CAUTIONARY STATEMENTS
The following discussion and other portions of this Quarterly Report on Form
10-Q contain "forward-looking statements" within the meaning of Section 21E of
the Securities Exchange Act of 1934 ("Exchange Act") and Section 27A of the
Securities Act of 1933 regarding our business, financial condition and results
of operations. We intend such forward-looking statements to be covered by the
safe-harbor provisions for forward-looking statements contained in the Private
Securities Litigation Reform Act of 1995, and we are including this statement
for purposes of complying with these safe-harbor provisions. These
forward-looking statements involve a number of risks and uncertainties. All
statements other than statements of historical information provided or
incorporated by reference herein may be deemed to be forward-looking statements.
Without limiting the foregoing, the words "believes," "anticipates," "plans,"
"expects," "may," "should," "could," "estimate," "intend," "feels," "will,"
"projects" and other similar expressions are intended to identify
forward-looking statements. Managed health care companies operate in a highly
competitive, constantly changing environment that is significantly influenced
by, among other things, aggressive marketing and pricing practices of
competitors and regulatory oversight. Factors that could cause our actual
results to differ materially from those reflected in forward-looking statements
include, but are not limited to, the factors set forth under the heading "Risk
Factors" in our Annual Report on Form 10-K for the year ended December 31, 2011
(the "Form 10-K") , our Quarterly Report on Form 10-Q for the quarterly period
ended March 31, 2012 and this Quarterly Report on Form 10-Q, and the risks
discussed in our other filings from time to time with the Securities and
Exchange Commission ("SEC").
Any or all forward-looking statements in this Quarterly Report on Form 10-Q and
in any other public filings or statements we make may turn out to be wrong. They
can be affected by inaccurate assumptions we might make or by known or unknown
risks and uncertainties. Many of the factors discussed in our filings with the
SEC may impact future results. These factors should be considered in conjunction
with any discussion of operations or results by us or our representatives,
including any forward-looking discussion, as well as information contained in
press releases, presentations to securities analysts or investors or other
communications by us or our representatives. You should not place undue reliance
on any forward-looking statements, which reflect management's analysis,
judgment, belief or expectation only as of the date thereof and are subject to
changes in circumstances and a number of risks and uncertainties. Except as may
be required by law, we undertake no obligation to publicly update or revise any
forward-looking statements to reflect events or circumstances that arise after
the date of this report.
This Management's Discussion and Analysis of Financial Condition and Results of
Operations, together with the consolidated financial statements included
elsewhere in this report, should be read in their entirety since they contain
detailed information that is important to understanding Health Net, Inc. and its
subsidiaries' results of operations and financial condition.
OVERVIEWGeneral
We are a publicly traded managed care organization that delivers managed health
care services through health plans and government-sponsored managed care plans.
Our mission is to help people be healthy, secure and comfortable. We provide and
administer health benefits to approximately 5.5 million individuals across the
country through group, individual, Medicare, Medicaid, U.S. Department of
Defense ("Department of Defense" or "DoD"), including TRICARE, and Veterans
Affairs programs. Our behavioral health services subsidiary, Managed Health
Network, Inc., provides behavioral health, substance abuse and employee
assistance programs to approximately 4.8 million individuals, including our own
health plan members. Our subsidiaries also offer managed health care product
coordination for multi-region employers and administrative services for medical
groups and self-funded benefits programs.
How We Report Our Results
We operate within three reportable segments, Western Region Operations,
Government Contracts and Divested Operations and Services, each of which is
described below. See Note 4 to our consolidated financial statements for more
information regarding our reportable segments.
Our health plan services are provided under our Western Region Operations
reportable segment, which includes
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the operations primarily conducted in California, Arizona, Oregon and Washington
for our commercial, Medicare and Medicaid health plans, our health and life
insurance companies, and our behavioral health and pharmaceutical services
subsidiaries. As of June 30, 2012, we had approximately 2.6 million members in
our Western Region Operations reportable segment. On April 1, 2012, we completed
the sale of our Medicare stand-alone prescription drug plan business ("Medicare
PDP business") to Pennsylvania Life Insurance Company, a subsidiary of CVS
Caremark Corporation ("CVS Caremark"). As a result, the operating results
related to our Medicare PDP business have been excluded from continuing
operations results and are classified in this Quarterly Report on Form 10-Q as
discontinued operations for the three and six months ended June 30, 2012 and
2011. Accordingly, the information included in this Quarterly Report on Form
10-Q regarding our Western Region Operations reportable segment excludes the
operating results of the Medicare PDP business for the three and six months
ended June 30, 2012 and 2011. For additional information regarding the sale of
our Medicare PDP business, see Note 3 to our consolidated financial statements.
Our Government Contracts segment includes our government-sponsored managed care
federal contract with the DoD under the TRICARE program in the North Region and
other health care related government contracts. On April 1, 2011, we began
delivery of administrative services under a new Managed Care Support Contract
("T-3") for the TRICARE North Region. Under the T-3 contract for the TRICARE
North Region, we provide administrative services to approximately 2.9 million
Military Health System ("MHS") eligible beneficiaries. See Note 2 to our
consolidated financial statements under the heading "T-3 TRICARE Contract" for
additional information on the T-3 contract. In addition, we also provide
behavioral health services to military families under the Department of Defense
Military and Family Life Consultant ("MFLC") contract, which is also included in
our Government Contracts segment.
Prior to its conclusion on March 31, 2011, our previous TRICARE contract for the
North Region was included in our Government Contracts segment. Under our
previous TRICARE contract for the North Region, we provided health care services
to approximately 3.1 million MHS eligible beneficiaries, including 1.8 million
TRICARE eligible beneficiaries for whom we provided health care and
administrative services and 1.3 million other MHS eligible beneficiaries for
whom we provided administrative services only ("ASO").
As a result of entering into a definitive agreement in January 2012 to sell our
Medicare PDP business, we reviewed our reportable segments in the first quarter
of 2012. Following this review , all services provided in connection with
divested businesses, including those relating to the sale of our Medicare PDP
business and the Northeast Sale (as defined below), were reported as part of our
Divested Operations and Services reportable segment beginning in the first
quarter of 2012.
Prior to the sale of our Medicare PDP business, our Divested Operations and
Services reportable segment, formerly called the "Northeast Operations"
reportable segment, included the operations of our businesses that provided
administrative and run-out support services to an affiliate of UnitedHealth
Group Incorporated ("United") and its affiliates under administrative services
and claims servicing agreements in connection with the sale of all of the
outstanding shares of capital stock of our health plan subsidiaries that were
domiciled and had conducted businesses in Connecticut, New Jersey, New York and
Bermuda to United (the "Northeast Sale"). Beginning in the first quarter of
2012, this segment also includes the transition-related expenses of our divested
Medicare PDP business. See Notes 2, 3 and 4 to our consolidated financial
statements for additional information regarding our reportable segments, the
Northeast Sale and the sale of our Medicare PDP business.
How We Measure Our Profitability
Our profitability depends in large part on our ability to, among other things,
effectively price our health care products; manage health care costs, and
pharmacy costs; contract with health care providers; attract and retain members;
and manage our general and administrative ("G&A") and selling expenses. In
addition, factors such as state and federal health care reform legislation and
regulation, competition and general economic conditions affect our operations
and profitability. The 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 business, financial condition or results of
operations.
We measure our Western Region Operations reportable segment profitability based
on medical care ratio ("MCR") and pretax income. MCR is calculated as health
plan services expense divided by health plan services premiums. Pretax income is
calculated as health plan services premiums and administrative services fees and
other income less health plan services expense and G&A and other net expenses.
See "-Results of Operations-Western Region Operations Reportable Segment-Western
Region Operations Segment Results" for a calculation of MCR and pretax income.
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Health plan services premiums include health maintenance organization ("HMO"),
point of service ("POS") and preferred provider organization ("PPO") premiums
from employer groups and individuals and from Medicare recipients who have
purchased supplemental benefit coverage (which premiums are based on a
predetermined prepaid fee), Medicaid revenues based on multi-year contracts to
provide care to Medicaid recipients, and revenue under Medicare risk contracts
to provide care to enrolled Medicare recipients. Medicare revenue can also
include amounts for risk factor adjustments and additional premiums that we
charge in some places to members who purchase our Medicare risk plans. The
amount of premiums we earn in a given period is driven by the rates we charge
and enrollment levels. Administrative services fees and other income primarily
include revenue for administrative services such as claims processing, customer
service, medical management, provider network access and other administrative
services. Health plan services expense includes medical and related costs for
health services provided to our members, including physician services, hospital
and related professional services, outpatient care, and pharmacy benefit costs.
These expenses are impacted by unit costs and utilization rates. Unit costs
represent the health care cost per visit, and the utilization rates represent
the volume of health care consumption by our members.
G&A expenses include those costs related to employees and benefits, consulting
and professional fees, marketing, business expansion initiatives, premium taxes
and assessments, occupancy costs and litigation and regulatory-related costs.
Such costs are driven by membership levels, introduction of new products, system
consolidations, outsourcing activities and compliance requirements for changing
regulations, among other things. These expenses also include expenses associated
with corporate shared services and other costs to reflect the fact that such
expenses are incurred primarily to support health plan services. Selling
expenses consist of external broker commission expenses and generally vary with
premium volume.
We measure our Government Contracts segment profitability based on pretax
income, which is calculated as Government Contracts revenue less Government
Contracts cost. See "-Results of Operations-Government Contracts Reportable
Segment-Government Contracts Segment Results" for a calculation of the
government contracts pretax income.
Under the T-3 contract for the TRICARE North Region, we provide various types of
administrative services including: provider network management, referral
management, medical management, disease management, enrollment, customer
service, clinical support service, and claims processing. We also provide
assistance in the transition into and out of the T-3 contract. These services
are structured as cost reimbursement arrangements for health care costs plus
administrative fees earned in the form of fixed prices, fixed unit prices, and
contingent fees and payments based on various incentives and penalties. We
recognize revenue related to administrative services on a straight-line basis
over the option period, when the fees become fixed and determinable. The TRICARE
North Region members are served by our network and out-of-network providers in
accordance with the T-3 contract. We pay health care costs related to these
services to the providers and are later reimbursed by the DoD for such payments.
Under the terms of the T-3 contract, we are not the primary obligor for health
care services and accordingly, we do not include health care costs and related
reimbursements in our consolidated statements of operations. The T-3 contract
also includes various performance-based incentives and penalties. For each of
the incentives or penalties, we adjust revenue accordingly based on the amount
that we have earned or incurred at each interim date and are legally entitled to
in the event of a contract termination. See Note 2 to our consolidated financial
statements under the heading "T-3 TRICARE Contract" for additional information
on our T-3 contract.
Under our previous TRICARE contract for the North Region, Government Contracts
revenue was made up of two major components: health care and administrative
services. The health care component included revenue recorded for health care
costs for the provision of services to our members, including paid claims and
estimated incurred but not reported claims ("IBNR") expenses for which we were
at risk, and underwriting fees earned for providing the health care and assuming
underwriting risk in the delivery of care. The administrative services component
encompassed fees received for all other services provided to both the government
customer and to beneficiaries, including services such as medical management,
claims processing, enrollment, customer services and other services unique to
the managed care support contract with the government. Government Contracts
revenue and expenses included the impact from underruns and overruns relative to
our target cost under the applicable contracts.
