nine months of 1995.
The Company has taken steps to lower the medical loss ratio for HMO products,
including, among other actions, negotiation of more favorable provider
contracts, selectively increasing premium rates, review of underwriting
practices, review of managed care procedures, and selective product design
changes.
The medical loss ratio for small group PPO products for the three months
ended September 30, 1996 increased to 79.9% from 77.7% for the same period in
the prior year. On a year-to-date basis, the medical loss ratio for small group
PPO products increased slightly to 80.9% from 80.6% for the first nine months of
1995. During 1995, management determined that the liability for unpaid insured
medical claims at December 31, 1994 was deficient by approximately $5.6 million,
net of amounts allocated to an insurance subsidiary of AMS. This deficiency was
charged to operations during the first six months of 1995, which increased the
reported medical loss ratio for the first nine months of 1995 by approximately
1.6 percentage points. Products sold by AMS, which are more sensitive to
changes in health care costs than the Company's other products, have been
adversely affected since the first quarter of 1995 by an unexpected increase in
the rate of health care inflation. The rate of change for health care costs for
the small group PPO products on a per contract basis experienced a significant
increase in late 1994 and early 1995. Since the second quarter of 1995, the
rate of change in health care costs for insured medical products sold by AMS has
steadily decreased from approximately 14% to just under 10% currently. This
stability in the rate of inflation has allowed the Company to better estimate
health care costs in the pricing of its products.
The increase in medical costs in 1995 and 1996 has affected other companies
operating in the small group PPO marketplace. The small group PPO products
utilize a variety of provider reimbursement arrangements, many of which are
based on, but do not necessarily control, provider prices. A number of steps
have been and are continuing to be taken in an effort to improve the
profitability of the small group PPO business, including (i) implementation of
renewal price quotes which have increased on average approximately 21% for
insured business and 27% for self-insured business for policies with effective
dates of September 1995 through November 1996, (ii) modification of the design
of certain PPO products to adjust to the changed market conditions, inflation
patterns and utilization trends, (iii) a tightening of underwriting practices by
type of risk and state, (iv) review and modification of provider contracting
arrangements, including direct contracting with providers to better control
health care costs, and (v) review and modification of claims processing
practices and procedures.
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COMMISSION EXPENSE RATIO -- The combined commission expense ratio for HMO
products and small group PPO products for the three months ended September 30,
1996 decreased to 6.4% from 6.8% for the same period in the prior year. On a
year-to-date basis, the combined commission expense ratio for the nine months
ended September 30, 1996 decreased to 6.6% from 6.7% for the same period in the
prior year. The commission ratio for small group PPO products for the three
months ended September 30, 1996 was 11.2%, compared with 12.0% for the three
months ended September 30, 1995. On a year-to-date basis, the commission ratio
for small group PPO products for the nine months ended September 30, 1996 was
11.5%, compared with 12.1% for the nine months ended September 30, 1995. Over
time, renewal business has gradually represented a larger proportion of the
total small group PPO business. Since renewal commissions are typically lower
than commissions on new sales, this has contributed to the decrease in the small
group PPO commission ratio. The commission ratio for HMO products has remained
steady at 0.5% for the three and nine month periods ended September 30, 1996 and
1995. Small group PPO products are sold exclusively through independent agents
who are compensated through commissions, while the Company's HMO products are
primarily sold directly by the Company's sales force. The costs of the
Company's sales force are included in administrative expenses and are,
therefore, not reflected in the commission expense ratio.
ADMINISTRATIVE EXPENSE RATIO -- The combined administrative expense ratio
for HMO products and small group PPO products for the third quarter of 1996
increased to 9.2% from 8.9% for the third quarter of 1995. On a year-to-date
basis, the combined administrative expense ratio increased to 9.3% from 9.1% for
the same period in the prior year. When the component ratios are viewed
separately the administrative expense ratio for HMO products increased to 8.1%
from 7.7% for the third quarter of 1995 and the year-to-date ratio increased to
8.3% from 8.1% for the same period in the prior year. The third quarter ratio
for small group PPO products for the three months and nine months ended
September 30, 1996 increased to 10.1% from 9.9% for the same periods in the
prior year. The Company has taken steps to reduce the administrative expense
ratio for small group PPO products including recent staff lay-offs and an
ongoing intensive review of operating expenses for every department within AMS.
OTHER EXPENSES
Premium taxes and other assessments for the third quarter of 1996 decreased
to $3.2 million from $3.4 million for the third quarter of 1995, while the year-
to-date totals increased to $10.3 million from $9.3 million for the same period
in the prior year. The year-to-date increase is due primarily to premium taxes
on the increased volume of business sold by AMS outside Wisconsin.
