10-Q 1 d432590d10q.htm FORM 10-Q Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period ended September 30, 2012

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number: 001-16751

 

 

WELLPOINT, INC.

(Exact name of registrant as specified in its charter)

 

 

 

INDIANA   35-2145715
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification Number)
120 MONUMENT CIRCLE
INDIANAPOLIS, INDIANA
  46204-4903
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (317) 488-6000

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for at least the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

 

Title of Each Class

 

Outstanding at October 31, 2012

Common Stock, $0.01 par value   303,655,451 shares

 

 

 


Table of Contents

WellPoint, Inc.

Quarterly Report on Form 10-Q

For the Period Ended September 30, 2012

Table of Contents

 

         Page  

PART I. FINANCIAL INFORMATION

  

ITEM 1.

 

FINANCIAL STATEMENTS

  
 

Consolidated Balance Sheets as of September 30, 2012 (Unaudited) and December 31, 2011

     3   
 

Consolidated Statements of Income (Unaudited) for the Three and Nine Months Ended September  30, 2012 and 2011

     4   
 

Consolidated Statements of Comprehensive Income (Unaudited) for the Three and Nine Months Ended September 30, 2012 and 2011

     5   
 

Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September  30, 2012 and 2011

     6   
 

Consolidated Statements of Shareholders’ Equity (Unaudited) for the Nine Months Ended September  30, 2012 and 2011

     7   
 

Notes to Consolidated Financial Statements (Unaudited)

     8   

ITEM 2.

  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS      31   

ITEM 3.

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     51   

ITEM 4.

 

CONTROLS AND PROCEDURES

     51   

PART II. OTHER INFORMATION

  

ITEM 1.

 

LEGAL PROCEEDINGS

     51   

ITEM 1A.

 

RISK FACTORS

     51   

ITEM 2.

 

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

     55   

ITEM 3.

 

DEFAULTS UPON SENIOR SECURITIES

     55   

ITEM 4.

 

MINE SAFETY DISCLOSURES

     55   

ITEM 5.

 

OTHER INFORMATION

     55   

ITEM 6.

 

EXHIBITS

     55   

SIGNATURES

     56   

INDEX TO EXHIBITS

     57   

 

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Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

WellPoint, Inc.

Consolidated Balance Sheets

 

     September 30,
2012
     December 31,
2011
 
(In millions, except share data)    (Unaudited)         

Assets

     

Current assets:

     

Cash and cash equivalents

   $ 2,442.1      $ 2,201.6  

Investments available-for-sale, at fair value:

     

Fixed maturity securities (amortized cost of $17,511.1 and $15,233.6)

     18,485.5        15,913.1  

Equity securities (cost of $849.1 and $937.7)

     1,187.4        1,188.1  

Other invested assets, current

     16.9        14.8  

Accrued investment income

     164.9        172.0  

Premium and self-funded receivables

     3,645.7        3,402.9  

Other receivables

     847.3        943.9  

Income taxes receivable

     213.0        105.8  

Securities lending collateral

     700.9        871.4  

Deferred tax assets, net

     61.1        424.8  

Other current assets

     1,875.5        1,859.0  
  

 

 

    

 

 

 

Total current assets

     29,640.3        27,097.4  

Long-term investments available-for-sale, at fair value:

     

Fixed maturity securities (amortized cost of $237.9 and $240.8)

     244.1        246.8  

Equity securities (cost of $26.7 and $28.4)

     29.4        28.8  

Other invested assets, long-term

     1,236.1        1,103.3  

Property and equipment, net

     1,536.5        1,418.1  

Goodwill

     14,469.1        13,858.7  

Other intangible assets

     8,210.5        7,931.7  

Other noncurrent assets

     451.9        433.6  
  

 

 

    

 

 

 

Total assets

   $ 55,817.9      $ 52,118.4  
  

 

 

    

 

 

 

Liabilities and shareholders’ equity

     

Liabilities

     

Current liabilities:

     

Policy liabilities:

     

Medical claims payable

   $ 5,523.2      $ 5,489.0  

Reserves for future policy benefits

     60.8        55.1  

Other policyholder liabilities

     2,229.0        2,278.2  
  

 

 

    

 

 

 

Total policy liabilities

     7,813.0        7,822.3  

Unearned income

     823.7        926.5  

Accounts payable and accrued expenses

     2,648.5        3,124.1  

Security trades pending payable

     138.1        51.7  

Securities lending payable

     701.0        872.5  

Short-term borrowings

     192.0        100.0  

Current portion of long-term debt

     0.2        1,274.5  

Other current liabilities

     1,766.6        1,727.1  
  

 

 

    

 

 

 

Total current liabilities

     14,083.1        15,898.7  

Long-term debt, less current portion

     13,395.7        8,420.9  

Reserves for future policy benefits, noncurrent

     723.2        730.7  

Deferred tax liabilities, net

     2,841.5        2,724.0  

Other noncurrent liabilities

     957.9        1,055.9  
  

 

 

    

 

 

 

Total liabilities

     32,001.4        28,830.2  
  

 

 

    

 

 

 

Commitment and contingencies - Note 10

     

Shareholders’ equity

     

Preferred stock, without par value, shares authorized – 100,000,000; shares issued and outstanding – none

     —           —     

Common stock, par value $0.01, shares authorized – 900,000,000; shares issued and outstanding: 314,012,463 and 339,372,680

     3.1        3.4  

Additional paid-in capital

     10,869.7        11,679.2  

Retained earnings

     12,556.8        11,490.7  

Accumulated other comprehensive income

     386.9        114.9  
  

 

 

    

 

 

 

Total shareholders’ equity

     23,816.5        23,288.2  
  

 

 

    

 

 

 

Total liabilities and shareholders’ equity

   $ 55,817.9      $ 52,118.4  
  

 

 

    

 

 

 

See accompanying notes.

 

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Table of Contents

WellPoint, Inc.

Consolidated Statements of Income

(Unaudited)

 

     Three Months Ended
September 30
    Nine Months Ended
September 30
 
(In millions, except per share data)    2012     2011     2012     2011  

Revenues

        

Premiums

   $ 14,037.1     $ 14,181.6     $ 42,336.6     $ 41,779.3  

Administrative fees

     955.6       963.1       2,928.9       2,882.8  

Other revenue

     141.0       10.4       191.7       27.6  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating revenue

     15,133.7       15,155.1       45,457.2       44,689.7  

Net investment income

     168.6       170.9       507.0       543.5  

Net realized gains on investments

     54.6       94.9       232.0       193.5  

Other-than-temporary impairment losses on investments:

        

Total other-than-temporary impairment losses on investments

     (3.8     (28.8     (24.0     (44.7

Portion of other-than-temporary impairment losses recognized in other comprehensive income

     —          5.9       3.4       11.0  
  

 

 

   

 

 

   

 

 

   

 

 

 

Other-than-temporary impairment losses recognized in income

     (3.8     (22.9     (20.6     (33.7
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     15,353.1       15,398.0       46,175.6       45,393.0  

Expenses

        

Benefit expense

     11,984.8       12,062.9       35,849.8       35,212.9  

Selling, general and administrative expense:

        

Selling expense

     390.2       403.0       1,176.5       1,205.6  

General and administrative expense

     1,688.4       1,716.6       5,149.6       5,001.6  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total selling, general and administrative expense

     2,078.6       2,119.6       6,326.1       6,207.2  

Cost of products

     66.5       —          73.2       —     

Interest expense

     133.6       108.2       360.3       317.7  

Amortization of other intangible assets

     63.9       62.1       182.1       175.5  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     14,327.4       14,352.8       42,791.5       41,913.3  
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income tax expense

     1,025.7       1,045.2       3,384.1       3,479.7  

Income tax expense

     334.5       362.0       1,192.8       1,168.3  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 691.2     $ 683.2     $ 2,191.3     $ 2,311.4  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per share

        

Basic

   $ 2.17     $ 1.92     $ 6.70     $ 6.33  
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 2.15     $ 1.90     $ 6.63     $ 6.24  
  

 

 

   

 

 

   

 

 

   

 

 

 

Dividends per share

   $ 0.2875     $ 0.25     $ 0.8625     $ 0.75  
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes.

 

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Table of Contents

WellPoint, Inc.

Consolidated Statements of Comprehensive Income

(Unaudited)

 

     Three Months Ended
September 30
    Nine Months Ended
September 30
 
(In millions)    2012     2011     2012     2011  

Net income

   $ 691.2     $ 683.2     $ 2,191.3     $ 2,311.4  

Other comprehensive income, net of tax:

        

Change in net unrealized gains/losses on investments

     168.3       (202.3     248.5       (104.3

Change in non-credit component of other-than-temporary impairment losses on investments

     —          (2.0     4.4       2.3  

Change in net unrealized gains/losses on cash flow hedges

     (1.0     (11.3     (0.6     (10.6

Change in net periodic pension and postretirement costs

     6.9       5.3       19.9       19.0  

Foreign currency translation adjustments

     0.5       (1.2     (0.2     1.2  
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss)

     174.7       (211.5     272.0       (92.4
  

 

 

   

 

 

   

 

 

   

 

 

 

Total comprehensive income

   $ 865.9     $ 471.7     $ 2,463.3     $ 2,219.0  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

 

See accompanying notes.

 

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Table of Contents

WellPoint, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

 

     Nine Months Ended
September 30
 
(In millions)    2012     2011  

Operating activities

    

Net income

   $ 2,191.3     $ 2,311.4  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Net realized gains on investments

     (232.0     (193.5

Other-than-temporary impairment losses recognized in income

     20.6       33.7  

Loss on disposal of assets

     1.6       2.5  

Deferred income taxes

     255.3       151.3  

Amortization, net of accretion

     474.8       386.3  

Depreciation expense

     72.8       71.1  

Share-based compensation

     123.7       98.1  

Excess tax benefits from share-based compensation

     (23.2     (38.4

Changes in operating assets and liabilities, net of effect of business combinations:

    

Receivables, net

     (133.2     (357.2

Other invested assets

     (26.6     (8.6

Other assets

     (33.3     (107.1

Policy liabilities

     (16.8     647.9  

Unearned income

     (102.8     747.2  

Accounts payable and accrued expenses

     (446.7     (412.2

Other liabilities

     (57.5     (5.1

Income taxes

     (79.5     14.1  

Other, net

     (3.7     (25.0
  

 

 

   

 

 

 

Net cash provided by operating activities

     1,984.8       3,316.5  

Investing activities

    

Purchases of fixed maturity securities

     (11,808.8     (10,017.2

Proceeds from fixed maturity securities:

    

Sales

     8,433.4       8,187.1  

Maturities, calls and redemptions

     1,347.8       1,561.3  

Purchases of equity securities

     (245.1     (219.0

Proceeds from sales of equity securities

     312.3       122.1  

Purchases of other invested assets

     (153.7     (139.9

Proceeds from sales of other invested assets

     25.4       19.3  

Changes in securities lending collateral

     171.5       128.2  

Purchases of subsidiaries, net of cash acquired

     (992.3     (602.3

Purchases of property and equipment

     (375.1     (334.4

Proceeds from sales of property and equipment

     0.4       1.3  

Other, net

     (0.9     (29.7
  

 

 

   

 

 

 

Net cash used in investing activities

     (3,285.1     (1,323.2

Financing activities

    

Net proceeds from commercial paper borrowings

     30.1       658.6  

Proceeds from long-term borrowings

     4,935.2       1,097.4  

Repayments of long-term borrowings

     (1,251.2     (703.8

Proceeds from short-term borrowings

     392.0       100.0  

Repayments of short-term borrowings

     (300.0     (100.0

Changes in securities lending payable

     (171.5     (128.4

Changes in bank overdrafts

     (94.6     159.7  

Repurchase and retirement of common stock

     (1,828.8     (2,354.2

Cash dividends

     (280.0     (272.1

Proceeds from issuance of common stock under employee stock plans

     86.7       229.2  

Excess tax benefits from share-based compensation

     23.2       38.4  
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     1,541.1       (1,275.2

Effect of foreign exchange rates on cash and cash equivalents

     (0.3     1.5  
  

 

 

   

 

 

 

Change in cash and cash equivalents

     240.5       719.6  

Cash and cash equivalents at beginning of period

     2,201.6       1,788.8  
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 2,442.1     $ 2,508.4  
  

 

 

   

 

 

 

See accompanying notes.

 

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Table of Contents

WellPoint, Inc.

Consolidated Statements of Shareholders’ Equity

(Unaudited)

 

     Common Stock     Additional
Paid-in
Capital
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income
    Total
Shareholders’
Equity
 
(In millions)    Number of
Shares
    Par
Value
         

January 1, 2012

     339.4     $ 3.4     $ 11,679.2     $ 11,490.7     $ 114.9     $ 23,288.2  

Net income

     —          —          —          2,191.3       —          2,191.3  

Other comprehensive income

     —          —          —          —          272.0       272.0  

Repurchase and retirement of common stock

     (28.6     (0.3     (986.4     (842.1     —          (1,828.8

Dividends and dividend equivalents

     —          —          —          (283.1     —          (283.1

Issuance of common stock under employee stock plans, net of related tax benefits

     3.2       —          176.9       —          —          176.9  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

September 30, 2012

     314.0     $ 3.1     $ 10,869.7     $ 12,556.8     $ 386.9     $ 23,816.5  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

January 1, 2011

     377.7     $ 3.8     $ 12,862.6     $ 10,721.6     $ 224.6     $ 23,812.6  

Net income

     —          —          —          2,311.4       —          2,311.4  

Other comprehensive loss

     —          —          —          —          (92.4     (92.4

Repurchase and retirement of common stock

     (34.2     (0.3     (1,168.6     (1,185.3     —          (2,354.2

Dividends and dividend equivalents

     —          —          —          (274.9     —          (274.9

Issuance of common stock under employee stock plans, net of related tax benefits

     5.7       —          315.6       —          —          315.6  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

September 30, 2011

     349.2     $ 3.5     $ 12,009.6     $ 11,572.8     $ 132.2     $ 23,718.1  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes.

