- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------
FORM 10-Q
--------------
(MARK ONE)
/ X / QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______ TO ________.
COMMISSION FILE NUMBER: 1-10864
--------------
UNITED HEALTHCARE CORPORATION
State of Incorporation: MINNESOTA
I.R.S. Employer Identification No: 41-1321939
Principal Executive Offices:
300 OPUS CENTER
9900 BREN ROAD EAST
MINNETONKA MN, 55343
Telephone Number: (612) 936-1300
--------------
Indicate by check mark (x) 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 periods 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
--- ---
The number of shares of Common Stock, par value $.01 per share, outstanding on
August 12, 1998, was 195,331,294
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
UNITED HEALTHCARE CORPORATION
INDEX
Page
Number
-------
PART I. FINANCIAL INFORMATION.
ITEM I. FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidated Balance Sheets at June 30, 1998 and
December 31, 1997............................................... 3
Condensed Consolidated Statements of Operations for the three
and six month periods ended June 30, 1998 and
1997............................................................ 4
Condensed Consolidated Statements of Cash Flows for the six
month periods ended June 30, 1998 and 1997...................... 5
Notes to Condensed Consolidated Financial Statements............ 6
Report of Independent Public Accountants........................ 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.....................10
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK....................................................15
PART II. OTHER INFORMATION.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS...............16
ITEM 5. OTHER INFORMATION.......................................16
ITEM 6. EXHIBITS................................................16
Signatures...........................................................17
2
UNITED HEALTHCARE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
JUNE 30, DECEMBER 31,
1998 1997
------- ----------
ASSETS
Current Assets
Cash and Cash Equivalents......................... $ 663 $ 750
Short-Term Investments............................ 126 506
Accounts Receivable, net (Note 7)................. 1,219 768
Assets Under Management (Note 7).................. 1,069 28
Other Current Assets.............................. 178 141
-------- --------
Total Current Assets........................... 3,255 2,193
Long-Term Investments.................................. 3,280 2,785
Property and Equipment, net............................ 333 364
Goodwill and Other Intangible Assets, net
(Note 2)............................................ 2,020 2,281
-------- --------
TOTAL ASSETS........................................... $ 8,888 $ 7,623
-------- --------
-------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Medical Costs Payable (Notes 2 and 7)............. $ 2,817 $ 1,565
Other Policy Liabilities (Note 7)................. 460 235
Accounts Payable and Accrued Liabilities
(Notes 2 and 6) ................................ 792 495
Unearned Premiums................................. 167 275
-------- --------
Total Current Liabilities...................... 4,236 2,570
Long-Term Obligations.................................. 21 19
Convertible Preferred Stock............................ 500 500
-------- --------
Shareholders' Equity
Common Stock, $.01 par value - 500,000,000 shares
authorized; 193,440,000 and 191,111,000 issued and
outstanding....................................... 2 2
Additional Paid-in Capital........................ 1,449 1,398
Retained Earnings................................. 2,649 3,105
Net Unrealized Holding Gains on Investments
Available for Sale, net of income tax
effects......................................... 31 29
-------- --------
Total Shareholders' Equity.................... 4,131 4,534
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY............. $ 8,888 $ 7,623
-------- --------
-------- --------
See notes to condensed consolidated financial statements
3
UNITED HEALTHCARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- ------------------------
1998 1997 1998 1997
-------- -------- -------- --------
REVENUES
Premiums.............................................. $ 3,773 $ 2,501 $ 7,455 $ 4,945
Management Services and Fees.......................... 402 366 773 722
Investment and Other Income........................... 60 64 122 115
-------- -------- -------- --------
Total Revenues..................................... 4,235 2,931 8,350 5,782
-------- -------- -------- --------
OPERATING EXPENSES
Medical Costs (Note 2)................................ 3,435 2,119 6,587 4,183
Selling, General and Administrative Expenses.......... 706 592 1,418 1,167
Depreciation and Amortization......................... 48 35 90 69
Operational Realignment Charges (Note 2).............. 725 - 725 -
-------- -------- -------- --------
Total Operating Expenses............................ 4,914 2,746 8,820 5,419
-------- -------- -------- --------
EARNINGS (LOSS) BEFORE INCOME TAXES........................ (679) 185 (470) 363
(Provision) Benefit for Income Taxes (Note 3)......... 114 (69) 37 (138)
-------- -------- -------- --------
NET EARNINGS (LOSS)........................................ (565) 116 (433) 225
CONVERTIBLE PREFERRED STOCK DIVIDENDS...................... (7) (7) (15) (15)
-------- -------- -------- --------
NET EARNINGS (LOSS) APPLICABLE TO
COMMON SHAREHOLDERS........................................ $ (572) $ 109 $ (448) $ 210
-------- -------- -------- --------
-------- -------- -------- --------
BASIC NET EARNINGS (LOSS) PER COMMON
SHARE...................................................... $ (2.96) $ 0.58 $ (2.33) $ 1.13
-------- -------- -------- --------
-------- -------- -------- --------
NET EARNINGS (LOSS) PER COMMON SHARE, ASSUMING
DILUTION................................................... $ (2.96) $ 0.57 $ (2.33) $ 1.11