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Interest and profit sharing on joint ventures for the third quarter of 1996
decreased to $2.9 million from $5.6 million for the third quarter of 1995, while
the year-to-date totals increased to $11.3 million from $11.0 million for the
same period in the prior year. Of these balances, $2.2 million and $4.5 million
for the three months ended September 30, 1996 and 1995, respectively, and $9.1
million and $8.9 million for the nine months ended September 30, 1996 and 1995,
respectively, were due to investment income and realized investment gains on
funds held by the Company on behalf of American Medical Security Insurance
Company (AMSIC), an insurance subsidiary of AMS. The higher amount of interest
and profit sharing on joint ventures in the third quarter of 1995 was due to the
higher level of realized gains in that quarter. See "Investment Income and
Realized Gains."
The Company also recorded interest expense related to the issuance of
$45.0 million of Subordinated Notes in 1993 totaling $0.9 million for the
three months ended September 30, 1996 and 1995, and $2.6 million for the nine
months ended September 30, 1996 and 1995.
NET INCOME
Consolidated net income for the three months ended September 30, 1996
decreased to $4.3 million, or $0.34 per share, from $6.3 million, or $0.50 per
share, for the same period in the prior year. Consolidated net income for the
nine months ended September 30, 1996 increased to $7.8 million, or $0.62 per
share, from $4.8 million, or $0.37 per share, for the same period in the prior
year.
Pre-tax income (loss) for small group PPO products for the three months ended
September 30, 1996 decreased to a loss of $0.8 million, compared with a gain of
$1.0 million for the same period in the prior year. Pre-tax income (loss) for
small group PPO products for the nine months ended September 30, 1996 improved
to a loss of $9.9 million, compared with a loss of $10.6 million for the same
period in the prior year. The improvement on a year-to-date basis is due
primarily to investment income on the increased capital base to support this
line of business. See "Investment Income and Realized Gains."
Pre-tax income for HMO products for the three months ended September 30,
1996 increased to $3.2 million, compared with $1.2 million for the same period
in the prior year. Pre-tax income for HMO products for the nine months ended
September 30, 1996 increased to $5.4 million, compared with $2.2 million for the
same period in the prior year. The increase in pre-tax income is due primarily
to an improved medical loss ratio in 1996, compared with the prior year. See
"Expense Ratios - Medical Loss Ratio."
Pre-tax income for specialty managed care products and services for the
three months ended September 30, 1996 decreased to
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$5.7 million, compared with $8.8 million for the same period in the prior
year, due primarily to the large amount of realized gains recorded in the
third quarter of 1995. Excluding investment income and realized gains,
results for the third quarter of 1996 increased 4.8%, compared with the same
quarter in the prior year. On a year-to-date basis, pre-tax income for
specialty managed care products and services increased to $20.3 million for
the nine months ended September 30, 1996 compared with $19.3 million for the
same period in the prior year. The second quarter of 1996 includes a gain of
$1.6 million from the sale of the vision line of business.
The Company's effective tax rate for the third quarter of 1996 increased to
39.1%, compared with 35.7% for the same quarter in the prior year. On a year-
to-date basis, the Company's effective tax rate increased to 39.9% for the nine
months ended September 30, 1996, compared with 37.9% for the nine months ended
September 30, 1995. The increase in the overall effective tax rate is due to a
change in the mix of income by unit along with different state tax requirements
by unit. The effective tax rate for the Company's HMO subsidiaries is
approximately 40% versus the effective tax rate for UWIC and UWLIC which
approximates 36%.
LIQUIDITY AND CAPITAL RESOURCES
The Company's sources of cash flow consist primarily of premium revenue
received and investment income. The primary uses of cash include medical and
other benefits, commissions and administrative 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.
Historically, the Company has generated positive cash flow from operations.
For the nine months ended September 30, 1996, however, net cash provided by
(used in) operating activities amounted to a use of $12.6 million, compared with
$8.8 million provided by operating activities for the same period in the prior
year. The use of cash in 1996 was due primarily to a reduction in funds held on
behalf of AMSIC due to the reduced profitability on the business sold by AMS and
cash payments to AMSIC during the first nine months of 1996, as discussed
further below. Due to periodic cash flow requirements of certain subsidiaries
the Company made borrowings under its bank line of credit ranging up to $14.4
million during the first nine months of 1996 to meet short-term cash needs, and
$1.2 million was outstanding at September 30, 1996.
