UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number 1-13248
RIGHTCHOICE MANAGED CARE, INC.
(Exact name of registrant as specified in its charter)
Missouri 43-1674052
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
1831 Chestnut Street, St. Louis, Missouri 63103-2275
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (314) 923-4444
Not Applicable
(Former name, former address and former fiscal year, if
changed since last report)
Indicate by check mark whether the registrant (1) has
filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the
issuer's classes of common stock, as of the latest
practicable date:
Title of each class Outstanding at October 31, 2000
Class A common stock, $0.01 par value 3,716,664 shares
Class B common stock, $0.01 par value 14,962,500 shares
RIGHTCHOICE MANAGED CARE, INC.
Third Quarter 2000 Form 10-Q
Table of Contents
PART I. FINANCIAL INFORMATION PAGE
ITEM 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2000
and December 31, 1999 3
Consolidated Statements of Income for the three and nine
months ended September 30, 2000 and 1999 4
Consolidated Statements of Changes in Shareholders'
Equity for the three and nine months ended
September 30, 2000 and 1999 5
Consolidated Statements of Cash Flows for the nine months
ended September 30, 2000 and 1999 6
Notes to Consolidated Financial Statements 7
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 22
ITEM 3. Quantitative and Qualitative Disclosures About Market
Risks 38
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 39
ITEM 2. Changes in Securities and Use of Proceeds 39
ITEM 3. Defaults Upon Senior Securities 39
ITEM 4. Submission of Matters to a Vote of Security Holders 39
ITEM 5. Other Information 39
ITEM 6. Exhibits and Reports on Form 8-K 39
SIGNATURES 40
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
<TABLE>
RIGHTCHOICE MANAGED CARE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except shares and per share data)
<CAPTION>
ASSETS September 30, 2000 December 31, 1999
(unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $49,474 $44,400
Investments available for sale 215,492 201,926
Receivables from members 98,554 78,947
Receivables from related parties 22,443 28,764
Deferred income taxes 7,527 8,629
Other assets 17,413 17,981
Total current assets 410,903 380,647
Property and equipment, net 50,620 55,470
Deferred income taxes 10,210 9,791
Investments in affiliates 6,188 5,905
Goodwill and intangible assets, net 66,611 71,400
Total assets $544,532 $523,213
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Medical claims payable $126,615 124,428
Unearned premiums 62,979 62,824
Accounts payable and accrued expenses 63,449 59,476
Current portion of long-term debt 8,000 8,000
Payables to related parties 24,325 27,009
Reserve for loss contract 2,314 7,259
Obligations for employee benefits 1,641 1,577
Income taxes payable 13,817 12,965
Obligations under capital leases 3,937 4,071
Total current liabilities 307,077 307,609
Long-term debt 20,063 26,063
Obligations for employee benefits 27,907 26,819
Obligations under capital leases 4,707 5,179
Total liabilities 359,754 365,670
Shareholders' equity:
Preferred stock, $0.01 par, 25,000,000 shares
authorized, no shares issued and outstanding
Common stock:
Class A, $0.01 par, 125,000,000 shares
authorized, 3,737,500 shares issued,
3,712,905 and 3,710,653
shares outstanding, respectively 37 37
Class B, convertible, $0.01 par,
100,000,000 shares authorized,
14,962,500 shares issued and outstanding 150 150
Additional paid-in capital 132,622 132,634
Retained earnings 55,042 29,529
Treasury stock, 24,595 and 26,847
class A shares, respectively, at cost (348) (380)
Accumulated other comprehensive loss (2,725) (4,427)
Total shareholders' equity 184,778 157,543
Total liabilities and
shareholders' equity $544,532 $523,213
See accompanying Notes to Consolidated Financial Statements.
</TABLE>
<TABLE>
RIGHTCHOICE MANAGED CARE, INC.
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(in thousands, except shares and per share data)
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
2000 1999 2000 1999
<S> <C> <C> <C> <C>
Revenues:
Premium $216,926 $183,498 $621,136 $540,990
Fees and other income 24,489 21,005 72,865 62,737
Total revenues 241,415 204,503 694,001 603,727
Operating expenses:
Health care services 176,041 149,777 504,452 443,762
Commissions 9,183 8,525 27,011 23,892
General and administrative (excludes
depreciation and amortization and
excludes net intercompany charges
of $3,406, $2,644, $10,172 and $8,898,
respectively, allocated to
Blue Cross and Blue Shield of Missouri) 38,942 36,587 116,933 108,927
Depreciation and amortization 4,440 4,405 13,232 12,788
Total operating expenses 228,606 199,294 661,628 589,369
Operating income 12,809 5,209 32,373 14,358
Investment income:
Interest and dividends 3,736 3,139 10,640 9,850
Realized (losses) gains, net (127) (63) 938 (512)
Total investment income, net 3,609 3,076 11,578 9,338
Other:
Interest expense (923) (1,414) (2,901) (3,423)
Other income, net 353 198 1,301 754
Total other, net (570) (1,216) (1,600) (2,669)
Income before provision for
income taxes 15,848 7,069 42,351 21,027
Provision for income taxes 6,301 3,064 16,838 8,438
Net income $9,547 $4,005 $25,513 $12,589
Weighted average common shares
outstanding 18,674,000 18,673,000 18,673,000 18,673,000
Basic earnings per share $0.51 $0.21 $1.37 $0.67
Diluted earnings per share $0.50 $0.21 $1.34 $0.67
See accompanying Notes to Consolidated Financial Statements.
</TABLE>
<TABLE>
RIGHTCHOICE MANAGED CARE, INC.
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' EQUITY (UNAUDITED)
(in thousands, except shares)
<CAPTION>
Accumulated
Additional Other
Common Stock Paid In Retained Treasury Comprehensive
Class A Class B Capital Earning Stock Income Total
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December
31, 1998 $37 $150 $132,635 $12,313 $(383) $1,122 $145,874
Comprehensive income:
Net income 8,584 8,584
Change in
unrealized
appreciation
on available-for-
sale securities, net
of income tax
benefit of $2,188 (3,872) (3,872)
Comprehensive income 4,712
Balance at
June 30, 1999 37 150 132,635 20,897 (383) (2,750) 150,586
Comprehensive income:
Net income 4,005 4,005
Change in
unrealized
depreciation
on available-for-
sale securities, net
of income tax
benefit of $463 (819) (819)
Comprehensive income 3,186
227 shares issued
under the
company's stock
option plan (1) 3 2
Balance at September
30, 1999 37 150 132,634 24,902 (380) (3,569) 153,774
Comprehensive income:
Net income 4,627 4,627
Change in
unrealized
depreciation
on available-for-
sale securities, net
of income tax
benefit of $547 (933) (933)
Minimum pension
liability
adjustment,
net of income tax
expense of $40 75 75
Comprehensive income 3,769
Balance at December
31, 1999 37 150 132,634 29,529 (380) (4,427) 157,543
Comprehensive income:
Net income 15,966 15,966
Change in
unrealized
depreciation
on available-for-
sale securities, net
of income tax 157 157
expense of $130
Comprehensive income 16,123
213 shares issued
pursuant to the
company's deferred
compensation
program for 3 3
directors
Balance at June 30,
2000 37 150 132,634 45,495 (377) (4,270) 173,669
Comprehensive income:
Net income 9,547 9,547
Change in
unrealized
depreciation
on available-for-
sale securities, net
of income tax
expense of $840 1,545 1,545
Comprehensive income 11,092
2,039 shares issued
under the
company's stock
option plan (12) 29 17
Balance at September
30, 2000 $37 $150 $132,622 $55,042 $(348) $(2,725) $184,778
See accompanying Notes to Consolidated Financial Statements.
</TABLE>
<TABLE>
RIGHTCHOICE MANAGED CARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
<CAPTION>
For the nine months ended
September 30,
2000 1999
<S> <C> <C>
Cash flows from operating
activities:
Net income $25,513 $12,589
Adjustments to reconcile net
income to net cash provided by
operating activities:
Benefit for deferred income
taxes (285) (1,030)
Depreciation and amortization 13,232 12,788
Undistributed earnings from an
unconsolidated affiliate (283) (2)
(Gain) loss on sale of
investments (938) 512
Amortization of premiums and
accretion of discounts, net 79 369
Gain on sale of property and
equipment (655) (231)
(Increase) decrease in certain assets:
Receivables from members (19,607) (15,817)
Receivables from related parties 6,321 (7,462)
Other assets 3,221 2,844
Increase (Decrease) in certain liabilities:
Medical claims payable 2,187 6,459
Unearned premiums 155 3,690
Accounts payable and accrued expenses 3,973 (2,547)
Payables to related parties (2,684) (2,124)
Reserve for loss contract (4,945) (6,789)
Obligations for employee benefits 1,152 1,958
Income taxes payable 852 2,591
Net cash provided by operating activities 27,288 7,798
Cash flows from investing activities:
Proceeds from matured investments:
Fixed maturities 8,515 7,114
Proceeds from investments sold:
Fixed maturities 52,627 144,847
Equity securities 21,820 521
Other 965 101
Investments purchased:
Fixed maturities (67,436) (142,795)
Equity securities (26,063) (7,534)
Other (490) (232)
Proceeds from property and
equipment sold 3,598 11
Property and equipment purchased (6,412) (4,772)
Net cash used in investing activities (12,876) (2,739)
Cash flows from financing activities:
Issuance of class A treasury stock 20 2
Payments of long-term debt (6,000) (7,000)
Payments of capital lease obligations (3,358) (3,277)
Net cash used in financing activities (9,338) (10,275)
Net increase (decrease) in cash and
cash equivalents 5,074 (5,216)
Cash and cash equivalents at
beginning of period 44,400 39,409
Cash and cash equivalents at end of
period $49,474 $34,193
Supplemental Disclosure of Cash Information:
Interest paid $2,885 $3,414
Income taxes paid, net 16,274 6,877
Supplemental Schedule of Noncash
Investing and Financing Activities:
Equipment acquired through
capital leases $3,417 $6,093
Disposal of equipment under
capital leases 665 2,223
See accompanying Notes to Consolidated Financial Statements.
</TABLE>
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 or
RightCHOICE) 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
Litigation of Blue Cross and Blue Shield of Missouri with the
Missouri Attorney General and Missouri Department of Insurance and
related actions, settlement efforts and proposed reorganization
In August 1994, Blue Cross and Blue Shield of Missouri created
RightCHOICE as a for-profit subsidiary. Blue Cross and Blue Shield
of Missouri transferred certain of its assets to RightCHOICE, and
offered to the public 20% of the common stock of RightCHOICE (such
events are referred to collectively as the 1994 Reorganization and
Public Offering). Although the Missouri Department of Insurance
(DOI) formally approved the 1994 Reorganization and Public Offering
on April 14, 1994, the DOI subsequently claimed that the 1994
Reorganization and Public Offering violated state laws and that Blue
Cross and Blue Shield of Missouri was obligated to transfer all of
its assets, including all of the stock of RightCHOICE that it owned,
to the State of Missouri or a charity designated by the State of
Missouri.
On May 13, 1996, Blue Cross and Blue Shield of Missouri filed a
declaratory judgment action in the Circuit Court of Cole County
Missouri (the Circuit Court) against the DOI and the Missouri
Attorney General (the Missouri Attorney General was a necessary
party due to his sole authority to enforce nonprofit corporation
laws). This litigation is described more fully below under
"Litigation relating to the 1994 Reorganization and Public
Offering."
RightCHOICE, Blue Cross and Blue Shield of Missouri, the DOI and the
Attorney General reached agreement for settlement of this
litigation. The settlement is described below under the caption
"Agreement for settlement of certain litigation matters and
reorganization of RightCHOICE." The agreement provides for the
dismissal of the lawsuit and appeals in which the State officials
claimed Blue Cross and Blue Shield of Missouri violated state law.
The agreement provides for a corporate reorganization of Blue Cross
and Blue Shield of Missouri and RightCHOICE and the creation of an
independent public benefit health care foundation. There are a
number of contingencies that might affect the closing of that
reorganization. RightCHOICE cannot provide any assurances that
those contingencies will be fulfilled. The parties have agreed to
use their best efforts to effect the reorganization by December 31,
2000. If the settlement does not go forward, the Attorney General
and DOI will be free to further prosecute their claims against Blue
Cross and Blue Shield of Missouri arising from the 1994
Reorganization and Public Offering which would have a material
adverse effect on RightCHOICE and its stock.
Agreement for settlement of certain litigation matters and
reorganization of RightCHOICE
Status of Proposed Settlement Agreements
Following many developments in the litigation described below, on
January 6, 2000, RightCHOICE, Blue Cross and Blue Shield of
Missouri, the Missouri Attorney General, and the DOI signed the
Amended and Restated Settlement Agreement which would, if
consummated, resolve all outstanding litigation and regulatory
issues between RightCHOICE, Blue Cross and Blue Shield of Missouri
and their affiliates and the State of Missouri described below and
would create an independent public benefit health care foundation.
This agreement modified the principal settlement agreement first
announced as a conceptual framework on April 22, 1998, which was
reduced to definitive settlement agreements entered into on
September 20, 1998, and subsequently modified on March 12, 1999 (as
amended, the amended settlement agreement).
The amended settlement agreement included a number of significant
conditions and contingencies described further herein. Among those
conditions were approval by an appropriate court and a judicial
determination by the Circuit Court that the reorganization
contemplated by the amended settlement agreement was lawful as to
the subscribers of Blue Cross and Blue Shield of Missouri,
RightCHOICE, and their affiliates. In the Amended and Restated
Settlement Agreement that the parties signed on January 6, 2000, the
parties removed the court approval and determination of lawfulness
contingencies from their settlement agreement. That action was the
result of the following events.
