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| WLP > SEC Filings for WLP > Form 10-Q on 28-Oct-2009 | All Recent SEC Filings |
28-Oct-2009
Quarterly Report
References to the terms "we", "our" or "us" used throughout this Management's Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, refer to WellPoint, Inc., an Indiana corporation, and unless the context otherwise requires, its direct and indirect subsidiaries.
Certain prior year amounts have been reclassified to conform to current year presentation.
The structure of our MD&A is as follows:
II. Overview
III. Significant Events
IV. Membership - September 30, 2009 Compared to September 30, 2008
VI. Results of Operations - Three Months Ended September 30, 2009 Compared to the Three Months Ended September 30, 2008
VII. Results of Operations - Nine Months Ended September 30, 2009 Compared to the Nine Months Ended September 30, 2008
VIII. Critical Accounting Policies and Estimates
IX. Liquidity and Capital Resources
X. Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995
This MD&A should be read in conjunction with our audited consolidated financial statements as of and for the year ended December 31, 2008 and the MD&A included in our 2008 Form 10-K, and in conjunction with our unaudited consolidated financial statements and accompanying notes as of and for the three and nine months ended September 30, 2009 included in this Form 10-Q. Results of operations, cost of care trends, investment yields and other measures for the three and nine months ended September 30, 2009 are not necessarily indicative of the results and trends that may be expected for the full year ending December 31, 2009.
I. Executive Summary
We are the largest health benefits company in terms of medical membership in the United States, serving 33.9 million medical members as of September 30, 2009. We are an independent licensee of the Blue Cross and Blue Shield Association, or BCBSA, an association of independent health benefit plans. We serve our members as the Blue Cross licensee in California and as the Blue Cross and Blue Shield, or BCBS, licensee for: Colorado, Connecticut, Georgia, Indiana, Kentucky, Maine, Missouri (excluding 30 counties in the Kansas City area), Nevada, New Hampshire, New York (as BCBS in 10 New York City metropolitan and surrounding counties, and as Blue Cross or BCBS in selected upstate counties only), Ohio, Virginia (excluding Northern Virginia suburbs of Washington, D.C.) and Wisconsin. In a majority of these service areas we do business as Anthem Blue Cross, Anthem Blue Cross Blue Shield or Empire Blue Cross Blue Shield (in our New York service areas). We also serve customers throughout the country as UniCare. We are licensed to conduct insurance operations in all 50 states through our subsidiaries.
Operating revenue for the three months ended September 30, 2009 was $15.2 billion, a decrease of $0.1 billion, or 1%, compared to the three months ended September 30, 2008. These decreases were primarily due to
fully-insured membership declines across our Commercial and Consumer businesses resulting from the current economic conditions, as well as our strategic withdrawal from certain State-Sponsored programs. These decreases were partially offset by premium rate increases for all medical lines of business and increased reimbursement in the Federal Employees Program, or FEP.
Operating revenue for the nine months ended September 30, 2009 was $45.8 billion, a decrease of $0.4 billion, or 1%, compared to the nine months ended September 30, 2008. These decreases were primarily due to fully-insured membership declines across our Commercial and Consumer businesses resulting from the current economic conditions, as well as our strategic withdrawal from certain State-Sponsored programs. These decreases were partially offset by premium rate increases for all medical lines of business and increased reimbursement in the FEP program.
Net income for the three months ended September 30, 2009 was $730.2 million, a decrease of $90.5 million, or 11%, compared to the three months ended September 30, 2008. The declines in net income were primarily driven by increased income tax expense, partially due to Internal Revenue Service, or IRS, settlements in 2008, increased administrative expenses, reduced operating revenue and increased intangible asset impairments, partially offset by lower other-than-temporary impairment losses recognized in income and lower benefit expense.
Net income for the nine months ended September 30, 2009 was $2.0 billion, a decrease of $155.2 million, or 7%, as compared to the nine months ended September 30, 2008. The declines in net income were primarily driven by increased income tax expense, partially due to IRS settlements in 2008, increased administrative expenses, reduced operating revenue, decreased net realized gains on investments and increased intangible asset impairments, partially offset by lower benefit expense and lower other-than-temporary impairment losses recognized in income.
