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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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(MARK ONE)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NUMBER: 1-10864
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UNITED HEALTHCARE CORPORATION
State of Incorporation: MINNESOTA
I.R.S. Employer Identification No: 41-1321939
Principal Executive Offices:
300 OPUS CENTER
9900 BREN ROAD EAST
MINNETONKA MN, 55343
Telephone Number: (612) 936-1300
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Indicate by check mark (x) whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter periods that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
The number of shares of Common Stock, par value $.01 per share, outstanding on
November 10, 1998, was 186,232,870
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UNITED HEALTHCARE CORPORATION
INDEX
2
UNITED HEALTHCARE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
See notes to condensed consolidated financial statements
3
UNITED HEALTHCARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN MILLIONS, EXCEPT PER SHARE DATA)
(UNAUDITED)
See notes to condensed consolidated financial statements
4
UNITED HEALTHCARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
(UNAUDITED)
See notes to condensed consolidated financial statements
5
UNITED HEALTHCARE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
Unless the context otherwise requires, the use of the terms the "Company," "we,"
"us," and "our" in the following refers to United HealthCare Corporation and its
subsidiaries.
The accompanying unaudited condensed consolidated financial statements reflect
all adjustments, consisting solely of normal recurring adjustments, needed to
present the financial results for these interim periods fairly. These financial
statements include some amounts that are based on our best estimates and
judgments. The most significant estimates relate to medical costs payable and
other policy liabilities, intangible asset valuations, integration reserves
relating to acquisitions, and liabilities and asset impairments relating to our
operational realignment activities. These estimates may be adjusted as more
current information becomes available, and any adjustment could be significant.
Following the rules and regulations of the Securities and Exchange Commission,
we have omitted footnote disclosures that would substantially duplicate the
disclosures contained in our annual audited financial statements. Read together
with the disclosures below, we believe the interim financial statements are
presented fairly. However, these unaudited condensed consolidated financial
statements should be read together with the consolidated financial statements
and the notes included in our Annual Report on Form 10-K for the year ended
December 31, 1997.
2. SPECIAL OPERATING CHARGES
OPERATIONAL REALIGNMENT CHARGES
In January 1998, we introduced a significant realignment of our operations
into six independent but strategically linked businesses, each focused on
performance, growth and shareholder value. In the months that followed, we began
to realign our resources and activities; introduce new management processes and
policies; evaluate our market positions and customer segments; and assess the
strategic fit, operational performance and contribution of our business units.
We have moved forward to establish more independent identities, brands and
market positions for each of our businesses. We have realigned significant
personnel and activities from corporate functions to more directly support the
operations of our businesses. We also have defined internal service
arrangements, systems platforms, and process requirements to support each
business's markets and products.
In conjunction with these efforts, we developed and, in the second quarter of
1998, approved a comprehensive plan (the Plan) to implement our operational
realignment. We recognized corresponding charges to operations of $725 million
in the quarter which reflect the estimated costs we will incur under the Plan.
The charges included costs associated with employee terminations, disposing or
discontinuing business units, product lines, and contracts; and consolidating
and eliminating certain processing operations and associated real estate
obligations. These activities will result in a net reduction of more than 4,000
positions impacting 7,000 people in various locations. Through September 30,
1998, we have eliminated approximately 1,700 positions pursuant to the Plan.
Our original provision for operational realignment activities was developed
based on management's best judgment and estimates at that time. As we began to
execute the Plan, we adjusted certain estimates based on current information and
reclassified certain activities and costs to more appropriate categories. In
total,
6
UNITED HEALTHCARE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
2. SPECIAL OPERATING CHARGES (CONTINUED)
our original estimate of the operational realignment charges did not change. The
following table summarizes realignment activities for the nine month period
ended September 30, 1998 (in millions):
The asset impairments principally relate to the write-down of intangibles and
other long-lived assets from businesses we intend to dispose of or discontinue;
or markets where we plan to curtail operations or change the nature of our
operating presence. The majority of these write-downs relate to businesses
acquired in our 1995 acquisition of The MetraHealth Companies, Inc. and certain
other under-performing health plan markets. The amount of write-downs were
primarily determined based on a forecast of expected discounted future cash
flows. In other instances, we determined the extent of the write-downs based on
a determination of the business unit's fair value.
