Item 1: Business
General
We are a leading publicly traded managed
health care company with 2.4 million members, excluding network rental members, as of December
31, 2003. We operate a diversified portfolio of local
market health plans serving 14 markets, primarily in the Mid-Atlantic, Midwest and Southeast United
States. Our health plans are operated under the names Altius Health Plans, Carelink Health Plans, Coventry
Health Care, Coventry Health and Life, Group Health Plan, HealthAmerica, HealthAssurance, HealthCare
USA, PersonalCare, SouthCare, Southern Health and WellPath. Our health plans generally are located in small to mid-sized metropolitan areas. Coventry was
incorporated under the laws of the State of Delaware on December 17, 1997 and is the successor to Coventry
Corporation, which was incorporated on November 21, 1986. Our Annual Report on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K and amendments to these reports, and recent press
releases can be found, within one week of being filed with or furnished to the Securities and Exchange
Commission and free of charge, on the Internet at www.coventryhealth.com.
We offer employer groups a broad range of
commercial managed care products that vary with respect to the level of benefits provided, the costs
paid by employers and members and our members’ access to providers without referral or preauthorization
requirements. We offer underwritten or “risk” products, including health maintenance organizations (“HMO”s),
preferred provider organizations (“PPO”s) and point of service (“POS”) plans. In addition, we offer
defined contribution health plans. Our risk products also include state-sponsored managed Medicaid programs
and Medicare+Choice programs in selected markets where we believe we can achieve profitable growth based
upon favorable reimbursement levels, provider costs and regulatory climates. For our risk products,
we receive premiums in exchange for assuming underwriting risks and performing sales, marketing and
administrative functions. We also offer “non-risk” products to employer groups that self-insure employee
health benefits.
Operating and Growth Strategy
Maintaining Leading Positions in Our
Markets
We operate health plans with strong competitive
positions in all of our markets. We believe our local focus enables us to compete effectively with large
national competitors that operate in the markets we serve, and our management expertise, resources and
economies of scale give us a competitive advantage over small, local market health plans. We believe
the combination of our local strengths and our resources as a large company makes our health plans attractive
to employers and members, and thereby enhances our competitive positions in the markets in which we
operate. We believe our strong market positions enable us to negotiate competitive contracts with providers
and realize operating efficiencies.
Pursuing Strategic Acquisitions
The managed care industry continues to be
highly fragmented, with many health plans in operation in the United States. A part of our acquisition strategy
is to acquire entities that we believe will benefit from our management expertise and provide opportunities
for improved operations and cost savings through our management practices and economies of scale. The
acquisitions have been at attractive valuations as a result of our ability to provide opportunities
for improved operations and cost savings. We believe that there will be additional acquisition opportunities
in the future as a result of the continued consolidation of the managed care industry and the increasing
difficulties that some of the small, local plans will face in competing with larger companies that have
greater access to capital, superior information systems, lower administrative costs, more innovative
product portfolios and more effective medical management techniques and management practices. We intend
to continue to pursue acquisitions in both our existing markets and in new markets as attractive opportunities
arise.
Throughout the entire acquisition process,
beginning with due diligence and thereafter, we undertake an extensive review of the premium rates, medical
and administrative cost structures, provider arrangements and medical management practices of the acquired
entity. Generally, we have been able to improve the operating margins of our acquired entities within
six to twenty-four months after we have completed the acquisition. This is primarily due to strict pricing
discipline, improved provider arrangements, more effective medical management protocols and/or reductions
in administrative costs resulting from operating efficiencies and our economies of scale. We believe
that we can continue to achieve improved operating margins at acquired entities through these means.
Products
Commercial Risk and Governmental Programs
Our health plans and insurance companies
offer employer groups a full range of commercial risk products, including HMO, PPO and POS products.
We design our products to meet the needs and objectives of a wide range of employers and members and
to comply with the regulatory requirements in the markets in which we operate. We had 1.5 million commercial
risk members as of December 31, 2003 that accounted for $3.4 billion of revenue in 2003.
Our products vary with respect to the level
of benefits provided, the costs to be paid by employers and members, including deductibles and co-payments,
and our members’ access to providers without referral or preauthorization requirements.
Health Maintenance Organizations
Our HMO products provide comprehensive health
care benefits to members, including ambulatory and inpatient physician services, hospitalization, pharmacy,
mental health and ancillary diagnostic and therapeutic services. In general, a fixed monthly membership
fee covers all HMO services although some benefit plans require co-payments or deductibles in addition
to the basic membership fee. A primary care physician assumes overall responsibility for the care of
a member, including preventive and routine medical care and referrals to specialists and consulting
physicians. While an HMO member’s choice of providers is limited to those within the health plan’s HMO
network, the HMO member is typically entitled to coverage of a broader range of health care services
than is covered by typical reimbursement or indemnity policies. Furthermore, many of our HMO plans have
added features to more easily allow “direct access” to providers.
Preferred Provider Organizations and Point of Service
Our PPO and POS products also provide comprehensive
managed health care benefits to members, but allow members to choose their health care providers at
the time medical services are required and allow members to use providers that do not participate in
our managed care networks. If a member chooses a non-participating provider, deductibles, co-payments
and other out-of-pocket costs to the member generally are higher than if the member chooses a participating
provider. Premiums for our PPO and POS products typically are lower than HMO premiums due to the increased
out-of-pocket costs borne by the members.
Medicare
As of December 31, 2003, we operated five
Medicare+Choice HMOs in six states covering 64,000 members. We also operated three Medicare+Choice demonstration
PPOs in as many states covering 1,000 members. In addition, we managed one Medicare+Choice alternative
payment demonstration HMO, for which we assume no underwriting risk, in two states covering 3,000 members.
The Medicare+Choice line of business accounted for $480.3 million of revenue in 2003.
Under the Medicare+Choice contracts, we
receive a county-specific fixed premium per member per month from the Centers for Medicare and Medicaid
Services (“CMS”). This premium reflects certain demographic adjusters of the Medicare population. Ten
percent of the CMS premium was based on individually determined health risk adjusters in 2003. Thirty
percent of the CMS premium will be based on individually determined health risk adjusters in 2004. Fifty,
seventy-five and one hundred percent of the CMS premium will be based on individually determined health
risk adjusters in 2005, 2006 and 2007, respectively. The average increase of the CMS rates in 2003 was
2%. In the HMO alternative payment demonstration, we provide only administrative services to an employer
retiree account for a fixed administrative fee with 10% of that fee at risk as part of an agreement
among CMS, the employer and us. PPO products in all markets benefit from a risk sharing arrangement
with CMS.
As of December 31, 2003, we withdrew from
the individual Medicare+Choice market in one county in West Virginia and one county in Ohio due to inadequate
rates. This affected only a few members, some of whom switched to our PPO product. In the first quarter of 2004, we introduced two products in the Kansas market and one in the Pennsylvania market.
Medicaid
We offer health care coverage to Medicaid
recipients in seven states which, as of December 31, 2003, covered 324,000 members and accounted for
$523.8 million of revenue in 2003. The Medicaid Management Care agreement is a contract with each individual
state. Under a Medicaid contract, the participating state pays a monthly premium per member based on
the age, sex, eligibility category and in some states, county or region of the Medicaid member enrolled.
In some states, these premiums are adjusted according to the health risk associated with the individual
member.
During 2003, our total Medicaid membership
grew by 17.8% and revenue increased by 14.5% related to an auto-assignment of additional members by
the State of Missouri due to the withdrawal of a competitor in the Missouri market. The majority of
the Medicaid members are in the Missouri and Pennsylvania markets, representing 84.6% of our total Medicaid
membership.
Financial Information
Required financial information related to
our business segments is set forth in Note O of our consolidated financial statements.
Management Services
We offer management services and access
to our provider networks to employers that self-insure their employee health benefits. The management
services we provide typically include network management, claims processing, utilization review and
quality assurance. For our management services, we receive a fixed fee for the access to our provider
networks and the management services we provide and assume no underwriting risk. As of December 31, 2003, we had approximately 484,000 non-risk members.
We offer a product to third-party payors
under which we provide access to our provider networks for members of self-insured employers, as well
as the benefits of our provider pricing arrangements, claims repricing and utilization review services.
We do not assume underwriting risk for these services. As of December 31, 2003, we had approximately
678,000 network rental members.
These management services accounted for
$92.7 million of revenue for the year ended December 31, 2003.
Markets
The markets in which we operate are described
as follows:
Delaware - commercial products in Delaware and eastern Maryland; Medicaid products in the Baltimore metropolitan area and northeast counties.
Georgia - commercial products in the Atlanta metropolitan area.
Illinois - commercial products, primarily in the Central and Southern areas.
Iowa - commercial products to members primarily in the Des Moines metropolitan area with additional networks in Sioux City, Waterloo and rural Iowa; and Medicaid products in the Waterloo area.
Kansas - commercial and Medicare+Choice products in the Kansas City and Wichita metropolitan areas, including portions of Western Missouri.
Louisiana - commercial products, primarily in the New Orleans and Baton Rouge metropolitan areas.
Missouri - commercial and Medicare+Choice products to members in the St. Louis metropolitan area, including portions of Southern Illinois; Medicaid products also in the St. Louis metropolitan area and Central and Western Missouri.
Nebraska - commercial products primarily in the Omaha metropolitan area with additional networks in Lincoln and rural Nebraska.
North Carolina - commercial and Medicaid products primarily in the Charlotte and Raleigh-Durham metropolitan areas.
Pennsylvania - commercial products primarily in Harrisburg and the State College metropolitan areas comprising the eastern Pennsylvania market; commercial products in Pittsburgh, Erie and portions of Eastern Ohio comprising the western Pennsylvania market; Medicaid products in the Harrisburg metropolitan area; and Medicare+Choice in the Pittsburgh and State College metropolitan areas.
Utah - commercial products primarily in the Ogden, Salt Lake City and Provo metropolitan areas.
Virginia - commercial and Medicaid products primarily in the Richmond, Roanoke and Charlottesville metropolitan areas and the Shenandoah Valley.
West Virginia - commercial, Medicaid and Medicare+Choice products to a service area covering a majority of the state’s population.
Membership
The following tables show the total number
of members as of December 31, 2003 and 2002 (rounded to the nearest thousand) and the percentage change
in membership between these dates.
* Membership by market excludes network rental membership
Provider Networks
Our health plans maintain provider networks
that furnish health care services through contractual arrangements with physicians, hospitals and other
health care providers. All of our health plans currently offer
an open panel delivery system. In an open panel structure, individual physicians or physician groups
contract with the health plans to provide services to members but also maintain independent practices
in which they provide services to individuals who are not members of our health plans.
A small percentage of our membership is
covered by global capitation arrangements. Under the typical arrangement, the provider receives a fixed
percentage of premium to cover all the medical costs provided to the globally capitated members. Under
some capitated arrangements, physicians may also receive additional compensation from risk sharing and
other incentive arrangements. Global capitation arrangements limit our exposure to the risk of increasing
medical costs, but expose us to risk as to the adequacy of the financial and medical care resources
of the provider organization. In addition to global capitation arrangements, we have capitation arrangements
for ancillary services, such as mental health care. We are ultimately responsible for the coverage of
our members pursuant to the customer agreements. To the extent that the respective provider organization
faces financial difficulties or otherwise is unable to perform its obligations under the capitation
arrangements, we will be required to perform such obligations. Consequently, we may have to incur costs
in excess of the amounts we would otherwise have to pay under the original global or ancillary capitation
arrangements. Medical costs associated with capitation arrangements made up approximately 9.9%, 8.9%,
and 8.8% of our total medical costs for the years ended December 31, 2003, 2002 and 2001, respectively.
Membership associated with global capitation arrangements was approximately 145,000, 116,000 and 84,000
as of December 31, 2003, 2002 and 2001, respectively. We consider the risk associated with these arrangements to be immaterial.
Most contracted primary care and specialist
physicians are compensated under a discounted fee-for-service arrangement. The majority of our contracts
with hospitals provide for inpatient per diem or per case hospital rates. Outpatient services are contracted
on a discounted fee-for-service, a per case basis or in some instances a discount from charges basis.
We pay ancillary providers on a fixed fee schedule or a capitation basis. Prescription drug benefits
are provided through a formulary comprised of an extensive list of drugs. Drug prices are negotiated
through a national network of pharmacies at discounted rates.
Medical Management
We have established systems to monitor the availability, appropriateness and effectiveness of the patient care we provide. We collect utilization data in each of our markets that we use to analyze over-utilization or under-utilization of services and assist our health plans in providing appropriate care for their members and improving patient outcomes in a cost efficient manner. Our corporate office monitors the medical management policies of our health plans and assists our health plans in implementing disease management programs, quality assurance programs and other medical management tools. In addition, our health plans have internal quality assurance review committees made up of practicing physicians and staff members whose responsibilities include periodic review of medical records, development and implementation of standards of care based on current medical literature and the collection of data relating to results of treatment. We review new medical technologies in advance to ensure that only safe and effective new medical procedures are used. We regularly conduct studies to discover possible adverse medical outcomes for both quality and risk management purposes.
We have developed a comprehensive disease management program that identifies those members having certain chronic diseases, such as asthma and diabetes. Our case managers proactively work with members and their physicians to facilitate appropriate treatment, help to ensure compliance with recommended therapies and educate members on lifestyle modifications to manage the disease. We believe that our disease management program promotes the delivery of efficient care and helps to improve the quality of health care delivered.
Each of our health plans either employs or contracts with physicians as medical directors who monitor the quality and appropriateness of the medical services provided to our members. The medical directors supervise medical managers who review and approve requests by physicians to perform certain diagnostic and therapeutic procedures, using nationally recognized clinical guidelines developed based on nationwide benchmarks that maximize efficiency in health care delivery and InterQual, a nationally recognized evidence-based set of criteria developed through peer review medical literature. Medical managers also continually review the status of hospitalized patients and compare their medical progress with established clinical criteria, make hospital rounds to review patients’ medical progress and perform quality assurance and utilization functions.
Medical directors also monitor the utilization of diagnostic services and encourage the use of outpatient surgery and testing where appropriate. Data showing each physician’s utilization profile for diagnostic tests, specialty referrals and hospitalization are collected by each health plan and presented to the health plan’s physicians. The medical directors monitor these results in an attempt to ensure the use of cost-effective, medically appropriate services.
We also focus on the satisfaction of our members. We monitor appointment availability, member-waiting times, provider environments and overall member satisfaction. Our health plans continually conduct membership surveys of existing employer groups concerning the quality of services furnished and suggestions for improvement.
Information Technology
We believe that integrated and reliable
information technology systems are critical to our success. We have implemented advanced information
systems to improve the operating efficiency of our health plans, support medical management, underwriting
and quality assurance decisions and effectively service our employer customers, members and providers.
Each of our health plans operates on a single financial reporting system along with a common, fully
integrated application which encompasses all aspects of our commercial, government and non-risk business,
including enrollment, provider referrals, claims processing and premium billing.
We have dedicated in-house teams providing
infrastructure and application support services to our members. Our data warehouse collects information
from all of our health plans and uses it in medical management to support our underwriting, product
pricing, quality assurance, rates, marketing and contracting functions. Our centralized data center
processes approximately 19 million claims annually. We have dedicated in-house teams that convert acquired
health plans to our information systems as soon as possible following the closing of the acquisition.
Approximately 60% of all claim transactions
are processed via electronic data interface which supports our ability to auto adjudicate 75% of all
claims.
Over the last four years, we have continued
to invest and expand our e-commerce capability. We are committed to delivering fully functional, secure,
e-commerce transactions, services and content across our member, employer groups, broker and provider
channels. In 2003, we experienced significant growth in all of our e-commerce channels, supported by
focused growth programs. Transaction growth for 2003 includes:
a 57% increase in the number of visitors to our public web sites;
a 281% increase in provider transactions;
a 46% increase in our password protected member self-service transactions; and
a significant growth of our password protected self-service transactions.
The Health Insurance Portability and Accountability
Act (“HIPAA”) of 1996 imposed new requirements relating to the standardization of electronic healthcare
transactions, privacy and security. Dedicated HIPAA project teams, along with a senior management steering
committee, have been created to ensure that we have satisfied all applicable requirements. The HIPAA
projects for privacy and for transaction and code sets were delivered on schedule by the mandatory compliance
dates. We are continuing to work on HIPAA security and expect to complete all security required enhancements
to our systems and business processes by the mandatory compliance date.
Marketing
Our health plans market commercial HMO,
POS and PPO products to employer group purchasers on both a fully insured and self-funded basis. Among
small and medium size employers, our commercial products are most commonly offered on an exclusive basis.
In the large group segment, our products may be made available to employees as one option among multiple
carriers. In all size segments, employers generally pay a large part of their employees’ health care
premiums, although we have witnessed a trend toward a growing portion of that cost being assumed by
employees. Typically our employer group contracts are renewed annually.
To respond to market demand in all size
segments, our health plans have expanded the number of lower cost product options made available to
employee group purchasers. These products also serve as the foundation for our consumer-driven strategy,
Coventry FlexChoice. We believe interest in this product type will continue to grow as increasing
premiums encourage employers to seek out more cost effective alternatives. We also intend to expand
Coventry FlexChoice to take advantage of the new Internal Revenue Service guidelines recently
promulgated concerning Health Savings Accounts.
We market our managed care products and
services through our own sales staff and a network of several thousand independent brokers and agents.
Our local direct sales staff and independent brokers and agents market our health plans, seeking to
attract new employer customers and members and retain our existing employer customers and members. We
compensate our direct sales staff through a combination of base salary and incentive arrangements. We
compensate our independent brokers and agents on a commission basis.
Our direct sales staff and independent brokers
and agents typically market our managed care products and services to employers in a two-step process
in which presentations are made first to employers to secure contracts to provide health benefits. In
most instances, our sales are made on a complete replacement basis. If we are co-existing in an account
with another carrier, our direct sales staff will then be involved in the solicitation of members from
the employee base during periodic open enrollments during which employees are permitted to change health
care programs. In some markets, we use workplace presentations, direct mail and radio and television
advertisements to market to prospective members.
Our Medicaid products are marketed to Medicaid
recipients by state Medicaid authorities. We market our Medicare+Choice products to both individuals
and retirees of employer groups that provide benefits to retirees through television, radio, newspaper
and billboard advertising and direct mail. Our Medicaid and Medicare+Choice contracts are renewable
annually. Medicare enrollees may disenroll monthly. Medicaid enrollees may disenroll monthly or annually,
depending on the jurisdiction.
Significant Customers
Our commercial business is diversified across
a large customer base and there are no commercial groups that make up 10% or more of our managed care
premiums. For the years ended 2003, 2002 and 2001, we received 10.8%, 12.3% and 11.4%, respectively,
of our managed care premiums from the Federal Medicare+Choice program throughout our various markets.
We also received 11.8%, 13.1% and 12.4% of our managed care premiums in 2003, 2002 and 2001, respectively,
from our state-sponsored Medicaid programs throughout our various markets. In 2003, the State of Missouri
accounted for over half of our Medicaid premiums.
Competition
The managed care industry is highly competitive,
both nationally and in the individual markets we serve. Generally, in each market, we compete against
local Blue Cross Blue Shield affiliated health plans, locally-owned plans and provider sponsored plans.
In certain markets, we also compete with national health plans. We compete for employer groups and members
primarily on the basis of the price of the benefit plans offered, locations of the health care providers,
reputation for quality care, financial stability, comprehensiveness of coverage, diversity of product
offerings and access to care. We also compete with other managed care organizations and indemnity insurance
carriers in obtaining and retaining favorable contracts for health care services and supplies. We maintain
an active presence in the communities served by our health plans through participation in health fairs,
special children’s programs and other community activities, which we believe enhances our visibility
and reputation in the communities we serve.
Corporate Governance
Our Board of Directors has adopted a Code
of Business Conduct and Ethics applicable to the members of our Board of Directors and our officers,
including our Chief Executive Officer and Chief Financial Officer and our employees. In addition, the Board of Directors
has adopted Corporate Governance Guidelines and committee charters for our Audit Committee, Compensation
Committee and Nominating/Corporate Governance Committee. Our Code of Business Conduct and Ethics, Corporate
Governance Guidelines and current committee charters can be accessed on our website at www.coventryhealth.com or may be requested by writing to the following address: Coventry Health Care, Inc., Attn: Corporate Secretary, 6705 Rockledge Drive, Suite 900, Bethesda, Maryland, 20817.
Government Regulation
As a managed health care company, we are
subject to extensive government regulation of our products and services. The laws and regulations affecting
our industry generally give state and federal regulatory authorities broad discretion in their exercise
of supervisory, regulatory and administrative powers. These laws and regulations are intended primarily
for the benefit of the members of the health plans. Managed care laws and regulations vary significantly
from jurisdiction to jurisdiction and changes are frequently considered and implemented.
State Regulation
The states served by our health plans provide
the principal legal and regulatory framework for the commercial risk products offered by our insurance
companies and HMO subsidiaries. One of our insurance company subsidiaries, Coventry Health and Life
Insurance Company (“CH&L”), offers managed care products, primarily PPO and POS products, in conjunction
with our HMO subsidiaries in states where HMOs are not permitted to offer these types of health care
benefits. CH&L does not offer traditional indemnity insurance.
Our regulated subsidiaries are required
by state law to file periodic reports and to meet certain minimum capital and deposit and/or reserve
requirements and may be restricted from paying dividends to the parent or making other distributions
or payments under certain circumstances. They also are required to provide their members with certain
mandated benefits. Our HMO subsidiaries are required to have quality assurance and educational programs
for their professionals and enrollees. Certain states’ laws further require that representatives of
the HMOs’ members have a voice in policy making. Several states impose requirements with respect to
the prompt payment of claims and permitting “any willing provider” to join our network. Compliance with
“any willing provider” laws could increase our costs of assembling and administering provider networks.