Our fully-diluted earnings per share, or EPS, was $1.53 for the three months ended September 30, 2009, which included $0.03 income per share of net realized gains on investments and other-than-temporary impairment losses recognized in income and $0.28 loss per share from intangible asset impairments, and was a 4% decrease from the EPS of $1.60 for the three months ended September 30, 2008, which included $0.90 per share income from tax benefits, primarily from settlements with the IRS, $0.71 loss per share in net realized losses on investments and other-than-temporary impairment losses recognized in income, and $0.17 per share loss from intangible asset impairments. The decrease in EPS resulted primarily from lower net income partially offset by the lower number of shares outstanding in 2009 due to share buy back activity under our share repurchase program.
Our fully-diluted EPS was $4.12 for the nine months ended September 30, 2009, which included $0.52 loss per share of net realized gains on investments and other-than-temporary impairment losses recognized in income and $0.28 loss per share from intangible asset impairments, and was a 1% increase over the EPS of $4.09 for the nine months ended September 30, 2008, which included $0.90 per share income from tax benefits, primarily from settlements with the IRS, $0.78 loss per share in net realized losses on investments and other-than-temporary impairment losses recognized in income, and $0.17 per share loss from intangible asset impairments. The increase in EPS resulted primarily from the lower number of shares outstanding in 2009 due to share buy back activity under our stock repurchase program, partially offset by lower net income.
Operating cash flow for the nine months ended September 30, 2009 was $3.0 billion, or 1.5 times net income. Operating cash flow for the nine months ended September 30, 2008 was $2.1 billion, or 1.0 times net income. The increase in operating cash flow from 2008 was driven primarily by the net change in provider advances, decreased tax payments, lower experience-rated refunds to certain large customers and decreased incentive compensation payments.
We manage our operations through three reportable segments: Commercial; Consumer; and Other.
Our Commercial and Consumer segments both offer a diversified mix of managed care products, including preferred provider organizations, or PPOs; health maintenance organizations, or HMOs; traditional indemnity benefits and point-of-service, or POS, plans; as well as a variety of hybrid benefit plans, including consumer-driven health plans, or CDHPs, hospital only and limited benefit products.
Our Commercial segment includes Local Group (including UniCare), National Accounts and certain other ancillary business operations (dental, vision, life and disability and workers' compensation). Business units in the Commercial segment offer fully-insured products and provide a broad array of managed care services to self-funded customers, including claims processing, underwriting, stop loss insurance, actuarial services, provider network access, medical cost management, disease management, wellness programs and other administrative services.
Our Consumer segment includes Senior, State-Sponsored and Individual businesses. Senior business includes services such as Medicare Part D, Medicare Advantage and Medicare Supplement, while State-Sponsored business includes our managed care alternatives for the Medicaid and State Children's Health Insurance Plan programs.
The Other segment includes our Comprehensive Health Solutions Business unit, or CHS, that brings together our resources focused on optimizing the quality of health care and cost of care management. CHS includes provider relations, care and disease management, employee assistance programs, including behavioral health, radiology benefit management, analytics-driven personal health care guidance and our pharmacy benefit management, or PBM, business, which includes NextRx, and our specialty pharmacy, PrecisionRx Specialty Solutions. Our Other segment also includes results from our Federal Government Solutions, or FGS, business. FGS business includes the FEP and National Government Services, Inc., or NGS, which acts as a Medicare contractor in several regions across the nation. The Other segment also includes other businesses that do not meet the quantitative thresholds for an operating segment as defined in FASB segment reporting guidance, as well as intersegment sales and expense eliminations and corporate expenses not allocated to the other reportable segments.
Our operating revenue consists of premiums, administrative fees and other revenue. Premium revenue comes from fully-insured contracts where we indemnify our policyholders against costs for covered health and life benefits. Administrative fees come from contracts where our customers are self-insured, or where the fee is based on either processing of transactions or a percent of network discount savings realized. Additionally, we earn administrative fee revenues from our Medicare processing business and from other health-related businesses, including disease management programs. Other revenue is principally generated from member co-payments and deductibles associated with the mail-order sale of drugs by our PBM companies.