We measure our Divested Operations and Services segment profitability based on
pretax income. This pretax income is calculated as Divested Operations and
Services segment total revenues less Divested Operations and Services segment
total expenses. See "-Results of Operations-Divested Operations and Services
Reportable Segment Results" for a calculation of our pretax income.
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Health Care Reform Legislation
During the first quarter of 2010, the President signed into law both the Patient
Protection and Affordable Care Act and the Health Care and Education
Reconciliation Act of 2010 (collectively, the "ACA"), which is causing and will
continue to cause significant changes to the U.S. health care system and alter
the dynamics of the health care insurance industry. The legislation includes
provisions, which, among other things, impose significant new non-deductible
premium-based taxes (technically taking the form of "fees") on health insurers,
effective for calendar years beginning after December 31, 2013. If these new
non-deductible premium-based taxes and fees are imposed as enacted by the
legislation, and we are not able to incorporate the costs of the premium-based
assessments into setting our premium rates, or if we are unable to otherwise
adjust our business to address these additional new costs, our financial
condition and results of operations may be materially adversely affected.
Payment of these new non-deductible premium-based taxes and fees will not be due
until 2014; however, they may impact us starting in 2013 since our premium rates
are set a year in advance, and the tax amounts for 2014 depend on net premiums
written in 2013. Additionally, regulations have not yet been issued by the
Internal Revenue Service ("IRS"), making payment procedures, timing and
financial reporting requirements unclear. Other provisions of the legislation
include requiring states to expand Medicaid eligibility to all individuals with
incomes up to 133 percent of the federal poverty level, commonly referred to as
"Medicaid expansion" (as discussed below, this provision was made optional for
states under the Supreme Court's recent ruling on the ACA); imposing an excise
tax on high premium insurance policies; requiring premium rate reviews in
certain market segments; stipulating a minimum medical loss ratio (as adopted by
the Secretary of the U.S. Department of Health and Human Services ("HHS"));
limiting Medicare Advantage payment rates; increasing mandated benefits in some
market segments; specifying certain actuarial value and cost-sharing
requirements; eliminating medical underwriting for medical insurance coverage
decisions, or "guaranteed issue"; increasing restrictions on rescinding
coverage; prohibiting some annual and all lifetime limits on amounts paid on
behalf of or to our members; limiting the ability of health plans to vary
premiums based on assessments of underlying risk; limiting the amount of
compensation paid to health insurance executives that is tax deductible;
creating federal regulations that impact premium rate increase requests;
requiring that most individuals obtain health care coverage or pay a penalty,
commonly referred to as the "individual mandate"; creating state-based and
federally facilitated "exchanges" where individuals and small business groups
may purchase health coverage; imposing a sales tax on medical device
manufacturers; increasing fees on pharmaceutical manufacturers; and requiring
contributions for a transitional reinsurance program.
In addition to the non-deductible premium-based taxes and fees described above,
some other potentially significant provisions of the ACA will not become
effective until 2014 or later, including, but not limited to, the excise tax on
high premium insurance policies, increased taxes on medical device
manufacturers, increased fees on pharmaceutical manufacturers, the guaranteed
issue requirement, the individual mandate and the creation of exchanges.
However, these provisions may have an earlier impact on our operations,
including in connection with the setting of our premium rates. Implementation of
the provisions of the ACA generally varies from as early as enactment to as late
as 2018.
Various aspects of the ACA, including those referenced above, could have an
adverse impact on the cost of operating our business, our revenues, enrollment
and premium growth in certain products and market segments. For example, among
other things, the ACA will require premium rate review in certain market
segments and will require that premium rebates be paid to policyholders in the
event certain specified minimum medical loss ratios are not met. Based on our
calculations, we were not required to pay any rebates with respect to our 2011
business, however, we cannot be certain that we will not be required to pay
material amounts in rebates in the future. The legislation may also make it more
difficult for us to attract and retain members, and will increase the amount of
certain taxes and fees we pay, the latter of which is expected to increase our
effective tax rate in future periods. We are unable to estimate the amount of
these fees and taxes or the increase in our effective tax rate because material
information and guidance regarding the calculations of these fees and taxes has
not been issued. The sales tax on medical device manufacturers and increase in
the amount of fees pharmaceutical manufacturers pay imposed by the ACA, in turn
could increase our medical costs.
We could also face additional competition as competitors seize on opportunities
to expand their business as a result of the ACA, though there remains
considerable uncertainty about the impact of the legislation on the health
insurance market as a whole and what actions our competitors could take in
response to the legislation. The response of other companies to the ACA and
related adjustments to their offerings, if any, could cause meaningful
disruption in the local health care markets. For example, companies could modify
their product features or benefits, change their pricing relative to others in
the market, adjust their mix of business or even exit segments of the market.
Companies could also seek to adjust their operating costs to support reduced
premiums by making changes to their distribution
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arrangements, decreasing spending on non-medical product features and services,
or otherwise reducing general and administrative expenses. Because of the
magnitude, scope and complexity of the ACA, we also need to dedicate substantial
resources and incur material expenses to implement the legislation, including
implementing the current and future regulations that will provide guidance and
clarification on important parts of the legislation. Any delay or failure by us
to execute our operational and strategic initiatives with respect to health care
reform or otherwise appropriately react to the legislation, implementing
regulations and actions of our competitors could result in operational
disruptions, disputes with our providers or members, regulatory issues, damage
to our existing or potential member relationships or other adverse consequences.
There are numerous steps required to implement the ACA, and clarifying
regulations and other guidance are expected over several years. Additional
guidance and regulations on certain provisions of the ACA have been issued, but
we are still awaiting further final guidance or regulations on a number of key
provisions. These provisions include the definition of essential health benefits
and the calculation of the new non-deductible premium-based taxes and fees on
health insurers, among others. The final regulations relating to the Medicare
Shared Savings program reflecting the use of accountable care organizations, or
"ACOs", have been issued and are intended to create incentives for health care
providers to work together to treat an individual across different care
settings. However, the impact of these new regulations on the healthcare market
and the role to be played by health plans in the operation of ACOs remains to be
determined. Though the federal government has in certain instances issued final
regulations, there remains considerable uncertainty around the ultimate
requirements of the legislation, as the final regulations are sometimes unclear
or incomplete, and are subject to further change. The federal government has
also issued additional forms of guidance that may not be consistent with the
final regulations. As a result, many of the impacts of health care reform will
not be known for certain until the ultimate requirements of the legislation have
been definitively determined.
On June 28, 2012, the U.S. Supreme Court issued a decision in NFIB v. Sebelius,
a major legal challenge to the ACA. The Supreme Court upheld the legislation's
individual mandate as valid under Congress' taxing power. Provisions relating to
the Medicaid expansion were partially upheld: the Supreme Court ruled that
states that choose to accept the Medicaid expansion can continue to go forward
and receive associated additional funding, but the Supreme Court also ruled that
states must have the option of rejecting the Medicaid expansion without losing
existing Medicaid funding. There is also some uncertainty as to how the Supreme
Court's decision will be interpreted at the federal and state levels, which in
turn creates further uncertainty over the future size and scope of state
Medicaid programs as state legislatures and governors discuss whether to accept
the Medicaid expansion.
Various health insurance reform proposals are also emerging at the state level.
Many of the states in which we operate are already implementing parts of the ACA
and many states have added new requirements that are more exacting than the
ACA's requirements. States may also mandate minimum medical loss ratios,
implement rate reforms and enact benefit mandates that go beyond provisions
included in the ACA. For example, pending legislation in the California
legislature would require prior approval of premium rates. In addition, an
initiative measure in California to require prior approval for individual and
small group rates did not qualify for the November 2012 ballot, but may do so
for the 2014 elections. Also, although many states may continue to consider
extending coverage to the uninsured through Medicaid expansions, the Supreme
Court's decision to overturn the part of the ACA that conditions ongoing funding
for Medicaid on participation by states in the Medicaid expansion may cause some
states to choose not to expand Medicaid coverage as required in the initial
legislation. In addition, some states have passed legislation or are considering
proposals to establish an insurance exchange within the state to comply with
provisions of the ACA that become effective in 2014. For example, California
passed legislation in 2010 establishing a state-based insurance exchange and
authorizing an oversight board to negotiate the price of plans sold on the
insurance exchange. At least some states and possibly the federal government may
condition health carrier participation in an exchange on a number of factors,
which could mean that some carriers would be excluded from participation.
Further, some states may not create state-operated exchanges, in which case the
federal government will manage exchanges in those states. These kinds of state
regulations and legislations could limit our ability to increase premiums even
where actuarially supported and thereby could negatively impact our revenues and
profitability. This also could increase the competition we face from companies
that have lower health care or administrative costs than we do and therefore can
price their premiums at lower levels than we can. Further, if other states in
which we operate adopt a format for their exchanges that is similar to that
included in the California legislation, the competition that we face and the
pressure on us to contain our premiums could be increased. Even in cases where
state action is limited to implementing federal reforms, new or amended state
laws will be required in many cases. States also may disagree in their
interpretations of the federal statute and regulations, and state "guidance"
that is issued could be unclear or untimely. The interaction of new federal
regulations and the implementation efforts of the various states in which we do
business will continue to create substantial uncertainty for us and other health
insurance companies about the requirements under which we must
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operate.
Although the Supreme Court has ruled on this challenge, other legal challenges
have been threatened or are still pending at lower court levels. These
challenges could result in portions of the ACA being struck down. Opponents of
the ACA have also discussed challenging the IRS's official position that premium
tax credits are available to low-income individuals who purchase insurance
through federally facilitated exchanges. A successful challenge in this area
could significantly affect the affordability of insurance to low-income
individuals in states that do not administer their own exchanges.
Congress has also proposed a number of legislative initiatives, including
possible repeal of the ACA. In 2011, the President signed legislation to
eliminate $2.2 billion of the $6 billion in start-up funding that the ACA
provided to support the launch of health insurance cooperatives, and Congress
may also withhold the funding necessary to implement the ACA. In addition,
should some of the provisions of the ACA fail to withstand potential future
legal challenges, Congress or state legislatures may respond by considering
various bills that propose to enact laws identical or similar to provisions
ultimately struck down or repealed from the ACA. At this time, it remains
unclear whether there will be any changes made to the ACA, whether to certain
provisions or its entirety. If the individual mandate is repealed, but
provisions relating to "guaranteed issue" are maintained, people with greater
needs for health care services could make up a greater portion of our
membership, which would have an adverse impact on our medical loss ratios,
profitability and earnings. These effects could be exacerbated if we are unable
to obtain, or are delayed in obtaining, regulatory approval of adequate premium
rates for the risk we assume.
Due to the unsettled nature of these reforms and the numerous steps required to
implement them, we cannot predict how future regulations and laws, including
state laws, implementing the health care reform legislation will impact our
business. To date, the legislation has not had a material adverse impact on our
business, financial results and results of operations. However, in the future,
depending in part on the ultimate requirements of the legislation, it could have
a material adverse effect on our business, financial condition and results of
operations.
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RESULTS OF OPERATIONSConsolidated Results
The table below and the discussion that follows summarize our results of
operations for the three and six months ended June 30, 2012 and 2011.