We also are subject to the insurance holding
company regulations in the states in which our regulated subsidiaries operate. These laws and associated
regulations generally require registration with the state department of insurance and the filing of
reports describing capital structure, ownership, financial condition, certain inter-company transactions
and business operations. Most state insurance holding company laws and regulations require prior regulatory
approval or, in some states, prior notice, of acquisitions or similar transactions involving regulated
companies, and of certain transactions between regulated companies and their parents. In connection
with obtaining regulatory approvals of acquisitions, we may be required to agree to maintain capital
of regulated subsidiaries at specified levels, to guarantee the solvency of such subsidiaries or to
other conditions.
Most states now impose risk-based or other
net worth-based capital requirements on our regulated entities. These requirements assess the capital
adequacy of the regulated subsidiary based upon the investment asset risks, insurance risks, interest
rate risks and other risks associated with the subsidiary’s business. If a subsidiary’s capital level
falls below certain required capital levels, it may be required to submit a capital corrective plan
to regulatory authorities, and at certain levels may be subjected to regulatory orders, including regulatory
control through rehabilitation or liquidation proceedings. See Part II, Item 7, “Management’s Discussion
and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources” for
more information.
Federal Regulation
Sarbanes-Oxley Act of 2002
On July 31, 2002, President George W. Bush
signed into law the Sarbanes-Oxley Act of 2002 (the “Act”). The Act is a comprehensive piece of legislation
that will increase the cost of doing business. The Act’s principal reforms include:
the creation of an independent public company accounting oversight board;
auditor independence provisions that restrict the non-audit services that accountants may provide to their audit clients;
a range of corporate governance and responsibility measures;
expanded disclosure requirements, including accelerated Section 16(a) reporting by insiders;
mandatory disclosure by analysts of potential conflicts of interest;
a range of new penalties for fraud and other violations; and
mandatory disclosure of management’s assessment of internal controls.
Other provisions in the Act increase the
Securities and Exchange Commission’s funding and enforcement powers, and require various studies and
reports. We are compliant with the Act.
Health Insurance Portability and Accountability Act of 1996
The Health Insurance Portability and Accountability
Act of 1996 (“HIPAA”) imposes new requirements relating to a variety of issues that affect the Company’s
business, including the privacy and security of medical information, limits on exclusions based on preexisting
conditions for certain plans, guaranteed renewability of health care coverage for most employers and
individuals and administrative simplification procedures involving the standardization of transactions
and the establishment of uniform health care provider, payor and employer identifiers. Various agencies
of the federal government have issued regulations to implement certain sections of HIPAA. This law is
far reaching and complex, and proper interpretation and practice under the law continues to evolve.
Because the rules implementing this law are still evolving, we can not assure you that the costs of
compliance with this law will not adversely affect our results of operations or cause us to significantly
change the way we operate our business.
The Department of Health and Human Services
also released its final rule for electronic data standards under the HIPAA on August 17, 2000, effective
October 17, 2000. This rule establishes the standard data content and format for the electronic submission
of claims and other administrative health transactions. We are compliant with the electronic data standards
established by the final rule.
On December 20, 2000, the Department
of Health and Human Services released a final rule regarding standards for privacy of individually identifiable
health information and the Department of Health and Human Services published revisions to the final
rule in August 2002. The primary purposes of the privacy rule are to protect and enhance the rights
of consumers by providing them access to their health information and controlling the inappropriate
use of that information, and to improve the efficiency and effectiveness of health care delivery by
creating a national framework for health privacy protection that builds on efforts by states, health
systems, individual organizations and individuals. We are compliant with the final rule.
On January 5, 2001, the U.S. Department
of Labor’s Pension and Welfare Benefits Administration, the Internal Revenue Service and the Department
of Health and Human Services issued two regulations that provide guidance on the nondiscrimination provisions
under the HIPAA as they relate to health factors and wellness programs. These nondiscrimination provisions
prohibit a group health plan or group health insurance issuer from denying an individual eligibility
for benefits or charging an individual a higher premium based on a health factor. We currently do not
believe that these regulations will have a material adverse effect on our business.
On February 20, 2003, the Department of
Health and Human Services issued its final rule for security standards under the HIPAA. This rule establishes
minimum standards for the security of electronic health information while being held by an entity and
while the information is in transit between entities. The compliance date for the security standards
rule is April 21, 2005. We have implemented a plan of action to achieve compliance with the final security
standards rule by the compliance date.
Employee Retirement Income Security Act of 1974
The provision of services to certain employee
health benefit plans is subject to the Employee Retirement Income Security Act of 1974 (“ERISA”). ERISA
regulates certain aspects of the relationships between us and employers who maintain employee benefit
plans subject to ERISA. Some of our administrative services and other activities may also be subject
to regulation under ERISA. In addition, some states require licensure or registration of companies providing
third party claims administration services for benefit plans. We provide a variety of products and services
to employee benefit plans that are covered by ERISA.
The U.S. Department of Labor adopted federal
regulations that establish claims procedures for employee benefit plans under ERISA (insured and self-insured).
The regulations shorten the time allowed for health and disability plans to respond to claims and appeals,
establishes new requirements for plan responses to appeals and expands required disclosures to participants
and beneficiaries. The regulations apply to claims filed under a group health plan on or after the first
day of the first plan year beginning on or after July 1, 2002 and not later than January 1, 2003.
These regulations have not had a material adverse effect on our business.
Medicare+Choice and Medicaid
Some of our HMOs contract with the Centers
for Medicare and Medicaid Services to provide services to Medicare beneficiaries pursuant to the Medicare+Choice
program. Some of our HMOs also contract with states to provide health benefits to Medicaid recipients.
As a result, we are subject to extensive federal and state regulation. The Centers for Medicare and
Medicaid Services may audit any health plan operating under a Medicare+Choice contract to determine
the plan’s compliance with federal regulations and contractual obligations. In addition, we must file
cost reimbursement reports for the Medicare cost contracts, which are subject to audit and revision.
The Centers for Medicare and Medicaid Services
and the appropriate state regulatory agency have the right to audit any health plan operating under
a Medicaid managed care contract to determine the plan’s compliance with state and federal law. In some
instances, states engage peer review organizations to perform quality assurance and utilization review
oversight of Medicaid managed care plans. Our HMOs are required to abide by the peer review organizations
standards.
The Centers for Medicare and Medicaid Services
issued a final Medicaid managed care rule on January 19, 2001. The final rule includes strengthened
beneficiary protections and new provisions designed to protect the rights of participants in the Medicaid
program. Specifically, the final rule requires states to assure continuous access to care for beneficiaries
with ongoing health care needs who transfer from one health plan to another. The new rule also requires
states and plans to identify enrollees with special health care needs and to assess the quality and
appropriateness of their care. This rule has not had a material adverse effect on our business.
The Social Security Act imposes criminal
and civil penalties for paying or receiving remuneration (which is deemed to include a kickback, bribe
or rebate) in connection with any federal health care program, including the Medicare, Medicaid and
Federal Employees Health Benefits Programs. The law and related regulations have been interpreted to
prohibit the payment, solicitation, offering or receipt of any form of remuneration in return for the
referral of federal health care program patients or any item or service that is reimbursed, in whole
or in part, by any federal health care program. Similar anti-kickback provisions have been adopted by
many states, which apply regardless of the source of reimbursement.
The Centers for Medicare and Medicaid Services
have promulgated regulations that prohibit HMOs with Medicare contracts from including any direct or
indirect payment to physicians or other providers as an inducement to reduce or limit medically necessary
services to a Medicare beneficiary. These regulations impose disclosure and other requirements relating
to physician incentive plans such as bonuses or withholds that could result in a physician being at
“substantial financial risk” as defined in Medicare regulations. Our ability to maintain compliance
with such regulations depends, in part, on our receipt of timely and accurate information from our providers.
Although we believe we are in compliance with all such Medicare regulations, we are subject to future
audit and review.
In 1996, as part of the HIPAA, Congress
adopted a statutory exception for certain risk-sharing arrangements. The Office of the Inspector General
has published two safe harbors addressing these risk-sharing arrangements. A safe harbor is a regulation
that describes relationships and activities that are deemed not to violate the federal anti-kickback
statute. However, failure to satisfy each criterion of an applicable safe harbor does not mean that
the arrangement constitutes a violation of the law; rather the arrangement must be analyzed on the basis
of its specific facts and circumstances. We believe that our risk agreements satisfy the requirements
of these safe harbors. In addition, the Office of the Inspector General has adopted other safe harbor
regulations that relate to managed care arrangements. We believe that the incentives offered by our
HMOs to Medicare and Medicaid beneficiaries and the discounts our plans receive from contracting health
care providers satisfy the requirements of these safe harbor regulations. We believe that our arrangements
do not violate the federal or similar state anti-kickback laws.
Federal Employees Health Benefits Program
We contract with the Office of Personnel
Management (“OPM”) to provide managed health care services under the Federal Employee Health Benefits
Program (“FEHBP”). These contracts with the OPM and applicable government regulations establish premium
rating arrangements for this program. The OPM conducts periodic audits of its contractors to, among
other things, verify that the premiums established under its contracts are in compliance with the community
rating and other requirements under FEHBP. The OPM may seek premium refunds or institute other sanctions
against health plans that participate in the program.
HealthAmerica Pennsylvania, Inc. (“HealthAmerica”),
our Pennsylvania HMO subsidiary, received audit reports from the OPM that questioned approximately $31.1
million of subscription charges that were paid to HealthAmerica under the FEHBP for contract years 1993
- 1999. In the fourth quarter of 2003, HealthAmerica settled this dispute with the OPM and the U.S.
Department of Justice. The final settlement payment of $29.0 million was fully reserved by HealthAmerica
and therefore had no impact on 2003 earnings, the regulated capital of HealthAmerica, or our consolidated
stockholders’ equity.
Recent Federal Managed Care Legislative Proposals
While both Houses of Congress passed some
form of Patients’ Bill of Rights legislation in 2001, no such federal legislation currently exists.
Despite Congress’ failure to reconcile and pass a final Patients’ Bill of Rights, the current administration
has indicated a willingness to pass some form of patient protection legislation. Such patient protection
legislation could adversely affect the managed care industry.
In February 2003, Rep. Charlie Norwood re-introduced
Patients’ Bill of Rights legislation that closely tracks the House version that died in the 107th Congress.
Among other provisions, the proposed legislation includes the following:
would require insurers to have approved utilization review programs, claims procedures and appeal procedures concerning claim denials;
would restrict interference by insurers with the doctor-patient relationship;
would prohibit insurers from discriminating against licensed healthcare professionals with respect to participation in their networks;
would provide opportunity for individuals battling life threatening, deadly diseases to participate in a federally approved or funded clinical trial; and
would permit every member who is denied care to have a fair, speedy and impartial appeal to a review organization not selected by the insurer;
The bill was referred to House Subcommittee
on Employer-Employee Relations on March 3, 2003. The bill’s status is unchanged.
We can not predict whether the provisions
of the Patients’ Bill of Rights legislation introduced by Rep. Norwood will ultimately be enacted into
law. The House may pass a different version or no version at all, and any passed legislation must be
passed by the Senate and signed by the President. We also can not predict what impact any Patients’
Bill of Rights or other federal legislation would have on our business and operations.
Numerous other proposals have been introduced
in the United States Congress and various state legislatures relating to managed health care reform.
The provisions of legislation that may be adopted at the state level can not be accurately and completely
predicted at this time, and we therefore can not predict the effect of proposed legislation on our operations.
On the federal level, it is possible that some form of managed health care reform may be enacted. At
this time, it is unclear as to when any legislation might be enacted or the content of any new legislation,
and we can not predict the effect on our operations of the proposed legislation or any other legislation
that may be adopted.
The Medicare Prescription Drug, Improvement and Modernization
Act of 2003
On December 8, 2003, President George W.
Bush signed into law the Medicare Prescription Drug, Improvement and Modernization Act of 2003. This
act makes changes to the existing Medicare law, including the creation of a new outpatient drug benefit
beginning in 2006 and an immediate drug discount card for the interim period until January 1, 2006.
The act makes managed care organizations eligible to be sponsors of both the drug card and drug benefit
plan programs. In addition, the Medicare+Choice program, renamed Medicare Advantage, is expanded in
a number of ways and payments are increased. At this time, we can not predict what impacts this new
law will have on our business and operations.
This act increased base rate payments
to Medicare+Choice plans. The total increase in 2004 for all of our markets averaged 10.7%. The increase
in revenue is required to be spent as follows: to increase benefits to members; to decrease cost sharing
of members through reduced co-payments and coinsurance; to stabilize provider networks; to decrease
member premiums; and to stabilize benefits. Title I of this same law created a prescription drug discount
card and provides for a future prescription drug benefit. We are planning to ensure our members have
access to a CMS endorsed prescription drug discount card throughout 2004 and 2005. The prescription
drug benefit will be effective on January 1, 2006. This benefit will become part of the Medicare+Choice
funding at that time. The Company is currently monitoring the implementation of the law to determine
how it will impact our offerings in 2006 and will continue to monitor this issue as new regulations
are released.
Risk Management
In the normal course of business, we have
been named as a defendant in various legal actions such as actions seeking payments for claims denied
by the Company, medical malpractice actions, employment related claims and other various claims seeking
monetary damages. The claims are in various stages of proceedings and some may ultimately be brought
to trial. Incidents occurring through December 31, 2003 may result in the assertion of additional claims.
We maintain general liability, professional liability and employment practices liability insurances
in amounts that we believe are appropriate, with varying deductibles for which we maintain reserves.
The professional liability and employment practices liability insurances are carried through our captive
subsidiary.
Our captive subsidiary provides up to $5
million in professional liability coverage for each single claim and up to $10 million in coverage for
each class action claim. The captive professional liability policy has an aggregate limit of $20 million
per year. The captive is also co-insured with a commercial carrier for an additional $10 million for
professional liability claims. Additionally, the captive employment practices liability policy provides
up to $250,000 per single claim, $10 million per class action claim, and an aggregate policy limit of
$10 million. Each year we will re-evaluate the most cost effective method for insuring these types of
claims.
Employees
At February 27, 2004, we employed 4,203 persons,
none of whom are covered by a collective bargaining agreement.
Acquisition Growth
We began operations in 1987 with the acquisition
of the American Service Companies entities, including Coventry Health and Life Insurance Company. We
have grown substantially through acquisitions. The table below summarizes all of our significant acquisitions.
See Note B to the consolidated financial statements for additional information on the most recent acquisitions.
Acquisition
Markets
Type of Business
Year Acquired
American Service Company (“ASC”) entities Multiple Markets Multiple Products
HealthAmerica Pennsylvania, Inc. (“HAPA”) Pennsylvania HMO
Group Health Plan, Inc. (“GHP”) Missouri HMO
Southern Health Services, Inc. (“SHS”) Virginia HMO
HealthCare USA, Inc. (“HCUSA”) Multiple Markets Medicaid
Principal Health Care, Inc. (“PHC”) Multiple Markets HMO
Carelink Health Plans (“Carelink”) West Virginia HMO
Kaiser Foundation Health Plan of North Carolina (“Kaiser - NC”) North Carolina HMO
PrimeONE, Inc. (“PrimeONE”) West Virginia HMO
Maxicare Louisiana, Inc. (“Maxicare”) Louisiana HMO
WellPath Community Health Plans (“WellPath”) North Carolina HMO
Prudential Health Care Plan, Inc. (“Prudential”) Missouri Medicaid
Blue Ridge Health Alliance, Inc. (“Blue Ridge”) Virginia HMO
Health Partners of the Midwest (“Health Partners”) Missouri HMO
Kaiser Foundation Health Plan of Kansas City, Inc. (“Kaiser - KC”) Kansas HMO
NewAlliance Health Plan, Inc. (“NewAlliance”) Pennsylvania HMO
Mid-America Health Partners, Inc. (“Mid-America”) Kansas HMO
PersonalCare Health Management, Inc. (“PersonalCare”) Illinois HMO
Altius Health Plans, Inc. (“Altius”) Utah HMO
Service Marks and Trademarks
We have the following federally registered
service marks: “Advantra,” “Carelink,” “Carelink Health Plans” logo, “Coventry,” “Coventry Healthy Choices
Program,” “Coventry USA,” cross design, “Delawarecare,” Doc Bear character, “GHP,” “GHP” logo, “GHP
Network Connection,” “HealthAmerica,” “HealthAssurance,” “HealthAssurance Flex,” “It’s That Simple,”
“Mid-America Health Network,” “Sensicare,” “SouthCare,” “SouthCare Medical Alliance” logo, sun design
logo, “Strong Starts,” “WellPath Select,” “WellPath 65,” “WellPath Community Health Plans,” “Senior
Life Management,” “The Good Life Times” and our torch logo design. We have the right in perpetuity to
use the federally registered name “HealthCare USA” in Missouri, Illinois, Kansas and Florida.
We have pending applications for federal
registration of the following service marks: “Coventry Healthy Decisions Program,” “Coventry FlexChoice,”
“With You When It Matters,” “The Answer To Your Health Care Needs,” “Mid America Health Access,” “Mid
America Health Access Plus,” “Mid America Health Access +,” “Mid America Health Administrators,” “Mid
America Health Care,” “Mid America Health Reinsurance, Ltd.,” “Mid America Health” logo and “The Health
Conscious Health Plan.”
Executive Officers of Our Company
The following table sets forth information
with respect to the current executive officers:
Name
Age
Position
Allen F. Wise President, Chief Executive Officer and Director
Thomas P. McDonough Executive Vice President and Chief Operating Officer
Dale B. Wolf Executive Vice President, Chief
Financial Officer and Treasurer
Nancy G. Cocozza Senior Vice President
Thomas A. Davis Senior Vice President
Harvey C. DeMovick, Jr. Senior Vice President, Customer Service
Operations and Chief Information Officer
Richard J. Gilfillan, M.D. Senior Vice President
Shawn M. Guertin Senior Vice President
J. Stewart Lavelle Senior Vice President, Sales and Marketing
Bernard J. Mansheim, M.D. Senior Vice President and Chief Medical Officer
James E. McGarry Senior Vice President
Timothy E. Nolan Senior Vice President
John J. Ruhlmann Vice President and Corporate Controller
Francis S. Soistman, Jr. Senior Vice President
Janet M. Stallmeyer Senior Vice President
Charles R. Stark Senior Vice President
Thomas C. Zielinski Senior Vice President and General Counsel
Allen F. Wise has been a director
and President and Chief Executive Officer of our Company since October 1996. From October 1994 to October
1995, he was Executive Vice President of MetraHealth Companies, Inc., a managed health care company
that was acquired by UnitedHealth Group, Incorporated, a diversified health and well being company,
in October 1995. From October 1995 to October 1996, he was Executive Vice President of UnitedHealth
Group, Incorporated. From January 1994 to October 1994, he was President and Chief Executive Officer
of Wise Health System, a health care investment company. From 1991 to 1994, Mr. Wise was President and
Chief Executive Officer of Keystone Health Plan, a managed health care company, and also Chief Operating
Officer of Independence Blue Cross, a health care insurance company. He is a director and a member of the audit committee
of NCO Group,
Inc., a provider of accounts receivable management and other outsourced services.
Thomas P. McDonough was elected Executive
Vice President of our Company in April 1998 and Chief Operating Officer in July 1998. He was Chief Executive
Officer of Uniprise, a subsidiary of UnitedHealth Group, Incorporated, a diversified health and well
being company, from November 1997 until April 1998; Executive Vice President, Customer Services Group
from February 1997 to November 1997; and Senior Vice President, Claim Services from August 1995 through
February 1997. Prior to 1995, he was the President of Harrington Service Corporation, an insurance services
company, and the Chief Operating Officer of Jardine Group Services Corporation, an insurance brokerage
company and third party administrator.
Dale B. Wolf was elected Executive
Vice President, Chief Financial Officer and Treasurer of our Company in April 1998. From December 1996
to April 1998, he was Senior Vice President, Chief Financial Officer and Treasurer of our Company. From
August 1995 to December 1996, he was Executive Vice President of SpectraScan Health Services, Inc.,
a women’s health care services company. From January 1995 to August 1995, Mr. Wolf was Senior Vice President,
Business Development of MetraHealth Companies, Inc., a managed health care company. From August 1988
to December 1994, Mr. Wolf was Vice President, Specialty Operations of the Managed Care and Employee
Benefits Operations of The Travelers, an insurance company. He is a director and a member of the audit committee of HealthExtras, Inc.,
a provider of pharmacy benefit management services and supplemental benefits. Mr. Wolf is a Fellow of
the Society of Actuaries.
Nancy G. Cocozza was elected Senior
Vice President, Government Programs, of our Company in May 2001, and has served as head of Medicare
Operations since August 2003. Prior to that time, she held the following positions with former Aetna
US HealthCare Inc. (now Aetna Inc.), a national employee benefits carrier: from October 1999 to February
2001, she was Vice President, e-Health PMO; from March 1998 to January 2000, she was Vice President,
Y2K Readiness; and from August 1996 to March 1998, she was Vice President, Mid Atlantic Region Customer
Service. Prior to that time, she was head of Self-Insured Operations of US HealthCare (now Aetna Inc.).
Thomas A. Davis was elected Senior
Vice President of our Company in April 1998 and President and Chief Executive Officer of Coventry Health
Care of Georgia, Inc., our Georgia health plan, in May 1998. Prior to that time from 1996 to 1998, he
was the Chief Executive Officer of the Utah operations of UnitedHealth Group, a diversified health and
well being company. From 1995 to 1996, Mr. Davis was Vice President, Operations, of MetraHealth Companies,
Inc., a managed health care company. From 1992 to 1994, he was Director, HMO Operations, of Prudential
Health Care System. Prior to 1992, Mr. Davis held various positions in health care venture capital and
management consulting firms.
Harvey C. DeMovick, Jr. was elected
Senior Vice President of our Company in April 1998. He has served as our Chief Information Officer since
April 2001 and as our Senior Vice President, Customer Service Operations since September 2001. From
April 2001 to September 2001, he served as our Senior Vice President, Organizational Development, Human
Resources and Compliance. From April 1998 to April 2001, he was Senior Vice President, Government Programs,
Compliance, Information Systems and Human Resources of our Company. He was Senior Vice President, Medical
and Government Programs of Coventry Corporation from July 1997 to April 1998. From October 1995 to July
1997, Mr. DeMovick was Senior Vice President, Customer Administrative Services, of UnitedHealth Group,
Incorporated, a diversified health and well being company, and from October 1994 through October 1995
he was Vice President, Managed Care Operations, of MetraHealth Companies, Inc., a managed health care
company.
