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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended Commission File Number: 33-99624
December 31, 1996
CHOICECARE CORPORATION
Ohio 31-1446609
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
655 Eden Park Drive, Suite 400 45202
Cincinnati, Ohio (Zip Code)
(Address of Principal Executive Offices)
(513) 784-5200
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Shares,
without Par Value
(pursuant to
filing Form 8-A)
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 by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
Aggregate market value of the registrant's common shares held by nonaffiliates
of the registrant as of March 10, 1997: $13,362,440 (1,336,244 shares at $10.00
per share; see Item 5
included herein)
Number of shares outstanding of the registrant's common shares as of March 10,
1997: 14,852,844
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the ChoiceCare Corporation Definitive Proxy Statement for the 1997
Annual Meeting of Shareholders are incorporated by reference in Part III.
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CHOICECARE CORPORATION
INDEX
PAGE
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PART I
Item 1. Business ....................................................... 3
Item 2. Properties ..................................................... 17
Item 3. Legal Proceedings .............................................. 18
Item 4. Submission of Matters to a Vote of Security Holders ............ 18
-- Executive Officers of the Registrant ........................... 18
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters ........................................... 19
Item 6. Selected Financial Data ........................................ 20
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations ........................... 21
Item 8. Financial Statements and Supplementary Data .................... 28
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure ........................... 28
PART III
Item 10. Directors and Executive Officers of the Registrant ............. 28
Item 11. Executive Compensation ......................................... 28
Item 12. Security Ownership of Certain Beneficial Owners
and Management ................................................ 28
Item 13. Certain Relationships and Related Transactions ................. 28
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K ................................................... 29
SIGNATURES .................................................................. 30
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PART I
ITEM 1. BUSINESS
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GENERAL
ChoiceCare Corporation (the "Company") is an Ohio for-profit corporation,
which is a majority-owned subsidiary of ChoiceCare Foundation (the
"Foundation"), an Ohio not-for-profit corporation (formerly named Tristate
Foundation for Health and Midwest Foundation Independent Physicians
Association). The Foundation was organized in 1978 as a not-for-profit health
maintenance organization ("HMO"). The Company was formed in 1995 to serve as a
for-profit holding company for the assets and liabilities relating to the
Foundation's managed health care operations. Prior to the Restructuring
described below, the Company had no assets or operations.
Pursuant to a Plan of Restructuring (the "Restructuring") adopted by the
Board of Trustees of the Foundation on March 10, 1995 and approved by the
Foundation's member physicians on May 3, 1995, substantially all of the
operating assets and liabilities relating to the Foundation's managed health
care operations were transferred to the Company on October 1, 1995 in exchange
for all of the issued and outstanding common shares of the Company. The
Foundation retained $25 million of cash and marketable securities to pursue its
community benefit objectives. Contemporaneously, the Company transferred the
assets and liabilities of the managed health care operations to its wholly-owned
subsidiary, ChoiceCare Health Plans, Inc. ("Health Plans;" formerly named Choice
Benefits Administrators, Inc.), in exchange for all of its issued and
outstanding common shares. As a result, since October 1, 1995, the managed
health care operations formerly conducted by the Foundation have been conducted
by Health Plans.
The Company, through Health Plans, is licensed by the States of Ohio and
Indiana and the Commonwealth of Kentucky to provide and administer managed
health care products and services to employer groups, individuals and
government-sponsored beneficiaries primarily in Southwestern Ohio, Southeastern
Indiana and Northern Kentucky (the "Cincinnati Service Area") and the Dayton,
Ohio/Greater Miami Valley area (the "Dayton Service Area"). The Cincinnati and
Dayton Services Areas are collectively referred to as the Service Area. In
addition, the Company provides claims administrative services and medical
management services for self-funded employers.
Health Plans has one of the largest enrollments of any HMO in its
Cincinnati Service Area, serving more than 272,000 members as of January 1997,
including commercial members and individuals.
PRODUCTS
The Company provides and administers managed health care products and
services with an emphasis on continually improving health care quality and cost
effectiveness. The Company's range of managed health care products and services
is provided through its prepaid plans, both HMO and point-of-service ("POS"),
and a managed care third-party administrative services program for employers'
self-funded medical plans. In addition, the Company has been approved to provide
a Medicare risk product and certified as a managed care organization by the Ohio
Bureau of Workers' Compensation under the Health Partnership Program. Prior to
assigning its Medicaid provider agreement with the Ohio Department of Human
Services to another Ohio-based HMO on June 30, 1996, the Company also offered an
ADC/Medicaid plan. Under self-funded plans, employer groups pay the Company a
monthly management services fee, but medical
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expenses incurred are funded by the employer groups, whereas prepaid plans are
structured to provide health care to employer groups in exchange for monthly
premium payments to the Company. The Company's prepaid plans are differentiated
primarily by network size and pricing. The pricing policy of each product is
driven by historical and projected medical costs, with consideration also being
given to market positioning and target customer segments. In general, the more
tightly managed limited network products have lower medical costs and,
therefore, lower premiums.
Health Plans offered the following products as of December 31, 1996:
PRIMARY ACCESS(TM). This HMO product is the Company's largest health care
product. With this product, a member chooses a primary care physician ("PCP")
who practices family medicine, internal medicine, general medicine or
pediatrics. The PCP is responsible for providing routine medical care and for
authorizing and coordinating the care received from specialty care physicians,
hospitals and other health care providers. Members are referred to certain
specialty care providers for a course of treatment for a specific timeframe. If
a member fails to obtain a referral authorization prior to consulting certain
specialty care providers, he or she may ultimately be financially responsible
for the service. This product offers the largest panel of providers to members
and, accordingly, charges the highest monthly premium in comparison to the
Company's other HMO products. This product is offered to members in prepaid and
self-funded employer plans and to individuals.
SELECT BY CHOICECARE(R). This HMO product is similar to the Company's
Primary Access product, but members are offered a smaller panel of participating
physicians who are selected based on performance criteria and provide more
closely-managed patient care. Accordingly, the monthly premiums are lower than
monthly premiums charged to members in the Company's Primary Access plan. This
product is offered to members in prepaid and self-funded employer plans.
CO-CHOICE(R) BY CHOICECARE. Members in this POS product choose between the
Company's Primary Access product ("network benefits") or indemnity-type
insurance benefits. Network benefits are available when a member follows the
requirements of the Primary Access product. If a member chooses a
non-participating provider (a provider outside of the network) or does not
follow the requirements of the Primary Access product, the member will receive
indemnity-type insurance benefits and will pay co-insurance and deductibles and
will be required to file claim forms. The Company has contracted with Allianz
Life Insurance Company to provide the indemnity insurance coverage to the
employers participating in this plan on an insured basis. This product is
offered to members in prepaid and self-funded employer plans.
NEWHEALTH(R). This HMO product is similar to the Company's Primary Access
plan and Select by ChoiceCare but the panel of providers is smaller than either
of the other HMO plans, practices at a limited panel of hospitals, commits to
group-practice development and global incentive/pre-payment, and provides more
closely-managed patient care. Monthly premiums charged to members in this plan
are the lowest monthly premiums of the three HMO plans. This product is offered
as the result of an alliance of Bethesda Hospital, Inc., Good Samaritan Hospital
and the Company, and is the first integrated managed health system to be offered
in the Company's Cincinnati Service Area. In this system, the three alliance
members share in the financial risk of the product. This product is offered to
members in prepaid and self-funded employer plans.
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The Company provides managed care administrative services for self-funded
employers, including claims processing, medical resource management and
enrollment services. Depending upon the employer's contract with the Company,
employees in these self-funded plans choose from among the Company's HMO plans
or POS plan and receive the same managed care services as members in prepaid
plans.
As previously noted, in addition to the aforementioned products offered as
of December 31, 1996, the Company began offering, or anticipates beginning to
offer, the following products during 1997. The success of these product
offerings is largely dependent upon the Company's ability to successfully market
the products and limit the effect, if any, of the risk factors set forth in the
Company's CAUTIONARY STATEMENT filed by the Company on November 12, 1996 as part
of its Form 10-Q for the period ended September 30, 1996 and incorporated herein
by reference (see "Management's Discussion and Analysis of Financial Condition
and Results of Operations"). As such, there can be no assurance of these
products' success, financial or otherwise.
SENIOR HEALTH BY CHOICECARE. This HMO Medicare risk product is provided
to Medicare-eligible individuals through a risk contract with the Health Care
Financing Administration ("HCFA"). With this product, a member chooses a PCP
group which practices family medicine, internal medicine, general medicine or
pediatrics. The PCP group is responsible for providing routine medical care and
for authorizing and coordinating the care a member receives from specialty care
physicians, hospitals and other health care providers. The PCP group designates
a primary hospital to deliver all inpatient services for the PCP's members. In
addition, the PCP will align with a specialty group of physicians for each of 12
key specialties. If a member fails to obtain referral authorization prior to
receiving services from specialty physicians or hospitals, he or she may
ultimately be financially responsible for the service. The Company is paid a
monthly per-member amount from HCFA in return for arranging for the provision of
the services offered under the Medicare product. In February 1997, the Company
began enrolling members for a March 1, 1997 effective date.
WORKERS' COMPENSATION. This product is offered through a contract
between the Company and the Ohio Bureau of Workers' Compensation (the "BWC"),
under which the Company administers health care services allowed under the
state workers' compensation program for those employees whose employers have
selected the Company as their managed care organization ("MCO"). Under the
contract with the BWC, the Company also offers a provider network and furnishes
provider management, but the Company does not insure and is not financially
liable for the payment of provider bills. Such payment continues to be the
responsibility of the BWC. However, the Company, as the MCO, is expected to act
as a pass-through for provider bill submission and reimbursement. An employee
may receive health care services from any BWC-certified health care provider,
but the Company will encourage the employee to seek care from providers with
whom the Company has contracted for workers' compensation services. The Company
pays providers for services after the Company receives compensation from the
BWC. The Company receives an administrative fee for its management of workers'
compensation services and may be eligible to receive bonuses for
BWC-established performance targets. The Company is dependent upon a
subcontracting arrangement with an independent party for access to a workers'
compensation information system, a bill payment system, an electronic interface
with the BWC and a 24-hour intake line. During the last quarter of 1996, the
Company began marketing this product to employer groups for a March 1, 1997
effective date and has currently enrolled employer groups comprised of
approximately 38,000 covered lives.
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DAYTON/GREATER MIAMI VALLEY SERVICE AREA EXPANSION. The Company has
received regulatory permission to expand into six additional counties in the
Dayton, Ohio area, including the counties of Champaign, Clark, Greene, Miami,
Montgomery and Preble. While the Company anticipates offering products similar
to its Primary Access and Co-Choice products offered in the Cincinnati Service
Area, through a network of approximately 15 hospitals and 1,200 physicians and
other health care professionals, contract negotiations continue with certain key
providers. The Company anticipates to begin sales to employer groups during the
second quarter of 1997.
PROVIDER ARRANGEMENTS
The Company's business is dependent, in part, upon its contracts with
participating providers and hospitals. The Company's participating providers
are physicians and other health care professionals who are reimbursed for
health care services provided to members at negotiated rates through
contractual arrangements with the Company. As of December 31, 1996, these
providers include approximately 3,400 participating physicians and other
credentialed health care professionals in the Cincinnati Service Area, the only
area in which the Company offered products as of December 31, 1996 -- see
"Dayton/Greater Miami Valley Service Area Expansion" above. Generally,
contracts with participating providers are renewable annually, and may be
terminated on 90 days' prior written notice by either party. Certain provider
contracts contain risk-sharing provisions which may, in certain situations,
cause providers to be at risk for additional health care expenditures. The
Company also has contracts with 22 hospitals in its Cincinnati Service Area.
Certain of these contracts are with risk/reward sharing hospitals and certain
are with other non-risk/reward sharing hospitals. These contracts are for
varying terms ranging from one to five years. Contracts with risk/reward
sharing hospitals generally utilize a methodology that incorporates a
combination of case rate and per diem methods of reimbursement. Contracts with
non-risk/reward sharing hospitals generally utilize discounted fee-for-service
reimbursement methods. For those providers who have agreed to participate in
the Medicare and/or managed Workers' Compensation products, their contracts
have been amended to reflect the requirements of those products. In addition,
certain providers have entered contracts to provide services only under the
Workers' Compensation program.
PHYSICIANS AND OTHER HEALTH CARE PROFESSIONALS.
Under the Company's current HMO plans and POS plan, members select a PCP
who provides or arranges for non-emergency medical care given to that member. As
of December 1996, ChoiceCare had contracted with approximately 1,000 PCPs in its
Cincinnati Service Area. The Company's PCPs include internists, family
practitioners, pediatricians and general practitioners. Health care services
provided directly by PCPs include periodic physical examinations, routine
immunizations, well-child care, and other preventive health care services.
Health care services provided by obstetrician/gynecologists, that do not require
PCP referrals, include well-woman care and maternity care. The Company believes
that the successful operation of its HMO and POS plans is dependent, in a large
part, upon the ability of PCPs, who coordinate the delivery of care for its
members, to accurately determine, with specialists and other health care
professionals when applicable, the nature and extent of services to be provided
to any given member. The Company believes that physicians and other health care
professionals are a critical factor in
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managing health care costs because they coordinate the overall health care of
members and assure the appropriate utilization of hospitals, specialists and
other health care professionals.
The Company has a system of incentive arrangements and medical resource
management programs with respect to PCPs and specialty care physicians. The
majority of PCPs are compensated pursuant to discounted fee-for-service
arrangements with certain portions of these fees held back by the Company and
placed in a risk reserve. A small portion of specialty care physicians and other
health care professionals are compensated on a capitated basis. In addition, the
Company has incentive arrangements which pay additional monies and a percentage
of the risk reserve to the physicians and other health care professionals based
on measurements of quality, efficiency and patient satisfaction. Risk reserve
funds remaining at year-end, if any, are available for payment to the physicians
and other health care professionals if the total medical expenditures are within
pre-determined ranges. The Company believes that this method of incentive
payment is advantageous to the physician, the Company and the members because
all share in the benefits of managing health care quality and costs.
The Company's ability to expand is dependent, in part, on its ability to
secure cost-effective contracts with additional physicians and health care
professionals or to ensure that existing providers expand capacity to
accommodate new members. Generally, all participating provider contracts have
one-year terms, are renewable annually and may be terminated upon 90 days'
written notice.
HOSPITALS.
