UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number 1-13248
RIGHTCHOICE MANAGED CARE, INC.
(Exact name of registrant as specified in its charter)
Missouri 43-1674052
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
1831 Chestnut Street, St. Louis, Missouri 63103-2275
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (314) 923-4444
Not Applicable
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the registrant (1) has
filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the
issuer's classes of common stock, as of the latest practicable date:
Title of each class Outstanding at April 30, 1998
Class A Common Stock, $0.01 par value 3,709,000 shares
Class B Common Stock, $0.01 par value 14,962,500 shares
RIGHTCHOICE MANAGED CARE, INC.
First Quarter 1998 Form 10-Q
Table of Contents
PART I. FINANCIAL INFORMATION PAGE
ITEM 1. Financial Statements
Consolidated Balance Sheets as of March 31, 1998
and December 31, 1997 3
Consolidated Statements of Income for the Three Months
Ended March 31, 1998 and 1997 4
Consolidated Statements of Changes in Shareholders' Equity
for the Three Months Ended March 31, 1998 and 1997 5
Consolidated Statements of Cash Flows for the Three
Months Ended March 31, 1998 and 1997 6
Notes to Consolidated Financial Statements 7
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 18
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 30
ITEM 2. Changes in Securities 30
ITEM 3. Defaults Upon Senior Securities 30
ITEM 4. Submission of Matters to a Vote of Security Holders 30
ITEM 5. Other Information 30
ITEM 6. Exhibits and Reports on Form 8-K 30
SIGNATURES 32
PART I.FINANCIAL INFORMATION
ITEM 1.Financial Statements
RIGHTCHOICE MANAGED CARE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except shares and per share data)
ASSETS March 31, December 31,
1998 1997
(unaudited)
Current assets:
Cash and cash equivalents $ 25,707 $ 29,872
Investments available for sale 218,789 220,972
Receivables from members 61,448 60,019
Receivables from related parties 30,292 16,130
Deferred income taxes 5,610 4,994
Other assets 21,206 14,410
Total current assets 363,052 346,397
Property and equipment, net 59,518 60,602
Deferred income taxes 11,793 12,737
Investments in affiliates 8,487 8,427
Goodwill and intangible assets, net 77,470 78,200
Total assets $520,320 $506,363
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Medical claims payable $111,189 $ 112,339
Unearned premiums 55,117 57,656
Accounts payable and accrued
expenses 58,358 55,892
Current portion of long-term debt 4,500 2,000
Payables to related parties 38,329 20,213
Reserve for loss contract 9,052 9,052
Obligations for employee benefits 3,011 2,935
Income taxes payable 12,229 12,051
Obligations under capital leases 4,270 4,515
Total current liabilities 296,055 276,653
Reserve for loss contract 14,048 16,311
Long-term debt 42,500 45,000
Obligations for employee benefits 22,709 22,140
Obligations under capital leases 4,427 5,394
Total liabilities 379,739 365,498
Shareholders' Equity:
Preferred Stock, $.01 par,
25,000,000 shares authorized,
no shares issued and outstanding
Common Stock:
Class A, $.01 par, 125,000,000
shares authorized, 3,737,500 shares
issued, 3,709,000 shares outstanding 37 37
Class B, convertible, $.01 par,
100,000,000 shares authorized,
14,962,500 shares
issued and outstanding 150 150
Additional paid-in capital 132,640 132,640
Retained earnings 7,621 6,653
Treasury stock, 28,500 Class A
shares, at cost (404) (404)
Accumulated other comprehensive
income 537 1,789
Total shareholders' equity 140,581 140,865
Total liabilities and
shareholders' equity $520,320 $506,363
See accompanying Notes to Consolidated Financial Statements.
RIGHTCHOICE MANAGED CARE, INC.
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(in thousands, except shares and per share data)
Three Months Ended
March 31,
1998 1997
Revenues:
Premium $173,694 $160,157
Fees and other income 18,158 16,157
Total revenues 191,852 176,314
Operating expenses:
Health care services 144,481 129,156
Commissions 7,737 7,283
General and administrative
(excludes depreciation and amor-
tization and excludes net inter-
company charges of $3,129 and
$2,133, respectively, allocated
to Blue Cross and Blue Shield of
Missouri) 36,280 34,949
Depreciation and amortization 4,603 5,018
Non-recurring relocation charges 2,062
Total operating expenses 193,101 178,468
Operating loss (1,249) (2,154)
Investment income:
Interest and dividends 3,817 3,329
Realized gains, net 555 10,181
Total investment income, net 4,372 13,510
Other:
Interest expense (1,150) (1,266)
Other income, net 85 13
Total other, net (1,065) (1,253)
Income before provision for
income taxes 2,058 10,103
Provision for income taxes 1,090 3,909
Net income $ 968 $ 6,194
Weighted average common shares
outstanding 18,672,000 18,676,000
Basic and diluted earnings per
share $ .05 $ .33
See accompanying Notes to Consolidated Financial Statements.
RIGHTCHOICE MANAGED CARE, INC.
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' EQUITY (UNAUDITED)
(in thousands, except shares)
Accumulated
Other
Common Stock Additional Compre-
Class Class Paid In Retained Treasury hensive
A B Capital Earnings Stock Income Total
Balance at
December 31, 1996 $37 $150 $132,640 $30,687 $(326) $9,766 $172,954
Comprehensive loss:
Net income 6,194 6,194
Change in
unrealized
appreciation on
available-
for-sale
securities, net of
income tax credit
of $4,368 (7,861) (7,861)
Comprehensive loss (1,667)
Purchase of 5,400
shares of
Class A Common
Stock, at cost (78) (78)
Balance at
March 31, 1997 37 150 132,640 36,881 (404) 1,905 171,209
Comprehensive loss:
Net loss (30,228) (30,228)
Change in
unrealized
appreciation on
available-
for-sale
securities, net of
income tax credit
of $18 (116) (116)
Comprehensive loss (30,344)
Balance at
December 31, 1997 37 150 132,640 6,653 (404) 1,789 140,865
Comprehensive loss:
Net income 968 968
Change in
unrealized
appreciation on
available-
for-sale
securities, net of
income tax credit
of $690 (1,252) (1,252)
Comprehensive loss (284)
Balance at
March 31, 1998 $37 $150 $132,640 $7,621 $(404) $537 $140,581
See accompanying Notes to Consolidated Financial Statements.
RIGHTCHOICE MANAGED CARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
For the three months ended,
March 31,
1998 1997
Cash flows from operating
activities:
Net income $ 968 $ 6,194
Adjustments to reconcile net
income to net cash used in
operating activities:
Provision (credit) for deferred
income taxes 1,018 (747)
Depreciation and amortization 4,603 5,018
Undistributed earnings of
affiliates (60) (110)
Gain on sale of investments (555) (10,181)
Amortization of premiums and
accretion of discounts, net (12) 35
(Increase) decrease in certain
assets:
Receivables from members (1,429) (2,520)
Receivables from related
parties (14,162) 1,320
Other assets (6,797) (6,623)
Increase (decrease) in certain
liabilities:
Medical claims payable (1,150) 6,110
Unearned premiums (2,539) (2,608)
Accounts payable and accrued
expenses 2,466 (2,459)
Payables to related parties 18,116 (3,581)
Reserve for loss contract (2,263)
Obligations for employee
benefits 645 331
Income taxes payable 178 7,534
Net cash used in operating
activities (973) (2,287)
Cash flows from investing
activities:
Proceeds from matured investments:
Fixed maturities 3,325
Proceeds from investments sold:
Fixed maturities 59,845 33,084
Equity securities 40,734
Other 4,408
Investments purchased:
Fixed maturities (66,523) (61,593)
Equity securities (230)
Other (247) (271)
Proceeds from property and
equipment sold 5
Property and equipment purchased (2,594) (3,556)
Net cash (used in) provided by
investing activities (1,781) 8,168
Cash flows from financing
activities:
Purchase of Class A Treasury
stock (78)
Repayment of borrowings under
revolving credit facility (15,000)
Payments of capital lease
obligations (1,411) (1,268)
Net cash used in financing
activities (1,411) (16,346)
Net decrease in cash and cash
equivalents (4,165) (10,465)
Cash and cash equivalents at
beginning of period 29,872 33,418
Cash and cash equivalents at end of
period $ 25,707 $ 22,953
Supplemental Disclosure of Cash
Information:
Interest paid $ 1,165 $ 1,638
Income tax refunds received, net (2,098) (2,879)
Supplemental Schedule of Noncash
Investing and Financing Activities:
Equipment acquired through
capital leases $ 199 $ 809
See accompanying Notes to Consolidated Financial Statements.
RightCHOICE Managed Care, Inc.
Notes to Consolidated Financial Statements
(unaudited)
1. Financial Statement Presentation
The interim consolidated financial statements included
herein have been prepared by RightCHOICE Managed Care, Inc.
(the company) without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission (the
SEC). Certain information and footnote disclosures,
normally included in the financial statements prepared in
accordance with generally accepted accounting principles,
have been condensed or omitted pursuant to such SEC rules
and regulations; however, the management of the company
believes that the disclosures herein are adequate to make
the information presented not misleading. In the opinion
of management, all adjustments, consisting only of normal
recurring adjustments necessary to present fairly the
consolidated financial position of the company with respect
to the interim consolidated financial statements, and the
consolidated results of its operations and its cash flows
for the interim periods then ended, have been included.
The results of operations for the interim periods are not
necessarily indicative of the results for the full year.
2. Contingencies
OPM audit
The company, through its subsidiary, HMO Missouri, Inc.
(BlueCHOICE), contracts with the Office of Personnel
Management (OPM) to provide or arrange health services to
federal employees under the Federal Employees Health
Benefits Program (FEHBP). FEHBP is the second largest
customer group (after MCHCP, discussed further herein) of
BlueCHOICE. OPM conducts periodic audits to, among other
things, verify that the premiums established under the OPM
contract were established in compliance with the community
rating and other requirements under the FEHBP.
On August 8, 1995, the company received a draft audit
report from the OPM regarding the audit, conducted in 1994,
of the FEHBP operations of BlueCHOICE for the years 1989
through 1994. The audit dealt primarily with a comparison
of premium rates charged to the FEHBP to rates charged by
BlueCHOICE to other similarly sized groups. The OPM draft
audit report indicates that BlueCHOICE has a potential
liability of $7.5 million to the FEHBP. The company
responded to the draft report in November of 1995 following
an in-depth analysis of the issues. In 1998, BlueCHOICE
received correspondence from the U.S. Department of Justice
requesting a meeting with BlueCHOICE regarding in excess of
$6.5 million in payments (alleged overcharges) received
during the reconciliation process for the years 1990
through 1994, plus interest thereon. If it is found that
BlueCHOICE knowingly received overpayments, it could be
subject to civil penalties of up to ten thousand dollars
per certified reconciliation statement, treble damages for
the amount of such overcharges and interest. At this time,
management is unable to determine the final dollar amount
which may be required to resolve the audit findings. There
can be no assurance that the resolution of these findings
will not have a material adverse effect on the company and
the market for the company's stock.