Our accompanying financial statements include the operating results of
businesses to be disposed of or discontinued in connection with the operational
realignment. We anticipate these actions will be completed by June 30, 1999. The
losses anticipated on the disposition of these businesses, including severance,
impairment of assets, abandoned facilities, and additional exit costs, represent
approximately $220 million and are included in the $725 million of operational
realignment charges. Our accompanying consolidated statements of operations
include revenues and operating losses from these businesses as follows (in
millions):
The table above does not include operating results from the counties where we
will be withdrawing our health plan Medicare product offerings, effective
January 1, 1999. Annual revenues for 1998 from the Medicare markets we are
exiting are expected to be approximately $225 million.
The operational realignment charges do not cover certain aspects of the Plan,
including new information systems, data conversions, process re-engineering, and
employee relocation and training. These costs will be charged to expense as
incurred or capitalized, as appropriate. We expect our operational realignment
initiatives will be substantially completed by June 30, 1999.
7
UNITED HEALTHCARE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
2. SPECIAL OPERATING CHARGES (CONTINUED)
MEDICAL COSTS
Medical costs reported in the second quarter of 1998 included $120 million
relating to losses in certain underperforming health plan Medicare markets. We
incurred $89 million of these Medicare losses during the second and third
quarters, which included current operating losses and increased Medicare reserve
estimates. We have reserves of $31 million as of September 30, 1998 and
management believes that these reserves are adequate to cover Medicare losses we
expect to incur in the fourth quarter of 1998. Second quarter medical costs also
included $55 million related to increasing our reserves in light of increasing
pressure on medical cost trends in certain health plan markets, including those
where we may reposition or withdraw our operating presence.
3. INCOME TAXES
The income tax provision of $42 million for the nine month period ended
September 30, 1998, included an income tax benefit of $196 million related to
our second quarter operating charges.
4. STOCK REPURCHASE PROGRAM
Under our stock repurchase program, we may purchase up to 18.7 million shares of
our outstanding common stock. Purchases may be made from time to time at
prevailing prices, subject to certain restrictions on volume, pricing, and
timing. During the nine month period ended September 30, 1998, we repurchased
7.6 million shares at an average price of $39 per share. Since inception of the
program in November 1997, we have repurchased 7.8 million shares.
5. CASH AND INVESTMENTS
As of September 30, 1998, the amortized cost, gross unrealized holding gains and
losses and fair value of cash and investments were as follows (in millions):
6. AMERICAN ASSOCIATION OF RETIRED PERSONS CONTRACT
We began providing insurance products and services to the American Association
of Retired Persons (AARP) on January 1, 1998. Our portion of the AARP's
insurance program represents approximately $3.5 billion in annual net premium
revenue from approximately 4 million AARP members. We also are developing an
array of new products and services designed to complement the insurance
offerings under the AARP program.
Under the terms of our 10-year agreement with the AARP, we receive monthly fees
for claim administrative services and as compensation for assuming a share of
the underwriting risk associated with the program. In addition, the AARP has
separately contracted with certain vendors to provide marketing and
8
UNITED HEALTHCARE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
6. AMERICAN ASSOCIATION OF RETIRED PERSONS CONTRACT (CONTINUED)
member services. We recognize premium revenues associated with the AARP program
net of the administrative fees paid to these vendors.
The following assets and liabilities were transferred from the program's
previous carrier and are included in our consolidated balance sheet (in
millions):
7. COMPREHENSIVE INCOME
The table below presents comprehensive income, defined as changes in the equity
of our business excluding changes resulting from investments by and
distributions to our shareholders, for the nine-month periods ended September
30, 1998 and 1997 (in millions):
8. RECENTLY ISSUED ACCOUNTING STANDARDS
In the fourth quarter of 1998, we will adopt a new accounting standard (SFAS No.
131) that will require us to report financial and descriptive information about
our reportable operating segments. Generally, financial information will be
required to be reported on the basis that is used internally to evaluate segment
performance and allocate resources to segments. This new standard will not
affect how we determine net earnings or shareholders' equity.
Effective January 1, 1998, we adopted a new accounting pronouncement on
accounting for costs of computer software developed or obtained for internal use
(SOP 98-1). This new pronouncement did not have a material impact on the our
financial position or results of operations.
In April 1998, a new pronouncement for reporting on the costs of start-up
activities (SOP 98-5) was issued. Our current accounting practices are
consistent with this new pronouncement and, accordingly, SOP 98-5 will not
change our financial position or results of operations.