Richard J. Gilfillan, M.D. was elected
Senior Vice President of our Company in August 2001. Prior to that time, from October 2000 to August
2001, he was an independent health care consultant. From June 1989 to October 2000, he held various
positions with Independence Blue Cross, a health care insurance company in southeastern Pennsylvania,
including most recently Senior Vice President and General Manager of AmeriHealth New Jersey, a managed
health care plan and subsidiary of Independence Blue Cross. Prior to that, he was Senior Vice President
and Chief Medical Officer of Independence Blue Cross. Prior to that time, from 1985 to 1989, he served
as Medical Director for Medigroup Central Health Plan, a managed health care plan, and from 1980 to
1985, he served as Medical Director and practicing physician with The Winchendon Community Health Center,
a health care clinic.
Shawn M. Guertin was elected Senior
Vice President of our Company in February 2003. He has served as President of Coventry Health and Life
Insurance Company since February 2002. From April 1998 to February 2003, he was Vice President of Finance
of our Company. Prior to that date, he was Vice President of Finance of Coventry Corporation from January
1998. From October 1995 to January 1998, he was a Vice President of UnitedHealth Group, Incorporated,
a diversified health and well being company. Prior to that time, from 1993 to 1995, he served as a Vice
President for The MetraHealth Companies, Inc., a Connecticut managed health care company, and for The
Travelers, a Connecticut insurance company.
J. Stewart Lavelle was elected Senior Vice President, Sales
and Marketing, of our Company in April 1998. He was the Chief Executive Officer of Southern Health Services,
our Virginia health plan, from January 1998 to December 1999. From 1996 to November 1997, Mr. Lavelle
was President of Riscorp Health Plans, a managed health care company. He joined U.S. Healthcare, Inc.
in 1987 and served as Senior Vice President, General Manager of its New Jersey, Delaware, Maryland,
Washington D.C. and Virginia operations from 1991 to 1996.
Bernard J. Mansheim, M.D. was elected
Senior Vice President and Chief Medical Officer of our Company in April 1998. From August 1997 to April
1998, he was the Chief Operating Officer of United HealthCare of the Mid-Atlantic, a managed health
care company, and, from August 1996 to July 1997, was its Chief Medical Officer. In April 1995, he became
President and Chief Executive Officer of HealthSpring, Inc., a pre-paid, primary care group medical
practice and subsidiary of MetraHealth Companies, Inc. Following the acquisition of MetraHealth Companies,
Inc. by UnitedHealth Group, Incorporated, a diversified health and well being company, in October 1995.
Dr. Mansheim continued as the President and Chief Executive Officer of HealthSpring, Inc. until its
divestiture in August 1996 and also served as National Medical Director of UnitedHealth Group, Incorporated.
From August 1994 to April 1995, he was President and Chief Executive Officer of Triangle HealthCare
Group, a primary care group medical practice, and Medical Director of Prudential Health Care System
of the Triangle in Raleigh-Durham-Chapel Hill, North Carolina, a managed health care company.
James E. McGarry was elected Senior
Vice President of our Company in July 1998. From November 1997 to July 1998, he was the Chief Operating
Officer of Uniprise of UnitedHealth Group, Incorporated. From January 1995 to October 1997, he was Senior
Vice President, Consumer Services Administration, of UnitedHealth Group, Incorporated. Prior to 1995,
he was Vice President of Field Operations of MetraHealth Companies, Inc. and Vice President of Field
Operations for The Travelers, an insurance company.
Timothy E. Nolan was elected Senior
Vice President of our Company in December 2003. From September 2000 to December 2003, he was an independent
consultant for various healthcare companies, including the Company. From September 2000 to January 2004,
he served as a director of Andrx Corporation, a generic pharmaceutical company. From late March 2000
through November 2001, Mr. Nolan served as President and Chief Operating Officer of Cybear, Inc., an
information technology company and a wholly owned subsidiary of Andrx Corporation. From June 1999 to
September 2000, he served as a director of Cybear, Inc. From 1985 through March 2000, Mr. Nolan was
employed by Aetna Inc., last serving as Senior Vice President of former AetnaUSHealthcare Inc. (now
Aetna Inc.) in charge of the field organization. On May 6, 2003, Mr. Nolan entered into an
administrative consent Order with the SEC pursuant to which, without admitting or denying the SEC’s
findings, he agreed to cease and desist from committing or causing any future violations of certain
of the reporting provisions of the Securities Exchange Act of 1934. The Order related to the SEC’s finding
that Cybear had improperly recognized approximately $1.3 million in revenue (representing approximately
$27,000 in gross profit) pursuant to a joint venture between Andrx and Cybear. The SEC’s Order found
that these amounts were improperly recognized in Cybear’s March 31, 2000 and June 30, 2000 Forms
10-Q, and in the July 31, 2000 joint proxy statement/prospectus with respect to a reorganization completed
in September 2000 under which Cybear became a wholly owned subsidiary of Andrx Corporation.
John J. Ruhlmann was elected Vice
President and Corporate Controller of our Company in November 1999. From December 1993 to September
1999, Mr. Ruhlmann was Vice President of Accounting of Integrated Health Services, Inc., a national
provider of health services that owned and managed hospitals, nursing homes and clinics.
Francis S. Soistman, Jr. was elected
Senior Vice President of our Company in April 1998. He was named President and Chief Executive Officer
of HealthAmerica Pennsylvania, Inc. and HealthAssurance Pennsylvania, Inc., our Pennsylvania subsidiaries,
in May 1998 and July 2001, respectively. He was Regional Vice President of Principal Health Care, Inc.,
from December 1994 to March 1998. From April 1994 to December 1994, he was Executive Director of Principal
Health Care of the Mid-Atlantic, Inc., a wholly owned managed health care subsidiary of one of Principal’s
subsidiaries. From January 1983 until March 1994, Mr. Soistman held various positions with Blue Cross
Blue Shield of Maryland and its subsidiary companies.
Janet M. Stallmeyer was elected Senior
Vice President of our Company in March 1999. She has been the President and Chief Executive Officer
of Coventry Health Care of Kansas, Inc., our Kansas health plan, since October 1998, and its Executive
Director from January 1995 to October 1998. From October 1992 to December 1994, she was the Executive
Director of our Louisiana health plan, Coventry Health Care of Louisiana, Inc.
Charles R. Stark was elected Senior
Vice President of our Company in August 2001 and was named President and Chief Executive Officer of
Group Health Plan, Inc., one of our Missouri health plans, in October 2001. He was President and Chief
Executive Officer of HealthCare USA of Missouri, LLC, one of our Missouri health plans, from January
2001 to October 2001. From December 1996 to September 1999, he was the President and Chief Executive
Officer of Antero Health Plans, a Colorado managed care company. From June 1992 to December 1996, he
was President and Chief Executive Officer of Health Direct, an Illinois health care company.
Thomas C. Zielinski was elected Senior
Vice President and General Counsel of our Company in August 2001. Prior to that time, Mr. Zielinski
worked for 19 years in various capacities for the law firm of Cozen and O’Connor, P.C., including as
a senior member, shareholder and Chair of the firm’s Commercial Litigation Department.
Item 2:
Item 2: Properties
As of December 31, 2003, we leased 60,000
square feet of space for our corporate office in Bethesda, Maryland. We also leased 848,000 aggregate
square feet for office space, subsidiary operations and customer service centers for the various markets
where our health plans operate, of which 10% is subleased. Our leases expire at various dates from 2004
through 2013. We also own a building in Richmond, Virginia with 45,000 square feet, which is used for
administrative services related to our health plan in that state, of which 46% is subleased. We believe
that our facilities are adequate for our operations.
Item 3:
Item 3: Legal Proceedings
See Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Legal Proceedings” for more information.
Item 4:
Item 4: Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security
holders during the fourth quarter of the fiscal year 2003.
PART II
Item 5:
Item 5: Market for the Registrant’s Common Equity and Related Stockholder Matters
Price Range of Common Stock
Our common stock is traded on the New York
Stock Exchange® (NYSE®) stock market under the ticker symbol “CVH.” On December 23, 2003, our Board
of Directors approved a three-for-two stock split of our common stock. The stock split, in the form
of a stock dividend, was effective January 30, 2004 for stockholders of record on January 9, 2004. The
stock split is reflected retroactively in our price per share for all periods presented. The following
table sets forth the quarterly range of the high and low closing sales prices of the common stock on
the NYSE® stock markets during the calendar period indicated. Such quotations represent inter-dealer
prices without retail markup, markdown or commission and may not necessarily represent actual transactions:
On February 27, 2004, we had approximately
300 stockholders of record, not including beneficial owners of shares held in nominee name. On February
27, 2004, our closing price was $43.57.
We have not paid any cash dividends on our
common stock and expect for the foreseeable future to retain all of our earnings to finance the development
of our business. Our ability to pay dividends is limited by certain covenants and restrictions contained
in our senior notes and by insurance regulations applicable to our subsidiaries. Subject to the terms
of such insurance regulations, any future decision as to the payment of dividends will be at the discretion
of our Board of Directors and will depend on our earnings, financial position, capital requirements
and other relevant factors. See Part II, Item 7, “Management’s Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources.”
Our Board of Directors has approved a program
to repurchase up to 10% of our outstanding common stock. Stock repurchases may be made from time to
time at prevailing prices on the open market, by block purchase or in private transactions. As a part
of this program, we purchased 3.3 million shares of our common stock in 2002 at an aggregate cost of
$65.5 million. We did not purchase any shares of our common stock in 2003 under this program. The total
remaining common shares we are authorized to repurchase under the program, is approximately 3.8 million
as of December 31, 2003.
Item 6:
Item 6: Selected Consolidated Financial Data
(in thousands, except per share and membership
data)
Item 7:
Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read
in conjunction with the accompanying audited consolidated financial statements and notes thereto. The organization of our Management’s Discussion and Analysis of Financial Condition and Results of Operations is as follows:
Executive-Level Overview
Critical Accounting Policies
New Accounting Standards
Acquisitions
Membership
Results of Operations
Liquidity and Capital Resources
Other Disclosures
Risk Factors
Executive-Level Overview
General Operations
We are a leading publicly traded managed
health care company with approximately 2.4 million members, excluding network rental members, as of
December 31, 2003. We operate a diversified portfolio of local market health plans, insurance companies
and provider networks serving 14 markets. Our operations are based in Bethesda, Maryland with our local
markets primarily covering the Mid-Atlantic, Midwest and Southeast regions of the United States. Our
primary focus is owning and operating health plans with a concentration on risk business with mid-sized
employer groups.
We operate our health plans with a local
focus but with the management expertise, resources and economies of scale of a large, well-capitalized
company. We believe the delivery of health care benefits and services is best managed on a market-by-market
basis. Each of our health plans operates under its local market name and has local management, including
sales and marketing, medical management, contracting and provider relations personnel that design and
manage health benefits to meet the needs of our individual markets. We believe that our local focus
enables us to quickly adapt our products and services to the needs of individual markets and maintain
strong relationships with our employer customers, members and health care providers. We will continue
to meet competitive challenges by offering quality products at adequate rates while maintaining our
low cost structure.
Highlights of 2003 Performance
Membership increased 17% over the prior year.
Revenue increased 27% over the prior year.
Medical loss ratio of 81.2% improved 210 basis points over the prior year.
Selling, general and administrative expenses, as a percentage of revenue, improved by 20 basis points over the prior year.
Operating margin of 8.1% improved 250 basis points over the prior year.
Diluted earnings per share increased 74% over the prior year.
Cash flows from operations was $323.1 million, a 55% improvement over the prior year.
Total cash and investments increased to $1.4 billion, a 26% increase over the prior year.
Operating Revenue and Products
We generate our operating revenues from
premiums for a broad range of managed care and management service products. Premiums for our commercial
risk products, for which we assume full underwriting risk, can vary. For example, premiums for our preferred
provider organization (“PPO”) and point of service (“POS”) products are typically lower than our health
maintenance organization (“HMO”) premiums due to medical underwriting and higher deductibles and co-payments
that are typically required of the PPO and POS members. Premium rates for our government programs, Medicare+Choice
and state-sponsored managed Medicaid, are established by governmental regulatory agencies. These government
products are offered in selected markets where we believe we can achieve profitable growth based upon
favorable reimbursement levels, provider costs and regulatory climates.
Revenue for our management services products
(“non-risk”) is generally a fixed administrative fee for access to our provider networks and management
services, for which we do not assume underwriting risk. The management services we provide typically
include network management, claims processing, utilization review and quality assurance. In addition,
we rent our network of providers (“network rental”), including claims repricing and utilization review,
to other managed care plans or non-risk employers and assume no underwriting risk.
During the three years ended December 31,
2003, we experienced substantial growth in operating revenues due to membership increases
from acquisitions. We pursue acquisitions that fit into our local market strategy and that we feel are
able to operate at target margins for the long term. Acquisitions must have a manageable regulatory
and business climate and have the ability to add value to our company. Additionally, membership growth
was achieved organically through marketing efforts, geographic expansion and increased product offerings.
Our ability to introduce products quickly
to each market has helped us to expand our customer base. In particular, we have been able to a add
a large variety of lower cost products, which has proven especially attractive to customers. In some
instances, we have introduced products in one market that we were already administering in another.
Such commonality can help not only in properly administering benefit plans from day one, but also in
expediting the regulatory approval processes. Although the approval processes are unique to each state,
common plan documents can provide additional efficiencies.
Operating Expenses
Our medical costs include medical claims
paid under contractual relationships with a wide variety of providers and capitation arrangements. Medical
costs also include an estimate of claims incurred but not reported (“IBNR”).
Our health plans maintain provider networks
that furnish health care services through contractual arrangements with physicians, hospitals and other
health care providers. Most contracted primary care and specialist
physicians are compensated under a discounted fee-for-service arrangement. The majority of our contracts
with hospitals provide for inpatient per diem or per case hospital rates. Outpatient services are contracted
on a discounted fee-for-service, a per case basis or in some instances a discount from charges basis.
We pay ancillary providers on a fixed fee schedule or a capitation basis. Prescription drug benefits
are provided through a formulary comprised of an extensive list of drugs. Drug prices are negotiated
through a national network of pharmacies at discounted rates.
A small percentage of our membership is
covered by global capitation arrangements. Under the typical arrangement, the provider receives a fixed
percentage of premium to cover all the medical costs provided to the globally capitated members. Under
some capitated arrangements, physicians may also receive additional compensation from risk sharing and
other incentive arrangements. Global capitation arrangements limit our exposure to the risk of increasing
medical costs, but expose us to risk as to the adequacy of the financial and medical care resources
of the provider organization. In addition to global capitation arrangements, we have capitation arrangements
for ancillary services, such as mental health care. We are ultimately responsible for the coverage of
our members pursuant to the customer agreements. To the extent that the respective provider organization
faces financial difficulties or otherwise is unable to perform its obligations under the capitation
arrangements, we will be required to perform such obligations. Consequently, we may have to incur costs
in doing so in excess of the amounts we would otherwise have to pay under the original global or ancillary
capitation arrangements.
We have established systems to monitor the
availability, appropriateness and effectiveness of the patient care we provide. We collect utilization
data in each of our markets that we use to analyze over-utilization or under-utilization of services
and assist our health plans in providing appropriate care for their members and improving patient outcomes
in a cost efficient manner. Medical directors also monitor the utilization of diagnostic services and
encourage the use of outpatient surgery and testing where appropriate. Each health plan collects data
showing each physician’s utilization profile for diagnostic tests, specialty referrals and hospitalization
collects and presents such data to the health plan’s physicians. The medical directors monitor these
results in an effort to ensure the use of cost-effective, medically appropriate services.
We operate four regional service centers
that perform claims processing, premium billing and collection, enrollment and customer service functions
for our plans. Our regional service centers enable us to take advantage of economies of scale, implement
standardized management practices at each of our plans and capitalize on the benefits of our integrated
information technology systems. We centralize the underwriting and product pricing functions for our
health plans, which allows us to utilize our underwriting expertise and a disciplined pricing strategy
at each of our plans. We believe our centralization of certain administrative functions at the corporate
and regional levels gives us a competitive advantage over local market health plans that lack our resources.
Cash Flows
We generate cash through operations. As
a profitable company in an industry that is not capital equipment intensive, we have not needed
to use financing methods to generate cash for operations. We have a low debt to capital ratio and while
we did issue senior notes in 2002 (as described in Note H to our consolidated financial statements of
this Form 10-K), the entire proceeds were used to repurchase a portion of our common stock and were
not used to fund operations. Our primary use of cash is to pay medical claims. Any excess cash has historically
been used for acquisitions and for repurchases of our common stock.
Critical Accounting Policies
The accounting policies described below
are ones we consider critical in preparing our consolidated financial statements. Critical accounting
policies are ones that require difficult, subjective, or complex judgments, often as a result of the
need to make estimates about the effect of matters that are inherently uncertain. The judgments and
uncertainties affecting the application of these policies include significant estimates and assumptions
made by us using information available at the time the estimates are made. Actual results could differ
materially from those estimates.
Revenue Recognition
Managed care premiums are recorded as revenue
in the month in which members are entitled to service. Premiums are based on both a per subscriber contract
rate and the number of subscribers in our records at the time of billing. Premium billings are generally
sent to employers in the month preceding the month of coverage. Premium billings may be subsequently
adjusted to reflect changes in membership as a result of retroactive terminations, additions, or other
changes. Due to early timing of the premium billing, we are able to identify the retroactive adjustments
for two subsequent months billings. Current period revenues are adjusted to reflect these retroactive
adjustments.
Based on information received subsequent
to generating premium billings, historical trends, bad debt write-offs and the collectibility of specific
accounts, we estimate, on a monthly basis, the amount of bad debt and future membership retroactivity
and adjust our revenue and reserves accordingly.
As of December 31, 2003, we maintained reserves
for retroactive billing adjustments of approximately $7.2 million compared with approximately $12.0
million at December 31, 2002. We also maintained reserves for doubtful accounts of approximately $1.4
million and $2.9 million as of December 31, 2003 and 2002, respectively. The calculation for these reserves
is based on a percentage of the gross accounts receivable with the reserve percentage increasing for
the older receivables. The reserves have declined as a result of an improvement in the aging of our
premium receivables.
We also receive premium payments from the
Centers for Medicare and Medicaid Services (“CMS”) on a monthly basis for our Medicare+Choice membership.
Membership and category eligibility are periodically reconciled with CMS and could result in adjustments
to revenue. Premiums collected in advance are recorded as deferred revenue.
We contract with the Office of Personnel
Management (“OPM”) to provide managed health care services under the Federal Employee Health Benefits
Program (“FEHBP”). These contracts with the OPM and applicable government regulations establish premium
rating arrangements for this program. The OPM conducts periodic audits of its contractors to, among
other things, verify that the premiums established under its contracts are in compliance with the community
rating and other requirements under FEHBP. The OPM may seek premium refunds or institute other sanctions
against health plans that participate in the program. Our contracts are periodically reconciled by us
with the OPM and could result in adjustments to revenue. Premiums for services to federal employee groups
are subject to audit and review by the OPM on a periodic basis. Such audits are usually a number of
years in arrears. We record reserves, on an estimated basis annually, based on appropriate guidelines.
Any differences between actual results and estimates are recorded in the year the audits are finalized.
We currently enter into performance guarantees
with employer groups where we pledge that we will meet certain standards. These standards vary widely
and could involve customer service, member satisfaction, claims processing, claims accuracy, telephone
on-hold time, etc. Under these performance guarantees, we could be at risk and may incur penalties for
not maintaining the standards established in the contracts. The risk level varies by agreement with
penalties based on a variety of calculations including per member per month, percentage of premium,
or percentage of administration fees. Risk levels are evaluated at least quarterly. We estimate our
potential exposure and record appropriate reserves. The penalties that we have incurred have been immaterial
and, although, we can not predict with precision the future effect on our results of operations of these
penalties, we expect them to remain immaterial.
Medical Claims Expense and Liabilities
Medical claims liabilities consist of actual
claims reported but not paid and estimates of health care services incurred but not reported (“IBNR”).
IBNR estimates are developed using actuarial principles and assumptions that consider, among other things,
contractual requirements, historical utilization trends and payment patterns, benefits changes, medical
inflation, product mix, seasonality, membership and other relevant factors. We also establish reserves,
if required, for the probability that anticipated future health care costs and contract maintenance
costs under the group of existing contracts will exceed anticipated future premiums and reinsurance
recoveries on those contracts. These accruals are continually monitored and reviewed, and as settlements
are made or accruals adjusted, differences are reflected in current operations. Changes in assumptions
for medical costs caused by changes in actual experience could cause these estimates to change in the
near term. Certain situations require judgment in setting reserves, such as system conversions, processing
interruptions, environmental changes or other factors.
We employ a team of actuaries that have
developed, refined and used the same set of reserve models over the past several years. For inpatient
reserves, our models use credibility weighting of lag-based incurred claim estimates (traditional triangle
based completion factors) and incurred claims estimates calculated as authorized days multiplied by
per diem forecasts. For non-inpatient reserves, our models use credibility weighting of lag-based incurred
claim estimates and trended per member per month estimates. For both the inpatient and non-inpatient
reserves, lag-based estimates receive little or no credibility weighting in the more current incurral
months. Credibility factors are increased for older months within the lag models since those older months
have a higher completion factor and are the best indicator of our ultimate cost.
Within the reserve setting methodologies
for inpatient and non-inpatient services, there are certain assumptions that are used. For inpatient
services, authorized days are used for utilization factors, while cost trend assumptions are incorporated
into per diem amounts. The per diem estimates reflect anticipated effects of changes in reimbursement
structure and severity mix. For non-inpatient services, a composite trend assumption is applied which
reflects anticipated changes in cost per service, provider contracts, utilization, and other factors.