Subscriber class action litigation
On March 15, 1996, a suit was filed in the Circuit Court of
the City of St. Louis, Missouri, by Anthony J. Sarkis, Sr.
and James Hacking individually and on behalf of a purported
class of (i) subscribers in individual or group health
plans insured or administered by Blue Cross and Blue Shield
of Missouri (BCBSMo, the class B shareholder of the
company) or the company, and (ii) all persons and/or
entities who benefited from BCBSMo's tax-exempt status.
The petition named the company, BCBSMo, HealthLink, Inc.
(HealthLink, a subsidiary of the company), and certain
officers of the company as defendants. The named
plaintiffs later abandoned their claim to represent all
persons or entities who benefited from BCBSMo's tax-exempt
status. They continue to seek to represent subscribers in
group health plans of BCBSMo or the company as of the date
of the transaction they challenge. No determination has
been made whether the case will be certified as a class
action.
The plaintiffs' claims relate to an alleged conversion of
BCBSMo from a not-for-profit entity to a for-profit entity
and payment of excessive compensation to management. The
complaint further alleges that certain amendments to
BCBSMo's Articles of Incorporation were improper. The
complaint also alleges the purchase of HealthLink was at an
excessive price and that HealthLink operates under
contracts providing for illegal discounts by health care
providers. The plaintiffs seek restitution, compensatory
damages and punitive damages in unspecified amounts, as
well as injunctive and other equitable relief.
The company and the other defendants removed the case to
the United States District Court for the Eastern District
of Missouri on May 26, 1996, and filed an answer on May 31,
1996. On August 8, 1996, the district court granted
plaintiff's motion to remand. In May 1997, plaintiffs
filed an amended petition alleging breach of contract by
the company. The company again removed the case to United
States District Court for the Eastern District of Missouri.
Plaintiffs have again moved to remand the case to state
court. Preliminary discovery has been conducted. BCBSMo
and the company believe the claims are without merit and
intend to vigorously defend the action and intend to seek
dismissal or otherwise resolve the action as part of the
transactions contemplated by the conceptual framework
described below under "Litigation with DOI and Attorney
General - Possible Settlement."
Litigation with DOI and Attorney General
Possible Settlement
On April 22, 1998, the company and BCBSMo announced a
conceptual framework for an agreement that would resolve
all outstanding litigation and regulatory issues between
the companies and the Missouri Department of Insurance (the
DOI) and the Missouri Attorney General. Under the terms of
the conceptual framework, BCBSMo would create a charitable
health care foundation that would be managed by an
independent board of directors. This foundation would be
created through a series of transactions in which BCBSMo
would contribute to the foundation all of its shares of
stock in the company (approximately 15 million shares).
The foundation would fund its activities through the
orderly divestiture of this stock. The shares held by the
foundation would be subject to a voting agreement that will
effectively vest voting control in the board of directors
of the company. The company would absorb the remaining
assets and related liabilities of BCBSMo and become a
consolidated, fully for-profit, direct licensee for the
Blue Cross and Blue Shield names and trademarks. The
company, BCBSMo, the Missouri Attorney General and the DOI
have agreed to stand still with regard to their litigation
until July 22, 1998 (the 90th day after the date of the
conceptual framework), during which period the parties will
attempt to finalize a definitive settlement agreement. The
definitive agreement, if executed by the parties, is
expected to include a number of significant conditions and
contingencies, including judicial, shareholder and Blue
Cross and Blue Shield Association approvals, resolution of
other pending litigation, state and federal securities
filings and registrations, and approval from various state
insurance departments and commissioners. There can be no
assurance that a definitive agreement will be negotiated
and executed, that it will receive the necessary court
approval, that all conditions and contingencies expected to
be included therein will be satisfied, or that the
transaction proposed thereby will be effected. In
addition, there can be no assurance that the Litigation
relating to the Reorganization and Public Offering and the
Litigation relating to the Market Conduct Study and
Copayment Calculations as further described below under the
same captions will not be pursued by the parties adverse to
the company and BCBSMo or that the appellate court
considering an appeal will refrain from rendering its
decision.
Litigation relating to the Reorganization and Public Offering
In August 1994, BCBSMo transferred certain assets to the
company in connection with an offering to the public of 20
percent of the common stock of the company (such events are
referred to collectively as the Reorganization and Public
Offering). Although the Director of the DOI (the Director)
formally approved the Reorganization and Public Offering on
April 14, 1994, the Director and DOI subsequently claimed
that the Reorganization and Public Offering violated state
laws and that BCBSMo was obligated to transfer all of its
assets, including all of its company stock, to the State of
Missouri or a charity designated by the State of Missouri.
The Director and DOI threatened to bring legal action, seek
a receivership or terminate BCBSMo's insurance license
unless BCBSMo gave up its assets.
BCBSMo's extensive efforts to resolve this dispute without
litigation were unsuccessful. On May 13, 1996, BCBSMo
filed a declaratory judgment action in the Circuit Court of
Cole County, Missouri (the Court) against the Director, DOI
and the Missouri Attorney General (the Missouri Attorney
General was a necessary party due to his sole authority to
enforce nonprofit corporation laws).
The Director and DOI filed an answer and counterclaims on
June 13, 1996. The answer sets forth several affirmative
defenses, including alleged fraud and negligent
misrepresentation with respect to the application filed by
BCBSMo seeking approval of the Reorganization and Public
Offering. The counterclaims allege violations of certain
health service corporation and nonprofit corporation
statutes. The Director and DOI's counterclaims sought
among other things: (i) permanent injunctions against
BCBSMo; (ii) imposition of a trust on BCBSMo's assets for
public benefit purposes; (iii) return of profits from
Medigap policies reinsured with a subsidiary; and (iv) an
accounting of all assets transferred by BCBSMo.
The Missouri Attorney General filed an answer and
counterclaim on June 20, 1996, alleging that the
Reorganization and Public Offering, and the continued
operations through the company and its subsidiaries, exceed
BCBSMo's statutory purposes. The Missouri Attorney General
requested a declaration that BCBSMo has exceeded its lawful
authority and seeks such relief as the Court determines to
be appropriate under the circumstances based on a statute
which authorizes judicial dissolution or less drastic
alternative relief in the Court's discretion.
On September 9, 1996 (the September 9 Order), the Court
granted BCBSMo's motion for summary judgment against the
Director and DOI, rejected all of the Director and DOI's
affirmative defenses (including allegations of fraud),
issued a permanent injunction against the Director and DOI
and declared that: (i) under Missouri law the Director and
DOI have no authority to demand that BCBSMo make a payment
as a result of the Reorganization and Public Offering; (ii)
under Missouri law the Director and DOI have no
jurisdiction to take any action, the practical effect of
which is to amend, modify or reverse the Director's April
14, 1994 final administrative approval of the
Reorganization and Public Offering; (iii) under Missouri
law the Director and DOI have no jurisdiction to take any
administrative action, including but not limited to,
revoking, suspending or refusing to renew BCBSMo's
Certificate of Authority based in any way on the
Reorganization and Public Offering and the consequences
thereof or BCBSMo's refusal to make a payment as the
Director and DOI have demanded; and (iv) (A) BCBSMo is a
mutual benefit type of nonprofit corporation rather than a
public benefit type of nonprofit corporation; (B) the
Reorganization and Public Offering were authorized under
all laws applicable to nonprofit health services
corporations; and (C) BCBSMo does not owe the State or any
person or entity a "toll charge," "charitable asset
settlement" or any other payment as a result of the August
1994 Reorganization and Public Offering. On December 30,
1996, the Court issued orders modifying the findings and
declarations set forth in (iv) above, on the grounds that
it was legally unnecessary to resolve such issues since the
Court had already ruled against the Director and DOI for
other reasons.
The September 9 Order permanently enjoined the Director and
DOI from, among other things, (i) revoking, suspending or
refusing to renew BCBSMo's insurance license based in any
part upon the Reorganization and Public Offering; (ii)
commencing a valuation of BCBSMo's assets and demanding a
payment as a result of the Reorganization and Public
Offering; (iii) commencing any administrative hearing or
making any administrative determination based in any part
upon the Reorganization and Public Offering; (iv)
instituting any seizure, receivership, conservatorship or
similar action or proceeding against BCBSMo based in any
part upon the Reorganization and Public Offering; and (v)
taking any other action, however denominated, against
BCBSMo based in any part upon the Reorganization and Public
Offering. This injunctive relief remains in place, but the
Court's December 30 Orders (described below) clarify that
the injunction does not prohibit the Director and DOI from
asserting that the post-Reorganization and Public Offering
operations of BCBSMo may violate the health services
corporation laws (even though such operations may have been
affected by the Reorganization and Public Offering).
On August 28, 1996, the Director and DOI filed an amended
answer asserting a new counterclaim that the Reorganization
and Public Offering were not reasonably designed to serve
any of BCBSMo's purposes as a health services corporation
and seeking a declaration that BCBSMo has exceeded or
abused its authority conferred upon it by law. Under this
counterclaim, the Director and DOI seek an order to
rehabilitate BCBSMo or, in the alternative, injunctive
relief.
On October 18, 1996, the Missouri Attorney General filed a
motion for leave to file an amended counterclaim against
BCBSMo seeking a declaration that BCBSMo is a public
benefit corporation, not a mutual benefit corporation, and
requesting an order that BCBSMo amend its Articles of
Incorporation accordingly. The Court granted the Missouri
Attorney General's motion for leave to file the amended
counterclaim, which remains pending.
On December 30, 1996, the court issued five orders (the
December 30 Orders): (i) denying BCBSMo's motion for
summary judgment against the Missouri Attorney General;
(ii) granting the Missouri Attorney General's motion for
partial summary judgment against BCBSMo; (iii) denying
BCBSMo's supplemental motion for summary judgment against
the Director and DOI on their amended counterclaim; (iv)
granting the Director and DOI's motion for summary judgment
against BCBSMo on their amended counterclaim; and (v)
modifying, in part, the Court's previous September 9 Order
as described above. The December 30 Orders declared that
(i) BCBSMo has continued to exceed or abuse its statutorily
permissible purposes and the authority conferred on it by
law; and (ii) BCBSMo is subject to judicial dissolution
proceedings, but that prior to ordering dissolution, the
Court is required to consider whether there are
alternatives to dissolution and whether dissolution is in
the public interest or is the best way of protecting the
interests of its members.
The Court also (i) certified the December 30 Orders and the
September 9 Order, as modified, for immediate appeal; (ii)
held in abeyance further proceedings on the Missouri
Attorney General's counterclaim pending appeal; and (iii)
stayed the legal effect of the order granting the Director
and DOI summary judgment pending the filing of an appeal
bond (which BCBSMo promptly filed). On January 9, 1997,
BCBSMo filed a notice of appeal of the December 30 Orders.
On January 21, 1997, the Director and DOI filed a notice of
appeal of the September 9 Order, as modified. Oral
arguments were heard by the Missouri Appellate Court on
February 24, 1998.