Three Months Ended June 30, Six Months Ended June 30,
2012 2011 2012 2011
(Dollars in thousands, except per share data)
Revenues
Health plan services premiums $ 2,618,927 $ 2,443,097 $ 5,239,876 $ 4,892,184
Government contracts 176,248 171,015 357,610 1,046,142
Net investment income 24,697 25,091 47,001 48,926
Administrative services fees and
other income 8,662 2,079 14,446 4,800
Divested operations and services
revenue 12,805 11,021 12,805 23,470
Total revenues 2,841,339 2,652,303 5,671,738 6,015,522
Expenses
Health plan services (excluding
depreciation and amortization) 2,358,455 2,123,285 4,702,114 4,240,571
Government contracts 153,406 130,828 315,716 952,980
General and administrative 228,756 201,631 466,032 606,131
Selling 58,390 57,417 119,951 117,982
Depreciation and amortization 7,385 8,661 14,815 17,129
Interest 8,246 8,238 16,874 15,858
Divested operations and services
expenses 19,290 42,356 42,386 100,685
Adjustment to loss on sale of
Northeast health plan subsidiaries - (6,283 ) - (41,137 )
Total expenses 2,833,928 2,566,133 5,677,888 6,010,199
Income (loss) from continuing
operations before income taxes 7,411 86,170 (6,150 ) 5,323
Income tax provision (benefit) 2,241 29,360 (3,186 ) 45,137
Income (loss) from continuing
operations 5,170 56,810 (2,964 ) (39,814 )
Discontinued operations:
Income (loss) from discontinued
operation, net of tax - 1,490 (18,452 ) (10,081 )
Gain on sale of discontinued
operation, net of tax 119,440 - 119,440 -
Income (loss) on discontinued
operation, net of tax 119,440 1,490 100,988 (10,081 )
Net income (loss) $ 124,610 $ 58,300 $ 98,024 $ (49,895 )
Net income(loss) per share-basic:
Income (loss) from continuing
operations $ 0.06 $ 0.63 $ (0.04 ) $ (0.43 )
Income (loss) on discontinued
operation, net of tax $ 1.44 $ 0.01 $ 1.22 $ (0.11 )
Net income (loss) per share-basic $ 1.50 $ 0.64 $ 1.18 $ (0.54 )
Net income (loss) per share-diluted:
Income (loss) from continuing
operations $ 0.06 $ 0.62 $ (0.04 ) $ (0.43 )
Income (loss) on discontinued
operation, net of tax $ 1.42 $ 0.01 $ 1.20 $ (0.11 )
Net income (loss) per share-diluted: $ 1.48 $ 0.63 $ 1.16 $ (0.54 )
On April 1, 2012, we completed the sale of our Medicare PDP business to CVS
Caremark. See Note 3 to our
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consolidated financial statements for more information. As a result of the sale,
the results of operations for the three and six months ended June 30, 2012
include loss from discontinued operation of $0 and $(18.5) million,
respectively, related to our Medicare PDP business as compared to income (loss)
from discontinued operation of $1.5 million and $(10.1) million, respectively,
for the same periods in 2011. Additionally, as a result of this sale, we
recorded a gain on sale of discontinued operation in the amount of $132.8
million pretax, or $119.4 million after-tax, for the three and six months ended
June 30, 2012. As of June 30, 2011, we had approximately 389,000 Medicare
stand-alone Prescription Drug Plan members. As of June 30, 2012, we had no
Medicare stand-alone Prescription Drug Plan members.
For the three and six months ended June 30, 2012, we reported net income of
$124.6 million or $1.48 per diluted share and net income of $98.0 million or
$1.16 per share, respectively, as compared to net income of $58.3 million or
$0.63 per diluted share and a net loss of $(49.9) million or $(0.54) per share,
respectively, for the same periods in 2011. For the three and six months ended
June 30, 2012, we reported net income from continuing operations of $5.2 million
and a net loss from continuing operations of $(3.0) million, respectively, as
compared to net income from continuing operations of $56.8 million and a net
loss from continuing operations of $(39.8) million for the same periods in 2011.
Pretax margins from continuing operations were 0.3 percent and (0.1) percent for
the three and six months ended June 30, 2012 compared to 3.2 percent and 0.1
percent for the same periods in 2011.
Our total revenues increased 7.1 percent for the three months ended June 30,
2012 to $2.8 billion from $2.7 billion for the same period in 2011 and decreased
5.7 percent for the six months ended June 30, 2012 to $5.7 billion from $6.0
billion in the same period in 2011. The increase for the three months ended June
30, 2012 was primarily due to an increase in health plan services premiums. The
decrease for the six months ended June 30, 2012 was primarily driven by the
decline in our Government Contracts revenue due to the impact of the change to
the T-3 contract as described below.
Our Government Contracts revenues increased by 3.1 percent for the three months
ended June 30, 2012 to $176.2 million from $171.0 million in the same period in
2011, and decreased by 65.8 percent for the six months ended June 30, 2012 to
$357.6 million from $1,046.1 million in the same period in 2011. Our Government
Contracts costs increased by 17.3 percent for the three months ended June 30,
2012 to $153.4 million from $130.8 million in the same period in 2011, and
decreased by 66.9 percent for the six months ended June 30, 2012 to $315.7
million from $953.0 million in the same period in 2011. The declines in our
Government Contracts revenues and costs for the six months ended June 30, 2012
were primarily due to the change from our prior contract for the TRICARE North
Region, which was a risk-based contract, to the new T-3 contract, which is a
cost reimbursement plus fixed fee contract. As a result of this change, health
care costs and related reimbursements that were included in our consolidated
statements of operations under the prior contract were subsequently excluded
under the T-3 contract. For additional information on our T-3 contract, see
"-Government Contracts Reportable Segment" and Note 2 to our consolidated
financial statements.
Health plan services premium revenues increased by 7.2 percent to $2.6 billion
for the three months ended June 30, 2012, compared with $2.4 billion for the
same period in 2011, and by 7.1 percent to $5.2 billion for the six months ended
June 30, 2012, compared with $4.9 billion for the same period in 2011. Health
plan services expenses increased by 11.1 percent from $2.1 billion for the three
months ended June 30, 2011 to $2.4 billion for the three months ended June 30,
2012, and increased by 10.9 percent from $4.2 billion for the six months ended
June 30, 2011 to $4.7 billion for the six months ended June 30, 2012. Investment
income decreased to $24.7 million and $47.0 million for the three and six months
ended June 30, 2012, respectively, compared with $25.1 million and $48.9 million
for the three and six months ended June 30, 2011, respectively.
For the three months ended June 30, 2012, we recorded $7.9 million of adverse
development related to prior periods. This adverse development consisted of
$61.0 million of incurred claims related to prior periods (comprised of $48.9
million from the first quarter of 2012 and $12.1 million from 2011 and prior
years), offset by a $53.1 million provision for adverse deviation originally
accrued to provide for such development. The $61.0 million is attributable to
the revision of the previous estimate of incurred claims for prior periods as a
result of adverse prior period development. For the six months ended June 30,
2012, we recorded $32.9 million of adverse development related to prior periods.
This adverse development consisted of $79.1 million of incurred claims related
to prior periods, offset by a $46.2 million provision for adverse deviation
originally accrued to provide for such development. The $79.1 million is
attributable to the revision of the previous estimate of incurred claims for
prior periods as a result of adverse prior period development. This negative
prior period reserve development was recorded as part of health care costs. Our
operating results for the six months ended June 30, 2011 were impacted by a $181
million pretax expense incurred in connection with a judgment rendered in the
AmCareco litigation. For additional information regarding the AmCareco
litigation, see Note 9 to our consolidated financial statements under the
heading, "AmCareco Judgment". This expense was recorded as part of our G&A
expenses. Our operating results for the three and six months ended
37
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June 30, 2011 were also impacted by a $6.3 million and a $41.1 million ,
respectively, favorable adjustment to loss on sale of Northeast health plan
subsidiaries.
Days Claims Payable
Days claims payable ("DCP") for the second quarter of 2012 was 39.0 days
compared with 38.6 days in the second quarter of 2011. Adjusted DCP, which we
calculate in accordance with the paragraph below, for the second quarter of 2012
was 54.3 days compared with 52.0 days in the second quarter of 2011.
Set forth below is a reconciliation of adjusted DCP, a non-GAAP financial
measure, to the comparable GAAP financial measure, DCP. DCP is calculated by
dividing the amount of reserve for claims and other settlements ("Claims
Reserve") by health plan services cost ("Health Plan Costs") during the quarter
and multiplying that amount by the number of days in the quarter. In this
Quarterly Report on Form 10-Q, the following table presents an adjusted DCP
metric that subtracts capitation, provider and other claim settlements and
Medicare Advantage Prescription Drug ("MAPD") payables/costs from the Claims
Reserve and Health Plan Costs. For the second quarter of 2011, adjusted DCP also
subtracts reserve for claims and other settlements related to discontinued
operations from the Claims Reserve. Management believes that adjusted DCP
provides useful information to investors because the adjusted DCP calculation
excludes from both Claims Reserve and Health Plan Costs amounts related to
health care costs for which no or minimal reserves are maintained. In addition,
solely with respect to the second quarter of 2011, adjusted DCP excludes from
Claims Reserve the reserves relating to discontinued operations. Therefore,
management believes that adjusted DCP may present a more accurate reflection of
DCP than does GAAP DCP, which includes such amounts. This non-GAAP financial
information should be considered in addition to, not as a substitute for,
financial information prepared in accordance with GAAP. You are encouraged to
evaluate these adjustments and the reasons we consider them appropriate for
supplemental analysis. In evaluating the adjusted amounts, you should be aware
that we have incurred expenses that are the same as or similar to some of the
adjustments in the current presentation and we may incur them again in the
future. Our presentation of the adjusted amounts should not be construed as an
inference that our future results will be unaffected by unusual or nonrecurring
items.
Three Months Ended June 30,
2012 2011
(Dollars in millions)
Reconciliation of Days Claims Payable:
(1) Reserve for Claims and Other Settlements-GAAP $ 1,010.5
$ 900.7
Less: Reserve for Claims and Other Settlements Related to
Discontinued Operations
- (30.9 )
Reserve for Claims and Other Settlements excluding
Discontinued Operations
$ 1,010.5
$ 869.8
Less: Capitation, Provider and Other Claim Settlements and
MAPD Payables
(106.5 ) (90.1 )
(2) Reserve for Claims and Other Settlements-Adjusted $ 904.0
$ 779.7
(3) Health Plan Services Cost-GAAP $ 2,358.5
$ 2,123.3
Less: Capitation, Provider and Other Claim Settlements and
MAPD Costs
(842.9 ) (759.8 )
(4) Health Plan Services Cost-Adjusted $ 1,515.6 $ 1,363.5
(5) Number of Days in Period 91 91
(1) / (3) * (5) Days Claims Payable on GAAP Basis-(using end
of period reserve amount)
39.0 38.6
(2) / (4) * (5) Days Claims Payable-Adjusted (using end of
period reserve amount) 54.3 52.0
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Income Tax Provision
Our income tax expense (benefit) and the effective income tax rate for the three
and six months ended June 30, 2012, and 2011 are as follows:
Three Months Ended June 30, Six Months Ended June 30,
2012 2011 2012 2011
(Dollars in
millions)
Continuing Operations:
Income tax expense (benefit) from
continuing operations $2.2 $29.4 $(3.2) $45.1
Effective income tax rate for
continuing operations 30.2 % 34.1 %
51.8 % 847.8 %
Discontinued Operation:
Income tax expense (benefit) from
discontinued operation A - $0.8 $(10.3) $(5.6)
Effective income tax rate for
discontinued operation A - 35.8 % 35.8 % 35.8 %
Income tax expense from gain on sale of
discontinued operation B $ 13.4 - $ 13.4 -
Effective income tax rate for gain on
sale of discontinued operation B 10.1 % - 10.1 % -
________
A - For the three months ended June 30, 2012, there was no income tax provision
from discontinued operation;
therefore, effective income rate tax for discontinued operation is not
applicable.