In conjunction with the AMS joint venture, the Company holds funds to
support policy reserves, holds AMSIC's undistributed net profits on this
business, and credits investment income and realized investment gains or losses
to AMSIC on the funds held balance at the Company's average portfolio rate. The
Company held
15
<PAGE>
$143.7 million and $117.3 million of funds on behalf of AMSIC at
December 31, 1995 and September 30, 1996, respectively, of which $83.4 million
and $82.8 million, respectively, were utilized to offset reinsurance recoverable
balances from AMSIC on the Company's balance sheet in accordance with SFAS No.
113. These funds are included in cash and investments, and $60.3 million and
$34.5 million were accessible as of December 31, 1995 and September 30, 1996,
respectively, upon request by AMSIC without prior approval of the Company. The
decrease in funds accessible by AMSIC during the first nine months of 1996 is
due primarily to cash payments to AMSIC totalling $17.0 million during 1996, net
losses allocable to AMSIC on the small group PPO and life business sold by AMS
of approximately $3.5 million during the nine-month period, and a $5.3 million
decrease in unrealized gains on investment securities which is included in the
funds held balance.
As of September 30, 1996, the Company owned approximately 12% of the common
stock of AMS and, through reinsurance agreements with AMSIC, the Company retains
50% of the small group PPO and life business sold by AMS on the books of UWIC
and UWLIC. In June 1996, the Company executed a letter of intent for an early
exercise of the Company's option under the 1988 Joint Venture Agreement to
acquire the approximately 88% of AMS common stock that the Company did not own
through a merger (the "Merger") of AMS with and into the Company. On July 31,
1996, the parties executed a definitive merger agreement (the "Merger
Agreement") which provides that, upon effectiveness of the Merger, all
outstanding shares of capital stock of AMS (other than shares owned by the
Company and shares with respect to which dissenters' rights are exercised) will
be converted into the right to receive $67.0 million in cash and 3,694,280 newly
issued shares of Company common stock. All outstanding options to purchase
shares of AMS capital stock will be converted into the right to receive options
of equivalent value to acquire Company common stock. Shareholders of both AMS
and the Company have approved the Merger, and the Merger will become effective
as soon as practicable after receipt of all necessary regulatory approvals which
are expected to be obtained by the end of 1996. The transaction will be
accounted for under the purchase method of accounting. Effective October 1,
1996, the Company terminated the reinsurance agreements with AMSIC and will
record 100% of the small group PPO and life business sold by AMS on behalf of
UWLIC.
The Company's investment portfolio consists primarily of investment grade
bonds and has a limited exposure to equity securities. At December 31, 1995,
$471.8 million or 86.8% of the Company's total investment portfolio was invested
in bonds. At September 30, 1996, $405.7 million or 86.5% of the Company's total
investment portfolio was invested in bonds. At December 31, 1995 and September
30, 1996, the bond portfolio had an average quality rating of "Aa3" by Moody's
Investor Service, and the majority of the bond portfolio was classified as
available for sale. In
16
<PAGE>
accordance with SFAS No. 115, bonds classified as available for sale are
recorded on the Company's balance sheet at market value. The market value of
the total bond portfolio exceeded amortized cost by $10.6 million at December
31, 1995 and was less than amortized cost by $3.6 million at September 30,
1996. Unrealized holding gains and losses on bonds classified as available
for sale are included as a component of shareholders' equity, net of
applicable deferred taxes and amounts attributable to funds held on behalf of
an affiliated reinsurer. The Company has no investments in mortgage loans,
non-publicly traded securities (except for common and preferred stock of
AMS), real estate held for investment or financial derivatives (except for
principal only strips of U. S. Government securities).
In December 1995, UWIC borrowed $65.0 million from BCBSUW under a Surplus
Note Agreement, which was guaranteed by the Company. The Surplus Note provided
UWIC with regulatory capital needed to replace capital paid to the Company in
the form of a dividend in December 1995. The dividend and Surplus Note are part
of a capital restructuring plan designed to transfer capital from UWIC to UWLIC
to support UWLIC's retention of the small group PPO business beginning in 1996.
As of September 30, 1996, the entire $65.0 million has been repaid to BCBSUW.
The Company's anticipated expansion of its business requires capital levels
sufficient to support premium growth. The Company's compound annual growth rate
in premium revenue for the five years ended December 31, 1995 was 28.7%, due
principally to the growth of small group PPO products. While the future rate of
growth is uncertain, growth in premium revenue is expected to continue. In
addition, effective October 1, 1996, the Company terminated the reinsurance
agreements with AMSIC and will record 100% of the premium revenues on the
business sold by AMS, compared with the 50% recorded through September 30,
1996.