On October 29, 1999, the Circuit Court entered an order disapproving
the amended settlement agreements. Blue Cross and Blue Shield of
Missouri, together with the Missouri Attorney General and the DOI,
filed a notice of appeal from that order to the Missouri Court of
Appeals for the Western District, and asked for immediate transfer
of that appeal to the Missouri Supreme Court. Blue Cross and Blue
Shield of Missouri and the Missouri Attorney General also notified
the Missouri Supreme Court of the Circuit Court's disapproval of the
amended settlement agreement, and asked the Missouri Supreme Court
to (1) deem the Circuit Court's order final for purposes of appeal,
(2) conduct its own review of the settlement agreement, and (3)
enter a stay prohibiting Judge Brown and the Special Master from
further proceedings, including consideration of alternatives,
pending the appeal.
The Supreme Court of Missouri accepted the appeal and stayed further
proceedings in the Circuit Court. Counsel for the Special Master
whose role in these proceedings is described further herein appeared
in the appeal as Amici Respondents, charged with defending the order
of the Circuit Court.
Following oral arguments before the Supreme Court of Missouri on
December 8, 1999, on December 9, the Supreme Court entered an order
which stated that the parties had "failed to establish that court
approval is required or authorized by law or that any such
determination would be other than advisory." The Supreme Court
stayed all proceedings until February 8, 2000, to permit the parties
to dismiss the underlying lawsuit and the appeals.
On January 6, 2000, the Amended and Restated Settlement Agreement
was signed, thereby removing the conditions requiring court approval
and a determination of lawfulness of the proposed reorganization.
On January 6, 2000, the parties filed a joint stipulation of
dismissal in the Circuit Court, dismissing all pending claims in
that court in the principal litigation between the parties. On
February 8, 2000, the parties moved for dismissal of the appeal
pending in the Supreme Court of Missouri. The Supreme Court granted
that motion and dismissed the appeals on February 9, 2000.
The litigation underlying the settlement is described below. See
"Litigation relating to the 1994 Reorganization and Public
Offering."
RightCHOICE continues to work toward completing the proposed
settlement which could occur as soon as November 30, 2000, although
the parties to the settlement have agreed to use their best efforts
to consummate the settlement and the related reorganization by
December 31, 2000. Progress that the parties have made toward
implementation of the settlement and the related reorganization
include the following:
* The Blue Cross and Blue Shield Association has fully restored the
licenses to use the Blue Cross and Blue Shield names and service
marks and has preliminarily approved the reorganization.
* New RightCHOICE, which will be the resulting company in the
reorganization, has been incorporated.
* The Missouri Department of Insurance has issued preliminary
approval for the reorganization.
* The Securities and Exchange Commission declared effective the
Registration Statement on Form S-4 that relates to the proposed
settlement and related reorganization.
* The company mailed the proxy statement/prospectus to its
shareholders on or about October 12, 2000 and the special meeting of
shareholders has been scheduled for November 28, 2000.
* Blue Cross and Blue Shield of Missouri has requested that the IRS
issue a private letter tax ruling to the effect that various aspects
of the reorganization will be tax-free. The company's special tax
advisor, PricewaterhouseCoopers LLP, has issued a tax opinion
relating to the tax-free nature of the reorganization.
* The Missouri Foundation for Health has been incorporated and has
received a determination from the IRS that it is a tax-exempt
organization. A nominating committee has been formed to select a
board of directors for the Foundation.
* The company's lenders under its credit facility have consented to
the reorganization.
A number of significant conditions must be satisfied before the
settlement is completed, including receipt of approval of the
reorganization from the company's shareholders at a special
shareholders' meeting that currently is expected to be held on
November 28, 2000. The reorganization is also conditioned upon the
receipt of a private letter ruling from the IRS or tax opinion from
PricewaterhouseCoopers LLP, final approval of the reorganization
from both the Blue Cross and Blue Shield Association and the
Missouri Department of Insurance, and the receipt of legal opinions
from counsel to the various parties. In addition, there remains
pending the potential appeal of a case regarding the status of Blue
Cross and Blue Shield of Missouri that could affect the closing of
the reorganization. The case relates to whether Blue Cross and Blue
Shield of Missouri is a public benefit or a mutual benefit company
(as described below under "Litigation relating to corporate status
of Blue Cross and Blue Shield of Missouri"). On November 3, 2000,
the Circuit Court entered a judgment finding that Blue Cross and
Blue Shield of Missouri is a public benefit corporation. That
judgment is consistent with the settlement but is subject to
possible appeal.
Terms of the Proposed Settlement Agreement
The principal terms of the Amended and Restated Settlement Agreement
include the following:
* Blue Cross and Blue Shield of Missouri would, through a series of
transactions, (i) transfer its insurance-related assets, contracts
and agreements and related liabilities to a wholly owned subsidiary
of RightCHOICE; (ii) convert to a for-profit corporation; (iii)
reincorporate in Delaware; and (iv) merge with RightCHOICE.
Approximately 20% of the outstanding common stock of the resulting
entity (referred to as New RightCHOICE) would be owned by
RightCHOICE's current public shareholders and approximately 80% of
the outstanding shares of New RightCHOICE would be owned by a
charitable independent health care foundation (which equals the
current aggregate ownership interests of the public shareholders and
Blue Cross and Blue Shield of Missouri, respectively, in the equity
of RightCHOICE).
* Blue Cross and Blue Shield of Missouri would pay approximately
$12.78 million to the Missouri Foundation For Health (in addition to
$175,000 paid by New RightCHOICE).
* The Missouri Foundation For Health would be required to liquidate
its shares of New RightCHOICE stock over a prescribed period of time
not to exceed seven years under a divestiture plan. The Foundation
would be required to reduce its ownership of New RightCHOICE stock
to less than 50% of the total outstanding stock of New RightCHOICE
within three years of the closing of the reorganization, subject to
possible extension, and to less than 20% of the total outstanding
stock of New RightCHOICE within five years of the closing of the
reorganization, subject to possible extension. The proceeds would
be used for health care purposes. All but up to 5% of the shares of
New RightCHOICE stock owned by the Foundation would be subject to a
voting trust that would, with certain exceptions, effectively vest
voting control of such shares of New RightCHOICE stock owned by the
Foundation in the board of directors of New RightCHOICE on all
matters except that the Foundation would have the right to vote as
it deems appropriate on a change of control transaction involving
New RightCHOICE.
* The charter documents of New RightCHOICE would include the "basic
protections" required by the Blue Cross and Blue Shield Association
(BCBSA) of all of its for-profit licensees to provide for
independence from the direction, control and influence of The
Missouri Foundation For Health or any other shareholder. The "basic
protections" would include limitations on the amount of New
RightCHOICE stock that may be owned by certain categories of
shareholders -- (i) no "institutional" shareholder may own 10% or
more of the voting power of New RightCHOICE, (ii) no "non-
institutional" shareholder may own 5% or more of the voting power of
New RightCHOICE, and (iii) no shareholder may own 20% or more of the
equity of New RightCHOICE (with certain exceptions in the case of
the Foundation as described above). Any shares owned by a
shareholder in excess of the applicable ownership limits could be
redistributed by New RightCHOICE.
Litigation relating to the 1994 Reorganization and Public Offering
In August 1994, Blue Cross and Blue Shield of Missouri effectuated
the 1994 Reorganization and Public Offering. The DOI had formally
approved the 1994 Reorganization and Public Offering on April 14,
1994. The DOI subsequently claimed that the 1994 Reorganization and
Public Offering violated Missouri state laws and that Blue Cross and
Blue Shield of Missouri was obligated to transfer all of its assets,
including all of the stock of RightCHOICE that it owned, to the
State of Missouri or a charity designated by the State of Missouri.
The DOI threatened to bring legal action, seek a receivership, or
terminate Blue Cross and Blue Shield of Missouri's insurance license
unless Blue Cross and Blue Shield of Missouri surrendered its
assets.
Blue Cross and Blue Shield of Missouri's extensive efforts to
resolve the dispute without litigation were unsuccessful. On May
13, 1996, Blue Cross and Blue Shield of Missouri filed a declaratory
judgment action in the Circuit Court against the DOI and the
Missouri Attorney General (the Missouri Attorney General was a
necessary party due to his sole authority to enforce nonprofit
corporation laws). The action sought a declaratory judgment that
Blue Cross and Blue Shield of Missouri followed all applicable laws
and regulations in the 1994 Reorganization and Public Offering
resulting in the creation of RightCHOICE. It also sought a
permanent injunction forbidding the DOI from refusing to renew Blue
Cross and Blue Shield of Missouri's license or taking other
administrative action against Blue Cross and Blue Shield of Missouri
to pressure it into paying a "toll charge" or "charitable asset
assessment" or any other fee as a result of the 1994 Reorganization
and Public Offering.
On June 13, 1996, the DOI filed an answer and counterclaims setting
forth several affirmative defenses, including alleged fraud and
negligent misrepresentation with respect to the application filed by
Blue Cross and Blue Shield of Missouri seeking approval of the 1994
Reorganization and Public Offering. The counterclaims alleged
violations of certain health services corporation and nonprofit
corporation statutes. The DOI's counterclaims sought, among other
things: (i) permanent injunctions against Blue Cross and Blue Shield
of Missouri; (ii) imposition of a trust on Blue Cross and Blue
Shield of Missouri'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 Blue Cross and
Blue Shield of Missouri.
On June 20, 1996, the Missouri Attorney General filed an answer and
counterclaim alleging that the 1994 Reorganization and Public
Offering, and its continued operations through RightCHOICE and its
subsidiaries, exceeded Blue Cross and Blue Shield of Missouri's
statutory purposes. The Missouri Attorney General requested a
declaration that Blue Cross and Blue Shield of Missouri exceeded its
lawful authority and sought such relief as the Circuit Court would
determine to be appropriate under the circumstances based on a
statute that authorizes judicial dissolution or less drastic
alternative relief in the Circuit Court's discretion.
On September 9, 1996, the Circuit Court granted Blue Cross and Blue
Shield of Missouri's motion for summary judgment against the DOI,
rejected all of the DOI's affirmative defenses (including
allegations of fraud), issued a permanent injunction against the DOI
and declared that: (i) under Missouri law the DOI had no authority
to demand that Blue Cross and Blue Shield of Missouri make a payment
as a result of the 1994 Reorganization and Public Offering; (ii)
under Missouri law the DOI had no jurisdiction to take any action,
the practical effect of which would be to amend, modify or reverse
the DOI's April 14, 1994 final administrative approval of the 1994
Reorganization and Public Offering; (iii) under Missouri law, the
DOI had no jurisdiction to take any administrative action,
including, but not limited to, revoking, suspending or refusing to
renew Blue Cross and Blue Shield of Missouri's Certificate of
Authority based in any way on the 1994 Reorganization and Public
Offering or Blue Cross and Blue Shield of Missouri's refusal to make
payment as the DOI had demanded; and (iv) (A) Blue Cross and Blue
Shield of Missouri was a mutual benefit type of nonprofit
corporation rather than a public benefit type of nonprofit
corporation; (B) the 1994 Reorganization and Public Offering were
authorized under all laws applicable to nonprofit health services
corporations; and (C) Blue Cross and Blue Shield of Missouri did not
owe the State or any person or entity a "toll charge," "charitable
asset settlement" or any other payment as a result of the 1994
Reorganization and Public Offering (the September 9 Order). On
December 30, 1996, the Circuit Court issued orders (described more
fully below) modifying the findings and declarations set forth in
(iv) above, on the grounds that it was legally unnecessary to
resolve such issues because the Circuit Court had already ruled
against the DOI for other reasons.
The September 9 Order permanently enjoined the DOI from, among other
things, (i) revoking, suspending or refusing to renew Blue Cross and
Blue Shield of Missouri's insurance license based in any part upon
the 1994 Reorganization and Public Offering; (ii) commencing a
valuation of Blue Cross and Blue Shield of Missouri's assets and
demanding a payment as a result of the 1994 Reorganization and
Public Offering; (iii) commencing any administrative hearing or
making any administrative determination based in any part upon the
1994 Reorganization and Public Offering; (iv) instituting any
seizure, receivership, conservatorship or similar action or
proceeding against Blue Cross and Blue Shield of Missouri based in
any part upon the 1994 Reorganization and Public Offering; and (v)
taking any other action, however denominated, against Blue Cross and
Blue Shield of Missouri based in any part upon the 1994
Reorganization and Public Offering.
On August 28, 1996, the DOI filed an amended answer asserting a new
counterclaim that the 1994 Reorganization and Public Offering were
not reasonably designed to serve any of Blue Cross and Blue Shield
of Missouri's purposes as a health services corporation and sought a
declaration that Blue Cross and Blue Shield of Missouri had exceeded
or abused the authority conferred upon it by law. Under this
counterclaim, the DOI sought an order to rehabilitate Blue Cross and
Blue Shield of Missouri 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 Blue Cross and
Blue Shield of Missouri that sought a declaration that Blue Cross
and Blue Shield of Missouri was a public benefit corporation, not a
mutual benefit corporation, and requested an order that Blue Cross
and Blue Shield of Missouri amend its Articles of Incorporation
accordingly. The Circuit Court granted the Missouri Attorney
General's motion for leave to file the amended counterclaim.