B - For the three and six months ended June 30, 2011, we had no sale of a
discontinued operation; therefore, income
tax expense from gain on sale of discontinued operation is not applicable.
The effective income tax rate for continuing operations differs from the
statutory federal tax rate of 35% for the three and six months ended June 30,
2012 due primarily to state income taxes, tax-exempt investment income,
non-deductible compensation, and the release of a valuation allowance against
deferred tax assets for capital loss carryforwards.
The effective income tax rate for continuing operations differs from the
statutory federal tax rate of 35% for the three and six months ended June 30,
2011 due primarily to state income taxes, tax-exempt investment income, and most
significantly due to the effect of a $51.1 million valuation allowance against
deferred tax assets established as a result of the judgment rendered in 2011 in
the AmCareco litigation (see Note 9 to our consolidated financial statements for
additional information regarding the AmCareco litigation).
With respect to discontinued operation, the effective income tax rate is
slightly higher than the statutory federal rate of 35% for the six months ended
June 30, 2012 and the three and six months ended June 30, 2011 as a result of
state income taxes.
The effective income tax rate on the gain on sale of discontinued operation
varies from the statutory federal rate of 35% for the three and six months ended
June 30, 2012 due to state income taxes and the release of a valuation allowance
against deferred tax assets for capital loss carryforwards, which were utilized
upon the gain on sale of the Medicare PDP business.
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Western Region Operations Reportable Segment
Our Western Region Operations segment includes the operations of our commercial,
Medicare and Medicaid health plans, the operations of our health and life
insurance companies primarily in California, Arizona, Oregon and Washington and
our behavioral health and pharmaceutical services subsidiaries in several states
including Arizona, California and Oregon. Our Western Region Operations segment
excludes the operating results of the Medicare PDP business, which has been
reclassified as discontinued operations for the six months ended June 30, 2012
and 2011, respectively.
Western Region Operations Segment Membership (in thousands)
Increase/ %
June 30, 2012 June 30, 2011 (Decrease) Change
California
Large Group 745 834 (89 ) (10.7 )%
Small Group and Individual 303 328 (25 ) (7.6 )%
Commercial Risk 1,048 1,162 (114 ) (9.8 )%
Medicare Advantage 141 125 16 12.8 %
Medi-Cal/Medicaid 1,060 963 97 10.1 %
Total California 2,249 2,250 (1 ) - %
Arizona
Large Group 84 75 9 12.0 %
Small Group and Individual 61 56 5 8.9 %
Commercial Risk 145 131 14 10.7 %
Medicare Advantage 43 41 2 4.9 %
Total Arizona 188 172 16 9.3 %
Oregon (including Washington)
Large Group 32 49 (17 ) (34.7 )%
Small Group and Individual 56 42 14 33.3 %
Commercial Risk 88 91 (3 ) (3.3 )%
Medicare Advantage 44 39 5 12.8 %
Total Oregon (including Washington) 132 130 2 1.5 %
Total Health Plan Enrollment
Large Group 861 958 (97 ) (10.1 )%
Small Group and Individual 420 426 (6 ) (1.4 )%
Commercial Risk 1,281 1,384 (103 ) (7.4 )%
Medicare Advantage 228 205 23 11.2 %
Medi-Cal/Medicaid 1,060 963 97 10.1 %
2,569 2,552 17 0.7 %
Total Western Region Operations enrollment at June 30, 2012 was approximately
2.6 million members, an increase of 0.7 percent compared with enrollment at June
30, 2011. Total enrollment in our California health plan was flat at
approximately 2.2 million members as of June 30, 2011 and 2012.
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Western Region Operations commercial enrollment declined by 7.4 percent from
June 30, 2011 to approximately 1.3 million members at June 30, 2012, primarily
due to increasingly competitive markets. Enrollment in our large group segment
decreased by 10.1 percent, or 97,000 members from 958,000 members at June 30,
2011 to 861,000 members at June 30, 2012. Enrollment in our small group and
individual segment in our Western Region Operations segment decreased by 1.4
percent, from 426,000 members at June 30, 2011 to 420,000 members at June 30,
2012. Membership in our tailored network products increased by 6.5 percent, or
28,000 members, from June 30, 2011 to June 30, 2012. As of June 30, 2012,
tailored network products accounted for 35.2 percent of our Western Region
Operations commercial enrollment compared with 30.5 percent at June 30, 2011.
Enrollment in our Medicare Advantage plans in our Western Region Operations
segment at June 30, 2012 was 228,000 members, an increase of 11.2 percent
compared with June 30, 2011. The overall increase in Medicare Advantage
membership was due to gains of 16,000 members in California, 5,000 members in
Oregon, and 2,000 members in Arizona, respectively.
We participate in the state Medicaid program in California, where the program is
known as Medi-Cal. Medicaid enrollment in California increased by 97,000 members
or 10.1 percent to 1,060,000 members as of June 30, 2012 compared with June 30,
2011. The increase in the Medicaid membership includes the impact of our
participation in California's Seniors and Persons with Disabilities ("SPD")
program. On November 2, 2010, CMS approved California's Section 1115 Medicaid
waiver proposal, which, among other things, authorized mandatory enrollment of
SPDs in managed care programs to help achieve care coordination and better
manage chronic conditions. The mandatory SPD enrollment period began in June
2011 and ended on May 31, 2012. As of June 30, 2012, we had 114,000 total SPD
members, of which 87,000 are from the newly mandated transition of those members
to managed care that began in June 2011.
We are the sole commercial plan contractor with the California Department of
Health Care Services ("DHCS") to provide Medi-Cal services in Los Angeles
County, California. On December 1, 2011, our contract with DHCS to provide
Medi-Cal service in Los Angeles County was extended for a third 24-month period
ending March 31, 2014.
Dual Eligibles Demonstration Pilot
On April 4, 2012, DHCS selected us to participate in its proposed "dual
eligibles" pilot program for both Los Angeles County and San Diego County. Dual
eligibles are persons that are eligible for both Medicare and Medi-Cal benefits.
The stated purpose of the pilot program is to provide a more efficient health
care delivery system and improved coordination of care to dual eligibles than
that which is currently provided to these individuals separately through the
Medicare and Medi-Cal programs.
The DHCS initially has selected the counties of Los Angeles, Orange, San Diego
and San Mateo to participate in the pilot program. Subject to the passage of
additional state legislation, the DHCS also could seek to implement the pilot
program in the counties of Alameda, Riverside, San Bernardino and Santa Clara.
We could seek to participate in these other counties directly or as a
subcontractor of another health plan where an appropriate business opportunity
exists or where we have been asked to participate as a subcontracting plan.
Health plans selected in the pilot program in a given county will be required to
provide a full range of medical services, including primary care and specialty
physician, hospital and ancillary services, as well as behavioral and long-term
services and in-home and other support services to dual eligibles in that
county. We currently do not provide all of the benefits required for
participation in the pilot program, including, among others, custodial care in
nursing homes and in-home support services. We will need to make arrangements to
provide such services either directly or by subcontracting with other parties
prior to the commencement of the pilot program.
Dual eligibles are expected to receive advance notice regarding their enrollment
options by county. As currently proposed, the pilot program would continue for a
three-year term beginning no sooner than March 1, 2013 and no later than June 1,
2013 with initial enrollment occurring on a phased in basis based on birth date.
Dual eligibles may choose to opt out of the pilot program and continue to
receive separate fee-for-service Medicare benefits. Those who do not opt out of
the pilot program may elect to choose a plan or be automatically enrolled
through the passive enrollment process in one of the pilot plan choices on the
planned phased in basis. Participation in the demonstration pilot would require
us to enter into a three way agreement with the DHCS and CMS, under which, among
other things, we would receive prospective blended capitated payments in an
amount to be determined to provide coverage for dual eligibles.
The DHCS has selected Health Net and the local initiative plan, L.A. Care Health
Plan ("L.A. Care"), for the pilot program in Los Angeles County. L.A. Care is a
public agency that serves low-income persons in Los Angeles
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County through health coverage programs such as Medi-Cal. Dual eligibles in Los
Angeles County will be able to choose between an "opt out" option or choose
either L.A. Care or us for benefits under the pilot program. If no selection is
made, the dual eligibles would be passively enrolled and allocated to either
L.A. Care or us. The methodology for this allocation process has yet to be
determined.
The DHCS has selected us and three other health plans for the pilot program in
San Diego County. Dual eligibles in San Diego County will be able to select to
receive benefits from any one of these health plans, or elect the "opt out"
option. If no selection is made, the dual eligibles will be passively enrolled
and allocated to one of the health plans. The methodology for this allocation
process has yet to be determined.
The pilot program is subject to the approval of CMS. Prior to CMS' determination
on whether to approve the pilot program, various stakeholders have been given
the opportunity to comment on the program, which may impact CMS' decision. In
addition, we intend to seek the approval of the Department of Managed Health
Care (the "DMHC") for certain modifications to the internal organizational
structure of our subsidiaries related to our participation in the pilot program.
We will likely also be required to make other required filings with, and obtain
other approvals from, the DMHC in connection with our participation in the pilot
program.
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Western Region Operations Segment Results
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(Dollars in thousands, except PMPM data)
Health plan services premiums $ 2,618,927 $ 2,442,771 $ 5,239,876 $ 4,889,854
Net investment income 24,697 25,081 47,001 48,855
Administrative services fees and
other income 8,662 2,079 14,446 4,800
Total revenues 2,652,286 2,469,931 5,301,323 4,943,509
Health plan services 2,358,400 2,123,745 4,707,777 4,240,133
General and administrative 218,689 197,380 449,493 417,475
Selling 58,390 57,349 119,951 117,810
Depreciation and amortization 7,385 8,655 14,814 17,117
Interest 8,246 8,053 16,874 15,673
Total expenses 2,651,110 2,395,182 5,308,909 4,808,208
Income (loss) from continuing
operations before income taxes 1,176 74,749 (7,586 ) 135,301
Income tax (benefit) provision (452 ) 27,664 (4,137 ) 49,767
Income (loss) from continuing
operations $ 1,628 $ 47,085 $ (3,449 ) $ 85,534
Pretax margin 0.04 % 3.0 % (0.1 )% 2.7 %
Commercial premium yield 4.6 % 4.7 % 5.0 % 5.2 %Commercial premium PMPM (d) $ 372.91$ 356.51$ 373.75$ 356.06
Commercial health care cost trend
8.2 % 4.0 % 10.2 % 4.5 %
Commercial health care cost PMPM (d) $ 330.71 $ 305.63 $ 336.52 $ 305.24
Commercial MCR (e) 88.7 % 85.7 % 90.0 % 85.7 %
Medicare Advantage MCR (e) 92.0 % 90.9 % 89.9 % 90.0 %
Medicaid MCR (e) 91.3 % 85.2 % 89.1 % 85.1 %
Health plan services MCR (a) 90.1 % 86.9 % 89.8 % 86.7 %
G&A expense ratio (b) 8.3 % 8.1 % 8.6 % 8.5 %
Selling costs ratio (c) 2.2 % 2.3 % 2.3 % 2.4 %
__________
(a) Medical Care Ratio ("MCR") is calculated as health plan services cost divided
by health plan services premiums revenue.
