-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, B7l4KmGp2X0sDLVNTbNN7MRvJEJzTcffJrIDQTNHXcnuGT1ZOB/RCjX3q1gBhbJa pBquSoMurvR6I9K7pODQbg== 0000916641-98-000376.txt : 19980401 0000916641-98-000376.hdr.sgml : 19980401 ACCESSION NUMBER: 0000916641-98-000376 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: TRIGON HEALTHCARE INC CENTRAL INDEX KEY: 0001017747 STANDARD INDUSTRIAL CLASSIFICATION: HOSPITAL & MEDICAL SERVICE PLANS [6324] IRS NUMBER: 541773225 STATE OF INCORPORATION: VA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-12617 FILM NUMBER: 98581701 BUSINESS ADDRESS: STREET 1: 2015 STAPLES MILL RD CITY: RICHMOND STATE: VA ZIP: 23230 BUSINESS PHONE: 8043547000 MAIL ADDRESS: STREET 1: 2221 EDWARD HOLLAND DR STREET 2: SUITE 42B CITY: RICHMOND STATE: VA ZIP: 23230 10-K 1 TRIGON HEALTHCARE, INC. 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 1997 OR [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Commission file number 001-12617 Trigon Healthcare, Inc. (Exact name of registrant as specified in its charter) Virginia 54-1773225 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2015 Staples Mill Road, Richmond, VA 23230 (Address of principal executive offices) Registrant's telephone number, including area code (804) 354-7000 Securities registered pursuant to Section 12(b) of the Act: Class A Common Stock, $.01 Par Value New York Stock Exchange (Title of Class) (Name of Exchange) Securities registered pursuant to Section 12(g) of the Act: None 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 the past 90 days. [ X ] Yes [ ] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock held by non-affiliates of the registrant as of March 27, 1998 was approximately $1,245,818,000 (based on the last reported sales price of $29 7/8 per share on March 27, 1998, on the New York Stock Exchange). As of March 27, 1998, 42,300,022 shares of the registrant's Class A Common Stock, par value $.01 per share, were issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE: Certain portions of Trigon Healthcare Inc.'s Annual Report to Shareholders for the year ended December 31, 1997 into Parts II and IV of this Form 10-K. Certain portions of Trigon Healthcare Inc.'s definitive Proxy Statement dated March 27, 1998 for the Annual Meeting of Shareholders into Part III of this Form 10-K. 1 PART I Item 1. Business. GENERAL Trigon Healthcare, Inc. ("Trigon" or the "Company") is the largest managed health care company in Virginia, serving approximately 1.8 million members primarily through statewide and regional provider networks. The Company's membership represents approximately 26% of the Virginia population and 31% of the Virginia population in those areas where Trigon has the exclusive right to use the Blue Cross and Blue Shield service marks and tradenames. Within Virginia, Trigon provides a comprehensive spectrum of managed care products through three network systems with a range of utilization and cost containment controls. The Company is pursuing a growth strategy which includes expansion within Virginia and outside of Virginia into other southeastern and mid-Atlantic states. As of December 31, 1997, the Company's network systems consisted of: HMO networks which, with 293,538 members, are the Company's most tightly managed and cost efficient networks; the preferred provider organization ("PPO") networks which, with 904,470 members, offer greater choice of providers than Trigon's HMO networks and may include a point of service ("POS") feature; and the participating provider ("PAR") network which, with 411,142 members, is the Company's broadest and most flexible network. As of December 31, 1997, the Company served 215,492 additional members through Medicare supplemental plans (125,686 members), third-party administration of health care claims (25,663 members) and through Mid-South Insurance Company ("Mid-South"), a Fayetteville, North Carolina-based health and life insurance company, which was acquired by the Company in 1996 (64,143 members). Within the Company's managed care product offerings, customers may choose between fully-insured arrangements (in which the Company bears the cost of providing specified health care services for a fixed payment) and self-funded arrangements (in which the customer bears all or a portion of the risk). As of December 31, 1997, 50.9% of members were covered under fully-insured arrangements and 37.8% were covered under self-funded arrangements, with the remaining 11.3% covered under the Federal Employee Program ("FEP"), administered under contract with the Blue Cross Blue Shield Association ("BCBSA"). Member enrollment information for FEP, Mid-South group health business and certain national group accounts are not maintained on the Company's systems. Member enrollment information presented herein for such groups have been calculated based on policy counts for these groups which have been converted to a membership number through the use of actuarially determined conversion factors. In 1990 the Company began to institute greater managed care controls in all of its product lines and networks, focusing in particular on its PPO and HMO networks and, depending on market readiness, designing, pricing and marketing its products to encourage members to migrate into these more tightly managed networks where the Company is better able to manage health care costs. While members decide which network to select, the Company generally offers more attractive rates in its more tightly managed networks to encourage members to choose these products. This strategy contributed to accelerated enrollment growth for the Company's HMO and PPO networks and a decline in enrollment in the Company's more traditional PAR network. Trigon operates four HMOs which are licensed to serve most areas of Virginia. Trigon has the largest number of HMO members in Virginia. Trigon's total HMO enrollment has grown from 60,683 members at December 31, 1992 to 293,538 members as of December 31, 1997, representing a compound annual growth rate of 37.1%. The Company's PPO network system is the largest in Virginia. Trigon's total PPO enrollment has grown from 561,686 members at December 31, 1992 to 904,470 members as of December 31, 1997, representing a compound annual growth rate of 10.0%. Membership in the Company's HMOs and PPOs increased from 38.4% of total enrollment at December 31, 1992 to 65.1% as of December 31, 1997. Trigon's more traditional products are offered through its PAR network, which is the Company's largest provider network. As a result of the Company's strategy of encouraging members to migrate to its more tightly managed networks, total membership in the PAR network, decreased from 683,982 members at December 31, 1992 to 411,142 members at December 31, 1997. Trigon also offers several specialty health care and related products, such as dental, wellness, behavioral health, life and accident and disability insurance coverage. 2 Trigon has the largest membership base in Virginia, which generally allows the Company to negotiate contracts with its Virginia providers that specify favorable rates and incorporate utilization management and other cost controls. As a result of its extensive networks, managed care expertise and broad product offerings, the Company competes favorably in all of its Virginia lines of business, including the individual, small, mid-sized and large employer groups and state and federal agency markets. Trigon has exclusive rights to use the Blue Cross and Blue Shield service marks and tradenames for purposes of doing business throughout Virginia other than certain northern Virginia suburbs adjacent to Washington, D.C. Since 1972, the Company has provided health benefits to employees and retirees of the Commonwealth of Virginia. In 1997, the Company recorded $398.7 million for amounts attributable to this self-funded arrangement, which represented 38% of the Company's self-funded business. The current contract to provide health benefits to the employees and retirees of the Commonwealth of Virginia will expire on June 30, 1999. Under the agreement, such services may be terminated by either party upon twelve months' written notice. The Company believes that it is well qualified to meet the Commonwealth of Virginia's health care requirements because of the size and geographic range of the Company's network systems and its broad offering of PPO and HMO network products. DEMUTUALIZATION AND INITIAL PUBLIC OFFERING Effective February 5, 1997, Blue Cross and Blue Shield of Virginia (dba Trigon Blue Cross Blue Shield) completed its conversion from a mutual insurance company to a stock insurance company in accordance with a Plan of Demutualization ("Demutualization"). In accordance with the Demutualization, Blue Cross and Blue Shield of Virginia changed its name to Trigon Insurance Company (dba Trigon Blue Cross Blue Shield) ("Trigon Insurance") and became a wholly-owned subsidiary of the Company. The membership interests of Blue Cross and Blue Shield of Virginia's eligible members were converted into Class A common stock of Trigon Healthcare, Inc., or, in certain circumstances, cash. The Demutualization also required the Company to complete an Initial Public Offering ("IPO") of stock simultaneously with the conversion. Accordingly, Trigon Healthcare, Inc. issued 17.8 million shares of Class A common stock at $13 per share in the IPO, generating net proceeds of $215.2 million. In connection with the Demutualization, the Company was required to make a payment of $175 million to the Commonwealth of Virginia ("Commonwealth Payment") in February 1997. The Commonwealth Payment was accrued and reflected as an extraordinary charge in the consolidated financial statements for 1996. The Company used approximately $90 million of the net proceeds and $85 million in borrowings under a revolving credit agreement to fund this payment. The Company also used approximately $91.1 million of the offering proceeds to pay certain eligible members cash in lieu of shares of common stock that would otherwise have been issued to such eligible members pursuant to the Demutualization. NETWORK SYSTEMS The Company's extensive managed health care provider networks enable it to offer a comprehensive array of managed health care programs throughout Virginia. These networks include its HMO, PPO and PAR networks, as well as specialty managed care networks. In establishing these networks, the Company enters into contracts with qualified providers in each geographic area to serve its members. These contracts are intended to control the cost of health care through both control of unit cost and utilization management. As a result, the Company reduces the need to utilize out-of-network providers that are not subject to the Company's cost controls. Within the Company's network product offerings, employer groups may choose various funding options ranging from fully-insured to partially or fully self-funded financial arrangements. While self-funded customers participate in Trigon's networks, the claims are not underwritten by Trigon but are funded by the groups. Self-funded arrangements are typically utilized by large and mid-size groups. In addition, most self-funded groups purchase aggregate and/or claim specific stop-loss coverage. In exchange for a premium, the group's aggregate liability is capped for the year or the group's liability on any one episode of care is capped. Trigon charges self-funded groups an administrative fee which is based on the number of members in a group or the group's claims experience. Under the Company's self-funded arrangements, amounts due are recognized based on incurred claims plus administrative and other fees and any stop-loss premiums. 3 The following table sets forth the number of members in each of the Company's product groups for the last five years. ENROLLMENT BY NETWORK SYSTEM
AS OF DECEMBER 31, ------------------ 1997 1996 1995 1994 1993 -------------- ------------- ------------- ------------- ------------- Commercial: HMO.......................................... 291,036 248,172 172,893 85,739 59,353 PPO.......................................... 263,828 230,675 212,322 155,433 131,052 PAR.......................................... 192,825 236,383 296,716 334,800 352,783 Other (1)................................. 189,829 177,266 149,109 158,503 156,737 -------------- ------------- ------------- ------------- ------------- Subtotal..................................... 937,518 892,496 831,040 734,475 699,925 Self-funded: HMO.......................................... 2,502 9,479 48,255 34,243 24,728 PPO.......................................... 433,185 363,754 336,414 321,863 313,744 PAR.......................................... 218,317 291,629 256,964 253,110 264,776 ASO.......................................... 25,663 35,620 63,826 77,481 78,903 -------------- ------------- ------------- ------------- ------------- Subtotal..................................... 679,667 700,482 705,459 686,697 682,151 FEP (PPO network)............................ 207,457 197,241 198,561 195,314 180,015 Fully insured and self-funded -------------- ------------- ------------- ------------- ------------- enrollment................................... 1,824,642 1,790,219 1,735,060 1,616,486 1,562,091 Processed for other Blue Cross and Blue -------------- ------------- ------------- ------------- ------------- Shield Plans (ASO)........................ 15,728 70,330 64,558 65,187 69,916 -------------- ------------- ------------- ------------- ------------- Total........................................ 1,840,370 1,860,549 1,799,618 1,681,673 1,632,007 -------------- ------------- ------------- ------------- -------------