The Company has negotiated contracts with 22 hospitals in its Cincinnati
Service Area to provide inpatient and outpatient hospital care, including
inpatient acute care services, ambulatory surgery services, emergency room
services, diagnostic radiology services, radiation oncology services, nuclear
medicine services, outpatient cardiac rehabilitation services and certain other
services. Certain of these contracts are with "core" hospitals, referred to as
risk/reward sharing hospitals, and certain of these contracts are with other
hospitals. All participating hospitals agree to provide services to members in
at least the same time availability as offered to other patients. Hospitals
agree to participate in, and comply with, the utilization review, quality
improvement and risk management programs as designated from time to time by the
Company. The Company completed renegotiation of its hospital contracts for the
risk/reward sharing hospitals effective January 1, 1996. The terms of these
contracts range from two and one-half years to five years.
In addition, these contracts contain risk/reward sharing and incentive
programs. These programs are based on the year-end surplus or deficit in the
Hospital Reimbursement Fund (the "Hospital Fund"). The Company funds the
Hospital Fund monthly from member premiums and draws from the fund, as
necessary, to pay claims for covered inpatient and outpatient hospital services.
If, at year-end, there is a surplus in the Hospital Fund, the Company pays 50%
of the surplus to the risk/reward sharing hospitals. If, however, at year-end,
there is a deficit in the Hospital Fund, the risk/reward sharing hospitals are
responsible for 50% of the deficit. To cover the hospitals' share of potential
deficits in the Hospital Fund, the Company currently withholds five percent of
inpatient claims during the year (as a "risk reserve"). The Company, however, is
able to adjust, on a quarterly basis with 30 days' written notice, the amount of
risk reserves withheld under certain circumstances.
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To provide an additional impetus for improvements to each hospital's
quality and efficiency, up to 50% of the remaining balance in each hospital's
risk reserve is used (together with a matching amount paid by the Company and
participating self-funded plans) to fund an incentive program. Although the
total incentive payment available to each hospital is based on year-end results,
the hospital incentive program provides for semi-annual incentive payments (as
long as the Hospital Fund is not operating at a deficit). Incentive payments are
based on certain criteria developed by the Company. In 1996, the Hospital Fund
operated at a deficit, and the hospital risk reserves were used to cover
such deficit. Consequently, no hospital incentive payments were paid or accrued
to be paid for 1996 as a result of prepaid membership.
The hospital risk/reward sharing and incentive programs generally apply
only to services rendered to members in HMO plans. If, however, the Company and
the plan sponsor of a self-funded plan mutually agree, the risk/reward sharing
and incentive programs are extended to services rendered to members of the
self-funded plan. In that case, the plan sponsor contributes, with respect to
the services rendered to the members of the self-funded plan, the amounts which
the Company would have been required to contribute if those services had been
provided to members covered under an HMO plan.
The Company has renegotiated its hospital contracts with the
non-risk/reward sharing hospitals in its Cincinnati Service Area to obtain lower
discount rates. These hospitals are generally reimbursed on a discounted
fee-for-service basis.
MEDICARE RISK PRODUCT.
In connection with the Medicare risk product, the Company has contracted
with physicians and other health care professionals, hospitals and ancillary
service providers to provide services to Medicare beneficiaries. Initially, the
PCPs, specialty care physicians and ancillary providers are to be reimbursed
according to a discounted fee-for-service arrangement, although the Company
anticipates that the specialty care physicians, and possibly the ancillary care
providers, eventually will be shifted to a capitation program. The hospitals
participating in the Medicare risk product will be reimbursed on a capitated
basis (i.e., at 43% of the per member per month ("PMPM") amount paid to the
Company by HCFA). The hospitals and the PCPs (and indirectly, the specialty care
physicians) will eventually participate in an incentive program that is
established for each care team (i.e., the integrated unit that is formed by a
PCP, the particular hospital to which such PCP refers Medicare members and the
specialty care physicians to whom the PCP refers Medicare members). The Company
will withhold a percentage of each hospital's capitation payment in order to
fund the incentive program for each care team. Any surplus or deficit in each
care team's incentive pool will be split as follows: 20%-ChoiceCare,
30%-Hospital, 50%-PCPs. Physicians will not be put at risk for the first two
years of the contract and their risk will be capped at $3.00 PMPM thereafter;
the Company will assume the physicians' share of any deficit during these first
two years.
ANCILLARY SERVICES.
The Company has negotiated discounted contracts with approximately 150
ancillary service providers for ancillary services such as nursing services,
home health agencies, laboratories, outpatient diagnostic radiological services,
durable medical equipment, ambulance services, pharmacy and occupational,
physical and speech therapy. The contracts for laboratory and outpatient
diagnostic imaging services are
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on a capitated basis with certain risk-sharing features, while other contracts
include incentives for appropriate utilization of services. The Company's mental
health and chemical dependency services, diagnostic imaging services and
pharmacy benefits are managed by third-party vendors.
MARKET
Ohio, Kentucky and Indiana had a population of approximately 21 million in
1996. With the expansion into the Dayton Service Area, approximately 15% of this
population resides in the Company's Service Area. Within the Service Area, the
Company estimates approximately 1.9 million people are enrolled in managed care
plans (HMOs, preferred provider organizations ("PPOs") and POS plans). The
Company believes there are still opportunities to grow commercial business
within its Service Area but also believes there is substantial opportunity in
the Medicare and Workers' Compensation markets as well as contiguous service
areas that are less penetrated with managed care enrollment.
A majority of employers continue to fund their medical benefit plans
through arrangements with commercial insurance carriers or HMOs. However, a
significant portion of employers in the Service Area fund their own medical
benefit plans and retain third-party administrators ("TPAs") to provide various
services including claims administration, processing and payment, member
communications and cost containment. Although a larger number of employers
continue to fund their plans through insurance, self-funded plans are offered
predominantly by larger employer groups. Two types of administrators compete for
the large numbers of eligibles (i.e., employees) in the self-funded market. One
type, the administrative services only ("ASO") administrator, sells services
based on low administrative fees, speed of claims processing and customization,
and offers minimum medical management services. The other type, with which the
Company is closely aligned, includes commercial insurance/HMO carriers that
offer self-funded managed care benefit options. These carriers compete less on
price, and more on value added medical management services and programs. There
are approximately 13 such commercial insurance/HMO carriers, including the
Company, offering self-funded options in the Service Area.
MARKETING
The Company markets its prepaid health plans and third-party administrative
services primarily to employer groups as a replacement for or alongside
traditional fee-for-service indemnity plans or other managed care plans. The
Company generates membership growth through several different sales channels.
Prospective employer groups with less than 100 employees are generally sold
through a network of approximately 150 contracted independent brokers.
Prospective employer groups with more than 100 employees are generally sold by
the Company's sales representatives, but may also be sold by one of the
Company's contracted independent brokers. A solid relationship with consultants
largely present in groups with 500 or more employees is also seen as an
essential component of the sales channel. Also critical is membership growth and
retention from existing accounts which are actively managed by the Company's
account management staff.
During the Company's typical sales cycle for commercial business, the
Company's representatives first make presentations to employer groups. Once the
employer group agreement is executed, the Company directly communicates with
employees. The Company uses print, television, radio, newspaper advertising,
worksite presentations and educational sessions to market and educate members
and potential members about
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its products. Other communications to reinforce the Company's message include a
quarterly magazine, member educational brochures, employer and broker seminars
and physician and office staff newsletters. The Company has received local
awards for its print and media advertising.
Senior Health will primarily be marketed directly to individual Medicare
beneficiaries, although some group sales are also expected. Medicare marketing
is extensively regulated by HCFA.
COMPETITION
Managed care companies operate in a highly competitive environment. The
Company believes that the most important competitive factors affecting its
ability to retain and increase membership include comprehensive benefit
packages, the price employers are willing to pay for these benefits, the size
and reputation of its provider networks and customer service quality. While the
competitive pressure is intense from local, regional and national carriers, the
Company believes the future managed care market in the Service Area will largely
be dictated by the importance national carriers place on the Service Area and
the resulting tactics they use to penetrate the market and improve market share.
The Company's competition comes from local or regional managed care companies
such as Anthem, Blue Cross/Blue Shield of Ohio, Health Services Preferred and
Ohio Health Choice Plan. The Company also competes with national carriers such
as United/MetraHealth, Pacificare/FHP, Aetna/U.S. Healthcare, Humana, Prudential
and CIGNA/Healthsource (pending merger). Many of these competitors have greater
financial resources and offer a broader range of products and/or benefit
packages than the Company. Additional competitors may also enter the Company's
Service Area in the future, either de novo or by acquiring a current competitor
in the Service Area.
Additionally, the hospital systems in the Service Area are positioning
themselves to compete with the Company by directly contracting with employers
and government payors, such as HCFA. Certain of these hospital systems have
already obtained HMO licenses, and others are believed to be considering
obtaining them. Legislative developments may make it easier for these hospital
systems (either directly or through integrated delivery systems, such as
physician hospital organizations or provider services networks) to contract on a
"risk" basis.
The Company also competes with other managed health care companies that
enter into contracts with independent physicians, physician groups and other
providers. Competitive factors influencing a physician's or other provider's
decision to contract with the Company include potential membership (i.e.,
patient) volume, reimbursement rates, timeliness of reimbursement and other
administrative service capabilities. An inability to contract with certain
physician groups or hospitals (with exclusivity or nearly exclusive contracts)
could negatively impact the attractiveness of the Company's provider networks
and its managed care product offerings.
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REGULATION AND RECENT LEGISLATION
FEDERAL REGULATION.
FEDERAL QUALIFICATION. The Federal Qualification Act of 1973 (the "Act")
fostered the development and growth of HMOs. The Act created a regulatory scheme
under which the federal government certified HMOs which qualified by complying
with stringent operational and organizational requirements (i.e., benefit
offerings, benefit delivery, rating methodology, fiscal stability, quality
assurance programs, etc.) Federal qualification thus served, to some extent, as
a seal of approval, with the result that federally qualified HMOs were perceived
by employers as providing higher quality services. Federal qualification also
had a practical advantage, in that employers were required, under certain
circumstances, to offer federally qualified HMOs to their employees.
Additionally, the Act preempted certain types of state laws that were barriers
to the development of HMOs.
In 1988, Congress passed amendments to the Act (the "1988 Amendments")
which, among other things, lessened the specific administrative requirements of
HMOs and ended the mandated employer offering of federally qualified HMOs as of
October 24, 1995. As a result of the 1988 Amendments, HMOs can no longer rely on
the employer mandate, but have gained greater flexibility to position themselves
favorably in the health care coverage market.
The Foundation became federally qualified on March 26, 1985, and operated
as a federally qualified HMO in its Ohio service area until the transfer of the
Foundation's managed care assets to Health Plans on October 1, 1995. Health
Plans became federally qualified in its Cincinnati Service Area on January 24,
1997.
ERISA. The Employee Retirement Income Security Act of 1974, as amended
("ERISA"), applies to most workplace health plans, with the exception of certain
church plans and government plans. Excluded government plans consist of plans
offered by state and federal governments and their political subdivisions, for
their employees and covered dependents. When it applies, ERISA preempts most
state laws related to workplace health plans, except laws regulating the
business of insurance. This creates a dichotomy between insured plans, including
HMO plans, which are subject to state regulation, and self-funded plans, which
are not. Additionally, the courts have held that state court actions for
compensatory damages (e.g., pain and suffering) and for punitive damages (e.g.,
"bad faith") are preempted by ERISA with respect to all health plans governed by
ERISA, including insured plans.
A number of state officials believe that the states should regulate
self-funded plans and have urged Congress to modify or repeal ERISA's broad
preemption. Plaintiff personal injury attorneys, presently barred from
recovering compensatory and punitive damages in connection with benefit claims,
have added their considerable support to these efforts. If ERISA is modified to
permit denied benefits claimants to recover punitive damages and damages for
pain and suffering and mental anguish, the impact on the managed care industry,
and indirectly on those employers who provide their workers with health care
coverage, would be substantial. If ERISA is repealed or altered to permit state
regulation of self-funded plans, the effects would be even more far-reaching and
difficult to predict.
Unlike traditional state insurance laws and regulations, ERISA does not
mandate specific benefits or the use of specific types of providers. ERISA also
does not require plans to meet minimum capital or reserve requirements or to
comply with any
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of the financial solvency measures typically required of insurers and HMOs.
Instead, ERISA imposes rules intended to assure that plan assets are used for
the exclusive purposes of providing benefits to participants and their covered
dependents and minimizing expenses associated with plan administration. These
rules impose fiduciary obligations on certain parties, require plan assets to be
held in trust or by an insurer, and ban certain transactions between plans and
interested parties. These rules were written primarily to apply to retirement
funds, and there is little guidance available with respect to the application of
these rules to managed care arrangements. As a result, it is possible that the
Department of Labor, the courts or plan sponsors may raise questions concerning
whether certain managed care arrangements, or the way in which they are
implemented by Health Plans, are compatible with ERISA's requirements.
MEDICARE-RELATED LEGISLATION. The Company's contract with HCFA subjects the
Company to various federal legislation which prohibits activities that are
deemed to be "fraudulent" or "abusive" and that would, thereby, raise the cost
of the Medicare and Medicaid programs. The Medicare/Medicaid Anti-Kickback
Statute prohibits the knowing or willful solicitation, offer, or payment of any
remuneration, whether direct or indirect, overt or covert, in cash or in kind,
in return for: (i) referring an individual for the furnishing of any item or
service; or (ii) purchasing, leasing, ordering or arranging for or recommending
the purchase, lease or order of any item or service, for which payment may be
made, in whole or in part, under Medicare or Medicaid. The Ethics in Patient
Referrals Act of 1989, as amended (the "Stark Laws"), prohibit a physician from
referring patients for "designated health services" to a facility in which the
physician (or a family member of the physician) has a "financial interest;" and
prohibit any person from billing patients or other third-party payors for
designated health services provided pursuant to prohibited referrals. These
prohibitions are very broad, encompassing many business transactions that are
permissible outside of the health care context; yet, there is very little
guidance as to what constitutes "fraudulent" or "abusive" activity in the
context of managed care. There are no exceptions for de minimis violations of
these laws. Courts have reasoned that if even one purpose of any remuneration is
to induce referrals of patients or services under the Medicare or Medicaid
programs, there may be a violation.
The penalties for willful violations of the Medicare/Medicaid Anti-Kickback
Statute and/or the Stark Laws are severe, including criminal prosecution and
fines, civil fines, "treble" damages, and exclusion of offending providers or
suppliers from the Medicare and Medicaid programs.
The Omnibus Budget Reconciliation Act of 1990 prohibits payment of any
incentive to induce a physician to withhold treatment from an individual
Medicare beneficiary. HCFA has promulgated regulations under this law that
govern the use of any HMO physician incentive plan ("PIP") for services to
Medicare beneficiaries. These regulations do not prohibit PIPs, but do subject
the Company to certain reporting requirements and to the potential for obtaining
stop-loss coverage for physicians if the Company's PIP puts physicians at
substantial financial risk for services which they do not provide. Failure to
abide by these regulations could subject the Company to civil monetary penalties
or exclusion from the Medicare program.
HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996. The Health
Insurance Portability and Accountability Act ("HIPAA") was signed into law by
President Clinton on August 26, 1996. This law was intended to make it easier
for individuals to maintain coverage under their current employer's health plan
- -- and to obtain
12
13
coverage under their next employer's health plan -- even if their health status
might otherwise make them uninsurable. This law amends ERISA, the Internal
Revenue Code and the Public Health Service Act.
HIPAA's key coverage provisions are its new portability and
nondiscrimination rules. These new rules: limit the length of pre-existing
condition exclusions; require health plans to credit prior creditable coverage
against any exclusion period; require health plans to issue (and accept)
certificates of prior creditable coverage; allow certain individuals who have
lost other coverage to enroll outside of their plan's normal open enrollment
periods; and prohibit discrimination based on health status-related factors.
These rules affect self-funded plans and insured plans.
HIPAA also contains a number of reforms aimed specifically at the group
market. These reforms are applicable only to health insurance issuers - not
self-funded plans. These new group market rules: require guaranteed issue in the
small group market; require guaranteed renewability in the small and large group
markets; and require health insurance issuers to disclose certain information to
their customers in the small group market.
HIPAA also creates new rules for the individual market. The new individual
market rules require guaranteed issue for eligible individuals (i.e., certain
persons with prior coverage) and require guaranteed renewability. States,
however, may opt out of the individual market rules if they provide "acceptable
alternative mechanisms" for guaranteeing that all eligible individuals will have
a choice of coverage.
To allow the states an opportunity to continue their regulation over the
insurance business, HIPAA creates a complex state-federal enforcement scheme
that allows the states to adopt and enforce their own standards, provided they
do not conflict with HIPAA's minimum requirements.
HIPAA also creates a trial program for "Medical Savings Accounts."
These accounts are similar to Individual Retirement Accounts, except that they
are intended to provide funds for health care expenses rather than for
retirement expenses. Medical Savings Accounts may only be established in
connection with a qualifying ("high deductible") health plan.
The Company, as an HMO, has never been allowed to discriminate against
individuals based on health status, and it has not used pre-existing condition
exclusions in its HMO products. (The non-network, indemnity-style benefits
portion of the Co-Choice product does have a pre-existing condition exclusion.)
The overall effect of HIPAA on the Company, therefore, may be that it will force
some of the Company's competitors to limit or abandon practices that gave them a
competitive advantage in certain market segments.
MENTAL HEALTH PARITY ACT OF 1996. The Mental Health Parity Act prohibits
health plans and health insurance issuers from adopting annual or lifetime
dollar limits for mental health services that are different from any similar
limits on other medical services, unless extending similar limits for mental
health services would cause a health plan's premiums to increase by more than
1%. The Company's prepaid products do not contain dollar limits on mental health
services. This legislation will, however, require changes to the mental health
benefits available under the non-network, indemnity portion of the Co-Choice POS
product.
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STATE INSURANCE REGULATION.
Health Plans is subject to the HMO laws and regulations of the States of
Ohio, Kentucky and Indiana.
OHIO. To obtain a certificate of authority as an HMO, Health Plans was
required to file a detailed description of its proposed plan of operations,
provider network, service area, finances and governance. It remains under a
continuing obligation to file with, and obtain the approval of, the
Superintendent of Insurance for any major modification of its operations, as
described in its application, if the modification affects: the solvency of
Health Plans, its continued provision of health care services, or the manner in
which it conducts its business. Additionally, its evidences of coverage, rates,
contracts with providers, solicitation documents and requests for expansion of
approved service area are subject to review and approval by the Superintendent.
As an HMO, Health Plans is required to provide unlimited "basic health care
services" to its members. These services include: physician services; inpatient
hospital services; outpatient medical services; worldwide emergency health care
services; diagnostic laboratory services; diagnostic and therapeutic
radiological services; and preventative health care services, including, but not
limited to, voluntary family planning services, infertility services, periodic
physical examinations, prenatal obstetrical care, and "well-child" care. "Basic
health care services" do not include dental care, mental health services or
experimental procedures. Health Plans is permitted to offer supplemental
benefits, such as podiatric care, mental health services, substance abuse
treatment, home health services, prescription drugs and physical therapy
services.
An HMO may not cancel or refuse to renew the coverage of a member because
of health status or requirements for health care services. Each HMO is also
required to hold an annual open enrollment period, during which individuals may
enroll without regard to their health status or health care requirements.
Health Plans is required by Ohio to maintain a net worth of at least 10% of
its liabilities, subject to a minimum amount of $500,000 and a maximum amount of
$2.5 million. Health Plans is also required to maintain a deposit with the
Superintendent of $250,000. Health Plans is subject to periodic review and audit
by the Department of Insurance. State insurance law governs the types of
investments an HMO may make.
INDIANA. To obtain a certificate of authority as an HMO, Health Plans was
required to file a detailed description of its proposed service area, plan of
operations, provider network, financial feasibility plan, and governance, in
addition to filing financial statements. Subject to certain limitations
established by the Commissioner of Insurance, it remains under a continuing
obligation to file with, and obtain the approval of, the Commissioner for any
major modification of its operations, as described in its application.
Additionally, its evidences of coverage, rates, contracts with providers and
solicitation documents are subject to review and approval by the Commissioner.
As an HMO, Health Plans is required to provide unlimited "basic health care
services" to its members, when "medically necessary." These services include:
preventive care; inpatient and outpatient hospital and physician care;
diagnostic laboratory care; diagnostic and therapeutic radiological services;
and emergency care. "Basic health care services" do not include: mental health
services; substance abuse treatment; dental services; vision services; and
long-term
14
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rehabilitation treatment. An HMO may offer additional health care services
beyond the required "basic health care services." In addition, mammography
screening is a required service, subject to certain age conditions and frequency
limitations.
Indiana has a variety of alternative measures for calculating an HMO's
required minimum net worth. Under the various alternatives, Health Plans is
required to maintain a minimum net worth of approximately $13.7 million at
December 31, 1996. Indiana also has a deposit requirement of $250,000, but this
requirement is satisfied by Health Plans maintaining $500,000 on deposit with
the State of Ohio. Health Plans is subject to periodic review and audit by the
Department of Insurance. State insurance law governs the types of investments
an HMO may make.
KENTUCKY. Kentucky's HMO law is intended to complement the federal Health
Maintenance Organization Act of 1973, as amended. Kentucky's HMO code and
regulations are not intended to be in conflict with the federal act and the
regulations thereunder. It is not clear, however, if the Kentucky HMO code
adopts the requirements of the federal act.
To obtain a certificate of authority as an HMO in Kentucky, Health Plans
was required to file a detailed description of its proposed plan of operations,
provider network, finances and governance. It remains under a continuing
obligation to file with, and obtain the approval of, the Commissioner of
Insurance for any major modification of its operations, as described in its
application. Additionally, its evidences of coverage, rates, advertisements and
solicitation documents are subject to review and approval by the Commissioner.
Kentucky requires every HMO health plan to provide coverage for: a
newly-born child from the moment of birth without positive enrollment; low-dose
mammography screening meeting certain minimum standards; and medically necessary
procedures to correct temporomandibular joint disorders and craniomandibular jaw
disorders, where the HMO contract provides coverage for surgical or non-surgical
treatment of skeletal disorders.
Kentucky requires every group HMO health plan to offer the master
policyholder the option to purchase the following coverages: a specified minimum
treatment for alcoholism; inpatient and outpatient treatment of mental illness,
at least to the same extent and degree as coverage for the treatment of physical
illnesses; routine nursing care for a well newly-born child for up to five days
in a hospital nursery where the group policy provides maternity benefits; a
minimum of 60 days of home health care each year; and long-term health care. The
master policyholder is not required to purchase any of these group coverages.
An HMO may not cancel or refuse to renew the coverage of a member because
of his or her health status or requirements for health care services. Each HMO
is also required to hold an annual open enrollment period, during which
qualified individuals may enroll without regard to their health status or health
care requirements.
Health Plans is required by Kentucky to maintain a net worth of $1.25
million. Kentucky also has a $500,000 deposit requirement, $250,000 of which is
satisfied by the funds Health Plans maintains on deposit with the State of
Ohio. Health Plans is subject to periodic review and audit by the Department of
Insurance. State insurance law governs the types of investments an HMO may
make.
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HEALTH CARE REFORM.
FEDERAL REFORM. In response to the continued escalation of health care
costs, and in an effort to protect the Medicare trust fund, numerous packages
aimed at reforming the Medicare program have been introduced in Congress. If
Medicare spending persists at its current level, the Medicare trust fund is
expected to be insolvent by the year 2000. Current Republican and Democratic
reform proposals are structured to encourage Medicare-eligible individuals to
join managed care organizations, thereby reducing costs to the Medicare program.
Not all reform proposals, however, would operate in favor of managed care
companies. Certain reforms propose revisions to the current capitation rate
methodology and could result in lower reimbursement amounts for managed care
companies and their participating providers. Other reforms could result in an
increase in competition for the limited pool of health care dollars from
Medicare beneficiaries. The current proposals for federal legislation are
expected to undergo significant revisions prior to approval and implementation.
The Company cannot predict what effect, if any, these proposals will have on
Health Plans if and when enacted. No assurance can be given, however, that
enactment of any federal and/or state health care reforms will not have a
material adverse effect on Health Plans' business.
MANAGED CARE LEGISLATION. A number of legislative initiatives have been
proposed at the state and federal levels, the effect of which would be to limit
certain arrangements used by managed care organizations to control the cost and
to enhance the quality of the medical care provided to their members. These
legislative initiatives, which include proposals labeled by their proponents as
"any willing provider," "patient protection" and "freedom of choice" acts,
typically attempt to protect specific classes of providers from competition. To
date, Kentucky is the only state in which Health Plans currently operates that
has adopted legislation of this nature affecting HMOs. There is no assurance
that similar managed care initiatives will not be adopted in the other states in
the future.
KENTUCKY. In 1994, Kentucky adopted a health reform act (the "Reform Act")
that has had, and is expected to continue to have, a wide-ranging effect on the
delivery and funding of health care in that state. Among its many provisions,
the Reform Act requires all insurers (including HMOs) to offer only certain
standard plans in an effort to make it easier for purchasers to compare
competing plans. The Reform Act requires insurers and HMOs to offer and issue
the basic health benefit plan on a "guaranteed-issue" basis, which means that no
applicant can be turned down except for nonpayment of premiums, thereby
requiring all carriers to issue coverage to each member of a group and to each
individual who applies, regardless of the individual's health. The Reform Act
further subjects all carriers to a limited "portability" requirement, with the
result that if a member switches plans, the new plan generally may not impose
new pre-existing condition limitations. Insurers and HMOs must also use a
"modified community rating methodology" to determine premiums for all health
benefit plans issued or renewed to employers with 50 employees or less,
individuals, and participants in the Alliance described below. The Reform Act
further establishes pricing parameters which have the potential of limiting an
amount of rate increase a carrier may be able to implement without completing a
rate hearing process, thereby potentially limiting the opportunity for the
carrier to achieve an appropriate premium. In addition, the Reform Act
incorporates an "any willing provider" provision, which prohibits discrimination
against any provider located within the geographic coverage area of the plan who
is willing to meet the health plan's terms and conditions of participation. The
Reform Act also creates an exclusive, statewide health care coverage purchasing
Alliance in which all state government employers are
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required to participate. Individuals and county and local employers with 50
employees or less are eligible to participate if they wish. Employees and
individuals who obtain their health coverage through the Alliance are able to
choose from any of the carriers certified by the Alliance as accountable health
plans.
Health Plans was certified as an accountable health plan, but voluntarily
left the Alliance in 1996 rather than agreeing to bring its rates below the
threshold established by the Alliance. Dropping its rates to the level required
by the Alliance would likely have resulted in inadequate premium rates to Health
Plans. Leaving the Alliance resulted in the Company's loss of approximately
3,200 members during January 1996.
OHIO. Ohio has a number of currently pending legislative proposals,
including "any willing provider" provisions, bills mandating coverage of certain
benefits or benefit levels, and bills regulating HMOs' conduct. One such bill is
the "Health Plan Standardization Act," drafted by the Ohio State Medical
Association. This proposed legislation sets forth strict processes to which HMOs
must adhere when dealing with provider contracting and credentialing and
performing utilization review and quality assurance procedures.
In addition, a bill drafted by the Department of Insurance has been
introduced. This bill, called the Uniform Licensure Act, is based on the current
HMO code, but if enacted, it would bring all entities which utilize managed care
techniques and which accept risk under the same legal standards and
requirements. The effect of this legislation would be to allow greater
competition from provider organizations.
INDIANA. The Indiana legislature has several bills pending which would
affect the operations of HMOs. The majority of these bills involve allowing
direct access of members to certain medical specialists, extending mental health
parity and providing state tax credits to businesses which offer mental health
benefits, and mandating specific grievance procedures for member complaints.
EMPLOYEES
As of December 31, 1996, the Company had approximately 560 employees, none
of whom are subject to a collective bargaining agreement. The Company believes
that its employee relations are good.
ITEM 2. PROPERTIES
----------
As of December 31, 1996, the Company leased approximately 129,000 square
feet of office space in Cincinnati, Ohio, which serves as the Company's
corporate offices, and approximately 5,900 square feet of office space in
Dayton, Ohio.
The majority of the Company's office facilities are under a lease
arrangement that expires during February 1998. Currently, the Company is
considering entering into a new ten-year lease agreement for a 200,000 square
foot stand-alone office facility in Cincinnati, Ohio. Although terms of the
lease are subject to negotiation, annual lease payments are estimated to be
approximately $2,125,000 per year.
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ITEM 3. LEGAL PROCEEDINGS
-----------------
The Company is routinely involved in litigation matters arising in the
normal course of business. Management believes, based upon the advice of
counsel, that these actions and proceedings and losses, if any, resulting from
the final outcome thereof, will not be material in the aggregate to the
Company's consolidated financial position. See Notes 5 and 11(b) of Notes to
Consolidated Financial Statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
The Company did not submit any matters to a vote of security holders during
the last quarter of the year ended December 31, 1996.
EXECUTIVE OFFICERS OF THE REGISTRANT (AS OF MARCH 10, 1997)
- ------------------------------------
NAME AGE PRESENT POSITION
---- --- ----------------
Daniel A. Gregorie, M.D. 47 President, Chief Executive Officer and Chairman of the Board of
Directors
Thomas D. Anthony, Esq. 44 Executive Vice President, Chief Legal Officer and Secretary
Michael J. Barber, M.D. 48 Executive Vice President and Chief Medical Officer
Jane E. Rollinson 37 Executive Vice President, Chief Operating Officer, Treasurer and a
Director
Juan M. Fraiz 39 Vice President and Chief Financial Officer
Daniel A. Gregorie, M.D. has been President and Chief Executive Officer of the
Company since October 1995, and previously served in the same positions with the
Foundation since 1989. He was elected Chairman of the Board of Directors on
March 5, 1997.