On December 30, 1996, the Circuit Court issued five orders (the
December 30 Orders): (i) denying Blue Cross and Blue Shield of
Missouri's motion for summary judgment against the Missouri Attorney
General; (ii) granting the Missouri Attorney General's motion for
partial summary judgment against Blue Cross and Blue Shield of
Missouri; (iii) denying Blue Cross and Blue Shield of Missouri's
supplemental motion for summary judgment against the DOI on their
amended counterclaim; (iv) granting the DOI's motion for summary
judgment against Blue Cross and Blue Shield of Missouri on their
amended counterclaim; and (v) modifying, in part, the Circuit
Court's previous September 9 Order. The December 30 Orders declared
that (i) Blue Cross and Blue Shield of Missouri had continued to
exceed or abuse its statutorily permissible purposes and the
authority conferred on it by law; and (ii) Blue Cross and Blue
Shield of Missouri is subject to judicial dissolution proceedings,
but that prior to ordering dissolution, the Circuit Court is
required to consider whether there are alternatives to dissolution
and whether dissolution is in the public interest or is the best way
of protecting the interests of its members.
The Circuit Court also (i) certified the December 30 Orders and the
September 9 Order, as modified, for immediate appeal; (ii) held in
abeyance further proceedings on the Missouri Attorney General's
counterclaim pending appeal; and (iii) stayed the legal effect of
the order granting the Director and the DOI summary judgment pending
the filing of an appeal bond (which Blue Cross and Blue Shield of
Missouri promptly filed).
On August 4, 1998, the Missouri Court of Appeals entered its opinion
affirming the judgments entered December 30, 1996.
On September 20, 1998, the company and certain of its affiliates
entered into various settlement agreements with the Missouri
Attorney General and certain state agencies, including the DOI. The
settlement agreements, as most recently amended on January 6, 2000,
(principally, the Amended and Restated Settlement Agreement) are
described above under the caption "Terms of the Proposed Settlement
Agreements." If consummated, the Amended and Restated Settlement
Agreement would resolve the outstanding litigation and regulatory
disputes between Blue Cross and Blue Shield of Missouri and its
affiliates and the State of Missouri, including the litigation
related to the 1994 Reorganization and Public Offering, and create
an independent public benefit health care foundation.
Notwithstanding the fact that the litigation had not yet been
remanded to the Circuit Court, on October 29, 1998, the Circuit
Court "acting on its own motion" issued an Order (the October 29,
1998 Order) in the litigation. The October 29, 1998 Order provided
for, among other things, the appointment of Robert G. Russell as
receiver/custodian to, among other things, take exclusive possession
and control of all of the issued and outstanding shares of the
company's common stock owned by Blue Cross and Blue Shield of
Missouri. The October 29, 1998 Order cited concerns by the Circuit
Court about the fairness of the transactions set forth in the
settlement agreements, alleged conflicts of interest and the need
for an independent examination of the proposed settlement and
related issues. The October 29, 1998 Order also approved the
engagement of legal counsel and an investment banker to advise the
receiver/custodian. Had the October 29, 1998 Order not been void
"from the beginning" as described below, a number of significant and
adverse consequences would have resulted, including the automatic
termination of the company's Blue Cross and Blue Shield licenses and
a resultant event of default under RightCHOICE's Credit Agreement.
On November 2, 1998, Blue Cross and Blue Shield of Missouri filed a
motion to vacate the October 29, 1998 order and a supporting
memorandum. Blue Cross and Blue Shield of Missouri alleged therein
that (i) the Circuit Court lacked jurisdiction to issue the October
29, 1998 Order because the case was still pending before the
Missouri Supreme Court; (ii) the Circuit Court issued the order
without notice and an opportunity to be heard; (iii) there were no
exigent circumstances that would warrant the appointment of a
receiver without due process; and (iv) the appointment of the
receiver had the effect of frustrating the purpose for which the
receiver was to be appointed, namely, the preservation of the
nonprofit assets of Blue Cross and Blue Shield of Missouri.
On November 2, 1998, BCBSA filed a complaint against the company,
its subsidiaries and Blue Cross and Blue Shield of Missouri in the
United States District Court for the Northern District of Illinois
alleging that the appointment of the receiver/custodian caused the
automatic termination of the licenses to use the Blue Cross and Blue
Shield service marks. The complaint alleged service mark
infringement and breach of license agreements as a result of the
company's continued use of the Blue Cross and Blue Shield service
marks following the issuance of the October 29 Order. The BCBSA
later dismissed its complaint (as described below under "Status of
Blue Cross and Blue Shield licenses").
On November 4, 1998, the Circuit Court issued an Order (the November
4 Order) vacating the October 29, 1998 Order and declaring it to be
void "from the beginning". The Circuit Court, in issuing the
November 4 Order, acknowledged that the significant and adverse
consequences that could have resulted from the October 29, 1998
Order were unintended. On November 4, 1998, the Circuit Court also
issued an Order (the November 4 Special Master Order) appointing a
special master for the purpose of collecting and analyzing
information related to the proposed settlement. The November 4
Special Master Order also approved the engagement of legal counsel
and such financial advisors as are approved by the court to advise
the special master. The effect of the November 4 Order was to void
the October 29, 1998 Order as if it never existed. The special
master, at that time, had expressed his interest in providing that
RightCHOICE would continue its business in the normal course during
his review.
On November 6, 1998, the Circuit Court entered an Order of Reference
(the November 6 Order), among other things, directing the special
master to collect and analyze information as to the options and
alternatives available to the Circuit Court for disposition of the
remaining issues in the litigation, including, but not limited to,
an examination of the settlement agreements. The special master was
also directed to address several concerns of the Circuit Court that
were originally outlined in the October 29, 1998 Order. The special
master was further directed to investigate issues concerning the
Blue Cross and Blue Shield licenses and marks and the company's
Credit Agreement.
On November 19, 1998, the Blue Cross and Blue Shield license
agreements were reinstated with addenda that provided, among other
things, that the licenses would terminate on the date of the next
scheduled meeting of the BCBSA Board of Directors, then March 11,
1999, unless extended by the Board of Directors of the BCBSA. On
March 11, June 17, September 17, and November 19, 1999, the BCBSA
Board of Directors extended the licenses until the next scheduled
meeting. On March 9, 2000, the BCBSA Board of Directors unanimously
voted to fully reinstate the licenses so that extension on a "board
to board" basis would no longer be required. See "Status of Blue
Cross and Blue Shield licenses" below.
On November 24, 1998, the Supreme Court of Missouri granted the
motion of Blue Cross and Blue Shield of Missouri to accept transfer
of the litigation related to the 1994 Reorganization and Public
Offering and, as a result of this action, the opinion of the
Missouri Court of Appeals dated August 4, 1998, (referred to above)
is of no effect. The Supreme Court, on application of the parties,
deferred briefing of the appeal pending review of the parties'
settlement agreement in the Circuit Court.
The special master conducted a series of public hearings on December
4, December 16, and December 22, 1998, and on February 4, 1999,
where evidence related to the proposed settlement and other subjects
was presented.
At the public hearing on December 16, representatives of Blue Cross
and Blue Shield of Kansas City presented an "alternative" to the
proposed settlement agreement by suggesting that the Kansas City
plan would acquire the assets of Blue Cross and Blue Shield of
Missouri, including the stock of RightCHOICE that it owns. The
Kansas City plan's proposal provided for a cash purchase price of
$13.50 per share for the shares of the company held by the public
and $15.25 per share for the other shares held by Blue Cross and
Blue Shield of Missouri. The proposal included a number of
conditions, such as a financing contingency and an obligation that
all litigation of Blue Cross and Blue Shield of Missouri be
resolved. This proposal was not made directly to RightCHOICE or
Blue Cross and Blue Shield of Missouri.
Following the completion of the hearings and other investigation, on
February 10, 1999, the special master issued his 47-page report (the
first report of the special master) which recommended that the
settlement agreement "not be approved in its present form" and that
the Circuit Court "withhold a ruling on the settlement agreement to
give the parties and the public interest groups who had filed briefs
and participated in the proceedings as "friends of the court" an
opportunity to meet and confer, and engage in a good faith effort to
address" concerns that were noted in the report of the special
master. While the special master stated that "there are many things
to commend the Settlement Agreement for the Court's approval," he
indicated he had concerns with its terms that prevented him from
recommending approval. Among the concerns he identified in his
first report were: (1) whether the charitable independent health
care foundation that would be created if the settlement were
implemented would receive full value of the present assets of Blue
Cross and Blue Shield of Missouri; (2) whether a contemplated method
of divestiture of the New RightCHOICE shares to be held by the
foundation -- sale of the shares over time pursuant to a Voting
Trust and Divestiture Agreement and Registration Rights Agreement --
would yield full value for the shares; (3) whether the proposed
provisions for governance of the foundation were reasonable; and (4)
whether the provisions for the purposes of the charitable
independent health care foundation were justified.
Following the first report of the special master, the parties and
the public interest groups discussed the concerns noted therein. On
March 12, 1999, RightCHOICE, Blue Cross and Blue Shield of Missouri,
the Missouri Attorney General, and the DOI entered into an Amendment
to Settlement Agreement. The parties to the amended settlement
agreement, together with certain consumer groups that had
participated in the public hearings, filed with the Circuit Court a
joint motion seeking approval of the amended settlement agreement.
On March 12, 1999, the parties also filed with the Circuit Court
their respective objections and comments to the first report of the
special master. In its objections, Blue Cross and Blue Shield of
Missouri asserted that the special master made certain erroneous
factual and unjustified legal conclusions in the report and
requested the Circuit Court to approve the amended settlement
agreement.
Although the Missouri Supreme Court initially had stayed the
briefing schedule for 120 days in the proceedings before it in order
to permit the proceedings in the Circuit Court concerning review of
the settlement agreement to go forward, that stay was lifted and
oral arguments were heard by the Missouri Supreme Court on September
8, 1999. Following the oral arguments, on September 9, 1999, the
Supreme Court entered an order that the Circuit Court "finally
dispose" of the amended settlement agreement.
The special master conducted public hearings on September 3, and
October 4, 1999. On October 8, 1999, he issued a second report (the
second report of the special master). The second report
recommended that the amended settlement agreement be disapproved
because it failed to provide for the full value of the Blue Cross
and Blue Shield of Missouri assets for the public. The report also
suggested that the settlement should provide for the forced sale of
RightCHOICE or provide that the foundation should have the right to
cause the sale of RightCHOICE.
On October 29, 1999 the Circuit Court issued an order in which it
disapproved the amended settlement agreement. Subsequent
proceedings were then had as described above under the caption
"Status of Proposed Settlement Agreements."
On January 6, 2000, as a result of the Amended and Restated
Settlement Agreement, the parties filed a joint notice of dismissal
without prejudice of the pending claims in the lawsuit in the
Circuit Court in which the Attorney General and the DOI contended
that Blue Cross and Blue Shield of Missouri were in violation of the
Missouri health services corporation law and non-profit corporation
law. On February 8, 2000, Blue Cross and Blue Shield of Missouri,
the Attorney General and DOI moved in the Missouri Supreme Court to
dismiss their pending appeals in that litigation. Their motions
were granted on February 9, 2000.
An effect of the dismissal of these appeals is to leave in place,
without further right of appeal, the December 30, 1996 Orders,
particularly the finding that Blue Cross and Blue Shield of Missouri
violated the non-profit law through the continued operation of
RightCHOICE. If the Settlement Agreement is not consummated, the
Attorney General and DOI remain free to seek further relief in
enforcement of those judgments, including seeking to terminate the
Certificate of Authority of Blue Cross and Blue Shield of Missouri
and seeking to dissolve Blue Cross and Blue Shield of Missouri under
the Missouri non-profit corporation law.
Subscriber class action litigation
On March 15, 1996, a suit (the Sarkis Litigation) was filed in the
Circuit Court of the City of St. Louis, Missouri (the St. Louis
Circuit Court), by Anthony J. Sarkis, Sr. and James Hacking
individually and on behalf of a purported class of (i) subscribers
in individual or group health plans insured or administered by Blue
Cross and Blue Shield of Missouri or RightCHOICE, and (ii) all
persons and/or entities who benefited from Blue Cross and Blue
Shield of Missouri's tax-exempt status (the Sarkis plaintiffs). The
petition named RightCHOICE, Blue Cross and Blue Shield of Missouri,
HealthLink, Inc. (a subsidiary of RightCHOICE), and certain officers
of RightCHOICE as defendants. The named plaintiffs later abandoned
their claim to represent all persons or entities that benefited from
Blue Cross and Blue Shield of Missouri's tax-exempt status.
The Sarkis plaintiffs' claims related to an alleged conversion of
Blue Cross and Blue Shield of Missouri from a not-for-profit entity
to a for-profit entity and payment of excessive compensation to
management. The petition further alleged that certain amendments to
Blue Cross and Blue Shield of Missouri's Articles of Incorporation
were improper. The petition also alleged that 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 sought restitution, compensatory
damages and punitive damages in unspecified amounts, as well as
injunctive and other equitable relief.
On November 4, 1998, the St. Louis Circuit Court issued its judgment
and order granting the motion of the defendants to dismiss the
action for lack of standing and entering judgment in favor of the
defendants. The Sarkis plaintiffs appealed the St. Louis Circuit
Court's order. James Hacking later dismissed his appeal, leaving
Anthony Sarkis as the only appellant.
On February 1, 2000, the Missouri Court of Appeals entered an Order
affirming the judgment of dismissal entered in the St. Louis Circuit
Court on November 4, 1998. Appellant did not file a motion for
rehearing or an application for transfer of the appeal to the
Missouri Supreme Court. As a result, the Sarkis Litigation is now
over.
The obligations of the parties to consummate the reorganization
contemplated by the Amended and Restated Settlement Agreement is
conditioned upon, among other things, satisfactory final resolution
of the Sarkis Litigation. This condition is now fully satisfied.
Anthony Sarkis, as a representative of a subscriber class, is also a
party in the actions described below under "Litigation relating to
corporate status of Blue Cross and Blue Shield of Missouri."
