ITEM 1. BUSINESS
Foundation Health Systems, Inc. (the "Company" or "FHS") is an integrated managed care organization which administers the delivery of managed health care services. The Company's health maintenance organizations ("HMOs"), insured preferred provider organizations ("PPOs") and government contracts subsidiaries provide health benefits to approximately 5.5 million individuals in 18 states through group, individual, Medicare risk, Medicaid and TRICARE (formerly Civilian Health and Medical Program of the Uniformed Services ("CHAMPUS")) programs. The Company's subsidiaries also offer managed health care products related to behavioral health, dental, vision and prescription drugs, and offer managed health care product coordination for multi-region employers and administrative services for medical groups and self-funded benefits programs. The Company operates and conducts its HMO and other businesses through its subsidiaries.
The Company currently operates within two segments of the managed health care industry: Health Plan Services and Government Contracts/Specialty Services. During 1999, the Health Plan Services segment consisted of four regional divisions: Arizona (Arizona and Utah), California (encompassing only the state of California), Central (Colorado, Florida, Idaho, Louisiana, New Mexico, Oklahoma, Oregon, Texas and Washington) and Northeast (Connecticut, New Jersey, New York, Ohio, Pennsylvania and West Virginia). During 1999, the Company divested its health plans or entered into arrangements to transition the membership of its health plans in the states of Colorado, Idaho, Louisiana, New Mexico, Oklahoma, Texas, Utah and Washington. See "Discontinued Operations and Anticipated Divestitures." Effective January 1, 2000, as a result of such divestitures, the Company consolidated and reorganized its Health Plan Services segment into two regional divisions, the Eastern Division (Connecticut, Florida, New Jersey, New York, Ohio, Pennsylvania and West Virginia) and the Western Division (Arizona, California and Oregon). The Company is one of the largest managed health care companies in the United States, with approximately 4 million at-risk and administrative services only ("ASO") members in its Health Plan Services segment. The Company also owns health and life insurance companies licensed to sell insurance in 33 states and the District of Columbia.
The Company's HMOs market traditional HMO products to employer groups and Medicare and Medicaid products to employer groups and directly to individuals. Health care services that are provided to the Company's commercial and individual members include primary and specialty physician care, hospital care, laboratory and radiology services, prescription drugs, dental and vision care, skilled nursing care, physical therapy and mental health. The Company's HMO service networks include approximately 56,000 primary care physicians and 69,000 specialists.
The Company's Government Contracts/Specialty Services segment consists of the Government Contracts Division and the Specialty Services Division. The Company's Government Contracts Division oversees the provision of contractual services to federal government programs such as TRICARE (formerly CHAMPUS). The Company receives revenues for administrative and management services and, under most of its contracts, also accepts financial responsibility for a portion of the health care costs. The Company's Specialty Services Division oversees the provision of supplemental programs to enrollees in the Company's HMOs, as well as to members whose basic medical coverage is provided by non-FHS companies, including vision coverage, dental coverage, managed behavioral health programs and a prescription drug program. The Specialty Services Division consists of both operations in which the Company assumes underwriting risk in return for premium revenue, and operations in which the Company provides administrative services only, including certain of the behavioral health and pharmacy benefits management programs. Such Division also provides certain bill review and third party administrative services as described elsewhere in this Annual Report.
The Company continues to evaluate the profitability realized or likely to be realized by its existing businesses and operations, and the opportunities to expand its businesses in profitable markets. In 1999,
the Company substantially completed its divestiture program by selling a PPO network subsidiary, a third-party administrator subsidiary, two Southern California hospitals, its HMO operations in Louisiana, New Mexico, Oklahoma, Texas and Utah, certain of its pharmacy benefits management assets, a regional claims processing facility and accompanying real estate in Colorado, and certain care centers and other real estate. The Company also entered into definitive agreements to transition to third parties its health plan and indemnity plan membership in the states of Colorado, Idaho and Washington. In addition, the Company purchased the remaining minority interests of FOHP, Inc., a then majority-owned subsidiary of the Company which owns a managed health care company in New Jersey. See "Discontinued Operations and Anticipated Divestitures" and "Other Information--Recent Developments."
The Company was incorporated in 1990. The current operations of the Company are the result of the April 1, 1997 merger transaction (the "FHS Combination") involving Health Systems International, Inc. ("HSI") and Foundation Health Corporation ("FHC"). Pursuant to the Agreement and Plan of Merger (the "Merger Agreement") that evidenced the FHS Combination, FH Acquisition Corp., a wholly-owned subsidiary of HSI, merged with and into FHC and FHC survived as a wholly-owned subsidiary of HSI, which changed its name to "Foundation Health Systems, Inc." and thereby became the Company.
The FHS Combination was accounted for as a pooling of interests for accounting and financial reporting purposes. The pooling of interests method of accounting is intended to present, as a single interest, two or more common stockholder interests which were previously independent and assumes that the combining companies have been merged from inception. Consequently, the Company's consolidated financial statements incorporated by reference into this Annual Report on Form 10-K have been prepared and/or restated as though HSI and FHC always had been combined on a calendar year basis.
Prior to the FHS Combination, the Company was the successor to the business conducted by Health Net, now the Company's HMO subsidiary in California, which became a subsidiary of the Company in 1992, and HMO and PPO networks operated by QualMed, Inc. ("QualMed"), which combined with the Company in 1994 to create HSI. FHC was incorporated in Delaware in 1984. The executive offices of the Company are located at 21650 Oxnard Street, Woodland Hills, CA 91367. Except as the context otherwise requires, the term "Company" refers to FHS and its subsidiaries.
HEALTH PLAN DIVISIONS
HMO AND PPO OPERATIONS. The Company's HMOs offer members a comprehensive range of health care services, including ambulatory and outpatient physician care, hospital care, pharmacy services, eye care, behavioral health and ancillary diagnostic and therapeutic services. The Company offers a full spectrum of managed health care products.
The integrated health care programs offered by the Company's HMOs include products offered through both traditional Network Model HMOs (in which the HMOs contract with individual physicians, physician groups and independent or individual practice associations ("IPAs")) and IPA Model HMOs (in which the HMOs contract with one or more IPAs that in turn subcontract with individual physicians to provide HMO patient services) which offer quality care, cost containment and comprehensive coverage; a matrix package which allows employees to select their desired coverage from alternatives that have interchangeable outpatient and inpatient co-payment levels; point-of-service programs which offer a multi-tier design that provides both conventional HMO and indemnity-like (in-network and out-of-network) tiers; a PPO-like tier which allows members to self-refer to the network physician of their choice; and a managed indemnity plan which is provided for employees who reside outside of their HMO service areas.
The Company's strategy is to offer a wide range of managed health care products and services to employers to assist them in containing health care costs. The pricing of the products offered is designed to provide incentives to both employers and employees to select and enroll in the products with greater managed health care and cost containment elements. In general, the Company's HMO subsidiaries provide comprehensive health care coverage for a fixed fee or premium that does not vary with the extent or
frequency of medical services actually received by the member. PPO enrollees choose their medical care from among the various contracting providers or choose a non-contracting provider and are reimbursed on a traditional indemnity plan basis after reaching an annual deductible. The Company assumes both underwriting and administrative expense risk in return for the premium revenue it receives from its HMO and PPO products. The Company's subsidiaries have contractual relationships with health care providers for the delivery of health care to the Company's enrollees. While a majority of the Company's members are covered by conventional HMO products, the Company is continuing to expand its other product lines, thereby enabling it to offer flexibility to an employer and to tailor its products to an employer's particular needs.
The following table contains certain information relating to commercial HMO and PPO members, Medicare members and employer groups under contract as of December 31, 1999 in each region in which the Company operated in 1999 (excluding point-of-service):
In addition, the following sets forth certain data regarding the Company's employer groups in the commercial managed care operations of its Health Plan Divisions as of December 31, 1999:
ARIZONA DIVISION
In Arizona, the Company believes that its commercial managed care operations rank it second largest both as measured by total membership and by size of provider network. The Company's commercial HMO membership in Arizona was 283,478 as of December 31, 1999. The Company's Medicare risk membership in Arizona was 56,942 as of December 31, 1999, which represented an increase of 11% during 1999. During 1999, the Arizona Division also oversaw certain of the Company's health and life insurance companies licensed to sell insurance in 33 states and the District of Columbia. In October 1999, the Company sold its HMO operations in Utah. See "Discontinued Operations and Anticipated Divestitures." Effective January 1, 2000, the Arizona Division, the California Division and the Company's HMO operations in Oregon were consolidated to form the Company's new Western Division.
CALIFORNIA DIVISION
The California market is characterized by a concentrated population. Health Net, the Company's California HMO, is believed by the Company to be the third-largest HMO in the state of California in terms of membership and the largest in terms of size of provider network. The Company's commercial HMO membership in California as of December 31, 1999 was 1,387,049, which represented a decrease of 10% during 1999. The Company's Medicare risk membership in California as of December 31, 1999 was 124,396, which represented a decrease of 3% during 1999. The decreases in commercial HMO and Medicare risk membership are due, in part, to the Company's pricing discipline and its focus on profitable accounts. The Company's Medicaid membership in California as of December 31, 1999 was 500,076 members, an increase of approximately 14% during 1999. As referenced above, effective January 1, 2000, the Arizona Division, the California Division and the Company's HMO operations in Oregon were consolidated to form the Company's new Western Division.
CENTRAL DIVISION
During 1999, the Central Division included Health Plan operations in Colorado, Florida, Idaho, Louisiana, New Mexico, Oklahoma, Oregon, Texas and Washington. During 1999, the Company sold its HMO operations in the states of Louisiana, New Mexico, Oklahoma and Texas, and a portion of its HMO operations in the state of Washington, and entered into definitive agreements to transition its HMO and indemnity membership in the states of Colorado, Idaho and Washington to third parties. See "Discontinued Operations and Anticipated Divestitures." Subsequently, the Company consolidated and reorganized its Health Plan Divisions into the Eastern Division, which consists of the Northeast Division and Florida, and the Western Division, which consists of the Arizona Division, California Division and Oregon.
The Company believes its Florida HMO and PPO operations make it the ninth largest HMO managed care provider in terms of membership and second largest HMO in terms of size of provider network in the state of Florida. The Company's commercial HMO membership in Florida was 88,064 as of December 31, 1999, which represented an increase of 5% during 1999. The Company's Medicare risk membership in Florida was 29,053 as of December 31, 1999, which represented an increase of 17% during 1999. The Company's Medicaid membership in Florida was 18,325 as of December 31, 1999, which represented a 35% decrease in 1999.
The Company believes that its Oregon HMO and PPO operations make it the sixth largest HMO managed care provider in terms of membership and third largest HMO in terms of size of provider network. The Company's commercial HMO and PPO membership in Oregon was 100,437 as of December 31, 1999, which represented a decrease of 24% during 1999. The decrease is due, in part, to the Company's pricing discipline and its focus on profitable accounts.
NORTHEAST DIVISION
During 1999, the Northeast Division included Company operations in Connecticut, New Jersey, New York, Ohio, Pennsylvania and West Virginia. As referenced above, effective January 1, 2000, the Northeast Division and the Company's operations in Florida were consolidated to form the Company's new Eastern Division.
In Connecticut, New Jersey and New York, the Company and The Guardian Life Insurance Company of America ("The Guardian") together offer both HMO and indemnity products through a joint venture doing business as "Healthcare Solutions." In general, the Company and The Guardian share equally in the profits of the joint venture, subject to certain terms of the joint venture arrangement related to expenses. The Guardian is a mutual insurer (owned by its policy owners) which offers financial products and services, including individual life and disability income insurance, employee benefits, pensions and 401(k) products. The Guardian is headquartered in New York and has more than 2,400 financial representatives in 119 general agencies.
The Company believes its Connecticut HMO and PPO operations make it the largest HMO managed care provider in terms of membership and size of provider network in the state of Connecticut. The Company's commercial HMO membership in Connecticut was 338,072 as of December 31, 1999 (including 54,681 members under The Guardian arrangement), a decrease of approximately 5% since the end of 1998. The Company's Medicare risk membership in Connecticut was 27,150 as of December 31, 1999, which represented a decrease of 39% during 1999, and the Company's Medicaid membership in Connecticut was 74,593 as of December 31, 1999, which represented an increase of 19% during 1999. The decreases in commercial HMO and Medicare risk membership are due, in part, to the Company's pricing discipline and its focus on profitable accounts.
The Company believes its New Jersey HMO and PPO operations make it the third largest HMO managed care provider in terms of membership and the second largest in terms of size of provider network in the state of New Jersey. The Company's commercial HMO membership in New Jersey was 215,473 as of
December 31, 1999 (including 83,054 members under The Guardian arrangement), a decrease of 7% since the end of 1998. The Company's Medicare risk membership in New Jersey was 1,897 as of December 31, 1999, which represented a decrease of 30% during 1999, and the Company's Medicaid membership in New Jersey was 25,698 as of December 31, 1999, which represented an increase of 16% during 1999. The decreases in commercial HMO and Medicare risk membership are due, in part, to the Company's pricing discipline and its focus on profitable accounts.
In New York, the Company had 227,119 members as of December 31, 1999, which represented an increase of 21% during 1999. Such membership included 117,009 members under The Guardian arrangement. The Company believes its New York HMO and PPO operations make it the fifth largest HMO managed care provider in terms of membership and the second largest in terms of size of provider network in the state of New York.
