FILED PURSUANT TO RULE NO. 424(b)(4)
REGISTRATION NOS. 333-67714
333-72438
48,000,000 Shares
Anthem, Inc.
Common Stock
----------------
This is an initial public offering of shares of common stock of Anthem,
Inc. The offering is being made in connection with the conversion of Anthem
Insurance Companies, Inc. from a mutual insurance company to a stock insurance
company in a process called demutualization. All of the shares of common stock
are being sold by Anthem, Inc.
In addition to these shares, an estimated 54,861,000 shares of our common
stock will be issued to eligible statutory members of Anthem Insurance
Companies, Inc. in the demutualization.
Prior to this offering, there has been no public market for our common
stock. Our common stock has been approved for listing on the New York Stock
Exchange, subject to official notice of issuance, under the symbol "ATH".
Concurrently with this offering, we are offering 4,000,000 6.00% equity
security units for an aggregate offering of $200.0 million, plus up to an
additional $30.0 million if the underwriters' option to purchase additional
units is exercised in full, by means of a separate prospectus. Each unit
consists of (a) a contract to purchase shares of our common stock and (b) a
5.95% subordinated debenture.
See "Risk Factors" beginning on page 10 to read about factors you should
consider before buying shares of our common stock.
----------------
Neither the Securities and Exchange Commission nor any other regulatory
body has approved or disapproved of these securities or passed upon the
accuracy or adequacy of this prospectus. Any representation to the contrary is
a criminal offense.
----------------
Per Share Total
--------- -----
Initial public offering price......................... $36.00 $1,728,000,000
Underwriting discount................................. $ 1.656 $ 79,488,000
Proceeds, before expenses, to Anthem, Inc............. $34.344 $1,648,512,000
To the extent that the underwriters sell more than 48,000,000 shares of
common stock, the underwriters have the option to purchase up to an additional
7,200,000 shares from Anthem, Inc. at the initial public offering price less
the underwriting discount.
----------------
The underwriters expect to deliver the shares against payment in New York,
New York on November 2, 2001.
Goldman, Sachs & Co.
Merrill Lynch & Co.
Morgan Stanley
JPMorgan
Banc of America Securities LLC
Credit Suisse First Boston
Lehman Brothers
UBS Warburg
ABN AMRO Rothschild LLC
Dresdner Kleinwort Wasserstein
A.G. Edwards & Sons, Inc.
McDonald Investments Inc.
Utendahl Capital Partners, L.P.
----------------
Prospectus dated October 29, 2001.
UNDER INDIANA LAW, FOR A PERIOD OF FIVE YEARS FOLLOWING THE EFFECTIVE DATE
OF THE DEMUTUALIZATION, NO PERSON MAY ACQUIRE BENEFICIAL OWNERSHIP OF 5% OR
MORE OF THE OUTSTANDING SHARES OF OUR COMMON STOCK WITHOUT THE PRIOR APPROVAL
OF THE INDIANA INSURANCE COMMISSIONER AND OUR BOARD OF DIRECTORS. THIS
RESTRICTION DOES NOT APPLY TO ACQUISITIONS MADE BY US OR MADE PURSUANT TO AN
EMPLOYEE BENEFIT PLAN OR EMPLOYEE BENEFIT TRUST SPONSORED BY US. THE INDIANA
INSURANCE COMMISSIONER HAS ADOPTED RULES UNDER WHICH PASSIVE INSTITUTIONAL
INVESTORS COULD PURCHASE 5% OR MORE BUT LESS THAN 10% OF OUR OUTSTANDING COMMON
STOCK WITH THE PRIOR APPROVAL OF OUR BOARD OF DIRECTORS AND PRIOR NOTICE TO THE
INDIANA INSURANCE COMMISSIONER. SEE "DESCRIPTION OF CAPITAL STOCK--CERTAIN
PROVISIONS OF INDIANA LAW."
i
[ALTERNATE PAGE FOR POSTING ON YAHOO! NET ROAD SHOW WEBSITE AND ANY PROSPECTUS
DELIVERED ELECTRONICALLY]
TABLE OF CONTENTS
Page
----
Prospectus Summary....................................................... 1
Risk Factors............................................................. 10
Available Information.................................................... 21
Information Pertaining to Forward-Looking Statements..................... 21
The Plan of Conversion................................................... 23
Use of Proceeds.......................................................... 30
Dividend Policy.......................................................... 30
Capitalization........................................................... 31
Selected Consolidated Financial and Other Data........................... 32
Unaudited Pro Forma Consolidated Financial Information................... 35
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 40
Recent Developments...................................................... 82
The Business of Anthem................................................... 85
Investments.............................................................. 102
Financial Strength Ratings............................................... 106
Legal and Regulatory Matters............................................. 107
Management............................................................... 120
Description of Capital Stock............................................. 133
Common Stock Eligible for Future Sale.................................... 139
Ownership of Common Stock................................................ 141
Description of the Equity Security Units................................. 142
Certain United States Tax Consequences to Non-U.S. Holders of Common
Stock................................................................... 145
Underwriting............................................................. 148
Validity of Common Stock................................................. 151
Experts.................................................................. 151
Consolidated Financial Statements........................................ F-1
Actuarial Opinions....................................................... A-1
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this prospectus.
As a result, it does not contain all of the information that you should
consider before investing in our common stock. You should read the entire
prospectus carefully, including the "Risk Factors" section and the consolidated
financial statements and the notes to those statements. References to the term
"Anthem Insurance" refer to Anthem Insurance Companies, Inc., an Indiana
insurance company. References to the term "Anthem" refer to Anthem Insurance
and its direct and indirect subsidiaries before the demutualization, and to
Anthem, Inc., a newly-formed Indiana holding company, and its direct and
indirect subsidiaries, including Anthem Insurance, after the demutualization,
as the context requires. References to the terms "we," "our," or "us," refer to
Anthem, before and after the demutualization.
Anthem
We are one of the nation's largest health benefits companies, serving over
seven million members, or customers, primarily in Indiana, Kentucky, Ohio,
Connecticut, New Hampshire, Maine, Colorado and Nevada. We hold the leading
market position in seven of these eight states and own the exclusive right to
market our products and services using the Blue Cross(R) Blue Shield(R), or
BCBS, names and marks in all eight states under license agreements with the
Blue Cross Blue Shield Association, or BCBSA, an association of independent
BCBS plans. We seek to be a leader in our industry by offering a broad
selection of flexible and competitively priced health benefits products.
Our product portfolio includes a diversified mix of managed care products,
including Health Maintenance Organizations or HMOs, Preferred Provider
Organizations or PPOs, and Point of Service or POS plans, as well as
traditional indemnity products. We also offer a broad range of administrative
and managed care services and partially insured products for employer self-
funded plans. These services and products include underwriting, stop loss
insurance, actuarial services, provider network access, medical cost
management, claims processing and other administrative services. In addition,
we offer our customers several specialty products including group life,
disability, prescription management, workers compensation, dental and vision.
Our products allow our customers to choose from a wide array of funding
alternatives. For our insured products, we charge a premium and assume all or a
majority of the health care risk. Under our self-funded and partially insured
products, we charge a fee for services, and the employer or plan sponsor
reimburses us for all or a majority of the health care costs.
Our managed care plans and products are designed to encourage providers and
members to select quality, cost-effective health care by utilizing the full
range of our innovative medical management services, quality initiatives and
financial incentives. Our leading market shares enable us to realize the long-
term benefits of investing in preventive and early detection programs. We
further improve our ability to provide cost-effective health benefits products
and services through a disciplined approach to internal cost containment,
prudent management of our risk exposure and successful integration of acquired
businesses. These measures have allowed us to achieve significant growth in
membership (78%), revenue (68%), and net income (135%) from 1996 through 2000.
Our Operating Segments
Our reportable segments are strategic business units delineated by
geographic areas within which we offer similar products and services, but
manage with a local focus to address each geographic region's unique market,
regulatory and health care delivery characteristics. The regions are:
. the Midwest, which includes Indiana, Kentucky and Ohio;
. the East, which includes Connecticut, New Hampshire and Maine; and
1
. the West, which includes Colorado and Nevada.
In addition to our three geographic regions, we have a Specialty segment and
an Other segment. Our Specialty segment includes business units providing:
. group life and disability insurance benefits;
. pharmacy benefit management;
. dental administration services; and
. third party occupational health services.
Various ancillary business units (reported with the Other segment) include:
. AdminaStar Federal, a subsidiary which administers Medicare programs in
Indiana, Illinois, Kentucky and Ohio; and
. Anthem Alliance Health Insurance Company, a subsidiary which primarily
provided health care benefits and administration in nine states for the
Department of Defense's TRICARE program for military families. On May
31, 2001, the TRICARE operations were sold.
The Other segment also includes intersegment revenue, expense eliminations and
corporate expenses not allocated to reportable segments.
Our Strategy and Operating Principles
Our strategic objective is to be among the best and biggest in our industry
with the size and scale to deliver the best product value with the best people.
To achieve these goals, we offer a broad selection of flexible and
competitively priced products and seek to establish leading market positions.
We believe that increased scale in each of our regional markets will provide us
competitive advantages, cost efficiencies and greater opportunities to sustain
profitable growth. The key to our ability to deliver this growth is our
commitment to work with providers to optimize the cost and quality of care
while improving the health of our members and improving the quality of our
service.
The following are key elements to our strategy and operating principles:
. Promote Quality Care: We believe that our ability to help our members
receive quality, cost-effective health care will be key to our success.
We promote the health of our members through education and through
products that cover prevention and early detection programs that help
our members and their providers manage illness before higher cost
intervention is required.
. Product Value: We aim to create products that offer value to our
customers. By offering a wide spectrum of products supported by broad
provider networks, we seek to meet the differing needs of our various
customers.
. Operational Excellence: To provide cost-effective products, we
continuously strive to improve operational efficiency. We actively
benchmark our performance against other leading health benefits
companies to identify opportunities to drive continuous performance
improvement.
. Technology: We continuously review opportunities to improve our
interactions with customers, brokers and providers. By utilizing
technologies, we seek to make the interactions as simple, efficient and
productive as possible.
2
. Growth: We believe that profitable growth, both organic and through
acquisitions, is an important part of our business. Increased scale
allows us to increase customer convenience and improve operating
margins, while keeping our products competitively priced. Expansion into
new geographic markets enables us to reduce exposure to economic cycles
and regulatory changes and provides options for business expansion.
Our principal executive offices are located at 120 Monument Circle,
Indianapolis, Indiana. Our telephone number is (317) 488-6000.
The Demutualization
This offering of our shares and the concurrent offering of our equity
security units, or the units, are made in connection with the conversion of
Anthem Insurance from a mutual insurance company into a stock insurance company
in a process called demutualization. Upon demutualization, all membership
interests in Anthem Insurance will be extinguished, and Anthem Insurance's
eligible statutory members will receive consideration in exchange for the
extinguishment of their membership interests. Their consideration will be in
the form of Anthem, Inc. common stock or cash.
The terms of the demutualization are governed by the plan of conversion. The
plan requires approval by Anthem Insurance's statutory members who are eligible
to vote on the plan and by the Indiana Insurance Commissioner. Anthem
Insurance's statutory members approved the plan on October 29, 2001. The
Indiana Insurance Commissioner approved the plan on October 25, 2001.
Anthem Insurance has formed an Indiana subsidiary, Anthem, Inc., the issuer
of the common stock offered by this prospectus. The demutualization of Anthem
Insurance includes the following steps, all of which will occur on or promptly
after the effective date of the demutualization:
. Anthem Insurance will convert from a mutual insurance company into a
stock insurance company;
. all membership interests in Anthem Insurance will be extinguished;
. the converted Anthem Insurance will become a wholly-owned subsidiary of
Anthem, Inc.;
. Anthem Insurance's eligible statutory members will be entitled to
receive shares of common stock of Anthem, Inc. or cash, as consideration
for the extinguishment of their membership interests in Anthem
Insurance;
. shares of Anthem, Inc. common stock will be sold to the public pursuant
to this offering;
. equity security units will be sold to the public pursuant to the units
offering; and
. a portion of the net proceeds from this offering and the units offering
will be paid to eligible statutory members of Anthem Insurance who
receive cash instead of shares of Anthem, Inc. common stock in the
demutualization, as set forth in "Use of Proceeds."
If the demutualization is not completed for any reason, Anthem Insurance
will remain a mutual insurance company, no shares of Anthem, Inc. common stock
will be sold to the public pursuant to this offering and no equity security
units will be sold pursuant to the units offering.
3
Offering of Equity Security Units
Concurrently with this offering, we are offering 4,000,000 equity security
units for an aggregate offering of $200.0 million, plus up to an additional
$30.0 million if the underwriters' option to purchase additional units is
exercised in full, by means of a separate prospectus. Each unit initially
consists of (a) a contract to purchase shares of our common stock and (b) a
5.95% subordinated debenture.
The purchase contract underlying a unit obligates holders to purchase, and
us to sell, for $50, on November 15, 2004, a number of newly issued shares of
our common stock equal to a settlement rate based on the average trading price
of our common stock at that time. We will pay quarterly contract fee payments
on the purchase contracts at the annual rate of 0.05% of the stated amount of
$50 per purchase contract, subject to our rights to defer these payments.
The debentures will be unsecured and will be subordinated in right of
payment to all of Anthem, Inc.'s existing and future senior indebtedness. The
debentures will mature on November 15, 2006. Each debenture will initially bear
interest at the rate of 5.95% per year, payable quarterly, subject to our
rights to defer these payments. The applicable interest rate on the debentures
outstanding on and after August 15, 2004 will be reset, and the debentures
remarketed, as described under "Description of the Equity Security Units."
During any period in which we defer contract fee payments or interest
payments on the debentures, in general we cannot declare or pay any dividend or
distribution on our capital stock or take specified other actions.
Before settlement of the purchase contracts through the issuance of common
stock, the units will be reflected in our diluted earnings per share
calculations using the treasury stock method. Under this method, the number of
shares of our common stock used in calculating earnings per share for any
period will be deemed to be increased by the excess, if any, of the number of
our shares that would be required to be issued upon settlement of the purchase
contracts over the number of shares that could be purchased by us in the
market, at the average market price during that period, using the proceeds that
would be required to be paid upon settlement. Consequently, there will be no
dilutive effect on our earnings per share, except during periods when the
average market price of our common stock is above $43.92 per share.
The closing of the offering of the units is conditioned on the concurrent
closing of the initial public offering, as well as the closing of the
demutualization.
4
The Offering
Common stock offered............... 48,000,000 shares
Common stock outstanding after the
offering and the demutualization.. 102,861,000 shares
Use of proceeds.................... Our net proceeds from the offering will be
approximately $1,616.5 million (or
$1,863.8 million if the underwriters
exercise their option to purchase
additional shares in full), based on the
initial public offering price of $36.00
per share. We will also receive estimated
net proceeds of approximately $191.0
million from the concurrent offering of
units (or $219.9 million if the
underwriters exercise their option to
purchase additional units in full). From
the aggregate net proceeds from both
offerings, we estimate that we will pay
$1,625.0 million to those eligible
statutory members of Anthem Insurance who
receive cash instead of shares of common
stock in connection with the
demutualization. We will use the remaining
proceeds from the offerings for general
corporate purposes.
Dividend policy.................... We currently do not intend to pay cash
dividends on our common stock. Future
dividends will be subject to our financial
condition, declaration by our board of
directors and other factors described
under "Dividend Policy."
New York Stock Exchange symbol..... "ATH"
Unless we specifically state otherwise, the information in this prospectus
does not take into account the sale of up to 7,200,000 shares of our common
stock, which the underwriters have the option to purchase from us to cover
over-allotments. In addition, the information in this prospectus regarding the
number of shares of our common stock to be outstanding after this offering does
not include shares of common stock issuable upon the settlement of the purchase
contracts that are a part of the equity security units being offered
concurrently herewith.
Our common stock outstanding after the offering also excludes 7,000,000
shares available for issuance pursuant to awards of options, restricted stock,
stock appreciation rights, performance stock and performance awards under our
2001 Stock Incentive Plan. See "Management--Stock Incentive Plan." In addition,
our common stock outstanding after the offering excludes shares issuable under
our Employee Stock Purchase Plan. The Employee Stock Purchase Plan reserves for
issuance and purchase by employees 3,000,000 shares of our common stock. See
"Management--Employee Stock Purchase Plan."
5
Recent Developments
On May 30, 2001, we signed a definitive agreement with Blue Cross and Blue
Shield of Kansas, Inc., or BCBS-KS, pursuant to which we have agreed to acquire
BCBS-KS for $190.0 million in cash. The transaction is expected to close in
early 2002, subject to the approval of BCBS-KS policyholders, the approval of
the BCBSA, the approval of the Kansas Department of Insurance and other
regulatory approvals. See "Risk Factors--Our pending acquisition of Blue Cross
and Blue Shield of Kansas involves risks which could cause our business to
suffer" and "Recent Developments--Pending Acquisition of Blue Cross and Blue
Shield of Kansas."
Prior to May 31, 2001, our subsidiary Anthem Alliance Health Insurance
Company provided health care benefits and administration in nine states for the
United States Department of Defense's TRICARE program for military families. On
May 31, 2001, we sold the TRICARE operations to a subsidiary of Humana, Inc.
for $45.0 million.
For the first nine months of 2001, net income increased 65.5% to $254.5
million compared with net income of $153.8 million for the first nine months of
2000. Net income excluding net realized gains on investments and
demutualization expenses was $215.0 million for the first nine months of 2001,
a 48.0% increase compared with $145.3 million for the first nine months of
2000. Total operating revenue was $7.5 billion for the first nine months of
2001, a 20.9% increase compared with $6.2 billion for the first nine months of
2000. Membership was 7.8 million at September 30, 2001, a 9.9% increase
compared with 7.1 million at September 30, 2000. See "Recent Developments--Nine
Months Financial Information."
6
Summary Consolidated Financial and Other Data
The following table summarizes financial information for Anthem. We prepared
this information using our unaudited consolidated financial statements for the
six-month periods ended June 30, 2001 and 2000 and our consolidated financial
statements for each of the years in the five-year period ended December 31,
2000, which have been audited by Ernst & Young LLP. You should read this
information with our audited consolidated financial statements and notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included in this prospectus. In our opinion, the summary financial
data for the six-month periods ended June 30, 2001 and 2000 include all
adjustments, consisting of only normal recurring adjustments, necessary for a
fair presentation of that data. The summary consolidated financial and other
data do not necessarily indicate the results to be expected in the future.
As of and for the
Six Months
Ended June 30, As of and for the Year Ended December 31,
------------------ -----------------------------------------------
2001(1) 2000(1) 2000(1) 1999(1) 1998 1997 1996
-------- -------- -------- -------- -------- -------- --------
(unaudited)
($ in Millions)
Income Statement Data
Revenues
Premiums................ $4,542.8 $3,589.3 $7,737.3 $5,418.5 $4,739.5 $4,581.4 $4,445.9
Administrative fees..... 430.3 356.5 755.6 611.1 575.6 445.9 452.9
Other revenue........... 22.6 18.9 50.6 51.0 74.6 82.7 108.5
-------- -------- -------- -------- -------- -------- --------
Total operating
revenue............... 4,995.7 3,964.7 8,543.5 6,080.6 5,389.7 5,110.0 5,007.3
Net investment income... 109.0 95.0 201.6 152.0 136.8 125.2 141.9
Net realized gains
(losses) on
investments............ (10.9) 6.5 25.9 37.5 155.9 97.0 73.3
Gain on sale of
subsidiary operations.. 25.0 -- -- -- -- -- --
-------- -------- -------- -------- -------- -------- --------
5,118.8 4,066.2 8,771.0 6,270.1 5,682.4 5,332.2 5,222.5
-------- -------- -------- -------- -------- -------- --------
Expenses
Benefit expense......... 3,870.8 3,080.6 6,551.0 4,582.7 3,934.2 3,833.3 3,715.1
Administrative
expense(2)............. 991.6 817.5 1,808.4 1,469.4 1,420.1 1,358.9 1,268.7
Interest expense........ 28.0 27.0 54.7 30.4 27.9 23.7 19.5
Amortization of goodwill
and other intangible
assets................. 15.7 11.4 27.1 12.7 12.0 9.6 10.7
Demutualization
expenses............... 3.0 -- -- -- -- -- --
Endowment of non-profit
foundations(3)......... -- -- -- 114.1 -- -- --
-------- -------- -------- -------- -------- -------- --------
4,909.1 3,936.5 8,441.2 6,209.3 5,394.2 5,225.5 5,014.0
-------- -------- -------- -------- -------- -------- --------
Income from continuing
operations before
income taxes and
minority interest...... 209.7 129.7 329.8 60.8 288.2 106.7 208.5
Income taxes............ 68.6 38.9 102.2 10.2 110.9 24.1 53.0
Minority interest
(credit)............... (1.9) 0.5 1.6 (0.3) (1.1) 3.5 15.0
-------- -------- -------- -------- -------- -------- --------
Income from continuing
operations............. 143.0 90.3 226.0 50.9 178.4 79.1 140.5
Discontinued operations,
net of income taxes
Loss from discontinued
operations prior to
disposal............... -- -- -- -- (3.9) (125.1) (44.4)
Loss on disposal of
discontinued
operations............. -- -- -- (6.0) (2.1) (113.0) --
-------- -------- -------- -------- -------- -------- --------
Net income (loss)....... $ 143.0 $ 90.3 $ 226.0 $ 44.9 $ 172.4 $ (159.0) $ 96.1
======== ======== ======== ======== ======== ======== ========
7
As of and
for the
Six Months Ended
June 30, As of and for the Year Ended December 31,
------------------ --------------------------------------------------
2001(1) 2000(1) 2000(1) 1999(1) 1998 1997 1996
-------- -------- --------- -------- -------- -------- --------
(unaudited)
($ in Millions, except ratios)
Other Data--unaudited(4)
Operating revenue and
premium
equivalents(5)......... $6,883.1 $5,559.0 $11,800.1 $8,691.6 $7,987.4 $7,269.3 $6,772.3
Benefit expense ratio... 85.2% 85.8% 84.7% 84.6% 83.0% 83.7% 83.6%
Administrative expense
ratio:
Calculated using
operating revenue..... 19.8% 20.6% 21.2% 24.2% 26.3% 26.6% 25.3%
Calculated using
operating revenue and
premium equivalents... 14.4% 14.7% 15.3% 16.9% 17.8% 18.7% 18.7%
Return on revenue....... 2.8% 2.2% 2.6% 0.7% 3.0% (3.0)% 1.8%
Return on revenue--
continuing operations.. 2.8% 2.2% 2.6% 0.8% 3.1% 1.5% 2.7%
Return on equity........ N/A N/A 12.6% 2.7% 10.7% (10.1)% 6.0%
Members (000s).......... 7,779 7,030 7,270 6,265 5,167 5,261 4,078
Ratio of earnings to
fixed charges(6)....... 8.49 5.80 7.03 3.00 11.33 5.50 11.69
Pro forma ratio of
earnings to fixed
charges(6)(7).......... 6.78 -- 5.52 -- -- -- --
Balance Sheet Data
Cash and investments.... $4,029.6 $3,418.4 $ 3,714.6 $2,972.4 $2,805.1 $2,415.6 $2,123.4
Total assets............ 5,838.0 5,364.0 5,708.5 4,816.2 4,359.2 4,131.9 4,085.8
Policy liabilities...... 1,593.8 1,625.5 1,698.3 1,431.1 1,118.1 1,143.9 1,231.5
Debt.................... 597.7 597.5 597.7 522.2 302.1 305.9 245.9
Total policyholders'
surplus(8)............. 2,063.9 1,756.3 1,919.8 1,660.9 1,702.5 1,524.7 1,625.2
--------
(1) On October 27, 1999 and November 16, 1999 Anthem acquired New Hampshire-
Vermont Health Service, formerly d/b/a Blue Cross Blue Shield of New
Hampshire, and Rocky Mountain Hospital and Medical Service, Inc., formerly
d/b/a Blue Cross and Blue Shield of Nevada/Colorado. On June 5, 2000,
Anthem acquired Associated Hospital Service of Maine, formerly d/b/a Blue
Cross and Blue Shield of Maine. These acquisitions were accounted for as
purchases and the net assets and results of operations have been included
in our consolidated financial statements from the respective purchase
dates. Below is information for the six months ended June 30, 2001 and 2000
and for the years ended December 31, 2000 and 1999 that is included in
Anthem's consolidated financial statements for the acquisitions that were
completed in those periods:
As of and for the Six Months Ended June 30,
---------------------------------------------------------------------
2001 2000
----------------------------------- ---------------------------------
Total Operating (000s) Total Operating (000s)
Revenues Gain Assets Members Revenues Loss Assets Members
-------- --------- -------- ------- -------- --------- ------ -------
BCBS-ME................. $ 457.6 $ 3.0 $ 326.4 496 $ 59.6 $(2.5) $264.8 468
======== ===== ======== ===== ====== ===== ====== ===
As of and for the Year Ended December 31,
---------------------------------------------------------------------
2000 1999
----------------------------------- ---------------------------------
Total Operating (000s) Total Operating (000s)
Revenues Gain Assets Members Revenues Loss Assets Members
-------- --------- -------- ------- -------- --------- ------ -------
BCBS-NH................. $ 591.0 $11.6 $ 316.8 479 $ 77.9 $(0.3) $250.6 366
BCBS-CO/NV.............. 678.6 6.5 545.8 595 76.9 (3.4) 521.5 486
BCBS-ME................. 489.4 8.7 339.5 487 -- -- -- --
-------- ----- -------- ----- ------ ----- ------ ---
Total................... $1,759.0 $26.8 $1,202.1 1,561 $154.8 $(3.7) $772.1 852
======== ===== ======== ===== ====== ===== ====== ===
Operating gain (loss) consists of operating revenue less benefit expense
and administrative expense.
8
(2) The 1999 administrative expense includes a non-recurring charge of $41.9
million related to the settlement agreement with the Office of Inspector
General. See Note 14 to our audited consolidated financial statements.
(3) During 1999, Anthem reached agreements with the states of Kentucky, Ohio
and Connecticut to resolve any questions as to whether Anthem or the
predecessor/successor entities were in possession of property that was
impressed with a charitable trust. The endowment of non-profit foundations
reflects contributions made for the benefit of charitable foundations in
these states. See Note 3 to our audited consolidated financial statements.
(4) The benefit expense ratio represents benefit expense as a percentage of
premium revenue. The administrative expense ratio represents administrative
expense as a percentage of operating revenue and has also been presented as
a percentage of operating revenue and premium equivalents. Return on
revenue represents net income (loss) as a percentage of total revenues.
Return on revenue--continuing operations represents income from continuing
operations as a percentage of total revenues. Return on equity, which is
only presented for annual periods, represents net income (loss) as a
percentage of the average of the sum of policyholders' surplus at the
beginning and the end of the period.
(5) Operating revenue and premium equivalents is a measure of the volume of
business serviced by Anthem that is commonly used in the health benefits
industry to allow for a comparison of operating efficiency among companies.
It is calculated by adding to premiums, administrative fees and other
revenue the amount of claims attributable to non-Medicare, self-funded
health business where Anthem provides a complete array of customer service,
claims administration and billing and enrollment services. The self-funded
claims included for the six months ended June 30, 2001 and 2000 were
$1,887.4 million and $1,594.3 million, respectively, and for the years
ended December 31, 2000, 1999, 1998, 1997 and 1996 were $3,256.6 million,
$2,611.0 million, $2,597.7 million, $2,159.3 million and $1,765.0 million,
respectively.
(6) For purposes of this computation, earnings are defined as pretax earnings
from continuing operations before adjustment for minority interest, plus
interest expense, and amortization of debt discount and expense related to
indebtedness. Fixed charges are interest expense, including amortization of
debt discount and expense on indebtedness.
(7) For purposes of the pro forma ratio of earnings to fixed charges, fixed
charges also reflect interest payments on the debentures included in the
units at a rate of 5.95% ($11.9 million and $6.0 million for the year ended
December 31, 2000 and for the six months ended June 30, 2001, respectively)
and amortization of underwriting discounts and estimated unit offering
expenses ($3.0 million and $1.5 million for the year ended December 31,
2000 and for the six months ended June 30, 2001, respectively). The pro
forma ratio of earnings to fixed charges has been presented to give effect
to the additional fixed charges related to the issuance of the units. The
pro forma ratio does not give effect to any pro forma earnings resulting
from the use of the net proceeds from the units offering.
(8) Policyholders' surplus represents shareholders' equity prior to
demutualization.
9
RISK FACTORS
An investment in our common stock involves a number of risks. The
performance of our common stock and the units will reflect the performance of
our business related to, among other things, our competition and general
economic, market and industry conditions. The price of our common stock and the
units may decline, and the value of your investment could decrease. You should
consider carefully, in addition to the other information contained in this
prospectus, the following factors before investing in shares of our common
stock. In reviewing information contained in this prospectus, you should bear
in mind that past experience is no indication of future performance.
Our ability to contain health care costs and implement increases in premium
rates affects our profitability.
Our profitability depends in large part on accurately predicting health care
costs and on our ability to manage future health care costs through
underwriting criteria, utilization management, product design and negotiation
of favorable provider contracts. The aging of the population and other
demographic characteristics and advances in medical technology continue to
contribute to rising health care costs. Government-imposed limitations on
Medicare and Medicaid reimbursement have also caused the private sector to bear
a greater share of increasing health care costs. Changes in health care
practices, inflation, new technologies, the cost of prescription drugs,
clusters of high cost cases, changes in the regulatory environment and numerous
other factors affecting the cost of health care are beyond any health plan's
control and may adversely affect our ability to predict and manage health care
costs, as well as our business, financial condition and results of operations.
In addition to the challenge of managing health care costs, we face pressure
to contain premium prices. Our customer contracts may be subject to
renegotiation as customers seek to contain their costs. Alternatively, our
customers may move to a competitor to obtain more favorable premiums. Fiscal
concerns regarding the continued viability of programs such as Medicare and
Medicaid may cause decreasing reimbursement rates for government-sponsored
programs. A limitation on our ability to increase or maintain our premium
levels could adversely affect our business, financial condition and results of
operations.
Our reserves for policy benefits may prove inadequate.
The reserves we establish for health insurance policy benefits and other
contractual rights and benefits are based upon assumptions concerning a number
of factors, including trends in health care costs, enrollment in our plans,
expenses, general economic conditions and other factors. Actual experience will
likely differ from assumed experience, and to the extent the actual claims
experience is less favorable than estimated based on our underlying
assumptions, our incurred losses would increase and future earnings could be
adversely affected.
Our profitability may be adversely affected if we are unable to maintain our
current provider agreements and to enter into other appropriate agreements.
Our profitability is dependent upon our ability to contract on favorable
terms with hospitals, physicians and other health benefits providers. The
failure to maintain or to secure new cost-effective health care provider
contracts may result in a loss in membership or higher medical costs. In
addition, our inability to contract with providers, or the inability of
providers to provide adequate care, could adversely affect our business.
10
A reduction in the enrollment in our health benefits programs could have an
adverse effect on our business and profitability.
Although our same store membership (excluding acquisitions) increased by
518,000 members, or 8.3%, from 1999 to 2000, a reduction in the number of
enrollees in our health benefits programs could adversely affect our business,
financial condition and results of operations. Factors that could contribute to
a reduction in enrollment include:
. failure to obtain new customers or retain existing customers;
. premium increases and benefit changes;
. our exit from a specific market;
. reductions in workforce by existing customers;
. negative publicity and news coverage;
. failure to attain or maintain nationally-recognized accreditations; and
. general economic downturn that results in business failures.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations" for more detailed membership information for past years.
The health benefits industry is subject to negative publicity, which can
adversely affect our profitability.
The health benefits industry is subject to negative publicity. Negative
publicity may result in increased regulation and legislative review of industry
practices, which may further increase our costs of doing business and adversely
affect our profitability by:
. adversely affecting our ability to market our products and services;
. requiring us to change our products and services; or
. increasing the regulatory burdens under which we operate.
In addition, as long as we use the BCBS names and marks in marketing our
health benefits products and services, any negative publicity concerning the
BCBSA or other BCBSA licensees may adversely affect us and the sale of our
health benefits products and services.
Changes in state and federal regulations may affect our business, financial
condition and results of operations.
Anthem Insurance and our other insurance and HMO subsidiaries are subject to
extensive regulation and supervision by the insurance regulatory authorities of
each state in which they are licensed or authorized, as well as to regulation
by federal and local agencies. See "Legal and Regulatory Matters." We cannot
assure you that future regulatory action by state insurance authorities will
not have a material adverse effect on the profitability or marketability of our
health benefits or managed care products or on our business, financial
condition and results of operations. In addition, because of our participation
in government-sponsored programs such as Medicare and
11
Medicaid, changes in government regulations or policy with respect to, among
other things, reimbursement levels, could also adversely affect our business,
financial condition and results of operations.
Moreover, state legislatures and Congress continue to focus on health care
issues. Congress is considering various forms of Patients' Bill of Rights
legislation which, if adopted, could fundamentally alter the treatment of
coverage decisions under the Employee Retirement Income Security Act of 1974,
or ERISA. Additionally, there recently have been legislative attempts to limit
ERISA's preemptive effect on state laws. If adopted, such limitations could
increase our liability exposure and could permit greater state regulation of
our operations. Other proposed bills and regulations at state and federal
levels may impact certain aspects of our business, including provider
contracting, claims payments and processing and confidentiality of health
information. While we cannot predict if any of these initiatives will
ultimately become effective or, if enacted, what their terms will be, their
enactment could increase our costs, expose us to expanded liability or require
us to revise the ways in which we conduct business. Further, as we continue to
implement our e-business initiatives, uncertainty surrounding the regulatory
authority and requirements in this area may make it difficult to ensure
compliance.
We face risks related to litigation.
We may be a party to a variety of legal actions that affect any business,
such as employment and employment discrimination-related suits, employee
benefit claims, breach of contract actions, tort claims and intellectual
property related litigation. In addition, because of the nature of our
business, we are subject to a variety of legal actions relating to our business
operations, including the design, management and offering of our products and
services. These could include:
. claims relating to the denial of health care benefits;
. medical malpractice actions;
. allegations of anti-competitive and unfair business activities;
. provider disputes over compensation and termination of provider
contracts;
. disputes related to self-funded business;
. disputes over co-payment calculations;
. claims related to the failure to disclose certain business practices;
and
. claims relating to customer audits and contract performance.
A number of class action lawsuits have been filed against us and certain of
our competitors in the managed care business. The suits are purported class
actions on behalf of certain of our managed care members and network providers
for alleged breaches of various state and federal laws. For more information
about these and other lawsuits filed against us, see "Legal and Regulatory
Matters--Litigation." While we intend to defend these suits vigorously, we will
incur expenses in the defense of these suits and we cannot predict their
outcome.
Recent court decisions and legislative activity may increase our exposure
for any of these types of claims. In some cases, substantial non-economic,
treble or punitive damages may be sought. We currently have insurance coverage
for some of these potential liabilities. Other potential liabilities may not be
covered by insurance, insurers may dispute coverage or the amount of insurance
may not be enough to cover the damages awarded. In addition, certain types of
damages, such as punitive damages, may not be covered by insurance and
insurance coverage for all or certain forms of liability may become unavailable
or prohibitively expensive in the future.
We have also received subpoenas from the Office of Inspector General, or
OIG, related to our Medicare fiscal intermediary Part A and Part B operations
and our Federal Employee Program operations. See "Legal and Regulatory
Matters--Other Contingencies."
12
We are using the Blue Cross and Blue Shield names and marks as identifiers for
our products and services under licenses from the Blue Cross Blue Shield
Association. The termination of these license agreements could adversely affect
our business, financial condition and results of operations.
We are a party to license agreements with the BCBSA that entitle us to the
exclusive use of the BCBS names and marks in the states of Indiana, Kentucky,
Ohio, Connecticut, New Hampshire, Maine, Colorado and Nevada. The license
agreements contain certain requirements and restrictions regarding the
operations of Anthem and our use of the BCBS names and marks, including:
. minimum capital and liquidity requirements;
. enrollment and customer service performance requirements;
. participation in programs which provide portability of membership
between plans;
. disclosures to the BCBSA relating to enrollment and financial
conditions;
. disclosures as to the structure of the BCBS system in contracts with
third parties and in public statements;
. plan governance requirements;
. a requirement that at least 80% of a licensee's annual combined net
revenue attributable to health care plans within its service area must
be sold, marketed, administered or underwritten under the BCBS names and
marks;
. a requirement that neither a plan nor any of its licensed affiliates may
permit an entity other than a plan or a licensed affiliate to obtain
control of the plan or the licensed affiliate or to acquire a
substantial portion of its assets related to licensable services;
. a requirement that we guarantee the contractual and financial
obligations of our licensed affiliates; and
. a requirement that we indemnify the BCBSA against any claims asserted
against it resulting from the contractual and financial obligations of
AdminaStar Federal, our subsidiary which serves as a fiscal intermediary
providing administrative services for Medicare Parts A and B.
We believe that we and our licensed affiliates are currently in compliance with
these standards.
Upon the occurrence of an event causing termination of the license
agreements, we would no longer have the right to use the BCBS names and marks
in one or more of Indiana, Kentucky, Ohio, Connecticut, New Hampshire, Maine,
Colorado and Nevada. Furthermore, BCBSA would be free to issue a license to use
the BCBS names and marks in these states to another entity. Events which could
cause the termination of a license agreement with BCBSA include failure to
comply with minimum capital requirements imposed by the BCBSA, a change of
control or violation of the BCBSA ownership limitations on our capital stock,
impending financial insolvency, the appointment of a trustee or receiver or the
commencement of any action against Anthem Insurance seeking its dissolution. We
believe that the BCBS names and marks are valuable identifiers of our products
and services in the marketplace. Accordingly, termination of the license
agreements could have a material adverse effect on our business, financial
condition and results of operations. We have obtained the consent of the BCBSA
in order to continue our licenses following the demutualization.
Our insurance and HMO subsidiaries are subject to risk-based capital
requirements. Our failure to meet these standards could subject us to
regulatory actions.
Anthem Insurance and our other insurance and HMO subsidiaries are subject to
risk-based capital, or RBC, standards, imposed by their states of domicile.
These laws are based on the RBC
13
Model Act adopted by the National Association of Insurance Commissioners, or
NAIC, and require our regulated subsidiaries to report their results of risk-
based capital calculations to the departments of insurance and the NAIC.
Failure to maintain the minimum RBC standards could subject our regulated
subsidiaries to corrective action, including state supervision or liquidation.
Anthem Insurance and our other insurance and HMO subsidiaries are currently in
compliance with the risk-based capital requirements imposed by their respective
states of domicile.
Compliance with the requirements of the Health Insurance Portability and
Accountability Act of 1996, or HIPAA, is expected to be costly.
In December 2000, the Department of Health and Human Services, known as HHS,
promulgated certain regulations under HIPAA related to the privacy of
individually identifiable health information, or protected health information.
The new regulations require health plans, clearinghouses and providers to:
. comply with various requirements and restrictions related to the use,
storage and disclosure of protected health information;
. adopt rigorous internal procedures to protect protected health
information; and
. enter into specific written agreements with business associates to whom
protected health information is disclosed.
The regulations establish significant criminal penalties and civil sanctions
for noncompliance. In addition, the regulations could expose us to additional
liability for, among other things, violations by our business associates. We
must comply with the new regulations by April 14, 2003. Although we have not
quantified the costs required to comply with the regulations, we believe the
costs could be material.
Regional concentrations of our business may subject us to economic downturns in
those states.
Our operating segments include regional companies located in the Midwest,
East and West, with most of our revenues generated in the states of Indiana,
Kentucky, Ohio, Connecticut, New Hampshire, Maine, Colorado and Nevada. Due to
this concentration of business in a small number of states, we are exposed to
potential losses resulting from the risk of an economic downturn in these
states. If economic conditions in these states deteriorate, we may experience a
reduction in existing and new business, which may have a material adverse
effect on our business, financial condition and results of operations.
A downgrade in our ratings may adversely affect our business, financial
condition and results of operations.
Claims paying ability and financial strength ratings by recognized rating
organizations have become an increasingly important factor in establishing the
competitive position of insurance companies and health benefits companies.
Rating organizations continue to review the financial performance and condition
of insurers, including Anthem Insurance and our other regulated subsidiaries.
Each of the rating agencies reviews its ratings periodically and there can be
no assurance that current ratings will be maintained in the future. We believe
our strong ratings are an important factor in marketing our products to our
customers, since ratings information is broadly disseminated and generally used
throughout the industry. If our ratings are downgraded or placed under
surveillance or review, with possible negative implications, the downgrade,
surveillance or review could adversely affect our business, financial condition
and results of operations. Our ratings reflect each rating agency's opinion of
our financial strength, operating performance and ability to meet our
obligations to policyholders, and are not evaluations directed toward the
protection of investors in our common stock, the units or the debentures and
should not be relied upon when making a decision to purchase shares of the
common stock offered hereby.
14
Our investment portfolio is subject to varying economic and market conditions,
as well as regulation.
Our investment portfolio consists primarily of fixed maturity securities,
indexed mutual funds, short-term investments, cash and other investments. The
market value of our investments varies from time to time depending on economic
and market conditions. For various reasons, we may sell certain of our
investments at prices that are less than the carrying value of the investments.
In addition, in periods of declining interest rates, bond calls and mortgage
loan prepayments generally increase, resulting in the reinvestment of these
funds at the then lower market rates. Although there have been adverse economic
conditions over the last three quarters, Anthem's liquidity has not been
impacted in a negative manner. Our portfolio, which is largely comprised of
fixed maturity securities, has returned 2.43%, 1.15% and 1.31% over the last
three quarters ended June 30, 2001. The fixed maturity portfolio has an average
credit rating of approximately double-A, and the equity securities portfolio is
currently invested in S&P 500 and S&P 400 index mutual funds. We cannot assure
you that our investment portfolio will produce positive returns in future
periods.
Anthem Insurance and our other regulated subsidiaries are subject to state
laws and regulations that require diversification of our investment portfolios
and limit the amount of investments in certain investment categories, such as
below-investment-grade fixed income securities, mortgage loans, real estate and
equity investments. Failure to comply with these laws and regulations might
cause investments exceeding regulatory limitations to be treated as non-
admitted assets for purposes of measuring statutory surplus and risk-based
capital, and, in some instances, require the sale of those investments.
As a Medicare fiscal intermediary, we are subject to complex regulations. If we
fail to comply with these regulations, we may be exposed to criminal sanctions
and significant civil penalties.
Anthem, like a number of other BCBS companies, serves as a fiscal
intermediary for the Medicare program, which generally provides coverage for
persons who are 65 or older and for persons with end-stage renal disease. Part
A of the Medicare program provides coverage for services provided by hospitals,
skilled nursing facilities and other health care facilities. Part B of the
Medicare program provides coverage for services provided by physicians,
physical and occupational therapists and other professional providers. Anthem
serves as a fiscal intermediary for Medicare Part A for Indiana, Kentucky,
Ohio, Illinois, New Hampshire, Maine, Vermont and Massachusetts and as a fiscal
intermediary for Medicare Part B for Indiana and Kentucky. As a fiscal
intermediary for these programs, we receive reimbursement for certain costs and
expenditures, which is subject to adjustment upon audit by the federal Centers
for Medicare and Medicaid Services, or CMS, formerly the Health Care Financing
Administration, or HCFA. The laws and regulations governing fiscal
intermediaries for the Medicare program are complex, subject to interpretation
and can expose a fiscal intermediary to penalties for non-compliance. Fiscal
intermediaries may be subject to criminal fines, civil penalties or other
sanctions as a result of such audits or reviews. In the last five years, at
least eight Medicare fiscal intermediaries have made payments to settle issues
raised by such audits or reviews. These payments have ranged from $700,000 to
$51.6 million, plus a payment by one company of $144 million. In the fourth
quarter of 1999, one of our subsidiaries reached a settlement agreement with
the federal government in the amount of $41.9 million to resolve an
investigation into the Medicare fiscal intermediary operations of a predecessor
of the subsidiary. The period investigated was before we acquired the
subsidiary. While we believe that we are in compliance in all material respects
with the regulations governing fiscal intermediaries, there are ongoing reviews
by the federal government of our activities under certain of our Medicare
fiscal intermediary contracts. Our affiliate, AdminaStar Federal, Inc., has
received several subpoenas from the OIG, Health and Human Services, and from
the U.S. Department of Justice seeking documents and information concerning its
responsibilities as a Medicare Part B contractor in its Kentucky operations,
and requesting certain financial records from AdminaStar Federal, Inc. and from
us related to our Medicare fiscal intermediary Part A and Part B operations.
For additional information, see "Legal and Regulatory Matters--Other
Contingencies."
15
We face significant competition from other health benefits companies.
As a health benefits company, we operate in a highly competitive environment
and in an industry that is currently subject to significant changes from
business consolidations, new strategic alliances, legislative reform,
aggressive marketing practices by other health benefits organizations and
market pressures brought about by an informed and organized customer base,
particularly among large employers. This environment has produced and will
likely continue to produce significant pressures on the profitability of health
benefits companies. Many of our competitors are larger and have greater
financial and other resources. In addition, the Gramm-Leach-Bliley Act, which
gives banks and other financial institutions the ability to affiliate with
insurance companies, could result in new competitors with significant financial
resources entering our markets. As of December 31, 2000, we had the following
approximate market share, based on number of members, in each of the eight core
states in which we operate: Indiana, 29%; Kentucky, 38%; Ohio, 20%;
Connecticut, 29%; New Hampshire, 31%; Maine, 40%; Colorado, 16%; and Nevada,
5%. We cannot assure you that we will be able to compete successfully against
current and future competitors or that competitive pressures faced by us will
not materially and adversely affect our business, financial condition and
results of operations. For a more detailed discussion of our competition,
please refer to "The Business of Anthem--Competition."
Acquisitions we have made or may make in the future may not be successful,
which could cause our business and future growth prospects to suffer.
We have built a significant portion of our current business through mergers
and acquisitions and we expect to pursue acquisitions in the future. The
following are some of the risks associated with acquisitions that could have a
material adverse effect on our business, financial condition and results of
operations:
. some of the acquired businesses may not achieve anticipated revenues,
earnings or cash flow;
. we may assume liabilities that were not disclosed to us;
. we may be unable to integrate acquired businesses successfully and
realize anticipated economic, operational and other benefits in a timely
manner, which could result in substantial costs and delays or other
operational, technical or financial problems;
. acquisitions could disrupt our ongoing business, distract management,
divert resources and make it difficult to maintain our current business
standards, controls and procedures;
. we may finance future acquisitions by issuing common stock for some or
all of the purchase price, which could dilute the ownership interests of
our shareholders;
. we may also incur additional debt related to future acquisitions; and
. we would be competing with other firms, many of which have greater
financial and other resources, to acquire attractive companies.
Our pending acquisition of Blue Cross and Blue Shield of Kansas involves risks
which could cause our business to suffer.
We have signed a definitive agreement with BCBS-KS pursuant to which we have
agreed to acquire BCBS-KS. Under the agreement, BCBS-KS will demutualize and
become a subsidiary of ours. BCBS-KS policyholders eligible to receive
consideration in its demutualization will be entitled to receive $190.0
million, which we will pay in cash to the escrow described below and which
amount thereafter may be reduced as described below. However, we and BCBS-KS
may agree to place less than the full $190.0 million in the escrow account, in
which case the portion of the $190.0 million not placed in escrow will be
distributed directly to eligible BCBS-KS policyholders. The amount held in
16
the escrow account will be used to pay costs, expenses and liabilities relating
to an investigation by the OIG of possible improper claims against Medicare by
BCBS-KS, and to pay costs and expenses of the escrow, with any remaining amount
to be distributed to eligible BCBS-KS policyholders. In addition, eligible
BCBS-KS policyholders will be entitled to receive an additional amount, to be
calculated based on the consolidated book value of BCBS-KS on the closing date
of the acquisition, which is expected to be paid as a special distribution by
BCBS-KS to its eligible policyholders. The proposed acquisition is expected to
close in early 2002, and must be approved by the policyholders of BCBS-KS, the
BCBSA, the Commissioner of Insurance of the State of Kansas and other
regulators, and is subject to other conditions.
This proposed acquisition involves a number of risks, including:
. if the amount of the purchase price that we will place in escrow is not
sufficient to pay in full the costs, expenses and liabilities relating
to the OIG investigation and the escrow, those remaining costs, expenses
and liabilities would reduce the value of BCBS-KS;
. if the final resolution of the OIG investigation results in operational
restrictions being placed upon BCBS-KS, which could include BCBS-KS
being disqualified from performing under federal contracts for a period
of up to five years, or if such restrictions and/or a disqualification
were extended to other corporate affiliates of BCBS-KS (which after
completion of the transaction would include Anthem), then the value of
BCBS-KS would be reduced and the operations of Anthem could be
negatively impacted;
. there may be liabilities that we assume but that were not disclosed to
us;
. we may be unable to integrate the operations of BCBS-KS successfully and
realize anticipated economic, operational and other benefits in a timely
manner, which could result in substantial costs and delays or other
operational, technical or financial problems; and
. the acquisition could distract our management and divert resources.
See "Recent Developments--Pending Acquisition of Blue Cross and Blue Shield
of Kansas" for a discussion of BCBS-KS and the proposed acquisition.
The failure to effectively maintain and modernize our operations in an Internet
environment could adversely affect our business.
Our businesses depend significantly on effective information systems, and we
have many different information systems for our various businesses. Our
information systems require an ongoing commitment of significant resources to
maintain and enhance existing systems and develop new systems in order to keep
pace with continuing changes in information processing technology, evolving
industry and regulatory standards, and changing customer preferences. For
example, HIPAA's administrative simplification provisions and the Department of
Labor's claim processing regulations may ultimately require significant changes
to current systems. In addition, we may from time to time obtain significant
portions of our systems-related or other services or facilities from
independent third parties, which may make our operations vulnerable to such
third parties' failure to perform adequately. As a result of our merger and
acquisition activities we have acquired additional systems. Our failure to
maintain effective and efficient information systems, or our failure to
efficiently and effectively consolidate our information systems to eliminate
redundant or obsolete applications, could have a material adverse effect on our
business, financial condition and results of operations.
Also, like many of our competitors in the health benefits industry, our
vision for the future includes becoming a premier e-business organization by
modernizing interactions with customers, brokers, agents, employees and other
stakeholders through web-enabling technology and re-designing internal
operations. We are developing our e-business strategy with the goal of becoming
widely regarded as an e-business leader in the health benefits industry. The
strategy includes not only sales and
17
distribution of health products on the Internet, but also implementation of
advanced self-service capabilities benefiting customers, agents, brokers,
partners and employees. There can be no assurance that we will be able to
successfully realize our e-business vision or integrate e-business operations
with our current method of operations. The failure to develop successful e-
business capabilities could result in competitive and cost disadvantages to us
as compared to our competitors.
A challenge to the plan of conversion or the Indiana Insurance Commissioner's
approval may create uncertainty about the status of the demutualization, the
issuance of our shares of common stock sold in this offering and the issuance
of the units sold in the units offering.
The plan of conversion and Anthem Insurance's Amended and Restated Articles
of Incorporation are subject to approval by the Indiana Insurance Commissioner.
That approval is a condition of the effectiveness of the demutualization. The
Indiana Insurance Commissioner approved the plan of conversion and Anthem
Insurance's Amended and Restated Articles of Incorporation on October 25, 2001.
Section 27-15-15-2 of the Indiana demutualization law provides that any
action challenging the validity of, or arising out of, acts taken or proposed
to be taken under any order of the Indiana Insurance Commissioner in connection
with a plan of conversion must be commenced within 30 days after the Indiana
Insurance Commissioner issues the order or determination. The 30-day appeal
period will not have expired prior to the effective date of the demutualization
and this offering. We cannot predict whether any action challenging the plan of
conversion or the approval thereof will be commenced or what aspects of the
plan an action might challenge. In the event that the order of the Indiana
Insurance Commissioner is challenged, a successful challenge could result in
monetary damages, a modification of the plan or the Indiana Insurance
Commissioner's approval of the plan being set aside. A successful challenge
would likely result in substantial uncertainty relating to the terms and
effectiveness of the plan, including the demutualization of Anthem Insurance,
the issuance of the shares of our common stock sold in this offering, the
issuance of the units sold in the units offering, payment of consideration and
the extinguishing of all membership interests. A substantial period of time
might be required to reach a final determination. In addition, pursuant to the
Indiana demutualization law, if certain claims have been asserted against
Anthem Insurance and remain unresolved on the effective date of the
demutualization, distribution of consideration to some or all eligible
statutory members may be delayed by more than six months, by establishing one
or more trusts for the purpose of holding assets on and following the effective
date of the demutualization that are adequate to satisfy such claims. Any one
or more of these outcomes could have a material adverse effect on the market
price of our common stock and the units.
Our ability to meet our obligations may be affected by the limitation on
dividends state insurance laws impose on our regulated subsidiaries.
After the demutualization, we will be a holding company whose assets will
include all of the outstanding shares of common stock of Anthem Insurance. As a
holding company, we will depend on dividends from Anthem Insurance and its
receipt of dividends from our other regulated subsidiaries. State insurance
laws may restrict the ability of our regulated subsidiaries to pay dividends.
For a discussion of these restrictions, see "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources--Anthem, Inc." Our ability to pay dividends in the future to
our shareholders and meet our obligations, including paying operating expenses
and debt service on the debentures and other debt, will depend upon the receipt
of dividends from our subsidiaries. An inability of our subsidiaries to pay
dividends in the future in an amount sufficient for us to meet our financial
obligations may materially adversely affect our business, financial condition
and results of operations and the value of our common stock and the units.
18
The initial public offering price of our common stock may not be indicative of
the market price of our common stock after this offering and our stock price
could be highly volatile.
The initial public offering price of our common stock is based on numerous
factors and may not be indicative of the market price of our common stock after
this offering. Factors including:
. variations in actual or anticipated operating results;
. changes in or failure to meet earnings estimates of securities analysts;
. market conditions in the health benefits industry;
. regulatory actions and general economic and stock market conditions; and
. the availability for sale, or sales, of a significant number of shares
of our common stock in the public market,
may have a significant effect on the market price of our common stock after
this offering. Accordingly, the market price of our common stock may decline
below the initial public offering price.
Sales of shares by eligible statutory members who receive shares in the
demutualization may reduce the market price of our common stock.
Anthem Insurance's eligible statutory members who receive shares in the
demutualization will not be required to pay any cash purchase price for those
shares, and generally will be free to sell their shares in the public market
after the demutualization. Only eligible statutory members who receive 30,000
or more shares of our common stock in the demutualization (whom we estimate
would hold an aggregate of approximately 11.5 million shares of our outstanding
common stock after the offering) and continue to hold 30,000 or more shares
will have volume and manner of sale restrictions on the sales of their shares
in the public market. For a period of 180 days after the effective date of the
demutualization, these large shareholders will be able to sell their shares
only under a large holder sale program that we will establish. See "The Plan of
Conversion--Large Holder Sale Program" for a description of the large holder
sale program and its limitations. We anticipate that eligible statutory members
receiving shares of our common stock in the demutualization will receive
notices regarding the number of shares registered in their name approximately
four to six weeks after the effective date of the demutualization. Sales of
substantial amounts of common stock, or the perception that such sales could
occur, could reduce the prevailing market price for our common stock. We
believe the following facts may increase selling pressure on our common stock:
. Some of Anthem Insurance's eligible statutory members, in particular
holders of group policies who did not elect to receive common stock in
the demutualization, are nevertheless likely to receive common stock
instead of cash because the amount of cash available for payments to
eligible statutory members will be limited. Those members may be
especially likely to sell the shares of common stock they receive in the
demutualization in order to realize cash proceeds.
. Some eligible statutory members may be fiduciaries of benefit plans that
are subject to ERISA or other legal or regulatory restrictions on their
investments. Those members, particularly if they originally did not
elect to receive common stock in the demutualization, may determine that
the exercise of their fiduciary duties requires them to promptly sell
the shares of common stock they receive in the demutualization.
. We intend to provide a program for the public sale of our common stock,
at prevailing market prices and without paying brokerage commissions or
similar expenses, to allow each of our shareholders who owns 99 or fewer
shares of our common stock to sell those shares or to purchase
additional shares to round-up their holdings to 100 shares. This program
would begin no sooner than the first business day after the 180th day
following, and no later
19
than the last business day before the twelfth-month anniversary of, the
effective date of the demutualization, and it would continue for at
least three months. We estimate that when we complete the
demutualization we will have approximately 150,000 eligible statutory
members who will in total receive in excess of five million shares that
we believe would be eligible to participate in this commission-free
sales program.
Applicable laws and our articles of incorporation and bylaws may prevent or
discourage takeovers and business combinations that our shareholders might
consider in their best interests.
State laws and our articles of incorporation and bylaws may delay, defer,
prevent or render more difficult a takeover attempt that our shareholders
might consider in their best interests. For instance, they may prevent our
shareholders from receiving the benefit from any premium to the market price
of our common stock offered by a bidder in a takeover context. Even in the
absence of a takeover attempt, the existence of these provisions may adversely
affect the prevailing market price of our common stock if they are viewed as
discouraging takeover attempts in the future.
Under the Indiana demutualization law, for a period of five years following
the effective date of the demutualization, no person may acquire beneficial
ownership of 5% or more of the outstanding shares of our common stock without
the prior approval of the Indiana Insurance Commissioner and our board of
directors. This restriction does not apply to acquisitions made by us or made
pursuant to an employee benefit plan or employee benefit trust sponsored by
us. The Indiana Insurance Commissioner has adopted rules under which passive
institutional investors could purchase 5% or more but less than 10% of our
outstanding common stock with the prior approval of our board of directors and
prior notice to the Indiana Insurance Commissioner.
Our license agreements with the BCBSA require that our articles of
incorporation contain certain provisions, including ownership limitations. The
BCBSA ownership limits restrict beneficial ownership of our voting capital
stock to less than 10% for institutional investors and less than 5% for
noninstitutional investors, both as defined in our articles of incorporation.
In addition, no person may beneficially own shares of our common stock or
other equity securities, or a combination thereof, representing a 20% or more
ownership interest in our company. Our articles of incorporation prohibit
ownership of our capital stock in excess of these BCBSA ownership limits
without prior approval of a majority of our continuing directors (as defined
in our articles of incorporation).
Certain other provisions included in our articles of incorporation and
bylaws may also have anti-takeover effects and may delay, defer or prevent a
takeover attempt that our shareholders might consider in their best interests.
In particular, our articles of incorporation and bylaws:
. permit our board of directors to issue one or more series of preferred
stock;
. divide our board of directors into three classes serving staggered
three-year terms;
. restrict the maximum number of directors;
. limit the ability of shareholders to remove directors;
. impose restrictions on shareholders' ability to fill vacancies on our
board of directors;
. prohibit shareholders from calling special meetings of shareholders;
. impose advance notice requirements for shareholder proposals and
nominations of directors to be considered at meetings of shareholders;
and
. impose restrictions on shareholders' ability to amend our articles of
incorporation and bylaws.
20
AVAILABLE INFORMATION
We have filed with the Securities and Exchange Commission in Washington,
D.C., a registration statement on Form S-1 under the Securities Act of 1933
with respect to the common stock being offered by this prospectus. This
prospectus which forms a part of the registration statement does not contain
all the information set forth in the registration statement, certain parts of
which are omitted in accordance with the rules and regulations of the
Securities and Exchange Commission. For further information with respect to
Anthem, Inc., our common stock and the units, we refer you to the registration
statement and to the exhibits to the registration statement. Statements made in
this prospectus describing the contents of any contract, agreement or other
document referred to are not necessarily complete. With respect to these
contracts, agreements or other documents filed as an exhibit to the
registration statement, we refer you to the exhibit for a more complete
description of the matter involved, and each statement is qualified in its
entirety by this reference. The registration statement and the exhibits to the
registration statement may be inspected and copied at the Securities and
Exchange Commission's Public Reference Room at 450 Fifth Street, N.W.,
Washington, D.C. 20549, and at its regional offices located at 233 Broadway,
The Woolworth Building, New York, New York 10279 and 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661-2511. The public may obtain information on
the operation of the Public Reference Room by calling the Securities and
Exchange Commission at 1-800-SEC-0330. The Securities and Exchange Commission
maintains an Internet world wide web site at http://www.sec.gov that contains
periodic and current reports, proxy and information statements, and other
information regarding issuers that file electronically with the Securities and
Exchange Commission.
As a result of Anthem Insurance's conversion to a stock insurance company,
this offering and the offering of the units, we will become subject to the
information reporting requirements of the Securities Exchange Act of 1934. We
will fulfill our obligations with respect to such requirements by filing
periodic and current reports, proxy statements and other information with the
Securities and Exchange Commission. These reports, proxy statements and
information may be inspected and copied at the public reference facilities
maintained by the Securities and Exchange Commission referenced above. We
intend to furnish holders of our common stock with annual reports that include
our annual consolidated financial statements audited by an independent
certified public accounting firm.
Our common stock has been approved for listing on the New York Stock
Exchange, subject to official notice of issuance, under the symbol "ATH". The
units have been approved for listing on the New York Stock Exchange, subject to
official notice of issuance, under the symbol "ATV." Upon notice of issuance,
copies of the registration statement, including all exhibits thereto, and
periodic reports, proxy statements and other information will be available for
inspection at the offices of the New York Stock Exchange, Inc. located at 20
Broad Street, New York, New York 10005.
INFORMATION PERTAINING TO FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements that reflect our views
about future events and financial performance. When used in this prospectus,
the words "may," "will," "should," "anticipate," "estimate," "expect," "plan,"
"believe," "predict," "potential," "intend" and similar expressions are
intended to identify forward-looking statements. Forward-looking statements are
subject to known and unknown risks and uncertainties that could cause actual
results to differ materially from those projected. You are cautioned not to
place undue reliance on these forward-looking statements that speak only as of
the date hereof. You are also urged to carefully review and consider the
various disclosures made by us which attempt to advise interested parties of
the factors which affect our business, including the discussion under the
caption "Risk Factors" as well as our reports filed with the Securities and
Exchange Commission from time to time.
21
Health benefits companies operate in a highly competitive, constantly
changing environment that is significantly influenced by very large
organizations that have resulted from business combinations, aggressive
marketing and pricing practices of competitors and regulatory oversight. The
following is a summary of factors, the results of which, either individually or
in combination, if markedly different from our planning assumptions, could
cause our results to differ materially from those expressed in any forward-
looking statements contained in this prospectus:
. trends in health care costs and utilization rates;
. ability to secure sufficient premium rate increases;
. competitor pricing below market trends of increasing costs;
. increased government regulation of health benefits and managed care;
. significant acquisitions or divestitures by major competitors;
. introduction and utilization of new prescription drugs and technology;
. a downgrade in our financial strength ratings;
. litigation targeted at health benefits companies;
. ability to contract with providers consistent with past practice; and
. general economic downturns.
22
THE PLAN OF CONVERSION
The following summary discussion of the plan of conversion does not purport
to be complete and is qualified in its entirety by reference to the complete
text of the plan of conversion. A copy of the plan of conversion is filed as an
exhibit to the registration statement of which this prospectus forms a part.
Background of the Demutualization
Mutual insurance companies, like Anthem Insurance, are not authorized to
issue or sell capital stock and as a result are limited in their ability to
raise capital. With increasing consolidation and competition in the health
benefits industry, and the resulting need to develop new business
opportunities, Anthem Insurance has examined alternative ways of raising
capital.
On January 29, 2001, Anthem Insurance's board of directors authorized
management to prepare a plan of conversion, whereby Anthem Insurance will
convert from a mutual insurance company to a stock insurance company under the
Indiana demutualization law, Indiana Code Section 27-15-1-1 et seq., and on
June 18, 2001, Anthem Insurance's board of directors unanimously approved the
plan of conversion. The principal reason for the demutualization is to increase
our financial flexibility through improved access to capital, which will
enhance our ability to expand existing business, develop new business
opportunities and enhance our competitive position in the health benefits
industry, and continue to improve service to our customers. In addition, if the
plan of conversion becomes effective, the eligible statutory members will
receive consideration in the form of Anthem, Inc. common stock or cash in
exchange for the extinguishing of their membership interests in Anthem
Insurance.
Exchange of Membership Interests
In general, holders of policies or certificates, including guaranty policies
or certificates thereunder, as applicable, issued by Anthem Insurance, have
rights as statutory members of Anthem Insurance, which in the context of
demutualization are called membership interests. Membership interests consist
principally of the right to vote on matters submitted to a vote of statutory
members, including the election of directors, and the right to participate in
any distribution of cash, stock or other consideration in the event of a
conversion of Anthem Insurance to a stock insurance company under the Indiana
demutualization law or a dissolution of Anthem Insurance. If the plan becomes
effective, the membership interests of all statutory members will be
extinguished and Anthem Insurance's eligible statutory members will receive
consideration in the form of our common stock or cash.
Consideration
Eligible Statutory Members
If the plan becomes effective, Anthem Insurance's eligible statutory members
will receive consideration in the form of our common stock or cash. Prior to
the vote on the plan of conversion by Anthem Insurance's statutory members
eligible to vote on the plan, they were given the opportunity to elect to
receive common stock in the demutualization. Those eligible statutory members
who failed to make a common stock election may be paid in cash. However, the
amount of cash available for distribution to eligible statutory members will be
limited, and a significant portion of eligible statutory members will likely
receive Anthem, Inc. common stock even if they did not elect to receive common
stock in the demutualization. The number of eligible statutory members for
which cash will be available will depend on a number of factors, including
market conditions, the size of this offering and the size of the offering of
the units. We have agreed in the plan of conversion to use our best
commercially reasonable efforts, consistent with our capital and liquidity
needs and projections, to assure that funds sufficient to pay cash to a
substantial number of eligible statutory members will be made available and
used for these cash payments.
