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 June 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 July 31, 1998
Class A Common Stock, $0.01 par value 3,709,000 shares
Class B Common Stock, $0.01 par value 14,962,500 shares
RIGHTCHOICE MANAGED CARE, INC.
Second Quarter 1998 Form 10-Q
Table of Contents
PART I. FINANCIAL INFORMATION PAGE
ITEM 1. Financial Statements
Consolidated Balance Sheets as of June 30, 1998
and December 31, 1997 3
Consolidated Statements of Income for the Three and Six
Months Ended June 30, 1998 and 1997 4
Consolidated Statements of Changes in Shareholders'
Equity for the Three and Six Months Ended
June 30, 1998 and 1997 5
Consolidated Statements of Cash Flows for the Six Months
Ended June 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 19
ITEM 3. Quantitative and Qualitative Disclosures About
Market Risk 32
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 32
ITEM 2. Changes in Securities 32
ITEM 3. Defaults Upon Senior Securities 32
ITEM 4. Submission of Matters to a Vote of Security Holders 32
ITEM 5. Other Information 33
ITEM 6. Exhibits and Reports on Form 8-K 33
SIGNATURES 35
PART I.FINANCIAL INFORMATION
ITEM 1.Financial Statements
RIGHTCHOICE MANAGED CARE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except shares and per share data)
ASSETS June 30, 1998 December 31, 1997
(unaudited)
Current assets:
Cash and cash equivalents $26,211 $29,872
Investments available for sale 218,900 220,972
Receivables from members 61,344 60,019
Receivables from related parties 19,656 16,130
Deferred income taxes 4,679 4,994
Other assets 19,682 14,410
Total current assets 350,472 346,397
Property and equipment, net 59,256 60,602
Deferred income taxes 11,027 12,737
Investments in affiliates 8,465 8,427
Goodwill and intangible assets, net 76,803 78,200
Total assets $506,023 $506,363
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Medical claims payable $114,092 $ 112,339
Unearned premiums 53,059 57,656
Accounts payable and accrued expenses 57,995 55,892
Current portion of long-term debt 7,000 2,000
Payables to related parties 24,416 20,213
Reserve for loss contract 9,052 9,052
Obligations for employee benefits 3,092 2,935
Income taxes payable 11,225 12,051
Obligations under capital leases 3,868 4,515
Total current liabilities 283,799 276,653
Reserve for loss contract 11,785 16,311
Long-term debt 40,000 45,000
Obligations for employee benefits 23,322 22,140
Obligations under capital leases 4,011 5,394
Total liabilities 362,917 365,498
Shareholders' Equity:
Preferred Stock, $.01 par,
25,000,000 shares authorized,
no shares issued and outstanding
Common Stock:
Class A, $.01 par, 125,000,000
shares authorized, 3,737,500 shares
issued, 3,709,000 shares outstanding 37 37
Class B, convertible, $.01 par,
100,000,000 shares authorized,
14,962,500 shares
issued and outstanding 150 150
Additional paid-in capital 132,640 132,640
Retained earnings 8,823 6,653
Treasury stock, 28,500 Class A (404) (404)
shares, at cost
Accumulated other comprehensive
income 1,860 1,789
Total shareholders' equity 143,106 140,865
Total liabilities and
shareholders' equity $506,023 $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 Six Months Ended
June 30, June 30,
1998 1997 1998 1997
Revenues:
Premium $173,665 $161,831 $347,359 $321,988
Fees and other income 18,153 14,318 36,311 30,475
Total revenues 191,818 176,149 383,670 352,463
Operating expenses:
Health care services 144,347 139,301 288,828 268,457
Commissions 8,333 7,072 16,070 14,355
General and administrative
(excludes depreciation and
amortization and excludes net
intercompany charges of
$2,906, $2,491, $6,035 and
$4,624, respectively, allocated
to Blue Cross and Blue Shield
of Missouri) 35,144 34,604 71,424 69,553
Depreciation and amortization 4,609 5,384 9,212 10,402
Charges for relocation 0 834 0 2,896
Total operating expenses 192,433 187,195 385,534 365,663
Operating loss (615) (11,046) (1,864) (13,200)
Investment income:
Interest and dividends 3,840 4,417 7,657 7,746
Realized gains, net 144 5,879 699 16,060
Total investment income, net 3,984 10,296 8,356 23,806
Other:
Interest expense (1,126) (1,056) (2,276) (2,322)
Other expense, net (111) (316) (26) (303)
Total other, net (1,237) (1,372) (2,302) (2,625)
Income (loss) before provision
for income taxes 2,132 (2,122) 4,190 7,981
Provision for income taxes 930 189 2,020 4,098
Net income (loss) $ 1,202 $(2,311) $ 2,170 $ 3,883
Weighted average common shares
outstanding 18,672,000 18,672,000 18,672,000 18,674,000
Basic and diluted earnings
(loss) per share $ 0.06 $ (0.12) $ 0.12 $ 0.21
See accompanying Notes to Consolidated Financial Statements.
RIGHTCHOICE MANAGED CARE, INC.
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' EQUITY (UNAUDITED)
(in thousands, except shares)
Accumulated
Additional Other
Common Stock Paid In Retained Treasury Comprehensive
Class A Class B Capital Earnings Stock Income Total
Balance at
December
31, 1996 $37 $150 $132,640 $30,687 $(326) $9,766 $172,954
Comprehensive loss:
Net income 6,194 6,194
Change in
unrealized
appreciation
on available-for-
sale securities,
net of income tax
credit of $4,368 (7,861) (7,861)
Comprehensive loss (1,667)
Purchase of 5,400
shares of
Class A Common
Stock, at cost (78) (78)
Balance at
March 31, 1997 37 150 132,640 36,881 (404) 1,905 171,209
Comprehensive loss:
Net loss (2,311) (2,311)
Change in
unrealized
appreciation
on available-for-
sale securities,
net of income tax
credit of $1,165 (2,037) (2,037)
Comprehensive loss (4,348)
Balance at
June 30, 1997 37 150 132,640 34,570 (404) (132) 166,861
Comprehensive loss:
Net loss (27,917) (27,917)
Change in
unrealized
appreciation
on available-for-
sale securities,
net of income tax
expense of $1,146 1,921 1,921
Comprehensive loss (25,996)
Balance at
December 31, 1997 37 150 132,640 6,653 (404) 1,789 140,865
Comprehensive loss:
Net income 968 968
Change in
unrealized
appreciation
on available-for-
sale securities,
net of income tax
credit of $690 (1,252) (1,252)
Comprehensive loss (284)
Balance at
March 31, 1998 37 150 132,640 7,621 (404) 537 140,581
Comprehensive income:
Net income 1,202 1,202
Change in
unrealized
appreciation
on available-for-
sale securities,
net of income tax
expense of $731 1,323 1,323
Comprehensive income 2,525
Balance at
June 30, 1998 $37 $150 $132,640 $8,823 $(404) $1,860 $143,106
See accompanying Notes to Consolidated Financial Statements.
RIGHTCHOICE MANAGED CARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
For the six months ended,
June 30,
1998 1997
Cash flows from operating
activities:
Net income $ 2,170 $ 3,883
Adjustments to reconcile net
income to net cash used in
operating activities:
Provision for deferred income taxes 1,985 2,416
Depreciation and amortization 9,212 10,402
Undistributed earnings of affiliates (38) 149
Gain on sale of investments (699) (16,060)
Amortization of premiums and
accretion of discounts, net 52 (160)
Loss on sale of property and equipment 1 8
(Increase) decrease in certain assets:
Receivables from members (1,325) (6,974)
Receivables from related parties (3,526) 2,874
Other assets (5,337) (9,270)
Increase (decrease) in certain liabilities:
Medical claims payable 1,753 3,462
Unearned premiums (4,597) (2,021)
Accounts payable and accrued expenses 2,103 791
Payables to related parties 4,203 (533)
Reserve for loss contract (4,526)
Obligations for employee benefits 1,339 (948)
Income taxes payable (826) 4,247
Net cash provided by (used in)
operating activities 1,944 (7,734)
Cash flows from investing activities:
Proceeds from matured investments:
Fixed maturities 15,060 215
Proceeds from investments sold:
Fixed maturities 124,943 132,317
Equity securities 40,734
Other 4,408 32,469
Investments purchased:
Fixed maturities (140,634) (186,280)
Equity securities (548) (230)
Other (399) (1,023)
Proceeds from property and equipment sold 6
Property and equipment purchased (5,749) (8,390)
Net cash (used in) provided by
investing activities (2,913) 9,812
Cash flows from financing activities:
Purchase of Class A Treasury stock (78)
Repayment of borrowings under
revolving credit facility (15,000)
Payments of capital lease obligations (2,692) (2,991)
Net cash used in financing activities (2,692) (18,069)
Net decrease in cash and cash equivalents (3,661) (15,991)
Cash and cash equivalents at
beginning of period 29,872 33,418
Cash and cash equivalents at end of period $ 26,211 $ 17,427
Supplemental Disclosure of Cash Information:
Interest paid $ 2,321 $ 2,713
Income taxes paid (refunds received), net (2,131) (2,565)
Supplemental Schedule of Noncash
Investing and Financing Activities:
Equipment acquired through
capital leases $ 662 $ 1,361
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 (after MCHCP, discussed further herein) of
BlueCHOICE. OPM conducts periodic audits to, among other
things, verify that the premiums established under the OPM
contract were established in compliance with the community
rating 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. At this time,
management is unable to determine the final dollar amount
which may be required to resolve the audit findings. There
can be no assurance that the resolution of these findings
will not have a material adverse effect on the company and
the market for the company's stock.