(b) The G&A expense ratio is computed as general and administrative expenses
divided by the sum of health plan services premiums and administrative
services fees and other income.
(c) The selling costs ratio is computed as selling expenses divided by health
plan services premiums revenue.
(d) Per member per month ("PMPM") is calculated based on commercial at-risk
member months and excludes ASO member months.
(e) MCR is calculated as commercial, Medicare Advantage or Medicaid health care
cost divided by commercial, Medicare Advantage or Medicaid premiums, as
applicable.
Revenues
Total revenues in our Western Region Operations segment increased 7.4 percent to
$2.7 billion for the three months ended June 30, 2012 and increased 7.2 percent
to $5.3 billion for the six months ended June 30, 2012, compared to the same
periods in 2011, primarily due to increases in premium revenues. Health plan
services premium revenues in our Western Region Operations segment increased 7.2
percent to $2.6 billion for the three months ended
43
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June 30, 2012 and increased 7.2 percent to $5.2 billion for the six months ended
June 30, 2012, compared to the same periods in 2011.
Investment income in our Western Region Operations segment decreased to $24.7
million for the three months ended June 30, 2012 from $25.1 million for the same
period in 2011 and decreased to $47.0 million for the six months ended June 30,
2012 from $48.9 million for the same period in 2011. These decreases were due to
less a decrease in realized gains.
Health Plan Services Expenses
Health plan services expenses in our Western Region Operations segment were $2.4
billion and $4.7 billion for the three and six months ended June 30, 2012,
respectively, compared to $2.1 billion and $4.2 billion for the three and six
months ended June 30, 2011, respectively.
Commercial Premium Yields and Health Care Cost Trends
In our Western Region Operations segment, commercial premium PMPM for the three
months ended June 30, 2012 was approximately $373, a 4.6 percent increase over
the commercial premium PMPM of approximately $357 for the same period of 2011.
Commercial premium PMPM increased 4.7 percent for the three months ended June
30, 2011 as compared with the same period of 2010. Commercial premium PMPM for
the six months ended June 30, 2012 was approximately $374, a 5.0 percent
increase over the commercial premium PMPM of approximately $356 for the same
period of 2011. Commercial premium PMPM increased 5.2 percent for the six months
ended June 30, 2011 as compared with the same period of 2010.
Commercial health care costs PMPM for the three months ended June 30, 2012 in
our Western Region Operations segment were approximately $331, an 8.2 percent
increase over the commercial health care costs PMPM of $306 for the same period
of 2011. Commercial health care costs PMPM increased 4.0 percent for the three
months ended June 30, 2011 as compared with the same period of 2010. We believe
the increase in the commercial health care costs for the second quarter of 2012
was caused by adverse development from higher medical claims trends in our
commercial business, primarily in a select number of commercial large group
accounts. Commercial health care costs PMPM for the six months ended June 30,
2012 were approximately $337, a 10.2 percent increase over the commercial health
care costs PMPM of approximately $305 for the same period of 2011. Commercial
health care costs increased 4.5 percent for the six months ended June 30, 2011
as compared with the same period of 2010. We believe the increase in the
commercial health care costs for the six months ended June 30, 2012 was caused
by adverse development primarily due to significant delays in claims submissions
for the fourth quarter of 2011 arising from issues related to a new billing
format required by the Health Insurance Portability and Accountability Act of
1996 (HIPAA) coupled with an unanticipated flattening of commercial trends and
higher commercial large group claims trend.
Medical Care Ratios
The health plan services MCR in our Western Region Operations segment was 90.1
percent and 89.8 percent for the three and six months ended June 30, 2012,
respectively, compared with 86.9 percent and 86.7 percent for the three and six
months ended June 30, 2011, respectively.
Commercial MCR in our Western Region Operations segment was 88.7 percent and
90.0 percent for the three and six months ended June 30, 2012, respectively,
compared with 85.7 percent and 85.7 percent for the three and six months ended
June 30, 2011, respectively. The deterioration of 300 basis points and 430 basis
points in commercial MCR for the three and six months ended June 30, 2012,
respectively, was primarily due to the adverse prior period development.
The Medicare Advantage MCR in our Western Region Operations segment was 92.0
percent and 89.9 percent for the three and six months ended June 30, 2012,
respectively, compared with 90.9 percent and 90.0 percent for the three and six
months ended June 30, 2011, respectively. The Medicare Advantage MCR
deteriorated 110 basis points for the three months ended June 30, 2012 and
improved 10 basis points for the six months ended June 30, 2012. This
deterioration for the three months ended June 30, 2012 was primarily due to
adverse prior period development in the second quarter of 2012 related to the
first quarter of 2012.
The Medicaid MCR in our Western Region Operations segment was 91.3 percent and
89.1 percent for the three and six months ended June 30, 2012, respectively,
compared with 85.2 percent and 85.1 percent for the three and six months ended
June 30, 2011, respectively. The increase in the MCR fort he three months ended
June 30, 2012 was primarily due to higher claims experience in SPD membership.
The SPD members have a higher MCR than the non-
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SPD members.
G&A, Selling and Interest Expenses
G&A expense in our Western Region Operations segment was $218.7 million and
$449.5 million for the three and six months ended June 30, 2012, respectively,
compared with $197.4 million and $417.5 million for the three and six months
ended June 30, 2011, respectively. The G&A expense ratio was 8.3 percent and 8.6
percent for the three and six months ended June 30, 2012, respectively, compared
to 8.1 percent and 8.5 percent for the three and six months ended June 30, 2011,
respectively.
Selling expense in our Western Region Operations segment was $58.4 million and
$120.0 million for the three and six months ended June 30, 2012, respectively,
compared with $57.3 million and $117.8 million for the three and six months
ended June 30, 2011, respectively. The selling costs ratio was 2.2 percent and
2.3 percent for the three and six months ended June 30, 2012, respectively,
compared to 2.3 percent and 2.4 percent for the three and six months ended June
30, 2011, respectively.
Interest expense in our Western Region Operations segment was $8.2 million and
$16.9 million for the three and six months ended June 30, 2012, respectively,
compared with $8.1 million and $15.7 million for the three and six months ended
June 30, 2011, respectively. These increases are primarily due to higher
interest rates under our revolving credit facility in the three months ended
June 30, 2012 compared to the same period in 2011 and due to higher borrowings
and interest rates under our revolving credit facility for the six months ended
June 30, 2012 compared to the same period in 2011.
Government Contracts Reportable Segment
On April 1, 2011, we began delivery of administrative services under our T-3
contract for the TRICARE North Region. The T-3 contract was awarded to us on
May 13, 2010. Under the T-3 contract for the TRICARE North Region, we provide
administrative services to approximately 2.9 million MHS eligible beneficiaries
as of June 30, 2012.
Under the T-3 contract for the TRICARE North Region, we provide various types of
administrative services including: provider network management, referral
management, medical management, disease management, enrollment, customer
service, clinical support service, and claims processing. We also provided
assistance in the transition into the T-3 contract, and will provide assistance
in any transition out of the T-3 contract. These services are structured as cost
reimbursement arrangements for health care costs plus administrative fees earned
in the form of fixed prices, fixed unit prices, and contingent fees and payments
based on various incentives and penalties. We recognize revenue related to
administrative services on a straight-line basis over the option period, when
the fees become fixed and determinable. The T-3 members are served by our
network and out-of-network providers in accordance with the T-3 contract. We pay
health care costs related to these services to the providers and are later
reimbursed by the DoD for such payments. Under the terms of the T-3 contract, we
are not the primary obligor for health care services and accordingly, we do not
include health care costs and related reimbursements in our consolidated
statement of operations. The contract also includes various performance-based
incentives and penalties. For each of the incentives or penalties, we adjust
revenue accordingly based on the amount that we have earned or incurred at each
interim date and are legally entitled to in the event of a contract termination.
See Note 2 to our consolidated financial statements under the heading "T-3
TRICARE Contract" for additional information on the T-3 contract.
As a result of the award of the T-3 contract for the TRICARE South Region,
responsibility for the delivery of services for the Fort Campbell area of
Kentucky and Tennessee was realigned from the TRICARE North Region to the
TRICARE South Region. This realignment was expected and, as a result, effective
April 1, 2012 we were no longer responsible for servicing approximately 120,000
eligible beneficiaries in the Fort Campbell area under our T-3 contract. This
realignment did not have a material impact to our consolidated results of
operations.
In addition to the beneficiaries that we service under the T-3 contract, we
administer contracts with the U.S. Department of Veterans Affairs to manage
community based outpatient clinics in seven states covering approximately 15,000
enrollees and provide behavioral health services to military families under the
Department of Defense sponsored MFLC contract. The five-year MFLC contract began
in January 2007, and was subsequently extended through July 25, 2012. On July
18, 2012, a new task order was issued under the MFLC contract that extended the
period for provision of services under the MFLC contract for 12 months. We
anticipate that services will continue to
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be provided under the new task order until award and full implementation of
service delivery under a follow-on MFLC contract. The Request for Proposals for
the MFLC follow-on contract was initially issued on behalf of the Department of
Defense on December 13, 2010. A contract award is anticipated in the third
quarter of 2012 with commencement of contract work in the fourth quarter of
2012. Revenues from the MFLC contract were $59.1 million and $116.2 million for
the three and six months ended June 30, 2012, respectively.
Government Contracts Segment Results
The following table summarizes the operating results for the Government
Contracts segment for the three and six months ended June 30, 2012 and 2011:
Six Months Ended
Three Months Ended June 30, June 30,
2012 2011 2012 2011
(Dollars in thousands)
Government contracts revenues $ 176,248 $ 171,015 $ 357,610 $ 1,046,142
Government contracts costs 152,705 130,802 312,028 948,101
Income from continuing operations
before income taxes 23,543 40,213 45,582 98,041
Income tax provision 9,305 16,341 18,081 39,730
Income from continuing operations $ 14,238 $ 23,872 $
27,501 $ 58,311
Government Contracts revenues increased by $5.2 million, or 3.1 percent, for the
three months ended June 30, 2012 and decreased by $688.5 million, or 65.8
percent, for the six months ended June 30, 2012 as compared to the same periods
in 2011. Government Contracts costs increased by $21.9 million or 16.7 percent
for the three months ended June 30, 2012 and decreased by $636.1 million, or
67.1 percent for the six months ended June 30, 2012 as compared to the same
periods in 2011. Increases in revenues for the three months ended June 30, 2012,
were primarily due to adjustments and phase-out revenue in 2011 related to our
previous TRICARE contract in the North Region and award fee revenue on the T-3
contract offset by a reduction in price on our family counseling business.
Increases in costs for the three months ended June 30, 2012, were primarily due
to adjustments in 2011 related to our previous TRICARE contract in the North
Region. Declines in Government Contracts revenues and costs for the six months
ended June 30, 2012 were primarily due to the impact of replacing our previous
TRICARE contract in the North Region with the new T-3 contract. This change
replaced a risk-based contract with a cost reimbursement plus fixed fee
contract, as a result of which, health care costs and related reimbursements
that were included in our consolidated statements of operations under the prior
contract were subsequently excluded under the T-3 contract.