23
In general, an eligible statutory member is an Anthem Insurance statutory
member who was the holder on June 18, 2001, of an in-force policy or
certificate issued by Anthem Insurance and continues to be the holder of an in-
force policy or certificate on the effective date of the plan. Of Anthem's more
than seven million members or customers, under applicable law and the articles
of incorporation and by-laws of Anthem Insurance, approximately one million are
statutory members.
We have signed a definitive agreement with BCBS-KS, pursuant to which we
will acquire BCBS-KS. See "Recent Developments--Pending Acquisition of Blue
Cross and Blue Shield of Kansas." Policyholders of BCBS-KS will not become
statutory members of Anthem Insurance and will not be eligible to receive any
consideration as a result of our demutualization.
Allocation of Shares
The aggregate consideration to be distributed to Anthem Insurance's eligible
statutory members in exchange for membership interests will consist of shares
of our common stock or cash equal to the fair value of Anthem Insurance as
determined under Indiana law. The amount of an eligible statutory member's
consideration will be based on an allocation to that member of a number of
shares of Anthem, Inc. common stock. The aggregate consideration distributed to
eligible statutory members will be shares of common stock and cash equal in
value to 100 million shares of our common stock. The method of allocation among
eligible statutory members provides to each eligible statutory member a "fixed
component" equal in value to 21 shares of Anthem, Inc. common stock and a
"variable component," which may be zero. The variable component in general is
based on an estimate of any positive contribution made by such member to Anthem
Insurance's statutory surplus relative to the sum of such positive
contributions made by all eligible statutory members. We anticipate that
approximately 20% of the aggregate consideration distributed to eligible
statutory members will represent the fixed component, and the balance will
represent the variable component. We retained Daniel J. McCarthy, FSA, MAAA,
Dale S. Hagstrom, FSA, MAAA, and Robert H. Dobson, FSA, MAAA, independent
consulting actuaries associated with Milliman USA, Inc., an independent
actuarial consulting firm, to advise us in connection with the actuarial
matters involved in the plan of conversion and the allocation of consideration
to eligible statutory members. The opinion of Messrs. McCarthy, Hagstrom and
Dobson, dated June 18, 2001, states, in reliance upon the matters described in
the opinion, that the principles, assumptions, methodologies and formulas used
to allocate consideration among eligible statutory members in exchange for
their membership interests are reasonable and appropriate and that the
resulting allocation of consideration to eligible statutory members is fair and
equitable. A copy of the opinion is attached as Annex A to this prospectus.
Cash Payment Amounts
For those eligible statutory members who receive cash in the
demutualization, the amount of cash payments will be based on the initial
public offering price of our common stock in this offering. The formula for
calculation of cash payments includes a "top up" provision. If the average
closing price of Anthem, Inc.'s common stock over the 20 consecutive trading
days commencing with the date on which the demutualization is completed is more
than 110% of the initial public offering price, eligible statutory members
receiving cash will receive an additional payment equal to the amount by which
the average closing price exceeds 110% of the initial public offering price, up
to 120% of the initial public offering price.
Other Capital Raising Transaction
The plan requires us to make the initial public offering and to raise
proceeds from the initial public offering, together with the offering of units,
to provide cash for the cash payments to be made to eligible statutory members
under the plan, as well as to pay the fees and expenses we have incurred in
connection with the demutualization. The plan also permits us to complete one
or more
24
other specified capital raising transactions concurrently with the initial
public offering. Concurrently with this offering, we are offering 4,000,000
equity security units for an aggregate offering of $200.0 million, plus up to
an additional $30.0 million if the underwriters' option to purchase additional
units is exercised in full. Each unit consists of (a) a contract to purchase
shares of our common stock and (b) a subordinated debenture. For a description
of the units, see "Description of the Equity Security Units."
Conditions to Effectiveness of the Plan
In order for the plan of conversion to become effective, the following
approvals and conditions must be obtained and/or satisfied:
Approval by Statutory Members
One of the conditions for the plan of conversion and Anthem Insurance's
Amended and Restated Articles of Incorporation to become effective is that they
must be approved by a vote of Anthem Insurance's statutory members eligible to
vote on the plan.
On June 18, 2001, the board of directors of Anthem Insurance unanimously
approved the plan of conversion and Amended and Restated Articles of
Incorporation, and recommended the plan and Amended and Restated Articles of
Incorporation to Anthem Insurance's statutory members. Anthem Insurance's
statutory members approved the plan and Amended and Restated Articles of
Incorporation at a special meeting held on October 29, 2001.
Approval by the Indiana Insurance Commissioner
In order for the plan to become effective, the plan and Anthem Insurance's
Amended and Restated Articles of Incorporation must be approved by the Indiana
Insurance Commissioner.
The Indiana demutualization law requires the Indiana Insurance Commissioner
to approve the plan and Anthem Insurance's Amended and Restated Articles of
Incorporation if she finds that:
. the amount and form of consideration to be given to Anthem Insurance's
eligible statutory members under the plan is fair in the aggregate and
to each member class;
. the plan complies with the Indiana demutualization law and other
applicable laws, is fair, reasonable and equitable to the eligible
statutory members and will not prejudice the interests of Anthem
Insurance's other statutory members or policyholders; and
. the total consideration provided to eligible statutory members under the
plan is equal to or greater than Anthem Insurance's policyholders'
surplus as determined in accordance with statutory accounting
principles.
A public hearing on the demutualization was held at the Indiana Government
Conference Center, Auditorium, 402 West Washington Street, Indianapolis,
Indiana 46204 on October 2, 2001. The Indiana Insurance Commissioner approved
the plan of conversion and the Amended and Restated Articles of Incorporation
on October 25, 2001.
Tax Opinion
Under the plan, an opinion of Anthem's tax advisor, Ernst & Young LLP,
regarding certain federal income tax consequences of the plan must be received
in order for the plan to become effective.
25
ERISA Exemption
Anthem Insurance will not cause or allow the demutualization to become
effective unless, on or prior to the effective date of the plan:
. the Department of Labor has granted an exemption from Section 406 of the
Employee Retirement Income Security Act of 1974, or ERISA, and Section
4975 of the Internal Revenue Code of 1986, as amended, or the Code, with
respect to the receipt of consideration pursuant to the plan by employee
benefit plans subject to the provisions of such sections; or
. Anthem has, upon advice of counsel, otherwise determined and reported to
the Indiana Insurance Commissioner that the distribution of
consideration will not have an adverse effect on eligible statutory
members or on Anthem, or that the distribution of consideration will not
constitute a prohibited transaction under ERISA or the Code; or
. the consideration payable to such employee benefit plans is placed in
trust for up to six months, pending the receipt of the required
exemptions.
Neither Anthem Insurance nor Anthem, Inc. nor their or their subsidiaries'
employees, officers or directors are, or will be, eligible statutory members
under any benefit or welfare plan established or maintained by Anthem
Insurance, Anthem, Inc. or any of their subsidiaries for the benefit of such
employees, officers or directors.
Initial Public Offering
Consummation of this offering is a condition to the effectiveness of the
plan of conversion.
Other Approvals
In connection with the demutualization, we will need to obtain various
regulatory approvals and the consent of the BCBSA.
Appeal Period
Section 27-15-15-2 of the Indiana demutualization law provides that any
action challenging the validity of or arising out of acts taken or proposed to
be taken under any order of the Indiana Insurance Commissioner in connection
with the plan must be commenced within 30 days after the Indiana Insurance
Commissioner issued the order or determination. The 30-day appeal period will
not have expired prior to the effective date of the demutualization and this
offering. In the event that the order of the Indiana Insurance Commissioner is
challenged, a successful challenge could result in monetary damages, a
modification of the plan or the Indiana Insurance Commissioner's approval of
the plan being set aside. A successful challenge would likely result in
substantial uncertainty relating to the terms and effectiveness of the plan,
including the demutualization of Anthem Insurance, payment of consideration and
the extinguishing of membership interests. A substantial period of time might
be required to reach a final determination. However, in order to challenge
successfully the Indiana Insurance Commissioner's approval of the plan, the
petitioner would have to sustain the burden of showing that such approval was
arbitrary, capricious, an abuse of discretion or otherwise not in accordance
with law, contrary to constitutional right, power, privilege or immunity, in
excess of statutory jurisdiction, authority or limitations, or short of
statutory right, without observance of procedure required by law or unsupported
by substantial evidence. In addition, pursuant to the Indiana demutualization
law, if certain claims have been asserted against Anthem Insurance and remain
unresolved on the effective date of the demutualization, distribution of
consideration to some or all eligible statutory members may be delayed by more
than six months, by establishing one or more trusts for the purpose of holding
assets on and following the effective date of the demutualization that are
adequate to satisfy such claims.
26
Amendment or Withdrawal of the Plan; Corrections
The plan of conversion may be modified, amended, withdrawn or terminated
only in a manner consistent with the provisions of the Indiana demutualization
law and by action of a majority of Anthem Insurance's board of directors.
Additionally, Anthem Insurance may make certain modifications, corrections of
errors or omissions and clarifications to the plan as may be necessary under
the plan, or as may be required by the Indiana Insurance Commissioner.
Effectiveness of the Plan
If the conditions to effectiveness of the plan are met, and upon Anthem
Insurance's filing with the Indiana Department of Insurance and the Indiana
Secretary of State the Amended and Restated Articles of Incorporation, the plan
of conversion will go into effect. The plan provides that the effective date of
the plan will occur upon the date and time of approval of Anthem Insurance's
Amended and Restated Articles of Incorporation by the Indiana Secretary of
State, unless a later date and time are specified in the Amended and Restated
Articles of Incorporation, in which case the plan and those Articles will
become effective at that later date and time. We anticipate that the plan will
become effective on the closing date of this offering.
If the plan does not become effective for any reason, Anthem Insurance will
remain a mutual insurance company, the interests of Anthem Insurance's
statutory members will remain unchanged, no consideration will be paid to
eligible statutory members, and no shares will be issued or sold in this
offering and no units will be issued or sold in the units offering.
Tax Effect on Anthem
The following sections are a summary of the material federal income tax
consequences to Anthem in connection with the plan, based on the opinion of
Ernst & Young LLP, Anthem's tax advisor.
Demutualization of Anthem Insurance
The demutualization of Anthem Insurance from a mutual insurance company to a
stock insurance company will be tax-free under the Code, and the holding
company formation whereby Anthem Insurance will become a wholly-owned
subsidiary of Anthem, Inc. will be tax-free to both Anthem Insurance and
Anthem, Inc. under the Code.
Distribution of Cash to Eligible Statutory Members
Neither Anthem Insurance nor Anthem, Inc. will recognize gain or loss on
Anthem, Inc.'s issuance of cash to those eligible statutory members who are to
receive cash in lieu of Anthem, Inc. common stock under the plan.
Treatment of Anthem, Inc.
Anthem, Inc. will not recognize gain or loss on its receipt of cash in this
offering.
Special Tax Rules Applicable to Blue Cross and Blue Shield Organizations
Under current law, Anthem currently enjoys certain federal income tax
benefits as described below, including special tax deductions, as a Blue Cross
or Blue Shield organization that was in existence on August 16, 1986. These
special tax benefits continue for as long as Anthem does not undergo a
"material change" in operations or structure. Current law does not address
whether a
27
demutualization transaction will constitute a material change in the operations
or structure of a Blue Cross or Blue Shield organization and, therefore, it is
not clear what effect the plan will have on Anthem's ability to continue to
qualify for such tax benefits.
As an existing Blue Cross and Blue Shield organization, Anthem is entitled
to take advantage of special tax provisions. These provisions include a
deduction based on the amount by which 25% of our claims and expenses exceed
our adjusted surplus (the "Section 833(b) Deduction") and a deduction for
increases to our unearned premium reserve that is higher than the deduction
allowable to most insurance companies. Because of the current level of adjusted
surpluses, Anthem has only one subsidiary that anticipates having a Section
833(b) Deduction in calendar year 2001.
If the plan is treated as effecting a "material change" to Anthem's
structure or operations, Anthem would not be allowed the Section 833(b)
Deduction. Anthem would also only be allowed to deduct 80% of our unearned
premium reserve rather than 100%. This would have the impact of accelerating
taxable income in the year in which the material change occurs.
In addition, as a Blue Cross or Blue Shield organization, Anthem was
entitled to adjust the tax basis of assets that we owned on January 1, 1987 to
their fair market value on that date. If we were deemed to undergo a material
change as a result of the plan, it is possible that we would lose the remaining
benefit of this special basis adjustment, which could cause an increase in our
tax liability on any further disposition of certain assets owned on January 1,
1987.
Status as an Insurance Company
As long as Anthem does not undergo a material change, Anthem will be treated
as an insurance company for federal income tax purposes. If Anthem were
determined to have undergone a material change, Anthem's status as an insurance
company would depend on whether its predominant business activities are
considered to be those of an insurance company. Loss of insurance company
status generally would preclude Anthem from taking into account deductions for
additions to certain reserves that insurance companies are permitted to deduct
for federal income tax purposes. The loss of these deductible reserves would,
in general, cause acceleration of the payment of federal income tax on income
derived from Anthem's operations. However, we believe that Anthem should
continue to qualify as an insurance company regardless of whether the
demutualization is viewed as a material change.
ERISA Considerations
Prohibited Transaction Exemption
A significant percentage of the policies or certificates held by likely
eligible statutory members are associated with welfare benefit plans subject to
ERISA. The Department of Labor, or DOL, has taken the position that the stock
or other consideration that is distributed in a demutualization with respect to
ERISA plans generally is a "plan asset" under ERISA. Anthem may be considered
to be a "party-in-interest" under ERISA with respect to these ERISA plans.
Absent an exemption, the receipt of Anthem, Inc. common stock or cash by
eligible statutory members whose policies or certificates are associated with
ERISA plans could be viewed as a prohibited transaction under Section 406 of
ERISA.
Anthem Insurance has received an individual prohibited transaction exemption
from the DOL. The individual prohibited transaction exemption allows eligible
statutory members with policies or certificates associated with ERISA plans to
receive the Anthem, Inc. common stock or cash without application of the
prohibited transaction rules. The DOL grants individual prohibited transaction
exemptions if it determines that the exemption is administratively feasible, is
in the interest of the ERISA plans and their participants and beneficiaries and
is protective of the rights of participants and beneficiaries.
28
Large Holder Sale Program
Pursuant to the plan of conversion, shares of our common stock distributed
to any of Anthem Insurance's eligible statutory members who receives and
continues to hold 30,000 or more shares of our common stock may not be
transferred or sold by such eligible statutory member until 180 days after the
effective date of the demutualization, except for transfers that occur by
operation of law, transfers with our written consent or sales in accordance
with a large holder sale program that we will establish. After the 180 day
period, these limitations will no longer apply.
The large holder sale program will be administered by EquiServe Trust
Company, N.A. as the program agent. Under the large holder sale program
procedures, if the aggregate number of shares of our common stock to be sold on
the open market on any day on behalf of all holders who hold more than 30,000
shares exceeds the lesser of (i) 1/10th of 1% of the number of shares of our
common stock outstanding or (ii) 25% of the average daily trading volume for
the 20 consecutive trading days (or such shorter period, if fewer than 20
consecutive trading days have elapsed since the effective date of the
demutualization) preceding such day, the designated broker-dealer will only
process trades on the open market up to that limit for all holders who hold
more than 30,000 shares. The designated broker-dealer will either defer the
excess shares to the next trading day (which will be subject to the same volume
limitations on that day) or sell the shares as principal through a block trade
or through a nationally recognized brokerage firm that will sell the shares, as
agent, at market clearing prices. The excess shares on any day may also be
purchased by Anthem, subject to compliance with applicable regulatory
requirements, but we have no obligation to purchase any excess shares.
Commission-Free Sales Program
Pursuant to the plan of conversion, we intend to establish a commission-free
sales program that would commence no sooner than the first business day after
the 180th day following, and no later than the last business day before the
twelfth-month anniversary of, the effective date of the demutualization, and
would continue for at least three months. Under this program, each of our
shareholders who owns 99 or fewer shares of our common stock on the record date
for the commission-free sales program would have the opportunity at any time
during the term of the program to sell all, but not less than all, of those
shares in one transaction at prevailing market prices without paying brokerage
commissions or other similar expenses. We would also offer each shareholder
eligible to participate in the commission-free sales program the opportunity to
purchase shares of common stock as necessary to increase their holdings to 100
share round lots without paying brokerage commissions or other similar
expenses. This stock purchase program would occur simultaneously and in
conjunction with the commission-free sales program. The program may provide
that we can repurchase shares of our common stock at prevailing market prices
when, during any particular day of the program, the number of shares requested
to be sold exceeds the number of shares requested to be purchased pursuant to
round-up requests.
29
USE OF PROCEEDS
Gross proceeds to us from the offering will be $1,728.0 million. This
reflects the sale of 48,000,000 shares of common stock by us, at an initial
public offering price of $36.00 per share. From these gross proceeds, we
estimate we will pay $1,434.0 million to Anthem Insurance's eligible statutory
members who receive cash in lieu of shares of common stock in connection with
the demutualization. We expect to pay from the gross proceeds $79.5 million for
underwriting discounts and an estimated $32.0 million for other offering and
additional demutualization expenses. We will use the estimated balance of
approximately $182.5 million, plus an estimated additional $247.3 million of
net proceeds if the underwriters exercise their over-allotment option in full,
for general corporate purposes.
With respect to the concurrent offering of units, gross proceeds to us will
be $200.0 million. We expect to pay from the gross proceeds approximately $9.0
million for underwriting discounts and offering expenses. From the resulting
net proceeds of $191.0 million, together with estimated net proceeds of
$1,616.5 million from this initial public offering of common stock (for
estimated net proceeds from both offerings aggregating $1,807.5 million),
payments totaling an estimated $1,625.0 million will be made to eligible
statutory members of Anthem Insurance who receive cash instead of shares of
Anthem, Inc. common stock in the demutualization. We will use the balance of
the net proceeds from both offerings of approximately $182.5 million, plus an
estimated additional $276.2 million of net proceeds if the underwriters
exercise both over-allotment options in full, for general corporate purposes.
DIVIDEND POLICY
Our board of directors does not presently intend to declare cash dividends
on our common stock. The declaration and payment of future dividends will be at
the discretion of our board of directors and must comply with applicable law.
Future dividend payments will depend upon our financial condition, results of
operations, future liquidity needs, potential acquisitions, regulatory and
capital requirements and other factors deemed relevant by our board of
directors. In addition, following the effective date of the plan of conversion,
we will be a holding company whose primary asset will be 100% of the capital
stock of Anthem Insurance. Our ability to pay dividends to our shareholders
will primarily depend upon the receipt of dividends from Anthem Insurance and
its receipt of dividends from our other regulated insurance subsidiaries.
In addition, the indenture governing the terms of the debentures to be
issued in connection with the offering of units prohibits, with certain limited
exceptions, the payment of dividends on our common stock during a deferral of
interest payments on the debentures or an event of default under the indenture.
We also have the option to defer contract fee payments on the purchase
contracts. If we elect to defer contract fee payments, we cannot, with certain
limited exceptions, pay dividends on our common stock during a deferral period.
30
CAPITALIZATION
The following table sets forth, as of June 30, 2001, Anthem's actual
capitalization and Anthem, Inc.'s capitalization as adjusted to give effect to:
. the demutualization;
. the sale of 48,000,000 shares of common stock in this offering at an
initial public offering price of $36.00 per share;
. the sale of 4,000,000 equity security units at an offering price of
$50.00 per unit; and
. the application of estimated net proceeds from this offering and from
the offering of the units as set forth under "Use of Proceeds."
At June 30, 2001
-----------------------
Anthem Anthem, Inc.
Historical Pro forma
---------- ------------
(In Millions,
except share data)
Debt:
9.00% surplus notes due 2027......................... $ 197.2 $ 197.2
9.125% surplus notes due 2010........................ 295.7 295.7
5.95% debentures included in equity security units... -- 191.0
Other................................................ 104.8 104.8
-------- --------
Total debt......................................... 597.7 788.7
-------- --------
Shareholders' equity(1):
Preferred stock, without par value, shares
authorized--100,000,000 shares issued and
outstanding--none................................... $ -- $ --
Common stock, par value $0.01, shares authorized--
900,000,000, shares issued and outstanding--none
historically and 102,861,000 pro forma.............. -- 1.0
Additional paid in capital........................... -- 1,982.1
Retained earnings.................................... 1,991.6 --
Accumulated other comprehensive income............... 72.3 72.3
-------- --------
Total shareholders' equity(1)...................... 2,063.9 2,055.4
-------- --------
Total capitalization................................... $2,661.6 $2,844.1
======== ========
--------
(1) Anthem historical amounts represent "Policyholders' surplus" prior to
demutualization.
31
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
In the table below, we provide selected consolidated financial data of
Anthem. We prepared this information using our unaudited consolidated financial
statements for the six-month periods ended June 30, 2001 and 2000 and our
consolidated financial statements for each of the years in the five-year period
ended December 31, 2000, which have been audited by Ernst & Young LLP. You
should read this selected consolidated financial data together with our audited
consolidated financial statements and notes and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included in this
prospectus. In our opinion, the selected consolidated financial data for the
six-month periods ended June 30, 2001 and 2000 include all adjustments,
consisting of only normal recurring adjustments, necessary for a fair
presentation of that data. The selected consolidated financial and other data
do not necessarily indicate the results to be expected in the future.
As of and for the
Six Months
Ended June 30, As of and for the Year Ended December 31,
------------------ -----------------------------------------------
2001(1) 2000(1) 2000(1) 1999(1) 1998 1997 1996
-------- -------- -------- -------- -------- -------- --------
(unaudited)
($ in Millions)
Income Statement Data
Revenues
Premiums................ $4,542.8 $3,589.3 $7,737.3 $5,418.5 $4,739.5 $4,581.4 $4,445.9
Administrative fees..... 430.3 356.5 755.6 611.1 575.6 445.9 452.9
Other revenue........... 22.6 18.9 50.6 51.0 74.6 82.7 108.5
-------- -------- -------- -------- -------- -------- --------
Total operating
revenue............... 4,995.7 3,964.7 8,543.5 6,080.6 5,389.7 5,110.0 5,007.3
Net investment income... 109.0 95.0 201.6 152.0 136.8 125.2 141.9
Net realized gains
(losses) on
investments............ (10.9) 6.5 25.9 37.5 155.9 97.0 73.3
Gain on sale of
subsidiary operations.. 25.0 -- -- -- -- -- --
-------- -------- -------- -------- -------- -------- --------
5,118.8 4,066.2 8,771.0 6,270.1 5,682.4 5,332.2 5,222.5
-------- -------- -------- -------- -------- -------- --------
Expenses
Benefit expense......... 3,870.8 3,080.6 6,551.0 4,582.7 3,934.2 3,833.3 3,715.1
Administrative
expense(2)............. 991.6 817.5 1,808.4 1,469.4 1,420.1 1,358.9 1,268.7
Interest expense........ 28.0 27.0 54.7 30.4 27.9 23.7 19.5
Amortization of goodwill
and other intangible
assets................. 15.7 11.4 27.1 12.7 12.0 9.6 10.7
Demutualization
expenses............... 3.0 -- -- -- -- -- --
Endowment of non-profit
foundations(3)......... -- -- -- 114.1 -- -- --
-------- -------- -------- -------- -------- -------- --------
4,909.1 3,936.5 8,441.2 6,209.3 5,394.2 5,225.5 5,014.0
-------- -------- -------- -------- -------- -------- --------
Income from continuing
operations before
income taxes and
minority interest...... 209.7 129.7 329.8 60.8 288.2 106.7 208.5
Income taxes............ 68.6 38.9 102.2 10.2 110.9 24.1 53.0
Minority interest
(credit)............... (1.9) 0.5 1.6 (0.3) (1.1) 3.5 15.0
-------- -------- -------- -------- -------- -------- --------
Income from continuing
operations............. 143.0 90.3 226.0 50.9 178.4 79.1 140.5
Discontinued operations,
net of income taxes
Loss from discontinued
operations prior to
disposal............... -- -- -- -- (3.9) (125.1) (44.4)
Loss on disposal of
discontinued
operations............. -- -- -- (6.0) (2.1) (113.0) --
-------- -------- -------- -------- -------- -------- --------
Net income (loss)....... $ 143.0 $ 90.3 $ 226.0 $ 44.9 $ 172.4 $ (159.0) $ 96.1
======== ======== ======== ======== ======== ======== ========
32
As of and for the
Six Months Ended
June 30, As of and for the Year Ended December 31,
------------------ --------------------------------------------------
2001(1) 2000(1) 2000(1) 1999(1) 1998 1997 1996
-------- -------- --------- -------- -------- -------- --------
(unaudited)
($ in Millions, except ratios)
Other Data-unaudited(4)
Operating revenue and
premium
equivalents(5)......... $6,883.1 $5,559.0 $11,800.1 $8,691.6 $7,987.4 $7,269.3 $6,772.3
Benefit expense ratio... 85.2% 85.8% 84.7% 84.6% 83.0% 83.7% 83.6%
Administrative expense
ratio:
Calculated using
operating revenue..... 19.8% 20.6% 21.2% 24.2% 26.3% 26.6% 25.3%
Calculated using
operating revenue and
premium equivalents... 14.4% 14.7% 15.3% 16.9% 17.8% 18.7% 18.7%
Return on revenue....... 2.8% 2.2% 2.6% 0.7% 3.0% (3.0)% 1.8%
Return on revenue--
continuing operations.. 2.8% 2.2% 2.6% 0.8% 3.1% 1.5% 2.7%
Return on equity........ N/A N/A 12.6% 2.7% 10.7% (10.1)% 6.0%
Members (000s).......... 7,779 7,030 7,270 6,265 5,167 5,261 4,078
Ratio of earnings to
fixed charges(6)....... 8.49 5.80 7.03 3.00 11.33 5.50 11.69
Pro forma ratio of
earnings to fixed
charges(6)(7).......... 6.78 -- 5.52 -- -- -- --
Balance Sheet Data
Cash and investments.... $4,029.6 $3,418.4 $ 3,714.6 $2,972.4 $2,805.1 $2,415.6 $2,123.4
Total assets............ 5,838.0 5,364.0 5,708.5 4,816.2 4,359.2 4,131.9 4,085.8
Policy liabilities...... 1,593.8 1,625.5 1,698.3 1,431.1 1,118.1 1,143.9 1,231.5
Debt.................... 597.7 597.5 597.7 522.2 302.1 305.9 245.9
Total policyholders'
surplus(8)............. 2,063.9 1,756.3 1,919.8 1,660.9 1,702.5 1,524.7 1,625.2
--------
(1) On October 27, 1999 and November 16, 1999 Anthem acquired New Hampshire-
Vermont Health Service, formerly d/b/a Blue Cross Blue Shield of New
Hampshire, and Rocky Mountain Hospital and Medical Service, Inc., formerly
d/b/a Blue Cross and Blue Shield of Nevada/Colorado. On June 5, 2000,
Anthem acquired Associated Hospital Service of Maine, formerly d/b/a Blue
Cross and Blue Shield of Maine. These acquisitions were accounted for as
purchases and the net assets and results of operations have been included
in our consolidated financial statements from the respective purchase
dates. Below is information for the six months ended June 30, 2001 and 2000
and for the years ended December 31, 2000 and 1999 that is included in
Anthem's consolidated financial statements for the acquisitions that were
completed in those periods:
As of and for the Six Months Ended June 30,
---------------------------------------------------------------------
2001 2000
----------------------------------- ---------------------------------
Total Operating (000s) Total Operating (000s)
Revenues Gain Assets Members Revenues Loss Assets Members
-------- --------- -------- ------- -------- --------- ------ -------
BCBS-ME................. $ 457.6 $ 3.0 $ 326.4 496 $ 59.6 $(2.5) $264.8 468
======== ===== ======== ===== ====== ====== ====== ===
As of and for the Year Ended December 31,
---------------------------------------------------------------------
2000 1999
----------------------------------- ---------------------------------
Total Operating (000s) Total Operating (000s)
Revenues Gain Assets Members Revenues Loss Assets Members
-------- --------- -------- ------- -------- --------- ------ -------
BCBS-NH................. $ 591.0 $11.6 $ 316.8 479 $ 77.9 $ (0.3) $250.6 366
BCBS-CO/NV.............. 678.6 6.5 545.8 595 76.9 (3.4) 521.5 486
BCBS-ME................. 489.4 8.7 339.5 487 -- -- -- --
-------- ----- -------- ----- ------ ------ ------ ---
Total................... $1,759.0 $26.8 $1,202.1 1,561 $154.8 $ (3.7) $772.1 852
======== ===== ======== ===== ====== ====== ====== ===
Operating gain (loss) consists of operating revenue less benefit expense
and administrative expense.
33
(2) The 1999 administrative expense includes a non-recurring charge of $41.9
million related to the settlement agreement with the Office of Inspector
General. See Note 14 to our audited consolidated financial statements.
(3) During 1999, Anthem reached agreements with the states of Kentucky, Ohio
and Connecticut to resolve any questions as to whether Anthem or the
predecessor/successor entities were in possession of property that was
impressed with a charitable trust. The endowment of non-profit foundations
reflects contributions made for the benefit of charitable foundations in
these states. See Note 3 to our audited consolidated financial statements.
(4) The benefit expense ratio represents benefit expense as a percentage of
premium revenue. The administrative expense ratio represents administrative
expense as a percentage of operating revenue and has also been presented as
a percentage of operating revenue and premium equivalents. Return on
revenue represents net income (loss) as a percentage of total revenues.
Return on revenue--continuing operations represents income from continuing
operations as a percentage of total revenues. Return on equity, which is
only presented for annual periods, represents net income (loss) as a
percentage of the average of the sum of policyholders' surplus at the
beginning and the end of the period.
(5) Operating revenue and premium equivalents is a measure of the volume of
business serviced by Anthem that is commonly used in the health benefits
industry to allow for a comparison of operating efficiency among companies.
It is calculated by adding to premiums, administrative fees and other
revenue the amount of claims attributable to non-Medicare, self-funded
health business where Anthem provides a complete array of customer service,
claims administration and billing and enrollment services. The self-funded
claims included for the six months ended June 30, 2001 and 2000 were
$1,887.4 million and $1,594.3 million, respectively, and for the years
ended December 31, 2000, 1999, 1998, 1997 and 1996 were $3,256.6 million,
$2,611.0 million, $2,597.7 million, $2,159.3 million and $1,765.0 million,
respectively.
(6) For purposes of this computation, earnings are defined as pretax earnings
from continuing operations before adjustment for minority interest, plus
interest expense, and amortization of debt discount and expense related to
indebtedness. Fixed charges are interest expense, including amortization of
debt discount and expense on indebtedness.
(7) For purposes of the pro forma ratio of earnings to fixed charges, fixed
charges also reflect interest payments on the debentures included in the
units at a rate of 5.95% ($11.9 million and $6.0 million for the year ended
December 31, 2000 and for the six months ended June 30, 2001, respectively)
and amortization of underwriting discounts and estimated unit offering
expenses ($3.0 million and $1.5 million for the year ended December 31,
2000 and for the six months ended June 30, 2001, respectively). The pro
forma ratio of earnings to fixed charges has been presented to give effect
to the additional fixed charges related to the issuance of the units. The
pro forma ratio does not give effect to any pro forma earnings resulting
from the use of the net proceeds from the units offering.
(8) Policyholders' surplus represents shareholders' equity prior to
demutualization.
34
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION
The unaudited pro forma consolidated financial information presented below
gives effect to (i) the demutualization, including the issuance of 54,861,000
shares of common stock to Anthem Insurance's eligible statutory members (net of
45,139,000 shares for which eligible statutory members receive cash in lieu of
shares), (ii) the offering of 48,000,000 shares of Anthem, Inc. common stock at
the initial public offering price of $36.00 per share (before deducting the
estimated underwriting discount and offering expenses payable by us), and (iii)
the offering of 4,000,000 units at $50.00 per unit, as if the demutualization
and the offerings had occurred as of June 30, 2001 for purposes of the
unaudited pro forma consolidated balance sheet, and as of January 1, 2000 for
purposes of the unaudited pro forma consolidated income statements for the year
ended December 31, 2000 and the six months ended June 30, 2001. Prior to the
demutualization, "shareholders' equity" represents consolidated policyholders'
surplus of Anthem.
The pro forma information does not take into account the sale of up to
7,200,000 shares of our common stock and up to 600,000 units which the
underwriters in the offerings have the option to purchase from us to cover
over-allotments. The pro forma information also assumes that no additional cash
payments (which could be up to a maximum of $162.5 million, at the initial
public offering price of $36.00 per share) will be made to eligible statutory
members pursuant to the cash "top up" provisions of the plan of conversion.
The pro forma information reflects gross proceeds of $1,728.0 million and
estimated net proceeds of $182.5 million that we expect to receive from this
offering. From the gross proceeds, we estimate that we will pay $1,434.0
million to eligible statutory members in cash in lieu of shares that would
otherwise be issued to such eligible statutory members in the demutualization,
$79.5 million will be applied to underwriting discounts and $32.0 million as
other offering and additional demutualization expenses. We will retain the
balance of the net proceeds from this offering for general corporate purposes.
The pro forma information also reflects gross proceeds of $200.0 million from
the issuance of units, less underwriting discounts and estimated offering
expenses aggregating $9.0 million, resulting in net proceeds from the offering
of units of $191.0 million, all of which would be used for cash payments to
eligible statutory members in the demutualization. See "Use of Proceeds."
We will account for the demutualization using the historical carrying values
of Anthem's assets and liabilities.
We based the pro forma information on available information and on
assumptions that management believes are reasonable and that reflect the
effects of these transactions. We provide the pro forma information for
informational purposes only and this information should not be construed to be
indicative of our consolidated financial position or our consolidated results
of operations had these transactions been consummated on the dates assumed.
This information does not represent a projection or forecast of our
consolidated financial position or consolidated results of operations for
future dates or periods. You should read the pro forma information in
conjunction with the historical consolidated financial statements of Anthem
beginning on page F-1 and with the information set forth under "The Plan of
Conversion," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "The Business of Anthem" included elsewhere in this
prospectus.
35
UNAUDITED PRO FORMA
CONSOLIDATED STATEMENTS OF INCOME
($ in Millions, except share data)
Six Months Ended June 30, 2001 Year Ended December 31, 2000
-------------------------------------------------- --------------------------------------------------
The The
Demutualization Demutualization
Anthem and Initial The Unit Anthem Pro Anthem and Initial The Unit Anthem Pro
Historical Public Offering Offering Forma Historical Public Offering Offering Forma
---------- --------------- -------- ----------- ---------- --------------- -------- -----------
Revenues
Premiums.......... $4,542.8 $ -- $ -- $ 4,542.8 $7,737.3 $ -- $ -- $ 7,737.3
Administrative
fees............. 430.3 -- -- 430.3 755.6 -- -- 755.6
Other revenue..... 22.6 -- -- 22.6 50.6 -- -- 50.6
-------- ----- ----- ----------- -------- ----- ----- -----------
Total operating
revenue.......... 4,995.7 -- -- 4,995.7 8,543.5 -- -- 8,543.5
Net investment
income........... 109.0 -- (1) -- 109.0 201.6 -- (1) -- 201.6
Net realized gains
(losses) on
investments...... (10.9) -- -- (10.9) 25.9 -- -- 25.9
Gain on sale of
subsidiary
operations....... 25.0 -- -- 25.0 -- -- -- --
-------- ----- ----- ----------- -------- ----- ----- -----------
5,118.8 -- -- 5,118.8 8,771.0 -- -- 8,771.0
-------- ----- ----- ----------- -------- ----- ----- -----------
Expenses
Benefit expense... 3,870.8 -- -- 3,870.8 6,551.0 -- -- 6,551.0
Administrative
expense.......... 991.6 -- -- 991.6 1,808.4 -- -- 1,808.4
Interest expense.. 28.0 -- 7.5 (2) 35.5 54.7 -- 14.9 (2) 69.6
Amortization of
goodwill and
other intangible
assets........... 15.7 -- -- 15.7 27.1 -- -- 27.1
Demutualization
expenses......... 3.0 (3.0)(3) -- -- -- -- -- --
-------- ----- ----- ----------- -------- ----- ----- -----------
4,909.1 (3.0) 7.5 4,913.6 8,441.2 -- 14.9 8,456.1
-------- ----- ----- ----------- -------- ----- ----- -----------
Income before
income taxes and
minority interest.. 209.7 3.0 (7.5) 205.2 329.8 -- (14.9) 314.9
Income taxes
(credit)......... 68.6 -- (2.6)(2) 66.0 102.2 -- (5.2)(2) 97.0
Minority interest
(credit)......... (1.9) -- -- (1.9) 1.6 -- -- 1.6
-------- ----- ----- ----------- -------- ----- ----- -----------
Net income ....... $ 143.0 $ 3.0 $(4.9) $ 141.1 $ 226.0 $ -- $(9.7) $ 216.3
======== ===== ===== =========== ======== ===== ===== ===========
Income per share.. $ 1.37 $ 2.10
=========== ===========
Shares used in
calculating per
share amount..... 102,861,000(4) 102,861,000(4)
=========== ===========
See accompanying notes.
36
UNAUDITED PRO FORMA
CONSOLIDATED BALANCE SHEET
($ in Millions)
June 30, 2001
---------------------------------------------------------------------------------
As Adjusted The Initial Anthem
Anthem The for The Public The Unit Pro
Historical Demutualization Demutualization Offering Offering Forma
---------- --------------- --------------- ----------- -------- --------
Assets
Current assets:
Investments........... $3,790.7 $ -- $ 3,790.7 $ -- $ -- $3,790.7
Cash and cash
equivalents.......... 238.9 (1,625.0)(5) (1,386.1) 1,616.5 (6) 191.0(7) 421.4
Premium and self
funded receivables... 498.5 -- 498.5 -- -- 498.5
Reinsurance
receivables.......... 78.9 -- 78.9 -- -- 78.9
Other receivables..... 194.5 -- 194.5 -- -- 194.5
Income tax
receivables.......... 7.4 -- 7.4 -- -- 7.4
Other current assets.. 33.4 -- 33.4 -- -- 33.4
-------- --------- --------- -------- ------ --------
Total current
assets............. 4,842.3 (1,625.0) 3,217.3 1,616.5 191.0 5,024.8
Other noncurrent
investments............ 13.1 -- 13.1 -- -- 13.1
Restricted cash and
investments............ 51.1 -- 51.1 -- -- 51.1
Property and equipment.. 409.6 -- 409.6 -- -- 409.6
Goodwill and other
intangible assets...... 480.4 -- 480.4 -- -- 480.4
Other noncurrent
assets................. 41.5 -- 41.5 -- -- 41.5
-------- --------- --------- -------- ------ --------
Total assets........ $5,838.0 $(1,625.0) $ 4,213.0 $1,616.5 $191.0 $6,020.5
======== ========= ========= ======== ====== ========
Liabilities and shareholders'
equity
Liabilities
Current liabilities:
Total policy
liabilities.......... $1,593.8 $ -- $ 1,593.8 $ -- $ -- $1,593.8
Unearned income....... 321.2 -- 321.2 -- -- 321.2
Accounts payable and
accrued expenses..... 269.0 22.0 (8) 291.0 (22.0)(6) -- 269.0
Bank overdrafts....... 281.6 -- 281.6 -- -- 281.6
Income taxes payable.. 34.6 -- 34.6 -- -- 34.6
Other current
liabilities.......... 283.7 -- 283.7 -- -- 283.7
-------- --------- --------- -------- ------ --------
Total current
liabilities........ 2,783.9 22.0 2,805.9 (22.0) -- 2,783.9
Long term debt, less
current portion........ 597.5 -- 597.5 -- -- 597.5
Debentures included in
units.................. -- -- -- -- 191.0(7) 191.0
Retirement benefits..... 187.5 -- 187.5 -- -- 187.5
Other noncurrent
liabilities............ 205.2 -- 205.2 -- -- 205.2
-------- --------- --------- -------- ------ --------
Total liabilities... 3,774.1 22.0 3,796.1 (22.0) 191.0 3,965.1
Shareholders' equity
Common stock............ -- 0.5 (9) 0.5 0.5 (6) -- 1.0
Additional paid in
capital................ -- 344.1 (9) 344.1 1,638.0 (6) -- 1,982.1
Retained earnings....... 1,991.6 (1,991.6)(9) -- -- -- --
Accumulated other
comprehensive income... 72.3 -- 72.3 -- -- 72.3
-------- --------- --------- -------- ------ --------
Total shareholders'
equity............. 2,063.9(10) (1,647.0) 416.9 1,638.5 -- 2,055.4
-------- --------- --------- -------- ------ --------
Total liabilities
and shareholders'
equity............. $5,838.0 $(1,625.0) $ 4,213.0 $1,616.5 $191.0 $6,020.5
======== ========= ========= ======== ====== ========
See accompanying notes.
37
NOTES TO UNAUDITED PRO FORMA
CONSOLIDATED FINANCIAL STATEMENTS
(1) Although such data is not reflected within the pro forma income statement,
the initial public offering net proceeds of $182.5 million would have
generated some level of net investment income during the income statement
periods shown.
(2) The charge to interest expense in the pro forma consolidated statement of
income reflects interest payments on the debentures included in the units
at a rate of 5.95% ($11.9 million and $6.0 million for the year ended
December 31, 2000 and for the six months ended June 30, 2001, respectively)
and amortization of underwriting discounts and estimated unit offering
expenses ($3.0 million and $1.5 million for the year ended December 31,
2000 and for the six months ended June 30, 2001, respectively). The income
tax benefit related to such charges is $5.2 million and $2.6 million for
the year ended December 31, 2000 and for the six months ended June 30,
2001, respectively.
(3) The demutualization expenses of $3.0 million incurred during the six months
ended June 30, 2001 have been eliminated as they resulted directly from the
demutualization and will not have a continuing impact on operations. In
addition, subsequent to the demutualization, we will incur additional
expenses associated with servicing our shareholder base, including mailing
and printing fees. As these expenses are not directly related to the
transaction, they have not been reflected within the unaudited pro forma
consolidated statements of income.
(4) Estimated total shares of common stock outstanding after the initial
public offering is calculated as follows:
Number of
Shares
-----------
Shares allocated to eligible statutory members................ 100,000,000
Less: estimated shares allocated to eligible statutory members
who receive cash in lieu of shares........................... 45,139,000
-----------
Shares issued to eligible statutory members................... 54,861,000
Shares issued in the offering................................. 48,000,000
-----------
Total shares of common stock outstanding...................... 102,861,000
===========
(5) Represents estimated $1,625.0 million cash paid to certain eligible
statutory members who receive cash in lieu of shares of common stock.
(6) Represents the gross proceeds of $1,728.0 million from the issuance of
48,000,000 shares of common stock in the offering at the initial public
offering price of $36.00 per share less underwriting discounts of $79.5
million and estimated other offering and additional demutualization
expenses of $32.0 million.
(7) Represents gross proceeds of $200.0 million from the issuance of the
units, less underwriting discounts and estimated unit offering expenses
aggregating $9.0 million. The debentures included in the units are shown
as a separate caption on our pro forma consolidated balance sheet. The
proceeds from the units will be allocated to the underlying purchase
contracts and debentures based on their relative fair values at the
offering date.
(8) Represents estimated additional nonrecurring expenses of $22.0 million for
demutualization costs and expenses to be incurred at the date of the
unaudited pro forma consolidated balance sheet. We have shown the
additional nonrecurring expenses as a liability and a decrease to
38
retained earnings within the unaudited pro forma consolidated balance
sheet. The additional nonrecurring demutualization expenses have not been
reflected within the unaudited pro forma statements of income as they will
not have a continuing impact and will be recorded as expense from
continuing operations when actually incurred.
(9) Represents reclassification of retained earnings of the mutual insurance
company to reflect the demutualization as follows (in millions):
Historical retained earnings..................................... $1,991.6
Less cash used to fund payments to eligible statutory members in
lieu of issuing shares.......................................... 1,625.0
Less additional demutualization expenses--see Note 8............. 22.0
--------
Retained earnings related to eligible statutory members receiving
common stock.................................................... $ 344.6
========
(10) Anthem historical amounts represent "Policyholders' Surplus" prior to
demutualization.
39
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Introduction
We are one of the nation's largest health benefits companies and an
independent licensee of the Blue Cross Blue Shield Association, or BCBSA. We
offer Blue Cross Blue Shield, or BCBS, branded products to over seven million
members throughout Indiana, Kentucky, Ohio, Connecticut, New Hampshire, Maine,
Colorado and Nevada.
Our reportable segments are strategic business units delineated by
geographic areas within which we offer similar products and services. We manage
our business units with a local focus to address each geographic region's
unique market, regulatory and health care delivery characteristics. The regions
are: Midwest, which includes Indiana, Kentucky and Ohio; East, which includes
Connecticut, New Hampshire and Maine; and West, which includes Colorado and
Nevada.
In addition to our three geographic regions, we operate a Specialty segment
and an Other segment. Our Specialty segment includes business units providing
group life and disability insurance benefits, pharmacy benefit management,
dental administration services and third party occupational health services.
Our Other segment includes primarily AdminaStar Federal, a subsidiary which
administers Medicare programs in Indiana, Illinois, Kentucky and Ohio. The
Other segment also includes Anthem Alliance Health Insurance Company, a
subsidiary which primarily provided health care benefits and administration in
nine states for the Department of Defense's TRICARE program for military
families prior to our sale of the TRICARE operations on May 31, 2001.
Additionally, the Other segment includes intersegment revenue and expense
eliminations and corporate expenses not allocated to reportable segments.
We offer a diversified mix of managed care products, including Health
Maintenance Organizations or HMOs, Preferred Provider Organizations or PPOs,
and Point of Service or POS plans, as well as traditional indemnity products.
We also offer a broad range of managed care services and partially insured
products for self-funded employers, including underwriting, stop loss
insurance, actuarial services, provider network access, medical cost
management, claims processing and other administrative services. Our operating
revenue consists primarily of premiums from fully insured contracts, where we
indemnify our policyholders against loss, and administrative fees from self-
funded contracts, where our contract holders are wholly or partially self-
insured. Fees received for administration of Medicare programs are also
included in our administrative revenue. Other revenue consists primarily of
fees generated by our pharmacy benefit management company. Our benefit expense
consists primarily of outpatient and inpatient care costs, as well as pharmacy
benefit costs. All three components are affected both by unit costs (for
example, the cost of outpatient medical procedures and inpatient hospital
stays, and prescription drug prices) and utilization rates, which vary due to
the age and health of our members, as well as due to broader social and
lifestyle factors in the population as a whole.
Our results in 1999 and 2000 were significantly impacted by the acquisitions
of Blue Cross and Blue Shield of New Hampshire, or BCBS-NH, which we completed
on October 27, 1999, Blue Cross and Blue Shield of Colorado and Nevada, or
BCBS-CO/NV, which we completed on November 16, 1999, and Blue Cross and Blue
Shield of Maine, or BCBS-ME, which we completed on June 5, 2000. The
acquisitions were accounted for as purchases and the net assets and results of
operations have been included in our consolidated financial statements from the
respective dates of purchase. The following represents the contribution to our
total revenues, operating gain, assets and membership for the six months ended
June 30, 2001 and 2000 and for the years ended December 31, 2000 and 1999 of
the acquisitions that were completed in those periods.
40
As of and for the Six Months Ended June 30,
-------------------------------------------------------------------
2001 2000
--------------------------------- ---------------------------------
Total Operating (000s) Total Operating (000s)
Revenues Gain Assets Members Revenues Loss Assets Members
-------- --------- ------ ------- -------- --------- ------ -------
($ in Millions) ($ in Millions)
BCBS-ME.... $457.6 $3.0 $326.4 496 $59.6 $(2.5) $264.8 468
====== ==== ====== === ===== ===== ====== ===
As of and for the Year Ended December 31,
---------------------------------------------------------------------
2000 1999
----------------------------------- ---------------------------------
Total Operating (000s) Total Operating (000s)
Revenues Gain Assets Members Revenues Loss Assets Members
-------- --------- -------- ------- -------- --------- ------ -------
($ in Millions) ($ in Millions)
BCBS-NH................. $ 591.0 $11.6 $ 316.8 479 $ 77.9 $(0.3) $250.6 366
BCBS-CO/NV.............. 678.6 6.5 545.8 595 76.9 (3.4) 521.5 486
BCBS-ME................. 489.4 8.7 339.5 487 -- -- -- --
-------- ----- -------- ----- ------ ----- ------ ---
Total................... $1,759.0 $26.8 $1,202.1 1,561 $154.8 $(3.7) $772.1 852
======== ===== ======== ===== ====== ===== ====== ===
Operating gain (loss) consists of operating revenue less benefit expense and
administrative expense.
We sold our TRICARE operations to a subsidiary of Humana, Inc. on May 31,
2001. The results of our TRICARE operations are reported in our Other segment
(for Anthem Alliance Health Insurance Company), and in our Midwest business
segment, which assumed a portion of the TRICARE risk from May 1, 1998 to
December 31, 2000. The operating results for our TRICARE operations for 2000,
1999, and 1998 were as follows and include both the Anthem Alliance Health
Insurance Company and Midwest business segment results:
Year Ended December
31,
--------------------
2000 1999 1998
------ ------ ------
($ in Millions)
Operating revenue..................................... $353.9 $292.4 $240.7
Operating gain........................................ 3.9 5.1 5.4
On May 30, 2001, we signed a definitive agreement with BCBS-KS, pursuant to
which BCBS-KS will become a subsidiary of ours. Subject to the approval of
BCBS-KS policyholders, the approval of the BCBSA, the approval of the Kansas
Department of Insurance and other regulatory approvals, the transaction is
expected to close in early 2002. The operating results for BCBS-KS for 2000,
1999 and 1998 were as follows:
Year Ended December
31,
-----------------------
2000 1999 1998
-------- ------ ------
($ in Millions)
Total revenues..................................... $1,026.0 $920.0 $851.0
Net income (loss).................................. 5.8 (7.0) 40.2
You should read this "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in conjunction with our audited
consolidated financial statements and accompanying notes for the years ended
December 31, 2000, 1999 and 1998 and our unaudited consolidated financial
statements and accompanying notes for the periods ended June 30, 2001 and 2000,
both included in this prospectus.
MEMBERSHIP--Six Months Ended June 30, 2001 Compared to Six Months Ended June
30, 2000
Our membership data presented below are unaudited and in certain instances
include management's estimates of the number of members represented by each
contract at the end of the period rounded to the nearest thousand.
41
Of our customer types listed below, "Large group" consists of those
customers with 51 or more eligible employees, while "Small group" consists of
those customers with one to 50 employees. Individual members include those in
our under age 65 business and our Medicare Supplement (age 65 and over)
business. Our National customers consist of employer groups which have multi-
state locations and require partnering with other Blue Cross and Blue Shield
plans for administration and/or access to non-Anthem provider networks.
Included within the National business are our "Blue Card" customers who
represent enrollees of health plans marketed by other Blue Cross and Blue
Shield Plans who receive health care services in Anthem's Blue Cross and Blue
Shield licensed markets. Under this arrangement, Anthem, as the "host plan,"
receives fees from the "home plan" for providing claims and other
administrative services for these members. Medicare + Choice members have
enrolled in coverages that are managed care alternatives for the Medicare
program. The Federal Employee Program, or FEP, provides health insurance
coverage to United States government employees and their dependents. Medicaid
members have enrolled in coverages that are managed care alternatives for the
Medicaid program. Our TRICARE program provided managed care services to active
and retired military personnel and their dependents. The TRICARE business was
sold to Humana, Inc. on May 31, 2001. At June 30, 2000, our TRICARE membership
totaled 125,000, was fully insured and included in our Midwest region.
Blue Card membership is calculated based on the amount of Blue Card
administrative fees we receive from the Blue Card members' home plans.
Generally, the administrative fees we receive are based on the number and type
of claims processed and a portion of the network discount on those claims. The
administrative fees are then divided by an assumed per member per month, or
PMPM, factor in order to calculate the number of members. The assumed PMPM
factor is based on an estimate of Anthem's experience and BCBSA guidelines.
Self-funded products are offered to customers, generally larger employers,
with the ability and desire to retain some or all of the risk associated with
their employees' health care costs.
The following table presents membership data by region, customer type and
funding type as of June 30, 2001 and June 30, 2000.
MEMBERSHIP
Total Total
June 30, June 30, Total Total
2001 2000 Change % Change
-------- -------- ------ ---------
(In Thousands)
Region
Midwest.............................. 4,826 4,496 330 7.3%
East................................. 2,216 1,952 264 13.5
West................................. 737 582 155 26.6
----- ----- ---- ------
Total.............................. 7,779 7,030 749 10.7%
===== ===== ==== ======
Customer Type
Large group.......................... 2,786 2,547 239 9.4%
Small group.......................... 807 731 76 10.4
Individual........................... 674 647 27 4.2
National............................. 2,877 2,367 510 21.5
Medicare + Choice.................... 101 103 (2) (1.9)
Federal Employee Program............. 426 411 15 3.6
Medicaid............................. 108 99 9 9.1
TRICARE.............................. -- 125 (125) (100.0)
----- ----- ---- ------
Total.............................. 7,779 7,030 749 10.7%
===== ===== ==== ======
Funding Type
Fully insured........................ 3,740 3,682 58 1.6%
Self-funded.......................... 4,039 3,348 691 20.6
----- ----- ---- ------
Total.............................. 7,779 7,030 749 10.7%
===== ===== ==== ======
42
Membership increased 749,000, or 10.7%, primarily due to growth in National
business, including a significant increase in enrollment in BlueCard programs.
Excluding TRICARE, membership increased 12.7%. Large group membership increased
239,000, or 9.4%, with growth in all regions primarily reflecting the success
of our PPO products, as more employer groups desire the additional choices our
PPO product offers. The 76,000, or 10.4%, growth in Small group business from
June 30, 2000 reflects management initiatives to increase Small group
membership, including revised commission structures, product offerings, brand
promotion and enhanced relationships with our brokers. Small group business
generally has higher profit margins than Large group business.
Medicare + Choice membership decreased as we withdrew from the Medicare +
Choice program in Connecticut effective January 1, 2001 due to losses in this
line of business in that market. At June 30, 2000 and December 31, 2000,
membership in Medicare + Choice in Connecticut was 24,000 and 18,000,
respectively. Offsetting this decrease was growth in Medicare + Choice
membership in Ohio, where many competitors have left the market and we are one
of the few remaining companies offering this product. We decided to remain in
selected markets for Medicare + Choice in Ohio because we believe that with a
critical mass of membership in those selected markets in Ohio, we can achieve
improved results.
Individual membership increased primarily due to additional Medicare
Supplement business in our East region and additional individual (under age 65)
business in our Midwest region. Medicare Supplement sales increased as a result
of approximately 6,000 members converting from our Medicare + Choice product,
which was terminated effective January 1, 2001 in Connecticut, to one of our
Medicare Supplement products in Connecticut.
Self-funded membership increased primarily due to the increase in BlueCard
utilization. Fully insured membership, excluding TRICARE, grew by 183,000
members, or 5.1%, due to growth in both Large and Small group businesses.
Midwest membership, excluding TRICARE, grew 10.4% primarily from growth in
BlueCard utilization, Large group and National account sales. East membership
grew primarily due to increased sales of Small group and growth in BlueCard
utilization. West's membership growth was primarily due to increased BlueCard
utilization.
43
Results of Operations for the Six Months Ended June 30, 2001 Compared to the
Six Months Ended June 30, 2000
The following table presents our consolidated results of operations for the
six months ended June 30, 2001 and 2000:
Six Months Ended
June 30,
------------------
2001 2000 $ Change % Change
-------- -------- -------- --------
($ in Millions)
Operating revenue and premium
equivalents (1).................. $6,883.1 $5,559.0 $1,324.1 23.8%
======== ======== ======== =======
Premiums.......................... $4,542.8 $3,589.3 $ 953.5 26.6%
Administrative fees............... 430.3 356.5 73.8 20.7%
Other revenue..................... 22.6 18.9 3.7 19.6%
-------- -------- -------- -------
Total operating revenue......... 4,995.7 3,964.7 1,031.0 26.0%
Benefit expense................... 3,870.8 3,080.6 790.2 25.7%
Administrative expense............ 991.6 817.5 174.1 21.3%
-------- -------- -------- -------
Total operating expense......... 4,862.4 3,898.1 964.3 24.7%
-------- -------- -------- -------
Operating gain.................... 133.3 66.6 66.7 100.2%
Net investment income............. 109.0 95.0 14.0 14.7%
Net realized gains (losses) on
investments...................... (10.9) 6.5 (17.4) NM (2)
Gain on sale of subsidiary
operations (TRICARE)............. 25.0 -- 25.0 NM (2)
Interest expense.................. 28.0 27.0 1.0 3.7%
Amortization of intangibles....... 15.7 11.4 4.3 37.7%
Demutualization expenses.......... 3.0 -- 3.0 NM (2)
-------- -------- -------- -------
Income before taxes and minority
interest......................... 209.7 129.7 80.0 61.7%
Income taxes...................... 68.6 38.9 29.7 76.3%
Minority interest (credit)........ (1.9) 0.5 (2.4) NM (2)
-------- -------- -------- -------
Net income........................ $ 143.0 $ 90.3 $ 52.7 58.4%
======== ======== ======== =======
Benefit expense ratio (3)......... 85.2% 85.8% (60) bp(4)
Administrative expense ratio: (5)
Calculated using operating
revenue (6).................... 19.8% 20.6% (80) bp(4)
Calculated using operating
revenue and premium equivalents
(7)............................ 14.4% 14.7% (30) bp(4)
Operating margin (8).............. 2.7% 1.7% 100 bp(4)
--------
(1) Operating revenue and premium equivalents is a measure of the volume of
business commonly used in the health insurance industry to allow for a
comparison of operating efficiency among companies. It is calculated by
adding to premiums, administrative fees and other revenue the amount of
claims attributable to non-Medicare, self-funded health business where we
provide a complete array of customer service, claims administration and
billing and enrollment services. Self-funded claims included in operating
revenue and premium equivalents for the six months ended June 30, 2001 were
$1,887.4 million and for the six months ended June 30, 2000 were $1,594.3
million.
(2) NM = Not meaningful.
(3) Benefit expense ratio = Benefit expense / Premiums.
(4) bp = basis point, one hundred basis points = 1%.
(5) While we include two calculations of administrative expense ratio, we
believe that administrative expense ratio including premium equivalents is
a better measure of efficiency as it eliminates changes in the ratio caused
by changes in our mix of insured and self-funded business. All discussions
and explanations related to administrative expense ratio will be related to
administrative expense ratio including premium equivalents.
(6) Administrative expense / Operating revenue.
(7) Administrative expense / Operating revenue and premium equivalents.
(8) Operating margin = Operating gain / Total operating revenue.
44
Premiums increased $953.5 million, or 26.6%, to $4,542.8 million in 2001 in
part due to the acquisition of BCBS-ME in June 2000 and the additional risk
recaptured as of January 1, 2001 by Anthem Alliance Health Insurance Company
for their TRICARE business. Prior to January 1, 2001, the TRICARE business had
been partially reinsured with other insurance companies. On January 1, 2001
Anthem Alliance Health Insurance Company retained 90% of the total risk for the
contract. The TRICARE business was sold on May 31, 2001. Excluding the
acquisition of BCBS-ME and the sale of our TRICARE business, premiums increased
$422.1 million, or 12.0%, primarily due to premium rate increases and higher
membership in the Midwest and East regions. Midwest premiums increased $266.6
million, or 13.0%, while East premiums increased $119.2 million, or 10.6%.
Midwest premiums increased primarily due to higher membership and premium rate
increases in our group accounts (both Large group and Small group) and higher
membership in Medicare + Choice. East premiums increased primarily due to
premium rate increases and higher membership in group business.
Administrative fees increased $73.8 million, or 20.7%, from $356.5 million
in 2000 to $430.3 million in 2001, with $30.7 million of this increase from the
acquisition of BCBS-ME. Excluding acquisitions and dispositions, administrative
fees increased $47.1 million, or 16.9%, primarily from membership growth in
National self-funded business. Excluding acquisitions and divestitures, other
revenue increased $2.3 million, or 12.2%, primarily due to higher mail order
revenues at Anthem Prescription Management, or APM. APM is our pharmacy benefit
manager and provides its services to other Anthem affiliates. These services
include contracting with retail pharmacies and providing mail order pharmacy
services.
Benefit expense increased $790.2 million, or 25.7%, in 2001 primarily due to
the acquisition of BCBS-ME and the additional risk assumed by Anthem Alliance
Health Insurance Company for TRICARE on January 1, 2001. Excluding acquisitions
and dispositions, benefit expense increased $304.8 million, or 10.2%, due to
higher average membership and increasing cost of care. Cost of care trends were
driven primarily by higher utilization of outpatient services and higher
prescription drug costs. Our benefit expense ratio decreased 60 basis points
from 85.8% in 2000 to 85.2% in 2001 primarily because premium rates increased
at a higher rate than benefit costs. Excluding acquisitions and dispositions,
our benefit expense ratio decreased 140 basis points from 85.6% in 2000 to
84.2% in 2001.
Outpatient cost increases have varied among regions and products and have
generally ranged from 15% to 20% in the first six months of 2001 over the first
six months of 2000. These increases have resulted from both increased
utilization and higher unit costs. Increased utilization reflects an industry-
wide trend towards a broader range of medical procedures being performed
without overnight hospital stays, as well as an increasing customer awareness
of, and demand for, diagnostic procedures such as magnetic resonance imagings,
or MRI's. In addition, improved medical technology has allowed more complicated
medical procedures to be performed on an outpatient basis rather than on an
inpatient (hospitalized) basis, increasing both utilization rates and unit
costs.
Prescription drug cost increases have varied among regions and by product,
but generally ranged from 10% to 15% in the first six months of 2001 over the
first six months of 2000, primarily due to introduction of new, higher cost
drugs as well as higher overall utilization as a result of increases in direct-
to-consumer advertising by pharmaceutical companies. In response to increasing
prescription drug costs, we have implemented a "three-tiered" drug program and
expanded use of formularies for our members. "Three-tiered" drug programs
reflect benefit designs that have three co-payment levels which depend on the
drug selected. Generic drugs have the lowest co-payment, brand name drugs
included in the drug formulary have a higher co-payment, and brand name drugs
not included in the drug formulary have the highest co-payment. Drug
formularies are a list of prescription drugs that have been reviewed and
selected for their quality and efficacy by a committee of practicing physicians
and clinical pharmacists. Through our pharmacy benefit design, we encourage use
of these listed brand name and generic drugs to ensure members receive quality
and cost-effective medication.
45
While growth in inpatient costs has been flat or in low single digits for
several years, we cannot guarantee that this trend will continue. Hospitals
have taken a more aggressive stance in their contracting with health insurance
companies as a result of reduced hospital reimbursements from Medicare and
pressure to recover the costs of additional investments in new medical
technology and facilities.
Administrative expense increased $174.1 million, or 21.3%, in 2001 primarily
due to the acquisition of BCBS-ME. Excluding acquisitions and dispositions,
administrative expense increased $111.7 million, or 15.3%, primarily due to
higher commissions and premium taxes, which vary with premium, additional costs
associated with higher membership and investments in technology.
Our administrative expense ratio decreased 30 basis points primarily due to
operating revenue increasing faster than administrative expense. Excluding
acquisitions and dispositions, our administrative expense ratio would have
increased 30 basis points largely due to increased mail order prescription
volumes at APM in 2001 and the cost of temporary help to reduce health claim
inventory in the West in the first quarter of 2001.
Net investment income increased $14.0 million, or 14.7%, primarily due to
higher overall investment portfolio balances. The higher portfolio balances
included net cash generated from operations, as well as cash generated from
improved balance sheet management, such as quicker collection of receivables
and sales of non-core assets. Excluding acquisitions and dispositions, net
investment income increased $9.1 million, or 9.8%.
During 2001, our investment portfolio generated a net yield of 5.90%
compared with a net yield of 5.96% in 2000. We define our net yield as earned
income divided by the amortized cost of our investments. The decrease of six
basis points was primarily due to lower returns on our fixed maturity
securities portfolio, in line with overall market conditions. As returns on
fixed maturity portfolios are dependent on market interest rates and changes in
interest rates are not easily predictable, there is no certainty that past
investment performance will be repeated in the future.
Net realized capital gains (losses) changed from $6.5 million in 2000 to
$(10.9) million in 2001 primarily due to $28.9 million in unrealized losses on
equity securities being recognized as other than temporary impairment. These
losses were partially offset by gains resulting from higher turnover in the
fixed maturity portfolio, which benefited from lower interest rates in 2001.
Net realized capital losses from sale and other than temporary loss recognition
of equity securities were $22.3 million in 2001 versus net realized capital
gains of $19.3 million in 2000. Net realized capital gains from sale of fixed
maturity securities were $11.4 million in 2001 versus net realized capital
losses of $12.8 million in 2000. Net gains or losses on investments are
influenced by market conditions when an investment is sold, and will vary from
year to year. We and our equity portfolio managers make decisions regarding
equity investments to ensure that the portfolios mirror the S&P 400 and S&P 500
indices, excluding in each case tobacco stocks.
Gain on sale of subsidiary operations of $25.0 million relates to the sale
of our TRICARE business to Humana on May 31, 2001.
