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 September 30, 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 October 31, 1998
Class A Common Stock, $0.01 par value 3,710,426 shares
Class B Common Stock, $0.01 par value 14,962,500 shares
RIGHTCHOICE MANAGED CARE, INC.
Third Quarter 1998 Form 10-Q
Table of Contents
PART I. FINANCIAL INFORMATION PAGE
ITEM 1. Financial Statements
Consolidated Balance Sheets as of September 30, 1998
and December 31, 1997 3
Consolidated Statements of Income for the Three and Nine
Months
Ended September 30, 1998 and 1997 4
Consolidated Statements of Changes in Shareholders'
Equity for the Three and Nine Months Ended
September 30, 1998 and 1997 5
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1998 and 1997 6
Notes to Consolidated Financial Statements 7
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 21
ITEM 3. Quantitative and Qualitative Disclosures About Market
Risk 35
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 35
ITEM 2. Changes in Securities 35
ITEM 3. Defaults Upon Senior Securities 35
ITEM 4. Submission of Matters to a Vote of Security Holders 36
ITEM 5. Other Information 36
ITEM 6. Exhibits and Reports on Form 8-K 36
SIGNATURES 37
PART I.FINANCIAL INFORMATION
ITEM 1.Financial Statements
RIGHTCHOICE MANAGED CARE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except shares and per share data)
ASSETS September 30, 1998 December 31, 1997
(unaudited)
Current assets:
Cash and cash equivalents $ 25,790 $ 29,872
Investments available for sale 212,542 220,972
Receivables from members 64,536 60,019
Receivables from related parties 21,203 16,130
Deferred income taxes 4,111 4,994
Other assets 19,809 14,410
Total current assets 347,991 346,397
Property and equipment, net 60,650 60,602
Deferred income taxes 12,035 12,737
Investments in affiliates 8,455 8,427
Goodwill and intangible assets, net 75,188 78,200
Total assets $504,319 $506,363
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Medical claims payable $118,617 $ 112,339
Unearned premiums 52,401 57,656
Accounts payable and accrued expenses 54,971 55,892
Current portion of long-term debt 8,750 2,000
Payables to related parties 21,333 20,213
Reserve for loss contract 9,052 9,052
Obligations for employee benefits 3,181 2,935
Income taxes payable 13,063 12,051
Obligations under capital leases 4,605 4,515
Total current liabilities 285,973 276,653
Reserve for loss contract 9,522 16,311
Long-term debt 35,563 45,000
Obligations for employee benefits 23,992 22,140
Obligations under capital leases 4,425 5,394
Total liabilities 359,475 365,498
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, 3,710,426 and 3,709,000
shares outstanding, respectively 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 132,635 132,640
Retained earnings 9,338 6,653
Treasury stock, 27,074 and 28,500
Class A shares, respectively, at cost (383) (404)
Accumulated other comprehensive income 3,067 1,789
Total shareholders' equity 144,844 140,865
Total liabilities and shareholders'
equity $504,319 $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 Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
Revenues:
Premium $172,212 $163,726 $519,571 $485,714
Fees and other income 17,592 16,766 53,903 47,241
Total revenues 189,804 180,492 573,474 532,955
Operating expenses:
Health care services 146,209 141,669 435,037 410,126
Commissions 7,637 7,524 23,707 21,879
General and administrative
(excludes depreciation and
amortization and excludes
net intercompany charges of
$2,887, $1,911, $8,922 and
$6,535, respectively, allocated
to Blue Cross and Blue Shield of
Missouri) 33,647 34,539 105,071 104,092
Depreciation and amortization 4,891 5,243 14,103 15,645
Charge for loss reserves 29,510 29,510
Non-recurring relocation charges 74 2,970
Total operating expenses 192,384 218,559 577,918 584,222
Operating loss (2,580) (38,067) (4,444) (51,267)
Investment income:
Interest and dividends 3,174 4,262 10,831 12,008
Realized gains, net 1,888 524 2,587 16,584
Total investment income, net 5,062 4,786 13,418 28,592
Other:
Interest expense (1,100) (1,056) (3,376) (3,378)
Other expense, net (104) (185) (130) (488)
Total other, net (1,204) (1,241) (3,506) (3,866)
Income (loss) before provision
(benefit) for income taxes 1,278 (34,522) 5,468 (26,541)
Provision (benefit) for income
taxes 763 (11,766) 2,783 (7,668)
Net income (loss) $ 515 $(22,756) $ 2,685 $(18,873)
Weighted average common
shares outstanding 18,672,000 18,672,000 18,672,000 18,673,000
Basic and diluted earnings
(loss) per share $ 0.03 $ (1.22) $ 0.14 $ (1.01)
See accompanying Notes to Consolidated Financial Statements.
<TABLE>
RIGHTCHOICE MANAGED CARE, INC.
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' EQUITY (UNAUDITED)
(in thousands, except shares)
<CAPTION>
Accumulated
Additional Other
Common Stock Paid In Retained Treasury Comprehensive
Class A Class B Capital Earnings Stock Income Total
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at
December 31, 1996 $37 $150 $132,640 $30,687 $(326) $9,766 $172,954
Comprehensive loss:
Net income 3,883 3,883
Change in unrealized
appreciation on
available-for-sale
securities, net of
income tax credit
of $5,533 (9,898) (9,898)
Comprehensive loss (6,015)
Purchase of 5,400
shares of
Class A Common
Stock, at cost (78) (78)
Balance at
June 30, 1997 37 150 132,640 34,570 (404) (132) 166,861
Comprehensive loss:
Net loss (22,756) (22,756)
Change in
unrealized
appreciation
on available-for-
sale securities, net
of income tax
expense of $859 1,405 1,405
Comprehensive loss (21,351)
Balance at
September 30, 1997 37 150 132,640 11,814 (404) 1,273 145,510
Comprehensive loss:
Net loss (5,161) (5,161)
Change in
unrealized
appreciation
on available-for-
sale securities,
net of income tax
expense of $287 516 516
Comprehensive loss (4,645)
Balance at
December 31, 1997 37 150 132,640 6,653 (404) 1,789 140,865
Comprehensive income:
Net income 2,170 2,170
Change in
unrealized
appreciation
on available-for-
sale securities, net
of income tax
expense of $41 71 71
Comprehensive income 2,241
Balance at
June 30, 1998 37 150 132,640 8,823 (404) 1,860 143,106
Comprehensive income:
Net income 515 515
Change in
unrealized
appreciation
on available-for-
sale securities, net
of income tax
expense of $686 1,207 1,207
Comprehensive income 1,722
1,426 shares issued
under the
company's stock
option plan (5) 21 16
Balance at
September 30, 1998 $37 $150 $132,635 $9,338 $(383) $3,067 $144,844
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
RIGHTCHOICE MANAGED CARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
For the nine months ended,
September 30,
1998 1997
Cash flows from operating
activities:
Net income (loss) $ 2,685 $ (18,873)
Adjustments to reconcile net
income (loss) to net cash used in
operating activities:
Provision (credit) for deferred
income taxes 859 (3,786)
Depreciation and amortization 14,103 15,645
Undistributed (earnings) losses of affiliates (28) 374
Gain on sale of investments (2,587) (16,584)
Amortization of premiums and
accretion of discounts, net 135 (49)
Gain on sale of property and equipment (72)
(Increase) decrease in certain assets:
Receivables from members (4,517) (2,687)
Receivables from related parties (5,073) 1,003
Other assets (4,580) (8,041)
Increase (decrease) in certain liabilities:
Medical claims payable 6,278 3,786
Unearned premiums (5,255) (2,649)
Accounts payable and accrued expenses (921) (5,829)
Payables to related parties 1,120 (955)
Reserve for loss contract (6,789) 28,048
Obligations for employee benefits 2,098 (906)
Income taxes payable 1,012 (1,543)
Net cash used in operating activities (1,460) (13,118)
Cash flows from investing activities:
Proceeds from matured investments:
Fixed maturities 19,860 535
Proceeds from investments sold:
Fixed maturities 222,048 220,797
Equity securities 40,734
Other 4,482 32,469
Investments purchased:
Fixed maturities (232,557) (269,164)
Equity securities (548) (230)
Other (399) (2,150)
Proceeds from property and equipment sold 1,944 556
Property and equipment purchased (10,606) (14,282)
Net cash provided by investing activities 4,224 9,265
Cash flows from financing activities:
Sale (purchase) of Class A
Treasury stock 16 (78)
Repayment of long-term debt (2,687) (15,000)
Payments of capital lease obligations (4,175) (4,584)
Net cash used in financing activities (6,846) (19,662)
Net decrease in cash and cash equivalents (4,082) (23,515)
Cash and cash equivalents at
beginning of period 29,872 33,418
Cash and cash equivalents at end of period $ 25,790 $ 9,903
Supplemental Disclosure of Cash Information:
Interest paid $ 3,560 $ 3,769
Income tax refunds received, net (2,079) (2,339)
Supplemental Schedule of Noncash
Investing and Financing Activities:
Equipment acquired through capital leases $ 3,296 $ 9,730
Disposal of equipment under capital leases 2,526
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 for health services
to federal employees under the Federal Employees Health
Benefits Program (FEHBP). FEHBP is the second largest
customer group of BlueCHOICE after the Missouri
Consolidated Health Care Plan (MCHCP). 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 or
experience 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 March 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. Although
management has met with the OPM and Department of Justice
with respect to this matter, 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 (the Sarkis Litigation) was filed
in the Circuit Court of the City of St. Louis, Missouri
(the St. Louis Circuit Court), 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
Sarkis plaintiffs). 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.