Notwithstanding the December 30 Orders, the company still
believes that the counterclaims of the Director, the DOI
and the Missouri Attorney General are without merit and
that BCBSMo's legal position is strong. If, however,
BCBSMo does not prevail on appeal in overturning the
summary judgment in favor of the Missouri Attorney General,
it may be subject to dissolution proceedings if the Court
determines that no reasonable alternatives to dissolution
exist. Likewise, BCBSMo could be unsuccessful on the
appeal of the relief already granted against the Director
and DOI or in its defense of the Missouri Attorney
General's amended counterclaim. Any of the foregoing could
have a material adverse effect on the company and the
market for the company's stock. See also "Contingencies -
Status of Blue Cross and Blue Shield trademark licenses."
As described above, in Litigation with DOI and Attorney
General - Possible Settlement, BCBSMo and the company have
announced a conceptual framework for an agreement with the
DOI and the Missouri Attorney General which could resolve
this litigation. The parties to this litigation have
agreed pursuant to the terms of the conceptual framework,
to a "standstill" with respect to such litigation until
July 22, 1998. As a part of the conceptual framework, the
parties have advised the appellate court that they are
working toward a definitive agreement. There can be no
assurance, however, that the appellate court will refrain
from issuing a decision on the appeal described above or
that the appropriate court will approve any definitive
agreement proposed by the parties.
On November 3, 1997, BCBSMo filed an action in the Court
against the Missouri Attorney General seeking declarations
that (1) BCBSMo is a mutual benefit type of nonprofit
corporation under Chapter 355 of the Missouri Revised
Statutes; and (2) BCBSMo does not hold its assets in
constructive, charitable, or other trust for the benefit of
the public generally, but rather holds its assets for the
benefit of its subscribers. The action was filed in
response to continued public and private statements by the
Missouri Attorney General, the DOI and others that BCBSMo
is a public benefit type of nonprofit corporation which
holds its assets for the benefit of the public generally.
See above in this section, "Litigation with DOI and
Attorney General." The Missouri Attorney General has
filed an answer and counterclaim seeking a declaration
that BCBSMo is a public benefit type of nonprofit
corporation.
BCBSMo believes its legal position is strong and has taken
the position that it is a mutual benefit type of nonprofit
corporation, and that it holds no assets for the benefit of
the public generally. If BCBSMo is declared to be a mutual
benefit type of nonprofit corporation that does not hold
its assets for the benefit of the public generally, BCBSMo
will be free to continue to exercise its ownership interest
in the company consistent with the best interests of
BCBSMo's subscribers, subject to any rulings made in the
litigation described above in this section, "Litigation
with the DOI and Attorney General." If BCBSMo is declared
to be a public benefit type of nonprofit corporation or if
it is declared that BCBSMo holds assets for the benefit of
the public generally, however, BCBSMo might be required to
exercise its ownership interest in the company consistent
with the best interests of the public at large, which could
result in a determination to dispose of some or all of the
company's shares at times and in quantities that could be
detrimental to the market for the company's stock. Also,
if this were to occur, either the DOI or the Missouri
Attorney General could take actions against BCBSMo based
upon such declarations (such as seeking the appointment of
a receiver to safeguard assets deemed dedicated to the
public which could result in the termination of the
company's licenses to use the "Blue Cross" and "Blue
Shield" tradenames and service marks and trigger a
termination fee and a notice to members thereunder) which,
if successful, could have a material adverse effect upon
the company and the market for the company's stock. See
"Contingencies - Status of Blue Cross and Blue Shield
Trademark Licenses." As described above, in Litigation
with DOI and Attorney General - Possible settlement, BCBSMo
and the company have announced a conceptual framework for
an agreement with the DOI and the Missouri Attorney General
which could resolve this litigation. The parties to this
litigation have agreed pursuant to the terms of the
conceptual framework, to a "standstill" with respect to
such litigation until July 22, 1998. There can be no
assurance that the parties will reach a definitive
agreement, that all conditions and contingencies expected to
be included therein including court approval will be satisfied,
or that the transaction proposed by such an agreement will be
effected. See "Litigation with the DOI and Attorney General" above.
Litigation relating to the Market Conduct Study and Copayment
Calculations
The DOI issued a market conduct report to the company and
BCBSMo in April 1996. The report findings cited the
company and BCBSMo for not complying with certain insurance
statutes and regulations including those that relate to the
Small Employer Health Insurance Availability Act,
coordination of benefits and copayment calculations. The
company responded to the report in May 1996. The company
and the DOI have had discussions relating to the issues
contained in the report from May 1996 to February 1998. On
February 11, 1998, the DOI filed a Notice of Institution of
Case requesting the Director to issue a cease and desist
order, an order requiring the payment of a monetary
penalty, an order to cease marketing and/or an order
suspending or revoking the certificate of authority of the
company and BCBSMo. The company has alleged in the action
described above under "Litigation with DOI and Attorney
General - Litigation relating to the Reorganization and
Public Offering," that the market conduct study was not
conducted for legitimate purposes of regulatory oversight
but rather as a pretext to either revoke or refuse to renew
BCBSMo's license to operate as a health services
corporation and thus to improperly pressure and coerce
BCBSMo into making the payment in the nature and amount
described above. The DOI believes the company should
refund excess premium payments to the small groups, pay
additional refunds to members for copayment calculations
made prior to January 1996, and take certain actions
relating to coordination of benefits. The issue relating
to the manner in which the company calculated copayment
amounts prior to January 1996 was the subject of a class
action suit, titled Kelly v. Blue Cross and Blue Shield of
Missouri, and subsequent settlement. BCBSMo settled the
case in 1995 and paid the majority of the total settlement
amount of five million dollars. The company believes it
has resolved this issue through the court-approved class
action settlement and intends to vigorously defend this new
action. As described above, in Litigation with DOI and
Attorney General - Possible Settlement, BCBSMo and the
company have announced a conceptual framework for an
agreement with the DOI and the Missouri Attorney General
which could resolve this litigation. The parties to this
litigation have agreed pursuant to the terms of the
conceptual framework, to a "standstill" with respect to
such litigation until July 22, 1998. There can be no
assurance that the parties will reach a definitive
agreement, that all conditions and contingencies expected
to be included therein including court approval will be satisfied,
or that the transaction proposed by such an agreement will be
effected. See "Litigation with the DOI and Attorney General" above.
On February 9, 1998, the Missouri Attorney General filed
suit against the company, BCBSMo, BlueCHOICE, Healthy
Alliance Life Insurance Company (HALIC), and Preferred
Health Plans of Missouri, Inc. (a subsidiary of the
company) in the Court seeking injunctive relief,
compensatory damages and civil penalties under Missouri's
Merchandising Practices Act for the way in which the
company disclosed and marketed copayment amounts prior to
January 1996. The factual allegations in the Missouri
Attorney General's suit are the same as the copayment
issues in the DOI Market Conduct Study Action and the same
issue which was the subject of a court-approved class
action suit settlement in the Kelly v. Blue Cross and Blue
Shield of Missouri case. The company discontinued the
copayment practices in January 1996. The company believes
it has already paid the restitution damages requested in
the settlement of the class action suit. BCBSMo and the
company believe the claims are without merit and intend to
vigorously defend the action. As described above, in
Litigation with DOI and Attorney General - Possible
Settlement, BCBSMo and the company have announced a
conceptual framework for an agreement with the DOI and the
Missouri Attorney General which could resolve this
litigation. The parties to this litigation have agreed,
pursuant to the terms of the conceptual framework, to a
"standstill" with respect to such litigation until July 22,
1998. There can be no assurance that the parties will
reach a definitive agreement, that all conditions and contingencies
expected to be included therein including court approval will be
satisfied, or that the transaction proposed by such an agreement will be
effected. See "Litigation with the DOI and Attorney
General" above.
Status of Blue Cross and Blue Shield trademark licenses
In March 1998, the Blue Cross and Blue Shield Association
(BCBSA) agreed to reinstate BCBSMo's exclusive trademark
licenses (the Primary Licenses) and the exclusive
controlled licenses (the Affiliate Licenses) of the
company, HALIC and BlueCHOICE (collectively, the Licenses).
The Licenses give the companies the right to use the "Blue
Cross" and "Blue Shield" names, trademarks and service
marks in connection with health insurance products marketed
and sold in BCBSMo's licensed operating area (consisting of
85 counties in eastern and central Missouri). The Licenses
replaced the Interim and Temporary Licenses granted in
January 1997 after notification by the BCBSA that the prior
licenses of BCBSMo and its affiliates had automatically
terminated in connection with the Litigation relating to
the Reorganization and Public Offering described above
(Litigation). The trademark licenses require BCBSMo, the
company and its controlled affiliates to pay license fees
to BCBSA for the use of the trademarks.
Each of the trademark licenses provide that it
automatically terminates if, among other things: (i) DOI
or another regulatory agency assumes control of the
licensee or delinquency proceedings are instituted; or (ii)
an action is instituted by any governmental entity or
officer against the licensee seeking dissolution or
liquidation of its assets or seeking the appointment of a
trustee, interim trustee, receiver or custodian for any of
its property or business, which is consented to or
acquiesced in by the licensee or is not dismissed within
130 days of the licensee being served with the pleading or
document commencing the action, provided that if the action
is stayed or its prosecution enjoined, the 130-day period
is tolled for the duration of the stay or injunction, and
provided further that the BCBSA's Board of Directors may
toll or extend the 130-day period at any time prior to its
expiration. Each trademark license also provides that it
may be terminated by BCBSA if, among other things, the
licensee fails to meet certain quality control standards or
minimum capital or liquidity requirements.
The Affiliate Licenses are derivative of the Primary
Licenses and automatically terminate if the Primary
Licenses terminate. According to their terms, if a
trademark license is terminated, BCBSMo, the company and
its controlled affiliates are jointly liable to BCBSA for
payment of a termination fee in an amount equal to $25
times the number of licensed enrollees of the terminated
entity and its licensed controlled affiliates, and must
give written notice of such termination to their enrollees.
The termination fee is reduced in accordance with a formula
set forth in the Primary Licenses if another plan is
licensed by BCBSA in BCBSMo's exclusive service area.
In March 1998, BCBSMo and BCBSA agreed that the Primary
Licenses are reinstated as if a suit seeking dissolution
had been served on BCBSMo but the 130-day period for
automatic termination described above was tolled. The
tolling will continue for as long as the stay entered in
the Litigation remains in full force and effect. In the
event that the stay is modified or lifted, the 130-day
period will begin to run on such date and no longer be
tolled. If the 130-day period elapses without BCBSA having
taken affirmative action to extend the 130-day tolling
period, the Reinstated Primary Licenses will automatically
and immediately terminate.
The company believes that the exclusive right to use the
"Blue Cross" and "Blue Shield" trademarks provides it and
its controlled affiliates with a significant marketing
advantage in BCBSMo's licensed operating area, the loss of
which would have a material adverse effect on the company
and the market for the company's stock. In connection with
the conceptual framework described above, under "Litigation
with DOI and Attorney General - Possible Settlement,"
BCBSMo and the company have filed a request with the BCBSA
to transfer its Primary License to the company as part of
the proposed transaction whereby the company would absorb
assets and certain liabilities of BCBSMo, other than
approximately 15 million shares of the company's stock held
by BCBSMo. There can be no assurance that the BCBSA will
approve such a request or that the proposed transaction will
be effected.