Interest expense increased $1.0 million, or 3.7%, primarily reflecting
increased net borrowings following our private placement of $300.0 million
principal amount of surplus notes in January 2000.
Amortization of intangibles increased $4.3 million, or 37.7%, primarily due
to amortization expense associated with the acquisition of BCBS-ME.
Demutualization expenses of $3.0 million were incurred in the first six
months of 2001 in connection with our plan to demutualize.
Income before taxes and minority interest increased $80.0 million, or 61.7%,
as a result of improvement in operating results in all business segments.
46
Income tax expense increased $29.7 million, or 76.3%, due to higher income
before taxes. Our effective income tax rate in 2001 was 32.7% versus 30.0% in
2000. The rate is lower than statutory effective tax rate in both periods
primarily as a result of changes in our deferred tax valuation allowance. The
effective tax rate increased in 2001 primarily due to the effect of higher
income before taxes and slightly higher state income tax rates. As the amount
of income before taxes increases, the effect of permanent tax differences on
our income tax rate is reduced.
Net income increased $52.7 million, or 58.4%, primarily due to the
improvement in operating results, gain on sale of subsidiary operations, and
higher investment income and was partially offset by net realized investment
losses, all as described above. Excluding the gain on sale of subsidiary
operations ($16.3 million after tax) and the acquisition of BCBS-ME, net income
increased $30.0 million, or 32.6%.
Midwest
The following table presents the Midwest region's results of operations for
the six months ended June 30, 2001 and 2000:
Six Months Ended
June 30,
------------------
2001 2000 $ Change % Change
-------- -------- -------- --------
($ in Millions)
Operating revenue and premium
equivalents...................... $3,797.0 $3,360.9 $436.1 13.0%
======== ======== ====== ========
Premiums.......................... $2,313.0 $2,046.4 $266.6 13.0%
Administrative fees............... 152.8 123.7 29.1 23.5%
Other revenue..................... 0.9 1.3 (0.4) (30.8)%
-------- -------- ------ --------
Total operating revenue........ 2,466.7 2,171.4 295.3 13.6%
Benefit expense................... 1,952.8 1,748.7 204.1 11.7%
Administrative expense............ 428.9 386.5 42.4 11.0%
-------- -------- ------ --------
Total operating expense........ 2,381.7 2,135.2 246.5 11.5%
-------- -------- ------ --------
Operating gain................. $ 85.0 $ 36.2 $ 48.8 134.8%
======== ======== ====== ========
Benefit expense ratio (1)......... 84.4% 85.5% (110) bp(2)
Administrative expense ratio:
Calculated using operating rev-
enue (3)...................... 17.4% 17.8% (40) bp(2)
Calculated using operating rev-
enue and
premium equivalents (4)....... 11.3% 11.5% (20) bp(2)
Operating margin (5).............. 3.4% 1.7% 170 bp(2)
Membership (in thousands)......... 4,826 4,496 7.3%
--------
(1) Benefit expense ratio = Benefit expense / Premiums.
(2) bp = basis point, one hundred basis points = 1%.
(3) Administrative expense / Operating revenue.
(4) Administrative expense / Operating revenue and premium equivalents.
(5) Operating margin = Operating gain / Total operating revenue.
Our Midwest region assumed a portion of the risk for Anthem Alliance Health
Insurance Company's TRICARE contract until December 31, 2000. Effective January
1, 2001, Anthem Alliance Health Insurance Company reassumed this risk. For the
first six months of 2000, our Midwest region received $55.3 million of premium
income, no administrative fees and other income, incurred $53.2 million of
benefit expense and $3.8 million of administrative expense, resulting in a $1.7
million operating loss on the TRICARE contract. There were also 125,000 TRICARE
members included in Midwest region's membership at June 30, 2000 and no members
at June 30, 2001.
47
Premiums increased $266.6 million, or 13.0%, in 2001. Excluding TRICARE,
premiums increased $321.9 million, or 16.2%, in 2001 primarily due to higher
premiums PMPM that accounted for $209.9 million of the increase and the effect
of higher average membership throughout the year. Excluding TRICARE, premiums
PMPM increased from $166.29 in 2000 to $188.23 in 2001 primarily due to premium
rate increases in group (both Large group and Small group) and Medicare +
Choice businesses. Increases in group and Medicare + Choice premiums accounted
for $258.2 million, or 80.2%, of the increase in premiums. Group PMPM premiums
increased 13.9% from $153.58 in 2000 to $174.97 in 2001 primarily due to
premium rate increases. Average insured group membership was essentially flat.
Medicare + Choice PMPM premiums increased 8.3% from $458.66 in 2000 to $496.69
in 2001 due to the aging of our Medicare + Choice population, resulting in
higher premiums. We received higher premiums starting in March 2001 as a result
of the Benefit Improvement and Protection Act of 2000, or BIPA. BIPA increased
the level of reimbursements from the government to payors that participate in
the Medicare + Choice program. Average Medicare + Choice membership increased
41.5% to 90,000 due to reduced competition in the Ohio marketplace as a result
of competitors discontinuing their participation in this product.
Administrative fees increased 23.5% from $123.7 million in 2000 to $152.8
million in 2001, primarily due to increased membership in both our National and
BlueCard business and our Large group Administrative Services Only, or ASO,
business. National business benefited from higher sales while our Large group
business benefited from growth in existing accounts.
Benefit expense increased $204.1 million, or 11.7%, in 2001. Excluding
TRICARE, benefit expense increased $257.3 million, or 15.2%, primarily due to
higher benefit expense PMPM (12.2%) and the effect of higher average membership
throughout the year. Excluding TRICARE, benefit expense PMPM increased from
$141.61 in 2000 to $158.91 in 2001, primarily due to higher outpatient costs
and higher prescription drug costs. Outpatient cost increases averaged
approximately 15% in 2001 due to continued trends of shifting services to
outpatient settings versus inpatient/facility based services. These cost
increases have come from both increased utilization and higher unit costs.
Improved medical technology has allowed more complicated medical procedures,
such as cardiac catheterization and angioplasties, to be performed on an
outpatient basis.
Prescription drug costs increased approximately 13% in 2001 primarily due to
introduction of new, higher cost drugs and increases in direct-to-consumer
advertising by pharmaceutical companies. We believe that utilization of a
three-tiered drug program for our members has helped contain the increase in
prescription drug costs.
While outpatient and prescription drug costs increased significantly in
2000, inpatient costs increased approximately 7%. Admissions per 1,000 members
increased less than 2%, while average length of stay was generally unchanged.
These factors were slightly offset by modest reimbursement increases under the
terms of our hospital contracting agreements.
Midwest's benefit expense ratio decreased 110 basis points from 85.5% in
2000 to 84.4% in 2001. Excluding TRICARE, the benefit expense ratio decreased
80 basis points as the growth in premium PMPM of 13.2% exceeded growth in
benefit expense PMPM of 12.2% as discussed above.
Administrative expense increased $42.4 million, or 11.0%, in 2001. Excluding
TRICARE, administrative expense increased $46.2 million, or 12.1%, primarily
due to higher commission and premium taxes related to higher premiums, as well
as costs associated with higher membership and incentive compensation costs
related to above target financial performance. The administrative expense ratio
decreased 20 basis points primarily due to higher premiums as discussed above.
48
East
The following table presents our East region's results of operations for
the six months ended June 30, 2001 and 2000. BCBS-ME is included from its
acquisition date of June 5, 2000.
Six Months Ended
June 30,
------------------
2001 2000 $ Change % Change
-------- -------- -------- --------
($ in Millions)
Operating revenue and premium
equivalents....................... $2,285.0 $1,596.5 $688.5 43.1%
======== ======== ====== =======
Premiums........................... $1,658.3 $1,175.6 $482.7 41.1%
Administrative fees................ 99.6 57.9 41.7 72.0%
Other revenue...................... 0.8 2.5 (1.7) (68.0)%
-------- -------- ------ -------
Total operating revenue.......... 1,758.7 1,236.0 522.7 42.3%
Benefit expense.................... 1,418.1 1,012.2 405.9 40.1%
Administrative expense............. 292.2 189.7 102.5 54.0%
-------- -------- ------ -------
Total operating expense.......... 1,710.3 1,201.9 508.4 42.3%
-------- -------- ------ -------
Operating gain................... $ 48.4 $ 34.1 $ 14.3 41.9%
======== ======== ====== =======
Benefit expense ratio (1).......... 85.5% 86.1% (60) bp(2)
Administrative expense ratio:
Calculated using operating
revenue (3)..................... 16.6% 15.3% 130 bp(2)
Calculated using operating
revenue and premium equivalents
(4)............................. 12.8% 11.9% 90 bp(2)
Operating margin (5)............... 2.8% 2.8% --
Membership (in thousands).......... 2,216 1,952 13.5%
--------
(1) Benefit expense ratio = Benefit expense / Premiums.
(2) bp = basis point, one hundred basis points = 1%.
(3) Administrative expense / Operating revenue.
(4) Administrative expense / Operating revenue and premium equivalents.
(5) Operating margin = Operating gain / Total operating revenue.
Premiums increased $482.7 million, or 41.1%, primarily due to the
acquisition of BCBS-ME in June 2000 ($363.5 million). Excluding the effect of
acquisitions and the exit from the Medicare + Choice business on December 31,
2000, premiums increased $204.9 million, or 19.8%, in 2001 due to premium rate
increases in group business and higher average membership. Group PMPM premiums
increased 12.1% from $203.93 in 2000 to $228.69 in 2001 primarily due to
premium rate increases in Large group. Average insured group membership
increased approximately 15% in 2001.
Administrative fees increased $41.7 million, or 72.0%, from $57.9 million
in 2000 to $99.6 million in 2001. The BCBS-ME acquisition contributed $29.1
million of this increase. Excluding the effect of acquisitions, administrative
fees increased $12.6 million, or 23.7%, primarily due to higher ASO
membership.
Benefit expense increased $405.9 million, or 40.1%, primarily due to the
acquisition of BCBS-ME. The BCBS-ME acquisition contributed $316.7 million of
this increase. Excluding the effect of acquisitions and Medicare + Choice
business, benefit expense increased $158.3 million, or 17.7%, in 2001
primarily due to higher average membership (12%) and to a lesser extent higher
benefit expense PMPM.
Benefit expense PMPM, excluding acquisitions and Medicare + Choice
business, increased 5.3% from $168.21 in 2000 to $177.10 in 2001. Prescription
drug costs and professional costs were the
49
biggest drivers of increased benefit expense PMPM. Prescription drug PMPM costs
increased over 10% due to introduction of new, higher cost drugs and increases
in direct to consumer advertising by pharmaceutical companies. We believe
utilization of a three-tiered drug program for our members has helped contain
prescription drug costs. Professional PMPM costs increased approximately 10%
primarily due to increased utilization resulting from direct to consumer drug
advertising which drives physician office visits and increased awareness of
preventive medicine.
Inpatient PMPM costs decreased approximately 1% due to lower admissions per
1,000 members and shorter average length of stay and the effect of hospital
recontracting. Outpatient PMPM costs increased about 6% primarily due to higher
utilization caused by the continuing shift of services from an inpatient basis
to an outpatient setting. While a decrease in inpatient utilization helped
contain increases in benefit expense PMPM, there is no guarantee that our East
region will experience these favorable trends in the future. Hospitals have
taken a more aggressive stance during contract negotiations to recover reduced
hospital reimbursements from Medicare and the costs of additional investments
in new medical technology and facilities.
On an overall basis, the benefit expense ratio decreased 60 basis points
from 86.1% in 2000 to 85.5% in 2001, however, excluding acquisitions and
Medicare + Choice, the benefit expense ratio decreased 150 basis points. This
decrease was primarily due to premium PMPM growth of 7.1% outpacing benefit
expense PMPM growth of 5.3%, as discussed above.
Administrative expense increased $102.5 million, or 54.0%, and the
administrative expense ratio increased 90 basis points primarily due to the
acquisition of BCBS-ME. Excluding acquisitions, administrative expense
increased $31.5 million, or 17.7%, and the administrative expense ratio
increased 40 basis points primarily due to higher commissions and premium
taxes, systems consolidation costs, investments in technology and higher
incentive compensation costs related to above target financial performance.
West
The following table presents our West region's results of operations for the
six months ended June 30, 2001 and 2000:
Six Months
Ended June
30,
--------------
2001 2000 $ Change % Change
------ ------ -------- --------
($ in Millions)
Operating revenue and premium
equivalents.......................... $384.7 $343.7 $41.0 11.9%
====== ====== ===== ========
Premiums.............................. $327.3 $278.1 $49.2 17.7%
Administrative fees................... 29.6 24.9 4.7 18.9%
Other revenue......................... -- 0.1 (0.1) (100.0)%
------ ------ ----- --------
Total operating revenue............. 356.9 303.1 53.8 17.7%
Benefit expense....................... 275.3 240.2 35.1 14.6%
Administrative expense................ 78.5 61.6 16.9 27.4%
------ ------ ----- --------
Total operating expense............. 353.8 301.8 52.0 17.2%
------ ------ ----- --------
Operating gain...................... $ 3.1 $ 1.3 $ 1.8 138.5%
====== ====== ===== ========
Benefit expense ratio (1)............. 84.1% 86.4% (230) bp(2)
Administrative expense ratio:
Calculated using operating revenue
(3)................................ 22.0% 20.3% 170 bp(2)
Calculated using operating revenue
and premium equivalents (4)........ 20.4% 17.9% 250 bp(2)
Operating margin (5).................. 0.9% 0.4% 50 bp(2)
Membership (in thousands)............. 737 582 26.6%
50
--------
(1) Benefit expense ratio = Benefit expense / Premiums.
(2) bp = basis point, one hundred basis points = 1%.
(3) Administrative expense / Operating revenue.
(4) Administrative expense / Operating revenue and premium equivalents.
(5) Operating margin = Operating gain / Total operating revenue.
West entered into an agreement with Sloan's Lake HMO in Colorado for the
conversion of Sloan's Lake HMO business effective January 1, 2001. The terms of
the agreement include payment to Sloan's Lake for each member selecting
Anthem's product at the group's renewal date and continuing as an Anthem member
for a minimum of nine months. Through June 30, 2001, we added approximately
31,000 members from Sloan's Lake, most of which were added in May and June.
Premiums and benefit expense associated with Sloan's Lake members were
approximately $6.3 million and $5.3 million, respectively, for the first six
months of 2001.
Premiums increased $49.2 million, or 17.7%, primarily due to increased sales
and premium rate increases in group business and membership from Sloan's Lake.
Group premiums PMPM increased 29.8% from $124.99 in 2000 to $162.29 in 2001
primarily due to rate increases to offset increasing benefit expense. Average
group insured membership increased 11.1%. Offsetting the group premium PMPM
increase was a 4.3% decline in FEP premium PMPM from $216.69 in 2000 to $207.42
in 2001 primarily due to a decrease in FEP claims paid. FEP premiums vary with
claim payment level. Also lowering the growth in West premiums PMPM was a
change in the mix of business with lower Medicare + Choice membership, which
has higher premium PMPM, and higher National business which has lower premium
PMPM. Average insured membership increased 12.0% in 2001.
Administrative fees increased $4.7 million, or 18.9%, from $24.9 million in
2000 to $29.6 million in 2001 primarily due to growth in BlueCard revenues.
Benefit expense increased $35.1 million, or 14.6%, primarily due to higher
membership and higher benefit expense PMPM in our group business. Benefit
expense PMPM for group business increased 23.6% from $106.69 in 2000 to $131.91
in 2001 reflecting higher outpatient and professional costs. Overall benefit
expense PMPM increased 2.4% as lower benefit expense for FEP business and
better claims experience in Medicare + Choice offset the increase in group
benefit expense PMPM.
Outpatient costs increased over 33% primarily due to increased utilization
and higher unit costs as medical services were moved from an inpatient to an
outpatient setting. Outpatient utilization increased over 20%. In response to
these escalating costs, we have implemented new contracts with providers,
particularly in high cost areas such as radiology and oncology, to better
contain the growth in outpatient costs. Professional costs have increased
approximately 14% primarily due to increased utilization and new fee schedules
reflecting higher reimbursement to physicians.
Inpatient PMPM costs increased 2% reflecting shorter lengths of stay,
offsetting an increase in hospital admissions. Pharmacy PMPM costs increased 3%
reflecting the West's switch to APM from a third party pharmacy benefit manager
early in 2001. Based on national pharmacy trends, we cannot guarantee that
future pharmacy costs for West will not increase.
Administrative expense increased $16.9 million, or 27.4%, and administrative
expense ratio increased 250 basis points primarily due to higher membership,
higher commission costs, higher temporary help costs and higher incentive
compensation costs. Commission costs increased due to both higher membership
and costs associated with implementation of a broker retention program.
Temporary help costs were incurred in early 2001 in order to reduce claims
inventory. Incentive compensation costs increased as West became fully
integrated into Anthem's incentive compensation program as of January 1, 2001.
51
Specialty
Our Specialty segment includes business units providing group life insurance
benefits, pharmacy benefit management, third party occupational health and
dental administration services.
The following table presents our Specialty segment's results of operations
for the six months ended June 30, 2001 and 2000:
Six Months
Ended June
30,
--------------
2001 2000 $ Change % Change
------ ------ -------- -----------
($ in Millions)
Operating revenue and premium
equivalents....................... $188.4 $165.0 $ 23.4 14.2%
====== ====== ====== ===========
Premiums from life and disability.. $ 47.4 $ 64.3 $(16.9) (26.3)%
Administrative fees................ 18.0 14.8 3.2 21.6%
Other revenue...................... 120.1 82.3 37.8 45.9%
------ ------ ------ -----------
Total operating revenue.......... 185.5 161.4 24.1 14.9%
Benefit expense.................... 31.8 51.2 (19.4) (37.9)%
Administrative expense............. 137.8 100.4 37.4 37.3%
------ ------ ------ -----------
Total operating expense.......... 169.6 151.6 18.0 11.9%
------ ------ ------ -----------
Operating gain................... $ 15.9 $ 9.8 $ 6.1 62.2%
====== ====== ====== ===========
Benefit expense ratio (1).......... 67.1% 79.6% (1,250) bp (2)
Administrative expense ratio:
Calculated using operating reve-
nue (3)......................... 74.3% 62.2% 1,210 bp (2)
Calculated using operating
revenue and premium equivalents
(4)............................. 73.1% 60.8% 1,230 bp (2)
Operating margin (5)............... 8.6% 6.1% 250 bp (2)
--------
(1) Benefit expense ratio = Benefit expense / Premiums.
(2) bp = basis point, one hundred basis points = 1%.
(3) Administrative expense / Operating revenue.
(4) Administrative expense / Operating revenue and premium equivalents.
(5) Operating margin = Operating gain / Total operating revenue.
Life and disability premiums decreased $16.9 million, or 26.3%, primarily
due to the termination of a large life group on December 31, 2000. This group
accounted for $20.2 million of life and disability premiums for the first six
months of 2000. Excluding this group, life and disability premiums would have
increased $3.3 million, or 7.5%, primarily due to growth in new sales in our
Midwest and West regions. Administrative fees increased $3.2 million, or 21.6%,
primarily due to increased membership served by APM.
Other revenue increased $37.8 million, or 45.9%, primarily from APM. In
2001, APM began to provide pharmacy benefit management services to BCBS-ME,
BCBS-CO and BCBS-CT. Excluding these new agreements, other revenue increased
primarily due to higher mail and retail volumes related to increased membership
and utilization from existing Anthem customers. In total, mail service
membership increased 47% while retail service membership increased 90%. Mail
service prescription volume increased 36% and retail prescription volume
increased 37%.
Benefit expense decreased $19.4 million, or 37.9%, due to the termination of
the large life group discussed above. This group accounted for $21.2 million of
benefit expense for the first six months of 2000. Excluding this group, benefit
expense would have increased $1.8 million, or 6.0%, primarily due to additional
life membership. The benefit expense ratio was 67.1% in 2001, a significant
52
decrease from 2000 primarily due to the termination of the large life group.
Excluding this group, the benefit expense ratio decreased 90 basis points from
68.0% in 2000 primarily due to improved underwriting results in our West life
business.
Administrative expense increased $37.4 million, or 37.3%, primarily due to
increased membership serviced by APM. Administrative expense ratio increased
significantly due to APM comprising a larger percentage of Anthem's specialty
business segment. APM incurs a higher administrative expense ratio than our
life and disability operations.
Other
Various ancillary business units (reported with the Other segment) include
AdminaStar Federal which administers Medicare Parts A and B programs in
Indiana, Illinois, Kentucky and Ohio, and Anthem Alliance Health Insurance
Company which provided health care benefits and administration in nine states
for the Department of Defense's TRICARE program for military families. The
TRICARE operations were sold on May 31, 2001 and are included in the results
below. The Other segment also includes intersegment revenue and expense
eliminations plus corporate expenses not allocated to reportable segments.
The following table presents the results of operations for the Other segment
for the six months ended June 30, 2001 and 2000:
Six Months
Ended June
30,
--------------
2001 2000 $ Change % Change
------ ------ -------- --------
($ in Millions)
Operating revenue and premium equiva-
lents.................................. $228.0 $ 92.9 $135.1 145.4%
====== ====== ====== =====
Premiums................................ $196.8 $ 24.9 $171.9 690.4%
Administrative fees..................... 130.3 135.2 (4.9) (3.6)%
Other revenue (expense)................. (99.2) (67.3) (31.9) 47.4%
------ ------ ------ -----
Total operating revenue............... 227.9 92.8 135.1 145.6%
Benefit expense......................... 192.8 28.3 164.5 581.3%
Administrative expense.................. 54.2 79.3 (25.1) (31.7)%
------ ------ ------ -----
Total operating expense............... 247.0 107.6 139.4 129.6%
------ ------ ------ -----
Operating loss.......................... $(19.1) $(14.8) $ (4.3) 29.1%
====== ====== ====== =====
Premiums increased $171.9 million, or 690%, due to higher premiums at Anthem
Alliance Health Insurance Company. This increase was primarily related to our
assumption of additional risk under our TRICARE contract with the Department of
Defense. Also, we received additional premiums from the Department of Defense
in connection with a global settlement related to a series of bid price
adjustments, requests for equitable adjustments and change orders filed during
the past two years under our TRICARE contract. Predominantly all premiums
received in our Other segment relate to the TRICARE business which was sold on
May 31, 2001 ($196.5 million in 2001 and $28.6 million in 2000).
Administrative fees decreased $4.9 million, or 3.6%, primarily due to
TRICARE business. Excluding the effect of TRICARE, administrative fees
increased $1.2 million, or 1.9%, due to AdminaStar Federal performing
additional customer service activities for Medicare beneficiaries. Excluding
the elimination of intersegment revenues in 2001 and 2000 of $96.9 million and
$67.9 million, respectively, other revenue decreased $2.9 million to a $2.3
million loss in 2001 from $0.6 million in 2000 primarily due to a write-off of
$3.0 million of previously capitalized systems development costs.
53
Benefit expense increased $164.5 million, or 581%, primarily due to the
assumption of additional risk under our TRICARE contract. Also, we incurred
additional benefit expense related to the global settlement under our TRICARE
contract as mentioned above. Benefit expense associated with the global
settlement offset most of the increase in premiums associated with the global
settlement and bid price adjustments.
Excluding intersegment administrative expense eliminations in 2001 and 2000
of $92.8 million and $70.9 million, respectively, administrative expense
decreased $3.2 million, or 2.1%, primarily due to TRICARE business being
included for five months in 2001 and six months in 2000. Excluding TRICARE,
administrative expense increased $9.8 million, or 12.9%, primarily due to
increased unallocated corporate expenses in 2001.
Certain corporate expenses are not allocated to our business segments. These
unallocated expenses accounted for $23.6 million in 2001 and $9.5 million in
2000, and primarily included such items as unallocated incentive compensation.
Excluding unallocated corporate expenses, operating gain was $4.5 million in
2001 versus a $5.3 million operating loss in 2000. Most of the improvement was
related to additional revenues from the global settlement with the Department
of Defense.
54
MEMBERSHIP--Year Ended December 31, 2000 Compared to Year Ended December 31,
1999
Our membership data presented below are unaudited and in certain instances
include management's estimates of the number of members at the end of the
period rounded to the nearest thousand.
The following table presents membership data by region, customer type and
funding type as of December 31, 2000 and 1999, comparing total and "same store"
membership respectively. We define "same store" membership as our membership at
a given year-end in a region or for a particular customer or funding type,
after excluding the impact of members obtained through acquisitions or
combinations during such year. As such, we believe that "same store" membership
data best captures the rate of organic growth of our operations year over year.
MEMBERSHIP
Same Total Same Store
Total BCBS-ME Store Total ------------ -----------
2000 Acquisition 2000 1999 Change % Change %
----- ----------- ----- ----- ------ ---- ------ ----
(In Thousands)
Region
Midwest............... 4,582 -- 4,582 4,382 200 4.6% 200 4.6%
East.................. 2,093 487 1,606 1,397 696 49.8 209 15.0
West.................. 595 -- 595 486 109 22.4 109 22.4
----- --- ----- ----- ----- ---- --- ----
Total............... 7,270 487 6,783 6,265 1,005 16.0% 518 8.3%
===== === ===== ===== ===== ==== === ====
Customer Type
Large group........... 2,634 278 2,356 2,249 385 17.1% 107 4.8%
Small group........... 775 62 713 637 138 21.7 76 11.9
Individual............ 650 84 566 586 64 10.9 (20) (3.4)
National.............. 2,468 32 2,436 2,106 362 17.2 330 15.7
Medicare + Choice..... 106 -- 106 96 10 10.4 10 10.4
Federal Employee
Program.............. 407 31 376 362 45 12.4 14 3.9
TRICARE............... 128 -- 128 129 (1) (0.8) (1) (0.8)
Medicaid.............. 102 -- 102 100 2 2.0 2 2.0
----- --- ----- ----- ----- ---- --- ----
Total............... 7,270 487 6,783 6,265 1,005 16.0% 518 8.3%
===== === ===== ===== ===== ==== === ====
Funding Type
Fully insured......... 3,789 360 3,429 3,354 435 13.0% 75 2.2%
Self-funded........... 3,481 127 3,354 2,911 570 19.6 443 15.2
----- --- ----- ----- ----- ---- --- ----
Total............... 7,270 487 6,783 6,265 1,005 16.0% 518 8.3%
===== === ===== ===== ===== ==== === ====
Same store membership increased 518,000, or 8.3%, from 1999 to 2000,
primarily due to growth in National business, including a significant increase
in enrollment in BlueCard programs. Small group business generally has higher
profit margins than Large group business. The 76,000, or 11.9%, growth in Small
group business in 2000 reflects management initiatives to increase Small group
membership, including revised commission structures, product offerings, brand
promotion and enhanced relationships with our brokers.
Medicare + Choice membership increased mostly due to growth in Ohio, where
many competitors have left the market and we are one of the few remaining
companies offering this product. We decided to remain in selected markets for
Medicare + Choice in Ohio because we believe that with a critical mass of
membership in those markets in Ohio, we can achieve improved results.
55
Individual membership dropped primarily due to a reduction in Medicare
Supplement business in our Midwest region. This block of business, which has
traditionally generated high profit margins, is shrinking due to terminations
of grandfathered policies, primarily mortality related, exceeding new sales.
Effective on January 1, 1992, CMS, then known as HCFA, required that new sales
of Medicare Supplement coverages be sold in the form of one of 10 standardized
policies, while persons with existing Medicare Supplement coverages could
retain their existing Medicare Supplement products, which generally had higher
profit margins than the new products. Since that time, our Medicare Supplement
membership has, through terminations of grandfathered policies and sales of new
policies, reached the point where at December 31, 2000, approximately 50% of
our Medicare Supplement membership in the Midwest was in the old plans and 50%
in the new plans. During 2001, we are introducing a line of competitive
Medicare Supplement policies in the Midwest in order to improve the growth of
this business and have modified the premium rate structures to improve the
attractiveness of these products in the marketplace.
Self-funded membership increased primarily due to the increase in BlueCard
utilization, while fully insured membership grew primarily as a result of the
growth in Small group membership sales.
Midwest membership grew in 2000 primarily from the growth in BlueCard
utilization discussed above, Large group and National account sales. East
membership grew primarily due to increased sales of Small group and growth in
BlueCard. Small group sales in our East region increased primarily due to the
withdrawal of two of our largest competitors from the New Hampshire market.
West membership growth was primarily due to higher BlueCard utilization.
We withdrew from the Medicare + Choice program in Connecticut effective
January 1, 2001 due to losses in this line of business. At December 31, 2000,
membership in the Medicare + Choice program in Connecticut was 18,000.
56
Results of Operations for the Year Ended December 31, 2000 Compared to the Year
Ended December 31, 1999
The following table presents our consolidated results of operations for the
years ended December 31, 2000 and 1999:
Year Ended
December 31,
-------------------
2000 1999 $ Change % Change
--------- -------- -------- --------
($ in Millions)
Operating revenue and premium
equivalents(1).................. $11,800.1 $8,691.6 $3,108.5 35.8%
========= ======== ======== ========
Premiums......................... $ 7,737.3 $5,418.5 $2,318.8 42.8%
Administrative fees.............. 755.6 611.1 144.5 23.6%
Other revenue.................... 50.6 51.0 (0.4) (0.8)%
--------- -------- -------- --------
Total operating revenue........ 8,543.5 6,080.6 2,462.9 40.5%
--------- -------- -------- --------
Benefit expense.................. 6,551.0 4,582.7 1,968.3 43.0%
Administrative expense........... 1,808.4 1,469.4 339.0 23.1%
--------- -------- -------- --------
Total operating expense........ 8,359.4 6,052.1 2,307.3 38.1%
--------- -------- -------- --------
Operating gain................... 184.1 28.5 155.6 NM(2)
Net investment income............ 201.6 152.0 49.6 32.6%
Net realized gains on
investments..................... 25.9 37.5 (11.6) (30.9)%
Interest expense................. 54.7 30.4 24.3 79.9%
Amortization of intangibles...... 27.1 12.7 14.4 113.4%
Endowment of non-profit
foundations..................... -- 114.1 (114.1) (100.0)%
--------- -------- -------- --------
Income from continuing operations
before taxes and minority
interest........................ 329.8 60.8 269.0 NM(2)
Income taxes..................... 102.2 10.2 92.0 NM(2)
Minority interest (credit)....... 1.6 (0.3) 1.9 NM(2)
--------- -------- -------- --------
Income from continuing
operations...................... 226.0 50.9 175.1 NM(2)
Discontinued operations, net of
income taxes Loss on disposal of
discontinued operations......... -- (6.0) 6.0 NM(2)
--------- -------- -------- --------
Net income..................... $ 226.0 $ 44.9 $ 181.1 NM(2)
========= ======== ======== ========
Benefit expense ratio(3)......... 84.7% 84.6% 10 bp(4)
Administrative expense ratio:
Calculated using operating
revenue(5).................... 21.2% 24.2% (300) bp(4)
Calculated using operating
revenue and premium
equivalents(6)................ 15.3% 16.9% (160) bp(4)
Operating margin(7)............ 2.2% 0.5% 170 bp(4)
--------
(1) Self-funded claims included in operating revenue and premium equivalents
for the year ended December 31, 2000 were $3,256.6 million and for the
year ended December 31, 1999 were $2,611.0 million.
(2) NM = Not meaningful.
(3) Benefit expense ratio = Benefit expense / Premiums.
(4) bp =basis point; one hundred basis points = 1%.
(5) Administrative expense /Operating revenue.
(6) Administrative expense / Operating revenue and premium equivalents.
(7) Operating margin = Operating gain / Total operating revenue.
57
Premiums increased by $2,318.8 million, or 42.8%, to $7,737.3 million in
2000 primarily due to the acquisitions of BCBS-NH and BCBS-CO/NV in the fourth
quarter of 1999 and BCBS-ME in June 2000. Excluding these acquisitions,
premiums increased by $870.5 million, or 16.5%, primarily due to premium rate
increases and higher membership in the Midwest and East regions. Midwest
premiums increased $473.8 million, or 12.7%, while East premiums increased
$353.4 million, or 24.9%. Midwest premiums increased primarily due to higher
membership and premium rate increases in our group accounts (both Large group
and Small group) and higher membership in Medicare + Choice. East premiums
increased primarily due to premium rate increases and higher membership in
group business, as well as the conversion of the State of Connecticut account
to fully insured from self-funded status in mid-1999.
Administrative fees increased $144.5 million, or 23.6%, from $611.1 million
in 1999 to $755.6 million in 2000, with $135.3 million of this increase
resulting from acquisitions of BCBS-NH, BCBS-CO/NV and BCBS-ME. In July 1999,
we sold two non-strategic businesses which combined had 1999 revenues of $12.8
million. Excluding acquisitions and divestitures, administrative fees increased
$20.6 million, or 3.5%, primarily from membership growth in National business.
Excluding acquisitions and divestitures, other revenue increased $6.0 million,
or 14.0%, primarily due to Anthem Alliance Health Insurance Company assuming
additional administrative functions under the TRICARE program.
Benefit expense increased $1,968.3 million, or 43.0%, in 2000, primarily due
to acquisitions. Excluding acquisitions, benefit expense increased $729.9
million, or 16.4%, due to increasing cost of care and the effect of higher
average membership throughout the year. Cost of care trends were driven
primarily by higher utilization of outpatient services and higher prescription
drug costs. Our benefit expense ratio increased 10 basis points from 84.6% in
1999 to 84.7% in 2000 due to the acquisition of BCBS-ME in 2000, which had a
higher benefit expense ratio than our other operations. Excluding acquisitions,
our benefit expense ratio remained constant at 84.6% in 2000 and 1999.
Outpatient cost increases ranged from 15% to 20% in 2000 over 1999. These
increases have resulted from both increased utilization and higher unit costs.
Increased utilization reflects an industry-wide trend towards a broader range
of medical procedures being performed without overnight hospital stays, as well
as an increasing customer awareness of and demand for diagnostic procedures
such as MRI's. In addition, improved medical technology has allowed more
complicated medical procedures to be performed on an outpatient basis rather
than on an inpatient basis, increasing both utilization rates and unit costs.
Prescription drug cost increases have varied among regions and by product,
but generally ranged from 12% to 20% in 2000 over 1999, primarily due to
introduction of new, higher cost drugs as well as higher overall utilization as
a result of increases in direct-to-consumer advertising by pharmaceutical
companies. In response to increasing prescription drug costs, we have
implemented a "three-tiered" drug program and expanded use of formularies for
our members.
Administrative expense increased $339.0 million, or 23.1%, in 2000,
primarily due to the acquisitions of BCBS-NH, BCBS-CO/NV and BCBS-ME.
Administrative expense in 1999 included $41.9 million resulting from a
settlement with the Office of Inspector General, or OIG, Health and Human
Services to resolve an investigation into alleged misconduct in the Medicare
fiscal intermediary operations in Connecticut during periods preceding BCBS-
CT's merger with Anthem. Excluding acquisitions and the effect of the OIG
settlement, administrative expense increased $75.6 million, or 5.4%, primarily
due to higher commissions and premium taxes, which vary with premium and higher
incentive compensation costs. Additionally, in December 2000, we made a $20.0
million contribution to the newly formed Anthem Foundation, Inc., which is a
charitable and educational not-for-proft corporation. Excluding these costs,
administrative expense would have been down slightly in 2000 due to
productivity improvements resulting from ongoing efforts to identify and
implement more efficient processes in our customer service and claims
operations.
58
Our administrative expense ratio decreased 160 basis points primarily due to
operating revenues increasing more than administrative expense. Excluding
acquisitions and the effect of the OIG settlement, our administrative expense
ratio would have decreased 120 basis points.
Net investment income increased $49.6 million, or 32.6%, primarily due to
higher rates of investment returns earned on our fixed income portfolio and
higher overall portfolio balances. The higher portfolio balances included net
cash resulting from acquisitions, net proceeds of $295.9 million from our
surplus note issuance in January 2000, as well as cash generated from
operations and from improved balance sheet management, such as more rapid
collection of receivables and sales of non-core assets. Excluding acquisitions,
net investment income increased $24.9 million, or 16.6%.
During 2000, our investment portfolio generated a net yield of 5.91%
compared with a net yield of 5.60% in 1999. We define our net yield as earned
income divided by the amortized cost of our investments. The increase of 31
basis points was primarily due to higher returns on our fixed income security
portfolio, in line with overall market conditions.
Net realized capital gains decreased $11.6 million, or 30.9%, in 2000.
Included in net realized capital gains in 1999 are capital losses of $20.5
million related to the sale of several non-core businesses. Excluding the
effect of the capital losses on dispositions, net realized capital gains
decreased $32.1 million, or 55.3%, primarily due to lower turnover in the
portfolio resulting in fewer capital gains. Net realized capital gains from
equities decreased 37.2% ($43.5 million in 2000 versus $69.3 million in 1999).
Net realized capital losses from fixed income securities increased 55.8% ($17.6
million loss in 2000 versus $11.3 million loss in 1999). Acquisitions had no
material effect on net realized capital gains. Net gains or losses on
investments are influenced by market conditions when an investment is sold, and
will vary from year to year as sales of investments are determined by cash flow
needs, as well as portfolio allocation decisions.
Interest expense increased $24.3 million, or 79.9%, primarily reflecting
increased net borrowings following our private placement of $300.0 million
principal amount of surplus notes in January 2000. The proceeds of our new
surplus notes were used to retire short-term borrowings which had been incurred
to finance the purchases of BCBS-NH and BCBS-CO/NV in late 1999 and to bolster
liquidity as a part of our Year 2000 readiness effort.
Amortization of intangibles increased $14.4 million, or 113.4%, primarily
due to amortization of goodwill associated with the acquisitions of BCBS-NH,
BCBS-CO/NV and BCBS-ME.
The endowment of non-profit foundations of $114.1 million in 1999
represented the expense of settlement of charitable asset claims brought by the
Attorneys General of the states of Ohio, Kentucky and Connecticut.
Income before taxes and minority interest increased $269.0 million as a
result of improvement in operating results in all business segments, and the
non-recurring endowment of non-profit foundations during 1999.
Income tax expense increased $92.0 million due to higher income before
taxes. Our effective income tax rate in 2000 was 31.0% versus 16.7% in 1999.
The rate is lower than the statutory effective tax rate in both periods
primarily as a result of changes in our deferred tax valuation allowance.
Excluding the after-tax endowment of non-profit foundations in 1999, net
income increased $109.3 million, or 93.7%, primarily due to the improvement in
operating results, acquisitions and higher investment income described above.
59
Midwest
The following table presents our Midwest region's results of operations for
the years ended December 31, 2000 and 1999:
Year Ended
December 31,
------------------
2000 1999 $ Change % Change
-------- -------- -------- --------
($ in Millions)
Operating revenue and premium
equivalents....................... $6,816.9 $5,892.2 $924.7 15.7%
======== ======== ====== =======
Premiums........................... $4,203.1 $3,729.3 $473.8 12.7%
Administrative fees................ 254.8 242.8 12.0 4.9%
Other revenue...................... 2.6 3.4 (0.8) (23.5)%
-------- -------- ------ -------
Total operating revenue.......... 4,460.5 3,975.5 485.0 12.2%
Benefit expense.................... 3,555.4 3,162.2 393.2 12.4%
Administrative expense............. 817.3 776.9 40.4 5.2%
-------- -------- ------ -------
Total operating expense.......... 4,372.7 3,939.1 433.6 11.0%
-------- -------- ------ -------
Operating gain................... $ 87.8 $ 36.4 $ 51.4 141.2%
======== ======== ====== =======
Benefit expense ratio(1)........... 84.6% 84.8% (20)bp(2)
Administrative expense ratio:
Calculated using operating
revenue(3)...................... 18.3% 19.5% (120)bp(2)
Calculated using operating
revenue and premium
equivalents(4).................. 12.0% 13.2% (120)bp(2)
Operating margin(5)................ 2.0% 0.9% 110bp(2)
Membership (in thousands).......... 4,582 4,382 4.6%
--------
(1) Benefit expense ratio = Benefit expense / Premiums.
(2) bp = basis point; one hundred basis points = 1%.
(3) Administrative expense / Operating revenue.
(4) Administrative expense / Operating revenue and premium equivalents.
(5) Operating margin = Operating gain / Total operating revenue.
Premiums increased $473.8 million, or 12.7%, primarily due to higher
premiums PMPM, which accounted for 12.2% of the increase, and the effect of
higher average membership throughout the year. Premiums PMPM increased from
$147.57 in 1999 to $165.08 in 2000 primarily due to premium rate increases in
group (both Large group and Small group) and Medicare + Choice businesses. The
increases in group and Medicare + Choice premiums accounted for $368.9 million,
or 77.9%, of the increase in premiums. Group premiums PMPM increased 12.9% from
$140.60 in 1999 to $158.76 in 2000 primarily due to premium rate increases.
Average insured group membership was essentially flat. Medicare + Choice PMPM
premiums increased 5.3% from $438.24 in 1999 to $461.58 in 2000 due to the
aging of our insured Medicare + Choice population in 2000, resulting in higher
premiums. We receive higher premiums from CMS as our Medicare + Choice
population ages. In addition, we received a premium rate increase from CMS of
approximately 3% at the beginning of 2000. Average Medicare + Choice membership
increased 27.7% due to reduced competition in the Ohio marketplace as a result
of competitors discontinuing their participation in the Medicare + Choice
product.
Administrative fees increased 4.9% from $242.8 million in 1999 to $254.8
million in 2000. In mid-1999, we sold our worker's compensation third party
administration business and a physician's group practice. Most of this increase
was from membership growth in National business. Excluding these dispositions
in 1999, administrative fees would have increased $23.4 million or 10.1%.
60
Benefit expense increased $393.2 million, or 12.4%, in 2000 primarily due to
higher benefit expense PMPM (11.9%) and the effect of higher average membership
(0.5%) throughout the year. Benefit expense PMPM increased from $125.13 in 1999
to $140.06 in 2000 primarily due to higher outpatient costs and higher
prescription drug costs. Outpatient cost increases averaged approximately 16%
in 2000 due to continued trends of shifting services to outpatient settings
versus inpatient/facility based services. These cost increases have come from
both increased utilization and higher unit costs. Improved medical technology
has allowed more complicated medical procedures, such as cardiac
catheterization and angioplasties, to be performed on an outpatient basis.
Prescription drug costs increased about 13% in 2000 primarily due to
introduction of new, higher cost drugs and increases in direct to consumer
advertising by pharmaceutical companies. Utilization of a three-tiered drug
program for our members has helped contain the increase in prescription drug
costs.
While outpatient and prescription drug costs increased significantly in
2000, inpatient costs increased approximately 3%. Admissions per 1,000 members
were generally unchanged, while average length of stay declined slightly in
2000. These factors were slightly offset by modest reimbursement increases
under the terms of our hospital contracting agreements.
Midwest's benefit expense ratio decreased 20 basis points from 84.8% in 1999
to 84.6% in 2000 as the growth in premium PMPM of 12.2% exceeded growth in
benefit expense PMPM of 11.9% as discussed above.
Administrative expense increased $40.4 million, or 5.2%, in 2000 primarily
due to higher commission and premium taxes related to higher premiums, as well
as incentive compensation costs related to above-target financial performance
and a contribution of $15.0 million to create the Anthem Foundation. Excluding
the additional incentive compensation and foundation contribution costs,
administrative expense was flat in 2000. The administrative expense ratio
decreased 120 basis points primarily due to higher premiums as discussed above.
61
East
The following table presents our East region's results of operations for the
years ended December 31, 2000 and 1999. BCBS-NH is included from its October
27, 1999 acquisition date and BCBS-ME is included from its June 5, 2000
acquisition date.
Year Ended
December 31,
------------------
2000 1999 $ Change % Change
-------- -------- -------- --------
($ in Millions)
Operating revenue and premium
equivalents...................... $3,751.2 $2,272.8 $1,478.4 65.1%
======== ======== ======== ========
Premiums.......................... $2,768.9 $1,495.4 $1,273.5 85.2%
Administrative fees............... 144.1 99.7 44.4 44.5%
Other revenue..................... 8.9 3.8 5.1 134.2%
-------- -------- -------- --------
Total operating revenue......... 2,921.9 1,598.9 1,323.0 82.7%
Benefit expense................... 2,332.4 1,259.9 1,072.5 85.1%
Administrative expense............ 485.7 339.9 145.8 42.9%
-------- -------- -------- --------
Total operating expense......... 2,818.1 1,599.8 1,218.3 76.2%
-------- -------- -------- --------
Operating gain (loss)........... $ 103.8 $ (0.9) $ 104.7 NM(1)
======== ======== ======== ========
Benefit expense ratio(2).......... 84.2% 84.3% (10) bp(3)
Administrative expense ratio:
Calculated using operating
revenue(4)..................... 16.6% 21.3% (470) bp(3)
Calculated using operating
revenue and premium
equivalents(5)................. 12.9% 15.0% (210) bp(3)
Operating margin(6)............... 3.6% (0.1)% 370 bp(3)
Membership (in thousands)......... 2,093 1,397 49.8%
--------
(1) NM = Not meaningful.
(2) Benefit expense ratio = Benefit expense / Premiums.
(3) bp = basis point; one hundred basis points = 1%.
(4) Administrative expense / Operating revenue.
(5) Administrative expense / Operating revenue and premium equivalents.
(6) Operating margin = Operating gain / Total operating revenue.
Premiums increased $1,273.5 million, or 85.2%, primarily due to the
acquisitions of BCBS-NH in October 1999 ($474.6 million) and BCBS-ME in June
2000 ($445.4 million) and the conversion of the State of Connecticut account
from self-funded to fully insured status in July 1999 ($197.8 million). Due to
the State of Connecticut's conversion, 2000 included a full year of premiums
versus six months of premiums (July through December) in 1999, since the new
funding arrangement was changed effective July 1999. For the first six months
of 1999, we recorded administrative fees for the State of Connecticut account,
which is consistent with accounting practices for Self-funded business.
Excluding the effect of acquisitions and the conversion of the State of
Connecticut account, premiums increased $155.7 million, or 12.5%, in 2000 due
to premium rate increases in group business and higher average membership.
Administrative fees increased $44.4 million, or 44.5%, from $99.7 million in
1999 to $144.1 million in 2000. The BCBS-NH and BCBS-ME acquisitions
contributed $66.6 million of this increase, while the conversion of the State
of Connecticut account resulted in a decline in administrative fees of
approximately $13.0 million. Excluding the effect of acquisitions and the
conversion of the State of Connecticut account, administrative fees decreased
$9.8 million, or 11.7%, primarily due to lower fees from Self-funded business
and our decision to discontinue our contract as the Medicare Part A
62
processor in Connecticut as of January 1, 2000. Self-funded administrative fees
fell $8.8 million, or 12.9%, primarily due to our focus on growing Fully
insured business. Medicare Part A fees were $3.0 million in 1999.
Benefit expense increased $1,072.5 million, or 85.1%, primarily due to the
acquisitions of BCBS-NH and BCBS-ME and the conversion of the State of
Connecticut account from self-funded to fully insured status in July 1999.
Excluding the effect of these acquisitions, benefit expense increased $285.7
million, or 23.9%, in 2000 due to the conversion of the State of Connecticut
account ($163.3 million) and higher average membership.
Benefit expense PMPM, excluding acquisitions, increased 5.1% in 2000.
Prescription drug PMPM costs increased over 8% due to the introduction of new,
higher cost drugs and increases in direct to consumer advertising by
pharmaceutical companies. Utilization of a three-tiered drug program for our
members has helped contain prescription drug costs.
Inpatient, outpatient and professional PMPM cost increases were 1.8%, 5.7%
and 5.1%, respectively. Utilization in all of these areas increased due to
higher respiratory and cardiology medical conditions, which resulted in both
higher admissions and increased additional follow-up treatment visits. The
increase in inpatient PMPM costs was also impacted by a slightly longer average
length of stay, offset by a decline in the average cost per inpatient visit.
On an overall basis, the benefit expense ratio decreased 10 basis points
from 84.3% in 1999 to 84.2% in 2000; however, excluding acquisitions, the
benefit expense ratio decreased 60 basis points. Excluding acquisitions, the
decrease in benefit expense ratio was primarily due to the effect of the
relatively modest trends discussed above.
Administrative expense increased $145.8 million, or 42.9%, primarily due to
the acquisitions of BCBS-NH and BCBS-ME. Excluding these acquisitions,
administrative expense decreased $35.0 million, or 10.8%, primarily due to a
one-time expense of $41.9 million in 1999 associated with the settlement of a
claim with respect to Medicare Part A claims processing related to activities
prior to Anthem's merger with BCBS-CT as discussed above. Excluding
acquisitions and the Medicare settlement, administrative expense increased $6.9
million, or 2.4%, primarily due to higher commissions and premium taxes,
investments in e-business technology development, higher incentive compensation
costs related to above-target financial performance and a contribution to
create the Anthem Foundation.
The administrative expense ratio in 2000 decreased 210 basis points
primarily due to the effect of the Medicare Part A settlement described above
(184 basis points). Excluding acquisitions and the Medicare settlement, the
administrative expense ratio decreased 80 basis points primarily due to higher
premiums as discussed above and productivity improvements implemented in the
last half of 1999. These productivity improvements are a result of ongoing
efforts to identify and implement more efficient processes in customer service
and claims operations.
63
West
Our Anthem West region was established in November 1999 following the
acquisition of BCBS-CO/NV. Results of this segment have been recorded in the
consolidated results from that date forward. The 1999 results include
approximately one and one-half months activity, while the 2000 results include
twelve months of results.
The following table presents our West region's results of operations for the
years ended December 31, 2000 and 1999:
Year Ended
December 31,
---------------
2000 1999(1) $ Change
------ ------- --------
($ in Millions)
Operating revenue and premium equivalents........ $686.9 $86.9 $600.0
====== ===== ======
Premiums......................................... $569.6 $64.2 $505.4
Administrative fees.............................. 52.8 1.7 51.1
Other revenue.................................... -- 6.8 (6.8)
------ ----- ------
Total operating revenue........................ 622.4 72.7 549.7
Benefit expense.................................. 491.7 55.0 436.7
Administrative expense......................... 128.2 21.2 107.0
------ ----- ------
Total operating expense........................ 619.9 76.2 543.7
------ ----- ------
Operating gain (loss).......................... $ 2.5 $(3.5) $ 6.0
====== ===== ======
Benefit expense ratio(2)......................... 86.3% 85.7%
Administrative expense ratio:
Calculated using operating revenue(3).......... 20.6% 29.2%
Calculated using operating revenue and premium
equivalents(4)................................ 18.7% 24.4%
Operating margin(5).............................. 0.4% (4.8)%
Membership (in thousands)........................ 595 486
--------
(1) Includes one and one-half months of activity in 1999.
(2) Benefit expense ratio = Benefit expense / Premiums.
(3) Administrative expense / Operating revenue.
(4) Administrative expense / Operating revenue and premium equivalents.
(5) Operating margin = Operating gain / Total operating revenue.
Operating results in the West improved in 2000, primarily due to reduced
administrative expense as a result of integration savings and cost reduction
programs as well as higher membership. Membership increased 22.4% due to higher
sales and better retention of business. These cost reduction programs included
reducing levels of management and improving productivity in customer service
and claims operations. The administrative expense ratio declined 570 basis
points as a result of lower administrative expenses and higher membership.
Benefit expense PMPM increased approximately 16% in 2000, primarily due to
higher outpatient and inpatient costs, reflecting increased utilization and
unit costs for both outpatient and inpatient services. In response to these
trends, our West region is seeking to implement new contracts with providers.
The improvement in the administrative expense ratio more than offset increased
benefit expense, resulting in a $6.0 million increase in operating results.
64
Specialty
The following table presents our Specialty segment's results of operations
for the years ended December 31, 2000 and 1999:
Year Ended
December 31,
--------------
2000 1999 $ Change % Change
------ ------ -------- --------
($ in Millions)
Operating revenue and premium
equivalents.......................... $338.7 $255.3 $83.4 32.7%
====== ====== ===== ========
Premiums from life and disability..... $123.7 $ 96.3 $27.4 28.5%
Administrative fees................... 31.8 14.6 17.2 117.8%
Other revenue......................... 176.8 138.2 38.6 27.9%
------ ------ ----- --------
Total operating revenue............. 332.3 249.1 83.2 33.4%
Benefit expense....................... 92.6 73.8 18.8 25.5%
Administrative expense................ 214.8 159.1 55.7 35.0%
------ ------ ----- --------
Total operating expense............. 307.4 232.9 74.5 32.0%
------ ------ ----- --------
Operating gain...................... $ 24.9 $ 16.2 $ 8.7 53.7%
====== ====== ===== ========
Benefit expense ratio(1).............. 74.9% 76.6% (170) bp(2)
Administrative expense ratio:
Calculated using operating
revenue(3)......................... 64.6% 63.9% 70 bp(2)
Calculated using operating revenue
and premium equivalents(4)......... 63.4% 62.3% 110 bp(2)
Operating margin(5)................... 7.5% 6.5% 100 bp(2)
--------
(1) Benefit expense ratio = Benefit expense / Premiums.
(2) bp = basis point; one hundred basis points = 1%.
(3) Administrative expense / Operating revenue.
(4) Administrative expense / Operating revenue and premium equivalents.
(5) Operating margin = Operating gain / Total operating revenue.
Life and disability premiums increased $27.4 million, or 28.5%, primarily
due to the acquisition of Rocky Mountain Life or RML, an affiliate of BCBS-
CO/NV. Excluding the acquisition of RML, premiums increased $4.5 million, or
4.8%, due to higher life sales in our Midwest region. Administrative fees
increased $17.2 million, or 117.8%, due to the acquisitions of Occupational
Healthcare Management Services, Inc., a worker's compensation third party
administration company, and Health Management Systems, Inc., a dental benefits
third party administration company, both subsidiaries of BCBS-CO/NV. Excluding
these acquisitions, administrative fees were essentially flat.
Other revenue increased $38.6 million, or 27.9%, primarily from APM. In
2000, APM began to provide pharmacy benefit management services to both BCBS-NH
and Anthem Alliance Health Insurance Company. These new markets for APM
generated an additional $3.5 million of other revenue in 2000. Excluding new
markets, other revenue increased primarily due to higher mail and retail
volumes related to increased membership and utilization. Mail service
membership increased 26% while retail service membership increased 80%. Mail
service prescription volume increased 15% and retail prescription volume
increased 39%.
Benefit expense increased $18.8 million, or 25.5%, due to the acquisition of
RML. Excluding the acquisition of RML, benefit expense increased $3.9 million,
or 5.4%, in line with the increase in life and disability premiums. The benefit
expense ratio was 74.9% in 2000, a 170 basis point decrease from 1999 primarily
due to the acquisition of RML, which generates a lower benefit expense ratio
than our other life business. Our other life business includes two large
customers that generate
65
higher benefit expense ratios as these two customers are retrospectively
experience rated. These higher benefit expense ratios are offset by a lower
administrative expense ratio on these two customers. One of these customers
terminated at the end of 1999, although this group had a small profit margin
and its termination should not impact future results.
Administrative expense increased $55.7 million, or 35.0%, as a result of the
acquisitions mentioned above and APM. Excluding acquisitions, administrative
expense increased $33.9 million, or 21.4%, primarily due to increased
membership and volume at APM. Administrative expense ratio increased 110 basis
points, primarily due to costs at APM associated with adding additional
customers in 2001.
Other
The following table presents the results of operations for our Other segment
for the years ended December 31, 2000 and 1999:
Year Ended
December 31,
----------------
2000 1999 $ Change % Change
------- ------- -------- --------
($ in Millions)
Operating revenue and premium
equivalents......................... $ 206.4 $ 184.4 $ 22.0 11.9%
======= ======= ====== =====
Premiums............................. $ 72.0 $ 33.3 $ 38.7 116.2%
Administrative fees.................. 272.1 252.3 19.8 7.8%
Other revenue (expense).............. (137.7) (101.2) (36.5) 36.1%
------- ------- ------ -----
Total operating revenue............ 206.4 184.4 22.0 11.9%
Benefit expense...................... 78.9 31.8 47.1 148.1%
Administrative expense............... 162.4 172.3 (9.9) (5.7)%
------- ------- ------ -----
Total operating expense............ 241.3 204.1 37.2 18.2%
------- ------- ------ -----
Operating loss..................... $ (34.9) $ (19.7) $(15.2) NM(1)
======= ======= ====== =====
--------
(1) NM = Not meaningful
Premiums increased $38.7 million, or 116.2%, primarily due to higher
premiums at Anthem Alliance Health Insurance Company related to amounts
received from the Department of Defense. These amounts were received in
connection with a global settlement related to a series of bid price
adjustments, requests for equitable adjustments and change orders filed during
the past two years with the Department of Defense under the TRICARE program.
Other administrative fees increased $19.8 million, or 7.8%, primarily due to
increased revenues at AdminaStar Federal related to performing additional
customer service activities for Medicare beneficiaries. Excluding intersegment
revenues in 2000 of $145.7 million and in 1999 of $104.3 million, other revenue
increased $4.9 million, or 158.1%, due to Anthem Alliance Health Insurance
Company's assuming additional administrative services related to the TRICARE
contract during 2000.
Benefit expense increased $47.1 million, or 148.1%, primarily due to the
services provided and risks assumed related to the global settlement received
by Anthem Alliance Health Insurance Company. Benefit expense associated with
the global settlement offset most of the increase in premiums associated with
the global settlement and bid price adjustments.
Excluding intersegment administrative expenses in 2000 of $154.1 million and
in 1999 of $112.1 million, administrative expense increased $32.1 million, or
11.3%, primarily due to expenses associated with AdminaStar Federal's
additional customer service activities and Anthem Alliance Health Insurance
Company's assuming additional administrative services.
Certain corporate expenses are not allocated to our business segments. These
unallocated expenses account for $39.9 million in 2000 and $26.7 million in
1999, and primarily include such items as unallocated incentive compensation
and other expenses associated with discontinued
66
operations. Excluding unallocated corporate expenses, operating gain was $5.0
million in 2000, $2.0 million, or 28.6%, less than in 1999. Most of the
decrease is due to higher non-reimbursable administrative expense at AdminaStar
Federal.
MEMBERSHIP--Year Ended December 31, 1999 Compared to Year Ended December 31,
1998
Our membership data presented below are unaudited and include estimates
based upon the number of contracts in place at the period-end date and an
actuarial estimate of the number of members represented by each contract. The
following table presents membership by region, customer type and funding type
as of December 31, 1999 and 1998, comparing total and "same store" (after
removing the impact of acquisitions) membership, respectively:
MEMBERSHIP
Same Total Same Store
Total Store Total ------------- ------------
1999 Acquisitions* 1999 1998 Change % Change %
----- ------------- ----- ----- ------ ----- ------ -----
(In Thousands)
Region
Midwest............... 4,382 -- 4,382 4,199 183 4.4% 183 4.4%
East.................. 1,397 366 1,031 968 429 44.3 63 6.5
West.................. 486 486 -- -- 486 -- -- --
----- --- ----- ----- ----- ----- --- -----
Total............... 6,265 852 5,413 5,167 1,098 21.3% 246 4.8%
===== === ===== ===== ===== ===== === =====
Customer Type
Large group........... 2,249 349 1,900 1,852 397 21.4% 48 2.6%
Small group........... 637 76 561 559 78 14.0 2 0.4
Individual............ 586 108 478 478 108 22.6 0 0.0
National.............. 2,106 213 1,893 1,696 410 24.2 197 11.6
Medicare + Choice..... 96 13 83 81 15 18.5 2 2.5
Federal Employee
Program.............. 362 89 273 268 94 35.1 5 1.9
TRICARE............... 129 -- 129 153 (24) (15.7) (24) (15.7)
Medicaid.............. 100 4 96 80 20 25.0 16 20.0
----- --- ----- ----- ----- ----- --- -----
Total............... 6,265 852 5,413 5,167 1,098 21.3% 246 4.8%
===== === ===== ===== ===== ===== === =====
Funding Type
Fully insured......... 3,354 552 2,802 2,791 563 20.2% 11 0.4%
Self-funded........... 2,911 300 2,611 2,376 535 22.5 235 9.9
----- --- ----- ----- ----- ----- --- -----
Total............... 6,265 852 5,413 5,167 1,098 21.3% 246 4.8%
===== === ===== ===== ===== ===== === =====
--------
* Represents acquisitions of BCBS-NH and BCBS-CO/NV.
Most of our membership growth in 1999 was due to the acquisitions of BCBS-NH
and BCBS-CO/NV.
Same store membership increased 246,000, or 4.8%, primarily due to a
significant increase in National BlueCard activity and growth in Large group
and Medicaid membership, which more than offset a decline in TRICARE
membership. Membership growth in group businesses was 50,000, or 2.1%, and
reflects the impact of both significant premium rate increases implemented to
improve profitability and severe price competition in several of our key
markets. TRICARE membership fell primarily due to more military personnel
selecting military primary care providers instead of civilian primary care
providers. Only those military personnel selecting civilian primary care
providers from Anthem's network are included in our membership data.
67
Self-funded membership increased primarily due to an increase in BlueCard
utilization. Fully insured membership decreased primarily due to lower
retention of Large group insured business following our January 1999 renewals
and lower TRICARE membership. Midwest membership grew in 1999 primarily from
growth in BlueCard utilization, reflecting greater overall membership in the
BCBS systems nationwide, as well as higher claims activity by BlueCard members
in Anthem's "host" territories. East membership showed strong growth primarily
due to higher BlueCard membership and Small group sales in Connecticut.
Results of Operations for the Year Ended December 31, 1999 Compared to the Year
Ended December 31, 1998
The following table presents our consolidated results of operations for the
years ended December 31, 1999 and 1998:
Year Ended
December 31,
------------------
1999 1998 $ Change % Change
-------- -------- -------- --------
($ in Millions)
Operating revenue and premium
equivalents(1).................. $8,691.6 $7,987.4 $ 704.2 8.8%
======== ======== ======= ========
Premiums......................... $5,418.5 $4,739.5 $ 679.0 14.3%
Administrative fees.............. 611.1 575.6 35.5 6.2%
Other revenue.................... 51.0 74.6 (23.6) (31.6)%
-------- -------- ------- --------
Total operating revenue........ 6,080.6 5,389.7 690.9 12.8%
Benefit expense.................. 4,582.7 3,934.2 648.5 16.5%
Administrative expense........... 1,469.4 1,420.1 49.3 3.5%
-------- -------- ------- --------
Total operating expense........ 6,052.1 5,354.3 697.8 13.0%
-------- -------- ------- --------
Operating gain................... 28.5 35.4 (6.9) (19.5)%
Net investment income............ 152.0 136.8 15.2 11.1%
Net realized gains on
investments..................... 37.5 155.9 (118.4) (75.9)%
Interest expense................. 30.4 27.9 2.5 9.0%
Amortization of intangibles...... 12.7 12.0 0.7 5.8%
Endowment of non-profit
foundations..................... 114.1 -- 114.1 NM(2)
-------- -------- ------- --------
Income from continuing operations
before taxes and minority
interest........................ 60.8 288.2 (227.4) (78.9)%
Income taxes..................... 10.2 110.9 (100.7) (90.8)%
Minority interest (credit)....... (0.3) (1.1) 0.8 NM(2)
-------- -------- ------- --------
Income from continuing
operations...................... 50.9 178.4 (127.5) (71.5)%
Discontinued operations, net of
income taxes
Loss from discontinued
operations prior to disposal.. -- (3.9) 3.9 NM(2)
Loss on disposal of
discontinued operations....... (6.0) (2.1) (3.9) NM(2)
-------- -------- ------- --------
Net income....................... $ 44.9 $ 172.4 $(127.5) (74.0)%
======== ======== ======= ========
Benefit expense ratio(3)......... 84.6% 83.0% 160 bp(4)
Administrative expense ratio:
Calculated using operating
revenue(5).................... 24.2% 26.3% (210) bp(4)
Calculated using operating
revenue and premium
equivalents(6)................ 16.9% 17.8% (90) bp(4)
Operating margin(7).............. 0.5% 0.7% (20) bp(4)
68
--------
(1) The self-funded claims included in Operating revenue and premium
equivalents for the years ended December 31, 1999 and 1998 were $2,611.0
and $2,597.7, respectively.
(2) NM = Not meaningful.
(3) Benefit expense ratio = Benefit expense / Premiums.
(4) bp = basis point; one hundred basis points = 1%.
(5) Administrative expense / Operating revenue.
(6) Administrative expense / Operating revenue and premium equivalents.
(7) Operating margin = Operating gain / Total operating revenue.
Premiums increased $679.0 million, or 14.3%, in 1999. The acquisitions of
BCBS-NH and BCBS-CO/NV, which were both accounted for using the purchase
accounting method during the last quarter of 1999, accounted for $140.7 million
of the overall increase. Midwest and East, excluding the impact of the BCBS-NH
acquisition, accounted for $196.0 million and $333.6 million of the increase,
respectively. The increase in the Midwest was a result of both rate increases
and increased enrollment. East's increase was attributable to the conversion of
the State of Connecticut account to a fully insured arrangement in July 1999
from a self-insured status for all of 1998, as well as rate increases and
enrollment growth. These increases are explained more fully in the Midwest and
East discussions that follow.
Administrative fees increased 6.2% from $575.6 million in 1998 to $611.1
million in 1999. Most of this increase was from higher BlueCard membership and
revenues. The acquisitions of BCBS-NH and BCBS-CO/NV had relatively little
effect ($5.5 million) on the increase in administrative fees. Other revenue
decreased $23.6 million, or 31.6%, primarily due to the sale of two non-core
businesses during 1998. Excluding the sale of these businesses and the
acquisitions of BCBS-NH and BCBS-CO/NV, other revenue decreased $8.1 million,
or 15.5%, primarily due to a one-time fee received in 1998 related to the
termination of a large block of group life business.