The Sarkis 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 Sarkis plaintiffs seek
restitution, compensatory damages and punitive damages in
unspecified amounts, as well as injunctive and other
equitable relief.
On November 4, 1998, the St. Louis Circuit Court issued its
judgment and order granting the motion of the defendants to
dismiss the action for lack of standing and entering
judgment in favor of the defendants. The Sarkis
plaintiffs' counsel has advised the company that they
intend to ask the trial court to reconsider this dismissal
or appeal the St. Louis Circuit Court's order. The
obligations of the parties to consummate the transactions
contemplated by the settlement agreements described below
under "Litigation with DOI and Attorney General" are
conditioned upon, among other things, the satisfactory
final resolution of the Sarkis Litigation.
The Sarkis plaintiffs have also filed a motion to intervene
in the action described below under "Litigation with DOI
and Attorney General" filed by BCBSMo seeking declaration
as to the status of BCBSMo as a mutual benefit or public
benefit type of non-profit corporation.
Litigation with DOI and Attorney General
Status of Proposed Settlement Agreements
On September 20, 1998, the company and certain of its
affiliates entered into various settlement agreements with
certain state agencies, including the Missouri Department
of Insurance (DOI), the Director of the DOI, and the
Missouri Attorney General. The settlement agreements,
which are based upon a conceptual framework announced by
the company and BCBSMo on April 22, 1998, would, if
consummated, resolve all outstanding litigation and
regulatory issues between the company and its affiliates
and the State of Missouri, including the DOI and the
Missouri Attorney General, and create a charitable health
care foundation that would be managed by an independent
board of directors. The litigation between the company and
its affiliates and the State of Missouri is described
below.
The principal terms of the settlement agreements include the
following:
* BCBSMo would, through a series of transactions set forth in the
settlement agreements and the related exhibits, (i) transfer its
insurance-related assets, contracts and agreements and related
liabilities to a wholly owned subsidiary of the company; (ii)
convert to a for-profit corporation; (iii) reincorporate in
Delaware; and (iv) merge with the company. The outstanding common
stock of the resulting entity (referred to herein as new
RightCHOICE) would be owned approximately 20% by the public
shareholders and approximately 80% by the charitable foundation
(which equals the current aggregate ownership interests of the
public shareholders and BCBSMo, respectively, in the equity of the
company).
* The charitable foundation would be required to liquidate its
shares of new RightCHOICE stock over a prescribed period of time
and use the proceeds for health care purposes. The charitable
foundation would be required to reduce its ownership of new
RightCHOICE stock to less than 50% of the total outstanding stock
within 3 years of the closing of the reorganization and to less
than 20% of the total outstanding stock within 5 years of the
closing of the reorganization. Until the charitable foundation
reduces its ownership to less than 5% of the total outstanding
stock, its shares of new RightCHOICE stock would be subject to a
voting trust that would, with certain exceptions, effectively vest
voting control of the shares owned by the charitable foundation in
the board of directors of new RightCHOICE.
* As a for-profit direct licensee for the Blue Cross and Blue
Shield names and trademarks, new RightCHOICE would be required to
include certain "basic protections" in its charter documents and
it would be required to be independent from the direction, control
and influence of the charitable foundation. The "basic
protections" would include limitations on the amount of new
RightCHOICE stock that may be owned by certain categories of
shareholders -- (i) no "institutional" shareholder may own 10% or
more of the voting power of new RightCHOICE, (ii) no "non-
institutional" shareholder may own 5% or more of the voting power
of new RightCHOICE, and (iii) no shareholder may own 20% or more
of the equity of new RightCHOICE (with certain exceptions in the
case of the charitable foundation as described above). The
charter documents of new RightCHOICE would include certain
provisions whereby any shares owned by a shareholder in excess of
the applicable ownership limits could be redistributed by new
RightCHOICE.
The consummation of the transactions contemplated by the
settlement agreements is subject to a number of significant
conditions and contingencies, including approval by the Cole
County Circuit Court, various regulators and the shareholders
of the company, the receipt of rulings from the IRS or tax
opinions regarding the tax-free nature of the transactions, and
the satisfactory resolution of certain other litigation
involving the company and BCBSMo (including the Sarkis
Litigation described above which was dismissed by the St. Louis
Circuit Court on November 4, 1998 but is subject to possible
appeal).
The settlement agreements provide that the company and BCBSMo,
together with the DOI and the Missouri Attorney General, shall
move in an appropriate court proceeding for approval of the
settlement agreements and the proposed reorganization described
therein. See " - Litigation relating to the Reorganization and
Public Offering" below.
The summary of the settlement agreements set forth herein is
qualified in its entirety by reference to the settlement
agreements and the exhibits thereto which are included as
exhibits to the company's Current Report on Form 8-K filed with
the SEC on September 23, 1998.
Appointment of Special Master
Following the announcement by the company and BCBSMo on April
22, 1998, of the conceptual framework for the proposed
settlement with the State of Missouri, Judge Thomas Brown III
of the Circuit Court of Cole County, Missouri (the Circuit
Court) indicated that he had substantial reservations about the
settlement as proposed in the conceptual framework and that any
final settlement would be scrutinized very carefully.
On September 20, 1998, the settlement agreements described
above were executed, and courtesy copies were provided to the
Circuit Court. The company and BCBSMo had intended that
following the remand to the Circuit Court of the litigation
relating to the Reorganization and Public Offering described
below, the company and BCBSMo together with the DOI and
Missouri Attorney General would file a motion with the Circuit
Court seeking approval of the settlement agreements and the
proposed reorganization described therein.
On October 29, 1998, notwithstanding the fact that the
litigation relating to the Reorganization and Public Offering
had not yet been remanded to the Circuit Court, the Circuit
Court, "acting on its own motion," issued an Order (the October
29 Order) providing for, among other things, the appointment of
Robert G. Russell as receiver/custodian pendente lite to, among
other things, take exclusive possession and control of all of
the issued and outstanding shares of the company's common stock
owned by BCBSMo. The October 29 Order cited concerns by the
Circuit Court about the fairness of the transactions set forth
in the settlement agreements, alleged conflicts of interest and
the need for an independent examination of the proposed
settlement and related issues. The October 29 Order also
approved the engagement of legal counsel and an investment
banker to advise the receiver/custodian. Although the October
29 Order did not constitute the appointment of a
receiver/custodian over the operations of either the company or
BCBSMo, had it not been void from the beginning as alleged by
BCBSMo and as declared by the Circuit Court as described below,
the October 29 Order could have had several significant and
adverse consequences, including the automatic termination of
the company's Blue Cross and Blue Shield licenses and a
resultant event of default under the company's credit facility.
A copy of the October 29 Order is attached as an exhibit to the
company's Current Report on Form 8-K filed with the SEC on
November 2, 1998.
On November 2, 1998, BCBSMo filed its Motion to Vacate Order
and its Memorandum in Support of Motion to Vacate in response
to the October 29 Order. BCBSMo alleged that (i) the Circuit
Court lacked jurisdiction to issue the October 29 Order because
the case was still pending before the Missouri Supreme Court
which had not then ruled on the application of BCBSMo to
transfer to the Missouri Supreme Court; (ii) the Circuit Court
issued the order without notice and an opportunity to be heard;
(iii) there were no exigent circumstances that would warrant
the appointment of a receiver without due process; and (iv)
that the appointment of the receiver had the effect of
frustrating the purpose for which the receiver was to be
appointed, namely, the preservation of the nonprofit assets of
BCBSMo. Copies of the Motion to Vacate Order and Memorandum in
Support of Motion to Vacate are attached as exhibits to the
company's Current Report on Form 8-K filed with the SEC on
November 6, 1998.
On November 2, 1998, the Blue Cross and Blue Shield Association
(the BCBSA) filed a complaint against the company, its
subsidiaries and BCBSMo in the United States District Court for
the Northern District of Illinois alleging that the appointment
of the receiver/custodian pendente lite caused the automatic
termination of the licenses to use the service marks. The
complaint alleged service mark infringement and breach of
license agreements as a result of the company's continued use
of the Blue Cross and Blue Shield service marks following the
issuance of the October 29 Order.
On November 4, 1998, the Circuit Court issued an Order (the
November 4 Order) vacating the October 29 Order and declaring
it to be void ab initio (or "from the beginning"). The Circuit
Court, in issuing the November 4 Order, acknowledged that the
significant and adverse consequences that could have resulted
from the October 29 Order were unintended. On November 4,
1998, the Circuit Court also issued an Order (the November 4
Special Master Order) appointing Robert G. Russell as special
master for the purpose of collecting and analyzing information
related to the proposed settlement. The November 4 Order also
approved the engagement of legal counsel and such financial
advisors as are approved by the court to advise the special
master. The effect of the November 4 Order was to void the
October 29 Order as if it never existed. The special master
has expressed his interest in ensuring that the company
continues its business in the normal course during his review.
Copies of the November 4 Order and the November 4 Special
Master Order are attached as exhibits to the company's Current
Report on Form 8-K filed with the SEC on November 6, 1998.
On November 6, 1998, the Circuit Court entered an Order of
Reference (the November 6 Order), among other things, directing
the special master to collect and analyze information as to the
options and alternatives available to the Circuit Court for
disposition of the remaining issues in the litigation,
including, but not limited to, an examination of the settlement
agreements. The special master is also directed to address
several concerns of the Circuit Court that were originally
outlined in the October 29 Order. The special master is
further directed to investigate issues concerning the Blue
Cross and Blue Shield licenses and trademarks and the company's
credit facility. A copy of the November 6 Order is attached as
an exhibit to this Report.