The Company's commercial HMO membership in eastern Pennsylvania was 41,738 as of December 31, 1999, which represented a decrease of 13% during 1999. The Company's Medicare risk membership in eastern Pennsylvania was 13,366 as of December 31, 1999, which represented a decrease of 5% during 1999. The decreases in commercial HMO and Medicare risk membership are due, in part, to the Company's pricing discipline and its focus on profitable accounts. Collectively, the Company's commercial HMO membership in Ohio, western Pennsylvania and West Virginia was approximately 16,500 as of December 31, 1999. The Company's Medicare risk membership in Ohio, western Pennsylvania and West Virginia was approximately 2,500 collectively as of December 31, 1999.
MEDICARE. The Company's Medicare+ Choice plans as of December 31, 1999 had a combined membership of approximately 265,751 compared to 322,171 as of December 31, 1998. The decrease in membership is due, in part, to exiting certain markets in connection with the substantial completion of the Company's divestiture program in 1999, the Company's pricing discipline and its focus on profitable accounts.
The Company offers its Medicare+ Choice products directly to individuals and to employer groups. To enroll in a Company Medicare+ Choice plan, covered persons must be eligible for Medicare. Health care services normally covered by Medicare are provided or arranged by the Company, in conjunction with a broad range of preventive health care services. The federal Health Care Financing Administration ("HCFA") pays the Company a monthly amount for each enrolled member based, in part, upon the "Adjusted Average Per Capita Cost," as determined by HCFA's analysis of fee-for-service costs related to beneficiary demographics. Depending on plan design and other factors, the Company may charge a monthly premium.
The Company's California Medicare+ Choice product, Seniority Plus, was licensed and certified to operate in 22 California counties as of December 31, 1999. The Company's other HMOs are licensed and certified to offer Medicare+ Choice plans in 9 counties in Pennsylvania, 34 counties in Oregon, 7 counties in Connecticut, 6 counties in Arizona, 3 counties in Florida, 20 counties in New Jersey and 12 counties in New York.
MEDICAID PRODUCTS. As of December 31, 1999, the Company had an aggregate of approximately 678,353 Medicaid members, principally in California. To enroll in these Medicaid products, an individual must be eligible for Medicaid benefits under the appropriate state regulatory requirements. The respective HMOs offer, in addition to standard Medicaid coverage, certain additional services including dental and vision benefits. The applicable state agency pays the Company's HMOs a monthly fee for each Medicaid member enrolled on a percentage of fee-for-service costs. In 1999, the Company had Medicaid members and operations in California, Connecticut, Florida, New Jersey, New York and Washington.
ADMINISTRATIVE SERVICES ONLY BUSINESS. The Company also provides third-party administrative services to large employer groups throughout its service areas. Under these arrangements, the Company provides claims processing, customer service, medical management and other administrative services without
assuming the risk for medical costs. The Company is generally compensated for these services on a fixed per member per month basis.
INDEMNITY INSURANCE PRODUCTS. The Company offers indemnity products as "stand-alone" products and as part of multiple option products in various markets. These products are offered by the Company's health and life insurance subsidiaries which are licensed to sell insurance in 33 states and the District of Columbia. Through these subsidiaries, the Company also offers HMO members certain auxiliary non-health products such as group life and accidental death and disability insurance.
The Company's health and life insurance products are provided throughout most of the Company's service areas. The following table contains certain information relating to such health and life insurance companies' insured PPO, point of service ("POS"), indemnity and group life products as of December 31, 1999 in each of the four Health Plan Divisions in which the Company operated in 1999:
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(a) Represents members under the Company's arrangement with The Guardian described elsewhere in this Annual Report on Form 10-K.
GOVERNMENT CONTRACTS DIVISION
TRICARE. The Company's wholly-owned subsidiary, Foundation Health Federal Services, Inc. ("Federal Services"), administers large, multi-year managed care federal contracts with the United States Department of Defense ("DoD").
Federal Services currently administers health care contracts for DoD's TRICARE program covering 1.5 million eligible individuals under TRICARE (formerly CHAMPUS). Through the federal government's TRICARE program, Federal Services provides TRICARE-eligible beneficiaries with improved access to care, lower out-of-pocket expenses and fewer claims forms. Federal Services currently administers three TRICARE contracts for five regions that cover the following states:
- Region 11: Washington, Oregon and part of Idaho
- Region 6: Arkansas, Oklahoma, most of Texas, and part of Louisiana
- Regions 9, 10 and 12: California, Hawaii, Alaska and part of Arizona
During 1999, enrollment of TRICARE beneficiaries in the HMO option (called "TRICARE Prime") of the TRICARE program for the Region 11 contract increased by 3% to 136,212 while the total estimated number of eligible beneficiaries, based on DoD data, decreased by 1% to 247,717. During 1999, enrollment of TRICARE beneficiaries in TRICARE Prime for the Region 6 contract increased by 13% to 364,099 while the total estimated number of eligible beneficiaries, based on DoD data, decreased by 1% to 614,166. During 1999, enrollment of TRICARE beneficiaries in TRICARE Prime for the Regions 9, 10 and 12 contract increased by 6% to 351,513 while the total estimated number of eligible beneficiaries, based on DoD data and excluding Alaska, decreased by 2% to 633,483. DoD estimated numbers of eligible beneficiaries are subject to revision when actual numbers become available.
Under the TRICARE contracts, Federal Services shares health care cost risk with DoD for both gains and losses. Federal Services subcontracts to affiliated and unrelated third parties for the administration and health care risk of parts of these contracts. If all option periods are exercised by DoD and no further extensions of the performance period are made, health care delivery ends on October 31, 2000 for the
Region 6 contract, on March 31, 2001 for the Regions 9, 10 and 12 contract, and February 28, 2002 for the Region 11 contract. The DoD Authorization Act for government fiscal year 1999 authorized DoD to extend the term of the current TRICARE contracts for two years. Federal Services and DoD negotiated a modification to the contract for Region 11 to add additional option periods which, if exercised, will extend the period of health care delivery to February 28, 2002. Federal Services and DoD are currently negotiating modifications to the contracts for Region 6 and Regions 9, 10 and 12 to add additional option periods which, if exercised, will extend the period of health care delivery to October 31, 2002 for the Region 6 contract and March 31, 2003 for the Regions 9, 10 and 12 contract. Federal Services also expects to compete for the rebid of those contracts.
Federal Services protested to the U.S. General Accounting Office (the "GAO") concerning the award of the TRICARE contract for Regions 2 and 5 (mid-Atlantic and mid-west states) to a competitor of Federal Services. The GAO sustained the protest and recommended that DoD conduct another round of competition for that contract. DoD filed a petition for reconsideration of the protest decision by the GAO. The GAO denied DoD's petition for reconsideration of the Regions 2 and 5 decision and DoD re-opened the competition for that contract on July 27, 1999. Federal Services expects to compete for the rebid of the contract for Regions 2 and 5. Proposals for the Regions 2 and 5 contract are currently due to be submitted to DoD on April 14, 2000 and health care delivery is currently scheduled to commence on September 1, 2001.
VETERANS AFFAIRS. During 1999, Federal Services administered nine contracts with the U.S. Department of Veterans Affairs to manage Community Based Outpatient Clinics ("CBOCs") in five states. Federal services also manages four contracts with the U.S. Department of Veterans Affairs for claims re-pricing services.
SPECIALTY SERVICES DIVISION
The Company's Specialty Services Division offers behavioral health, dental, vision and pharmacy benefit management products and services as well as managed care products related to bill review, administration and cost containment for hospitals, health plans and other entities.
DENTAL AND VISION. Through DentiCare of California, Inc. ("DentiCare"), the Company operates a dental HMO in California and Hawaii and performs dental administrative services for an affiliate company in California and Colorado, serving in the aggregate approximately 562,000 enrollees as of December 31, 1999. This enrollment includes 122,832 enrollees who are beneficiaries under Medicaid dental programs, of which 34,431 enrollees are beneficiaries of Hawaii's Medicaid program, and 88,401 enrollees who are also enrollees of affiliated Health Plans. DentiCare is also a participant in California's Healthy Families Program, for which initial beneficiary enrollment and service delivery commenced in July 1998. Acquired by the Company in 1991, DentiCare has grown from total revenues in 1992 of $24 million to $51 million for the year ended December 31, 1999.
Operating on administrative and information system platforms in common with DentiCare is Foundation Health Vision Services, Inc., d.b.a. AVP Vision Services ("AVP"). AVP operates in California and Arizona and provides at-risk and administrative services under various programs that result in the delivery of vision benefits to over 685,000 enrollees. Total revenues from AVP operations for the year ended December 31, 1999 were $11 million. Since its acquisition by the Company in 1992, AVP has grown from 30,000 covered enrollees to 423,000 enrollees in full-risk products and 262,000 enrollees covered under administrative services contracts as of December 31, 1999.
Both DentiCare and AVP are licensed in California under the Knox-Keene Health Care Service Plan Act of 1975, as amended (the "Knox-Keene Act"), as Specialized Health Care Service Plans, and compete with other HMOs, traditional insurance companies, self-funded plans, PPOs and discounted fee-for-service plans. The two companies share a common strategy to maximize the value and quality of managed dental
and vision care services while appropriately balancing financial risk assumption among providers, enrollees and other entities to achieve the effective and efficient use of available resources.
BEHAVIORAL HEALTH. The Company's behavioral health subsidiary, Managed Health Network ("MHN"), is licensed in California under the Knox-Keene Act as a Specialized Health Care Service Plan. MHN, directly and through Specialty Services affiliates, offers behavioral health, substance abuse and employee assistance programs ("EAPs") on an insured and self-funded basis to employers, governmental entities and other payors in various states.
MHN provides managed behavioral health programs to employers, governmental agencies and public entitlement programs, such as TRICARE and Medicaid. Employer group sizes range from Fortune 100 to mid-sized companies with 200 employees. MHN's strategy is to continue its market share achievement in the Fortune 500, health plan and TRICARE markets through a combination of direct and consultant/ broker sales. MHN intends to achieve additional market share by capitalizing on competitor consolidation, remaining TRICARE procurement opportunities and the growing state and county Medicaid behavioral carve-outs, funded on either a risk or administrative-services-only ("ASO") basis.
These products and services were provided to over 8.6 million individuals in the year ended December 31, 1999, with approximately 3.6 million individuals under risk-based programs, approximately 1.4 million individuals under self-funded programs, and approximately 3.6 million individuals under EAP programs.
WORKERS' COMPENSATION ADMINISTRATIVE SERVICES. The Company's subsidiaries organized under Employer & Occupational Services Group, Inc. ("EOS"), formerly WC Division, Inc., provide a full range of workers' compensation administrative services to insurers, self-funded employers, third-party claims administrators and public agencies. These services include injury reporting and provider referral, automated bill review and PPO network access, field and telephonic case management, direction of care and practice management, claim/benefit administration, claim investigation and adjudication, litigation management and employer personnel services. During 1999, EOS' Managed Care Services unit provided services on more than $1.2 billion of billed charges for medical care for covered beneficiaries of its customers. The unit processed over 2.6 million bills from providers and hospitals located in 50 states and handled 90,000 intake calls resulting in the processing of over 47,000 injury reports and 40,000 medical care cases referred for case management services and/or utilization review services. EOS' Claims Administration Services unit handled more than 26,000 claims, with aggregate benefit payments by its payor customers in excess of $237 million. Also, EOS' Employment Services unit, a temporary staffing and direct placement service for managed care, workers' compensation and information technology specialists, placed 3,200 temporary assignments and had 127 personnel available for assignment in 14 states.
PHARMACY BENEFIT MANAGEMENT. Effective March 31, 1999, the Company sold certain pharmacy benefit management assets to Advance Paradigm, Inc. ("Advance Paradigm"). In addition, the Company and Advance Paradigm entered into a services agreement, whereby Advance Paradigm provides to the Company's Health Plan Divisions certain pharmacy benefit management services, primarily, processing of claims with respect to pharmacy benefits, mail order service and retail pharmacy network management. See "Discontinued Operations and Anticipated Divestitures." The Company continues to manage drug manufacturer rebates, clinical management of the pharmacy benefit and pharmacy reporting.
PROVIDER RELATIONSHIPS AND RESPONSIBILITIES
PHYSICIAN RELATIONSHIPS. Upon enrollment in most of the Company's HMO plans, each member selects a participating physician group ("PPG") or primary care physician from the HMO's provider panel. The primary care physicians and PPGs assume overall responsibility for the care of members. Medical care provided directly by such physicians includes the treatment of illnesses not requiring referral, as well as physical examinations, routine immunizations, maternity and child care, and other preventive health
services. The primary care physicians and PPGs are responsible for making referrals (approved by the HMO's or PPG's medical director) to specialists and hospitals. Certain Company HMOs offer enrollees "open panels" under which members may access any physician in the network without first consulting a primary care physician.