Actuarial standards of practice generally
require the actuarial developed medical claims estimates to cover obligations under an assumption of
moderately adverse conditions. Adverse conditions are situations in which the actual claims are expected
to be higher than the otherwise estimated value of such claims. In many situations, the claims paid
amount experienced will be less than the estimate that satisfies the actuarial standards of practice.
Medical claims liabilities are recorded at an amount we estimate to be appropriate. Adjustments
of prior years estimates may result in additional medical costs or, as we have experienced during the
last several years, a reduction in medical costs in the period an adjustment was made. Our reserve models
have historically developed favorably suggesting that the accrued liabilities calculated from the models
were more than adequate to cover our ultimate liability for unpaid claims. We believe that this favorable
development is a result of good communications between our health plans and our actuarial staff regarding
medical utilization, mix of provider rates and other components of medical cost trend.
The following table presents the components
of the change in medical liabilities (Medical claims liabilities and Other medical liabilities) for the years ended December 31, 2003, 2002 and 2001, respectively
(in thousands).
Acquisition balances represent medical liabilities as of the applicable acquisition date. Subsequent changes in estimates related to the acquired balances are recorded as adjustments to the settlement account with the acquired entity’s previous owner.
The negative amounts noted as “prior year” medical costs are favorable adjustments for claim estimates being settled for amounts less than originally anticipated. As noted above, these favorable restatements from original estimates occur due to changes in medical utilization, mix of provider rates and other components of medical cost trends.
We believe that the amount of medical liabilities is adequate to cover our ultimate liability for unpaid claims as of December 31, 2003; however,
actual claim payments and other items may differ from established estimates. Assuming a hypothetical
1% variance between our December 31, 2003 estimates of medical liabilities and actual costs payable,
net earnings for the year ended December 31, 2003, would increase or decrease by approximately $3.8
million and diluted earnings per share would increase or decrease by approximately $0.04 per share.
Investments
We account for investments in accordance
with Statement of Financial Accounting Standards (“SFAS”) No. 115 - “Accounting for Certain Investments
in Debt and Equity Securities.” We invest primarily in fixed income securities and classify all our
investments as available-for-sale. Investments are evaluated at least quarterly to determine if declines
in value are other-than-temporary. In making that determination, we consider all available evidence
relating to the realizable value of a security. This evidence includes, but is not limited to, the following:
adverse financial conditions of a specific issuer, segment, industry, region or other variables;
the length of the time and the extent to which the fair value has been less than cost;
the financial condition and near-term prospects of the issuer;
our intent and ability to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value;
elimination or reduction in dividend payments, or scheduled interest and principal;
rating agency downgrade of a debt security; and
expected cash flows of a debt security.
Temporary declines in value of investments
classified as available-for-sale are netted with unrealized gains and reported as a net amount in a
separate component of stockholders’ equity. A decline in fair value below amortized cost that is judged
to be other-than-temporary is accounted for as a realized loss and the write down is included in earnings.
Realized gains and losses on the sale of investments are determined on a specific identification basis.
The following table shows our investments’
gross unrealized losses and fair value, at December 31, 2003, aggregated by investment category and
length of time that individual securities have been in a continuous unrealized loss position (in thousands).
The securities presented in this table do
not meet the criteria for an other-than-temporarily impaired investment. These securities have an investment
grade credit rating. The current unrealized loss is the result of interest rate increases and not unfavorable
changes in the credit ratings associated with these securities. These investments are not in high risk
industries or sectors and we intend to hold these investments for a period of time sufficient to allow
for a recovery in market value.
Investments with original maturities in
excess of three months and less than one year are classified as short-term investments and generally
consist of corporate bonds, U.S. treasury notes and commercial paper. Long-term investments have original
maturities in excess of one year and primarily consist of fixed income securities.
Goodwill and Other Intangible Assets
Goodwill and other intangible assets that
have indefinite lives are subject to a periodic assessment for impairment by applying a fair-value-based
test. We use three approaches to identifying the fair value of our goodwill and other intangible assets:
a market approach, a market capitalization approach and an income approach. The market approach estimates
a business’s fair value by analyzing the recent sales of similar companies. The market capitalization
approach is based on the market value of our total shares outstanding. The income approach is based
on the present value of expected future cash flows. All three approaches are reviewed together for consistency
and commonality. Any impairment charges that may result will be recorded in the period in which the
impairment took place. We have not incurred an impairment charge related to goodwill. See
Note C to the consolidated financial statements for additional disclosure related to intangible assets.
New Accounting Standards
In December 2002, the Financial Accounting
Standards Board (“FASB”) issued SFAS No. 148 - “Accounting for Stock-Based Compensation - Transition
and Disclosure” as an amendment to FASB statement No. 123, “Accounting for Stock-Based Compensation.”
This statement provides alternative methods of transition to the fair value method of accounting for
stock-based compensation and requires prominent disclosure in our footnotes to the financial statements
of our interim and annual reports. Unless the accounting rules change, we currently do not expect to
transition to the fair value method of accounting for stock-based compensation, and, accordingly, this
statement did not affect our financial position or results of operations.
In July 2002, the FASB issued SFAS No. 146
- “Accounting for Costs Associated with Exit or Disposal Activities.” This statement addresses the financial
accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging
Issues Task Force (“EITF”) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring),” and nullifies
EITF Issue No. 88-10, “Cost Associated with Lease Modification or Termination.” SFAS No. 146 requires
a liability for a cost associated with an exit or disposal activity to be recognized and measured at
fair value only when the liability is incurred. This statement did not have a material impact on our
financial position or results of operations.
In June 2001, the FASB issued two standards
related to business combinations. The first statement, SFAS No. 141 - “Business Combinations,” requires
all business combinations initiated after June 30, 2001 to be accounted for using the purchase method
and prohibits the pooling-of-interest method of accounting. SFAS No. 141 also states that acquired intangible
assets should be separately recognized upon meeting certain criteria. Such intangible assets include,
but are not limited to, trade and service marks, non-compete agreements, customer lists and licenses.
We were not significantly affected by the implementation of this statement.
The second statement, SFAS No. 142 - “Goodwill
and Other Intangible Assets,” requires companies to cease amortization of goodwill. Rather, goodwill
and other intangible assets that have indefinite lives will be subject to a periodic assessment for
impairment by applying a fair-value-based test. Impairment charges may result in future write-downs
in the period in which the impairment took place. As required, we adopted SFAS No. 142 for the fiscal
year beginning January 1, 2002, and, accordingly, goodwill was not amortized during 2002 nor 2003. Refer
to Note C of our consolidated financial statements for more information.
In June 1998, the FASB issued SFAS No. 133
- “Accounting for Derivative Instruments and Hedging Activities.” Effective January 1, 2001, we adopted
SFAS No. 133. Accordingly, a transition gain of $0.9 million, net of tax, was recorded in the first
quarter of 2001 related to one financial investment classified as derivative in nature. The adjustment
was shown separately as a cumulative effect of a change in accounting principle.
Acquisitions
During the three years ended December 31,
2003, we completed several business combinations and membership purchases. These business combinations
are all accounted for using the purchase method of accounting, and, accordingly, the operating results
of each acquisition have been included in our consolidated financial statements since their effective
date of acquisition. The purchase price for each business combination was allocated to the assets, including
the identifiable intangible assets, and liabilities based on estimated fair values. The excess of the
purchase price over the net identifiable assets acquired was allocated to goodwill. Prior to December
31, 2001, goodwill was amortized over a useful life of 35 years. In accordance with SFAS No. 142, effective
January 1, 2002, we no longer amortize goodwill. The purchase price of our membership purchases is allocated
to identifiable intangible assets and is being amortized over a useful life of five to twenty years.
The following table summarizes all business
combinations and membership purchases for the three years ended December 31, 2003. The purchase price,
in thousands, of each business combination includes the payment for net worth and transition costs.
Transition costs are initial estimates of future expenses based on historical experience and known costs.
These estimates may be adjusted as actual expenses are incurred, thereby affecting the final purchase
price of the acquisition. In addition, most of our acquisition agreements contain a provision for a
final retroactive balance sheet settlement which may result in adjustments to the purchase price. The
purchase price shown for recent acquisitions, in thousands, is inclusive of all retroactive balance
sheet settlements to date and transaction cost adjustments.
Effective Date
Market
Purchase
Price
Business Combinations
Blue Ridge Health Alliance, Inc. (“Blue Ridge”) September 1, 2001
Virginia
$ 14,850
NewAlliance Health Plan, Inc. (“NewAlliance”) May 1, 2002
Pennsylvania
$ 8,303
Mid-America Health Partners, Inc. (“Mid-America”) December 1, 2002
Kansas
$ 41,260
PersonalCare Health Management, Inc. (“PersonalCare”) February 1, 2003
Illinois
$ 20,116
Altius Health Plans, Inc. (“Altius”) September 1, 2003
Utah
$ 46,696
Membership Purchases
Health Partners of the Midwest (“Health Partners”) January 1, 2001
Missouri
$ 4,863
Kaiser Foundation Health Plan of Kansas City, Inc. (“Kaiser-KC”) April 2, 2001
Kansas
$ 6,498
Membership
The following table presents our membership
as of December 31, 2003 and 2002 (rounded to the nearest thousand) and the percentage change in membership
between these dates.
This increase in commercial risk membership
is attributable to the acquisitions of Altius in the third quarter of 2003 and PersonalCare in the first
quarter of 2003, as well as continued organic growth. Medicare membership decreased as a result of the
termination of the Mid-America Medicare Risk contract as of January 1, 2003. Medicaid membership increased
primarily as a result of an auto-assignment of additional members by the State of Missouri due to the
withdrawal of a competitor in that market. Non-risk membership increased as a result of the
Altius acquisition and from additional organic membership obtained in our Missouri market. Overall organic
membership growth, which excludes initial acquisitions and all changes to acquired entities during the
first twelve months of operations, was approximately 7.7% and 2.8% for the years ended December 31,
2003 and 2002, respectively.
Results of Operations
The following table (in thousands, except
percentages and membership data) is provided to facilitate a more meaningful discussion regarding the
comparison of our operations for each of the three years in the period ended December 31, 2003. On December
23, 2003, our Board of Directors approved a three-for-two stock split of our common stock, effective
January 30, 2004 for stockholders of record on January 9, 2004. The stock split is reflected retroactively
in per share data for all periods presented.
Comparison of 2003 to 2002
Managed care premium revenue increased as
a result of rate increases on renewals that occurred throughout all markets, acquisitions and organic
membership growth. Rate increases on commercial risk renewals averaged 13.5% for the year 2003. Commercial
yields increased by an average of 12.1% on a per member per month (“PMPM”) basis. Excluding the Altius
acquisition, the commercial yield increased 12.8%. Medicare yields increased 6.1% on a PMPM basis as
a result of changes being made to rate structures, as well as changes in demographics. The acquisitions
of Mid-America, PersonalCare, and Altius resulted in an increase in managed care premium revenue of
approximately $325 million. Organic membership growth resulted in an increase to managed care premiums
of approximately $265 million.
Management services revenue increased due
to the increase in non-risk membership discussed earlier.
Medical costs have increased due to acquisitions,
organic growth and medical trend. Our total medical loss ratio (medical costs as a percentage of managed
care premiums) for all products improved 2.1%. This favorable change was attributable mostly to our
commercial business and is a result of the commercial premium rate increases mentioned above outpacing
commercial medical trend. Reported commercial medical trends, net of benefit buy downs, have been below
10% for each of the last two years. Our Medicare business medical loss ratio improved as a result of
an increase in premium yields discussed above and exiting three counties in the Kansas City market on
January 1, 2003. Our Medicaid medical loss ratio increased as a result of changes in the geographical
markets in which we operate, and an increase in membership in a capitated service. We exited the Delaware
Medicaid market on July 1, 2002. Within our Pennsylvania market, membership in our capitated Medicaid
behavioral health program has increased significantly during 2002 and 2003. This program has a high
medical loss ratio, but is lower in risk to our Company. Our days in total medical claims liabilities
have decreased 10.1 days from prior year due to faster claim receipts and processing cycle times as
well as efforts to reduce claim inventories.
Selling, general and administrative expense
increased primarily due to increased costs associated with acquisitions, an increase in broker commissions
and an increase in salary expenses. Broker commissions, excluding acquisitions, have increased due to
the growth in both organic membership and in premium yields. Salary expenses, excluding acquisitions,
have increased due to annual salary increases, additional amortization expense related to restricted
shares of common stock granted in 2003, additional management and sales incentive accruals and incremental
salary expense related to our organic membership growth. As a percentage of revenue, selling, general
and administrative expense decreased by 0.2%.
Senior notes interest and amortization expense
has increased in 2003. Due to the issuance of the notes on February 1, 2002, the prior year period represented
eleven months of interest compared to twelve months in 2003. Also contributing to the increase is a
$0.5 million loss on the repurchase of a portion of our senior notes at a premium in the third quarter
of 2003.
Other income increased due to a larger investment
portfolio in 2003 offset by a decrease in interest income as a result of lower interest rates. Additionally,
the current year included a gain from our single derivative investment compared to a loss in the prior
year. This derivative investment was sold during the second quarter of 2003.
Our provision for income taxes increased
primarily due to an increase in earnings before taxes. The effective tax rate increased to 36.4% in
2003 from 35.5% in 2002.
Comparison of 2002 to 2001
Managed care premium revenue increased in
2002 over 2001 primarily from commercial rate increases that occurred throughout both years and from
membership growth, both organically and through the previously discussed acquisitions. Commercial premium
rates increased by an average of $20.75 over 2001 on a per member per month (“PMPM”) basis, to $183.80
PMPM.
Management services revenue increased in
2002 from 2001 as a result of acquisitions. In particular, the Health Partners, Blue Ridge, NewAlliance
and Mid-America acquisitions accounted for approximately 113,800 new non-risk members.
Medical costs increased in 2002 compared
to 2001 due to membership growth, as discussed above and medical trend. Our commercial medical trend
for the year ended 2002 was 8.6% and the average trend for the three year period ended December 31,
2002 was 10.1%. Our medical loss ratio improved in 2002 in our Commercial and Medicare product lines
as a result of rate increases outpacing medical trends.
Selling, general and administrative expense
increased in 2002 primarily due to acquisitions, an increase in fees paid to brokers and incremental
salary expense related to the expansion of our customer service organization. During 2002, we opened
a new regional service center in Bismarck, North Dakota to perform customer service functions related
to the Mid-America acquisition and to create additional capacity for future acquisitions. As a percentage
of revenue, selling general and administrative expense increased slightly by 0.2% to 12.2% for 2002.
Depreciation and amortization decreased
compared to the prior year primarily due to the adoption of SFAS No. 142 in January 2002. In accordance
with SFAS No. 142, we no longer amortize goodwill but rather test for impairment at least once a year.
In 2001, we amortized $7.5 million in goodwill. We did not incur any impairment charges during 2002.
Senior notes interest and amortization expense
were incurred in 2002 due to the issuance of our senior notes on February 1, 2002, as described below
in “Liquidity and Capital Resources.”
Other income, net decreased in 2002 from
2001 due primarily to the change in valuation of a derivative investment. We recorded a gain in 2001
and a loss in 2002 related to this derivative. The decrease is also related to a decrease in the amortization
of discounts on investments, offset by an increase in interest income due to cash placed in long-term
investments to achieve higher yields.
Our provision for income taxes increased
in 2002 due to an increase in operating earnings, offset by a decrease in our effective tax rate from
38.0% in 2001 to 35.5% in 2002. This decrease in the tax rate is the result of strategic tax planning
and due to the elimination of goodwill amortization in 2002.
Liquidity and Capital Resources
Consolidated
Our total cash and investments, consisting
of cash and cash equivalents and short-term and long-term investments, but excluding deposits of $23.2
million restricted under state regulations, increased $283.1 million to $1.4 billion at December 31,
2003 from $1.1 billion at December 31, 2002.
Net cash from operating activities for the year ended December 31, 2003 increased over the prior year due to an increase in net earnings, a decrease in other receivables and an increase in deferred revenue. These are offset by an increase in the long-term deferred tax asset. Other receivables have decreased due to accelerated collections of our pharmacy rebate receivables as a result of improved procedures implemented in 2003. Deferred revenue has increased due to accelerated collections of premium billings as a result of operational efficiencies experienced at our regional service centers.
Net cash from investing activities for the
year ended December 31, 2003 improved over the prior year primarily as a result of investment activity,
offset by an increased amount of payments for acquisitions. Capital expenditures for the year ended
December 31, 2003 were only slightly above that of the prior year. Projected capital investments in
2004 of approximately $16 million consist primarily of computer hardware, software and related equipment
costs associated with the development and implementation of improved operational and communication systems.
Net cash from financing activities for the
year ended December 31, 2003 improved over the prior year as result of fewer repurchases of our common
stock in 2003. On February 1, 2002, we completed the purchase of 7.1 million shares of
our common stock and a warrant exercisable, at that time, for 3.1 million shares of our
common stock, owned by Principal Health Care, Inc. The aggregate purchase price for the shares of common
stock and the warrant was $176.1 million. The purchase of the shares and warrant from
Principal ended their ownership of our common stock. We financed the stock and warrant repurchase with
the proceeds from the sale of $175.0 million of our 8.125% senior notes due February 15, 2012. Interest
on the notes is payable on February 15 and August 15 each year. As required under the terms of the senior
notes, we made interest payments of $14.2 million and $7.7 million during the years ended December 31,
2003 and 2002, respectively. In addition to the repurchase of our common stock from Principal we made
repurchases or our common stock, as described below in “Share Repurchase Program,” at an aggregate cost of $65.5
million. In August 2003, we repurchased a portion
of our senior notes with a face value of $4.5 million and a weighted average premium of 8.9%.
The senior notes contain certain covenants
and restrictions regarding incurring additional debt, limiting dividends or other restricted payments,
and restricting transactions with affiliates, sales of assets and consolidations or mergers. We have
complied with all covenants under the senior notes.
Net cash from operating activities for the
year ended December 31, 2002 increased over 2001 due to an increase in net earnings and an increase
in accounts payable and other accrued liabilities. The latter was a result of increases in additional
selling, general and administrative liabilities related to our acquisitions and business growth throughout
2001 and 2002 and an increase in our deferred tax liability. These increases were offset by a decrease
in total medical claims liabilities as a result of the timing of medical claims payments. Also, in 2001
we received 13 months worth of Medicare premium payments as a result of the timing of CMS payments and
only 12 months of premium payments were received during 2002 which led to the decrease in our deferred
revenue.
Our investment guidelines emphasize investment
grade fixed income instruments in order to provide liquidity to meet future payment obligations and
minimize the risk of principal. The fixed income portfolio includes government and corporate securities
with an average quality rating of “AA+” and an average contractual duration of 3.1 years, as of December
31, 2003. We will continue to fund our working capital requirements from our cash flow from operations.
We believe that because our long-term investments are available-for-sale, the amount of such investments
should be considered when assessing our liquidity. On such basis, current assets plus long-term investments
available-for-sale less current liabilities increased to $730.5 million at December 31, 2003 from $498.0
million at December 31, 2002.
Health Plans
Our regulated HMO and insurance company
subsidiaries are required by state regulatory agencies to maintain minimum surplus balances, thereby
limiting the dividends the parent may receive from its regulated entities. During 2003, we collected
$108.7 million in dividends from our regulated subsidiaries.
The National Association of Insurance Commissioners
(“NAIC”) has proposed that states adopt risk-based capital (“RBC”) standards that, if adopted, generally
require higher minimum capitalization requirements for HMOs and other risk-bearing health care entities.
RBC is a method of measuring the minimum amount of capital deemed appropriate for a managed care organization
to support its overall business operations with consideration for its size and risk profile. This calculation,
approved by the NAIC, incorporates asset risk, underwriting risk, credit risk and business risk components.
The Company’s health plans are required to submit an RBC report to the NAIC and their domiciled state’s
department of insurance with their annual filing.
The RBC results are used to determine if
the health plan’s statutory net worth is adequate to support the amount of its calculated risk profile.
Regulators also use the RBC results to determine if any regulatory actions are required. Regulatory
actions that could take place, if any, range from filing a financial action plan explaining how the
plan will increase its statutory net worth to the approved levels, to the health plan being placed under
regulatory control.
The majority of states in which we operate
health plans have adopted an RBC policy that recommends the health plans maintain statutory reserves
at or above the ‘Company Action Level’ which is currently equal to 200% of their RBC. We have adopted an
internal policy to maintain all of our regulated subsidiaries’ statutory capital and surplus at or above
250% of their RBC. Some states in which our regulated subsidiaries operate, require deposits to be maintained
with the respective states’ departments of insurance. The table below summarizes our statutory reserve
information, as of December 31, 2003 and 2002 (in millions except percentage data).
Capital and surplus $ 588.6
$ 437.1
250% of RBC 374.5
315.9
Excess capital and surplus above 250% of RBC 214.1
121.2
Capital and surplus as a percentage of RBC 393%
346%
Statutory deposits 23.2
19.5
The increase in capital and surplus for
our regulated subsidiaries is a result of income from 2003 and the acquisitions of PersonalCare and Altius, offset by dividends paid to the parent company.
The increase in statutory deposits is mainly a result of the acquisitions of PersonalCare and Altius.
Excluding funds held by entities subject
to regulation, we had cash and investments of approximately $209.5 million and $86.7 million at December
31, 2003 and December 31, 2002, respectively. The increase in non-regulated cash and investments is
primarily a result of dividends received from subsidiaries mentioned above and ordinary operating activities
offset by payments for acquisitions. During the year ended December 31, 2003, we made capital contributions
of approximately $14.1 million to our HMO subsidiaries. This contribution was almost exclusively made
to our recently acquired Altius Health Plan in order to increase capital and surplus to appropriate
levels.
Other
The United States Department of Health and
Human Services has issued rules, as mandated by the Health Insurance Portability and Accountability
Act of 1996, which, among other things, impose security and privacy requirements with respect to individually
identifiable patient data, including a member’s transactions with health care providers and payors,
as well as requirements for the standardization of certain electronic transaction code sets and provider
identifiers. We have spent approximately $4.2 million, $4.1 million and $0.9 million on compliance matters
for the years ended December 31, 2003, 2002 and 2001, respectively. We anticipate spending approximately
$2.6 million in 2004, of which approximately $1.0 million will be capitalized, related to improved functionality
of our electronic transaction code sets, improved provider identifier standards, and improved security
and patient information privacy standards.