Thomas D. Anthony, Esq. has been Executive Vice President, Chief Legal Officer
and Secretary of the Company since January 1, 1996. Prior to that he was a
partner with the law firm of Frost & Jacobs, Cincinnati, Ohio, since 1989.
Michael J. Barber, M.D. has been Executive Vice President and Chief Medical
Officer of the Company since October 1995, and previously served as Executive
Vice President, Medical Systems and Chief Medical Officer of the Foundation
since August 1995. He was Medical Director and Senior Vice President of
Clinical Services of the Foundation from 1990 to August 1995.
Jane E. Rollinson has been Executive Vice President, Chief Operating Officer
and Treasurer of the Company since October 1995, and previously served as
Executive Vice President, Operating and Corporate Support Systems of the
Foundation since May 1993. She was Senior Vice President, Finance from
August 1991 to May 1993 and was Vice President
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from February 1990 to August 1991. She was Chief Financial Officer, Treasurer
and Secretary of the Foundation from 1989 through November 1995. She was named
a Director of the Company on March 5, 1997 to complete the unexpired term of
Robert Westheimer, which resulted from his death on February 23, 1997.
Juan M. Fraiz has been Vice President and Chief Financial Officer of the Company
since December 5, 1995. He was Vice President, Financial Reporting Group of
NationsBank Corporation, from April 1994 to November 1995. He was Vice President
and Chief Financial Officer of Woburn National Bank from April 1992 to April
1994. He was Chief Financial Officer of Stonyfield Farm, Inc. from August 1991
to April 1992 and was Senior Vice President and Chief Financial Officer of BTB
Corporation/Boston Trade Bank from July 1988 to July 1991.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
-----------------------------------------------------------------
MATTERS
-------
There is no established public trading market for the Company's common
shares nor published quotations related to the common shares. Any trades of the
Company's common shares are on an individually negotiated basis between eligible
investors. To the Company's knowledge, which is not complete, there have been a
limited number of trades in the Company's stock during 1996, negotiated among
eligible investors, at approximately $10.00 per share. The Shareholder Agreement
between the Company and the Foundation prohibits the Company from paying
dividends on its common shares until after March 15, 2001, unless certain
specific events, as defined in the Shareholder Agreement, occur prior to that
date. No dividends were paid in 1996. See Note 3 of Notes to Consolidated
Financial Statements.
As of March 10, 1997, there were 1,076 shareholders of record of the Company's
common shares, consisting of 1,075 eligible investors and the Foundation.
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ITEM 6. SELECTED FINANCIAL DATA
-----------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE DATA AND OPERATING STATISTICS)
STATEMENT OF OPERATIONS DATA:
Premium revenue $276,609 $267,127 $247,330 $246,233 $226,819
Management services revenue 13,277 15,124 10,174 3,042 2,206
Other operating revenue 1,941 589 1,562 60 21
-------- -------- --------- -------- --------
Total operating revenue 291,827 282,840 259,066 249,335 229,046
Investment income (loss), net 5,692 12,385 (464) 5,824 5,134
Settlement expense (1) -- 28,000 -- -- 19,035
Net income (loss) 4,876 (15,353) 13,517 23,385 4,941
Earnings per common share .34
Pro forma earnings per common
share (2) .50
BALANCE SHEET DATA:
Total assets $149,788 $147,187 $128,334 $110,921 $88,608
Shareholders' equity 50,552 34,529 49,036 35,519 12,134
OPERATING STATISTICS:
Medical-expense ratio (3) 85.2% 85.9% 82.3% 81.2% 82.2%
Members at end of year:
Prepaid
Commercial 198,076 192,596 162,142 155,059 150,111
Medicaid (4) -- 12,138 7,064 6,453 5,252
------- ------- ------- ------- -------
198,076 204,734 169,206 161,512 155,363
Self-funded 85,050 88,577 85,916 19,536 18,021
------- ------- ------- ------- -------
Total 283,126 293,311 255,122 181,048 173,384
======= ======= ======= ======= =======
- --------------
(1) Relates to the settlement of the THOMPSON litigation. See Note 5 of Notes
to Consolidated Financial Statements.
(2) Through September 30, 1995, the Company operated as a social welfare
organization under Section 501(c)(4) of the Internal Revenue Code and,
except for its for-profit subsidiary, accordingly, was not subject to
federal income taxes or certain accounting standards applicable to
for-profit entities. The pro forma earnings per common share is based upon
13,500 issued and outstanding common shares and the Company's net income
after giving effect to (i) the estimated provision for income taxes that
would have been reported in accordance with Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" had the Company
filed income tax returns as a for-profit corporation; (ii) the application
of Statement of Financial Accounting Standards No. 115, "Accounting for
Investments in Certain Debt and Equity Securities" to the accounting for
marketable securities; and (iii) a reduction in other expenses of $28,000
relating to the settlement of the THOMPSON litigation. The pro forma tax
provision is based on an assumed effective tax rate of 35.5%. See Note
12(a) of Notes to Consolidated Financial Statements.
(3) Calculated as total health care services expense as a percentage of premium
revenue, this ratio indicates the percentage of premium revenues expended
on providing total health care services to the Company's members.
(4) Effective June 30, 1996, the Company assigned its Medicaid provider
agreement with the Ohio Department of Human Services to another health
maintenance organization, and no longer serves Medicaid members. See Note 4
of Notes to Consolidated Financial Statements.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
(In thousands, except member and PMPM data)
OVERVIEW
- --------
During 1996, the first full year ChoiceCare Corporation (the "Company") operated
as a taxable, for-profit company, net income of $4,876 was generated, as
compared to a $15,353 net loss in 1995 and net income of $13,517 in 1994. See
Note 1 of Notes to Consolidated Financial Statements regarding the Company's
October 1, 1995 restructuring (the "Restructuring"). Comparisons of the 1996 and
1995 year-to-year results were significantly impacted by the following
transactions not related to operations:
1996
----
- Recognition of a $4,554 gain on the assignment of the Company's
Medicaid contract with the Ohio Department of Human Services.
1995
----
- Recording of a $28,000 settlement expense in accordance with the
THOMPSON litigation settlement agreement as a result of the
Restructuring.
- Receipt of a $3,350 payment in connection with the termination of an
agreement with another managed care entity.
Operating in an increasingly competitive environment and following two years
of flat or decreasing premium rates, the Company experienced a $2,473 operating
loss during 1996, as compared to a $3,088 operating loss in 1995 and operating
income of $13,981 in 1994. Despite certain factors which contributed positively
to operating results in this competitive environment, most notably 1) a 5.0%
increase in member months for prepaid commercial products; 2) a modest increase
in average premium rates for fully-insured groups renewing during the year; and
3) an approximate $5,875 decrease in the amount incurred in connection with the
Company's hospital risk/reward sharing arrangements, due to the hospitals'
performance against established cost of hospital services and quality targets,
1996 operating results reflect the offsetting effects of the following
factors:
- loss of premium revenues recognized from the Company's Special Health
Medicaid product as a result of the June 30, 1996 assignment of the
Medicaid contract;
- 6.7% decrease in self-funded membership, resulting largely from the
downsizing activities of two large self-funded employer groups;
- increased health care professional services utilization levels and
drug costs compared to 1995; and
- continued industry-wide health care cost inflation trends,
particularly costs of pharmacy benefits.
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Finally, results reflect selling, general and administrative ("SG&A")
expenditures related to servicing membership growth, developing new products
and expanding into a new geographic market, variations in the Company's net
investment income and the recognition of a tax provision in 1996.
RESULTS OF OPERATIONS
- ---------------------
The following table sets forth selected operating data, expressed as a
percentage of total operating revenues and/or on a per member per month ("PMPM")
basis, selected member data and medical-expense ratios:
YEARS ENDED DECEMBER 31,
1996 1995 1994
---- ---- ----
OPERATING REVENUES:
Premiums 94.8% 94.4% 95.5%
Management services revenue 4.5 5.4 3.9
Other .7 .2 .6
------------- ------------- -------------
Total 100.0 100.0 100.0
------------- ------------- -------------
OPERATING EXPENSES:
Health care services 80.7 81.1 78.6
SG&A 20.1 20.0 16.0
------------- ------------- -------------
Total 100.8 101.1 94.6
------------- ------------- -------------
Operating income (loss) (.8) (1.1) 5.4
Investment income, net 1.9 4.4 (.2)
Other non-operating income
(expense) 1.6 (8.7) --
------------- ------------- -------------
Income (loss) before
income taxes 2.7 (5.4) 5.2
Provision for income taxes 1.0 -- --
------------- ------------- -------------
Net income (loss) 1.7% (5.4%) 5.2%
============= ============= =============
MEDICAL-EXPENSE RATIO* 85.2% 85.9% 82.3%
PMPM DATA:
Premium revenue
Commercial $ 114.46 $ 114.25 $ 123.49
Medicaid 138.97 138.44 140.96
Management services revenue 12.84 13.64 13.16
Health care services expense 98.15 99.08 102.27
SG&A expense 17.10 16.49 15.00
MEMBER MONTHS:
Prepaid
Commercial 2,322,619 2,211,676 1,908,301
Medicaid 77,496 104,367 82,753
------------- ------------- -------------
2,400,115 2,316,043 1,991,054
Self-funded 1,033,915 1,108,694 772,826
------------- ------------- -------------
Total 3,434,030 3,424,737 2,763,880
============= ============= =============
* Health care services expense as a percentage of premiums.
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1996 COMPARED TO 1995
- ---------------------
PREMIUM REVENUE -
The 3.5% increase in premium revenue during 1996 reflects 1) the June 30, 1996
assignment of the Company's Medicaid contract, on which approximately $10,770 of
premiums were recognized during 1996 prior to assignment, as compared to
approximately $14,450 during 1995; 2) a 5.0% increase in member months for the
Company's prepaid commercial products; and 3) a .2% increase in the weighted
average PMPM premium on prepaid commercial products. The slight increase in
weighted average PMPM premium on prepaid commercial products primarily can be
attributed to the effects of the modest average increase in premium rates on
1996 renewals being substantially offset by the effects of continued migration
of the customer base to the Company's more cost-effective products and benefit
structures.
MANAGEMENT SERVICES REVENUE -
The 12.2% decrease in management services revenue from self-funded employer
groups results primarily from the combined effects of the 6.7% decrease in
self-funded membership, due largely to the downsizing activities of two large
self-funded employer groups and the net effects of retroactive rate adjustments
with a self-funded employer group negotiated during 1996 and 1995.
In September 1996, the Company was informed by a customer accounting for
approximately 33% of the Company's total self-funded members that the health
care services management agreement between the Company and the customer, which
expires March 31, 1997, will not be renewed. Management services revenue
received from the customer during 1996 and 1995 totaled approximately $3,850 and
$4,400, respectively. Contributions to operating income from the contract have
historically not been material to the Company's total results of operations due
to the operating expenses associated with the administration of the contract and
providing services to the customer's members.
In July 1996, the Company was successful in receiving a commitment for the
renewal of a multi-year contract, which began January 1, 1997, with an existing
customer that accounts for approximately 39% of the Company's total self-funded
members. While the customer opted to also offer another competitor's managed
care plan, the Company retained approximately 78% of its existing membership
base from this customer.
OTHER OPERATING REVENUE -
The increase in other operating revenue reflects increases in the amounts earned
in connection with risk/reward sharing arrangements with two vendors ($540
related to the Company's pharmacy benefit administrator for the contract year
ended May 1996 and $486 related to the Company's out-of-area coverage provider)
and net increases in revenue from various miscellaneous sources.
HEALTH CARE SERVICES EXPENSE -
The 2.7% increase in total health care services expense during 1996 reflects 1)
a 3.6% increase in prepaid member months, including a 25.7% decrease in member
months related to the Company's former Medicaid product as a result of the
assignment of the contract on June 30, 1996; 2) a 2.1% increase in physician
expenses on a PMPM basis; 3) a 7.1% decrease in hospital expenses on a PMPM
basis; and 4) a 7.8% increase in pharmacy services costs on a PMPM basis,
resulting largely from continued industry-wide drug cost inflation.
23
24
The 2.1% increase in PMPM physician expenses reflects the net effects of:
- increased health care professional services utilization levels and
relatively stable average cost per service; and
- refinement downward of the Company's estimate of physician claims
expense in 1995.
The 7.1% decrease in hospital expenses on a PMPM basis can be attributed
primarily to the net effects of:
- negotiation of more favorable terms in the new hospital contracts,
which contributed to decreased amounts being incurred in connection
with the Company's hospital risk/reward sharing arrangements, due to
the hospitals' performance against established cost of hospital
services and quality targets;
- decreased utilization, relatively stable average outpatient cost per
service and increased average inpatient cost per service, reflecting
the transition of certain less complex services to outpatient
settings; and
- refinement downward of the Company's prior year's estimate of hospital
claims expense during 1995.
As a result of the .9% decrease in health care services expense on a PMPM basis
outpacing the less than .1% decrease in the overall weighted average PMPM
premium, the Company's medical-expense ratio decreased to 85.2% in 1996 from
85.9% in 1995.
During the last two quarters of 1996, the Company began implementation of
several initiatives designed to decrease health care services expense,
particularly the pharmacy expense component. However, there is no assurance that
the benefits of such efforts will be realized.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES -
The 4.0% increase in expenses for SG&A costs in 1996 largely reflects the
continued effect of expenses incurred in connection with infrastructure and new
product investments made in order to raise the standard of service provided to
current members, to service anticipated membership growth and to manage medical
cost inflation effectively. Included are approximately $3,300 of expenses
incurred in connection with developing the Company's Medicare and Workers'
Compensation products and expanding into the Dayton, Ohio market, none of which
generated revenues in 1996. Increased expenses are substantially comprised of 1)
compensation, reflecting routine salary adjustments and a 5% net increase in the
average number of employees over 1995, largely to support the aforementioned new
initiatives; 2) commissions paid to sales brokers, as an increased number of
smaller employer groups are being sold through this channel; and 3) depreciation
and amortization expense, relating to additional investments in computer
hardware and software and payments related to the Company's medical group
assistance program. These factors were partially offset by a lower amount of
employee incentive compensation recorded in 1996, as compared to 1995, and the
fact that 1995 included approximately $1,600 of expenses incurred in connection
with the Restructuring.