-------- -------- -------- --------
-------- -------- -------- --------
WEIGHTED-AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING................................................ 193 187 192 186
DILUTIVE EFFECT OF OUTSTANDING STOCK
OPTIONS.................................................... - 4 - 4
-------- -------- -------- --------
WEIGHTED-AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING, ASSUMING DILUTION............................. 193 191 192 190
-------- -------- -------- --------
-------- -------- -------- --------
See notes to condensed consolidated financial statements
4
UNITED HEALTHCARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
(UNAUDITED)
SIX MONTHS ENDED JUNE 30,
-------------------------
1998 1997
------- -------
OPERATING ACTIVITIES
Net Earnings (Loss)................................... $ (433) $ 225
Noncash Items:
Depreciation and Amortization...................... 90 69
Deferred Income Taxes.............................. (214) 45
Operational Realignment Charges.................... 725 -
Net Change in Other Operating Items:
Accounts Receivable and Other Current Assets....... (118) (57)
Medical Costs Payable.............................. 200 80
Accounts Payable and Other Current
Liabilities...................................... 109 (103)
Unearned Premiums.................................. (142) (126)
------- -------
Cash Flows From Operating Activities............ 217 133
------- -------
INVESTING ACTIVITIES
Cash Paid for Acquisition, net of cash assumed and
other effects...................................... (86) -
Purchases of Property and Equipment and Capitalized
Software, net....................................... (90) (90)
Purchases of Investments.............................. (1,976) (3,210)
Maturities / Sales of Investments..................... 1,867 2,708
------- -------
Cash Flows Used for Investing
Activities......................................... (285) (592)
------- -------
FINANCING ACTIVITIES
Proceeds from Stock Option Exercises.................. 73 52
Common Stock Repurchases.............................. (72) -
Dividends Paid........................................ (20) (20)
------- -------
Cash Flows (Used for) From Financing Activities.... (19) 32
------- -------
DECREASE IN CASH AND CASH EQUIVALENTS...................... (87) (427)
CASH AND EQUIVALENTS, BEGINNING OF PERIOD.................. 750 1,037
------- -------
CASH AND EQUIVALENTS, END OF PERIOD........................ $ 663 $ 610
------- -------
------- -------
See notes to condensed consolidated financial statements
5
UNITED HEALTHCARE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
Unless the context otherwise requires, the use of the terms the "Company,"
"we," "us," and "our" in the following refers to United HealthCare Corporation
and its subsidiaries.
The accompanying unaudited condensed consolidated financial statements reflect
all adjustments, consisting solely of normal recurring adjustments, needed to
present the financial results for these interim periods fairly. These
financial statements include some amounts that are based on our best estimates
and judgments. The most significant estimates relate to medical costs payable
and other policy liabilities, intangible asset valuations, integration reserves
relating to acquisitions, and reserves relating to our operational realignment
activities. These estimates may be adjusted as more current information
becomes available, and any adjustment could be significant.
Following the rules and regulations of the Securities and Exchange Commission,
we have omitted footnote disclosures that would substantially duplicate the
disclosures contained in the Company's annual audited financial statements.
Read together with the disclosures below, we believe the interim financial
statements are presented fairly. However, these unaudited condensed
consolidated financial statements should be read together with the consolidated
financial statements and the notes included in the Company's Annual Report on
Form 10-K for the year ended December 31, 1997.
2. SPECIAL OPERATING CHARGES
OPERATIONAL REALIGNMENT CHARGES
In January 1998, we introduced a significant realignment of our operations into
six independent but strategically linked business segments, each focused on
performance, growth and shareholder value. In the months that followed, we
began to realign our resources and activities; introduce new management
processes and policies; evaluate our business units and operations, market
positions and customer segments; and assess their strategic fit, operational
performance and contribution. We have moved forward to establish more
independent identities, brands and market positions for each of these segments.
We also have realigned significant personnel and activities from corporate
functions to more directly support the operations of our business segments, and
we have defined intersegment service arrangements and system platform and
process requirements to support each segment's markets and products.
In conjunction with these efforts, we developed and approved a comprehensive
plan (the Plan) to implement our operational realignment in the second
quarter of 1998, and we recognized corresponding charges to operations of
$725 million. The charges reflect the estimated costs we will incur
principally over the next twelve months under the Plan, including charges
associated with disposing or discontinuing business units, product lines, and
contracts; transitioning from and eliminating non-core system platforms; and
consolidating and eliminating certain processing operations and associated
real estate obligations. These activities are anticipated to result in a
reduction of more than 4,000 positions, potentially affecting approximately
7,000 people in various locations. The charges do not cover certain aspects
of the Plan, including new information systems and employee relocation and
training. These costs will be recognized in future periods as incurred.