As of December 31, 2003, we were contractually
obligated to make the following payments within the next five years and thereafter (in thousands):
The nature of our operations is such that
cash receipts from premium revenues are typically received up to two months prior to the expected cash
payment for related medical costs. The demand for our products and services are subject to many economic
fluctuations, risks and uncertainties that could materially affect the way we do business. Please refer
to the section entitled “Risk Factors” in this Form 10-K for more information. Management believes
that the combination of our ability to generate cash flows from operations, cash and investments on hand and the excess funds held
in certain of our regulated subsidiaries will be sufficient to fund continuing operations, capital expenditures,
debt interest costs and any other reasonably likely future cash requirements.
Other Disclosures
Share Repurchase Program
Our Board of Directors has approved a program
to repurchase up to 10% of our outstanding common stock. Stock repurchases may be made from time to
time at prevailing prices on the open market, by block purchase or in private transactions. As a part
of this program, we purchased 5.6 million shares of our common stock from 1999 to 2002, which includes 3.3 million purchased in 2002 at an aggregate cost of $65.5
million. We did not purchase any shares of our common stock in 2003 under this program.
Between January 1, 2004, and the date of this filing, under the share repurchase program previously approved by the Board of Directors, the Company purchased 2.0 million shares of its common stock at an aggregate purchase price of $84.6 million. The remaining common shares the Company is authorized to repurchase under the program is approximately 1.8 million.
Legal Proceedings
In the normal course of business, we have
been named as a defendant in various legal actions such as actions seeking payments for claims denied
by the Company, medical malpractice actions, employment related claims and other various claims seeking
monetary damages. The claims are in various stages of proceedings and some may ultimately be brought
to trial. Incidents occurring through December 31, 2003 may result in the assertion of additional claims.
We maintain general liability, professional liability and employment practices liability insurances
in amounts that we believe are appropriate, with varying deductibles for which we maintain reserves.
The professional liability and employment practices liability insurances are carried through our captive
subsidiary.
Our captive subsidiary provides up to $5
million in professional liability coverage for each single claim and up to $10 million in coverage for
each class action claim. The captive professional liability policy has an aggregate limit of $20 million
per year. The captive is also co-insured with a commercial carrier for an additional $10 million for
professional liability claims. Additionally, the captive employment practices liability policy provides
up to $250,000 per single claim, $10 million per class action claim, and an aggregate policy limit of
$10 million. Each year we will re-evaluate the most cost effective method for insuring these types of
claims.
We are a defendant in the provider track
in the Managed Care Litigation filed in the United States District Court for the Southern District of
Florida, Miami Division, MDL No. 1334, styled in re: Humana, Inc., Charles B. Shane, MD, et al. vs.
Humana, Inc., et al. This action was filed by a group of physicians as a class action against us
and twelve other companies in the managed care industry. In its fourth amended complaint, the plaintiffs
have alleged violations of RICO, conspiracy to violate RICO and aiding and abetting a scheme to violate
RICO. In addition to these RICO claims, the complaint includes counts for breach of contract, violations
of various state prompt payment laws and equitable claims for unjust enrichment and quantum meruit.
We have filed a motion to dismiss each of these claims because they fail to state a cause of action
or, in the alternative, to compel arbitration pursuant to the arbitration provisions which exist in
our physician contracts. In response to the motion to dismiss, the trial court dismissed several of
the claims and ordered that all physicians who have an arbitration provision in their provider contracts
must submit all of their claims to arbitration. As a consequence of this ruling, all the plaintiffs
who have arbitration provisions voluntarily dismissed all of their arbitratable claims. The trial court
excluded from the scope of claims subject to arbitration, the plaintiffs’ claims of conspiracy, conspiracy
to violate RICO and aiding and abetting violations of RICO. The defendants, including the Company, have
appealed the trial court’s decision to the 11th Circuit Court of Appeals. The appeal has been fully
briefed and the parties are awaiting a date for oral argument. The trial court has certified various
subclasses of physicians; however, we are not subject to the class certification order because the motion
to certify was filed before we were joined as a defendant. The plaintiffs have now filed a motion to
certify a class as to the Company, and we have filed our opposition to that motion. The trial court
has not yet issued a ruling on the motion. The defendants who were subject to the certification order
filed an appeal to the 11th Circuit which has been argued. The appeals court has not yet issued its
decision. Subsequent to this appeal, two companies have entered into settlement agreements with the
plaintiffs. Both settlement agreements have been filed with the Court and have received final approval. Although we can not predict the outcome, management believes that this lawsuit will not have a material
adverse effect on our financial position or our results of operations. Management also believes that
the claims asserted in this lawsuit are without merit, and we intend to defend our position.
We may be the target of other similar lawsuits
involving RICO and ERISA, generally claiming that managed care companies overcharge consumers and misrepresent
that they deliver quality health care. Although we may be the target of other similar lawsuits, we believe
there is no valid basis for such lawsuits.
Our industry is heavily regulated and the
laws and rules governing the industry and interpretations of those laws and rules are subject to frequent
change. Existing or future laws could have a significant effect on our operations.
Legislation and Regulation
As a managed health care company, we are
subject to extensive government regulation of our products and services. The laws and regulations affecting
our industry generally give state and federal regulatory authorities broad discretion in their exercise
of supervisory, regulatory and administrative powers. These laws and regulations are intended primarily
for the benefit of the members of the health plans. Managed care laws and regulations vary significantly
from jurisdiction to jurisdiction and changes are frequently considered and implemented.
Although the provisions of any legislation
adopted at the state or federal level can not be accurately predicted at this time, management believes
that the ultimate outcome of currently proposed legislation would not have a material adverse effect
on our results of operations in the short-term.
Our industry is heavily regulated and the
laws and rules governing the industry and interpretations of those laws and rules are subject to frequent
change. Existing or future laws could have significant effect on our operations.
Inflation
In recent years, health care cost inflation
has exceeded the general inflation rate. To reduce the effect of health care cost inflation on our business
operations we have, where possible, increased premium rates and implemented cost control measures in
our patient care management and provider contracting. We can not be certain that we will be able to
increase future premium rates at a rate that equals or exceeds the health care cost inflation rate or
that our other cost control measures will be effective.
2004 Outlook
As a result of a strong sales force, a broad
product offering, a disciplined underwriting process and superior customer service, we have an organic
membership growth target of 3 -5% for the year 2004.
We operate in highly competitive markets,
but believe that the pricing environment is rational in our existing markets, thus creating the opportunity
for reasonable price increases. We will continue to obtain adequate premium increases and expect premium
rates to continue to rise at a rate equal to or greater than medical trend in 2004. Management believes
that existing markets have potential for premium growth for our commercial and governmental products.
In 2004, we have received Medicare rate
increases of 10.7%, which was 5.7% from the original Adjusted Community Rating filings and 5% additional
as a result of the Medicare Modernization Act passed in December 2003. The rate increases will not improve
our profitability as the increases are for enhanced member benefits and/or network access.
We currently anticipate reducing selling,
general and administrative expenses as a percentage of revenue in 2004, excluding the effect of any
future acquisitions, through medical claims auto-adjudication, improved customer service, e-commerce
initiatives, spending controls and fixed costs leverage.
Management believes that the foregoing should
result in earnings improvements in 2004, although realization is dependent upon a variety of factors,
some of which may be outside of our control.
Risk Factors
The risks described below are not the only
ones that we face. Additional risks not presently known to us or that we currently deem immaterial may
also impair our business operations.
Our business, financial condition or results
of operations could be materially adversely affected by any of these risks. Further, the trading price
of our common stock could decline due to any of these risks, and you may lose all or part of your investment.
Our results of operations may be adversely
affected if we are unable to accurately estimate and control future health care costs.
Most of the premium revenue we receive is
based upon rates set months before we deliver services. As a result, our results of operations largely
depend on our ability to accurately estimate and control future health care costs. We base the premiums
we charge, at least in part, on our estimate of expected health care costs over the applicable premium
period. Factors that may cause health care costs to exceed our estimates include:
an increase in the cost of health care services and supplies, including pharmaceuticals;
higher than expected utilization of health care services;
periodic renegotiations of hospital, physician and other provider contracts;
the occurrence of epidemics and catastrophic events;
changes in the demographics of our members and medical trends affecting them;
general inflation or economic downturns;
new mandated benefits or other regulatory changes that increase our costs; and
other unforeseen occurrences.
In addition, medical claims payable in our
financial statements include our estimated reserves for incurred but not reported and unpaid claims,
which we call IBNR. The estimates for submitted claims and IBNR are made on an accrual basis. We believe
that our reserves for IBNR are adequate to satisfy our medical claims liabilities, but we can not assure
you of this. Any adjustments to our IBNR reserves could adversely affect our results of operations.
Our results of operations will be adversely
affected if we are unable to increase premiums to offset increases in our health care costs.
Our results of operations depend on our
ability to increase premiums to offset increases in our health care costs. Although we attempt to base
the premiums we charge on our estimate of future health care costs, we may not be able to control the
premiums we charge as a result of competition, government regulations and other factors. Our results
of operations could be adversely affected if we are unable to set premium rates at appropriate levels
or adjust premium rates in the event our health care costs increase.
A reduction in the number of members
in our health plans could adversely affect our results of operations.
A reduction in the number of members in
our health plans could adversely affect our results of operations. Factors that could contribute to
the loss of membership include:
reductions in the number of employers offering health care coverage;
reductions in work force by existing customers;
increases in premiums or benefit changes;
benefit changes or reductions in premiums by our competitors;
our exit from a market or the termination of a health plan; and
negative publicity and news coverage relating to our company or the managed health care industry generally.
Our growth strategy is dependent in part
upon our ability to acquire additional health plans and successfully integrate those plans into our
operations.
Part of our growth strategy
is to grow through the acquisition of additional health plans. During the last several years, we have
significantly increased our membership through a number of acquisitions. We can not assure you that
we will be able to continue to locate suitable acquisition candidates, successfully integrate the plans
we acquire and realize anticipated operational improvements and cost savings. The plans we acquire also
may not achieve our anticipated levels of profitability. Our future growth rate will be adversely affected
if we are not able to successfully complete acquisitions.
Competition in our industry may limit
our ability to attract new members or to increase or maintain our premium rates, which would adversely
affect our results of operations.
We operate in a highly competitive environment
that may affect our ability to attract new members and increase premium rates. We compete with other
health plans for members. We believe the principal factors influencing the choice among health care
options are:
price of benefits offered;
location and choice of health care providers;
quality of customer service;
comprehensiveness of coverage offered;
reputation for quality care;
financial stability of the plan; and
diversity of product offerings.
We face competition from other managed care
companies, hospitals, health care facilities and other health care providers that may have broader geographical
coverage, more established reputations in our markets, greater market share, lower costs and greater
financial and other resources. We also may theoretically face increased rate competition from certain not-for-profit health insurance organizations that would potentially be required by state regulation to reduce capital surpluses that have been excessive.
We depend on the services of non-exclusive
independent agents and brokers to market our products to employers, and we can not assure you that they
will continue to market our products in the future.
We depend on the services of independent
agents and brokers to market our managed care products and services, particularly to small employer
group members. We do not have long term contracts with independent agents and brokers and they typically
are not dedicated exclusively to us and frequently market the health care products of our competitors.
We face intense competition for the services and allegiance of independent agents and brokers, and we
can not assure you that agents and brokers will continue to market our products in a fair and consistent
manner.
Our failure to obtain cost-effective
agreements with a sufficient number of providers may result in higher medical costs and a decrease in
our membership.
Our future results largely depend on our
ability to enter into cost-effective agreements with hospitals, physicians and other health care providers.
The terms of those provider contracts will have a material effect on our medical costs and our ability
to control these costs. In addition, our ability to contract successfully with a sufficiently large
number of providers in a particular geographic market will impact the relative attractiveness of our
managed care products in those markets.
In some of our markets, there are large
provider systems that have a major presence. Some of these large provider systems have operated their
own health plans in the past or may choose to do so in the future. These provider systems could adversely
affect our product offerings and results of operations if they refuse to contract with us, place us
at a competitive disadvantage or use their market position to negotiate contracts that are less favorable
to us. Provider agreements are subject to periodic renewal and renegotiations. We can not assure you
that these large provider systems will continue to contract with us or that they will contract with
us on terms that are favorable to us.
Negative publicity regarding the managed
health care industry generally or our company in particular could adversely affect our results of operations.
Over the last several years, the managed
health care industry has been subject to negative publicity. Negative publicity regarding the managed
health care industry generally or our company in particular may result in increased regulation and legislative
review of industry practices, such as the Patients’ Bill of Rights legislation in 2001, which may further
increase our costs of doing business and adversely affect our results of operations by:
requiring us to change our products and services;
increasing the regulatory burdens under which we operate; or
adversely affecting our ability to market our products or services.
Negative publicity relating to our company
or the managed care industry generally also may adversely affect our ability to attract and retain members.
A failure of our information systems
could adversely affect our business.
We depend on our information systems for
timely and accurate information. Failure to maintain effective and efficient information systems or
disruptions in our information systems could cause disruptions in our business operations, loss of existing
customers, difficulty in attracting new customers, disputes with customers and providers, regulatory
problems, increases in administrative expenses and other adverse consequences.
Compliance with privacy laws could adversely
affect our business and results of operations.
The use of patient data by all of our businesses
is regulated at the federal, state and local level. The Health Insurance Portability and Accountability
Act of 1996, for example, imposed significant new requirements relating to maintaining the privacy of
medical information. Various agencies of the federal government have issued regulations to implement
certain sections of this Act. The law is far-reaching and complex and proper interpretation and practice
under the law continues to evolve. Consequently, our efforts to measure, monitor and adjust our business
practices to comply with the law are ongoing. Because these regulations and other similar federal, state
and local laws and regulations continue to evolve, we can not guarantee that the costs of compliance
will not adversely affect our results of operations or cause us to change our operations significantly.
We conduct business in a heavily regulated
industry and changes in laws or regulations or violations of regulations could adversely affect our
business and results of operations.
Our business is heavily regulated by federal,
state and local authorities. Legislation or other regulatory reform that increases the regulatory requirements
imposed on us or that changes the way we currently do business may in the future adversely affect our
business and results of operations. Legislative or regulatory changes that could significantly harm
us and our subsidiaries include changes that:
impose increased liability for adverse consequences of medical decisions;
limit premium levels;
increase minimum capital, reserves and other financial viability requirements;
impose fines or other penalties for the failure to pay claims promptly;
impose fines or other penalties as a result of market conduct reviews;
prohibit or limit rental access to health care provider networks;
prohibit or limit provider financial incentives and provider risk-sharing arrangements;
require health plans to offer expanded or new benefits;
limit the ability of health plans to manage care and utilization due to “any willing provider” and direct access laws that restrict or prohibit product features that encourage members to seek services from contracted providers or through referral by a primary care provider;
limit contractual terms with providers, including audit, payment and termination provisions; and
implement mandatory third party review processes for coverage denials.
In addition, we are required to obtain and
maintain various regulatory approvals to market many of our products. Delays in obtaining or failure
to obtain or maintain these approvals could adversely impact our results of operations. Federal, state
and local authorities frequently consider changes to laws and regulations that could adversely affect
our business. We can not predict the changes that government authorities will approve in the future
or assure you that those changes will not have an adverse effect on our business or results of operations.
We face periodic reviews, audits and
investigations under our contracts with federal and state government agencies, and these audits could
have adverse findings that may negatively impact our business.
We contract with various federal and state
governmental agencies to provide managed health care services. Pursuant to these contracts, we are subject
to various governmental reviews, audits and investigations to verify our compliance with the contracts
and applicable laws and regulations. Any adverse review, audit or investigation could result in:
refunding of amounts we have been paid pursuant to our government contracts;
imposition of fines, penalties and other sanctions on us;
loss of our right to participate in various federal programs;
damage to our reputation in various markets;
increased difficulty in selling our products and services; and
loss of one or more of our licenses to act as an insurer or HMO or to otherwise provide a service.
We are subject to litigation in the ordinary
course of our business, including litigation based on new or evolving legal theories, that could significantly
affect our results of operations.
Due to the nature of our business, we are
subject to a variety of legal actions relating to our business operations including claims relating
to:
our denial of non-covered benefits;
vicarious liability for our actions or medical malpractice claims;
disputes with our providers over alleged violations of RICO;
disputes with our providers over compensation and termination of provider contracts;
disputes related to our non-risk business, including actions alleging breach of fiduciary duties, claim administration errors and failure to disclose network rate discounts and other fee and rebate arrangements;
disputes over our co-payment calculations;
customer audits of our compliance with our plan obligations; and
disputes over payments for out-of-network benefits.
In addition, plaintiffs continue to bring
new types of purported legal claims against managed care companies. Recent court decisions and legislative
activity increase our exposure to these types of claims. In some cases, plaintiffs may seek class action
status and substantial economic, non-economic or punitive damages. The loss of even one of these claims,
if it resulted in a significant damage award, could have a significant adverse effect on our financial
condition or results of operations. In the event that a significant damage award does occur it may make
reasonable settlements of claims more difficult to obtain. We can not determine with any certainty what
new theories of recovery may evolve or what their impact may be on the managed care industry in general
or on us in particular.
We have, and expect to maintain, liability
insurance coverage for some of the potential legal liabilities we may incur. Currently, the professional
liability and employment practices liability insurance is covered through our captive subsidiary. Potential
liabilities that we incur may not, however, be covered by insurance, our insurers may dispute coverage,
our insurers may be unable to meet their obligations or the amount of our insurance coverage may be
inadequate. We can not assure you that we will be able to obtain insurance coverage in the future, or
that insurance will continue to be available on a cost effective basis, if at all.
Our stock price and trading volume may
be volatile.
From time to time, the price and trading
volume of our common stock, as well as the stock of other companies in the health care industry may
experience periods of significant volatility. Company-specific issues and developments generally in
the health care industry (including the regulatory environment) and the capital markets may cause this
volatility. Our stock price and trading volume may fluctuate in response to a number of events and factors,
including:
quarterly variations in our operating results;
changes in the market’s expectations about our future operating results;
changes in financial estimates and recommendations by securities analysts concerning our company or the health care industry generally;
operating and stock price performance of other companies that investors may deem comparable;
news reports relating to trends in our markets;
changes in the laws and regulations affecting our business;
acquisitions and financings by us or others in our industry; and
sales of substantial amounts of our common stock by our directors and executive officers or principal stockholders, or the perception that such sales could occur.
Our indebtedness will impose restrictions
on our business and operations.
The indenture for our senior notes, which
were issued on February 1, 2002, imposes restrictions on our business and operations. These restrictions
limit our ability to, among other things:
incur additional debt;
pay dividends or make other restricted payments;
create or permit certain liens on our assets;
sell assets;
create or permit restrictions on the ability of certain of our restricted subsidiaries to pay dividends or make other distributions to us;
enter into transactions with affiliates;
enter into sale and leaseback transactions; and
consolidate or merge with or into other companies or sell all or substantially all of our assets.
In addition, we may incur additional indebtedness
in the future, which may impose further restrictions on us. The restrictions in the indenture for our
senior notes and in any future debt instruments could limit, among other things, our ability to finance
our future operations or capital needs, make acquisitions or pursue available business opportunities.
We may not be able to satisfy our obligations
to holders of the senior notes upon a change of control.
In the event of a change of control of our
company, we will be required, subject to certain conditions, to offer to purchase all of our outstanding
senior notes at a price equal to 101% of the principal amount thereof, plus accrued and unpaid interest
thereon to the date of purchase. It is possible that we will not have sufficient funds at the time of
the change of control to make the required repurchase of the senior notes or that restrictions in any
other debt instruments may not allow such repurchases. Our failure to purchase the senior notes would
be a default under the indenture governing the senior notes.
Even if we are able to repurchase the senior
notes in the event of a change of control, the use of our cash resources to complete the repurchase
may have a material adverse effect on our financial condition and results of operations.
Our stockholder rights plan, certificate
of incorporation and bylaws and Delaware law could delay, discourage or prevent a change in control
of our company that our stockholders consider favorable.
We have a stockholder rights plan that may
have the effect of discouraging unsolicited takeover proposals. The rights issued under the stockholder
rights plan would cause substantial dilution to a person or group that attempts to acquire us on terms
not approved in advance by our board of directors. In addition, provisions in our certificate of incorporation
and bylaws and Delaware law may delay, discourage or prevent a merger, acquisition or change in control
involving our company that our stockholders may consider favorable. These provisions could also discourage
proxy contests and make it more difficult for stockholders to elect directors and take other corporate
actions. Among other things, these provisions:
authorize us to issue preferred stock, the terms of which may be determined at the sole discretion of our board of directors and may adversely affect the voting or economic rights of our common stockholders;
provide for a classified board of directors with staggered three-year terms so that no more than one-third of our directors can be replaced at any annual meeting;
provide that directors may be removed without cause only by the affirmative vote of the holders of two-thirds of our outstanding shares;
provide that any amendment or repeal of the provisions of our certificate of incorporation establishing our classified board of directors must be approved by the affirmative vote of the holders of three-fourths of our outstanding shares; and
establish advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted on by stockholders at a meeting.
These provisions of our stockholder rights
plan, certificate of incorporation and bylaws and Delaware law may discourage transactions that otherwise
could provide for the payment of a premium over prevailing market prices for our common stock and also
could limit the price that investors are willing to pay in the future for shares of our common stock.
Effects of terrorism
There can be no assurance that the war on
terrorism, the threat of future acts of terrorism or the related concerns of members or providers will
not adversely affect our health care costs and our ability to predict and control such costs. Future
acts of terrorism and bio-terrorism could adversely affect us through, among other things:
increased utilization of health care services including, without limitation, hospital and physician services, ancillary testing and procedures, vaccinations, prescriptions for drugs, mental health services and other services;
loss of membership as the result of lay-offs or other in force reductions of employment;
adverse effects upon the financial condition or business of employers who sponsor health care coverage for their employees;
disruption of our business or operations; and
disruption of the financial and insurance markets in general.