Subscriber class action litigation
On March 15, 1996, a suit was filed in the Circuit Court of
the City of St. Louis, Missouri, by Anthony J. Sarkis, Sr.
and James Hacking individually and on behalf of a purported
class of (i) subscribers in individual or group health
plans insured or administered by Blue Cross and Blue Shield
of Missouri (BCBSMo, the class B shareholder of the
company) or the company, and (ii) all persons and/or
entities who benefited from BCBSMo's tax-exempt status (the
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. They continue to seek to
represent subscribers in group health plans of BCBSMo or
the company as of the date of the transaction they
challenge. No determination has been made whether the case
will be certified as a class action.
The 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.
The company and the other defendants removed the case to
the United States District Court for the Eastern District
of Missouri on May 26, 1996, and filed an answer on May 31,
1996. On August 8, 1996, the district court granted
plaintiff's motion to remand. In May 1997, plaintiffs
filed an amended petition alleging breach of contract by
the company. BCBSMo again removed the case to United
States District Court for the Eastern District of Missouri.
The Sarkis plaintiffs moved again to remand the case to
state court, which motion to remand was granted. BCBSMo
has filed a motion to dismiss for lack of standing, which
motion was heard by the Circuit Court on August 6, 1998.
Preliminary discovery has been conducted. BCBSMo and the
company intend to vigorously defend the action or
otherwise resolve the action as part of the transactions
contemplated by the conceptual framework described below
under "Litigation with DOI and Attorney General - Possible
Settlement." There can be no assurance, however, that the
action will be dismissed or otherwise resolved. An adverse
decision could have a material adverse effect on the
company and the market for the company's stock.
As more fully described below under "Litigation with DOI
and Attorney General," the Sarkis plaintiffs have filed a
motion to intervene in the action filed by BCBSMo seeking
declaration as to the status of BCBSMo as a mutual or
public benefit type of non-profit corporation.
Litigation with DOI and Attorney General
Possible Settlement
On April 22, 1998, the company and BCBSMo announced a
conceptual framework for an agreement that would resolve
all outstanding litigation and regulatory issues between
the companies and the Missouri Department of Insurance (the
DOI) and the Missouri Attorney General. Under the terms of
the conceptual framework, BCBSMo would create a charitable
health care foundation that would be managed by an
independent board of directors. This foundation would be
created through a series of transactions in which BCBSMo
would contribute to the foundation all of its shares of
stock in the company (approximately 15 million shares).
The foundation would fund its activities through the
orderly divestiture of this stock. The shares held by the
foundation would be subject to a voting agreement that
would, with certain exceptions, effectively vest voting
control in the board of directors of the company. The
company would absorb the remaining assets and related
liabilities of BCBSMo and become a consolidated, fully for-
profit, direct licensee for the Blue Cross and Blue Shield
names and trademarks.
The company, BCBSMo, the Missouri Attorney General and the
DOI originally agreed to stand still with regard to certain
litigation until July 22, 1998 (the 90th day after the date
of the conceptual framework), during which period the
parties attempted to finalize a definitive settlement
agreement. On July 17, 1998, the company, BCBSMo, the
Missouri Attorney General and the DOI announced the
extension of the standstill with regard to certain
litigation until September 15, 1998 and stated their
intentions to continue to work together to complete the
proposed settlement. The company expects that a definitive
agreement will be reached by September 15, 1998.
Although the parties to the conceptual framework originally
agreed to stand still with respect to certain pending
litigation for which no rulings have been issued, on August
4, 1998, the Missouri Court of Appeals entered its opinion
affirming the judgments entered by the Circuit Court on
December 30, 1996, in the "Litigation relating to the
Reorganization and Public Offering" described below.
Although the case could be reheard by the Appellate Court
or appealed to the Missouri Supreme Court, if the August 4
appellate opinion becomes final without modification, 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
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. If a definitive agreement
with respect to the conceptual framework is finalized, it
will be presented to the Cole County Circuit Court for
approval and offered as a reasonable alternative to
dissolution of BCBSMo. The Circuit Court has informally
advised the parties that it has substantial reservations
about the terms of the tentative settlement as outlined in
the conceptual framework, and will scrutinize any final
settlement presented to it very carefully.
In addition to court approval, the definitive agreement, if
executed by the parties, is expected to include a number of
significant conditions and contingencies, including
judicial, shareholder and Blue Cross and Blue Shield
Association approvals, resolution of other pending
litigation, state and federal securities filings and
registrations, and approval from various state insurance
departments and commissioners. There can be no assurance
that a definitive agreement will be negotiated and
executed, that it will receive the necessary court approval
as an acceptable alternative to dissolution of BCBSMo, that
all conditions and contingencies expected to be included
therein will be satisfied, or that the transaction proposed
thereby will be effected. In the event that the definitive
agreement is not executed or the standstill not extended,
or the transactions contemplated by the conceptual
framework not consummated, it is expected that the Missouri
Attorney General and DOI would pursue the Litigation
relating to the Reorganization and Public Offering and the
Litigation relating to the Market Conduct Study and
Copayment Calculations, as further described below under
the same captions. An adverse ruling in that litigation
could have a material adverse affect on the company and the
market for the company's stock.
Litigation relating to the Reorganization and Public
Offering
In August 1994, BCBSMo transferred certain assets to the
company in connection with an offering to the public of 20
percent of the common stock of the company (such events are
referred to collectively as the Reorganization and Public
Offering). Although the Director of the DOI (the Director)
formally approved the Reorganization and Public Offering on
April 14, 1994, the Director and DOI subsequently claimed
that the Reorganization and Public Offering violated state
laws and that BCBSMo was obligated to transfer all of its
assets, including all of its company stock, to the State of
Missouri or a charity designated by the State of Missouri.
The Director and DOI threatened to bring legal action, seek
a receivership or terminate BCBSMo's insurance license
unless BCBSMo gave up its assets.
BCBSMo's extensive efforts to resolve this dispute without
litigation were unsuccessful. On May 13, 1996, BCBSMo
filed a declaratory judgment action in the Circuit Court of
Cole County, Missouri (the Court) against the Director, DOI
and the Missouri Attorney General (the Missouri Attorney
General was a necessary party due to his sole authority to
enforce nonprofit corporation laws).
The Director and DOI filed an answer and counterclaims on
June 13, 1996. The answer 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 service corporation and nonprofit corporation
statutes. The Director and DOI's counterclaims sought
among other things: (i) permanent injunctions against
BCBSMo; (ii) imposition of a trust on BCBSMo's assets for
public benefit purposes; (iii) return of profits from
Medigap policies reinsured with a subsidiary; and (iv) an
accounting of all assets transferred by BCBSMo.
The Missouri Attorney General filed an answer and
counterclaim on June 20, 1996, alleging that the
Reorganization and Public Offering, and the continued
operations through the company and its subsidiaries, exceed
BCBSMo's statutory purposes. The Missouri Attorney General
requested a declaration that BCBSMo has exceeded its lawful
authority and seeks such relief as the Court determines to
be appropriate under the circumstances based on a statute
which authorizes judicial dissolution or less drastic
alternative relief in the Court's discretion.
On September 9, 1996 (the September 9 Order), the Court
granted BCBSMo's motion for summary judgment against the
Director and DOI, rejected all of the Director and DOI's
affirmative defenses (including allegations of fraud),
issued a permanent injunction against the Director and DOI
and declared that: (i) under Missouri law the Director and
DOI have no authority to demand that BCBSMo make a payment
as a result of the Reorganization and Public Offering; (ii)
under Missouri law the Director and DOI have no
jurisdiction to take any action, the practical effect of
which is to amend, modify or reverse the Director's April
14, 1994 final administrative approval of the
Reorganization and Public Offering; (iii) under Missouri
law the Director and DOI have no jurisdiction to take any
administrative action, including but not limited to,
revoking, suspending or refusing to renew BCBSMo's
Certificate of Authority based in any way on the
Reorganization and Public Offering and the consequences
thereof or BCBSMo's refusal to make a payment as the
Director and DOI have demanded; and (iv) (A) BCBSMo is a
mutual benefit type of nonprofit corporation rather than a
public benefit type of nonprofit corporation; (B) the
Reorganization and Public Offering were authorized under
all laws applicable to nonprofit health services
corporations; and (C) BCBSMo does not owe the State or any
person or entity a "toll charge," "charitable asset
settlement" or any other payment as a result of the August
1994 Reorganization and Public Offering. On December 30,
1996, the Court issued orders modifying the findings and
declarations set forth in (iv) above, on the grounds that
it was legally unnecessary to resolve such issues since the
Court had already ruled against the Director and DOI for
other reasons.