The following table summarizes the components of the operational realignment
charges (in millions):
Asset write-downs $ 399
Severance and outplacement costs 142
Noncancellable lease obligations 82
Disposition of businesses and other costs 102
------
$ 725
------
------
6
The asset write-downs consist principally of intangibles and other long-lived
assets from businesses we intend to dispose of or discontinue, or markets
where we plan to curtail operations or change the nature of our operating
presence. The majority of these write-downs relate to businesses acquired
after 1994. We prepared a forecast of expected undiscounted cash flows, where
appropriate, to determine whether asset impairment existed, and we used fair
values to measure the required write-downs. In other instances, we determined
the extent of the write-downs based on a determination of the business unit's
fair value.
Our accompanying financial statements include the operating results of
businesses to be disposed of or discontinued in connection with the
operational realignment, as follows (in millions):
Three Months Ended Six Months Ended
June 30 June 30
------------------------ -------------------------
1998 1997 1998 1997
------- ------- ------- -------
Revenues $ 240 $ 208 $ 475 $ 401
Operating losses before income taxes $ (8) $ (16) $ (23) $ (23)
MEDICAL COSTS
Medical costs reported in the second quarter of 1998 included $120 million
relating to losses in certain underperforming Medicare markets and $55
million related to strengthening our reserves across certain health plan
markets, including those where the company may reposition and withdraw its
presence, in light of increasing pressure on medical cost trends at the end
of the second quarter. We incurred $38 million of these Medicare losses in
the second quarter, and accrued $82 million for the losses we expect to incur
over the remainder of 1998.
3. INCOME TAXES
The income tax benefit associated with the second quarter special operating
charges was $196 million. This benefit resulted in an overall effective
income tax benefit rate of 17% and 8% for the three and six months ended June
30, 1998.
4. TERMINATED ACQUISITION
In May 1998, we entered into an agreement to acquire Humana Inc. (Humana)
through the exchange of one share of Company common stock for every two
shares of Humana common stock. On August 10, 1998, the Company and Humana
mutually terminated the transaction. The costs we incurred associated with
the proposed transaction were charged against operations in the second
quarter of 1998.
5. STOCK REPURCHASE PROGRAM
Under our stock repurchase program, we may purchase up to 10% of our
outstanding common stock. Purchases may be made from time to time at prevailing
market prices, subject to certain restrictions on volume, pricing, and timing.
Repurchased shares will be available for reissuance for employee stock option
and purchase plans and for other corporate purposes. During the six-month
period ended June 30, 1998, we repurchased 1.2 million shares at an average
price of $59 per share. Shares issued under our stock plans over the same
period exceeded the number of shares repurchased.
6. CASH AND INVESTMENTS
As of June 30, 1998, the amortized cost, gross unrealized holding gains and
losses and fair value of cash and investments were as follows (in millions):
GROSS UNREALIZED GROSS UNREALIZED
AMORTIZED COST HOLDING GAINS HOLDING LOSSES FAIR VALUE
-------------- ---------------- ---------------- -----------
Cash and Cash Equivalents...................... $ 663 $ - $ - $ 663
Investments Available for Sale................. 3,282 50 (2) 3,330
Investments Held to Maturity................... 76 - - 76
-------- ----- ------ -------
Total Cash and Investments.................. $ 4,021 $ 50 $ (2) $ 4,069
-------- ----- ------ -------
-------- ----- ------ -------
7
7. AMERICAN ASSOCIATION OF RETIRED PERSONS CONTRACT
We began providing insurance products and services to the American Association
of Retired Persons (AARP) on January 1, 1998. Our portion of the AARP's
insurance program represents approximately $3.5 billion in annual net premium
revenue from more than 4 million AARP members. We also are developing an array
of new products and services designed to complement the insurance offerings
under the AARP program.
Under the terms of our 10-year agreement with the AARP, we receive monthly
fees for claim administrative services and as compensation for assuming the
underwriting risk associated with the program. In addition, the AARP has
separately contracted with certain vendors to provide marketing and member
services. We recognize premium revenues associated with the AARP program net of
the administrative fees paid to these vendors.
The following assets and liabilities were transferred from the program's
previous carrier and are included in our consolidated balance sheet (in
millions):
- ----------------------------------------------------------------------------------
Amounts
Description Transferred as of Balance as of
January 1, 1998 June 30, 1998
- ----------------------------------------------------------------------------------
Assets Under Management $ 959 $ 1,041
Accounts Receivable $ 300 $ 375
Medical Costs Payable $ 1,024 $ 1,074
Other Policy Liabilities $ 192 $ 229
Other Current Liabilities $ 43 $ 79
8. COMPREHENSIVE INCOME
The table below presents comprehensive income, defined as changes in the equity
of our business excluding charges resulting from investments by and
distributions to our shareholders, for the six-month periods ended June 30,
1998 and 1997 (in millions):
- -------------------------------------------------------------------------
1998 1997
- -------------------------------------------------------------------------
Net Earnings (Loss) $(433) $225
Change in Net Unrealized Holding Gains
on Investments Available for Sale, net of
income tax effects 2 9
- -------------------------------------------------------------------------
Comprehensive Income (Loss) $(431) $234
- -------------------------------------------------------------------------
9. RECENTLY ISSUED ACCOUNTING STANDARDS
In the fourth quarter of 1998, we will adopt a new accounting standard (SFAS
No. 131) that will require us to report financial and descriptive information
about our reportable operating segments. Generally, financial information will
be required to be reported on the basis that is used internally to evaluate
segment performance and allocate resources to segments. This new standard will
not affect how we determine net earnings or shareholders' equity.