General economic conditions
Changes in economic conditions could affect
our business and results of operations. The state of the economy could affect our employer group renewal
prospects and our ability to collect or increase premiums. The state of the economy has also affected
the states’ budgets, which could result in the states attempting to reduce payments to Medicaid plans
in those states in which we offer Medicaid plans, and increase taxes and assessments on our activities.
Although we could attempt to mitigate or cover our exposure from such increased costs through, among
other things, increases in premiums, there can be no assurance that we will be able to mitigate or cover
all of such costs resulting from any budget cuts in states in which we operate. Although we have attempted
to diversify our product offerings to address the changing needs of our membership, there can be no
assurance that the effects of economic conditions will not cause our existing membership to seek health
coverage alternatives that we do not offer or will not result in significant membership loss, lower
average premium yields or decreased margins on continuing membership.
Item 7A:
Item 7A: Quantitative and Qualitative Disclosures of Market Risk
Under an investment policy approved by our
Board of Directors, we invest primarily in marketable U.S. government and agency, state, municipal,
mortgage-backed and asset-backed securities and corporate debt obligations that are investment grade.
The investment policy specifically prohibits investments in any equities or in fixed income securities
that are below investment grade. We have classified all of our investments as available-for-sale. We
are exposed to certain market risks including interest rate risk and credit risk.
We have established policies and procedures
to manage our exposure to changes in the fair value of our investments. Our policies include an emphasis
on credit quality and the management of our portfolio’s duration and mix of securities. We believe
our investment portfolio is diversified and currently expect no material loss to result from the failure
to perform by the issuers of the debt securities we hold. The mortgage-backed securities are insured
by several associations, including Government National Mortgage Administration, Federal National Mortgage
Administration and the Federal Home Loan Mortgage Corporation.
We invest primarily in fixed income securities
and classify all our investments as available-for-sale. Investments are evaluated at least quarterly
to determine if declines in value are other-than-temporary. In making that determination, we consider
all available evidence relating to the realizable value of a security. This evidence includes, but is
not limited to, the following:
adverse financial conditions of a specific issuer, segment, industry, region or other variables;
the length of the time and the extent to which the fair value has been less than cost;
the financial condition and near-term prospects of the issuer;
our intent and ability to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value;
elimination or reduction in dividend payments, or scheduled interest and principal;
rating agency downgrade of a debt security; and
expected cash flows of a debt security.
Temporary declines in value of investments
classified as available-for-sale are netted with unrealized gains and reported as a net amount in a
separate component of stockholders’ equity. A decline in fair value below amortized cost that is judged
to be other-than-temporary is accounted for as a realized loss and the write down is included in earnings.
Realized gains and losses on the sale of investments are determined on a specific identification basis.
See Note E to our consolidated financial statements in this Form 10-K for more information concerning
other-than-temporary impaired investments.
Our investments at December 31, 2003 mature
according to their contractual terms, as follows, in thousands (actual maturities may differ because
of call or prepayment rights):
Amortized
Cost
Fair
Value
As of December 31, 2003
Maturities:
Within 1 year $ 234,553
$ 236,036
1 to 5 years 554,629
570,671
5 to 10 years 312,224
323,040
Over 10 years 22,111
22,844
Total short-term and long-term securities $1,123,517
$1,152,591
Our projections of hypothetical net losses
in fair value of our market rate sensitive instruments, should potential changes in market rates occur,
are presented below. The projection is based on a model, which incorporates effective duration, convexity
and price to forecast hypothetical instantaneous changes in interest rates of positive and negative
100, 200 and 300 basis points. The model only takes into account the fixed income securities in the
portfolio and excludes all cash. While we believe that the potential market rate change is reasonably
possible, actual results may differ.
Item 8:
Item 8: Financial Statements and Supplementary Data
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Coventry
Health Care, Inc.:
We have audited the accompanying consolidated
balance sheets of Coventry Health Care, Inc. and subsidiaries as of December 31, 2003 and 2002, and
the related consolidated statements of operations, shareholders’ equity, and cash flows for the years
then ended. Our audits also included the financial statement schedule listed in the Index at Item 15(a).
These financial statements and schedule are the responsibility of the Company’s management. Our responsibility
is to express an opinion on these financial statements based on our audits. The financial statements
and schedule of Coventry Health Care, Inc. and subsidiaries for the year ended December 31, 2001 were
audited by other auditors who have ceased operations and whose report dated February 1, 2002 expressed
an unqualified opinion on those statements and schedule before the restatement disclosures described
in Note C.
We conducted our audits in accordance with
auditing standards generally accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements
referred to above present fairly, in all material respects, the consolidated financial position of Coventry
Health Care, Inc. and subsidiaries as of December 31, 2003 and 2002, and the consolidated results of
their operations and their cash flows for the years then ended in conformity with accounting principles
generally accepted in the United States. Also, in our opinion, the related financial statement schedule,
when considered in relation to the basic financial statements taken as a whole, presents fairly, in
all material respects, the information set forth therein.
As discussed in Note C to the consolidated
financial statements, effective January 1, 2002, Coventry Health Care, Inc., changed its method of accounting
for goodwill and other intangible assets.
As discussed above, the consolidated financial
statements of Coventry Health Care, Inc. as of December 31, 2001, and for the year ended December 31,
2001 were audited by other auditors who have ceased operations. As described in Note C, these consolidated
financial statements have been revised to include the transitional disclosures required by Statement
of Financial Accounting Standards (Statement) No. 142, Goodwill and Other Intangible Assets, which was
adopted by the Company as of January 1, 2002. Our audit procedures with respect to the disclosures in
Note C with respect to 2001 included (a) agreeing the previously reported net earnings to the previously
issued financial statements and the adjustments to reported net earnings representing amortization expense
recognized in those periods related to goodwill to the Company’s underlying records obtained from management,
and (b) testing the mathematical accuracy of the reconciliation of adjusted net earnings to reported
net earnings, and the related earnings-per-share amounts. In our opinion, the disclosures for 2001 in
Note C are appropriate. However, we were not engaged to audit, review, or apply any procedures to the
2001 financial statements of the Company other than with respect to such disclosures and, accordingly,
we do not express an opinion or any other form of assurance on the 2001 consolidated financial statements
taken as a whole.
ERNST & YOUNG LLP
Baltimore, Maryland
January
29, 2004
The following report is a copy of a report previously issued by Arthur Andersen LLP (“Andersen”),
which has not been reissued by Andersen. Certain financial information for the year ended December 31, 2001 was not reviewed by Andersen and includes additional disclosures
to conform with new accounting pronouncements and SEC rules and regulations issued during the fiscal
year 2002.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Coventry
Health Care, Inc.:
We have audited the accompanying consolidated
balance sheets of Coventry Health Care, Inc. (a Delaware corporation) and subsidiaries as of December
31, 2001 and 2000, and the related consolidated statements of operations, stockholders’ equity and cash
flows for each of the three years in the period ended December 31, 2001. These financial statements
are the responsibility of the Company’s management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with
auditing standards generally accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements
referred to above present fairly, in all material respects, the financial position of Coventry Health
Care, Inc. and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and
their cash flows for each of the three years in the period ended December 31, 2001 in conformity with
accounting principles generally accepted in the United States.
ARTHUR ANDERSEN LLP
Baltimore, Maryland
February
1, 2002
Coventry Health Care, Inc. and Subsidiaries
Consolidated Balance Sheets
(in thousands,
except share data)
December 31,
December 31,
ASSETS
Current assets:
Cash and cash equivalents $ 253,331
$ 186,768
Short-term investments 101,191
57,895
Accounts receivable, net of allowance of $1,373 and $2,885
as of December 31, 2003 and 2002, respectively 89,766
71,044
Other receivables, net 45,335
63,943
Deferred income taxes 36,255
36,861
Other current assets 8,089
7,764
Total current assets 533,967
424,275
Long-term investments 1,051,400
874,457
Property and equipment, net 33,085
34,045
Goodwill 281,183
243,746
Other intangible assets, net 27,447
25,687
Other long-term assets 54,654
41,230
Total assets $ 1,981,736
$ 1,643,440
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Medical claims liabilities $ 537,340
$ 497,318
Other medical liabilities 59,850
61,281
Accounts payable and other accrued liabilities 183,781
178,577
Deferred revenue 73,909
63,536
Total current liabilities 854,880
800,712
Senior notes 170,500
175,000
Other long-term liabilities 27,358
21,691
Total liabilities 1,052,738
997,403
Stockholders’ equity:
Common stock, $.01 par value; 200,000,000 shares
authorized; 104,797,091 shares issued and 90,571,189
outstanding in 2003; and 102,727,053 shares issued
and 88,182,445 outstanding in 2002 1,048
1,027
Treasury stock, at cost, 14,225,902 and 14,544,608 shares in 2003
and 2002, respectively (204,274)
(205,644)
Additional paid-in capital 565,734
529,980
Accumulated other comprehensive income 17,838
22,167
Retained earnings 548,652
298,507
Total stockholders’ equity 928,998
646,037
Total liabilities and stockholders’ equity $ 1,981,736
$ 1,643,440
See accompanying notes to the consolidated
financial statements.
Coventry Health Care, Inc. and Subsidiaries
Consolidated Statements of Operations
(in
thousands, except per share data)
See accompanying notes to the consolidated
financial statements.
Coventry Health Care, Inc. and Subsidiaries
Consolidated Statements of Stockholders’
Equity
Years Ended December 31, 2003, 2002 and 2001
(in thousands)
See accompanying notes to the consolidated
financial statements.
Coventry Health Care, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(in
thousands)
See accompanying notes to the consolidated
financial statements.
COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2003, 2002 and 2001
A. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Coventry Health Care, Inc. (together with
its subsidiaries, the “Company” or Coventry) is a managed health care company operating health plans
under the names Altius Health Plans, Carelink Health Plans, Coventry Health Care, Coventry Health and
Life, Group Health Plan, HealthAmerica, HealthAssurance, HealthCare USA, PersonalCare, SouthCare, Southern
Health and WellPath. The Company provides a full range of managed care products and services including
health maintenance organization (“HMO”), preferred provider organization (“PPO”) and point of service
(“POS”) products. The Company also administers self-insured plans for large employer groups and rents
its provider networks to various third parties.
Since the Company began operations in 1987
with the acquisition of the American Service Companies entities, including Coventry Health and Life
Insurance Company (“CH&L”), the Company has grown substantially through acquisitions. The table
below lists all of the Company’s acquisitions. See Note B to consolidated financial statements for additional
information on the most recent acquisitions.
Acquisition
Markets
Type of Business
Year Acquired
American Service Company (“ASC”) entities Multiple Markets Multiple Products
HealthAmerica Pennsylvania, Inc. (“HAPA”) Pennsylvania HMO
Group Health Plan, Inc. (“GHP”) Missouri HMO
Southern Health Services, Inc. (“SHS”) Virginia HMO
HealthCare USA, Inc. (“HCUSA”) Multiple Markets Medicaid
Principal Health Care, Inc. (“PHC”) Multiple Markets HMO
Carelink Health Plans (“Carelink”) West Virginia HMO
Kaiser Foundation Health Plan of North Carolina (“Kaiser - NC”) North Carolina HMO
PrimeONE, Inc. (“PrimeONE”) West Virginia HMO
Maxicare Louisiana, Inc. (“Maxicare”) Louisiana HMO
WellPath Community Health Plans (“WellPath”) North Carolina HMO
Prudential Health Care Plan, Inc. (“Prudential”) Missouri Medicaid
Blue Ridge Health Alliance, Inc. (“Blue Ridge”) Virginia HMO
Health Partners of the Midwest (“Health Partners”) Missouri HMO
Kaiser Foundation Health Plan of Kansas City, Inc. (“Kaiser - KC”) Kansas HMO
NewAlliance Health Plan, Inc. (“NewAlliance”) Pennsylvania HMO
Mid-America Health Partners, Inc. (“Mid-America”) Kansas HMO
PersonalCare Health Management, Inc. (“PersonalCare”) Illinois HMO
Altius Health Plans, Inc. (“Altius”) Utah HMO
Significant Accounting Policies
Principles of Consolidation - The consolidated
financial statements include the accounts of the Company and its subsidiaries, all of which are 100%
owned. All significant inter-company transactions have been eliminated.
Use of Estimates - The preparation of financial
statements in conformity with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results could differ from those
amounts.
Reclassifications - Certain 2002 and 2001
amounts have been reclassified to conform to the 2003 presentation.
Stock Split - On December 23, 2003, the
Company’s Board of Directors approved a three-for-two stock split of the Company’s common stock. The
stock split, in the form of a stock dividend, was distributed January 30, 2004 for stockholders of record
on January 9, 2004. The stock split is reflected retroactively in the Company’s consolidated financial
statements and notes thereto for all periods presented.
Significant Customers - The Company’s commercial
business is diversified across a large customer base and there are no commercial groups that make up
10% or more of managed care premiums. For the years ended 2003, 2002 and 2001, the Company received
10.8%, 12.3% and 11.4%, respectively, of its managed care premiums from the Federal Medicare+Choice
program throughout its various markets. The Company also received 11.8%, 13.1% and 12.4% of its managed
care premiums in 2003, 2002 and 2001, respectively, from its state-sponsored Medicaid programs throughout
its various markets. In 2003, the State of Missouri accounted for over half of the Company’s Medicaid
membership.
Cash and Cash Equivalents - Cash and cash
equivalents consist principally of money market funds, commercial paper and certificates of deposit.
The Company considers all highly liquid securities purchased with an original maturity of three months
or less to be cash equivalents. The carrying amounts of cash and cash equivalents reported in the accompanying
consolidated balance sheets approximate fair value.
Investments - The Company accounts for investments
in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115 - “Accounting for Certain
Investments in Debt and Equity Securities,” issued by the Financial Accounting Standards Board (“FASB”).
The Company invests primarily in fixed income securities and classifies all its investments as available-for-sale.
Investments are evaluated at least quarterly to determine if declines in value are other-than-temporary.
In making that determination, the Company considers all available evidence relating to the realizable
value of a security. This evidence includes, but is not limited to, the following:
adverse financial conditions of a specific issuer, segment, industry, region or other variables;
the length of the time and the extent to which the fair value has been less than cost;
the financial condition and near-term prospects of the issuer;
the Company’s intent and ability to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value;
elimination or reduction in dividend payments, or scheduled interest and principal;
rating agency downgrade of a debt security; and
expected cash flows of a debt security.
Temporary declines in value of investments
classified as available-for-sale are netted with unrealized gains and reported as a net amount in a
separate component of stockholders’ equity. A decline in fair value below amortized cost that is judged
to be other-than-temporary is accounted for as a realized loss and the write down is included in earnings.
Realized gains and losses on the sale of investments are determined on a specific identification basis.
Investments with original maturities in
excess of three months and less than one year are classified as short-term investments and generally
consist of corporate bonds, U.S. Treasury notes and commercial paper. Long-term investments have original
maturities in excess of one year and primarily consist of fixed income securities.
Derivative Investment - In June 1998, the
FASB issued SFAS No. 133 - “Accounting for Derivative Instruments and Hedging Activities.” Effective
January 1, 2001, the Company adopted SFAS No. 133. Accordingly, a transition gain of $0.9 million, net
of tax, was recorded in the first quarter of 2001 related to one financial investment classified as
derivative in nature. The adjustment is shown separately as a cumulative effect of a change in accounting
principle. The derivative investment was sold during the second quarter of 2003 and a gain of $0.8 million
was recorded as other income, net in the consolidated financial statements.
Other Receivables - Other receivables include
interest receivables, reinsurance claims receivables, receivables from providers and suppliers and any
other receivables that do not relate to premiums.
Property and Equipment - Property, equipment
and leasehold improvements are recorded at cost. Depreciation is computed using the straight-line method
over the estimated lives of the related assets or, if shorter, over the terms of the respective leases.
Long-term Assets - Long-term assets include primarily assets associated with the Supplemental Executive Retirement Plan (“SERP” )
and the deferred tax assets.
Business Combinations, Accounting for Goodwill
and Other Intangibles - In June 2001, the FASB issued two standards related to business combinations.
The first statement, SFAS No. 141 - “Business Combinations,” requires all business combinations initiated
after June 30, 2001 to be accounted for using the purchase method and prohibits the pooling-of-interest
method of accounting. SFAS No. 141 also states that acquired intangible assets should be separately
recognized upon meeting certain criteria. Such intangible assets include, but are not limited to, trade
and service marks, non-compete agreements, customer lists and licenses. The Company was not significantly
affected by the implementation of this statement.
The second statement, SFAS No. 142 - “Goodwill
and Other Intangible Assets,” requires companies to cease amortization of goodwill. Rather, goodwill
and other intangible assets that have indefinite lives will be subject to a periodic assessment for
impairment by applying a fair-value-based test. The Company uses three approaches to identifying the
fair value of its goodwill and other intangible assets: the market approach, the market capitalization
approach and the income approach. The market approach estimates a business’s fair value by analyzing
the recent sales of similar companies. The market capitalization approach is based on market value of
the Company’s total shares outstanding. The income approach is based on the present value of expected
future cash flows. As, impairment charges occur, write-downs charges will be recorded in the
period in which the impairment took place. As required, the Company adopted SFAS No. 142 for the fiscal
year beginning January 1, 2002, and, accordingly, goodwill was not amortized during 2002 nor 2003. See
Note C to consolidated financial statements for disclosure related to intangible assets.
Medical Claims Liabilities and Expense -
Medical claims liabilities consist of actual claims reported but not paid and estimates of health care
services incurred but not reported. The estimated claims incurred but not reported are based on historical
data, current enrollment, health service utilization statistics and other related information. In determining
IBNR liabilities, the Company employs standard actuarial reserve methods that are specific to each market’s
membership, product characteristics, geographic territories and provider network. The Company also considers
utilization frequency and unit costs of inpatient, outpatient, pharmacy and other medical expenses,
as well as claim payment backlogs and the timing of provider reimbursements. The Company also establishes
reserves, if required, for the probability that anticipated future health care costs and contract maintenance
costs under the group of existing contracts will exceed anticipated future premiums and reinsurance
recoveries on those contracts. These accruals are continually monitored and reviewed, and as settlements
are made or accruals adjusted, differences are reflected in current operations. Changes in assumptions
for medical costs caused by changes in actual experience could cause these estimates to change in the
near term.
The following table shows the components
of the change in medical liabilities (Medical claims liabilities and Other medical liabilities) for the years ended December 31, 2003, 2002 and 2001, respectively:
Acquisition balances represent medical liabilities as of the applicable acquisition date. Subsequent changes in estimates related to the acquired balances are recorded as adjustments to the settlement account with the acquired entity’s previous owner.
The negative amounts noted as “prior year” medical costs are favorable adjustments for claim estimates being settled for amounts less than originally anticipated. As noted above, these favorable restatements from original estimates occur due to changes in medical utilization, mix of provider rates and other components of medical cost trends.
The Company believes that the amount of
medical liabilities is adequate to cover its ultimate liability for unpaid claims as of December 31,
2003; however, actual claim payments and other items may differ from established estimates. Assuming
a hypothetical 1% variance between the December 31, 2003 estimates of medical liabilities and actual
costs payable, net earnings for the year ended December 31, 2003, would increase or decrease by approximately
$3.8 million and diluted earnings per share would increase or decrease by approximately $0.04 per share.
Other Long-term Liabilities - Other Long-term
Liabilities consist primarily of liabilities associated with the SERP and the deferred tax liability
associated with the net unrealized gains on investments.
Revenue Recognition - Managed care premiums
are recorded as revenue in the month in which members are entitled to service. Premiums are based on
a per subscriber contract rate and the subscribers in the Company’s records at the time of billing.
Premium billings are generally sent to employers in the month preceding the month of coverage. Premium
billings may be subsequently adjusted to reflect changes in membership as a result of retroactive terminations,
additions, or other changes. The Company also receives premium payments from the Centers for Medicare
and Medicaid Services (“CMS”) on a monthly basis for its Medicare+Choice membership. Membership and
category eligibility are periodically reconciled with CMS and could result in adjustments to revenue.
Premiums collected in advance are recorded as deferred revenue. Employer contracts are typically on
an annual basis, subject to cancellation by the employer group or by the Company upon 30 days notice.
Based on information received subsequent
to premium billings being sent, historical trends, bad debt write-offs and the collectibility of specific
accounts, the Company estimates, on a monthly basis, the amount of bad debt and future retroactivity
and adjusts its revenue and reserves accordingly.
Premiums for services to federal employee
groups are subject to audit and review by the Office of Personnel Management (“OPM”) on a periodic basis.
Such audits are usually a number of years in arrears. Adjustments are recorded as additional information regarding
the audits and reviews becomes available. Any differences between actual results and estimates are recorded
in the year the audits are finalized.
The Company currently enters into performance
guarantees with employer groups where the Company guarantees that it will meet certain
standards. These standards vary widely and could involve customer service, member satisfaction, claims
processing, claims accuracy and telephone on-hold time. Under these performance guarantees, the Company
could be at risk for not maintaining the standards agreed upon in the contracts. The risk level varies
by agreement with penalties based on a variety of calculations including per member per month, percentage
of premium, or percentage of administration fees. Performance levels are evaluated at least quarterly.
The Company estimates its potential exposure and records the appropriate reserves. The penalties that
the Company have incurred have been immaterial and, although, the Company can not predict with precision
the future effect on its results of operations of these penalties, the Company expects them
to remain immaterial.