The September 9 Order permanently enjoined the Director and
DOI from, among other things, (i) revoking, suspending or
refusing to renew BCBSMo's insurance license based in any
part upon the Reorganization and Public Offering; (ii)
commencing a valuation of BCBSMo's assets and demanding a
payment as a result of the Reorganization and Public
Offering; (iii) commencing any administrative hearing or
making any administrative determination based in any part
upon the Reorganization and Public Offering; (iv)
instituting any seizure, receivership, conservatorship or
similar action or proceeding against BCBSMo based in any
part upon the Reorganization and Public Offering; and (v)
taking any other action, however denominated, against
BCBSMo based in any part upon the Reorganization and Public
Offering. This injunctive relief remains in place, but the
Court's December 30 Orders (described below) clarify that
the injunction does not prohibit the Director and DOI from
asserting that the post-Reorganization and Public Offering
operations of BCBSMo may violate the health services
corporation laws (even though such operations may have been
affected by the Reorganization and Public Offering).
On August 28, 1996, the Director and DOI filed an amended
answer asserting a new counterclaim that the Reorganization
and Public Offering were not reasonably designed to serve
any of BCBSMo's purposes as a health services corporation
and seeking a declaration that BCBSMo has exceeded or
abused its authority conferred upon it by law. Under this
counterclaim, the Director and DOI seek an order to
rehabilitate BCBSMo or, in the alternative, injunctive
relief.
On October 18, 1996, the Missouri Attorney General filed a
motion for leave to file an amended counterclaim against
BCBSMo seeking a declaration that BCBSMo is a public
benefit corporation, not a mutual benefit corporation, and
requesting an order that BCBSMo amend its Articles of
Incorporation accordingly. The Court granted the Missouri
Attorney General's motion for leave to file the amended
counterclaim, which remains pending.
On December 30, 1996, the court issued five orders (the
December 30 Orders): (i) denying BCBSMo's motion for
summary judgment against the Missouri Attorney General;
(ii) granting the Missouri Attorney General's motion for
partial summary judgment against BCBSMo; (iii) denying
BCBSMo's supplemental motion for summary judgment against
the Director and DOI on their amended counterclaim; (iv)
granting the Director and DOI's motion for summary judgment
against BCBSMo on their amended counterclaim; and (v)
modifying, in part, the Court's previous September 9 Order
as described above. The December 30 Orders declared that
(i) BCBSMo has continued to exceed or abuse its statutorily
permissible purposes and the authority conferred on it by
law; and (ii) BCBSMo is subject to judicial dissolution
proceedings, but that prior to ordering dissolution, the
Court is required to consider whether there are
alternatives to dissolution and whether dissolution is in
the public interest or is the best way of protecting the
interests of its members.
The Court also (i) certified the December 30 Orders and the
September 9 Order, as modified, for immediate appeal; (ii)
held in abeyance further proceedings on the Missouri
Attorney General's counterclaim pending appeal; and (iii)
stayed the legal effect of the order granting the Director
and DOI summary judgment pending the filing of an appeal
bond (which BCBSMo promptly filed). On January 9, 1997,
BCBSMo filed a notice of appeal of the December 30 Orders.
On January 21, 1997, the Director and DOI filed a notice of
appeal of the September 9 Order, as modified. Oral
arguments were heard by the Missouri Appellate Court on
February 24, 1998.
On August 4, 1998, the Missouri Court of Appeals entered
its opinion affirming the judgments entered December 30,
1996. BCBSMo has the right to apply in the Court of
Appeals for rehearing and alternatively for transfer of the
case to the Supreme Court of Missouri. If the Court of
Appeals denies that relief, BCBSMo can ask the Supreme
Court of Missouri to accept transfer of the case. If the
August 4 appellate opinion becomes final without
modification, 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 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 Circuit Court has informally advised the parties that
it has substantial reservations about the terms of the
conceptual framework for settlement as outlined above, and
will scrutinize any final settlement presented to it very
carefully.
Any of the foregoing could have a material adverse effect
on the company and the market for the company's stock. See
also "Contingencies - Status of Blue Cross and Blue Shield
trademark licenses." As described above, in Litigation
with DOI and Attorney General - Possible Settlement, BCBSMo
and the company have announced a conceptual framework for
an agreement with the DOI and the Missouri Attorney General
which could resolve this litigation. The parties to this
litigation have agreed pursuant to the terms of the
conceptual framework, to a standstill with respect to
certain litigation until September 15, 1998. It is
expected that BCBSMo, the Missouri Attorney General, and
DOI will present the reorganization contemplated by the
conceptual framework to the Circuit Court as a reasonable
alternative to dissolution. If the Court were to approve
the conceptual framework on that basis, it would avoid the
possibility of dissolution of BCBSMo as a result of these
proceedings. There can be no assurance, however, that a
definitive agreement will be reached or that the conceptual
framework would be accepted by the Court as an alternative
to dissolution.
On November 3, 1997, BCBSMo filed an action in the Court
against the Missouri Attorney General seeking declarations
that (1) BCBSMo is a mutual benefit type of nonprofit
corporation under Chapter 355 of the Missouri Revised
Statutes; and (2) BCBSMo does not hold its assets in
constructive, charitable, or other trust for the benefit of
the public generally, but rather holds its assets for the
benefit of its subscribers. The action was filed in
response to continued public and private statements by the
Missouri Attorney General, the DOI and others that BCBSMo
is a public benefit type of nonprofit corporation which
holds its assets for the benefit of the public generally.
See above in this section, "Litigation with DOI and
Attorney General." The Missouri Attorney General has
filed an answer and counterclaim seeking a declaration
that BCBSMo is a public benefit type of nonprofit
corporation. 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 above in this section, "Litigation with the DOI
and Attorney General." If BCBSMo is declared to be a
public benefit type of nonprofit corporation or if it is
declared that BCBSMo holds assets for the benefit of the
public generally, however, BCBSMo 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" tradenames and service
marks and trigger a termination fee and a notice to members
thereunder) which, if successful, could have a material
adverse effect upon the company and the market for the
company's stock. See "Contingencies - Status of Blue Cross
and Blue Shield Trademark Licenses." As described above,
in Litigation with DOI and Attorney General - Possible
Settlement, BCBSMo and the company have announced a
conceptual framework for an agreement with the DOI and the
Missouri Attorney General which could resolve this
litigation. There can be no assurance that the parties
will reach a definitive agreement, that all conditions and
contingencies expected to be included therein including
court approval will be satisfied, or that the transaction
proposed by such an agreement will be effected. See
"Litigation with the DOI and Attorney General" above.
Litigation relating to the Market Conduct Study and
Copayment Calculations
The DOI issued a market conduct report to the company and
BCBSMo in April 1996. The report findings cited the
company and BCBSMo for not complying with certain insurance
statutes and regulations including those that relate to the
Small Employer Health Insurance Availability Act,
coordination of benefits and copayment calculations. The
company responded to the report in May 1996. The company
and the DOI have had discussions relating to the issues
contained in the report from May 1996 to February 1998. On
February 11, 1998, the DOI filed a Notice of Institution of
Case requesting the Director to issue a cease and desist
order, an order requiring the payment of a monetary
penalty, an order to cease marketing and/or an order
suspending or revoking the certificate of authority of the
company and BCBSMo. The company has alleged in the action
described above under "Litigation with DOI and Attorney
General - Litigation relating to the Reorganization and
Public Offering," that the market conduct study was not
conducted for legitimate purposes of regulatory oversight
but rather as a pretext to either revoke or refuse to renew
BCBSMo's license to operate as a health services
corporation and thus to improperly pressure and coerce
BCBSMo into making the payment in the nature and amount
described above. The DOI believes the company should
refund excess premium payments to the small groups, pay
additional refunds to members for copayment calculations
made prior to January 1996, and take certain actions
relating to coordination of benefits. The issue relating
to the manner in which the company calculated copayment
amounts prior to January 1996 was the subject of a class
action suit, titled Kelly v. Blue Cross and Blue Shield of
Missouri, and subsequent settlement. BCBSMo settled the
case in 1995 and paid the majority of the total settlement
amount of five million dollars. The company believes it
has resolved this issue through the court-approved class
action settlement and intends to vigorously defend this new
action if required. As described above, in Litigation with
DOI and Attorney General - Possible Settlement, BCBSMo and
the company have announced a conceptual framework for an
agreement with the DOI and the Missouri Attorney General
which could resolve this litigation. The parties to this
litigation have agreed, pursuant to the terms of the
conceptual framework, to a standstill with respect to this
litigation until September 15, 1998. There can be no
assurance that the parties will reach a definitive
agreement, that all conditions and contingencies expected
to be included therein including court approval will be
satisfied, or that the transaction proposed by such an
agreement will be effected. See "Litigation with the DOI
and Attorney General" above.