(1) "Other" members include enrollment from Medicare supplement plans, out-of-state student health care coverage (which was discontinued as of December 31, 1995) and Mid-South members beginning in 1996. HMO NETWORKS Trigon established its first HMO in 1984 and now operates four separate HMOs. HealthKeepers, Inc. ("HealthKeepers") is a state qualified HMO that operates primarily in the central, eastern, and southwestern areas of Virginia. Physicians Health Plan, Inc. ("PHP") is a federally qualified HMO operating in Northern Virginia, Washington D.C. and the surrounding Maryland counties. Peninsula Health Care, Inc. ("PHC"), a joint venture owned 51% by Trigon, is a state qualified HMO operating primarily on the Peninsula in Eastern Virginia. The Company owns 80% of Priority Inc. ("Priority") (acquired in 1995), which owns a federally qualified HMO, Priority Health Care, Inc. (formerly, Health First, Inc.), operating in the Tidewater area in Eastern Virginia. As of December 31, 1997, the HMO networks included approximately 2,200 primary care physicians, 6,600 specialist physicians and 66 hospitals throughout Virginia. Each of Trigon's HMOs uses the Blue Cross and Blue Shield service mark except for PHP, which operates outside the area covered by the Company's license to use the service mark. The Company's HMOs are able to provide for the delivery of health care services at lower costs than traditional health insurance plans due to their network provider arrangements which specify favorable rates and require utilization management and other cost control measures. Members choose a primary care physician who is responsible for coordinating health care services for the member. The HMO product portfolio is presented to customers as a stand-alone HMO offering, or through "Blue Advantage," a program which includes HMO and PPO options administered and priced as a single program and which can only be utilized by groups that contract with Trigon on an exclusive basis. Most HMO products have a copayment provision under which the member bears a portion of health care costs. All of the Company's HMOs offer a feature which permits the member to receive health care services from providers that are not part of the Company's HMO network or without a primary care physician referral at additional out-of- 4 pocket cost to the member which includes a deductible and higher copayment obligation. The Company believes that copayment obligations, out-of-network costs and other obligations of these HMO plans enhance its ability to control costs by encouraging members to take more responsibility for their health care decisions. MEDICAID AND MEDICARE HMO PRODUCTS. PHC and Priority Health Care, Inc. market a Medicaid HMO product to participants in the Aid to Families with Dependent Children program and the Aged, Blind and Disabled Individuals programs in the Peninsula and Tidewater regions of Virginia. HealthKeepers received federal and state regulatory approval in the first quarter of 1998 to begin selling a Medicare HMO product within the City of Richmond and five surrounding counties in central Virginia. The product is available to individuals who are eligible for Medicare either through age or disability. Health care services will be provided by a special network comprised of a subset of the HealthKeepers provider network. The Company is currently beginning its marketing and enrollment efforts, with enrollment of 5,000 to 7,000 members expected by the end of 1998. PPO NETWORKS The Company's PPO network is a statewide PPO network, which as of December 31, 1997 included approximately 15,900 physicians and 136 hospitals. Approximately 24% of PPO members as of December 31, 1997 were employees of the Commonwealth of Virginia, whose plan includes the POS feature discussed below. The Company's PPO products are similar to its HMO products in that they are able to provide for health care delivery at lower costs than traditional health insurance due to network provider arrangements which specify favorable rates and employ utilization management and other cost control measures. Members have copayment or coinsurance obligations for services rendered by network providers that are similar to those of the Company's HMO products. Trigon includes as part of its PPO network the option of including a POS feature in which each member chooses a primary care physician who is responsible for coordinating all health care services for the member. Unlike the HMO and PPO products electing the POS feature, members with the standard PPO products may seek care from any PPO network physician in the appropriate PPO network depending on services required. PPO members may also choose to receive health care services from providers that are not a part of the network, typically at substantial out-of-pocket costs. Trigon believes that copayments and out-of-network obligations of its PPO products enhance its ability to control costs by encouraging members to take more responsibility for their health care decisions. PAR NETWORK Trigon's PAR network provides more traditional health coverage and included approximately 17,400 physicians and 137 hospitals as of December 31, 1997. The PAR network offers members more providers to choose from, greater customization of benefit design, and fewer restrictions in the use of non-network providers than the PPO network. The Company's strategy is to transition members from the PAR network to the more tightly managed PPO and HMO networks. However, Trigon expects that its PAR network and products will continue to be an important offering for groups desiring greater flexibility and choice in networks and benefits, as well as a source of new PPO and HMO members. The Company's PAR network and products are able to provide for health care delivery at lower costs than many other traditional health plans due to network arrangements which specify favorable rates and encourage utilization management and other cost control measures. Members may choose any physician from the PAR network depending on services required, and are generally subject to annual deductible requirements and coinsurance. Trigon believes that annual deductibles and higher out-of-network costs of its PAR products enhance its ability to control costs by encouraging members to take more responsibility for their health care decisions. In the PAR network, physicians accept payments for covered services and do not bill the members for the difference between the provider charges and the Company reimbursements. If a member chooses to receive out-of-network services under a PAR health plan, the member will be required to bear a larger portion of the total expenses for such services since the provider is able to bill the member for the difference between the provider's charge and the Company payment. 5 PROVIDER ARRANGEMENTS Trigon's HMO networks have contracts with hospitals, physicians and other professionals at reduced rates, which are typically more favorable than rates for the Company's PPO and PAR networks. Almost all of the primary care physicians in the HMO networks are reimbursed on a capitated basis. Specialists are reimbursed based on a fee schedule or on a capitated basis. Some ancillary services, lab services, behavioral health and vision services are also capitated. These arrangements provide the incentive to control utilization and cost. HMO network hospital provider contracts, typically two years in duration, are on a nonexclusive basis and are generally paid on the basis of per diems (fixed fee schedules where the daily rate is based on the type of service), per case per admission (fixed fee schedules for all services during a member's hospitalization), or a percentage of covered charges with limits on the subsequent year increases. The average rate negotiated with hospitals under this arrangement is lower than the hospital's average standard retail charges. Services not subject to special per case or per diem payment arrangements are generally paid according to a fee schedule or as a percentage of billed charges. Based on these payment arrangements, physicians and hospitals in the HMO networks have financial incentives to control health care costs. PPO and PAR network hospital provider contracts are generally based upon per diem or per case or a percentage of covered charges arrangements that are typically lower than the hospital's average standard billing rates. The PPO provider contracts provide for rates that are generally more favorable than rates for the Company's PAR network. The Company is able to obtain discounted prices for services because of the volume of business it offers to healthcare providers that are part of the network. Hospital reimbursement rates are generally negotiated for terms of two years. Physician provider contracts also employ attractive fixed fee schedules which are below standard billing rates with the PPO contracts typically more favorable than the PAR network. Physician fee schedule payments are set by the Company using Resource Based Relative Value System methodologies and are generally adjusted annually. When considering whether to contract with a physician for its PPO or PAR networks, the Company conducts a credentialing program to evaluate the applicant's professional experience, including licensure. UTILIZATION MANAGEMENT Trigon also manages health care costs in its HMO networks by using utilization management systems guidelines for the HMO network that are intended to address quality of care and help to ensure that only appropriate services are rendered, and that such services are provided in the most cost-effective manner. The primary care physicians are considered to be the overall manager of the individual's health care needs. Primary care physicians manage and optimize care through the use of referrals and by approving all specialty care before it is rendered. In addition, under a utilization review program, the HMO reviews all high cost services needed by individual members which are not provided by the primary care physician. This review program is intended to ensure that all enrollees receive necessary, appropriate and cost-effective care. Focused case management techniques are used on all high cost cases. New medical technologies are reviewed in advance through Trigon's participation in a new technology evaluation program sponsored by the BCBSA and a large HMO company. Such review of new medical technologies attempts to ensure that only safe and effective new medical procedures are covered. The Company also manages health care costs and quality by reviewing monthly cost and utilization trends within its HMO networks. Utilization rates and cases are reviewed in the aggregate and by service type to identify opportunities for better cost and quality control. In addition, the highest cost services are studied to determine if costs can be reduced by using new, less expensive technologies or by creating additional networks or contracts, such as networks for ambulatory care, to reduce provider costs. The Company also manages health care costs in its PPO and PAR networks by adopting utilization management systems that are intended to reduce unnecessary procedures, admissions and other medical costs. The Company's utilization management systems guidelines for the PPO and PAR networks help to ensure that only appropriate services are rendered and that such services are provided in the most cost-effective manner. Trigon utilizes Milliman & Robertson's healthcare management guidelines and requires pre-admission approvals of all hospital and skilled nursing facility stays and concurrent review of length of stay. Trigon prospectively reviews the medical necessity of home health, private duty nursing and durable medical equipment. Trigon also retrospectively reviews physician practice patterns. Review of physician practice patterns may result in modifications and refinements to the PPO and 6 PAR network of providers and network contractual arrangements. Physicians participating in the PPO network and in the POS program are required to meet certain economic profiling criteria that indicate cost effective and quality practice standards. Primary care and specialist providers in the POS program are periodically given utilization, cost and quality profiles, or "report cards." In the POS program, utilization management includes an outpatient review program, with pre-authorization of high-cost outpatient care, in addition to management of hospital care through precertification, concurrent review, case management and discharge planning capacity. Outpatient care is further controlled through claim edits designed to detect and correct inappropriate provider billing patterns. All new medical technologies are reviewed in advance in an attempt to ensure that only safe and effective new medical procedures are covered. Additionally, the Company also employs a comprehensive case management program. In this program, the Company identifies those members having certain chronic diseases (such as asthma, hypertension and cancer) and proactively works with the member and the physician to facilitate appropriate treatment, help to ensure compliance with recommended therapies and educate members on lifestyle modifications to manage the disease. The Company believes that the program promotes the delivery of efficient care and helps to improve the quality of health care delivered. As with its HMO network, Trigon further manages health care costs by reviewing monthly cost and utilization trends within its PPO and PAR networks. QUALITY MANAGEMENT Trigon's HMO quality improvement standards are modeled on those of the National Committee on Quality Assurance ("NCQA"), an independent, nonprofit institution that reviews and accredits health maintenance and managed care organizations. The quality improvement program instituted by the Company's HMOs provides for the review of quality of care service and the initial and ongoing review of the credentials of all network providers. This credentialing process includes a review of whether the provider has the necessary licenses, is qualified in the specialty indicated, and meets standards for safety, sanitation, and accessibility. The HMO reviews the findings with a quality improvement committee, which includes practicing physicians from the HMO network. In addition, quality of care services are monitored through profiling and data analysis, member satisfaction surveys, and problem case review. During 1997, the Company obtained one-year accreditation from the NCQA for HealthKeepers, its largest HMO. The one-year accreditation is granted to companies that have well-established quality improvement programs and meet most NCQA standards. NCQA provides companies with specific recommendations and reviews the companies again after one year to determine if they have reached full accreditation. The remaining Trigon HMO plans -- PHC, PHP and Priority Health Care, Inc. -- did not seek accreditation in 1997. PHC is currently undergoing an NCQA-review in 1998. The Company will not know the results of this review until later this year. The Company has an active program to evaluate the quality and appropriateness of care provided by its PPO and PAR networks. Provider credentialing, profiling and member satisfaction, along with monitoring of outcomes, and clinical studies are all performed to monitor and manage quality of care. Network physicians and other providers participate in quality management programs overseen by medical advisory panels. Using the Company's computerized medical information database, these programs involve profiles of the tests, types of treatment and procedures performed for specific diagnoses by these physicians, as well as reviews of aggregate data. SPECIALTY MANAGED HEALTH CARE PLANS Trigon also offers specialty managed health care services through a number of specialized networks. The Company believes that these specialty networks and plans complement and facilitate the Company's marketing plans and enable the Company to attract employer groups and other members that are increasingly seeking a variety of options and services. These specialty plans include pharmacy plans, dental plans, behavioral health plans as well as ancillary networks for certain outpatient services. In addition, Trigon offers numerous Medicare supplemental plans, which typically pay the difference between the health care cost incurred and the amount paid by Medicare. 