 

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Table of Contents

WellPoint, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

September 30, 2012

(In Millions, Except Per Share Data or As Otherwise Stated Herein)

 

1. Organization

References to the terms “we”, “our”, “us”, “WellPoint” or the “Company” used throughout these Notes to Consolidated Financial Statements refer to WellPoint, Inc., an Indiana corporation, and unless the context otherwise requires, its direct and indirect subsidiaries.

We are one of the largest health benefits companies in the United States, serving 33.5 medical members through our affiliated health plans and more than 63.7 individuals through all subsidiaries as of September 30, 2012. We offer a broad spectrum of network-based managed care plans to large and small employer, individual, Medicaid and senior markets. Our managed care plans include: preferred provider organizations, or PPOs; health maintenance organizations, or HMOs; point-of-service, or POS, plans; traditional indemnity plans and other hybrid plans, including consumer-driven health plans, or CDHPs; and hospital only and limited benefit products. In addition, we provide a broad array of managed care services to self-funded customers, including claims processing, underwriting, stop loss insurance, actuarial services, provider network access, medical cost management, disease management, wellness programs and other administrative services. We provide an array of specialty and other insurance products and services such as behavioral health benefit services, dental, vision, life and disability insurance benefits, radiology benefit management, analytics-driven personal health care guidance and long-term care insurance. We also provide services to the Federal Government in connection with the Federal Employee Program, or FEP, and various Medicare programs. Finally, we sell contact lenses, eyeglasses and other ocular products through our recently acquired 1-800 CONTACTS, Inc., or 1-800 CONTACTS, subsidiary.

We are an independent licensee of the Blue Cross and Blue Shield Association, or BCBSA, an association of independent health benefit plans. We serve our members as the Blue Cross licensee for California; the Blue Cross and Blue Shield, or BCBS, licensee for Colorado, Connecticut, Georgia, Indiana, Kentucky, Maine, Missouri (excluding 30 counties in the Kansas City area), Nevada, New Hampshire, New York (as the BCBS licensee in 10 New York City metropolitan and surrounding counties and as the Blue Cross or BCBS licensee in selected upstate counties only), Ohio, Virginia (excluding the Northern Virginia suburbs of Washington, D.C.) and Wisconsin. In a majority of these service areas we do business as Anthem Blue Cross, Anthem Blue Cross and Blue Shield, Blue Cross and Blue Shield of Georgia, Empire Blue Cross Blue Shield, or Empire Blue Cross (in our New York service areas). We also serve customers throughout the country as UniCare, and in certain California, Arizona and Nevada markets through our CareMore Health Group, Inc., or CareMore, subsidiary. We are licensed to conduct insurance operations in all 50 states through our subsidiaries.

 

2. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP, for interim financial reporting. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. We have omitted certain footnote disclosures that would substantially duplicate the disclosures in our 2011 Annual Report on Form 10-K, unless the information contained in those disclosures materially changed or is required by GAAP. In the opinion of management, all adjustments, including normal recurring adjustments, necessary for a fair statement of the consolidated financial statements as of and for the three and nine months ended September 30, 2012 and 2011 have been recorded. The results of operations for the three and nine months ended September 30, 2012 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2012. These unaudited consolidated financial statements should be read in conjunction with our audited

 

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consolidated financial statements for the year ended December 31, 2011 included in our 2011 Annual Report on Form 10-K.

Certain of our subsidiaries operate outside of the United States and have functional currencies other than the U.S. dollar, or USD. We translate the assets and liabilities of those subsidiaries to USD using the exchange rate in effect at the end of the period. We translate the revenues and expenses of those subsidiaries to USD using the average exchange rates in effect during the period. The net effect of these translation adjustments is included in “Foreign currency translation adjustments” in our consolidated statements of comprehensive income.

Certain prior period amounts have been reclassified to conform to the current period presentation.

 

3. Business Combinations

Acquisition of 1-800 CONTACTS

On June 20, 2012, we completed our acquisition of 1-800 CONTACTS, the largest direct-to-consumer retailer of contact lenses in the United States, whose model is built on providing a superior customer experience and a wide selection of ocular products at affordable prices. The acquisition strategically aligns with our efforts to capitalize on new opportunities for growth to diversify our revenue stream into complementary and higher-margin specialty businesses.

In accordance with Financial Accounting Standards Board, or FASB, Accounting Standards Codification 805—Business Combinations, or ASC 805, the consideration transferred was allocated to the fair value of 1-800 CONTACTS’ assets acquired and liabilities assumed, including identifiable intangible assets. The excess of the consideration transferred over the fair value of net assets acquired resulted in non tax-deductible goodwill of $612.3 at September 30, 2012, all of which was allocated to our Commercial segment. Goodwill recognized from the acquisition of 1-800 CONTACTS primarily relates to the expected future growth of 1-800 CONTACTS’ business and further expansion of product offerings, including eyeglasses. In accordance with ASC 805, any subsequent adjustments made to the assets acquired or liabilities assumed during the measurement period will be recorded as an adjustment to goodwill.

The fair value of the net assets acquired from 1-800 CONTACTS includes $449.4 of other intangible assets, which primarily consist of finite-lived customer relationships with an amortization period of 13 years and indefinite-lived trade names.

The results of operations of 1-800 CONTACTS are included in our consolidated financial statements within our Commercial segment for the period following June 20, 2012. 1-800 CONTACTS currently operates under an alliance agreement, or the Alliance, with an unrelated third party to provide for the joint management, marketing and fulfillment of orders for products. Profits and losses of the Alliance are allocated to 1-800 CONTACTS based on the terms set forth in the Alliance agreement. Product sales made by 1-800 CONTACTS are reported on our consolidated income statement within “Other revenue” and expenses for the cost of products sold, as well as certain other allowed expenses as defined in the Alliance agreement, are presented on our consolidated income statement within “Cost of products.” The Alliance will terminate on December 31, 2012.

The pro-forma effects of this acquisition for prior periods were not material to our consolidated results of operations.

Pending Acquisition of AMERIGROUP Corporation

On July 9, 2012, we announced that we had entered into a definitive agreement to acquire AMERIGROUP Corporation, or Amerigroup, one of the nation’s leading managed care companies that is focused on meeting the health care needs of financially vulnerable Americans. This acquisition will further our goal of creating better

 

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health care quality at more affordable prices for our customers. It will also advance our capabilities to more effectively and efficiently serve the growing Medicaid population, including the expanding dual eligible, seniors, persons with disabilities and long-term services and support markets. Under the terms of the agreement, we will pay $92.00 per share in cash to acquire all of the outstanding shares of Amerigroup for an estimated transaction value of approximately $4,900.0. The acquisition, which was approved by Amerigroup’s shareholders on October 23, 2012, remains subject to certain state regulatory approvals, standard closing conditions and approvals required under the Hart-Scott-Rodino Antitrust Improvements Act, and is expected to close in the fourth quarter of 2012.

 

4. Restructuring Activities

As a result of restructuring activities implemented during 2011, 2010 and 2009, we recorded liabilities for employee termination costs and lease and other contract exit costs. The restructuring activities are classified as components of general and administrative expenses in the consolidated statements of income for the respective period in which they occurred.

The 2011 restructuring activities were initiated as a result of our efforts to improve, streamline and make our core business processes more efficient and effective. Activity related to these liabilities for the nine months ended September 30, 2012, by reportable segment, is as follows:

 

     Commercial     Consumer     Other     Total  

2011 Restructuring Activities

        

Employee termination costs:

        

Liability for employee termination costs at January 1, 2012

   $ 51.8     $ 11.8     $ 0.7     $ 64.3  

Payments

     (20.4     (4.6     (0.3     (25.3

Liability released

     (3.1     (0.7     —          (3.8
  

 

 

   

 

 

   

 

 

   

 

 

 

Liability for employee termination costs at September 30, 2012

     28.3       6.5       0.4       35.2  

Lease and other contract exit costs:

        

Liability for lease and other contract exit costs at January 1, 2012

     17.2       5.7       1.9       24.8  

Payments

     (2.7     (0.9     (1.0     (4.6

Liability released

     (1.6     (0.5     (0.1     (2.2
  

 

 

   

 

 

   

 

 

   

 

 

 

Liability for lease and other contract exit costs at September 30, 2012

     12.9       4.3       0.8       18.0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total liability for 2011 restructuring activities at September 30, 2012

   $ 41.2     $ 10.8     $ 1.2     $ 53.2  
  

 

 

   

 

 

   

 

 

   

 

 

 

The 2010 restructuring activities were initiated as a result of a change in strategic focus primarily in response to federal health care reform legislation. At September 30, 2012, our total liability for 2010 restructuring activities was $10.5, of which $4.5 related to employee termination costs and $6.0 related to lease and other contract exit costs. We expect the remaining payments for employee termination costs to be substantially completed by the end of 2012. Payments for lease and other contract exit costs will continue to occur over the remaining terms of the related contracts, which have expiration dates ranging through 2020.

The 2009 restructuring activities were executed as a result of a realignment of our corporate strategy. At September 30, 2012, our total liability for 2009 restructuring activities was $27.3, which was primarily comprised of lease and other contract exit costs. Payments for lease and other contract exit costs will continue to occur over the remaining terms of the related contracts, which have expiration dates ranging through 2020.

 

5. Investments

We evaluate our investment securities for other-than-temporary declines based on qualitative and quantitative factors. Other-than-temporary impairment losses recognized in income totaled $3.8 and $22.9 for the three months ended September 30, 2012 and 2011, respectively. Other-than-temporary impairment losses

 

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recognized in income totaled $20.6 and $33.7 for the nine months ended September 30, 2012 and 2011, respectively. There were no individually significant other-than-temporary impairment losses on investments by issuer during the three and nine months ended September 30, 2012 and 2011. We continue to review our investment portfolios under our impairment review policy. Given the current market conditions and the significant judgments involved, there is a continuing risk that further declines in fair value may occur and additional material other-than-temporary impairment losses on investments may be recorded in future periods.

The changes in the amount of the credit component of other-than-temporary impairment losses on fixed maturity securities recognized in income, for which a portion of the other-than-temporary impairment losses was recognized in other comprehensive income, was not material for the three and nine months ended September 30, 2012 and 2011.

A summary of current and long-term investments, available-for-sale, at September 30, 2012 and December 31, 2011 is as follows:

 

    Cost or
Amortized
Cost
    Gross
Unrealized
Gains
    Gross Unrealized Losses     Estimated
Fair Value
    Non-Credit
Component of
Other-Than-
Temporary
Impairments

Recognized in
AOCI
 
        Less than
12 Months
    Greater than
12 Months
     

September 30, 2012:

           

Fixed maturity securities:

           

United States Government securities

  $ 447.4     $ 19.4     $ —        $ —        $ 466.8     $ —     

Government sponsored securities

    168.1       2.8       —          —          170.9       —     

States, municipalities and political subdivisions - tax-exempt

    5,099.1       421.3       (0.6     (2.2     5,517.6       —     

Corporate securities

    8,933.5       412.7       (13.1     (13.1     9,320.0       (1.7

Options embedded in convertible debt securities

    78.3       —          —          —          78.3       —     

Residential mortgage-backed securities

    2,407.0       129.2       (0.2     (2.8     2,533.2       (0.4

Commercial mortgage-backed securities

    346.3       24.7       (0.1     (0.1     370.8       —     

Other debt obligations

    269.3       6.5       (0.2     (3.6     272.0       (1.3
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed maturity securities

    17,749.0       1,016.6       (14.2     (21.8     18,729.6     $ (3.4
           

 

 

 

Equity securities

    875.8       357.3       (16.3     —          1,216.8    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Total investments, available-for-sale

  $ 18,624.8     $ 1,373.9     $ (30.5   $ (21.8   $ 19,946.4    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

December 31, 2011:

           

Fixed maturity securities:

           

United States Government securities

  $ 564.9     $ 39.9     $ (0.1   $ —        $ 604.7     $ —     

Government sponsored securities

    173.1       2.5       —          —          175.6       —     

States, municipalities and political subdivisions - tax-exempt

    4,994.2       352.3       (3.9     (15.0     5,327.6       (0.5

Corporate securities

    6,588.0       305.3       (88.4     (6.9     6,798.0       (0.4

Options embedded in convertible debt securities

    79.7       —          —          —          79.7       —     

Residential mortgage-backed securities

    2,471.4       112.1       (7.6     (10.9     2,565.0       (6.2

Commercial mortgage-backed securities

    363.2       14.9       (1.0     (1.7     375.4       —     

Other debt obligations

    239.9       3.1       (2.0     (7.1     233.9       (3.2
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total fixed maturity securities

    15,474.4       830.1       (103.0     (41.6     16,159.9     $ (10.3
           

 

 

 

Equity securities

    966.1       277.0       (26.2     —          1,216.9    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Total investments, available-for-sale

  $ 16,440.5     $ 1,107.1     $ (129.2   $ (41.6   $ 17,376.8    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

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At September 30, 2012, we owned $2,904.0 of mortgage-backed securities and $272.0 of asset-backed securities out of a total available-for-sale investment portfolio of $19,946.4. These securities included sub-prime and Alt-A securities with fair values of $45.0 and $142.2, respectively. These sub-prime and Alt-A securities had accumulated net unrealized losses of $0.3 and gains of $5.6, respectively. The average credit rating of the sub-prime and Alt-A securities was “BB” and “B”, respectively.

The following tables summarize for fixed maturity securities and equity securities in an unrealized loss position at September 30, 2012 and December 31, 2011, the aggregate fair value and gross unrealized loss by length of time those securities have been continuously in an unrealized loss position.