On February 9, 1998, the Missouri Attorney General filed
suit against the company, BCBSMo, BlueCHOICE, Healthy
Alliance Life Insurance Company (HALIC), and Preferred
Health Plans of Missouri, Inc. (a subsidiary of the
company) in the Court seeking injunctive relief,
compensatory damages and civil penalties under Missouri's
Merchandising Practices Act for the way in which the
company disclosed and marketed copayment amounts prior to
January 1996. The factual allegations in the Missouri
Attorney General's suit are the same as the copayment
issues in the DOI Market Conduct Study Action and the same
issue which was the subject of a court-approved class
action suit settlement in the Kelly v. Blue Cross and Blue
Shield of Missouri case. The company discontinued the
copayment practices in January 1996. The company believes
it has already paid the restitution damages requested in
the settlement of the class action suit. BCBSMo and the
company believe the claims are without merit and intend to
vigorously defend the action if required. As described
above, in Litigation with DOI and Attorney General -
Possible Settlement, BCBSMo and the company have announced
a conceptual framework for an agreement with the DOI and
the Missouri Attorney General which could resolve this
litigation. The parties to this litigation have agreed,
pursuant to the terms of the conceptual framework, to a
standstill with respect to this litigation until September
15, 1998. There can be no assurance that the parties will
reach a definitive agreement, that all conditions and
contingencies expected to be included therein including
court approval will be satisfied, or that the transaction
proposed by such an agreement will be effected. See
"Litigation with the DOI and Attorney General" above.
Status of Blue Cross and Blue Shield trademark licenses
In March 1998, the Blue Cross and Blue Shield Association
(BCBSA) agreed to reinstate BCBSMo's exclusive trademark
licenses (the Primary Licenses) and the exclusive
controlled licenses (the Affiliate Licenses) of the
company, HALIC and BlueCHOICE (collectively, the Licenses).
The Licenses give the companies the right to use the "Blue
Cross" and "Blue Shield" names, trademarks and service
marks in connection with health insurance products marketed
and sold in BCBSMo's licensed operating area (consisting of
85 counties in eastern and central Missouri). The Licenses
replaced the Interim and Temporary Licenses granted in
January 1997 after notification by the BCBSA that the prior
licenses of BCBSMo and its affiliates had automatically
terminated in connection with the Litigation relating to
the Reorganization and Public Offering described above
(Litigation). The trademark licenses require BCBSMo, the
company and its controlled affiliates to pay license fees
to BCBSA for the use of the trademarks.
Each of the trademark licenses provide that it
automatically terminates if, among other things: (i) DOI
or another regulatory agency assumes control of the
licensee or delinquency proceedings are instituted; or (ii)
an action is instituted by any governmental entity or
officer against the licensee seeking dissolution or
liquidation of its assets or seeking the appointment of a
trustee, interim trustee, receiver or custodian for any of
its property or business, which is consented to or
acquiesced in by the licensee or is not dismissed within
130 days of the licensee being served with the pleading or
document commencing the action, provided that if the action
is stayed or its prosecution enjoined, the 130-day period
is tolled for the duration of the stay or injunction, and
provided further that the BCBSA's Board of Directors may
toll or extend the 130-day period at any time prior to its
expiration. Each trademark license also provides that it
may be terminated by BCBSA if, among other things, the
licensee fails to meet certain quality control standards or
minimum capital or liquidity requirements.
The Affiliate Licenses are derivative of the Primary
Licenses and automatically terminate if the Primary
Licenses terminate. According to their terms, if a
trademark license is terminated, BCBSMo, the company and
its controlled affiliates are jointly liable to BCBSA for
payment of a termination fee in an amount equal to $25
times the number of licensed enrollees of the terminated
entity and its licensed controlled affiliates, and must
give written notice of such termination to their enrollees.
The termination fee is reduced in accordance with a formula
set forth in the Primary Licenses if another plan is
licensed by BCBSA in BCBSMo's exclusive service area.
In March 1998, BCBSMo and BCBSA agreed that the Primary
Licenses are reinstated as if a suit seeking dissolution
had been served on BCBSMo but the 130-day period for
automatic termination described above was tolled. The
tolling will continue for as long as the stay entered in
the Litigation remains in full force and effect. In the
event that the stay is modified or lifted, the 130-day
period will begin to run on such date and no longer be
tolled. If the Appellate Court ruling issued on August 4,
1998 becomes final because the Appellate Court denies the
motion for rehearing and the Missouri Supreme Court denies
the motion to transfer, the 130-day period will begin to
run on such date and no longer be tolled. If the 130-day
period elapses without BCBSA having taken affirmative
action to extend the 130-day tolling period, the Reinstated
Primary Licenses will automatically and immediately
terminate.
The company believes that the exclusive right to use the
"Blue Cross" and "Blue Shield" trademarks provides it and
its controlled affiliates with a significant marketing
advantage in BCBSMo's licensed operating area, the loss of
which would have a material adverse effect on the company
and the market for the company's stock. In connection with
the conceptual framework described above, under "Litigation
with DOI and Attorney General - Possible Settlement,"
BCBSMo and the company have filed a request with the BCBSA
to transfer its Primary License to the company or a
successor to the company as part of the proposed
transaction whereby the company would absorb assets and
certain liabilities of BCBSMo, other than approximately 15
million shares of the company's stock held by BCBSMo. The
BCBSA conditionally approved the proposed reorganization.
There can be no assurance, however, that final approval of
the definitive agreement will be granted or that the
proposed transaction will be effected.
Litigation with MCHCP
The following is a discussion of the litigation between the
company and the Missouri Consolidated Health Care Plan
(MCHCP). As later described herein, the company and MCHCP
dismissed these lawsuits on June 10, 1998.
On August 28, 1997, the company brought suit against the
MCHCP and its trustees in the Circuit Court of Cole County,
Missouri. MCHCP is a Missouri public agency which
purchases health care coverage for employees of the State
and of selected public entities which have been admitted
into the MCHCP. MCHCP is currently the largest customer
group served by BlueCHOICE, a subsidiary of the company.
In 1995, the company, after bidding on certain Requests for
Proposal from MCHCP, was awarded a contract to furnish
various managed care products to employees of the State and
to public entities. The contract was for an initial one-
year term with four one-year renewal terms.
In its lawsuit, the company contended 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. It further contended that MCHCP had breached
that duty by renewing the contract from year to year while
allowing only limited rate increases, without negotiation.
The company further contended that MCHCP had violated
Missouri law by admitting numerous public entities into the
MCHCP without conducting any actuarial or other appropriate
analysis, thus compelling the company to provide managed
care services to public entities without regard to the
actuarial risk that they pose. The company also contended
that MCHCP violated the Missouri Administrative Procedure
Act in the manner in which it adopted the regulations by
which it administers its managed care program, and that
MCHCP had violated the Missouri Open Meetings and Open
Records Law in the manner in which it had conducted its
business.
The company contended in its lawsuit that it had been
damaged in the 1997 plan year in an amount in excess of $5
million, and that it would have estimated losses during the
1998 plan year under its contract with MCHCP in an amount
in excess of $10 million. The company further contended
that if the contract is renewed for the 1999 and 2000 plan
years without requested rate increases, it would have
further losses. On August 29, 1997, the company reported
the commencement of the litigation and estimated losses
(giving effect to all possible renewal terms of the MCHCP
contract without requested rate increases) in the range of
$30 million to $40 million. In the third quarter of 1997,
the company took a pre-tax charge of $29.5 million, which
was based on actuarial estimates, including projected
limited rate increases, and projected enrollment and
medical cost trends accounted for through the year 2000 in
accordance with generally accepted accounting principles.
There can be no assurance that the amount of the reserve
taken in the third quarter of 1997 will be sufficient to
cover all losses which may be associated with the MCHCP
contract, which losses could have a material adverse effect
on the company and the market for the company's stock.
For its relief, the company sought a permanent injunction
against the promulgation and implementation by MCHCP of any
rates for the 1998 plan year other than rates which are the
product of the negotiation process called for by the
parties' contract, and for a decree of specific performance
requiring MCHCP to negotiate rates in good faith for the
1998 plan year and later plan years. Absent such relief,
the company prayed for a declaration that the contract is
void and is of no effect. The company also prayed for
damages in the amount of its losses incurred, for its
attorney fees, for relief for violation of the Open
Meetings Law, and for such other relief as was appropriate.
Also on August 28, 1997, and in anticipation of the
company's suit, MCHCP filed suit against BCBSMo, the
company and HealthLink HMO, Inc., a wholly owned subsidiary
of the company (HealthLink HMO). MCHCP in its lawsuit
contended that the company and HealthLink HMO had committed
anticipatory breaches of their contracts with MCHCP, and
had tortiously interfered with MCHCP's contractual
relations with its members. It prayed only for equitable
relief, in the form of a decree compelling the company and
HealthLink HMO to perform in accordance with MCHCP's
interpretation of the contracts' terms.
Subsequently, HealthLink HMO and Continental Assurance Co.
(CNA) filed suit in the Circuit Court of Cole County,
Missouri against MCHCP. HealthLink HMO is a party to an
HMO contract with MCHCP similar to the contract of the
company; substantially all the underwriting risk under that
contract is borne by CNA under an agreement between
HealthLink HMO and CNA. HealthLink HMO and CNA sought
relief similar to that sought on behalf of the company,
including a declaration that their contract with MCHCP is
void and of no effect. On March 18, 1998, MCHCP dismissed
its claims against HealthLink HMO and CNA without prejudice
and HealthLink HMO and CNA similarly dismissed their claims
against MCHCP without prejudice.