7 MARKETING Trigon markets its products and services to both individuals and groups. The individual products are marketed principally through a telemarketing unit and through brokers. The group market includes small, medium and large group employers. The smaller group employers generally use insurance brokers to assist in the selection of products and analysis of the actual cost of competing plans. As the group size grows, employers may use consultants to assist in the tailoring of benefits and networks. The larger group employers are generally more sophisticated purchasers, often engaging consultants to work with the Trigon sales staff to tailor benefit and network design to match their specific needs more closely. In addition, Trigon has a direct sales staff that markets the full range of Trigon products and services. RELATED BUSINESSES In addition to its core managed care business, the Company engages in several other health-related businesses including employee benefits administration, workers' compensation administration and health management services. Together, these and other health-related benefits businesses generated $25.5 million in revenues for the year ended December 31, 1997, included in "Other Revenues" in the Company's consolidated financial statements. These businesses represent approximately 1% of the Company's total revenues, a trend which is expected to remain consistent in the next several years. Aside from their direct contribution to revenue, the Company believes these related businesses also provide Trigon with competitive advantages from single-source product offerings, cross-selling, market presence and as avenues into new markets. GOVERNMENT PROGRAMS Trigon acts as an intermediary and administrative agent in servicing approximately 1.2 million Medicare Part A beneficiaries in Virginia and West Virginia. In 1997, the Company processed over 3.7 million Medicare Part A claims amounting to $3.3 billion of charges. Claims processed and the reimbursement for these claims are not included in the Company's consolidated statements of operations. However, the Company is reimbursed for operating expenses related to administering this business. In 1997, such expense reimbursements totaled $12.5 million. Trigon's intermediary Medicare program carries no underwriting risk. Trigon also administers Virginia's portion of the BCBSA's national contract with the U.S. Office of Personnel Management ("OPM") to provide benefits through its PPO networks for approximately 207,000 federal employees and their dependents living in Virginia. The contract renews automatically for a term of one year each January 1, unless written notice is given by either party at least 60 days prior to the date of renewal. In 1997, Trigon recorded revenues of $377.7 million under this program, which represented 18% of total revenues. Under the program, a special FEP reserve is maintained at the national level as protection against adverse claims trends. However, if the contract should terminate with a negative balance in the FEP special reserve, the losses would be allocated to participating plans or subcontractors based on a ratio of the Company's past five year claims experience as a percent of the total program's experience. As of December 31, 1997, the national reserve amounted to $3.3 billion or 5.7 months of program income. INFORMATION SYSTEMS The Company develops and maintains its own information systems. Information systems have played and will continue to play a key role in ongoing plans to continually improve quality, lower costs and increase benefit flexibility for the Company's customers. Trigon's centralized, common database and analytical technologies allow for increasingly more sophisticated methods of managing costs and quality of care. The database includes comprehensive information on virtually all physicians and hospitals and one third of the population in Virginia, which assists Trigon in analyzing the medical and economic performance of providers and the medical and economic experience of specific customer groups and individuals. The Company believes that its information systems are a competitive advantage and are sufficient to meet its current needs and future expansion plans. 8 The Company uses an integrated set of applications software to support marketing and underwriting, eligibility and billing, electronic claims submission, claims administration, managed care programs and corporate financial management. A combination of custom developed and licensed systems are used to meet the unique needs of different products and markets. An overall systems architecture is maintained to promote consistency of data, processing rules and flexibility. Different systems serving the unique products or markets feed data to a corporate information and decision support system. This decision support system provides a single source of information for all of the Company's data reporting and analytic needs. This includes operational and financial performance, underwriting and marketing analysis, utilization management and actuarial reporting. The Company has developed and is currently executing a comprehensive plan to prepare the computer systems and application software for the year 2000. Project completion for the Company's systems and software is scheduled for the end of 1998, allowing adequate time for testing. The Company is using both external and internal resources for the project. The incremental costs for the project were $6.8 million through December 31, 1997 and are expected to approximate $20.0 million through 1999. The costs will be expensed as incurred and will be funded through operating cash flows. In addition, the Company is actively working with hospitals, providers and others depended upon for electronic commerce in an effort to ensure they are assessing and correcting any issues relating to the year 2000 which could impact their ability to conduct business with the Company. Lack of appropriate action on the part of these third parties could impact the Company's ability to serve its customers. The Company will continue to monitor the progress of these entities. COMPETITION The health care industry is highly competitive both in Virginia and in other states in the southeastern and mid-Atlantic United States into which the Company principally intends to expand. Managed care companies, including large, well-capitalized companies which market managed care products nationwide, have targeted the southeastern and mid-Atlantic regions of the United States as being favorable for expansion, and have begun entering Virginia and markets targeted by Trigon in increasing numbers. In some cases, new market entrants, as well as existing health care companies, have competed with the Company for business by offering very favorable pricing terms to customers. The Company is facing this increased competition in the areas in which it is licensed to use the Blue Cross and Blue Shield service marks and tradenames, as well as the areas in which it operates without these service marks and tradenames. In areas outside of its licensed territory, the Company's ability to successfully compete may be adversely affected by its inability to use the Blue Cross and Blue Shield service marks and tradenames, by the presence of competitors that are able to use such service marks and tradenames in the areas, and by the Company's lack of substantial market share or established provider networks in these areas. The Company also faces competition from a trend among health care providers to combine and form their own networks in order to contract directly with employer groups and other prospective customers to provide health care services. There is no assurance that such overall increased competition will not exert strong pressures upon Trigon's profitability, its ability to increase enrollment or its ability to successfully pursue growth in areas both within and outside of Virginia. The Company believes that it has effectively integrated its managed care programs into its traditional business, principally through its PPO and HMO networks and products. The trend in the health care industry is toward both vertical and horizontal integration coupled with significant levels of managed care, principally through HMOs. In the Company's principal geographic market areas, HMOs have a smaller share of the health care market than in other areas of the country, but the Company believes that HMOs will capture an increasing share of the health care market. The Company believes that it will be necessary to expand significantly its market share in the HMO market, in part by successfully transitioning its PAR and PPO members into HMOs, if it is to succeed in retaining a high overall market share in its existing geographic markets. There can be no assurance that the Company will succeed in significantly expanding its market share in HMOs. 9 INVESTMENTS The Company's investment policies are designed to provide liquidity to meet anticipated payment obligations and preserve capital within acceptable limits of risk. The Company believes that concentration of investments in any one asset class is unwise due to constantly changing interest rates, market and economic conditions. A portion of the portfolio has been designated to meet the operating and liquidity needs of the Company. The liquidity portfolio is invested in short- to intermediate-term fixed income instruments with an average portfolio duration of two and one-half years and an average quality of AA. Additional funds not required for liquidity needs are invested by internal and external money managers in fixed income and equity securities with the dual objectives of generating income and safeguarding principal. The long-term fixed income portfolio is invested in governmental and corporate securities, both domestic and international, with an average quality rating of A. The equity portfolio contains readily marketable investment securities (domestic and international) ranging from small growth to well-established Fortune 500 companies. During the first quarter of 1997, the Company reduced its equity allocation from 27.8% of the total portfolio at December 31, 1996 to approximately 10.5%. The Company currently plans to maintain the equity allocation at levels generally no greater than 15%. Each external manager invests within certain guidelines established by the Company designed to fit into the overall investment strategy. These guidelines establish minimum quality and diversification requirements which, among other things, provide limitations on the allowable investment for a single issuer as well as currency exposure for those managers investing in international securities. At December 31, 1997, 13.5% of the portfolio was invested to meet the liquidity needs of the Company with an additional 76.0% in long-term fixed income portfolios (including derivative instruments) and 10.5% in equity portfolios. At December 31, 1997, 4.8% of the fixed income portfolio and 44.1% of the equity portfolio was invested internationally. The exposure to securities denominated in any one currency (other than U.S. dollars) was no greater than 1.8% at December 31, 1997. At December 31, 1997 the investment portfolio was comprised of the following (in thousands):
ESTIMATED PERCENT OF FAIR VALUE PORTFOLIO ---------- ---------- Fixed income: Domestic: U.S. Treasury securities and obligations of U.S. government agencies............................................................... $429,947 31.3% Mortgage-backed obligations of U.S. government agencies................ 73,453 5.3 States and political subdivisions securities........................... 33,232 2.4 Other mortgage-backed and asset-backed securities...................... 139,916 10.2 Domestic corporate securities.......................................... 398,217 29.0 Short-term debt securities with maturities of less than one year................................................................... 93,561 6.8 Foreign: Debt securities issued by foreign governments.......................... 42,872 3.1 Foreign corporate bonds............................................... 6,973 0.5 Short-term debt securities with maturities of less than one year....... 9,182 0.7 ---------------- ---------------- Total fixed income..................................................... 1,227,353 89.3 ---------------- ---------------- Equities: Domestic........................................................... 80,635 5.9 Foreign............................................................ 63,697 4.6 ---------------- ---------------- Total equities......................................................... 144,332 10.5 Derivative instruments................................................. 2,312 0.2 ---------------- ---------------- Total investments...................................................... $ 1,373,997 100.0% ================ ================
10 As of December 31, 1997, the composition of the Company's fixed income investment securities by rating is as follows (in thousands): ESTIMATED PERCENT OF RATING (1) FAIR VALUE TOTAL ---------- ----------- ---------- AAA........................... $ 727,932 59.3% AA............................ 30,283 2.5 A............................. 30,552 2.5 BBB........................... 102,849 8.4 BB............................ 149,476 12.2 B............................. 185,546 15.1 CCC or lower.................. - - Not rated..................... 715 - ----------- ------ Total......................... $ 1,227,353 100.0% =========== ====== (1) Ratings are assigned by Standard & Poor's Corporation or Moody's Investor Service, Inc. At December 31, 1997, $122.7 million, or 8.9% of the Company's investment portfolio was invested internationally. This amount includes $8.3 million invested in U.S. dollar denominated investment funds containing international investment securities. Derivative instruments consist of foreign currency forward contracts and foreign currency options. The Company enters into foreign currency derivative instruments to hedge exposure to fluctuations in foreign currency exchange rates. Company policy only permits utilization of these instruments in its foreign denominated bond and equity portfolios. The counterparties to these transactions are major financial institutions. The Company may incur a loss with respect to these transactions to the extent that a counterparty fails to perform under a contract and exchange rates have changed unfavorably since the inception of the contract. The Company anticipates that the counterparties will be able to fully satisfy their obligations under the agreements. The forward contracts involve the exchange of one currency for another at a future date and typically have maturities of six months or less. As of December 31, 1997, the Company had forward contracts outstanding to purchase approximately $3.3 million in foreign currencies and to sell approximately $35.8 million in foreign currencies (primarily British Pound, German Mark and Canadian Dollar). The gross unrealized gains and losses related to these contracts as of December 31, 1997 aggregated $547,000 and $406,000, respectively. Foreign currency options are contracts that give the option purchaser the right, but not the obligation, to buy or sell, within a specific period of time, a financial instrument at a specified price. Foreign currency options to sell approximately $20.6 million of foreign currencies (Japanese Yen and German Mark) at set prices were outstanding as of December 31, 1997. These options generally expire within twelve months. The gross unrealized gains related to these options as of December 31, 1997 aggregated $1.7 million. There were no gross unrealized losses as of December 31, 1997. The Company enters into financial futures contracts for portfolio strategies such as minimizing interest rate risk and managing portfolio duration. The notional amount of the futures, $174.8 million as of December 31, 1997, is limited to that of the market value of the underlying portfolios. Other than currently or formerly occupied Company property or through mortgage-backed securities, the Company has no investment in real estate or mortgage loans. The company does not enter into any derivative instruments