Litigation with MCHCP
On August 28, 1997, the company brought suit against the
Missouri Consolidated Health Care Plan (MCHCP) and its
trustees in the Circuit Court of Cole County, Missouri.
MCHCP is a Missouri public agency which purchases health
care coverage for employees of the State and of selected
public entities which have been admitted into the MCHCP.
MCHCP is currently the largest customer group served by
BlueCHOICE, a subsidiary of the company. In 1995, the
company, after bidding on certain Requests for Proposal
from MCHCP, was awarded a contract to furnish various
managed care products to employees of the State and to
public entities. The contract was for an initial one-year
term with four one-year renewal terms. The respective
rights of the parties to renew the contract and the
applicable rates for any such renewal term are presently in
dispute. MCHCP has purported to renew the contract for the
years 1997 and 1998.
In its lawsuit, the company contends that under the
language of the applicable contract, MCHCP has express and
implied duties to negotiate the amount of any rate increase
that might become effective for each succeeding one-year
renewal term. It is the company's position that if no
agreements to the negotiated rates can be reached, MCHCP's
sole remedy is to request bids from other insurers. It
further contends that MCHCP has breached that duty by
renewing the contract from year to year while allowing only
limited rate increases, without negotiation. The company
further contends that MCHCP has violated Missouri law by
admitting numerous public entities into the MCHCP without
conducting any actuarial or other appropriate analysis,
thus compelling the company to provide managed care
services to public entities without regard to the actuarial
risk that they pose. The company also contends that MCHCP
violated the Missouri Administrative Procedure Act in the
manner in which it adopted the regulations by which it
administers its managed care program, and that MCHCP has
violated the Missouri Open Meetings and Open Records Law in
the manner in which it has conducted its business.
The company contends in its lawsuit that it has been
damaged in the 1997 plan year in an amount in excess of $5
million, and that it will have estimated losses during the
1998 plan year under its contract with MCHCP in an amount
in excess of $10 million. The company further contends
that if the contract is renewed for the 1999 and 2000 plan
years without requested rate increases, it will have
further losses. On August 29, 1997, the company reported
the commencement of the litigation and estimated losses
(giving effect to all possible renewal terms of the MCHCP
contract without requested rate increases) in the range of
$30 million to $40 million. In the third quarter of 1997,
the company took a pre-tax charge of $29.5 million, which
was based on actuarial estimates, including projected
limited rate increases, and projected enrollment and
medical cost trends accounted for through the year 2000 in
accordance with generally accepted accounting principles.
There can be no assurance that the amount of the reserve
taken in the third quarter would be sufficient to cover all
losses which may be associated with the MCHCP contract,
which losses could have a material adverse effect on the
company and the market for the company's stock.
For its relief, the company seeks a permanent injunction
against the promulgation and implementation by MCHCP of any
rates for the 1998 plan year other than rates which are the
product of the negotiation process called for by the
parties' contract, and for a decree of specific performance
requiring MCHCP to negotiate rates in good faith for the
1998 plan year and later plan years. Absent such relief,
the company prays for a declaration that the contract is
void and is of no effect. The company also prays for
damages in the amount of its losses incurred, for its
attorney fees, for relief for violation of the Open
Meetings Law, and for such other relief as is appropriate.
Also on August 28, 1997, and in anticipation of the
company's suit, MCHCP filed suit against BCBSMo, the
company and HealthLink HMO, Inc., a wholly owned subsidiary
of the company (HealthLink HMO). MCHCP in its lawsuit
contended that the company and HealthLink HMO had committed
anticipatory breaches of their contracts with MCHCP, and
had tortiously interfered with MCHCP's contractual
relations with its members. It prayed only for equitable
relief, in the form of a decree compelling the company and
HealthLink HMO to perform in accordance with MCHCP's
interpretation of the contracts' terms.
Subsequently, HealthLink HMO and Continental Assurance Co.
(CNA) filed suit in the Circuit Court of Cole County,
Missouri against MCHCP. HealthLink HMO is a party to an
HMO contract with MCHCP similar to the contract of the
company; substantially all the underwriting risk under that
contract is borne by CNA under an agreement between
HealthLink HMO and CNA. HealthLink HMO and CNA seek relief
similar to that sought on behalf of the company, including
a declaration that their contract with MCHCP is void and of
no effect. On March 18, 1998, MCHCP dismissed its claims
against HealthLink HMO and CNA without prejudice and
HealthLink HMO and CNA similarly dismissed their claims
against MCHCP without prejudice.
On March 16, 1998, MCHCP voluntarily dismissed its suit
against the company which had accused the company of
anticipatory breach of contract and tortious interference
with MCHCP's members; however, the MCHCP was allowed to
amend its petition to include a declaratory judgment action
relating to the entrance of public entities into the MCHCP.
On March 19, 1998, the trial court entered rulings on
various motions and cross-motions for summary judgment of
the parties. On a motion for summary judgment filed by
another contractor, the Court ruled that under the uniform
contract between MCHCP and its contractors, rate increases
from year to year are limited to the medical cost component
of the Consumer Price Index. On motions for summary
judgment filed by RightCHOICE, the Court held that MCHCP's
rules relating to the admission of public entities and its
adoption of a community rating policy were lawful under the
Missouri Administrative Procedure Act, and that RightCHOICE
is estopped from questioning the validity of those rules
and policies. The Court also held that MCHCP did not
violate the Missouri Open Meetings and Open Records Act in
the manner in which it responded to a request for access to
public records made by RightCHOICE, and that RightCHOICE's
claims for breach of the Act in the conduct of closed
meetings are time barred as to all meetings conducted on or
before February 27, 1997. RightCHOICE's claims based on
alleged violation by MCHCP of the covenant of good faith
and fair dealing remain pending in the trial court. MCHCP
has moved for summary judgment on those claims.
The company continues to consider its options. The
ultimate outcome of the litigation cannot be predicted with
certainty, but it is likely that no more favorable result
will be achieved unless a decision is made to appeal the
decisions of March 19, and the appellate court takes a
different view of the legal issues than did the trial
court. Should MCHCP prevail, the company would be held
contractually bound to serve the MCHCP members through the
year 2000 at the rates contracted for in 1995, with annual
rate increases, if any, which are far less than necessary
to permit the company to recover its costs in serving those
members. While management of the company believes the
current provision for losses is adequate, if the actual
public entity membership in MCHCP grows at a rate in excess
of the rate used in the actuarial estimates, or if the
projected limited rate increases and medical cost trends
should differ materially from those assumed in the
actuarial estimates, then the amount of the reserve
recorded to date could be insufficient to cover all future
losses which may be associated with the MCHCP contract, and
such losses could have a material adverse effect on the
company and the market for the company's stock.
Other contingencies
In addition to the matters described above, the company is
a party to litigation in the normal course of business,
including professional liability and litigation with former
executives of the company.
3. Recently Issued Accounting Standards
The Financial Accounting Standards Board (FASB) recently
released Statement of Financial Accounting Standards (SFAS)
No. 131, "Disclosures about Segments of an Enterprise and
Related Information" and SFAS No. 132, "Employers'
Disclosures about Pensions and Other Postretirement
Benefits." SFAS No. 131 establishes standards for the way
public business enterprises report information about
operating segments in annual financial statements and
requires that those enterprises report selected information
about operating segments in interim financial reports
issued to shareholders. It also establishes standards for
related disclosures about products and services, geographic
areas, and major customers. The new rules will be
effective for the 1998 fiscal year. Abbreviated quarterly
disclosure will be required beginning first quarter of
1999, with both 1999 and 1998 information. SFAS No. 132
revises employers' disclosures about pension and other
postretirement benefit plans. It does not change the
measurement or recognition of those plans. It standardizes
the disclosure requirements for pensions and other
postretirement benefits to the extent practicable, requires
additional information on changes in the benefit
obligations and fair values of plan assets that will
facilitate financial analysis, and eliminates certain
disclosures that are no longer considered useful. The new
rules will be effective for the 1998 fiscal year.
In March 1998, the Accounting Standards Executive Committee
issued Statement of Position (SOP) 98-1, "Accounting for
Computer Software Developed For or Obtained For Internal-
Use," which is effective for fiscal years beginning after
December 15, 1998. The SOP requires preliminary stage
project costs to be expensed as incurred. Once a project
is in the application development stage, the SOP requires
all external direct costs for materials and services and
payroll and related fringe benefit costs to be capitalized,
and subsequently amortized over the estimated useful life
of the project. The company's management has not yet
assessed what the impact of the SOP will be on the
company's future results of operations or financial
position.
4. Provision for Income Taxes
The company's effective income tax rates of 53.0% and 38.7%
for the first quarters of 1998 and 1997, respectively,
presented in the Consolidated Statements of Income were
affected by non-deductible goodwill amortization.
5. Earnings Per Share
During March 1997, the Financial Accounting Standards Board
(FASB) released Statement of Financial Accounting Standards
No. 128, "Earnings per Share" (SFAS No. 128), which changed
the computation and disclosure of earnings per share. SFAS
No. 128 is effective for both interim and annual periods
ending after December 15, 1997 and earlier application is not
permitted.
Basic earnings per share are computed by dividing net income
by the weighted average number of common and common
equivalent shares outstanding during the year. Diluted
earnings per share are calculated by dividing net income by
the number of weighted average shares outstanding plus
additional shares representing stock distributable under
stock-based compensation plans using the treasury stock
method. For the first quarter of 1998 and 1997, there were
55 and 93,955, respectively, of dilutive potential common
shares that were added to the weighted average number of
shares outstanding in order to compute diluted earnings per
share. The antidilutive potential common shares that could
dilute earnings per share in the future were 714,421 and
47,732 as of March 31, 1998 and 1997, respectively.
6. Comprehensive Income
As of January 1, 1998, the company adopted SFAS No. 130,
"Reporting Comprehensive Income." SFAS No. 130 establishes
new rules for the reporting and display of comprehensive
income and its components. SFAS No. 130 requires unrealized
gains or losses on the company's available-for-sale
securities, which prior to adoption were reported separately
in shareholders' equity, to be included in other
comprehensive income. Prior year financial statements have
been reclassified to conform to the requirements of SFAS No.
130.
The components of other comprehensive income for the three
month periods ended March 31, 1998 and 1997 are as follows:
1998 1997
(in thousands)
Unrealized holding losses arising
during period, net of taxes $(891) $(1,327)
Less: reclassification adjustment for
gains included in net income,
net of taxes (361) (6,534)
Net unrealized losses on securities $(1,252) $(7,861)
7. Reclassifications
Certain reclassifications have been made to the Consolidated
Financial Statements for 1997 to conform with the 1998
presentation.
ITEM 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations
Results of Operations
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH
THE CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO.
EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, THIS
REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL
RESULTS, FINANCIAL CONDITION OR BUSINESS COULD DIFFER
MATERIALLY FROM ITS HISTORICAL RESULTS, FINANCIAL CONDITION
OR BUSINESS, OR THE RESULTS OF OPERATIONS, FINANCIAL
CONDITION OR BUSINESS CONTEMPLATED BY SUCH FORWARD-LOOKING
STATEMENTS. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH
DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED
IN THE SECTION ENTITLED "FACTORS THAT MAY AFFECT FUTURE
RESULTS OF OPERATIONS, FINANCIAL CONDITION OR BUSINESS."