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Divested Operations and Services Reportable Segment Results
The following table summarizes the operating results for our Divested Operations
and Services reportable segment for the three and six months ended June 30, 2012
and 2011:
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(Dollars in thousands)
Health plan services premiums $ - $ 326 $ - $ 2,330
Net investment income - 10 - 71
Divested operations and services
revenue 12,805 11,021 12,805 23,470
Total revenues 12,805 11,357 12,805 25,871
Health plan services 14 (160) 140 738
General and administrative (7) 690 (2) 1,718
Selling - 68 - 172
Depreciation and amortization - 6 1 12
Interest - 185 - 185
Divested operations and services
expenses 19,290 42,356 42,386 100,685
Adjustment to loss on sale of Northeast
health plan subsidiaries - (6,283) - (41,137)
Total expenses 19,297 36,862 42,525 62,373
Loss from continuing operations before
income taxes (6,492) (25,505) (29,720) (36,502)
Income tax benefit (2,537) (12,864)
(11,383) (19,036)
Net loss from continuing operations $ (3,955 ) $ (12,641 ) $ (18,337 ) $ (17,466 )
As a result of entering into a definitive agreement in January 2012 to sell our
Medicare PDP business, we reviewed our reportable segments in the first quarter
of 2012. For additional information on the sale of our Medicare PDP business,
see Note 3 to our consolidated financial statements. As a result of our review
of our reportable segments, all services provided in connection with divested
businesses, including the Northeast Sale and the sale of our Medicare PDP
business, are now reported as part of our Divested Operations and Services
reportable segment. See Note 4 to our consolidated financial statements for more
information regarding our reportable segments.
Our operating results for the three and six months ended June 30, 2011 were
impacted by a $6.3 million and $41.1 million, respectively, favorable adjustment
to loss on sale of our Northeast health plan subsidiaries. See Note 3 to our
consolidated financial statements for additional information regarding the
Northeast Sale.
Corporate/Other
The following table summarizes the Corporate/Other segment for the three and six
months ended June 30, 2012 and 2011:
Six Months Ended
Three Months Ended June 30, June 30,
2012 2011 2012 2011
(Dollars in thousands)
Costs included in health plan services
costs $ 41 $ (300 ) $ (5,803 ) $ (300 )
Costs included in government contract costs 701 26 3,688 4,879
Costs included in G&A 10,074 3,561 16,541 186,938
Loss from continuing operations before
income taxes (10,816 ) (3,287 ) (14,426 ) (191,517 )
Income tax benefit (4,075 )
(1,781 ) (5,747 ) (25,324 )
Net loss from continuing operations $ (6,741 ) $ (1,506 ) $ (8,679 ) $ (166,193 )
Our Corporate/Other segment is not a business operating segment. It is added to
our reportable segments to reconcile to our consolidated results. Our
Corporate/Other segment includes costs that are excluded from the
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calculation of segment pretax income because they are not managed within our
reportable segments.
Our operating results in our Corporate/Other segment for the three months ended
June 30, 2012 were impacted primarily by $10.8 million in pretax costs related
to our G&A cost reduction efforts. Our operating results in our Corporate/Other
segment for the six months ended June 30, 2012 were impacted primarily by $20.2
million in pretax costs related to our G&A cost reduction efforts and $0.7
million in pretax litigation reserve true-ups, partially reduced by a $6.5
million insurance reimbursement related to a prior class action settlement.
Our operating results for the three months ended June 30, 2011 were impacted by
$2.7 million in pretax costs related to our cost management initiatives and $0.9
million in additional interest related to the judgment in the AmCareco
litigation, reduced by a $0.3 million benefit from a litigation reserve true-up.
Our operating results for the six months ended June 30, 2011 were impacted by a
$181 million pretax charge related to the judgment in the AmCareco litigation
and $13.7 million in pretax costs related to our cost management initiatives.
See Note 9 to our consolidated financial statements for additional information
regarding the AmCareco litigation.
LIQUIDITY AND CAPITAL RESOURCES
Market and Economic Conditions
The current state of the global economy and market conditions continue to be
challenging with relatively high levels of unemployment, diminished business and
consumer confidence, and volatility in both U.S. and international capital and
credit markets. Market conditions could limit our ability to timely replace
maturing liabilities, or otherwise access capital markets for liquidity needs,
which could adversely affect our business, financial condition and results of
operations. Furthermore, if our customer base experiences cash flow problems and
other financial difficulties, it could, in turn, adversely impact membership in
our plans. For example, our customers may modify, delay or cancel plans to
purchase our products, may reduce the number of individuals to whom they provide
coverage, or may make changes in the mix or products purchased from us. In
addition, if our customers experience financial issues, they may not be able to
pay, or may delay payment of, accounts receivable that are owed to us. Further,
our customers or potential customers may force us to compete more vigorously on
factors such as price and service to retain or obtain their business. A
significant decline in membership in our plans and the inability of current
and/or potential customers to pay their premiums as a result of unfavorable
conditions may adversely affect our business, including our revenues,
profitability and cash flow.
Cash and Investments
As of June 30, 2012, the fair value of our investment securities
available-for-sale was $1.5 billion, all in current investments. We hold
high-quality fixed income securities primarily comprised of corporate bonds,
mortgage-backed bonds, municipal bonds and bank loans. We evaluate and determine
the classification of our investments based on management's intent. We also
closely monitor the fair values of our investment holdings and regularly
evaluate them for other-than-temporary impairments.
Our cash flow from investing activities is primarily impacted by the sales,
maturities and purchases of our available-for-sale investment securities and
restricted investments. Our investment objective is to maintain safety and
preservation of principal by investing in a diversified mix of high-quality
fixed-income securities, which are largely investment grade, while maintaining
liquidity in each portfolio sufficient to meet our cash flow requirements and
attaining an expected total return on invested funds.
Our investment holdings are currently comprised of investment grade securities
with an average rating of "A+" and "A1" as rated by S&P and/or Moody's,
respectively. At this time, there is no indication of default on interest and/or
principal payments under our holdings. We have the ability and current intent to
hold to recovery all securities with an unrealized loss position. As of June 30,
2012, our investment portfolio includes $598.4 million, or 39.5% of our
portfolio holdings, of mortgage-backed and asset-backed securities. The majority
of our mortgage-backed securities are Fannie Mae, Freddie Mac and Ginnie Mae
issues, and the average rating of our entire asset-backed securities is AA+/Aa1.
However, any failure by Fannie Mae or Freddie Mac to honor the obligations under
the securities they have issued or guaranteed could cause a significant decline
in the value or cash flow of our mortgage-backed securities. As of June 30,
2012, our investment portfolio also included $434.4 million, or 28.7% of our
portfolio holdings, of obligations of state and other political subdivisions and
$456.6 million, or 30.1% of our portfolio holdings, of corporate debt
securities.
We had gross unrealized losses of $1.9 million as of June 30, 2012, and $4.8
million as of December 31, 2011. Included in the gross unrealized losses as of
December 31, 2011 are $0.3 million related to noncurrent investments
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available-for-sale. We believe that these impairments are temporary and we do
not intend to sell these investments. It is not likely that we will be required
to sell any security in an unrealized loss position before recovery of its
amortized cost basis. Given the current market conditions and the significant
judgments involved, there is a continuing risk that further declines in fair
value may occur and additional material other-than-temporary impairments may be
recorded in future periods. No impairment was recognized during the three and
six months ended June 30, 2012 or 2011.
Liquidity
We believe that expected cash flow from operating activities, any existing cash
reserves and other working capital and lines of credit are adequate to allow us
to fund existing obligations, repurchase shares under our stock repurchase
program, introduce new products and services, enter into new lines of business
and continue to operate and develop health care-related businesses at least for
the next twelve months. We regularly evaluate cash requirements for current
operations and commitments, for acquisitions and other strategic transactions
and for business expansion opportunities, such as the state of California's dual
eligibles pilot program. We may elect to raise additional funds for these
purposes, either through issuance of debt or equity, the sale of investment
securities or otherwise, as appropriate. Based on the composition and quality of
our investment portfolio, our expected ability to liquidate our investment
portfolio as needed, and our expected operating and financing cash flows, we do
not anticipate any liquidity constraints as a result of the current credit
environment. However, continued turbulence in U.S. and international markets and
certain costs associated with the implementation of health care reform
legislation could adversely affect our liquidity.
Our cash flow from operating activities is impacted by, among other things, the
timing of collections on our amounts receivable from state and federal
governments and agencies. Our receivable from CMS related to our Medicare
business was $261.5 million as of June 30, 2012 and $198.5 million as of
December 31, 2011. The receivable from DHCS related to our California Medicaid
business was $105.4 million as of June 30, 2012 and $87.4 million as of
December 31, 2011. Our receivable from the DoD relating to our current and prior
contracts for the TRICARE North Region were $247.4 million and $234.7 million as
of June 30, 2012 and December 31, 2011, respectively. The timing of collection
of such receivables is impacted by government audit and can extend for periods
beyond a year.
Operating Cash Flows
Our net cash flow provided by (used in) operating activities for the six months
ended June 30, 2012 compared to the same period in 2011 is as follows:
June 30, June 30, Change
Period over
2012 2011 Period
(Dollars in millions)
Net cash provided by (used in) operating
activities $123.9 $(297.5)
$421.4
The increase of $421.4 million in operating cash flow is primarily due to the
following:
• $134.4 million increase in Medi-Cal payments during the six months
ended June 30, 2012 as compared to the same period in 2011,
• $181 million in payments related to the decision rendered in the
AmCareco litigation during the three months ended June 30, 2011, and
• $84.2 million in aggregate quarterly net payments to United in
accordance with the terms of the stock purchase agreement in
connection with the Northeast Sale during the six months ended June
30, 2011.
Investing Activities
Our net cash flow provided by investing activities for the six months ended June
30, 2012 compared to the same period in 2011 is as follows:
June 30, June 30, Change
2012 2011 Period over Period
(Dollars in millions)
Net cash provided by investing activities $291.2$112.8$178.4
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Net cash provided by investing activities increased by $178.4 million during the
six months ended June 30, 2012 as compared to the same period in 2011. This
increase is primarily due to $248.2 million received for the sale of our
Medicare PDP business, partially offset by a $31.3 million decrease in net sales
and maturities of available-for-sale securities and $41.0 million received from
United for additional consideration related to the Northeast Sale during the
first six months of 2011.
Financing Activities
Our net cash flow (used in) provided by financing activities for the six months
ended June 30, 2012 compared to the same period in 2011 is as follows:
June 30, June 30, Change
Period over
2012 2011 Period
(Dollars in millions)
Net cash (used in) provided by financing
activities $(12.3) $1.0 $(13.3)
Net cash provided by financing activities decreased by $13.3 million during the
six months ended June 30, 2012 as compared to the same period in 2011 primarily
due to a net decrease in revolving credit facility borrowings of $207.5 million,
partially offset by a $161.1 million decrease in stock repurchases.
Capital Structure
Our debt-to-total capital ratio was 24.1 percent as of June 30, 2012 compared
with 26.2 percent as of December 31, 2011. This decrease was driven by a
decrease in borrowings and an increase in equity resulting from net income
during the first six months of 2012.