 

     12 Months or Less     Greater than 12 Months  
(Securities are whole amounts)    Number of
Securities
     Estimated
Fair Value
     Gross
Unrealized
Loss
    Number of
Securities
     Estimated
Fair Value
     Gross
Unrealized
Loss
 

September 30, 2012:

                

Fixed maturity securities:

                

States, municipalities and political subdivisions - tax-exempt

     27      $ 81.0      $ (0.6     32      $ 76.5      $ (2.2

Corporate securities

     317        794.0        (13.1     100        116.8        (13.1

Residential mortgage-backed securities

     28        40.0        (0.2     39        30.9        (2.8

Commercial mortgage-backed securities

     6        6.4        (0.1     3        4.1        (0.1

Other debt obligations

     8        8.0        (0.2     23        30.7        (3.6
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total fixed maturity securities

     386        929.4        (14.2     197        259.0        (21.8

Equity securities

     970        93.4        (16.3     —           —           —     
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total fixed maturity and equity securities

     1,356      $ 1,022.8      $ (30.5     197      $ 259.0      $ (21.8
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

December 31, 2011:

                

Fixed maturity securities:

                

United States Government securities

     3      $ 7.1      $ (0.1     —         $ —         $ —     

States, municipalities and political subdivisions - tax-exempt

     19        86.6        (3.9     84        195.2        (15.0

Corporate securities

     1,047        1,798.1        (88.4     36        35.4        (6.9

Residential mortgage-backed securities

     91        170.4        (7.6     65        78.0        (10.9

Commercial mortgage-backed securities

     14        27.7        (1.0     5        15.6        (1.7

Other debt obligations

     41        118.5        (2.0     31        32.7        (7.1
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total fixed maturity securities

     1,215        2,208.4        (103.0     221        356.9        (41.6

Equity securities

     1,137        271.6        (26.2     —           —           —     
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total fixed maturity and equity securities

     2,352      $ 2,480.0      $ (129.2     221      $ 356.9      $ (41.6
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

 

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The amortized cost and fair value of fixed maturity securities at September 30, 2012, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.

 

     Amortized
Cost
     Estimated
Fair Value
 

Due in one year or less

   $ 3,325.2      $ 3,360.5  

Due after one year through five years

     4,702.2        4,934.3  

Due after five years through ten years

     4,287.5        4,620.9  

Due after ten years

     2,680.8        2,909.9  

Mortgage-backed securities

     2,753.3        2,904.0  
  

 

 

    

 

 

 

Total available-for-sale fixed maturity securities

   $ 17,749.0      $ 18,729.6  
  

 

 

    

 

 

 

During the nine months ended September 30, 2012, we sold $8,745.7 of fixed maturity and equity securities, which resulted in gross realized gains of $364.1 and gross realized losses of $132.1. In the ordinary course of business, we may sell securities at a loss for a number of reasons, including, but not limited to: (i) changes in the investment environment; (ii) expectation that the fair value could deteriorate further; (iii) desire to reduce exposure to an issuer or an industry; (iv) changes in credit quality; or (v) changes in expected cash flow.

All securities sold resulting in investment gains and losses are recorded on the trade date. Realized gains and losses are determined on the basis of the cost or amortized cost of the specific securities sold.

 

6. Fair Value

Assets and liabilities recorded at fair value in the consolidated balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Level inputs, as defined by FASB guidance for fair value measurements and disclosures, are as follows:

 

Level Input:

  

Input Definition:

Level I    Inputs are unadjusted, quoted prices for identical assets or liabilities in active markets at the measurement date.
Level II    Inputs other than quoted prices included in Level I that are observable for the asset or liability through corroboration with market data at the measurement date.
Level III    Unobservable inputs that reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.

The following methods, assumptions and inputs were used to determine the fair value of each class of the following assets and liabilities recorded at fair value in the consolidated balance sheets:

Cash equivalents: Cash equivalents primarily consist of highly rated money market funds with maturities of three months or less, and are purchased daily at par value with specified yield rates. Due to the high ratings and short-term nature of the funds, we designate all cash equivalents as Level I.

Fixed maturity securities, available-for-sale: Fair values of available-for-sale fixed maturity securities are based on quoted market prices, where available. These fair values are obtained primarily from third party pricing services, which generally use Level I or Level II inputs for the determination of fair value to facilitate fair value measurements and disclosures. United States Government securities represent Level I securities, while Level II securities primarily include corporate securities, securities from states, municipalities and political subdivisions and mortgage-backed securities. For securities not actively traded, the third party pricing services may use quoted market prices of comparable instruments or discounted cash flow analyses, incorporating inputs that are

 

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currently observable in the markets for similar securities. We have controls in place to review the third party pricing services’ qualifications and procedures used to determine fair values. In addition, we periodically review the third party pricing services’ pricing methodologies, data sources and pricing inputs to ensure the fair values obtained are reasonable. Inputs that are often used in the valuation methodologies include, but are not limited to, broker quotes, benchmark yields, credit spreads, default rates and prepayment speeds. We also have certain fixed maturity securities, primarily corporate debt securities that are designated Level III securities. For these securities, the valuation methodologies may incorporate broker quotes or discounted cash flow analyses using assumptions for inputs such as expected cash flows, benchmark yields and credit spreads that are not observable in the markets.

Equity securities, available-for-sale: Fair values of equity securities are generally designated as Level I and are based on quoted market prices. For certain equity securities, quoted market prices for the identical security are not always available and the fair value is estimated by reference to similar securities for which quoted prices are available. These securities are designated Level II. We also have certain equity securities, including private equity securities, for which the fair value is estimated based on each security’s current condition and future cash flow projections. Such securities are designated Level III. The fair values of these private equity securities are generally based on either broker quotes or discounted cash flow projections using assumptions for inputs such as the weighted average cost of capital, long-term revenue growth rates and earnings before interest, taxes, depreciation and amortization, or EBITDA, and/or revenue multiples that are not observable in the markets.

Other invested assets, current: Other invested assets, current include securities held in rabbi trusts that are classified as trading. Fair values are based on quoted market prices.

Securities lending collateral: Fair values of securities lending collateral are based on quoted market prices, where available. These fair values are obtained primarily from third party pricing services, which generally use Level I or Level II inputs for the determination of fair value, to facilitate fair value measurements and disclosures.

Derivatives-interest rate swaps: Fair values are based on the quoted market prices by the financial institution that is the counterparty to the swap. We independently verify prices provided by the counterparties using valuation models that incorporate market observable inputs for similar interest rate swaps.

 

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A summary of fair value measurements by level for assets measured at fair value on a recurring basis at September 30, 2012 and December 31, 2011 is as follows:

 

     Level I      Level II      Level III      Total  

September 30, 2012:

           

Assets:

           

Cash equivalents

   $ 1,309.3      $ —         $ —         $ 1,309.3  

Investments available-for-sale:

           

Fixed maturity securities:

           

United States Government securities

     466.8        —           —           466.8  

Government sponsored securities

     —           170.9        —           170.9  

States, municipalities and political subdivisions -
tax-exempt

     —           5,517.6        —           5,517.6  

Corporate securities

     —           9,207.6        112.4        9,320.0  

Options embedded in convertible debt securities

     —           78.3        —           78.3  

Residential mortgage-backed securities

     —           2,531.8        1.4        2,533.2  

Commercial mortgage-backed securities

     —           365.5        5.3        370.8  

Other debt obligations

     —           257.7        14.3        272.0  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturity securities

     466.8        18,129.4        133.4        18,729.6  

Equity securities

     1,081.2        108.3        27.3        1,216.8  

Other invested assets, current

     16.9        —           —           16.9  

Securities lending collateral

     268.9        432.0        —           700.9  

Derivatives excluding embedded options (reported with other assets)

     —           67.0        —           67.0  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

   $ 3,143.1      $ 18,736.7      $ 160.7      $ 22,040.5   
  

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2011:

           

Assets:

           

Cash equivalents

   $ 1,675.8      $ —         $ —         $ 1,675.8  

Investments available-for-sale:

           

Fixed maturity securities:

           

United States Government securities

     604.7        —           —           604.7  

Government sponsored securities

     —           175.6        —           175.6  

States, municipalities and political subdivisions -
tax-exempt

     —           5,327.6        —           5,327.6  

Corporate securities

     —           6,602.9        195.1        6,798.0  

Options embedded in convertible debt securities

     —           79.7        —           79.7  

Residential mortgage-backed securities

     —           2,565.0        —           2,565.0  

Commercial mortgage-backed securities

     —           369.1        6.3        375.4  

Other debt obligations

     —           174.9        59.0        233.9  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturity securities

     604.7        15,294.8        260.4        16,159.9  

Equity securities

     1,104.9        87.6        24.4        1,216.9  

Other invested assets, current

     14.8        —           —           14.8  

Securities lending collateral

     422.3         449.1        —           871.4  

Derivatives excluding embedded options (reported with other assets)

     —           86.6        —           86.6  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

   $ 3,822.5      $ 15,918.1      $ 284.8      $ 20,025.4   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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A reconciliation of the beginning and ending balances of assets measured at fair value on a recurring basis using Level III inputs for the three months ended September 30, 2012 and 2011 is as follows:

 

     Corporate
Securities
    Residential
Mortgage-
backed
Securities
    Commercial
Mortgage-
backed
Securities
    Other Debt
Obligations
    Equity
Securities
    Total  

Three Months Ended September 30, 2012:

            

Beginning balance at July 1, 2012

   $ 127.7     $ 1.4     $ 5.3     $ 3.9     $ 28.8     $ 167.1  

Total gains (losses):

            

Recognized in net income

     (0.2     —          —          —          (0.2     (0.4

Recognized in accumulated other comprehensive income

     2.0       —          0.1       0.6       (5.5     (2.8

Purchases

     15.6       —          —          —          4.2       19.8  

Sales

     (21.2     —          —          —          —          (21.2

Issues

     —          —          —          —          —          —     

Settlements

     (5.7     —          (0.1     (0.2     —          (6.0

Transfers into Level III

     —          —          —          10.0       —          10.0  

Transfers out of Level III

     (5.8     —          —          —          —          (5.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance at September 30, 2012

   $ 112.4     $ 1.4     $ 5.3     $ 14.3     $ 27.3     $ 160.7  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Change in unrealized losses included in net income related to assets still held for the three months ended September 30, 2012

   $ —        $ —        $ —        $ —        $ (0.2   $ (0.2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Three Months Ended September 30, 2011:

            

Beginning balance at July 1, 2011

   $ 182.6     $ —        $ 13.1     $ 63.8     $ 29.0     $ 288.5  

Total gains (losses):

            

Recognized in net income

     (0.6     —          —          0.4       (0.4     (0.6

Recognized in accumulated other comprehensive income

     (3.5     0.1       (0.4     (2.5     (2.2     (8.5

Purchases

     4.6       —          —          7.4       0.1       12.1  

Sales

     (1.5     —          (5.6     (7.6     —          (14.7

Issues

     —          —          —          —          —          —     

Settlements

     (1.1     (0.6     (0.5     (3.9     —          (6.1

Transfers into Level III

     —          9.7       —          7.7       —          17.4  

Transfers out of Level III

     —          —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance at September 30, 2011

   $ 180.5     $ 9.2     $ 6.6     $ 65.3     $ 26.5     $ 288.1  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Change in unrealized losses included in net income related to assets still held for the three months ended September 30, 2011

   $ (0.6   $ —        $ —        $ (0.2   $ (0.4   $ (1.2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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A reconciliation of the beginning and ending balances of assets measured at fair value on a recurring basis using Level III inputs for the nine months ended September 30, 2012 and 2011 is as follows:

 

     Corporate
Securities
    Residential
Mortgage-
backed
Securities
    Commercial
Mortgage-
backed
Securities
    Other Debt
Obligations
    Equity
Securities
    Total  

Nine Months Ended September 30, 2012:

            

Beginning balance at January 1, 2012

   $ 195.1     $ —        $ 6.3     $ 59.0     $ 24.4     $ 284.8  

Total gains (losses):

            

Recognized in net income

     15.3       —          —          0.1       (0.5     14.9  

Recognized in accumulated other comprehensive income

     (15.5     —          0.1       0.8       (13.2     (27.8

Purchases

     61.8       —          3.4       —          4.5       69.7  

Sales

     (26.3     —          —          (6.6     (0.4     (33.3

Issues

     —          —          —          —          —          —     

Settlements

     (64.5     —          (0.1     (1.0     —          (65.6

Transfers into Level III

     1.7       1.4       1.9       12.0       12.5       29.5  

Transfers out of Level III

     (55.2     —          (6.3     (50.0     —          (111.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance at September 30, 2012

   $ 112.4     $ 1.4     $ 5.3     $ 14.3     $ 27.3     $ 160.7  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Change in unrealized losses included in net income related to assets still held for the nine months ended September 30, 2012

   $ —        $ —        $ —        $ —        $ (0.6   $ (0.6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Nine Months Ended September 30, 2011:

            

Beginning balance at January 1, 2011

   $ 278.4     $ 3.8     $ 7.8     $ 81.4     $ 17.3     $ 388.7  

Total gains (losses):

            

Recognized in net income

     5.9       —          —          (0.2     (4.3     1.4  

Recognized in accumulated other comprehensive income

     (10.0     0.1       0.1       (1.5     3.5       (7.8

Purchases

     19.9       —          —          10.9       10.2       41.0  

Sales

     (25.4     (3.6     (5.6     (19.1     (0.4     (54.1

Issues

     —          —          —          —          —          —     

Settlements

     (129.7     (0.8     (1.1     (14.0     —          (145.6

Transfers into Level III

     41.4       9.7       5.4       7.8       0.2       64.5  

Transfers out of Level III

     —          —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance at September 30, 2011

   $ 180.5     $ 9.2     $ 6.6     $ 65.3     $ 26.5     $ 288.1  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Change in unrealized losses included in net income related to assets still held for the nine months ended September 30, 2011

   $ (0.6   $ —        $ —        $ (0.5   $ (4.3   $ (5.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Transfers between levels, if any, are recorded as of the beginning of the reporting period. During the nine months ended September 30, 2012, certain securities, primarily other debt obligations and equity securities, that were previously classified as Level II were transferred into Level III as a result of previously observable inputs becoming unobservable due to market inactivity. During the nine months ended September 30, 2012, the transfers out of Level III of corporate securities and commercial mortgage-backed securities were for certain sub-prime securities transferred from Level III to Level II as a result of inputs that were previously unobservable becoming observable due to increased volume and level of trading in active markets. In addition, the transfers out of Level III of other debt obligations were for certain inverse floating rate securities transferred from Level III to Level II as a result of those securities’ impending maturity and settlement and recent trading activity of similar securities in observable markets.