The following table sets forth premium revenue by product
group for the three month periods ended March 31, 1998 and
1997 (unaudited):
Three Months Ended
March 31,
Product Group 1998 1997
(in thousands)
PPO:
Alliance PPO $ 47,990 $ 51,958
AllianceChoice POS 36,112 27,463
HMO (includes other POS) 52,325 43,331
Medicare supplement 24,193 24,660
Managed indemnity 2,368 3,600
Other specialty services 10,706 9,145
Total premium revenue 173,694 160,157
ASO/Self-funded and other income 18,158 16,157
Total revenues $191,852 $176,314
The following table sets forth selected operating ratios. The
medical loss ratio is shown as a percentage of health care
services expense over premium revenue. All other ratios are
shown as a percentage of premium revenue and fees and other
income combined:
Three Months Ended
March 31,
1998 1997
Operating revenues:
Premium revenue 90.5% 90.8%
Fees and other income 9.5% 9.2%
100.0% 100.0%
Operating expenses:
Medical loss ratio 83.2% 80.6%
Commission expense 4.0% 4.1%
General and administrative expense
(includes depreciation and
amortization) 21.3% 22.7%
Membership
The following table sets forth membership data and the percent
change in membership:
March 31
Product Group 1998 1997 %
Underwritten:
PPO:
Alliance PPO 147,400 175,538 (16.0)%
AllianceChoice POS 132,800 115,347 15.1
HMO:
Commercial (includes other POS) 132,599 116,845 13.5
BlueCHOICE Senior 5,707 5,710 (0.1)
BlueCHOICE Medicaid (MC+) 5,031 N/A
Medicare supplement 60,537 66,500 (9.0)
Managed indemnity 6,181 10,216 (39.5)
485,224 495,187 (2.0)
Self-funded:
PPO 46,451 92,427 (49.7)
HMO 13,622 15,229 (10.6)
ASO (includes HealthLink):
Workers' Compensation 366,532 317,271 15.5
Other ASO* 1,085,962 943,555 15.1
Total Membership 1,997,791 1,863,669 7.2%
* does not include 478,902 and 615,407 as of March 31,
1998 and March 31, 1997, respectively, relating to
additional third-party administrator members that are part
of The EPOCH Group, L.C., a joint venture with Blue Cross
and Blue Shield of Kansas City formed in December 1995.
Comparison of Results for First Quarter 1998 to First Quarter 1997
Revenues
Premium revenue increased 8.5 percent in the first quarter of
1998 in comparison to the first quarter of 1997. As
described below, components of premium revenue were affected
by shifts in product mix, rate increases, and other factors;
and as a result, such changes may not be indicative of future
periods. The company will continue to strive to establish
its commercial premium rates based on anticipated health care
costs. Depending on the level of future competition,
customer acceptance of the company's premium increases,
future health care cost trends or other factors, there can be
no assurance that the company will be able to price its
products consistent with health care cost trends.
PPO revenues increased $4.7 million - - $8.2 million due to
a 9.5 percent increase in net premium rates partially offset
by a $3.5 million decrease resulting from a 3.3 percent
decrease in member months. Net rates increased due in part
to the company's targeted general rate increases averaging 7
percent to 18 percent during enrollment periods in the first
quarter of 1998. Net rate increases are at the lower end of
the targeted range due in part to changes in deductibles, the
timing of group renewals throughout the year, and product mix
changes. Alliance PPO membership decreased by 28,138 members
from March 31, 1997 to March 31, 1998 while AllianceChoice
POS membership increased by 17,453 over the same time period.
The company also began offering PPO products in Illinois at
the end of the first quarter of 1997. Included in the
Alliance PPO member count are 3,300 PPO Illinois members as
of March 31, 1998.
HMO premium revenue increased $9.0 million or 20.8 percent -
- - $6.5 million due to a 15.3 percent increase in member
months and $2.5 million due to a 4.8 percent increase in net
premium rates. Net premium rates increased in part due to
the company's targeted general rate increases averaging 7 percent to
18 percent during enrollment periods in the first quarter of
1998. Net rate increases are lower than the targeted renewal
rates due to HMO competition in the company's HMO service
areas, the status of a large group (MCHCP) with which the
company is currently involved in litigation (see Note 2
entitled "Contingencies - Litigation with MCHCP" of Part I),
shifts in chosen benefit levels, changes in the geographic
mix of the HMO business, and product mix shifts. Membership
increases were driven primarily by an enrollment increase of
11,900 members in MCHCP products from March 31, 1997 to March
31, 1998. In addition, the company's efforts to expand
geographically outside of the St. Louis metropolitan area
resulted in a 25.2 percent increase (9,100 members) in non-
MCHCP members in these regions over the same time period.
The company's future enrollment growth in its products and
geographic regions is dependent on network attractiveness,
continued cooperation with physician hospital organizations,
and other factors. There can be no assurance that these
objectives will be realized. Future enrollment growth in the
company's products offered to MCHCP and revenues generated
therefrom are also dependent on the litigation with MCHCP and
other factors (see "Contingencies - Litigation with MCHCP").
Effective March 1, 1998, the company discontinued its
Medicaid product in an 18-county central Missouri region.
The decision to discontinue was made due to what the company
believes were unacceptable terms proposed by the State of
Missouri. As of December 31, 1997, the company had
approximately 5,100 members enrolled in its Medicaid product.
Premium revenue from Medicare supplement decreased by $0.5
million in the first quarter of 1998. Premium rates
increased 7.7 percent partially offset by an 8.9 percent
decrease in member months.
Managed indemnity premium revenue decreased by $1.2 million
due to a 39.2 percent decline in member months in keeping
with the company's strategy to move towards more highly
managed care products.
Revenue from other specialty services increased $1.6 million
due to a 1.5 percent increase in member months and a 15.3
percent increase in net premium rates. The company's drug
products including AllianceRx continued to gain momentum with
revenues increasing $1.5 million due to a 2.6 percent
increase in member months in the first quarter of 1998 as
compared to the first quarter of 1997.
Fees and other income from administrative services only/self-
funded and network services increased by $2.0 million. This
increase is primarily due to increased 1998 revenues from
HealthLink, Inc. (HealthLink), the company's network rental
and managed care service subsidiary, of $3.8 million.
HealthLink's revenues increased due to an 18.0 percent
increase in members from March 31, 1997 to March 31, 1998.
HealthLink's increases to fees and other income were
partially offset by decreases to revenue caused by the loss of
approximately 72,000 members in the company's self-funded business
due to the nonrenewal of three large groups. One of these groups,
comprised of approximately 30,000 members, enrolled in
HealthLink's self-funded ASO plans in 1998.
Operating Expenses
The overall medical loss ratio increased from 80.6 percent in
the first quarter of 1997 to 83.2 percent in the first
quarter of 1998. The overall medical loss ratio has
increased primarily as a result of continued escalation of
the medical cost trend, driven by increased cost and
utilization of both outpatient services and drug therapies.
The medical loss ratios of both quarters were adversely
impacted by the poor performance of MCHCP (see Note 2
entitled "Contingencies - Litigation with MCHCP" in Part I).
The company continues the efforts initiated in 1997 to modify
its pharmacy benefits management program and recontract with
physicians and ancillary service providers. The drug cost
trend has increased to the low twenty percent range, driven
by a combination of factors, including introduction of new
drug therapies; physicians' use of newer, more expensive
drugs; and physicians' decreased use of generic drugs in
favor of specific drugs promoted by pharmaceutical companies.
Among the medical cost control strategies targeted for 1998
are a combination of changes in the pharmacy program to save
costs and increase member satisfaction through: introducing
a new three-tiered benefit design that allows members to make
choices, albeit with a higher member copayment; and making
other adjustments to copayments, quantity limits and
exclusions. Physician education, utilization and prescribing
pattern analysis will be increased. The company will also
continue its hospital, physician and service recontracting
strategy, using the more detailed data and analysis available
through the company's information and operating strategy
(IOS), which is comprised of projects being implemented to
improve business processes and systems. There can be no
assurance that the company's initiatives to control future
increases in medical cost trends to improve the medical loss
ratio will be effective.
Commission expense increased by $0.5 million or 6.2 percent
in the first quarter of 1998 as compared to the first quarter
of 1997; however the commission expense ratio dropped to 4.0
percent for the first quarter of 1998 as compared to 4.1
percent for the first quarter of 1997.
General and administrative expenses (excluding depreciation
and amortization) increased by $1.3 million, or 3.8 percent
in the first quarter of 1998 as compared to the first quarter
of 1997. This increase is partially due to a $1.6 million
increase in HealthLink expenses.
Depreciation and amortization expenses decreased by $0.4
million in the first quarter of 1998 as compared to the first
quarter of 1997 primarily due to intangible assets that
became fully amortized during 1997. Amortization expenses
for completed components of the company's information and
operations strategy (IOS) project increased by $0.6 million
in the first quarter of 1998 as compared to the first quarter
of 1997. See "Outlook - Information Strategies" for more
information related to this project.
Operating Loss
Operating loss decreased by $0.9 million in the first quarter
of 1998 in comparison to the first quarter of 1997. Non-
recurring relocation charges in the first quarter of 1997 of
$2.1 million related to costs associated with the company's
relocation of its St. Louis-based claims, customer service,
billing, and provider services functions to its Springfield,
Missouri facility and a new facility in Cape Girardeau,
Missouri. This relocation effort was completed in 1997.
Net Investment Income
The first quarter 1998 net investment income of $4.4 million
represents a $9.1 million decrease over the first quarter of
1997, inclusive of a $9.6 million decrease in net realized
gains. Realized gains in the first quarter of 1997 resulted
primarily from the liquidation of equity securities due to
the company's intent to increase its holdings of fixed income
securities and the company's decision to repay $15.0 million
of its debt in the first quarter of 1997.
Provision for Income Taxes
The company's effective income tax rates were 53.0 percent
and 38.7 percent for the first quarter of 1998 and 1997,
respectively. The company's effective income tax rates for
1998 and 1997 were affected by non-deductible goodwill
amortization.
Net Income
The company's net income of $1.0 million, or $0.05 per share,
for the first quarter of 1998 represents a decrease of $5.2
million compared to first quarter 1997 net income of $6.2
million, or $0.33 per share.
Liquidity and Capital Resources
The company's working capital as of March 31, 1998 was $67.0
million, a decrease of $2.7 million from December 31, 1997.
The decrease is partially attributable to $2.5 million of
additional debt from the company's reducing revolving credit
facility that became a current payable during the first
quarter of 1998. In addition, the company capitalized $2.6
million of costs for property and equipment purchases, $2.1
million of which relates to capitalized IOS development
costs. The company's unrealized net appreciation of
investments available for sale decreased by $1.3 million in
1998.