In June 1998, a new standard on accounting for derivative instruments and
hedging activities (SFAS No. 133) was issued. This new standard will not
materially affect our financial results or disclosures given our current
investment portfolio and investment policies.
8
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To United HealthCare Corporation:
We have reviewed the accompanying condensed consolidated balance sheet of
United HealthCare Corporation (a Minnesota corporation) and Subsidiaries as of
June 30, 1998 and the related condensed consolidated statements of operations
and cash flows for the three and six month periods ended June 30, 1998 and
1997. These financial statements are the responsibility of the Company's
management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted
in accordance with generally accepted auditing standards, the objective of
which is the expression of an opinion regarding the financial statements taken
as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the financial statements referred to above for them to be in
conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated financial statements of United HealthCare
Corporation and Subsidiaries as of and for the year-ended December 31, 1997
(not presented herein), and, in our report dated February 12, 1998, we
expressed an unqualified opinion on those statements. In our opinion, the
information set forth in the accompanying condensed consolidated balance sheet
as of December 31, 1997, is fairly stated, in all material respects, in
relation to the consolidated balance sheet from which it has been derived.
Arthur Andersen LLP
Minneapolis, Minnesota,
August 6, 1998
9
UNITED HEALTHCARE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Unless the context otherwise requires, the use of the terms the "Company,"
"we," "us," and "our" in the following refers to United HealthCare Corporation
and its subsidiaries.
On January 1, 1998, we began delivering Medicare supplement insurance and
other medical insurance coverage for the American Association of Retired
Persons (AARP) to more than 4 million AARP members. In the second quarter of
1998, we recorded special operating charges related to our operational
realignment activities ($725 million) and certain medical cost items. The
significance of the AARP business and the special charges affects the
year-to-year comparability of our consolidated financial position and results
of operations. The Summary Operating Information below should be read
together with the narrative portions of Management's Discussion and Analysis
that more fully describe the specific effects of the AARP business and the
special charges.
The following discussion should be read together with the accompanying
condensed consolidated financial statements and notes. In addition, the
following discussion should be considered in light of a number of factors that
affect the Company, the industry in which we operate, and business generally.
These factors are described in Exhibit 99 to this Quarterly Report.
SUMMARY OPERATING INFORMATION
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
----------------------------------- -------------------------------
Operating Results (IN MILLIONS, EXCEPT PER PERCENT PERCENT
SHARE DATA) 1998 1997 CHANGE 1998 1997 CHANGE
- ------------------------------------------ ------- -------- ------- ------ -------- -------
Total Revenues..................................... $ 4,235 $ 2,931 44% $8,350 $ 5,782 44%
Earnings (Loss) from Operations................... $ (679) $ 185 (467)% $ (470) $ 363 (229)%
Net Earnings (Loss)................................ $ (565) $ 116 (587)% $ (433) $ 225 (292)%
Net Earnings (Loss) Per Common Share,
Assuming Dilution.................................. $ (2.96) $ 0.57 (619)% $(2.33) $ 1.11 (310)%
Medical Costs to Premium Revenues.................. 91.0% (a) 84.7% 88.4% (a) 84.6%
SG&A Expenses to Total Revenues.................... 16.7% 20.2% 17.0% 20.2%
JUNE 30, JUNE 30, PERCENT
Enrollment by Product (IN THOUSANDS) 1998 1997 CHANGE
- ------------------------------------ -------- -------- -------
Health Plan Products
Commercial......................................... 5,719 (b) 5,139 (b) 11%
Medicare........................................... 427 286 49%
Medicaid........................................... 511 483 6%
------ ------ ---
Total Health Plan Products...................... 6,657 5,908 13%
Other Network-Based Products............................ 4,906 (b) 4,594 (b) 7%
Indemnity Products...................................... 1,639 2,492 (34)%
------ ------ ---
Total Enrollment................................ 13,202 12,994 2%
------ ------ ---
------ ------ ---
JUNE 30, JUNE 30, PERCENT
Enrollment by Funding Arrangement (IN THOUSANDS) 1998 1997 CHANGE
- ------------------------------------------------ -------- -------- -------
Fully Insured
Health Plan Products............................... 5,693 5,042 13%
Other Network-Based Products....................... 503 496 1%
Indemnity Products................................. 319 492 (35)%
------ ------ ---
Total Fully Insured............................. 6,515 6,030 8%
------ ------ ---
Self-Funded
Health Plan Products............................... 964 866 11%
Other Network-Based Products....................... 4,403 4,098 7%
Indemnity Products................................. 1,320 2,000 (34)%
------ ------ ---
Total Self Funded............................... 6,687 6,964 (4)%
------ ------ ---
Total Enrollment.............................. 13,202 12,994 2%
------ ------ ---
------ ------ ---
(a) Includes $120 million related to certain Medicare markets and $55
million related to reserve strengthening associated with increasing pressure
on medical cost trends.