The following table sets forth the number of primary care and specialist physicians with whom the Company's HMOs (and certain of such HMOs' PPGs) were contracted as of December 31, 1999 in each of the four Health Plan Divisions operated by the Company in 1999:
PPG and physician contracts are generally for a period of at least one year and are automatically renewable unless terminated, with certain requirements for maintenance of good professional standing and compliance with the Company's quality, utilization and administrative procedures. In California PPGs generally receive a monthly "capitation" fee for every member served. The capitation fee represents payment in full for all medical and ancillary services specified in the provider agreements. The non-physician component of all hospital services is covered by a combination of capitation and/or per diem charges. In such capitated arrangements, in cases where the capitated provider cannot provide the health care services needed, such providers generally contract with specialists and other ancillary service providers to furnish the requisite services pursuant to capitation agreements or negotiated fee schedules with specialists. Many of the Company's HMOs outside California reimburse physicians according to a discounted fee-for-service schedule, although several HMOs have commenced capitation arrangements with certain providers and provider groups in their market areas.
HOSPITAL RELATIONSHIPS. The Company's HMOs arrange for hospital care primarily through contracts with selected hospitals in their service areas. Such hospital contracts generally provide for multi-year terms and provide for payments on a variety of bases, including capitation, per diem rates, case rates and discounted fee-for-service schedules.
Covered inpatient hospital care for a member is comprehensive; it includes the services of physicians, nurses and other hospital personnel, room and board, intensive care, laboratory and x-ray services, diagnostic imaging and generally all other services normally provided by acute-care hospitals. HMO or PPG nurses and medical directors are actively involved in discharge planning and case management, which often involves the coordination of community support services, including visiting nurses, physical therapy, durable medical equipment and home intravenous therapy.
In August 1999, the Company sold two hospitals which it owned and operated: a 128-bed hospital located in Los Angeles, California, the East Los Angeles Doctors Hospital, and a 200-bed hospital located in Gardena, California, the Memorial Hospital of Gardena. See "Discontinued Operations and Anticipated Divestitures."
COST CONTAINMENT. In most HMO plan designs, the primary care physician or PPG is responsible for authorizing all needed medical care except for emergency medical services. By coordinating care through such physicians in cases where reimbursement includes risk-sharing arrangements, the Company believes that inappropriate use of medical resources is reduced and efficiencies are achieved.
To limit possible abuse in utilization of hospital services in non-emergency situations, a certification process precedes the inpatient admission of each member, followed by continuing review during the member's hospital stay. In addition to reviewing the appropriateness of hospital admissions and continued
hospital stay, the Company plays an active role in evaluating alternative means of providing care to members and encourages the use of outpatient care, when appropriate, to reduce the cost that would otherwise be associated with an inpatient admission.
QUALITY ASSESSMENT. Quality assessment is a continuing priority for the Company. Most of the Company's health plans have a quality assessment plan administered by a committee comprised of medical directors and primary care and specialist physicians. The committees' responsibilities include periodic review of medical records, development and implementation of standards of care based on current medical literature and community standards, and the collection of data relating to results of treatment. All of the Company's health plans also have a subscriber grievance procedure and/or a member satisfaction program designed to respond promptly to member grievances. Aspects of such member service programs take place both within the PPGs and within the Company's health plans. Set forth under the heading "National Committee for Quality Assurance" below is information regarding certain quality assessment accreditations received by the Company's subsidiaries.
Health Benchmarks, Inc. ("HBI"), formerly the Company's Quality Initiatives Division, was incorporated in 1999 as a wholly-owned subsidiary of the Company. HBI is a health services information company which provides services to the managed care sector, employers and the pharmaceutical industry. These services include data management (data warehouse tools) and data analysis, pharmacoeconomic analysis, Phase III and IV clinical trial support, and disease management programs and services that support NCQA and Health Plan Employer Data and Information Set ("HEDIS") initiatives. HBI assists decision-makers in allocating health resources cost-effectively through evidence-based programs. HBI also supports certain quality assessment activities of the Company's health plans. In addition, HBI designs, implements and administers performance-based contracting programs for hospitals and physicians on behalf of managed care companies.
MANAGEMENT INFORMATION SYSTEMS
Effective information technology systems are critical to the Company's operations. The Company's information technology systems include several computer systems, each utilizing a combination of packaged and customized software and a network of on-line terminals. The information technology systems gather and store data on the Company's members and physician and hospital providers. The systems contain all of the Company's necessary membership and claims-processing capabilities as well as marketing and medical utilization programs. These systems provide the Company with an integrated and efficient system of billing, reporting, member services and claims processing, and the ability to examine member encounter information for the optimization of clinical outcomes.
The Company implemented a Year 2000 project to address the challenges posed by the "Year 2000" issue. The Year 2000 issue is the result of computer programs having been written in a language that used two digits rather than four to define the applicable year. Any of the Company's computer programs (both external and internal) that have date/time sensitive software and the outdated software language may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or material miscalculations causing disruptions of operations, including, among other things, the inability to process transactions, prepare invoices or engage in normal business activities. As of March 15, 2000, the Company has not identified any significant disruptions or operational problems resulting from Year 2000 issues. There can be no assurance, however, that the Company will not still experience significant Year 2000 problems, including as a result of third party Year 2000 problems.
The costs of the Company's Year 2000 project are set forth under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's 1999 Annual Report to Stockholders attached as an exhibit to this Annual Report on Form 10-K.
DISCONTINUED OPERATIONS AND ANTICIPATED DIVESTITURES
PHARMACY BENEFIT MANAGEMENT ASSETS. On March 31, 1999, the Company completed the sale to Advance Paradigm of the capital stock of Foundation Health Pharmaceutical Services, Inc., and certain pharmacy benefit management assets of Integrated Pharmaceutical Services for approximately $65 million in cash. In addition, the Company and Advance Paradigm entered into a services agreement, whereby Advance Paradigm provides to the Company's Health Plan Divisions certain pharmacy benefit management services, primarily, processing of claims with respect to pharmacy benefits, mail order service and retail pharmacy network management. For a period of five years, the Company may not compete with respect to such services in any market in which Advance Paradigm conducts business, subject to certain exceptions.
LOUISIANA, OKLAHOMA AND TEXAS HMO OPERATIONS. On April 30, 1999, the Company completed the sale of its HMO operations in the states of Texas, Louisiana and Oklahoma to AmCareco, Inc. As part of the transaction, the Company received convertible preferred stock of the buyer and cash in excess of certain statutory surplus and minimum working capital requirements of the plans sold.
PREFERRED HEALTH NETWORK, INC. In May 1999, the Company sold the capital stock of Preferred Health Network, Inc., a PPO network ("PHN"), to Beyond Benefits, Inc. PHN and the Company, or certain affiliates thereof, entered into agreements at closing to provide each other with certain continued access to each other's networks.
SOUTHERN CALIFORNIA HOSPITALS. In August 1999, the Company sold East Los Angeles Doctors Hospital and Memorial Hospital of Gardena, two Southern California hospitals, to HealthPlus+ Corporation and certain affiliated entities. Certain subsidiaries of the Company continue to maintain contractual arrangements with the hospitals following the sale.
FHPA. In September 1999, the Company sold the capital stock of Foundation Health Preferred Administrators, Inc., a third-party administrator subsidiary of the Company, to Capitol Administrators, Inc.
NEW MEXICO OPERATIONS. In September 1999, the Company sold the capital stock of QualMed Plans for Health, Inc., the Company's HMO subsidiary in the state of New Mexico, to Health Care Horizons, Inc.
UTAH OPERATIONS. In October 1999, the Company sold the outstanding capital stock of Intergroup of Utah, Inc., the Company's HMO subsidiary in the state of Utah, to Altius Health Plans Inc.
HN REINSURANCE LIMITED. In October 1999, the Company sold the outstanding capital stock of HN Reinsurance Limited, a Cayman Island reinsurance subsidiary, to AmCareco, Inc.
COLORADO OPERATIONS. In November 1999, the Company commenced the transition of its membership in Colorado to PacifiCare of Colorado, Inc. ("PacifiCare-CO") pursuant to a definitive agreement with PacifiCare-CO. The Company believes the transition will be completed during the first half of 2000. Pursuant to the definitive agreement, PacifiCare-CO is offering replacement coverage to substantially all of the Company's Colorado HMO membership and PacifiCare Life Assurance Company is issuing replacement indemnity coverage to substantially all of the Company's Colorado POS membership. PacifiCare-CO is offering to enroll such HMO members at the earliest date possible in comparable PacifiCare-CO benefit plans within PacifiCare-CO's service area at PacifiCare's rates.
In August 1999, in connection with the Company's wind down of its business in Colorado, the Company sold its regional claims processing facility and accompanying real estate in Pueblo, Colorado, including certain equipment and other assets located at the facility, to the Pueblo Economic Development Company for total aggregate proceeds of approximately $5 million and certain other consideration
(including a complete release from the City of Pueblo of liabilities arising out of certain agreements between the City and the Company).
WASHINGTON OPERATIONS. In December 1999, the Company sold the capital stock of QualMed Washington Health Plan, Inc., the Company's HMO subsidiary in the state of Washington ("QM-Washington"), to American Family Care Inc. ("AFC"). AFC assumed control of the health-plan license and acquired the Medicaid and Basic Health Plan membership of QM-Washington. The commercial HMO membership of QM-Washington is being transitioned to PacifiCare of Washington, Inc. ("PacifiCare-WA"), Premera Blue Cross and Blue Cross of Idaho pursuant to definitive agreements with such companies. As part of such agreements, PacifiCare-WA will offer replacement coverage to QM-Washington's HMO and POS groups in western Washington, Premera Blue Cross will offer replacement coverage to substantially all of QM-Washington's HMO and POS group membership in eastern Washington and Blue Cross of Idaho will offer replacement coverage for certain members who reside in Idaho. Replacement coverage will consist of the new company's benefit plans in the new company's service areas at the new company's rates. The transition commenced in January 2000 and is anticipated to be substantially completed during the first half of 2000.
QUALMED PLANS FOR HEALTH OF PENNSYLVANIA, INC. Effective December 31, 1998, the Company purchased the minority interests in QualMed Plans for Health of Pennsylvania, Inc. ("QualMed-PA"), a then majority-owned subsidiary of the Company. Previously, the Company owned approximately 83% of the common stock of QualMed-PA. In January 1999, the Company transferred certain assets of QualMed-PA, including the assets relating to its preferred provider organization, MaxNet-Registered Trademark-, to Preferred Health Network, Inc., then another wholly-owned subsidiary of the Company. As set forth above in this "Discontinued Operations and Anticipated Divestitures," the Company subsequently sold the capital stock of Preferred Health Network, Inc.
INSURANCE SUBSIDIARIES. In July 1999, the Company completed the restructuring of certain of its insurance subsidiaries by merging Foundation Health National Life Insurance Company ("FHNL") with Foundation Health Systems Life and Health Insurance Company ("FHS Life") under a holding company subsidiary of the Company, FHS Life Holdings Company, Inc.
GEM INSURANCE COMPANY. Since October of 1997, Gem Insurance Company ("Gem"), a subsidiary of the Company, has implemented a restructuring plan to reduce operating losses and its in-force insurance risk. As part of such restructuring, Gem is withdrawing from certain insurance markets. Upon completion of its current withdrawals, Gem will be operating in only two states. As of December 31, 1999, the number of Gem's insureds was under 1,000. Currently, Foundation Health Systems Life and Health Insurance Company, a subsidiary of the Company, services Gem's insureds through an administrative services agreement between the companies. The Company is reviewing the possibility of winding up the operations of Gem or merging such operations into another insurance subsidiary of the Company.
REAL ESTATE TRANSACTIONS. During 1999, the Company completed the sale of nine health care centers for net proceeds of approximately $17.6 million. Such care centers were part of fourteen care centers originally leased to, and subsequently vacated by, FPA Medical Management, Inc. As of March 17, 2000, the Company has sold twelve such care centers. As set forth above, in August 1999, in connection with the Company's wind down of its business in Colorado, the Company sold its regional claims processing facility and accompanying real estate in Pueblo, Colorado, including certain equipment and other assets located at the facility, to the Pueblo Economic Development Company for total aggregate proceeds of approximately $5 million and certain other consideration. In addition, in 1999, the Company sold a land parcel in Roseville, California and certain other real estate located in Pueblo, Colorado for aggregate net proceeds of approximately $913,000.
CERTAIN OTHER OPERATIONS. The Company continues to evaluate the profitability realized or likely to be realized by its existing businesses and operations, and is reviewing from a strategic standpoint which of such businesses or operations should be divested.
ADDITIONAL INFORMATION CONCERNING THE COMPANY'S BUSINESS
MARKETING AND SALES. Marketing for group Health Plan business is a two-step process in which the Company first markets to employer groups and then provides information directly to employees once the employer has selected a Company HMO. The Company typically uses its internal sales staff to serve the large employer groups while independent brokers work with the Company's internal sales staff to develop business with smaller employer groups. Once selected by an employer, the Company solicits enrollees from the employee base directly. In 1999, the Company marketed its programs and services primarily through its direct sales staff and independent brokers, agents and consultants. During "open enrollment" periods when employees are permitted to change health care programs, the Company uses direct mail, work day and health fair presentations, telemarketing, outdoor print, radio and television advertisements to attract new enrollees. The Company's sales efforts are supported by its marketing division which includes research and product development, corporate communications, public relations and marketing services.