other than forward currency contracts, foreign currency options and financial futures. REGULATION HEALTHCARE REFORM - VIRGINIA. In its 1998 session, the Virginia General Assembly passed the following legislation which will become effective July 1, 1998, pending approval by the Governor of Virginia: 11 * a new small group reform measure which requires all insurers and HMOs doing business in the small group market (employers with 2-50 employees) to offer and make available both an essential and a standard benefit plan to small group employers in addition to other insurance plans which they now market. Prior law required the offering only to groups of 2-25. Rating requirements apply to the two benefit plans, which will allow carriers to use the demographic risk classification factors of age, gender and geographic area. Variations in premiums charged by a small employer carrier based on claim experience, health status and duration are limited to a range of 20% above or 20% below the community rate filed by the carrier, defined as the average rate charged for the same or similar coverage to all of that carrier's small employer group business. * legislation that requires HMOs to offer a point of service option as part of any plan offered to an employer. However, an HMO is not required to do so if the employer has a non-HMO option in place. Because Trigon Insurance offers point of service options to its affiliated HMO customers, this legislation is not expected to have a material effect on the Company's operations or financial condition. * legislation that transfers the responsibility for regulation of utilization review activities and quality of care in managed care plans from the Bureau of Insurance to the Department of Health. The law also imposes material change filing requirements previously imposed on HMOs only to all carriers offering managed care plans. The legislation establishes a mechanism by which any carrier offering a managed care plan must apply to the Department of Health and receive a certificate of quality assurance. The Department will review the carrier's procedures regarding adequacy of complaint systems, access to care, provider credentialing, patient privacy, as well as other factors in determining whether to issue the certificate. Full implementation of the quality bill does not occur until regulations are promulgated by the Department of Health, and certificates are not required to maintain a carrier's insurance license until July 1, 2000, so long as an application for a certificate is made by December 1, 1999. There is no indication or expectation that the regulatory process will result in requirements that will materially affect the Company's operations or financial condition, however, there can be no assurance of that result at this time. HEALTHCARE REFORM - FEDERAL. Effective January 1, 1998, provisions of the Health Insurance Portability and Accountability Act ("HIPAA") affecting the individual market took effect. The provisions impose requirements concerning guaranteed renewability and availability, the waiving of waiting periods for certain eligible individuals coming from group coverage and limitations on the insurers ability to terminate policies. Also, new requirements on group insurance plans concerning maternity length of stay and mental health benefits became effective for group coverage with the commencement of plan years beginning on or after January 1, 1998. There is no expectation that any of these new requirements will materially affect the Company's operations or financial condition. Currently, at the federal level, there are numerous legislative proposals to regulate health plans in order to address the issues of health care quality and patient rights. Many of these proposals are viewed by health plans as adverse to managed care but it is not clear at present whether any of these federal proposals will be adopted. Moreover, there can be no assurance that additional legislative or regulatory initiatives will not be undertaken in the future, either at the federal or state level, to engage in structural reform of the health care industry in order to reduce the escalation in health care costs or to make health care more accessible. Such reform, if it occurs, could adversely affect Trigon's results of operations or financial condition. HMO REGULATION. Trigon has four HMO subsidiaries, two of which are federally qualified HMOs. All of Trigon's HMO subsidiaries are licensed by the Commonwealth of Virginia and are subject to regulation and review by the State Corporation Commission, with which they must file periodic reports. In addition, one of the HMO subsidiaries is licensed by and subject to regulation and review by the State of Maryland, with which it must file periodic reports. Among the areas regulated by Virginia and Maryland law are policy forms, market conduct, quality assurance, covered benefits, contracts between the HMO and its health care providers, the HMO's financial condition, including net worth requirements, and the geographic service area of an HMO. Trigon's federally qualified HMOs are also subject to regulation and review by the U.S. Department of Health and Human Services and certain other federal authorities, with which they must file periodic reports. Areas covered by federal law are similar to those covered by state law and regulation. In addition, one of the Company's HMOs 12 offers a Medicare risk product that subjects that HMO to regulation and review by the U.S. Department of Health and Human Services and certain other federal authorities as well. INSURANCE HOLDING COMPANY REGULATION. Trigon Healthcare, Inc. is not regulated as an insurance company but, as the direct or indirect owner of all the capital stock of Trigon Insurance, Trigon Health and Life Insurance Company, formerly Monticello Life Insurance Company ("Trigon Health and Life"), a Virginia-based group life and disability company, and Mid-South, is regulated as an insurance holding company and subject to the insurance holding company acts of Virginia and North Carolina, the states in which the insurance company subsidiaries are domiciled. Effective July 1, 1998, the Company's HMOs will also be required to meet the obligations and restrictions under the Virginia Holding Company Act. These acts contain certain reporting requirements as well as restrictions on transactions between an insurer and its affiliates. The Virginia insurance holding company laws and regulations generally require insurance companies within an insurance holding company system to register with the State Corporation Commission, and to file with the State Corporation Commission certain reports describing capital structure, ownership, financial condition, certain intercompany transactions and general business operations. In addition, various notice and reporting requirements generally apply to transactions between insurance companies and their affiliates within an insurance holding company system, depending on the size and nature of the transactions. Virginia insurance holding company laws and regulations require prior regulatory approval or, in certain circumstances, prior notice of, certain material intercompany transfers of assets as well as certain transactions between insurance companies, their parent holding companies and affiliates. Additionally, holding company acts (including those of Virginia and North Carolina) restrict the ability of any person to obtain control of an insurance company without prior regulatory approval. Under Virginia insurance holding company laws and regulations, the acquisition of control of a Virginia insurer or a person controlling a Virginia insurer, including the Company, requires the prior approval of the State Corporation Commission. Without such approval (or an exemption), no person may acquire any voting security of an insurance holding company which controls a Virginia insurance company, or merge with such a holding company, if as a result of such transaction such person would "control" the insurance holding company. "Control" is defined as the direct or indirect power to direct or cause the direction of the management and policies of a person and is presumed to exist if a person directly or indirectly owns or controls 10% or more of the voting securities of another person. INSURANCE COMPANY REGULATION. Trigon Insurance and its HMO subsidiaries and Trigon Health and Life are subject to the insurance laws and regulations of the Commonwealth of Virginia, the domiciliary state of these companies. Mid-South is domiciled in North Carolina and is subject to the laws and regulations of that state. In addition, Trigon Insurance and its HMO subsidiaries, Trigon Health and Life and Mid-South are subject to the insurance laws and regulations of the other jurisdictions in which they are licensed or authorized to do business. These insurance laws and regulations generally give state regulatory authorities broad supervisory, regulatory and administrative powers over insurance companies and insurance holding companies with respect to most aspects of their insurance businesses. This regulation is intended primarily for the benefit of the policyholders and members of insurance companies and not investors. Regulatory authorities exercise extensive supervisory power over health and life insurance companies with respect to the licensing of insurance companies; the approval of forms and insurance policies used; the nature of, and limitations on, an insurance company's investments; the periodic examination of the operations of insurance companies; the form and content of annual statements and other reports required to be filed on the financial condition of insurance companies; and the establishment of capital requirements for insurance companies. Trigon Insurance, the HMO subsidiaries, Trigon Health and Life and Mid-South are required to file periodic statutory financial statements in each jurisdiction in which they are licensed. Additionally, Trigon Insurance, the HMO subsidiaries, Trigon Health and Life, and Mid-South are periodically examined by the insurance departments of the jurisdictions in which they are licensed to do business. Some states impose surcharges on all insurance companies operating in the state except for the Blue Cross plan or plans operating there. The Company does not believe that these surcharges will materially affect its ability to expand outside of Virginia because the surcharges have generally not been imposed in the states in which the Company principally intends to expand and, if imposed, would likely apply equally to all non-Blue Cross companies operating in the state. RISK-BASED CAPITAL REQUIREMENTS. In 1994, Virginia adopted new statutory risk-based capital ("RBC") requirements for health and other insurance companies. Such requirements are intended to assess the capital 13 adequacy of life and health insurers, taking into account the risk characteristics of an insurer's investments and products. The formula for calculating such RBC requirements, set forth in instructions adopted by the NAIC, is designed to take into account asset risks, insurance risks, interest rate risks and other relevant risks with respect to an individual insurance company's business. Under these laws, an insurance company must submit a report of its RBC level to the State Corporation Commission as of the end of the previous calendar year. The Virginia RBC requirements categorize insurance companies according to the extent to which they meet or exceed certain RBC thresholds. The law requires increasing degrees of regulatory oversight and intervention as an insurance company's RBC declines. The level of regulatory oversight ranges from requiring the insurance company to inform and obtain approval from the Virginia Insurance Commissioner of a comprehensive financial plan for increasing its RBC to mandatory regulatory intervention requiring an insurance company to be placed under regulatory control in a rehabilitation or liquidation proceeding. As of December 31, 1997, the RBC levels of Trigon Insurance, Trigon Health and Life, and Mid-South, as calculated in accordance with the NAIC RBC instructions, exceeded all RBC thresholds. RESTRICTIONS ON DIVIDENDS. In the event the Company determines to pay dividends, the principal source of funds to pay dividends to stockholders would be dividends received by the Company from its subsidiaries, including Trigon Insurance. Virginia insurance laws and regulations restrict the payment of extraordinary dividends declared by insurance companies, including health care insurers such as Trigon Insurance, in a holding company system. An insurance company is prohibited from paying an extraordinary dividend unless it obtains the approval of the State Corporation Commission. An extraordinary dividend is one which, together with the amount of dividends and distributions paid by the insurance company during the immediately preceding 12 months, exceeds the lesser of (i) 10% of the insurance company's surplus to policyholders as of the preceding December 31st or (ii) the insurance company's net income (not including realized capital gains) for the preceding calendar year. Further, an insurance company may not pay a dividend unless, after such payment, its surplus to policyholders is reasonable in relation to its outstanding liabilities and adequate to meet its financial needs. The State Corporation Commission may bring an action to enjoin or rescind payment of any dividend or distribution that would cause the insurance company's statutory surplus to be unreasonable or inadequate. The maximum amount available after certain dates in 1998 for payment of dividends by Trigon Insurance to the Company without the prior approval of the State Corporation Commission is $61.8 million. North Carolina, Mid-South's domiciliary state, similarly restricts the payment of dividends by their domiciliary insurance companies. ASSESSMENTS AGAINST INSURERS. Under insolvency or guaranty association laws in most states, insurance companies can be assessed for amounts paid by guaranty funds for policyholder losses incurred by insolvent insurance companies. Most state insolvency or guaranty association laws, including Virginia's, currently provide for assessments based upon the amount of premiums received on insurance underwritten within such state (with a minimum amount payable where Mid-South is licensed even if no premium is received). Substantially all of Trigon's premiums are currently derived from insurance underwritten in Virginia. Under the Virginia Life, Accident and Sickness Insurance Guaranty Association (the "Association") Act, assessments against insurance companies which issue policies of accident or sickness insurance, such as Trigon Insurance, are made retrospectively and are based (up to prescribed limits) upon the ratio of (i) the insurance company's premiums received in Virginia over the previous three calendar years on accident and sickness insurance, to (ii) the aggregate amount of premiums received by all assessed member insurance companies over such three calendar years on accident and sickness insurance. The guaranty fund and assessments made under the act are administered by the Association, which has its own board of directors selected by member insurers with the approval of the State Corporation Commission. An assessment may be abated or deferred by the Association if, in the opinion of the board, payment would endanger the ability