Net cash used in operations totaled $1.0 million for the
three months ended March 31, 1998. The company's net income
was $1.0 million which included (on a before tax basis) $0.6
million of realized gains from the sale of investments and
$4.6 million of depreciation and amortization expenses. In
addition, other assets, medical claims payable, receivables
from members, and net intercompany receivables were affected
by the timing of operating cash payments and receipts,
intercompany tax settlements, as well as changes in
membership and utilization and claims payment trends.
On August 29, 1997, the company reported the commencement of
the litigation with MCHCP (see Note 2 entitled "Contingencies
- - Litigation with MCHCP" of Part I) and estimated losses
(giving effect to all possible renewal terms of the MCHCP
contract without requested rate increases) in the range of
$30 million to $40 million. In the third quarter of 1997,
the company took a pre-tax charge of $29.5 million, which was
based on actuarial estimates, including projected limited
rate increases, and projected enrollment and medical cost
trends accounted for through the year 2000 in accordance with
generally accepted accounting principles. The health care
services caption of the 1998 Consolidated Statement of Income
includes credit for the amortization of this loss reserve
provision during the first quarter of 1998. There can be no
assurance that the amount of the reserve taken in the third
quarter will be sufficient to cover all losses which may be
associated with the MCHCP contract, which losses could have a
material adverse effect on the company and the market for the
company's stock.
Recent Developments
Information and operations strategy
In 1995, the company implemented a comprehensive information
and operations strategy (IOS) to assist the company in
implementing its managed care strategy of delivering the
lowest cost medical care consistent with quality outcomes.
The company believes that controlling medical costs in the
future will be highly dependent on readily accessing both
member and provider medical information at a detail level
which provides real-time analytical support. The company
receives capital expenditure authorizations from the Board of
Directors to expend funds for the project subject to periodic
review by an ad-hoc committee of the board. In the first
three months of 1998, the company incurred capitalized
expenditures of $2.1 million on this project. Cumulatively,
since 1995, the company has incurred capitalized expenditures
of $41.1 million. The company anticipates that it will
expend approximately $10 million for capitalized costs
associated with the IOS project in 1998 and an additional $9
million for capitalized costs in subsequent years to complete
the project. While management believes that the IOS project
will initially be dilutive to earnings per share, it is
believed that opportunities exist for significant medical and
administrative savings, which are expected to provide a
payback and contribute to earnings per share over the long
term.
Year 2000 issue
In January 1996, the company began converting its computer
systems to be year 2000 compliant (e.g. to recognize the
difference between 1999 and 2000 as one year instead of
negative 99 years). The company's operations would be
significantly impacted by incomplete or untimely resolution
of the problem as the company utilizes automated systems to
process claims, prepare invoices, retain membership data,
perform utilization management, and many other processes.
The company believes that at March 31, 1998, approximately 35
percent of the company's systems were compliant, with all
systems expected to be compliant by March 31, 1999. The
total cost of the project is estimated to be between $8
million and $10 million. The company is expensing all costs
associated with these system changes. From 1996 through
March 31, 1998, the company has cumulatively expensed $4.0
million on this project with $1.3 million expensed in the
first three months of 1998.
Recently issued accounting standards
The Financial Accounting Standards Board (FASB) recently
released Statement of Financial Accounting Standards (SFAS)
No. 131, "Disclosures about Segments of an Enterprise and
Related Information" and SFAS No. 132, "Employers'
Disclosures about Pensions and Other Postretirement
Benefits." SFAS No. 131 establishes standards for the way
public business enterprises report information about
operating segments in annual financial statements and
requires that those enterprises report selected information
about operating segments in interim financial reports issued
to shareholders. It also establishes standards for related
disclosures about products and services, geographic areas,
and major customers. The new rules will be effective for the
1998 fiscal year. Abbreviated quarterly disclosure will be
required beginning first quarter of 1999, with both 1999 and
1998 information. SFAS No. 132 revises employers'
disclosures about pension and other postretirement benefit
plans. It does not change the measurement or recognition of
those plans. It standardizes the disclosure requirements for
pensions and other postretirement benefits to the extent
practicable, requires additional information on changes in
the benefit obligations and fair values of plan assets that
will facilitate financial analysis, and eliminates certain
disclosures that are no longer considered useful. The new
rules will be effective for the 1998 fiscal year.
In March 1998, the Accounting Standards Executive Committee
issued Statement of Position (SOP) 98-1, "Accounting for
Computer Software Developed For or Obtained For Internal-
Use," which is effective for fiscal years beginning after
December 15, 1998. The SOP requires preliminary stage
project costs to be expensed as incurred. Once a project is
in the application development stage, the SOP requires all
external direct costs for materials and services and payroll
and related fringe benefit costs to be capitalized, and
subsequently amortized over the estimated useful life of the
project. The company's management has not yet assessed what
the impact of the SOP will be on the company's future results
of operations or financial position.
Operating outlook
The following statements are based on short-term
expectations. The statements are forward-looking and actual
results may differ materially. Reference is made to the
information set forth under the caption "Factors that May
Affect Future Results of Operations, Financial Condition or
Business" that follows. The company expects that 1998 will
be a transitional year with targeted improvements and the
expectation of entering 1999 with a strong operating base.
The company's performance targets for 1998 include: overall
premium revenue growth per member per month in the 9 percent
to 10 percent range, reflecting price increases in the high
teens to low twenties (in percentages) for some categories of
members, consistent with market trends; maintaining the
medical loss ratio in the low eighties (in percentages), with
an anticipated net medical cost increase per member per month
of approximately 5 percent to 7 percent, inclusive of
pharmacy benefits, medical services, and the cost of
government-mandated benefits; continued reduction in core
overhead expenses, with amortization expense for IOS,
investments in programming to accommodate the year 2000, and
other initiatives contributing to a general and
administrative expense ratio in the low twenties (in
percentages).
The company's ability to deliver these performance targets is
dependent on, among other things, achieving targeted sales to
new members and retention rates at higher prices, and
realizing projected medical and overhead cost savings.
Contingencies
See the description under the same caption in Note 2 of the
Notes to Consolidated Financial Statements of Item I, which
description is incorporated herein by reference.
Factors that May Affect Future Results of Operations, Financial
Condition or Business
Pursuant to the safe harbor provisions for forward-looking
statements contained in Section 27A of the Securities Act of
1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended, added to those Acts by the Private
Securities Litigation Reform Act of 1995, the company is
identifying important risks and uncertainties that could
cause the company's actual results of operations, financial
condition or business to differ materially from its
historical results of operations, financial condition or
business, or the results of operations, financial condition
or business contemplated by forward-looking statements made
herein or elsewhere orally or in writing. Factors that could
cause or contribute to such differences include, but are not
limited to, those factors described below.
Conceptual framework for settlement of certain litigation matters
and reorganization of the company
On April 22, 1998, the company announced that a conceptual
framework has been proposed by BCBSMo, the company, the
Missouri Attorney General, and the Director of the Missouri
Department of Insurance with the support of the Missouri
Governor to resolve the outstanding litigation and regulatory
disputes between the company, BCBSMo and the state and create
an independent health care foundation. The conceptual
framework is described further in Note 2, "Contingencies -
Litigation with DOI and Attorney General - Proposed
Settlement" of Part I, Financial Information, and such
description is incorporated by reference in its entirety in
this section. As contemplated by the conceptual framework,
the company and BCBSMo will endeavor to negotiate and execute
a definitive agreement for the proposed transaction. There
can be no assurance that a definitive agreement will be
negotiated and executed, that it will receive the necessary
court approval, that all of the conditions and contingencies
expected to be included therein will be satisfied, or that the
transaction will be effected. The inability to reach such a
definitive agreement and complete the proposed transaction
could have a material adverse effect on the company and the
market for the company's stock. See the information under the
caption "Litigation with DOI and Attorney General" below for
further details on the specific risk factors associated with
certain litigation in the event that a definitive agreement is
not reached and the proposed transaction is not effected as
contemplated by the conceptual framework.
OPM audit
Reference is made to the information included under the
caption in Note 2 entitled "Contingencies - OPM audit" of Part
I, Financial Information which information is incorporated by
reference in its entirety in this section. At this time,
management is unable to determine the final dollar amount
which may be required to resolve the audit findings. There
can be no assurance that the resolution of these findings will
not have a material adverse effect on the company and the
market for the company's stock.
Subscriber class action litigation
Reference is made to the information included under the
caption in Note 2 entitled "Contingencies - Subscriber class
action litigation" of Part I, Financial Information which
information is incorporated by reference in its entirety in
this section. There can be no assurance that the ultimate
outcome of this litigation will not have a material adverse
affect on the company and the market for the company's stock.
Litigation with DOI and Attorney General
Reference is made to the information included under the
caption in Note 2 entitled "Contingencies - Litigation with
DOI and Attorney General - Litigation relating to the
Reorganization and Public Offering" of Part I, Financial
Information which information is incorporated by reference in
its entirety in this section.
Reference also is made to the information included under the
caption in Note 2, entitled "Contingencies - Litigation with
DOI and Attorney General - Litigation relating to the Market
Conduct Study and Copayment Calculations" of Part I, Financial
Information which information is incorporated by reference in
its entirety in this section.
While the company believes, after reviewing the litigation
identified above with legal counsel, that BCBSMo's and the
company's legal positions are strong, the risks and
uncertainties of litigation are such that there can be no
assurance that BCBSMo and the company will prevail on all
issues, that the appellate court hearing the appeal of the
judgments relating to the Reorganization and Public Offering
will affirm all the rulings of the trial court favorable to
BCBSMo and will reverse the rulings of the trial court adverse
to BCBSMo, that the DOI and Missouri Attorney General will not
pursue administrative action during or after these
proceedings, or that any of such actions would not have a
material adverse impact on the company or the market for the
company's stock. The transactions contemplated by the
conceptual framework described above are intended to include
the resolution and dismissal of all of the litigation with the
DOI and the Missouri Attorney General identified above. If
BCBSMo, the company, the DOI, and the Missouri Attorney
General do not resolve these matters as proposed in the
conceptual framework or if, in the alternative, BCBSMo or the
company does not prevail in all of these matters, it is
possible that actions could be taken by BCBSMo, the Missouri
Attorney General, the DOI, the BCBSA or others which could
have a material adverse impact on the company or the market
for the company's stock.
Status of Blue Cross and Blue Shield Trademark Licenses
Reference is made to the information included under the
caption in Note 2 entitled "Contingencies - Status of Blue
Cross and Blue Shield trademark licenses" of Part I, Financial
Information which information is incorporated by reference in
its entirety in this section. If BCBSMo's and the company's
litigation against the DOI and the Missouri Attorney General
is not resolved in a manner that is in the best interests of
the BCBSA, the marks and the other Blue plans, then the
company's licenses to use such names and marks may be
terminated. The loss of such licenses and the obligation of
the company to pay a $25 per enrollee termination fee and
provide notice of termination to enrollees would have a
material adverse effect on the company and the market for the
company's stock.
Litigation with MCHCP
Reference is made to the information included under the
caption in Note 2 entitled "Contingencies - Litigation with
MCHCP" of Part I, Financial Information which information is
incorporated by reference in its entirety in this section.