Premiums for each employer group are generally contracted for on a yearly basis, payable monthly. Numerous factors are considered by the Company in fixing its monthly premiums, including employer group needs and anticipated health-care utilization rates as forecasted by the Company's management based on the demographic composition of, and the Company's prior experience in, its service areas. Premiums are also affected by applicable regulations that prohibit experience rating of group accounts (i.e., setting the premium for the group based on its past use of health care services) and by state regulations governing the manner in which premiums are structured.
The Company believes that the importance of the ultimate health care consumer (or member) in the health care product purchasing process is likely to increase in the future. Accordingly, the Company intends to focus its marketing strategies on the development of distinct brand identities and innovative product service offerings that will appeal to potential Health Plan members.
COMPETITION. HMOs operate in a highly competitive environment in an industry currently subject to significant changes from business consolidations, new strategic alliances, legislative reform and market pressures brought about by a better informed and better organized customer base. The Company's HMOs face substantial competition from for-profit and nonprofit HMOs, PPOs, self-funded plans (including self-insured employers and union trust funds), Blue Cross/Blue Shield plans, and traditional indemnity insurance carriers, some of which have substantially larger enrollments and greater financial resources than the Company. The Company believes that the principal competitive features affecting its ability to retain and increase membership include the range and prices of benefit plans offered, provider network, quality of service, responsiveness to user demands, financial stability, comprehensiveness of coverage, diversity of product offerings, and market presence and reputation. The relative importance of each of these features and key competitors vary by market. The Company believes that it competes effectively with respect to all of these factors.
Kaiser Foundation Health Plan ("Kaiser") is the largest HMO in California and is a competitor of the Company in the California HMO industry. In addition to Kaiser, the Company's other HMO competitors include PacifiCare of California, California Care (Blue Cross), Blue Shield, Aetna and CIGNA Healthplans of California, Inc. There are also a number of other types of competitors including self-directed plans, traditional indemnity insurance plans, and other managed care plans. Despite the concentration of membership in the large health plans, the environment in the state is also impacted by small, regional-based HMOs, whose combined membership constitutes approximately 20-25% of the market. In addition, the Company competes in California against a variety of PPOs.
The Company's largest competitor in Arizona is Health Partners. The Company's Arizona HMO also competes with CIGNA, PacifiCare, Aetna and Blue Cross/Blue Shield. The Company's Oregon HMO competes primarily against other HMOs including Kaiser, PacifiCare of Oregon, Providence, Blue Cross Lifewise and Blue Shield Regions, and with various PPOs.
The Company's HMOs in Connecticut compete for business with commercial insurance carriers, Blue Cross and Blue Shield of Connecticut, Aetna/U.S. Healthcare and more than ten other HMOs. The Company's main competitors in Pennsylvania, New York and New Jersey are Aetna/U.S. Healthcare, Independence Blue Cross, Empire Blue Cross, Oxford Health Plans, AmeriHealth, United Health Care, Horizon Blue Cross and Keystone Health Plan East. The Company's HMO operations in Florida compete for business with Humana Medical Plan, United Health Care, Health Options and Prudential HealthCare, among others.
In 1999, the Company sold its HMO operations in Louisiana, New Mexico, Oklahoma, Texas and Utah, and a portion of its HMO operations in Washington, and entered into definitive agreements to transition its HMO and indemnity membership in Colorado, Idaho and Washington to third parties. See "Discontinued Operations and Anticipated Divestitures."
GOVERNMENT REGULATION. The Company believes it is in compliance in all material respects with all current state and federal regulatory requirements applicable to the business being conducted by its subsidiaries. Certain of these requirements are discussed below.
CALIFORNIA HMO REGULATIONS. California HMOs such as Health Net and certain of the Company's specialty plans are subject to California state regulation, principally by the DOC under the Knox-Keene Act. In 1999, California enacted a law transferring jurisdiction of the Knox-Keene Act to a new agency, the Department of Managed Care, which will become effective no later than July 1, 2000. Among the areas regulated by the Knox-Keene Act are: (i) adequacy of administrative operations, (ii) the scope of benefits required to be made available to members, (iii) manner in which premiums are structured, (iv) procedures for review of quality assurance, (v) enrollment requirements, (vi) composition of policy making bodies to assure that plan members have access to representation, (vii) procedures for resolving grievances, (viii) the interrelationship between HMOs and their health care providers, (ix) adequacy and accessibility of the network of health care providers, (x) provider contracts, and (xi) initial and continuing financial viability of the HMO and its risk-bearing providers. Any material modifications to the organization or operations of Health Net are subject to prior review and approval by the DOC. This approval process can be lengthy and there is no certainty of approval. Other significant changes require filing with the DOC, which may then comment and require changes. In addition, under the Knox-Keene Act, Health Net and certain other Company subsidiaries must file periodic reports with, and are subject to periodic review and investigation by, the DOC. Non-compliance with the Knox-Keene Act may result in an enforcement action, fines and penalties, and in egregious cases, limitations on or revocation of the Knox-Keene license.
The DOC has also required the Company and its Knox-Keene licensed subsidiaries to provide the DOC with a number of undertakings in connection with the FHS Combination and the merger of the Company's two California full-service HMOs in 1998. These undertakings obligate the affected companies to certain requirements not applicable to licensees generally, or prohibit or require regulatory approval preceding the institution of certain changes. While the Company has been permitted to withdraw a number of these undertakings, others remain in effect and constrain the Company's flexibility of operations. The Company does not believe, however, that the remaining undertakings have a material adverse effect on the Company and its licensees taken as a whole.
FEDERAL HMO REGULATION. Under the Federal Health Maintenance Organization Act of 1973 (the "HMO Act"), services to members must be provided substantially on a fixed, prepaid basis without regard to the actual degree of utilization of services. Premiums established by an HMO may vary from account to account through composite rate factors and special treatment of certain broad classes of members, and through prospective (but not retrospective) rating adjustments. Several of the Company's HMOs are federally qualified in certain parts of their respective service areas under the HMO Act and are therefore subject to the requirements of such act to the extent federally qualified products are offered and sold.
Additionally, there are a number of recently enacted federal laws that further regulate managed health care. Such legislation includes the Balanced Budget Act of 1997 and the Health Insurance Portability and Accountability Act of 1996 ("HIPAA"). The primary effects of HIPAA are that it (i) limits pre-existing condition exclusions applicable to individuals changing jobs or moving to individual coverage, (ii) guarantees the availability of health insurance for employees in the small group market and (iii) prevents the exclusion of individuals from coverage under group plans based on health status.
The Company's Medicare risk contracts are subject to regulation by HCFA. HCFA has the right to audit HMOs operating under Medicare contracts to determine the quality of care being rendered and the degree of compliance with HCFA's contracts and regulations. The Company's Medicaid business is also subject to regulation by HCFA, as well as state agencies.
PENDING FEDERAL AND STATE LEGISLATION. There are a number of initiatives and regulations currently pending at the federal and state level which could increase regulation of the health care industry. Such legislation includes "managed care reform," "patients bill of rights," regulations under HIPAA and certain other initiatives which, if enacted, could have significant adverse effects on the Company's operations. See "Item 4 - -Cautionary Statements--Federal and State Legislation." The Company cannot predict the outcome of any of the pending legislative or regulatory proposals, nor the extent to which the Company may be affected by the enactment of any such legislation or regulation.
OTHER HMO REGULATIONS. In each state in which the Company does business, HMOs must file periodic reports with, and their operations are subject to periodic examination by, state licensing authorities. In addition, each HMO must meet numerous state licensing criteria and secure the approval of state licensing authorities before implementing certain operational changes, including the development of new product offerings and, in some states, the expansion of service areas. To remain licensed, each HMO must continue to comply with state laws and regulations and may from time to time be required to change services, procedures or other aspects of its operations to comply with changes in applicable laws and regulations. HMOs are required by state law to meet certain minimum capital and deposit and/or reserve requirements in each state and may be restricted from paying dividends to their parent corporations under certain circumstances from time to time. Several states have increased minimum capital requirements, pursuant to proposals by the National Association of Insurance Commissioners to institute risk-based capital requirements. Regulations in these and other states may be changed in the future to further increase equity requirements. Such increases could require the Company to contribute additional capital to its HMOs. Any adverse change in governmental regulation or in the regulatory climate in any state could materially impact the HMOs operating in that state. The HMO Act and state laws place various restrictions on the ability of HMOs to price their products freely. The Company must comply with certain provisions of state insurance and similar laws, including regulations governing the Company's ability to seek ownership interests in new HMOs, PPOs and insurance companies, or otherwise expand its geographic markets or diversify its product lines.
INSURANCE REGULATIONS. State departments of insurance (the "DOIs") regulate insurance and third-party administrator business conducted by certain subsidiaries of the Company (the "Insurance Subsidiaries") pursuant to various provisions of state insurance codes and regulations promulgated thereunder. The Insurance Subsidiaries are subject to various capital reserve and other financial, operating and disclosure requirements established by the DOIs and state laws. The Insurance Subsidiaries must also file periodic reports regarding their activities regulated by the DOIs and are subject to periodic reviews of those activities by the DOIs. The Company must also obtain approval from, or file copies with, the DOIs for all of its group and individual policies prior to issuing those policies. The Company does not believe that the requirements imposed by the DOIs will have a material impact on the ability of the Insurance Subsidiaries to conduct their business profitably.
NATIONAL COMMITTEE FOR QUALITY ASSURANCE ("NCQA"). NCQA is an independent, non-profit organization that reviews and accredits HMOs and assesses an HMO's quality improvement, utilization management, credentialing process, commitment to members' rights and preventive health services. HMOs that comply with NCQA's review requirements and quality standards receive NCQA accreditation. After an NCQA review is completed, NCQA will issue one of four designations. These are (i) accreditation for three years; (ii) accreditation for one year; (iii) provisional accreditation for twelve to eighteen months to correct certain problems with a follow-up review to determine qualification for accreditation; and (iv) not accredited. Foundation Health, A Florida Health Plan, Inc.; Health Net, the Company's HMO in California; and Intergroup Prepaid Health Services of Arizona, Inc., the Company's HMO in Arizona, have all received NCQA accreditations for three years. QualMed Plans for Health, Inc. (Pennsylvania) and QualMed Plans for Health of Western Pennsylvania, Inc. have each received one year provisional accreditation from NCQA. QualMed Plans for Health of Ohio and West Virginia, Inc. applied for NCQA accreditation in October 1998, but did not receive it. Certain of the Company's other Health Plan subsidiaries are in the process of applying for NCQA accreditation.
SERVICE MARKS
The Company's service marks and/or trademarks include, among others: THE ACUTE CARE ALTERNATIVE-Registered Trademark-, Alliance 2000-SM- Alliance 1000-SM-, Asthmawise-SM-, AVP-SM-, AVP Vision Plans-SM-, BabyWell-SM-, BEING WELL-Registered Trademark-, CARECAID-Registered Trademark-, CMP-Registered Trademark-, COMBINED CARE-Registered Trademark-, COMBINED CARE PLUS-SM-, COMMUNITY MEDICAL PLAN, INC. and design-Registered Trademark-, A CURE FOR THE COMMON HMO-Registered Trademark-, Feetbeat Worksite Walking Program-SM-, FIRM SOLUTIONS-Registered Trademark-, FLEX ADVANTAGE-Registered Trademark-, FLEX NET-SM-, FOUNDATION HEALTH and design-Registered Trademark-, FOUNDATION HEALTH GOLD-Registered Trademark-, Foundation Health Systems-SM-, HANK-Registered Trademark-, HANK and design-Registered Trademark-, HEALTH NET-Registered Trademark-, Health Net ACCESS-SM-, Health Net Comp.24-SM-, Health Net ELECT-SM-, Health Net INSIGHT-SM-, Health Net OPTIONS-SM-, Health Net SELECT-SM-, Health Net Seniority Plus-SM-, Health Smart and design-SM-, Healthworks (stylized)-SM-, Heart & Soul-SM-, IMET and design-Registered Trademark-, Indian design-Registered Trademark-, INDIVIDUAL PREFERRED PPO-Registered Trademark-, InterCare-SM-, InterComp-SM-, InterFlex-SM-, Inter Mountain Employers Trust-SM-, InterPlus-SM-, LIFE WITH DIGNITY AND HOPE-Registered Trademark-, MAKING QUALITY HEALTH CARE AFFORDABLE-Registered Trademark-, M.D. Health Plan Personal Medical Management-SM-, On the Road to Good Health-SM-, PHYSICIANS HEALTH SERVICES-Registered Trademark-, QUALASSIST-Registered Trademark-, QUALADMIT-Registered Trademark-, QUALCARE-Registered Trademark-, QUALCARE PREFERRED-Registered Trademark-, QUAL-MED-Registered Trademark-, QUALMED-SM-, QUALMED HEALTH & LIFE INSURANCE COMPANY-Registered Trademark-, QUALMED PLANS FOR HEALTH-Registered Trademark-, Rapid Access-SM-, SENIOR SECURITY-Registered Trademark-, SENIOR VALUE-Registered Trademark-, Someone at Your Side-SM-, Sun/Mountain design-Registered Trademark-, The Final Piece of the Healthcare Puzzle-SM-, VitalLine-SM-, VITALTEAM-Registered Trademark-, WELL MANAGED CARE RIGHT FROM THE START-Registered Trademark-, WELL REWARDS-Registered Trademark-, Well Woman-SM-, Wise Choice-SM-, WORKING WELL TOGETHER-Registered Trademark-, and Your Partner in Healthy Living-SM-, and certain designs related to the foregoing.