In June 1998, a new standard on accounting for derivative instruments and
hedging activities (SFAS No. 133) was issued. This new standard will not
materially affect our financial results or disclosures based upon our current
investment portfolio.
9
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To United HealthCare Corporation:
We have reviewed the accompanying condensed consolidated balance sheet of United
HealthCare Corporation (a Minnesota corporation) and Subsidiaries as of
September 30, 1998 and the related condensed consolidated statements of
operations and cash flows for the three and nine month periods ended September
30, 1998 and 1997. These financial statements are the responsibility of the
Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the financial statements referred to above for them to be in
conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated financial statements of United HealthCare
Corporation and Subsidiaries as of and for the year-ended December 31, 1997 (not
presented herein), and, in our report dated February 12, 1998, we expressed an
unqualified opinion on those statements. In our opinion, the information set
forth in the accompanying condensed consolidated balance sheet as of December
31, 1997, is fairly stated, in all material respects, in relation to the
consolidated balance sheet from which it has been derived.
/s/ Arthur Andersen LLP
Minneapolis, Minnesota,
November 5, 1998
10
UNITED HEALTHCARE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Unless the context otherwise requires, the use of the terms the "Company," "we,"
"us," and "our" in the following refers to United HealthCare Corporation and its
subsidiaries.
On January 1, 1998, we began delivering Medicare supplement insurance and other
medical insurance coverage for the American Association of Retired Persons
(AARP) to approximately 4 million AARP members. In the second quarter of 1998,
we recorded special operating charges related to our operational realignment
activities ($725 million), Medicare loss contracts ($120 million) and certain
medical cost adjustments ($55 million). The significance of the AARP business
and the special charges affects the year-to-year comparability of our
consolidated financial position and results of operations. The Summary Operating
Information below should be read together with the narrative portions of
Management's Discussion and Analysis that more fully describe the specific
effects of the AARP business and the special charges.
The following discussion should be read together with the accompanying condensed
consolidated financial statements and notes. In addition, the following
discussion should be considered in light of a number of factors that affect the
Company, the industry in which we operate, and business generally. These factors
are described in Exhibit 99 to this Quarterly Report.
SUMMARY OPERATING INFORMATION
11
UNITED HEALTHCARE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
------------------------------
(a) Includes $120 million of losses related to certain Medicare markets and $55
million related to reserve strengthening associated with increasing pressure
on medical costs trends.
(b) In conjunction with the realignment of our operations, small group and
middle market point-of-service membership, previously classified as other
network based products, are now being presented with our commercial health
plan products (907,000 members at September 30, 1998 and 766,000 members at
September 30, 1997).
12
RESULTS OF OPERATIONS
SPECIAL OPERATING CHARGES
OPERATIONAL REALIGNMENT In January 1998, we introduced a significant
realignment of our operations into six independent but strategically linked
businesses, each focused on performance, growth and shareholder value. In the
months that followed, we began to realign our resources and activities;
introduce new management processes and policies; evaluate our market positions
and customer segments; and assess the strategic fit, operational performance and
contribution of our business units. We have moved forward to establish more
independent identities, brands and market positions for each of our businesses.
We have realigned significant personnel and activities from corporate functions
to more directly support the operations of our businesses. We also have defined
internal service arrangements, systems platforms, and process requirements to
support each business's markets and products.
In conjunction with these efforts, we developed and, in the second quarter of
1998, approved a comprehensive plan (the Plan) to implement our operational
realignment. We recognized corresponding charges to operations of $725 million
in the quarter which reflect the estimated costs we will incur under the Plan.
The charges included costs associated with employee terminations, disposing or
discontinuing business units, product lines, and contracts; and consolidating
and eliminating certain processing operations and associated real estate
obligations. These activities will result in a net reduction of more than 4,000
positions impacting 7,000 people in various locations. Through September 30,
1998, we have eliminated approximately 1,700 positions pursuant to the Plan. We
believe the aggregate reduction in our overall cost structure from our
realignment will approximate $300 million annually. We expect to realize $75
million of these reductions in 1999.
The operational realignment charges do not cover certain aspects of the Plan,
including new information systems, data conversions, process re-engineering, and
employee relocation and training. These costs will be charged to expense as
incurred or capitalized, as appropriate. We expect our operational realignment
initiatives will be substantially completed by June 30, 1999.