The company believes, and has taken the position, that the Blue
Cross and Blue Shield license agreements continue uninterrupted
and in full force and effect, and that the company continues in
compliance with its credit facility covenants. While the BCBSA
acknowledges that BCBSMo and the company believe that the
license agreements were not effectively terminated because the
October 29 Order was void from the beginning and declared void
ab initio in the November 4 Order, the BCBSA has continued to
take the position that the license agreements automatically
terminated and that BCBSMo should request that the licenses be
reinstated, effective as of October 29, in order to clarify the
rights of BCBSMo to continue uninterrupted to use the licensed
names and marks. Although BCBSMo has not agreed with the
position of BCBSA for the reasons described above, BCBSMo has
requested reinstatement of the licenses which requires the
approval of the BCBSA Board of Directors, which will vote upon
the request at the meeting of the BCBSA Board of Directors
which is expected to be held on November 19, 1998. Although
the company expects that the BCBSA Board of Directors will
approve the requested reinstatement, no assurance can be given
in such regard. See "Status of Blue Cross and Blue Shield
trademark licenses" below.
The company and BCBSMo intend to file with the special master
and the Circuit Court a motion requesting approval of the
settlement agreements as a reasonable alternative to
dissolution of BCBSMo. There can be no assurance that the
transactions contemplated by the settlement agreements will
receive the necessary court approval as an acceptable
alternative to dissolution of BCBSMo, that all conditions and
contingencies included in the settlement agreements will be
satisfied, or that the transactions set forth in the settlement
agreements will be effected. The failure to consummate the
transactions contemplated by the settlement agreements could
have a material adverse effect on the company and the market
for its stock.
The summary of the Circuit Court's Orders set forth herein is
qualified in its entirety by reference to the Orders which are
included as exhibits to the Company's Current Reports on Form 8-
K filed with the SEC on November 2, 1998, and November 6, 1998,
and included as an exhibit to this Report.
Litigation relating to the Reorganization and Public Offering
The litigation described below would be settled in the event
that the transactions contemplated by the settlement agreements
are consummated. As described above under "-Appointment of
Special Master," the Circuit Court has appointed a special
master for the purpose of, among other things, collecting and
analyzing information related to options and alternatives for
the disposition of the remaining issues in the litigation
described below, including the proposed settlement, and there
can be no assurance that the transactions contemplated by the
settlement agreements will be consummated. The failure to
consummate the transactions contemplated by the settlement
agreements or to otherwise resolve the litigation described
below in a manner satisfactory to the company could have a
material adverse effect on the company and the market for its
stock.
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 the 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 the 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 the dispute without
litigation were unsuccessful. On May 13, 1996, BCBSMo filed a
declaratory judgment action in the Circuit Court against the
Director, the DOI and the Missouri Attorney General (the
Missouri Attorney General was a necessary party due to his sole
authority to enforce nonprofit corporation laws).
On June 13, 1996, the Director and the DOI filed an answer and
counterclaims. The answer set 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 alleged violations of certain
health services corporation and nonprofit corporation statutes.
The Director's and the 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.
On June 20, 1996, the Missouri Attorney General filed an answer
and counterclaim alleging that the Reorganization and Public
Offering, and the continued operations through the company and
its subsidiaries, exceeded BCBSMo's statutory purposes. The
Missouri Attorney General requested a declaration that BCBSMo
exceeded its lawful authority and sought such relief as the
Circuit Court would determine to be appropriate under the
circumstances based on a statute that authorizes judicial
dissolution or less drastic alternative relief in the Circuit
Court's discretion.
On September 9, 1996 (the September 9 Order), the Circuit Court
granted BCBSMo's motion for summary judgment against the
Director and the DOI, rejected all of the Director's and the
DOI's affirmative defenses (including allegations of fraud),
issued a permanent injunction against the Director and the DOI
and declared that: (i) under Missouri law the Director and the
DOI had 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 the DOI had no jurisdiction to
take any action, the practical effect of which would be 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 the DOI had
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 payment as the Director and the DOI
had demanded; and (iv) (A) BCBSMo was 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 did 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 Circuit 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 Circuit Court had already ruled against the Director
and the DOI for other reasons.
The September 9 Order permanently enjoined the Director and the
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. Although the
injunctive relief described above remains in place, the Circuit
Court's December 30 Orders (described below) clarify that the
injunction does not prohibit the Director and the 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 the 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 sought a
declaration that BCBSMo had exceeded or abused the authority
conferred upon it by law. Under this counterclaim, the
Director and the DOI sought 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
that sought a declaration that BCBSMo was a public benefit
corporation, not a mutual benefit corporation, and requested an
order that BCBSMo amend its Articles of Incorporation
accordingly. The Circuit Court granted the Missouri Attorney
General's motion for leave to file the amended counterclaim,
which remains pending.
On December 30, 1996, the Circuit 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 the DOI on
their amended counterclaim; (iv) granting the Director's and
the DOI's motion for summary judgment against BCBSMo on their
amended counterclaim; and (v) modifying, in part, the Circuit
Court's previous September 9 Order as described above. The
December 30 Orders declared that (i) BCBSMo had 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 Circuit 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 Circuit 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 the 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 the
DOI filed a notice of appeal of the September 9 Order, as
modified. Oral arguments were heard by the Missouri Court of
Appeals on February 24, 1998. On August 4, 1998, the Missouri
Court of Appeals entered its opinion affirming the judgments
entered December 30, 1996.
On September 22, 1998, the application of BCBSMo in the
Missouri Court of Appeals for rehearing and alternatively for
transfer of the case to the Supreme Court of Missouri was
denied. On October 7, 1998, BCBSMo requested that the Supreme
Court of Missouri accept transfer of the case. If the Missouri
Supreme Court denies the request, the August 4 appellate
opinion will become final without modification and the case
will be remanded to the Circuit Court for further proceedings
to determine the remedy for the violation of BCBSMo's statutory
purposes that the Circuit Court previously found to have
occurred. The remedy phase of the proceeding would include
consideration by the Circuit Court with the report of the
special master of whether there are reasonable alternatives to
dissolution of BCBSMo, whether BCBSMo should be dissolved, and
whether BCBSMo should forfeit its Certificate of Authority as a
health services corporation. The company and BCBSMo intend to
file a motion with the Court requesting approval of the
settlement agreements as a reasonable alternative to
dissolution of BCBSMo.
Litigation relating to corporate status of BCBSMo
The litigation described below would be settled in the event
that the transactions contemplated by the settlement agreements
are consummated. As described above under "-Appointment of
Special Master," the Circuit Court has appointed a special
master for the purpose of collecting and analyzing information
related to options and alternatives for the disposition of the
remaining issues in the litigation involving the Reorganization
and Public Offering as described above, including the proposed
settlement, and there can be no assurance that the transactions
contemplated by the settlement agreements will be consummated.
The failure to consummate the transactions contemplated by the
settlement agreements or to otherwise resolve the litigation
described below in a manner satisfactory to the company could
have a material adverse effect on the company and the market
for its stock.
On November 3, 1997, BCBSMo filed an action in the Circuit
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 was a public
benefit type of nonprofit corporation which held its assets for
the benefit of the public generally. The Missouri Attorney
General has filed an answer and counterclaim seeking a
declaration that BCBSMo is a public benefit type of nonprofit
corporation.
On June 10, 1998, Anthony Sarkis and James Hacking (plaintiffs
in the Sarkis litigation described above under "Subscriber
class action litigation") moved to intervene in this action as
plaintiffs. Sarkis and Hacking are or have been subscribers of
BCBSMo. They sought to intervene, contending that the present
parties to the action would not adequately represent their
interests in the resolution of the question whether BCBSMo is a
public benefit or a mutual benefit corporation. Thereafter,
BCBSMo moved to file an amended petition adding Sarkis, Hacking
and the Director of the DOI as parties to the action. For its
relief, BCBSMo sought a declaration of its status as a public
benefit or mutual benefit corporation. The Circuit Court
granted BCBSMo's motion to file the amended petition on August
17, 1998.
On September 16, 1998, Sarkis and Hacking filed an application
for change of judge under Missouri procedure. They contended
that they were entitled as of right to disqualify the Hon.
Thomas J. Brown, III from further proceedings in the action.
The Attorney General resisted this application. On October 15,
1998, Judge Brown denied the motion to disqualify himself. He
directed the parties to prepare a discovery schedule that would
have this lawsuit prepared for trial by December 21, 1998.
On November 5, 1998, Sarkis and Hacking gave notice of their
intent to file an original proceeding in the Missouri Court of
Appeals prohibiting Judge Brown from proceeding further in the
case.
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 would be required to exercise its
ownership interest in the company consistent with the best
interests of BCBSMo's subscribers, subject to any final rulings
made in the litigation described elsewhere 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, BCBSMo would be required to exercise
its ownership interest in the company consistent with the best
interests of the public at large. In either event, BCBSMo
could be dissolved, or required 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,
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
which, like dissolution, could result in the termination of the
company's licenses to use the Blue Cross and Blue Shield trade
names 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
its stock. See "Contingencies - Status of Blue Cross and Blue
Shield Trademark Licenses."
Litigation relating to the Market Conduct Study and Copayment
Calculations
The litigation described below would be settled in the event
that the transactions contemplated by the settlement agreements
are consummated. As described above under "-Appointment of
Special Master," the Circuit Court has appointed a special
master for the purpose of collecting and analyzing information
related to options and alternatives for the disposition of the
remaining issues in the litigation involving the Reorganization
and Public Offering as described above, including the proposed
settlement, and there can be no assurance that the transactions
contemplated by the settlement agreements will be consummated.
The failure to consummate the transactions contemplated by the
settlement agreements or to otherwise resolve the litigation
described below in a manner satisfactory to the company could
have a material adverse effect on the company and the market
for its stock.