The Company utilizes these and other marks in connection with the marketing and identification of products and services. The Company believes such marks are valuable and material to its marketing efforts.
EMPLOYEES
The Company currently employs approximately 12,000 employees, excluding temporary employees. Such employees perform a variety of functions, including administrative services for employers, providers and members, negotiation of agreements with physician groups, hospitals, pharmacies and other health care providers, handling claims for payment of hospital and other services, and providing data processing services. The Company's employees are not unionized and the Company has not experienced any work stoppage since its organization. The Company considers its relations with its employees to be very good.
In connection with the FHS Combination, the Company adopted a significant restructuring plan which provides for a workforce reduction, the consolidation of employee benefit plans and the consolidation of certain office locations, which the Company has been effectuating. In addition, the Company's
substantial completion of its divestiture program in 1999 resulted in additional workforce reductions and operational consolidations.
ITEM 2.
ITEM 2. PROPERTIES
The Company leases office space for its principal executive offices in Woodland Hills, California and its offices in Rancho Cordova, California.
The Woodland Hills facility, with approximately 410,000 square feet, is leased pursuant to two leases, the earlier of which expires in December 2001 with respect to 300,000 square feet. The Company has a right to renew each of such leases. The aggregate rent for the two leases for 1999 was approximately $11.1 million. The Company's principal executive offices are located in the Woodland Hills facility, as are much of the Company's California HMO operations.
The Company and its subsidiaries also lease an aggregate of approximately 390,000 square feet of office space in Rancho Cordova, California. The Company's aggregate rent obligations under these leases were approximately $6.1 million in 1999. These leases expire at various dates through January 2003. The Rancho Cordova facilities serve as a regional data processing center and house certain Specialty Services and California HMO operations.
The Company also leases a total of approximately 250,000 square feet of office space in Irvine, California and San Rafael, California for certain Specialty Services operations. In addition to the Company's office space referenced above, the Company and its subsidiaries lease approximately 140 sites in 23 states, comprising roughly 1.85 million square feet of space.
In addition, the Company owns facilities comprising, in the aggregate, nearly 1.1 million square feet of space. These facilities include headquarters for the Company's health plan subsidiaries in Connecticut and Arizona, as well as data processing facilities located in Rancho Cordova, California. The Company is currently considering the sale of certain care centers in California and Arizona.
In August 1999, in connection with the Company's wind down of its business in Colorado, the Company sold its regional claims processing facility and accompanying real estate in Pueblo, Colorado, including certain equipment and other assets located at the facility. See "Discontinued Operations and Anticipated Divestitures." Such facility consisted of approximately 72,500 square feet of office space. The Company is in the process of selling certain remaining facilities in Pueblo, Colorado. Also in August 1999, the Company sold two Southern California hospitals owned and operated by the Company, which hospitals comprised approximately 250,000 square feet of space.
Management believes that its ownership and rental costs are consistent with those available for similar space in the applicable local area. The Company's properties are well maintained, considered adequate and are being utilized for their intended purposes.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
MEDAPHIS CORPORATION
In July 1996, the Company's predecessor, HSI, the owner of 1,234,544 shares of Series F Preferred Stock of Health Data Sciences Corporation ("HDS"), voted its HDS shares in favor of the acquisition of HDS by Medaphis Corporation ("Medaphis"). HSI received as the result of the acquisition 976,771 shares of Medaphis common stock in exchange for its Series F Preferred Stock. In November 1996, HSI filed a lawsuit against Medaphis and its former Chairman and Chief Executive Officer. The Company alleged that Medaphis and certain insiders deceived the Company by presenting materially false financial statements and by failing to disclose that Medaphis would shortly reveal a "write off" of up to $40 million in reorganization costs and would lower its earnings estimate for the following year, thereby more than halving the value of the Medaphis shares received by the Company.
In September 1999, the Company and Medaphis (which changed its name to Per-Se Technologies, Inc. ("Per-Se")) entered into a Settlement Agreement and Release pursuant to which the Company received net proceeds of approximately $25 million consisting of cash from Per-Se and Per-Se's insurers and proceeds from the sale of both the 976,771 shares of Medaphis (now Per-Se) common stock then owned by the Company and additional shares of Per-Se common stock issued to the Company as part of the settlement. In exchange, the Company and Per-Se terminated the ongoing litigation and granted each other a general release.
FPA MEDICAL MANAGEMENT, INC.
Since May 1998, several complaints (the "FPA Complaints") have been filed in federal and state courts seeking an unspecified amount of damages on behalf of an alleged class of persons who purchased shares of common stock, convertible debentures and options to purchase common stock of FPA Medical Management, Inc. ("FPA") at various times between February 3, 1997 and May 15, 1998. The FPA Complaints name as defendants FPA, certain of FPA's auditors, the Company and certain of the Company's former officers. The FPA Complaints allege that the Company and such former officers violated federal and state securities laws by misrepresenting and failing to disclose certain information about a 1996 transaction between the Company and FPA, about FPA's business and about the Company's 1997 sale of FPA common stock held by the Company. All claims against the Company's former officers were voluntarily dismissed from the consolidated class actions in both federal and state court. The Company has filed a motion to dismiss all claims asserted against it in the consolidated federal class actions but has not formally responded to the other complaints. Management believes these suits against the Company and its former officers are without merit and intends to defend the actions vigorously.
PAY V. FOUNDATION HEALTH SYSTEMS, INC.
On November 22, 1999, a complaint was filed in the United States District Court for the Southern District of Mississippi in a lawsuit entitled PAY V. FOUNDATION HEALTH SYSTEMS, INC. (2:99CV329). The two count complaint seeks certification of a nationwide class action and alleges that cost containment measures used by FHS-affiliated health maintenance organizations, preferred provider organizations and point-of-service health plans violate provisions of the federal Racketeer Influenced and Corrupt Organizations Act ("RICO") and the federal Employee Retirement Income Security Act ("ERISA"). The action seeks unspecified damages and injunctive relief. On January 24, 2000, FHS filed a motion to stay consideration of class certification issues until the resolution of a motion to transfer or dismiss the action for lack of jurisdiction and venue. On January 25, 2000, the court stayed the case pending resolution of matters in an action pending in the Southern District of Mississippi against Humana, Inc. Management believes the suit is without merit and intends to vigorously defend the action.
BAJA INC. V. LOS ANGELES MEDICAL MANAGEMENT CORP., EAST LOS ANGELES DOCTORS HOSPITAL FOUNDATION, INC.
In September 1983, a lawsuit was filed in Los Angeles Superior Court by Baja Inc. ("Baja") against East Los Angeles Doctors Hospital Foundation, Inc. ("Hospital") and Century Medicorp ("Century") arising out of a multi-phase written contract for operation of a pharmacy at the Hospital during the period September 1978 through September 1983. In October 1992, Foundation Health Corporation, now a subsidiary of the Company, acquired the Hospital and Century, and thereafter continued the vigorous defense of this action. In August 1993, the Court awarded Baja $549,532 on a portion of its claim. In December 1994, the Court concluded that Baja also could seek certain additional damages subject to proof. On July 5, 1995, the Court awarded Baja an additional $1,015,173 (plus interest) in lost profits damages. In October 1995, both of the parties appealed. The Court of Appeal reversed portions of the judgment, directing the trial court to conduct additional hearings on Baja's damages. In January 2000, after further proceedings on the issue of Baja's lost profits, the Court awarded Baja an additional $4,996,019,
plus prejudgment interest. The Company is in the process of preparing appropriate post trial motions in this case, and is also considering an appeal of the Court's final judgment.
STATE OF CONNECTICUT V. PHYSICIANS HEALTH SERVICES, INC.
Physicians Health Services, Inc. ("PHS"), a subsidiary of the Company, was sued on Dec. 14, 1999 in the United States District Court in Connecticut by the Attorney General of Connecticut, Richard Blumenthal, acting on behalf of a group of state residents. The lawsuit is premised on ERISA, and alleges that PHS has violated its duties under that Act by managing its prescription drug formulary in a manner that serves its own financial interest rather than those of plan beneficiaries. The suit seeks to have PHS revamp its formulary system, and to provide patients with written denial notices and instructions on how to appeal. PHS intends to defend the suit vigorously, and has filed a motion to dismiss which asserts that the state residents the Attorney General purports to represent all received a prescription drug appropriate for their conditions and therefore suffered no injuries whatsoever, that his office lacks standing to bring the suit and that the allegations fail to state a claim under ERISA. The State must file an answer to the motion by March 15, 2000, and a decision is expected this spring.
MISCELLANEOUS PROCEEDINGS
The Company and certain of its subsidiaries are also parties to various other legal proceedings, many of which involve claims for coverage encountered in the ordinary course of its business. Based in part on advice from litigation counsel to the Company and upon information presently available, management of the Company is of the opinion that the final outcome of all such proceedings should not have a material adverse effect upon the Company's results of operations or financial condition.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of the security holders of the Company, either through solicitation of proxies or otherwise, during the fourth quarter of the year ended December 31, 1999.
OTHER INFORMATION
REVOLVING CREDIT FACILITY
The Company has an unsecured, five-year $1.5 billion revolving credit facility pursuant to a Credit Agreement dated July 8, 1997 (the "Credit Agreement") with the banks identified in the Credit Agreement (the "Banks") and Bank of America National Trust and Savings Association ("Bank of America") as Administrative Agent. All previous revolving credit facilities were terminated and rolled into the Credit Agreement. The Credit Agreement contains customary representations and warranties, affirmative and negative covenants, and events of default. Specifically, Section 7.11 of the Credit Agreement provides that the Company and its subsidiaries may, so long as no event of default exists: (i) declare and distribute stock as a dividend; (ii) purchase, redeem or acquire its stock, options and warrants with the proceeds of concurrent public offerings; and (iii) declare and pay dividends or purchase, redeem or otherwise acquire its capital stock, warrants, options or similar rights with cash subject to certain specified limitations.
Under the Credit Agreement, as amended pursuant to a Letter Agreement dated as of March 27, 1998, the First Amendment and Waiver to Credit Agreement dated as of April 6, 1998, the Second Amendment to Credit Agreement dated as of July 31, 1998, the Third Amendment to Credit Agreement dated as of November 6, 1998 and the Fourth Amendment of Credit Agreement dated as of March 26, 1999 (collectively, the "Amendments") with the Banks, the Company is: (i) obligated to maintain certain covenants keyed to the Company's financial condition and performance (including a Total Leverage Ratio and Fixed Charge Ratio); (ii) obligated to limit liens; (iii) subject to customary covenants, including (A) disposition of assets only in the ordinary course and generally at fair value and (B) restrictions on acquisitions, mergers, consolidations, loans, leases, joint ventures, contingent obligations and certain
transactions with affiliates; and (iv) permitted to incur additional indebtedness in an aggregate amount not to exceed $1,000,000,000 upon certain terms and conditions. The Credit Agreement also provides for mandatory prepayment of the outstanding loans under the Credit Agreement with a certain portion of the proceeds from the issuance of such indebtedness and from the sales of assets, resulting in a permanent reduction of the aggregate amount of commitments under the Credit Agreement by the amount so prepaid. As of December 31, 1999, the maximum commitment level permitted under the Credit Agreement was approximately $1.37 billion, of which approximately $330 million remained available. The Amendments also provided for an increase in the interest and facility fees under the Credit Agreement.
SHAREHOLDER RIGHTS PLAN
On May 20, 1996, the Board of Directors of the Company declared a dividend distribution of one right (a "Right") for each outstanding share of the Company's Class A Common Stock and Class B Common Stock (collectively, the "Common Stock"), to stockholders of record at the close of business on July 31, 1996 (the "Record Date"). The Board of Directors of the Company also authorized the issuance of one Right for each share of Common Stock issued after the Record Date and prior to the earliest of the Distribution Date (as defined below), the redemption of the Rights and the expiration of the Rights, and in certain other circumstances. Rights will attach to all Common Stock certificates representing shares then outstanding and no separate Rights certificates will be distributed. Subject to certain exceptions contained in the Rights Agreement dated as of June 1, 1996 by and between the Company and Harris Trust and Savings Bank, as Rights Agent (the "Rights Agreement"), the Rights will separate from the Common Stock in the event any person acquires 15% or more of the outstanding Class A Common Stock, the Board of Directors of the Company declares a holder of 10% or more of the outstanding Class A Common Stock to be an "Adverse Person," or any person commences a tender offer for 15% or more of the Class A Common Stock (each event causing a "Distribution Date").
Except as set forth below and subject to adjustment as provided in the Rights Agreement, each Right entitles its registered holder, upon the occurrence of a Distribution Date, to purchase from the Company one one-thousandth of a share of Series A Junior Participating Preferred Stock at a price of $170.00 per one-thousandth share. However, in the event any person acquires or commences a tender offer for 15% or more of the outstanding Class A Common Stock, or the Board of Directors of the Company declares a holder of 10% or more of the outstanding Class A Common Stock to be an "Adverse Person," the Rights (subject to certain exceptions contained in the Rights Agreement) will instead become exercisable for Class A Common Stock having a market value at such time equal to $340.00. The Rights are redeemable under certain circumstances at $.01 per Right and will expire, unless earlier redeemed, on July 31, 2006.