Our benefit expense primarily includes costs of care for health services consumed by our members, such as outpatient care, inpatient hospital care, professional services (primarily physician care) and pharmacy benefit costs. All four components are affected both by unit costs and utilization rates. Unit costs include the cost of outpatient medical procedures per visit, inpatient hospital care per admission, physician fees per office visit and prescription drug prices. Utilization rates represent the volume of consumption of health services and typically vary with the age and health status of our members and their social and lifestyle choices, along with clinical protocols and medical practice patterns in each of our markets. A portion of benefit expense recognized in each reporting period consists of actuarial estimates of claims incurred but not yet paid by us. Any changes in these estimates are recorded in the period the need for such an adjustment arises. While we offer a diversified mix of managed care products, including PPO, HMO, POS and CDHP products, our aggregate cost of care can fluctuate based on a change in the overall mix of these products. In recent periods, we have seen an increase in COBRA
coverage within these product offerings that can further impact our cost of care. COBRA is named for the Consolidated Omnibus Budget Reconciliation Act of 1986, which provides unemployed group members with coverage for up to 18 months after losing their job. On February 17, 2009, the American Recovery and Reinvestment Act of 2009, or ARRA, was signed into law. ARRA provides for a temporary subsidy of COBRA premiums for individuals that were involuntarily terminated from employment (for reasons other than gross misconduct) between September 1, 2008 and December 31, 2009. The COBRA subsidy under ARRA may cause more individuals to elect COBRA coverage.
Our selling expense consists of external broker commission expenses and generally varies with premium or membership volume. Our general and administrative expense consists of fixed and variable costs. Examples of fixed costs are depreciation, amortization and certain facilities expenses. Other costs are variable or discretionary in nature. Certain variable costs, such as premium taxes, vary directly with premium volume. Other variable costs, such as salaries and benefits, do not vary directly with changes in premium, but are more aligned with changes in membership. The acquisition or loss of a significant block of business would likely impact staffing levels, and thus associate compensation expense. Examples of discretionary costs include professional and consulting expenses and advertising. Other factors can impact our administrative cost structure, including systems efficiencies, inflation and changes in productivity.
Our cost of drugs consists of the amounts we pay to pharmaceutical companies for the drugs we sell via mail order through our PBM and specialty pharmacy companies. This amount excludes the cost of drugs related to affiliated health customers which is recorded in benefit expense. Our cost of drugs can be influenced by the volume of prescriptions at our PBM companies, as well as cost changes, driven by prices charged by pharmaceutical companies and the mix of drugs sold.
Our results of operations depend in large part on our ability to accurately predict and effectively manage health care costs through effective contracting with providers of care to our members and our medical management programs. Several economic factors related to health care costs, such as regulatory mandates of coverage as well as direct-to-consumer advertising by providers and pharmaceutical companies, have a direct impact on the volume of care consumed by our members. While we price our business so that premium yield exceeds total cost trends, the potential effect of escalating health care costs as well as any changes in our ability to negotiate competitive rates with our providers may impose further risks to our ability to profitably underwrite our business, and may have a material impact on our results of operations.
Our future results of operations may also be impacted by certain external forces and resulting changes in our business model and strategy. During 2009, the U.S. Congress has proposed several new pieces of legislation aimed at reforming the U.S. health care system. The proposals vary widely and encompass certain new taxes and fees, including an excise tax on high value insurance policies and new fees on companies in our industry which may not be deductible for income tax purposes, as well as the establishment of a public health insurance plan that would compete with private health insurance plans, guaranteed coverage requirements and greater limitations on premiums we could charge based on our underwriting of policy applications. None of these proposals have yet been enacted; however, certain of the provisions could have a material adverse effect on our business model and results of operations. Also see Item 1A. "Risk Factors" in Part I of our 2008 Form 10-K.
In addition to external forces discussed in the preceding paragraph, our results of operations are also impacted by levels and mix of membership. During 2009, we have experienced both fully-insured and self-funded membership declines. Given the current economic conditions in the U.S., it is expected that unemployment levels will remain high throughout 2010, which will impact our ability to increase or even maintain current membership levels. These membership trends could have a material adverse effect on our future results of operations. Also see Item 1A. "Risk Factors" in Part I of our 2008 Form 10-K.