of the member to fulfill its contractual obligations, but the other member insurers may be assessed for the amount of such abatement or deferral. Any such assessment paid by a member insurance company may be offset against its premium tax liability to the Commonwealth of Virginia in each succeeding year in an amount not to exceed 0.05 (one twentieth) of one percent of the member's direct gross 14 premium income for the class of insurance for which the insurer is assessed. The amount and timing of any future assessments, however, cannot be reasonably estimated and are beyond the control of the Company. During 1997, legislation was enacted in Virginia that changed the methodology by which these amounts are offset against the premium tax liability. Any assessments issued after January 1, 1998 will be offset against the premium tax liability over the ten calendar years following the year of the payment, in amounts equal to ten percent of the amount paid. VIRGINIA'S OPEN ENROLLMENT PROGRAM. The Commonwealth of Virginia has an open enrollment program pursuant to which Trigon Insurance is required to offer comprehensive accident and sickness insurance contracts to individuals without imposition of certain underwriting criteria that would deny coverage on the basis of medical condition, age or employment status. As an incentive for participating in the open enrollment program, Trigon Insurance pays Virginia premium tax of three-fourths of one percent (0.75%) on premiums received from individual accident and sickness insurance rather than the general Virginia premium tax of two and one fourth percent (2.25%). This general Virginia premium tax applies to accident and sickness insurance premiums received by Trigon Insurance from group business. Prior to January 1, 1998, policies issued to small employers were also part of the open enrollment program. Subsequent to health care reform legislation in 1997, all carriers offering coverage in the small group market are required to issue any policy in its small group market portfolio to any small employer that wants to purchase the product. To withdraw from the open enrollment program, Trigon Insurance would be required to give 24 months advance notice of withdrawal to the State Corporation Commission. BANKRUPTCY AND INSOLVENCY. In the event of a default on any debt incurred by the Company or the bankruptcy of the Company, the creditors and stockholders of the Company would have no right to proceed against the assets of Trigon Insurance or any other subsidiary of the Company. If Trigon Insurance were subject to a rehabilitation or liquidation proceeding, such proceeding would be brought by the State Corporation Commission which would act as the receiver with respect to such insurance company's property and business. All creditors of Trigon Insurance, including, without limitation, members and, if applicable, the various state guaranty associations, would be entitled to payment in full from such assets before the Company, as a stockholder, would be entitled to receive any distributions therefrom. THE BLUE CROSS BLUE SHIELD LICENSE The Company and its subsidiaries have the exclusive right to use certain Blue Cross and Blue Shield service marks and tradenames for all of their plans and products throughout Virginia other than a small portion of the northern Virginia suburbs adjacent to Washington, D.C. The license requires a fee to be paid to BCBSA equal to total association expenses allocated to members based upon enrollment and premium. BCBSA is a national trade association of Blue Cross and Blue Shield licensees, the primary function of which is to promote and preserve the integrity of the Blue Cross and Blue Shield name and service marks as well as provide certain coordination among plan and provider services. BCBSA has 55 primary licensee members, each of which holds exclusive rights to use the Blue Cross and/or Blue Shield name and service mark in specific geographic areas, subject to annual licensing fees and certain other guidelines. Each BCBSA licensee is an independent legal organization and is not responsible for obligations of other BCBSA member organizations. The Company has no right to use the Blue Cross and Blue Shield service marks and tradenames outside of its designated territory within the Commonwealth of Virginia. The Company and its subsidiaries intend to conduct their businesses outside of Virginia under the name "Trigon" without reference to the Blue Cross and Blue Shield service marks and tradenames. Under the Company's license agreement with BCBSA, an institutional investor (generally defined as an entity identified in Rule 13d-1(b) (1) (ii) of the rules and regulations under the Securities Exchange Act of 1934 and which makes certifications required by item 10 of SEC Schedule 13G) may own up to 10% of the outstanding voting securities of the Company. All other stockholders are subject to a 5% ownership limitation. Ownership by any stockholder of voting securities in excess of such limits would subject the Company to automatic termination of its license. 15 The Company's Articles of Incorporation contain certain provisions which are intended to prevent any holder from acquiring shares in excess of the limits set forth in the Company's license agreement. However, there can be no assurance that a court would enforce these provisions, or that if these provisions were not enforced that the Company would retain the license from BCBSA. If the BCBSA license were to be terminated, there would be a material adverse effect on the Company's business and operations, which the Company does not believe it can meaningfully quantify. The license agreements between BCBSA and its licensees prohibit a licensee from entering into certain transactions which would result in an unlicensed entity obtaining control of the licensee or acquiring a substantial portion of the licensee's assets related to services provided under the Blue Cross or Blue Shield service marks. The license agreements also require that a licensee pay to BCBSA a specific amount upon termination of the license agreement, subject to certain limited exceptions. The amount payable upon termination of the license agreement is equal to $25 multiplied by the number of the licensee's members receiving products or services sold or administered under the Blue Cross or Blue Shield service marks, subject to reduction to the extent the payment of such fee would cause such licensee to fall below certain capital requirements established by the BCBSA. RATING Trigon Insurance, HealthKeepers and PHP are each presently assigned a rating of "A" (Excellent) by A.M. Best Company. Mid-South, Trigon Health and Life, PHC and Priority Health Care, Inc. are each presently assigned an A.M. Best rating of "A-" (Excellent). A.M. Best's ratings of "A" and "A-" are assigned to companies which have, on balance, excellent financial strength, operating performance and market profile when compared to the standards established by the A.M. Best Company. It is the opinion of A.M. Best Company that such companies have a strong ability to meet their ongoing obligations. Such ratings are not directed to the protection of investors and are subject to review and change over time. EMPLOYEES As of December 31, 1997, the Company had 3,583 full-time employees. The employees are primarily located in Richmond and Roanoke, Virginia, with employees also located in Illinois, Maryland, Georgia, New Jersey, North Carolina, Pennsylvania, South Carolina, Texas, Washington D.C. and West Virginia. The Company believes that its relationship with its employees is good. No employees are subject to collective bargaining agreements. EXECUTIVE OFFICERS
Name Age Position - ---- --- -------- Norwood H. Davis, Jr. 58 Chairman of the Board and Chief Executive Officer Thomas G. Snead, Jr. 44 President and Chief Operating Officer John C. Berry 60 Executive Vice President and Chief Operating Officer, Government and Individual Business Unit Thomas R. Byrd 40 Senior Vice President and Chief Financial Officer Paul F. Nezi 50 Senior Vice President, Marketing and Sales J. Christopher Wiltshire 43 Senior Vice President, General Counsel and Corporate Secretary
Norwood H. Davis, Jr. joined Trigon Insurance in 1968, and was elected to the Board of Directors in 1975. Since 1989, he has served as Chairman of the Board and Chief Executive Officer. He also became Chairman of the Company in June 1995. Mr. Davis is a director of Altris Software, Inc. and Hilb, Rogal & Hamilton Co. 16 Thomas G. Snead, Jr. joined Trigon Insurance in 1985. He served as Group Financial Officer from 1989 to 1990 and as Senior Vice President and Chief Financial Officer from 1990 to 1997. He became Treasurer of the Company in June 1995. He was elected to his current position of President and Chief Operating Officer of the Company in October 1997. John C. Berry joined Trigon Insurance in 1987. He served as Chief Operating Officer of Government and Individual Business from 1987 through 1989 and as Senior Vice President and Chief Operating Officer of Government and Individual Business during 1990. In 1991, he was appointed to his current position of Executive Vice President and Chief Operating Officer of Government and Individual Business. Thomas R. Byrd joined Trigon Insurance in 1991 as Director, Financial Analysis. In 1992, he was named Vice President and Controller, a position he held until 1995 when he became Vice President, Financial Planning and Analysis. He was appointed to his current position of Senior Vice President and Chief Financial Officer of the Company in November 1997. Paul F. Nezi joined Trigon Insurance in October 1996 as Senior Vice President, Marketing and Underwriting. In 1997, he was named Senior Vice President, Marketing and Sales. Prior to joining the Company, he served as Executive Vice President, Marketing, Sales and Product Development of ChoiceCare in Cincinnati, Ohio since 1993. Beginning in November 1995, he also served as President of ChoiceCare's Development Division. From 1991 through 1992, he served as Vice President and General Manager for the Advanced Imaging Products group of AM Graphics, a division of AM International in Dayton, Ohio. J. Christopher Wiltshire joined Trigon Insurance in October 1996 as Senior Vice President, General Counsel and Corporate Secretary. He also became Secretary of the Company in October 1996. Prior to joining the Company, he was employed by the law firm, McGuire, Woods, Battle & Boothe, L.L.P. for 17 years, the last nine years as partner. SERVICE MARKS The Company has registered and maintains several service marks, trademarks and tradenames at the federal level, in the Commonwealth of Virginia and in certain other states. "Trigon," "Keycare" and "HealthKeepers" are included among these marks. Although the Company considers its registered service marks, trademarks and tradenames important in the operation of its business, the business of the Company is not dependent on any individual service mark, trademark or tradename. For a discussion of the Company's license to use certain Blue Cross and Blue Shield service marks and tradenames, see "The Blue Cross Blue Shield License." FORWARD-LOOKING INFORMATION The Private Securities Litigation Reform Act of 1995 (the "Act") provides a "safe harbor" for forward-looking statements, so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those discussed in the statement. The Company desires to take advantage of these safe harbor provisions. Certain information contained in this Form 10-K is forward-looking within the meaning of the Act or Securities and Exchange Commission rules. Words such as expects, anticipates, intends, plans, believes, seeks or estimates, or variations of such words and similar expressions are also intended to identify forward-looking statements. These forward-looking statements are subject to significant uncertainties and contingencies, many of which are beyond the control of the Company. Set forth below are certain important factors that, in addition to general economic conditions and other factors, some of which are discussed elsewhere in this Form 10-K, may affect these forward-looking statements and the Company's business generally. ESCALATING HEALTH CARE COSTS AND THE HEALTH CARE INDUSTRY. The Company's profitability depends in large part on accurately predicting and effectively managing health care costs. Predicting medical costs is difficult partially due to the variability of medical inflation. Trigon continually reviews and adjusts its premium 17 and benefit structure to reflect its underlying claims experience and revised actuarial data; however, several factors could adversely affect the medical loss ratios. Certain of these factors, which include changes in health care practices, inflation, new technologies, major epidemics, natural disasters and malpractice litigation, are beyond any health plan's control and could adversely affect the Company's ability to accurately predict and effectively control health care costs. Competitive price pressures in the health insurance and managed care industry, which generally result from the entry and exit of health care companies in the marketplace, historically have resulted in, or contributed to, pricing and profitability cycles. The extent to which recent structural changes in the managed health care and health insurance industry have altered cyclical patterns is uncertain. There can be no assurance, however, that a continuation of the typical cyclical pattern will not adversely affect the profitability of the Company in the next few years. COMPETITION. The health care industry is highly competitive both in Virginia and in other states in the southeastern and mid-Atlantic United States into which the Company principally intends to expand. See "Competition". There is no assurance that the overall increased competition will not exert strong pressures upon Trigon's profitability, its ability to increase enrollment, or its ability to successfully pursue growth in areas both within and outside of Virginia. The trend in the health care industry is toward both vertical and horizontal integration coupled with significant levels of managed care, principally through HMOs. In the Company's principal geographic market areas, HMOs have a smaller share of the health care market than in other areas of the country, but the Company believes that HMOs will capture an increasing share of the health care market. The Company believes that it will be necessary to significantly expand its market share in the HMO market, in part by successfully transitioning its PAR and PPO members into HMOs, if it is to succeed in retaining a high overall market share in its existing geographic markets. There can be no assurance that the Company will succeed in significantly expanding its market share in HMOs. GOVERNMENT REGULATION. The Company and its subsidiaries are subject to federal and state regulation. See "Regulation". Regulatory initiatives may be undertaken in the future, either as the federal or state level, to engage in structural reform of the health care industry in order to reduce the escalation in health care costs or to make health care more accessible. Such reform, if it occurs, could adversely affect Trigon's results of operations or financial condition. POTENTIAL RISKS ASSOCIATED WITH GROWTH THROUGH ACQUISITIONS. As a result of the expansion of managed care companies into Virginia and the southeastern and mid-Atlantic