A copy of the Rights Agreement has been filed with the Securities and Exchange Commission as Exhibit 99.1 to the Company's Registration Statement on Form 8-A (File No. 001-12718). In connection with its execution of the Merger Agreement for the merger transaction involving Foundation Health Corporation and Health Systems International, Inc., the Company's predecessors, the Company entered into Amendment No. 1 (the "Rights Amendment") to the Rights Agreement to exempt the Merger Agreement and related transactions from triggering the Rights. In addition, the Rights Amendment modifies certain terms of the Rights Agreement applicable to the determination of certain "Adverse Persons," which modifications became effective upon consummation of the transactions provided for under the Merger Agreement. This summary description of the Rights does not purport to be complete and is qualified in its entirely by reference to the Rights Agreement.
THE CALIFORNIA WELLNESS FOUNDATION
Pursuant to the Amended California Wellness Foundation Shareholder Agreement, dated as of January 28, 1992 (the "CWF Shareholder Agreement"), by and among the Company, The California Wellness Foundation (the "CWF"), and certain stockholders (the "HNMH Stockholders") of HN Management Holdings, Inc. (a predecessor to the Company) ("HNMH") named therein, the CWF was subject to various volume and manner of sale restrictions specified in the CWF Shareholder Agreement which limited the number of shares of Class B Common Stock that the CWF could dispose of prior to December 31, 1998. The CWF and the Company are also party to a Registration Rights Agreement dated as of March 2, 1995 (the "CWF Registration Rights Agreement") pursuant to which the CWF has the right to demand registration for sale in underwritten public offerings of up to 8,026,298 shares of Class B Common Stock.
Under the relevant provisions of California law, when a corporation converts from nonprofit to for-profit corporate status, the equivalent of the fair market value of the nonprofit corporation must be contributed to a successor charity that has a charitable purpose consistent with the purposes of the nonprofit entity. The CWF was formed to be the charitable recipient of the conversion settlement when Health Net (a subsidiary of the Company) effected a conversion from nonprofit to for-profit status, which occurred in February 1992 (the "Conversion"). In connection with the Conversion, Health Net issued to the CWF promissory notes in the original principal amount of $225 million (the "CWF Notes") and shares of Class B Common Stock (which immediately prior to the business combination involving HNMH and QualMed, Inc. were split to become 25,684,152 shares of Class B Common Stock then held by the CWF). While such shares are held by the CWF, they are entitled to the same economic benefit as Class A Common Stock, but are non-voting in nature. If the CWF sells or transfers such shares to an unrelated third party, they automatically convert to Class A Common Stock.
Pursuant to certain agreements with the CWF, the Company redeemed 4,550,000 shares of Class B Common Stock from the CWF on June 27, 1997. The CWF has also sold shares of Class B Common Stock to unrelated third parties, which shares of common stock automatically converted into shares of Class A Common Stock at the time of such sales.
As a result of various sales of Class B Common Stock by CWF, CWF has gradually reduced its holdings and, as of March 17, 2000, held 563,742 shares of Class B Common Stock. On November 15, 1999, $13,482,745, representing the remaining principal and interest under the CWF Notes, was paid off. As a result, the CWF Notes are no longer outstanding.
CAUTIONARY STATEMENTS
In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company is hereby filing cautionary statements identifying important risk factors that could cause the Company's actual results to differ materially from those projected in forward-looking statements of the Company made by or on behalf of the Company.
The Company wishes to caution readers that these factors, among others, could cause the Company's actual financial or enrollment results to differ materially from those expressed in any projected, estimated or forward-looking statements relating to the Company. The following factors should be considered in conjunction with any discussion of operations or results by the Company or its representatives, including any forward-looking discussion, as well as comments contained in press releases, presentations to securities analysts or investors, or other communications by the Company.
In making these statements, the Company is not undertaking to address or update each factor in future filings or communications regarding the Company's business or results, and is not undertaking to address how any of these factors may have caused changes to discussions or information contained in previous filings or communications. In addition, certain of these matters may have affected the Company's past results and may affect future results.
HEALTH CARE COSTS. A large portion of the revenue received by the Company is expended to pay the costs of health care services or supplies delivered to its members. The total health care costs incurred by the Company are affected by the number of individual services rendered and the cost of each service. Much of the Company's premium revenue is set in advance of the actual delivery of services and the related incurring of the cost, usually on a prospective annual basis. While the Company attempts to base the premiums it charges at least in part on its estimate of expected health care costs over the fixed premium period, competition, regulations and other circumstances may limit the Company's ability to fully base premiums on estimated costs. In addition, many factors may and often do cause actual health care costs to exceed those costs estimated and reflected in premiums. These factors may include increased utilization of services, increased cost of individual services, catastrophes, epidemics, seasonality, new mandated benefits or other regulatory changes, and insured population characteristics.
The managed health care industry is labor intensive and its profit margin is low. Hence, it is especially sensitive to inflation. Health care industry costs have been rising annually at rates higher than the Consumer Price Index. Increases in medical expenses without corresponding increases in premiums could have a material adverse effect on the Company.
PHARMACEUTICAL COSTS. The costs of pharmaceutical products and services are increasing faster than the costs of other medical products and services. Thus, the Company's HMOs face ever higher pharmaceutical expenses. The inability to manage pharmaceutical costs could have an adverse effect on the Company's financial condition.
MEDICAL MANAGEMENT. The Company's profitability is dependent, to a large extent, upon its ability to accurately project and manage health care costs, including without limitation, appropriate benefit design, utilization review and case management programs, and to secure appropriate risk-sharing arrangements with providers, while providing members with quality health care. For example, high out-of-network utilization of health care providers and services may have significant adverse affects on the Company's ability to manage health care costs and member utilization of health care. There can be no assurance that the Company through its medical management programs will be able to continue to manage medical costs sufficiently to restore and/or maintain profitability in all of its product lines.
FEDERAL AND STATE LEGISLATION. There are numerous legislative proposals currently before Congress and the state legislatures which, if enacted, could materially affect the managed health care industry and the regulatory environment. Recent financial difficulties of certain health care service providers and plans and/or continued publicity of the health care industry could alter or increase legislative consideration of these or additional proposals. These proposals include "managed care reform," "patients bill of rights" and certain other initiatives which, if enacted, could have significant adverse effects on the Company's operations. Such measures propose, among other things, to:
- expand a health plan's exposure to tort and other liability, under federal and/or state law, including for coverage determinations and provider malpractice and care decisions;
- restrict a health plan's ability to limit coverage to medically necessary care;
- require third party review of certain care decisions;
- expedite or modify grievance and appeals procedures;
- mandate certain benefits and services that could increase costs;
- limit a health plan's ability to use medical information for managed care coordination, disease management and research;
- mandate additional administrative oversight and structure for handling medical information;
- restrict a health plan's ability to select and/or terminate providers; and
- restrict or eliminate the use of prescription drug formularies.
In particular, the Department of Health and Human Services has proposed certain regulations under the Health Insurance Portability and Accountability Act of 1996. Currently, the primary effects of HIPAA are that it (i) limits pre-existing condition exclusions applicable to individuals changing jobs or moving to
individual coverage, (ii) guarantees the availability of health insurance for employees in the small group market and (iii) prevents the exclusion of individuals from coverage under group plans based on health status. The proposed regulations under HIPAA could significantly impact how individually identifiable health information is stored and disclosed, as well as materially increase the responsibilities, and potential liabilities, of parties who handle such information. While such regulations have not yet been enacted and are subject to change, there can be no assurance that such regulations or similar regulations will not be enacted.
The Company cannot predict the outcome of any of these legislative or regulatory proposals, nor the extent to which the Company may be affected by the enactment of any such legislation or regulation. Legislation or regulation which causes the Company to change its current manner of operation or increases its exposure to liability could have a material adverse effect on the Company's results of operations, financial condition and ability to compete.
COMPETITION. The Company competes with a number of other entities in the geographic and product markets in which it operates, some of which other entities may have certain characteristics, capabilities or resources which give them an advantage in competing with the Company. These competitors include HMOs, PPOs, self-funded employers, insurance companies, hospitals, health care facilities and other health care providers. The Company believes there are few barriers to entry in these markets, so that the addition of new competitors can readily occur. Certain of the Company's customers may decide to perform for themselves functions or services currently provided by the Company, which could result in a decrease in the Company's revenues. Certain of the Company's providers may decide to market products and services to Company customers in competition with the Company. In addition, significant merger and acquisition activity has occurred in the industry in which the Company operates as well as in industries which act as suppliers to the Company such as the hospital, physician, pharmaceutical and medical device industries. This activity may create stronger competitors and/or result in higher health care costs. Provider service organizations may be created by health care providers to offer competing managed care products. To the extent that there is strong competition or that competition intensifies in any market, the Company's ability to retain or increase customers, its revenue growth, its pricing flexibility, its control over medical cost trends and its marketing expenses may all be adversely affected.
PROVIDER RELATIONS. One of the significant techniques the Company uses to manage health care costs and utilization and to monitor the quality of care being delivered is to contract with physicians, hospitals and other providers. Because of the large number of providers with which the Company's health plans contract, the Company currently believes it has a limited exposure to provider relations issues. In any particular market, however, providers could refuse to contract with the Company, demand higher payments or take other actions which could result in higher health care costs, less desirable products for customers and members, insufficient provider access for current members or to support growth, or difficulty in meeting regulatory or accreditation requirements.
In some markets, certain providers, particularly hospitals, physician/hospital organizations or multi-specialty physician groups, may have significant market positions or even monopolies. Many of these providers may compete directly with the Company. If such providers refuse to contract with the Company or utilize their market position to negotiate favorable contracts or place the Company at a competitive disadvantage, the Company's ability to market products or to be profitable in those areas could be adversely affected.
The Company contracts with providers in California and to a lesser degree in other areas, primarily through capitation fee arrangements. Under a capitation fee arrangement, the Company pays the provider a fixed amount per member on a regular basis and the provider accepts the risk of the frequency and cost of member utilization of services. Providers who enter into such arrangements generally contract with specialists and other secondary providers to provide services not offered by the primary provider. The inability of providers to properly manage costs under capitation arrangements can result in financial instability of such providers and the termination of their relationship with the Company. In addition,
payment or other disputes between the primary provider and specialists with whom it contracts can result in a disruption in the provision of services to the Company's members or a reduction in the services available. A primary provider's financial instability or failure to pay secondary providers for services rendered could lead secondary providers to demand payment from the Company, even though the Company has made its regular capitated payments to the primary provider. Depending on state law, the Company could be liable for such claims. In California, the liability of the Company's HMO subsidiaries for unpaid provider claims has not been definitively settled. There can be no assurance that the Company's subsidiaries will not be liable for unpaid provider claims. There can also be no assurance that providers with whom the Company contracts will properly manage the costs of services, maintain financial solvency or avoid disputes with secondary providers, the failure of any of which could have an adverse effect on the provision of services to members and the Company's operations.
MARKETING. The Company markets its products and services through both employed sales people and independent sales agents. Although the Company has a number of such sales employees and agents, if certain key sales employees or agents or a large subset of such individuals were to leave the Company, its ability to retain existing customers and members could be impaired. In addition, certain of the Company's customers or potential customers consider rating, accreditation or certification of the Company by various private or governmental bodies or rating agencies necessary or important. Certain of the Company's health plans or other business units may not have obtained or may not desire or be able to obtain or maintain such accreditation or certification which could adversely affect the Company's ability to obtain or retain business with such customers.
The managed health care industry has recently received a significant amount of negative publicity. Such general publicity, or any negative publicity regarding the Company in particular, could adversely affect the Company's ability to sell its products or services, could require changes to the Company's products or services, or could create regulatory problems for the Company. In this connection, certain of the Company's subsidiaries have experienced significant negative enrollment trends in certain lines of business. Furthermore, the managed care industry recently has experienced significant merger and acquisition activity. Speculation, uncertainty or negative publicity about the Company or certain of its lines of business could adversely affect the ability of the Company to market its products.
GOVERNMENT PROGRAMS AND REGULATION. The Company's business is subject to extensive federal and state laws and regulations, including, but not limited to, financial requirements, licensing requirements, enrollment requirements and periodic examinations by governmental agencies. The laws and rules governing the Company's business and interpretations of those laws and rules are subject to frequent change. For example, as described earlier in this Annual Report on Form 10-K, in the section entitled "California HMO Regulations," the California legislature has recently made significant changes to the laws regulating HMOs operating in that state. Existing or future laws and rules could force the Company to change how it does business and may restrict the Company's revenue and/or enrollment growth, and/or increase its health care and administrative costs, and/or increase the Company's exposure to liability with respect to members, providers or others. In particular, the Company's HMO and insurance subsidiaries are subject to regulations relating to cash reserves, minimum net worth, premium rates, and approval of policy language and benefits. Although such regulations have not significantly impeded the growth of the Company's business to date, there can be no assurance that the Company will be able to continue to obtain or maintain required governmental approvals or licenses or that regulatory changes will not have a material adverse effect on the Company's business. Delays in obtaining or failure to obtain or maintain such approvals, or moratoria imposed by regulatory authorities, could adversely affect the Company's revenue or the number of its members, increase costs or adversely affect the Company's ability to bring new products to market as forecasted. In addition, efforts to enact changes to Medicare could impact the structure of the Medicare program, benefit designs and reimbursement. Changes to the current operation of the Company's Medicare services could have a material adverse affect on the Company's results of operations.