On March 16, 1998, MCHCP voluntarily dismissed its suit
against the company which had accused the company of
anticipatory breach of contract and tortious interference
with MCHCP's members; however, MCHCP was allowed to amend
its petition to include a declaratory judgment action
relating to the entrance of public entities into the MCHCP.
On March 19, 1998, the trial court entered rulings on
various motions and cross-motions for summary judgment of
the parties. On a motion for summary judgment filed by
another contractor, the Court ruled that under the uniform
contract between MCHCP and its contractors, rate increases
from year to year are limited to the medical cost component
of the Consumer Price Index. On motions for summary
judgment filed by the company, the Court held that MCHCP's
rules relating to the admission of public entities and its
adoption of a community rating policy were lawful under the
Missouri Administrative Procedure Act, and that the company
is estopped from questioning the validity of those rules
and policies. The Court also held that MCHCP did not
violate the Missouri Open Meetings and Open Records Act in
the manner in which it responded to a request for access to
public records made by the company, and that the company's
claims for breach of the Act in the conduct of closed
meetings are time barred as to all meetings conducted on or
before February 27, 1997. The company's claims based on
alleged violation by MCHCP of the covenant of good faith
and fair dealing remained pending in the trial court.
MCHCP had moved for summary judgment on those 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. Based upon the rulings, the
company will 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 rates contracted for in
1995, with annual rate increases, if any, which are far
less than necessary to permit the company to recover its
costs in serving those members. While management of the
company believes the current provision for losses is
adequate, if the actual number of the company's members
through MCHCP grows at a rate in excess of the rate used in
the 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 actuarial estimates, then the
amount of the reserve recorded to date could be
insufficient to cover all future losses which may be
associated with the MCHCP contract, and such losses could
have a material adverse effect on the company and the
market for the company's stock.
Other contingencies
In addition to the matters described above, the company is
a party to litigation in the normal course of business,
including professional liability and litigation with former
executives of the company.
3. Recently Issued Accounting Standards
The Financial Accounting Standards Board (FASB) recently
released Statement of Financial Accounting Standards (SFAS)
No. 131, "Disclosures about Segments of an Enterprise and
Related Information", 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 133 is
effective for all fiscal years beginning after June 15,
1999. Earlier application of SFAS 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 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's management has not yet
assessed what the impact of the SOP will be on the
company's future results of operations or financial
position.
4. Provision for Income Taxes
The company's effective income tax rates presented in the
Consolidated Statements of Income, of 43.6 percent and
(8.9) percent for the second quarters of 1998 and 1997,
respectively, and 48.2 percent and 51.3 percent for the
first half of 1998 and 1997, respectively, were affected by
non-deductible goodwill amortization. The effective income
tax rates for the second quarter and first half of 1997
were 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 41,071 and 0 dilutive potential common
shares for the second quarter of 1998 and 1997,
respectively and 18,802 and 55,166 dilutive potential
common shares for the first half 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 six month periods ended June 30, 1998 and 1997 are as
follows:
Three months Six months
ended ended
June 30, June 30,
1998 1997 1998 1997
(in thousands) (in thousands)
Unrealized holding gains arising
during period, net of taxes $1,416 $1,784 $ 525 $ 457
Less: reclassification adjustment
for gains included in net
income, net of taxes (93) (3,821) (454) (10,355)
Net unrealized gains (losses) on
securities $1,323 $(2,037) $ 71 $(9,898)
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 six month periods ended June 30,
1998 and 1997 (unaudited):
Three Months Ended Six Months Ended
June 30, June 30
Product Group 1998 1997 1998 1997
(in thousands) (in thousands)
PPO:
Alliance PPO $ 47,143 $ 50,106 $ 95,133 $102,064
AllianceChoice POS 37,631 30,367 73,743 57,830
HMO (includes other POS) 51,821 43,431 104,146 86,762
Medicare supplement 24,055 24,798 48,248 49,458
Managed indemnity 2,298 3,667 4,666 7,267
Other specialty services 10,717 9,462 21,423 18,607
Total premium revenue 173,665 161,831 347,359 321,988
ASO/Self-funded and other income 18,153 14,318 36,311 30,475
Total revenues $191,818 $176,149 $383,670 $352,463
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 Six Months Ended
June 30, June 30,
1998 1997 1998 1997
Operating revenues:
Premium revenue 90.5% 91.9% 90.5% 91.4%
Fees and other income 9.5% 8.1% 9.5% 8.6%
100.0% 100.0% 100.0% 100.0%
Operating expenses:
Medical loss ratio 83.1% 86.1% 83.1% 83.4%
Commission expense 4.3% 4.0% 4.2% 4.1%
General and administrative expense 20.7% 22.7% 21.0% 22.7%
Adjusted general and administrative expense
(excludes depreciation and amortization) 18.3% 19.6% 18.6% 19.7%
Membership
The following table sets forth membership data and the percent
change in membership:
June 30,
Product Group 1998 1997 %
Underwritten:
PPO:
Alliance PPO 143,367 167,858 (14.6)%
AllianceChoice POS 131,809 124,568 5.8
HMO:
Commercial (includes other POS) 134,950 118,641 13.7
BlueCHOICE Senior 5,647 5,825 (3.1)
BlueCHOICE Medicaid (MC+) 4,831 N/A
Medicare supplement 59,498 64,991 (8.5)
Managed indemnity 5,530 8,984 (38.4)
480,801 495,698 (3.0)
Self-funded:
PPO 45,969 89,737 (48.8)
HMO 10,683 16,326 (34.6)
ASO (includes HealthLink):
Workers' Compensation 373,109 326,061 14.4
Other ASO* 1,102,532 970,230 13.6
Total Membership 2,013,094 1,898,052 6.1
* does not include 454,823 and 565,521 as of June 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 $11.8 million or 7.3 percent in
the second quarter of 1998 in comparison to the second
quarter of 1997. For the first half of 1998, premium
revenue increased $25.4 million, or 7.9 percent, in
comparison to the first half of 1997. As described below,
components of premium revenue were affected by shifts in
product mix, rate increases, and other factors; and as a
result, such changes may not be indicative of future
periods. The company will continue to strive to establish
its commercial premium rates based on anticipated health
care costs. Depending on the level of future competition,
customer acceptance of the company's premium increases,
future health care cost trends or other factors, there can
be no assurance that the company will be able to price its
products consistent with health care cost trends.
PPO revenues increased $4.3 million in the second quarter
of 1998 as compared to the second quarter of 1997 - - $9.2
million due to a 10.8 percent increase in net premium rates
partially offset by a $4.9 million decrease resulting from
a 4.9 percent decrease in member months. For the first
half of 1998, PPO revenues increased $9.0 million as
compared to the first half of 1997 - - $17.4 million due to
a 10.2 percent increase in net premium rates partially
offset by an $8.4 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 half 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 24,491 members from June 30, 1997 to June 30,
1998 while AllianceChoice POS membership increased by 7,241
over the same time period. The company also began offering
PPO products in Illinois at the end of the first quarter of
1997. Included in the Alliance PPO member count are 4,600
PPO Illinois members as of June 30, 1998.
HMO premium revenue increased $8.4 million or 19.3 percent
in the second quarter of 1998 as compared to the second
quarter of 1997 - - $2.3 million due to an 8.5 percent
increase in net premium rates and $6.1 million due to a
10.0 percent increase in member months. For the first half
of 1998, HMO revenues increased $17.4 million or 20.0
percent as compared to the first half of 1997 - - $10.0
million due to a 12.6 percent increase in member months and
$7.4 million due to a 6.6 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 half of 1998. Net rate increases are lower than the
targeted renewal rates due to HMO competition in the
company's HMO service areas, the status of a large group
(MCHCP) with which the company had been involved in
litigation (see Note 2 entitled "Contingencies - Litigation
with MCHCP" of Part I), shifts in chosen benefit levels,
changes in the geographic mix of the HMO business, and
product mix shifts. Membership increases were driven
primarily by an enrollment increase of 13,900 members
through MCHCP from June 30, 1997 to June 30, 1998. In
addition, the company's efforts to expand geographically
outside of the St. Louis metropolitan area resulted in an
11.6 percent increase (4,700 members) in non-MCHCP members
in these regions over the same time period. The company's
future enrollment growth in its products and geographic
regions is dependent on network attractiveness, continued
cooperation with physician hospital organizations, and
other factors. There can be no assurance that these
objectives will be realized. Future enrollment growth in
the company's products offered to MCHCP and revenues
generated therefrom are also dependent on other factors
(see Note 2 entitled "Contingencies - Litigation with MCHCP
of Part I").
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 $0.7
million in the second quarter of 1998 as compared to the
second quarter of 1997. Net premium rates increased 6.1
percent partially offset by an 8.5 percent decrease in
member months. For the first half of 1998, premium revenue
decreased by $1.2 million as compared to the first half of
1997. Member months decreased by 8.7 percent partially
offset by a 6.9 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. Membership in this product has also declined
due to member expiration.