Litigation relating to corporate status of Blue Cross and Blue
Shield of Missouri
On November 3, 1997, Blue Cross and Blue Shield of Missouri filed an
action in the Circuit Court against the Missouri Attorney General
seeking declarations that (1) Blue Cross and Blue Shield of Missouri
is a mutual benefit type of nonprofit corporation under Chapter 355
of the Missouri Revised Statutes; and (2) Blue Cross and Blue Shield
of Missouri 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 Blue Cross and
Blue Shield of Missouri was a public benefit type of nonprofit
corporation that held its assets for the benefit of the public
generally. The Missouri Attorney General filed an answer and
counterclaim seeking a declaration that Blue Cross and Blue Shield
of Missouri is a public benefit type of nonprofit corporation.
On June 10, 1998, Anthony Sarkis and James Hacking (plaintiffs in
the Sarkis Litigation described above under "Subscriber class action
litigation") moved to intervene in this action as plaintiffs.
Sarkis and Hacking are or have been subscribers of Blue Cross and
Blue Shield of Missouri. They sought to intervene, contending that
the present parties to the action would not adequately represent
their interests in the resolution of the question whether Blue Cross
and Blue Shield of Missouri is a public benefit or a mutual benefit
corporation. Thereafter, Blue Cross and Blue Shield of Missouri
moved to file an amended petition adding Sarkis, Hacking and the DOI
as parties to the action. For its relief, Blue Cross and Blue
Shield of Missouri sought, among other things, a declaration of its
status as a public benefit or mutual benefit corporation. The
Circuit Court granted Blue Cross and Blue Shield of Missouri's
motion to file the amended petition on August 17, 1998.
On June 17, 1999, the Circuit Court determined that this action
would go forward as a class action for declaratory relief. On that
date, Sarkis and Hacking dismissed all claims other than their
claims for declaratory relief. On July 6, 1999, the Attorney
General of Missouri filed a motion for a summary judgment declaring
that Blue Cross and Blue Shield of Missouri is a public benefit
corporation. On August 5, 1999, Blue Cross and Blue Shield of
Missouri filed a motion for summary judgment that the class
representatives and the class lack standing to assert the claims for
declaratory relief that they had asserted.
On November 3, 2000, the Circuit Court entered a final judgment
finding that Blue Cross and Blue Shield of Missouri is a public
benefit corporation. That judgment is consistent with the
settlement but is subject to possible appeal. If an appeal is
taken, one outcome of that appeal could be a reversal of the Circuit
Court's judgment and a determination that Blue Cross and Blue Shield
of Missouri is a mutual benefit corporation.
If on appeal Blue Cross and Blue Shield of Missouri is declared to
be a mutual benefit type of nonprofit corporation that does not hold
its assets for the benefit of the public generally, Blue Cross and
Blue Shield of Missouri would be required to exercise its ownership
interest in RightCHOICE consistent with the best interests of Blue
Cross and Blue Shield of Missouri's subscribers. If there is no
appeal or, if after all appeals are concluded, Blue Cross and Blue
Shield of Missouri is declared to be a public benefit type of
nonprofit corporation or if it is declared that Blue Cross and Blue
Shield of Missouri holds assets for the benefit of the public
generally, Blue Cross and Blue Shield of Missouri would be required
to exercise its ownership interest in RightCHOICE consistent with
the best interests of the public at large, such as is provided by
the settlement.
The subscriber class in this action requested a declaration that
Blue Cross and Blue Shield of Missouri may not lawfully transfer its
assets to a charitable trust. If, on appeal from the trial court's
judgment of November 3, 2000, such a judgment is entered at a time
after the reorganization is completed, the company resulting from
the reorganization, referred to herein as New RightCHOICE, could be
obligated to pay substantial money damages. It is also possible,
although RightCHOICE believes unlikely, that if such a judgment were
entered on appeal a court could order that the reorganization be
rescinded. If an order like that were entered, it would have a
material adverse effect on New RightCHOICE.
Litigation relating to the Market Conduct Study and Copayment
Calculations
On February 11, 1998, the DOI filed a Notice of Institution of Case
(the Market Conduct Proceeding) relating to a market conduct
examination of RightCHOICE and its affiliates. On January 6, 2000,
the settlement agreement relating to these proceedings was
consummated, and the Market Conduct Proceeding was dismissed.
On February 9, 1998, the Missouri Attorney General filed suit
against RightCHOICE, Blue Cross and Blue Shield of Missouri,
BlueCHOICE, Healthy Alliance Life Insurance Company (HALIC, a
subsidiary of RightCHOICE), and Preferred Health Plans of Missouri,
Inc. (a subsidiary of RightCHOICE) in the Circuit Court seeking
injunctive relief, compensatory damages and civil penalties under
Missouri's Merchandising Practices Act for the way in which
RightCHOICE disclosed and marketed co-payment amounts prior to
January 1996 (the Attorney General Co-Payment Claim). RightCHOICE
discontinued the challenged co-payment practices in January 1996.
On September 20, 1998, RightCHOICE entered a settlement agreement
with the Attorney General for resolution of the Attorney General Co-
Payment Claim conditioned on court approval of the separate
principal settlement agreement of September 20, 1998 described above
under the caption Terms of the Settlement Agreement. The Attorney
General Co-Payment Claim was dismissed by the Missouri Attorney
General without prejudice pending the approval of the amended
settlement agreement described above.
On January 6, 2000, the parties agreed to remove the court approval
condition precedent to consummating the settlement of the Attorney
General Co-Payment Claim. The settlement is now completed.
Status of Blue Cross and Blue Shield licenses
On March 9, 2000, after a period of "board to board" extensions
resulting from the pendency of the principal litigation with the
State of Missouri, the BCBSA Board of Directors voted to reinstate
the full licenses for RightCHOICE and its licensed affiliates. This
action followed the dismissal of the principal litigation pursuant
to the Amended and Restated Settlement Agreement described above
under "Agreement for Settlement of Certain Litigation Matters and
Reorganization of RightCHOICE." Important events that preceded this
reinstatement are described in the following paragraphs.
The October 29 Order (as described above under "Litigation relating
to the 1994 Reorganization and Public Offering") provided for the
appointment of Robert G. Russell as receiver/custodian to, among
other things, take exclusive possession and control of all of the
issued and outstanding shares of RightCHOICE's class B common stock,
all of which is owned by Blue Cross and Blue Shield of Missouri. On
November 2, 1998, the BCBSA notified RightCHOICE and its licensed
affiliates that their licenses to use the Blue Cross and Blue Shield
service marks had terminated automatically pursuant to their terms
on October 29, 1998, as a result of the October 29 Order, and filed
a complaint against RightCHOICE and its licensed affiliates alleging
service mark infringement and breach of license agreements as a
result of the continued use of the service marks following the
issuance of the October 29 Order (the BCBSA Complaint). On November
4, 1998, after Blue Cross and Blue Shield of Missouri filed a motion
seeking a revocation of the October 29 Order and supporting
memorandum, the Circuit Court issued the November 4 Order and the
November 4 Special Master Order. The November 4 Order set aside the
October 29 Order and declared it to be "void from the beginning."
The November 4 Special Master Order appointed Robert G. Russell as
special master for the purpose of collecting and analyzing
information related to the proposed settlement of the litigation
described above. On November 6, 1998, the Court issued an Order of
Reference for the special master. As a result of the November 4
Order, the BCBSA agreed to dismiss the BCBSA Complaint.
Each of the reinstated license agreements approved by the BCBSA on
November 19, 1998 included an addendum that provided, among other
things, that the licenses granted under such license agreements
would be reviewed by the BCBSA at the next regularly scheduled
meeting of the BCBSA Board of Directors (originally, March 11,
1999). If, on or before such date, the BCBSA did not extend the
termination dates for the license agreements until the next
regularly scheduled meeting of the BCBSA Board of Directors after
such date, or otherwise modify the addenda, the license agreements
would have terminated. This "board-to-board" extension of the
license agreements has been adopted in conjunction with the issuance
of reinstated licenses granted to other BCBSA licensees following a
license termination. On March 11, June 17, September 17, and
November 19, 1999, the Board of Directors of the BCBSA unanimously
voted to extend RightCHOICE's licenses to use the Blue Cross and
Blue Shield service marks until the next scheduled meeting of the
BCBSA Board of Directors.
The licenses (which include the primary licenses granted to Blue
Cross and Blue Shield of Missouri and the controlled affiliate
licenses to RightCHOICE, HALIC and BlueCHOICE) give these companies
the right to use the Blue Cross and Blue Shield names and service
marks in connection with health insurance products marketed and sold
in Blue Cross and Blue Shield of Missouri's licensed operating area
(consisting of 85 counties in eastern and central Missouri). The
licenses require Blue Cross and Blue Shield of Missouri,
RightCHOICE, HALIC and BlueCHOICE to pay license fees to BCBSA for
the use of the marks. The license fees have aggregated
approximately $0.7 million to $0.8 million per year for 1997 through
1999. The company expects to continue to incur annual license fees
of similar amounts; however, the amounts may vary from year to year
based on the company's total revenue as compared to that of all Blue
Cross and Blue Shield licensees as well as changes adopted by BCBSA
to its overall formulas for computing the license fees.
Each of the licenses provides that it automatically terminates if,
among other things: (i) the DOI or another regulatory agency
assumes control of the licensee or delinquency proceedings are
instituted; (ii) a trustee, interim trustee, receiver or other
custodian for any of Blue Cross and Blue Shield of Missouri's or the
BCBSA's property or business is appointed, or (iii) an action is
instituted by any governmental entity or officer against the
licensee seeking dissolution or liquidation of its assets or seeking
the appointment of a trustee, interim trustee, receiver or custodian
for any of its property or business, which is consented or
acquiesced to 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 license also provides that it may be
terminated by BCBSA if, among other things, the licensee fails to
meet certain quality control standards or minimum capital or
liquidity requirements. Pursuant to the addendum, which became part
of the reinstated license agreements following the November 19, 1998
BCBSA Board meeting, an automatic termination will also occur (i) if
the BCBSA Board does not take action to extend the licenses on or
before the date of the next regularly scheduled BCBSA Board meeting,
and (ii) upon any judicial act that (a) provides for or approves a
transaction pursuant to which a person, entity or group other than
the licensees of BCBSA, acquires the ability to select the majority
of the members of the Board of Directors of Blue Cross and Blue
Shield of Missouri, RightCHOICE or certain of its affiliates or
otherwise gains control of Blue Cross and Blue Shield of Missouri,
RightCHOICE or such affiliates, or (b) changes the composition of,
or the voting rights of the members of the Board of Directors of
Blue Cross and Blue Shield of Missouri, RightCHOICE or such
affiliates. The foregoing provision does not apply to a settlement
or resolution of the litigation described above that complies with
all BCBSA rules, regulations and standards and is approved by or
conditioned on the approval of the BCBSA. In addition, the licenses
may be terminated if Blue Cross and Blue Shield of Missouri,
RightCHOICE, or certain subsidiaries of RightCHOICE are unable to
achieve certain financial benchmarks as required by the BCBSA.
The affiliate licenses are derivative of the primary licenses and
automatically terminate if the primary licenses terminate.
According to their terms, if a license is terminated, Blue Cross and
Blue Shield of Missouri, RightCHOICE, HALIC and BlueCHOICE are
jointly liable to the 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. In
connection with the reinstatement described above, the BCBSA waived
the application of these provisions to the alleged automatic
termination resulting from the entry of the October 29 Order.
RightCHOICE believes that the exclusive right to use the Blue Cross
and Blue Shield names and service marks provides it and its
controlled affiliates with a marketing advantage in Blue Cross and
Blue Shield of Missouri's licensed operating area, the loss of which
would have a material adverse effect on RightCHOICE and the market
for its stock. In addition, the loss of the licenses would be an
event of default under RightCHOICE's Credit Agreement which, if not
waived or otherwise addressed, could result in a material adverse
effect on RightCHOICE and the market for its stock.
In connection with the settlement agreements described above under
"Status of Proposed Settlement Agreements," Blue Cross and Blue
Shield of Missouri and RightCHOICE have filed a request with the
BCBSA to transfer its primary license to New RightCHOICE as part of
the transactions contemplated by the Amended and Restated Settlement
Agreement. The BCBSA had conditionally approved the transfer as
proposed under the Amended and Restated Settlement Agreement.
RightCHOICE cannot provide any assurances that the transactions
contemplated by the Amended and Restated Settlement Agreement will
be effected. The failure to consummate the transactions
contemplated by the Amended and Restated Settlement Agreement could
have a material adverse effect on RightCHOICE and the market for its
stock.
Other contingencies
In addition to the matters described above, from time to time in the
ordinary course of business, RightCHOICE and certain of its
subsidiaries are parties to various legal proceedings, many of which
involve claims relating to the denial of health care benefits. In
some cases, plaintiffs may seek substantial punitive damages. The
loss of even one of these claims, if it resulted in a significant
punitive damage award, could adversely affect RightCHOICE's
financial condition or results of operations. The risk of potential
liability under punitive damage theories also may make reasonable
settlements of claims more difficult to obtain.
In addition, plaintiffs continue to bring new types of purported
legal claims against managed care companies such as RightCHOICE.
RightCHOICE cannot determine with any certainty the impact that
these evolving theories of recovery may have on the managed care
industry in general or on RightCHOICE or its subsidiaries in
particular.
RightCHOICE anticipates that it will have insurance coverage for
some of these potential liabilities. Other potential liabilities
may not be covered by insurance, insurers may dispute coverage, or
the amount of insurance may not be enough to cover the damages
awarded.
RightCHOICE's parent, Blue Cross and Blue Shield of Missouri, is
presently a party to a class action lawsuit brought by a purported
class of subscribers of Medicare supplement policies. In the
settlement reorganization, New RightCHOICE as the successor to Blue
Cross and Blue Shield of Missouri and RightCHOICE will succeed to
any liability they may have to the plaintiffs in this case, and an
adverse decision in this lawsuit could subject New RightCHOICE to
substantial damages.