(b) In conjunction with the realignment of our operations, small group and
middle market point-of-service membership, previously classified as other
network based products, are now being presented with our commercial health plan
products (867,000 members at June 30, 1998 and 756,000 members at June 30,
1997).
10
RESULTS OF OPERATIONS
SPECIAL OPERATING CHARGES
OPERATIONAL REALIGNMENT CHARGES
In November 1997, we embarked on a course to realign our business
operationally. Many factors, both strategic and operational, drove this
decision. Among them was a recognition that we have grown significantly over
the last several years and, as a result, have redundant systems, offices and
enterprises that are no longer core to our future strategy. We concluded that
an operational realignment would be required to improve our customer support
and reduce our cost structure.
In January 1998, we introduced a significant realignment of our operations
into six independent but strategically linked business segments, each focused
on performance, growth and shareholder value. In the months that followed, we
began to realign our resources and activities; introduce new management
processes and policies; evaluate our business units and operations, market
positions and customer segments; and assess their strategic fit, operational
performance and contribution. We have moved forward in establishing more
independent identities, brands and market positions for each of these segments.
We also have realigned significant personnel and activities from corporate
functions to more directly support the operations of our business segments, and
have defined intersegment service arrangements and system platform and process
requirements to support each segment's markets and products.
In conjunction with these efforts, we developed and introduced a
comprehensive plan (the Plan) to implement our operational realignment in the
second quarter of 1998, and we recognized corresponding charges to operations
of $725 million. The charges reflect the estimated costs we will incur
principally over the next twelve months under the Plan, including charges
associated with disposing or discontinuing business units, product lines, and
contracts; transitioning from and eliminating non-core system platforms; and
consolidating and eliminating certain processing operations and associated
real estate obligations. These activities are anticipated to result in a
reduction of more than 4,000 positions potentially affecting approximately
7,000 people in various locations. We believe the aggregate reduction in our
overall cost structure from our realignment will reach an annual run rate of
approximately $300 million. We expect to realize $125 to $150 million of
these reductions by the end of 1999 and $225 million to $250 million by the
end of year 2000. The charges do not cover certain aspects of the Plan,
including new information systems and employee relocation and training.
These costs will be recognized in future periods as incurred.
MEDICAL COSTS
During the second quarter, we considered many factors influencing medical
cost trends. On balance, we believe that we can respond to factors that
increase medical cost trends and price our products and services sufficient
to realize satisfactory margins. While half of our Medicare business remains
solidly profitable, certain of our markets are not profitable. This
unprofitable Medicare business generally resides in newer markets where we
have been unable to achieve the scale necessary to achieve profitability. As
a result of these factors, medical costs reported in the second quarter of
1998 included $120 million relating to losses in certain underperforming
Medicare markets and $55 million related to strengthening our reserves across
certain health plan markets, including those where the company may reposition
and withdraw its presence, in light of increasing pressure on medical cost
trends at the end of the second quarter. We incurred $38 million of these
Medicare losses in the second quarter, and accrued $82 million for the losses
we expect to incur over the remainder of 1998.
PREMIUM REVENUES
Premium revenues in the second quarter of 1998 totaled $3.8 billion, an
increase of $1.3 billion, or 51%, over the second quarter of 1997. For the six
months ended June 30, 1998, premium revenues of $7.5 billion increased $2.5
billion, or 51% over the same period in 1997. On January 1, 1998, we began
delivering Medicare supplement insurance and other medical insurance coverage
for the American Association of Retired Persons (AARP) to more than 4 million
AARP members. Premium revenues from our portion of the AARP insurance
offerings during the first six months of 1998 were $1.8 billion.
Excluding the AARP business, second quarter 1998 premium revenues totaled
$2.9 billion, an increase of 16% over second quarter 1997. For the six months
ended June 30, 1998, premium revenues excluding the AARP business were $5.7
billion, an increase of 15% over the same period in 1997. This increase is
primarily the result of growth in year-over-year same-store health plan premium
revenues of $898 million, or 22%, through the second quarter of 1998.
Increases in the health plan premium revenue reflect same-store enrollment
growth of 13% and an average year-over-year premium rate increase on renewing
commercial groups exceeding 6%. Growth in our Medicare programs also
contributed to the increase in premium revenues. The total health plan same-
store enrollment growth of 13% includes a year-over-year same-store increase of
49% in Medicare enrollment. Significant growth in Medicare enrollment affects
11
year-over-year comparability of premium revenues. The Medicare product
generally has per member premium rates three to four times higher than average
commercial premium rates because Medicare members typically use proportionately
more medical care services.
The six-month year-over-year increase in premium revenues from health plan
operations was partially offset by an expected decrease in premium revenues
from fully insured non-network-based indemnity products of $82 million. Nearly
$60 million of this decrease is because we discontinued our relationship with a
broker who sold and administered small group indemnity business on our behalf,
which led to the loss of 30,000 indemnity members effective July 1, 1997. The
remaining decrease is from declining enrollment in these products, due to rate
increases averaging 10% to 20% in 1997 and into 1998, as well as other business
factors. We expect enrollment in the non-network-based indemnity products will
continue to decline through 1998. To the extent possible, we will try to
convert these members to our network-based managed care products.