Stock-based Compensation - The Company accounts
for stock-based compensation to employees under Accounting Principles Board (“APB”) No. 25 - “Accounting
for Stock Issued to Employees,” and complies with the disclosure requirements for SFAS No. 123 - “Accounting
for Stock-Based Compensation” and SFAS No. 148 - “Accounting for Stock-Based Compensation - Transition
and Disclosure.” Unless the accounting rules change, the Company does not expect to transition to the
fair value method of accounting for stock-based compensation. Had compensation cost for these plans
been determined consistent with SFAS No. 123, the Company’s net earnings and earnings per share (“EPS”)
would have been reduced to the following pro-forma amounts (in thousands, except per share data):
The fair value of the stock options included
in the pro-forma amounts shown above was estimated as of the grant date using the Black-Scholes option-pricing
model with the following weighted-average assumptions:
Dividend yield 0% 0% 0%
Expected volatility 68% 71% 73%
Risk-free interest rate 2% 2% 4%
Expected life 5.2 years 4.9 years 4.5 years
See Note G to consolidated financial statements
for disclosure related to stock-based compensation.
Income Taxes - The Company files a consolidated
federal tax return for the Company and its subsidiaries. The Company accounts for income taxes in accordance
with SFAS No. 109 - “Accounting for Income Taxes.” The deferred tax assets and/or liabilities are determined
by multiplying the differences between the financial reporting and tax reporting bases for assets and
liabilities by the enacted tax rates expected to be in effect when such differences are recovered or
settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period
that includes the enactment date. See Note F to consolidated financial statements for disclosures related
to income taxes.
B. ACQUISITIONS
During the three years ended December 31,
2003, the Company completed several business combinations and membership purchases. The Company’s business
combinations are all accounted for using the purchase method of accounting, and, accordingly, the operating
results of each acquisition have been included in the Company’s consolidated financial statements since
their effective date of acquisition. The purchase price for each business combination was allocated
to the assets, including the identifiable intangible assets, and liabilities based on estimated fair
values. The excess of the purchase price over the net identifiable assets acquired was allocated to
goodwill. Through December 31, 2001, goodwill was amortized over a useful life of 35 years. In accordance
with SFAS No. 142, effective January 1, 2002, the Company no longer amortizes goodwill. The purchase
price of the Company’s membership purchases is allocated to identifiable intangible assets and is being
amortized over a useful life of five to twenty years.
The following table summarizes all business
combinations and membership purchases for the three years ended December 31, 2003. The purchase price,
in thousands, of each business combination includes the payment for net worth and transition costs.
Transition costs are initial estimates of future expenses based on historical experience and known costs.
These estimates may be adjusted as actual expenses are incurred in effect modifying the final purchase
price of the acquisition. In addition, the Company’s acquisition agreements contain a provision for
a final retroactive balance sheet settlement after the effective date of the acquisition which may result
in adjustments to the purchase price. The purchase price, in thousands, is inclusive of all retroactive
balance sheet settlements to date and transaction cost adjustments.
Effective Date
Market
Purchase
Price
Business Combinations
Blue Ridge Health Alliance, Inc. (“Blue Ridge”) September 1, 2001
Virginia
$ 14,850
NewAlliance Health Plan, Inc. (“NewAlliance”) May 1, 2002
Pennsylvania
$ 8,303
Mid-America Health Partners, Inc. (“Mid-America”) December 1, 2002
Kansas
$ 41,260
PersonalCare Health Management, Inc. (“PersonalCare”) February 1, 2003
Illinois
$ 20,116
Altius Health Plans, Inc. (“Altius”) September 1, 2003
Utah
$ 46,696
Membership Purchases
Health Partners of the Midwest (“Health Partners”) January 1, 2001
Missouri
$ 4,863
Kaiser Foundation Health Plan of Kansas City, Inc. (“Kaiser-KC”) April 2, 2001
Kansas
$ 6,498
C. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and other intangible assets consist
of costs in excess of the fair value of the net tangible assets of subsidiaries or operations acquired
through December 31, 2003.
Goodwill
As described in the Company’s segment disclosure,
assets are not allocated to specific products, and, accordingly, goodwill can not be reported by segment.
The Company has completed its impairment test of goodwill and has determined that there was no impairment
of goodwill as of October 1, 2003, the Company’s annual revaluation date. The changes in the carrying
amount of goodwill for the year ended December 31, 2003 and 2002 were as follows (in thousands):
Balance January 1, $ 243,746
$ 237,392
Acquisition of NewAlliance Health Plan, Inc. --
6,484
Acquisition of PersonalCare Health Management, Inc. 9,237
--
Acquisition of Altius Health Plans, Inc. 28,496
--
Transition cost adjustments (296)
(130)
Impairment loss --
--
Balance December 31, $ 281,183
$ 243,746
The following table presents net earnings
and earnings per share amounts restated to exclude goodwill amortization for the years ended December
31, 2003, 2002 and 2001 (in thousands, except per share data).
Other Intangible Assets
The other intangible asset balances are
as follows (in thousands):
Other intangible amortization expense for
the years ended December 31, 2003, 2002 and 2001 was $2.5 million, $3.1 million and $2.6 million, respectively.
Estimated intangible amortization expense is $2.5 million for the years ending December 31, 2004 through
2006 and $2.4 million for the years ending December 31, 2007 and 2008. The weighted-average amortization
period is 14 years for other intangible assets.
D. PROPERTY AND EQUIPMENT
Property and equipment is comprised of the
following (in thousands):
Depreciation expense for the years ended
December 31, 2003, 2002 and 2001 was $15.6 million, $15.8 million and $15.8 million, respectively.
E. INVESTMENTS
The Company considers all of its investments
as available-for-sale securities and, accordingly, records unrealized gains and losses, except for those
determined to be other-than-temporary impairments, as other comprehensive income in the stockholders’
equity section of its consolidated balance sheets.
The amortized cost, gross unrealized gain
or loss and estimated fair value of short-term and long-term investments by security type were as follows
at December 31, 2003 and 2002 (in thousands):
The amortized cost and estimated fair value
of short-term and long-term investments by contractual maturity were as follows at December 31, 2003
and December 31, 2002 (in thousands):
Gross investment gains of $2.2 million and
gross investment losses of $1.5 million were realized on sales of investments for the year ended December 31,
2003. This compares to gross investment gains of $1.9 million and gross investment losses of $3.1 million
on these sales for the year ended December 31, 2002, and gross investment gains of $4.7 million and
gross investment losses of $2.2 million on these sales for the year ended December 31, 2001.
The following table shows the Company’s
investments’ gross unrealized losses and fair value, at December 31, 2003, aggregated by investment
category and length of time that individual securities have been in a continuous unrealized loss position
(in thousands).
The securities referenced in this table
do not meet the criteria for an other-than-temporarily impaired investment. These securities have an
investment grade credit rating. The current unrealized loss is the result of interest rate increases
and not the credit ratings associated with these securities. These investments are not in high risk
industries or sectors and the Company intends to hold these investments for a period of time sufficient
to allow for a recovery in market value.
F. INCOME TAXES
At December 31, 2003, the Company had approximately $63 million of federal and $151 million
of state tax net operating loss carryforwards. The net operating losses were primarily acquired through
various acquisitions. The net operating loss carryforwards can be used to reduce future taxable income
until they expire through the year 2021.
The provision for income taxes consists
of the following (in thousands):
The Company’s effective tax rate differs
from the federal statutory rate of 35% as a result of the following:
The effect of temporary differences that
give rise to significant portions of the deferred tax assets and deferred tax liabilities at December
31, 2003 and 2002 are presented below (in thousands):
The valuation allowance for deferred tax
assets is due to the Company’s belief that the realization of the deferred tax asset resulting from
net operating losses associated with certain acquisitions is unlikely.
G. EMPLOYEE BENEFIT PLANS
Stock-Based Compensation
As of December 31, 2003, the Company had
one stock incentive plan, the Amended and Restated 1998 Stock Incentive Plan (the “Stock Incentive Plan”)
under which shares of the Company’s common stock were authorized for issuance to key employees, consultants
and directors in the form of stock options, restricted stock and other
stock-based awards.
The Stock Incentive Plan is authorized to
grant either incentive stock options or nonqualified stock options, stock appreciation rights, restricted
stock and other stock-based awards at the discretion of the Compensation and Benefits Committee of the
Board of Directors. At the annual meeting of shareholders held on June 5, 2003, the Company’s shareholders
voted to increase the shares of common stock authorized for issuance under the Stock Incentive Plan
from an aggregate of 13.5 million shares to an aggregate of 16.5 million shares. Shares available for
issuance under the Stock Incentive Plan were 1.8 million and 1.0 million as of December 31, 2003 and
2002, respectively.
Stock Options
Under the Stock Incentive Plan, the terms
and conditions of option grants are established on an individual basis with the exercise price of the
options being equal to not less than 100% of the fair value of the underlying stock at the date of grant.
Options generally become exercisable after one year in 25% increments per year and expire ten years
from the date of grant. At December 31, 2003, the Stock Incentive Plan had outstanding options representing
5.4 million shares of common stock.
Transactions with respect to stock options
granted under the Stock Incentive Plan for the three years ended December 31, 2003 were as follows (shares
in thousands):
The weighted-average grant date fair values
for options granted in 2003, 2002 and 2001 were $10.69, $10.44 and $6.78, respectively.
Restricted Stock Awards
During 2003, the Company awarded 534,000
shares of restricted stock with varying vesting periods through 2007. The fair value of the restricted
shares, at the grant date, is amortized over the vesting period. The restricted stock shares were granted
at a weighted-average fair value of $28.35. The Company recorded compensation expense related to restricted
stock grants of $9.6 million, $5.7 million and $1.5 million for the years ended December 31, 2003, 2002
and 2001, respectively. The deferred portion of the restricted stock as reported in additional paid
in capital is $23.4 million at December 31, 2003.
Employee Stock Purchase Plan
The Company’s Employee Stock Purchase Plan,
implemented in 1994, allows substantially all employees who meet length of service requirements to set
aside a portion of their salary for the purchase of the Company’s common stock. At the end of each plan
year, the Company issues the stock to participating employees at an issue price equal to 85% of the
lower of the stock price at the end of the plan year or the average stock price, as defined. The Company
has reserved 1.4 million shares of stock for this plan and has issued 25,696, 16,495 and 13,912 shares
in 2003, 2002 and 2001, respectively.
Employee Retirement Plans
As of December 31, 2003, the Company had
three defined contribution retirement plans qualifying under the Internal Revenue Code Section 401(k):
the Coventry Health Care, Inc. Retirement Savings Plan (the “Savings Plan”); Mid-America Health Partners
Inc. 401(k) and Investment Plan (the “MAH Plan”); and the Altius SaveMore 401(k) Plan (the “Altius Plan”).
All employees of Coventry Health Care, Inc. and employees of its subsidiaries can elect to participate
in the Savings Plan. The Savings Plan assets were held by (1) Principal Life Insurance Company, as funding
agent of the assets held under the terms of the Flexible Investment Annuity Contract with Coventry Health
Care, Inc., (2) Delaware Charter Guarantee and Trust Company, as custodial trustee of the mutual funds
and (3) Bankers Trust Company, as custodial trustee of the Savings Plan’s participant loans and the
Coventry Health Care, Inc. common stock. Effective January 1, 2004, T. Rowe Price became the custodial
trustee of the mutual funds, Savings Plan, participant loans and the Coventry Health Care, Inc. common
stock in the Savings Plan.
Under the Savings Plan, participants may
defer up to 15% of their eligible compensation, limited by the maximum compensation deferral amount
permitted by applicable law. The Company makes matching contributions in the Company’s common stock
equal to 100% of the participant’s contribution on the first 3% of the participant’s eligible compensation
and equal to 50% of the participant’s contribution on the second 3% of the participant’s eligible compensation.
Participants will vest in the Company’s matching contributions in 50% increments annually on their anniversary
date over a period of two years of service with the Company. All costs of the Savings
Plan’s are funded by the Company and participants as they are incurred.
Several acquisitions have been completed
since the adoption of the Savings Plan. Pursuant to specific terms of each acquisition’s respective
merger agreement, the surviving entity (1) became an adopting employer of the Savings Plan, and/or (2)
commenced participation in the Savings Plan following approval by the Company’s Board of Directors.
Merged/Acquired Entity
Effective Date
Blue Ridge Health Alliance, Inc. (2) September 1, 2001
NewAlliance Health Plan, Inc. (2) July 1, 2002
Mid-America Health Partners, Inc. (2) December 2, 2002
PersonalCare Health Management, Inc. (1) (2) February 1, 2003
Altius Health Plans, Inc. (1) (2) January 1, 2004
Immediately upon participation in the Savings Plan, all participant account balances included in the
assets of the former qualified retirement plan were rolled over into the Savings Plan and employees
were permitted to commence participation in the Savings Plan, except for participants of the former
Mid-America Health Partners. All employees of the former Mid-America Health Partners were eligible to
participate in the Savings Plan effective December 2, 2002; however their balance in the MAH Plan remained
in the MAH Plan. The MAH Plan was terminated effective December 1, 2002 and the MAH Plan assets will
remain until the earlier of (i) termination of employment with Coventry or one of it’s affiliates; or
(ii) receipt of the Internal Revenue Service determination letter approving the termination of the MAH
Plan. No contributions were made to the MAH Plan after December 1, 2002. The MAH Plan assets are held
by Fidelity Management Trust Company, as funding agent of the assets held under the terms of the Plan
and Trust. All participants in the MAH Plan were 100% vested in employer matching contributions as of
December 1, 2002. All costs of the MAH Plan are funded by the Company and participants as they are incurred.
All employees of Altius were eligible to participate in the Savings Plan effective January 1, 2004.
The Altius Plan was frozen effective December 31, 2003 and the Plan assets will be merged with and into
the Savings Plan on February 2, 2004. No contributions were made to the Altius Plan after December 31,
2003. The Altius Plan assets are held by Reliance Trust Company, as funding agent of the assets held
under the terms of the Plan and Trust. All participants in the Altius Plan were 100% vested in employer
matching contributions as of September 1, 2003. All costs of the Altius Plan are funded by the Company
and participants as they are incurred.
Supplemental Executive Retirement Plan
As of December 31, 2003, the Company was
the sponsor of a Supplemental Executive Retirement Plan (the “SERP”), currently known as the Coventry
Health Care, Inc. Supplemental Executive Retirement Plan. Under the SERP, participants may defer up
to 15% of their base salary and up to 100% of any bonus awarded. The Company makes matching contributions
equal to 100% of the participant’s contribution on the first 3% of the participant’s compensation and
50% of the participant’s contribution on the second 3% of the participant’s compensation. Participants
vest in the Company’s matching contributions ratably over two years. All costs of the SERP are funded
by the Company as they are incurred.
The cost, principally employer matching
contributions, of the Savings Plan and the SERP charged to operations for 2003, 2002 and 2001 was $7.3
million, $5.4 million and $5.6 million, respectively.
H. SENIOR NOTES
On February 1, 2002, the Company completed
a transaction to sell $175.0 million original 8.125% senior notes due February 15, 2012 in a private
placement. These senior notes were then registered with the Securities and Exchange Commission. The
proceeds from the sale of senior notes were used to purchase, from Principal Health Care, Inc., 7.1
million shares of Coventry common stock and a warrant exercisable, at that time, for 3.1 million shares
of Coventry common stock. The aggregate purchase price for the shares of common stock and the warrant
was $176.1 million. Interest on the notes is payable on February 15 and August 15 each year.
In August 2003, the Company repurchased
a portion of its senior notes with a face value of $4.5 million and a weighted average premium of 8.9%.
The Company recorded a loss on the repurchase in accordance with SFAS No. 145 which requires gains and
losses on extinguishments of debt to be classified as income or loss from continuing operations. The
loss of $0.5 million was included as additional senior notes interest expense. The carrying value of the senior notes is equal to the face value and the fair value is based on the quoted market prices. As of December 31, 2003, the carrying value was $170.5 million and the fair value was $189.7 million. As of December 31, 2002, the carrying value was $175.0 million and the fair value was $182.0 million.
The senior notes contain certain covenants and restrictions regarding incurring additional debt, limiting dividends or other restricted payments,
and restricting transactions with affiliates, sales of assets and consolidations or mergers. The Company
has complied with all covenants under the senior notes.
I. COMMITMENTS AND CONTINGENCIES
The Company is contractually obligated to
make the following payments within the next five years and thereafter (in thousands):
Leases
The Company operates primarily in leased
facilities with original lease terms of up to ten years with options for renewal. Through its acquisitions,
the Company has office equipment leases with terms of approximately three years.
Total rent expense was $17.4 million, $15.2
million and $15.3 million, for the years ended December 31, 2003, 2002 and 2001, respectively.
Legal Proceedings
In the normal course of business, the Company
has been named as a defendant in various legal actions such as actions seeking payments for claims denied
by the Company, medical malpractice actions, employment related claims and other various claims seeking
monetary damages. The claims are in various stages of proceedings and some may ultimately be brought
to trial. Incidents occurring through December 31, 2003 may result in the assertion of additional claims.
The Company carries general liability insurance for each of the Company’s operations on a claims-made
basis with varying deductibles for which the Company maintains reserves. The Company maintains general
liability, professional liability and employment practices liability insurance in amounts that the Company
believes is appropriate. The professional liability and employment practices liability insurances are
carried through the Company’s captive subsidiary.
The Company’s captive subsidiary provides
up to $5 million in professional liability coverage for each single claim and up to $10 million in coverage
for each class action claim. The captive professional liability policy has an aggregate limit of $20
million per year. The captive is also co-insured with a commercial carrier for an additional $10 million
for professional liability claims. Additionally, the captive employment practices liability policy provides
up to $250,000 per single claim, $10 million per class action claim, and an aggregate policy limit of
$10 million. Each year the Company will re-evaluate the most cost effective method for insuring these
types of claims.
Coventry Health Care, Inc. is a defendant
in the provider track in the Managed Care Litigation filed in the United States District Court for the
Southern District of Florida, Miami Division, MDL No. 1334, styled in re: Humana, Inc., Charles B. Shane,
MD, et al. vs. Humana, Inc., et al. This action was filed by a group of physicians as a class action
against Coventry and twelve other companies in the managed care industry. In its fourth amended complaint,
the plaintiffs have alleged violations of the federal racketeering act, Racketeer Influenced and Corrupt
Organizations (“RICO”), conspiracy to violate RICO and aiding and abetting a scheme to violate RICO.
In addition to these RICO claims, the complaint includes counts for breach of contract, violations of
various state prompt payment laws and equitable claims for unjust enrichment and quantum meruit. Coventry
has filed a motion to dismiss each of these claims because they fail to state a cause of action or,
in the alternative, to compel arbitration pursuant to the arbitration provisions which exist in the
Company’s physician contracts. In response to the motion to dismiss, the trial court dismissed several
of the claims and ordered that all physicians who have an arbitration provision in their provider contracts
must submit all of their claims to arbitration. As a consequence of this ruling, all the plaintiffs
who have arbitration provisions voluntarily dismissed all of their arbitratable claims. The trial court
excluded from the scope of claims subject to arbitration, the plaintiffs’ claims of conspiracy, conspiracy
to violate RICO and aiding and abetting violations of RICO. The defendants, including Coventry, have
appealed the trial court’s decision to the 11th Circuit Court of Appeals. The appeal has been fully
briefed and the parties are awaiting a date for oral argument. The trial court has certified various
subclasses of physicians; however, Coventry is not subject to the class certification order because
the motion to certify was filed before Coventry was joined as a defendant. The plaintiffs have now filed
a motion to certify a class as to Coventry, and Coventry has filed their opposition to that motion.
The trial court has not yet issued a ruling on the motion. The defendants who were subject to the certification
order filed an appeal to the 11th Circuit which has been argued. The appeals court has not yet issued
its decision. Subsequent to this appeal, two companies have entered into settlement agreements with
the plaintiffs. Both settlement agreements have been filed with the Court and have received final approval. Although the Company can not predict the outcome, management believes that this lawsuit will not have a material
adverse effect on its financial position or our results of operations. Management also believes that
the claims asserted in this lawsuit are without merit, and the Company intends to defend its position.
The Company may be the target of other similar
lawsuits involving RICO and the Employee Retirement Income Security Act, generally claiming that managed
care companies overcharge consumers and misrepresent that they deliver quality health care. Although
the Company may be the target of other similar lawsuits, the Company believes there is no valid basis
for such lawsuits.
The Company’s industry is heavily regulated
and the laws and rules governing the industry and interpretations of those laws and rules are subject
to frequent change. Existing or future laws could have a significant effect on the Company’s operations.
Capitation Arrangements
A small percentage of the Company’s membership
is covered by global capitation arrangements. Under the typical arrangement, the provider receives a
fixed percentage of premium to cover all the medical costs provided to the globally capitated members.
Under some capitated arrangements, physicians may also receive additional compensation from risk sharing
and other incentive arrangements. Global capitation arrangements limit the Company’s exposure to the
risk of increasing medical costs, but expose the Company to risk as to the adequacy of the financial
and medical care resources of the provider organization. In addition to global capitation arrangements,
the Company has capitation arrangements for ancillary services, such as mental health care. The Company
is responsible for the coverage of its members pursuant to its customer agreements. To the extent that
the respective provider organization faces financial difficulties or otherwise is unable to perform
its obligations under the capitation arrangements, the Company will be required to perform such obligations.
Consequently, the Company may have to incur costs in excess of the amounts it would otherwise have to pay under
the original global or ancillary capitation arrangements. Medical costs associated with capitation arrangements
made up approximately 9.9%, 8.9%, and 8.8% of the Company’s total medical costs for the years ended
December 31, 2003, 2002 and 2001, respectively. Membership associated with global capitation arrangements
was approximately 145,000, 116,000 and 84,000 as of December 31, 2003, 2002 and 2001, respectively.
Federal Employees Health Benefits Program
The Company contracts with the Office of
Personnel Management (“OPM”) to provide managed health care services under the Federal Employee Health
Benefits Program (“FEHBP”). These contracts with the OPM and applicable government regulations establish
premium rating arrangements for this program. The OPM conducts periodic audits of its contractors to,
among other things, verify that the premiums established under its contracts are in compliance with
the community rating and other requirements under FEHBP. The OPM may seek premium refunds or institute
other sanctions against health plans that participate in the program.