regions of the United States, the competition to purchase health care companies has intensified, which in many instances has resulted in significant increases in the costs of acquiring such companies, and which could affect the availability of attractive acquisition opportunities. In addition, the Company has no significant experience in expanding its managed health care business outside Virginia. There can be no assurance that the Company will successfully identify or complete acquisitions or that any acquisitions, if completed, will perform as expected or will contribute significant revenues or profits to the Company. The Company's ability to expand successfully outside of Virginia through acquisitions or otherwise may be adversely affected by its inability to use the Blue Cross and Blue Shield service marks and trademarks outside of the Company's licensed territory in Virginia, by the Company's lack of substantial market share or established provider networks outside of Virginia and by the presence of competitors with strong market positions in these areas. CONCENTRATION OF BUSINESS IN VIRGINIA. While the Company's growth strategy includes expansion outside Virginia, for the foreseeable future a significant portion of the Company's revenues may be subject to economic factors specific to Virginia. Therefore, there can be no assurance that a downturn in the Virginia economy would not adversely affect the Company. POTENTIAL LOSS OF BLUE CROSS AND BLUE SHIELD SERVICE MARKS AND TRADENAMES. Trigon and the BCBSA are parties to a license agreement pursuant to which the Company and its subsidiaries have the 18 exclusive right to use certain Blue Cross and Blue Shield service marks and tradenames for their products throughout Virginia other than certain northern Virginia suburbs adjacent to Washington, D.C. See "The Blue Cross Blue Shield License". If the BCBSA license were to be terminated, there would be a material adverse effect on the Company's business and operations, which the Company does not believe it can meaningfully quantify. To the extent that the Company continues to use the Blue Cross and Blue Shield service marks and tradenames in marketing its managed care products, there can be no assurance that any negative publicity concerning BCBSA and other BCBSA licenses will not adversely affect the sales of the Company's managed care products and the Company's operations. Item 2. Properties. The Company is headquartered in Richmond, Virginia, where it owns a four-story building with 265,000 square feet. The Company also owns an office facility and warehouse in Roanoke, Virginia with 201,000 square feet and an office facility in Fayetteville, North Carolina with 71,000 square feet. The Company leases an additional 428,000 square feet at various other locations in Richmond, Virginia. The Company also leases space at two other facilities in Roanoke, Virginia comprising 52,000 square feet. The Company leases 73,000 square feet for regional offices throughout Virginia and 22,000 square feet for office space in Maryland, North Carolina, West Virginia, Pennsylvania, Texas and South Carolina. Item 3. Legal Proceedings. The Company is the defendant in three lawsuits that have been filed by self-funded employer groups in connection with the Company's past practices regarding provider discounts. The suits claim that the Company was obligated to credit each self-funded plan with the full amount of the discounts that the Company negotiated with facilities providing health care to members covered by the plans. Collectively, the suits seek $1.3 million in compensatory damages plus unspecified punitive and other damages. The Company is also presently the subject of four other claims by self-funded employer groups related to the Company's past practices regarding provider discounts, some of which involve larger amounts of withheld discounts. The Company is communicating with these groups, and lawsuits have not been filed in connection with these claims. The Company believes that additional discount-related claims may be made against it. Although the ultimate outcome of such claims and litigation cannot be estimated, the Company believes that the discount-related claims and litigation brought by these self-funded employer groups will not have a material adverse effect on the consolidated financial condition of the Company. The Company and certain of its subsidiaries are involved in other various legal actions occurring in the normal course of business. While the ultimate outcome of such litigation cannot be predicted with certainty, in the opinion of Company management, after consultation with counsel responsible for such litigation, the outcome of those actions is not expected to have a material adverse effect on the consolidated financial condition of the Company. Item 4. Submission of Matters to a Vote of Security Holders. Not applicable. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. Refer to page 30, "Market Prices of Common Stock and Dividend Data", of Trigon Healthcare Inc.'s Annual Report to Shareholders, which is incorporated herein by reference. Refer to "Part 1 - Business -- Regulation -- Insurance Holding Company Regulation" and "Part 1 - Business -- Regulation -- Restriction on Dividends" for discussion of insurance holding company regulations and dividend 19 restrictions. In addition, under the terms of the Company's $300 million revolving credit agreement, the Company may not pay dividends on the Common Stock unless the aggregate of all dividends paid by the Company plus payments to purchase, redeem or otherwise acquire capital stock of the Company (other than the Commonwealth Payment) does not exceed the sum of (i) $10,000,000 plus (ii) 50% of the consolidated net income (or minus 100% of consolidated net loss) of the Company for the period from the effectiveness of the Demutualization through the end of the most recently completed fiscal quarter, plus (iii) an amount (not to exceed $50,000,000) equal to 50% of the cumulative cash dividends paid out of income of certain subsidiaries of the Company earned prior to January 1, 1997 and received by the Company after the date of the revolving credit agreement and before December 31, 1997. Item 6. Selected Financial Data. Refer to pages 22 and 23 of Trigon Healthcare Inc.'s Annual Report to Shareholders, which are incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. Refer to pages 24 through 30, "Management's Analysis of Operating Results", of Trigon Healthcare Inc.'s Annual Report to Shareholders, which are incorporated herein by reference. Item 7a. Quantitative and Qualitative Disclosures About Market Risk. Not applicable for 1997. Item 8. Financial Statements and Supplementary Data. Refer to pages 31 through 55, the Consolidated Financial Statements, page 56, "Independent Auditors' Report", and page 21, "Quarterly Financial Data", of Trigon Healthcare Inc.'s Annual Report to Shareholders, which are incorporated herein by reference. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. Not applicable. PART III Item 10. Directors and Executive Officers of the Registrant. Refer to pages 1 through 3, "Election of Directors", and page 6, "Section 16(a) Beneficial Ownership Reporting Compliance", of the Company's definitive Proxy Statement dated March 27, 1998, which are incorporated herein by reference solely as they relate to the Directors of the Company. Pursuant to General Instruction G(3) to Form 10-K, information as to executive officers of the Company is set forth in Part I of this Form 10-K. See "Part 1 - Business -- Executive Officers." Item 11. Executive Compensation. Refer to pages 7 through 12, "Compensation of Executive Officers", of the Company's definitive Proxy Statement dated March 27, 1998, which are incorporated herein by reference solely as they relate to this item. Item 12. Security Ownership of Certain Beneficial Owners and Management. Refer to pages 3 and 4, "Beneficial Ownership of Securities", of the Company's definitive Proxy Statement dated March 27, 1998, which are incorporated herein by reference solely as they relate to this item. Item 13. Certain Relationships and Related Transactions. R. Gordon Smith, a director of the Company, is a partner of McGuire, Woods, Battle & Boothe, L.L.P., a law firm which regularly provides legal services to the Company and its subsidiaries. 20 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. (a) The following documents are filed as part of this report. 1. Consolidated Financial Statements from Trigon Healthcare Inc.'s Annual Report to Shareholders are incorporated herein by reference in Item 8: -- Consolidated Balance Sheets as of December 31, 1997 and 1996 (page 31) -- Consolidated Statements of Operations for the years ended December 31, 1997, 1996 and 1995 (page 32) -- Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1997, 1996 and 1995 (page 33) -- Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995 (page 34) -- Summary of Significant Accounting Policies (pages 35 through 38) -- Notes to Consolidated Financial Statements (pages 39 through 55) -- Independent Auditors' Report (page 56) 2. Financial statement schedules Independent Auditors' Report on Financial Statement Schedule.......................(filed herein on page S-1) Schedule I - Condensed Financial Information of Registrant (parent only) as of December 31, 1997 and for the period February 5, 1997 through December 31, 1997 (filed herein on pages S-2 - S-6) 3. Exhibits. The following is a list of exhibits to this Form 10-K.
Exhibit Number Description - ------- ----------- 2 -- Amended and Restated Plan of Demutualization. (1) 3.1 -- Amended and Restated Articles of Incorporation of Trigon Healthcare, Inc. (1) 3.2 -- Amended and Restated Bylaws of Trigon Healthcare, Inc. (2) 3.3 -- Articles of Amendment to Amended and Restated Articles of Incorporation setting forth the designation, preferences and rights of Series A Junior Participating Preferred Stock of Trigon Healthcare, Inc. dated July 16, 1997. (4) 4 -- Form of Stock Certificate (other Instruments Defining the Rights of Security-Holders). (1) 4.1 -- Rights Agreement dated as of July 16, 1997 between Trigon Healthcare, Inc. and First Chicago Trust Company of New York, as Rights Agent. (4) 4.2 -- Form of Rights Certificate. (4) 10.1 -- License Agreement by and between the Blue Cross Blue Shield Association and the Company. (2) (a) Blue Cross license (b) Blue Shield license 10.2 -- Limited Fixed Return Plan for Certain Officers and Directors of the Company. (1) * 10.4 -- Non-Contributory Retirement Program for Certain Employees of the Company. (1) * 10.5 -- Supplemental Executive Retirement Program for Certain Employees of the Company. (1) * 10.6 -- Salary Deferral Plan for Norwood H. Davis, Jr.. (1) * 10.7 -- Amended and Restated Employment Agreement dated January 2, 1998 by and between the Company and Norwood H. Davis, Jr.. * 10.9 -- Employee Thrift Plan of the Company. (1)* 10.10 -- 401(k) Restoration Plan of the Company . (1) * 10.11 -- First Amendment to the Employee Thrift Plan of the Company, dated as of February 19, 1997. (2) * 10.12 -- Form of Employment Agreement dated as of December 12, 1990 by and between the Company and John C. Berry and certain other executive officers. (1) * 21 10.14 -- Credit Agreement dated as of February 5, 1997 among Trigon Healthcare, Inc., the banks party thereto and Morgan Guaranty Trust Company of New York, as Agent. (2) 10.15 -- 1997 Stock Incentive Plan (6).* 10.16 -- Employee Stock Purchase Plan (6).* 10.17 -- Non-Employee Directors Stock Incentive Plan (6).* 10.18 -- Amendment to the License Agreement by and between the Blue Cross Blue Shield Association and the Company. (5) 10.19 -- Amendment to the Non-Contributory Retirement Program for Certain Employees of Trigon Insurance Company. * 10.20 -- Form of Executive Continuity Agreement dated as of April 29, 1997 between Trigon Insurance Company and certain executive officers. (3) * 10.21 -- Form of Executive Continuity Agreement dated as of April 29, 1997 between Trigon Insurance Company and John C. Berry and certain other executive officers. (3) * 11 -- Computation of per share earnings. Refer to pages 50 and 51, "Note 14. Net Income and Pro Forma Net Income Per Share", of Trigon Healthcare Inc.'s Annual Report to Shareholders, which are incorporated herein by reference. 13 -- Excerpts from the Company's Annual Report to Shareholders for the year ended December 31, 1997. 21 -- Subsidiaries of the Registrant. 23.1 -- Consent of KPMG Peat Marwick LLP. 27 -- Financial Data Schedule (1) Incorporated by reference to exhibits filed with the Company's Registration Statement on Form S-1 (registration number 333-09773). (2) Incorporated by reference to exhibits filed with the Company's Form 10-K for the year ended December 31, 1997. (3) Incorporated by reference to exhibits filed with the Company's Form 10-Q for the period ended March 31, 1997. (4) Incorporated by reference to exhibits filed with the Company's Form 8-A/A filed on July 16, 1997. (5) Incorporated by reference to exhibits filed with the Company's Form 10-Q for the period ended September 30, 1997. (6) Incorporated by reference to exhibits filed with the Company's Proxy Statement dated March 13, 1997. * Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-k pursuant to Item 14(c) of this Form 10-K.
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted. 22 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the County of Henrico, Commonwealth of Virginia, on March 30, 1998. TRIGON HEALTHCARE, INC. By: /s/ THOMAS R. BYRD ------------------ THOMAS R. BYRD Title: SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ NORWOOD H. DAVIS, JR. Chairman (Principal Executive Officer) March 24, 1998 - ---------------------------- NORWOOD H. DAVIS, JR. /s/ THOMAS R. BYRD Senior Vice President and Chief - ---------------------------- Financial Officer (Principal Financial THOMAS R. BYRD and Accounting Officer) March 30, 1998 /s/ LENOX D. BAKER, JR. Director March 21, 1998 - ---------------------------- LENOX D. BAKER, JR., M.D. /s/ JAMES K. CANDLER Director March 23, 1998 - ---------------------------- JAMES K. CANDLER /s/ JOHN COLE, JR. Director March 23, 1998 - ---------------------------- JOHN COLE, JR., M.D. /s/ ROBERT M. FREEMAN Director March 25, 1998 - ---------------------------- ROBERT M. FREEMAN SIGNATURE TITLE DATE --------- ----- ---- /s/ WILLIAM R. HARVEY Director March 26, 1998 - ---------------------------- WILLIAM R. HARVEY, Ph.D. /s/ ELIZABETH G. HELM Director March 25, 1998 - ---------------------------- ELIZABETH G. HELM /s/ GARY A. JOBSON Director March 20, 1998 - ---------------------------- GARY A. JOBSON /s/ FRANK C. MARTIN, JR. Director March 23, 1998 - ---------------------------- FRANK C. MARTIN, JR. /s/ DONALD B. NOLAN Director March 27, 1998 - ---------------------------- DONALD B. NOLAN, M.D. /s/ WILLIAM N. POWELL Director March 20, 1998 - ---------------------------- WILLIAM N. POWELL /s/ J. CARSON QUARLES Director March 25, 1998 - ---------------------------- J. CARSON QUARLES /s/ R. GORDON SMITH Director March 25, 1998 - ---------------------------- R. GORDON SMITH /s/ HUBERT R. STALLARD Director March 24, 1998 - ---------------------------- HUBERT R. STALLARD /s/ JACKIE M. WARD Director March 23, 1998 - ---------------------------- JACKIE M. WARD /s/ STIRLING L. WILLIAMSON, JR. Director March 20, 1998 - ---------------------------- STIRLING L. WILLIAMSON, JR.