Benefit expense increased $648.5 million, or 16.5%, in 1999 due to increases
in costs of care, growth in membership and the acquisitions of BCBS-NH and
BCBS-CO/NV. Midwest accounted for $239.3 million of the increase, resulting
from both enrollment growth and increased costs. East, excluding the impact of
the BCBS-NH acquisition, increased by $296.0 million. Conversion of the State
of Connecticut account to fully insured from self-insured status and increased
outpatient and prescription drug costs contributed to these increases. These
factors are discussed more fully in the Midwest and East discussions that
follow.
Administrative expense increased $49.3 million, or 3.5%, in 1999 primarily
due to acquisitions and a $41.9 million expense resulting from a settlement
agreement with the OIG to resolve an investigation into alleged misconduct in
the Medicare fiscal intermediary operations of BCBS-CT. The events giving rise
to this investigation occurred prior to the merger of BCBS-CT with Anthem.
After taking the acquisitions and OIG settlement increases into account,
overall administrative expense decreased by $30.1 million, or 2.1%, from 1998.
Simultaneously, same store membership increased by 4.8%. Midwest expenses
decreased by $20.8 million, or 2.6%, primarily as a result of divestiture of
two small non-core businesses in 1999 (1998 included a full year of expenses
associated with these businesses while 1999 included only a partial year). East
expenses, excluding the impact of BCBS-NH and the OIG settlement, decreased by
$12.1 million, or 4.1%. This decrease was primarily as a result of various cost
control initiatives being implemented in late 1998 and early 1999, primarily
related to installation of more efficient processes in our customer service and
claims operations.
Net investment income increased by $15.2 million, or 11.1%, to $152.0
million in 1999 from $136.8 million in 1998. During the first half of 1998, we
completed a portfolio restructuring that resulted in increasing the allocation
of our investment in fixed income securities in our portfolio and reducing the
amount of equity securities. Equities with a market value of $437.3 million
were sold as part of this restructuring and reinvested in fixed income
securities, reducing the equity allocation in
69
the portfolio from 33% to 18%. This, coupled with rising interest rates,
resulted in higher investment income in 1999, as we had a higher portion of the
investment portfolio in fixed income securities for a full year in 1999
compared to only three quarters in 1998. Net realized gains on investments were
$37.5 million in 1999, a decrease of $118.4 million, or 75.9%, from net gains
of $155.9 million in 1998. As discussed above, we executed a restructuring of
the portfolio in 1998 to allocate a higher portion of our investments to fixed
income securities. This restructuring generated approximately $80.0 million of
realized capital gains during the year ended December 31, 1998. The remaining
$38.4 million of the 1999 decrease resulted from gains realized through normal
trading during robust market conditions in 1998.
Interest expense increased $2.5 million, or 9.0%, in 1999 as we borrowed
$220.0 million in the fourth quarter of 1999 to partially fund the acquisitions
of BCBS-NH and BCBS-CO/NV in the fourth quarter of 1999.
Amortization of intangibles increased $0.7 million, or 5.8%, in 1999. The
increase in amortization was primarily due to goodwill created from the
acquisitions of BCBS-NH and BCBS-CO/NV in late 1999.
The endowment of non-profit foundations of $114.1 million in 1999 arose from
the settlements of charitable asset claims brought by Attorneys General of the
states of Kentucky, Ohio and Connecticut. In 1999, contributions of $45.0
million, $28.0 million and $41.1 million were made for the benefit of
charitable foundations in Kentucky, Ohio and Connecticut, respectively.
Income tax expense was $10.2 million in 1999, compared to $110.9 million in
1998. The higher tax expense in 1998 reflected the higher pre-tax income
recognized in that period. Also, the effective tax rate for the year ended
December 31, 1999 was 16.7%, while the rate for the same period in 1998 was
38.5%. The decrease in our effective tax rate was primarily due to a reduction
in the valuation allowance on deferred tax assets. The effective rate for the
year ended December 31, 1998 was higher than the combined statutory rates
primarily due to state and local taxes. A reconciliation to the statutory rate
for both years is included in Note 10 to our audited consolidated financial
statements.
Net income in 1999 was $44.9 million, a $127.5 million, or 74%, decrease
from $172.4 million for the prior year. As discussed above, the primary reasons
for the lower net income were reduced realized capital gains, the endowment of
non-profit foundations and the OIG settlement, offset in part by lower income
taxes and improved administrative expense ratios.
70
Midwest
The following table presents our Midwest region's results of operations for
the years ended December 31, 1999 and 1998:
Year Ended
December 31,
------------------
1999 1998 $ Change % Change
-------- -------- -------- --------
($ in Millions)
Operating revenue and premium
equivalents.................... $5,892.2 $5,681.8 $210.4 3.7%
======== ======== ====== =====
Premiums........................ $3,729.3 $3,533.3 $196.0 5.5%
Administrative fees............. 242.8 234.8 8.0 3.4%
Other revenue................... 3.4 3.0 0.4 13.3%
-------- -------- ------ -----
Total operating revenue....... 3,975.5 3,771.1 204.4 5.4%
Benefit expense................. 3,162.2 2,922.9 239.3 8.2%
Administrative expense.......... 776.9 797.7 (20.8) (2.6)%
-------- -------- ------ -----
Total operating expense....... 3,939.1 3,720.6 218.5 5.9%
-------- -------- ------ -----
Operating gain................ $ 36.4 $ 50.5 $(14.1) (27.9)%
======== ======== ====== =====
Benefit expense ratio(1)........ 84.8% 82.7% 210 bp(2)
Administrative expense ratio:
Calculated using operating
revenue(3)................... 19.5% 21.2% (170) bp(2)
Calculated using operating
revenue and premium
equivalents(4)............... 13.2% 14.0% (80) bp(2)
Operating margin(5)............. 0.9% 1.3% (40) bp(2)
Membership (in thousands)....... 4,382 4,199 4.4%
--------
(1) Benefit expense ratio = Benefit expense /Premiums.
(2) bp = basis point; one hundred basis points = 1%.
(3) Administrative expense / Operating revenue.
(4) Administrative expense / Operating revenue and premium equivalents.
(5) Operating margin = Operating gain / Total operating revenue.
Premiums increased $196.0 million, or 5.5%, primarily due to higher premiums
PMPM, which more than offset the effect of lower average membership throughout
the year. Premiums PMPM increased 10.7% from $133.32 in 1998 to $147.57 in
1999, primarily due to rate increases in group and National businesses. Group
premiums PMPM increased 10.2% from $127.54 in 1998 to $140.60 in 1999,
reflecting premium rate increases averaging 15% in response to increasing claim
trends. Average insured group membership fell 4.6%, primarily due to
competitive pressures in Kentucky and Ohio. National PMPM premiums increased
14.6% from $137.99 in 1998 to $158.15 in 1999, due to rate increases
implemented in response to increasing claim trends. Average National insured
membership decreased 9.1% or 9,600 members, primarily due to non-renewals at
the beginning of 1999.
Administrative fees increased 3.4% from $234.8 million in 1998 to $242.8
million in 1999. Most of this increase was from membership growth in National
self-funded business which more than offset reductions arising from the sale of
our worker's compensation third party administration subsidiary and a
physician's group practice during 1999. Excluding the administrative fees from
the divested businesses, administrative fees increased $20.1 million, or 9.5%,
to $231.4 million in 1999 due to membership growth in National self-funded
business.
Benefit expense increased $239.3 million, or 8.2%, in 1999 primarily due to
higher benefit expense PMPM, which was offset by the effect of lower average
membership throughout the year.
71
Benefit expense PMPM increased 13.0% from $110.69 in 1998 to $125.13 in 1999
primarily due to higher outpatient costs and higher prescription drug costs.
Increases in outpatient costs were primarily due to continued shifting of
services to outpatient settings versus inpatient service, which has increased
both utilization and unit costs. Improved medical technology has also allowed
more complicated medical procedures to be performed on an outpatient basis,
thus increasing unit costs.
Prescription drug cost increases accelerated in 1999 primarily due to
introduction of new, higher cost drugs and increases in direct-to-consumer
advertising by pharmaceutical companies. Midwest utilized several strategies to
optimize prescription drug benefits, including expanded use of drug formularies
and expansion of a three-tiered drug program for our members.
The benefit expense ratio increased 210 basis points from 82.7% in 1998 to
84.8% in 1999, as the growth in premium PMPM of 10.7% was not sufficient to
cover the growth in benefit expense PMPM of 13.0% as discussed above. Ohio
group, National business and Medicare + Choice were the primary drivers of the
deterioration in benefit expense ratio. Ohio group and National were impacted
by increasing outpatient and prescription drug costs, while Medicare + Choice
was impacted by provider risk share write-offs and claim reserve increases.
Provider risk share agreements were used in Medicare + Choice business in Ohio
in order to share the risk of claim costs with providers. Midwest implemented
corrective pricing actions late in 1999 that were targeted at improving
underwriting results.
Administrative expense decreased $20.8 million, or 2.6%, in 1999, primarily
due to the sale of a worker's compensation third party administration company
and physicians' group practice in July 1999, and the effect of expense
reduction programs initiated in 1998. Most of the benefit of these programs
occurred in 1999. These expense reduction programs included process
improvements in claims and customer service operations and reduction in the
number of levels of management. The administrative expense ratio decreased 80
basis points from 14.0% in 1998 to 13.2% in 1999 primarily due to higher
premiums and the reduced administrative expense discussed above.
72
East
The following table presents our East region's results of operations for the
years ended December 31, 1999 and 1998. BCBS-NH results are included from
October 27, 1999:
Year Ended
December 31,
-------------------
1999 1998 $ Change % Change
-------- -------- -------- --------
($ in Millions)
Operating revenue and premium
equivalents................. $2,272.8 $1,871.5 $401.3 21.4%
======== ======== ====== =======
Premiums..................... $1,495.4 $1,088.3 $407.1 37.4%
Administrative fees.......... 99.7 91.4 8.3 9.1%
Other revenue................ 3.8 11.2 (7.4) (66.1)%
-------- -------- ------ -------
Total operating revenue.... 1,598.9 1,190.9 408.0 34.3%
Benefit expense.............. 1,259.9 901.9 358.0 39.7%
Administrative expense....... 339.9 294.6 45.3 15.4%
-------- -------- ------ -------
Total operating expense.... 1,599.8 1,196.5 403.3 33.7%
-------- -------- ------ -------
Operating loss............. $ (0.9) $ (5.6) $ 4.7 NM(1)
======== ======== ====== =======
Benefit expense ratio(2)..... 84.3% 82.9% 140 bp(3)
Administrative expense ratio:
Calculated using operating
revenue(4)................ 21.3% 24.7% (340) bp(3)
Calculated using operating
revenue and premium
equivalents(5)............ 15.0% 15.7% (70) bp(3)
Operating margin(6).......... (0.1)% (0.5)% 40 bp(3)
Membership (in thousands).... 1,397 968 44.3%
--------
(1) NM = Not meaningful.
(2) Benefit expense ratio = Benefit expense / Premiums.
(3) bp = basis point; one hundred basis points = 1%.
(4) Administrative expense / Operating revenue.
(5) Administrative expense / Operating revenue and premium equivalents.
(6) Operating margin = Operating gain / Total operating revenue.
Premiums increased $407.1 million, or 37.4%, primarily due to the conversion
of the State of Connecticut account from self-funded to fully insured in July
1999 and the acquisition of BCBS-NH in October 1999. Excluding the effect of
$73.5 million in premiums from the acquisition, premiums increased 30.7%. The
State of Connecticut account accounted for $175.0 million, or 52.5%, of the
increase. Excluding the effect of the acquisition and the conversion of the
State of Connecticut account, premiums increased $158.6 million, or 14.6%,
primarily due to premium rate increases in group business and higher average
membership.
Administrative fees increased $8.3 million, or 9.1%, from $91.4 million in
1998 to $99.7 million in 1999. The acquisition of BCBS-NH accounted for $3.8
million of the increase. Conversion of the State of Connecticut account from
self-funded to fully insured caused a $10.6 million reduction in administrative
fees in 1999. Excluding the effect of the acquisition of BCBS-NH and the
conversion of the State of Connecticut account, administrative fees increased
$15.1 million, or 22.1%, to $83.5 million in 1999. This increase in
administrative fees was primarily due to higher sales of self-funded business
in Connecticut. Other revenue decreased $7.4 million, or 66.1%, in 1999
primarily due to the sale of a small real estate subsidiary at the end of 1998.
Benefit expense increased $358.0 million, or 39.7%, primarily due to the
conversion of the State of Connecticut account from self-funded to fully
insured in July 1999 and the acquisition of BCBS-NH
73
in October 1999. Excluding the effect of $62.0 million of benefit expense from
BCBS-NH, benefit expense increased $296.0 million, or 32.8%, in 1999 primarily
due to the conversion of the State of Connecticut account, which accounted for
$154.1 million, or 52.1%, of the increase. Excluding the effect of the
acquisition and the conversion of the State of Connecticut account, benefit
expense increased $141.9 million, or 15.7%, due to increasing cost of care
trends and higher average membership.
The benefit expense ratio increased 140 basis points from 82.9% in 1998 to
84.3% in 1999. However, excluding the effect of the conversion of the State of
Connecticut account, benefit expense ratio increased 80 basis points to 83.7%.
The acquisition of BCBS-NH had no effect on the benefit expense ratio in 1999.
Administrative expense increased $45.3 million, or 15.4%, primarily due to a
one-time expense of $41.9 million in 1999 associated with a settlement of
claims brought by the OIG, alleging overpayment for Medicare Part A claims
prior to Anthem's merger with BCBS-CT. Excluding this settlement and the
acquisition of BCBS-NH, administrative expense decreased $12.1 million, or
4.1%, as a result of the implementation of cost savings initiatives in
Connecticut designed to identify duplication of administrative services and
improve efficiency in the services we provide our customers. Excluding
acquisitions and the Medicare settlement, the administrative expense ratio
improved 270 basis points to 13.0% in 1999.
West
The following table presents our West region's results of operations for the
period ended December 31, 1999:
Period Ended
December 31, 1999
-----------------
($ in Millions)
Operating revenue and premium equivalents................ $86.9
=====
Premiums................................................. $64.2
Administrative fees...................................... 1.7
Other revenue............................................ 6.8
-----
Total operating revenue................................ 72.7
Benefit expense.......................................... 55.0
Administrative expense................................... 21.2
-----
Total operating expense................................ 76.2
-----
Operating loss......................................... $(3.5)
=====
Benefit expense ratio(1)................................. 85.7%
Administrative expense ratio:
Calculated using operating revenue(2).................. 29.2%
Calculated using operating revenue and premium
equivalents(3)........................................ 24.4%
Operating margin(4)...................................... (4.8)%
Membership (in thousands)................................ 486
--------
(1) Benefit expense ratio = Benefit expense / Premiums.
(2) Administrative expense / Operating revenue.
(3) Administrative expense / Operating revenue and premium equivalents.
(4) Operating margin = Operating gain / Total operating revenue.
Anthem West was established with the acquisition of BCBS-CO/NV on November
16, 1999. Results of operations for this segment have been included in our
consolidated financial statements
74
since the purchase date. This transaction was accounted for as a purchase and,
accordingly, 1999 includes only a partial year with no results reported for
1998. At the time of the acquisition, we began to fully implement our
turnaround strategy for West. We implemented cost reduction programs, including
reducing layers of management, integrating certain administrative functions
into existing Anthem operations and instituting appropriate pricing discipline
and customer service standards.
Specialty
The following table presents our Specialty segment's results of operations
for the years ended December 31, 1999 and 1998:
Year Ended
December 31,
--------------
1999 1998 $ Change % Change
------ ------ -------- --------
($ in Millions)
Operating revenue and premium
equivalents........................ $255.3 $248.0 $ 7.3 2.9%
====== ====== ===== =====
Premiums from life and disability... $ 96.3 $ 90.3 $ 6.0 6.6%
Administrative fees................. 14.6 21.1 (6.5) (30.8)%
Other revenue....................... 138.2 130.2 8.0 6.1%
------ ------ ----- -----
Total operating revenue........... 249.1 241.6 7.5 3.1%
Benefit expense..................... 73.8 76.1 (2.3) (3.0)%
Administrative expense.............. 159.1 142.3 16.8 11.8%
------ ------ ----- -----
Total operating expense........... 232.9 218.4 14.5 6.6%
------ ------ ----- -----
Operating gain.................... $ 16.2 $ 23.2 $(7.0) (30.2)%
====== ====== ===== =====
Benefit expense ratio (1)........... 76.6% 84.3% (770) bp(2)
Administrative expense ratio:
Calculated using operating revenue
(3).............................. 63.9% 58.9% 500 bp(2)
Calculated using operating revenue
and premium equivalents (4)...... 62.3% 57.4% 490 bp(2)
Operating margin (5)................ 6.5% 9.6% (310) bp(2)
--------
(1) Benefit expense ratio = Benefit expense / Premiums.
(2) bp = basis point; one hundred basis points = 1%.
(3) Administrative expense / Operating revenue.
(4) Administrative expense / Operating revenue and premium equivalents.
(5) Operating margin = Operating gain / Total operating revenue.
Premiums increased $6.0 million, or 6.6%, primarily due to higher group life
sales that offset the sale of a small block of unprofitable non-core health
business. Administrative fees decreased $6.5 million, or 30.8%, primarily due
to loss of third party business at APM. Other revenue increased $8.0 million,
or 6.1%, primarily due to growth in business with other Anthem companies.
Benefit expense decreased $2.3 million, or 3.0%, primarily due to the sale
of the non-core block of group life and health business in California. The
effect of this sale on the benefit expense ratio in 1999 was a reduction of 490
basis points. The benefit expense ratio fell an additional 280 basis points
primarily due to a change in the funding arrangement with a major group in
California. Until October 1998, we held the assets of this group's retirement
funding account and utilized investment income from these assets to subsidize
the group's life insurance premiums. In October 1998, the retirement funding
account was returned to the group. Since investment income was no longer
available to subsidize the life insurance premiums, the premiums paid by the
group increased, resulting in a lower benefit expense ratio.
75
Administrative expense increased primarily at APM due to higher mail order
volume, costs associated with switching third party claims processing vendors,
as well as costs incurred in anticipation of adding the business of BCBS-NH and
BCBS-CO/NV.
Operating gain decreased $7.0 million, or 30.2%, primarily due to the loss
of a large customer in 1999 and an increase in drug rebates shared with our
Midwest region.
Other
The following table presents our Other segment's results of operations for
the years ended December 31, 1999 and 1998:
Year Ended
December 31,
---------------
1999 1998 $ Change % Change
------- ------ -------- --------
($ in Millions)
Operating revenue and
premium equivalents...... $ 184.4 $186.1 $ (1.7) (0.9)%
======= ====== ====== ====
Premiums.................. $ 33.3 $ 27.6 $ 5.7 20.7%
Administrative fees....... 252.3 228.3 24.0 10.5%
Other revenue (expense)... (101.2) (69.8) (31.4) 45.0%
------- ------ ------ ----
Total operating
revenue................ 184.4 186.1 (1.7) (0.9)%
Benefit expense........... 31.8 33.3 (1.5) (4.5)%
Administrative expense.... 172.3 185.5 (13.2) (7.1)%
------- ------ ------ ----
Total operating
expense................ 204.1 218.8 (14.7) (6.7)%
------- ------ ------ ----
Operating loss............ $ (19.7) $(32.7) $ 13.0 NM(1)
======= ====== ====== ====
--------
(1) NM = Not meaningful.
Premiums increased $5.7 million, or 20.7%, primarily due to additional
premiums from non-core business that was subsequently disposed of in 1999. The
business that was sold generated $11.4 million of premiums in 1999 versus $2.2
million in 1998. Excluding this business, premiums decreased $3.5 million, or
13.8%, due to lower membership at Anthem Alliance Health Insurance Company, as
more military personnel opted to use military primary care physicians instead
of civilian primary care physicians. Administrative fees increased $24.0
million, or 10.5%, primarily due to increased business at AdminaStar Federal.
Excluding intersegment other revenue of $104.3 million and $105.8 million in
1999 and 1998, respectively, other revenue decreased $32.9 million, or 91.4%,
to $3.1 million in 1999 primarily due to the transfer of document management
operations to our Midwest region at the beginning of 1999 and the sale of non-
core businesses.
Benefit expense decreased $1.5 million, or 4.5%, primarily due to lower
membership at Anthem Alliance Health Insurance Company as discussed above.
Excluding intersegment administrative expense of $112.1 million and $116.3
million in 1999 and 1998 respectively, administrative expense decreased $17.4
million, or 5.8%, primarily due to sale of non-core businesses during 1998,
transfer of document management operations and lower unallocated corporate
expenses. Excluding the sale of non-core businesses, administrative expense
decreased $1.1 million, or 0.4%, to $284.4 million in 1999.
Almost all of our operating loss reported in our Other segment relates to
unallocated corporate expenses. In 1999, unallocated corporate expenses were
$26.7 million versus $32.1 million in 1998, primarily due to higher employee
benefit cost allocations in 1999.
76
Income Taxes
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes," requires, among other things, the separate recognition, measured at
currently enacted tax rates, of deferred tax assets and deferred tax
liabilities for the tax effect of temporary differences between the financial
reporting and tax reporting. A valuation allowance must be established for
deferred tax assets if it is "more likely than not" that all or a portion may
not be realized. See Note 10 to the audited consolidated financial statements
for additional information.
We believe we will be able to realize the benefit of the net deferred tax
asset of $2.7 million as of June 30, 2001. This net deferred tax asset is
comprised of a gross tax asset of $484.5 million, less a valuation allowance of
$262.2 million and a deferred tax liability of $219.6 million. We believe that
the allowance is sufficient and at each quarterly financial reporting date, we
evaluate each of our gross deferred tax assets based on each of the five key
elements that follow:
. the types of temporary differences making up our gross deferred tax
asset;
. the anticipated reversal periods of those temporary differences;
. the amount of taxes paid in prior periods and available for a carry-back
claim;
. the forecasted near term future taxable income; and
. any significant other issues impacting the likely realization of the
benefit of the temporary differences.
As an entity taxed under Internal Revenue Code Section 833, at June 30,
2001, we have tax temporary differences of approximately $206.6 million for net
operating loss carry-forwards and alternative minimum tax credits. Due to
uncertainty of the realization of these deferred tax assets, we have provided a
valuation allowance included above of $188.1 million for these amounts. This
amount is part of the total valuation allowance of $262.2 million at June 30,
2001.
Liquidity and Capital Resources
Anthem Cash Flow
Our cash collections consist primarily of premiums and administrative fees,
investment income and proceeds from the sale or maturity of our investment
securities. Cash disbursements result mainly from policyholder benefit
payments, administrative expenses and taxes. We also use cash for purchases of
investment securities, capital expenditures and acquisitions. Cash outflows can
fluctuate because of uncertainties regarding the amount and timing of
settlement of our liabilities for unpaid benefit claims and the timing of
payments of operating expenses. Our investment strategy is to make prudent
investments, consistent with insurance statutes and other regulatory
requirements, with the main objective of preserving our asset base. Management
believes that cash flow from operations, together with the portfolio, will
continue to provide sufficient liquidity to meet general operations needs,
special needs arising from changes in financial position and changes in
financial markets. We also maintain a bank line of credit and a commercial
paper program to provide additional liquidity.
Six Months Ended June 30, 2001 and 2000
Net cash flow provided by operating activities was $261.1 million in 2001,
as compared to $365.4 million in 2000. Net cash flow provided by operating
activities decreased as the 2000 period included the initial results of
improved balance sheet management in which we converted certain operating
assets, such as receivables and investments in non-strategic assets, to cash.
These activities contributed additional operating cash above levels in 2000.
Also, in 2001, higher payments were made related to incentive compensation that
had been accrued in previous years. These items
77
offset significant growth in the amount of net income, increased depreciation
and amortization expense related to acquisitions. Net cash used in investing
activities was $225.5 million in 2001 compared to cash used in investing
activities of $320.9 million in 2000. The net cash received from the sale of
our TRICARE business and other purchase price adjustments paid in respect of
prior acquisitions in 2001 resulted in a decrease of approximately $105.5
million in cash used in investing activities as compared to 2000 when we
purchased BCBS-ME.
There were no financing activities in the first six months of 2001. Net cash
provided by financing activities was $75.3 million for 2000, which constituted
the net proceeds received from the issuance of $295.3 million of surplus notes
on a discounted basis less $220.0 million repayment of bank debt.
Twelve Months Ended December 31, 2000 and 1999
Net cash flow provided by operating activities was $684.5 million in 2000,
as compared to $219.8 million in 1999. Significant growth occurred in the
amount of net income, increased depreciation and amortization expense related
to acquisitions, amortization of a new claims and administration system in our
Midwest region and better balance sheet management. The 1999 period included
non-recurring disbursements of $156.0 million related to payments for the
settlement of charitable asset claims in the states of Ohio, Kentucky and
Connecticut and the $41.9 million settlement with the OIG with respect to BCBS-
CT. Additionally, during 2000, through improved balance sheet management, we
converted certain operating assets, such as receivables and investments in non-
strategic assets, to cash. These activities contributed $256.4 million of
additional operating cash in 2000. Net cash used in investing activities was
$761.1 million in 2000 compared to cash used in investing activities of $356.8
million in 1999. As a result of the increased operating cash flow discussed
above and the increased cash from financing activities discussed below, we
purchased significantly more investment securities in 2000 accounting for
$596.8 million of the total increase in cash used in investing activities.
Additionally, the net cash paid to acquire BCBS-ME and other purchase price
adjustments paid in respect of prior acquisitions in 2000 resulted in a
decrease of approximately $161.7 million in cash used for investing activities,
as compared to 1999 when we purchased BCBS-NH and BCBS-CO/NV. Offsetting these
increases was a decrease of $23.4 million in capital expenditures from the
prior year. Capital expenditures decreased in 2000 primarily due to lower
capitalization of software costs related to the new Midwest claims and
administration system and lower purchases of computer equipment.
Net cash provided by financing activities was $75.5 million for 2000, as
compared to $220.1 million for 1999. The cash provided in 2000 was the net
proceeds received from the issuance of $295.9 million of surplus notes on a
discounted basis less $220.4 million repayment of bank debt.
Twelve Months Ended December 31, 1999 and 1998
Net cash provided by operating activities was $219.8 million in 1999 and
$119.9 million in 1998, an increase of $99.9 million, or 83.3%. The 1999 period
included non-recurring disbursements of $156.0 million relating to payments for
the settlement of charitable asset claims in the states of Ohio, Connecticut
and Kentucky and the $41.9 million settlement with the OIG with respect to
BCBS-CT. After eliminating the effect of these one-time disbursements, the
increase in 1999 operating cash flow from 1998 was $255.9 million. This
increase was primarily attributable to improved operating cash flow resulted
from a net increase in policy liabilities of $145.9 million. Additionally,
during 1999 through balance sheet management, we converted certain operating
assets such as receivables to cash. Finally, net cash used in discontinued
operations declined between the two years as obligations related to the sales
of these operations were nearing completion.
Net cash used in investing activities increased $248.0 million, to $356.8
million during 1999 from $108.8 million in 1998. Anthem acquired BCBS-NH and
BCBS-CO/NV in the fourth quarter of 1999, which accounted for most of the
increased usage. During 1999, we had fewer net investment purchases than in
1998, primarily due to the restructuring of the investment portfolio in 1998
78
described earlier. Net investment sales and purchases tend to fluctuate from
year to year as other sources and uses of cash, such as financing or
acquisitions, affect changes in the portfolio. Capital expenditures increased
$7.5 million to $96.7 million primarily due to purchases of personal computers
as part of our desktop standardization program.
Net cash provided by financing activities was $220.1 million in 1999, a
$223.9 million increase from the $3.8 million cash used in financing activities
during 1998. During 1999, we utilized our revolving credit lines to partially
finance the acquisition of BCBS-NH and BCBS-CO/NV, while no such borrowings
occurred in 1998.
Anthem, Inc.
Following this offering, the units offering and the effective date of the
plan to convert from a mutual into a stock insurance company, Anthem Insurance
will become a wholly owned subsidiary and the primary asset of Anthem, Inc.
From the net proceeds of the offerings, it is estimated that $1,625.0 million
will be paid to certain of Anthem Insurance's eligible statutory members in
lieu of shares that would otherwise be issued to such members in the
demutualization.
Our future liquidity needs may include acquisitions, operating expenses,
capital contributions to our subsidiaries and dividend payments, and will
include interest and contract fee payments on the units being offered in the
units offering. On an ongoing basis, we will rely upon dividends from our
subsidiary, Anthem Insurance, to meet liquidity needs. Although Anthem
Insurance and its insurance subsidiaries are subject to capitalization
requirements, as well as restrictions and limitations on the amounts of
dividends or distributions that can be made, we believe, based on historical
results of Anthem Insurance and its subsidiaries, that we will have the
liquidity needed.
The ability of our licensed insurance company subsidiaries to pay dividends
is limited by the departments of insurance in their respective states of
domicile. Generally, dividends in any 12-month period are limited to the
greater or lesser (depending on state statute) of the prior year's statutory
net income or 10% of statutory surplus. Dividends in excess of this amount are
classified as extraordinary and require prior approval of the respective
departments of insurance. Further, an insurance company may not pay a dividend
unless, after such payment, its surplus to policyholders is reasonable in
relation to its outstanding liabilities and adequate to meet its financial
needs, as determined by the department of insurance. In connection with our
acquisitions of BCBS-ME and BCBS-NH, further limitations were imposed on their
ability to pay dividends. Until June 2005, BCBS-ME may not declare any dividend
without the prior approval of the department of insurance of Maine. BCBS-NH may
not pay any dividends for as long as the New Hampshire department of insurance
permits BCBS-NH to continue to use certain accounting practices permitted prior
to the acquisition. The maximum dividend payable by Anthem Insurance's licensed
insurance company subsidiaries without prior approval in 2001 is $185.0
million. The dividends paid by such regulated subsidiaries in 2000 was $71.3
million. The amount of dividends that could be paid by Anthem Insurance to
Anthem, Inc. in 2001, based upon the foregoing standards, is $190.7 million.
Anthem Insurance currently has a $300 million commercial paper program
available for general corporate purposes. Commercial paper notes are short term
in nature, with a maturity not to exceed 270 days from date of issuance. The
notes bear interest at then available market rates. The commercial paper
program is supported by the revolving credit agreement discussed below. Anthem
Insurance had no commercial paper outstanding at June 30, 2001.
Anthem Insurance has a $300 million multi-year revolving credit agreement
with a syndicate of banks. The facility is available for general corporate
purposes and support of the commercial paper program. Borrowings under the
credit facility bear interest at rates determined by reference to the banks'
base rate or to the London Interbank Offered Rate, or LIBOR, plus a margin
determined by reference to Anthem Insurance's then current claims paying
ability ratings issued by certain specified rating agencies. The agreement
requires payment of quarterly facility fees, again determined by the then
current claims paying ability ratings of Anthem Insurance. The agreement
contains certain
79
financial covenants, including limits on minimum net worth, maximum
consolidated debt and maximum asset dispositions annually. We are currently in
compliance with all such covenants. The facility matures on October 22, 2002.
No borrowings were outstanding as of June 30, 2001.
Anthem Insurance intends to replace its current $300 million credit
facility. Anthem Insurance has entered into a commitment letter with respect to
senior unsecured revolving credit facilities in the aggregate principal amount
of $750 million, which Anthem Insurance may request be increased to up to $1.0
billion in the event of oversubscription by the syndicate of banks. The
commitment letter also provides that the facilities would consist of one 364-
day facility and one five-year facility. Subject to final documentation and
other conditions, we expect the new facilities to be in place shortly after the
completion of this offering. Subject to the effectiveness of the
demutualization, Anthem, Inc. will guarantee all obligations of Anthem
Insurance under the facilities. Anthem, Inc. also will be permitted to be a
borrower under the facilities, if the Indiana Insurance Commissioner approves
Anthem Insurance's guaranty of Anthem, Inc.'s obligations.
We will pay for the BCBS-KS acquisition with currently available funds. We
plan to utilize our investment portfolio, current capacity of existing
borrowing facilities, new bank borrowings, equity or debt offerings or
operating cash flow to fund any future acquisitions. The source of financing
would be determined at the time of any future transaction, based on market
conditions at that time. Any proceeds from previously issued debt, not used for
acquisitions, are currently invested as part of our investment portfolio. See
Note 4 of our audited consolidated financial statements for information related
to our investment portfolio.
Risk-Based Capital
Our subsidiaries' states of domicile have statutory risk-based capital or
RBC requirements for health and other insurance companies based on the RBC
Model Act. These RBC requirements are intended to assess the capital adequacy
of life and health insurers, taking into account the risk characteristics of an
insurer's investments and products. The RBC Model Act sets forth the formula
for calculating the RBC requirements which are designed to take into account
asset risks, insurance risks, interest rate risks and other relevant risks with
respect to an individual insurance company's business. In general, under these
laws, an insurance company must submit a report of its RBC level to the state
insurance department or insurance commissioner, as appropriate, as of the end
of the previous calendar year.
Risk-based capital standards will be used by regulators to set in motion
appropriate regulatory actions relating to insurers that show indications of
weak or deteriorating conditions. It also provides an additional standard for
minimum capital requirements that companies should meet to avoid being placed
in rehabilitation or liquidation.
Anthem's risk based capital as of June 30, 2001 continues to be
substantially in excess of all mandatory RBC thresholds.
Quantitative and Qualitative Disclosure About Market Risk
As a result of our investing and borrowing activities, we are exposed to
financial market risks, including those resulting from changes in interest
rates and changes in equity market valuations. Potential impacts discussed
below are based upon sensitivity analyses performed on Anthem's financial
positions as of June 30, 2001. Actual results could vary significantly from
these estimates.
Our primary objective is the preservation of the asset base and the
maximization of total return given an acceptable level of risk. Our portfolio
is exposed to three primary sources of risk: (1) interest rate risk, (2) credit
risk, and (3) market valuation risk for equity holdings. As of June 30, 2001,
the fair value of fixed income securities and equity securities represented
approximately 88% and 12% of the securities available for sale, respectively.
Since June 30, 2001, we have increased the percentage of fixed income
securities to approximately 95% and decreased equity securities to
approximately 5% of the securities available for sale.
80
The primary risks associated with our fixed maturity securities are credit
quality risk and interest rate risk. Credit quality risk is defined as the risk
of a credit downgrade to an individual fixed income security and the potential
loss attributable to that downgrade. We manage this risk through our investment
policy, which establishes credit quality limitations on the overall portfolio
as well as dollar limits for individual issuers. Since we are advised
immediately of circumstances surrounding credit rating downgrades, we are able
to promptly avoid or minimize exposure to losses by selling the subject
security. The result is a well-diversified portfolio of fixed income
securities, with an average credit rating of approximately double-A. Interest
rate risk is defined as the potential for economic losses on fixed-rate
securities, due to an adverse change in market interest rates. Our fixed
maturity portfolio consists exclusively of U.S. dollar-denominated assets,
invested primarily in U.S. government securities, corporate bonds, asset-backed
bonds and mortgage-related securities, all of which represent an exposure to
changes in the level of market interest rates. We manage interest rate risk by
maintaining a duration commensurate with our insurance liabilities and
policyholders' surplus. Additionally, we have the capability of holding any
security to maturity, which would allow us to realize full par value. Further,
we do not engage in the use of derivatives to manage interest rate risk, as
they are prohibited in our investment policy.
Our portfolio consists of corporate securities (approximately 34% of the
total fixed income portfolio) which are subject to credit/default risk. In a
declining economic environment, corporate yields will usually increase prompted
by concern over the ability of corporations to make interest payments, thus
causing a decrease in the price of corporate securities, and the decline in
value of the corporate fixed income portfolio. This risk is managed externally
by our money managers--through fundamental credit analysis, diversification of
issuers and industries, and an average credit rating of the corporate fixed
income portfolio of approximately double-A.
The equity portfolio is exposed to the volatility inherent in the stock
market, driven by concerns over economic conditions, earnings and sales growth,
inflation and consumer confidence. These systematic risks cannot be managed
through diversification. However, unsystematic risks, such as stock/industry
specific risks, are managed by investing in index mutual funds that replicate
the risk and performance of the S&P 500 and S&P 400 indices (78% and 22%
respectively), resulting in a diversified equity portfolio.
All of our investments are classified as available-for-sale. As of June 30,
2001, approximately 88% of these were fixed maturity securities. Market risk is
addressed by actively managing the duration, allocation and diversification of
the investment portfolio. We have evaluated the impact on the fixed income
portfolio's fair value considering a 100 basis point change in interest rates
over the next twelve-month period. A 100 basis point increase in interest rates
would result in an approximate $166.8 million decrease in fair value, whereas a
100 basis point decrease in interest rates would result in an approximate
$164.9 million increase in fair value. This analysis includes the assumption
that the 100 basis point change occurs evenly throughout the 12-month period.
The analysis also assumes investment income earned is reinvested into the
portfolio thus mitigating the effects of change in fair value. As of June 30,
2001, no portion of our fixed income portfolio was invested in non-US dollar
denominated investments.
We also maintain a diverse portfolio of large capitalization equity
securities. An immediate 10% decrease in each equity investment's value,
arising from market movement, would result in a fair value decrease of $43.9
million. Alternatively, an immediate 10% increase in each equity investment's
value, attributable to the same factor, would result in a fair value increase
of $43.9 million. No portion of our equity portfolio was invested in non-US
dollar denominated investments as of June 30, 2001. As of June 30, 2001, we
held no derivative financial or commodity-based instruments.
During the six months ended June 30, 2001, $28.9 million of unrealized
investment losses were charged to income as equity securities declines in value
were determined to be other than temporary.
81
RECENT DEVELOPMENTS
Pending Acquisition of Blue Cross and Blue Shield of Kansas
General
On May 30, 2001, we signed a definitive agreement with Blue Cross and Blue
Shield of Kansas, Inc., or BCBS-KS, pursuant to which we have agreed to acquire
BCBS-KS, which will become a wholly owned subsidiary of ours.
Under the proposed transaction, BCBS-KS will convert from a mutual insurance
company to a stock insurance company through a process known as a sponsored
demutualization. Under the agreement, BCBS-KS policyholders eligible to receive
consideration in its demutualization will be entitled to receive $190.0
million, which we will pay in cash to the escrow described below at the closing
of the transaction and which amount thereafter may be reduced as described
below. However, we and BCBS-KS may agree to place less than the full $190.0
million in the escrow account, in which case the portion of the $190.0 million
not placed in escrow will be distributed directly to eligible BCBS-KS
policyholders. The amount placed in the escrow account will be held in escrow
pending the resolution of a matter involving a subpoena dated February 28,
2001, received by BCBS-KS from the OIG. The subpoena seeks documents related to
an investigation of possible improper claims against Medicare. The amount held
in escrow will be used to pay costs, expenses and liabilities related to the
OIG investigation, and to pay costs and expenses of the escrow, with any
remaining amount to be distributed to eligible BCBS-KS members following final
resolution of the matter. In addition, at or prior to the closing, BCBS-KS will
declare a special distribution payable after the closing to its eligible
policyholders in an amount equal to the excess of BCBS-KS' consolidated closing
book value over $155.0 million.
The transaction is expected to close in early 2002, subject to the approval
of BCBS-KS policyholders, the approval of the BCBSA, the approval of the Kansas
Department of Insurance and other regulatory approvals. Once the transaction is
completed, we will market our health benefits products in Kansas under the
Anthem Blue Cross and Blue Shield name. The acquisition will be accounted for
as a purchase and the net assets and results of operations will be included in
our consolidated financial statements from the purchase date.
Policyholders of BCBS-KS will not become statutory members of Anthem
Insurance and will not be eligible to receive any consideration as a result of
Anthem Insurance's demutualization.
BCBS-KS
BCBS-KS is the largest health insurer in Kansas. BCBS-KS provides insurance
coverage or self-insured administration services to more than 715,000
individuals in all Kansas counties except Johnson and Wyandotte, two counties
near Kansas City. BCBS-KS also administers Medicare and Medicaid government
programs.
BCBS-KS offers a wide range of health benefit products including traditional
indemnity products and HMO, POS and PPO managed care products. BCBS-KS also
offers claims administration and stop-loss coverage for employer self-funded
plans, as well as underwriting, actuarial services, provider network access,
and medical cost management. Additionally, BCBS-KS offers several specialty
insurance products, including group life, disability, dental and long-term
care.
BCBS-KS provides its products to a diverse customer base, including non-
group, small group, large group national accounts, federal employees and
government programs. BCBS-KS markets its products primarily through its captive
sales force and contracts with independent agents and brokers on only a limited
basis.
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BCBS-KS has various subsidiaries, including a majority-owned HMO operated in
partnership with two hospitals and a majority-owned company licensed to sell
life insurance in 38 states.
For the year ended December 31, 2000, BCBS-KS had revenue of $1,026.0
million and net income of $5.8 million and, at December 31, 2000, assets of
$730.8 million and surplus of $328.5 million.
Escrow of Funds; Certain Liabilities
Pursuant to the definitive agreement, we will place the $190.0 million
purchase price (or a lesser amount, if so agreed upon by us and BCBS-KS) in an
escrow account, to be held pending resolution of all matters relating to the
subpoena received from the OIG seeking documents related to an investigation of
possible improper claims against Medicare. The amount held in escrow will be
used to pay fees and costs attributable to the OIG investigation, certain
related tax costs and other related costs, expenses and liabilities of the
escrow. Any amounts remaining in the escrow account, including any interest on
the escrow funds, following the final resolution of the matter and the payment
of such costs, expenses and liabilities will be distributed to eligible BCBS-KS
policyholders. However, if the amount that we have placed in escrow is not
enough to cover the costs, expenses and liabilities relating to the OIG
investigation and the escrow, then those remaining costs, expenses and
liabilities would reduce the value of BCBS-KS.
Disposition of TRICARE Operations
Under a contract between our subsidiary, Anthem Alliance Health Insurance
Company, or Alliance, and the United States Department of Defense, Alliance
managed and administered the TRICARE Managed Care Support Program for military
families from May 1, 1998 through May 31, 2001. TRICARE administration is
outside of our focus on core Blue Cross and Blue Shield health benefits
business and on those specialty businesses that enable us to offer a broad line
of products to health plan customers. Accordingly, a decision was made to sell
the TRICARE operations.
On April 18, 2001, along with Alliance, we entered into an Agreement and
Plan of Merger to sell the TRICARE operations of Alliance to a subsidiary of
Humana, Inc. for $45.0 million. The transaction, which closed on May 31, 2001,
resulted in a gain on sale of subsidiary operations of $25.0 million, net of
selling expenses.
Nine Months Financial Information
Nine Months Ended
September 30,
-------------------
2001 2000
--------- --------
($ in Millions)
Operating revenue and premium equivalents (1).............. $10,428.6 $8,666.8
========= ========
Total operating revenue.................................... $ 7,525.9 $6,225.9
Benefit expense............................................ 5,847.6 4,831.3
Administrative expense..................................... 1,465.9 1,274.7
--------- --------
Operating gain............................................. 212.4 119.9
Net investment income...................................... 170.4 147.2
Net realized gains on investments (2)...................... 86.2 13.1
Interest and amortization expense.......................... 65.6 59.4
Demutualization expenses................................... 16.6 --
--------- --------
Income before income taxes and minority interest........... 386.8 220.8
Income taxes............................................... 133.2 66.3
Minority interest (credit)................................. (0.9) 0.7
--------- --------
Net income................................................. $ 254.5 $ 153.8
========= ========
Adjusted net income (3).................................... $ 215.0 $ 145.3
========= ========
Membership (000s).......................................... 7,834 7,136
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(1) Operating revenue and premium equivalents is a measure of the volume of
business serviced by Anthem that is commonly used in the health benefits
industry to allow for a comparison of operating efficiency among companies.
It is calculated by adding to premiums, administrative fees and other
revenue the amount of claims attributable to non-Medicare, self-funded
health business where Anthem provides a complete array of customer service,
claims administration and billing and enrollment services.
(2) Includes gain on sale of subsidiary operations (TRICARE) of $25.0 million
in 2001.
(3) Excludes net realized gains on investments and demutualization expenses,
less tax expense of $30.1 million and $4.6 million, in 2001 and 2000,
respectively.
Net income increased 65.5% to $254.5 million for the first nine months of
2001 compared with net income of $153.8 million for the first nine months of
2000. Net income excluding net realized gains on investments and
demutualization expenses was $215.0 million for the first nine months of 2001,
a 48.0% increase compared with $145.3 million for the first nine months of
2000. Earnings improved in 2001 compared with 2000 primarily due to increased
membership, improved underwriting performance and administrative expense
management.
Medical membership reached 7.8 million at September 30, 2001, a 9.9%
increase compared with September 30, 2000. Operating revenue increased 20.9% to
$7.5 billion for the first nine months of 2001. The increase was primarily due
to increased membership, premium rate increases and the acquisition of BCBS-ME
during the second quarter of 2000.
The benefit expense ratio was 85.2% for the first nine months of 2001, a 50
basis point improvement compared with the first nine months of 2000. The change
was primarily due to improved underwriting results which more than offset the
impact of approximately $21.0 million of net adjustments to benefit expense
recorded during the third quarter of 2001. Excluding these adjustments, the
benefit expense ratio would have improved 80 basis points over the comparable
2000 period. These adjustments were principally to strengthen reserves in the
Midwest and East regions during the third quarter of 2001. The benefit expense
ratio in our Midwest and East regions increased for the three months ended
September 30, 2001, compared to the three months ended June 30, 2001, by 80
basis points and 20 basis points, respectively, including the effect of these
adjustments. The benefit expense ratio would have improved sequentially and
year over year in each of the regions without these adjustments. At September
30, 2001, days in claims payable totaled 63.5 days as compared to 62.8 days at
June 30, 2001.
The administrative expense ratio, calculated using operating revenue and
premium equivalents, was 14.1% for the first nine months of 2001, a 60 basis
point improvement compared with the first nine months of 2000, and was related
mostly to cost containment efforts and the 20.9% increase in operating revenue.
Net realized capital gains, excluding the gain on sale of subsidiary
operations, for the nine months ended September 30, 2001 were $61.2 million
compared with net realized capital gains of $13.1 million for the nine months
ended September 30, 2000. Included in net realized capital gains in 2001 was
$65.2 million of gains resulting from restructuring the equity portfolio into
fixed maturity securities and equity index funds during the third quarter.
Net investment income increased 15.8%, to $170.4 million, in the first nine
months of 2001, primarily due to growth in the investment portfolio. Income
before taxes and minority interest increased 75.2%, to $386.8 million, in the
first nine months of 2001, primarily due to improved operating results and
higher net realized capital gains.
All adjustments, including normal recurring adjustments, necessary for a
fair presentation of the financial information for the nine months ended
September 30, 2001 and 2000, have been recorded.
84
THE BUSINESS OF ANTHEM
General Business Description
We are one of the nation's largest health benefits companies, serving over
seven million members, or customers, primarily in Indiana, Kentucky, Ohio,
Connecticut, New Hampshire, Maine, Colorado and Nevada. We hold the leading
market position in seven of these eight states and own the exclusive right to
market our products and services using the Blue Cross Blue Shield, or BCBS,
names and marks in all eight states under license agreements with the Blue
Cross Blue Shield Association, or BCBSA, an association of independent BCBS
plans. We seek to be a leader in our industry by offering a broad selection of
flexible and competitively priced health benefits products.
Our product portfolio includes a diversified mix of managed care products,
including HMO, PPO, and POS plans, as well as traditional indemnity products.
We also offer a broad range of administrative and managed care services and
partially insured products for employer self-funded plans. These services and
products include underwriting, stop loss insurance, actuarial services,
provider network access, medical cost management, claims processing and other
administrative services. In addition, we offer our customers several specialty
products including group life, disability, prescription management, workers
compensation, dental and vision. Our products allow our customers to choose
from a wide array of funding alternatives. For our insured products, we charge
a premium and assume all or a majority of the health care risk. Under our self-
funded and partially insured products, we charge a fee for services, and the
employer or plan sponsor reimburses us for all or a majority of the health care
costs. Of our 2000 operating revenue, 90.6% was derived from fully insured
products, while 9.4% was derived from administrative services and other
revenues.
Our customer base primarily includes large groups (contracts with 51 or more
eligible employees), individuals and small groups (one to 50 employees), each
of which accounted for 36.8%, 19.0% and 17.0% of our 2000 operating revenue,
respectively. Other major customer categories include National accounts,
Medicare recipients, federal employees and other federally funded programs. We
principally market our products through an extensive network of independent
agents and brokers who are compensated on a commission basis for new sales and
retention of existing business.
Our managed care plans and products are designed to encourage providers and
members to select quality, cost-effective health care by utilizing the full
range of our innovative medical management services, quality initiatives and
financial incentives. Our leading market shares enable us to realize the long-
term benefits of investing in preventive and early detection programs. We
further improve our ability to provide cost-effective health benefits products
and services through a disciplined approach to internal cost containment,
prudent management of our risk exposure and successful integration of acquired
businesses. These measures have allowed us to achieve significant growth in
membership (78%), revenue (68%), and net income (135%) from 1996 through 2000.
We intend to continue to expand through a combination of organic growth and
strategic acquisitions in both existing and new markets. Our growth strategy is
designed to enable us to take advantage of the additional economies of scale
provided by increased overall membership. In addition, we believe geographic
diversity reduces our exposure to local or regional economic, regulatory and
competitive pressures and provides us with increased opportunities for
expansion. While the majority of our growth has been the result of strategic
mergers and acquisitions, we have also achieved growth in our existing markets
by providing excellent service, offering competitively priced products and
effectively capturing the brand strength of the Blue Cross and Blue Shield
names and marks.
85
Industry Overview
The health benefits industry has experienced significant change in recent
years. The increasing focus on health care costs by employers, the government
and consumers has led to the growth of alternatives to traditional indemnity
health insurance. HMO, PPO and hybrid plans, such as POS plans, incorporating
features of each, are among the various forms of managed care products that
have developed in recent years. Through these types of products, the cost of
health care is contained by negotiating contracts with hospitals, physicians
and other providers to deliver health care at favorable rates. These products
also can feature medical management and other quality and cost containment
measures such as pre-admission review and approval for non-emergency hospital
services, pre-authorization of outpatient surgical procedures, and network
credentialing to determine that network doctors and hospitals have the required
certifications and expertise. In addition, providers may share medical cost
risk or have other incentives to deliver quality medical services in a cost-
effective manner. HMO, PPO and POS enrollees generally are charged periodic,
pre-paid premiums, and pay co-payments or deductibles when they receive
services. PPO and POS plans allow out-of-network usage, typically at higher
out-of-pocket costs to members. HMO members generally select one of the
network's primary care physicians who then assumes responsibility for
coordinating their health care services. Typically, there is no out-of-network
benefit for HMO members. PPOs and other open access plans generally allow
members to select non-network providers without coordination through a primary
care physician, but at a higher out-of-pocket cost. Hybrid plans, such as POS
plans, typically involve the selection of primary care physicians similar to
HMOs, but allow members to self refer or to choose non-network providers at
higher out-of-pocket costs similar to those of PPOs.
Recently, economic factors and greater consumer awareness have resulted in
the increasing popularity of products that offer larger, more extensive
networks, more member choice related to coverage and the ability to self refer
within those networks. There is also a growing preference for greater
flexibility to assume larger deductibles and co-payments in exchange for lower
premiums. We believe we are well positioned in each of our regions to respond
to these market preferences. Our PPO products, which contain most or all of the
features noted above, have experienced significant growth over the past few
years.
The Blue Cross Blue Shield Association, or BCBSA, has also undergone
significant change in recent years. Historically, most states had at least one
Blue Cross (hospital coverage) and a separate Blue Shield (physician coverage)
company. Prior to the mid 1980s there were more than 125 separate Blue Cross or
Blue Shield companies. Many of these organizations have merged, reducing the
number of independent licensees to under 50 as of December 2000. We expect this
trend to continue, with plans merging or affiliating to address capital needs
and other competitive pressures.
Each of the BCBS plans work cooperatively in a number of ways that create
significant market advantages, especially when competing for very large multi-
state employer groups. As a result of this cooperation, each plan is able to
take advantage of other member plans' substantial provider networks and
discounts when any member from one state works or travels outside of the state
in which the policy is written. We receive a substantial and growing source of
revenue under this "BlueCard" program for providing member services in our
states for individuals who are customers of other BCBS plans.
Our Strategy
Our strategic objective is to be among the best and biggest in our industry
with the size and scale to deliver the best product value with the best people.
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To achieve these goals, we offer a broad selection of flexible and
competitively priced products and seek to establish leading market positions.
We believe that increased scale in each of our regional markets will provide us
competitive advantages, cost efficiencies and greater opportunities to sustain
profitable growth. The key to our ability to deliver this growth is our
commitment to work with providers to optimize the cost and quality of care
while improving the health of our members and improving the quality of our
service.
Promote Quality Care
We believe that our ability to help our members receive quality, cost-
effective health care will be key to our success. We promote the health of our
members through education and through products that cover prevention and early
detection programs that help our members and their providers manage illness
before higher cost intervention is required. To help develop those programs, we
collaborate with the providers in our networks to promote improved quality of
care for our members. The following policies and programs are key to improving
the quality of care that our members receive:
. Selection and continued assessment of provider networks: We select for
our networks providers who meet and maintain our standards of medical
education, training and professional experience.
. Disease management: We develop disease management programs that educate
members on actions they can take to help monitor and better control
their illnesses and to manage diseases such as diabetes, asthma and
congestive heart failure.
. Prevention measures: We work with providers and members to promote
preventive measures such as childhood and adult immunizations, as well
as breast cancer screening.
. Education: We help our members prevent disease and illness or minimize
their impact by promoting lifestyle modification through education. For
example, our nationally recognized smoking cessation program in Maine
has helped to reduce the number of our members in Maine who smoke by 49%
over four years.
. Technology: We also utilize technology to evaluate the medical care
provided to our customers. For example, our Anthem Prescription
Management decision support system helps to identify potentially harmful
drug interactions and helps prevent members from receiving potentially
dangerous combinations of drugs.
Product Value
We aim to create products that offer value to our customers. By offering a
wide spectrum of products supported by broad provider networks, we seek to meet
the differing needs of our various customers. The breadth and flexibility of
our benefit plan options, coupled with quality care initiatives, are designed
to appeal to a broad base of employer groups and individuals with differing
product and service preferences. We use innovative product design, such as a
three-tiered prescription program that provides customer selection among
generic, brand and formulary drugs at various out-of-pocket costs. Innovative
product design helps us to contain costs, which allows our products to be
competitively priced in the market.
Formulary drugs are prescription drugs that have been reviewed and selected
by a committee of practicing doctors and clinical pharmacists for their quality
and cost effectiveness. Use of medications from the formulary, which includes
hundreds of brand name and generic medications, is encouraged through pharmacy
benefit design. A three-tier pharmacy benefit and the use of formulary drugs
allow members access to highly useful prescription medications, while also
helping to control the cost of pharmacy benefits to employers. Members have the
same access to medications but share a greater
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portion of the cost for brand name drugs through the co-payment structure.
Under a three-tier program, the customer pays the lowest price for generic
drugs, a higher price for formulary brand name drugs and the highest price for
brand name drugs not included in the formulary.
Operational Excellence
To provide cost-effective products, we continuously strive to improve
operational efficiency. We actively benchmark our performance against other
leading health benefits companies to identify opportunities to drive continuous
performance improvement. Important performance measures we use include
operating margin, administrative expense ratio, administrative expense PMPM and
return on equity. Current initiatives to drive operational efficiency include:
. consolidating and eliminating information systems;
. standardizing operations and processes;
. implementing e-business strategies; and
. integrating acquired businesses.
Technology
We continuously review opportunities to improve our interactions with
customers, brokers and providers. By utilizing technologies, we seek to make
the interactions as simple, efficient and productive as possible. We monitor
ourselves using industry standard customer service metrics, which measure,
among other things, call center efficiency, claims paying accuracy and speed of
enrollment. We ease the administrative burden of enrolling new accounts,
processing claims and updating records for our brokers and providers by
automating many of these processes. We also collect information that enables us
to further improve customer service, product design and underwriting decisions.
Growth
We believe that profitable growth, both organic and through acquisitions, is
an important part of our business. Increased scale allows us to increase
customer convenience and improve operating margins, while keeping our products
competitively priced. Expansion into new geographic markets enables us to
reduce exposure to economic cycles and regulatory changes and provides options
for business expansion. We plan to generate earnings growth first by increasing
revenues through new enrollment, while maintaining pricing discipline. In
addition, we plan to increase the penetration of specialty products to existing
health members through cross selling and expansion into non-Anthem markets.
These specialty products include prescription management, vision, dental, group
life and disability insurance. While enjoying a leading market share in seven
of our eight markets, we have a market share ranging from 16% to 40% and
believe there is remaining opportunity to grow profitably in each market. We
also intend to make strategic acquisitions to augment our internal growth.
Our History
We were formed in 1944 under the name of Mutual Hospital Insurance, Inc.,
commonly known as Blue Cross of Indiana. In 1946, Mutual Medical Insurance
Inc., also known as Blue Shield of Indiana, was incorporated as an Indiana
mutual insurance company. In 1985, these two companies merged under the name
Associated Insurance Companies, Inc. In 1993, Southeastern Mutual Insurance
Company, a Kentucky-domiciled mutual insurance company doing business as Blue
Cross and Blue Shield of Kentucky, was merged into us. In 1995, Community
Mutual Insurance Company, an Ohio-domiciled mutual insurance company doing
business as Community Mutual Blue Cross and Blue Shield, was merged into us. We
changed our name to Anthem Insurance Companies, Inc. in
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1996. In 1997, Blue Cross & Blue Shield of Connecticut, Inc., a Connecticut-
domiciled mutual insurance company, was merged into Anthem Insurance. We
completed our purchases of New Hampshire-Vermont Health Service, which did
business as Blue Cross and Blue Shield of New Hampshire, and Rocky Mountain
Hospital and Medical Service, which did business as Blue Cross and Blue Shield
of Colorado and Nevada, during 1999. In 2000, we completed our purchase of
Associated Hospital Service of Maine, which did business as Blue Cross and Blue
Shield of Maine.
Mergers and Acquisitions
Much of our recent growth in membership has resulted from strategic mergers
and acquisitions, primarily with other Blue Cross and Blue Shield licensees.
These combinations, coupled with growth in existing markets, have enabled us to
establish multi-regional centers of focus with a significant share of each
region's health benefits market. The following table sets forth our membership
by state as of the dates indicated:
MEMBERSHIP
At June 30, At December 31,
----------- ----------------------------------
2001 2000 1999 1998 1997 1996
----------- ----- ----- ----- ----- -----
(In Thousands)
Midwest
Ohio...................... 2,198 2,118 1,987 2,096 1,990 1,868
Indiana................... 1,532 1,410 1,358 1,175 1,226 1,151
Kentucky.................. 1,096 1,054 1,037 928 1,129 1,059
----- ----- ----- ----- ----- -----
Subtotal................ 4,826 4,582 4,382 4,199 4,345 4,078
East
Connecticut............... 1,194 1,127 1,031 968 916 --
New Hampshire............. 526 479 366 -- -- --
Maine..................... 496 487 -- -- -- --
----- ----- ----- ----- ----- -----
Subtotal................ 2,216 2,093 1,397 968 916 --
West
Colorado.................. 581 463 395 -- -- --
Nevada.................... 156 132 91 -- -- --
----- ----- ----- ----- ----- -----
Subtotal................ 737 595 486 -- -- --
----- ----- ----- ----- ----- -----
Total................. 7,779 7,270 6,265 5,167 5,261 4,078
===== ===== ===== ===== ===== =====
Percentage increase
(decrease) from
previous year end.... 7% 16% 21% (2)% 29% --
During the last three years, we have completed the following acquisitions:
. On June 5, 2000, we purchased substantially all of the assets and
liabilities of BCBS-ME. The cash purchase price was $95.4 million
(including direct costs of acquisition).
. On November 16, 1999, we purchased the stock of BCBS-CO/NV. The cash
purchase price was $160.7 million (including direct costs of
acquisition).
. On October 27, 1999, we purchased the assets and liabilities of BCBS-NH.
The cash purchase price was $125.4 million (including direct costs of
acquisition).
In addition, we have signed a definitive agreement pursuant to which we have
agreed to acquire BCBS-KS. See "Recent Developments--Pending Acquisition of
Blue Cross and Blue Shield of Kansas."
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When integrating new operations, we focus on improving customer service,
underwriting, medical management and administrative operations. We improve
operations by centralizing certain management and support functions, sharing
best practices and consolidating information systems. We also improve
underwriting practices by establishing discipline in our data analysis and
product design.
The following table illustrates the success we have had in improving the
operating performance of BCBS-CT, BCBS-NH and BCBS-CO/NV. The table includes
operating gain (loss) of the year prior to the merger or acquisition, the year
of the merger or acquisition and the year or years following the merger or
acquisition:
Operating Gain(1)
Date of
Acquisition 2000 1999 1998 1997 1996
------------- ----- ------ ------ ------ -----
(In Millions)
BCBS-CT................ August 1997 $86.6 $ 41.3(2) $ (5.6) $(15.6) $(1.7)
BCBS-NH................ October 1999 $11.6 $ 1.3 $(21.6) -- --
BCBS-CO/NV............. November 1999 $ 6.5 $(30.2) $(62.2) -- --
--------
(1) Operating gain consists of operating revenue minus benefit expense and
administrative expense. Results are shown on a stand alone basis including
the year prior to affiliating with Anthem.
(2) Excludes one time $41.9 million expense related to settlement of claims
pertaining to pre-merger operations. See "Legal and Regulatory Matters--
Other Contingencies."
Core Health Benefits Products and Services
We offer a diversified mix of managed care products, including HMO, PPO and
POS plans, as well as traditional indemnity products. Our managed care products
incorporate a broad range of options and financial incentives for both members
and participating providers, including co-payments and provider risk pools. We
also offer a broad range of administrative and managed care services and
partially insured products for employer self-funded plans. These services and
products include underwriting, stop loss insurance, actuarial services, network
access, medical cost management, claims processing and other administrative
services. We charge a premium for insured plans and typically assume all or a
majority of the health care risk. For self-funded or partially-insured
products, we charge a fee for services while the employer assumes all or a
majority of the risks. The fee is based upon the customer's selection from our
portfolio of services. We also provide specialty products including group life,
disability, prescription management, dental and vision care. Our principal
health products, offered both on an insured and employer-funded basis, are
described below. Some managed care and medical cost containment features may be
included in each of these products, such as inpatient pre-certification,
benefits for preventive services and reimbursement at reasonable and customary
charges with no additional billing to members.
Preferred Provider Organization, or PPO. PPO products offer the member an
option to select any health care provider, with benefits paid at a higher level
when care is received from a participating network provider. Coverage is
subject to co-payments or deductibles and coinsurance, with member cost sharing
limited by out-of-pocket maximums.
Traditional Indemnity. Indemnity products offer the member an option to
select any health care provider for covered services. Coverage is subject to
deductibles and coinsurance, with member cost sharing limited by out-of-pocket
maximums.
Health Maintenance Organization, or HMO. HMO products include comprehensive
managed care benefits, generally through a participating network of physicians,
hospitals and other providers.
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A member in one of our HMOs must typically select a primary care physician, or
PCP, from our network. PCPs generally are family practitioners, internists or
pediatricians who provide necessary preventive and primary medical care, and
are generally responsible for coordinating other necessary health care.
Preventive care services are emphasized in these plans. We offer HMO plans with
varying levels of co-payments, which result in different levels of premium
rates.
Point-of-Service, or POS. POS products blend the characteristics of HMO and
indemnity plans. Members can have comprehensive HMO-style benefits through
participating network providers with minimum out-of-pocket expense (co-
payments) and also can go directly, without a referral, to any provider they
choose, subject to, among other things, certain deductibles and coinsurance.
Member cost sharing is limited by out-of-pocket maximums.
BlueCard Plan. BCBS plans across the United States share their local
provider networks in a unique arrangement, where one plan's enrolled members
travel or live in another plan's service area. The local or "host" plan is paid
an administrative fee by the "home" or selling plan in exchange for providing
claims and member services to home plan customers in the host plan's service
area. All claims are reimbursed by the home plan, which may have an insured or
self-funded relationship with the member's employer under any of the product
designs discussed above. BlueCard membership is calculated based on the amount
of BlueCard administrative fees we receive from the BlueCard members' home
plans. Generally, the administrative fees we receive are based on the number
and type of claims processed and a portion of the network discount on those
claims. The administrative fees are then divided by an assumed PMPM factor in
order to calculate the number of members. The assumed PMPM factor is based on
an estimate of Anthem's experience and BCBSA guidelines.
The following table sets forth our health benefits membership data by
product:
At June 30, At December 31,
----------- -----------------
2001 2000 1999 1998
----------- ----- ----- -----
(In Thousands)
PPO............................................... 3,072 2,835 2,540 2,322
Traditional Indemnity............................. 1,137 1,155 1,048 1,075
HMO............................................... 1,203 1,147 980 697
POS............................................... 757 813 723 543
----- ----- ----- -----
Directly Contracted Membership.................... 6,169 5,950 5,291 4,637
BlueCard (Anthem Host)............................ 1,610 1,320 974 530
----- ----- ----- -----
Total........................................... 7,779 7,270 6,265 5,167
===== ===== ===== =====
Specialty Products and Services
Prescription Management Services. We provide pharmacy network management,
pharmacy benefits and mail order prescription services through our subsidiary,
Anthem Prescription Management, or APM, our pharmacy benefit manager. APM
administers its programs primarily to customers who are also Anthem health plan
members. Anthem Rx, our retail pharmacy network, provides members access to
more than 53,000 chain and independent pharmacies across the United States, and
Anthem Rx Direct, our mail service pharmacy, provides long-term therapy
medications through convenient home delivery.