HealthAmerica Pennsylvania, Inc. (“HealthAmerica”),
the Company’s Pennsylvania HMO subsidiary, received audit reports from the OPM that questioned approximately
$31.1 million of subscription charges that were paid to HealthAmerica under the FEHBP for contract years
1993 - 1999. In the fourth quarter of 2003, HealthAmerica, settled this dispute with the OPM and the
U.S. Department of Justice. The final settlement payment of $29.0 million was fully reserved by HealthAmerica
and therefore had no impact on 2003 earnings, the regulated capital of HealthAmerica, or the Company’s
consolidated stockholders’ equity.
J. CONCENTRATIONS OF CREDIT RISK
The Company’s financial instruments that
are exposed to credit risk consist primarily of cash equivalents, investments in fixed income securities
and accounts receivable. The Company invests its excess cash in state and municipal bonds, U.S. Treasury
and agency securities, mortgage-backed securities, asset-backed securities, corporate debt and other
securities. Investments in marketable securities are managed within guidelines established by the Board
of Directors, which require investment-grade fixed income securities and limit the amount that may be
invested in any one issuer. The fair value of the Company’s financial instruments is equivalent to their
carrying value and, although there is some credit risk associated with these instruments, the Company
believes this risk to be minimal.
Concentration of credit risk with respect
to receivables is limited due to the large number of customers comprising the Company’s customer base
and their breakdown among geographical locations. The Company believes the allowance for doubtful accounts
adequately provides for estimated losses as of December 31, 2003. The Company has a risk of incurring
losses if such allowances are not adequate.
K. STATUTORY INFORMATION
The Company’s HMO and insurance company
subsidiaries are required by state regulatory agencies to maintain minimum surplus balances, thereby
limiting the dividends the parent may receive from its regulated entities. During 2003, the Company
collected $108.7 million in dividends from its regulated subsidiaries.
The National Association of Insurance Commissioners
(“NAIC”) has proposed that states adopt risk-based capital (“RBC”) standards that, if adopted, would
generally require higher minimum capitalization requirements for HMOs and other risk-bearing health
care entities. RBC is a method of measuring the minimum amount of capital deemed appropriate for a managed
care organization to support its overall business operations with consideration for its size and risk
profile. This calculation, approved by the NAIC, incorporates asset risk, underwriting risk, credit
risk and business risk components. The Company’s health plans are required to submit an RBC report to
the NAIC and their domiciled state’s department of insurance with their annual filing.
The RBC results will then be used to determine
if the health plan’s statutory net worth is adequate to support the amount of its calculated risk profile.
Regulators will also use the RBC results to determine if any regulatory actions are required. Regulatory
actions that could take place, if any, range from filing a financial action plan explaining how the
plan will increase its statutory net worth to the approved levels, to the health plan being placed under
regulatory control.
The majority of states in which the Company
operates health plans have adopted an RBC policy that recommends the health plans maintain statutory
reserves at or above the ‘Company Action Level’ which is currently equal to 200% of their RBC.
The Company has adopted an internal policy to maintain all of its regulated subsidiaries’
statutory reserves at or above 250% of their RBC. Some states in which the Company’s regulated subsidiaries
operate, require deposits to be maintained with the respective states’ departments of insurance. The
table below summarizes the Company’s statutory reserve information, as of December 31, 2003 and 2002
(in millions except percentage data).
Capital and surplus $ 588.6
$ 437.1
250% of RBC 374.5
315.9
Excess capital and surplus above 250% of RBC 214.1
121.2
Capital and surplus as a percentage of RBC 393%
346%
Statutory deposits 23.2
19.5
The increase in capital and surplus for
the Company’s regulated subsidiaries is a result of income during 2003 and the acquisitions of PersonalCare and Altius, offset by dividends paid to the
parent company. The increase in statutory deposits is mainly a result of the acquisitions of PersonalCare
and Altius.
Excluding funds held by entities subject
to regulation, the Company had cash and investments of approximately $209.5 million and $86.7 million
at December 31, 2003 and December 31, 2002, respectively. The increase in non-regulated cash and investments
is primarily a result of dividends received from subsidiaries mentioned above and ordinary operating
activities offset by payments for acquisitions. During the year ended December 31, 2003, Coventry made
capital contributions of approximately $14.1 million to the Company’s HMO subsidiaries. This contribution
was almost exclusively made to the Company’s recently acquired Altius Health Plan in order to increase
capital to appropriate levels.
L. OTHER INCOME
Other income for the years ended December
31, 2003, 2002 and 2001 includes investment income, net of fees, of approximately $40.2 million, $40.9
million and $43.2 million, respectively.
M. EARNINGS PER SHARE
Basic earnings per share are based on the
weighted average number of common shares outstanding during the year. Diluted earnings per share assume
the exercise of all options and warrants and the vesting of all restricted stock using the treasury
stock method.
The following table summarizes the earnings
and the average number of common shares used in the calculation of basic and diluted earnings per share
(in thousands, except for per share amounts):
Earnings
Shares
Per Share
Amount
Year Ended December 31, 2003
Basic earnings per share $ 250,145
88,113
$ 2.84
Effect of dilutive securities:
Options and warrants --
2,652
Diluted earnings per share $ 250,145
90,765
$ 2.75
Year Ended December 31, 2002
Basic earnings per share $ 145,603
88,802
$ 1.64
Effect of dilutive securities:
Options and warrants --
3,063
--
Diluted earnings per share $ 145,603
91,865
$ 1.58
Year Ended December 31, 2001
Basic earnings per share
Earnings before cumulative effect - SFAS No. 133 $ 83,529
97,485
$ 0.86
Cumulative effect - SFAS No. 133
--
0.01
Basic earnings per share $ 84,407
97,485
$ 0.87
Diluted earnings per share
Earnings before cumulative effect - SFAS No. 133 $ 83,529
97,485
Effect of dilutive securities:
Options and warrants --
4,328
$ 83,529
101,813
$ 0.82
Cumulative effect - SFAS No. 133
--
0.01
Diluted earnings per share $ 84,407
101,813
$ 0.83
N. SHARE REPURCHASE PROGRAM
The Company’s Board of Directors has approved
a program to repurchase up to 10% of its outstanding common stock. Stock repurchases may be made from
time to time at prevailing prices on the open market, by block purchase or in private transactions.
As a part of this program, the Company purchased 5.6 million shares of its common stock from 1999 to 2002, which includes 3.3 million purchased in 2002 at an
aggregate cost of $65.5 million. The Company did not purchase any shares of its common stock in 2003
under this program. The total remaining common shares the Company are authorized to repurchase under
the program, including the new authorization, is approximately 3.8 million as of December 31, 2003.
O. SEGMENT INFORMATION
The Company has three reportable segments:
Commercial, Medicare and Medicaid products. The products are provided to a cross section of employer
groups and individuals throughout the Company’s health plans. Commercial products include HMO, PPO and
POS products. HMO products provide comprehensive health care benefits to members through a primary care
physician. PPO and POS products permit members to participate in managed care but allow them the flexibility
to utilize out-of-network providers in exchange for increased out-of-pocket costs. The Company provides
comprehensive health benefits to members participating in Medicare and Medicaid programs and receives
premium payments from federal and state governments.
The Company evaluates the performance of
its operating segments and allocates resources based on gross margin. Assets are not allocated to specific
products and, accordingly, can not be reported by segment. The following tables summarize the Company’s
reportable segments through gross margin and include a medical loss ratio (“MLR”) calculation:
P. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of unaudited
quarterly results of operations (in thousands, except per share data) for the years ended December 31,
2003 and 2002.
Q. SUBSEQUENT EVENTS (UNAUDITED)
On January 14, 2004, the Company announced
that its Illinois subsidiary, PersonalCare Health Management, Inc. (“PersonalCare”), had entered into
a renewal rights agreement with Rockford Health Systems whereby PersonalCare will serve as the carrier
of choice for the transition of Rockford Health Plans’ business. Rockford Health Plans, a for-profit
plan wholly owned by Rockford Health Systems, covers a seven-county service area and provides health
benefits to approximately 14,000 fully insured commercial members and 6,000 full-service self insured
members. Under the terms of the agreement, Rockford Health Systems providers will become participating
providers in PersonalCare’s network. The agreement expected to commence upon final regulatory approvals.
Between January 1, 2004, and the date of this filing, under the share repurchase program previously approved by the Board of Directors, the Company purchased 2.0 million shares of its common stock at an aggregate purchase price of $84.6 million. The remaining common shares the Company is authorized to repurchase under the program is approximately 1.8 million.
Item 9:
Item 9: Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
The information required to be furnished
in Item 9 was previously reported in our Form 8-K dated May 15, 2002, and is not included herein pursuant
to Instruction 1 to Item 9.
Item 9a:
Item 9a: Controls and Procedures
We have performed an evaluation as of the
end of the period covered by this report of the effectiveness of our “disclosure controls and procedures”
(as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934 ), under the supervision
and with the participation of our Chief Executive Officer and our Chief Financial Officer. Based upon
our evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures are effective. There have been no significant changes in our internal controls
or in other factors that could significantly affect these internal controls and there have been no corrective
actions taken with regard to significant deficiencies and material weaknesses subsequent to the date
of our most recent evaluation.
PART III
Item 10:
Item 10: Directors and Executive Officers of the Registrant.
The information set forth under the captions
“Election of Directors,” “Section 16(a) Beneficial Ownership Reporting Compliance,” “Audit Committee,”
“Financial Expert,” “Nomination of Board Members” and “Code of Ethics” in our definitive Proxy Statement
for our 2004 Annual Meeting of Shareholders to be held on June 3, 2004, which we intend to file within
120 days after our fiscal year-end, is incorporated herein by reference. As provided in General Instruction
G(3) to Form 10-K and Instruction 3 to Item 401(b) of Regulation S-K, information regarding executive
officers of our Company is provided in Part I of this Annual Report on Form 10-K under the caption “Executive
Officers of our Company.”
Item 11:
Item 11: Executive Compensation.
The information set forth under the caption
“Executive Compensation” in our definitive Proxy Statement for our 2004 Annual Meeting of Shareholders
to be held on June 3, 2004, which we intend to file within 120 days after our fiscal year-end, is incorporated
herein by reference.
Item 12:
Item 12: Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters.
The information set forth under the captions
“Executive Compensation,” “Voting Stock Ownership of Principal Shareholders, Directors and Executive
Officers” and “Equity Compensation Plan Information” in our Proxy Statement for our 2004 Annual Meeting
of Shareholders to be held on June 3, 2004, which we intend to file within 120 days after our fiscal
year-end, is incorporated herein by reference.
Item 13:
Item 13: Certain Relationships and Related Transactions.
The information set forth under the caption
“Certain Relationships and Related Transactions” in our definitive Proxy Statement for our 2004 Annual
Meeting of Shareholders to be held on June 3, 2004, which we intend to file within 120 days after our
fiscal year-end, is incorporated herein by reference.
Item 14:
Item 14: Principal Accounting Fees and Services
The information set forth under the caption
“Fees Paid to Independent Auditors” and “Audit Committee’s Pre-approval Policies and Procedures” in
our definitive Proxy Statement for our 2004 Annual Meeting of Shareholders to be held on June 3, 2004,
which we intend to file within 120 days after our fiscal year-end, is incorporated herein by reference.
PART IV
Item 15:
Item 15: Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) 1. Financial Statements
Form 10-K
Pages
Reports of Independent Public Accountants 42 - 43
Consolidated Balance Sheets, December 31, 2003 and 2002
Consolidated Statements of Operations for the Years Ended December 31, 2003, 2002 and 2001
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2003, 2002 and 2001
Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and 2001
Notes to Consolidated Financial Statements, December 31, 2003, 2002 and 2001 48 - 68
2. Financial Statement Schedules
Schedule V - Valuation and Qualifying Accounts S - 1
3. Exhibits Required To Be Filed By Item 601 Of Regulation S-K
Exhibit
No.
Description of Exhibit
3.1
Certificate of Incorporation of Coventry Health Care, Inc. (Incorporated by reference to Exhibit 3.1 to the Company’s Form S-4, Registration Statement No. 333-45821).
3.2.1
Bylaws of Coventry Health Care, Inc. (Incorporated by reference to Exhibit 3.2 to the Company’s Form S-4, Registration Statement No. 333-45821).
3.2.2
Amendment No. 1 to the Bylaws of Coventry Health Care, Inc. effective as of November 8, 2001 (Incorporated by reference to Exhibit 3.3 to the Company’s Form S-4, Registration Statement No. 333-83106).
4.1
Specimen Common Stock Certificate (Incorporated by reference to Exhibit 4.1 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002).
4.2.1
Rights Agreement dated March 30, 1998 between Coventry Health Care, Inc. and ChaseMellon Shareholder Services, L.L.C., now known as Mellon Investor Services, LLC, as Rights Agent (Incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K dated April 8, 1998).
4.2.2
Amendment No. 1 to Rights Agreement, dated as of December 18, 1998 by and between Coventry Health Care, Inc. and ChaseMellon Shareholder Services, L.L.C., now known as Mellon Investor Services, LLC (Incorporated by reference to Exhibit 2 to the Company’s Current Report on Form 8-K dated December 21, 1998).
4.2.3
Amendment No. 2 to Rights Agreement, dated as of May 5, 2000 by and between Coventry Health Care, Inc. and ChaseMellon Shareholder Services, L.L.C., now known as Mellon Investor Services, LLC (Incorporated by reference to Exhibit 4.2.3 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2000).
4.2.4
Amendment No. 3 to Rights Agreement, dated as of March 5, 2003, by and between Coventry Health Care, Inc. and Mellon Investor Services LLC, formerly ChaseMellon Shareholder Services, L.L.C. (Incorporated by reference to Exhibit 4.2.4 to the Company’s Current Report on Form 8-K dated March 5, 2003).
4.3
Indenture dated as of February 1, 2002 between Coventry Health Care, Inc., as Issuer, and First Union National Bank, as Trustee. (Incorporated by reference to Exhibit 4.9 to the Company’s Form S-4, Registration Statement No. 333-83106).
4.4
Form of Note issued pursuant to the Indenture dated as of February 1, 2002 between Coventry Health Care, Inc., as Issuer, and First Union National Bank, as Trustee (Incorporated by reference to Exhibit 4.9 to the Company’s Form S-4, Registration Statement No. 333-83106).
10.1
Employment Agreement effective as of January 1, 2001, between Allen F. Wise and the Company (Incorporated by reference to Exhibit 10.11 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2000).
10.2
Employment Agreement effective as of January 1, 2001 between Thomas P. McDonough and the Company (Incorporated by reference to Exhibit 10.12 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2000).
10.3
Employment Agreement effective as of January 1, 2001 between Dale B. Wolf and the Company (Incorporated by reference to Exhibit 10.13 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2000).
10.4.1
Employment Letter dated May 22, 1998 between James E. McGarry and Coventry Health Care, Inc. (Incorporated by reference to Exhibit 10.34 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 1998).
Exhibit
No.
Description of Exhibit
10.4.2
Employment Agreement effective as of June 17, 1999, executed by James E. McGarry and Coventry Health Care, Inc. (Incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 1999).
10.5
Employment Agreement effective as of September 1, 2001 between Harvey C. DeMovick, Jr. and Coventry Health Care, Inc. (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2001).
10.6
Employment Agreement effective as of September 1, 2001 between Thomas C. Zielinski and Coventry Health Care, Inc. (Incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2001).
10.7
Employment Agreement effective as of August 27, 2001, between Richard J. Gilfillan and Coventry Health Care, Inc. (Incorporated by reference to Exhibit 10.7 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002).
10.8
Employment Agreement effective as of December 1, 2003, between Timothy Nolan and Coventry Health Care, Inc.
10.9
Form of Company’s Employment Agreement executed by the following executives upon terms substantially similar, except as to compensation, dates of employment, position, and as otherwise noted: Janet M. Stallmeyer, Francis S. Soistman, Jr., Bernard J. Mansheim, M.D., Thomas Davis (included executive’s right to terminate and receive severance if he is required to relocate other than to Atlanta, Georgia or Bethesda, Maryland), and J. Stewart LaVelle (includes executive’s right to terminate and receive severance if there is a material reduction in position or compensation without consent, a change of control or a requirement to relocate) (Incorporated by reference to Exhibit 10.32 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 1998).
10.10
Third Amended and Restated 1989 Stock Option Plan (Incorporated by reference to Exhibit 10.8.2 attached to Coventry Corporation’s Annual Report on Form 10-K for the fiscal year ended December 31, 1993).
10.11
1993 Outside Directors Stock Option Plan (as amended) (Incorporated by reference to Exhibit 10.8.3 attached to Coventry Corporation’s Annual Report on Form 10-K for the fiscal year ended December 31, 1995).
10.12
1993 Stock Option Plan (as amended) (Incorporated by reference to Exhibit 10.8.4 attached to the Coventry Corporation’s Annual Report on Form 10-K for the fiscal year ended December 31, 1995).
10.13
Southern Health Management Corporation 1993 Stock Option Plan (Incorporated by reference to Exhibit 10.8.5 to Coventry Corporation’s Annual Report on Form 10-K for the year ended December 31, 1995).
10.14
Coventry Corporation 1997 Stock Incentive Plan, as amended. (Incorporated by reference to Exhibit 10.29 to Coventry Corporation’s Annual Report on Form 10-K for the fiscal year ended December 31, 1997).
10.15
Coventry Health Care, Inc. Amended and Restated 1998 Stock Incentive Plan, amended as of June 5, 2003.
10.16
2001 Management Incentive Plan (Incorporated by reference to Exhibit 10.1 to the Company’s Form 10-Q, Quarterly Report, for the quarter ended March 31, 2001).
10.17
2002 Management Incentive Plan (Incorporated by reference to Exhibit 10.17 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001).
10.18
2003 Management Incentive Plan (Incorporated by reference to Exhibit 10.17 to the Company’s Annual Report on Form 10-K/A (Amendment No.1) for the fiscal year ended December 31, 2002).
Exhibit
No.
Description of Exhibit
10.19
2004 Management Incentive Plan
10.20
2004 Executive Management Incentive Plan
10.21
Coventry Health Care, Inc. 2000 Deferred Compensation Plan effective as of September 1, 2000. (Incorporated by reference to Exhibit 10.28 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000).
10.22
Amendment to the Coventry Health Care, Inc. 2000 Deferred Compensation Plan effective as of August 1, 2002 (Incorporated by reference to Exhibit 10.18.2 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002).
10.23
2003 Deferred Compensation Plan (Incorporated by reference to Exhibit 10.18.3 to the Company’s Quarterly Report, on Form 10-Q for the quarter ended June 30, 2003.
10.24
Coventry Health Care, Inc. Retirement Savings Plan, as amended and restated, effective April 1, 1998 (Incorporated by reference to Exhibit 10.19 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001).
10.25
Amendment No. 1 to the Company’s Retirement Savings Plan executed as of May 14, 2002 (Incorporated by reference to Exhibit 10.19.2 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002).
10.26
Amendment No. 2 to the Company’s Retirement Savings Plan executed as of October 29, 2002 (Incorporated by reference to Exhibit 10.19.3 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002).
10.27
Coventry Health Care, Inc. Supplemental Executive Retirement (“SERP”) Plan effective July 1, 1994 (amended and restated).
10.28
Coventry Share Plan, as amended and restated, effective as of September 1, 2002 (Incorporated by reference to Exhibit 10.21 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002).
Code of Business Conduct and Ethics, as amended and restated, effective as of February 20, 2003.
Subsidiaries of the Registrant.
23.1
Consent of Ernst & Young LLP
23.2
Statement Regarding Consent of Arthur Andersen LLP
31.1
Certification pursuant to 18 U.S.C. section 1350 as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002 made by Allen F. Wise, President, Chief Executive Officer and Director.
31.2
Certification pursuant to 18 U.S.C. section 1350 as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002 made by Dale B. Wolf, Executive Vice President, Chief Financial Officer and Treasurer.
32.1
Certification pursuant to 18 U.S.C. section 1350 as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 made by Allen F. Wise, President, Chief Executive Officer and Director and Dale B. Wolf, Executive Vice President, Chief Financial Officer and Treasurer.
Reports on Form 8-K
In connection with a press release regarding our
results of operations for the quarter ended September 30, 2003 and our financial condition as of the
period then ended, we filed a current report on Form 8-K with the Securities and Exchange Commission
on October 30, 2003.
In connection with a press release regarding our
settlement of a claim over health care premiums for federal employees, we filed a current report on
Form 8-K with the Securities and Exchange Commission on November 26, 2003.
In connection with the temporary suspension of
transactions by participants in the Coventry Health Care, Inc. Retirement Savings Plan, we filed a current
report on Form 8-K with the Securities and Exchange Commission on December 23, 2003.
_________________
* Portions of this exhibit have been omitted and have been accorded confidential treatment
pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.
SIGNATURES
S-1
SCHEDULE V
COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING
ACCOUNTS
(in thousands)
INDEX TO EXHIBITS
Reg. S-K: Item 601
Exhibit
No. Description of Exhibit
10.8 Employment Agreement effective as of December 1, 2003, between Timothy Nolan and Coventry Health Care, Inc.
10.15 Coventry Health Care, Inc. Amended and Restated 1998 Stock Incentive Plan, amended as of June 5, 2003.
10.19 2004 Management Incentive Plan
10.20 2004 Executive Management Incentive Plan
10.27 Coventry Health Care, Inc. Supplemental Executive Retirement (“SERP”) Plan effective July 1, 1994 (amended and restated).
Code of Business Conduct and Ethics, as amended and restated, effective as of February 20, 2003.
Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP
23.2 Statement Regarding Consent of Arthur Andersen LLP
31.1 Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002 made by Allen F. Wise, President, Chief Executive Officer and Director.
31.2 Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002 made by Dale B. Wolf, Executive Vice President, Chief Financial Officer and Treasurer.
32.1 Certification pursuant to 18 U.S.C. section 1350 as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002 made by Allen F. Wise, President, Chief Executive Officer and Director and Dale B. Wolf, Executive Vice President, Chief Financial Officer and Treasurer.
Note: This index only lists the exhibits included in this Form 10-K. A complete list of
exhibits can be found in “Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K”
of this Form 10-K.