Independent Auditors' Report on Financial Statement Schedule The Board of Directors Trigon Healthcare, Inc.: Over date of February 4, 1998, we reported on the consolidated balance sheets of Trigon Healthcare, Inc. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedule included in this annual report on Form 10-K. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/ KPMG Peat Marwick LLP KPMG Peat Marwick LLP Richmond, Virginia February 4, 1998 S-1 SCHEDULE I TRIGON HEALTHCARE, INC. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY) Balance Sheet December 31, 1997 (In thousands)
Assets 1997 ------ ---------------- Current assets Cash $ 1 Investment securities, at estimated fair value 81,364 Premiums and other receivables 2,569 ---------------- Total current assets 83,934 ---------------- Investment in subsidiaries 960,418 Other assets 425 ---------------- Total assets $ 1,044,777 ================ Liabilities and Shareholders' Equity ------------------------------------ Current liabilities Accounts payable and accrued expenses $ 562 Deferred income taxes 389 Payable to affiliates 89 ---------------- Total current liabilities 1,040 ---------------- Long-term debt 85,000 ---------------- Total liabilities 86,040 ---------------- Shareholders' equity Common stock,$0.01 par; 42,300 shares issued and outstanding 423 Capital in excess of par 842,035 Retained earnings 78,982 Net unrealized gain on investment securities, net of deferred income taxes of $20,083 in 1997 37,297 ---------------- Total shareholders' equity 958,737 Commitments and contingencies - ---------------- Total liabilities and shareholders' equity $ 1,044,777 ================
See accompanying independent auditors' report and notes to condensed financial information. S-2 SCHEDULE I TRIGON HEALTHCARE, INC. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY), CONTINUED Statement of Operations For the Period February 5, 1997 through December 31, 1997 (In thousands) 1997 ---- Revenues Investment income $ 4,358 Net realized losses (105) Cash dividends from subsidiaries 50,000 ----------- Total revenues 54,253 Expenses Selling, general and administrative expenses 1,742 Interest expense 4,601 ---------- Total expenses 6,343 ---------- Income before income taxes and equity in undistributed 47,910 net income of subsidiaries Income tax benefit (868) ---------- Income before equity in undistributed net income of subsidiaries 48,778 Equity in undistributed net income of subsidiaries 30,204 ---------- Net income $ 78,982 =========== See accompanying independent auditors' report and notes to condensed financial information. S-3 SCHEDULE I TRIGON HEALTHCARE, INC. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY), CONTINUED Statement of Changes in Shareholders' Equity For the Period February 5, 1997 through December 31, 1997 (in thousands)
Unrealized gains (losses) Common Capital in Retained on investment stock excess of par earnings securities, net Total ----- ------------- -------- --------------- ----- Balance at January 1, 1997 $ - $ - $ - $ - $ - Undistributed earning of subsidiaries before Demutualization and IPO - - 722,330 33,521 755,851 Issuance of 24,475,022 shares to eligible policyholders in the Demutualization and cash payment to eligible policyholders in lieu of shares of common stock 245 630,941 (722,330) - (91,144) Issuance of 17,825,000 shares in the Initial Public Offerings, net of expenses 178 215,027 - - 215,205 Other, principally shares held by consolidated grantor trusts - (3,933) - (3,933) Net income after Demutualization 78,982 - 78,982 Change in unrealized gains (losses) on investment securities, net - - - 3,776 3,776 -------- -------------- -------------- -------------- ------------- Balance at December 31, 1997 $ 423 $ 842,035 $ 78,982 $ 37,297 $ 958,737 ======= ============== ============== ============== =============
See accompanying independent auditors' report and notes to condensed financial information. S-4 SCHEDULE I TRIGON HEALTHCARE, INC. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY), CONTINUED Statement of Cash Flows For the Period February 5, 1997 through December 31, 1997 (in thousands) 1997 ------------- Net income $ 78,982 Adjustments to reconcile net income to net cash provided (used) by operating activities Accretion of discounts and amortization of premiums, net (129) Undistributed earnings of subsidiaries (30,204) Increase in accounts receivable (2,569) Increase in other assets (425) Increase in accounts payable and accrued expenses 562 Payment of obligation for commonwealth payment (175,000) Change in deferred income taxes 53 Increase in payable to affiliates 89 Realized investment losses (net) 105 ------------- Net cash provided by operating activities (128,536) Cash flows from investing activities: Investment securities purchased (214,562) Proceeds from investment securities sold 77,002 Maturities of fixed income securities 57,180 ------------- Net cash used by investing activities (80,380) Cash flows from financing activities: Proceeds from long-term debt 85,000 Net proceeds from issuance of common stock 215,205 Net payments from issuance of common stock under employee benefit plans (144) Payments to members in lieu of common stock pursuant to Plan of Demutualization (91,144) ------------- Net cash provided by financing activities 208,917 ------------- Net increase in cash 1 Cash - beginning of year - ============= Cash - end of year $ 1 ============= Cash paid during the year for ============= Interest $ 4,344 ============= See accompanying independent auditors' report and notes to condensed financial information. S-5 SCHEDULE I TRIGON HEALTHCARE, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT ONLY), CONTINUED Notes to Condensed Financial Information of Registrant (Parent Only) The condensed financial information provided should be read in conjunction with the Consolidated Financial Statements incorporated by reference in Part II, Section 8 of this Form 10-K and the following notes: (a) Basis of Presentation The accompanying condensed financial information reflects the financial position as of December 31, 1997 and the results of operations, changes in shareholders' equity and cash flows for the period after the Demutualization and Initial Public Offering, February 5, 1997 through December 31, 1997. The Registrant had no operations prior to February 5, 1997, the date it became the holding company. Refer to note 1 to the consolidated financial statements for details regarding the Demutualization and Initial Public Offering. (b) Long-Term Debt The information about long-term debt contained in Note 11 of the notes to the consolidated financial statements is incorporated herein by reference. (c) Cash and Stock Dividends During 1997, a subsidiary of the Registrant, Trigon Insurance Company, received permission from the Virginia Bureau of Insurance to pay a $238.7 million dividend to the Registrant, consisting of $188.7 million in stock of a wholly-owned subsidiary and $50 million in cash. This dividend was effected on July 31, 1997. S-6 EXHIBIT INDEX Exhibit Number Description 10.7 -- Amended and Restated Employment Agreement dated January 2, 1998 by and between the Company and Norwood H. Davis, Jr. 10.19 -- Amendment to the Non-Contributory Retirement Program for Certain Employees of Trigon Insurance Company 13 -- Excerpts from the Company's Annual Report to Shareholders for the year ended December 31, 1997. 21 -- Subsidiaries of the Registrant. 23.1 -- Consent of KPMG Peat Marwick LLP. 27 -- Financial Data Schedule. EX-10 2 EXHIBIT 10.7 EXHIBIT 10.7 NORWOOD H. DAVIS, JR. AMENDED AND RESTATED EMPLOYMENT AGREEMENT (As amended and restated January 2, 1998) This Agreement is made as of the 2nd day of January, 1998, between TRIGON INSURANCE COMPANY, a Virginia corporation (the "Company"), and NORWOOD H. DAVIS, JR., of Richmond, Virginia ("Executive"). RECITALS Executive has been employed by the Company or its affiliates since April 1, 1968. Since April 1, 1981, Executive has served as Chief Executive Officer of the Company or of its affiliate, Consolidated Healthcare, Inc. The Company and Executive are parties to an agreement dated March 13, 1996 (the "Prior Agreement"). The parties desire to amend and restate the Prior Agreement in the manner herein set forth. NOW, THEREFORE, in consideration of the premises and the mutual promises herein contained, the parties agree as follows: ARTICLE I EMPLOYMENT 1.1 Employment. The Company hereby employs Executive as Chairman of the Board and Chief Executive Officer of the Company. Executive shall have the powers, duties, and responsibilities that are customary to the position of Chief Executive Officer and shall preside at all meetings of the Board of Directors of the Company. Subject to approval by the Board, Executive shall select the officers of the Company and each of its affiliates. Executive shall devote his full business time and efforts to the business and affairs of the Company and its affiliates; provided, however, that this provision shall not preclude Executive from serving as a director of any other corporation or other -1- organization involving no conflict of interest with the interests of the Company. All such directorships shall be disclosed to and reviewed by the Executive Committee of the Company. 1.2 At Will Employment. Executive's employment hereunder is at will. Executive may resign at any time and the Company may discharge Executive at any time, with or without cause. ARTICLE II COMPENSATION AND BENEFITS 2.1 Base Salary Executive's base salary for 1998 has been determined by the Board of Directors upon recommendation from the Chair of the Human Resources Committee. 2.2 Incentive Compensation. Executive shall also be eligible for an award of incentive compensation each year. 2.3 Annual Reviews. Effective each January 1 during the term of this Agreement, the Chairmen of the Executive and Human Resources, Compensation and Employee Benefits Committees will review Executive's performance as Chief Executive Officer and will recommend to the Board (i) such annual increase in base salary as may be appropriate and in accordance with the Company's regular salary administration program and (ii) such award of incentive compensation for the prior year as may be appropriate. The Board will determine such annual increase in base salary and such award of incentive compensation. 2.4 Participation in Employee Benefit Plans. While employed by the Company, Executive shall be entitled to participate in the Company's Non-Contributory Retirement Program, the Employees' Thrift Plan, the split-dollar life insurance program, the group health insurance program, the group term life insurance program, and the disability insurance program. In addition, the Company shall provide to Executive an automobile and gasoline allowance, tax and financial planning services, and reimbursement for club dues and other business expenses. ARTICLE III DISABILITY 3.1 Supplemental Disability Payment. If Executive becomes disabled while employed by the Company and is entitled to receive benefits under the Company's Long-Term Disability Program, then the Company will pay to Executive a Monthly Supplemental Disability Benefit (as hereinafter defined) for so long as Executive is entitled to receive disability payments under the - 2 - Company's Long-Term Disability Program (or under any similar disability program maintained by the Company). The amount of the Monthly Supplemental Disability Benefit shall be equal to the difference between (i) one-twelfth (1/12) of sixty percent (60%) of Executive's annual base salary for the year in which Executive becomes disabled and (ii) the amount of the monthly disability benefit payable to Executive under the Company's Long-Term Disability Program. ARTICLE IV SEVERANCE PAYMENT AND EMPLOYMENT BENEFIT TRUST 4.1 Severance Payment. (a) Upon a Termination Event, as defined in Section 4.1(b) below, the Company will pay the Severance Payment, as defined in Section 4.1(c) below, to Executive. (b) The term Termination Event shall mean the following: (i) the termination of Executive's employment with the Company for any reason other than by reason of Executive's resignation; and (ii) the termination of Executive's employment with the Company by reason of Executive's resignation but only if Executive shall have given the Company at least six (6) months prior written notice of such resignation. The term Termination Event shall not include the termination of Executive's employment with the Company by reason of Executive's resignation if Executive shall not have given the Company at least six (6) months prior written notice of such resignation. (c) The term Severance Payment shall mean a payment equal to four times the Annual Compensation of Executive as defined in Section 4.1(d) below. (d) The term Annual Compensation of Executive shall mean the highest amount of cash compensation (including, without limitation, salary and bonus) earned by Executive with respect to one of the three calendar years immediately preceding the Termination Event. The Annual Compensation of Executive for a calendar year shall include (i) Executive's annual base salary for the calendar year in question, without any reduction for any amounts that Executive may have deferred under the Company's 401(k) Plan, 401(k) Restoration Plan, Deferred Benefit Plan for Officers, or otherwise, and (ii) any cash bonus or incentive payments (annual and long term) that are earned for a period of performance ending in the calendar year in question, but which are paid after the calendar year in question. 4.2 Establishment of Employment Benefit Trust. The Company has established an Employment Benefit Trust (the "Trust") for the benefit of Executive and other key executives of the - 3 - Company. The form of Trust Agreement is attached as Exhibit A. In order to provide benefits to Executive, the Company has transferred to the Trust the assets and amounts specified in paragraph 4.3 and has instructed the trustee of the Trust to maintain such assets and amounts in a separate account for the benefit of Executive (the "Account"). 4.3 Assets and Amounts Transferred to the Trust. (a) Prior to the execution of the Prior Agreement, the Company transferred to the Trust all of the assets held in the account established for Executive under the Agreement between the Company and Executive dated December 12, 1990, and certain additional amounts that were authorized by the Board of Directors on December 9, 1992, and were transferred to the Trust on or about June 22, 1993. (b) The strategy of the Company is to expand by acquiring, merging, or affiliating with other Blue Cross and Blue Shield plans, insurance companies, and managed care companies. If the Executive Committee or the Board of Directors determines that Executive's duties have expanded because of such acquisitions, mergers or affiliations or for other reasons, then the Executive Committee or the Board of Directors may make additional contributions to the Trust in recognition of such expanded duties. 4.4 Investment of Amounts Transferred to the Trust. The Company shall from time to time appoint an investment manager (the "Investment Manager") to invest and manage the assets of the Trust. The initial Investment Manager will be James W. Copley, Jr., President, Consolidated Investment Corporation. The Company, acting through the Investment Manager, shall have sole discretion to select investments for the Trust. Annually, the Investment Manager will report the investments made in the Trust to the Chairman of the Executive Committee and will confer with him about the investment policy for the Trust. Executive shall have no right to have any particular investment made in the Trust. The Company shall bear all risk of gain or loss with respect to the investments made in the Trust. Such gains or losses shall not affect the amount of the Severance Payment. 4.5 Fees, Expenses, and Taxes. The Company shall pay the fees and expenses of the Investment Manager for its services and the fees and expenses of the trustee of the Trust for its services. All fees, commissions, and expenses resulting from transactions made in the Trust shall be paid from assets held in the Trust to the extent such assets are available, but if such assets are insufficient to pay - 4 - such sums, such sums shall be paid by the Company from its other funds. Income taxes incurred by the Company as the result of transactions made in the Trust shall be paid by the Company and shall not be charged to the Trust. 