Group Life and Disability. We offer an array of competitive group life
insurance and disability benefit products to both large and small group
customers. We have over $27.7 billion of life insurance in force, insuring over
31,000 groups with more than 800,000 employees. Our traditional group insurance
products include term life, accidental death and dismemberment, short-term
disability income and long-term disability income. In addition, we offer
voluntary group life and disability products through employers which payroll-
deduct premiums from their participating employees.
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Vision and Dental Care Programs. These programs are primarily for customers
enrolled in our Blue Cross and Blue Shield health plans. Vision and dental
products available include both fully insured and self-insured products. In
addition, we provide dental third-party administration services through Health
Management Systems, Inc., our wholly owned subsidiary.
Other Products and Services
In addition to the above-described products and services, we provide
services as a fiscal intermediary for the Medicare Part A and Part B program in
certain states.
Marketing
We market our managed care and specialty products through three regional
business units. Our health plans are generally marketed under the Blue Cross
and Blue Shield brand, except for certain government programs. We organize our
marketing efforts by customer segment and by region in order to maximize our
ability to meet the specific needs of our customers. Marketing programs are
developed by a cross-functional team including the actuarial, underwriting,
sales, operations and finance departments to evaluate risk and pricing and to
ensure adherence to established underwriting guidelines. We believe our
reputation, financial stability, high quality customer service and exclusive
BCBS license provide us with competitive advantages and allow us to gain share
in our markets. We strive to develop solutions for our customers. Our keys to
success include developing long-term relationships and providing stable pricing
of our products. Most contracts are for one year, although we occasionally
enter into multi-year arrangements.
We maintain the quality of our sales staff and independent brokers through
regularly held training seminars and advisory groups, which familiarize them
with evolving consumer preferences, as well as our products and current
marketing strategies. In addition, we structure sales commissions to provide
incentives to our sales staff and brokers to promote the full value of our
products.
Each region is responsible for enrolling, underwriting and servicing its
respective businesses. We pursue product standardization where practical to
gain efficiencies resulting from the simplification of the marketing and sales
process.
Customers
In each region, we balance the need to customize products with the
efficiencies of product standardization. Overall, we seek to establish pricing
and product designs to achieve an appropriate level of profitability for each
of our customer categories. Our customers include several distinguishable
categories:
. Large groups, defined as contracts with 51 or more eligible employees
(but excluding "National business", described below), accounted for
38.9% of our operating revenue and 35.8% of our members as of and for
the six months ended June 30, 2001. These groups are generally sold
through brokers or consultants working with industry specialists from
our in-house sales force. Large group cases are usually experience rated
or sold on a self-insured basis. The customer's buying decision is
typically based upon the size and breadth of our networks, the quality
of our medical management services, the administrative cost included in
our quoted price, our financial stability and our ability to effectively
service large complex accounts.
. Small groups, defined as contracts with one to 50 employees, accounted
for 17.4% of our operating revenue and 10.4% of our members as of and
for the six months ended June 30, 2001. These groups are sold
exclusively through independent agents and brokers. Small group cases
are sold on a fully insured basis. Underwriting and pricing is done on a
community rated basis, with individual state insurance departments
approving the rates. See "Legal and Regulatory Matters--Small Group
Reform." Small group customers are generally
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more sensitive to product pricing and, to a lesser extent, the
configuration of the network and the efficiency of administration.
Account turnover is generally higher with small groups.
. Individual policies (under age 65) accounted for 4.9% of our operating
revenue and 3.6% of our members as of and for the six months ended June
30, 2001. These policies are generally sold through independent agents
and brokers. In some cases an in-house telemarketing unit is used to
generate leads. This business is usually medically underwritten at the
point of initial issuance. Rates are filed with and approved by state
insurance departments. In several of our markets, there is much less
competition for individual business than group contracts.
. Medicare Supplement business accounted for 6.8% of our operating revenue
and 5.1% of our members as of and for the six months ended June 30,
2001. These standardized policies are sold to Medicare recipients as
supplements to the benefits they receive from the Medicare program. New
policyholders come from independent agents or brokers or through the
conversion of existing member groups or individual policies when they
retire and reach age 65.
. The Federal Employee Program accounted for 10.1% of our operating
revenue and 5.5% of our members as of and for the six months ended June
30, 2001. As a BCBSA licensee, we participate in a nationwide contract
with the Federal government whereby we cover Federal employees and their
dependents in our eight-state service area. Under a complex formula, we
are reimbursed for our costs plus a fee. We also participate in the
overall medical risk on a pooled basis with the other participating BCBS
plans.
. Medicare + Choice accounted for 6.0% of our operating revenue and 1.3%
of our members as of and for the six months ended June 30, 2001. This
program is the managed care alternative to the federally funded Medicare
program. Most of the premium is paid directly by the Federal government
on behalf of the participant who may also be charged a small premium.
Medicare+Choice is marketed in the same manner as Medicare Supplement
products.
. National business (including BlueCard) accounted for 5.1% of our
operating revenue, but 37.0% of our members as of and for the six months
ended June 30, 2001, because much of our National business is self-
insured. These groups are generally sold through brokers or consultants
working with our in-house sales force. We have a significant competitive
advantage when competing for very large National accounts due to our
ability to access the national network of BCBS plans and take advantage
of their provider discounts in their local markets.
The following chart shows our membership by customer segment:
MEMBERSHIP
At June 30, At December 31,
----------- -----------------
Customer Segment 2001 2000 1999 1998
---------------- ----------- ----- ----- -----
(In Thousands)
Large group....................................... 2,786 2,634 2,249 1,852
Small group....................................... 807 775 637 559
Individual (under age 65)......................... 281 260 215 159
Medicare Supplement (age 65 and over)............. 393 390 371 319
Federal Employee Program.......................... 426 407 362 268
Medicare + Choice................................. 101 106 96 81
National.......................................... 2,877 2,468 2,106 1,696
Other (TRICARE and Medicaid)...................... 108 230 229 233
----- ----- ----- -----
Total........................................... 7,779 7,270 6,265 5,167
===== ===== ===== =====
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The Blue Cross Blue Shield License
We have the exclusive right to use the Blue Cross and Blue Shield names and
marks for all of our health benefits products in Indiana, Kentucky, Ohio,
Connecticut, New Hampshire, Maine, Colorado and Nevada. We believe that the
BCBS names and marks are valuable identifiers of our products and services in
the marketplace. The license agreements, which have a perpetual term, contain
certain requirements and restrictions regarding our operations and our use of
the BCBS names and marks. Upon termination of the license agreements, we would
cease to have the right to use the BCBS names and marks in one or more of
Indiana, Kentucky, Ohio, Connecticut, New Hampshire, Maine, Colorado and
Nevada, and the BCBSA could thereafter issue a license to use the BCBS names
and marks in these states to another entity. Events that could cause the
termination of a license agreement with the BCBSA include:
. failure to comply with minimum capital requirements imposed by the
BCBSA;
. impending financial insolvency;
. the appointment of a trustee or receiver;
. a change of control or violation of the BCBSA ownership limitations on
our capital stock; and
. the commencement of any action against Anthem Insurance seeking its
dissolution.
Pursuant to the rules and license standards of the BCBSA, we have certified
to the BCBSA that we guarantee the contractual and financial obligations to
respective customers of our subsidiaries that hold controlled affiliate
licenses from the BCBSA. Those subsidiaries are Anthem Health Plans of
Kentucky, Inc., Anthem Life Insurance Company, Anthem Health Plans, Inc.,
Community Insurance Company, Anthem Health Plans of New Hampshire, Inc., Rocky
Mountain Hospital and Medical Service, Inc., Anthem Health Plans of Maine,
Inc., HMO Colorado, Inc., Matthew Thornton Health Plan, Inc., Maine Partners
Health Plan, Inc. and Health Management Systems, Inc.
In addition, pursuant to the rules and license standards of the BCBSA, we
have agreed to indemnify BCBSA against any claims asserted against it resulting
from the contractual and financial obligations of AdminaStar Federal, our
subsidiary which serves as a fiscal intermediary providing administrative
services for Medicare Part A and B.
Each license requires an annual fee to be paid to the Blue Cross Blue Shield
Association. The fee is based upon enrollment and premium. BCBSA is a national
trade association of Blue Cross and Blue Shield licensees, the primary function
of which is to promote and preserve the integrity of the Blue Cross and Blue
Shield names and marks, as well as provide certain coordination among the
member plans. Each BCBSA licensee is an independent legal organization and is
not responsible for obligations of other BCBSA member organizations. We have no
right to market products and services using the Blue Cross and Blue Shield
names and marks outside of our eight core states.
The BCBSA license agreements and membership standards specifically permit a
licensee to operate as a for-profit, publicly traded stock company. We have
obtained the consent of the BCBSA in order to continue our licenses following
our conversion to a publicly traded stock company.
BCBS-KS is a licensee of the BCBSA. We will need to obtain the consent of
the BCBSA to continue that license following our acquisition of BCBS-KS.
Information Systems
Information systems have played and will continue to play a key role in our
ongoing efforts to continuously improve quality, lower costs and increase
benefit flexibility for our customers. Our analytical technologies are designed
to support increasingly sophisticated methods of managing
94
costs and monitoring quality of care, and we believe that our information
systems are sufficient to meet current needs and future expansion plans.
We use a combination of custom developed and licensed systems throughout our
regions. An overall systems architecture is maintained to promote consistency
of data and reduce duplicative platforms. This architecture assumes single
separate core systems supporting each of our operating regions with centralized
systems for key company-wide functions such as financial services, human
resources and servicing National accounts. Focus is placed on identifying and
eliminating redundant or obsolete applications with an emphasis on increasing
our capability to operate in an Internet-enabled environment. Regional
administration systems serving unique products and markets feed data to a
combination of regional and corporate decision support systems. These systems
provide sources of information for all of our data reporting and analysis
needs.
Our architecture calls for significant standardization of software, hardware
and networking products. Enhancements are undertaken based on a defined
information systems plan. This plan, which is developed collaboratively by our
technical and operating leadership, is revalidated regularly and maps out
business-driven technology requirements for the upcoming three-to-five year
period.
We recognize consumer demand will cause an increasing need for more of our
business to be conducted electronically. Toward that end we have developed
several Internet-enabled initiatives focused on improving interactions with our
customers, members, providers, brokers and associates. We also are improving
communication and data collection through compliance with the provisions of the
Federal Health Insurance Portability and Accountability Act or HIPAA. See
"Legal and Regulatory Matters--Regulation of Insurance Company and HMO Business
Activities."
We are also engaged in a series of pilot programs that will result in web-
enabled services such as on-line membership enrollment and on-line price
quoting for brokers. Brokers will also receive on-line quoting capabilities for
life, dental and vision related products. For our members, we will have on-line
access to health information using carefully chosen content providers for
consumer health information. All of our members currently have on-line access
to physician and hospital network directories for their specific health plan.
Collaborations
In addition to internal efforts to leverage technology, we are actively
involved as investors and leaders in several collaborative technology
initiatives. As an example, we are one of seven major national health benefits
companies that are initial investors in MedUnite, Inc., an e-business company.
MedUnite is designing Internet-based technology that will permit real-time
transactions between providers and insurance companies. MedUnite's solutions
will address claims filing, eligibility determination and specialist referrals.
These programs will make these transactions more convenient for members while
improving efficiencies among doctors, hospitals and health insurers.
Additionally, we are a founding member of the Coalition for Affordable
Healthcare. This group, formed by 24 of the nation's largest health benefits
companies and associations, develops programs to improve access to quality
health care coverage and to simplify plan administration.
Pricing and Underwriting
We price our products based on our assessment of underwriting risk and
competitive factors. We continually review our underwriting and pricing
guidelines on a national and regional basis so that our products remain
competitive and consistent with our marketing strategies and profitability
goals.
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We have focused our efforts to maintain consistent, competitive and strict
underwriting standards. Our individual and group underwriting targets have been
based on our proprietary accumulated actuarial data. Subject to applicable
legal constraints, we have traditionally employed case specific underwriting
procedures for small group products and traditional group underwriting
procedures with respect to large group products. Also, we employ credit
underwriting procedures with respect to our self-funded products.
In most circumstances, our pricing and underwriting decisions follow a
prospective rating process. A fixed premium rate is determined at the beginning
of the policy period. Unanticipated increases in medical costs may not be able
to be recovered in that current policy year. However, prior experience, in the
aggregate, is considered in determining premium rates for future periods.
For larger groups (over 300 lives) with PPO, POS or traditional benefit
designs, we often employ retrospective rating reviews. In retrospective rating,
a premium rate is determined at the beginning of the policy period. Once the
policy period has ended, the actual experience is reviewed. If the experience
is positive (i.e., actual claim costs and other expenses are less than those
expected), then a refund may be credited to the policy. If the experience is
negative, then the resulting deficit may either be recovered through
contractual provisions or the deficit may be considered in setting future
premium levels for the group. If a customer elects to terminate coverage,
deficits generally are not recovered.
We have contracts with CMS to provide HMO Medicare+Choice coverage to
Medicare beneficiaries who choose health care coverage through one of our HMO
programs. Under these annual contracts, CMS pays us a set rate based on
membership that is adjusted for demographic factors. These rates are subject to
annual unilateral revision by CMS. In addition to premiums received from CMS,
most of the Medicare products offered by us require a supplemental premium to
be paid by the member.
See "Legal and Regulatory Matters--Small Group Reform" for a discussion of
certain regulatory restrictions on our underwriting and pricing.
Reserves
We establish and report liabilities or reserves on our balance sheet for
unpaid health care costs by estimating the ultimate cost of incurred claims
that have not yet been reported to us by members or providers and reported
claims that we have not yet paid. Since these reserves represent our estimates,
the process requires a degree of judgment. Reserves are established according
to Actuarial Standards of Practice and generally accepted actuarial principles
and are based on a number of factors. These factors include experience derived
from historical claims payments and actuarial assumptions to arrive at loss
development factors. Such assumptions and other factors include healthcare cost
trends, the incidence of incurred claims, the extent to which all claims have
been reported and internal claims processing charges. Due to the variability
inherent in these estimates, reserves are sensitive to changes in medical
claims payment patterns and changes in medical cost trends. A worsening (or
improvement) of the medical cost trend or changes in claims payment patterns
from the trends and patterns assumed in estimating reserves would trigger a
change. See Note 8 to our audited consolidated financial statements for
quantitative information on our reserves, including a progression of reserve
balances for each of the last three years.
Medical Management
Our medical management programs include a broad array of activities that are
intended to improve the quality and cost-effectiveness of care provided to our
members. One of the goals of these benefit features is to assure that the care
delivered to our members is supported by appropriate medical and scientific
evidence.
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Precertification. A traditional medical management program that we use
involves assessment of the appropriateness of certain hospitalizations and
other medical services. For example, precertification is used to determine
whether a set of hospital and medical services is being appropriately applied
to the member's clinical condition.
Concurrent review. Another traditional medical management strategy we use
is concurrent review, which is based on nationally recognized criteria
developed for the industry. With concurrent review, the requirements and
intensity of services during a patient's hospital stay are reviewed, often by
an onsite skilled nurse professional in coordination with the hospital's
medical and nursing staff.
Disease management. More and more, health plans, including ours, are moving
away from traditional medical management approaches to more sophisticated
models built around disease management and advanced care management. These
programs focus on those members who require the greatest amount of medical
services. We provide important information to our providers and members to help
them optimally manage the care of their specific conditions. For example,
certain therapies and interventions for patients with diabetes help prevent
some of the serious, long-term medical consequences of diabetes and reduce the
risks of kidney, eye and heart disease. Our information systems can provide
feedback to our physicians to enable them to improve the quality of care. For
other prevalent medical conditions such as heart disease or asthma, our ability
to correlate pharmacy data and medical management data allows us to provide
important information to our members and providers which enables them to more
effectively manage these conditions.
Formulary management. APM develops a formulary, a selection of drugs based
on clinical quality and effectiveness, which is used across all of our regions.
A pharmacy and therapeutics committee consisting of 20 physicians, 16 of whom
are academic and community physicians practicing in our markets, make pharmacy
medical decisions about the clinical quality and efficacy of drugs. In the last
two years, pharmacy costs have increased by 15% to 18% nationally. We have,
through our focused activities in this area, been able to perform better than
the national trend by 3% to 5%. Our three-tiered co-pay strategy enables
members to have access to all drugs that are not covered on formulary for an
additional co-pay. This has been our primary tool to contain pharmacy costs.
Medical policy. A medical policy group comprised of physician leaders from
all Anthem regions, working in close cooperation with national organizations
such as the Centers for Disease Control, the American Cancer Society and
community physician leaders, determines Anthem's national policy for best
approaches to the application of new technologies.
Patient outcomes. A significant amount of health care expenditures are used
by a small percent of our members who suffer from complex or chronic illnesses.
We have developed a series of programs aimed at helping our providers better
manage and improve the health of these members. Often, these programs provide
benefits for home care services and other support to reduce the need for
repeated, expensive hospitalizations. Increasingly, we are providing
information to our hospital networks to enable them to improve medical and
surgical care and outcomes to our members. We endorse, encourage and
incentivize hospitals to support national initiatives to improve patient
outcomes and reduce medication errors. We have been recognized as a national
leader in developing hospital quality programs.
External Review Procedures (Patients' Bill of Rights). In light of
increasing public concerns about health plans denying coverage of medical
services, we work with outside experts through a process of external review to
help provide our members with timely medical care. When we receive member
concerns, we have formal appeals procedures that ultimately allow coverage
disputes to be settled by independent expert physicians.
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Service management. In HMO and POS networks, primary care physicians serve
as the overall coordinators of members' health care needs by providing an array
of preventive health services and overseeing referrals to specialists for
appropriate medical care. In PPO networks, patients have greater access to
network physicians without a primary care physician serving as the coordinator
of care.
Health Care Quality Initiatives
Increasingly, the health care industry is able to define quality health care
based on preventive health measurements and outcomes of care. A key to our
success has been our ability to work with our network providers to improve the
quality and outcomes of the health care services provided to our members. Our
ability to provide high quality service has been recognized by the National
Committee on Quality Assurance, or NCQA, the largest and most respected
national accreditation program for managed care health plans. All of our HMO
plans in the East region hold the highest NCQA rating. Our HMO plan for
Colorado has received a three-year accreditation. In our Midwest region, health
plans in Ohio and Kentucky held NCQA accreditation into 1999. We decided not to
seek re-accreditation in 1999 for our Midwest plans, but rather focused on
consolidating provider networks, products and systems. We will again seek NCQA
accreditation for our Midwest HMO and POS health plans in 2001.
A range of quality health care measures have been adopted by the Health Plan
Employer Data and Information Set, or HEDIS, which has been incorporated into
the oversight certification by NCQA. These HEDIS measures range from preventive
services, such as screening mammography and pediatric immunization, to elements
of care, including decreasing the complications of diabetes and improving
treatment for heart patients. While our results on specific measures have
varied over time, we are seeing continuous improvement overall in our HEDIS
measurements, and a number of our state plans are among the best performers in
the nation with respect to certain HEDIS standards.
In addition, we have initiated a broad array of quality programs, including
those built around smoking cessation and transplant management, and an array of
other programs specifically tailored to local markets. Many of these programs
have been developed in conjunction with organizations such as the Arthritis
Foundation and regional diabetes associations.
Provider Arrangements
Our relationships with health care providers, physicians, hospitals and
those professionals that provide ancillary health care services are guided by
regional and national standards for network development, reimbursement and
contract methodologies.
In contrast to some health benefits companies, it is generally our
philosophy not to delegate full financial responsibility to our providers in
the form of capitation-based reimbursement. While capitation can be a useful
method to lower costs and reduce underwriting risk, we have observed that, in
general, providers do not positively accept the burden of maintaining the
necessary financial reserves to meet the risks related to capitation contracts.
We attempt to provide fair, market-based hospital reimbursement along
industry standards. We also seek to ensure physicians in our network are paid
in a timely manner at appropriate rates. We use multi-year contracting
strategies, including case or fixed rates, to limit trend exposure and increase
cost predictability. In all regions, we seek to maintain broad provider
networks to ensure member choice while implementing effective management
programs designed to improve the quality of care received by our members.
Depending on the consolidation and integration of physician groups and
hospitals, reimbursement strategies vary substantially across markets. Fee for
service is our predominant reimbursement methodology for physicians. We
generally use a resource-based relative value system fee schedule to determine
fee for service reimbursement. This structure was developed and
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is maintained by CMS and is used by the Medicare system and other major payers.
This system is independent of submitted fees and therefore is not as vulnerable
to inflation. In addition, physician incentive contracting is used to reward
physician quality and performance.
Like our physician contracts, our hospital contracts provide for a variety
of reimbursement arrangements depending on the network. Our hospital contracts
recognize the size of the facility and the volume of care performed for our
members. Many hospitals are reimbursed on a fixed allowance per day for covered
services (per diem) or a case rate basis similar to Medicare (Diagnosis Related
Groups). Other hospitals are reimbursed on a discount from approved charge
basis for covered services. Hospital outpatient services are reimbursed based
on fixed case rates, fee schedules or percent of charges. To improve
predictability of expected cost, we frequently use a multi-year contracting
approach which provides stability in our competitive position versus other
health benefit plans in the market.
We believe our market share enables us to negotiate favorable provider
reimbursement rates. In some markets, we have a "modified favored rate"
provision in our hospital and ancillary contracts that guarantees contracted
rates at least as favorable as those given to our competitors with an equal or
smaller volume of business.
Behavioral Health and Other Provider Arrangements
We have a series of contracts with third party behavioral health networks
and care managers who organize and provide for a continuum of behavioral health
services focusing on access to appropriate providers and settings for
behavioral health care. These contracts are generally multi-year capitation
based arrangements. Substance abuse and alcohol dependency treatment programs
are an integral part of these behavioral health programs.
In addition, a number of other ancillary service providers, including
laboratory service providers, home health agency providers and intermediate and
long term care providers, are contracted on a region-by-region basis to provide
access to a wide range of services. These providers are normally paid on either
a fee schedule, fixed-per-day or per case basis.
Competition
The managed care industry is highly competitive, both nationally and in our
regional markets. Competition has intensified in recent years due to more
aggressive marketing and pricing, a proliferation of new products and increased
quality awareness and price sensitivity among customers. Significant
consolidation within the industry has also added to competition. In addition,
with the 1999 enactment of the Gramm-Leach-Bliley Act, banks and other
financial institutions have the ability to affiliate with insurance companies,
which may lead to new competitors in the insurance and health benefits fields.
Industry participants compete for customers mainly on the following factors:
. price;
. quality of service;
. access to provider networks;
. flexibility of benefit designs;
. reputation (including NCQA accreditation status);
. brand recognition; and
. financial stability.
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We believe our exclusive right to market products under the Blue Cross Blue
Shield brand in our markets provides us with an advantage over our competition.
In addition, our strong market share and existing provider networks in both our
Midwest and East regions enable us to achieve cost-efficiencies and service
levels that allow us to offer a broad range of health benefits to our customers
on a more cost-effective basis than many of our competitors. In our West
region, the marketplace is highly fragmented with no single player having a
dominant market share. There, as in all regions, we strive to distinguish our
products through excellent service, product value and brand recognition.
Competitors in our markets include local and regional managed care plans,
and national health benefits companies. In our Midwest region, our largest
competitors include UnitedHealthcare, Humana Inc., Aetna U.S. Healthcare and
Medical Mutual of Ohio. In our East region, our main competitors are Aetna U.S.
Healthcare, Health Net, Inc., CIGNA HealthCare, ConnectiCare, Inc. and Harvard
Pilgrim Health Care. In our West region, our principal competitors include
Sierra Health Services, Inc., PacifiCare Health Systems, Inc.,
UnitedHealthcare, Kaiser Permanente, Aetna U.S. Healthcare and Hometown Health
Plan, Inc. To build our provider networks, we also compete with other health
benefits plans for contracts with hospitals, physicians and other providers. We
believe that physicians and other providers primarily consider member volume,
reimbursement rates, timeliness of reimbursement and administrative service
capabilities along with the "non-hassle" factor or reduction of non-value added
administrative tasks when deciding whether to contract with a health benefits
plan. At the distribution level, we compete for qualified agents and brokers to
distribute our products. Strong competition exists among insurance companies
and health benefits plans for agents and brokers with demonstrated ability to
secure new business and maintain existing accounts. The basis of competition
for the services of such agents and brokers are:
. commission structure;
. support services;
. reputation and prior relationships; and
. quality of the products.
We believe that we have good relationships with our agents and brokers, and
that our products, support services and commission structure compare favorably
to our competitors in all of our regions.
Employees
As of June 30, 2001, we had approximately 14,800 full-time equivalent
employees primarily located in Cincinnati and Columbus, Ohio; Indianapolis,
Indiana; Louisville, Kentucky; North Haven, Connecticut; Denver, Colorado;
Portland, Maine; and Manchester, New Hampshire. Employees were also located in
various other cities within our regions, as well as in Illinois, Nevada and New
York. Our employees are an important asset, and we seek to develop them to
their full potential. We believe that our relationships with our employees are
good. No employees are subject to collective bargaining agreements.
Properties
Our principal executive offices are located at 120 Monument Circle,
Indianapolis, Indiana. In addition to this property, our principal operating
facilities are located in Denver, Colorado; North Haven, Connecticut;
Indianapolis, Indiana; Cincinnati, Ohio; Columbus, Ohio; Manchester, New
Hampshire; and Portland, Maine. In total, we own approximately 15 facilities
and lease approximately 65 facilities, totaling 4.6 million square feet in 19
states. Many of the facilities are connected to our government businesses,
which extend well beyond our eight core states. We believe that our properties
are adequate and suitable for our business as presently conducted.
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Regulation
We are subject to extensive regulation and supervision by authorities of
each state in which we operate. We are also subject to regulation by federal
and local agencies. The extent of state regulation varies, but most
jurisdictions have laws and regulations requiring the licensing of insurers and
HMOs and their agents and standards of solvency and business conduct for
insurance companies and HMOs. State laws may also regulate withdrawal from
certain markets. In addition, statutes and regulations usually require the
approval of policy forms and, for certain products, the approval of premium
rates. The statutes and regulations also prescribe types and concentration of
investments. We are required to file detailed annual financial statements with
supervisory agencies in each of the jurisdictions in which we do business. Our
operations and accounts are also subject to examination by those agencies at
regular intervals. We are also subject to federal and state laws and
regulations affecting the conduct of our business. In addition, assessments are
levied against us as a result of our mandatory participation in funds that
guarantee the viability of insurance companies which assume risk in each of our
states. For more information, see "Legal and Regulatory Matters--Regulation of
Insurance Company and HMO Business Activities."
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INVESTMENTS
Our investment objective is to preserve our asset base and to achieve rates
of return which are consistent with our defined risk parameters, mix of
products, liabilities and surplus. Our portfolio is structured to provide
sufficient liquidity to meet general operating needs, special needs arising
from changes in our financial position and changes in the financial market. In
accordance with these objectives, our investment policy authorizes investments
in U.S. dollar-denominated fixed income securities and publicly traded equity
securities, both domestic and international, or mutual funds whose focus is
investing in such securities.
As of June 30, 2001 and December 31, 2000, our cash and investment portfolio
was comprised of the following (at fair value):
Percent Percent
June 30, of December 31, of
2001 Total 2000 Total
-------- ------- ------------ -------
($ in Millions)
Cash and cash equivalents................ $ 238.9 5.9% $ 203.3 5.5%
Fixed maturity securities:
United States Government securities.... 729.7 18.1 746.5 20.1
Obligations of states and political
subdivisions.......................... 3.8 0.1 0.8 --
Corporate securities................... 1,140.6 28.3 1,040.7 28.0
Mortgaged-backed securities............ 1,477.2 36.7 1,258.4 33.9
Preferred stocks....................... -- -- 1.8 --
-------- ----- -------- -----
Total fixed maturity securities...... 3,351.3 83.2 3,048.2 82.0
Equity securities........................ 439.4 10.9 463.1 12.5
-------- ----- -------- -----
Total cash and investments........... $4,029.6 100.0% $3,714.6 100.0%
======== ===== ======== =====
Our fixed maturity and equity securities are subject to the risk of
potential losses from adverse market conditions. To manage the potential for
economic losses, we regularly evaluate certain risks, as well as the
appropriateness of the investments, to be certain the portfolio is managed
within its risk guidelines. The result is a portfolio that is well diversified,
both across and within asset classes. Our primary risk exposures are (1)
changes in market interest rates, (2) credit quality and (3) changes in equity
prices.
Interest Rate Risk
Interest rate risk is defined as the potential for economic losses on fixed-
rate securities, due to an adverse change in market interest rates. Our fixed
maturity portfolio consists exclusively of U.S. dollar-denominated assets,
invested primarily in U.S. government securities, corporate bonds, asset-backed
bonds and mortgage-related securities, all of which represent an exposure to
changes in the level of market interest rates. We manage interest rate risk by
maintaining a duration commensurate with our insurance liabilities and
policyholders' surplus. Further, we do not engage in the use of derivatives to
manage interest rate risk, as they are prohibited in our investment policy. We
believe that a hypothetical increase in interest rates of 100 basis points
would result in an estimated decrease in the fair value of the fixed income
portfolio of $166.8 million.
Credit Quality Risk
Credit quality risk is defined as the risk of a credit downgrade to an
individual fixed income security and the potential loss attributable to that
downgrade. We manage this risk through our investment policy, which establishes
credit quality limitations on the overall portfolio as well as dollar limits
for individual issuers. The result is a well-diversified portfolio of fixed
income securities, with an average credit rating of approximately double-A.
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Equity Price Risk
Equity price risk for stocks is defined as the potential for economic losses
due to an adverse change in equity prices. Equity risk exposure is managed
through our investment in indexed mutual funds. Specifically, we are invested
in S&P 500 and S&P 400 index mutual funds, resulting in a well- diversified and
liquid portfolio that replicates the risk and performance of the broad U.S.
stock market. We estimate our equity price risk from a hypothetical 10% decline
in the S&P 500 and 400 indices and the relative effect of that decline in the
value of our portfolio to be a decrease in fair value of $43.9 million.
Fixed Maturity Securities
Our fixed income strategy is to employ external money managers who will
construct and manage a high quality, diversified portfolio of securities.
External money managers are selected based on consistent performance and
experience in insurance asset management. Additionally, our investment policy
establishes minimum quality and diversification requirements resulting in an
average credit rating of approximately double-A. The duration of our portfolio
is 4.6 years as of December 31, 2000, and is managed to within +/- 20% of the
Lehman Aggregate Bond Index.
Fixed Maturity Securities Quality Distribution
The following chart shows the quality distribution of our fixed maturity
securities portfolio as of June 30, 2001 and December 31, 2000 (at fair value):
Percent Percent
June 30, of December 31, of
Credit quality(1) 2001 Total 2000 Total
----------------- -------- ------- ------------ -------
($ in Millions)
Aaa................................... $2,399.3 71.6% $2,267.9 74.4%
Aa.................................... 86.5 2.6 72.4 2.4
A..................................... 481.5 14.4 391.6 12.8
Baa................................... 338.6 10.1 245.9 8.1
Ba.................................... 45.4 1.4 70.4 2.3
-------- ----- -------- -----
Total fixed maturity securities....... $3,351.3 100.0% $3,048.2 100.0%
======== ===== ======== =====
--------
(1) Ratings are primarily assigned by Standard & Poor's Corporation and Moody's
Investor Service.
Corporate fixed maturity securities consist primarily of investment grade
bonds (securities rated triple-B or higher). Further, our investment policy
prohibits investing in below double-B rated credit securities. Our corporate
securities portfolio is diversified by industry and issuer, with no significant
exposure to any single corporation. At June 30, 2001, our 10 largest
investments in corporate securities totaled $166.9 million, or 5.0% of total
fixed maturity securities.
Corporate Fixed Maturity Securities Sector Distribution
The following chart shows the sector distribution of our corporate fixed
maturity securities portfolio as of June 30, 2001 and December 31, 2000 (at
fair value):
Percent Percent
June 30, of December 31, of
2001 Total 2000 Total
-------- ------- ------------ -------
($ in Millions)
Industrial........................... $ 726.0 63.7% $ 375.9 36.1%
Finance.............................. 198.0 17.4 350.8 33.7
Utility.............................. 33.1 2.9 78.5 7.6
Asset-backed securities.............. 160.1 14.0 218.4 21.0
Other................................ 23.4 2.1 17.1 1.6
-------- ----- -------- -----
Total fixed maturity corporate
securities........................ $1,140.6 100.0% $1,040.7 100.0%
======== ===== ======== =====
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Mortgage-backed securities represent 44.1% of the fixed maturity securities
portfolio. A majority of this amount is agency-issued pass-through certificates
and collateralized mortgage obligation securities, issued by the Federal
National Mortgage Association, Federal Home Loan Mortgage Corporation and
Government National Mortgage Association.
Fixed mortgage-backed securities, as of June 30, 2001 and December 31, 2000,
was comprised of the following (at fair value):
Percent Percent
June 30, of December 31, of
2001 Total 2000 Total
-------- ------- ------------ -------
($ in Millions)
Mortgage pass through certificates... $1,092.1 73.9% $ 911.1 72.4%
Collateralized mortgage obligations.. 284.8 19.3 260.9 20.7
Commercial mortgage-backed
securities.......................... 100.3 6.8 86.4 6.9
-------- ----- -------- -----
Total mortgage-related securities.. $1,477.2 100.0% $1,258.4 100.0%
======== ===== ======== =====
Equity Securities
On June 30, 2001, our equity portfolio contained readily marketable domestic
investment securities that were indexed to the S&P 500 and S&P 400 by an
external money manager. Specifically, $342.3 million, or 77.9% of the total
equity allocation was invested to mirror the S&P 500 Index, and $97.1 million,
or 22.1%, to mirror the S&P 400 Index, excluding in each case tobacco stocks.
On August 10, 2001, we reduced our total equity exposure, resulting in the sale
of $235.1 million of equity securities. The proceeds of that transaction were
invested in fixed maturity securities.
Additionally, subsequent to that transaction, we sold the remaining equity
securities in the portfolio and purchased S&P 500 and S&P 400 index mutual
funds, thus eliminating direct ownership of common stocks.
Overall Investment Return
The table below shows the overall return of the fixed maturity and equity
security portfolios for the six months ended June 30, 2001 and years ended
December 31, 2000, 1999 and 1998. The overall return includes gross investment
income earned, net realized gains or losses incurred, and the change in
unrealized gains or losses on these securities.
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Fixed Maturity Equity
Securities Securities Total
-------------- ---------- -------
($ in Millions)
June 30, 2001
Gross investment income...................... $ 104.7 $ 3.3 $ 108.0
Net realized gains/(losses).................. 11.4 (22.3) (10.9)
Change in unrealized gains/(losses).......... 1.3 (0.3) (1.0)
------- ------ -------
Total........................................ $ 117.4 $(19.3) $ 98.1
======= ====== =======
December 31, 2000
Gross investment income...................... $ 178.8 $ 6.1 $ 184.9
Net realized gains/(losses).................. (17.5) 43.4 25.9
Change in unrealized gains/(losses).......... 128.4 (71.2) 57.2
------- ------ -------
Total........................................ $ 289.7 $(21.7) $ 268.0
======= ====== =======
December 31, 1999
Gross investment income...................... $ 137.0 $ 6.3 $ 143.3
Net realized gains/(losses).................. (13.8) 51.3 37.5
Change in unrealized gains/(losses).......... (145.0) 8.3 (136.7)
------- ------ -------
Total........................................ $ (21.8) $ 65.9 $ 44.1
======= ====== =======
December 31, 1998
Gross investment income...................... $ 121.1 $ 7.4 $ 128.5
Net realized gains........................... 33.9 122.0 155.9
Change in unrealized gains................... 10.9 18.8 29.7
------- ------ -------
Total........................................ $ 165.9 $148.2 $ 314.1
======= ====== =======
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FINANCIAL STRENGTH RATINGS
Financial strength ratings are the opinions of the rating agencies regarding
the financial ability of an insurance company to meet its obligations to its
policyholders. Ratings provide both industry participants and insurance
consumers with meaningful information on specific insurance companies and have
become an increasingly important factor in establishing the competitive
position of insurance companies. Rating agencies continually review the
financial performance and condition of insurers and higher ratings generally
indicate financial stability and a strong ability to pay claims. The current
financial strength ratings of Anthem Insurance and its consolidated
subsidiaries are as follows:
Financial
Strength
Rating Agency Rating Rating Description
------------- ------------- ------------------
AM Best Company, Inc. ("Best") A- Second highest of nine
("Excellent") ratings categories and second
highest within the category
based on modifiers (i.e., A
and A- are "Excellent")
Standard & Poor's Rating Services A Third highest of nine ratings
("S&P") ("Strong") categories and mid-range
within the category based on
modifiers (i.e., A+, A and A-
are "Strong")
Moody's Investor Service, Inc. A3 Third highest of nine ratings
("Moody's") ("Good") categories and lowest within
the category based on
modifiers (i.e., A1, A2 and
A3 are "Good")
Fitch, Inc. ("Fitch") A+ Third highest of eight
("Strong") ratings categories and
highest within the category
based on modifiers (i.e., A+,
A and A- are "Strong")
These financial strength ratings reflect each rating agency's opinion as to
our financial strength, operating performance and ability to meet our claim
obligations to our policyholders, not shareholders. In January 2001, S&P
reaffirmed our A rating and revised its outlook to positive. In April 2001,
Fitch reaffirmed our A+ rating, and revised its outlook to positive. Each of
the rating agencies reviews its ratings periodically and there can be no
assurance that current ratings will be maintained in the future. We believe our
strong ratings are an important factor in marketing our products to our
customers, since ratings information is broadly disseminated and generally used
throughout the industry. Our ratings reflect each rating agency's opinion of
our financial strength, operating performance and ability to meet our
obligations to policyholders, and are not evaluations directed toward the
protection of investors in our common stock, the units or the debentures and
should not be relied upon when making a decision to purchase shares of the
common stock offered hereby or the units being offered concurrently herewith.
106
LEGAL AND REGULATORY MATTERS
General
Our operations are subject to comprehensive and detailed state and federal
regulation throughout the United States in the jurisdictions in which we do
business. Supervisory agencies, including state health, insurance and
corporation departments, have broad authority to:
. grant, suspend and revoke licenses to transact business;
. regulate many aspects of our products and services;
. monitor our solvency and reserve adequacy; and
. scrutinize our investment activities on the basis of quality,
diversification and other quantitative criteria.
To carry out these tasks, these regulators periodically examine our
operations and accounts.
Regulation of Insurance Company and HMO Business Activities
The federal government as well as the governments of the states in which we
conduct our operations have adopted laws and regulations that govern our
business activities in various ways. These laws and regulations may restrict
how we conduct our businesses and may result in additional burdens and costs to
us. Areas of governmental regulation include:
. licensure;
. premium rates;
. benefits;
. service areas;
. market conduct;
. utilization review activities;
. prompt payment of claims;
. member rights and responsibilities;
. sales and marketing activities;
. quality assurance procedures;
. plan design and disclosures;
. disclosure of medical information;
. eligibility requirements;
. provider rates of payment;
. surcharges on provider payments;
. provider contract forms;
. underwriting and pricing;
. financial arrangements;
. financial condition (including reserves); and
. corporate governance.
These laws and regulations are subject to amendments and changing
interpretations in each jurisdiction.
107
States generally require health insurers and HMOs to obtain a certificate of
authority prior to commencing operations. If we were to establish a health
insurance company or an HMO in any state where we do not presently operate, we
generally would have to obtain such a certificate. The time necessary to obtain
such a certificate varies from state to state. Each health insurer and HMO must
file periodic financial and operating reports with the states in which it does
business. In addition, health insurers and HMOs are subject to state
examination and periodic license renewal.
There has been a recent trend of increased health care regulation at the
federal and state levels. Legislation, regulation and initiatives relating to
this trend include, among other things, the following:
. eliminating or reducing the scope of ERISA pre-emption of state medical
and bad faith claims under state law, thereby exposing health benefits
companies to expanded liability for punitive and other extra-contractual
damages;
. extending malpractice and other liability for medical and other
decisions from providers to health plans;
. imposing liability for negligent denials or delays in coverage;
. requiring
. coverage of experimental procedures and drugs,
. direct access to specialists for patients with chronic conditions,
. direct access to specialists (including OB/GYNs) and chiropractors,
. expanded consumer disclosures and notices and expanded coverage for
emergency services,
. liberalized definitions of medical necessity,
. liberalized internal and external grievance and appeal procedures
(including expedited decision making),
. maternity and other lengths of hospital inpatient stay, and
. point-of-service benefits for HMO plans;
. prohibiting
. so-called "gag" and similar clauses in physician agreements,
. incentives based on utilization, and
. limitation of arrangements designed to manage medical costs such as
capitated arrangements with providers or provider financial
incentives;
. regulating and restricting the use of utilization management and review;
. regulating and monitoring the composition of provider networks, such as
"any willing provider" and pharmacy laws (which generally provide that
providers and pharmacies cannot be denied participation in a managed
care plan where the providers and pharmacies are willing to abide by the
terms and conditions of that plan);
. imposing
. payment levels for out-of-network care, and
. requirements to apply lifetime limits to mental health benefits with
parity;
. exempting physicians from the antitrust laws that prohibit price fixing,
group boycotts and other horizontal restraints on competition;
. restricting the use of health plan claims information;
108
. regulating procedures that protect the confidentiality of health and
financial information;
. imposing third-party review of denials of benefits (including denials
based on a lack of medical necessity); and
. restricting or eliminating the use of formularies for prescription
drugs.
On August 8, 2001, the House of Representatives passed a version of the
Patients' Bill of Rights legislation (an amended version of the Ganske-Dingell
bill) which would permit health plans to be sued in state court for coverage
determinations. The current administration has indicated a willingness to pass
some form of patient protection legislation which could adversely affect the
health benefits business, and, in fact, the bill adopted by the House was the
result of a compromise reached by President Bush and Representative Charles
Norwood (R-GA). Under the bill a claim would be permitted for a wrongful
coverage denial which is the proximate cause of personal injury to, or the
death of, a patient. Medically reviewable claims against health insurers would
be tried in state court but under federal law. Patients would be required to
exhaust external review before filing suit. Patients who lose an external
review decision would have to overcome a rebuttable presumption that the
insurer made the correct decision. The bill caps non-economic damages at $1.5
million. Punitive damages would be available only if insurers do not follow an
external review decision and would be capped at an additional $1.5 million. The
bill also limits class action lawsuits (both future suits and pending suits
where a class has not yet been certified) against health insurers under both
ERISA and the Racketeer Influenced and Corrupt Organizations Act to group
health plans established by a single plan sponsor.
The Senate version of the Patients' Bill of Rights legislation (the McCain-
Edwards bill) was passed on June 29, 2001 and contains broader liability
provisions than the House bill. The Senate bill would permit patients to sue
health plans in state court over medical judgments or in federal court over
contractual issues, and it would not cap damages in state courts. In federal
court, punitive damages would be allowed, up to $5 million, and there would be
no limit on economic and non-economic damages. President Bush has stated that
he will veto any Patients' Bill of Rights legislation that contains liability
provisions similar to the Senate bill. The House and Senate versions of the
bill are expected to be reconciled in the Conference Committee. We cannot
predict the provisions of the Patients' Bill of Rights legislation that may
emerge from the Conference Committee, if any, and whether any Patients' Bill of
Rights legislation would be enacted into law. We also cannot predict what
impact any Patients' Bill of Rights legislation would have on our business,
financial condition and results of operations.
The health benefits business also may be adversely impacted by court and
regulatory decisions that expand the interpretations of existing statutes and
regulations. It is uncertain whether we can recoup, through higher premiums or
other measures, the increased costs of mandated benefits or other increased
costs caused by potential legislation or regulation.
Small Group Reform
All of the principal states in which Anthem does business have enacted
statutes that limit the flexibility of Anthem and other health insurers
relative to their small group underwriting and rating practices. Commonly
referred to as "small group reform" statutes, these laws are generally
consistent with model laws originally adopted by the NAIC.
In 1991, the NAIC adopted the Small Group Health Insurance Availability
Model Act. This model law limits the differentials in rates carriers could
charge between new business and health insurance renewal business, and with
respect to small groups with similar demographic characteristics (commonly
referred to as a "rating law"). It also requires that insurers disclose to
customers the basis on which the insurer establishes new business and renewal
rates, restricts the applicability of pre-existing condition exclusions and
prohibits an insurer from terminating coverage of an employer
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group because of the adverse claims experience of that group. The model law
requires that all small group insurers accept for coverage any employer group
applying for a basic and standard plan of benefits (commonly known as a
"guarantee issue law"), and provides for a voluntary reinsurance mechanism to
spread the risk of high risk employees among all small group carriers
participating in the reinsurance mechanism. Representatives of Anthem actively
participated in the committees of the NAIC, which drafted and proposed this
model law. NAIC model laws are not applicable to the industry until adopted by
individual states, and there is significant variation in the degree to which
states adopt and/or alter NAIC model laws. Some, if not all, of these rating
and underwriting limitations are present in small group reform statutes
currently adopted in all of the principal states in which Anthem does business.
Underwriting Limitations
In the past, insurance companies were free to select and reject risks based
on a number of factors, including the medical condition of the person seeking
to become insured. Small group health insurers were free to accept some
employees and reject other employees for coverage within one employer group. An
insurance company was also free to exclude from coverage medical conditions
existing within a group which the insurance company believed represented an
unacceptable risk level. Also, for the most part, insurance companies were free
to cancel coverage of a group due to the medical conditions which were present
in that group. Additionally, a new employee seeking medical coverage under an
existing group plan could be either accepted or rejected for coverage, or could
have coverage excluded or delayed for existing medical conditions.
The small group health insurance reform laws limit or abolish a number of
these commonly utilized practices to address a societal need to extend
availability of insurance coverage more broadly to those who were previously
not eligible for coverage. Reform laws have been adopted which at a minimum
generally require that a group either be accepted or rejected for coverage as
one unit. The law in all of the states in which Anthem does business now
prohibits the practice of terminating the coverage of an employer group based
on the medical conditions existing within that group. (Insurers may still
cancel business for a limited number of reasons.) These states also generally
require "portability" of coverage, which means that an insurer cannot exclude
coverage for a pre-existing condition of a new employee of an existing employer
group if that person had previously satisfied a pre-existing condition
limitation period with the prior insurer, and if that person maintained
continuous coverage. Most state small group reform statutes also prohibit
insurers from denying coverage to employer groups based upon industry
classification.
All states in which Anthem does business require the "guarantee issue" of
small group policies, either through specific state law or the states'
requirement to enforce HIPAA. These laws require an insurer to issue coverage
to any group that applies for coverage under any of the small group policies
marketed by the insurer in that state, regardless of the medical risks
presented by that group.
Rating Limitations
Prior to the adoption of state rate reform laws, there was very limited
regulation of the rating practices utilized in the small group health insurance
market. There was virtually no regulation of the amount by which one group's
rate could vary from that of a demographically similar group with different
claims experience, and there was no statutorily placed limit on the extent and
frequency of rate increases that could be applied to any one employer group.
Over the last nine years, all of the principal states in which Anthem does
business have enacted rating laws. These laws are designed to reduce the
variation in rates charged to insured groups who have favorable and unfavorable
claims experience. They also limit the extent and frequency of rate
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increases. They do not, however, establish an appropriate base or "manual" rate
level for an insurer. The most stringent rate reform regulation would be a pure
community rating requirement, pursuant to which all persons in a geographic
region would receive the same rate for the same coverage as any other person,
without consideration of demographic factors such as age, gender, geographic
location, medical risk or occupation. Most existing rating laws also impose a
limit on the extent and frequency of a group's rate increases.
Small Group Statutory Reinsurance Mechanisms
At this time, the Connecticut, New Hampshire and Nevada (HMO only) Anthem
plans are subject to involuntary assessments from state small group reinsurance
mechanisms. These mechanisms are designed to provide risk-spreading mechanisms
for insurers doing business in jurisdictions that mandate that health insurance
be issued on a guarantee issue basis. Guarantee issue requirements increase
underwriting risk for insurers by forcing them to accept higher-risk business
than they would normally accept. This reinsurance mechanism allows the insurer
to cede this high-risk business to the reinsurance facility, thus sharing the
underwriting experience with all insurers in the state. Each of Connecticut and
New Hampshire subject insurance companies doing business in that jurisdiction
to assessments to fund losses from the reinsurance mechanisms. Each of Indiana,
Ohio and Nevada provide voluntary reinsurance mechanisms in which the
assessment is against only those carriers electing to participate in the
reinsurance mechanism. Anthem has elected not to participate in these voluntary
reinsurance mechanisms. Neither Kentucky nor Maine has a small group
reinsurance mechanism.
Recent Medicare Changes
In 1997, the federal government passed legislation related to Medicare that
changed the method for determining premiums that the government pays to HMOs
for Medicare members. In general, the new method has reduced the premiums
payable to us compared to the old method, although the level and extent of the
reductions varies by geographic market and depends on other factors. The
legislation also requires us to pay a "user fee." The changes began to be
phased in on January 1, 1998 and will continue over five years. The federal
government also announced in 1999 that it planned to begin to phase in risk
adjustments to its premium payments over a five-year period commencing January
1, 2000. While we cannot predict exactly what effect these Medicare reforms
will have on our results of operations, we anticipate that the net impact of
the risk adjustments will be to reduce the premiums payable to us.
HIPAA and Gramm-Leach-Bliley Act
The Health Insurance Portability and Accountability Act of 1996, known as
HIPAA, and its regulations impose obligations for issuers of health insurance
coverage and health benefit plan sponsors. This law requires guaranteed health
care coverage for small employers having 50 or fewer employees and for
individuals who meet certain eligibility requirements. It also requires
guaranteed renewability of health care coverage for most employers and
individuals. The law limits exclusions based on preexisting conditions for
individuals covered under group policies to the extent the individuals had
prior creditable coverage, and the gap between the prior coverage and the new
coverage cannot exceed certain time frames.
In addition, HIPAA authorized the Secretary of the United States Department
of Health and Human Services, known as HHS, to issue standards for
administrative simplification, as well as privacy and security of medical
records and other individually identifiable patient data. HIPAA requirements
apply to plan sponsors, health plans, health care providers and health care
clearinghouses that transmit health information electronically. Regulations
adopted to implement HIPAA also require that business associates acting for or
on behalf of these HIPAA-covered entities be contractually obligated to meet
HIPAA standards.
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Although HIPAA was intended ultimately to reduce administrative expenses and
burdens faced within the health care industry, we believe the law will
initially bring about significant and, in some cases, costly changes. HHS has
released two rules to date mandating the use of new standards with respect to
certain health care transactions, including health information. The first rule
requires the use of uniform standards for common health care transactions,
including health care claims information, plan eligibility, referral
certification and authorization, claims status, plan enrollment and
disenrollment, payment and remittance advice, plan premium payments and
coordination of benefits, and it establishes standards for the use of
electronic signatures. The new transaction standards became effective in
October 2000, and we will be required to comply with them by October 16, 2002.
Second, HHS has developed new standards relating to the privacy of
individually identifiable health information. In general, these regulations
restrict the use and disclosure of medical records and other individually
identifiable health information held or disclosed by health plans and other
affected entities in any form, whether communicated electronically, on paper or
orally, subject only to limited exceptions. In addition, the regulations
provide patients with significant new rights to understand and control how
their health information is used. These regulations do not preempt more
stringent state laws and regulations that may apply to us. The privacy
standards became effective on April 14, 2001. We must comply with these privacy
standards by April 14, 2003. One more regulation integral to administration and
privacy under HIPAA has yet to be published. It will address security
requirements to be met regarding accessibility of personal health information.
We have not quantified the cost of complying with these new standards; however,
the cost of such compliance could be material.
Other recent federal legislation includes the Gramm-Leach-Bliley Act, which
generally requires insurers to provide affected customers with notice regarding
how their personal health and financial information is used and the opportunity
to "opt out" of certain disclosures before the insurer shares non-public
personal information with a non-affiliated third party. These requirements are
to be implemented on a state-by-state basis by July 1, 2001. The Gramm-Leach-
Bliley Act also gives banks and other financial institutions the ability to
affiliate with insurance companies, which may lead to new competitors in the
insurance and health benefits fields.
Investment and Retirement Products and Services
We are subject to regulation by various government agencies where we conduct
business, including the insurance departments of Indiana, Kentucky, Ohio,
Connecticut, New Hampshire, Maine, Colorado and Nevada. Among other matters,
these agencies may regulate premium rates, trade practices, agent licensing,
policy forms, underwriting and claims practices, the maximum interest rates
that can be charged on life insurance policy loans, and the minimum rates that
must be provided for accumulation of surrender value.
ERISA
The provision of services to certain employee health benefit plans is
subject to the Employee Retirement Income Security Act of 1974 ("ERISA"), a
complex set of laws and regulations subject to interpretation and enforcement
by the Internal Revenue Service and the Department of Labor ("DOL"). 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.
In December 1993, in a case involving an employee benefit plan and an
insurance company, the United States Supreme Court ruled that assets in the
insurance company's general account that were attributable to a portion of a
group pension contract issued to the plan that was not a "guaranteed benefit
policy" were "plan assets" for purposes of ERISA and that the insurance
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company had fiduciary responsibility with respect to those assets. In reaching
its decision, the Supreme Court declined to follow a 1975 DOL interpretive
bulletin that had suggested that insurance company general account assets were
not plan assets.
The Small Business Job Protection Act (the "Act") was signed into law in
1996. The Act created a framework for resolving potential issues raised by the
Supreme Court decision. The Act provides that, absent criminal conduct,
insurers generally will not have liability with respect to general account
assets held under contracts that are not guaranteed benefit policies based on
claims that those assets are plan assets. The relief afforded extends to
conduct that occurs before the date that is 18 months after the DOL issues
final regulations required by the Act, except as provided in the anti-avoidance
portion of the regulations. The regulations, which were issued on January 5,
2000, address ERISA's application to the general account assets of insurers
attributable to contracts issued on or before December 31, 1998 that are not
guaranteed benefit policies. The conference report relating to the Act states
that policies issued after December 31, 1998 that are not guaranteed benefit
policies will be subject to ERISA's fiduciary obligations. We are not currently
able to predict how these matters may ultimately affect our businesses.
HMO and Insurance Holding Company Laws
After the demutualization, we will be regulated as an insurance holding
company and will be subject to the insurance holding company acts of the states
in which our subsidiaries are domiciled. These acts contain certain reporting
requirements as well as restrictions on transactions between an insurer or HMO
and its affiliates. These holding company laws and regulations generally
require insurance companies and HMOs within an insurance holding company system
to register with the insurance department of each state where they are
domiciled and to file with those states' insurance departments certain reports
describing capital structure, ownership, financial condition, certain
intercompany transactions and general business operations. In addition, various
notice and reporting requirements generally apply to transactions between
insurance companies and HMOs and their affiliates within an insurance holding
company system, depending on the size and nature of the transactions. Some
insurance holding company laws and regulations require prior regulatory
approval or, in certain circumstances, prior notice of certain material
intercompany transfers of assets as well as certain transactions between
insurance companies, HMOs, their parent holding companies and affiliates.
Additionally, the holding company acts for the states of domicile of Anthem
and its subsidiaries restrict the ability of any person to obtain control of an
insurance company or HMO without prior regulatory approval. Under those
statutes, without such approval (or an exemption), no person may acquire any
voting security of an insurance holding company which controls an insurance
company or HMO, or merge with such a holding company, if as a result of such
transaction such person would "control" the insurance holding company.
"Control" is generally defined as the direct or indirect power to direct or
cause the direction of the management and policies of a person and is presumed
to exist if a person directly or indirectly owns or controls 10% or more of the
voting securities of another person.
Guaranty Fund Assessments
Under insolvency or guaranty association laws in most states, insurance
companies can be assessed for amounts paid by guaranty funds for policyholder
losses incurred when an insurance company becomes insolvent. Most state
insolvency or guaranty association laws currently provide for assessments based
upon the amount of premiums received on insurance underwritten within such
state (with a minimum amount payable even if no premium is received).
Substantially all of our premiums are currently derived from insurance
underwritten in Indiana, Kentucky, Ohio, Connecticut, New Hampshire, Maine,
Colorado and Nevada.
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Under many of these guaranty association laws, assessments against insurance
companies that issue policies of accident or sickness insurance, such as
Anthem, are made retrospectively and are based (up to prescribed limits) upon
the ratio of (i) the insurance company's premiums received in the applicable
state over the previous three calendar years on accident and sickness insurance
to (ii) the aggregate amount of premiums received by all assessed member
insurance companies over such three calendar years on accident and sickness
insurance. The guaranty fund assessments made under these acts are administered
by the state's Guaranty Association, which has its own board of directors
selected by member insurers with the approval of the State Insurance
Department. In general, an assessment may be abated or deferred by the Guaranty
Association if, in the opinion of the board, payment would endanger the ability
of the member to fulfill its contractual obligations. The other member
insurers, however, may be assessed for the amount of such abatement or
deferral. Any such assessment paid by a member insurance company may be offset
against its premium tax liability to the state in question over a multiple year
period (generally five to 10 years) following the year in which the assessment
was paid. The amount and timing of any future assessments, however, cannot be
reasonably estimated and are beyond our control. The life/health guaranty
association assessments, prior to available premium tax offsets, paid by us
totaled $5.0 million in 2000, $1.4 million in 1999, and there were none in
1998.
While the amount of any assessments applicable to life and health guaranty
funds cannot be predicted with certainty, we believe that future guaranty
association assessments for insurer insolvencies will not have a material
adverse effect on our liquidity and capital resources.
Risk-Based Capital Requirements
The states of domicile of our subsidiaries have statutory risk-based
capital, or RBC, requirements for health and other insurance companies based on
the RBC Model Act. These RBC requirements are intended to assess the capital
adequacy of life and health insurers, taking into account the risk
characteristics of an insurer's investments and products. The RBC Model Act
sets forth the formula for calculating the RBC requirements which are designed
to take into account asset risks, insurance risks, interest rate risks and
other relevant risks with respect to an individual insurance company's
business. In general, under these laws, an insurance company must submit a
report of its RBC level to the Insurance Department or Insurance Commissioner,
as appropriate, of its state of domicile as of the end of the previous calendar
year.
The RBC Model Act provides for four different levels of regulatory attention
depending on the ratio of a company's total adjusted capital (defined as the
total of its statutory capital, surplus and asset valuation reserve) to its
risk-based capital. The "Company Action Level" is triggered if a company's
total adjusted capital is less than 200 percent but greater than or equal to
150 percent of its risk-based capital. At the "Company Action Level", a company
must submit a comprehensive plan to the regulatory authority which discusses
proposed corrective actions to improve its capital position. A company whose
total adjusted capital is between 250 percent and 200 percent of its risk-based
capital is subject to a trend test. The trend test calculates the greater of
any decrease in the margin (i.e., the amount in dollars by which a company's
adjusted capital exceeds its risk-based capital) between the current year and
the prior year and between the current year and the average of the past three
years, and assumes that the decrease could occur again in the coming year. If a
similar decrease in margin in the coming year would result in a risk-based
capital ratio of less than 190 percent, then "Company Action Level" regulatory
action would be triggered. The "Regulatory Action Level" is triggered if a
company's total adjusted capital is less than 150 percent but greater than or
equal to 100 percent of its risk-based capital. At the "Regulatory Action
Level", the regulatory authority will perform a special examination of the
company and issue an order specifying corrective actions that must be followed.
The "Authorized Control Level" is triggered if a company's total adjusted
capital is less than 100 percent but greater than or equal to 70 percent of its
risk-based capital, at which level the regulatory authority may take any action
it deems necessary, including
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placing the company under regulatory control. The "Mandatory Control Level" is
triggered if a company's total adjusted capital is less than 70 percent of its
risk-based capital, at which level the regulatory authority is mandated to
place the company under its control.
The law requires increasing degrees of regulatory oversight and intervention
as an insurance company's RBC declines. The level of regulatory oversight
ranges from requiring the insurance company to inform and obtain approval from
the domiciliary Insurance Commissioner of a comprehensive financial plan for
increasing its RBC to mandatory regulatory intervention requiring an insurance
company to be placed under regulatory control in a rehabilitation or
liquidation proceeding. As of December 31, 2000, the RBC levels of Anthem and
our insurance subsidiaries exceeded all RBC thresholds.
NAIC IRIS Ratios
In the 1970's, the NAIC developed a set of financial relationships or
"tests" called the Insurance Regulatory Information System, or IRIS, that were
designed for early identification of companies that may require special
attention by insurance regulatory authorities. Insurance companies submit
statutory financial data on an annual basis to the NAIC, which in turn analyzes
the data using ratios covering eleven categories of data with defined "usual
ranges" for each category. An insurance company may fall out of the usual range
for one or more ratios because of specific transactions or events that are, in
and of themselves, immaterial. Generally, an insurance company will become
subject to regulatory scrutiny if its IRIS results fall outside of the usual
ranges on four or more of the ratios. If a company is outside the ranges on
four or more of the ratios, a written explanation is prepared and sent to
regulators. Neither Anthem nor its subsidiaries is currently subject to
regulatory scrutiny based on IRIS ratios.
Litigation
A number of managed care organizations have recently been sued in class
action lawsuits asserting various causes of action under federal and state law.
These lawsuits typically allege that the defendant managed care organizations
employ policies and procedures for providing health care benefits that are
inconsistent with the terms of the coverage documents and other information
provided to their members, and because of these misrepresentations and
practices, a class of members has been injured in that they received benefits
of lesser value than the benefits represented to and paid for by such members.
Two such proceedings which allege various violations of the Employee Retirement
Income Security Act of 1974 ("ERISA") have been filed in Connecticut against
Anthem or our Connecticut affiliate. One proceeding, The State of Connecticut
v. Anthem Blue Cross and Blue Shield of Connecticut, Anthem Health Plans, Inc.,
et al., No. 3:00 CV 1716 (AWT), filed on September 7, 2000 in the United States
District Court, District of Connecticut, was brought by the Connecticut
Attorney General on behalf of a purported class of HMO and Point of Service
members in Connecticut. No monetary damages are sought, although the suit does
seek injunctive relief from the court to preclude us from allegedly utilizing
arbitrary coverage guidelines, making late payments to providers or members,
denying coverage for medically necessary prescription drugs and misrepresenting
or failing to disclose essential information to enrollees. The complaint
contends that these alleged policies and practices are a violation of ERISA. A
second proceeding, William Strand v. Anthem Blue Cross and Blue Shield of
Connecticut, Anthem Health Plans, Inc., et al., No. 3:00 CV 2037 (SRU), filed
on October 20, 2000 in the United States District Court, District of
Connecticut, was brought on behalf of a purported class of HMO and Point of
Service members in Connecticut and elsewhere, and seeks injunctive relief to
preclude us from allegedly making coverage decisions relating to medical
necessity without complying with the express terms of the policy documents, and
unspecified monetary damages (both compensatory and punitive).
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In addition, our Connecticut affiliate is a defendant in three class action
lawsuits brought on behalf of professional providers in Connecticut. Edward
Collins, M.D., et al. v. Anthem Health Plans, Inc., No. CV-99 0156198 S, was
filed on December 14, 1999, in the Superior Court Judicial District of
Waterbury, Connecticut. Stephen R. Levinson, M.D., Karen Laugel, M.D. and J.
Kevin Lynch, M.D. v. Anthem Health Plans, Inc. d/b/a Anthem Blue Cross and Blue
Shield of Connecticut, No. 3:01 CV 426 (JBA), was filed on February 14, 2001 in
the Superior Court Judicial District of New Haven, Connecticut. Connecticut
State Medical Society v. Anthem Health Plans, Inc., No. 3:01 CV 428 (JBA) was
filed on February 14, 2001 in the Superior Court Judicial District of New
Haven, Connecticut. The suits allege that the Connecticut affiliate has
breached its contracts by, among other things, allegedly failing to pay for
services in accordance with the terms of the contracts. The suits also allege
violations of the Connecticut Unfair Trade Practices Act, breach of the implied
duty of good faith and fair dealing, negligent misrepresentation and unjust
enrichment. The Collins and Levinson suits seek injunctive relief. Collins
seeks an accounting under the terms of the provider agreements and injunctive
relief prohibiting us from continuing the unfair actions alleged in the
complaint and violating its agreements. Levinson seeks permanent injunctive
relief prohibiting us from, among other things, utilizing methods to reduce
reimbursement of claims, paying claims in an untimely fashion and providing
inadequate communication with regards to denials and appeals. Both of the suits
seek unspecified monetary damages (both compensatory and punitive). The third
suit, brought by the Connecticut State Medical Society, seeks the same
injunctive relief as the Levinson case, but no monetary damages.