Partially in response to the external forces discussed in the preceding two paragraphs, we are reviewing our business model and are exploring various cost reduction activities to make us more efficient and effective. As a
result of this strategic review, we may incur charges in future periods including employee termination costs and other charges, some of which may have a material impact on our results of operations.
III. Significant Events
Announcement of Member Transition Agreement for UniCare Business
As a result of a strategic action, on October 28, 2009, we announced that we entered into a member transition agreement with Health Care Service Corporation, or HCSC, which operates as Blue Cross and Blue Shield in Illinois and Texas. Under this agreement, HCSC will, upon completion of receipt of regulatory approvals, offer guaranteed replacement coverage to our UniCare commercial group and individual members in those states. We believe this agreement provides our UniCare commercial membership in Illinois and Texas with an opportunity for a smooth transition of benefits and coverage, and we expect most of this membership to transition to HCSC by December 31, 2009. We expect that members transitioning to HCSC will experience significant benefits, including gaining access to HCSC's extensive provider networks and leading discounts. For those members who elect not to accept HCSC's offer of replacement coverage, UniCare will continue to provide coverage until the members' current policies expire or are terminated. UniCare will continue to operate nationwide and offer Senior and State-Sponsored related products and specialty products.
Announcement to Sell PBM Operations
On April 13, 2009, we announced that we entered into a definitive agreement to sell our NextRx subsidiaries to Express Scripts, Inc., or Express Scripts, one of the largest PBM companies in North America, for $4.675 billion, consisting of at least $3.275 billion in cash, subject to customary working capital and indebtedness adjustments. We expect to use the net after-tax proceeds from the sale for a variety of purposes, including share repurchases, repayment of current maturities of long-term debt and other general corporate purposes. In connection with the agreement, at closing, we will enter into a 10-year contract for Express Scripts to provide PBM services to us following the close of the Express Scripts transaction. The Express Scripts transaction is expected to close in the fourth quarter of 2009, subject to customary closing conditions and any required regulatory approvals.
Acquisition of DeCare Dental, LLC
On April 9, 2009, we completed our acquisition of DeCare Dental, LLC, or DeCare, a wholly-owned subsidiary of DeCare International. DeCare is one of the country's largest administrators of dental benefit plans and provides services directly and through partnerships and administrative agreements with ten dental insurance brands, primarily as a third party administrator. DeCare also operates DeCare Systems Ireland, which offers custom enterprise software solutions, e-business applications and application performance tuning and is also the first American company to offer dental benefits in Ireland as Vhi DeCare Dental. DeCare manages benefits for over four million people and is expected to provide our customers with innovative dental products and enhanced customer service.
The acquisition was accounted for using the purchase method of accounting. Accordingly, the results of operations of DeCare have been included in our consolidated results for periods following April 9, 2009.
Bond Issue
On February 5, 2009, we issued $400.0 million of 6.000% notes due 2014 and $600.0 million of 7.000% notes due 2019 under our shelf registration statement. The proceeds from this debt issuance have been used for general corporate purposes, including, but not limited to, repayment of the current maturities of long-term debt and repurchasing shares of our common stock. The notes have a call feature that allows us to repurchase the notes at any time at our option and a put feature that allows a note holder to require us to repurchase the notes upon the occurrence of both a change of control event and a downgrade of the notes.
Suspension by The Centers for Medicare and Medicaid Services
Over the past year, we have been working with The Centers for Medicare and Medicaid Services, or CMS, to resolve issues identified as a result of our internal compliance audits and findings from a 2008 CMS audit. Our work included detailed action plans to remediate such findings. In addition, we engaged an independent third party to provide CMS with on-going assessments regarding our compliance, including verification of systems, processes and procedures.
On January 12, 2009, CMS notified us that we were suspended from marketing to and enrolling new members in our Medicare Advantage and Medicare Part D health benefit products until remediation efforts have been fully implemented and confirmed. On September 9, 2009 CMS notified us that the sanctions have been lifted. We began marketing our Medicare Advantage and Medicare Part D products on October 1, 2009 and may begin enrolling new members on November 15, 2009 for the 2010 contract year. However, we are not currently eligible to receive auto-enrollment or reassignment of Medicare Part D Low Income Subsidy, or LIS, beneficiaries. We continue to work with CMS to demonstrate that our operations related to the CMS Part D LIS programs have been corrected so that we will again be allowed to participate in the CMS Part D LIS auto-assignment process.