A significant portion of the Company's revenues relate to federal, state and local government health care coverage programs, such as Medicare and Medicaid programs. Such contracts carry certain risks such as higher comparative medical costs, government regulatory and reporting requirements, the possibility of reduced or insufficient government reimbursement in the future, and higher marketing and advertising costs per member as a result of marketing to individuals as opposed to groups. Such risk contracts also are generally subject to frequent change including changes which may reduce the number of persons enrolled or eligible, reduce the revenue received by the Company or increase the Company's administrative or health care costs under such programs. In the event government reimbursement were to decline from projected amounts, the Company's failure to reduce the health care costs associated with such programs could have a material adverse effect upon the Company's business. Changes to such government programs in the future may also affect the Company's willingness to participate in such programs.
The Company is also subject to various governmental audits and investigations. Such activities could result in the loss of licensure or the right to participate in certain programs, or the imposition of fines, penalties and other sanctions. In addition, disclosure of any adverse investigation or audit results or sanctions could negatively affect the Company's reputation in various markets and make it more difficult for the Company to sell its products and services.
The amount of government receivables set forth in the Company's financial statements represents the Company's best estimate of the government's liability. As of December 31, 1999, the Company's government receivables were $290.3 million. The receivables are estimates and generally subject to government audit and negotiation. In addition, inherent in government contracts are an uncertainty of and vulnerability to government disagreements. The final amounts actually received by the Company may be significantly greater or less than the amounts recognized by the Company.
MANAGEMENT INFORMATION SYSTEMS. The Company's business is significantly dependent on effective information systems. The information gathered and processed by the Company's management information systems assists the Company in, among other things, pricing its services, monitoring utilization and other cost factors, processing provider claims, billing its customers on a timely basis and identifying accounts for collection. The Company's customers and providers also depend upon the Company's information systems for membership verification, claims status and other information. The Company has many different information systems for its various businesses and such systems require continual maintenance, upgrading and enhancement to meet the Company's operational needs. Moreover, the merger, acquisition and divestiture activity of the Company requires frequent transitions to or from, and the integration of, various information management systems. The Company is in the process of attempting to reduce the number of its systems and also to upgrade and expand its information systems capabilities. Any difficulty associated with the transition to or from information systems, any inability or failure to properly maintain management information systems, or any inability or failure to successfully update or expand processing capability in the future in accordance with the Company's business needs, could result in operational disruptions, loss of existing customers and difficulty in attracting new customers, customer and provider disputes, regulatory problems, increases in administrative expenses and/or other adverse consequences. In addition, the Company may, from time-to-time, obtain significant portions of its systems-related or other services or facilities from independent third parties which may make the Company's operations vulnerable to such third parties' failure to perform adequately.
The Company undertook an extensive effort to assess and modify its computer applications and business processes to provide for their continued functionality in light of the "Year 2000" issue. The "Year 2000" issue is the result of computer programs having been written in a language that used two digits rather than four to define the applicable year. Any of the Company's computer programs that have time sensitive software and the outdated software language may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, prepare invoices or engage in normal business activities.
As of March 15, 2000, the Company has not identified any significant disruptions or operational problems resulting from Year 2000 issues. In addition, the Company is not aware of any significant problems experienced by delegated authorities or strategically important third parties that would have a material adverse impact on the Company's operations. There can be no assurance, however, that the Company will not still experience significant disruptions or operational problems related to Year 2000 issues, including as a result of Year 2000 problems experienced by third parties.
The costs of the Company's Year 2000 project are set forth under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's 1999 Annual Report to Stockholders attached as an exhibit to this Annual Report on Form 10-K.
ADMINISTRATION AND MANAGEMENT. The level of administrative expense is a partial determinant of the Company's profitability. While the Company attempts to effectively manage such expenses, increases in staff-related and other administrative expenses may occur from time to time due to business or product start-ups or expansions, growth or changes in business, acquisitions, regulatory requirements or other reasons. Such expense increases are not clearly predictable and increases in administrative expenses may adversely affect results.
The Company currently believes it has a relatively experienced, capable management staff. Loss of certain managers or a number of such managers could adversely affect the Company's ability to administer and manage its business.
MANAGEMENT OF GROWTH. The Company has made several large acquisitions in recent years, and continues to explore acquisition opportunities. Failure to effectively integrate acquired operations could result in increased administrative costs or customer confusion or dissatisfaction. The Company may also not be able to manage this growth effectively, including not being able to continue to develop processes and systems to support growing operations. There can be no assurance that the Company will be able to maintain its historic growth rate or efficiently or effectively expand its operations.
POTENTIAL DIVESTITURES. In 1999, the Company substantially completed a program to divest certain non-core assets. There can be no assurance that indemnification obligations, unknown liabilities or unforeseen post-transaction costs related to such transactions will not have an adverse effect on the Company's business or financial condition. Furthermore, there can be no assurance that, having divested such non-core operations, the Company will be able to achieve greater profitability, or any profitability, strengthen its core operations or compete more effectively in its existing markets. In addition, the Company continues to evaluate the profitability realized or likely to be realized by its existing businesses and operations, and is reviewing from a strategic standpoint which of its businesses or operations should be divested. Entering into, evaluating or consummating divestiture transactions may entail certain risks and uncertainties in addition to those which may result from any such change in the Company's business operations, including but not limited to extraordinary transaction costs, unknown indemnification liabilities or unforeseen administrative needs, any of which could result in reduced revenues, increased charges, post-transaction administrative costs or could otherwise have a material adverse effect on the Company's business, financial condition or results of operations. See "Discontinued Operations and Anticipated Divestitures."
LOSS RESERVES. The Company's loss reserves are estimates of future costs based on various assumptions. The accuracy of these estimates may be affected by external forces such as changes in the rate of inflation, the regulatory environment, the judicious administration of claims, medical costs and other factors. Included in the loss reserves are estimates for the costs of services which have been incurred but not reported ("IBNR"). Estimates are continually monitored and reviewed and, as settlements are made or estimates adjusted, differences are reflected in current operations. Such estimates are subject to the impact of changes in the regulatory environment and economic conditions. Given the inherent variability of such estimates, the actual liability could differ significantly from the amounts provided. Moreover, if the assumptions on which the estimates are based prove to be incorrect and reserves are inadequate to cover the Company's actual experience, the Company's financial condition could be adversely affected.
LITIGATION AND INSURANCE. The Company is subject to a variety of legal actions to which any corporation may be subject, including employment and employment discrimination-related suits, employee benefit claims, breach of contract actions, tort claims, shareholder suits, including for securities fraud, and intellectual property related litigation. In addition, because of the nature of its business, the Company incurs and likely will continue to incur potential liability for claims related to its business, such as failure to pay for or provide health care, poor outcomes for care delivered or arranged, provider disputes, including disputes over withheld compensation, and claims related to self-funded business. In some cases, substantial non-economic or punitive damages may be sought. While the Company currently has insurance coverage for some of these potential liabilities, others may not be covered by insurance (such as punitive damages), the insurers may dispute coverage or the amount of insurance may not be enough to cover the damages awarded. In addition, insurance coverage for all or certain forms of liability may become unavailable or prohibitively expensive in the future.
STOCK MARKET. Recently, the market prices of the securities of certain of the publicly-held companies in the industry in which the Company operates have shown volatility and sensitivity in response to many factors, including public communications regarding managed care, legislative or regulatory actions, litigation or threatened litigation, health care cost trends, pricing trends, competition, earning or membership reports of particular industry participants, and acquisition activity. There can be no assurances regarding the level or stability of the Company's share price at any time or the impact of these or any other factors on the share price.
RECENT DEVELOPMENTS
PHARMACY BENEFITS MANAGEMENT ASSETS. On March 31, 1999, the Company completed the sale to Advance Paradigm of the capital stock of Foundation Health Pharmaceutical Services, Inc., and certain pharmacy benefit management assets of Integrated Pharmaceutical Services for approximately $65 million in cash. In addition, the Company and Advance Paradigm entered into a services agreement, whereby Advance Paradigm provides to the Company's Health Plan Divisions certain pharmacy benefit management services, primarily, processing of claims with respect to pharmacy benefits, mail order service and retail pharmacy network management. For a period of five years, the Company may not compete with respect to such services in any market in which Advance Paradigm conducts business, subject to certain exceptions.
LOUISIANA, OKLAHOMA AND TEXAS HMO OPERATIONS. On April 30, 1999, the Company completed the sale of its HMO operations in the states of Texas, Louisiana and Oklahoma to AmCareco, Inc. As part of the transaction, the Company received convertible preferred stock of the buyer and cash in excess of certain statutory surplus and minimum working capital requirements of the plans sold.
PREFERRED HEALTH NETWORK, INC. In May 1999, the Company sold the capital stock of Preferred Health Network, Inc., a PPO network ("PHN"), to Beyond Benefits, Inc. PHN and the Company, or certain affiliates thereof, entered into agreements at closing to provide each other with certain continued access to each other's networks.
SOUTHERN CALIFORNIA HOSPITALS. In August 1999, the Company sold East Los Angeles Doctor's Hospital and Memorial Hospital of Gardena, two Southern California hospitals, to HealthPlus+ Corporation and certain affiliated entities. Certain subsidiaries of the Company continue to maintain contractual arrangements with the hospitals following the sale.
FHPA. In September 1999, the Company sold the capital stock of Foundation Health Preferred Administrators, Inc., a third-party administrator subsidiary of the Company, to Capitol Administrators, Inc.
NEW MEXICO OPERATIONS. In September 1999, the Company sold the capital stock of QualMed Plans for Health, Inc., the Company's HMO subsidiary in the state of New Mexico, to Health Care Horizons, Inc.
UTAH OPERATIONS. In October 1999, the Company sold the outstanding capital stock of Intergroup of Utah, Inc., the Company's HMO subsidiary in the state of Utah, to Altius Health Plans Inc.
HN REINSURANCE LIMITED. In October 1999, the Company sold the outstanding capital stock of HN Reinsurance Limited, a Cayman Island reinsurance subsidiary, to AmCareco, Inc.
COLORADO OPERATIONS. Effective November 16, 1999, the Company commenced the transition of its membership in Colorado to PacifiCare of Colorado, Inc. ("PacifiCare-CO") pursuant to a definitive agreement with PacifiCare-CO. The Company believes the transition will be completed during the first half of 2000. Pursuant to the definitive agreement, PacifiCare-CO is offering replacement coverage to substantially all of the Company's Colorado HMO membership and PacifiCare Life Assurance Company is issuing replacement indemnity coverage to substantially all of the Company's Colorado POS membership. PacifiCare-CO is offering to enroll such HMO members at the earliest date possible in comparable PacifiCare-CO benefit plans within PacifiCare-CO's service area at PacifiCare's rates.
In August 1999, in connection with the Company's wind down of its business in Colorado, the Company sold its regional claims processing facility and accompanying real estate in Pueblo, Colorado, including certain equipment and other assets located at the facility, to the Pueblo Economic Development Company for total aggregate proceeds of approximately $5 million and certain other consideration (including a complete release from the City of Pueblo of liabilities arising out of certain agreements between the City and the Company).
WASHINGTON OPERATIONS. In December 1999, the Company sold the capital stock of QualMed Washington Health Plan, Inc., the Company's HMO subsidiary in the state of Washington ("QM-Washington"), to American Family Care Inc. ("AFC"). AFC assumed control of the health-plan license and acquired the Medicaid and Basic Health Plan membership of QM-Washington. The commercial HMO membership of QM-Washington is being transitioned to PacifiCare of Washington, Inc. ("PacifiCare-WA"), Premera Blue Cross and Blue Cross of Idaho pursuant to definitive agreements with such companies. As part of such agreements, PacifiCare-WA will offer replacement coverage to QM-Washington's HMO and POS groups in western Washington, Premera Blue Cross will offer replacement coverage to substantially all of QM-Washington's HMO and POS group membership in eastern Washington and Blue Cross of Idaho will offer replacement coverage for certain members who reside in Idaho. Replacement coverage will consist of the new company's benefit plans in the new company's service areas at the new company's rates. The transition commenced on January 1, 2000 and is anticipated to be substantially completed during the first half of 2000.
MEDAPHIS. In July 1996, the Company's predecessor, HSI, the owner of 1,234,544 shares of Series F Preferred Stock of Health Data Sciences Corporation ("HDS"), voted its HDS shares in favor of the acquisition of HDS by Medaphis Corporation ("Medaphis"). HSI received as the result of the acquisition 976,771 shares of Medaphis common stock in exchange for its Series F Preferred Stock. In November 1996, HSI filed a lawsuit against Medaphis and its former Chairman and Chief Executive Officer. The Company alleged that Medaphis and certain insiders deceived the Company by presenting materially false financial statements and by failing to disclose that Medaphis would shortly reveal a "write off" of up to $40 million in reorganization costs and would lower its earnings estimate for the following year, thereby more than halving the value of the Medaphis shares received by the Company.