3. Recently issued accounting standards
In June 1998, the Financial Accounting Standards Board (FASB)
released Statement of Financial Accounting Standards (SFAS) No. 133,
"Accounting for Derivative Instruments and Hedging Activities."
SFAS No. 133 establishes standards for derivative instruments,
including certain derivative instruments embedded in other
contracts, and for hedging activities. It requires an entity to
recognize all derivatives as either assets or liabilities in the
statement of financial position and measures those instruments at
fair value. SFAS No. 133 is effective for all fiscal years
beginning after June 15, 2000, as extended by SFAS No. 137. Earlier
application of SFAS No. 133 is encouraged but should not be applied
retroactively to financial statements of prior periods. The company
believes that the adoption of SFAS No. 133 will not have a material
impact on the company's financial position or results of operations.
4. Provision for income taxes
The company's effective income tax provision rates of 39.8 percent
and 43.3 percent for the third quarter of 2000 and 1999,
respectively, and 39.8 percent and 40.1 percent for the first three
quarters of 2000 and 1999, respectively, presented in the
Consolidated Statements of Income were affected by state income
taxes and non-deductible goodwill amortization, among other things.
Statement of Financial Accounting Standards No. 109, "Accounting for
Income Taxes," requires a valuation allowance against deferred tax
assets if, based on the weight of available evidence, it is more
likely than not that some or all of the deferred tax assets will not
be realized. Based upon all the available evidence, management
believes it is more likely than not that the company will realize
its deferred tax assets and, accordingly, no valuation allowance has
been provided against such assets as of September 30, 2000.
5. Earnings per share
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 462,904 and 35,001 dilutive
potential common shares for the third quarter of 2000 and 1999,
respectively and 315,436 and 49,284 dilutive potential common shares
for the first three quarters of 2000 and 1999, respectively.
6. Comprehensive income
<TABLE>
The components of other comprehensive income for the three and nine
month periods ended September 30, 2000 and 1999 are as follows:
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
2000 1999 2000 1999
(in thousands) (in thousands)
<S> <C> <C> <C> <C>
Unrealized holding gains (losses) arising
during period, net of taxes $1,434 $(860) $2,284 $(5,025)
Less: reclassification adjustment for
losses (gains) included in net income,
net of taxes 111 41 (582) 334
Net unrealized (losses) gains on securities $1,545 $(819) $1,702 $(4,691)
</TABLE>
The components of accumulated other comprehensive income on the Consolidated
Balance Sheets include unrealized net depreciation of investments as well as
a minimum pension liability adjustment. The unrealized net depreciation of
investments was $2,430 and $4,132 at September 30, 2000 and December 31, 1999,
respectively. The minimum pension liability increase was $295 and $295 at
September 30, 2000 and December 31, 1999, respectively.
7. Segment information
The company operates in two segments which it defines as
underwritten and self-funded. The company's underwritten segment
includes a comprehensive array of products including PPO, POS, HMO,
Medicare supplement, managed indemnity and specialty managed care
coverages. The company's self-funded segment includes TPA, ASO for
self-insured organizations, network rental services for self-insured
organizations, insurance companies and other organizations, and life
insurance agency services. All of the company's revenues, both
underwritten premiums and self-funded fees and other income, are
derived from domestic (United States) sources and no single customer
accounts for more than 10 percent of total revenues.
Operating income for the company's underwritten segment is
determined by deducting from premium revenue the health care service
costs, commissions, and general and administrative expenses that are
attributable to that segment's operations. Operating income for the
self-funded segment is determined by deducting the commissions and
general and administrative expenses attributable to the segment from
fees and other income. Expenses not directly traceable to an
industry segment are allocated on a consistent and reasonable basis
utilizing membership, groups, claims, and other key drivers.
Corporate identifiable assets by segment include only receivables
from members since the company does not produce more detailed
information by segment internally. Inter-segment revenues are not
material. Financial information by segment is as follows (in
thousands):
<TABLE>
<S> <C> <C> <C>
Three months ended September 30, 2000 Underwritten Self-funded Consolidated
Revenues $217,176 $24,239 $241,415
Operating income 3,652 9,157 12,809
Depreciation and amortization expense 3,021 1,419 4,440
Identifiable assets 60,457 38,097 98,554
Nine months ended September 30, 2000 Underwritten Self-funded Consolidated
Revenues $621,566 $72,435 $694,001
Operating income 6,754 25,619 32,373
Depreciation and amortization expense 8,989 4,243 13,232
Three months ended September 30, 1999 Underwritten Self-funded Consolidated
Revenues $183,496 $21,007 $204,503
Operating (loss) income (695) 5,904 5,209
Depreciation and amortization expense 3,016 1,389 4,405
Identifiable assets 56,063 27,778 83,841
Nine months ended September 30, 1999 Underwritten Self-funded Consolidated
Revenues $541,436 $62,291 $603,727
Operating (loss) income (4,054) 18,412 14,358
Depreciation and amortization expense 8,742 4,046 12,788
</TABLE>
ITEM 2. Management's Discussion and Analysis
of Financial Condition and 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 WITHIN THE MEANING
OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. THESE
STATEMENTS ARE BASED ON MANAGEMENT'S CURRENT EXPECTATIONS AND ARE
SUBJECT TO UNCERTAINTY AND CHANGES IN CIRCUMSTANCES. ACTUAL RESULTS
MAY VARY MATERIALLY FROM THE EXPECTATIONS CONTAINED HEREIN. THE
RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY FROM THOSE DESCRIBED HEREIN INCLUDE, BUT ARE NOT LIMITED
TO, THOSE DISCUSSED BELOW IN THE SECTION ENTITLED "FACTORS THAT MAY
AFFECT FUTURE RESULTS OF OPERATIONS, FINANCIAL CONDITION OR
BUSINESS." RIGHTCHOICE IS NOT UNDER ANY OBLIGATION, AND EXPRESSLY
DISCLAIMS ANY OBLIGATION, TO UPDATE OR ALTER ITS FORWARD-LOOKING
STATEMENTS WHETHER AS A RESULT OF NEW INFORMATION, FUTURE RESULTS,
OR OTHERWISE.
Results of operations
<TABLE>
The following table contains revenue by product group for the three
and nine month periods ended September 30, 2000 and 1999
(unaudited):
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
Product Group 2000 1999 2000 1999
(in thousands) (in thousands)
<S> <C> <C> <C> <C>
PPO:
Alliance PPO $70,731 $53,453 $193,070 $154,500
AllianceChoice POS 50,715 42,310 145,380 123,380
HMO (includes other POS) 55,718 51,814 166,369 156,207
Medicare supplement 22,049 22,915 67,302 69,778
Managed indemnity 653 955 1,757 2,806
Other specialty Services 17,060 12,051 47,258 34,319
Total premium revenue 216,926 183,498 621,136 540,990
ASO/self-funded and other income 24,489 21,005 72,865 62,737
Total revenues $241,415 $204,503 $694,001 $603,727
</TABLE>
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:
<TABLE>
Three months ended Nine months ended
September 30, September 30,
2000 1999 2000 1999
<S> <C> <C> <C> <C>
Operating revenues:
Premium revenue 89.9% 89.7% 89.5% 89.6%
Fees and other income 10.1% 10.3% 10.5% 10.4%
100.0% 100.0% 100.0% 100.0%
Operating expenses:
Medical loss ratio 81.2% 81.6% 81.2% 82.0%
Commission expense ratio 3.8% 4.2% 3.9% 4.0%
General and administrative expense ratio
(includes depreciation and amortization) 18.0% 20.0% 18.8% 20.2%
Adjusted general and administrative
expense ratio (excludes depreciation
and amortization) 16.1% 17.9% 16.8% 18.0%
</TABLE>
<TABLE>
Membership
The following table sets forth membership data and the
percent change in membership:
<CAPTION>
September 30, %
2000 1999 increase (decrease)
<S> <C> <C> <C>
Product Group:
Underwritten:
PPO:
Alliance PPO 178,155 145,826 22.2%
AllianceChoice POS 138,928 126,997 9.4
HMO:
Commercial (includes other POS) 124,224 125,501 (1.0)
Blue Horizons Medicare HMO 3,498 5,025 (30.4)
Medicare supplement 49,888 54,187 (7.9)
Managed indemnity 1,505 1,965 (23.4)
496,198 459,501 8.0
Self-funded:
PPO 47,699 45,718 4.3
HMO 7,723 7,173 7.7
ASO (includes HealthLink):
Workers' compensation 723,771 497,055 45.6
Other ASO* 1,249,944 1,225,234 2.0
Total membership 2,525,335 2,234,681 13.0%
* does not include 411,026 and 384,885 as of September 30, 2000 and
1999, respectively, relating to additional third-party administrator
members that are part of The EPOCH Group, L.C. (Epoch), a joint
venture with Blue Cross and Blue Shield of Kansas City formed in
December 1995.
</TABLE>
Comparison of 2000 Results to 1999 Results
Revenues - underwritten
Premium revenue increased $33.4 million, or 18.2 percent, in the
third quarter of 2000 in comparison to the third quarter of 1999.
For the first three quarters of 2000, premium revenue increased
$80.1 million, or 14.8 percent, in comparison to the first three
quarters of 1999. 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 in premium revenue may not be
indicative of future periods. The company will continue to strive
to establish its premium rates based on anticipated health care
costs. Depending on future competition, customer acceptance of
premium increases, future health care cost trends or other factors,
the company cannot provide any assurances that it will be able to
price its products consistent with health care cost trends.
PPO premium revenue increased $25.7 million in the third quarter of
2000 as compared to the third quarter of 1999 -- $8.7 million due to
a 9.2 percent increase in net premium rates and $17.0 million
resulting from a 16.1 percent increase in member months. For the
first three quarters of 2000, PPO premium revenue increased $60.6
million as compared to the first three quarters of 1999 -- $24.6
million due to an 8.7 percent increase in net premium rates and $36.0
million resulting from a 12.1 percent increase in member months. The
term member months refers to the cumulative number of members added
together over a specific time period. Thus, for a quarter, member
months are determined by adding together the membership counts for
all three months. Net premium rates increased due in part to overall
premium renewal rate increases typically ranging from approximately 8
percent to 18 percent during enrollment periods in the last quarter
of 1999 and the first three quarters of 2000. Net premium rate
increases are at the lower end of the overall premium increase range
due in part to changes in deductibles, the timing of group renewals
throughout the year and product mix changes. Alliance PPO
membership increased by 32,329 members from September 30, 1999 to
September 30, 2000 while AllianceChoice POS membership increased by
11,931 over the same time period. These increases are partially due
to the announced departure from the Missouri market of several
competitors coupled with strong retention of the company's existing
members. The company's membership has also benefited from the
positive performance of its BlueCard (registered trademark) PPO program.
The BlueCard (registered trademark) PPO program allows the company's
Alliance PPO and POS members access to Blue Cross and Blue Shield plans'
PPO providers throughout the majority of the nation. In addition, the
company began offering PPO products in Illinois at the end of the first
quarter of 1997. Included in the Alliance PPO member count are 26,865
PPO Illinois members as of September 30, 2000, an increase of 14,780 from
September 30, 1999.
HMO premium revenue increased $3.9 million or 7.5 percent -- $6.0
million increase due to a 9.2 percent increase in net premium rates,
partially offset by a $2.1 million decrease resulting from a 1.5
percent decrease in member months. For the first three quarters of
2000, HMO premium revenue increased $10.2 million, or 6.5 percent,
as compared to the first three quarters of 1999 -- $16.4 million due
to a 9.3 percent increase in net premium rates partially offset by a
$6.2 million decrease resulting from a 2.6 percent decrease in
member months. Net premium rates increased in part due to the
company's premium renewal rate increases typically ranging from
approximately 8 percent to 18 percent during enrollment periods in
the last quarter of 1999 and the first three quarters of 2000. Net
premium rate increases are at the lower end of the overall premium
increase range because of:
* shifts in chosen benefit levels,
* changes in the geographic mix of the HMO business,
* product mix shifts, and
* the status of a large group, the Missouri Consolidated Health Care
Plan (MCHCP), comprised of approximately 40,725 members as of
September 30, 2000.
Membership in MCHCP increased by 2,167 from September 30, 1999 to
September 30, 2000. The company's 1999 year-end annual report on
Form 10-K noted that a rate increase of approximately 21 percent
would be effective for MCHCP for the contract year beginning January
1, 2000. In March 2000, MCHCP notified the company that a risk
adjustment factor applied to the premiums MCHCP pays insurance
carriers will result in a reduction of that increase to
approximately 12 percent. Although the company contested this MCHCP
action, it increased its loss reserve at March 31, 2000, by $1.5
million. This charge is reflected in the health care services
expense caption of the Consolidated Statement of Income for the nine
months ended September 30, 2000. The company's participation in the
MCHCP program is currently scheduled to terminate on December 31,
2000. See "Liquidity and Capital Resources" below. Excluding the
MCHCP, membership in the company's HMO products decreased over the
same time period by 4,971 members, partially due to increases in
premium and partially due to a general migration from HMO products
to other managed care products such as PPO products.
As of September 30, 2000, the company had 3,498 Blue Horizons
Medicare HMO members. Effective December 31, 2000, the company will
no longer contract with the Health Care Financing Administration of
the United States Department of Health and Human Services to provide
benefits under the Medicare HMO program. The company expects the
Blue Horizons Medicare HMO membership to gradually decline over the
remainder of the year as members opt for other Medicare-risk
carriers. Excluding the membership reductions related to MCHCP and
Blue Horizons Medicare HMO, the company expects to add 10,000 net
new underwritten members effective in the first quarter of 2001.