 

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During the three and nine months ended September 30, 2012, there were no transfers from Level I to Level II or from Level II to Level I.

There were no material transfers between Level I, Level II and Level III during the three and nine months ended September 30, 2011.

As disclosed in Note 3, “Business Combinations”, we completed our acquisition of 1-800 CONTACTS on June 20, 2012. We also completed our acquisition of CareMore on August 22, 2011. The values of net assets acquired in our acquisitions of 1-800 CONTACTS and CareMore and resulting goodwill and other intangible assets were recorded at fair value using Level III inputs. The majority of 1-800 CONTACTS’ and CareMore’s assets acquired and liabilities assumed were recorded at their carrying values as of the date of acquisition, as their carrying values approximated their fair values due to their short-term nature. The fair values of goodwill and other intangible assets acquired in our acquisitions of 1-800 CONTACTS and CareMore were internally estimated based on the income approach. The income approach estimates fair value based on the present value of the cash flows that the assets can be expected to generate in the future. We developed internal estimates for the expected cash flows and discount rate in the present value calculation. Other than assets acquired and liabilities assumed in our acquisitions of 1-800 CONTACTS and CareMore, there were no assets or liabilities measured at fair value on a nonrecurring basis during the three and nine months ended September 30, 2012 or 2011.

Our valuation policy is determined by members of our treasury and accounting departments. Whenever possible, our policy is to obtain quoted market prices in active markets to estimate fair values for recognition and disclosure purposes. Where quoted market prices in active markets are not available, fair values are estimated using discounted cash flow analyses, broker quotes or other valuation techniques. These techniques are significantly affected by our assumptions, including discount rates and estimates of future cash flows. Potential taxes and other transaction costs are not considered in estimating fair values. Our valuation policy is generally to obtain only one quoted price for each security from third party pricing services, which are derived through recently reported trades for identical or similar securities making adjustments through the reporting date based upon available market observable information. When broker quotes are used, we generally obtain only one broker quote per security. As we are responsible for the determination of fair value, we perform monthly analysis on the prices received from third parties to determine whether the prices are reasonable estimates of fair value. This analysis is performed by our internal treasury personnel who are familiar with our investment portfolios, the third party pricing services engaged and the valuation techniques and inputs used. Our analysis includes a review of month-to-month price fluctuations. If unusual fluctuations are noted in this review, we may obtain additional information from other pricing services to validate the quoted price. There were no adjustments to quoted market prices obtained from third party pricing services during the three and nine months ended September 30, 2012 or 2011.

In addition to the preceding disclosures on assets recorded at fair value in the consolidated balance sheets, FASB guidance also requires the disclosure of fair values for certain other financial instruments for which it is practicable to estimate fair value, whether or not such values are recognized in the consolidated balance sheets.

Non-financial instruments such as real estate, property and equipment, other current assets, deferred income taxes and intangible assets, and certain financial instruments such as policy liabilities are excluded from the fair value disclosures. Therefore, the fair value amounts cannot be aggregated to determine our underlying economic value.

The carrying amounts reported in the consolidated balance sheets for cash, accrued investment income, premium and self-funded receivables, other receivables, unearned income, accounts payable and accrued expenses, income taxes receivable/payable, security trades pending payable, securities lending payable and certain other current liabilities approximate fair value because of the short term nature of these items. These assets and liabilities are not listed in the table below.

 

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The following methods, assumptions and inputs were used to estimate the fair value of each class of financial instrument:

Other invested assets, long-term: Other invested assets, long-term include primarily our investments in limited partnerships, joint ventures and other non-controlled corporations, as well as the cash surrender value of corporate-owned life insurance policies. In accordance with FASB guidance, our investments in limited partnerships, joint ventures and other non-controlled corporations are generally carried at our share in the entities’ undistributed earnings, which approximates fair value. As these investments are not actively traded and the corresponding inputs are derived from internal estimates, they are classified as Level III. Corporate-owned life insurance policies are classified as Level III and are carried at the cash surrender value as reported by the respective insurer, which approximates fair value.

Short-term borrowings: The fair value of our short-term borrowings is based on quoted market prices for the same or similar debt, or, if no quoted market prices are available, on the current market interest rates available to us for debt of similar terms and remaining maturities.

Long-term debt-commercial paper: The carrying amount for commercial paper approximates fair value as the underlying instruments have variable interest rates at market value.

Long-term debt-notes and capital leases: The fair values of our notes are based on quoted market prices in active markets for the same or similar debt, or, if no quoted market prices are available, on the current market observable rates estimated to be available to us for debt of similar terms and remaining maturities. Capital leases are classified as Level III and are carried at the unamortized present value of the minimum lease payments, which approximates fair value.

A summary of the carrying value and fair value by level of financial instruments not recorded at fair value on our consolidated balance sheet at September 30, 2012 are as follows:

 

     Carrying
Value
     Fair Value  
        Level I      Level II      Level III      Total  

Assets:

              

Other invested assets, long-term

   $ 1,236.1      $ —         $ —         $ 1,236.1      $ 1,236.1  

Liabilities:

              

Debt:

              

Short-term borrowings

     192.0        —           192.0        —           192.0  

Commercial paper

     829.9        —           829.9        —           829.9  

Notes and capital leases

     12,566.0        —           13,712.2        29.9        13,742.1  

A summary of the carrying value and fair value of financial instruments not recorded at fair value on our consolidated balance sheet at December 31, 2011 are as follows:

 

     Carrying
Value
     Fair Value  

Assets:

     

Other invested assets, long-term

   $ 1,103.3      $ 1,103.3  

Liabilities:

     

Debt:

     

Short-term borrowings

     100.0        100.0  

Commercial paper

     799.8        799.8  

Notes and capital leases

     8,895.6        9,871.7  

 

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7. Income Taxes

During the three months ended September 30, 2012 and 2011, we recognized income tax expense of $334.5 and $362.0, respectively, which represents effective tax rates of 32.6% and 34.6%, respectively. The decrease in the effective tax rate in 2012 resulted primarily from the settlement with the Internal Revenue Service, or IRS, of a portion of our open tax issues related to taxes at certain of our acquired companies incurred prior to our acquisition of those companies. This benefit was partially offset by an increase in our state deferred tax asset valuation allowance attributable to the uncertainty associated with some of our state net operating loss carryforwards.

During the nine months ended September 30, 2012 and 2011, we recognized income tax expense of $1,192.8 and $1,168.3, respectively, which represents effective tax rates of 35.2% and 33.6%, respectively. The increase in the effective tax rate in 2012 primarily resulted from the non-tax deductibility of litigation settlement expenses associated with the settlement of a class action lawsuit in June 2012 and the increase in our state deferred tax asset valuation allowance, partially offset by the settlement with the IRS of a portion of our open tax issues related to certain of our acquired companies. In addition, the 2011 effective tax rate was lower due to prior year federal and state audit settlements that occurred during 2011.

A number of our remaining open tax issues, primarily related to not-for-profit conversions and corporate reorganizations in prior years, still require approval from the Joint Committee on Taxation before they can be finalized. The resulting tax benefit from resolution of these open tax issues could possibly be material to our future results of operations and operating cash flows.

For additional information regarding the settlement of a class action lawsuit in June 2012, see Note 10, “Commitments and Contingencies.”

 

8. Retirement Benefits

The components of net periodic benefit cost included in the consolidated statements of income for the three months ended September 30, 2012 and 2011 are as follows:

 

     Pension Benefits     Other Benefits  
     2012     2011     2012     2011  

Service cost

   $ 4.1     $ 4.4     $ 1.7     $ 1.6  

Interest cost

     19.1       21.1       6.8       7.6  

Expected return on assets

     (33.7     (32.1     (5.2     (4.4

Recognized actuarial loss

     7.6       6.5       3.5       2.5  

Settlement loss

     4.0       3.5       —          —     

Amortization of prior service credit

     (0.2     (0.2     (3.3     (3.3
  

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic benefit cost

   $ 0.9     $ 3.2     $ 3.5     $ 4.0  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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The components of net periodic benefit cost included in the consolidated statements of income for the nine months ended September 30, 2012 and 2011 are as follows:

 

     Pension Benefits     Other Benefits  
     2012     2011     2012     2011  

Service cost

   $ 12.3     $ 13.0     $ 5.1     $ 4.8  

Interest cost

     57.4       63.5       20.6       23.8  

Expected return on assets

     (101.0     (96.2     (15.7     (13.0

Recognized actuarial loss

     22.8       19.4       10.6       7.7  

Settlement loss

     10.6       14.2       —          —     

Amortization of prior service credit

     (0.6     (0.6     (10.0     (8.7
  

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic benefit cost

   $ 1.5     $ 13.3     $ 10.6     $ 14.6  
  

 

 

   

 

 

   

 

 

   

 

 

 

For the year ending December 31, 2012, no material contributions are expected to be necessary to meet the Employee Retirement Income Security Act, or ERISA, required funding levels; however, we may elect to make discretionary contributions up to the maximum amount deductible for income tax purposes. Contributions of $30.9 and $1.2 were made to our retirement benefit plans during the nine months ended September 30, 2012 and 2011.

 

9. Debt

We have a senior revolving credit facility, or the facility, with certain lenders for general corporate purposes. The facility, as amended, provides credit up to $2,000.0, and matures on September 29, 2016. There were no amounts outstanding under this facility as of September 30, 2012 or at any time during the three and nine months then ended.

We have an authorized commercial paper program of up to $2,500.0, the proceeds of which may be used for general corporate purposes. At September 30, 2012, we had $829.9 outstanding under this program.

At maturity on April 9, 2012, we refinanced the $100.0 outstanding balance of our 1.430% fixed rate Federal Home Loan Bank secured loan to a three month term loan with a fixed interest rate of 0.370% which matured on July 9, 2012.

On May 7, 2012, we issued $850.0 of 3.125% notes due 2022 and $900.0 of 4.625% notes due 2042 under our shelf registration statement. We intend to use the proceeds from this offering for working capital and for general corporate purposes, including, but not limited to, repayment of short-term and long-term debt. The notes have a call feature that allows us to repurchase the notes at any time at our option and a put feature that allows a note holder to require us to repurchase the notes upon the occurrence of both a change in control event and a downgrade of the notes below an investment grade rating.

At maturity on August 1, 2012, we repaid the $800.0 outstanding balance of our 6.800% senior unsecured notes.

On September 10, 2012, we issued $625.0 of 1.250% notes due 2015, $625.0 of 1.875% notes due 2018, $1,000.0 of 3.300% notes due 2023 and $1,000.0 of 4.650% notes due 2043 under our shelf registration statement. We intend to use the net proceeds of this offering to pay a portion of the consideration for the previously announced acquisition of Amerigroup and the balance for general corporate purposes. The notes have a call feature that allows us to repurchase the notes at any time at our option and a put feature that allows a note holder to require us to repurchase the notes upon the occurrence of both a change in control event and a downgrade of the notes below an investment grade rating. In addition, the notes have a mandatory redemption

 

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feature that requires us to redeem the notes in the event that the acquisition of Amerigroup is not consummated on or prior to September 9, 2013.

Convertible Debentures

On October 9, 2012, we issued $1,500.0 of senior convertible debentures, or the Debentures. The Debentures are governed by an indenture, or the Indenture, dated as of October 9, 2012 between us and The Bank of New York Mellon Trust Company, N.A., as trustee. The Debentures bear interest at a rate of 2.750% per year, payable semi-annually in arrears in cash on April 15 and October 15 of each year, and mature on October 15, 2042, unless earlier redeemed, repurchased or converted. The Debentures also have a contingent interest feature that will require us to pay additional interest based on certain thresholds and for certain events, as defined in the Indenture, beginning on October 15, 2022.

Holders may convert their Debentures at their option prior to the close of business on the business day immediately preceding April 15, 2042, only under the following circumstances: (1) during any fiscal quarter commencing after the fiscal quarter ending on December 31, 2012, if the last reported sale price of our common stock for at least 20 trading days during a period of 30 consecutive trading days ending on the last trading day of the preceding fiscal quarter is greater than or equal to 130% of the applicable conversion price on each applicable trading day; (2) during the five business day period after any 10 consecutive trading day period, or the measurement period, in which the trading price per $1,000 (whole dollars) principal amount of Debentures for each trading day of that measurement period was less than 98% of the product of the last reported sale price of our common stock and the applicable conversion rate on each such day; (3) if we call any or all of the Debentures for redemption, at any time prior to the close of business on the third scheduled trading day prior to the redemption date; or (4) upon the occurrence of specified corporate events, as defined in the Indenture. On and after April 15, 2042 and until the close of business on the third scheduled trading day immediately preceding the Debentures’ maturity date of October 15, 2042, holders may convert their Debentures at any time irrespective of the preceding circumstances. The Debentures are redeemable at our option at any time on or after October 20, 2022, upon the occurrence of certain events, as defined in the Indenture.