From time to time, the Company makes capital contributions to its
subsidiaries to assist them in maintaining appropriate levels of capital and
surplus for regulatory and rating purposes. Compcare, Valley, Unity, UWIC
and UWLIC are required to maintain certain levels of statutory capital and
surplus. 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 September 30, 1996,
statutory capital and surplus for each of these insurance subsidiaries
exceeded required levels.
In compliance with applicable state insurance regulations, UWIC and UWLIC
have deposited securities with various states aggregating $5.5 million at
September 30, 1996. In addition, HMOs are required to maintain a deposit with
the State of Wisconsin for future assessments for HMO insolvencies. As of
September 30, 1996, the combined deposit for Compcare, Valley and Unity was $4.4
million. States in which UWIC and UWLIC are licensed to do
17
<PAGE>
business independently establish deposit requirements. Increases in
deposit levels, resulting in the segregation of certain investments, may
adversely affect the Company's liquidity.
The National Association of Insurance Commissioners (NAIC) has adopted
risk-based capital guidelines for both life and health insurers and for property
and casualty insurers. These guidelines currently apply only to certain of the
Company's subsidiaries. Those subsidiaries exceed the Company action level for
NAIC risk-based capital guidelines. The NAIC is also developing risk-based
capital guidelines for health organizations, which would apply to the Company's
HMO subsidiaries. In addition, the OCI and other state regulators have the
authority to establish capital and surplus requirements for individual companies
and may propose stricter capital and surplus requirements for Compcare, Valley,
Unity, UWIC and UWLIC.
The Company believes that internal funds and periodic borrowings on its
bank line of credit will be sufficient to finance planned growth for the
foreseeable future, other than financing required in connection with the
acquisition of the remaining interest of AMS, which will be financed with newly
issued common stock of the Company and borrowings of approximately $70.0 million
from BCBSUW. In the event the Company seeks additional financing to facilitate
long-term growth, the Company believes that such financing could be obtained
through equity offerings, debt offerings, financings from BCBSUW or other bank
borrowings, as market conditions may permit or dictate.
This report contains certain forward looking statements with respect to the
financial condition, results of operations and business of the Company. Such
forward looking statements are subject to inherent risks and uncertainties that
may cause actual results to differ materially from those contemplated by such
forward looking statements. Factors that may cause actual results to differ
materially from those contemplated by such forward looking statements include,
among others, the following possibilities: (1) the steps being taken to improve
the profitability of the small group PPO business and to reduce the
administrative expense ratio for small group PPO products do not have the effect
that the Company expects; (2) competitive pressure in the health care industry
increases significantly; and (3) general economic conditions, either nationally
or in the states in which the Company does business are less favorable than
expected.
18
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In February 1994, Compcare and BCBSUW filed a lawsuit in U.S. District
Court, Western District of Wisconsin against The Marshfield Clinic (the
"Clinic") and Security Health Plan of Wisconsin, Inc., a Wisconsin HMO sponsored
by the Clinic ("Security"), asserting that the defendants committed violations
of antitrust law through monopolization of physician services and HMO services
in northern and north central Wisconsin. BCBSUW and Compcare sought: (i)
treble damages to compensate for excessive payments to the Clinic and lost
revenues due to the defendants' anti-competitive actions, as well as (ii)
certain injunctive relief intended to remedy and prevent the defendants from
maintaining their anti-competitive behavior. On January 4, 1995 a jury found in
favor of BCBSUW and Compcare and awarded damages to BCBSUW and Compcare in the
amount of approximately $48.5 million (after trebling), of which approximately
$17.0 million was allocable to Compcare. On March 22, 1995 the U.S. District
Court, Western District of Wisconsin affirmed the jury's verdict but reduced the
damage award to approximately $16.8 million (after trebling) of which
approximately $15.2 million is allocable to Compcare. The Court also awarded
injunctive relief enjoining the Clinic from various anti-competitive acts and
requiring that the Clinic contract with Compcare for HMO services on a non-
discriminatory basis. The Clinic and Security filed for appeal with the Seventh
Circuit Court of Appeals.
In May, 1995, the Seventh Circuit stayed the injunctive order pending
the Court's ruling on the case. On September 18, 1995 the Seventh Circuit
affirmed the District Court's decision on the per se violation of dividing the
market and ordered another trial to determine the damages resulting from the
violation. The Seventh Circuit reversed the District Court on the other counts.
On October 2, 1995, BCBSUW and Compcare filed a petition for a rehearing
with the Seventh Circuit. The U.S. Justice Department and the Federal Trade
Commission filed an amici brief in support of BCBSUW and Compcare.
The Seventh Circuit denied the rehearing petition but on October 13,
1995, issued amendments to its original decision. On October 18, 1995 BCBSUW
and Compcare filed a motion to stay the retrial pending their Petition for a
Writ of Certiorari to the U.S. Supreme Court which the Seventh Circuit granted.