Premium revenue from Medicare supplement decreased by $0.9 million
in the third quarter of 2000 as compared to the third quarter of
1999. Member months decreased by 7.7 percent partially offset by a
4.3 percent increase in net premium rates. For the first three
quarters of 2000, premium revenue decreased by $2.5 million as
compared to the first three quarters of 1999. Member months
decreased by 7.8 percent partially offset by a 4.6 percent increase
in net premium rates. Membership in the company's Medicare
supplement products has decreased in part due to subscribers opting
for competitors' Medicare-risk programs, similar to the company's
Blue Horizons Medicare HMO product, in which medical benefits are at
least as comprehensive as Medicare benefits for persons eligible to
receive Medicare (parts A and B). Historically, these Medicare-risk
programs were offered at no additional cost to the member. In
addition, new Medicare supplement sales have lagged in 2000 as
compared to 1999 due to mandated changes by the State of Missouri in
the pricing methodologies for these products.
Managed indemnity premium revenue decreased by $0.3 million in the
third quarter of 2000 as compared to the third quarter of 1999 due
to a 24.8 percent decline in member months. For the first three
quarters of 2000, premium revenue decreased by $1.0 million due to a
30.1 percent decline in member months. Member month declines are
consistent with the company's strategy to move toward more highly
managed care products. With the exception of a short-term medical
product, the company no longer sells managed indemnity products, but
continues to renew coverage for those members who wish to remain in
these managed indemnity programs.
Premium revenue from other specialty services, which includes
certain of the company's drug and dental health care benefits plans,
increased $5.0 million or 41.6 percent in the third quarter of 2000
as compared to the third quarter of 1999 -- $2.4 million due to a
21.2 percent increase in net premium rates and $2.6 million
resulting from a 16.8 percent increase in member months. For the
first three quarters of 2000, revenue increased $12.9 million as
compared to the first three quarters of 1999 due to a 21.3 percent
increase in net premium rates as well as a 13.5 percent increase in
member months. Specialty product membership related to the
company's drug products increased during this period as a result of
growth in the company's Alliance group membership, growth in the
RightCHOICE Insurance Company PPO Illinois group membership, and an
increase in the AllianceChoice group membership. The increase in
membership for drug products was offset in part by decreases in the
company's dental product member months, which decreased by 6.7
percent and 4.7 percent in the third quarter and first three
quarters of 2000, respectively, as compared to the same periods in
1999; these decreases are due to competition from dental products
that are priced below the company's dental product. The company
continues to work towards revising its dental product to be more
competitive in the market. The large net premium rate increases
primarily relate to the company's drug products 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.
Revenues - self-funded
Fees and other income from administrative services only, network
services and life insurance commission revenues increased $3.5
million in the third quarter of 2000 as compared to the third
quarter of 1999. For the first three quarters of 2000, fees and
other income increased $10.1 million as compared to the first three
quarters of 1999. These increases are primarily due to increased
2000 revenues from HealthLink, Inc. (HealthLink), the company's
network rental and managed care service subsidiary, of $3.2 million
and $10.4 million for the third quarter and first three quarters of
2000, respectively, as compared to the same periods of 1999.
HealthLink's revenues increased as a result of an 18.9 percent
increase in membership from September 30, 1999 to September 30,
2000 which was partially due to expansion into new territories as
well as membership growth in HealthLink's workers' compensation
program, which increased 45.6 percent to 723,771 at September 30,
2000 compared to 497,055 at September 30, 1999.
Operating expenses
The overall medical loss ratio decreased from 81.6 percent in the
third quarter of 1999 to 81.2 percent in the third quarter of 2000.
The overall medical loss ratio decreased from 82.0 percent in the
first three quarters of 1999 to 81.2 percent in the first three
quarters of 2000. The medical loss ratio has decreased, in part,
due to the company's pricing strategy. For the third quarter and
first three quarters of 2000, the premium per member per month
increased by 9.4 percent and 9.1 percent, respectively, as compared
to the third quarter and first three quarters of 1999. For the
third quarter and first three quarters of 2000, the net medical cost
per member per month increased by 8.8 percent and 8.0 percent,
respectively, as compared to the third quarter and first three
quarters of 1999.
The company continues its efforts initiated in 1998 to modify its
pharmacy benefits management program and recontract with physicians
and ancillary service providers. The drug cost trend increase
ranged from approximately 17 percent to the mid twenty percent range
for the twelve month period ended September 30, 2000, driven by a
combination of factors, including:
* introduction of new drug therapies,
* physicians' use of newer, more expensive drugs, and
* greater utilization of drugs driven in part by direct-to-consumer
advertising.
The per member per month drug cost has been reduced somewhat by the
company's continuing strategy for managing drug costs by utilizing a
three-tier drug benefit design that allows members to make choices
among generic, preferred drugs (drugs which are part of the
company's preferred drug list), or other brand name drugs, albeit at
different copayment levels. Approximately 93 percent and 71 percent
of the company's underwritten members with a drug benefit were
covered under the three-tier pharmacy benefit program as of
September 30, 2000 and September 30, 1999, respectively. Physician
education, utilization and prescribing pattern analysis have
increased through the assistance of an on-site pharmacist whose
services were negotiated through the company's pharmacy benefit
contract, which runs through April 2002. 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 operations strategy (IOS). The company
continues to work on cooperative programs with physicians designed
to increase client satisfaction and improve the medical cost trend.
The company launched the specialist model of the Physician Group
Partners Program (registered trademark) (PGPP - registered trademark)
in October 2000 and signed the first two group practices to the program.
Designed for the PPO and POS programs, initial specialties to be included
are internal medicine/family practice, pediatrics, OB/GYN, cardiology,
orthopedics, and general surgery. Like the current program for the
HMO physicians, the program will include patient satisfaction and
quality measurements. The company cannot assure investors that its
initiatives to manage future increases in medical and pharmacy cost
trends to improve the medical loss ratio will be effective.
Commission expense increased by $0.7 million, or 7.7 percent, in the
third quarter of 2000 as compared to the third quarter of 1999. For
the first three quarters of 2000, commission expense increased by
$3.1 million, or 13.1 percent, as compared to the first three
quarters of 1999. The increases are primarily due to an increase in
overall premium. The commission expense ratio decreased to 3.8
percent for the third quarter of 2000 from 4.2 percent for the third
quarter of 1999. For the first three quarters of 2000, the
commission expense ratio decreased slightly to 3.9 percent from 4.0
percent for the first three quarters of 1999.
General and administrative expenses, excluding depreciation and
amortization, increased $2.4 million, or 6.4 percent, in the third
quarter of 2000 as compared to the third quarter of 1999. For the
first three quarters of 2000, these expenses increased by $8.0
million, or 7.3 percent, as compared to the first three quarters of
1999. These increases are partially attributable to HealthLink's
geographic and member expansion efforts which resulted in increased
HealthLink expenses of $1.0 million and $4.1 million ($0.9 million
and $3.8 million excluding depreciation and amortization) in the
third quarter and first three quarters of 2000, respectively, as
compared to the same periods of 1999. The company's general and
administrative expense ratio, excluding depreciation and
amortization, decreased to 16.1 percent in the third quarter of 2000
as compared to 17.9 percent in the third quarter of 1999. For the
first three quarters of 2000, the general and administrative expense
ratio, excluding depreciation and amortization, decreased to 16.8
percent from 18.0 percent in the first three quarters of 1999.
Depreciation and amortization expenses remained flat at $4.4 million
in the third quarter of 2000 compared to $4.4 million in the third
quarter of 1999. For the first three quarters of 2000, depreciation
and amortization expenses increased to $13.2 million from $12.8
million in the first three quarters of 1999. Amortization expenses
for the completed components of the company's IOS project increased
by $0.1 million and $0.4 million in the third quarter and first
three quarters of 2000, respectively, as compared to the same
periods in 1999.
Operating expenses for the company's underwritten segment include
health care service costs, commissions, and general and
administrative expenses. Operating expenses for the company's self-
funded segment include commissions and general and administrative
expenses. Operating expenses for the underwritten segment of $213.5
million and $614.8 million for the third quarter and first three
quarters of 2000, respectively, represent increases of $29.3 million
and $69.3 million, respectively, as compared to the same periods in
1999. The increases are primarily due to an increase in health care
service costs of $26.3 million and $60.7 million in the third
quarter and first three quarters of 2000, respectively, as compared
to the same periods in 1999. Health care service costs increased
due to an increase in the company's underwritten membership as well
as an increase in per member claims costs, as previously described.
General and administrative expenses also increased by $2.3 million
and $5.3 million in the third quarter and first three quarters of
2000, respectively, as compared to the same periods of 1999. These
increases were also partially attributable to an increase in the
company's underwritten membership of approximately 8 percent from
September 30, 1999 to September 30, 2000. Operating expenses for
the self-funded segment were $15.1 million for both the third
quarter of 2000 and the third quarter of 1999. For the first three
quarters of 2000, operating expenses for the self-funded segment of
$46.8 million represents an increase of $2.9 million as compared to
the same period of 1999. This increase is primarily due to an
increase in HealthLink's general and administrative costs, as
previously described.
Operating income
Operating income increased by $7.6 million in the third quarter of
2000 in comparison to the third quarter of 1999. For the first
three quarters of 2000, operating income increased by $18.0 million
as compared to the first three quarters of 1999.
Operating income for the company's underwritten segment increased to
$3.7 million in the third quarter of 2000 as compared to an
operating loss of $0.7 million in the third quarter of 1999. For
the first three quarters of 2000, operating income increased to $6.8
million as compared to an operating loss of $4.1 million for the
first three quarters of 1999. Operating income increases related to
these comparable periods were primarily due to enrollment growth and
an improved pricing environment for the company's underwritten
products.
Operating income for the company's self-funded segment increased to
$9.2 million in the third quarter of 2000 as compared to $5.9
million in the third quarter of 1999. For the first three quarters
of 2000, operating income increased to $25.6 million as compared to
$18.4 million for the first three quarters of 1999. Operating
income increases related to these comparable periods were primarily
due to HealthLink's continued growth from increased membership and
regional expansion, as previously described. HealthLink's operating
income increased by $2.2 million and $6.3 million in the third
quarter and first three quarters of 2000 as compared to the same
periods of 1999.
Net investment income
Net investment income includes investment income in the form of
interest and dividend income and net realized gains or losses from
the sale of portfolio securities. Net investment income of $3.6
million in the third quarter of 2000 represents a $0.5 million
increase over the third quarter of 1999. For the first three
quarters of 2000, net investment income of $11.6 million represents
a $2.2 million increase over the first three quarters of 1999.
Realized gains from sales of investments increased by $1.5 million
during the first three quarters of 2000 as compared to the same
period of 1999.
Provision for income taxes
The company's effective income tax provision rates were 39.8 percent
and 43.3 percent for the third quarter of 2000 and 1999,
respectively. The company's effective income tax provision rates
were 39.8 percent and 40.1 percent for the first three quarters of
2000 and 1999, respectively. The company's effective income tax
rates for 2000 and 1999 were affected by state income taxes and non-
deductible goodwill amortization, among other things.
Net income
The company's net income of $9.5 million for the third quarter of
2000 represents an increase of $5.5 million compared to net income
of $4.0 million for the third quarter of 1999. Basic and diluted
earnings per share for the third quarter of 2000 were $0.51 and
$0.50, respectively, compared to basic and diluted earnings per
share of $0.21 and $0.21, respectively, for the third quarter of
1999. The company's net income of $25.5 million for the first three
quarters of 2000 represents an increase of $12.9 million compared to
net income of $12.6 million for the first three quarters of 1999.
Basic and diluted earnings per share for the first three quarters of
2000 were $1.37 and $1.34, respectively, compared to basic and
diluted earnings per share of $0.67 and $0.67, respectively, for the
first three quarters of 1999.
Liquidity and capital resources
RightCHOICE's working capital as of September 30, 2000 was $103.8
million, an increase of $30.8 million from December 31, 1999. A
majority of the increase is attributable to the net income of $25.5
million in the first three quarters of 2000. Depreciation and
amortization expenses related to noncurrent assets were $13.2
million. The company's unrealized net depreciation of investments
available for sale decreased (improved) by $1.7 million in the first
three quarters of 2000. In addition, RightCHOICE repaid $6.0
million of the debt from its reducing revolving credit facility as
well as $3.4 million of debt related to capital leases. The company
capitalized $6.4 million of costs for property and equipment
purchases, $3.8 million of which relates to capitalized IOS
development costs. In the first three quarters of 2000, the company
incurred expenditures of $4.5 million on its IOS project, of which
$3.8 million were capitalized. During the remainder of the year
2000, the company anticipates that it will expend approximately $2.6
million to $3.4 million on its IOS project of which approximately
$2.0 million to $2.5 million will be capitalized. For the year
2001, the company anticipates that it will expend approximately $13
million to $14 million of which approximately $8 million to $9
million will be capitalized. The company sold its Southwest
Missouri regional office building in May 2000 for $3.6 million
realizing a gain on the sale of $0.7 million. The company relocated
the employees and its operations to a larger leased facility within
the same region.
Net cash provided by operations totaled $27.3 million for the first
three quarters of 2000 as compared to net cash provided by
operations of $7.8 million for the first three quarters of 1999.
The company's net income for the first three quarters of 2000 was
$25.5 million, which included $13.2 million of depreciation and
amortization expenses, and $4.9 million related to the net reduction
in the MCHCP contract loss reserve. In addition, receivables from
members, accounts payable and accrued expenses, medical claims
payable, and net intercompany payables 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. Receivables from members increased by $19.6
million in part due to an increase of $7.7 million related to
HealthLink receivables, increased membership levels, and rate
increases related to the company's underwritten products, and other
timing factors. Accounts payable and accrued expenses increased by
$4.0 million due to the timing of various operating cash payments
and accruals. Medical claims payable increased by $2.2 million due
in part to increased membership. Net intercompany payables
increased by $3.6 million due to intercompany tax settlements and
the timing of operating cash receipts and payments, among other
things.