Upon conversion of the Debentures, we will deliver cash up to the aggregate principal amount of the Debentures converted. With respect to any conversion obligation in excess of the aggregate principal amount of the Debentures converted, we have the option to settle the excess with cash, shares of our common stock or a combination of cash and shares of common stock based on a daily conversion value, determined in accordance with the Indenture. The initial conversion rate for the Debentures will be 13.2319 shares of our common stock per $1,000 (whole dollars) of principal amount of Debentures, which represents a 25.0% conversion premium based on the closing price of $60.46 per share of our common stock on October 2, 2012 (the date the Debentures’ terms were finalized) and is equivalent to an initial conversion price of approximately $75.575 per share of our common stock.

The Debentures and underlying shares of our common stock have not been and will not be registered under the Securities Act of 1933, as amended, or the Securities Act, or any state securities laws and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements. The Debentures were offered and sold to qualified institutional buyers pursuant to Rule 144A under the Securities Act. We used approximately $371.0 of the net proceeds from the issuance to repurchase shares of our common stock concurrently with the offering of the Debentures, with the balance to be used for general corporate purposes, including but not limited to additional purchases of shares of our common stock pursuant to our share repurchase program and the repayment of short-term and/or long-term debt.

 

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10. Commitments and Contingencies

Litigation

In the ordinary course of business, we are defendants in, or parties to, a number of pending or threatened legal actions or proceedings. To the extent a plaintiff or plaintiffs in the following cases have specified in their complaint or in other court filings the amount of damages being sought, we have noted those alleged damages in the descriptions below. With respect to the cases described below, we contest liability and/or the amount of damages in each matter and believe we have meritorious defenses.

In the Los Angeles County Superior Court, we are defending a lawsuit filed by the Los Angeles City Attorney alleging the wrongful rescission of individual insurance policies and representations made concerning rescission practices and policies. The suit names WellPoint as well as Blue Cross of California, or BCC, and BC Life & Health Insurance Company, or BCL&H (which name changed to Anthem Blue Cross Life and Health Insurance Company in July 2007), both WellPoint subsidiaries. The lawsuit generally alleges unfair business practices in a purported practice of rescinding new individual members following the submission of large claims. The Los Angeles City Attorney filed an amended complaint in October 2010, adding claims of misrepresentation arising from several public statements made by the Company during 2010. The Los Angeles City Attorney is requesting two thousand five hundred dollars ($2,500) per alleged violation of the California Business and Professions Code. We intend to vigorously defend this suit; however, the ultimate outcome cannot be presently determined.

We are currently defending two certified class actions filed as a result of the 2001 demutualization of Anthem Insurance Companies, Inc., or AICI, and the initial public offering of common stock, or IPO, for its holding company, Anthem, Inc. (n/k/a WellPoint, Inc.). The suits name AICI as well as Anthem, Inc., or Anthem, n/k/a WellPoint, Inc. The suits are captioned as Ronald Gold, et al. v. Anthem, Inc. et al. and Mary E. Ormond, et al. v. Anthem, Inc., et al. AICI’s 2001 Plan of Conversion, or the Plan, provided for the conversion of AICI from a mutual insurance company into a stock insurance company pursuant to Indiana law. Under the Plan, AICI distributed the fair value of the company at the time of conversion to its Eligible Statutory Members, or ESMs, in the form of cash or Anthem common stock in exchange for their membership interests in the mutual company. The lawsuits generally allege that AICI distributed value to the wrong ESMs or distributed insufficient value to the ESMs. In Gold, cross motions for summary judgment were granted in part and denied in part on July 26, 2006 with regard to the issue of sovereign immunity asserted by co-defendant, the State of Connecticut, or the State. The court also denied our motion for summary judgment as to plaintiffs’ claims on January 10, 2005. The State appealed the denial of its motion to the Connecticut Supreme Court. We filed a cross-appeal on the sovereign immunity issue. On May 11, 2010, the Court reversed the judgment of the trial court denying the State’s motion to dismiss the plaintiff’s claims under sovereign immunity and dismissed our cross-appeal. The case was remanded to the trial court for further proceedings. Plaintiffs’ motion for class certification was granted on December 15, 2011. We intend to vigorously defend the Gold lawsuit; however, its ultimate outcome cannot be presently determined. In the Ormond suit, our motion to dismiss was granted in part and denied in part on March 31, 2008. The Court dismissed the claims for violation of federal and state securities laws, for violation of the Indiana Demutualization Law, for unjust enrichment, and for negligent misrepresentation with respect to ESMs residing in Indiana. On September 29, 2009, a class was certified with respect to some but not all claims asserted in the plaintiffs’ Fourth Amended Complaint. The class consists of all ESMs residing in Ohio, Indiana, Kentucky or Connecticut who received cash compensation in connection with the demutualization. The class does not include employers located in Ohio and Connecticut that received cash distributions pursuant to the Plan. On July 1, 2011, the Court issued an Order granting in part and denying in part our motion for summary judgment. The Court held that we were entitled to judgment on all of plaintiffs’ claims except those tort claims in connection with the pricing and sizing of the Anthem, Inc. IPO. The parties have reached an agreement to resolve the Ormond suit. On June 15, 2012, plaintiffs filed an unopposed motion for preliminary approval of a $90.0 cash settlement, including any amounts to be awarded for attorneys’ fees and expenses and other costs to administer the settlement. As a result, during the six months ended June 30, 2012, we recorded selling, general and administrative expense of $90.0, or $0.27 per diluted share, associated with this

 

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settlement, which was non-deductible for tax purposes. The Court granted plaintiffs’ motion and entered preliminary approval of the settlement on June 18, 2012. As a result, the trial that had been set for June 18, 2012 was vacated. The cash settlement was paid on July 3, 2012 into an escrow account. A final fairness hearing on the settlement was held on October 25, 2012. The Court approved the settlement agreement and dismissed the matter with prejudice but took the issue of attorneys’ fees under advisement. On November 4, 2009 a class was certified in the Ronald E. Mell, Sr., et al. v. Anthem, Inc., et al suit. That class consisted of persons who were continuously enrolled in the health benefit plan sponsored by the City of Cincinnati between June 18, 2001 and November 2, 2001. On March 3, 2010, the Court issued an order granting our motion for summary judgment. As a result, the Mell suit was dismissed. The plaintiffs filed an appeal with the United States Court of Appeals for the Sixth Circuit Court. Argument on the appeal was held on January 20, 2012. The United States Court of Appeals for the Sixth Circuit Court upheld the district court’s dismissal of the suit on July 25, 2012. The plaintiff’s did not file a petition for a writ of certiori with the United States Supreme Court.

We are currently a defendant in a putative class action relating to out-of-network, or OON, reimbursement of dental claims called American Dental Association v. WellPoint Health Networks, Inc. and Blue Cross of California. The lawsuit was filed in March 2002 by the American Dental Association, and three dentists who are suing on behalf of themselves and are seeking to sue on behalf of a nationwide class of all non-participating dental providers who were paid less than their actual charges for dental services provided to members of some of our affiliates’ and subsidiaries’ dental plans. The dentists sue as purported assignees of their patients’ rights to benefits under our dental plans. The complaint alleges that we breached our contractual obligations in violation of ERISA by paying usual, customary and reasonable, or UCR, rates, rather than the dentists’ actual charges, allegedly relying on undisclosed, non-existent or flawed UCR data. The plaintiffs claim, among other things, that the data failed to account for differences in geography, provider specialty, outlier (high) charges, and complexity of procedure. The complaint further alleges that we were aware that the data was inappropriate to set UCR rates and that we routinely paid OON dentists less than their actual charges, representing that our OON payments were properly determined usual, customary and reasonable rates. The suit was pending in the United States District Court for the Southern District of Florida. On December 23, 2011, the District Court granted our motion for summary judgment and dismissed the case. The plaintiffs filed a notice of appeal with the United States Court of Appeals for the Eleventh Circuit. On October 23, 2012, the Court affirmed the entry of summary judgment in the Company’s favor.

We are currently a defendant in eleven putative class actions relating to OON reimbursement that were consolidated into a single multi-district lawsuit called In re WellPoint, Inc. Out-of-Network “UCR” Rates Litigation that is pending in the United States District Court for the Central District of California. The lawsuits were filed in 2009. The plaintiffs include current and former members on behalf of a putative class of members who received OON services for which the defendants paid less than billed charges, the American Medical Association, four state medical associations, OON physicians, chiropractors, clinical psychologists, podiatrists, psychotherapists, the American Podiatric Association, California Chiropractic Association and the California Psychological Association on behalf of a putative class of all physicians and all non-physician health care providers, and an OON surgical center. In the consolidated complaint, the plaintiffs allege that the defendants violated the Racketeer Influenced and Corrupt Organizations Act, or RICO, the Sherman Antitrust Act, ERISA, federal regulations, and state law by relying on databases provided by Ingenix in determining OON reimbursement. A consolidated amended complaint was filed to add allegations in the lawsuit that OON reimbursement was calculated improperly by methodologies other than the Ingenix databases. We filed a motion to dismiss the amended consolidated complaint. The motion was granted in part and denied in part. The court gave the plaintiffs permission to replead many of those claims that were dismissed. The plaintiffs then filed a third amended consolidated complaint repleading some of the claims that had been dismissed without prejudice and adding additional statements in an attempt to bolster other claims. We filed a motion to dismiss the third amended consolidated complaint, which was granted in part and denied in part. The plaintiffs filed a fourth amended consolidated complaint on November 5, 2012. The OON surgical center voluntarily dismissed their claims. Fact discovery is complete. At the end of 2009, we filed a motion in the United States District Court for the Southern District of Florida, or the Florida Court, to enjoin the claims brought by the medical doctors and

 

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doctors of osteopathy and certain medical associations based on prior litigation releases, which was granted in 2011, and that court ordered the plaintiffs to dismiss their claims that are barred by the release. The plaintiffs then filed a petition for declaratory judgment asking the court to find that these claims are not barred by the releases from the prior litigation. We filed a motion to dismiss the declaratory judgment action, which was granted. The plaintiffs appealed the dismissal of the declaratory judgment to the United States Court of Appeals for the Eleventh Circuit, but the dismissal was upheld. The enjoined physicians have not yet dismissed their claims. The Florida Court found the enjoined physicians in contempt and sanctioned them on July 25, 2012. The barred physicians are paying the sanctions. We intend to vigorously defend these suits; however, their ultimate outcome cannot be presently determined.

Where available information indicates that it is probable that a loss has been incurred as of the date of the consolidated financial statements and we can reasonably estimate the amount of that loss, we accrue the estimated loss by a charge to income. In many proceedings, however, it is difficult to determine whether any loss is probable or reasonably possible. In addition, even where loss is possible or an exposure to loss exists in excess of the liability already accrued with respect to a previously identified loss contingency, it is not always possible to reasonably estimate the amount of the possible loss or range of loss.

With respect to many of the proceedings to which we are a party, we cannot provide an estimate of the possible losses, or the range of possible losses in excess of the amount, if any, accrued, for various reasons, including but not limited to some or all of the following: (i) there are novel or unsettled legal issues presented, (ii) the proceedings are in early stages, (iii) there is uncertainty as to the likelihood of a class being certified or decertified or the ultimate size and scope of the class, (iv) there is uncertainty as to the outcome of pending appeals or motions, (v) there are significant factual issues to be resolved, and/or (vi) in many cases, the plaintiffs have not specified damages in their complaint or in court filings. For those legal proceedings where a loss is probable, or reasonably possible, and for which it is possible to reasonably estimate the amount of the possible loss or range of losses, we currently believe that the range of possible losses, in excess of established reserves, for all of those proceedings is from $0 to approximately $350.0 at September 30, 2012. This estimated aggregate range of reasonably possible losses is based upon currently available information taking into account our best estimate of such losses for which such an estimate can be made.

Other Contingencies

From time to time, we and certain of our subsidiaries are parties to various legal proceedings, many of which involve claims for coverage encountered in the ordinary course of business. We, like HMOs and health insurers generally, exclude certain health care and other services from coverage under our HMO, PPO and other plans. We are, in the ordinary course of business, subject to the claims of our enrollees arising out of decisions to restrict or deny reimbursement for uncovered services. The loss of even one such claim, if it results in a significant punitive damage award, could have a material adverse effect on us. In addition, the risk of potential liability under punitive damage theories may increase significantly the difficulty of obtaining reasonable settlements of coverage claims.

In addition to the lawsuits described above, we are also involved in other pending and threatened litigation of the character incidental to our business, and are from time to time involved as a party in various governmental investigations, audits, reviews and administrative proceedings. These investigations, audits, reviews and administrative proceedings include routine and special inquiries by state insurance departments, state attorneys general, the U.S. Attorney General and subcommittees of the U.S. Congress. Such investigations, audits, reviews and administrative proceedings could result in the imposition of civil or criminal fines, penalties, other sanctions and additional rules, regulations or other restrictions on our business operations. Any liability that may result from any one of these actions, or in the aggregate, could have a material adverse effect on our consolidated financial position or results of operations.

The National Organization of Life & Health Insurance Guaranty Associations, or NOLHGA, is a voluntary organization consisting of the state life and health insurance guaranty associations located throughout the U.S.

 

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State life and health insurance guaranty associations, working together with NOLHGA, provide a safety net for their state’s policyholders, ensuring that they continue to receive coverage even if their insurer is declared insolvent. We are aware that the Pennsylvania Insurance Commissioner, or Insurance Commissioner, has placed Penn Treaty Network America Insurance Company and its subsidiary American Network Insurance Company, or collectively Penn Treaty, in rehabilitation, an intermediate action before insolvency. The state court denied the Insurance Commissioner’s petition for the liquidation of Penn Treaty and ordered the Commissioner to file an updated plan of rehabilitation. The Insurance Commissioner has filed a Notice of Appeal asking the Pennsylvania Supreme Court to reverse the order denying the liquidation petition. In the event rehabilitation of Penn Treaty is unsuccessful and Penn Treaty is declared insolvent and placed in liquidation, we and other insurers may be required to pay a portion of their policyholder claims through state guaranty association assessments in future periods. Given the uncertainty around whether Penn Treaty will ultimately be declared insolvent and, if so, the amount of the insolvency, the amount and timing of any associated future guaranty fund assessments and the availability and amount of any potential premium tax and other offsets, we currently cannot estimate our net exposure, if any, to this potential insolvency. We will continue to monitor the situation and may record a liability and expense in future reporting periods, which could be material to our cash flows and results of operations.