INVESTMENT INCOME -
During 1996, the Company experienced a $6,693 decrease in net investment income
as compared to 1995. This decline can primarily be attributed to 1) a decrease
in the average outstanding portfolio balance, due largely to funding the $28,000
THOMPSON litigation settlement escrow account in October 1995; and 2) a $5,628
decrease in net realized gains on investment sales, as the Company liquidated a
substantial
24
25
portion of its investment portfolio during 1995 in preparation for the
Restructuring and the THOMPSON litigation settlement payment. As a result of
1995's favorable market conditions, this liquidation gave rise to significant
realized gains in 1995.
OTHER NON-OPERATING INCOME (EXPENSE) -
During 1996, the Company recognized a $4,554 gain on the assignment of its
Medicaid contract. See Note 4 of Notes to Consolidated Financial Statements.
The 1995 results included the $3,350 payment received in connection with the
termination of an agreement with another managed care entity, representing
reimbursement for expenses incurred in 1994 and 1995 for negotiating and
implementing infrastructure changes to provide services under the agreement, the
cost of negotiating termination of the agreement and an element of compensation
for potential lost profits the Company may have realized under the terms of the
agreement.
The 1995 results also included the $28,000 THOMPSON litigation settlement
expense recorded in connection with the Restructuring, which stemmed from the
1988 settlement of a judgment against the Company.
INCOME TAX EXPENSE -
Income tax expense has been recorded at an effective tax rate of 37.3% in 1996,
compared to no expense in 1995. See Note 9 of Notes to Consolidated Financial
Statements.
1995 COMPARED TO 1994
- ---------------------
PREMIUM REVENUE -
The 8.0% increase in premium revenue during 1995 reflects a 16.3% increase in
member months for the Company's prepaid products, offset by a 7.1% decrease in
the weighted average PMPM premium on such products. The decrease in weighted
average PMPM premium on prepaid products can primarily be attributed to the
Company's decision to decrease overall premium rates and the continued migration
of the customer base to the Company's more cost-effective products and benefit
structures.
MANAGEMENT SERVICES REVENUE -
The 48.7% increase in management services revenue from self-funded employer
groups resulted primarily from the 43.5% increase in self-funded membership.
OTHER OPERATING REVENUE -
The decrease in other operating revenue reflects a $1,363 decrease in the amount
earned in connection with the risk/reward sharing arrangement with the Company's
out-of-area coverage provider and net increases in revenue from various
miscellaneous sources.
HEALTH CARE SERVICES EXPENSE -
The 12.7% increase in total health care services expense during 1995 reflects 1)
the 16.3% increase in prepaid member months; 2) an 8.7% decrease in physician
expenses on a PMPM basis; 3) a 1.1% increase in hospital expenses on a PMPM
basis; and 4) a 5.2% increase in pharmacy services costs on a PMPM basis.
25
26
The 8.7% decrease in PMPM physician expenses resulted in large part from the net
effects of:
- the mix of frequency and cost of service;
- a reduction in the estimated amount incurred in connection with the
Company's risk/reward sharing arrangements with health care
professionals; and
- refinement of the Company's estimate of physician claims expense.
The 1.1% increase in hospital expenses on a PMPM basis can be attributed
primarily to the net effects of:
- decreased inpatient utilization, offset by increased inpatient cost
per day, increased outpatient utilization and decreased outpatient
cost per service;
- refinement of the Company's estimate of hospital claims expense;
- a decrease in the level of hospital expenses covered by third parties;
and
- a decrease in expenses incurred in connection with the Company's
hospital risk/reward sharing arrangements, due to the hospitals'
performance against established cost of hospital services targets.
As a result of the 7.1% decrease in the weighted average PMPM premium outpacing
the 3.1% decrease in health care services expense on a PMPM basis, the Company's
medical-expense ratio increased to 85.9% in 1995 from 82.3% in 1994.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES -
The 36.2% increase in expenses for SG&A costs in 1995 largely reflects the 23.9%
growth in overall member months, the approximate $1,600 of expenses incurred in
connection with the Restructuring and the effect of expenses incurred in
connection with infrastructure and new product investments made in order to
raise the standard of service provided to current members, to service
anticipated membership growth and to manage medical cost inflation effectively.
INVESTMENT INCOME -
During 1995, the Company experienced a $12,385 net gain on its investment
portfolio, compared to a $464 net loss in 1994. This 1995 net gain reflected the
effects of 1) a larger balance of equity securities being held during 1995; and
2) the aforementioned liquidation of a substantial portion of the Company's
investment portfolio during 1995 in preparation for the Restructuring and the
THOMPSON litigation settlement payment, which gave rise to significant realized
gains.
OTHER NON-OPERATING INCOME (EXPENSE) -
During 1995, the Company recognized the $3,350 and $28,000 non-recurring items
discussed in the Overview and the 1996 to 1995 comparative analysis.
FOURTH QUARTER RESULTS
- ----------------------
During the fourth quarter of 1996, the Company generated net income of $1,734
and operating income of $568. These results reflect 1) approximately $1,700 of
expenses incurred in connection with the continued development of the Company's
Medicare and Workers' Compensation products and expansion into the Dayton, Ohio
market, the revenues from which are expected to commence during 1997; and 2) a
$250 reduction in management services revenue, resulting from a retroactive rate
adjustment with a self-funded employer group. Positively impacting the quarter's
results were a $774
26
27
refinement downward of the estimates of health care services claims expense
recorded earlier in the year and a $1,032 reduction of the amount incurred in
connection with risk/reward sharing arrangements with health care professionals.
During the fourth quarter of 1995, the Company reported a net loss of $366 and
an operating loss of $2,326. These results reflected a $1,651 reduction of the
amount incurred in connection with risk/reward sharing arrangements with health
care professionals.
FINANCIAL CONDITION
- -------------------
Reflecting the receipt of net cash proceeds of $12,015 from the May 1996 stock
offering and $4,554 from the June 1996 Medicaid contract assignment, the
Company's cash and cash equivalents increased $25,975 during 1996. Of this total
increase, $9,969 was provided by operations, as compared to $10,637 in 1995.
This decrease in cash from operations can largely be attributed to the net
effects of the aforementioned decrease in management services revenue and the
overall changes in certain of the Company's balance sheet components. See the
Consolidated Statements of Cash Flows.
As of December 31, 1996, the Company maintained an investment portfolio with a
market value of $70,436 which is available to meet current obligations and is
classified as available-for-sale in the accompanying Consolidated Balance Sheet.
The available-for-sale investment portfolio was comprised of debt securities
(79.6%), equity-based mutual funds (11.5%) and fixed income mutual funds (8.9%)
at December 31, 1996. The $17,621 increase in net cash provided by the Company's
investing activities in 1996 reflects the assignment of the Medicaid contract
and the combined net effects of 1) decreased capital expenditures; 2) the
significant level of investment portfolio transactions during 1995 in
preparation for the Restructuring and the THOMPSON litigation settlement
payment; and 3) the 1995 funding of such litigation settlement.
Reflecting the Company's ongoing commitment to upgrade its management
information systems, capital expenditures and the portion thereof related to
computer hardware and software totaled $2,851 and $2,341, respectively, during
1996, and $6,298 and $3,866, respectively, during 1995. The Company expects to
make capital expenditures of approximately $1,280 during 1997, with the majority
related to computer hardware and software.
The Company believes that its cash and cash equivalents, investment portfolio
and credit facility will be sufficient to fund its liquidity needs for at least
the next twelve months, including capital expenditures and current commitments.
See Note 11 of Notes to Consolidated Financial Statements.
INFLATION
- ---------
While the rate of inflation has remained relatively stable in recent years,
health care costs have been rising at a rate consistent with or above the
consumer price index. There are various means available to the Company to reduce
the negative effects of inflation, including the adjustment of premium rates. In
addition, the effects of inflation on operations are mitigated by the Company's
cost control measures and risk/reward sharing arrangements with various health
care providers. There is no assurance that the Company's efforts to reduce the
impact of inflation will be successful in the future or that future premium rate
adjustments will be commensurate with future health care cost increases
experienced by the Company.
27
28
CAUTIONARY STATEMENT
- --------------------
The information set forth above may include "forward-looking" information, as
defined in the Private Securities Litigation Reform Act of 1995. The CAUTIONARY
STATEMENT filed by the Company on November 12, 1996 as part of its Form 10-Q for
the period ended September 30, 1996 is incorporated herein by reference, and
investors are specifically referred to such CAUTIONARY STATEMENT for a
discussion of factors which could affect the Company's operations and
"forward-looking" statements contained herein.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
-------------------------------------------
See Index to Consolidated Financial Statements and Schedules on page 32.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
---------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
None.
PART III
ITEMS 10 THROUGH 13
Information regarding executive officers required by Item 401 of Regulation
S-K is furnished in a separate disclosure in Part I of this report since the
registrant will not furnish such information in its definitive proxy statement
prepared in accordance with Regulation 14A.
The remainder of the information required by these items will be included
in the Company's definitive Proxy Statement which will be filed with the
Securities and Exchange Commission in connection with the 1997 Annual Meeting of
Shareholders and is incorporated herein by reference.
28
29
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
----------------------------------------------------------------
The following documents are filed as part of this report:
(a) 1. Consolidated Financial Statements (Registrant and subsidiary)
See Index to Consolidated Financial Statements and Schedules
(page 32).
2. Financial Statement Schedules
See Index to Consolidated Financial Statements and Schedules
(page 32).
All other schedules are omitted because they are not applicable
or not required or because the required information is set forth
in the consolidated financial statements or notes thereto.
3. Exhibits
See Index of Exhibits (page 55).
(b) Reports on Form 8-K
The Company did not file a report on Form 8-K during the last
quarter of the year ended December 31, 1996.
29
30
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
CHOICECARE CORPORATION
Date: March 27, 1997 By: /s/ Juan M. Fraiz
--------------------------------------
Juan M. Fraiz
Vice President and Chief
Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Date: March 27, 1997 /s/ Daniel A. Gregorie
---------------------------------------
Daniel A. Gregorie, M.D.
President, Chief Executive Officer
and Chairman of the Board of
Directors (Principal Executive
Officer)
Date: March 27, 1997 /s/ Jane E. Rollinson
---------------------------------------
Jane E. Rollinson
Executive Vice President, Chief
Operating Officer and Director
Date: March 27, 1997 /s/ Juan M. Fraiz
---------------------------------------
Juan M. Fraiz
Vice President and Chief Financial
Officer (Principal Financial and
Accounting Officer)
Date: March 27, 1997 /s/ Daniel W. Geeding
---------------------------------------
Daniel W. Geeding, Ph.D.
Director
Date: March 27, 1997 /s/ Donald E. Hoffman
---------------------------------------
Donald E. Hoffman
Director
Date: March 27, 1997 /s/ James P. Long
---------------------------------------
James P. Long, Ph.D.
Director
30
31
Date: March 27, 1997 /s/ Janet B. Reid
---------------------------------------
Janet B. Reid, Ph.D.
Director
Date: March 27, 1997 /s/ Donald A. Saelinger
---------------------------------------
Donald A. Saelinger, M.D.
Director
Date: March 27, 1997 /s/ Richard G. Santangelo
---------------------------------------
Richard G. Santangelo, M.D.
Director
Date: March 27, 1997 /s/ Michael Schmerler
---------------------------------------
Michael Schmerler, M.D.
Director
Date: March 27, 1997 /s/ Chad P. Wick
---------------------------------------
Chad P. Wick
Director
31
32
CHOICECARE CORPORATION AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
PAGE
----
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS.........................................33
CONSOLIDATED STATEMENTS OF OPERATIONS for the Years Ended
December 31, 1996, 1995 and 1994 ...............................................34
CONSOLIDATED BALANCE SHEETS as of December 31, 1996 and 1995 ....................35
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
for the Years Ended December 31, 1996, 1995 and 1994 ...........................36
CONSOLIDATED STATEMENTS OF CASH FLOWS for the Years Ended
December 31, 1996, 1995 and 1994 ...............................................37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ......................................38
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT ......................51
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES ....................54
32
33
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of
ChoiceCare Corporation:
We have audited the accompanying consolidated balance sheets of
CHOICECARE CORPORATION AND SUBSIDIARY (the "Company") as of December 31, 1996
and 1995, and the related consolidated statements of operations, changes in
shareholders' equity, and cash flows for each of the three years in the period
ended December 31, 1996. These financial statements and the schedules referred
to below are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and schedules based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of ChoiceCare
Corporation and subsidiary as of December 31, 1996 and 1995, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1996, in conformity with generally accepted accounting
principles.
As explained in Note 2 to the financial statements, effective October
1, 1995, the Company changed its method of accounting for investments and income
taxes.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedules listed in the Index to
Consolidated Financial Statements and Schedules are presented for the purposes
of complying with the Securities and Exchange Commission's rules and are not a
part of these basic financial statements. These schedules have been subjected to
the auditing procedures applied in the audit of the basic financial statements
and, in our opinion, fairly state in all material respects the financial data
required to be set forth therein in relation to the basic financial statements
taken as a whole.
ARTHUR ANDERSEN LLP
Cincinnati, Ohio,
February 13, 1997
33
34
CHOICECARE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
YEARS ENDED DECEMBER 31,
1996 1995 1994
---- ---- ----
REVENUES:
Premium revenue $ 276,609 $ 267,127 $ 247,330
Management services revenue 13,277 15,124 10,174
Other operating revenue 1,941 589 1,562
--------- --------- ---------
Total Operating Revenue 291,827 282,840 259,066
--------- --------- ---------
EXPENSES:
Health care services
Physician services 110,302 104,264 98,159
Hospital services 90,916 94,446 80,338
Pharmacy services 34,349 30,758 25,126
--------- --------- ---------
Total Health Care Services 235,567 229,468 203,623
Selling, general and administrative expenses 58,733 56,460 41,462
--------- --------- ---------
Total Operating Expenses 294,300 285,928 245,085
OPERATING INCOME (LOSS) (2,473) (3,088) 13,981
OTHER INCOME (EXPENSE):
Investment income (loss), net 5,692 12,385 (464)
Gain on assignment of Medicaid contract 4,554 -- --
Income from agreement termination -- 3,350 --
Settlement expense -- (28,000) --
--------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES 7,773 (15,353) 13,517
PROVISION FOR INCOME TAXES 2,897 -- --
--------- --------- ---------
NET INCOME (LOSS) $ 4,876 $ (15,353) $ 13,517
========= ========= =========
UNAUDITED
PRO FORMA
INFORMATION
(NOTE 12(a))
EARNINGS (LOSS) PER COMMON SHARE $ .34 $ (.74)
========== ==========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 14,361 13,500
========== ==========
The accompanying Notes to Consolidated Financial Statements are
an integral part of these statements.