MEDICAL COSTS
Medical costs reported in the second quarter of 1998 included $120 million
relating to losses in certain underperforming health plan Medicare markets. We
incurred $89 million of these Medicare losses during the second and third
quarters, which included current operating losses and increased Medicare reserve
estimates. We have reserves of $31 million as of September 30, 1998 and
management believes that these revenues are adequate to cover Medicare losses we
expect to incur in the fourth quarter of 1998. Second quarter medical costs also
included $55 million related to increasing our reserves in light of increasing
pressure on medical cost trends in certain health plan markets, including those
where we may reposition or withdraw our operating presence.
PREMIUM REVENUES
Premium revenues in the third quarter of 1998 totaled $3.9 billion, an increase
of $1.3 billion, or 53%, over the third quarter of 1997. For the nine months
ended September 30, 1998, premium revenues of $11.4 billion increased $3.9
billion, or 51%, over the same period in 1997. On January 1, 1998, we began
delivering Medicare supplement insurance and other medical insurance coverage
for the American Association of Retired Persons (AARP) to approximately 4
million AARP members. Premium revenues from our portion of the AARP insurance
offerings during the first nine months of 1998 were $2.6 billion.
Excluding the AARP business, third quarter 1998 premium revenues totaled $3.0
billion, an increase of 19% over third quarter 1997. For the nine months ended
September 30, 1998, premium revenues excluding the AARP business were $8.7
billion, a 16% increase over the same period in 1997. This increase is primarily
the result of growth in year-over-year same-store health plan premium revenues
of $1.3 billion, or 22%, through the third quarter of 1998. Increases in the
health plan premium revenue reflect same-
13
store enrollment growth of 12% and an average year-over-year premium rate
increase on renewing commercial groups exceeding 6%. Growth in our health plan
Medicare programs also contributed to the increase in premium revenues. The
total health plan same-store enrollment growth of 12% includes a year-over-year
same-store increase of 42% in Medicare enrollment. Significant growth in
Medicare enrollment affects year-over-year comparability of premium revenues.
The Medicare product generally has per member premium rates three to four times
higher than average commercial premium rates because Medicare members typically
use proportionately more medical care services.
The nine-month year-over-year increase in premium revenues from health plan
operations was partially offset by a decrease in premium revenues from fully
insured non-network-based indemnity products of $54 million. This decrease is
primarily attributable to a relationship that we discontinued with a broker who
sold and administered small group indemnity business on our behalf, which led to
the loss of 30,000 indemnity members effective July 1, 1997.
MEDICAL COSTS
Our medical care ratio (the percent of premiums expensed as medical costs)
increased from 84.1% in the third quarter of 1997 to 86.0% in the third quarter
of 1998. The year-over-year increase includes the effects of the AARP business
on our medical care ratio. We report a medical care ratio of approximately 92%
related to our portion of the AARP insurance offerings, which we began
delivering on January 1, 1998. Excluding the AARP business, on a year-over-year
basis, the medical care ratio increased twenty basis points to 84.3%.
On a comparable basis for the nine-month periods ended September 30, the medical
care ratio increased from 84.4% in 1997 to 86.3% in 1998. The most significant
cause of the increase in the year-over-year medical care ratio is the $175
million of medical cost charges recorded in the second quarter of 1998. Of this
amount, $120 million related to losses we expect to incur in 13 of our 22
Medicare health plans. These plans contribute half of our annualized Medicare
premiums of $2.3 billion and are generally located in newer markets where we
have been unable to achieve the scale of operations necessary to achieve
profitability. We incurred $89 million of these Medicare losses in the second
and third quarter. We have reserves of $31 million as of September 30, 1998 and
mangement believes that these reserves are adequate to cover the Medicare losses
we expect to incur in the fourth quarter of 1998. We recorded an additional $55
million of medical costs during the second quarter to strengthen our reserves in
light of increasing pressure on medical cost trends in certain health plan
markets, including those where we may reposition or withdraw our operating
presence.
In addition to the second quarter charges, lower margins in our nine other
Medicare health plans also adversely affected the medical care ratio. While
these plans are profitable, average Medicare premium rate increases of 2.5% in
these plans were more than offset by increased medical utilization, reflected
mostly in inpatient hospital costs. Although we see improvement in our overall
commercial medical care ratio, performance in a few of our commercial health
plans lagged behind the performance of our remaining commercial health plans and
modestly contributed to the increased medical care ratio. We are addressing the
overall medical care ratio by altering benefit designs, recontracting with
providers, and aggressively increasing both contemporaneous and retrospective
claim management activities. We also are continuing to evaluate the markets we
serve and products we offer and will curtail activities or exit markets where we
believe near term prospects are unacceptable. In October 1998, we announced our
decision to withdraw Medicare product offerings from 86 of the 206 counties we
currently serve. The decision, effective January 1, 1999, will affect
approximately 60,000, or 13%, of current Medicare members. We will continue to
offer Medicare products in strong and economically viable markets. Annual
revenues for 1998 from Medicare markets we are exiting are expected to be
approximately $225 million.