Contractual Obligations and Commitments

We are a party to an agreement with Express Scripts, Inc., or Express Scripts, to provide pharmacy benefit management services for our plans. The initial term of this agreement expires on December 31, 2019. Under this agreement, Express Scripts is the exclusive provider of certain specified pharmacy benefit management services, such as pharmacy network management, home delivery, pharmacy customer service, claims processing, rebate management, drug utilization and specialty pharmaceutical management services. Accordingly, the agreement contains certain financial and operational requirements obligating both Express Scripts and us. Express Scripts’ primary obligations relate to the performance of such services and meeting certain pricing guarantees and performance standards. Our primary obligations relate to oversight, provision of data, payment for services and certain minimum volume requirements. The failure by either party to meet the respective requirements could potentially serve as a basis for financial penalties or early termination of the contract. We believe we have appropriately recognized all rights and obligations under this contract at September 30, 2012.

During the first quarter of 2010, we entered into a new agreement with International Business Machines Corporation to provide information technology infrastructure services. This new agreement supersedes certain prior agreements and also includes provisions for additional services. Our remaining commitment under this agreement at September 30, 2012 was $636.6 over a two and a half year period. We have the ability to terminate this agreement upon the occurrence of certain events, subject to early termination fees.

On March 31, 2009, we entered into an agreement with Affiliated Computer Services, Inc. to provide certain print and mailroom services that were previously performed in-house. Our remaining commitment under this agreement at September 30, 2012 was $220.0 over a three and a half year period. We have the ability to terminate this agreement upon the occurrence of certain events, subject to early termination fees.

 

11. Capital Stock

Use of Capital – Dividends and Stock Repurchase Program

We regularly review the appropriate use of capital, including common stock repurchases and dividends to shareholders. The declaration and payment of any dividends or repurchases of our common stock are at the discretion of our Board of Directors and depend upon our financial condition, results of operations, future liquidity needs, regulatory and capital requirements and other factors deemed relevant by our Board of Directors.

 

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A summary of the cash dividend activity for the nine months ended September 30, 2012 and 2011 is as follows:

 

Declaration Date

  

Record Date

    

Payment Date

    

Cash
Dividend
per Share

    

Total

 
Nine Months Ended September 30, 2012            

January 24, 2012

     March 9, 2012         March 23, 2012       $ 0.2875      $ 95.8  

May 16, 2012

     June 8, 2012         June 25, 2012         0.2875        93.5  

July 24, 2012

     September 10, 2012         September 25, 2012         0.2875        90.7  
Nine Months Ended September 30, 2011            

February 22, 2011

     March 10, 2011         March 25, 2011       $ 0.25      $ 92.8  

May 17, 2011

     June 10, 2011         June 24, 2011         0.25        91.1  

July 26, 2011

     September 9, 2011         September 23, 2011         0.25        88.2  

Under our Board of Directors’ authorization, we maintain a common stock repurchase program. Repurchases may be made from time to time at prevailing market prices, subject to certain restrictions on volume, pricing and timing. The repurchases are effected from time to time in the open market, in private transactions, including accelerated share repurchase agreements, and through plans designed to comply with Rule 10b5-1 under the Securities Exchange Act of 1934, as amended. Our stock repurchase program is discretionary as we are under no obligation to repurchase shares. We repurchase shares under the program when we believe it is a prudent use of capital. The excess cost of repurchased shares over par value is charged on a pro rata basis to additional paid-in capital and retained earnings.

A summary of share repurchases for the period October 1, 2012 through October 31, 2012 (subsequent to September 30, 2012) and for the nine months ended September 30, 2012 and 2011 is as follows:

 

     October 1, 2012
Through

October 31, 2012
     Nine Months Ended
September 30
 
        2012      2011  

Shares repurchased

     10.4        28.6        34.2  

Average price per share

   $ 60.94      $ 63.85      $ 68.87  

Aggregate cost

   $ 634.3      $ 1,828.8      $ 2,354.2  

Authorization remaining at the end of each period

   $ 1,870.6      $ 2,504.9      $ 5,019.3  

Stock Incentive Plans

A summary of stock option activity for the nine months ended September 30, 2012 is as follows:

 

     Number of
Shares
    Weighted-
Average
Option Price
per Share
     Weighted-
Average
Remaining
Contractual
Life (Years)
     Aggregate
Intrinsic
Value
 

Outstanding at January 1, 2012

     20.0     $ 62.30        

Granted

     1.7       66.24        

Exercised

     (1.9     45.69        

Forfeited or expired

     (1.3     73.52        
  

 

 

         

Outstanding at September 30, 2012

     18.5       63.58        3.6      $ 92.9  
  

 

 

         

Exercisable at September 30, 2012

     16.1       63.30        3.2      $ 92.7  
  

 

 

         

 

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A summary of nonvested restricted stock unit activity for the nine months ended September 30, 2012 is as follows:

 

     Restricted
Stock
Units
    Weighted-
Average
Grant Date
Fair Value
per Share
 

Nonvested at January 1, 2012

     4.0     $ 56.00  

Granted

     1.9       66.20  

Vested

     (2.1     48.76  

Forfeited

     (0.3     65.39  
  

 

 

   

Nonvested at September 30, 2012

     3.5       65.29  
  

 

 

   

Fair Value

We use a binomial lattice valuation model to estimate the fair value of all stock options granted. For a more detailed discussion of our stock incentive plan fair value methodology, see Note 15, “Capital Stock,” to our audited consolidated financial statements as of and for the year ended December 31, 2011 included in our 2011 Annual Report on Form 10-K.

The following weighted-average assumptions were used to estimate the fair values of options granted during the nine months ended September 30, 2012 and 2011:

 

     2012     2011  

Risk-free interest rate

     1.41     2.84

Volatility factor

     34.00     34.00

Quarterly dividend yield

     0.400     0.379

Weighted-average expected life (years)

     4.1       4.0  

The following weighted-average fair values were determined for the nine months ended September 30, 2012 and 2011:

 

     2012      2011  

Options granted during the period

   $ 16.51      $ 17.84  

 

12. Earnings per Share

The denominator for basic and diluted earnings per share for the three and nine months ended September 30, 2012 and 2011 is as follows:

 

     Three Months
Ended
September 30
     Nine Months
Ended
September 30
 
     2012      2011      2012      2011  

Denominator for basic earnings per share – weighted average shares

     318.9        356.0        327.2        365.3  

Effect of dilutive securities – employee and director stock options and non-vested restricted stock awards

     3.0        4.4        3.5        5.0  
  

 

 

    

 

 

    

 

 

    

 

 

 

Denominator for diluted earnings per share

     321.9        360.4        330.7        370.3  
  

 

 

    

 

 

    

 

 

    

 

 

 

During the three months ended September 30, 2012 and 2011, weighted average shares related to certain stock options of 14.8 and 10.9, respectively, were excluded from the denominator for diluted earnings per share

 

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because the stock options were anti-dilutive. During the nine months ended September 30, 2012 and 2011, weighted average shares related to certain stock options of 11.9 and 10.3, respectively, were excluded from the denominator for diluted earnings per share because the stock options were anti-dilutive.

During the nine months ended September 30, 2012, we issued approximately 1.9 restricted stock units under our stock incentive plans, 0.8 of whose vesting is contingent upon us meeting specified annual performance targets for 2012. The contingent restricted stock units have been excluded from the denominator for diluted earnings per share and will be included only if and when the contingency is met.

 

13. Segment Information

Our organizational structure is comprised of three reportable segments: Commercial, Consumer and Other, as further described in Note 20, “Segment Information,” to our audited consolidated financial statements as of and for the year ended December 31, 2011 included in our 2011 Annual Report on Form 10-K.

Financial data by reportable segment for the three and nine months ended September 30, 2012 and 2011 is as follows:

 

     Commercial      Consumer      Other      Total  

Three Months Ended September 30, 2012:

           

Operating revenue from external customers

   $ 8,360.6      $ 4,879.1      $ 1,894.0      $ 15,133.7  

Operating gain

     818.6        184.7        0.5        1,003.8  

Three Months Ended September 30, 2011:

           

Operating revenue from external customers

   $ 8,657.9      $ 4,576.4      $ 1,920.8      $ 15,155.1  

Operating gain

     711.5        245.2        15.9        972.6  

Nine Months Ended September 30, 2012:

           

Operating revenue from external customers

   $ 25,255.8      $ 14,456.0      $ 5,745.4      $ 45,457.2  

Operating gain

     2,581.6        613.5        13.0        3,208.1  

Nine Months Ended September 30, 2011:

           

Operating revenue from external customers

   $ 25,868.8      $ 13,164.2      $ 5,656.7      $ 44,689.7  

Operating gain

     2,583.8        627.7        58.1        3,269.6  

A reconciliation of reportable segments operating revenues to total revenues reported in the consolidated statements of income for the three and nine months ended September 30, 2012 and 2011 is as follows:

 

     Three Months Ended
September 30
    Nine Months Ended
September 30
 
     2012     2011     2012     2011  

Reportable segments operating revenues

   $ 15,133.7     $ 15,155.1     $ 45,457.2     $ 44,689.7  

Net investment income

     168.6       170.9       507.0       543.5  

Net realized gains on investments

     54.6       94.9       232.0       193.5  

Other-than-temporary impairment losses recognized in income

     (3.8     (22.9     (20.6     (33.7
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

   $ 15,353.1     $ 15,398.0     $ 46,175.6     $ 45,393.0  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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A reconciliation of reportable segments operating gain to income before income tax expense included in the consolidated statements of income for the three and nine months ended September 30, 2012 and 2011 is as follows:

 

     Three Months Ended
September 30
    Nine Months Ended
September 30
 
     2012     2011     2012     2011  

Reportable segments operating gain

   $ 1,003.8     $ 972.6     $ 3,208.1     $ 3,269.6  

Net investment income

     168.6       170.9       507.0       543.5  

Net realized gains on investments

     54.6       94.9       232.0       193.5  

Other-than-temporary impairment losses recognized in income

     (3.8     (22.9     (20.6     (33.7

Interest expense

     (133.6     (108.2     (360.3     (317.7

Amortization of other intangible assets

     (63.9     (62.1     (182.1     (175.5
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income tax expense

   $ 1,025.7     $ 1,045.2      $ 3,384.1     $ 3,479.7   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(In Millions, Except Per Share Data or Otherwise Stated Herein)

References to the terms “we”, “our” or “us” used throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, refer to WellPoint, Inc., an Indiana corporation, and unless the context otherwise requires, its direct and indirect subsidiaries.

This MD&A should be read in conjunction with our audited consolidated financial statements as of and for the year ended December 31, 2011 and the MD&A included in our 2011 Annual Report on Form 10-K, and our unaudited consolidated financial statements and accompanying notes as of and for the three and nine months ended September 30, 2012 included in this Form 10-Q. Results of operations, cost of care trends, investment yields and other measures for the three and nine month periods ended September 30, 2012 are not necessarily indicative of the results and trends that may be expected for the full year ending December 31, 2012. Also see Part I, Item 1A, “Risk Factors” of our 2011 Annual Report on Form 10-K and Part II, Item 1A, “Risk Factors” of this Form 10-Q.

Overview

We manage our operations through three reportable segments: Commercial, Consumer and Other. For additional information about our organization, see the “Overview” section of Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our 2011 Annual Report on Form 10-K.

Executive Summary

We are one of the largest health benefits companies in the United States, serving approximately 33.5 medical members through our affiliated health plans and more than 63.7 individuals through all subsidiaries as of September 30, 2012. We are an independent licensee of the Blue Cross and Blue Shield Association, or BCBSA, an association of independent health benefit plans. We serve our members as the Blue Cross licensee for California and as the Blue Cross and Blue Shield, or BCBS, licensee for: Colorado, Connecticut, Georgia, Indiana, Kentucky, Maine, Missouri (excluding 30 counties in the Kansas City area), Nevada, New Hampshire, New York (as BCBS in 10 New York City metropolitan and surrounding counties, and as Blue Cross or BCBS in selected upstate counties only), Ohio, Virginia (excluding the Northern Virginia suburbs of Washington, D.C.), and Wisconsin. In a majority of these service areas we do business as Anthem Blue Cross, Anthem Blue Cross and Blue Shield, Blue Cross and Blue Shield of Georgia, Empire Blue Cross Blue Shield, or Empire Blue Cross (in our New York service areas). We also serve customers throughout the country as UniCare and in certain California, Arizona and Nevada markets through our CareMore Health Group, Inc., or CareMore, subsidiary. We are licensed to conduct insurance operations in all 50 states through our subsidiaries. We also sell contact lenses, eyeglasses and other ocular products through our recently acquired 1-800 CONTACTS, Inc., or 1-800 CONTACTS, subsidiary.

Operating revenue for the three months ended September 30, 2012 was $15,133.7, a decrease of $21.4, or 0.1%, from the three months ended September 30, 2011, reflecting lower premium revenue in our Commercial segment, partially offset by higher premium revenue in our Consumer segment. The lower premiums in our Commercial segment were driven primarily by fully insured membership declines in our Local Group business resulting from strategic product portfolio changes in certain markets, competitive pressure in certain markets and unfavorable economic conditions, partially offset by premium rate increases designed to cover overall cost trends. The higher premiums in our Consumer segment resulted primarily from membership growth in our Senior Medicare Advantage business, including additional membership from CareMore, which was acquired in August 2011, and growth in our State-Sponsored business resulting primarily from retroactive premium rate increases in

 

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the California market. In addition, increased other revenue in our Commercial segment resulting primarily from product sales by our 1-800 CONTACTS business, which was acquired in June 2012, partially offset the decline in premium revenue.