34
35
CHOICECARE CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(In thousands)
DECEMBER 31,
1996 1995
---- ----
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 38,597 $ 12,622
Cash held in escrow -- 28,000
Securities available-for-sale 70,436 73,009
Premiums receivable 7,815 7,637
Health care receivables 5,636 6,251
Other current assets 12,489 5,545
--------- --------
Total Current Assets 134,973 133,064
PROPERTY AND EQUIPMENT, net 9,536 10,258
OTHER LONG-TERM ASSETS 5,279 3,865
--------- --------
Total Assets $ 149,788 $147,187
========= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Medical costs payable $ 48,260 $ 46,754
Accounts payable and other accrued liabilities 15,043 14,829
Amounts due to vendor 6,200 --
Unearned premiums 5,133 4,104
Provider risk pool liability 12,304 15,681
Settlement liability -- 28,000
--------- --------
Total Current Liabilities 86,940 109,368
LONG-TERM LIABILITIES 12,296 3,290
--------- --------
Total Liabilities 99,236 112,658
--------- --------
COMMITMENTS AND CONTINGENCIES (Note 11)
SHAREHOLDERS' EQUITY:
Preferred stock, without par value,
4,000 shares authorized; none issued -- --
Common stock, without par or stated value,
45,000 shares authorized; 14,853 shares
issued and outstanding at December 31, 1996
(13,500 at December 31, 1995) 12,014 --
Net unrealized gains (losses) on securities
available-for-sale (21) 846
Retained earnings 38,559 33,683
--------- --------
Total Shareholders' Equity 50,552 34,529
--------- --------
Total Liabilities and Shareholders' Equity $ 149,788 $147,187
========= ========
The accompanying Notes to Consolidated Financial Statements are
an integral part of these statements.
35
36
CHOICECARE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(In thousands)
NUMBER OF COMMON RETAINED
SHARES STOCK OTHER EARNINGS TOTAL
------ -------- ----- -------- --------
BALANCE, December 31, 1993 13,500 $ -- $-- $ 35,519 $ 35,519
Net income -- -- -- 13,517 13,517
------ -------- ----- -------- --------
BALANCE, December 31, 1994 13,500 -- -- 49,036 49,036
Net unrealized gains on
securities available-for-sale -- -- 846 -- 846
Net loss -- -- -- (15,353) (15,353)
------ -------- ----- -------- --------
BALANCE, December 31, 1995 13,500 -- 846 33,683 34,529
Sale of common stock 1,353 12,015 -- -- 12,015
Purchase of treasury stock -- (1) -- -- (1)
Net unrealized losses on
securities available-for-sale -- -- (867) -- (867)
Net income -- -- -- 4,876 4,876
------ -------- ----- -------- --------
BALANCE, December 31, 1996 14,853 $ 12,014 $ (21) $ 38,559 $ 50,552
====== ======== ===== ======== ========
The accompanying Notes to Consolidated Financial Statements are
an integral part of these statements.
36
37
CHOICECARE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
YEARS ENDED DECEMBER 31,
1996 1995 1994
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 4,876 $ (15,353) $ 13,517
Adjustments to reconcile net income (loss)
to net cash provided by operating activities--
Loss (gain) on sale of investments (308) (5,936) 3,748
Gain on assignment of Medicaid contract (4,554) -- --
Investment valuation reserve -- -- 2,243
Amortization of investment discounts, net (542) (123) (435)
Depreciation and amortization 3,538 2,382 1,298
Other, net 126 120 70
Change in--
Receivables 437 2,008 (9,289)
Other assets (7,737) (5,821) --
Medical costs payable 1,216 6,050 8,387
Accounts payable and other accrued
liabilities 59 5,444 482
Amounts due to vendor 6,200 -- --
Unearned premiums 1,029 (2,470) 1,490
Provider risk pool liability (3,377) (5,439) (1,171)
Settlement liability -- 28,000 (6,125)
Long-term liabilities 9,006 1,775 833
-------- --------- ---------
Net cash provided by operating activities 9,969 10,637 15,048
-------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments to escrow -- (28,000) --
Proceeds from sale of investments and
statutory deposits 55,059 224,051 149,096
Purchases of investments and statutory
deposits (53,216) (203,382) (160,994)
Proceeds from assignment of Medicaid contract 5,000 -- --
Purchases of property and equipment (2,851) (6,298) (5,160)
-------- --------- ---------
Net cash provided by (used in)
investing activities 3,992 (13,629) (17,058)
-------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock, net 12,015 -- --
Purchase of treasury stock (1) -- --
-------- --------- ---------
Net cash provided by financing activities 12,014 -- --
-------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 25,975 (2,992) (2,010)
CASH AND CASH EQUIVALENTS, beginning of year 12,622 15,614 17,624
-------- --------- ---------
CASH AND CASH EQUIVALENTS, end of year $ 38,597 $ 12,622 $ 15,614
======== ========= =========
The accompanying Notes to Consolidated Financial Statements are
an integral part of these statements.
37
38
CHOICECARE CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
NOTE 1. BASIS OF PRESENTATION
ChoiceCare Corporation (the "Company") is an Ohio for-profit corporation, which
is a majority-owned subsidiary of ChoiceCare Foundation (the "Foundation"), an
Ohio not-for-profit corporation (formerly named Tristate Foundation for Health
and Midwest Foundation Independent Physicians Association). The Foundation was
organized in 1978 as a not-for-profit health maintenance organization. The
Company was formed to serve as a for-profit holding company for the assets and
liabilities relating to the Foundation's managed health care operations. Prior
to the Restructuring described below, the Company had no assets or operations.
Pursuant to a Plan of Restructuring (the "Restructuring") adopted by the Board
of Trustees of the Foundation on March 10, 1995 and approved by the Foundation's
member physicians on May 3, 1995, substantially all of the operating assets and
liabilities relating to the Foundation's managed health care operations were
transferred to the Company on October 1, 1995 in exchange for all of the issued
and outstanding common shares of the Company. The Foundation retained $25,000 of
cash and marketable securities to pursue its community benefit objectives.
Contemporaneously, the Company transferred the assets and liabilities of the
managed health care operations to its wholly-owned subsidiary, ChoiceCare Health
Plans, Inc. ("Health Plans;" formerly named Choice Benefits Administrators,
Inc.), in exchange for all of its issued and outstanding common shares. As a
result, since October 1, 1995, the managed health care operations formerly
conducted by the Foundation have been conducted by Health Plans.
These financial statements present the Company's consolidated financial position
as of December 31, 1996 and 1995 and its consolidated results of operations and
cash flows for each of the three years in the period ended December 31, 1996 as
if the Company had been operating as a separate, stand-alone entity for each
year presented. The Restructuring represented a combination of entities under
common control, and, accordingly, the combination was accounted for similar to a
pooling-of-interests. The Company's assets and liabilities have, therefore, been
recorded at the Foundation's historical costs. Assets remaining in the
Foundation, primarily investments and related income, have been excluded from
the accompanying financial statements.
Effective October 1, 1995, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 109, "Accounting for Income Taxes" and SFAS No. 115,
"Accounting for Investments in Certain Debt and Equity Securities." These
accounting standards were not applicable to the Company while it operated as a
not-for-profit corporation. See Notes 2, 6, and 9 regarding the impact of
adopting these standards and Note 12(a) regarding pro forma information which
gives effect to the impact of these accounting standards.
The Company operates in the managed health care industry and, through Health
Plans, is licensed by the States of Ohio and Indiana and the Commonwealth of
Kentucky to provide and administer managed health care products and services to
employer groups, individuals and government-sponsored beneficiaries primarily in
Southwestern Ohio, Southeastern Indiana and Northern Kentucky. In addition, the
Company provides claims administrative services and medical management services
for self-funded employers.
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39
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) CONSOLIDATION - The consolidated financial statements include the accounts
of the Company and its subsidiary, Health Plans. All significant
intercompany accounts and transactions have been eliminated.
(b) ESTIMATES - In preparing the consolidated financial statements in
conformity with generally accepted accounting principles, management has
made, where necessary, estimates and judgments based on currently available
information that affect certain of the amounts reflected in the
consolidated financial statements. Actual results could differ from those
estimates.
(c) CASH AND CASH EQUIVALENTS - Cash and cash equivalents include cash in the
bank and highly liquid investments with original maturities less than
ninety days. At December 31, 1996, repurchase agreements with two-day
maturities were executed with Fifth Third Bank ($5,800) and Star Bank, N.A.
($5,850). Each counterparty held collateral with a market value of
approximately 102% of the par amount of the repurchase agreement.
(d) HEALTH CARE RECEIVABLES - Health care receivables include amounts due under
administrative services contracts with certain employer groups and
contractual arrangements with the Company's reinsurer and pharmacy benefit
administrator.
(e) INVESTMENT SECURITIES - Investment securities consist primarily of U.S.
Treasury bonds and notes, mortgage-backed securities, investment grade
corporate bonds and shares of mutual funds that invest primarily in equity
securities.
Effective October 1, 1995, the Company adopted SFAS No. 115. The Company's
investment securities are classified as available-for-sale and are reported
at fair value in the accompanying Consolidated Balance Sheets, with the net
unrealized appreciation and/or depreciation reflected as a separate
component of shareholders' equity. The effect of the initial adoption of
SFAS No. 115 on shareholders' equity was immaterial. This statement was not
applicable to not-for-profit corporations.
Prior to October 1, 1995, debt securities were valued at the lower of
amortized cost or market. Equity and other investments were carried at the
lower of aggregate cost or market. Valuation reserves established to adjust
debt and short-term equity securities to market value and realized gains
and losses on the disposition of investments were recorded as components of
investment income.
The market value of investments is estimated based on published market
prices where available, or dealer quotes. The cost of investments sold is
determined on a specific identification basis.
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40
(f) PROPERTY AND EQUIPMENT - Property and equipment is carried at cost and is
comprised of the following:
DECEMBER 31,
1996 1995
---- ----
Office equipment $ 5,800 $ 5,532
Leasehold improvements 2,367 2,125
Computer hardware 3,640 4,201
Computer software 6,176 4,756
------- -------
17,983 16,614
Accumulated depreciation and amortization (8,447) (6,356)
------- -------
Property and equipment, net $ 9,536 $10,258
======= =======
Depreciation and amortization are computed using the straight-line method
over estimated useful service lives ranging from three to seven years.
(g) REVENUE RECOGNITION - Premiums are due monthly and are recognized as
revenue over the period for which the Company is obligated to provide
services to members. Premiums received prior to such period are recorded as
unearned premiums. Management services revenue is recognized in the period
the related services are performed.
(h) HEALTH CARE SERVICES - The Company's health care operations arrange for
comprehensive health care services to be provided to its members through
fee for service, case rate, per diem (per day) and capitation (a fixed
monthly payment) arrangements through contractual relationships with
physicians, hospitals and other ancillary service providers. To limit its
exposure to catastrophic health care services claims, the Company maintains
stop-loss insurance on inpatient hospital claims.
The Company's health care operations have various programs that provide
incentives to participating medical providers, including certain hospitals,
and the Company's pharmacy benefit administrator through the use of
risk/reward sharing arrangements and other programs. To fund amounts the
participating providers might ultimately owe the Company under these
programs, the Company withholds various percentages of certain claims
payments made to such participating medical services providers. The
ultimate payment to participating health care professionals of amounts
withheld is dependent upon factors such as their compliance with
Company-sponsored programs measuring quality, commitment and the cost of
health care, while ultimate payment to participating hospitals of amounts
withheld is dependent upon their performance against established cost of
hospital services and quality targets.
The expenses related to providing health care services, including the net
expenses incurred in connection with the aforementioned risk/reward sharing
and reinsurance arrangements, which are based in part on estimates, are
recorded in the period in which the related services are rendered,
including an estimate for claims incurred but not yet reported which is
actuarially determined based upon historical claims incurrence patterns,
membership levels and medical cost trends of the Company. Changes in
assumptions, as well as changes in actual experience, could cause these
estimates to change significantly in the near term. Adjustments to prior
periods' estimates are reflected in the current period.
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41
(i) MINIMUM NET WORTH REQUIREMENTS - Health Plans is subject to regulations in
conjunction with its licenses to operate in the States of Ohio and Indiana
and the Commonwealth of Kentucky, resulting in a restriction on this
subsidiary's net assets. Under the most restrictive state insurance
regulation, that of Indiana, Health Plans was required to maintain a
minimum statutory net worth balance of approximately $13,740 at December
31, 1996. Health Plans' statutory net worth at December 31, 1996 was
$34,145.
(j) STOCK OPTIONS - The Company utilizes the intrinsic value based method of
accounting prescribed by APB Opinion No. 25, "Accounting for Stock Issued
to Employees" to account for stock options granted during 1996. As such, no
compensation expense was recognized in connection with the stock options.
See Note 10(a) for discussion of the stock options granted and the
disclosures required by SFAS No. 123, "Accounting for Stock-Based
Compensation."
(k) INCOME TAXES - Effective October 1, 1995, the Company commenced operations
as a taxable corporation and adopted the provisions of SFAS No. 109. This
statement requires, in accordance with the liability method, deferred tax
recognition for all temporary differences between the tax and financial
reporting bases of assets and liabilities and requires adjustment of
deferred tax assets and liabilities for enacted changes in the tax law and
rates. The cumulative effect of adoption of SFAS No. 109 was not material
to the Company's consolidated financial statements, as the Company's net
deferred tax assets as of the date of adoption were fully reserved by a
valuation allowance of approximately $1,200.
The Company had previously operated as a tax exempt organization under
Section 501(c)(4) of the Internal Revenue Code through September 30, 1995.
Health Plans has been a for-profit corporation since its formation and has,
therefore, always been subject to income taxes. Prior to October 1, 1995,
Health Plans' income tax provisions were not material to the Company's
consolidated financial statements.
(l) EARNINGS PER SHARE - Earnings (loss) per share are based on the weighted
average number of shares of common stock outstanding during the periods and
the dilutive effect of the assumed exercise of stock options, if any.
(m) RECLASSIFICATIONS - Certain reclassifications have been made to the prior
year consolidated financial statements to conform with the current year
presentation.
NOTE 3. STOCK TRANSACTIONS
Pursuant to the Company's stock offering completed on May 1, 1996, 1,353 shares
of common stock were purchased by more than one thousand shareholders. Gross
proceeds from the offering totaled $13,529 and were reduced by $1,514 of
offering-related expenses, which were comprised of underwriting discounts and
commissions ($706) and other expenses incurred in connection with the offering
($808). The $12,015 of net proceeds are reflected within common stock in the
December 31, 1996 Consolidated Balance Sheet. The Foundation was issued 13,500
shares of the Company's common stock as part of the Restructuring. The
Shareholder Agreement between the Company and the Foundation prohibits the
Company from paying dividends on its common stock
41
42
until after March 15, 2001, unless the Company (i) has a registered underwritten
public offering of common shares in addition to the offering described above; or
(ii) sells at least 5% of its common shares to one investor. See Note 11(c) for
further discussion of the Shareholder Agreement.