MANAGEMENT SERVICES AND FEE REVENUES
Management services and fee revenues during the three months and nine months
ended September 30, 1998, totaled $399 million and $1.2 billion, representing
increases of $48 million and $99 million,
14
respectively, over the same periods in 1997. These revenues are primarily
generated from self-funded products where we receive a fee for administrative
services and generally assume no financial responsibility for health care costs
associated with these products. In addition, we generate fee revenues from
administrative services we perform on behalf of managed health plans and for
services provided by our Specialized Care Services and Knowledge and Information
businesses.
The overall increase in management services and fee revenues is primarily the
result of acquisitions by our Knowledge and Information business during 1997 and
1998. Additionally, our Specialized Care Services business, most notably in
United Behavioral Health and Optum-Registered Trademark-, our telephone- and
Internet-based health information and personal care management business,
continues to increase the number of individuals it serves.
OPERATING EXPENSES
Selling, general and administrative expenses as a percent of total revenues (the
SG&A ratio) decreased from 20.0% during the third quarter of 1997 to 17.2%
during the third quarter of 1998. The improvement in the year-over-year SG&A
ratio reflects the operating leverage we gained with the addition of the AARP
business. On a sequential basis, selling, general and administrative expenses
increased by $43 million, or 6%, from the second quarter of 1998. This increase
is primarily attributable to our efforts to convert and integrate members onto
our two core operating platforms, expenses related to initiation of enrollment,
set up and support costs for over 500,000 new members that we will begin
servicing in January 1999, and incremental Year 2000 compliance costs. For the
nine months ended September 30, 1998, selling, general and administrative
expenses increased $409 million, or 23%, over the comparable period in 1997.
This increase reflects the additional costs to support the corresponding $4.0
billion, or 45%, increase in revenues, as well as our additional investment in
future growth platforms.
GOVERNMENT REGULATION
Our primary business, offering health care coverage and health care management
services, is heavily regulated at the federal and state levels. We strive to
comply in all respects with applicable regulations and may need to make changes
from time to time in our services, products, marketing methods or organizational
or capital structure.
Regulatory agencies generally have broad discretion to issue regulations and
interpret and enforce laws and rules. Changes in applicable laws and regulations
are continually being considered, and the interpretation of existing laws and
rules also may change from time to time. These changes could affect our
operations and financial results.
Certain proposed changes in Medicare and Medicaid programs may improve
opportunities to enroll people under products developed for these populations.
Other proposed changes could limit available reimbursement and increase
competition in those programs, with adverse affects on our financial results.
Also, it could be more difficult for us to control medical costs if federal and
state bodies continue to consider and enact significant and onerous managed care
laws and regulations.
The Health Insurance Portability and Accountability Act of 1996 (HIPAA) may
represent the most significant federal reform of employee benefit law since the
enactment of the Employee Retirement Income Security Act (ERISA) in 1974.
Significant provisions of HIPAA include guaranteeing the availability of health
insurance for certain employees, limiting the use of preexisting condition
exclusions, prohibiting discrimination on the basis of health status, and making
it easier to continue coverage in cases where a person is terminated or changes
employers. Under HIPAA and other similar state laws, medical cost control
through amended provider contracts and improved preventive and chronic care
management may become more important. We believe our experience in these areas
will allow us to compete effectively.
Health care fraud and abuse has become a top priority for the nation's law
enforcement entities, which have focused on participants in federal government
health care programs such as Medicare, Medicaid and the Federal Employees Health
Benefits Program (FEHBP). We participate extensively in these programs.
15
We also are subject to governmental investigations and enforcement actions.
Included are actions relating to ERISA, which regulates insured and self-insured
health coverage plans offered by employers; the FEHBP; federal and state fraud
and abuse laws; and laws relating to care management and health care delivery.
Government actions could result in assessment of damages, civil or criminal
fines or penalties, or other sanctions, including exclusion from participation
in government programs. We currently are involved in various government
investigations and audits, but we do not believe the results will have a
material adverse effect on our financial position or results of operations.