Operating revenue for the nine months ended September 30, 2012 was $45,457.2, an increase of $767.5, or 1.7%, from the nine months ended September 30, 2011, reflecting higher premium revenue in our Consumer segment, partially offset by lower premium revenue in our Commercial segment. The higher premiums in our Consumer segment primarily resulted from membership growth in our Senior Medicare Advantage business, including additional membership from CareMore. The premium revenue decrease in our Commercial segment was driven primarily by fully insured membership declines in our Local Group business resulting from strategic product portfolio changes in certain markets, competitive pressure in certain markets and unfavorable economic conditions, partially offset by premium rate increases in our Local Group business designed to cover overall cost trends.

Net income for the three months ended September 30, 2012 was $691.2, an increase of $8.0, or 1.2%, from the three months ended September 30, 2011. This increase in net income was primarily driven by a higher operating gain in our Commercial segment, partially offset by lower operating gains in our Consumer and Other segments. Our fully-diluted earnings per share, or EPS, was $2.15 for the three months ended September 30, 2012, which represented a 13.2% increase over the EPS of $1.90 for the three months ended September 30, 2011. The increase in EPS resulted primarily from the lower number of shares outstanding in 2012 due to share buyback activity under our share repurchase program and the increase in net income.

Net income for the nine months ended September 30, 2012 was $2,191.3, a decrease of $120.1, or 5.2%, from the nine months ended September 30, 2011. This decrease in net income was primarily driven by lower operating results in our Other, Consumer and Commercial segments, including the impact of non-tax deductible litigation settlement costs recorded in June 2012 resulting in higher general and administrative expense and income tax expense, as well as increased interest expense resulting from higher outstanding debt balances. For additional details, see Note 10, “Commitments and Contingencies,” to our unaudited consolidated financial statements included in Part 1, Item 1 of this Form 10-Q and “Consolidated Results of Operations – Nine Months Ended September 30, 2012 Compared to the Nine Months Ended September 30, 2011” included in this MD&A. Our fully-diluted EPS was $6.63 for the nine months ended September 30, 2012, which represented a 6.2% increase over the EPS of $6.24 for the nine months ended September 30, 2011. The increase in EPS resulted primarily from the lower number of shares outstanding in 2012 due to share buyback activity under our share repurchase program, partially offset by the decline in net income.

Our results of operations discussed throughout this MD&A are determined in accordance with U.S. generally accepted accounting principles, or GAAP. We also calculate adjusted net income and adjusted EPS, which are non-GAAP measures, to further aid investors in understanding and analyzing our core operating results and comparing them among periods. Adjusted net income and adjusted EPS exclude realized gains and losses on investments, other-than-temporary losses on investments recognized in income and certain other items, if applicable, that we do not consider as part of our core operating results. Operating gain is calculated as total operating revenue less benefit expense, selling, general and administrative expense and cost of products. We use these measures as a basis for evaluating segment performance, allocating resources, setting incentive compensation targets and for forecasting future operating periods. This information is not intended to be considered in isolation or as a substitute for net income or diluted EPS prepared in accordance with GAAP, and may not be comparable to similarly titled measures reported by other companies. For additional details on operating gain, see our “Consolidated Results of Operations” discussion within this MD&A.

 

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The table below reconciles net income and EPS calculated in accordance with GAAP to adjusted net income and adjusted EPS for the three months ended September 30, 2012 and 2011.

 

     Three Months Ended
September 30
             
     2012      2011     Change     % Change  

Net income

   $ 691.2      $ 683.2     $ 8.0       1.2

Less:

         

Net realized gains on investments

     54.6        94.9       (40.3  

Other-than-temporary impairment losses on investments

     (3.8      (22.9     19.1    

Acquisition and integration related costs

     (21.3      —          (21.3  

Tax effect of adjustments

     (10.4      (25.2     14.8    
  

 

 

    

 

 

   

 

 

   

Adjusted net income

   $ 672.1      $ 636.4     $ 35.7       5.6
  

 

 

    

 

 

   

 

 

   

EPS

   $ 2.15      $ 1.90     $ 0.25       13.2

Less:

         

Net realized gains on investments

     0.17        0.26       (0.09  

Other-than-temporary impairment losses on investments

     (0.01      (0.06     0.05    

Acquisition and integration related costs

     (0.07      —          (0.07  

Tax effect of adjustments

     (0.03      (0.07     0.04    
  

 

 

    

 

 

   

 

 

   

Adjusted EPS

   $ 2.09      $ 1.77     $ 0.32       18.1
  

 

 

    

 

 

   

 

 

   

The table below reconciles net income and EPS calculated in accordance with GAAP to adjusted net income and adjusted EPS for the nine months ended September 30, 2012 and 2011.

 

     Nine Months Ended
September 30
             
     2012     2011     Change     % Change  

Net income

   $ 2,191.3     $ 2,311.4     $ (120.1     (5.2 )% 

Less:

        

Net realized gains on investments

     232.0       193.5       38.5    

Other-than-temporary impairment losses on investments

     (20.6     (33.7     13.1    

Litigation related costs

     (24.0     —          (24.0  

Acquisition and integration related costs

     (33.1     —          (33.1  

Tax effect of adjustments

     (103.4     (55.9     (47.5  
  

 

 

   

 

 

   

 

 

   

Adjusted net income

   $ 2,140.4     $ 2,207.5     $ (67.1     (3.0 )% 
  

 

 

   

 

 

   

 

 

   

EPS

   $ 6.63     $ 6.24     $ 0.39       6.2

Less:

        

Net realized gains on investments

     0.70       0.52       0.18    

Other-than-temporary impairment losses on investments

     (0.06     (0.09     0.03    

Litigation related costs

     (0.07     —          (0.07  

Acquisition and integration related costs

     (0.10     —          (0.10  

Tax effect of adjustments

     (0.31     (0.15     (0.16  
  

 

 

   

 

 

   

 

 

   

Adjusted EPS

   $ 6.47     $ 5.96     $ 0.51       8.6
  

 

 

   

 

 

   

 

 

   

Operating cash flow for the nine months ended September 30, 2012 was $1,984.8, or 0.9 times net income. Operating cash flow for the nine months ended September 30, 2011 was $3,316.5. The decrease in operating cash flow from 2011 of $1,331.7 was driven primarily by the timing of premium receipts related to federal government contracts. We received ten monthly premium payments related to these government contracts during 2011, while we only received nine monthly premium payments during 2012. In addition, the decrease in

 

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operating cash flow in 2012 was impacted by payments related to the run-out of medical claims for former members, increased litigation settlement payments, the addition of required minimum medical loss ratio rebate payments and overall lower net income.

Significant Transactions

Acquisition of 1-800 CONTACTS

On June 20, 2012, we completed our acquisition of 1-800 CONTACTS, the largest direct-to-consumer retailer of contact lenses in the United States, whose model is built on providing a superior customer experience and a wide selection of ocular products at affordable prices. The acquisition strategically aligns with our efforts to capitalize on new opportunities for growth to diversify our revenue stream into complementary and higher-margin specialty businesses. For additional information regarding this acquisition, see Note 3, “Business Combinations,” to our unaudited consolidated financial statements included in Part I, Item 1 of this Form 10-Q.

Pending Acquisition of AMERIGROUP Corporation

On July 9, 2012, we announced that we had entered into a definitive agreement to acquire AMERIGROUP Corporation, or Amerigroup, one of the nation’s leading managed care companies that is focused on meeting the health care needs of financially vulnerable Americans. This acquisition will further our goal of creating better health care quality at more affordable prices for our customers. It will also advance our capabilities to more effectively and efficiently serve the growing Medicaid population, including the expanding dual eligible, seniors, persons with disabilities and long-term services and support markets. Under the terms of the agreement, we will pay $92.00 per share in cash to acquire all of the outstanding shares of Amerigroup for an estimated transaction value of approximately $4,900.0. The acquisition, which was approved by Amerigroup’s shareholders on October 23, 2012, remains subject to certain state regulatory approvals, standard closing conditions and approvals required under the Hart-Scott-Rodino Antitrust Improvements Act, and is expected to close in the fourth quarter of 2012.

Sources and Uses of Capital

We regularly review the appropriate sources and uses of capital, including debt borrowings, common stock repurchases and dividends to shareholders. The issuance of debt and the declaration and payment of any dividends or repurchases of our common stock are at the discretion of our Board of Directors and depend upon our financial condition, results of operations, future liquidity needs, regulatory and capital requirements and other factors deemed relevant by our Board of Directors.

For additional information regarding our sources and uses of capital during the three and nine months ended September 30, 2012, see Note 9, “Debt,” and the “Use of Capital – Dividends and Stock Repurchase Program” section of Note 11, “Capital Stock,” to our unaudited consolidated financial statements included in Part I, Item 1 of this Form 10-Q.

Membership

Our medical membership includes seven different customer types: Local Group, Individual, National Accounts, BlueCard, Senior, State-Sponsored and FEP. BCBSA-branded business generally refers to members in our service areas licensed by the BCBSA. Non-BCBSA-branded business refers to UniCare members predominantly outside of our BCBSA service areas and members from our CareMore subsidiary. For a more detailed description of our medical membership, see the “Membership” section of Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our 2011 Annual Report on Form 10-K.

The following table presents our medical membership by customer type, funding arrangement and reportable segment as of September 30, 2012 and 2011. Also included below is other membership by product.

 

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The medical membership and other membership presented are unaudited and in certain instances include estimates of the number of members represented by each contract at the end of the period.

 

      September 30               
(In thousands)    2012      2011      Change     % Change  

Medical Membership

          

Customer Type

          

Local Group

     14,602        15,296        (694     (4.5 )% 

Individual

     1,862        1,855        7       0.4  

National:

          

National Accounts

     7,019        7,435        (416     (5.6

BlueCard

     5,062        4,961        101       2.0  
  

 

 

    

 

 

    

 

 

   

Total National

     12,081        12,396        (315     (2.5

Senior

     1,538        1,442        96       6.7  

State-Sponsored

     1,891        1,849        42       2.3  

FEP

     1,519        1,517        2       0.1  
  

 

 

    

 

 

    

 

 

   

Total Medical Membership by Customer Type

     33,493        34,355        (862     (2.5
  

 

 

    

 

 

    

 

 

   

Funding Arrangement

          

Self-Funded

     20,172        20,570        (398     (1.9

Fully-Insured

     13,321        13,785        (464     (3.4
  

 

 

    

 

 

    

 

 

   

Total Medical Membership by Funding Arrangement

     33,493        34,355        (862     (2.5
  

 

 

    

 

 

    

 

 

   

Reportable Segment

          

Commercial

     26,683        27,692        (1,009     (3.6

Consumer

     5,291        5,146        145       2.8  

Other

     1,519        1,517        2       0.1  
  

 

 

    

 

 

    

 

 

   

Total Medical Membership by Reportable Segment

     33,493        34,355        (862     (2.5
  

 

 

    

 

 

    

 

 

   

Other Membership & Customers

          

Behavioral Health Members

     24,386        25,203        (817     (3.2

Life and Disability Members

     4,895        5,014        (119     (2.4

Dental Members

     3,835        4,079        (244     (6.0

Dental Administration Members

     4,103        4,318        (215     (5.0

Vision Members

     4,435        3,765        670       17.8  

Medicare Advantage Part D Members

     621        564        57       10.1  

Medicare Part D Standalone Members

     579        668        (89     (13.3

Retail Vision Customers

     3,112        —           3,112       —     

Medical Membership (in thousands)

During the twelve months ended September 30, 2012, total medical membership decreased 862, or 2.5%, primarily due to decreases in our Local Group and National Accounts membership. These decreases were partially offset by increases in our Senior and State-Sponsored membership.

Self-funded medical membership decreased 398, or 1.9%, primarily due to pricing increases in our National Accounts business.

Fully-insured membership decreased 464, or 3.4%, primarily due to strategic product portfolio changes and heightened competition in certain Local Group markets, partially offset by growth in our Senior business.

 

 

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Local Group membership decreased 694, or 4.5%, primarily due to increased competition, strategic product portfolio changes in the New York market and network rental markets and negative in-group change.

Individual membership increased 7, or 0.4%, primarily due to an overall improved competitive position in our California market.

National Accounts membership decreased 416, or 5.6%, primarily driven by pricing increases in our self-funded National Accounts business and negative in-group change.

BlueCard membership increased 101, or 2.0%, primarily due to favorable net sales and in-group change at other BCBSA plans whose members reside in or travel to our licensed areas.

Senior membership increased 96, or 6.7%, primarily due to strong sales during the open enrollment period resulting from our geographic expansion into several new counties, partially offset by our withdrawal of the California Regional PPO Medicare Advantage product.

State-Sponsored membership increased 42, or 2.3%, primarily due to growth in Virginia, California, Kansas, Indiana and South Carolina, partially offset by exiting selected markets.

FEP membership increased 2, or 0.1%, primarily due to favorable in-group change.

Other Membership (in thousands)

Our Other products are often ancillary to our health business, and can therefore be impacted by corresponding changes in our medical membership.

Behavioral health membership decreased 817, or 3.2%, primarily due to the overall declines in our fully-insured medical membership and negative in-group change.

Life and disability membership decreased 119, or 2.4%, primarily due to the overall declines in our Commercial fully-insured medical membership and negative in-group change. Life and disability products are generally offered as part of Commercial medical fully-insured membership sales.

Dental membership decreased 244, or 6.0%, primarily due to the lapse of a large dental contract, partially offset by the launch of new dental products in 2012.

Dental administration membership decreased 215, or 5.0%, primarily due to the lapse of a large contract for which we provided dental administrative services.