The company is considering its options in light of recent
adverse rulings in the MCHCP litigation, including a possible
appeal. If the trial court's order becomes final, the company
would be contractually bound to serve the MCHCP members
through the year 2000 at the rates contracted for in 1995,
with annual rate increases, if any, which are no more than the
annual increase in the medical cost component of the Consumer
Price Index and far less than necessary to permit the company
to recover its costs in serving those members. In the third
quarter of 1997, the company recorded a pre-tax charge of
$29.5 million, which was based on actuarial estimates,
including projected limited rate increases, and projected
enrollment and medical cost trends accounted for through the
year 2000, in accordance with generally accepted accounting
principles. The company was advised by the DOI in March, 1998,
that the entire amount of the reserve for the MCHCP contract
recorded by the company for projected losses under the
contract through the year 2000 must, for statutory accounting
purposes, be recorded by the company's subsidiary, HMO
Missouri, Inc. (BlueCHOICE), on its statutory filings with
the DOI. With the prior regulatory approval of the DOI,
BlueCHOICE issued surplus notes to the company in the amount
of $29 million to ensure the statutory solvency of BlueCHOICE.
While management of the company believes the current provision
for losses is adequate, if the actual public entity membership
in MCHCP grows at a rate in excess of the rate used in the
actuarial estimates, or if the projected limited rate
increases and medical cost trends should differ materially
from those assumed in the actuarial estimates, then the amount
of the reserve recorded to date could be insufficient to cover
all future losses which may be associated with the MCHCP
contract, and such losses could have a material adverse effect
on the company and the market for the company's stock. In
addition, the company's Credit Agreement (described elsewhere
herein) provides that the company's subsidiaries, including
BlueCHOICE, may not issue surplus notes to the company in an
aggregate principal amount in excess of $40 million. As the
aggregate principal amount of surplus notes issued by such
subsidiaries to the company currently approximates $40
million, any additional funding required by any subsidiaries
of the company, including BlueCHOICE, as a result of
additional losses or reserves associated with the MCHCP
contract, or otherwise, would require approval of the lenders
under the Credit Agreement. See "- Credit Agreement
Restrictions."
Government Regulations and Health Care Reform
The company operates its managed health care business
principally through wholly owned subsidiaries whose business
is subject to extensive federal, state and local laws and
regulations. To date, these laws and regulations have not had
a significant negative impact on the growth of the company's
business. However, there can be no assurance that the company
will be able to obtain or maintain required governmental
approvals or licenses or that any current or proposed federal
and state legislation or other regulatory reform such as
President Clinton's Patient's Bill of Rights, the Health
Insurance Portability and Accountability Act of 1996 (HIPAA),
Missouri's House Bill 335 (HB335), and mandatory benefits
(e.g. mandatory maternity benefits), which have all increased
the regulatory requirements imposed on the company and its
subsidiaries, will not have a material adverse effect on the
company's business or results of operations in the future.
Competition and Consolidation
The health care industry is highly competitive. The company
has numerous competitors in its PPO, POS and HMO operations,
many of which have substantially greater financial and other
resources than the company. Because the company's existing
business operations are confined to markets within or
contiguous to the state of Missouri, the company currently is
unable to subsidize losses in these markets with profits from
other markets. The company believes that certain larger,
national competitors are able to subsidize losses in the
Missouri market with profits from other markets in which they
operate and may pursue such a strategy in the company's
markets in an effort to increase their market share. Health
care providers are consolidating into larger health care
delivery enterprises and their increased bargaining power may
lead to a reduction in the gross margins of the company's
products and services. The company also faces competition in
its markets from a trend among some health care providers to
combine and form their own networks in order to contract
directly with employer groups and other prospective customers
for the delivery of health care services.
Escalating Health Care Costs
The company's profitability depends in large part on
predicting and effectively managing medical costs under its
managed care plans. A variety of external factors affecting
the delivery and cost of health care, including increased
costs and utilization of high-technology diagnostic testing
and treatments, the increasing cost and utilization of
prescription medications, the rising costs of malpractice
insurance, efforts in the medical community to avoid
malpractice claims, higher operating costs of hospitals and
physicians, the aging of the population and other demographic
characteristics, changes in federal and state health care
regulations and major epidemics may adversely affect the
company's ability to predict and control health care costs and
claims. Other relevant factors affecting the company's
ability to control health care costs include higher outpatient
and drug utilization, medical and drug cost trends, and growth
of business in regions with less cost efficient networks.
Dependence on Sales to Individuals
Sales of the company's health care benefit products to
individuals comprise a substantial portion of the company's
business. The medical loss ratio attributable to some
components of the company's individual business is
significantly lower than that of the company's insured group
business. As a result, individual business accounts for a
proportionately greater percent of the company's operating
income. The company's overall margins would be adversely
impacted by a reduction in the relative percent of its
business represented by certain individual products or by an
increase in the medical loss ratio for individuals enrolled in
those products. The company believes that the success of the
individual business is more dependent than that of its group
business on the management of health care costs through
product design, pricing decisions and the application of
appropriate underwriting standards. There can be no assurance
that the profitability of this business will be sustained or
that the company will not experience unanticipated increases
in claims.
Potential Nonrenewal of Subscriber and Provider Agreements
The company's profitability is dependent upon its ability to
obtain and maintain contracts with employee groups and
individual consumers which generally are renewable annually.
The company's profitability is also dependent, in large part,
on its ability to contract on favorable terms with hospitals,
physicians and other health care providers. There can be no
assurance that the subscribers or providers will renew their
contracts or enter into new contracts with the company or, in
the case of provider contracts, will not seek terms that are
less profitable to the company in connection with any such
renewal.
Control by BCBSMo
BCBSMo has voting control on all stockholder actions,
including the sale or merger of the company, a sale of
substantially all of its assets and the election of all of the
company's directors. BCBSMo may have interests with respect
to its ownership of the company that diverge from those of the
company's public shareholders. There can be no assurance that
the company will not be adversely impacted by the control that
BCBSMo has with respect to matters affecting the company.
Dependence on Key Management
The company depends to a significant extent on key management
members. Although the company has experienced turnover in
certain key management positions in the past, those positions
have been successfully filled. There can be no assurance,
however, that the loss of current key management would not
result in a material adverse effect on the company's results
of operations, financial condition or business.
Variability of Operating Results and Stock Price
The company's results of operations could be adversely
affected by the timing of new product and service
introductions, competitive pricing pressures, contract
renegotiations with customers and providers, fluctuations in
the medical loss ratio (due to changes in utilization, timing
of submission of claims presented for payment in the period
and the unpredictability of unusually large claims), increases
in commission expense and general and administrative expenses,
changes in interest rates, acquisitions, governmental and
regulatory actions, overall market conditions, and other
factors. The company's stock price may experience significant
price and volume fluctuations in response to these and other
internal and external factors which cause variations in its
results of operations and in the volatility of the stock
markets generally.
Credit Agreement Restrictions
The company's revolving credit agreement with its existing
lenders contains certain restrictions on the company and its
subsidiaries, including requirements as to the maintenance of
net worth and certain financial ratios, restrictions on
payment of cash dividends or purchases of stock, restrictions
on acquisitions, dispositions and mergers, restrictions on
additional indebtedness and liens, and limitations on
indebtedness of the company's subsidiaries and certain other
matters. There can be no assurance that the company will be
able to achieve and maintain compliance with the prescribed
financial ratio tests or other requirements of the revolving
credit agreement. As discussed in the company's 1997 annual
report on Form 10-K, the company amended its credit facility
in the fourth quarter of 1997. The failure to obtain any
waivers or similar amendments that might be needed in the
future to remain in compliance with such requirements would,
among other things, reduce the company's ability to respond to
adverse industry conditions and could have a material adverse
effect on the company's results of operations, financial
condition or business.
Year 2000 Issue
In January 1996, the company began converting its computer
systems to be year 2000 compliant (e.g. to recognize the
difference between 1999 and 2000 as one year instead of
negative 99 years). The company believes that at March 31,
1998, approximately 35 percent of the company's systems were
compliant, with all systems expected to be compliant by March
31, 1999. In addition, the company's plan for completion of
this project is partially dependent upon the work of third
parties. The company's operations would be significantly
impacted by incomplete or untimely resolution of the problem
as the company utilizes automated systems to process claims,
prepare invoices, retain membership data, perform utilization
management, and many other processes.
Additional Factors
Additional risk and uncertainties that may affect future
results of operations, financial condition or business of the
company include, but are not limited to: demand for and
market acceptance of the company's products and services; the
effect of economic and industry conditions on prices for the
company's products and services and its cost structure; the
ability to develop and deliver new products and services and
adapt existing products and services to meet customer needs
and expectations; the ability to keep pace with technological
change including developing and implementing technological
advances timely and cost effectively in order to lower its
cost structure, to provide better service and remain
competitive; adverse publicity, news coverage by the media, or
negative reports by brokerage firms, industry and financial
analysts regarding the company, its parent or BCBSA or their
products or services which may have the effect of reducing the
reputation, goodwill or customer demand for, or confidence in,
the company's products or services; the ability to attract and
retain capital for growth and operations on competitive terms;
and changes in accounting policies and practices.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
Note 2 to the Consolidated Financial Statements in Part I,
Item 1 contains a description of various pending and
threatened claims, including a description of the
subscriber class action lawsuit filed on March 15,
1996, litigation with the Missouri Department of
Insurance (DOI), the Director of the DOI, and the
Missouri Attorney General, litigation with the Missouri
Consolidated Health Care Plan (MCHCP), and other legal
proceedings, which descriptions are incorporated by
reference herein. Also, see "Management's Discussion
and Analysis of Financial Condition and Results of
Operations - Factors that May Affect Future Results of
Operations, Financial Condition or Business."
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
a) Exhibits
Exhibit
Number Exhibit
The following exhibits are submitted herewith:
2 Conceptual framework for agreement to resolve litigation and
regulatory issues with the Missouri Department of
Insurance and the Missouri Attorney General.*
27 Financial Data Schedule (Electronic Filing Only).
* Portion omitted pursuant to request for confidential treatment.
b) Reports on Form 8-K:
None filed during the three months ended March 31, 1998.
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 thereunto duly authorized.
RIGHTCHOICE MANAGED CARE, INC.
Registrant
Date: May 14, 1998 By: [s] JOHN A. O'ROURKE
John A. O'Rourke
President and Chief Executive Officer
Date: May 14, 1998 By: [s] SANDRA VAN TREASE
Sandra Van Trease
Chief Financial Officer,
Executive Vice President and
Chief Operating Officer
Exhibit 2
[Letterhead of Attorney General of Missouri]
April 20, 1998
Via Facsimile and Overnight Delivery
John Riffle, Esq.,
Lewis, Rice & Fingersh, L.C.,
500 N. Broadway, Suite 2000,
St. Louis, Missouri 63102.
Re: Blue Cross and Blue Shield of Missouri
Dear Mr. Riffle:
You have asked the State formally to propose terms that
would resolve the many outstanding legal and regulatory disputes
involving Blue Cross and Blue Shield (BCBS). Attached is our
proposal. It is our understanding that this proposal will be
presented to the Boards of Directors of BCBS and RightCHOICE
Managed Care, Inc. on Tuesday, April 21, 1998.