INFLATION
Although the general rate of inflation has remained relatively stable and health
care cost inflation has stabilized in recent years, the national health care
cost inflation rate still exceeds the general inflation rate. We use various
strategies to mitigate the negative effects of health care cost inflation,
including setting commercial premiums based on anticipated health care costs,
risk-sharing arrangements with various health care providers, and other health
care cost containment measures. Specifically, health plans try to control
medical and hospital costs through contracts with independent providers of
health care services. Through these contracted care providers, our health plans
emphasize preventive health care and appropriate use of specialty and hospital
services.
While we currently believe our strategies to mitigate health care cost inflation
will continue to be successful, competitive pressures, new health care product
introductions, demands from health care providers and customers, applicable
regulations or other factors may affect our ability to control the impact of
health care cost increases. In addition, certain non-network-based products do
not have health care cost containment measures similar to those in place for
network-based products. As a result, there is added health care cost inflation
risk with these products.
FINANCIAL CONDITION AND LIQUIDITY
Cash and investments at September 30, 1998, were $4.0 billion, comparable to
December 31, 1997 balances. Through the third quarter of 1998, we generated cash
from operations of $433 million and realized proceeds from stock option
exercises and the sale of property and equipment of $115 million. In the same
period, we used $580 million in cash for capital expenditures, acquisitions,
common stock repurchases, and dividends.
Under applicable government regulations, several subsidiaries are required to
maintain specific capital levels to support their operations. After taking these
regulations and certain business considerations into account, we had $665
million in cash and investments available for general corporate use at September
30, 1998.
The National Association of Insurance Commissioners has adopted rules which, to
the extent that they are implemented by the states, will set new minimum
capitalization requirements for insurance companies, Health Maintenance
Organizations (HMO's), and other entities bearing risk for health care coverage.
The requirements take the form of risk-based capital rules. The change in rules
for insurance companies is effective December 31, 1998. The new HMO rules are
subject to state-by-state adoption, but it appears that very few states will
adopt the rules by the end of 1998. The HMO rules, if adopted by the states in
their proposed form, would significantly increase the capital required for
certain of our subsidiaries. Although some reallocation of capital among our
regulated entities will be necessary, we do not anticipate a significant impact
on financial resources available for general corporate purposes. We have
initiated a plan to redeploy capital among our regulated entities to minimize
the need for incremental capital investments of general corporate financial
resources into regulated subsidiaries.
Under our stock repurchase program, we may purchase up to 18.7 million shares of
our outstanding common stock. Purchases may be made from time to time at
prevailing prices, subject to certain restrictions relating to volume, pricing
and timing. During the first nine months of 1998, we repurchased
16
7.6 million shares at an average price of $39 per share. Since inception of the
program in November of 1997, we have repurchased 7.8 million shares.
Effective October 1, 1998, we have the right to redeem in whole or in part the
500,000 outstanding shares of our 5.75% Series A Convertible Preferred Stock
(the Preferred Stock) at certain defined redemption rates. The initial aggregate
redemption price of the Preferred Stock would be $520 million, or $1,040 per
share.
On October 1, 1998, we completed our acquisition of Health Partners of Arizona,
a 501,000 member health plan, for $235 million in cash.
In the second quarter of 1998, we recognized special charges to operations of
$725 million associated with the implementation of our operational realignment
and certain medical cost adjustments of $175 million. We believe our after tax
cash outlay associated with these charges will be in the range of $275 million
to $325 million over the next twelve months.
In January 1998, we filed a shelf registration statement with the Securities and
Exchange Commission (SEC) to sell up to $200 million of debt securities and
preferred or common shares. The shelf filing registered the securities and
allows us to sell them from time to time in the event we need financing.
Proceeds from sales of these securities may be used for a variety of general
corporate purposes, including working capital, securities repurchases and
acquisitions. In October 1998, we filed another shelf registration statement to
sell up to $1.05 billion of debt securities, preferred stock, common stock,
depository shares, warrants and trust preferred securities. This registration
statement has not yet been approved by the SEC and, accordingly, these
securities may not be sold until their approval is received.
We expect our available cash resources and operating cash flows will be
sufficient to meet our current operating requirements and internal development
and realignment initiatives. In addition, based on our current financial
condition and results of operations, we should be able to finance additional
cash requirements in the public or private markets, if necessary. In the fourth
quarter of 1998, we expect to obtain additional financing through one or more of
the following financing alternatives; a revolving credit facility; a commercial
paper program; fixed and floating rate notes pursuant to a Rule 144A offering.