In April 1996, the DOI issued a market conduct report to the
company. 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 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 has stated that 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 if
required. The DOI has issued a stay of the market conduct
proceeding pending approval of the settlement agreements
described herein.
On February 9, 1998, the Missouri Attorney General filed suit
against the company, BCBSMo, BlueCHOICE, Healthy Alliance Life
Insurance Company (HALIC, a subsidiary of the company), and
Preferred Health Plans of Missouri, Inc. (a subsidiary of the
company) in the Circuit 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 that 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 if required. This action was
dismissed by the Missouri Attorney General without prejudice
pending the approval of the settlement agreements described
herein.
Status of Blue Cross and Blue Shield trademark licenses
On October 30, 1998, the Blue Cross and Blue Shield Association
(the BCBSA) notified BCBSMo and the company that the October 29
Order appointing a receiver/custodian pendente lite for the
stock of the company owned by BCBSMo resulted in the automatic
termination of the licenses granted to BCBSMo and its
affiliates for the use of the Blue Cross and Blue Shield
trademarks. The license agreements provide for automatic
termination in the event that a trustee, interim trustee,
receiver or other custodian for any of BCBSMo's or the BCBSA's
property or business is appointed.
On November 2, 1998, the BCBSA filed a complaint against the
company, its subsidiaries and BCBSMo in the United States
District Court for the Northern District of Illinois alleging
that the appointment of the receiver/custodian pendente lite
caused the automatic termination of the licenses to use the
service marks. The complaint alleged service mark infringement
and breach of license agreements as a result of the company's
continued use of the Blue Cross and Blue Shield service marks
following the issuance of the October 29 Order.
The company believes that, because the October 29 Order was
void from the beginning for the reasons stated in the Motion to
Vacate Order and Memorandum in Support of Motion described
above and as a result of the November 4 Order declaring the
October 29 Order void ab initio, there was not an automatic
termination of the license agreements. The BCBSA has continued
to take the position that the licenses automatically terminated
as a result of the October 29 Order and that BCBSMo should
request that the licenses be reinstated effective as of October
29 in order to clarify the rights of BCBSMo to continue
uninterrupted to use the licensed names and marks. Although
BCBSMo has not agreed with the position of the BCBSA for the
reasons described herein, to avoid the expense and delay of
resolving this issue in litigation and to clarify the right of
BCBSMo, the company and its licensed affiliates to continue
uninterrupted to use the Blue Cross and Blue Shield names and
marks, BCBSMo has requested reinstatement of the licenses
effective as of October 29 without an admission that the
licenses were terminated. Reinstatement of the licenses
requires the approval of the BCBSA Board of Directors which is
expected to vote upon the request at the BCBSA meeting expected
to be held on November 19, 1998. Although the company expects
that the BCBSA Board of Directors will approve the requested
reinstatement, no assurances can be given in such regard. If
approved, the reinstatement is expected to be effective as of
October 29, 1998. The BCBSA has demanded, and BCBSMo intends
to accept, provisions of an Addendum to the reinstated licenses
which would, among other things, provide that the licenses will
be reviewed by the BCBSA Board of Directors at its next
regularly scheduled meeting on March 11, 1999. If on or before
that date the BCBSA Board does not extend the license
termination date to the next regularly scheduled BCBSA Board
meeting or otherwise modify the Addendum, the licenses will
automatically terminate on March 11, 1999. This "board to
board" extension of the licenses is similar to the provisions
of reinstated licenses granted to other BCBSA licensees
following a license termination. There can be no assurance
that the BCBSA Board of Directors would take the necessary
action to extend the licenses on the "board to board" review.
The licenses (which include the primary licenses granted to
BCBSMo and the controlled affiliate licenses to the company,
HALIC and BlueCHOICE) give these 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 require BCBSMo,
the company and its controlled affiliates to pay license fees
to BCBSA for the use of the trademarks.
In January of 1997, interim and temporary licenses were granted
to BCBSMo and its affiliates after notification by the BCBSA
that the prior licenses had automatically terminated in
connection with the litigation relating to the Reorganization
and Public Offering described above under "Litigation with DOI
and Attorney General" (the Litigation). The interim and
temporary licenses were later replaced by reinstated full
licenses granted in March of 1998.
Each of the licenses provides that it automatically terminates
if, among other things: (i) the DOI or another regulatory
agency assumes control of the licensee or delinquency
proceedings are instituted; (ii) a trustee, interim trustee,
receiver or other custodian for any of BCBSMo's or the BCBSA's
property or business is appointed, or (iii) 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. Pursuant to the proposed Addendum that
would become part of the reinstated license agreements if
approved at the November 19, 1998 BCBSA Board meeting, an
automatic termination will also occur (i) if the BCBSA Board
does not take action to extend the licenses on or before March
11, 1999, the date of the next regularly scheduled BCBSA Board
meeting, and (ii) upon any judicial act which (a) provides that
or approves a transaction pursuant to which a person, entity or
group other than the licensees of BCBSA, acquires the ability
to select the majority of the members of the Board of Directors
of BCBSMo, the company or certain of its affiliates or
otherwise gains control of BCBSMo, the company or such
affiliates, or (b) changes the composition of, or the voting
rights of the members of the Board of Directors of BCBSMo, the
company or such affiliates. This provision does not apply to a
settlement or resolution of the Litigation that complies with
all BCBSA rules, regulations and standards and is approved by
or conditioned on the approval of the BCBSA.
The affiliate licenses are derivative of the primary licenses
and automatically terminate if the primary licenses terminate.
According to their terms, if a 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 connection with
the proposed reinstatement described above, the BCBSA has
waived the application of these provisions to the alleged
automatic termination resulting from the entry of the October
29 Order.
In March 1998, BCBSMo and BCBSA agreed that the primary
licenses were 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 thereunder
was to continue for as long as the stay entered in the
Litigation remained in full force and effect. Under the
proposed Addendum that would become part of the reinstated
license agreements if approved at the November 19, 1998 BCBSA
Board meeting, the automatic termination provision relating to
the stay would no longer be controlling, rather, the licenses
will be on a "board to board" basis, which means that on or
before the next regularly scheduled meeting of the BCBSA Board
(expected to be held on March 11, 1999), the Board must take
action to extend the licenses or else they will automatically
terminate on March 11, 1999. There can be no assurances that
the BCBSA Board will take the action necessary to extend the
licenses on or before the March 11, 1999 meeting as part of the
"board to board" review.
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 its
stock. In addition, the loss of the licenses would be an event
of default under the company's credit agreement which if not
waived or otherwise addressed could result in a material
adverse effect on the company and the market for its stock.
See "Credit Agreement Restrictions" herein.
In connection with the proposed settlement agreements described
above under "Litigation with DOI and Attorney General - Status
of Proposed Settlement Agreements," BCBSMo and the company have
filed a request with the BCBSA to transfer its primary license
to new RightCHOICE as part of the transactions contemplated by
the settlement agreements. The BCBSA has conditionally approved
the transfer as proposed. There can be no assurance that the
transactions contemplated by the settlement agreements will
receive the necessary court approval as an acceptable
alternative to dissolution of BCBSMo, that all conditions and
contingencies included in the settlement agreements will be
satisfied, or that the transactions set forth in the settlement
agreements will be effected. The failure to consummate the
transactions contemplated by the settlement agreements could
have a material adverse effect on the company and the market
for its stock.
Other contingencies
In addition to the matters described above, from time to time,
the company and certain of its subsidiaries are parties to
various legal proceedings, many of which involve claims for
coverage encountered in the ordinary course of business. The
company, like health insurers and HMOs generally, excludes
certain health care services from coverage under its PPO, HMO
and other products. The company is, in its ordinary course of
business, subject to the claims of its members arising out of
decisions to restrict treatment or reimbursement for certain
services. The loss of even one such claim, if it results in a
significant punitive damage award, could have a material
adverse effect on the company.
In addition, the risk of potential liability under punitive
damage theories may increase significantly the difficulty of
obtaining reasonable settlements of coverage claims. However,
the financial and operational impact that such evolving
theories of recovery will have on the managed care industry
generally, or the company in particular, is at present unknown.
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," SFAS No. 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits" and SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities."
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. SFAS No.
133 establishes standards for derivative instruments, including
certain derivative instruments embedded in other contracts, and
for hedging activities. It requires an entity to recognize all
derivatives as either assets or liabilities in the statement of
financial position and measures those instruments at fair
value. SFAS No. 133 is effective for all fiscal years
beginning after June 15, 1999. Earlier application of SFAS No.
133 is encouraged but should not be applied retroactively to
financial statements of prior periods. The company's
management has not yet assessed what the impact of SFAS No. 133
will be on the company's future results of operations or
financial position.
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
believes that the adoption of SOP 98-1 will not have a material
impact on the company's financial position or results of
operations.
4. Provision for Income Taxes
The company's effective income tax rates presented in the
Consolidated Statements of Income of 59.7 percent and 34.1
percent for the third quarter of 1998 and 1997, respectively,
and 50.9 percent and 28.9 percent for the first three quarters
of 1998 and 1997, respectively, were affected by non-deductible
goodwill amortization. The effective income tax rate for the
first three quarters of 1997 was also affected by gains from
the liquidation of company-owned life insurance policies.
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 was 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. There were 46,138 and 0 dilutive
potential common shares for the third quarter of 1998 and 1997,
respectively, and 25,155 and 0 dilutive potential common shares
for the first three quarters of 1998 and 1997, respectively,
that were added to the weighted average number of shares
outstanding in order to compute diluted earnings per share.