NOTE 4. ASSIGNMENT OF MEDICAID CONTRACT
Effective June 30, 1996, the Company assigned its Medicaid provider agreement
with the Ohio Department of Human Services to a Columbus, Ohio-based health
maintenance organization. Consideration of $5,000 in cash was received,
resulting in a gain of $4,554, after deducting a provision of approximately $446
for expenses related to this transaction. During the years ended December 31,
1996, 1995 and 1994, the Company recognized premium revenues of approximately
$10,770, $14,450 and $11,665, respectively, related to members enrolled in its
Special Health Medicaid product.
NOTE 5. LITIGATION SETTLEMENT
In accordance with the 1988 settlement provisions of a lawsuit filed by a group
of participating and formerly participating physicians against the Company and
certain former officers(the "THOMPSON litigation"), on October 2, 1995, the
Company disbursed $28,000 of its cash and cash equivalents to fund the final
settlement. The amount was held in an escrow account until final disbursement to
the physician group occurred on February 20, 1996. In addition, $500 of
additional plaintiff attorneys' fees and incentive payments to the class
representatives was paid from the earnings on the $28,000 while it was in
escrow.
NOTE 6. INVESTMENTS AND STATUTORY DEPOSITS
The investment portfolio consists primarily of fixed income securities.
Accordingly, the value of the portfolio is subject to interest rate risk. This
risk may arise from changes in the level of market interest rates. If interest
rates increase, the market value of the portfolio may decrease. Also, the
portfolio is subject to reinvestment risk that once a security matures or is
sold, market conditions may dictate that the proceeds be reinvested at lower
interest rates. Changes in the level of interest rates may affect market
interest rates for residential mortgage loans. Accordingly, changes in interest
rates for such loans may affect levels of prepayments of the residential loans
that serve as collateral for the mortgage-backed securities. For example, if the
rates decrease, the level of prepayments may increase and subject the prepayment
proceeds to the reinvestment risk. For all periods presented, the Company's
mortgage-backed securities are comprised solely of Federal National Mortgage
Association, Government National Mortgage Association and Federal Home Loan
Mortgage Corporation securities.
The following tables summarize the unrealized gains and losses for investment
securities, all of which have been classified as available-for-sale under the
provisions of SFAS No. 115. For debt securities, the cost represents the
acquisition cost adjusted for the amortization of premiums and discounts.
42
43
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---- ----- ------ -----
DECEMBER 31, 1996
Debt Securities:
U.S. Treasury and Agency $43,354 $ 97 $(224) $43,227
Mortgage-Backed Securities 12,780 11 (209) 12,582
Corporate Obligations 275 1 (2) 274
------- ---- ----- -------
56,409 109 (435) 56,083
Mutual Funds - Equity Securities 14,097 296 (40) 14,353
------- ---- ----- -------
$70,506 $405 $(475) $70,436
======= ==== ===== =======
DECEMBER 31, 1995
Debt Securities:
U.S. Treasury and Agency $27,623 $ 775 $ -- $28,398
Mortgage-Backed Securities 21,895 317 (1) 22,211
Corporate Obligations 6,317 116 (6) 6,427
Other 3,702 38 (33) 3,707
------- ------ ------ -------
59,537 1,246 (40) 60,743
Mutual Funds - Equity Securities 12,653 17 (404) 12,266
------- ------ ------ -------
$72,190 $1,263 $ (444) $73,009
======= ====== ====== =======
The carrying amount and estimated fair value of debt securities as of December
31, 1996, based on contractual maturity, are shown below. Expected maturities
will differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.
CARRYING FAIR
AMOUNT VALUE
------ -----
Due after one year through five years $34,921 $34,931
Due after five years through ten years 8,708 8,570
Mortgage-Backed Securities 12,780 12,582
------- -------
$56,409 $56,083
======= =======
The components of investment income (loss), net, consisted of the following:
YEARS ENDED DECEMBER 31,
1996 1995 1994
---- ---- ----
Interest and dividend income, net of
management fees and expenses $4,842 $ 6,326 $ 5,092
Discount amortization, net 542 123 435
Gross gains on sale of investments 377 6,676 524
Gross losses on sale of investments (69) (740) (4,272)
Lower of cost or market adjustment -- -- (2,243)
------ ------- -------
$5,692 $12,385 $ (464)
====== ======= =======
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44
In addition to securities classified as current assets, classified in other
long-term assets on the accompanying Consolidated Balance Sheets are mutual fund
investments maintained by the Company in connection with a certain retirement
plan and an investment in a venture capital fund. Such mutual fund investments
had a cost and market value of $591 and $640, respectively, at December 31,
1996, and a cost and market value of $394 at December 31, 1995. At December 31,
1996 and 1995, the Company had invested $1,100 and $600, respectively, in the
venture capital fund, valued at cost in the accompanying Consolidated Balance
Sheets. At December 31, 1996, the Company's remaining commitment to the fund was
$900.
The states in which Health Plans holds an HMO license require varying amounts of
securities to be maintained on deposit for protection of Health Plans' members.
The Company maintained such statutory deposit investments having both an
amortized cost and market value of $755 at December 31, 1996, and a cost and
market value of $761 and $788, respectively, at December 31, 1995.
NOTE 7. CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject the Company to concentrations of
credit risk consist primarily of investments, commercial premiums receivable and
the amounts due from certain hospitals participating in the Company's
risk/reward sharing arrangement. The Company's investments are managed by
professional investment managers within the guidelines established by management
and the Board of Directors, which as a matter of policy, limit the amounts which
may be invested in any one issuer. Concentrations of credit risk with respect to
commercial premiums receivable are limited due to the large number of employer
groups located primarily in Cincinnati, Ohio, comprising the Company's
membership base. As described in Note 2(h), the Company substantially mitigates
its credit risk related to amounts due from the hospitals by withholding various
percentages of certain claims payments made to the hospitals.
NOTE 8. OTHER LIABILITIES
(a) VENDOR AGREEMENT - During 1996, the Company received $6,200 from one of its
medical management services vendors. This amount represents a portion of
the amounts previously paid by the Company to the vendor and an
approximation of the vendor's ChoiceCare-related outstanding claims
liabilities, which the Company may be obligated to satisfy in the event the
vendor were unable to satisfy such claims.
The Company's agreement with the aforementioned vendor to provide medical
management services is currently anticipated to terminate on June 30, 1997.
(b) DEBT FACILITY - On October 21, 1996, the Company entered into a $15,000
floating rate revolving credit agreement with a commercial bank. The credit
agreement includes, among other things, provisions which limit total
indebtedness, require a negative pledge of assets, require the maintenance
of certain liquidity ratios, and limit the amount of capital expenditures,
capital stock repurchases, asset sales and cash dividend payments by the
Company. There are no borrowings currently outstanding on the facility.
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45
NOTE 9. INCOME TAXES
At December 31, 1996, net deferred tax assets of $8,708 and $473 were included
in other current assets and other long-term assets, respectively, in the
accompanying Consolidated Balance Sheets; $1,382 and $813, respectively, at
December 31, 1995.
The significant components of the Company's net deferred tax assets are as
follows:
DECEMBER 31,
1996 1995
---- ----
Deferred tax assets:
Compensation and benefits $ 881 $ 508
Provider risk and incentive arrangements 2,674 1,077
Medical costs payable 6,314 1,154
Depreciation 841 685
State and local taxes 411 137
Other 927 224
------- -------
12,048 3,785
Valuation allowance (1,313) (1,313)
------- -------
10,735 2,472
------- -------
Deferred tax liabilities:
Provider risk and incentive arrangements 910 --
Other 644 277
------- -------
1,554 277
------- -------
Net deferred tax assets $ 9,181 $ 2,195
======= =======
During the three months ended December 31, 1995, the Company estimates that it
utilized all of the net operating loss carryforwards that had been previously
reported in tax returns filed by its for-profit subsidiary, Health Plans
(approximately $3,489).
The following tables present the summary of the provision for income taxes and
the reconciliation between the actual provision for income taxes and the
provision for income taxes at the U.S. federal statutory rate, respectively:
DECEMBER 31,
1996 1995
---- ----
Federal:
Current $ 9,317 $ 2,064
Deferred (6,571) (2,064)
------- -------
2,746 --
------- -------
State and local:
Current 566 131
Deferred (415) (131)
------- -------
151 --
------- -------
Provision for income taxes $ 2,897 $ --
======= =======
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46
DECEMBER 31,
1996 1995
---- ----
Provision (benefit) at federal statutory rate $2,643 $(5,220)
Effect of net loss incurred prior to
October 1, 1995 Restructuring (Note 1) -- 5,096
Provision (benefit) for state and local taxes,
net of federal taxes 100 (5)
Valuation allowance -- 117
Other 154 12
------ -------
Provision for income taxes $2,897 $ --
====== =======
The Company has requested a private letter ruling from the Internal Revenue
Service related to the establishment of the beginning tax bases of its assets
and liabilities upon conversion to a taxable entity. The current and deferred
tax provisions and the related deferred tax balances described above give no
effect to the possible receipt of a favorable ruling. In addition, long-term
liabilities in the December 31, 1996 Consolidated Balance Sheet include an
approximate $10,400 tax liability which was determined without giving effect to
the possible receipt of a favorable ruling; approximately $1,200 at December 31,
1995. Should a favorable ruling be received, deferred tax assets, net of any
necessary valuation allowance, would be increased and taxes payable recorded as
long-term liabilities would be decreased, the amounts of which would be
significant. Income taxes paid during the year ended December 31, 1996 totaled
$1,637.
NOTE 10. EMPLOYEE BENEFIT PLANS
(a) LONG TERM STOCK INCENTIVE PLAN - Pursuant to the Company's 1996 Long Term
Stock Incentive Plan (the "Stock Incentive Plan"), during 1996, options to
purchase shares of the Company's common stock at a price equal to the
market value at date of grant were granted to eligible employees. The
options granted have ten-year terms and become exercisable ratably over
either the three or four annual grant anniversary dates following the date
of grant, or upon a change in control, as defined in the Stock Incentive
Plan. The 1996 stock option activity is as follows:
WEIGHTED-AVERAGE
SHARES ----------------
UNDER EXERCISE REMAINING
OPTION PRICE LIFE (YRS.)
------ ----- -----------
Outstanding, December 31, 1995 --
Granted ($5.02 weighted-average
fair value per option) 1,177 $10.00
Forfeited (120) 10.00
-----
Outstanding, December 31, 1996
(none exercisable) 1,057 10.00 9.5
=====
At December 31, 1996, a total of 2,000 shares of the Company's common stock
were available for issuance under the Stock Incentive Plan, including 943
reserved for future grant.
46
47
The following pro forma net income and earnings per share give effect to
the fair value method of accounting for stock options prescribed by SFAS
No. 123 for the year ended December 31, 1996, the first year in which the
Company granted stock options:
Pro forma net income $3,949
Pro forma earnings per share
(primary and fully diluted) $ .28
The fair value of each option on the date of grant was estimated using the
Black-Scholes option-pricing model and the following weighted-average
assumptions: 1) interest rate of 6.98%; 2) expected life of ten years; and
3) zero dividend yield. A near-zero volatility assumption has been used due
to various restrictions on ownership which limit the transferability of the
stock.
(b) CASH INCENTIVE PLANS - The Company also has annual incentive plans
available to eligible employees and a long-term incentive plan (the "LTIP")
for certain employees, as designated by the Human Resources and
Compensation Committee of the Board of Directors. Although the LTIP was
replaced by the Stock Incentive Plan in 1996, the three-year terms of the
grants made under the LTIP will result in payments being made in 1997 and
1998. Payments made under both the annual incentive plans and the LTIP are
dependent upon the achievement of certain strategic goals and performance
measures. For the years ended December 31, 1996, 1995 and 1994, the Company
recorded expenses of $2,619, $3,908 and $2,503, respectively, relating to
these plans.
(c) EMPLOYEE RETIREMENT PLANS - The Company has a 401(k) savings plan which is
available to substantially all employees, in which the Company matches
contributions up to 3% of an employee's salary. The Company also has a
money purchase pension plan covering substantially all employees, which
provides for annual contributions by the Company equal to 5% of each
employee's salary up to the FICA limit, and 10% of salary above such limit.
Contributions under both plans are made subject to the limits established
in the Internal Revenue Code. For the years ended December 31, 1996, 1995
and 1994, the Company recorded expenses of $1,833, $1,421 and $1,259,
respectively, relating to its contributions to these plans.
The Company maintains a supplemental retirement plan (the "SERP") to
provide benefits in excess of amounts permitted under the provisions of
prevailing tax law. As of December 31, 1996, there has been only one
participant in the SERP. For the years ended December 31, 1996, 1995 and
1994, the Company recorded expenses of $120, $111 and $390, respectively,
relating to its contributions to the SERP.
NOTE 11. COMMITMENTS AND CONTINGENCIES
(a) EMPLOYMENT AGREEMENTS - The Company currently has in effect employment
agreements with certain of its executives which provide for severance
payments in the event that employment is terminated for reasons other than
for cause. Payments would include base pay plus incentives for a period of
six months to two years, depending upon the executive. The employment
agreements also contain a non-compete clause in which the executive may not
compete with the Company for a period of one year after the termination of
his or her employment with the Company.
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48
If a change in control (as defined in the employment agreements) is
followed within six months by a resignation or termination (as defined in
the employment agreements) of employment, such agreements provide for
payments to these executives of amounts ranging from one and one half to
three times their base salary plus budgeted incentives. The maximum
contingent liability of the Company pursuant to such agreements is
currently estimated at approximately $3,900.
(b) LITIGATION - The Company is routinely involved in litigation matters
arising in the normal course of business. Management believes, based upon
the advice of counsel, that these actions and proceedings and losses, if
any, resulting from the final outcome thereof, will not be material in the
aggregate to the Company's consolidated financial position. See Note 5 for
additional information related to litigation.
In 1994, the Company entered into an agreement with another managed care
entity to allow such entity to market the Company as its Cincinnati managed
care network and to allow the Company to offer certain of the entity's
products. A dispute arose over the arrangement and the agreement was
terminated in May 1995, resulting in a payment to the Company of $3,350 as
reimbursement for expenses incurred in 1994 and 1995 for negotiating and
implementing infrastructure changes to provide services under the
agreement, the cost of negotiating termination of the agreement and an
element of compensation for potential lost profits the Company may have
realized under the terms of the agreement. This amount is reported as other
income in the December 31, 1995 Consolidated Statement of Operations.
(c) COMMON STOCK REDEMPTION - In connection with the Company's offering for the
sale of common shares, the Company entered into a Shareholder Agreement
with the Foundation that grants the Foundation the right to request
redemption of up to $1,000 of its common shares per year for a ten-year
period. Such requested redemptions are subject to the Company meeting
certain financial tests and subject to the approval of the Company's Board
of Directors.