In January 1996, BCBSUW and Compcare filed a petition for a Writ of Certiorari
("Petition") with the U.S. Supreme Court on the reversed counts.
The U.S. Supreme Court denied the Petition in March 1996. A new trial
is scheduled for April 14, 1997, in the District Court to determine the amount
of damages for those violations affirmed by the Seventh Circuit and for the
awarding of attorneys' fees. An injunction was entered by the District Court on
September 10, 1996 prohibiting the Clinic or Security from entering into any
agreements to divide markets and requiring the Clinic to send a copy of the
injunction to six named provider groups. This injunction may be amended after
trial.
19
<PAGE>
On April 20, 1995, April 27, 1995 and May 10, 1995, suits against the
Company and certain of its officers were filed in United States District Court
for the Eastern District of Wisconsin on behalf of purchasers of the Company's
common stock between February 7, 1995 and April 18, 1995. The suits allege that
the Company violated federal securities laws by issuing false and misleading
statements regarding the Company, its financial condition and operations and
seek damages yet to be defined. The suits were subsequently consolidated into
one action. The Company and its officers have denied the plaintiffs'
allegations and announced that they will vigorously defend the consolidated
action. Motions to Dismiss filed on behalf of the defendants are pending.
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
In June 1996, the Company executed a letter of intent for an early
exercise of the Company's option under the 1988 Joint Venture Agreement to
acquire the approximately 88% of AMS common stock that the Company did not own
through a merger (the "Merger") of AMS with and into the Company. On July 31,
1996, the parties executed a definitive merger agreement (the "Merger
Agreement") which provides that, upon effectiveness of the Merger, all
outstanding shares of capital stock of AMS (other than shares owned by the
Company and shares with respect to which dissenters' rights are exercised) will
be converted into the right to receive $67.0 million in cash and 3,694,280 newly
issued shares of Company common stock. All outstanding options to purchase
shares of AMS capital stock will be converted into the right to receive options
of equivalent value to acquire Company common stock. Shareholders of both AMS
and the Company have approved the Merger, and the Merger will become effective
as soon as practicable after receipt of all necessary regulatory approvals which
are expected to be obtained by the end of 1996.
20
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
2.1 Agreement and Plan of Merger dated as of July 31, 1996
between United Wisconsin Services, Inc., Blue Cross & Blue
Shield United of Wisconsin, American Medical Security Group,
Inc., (incorporated by reference to Registrant's
Registration Statement on Form S-4 Registration No. 333-
10935).
11 Statement regarding computation of per share earnings,
(incorporated by reference to Note 1 of Notes to Interim
Consolidated Financial Statements).
(b) Reports on Form 8-K
(1) Current Report on Form 8-K dated August 28, 1996 including
under Item 5 certain proforma financial information
contained in Registrant's Registration Statement on Form S-4
(Registration No. 333-10935) filed August 31, 1996.
(2) Current Report on Form 8-K dated September 17, 1996
including under Item 5 certain revised proforma financial
information contained in Amendment No. 1 to Registrant's
Registration Statement (Registration No. 333-10935) filed
September 23, 1996.
21
<PAGE>
SIGNATURE
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: 11/11/96
-----------------------
UNITED WISCONSIN SERVICES, INC.
/s/ C. Edward Mordy
------------------------------------
Vice President and Chief Financial Officer
(Principal Financial Officer and
Chief Accounting Officer)
22
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AT SEPTEMBER 30, 1996 (UNAUDITED) AND THE
CONSOLIDATED STATEMENT OF INCOME FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
(UNAUDITED) AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<DEBT-HELD-FOR-SALE> 395,023
<DEBT-CARRYING-VALUE> 10,659
<DEBT-MARKET-VALUE> 10,689
<EQUITIES> 63,468
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 469,150
<CASH> 24,273
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 0
<TOTAL-ASSETS> 632,314
<POLICY-LOSSES> 0
<UNEARNED-PREMIUMS> 49,202
<POLICY-OTHER> 228,571
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 44,888
0
0
<COMMON> 12,600
<OTHER-SE> 196,646
<TOTAL-LIABILITY-AND-EQUITY> 632,314
786,929
<INVESTMENT-INCOME> 22,578
<INVESTMENT-GAINS> 9,033
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<UNDERWRITING-OTHER> 162,451
<INCOME-PRETAX> 12,951
<INCOME-TAX> 5,173
<INCOME-CONTINUING> 7,778
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<EXTRAORDINARY> 0
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<NET-INCOME> 7,778
<EPS-PRIMARY> .62
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