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 and
nine month periods ended September 30, 1998 and 1997 are as
follows:
Three months ended Nine months ended
September 30, September 30,
1998 1997 1998 1997
(in thousands) (in thousands)
Unrealized holding gains arising
during period, net of taxes $ 2,417 $ 1,745 $ 2,942 $2,202
Less: reclassification adjustment
for gains included in net
income, net of taxes (1,210) (340) (1,664) (10,695)
Net unrealized gains (losses) on
securities $ 1,207 $ 1,405 $ 1,278 $(8,493)
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 and nine month periods ended September 30, 1998
and 1997 (unaudited):
Three Months Ended Nine Months Ended
September 30, September 30,
Product Group 1998 1997 1998 1997
(in thousands) (in thousands)
PPO:
Alliance PPO $ 48,583 $ 48,038 $ 143,716 $150,102
AllianceChoice POS 38,356 32,687 112,099 90,517
HMO (includes other POS) 49,604 46,515 153,750 133,277
Medicare supplement 23,568 24,064 71,816 73,522
Managed indemnity 1,669 2,682 6,335 9,949
Other specialty services 10,432 9,740 31,855 28,347
Total premium revenue 172,212 163,726 519,571 485,714
ASO/Self-funded and other income 17,592 16,766 53,903 47,241
Total revenues $189,804 $180,492 $573,474 $532,955
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 Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
Operating revenues:
Premium revenue 90.7% 90.7% 90.6% 91.1%
Fees and other income 9.3% 9.3% 9.4% 8.9%
100.0% 100.0% 100.0% 100.0%
Operating expenses:
Medical loss ratio 84.9% 86.5% 83.7% 84.4%
Commission expense 4.0% 4.2% 4.1% 4.1%
General and administrative expense 20.3% 22.0% 20.8% 22.5%
Adjusted general and administrative
expense (excludes depreciation
and amortization) 17.7% 19.1% 18.3% 19.5%
Membership
The following table sets forth membership data and the percent
change in membership:
September 30,
Product Group 1998 1997 %
Underwritten:
PPO:
Alliance PPO 141,297 152,502 (7.3)%
AllianceChoice POS 128,712 130,773 (1.6)
HMO:
Commercial (includes other POS) 133,288 131,374 1.5
BlueCHOICE Senior 5,448 5,788 (5.9)
BlueCHOICE Medicaid (MC+) 4,964 N/A
Medicare supplement 58,752 63,469 (7.4)
Managed indemnity 3,499 7,515 (53.4)
470,996 496,385 (5.1)
Self-funded:
PPO 45,445 90,137 (49.6)
HMO 12,235 13,471 (9.2)
ASO (includes HealthLink):
Workers' Compensation 432,786 340,222 27.2
Other ASO* 1,130,068 982,915 15.0
Total Membership 2,091,530 1,923,130 8.8
* does not include 453,797 and 497,701 as of September 30,
1998 and 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 1998 Results to 1997 Results
Revenues
Premium revenue increased $8.5 million or 5.2 percent in the
third quarter of 1998 in comparison to the third quarter of
1997. For the first three quarters of 1998, premium revenue
increased $33.9 million, or 7.0 percent, in comparison to the
first three quarters 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 $6.2 million or 7.7 percent in the third
quarter of 1998 as compared to the third quarter of 1997 - -
$9.5 million due to a 12.3 percent increase in net premium
rates partially offset by a $3.3 million decrease resulting
from a 4.1 percent decrease in member months. For the first
three quarters of 1998, PPO revenues increased $15.2 million or
6.3 percent as compared to the first three quarters of 1997 - -
$26.7 million due to a 10.9 percent increase in net premium
rates partially offset by an $11.5 million decrease resulting
from a 4.1 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 three quarters 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 11,205 members from September 30, 1997
to September 30, 1998 and AllianceChoice POS membership
decreased by 2,061 over the same time period. Net membership
decreases are due primarily to the company's aforementioned
pricing strategy during 1998. 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 6,100 PPO
Illinois members as of September 30, 1998, an increase of 4,900
from September 30, 1997.
HMO premium revenue increased $3.1 million or 6.6 percent in
the third quarter of 1998 as compared to the third quarter of
1997 - - $3.0 million due to a 7.2 percent increase in net
premium rates and $0.1 million due to membership changes. For
the first three quarters of 1998, HMO revenues increased $20.5
million or 15.4 percent as compared to the first three quarters
of 1997 - - $9.2 million due to an 8.0 percent increase in
member months and $11.3 million due to a 6.8 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
three quarters 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 one large group, Missouri
Consolidated Health Care Plan (MCHCP), comprised of 32,800
members as of September 30, 1998 with which the company has
limited ability to increase premium rates, 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 8,400 members in
MCHCP products from September 30, 1997 to September 30, 1998.
The company's HMO membership in non-MCHCP products (and
excluding the company's Medicaid product) decreased over the
same time period by 6,800 members, or 6.0 percent, due
primarily to the company's aforementioned pricing strategy
during 1998. The company's future enrollment growth in its
products and geographic regions is dependent on network
attractiveness, continued cooperation with physician hospital
organizations, future pricing strategy, 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 these and other factors.
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 third quarter of 1998 as compared to the third
quarter of 1997. Net premium rates increased 6.1 percent
partially offset by a 7.7 percent decrease in member months.
For the first three quarters of 1998, premium revenue decreased
by $1.7 million as compared to the first three quarters of
1997. Member months decreased by 8.4 percent partially offset
by a 6.6 percent increase in net premium rates. Membership in
the company's Medicare supplement products has decreased in
part due to subscribers opting for Medicare-risk programs,
similar to the company's BlueCHOICE Senior product, in which
medical benefits are at least as comprehensive as Medicare
benefits for persons eligible to receive Medicare (parts A and
B) at no additional cost to the member.
Managed indemnity premium revenue decreased by $1.0 million in
the third quarter of 1998 as compared to the third quarter of
1997 due to a 47.0 percent decline in member months. For the
first three quarters of 1998, premium revenue decreased by $3.6
million due to a 41.1 percent decline in member months. Member
month declines are consistent with the company's strategy to
move toward more highly managed care products.
Revenue from other specialty services increased $0.7 million in
the third quarter of 1998 as compared to the third quarter of
1997 primarily due to a 17.1 percent increase in net premium
rates. For the first three quarters of 1998, revenues
increased $3.5 million as compared to the first three quarters
of 1997 due primarily to a 17.4 percent increase in net premium
rates. The large rate increases relate to the company's drug
products, including AllianceRx, and correspond to the high
levels of prescription utilization and trends that the company,
as well as the industry as a whole, have experienced in recent
years.
Fees and other income from administrative services only/self-
funded and network services increased by $0.8 million in the
third quarter of 1998 as compared to the third quarter of 1997.
For the first three quarters of 1998, fees and other income
increased $6.7 million as compared to the first three quarters
of 1997. These increases are primarily due to increased 1998
revenues from HealthLink, Inc. (HealthLink), the company's
network rental and managed care service subsidiary, of $3.5
million and $11.0 million for the third quarter and first three
quarters of 1998, respectively, as compared to the same periods
in 1997. HealthLink's revenues increased due to a 21.3 percent
increase in members from September 30, 1997 to September 30,
1998. This increase arose from strong sales during the period,
along with the roll-out of new, open access products. Sales
during this period included a 30,000 member group that enrolled
in HealthLink's self-funded ASO plan, transferring from the
company's other self-funded business. 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 other self-funded business due to the nonrenewal
of three large groups. HealthLink also continues to expand its
service area into contiguous states, such as Arkansas, Iowa,
Illinois, Indiana and Kentucky.
Operating Expenses
The overall medical loss ratio decreased from 86.5 percent in
the third quarter of 1997 to 84.9 percent in the third quarter
of 1998. For the first three quarters of 1998, the medical
loss ratio decreased to 83.7 percent from 84.4 percent for the
first three quarters of 1997. The medical loss ratio is higher
in the third quarter of each year as compared to the medical
loss ratio for the first three quarters of each year due in
part to seasonal trends resulting in an increase in claims
expense in the third quarter of the year. The medical loss
ratio experienced in 1998 is slightly lower compared to that in
1997 due to the company's pricing strategy, which the company
expects will result in an increase in the premium per member
per month of approximately 9 percent to 10 percent for the
year. The medical loss ratio in 1998 is slightly higher than
the company previously anticipated in the beginning of the year
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 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. One of the
company's medical cost control strategies for 1998 is the
introduction of a new three-tiered benefit design that allows
members to make choices, albeit with a higher member copayment.
Through the end of the third quarter of 1998, the company
achieved 20 percent penetration of its underwritten membership
with respect to the three-tier pharmacy benefit program. In
addition to continuing the conversion to this new drug benefit
program, the company intends to continue to make other
adjustments to copayments, quantity limits and exclusions as
well as to increase physician education, utilization and
prescribing pattern analysis. The company also intends to
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 $0.1 million or 1.5 percent in
the third quarter of 1998 as compared to the third quarter of
1997. For the first three quarters of 1998, commission expense
increased by $1.8 million or 8.4 percent as compared to the
first three quarters of 1997. The commission expense ratio
decreased from 4.2 percent for the third quarter of 1997 to 4.0
percent for the third quarter of 1998. For the first three
quarters of 1998 and 1997, the commission expense ratio
remained relatively flat at 4.1 percent.
General and administrative expenses (excluding depreciation and
amortization) decreased by $0.9 million, or 2.6 percent, in the
third quarter of 1998 as compared to the third quarter of 1997.
For the first three quarters of 1998, these expenses increased
by $1.0 million, or 0.9 percent, as compared to the first three
quarters of 1997. The company managed to keep general and
administrative expenses consistent despite the fact that
HealthLink's expenses increased by $1.8 million and $4.8
million in the third quarter and first three quarters of 1998,
respectively, as compared to the same periods of 1997.