Proceeds received from our financing activities may be used to redeem
outstanding preferred stock, repurchase common stock, or for other general
corporate purposes, including financing possible future acquisitions.
Currently, we do not have any other material definitive commitments that require
cash resources; however, we continually evaluate opportunities to expand our
operations. This includes internal development of new products and programs and
may include acquisitions.
YEAR 2000 ACTIVITIES
Our business depends significantly on effective information systems, and we have
many different information systems for our various businesses. Our information
systems require on-going enhancements to keep pace with the continuing changes
in information technology, evolving industry standards, and customer
preferences. We are currently modifying our computer systems to accommodate the
"Year 2000". The "Year 2000" problem exists throughout the global marketplace as
many computer systems and applications were developed to recognize the year as a
two-digit number, with the digits "00" being recognized as the year 1900 as a
common business practice. Starting in 1995, our formal Year 2000 Project Office
began implementing a remediation plan to ensure that critical information
systems applications, end-user developed application tools, and critical
business interfaces remain intact, and can function properly through the century
change. We are on schedule to complete, test, and certify our Year 2000
remediation efforts by September 30, 1999. A more detailed description and
current status of our Year 2000 activities follows.
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TECHNICAL INFRASTRUCTURE
MAINFRAME TECHNOLOGY In conjunction with our two vendors that provide
support for our data center operations, we have completed 96% or more of our
hardware, operating system, and supporting software remediation efforts on our
two primary mainframe computer systems. In addition, we are in the process of
reviewing some of our smaller mainframe systems and making modifications as
necessary. We expect to be 100% complete with all mainframe hardware and
software technology Year 2000 modifications by December 31, 1998. We have also
installed separate test environments (both mainframe and distributed) to test
our business applications in a simulated Year 2000 environment.
DESKTOP HARDWARE & SOFTWARE We have recently inventoried all of our desktop
hardware and software-- over 40,000 computing devices of multiple makes and
models. All non-compliant desktop hardware and software have been identified and
will be modified or replaced with compliant systems by September 30, 1999. In
addition, all of our UNIX client server installations are compliant at September
30, 1998.
TELECOMMUNICATIONS We have inventoried all of our telecommunication
systems--over 28,000 telecommunication devices, including traffic routers and
phone switches. We are using two outside vendors to assist us in modifying or
replacing non-compliant telecommunication systems. As of September 30, 1998, we
are approximately 50% Year 2000 compliant with our data and voice networks. We
expect all our telecommunication networks and devices will be Year 2000
compliant by September 30, 1999.
BUSINESS APPLICATIONS
SOFTWARE APPLICATIONS We use 475 different software applications that
include over 80 million lines of computer code. We have surveyed our software
applications and have identified systems that will not be used after December
31, 1999, and those systems that will be modified for Year 2000 compliance. We
have determined that 37% of our software applications will not be used after
December 31, 1999 due to conversions, consolidations and software replacements.
Of the remaining applications, over 75% have been made Year 2000 compliant,
tested and certified or are scheduled to be certified for compliance, with the
balance yet to be tested. We expect all Year 2000 software modifications to be
completed by March 31, 1999, with further testing and certification during 1999.
END USER DEVELOPED APPLICATIONS End-user developed applications are analysis
tools that have been internally developed by individual employees or operating
segments primarily running on personal computers or client servers. The Year
2000 Project Office has continuously communicated with all employees explaining
the risks of non-compliant applications and provided tools and techniques to
make them compliant. We are currently identifying, tracking, and assessing Year
2000 compliance issues with respect to all potentially critical end-user
applications.
OTHER YEAR 2000 MATTERS
NON-INFORMATION TECHNOLOGY SYSTEMS We have approximately 300 owned or
leased facilities throughout the world. We have contacted all of our facility
managers regarding Year 2000 compliance issues. In addition, we have contracted
with a real estate management company to assist in our Year 2000 compliance
efforts. All facilities are scheduled to be Year 2000 compliant by September 1,
1999.
DEPENDENCE ON THIRD PARTIES We use approximately 300,000 different medical
providers and over 92,000 vendors. Approximately 2,000 vendors have been
identified as critical business partners and suppliers. We are currently in
communication with these critical business partners to analyze their Year 2000
compliance efforts. We expect to complete our analysis of critical vendor
readiness and identification of alternative vendors, where necessary, by July
31, 1999. We will not be contacting all of the 300,000 medical providers we
conduct business with regarding Year 2000 compliance issues. However, we will be
testing and verifying the electronic collection of data with these providers
through our EDI (electronic data interface) clearinghouse vendors.