Vision membership increased 670, or 17.8%, primarily due to strong sales and positive in-group change in our National Accounts, Local Group and Senior businesses.

Medicare Advantage Part D membership increased 57, or 10.1%, primarily due to strong sales during the Medicare Advantage open enrollment period resulting from our geographic expansion into several new counties and the addition of membership from CareMore, partially offset by our withdrawal of the California Regional PPO Medicare Advantage product.

Medicare Part D standalone membership decreased 89, or 13.3%, primarily due to competitive pressure in certain markets.

Retail vision customers increased 3,112 due to our acquisition of 1-800 CONTACTS.

 

 

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Cost of Care

The following discussion summarizes our aggregate underlying cost of care trends for the rolling 12 months ended September 30, 2012 for our Local Group fully-insured business only.

Our cost of care trends are calculated by comparing the year-over-year change in average per member per month claim costs, including member co-payments and deductibles. While our cost of care trend varies by geographic location, based on underlying medical cost trends, we believe that our 2012 cost of care trend estimate of 7.0% plus or minus 50 basis points is appropriate.

Overall, our medical cost trend is driven by unit cost. Inpatient hospital trend is in the high single digit range and is primarily related to increases in the average cost per admission. Recent increases in the average case acuity (intensity) continue to abate. While provider rate increases are a primary driver of unit cost trends, we continually negotiate with hospitals to manage these cost trends. We remain committed to optimizing our reimbursement rates and strategies to help address the cost pressures faced by employers and consumers. Inpatient admission counts per thousand members are only slightly higher than prior year. Inpatient day counts per thousand members are growing at a slightly higher rate, but trend is still in the low single digit range. While the average length of stay is lengthening slightly, the rate of increase is slowing. In addition to our recontracting efforts a number of clinical management initiatives are in place to help mitigate the inpatient trend. Focused review efforts continue in key areas, including inpatient behavioral health stays and spinal surgery cases, among others. Additionally, we continue to refine our programs related to readmission management, focused utilization management at high cost facilities, and post-discharge follow-up care.

Outpatient trend is in the high single digit range and is 70% cost driven and 30% utilization driven. Outpatient costs are a collection of different types of expenses, such as outpatient facilities, labs, x-rays, emergency room, and occupational and physical therapy. Per visit costs are still the largest contributor to overall outpatient trend, influenced largely by price increases within certain provider contracts. Outpatient utilization (visits per thousand members) is higher than the prior year. We continue to work with vendors and providers to help optimize site of service decisions including key areas such as emergency room, lab, radiology, sleep studies, and surgery settings. As an example we are in execution on our American Imaging Management’s Sleep Management Program for the fourth quarter of 2012 in our central and western states, as well as in Georgia, and for the first quarter of 2013 in New York and the other northeastern states. The program aligns the diagnosis and treatment of sleep apnea with clinical guidelines based on widely accepted medical literature, while at the same time enhancing member access to high value providers and ensuring treatment compliance for the continuing payment for equipment rental and ongoing supplies. Programs like this, along with continued expansion and optimization of our utilization management programs, are serving to moderate trend.

Physician services trend is in the mid single digit range and is 75% unit cost related and 25% utilization related. Increases in the physician care category are partially driven by contracting changes. We continue to collaborate with physicians to improve quality of care through pay-for-performance programs and bundled payment initiatives. Additionally, we continue to enhance our ability to detect and deter fraud and abuse, reducing waste in the system.

Pharmacy trend is in the high single digit range and driven primarily by unit cost (cost per prescription). Continued inflation in the average wholesale price of drugs is applying upward pressure to the overall cost per prescription as is the increasing cost of specialty drugs. The increase in cost per prescription measures continues to be mitigated by improvements in our generic usage rates and benefit plan design changes. We are continuously evaluating our drug formulary to ensure the most effective pharmaceutical therapies are available to our members.

In response to cost trends, we continue to pursue contracting and plan design changes, promote and implement performance-based contracts that reward clinical outcomes and quality, and expand our radiology

 

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management, disease management and advanced care management programs. We are taking a leadership role in the area of payment reform as evidenced by the introduction of the Patient Centered Primary Care program. By establishing the primary care doctor as central to the coordination of a patient’s health care needs, the initiative builds on the success of current patient-centered medical home programs in helping improve patient care while lowering costs. Additionally, our value-based contracting initiative continues to underscore our commitment to partnering with providers to improve quality and lower cost.

As evidenced by the recent acquisition of CareMore, we remain committed to providing access-based health care products and services that are simple to use and that customers can trust. CareMore’s mission is to improve the overall lives and wellbeing of seniors by providing innovative, focused health care approaches to the complex problems of aging, while protecting the financial resources of seniors and the Medicare Program. CareMore’s model is focused on disease management programs that provide Medicare members with a hands-on approach to care coordination and intensive treatment of chronic conditions.

 

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Consolidated Results of Operations

Our consolidated summarized results of operations for the three and nine months ended September 30, 2012 and 2011 are as follows:

 

                             Change  
    Three Months Ended     Nine Months Ended     Three Months Ended
September 30
   

 

  Nine Months Ended
September 30
 
    September 30     September 30     2012 vs. 2011    

 

  2012 vs. 2011  
    2012      2011     2012     2011     $     %    

 

  $     %  

Total operating revenue

  $15,133.7       $ 15,155.1     $ 45,457.2     $ 44,689.7     $ (21.4     (0.1 )%      $767.5         1.7

Net investment income

    168.6       170.9       507.0       543.5       (2.3     (1.3       (36.5     (6.7

Net realized gains on
investments

    54.6       94.9       232.0       193.5       (40.3     (42.5       38.5       19.9   

Other-than-temporary
impairment losses
on investments

    (3.8     (22.9     (20.6     (33.7     19.1       (83.4       13.1       (38.9
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

   

Total revenues

    15,353.1       15,398.0       46,175.6       45,393.0       (44.9     (0.3       782.6       1.7   

Benefit expense

    11,984.8       12,062.9       35,849.8       35,212.9       (78.1     (0.6       636.9       1.8   

Selling, general and
administrative expense

    2,078.6       2,119.6       6,326.1       6,207.2       (41.0     (1.9       118.9       1.9   

Cost of products

    66.5       —          73.2       —          66.5       —            73.2       —     

Other expense

    197.5       170.3       542.4       493.2       27.2       16.0          49.2       10.0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

   

Total expenses

    14,327.4       14,352.8       42,791.5       41,913.3       (25.4     (0.2       878.2       2.1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

   

Income before income
tax expense

    1,025.7       1,045.2       3,384.1       3,479.7       (19.5     (1.9       (95.6     (2.7

Income tax expense

    334.5       362.0       1,192.8       1,168.3       (27.5     (7.6       24.5       2.1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

   

Net income

  $691.2       $ 683.2     $ 2,191.3     $ 2,311.4     $ 8.0       1.2        $(120.1)       (5.2
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

 

 

   

Average diluted shares
outstanding

    321.9       360.4       330.7       370.3       (38.5     (10.7 )%        (39.6     (10.7 )% 

Diluted net income per
share

  $2.15       $ 1.90     $ 6.63     $ 6.24     $ 0.25       13.2     $ 0.39       6.2

Benefit expense ratio

    85.4     85.1     84.7     84.3       30  bp          40  bp 

Selling, general and
administrative expense
ratio

    13.7     14.0     13.9     13.9       (30 )bp          —   bp 

Income before income
taxes as a percentage
of total revenue

    6.7     6.8     7.3     7.7       (10 )bp          (40 )bp 

Net income as a
percentage of total
revenue

    4.5     4.4     4.7     5.1       10  bp          (40 )bp 

Certain of the following definitions are also applicable to all other results of operations tables in this discussion:

 

1 

Includes interest expense and amortization of other intangible assets

2 

Benefit expense ratio = Benefit expense ÷ Premiums

3 

bp = basis point; one hundred basis points = 1%

4 

Selling, general and administrative expense ratio = Total selling, general and administrative expense ÷ Total operating revenue

 

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Three Months Ended September 30, 2012 Compared to the Three Months Ended September 30, 2011

Total operating revenue decreased $21.4, or 0.1%, to $15,133.7 in 2012, resulting primarily from lower premiums, partially offset by increased other revenue. The lower premiums were due primarily to fully-insured membership declines in our Local Group business resulting from strategic product portfolio changes in certain states, competitive pressure in certain markets and unfavorable economic conditions. In addition, lower risk score revenue in our Senior business contributed to the decrease in premium revenue. This decrease in premium revenue was partially offset by membership growth in our Senior Medicare Advantage business, including additional membership from CareMore. In addition, growth in our State-Sponsored business resulting primarily from retroactive premium rate increases in the California market contributed to the increased premiums in our Consumer segment. The increase in other revenue resulted primarily from product sales from our 1-800 CONTACTS business.

Net investment income decreased $2.3, or 1.3%, to $168.6 in 2012, primarily due to lower investment yields.

Net realized gains on investments decreased $40.3, or 42.5%, to $54.6 in 2012, primarily due to decreased realized gains resulting from sales of fixed maturity securities.

Benefit expense decreased $78.1, or 0.6%, to $11,984.8 in 2012, primarily due to a decrease in our Local Group business, partially offset by increases in our Senior and State-Sponsored businesses. The decrease in our Local Group business resulted primarily from fully-insured membership declines, as described above, partially offset by increased benefit costs for remaining members. The increase in our Senior business was driven primarily by membership growth in our Medicare Advantage business, including membership acquired from CareMore. The increase in our State-Sponsored business was driven primarily by increased benefit cost trends, predominantly in California.

Our benefit expense ratio increased 30 basis points to 85.4% in 2012, primarily driven by lower risk score revenue in our Senior business and higher benefit costs in our Individual and State-Sponsored businesses, partially offset by improved benefit costs in our Local Group business.

Selling, general and administrative expense decreased $41.0, or 1.9%, to $2,078.6 in 2012, primarily due to lower employee compensation costs, partially offset by additional selling, general and administrative expense related to CareMore.

Our selling, general and administrative expense ratio decreased 30 basis points to 13.7% in 2012, primarily due to the decreased selling, general and administrative expense discussed in the preceding paragraph.

Other expense increased $27.2, or 16%, to $197.5, primarily due to increased interest expense resulting from higher outstanding debt balances and financing costs associated with our pending acquisition of Amerigroup.

Income tax expense decreased $27.5, or 7.6%, to $334.5 in 2012. The effective tax rates in 2012 and 2011 were 32.6% and 34.6%, respectively. These decreases resulted primarily from the impact of the settlement with the Internal Revenue Service, or IRS, of a portion of our open tax issues related to certain of our acquired companies incurred prior to the acquisition of those companies. In addition, to a lesser extent, lower income before income tax expense contributed to the decrease in income tax expense in 2012. These decreases were partially offset by an increase in our state deferred tax asset valuation allowance attributable to the uncertainty associated with certain state net operating loss carryforwards.

Our net income as a percentage of total revenue increased 10 basis points to 4.5% in 2012 as compared to 2011 as a result of all factors discussed above.

 

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Nine Months Ended September 30, 2012 Compared to the Nine Month Ended September 30, 2011

Total operating revenue increased $767.5, or 1.7%, to $45,457.2 in 2012, resulting primarily from higher premiums and, to a lesser extent, increased other revenue and administrative fees. The higher premiums were due primarily to membership growth in our Senior Medicare Advantage business, including additional membership from CareMore. Growth in our State-Sponsored business, primarily in the California market, premium rate increases in our Local Group and Individual businesses designed to cover overall cost trends and increased reimbursement in our FEP business also contributed to the increased premiums. These increases were partially offset by fully-insured membership declines in our Local Group business resulting from strategic product portfolio changes in certain states, competitive pressure in certain markets and unfavorable economic conditions. The increase in other revenue resulted primarily from product sales by our 1-800 CONTACTS business. Administrative fees increased primarily as a result of pricing increases for self-funded members in our National Accounts and Local Group businesses, partially offset by membership declines in our self-funded National Accounts business.

Net investment income decreased $36.5, or 6.7%, to $507.0 in 2012, primarily due to lower investment yields.

Net realized gains on investments increased $38.5, or 19.9%, to $232.0 in 2012, primarily due to increased realized gains resulting from sales of fixed maturity securities.

Benefit expense increased $636.9, or 1.8%, to $35,849.8 in 2012, primarily due to increases in our Senior, State-Sponsored, Individual and FEP businesses. The increase in our Senior business was driven primarily by membership growth in our Medicare Advantage business, including membership acquired from CareMore. The increases in our State-Sponsored, Individual and FEP businesses were driven primarily by increased benefit cost trends. These increases were partially offset by the fully-insured membership declines in our Local Group business as described above, as well as favorable prior year reserve development in 2012 compared to modest reserve strengthening in 2011.

Our benefit expense ratio increased 40 basis points to 84.7% in 2012, primarily due to higher medical costs and lower premium revenues in our State-Sponsored and Local Group businesses. These benefit expense ratio increases were partially offset by improvements in our Senior business and the favorable prior year reserve development.

Selling, general and administrative expense increased $118.9, or 1.9%, to $6,326.1 in 2012, primarily due to additional selling, general and administrative expense related to CareMore and the impact of litigation settlement expenses, partially offset by lower employee compensation costs, including incentive plan expenses.

Our selling, general and administrative expense ratio remained flat at 13.9% in 2012, primarily due to the increased selling, general and administrative expenses discussed in the preceding paragraph offset by the effect of the increase in operating revenue.

Other expense increased $49.2, or 10%, to $542.4, primarily due to increased interest expense resulting from higher outstanding debt balances and financing costs associated with our pending acquisition of Amerigroup.

Income tax expense increased $24.5, or 2.1%, to $1,192.8 in 2012. The effective tax rates in 2012 and 2011 were 35.2% and 33.6%, respectively. These increases