HealthLink's increased expenses are directly attributable to
HealthLink's geographic and member expansion efforts. The
company's general and administrative expense ratio (excluding
depreciation and amortization) decreased to 17.7 percent and
18.3 percent for the third quarter and first three quarters of
1998, respectively, as compared to 19.1 percent and 19.5
percent for the same periods in 1997.
Depreciation and amortization expenses decreased by $0.4
million in the third quarter of 1998 as compared to the third
quarter of 1997. For the first three quarters of 1998,
depreciation and amortization expenses of $14.1 million
represented a decrease of $1.5 million as compared to the first
three quarters of 1997. These reductions in depreciation and
amortization expenses primarily relate to intangible assets
that became fully amortized during 1997. Amortization expenses
for completed components of the company's IOS project increased
by $0.5 million and $1.7 million in the third quarter and first
three quarters of 1998, respectively, as compared to the same
periods in 1997. See "Recent Developments - Information and
operations strategy" for more information related to this
project.
There were no nonrecurring charges in the third quarter and
first three quarters of 1998. Non-recurring relocation charges
of $0.1 million and $3.0 million were recorded in the third
quarter and first three quarters of 1997, respectively. These
charges were related to the relocation of the company's St.
Louis-based claims, customer service, billing, and provider
services functions to its Springfield, Missouri facility and a
new facility in Cape Girardeau, Missouri. In addition, in the
third quarter of 1997, the company recorded a $29.5 million
loss reserve for its contract with MCHCP.
Operating Loss
Operating loss decreased by $35.5 million in the third quarter
of 1998 in comparison to the third quarter of 1997. For the
first three quarters of 1998, the operating loss decreased by
$46.8 million as compared to the first three quarters of 1997.
Excluding the non-recurring relocation charges and the charge
for the MCHCP loss reserve, the operating loss decreased by
$5.9 million and $14.3 million in the third quarter and first
three quarters of 1998, respectively, as compared to the
comparable periods of 1997. The improved operating results
were due in part to the increase in revenues from HealthLink,
the increase in the company's overall premium rates, and the
slight decrease in overall general and administrative expenses
inclusive of depreciation and amortization.
Net Investment Income
The third quarter 1998 net investment income of $5.1 million
represents a $0.3 million increase over the third quarter of
1997, inclusive of a $1.4 million increase in net realized
gains. For the first three quarters of 1998, net investment
income decreased by $15.2 million as compared to the first
three quarters of 1997 inclusive of a reduction in net realized
gains of $14.0 million in 1998 as compared to 1997. Realized
gains in the first three quarters of 1997 include a $5.7
million gain on the sale of company-owned life insurance
policies as well as additional 1997 net realized gains 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 59.7 percent and
34.1 percent for the third quarter of 1998 and 1997,
respectively. For the first three quarters of 1998 and 1997,
the effective tax rates were 50.9 percent and 28.9 percent,
respectively. The company's effective income tax rates for
1998 and 1997 were affected by non-deductible goodwill
amortization. The rate for the first three quarters of 1997
was also affected by gains recognized from the liquidation of
company-owned life insurance policies.
Net Income
The company's net income of $0.5 million, or $0.03 per share,
for the third quarter of 1998 represents an increase of $23.3
million compared to the third quarter 1997 net loss of $22.8
million, or $1.22 per share. For the first three quarters of
1998, the company's net income of $2.7 million, or $0.14 per
share, represented a $21.6 million increase as compared to a
net loss of $18.9 million, or $1.01 per share, for the first
three quarters of 1997. Excluding the non-recurring relocation
charges and the charge for the MCHCP loss reserve, the
company's net income increased by $4.0 million and $0.5 million
in the third quarter and first three quarters of 1998,
respectively, as compared to the same periods of 1997.
Liquidity and Capital Resources
The company's working capital as of September 30, 1998 was
$62.0 million, a decrease of $7.7 million from December 31,
1997. The decrease is partially attributable to $6.8 million
of additional debt from the company's reducing revolving credit
facility that became a current payable during the first three
quarters of 1998. In the third quarter of 1998, the company
also repaid $2.7 million of the debt pursuant to the credit
facility's requirements. In addition, the company capitalized
$10.6 million of costs for property and equipment purchases,
$6.7 million of which relates to capitalized IOS development
costs. The company's HealthLink subsidiary sold its former
headquarters building for $1.9 million in the third quarter of
1998 as HealthLink completed its relocation to a leased
facility.
Net cash used in operations totaled $1.5 million for the nine
months ended September 30, 1998. The company's net income was
$2.7 million which included (on a before tax basis) $2.6
million of realized gains from the sale of investments and
$14.1 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.
In the third quarter of 1997, the company took a pre-tax charge
of $29.5 million associated with the MCHCP contract, 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 Consolidated Statements of Income
includes the credit for the amortization of this loss reserve
provision during the first three quarters of 1998 and the third
quarter of 1997. The company is currently reviewing the
adequacy of this reserve and there can be no assurance that the
amount of the reserve taken in the third quarter of 1997 will
be sufficient to cover all losses that 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
Strategic realignment
The company recently announced a strategic realignment of
business operations to control overall general and
administrative expenses for 1999. By reducing personnel and
other administrative expenses, the company's goal is to offset
anticipated 1999 investments in new products, further expansion
of the HealthLink network in regions outside of Missouri and
other items. The realignment plan calls for the reduction of
approximately 135 positions, or 7.5 percent of the company's
workforce, by the middle of 1999. These positions will be
eliminated through strategic reductions and attrition and will
be offset to a small degree by positions added in other growing
business areas. The company's goal also is to control general
and administrative costs by decreasing the use of outside
consultants, changing employee health care benefits, and
reducing software costs, travel, entertainment, and other
expenses. As a result of the company's strategic realignment,
the company anticipates recording a charge of approximately
$0.9 million in the fourth quarter of 1998. There can be no
assurance that the goals of the company's strategic realignment
will be achieved.
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 that 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 nine months of
1998, the company incurred capitalized expenditures of $6.7
million on this project. Cumulatively, since 1995, the company
has incurred capitalized expenditures of $45.7 million. The
company anticipates that it will expend approximately $9
million for capitalized costs associated with the IOS project
in 1998 and an additional $8 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
The company has a program to evaluate its major systems and
equipment to minimize the possibility of a material disruption
to its business due to year 2000 problems (e.g. the
difficulties of certain computers, computer programs and other
equipment to distinguish between the year 1900 and the year
2000). The program was initiated in 1996 and includes an
inventory of software, hardware and related infrastructure
components; assessments and decisions to retire, replace or
remediate these elements as well as to establish how critical
they are to continued operations; a strategy to conduct
integrated testing of critical applications and technology
infrastructure; and development of contingency plans.
The inventory and assessment phases of the year 2000 project
are substantially complete and include information technology
such as application software on various platforms (mainframe,
midrange and personal computer), system software and data/voice
communication networks; as well as facility equipment such as
elevators, security and building control systems. Although the
company is increasing its use of client server applications,
the majority of its application and system software uses a
mainframe platform with COBOL programming. The company believes
that at September 30, 1998, approximately 70 percent of these
COBOL programs were year 2000 ready. The remaining COBOL
programs are expected to be year 2000 ready by March 31, 1999.
The balance of the company's other system modifications is
expected to be completed by September 30, 1999, with the
majority of these modifications currently underway. The
company's plan for completion of this project is partially
dependent upon the work of third parties. The company has
limited internal exposure to equipment with embedded technology
and expects any affected equipment to be ready before January
1, 2000.
Integrated testing of purchased or internally developed
applications, hardware, operating systems and other support
software is expected to begin in the fourth quarter of 1998.
This integrated testing (including the leap year test) will
include advancing the hardware dates forward to several key
dates in the year 2000. Testing will continue through the
end of 1999 for existing systems, new releases, and
enhancements to provide for continued readiness and to prevent
reappearance of year 2000 problems.
The total cost associated with the modifications required to
become year 2000 ready is estimated to be approximately $10
million to $12 million. The company is expensing all costs
associated with these changes as they are incurred. From 1996
through September 30, 1998, the company has cumulatively
expensed $6.2 million on this project with $3.5 million
expensed in the first nine months of 1998. These costs are
being funded internally through operating cash flows or
investment sales and represent less than 10 percent of the
company's information technology budget, either within a single
year or over the life of the year 2000 program. Although the
company continually evaluates and prioritizes its information
technology projects, the company has not deferred any
significant, identifiable projects due to the year 2000
program.
In addition to internal year 2000 implementation activities,
some of the company's computer systems and business operations
are provided by outside suppliers. As part of the program, the
company is asking for the readiness status of its vendors,
providers and suppliers. There can be no assurance that there
will not be an adverse effect on the company if critical
vendors and providers, such as major healthcare providers,
third parties performing delegated services or utility
companies do not convert their systems in a timely manner and
in a way that is compatible with the company's systems.
The company's operations would be significantly impacted by
incomplete or untimely resolution of year 2000 issues, whether
caused by internal or external action. The company uses
automated systems to process claims, prepare invoices, collect
and remit payments, maintain membership data, perform
utilization management and many other processes. In the worst
case, the company's inability to perform these basic operating
activities in an accurate and timely manner would have a
material adverse effect on the company's revenues, liquidity
and results of operations, although the company is unable to
estimate the total financial impact.