Managed indemnity premium revenue decreased by $1.4 million
in the second quarter of 1998 as compared to the second
quarter of 1997 due to a 38.2 percent decline in member
months. For the first half of 1998, premium revenue
decreased by $2.6 million due to a 38.7 percent decline in
member months. Member month declines are consistent with
the company's strategy to move towards more highly managed
care products.
Revenue from other specialty services increased $1.3
million in the second quarter of 1998 as compared to the
second quarter of 1997 primarily due to an 18.2 percent
increase in net premium rates. For the first half of 1998,
revenues increased $2.8 million as compared to the first
half of 1997 due primarily to a 17.7 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 $3.8
million in the second quarter of 1998 as compared to the
second quarter of 1997. For the first half of 1998, fees
and other income increased $5.8 million as compared to the
first half 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 $3.7 million and $7.5 million for the second
quarter and first half of 1998, respectively. HealthLink's
revenues increased due to a 16.4 percent increase in
members from June 30, 1997 to June 30, 1998. This increase
arose from strong sales during the period 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 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 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 86.1 percent
in the second quarter of 1997 to 83.1 percent in the second
quarter of 1998. For the first half of 1998, the medical
loss ratio remained relatively consistent at 83.1 percent
as compared to 83.4 percent for the first half of 1997.
The overall medical loss decreased in 1998 in part due to a
$1.8 million reserve increase in the second quarter of 1997
relating to the estimate of claims which had been incurred
but not reported in 1996. The medical loss ratio in 1998
is slightly higher than the company previously anticipated
as a result of continued escalation of the medical cost
trend, driven by increased cost and utilization of both
outpatient services and drug therapies. Due to the
company's higher than expected medical claims trend in the
first half of 1998 along with the company's seasonal
pattern of higher medical expenses in the third quarter of
the year, the company believes that its medical loss ratio
and operating losses will increase in the third quarter of
1998, and that gains from operations may not be realized
until late in 1998.
The company continues the efforts initiated in 1997 to
modify its pharmacy benefits management program and
recontract with physicians and ancillary service providers.
The drug cost trend has increased to the low twenty percent
range, driven by a combination of factors, including
introduction of new drug therapies; physicians' use of
newer, more expensive drugs; and physicians' decreased use
of generic drugs in favor of specific drugs promoted by
pharmaceutical companies. Among the medical cost control
strategies targeted for 1998 are a combination of changes
in the pharmacy program to save costs and increase member
satisfaction through: introducing a new three-tiered
benefit design that allows members to make choices, albeit
with a higher member copayment; and making other
adjustments to copayments, quantity limits and exclusions.
Physician education, utilization and prescribing pattern
analysis are expected to be increased. The company will
also continue its hospital, physician and service
recontracting strategy, using the more detailed data and
analysis available through the company's information and
operating strategy (IOS), which is comprised of projects
being implemented to improve business processes and
systems. There can be no assurance that the company's
initiatives to control future increases in medical cost
trends to improve the medical loss ratio will be effective.
Commission expense increased by $1.3 million or 17.8
percent in the second quarter of 1998 as compared to the
second quarter of 1997. For the first half of 1998,
commission expense increased by $1.7 million or 11.9
percent as compared to the first half of 1997. The
commission expense ratio increased from 4.0 percent for the
second quarter of 1997 to 4.3 percent for the second
quarter of 1998. For the first half of 1998, the
commission expense ratio remained relatively flat at 4.2
percent as compared to 4.1 percent for the first half of
1997.
General and administrative expenses (excluding depreciation
and amortization) increased by $0.5 million, or 1.6 percent
in the second quarter of 1998 as compared to the second
quarter of 1997. For the first half of 1998, these
expenses increased by $1.9 million, or 2.7 percent as
compared to the first half of 1997. This increase is
partially due to the $1.5 million and $3.0 million
increases in HealthLink expenses in the second quarter and
first half of 1998, respectively, as compared to the
comparable periods of 1997. HealthLink's increased
expenses are directly attributable to HealthLink's
geographic and member expansion efforts.
Depreciation and amortization expenses decreased by $0.8
million in the second quarter of 1998 as compared to the
second quarter of 1997. For the first half of 1998,
depreciation and amortization expenses of $9.2 million
represented a decrease of $1.2 million as compared to the
first half 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 $0.6 million and $1.2 million in the
second quarter and first half of 1998, respectively as
compared to the comparable periods in 1997. See "Recent
Developments - Information and operations strategy" for
more information related to this project.
There were no nonrecurring charges in the second quarter
and first half of 1998 as compared to $0.8 million and $2.9
million in the second quarter and first half 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.
Operating Loss
Operating loss decreased by $10.4 million in the second
quarter of 1998 in comparison to the second quarter of
1997. For the first half of 1998, the operating loss
decreased by $11.3 million as compared to the first half of
1997. The improved results in 1998 relate in part to the
aforementioned completion and cessation of costs in 1997
related to the company's relocation project, the increase
in revenues from HealthLink, and the increase in the
company's overall premium rates. The company expects that
its operating losses will widen in the third quarter,
consistent with the company's seasonal trends, and that
gains from operations may not be realized until late in the
year.
Net Investment Income
The second quarter 1998 net investment income of $4.0
million represents a $6.3 million decrease over the second
quarter of 1997, inclusive of a $5.7 million decrease in
net realized gains. For the first half of 1998, net
investment income decreased by $15.5 million as compared to
the first half of 1997 inclusive of a reduction in net
realized gains of $15.4 million. Realized gains in the
first half 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 43.6 percent
and (8.9) percent for the second quarter of 1998 and 1997,
respectively. For the first half of 1998 and 1997, the
effective tax rates were 48.2 percent and 51.3 percent,
respectively. The company's effective income tax rates for
1998 and 1997 were affected by non-deductible goodwill
amortization. The 1997 rate was also affected by gains
recognized from the liquidation of company-owned life
insurance policies.
Net Income
The company's net income of $1.2 million, or $0.06 per
share, for the second quarter of 1998 represents an
increase of $3.5 million compared to the second quarter
1997 net loss of $2.3 million, or $0.12 per share. For the
first half of 1998, the company's net income of $2.2
million ($0.12 per share) represented a $1.7 million
decrease as compared to net income of $3.9 million ($0.21
per share) for the first half of 1997.
Liquidity and Capital Resources
The company's working capital as of June 30, 1998 was $66.7
million, a decrease of $3.1 million from December 31, 1997.
The decrease is partially attributable to $5.0 million of
additional debt from the company's reducing revolving
credit facility that became a current payable during the
first half of 1998. In addition, the company capitalized
$5.7 million of costs for property and equipment purchases,
$4.6 million of which relates to capitalized IOS
development costs.
Net cash provided by operations totaled $1.9 million for
the six months ended June 30, 1998. The company's net
income was $2.2 million which included (on a before tax
basis) $0.7 million of realized gains from the sale of
investments and $9.2 million of depreciation and
amortization expenses. In addition, other assets, medical
claims payable, receivables from members, and net
intercompany receivables were affected by the timing of
operating cash payments and receipts, intercompany tax
settlements, as well as changes in membership and
utilization and claims payment trends.
On August 29, 1997, the company reported the commencement
of the litigation with MCHCP (see Note 2 entitled
"Contingencies - Litigation with MCHCP" of Part I) and
estimated losses (giving effect to all possible renewal
terms of the MCHCP contract without requested rate
increases) in the range of $30 million to $40 million. In
the third quarter of 1997, the company took a pre-tax
charge of $29.5 million, which was based on actuarial
estimates, including projected limited rate increases, and
projected enrollment and medical cost trends accounted for
through the year 2000 in accordance with generally accepted
accounting principles. The health care services caption of
the 1998 Consolidated Statements of Income includes the
credit for the amortization of this loss reserve provision
during the first quarter and first half of 1998. The
litigation with MCHCP was dismissed on June 10, 1998.
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 which may be associated with the MCHCP
contract, which losses could have a material adverse effect
on the company and the market for the company's stock.
Recent Developments
Information and operations strategy
In 1995, the company implemented a comprehensive
information and operations strategy (IOS) to assist the
company in implementing its managed care strategy of
delivering the lowest cost medical care consistent with
quality outcomes. The company believes that controlling
medical costs in the future will be highly dependent on
readily accessing both member and provider medical
information at a detail level which provides real-time
analytical support. The company receives capital
expenditure authorizations from the Board of Directors to
expend funds for the project subject to periodic review by
an ad-hoc committee of the board. In the first six months
of 1998, the company incurred capitalized expenditures of
$4.6 million on this project. Cumulatively, since 1995,
the company has incurred capitalized expenditures of $43.6
million. The company anticipates that it will expend
approximately $10 million for capitalized costs associated
with the IOS project in 1998 and an additional $9 million
for capitalized costs in subsequent years to complete the
project. While management believes that the IOS project
will initially be dilutive to earnings per share, it is
believed that opportunities exist for significant medical
and administrative savings, which are expected to provide a
payback and contribute to earnings per share over the long
term.