Share Repurchases. On March 18, 2010, our Board of Directors authorized our 2010
stock repurchase program pursuant to which a total of $300 million of our common
stock could be repurchased. During the three and six months ended June 30, 2011,
we repurchased 1.4 million shares and 4.9 million shares, respectively, of our
common stock for aggregate consideration of approximately $45.2 million and
$149.8 million, respectively, under our 2010 stock repurchase program. We
completed our 2010 stock repurchase program in April 2011 after repurchasing an
aggregate of 10.8 million shares of our common stock at an average price of
$27.80 per share for aggregate consideration of $300.0 million.
On May 2, 2011, our Board of Directors authorized our 2011 stock repurchase
program pursuant to which a total of $300 million of our outstanding common
stock could be repurchased. As of December 31, 2011, the remaining authorization
under the 2011 stock repurchase program was $76.3 million. On March 8, 2012, our
Board of Directors approved a $323.7 million increase to our 2011 stock
repurchase program. During the three and six months ended June 30, 2012, we
repurchased 562,000 shares of our common stock for aggregate consideration of
$13.9 million under our 2011 stock repurchase program. The remaining
authorization under our 2011 stock repurchase program as of June 30, 2012 was
$386.1 million. For additional information on our 2010 and 2011 stock repurchase
programs, see Note 6 to our consolidated financial statements.
Under our various stock option and long-term incentive plans, employees and
non-employee directors may elect for the Company to withhold shares to satisfy
minimum statutory federal, state and local tax withholding and/or exercise price
obligations, as applicable, arising from the exercise of stock options. For
certain other equity awards, we have the right to withhold shares to satisfy any
tax obligations that may be required to be withheld or paid in connection with
such equity award, including any tax obligation arising on the vesting date.
These repurchases were not part of either of our stock repurchase programs.
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The following table presents monthly information related to repurchases of our
common stock, including shares withheld by the Company to satisfy tax
withholdings and exercise price obligations, as of June 30, 2012:
Maximum Number
Total Number (or Approximate
of Shares Dollar Value) of
Purchased as Shares (or Units)
Total Number Average Part of Publicly that May Yet Be
of Shares Price Paid Total Announced Purchased Under
Period Purchased (a) per Share Price Paid Programs (b) the Programs (b)
January 1-January 31 - $ - $ - - $ 76,341,683
February 1-February 29 488,964 (c) 39.28 19,205,186 - $ 76,341,683
March 1-March 31 857 (c) 38.59 33,072 - $ 400,000,000
April 1-April 30 - - - - $ 400,000,000
May 1-May 31 - - - - $ 400,000,000
June 1-June 30 561,600 24.75 13,899,362 561,600 $ 386,100,638
1,051,421 $ 31.52 $ 33,137,620 561,600
________(a) During the six months ended June 30, 2012, we did not repurchase any shares
of our common stock outside our 2011 stock repurchase program, except shares
withheld in connection with our various stock option and long-term incentive
plans.
(b) On May 2, 2011, our Board of Directors authorized our 2011 stock repurchase
program, pursuant to which a total of $300 million of our common stock can
be repurchased. On March 8, 2012, our Board of Directors approved a $323.7
million increase to our 2011 stock repurchase program. Our 2011 stock
repurchase program does not have an expiration date. During the six months
ended June 30, 2012, we did not have any repurchase program expire, and we
did not terminate any repurchase program prior to its expiration date.
(c) Represents shares withheld by the Company to satisfy tax withholding and/or
exercise price obligations arising from the vesting and/or exercise of
restricted stock units, stock options and other equity awards.
Revolving Credit Facility. In October 2011, we entered into a $600 million
unsecured revolving credit facility due in October 2016, which includes a $400
million sublimit for the issuance of standby letters of credit and a $50 million
sublimit for swing line loans (which sublimits may be increased in connection
with any increase in the credit facility described below). In addition, we have
the ability from time to time to increase the credit facility by up to an
additional $200 million in the aggregate, subject to the receipt of additional
commitments. We utilized proceeds of the initial borrowing on the closing date
of this credit facility to refinance our obligations under our previous
revolving credit facility. As of June 30, 2012, $90.0 million was outstanding
under our revolving credit facility and the maximum amount available for
borrowing under the revolving credit facility was $450.6 million (see "-Letters
of Credit" below). As of August 2, 2012, we had $100.0 million in borrowings
outstanding under the revolving credit facility.
Amounts outstanding under our revolving credit facility bear interest, at the
Company's option, at either (a) the base rate (which is a rate per annum equal
to the greatest of (i) the federal funds rate plus one-half of one percent,
(ii) Bank of America, N.A.'s "prime rate" and (iii) the Eurodollar Rate (as such
term is defined in the credit facility) for a one-month interest period plus one
percent) plus an applicable margin ranging from 45 to 105 basis points or
(b) the Eurodollar Rate plus an applicable margin ranging from 145 to 205 basis
points. The applicable margins are based on our consolidated leverage ratio, as
specified in the credit facility, and are subject to adjustment following the
Company's delivery of a compliance certificate for each fiscal quarter.
Our revolving credit facility includes, among other customary terms and
conditions, limitations (subject to specified exclusions) on our and our
subsidiaries' ability to incur debt; create liens; engage in certain mergers,
consolidations and acquisitions; sell or transfer assets; enter into agreements
that restrict the ability to pay dividends or make or repay loans or advances;
make investments, loans, and advances; engage in transactions with affiliates;
and make dividends. In addition, we are required to be in compliance at the end
of each fiscal quarter with a specified consolidated leverage ratio and
consolidated fixed charge coverage ratio.
Our revolving credit facility contains customary events of default, including
nonpayment of principal or other amounts when due; breach of covenants;
inaccuracy of representations and warranties; cross-default and/or cross-
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acceleration to other indebtedness of the Company or our subsidiaries in excess
of $50 million; certain ERISA-related events; noncompliance by the Company or
any of our subsidiaries with any material term or provision of the HMO
Regulations or Insurance Regulations (as each such term is defined in the credit
facility) in a manner that could reasonably be expected to result in a material
adverse effect; certain voluntary and involuntary bankruptcy events; inability
to pay debts; undischarged, uninsured judgments greater than $50 million against
us and/or our subsidiaries that are not stayed within 60 days; actual or
asserted invalidity of any loan document; and a change of control. If an event
of default occurs and is continuing under the revolving credit facility, the
lenders thereunder may, among other things, terminate their obligations under
the facility and require us to repay all amounts owed thereunder.
As of June 30, 2012, we were in compliance with all covenants under our
revolving credit facility.
Letters of Credit
Pursuant to the terms of our revolving credit facility, we can obtain letters of
credit in an aggregate amount of $400 million and the maximum amount available
for borrowing is reduced by the dollar amount of any outstanding letters of
credit. As of June 30, 2012 and as of August 2, 2012, we had outstanding letters
of credit of $59.4 million, resulting in a maximum amount available for
borrowing of $450.6 million as of June 30, 2012 and $440.6 million as of August
2, 2012. As of June 30, 2012 and August 2, 2012, no amount had been drawn on any
of these letters of credit.
Senior Notes. We have issued $400 million in aggregate principal amount of
6.375% Senior Notes due 2017 (the "Senior Notes"). The indenture governing the
Senior Notes limits our ability to incur certain liens, or consolidate, merge or
sell all or substantially all of our assets. In the event of the occurrence of
both (1) a change of control of Health Net, Inc. and (2) a below investment
grade rating by any two of Fitch, Inc., Moody's Investors Service, Inc. and
Standard & Poor's Ratings Services, within a specified period, we will be
required to make an offer to purchase the Senior Notes at a price equal to 101%
of the principal amount of the Senior Notes plus accrued and unpaid interest to
the date of repurchase. As of June 30, 2012, we were in compliance with all of
the covenants under the indenture governing the Senior Notes.
The Senior Notes may be redeemed in whole at any time or in part from time to
time, prior to maturity at our option, at a redemption price equal to the
greater of:
• 100% of the principal amount of the Senior Notes then outstanding to be
redeemed; or
• the sum of the present values of the remaining scheduled payments of
principal and interest on the Senior Notes to be redeemed (not
including any portion of such payments of interest accrued to the date
of redemption) discounted to the date of redemption on a semiannual
basis (assuming a 360-day year consisting of twelve 30-day months) at
the applicable treasury rate plus 30 basis points
plus, in each case, accrued and unpaid interest on the principal amount being
redeemed to the redemption date.
Each of the following will be an Event of Default under the indenture governing
the Senior Notes:
• failure to pay interest for 30 days after the date payment is due and
payable; provided that an extension of an interest payment period by us in accordance with the terms of the Senior Notes shall not constitute a
failure to pay interest;
• failure to pay principal or premium, if any, on any note when due,
either at maturity, upon any redemption, by declaration or otherwise;
• failure to perform any other covenant or agreement in the notes or
indenture for a period of 60 days after notice that performance was
required;
• (A) our failure or the failure of any of our subsidiaries to pay indebtedness for money we borrowed or any of our subsidiaries borrowed
in an aggregate principal amount of at least $50 million, at the later
of final maturity and the expiration of any related applicable grace
period and such defaulted payment shall not have been made, waived or
extended within 30 days after notice or (B) acceleration of the
maturity of indebtedness for money we borrowed or any of our
subsidiaries borrowed in an aggregate principal amount of at least $50
million, if that acceleration results from a default under the
instrument giving rise to or securing such indebtedness for money
borrowed and such indebtedness has not been discharged in full or such
acceleration has not been rescinded or annulled within 30 days after
notice; or
• events in bankruptcy, insolvency or reorganization of our Company.
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Statutory Capital Requirements
Certain of our subsidiaries must comply with minimum capital and surplus
requirements under applicable state laws and regulations, and must have adequate
reserves for claims. Management believes that as of June 30 2012, all of our
active health plans and insurance subsidiaries met their respective regulatory
requirements relating to maintenance of minimum capital standards, surplus
requirements and adequate reserves for claims in all material respects.
By law, regulation and governmental policy, our health plan and insurance
subsidiaries, which we refer to as our regulated subsidiaries, are required to
maintain minimum levels of statutory capital and surplus. The minimum statutory
capital and surplus requirements differ by state and are generally based on
balances established by statute, a percentage of annualized premium revenue, a
percentage of annualized health care costs, or risk-based capital ("RBC") or
tangible net equity ("TNE") requirements. The RBC requirements are based on
guidelines established by the National Association of Insurance Commissioners.
The RBC formula, which calculates asset risk, underwriting risk, credit risk,
business risk and other factors, generates the authorized control level ("ACL"),
which represents the minimum amount of capital and surplus believed to be
required to support the regulated entity's business. For states in which the RBC
requirements have been adopted, the regulated entity typically must maintain the
greater of the Company Action Level RBC, calculated as 200% of the ACL, or the
minimum statutory capital and surplus requirement calculated pursuant to pre-RBC
guidelines. Because our regulated subsidiaries are also subject to their state
regulators' overall oversight authority, some of our subsidiaries are required
to maintain minimum capital and surplus in excess of the RBC requirement, even
though RBC has been adopted in their states of domicile. Although RBC standards
are not yet applicable to all of our regulated subsidiaries, we generally manage
our aggregate regulated subsidiary capital and surplus at approximately 400% of
ACL. In certain interim periods, we may manage our aggregate regulated
subsidiary capital and surplus below 400% of ACL.