On July 19, 2001, the court in the Collins suit certified a class as to
three of the plaintiff's fifteen allegations. The class is defined as those
physicians who practice in Connecticut or group practices which are located in
Connecticut that were parties to either a Participating Physician Agreement or
a Participating Physicians Group Agreement with Anthem and/or its Connecticut
affiliate during the period from 1993 to the present, excluding risk-sharing
arrangements and certain other contracts. The claims which were certified as
class claims are: Anthem's alleged failure to provide plaintiffs and other
similarly situated physicians with consistent medical utilization/quality
management and administration of covered services by paying financial incentive
and performance bonuses to providers and Anthem staff members involved in
making utilization management decisions; an alleged failure to maintain
accurate books and records whereby improper payments to the plaintiffs were
made based on claim codes submitted; and an alleged failure to provide senior
personnel to work with plaintiffs and other similarly situated physicians.
We intend to vigorously defend these proceedings. Anthem denies all the
allegations set forth in the complaints and has asserted defenses, including
improper standing to sue, failure to state a claim and failure to exhaust
administrative remedies. All of the proceedings are in the early stages of
litigation, and their ultimate outcomes cannot presently be determined.
On October 10, 2001, the Connecticut State Dental Association along with
five dental providers filed suit against our Connecticut affiliate. Connecticut
State Dental Association, Dr. Martin Rutt, Dr. Michael Egan, Dr. Sheldon
Natkin, Dr. Suzanna Nemeth, and Dr. Bruce Tandy v. Anthem Health Plans, Inc.
d/b/a Anthem Blue Cross and Blue Shield of Connecticut was filed in the
Superior Court Judicial District of Hartford, Connecticut. The suit alleges
that our Connecticut affiliate violated the Connecticut Unfair Trade Practices
Act by allegedly unilaterally altering fee schedules without notice or a basis
to do so, instituting unfair and deceptive cost containment measures and
refusing to enroll new providers unless they agreed to participate in all
available networks. The plaintiffs seek declaratory relief that the practices
alleged in the complaint constitute deceptive and unfair trade practices. A
permanent injunction is also sought prohibiting us from, among other things,
failing and refusing to inform network providers of the methodology supporting
our fee schedules and substituting our medical judgment for that of dental
providers. The suit requests costs and attorney fees, but no other specified
monetary damages. Anthem denies the allegations set forth in this complaint and
intends to vigorously defend this suit.
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Following our purchase of BCBS-ME, the Attorney General of Maine and
Consumers for Affordable Health Care filed administrative appeals challenging
the Superintendent of Insurance's (the "Superintendent") decision approving the
conversion of BCBS-ME to a stock insurer, which was a required step before the
acquisition. Both the Attorney General and the consumers group filed a petition
for administrative review seeking, among other things, a determination that the
decision of the Superintendent in regard to the application of BCBS-ME to
convert to a stock insurer was in violation of statute or unsupported by
substantial evidence on the record. Consumers for Affordable Health Care, et
al. v. Superintendent of Insurance, et al, Nos. AP-00-37, AP-00-42
(Consolidated). In addition, the Attorney General filed an independent claim
for relief, requesting the court to modify the Superintendent's decision by
requiring BCBS-ME to submit an update to the statutorily mandated appraisal of
its fair market value and to deposit into the charitable foundation the
difference between the net proceeds that have been transferred to the
foundation and the final value of BCBS-ME, if greater. On May 18, 2001, the
court dismissed the Attorney General's independent claim, ruling that the claim
was an impermissible collateral challenge to the Superintendent's
determination. The effect of this ruling is that the Attorney General does not
have a cause of action separate from the administrative review that he has
already requested. Following the court's May 18, 2001 order, the Attorney
General filed a motion to clarify the court's ruling, asserting that the court
did not intend to dismiss his independent claim with prejudice. The court
denied the Attorney General's motion. Anthem intends to vigorously defend these
proceedings. Anthem denies all the allegations set forth in the petitions for
review and has asserted defenses, including waiver, estoppel and mootness.
While the appeals are still pending, we do not believe that the appeals will
have a material adverse effect on our consolidated financial position or
results of operations.
On March 11, 1998, Anthem and its Ohio subsidiary, Community Insurance
Company ("CIC") were named as defendants in a lawsuit, Robert Lee Dardinger,
Executor of the Estate of Esther Louise Dardinger v. Anthem Blue Cross and Blue
Shield, et al., filed in the Licking County Court of Common Pleas in Newark,
Ohio. The plaintiff sought compensatory damages and unspecified punitive
damages in connection with claims alleging wrongful death, bad faith and
negligence arising out of our denial of certain claims for medical treatment
for Ms. Dardinger. On September 24, 1999, the jury returned a verdict for the
plaintiff, awarding $1,350 for compensatory damages, $2.5 million for bad faith
in claims handling and appeals processing, $49.0 million for punitive damages
and unspecified attorneys' fees in an amount to be determined by the court. The
court later granted attorneys' fees of $0.8 million. Both companies filed an
appeal of the verdict on November 19, 1999, and as part of the appeal, a bond
in the amount of $60.0 million was posted to secure the judgment and interest
and attorneys' fees. On May 22, 2001, the Ohio Court of Appeals (Fifth
District) affirmed the jury award of $1,350 for breach of contract against CIC,
affirmed the award of $2.5 million compensatory damages for bad faith in claims
handling and appeals processing against CIC, but dismissed the claims and
judgments against Anthem. The court also reversed the award of $49.0 million in
punitive damages against both Anthem and CIC, and remanded the question of
punitive damages against CIC to the trial court for a new trial. Anthem and
CIC, as well as the plaintiff, appealed certain aspects of the decision of the
Ohio Court of Appeals. On October 10, 2001, the Supreme Court of Ohio agreed to
hear the plaintiff's appeal, including the question of punitive damages, and
denied the cross-appeals of Anthem and CIC. The ultimate outcome of this matter
cannot be determined at this time.
In addition to the lawsuits described above, we are involved in other
pending and threatened litigation of the character incidental to our business
or arising out of our insurance and investment operations, and are from time to
time involved as a party in various governmental and administrative
proceedings. We believe that any liability that may result from any one of
these actions is unlikely to have a material adverse effect on our financial
position or results of operations.
Other Contingencies
Anthem, like a number of other Blue Cross and Blue Shield companies, serves
as a fiscal intermediary providing administrative services for Medicare Parts A
and B. The fiscal intermediaries
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for these programs receive reimbursement for certain costs and expenditures,
which are subject to adjustment upon audit by CMS. The laws and regulations
governing fiscal intermediaries for the Medicare program are complex, subject
to interpretation and can expose an intermediary to penalties for non-
compliance. Fiscal intermediaries may be subject to criminal fines, civil
penalties or other sanctions as a result of such audits or reviews. In the last
five years, at least eight Medicare fiscal intermediaries have made payments to
settle issues raised by such audits and reviews. These payments have ranged
from $0.7 million to $51.6 million, plus a payment by one company of $144.0
million. While we believe we are currently in compliance in all material
respects with the regulations governing fiscal intermediaries, there are
ongoing reviews by the federal government of Anthem's activities under certain
of its Medicare fiscal intermediary contracts.
On December 8, 1999, Anthem Health Plans, Inc., or AHP, one of our
subsidiaries, reached a settlement agreement with the Office of Inspector
General, or OIG, Health and Human Services, in the amount of $41.9 million, to
resolve an investigation into misconduct in the Medicare fiscal intermediary
operations of BCBS-CT, AHP's predecessor. The period investigated was before
Anthem's merger with BCBS-CT. The resolution of this case involved no criminal
penalties against Anthem as successor-in-interest nor any suspension or
exclusion from federal programs. This expense was included in administrative
expense in our statement of consolidated income for the year ended December 31,
1999.
AdminaStar Federal, Inc., one of our affiliates, has received several
subpoenas from the OIG and the U.S. Department of Justice, seeking documents
and information concerning its responsibilities as a Medicare Part B contractor
in its Kentucky office, and requesting certain financial records from
AdminaStar Federal, Inc. and from us related to our Medicare fiscal
intermediary Part A and Part B operations. We have made certain disclosures to
the government relating to our Medicare Part B work in Kentucky. The
government, however, has not notified us of any non-compliance. We are not in a
position to predict either the ultimate outcome of this review or the extent of
any potential exposure should claims be made against us. However, we believe
any fines or penalties that may arise from this review would not have a
material adverse effect on our consolidated financial condition.
As a BCBSA licensee, we participate in a nationwide contract with the
federal Office of Personnel Management to provide coverage to federal employees
and their dependents in our core eight-state area. The program is called the
Federal Employee Program, or FEP. On July 11, 2001, we received a subpoena from
the OIG, Office of Personnel Management, seeking certain financial documents
and information, including information concerning intercompany transactions,
related to our operations in Ohio, Indiana and Kentucky under the FEP contract.
We are currently cooperating with the OIG and the U.S. Department of Justice on
this matter. We are not in a position to predict either the ultimate outcome of
this review or the extent of any potential exposure should claims be made
against us. Accordingly, we cannot assure you that the ultimate outcome of this
review will not have a material adverse effect on our consolidated results of
operations or financial condition.
We guaranteed certain financial contingencies of our subsidiary, Anthem
Alliance Health Insurance Company, under a contract between Anthem Alliance and
the United States Department of Defense. Under that contract, Anthem Alliance
managed and administered the TRICARE Managed Care Support Program for military
families from May 1, 1998 through May 31, 2001. The contract required Anthem
Alliance, as the prime contractor, to assume certain risks in the event, and to
the extent, the actual cost of delivering health care services exceeded the
health care cost proposal submitted by Anthem Alliance (the "Health Care
Risk"). The contract has a five-year term, but was transferred to a third
party, effective May 31, 2001. We guaranteed Anthem Alliance's assumption of
the Health Care Risk, which is capped by the contract at $20.0 million annually
and $75.0 million cumulatively over the contract period. Through December 31,
2000, Anthem Alliance had subcontracts with two other BCBS companies not
affiliated with us by which the subcontractors
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agreed to provide certain services under the contract and to assume
approximately 50% of the Health Care Risk. Effective January 1, 2001, one of
those subcontracts terminated by mutual agreement of the parties, which
increased Anthem Alliance's portion of the Health Care Risk to 90%. Effective
May 1, 2001, the other subcontract was amended to eliminate the Health Care
Risk sharing provision, which resulted in Anthem Alliance assuming 100% of the
Health Care Risk for the period from May 1, 2001 to May 31, 2001. There was no
call on the guarantee for the period from May 1, 1998 to April 30, 1999 (which
period is now "closed"), and we do not anticipate a call on the guarantee for
the periods beginning May 1, 1999 through May 31, 2001 (which periods remain
"open" for possible review by the Department of Defense).
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MANAGEMENT
Directors and Executive Officers
The following table shows information as of September 30, 2001 concerning
our directors and executive officers.
Name Age Position
---- --- --------
L. Ben Lytle.................... 55 Chairman of the Board of Directors
Larry C. Glasscock.............. 53 President and Chief Executive Officer and Director
Susan B. Bayh................... 41 Director
William B. Hart................. 58 Director
Allan B. Hubbard................ 54 Director
Victor S. Liss.................. 64 Director
William G. Mays................. 55 Director
James W. McDowell, Jr. ......... 60 Director
B. LaRae Orullian............... 68 Director
Senator Donald W. Riegle, Jr. .. 63 Director
William J. Ryan................. 57 Director
George A. Schaefer, Jr. ........ 56 Director
Dennis J. Sullivan, Jr. ........ 69 Director
David R. Frick.................. 57 Executive Vice President and Chief Legal and
Administrative Officer
Samuel R. Nussbaum, M.D. ....... 53 Executive Vice President and Chief Medical Officer
Michael L. Smith................ 53 Executive Vice President and Chief Financial and
Accounting Officer
Marjorie W. Dorr................ 39 President, Anthem East
Keith R. Faller................. 54 President, Anthem Midwest
Michael D. Houk................. 57 Vice President and General Manager, National Accounts
Caroline S. Matthews............ 42 Chief Operating Officer, Anthem Blue Cross and
Blue Shield in Colorado and Nevada
John M. Murphy.................. 49 President, Specialty Business Division of Anthem
Jane E. Niederberger............ 41 Chief Information Officer
The following is biographical information for our directors and executive
officers:
L. Ben Lytle has been a director of Anthem Insurance since 1987 and Chairman
of the Board of Anthem Insurance since 1997. Mr. Lytle served as President and
Chief Executive Officer from March 1989 to October 1999, when he retired. He is
an Executive-in-Residence at the University of Arizona School of Business,
Adjunct Fellow at the American Enterprise Institute and Senior Fellow at the
Hudson Institute. He is a director of CID Equity Partners (venture capital
firm); Duke Realty Corporation (real estate investment firm); and Healthx.com
(privately held company providing internet services to small insurance
companies).
Larry C. Glasscock has served as President and Chief Executive Officer and
as a director of Anthem Insurance since October 1999. He joined Anthem
Insurance in April 1998 as Senior Executive Vice President and Chief Operating
Officer. He was named President and Chief Operating Officer in April 1999 and
succeeded L. Ben Lytle as Chief Executive Officer upon Mr. Lytle's retirement
in October 1999. Mr. Glasscock was President and Chief Executive Officer of
Blue Cross Blue Shield of the National Capital Area from 1993 to 1998 and
oversaw its affiliation with Blue Cross Blue Shield of Maryland. Prior to
moving to the health insurance industry, he served as President and Chief
Operating Officer and a director of First American Bank, N.A. (Washington, DC)
from 1991 until 1993 when the bank was sold. During 1991, Mr. Glasscock was
President and Chief Executive
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Officer of Essex Holdings, Inc. (an Ohio-based capital investment firm). He
also held various executive positions during his twenty-year tenure with
Ameritrust Corporation, a Cleveland, Ohio bank holding company. Mr. Glasscock
is a director of Zimmer Holdings, Inc. (orthopaedic industry).
Susan B. Bayh has been a director of Anthem Insurance since 1998. Mrs. Bayh
has been a Distinguished Visiting Professor in the College of Business
Administration at Butler University since 1994. She was a member of the
International Joint Commission between the United States and Canada from 1994
to 2001. Mrs. Bayh is a director of Corvas International, Inc. (biotechnology),
Cubist Pharmaceuticals, Inc. (biotechnology), Curis, Inc. (biomedical) and
Emmis Communications Corporation (telecommunications). She is also a member of
the Board of Trustees of Butler University.
William B. Hart has been a director of Anthem Insurance since 2000. He was
President of The Dunfey Group (capital consulting firm) from 1986 to 1998.
Since 1999, he has been Chairman of the National Trust for Historic
Preservation. He served as Chairman of the Board of the former Blue Cross Blue
Shield of New Hampshire.
Allan B. Hubbard has been a director of Anthem Insurance since 1999. He has
been President of E & A Industries (holding company for various industrial
companies) since 1993. From 1991 to 1992, Mr. Hubbard served as Deputy Chief of
Staff to the Vice President of the United States, and from 1998 to 2000 he was
a director of the U.S. Chamber of Commerce. Mr. Hubbard is a director of The
Hudson Institute, Maxon Corporation (manufacturer) and Medical Savings
Insurance Company.
Victor S. Liss has been a director of Anthem Insurance since 1997. He has
been President, Vice Chairman and Chief Executive Officer of Trans-Lux
Corporation (electronics) since 1993. He is a trustee of Norwalk Hospital in
Norwalk, Connecticut.
William G. Mays has been a director of Anthem Insurance since 1993. He has
been President and Chief Executive Officer of Mays Chemical Company, Inc.
(chemical distribution) since 1980. Mr. Mays is a director of Vectren
Corporation (gas and electric utility), the Indiana University Foundation and
the National Urban League.
James W. McDowell, Jr. has been a director of Anthem Insurance since 1993.
He founded McDowell Associates (business management consulting) in 1992 after
serving as Chief Executive Officer of Dairymen, Inc. from 1980 to 1992. He is a
director of Fifth Third Bank, Kentucky. Mr. McDowell was Chairman of the Board
of the former Blue Cross Blue Shield of Kentucky.
B. LaRae Orullian has been a director of Anthem Insurance since 2000. She
has been Vice Chair of Guaranty Bank and a Director of the Guaranty Corporation
in Denver, Colorado since 1997. From 1977 to 1997, Ms. Orullian held various
executive positions with the Women's Bank of Denver. Ms. Orullian also serves
as Chair of the Board of Frontier Airlines, Inc. She served as Chair of the
Board of the former Blue Cross Blue Shield of Colorado and Nevada.
Senator Donald W. Riegle, Jr., has been a director of Anthem Insurance since
1999. In March 2001, he joined APCO Worldwide as Chairman of APCO Government
Affairs. From 1995 to 2001, he was Deputy Chairman of Shandwick International.
He served in the U.S. Senate from 1976 through 1994 and in the U.S. House of
Representatives from 1967 through 1975. He is a director of Rx Optical,
Cyberian Outpost (Internet fulfillment company), E. Team (Internet emergency
management company) and Tri-Union Development Corp. (oil and gas development
company).
William J. Ryan has been a director of Anthem Insurance since 2000. He has
served as Chairman, President and Chief Executive Officer of Banknorth
Financial Group since 1990. He is a director of the University of New England.
Mr. Ryan is also a trustee of Colby College and the Portland Museum of Art. He
served as Chairman of the Board of the former Blue Cross Blue Shield of Maine.
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George A. Schaefer, Jr. has been a director of Anthem Insurance since 1995.
He has been President and Chief Executive Officer of Fifth Third Bancorp since
1990. Mr. Schaefer is Vice Chairman of the Board of the University of
Cincinnati. He is a trustee of the Children's Hospital in Cincinnati, Ohio.
Dennis J. Sullivan, Jr., has been a director of Anthem Insurance since 1995.
He is an Executive Counselor for Dan Pinger Public Relations, a position he
also held from April 1993 to September 2000. Mr. Sullivan served as interim
President and Chief Executive Officer of Gaylord Entertainment Company from
September 2000 to May 2001. He is a director of Fifth Third Bancorp.
David R. Frick joined Anthem Insurance in 1995 as Executive Vice President
and Chief Legal and Administrative Officer. Prior to joining Anthem Insurance,
he served as a member of its board of directors. Mr. Frick was a partner at the
law firm of Baker & Daniels from 1982 to 1995, and he was managing partner from
1987 to 1992. He was Deputy Mayor of the City of Indianapolis from 1977 to
1982. He is a director of Artistic Media Partners, Inc. (radio stations) and
The National Bank of Indianapolis Corporation (bank holding company).
Samuel R. Nussbaum, M.D. joined Anthem Insurance in January 2001 as
Executive Vice President and Chief Medical Officer. From 1996 to 2000, Dr.
Nussbaum served both as Executive Vice President for Medical Affairs and System
Integration at BJC Health System of St. Louis and as Chairman and Chief
Executive Officer of Health Partners of the Midwest. Prior to that, Dr.
Nussbaum was President and Chief Executive Officer of Physician Partners of New
England, Senior Vice President for Health Care Delivery at Blue Cross Blue
Shield of Massachusetts and a professor at Harvard Medical School.
Michael L. Smith has been Executive Vice President and Chief Financial
Officer of Anthem Insurance since 1999. From 1996 to 1998, Mr. Smith served as
Chief Operating Officer and Chief Financial Officer of American Health Network,
Inc., a former Anthem subsidiary. He was Chairman, President and Chief
Executive Officer of Mayflower Group, Inc. (transport company) from 1989 to
1995. He is a director of First Indiana Corporation (bank holding company) and
Finishmaster, Inc. (auto paint distribution).
Marjorie W. Dorr became President of Anthem East in July 2000. She has held
numerous executive positions since joining Anthem Insurance in 1991, including
Vice President of Corporate Finance; Chief Financial Officer of Anthem Casualty
Insurance Group; President of Anthem Prescription Management, LLC; and Chief
Operating Officer of Anthem Health Plans, Inc. in Connecticut.
Keith R. Faller has been President of Anthem Midwest since 1997. He has held
numerous executive positions since joining Anthem Insurance in 1970, including
Senior Vice President for Customer Administration; President of Acordia of the
South; Executive Vice President, Health Operations; Chief Executive Officer,
Anthem Life Insurance Companies, Inc.; and President and Chief Executive
Officer, Acordia Small Business Benefits, Inc.
Michael D. Houk has been Vice President and General Manager of National
Accounts for Anthem Insurance since 1999. He has held various executive
positions since joining Anthem Insurance in 1979, including Vice President of
Sales and President and Chief Executive Officer of Acordia of Central Indiana.
Caroline S. Matthews became Chief Operating Officer of Anthem Blue Cross and
Blue Shield in Colorado and Nevada in 2000. She has held various executive
positions since joining Anthem Insurance in 1988, including Vice President of
Corporate Finance; Vice President of Planning and Administration for
Information Technology; and Chief Operating Officer and Chief Financial Officer
of Acordia of the South.
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John M. Murphy became President, Specialty Business Division of Anthem in
2000. He has held various executive positions since joining Anthem Insurance in
1988, including Vice President of Operations of Anthem Insurance; President and
Chief Executive Officer of Anthem Life Insurance Company; and President and
Chief Executive Officer of Acordia Senior Benefits, Inc.
Jane E. Niederberger joined Anthem Insurance in 1997 and has been Chief
Information Officer since 1999. From 1983 to 1996, she held various executive
positions with Harvard Pilgrim Health Care.
None of these executive officers and directors has family relationships with
any other executive officer or director. The directors and executive officers
of each of Anthem, Inc. and Anthem Insurance are initially the same.
Information about the Board of Directors of Anthem, Inc.
Composition of the Board of Directors
The business of Anthem, Inc. is managed under the direction of the board of
directors. The board of directors consists of 13 directors, all of whom are
non-employee directors, except Mr. Glasscock.
The directors are divided into three classes, each serving three-year terms
with the terms staggered so that only one class will be elected each year:
Class I, consisting of Mrs. Bayh, Mr. Hubbard, Mr. Mays, Senator Riegle, and
Mr. Ryan, whose term will expire at the 2002 annual meeting; Class II,
consisting of Mr. Glasscock, Mr. Hart, Mr. Lytle and Ms. Orullian, whose term
will expire at the 2003 annual meeting; and Class III, consisting of Mr. Liss,
Mr. McDowell, Mr. Schaefer, and Mr. Sullivan, whose term will expire at the
2004 annual meeting.
Committees of the Board of Directors
There are five standing committees of our board of directors. From time to
time, the board of directors, in its discretion, may form other committees. Set
forth below are the primary responsibilities and membership of each of the
committees.
The Executive Committee
Between meetings of the board of directors, the Executive Committee has and
may exercise the powers and authority of the board.
Members of the Executive Committee are: L. Ben Lytle (Chairman), Larry C.
Glasscock (Vice Chairman), Victor S. Liss, William G. Mays, and James W.
McDowell, Jr.
The Audit Committee
The Audit Committee, composed entirely of non-employee directors, advises
the board of directors in the selection of independent auditors, reviews with
internal and independent auditors the scope and results of their audits,
reviews financial statements and other financial disclosures, monitors
developments in accounting principles and practices used in presenting
financial results, and monitors our ethics and corporate compliance program.
Members of the Audit Committee are: Victor S. Liss (Chairman), George A.
Schaefer, Jr. (Vice Chairman), Allan B. Hubbard, James W. McDowell, Jr., B.
LaRae Orullian, and Senator Donald W. Riegle, Jr.
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The Compensation Committee
The Compensation Committee, composed entirely of non-employee directors,
reviews and recommends to the board of directors our overall compensation
policy, reviews and approves the compensation of executive officers and
administers our stock plans.
Members of the Compensation Committee are: William G. Mays (Chairman),
William J. Ryan (Vice Chairman), Victor S. Liss, B. LaRae Orullian, and Dennis
J. Sullivan, Jr.
The Planning Committee
The Planning Committee reviews and monitors the annual operating plan,
recommends strategies to achieve the strategic plan, and reviews integration
plans for mergers, acquisitions and other corporate transactions.
Members of the Planning Committee are: James W. McDowell, Jr. (Chairman),
Senator Donald W. Riegle, Jr. (Vice Chairman), Susan B. Bayh, William B. Hart,
L. Ben Lytle, and William J. Ryan.
The Board Governance and Executive Development Committee
The Board Governance and Executive Development Committee reviews the
qualifications of potential board members, makes recommendations with respect
to electing directors and filling vacancies on the board, reviews the operation
and organization of the board, assists in the design and implementation of
executive training and development programs, and provides counsel on executive
succession planning.
Members of the Board Governance and Executive Development Committee are: L.
Ben Lytle (Chairman), Susan B. Bayh (Vice Chairman), William B. Hart, William
G. Mays, George A. Schaefer, Jr., and Dennis J. Sullivan, Jr.
Compensation of Directors
The compensation of non-employee directors of Anthem, Inc. will initially be
the same as the compensation currently provided by Anthem Insurance to its non-
employee directors. Each non-employee director will receive an annual retainer
fee of $40,000, paid in equal quarterly installments, for board membership, a
meeting fee of $1,500 for attendance at each board meeting and a meeting fee of
$1,200 for attendance at each standing or special committee meeting, with an
additional $3,000 annual retainer for the chairperson. Employee directors are
not paid a fee for their service as a director. Fees paid to directors may be
deferred under the Board of Directors' Deferred Compensation Plan, which
provides a method of deferring payment until a date selected by the director.
Fees deferred accrue interest at the same rate as in effect from time to time
under the Deferred Compensation Plan for employees. Under the 2001 Stock
Incentive Plan, the Board of Directors may elect to pay non-employee directors
all or a part of their retainer fees in Anthem, Inc. common stock, and non-
employee directors may elect to receive all or a part of their other fees in
Anthem, Inc. common stock. In addition, after six months following the
effective date of the demutualization, the Board of Directors may grant non-
qualified stock options to non-employee directors to purchase shares of Anthem,
Inc. common stock at a price no less than the fair market value of a share of
stock on the grant date of the stock option.
Compensation of Executive Officers
Since the formation of Anthem, Inc., none of the executive officers or other
personnel has received any compensation from Anthem, Inc. All compensation has
been paid by Anthem Insurance or one of its subsidiaries. We expect that after
the demutualization, the executive officers of Anthem, Inc. will continue to be
paid by Anthem Insurance or one of its subsidiaries.
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The following table sets forth the compensation paid by Anthem Insurance or
one of its subsidiaries to our Chief Executive Officer and our other four most
highly compensated executive officers for the year ended December 31, 2000.
Summary Compensation Table
Long Term
Annual Compensation Compensation
-------------------------- ------------
Name and Principal Other Annual LTIP All Other
Position Year Salary Bonus(1) Compensation(2) Payouts(3) Compensation(4)
------------------ ---- -------- ---------- --------------- ------------ ---------------
Larry C. Glasscock...... 2000 $800,000 $1,027,298 $65,675 $ 0 $51,467
President and
Chief Executive Officer
David R. Frick.......... 2000 $410,000 $ 520,369 $16,968 $297,049 $24,523
Executive Vice
President
and Chief Legal and
Administrative Officer
Michael L. Smith........ 2000 $375,000 $ 368,122 $ 437 $ 44,557 $18,750
Executive Vice
President
and Chief Financial
Officer
Keith R. Faller......... 2000 $350,000 $ 196,219 $30,202 $178,229 $12,779
President, Anthem
Midwest
Marjorie W. Dorr........ 2000 $306,731 $ 257,175 $25,406 $ 80,202 $13,456
President, Anthem
East(5)
--------
(1) The amount in this column represents the Annual Incentive Plan award paid
in 2000 for the prior performance year of 1999.
(2) Mr. Glasscock received $42,000 in cash and $20,812 in reimbursements as
part of the Directed Executive Compensation Program including financial
counseling fees for $8,892. None of the other named individuals received
perquisites or other personal benefits in excess of the lesser of $50,000
or 10% of the total of their salary and bonus. Amounts include the above-
market portion of interest paid on the deferred compensation for Mr.
Glasscock ($2,863), Mr. Frick ($4,897), Mr. Smith ($437), Mr. Faller
($3,072) and Ms. Dorr ($1,421) and the above market portion of interest
paid on the deferred long-term incentive payments for Mr. Frick ($12,070)
and Mr. Faller ($27,130). Ms. Dorr's amount also includes $23,985 for
reimbursement of relocation expenses.
(3) The amounts in this column represent Long-Term Incentive Plan awards
received or deferred in 2000 for prior performance cycles.
(4) The amounts in this column represent matching contributions under our
401(k) and Deferred Compensation Plans.
(5) Ms. Dorr was appointed President of Anthem East, effective July 29, 2000.
Annual Incentive Plan
Under the Annual Incentive Plan (the "AIP"), employees are eligible to
receive cash awards based upon the achievement of performance measures
established by the Compensation Committee. Such cash awards are stated as a
percentage of salary payable to the eligible employees, with the range of
targets from 5% to 100%. Actual amounts payable are adjusted up or down for
performance at or above targeted levels of performance, with a threshold award
of 50% of target if minimum results are achieved and a maximum award of 200% of
target if maximum results are achieved. Amounts payable under the AIP are paid
during the year immediately following the performance year and are payable only
upon approval of the Compensation Committee. An employee must be employed
before October 1 of the plan year in order to receive a payment under the AIP
in respect
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of such fiscal year. Also, employees must be actively employed by Anthem on the
last business day of the plan year to receive an award. In the event of a
death, disability or an approved retirement of an employee, a prorated amount
may be payable in accordance with administrative guidelines.
Long-Term Incentive Plan
Senior executives, as may be recommended by the Chief Executive Officer and
approved by the Compensation Committee, are participants in the Long-Term
Incentive Plan (the "LTIP"). The LTIP operates during successive three-year
periods. Employees must be actively employed by us on the last business day of
the period to receive an award. Under the LTIP, the Compensation Committee
establishes performance goals for Anthem Insurance at the beginning of each
three-year performance period which include specific objectives for growth in
net income, operating margin and comparison of performance against peer
companies. At the end of the period, the Compensation Committee judges the
performance of Anthem Insurance against the established goals. For each
participant, a target award is established as a percentage of base salary with
the payouts for executives expected to range from 30% to 150% of the annual
base salary for each year of the three-year period. Actual amounts payable are
adjusted up or down for performance above or below targeted levels of
performance with an expected threshold award of 50% of target if minimum
results are achieved. Awards under the LTIP in each three-year period become
payable upon approval of the Compensation Committee and are paid in the year
immediately following the end of the period, with the executive having the
option to defer payment. In the event of a change of control of Anthem, an
amount may be payable at the discretion of the Compensation Committee.
The table below provides information concerning estimated target awards
during the period 2001-2003 depending upon achievement of the performance
goals.
Long-Term Incentive Plan (2001-2003)
Targeted Future
Payouts under Non-
Stock Price-Based
Plan (1)(2)
Performance ---------------------
Name Period Threshold Target
---- ----------- ---------- ----------
Larry C. Glasscock............................ 2001-2003 $2,025,000 $4,050,000
David R. Frick................................ 2001-2003 $ 738,000 $1,476,000
Michael L. Smith.............................. 2001-2003 $ 738,000 $1,476,000
Keith R. Faller............................... 2001-2003 $ 540,000 $1,080,000
Marjorie W. Dorr.............................. 2001-2003 $ 420,000 $ 840,000
--------
(1) Payout scheduled to occur in 2004.
(2) Under the Plan, there is no maximum limitation.
Stock Incentive Plan
We have a 2001 Stock Incentive Plan (the "Stock Plan"), the purposes of
which are to promote the interests of Anthem, Inc. and its shareholders and to
further align the interests of our employees with our shareholders. Directors,
executives and employees, as selected by the Compensation Committee, will
participate in the Stock Plan. The Compensation Committee will administer the
Stock Plan and will have complete discretion to determine whether to grant
incentive awards, the types of incentive awards to grant and any requirements
and restrictions relating to incentive awards. The Stock Plan is an omnibus
plan, which allows for the grant of stock options, restricted stock, stock
appreciation rights, performance stock and performance awards.
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The Stock Plan reserves for issuance 5,000,000 shares of our common stock
for incentive awards to employees and non-employee directors, plus an
additional 2,000,000 shares solely for issuance under grants of stock options
that may be made to substantially all of our employees (and for issuance under
similar grants that may be made to new employees). If any grant is for any
reason canceled, terminated or otherwise settled without the issuance of some
or all of the shares of common stock subject to the grant, such shares will be
available for future grants. For a period of six months following the effective
date of the demutualization, we may not make any grants under the Stock Plan to
our directors or any executive who participates in the LTIP.
If not sooner terminated by the board of directors, the Stock Plan shall
terminate at the close of business on July 29, 2011. The board of directors may
amend the Stock Plan in such respects as it deems advisable provided that the
shareholders must approve certain amendments. A termination or amendment of the
Stock Plan shall not, without the participant's consent or unless made to
ensure compliance with applicable law, adversely affect a participant's rights
under an incentive award previously granted to the participant.
Options to purchase shares of stock granted under the Stock Plan to
employees may be incentive stock options, as described in Internal Revenue Code
(S)422, or nonstatutory stock options. Options to purchase shares of stock
granted under the Stock Plan to non-employee directors must be nonstatutory
stock options. The exercise price per share subject to either an incentive
stock option or a nonstatutory stock option will not be less than 100% (or, in
the case of an incentive stock option granted to a 10% shareholder, 110%) of
the fair market value of stock on the date of the grant of such option. In
addition, no more than $100,000 of incentive stock options, based on the
exercise price, may be initially exercisable in any calendar year. An option
shall not be exercisable more than ten years after the date of grant.
The Compensation Committee intends to grant stock options to purchase 100
shares of Anthem, Inc. common stock under the Stock Plan to each of our
approximately 15,000 employees, other than our approximately top 50 executives,
effective on the first day that Anthem, Inc. common stock trades on the New
York Stock Exchange. None of our executive officers will receive stock options
under these grants. Each of such options will have an exercise price per share
equal to the initial public offering price set forth on the cover page of this
prospectus and will have a term of ten years. The options will generally become
fully exercisable two years after their effective date.
The Compensation Committee may grant similar stock options under the Stock
Plan to new employees. The exercise price of any such options would not be less
than 100% of the fair market value of a share of our common stock on the date
of the grant of such option and any such options would have a term of ten
years.
The Compensation Committee may issue restricted stock to employees. None of
the shares of restricted stock may be transferred or encumbered until the
restrictions on such shares lapse or are removed.
The Compensation Committee may award stock appreciation rights to employees
either with or without related stock options. When the stock appreciation right
is exercisable, the holder may surrender all or a portion of the unexercised
stock appreciation right to Anthem and receive in exchange an amount equal to
the difference between (i) the fair market value on the date of exercise of the
stock covered by the surrendered portion of the stock appreciation right, and
(ii) the exercise price of the stock on the date the stock appreciation right
was awarded.
The Compensation Committee may grant performance awards to employees. For
each plan year, the Compensation Committee will select the performance criteria
to be used for that plan year in granting performance awards, which criteria
may include asset growth, combined net worth, debt
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to equity ratio, earnings per share, revenues, investment performance,
operating income (with or without investment income or income taxes), operating
cash flow, operating margins, net income before or after taxes, earnings before
interest, taxes, depreciation and/or amortization, return on total capital,
equity, revenue or assets, medical loss ratio or number of policyholders or
insureds. Performance awards will be paid in cash, Anthem, Inc. common stock or
both, at such time or times as are provided in the award agreement between us
and the employee. The award agreement may provide that the employee may make a
prior election to defer the payment under the performance award as the
Compensation Committee may determine.
All options granted under the Stock Plan to non-employee directors will
become exercisable in full upon the occurrence of a change in control of
Anthem, Inc. Except as otherwise provided by the Compensation Committee, upon
the occurrence of a change in control of Anthem, Inc., all other options
granted under the Stock Plan will become exercisable in full.
Federal Income Tax Consequences
The following is a brief summary of the federal income tax consequences of
awards under the Stock Plan based on the federal income tax laws in effect on
the date hereof. This summary is not intended to be exhaustive and does not
describe state or local tax consequences.
No taxable income is realized by the grantee upon the grant or exercise of
an incentive stock option. The difference between the fair market value of the
option shares on the date an incentive stock option is exercised and their
exercise price will constitute a tax preference for purposes of the individual
alternative minimum tax. If a grantee does not sell the stock received for at
least two years from the date of grant and one year from the date of exercise,
when the shares are sold any gain or loss realized will be treated as long-term
capital gain or loss. In such circumstances, no deduction will be allowed to
Anthem for federal income tax purposes.
If incentive stock option shares are disposed of prior to the expiration of
the holding periods described above, the grantee generally will recognize
ordinary income at that time equal to the lesser of the excess of the fair
market value of the shares at exercise over the price paid for such shares or
the actual gain on the disposition. Anthem will generally be entitled to deduct
any such recognized amount. Any further gain or loss realized by the grantee
will be taxed as short-term or long-term capital gain or loss. Subject to
certain exceptions for disability or death, if an incentive stock option is
exercised more than three months following the termination of the grantee's
employment, the incentive stock option will generally be taxed as a
nonstatutory stock option.
No income is realized by the grantee at the time a nonstatutory stock option
is granted. Generally upon exercise of a nonstatutory stock option, the grantee
will realize ordinary income in an amount equal to the difference between the
price paid for the shares and the fair market value of the shares on the date
of exercise. Anthem will generally be entitled to a deduction for federal
income tax purposes in the same amount and at the same time as the grantee
recognizes ordinary income. Any appreciation or depreciation after the date of
exercise will be treated as either short-term or long-term capital gain or
loss, depending upon the length of time that the grantee has held the shares.
No deduction will be available to Anthem by reason of such gain or loss.
Employee Stock Purchase Plan
The Employee Stock Purchase Plan (the "Stock Purchase Plan") is intended to
comply with Internal Revenue Code (S)423 and to provide a means by which to
encourage and assist employees in acquiring a stock ownership interest in
Anthem, Inc. We anticipate implementing the Stock Purchase Plan by mid 2002.
The Stock Purchase Plan is administered by the Compensation Committee, and the
Compensation Committee will have complete discretion to interpret and
administer the Stock Purchase Plan and the rights granted under it. Any
employee of Anthem is
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eligible to participate, as long as such employee's customary employment is
more than 20 hours per week, more than five months in a calendar year, and the
employee does not own stock totaling 5% or more of the voting power or value of
Anthem, Inc. No employee will be permitted to purchase more than $25,000 worth
of stock in any calendar year. The Stock Purchase Plan reserves for issuance
and purchase by employees 3,000,000 shares of stock.
Employees become participants by electing payroll deductions from 1% to 15%
of gross compensation. Payroll deductions are accumulated during each quarter
and applied toward the purchase of stock on the last trading day of each
quarter. Once purchased, the stock is accumulated in the employee's investment
account. The purchase price per share equals the lower of (i) 85% of the fair
market value of a share of our common stock on the first trading day of the
quarter, or (ii) 85% of the fair market value of a share of our common stock on
the last trading day of the quarter.
The board of directors may amend the Stock Purchase Plan in such respects as
it deems advisable provided that the shareholders must approve certain
amendments. Rights under the Stock Purchase Plan are not transferable, except
by will or the law of descent and distribution. In the event of a participant's
retirement, termination or death, the amount in the participant's payroll
deduction account shall be refunded.
Deferred Compensation
Highly compensated employees, as defined in the Internal Revenue Code, are
eligible to participate in an unfunded non-qualified deferred compensation
plan. There are three types of deferral options in the plan. The Restoration
Option allows deferral amounts that are limited under our 401(k) Plan and
restores company match that would otherwise be contributed in our 401(k) Plan.
The Supplemental Option allows an additional deferral of base salary and
commissions, up to 80%, above the Restoration Option and these deferrals are
not matched by us. The Annual Incentive Deferral Option allows an additional
deferral of annual incentive compensation above the Restoration Option and is
matched at a rate of 3%.
The declared interest rate on deferred amounts is the average of the 10-year
U.S. Treasury Note monthly average rates for the 12-month period ending on
September 30 of the previous year, plus 150 basis points. Interest is accrued
daily, posted monthly and compounded annually. The retirement rate is credited
at 125% of the declared interest rate. Distributions are made at the end of the
quarter of termination or retirement based on the participant's filed
distribution election or as otherwise specified in the plan document. Limited
in-service withdrawals are available in the event of unforeseeable financial
emergencies.
Retirement Plan
We sponsor a non-contributory pension plan for certain employees that is
qualified under Internal Revenue Code (S)401(a) and subject to the Employee
Retirement Income Security Act (the "Qualified Plan"). We also sponsor the
Anthem Supplemental Executive Retirement Plan ( the "SERP") which provides
additional benefits payable out of our general assets to certain participants.
The benefits under the SERP are equal to the benefits those participants cannot
receive under the Qualified Plan because of Internal Revenue Code limits on
benefits and restrictions on participation by highly compensated employees, as
defined in the Internal Revenue Code.
On January 1, 1997, we converted the Qualified Plan from a final average
compensation pension plan into a cash balance pension plan. The Qualified Plan
covers substantially all full-time,
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part-time and temporary employees, including executive officers, and provides a
set benefit at age 65, the normal retirement age under the Qualified Plan.
Under the Qualified Plan, at the end of each calendar quarter, a bookkeeping
account for each participant is credited with (1) an amount based on the
participant's compensation and years of service (the "Pay Credit"), and (2)
interest based on the average of the monthly yields for 10-year U.S. Treasury
Security Constant Maturities for the twelve month period ending on September 30
of the preceding plan year. The Pay Credit equals a percentage of the
participant's compensation for the plan year and is determined according to the
following schedule:
Years of Service Pay Credit
---------------- ----------
Up to and including 4......................................... 3%
5-9........................................................ 4%
10-19....................................................... 5%
20+......................................................... 6%
The definition of compensation in the Qualified Plan is the participant's
total earned income, including base salary, commissions, overtime pay, and cash
bonuses, before it is reduced by any before-tax contributions the participant
makes to the 401(k) plan and flexible benefit plan. Compensation does not
include imputed income, car allowances, non-qualified deferred compensation,
severance payments, payment of accrued paid time off days, payments under the
Directed Executive Compensation Program, or similar items.
The SERP continues the calculation of the retirement benefits on a uniform
basis. Any excess benefit accrued to a participant under the SERP will be
payable according to one of five payment options available under the SERP at
termination or retirement.
Messrs. Glasscock, Frick, Smith and Faller and Ms. Dorr receive benefits
under both the Qualified Plan and the SERP. The estimated benefits, under both
the Qualified Plan and the SERP, payable in a lump sum upon retirement at
normal retirement age are as follows: Mr. Glasscock ($1,787,981), Mr. Frick
($650,913), Mr. Smith ($774,339), Mr. Faller ($3,879,546), and Ms. Dorr
($2,581,168). Mr. Faller's benefit is calculated under a different formula
through 2001 as a result of transition benefits in the Qualified Plan. These
estimates use 2000 base pay and annual bonus for all future years and assume
that the named executive officers remain actively employed until normal
retirement age.
In addition, the employment agreements for Messrs. Glasscock, Frick and
Smith set forth a Replacement Ratio SERP benefit, calculated as a retirement at
age 62 or the date of termination, if later than age 62, in an amount equal to
50% of the executive's average annual pay during the three highest consecutive
calendar years of his final five calendar years of employment. The benefit will
be offset by the amount payable under the Qualified Plan and the SERP. The
estimated replacement ratio SERP benefit payable upon retirement at age 65 is
as follows: Mr. Glasscock ($738,852 annually), Mr. Frick ($401,880 annually),
and Mr. Smith ($295,008 annually). These estimates use 2000 base salary and
annual bonus for all future years and assume that the named executive officers
remain actively employed until normal retirement age.
Employment Agreements
Anthem Insurance has entered into employment agreements with certain of our
executive officers, including Messrs. Glasscock, Frick, Smith, Faller and Ms.
Dorr, that provide for each executive's continued employment with us. The
current terms of the employment agreements are effective through December 31,
2005 for Mr. Glasscock, December 31, 2004 for Messrs. Frick and Smith and
December 31, 2003 for Mr. Faller and Ms. Dorr.
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Under these agreements, each eligible executive's terms and conditions of
employment, including rate of base salary, incentive compensation
opportunities, participation in employee benefit plans and perquisites are
addressed.
The employment agreements provide that Anthem Insurance will have the right
at any time to terminate an executive's employment and that any executive will
have the right to terminate his or her employment at Anthem Insurance. Under
the employment agreements with Messrs. Glasscock, Frick and Smith, Anthem
Insurance will provide them for the remainder of the term with the following
benefits in the event of termination by us other than for cause, in the event
of an approved retirement or in the event of termination by the executive for
good reason (as those terms are defined in the employment agreements):
. salary;
. all unvested prior long-term incentive awards;
. annual incentive and long-term incentive awards for the year of
termination based upon the achievement of the performance goals for the
plans for the entire year of termination prorated to reflect the full
number of months the executive was employed;
. an amount equal to 80% of any target annual incentive and target long-
term incentive opportunities;
. an amount equal to 20% of any target annual incentive and target long-
term incentive opportunities if the executive is available for
consultation up to a maximum of eight days each quarter of the year;
. medical and dental plan benefits and directed executive compensation for
which the executive would otherwise have been eligible to receive; and
. the Replacement Ratio SERP Benefit described under "--Retirement Plan."
Section 280G and Section 4999 of the Code limit deductions for compensation
paid to certain senior executives if the payment is contingent on a change of
ownership or effective control of a corporation. This deduction is limited to
the average taxable compensation of the affected executive for the five years
prior to the year that the change of control occurred. If the payments to the
executive equal or exceed three times such average taxable compensation, the
deduction is limited pursuant to Code Section 280G and these payments are
referred to as "golden parachute" payments. In addition, Code Section 4999
imposes a 20% nondeductible excise tax on the executive on all nondeductible
payments.
Pursuant to their employment agreements, in the event Messrs. Glasscock,
Frick or Smith is a recipient of a "golden parachute" payment, we will make an
additional gross-up payment to the executive in order to put him in the same
after-tax position that he would have been in had no excise tax been imposed.
The gross-up will result in Anthem paying not only the excise tax payable by
the executive but also the income and excise taxes on the additional payments.
Under the employment agreements for Ms. Dorr and Mr. Faller, Anthem
Insurance will provide them with the following benefits in the event of
termination by us other than for cause:
. salary;
. all unvested prior long-term incentive awards;
. annual incentive and long-term incentive awards for the year of
termination based upon the achievement of the performance goals for the
plans for the entire year of termination prorated to reflect the full
number of months the executive was employed;
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. an amount equal to 50% of any target annual incentive and target long-
term incentive opportunities; and
. medical and dental plan benefits for which the executive would otherwise
have been eligible to receive.
The employment agreements for Ms. Dorr and Mr. Faller also state that the
foregoing benefits are limited to either the greater of one year or the
remainder of the term.
Under these agreements, Messrs. Glasscock, Frick and Smith agree not to
compete as an equity owner or employee with us or our subsidiaries for the
greater of (i) two years after the executive's termination for any reason or
(ii) the remainder of the term after their termination by us other than for
cause, after an approved retirement or after termination by the executive for
good reason. Mr. Faller and Ms. Dorr are subject to the same limitation but for
the greater of one year or the remainder of the term after their termination
other than for cause.
Ownership of Common Stock
No directors or executive officers own any stock in Anthem, Inc. and no
directors or executive officers will receive any stock in connection with the
demutualization. Under the plan of conversion, we cannot make any grants of our
common stock or options to purchase our common stock to any of our directors or
our approximately top 50 executives until six months after the effective date
of the demutualization. In addition, under the Indiana Insurance Commissioner's
order approving the plan of conversion, none of our directors or our
approximately top 50 executives may acquire beneficial ownership of shares of
our common stock for a period of six months following the effective date of the
demutualization.
Certain Relationships and Related Transactions
In the ordinary course of business, we from time to time may engage in
transactions with other corporations or financial institutions whose officers
or directors are also directors of Anthem. Transactions with such corporations
and financial institutions are conducted on an arm's length basis and may not
come to the attention of the directors of Anthem or of the other corporations
or financial institutions involved.
Mr. Lytle, Chairman of the board of directors, retired as Chief Executive
Officer in October 1999. Pursuant to his employment agreement and retirement
agreement, Anthem pays Mr. Lytle $400,000 annually until December 31, 2002 for
his consultation services up to a maximum of eight days per quarter. In
addition, in any quarter in which Anthem has requested Mr. Lytle to provide
more than eight days of consultation, he is to be paid five hundred dollars
($500) per hour, up to a maximum of five thousand dollars ($5,000) per day.
Compensation Committee Interlocks and Insider Participation
The Compensation Committee, among other things, approves compensation for
Anthem's executive officers. The Compensation Committee members during 2000
were Victor S. Liss, William G. Mays, B. LaRae Orullian, William J. Ryan, Allan
B. Hubbard and Dennis J. Sullivan, Jr. None of the Compensation Committee
members were involved in a relationship requiring disclosure as an interlocking
director, or under Item 404 of Regulation S-K, or as a former officer or
employee of Anthem.
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DESCRIPTION OF CAPITAL STOCK
The following description of our capital stock does not purport to be
complete and is subject in all respects to applicable Indiana law and to the
provisions of our articles of incorporation and by-laws, copies of which are
included as exhibits to the registration statement of which this prospectus
forms a part.
Our authorized capital stock consists of 900,000,000 shares of common stock,
$.01 par value per share, and 100,000,000 shares of preferred stock, without
par value. After giving effect to (a) the issuance of an estimated 54,861,000
shares of common stock in the demutualization and (b) the issuance of
48,000,000 shares of common stock in this offering, and assuming that the
underwriters do not exercise their over-allotment option, we would have
102,861,000 shares of common stock issued and outstanding and no shares of
preferred stock issued and outstanding. An additional 10,000,000 shares of
common stock are reserved for issuance under our Stock Plan and under our Stock
Purchase Plan. Additional shares of common stock will be issuable upon
settlement of the purchase contracts included in the units.
Common Stock
Each holder of common stock is entitled to one vote per share of record on
all matters to be voted upon by the shareholders. Holders do not have
cumulative voting rights in the election of directors or any other matter.
Subject to the preferential rights of the holders of any preferred stock that
may at the time be outstanding, each share of common stock will entitle the
holder of that share to an equal and ratable right to receive dividends when,
if and as declared from time to time by the board of directors and paid out of
legally available funds. We do not anticipate paying cash dividends. See
"Dividend Policy."
In the event of our liquidation, dissolution or winding up, the holders of
common stock will be entitled to share ratably in all assets remaining after
payments to creditors and after satisfaction of the liquidation preference, if
any, of the holders of any preferred stock that may at the time be outstanding.
Holders of common stock have no preemptive or redemption rights and will not be
subject to further calls or assessments by us. All of the shares of common
stock to be issued and sold in this offering will be, immediately upon
consummation of this offering, validly issued, fully paid and non-assessable.
Preferred Stock
The authorized preferred stock is available for issuance from time to time
at the discretion of the board of directors without shareholder approval. The
board of directors has the authority to prescribe for each series of preferred
stock it establishes the number of shares in that series, the number of votes,
if any, to which the shares in that series are entitled, the consideration for
the shares in that series, and the designations, powers, preferences and other
rights, qualifications, limitations or restrictions of the shares in that
series. Depending upon the rights prescribed for a series of preferred stock,
the issuance of preferred stock could have an adverse effect on the voting
power of the holders of common stock and could adversely affect holders of
common stock by delaying or preventing a change in control of us, making
removal of our present management more difficult or imposing restrictions upon
the payment of dividends and other distributions to the holders of common
stock.
Authorized But Unissued Shares
Indiana law does not require shareholder approval for any issuance of
authorized shares. Authorized but unissued shares may be used for a variety of
corporate purposes, including future public or private offerings to raise
additional capital or to facilitate corporate acquisitions. One of the effects
of the existence of authorized but unissued shares may be to enable the board
of directors to issue shares to persons friendly to current management, which
issuance could render more difficult or discourage an attempt to obtain control
of us by means of a merger, tender offer, proxy contest or
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otherwise, and thereby protect the continuity of current management and
possibly deprive the shareholders of opportunities to sell their shares of
common stock at prices higher than prevailing market prices.
Limitations on Ownership of Common Stock in Articles of Incorporation
Our license agreements with the BCBSA require as a condition to our
retention of the licenses that our articles of incorporation contain certain
provisions, including limitations on the ownership of our common stock. Our
articles of incorporation provide that after the demutualization no person may
beneficially own shares of our voting capital stock in excess of the specified
BCBSA ownership limit, except with the prior approval of a majority of the
continuing directors (as defined in our articles of incorporation). The BCBSA
ownership limit, which may not be exceeded without the prior approval of the
BCBSA, is the following:
. for any "Institutional Investor," one share less than 10% of our
outstanding voting securities;
. for any "Noninstitutional Investor," one share less than 5% of our
outstanding voting securities; and
. for any person, one share less than the number of shares of our common
stock or other equity securities (or a combination thereof) representing
a 20% or more ownership interest in our company.
"Institutional Investor" means any person if (but only if) such person is:
. a broker or dealer registered under Section 15 of the Securities
Exchange Act of 1934, or Exchange Act;
. a bank as defined in Section 3(a)(6) of the Exchange Act;
. an insurance company as defined in Section 3(a)(19) of the Exchange Act;
. an investment company registered under Section 8 of the Investment
Company Act of 1940;
. an investment adviser registered under Section 203 of the Investment
Advisers Act of 1940;
. an employee benefit plan, or pension fund which is subject to the
provisions of ERISA or an endowment fund;
. a parent holding company, provided the aggregate amount held directly by
the parent, and directly and indirectly by its subsidiaries which are
not persons specified in the six bullet points listed above, does not
exceed one percent of the securities of the subject class such as common
stock; or
. a group, provided that all the members are persons specified in the
seven bullet points listed above.
In addition, every filing made by such person with the SEC under Regulations
13D-G (or any successor regulations) under the Exchange Act with respect to
that person's beneficial ownership must contain a certification substantially
to the effect that our common stock acquired by that person was acquired in the
ordinary course of business and was not acquired for the purpose of and does
not have the effect of changing or influencing the control of our company and
was not acquired in connection with or as a participant in any transaction
having such purpose or effect.
"Noninstitutional Investor" means any person that is not an Institutional
Investor.
Any transfer of stock that would result in any person beneficially owning
shares of capital stock in excess of the ownership limit will result in the
intended transferee acquiring no rights in such shares (with certain
exceptions) and the person's shares will be deemed transferred to an escrow
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agent to be held until the shares are transferred to a person whose ownership
of the shares will not violate the ownership limit. These provisions prevent a
third party from obtaining control of our company without obtaining the prior
approval of our continuing directors or the 75% supermajority vote required to
amend these provisions of our articles of incorporation and may have the effect
of discouraging or even preventing a merger or business combination, a tender
offer or similar extraordinary transaction involving us.
Certain Other Provisions of Articles of Incorporation and By-Laws
Certain other provisions of our articles of incorporation and by-laws may
delay or make more difficult unsolicited acquisitions or changes of control of
us. These provisions could have the effect of discouraging third parties from
making proposals involving an unsolicited acquisition or change in control of
us, although these proposals, if made, might be considered desirable by a
majority of our shareholders. These provisions may also have the effect of
making it more difficult for third parties to cause the replacement of the
current management without the concurrence of the board of directors. These
provisions include:
. the division of the board of directors into three classes serving
staggered terms of office of three years (see "Management--Directors and
Executive Officers");
. provisions allowing the removal of directors only upon a 66 2/3%
shareholder vote or upon the affirmative vote of both a majority of all
directors and a majority of continuing directors (as defined in our
articles of incorporation);
. provisions limiting the maximum number of directors to 19, and requiring
that any increase in the number of directors then in effect must be
approved by a majority of continuing directors;
. permitting only the board of directors, the Chairman, the Chief
Executive Officer or the President to call a special meeting of
shareholders;
. requirements for a 75% supermajority vote to amend certain provisions of
our articles of incorporation, including those provisions discussed in
this section; and
. requirements for advance notice for raising business or making
nominations at shareholders' meetings.
Our by-laws establish an advance notice procedure with regard to business to
be brought before an annual or special meeting of shareholders and with regard
to the nomination of candidates for election as directors, other than by or at
the direction of the board of directors. Although our by-laws do not give the
board of directors any power to approve or disapprove shareholder nominations
for the election of directors or proposals for action, they may have the effect
of precluding a contest for the election of directors or the consideration of
shareholder proposals if the established procedures are not followed, and of
discouraging or deterring a third party from conducting a solicitation of
proxies to elect its own slate of directors or to approve its proposal without
regard to whether consideration of those nominees or proposals might be harmful
or beneficial to us and our shareholders.
Our articles of incorporation provide that, in the case of a merger, sale or
purchase of assets, issuance of securities or reclassification, each a
"business combination," involving a beneficial owner of 10% or more of the
voting power of our capital stock (a "related person"), or any affiliate or
associate of a related person, such business combination must be approved by
(i) 66 2/3% of the voting power of our outstanding voting stock and (ii) a
majority of the then outstanding voting power of the voting stock held by
shareholders other than the related person. However, these shareholder approval
requirements do not apply if the business combination is approved in advance by
at least
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two-thirds of the continuing directors (as defined in our articles of
incorporation) or the consideration to be received by shareholders in the
business combination is at least equal to the highest price paid by the related
person in acquiring its interest in our company, with specified adjustments,
and some other requirements are met.
Certain Provisions of Indiana Law
Under the Indiana demutualization law, for a period of five years following
the effective date of the demutualization, no person may acquire beneficial
ownership of 5% or more of the outstanding shares of our common stock without
the prior approval of the Indiana Insurance Commissioner and our board of
directors.
This restriction does not apply to acquisitions made by us or made pursuant
to an employee benefit plan or employee benefit trust sponsored by us. The
Indiana Insurance Commissioner has adopted rules under which passive
institutional investors could purchase 5% or more but less than 10% of any
outstanding common stock with the approval of our board of directors and prior
notice to the Indiana Insurance Commissioner.
The Indiana Business Corporation Law, or IBCL, applies to us as an Indiana
corporation. Under specified circumstances, the following provisions of the
IBCL may delay, prevent or make more difficult unsolicited acquisition or
changes of control of us. These provisions also may have the effect of
preventing changes in our management. It is possible that these provisions
could make it more difficult to accomplish transactions which shareholders may
otherwise deem to be in their best interests.
Control Share Acquisitions. Under Sections 23-1-42-1 to 23-1-42-11 of the
IBCL, an acquiring person or group who makes a "control share acquisition" in
an "issuing public corporation" may not exercise voting rights on any "control
shares" unless these voting rights are conferred by a majority vote of the
disinterested shareholders of the issuing corporation at a special meeting of
those shareholders held upon the request and at the expense of the acquiring
person. If control shares acquired in a control share acquisition are accorded
full voting rights and the acquiring person has acquired control shares with a
majority or more of all voting power, all shareholders of the issuing public
corporation have dissenters' rights to receive the fair value of their shares
pursuant to Section 23-1-44 of the IBCL.
Under the IBCL, "control shares" means shares acquired by a person that,
when added to all other shares of the issuing public corporation owned by that
person or in respect to which that person may exercise or direct the exercise
of voting power, would otherwise entitle that person to exercise voting power
of the issuing public corporation in the election of directors within any of
the following ranges:
. one-fifth or more but less than one-third;
. one-third or more but less than a majority; or
. a majority or more.
"Control share acquisition" means, subject to specified exceptions, the
acquisition, directly or indirectly, by any person of ownership of, or the
power to direct the exercise of voting power with respect to, issued and
outstanding control shares. Shares acquired within 90 days or under a plan to
make a control share acquisition are considered to have been acquired in the
same acquisition. "Issuing public corporation" means a corporation which is
organized in Indiana and has (i) 100 or more shareholders, (ii) its principal
place of business, its principal office or substantial assets within Indiana
and (iii) either:
. more than 10% of its shareholders resident in Indiana;
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. more than 10% of its shares owned by Indiana residents; or
. 10,000 shareholders resident in Indiana.
The above provisions do not apply if, before a control share acquisition is
made, the corporation's articles of incorporation or by-laws, including a board
adopted by-law, provide that they do not apply. Our articles of incorporation
and by-laws do not currently exclude us from the restrictions imposed by the
above provisions.
Certain Business Combinations. Sections 23-1-43-1 to 23-1-43-24 of the IBCL
restrict the ability of a "resident domestic corporation" to engage in any
combinations with an "interested shareholder" for five years after the
interested shareholder's date of acquiring shares unless the combination or the
purchase of shares by the interested shareholder on the interested
shareholder's date of acquiring shares is approved by the board of directors of
the resident domestic corporation before that date. If the combination was not
previously approved, the interested shareholder may effect a combination after
the five-year period only if that shareholder receives approval from a majority
of the disinterested shares or the offer meets specified fair price criteria.
For purposes of the above provisions, "resident domestic corporation" means an
Indiana corporation that has 100 or more shareholders. "Interested shareholder"
means any person, other than the resident domestic corporation or its
subsidiaries, who is (1) the beneficial owner, directly or indirectly, of 10%
or more of the voting power of the outstanding voting shares of the resident
domestic corporation or (2) an affiliate or associate of the resident domestic
corporation, which at any time within the five-year period immediately before
the date in question, was the beneficial owner, directly or indirectly, of 10%
or more of the voting power of the then outstanding shares of the resident
domestic corporation. The above provisions do not apply to corporations that so
elect in an amendment to their articles of incorporation approved by a majority
of the disinterested shares. That amendment, however, cannot become effective
until 18 months after its passage and would apply only to share acquisitions
occurring after its effective date. Our articles of incorporation do not
exclude us from the restrictions imposed by the above provisions.
Directors' Duties and Liability. Under Section 23-1-35-1 of the IBCL,
directors are required to discharge their duties:
. in good faith;
. with the care an ordinarily prudent person in a like position would
exercise under similar circumstances; and
. in a manner the directors reasonably believe to be in the best interests
of the corporation.
However, the IBCL also provides that a director is not liable for any action
taken as a director, or any failure to act, unless the director has breached or
failed to perform the duties of the director's office and the action or failure
to act constitutes willful misconduct or recklessness. The exoneration from
liability under the IBCL does not affect the liability of directors for
violations of the federal securities laws.
Section 23-1-35-1 of the IBCL also provides that a board of directors, in
discharging its duties, may consider, in its discretion, both the long-term and
short-term best interests of the corporation, taking into account, and weighing
as the directors deem appropriate, the effects of an action on the
corporation's shareholders, employees, suppliers and customers and the
communities in which offices or other facilities of the corporation are located
and any other factors the directors consider pertinent. If a determination is
made with the approval of a majority of the disinterested directors of the
board, that determination is conclusively presumed to be valid unless it can be
demonstrated that the determination was not made in good faith after reasonable
investigation. Once the board, in exercising its business judgment, has
determined that a proposed action is not in the best interests
137
of the corporation, it has no duty to remove any barriers to the success of the
action, including a shareholder rights plan. Section 23-1-35-1 specifically
provides that specified judicial decisions in Delaware and other jurisdictions,
which might be looked upon for guidance in interpreting Indiana law, including
decisions that propose a higher or different degree of scrutiny in response to
a proposed acquisition of the corporation, are inconsistent with the proper
application of the business judgment rule under that section.
Transfer Agent and Registrar
The transfer agent and registrar for the common stock is EquiServe Trust
Company, N.A.
138
COMMON STOCK ELIGIBLE FOR FUTURE SALE
All of the 48,000,000 shares of our common stock sold to investors in the
public market in this offering (55,200,000 shares if the underwriters exercise
their over-allotment option in full) will be eligible for immediate resale in
the public market without restriction, except for any of those shares that are
beneficially owned at any time by our affiliates, as defined in Rule 144 of the
Securities Act, which sales will be subject to the timing, volume and manner of
sale limitations of Rule 144.
Anthem Insurance's eligible statutory members who receive fewer than 30,000
shares of our common stock in exchange for their membership interests may sell
their shares of our common stock in the public market without restriction,
except for any shares owned by our affiliates, which must be sold in compliance
with Rule 144. Anthem Insurance's eligible statutory members who receive 30,000
or more shares of our common stock in exchange for their membership interests
(whom we estimate would hold an aggregate of approximately 11.5 million shares
of our outstanding common stock after the offering) and continue to hold 30,000
or more shares will be restricted from selling their shares in the public
market for 180 days following the effective date of the demutualization, except
for sales in accordance with a large holder sale program we will establish, a
transfer that occurs by operation of law or transfers with our written consent.
After the expiration of this period, those eligible statutory members may sell
their shares of our common stock in the public market without restriction,
except for any shares owned by our affiliates, which must be sold in compliance
with Rule 144. See "The Plan of Conversion--Large Holder Sale Program" for a
description of the large holder sale program and its limitations. We anticipate
that eligible statutory members receiving shares of our common stock in the
demutualization will receive notices regarding the number of shares registered
in their name approximately four to six weeks after the effective date of the
demutualization.
In general, under Rule 144 as currently in effect, (a) a person, or persons
whose shares are aggregated, who has beneficially owned restricted shares for
at least one year or (b) an affiliate who holds non-restricted shares, will be
entitled to sell, within any three-month period, a number of shares that does
not exceed the greater of 1% of the then outstanding shares of our common
stock, or the average weekly trading volume of our common stock during the four
calendar weeks preceding such sale. Sales under Rule 144 are also subject to
certain provisions regarding the manner of sale, notice requirements and the
availability of current public information about us. If two years have elapsed
since the date of acquisition of restricted shares of our common stock from us
or any of our affiliates and the holder is not deemed to have been an affiliate
of ours for at least three months prior to a proposed transaction, such person
would be entitled to sell such shares under Rule 144 without regard to the
limitations described above.