In September 1999, the Company and Medaphis (which changed its name to Per-Se Technologies, Inc. ("Per-Se")) entered into a Settlement Agreement and Release pursuant to which the Company received net proceeds of approximately $25 million consisting of cash from Per-Se and Per-Se's insurers and proceeds from the sale of both the 976,771 shares of Medaphis (now Per-Se) common stock then owned by
the Company and additional shares of Per-Se common stock issued to the Company as part of the settlement. In exchange, the Company and Per-Se terminated the ongoing litigation and granted each other a general release.
MEDPARTNERS PROVIDER NETWORK, INC. On March 11, 1999, MedPartners Provider Network, Inc. ("MPN"), a Knox-Keene licensed entity and a subsidiary of MedPartners, Inc., a publicly-held physician practice and pharmacy benefit management company (now known as Caremark Rx, Inc.) was placed into conservatorship by the State of California under Section 1393(c) of the California Health and Safety Code. The conservator immediately filed a petition under Chapter 11 of the Bankruptcy Code on behalf of MPN.
MedPartners, Inc., MPN and the State of California executed an Amended and Restated Operations and Settlement Agreement dated as of June 16, 1999 (the "O&S Agreement"), containing the basic principles for an orderly transition of the California operations of MedPartners, Inc., and the resolution of unpaid provider claims. A Bankruptcy Court Order approving the O&S Agreement was obtained by MPN on July 19, 1999. Although court approval of the O&S Agreement has been obtained, a number of conditions subsequent and third party consents required by such agreement are yet to occur or be obtained before the transactions reflected therein will become effective.
At this time, no assurances can be given that a final settlement agreement on the terms reflected in the O&S Agreement will become effective or be implemented. In the event of a final implementation of a settlement on the terms reflected in the O&S Agreement, the Company believes that the bankruptcy of MPN will not have a material adverse effect on the Company's California operations. If the settlement reflected in the O&S Agreement is not fully implemented, such failure could have a material adverse effect on the Company's California operations in the event the Company is ultimately held liable to pay unpaid provider claims.
At the time MPN was placed into conservatorship, MPN and various provider groups and clinics affiliated with MedPartners, Inc. provided health care services to approximately 215,000 enrollees of the Company's Health Net HMO subsidiary. As of August 1999, sales had been consummated on all of the physician groups associated with MedPartners, Inc. Accordingly, all Health Net enrollees have been moved to the successor physician groups or other providers.
REAL ESTATE TRANSACTIONS. During 1999, the Company completed the sale of nine health care centers for net proceeds of approximately $17.6 million. Such care centers were part of fourteen care centers originally leased to, and subsequently vacated by, FPA Medical Management, Inc. As of March 17, 2000, the Company has sold twelve such care centers. As set forth above, in August 1999, in connection with the Company's wind down of its business in Colorado, the Company sold its regional claims processing facility and accompanying real estate in Pueblo, Colorado, including certain equipment and other assets located at the facility, to the Pueblo Economic Development Company for total aggregate proceeds of approximately $5 million and certain other consideration. In addition, in 1999, the Company sold a land parcel in Roseville, California and certain other real estate located in Pueblo, Colorado for aggregate net proceeds of approximately $913,000.
FOHP. In 1997, the Company purchased convertible and nonconvertible debentures of FOHP, Inc., a New Jersey corporation ("FOHP"), in the aggregate principal amounts of approximately $80.7 million and $24 million, respectively. In 1997 and 1998, the Company converted certain of the convertible debentures into shares of Common Stock of FOHP, resulting in the Company owning 99.6% of the outstanding common stock of FOHP. The nonconvertible debentures mature on December 31, 2002.
Effective January 1, 1999, Physicians Health Services of New Jersey, Inc., a New Jersey HMO wholly-owned by the Company, merged with and into First Option Health Plan of New Jersey ("FOHP-NJ"), a New Jersey HMO subsidiary of FOHP, and FOHP-NJ changed its name to Physicians Health Services of New Jersey, Inc. ("PHS-NJ"). Effective July 30, 1999, upon approval by the stockholders of FOHP at a special meeting, a wholly-owned subsidiary of the Company merged into FOHP and FOHP became a
wholly-owned subsidiary of the Company. In connection with the merger, the former minority shareholders of FOHP are entitled to either $0.25 per share (the value per FOHP share as of December 31, 1998 as determined by an outside appraiser) or payment rights which entitle the holders to receive as much as $15.00 per payment right on or about July 1, 2001, provided certain hospital and other provider participation conditions are met. Additional consideration of $2.25 per payment right will be paid to certain holders of the payment rights if PHS-NJ achieves certain annual returns on common equity and the participation conditions are met.
QUALMED PLANS FOR HEALTH OF PENNSYLVANIA, INC. Effective December 31, 1998, the Company purchased the minority interests in QualMed Plans for Health of Pennsylvania, Inc. ("QualMed-PA"), a then majority-owned subsidiary of the Company. Previously, the Company owned approximately 83% of the common stock of QualMed-PA. In January 1999, the Company transferred certain assets of QualMed-PA, including the assets relating to its preferred provider organization, MaxNet-Registered Trademark-, to Preferred Health Network, Inc., then another wholly-owned subsidiary of the Company. As set forth above in this "Recent Developments," the Company subsequently sold the capital stock of Preferred Health Network, Inc.
INSURANCE SUBSIDIARIES. In July 1999, the Company completed the restructuring of certain of its insurance subsidiaries by merging Foundation Health National Life Insurance Company ("FHNL") with Foundation Health Systems Life and Health Insurance Company ("FHS Life") under a holding company subsidiary of the Company, FHS Life Holdings Company, Inc.
GEM INSURANCE COMPANY. Since October of 1997, Gem Insurance Company ("Gem"), a subsidiary of the Company, has implemented a restructuring plan to reduce operating losses and its in-force insurance risk. As part of such restructuring, Gem is withdrawing from certain insurance markets. Upon completion of its current withdrawals, Gem will be operating in only two states. As of December 31, 1999, the number of Gem's insureds was under 1,000. Currently, Foundation Health Systems Life and Health Insurance Company, a subsidiary of the Company, services Gem's insureds through an administrative services agreement between the companies. The Company is reviewing the possibility of winding up the operations of Gem or merging such operations into another insurance subsidiary of the Company.
OTHER POTENTIAL DIVESTITURES
CERTAIN OTHER OPERATIONS. The Company continues to evaluate the profitability realized or likely to be realized by its existing businesses and operations, and is reviewing from a strategic standpoint which of such businesses or operations should be divested.
NEW VENTURES GROUP
The Company believes that the Internet and related new technologies will fundamentally change managed care organizations. Accordingly, the Company has created a New Ventures Group to focus on the strategic direction of the Company in light of the Internet and related technologies and to pursue opportunities consistent with such direction. Currently, the Company is developing collaborative approaches with business partners to transform their existing assets and expertise into new e-business opportunities. The Company believes that net-enabled connectivity among purchasers, consumers, managed care organizations, providers and other trading partners is a prerequisite to creating and capturing e-business opportunities. The Company is currently developing business concepts to take advantage of those market opportunities that provide value to consumers, purchasers of benefits and the providers of medical and health care services.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The following table sets forth the high and low sales prices of the Company's Class A Common Stock, par value $.001 per share (the "Class A Common Stock"), on The New York Stock Exchange, Inc. ("NYSE") since January 2, 1998.
On March 17, 2000, the last reported sales price per share of the Class A Common Stock was $7 15/16 per share.
DIVIDENDS
No dividends have been paid by the Company during the preceding two fiscal years. The Company has no present intention of paying any dividends on its Common Stock.
The Company is a holding company and, therefore, its ability to pay dividends depends on distributions received from its subsidiaries, which are subject to regulatory net worth requirements and certain additional state regulations which may restrict the declaration of dividends by HMOs, insurance companies and licensed managed health care plans. The payment of any dividend is at the discretion of the Company's Board of Directors and depends upon the Company's earnings, financial position, capital requirements and such other factors as the Company's Board of Directors deems relevant.
Under the Credit Agreement entered into on July 8, 1997 with Bank of America as agent, the Company cannot declare or pay cash dividends to its stockholders or purchase, redeem or otherwise acquire shares of its capital stock or warrants, rights or options to acquire such shares for cash except to the extent permitted under such Credit Agreement as described elsewhere in this Annual Report on Form 10-K.
HOLDERS
As of March 17, 2000, there were approximately 2,000 holders of record of Class A Common Stock. The California Wellness Foundation (the "CWF") is the only holder of record of the Company's Class B Common Stock, par value $.001 per share (the "Class B Common Stock"), which constitutes less than 1% of the Company's aggregate equity. Under the Company's Fourth Amended and Restated Certificate of Incorporation, shares of the Company's Class B Common Stock have the same economic benefits as shares of the Company's Class A Common Stock, but are non-voting. Upon the sale or other transfer of shares of
Class B Common Stock by the CWF to an unrelated third party, such shares automatically convert into Class A Common Stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item is set forth in the Company's Annual Report to Stockholders on page 1, and is incorporated herein by reference and made a part hereof.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The information required by this Item is set forth in the Company's Annual Report to Stockholders on pages 15 through 23, and is incorporated herein by reference and made a part hereof.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this Item is set forth in the Company's Annual Report to Stockholders on page 24, and is incorporated herein by reference and made a part hereof.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is set forth in the Company's Annual Report to Stockholders on pages 25 through 53, and is incorporated herein by reference and made a part hereof.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is set forth in the Company's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days of December 31, 1999. Such information is incorporated herein by reference and made a part hereof.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is set forth in the Company's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days of December 31, 1999. Such information is incorporated herein by reference and made a part hereof.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is set forth in the Company's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days of December 31, 1999. Such information is incorporated herein by reference and made a part hereof.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is set forth in the Company's definitive proxy statement, which will be filed with the Securities and Exchange Commission within 120 days of December 31, 1999. Such information is incorporated herein by reference and made a part hereof.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A) FINANCIAL STATEMENTS, SCHEDULES AND EXHIBITS
1. FINANCIAL STATEMENTS
The following consolidated financial statements are incorporated by reference into this Annual Report on Form 10-K from pages 25 to 53 of the Company's Annual Report to Stockholders for the year ended December 31, 1999:
Report of Deloitte & Touche LLP
Consolidated balance sheets at December 31, 1999 and 1998
Consolidated statements of operations for each of the three years in the period ended December 31, 1999
Consolidated statements of stockholders' equity for each of the three years in the period ended December 31, 1999
Consolidated statements of cash flows for each of the three years in the period ended December 31, 1999
Notes to consolidated financial statements
2. FINANCIAL STATEMENT SCHEDULES
The following financial statement schedule and accompanying report thereon are filed as a part of this Annual Report on Form 10-K:
Report of Deloitte & Touche LLP
Schedule I--Condensed Financial Information of Registrant (Parent Company Only)
All other schedules are omitted because they are not applicable, not required or because the required information is included in the consolidated financial statements or notes thereto which are incorporated by reference into this Annual Report on Form 10-K from the Company's 1999 Annual Report to Stockholders.
3. EXHIBITS
The following exhibits are filed as part of this Annual Report on Form 10-K or are incorporated herein by reference:
- ------------------------
* Management contract or compensatory plan or arrangement required to be filed (and/or incorporated by reference) as an exhibit to this Annual Report on Form 10-K pursuant to Item 14(c) of Form 10-K.
+ A copy of the exhibit is being filed with this Annual Report on Form 10-K.
(b) Reports on Form 8-K
No Current Reports on Form 8-K were filed by the Company during the quarterly period ended December 31, 1999.
INDEPENDENT AUDITORS' REPORT ON SCHEDULE
To the Board of Directors and Stockholders of Foundation Health Systems, Inc. Woodland Hills, California
We have audited the consolidated financial statements of Foundation Health Systems, Inc. (the "Company") as of December 31, 1999 and 1998 and for each of the three years in the period ended December 31, 1999, and have issued our report thereon dated February 29, 2000, appearing in and incorporated by reference in this Annual Report on Form 10-K of Foundation Health Systems, Inc. for the year ended December 31, 1999. Our audits also included the financial statement schedule of Foundation Health Systems, Inc., listed in Item 14(a)(2). The financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ Deloitte & Touche LLP Los Angeles, California February 29, 2000
SUPPLEMENTAL SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY)
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED BALANCE SHEETS
(AMOUNTS IN THOUSANDS)
See accompanying note to condensed financial statements.
SUPPLEMENTAL SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY)--(CONTINUED)
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS)
See accompanying note to condensed financial statements.
SUPPLEMENTAL SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY)--(CONTINUED)
FOUNDATION HEALTH SYSTEMS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
See accompanying note to condensed financial statements.
SUPPLEMENTAL SCHEDULE I CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY)--(CONTINUED)
FOUNDATION HEALTH SYSTEMS, INC.
NOTE TO CONDENSED FINANCIAL STATEMENTS
NOTE 1--BASIS OF PRESENTATION
Foundation Health Systems, Inc.'s ("FHS") investment in subsidiaries is stated at cost plus equity in undistributed earnings (losses) of subsidiaries. FHS' share of net income (loss) of its unconsolidated subsidiaries is included in consolidated income (loss) using the equity method. This condensed financial information of registrant should be read in conjunction with the consolidated financial statements of Foundation Health Systems, Inc. and subsidiaries.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Company has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized, on the 20th day of March, 2000.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Report has been signed below by the following persons on behalf of the Company and in the capacities indicated on the 20th day of March, 2000.