Year 2000 issue
In January 1996, the company began converting its computer
systems to be year 2000 ready (e.g. to recognize the
difference between 1999 and 2000 as one year instead of
negative 99 years). The company's operations would be
significantly impacted by incomplete or untimely resolution
of the problem, by internal or external parties, as the
company utilizes automated systems to process claims,
prepare invoices, retain membership data, perform
utilization management, and many other processes. The
company's plan for completion of this project is partially
dependent upon the work of third parties. In addition,
some of the company's computer systems and business
operations are provided and maintained by outside
suppliers. The company is unable to determine the level of
exposure relating to the possibility that the providers
that the company contracts with are unable to address the
year 2000 readiness issues appropriately. The company
believes that at June 30, 1998, approximately 50 percent of
the company's core COBOL systems were year 2000 ready, with
the majority of the company's systems expected to be ready
by March 31, 1999 and other remaining significant systems
ready by September 30, 1999. The total cost of the project
is estimated to be between $8 million and $10 million. The
company is expensing all costs associated with these system
changes. From 1996 through June 30, 1998, the company has
cumulatively expensed $5.2 million on this project with
$2.5 million expensed in the first six months of 1998. The
company is currently reviewing various contingency plans in
the event that full year 2000 readiness is not achieved or
parties upon whom the company depends are not ready by
January 1, 2000 and expects to have a formal approved plan
by the end of 1998. There can be no assurance that the
company or any third party with which the company is
dependent upon will be able to achieve year 2000 readiness
which could have a material adverse effect on the company
and the market for the company's stock.
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 1998 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 a range approaching
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 expects that its operating losses will widen in the
third quarter, consistent with the company's seasonal
trends, and that gains from operations may not be realized
until late in the year.
The company's ability to deliver these performance targets
is dependent on, among other things, achieving targeted
sales to new members and retention rates at higher prices,
and realizing projected medical and overhead cost savings.
Contingencies
See the description under the same caption in Note 2 of the
Notes to Consolidated Financial Statements of Item I, which
description is incorporated herein by reference.
Factors that May Affect Future Results of Operations,
Financial Condition or Business
Pursuant to the safe harbor provisions for forward-looking
statements contained in Section 27A of the Securities Act
of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended, added to those Acts by
the Private Securities Litigation Reform Act of 1995, the
company is identifying important risks and uncertainties
that could cause the company's actual results of
operations, financial condition or business to differ
materially from its historical results of operations,
financial condition or business, or the results of
operations, financial condition or business contemplated by
forward-looking statements made herein or elsewhere orally
or in writing. Factors that could cause or contribute to
such differences include, but are not limited to, those
factors described below.
Conceptual framework for settlement of certain litigation
matters and reorganization of the company
On April 22, 1998, the company announced that a conceptual
framework has been proposed by BCBSMo, the company, the
Missouri Attorney General, and the Director of the Missouri
Department of Insurance with the support of the Missouri
Governor to resolve the outstanding litigation and
regulatory disputes between the company, BCBSMo and the
state and create an independent health care foundation.
The conceptual framework is described further in Note 2,
"Contingencies - Litigation with DOI and Attorney General -
Proposed Settlement" of Part I, Financial Information, and
such description is incorporated by reference in its
entirety in this section. As contemplated by the
conceptual framework, the company and BCBSMo will endeavor
to negotiate and execute a definitive agreement for the
proposed transaction. There can be no assurance that a
definitive agreement will be negotiated and executed, that
it will receive the necessary court approval, that all of
the conditions and contingencies expected to be included
therein will be satisfied, or that the transaction will be
effected. The inability to reach such a definitive
agreement and complete the proposed transaction could have
a material adverse effect on the company and the market for
the company's stock. See the information under the caption
"Litigation with DOI and Attorney General" below for
further details on the specific risk factors associated
with certain litigation in the event that a definitive
agreement is not reached and the proposed transaction is
not effected as contemplated by the conceptual framework.
OPM audit
Reference is made to the information included under the
caption in Note 2 entitled "Contingencies - OPM audit" of
Part I, Financial Information which information is
incorporated by reference in its entirety in this section.
At this time, management is unable to determine the final
dollar amount which may be required to resolve the audit
findings. There can be no assurance that the resolution of
these findings will not have a material adverse effect on
the company and the market for the company's stock.
Similarly with the losses described below related to the
litigation with the MCHCP, the OPM audit relates to the
company's subsidiary, HMO Missouri, Inc. (BlueCHOICE). As
described therein below, any additional funding to
BlueCHOICE as a result of audit findings associated with
the OPM audit, or otherwise, would require approval under
the company's credit agreement. See "Credit Agreement
Restrictions" below.
Subscriber class action litigation
Reference is made to the information included under the
caption in Note 2 entitled "Contingencies - Subscriber
class action litigation" of Part I, Financial Information
which information is incorporated by reference in its
entirety in this section. There can be no assurance that
the ultimate outcome of this litigation will not have a
material adverse affect on the company and the market for
the company's stock.
Litigation with DOI and Attorney General
Reference is made to the information included under the
caption in Note 2 entitled "Contingencies - Litigation with
DOI and Attorney General - Litigation relating to the
Reorganization and Public Offering" of Part I, Financial
Information which information is incorporated by reference
in its entirety in this section.
Reference also is made to the information included under
the caption in Note 2, entitled "Contingencies - Litigation
with DOI and Attorney General - Litigation relating to the
Market Conduct Study and Copayment Calculations" of Part I,
Financial Information which information is incorporated by
reference in its entirety in this section.
The transactions contemplated by the conceptual framework
described elsewhere herein are intended to include the
resolution and dismissal of all of the litigation with the
DOI and the Missouri Attorney General identified above. If
BCBSMo, the company, the DOI, and the Missouri Attorney
General do not resolve these matters as proposed in the
conceptual framework or if, in the alternative, BCBSMo or
the company does not prevail in all of these matters, it is
possible that BCBSMo could be dissolved, the license of
BCBSMo and the company to use the Blue Cross and Blue
Shield tradenames and marks could be terminated, 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 the company's stock.
Status of Blue Cross and Blue Shield Trademark Licenses
Reference is made to the information included under the
caption in Note 2 entitled "Contingencies - Status of Blue
Cross and Blue Shield trademark licenses" of Part I,
Financial Information which information is incorporated by
reference in its entirety in this section. If BCBSMo's and
the company's litigation against the DOI and the Missouri
Attorney General is not resolved in a manner that is in the
best interests of the BCBSA, the marks and the other Blue
plans, then the company's licenses to use such names and
marks may be terminated. The loss of such licenses and the
obligation of the company to pay a $25 per enrollee
termination fee and provide notice of termination to
enrollees would have a material adverse effect on the
company and the market for the company's stock.
Litigation with MCHCP
Reference is made to the information included under the
caption in Note 2 entitled "Contingencies - Litigation with
MCHCP" of Part I, Financial Information which information
is incorporated by reference in its entirety in this
section.
Based upon the rulings, the company will 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 rates contracted for in 1995, with annual
rate increases, if any, which are no more than the annual
increase in the medical cost component of the Consumer
Price Index and far less than necessary to permit the
company to recover its costs in serving those members. In
the third quarter of 1997, the company recorded a pre-tax
charge of $29.5 million, which was based on actuarial
estimates, including projected limited rate increases, and
projected enrollment and medical cost trends accounted for
through the year 2000, in accordance with generally
accepted accounting principles. The company was advised by
the DOI in March, 1998, that the entire amount of the
reserve for the MCHCP contract recorded by the company for
projected losses under the contract through the year 2000
must, for statutory accounting purposes, be recorded by the
company's subsidiary, HMO Missouri, Inc. (BlueCHOICE), on
its statutory filings with the DOI. With the prior
regulatory approval of the DOI, BlueCHOICE issued surplus
notes to the company in the amount of $29 million to ensure
the statutory solvency of BlueCHOICE. While management of
the company believes the current provision for losses is
adequate, if the actual number of BlueCHOICE members
through MCHCP grows at a rate in excess of the rate used in
the 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 actuarial estimates, then the
amount of the reserve recorded to date could be
insufficient to cover all future losses which may be
associated with the MCHCP contract, and such losses could
have a material adverse effect on the company and the
market for the company's stock. In addition, the company's
revolving credit agreement (described elsewhere herein)
provides that the company's subsidiaries, including
BlueCHOICE, may not issue surplus notes to the company in
an aggregate principal amount in excess of $40 million. As
the aggregate principal amount of surplus notes issued by
such subsidiaries to the company currently approximates $40
million, any additional funding required by any
subsidiaries of the company, including BlueCHOICE, as a
result of additional losses or reserves associated with the
MCHCP contract, or otherwise, would require approval of the
lenders under the Credit Agreement. See "- Credit
Agreement Restrictions."
Government Regulations and Health Care Reform
The company operates its managed health care business
principally through wholly owned subsidiaries whose
business is subject to extensive federal, state and local
laws and regulations. There can be no assurance that the
company will be able to obtain or maintain required
governmental approvals or licenses or that any current or
proposed federal and state legislation or other regulatory
reform such as President Clinton's Patient's Bill of
Rights, the Health Insurance Portability and Accountability
Act of 1996 (HIPAA), Missouri's House Bill 335 (HB335), and
mandatory benefits (e.g. mandatory maternity benefits),
which have all increased the regulatory requirements
imposed on the company and its subsidiaries, will not have
a material adverse effect on the company's business or
results of operations in the future.