Under the California Knox-Keene Health Care Service Plan Act of 1975, as amended
("Knox-Keene"), certain California subsidiaries must comply with TNE
requirements. Under these Knox-Keene TNE requirements, actual net worth less
unsecured receivables and intangible assets must be more than the greater of (i)
a fixed minimum amount, (ii) a minimum amount based on premiums or (iii) a
minimum amount based on health care expenditures, excluding capitated amounts.
In addition, certain California subsidiaries have made certain undertakings to
the Department of Managed Health Care to restrict dividends and loans to
affiliates, to the extent that the payment of such would reduce such entities'
TNE below 130% of the minimum requirement, or reduce the cash-to-claims ratio
below 1:1. At June 30, 2012, all of the subsidiaries subject to the TNE
requirements and the undertakings to the Department of Managed Health Care
exceeded the minimum requirements.
As necessary, we make contributions to and issue standby letters of credit on
behalf of our subsidiaries to meet RBC or other statutory capital requirements
under state laws and regulations. During the six months ended June 30, 2012, we
made no such capital contributions. In addition, we made no capital
contributions to any of our subsidiaries to meet RBC or other statutory capital
requirements under state laws and regulations thereafter through August 2, 2012.
Legislation has been or may be enacted in certain states in which our
subsidiaries operate imposing substantially increased minimum capital and/or
statutory deposit requirements for HMOs in such states. Such statutory deposits
may only be drawn upon under limited circumstances relating to the protection of
policyholders.
As a result of the above requirements and other regulatory requirements, certain
subsidiaries are subject to restrictions on their ability to make dividend
payments, loans or other transfers of cash to their parent companies. Such
restrictions, unless amended or waived or unless regulatory approval is granted,
limit the use of any cash generated by these subsidiaries to pay our
obligations. The maximum amount of dividends that can be paid by our insurance
company subsidiaries without prior approval of the applicable state insurance
departments is subject to restrictions relating to statutory surplus, statutory
income and unassigned surplus.
CONTRACTUAL OBLIGATIONS
Pursuant to Item 303(a)(5) of Regulation S-K, we identified our known
contractual obligations as of December 31, 2011 in our Form 10-K and identified
additional significant contractual obligations in our Form 10-Q for the quarter
ended March 31, 2012. During the three months ended June 30, 2012, there were no
significant changes to our contractual obligations as previously disclosed in
our Form 10-K and Form 10-Q for the quarter ended March 31, 2012.
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OFF-BALANCE SHEET ARRANGEMENTS
As of June 30, 2012, we had no off-balance sheet arrangements as defined under
Regulation S-K Item 303(a)(4) and the instructions thereto. See Note 7 to our
consolidated financial statements for a discussion of our letters of credit.
CRITICAL ACCOUNTING ESTIMATES
In our Form 10-K, we identified the critical accounting policies, which affect
the more significant estimates and assumptions used in preparing our
consolidated financial statements. Those policies include revenue recognition,
health care costs, reserves for contingent liabilities, amounts receivable or
payable under government contracts, goodwill and recoverability of long-lived
assets and investments, income taxes and the consolidation of variable interest
entities. We have not changed existing policies from those previously disclosed
in our Form 10-K. Our critical accounting policy on estimating reserves for
claims and other settlements and the quantification of the sensitivity of
financial results to reasonably possible changes in the underlying assumptions
used in such estimation as of June 30, 2012 is discussed below. Our critical
accounting policy on goodwill impairment testing is also discussed below. There
were no other significant changes to the critical accounting estimates as
disclosed in our Form 10-K.
Reserves for Claims and Other Settlements
Reserves for claims and other settlements include reserves for claims (IBNR
claims and received but unprocessed claims), and other liabilities including
capitation payable, shared risk settlements, provider disputes, provider
incentives and other reserves for our Western Region Operations reporting
segment.
We estimate the amount of our reserves for claims primarily by using standard
actuarial developmental methodologies. This method is also known as the
chain-ladder or completion factor method. The developmental method estimates
reserves for claims based upon the historical lag between the month when
services are rendered and the month claims are paid while taking into
consideration, among other things, expected medical cost inflation, seasonal
patterns, product mix, benefit plan changes and changes in membership. A key
component of the developmental method is the completion factor, which is a
measure of how complete the claims paid to date are relative to the estimate of
the claims for services rendered for a given period. While the completion
factors are reliable and robust for older service periods, they are more
volatile and less reliable for more recent periods since a large portion of
health care claims are not submitted to us until several months after services
have been rendered. Accordingly, for the most recent months, the incurred claims
are estimated from a trend analysis based on per member per month claims trends
developed from the experience in preceding months. This method is applied
consistently year over year while assumptions may be adjusted to reflect changes
in medical cost inflation, seasonal patterns, product mix, benefit plan changes
and changes in membership.
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An extensive degree of actuarial judgment is used in this estimation process,
considerable variability is inherent in such estimates, and the estimates are
highly sensitive to changes in medical claims submission and payment patterns
and medical cost trends. As such, the completion factors and the claims per
member per month trend factor are the most significant factors used in
estimating our reserves for claims. Since a large portion of the reserves for
claims is attributed to the most recent months, the estimated reserves for
claims are highly sensitive to these factors. The following table illustrates
the sensitivity of these factors and the estimated potential impact on our
operating results caused by these factors:
Completion Factor (a)
Percentage-point Western Region Operations Health Plan Services
Increase (Decrease) (Decrease) Increase in
in Factor Reserves for Claims
2% $ (51.6) million
1% $ (26.3) million
(1)% $ 27.4 million
(2)% $ 56.0 million
Medical Cost Trend (b)
Percentage-point Western Region Operations Health Plan Services
Increase (Decrease) Increase (Decrease) in
in Factor Reserves for Claims
2% $ 24.6 million
1% $ 12.3 million
(1)% $ (12.3) million
(2)% $ (24.6) million
__________
(a) Impact due to change in completion factor for the most recent three months.
Completion factors indicate how complete claims paid to date are in relation
to the estimate of total claims for a given period. Therefore, an increase
in the completion factor percent results in a decrease in the remaining
estimated reserves for claims.
(b) Impact due to change in annualized medical cost trend used to estimate the
per member per month cost for the most recent three months.
Other relevant factors include exceptional situations that might require
judgmental adjustments in setting the reserves for claims, such as system
conversions, processing interruptions or changes, environmental changes or other
factors. All of these factors are used in estimating reserves for claims and are
important to our reserve methodology in trending the claims per member per month
for purposes of estimating the reserves for the most recent months. In
developing our best estimate of reserves for claims, we consistently apply the
principles and methodology described above from year to year, while also giving
due consideration to the potential variability of these factors. Because
reserves for claims include various actuarially developed estimates, our actual
health care services expense may be more or less than our previously developed
estimates. Claims processing expenses are also accrued based on an estimate of
expenses necessary to process such claims. Such reserves are continually
monitored and reviewed, with any adjustments reflected in current operations.
Goodwill and Other Intangible Assets
Goodwill and other intangible assets arise primarily as a result of various
business acquisitions and consist of identifiable intangible assets acquired and
the excess of the cost of the acquisitions over the tangible and intangible
assets acquired and liabilities assumed (goodwill). Identifiable intangible
assets primarily consist of the value of employer group contracts, provider
networks and customer relationships, which are all subject to amortization.
On April 1, 2012, we completed the sale of our Medicare PDP business. Our
Medicare PDP business was previously reported as part of our Western Region
Operations reporting unit. As of March 31, 2012, we re-allocated a portion of
the Western Region Operations reporting unit goodwill to the Medicare PDP
business based on relative fair values of the reporting unit with and without
the Medicare PDP business. Our measurement of fair value is based on a
combination of the income approach based on a discounted cash flow methodology
and the discounted total consideration received in connection with the sale of
our Medicare PDP business. After the reallocation of goodwill,
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we performed a two-step impairment test to determine the existence of any
impairment and the amount of the impairment. In the first step, we compared the
fair value to the related carrying value and concluded that no impairment to
either the carrying value of our Medicare PDP business or our Western Region
Operations reporting unit had occurred. Based on the result of the first step
test, we did not need to complete the second step test. See Note 3 to our
consolidated financial statements for additional information regarding the sale
of our Medicare PDP business and Note 8 to our consolidated financial statements
for additional goodwill fair value measurement information.
We perform our annual impairment test on our recorded goodwill as of June 30 or
more frequently if events or changes in circumstances indicate that we might not
recover the carrying value of these assets for each of our reporting units. We
performed our annual impairment test on our goodwill and other intangible assets
as of June 30, 2012 for our Western Region Operations reporting unit, and no
impairment was identified. We performed a two-step impairment test to determine
the existence of impairment and the amount of the impairment. In the first step,
we compared the fair values to the related carrying values and concluded that
the carrying value of the Western Region Operations was not impaired. As a
result, the second step was not performed. We also re-evaluated the useful lives
of our other intangible assets and determined that the current estimated useful
lives were properly reflected.
Due to the many variables inherent in the estimation of a business's fair value
and the relative size of recorded goodwill, changes in assumptions may have a
material effect on the results of our impairment test. The discounted cash flows
and market participant valuations (and the resulting fair value estimates of the
Western Region Operations reporting unit) are sensitive to changes in
assumptions including, among others, certain valuation and market assumptions,
the Company's ability to adequately incorporate into its premium rates the
future costs of premium-based assessments imposed by the Patient Protection and
Affordable Care Act and the Health Care and Reconciliation Act of 2010, and
assumptions related to the achievement of certain administrative cost reductions
and the profitable implementation of the dual eligibles pilot program. Changes
to any of these assumptions could cause the fair value of our Western Region
Operations reporting unit to be below its carrying value. As of June 30, 2011
and June 30, 2012, the ratio of the fair value of our Western Region Operations
reporting unit to its carrying value was approximately 180% and 115%,
respectively.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We are exposed to interest rate and market risk primarily due to our investing
and borrowing activities. Market risk generally represents the risk of loss that
may result from the potential change in the value of a financial instrument as a
result of fluctuations in interest rates and/or market conditions and in equity
prices. Interest rate risk is a consequence of maintaining variable interest
rate earning investments and fixed rate liabilities or fixed income investments
and variable rate liabilities. We are exposed to interest rate risks arising
from changes in the level or volatility of interest rates, prepayment speeds
and/or the shape and slope of the yield curve. In addition, we are exposed to
the risk of loss related to changes in credit spreads. Credit spread risk arises
from the potential changes in an issuer's credit rating or credit perception
that may affect the value of financial instruments. We believe that no material
changes to any of these risks have occurred since December 31, 2011.
For a more detailed discussion of our market risks relating to these activities,
refer to Item 7A, Quantitative and Qualitative Disclosures about Market Risk,
included in our Form 10-K.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as such term is defined in Rules
13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to ensure that
information required to be disclosed in the reports we file or submit under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms, and that such information is
accumulated and communicated to our management, including our Chief Executive
Officer and our Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure. In designing and evaluating the
disclosure controls and procedures, management recognized that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and management
necessarily was required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures.
As required by Rule 13a-15(b) under the Exchange Act, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and our Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures as of the end of the period covered by this report. Based upon the
evaluation of the effectiveness of the design and operation of our disclosure
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controls and procedures as of the end of the period covered by this report, our
Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures were effective at the reasonable assurance
level as of the end of such period.
Changes in Internal Control Over Financial Reporting
There have not been any changes in the Company's internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) during the three months ended June 30, 2012 that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
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