The company is currently preparing its contingency plan in the
event that full year 2000 readiness for critical business
functions is not achieved. The company expects to have the
plan substantially defined on or before the end of the second
quarter of 1999. There can be no assurance that the company or
any third party upon which the company depends will be able to
achieve year 2000 readiness or will have sufficient contingency
plans, which could have a material adverse effect on the
company and the market for the company's stock.
The projected cost of the year 2000 program and the expected
completion dates are based on management's best estimates and
may be updated as additional information becomes available.
These estimates were derived using numerous assumptions of
future events, including the availability of certain resources
and other factors. There can be no guarantee these estimates
will be achieved, and actual results could differ materially
from expected results.
Recently issued accounting standards
See the description under the same caption in Note 3 of the
Notes to Consolidated Financial Statements of Item I, which
description is incorporated herein by reference.
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 the 1998 year include:
overall premium revenue growth per member per month in the 9
percent to 10 percent range, reflecting price increases up to
the high teens to low twenties (in percentages) for some
categories of members, consistent with market trends;
maintaining the medical loss ratio in the mid eighties (in
percentages), with an anticipated net medical cost increase per
member per month of approximately 7 percent to 9 percent,
inclusive of pharmacy benefits, medical services, and the cost
of government-mandated benefits; continued flat levels of 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
The statements included in this Report regarding future
financial performance and results and the other statements
herein that are not historical facts are "forward-looking
statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. Such statements may include,
but are not limited to, projections of earnings, revenues,
income or loss, capital expenditures, plans for future
operations and financing needs, matters relating to the
proposed settlement agreements, as well as assumptions relating
to the foregoing. Forward-looking statements are inherently
subject to risks and uncertainties, some of which cannot be
predicted or quantified. Future events and actual results,
performance and achievements could differ materially from those
set forth in, contemplated by or underlying the forward-looking
statements. Factors that could cause actual results to differ
materially (the Cautionary Statements) include, but are not
limited to, those set forth below. Should one or more of the
risks or uncertainties set forth below materialize, or should
underlying assumptions prove incorrect, actual outcomes may
vary materially from those indicated. Undue reliance should
not be placed on the Cautionary Statements, which speak only as
of the date of this Report. The company undertakes no
obligation to release publicly any revisions to the forward-
looking statements after the date of this Report to reflect
events or circumstances after the date of this Report or to
reflect the occurrence of unanticipated events.
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 that
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 its
stock. The OPM audit relates to the company's subsidiary, HMO
Missouri, Inc. (BlueCHOICE) and, as described below, any
additional funding to BlueCHOICE as a result of audit findings
associated with the OPM audit, or otherwise, may require
approval under the company's credit agreement and there can be
no assurance that such approvals could be obtained. See
"Credit Agreement Restrictions" below.
Agreement for settlement of certain litigation matters and
reorganization of the company
On September 20, 1998, the company and certain of its
affiliates entered into various settlement agreements with
certain state agencies, including the Missouri Attorney General
and the DOI which, if consummated, would resolve the
outstanding litigation and regulatory disputes between the
company and its affiliates and the State of Missouri and create
an independent health care foundation. The settlement
agreements are described further in Note 2, "Contingencies -
Litigation with DOI and Attorney General - Status of Proposed
Settlement Agreements" of Part I, Financial Information, and
such description is incorporated by reference in its entirety
in this section. As described further in Note 2,
"Contingencies - Litigation with DOI and Attorney General -
Appointment of Special Master," which description is
incorporated by reference in its entirety in this section, the
Circuit Court has appointed a special master for the purpose
of, among other things, collecting and analyzing information
related to the proposed settlement. There can be no assurance
that the transactions contemplated by the settlement agreements
will receive the necessary court approval as an acceptable
alternative to dissolution of BCBSMo, that all conditions and
contingencies included in the settlement agreements will be
satisfied, or that the transactions set forth in the settlement
agreements will be effected. The failure to consummate the
transactions contemplated by the settlement agreements could
have a material adverse effect on the company and the market
for its stock.
Litigation with DOI and Attorney General
Reference is made to the litigation and 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 litigation and 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.
The transactions contemplated by the proposed settlement
agreements described elsewhere herein 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 provided in the settlement agreements,
or if, in the alternative, BCBSMo or the company does not
prevail in all of these matters, it is possible that BCBSMo
could be dissolved, the license of BCBSMo and the company to
use the Blue Cross and Blue Shield trade names and marks could
be terminated, an event of default could occur under the
company's credit agreement, BCBSMo could be required 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, and other actions could be taken by BCBSMo,
the Missouri Attorney General, the DOI, the BCBSA or others all
of which could have a material adverse impact on the company or
the market for its 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 with 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 as well as an event of default under
the company's credit agreement would have a material adverse
effect on the company and the market for the company's stock.
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, limitations on indebtedness
of the company's subsidiaries, maintenance of the licenses to
use Blue Cross and Blue Shield names and marks 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 described under the caption in Note 2
entitled "Contingencies - Status of Blue Cross and Blue Shield
Trademark Licenses" of Part I, Financial Information, the loss
of the licenses would result in an event of default under the
credit agreement.
As described further herein, the company believes that, because
the October 29 Order described above was void and was declared
void ab initio by the November 4 Order, there was not an
automatic termination of the licenses, and therefore no
resultant event of default under the credit agreement. As
described above under the heading "Status of Blue Cross and
Blue Shield trademark licenses," the BCBSA has continued to
take the position that the licenses automatically terminated
and that BCBSMo should request that the licenses be reinstated.
To clarify the rights of BCBSMo and its affiliates to use the
names and marks, BCBSMo has requested reinstatement of the
licenses effective as of October 29 without an admission that
the licenses were terminated. Reinstatement of the licenses
requires the approval of the BCBSA Board of Directors which is
expected to vote upon the request at the BCBSA meeting expected
to be held on November 19, 1998. There can be no assurances
that the licenses will be reinstated. If the licenses are not
reinstated, the lenders under the credit agreement could take
the position of the BCBSA and allege that there was an
automatic termination of the licenses which is an event of
default under the credit agreement. Such an event if not
waived or otherwise addressed could have a material adverse
affect on the company and the market for its stock.
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.
MCHCP issues
The Missouri Consolidated Health Care Plan (MCHCP), which is a
Missouri public agency that purchases health care coverage for
employees of the State of Missouri and of selected public
entities that have been admitted into the MCHCP, is currently
the largest customer group served by HMO Missouri, Inc.
(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 of Missouri and to public
entities. The contract was for an initial one-year term with
four one-year renewal terms. In a lawsuit that the company
filed against MCHCP on August 28, 1997, the company contended,
among other things, that under the language of the applicable
contract, MCHCP had express and implied duties to negotiate the
amount of any rate increase that might become effective for
each succeeding one-year renewal term. It was the company's
position that if no agreements to the negotiated rates could be
reached, MCHCP's sole remedy was to request bids from other
insurers. The Circuit Court of Cole County, Missouri, on March
19, 1998, ruled in favor of MCHCP with respect to such claim
and certain other claims. The company determined not to appeal
the decisions of March 19, and on June 10, 1998, the company
and MCHCP agreed to mutually dismiss the lawsuits. The company
will, therefore, be held contractually bound to serve the MCHCP
members if the contract is extended at the option of the MCHCP
through the year 2000 at the rate 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. In the third quarter of 1997, the company took
a pre-tax charge of $29.5 million, which was based upon
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. Management of the
company is currently reviewing the adequacy of this reserve.
If the actual number of the company's members through MCHCP
grows at a rate in excess of the rate used in the company's
actuarial estimates (whether due to the increase generally in
MCHCP members, decrease in the number of MCHCP contractors or
otherwise), or if the projected limited rate increases and
medical cost trends should differ materially from those assumed
in the company's actuarial estimates, then the amount of the
reserve recorded to date could be insufficient to cover all
future losses that 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 revolving credit agreement (described above)
provides that the company's subsidiaries, including BlueCHOICE,
may not issue any form of debt 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. No assurances can be given that such approval would
be granted. 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. 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
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 (excluding its HealthLink subsidiary) are
primarily 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 that 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.
Year 2000 Issue
Reference is made to the information set forth above under the
caption " - Recent Developments - Year 2000 issue," which
information is incorporated by reference in its entirety in
this section. There can be no assurance that the company or
any third party upon which the company depends will be able to
achieve year 2000 readiness or will have sufficient contingency
plans, which could have a material adverse effect on the
company and the market for the company's stock.
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 that 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.
ITEM 3. Quantitative and Qualitative Disclosures About
Market Risk
Not applicable to the company until December 31, 1998.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
Note 2, "Contingencies," of Part I, Financial Information,
contains a description of various pending and threatened
claims involving the company and its affiliates,
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, 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:
10 Order of Reference dated November 6, 1998.
27 Financial Data Schedule (Electronic Filing Only).
b) Reports on Form 8-K:
The company filed a report with the SEC on Form 8-K on July 22,
1998 relating to an extension to reach a definitive agreement
to resolve litigation with the Missouri Department of Insurance
and the Missouri Attorney General through the establishment of
a charitable health care foundation.
The company filed a report with the SEC on Form 8-K on
September 23, 1998 relating to various Settlement Agreements
with certain state agencies, including the Missouri Department
of Insurance and the Missouri Attorney General.
The company filed a report with the SEC on Form 8-K on November
2, 1998 relating to an Order issued by Judge Thomas J. Brown,
III of the Circuit Court of Cole County, Missouri in the case
styled Blue Cross and Blue Shield of Missouri, a Nonprofit
Corporation v. Jay Angoff, Director, Missouri Department of
Insurance, and Jeremiah W. (Jay) Nixon, Attorney General of
State of Missouri, Cause No. CV196-0619CC, on October 29, 1998
(the October 29 Order).