Please understand that, given the breadth and
complexity of the issues involved, the purpose of the attached
proposal is not to serve as an offer of a binding contract.
Rather, the attachment articulates a framework within which the
Department and the Attorney General are willing to commit to
resolving all pending disputes. Because the framework itself
resolves most of the pending legal and regulatory claims, we
believe that an agreement faithful to those terms can be worked
out and we are willing to commit whatever resources are necessary
to doing so.
Thank you for you consideration and we await your
response.
Sincerely,
/s/ Jeremiah W. (Jay) Nixon /s/ Jay B. Angoff
Jeremiah W. (Jay) Nixon Jay B. Angoff, Director
Attorney General Missouri Department of Insurance
BLUE CROSS BLUE SHIELD LITIGATION
PROPOSED RESOLUTION TERMS
APRIL 20, 1998
A. Blue Cross and Blue Shield ("BCBS") and RightCHOICE ("RC")
will engage in a transaction or series of transactions the
result of which will be:
1. a single Missouri for-profit general business corporation
("NewBCBS") which would own all of the assets and assume all
of the liabilities of BCBS and RC, excluding certain
liabilities specifically reserved and the shares of RC that
are presently owned by BCBS, and
2. a new, Missouri non-profit, public benefit foundation
("NewFo") which would own all of the stock in RC presently
owned by BCBS.
3. NewBCBS would become the direct licensee for the Blue Cross
and Blue Shield names and marks.
4. it will be important for NewFo to have sufficient cash on
hand on or about the date of the close of the transaction to
cover organization and start-up expenses, including any
taxes owed by the resulting foundation as a result of the
transactions and any cash necessary to resolve any of the
claims described below.
5. As a general principle, the more cash the foundation has,
the less the foundation will need to be concerned with the
immediate effects of the resale restrictions, divestiture
plan and voting trust referred to below.
6. Similarly, the parties acknowledge that following the close
of the transactions, NewBCBS must have sufficient cash or
access to cash to conduct its regular business operations
and meet regulatory reserve requirements.
B. NewFo would have the following characteristics:
1. it would be a Ch.355, public benefit corporation
2. it would NOT be a Ch.354 H.S.C. (or an insurance company of
any kind)
3. it would have a new name with no relation to its history as
a "Blue"
4. a reference to having been "funded through the conversion of
Blue Cross and Blue Shield of Missouri" may be required in
NewFo's publications and other marketing materials
5. it would have new, narrowly formulated health care related
charitable purposes that demonstrate a clear break from
BCBS's historic insurance underwriting purposes. These
purposes would permit NewFo to make health care available to
qualified persons residing in the former BCBS service area,
and may include subsidizing the costs of medically
appropriate, experimental procedures as well as subsidizing
the costs of treatment of catastrophic illnesses. The
organizational documents would provide that the purposes
could not be amended for a period of 10 years from the date
of the reformation described herein without a proper cy pres
showing before a Missouri state court of competent
jurisdiction.
6. it is neither expected nor intended that NewFo will
undertake, in furtherance of its new purposes, to purchase
(or subsidize the purchase of) health benefit plans,
insurance coverage, or other products or services sold by
NewBCBS or its related entities or any other health
insurance company
a. The parties agree, however, that should NewFo determine that
such is an appropriate use of its assets in furtherance of
its purposes, NewFo's bylaws will provide that such products
or services not only may be purchased from NewBCBS, but that
NewFo's Board should grant preferential status to NewBCBS as
a provider as long as NewFo owns 5% or more of the
outstanding stock of NewBCBS
b. It is agreed that for this period the preference shall take
the form, with respect to any particular product or service
for which NewFo seeks bids from potential providers, of
giving NewBCBS the "last opportunity" to provide such
products or services on the most favorable bona fide terms
offered to NewFo by any other potential provider.
7. it has a newly constituted Board of Directors:
a. number of Directors to be negotiated, depending upon the
number of present BCBS directors seeking a spot on NewFo's
Board, but 9 members as a starting point
b. a majority of NewFo's Board immediately upon reformation
will not have previously served on the Board of BCBS or RC
c. method of selecting new Directors, those not carrying over
from present BCBS Board, to be settled during negotiation
d. no Director or Officer of NewFo is permitted to be an
Officer/Director of NewBCBS
e. no NewFo Director is permitted to own stock in NewBCBS
without subjecting that stock to a voting trust similar to
the one that will apply to the NewFo's NewBCBS stock
f. all members of NewFo Board must meet qualifications to be
determined by the parties that are consistent with NewFo's
new purposes
*
12. it commits all of its NewBCBS stock to a voting trust, and
holds the stock subject to a divestiture plan
a. the purpose of the voting trust is to ensure that NewFo has
no voice over, or responsibility for, the operation and
management of NewBCBS
b. the purpose of the divestiture plan is to liquidate NewFo's
holdings of NewBCBS stock as rapidly as is prudent,
consistent with securities laws and regulations, and the
rules and requirements of the Blue Cross and Blue Shield
Association, consistent with a commitment to protect the
value of the shares and the rights of the other
shareholders, consistent with NewBCBS's objective to emerge
from these transactions as a viable health insurer with the
ability to access the capital markets in the future,
consistent with the liquidity needs of NewFo, and consistent
with the anti-takeover protections deemed prudent by the
NewBCBS Board
c. the parties acknowledge that, during the pendency of the
divestiture plan, nearly all of NewFo's corpus will be
vulnerable to changes in fortunes at NewBCBS and that NewFo
will have no control over management of NewBCBS, but the
parties further acknowledge that the NewBCBS Board will owe
NewFo the same fiduciary duties that it owes all other
NewBCBS shareholders and NewFo will have all of the other
rights and protections afforded shareholders of for-profit
corporations under Missouri law and, specifically, that no
term of the voting trust or divestiture plan shall infringe
upon the NewFo's right, nor relieve it nor its Directors of
their duty in a proper case, to protect the value of the
foundation by all such means available at law or equity.
d. the divestiture plan would provide that NewBCBS would have
the right of first refusal to purchase shares of NewBCBS
stock before they are sold by NewFo as long as NewBCBS and
its insurance subsidiaries continue to meet all regulatory
solvency and surplus requirements after the purchase.
e. NewBCBS would have the continuing option to purchase NewBCBS
stock from NewFo at the market price, as long as NewBCBS and
its insurances affiliates continue to meet all regulatory
solvency and surplus requirements after the purchase
f. BCBS is invited to make the initial proposal as to the exact
terms of the voting trust and divestiture plan
- ----------------
* Approximately one page of material has been omitted pursuant to a request
for confidential treatment. This material has been filed separtely.
g. provided that this agreement may be terminated prior to the
close of transactions described herein if any party to this
agreement declares that the terms of the divestiture
agreement affect the value of stock owned by NewFo to the
extent that it will prevent NewFo from adequately carrying
out the purposes set out in paragraph B.5 of this agreement
13. that, should the AG or DOI seek reimbursement for any
expenses, including legal, accounting and other outside
consulting and advisory services incurred by them in
connection with the transactions described herein on their
behalf or on behalf of NewFo, NewFo will be solely
responsible for such payments.
14. the transactions described herein would be accomplished to
minimize income tax liability resulting therefrom. The
parties agree that alternative transaction structures will
be considered in order to accomplish this goal within the
general framework of this term sheet.
C. It is understood by all parties that it is the intention of
the directors of BCBS, in connection with these
transactions, to fulfill all fiduciary duties imposed upon
them by law. Various interested parties, in pending
litigation, have made conflicting claims about to whom those
duties are owed and by whom they may be enforced. These
Proposed Resolution Terms will be effected only if there is
a judicial determination, binding on all interested parties,
that it is lawful for BCBS to organize as a Chapter 355
public benefit corporation and enter into the other
transactions contemplated herein, and that such a
reorganization can be effected without any breach of duty by
the directors of BCBS. To secure such a determination, the
parties would agree to take the following steps:
*
D. It is understood that all parties intend for this resolution
to address all outstanding issues between the State and
BCBS/RC. To that end,
1. all issues in the "main litigation," including the related
action for declaratory judgment regarding BCBS' status as
public (or mutual) benefit corporation, would be resolved by
the reorganization described above
2. in addition to the "main litigation," all "market conduct"
issues, including "co-pay," would be resolved finally and
completely and that payment of damages, fines or other
amounts, if any, will be the responsibility of NewFo, not
NewBCBS.
3. in addition to the "main litigation" and "market conduct"
issues, all "premium tax" issues would be resolved as a part
of this reorganization.
4. all other liabilities, including litigation and other
contingent liabilities, which arise or have arisen prior to
the transactions described herein, unless specifically
- ----------------
* Approximately one page of material has been omitted pursuant to a request
for confidential treatment. This material has been filed separately.
identified and addressed in the transaction documents, will
belong to NewBCBS, not NewFo.
5. the final transaction documents will contain releases from
the AG and DOI on behalf of themselves, their agencies and
offices, and the state as a whole, releasing BCBS, RC,
NewBCBS (and their affiliates), and all past and present
directors, offers, agents, employees and independent
contractors of BCBS, RC and NewBCBS (and their affiliates),
from (i) all claims and liability arising out of or relating
to the 1994 reorganization, (ii) all claims and liability
arising out of or relating to the transactions described
herein, and (iii) all claims and liability arising out of or
relating to all other outstanding issues and disputes
pending between the State and BCBS/RC described above and
those described on the list to be prepared by the AG and DOI
described in (b.) below, but excluding those described in
(a.) below:
a. no such release, however, will, or will purport to, relieve
any individual or entity from complaints lodged by consumers
with the DOI, or any criminal liability of any kind, nor any
liability from or on account of any conduct which is finally
adjudged to have been knowingly fraudulent, deliberately
dishonest or willful misconduct
b. because it is the parties' intention that the transactions
described herein will resolve to the fullest extent possible
the entire panoply of issues that has arisen between the
parties, the AG and DOI will represent that, except as
described on a list to be prepared by the AG and DOI, there
are no claims, disputes, investigations, audits or
complaints pending against BCBS, RC or any of their
affiliates, nor to the knowledge of the AG and DOI is there
nay basis for such claims, disputes, investigations, audits
or complaints.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
financial statements in the RightCHOICE Managed Care, Inc. Form 10-Q for the
quarterly period ended March 31, 1998 and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
<CASH> 25,707
<SECURITIES> 218,789
<RECEIVABLES> 61,448
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 350,380
<PP&E> 109,049
<DEPRECIATION> 49,531
<TOTAL-ASSETS> 520,320
<CURRENT-LIABILITIES> 296,055
<BONDS> 55,697
0
0
<COMMON> 187
<OTHER-SE> 140,394
<TOTAL-LIABILITY-AND-EQUITY> 520,320
<SALES> 0
<TOTAL-REVENUES> 191,852
<CGS> 0
<TOTAL-COSTS> 193,101
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,150
<INCOME-PRETAX> 2,058
<INCOME-TAX> 1,090
<INCOME-CONTINUING> 968
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 968
<EPS-PRIMARY> .05
<EPS-DILUTED> .05
</TABLE>