On August 29, 1997, RightCHOICE reported the commencement of the
litigation with the MCHCP 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. As a result
of management's assessment of the profitability of its contract for
providing health care services to members of the MCHCP, the company
recorded a pre-tax charge for probable future losses of $29.5
million during the third quarter of 1997. The charge resulted from
inadequate rate increases that were contractually limited for the
remainder of the MCHCP contract, which extended through the year
2000. The pre-tax charge 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.
RightCHOICE was advised by the Missouri Department of Insurance in
March 1998 that the entire amount of the reserve for the MCHCP
contract recorded by RightCHOICE for projected losses under the
contract through the year 2000 must, for statutory accounting
purposes, be recorded by RightCHOICE's subsidiary BlueCHOICE on its
statutory filings with the Missouri Department of Insurance. With
the prior regulatory approval of the Missouri Department of
Insurance, BlueCHOICE issued surplus notes to RightCHOICE in the
amount of $29 million to ensure the statutory solvency of
BlueCHOICE. On August 6, 1999, the MCHCP executed an amendment to
the contract providing a rate increase that was anticipated to be
approximately 21 percent for public entities, modified rate factors
for state employees, and modification of the pharmacy benefit,
effective January 1, 2000, for the 2000 contract year. In March
2000, MCHCP notified the company that a risk adjustment factor
applied to the premiums MCHCP pays insurance carriers will result in
a reduction of that increase to approximately 12 percent. Although
the company contested this MCHCP action, it increased its loss
reserve at March 31, 2000, by $1.5 million. This charge is
reflected in the health care services expense caption of the
Consolidated Statement of Income for the nine months ended September
30, 2000 in Item 1, Financial Statements. While management of the
company believes the current provision for losses is adequate, if
the actual public entity membership in the MCHCP grows at a rate in
excess of the rate used in the actuarial estimates, or if the
projected limited rate increases and medical cost trends should
differ materially from those assumed in the actuarial estimates,
then the amount of the reserve recorded to date could be
insufficient to cover all future losses which may be associated with
the MCHCP contract, and such losses could have a material adverse
effect on RightCHOICE. RightCHOICE's participation in the MCHCP
program is currently scheduled to terminate on December 31, 2000.
In the first quarter of 1999, RightCHOICE received regulatory
approval of a reinsurance arrangement between its subsidiaries,
Healthy Alliance Life Insurance Company and BlueCHOICE. Under this
arrangement, Healthy Alliance Life Insurance Company will reinsure
the MCHCP losses that exceed certain thresholds over the remaining
term of the current MCHCP contract. RightCHOICE anticipates that
this arrangement will assist in mitigating the risk that additional
surplus notes or other funding will need to be provided to
BlueCHOICE.
Year 2000 issue
RightCHOICE executed a program to evaluate its major systems,
processes and equipment to minimize the possibility of a material
disruption to its business due to Year 2000 problems, e.g., the
difficulties of certain computers, computer programs and other
equipment to distinguish between the year 1900 and the year 2000.
RightCHOICE substantially completed its Year 2000 program in
December 1999. This included necessary remediation, implementation
of new packages, testing of critical components, testing of critical
external interfaces and completion of contingency plans for critical
processes.
As a result of those planning and implementation efforts, the
company experienced no significant problems relating to the Year
2000 transition. The company will continue to monitor its systems
for continued processing. In addition, as of September 30, 2000,
RightCHOICE was not aware of significant Year 2000 problems
encountered by its critical vendors, suppliers and providers or in
RightCHOICE's use of their services.
The total cost associated with modifications required to become Year
2000 ready was approximately $13.0 million with $0.1 million
expensed in the first nine months of 2000 and $5.4 million expensed
in the full year of 1999. RightCHOICE expensed all costs associated
with these changes as they were incurred. These costs were funded
internally through operating cash flows or investment sales and
represented less than 10 percent of RightCHOICE's information
technology budget over the life of the Year 2000 program.
Health Insurance Portability and Accountability Act of 1996
The United States Department of Health and Human Services (HHS) has
issued proposed rules, as contemplated by the Health Insurance
Portability and Accountability Act of 1996 (HIPAA), which would, if
the rules are adopted, among other things, impose security and
confidentiality requirements with respect to a member's transactions
with health care providers and payers. In addition, HHS has issued
final rules which require the standardization of certain electronic
transaction code sets by October 2002. For 2001, the company
anticipates that it will expend approximately $4 million to $4.5
million on HIPAA compliance, a portion of which will be capitalized
relating to internally developed software. RightCHOICE has not
fully assessed the remaining financial impact for all future years
related to full compliance with the Health Insurance Portability and
Accountability Act of 1996 and its regulations; however, RightCHOICE
believes such financial impact could be material.
Other proposed health care reform legislation
The United States House of Representatives has passed the
"Bipartisan Consensus Managed Care Improvement Act," also known as
the Norwood-Dingell bill, which would, if it became law, among other
things, impose limits on the methods of operation for group health
plans and health insurance issuers, limit the ability of group
health plans and health insurance issuers to define medical
necessity for purposes of coverage, and permit group health plans
and health insurance issuers to be sued in state courts for coverage
determinations. In addition, the United States Senate recently
passed the "Patients' Bill of Rights Plus Act," which would, if it
became law, among other things, require access to emergency medical
care for certain group plans, require direct access by female
participants to obstetrical or gynecological care for certain group
plans, require timely access to specialty care when specialty care
is a benefit for certain group plans, and require continuity of care
for certain group plans. These proposals and other proposals,
including those referred to generally as the "Patients' Bill of
Rights," could impose additional restrictions or obligations on the
operations of RightCHOICE.
It is uncertain whether RightCHOICE can recoup, through higher
premiums or other measures, the increased costs caused by any new
legislation or regulation, or any court or regulatory decision that
expands or reduces the interpretation or application of existing
statutes and regulations. While certain of these measures would
adversely affect RightCHOICE and its subsidiaries, at this time
RightCHOICE cannot predict the extent of this impact or which of (or
in what form) the pending laws or rules will be enacted or adopted.
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 is incorporated
herein by reference.
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 Our Future Results of Operations, Financial
Condition or Business
If we do not complete the reorganization, the State of Missouri
could enforce judgments previously entered against Blue Cross
and Blue Shield of Missouri which could lead to the dissolution
of Blue Cross and Blue Shield of Missouri and materially
adversely affect our company.
On December 30, 1996, the Circuit Court of Cole County,
Missouri entered judgments in favor of the Missouri Department of
Insurance and the Missouri Attorney General. These judgments
declared that Blue Cross and Blue Shield of Missouri, a non-profit
corporation, violated the Missouri Health Services Corporation Law
and the Missouri Non-Profit Corporation Law by operating our company
as a for-profit subsidiary. These judgments are now final, without
right of further appeal.
The Missouri Attorney General and the Missouri Department of
Insurance may enforce these judgments in the following manner if we
do not complete the reorganization by December 31, 2000 or the
parties do not extend the deadline or otherwise settle the
litigation:
* the Missouri Attorney General and the Missouri Department of
Insurance could seek further judicial relief, including
the possible dissolution of Blue Cross and Blue Shield of
Missouri and the possible termination of Blue Cross and
Blue Shield of Missouri's certificate of authority to
engage in the health insurance business, and
* the Missouri Attorney General and the Missouri Department of
Insurance could also seek monetary relief arising from the
1994 reorganization of Blue Cross and Blue Shield of
Missouri and the subsequent operations of Blue Cross and
Blue Shield of Missouri and our company.
Any one or more of these actions could have a material adverse
effect on us because:
* the Missouri Attorney General and the Missouri Department of
Insurance would be free to assert claims directly against
us arising from the 1994 reorganization of Blue Cross and
Blue Shield of Missouri and the subsequent operation of
our Company, and
* the Blue Cross and Blue Shield Association might take the
position that the assertion of these claims automatically
terminates our licenses and the respective licenses of
Blue Cross and Blue Shield of Missouri and our
subsidiaries to use the Blue Cross and Blue Shield names
and service marks.
If an appellate court finds that Blue Cross and Blue Shield of
Missouri is a mutual benefit corporation, the effect of its
ruling could be to cancel the reorganization or, if the
reorganization is already completed, a court could undo the
reorganization or New RightCHOICE could have to pay substantial
damages.
On November 3, 2000, a final judgment was entered in a
certified subscriber class action in the Circuit Court of Cole
County, Missouri. That judgment remains subject to appeal and could
be reversed. In that action the subscriber class sought a
declaratory judgment that:
* Blue Cross and Blue Shield of Missouri is a mutual benefit non-
profit corporation -- meaning that Blue Cross and Blue
Shield of Missouri holds its assets for the benefit of a
limited class of persons who are subscribers of Blue Cross
and Blue Shield of Missouri and RightCHOICE rather than
for the benefit of the public as a whole, and
* It is unlawful for Blue Cross and Blue Shield of Missouri to
transfer its assets to a "charitable trust."
Blue Cross and Blue Shield of Missouri, the Attorney General
and the Missouri Department of Insurance contested these claims.
They were successful in the Circuit Court, which has entered a
judgment finding that Blue Cross and Blue Shield of Missouri is a
public benefit corporation. The judgment of the Circuit Court of
Cole County is subject to appeal, and an appellate court could award
the subscriber class the relief they seek. A judgment in favor of
the subscriber class could have several adverse effects:
* It could prohibit the reorganization, if the appellate court
enters the judgment before completion of the
reorganization.
* It could cause the Blue Cross and Blue Shield Association to
terminate our licenses for use of the Blue Cross and Blue
Shield names and service marks.
* It could require New RightCHOICE to pay substantial money
damages, if the court enters the judgment after we
complete the reorganization. It is also possible,
although we believe unlikely, that a court could order
that the reorganization be undone.
* It could cause the charter conversion transaction to be a
taxable transaction to New RightCHOICE.
Although The Missouri Foundation For Health will indemnify New
RightCHOICE against claims asserted in this litigation that arise
out of the reorganization and relate to the corporate status of Blue
Cross and Blue Shield of Missouri, this indemnification may not be
sufficient to reimburse New RightCHOICE for all of the damages it
could suffer.
Someone might bring an action seeking an injunction against
completion of the reorganization.
We are not required to complete the reorganization if a court
has issued a temporary restraining order or injunction against
completing the reorganization or if someone files an action seeking
a restraining order or injunction and that action has not been
dismissed. If someone brings an action, or a court enters a
restraining order or injunction, in connection with any of the
litigation or potential litigation described above or in any other
litigation, any party may choose not to complete the reorganization.
If this occurs, we will be subject to the risks described in the
risk factor "If we do not complete the reorganization, the State of
Missouri could enforce judgments previously entered against Blue
Cross and Blue Shield of Missouri which could lead to the
dissolution of Blue Cross and Blue Shield of Missouri and materially
adversely affect our company."
Our Blue Cross and Blue Shield license agreements could
terminate upon the occurrence of events specified in the
license agreements and termination would have a material
adverse effect on our business.
Under controlled affiliate license agreements with the Blue
Cross and Blue Shield Association, we have the right to use the Blue
Cross and Blue Shield names and service marks in the managed health
care business in the 85 Missouri counties that comprise our service
area. Termination of our licenses would have a material adverse
effect on our business.
We believe that the exclusive right to use the Blue Cross and
Blue Shield names and service marks provides us with a marketing
advantage in our licensed operating area. Loss of the licenses
would adversely affect our ability to compete in our markets. If we
lose the licenses, we would be subject to a significant monetary
penalty to the Blue Cross and Blue Shield Association and be in
default under our major credit agreement.
The Blue Cross and Blue Shield Association could terminate our
license agreements if we do not satisfy its financial and service
performance requirements or if other events described in the license
agreements occur.
Our profitability may be adversely affected by rising health
care costs and changes in the delivery of health care services.
Our future results largely depend on our ability and the
ability of our subsidiaries to accurately predict and manage future
health care costs. Much of the premium revenue our subsidiaries
receive is based upon rates set before they deliver services, and
they usually incur the related costs on a prospective annual basis.
Although our subsidiaries attempt to base the premiums charged on an
estimate of future health care costs over the fixed premium period,
competition, regulations and other circumstances may limit their
ability to fully base premiums on these estimated costs.
Our subsidiaries use a large portion of their revenue to pay
the costs of health care services and supplies that their members
receive. As a result, our financial condition or results of
operations could be adversely affected because of rising costs and
other changes in the delivery of health care services. These
changes could include:
* higher-than-expected utilization of services,
* an increase in the number of high-cost cases,
* changes in the population or demographic characteristics of members
served,
* inflation,
* periodic renegotiation of hospital, physician and other provider
contracts,
* continued consolidation of physician, hospital and other provider
groups,
* the aging of the population,
* advances in medical technology and pharmaceuticals,
* government-imposed limitations on Medicare reimbursement, and
* other regulatory changes.
Competition in the industry may limit our ability to increase
or maintain our premium rates, which would adversely affect our
profitability.
We operate in a highly competitive environment which may affect
the ability of our subsidiaries to increase premium rates. We face
competition from other managed care companies, hospitals, health
care facilities and other health care providers that have
substantially greater financial and other resources than we do.
We compete with a number of established companies that offer a
variety of benefit plans. Because we conduct business primarily in
markets within or contiguous to the State of Missouri, except for
our HealthLink and HealthLink HMO subsidiaries, we are unable to
subsidize losses in these markets with profits from other markets.