There are 7,000,000 shares of common stock available for grant of options,
restricted stock, stock appreciation rights, performance stock and performance
awards under our Stock Plan. We intend to grant options to purchase 100 shares
of common stock to each of our approximately 15,000 employees (other than our
approximately top 50 executives), pursuant to our Stock Plan, effective on the
first day that our common stock trades on the New York Stock Exchange. See
"Management--Stock Incentive Plan." We intend to file a registration statement
on Form S-8 to register the shares of common stock that are issuable upon the
exercise of stock options outstanding or available for grant pursuant to our
Stock Plan. Under our Stock Purchase Plan, we have reserved for issuance and
purchase by employees 3,000,000 shares of common stock. See "Management--
Employee Stock Purchase Plan." We intend to file a registration statement on
Form S-8 to register the shares of common stock that are issuable under the
Stock Purchase Plan. Following effectiveness of each Form S-8, shares covered
by that Form S-8 will be eligible for sale in the public markets, subject to
Rule 144 limitations applicable to affiliates as well as to the limitations on
sale and vesting described above.
139
In addition, in accordance with the plan of conversion, we intend, for not
less than a three month period commencing no earlier than the first business
day after the 180th day following, and no later than the last business day
before the twelfth-month anniversary of, the effective date of the
demutualization, to provide for the public sale, at prevailing market prices
and without brokerage commissions or similar fees to shareholders, of all
shares of our common stock held by shareholders who own 99 shares or fewer of
our common stock. We estimate that when we complete the demutualization we will
have approximately 150,000 eligible statutory members who will in total receive
in excess of five million shares that we believe would be eligible to
participate in this commission-free sales program. We would also,
simultaneously and in conjunction with the commission-free sales program, offer
to each shareholder entitled to participate in the commission-free sales
program the opportunity to purchase that number of shares of our common stock
necessary to increase such shareholder's holdings to 100 shares without paying
brokerage commissions or other similar expenses. The program may provide that
we can repurchase shares of our common stock at prevailing market prices when,
during any particular day of the program, the number of shares requested to be
sold exceeds the number of shares requested to be purchased pursuant to round-
up requests.
We have agreed with the Underwriters not to dispose of or hedge any of our
common stock or securities convertible into or exchangeable for shares of
common stock (other than the units to be offered and sold concurrently with
this offering) during the period from the date of this prospectus continuing
through the date 180 days after the date of this prospectus, except with the
prior written consent of the representatives. This agreement does not apply to
any existing employee benefit plans.
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OWNERSHIP OF COMMON STOCK
The following table sets forth certain information regarding the beneficial
ownership of our common stock as of the effective date of the demutualization
by:
. each of our directors and Named Executive Officers; and
. all of our directors and executive officers as a group.
We believe that no person will beneficially own more than 5% of our
outstanding shares of common stock as a result of the shares distributed
pursuant to the plan of conversion and shares sold in this offering.
None of our directors or executive officers will receive any stock in
connection with the demutualization, nor will they be permitted to acquire
beneficial ownership of any shares of our common stock for a period of six
months following the effective date of the demutulization.
Number of Shares to Be
Name Beneficially Owned (1)
---- ----------------------
L. Ben Lytle........................................... 0
Susan B. Bayh.......................................... 0
Larry C. Glasscock..................................... 0
William B. Hart........................................ 0
Allan B. Hubbard....................................... 0
Victor S. Liss......................................... 0
William G. Mays........................................ 0
James W. McDowell, Jr.................................. 0
B. LaRae Orullian...................................... 0
Senator Donald W. Riegle, Jr. ......................... 0
William J. Ryan........................................ 0
George A. Schaefer, Jr. ............................... 0
Dennis J. Sullivan, Jr................................. 0
David R. Frick......................................... 0
Michael L. Smith....................................... 0
Keith R. Faller........................................ 0
Marjorie W. Dorr....................................... 0
All directors and executive officers as a group (22
persons).............................................. 0
--------
(1) Based on an estimated allocation of shares based upon statutory membership
ownership records as of June 18, 2001.
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DESCRIPTION OF THE EQUITY SECURITY UNITS
The Units
Concurrently with the closing of this initial public offering, we are
selling 4,000,000 6.00% equity security units for a total gross offering of
$200.0 million, plus up to an additional $30.0 million if the underwriters'
option to purchase additional units is exercised in full. Each unit will
initially consist of and represent:
. a purchase contract under which the holder agrees to purchase, for $50,
shares of our common stock on November 15, 2004. The number of shares
the holder will receive will be determined by the settlement rate
described below, based on the average trading price of our common stock
at that time; and
. a subordinated debenture with a principal amount of $50. The debenture
will initially be pledged to secure the holder's obligations under the
purchase contract.
The Purchase Contracts
The purchase contract underlying a unit obligates the holder to purchase,
and us to sell, for $50, on November 15, 2004, a number of newly issued shares
of our common stock. We will determine the number of shares the holder will
receive by the settlement rate described below, based on the average closing
price of the common stock during a specified period prior to the stock purchase
date.
We will pay the holder quarterly contract fee payments on the purchase
contracts at the annual rate of 0.05% of the stated amount of $50 per purchase
contract, subject to our rights to defer these payments. We will make contract
fee payments only to but excluding the earlier of November 15, 2004 or the most
recent quarterly payment date on or before any early settlement of the related
purchase contracts. We have the option to defer contract fee payments on the
purchase contracts for up to three years. We may elect the option to defer
payments on more than one occasion. In no event may we defer payments beyond
November 15, 2004. Deferred contract fee payments will accrue additional
contract fee payments until paid, compounded quarterly, at the annual rate of
6.00%. This annual rate is equal to the sum of the initial interest rate on the
debentures and the rate of contract fee payments on the purchase contracts.
The Debentures
The debentures will be unsecured and will be subordinated in right of
payment to all of Anthem, Inc.'s existing and future senior indebtedness. The
debentures will mature on November 15, 2006.
Each debenture shall initially bear interest at the rate of 5.95% per year,
payable quarterly in arrears on February 15, May 15, August 15 and November 15
of each year, subject to the deferral provisions described below, commencing
February 15, 2002 and ending on November 15, 2006. The applicable interest rate
on the debentures outstanding on and after August 15, 2004 will be reset on the
third business day preceding August 15, 2004, effective for interest accrued
from August 15, 2004 to November 15, 2006, as described below.
The reset rate will be the interest rate on the debentures determined by the
reset agent to be sufficient to cause the then current aggregate market value
of all then outstanding debentures to be equal to 100.5% of the remarketing
value. For this purpose we will assume, even if not true, that all of the
debentures will be remarketed. If the reset agent cannot establish a reset rate
on the remarketing date that will be sufficient to cause the then current
aggregate market value of all debentures to be equal to 100.5% of the
remarketing value, and as a result the debentures cannot
142
be sold, the interest rate will not be reset but will continue to be the
initial interest rate of the debentures. However, the reset agent may
thereafter attempt to establish a reset rate meeting these requirements, and
the remarketing agent may attempt to remarket the debentures, on one or more
subsequent remarketing dates after the initial remarketing date until November
15, 2004. The reset rate will be determined by a nationally recognized
investment banking firm acting as reset agent.
We can, on one or more occasions, defer the interest payments due on the
debentures for up to five years, unless an event of default under the
debentures has occurred and is continuing. However, we cannot defer interest
payments beyond the maturity date of the debentures, which is November 15,
2006. During any deferral period, interest on the debentures will continue to
accrue quarterly at the initial annual rate of 5.95% of the principal amount of
$50 per debenture through and including August 15, 2004, and at the reset rate
from that date to November 15, 2006. Additional interest will accrue on the
deferred interest at the applicable rate, to the extent permitted by law.
Interest payments may be deferred if we do not have funds available to make the
interest payments or for any other reason.
During any period in which we defer contract fee payments or interest
payments on the debentures, in general we cannot:
. declare or pay any dividend or distribution on our capital stock; or
. redeem, purchase, acquire or make a liquidation payment on any of our
capital stock.
In addition, during any period in which we defer interest payments on the
debentures, in general we cannot:
. make any interest, principal or premium payment on, or repurchase or
redeem, any of our debt securities that rank equally with or junior in
right of payment to the debentures; or
. make any payment on any guarantee of the debt securities of any of our
subsidiaries if the guarantee ranks equally with or junior in right of
payment to the debentures.
Remarketing
Through a remarketing, the debentures held by the holders of units, other
than those electing not to participate in the remarketing, will be sold and the
proceeds used to purchase U.S. treasury securities, which will be pledged to
secure the unitholders' obligations under the purchase contracts. Cash payments
received on the pledged treasury securities will be used to satisfy the
unitholders' obligations to purchase our common stock on November 15, 2004.
Unless a holder elects not to participate in the remarketing by delivering
treasury securities to secure its obligations under the purchase contract, or
unless the remarketing agent delays the remarketing to a later date, the
debentures will be sold in a remarketing on August 15, 2004.
Settlement
The settlement rate is the number of newly issued shares of our common stock
that we are obligated to sell and the holders are obligated to buy upon
settlement of a purchase contract on November 15, 2004. The settlement rate for
each purchase contract will be as follows, subject to adjustment under
specified circumstances:
. if the applicable market value of our common stock is equal to or
greater than the threshold appreciation price (which is equal to 122% of
the initial public offering price of our common stock (which initial
public offering price we refer to herein as the reference price)), the
settlement rate will be equal to $50 divided by the threshold
appreciation price per purchase contract;
143
. if the applicable market value of our common stock is less than the
threshold appreciation price but greater than the reference price, the
settlement rate will be equal to $50 divided by the applicable market
value of our common stock per purchase contract; and
. if the applicable market value of our common stock is less than or equal
to the reference price, the settlement rate will be equal to $50 divided
by the reference price per purchase contract.
The "applicable market value" means the average of the closing price per
share of our common stock on each of the twenty consecutive trading days ending
on the third trading day preceding November 15, 2004.
In addition to the remarketing, the holder's obligations under the purchase
contract may be satisfied:
. if the holder has elected not to participate in the remarketing by
delivering treasury securities to secure its obligations under the
purchase contract, and in certain other circumstances, through the
application of the cash payments received on the treasury securities;
. through the early delivery of cash to the purchase contract agent in the
manner described in the purchase contracts; and
. if we are involved in a merger prior to the stock purchase date in which
at least 30% of the consideration for our common stock consists of cash
or cash equivalents, through an early settlement as described in the
purchase contracts.
In addition, the purchase contracts, our related rights and obligations and
those of the holders of the units, including their obligations to purchase
common stock, will automatically terminate upon the occurrence of particular
events of our bankruptcy, insolvency or reorganization. Upon termination, the
debentures or treasury securities pledged to secure the holder's obligations
under the purchase contract will be released and distributed to the holder.
Listing
The units have been approved for listing on the New York Stock Exchange,
subject to official notice of issuance, under the symbol "ATV."
Accounting Treatment
The purchase contracts are forward transactions in our common stock. Upon
settlement of a purchase contract, we will receive $50 on that purchase
contract and will issue the requisite number of shares of Anthem, Inc. common
stock. The $50 we receive will be credited to shareholders' equity and
allocated between the common stock and additional paid-in-capital accounts.
Before settlement of the purchase contracts through the issuance of common
stock, the units will be reflected in our diluted earnings per share
calculations using the treasury stock method. Under this method, the number of
shares of our common stock used in calculating earnings per share for any
period will be deemed to be increased by the excess, if any, of the number of
our shares that would be required to be issued upon settlement of the purchase
contracts over the number of shares that could be purchased by us in the
market, at the average market price during that period, using the proceeds that
would be required to be paid upon settlement. Consequently, there will be no
dilutive effect on our earnings per share, except during periods when the
average market price of our common stock is above $43.92 per share.
144
CERTAIN UNITED STATES TAX CONSEQUENCES
TO NON-U.S. HOLDERS OF COMMON STOCK
This section summarizes certain United States federal income and estate tax
consequences of the ownership and disposition of common stock by a non-U.S.
holder. You are a non-U.S. holder if you are, for United States federal income
tax purposes:
. a nonresident alien individual;
. a foreign corporation;
. a foreign partnership; or
. an estate or trust that in either case is not subject to United States
federal income tax on a net income basis on income or gain from common
stock.
This section does not consider the specific facts and circumstances that may
be relevant to a particular non-U.S. holder and does not address the treatment
of a non-U.S. holder under the laws of any state, local or foreign taxing
jurisdiction. This section is based on the tax laws of the United States,
including the Internal Revenue Code of 1986, as amended, existing and proposed
regulations, and administrative and judicial interpretations, all as currently
in effect. These laws are subject to change, possibly on a retroactive basis.
You should consult a tax advisor regarding the United States
federal tax consequences of acquiring, holding and disposing of
common stock in your particular circumstances, as well as any tax
consequences that may arise under the laws of any state, local or
foreign taxing jurisdiction.
Dividends
Except as described below, if you are a non-U.S. holder of common stock,
dividends paid to you are subject to withholding of United States federal
income tax at a 30% rate or at a lower rate if you are eligible for the
benefits of an income tax treaty that provides for a lower rate. Even if you
are eligible for a lower treaty rate, we and other payors will generally be
required to withhold at a 30% rate (rather than the lower treaty rate) on
dividend payments to you, unless you have furnished to us or another payor:
. a valid Internal Revenue Service Form W-8BEN or an acceptable substitute
form upon which you certify, under penalties of perjury, your status as
a non-United States person and your entitlement to the lower treaty rate
with respect to such payments; or
. in the case of payments made outside the United States to an offshore
account (generally, an account maintained by you at an office or branch
of a bank or other financial institution at any location outside the
United States), other documentary evidence establishing your entitlement
to the lower treaty rate in accordance with U.S. Treasury regulations.
If you are eligible for a reduced rate of United States withholding tax
under a tax treaty, you may obtain a refund of any amounts withheld in excess
of that rate by filing a refund claim with the United States Internal Revenue
Service.
If dividends paid to you are "effectively connected" with your conduct of a
trade or business within the United States, and, if required by a tax treaty,
the dividends are attributable to a permanent establishment that you maintain
in the United States, we and other payors generally are not required
145
to withhold tax from the dividends, provided that you have furnished to us or
another payor a valid Internal Revenue Service Form W-8ECI or an acceptable
substitute form upon which you represent, under penalties of perjury, that:
. you are a non-United States person; and
. the dividends are effectively connected with your conduct of a trade or
business within the United States and are includible in your gross
income.
"Effectively connected" dividends are taxed at rates applicable to United
States citizens, resident aliens and domestic United States corporations.
If you are a corporate non-U.S. holder, "effectively connected" dividends
that you receive may, under certain circumstances, be subject to an additional
"branch profits tax" at a 30% rate or at a lower rate if you are eligible for
the benefits of an income tax treaty that provides for a lower rate.
Gain on Disposition of Anthem, Inc. Common Stock
If you are a non-U.S. holder, you generally will not be subject to United
States federal income tax on gain that you recognize on a disposition of common
stock unless:
. the gain is "effectively connected" with your conduct of a trade or
business in the United States, and the gain is attributable to a
permanent establishment that you maintain in the United States, if that
is required by an applicable income tax treaty as a condition for
subjecting you to United States taxation on a net income basis;
. you are an individual, you hold the common stock as a capital asset, you
are present in the United States for 183 or more days in the taxable
year of the sale and certain other conditions exist; or
. we are or have been a United States real property holding corporation
for federal income tax purposes and you held, directly or indirectly, at
any time during the five-year period ending on the date of disposition,
more than 5% of the common stock and you are not eligible for any treaty
exemption.
If you are a corporate non-U.S. holder, "effectively connected" gains that
you recognize may also, under certain circumstances, be subject to an
additional "branch profits tax" at a 30% rate or at a lower rate if you are
eligible for the benefits of an income tax treaty that provides for a lower
rate.
We have not been, are not and do not anticipate becoming a United States
real property holding corporation for United States federal income tax
purposes.
Federal Estate Taxes
Common stock held by a non-U.S. holder at the time of death will be included
in the holder's gross estate for United States federal estate tax purposes,
unless an applicable estate tax treaty provides otherwise.
Backup Withholding and Information Reporting
If you are a non-U.S. holder, you are generally exempt from backup
withholding and information reporting requirements with respect to:
. dividend payments; and
. the payment of the proceeds from the sale of common stock effected at a
United States office of a broker,
146
as long as the income associated with such payments is otherwise exempt from
United States federal income tax, and:
. the payor or broker does not have actual knowledge or reason to know
that you are a United States person and you have furnished to the payor
or broker:
. a valid Internal Revenue Service Form W-8BEN or an acceptable
substitute form upon which you certify, under penalties of perjury,
that you are a non-United States person, or
. other documentation upon which it may rely to treat the payments as
made to a non-United States person in accordance with U.S. Treasury
regulations; or
. you otherwise establish an exemption.
Payment of the proceeds from the sale of common stock effected at a foreign
office of a broker generally will not be subject to information reporting or
backup withholding. However, a sale of common stock that is effected at a
foreign office of a broker will be subject to information reporting and backup
withholding if:
. the proceeds are transferred to an account maintained by you in the
United States;
. the payment of proceeds or the confirmation of the sale is mailed to you
at a United States address; or
. the sale has some other specified connection with the United States as
provided in U.S. Treasury regulations,
unless the broker does not have actual knowledge or reason to know that you are
a United States person and the documentation requirements described above are
met or you otherwise establish an exemption.
In addition, a sale of common stock will be subject to information reporting
(but not backup withholding) if it is effected at a foreign office of a broker
that is:
. a United States person;
. a controlled foreign corporation for United States tax purposes;
. a foreign person 50% or more of whose gross income is effectively
connected with the conduct of a United States trade or business for a
specified three-year period; or
. a foreign partnership, if at any time during its tax year:
. one or more of its partners are "U.S. persons", as defined in U.S.
Treasury regulations, who in the aggregate hold more than 50% of the
income or capital interest in the partnership, or
. such foreign partnership is engaged in the conduct of a United
States trade or business,
unless the broker does not have actual knowledge or reason to know that you are
a United States person and the documentation requirements described above are
met or you otherwise establish an exemption. Backup withholding will apply if
the sale is subject to information reporting and the broker has actual
knowledge that you are a United States person.
You generally may obtain a refund of any amounts withheld under the backup
withholding rules that exceed your income tax liability by filing a refund
claim with the Internal Revenue Service.
147
UNDERWRITING
Anthem, Inc., Anthem Insurance and the underwriters named below (the
"Underwriters") have entered into an underwriting agreement with respect to the
shares being offered. Subject to certain conditions, each Underwriter has
severally agreed to purchase the number of shares indicated in the following
table. Goldman, Sachs & Co., Merrill Lynch, Pierce, Fenner & Smith
Incorporated, Morgan Stanley & Co. Incorporated, J.P. Morgan Securities Inc.,
Banc of America Securities LLC, Credit Suisse First Boston Corporation, Lehman
Brothers Inc., UBS Warburg LLC, ABN AMRO Rothschild LLC, Dresdner Kleinwort
Wasserstein Securities LLC, A.G. Edwards & Sons, Inc., McDonald Investments
Inc. and Utendahl Capital Partners, L.P. are the representatives of the
Underwriters.
Underwriters Number of Shares
------------ ----------------
Goldman, Sachs & Co. .......................................... 15,367,600
Merrill Lynch, Pierce, Fenner & Smith
Incorporated.................................................. 6,403,200
Morgan Stanley & Co. Incorporated.............................. 6,403,200
J.P. Morgan Securities Inc. ................................... 2,475,900
Banc of America Securities LLC................................. 2,475,900
Credit Suisse First Boston Corporation......................... 2,475,900
Lehman Brothers Inc. .......................................... 2,475,900
UBS Warburg LLC................................................ 2,475,900
ABN AMRO Rothschild LLC........................................ 426,900
Dresdner Kleinwort Wasserstein Securities LLC.................. 426,900
A.G. Edwards & Sons, Inc. ..................................... 426,900
McDonald Investments Inc. ..................................... 426,900
Utendahl Capital Partners, L.P. ............................... 426,900
BNY Capital Markets, Inc. ..................................... 294,000
Dain Rauscher Incorporated..................................... 294,000
Epoch Securities, Inc. ........................................ 294,000
First Union Securities, Inc. .................................. 294,000
Edward D. Jones & Co., L.P. ................................... 294,000
Keefe, Bruyette & Woods, Inc. ................................. 294,000
Prudential Securities Incorporated............................. 294,000
Sandler O'Neill & Partners, L.P. .............................. 294,000
SunTrust Capital Markets, Inc. ................................ 294,000
Wells Fargo Van Kasper, LLC. .................................. 294,000
Advest, Inc. .................................................. 168,000
Robert W. Baird & Co. Incorporated............................. 168,000
William Blair & Company, L.L.C. ............................... 168,000
Blaylock & Partners, L.P. ..................................... 168,000
Dowling & Partners Securities, LLC............................. 168,000
C.L. King & Associates, Inc. .................................. 168,000
Legg Mason Wood Walker, Incorporated........................... 168,000
Loop Capital Markets, LLC...................................... 168,000
Melvin Securities, L.L.C. ..................................... 168,000
NatCity Investments, Inc. ..................................... 168,000
Neuberger Berman, LLC.......................................... 168,000
Ramirez & Co., Inc. ........................................... 168,000
Stephens Inc. ................................................. 168,000
Stifel, Nicholaus & Company, Incorporated...................... 168,000
May Davis Group, Inc. ......................................... 20,000
----------
Total........................................................ 48,000,000
==========
148
The consummation of the offering of the shares is conditioned on the
consummation of the demutualization.
If the Underwriters sell more shares than the total number set forth in the
table above, the Underwriters have an option to buy, at the initial public
offering price less the underwriting discount, up to an additional 7,200,000
shares from Anthem, Inc. to cover such sales. They may exercise that option for
30 days. If any shares are purchased pursuant to this option, the Underwriters
will severally purchase shares in approximately the same proportion as set
forth in the table above.
The following table shows the per share and total underwriting discounts and
commissions to be paid to the Underwriters by Anthem, Inc. Such amounts are
shown assuming both no exercise and full exercise of the Underwriters' option
to purchase 7,200,000 additional shares.
Paid by Anthem, Inc. No Exercise Full Exercise
-------------------- ----------- -------------
Per Share............................................. $ 1.656 $ 1.656
Total................................................. $79,488,000 $91,411,200
A prospectus in electronic format may be made available on the web sites
maintained by one or more Underwriters or by third parties with whom one or
more Underwriters have arrangements in place to host the prospectus. The
Underwriters may agree to allocate a number of shares to Underwriters for sale
to their online brokerage account holders. Internet distributions will be
allocated by the lead managers to Underwriters that may make Internet
distributions on the same basis as other allocations.
Shares sold by the Underwriters to the public will initially be offered at
the initial public offering price set forth on the cover of this prospectus.
Any shares sold by the Underwriters to securities dealers may be sold at a
discount of up to $1.00 per share from the initial public offering price. Any
such securities dealers may resell any shares purchased from the Underwriters
to certain other brokers or dealers at a discount of up to $0.10 per share from
the initial public offering price. If all the shares are not sold at the
initial public offering price, the representatives may change the offering
price and the other selling terms.
Anthem, Inc. has agreed with the Underwriters not to dispose of or hedge any
of its common stock or securities convertible into or exchangeable for shares
of common stock (other than the equity security units to be offered and sold
concurrently with this offering) during the period from the date of this
prospectus continuing through the date 180 days after the date of this
prospectus, except with the prior written consent of the representatives. This
agreement does not apply to any existing employee benefit plans. See "Common
Stock Eligible for Future Sale" for a discussion of certain transfer
restrictions.
Prior to the demutualization and this offering, there has been no public
market for the shares. The initial public offering price has been negotiated
among Anthem, Inc. and the representatives. Among the factors considered in
determining the initial public offering price of the shares, in addition to
prevailing market conditions, were Anthem's historical performance, estimates
of our business potential and earnings prospects, an assessment of our
management and the consideration of the above factors in relation to market
valuation of companies in related businesses.
The common stock has been approved for listing, upon official notice of
issuance, on the New York Stock Exchange under the symbol "ATH". In order to
meet one of the requirements for listing the common stock on the NYSE, the
Underwriters have undertaken to sell lots of 100 or more shares to a minimum of
2,000 beneficial holders.
In connection with the offering, the Underwriters may purchase and sell
shares of common stock in the open market. These transactions may include short
sales, stabilizing transactions and
149
purchases to cover positions created by short sales. Shorts sales involve the
sale by the Underwriters of a greater number of shares than they are required
to purchase in the offering. "Covered" short sales are sales made in an amount
not greater than the Underwriters' option to purchase additional shares from
Anthem, Inc. in the offering. The Underwriters may close out any covered short
position by either exercising their option to purchase additional shares or
purchasing shares in the open market. In determining the source of shares to
close out the covered short position, the underwriters will consider, among
other things, the price of shares available for purchase in the open market as
compared to the price at which they may purchase shares through the over-
allotment option. "Naked" short sales are any sales in excess of such option.
The Underwriters must close out any naked short position by purchasing shares
in the open market. A naked short position is more likely to be created if the
Underwriters are concerned that there may be downward pressure on the price of
the common stock in the open market after pricing that could adversely affect
investors who purchase in the offering. Stabilizing transactions consist of
various bids for or purchases of common stock made by the Underwriters in the
open market prior to the completion of the offering.
The Underwriters may also impose a penalty bid. This occurs when a
particular Underwriter repays to the Underwriters a portion of the underwriting
discount received by it because the representatives have repurchased shares
sold by or for the account of such underwriter in stabilizing or short covering
transactions.
Purchases to cover a short position and stabilizing transactions may have
the effect of preventing or retarding a decline in the market price of Anthem,
Inc.'s common stock, and together with the imposition of the penalty bid, may
stabilize, maintain or otherwise affect the market price of the common stock.
As a result, the price of the common stock may be higher than the price that
otherwise might exist in the open market. If these activities are commenced,
they may be discontinued at any time. These transactions may be effected on the
NYSE, in the over-the-counter market or otherwise.
The Underwriters do not expect sales to discretionary accounts to exceed
five percent of the total number of shares offered.
Each Underwriter has represented and agreed that (1) it has not offered or
sold and prior to the date six months after the date of issue of the shares
will not offer or sell any shares to persons in the United Kingdom, except to
persons whose ordinary activities involve in them in acquiring, holding,
managing or disposing of investments (as principal or agent) for the purposes
of their businesses or otherwise in circumstances that have not resulted and
will not result in an offer to the public in the United Kingdom within the
meaning of the Public Offers of Securities Regulations 1995; (2) it has
complied, and will comply with, all applicable provisions of the Financial
Services Act 1986 of Great Britain with respect to anything done by it in
relation to the shares in, from or otherwise involving the United Kingdom; and
(3) it has only issued or passed on and will only issue or pass on in the
United Kingdom any document received by it in connection with the issuance of
the shares to a person who is of a kind described in Article 11(3) of the
Financial Services Act 1986 (Investment Advertisements) (Exemptions) Order 1996
of Great Britain or is a person to whom the document may lawfully be issued or
passed on.
Each Underwriter has acknowledged and agreed that the shares have not been
registered under the Securities and Exchange Law of Japan and are not being
offered or sold and may not be offered or sold, directly or indirectly, in
Japan or to or for the account of any resident of Japan, except (i) pursuant to
an exemption from the registration requirements of the Securities and Exchange
Law of Japan and (ii) in compliance with any other applicable requirements of
Japanese law. As part of the offering, the Underwriters may offer shares in
Japan to a list of 49 offerees in accordance with the above provisions.
150
The shares may not be offered, sold, transferred or delivered in or from The
Netherlands, as part of their initial distribution or as part of any re-
offering, and neither this prospectus nor any other document in respect of the
offering may be distributed or circulated in The Netherlands, other than to
individuals or legal entities which include, but are not limited to, banks,
brokers, dealers, institutional investors and undertakings with a treasury
department, who or which trade or invest in securities in the conduct of a
business or profession.
Each of the Underwriters has agreed that it has not and will not offer or
sell any shares or distribute any document or other material relating to the
shares, either directly or indirectly, to the public or any member of the
public in Singapore other than (i) to an institutional investor or other person
specified in Section 106C of the Companies Act, Chapter 50 of Singapore (the
"Singapore Companies Act") or (ii) to a sophisticated investor in accordance
with the conditions specified in Section 106D of the Singapore Companies Act or
(iii) otherwise pursuant to, and in accordance with the conditions of, any
other provision of the Singapore Companies Act.
Anthem, Inc. estimates that the total expenses of the offering, excluding
underwriting discounts and commissions, will be approximately $10.0 million.
Anthem, Inc. and Anthem Insurance have agreed to indemnify the several
Underwriters against certain liabilities, including liabilities under the
Securities Act of 1933.
Certain of the Underwriters or their affiliates have provided from time to
time, and expect to provide in the future, investment and commercial banking
and financial advisory services to us and our affiliates in the ordinary course
of business, for which they have received and may continue to receive customary
fees and commissions. The lead managing underwriter, Goldman, Sachs & Co., is
currently acting as financial advisor to us in connection with the
demutualization and lead managing underwriter of the concurrent offering of the
units.
VALIDITY OF COMMON STOCK
The validity of the shares of our common stock that are being offered by
this prospectus will be passed upon for Anthem, Inc. by Baker & Daniels,
Indianapolis, Indiana, and for the Underwriters by Sullivan & Cromwell, New
York, New York. Sullivan & Cromwell will rely on the opinion of Baker & Daniels
as to all matters of Indiana law.
EXPERTS
Ernst & Young LLP, independent auditors, have audited our consolidated
financial statements at December 31, 2000 and 1999, and for each of the three
years in the period ended December 31, 2000, as set forth in their report. We
have included our consolidated financial statements in this prospectus and in
the registration statement in reliance on the report of Ernst & Young LLP,
given on their authority as experts in accounting and auditing.
Daniel J. McCarthy, FSA, MAAA, Dale S. Hagstrom, FSA, MAAA, and Robert H.
Dobson, FSA, MAAA, consulting actuaries associated with Milliman USA, Inc.,
have rendered an opinion, dated June 18, 2001, to our board of directors that
is included as Annex A to this prospectus. Such opinion is included herein in
reliance upon the authority of such actuaries as experts in actuarial matters
generally and in the application of actuarial concepts to insurance matters.
151
ANTHEM INSURANCE COMPANIES, INC.
CONSOLIDATED FINANCIAL STATEMENTS
CONTENTS
Page
-----
Audited Consolidated Financial Statements
Report of Independent Auditors......................................... F-2
Consolidated Balance Sheets as of December 31, 2000 and 1999........... F-3
Consolidated Statements of Income for the Years Ended December 31,
2000, 1999 and 1998................................................... F-4
Consolidated Statements of Policyholders' Surplus for the Years Ended
December 31, 2000, 1999 and 1998...................................... F-5
Consolidated Statements of Cash Flows for the Years Ended December 31,
2000, 1999 and 1998................................................... F-6
Notes to Consolidated Financial Statements............................. F-7
Selected Quarterly Financial Data (Unaudited).......................... F-28
Unaudited Consolidated Financial Statements
Consolidated Balance Sheet as of June 30, 2001......................... F-29
Consolidated Statements of Income for the Six Months Ended June 30,
2001 and 2000......................................................... F-30
Consolidated Statements of Policyholders' Surplus for the Six Months
Ended June 30, 2001 and 2000.......................................... F-31
Consolidated Statements of Cash Flows for the Six Months Ended June 30,
2001 and 2000......................................................... F-32
Notes to Consolidated Financial Statements............................. F-33
F-1
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Anthem Insurance Companies, Inc.
We have audited the accompanying consolidated balance sheets of Anthem
Insurance Companies, Inc. as of December 31, 2000 and 1999, and the related
consolidated statements of income, policyholders' surplus and cash flows for
each of the three years in the period ended December 31, 2000. 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 audits 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 Anthem
Insurance Companies, Inc. at December 31, 2000 and 1999, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 2000, in conformity with accounting principles
generally accepted in the United States.
/s/ Ernst & Young LLP
Indianapolis, Indiana
January 29, 2001,
except for Note 17, as to which
the date is June 18, 2001
F-2
ANTHEM INSURANCE COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
December 31
-----------------
2000 1999
-------- --------
(In Millions)
Assets
Current assets:
Investments available-for-sale, at fair value:
Fixed maturity securities................................ $3,048.2 $2,280.3
Equity securities........................................ 463.1 487.7
-------- --------
3,511.3 2,768.0
Cash and cash equivalents.................................. 203.3 204.4
Premium and self funded receivables........................ 477.5 388.1
Reinsurance receivables.................................... 105.1 179.7
Other receivables.......................................... 272.4 168.1
Income tax receivables..................................... 11.0 37.6
Other current assets....................................... 32.2 59.5
-------- --------
Total current assets......................................... 4,612.8 3,805.4
Other noncurrent investments................................. 18.0 15.8
Restricted cash and investments.............................. 89.6 99.6
Property and equipment....................................... 428.8 408.5
Goodwill and other intangible assets......................... 498.9 398.5
Other noncurrent assets...................................... 60.4 88.4
-------- --------
Total assets................................................. $5,708.5 $4,816.2
======== ========
Liabilities and policyholders' surplus
Liabilities
Current liabilities:
Policy liabilities:
Unpaid life, accident and health claims.................. $1,393.0 $1,145.5
Future policy benefits................................... 186.5 172.4
Other policyholder liabilities........................... 118.8 113.2
-------- --------
Total policy liabilities................................... 1,698.3 1,431.1
Unearned income............................................ 262.8 226.3
Accounts payable and accrued expenses...................... 262.7 178.6
Bank overdrafts............................................ 250.5 146.7
Income taxes payable....................................... 25.7 4.7
Other current liabilities.................................. 307.5 249.6
-------- --------
Total current liabilities.................................... 2,807.5 2,237.0
Long term debt, less current portion......................... 597.5 522.0
Retirement benefits.......................................... 175.1 181.2
Other noncurrent liabilities................................. 208.6 215.1
-------- --------
Total liabilities............................................ 3,788.7 3,155.3
Policyholders' surplus
Surplus...................................................... 1,848.6 1,622.6
Accumulated other comprehensive income....................... 71.2 38.3
-------- --------
Total policyholders' surplus................................. 1,919.8 1,660.9
-------- --------
Total liabilities and policyholders' surplus................. $5,708.5 $4,816.2
======== ========
See accompanying notes.
F-3
ANTHEM INSURANCE COMPANIES, INC.
CONSOLIDATED STATEMENTS OF INCOME
Year ended December 31,
---------------------------
2000 1999 1998
-------- -------- --------
(In Millions)
Revenues
Premiums......................................... $7,737.3 $5,418.5 $4,739.5
Administrative fees.............................. 755.6 611.1 575.6
Other revenue.................................... 50.6 51.0 74.6
-------- -------- --------
Total operating revenue........................ 8,543.5 6,080.6 5,389.7
Net investment income............................ 201.6 152.0 136.8
Net realized gains on investments................ 25.9 37.5 155.9
-------- -------- --------
8,771.0 6,270.1 5,682.4
-------- -------- --------
Expenses
Benefit expense.................................. 6,551.0 4,582.7 3,934.2
Administrative expense........................... 1,808.4 1,469.4 1,420.1
Interest expense................................. 54.7 30.4 27.9
Amortization of goodwill and other intangible
assets.......................................... 27.1 12.7 12.0
Endowment of non-profit foundations.............. -- 114.1 --
-------- -------- --------
8,441.2 6,209.3 5,394.2
-------- -------- --------
Income from continuing operations before income
taxes and minority interest..................... 329.8 60.8 288.2
Income taxes..................................... 102.2 10.2 110.9
Minority interest (credit)....................... 1.6 (0.3) (1.1)
-------- -------- --------
Income from continuing operations................ 226.0 50.9 178.4
Discontinued operations, net of income taxes
Loss from discontinued operations prior to
disposal........................................ -- -- (3.9)
Loss on disposal of discontinued operations...... -- (6.0) (2.1)
-------- -------- --------
Net income....................................... $ 226.0 $ 44.9 $ 172.4
======== ======== ========
See accompanying notes.
F-4
ANTHEM INSURANCE COMPANIES, INC.
CONSOLIDATED STATEMENTS OF POLICYHOLDERS' SURPLUS
Accumulated
Other Total
Comprehensive Policyholders'
Surplus Income Surplus
-------- ------------- --------------
(In Millions)
Balance at December 31, 1997............ $1,405.3 $119.4 $1,524.7
Net income.............................. 172.4 -- 172.4
Change in net unrealized gains on
securities............................. -- 5.4 5.4
--------
Comprehensive income.................... 177.8
-------- ------ --------
Balance at December 31, 1998............ 1,577.7 124.8 1,702.5
Net income.............................. 44.9 -- 44.9
Change in net unrealized gains on
securities............................. -- (88.5) (88.5)
Change in additional minimum pension
liability.............................. -- 2.0 2.0
--------
Comprehensive loss...................... (41.6)
-------- ------ --------
Balance at December 31, 1999............ 1,622.6 38.3 1,660.9
Net income.............................. 226.0 -- 226.0
Change in net unrealized gains on
securities............................. -- 36.8 36.8
Change in additional minimum pension
liability.............................. -- (3.9) (3.9)
--------
Comprehensive income.................... 258.9
-------- ------ --------
Balance at December 31, 2000............ $1,848.6 $ 71.2 $1,919.8
======== ====== ========
See accompanying notes.
F-5
ANTHEM INSURANCE COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31
-------------------------------
2000 1999 1998
--------- --------- ---------
(In Millions)
Operating activities
Net income.................................... $ 226.0 $ 44.9 $ 172.4
Adjustments to reconcile net income to net
cash provided by operating activities:
Realized gains on investments............... (25.9) (37.5) (155.9)
Depreciation, amortization and accretion.... 102.1 61.8 58.3
Deferred income taxes....................... 36.6 23.0 32.0
Loss from discontinued operations........... -- 6.0 6.0
Loss on sale of assets...................... 0.5 0.2 2.6
Changes in operating assets and liabilities,
net of effect of purchases and
divestitures:
Restricted cash and investments........... 10.0 (2.1) 93.7
Receivables............................... (70.7) 6.0 (76.8)
Other assets.............................. 25.3 80.7 (31.4)
Policy liabilities........................ 124.1 105.6 (40.3)
Unearned income........................... 22.3 15.9 22.8
Accounts payable and accrued expenses..... 69.9 (7.5) 27.2
Other liabilities......................... 119.0 (40.1) 23.3
Income taxes.............................. 47.5 (20.4) 10.1
--------- --------- ---------
Net cash provided by continuing operations.. 686.7 236.5 144.0
Net cash used in discontinued operations ... (2.2) (16.7) (24.1)
--------- --------- ---------
Cash provided by operating activities......... 684.5 219.8 119.9
Investing activities
Purchases of investments...................... (3,544.8) (2,331.1) (3,286.8)
Sales or maturities of investments............ 2,925.2 2,308.3 3,217.2
Purchases of subsidiaries, net of cash
acquired..................................... (85.1) (246.8) (35.2)
Sales of subsidiaries, net of cash sold....... 5.4 2.3 79.3
Proceeds from sale of property and equipment.. 11.5 7.2 5.9
Purchases of property and equipment........... (73.3) (96.7) (89.2)
--------- --------- ---------
Cash used in investing activities............. (761.1) (356.8) (108.8)
Financing activities
Proceeds from borrowings...................... 295.9 220.1 0.4
Payments on borrowings........................ (220.4) -- (4.2)
--------- --------- ---------
Cash provided by (used in) financing
activities................................... 75.5 220.1 (3.8)
--------- --------- ---------
Change in cash and cash equivalents........... (1.1) 83.1 7.3
Cash and cash equivalents at beginning of
year......................................... 204.4 121.3 114.0
--------- --------- ---------
Cash and cash equivalents at end of year...... $ 203.3 $ 204.4 $ 121.3
========= ========= =========
See accompanying notes.
F-6
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000
(Dollars in Millions)
1. Basis of Presentation and Significant Accounting Policies
Basis of Presentation: The accompanying consolidated financial statements of
Anthem Insurance Companies, Inc. ("Anthem"), a mutual insurance company, and
its subsidiaries (collectively, the "Company") have been prepared in conformity
with generally accepted accounting principles. All significant intercompany
accounts and transactions have been eliminated in consolidation. Anthem or its
subsidiary insurance companies are licensed in all states and are Blue Cross
Blue Shield Association licensees in Indiana, Kentucky, Ohio, Connecticut,
Maine, New Hampshire, Colorado and Nevada. Products include health and group
life insurance, managed health care, and government health program
administration.
Minority interest represents other shareholders' interests in subsidiaries,
which are majority-owned by Anthem, or its subsidiaries.
Use of Estimates: Preparation of the consolidated financial statements
requires management to make estimates and assumptions that affect the amounts
reported in the consolidated financial statements and accompanying notes.
Actual results could differ from those estimates.
Investments: All fixed maturity and equity securities are classified as
"available-for-sale" securities and investments in equity securities that have
readily determinable fair values and all fixed maturity securities are reported
at fair value. The Company has determined that all investments in its portfolio
are available to support current operations and, accordingly, has classified
such investment securities as current assets. The unrealized gains or losses on
these securities are included in accumulated other comprehensive income as a
separate component of policyholders' surplus unless the decline in value is
deemed to be other than temporary, in which case the loss is charged to income.
Realized gains or losses, determined by specific identification of
investments sold, are included in income.
Cash Equivalents: All highly liquid investments with maturities of three
months or less when purchased are classified as cash equivalents.
Premium and Self Funded Receivables: Premium and self funded receivables
include the uncollected amounts for insured and self funded groups, less an
allowance for doubtful accounts of $35.1 and $38.7 as of December 31, 2000 and
1999, respectively.
Reinsurance Receivables: Reinsurance receivables represent amounts
recoverable on claims paid or incurred, and amounts paid to the reinsurer for
premiums collected but not yet earned, and are estimated in a manner consistent
with the liabilities associated with the reinsured policies. These receivables
have been reduced by an allowance for uncollectible amounts of $0.0 and $1.7 as
of December 31, 2000 and 1999, respectively.
Other Receivables: Other receivables include amounts for interest earned on
investments, government programs, pharmacy sales and other miscellaneous
amounts due to the Company. These receivables have been reduced by an allowance
for uncollectible amounts of $33.4 and $29.4 as of December 31, 2000 and 1999,
respectively.
F-7
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Restricted Cash and Investments: Restricted cash and investments represent
fiduciary amounts held under an insurance contract and other agreements.
Property and Equipment: Property and equipment is recorded at cost.
Depreciation is computed principally by the straight-line method over the
estimated useful lives of the assets.
Goodwill and Other Intangible Assets: Goodwill represents the excess of cost
of acquisition over the fair value of net assets acquired. Other intangible
assets represent the values assigned to non-compete agreements, and licenses
and agreements. Goodwill and other intangible assets are amortized using the
straight-line method over periods ranging from two to 20 years.
Accumulated amortization of goodwill and other intangible assets at December
31, 2000 and 1999 was $58.4 and $27.3, respectively.
The carrying value of goodwill and other intangible assets is reviewed
annually to determine if the facts and circumstances indicate that they may be
impaired. The carrying value of these assets is reduced to its fair value if
this review, which includes comparison of asset carrying amounts to expected
cash flows, indicates that such amounts will not be recoverable.
Policy Liabilities: Liabilities for unpaid claims include estimated
provisions for both reported and unreported claims incurred on an undiscounted
basis. The liabilities are adjusted regularly based on historical experience
and include estimates of trends in claim severity and frequency and other
factors, which could vary as the claims are ultimately settled. Although it is
not possible to measure the degree of variability inherent in such estimates,
management believes these liabilities are adequate.
The life future policy benefit liabilities represent primarily group term
benefits determined using standard industry mortality tables with interest
rates ranging from 3.0% to 5.5%.
Premium deficiency losses are recognized when it is probable that expected
claims expenses will exceed future premiums on existing health and other
insurance contracts without consideration of investment income. For purposes of
premium deficiency losses, contracts are grouped in a manner consistent with
the Company's method of acquiring, servicing and measuring the profitability of
such contracts.
Retirement Benefits: Retirement benefits represent outstanding obligations
for retiree health, life and dental benefits and any unfunded liability related
to defined benefit pension plans.
Comprehensive Income: Comprehensive income includes net income, the change
in unrealized gains (losses) on investments and the change in the additional
minimum pension liability.
Revenue Recognition: Gross premiums for fully insured contracts are prorated
over the term of the contracts, with the unearned premium representing the
unexpired term of policies. For insurance contracts with retrospective rated
premiums, the estimated ultimate premium is recognized as revenue over the
period of the contract. Actual experience is reviewed once the policy period is
completed and adjustments are recorded when determined. Premium rates for
certain lines of business are subject to approval by the Department of
Insurance of each respective state.
Administrative fees include revenue from certain groups contracts that
provide for the group to be at risk for all, or with supplemental insurance
arrangements, a portion of their claims experience. The Company charges self-
funded groups an administrative fee which is based on the number of
F-8
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
members in a group or the group's claim experience. Under the Company's self-
funded arrangements, amounts due are recognized based on incurred claims paid
plus administrative and other fees. In addition, administrative fees include
amounts received for the administration of Medicare or certain other government
programs. Administrative fees are recognized in accordance with the terms of
the contractual relationship between the Company and the customer. Such fees
are based on a percentage of the claim amounts processed or a combination of a
fixed fee per claim plus a percentage of the claim amounts processed. All
benefit payments under these programs are excluded from benefit expenses.
Other revenue principally includes amounts from the sales of prescription
drugs and revenues are recognized as prescription drug orders are delivered or
shipped.
Federal Income Taxes: Anthem files a consolidated return with its
subsidiaries that qualify as defined by the Internal Revenue Code.
Reclassifications: Certain prior year balances have been reclassified to
conform to the current year presentation.
2. Acquisitions, Divestitures and Discontinued Operations
Acquisitions:
2000
On June 5, 2000, the Company completed its purchase of substantially all of
the assets and liabilities of Associated Hospital Service of Maine, formerly
d/b/a Blue Cross and Blue Shield of Maine ("BCBS-ME"), in accordance with the
Asset Purchase Agreement dated July 13, 1999. The purchase price was $95.4
(including direct costs of acquisition) and resulted in $92.6 of goodwill and
other intangible assets which are being amortized over periods which range from
ten to 20 years. The application of purchase accounting for this acquisition is
subject to further refinement based on final valuation studies and post-closing
adjustments in certain circumstances. This acquisition was accounted for as a
purchase and the net assets and results of operations have been included in the
Company's consolidated financial statements from the purchase date. The pro
forma effects of the BCBS-ME acquisition would not be material to the Company's
consolidated results of operations for periods preceding the purchase date.
1999
On October 27, 1999, the Company completed its purchase of the assets and
liabilities of New Hampshire-Vermont Health Services, formerly d/b/a Blue Cross
Blue Shield of New Hampshire ("BCBS-NH"), in accordance with the Asset Purchase
Agreement entered into on February 19, 1999. The purchase price was $125.4
(including direct costs of acquisition), which resulted in $107.9 of goodwill
and other intangible assets which are being amortized over periods which range
from two to 20 years.
On November 16, 1999, the Company completed its purchase of the stock of
Rocky Mountain Hospital and Medical Service, formerly d/b/a Blue Cross and Blue
Shield of Colorado and Blue Cross and Blue Shield of Nevada ("BCBS-CO/NV"). The
purchase price was $160.7 (including direct costs of acquisition) and resulted
in $152.1 of goodwill and other intangible assets which are being amortized
over periods which range from five to 20 years.
F-9
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
These acquisitions were accounted for as purchases and the net assets and
results of operations have been included in the Company's consolidated
financial statements from the respective purchase dates. During 2000, purchase
price allocations for these acquisitions were refined based on final valuation
studies resulting in increases to goodwill and other intangible assets of
$33.8.
Unaudited pro forma results of operations assuming the 1999 acquisitions
occurred on January 1, 1999 would have resulted in total revenues of $7,186.4,
income from continuing operations of $83.3 and net income of $5.5 for 1999,
respectively.
1998
During 1998, the Company made acquisitions with purchase prices aggregating
$35.2. All acquisitions were accounted for as purchases and the purchase prices
were allocated to the assets and liabilities of the acquired entities based
upon their estimated fair values. The total purchase price for these
acquisitions exceeded the fair value of the net tangible assets acquired by
approximately $28.3, which was assigned to goodwill and other intangible assets
and are being amortized over periods not to exceed 20 years. The pro forma
effects of these acquisitions are insignificant to the Company's consolidated
results of operations.
Divestitures:
1999
During 1999, the Company divested of several small business operations,
which were no longer deemed strategically aligned with the Company's core
business. The Company recognized a loss of $14.2 (net of income tax benefit of
$6.1) on these disposals. The pro forma effects of these divestitures are
insignificant to the consolidated results of operations.
Discontinued Operations:
1999
During 1999, the Company recognized additional losses of $6.0, net of income
tax benefit of $6.2, resulting from sales agreement contingency adjustments
relating to the discontinued operations sold in prior years.
1998
In March 1998, the Company made the decision to exit principally all of its
non-Blue Cross and Blue Shield health businesses as follows:
In May 1998 the Company principally completed its exit from its non-health
insurance related businesses through the sale of its durable medical equipment
business for $23.3, resulting in a gain of $12.9 (net of income tax expense of
$8.4).
In June 1998, the Company completed the sale of two of its HMO businesses
for $10.1 resulting in a gain of $3.3 (net of income tax expense of $1.8).
Further, in July 1998, the Company completed the sale of Anthem Health and Life
Insurance Company for $77.5 resulting in a gain of $1.1 (including income tax
benefit of $14.1). In September 1998, the Company made a provision of $10.4
F-10
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(net of income tax benefit of $3.4) for the estimated loss on the disposal of
its one remaining non-Blue Cross and Blue Shield health business.
During 1998, the Company disposed of its health finance and management
operations and its integrated health delivery operations resulting in a net
loss of $7.9 (including income tax expense of $2.7) greater than the reserve of
$43.2 (net of income tax benefit of $23.3) which was reported as discontinued
operations in 1997.
Additionally, during 1998 the Company recognized a loss of $1.1, with no
income tax benefit, relating to all other operations discontinued in 1997.
Operating results from discontinued operations prior to disposal in 1998
(none in 2000 or 1999), exclusive of the aforementioned provisions, were as
follows: operating revenues $190.8, loss before provision for income taxes
$(5.6) and loss from discontinued operations net of income taxes $(3.9).
3. Endowment of Non-Profit Foundations
During 1999, Anthem reached agreements with the states of Kentucky, Ohio and
Connecticut to resolve any questions as to whether Anthem or the
predecessor/successor entities were in possession of property that was
impressed with a charitable trust.
In 1999, contributions of $45.0, $28.0 and $41.1, respectively, were made
for the benefit of charitable foundations in Kentucky, Ohio, and Connecticut,
respectively, from Anthem's subsidiaries, Anthem Health Plans of Kentucky,
Inc., Community Insurance Company and Anthem Health Plans, Inc., respectively.
4. Investments
The following is a summary of available-for-sale securities:
Cost or Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
--------- ---------- ---------- --------
December 31, 2000
Fixed maturity securities:
United States Government
securities......................... $ 723.4 $ 25.6 $ (2.5) $ 746.5
Obligations of states and Political
subdivisions....................... 0.8 -- -- 0.8
Corporate securities................ 1,041.4 19.4 (20.1) 1,040.7
Mortgage-backed securities.......... 1,250.3 21.1 (13.0) 1,258.4
Preferred stocks.................... 1.9 -- (0.1) 1.8
-------- ------ ------- --------
Total fixed maturity securities....... 3,017.8 66.1 (35.7) 3,048.2
Equity securities..................... 376.2 162.0 (75.1) 463.1
-------- ------ ------- --------
$3,394.0 $228.1 $(110.8) $3,511.3
======== ====== ======= ========
F-11
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Cost or Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
--------- ---------- ---------- --------
December 31, 1999
Fixed maturity securities:
United States Government
securities......................... $ 550.1 $ 0.2 $ (29.3) $ 521.0
Obligations of states and political
subdivisions....................... 34.2 -- (2.1) 32.1
Corporate securities................ 816.8 0.4 (35.6) 781.6
Mortgage-backed securities.......... 975.3 0.9 (32.1) 944.1
Preferred stocks.................... 1.9 -- (0.4) 1.5
-------- ------ ------- --------
Total fixed maturity securities....... 2,378.3 1.5 (99.5) 2,280.3
Equity securities..................... 329.6 186.0 (27.9) 487.7
-------- ------ ------- --------
$2,707.9 $187.5 $(127.4) $2,768.0
======== ====== ======= ========
The amortized cost and fair value of fixed maturity securities at December
31, 2000, by contractual maturity, are shown below. Expected maturities may be
less than contractual maturities because the issuers of the securities may have
the right to prepay obligations without prepayment penalties.
Amortized Fair
Cost Value
--------- --------
Due in one year or less.................................. $ 48.2 $ 48.4
Due after one year through five years.................... 611.7 618.1
Due after five years through ten years................... 439.3 451.9
Due after ten years...................................... 666.4 669.6
-------- --------
1,765.6 1,788.0
Mortgage-backed securities............................... 1,250.3 1,258.4
Preferred stocks......................................... 1.9 1.8
-------- --------
$3,017.8 $3,048.2
======== ========
The major categories of net investment income are as follows:
Year ended December 31
-------------------------
2000 1999 1998
------- ------- -------
Fixed maturity securities......................... $ 178.8 $ 137.0 $ 121.1
Equity securities................................. 6.1 6.3 7.4
Cash, cash equivalents and other.................. 21.5 12.8 11.9
------- ------- -------
Investment revenue................................ 206.4 156.1 140.4
Investment expense................................ (4.8) (4.1) (3.6)
------- ------- -------
Net investment income............................. $ 201.6 $ 152.0 $ 136.8
======= ======= =======
Proceeds from sales of fixed maturity and equity securities during 2000,
1999 and 1998 were $2,911.8, $2,336.8 and $3,162.8, respectively. Gross gains
of $71.3, $86.8 and $175.3 and gross losses of $45.4, $49.3 and $19.4 were
realized in 2000, 1999 and 1998, respectively, on those sales.
F-12
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
5. Long Term Debt and Commitments
Debt consists of the following at December 31:
2000 1999
------ ------
Surplus notes at 9.00% due 2027.............................. $197.2 $197.0
Surplus notes at 9.125% due 2010............................. 295.5 --
Senior guaranteed notes at 6.75% due 2003.................... 99.5 99.3
Bank credit agreements....................................... -- 220.0
Other........................................................ 5.5 5.9
------ ------
Long term debt............................................... $597.7 $522.2
Current portion of long-term debt............................ (0.2) (0.2)
------ ------
Long-term debt, less current portion......................... $597.5 $522.0
====== ======
On January 28, 2000, Anthem issued $300.0 principal amount of 9.125% surplus
notes due April 1, 2010. On February 3, 2000, a portion of the proceeds was
used for repayment of the $220.0 outstanding under the revolving bank credit
agreement discussed below. The remainder of the proceeds was used for general
corporate purposes including the acquisition of BCBS-ME (see Note 2).
The Company has a $300.0 revolving credit agreement with a syndicate of
banks which is available for general corporate purposes and to support the
Company's commercial paper program. The facility matures in 2002. In 1999, the
Company borrowed $220.0 to facilitate the acquisitions of BCBS-NH and BCBS-
CO/NV as described in Note 2. No additional borrowings were made under this
credit agreement during 2000 and 1999 borrowings were paid in February 2000.
Availability under this facility is reduced by the amount of any commercial
paper outstanding.
The Company has a $300.0 commercial paper program available for general
corporate purposes. Commercial paper is sold through a dealer, in denominations
greater than $150 thousand dollars with a maturity not to exceed 270 days from
date of issuance, at then available market rates. Availability under the
commercial paper program is reduced by the amount of any borrowings outstanding
under the Company's revolving credit agreement. There were no commercial paper
notes outstanding at December 31, 2000 or 1999.
The Company must maintain certain financial covenants including limits on
minimum net worth, maximum consolidated debt, and maximum asset dispositions
annually.
Any payment of interest or principal on the surplus notes may be made only
with the prior approval of the Indiana Department of Insurance ("DOI"), and
only out of policyholders' surplus funds that the DOI determines to be
available for the payment under Indiana insurance laws. For statutory
accounting purposes, the surplus notes are considered a part of policyholders'
surplus.
Interest paid during 2000, 1999 and 1998 was $54.7, $28.2 and $28.0,
respectively.
Future maturities of debt are as follows: 2001, $0.2; 2002, $0.3; 2003,
$99.9; 2004, $1.4; 2005, $0.5 and thereafter $495.4.
F-13
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
6. Fair Value of Financial Instruments
Considerable judgment is required to develop estimates of fair value for
financial instruments. Accordingly, the estimates shown are not necessarily
indicative of the amounts that would be realized in a one time, current market
exchange of all of the financial instruments.
The carrying values and estimated fair values of certain financial
instruments are as follows at December 31:
2000 1999
----------------- -----------------
Carrying Fair Carrying Fair
Value Value Value Value
-------- -------- -------- --------
Fixed maturity securities............... $3,048.2 $3,048.2 $2,280.3 $2,280.3
Equity securities....................... 463.1 463.1 487.7 487.7
Restricted investments.................. 42.7 42.7 38.8 38.8
Debt.................................... 597.7 562.2 522.2 507.0
The carrying value of all other financial instruments approximates fair
value because of the relatively short period of time between the origination of
the instruments and their expected realization. Fair values for securities and
restricted investments are based on quoted market prices, where available. For
securities not actively traded, fair values are estimated using values obtained
from independent pricing services. The fair value of debt is estimated using
discounted cash flow analyses, based on the Company's current incremental
borrowing rates for similar types of borrowing arrangements.
7. Property and Equipment
Property and equipment includes the following at December 31:
2000 1999
------ ------
Land and improvements......................................... $ 21.0 $ 17.2
Building and components....................................... 251.3 222.2
Data processing equipment, furniture and other equipment...... 407.6 425.2
Leasehold improvements........................................ 37.2 39.2
------ ------
717.1 703.8
Less accumulated depreciation and amortization................ 288.3 295.3
------ ------
$428.8 $408.5
====== ======
Property and equipment includes non-cancelable capital leases of $7.4 and
$8.7 at December 31, 2000 and 1999, respectively. Total accumulated
amortization on these leases at December 31, 2000 and 1999 was $3.7 and $4.5,
respectively. The related lease amortization expense is included in
depreciation and amortization expense. Depreciation and leasehold improvement
amortization expense for 2000, 1999 and 1998 was $75.3, $47.1, and $43.7,
respectively.
F-14
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
8. Unpaid Life, Accident and Health Claims
The following table provides a reconciliation of the beginning and ending
balances for unpaid life, accident and health claims:
2000 1999 1998
-------- -------- --------
Balances at January 1, net of reinsurance....... $1,036.3 $ 734.6 $ 707.8
Business combinations........................... 113.9 190.4 --
Incurred related to:
Current year.................................. 6,611.1 4,608.9 3,960.0
Prior years................................... (60.1) (30.9) (32.8)
-------- -------- --------
Total incurred.................................. 6,551.0 4,578.0 3,927.2
-------- -------- --------
Paid related to:
Current year.................................. 5,381.2 3,785.1 3,245.4
Prior years................................... 956.0 681.6 655.0
-------- -------- --------
Total paid...................................... 6,337.2 4,466.7 3,900.4
-------- -------- --------
Balances at December 31, net of reinsurance..... 1,364.0 1,036.3 734.6
Reinsurance recoverables at December 31......... 29.0 109.2 92.2
-------- -------- --------
Reserve gross of reinsurance recoverables on
unpaid claims at December 31................... $1,393.0 $1,145.5 $ 826.8
======== ======== ========
Amounts incurred related to prior years vary from previously estimated
liabilities as the claims are ultimately settled. Negative amounts reported
for incurred related to prior years resulted from claims being settled for
amounts less than originally estimated.
9. Reinsurance
The Company reinsures certain of its risks with other companies and assumes
risk from other companies and such reinsurance is accounted for as a transfer
of risk. The Company is contingently liable for amounts recoverable from the
reinsurer in the event that it does not meet its contractual obligations.
The Company evaluates the financial condition of its reinsurers and
monitors concentrations of credit risk arising from similar geographic
regions, activities, or economic characteristics of the reinsurers to minimize
its exposure to significant losses from reinsurer insolvencies.
The details of net premiums written and earned are as follows for the years
ended December 31:
2000 1999 1998
------------------ ------------------ ------------------
Written Earned Written Earned Written Earned
-------- -------- -------- -------- -------- --------
Consolidated:
Direct........... $7,993.0 $7,961.5 $5,674.8 $5,693.7 $4,956.8 $4,945.6
Assumed.......... 0.7 1.9 23.9 26.9 12.4 11.6
Ceded............ (229.2) (226.1) (305.6) (302.1) (218.6) (217.7)
-------- -------- -------- -------- -------- --------
Net Premiums..... $7,764.5 $7,737.3 $5,393.1 $5,418.5 $4,750.6 $4,739.5
======== ======== ======== ======== ======== ========
F-15
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
2000 1999 1998
----------------- ----------------- -----------------
Written Earned Written Earned Written Earned
-------- -------- -------- -------- -------- --------
Reportable segments:
Midwest................ $4,240.4 $4,203.1 $3,708.6 $3,729.3 $3,554.4 $3,533.3
East................... 2,753.0 2,768.9 1,490.3 1,495.4 1,076.2 1,088.3
West................... 571.1 569.6 64.5 64.2 -- --
Specialty.............. 123.7 123.7 96.3 96.3 90.3 90.3
Other.................. 76.3 72.0 33.4 33.3 29.7 27.6
-------- -------- -------- -------- -------- --------
Total.................. $7,764.5 $7,737.3 $5,393.1 $5,418.5 $4,750.6 $4,739.5
======== ======== ======== ======== ======== ========
The effect of reinsurance on policyholder benefits is as follows for the
years ended December 31:
2000 1999 1998
------ ------ ------
Benefits assumed--increase in policyholder benefits
expense............................................. $ 8.6 $ 27.4 $ 2.5
Benefits ceded--decrease in policyholder benefits
expense............................................. 233.0 299.8 208.3
The effect of reinsurance on certain assets and liabilities is as follows at
December 31:
2000 1999
----- -----
Policy liabilities assumed...................................... $28.6 $30.6
Unearned premiums assumed....................................... 0.2 0.2
Premiums payable ceded.......................................... 8.5 36.3
Premiums receivable assumed..................................... 0.3 0.7
10. Income Taxes
The components of deferred income taxes are as follows:
December 31
----------------
2000 1999
------- -------
Deferred tax assets:
Pension and postretirement benefits..................... $ 84.7 $ 87.9
Accrued expenses........................................ 85.2 69.5
Alternative minimum tax and other credits............... 83.7 35.4
Insurance reserves...................................... 33.0 32.3
Net operating loss carryforwards........................ 174.5 57.4
Bad debt reserves....................................... 35.1 30.1
Other................................................... 31.5 24.1
------- -------
Total deferred tax assets............................. 527.7 336.7
Valuation allowance................................... (338.7) (148.2)
------- -------
Total deferred tax assets, net of valuation allowance... 189.0 188.5
Deferred tax liabilities:
Unrealized gains on securities.......................... 41.4 21.0
Goodwill and other tax intangibles...................... 55.1 57.7
Other................................................... 72.4 52.2
------- -------
Total deferred tax liabilities.......................... 168.9 130.9
------- -------
Net deferred tax asset.................................... $ 20.1 $ 57.6
======= =======
F-16
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The resolution of an Internal Revenue Service examination during 2000
resulted in certain subsidiaries having an increase in alternative minimum tax
credits and net operating loss carryforwards. Due to the uncertainty of the
realization of these deferred tax assets, the Company increased its valuation
allowance accordingly. The net change in the valuation allowance for 2000, 1999
and 1998 totaled $190.5, $(14.4) and $1.1, respectively.
Deferred tax assets and liabilities reported with other current assets and
other noncurrent assets on the accompanying consolidated balance sheets are as
follows:
December 31
-----------
2000 1999
----- -----
Deferred tax assets--current.................................... $10.5 $29.4
Deferred tax assets--noncurrent................................. 9.6 28.2
----- -----
Net deferred tax assets......................................... $20.1 $57.6
===== =====
Significant components of the provision for income taxes consist of the
following:
Year ended December
31
--------------------
2000 1999 1998
------ ----- ------
Current tax expense (benefit):
Federal.............................................. $ 53.9 $(2.6) $ 63.0
State and local...................................... 3.9 (7.0) 9.8
------ ----- ------
Total current tax expense (benefit).................... 57.8 (9.6) 72.8
Deferred tax expense................................... 44.4 19.8 38.1
------ ----- ------
Total income tax expense............................... $102.2 $10.2 $110.9
====== ===== ======
Current federal income taxes consisted of amounts due for alternative
minimum tax and tax obligations of subsidiaries not included in the
consolidated return of Anthem. During 2000, 1999 and 1998 federal income taxes
paid totaled $26.3, $0.0 and $23.7, respectively.
A reconciliation between actual income tax expense and the amount computed
at the statutory rate is as follows:
Year ended December 31
-----------------------------------------
2000 1999 1998
------------ ------------- ------------
Amount % Amount % Amount %
------ ---- ------ ----- ------ ----
Amount at statutory rate............. $115.4 35.0 $21.3 35.0 $100.9 35.0
State and local income taxes
(benefit) net of federal tax
benefit............................. 2.6 0.8 (4.8) (7.9) 7.0 2.4
Amortization of goodwill............. 5.6 1.7 3.1 5.1 3.0 1.1
Dividends received deduction......... (1.2) (0.4) (1.3) (2.1) (1.7) (0.6)
Deferred tax valuation allowance
change, net of net operating loss
carryforwards and other tax
credits............................. (20.0) (6.0) (14.4) (23.7) 1.1 0.4
Other, net........................... (0.2) (0.1) 6.3 10.4 0.6 0.2
------ ---- ----- ----- ------ ----
$102.2 31.0 $10.2 16.8 $110.9 38.5
====== ==== ===== ===== ====== ====
At December 31, 2000, the Company had unused federal tax net operating loss
carryforwards of approximately $498.7 to offset future taxable income. The loss
carryforwards expire in the years 2001 through 2019.