MEDICAL COSTS
Medical costs reported in the second quarter of 1998 include $175 million of
charges. Of this amount $120 million relates to losses we expect to incur
related to 13 of our 22 Medicare health plans which contribute half of our
annualized Medicare premiums of $2.3 billion. We incurred $38 million of
these losses in the second quarter, and accrued $82 million for the losses we
expect to incur over the remainder of 1998. These plans are generally located
in newer markets where we have been unable to achieve the scale of operations
necessary to achieve profitability. An additional $55 million related to
strengthening our reserves across certain health plan markets, including
those where the company may reposition or withdraw its presence, in light of
increasing pressure on medical cost trends at the end of the second quarter.
Our medical care ratio (the percent of premiums expensed as medical costs)
increased from 84.7% in the second quarter of 1997, and 85.6% in the first
quarter of 1998, to 91.0% in the second quarter of 1998. The year-over-year
increase includes the effects of the AARP business on our medical care ratio.
We report a medical care ratio of nearly 92% related to our portion of the
AARP insurance offerings, which we began delivering on January 1, 1998. The
increase in the medical care ratio over the first quarter reflects the
medical cost adjustments discussed above. Lower margins in our nine other
Medicare health plans also adversely affected the medical core ratio. While
these plans are profitable, average Medicare premium rate increases of 2.5%
in these plans were more than offset by increased medical utilization,
reflected mostly in inpatient hospital costs. Performance in a few of our
commercial health plans lagged behind the performance of our remaining
commercial health plans and modestly contributed to the increased medical
care ratio.
We are addressing the medical cost trend by altering benefit designs,
recontracting with providers and further enhancing disease specific and local
medical management programs. We are also accelerating and intensifying the
contemporaneous and retrospective claim management activities that we have in
place. We are continuing to evaluate the markets we serve and products we
offer and will curtail activities or exit markets where we believe near term
prospects are unacceptable. We believe these efforts will help us to maintain
an aggregate medical cost trend in the 3.5% to 4.5% range in the face of a
rising national cost trend that could exceed 5.0% in 1999. We have considered
known and anticipated medical inflation in our product pricing for 1998 and
1999.
MANAGEMENT SERVICES AND FEE REVENUES
Management services and fee revenues during the three months and six months
ended June 30, 1998, totaled $402 million and $773 million, which represented
increases of $36 million and $51 million, respectively, over management
services and fee revenues for the same periods in 1997. These revenues are
primarily generated from self-funded products where we receive a fee for
administrative services and generally assume no financial responsibility for
health care costs. In
12
addition, we generate fee revenues from administrative services we perform on
behalf of managed health plans and for services provided by our specialty
businesses.
The overall increase in management services and fee revenues is due to
enrollment growth within our managed health plans and an increase in
individuals served by our specialty services operations, most notably in
United Behavioral Health and Optum-Registered Trademark-, our telephone- and
Internet-based health information and personal care management business.
These increases are partially offset by the effects of our June 30, 1997 sale
of our subsidiary, United HealthCare Administrators, Inc., which resulted in
a $24 million decrease in these revenues for the first six months of 1998,
compared to 1997.
OPERATING EXPENSES
Selling, general and administrative expenses as a percent of total revenues
(the SG&A ratio) decreased from 20.2 % during the second quarter of 1997 to
17.3% during the first quarter of 1998, and decreased again to 16.7% during the
second quarter of 1998. The improvement in the SG&A ratio reflects the
operating leverage we gained with the addition of the AARP business, as well as
our diligence in managing these expenses. On an absolute dollar basis,
selling, general and administrative costs through the first half of 1998
increased $251 million, or 22%, over the comparable period in 1997. This
increase reflects the additional costs to support the corresponding $2.6
billion increase in revenues, as well as our additional investment in future
growth platforms.
GOVERNMENT REGULATION
Our primary business, offering health care coverage and health care
management services, is heavily regulated at the federal and state levels. We
strive to comply in all respects with applicable regulations and may need to
make changes from time to time in our services, products, marketing methods or
organizational or capital structure.
Regulatory agencies generally have broad discretion to issue regulations and
interpret and enforce laws and rules. Changes in applicable laws and
regulations are continually being considered, and the interpretation of
existing laws and rules also may change from time to time. These changes could
affect our operations and financial results.
Certain proposed changes in Medicare and Medicaid programs may improve
opportunities to enroll people under products developed for these populations.
Other proposed changes could limit available reimbursement and increase
competition in those programs, with adverse affects on our financial results.
Also, it could be more difficult for us to control medical costs if federal and
state bodies continue to consider and enact significant and onerous managed
care laws and regulations.
The Health Insurance Portability and Accountability Act of 1996 (HIPAA) may
represent the most significant federal reform of employee benefit law since the
enactment of the Employee Retirement Income Security Act (ERISA) in 1974. Some
of HIPAA's significant provisions include guaranteeing the availability of
health insurance for certain employees and individuals, limits on the use of
preexisting condition exclusions, prohibitions against discriminating on a
basis of health status, and requirements that make it easier to continue
coverage in cases where a person is terminated or changes employers. Under
HIPAA and other similar state laws, medical cost control through amended
provider contracts and improved preventive and chronic care management may
become more important. We believe our experience in these areas will allow us
to compete effectively.