The company filed a report with the SEC on Form 8-K on November
6, 1998 relating to an Order issued by Judge Thomas J. Brown,
III on November 4, 1998 that set aside the October 29 Order and
declared it to be void ab initio.
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: November 13, 1998 By: [S] JOHN A. O'ROURKE
John A. O'Rourke
President and Chief Executive Officer
Date: November 13, 1998 By: [S] SANDRA VAN TREASE
Sandra Van Trease
Chief Financial Officer,
Executive Vice President and
Chief Operating Officer
IN THE CIRCUIT COURT OF COLE COUNTY, MISSOURI
BLUE CROSS AND BLUE SHIELD OF )
MISSOURI, a Nonprofit Corporation, )
)
Plaintiff, )
) Case No. CV196-0619CC
vs. )
)
JAY ANGOFF, Director, )
Missouri Department of Insurance, and )
)
JEREMIAH W. (JAY) NIXON, Attorney General )
of State of Missouri, )
)
Defendants. )
ORDER OF REFERENCE
Now on this 6th day of November, 1998, the Court considers
the specifications and directions to be included in an order of
reference under Supreme Court Rule 68.01(e) to the Special
Master, Robert G. Russell, appointed November 4, 1998, by
agreement of the parties. The Special Master is directed to
collect and analyze information as to the options and
alternatives available to the Court for disposition of the
remaining issues in the litigation, including, but not limited
to, an examination of the settlement agreement of September 20,
1998. In addition to this general charge, he is directed to
address several concerns of the Court. These concerns are not
exhaustive of other concerns, nor should they be mistaken as a
predisposition to rule one way or the other. All rulings are
reserved until after the Special Master makes his final report
and interested parties have had the opportunity to present their
evidence and arguments.
A. Concerns About Apparent Conflicts of Interest.
The fact that John A. O'Rourke signed the settlement
agreement both as President of Blue Cross and as Chief Executive
Officer of Right Choice is an indication of a deeper problem.
Both entities are controlled by the same management. Yet, the
purposes of the two organizations are divergent and in some
respects in conflict. Blue Cross is a nonprofit corporation,
formed and operated for six decades for benevolent purposes.
Right Choice is a for-profit corporation, formed and operated to
make a profit. Evidence presented in earlier proceedings showed
that pursuant to a reorganization in 1994 Blue Cross transferred
the bulk of its business to Right Choice, in exchange for which
Blue Cross received 80% of Right Choice's stock. As a result,
the Blue Cross management at that time created a for-profit
insurance enterprise using assets and relationships built up
during six decades of nonprofit operations. As the Court
previously found, these transfers were an abuse of Blue Cross's
authority as a nonprofit health services corporation and they
exposed Blue Cross to judicial proceedings under section 355.726, RSMo
1994.
A looming issue is the divestiture of the nonprofit assets(1)
from the present for-profit Blue Cross/Right Choice enterprise.
The parties to the settlement agreement propose to accomplish
that task by transferring legal title to Right Choice shares to
"The Missouri Foundation for Health," which presently does not
exist. While the idea of a public health foundation serving
unmet health insurance needs of Missourians has some appeal, the
conditions under which the proposed Foundation is supposed to be
established and operated raise flags of caution. The parties
propose that the Right Choice stock be placed into a voting
trust. Voting rights are to be exercised by a Trustee to be
named (and apparently controlled) by Right Choice. See Exhibit L
to the settlement agreement, Bates Nos. 303-317. The voting
trust appears to eliminate any effective control by the
Foundation. Section 4.06 would prohibit the Trustee from
following instructions of the Foundation. Section 5.03 makes it
clear that the Foundation would have no control over Right
Choice's Board of Directors, in spite of the fact that the
Foundation would own 80% of the stock. Sections 5.04 and 5.05
appears to freeze the Foundation out of any meaningful role in
the sale of the stock.
All of this (and more) indicates that the settlement
agreement was not the result of arms-length negotiations between
a benevolent corporation and a for-profit corporation. The
interests of the for-profit corporation appear to have been given
precedence. Is Blue Cross, who has strayed from its nonprofit
purposes, allowing the for-profit management of Right Choice to
indirectly but effectively control the nonprofit assets of Blue
Cross? How the Court will ultimately answer that question
remains to be seen. What can be said is that there is the
appearance that the proposed settlement agreement is so infected
with inside dealing that it should be closely scrutinized by
independent experts and weighed by persons with no stake in the
agreement. The Special Master will address that problem.
B. Concerns About Fairness.
Prior to the reorganization in 1994, Blue Cross was the
largest provider of managed health care benefits in Missouri. In
1993, its last year of normal operations, it reported premium
revenues of approximately $842 million. Its net income was $25.5
million. After most of its business was transferred to Right
Choice, its premium income dropped to $82 million and it reported
a loss of $1.4 million. Right Choice emerged with 830,000
members and 90% of Blue Cross' total premium business (apparently
including all of the profitable business).
What did Blue Cross get in return for the lucrative
insurance business transferred to Right Choice? The settlement
agreement provides for a cash payment of $175,000. Section 3.16,
Bates No. 131. Considering what was transferred, $175,000 seems
to be nothing more than a nominal sum.
In addition to a nominal amount of cash, there is the
expectancy from the proceeds of the sale of Right Choice stock,
but the proposed settlement agreement places so many restrictions
on the stock that there is a concern whether the fair market
value of the shares will ever be realized. What is an 80%
interest in Right Choice worth on the open market, without
restrictions? The settlement agreement does not provide any
information about that. For the reasons set forth under part C
below, the Court has doubts whether the existing parties will
offer evidence that would show the highest and best price that
might be obtained for these shares. What may be a fair price and
what may constitute fair terms should be examined by the Special
Master. Further, the Special Master should inquire whether there
are any other nonprofit assets, in addition to the Right Choice
stock and the $175,000 cash payment.
C. Concerns About the Absence of a Party Willing to Take
an Adversarial Role.
One of the basic tenets of the American judicial system is
that there is an adversary for each side of an issue.
Propositions are exposed to the rigor of challenge. In this way,
weak propositions are exposed and discarded.
Unfortunately, none of the existing parties are willing to
take an adversarial role when it comes to the proposed settlement
agreement. In paragraph 7, all agree to jointly move for
approval of the settlement, and all agree to cooperate in the
presentation of evidence. On its face, this indicates that the
Court will be offered no evidence by the parties that would
expose the settlement agreement to the rigor of challenge. Now,
with the appointment of the Special Master, this will not happen.
There are many unanswered questions, not the least of which
is what is the fair market value of the 80% interest in Right
Choice. The management of Right Choice has an interest in not
having the shares sold on the open market to the highest bidder,
because that could result in a change of control and the
replacement of management. One would have expected the Attorney
General and Director to have insisted on a process that would
have realized the most money for the Foundation. The Special
Master should address issues relating to the process.
D. Other Concerns
The Special Master is directed to scrutinize the settlement
agreement and examine all relevant issues. What are the stock
options referred to in Section 1.06(a) at Bates No. 120 that are
proposed to pass through and survive the settlement? Why is
management released from all liability? See paragraph 9 at Bates
No. 14. Is it fair to let management profit from stock options
while at the same time releasing management from any and all
liability, even liability for any self-dealing relating to stock
options? And why are the Attorney General and Department of
Insurance being released? See paragraph 10, Bates Nos. 15-16.
What, if anything, have they done wrong that they want released?
Are potential claims against Blue Cross/Right Choice management
or against state officials potential claims that would have value
to Blue Cross, in its nonprofit form and not as part of a for-
profit enterprise?
The Court has concerns other than the monetary issues. What
are the various ways to apply the nonprofit assets to provide
health insurance for those Blue Cross was designed to serve? The
parties are proposing the foundation, managed by persons
appointed by political office holders. Is that the best for all
concerned?
The Special Master should also investigate issues concerning
the Blue Cross licenses and trademarks. Further, the Special
Master should investigate the constraints, if any, imposed by
lending agreements.
As provided in the agreed order of November 4, 1998, the
Special Master has authority to retain Dale C. Doerhoff and
James W. Gallaher as counsel, and this engagement shall include
their respective law firms. Also as provided in the agreed
order, the Special Master has authority to employ such financial
advisors as are approved by the Court. The costs of the Special
Master, counsel and financial advisors are to be taxed as costs
of suit.
The Special Master shall promptly take and subscribe an oath
as required by Rule 68.01(d).
The Special Master shall have the right, during the pendency
of this action, to apply to this Court for further instructions
or directors.
/s/ Thomas J. Brown III
THOMAS J. BROWN III, JUDGE
STATE OF MISSOURI )
COUNTY OF COLE )SS
I, LINDA I. ROARK, Clerk of the Circuit Court of Cole
County, Missouri, hereby certify that the above and foregoing is
a full true and correct copy of
/s/ Order of Reference
as truly as the same remains of record in my said office.
IN WITNESS WHEREOF, I have hereunto sat my hand and affixed
the seal of my said office this /s/ 6th day of /s/ November
19/s/98.
LINDA I. ROARK Clerk
By /s/
Circuit Court of Cole County, Missouri Deputy Clerk
_______________________________
(1) The term "nonprofit assets" as used in this Order describes
the assets or their equivalent accumulated by Blue Cross during
sixty years of nonprofit operations, prior to the 1994
reorganization. At the present time, the nonprofit assets appear
to be 80% of the outstanding stock of Right Choice, plus the cash
payment of $175,000. Other or different assets may be identified
as "nonprofit assets" as this case progresses.
<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 September 30, 1998 and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
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<S> <C>
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<PERIOD-END> SEP-30-1998
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0
0
<COMMON> 187
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</TABLE>