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COSTS OF YEAR 2000 COMPLIANCE The projected costs of our Year 2000 compliance
efforts and the date on which we plan to complete the necessary Year 2000
remediation efforts are based on management's best estimates, which were derived
utilizing various assumptions of future events. However, there can be no
guarantee that these estimates will be achieved and actual results could differ
significantly from our current plans. Specific factors that might cause
significant differences include, but are not limited to, the availability and
cost of personnel trained in this area, the ability to locate and correct the
relevant computer codes, the ability of our significant vendors, providers,
customers and others with which we conduct business to identify and resolve
their own Year 2000 issues.
Costs associated with modifying internal use software for Year 2000 compliance
are charged to expense as incurred. Purchases of hardware or software that
replace existing hardware or software that is not Year 2000 compliant are
capitalized and amortized over their useful lives. As of September 30, 1998, our
historical and projected costs to complete our Year 2000 remediation plan is as
follows (amounts in millions):
------------------------
* Equipment expense assumes a three year useful life for $29 million in
purchased hardware and software.
BUSINESS RISKS OF NON-COMPLIANT SYSTEMS Although we are committed to completing
and testing our remediation plan well in advance of the Year 2000, there are
risks if we do not meet our objectives by December 31, 1999. Operationally, the
most severe risk is business interruption. Specific examples of situations that
could cause business interruption include, but are not limited to 1) computer
hardware or application software processing errors or failures, 2) facilities or
infrastructure failures, or 3) outside providers, suppliers, or customers who
may not be Year 2000 compliant. Depending on the extent and duration of business
interruption resulting from non-compliant Year 2000 systems, such interruption
may have a material adverse effect on our results of operations, liquidity, and
financial condition.
CONTINGENCY PLANS Each area of our Year 2000 compliance effort is currently
developing contingency plans in the event we are unable to complete remediation
efforts by December 31, 1999. These contingency plans are expected to be
developed by the end of the first quarter of 1999.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Since the date of the Company's Quarterly Report filed on Form 10-Q for the
quarter ended June 30, 1998, no material changes have occurred in the Company's
exposure to market risk associated with the Company's investments in market risk
sensitive financial instruments. We do not believe that our risk of a loss in
future earnings or a decline in fair values or cash flow attributable to such
investments is material.
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UNITED HEALTHCARE CORPORATION
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Six suits assert claims under the United States securities laws against the
Company and certain of its officers and directors. The plantiffs are individual
stockholders of the Company who purport to sue on behalf of a class of
purchasers of common shares of the Company during the period February 12, 1998
through August 5, 1998 (the Class Period). In substance, the complaints allege
that the Company made materially false or misleading statements about the
profitability and performance of the Company's Medicare business during the
Class Period. Two of the complaints also allege that the statements were made
with the intention of deceiving members of the investing public and with the
intention that the price of United HealthCare Corporation's shares would rise,
making it possible for insiders at the Company to profit by selling shares at a
time when they knew the Company's true financial condition, but the investing
public did not. The complaints seek compensatory damages in unspecified amounts.
We do not expect that the ultimate resolution of these matters will have a
material adverse effect on the results of operations and financial position of
the Company.
ITEM 5. OTHER INFORMATION
The Company on November 4, 1998 amended its Amended and Restated Bylaws (the
Bylaws) to extend the advance notice provisions for business to be brought by a
shareholder at an annual meeting and for director(s) to be nominated by a
shareholder at an annual meeting. The Company must now receive notice of such
shareholder proposals within 120 days before the date of the prior year's proxy
materials. For the 1999 Annual Meeting, to be held on May 12, 1999, the Company
must receive advance notice of business to be brought by a shareholder and for
director(s) to be nominated by a shareholder no later than December 1, 1998. The
foregoing is qualified in its entirety by reference to the full text of the
Bylaws, as amended, filed as Exhibit 3.1 hereto and incorporated herein by
reference.
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ITEM 6. EXHIBITS
(a) The following exhibits are filed in response to Item 601 of Regulation S-K.
(b) No reports on Form 8-K were filed during the three month period ended
September 30, 1998.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
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UNITED HEALTHCARE CORPORATION
EXHIBITS
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