F-17
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
11. Accumulated Other Comprehensive Income
The following is a reconciliation of the components of accumulated other
comprehensive income at December 31:
2000 1999
------- -------
Gross unrealized gains on securities....................... $ 228.1 $ 187.5
Gross unrealized losses on securities...................... (110.8) (127.4)
------- -------
Total pretax net unrealized gains on securities............ 117.3 60.1
Deferred tax liability..................................... (41.4) (21.0)
------- -------
Net unrealized gains on securities......................... 75.9 39.1
------- -------
Additional minimum pension liability....................... (7.2) (1.2)
Deferred tax asset......................................... 2.5 0.4
------- -------
Net additional minimum pension liability................... (4.7) (0.8)
------- -------
Accumulated other comprehensive income..................... $ 71.2 $ 38.3
======= =======
A reconciliation of the change in unrealized and realized gains (losses) on
securities included in accumulated other comprehensive income follows:
2000 1999 1998
------ ------ ------
Change in pretax net unrealized gains on
securities......................................... $ 83.1 $(99.2) $185.6
Less change in deferred taxes....................... (28.4) 36.9 (64.0)
Less net realized gains on securities, net of income
taxes (2000, $8.0; 1999, $11.3; 1998, $54.6),
included in net income............................. (17.9) (26.2) (101.3)
Change in net unrealized gains of discontinued
operations......................................... -- -- (14.9)
------ ------ ------
Change in net unrealized gains on securities........ $ 36.8 $(88.5) $ 5.4
====== ====== ======
12. Leases
The Company leases office space and certain computer equipment using
noncancelable operating leases. Related lease expense for 2000, 1999 and 1998
was $64.0, $60.9, and $42.9, respectively.
At December 31, 1999, future lease payments for operating leases with
initial or remaining noncancelable terms of one year or more consisted of the
following: 2001, $48.7; 2002, $38.6; 2003, $31.7; 2004, $25.1; 2005, $22.9; and
thereafter $136.7.
13. Retirement Benefits
Anthem and its subsidiaries, Anthem Health Plans of New Hampshire, Inc.
(which acquired the business of BCBS-NH), Rocky Mountain Hospital and Medical
Service, Inc. ("RMHMS") (formerly known as BCBS-CO/NV) and Anthem Health Plans
of Maine, Inc. (which acquired the business of BCBS-ME), all sponsor defined
benefit pension plans. These plans generally cover all full-time employees who
have completed one year of continuous service and attained the age of twenty-
one.
The Company plan, which includes all affiliates except for Anthem Health
Plans of New Hampshire, Inc., RMHMS, and Anthem Health Plans of Maine, Inc., is
a cash balance arrangement where participants have an individual account
balance and will earn a pay credit equal to three to six
F-18
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
percent of compensation, depending on years of service. In addition to the pay
credit, participant accounts earn interest at a rate based on the 10-year
Treasury notes.
Anthem Health Plans of New Hampshire, Inc. sponsors a plan that is also a
cash balance arrangement where participants have an individual account balance
and will earn a pay credit equal to five percent of compensation. The
participant accounts earn interest at a rate based on the lesser of the 1-year
Treasury note or 7%.
RMHMS sponsors a pension equity plan where the participant earns retirement
credit percentages based on their age and service when the credit was earned. A
lump sum benefit is calculated for each participant based on this formula.
Effective December 31, 2000, the RMHMS plan was frozen and its participants
became participants of the Company's plan on January 1, 2001.
Anthem Health Plans of Maine, Inc. sponsors a final average pay defined
benefit plan with contributions made at a rate intended to fund the cost of
benefits earned. The plan's benefits are based on years of service and the
participant's highest five year average compensation during the last ten years
of employment. Effective December 31, 2000, the Anthem Health Plans of Maine,
Inc. plan was merged into the Company's plan and its participants became
participants of the Company's plan on January 1, 2001.
All of the plans' assets consist primarily of common and preferred stocks,
bonds, notes, government securities, investment funds and short-term
investments. The funding policies for all plans are to contribute amounts at
least sufficient to meet the minimum funding requirements set forth in the
Employee Retirement Income Security Act plus such additional amounts as are
necessary to provide assets sufficient to meet the benefits to be paid to plan
members.
The effect of the above acquisitions on the consolidated benefit obligation
and plan assets is reflected through the business combination lines of the
tables below.
In addition to the Company's defined benefit and defined contribution plans,
the Company offers most active and retired employees certain life, health,
vision and dental benefits upon retirement. There are several plans that differ
in amounts of coverage, deductibles, retiree contributions, years of service
and retirement age. The Company funds certain benefit costs through
contributions to a Voluntary Employees' Beneficiary Association ("VEBA") trust
and others are accrued, with the retiree paying a portion of the costs.
Postretirement plan assets held in the VEBA trust consist primarily of bonds
and equity securities.
The reconciliation of the benefit obligation for the years ended December 31
is as follows:
Pension Other
Benefits Benefits
-------------- --------------
2000 1999 2000 1999
------ ------ ------ ------
Benefit obligation at beginning of year......... $471.8 $473.3 $117.1 $ 91.8
Service cost.................................... 27.3 26.6 1.3 2.1
Interest cost................................... 36.6 31.4 8.4 6.2
Plan amendments................................. (1.2) -- (5.2) (13.5)
Actuarial (gain) loss........................... 35.4 (47.9) (11.0) 9.1
Business combinations........................... 50.8 73.2 9.0 28.9
Benefits paid................................... (53.1) (84.8) (8.0) (7.5)
------ ------ ------ ------
Benefit obligation at end of year............... $567.6 $471.8 $111.6 $117.1
====== ====== ====== ======
F-19
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The changes in plan assets were as follows:
Pension Other
Benefits Benefits
-------------- ------------
2000 1999 2000 1999
------ ------ ----- -----
Fair value of plan assets at beginning of year... $557.5 $445.4 $23.2 $21.2
Actual return on plan assets..................... 75.3 80.5 3.1 8.3
Employer contributions........................... 30.0 37.0 1.2 1.2
Business combinations............................ 40.9 79.4 4.6 --
Benefits paid.................................... (53.1) (84.8) (3.7) (7.5)
------ ------ ----- -----
Fair value of plan assets at end of year......... $650.6 $557.5 $28.4 $23.2
====== ====== ===== =====
The reconciliation of the funded status to the net benefit cost accrued is
as follows:
Pension
Benefits Other Benefits
-------------- ----------------
2000 1999 2000 1999
------ ------ ------- -------
Funded status................................ $ 83.0 $ 85.7 $ (83.2) $ (93.9)
Unrecognized net gain........................ (61.5) (68.7) (44.1) (33.1)
Unrecognized prior service cost.............. (22.8) (24.9) (41.9) (43.3)
Unrecognized transition asset................ (1.0) (2.8) -- --
Additional minimum liability................. (7.2) (1.2) -- --
------ ------ ------- -------
Accrued benefit cost at September 30......... (9.5) (11.9) (169.2) (170.3)
Payments made after the measurement date..... 1.0 0.5 2.6 0.5
------ ------ ------- -------
Accrued benefit cost at December 31........ $ (8.5) $(11.4) $(166.6) $(169.8)
====== ====== ======= =======
The weighted average assumptions used in calculating the accrued liabilities
for all plans are as follows:
Pension Benefits Other Benefits
----------------- -----------------
2000 1999 1998 2000 1999 1998
----- ----- ----- ----- ----- -----
Discount rate.............................. 7.50% 7.50% 6.75% 7.50% 7.50% 6.75%
Rate of compensation increase.............. 4.50% 4.50% 4.50% 4.50% 4.50% 4.50%
Expected rate of return on plan assets..... 9.00% 9.00% 9.55% 6.27% 6.50% 6.50%
The assumed health care cost trend rate used in measuring the other benefit
obligations is generally 6% in 2000 and is assumed to decrease to 5% in 2001,
and remain level thereafter. For 1999, the rates were generally 7% decreasing
by 1% per year, to 5% in 2001.
The health care cost trend rate assumption can have a significant effect on
the amounts reported. A one-percentage point change in assumed health care cost
trend rates would have the following effects:
1-Percentage 1-Percentage
Point Increase Point Decrease
-------------- --------------
Effect on total of service and interest cost
components................................. $0.4 $(0.4)
Effect on the postretirement benefit
obligation................................. 5.2 (4.3)
F-20
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Below are the components of net periodic benefit cost:
Pension Benefits Other Benefits
---------------------- -------------------
2000 1999 1998 2000 1999 1998
------ ------ ------ ----- ----- -----
Service cost..................... $ 27.3 $ 26.6 $ 27.5 $ 1.3 $ 2.1 $ 2.5
Interest cost.................... 36.6 31.4 32.2 8.4 6.2 6.9
Expected return on assets........ (49.9) (39.6) (42.2) (1.4) (1.2) (1.2)
Recognized actuarial (gain)
loss............................ 2.8 1.2 0.3 (1.7) (2.4) (2.1)
Amortization of prior service
cost............................ (3.3) (3.3) (3.6) (6.5) (5.4) (5.6)
Amortization of transition
asset........................... (1.7) (2.0) (2.1) -- -- --
------ ------ ------ ----- ----- -----
Net periodic benefit cost before
curtailments.................... 11.8 14.3 12.1 0.1 (0.7) 0.5
Net settlement/curtailment
credit.......................... -- (7.9) (3.3) -- -- (5.4)
------ ------ ------ ----- ----- -----
Net periodic benefit cost
(credit)........................ $ 11.8 $ 6.4 $ 8.8 $ 0.1 $(0.7) $(4.9)
====== ====== ====== ===== ===== =====
The net settlement/curtailment credits in 1999 and 1998 result from the
divestitures of several non-core businesses as previously discussed in Note 2.
The Company has several qualified defined contribution plans covering
substantially all employees. Eligible employees may only participate in one
plan. Voluntary employee contributions are matched at the rate of 40% to 50%
depending upon the plan subject to certain limitations. Contributions made by
the Company totaled $10.3, $8.7 and $10.0 during 2000, 1999 and 1998,
respectively.
14. Contingencies
Litigation:
A number of managed care organizations have recently been sued in class
action lawsuits asserting various causes of action under federal and state law.
These lawsuits typically allege that the defendant managed care organizations
employ policies and procedures for providing health care benefits that are
inconsistent with the terms of the coverage documents and other information
provided to their members, and because of these misrepresentations and
practices, a class of members has been injured in that they received benefits
of lesser value than the benefits represented to and paid for by such members.
Two such proceedings which allege various violations of the Employee Retirement
Income Security Act of 1974 ("ERISA") have been filed in Connecticut against
the Company or its Connecticut affiliate. One proceeding, brought by the
Connecticut Attorney General on behalf of a purported class of HMO and Point of
Service members in Connecticut, seeks to enjoin the policies and practices that
are alleged to violate ERISA. No monetary damages are sought. A second
proceeding, brought on behalf of a purported class of HMO and Point of Service
members in Connecticut and elsewhere, seeks injunctive relief and monetary
damages (both compensatory and punitive).
In addition, the Company's Connecticut affiliate is a defendant in three
class action lawsuits brought on behalf of professional providers in
Connecticut. The suits allege that the Connecticut affiliate has breached its
contracts by, among other things, failing to pay for services in accordance
with the terms of the contracts. The suits also allege violations of the
Connecticut Unfair Trade Practices Act, breach of the implied duty of good
faith and fair dealing, negligent misrepresentation and unjust enrichment. Two
of the suits seek injunctive relief and monetary damages (both
F-21
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
compensatory and punitive). The third suit, brought by the Connecticut State
Medical Society, seeks injunctive relief only.
The Company intends to vigorously defend these proceedings. All of the
proceedings are in the early stages of litigation, and their ultimate outcomes
cannot presently be determined. Accordingly, no provision has been made in the
accompanying consolidated financial statements for liability, if any, that may
result from these proceedings.
Following the purchase of BCBS-ME, appeals have been filed by two parties
that intervened in the administrative proceeding before Maine's Superintendent
of Insurance (the "Superintendent"), challenging the Superintendent's decision
approving the conversion of BCBS-ME to a stock insurer, which was a required
step before the acquisition. In one appeal, Maine's Attorney General is
requesting the Court to modify the Superintendent's decision, by requiring
BCBS-ME to submit an update to the statutorily mandated appraisal of its fair
market value and to deposit into the charitable foundation the difference
between the net proceeds that have been transferred to the foundation and the
final value of BCBS-ME, if greater. In the other appeal, a consumers' group is
also challenging that portion of the Superintendent's decision regarding the
value of BCBS-ME. While the appeals are still pending, Anthem does not believe
that the appeals will have a material adverse effect on its consolidated
financial position or results of operations.
On March 11, 1998, Anthem and a subsidiary were named as defendants in a
lawsuit, Robert Lee Dardinger, Executor of the Estate of Esther Louise
Dardinger v. Anthem Blue Cross and Blue Shield, et al., filed in the Licking
County Court of Common Pleas in Newark, Ohio. The plaintiff sought compensatory
damages and unspecified punitive damages in connection with claims alleging
wrongful death, bad faith and negligence arising out of the Company's denial of
certain claims for medical treatment for Ms. Dardinger. On September 24, 1999,
the jury returned a verdict for the plaintiff, awarding $1,350 (actual dollars)
for compensatory damages, $2.5 for bad faith in claims handling and appeals
processing, $49.0 for punitive damages and unspecified attorneys' fees in an
amount to be determined by the court. The court later granted attorneys' fees
of $0.8. An appeal of the verdict was filed by the defendants on November 19,
1999, and as part of the appeal, a bond in the amount of $60.0 was posted to
secure the judgement and interest and attorneys' fees. The ultimate outcome of
this appeal cannot be determined at this time. (See Note 17, fourth paragraph.)
In addition to the lawsuits described above, the Company is involved in
other pending and threatened litigation of the character incidental to the
business transacted, arising out of its insurance and investment operations and
is from time to time involved as a party in various governmental and
administrative proceedings. The Company believes that any liability that may
result from any one of these actions is unlikely to have a material adverse
effect on its financial position or results of operations.
Other Contingencies:
The Company, like a number of other Blue Cross and Blue Shield companies,
serves as a fiscal intermediary for Medicare Part A and B. The fiscal
intermediaries for these programs receive reimbursement for certain costs and
expenditures, which are subject to adjustment upon audit by the Health Care
Finance Administration. The laws and regulations governing fiscal
intermediaries for the Medicare program are complex, subject to interpretation
and can expose an intermediary to penalties for non-compliance. Fiscal
intermediaries may be subject to criminal fines, civil penalties or other
sanctions as a result of such audits or reviews. In the last five years, at
least eight Medicare fiscal intermediaries have made payments to settle issues
raised by such audits and reviews. These
F-22
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
payments have ranged from $0.7 to $51.6, plus a payment by one company of
$144.0. While the Company believes it is currently in compliance in all
material respects with the regulations governing fiscal intermediaries, there
are ongoing reviews by the federal government of the Company's activities under
certain of its Medicare fiscal intermediary contracts.
On December 8, 1999, Anthem Health Plans, Inc. ("AHP"), a subsidiary of
Anthem, reached a settlement agreement with the Office of Inspector General,
Department of Health and Human Services ("OIG"), in the amount of $41.9, to
resolve an investigation into misconduct in the Medicare fiscal intermediary
operations of Blue Cross and Blue Shield of Connecticut, Inc. ("BCBS-CT"),
AHP's predecessor. The period investigated was before Anthem merged with BCBS-
CT. The resolution of this case involved no criminal penalties against the
Company nor any suspension or exclusion from federal programs. This expense was
included in administrative expenses in the statement of consolidated income for
the year ended December 31, 1999.
AdminaStar Federal, Inc., an affiliate of Anthem, has received two subpoenas
from the OIG, one seeking documents and information concerning its
responsibilities as a Medicare Part B contractor in its Kentucky office, and
the other requesting certain financial records of AdminaStar Federal, Inc. and
Anthem related to the Company's Medicare fiscal intermediary (Part A) and
carrier (Part B) operations. The Company has made certain disclosures to the
government of issues relating to its Medicare Part B work in Kentucky. The
Company is not in a position to predict either the ultimate outcome of this
review or the extent of any potential exposure should claims be made against
the Company. However, the Company believes any fines or penalties that may
arise from this review would not have a material adverse effect on the
consolidated financial condition of the Company.
Anthem guarantees certain financial contingencies of its subsidiary, Anthem
Alliance Health Insurance Company (Anthem Alliance), under a contract between
Anthem Alliance and the United States Department of Defense. Under that
contract, Anthem Alliance manages and administers the TRICARE Managed Care
Support Program for military families. The contract requires Anthem Alliance,
as the prime contractor, to assume certain risks in the event, and to the
extent, the actual cost of delivering health care services during the five-year
contract period exceeds the health care cost proposal submitted by Anthem
Alliance ("the Health Care Risk"). Anthem has guaranteed Anthem Alliance's
assumption of the Health Care Risk, which is capped by the contract at $20.0
annually and $75.0 cumulatively over the five-year contract period. Anthem
Alliance has subcontracts with two other Blue Cross and Blue Shield companies
not affiliated with the Company by which the subcontractors have agreed to
provide certain services under the contract and to assume approximately 50% of
the Health Care Risk. Effective January 1, 2001, one of those subcontracts will
terminate by mutual agreement of the parties. As a result, Anthem Alliance
would then have one Blue Cross and Blue Shield subcontractor assuming 10% of
the Health Care Risk.
Vulnerability from Concentrations:
Financial instruments that potentially subject the Company to concentrations
of credit risk consist primarily of investment securities and premiums
receivable. All investment securities are managed by professional investment
managers within guidelines authorized by the board of directors. Such policies
limit the amounts that may be invested in any one issuer and prescribe certain
investee company criteria. Concentrations of credit risk with respect to
premiums receivable are limited due to the large number of employer groups that
constitute the Company's customer base in the geographic regions in which we
conduct business. As of December 31, 2000, there were no significant
concentrations of financial instruments in a single investee, industry or
geographic location.
F-23
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
15. Segment Information
The Company's principal reportable segments are strategic business units
primarily delineated by geographic areas that essentially offer similar
insurance products and services. They are managed separately because each
geographic region has unique market, regulatory and healthcare delivery
characteristics. The geographic regions are: the Midwest region, which operates
primarily in Indiana, Kentucky and Ohio; the East region, which operates
primarily in Connecticut, New Hampshire and Maine; and the West region, which
operates in Colorado and Nevada. BCBS-NH was added to the East region effective
with its October 27, 1999 acquisition, while the West region was established
following the acquisition of BCBS-CO/NV on November 16, 1999. BCBS-ME is
included in the East segment since its acquisition date of June 5, 2000.
In addition to its three principal reportable geographic segments, the
Company operates a Specialty segment which includes business units providing
group life insurance benefits, pharmacy benefit management and third party
occupational health and dental administration services. Various ancillary
business units (reported with the Other segment) consist primarily of
AdminaStar Federal which administers Medicare programs in Indiana, Illinois,
Kentucky and Ohio and Anthem Alliance which provides health care benefits and
administration in nine states for the Department of Defense's TRICARE Program
for military families. The Other segment also includes intersegment revenue and
expense eliminations and corporate expenses not allocated to reportable
segments.
Through its participation in the Federal Employee Program ("FEP"), Medicare,
Medicare at Risk, and TRICARE Program, the Company generated approximately 22%,
23%, and 22% of its total consolidated revenues from agencies of the U.S.
government for the years ended December 31, 2000, 1999, and 1998, respectively.
The Company defines operating revenues to include premium income,
administrative fees and other revenues. Operating revenues are derived from
premiums and fees received primarily from the sale and administration of health
benefit products. Operating expenses are comprised of benefit and
administrative expenses. The Company calculates operating gain or loss as
operating revenue less operating expenses.
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies except that pension and
postretirement benefit costs for each segment are recognized on a per associate
per month charge, which in aggregate approximates the consolidated expense. Any
difference between the per associate per month charge and actual consolidated
expense is included in corporate expenses not allocated to reportable segments.
Intersegment sales and expenses are recorded at cost, and eliminated in the
consolidated financial statements. The Company evaluates performance of the
reportable segments based on operating gain or loss as defined above. The
Company evaluates investment income, interest expense, amortization expense,
income taxes, and asset and liability details on a consolidated basis as these
items are managed in a corporate shared service environment and are not the
responsibility of segment operating management.
F-24
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following tables present operating gain (loss) by reportable segment for
each of the years ended December 31, 2000, 1999 and 1998:
Reportable Segments
------------------------------------------------------
Midwest East West Specialty Other Total
-------- -------- ------ --------- ------- --------
2000
Premiums................ $4,203.1 $2,768.9 $569.6 $123.7 $ 72.0 $7,737.3
Administrative fees..... 254.8 144.1 52.8 31.8 272.1 755.6
Other revenues.......... 2.6 8.9 -- 176.8 (137.7) 50.6
-------- -------- ------ ------ ------- --------
Operating revenue(1).... 4,460.5 2,921.9 622.4 332.3 206.4 8,543.5
Benefit expense......... 3,555.4 2,332.4 491.7 92.6 78.9 6,551.0
Administrative
expense(2)............. 817.3 485.7 128.2 214.8 162.4 1,808.4
-------- -------- ------ ------ ------- --------
Operating expense....... 4,372.7 2,818.1 619.9 307.4 241.3 8,359.4
-------- -------- ------ ------ ------- --------
Operating gain (loss)... $ 87.8 $ 103.8 $ 2.5 $ 24.9 $ (34.9) $ 184.1
======== ======== ====== ====== ======= ========
(1) Includes
intersegment revenues.. $ 8.2 $ -- $ -- $143.5 $(151.7) $ --
(2) Includes
depreciation and
amortization......... 16.9 17.1 8.7 2.1 30.5 75.3
Reportable Segments
------------------------------------------------------
Midwest East West Specialty Other Total
-------- -------- ------ --------- ------- --------
1999
Premiums................ $3,729.3 $1,495.4 $ 64.2 $ 96.3 $ 33.3 $5,418.5
Administrative fees..... 242.8 99.7 1.7 14.6 252.3 611.1
Other revenues.......... 3.4 3.8 6.8 138.2 (101.2) 51.0
-------- -------- ------ ------ ------- --------
Operating revenue(1).... 3,975.5 1,598.9 72.7 249.1 184.4 6,080.6
Benefit expense......... 3,162.2 1,259.9 55.0 73.8 31.8 4,582.7
Administrative
expense(2)............. 776.9 339.9 21.2 159.1 172.3 1,469.4
-------- -------- ------ ------ ------- --------
Operating expense....... 3,939.1 1,599.8 76.2 232.9 204.1 6,052.1
-------- -------- ------ ------ ------- --------
Operating gain (loss)... $ 36.4 $ (0.9) $ (3.5) $ 16.2 $ (19.7) $ 28.5
======== ======== ====== ====== ======= ========
(1) Includes
intersegment revenues.. $ 7.5 $ -- $ -- $103.7 $(111.2) $ --
(2) Includes
depreciation and
amortization......... 16.6 8.5 0.5 1.4 20.1 47.1
F-25
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Reportable Segments
----------------------------------------------------
Midwest East West Specialty Other Total
-------- -------- ----- --------- ------- --------
1998
Premiums................. $3,533.3 $1,088.3 $ -- $ 90.3 $ 27.6 $4,739.5
Administrative fees...... 234.8 91.4 -- 21.1 228.3 575.6
Other revenues........... 3.0 11.2 -- 130.2 (69.8) 74.6
-------- -------- ----- ------ ------- --------
Operating revenue(1)..... 3,771.1 1,190.9 -- 241.6 186.1 5,389.7
Benefit expense.......... 2,922.9 901.9 -- 76.1 33.3 3,934.2
Administrative
expense(2).............. 797.7 294.6 -- 142.3 185.5 1,420.1
-------- -------- ----- ------ ------- --------
Operating expense........ 3,720.6 1,196.5 -- 218.4 218.8 5,354.3
-------- -------- ----- ------ ------- --------
Operating gain (loss).... $ 50.5 $ (5.6) $ -- $ 23.2 $ (32.7) $ 35.4
======== ======== ===== ====== ======= ========
(1) Includes intersegment
revenues................ $ 9.4 $ -- $ -- $104.3 $(113.7) $ --
(2) Includes depreciation
and amortization...... 16.2 9.3 -- 1.1 17.1 43.7
Asset and equity details by reportable segment have not been disclosed, as
they are not reported internally by the Company.
A reconciliation of reportable segment operating revenues to the amounts of
total revenues included in the consolidated statements of income for 2000, 1999
and 1998 is as follows:
2000 1999 1998
-------- -------- --------
Reportable segments operating revenues........... $8,543.5 $6,080.6 $5,389.7
Net investment income............................ 201.6 152.0 136.8
Net realized gains on investments................ 25.9 37.5 155.9
-------- -------- --------
Total revenues................................. $8,771.0 $6,270.1 $5,682.4
======== ======== ========
A reconciliation of reportable segment operating gain to income from
continuing operations before income taxes and minority interest included in the
consolidated statements of income for 2000, 1999 and 1998 is as follows:
2000 1999 1998
------ ------- ------
Reportable segments operating gain................ $184.1 $ 28.5 $ 35.4
Net investment income............................. 201.6 152.0 136.8
Net realized gains on investments................. 25.9 37.5 155.9
Interest expense.................................. (54.7) (30.4) (27.9)
Amortization of goodwill and other intangible
assets........................................... (27.1) (12.7) (12.0)
Endowment of non-profit foundations............... -- (114.1) --
------ ------- ------
Income from continuing operations before income
taxes and minority interest...................... $329.8 $ 60.8 $288.2
====== ======= ======
F-26
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
16. Statutory Information
Statutory policyholders' surplus of Anthem amounted to $1,907.5 and $1,444.2
at December 31, 2000 and 1999, respectively. Statutory net income of Anthem was
$91.7, $201.7 and $80.6 for 2000, 1999 and 1998, respectively. Surplus of
insurance subsidiaries of Anthem is subject to regulatory restrictions with
respect to amounts available for dividends to Anthem.
In 1998, the National Association of Insurance Commissioners adopted
codified statutory accounting principles ("Codification") which will be
effective January 1, 2001. Codification will result in changes to certain
accounting practices that Anthem and it's insurance subsidiaries use to prepare
statutory-basis financial statements. Management believes the impact of these
changes will not be significant.
17. Subsequent Events
On January 29, 2001 Anthem's board of directors appointed a special
committee to work with management to develop a plan for demutualization and
conversion to a publicly traded stock company (the "Plan") for the board's
further review. On June 18, 2001, the Plan was approved by Anthem's board of
directors and management believes that the demutualization and conversion
process could be completed before the end of 2001. Anthem's members will see no
increase in premiums or changes to the terms of their health care benefits as a
result of the demutualization.
On April 18, 2001, Anthem and its subsidiary Anthem Alliance Health
Insurance Company ("Alliance"), entered into an Agreement and Plan of Merger to
sell the TRICARE operations of Alliance to a subsidiary of Humana, Inc. The
transaction closed on May 31, 2001.
On May 30, 2001, Anthem and Blue Cross and Blue Shield of Kansas ("BCBS-KS")
signed a definitive agreement pursuant to which BCBS-KS will become a wholly
owned subsidiary of Anthem. Under the proposed transaction, BCBS-KS will
demutualize and convert to a stock insurance company. The agreement calls for
Anthem to pay $190.0 in exchange for all of the shares of BCBS-KS. Subject to
the approval of BCBS-KS policyholders and the approval of the Kansas Department
of Insurance, the transaction is expected to close in early 2002.
On May 22, 2001, the Ohio Court of Appeals (Fifth District) affirmed the
jury award of $1,350 (actual dollars) for breach of contract against Community
Insurance Company ("CIC"), a subsidiary of the Company, affirmed the award of
$2.5 compensatory damages for bad faith in claims handling and appeals
processing against CIC, but dismissed the claims and judgments against Anthem.
The court also reversed the award of $49.0 in punitive damages against both the
Company and CIC, and remanded the question of punitive damages against CIC to
the trial court for a new trial. (See Note 14, fifth paragraph.)
F-27
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
For the Quarter Ended
-------------------------------------------
March 31 June 30 September 30 December 31
-------- -------- ------------ -----------
($ in Millions)
2000 Data
Total revenues.................... $1,962.1 $2,104.1 $2,320.0 $2,384.8
Operating gain.................... 32.4 34.2 53.3 64.2
Net income........................ 40.4 49.9 63.5 72.2
1999 Data
Total revenues.................... $1,450.3 $1,465.3 $1,571.8 $1,782.7
Operating gain (loss)(1).......... (0.4) 6.5 27.9 (5.5)
Income (loss) from continuing
operations(2).................... 11.9 24.4 17.8 (3.2)
Discontinued operations, net of
income taxes(3).................. -- -- -- (6.0)
Net income (loss)................. 11.9 24.4 17.8 (9.2)
--------
(1) The operating loss of $(5.5 million) for the quarter ended December 31,
1999 includes a non recurring charge of $41.9 million related to the
settlement agreement with the OIG. See Note 14 to our audited consolidated
financial statements.
(2) During 1999, we reached agreements with the states of Kentucky, Ohio and
Connecticut to resolve any questions as to whether we or our
predecessor/successor entities were in possession of property that was
impressed with a charitable trust. Income (loss) from continuing operations
for the quarters ended March 31, September 30 and December 31, 1999
includes the non-recurring after-tax endowment of non-profit foundations of
$18.2 million, $26.8 million and $26.8 million, respectively. See Note 3 to
our audited consolidated financial statements.
(3) Loss on discontinued operations for the quarter ended December 31, 1999
resulted when we recognized additional losses resulting from sales
agreement contingency adjustments relating to discontinued operations sold
in prior years. See Note 2 to our audited consolidated financial
statements.
F-28
ANTHEM INSURANCE COMPANIES, INC.
CONSOLIDATED BALANCE SHEET
(Unaudited)
June 30, 2001
-------------
(In Millions)
Assets
Current assets:
Investments available-for-sale, at fair value:
Fixed maturity securities..................................... $3,351.3
Equity securities............................................. 439.4
--------
3,790.7
Cash and cash equivalents....................................... 238.9
Premium and self funded receivables............................. 498.5
Reinsurance receivables......................................... 78.9
Other receivables............................................... 194.5
Income tax receivables.......................................... 7.4
Other current assets............................................ 33.4
--------
Total current assets.............................................. 4,842.3
Other noncurrent investments...................................... 13.1
Restricted cash and investments................................... 51.1
Property and equipment............................................ 409.6
Goodwill and other intangible assets.............................. 480.4
Other noncurrent assets........................................... 41.5
--------
Total assets...................................................... $5,838.0
========
Liabilities and policyholders' surplus
Liabilities
Current liabilities:
Policy liabilities:
Unpaid life, accident and health claims....................... $1,295.1
Future policy benefits........................................ 237.5
Other policyholder liabilities................................ 61.2
--------
Total policy liabilities........................................ 1,593.8
Unearned income................................................. 321.2
Accounts payable and accrued expenses........................... 269.0
Bank overdrafts................................................. 281.6
Income taxes payable............................................ 34.6
Other current liabilities....................................... 283.7
--------
Total current liabilities......................................... 2,783.9
Long term debt, less current portion.............................. 597.5
Retirement benefits............................................... 187.5
Other noncurrent liabilities...................................... 205.2
--------
Total liabilities................................................. 3,774.1
Policyholders' surplus
Surplus........................................................... 1,991.6
Accumulated other comprehensive income............................ 72.3
--------
Total policyholders' surplus...................................... 2,063.9
--------
Total liabilities and policyholders' surplus...................... $5,838.0
========
See accompanying notes.
F-29
ANTHEM INSURANCE COMPANIES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Six Months Ended
June 30
------------------
2001 2000
-------- --------
(In Millions)
Revenues
Premiums.................................................... $4,542.8 $3,589.3
Administrative fees......................................... 430.3 356.5
Other revenue............................................... 22.6 18.9
-------- --------
Total operating revenue................................. 4,995.7 3,964.7
Net investment income....................................... 109.0 95.0
Net realized gains (losses) on investments.................. (10.9) 6.5
Gain on sale of subsidiary operations....................... 25.0 --
-------- --------
5,118.8 4,066.2
-------- --------
Expenses
Benefit expense............................................. 3,870.8 3,080.6
Administrative expense...................................... 991.6 817.5
Interest expense............................................ 28.0 27.0
Amortization of goodwill and other intangible assets........ 15.7 11.4
Demutualization expenses.................................... 3.0 --
-------- --------
4,909.1 3,936.5
-------- --------
Income before income taxes and minority interest............ 209.7 129.7
Income taxes................................................ 68.6 38.9
Minority interest (credit).................................. (1.9) 0.5
-------- --------
Net income.................................................. $ 143.0 $ 90.3
======== ========
See accompanying notes.
F-30
ANTHEM INSURANCE COMPANIES, INC.
CONSOLIDATED STATEMENTS OF POLICYHOLDERS' SURPLUS
(Unaudited)
Accumulated
Other Total
Comprehensive Policyholders'
Surplus Income Surplus
-------- ------------- --------------
(In Millions)
Balance at December 31, 2000............ $1,848.6 $71.2 $1,919.8
Net income.............................. 143.0 -- 143.0
Change in net unrealized gains on
securities............................. -- 1.1 1.1
--------
Comprehensive income.................... 144.1
-------- ----- --------
Balance at June 30, 2001................ $1,991.6 $72.3 $2,063.9
======== ===== ========
Balance at December 31, 1999............ $1,622.6 $38.3 $1,660.9
Net income.............................. 90.3 -- 90.3
Change in net unrealized gains on
securities............................. -- 5.1 5.1
--------
Comprehensive income.................... 95.4
-------- ----- --------
Balance at June 30, 2000................ $1,712.9 $43.4 $1,756.3
======== ===== ========
See accompanying notes.
F-31
ANTHEM INSURANCE COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended June 30
--------------------------
2001 2000
------------ ------------
(In Millions)
Operating activities
Net income......................................... $ 143.0 $ 90.3
Adjustments to reconcile net income to net cash
provided by operating activities:
Realized (gains) losses on investments........... 10.9 (6.5)
Gain on sale of subsidiary operations............ (25.0) --
Depreciation, amortization and accretion......... 61.2 47.2
Deferred income taxes............................ 16.9 3.4
Loss on sale of assets........................... 2.9 0.6
Changes in operating assets and liabilities, net
of effect of purchases and divestitures:
Restricted cash and investments................ (3.3) 5.1
Receivables.................................... 12.2 21.9
Other assets................................... (3.7) (8.9)
Policy liabilities............................. 27.0 91.6
Unearned income................................ 64.7 27.9
Accounts payable and accrued expenses.......... 6.7 (18.3)
Other liabilities.............................. (63.4) 75.7
Income taxes................................... 12.5 36.7
------------ ------------
Net cash provided by continuing operations....... 262.6 366.7
Net cash used in discontinued operations......... (1.5) (1.3)
------------ ------------
Cash provided by operating activities.............. 261.1 365.4
Investing activities
Purchases of investments........................... (1,957.9) (1,685.2)
Sales or maturities of investments................. 1,721.4 1,458.3
Purchases of subsidiaries, net of cash acquired.... (2.7) (69.2)
Sales of subsidiaries, net of cash sold............ 45.0 6.0
Proceeds from sale of property and equipment....... 0.9 4.4
Purchases of property and equipment................ (32.2) (35.2)
------------ ------------
Cash used in investing activities.................. (225.5) (320.9)
Financing activities
Proceeds from borrowings........................... -- 295.3
Payments on borrowings............................. -- (220.0)
------------ ------------
Cash provided by financing activities.............. -- 75.3
------------ ------------
Change in cash and cash equivalents................ 35.6 119.8
Cash and cash equivalents at beginning of period... 203.3 204.4
------------ ------------
Cash and cash equivalents at end of period......... $ 238.9 $ 324.2
============ ============
See accompanying notes.
F-32
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
June 30, 2001
(Dollars in Millions)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements of Anthem
Insurance Companies, Inc. ("Anthem") and its subsidiaries (collectively, the
"Company") have been prepared in accordance with accounting principles
generally accepted in the United States ("GAAP") for interim financial
reporting. Accordingly, they do not include all of the information and
footnotes required by GAAP for complete financial statements. In the opinion of
management, all adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation have been included. The results of operations
for the six month period ended June 30, 2001 are not necessarily indicative of
the results that may be expected for the full year ending December 31, 2001.
These unaudited consolidated interim financial statements should be read in
conjunction with the Company's audited consolidated financial statements for
the year ended December 31, 2000.
2. Demutualization
On January 29, 2001 Anthem's board of directors appointed a special
committee to work with management to develop a plan for demutualization and
conversion to a publicly traded stock company (the "Plan") for the board's
further review. On June 18, 2001, the Plan was approved by Anthem's board of
directors and management believes that the demutualization and conversion
process could be completed before the end of 2001. Anthem's members will see no
increase in premiums or change to the terms of their health care benefits as a
result of the demutualization.
3. Disposition and Pending Acquisition
On April 18, 2001, Anthem and its subsidiary Anthem Alliance Health
Insurance Company ("Alliance"), entered into an Agreement and Plan of Merger to
sell the TRICARE operations of Alliance to a subsidiary of Humana, Inc. for
$45.0. The transaction, which closed on May 31, 2001 resulted in a gain on sale
of subsidiary operations of $25.0, net of selling expenses.
On May 30, 2001, Anthem and Blue Cross and Blue Shield of Kansas ("BCBS-KS")
signed a definitive agreement pursuant to which BCBS-KS will become a wholly
owned subsidiary of Anthem. Under the proposed transaction, BCBS-KS will
demutualize and convert to a stock insurance company. The agreement calls for
Anthem to pay $190.0 in exchange for all of the shares of BCBS-KS. Subject to
the approval of BCBS-KS policyholders and the approval of the Kansas Department
of Insurance, the transaction is expected to close in early 2002.
4. Pending Adoption of Accounting Standard
On June 29, 2001, members of the Financial Accounting Standards Board voted
unanimously in favor of FAS 141, Business Combinations, and FAS 142, Goodwill
and Other Intangible Assets. Both FAS 141 and FAS 142 will be issued in July
2001. FAS 141 will require business combinations completed after June 30, 2001
to be accounted for using the purchase method of accounting. Under FAS 142
goodwill will not be amortized but will be tested for impairment at least
annually. The Company will be required to adopt FAS 142 on January 1, 2002 and
early adoption is not permitted. The Company has not yet completed the analysis
necessary to provide a precise estimate of the effect of the adoption of FAS
142, however the elimination of goodwill expense from the consolidated
statements of income is expected to be material.
F-33
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
5. Contingencies
Litigation
A number of managed care organizations have recently been sued in class
action lawsuits asserting various causes of action under federal and state law.
These lawsuits typically allege that the defendant managed care organizations
employ policies and procedures for providing health care benefits that are
inconsistent with the terms of the coverage documents and other information
provided to their members, and because of these misrepresentations and
practices, a class of members has been injured in that they received benefits
of lesser value than the benefits represented to and paid for by such members.
Two such proceedings which allege various violations of the Employee Retirement
Income Security Act of 1974 ("ERISA") have been filed in Connecticut against
the Company or its Connecticut affiliate. One proceeding was brought by the
Connecticut Attorney General on behalf of a purported class of HMO and Point of
Service members in Connecticut. No monetary damages are sought, although the
suit does seek injunctive relief from the court to preclude the Company from
allegedly utilizing arbitrary coverage guidelines, making late payments to
providers or members, denying coverage for medically necessary prescription
drugs and misrepresenting or failing to disclose essential information to
enrollees. The complaint contends that these alleged policies and practices are
a violation of ERISA. A second proceeding, brought on behalf of a purported
class of HMO and Point of Service members in Connecticut and elsewhere, seeks
injunctive relief to preclude the Company from allegedly making coverage
decisions relating to medical necessity without complying with the express
terms of the policy documents, and unspecified monetary damages (both
compensatory and punitive).
In addition, the Company's Connecticut affiliate is a defendant in three
class action lawsuits brought on behalf of professional providers in
Connecticut. The suits allege that the Connecticut affiliate has breached its
contracts by, among other things, failing to pay for services in accordance
with the terms of the contracts. The suits also allege violations of the
Connecticut Unfair Trade Practices Act, breach of the implied duty of good
faith and fair dealing, negligent misrepresentation and unjust enrichment. Two
of the suits seek injunctive relief and monetary damages (both compensatory and
punitive). The third suit, brought by the Connecticut State Medical Society,
seeks injunctive relief only.
The Company intends to vigorously defend these proceedings. All of the
proceedings are in the early stages of litigation, and their ultimate outcomes
cannot presently be determined. Accordingly, no provision has been made in the
accompanying unaudited consolidated financial statements for liability, if any,
that may result from these proceedings.
Following the purchase of BCBS-ME, appeals have been filed by two parties
that intervened in the administrative proceeding before Maine's Superintendent
of Insurance (the "Superintendent"), challenging the Superintendent's decision
approving the conversion of BCBS-ME to a stock insurer, which was a required
step before the acquisition. In one appeal, Maine's Attorney General is
requesting the Court to modify the Superintendent's decision, by requiring
BCBS-ME to submit an update to the statutorily mandated appraisal of its fair
market value and to deposit into the charitable foundation the difference
between the net proceeds that have been transferred to the foundation and the
final value of BCBS-ME, if greater. In the other appeal, a consumers' group is
also challenging that portion of the Superintendent's decision regarding the
value of BCBS-ME. While the appeals are still pending, Anthem does not believe
that the appeals will have a material adverse effect on its unaudited
consolidated financial position or results of operations.
F-34
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
On March 11, 1998, Anthem and its Ohio subsidiary Community Insurance
Company ("CIC") were named as defendants in a lawsuit, Robert Lee Dardinger,
Executor of the Estate of Esther Louise Dardinger v. Anthem Blue Cross and Blue
Shield, et al., filed in the Licking County Court of Common Pleas in Newark,
Ohio. The plaintiff sought compensatory damages and unspecified punitive
damages in connection with claims alleging wrongful death, bad faith and
negligence arising out of the Company's denial of certain claims for medical
treatment for Ms. Dardinger. On September 24, 1999, the jury returned a verdict
for the plaintiff, awarding $1,350 (actual dollars) for compensatory damages,
$2.5 for bad faith in claims handling and appeals processing, $49.0 for
punitive damages and unspecified attorneys' fees in an amount to be determined
by the court. The court later granted attorneys' fees of $0.8. An appeal of the
verdict was filed by the defendants on November 19, 1999, and as part of the
appeal, a bond in the amount of $60.0 was posted to secure the judgement and
interest and attorneys' fees. On May 22, 2001, the Ohio Court of Appeals (Fifth
District) affirmed the jury award of $1,350 (actual dollars) for breach of
contract against CIC, affirmed the award of $2.5 compensatory damages for bad
faith in claims handling and appeals processing against CIC, but dismissed the
claims and judgments against Anthem. The court also reversed the award of $49.0
in punitive damages against CIC to the trial court for a new trial. Anthem and
CIC, as well as the plaintiff, appealed certain aspects of the decision of the
Ohio Court of Appeals. On October 10, 2001, the Supreme Court of Ohio agreed to
hear the plaintiff's appeal, including the question of punitive damages, and
denied the cross-appeals of Anthem and CIC. The ultimate outcome of this matter
cannot be determined at this time.
In addition to the lawsuits described above, the Company is also involved in
other pending and threatened litigation of the character incidental to the
business transacted, arising out of its insurance and investment operations and
is from time to time involved as a party in various governmental and
administrative proceedings. The Company believes that any liability that may
result from any one of these actions is unlikely to have a material adverse
effect on its financial position or results of operations.
Other Contingencies
The Company, like a number of other Blue Cross and Blue Shield companies,
serves as a fiscal intermediary for Medicare Part A and B. The fiscal
intermediaries for these programs receive reimbursement for certain costs and
expenditures, which is subject to adjustment upon audit by the Health Care
Finance Administration. The laws and regulations governing fiscal
intermediaries for the Medicare program are complex, subject to interpretation
and can expose an intermediary to penalties for non-compliance. Fiscal
intermediaries may be subject to criminal fines, civil penalties or other
sanctions as a result of such audits or reviews. In the last five years, at
least eight Medicare fiscal intermediaries have made payments to settle issues
raised by such audits and reviews. These payments have ranged from $0.7 to
$51.6, plus a payment by one company of $144.0. While the Company believes it
is currently in compliance in all material respects with the regulations
governing fiscal intermediaries, there are ongoing reviews by the federal
government of the Company's activities under certain of its Medicare fiscal
intermediary contracts.
AdminaStar Federal, Inc., an affiliate of Anthem, has received several
subpoenas from the Office of Inspector General, Department of Health and Human
Services, one seeking documents and information concerning its responsibilities
as a Medicare Part B contractor in its Kentucky office, and the other
requesting certain financial records of AdminaStar Federal, Inc. and Anthem
related to the Company's Medicare fiscal intermediary (Part A) and carrier
(Part B) operations. The Company has made certain disclosures to the government
of issues relating to its Medicare Part B work in Kentucky. The Company is not
in a position to predict either the ultimate outcome of this review or
F-35
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
the extent of any potential exposure should claims be made against the Company.
However, the Company believes any fines or penalties that may arise from this
review would not have a material adverse effect on the consolidated financial
condition of the Company.
As a Blue Cross Blue Shield Association licensee, the Company participates
in the Federal Employee Program ("FEP"), a nationwide contract with the federal
Office of Personnel Management, to provide coverage to federal employees and
their dependents. On July 11, 2001 the Company received a subpoena from the
Office of Inspector General, Office of Personnel Management, seeking certain
financial documents and information, including information concerning
intercompany transactions, related to operations in Ohio, Indiana and Kentucky
under the FEP contract. The Company is currently evaluating the subpoena and
intends to cooperate with the government's review. The Company is not in a
position to predict either the ultimate outcome of this review or the extent of
any potential exposure should claims be made against the Company. There can be
no assurance that the ultimate outcome of this review will not have a material
adverse effect on the Company's consolidated results of operations or financial
condition.
Anthem guaranteed certain financial contingencies of its subsidiary, Anthem
Alliance Health Insurance Company ("Alliance") under a contract between
Alliance and the United States Department of Defense. Under that contract,
Alliance managed and administered the TRICARE Managed Care Support Program for
military families from May 1, 1998 through May 31, 2001. The contract required
Alliance, as the prime contractor, to assume certain risks in the event, and to
the extent, the actual cost of delivering health care services exceeded the
health care cost proposal submitted by Alliance ("the Health Care Risk"). The
contract has a five-year term, but was transferred to a third party, effective
May 31, 2001. Anthem guaranteed Alliance's assumption of the Health Care Risk,
which is capped by the contract at $20.0 annually and $75.0 cumulatively over
the contract period. Through December 31, 2000, Alliance had subcontracts with
two other Blue Cross and Blue Shield companies not affiliated with the Company
by which the subcontractors agreed to provide certain services under the
contract and to assume approximately 50% of the Health Care Risk. Effective
January 1, 2001, one of those subcontracts terminated by mutual agreement of
the parties, which increased Alliance's portion of the Health Care Risk to 90%.
Effective May 1, 2001, the other subcontract was amended to eliminate the
Health Care Risk sharing provision, which resulted in Alliance assuming 100% of
the Health Care Risk for the period from May 1, 2001 to May 31, 2001. There was
no call on the guarantee for the period from May 1, 1998 to April 30, 1999
(which period is now "closed"), and we do not anticipate a call on the
guarantee for the periods beginning May 1, 1999 through May 31, 2001 (which
periods remain "open" for possible review by the Department of Defense).
F-36
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
6. Segment Information
The following tables show financial data by segment for the six months ended
June 30, 2001 and 2000:
Reportable Segments
---------------------------------------------------
Midwest East West Specialty Other Total
-------- -------- ------ --------- ------ --------
Six Months Ended June 30,
2001
Premiums.................. $2,313.0 $1,658.3 $327.3 $47.4 $196.8 $4,542.8
Administrative fees....... 152.8 99.6 29.6 18.0 130.3 430.3
Other revenue............. 0.9 0.8 -- 120.1 (99.2) 22.6
-------- -------- ------ ----- ------ --------
Operating revenue(1).... 2,466.7 1,758.7 356.9 185.5 227.9 4,995.7
Benefit expense........... 1,952.8 1,418.1 275.3 31.8 192.8 3,870.8
Administrative
expense(2)............... 428.9 292.2 78.5 137.8 54.2 991.6
-------- -------- ------ ----- ------ --------
Operating expense....... 2,381.7 1,710.3 353.8 169.6 247.0 4,862.4
-------- -------- ------ ----- ------ --------
Operating gain (loss)..... $ 85.0 $ 48.4 $ 3.1 $15.9 $(19.1) $ 133.3
======== ======== ====== ===== ====== ========
(1) Includes intersegment
revenues................. $ -- $ -- $ -- $97.5 $(97.5) $ --
(2) Includes depreciation
and amortization........ 0.5 1.2 1.3 1.4 40.4 44.8
Reportable Segments
---------------------------------------------------
Midwest East West Specialty Other Total
-------- -------- ------ --------- ------ --------
Six Months Ended June 30,
2000
Premiums.................. $2,046.4 $1,175.6 $278.1 $64.3 $ 24.9 $3,589.3
Administrative fees....... 123.7 57.9 24.9 14.8 135.2 356.5
Other revenues............ 1.3 2.5 0.1 82.3 (67.3) 18.9
-------- -------- ------ ----- ------ --------
Operating revenue(1).... 2,171.4 1,236.0 303.1 161.4 92.8 3,964.7
Benefit expense........... 1,748.7 1,012.2 240.2 51.2 28.3 3,080.6
Administrative
expense(2)............... 386.5 189.7 61.6 100.4 79.3 817.5
-------- -------- ------ ----- ------ --------
Operating expense....... 2,135.2 1,201.9 301.8 151.6 107.6 3,898.1
-------- -------- ------ ----- ------ --------
Operating gain (loss)..... $ 36.2 $ 34.1 $ 1.3 $ 9.8 $(14.8) $ 66.6
======== ======== ====== ===== ====== ========
(1) Includes intersegment
revenues................. $ 3.9 $ -- $ -- $68.6 $(72.5) $ --
(2) Includes depreciation
and amortization........ 8.9 7.2 4.4 1.0 14.5 36.0
F-37
ANTHEM INSURANCE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
A reconciliation of reportable segment operating revenues to the amounts of
total revenues included in the unaudited consolidated statements of income for
the six months ended June 30, 2001 and 2000 is as follows:
Six Months Ended
June 30
------------------
2001 2000
-------- --------
Reportable segments operating revenue.................. $4,995.7 $3,964.7
Net investment income.................................. 109.0 95.0
Net realized gains (losses) on investments............. (10.9) 6.5
Gain on sale of subsidiary operations.................. 25.0 --
-------- --------
Total revenues......................................... $5,118.8 $4,066.2
======== ========
A reconciliation of reportable segment operating gain to income before
income taxes and minority interest included in the unaudited consolidated
statements of income for the six months ended June 30, 2001 and 2000 is as
follows:
Six Months Ended
June 30
------------------
2001 2000
-------- --------
Reportable segments
operating gain......... $ 133.3 $ 66.6
Net investment income... 109.0 95.0
Net realized gains
(losses) on
investments............ (10.9) 6.5
Gain on sale of
subsidiary operations.. 25.0 --
Interest expense........ (28.0) (27.0)
Amortization of goodwill
and other intangible
assets................. (15.7) (11.4)
Demutualization
expenses............... (3.0) --
-------- --------
Income before income
taxes and minority
interest............... $ 209.7 $ 129.7
======== ========
F-38
ANNEX A
ACTUARIAL OPINIONS
[LOGO OF MILLIMAN]
One Pennsylvania Plaza, 38th
Floor
New York, NY 10119
Tel +1 212 279.7166
Fax +1 212 629.5657
www.milliman.com
June 18, 2001
Board of Directors
Anthem Insurance Companies, Inc.
120 Monument Circle
Indianapolis, Indiana 46204
Re: Plan of Conversion of Anthem Insurance Companies, Inc.
STATEMENT OF ACTUARIAL OPINIONS
Subject of this Opinion Letter
This opinion letter relates to the actuarial aspects of the proposed
reorganization of Anthem Insurance Companies, Inc. ("Anthem Insurance")
pursuant to its Plan of Conversion (the "Plan") as presented to the Board of
Directors of Anthem Insurance for its consideration and approval on June 18,
2001. The specific opinions set forth herein relate to the proposed allocation
of consideration among the Eligible Statutory Members of Anthem Insurance and
the decision not to include a Closed Block dividend preservation mechanism,
each of which is described in the Plan.
Capitalized terms have the same meaning in this opinion as they have in the
Plan.
Qualifications and Usage
We, Robert H. Dobson, Dale S. Hagstrom, and Daniel J. McCarthy, are
associated with the firm of Milliman USA ("Milliman") and are Members of the
American Academy of Actuaries, qualified under the Academy's Qualification
Standards to render the opinions set forth herein. We, and other Milliman staff
acting under our direction, have advised Anthem Insurance during the course of
its development of the Plan and the Actuarial Contribution Memorandum, which is
Exhibit F thereto. The Plan is based on authority in Title 27 Article 15 of the
Indiana Code ("the Indiana Demutualization Law"). The opinions set forth herein
are not legal opinions concerning the Plan, the Articles of Incorporation of
Anthem Insurance, or Indiana law, but rather are opinions concerning the
application of actuarial concepts and standards of practice to the provisions
of the Plan.
Chapter 3 Section 2 (11) of the Indiana Demutualization Law requires "an
actuarial opinion as to the following: (A) The reasonableness and
appropriateness of the methodology or formulas used to allocate consideration
among eligible members, and (B) The reasonableness of the plan of
operation . . . of . . . the closed block if a closed block is used
for . . . policies that provide for the distribution of policy dividends." We
are aware that, per Chapter 3 Section 4 (4) of the Indiana Demutualization Law,
our opinion will be furnished to the Insurance Commissioner of the State of
Indiana in fulfillment of this requirement and for her use in determining the
fairness of the Plan, and to the Statutory Members of Anthem Insurance as part
of the Member Information Statement that will be delivered to them, and we
consent to the use of this opinion letter for those purposes.
A-1
Reliance
In forming the opinions set forth in this opinion letter, we have received
from Anthem Insurance extensive information concerning the past and present
practices and financial results of Anthem Insurance and its predecessors. We
also received from Anthem Insurance relevant corporate documents and Membership
information. We, and other Milliman staff acting under our direction, met with
personnel of Anthem Insurance and defined the information we required. In all
cases, we were provided with the information we requested to the extent that it
was available or to the extent it was practicable to develop the information
from the records of Anthem Insurance. We have made no independent verification
of this information, although we have reviewed it where practicable for general
reasonableness and internal consistency. We have relied on this information,
which was provided under the general direction of Cynthia S. Miller, Vice
President and Chief Actuary of Anthem Insurance. Our opinions depend on the
substantial accuracy of this information.
Process
In all cases, we and other Milliman staff acting under our direction either
derived the results on which our opinions rest or reviewed derivations carried
out by Anthem Insurance employees.
Opinion #1
Under the Plan, consideration (shares of Common Stock or their equivalent
value in cash) is to be distributed to each Eligible Statutory Member in
exchange for such Member's Membership Interest. In our opinion, the principles,
assumptions, methodologies, and formulas used to allocate consideration among
the Eligible Statutory Members of Anthem Insurance as set forth in Article VII
of the Plan (including the Actuarial Contribution Memorandum, which is Exhibit
F thereto) are reasonable and appropriate and consistent with the requirements
of the Indiana Demutualization Law, and the resulting allocation of
consideration is fair and equitable to the Eligible Statutory Members.
Discussion
Statutory requirements. Chapter 9 Section 1 of the Indiana Demutualization
Law requires that "The method or formula for allocating consideration among the
eligible members shall provide for each eligible member to receive (1) a fixed
value, amount or proportion of consideration; (2) a variable value, amount or
proportion of consideration; or (3) a combination of fixed and variable values,
amounts, or proportions of consideration." Section 2 of Chapter 9 further
requires that "Any method used or formula developed for the fair and equitable
allocation of stock among eligible members under this article must utilize
generally accepted actuarial principles."
General description of the method of allocation of consideration among
Eligible Statutory Members. In general, Statutory Members with coverage in
force on both the Board Adoption Date and the Effective Date are eligible to
receive consideration, which will consist of both a variable component and a
fixed component of consideration. The amount of such consideration, whether
actually distributed in the form of cash or shares of Common Stock, is
expressed in terms of shares of Common Stock. (For a further discussion of this
subject, see "The effect of different forms of consideration", below.)
Prior mergers. Statutory Members of Anthem Insurance include Statutory
Members whose initial eligibility arose from three companies--Southeastern
Mutual Insurance Company, Community Mutual Insurance Company, and Blue Cross &
Blue Shield of Connecticut, Inc.-- that were merged into Anthem Insurance in
1993, 1995 and 1997, respectively. The Articles of Incorporation of Anthem
Insurance contain provisions arising from these three mergers, and these
provisions in the Articles of Incorporation are important to our understanding
of the Plan and our view of the fairness and equity of the allocation. The
allocation of the Aggregate Variable Component and the Aggregate Fixed
Component, discussed below, reflects these provisions.
The Aggregate Variable Component and its allocation. The Aggregate Variable
Component is the majority of the consideration to be distributed to Eligible
Statutory Members (approximately 80%
A-2
of the total). Its allocation among the Eligible Statutory Members is based on
an "actuarial contribution method", which takes into account Actuarial
Contributions of policies held by Eligible Statutory Members. The "actuarial
contribution" method used with respect to Anthem Insurance takes into account,
at each past merger point and at the Actuarial Contribution Date, both
historical contributions to surplus and then-anticipated future contributions
to surplus. The concept of an actuarial contribution method is recognized in
the actuarial literature, most notably in Actuarial Standard of Practice number
37, "Allocation of Policyholder Consideration in Mutual Life Insurance Company
Demutualizations" ("ASOP 37") as an appropriate allocation method. While ASOP
37 does not strictly apply to a nonlife insurer such as Anthem Insurance, there
is no other Actuarial Standard of Practice regarding allocation of
consideration in a demutualization that does apply. Further, much of the health
insurance underwritten by Anthem Insurance could be underwritten by a life
insurer, to which ASOP 37 would apply. In our view, the conformance of the Plan
with ASOP 37 means that the distribution methodology proposed in the Plan is
consistent with generally accepted actuarial principles. We therefore find that
the use of the "actuarial contribution" method as the principal basis
underlying the allocation of consideration is reasonable and appropriate. We
further find that the actuarial contribution method has been implemented in a
reasonable manner, consistent with the Articles of Incorporation, as well as
with the past and present business practices of Anthem Insurance. We disclose,
as a deviation from the guidance of ASOP 37, the fact that Actuarial
Contributions of group insurance policies issued by Anthem Insurance and by the
three previously-mentioned companies that were merged into Anthem Insurance
were calculated by treating the experience of such policies on a pooled basis,
notwithstanding that some of them have historically been rated on a policy-by-
policy basis. This deviation is justified principally because of data
limitations; with respect to most of the time period over which historical
contributions to surplus were analyzed, Anthem Insurance does not have
sufficiently complete or reliable data to support a policy-by-policy analysis
of such contributions.
The Aggregate Fixed Component and its allocation. The distribution also
takes into account, through the Aggregate Fixed Component, the fact that
Statutory Members have membership rights that are independent of their
actuarial contributions. Each Eligible Statutory Member is, under the Plan,
allocated a fixed number of shares of Common Stock without regard to the
Actuarial Contribution of Policies of which that Statutory Member is the
Holder. This element of the allocation assures that each Eligible Statutory
Member will receive some distribution, and is consistent with overall concepts
of equity. Under the Plan, the percentage of the total consideration that is
allocated in this manner (approximately 20% of the total) is small relative to
that allocated in proportion to positive actuarial contributions, which is
appropriate. We find that including a fixed share in the allocation to each
Eligible Statutory Member to reflect intangible membership rights is reasonable
and appropriate.
The effect of different forms of consideration and of conditions under which
shares of Common Stock may be sold.
a. Section 6.1 of the Plan provides that, subject to the limitations set
forth therein, Eligible Statutory Members who do not affirmatively elect
to receive their consideration in the form of shares of Common Stock
may, at the option of Anthem Insurance and Anthem, Inc., receive
consideration in cash. Section 6.3 of the Plan provides that, if the
average of the closing prices ("average price") of the Common Stock for
the twenty consecutive days commencing with the Effective Date exceeds
110% of the IPO Price, each recipient of cash will receive an amount
equal to the number of shares of Common Stock determined as set forth
above multiplied by a price per share equal to the sum of the IPO Price
and either (A) the excess of the average price over 110% of the IPO
Price or (B) 10% of the IPO Price, whichever is less; otherwise, each
recipient of cash will receive an amount equal to the number of shares
of Common Stock determined as set forth above multiplied by a price per
share equal to the IPO price.
b. Section 6.2 of the Plan provides that Common Stock distributed to an
Eligible Statutory Member who receives 30,000 or more shares of such
Common Stock (a "large holder")
A-3
may be sold or otherwise transferred, during the 180 days following the
Effective Date, only under "Large holder sale program procedures and
restrictions" set forth in Exhibit E to the Plan.
We find that for recipients of cash, the adjustment to the allocation of
consideration described in (a) above is fair and equitable because it
reasonably reflects the different risks assumed by recipients of cash in
contrast to those of recipients of Common Stock. We find that for large
holders, the conditions and restrictions referred to in (b) above are fair and
equitable because in their absence, such holders might have the unfair
advantage of being able to dispose of their Common Stock on favorable terms to
the detriment of other holders of Common Stock, and that those conditions and
restrictions are not likely to impose an economic disadvantage on them.
Opinion #2
Pursuant to Article VIII of the Plan, no special provisions, such as a
closed block, are being created to preserve the dividend expectations of
policyholders and members. In our opinion, this is fair and reasonable.
Discussion
Our opinion is based on the following considerations:
1. Anthem Insurance has not paid policyholder dividends regularly enough
to create any expectations; in fact, Anthem Insurance and its predecessors
have paid no policyholder dividends for more than twenty-five years. In
addition, almost all policies are silent as to dividends or even as to
participating status vs. nonparticipating status.
2. Because there are no reasonable dividend expectations to preserve, no
special provisions are needed in the Plan.
3. Anthem Insurance has no individual life insurance policies or annuity
contracts in force, nor has it ever issued any such contracts. Thus, under
the Indiana Demutualization Law, a closed block is not required.
Sincerely yours,
/s/ Robert H. Dobson
Robert H. Dobson
Consulting Actuary
/s/ Dale S. Hagstrom
Dale S. Hagstrom
Consulting Actuary
/s/ Daniel J. McCarthy
Daniel J. McCarthy
Consulting Actuary
A-4
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No dealer, salesperson or other person is authorized to give any
information or to represent anything not contained in this prospectus. You
must not rely on any unauthorized information or representations. This
prospectus is an offer to sell only the shares offered hereby, but only under
circumstances and in jurisdictions where it is lawful to do so. The
information contained in this prospectus is current only as of its date.
----------------
TABLE OF CONTENTS
Page
----
Prospectus Summary....................................................... 1
Risk Factors............................................................. 10
Available Information.................................................... 21
Information Pertaining to Forward-Looking Statements..................... 21
The Plan of Conversion................................................... 23
Use of Proceeds.......................................................... 30
Dividend Policy.......................................................... 30
Capitalization........................................................... 31
Selected Consolidated Financial and Other Data........................... 32
Unaudited Pro Forma Consolidated Financial Information................... 35
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 40
Recent Developments...................................................... 82
The Business of Anthem................................................... 85
Investments.............................................................. 102
Financial Strength Ratings............................................... 106
Legal and Regulatory Matters............................................. 107
Management............................................................... 120
Description of Capital Stock............................................. 133
Common Stock Eligible for Future Sale.................................... 139
Ownership of Common Stock................................................ 141
Description of the Equity Security Units................................. 142
Certain United States Tax Consequences to Non-U.S. Holders of Common
Stock................................................................... 145
Underwriting............................................................. 148
Validity of Common Stock................................................. 151
Experts.................................................................. 151
Consolidated Financial Statements........................................ F-1
Actuarial Opinions....................................................... A-1
Through and including November 23, 2001 (the 25th day after the date of
this prospectus), all dealers effecting transactions in these securities,
whether or not participating in this offering, may be required to deliver a
prospectus. This is in addition to a dealer's obligation to deliver a
prospectus when acting as an underwriter and with respect to an unsold
allotment or subscription.
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48,000,000 Shares
Anthem, Inc.
Common Stock
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Goldman, Sachs & Co.
Merrill Lynch & Co.
Morgan Stanley
JPMorgan
Banc of America Securities LLC
Credit Suisse First Boston
Lehman Brothers
UBS Warburg
ABN AMRO Rothschild LLC
Dresdner Kleinwort Wasserstein
A.G. Edwards & Sons, Inc.
McDonald Investments Inc.
Utendahl Capital Partners, L.P.
Representatives of the Underwriters
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