We believe that larger, national competitors can subsidize losses in
the Missouri market with profits from other markets in which they
operate and may pursue that strategy in our markets in an effort to
increase their market share.
We believe there are no significant impediments facing
potential competitors who wish to enter the markets we serve. As a
result, the addition of new competitors can occur relatively easily
which affords consumers significant flexibility in moving to new
managed care providers. Our managed care operations may encounter
competition from companies with broader geographical markets or
narrower geographical markets which allows for greater cost control
and lower prices or greater market share. Our financial condition
or results of operations may be adversely affected by significant
premium decreases by any major competitor or by any other limitation
on the ability of our subsidiaries to increase or maintain premium
levels.
We conduct business in a heavily regulated industry and changes
in regulations or violations of regulations could materially
adversely affect us.
Our business is heavily regulated on federal, state and local
levels. Legislation or other regulatory reform that increases the
regulatory requirements imposed on us and our subsidiaries may have
a material adverse effect on our business or results of operations
in the future. Legislative or regulatory changes that could
materially affect us and our subsidiaries include:
* adoption of federal or state legislation that holds insurance
companies, health maintenance organizations or managed care
companies liable for medical decisions,
* limitations on premium levels,
* increases in minimum capital, reserves, and other financial
viability requirements,
* prohibition or limitation of provider financial incentives and
provider risk-sharing arrangements,
* new benefit mandates, and
* limitations on the ability to manage care and utilization due to
"any willing provider" and direct access laws that limit or
eliminate product features that encourage members to seek services
from contracted providers or through referral by a primary care
provider.
Our subsidiaries need to obtain and maintain regulatory
approvals to market many of their products. Delays in obtaining or
failure to obtain or maintain these approvals could adversely affect
us.
A portion of our revenues relate to Medicare Supplement
programs. Changes in these programs, particularly changes affecting
enrollment or changes in premium payment or reimbursement levels,
could materially affect our business and profitability.
We and our subsidiaries are also subject to various
governmental reviews, audits and investigations. Any adverse
investigation, audit results or sanctions could result in:
* damage to our reputation and the reputation of our subsidiaries in
various markets,
* increased difficulty in selling our subsidiaries' products and
services,
* loss of a subsidiary's license to act as an insurer or health
maintenance organization or to otherwise provide a service,
* loss of the right to participate in various federal programs,
including the Medicare Supplement programs, or
* the imposition of fines, penalties and other sanctions.
Our profitability will be adversely affected if we are unable
to enter into provider agreements or other appropriate
agreements.
Our profitability depends upon our ability and the ability of
our subsidiaries to contract on favorable terms with hospitals,
physicians and other health care providers. If we fail to obtain
cost-effective health care provider contracts, we may lose some of
our members or incur higher medical costs. In addition, our
inability or the inability of our subsidiaries to contract with
providers, or the inability of providers to provide adequate care,
could materially affect us.
A reduction in the number of subscribers to our health care
programs could have an adverse effect on our business and
profitability.
A reduction in the number of subscribers to our health care
programs could adversely affect our financial position, results of
operations and cash flows. Factors that could contribute to the
loss of membership include:
* failure to obtain new customers or retain existing customers,
* premium increases and benefit changes,
* our exit from markets,
* reductions in work force by existing customers, or
* negative publicity and news coverage.
Loss of key members of our management could adversely affect us.
Our success depends, to a significant extent, on key management
members. The competition for highly skilled people with extensive
experience in the health care industry is intense. We believe that
our key management members have significant experience and
competence in the managed care industry that would be difficult to
replace. All of our key management members are able to voluntarily
terminate their employment with us at any time. The loss of current
key management members may result in a material adverse effect on
our results of operations, financial condition or business.
Competition among potential employers may result in increased
salaries or an inability to retain existing employees or
attract additional employees, which could adversely affect our
profitability.
We need to retain our qualified employees to meet our future
needs. In addition, we face intense competition for qualified
employees, particularly during the present economic environment of
low unemployment. The unemployment rate in Missouri is among the
lowest in the nation. We may not be able to attract and retain
employees. Competition among potential employees may result in
increased salaries or an inability to retain existing employees or
attract additional employees. While we believe that our current
employee relations are good, competitive factors still could cause
us to lose employees or to have to pay more to retain them.
Negative publicity regarding the health care industry could
adversely affect our profitability.
The health care industry is subject to negative publicity.
Negative publicity may result in increased regulation and
legislative review of industry practices which may further increase
our costs of doing business and adversely affect our profitability
by:
* adversely affecting our ability to market our products or services,
* requiring us to change our products and services, or
* increasing the regulatory burdens under which we operate.
In addition, as long as we use the Blue Cross and Blue Shield names
and service marks in marketing our managed care products, any
negative publicity concerning the Blue Cross and Blue Shield
Association or other Blue Cross and Blue Shield Association
licensees may adversely affect our business and the sales of our
managed care products.
Our stock and the stocks of companies in the health care
industry are subject to stock price and trading volume
volatility.
From time to time, the stock price and the number of shares
traded of companies in the health care industry experience periods
of significant volatility. Both company specific issues and
development generally in the health care industry may cause this
volatility. Our stock price may experience significant price and
volume fluctuations in response to these and other factors.
The trading volume for our stock has historically been low.
Significant changes in volume could result in significant price
fluctuations. For the one year period ended December 31, 1999, the
trading price of our class A common stock ranged from a low $9.50
per share to a high of $13.00 per share, and the average daily
trading volume was 7,356 shares per day. For the ten months ended
October 31, 2000, the trading price of our class A common stock
ranged from a low of $11.50 per share to a high of $28.00 per share,
and the average daily trading volume was 12,970 shares per day.
Our business and operations may be adversely affected if we do
not maintain our information systems and the integrity of our
proprietary information.
Our business depends on our ability to maintain our information
systems and to ensure the continued integrity of our proprietary
information. Failure to maintain effective and efficient
information systems could cause the loss of existing customers,
difficulty in attracting new customers, customer and provider
disputes, regulatory problems, increases in administrative expenses
or other adverse consequences.
If the market found or perceived the information we maintain to
be inaccurate, or if the market perceived the information to be
unreliable, commercial acceptance of our products would be adversely
and materially affected. Furthermore, the use of patient data by
all of our businesses is regulated at federal, state, and local
levels. These laws and rules change frequently. These changes
could adversely affect our business, financial condition and results
of operations.
We are subject to litigation in the ordinary course of our
business, including litigation based on new or evolving legal
theories, which could adversely affect our profitability.
Due to the nature of our business, we and our subsidiaries are
subject to a variety of legal actions relating to our business
operations including claims relating to:
* denial of health care benefits,
* claims of vicarious liability for providers' actions or medical
malpractice claims,
* provider disputes over compensation and termination of provider
contracts,
* disputes related to self-funded business, including actions
alleging breach of fiduciary duties, claim administration errors and
the failure to disclose network rate discounts and other fee and
rebate arrangements,
* disputes over copayment calculations, and
* claims relating to customer audits and contract performance.
In addition, plaintiffs continue to bring new types of
purported legal claims against managed care companies. We cannot
determine with any certainty the impact that these evolving theories
of recovery may have on the managed care industry in general or on
our subsidiaries or us in particular.
Recent court decisions and legislative activity increase our
exposure and the exposure of our subsidiaries to these types of
claims. In some cases, plaintiffs may seek substantial non-economic
or punitive damages. The loss of even one of these claims, if it
resulted in a significant punitive damage award, could adversely
affect our financial condition or results of operations. This risk
of potential liability may make reasonable settlements of claims
more difficult to obtain.
We and our subsidiaries currently have, and anticipate that in
the future we and our subsidiaries will have, insurance coverage for
some of these potential liabilities. Other potential liabilities
may not be covered by insurance, insurers may dispute coverage, or
the amount of insurance may not be enough to cover the damages
awarded. In addition, we may not be able to obtain insurance
coverage for all or some forms of liability on a cost-effective
basis, if at all, in the future.
Our failure to comply with limitations in our credit agreement
could adversely impact us.
Our credit agreement contains limitations on us and on our
subsidiaries. We may not be able to achieve and maintain compliance
with the requirements of our credit agreement. If that occurs, our
operations, financial condition or business may be adversely
impacted. The limitations in the credit agreement include:
* limitations on additional indebtedness and liens,
* limitations on payment of cash dividends or purchases of stock,
* limitations on acquisitions, dispositions and mergers,
* limitations on indebtedness of our subsidiaries,
* maintaining net worth and financial ratios, and
* maintaining the licenses to use the Blue Cross and Blue Shield of
Missouri names and service marks.
Future losses related to the Missouri Consolidated Health Care
Plan could adversely affect New RightCHOICE.
In 1997, BlueCHOICE, one of our subsidiaries, recorded a
$29.5 million pre-tax charge related to a health maintenance
organization contract with the Missouri Consolidated Health Care
Plan. The Missouri Consolidated Health Care Plan is a Missouri
public agency that purchases health care coverage for employees of
the State of Missouri and selected public entities. It is currently
the largest customer group served by BlueCHOICE. Continued losses
related to the Missouri Consolidated Health Care Plan could
adversely affect us. BlueCHOICE is contractually bound to serve the
Missouri Consolidated Health Care Plan members through the year 2000
at rates originally contracted for in 1995. RightCHOICE's 1999 year-
end financial report noted that a rate increase of 21% would be
effective for the contract year beginning January 1, 2000. In March
2000, the Missouri Consolidated Health Care Plan notified us that a
risk adjustment factor applied to the premiums the Missouri
Consolidated Health Care Plan pays insurance carriers will result in
a reduction of that increase to approximately 12%. Although we
contested this action, we increased our loss reserve at March 31,
2000 by $1.5 million.
We calculated the pre-tax charge and additional reserve based
upon actuarial estimates, including projected limited rate increases
and projected enrollment and medical cost trends accounted for
through the year 2000. Our management reviews the adequacy of this
reserve on an ongoing basis. If the actual number of BlueCHOICE's
members participating through the Missouri Consolidated Health Care
Plan or medical cost trends differ materially from those assumed in
our actuarial estimates, the amount of the reserve recorded to date
could be insufficient to cover all future losses that may be
associated with the Missouri Consolidated Health Care Plan contract.
As a result, these losses could have an adverse effect on us and the
market for our stock.
Blue Cross and Blue Shield of Missouri has voting control on
all stockholder actions.
Blue Cross and Blue Shield of Missouri has voting control over
all of our stockholder actions, including the sale or merger of our
company, a sale of substantially all of our assets and the election
of all of our directors. Blue Cross and Blue Shield of Missouri may
have interests with respect to its ownership of our company that
diverge from those of our public shareholders. We cannot provide
any assurance that we will not be adversely impacted by the control
that Blue Cross and Blue Shield of Missouri has with respect to
matters affecting our company.
There are other risks and uncertainties which may have an
adverse effect on our business and profitability.
Additional risks and uncertainties that may affect our future
results of operations, financial condition or business include, but
are not limited to:
* the demand for, and market acceptance of, our products and
services,
* the effect of economic and industry conditions on prices for our
subsidiaries' products and services and their cost structure,
* our ability to develop and deliver new products and services and
adapt existing products and services to meet customer needs and
expectations,
* our ability to keep pace with technological change in order to
provide better service and remain competitive,
* our ability to attract and retain capital for growth and operations
on competitive terms, and
* changes in accounting policies and practices.
Forward-looking statements may prove inaccurate.
The statements included in this Quarterly Report regarding
future financial performance and results and the other statements
herein that are not historical facts are "forward-looking
statements" within the meaning of Section 27A and of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended. These statements include those preceded
by, followed by or that include the words "believes," "expects,"
"anticipates," "could," "plans," "projects," "may," "should" or
similar expressions. These forward-looking statements involve risks
and uncertainties. Factors that may cause actual results to differ
materially from those contemplated by these forward-looking
statements include, among others, those risks discussed above.
These forward-looking statements may prove inaccurate and investors
should not view them as guarantees of future performance.
ITEM 3. Quantitative and Qualitative Disclosures About Market Risks
There have been no material changes in market risk exposures that
affect the quantitative and qualitative disclosures presented in the
company's annual report on Form 10-K for the year ended December 31,
1999.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
Note 2, "Contingencies" of Part I, Item 1, contains a description of
various pending and threatened claims involving the company and its
affiliates, including a description of the litigation with the
Missouri Department of Insurance (DOI) and the Missouri Attorney
General, and other legal proceedings, which descriptions are
incorporated by reference herein. Also, see "Management's
Discussion and Analysis of Financial Condition and Results of
Operations - Factors that May Affect Our Future Results of
Operations, Financial Condition or Business."
ITEM 2. Changes in Securities and Use of Proceeds
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 July 11, 2000.
b) Two Class III directors of the company were elected for three
year terms by the shareholders at the annual
meeting. The two newly elected directors are:
Nominee Number of Votes
William H.T. Bush 152,830,252
William J. Schicker 152,827,927
The following directors' terms continued in effect
after the meeting:
John A. O'Rourke Earle H. Harbison, Jr.
Roger B. Porter, Ph.D. Gloria W. White
ITEM 5. Other Information
None.
ITEM 6. Exhibits and Reports on Form 8-K
a) Exhibits
Exhibit
Number Exhibit
The following exhibits are submitted herewith:
27 Financial Data Schedule (Electronic Filing Only).
b) Reports on Form 8-K:
None.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
RIGHTCHOICE MANAGED CARE, INC.
Registrant
Date: November 13, 2000 By: /s/ Sandra Van Trease
Sandra Van Trease
Chief Financial Officer,
Senior Executive Vice President and
Chief Operating Officer
Date: November 13, 2000 By: /s/ Angela F. Braly
Angela F. Braly
Executive Vice President,
General Counsel and
Corporate Secretary