Health care fraud and abuse has become a top priority for the nation's law
enforcement entities, which have focused on participants in federal government
health care programs such as Medicare, Medicaid and the Federal Employees
Health Benefits Program (FEHBP). We participate extensively in these programs.
We also are subject to governmental investigations and enforcement actions.
Included are actions relating to ERISA, which regulates insured and self-
insured health coverage plans offered by employers;
13
the FEHBP; federal and state fraud and abuse laws; and laws relating to care
management and health care delivery. Government actions could result in
assessment of damages, civil or criminal fines or penalties, or other
sanctions, including exclusion from participation in government programs. We
currently are involved in various government investigations and audits, but
we do not believe the results will have a material adverse effect on our
financial position or results of operations.
INFLATION
Although the general rate of inflation has remained relatively stable and
health care cost inflation has stabilized in recent years, the national health
care cost inflation rate still exceeds the general inflation rate. We use
various strategies to mitigate the negative effects of health care cost
inflation, including setting commercial premiums based on anticipated health
care costs, risk-sharing arrangements with various health care providers, and
other health care cost containment measures. Specifically, health plans try to
control medical and hospital costs through contracts with independent providers
of health care services. Through these contracted care providers, our health
plans emphasize preventive health care and appropriate use of specialty and
hospital services.
While we currently believe our strategies to mitigate health care cost
inflation will continue to be successful, competitive pressures, new health
care product introductions, demands from health care providers and customers,
applicable regulations or other factors may affect our ability to control the
impact of health care cost increases. In addition, certain non-network-based
products do not have health care cost containment measures similar to those in
place for network-based products. As a result, there is added health care cost
inflation risk with these products.
FINANCIAL CONDITION AND LIQUIDITY
Cash and investments at June 30, 1998, were $4.1 billion, a $28 million
increase from December 31, 1997 and a $71 million increase from March 31, 1998.
Through the second quarter of 1998, we generated cash from operations of $217
million and realized proceeds from stock option exercises and the sale of
property and equipment of $103 million. In the same period, we used nearly $300
million in cash for capital expenditures, acquisitions, common stock
repurchases, and dividends.
Under applicable government regulations, several subsidiaries are required to
maintain specific capital levels to support their operations. After taking
these regulations and certain business considerations into account, we had $856
million in cash and investments available for general corporate use at June 30,
1998.
The National Association of Insurance Commissioners is expected to adopt
rules which, if implemented by the states, would require new minimum
capitalization limits for health care coverage provided by insurance companies,
HMOs and other risk-bearing health care entities. The requirements would take
the form of risk-based capital rules. Depending on the nature and extent of
the new minimum capitalization requirements ultimately adopted, there could be
an increase in the capital required for certain of our subsidiaries. We do not
expect a significant increase in the overall capital required by our regulated
entities. Any increase would be funded from our corporate usable cash
reserves. The new requirements are expected to be effective December 31, 1998.
We are in the process of modifying our computer systems to accommodate the
Year 2000. We currently expect these modifications to be completed well in
advance of the Year 2000 with no adverse effect on our operations. We expect
to incur associated expenses of approximately $20 million in 1998 and $15
million in 1999 to complete this effort. Our inability to complete Year 2000
modifications on a timely basis or the inability of other companies with which
we do business to complete their Year 2000 modifications on a timely basis
could adversely affect our operations.
Under our stock repurchase program, we may purchase up to 10% of our
outstanding common stock. Purchases may be made from time to time at
prevailing market prices, subject to certain restrictions relating to volume,
pricing and timing. The repurchased shares will be available for reissuance
14
through employee stock option and purchase plans and for other corporate
purposes. During the first six months of 1998, we repurchased 1.2 million
shares at an average price of $59 per share. Shares issued under our stock
plans over the same period have exceeded the number of shares repurchased.
In January 1998, we filed a shelf registration statement with the
Securities and Exchange Commission to sell as much as $200 million of debt
securities, and preferred shares or common shares. The shelf filing
registers the securities and allows us to sell them from time to time in the
event we need financing. Proceeds from sales of these securities may be used
for a variety of general corporate purposes, including working capital,
securities repurchases and acquisitions.
Effective October 1, 1998, we have the right to redeem in whole or in part
the 500,000 outstanding shares of our 5.75% Series A Convertible Preferred
Stock (the Preferred Stock) at certain defined redemption rates. The initial
aggregate redemption price of the Preferred Stock would be $520 million, or
$1,040 per share.
In June 1998, we agreed to acquire HealthPartners of Arizona, Inc. for $235
million in cash, subject to regulatory approvals. We expect the transaction
will close in the third quarter of 1998.
In the second quarter of 1998, we recognized special charges to operations
of $725 million associated with the implementation of our operational
realignment and certain medical cost adjustments of $175 million. We believe
our after tax cash outlay associated with these charges will be in the range
of $225 million to $275 million over the next twelve months.
We expect our available cash resources will be sufficient to meet our current
operating requirements and internal development and realignment initiatives.