(d) LEASE OBLIGATIONS - The Company leases its office facilities, certain
office equipment and certain computer equipment under operating leases
expiring through the year 2001.
Future minimum lease payments for each of the five years ending December 31
are as follows:
1997 $3,695
1998 2,003
1999 1,181
2000 958
2001 610
------
Total minimum lease payments $8,447
======
The majority of the Company's office facilities are under a lease
arrangement that expires during February 1998. Currently, the Company is
considering entering into a ten-year lease agreement for a two hundred
thousand square foot stand-alone office facility in Cincinnati, Ohio.
Although terms of the lease are subject to negotiation, annual lease
payments are estimated to be approximately $2,125 per year.
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49
Total rent expense was approximately $3,061, $2,805 and $2,933 in 1996,
1995 and 1994, respectively.
(e) PREFERRED MEDICAL GROUPS - The Company has made commitments of $3,980 in
connection with its medical group assistance program, $1,914 of which has
been funded as of December 31, 1996.
NOTE 12. UNAUDITED PRO FORMA INFORMATION
(a) RESTRUCTURING - The pro forma information reflected in the accompanying
Consolidated Statements of Operations is presented solely to give effect to
the estimated provision for income taxes that would have been reported in
accordance with SFAS No. 109 had the Company filed federal, state and local
income tax returns as a for-profit corporation. The pro forma tax provision
is based on an assumed effective federal, state and local tax rate of
35.5%. The unaudited pro forma earnings per share information is based upon
13,500 issued and outstanding common shares at December 31, 1995.
The following condensed Pro Forma Statement of Operations presents the
Company's pro forma net income and earnings per share after giving effect
to (i) the application of SFAS No. 115 to the accounting for marketable
securities; (ii) a reduction in other expenses of $28,000 relating to the
settlement of the THOMPSON litigation; and (iii) the estimated provision
for income taxes that would have been reported in accordance with SFAS No.
109 had the Company filed income tax returns as a for-profit corporation
for the full twelve-month period.
YEAR ENDED DECEMBER 31, 1995
AS
HISTORICAL ADJUSTMENTS ADJUSTED
---------- ----------- --------
Operating revenues $ 282,840 $ -- $ 282,840
Operating expenses 285,928 -- 285,928
--------- -------- ---------
Operating loss (3,088) -- (3,088)
Investment income, net 12,385 (2,243) 10,142
Income from agreement termination 3,350 -- 3,350
Settlement expense (28,000) 28,000 --
--------- -------- ---------
Income (loss) before income taxes (15,353) 25,757 10,404
Provision for income taxes -- (3,693) (3,693)
--------- -------- ---------
Net income (loss) $ (15,353) $ 22,064 $ 6,711
========= ======== =========
Earnings per share (based upon
13,500 issued and outstanding
common shares) $ .50
=========
INVESTMENTS
Unaudited pro forma adjustments to net income for the year ended December
31, 1995 to reflect adoption of SFAS No. 115 decreased pretax net income by
$2,243. This amount represents the lower of cost or market reserve which,
under the Company's previous accounting policy, had been recorded as a
component of investment income and was subsequently reversed due to the
recovery in the investment values in 1995. Under SFAS No. 115, such market
value adjustments are recorded to equity.
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50
LITIGATION SETTLEMENT
As discussed in Note 5, $28,000 was accrued as settlement expense in 1995,
when payment of the THOMPSON litigation settlement was evaluated as
probable. The $28,000 settlement expense has been excluded from the
unaudited pro forma information because the amount is unrelated to the
Company's current operations.
INCOME TAXES
Effective October 1, 1995, the Company is subject to federal, state and
local income taxes on its taxable income.
The following is a summary of components of the pro forma provision for
income taxes in accordance with SFAS No. 109:
YEAR ENDED
DECEMBER 31,
1995
----
Federal:
Current $2,513
Deferred 850
------
3,363
------
State and local:
Current 160
Deferred 170
------
330
------
Pro forma provision for income taxes $3,693
======
(b) STOCK OFFERING - Had the shares issued as part of the Company's stock
offering discussed in Note 3 been outstanding from the beginning of the
year ended December 31, 1996, earnings per share for the year would have
been $.33, without giving pro forma effect to earnings on the proceeds.
50
51
CHOICECARE CORPORATION AND SUBSIDIARY
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CHOICECARE CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1996 AND THE
THREE MONTHS ENDED DECEMBER 31, 1995
(In thousands)
1996 1995
---- ----
(a) (a)
REVENUES $ -- $ --
------- -----
EXPENSES:
Selling, general and administrative expenses 91 13
------- -----
Total Operating Expenses 91 13
OPERATING LOSS (91) (13)
OTHER INCOME (EXPENSES):
Investment income, net 407 --
------- -----
INCOME (LOSS) BEFORE INCOME TAXES 316 (13)
PROVISION FOR INCOME TAXES 68 100
------- -----
NET INCOME (LOSS) BEFORE EQUITY IN INCOME
(LOSS) OF SUBSIDIARY 248 (113)
EQUITY IN INCOME (LOSS) OF SUBSIDIARY 4,628 (253)
------- -----
NET INCOME (LOSS) $ 4,876 $(366)
======= =====
See explanatory notes on page 53, Condensed Statements of Cash Flows.
51
52
CHOICECARE CORPORATION AND SUBSIDIARY
SCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CHOICECARE CORPORATION
CONDENSED BALANCE SHEETS
AS OF DECEMBER 31, 1996 AND 1995
(In thousands)
1996 1995
---- ----
(a) (a)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 11,884 $ --
Other current assets 117 455
-------- -------
Total Current Assets 12,001 455
INVESTMENT IN SUBSIDIARY 38,403 34,642
OTHER LONG-TERM ASSETS 315 406
-------- -------
Total Assets $ 50,719 $35,503
======== =======
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accrued liabilities $ 127 $ 100
Due to subsidiary 40 874
-------- -------
Total Liabilities 167 974
-------- -------
SHAREHOLDERS' EQUITY:
Preferred stock, without par value,
4,000 shares authorized; none issued -- --
Common stock, without par or stated value,
45,000 shares authorized; 14,853 shares
issued and outstanding at December 31, 1996
(13,500 at December 31, 1995) 12,014 --
Net unrealized gains (losses) on securities
available-for-sale (21) 846
Retained earnings 38,559 33,683
-------- -------
Total Shareholders' Equity 50,552 34,529
-------- -------
Total Liabilities and Shareholders' Equity $ 50,719 $35,503
======== =======
See explanatory notes on page 53, Condensed Statements of Cash Flows.
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53
CHOICECARE CORPORATION AND SUBSIDIARY
SCHEDULE I--CONDENSED FINANCIAL INFORMATI0N OF REGISTRANT
CHOICECARE CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1996 AND THE
THREE MONTHS ENDED DECEMBER 31, 1995
(In thousands)
1996 1995
---- ----
(a) (a)(b)
NET CASH FLOWS USED IN OPERATING ACTIVITIES $ (130) $ --
-------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock, net 12,015 --
Purchase of treasury stock (1) --
-------- -------
Net cash provided by financing activities 12,014 --
-------- -------
NET INCREASE IN CASH AND CASH EQUIVALENTS 11,884 --
CASH AND CASH EQUIVALENTS, beginning of year -- --
-------- -------
CASH AND CASH EQUIVALENTS, end of year $ 11,884 $ --
======== =======
NOTES:
(a) See Note 1 of Notes to Consolidated Financial Statements concerning the
October 1, 1995 restructuring, which explains the periods presented on
these ChoiceCare Corporation Condensed Financial Statements.
(b) Prior to the stock offering discussed in Note 3 of Notes to Consolidated
Financial Statements, ChoiceCare Corporation did not receive, disburse or
maintain any cash or cash equivalents. Cash payments relating to ChoiceCare
Corporation during the three month period ended December 31, 1995 were made
by ChoiceCare Health Plans, Inc. and a "due to subsidiary" liability
established, payment on which was made during 1996.
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54
CHOICECARE CORPORATION AND SUBSIDIARY
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(In thousands)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
-------- -------- -------- -------- --------
ADDITIONS
BALANCE AT CHARGED CHARGED BALANCE
BEGINNING TO COSTS TO OTHER AT END
DESCRIPTION OF PERIOD AND EXPENSE ACCOUNTS DEDUCTIONS OF PERIOD
----------- --------- ----------- -------- ---------- ---------
For the year ended
December 31, 1996:
Allowance for doubtful accounts
receivable $ 68 -- -- -- $ 68
For the year ended
December 31, 1995:
Allowance for doubtful accounts
receivable $ 68 -- -- -- $ 68
Investment valuation reserve 2,243 -- -- (2,243)(a) --
For the year ended December 31, 1994:
Allowance for doubtful accounts
receivable $ 96 10 -- (38)(b) $ 68
Investment valuation reserve -- 2,243 -- -- 2,243
NOTES:
(a) Results from the related investments being sold during the year.
(b) Represents uncollectible accounts charged off.
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55
CHOICECARE CORPORATION
INDEX OF EXHIBITS
EXHIBIT
NO. DESCRIPTION
------- -----------
* 3(i) Articles of Incorporation of ChoiceCare.
* 3(i)(A) Amendment to Articles of Incorporation of ChoiceCare.
* 3(ii) Regulations of ChoiceCare.
* 3(ii)(A) Amendment to Regulations of ChoiceCare.
3(ii)(B) Amendment to Regulations of ChoiceCare, dated May 8, 1996, incorporated herein by
reference to the Company's Form 8-A, dated March 24, 1997, and filed with the
Commission.
* 4 Specimen Common Share Certificate.
* 10(ii)(A)(1) Amended and Restated Employment Agreement between ChoiceCare and Daniel A. Gregorie,
M.D., dated as of January 25, 1996.
* 10(ii)(A)(2) Employment Agreement between ChoiceCare and Thomas D. Anthony, Esq., dated as of
January 1, 1996.
* 10(ii)(A)(3) Amended and Restated Employment Agreement between ChoiceCare and Jane E. Rollinson,
C.P.A., dated as of January 25, 1996.
* 10(ii)(A)(5) Amended and Restated Employment Agreement between ChoiceCare and Michael J. Barber,
M.D., dated as of January 25, 1996.
* 10(ii)(A)(6) Supplemental Executive Retirement Agreement between the Foundation (assumed by
ChoiceCare) and Daniel A. Gregorie, M.D., dated as of January 1, 1994.
* 10(ii)(A)(7) Shareholder Agreement of ChoiceCare Corporation between the Foundation and ChoiceCare,
dated as of January 25, 1996.
* 10(ii)(A)(8) Registration Rights Agreement between the Foundation and ChoiceCare, dated as of
January 25, 1996.
* # 10(ii)(B)(1) ChoiceCare -- The Health Alliance of Greater Cincinnati Hospital Participation
Agreement dated as of December 5, 1995.
* # 10(ii)(B)(2) ChoiceCare -- Tri Health, Inc. Hospital Participation Agreement dated as of December
14, 1995.
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56
CHOICECARE CORPORATION
INDEX OF EXHIBITS
(CONTINUED)
EXHIBIT
NO. DESCRIPTION
------- -----------
* 10(ii)(B)(4) Product Alliance Agreement among the Foundation and Bethesda Hospital Inc. and The
Good Samaritan Hospital of Cincinnati, Ohio, dated July 22, 1993.
* 10(ii)(B)(5) First Amendment to the Product Alliance Agreement among the Foundation and Bethesda
Hospital Inc. and The Good Samaritan Hospital of Cincinnati, Ohio, dated July 22, 1994.
* 10(ii)(B)(6) Compensation Agreement between the Foundation and Allianz Life Insurance Company of
North America, dated June 6, 1995.
* 10(ii)(B)(7) Reinsurance Agreement between the Foundation and Allianz Life Insurance Company of
North America, dated July 1, 1995.
* 10(ii)(B)(8) Reinsurance Agreement between the Foundation and Allianz Life Insurance Company of
North America, dated January 1, 1994.
* 10(ii)(B)(9) Reinsurance Agreement Renewal between the Foundation and Allianz Life Insurance
Company of North America, dated January 1, 1994.
* 10(ii)(B)(10) Reinsurance Agreement between the Foundation and Allianz Life Insurance Company of
North America, dated March 1, 1993.
* 10(ii)(B)(11) Agreement of Limited Partnership of The Woodlands/Essex Venture Fund III, L.P., dated
as of September 22, 1994.
10(ii)(B)(12) Diagnostic Imaging Services Agreement between Health Plans and Medicon, Inc., dated
April 1, 1996, incorporated herein by reference to the Company's Quarterly Report on
Form 10-Q, dated August 12, 1996, and filed with the Commission.
* 10(ii)(B)(12)(a) Supplemental Letter Agreement between Health Plans and Medicon, Inc., dated March 12, 1996.
* 10(ii)(B)(13)(a) Form of Provider Agreement-Individual.
* 10(ii)(B)(13)(b) Form of Provider Agreement-Group.
10(ii)(C)(1) Agreement to assign Medicaid provider agreement, between Health Plans and Health Power HMO,
Inc., dated April 9, 1996, incorporated herein by reference to the Company's Current Report on
Form 8-K, dated April 11, 1996, and filed with the Commission.
* 10(ii)(D)(1) Amended and Restated Lease Agreement between the Foundation and Corporex Properties,
Inc., dated February 27, 1992.
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57
CHOICECARE CORPORATION
INDEX OF EXHIBITS
(CONTINUED)
EXHIBIT
NO. DESCRIPTION
------- -----------
* 10(ii)(D)(2) Lease Agreement between the Foundation and CPX-Commercial Development Corporation,
dated May 1, 1994.
* 10(ii)(D)(3) Lease Agreement between the Foundation and CPX-Commercial Development Corporation,
dated May 1, 1994.
* 10(ii)(D)(4) Lease Agreement between the Foundation and Key Property Development Corporation, dated
April 1994.
* 10(iii)(A)(1) Executive Annual Incentive Plan.
* 10(iii)(A)(2) Executive Long-Term Incentive Plan.
* 10(iii)(A)(3) Voluntary Deferred Compensation Plan.
10(iii)(A)(4) 1996 Long Term Stock Incentive Plan, incorporated herein by reference to the Company's
Quarterly Report on Form 10-Q, dated May 14, 1996, and filed with the Commission.
21 List of Subsidiaries.
27 Financial Data Schedule.
- ---------------
* Incorporated herein by reference to the Company's Registration on Form S-1
(No. 33-99624) and filed with the Commission.
# Subject of a confidential treatment request filed with the Commission
pursuant to Item 601 of Regulation S-K.
57