Competition and Consolidation
The health care industry is highly competitive. The
company has numerous competitors in its PPO, POS and HMO
operations, many of which have substantially greater
financial and other resources than the company. Because
the company's existing business operations are 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 which generally are renewable
annually. The company's profitability is also dependent,
in large part, on its ability to contract on favorable
terms with hospitals, physicians and other health care
providers. There can be no assurance that the subscribers
or providers will renew their contracts or enter into new
contracts with the company or, in the case of provider
contracts, will not seek terms that are less profitable to
the company in connection with any such renewal.
Control by BCBSMo
BCBSMo has voting control on all stockholder actions,
including the sale or merger of the company, a sale of
substantially all of its assets and the election of all of
the company's directors. BCBSMo may have interests with
respect to its ownership of the company that diverge from
those of the company's public shareholders. There can be
no assurance that the company will not be adversely
impacted by the control that BCBSMo has with respect to
matters affecting the company.
Dependence on Key Management
The company depends to a significant extent on key
management members. Although the company has experienced
turnover in certain key management positions in the past,
those positions have been successfully filled. There can
be no assurance, however, that the loss of current key
management would not result in a material adverse effect on
the company's results of operations, financial condition or
business.
Variability of Operating Results and Stock Price
The company's results of operations could be adversely
affected by the timing of new product and service
introductions, competitive pricing pressures, contract
renegotiations with customers and providers, fluctuations
in the medical loss ratio (due to changes in utilization,
timing of submission of claims presented for payment in the
period and the unpredictability of unusually large claims),
increases in commission expense and general and
administrative expenses, changes in interest rates,
acquisitions, governmental and regulatory actions, overall
market conditions, and other factors. The company's stock
price may experience significant price and volume
fluctuations in response to these and other internal and
external factors which cause variations in its results of
operations and in the volatility of the stock markets
generally.
Credit Agreement Restrictions
The company's revolving credit agreement with its existing
lenders contains certain restrictions on the company and
its subsidiaries, including requirements as to the
maintenance of net worth and certain financial ratios,
restrictions on payment of cash dividends or purchases of
stock, restrictions on acquisitions, dispositions and
mergers, restrictions on additional indebtedness and liens,
and limitations on indebtedness of the company's
subsidiaries and certain other matters. There can be no
assurance that the company will be able to achieve and
maintain compliance with the prescribed financial ratio
tests or other requirements of the revolving credit
agreement. As discussed in the company's 1997 annual
report on Form 10-K, the company amended its credit
facility in the fourth quarter of 1997. The failure to
obtain any waivers or similar amendments that might be
needed in the future to remain in compliance with such
requirements would, among other things, reduce the
company's ability to respond to adverse industry conditions
and could have a material adverse effect on the company's
results of operations, financial condition or business.
Year 2000 Issue
In January 1996, the company began converting its computer
systems to be year 2000 ready (e.g. to recognize the
difference between 1999 and 2000 as one year instead of
negative 99 years). The company believes that at June 30,
1998, approximately 50 percent of the company's core COBOL
systems were ready, with the majority of the company's
systems expected to be ready by March 31, 1999 and other
remaining significant systems ready by September 30, 1999.
The company's plan for completion of this project is
partially dependent upon the work of third parties. In
addition, many of the company's computer systems and
business operations are provided and maintained by outside
suppliers. The company is unable to determine the level of
exposure relating to the possibility that the providers
that the company contracts with are unable to address the
year 2000 compliance issues appropriately. The company's
operations could be significantly impacted by incomplete or
untimely resolution of the problem, by internal or external
parties, as the company utilizes automated systems to
process claims, prepare invoices, retain membership data,
perform utilization management, and many other processes.
The company is currently reviewing various contingency
plans in the event that full year 2000 readiness is not
achieved by January 1, 2000 and expects to have a formal
approved plan by the end of 1998. There can be no assurance
that the company or any third party with whom the company
is dependent will be able to achieve year 2000 readiness
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 which may have the effect of reducing
the reputation, goodwill or customer demand for, or
confidence in, the company's products or services; the
ability to attract and retain capital for growth and
operations on competitive terms; and changes in accounting
policies and practices.
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 to the Consolidated Financial Statements in Part I,
Item 1 contains a description of various pending and
threatened claims, including a description of the
subscriber class action lawsuit filed on March 15, 1996,
litigation with the Missouri Department of Insurance (DOI),
the Director of the DOI, and the Missouri Attorney General,
litigation with the Missouri Consolidated Health Care Plan
(MCHCP), and other legal proceedings, which descriptions
are incorporated by reference herein. Also, see
"Management's Discussion and Analysis of Financial
Condition and Results of Operations - Factors that May
Affect Future Results of Operations, Financial Condition or
Business."
ITEM 2. Changes in Securities
None.
ITEM 3. Defaults Upon Senior Securities
None.
ITEM 4. Submission of Matters to a Vote of Security Holders
a) The Annual Meeting of Shareholders of the company was
held on May 12, 1998
b) Three class I directors of the company were elected for
three year terms by the shareholders at the annual
meeting. The three newly elected directors are:
Nominee Number of Votes
Earle H. Harbison, Jr. 152,482,121
Roger B. Porter, Ph.D. 152,706,438
Gloria W. White 152,705,988
The following directors' terms continued in effect after the
meeting:
Edward C. Gomes, Jr.
William H.T. Bush John A. O'Rourke
Ronald G. Evens, M.D. Norman J. Tice
ITEM 5. Other Information
The Securities and Exchange Commission recently adopted
certain amendments to its rules governing the
submission by shareholders of proposals intended to
be presented at meetings of shareholders. These
amendments, which became effective on June 29, 1998,
included provisions granting companies the right to
exercise discretionary voting authority with respect
to certain shareholder proposals that the company did
not have notice of within a specified time period
prior to a meeting of shareholders.
As disclosed in the company's 1998 Proxy Statement,
shareholder proposals for the Annual Meeting of
Shareholders to be held in May 1999 must be received
by the company not later than November 23, 1998 in
order to be considered for inclusion in the 1999
Proxy Statement and must meet the requirements of
Rule 14a-8 under the Securities Exchange Act of 1934
(the Exchange Act). Pursuant to the company's
Bylaws, in order for a shareholder proposal not
included in the company's 1999 Proxy Statement to be
presented at the company's 1999 Annual Meeting of
Shareholders, a notice of such proposal must be
received in writing by the Secretary of the company
at its principal executive offices on or before March
13, 1999. The notice must set forth as to each
proposal: (i) a brief description of the business
desired to be brought before the annual meeting; (ii)
a representation that the shareholder making such
proposal is a holder of record of stock entitled to
vote on the business proposed by such shareholder and
that such shareholder intends to appear in person or
by proxy at the annual meeting to present the
proposed business to be brought before the annual
meeting; (iii) the name and address of the
shareholder proposing such business, as it appears on
the company's books, and of the beneficial owner (as
such term is defined in Rule 13d-3 under the Exchange
Act), if any, on whose behalf the business is
proposed; (iv) the class and number of shares of the
company which are owned beneficially (as such term is
defined in Rule 13d-3 under the Exchange Act) and of
record by the shareholder making such proposal; (v)
the reason for conducting such business at the annual
meeting and any material interest of the shareholder
making such proposal or such beneficial owner in such
business; and (vi) all other information with respect
to each matter as would have been required to be
included in a proxy statement filed pursuant to
Regulation 14A as then in effect under the Exchange
Act had proxies been solicited by the Board of
Directors of the company with respect thereto.
Management proxies will be authorized to exercise
discretionary voting authority with respect to any
shareholder proposal not included in the company's
Proxy Statement for its 1999 Annual Meeting unless
(a) the company receives the requisite notice of such
proposal on or before March 13, 1999, and (b) the
conditions set forth in Rule 14a-4(c)(2)(i)-(iii)
under the Exchange Act are satisfied.
ITEM 6. Exhibits and Reports on Form 8-K
a) Exhibits
Exhibit
Number Exhibit
The following exhibits are submitted herewith:
27 Financial Data Schedule (Electronic Filing Only).
b) Reports on Form 8-K:
The company filed a report on Form 8-K dated April 24, 1998
relating to a conceptual framework which would lead
to 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.
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: August 13, 1998 By: [S] JOHN A. O'ROURKE
John A. O'Rourke
President and Chief Executive Officer
Date: August 13, 1998 By: [S] SANDRA VAN TREASE
Sandra Van Trease
Chief Financial Officer,
Executive Vice President and
Chief Operating Officer
<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 June 30, 1998 and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
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<SECURITIES> 218,900
<RECEIVABLES> 61,344
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<CURRENT-ASSETS> 350,472
<PP&E> 111,352
<DEPRECIATION> 52,096
<TOTAL-ASSETS> 506,023
<CURRENT-LIABILITIES> 283,799
<BONDS> 54,879
0
0
<COMMON> 187
<OTHER-SE> 142,919
<TOTAL-LIABILITY-AND-EQUITY> 506,023
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<TOTAL-REVENUES> 383,670
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