In addition, based on our current financial condition and results of
operations, we should be able to finance additional cash requirements in the
public or private markets, if necessary.
Currently, we do not have any other material definitive commitments that
require cash resources; however, we continually evaluate opportunities to
expand our operations. This includes internal development of new products and
programs and may include acquisitions.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Since the date of the Company's Quarterly Report filed on Form 10-Q for the
quarter ended March 31, 1998, no material changes have occurred in the
Company's exposure to market risk associated with the Company's investments
in market risk sensitive financial instruments. The Company does not believe
that its risk of a loss in future earnings, fair values or cash flow
attributable to such investments is material.
15
UNITED HEALTHCARE CORPORATION
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The Company exchanged 210,675 shares of its common stock for all of the
outstanding capital stock of Insite Clinical Trials, LLC in a transaction that
closed on May 1, 1998. The Company issued these shares in reliance on Section
4(2) of the Securities Act of 1933. The Company made inquiries of the
recipients of securities in this transaction and obtained representations from
such persons to establish that such issuance qualified for an exemption from
the registration requirements.
ITEM 5. OTHER INFORMATION
The Company and Humana Inc. ("Humana") announced on August 10, 1998 the
mutual agreement to terminate the previously announced merger of the two
companies. The termination of the merger was approved by the boards of
directors of the Company and Humana. The Termination Agreement, dated August
9, 1998, by and among the Company, UH-1 Inc., a wholly owned subsidiary of
the Company, and Humana, is included as Exhibit 10e to this Form 10-Q.
ITEM 6. EXHIBITS
(a) The following exhibits are filed in response to Item 601 of Regulation S-K.
EXHIBIT
NUMBER DESCRIPTION
- ------------- -------------------------------------------------------------
Exhibit 10(a) - First Amendment to the AARP Health Insurance Agreement by and
among American Association of Retired Persons, Trustees of the
AARP Insurance Plan and United HealthCare Insurance Company
effective January 1, 1998.*
Exhibit 10(b) - Second Amendment to the AARP Health Insurance Agreement by and
among American Association of Retired Persons, Trustees of the
AARP Insurance Plan and United HealthCare Insurance Company
effective January 1, 1998.*
Exhibit 10(c) - Employment Agreement, dated as of May 20, 1998, between United
HealthCare Services, Inc. and R. Channing Wheeler.
Exhibit 10(d) - Employment Agreement, dated as of May 19, 1998, between United
HealthCare Services, Inc. and Arnold H. Kaplan.
Exhibit 10(e) - Termination Agreement, dated August 9, 1998, by and among
the Company, UH-1 Inc., a wholly owned subsidiary of the
Company, and Humana.
Exhibit 15 - Letter Re Unaudited Interim Financial Information
Exhibit 99 - Cautionary Statements.
* Pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended,
portions of these amendments have been omitted and filed separately with the
Securities and Exchange Commission in connection with a confidential
treatment request.
(b) The Company filed the following reports on Form 8-K during the three month
period ended June 30, 1998.
1. Form 8-K Dated May 29, 1998. The items reported were items 5 and 7
concerning the announcement of the Agreement and Plan of Merger entered
into by and among the Company, Humana Inc. and UH-1 Inc., a wholly owned
subsidiary of the Company.
2. Form 8-K Dated June 11, 1998. The items reported were items 5 and 7
concerning the announcement of the agreement entered into between the
Company and HealthPartners of Arizona, Inc., pursuant to which the
Company will acquire HealthPartners.
16
UNITED HEALTHCARE CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
UNITED HEALTHCARE CORPORATION
/s/ STEPHEN J. HEMSLEY Chief Operating Dated: August 14, 1998
- ------------------------------- Officer
Stephen J. Hemsley
/s/ GREGORY J. SPRINGER Chief Accounting Dated: August 14, 1998
- ------------------------------- Officer
Gregory J. Springer
17
UNITED HEALTHCARE CORPORATION
EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- ------------- -------------------------------------------------------------
Exhibit 10(a) - First Amendment to the AARP Health Insurance Agreement by and
among American Association of Retired Persons, Trustees of the
AARP Insurance Plan and United HealthCare Insurance Company
effective January 1, 1998.*
Exhibit 10(b) - Second Amendment to the AARP Health Insurance Agreement by and
among American Association of Retired Persons, Trustees of the
AARP Insurance Plan and United HealthCare Insurance Company
effective January 1, 1998.*
Exhibit 10(c) - Employment Agreement, dated as of May 20, 1998, between United
HealthCare Services, Inc. and R. Channing Wheeler.
Exhibit 10(d) - Employment Agreement, dated as of May 19, 1998, between United
HealthCare Services, Inc. and Arnold H. Kaplan.
Exhibit 10(e) - Termination Agreement, dated August 9, 1998, by and among
the Company, UH-1 Inc., a wholly owned subsidiary of the
Company, and Humana.
Exhibit 15 - Letter Re Unaudited Interim Financial Information
Exhibit 99 - Cautionary Statements.
* Pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended,
portions of these amendments have been omitted and filed separately with the
Securities and Exchange Commission in connection with a confidential
treatment request.
18