Stock Repurchase Program
We regularly review the appropriate use of capital. Accordingly, under our Board of Directors' authorization, we maintain a common stock repurchase program. Repurchases may be made from time to time at prevailing market prices, subject to certain restrictions on volume, pricing and timing. The repurchases are effected from time to time in the open markets through negotiated transactions and through plans designed to comply with Rule 10b5-1 under the Securities Exchange Act of 1934, as amended, or Exchange Act. During the nine months ended September 30, 2009, we repurchased and retired approximately 40.8 million shares at an average per share price of $44.38, for an aggregate cost of $1.8 billion. On March 5, 2009, our Board of Directors authorized an increase of $1.5 billion in our stock repurchase program. As of September 30, 2009, $0.7 billion remained authorized for future repurchases. Subsequent to September 30, 2009, we repurchased and retired approximately 6.7 million shares for an aggregate cost of approximately $0.3 billion, leaving approximately $0.4 billion for authorized future repurchases at October 23, 2009. Our stock repurchase program is discretionary as we are under no obligation to repurchase shares. We repurchase shares under the program when we believe it is a prudent use of capital. On October 23, 2009, our Board of Directors authorized an increase of $0.5 billion in our stock repurchase program, subject to completion of the Express Scripts transaction and pending current market conditions, including the possible impact of health care reform. If approved by our Board of Directors, we may utilize further proceeds from the Express Scripts transaction for share repurchases.
Our medical membership includes seven different customer types: Local Group, Individual, National Accounts, BlueCard, Senior, State-Sponsored and FEP. BCBSA-branded business refers to members in our service, or geographic, areas licensed by the BCBSA. Non-BCBSA-branded business refers to UniCare members predominately outside of our BCBSA service areas.
• Local Group (including UniCare) consists of those employer customers with less than 5% of eligible employees located outside of the headquarter state, as well as customers with more than 5% of eligible employees located outside of the headquarter state with up to 2,500 eligible employees.
• Individual consists of individual customers under age 65 (including UniCare) and their covered dependents.
• National Accounts generally consist of multi-state employer groups primarily headquartered in a WellPoint service area with at least 5% of the eligible employees located outside of the headquarter state and with more than 2,500 eligible employees. Some exceptions are allowed based on broker relationships.
• BlueCard host members represent enrollees of Blue Cross and/or Blue Shield plans not owned by WellPoint who receive health care services in our BCBSA licensed markets. BlueCard membership consists of estimated host members using the national BlueCard program. Host members are generally members who reside in or travel to a state in which a WellPoint subsidiary is the Blue Cross and/or Blue Shield licensee and who are covered under an employer-sponsored health plan issued by a non-WellPoint controlled BCBSA licensee (i.e., the "home" plan). We perform certain administrative functions for BlueCard members, for which we receive administrative fees from the BlueCard members' home plans. Other administrative functions, including maintenance of enrollment information and customer service, are performed by the home plan. Host members are computed using, among other things, the average number of BlueCard claims received per month.
• Senior members are Medicare-eligible individual members age 65 and over who have enrolled in Medicare Advantage, a managed care alternative for the Medicare program, or who have purchased Medicare Supplement benefit coverage.
• State-Sponsored membership represents eligible members with State-Sponsored managed care alternatives in Medicaid and State Children's Health Insurance Plan programs.
• FEP members consist of United States government employees and their dependents within our geographic markets through our participation in the national contract between the BCBSA and the U.S. Office of Personnel Management.
In addition to reporting our medical membership by customer type, we report by funding arrangement according to the level of risk that we assume in the product contract. Our two funding arrangement categories are fully-insured and self-funded. Fully-insured products are products in which we indemnify our policyholders against costs for health benefits. Self-funded products are offered to customers, generally larger employers, who elect to retain most or all of the financial risk associated with their employees' health care costs. Some self-funded customers choose to purchase stop-loss coverage to limit their retained risk.
The following table presents our medical membership by customer type, funding arrangement and reportable segment as of September 30, 2009 and 2008. Also included below are other businesses' key metrics, including prescription volume for our PBM companies and other membership by product. The medical membership and other businesses' metrics presented are unaudited and in certain instances . . .
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