4.6 Distribution of the Assets in the Trust. (a) Upon the happening of a Termination Event, the trustee of the Trust may either (i) transfer assets held in the Trust for Executive's Benefit to Executive in kind to the extent of the Severance Payment; or (ii) sell all or any part of such assets and distribute the sales proceeds to Executive to the extent of the Severance Payment. If any asset distributed to Executive in kind does not have a readily ascertainable fair market value, the Company may at its expense have such asset appraised by an independent appraiser, and the Company and Executive agree to be bound by such appraisal for all purposes under this Agreement (including federal and state income tax filings). To the extent the value of such assets transferred to Executive in kind or such proceeds distributed to Executive (as the case may be) is insufficient to fund the Severance Payment, the Company shall pay the balance of the Severance Payment to Executive in immediately available funds. To the extent that the value of such assets or such proceeds distributed to Executive or such proceeds (as the case may be) exceeds the Severance Payment, such assets or such proceeds (as the case may be) shall be distributed to the Company. If the Termination Event is the result of the death of Executive, then the distribution under this paragraph shall be made to Executive's personal representative. (b) In consideration of the Severance Payment to Executive, Executive agrees that he will not, prior to the expiration of four (4) years following the termination of his employment, become an officer, director, or employee of, or consultant to, or 10% or more owner of, any entity that competes with the Company in any business in which the Company is engaged as of the date of the termination of Executive's employment; provided, however, that if the Company terminates Executive's employment without cause, then this covenant not to compete shall not be applicable. For purposes of this Agreement, termination without cause means termination for any reason other than continued neglect by Executive of his duties hereunder or willful misconduct by Executive in the performance of his duties hereunder. Executive agrees that in the event of a breach by Executive of this covenant not to compete, the Company's remedies at law will be inadequate and that the Company will be entitled to appropriate equitable relief, including an injunction restraining such breach. If Executive so requests, the Executive Committee is authorized to determine, by written communication to Executive, that a - 5 - particular activity that Executive proposes to engage in does not constitute competition with the Company within the meaning of this paragraph and such determination shall be conclusive and binding on the parties to this Agreement. 4.7 Beneficial Ownership. Unless and until the assets held in the Account are distributed to Executive pursuant to Section 4.6(a) of this Agreement, beneficial ownership of all assets in the Account shall remain with the Company, and Executive shall have no property interest in any such assets. ARTICLE V RETIREMENT AND SUPPLEMENTAL RETIREMENT BENEFITS 5.1 Normal Retirement. If Executive's employment with the Company has not sooner terminated, then he shall retire as of the end of the month in which he attains the age of 61 (that is to say, on March 31, 2001). 5.2 Early Retirement. Executive may at his option elect early retirement effective as of the end of any month following the date on which he attains the age of 56 (that is to say, beginning March 31, 1996) by giving the Company written notice of such election at least one hundred twenty (120) days before the effective date of such retirement. 5.3 Participation in Existing Retirement Programs. Executive is a participant in the Company's Non-Contributory Retirement Program (herein referred to as the "Retirement Program") and in the Company's Supplemental Retirement Program for Certain Employees (herein referred to as the "Supplemental Retirement Program"). 5.4 Enhanced Supplemental Retirement Benefit at Normal Retirement. If Executive's continuous employment with the Company continues until March 10, 2001, then in addition to the benefit that Executive receives under the Supplemental Retirement Program, the Company shall pay to Executive a nonqualified unfunded supplemental retirement benefit (the "Enhanced Supplemental Retirement Benefit") in the amount described below. The amount of the Enhanced Supplemental Retirement Benefit shall be equal to the difference between (i) the retirement benefit that Executive would have received under the Retirement Program if (a) earnings used in computing benefits under the Retirement Program included nonqualified deferred compensation in the year in which the amounts were deferred, (b) the limitations of Sections 401(a)(17) and 415 of the Internal Revenue Code did not apply to the calculation and amount of such benefit, (c) Executive had remained in the employ of the Company - 6 - and received credited service until March 31, 2005, and (d) Executive had received earnings from the Company from the date of termination of employment until March 31, 2005 at an annual rate equal to the Annual Compensation of Executive as defined in Section 4.1(d) above, and (ii) the sum of the retirement benefits that Executive actually receives under the Retirement Program and under the Supplemental Retirement Program. 5.5 Reduced Enhanced Supplemental Retirement Benefit at Early Retirement. If Executive's continuous employment with the Company terminates at any time on or after March 10, 1996 but before March 10, 2001, then the Company shall pay Executive that percentage of the Enhanced Supplemental Retirement Benefit reflected in the following schedule: Percentage of Enhanced Supplemental Retirement Date Retirement Benefit March 10, 1996 - March 9, 1997 80% March 10, 1997 - March 9, 1998 84% March 10, 1998 - March 9, 1999 88% March 10, 1999 - March 9, 2000 92% March 10, 2000 - March 9, 2001 96% March 10, 2001 - or thereafter 100% 5.6 Calculation and Payment of Enhanced Supplemental Retirement Benefits. The enhanced supplemental retirement benefits payable to Executive pursuant to Sections 5.4 and 5.5 of this Agreement shall be calculated and paid to Executive at the same time and in the same manner that benefits are calculated and paid to Executive under the Supplemental Retirement Program. 5.7 Other Retirement Benefits. If Executive retires from the Company, then irrespective of when such retirement occurs, Executive shall be entitled to all retirement benefits that are made generally available to retired executive officers of the Company, including health care coverage and group term life insurance benefits. ARTICLE VI MISCELLANEOUS 6.1 Termination of Prior Agreements. This Agreement supersedes all prior agreements respecting the subject matter of Executive's employment, written or oral; provided, however, that nothing herein shall affect the Salary Deferral Agreement between the Company and Executive dated December 13, 1989. - 7 - 6.2 Notices. Any notice required or permitted hereunder shall be in writing and shall be deemed given if delivered personally or mailed, registered or certified mail, as follows: (a) If to the Company, to: Chairman of the Executive Committee Trigon Insurance Company 2015 Staples Mill Road Post Office Box 27401 Richmond, Virginia 23279 (b) If to Executive, to his last address shown on the records of the Company. 6.3 Successors. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective heirs, representatives, and successors, including, without limitation, any person acquiring directly or indirectly all or substantially all of the assets of the Company, whether by merger, consolidation, sale, or otherwise, but neither this Agreement nor any right hereunder may be otherwise assigned or transferred by either party hereto. 6.4 Applicable Law. This Agreement shall be governed by and construed and enforced in accordance with the laws of Virginia. 6.5 Amendment. This Agreement may be amended only by a written instrument signed by the parties hereto. IN WITNESS WHEREOF, the parties have duly executed this Agreement as of the day and year first above written. TRIGON INSURANCE COMPANY By: ______________________________________ Jackie M. Ward, Chairperson Human Resources, Compensation and Employee Benefits Committee -------------------------------------- Norwood H. Davis, Jr. - 8 - EX-10 3 EXHIBIT 10.19 Exhibit 10.19 THE NON-CONTRIBUTORY RETIREMENT PROGRAM FOR CERTAIN EMPLOYEES OF TRIGON INSURANCE COMPANY AMENDMENT ADOPTING NEW DEFINITION OF EARNINGS AND ADDING A DEFINITION OF HIGHLY COMPENSATED EMPLOYEE WHEREAS, Trigon Insurance Company (herein referred to as the "Employer") maintains a non-contributory retirement program, the Non-Contributory Retirement Program for Certain Employees of Trigon Insurance Company (herein referred to as the "Retirement Program") pursuant to the provisions of the National Retirement Program; WHEREAS, pursuant to Section 7.01 of the Retirement Program, the Employer has reserved the right to amend or modify the Retirement Program; WHEREAS, it is desirable to modify the Retirement Program to clarify that Earnings do not include the value of taxable income derived from stock options granted by the Employer for purposes of determining either the benefits accrued under the Retirement Program, the limitation on benefits imposed by Section 415 of the Internal Revenue Code, or each Participant's status as a Highly Compensated Employee; WHEREAS, it is also desirable to modify the Retirement Program to add a definition of "Highly Compensated Employee;" NOW, THEREFORE, the Employer hereby amends the Retirement Program, effective January 1, 1998, as follows with respect to those Participants who on or after such date are employees of the Employer or any other entity that has adopted the Retirement Program with the approval of the Employer: 1. The introductory sentence under Section 1.06, Earnings, is modified to read as follows: "1.06 "Earnings" shall mean the following, for the purposes of determining both benefits accrued under the Program and, for Program Years beginning on or after January 1, 1998, a Participant's status as a Highly Compensated Employee:" 2. Subsection (c) of Section 1.06, Earnings, is renumbered (c)(1), subsections (c)(1) and (2) are renumbered (c)(1)(i) and (ii), respectively, and any cites to such subsections are modified accordingly. 3. The first sentence of Section 1.06(c )(1), Earnings, is modified to read as follows: -1- "For a Program Year beginning on or after January 1, 1988 and before January 1, 1998, (i) or (ii) as checked below:" 4. Subsection (c) of Section 1.06, Earnings, is modified to add a new subsection (c)(2) to read as follows: "(c)(2) For a Program Year beginning on or after January 1, 1998: Compensation paid or made available in such Program Year, including the following - "(i) the Participant's earned income, wages, salaries, fees for professional services and other amounts received (without regard to whether or not an amount is paid in cash) for personal services actually rendered in the course of employment with the Employer to the extent that the amounts are includible in gross income (including, but not limited to, commissions paid to sales people, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, tips, bonuses, fringe benefits, reimbursements, expense allowances under a nonaccountable plan (as described in Treas. Reg. Section 1.62-2(c)); "(ii) elective deferrals (as defined in Section 402(g)(3) of the Internal Revenue Code), and any amount which is contributed or deferred by the Employer at the election of the Participant and which is not includible in the gross income of the Participant by reason of Section 125 or 457 of the Internal Revenue Code; "(iii) amounts described in Sections 104(a)(3), 105(a), and 105(h) of the Internal Revenue Code, but only to the extent that these amounts are includible in the gross income of the Participant; "(iv) amounts paid or reimbursed by the Employer for moving expenses incurred by the Participant, but only to the extent that at the time of the payment it is reasonable to believe that these amounts are not deductible by the Participant under Section 217 of the Internal Revenue Code; "(v) the value of a non-qualified stock option granted to a Participant by the Employer, but only to the extent that the value of the option is includible in the gross income of the Participant for the taxable year in which granted; and "(vi) the amount includible in the gross income of a Participant upon making the election described in Section 83(b) of the Internal Revenue Code. "Earnings shall not include the following items: "(vii) (Except as described in (ii) above) Employer contributions to a program of deferred compensation to the extent that, before the application of the limitations imposed by Section 415 of the Internal Revenue Code, the contributions are not included in the gross income - 2 - of the Participant for the taxable year in which contributed; Employer contributions made on behalf of the Participant to a simplified employee pension plan described in Section 408(k) of the Internal Revenue Code; and any distributions from a plan of deferred compensation, whether or not included in the gross income of the Participant when distributed; "(viii) Amounts realized from the exercise of a non-qualified stock option, or when restricted stock (or property) held by a Participant either becomes freely transferable or is no longer subject to a substantial risk of forfeiture; "(ix) Amounts realized from the sale, exchange or other disposition of stock acquired under a qualified stock option (or under an option described in Section 422 or 423 of the Internal Revenue Code); "(x) Other amounts which receive special tax benefits, such as premiums for group-term life insurance (but only to the extent that the premiums are not includible in the gross income of the Participant), or (except as provided in (ii) above) contributions made by an Employer (whether or not under a salary reduction agreement) towards the purchase of a Section 403(b) annuity contract (whether or not the contributions are excluded from the gross income of the Participant). "However, such amounts earned after the last complete calendar year prior to the earlier of the Employee's Early Retirement Date or last date of Employment shall be disregarded." 5. Section 1.12A, Maximum Annual Social Security Covered Compensation, is renumbered as Section 1.12B, and a new Section 1.12A, Highly Compensated Employee, is added to read as follows: "1.12A "Highly Compensated Employee" shall mean a Participant who was either: (a) a 5-percent owner at any time during the Program Year or the preceding Program Year, or (b) for the preceding Program Year (i) had Earnings (as defined in Section 1.06(c)(2)) from the Employer in excess of $80,000 (as adjusted to reflect cost-of-living increases). "An employee shall be treated as a 5-percent owner for any Program Year, if at any time during such Program Year, such employee owns (or is considered as owning within the meaning of Section 318 of the Internal Revenue Code) more than 5% of the outstanding stock of the Employer or stock possessing more than 5% of the total combined voting power of all stock of the Employer. - 3 - "A former employee shall be considered a Highly Compensated Employee if such employee was a Highly Compensated Employee (i) when he terminated employment, or (ii) during any Program Year following his attainment of age 55." 6. Subsection (a) of Section 4.12, Limitations on Benefits, is hereby modified by inserting the following in lieu of the last paragraph: "Notwithstanding anything in this paragraph to the contrary, with respect to Program Years beginning on or after January 1, 1998, for purposes of this Section, the term "annual benefit" means the benefit that is payable annually to a Participant in the form of a straight lifetime benefit with no ancillary benefits, and the term "compensation" has the same meaning as Earnings, as defined in Section 1.06(c)(2) (without regard to the last paragraph under Section 1.06(c)(2))." TRIGON INSURANCE COMPANY By: ________________________ Authorized Officer - ------------------------ ---------------------------- Attest Title - ------------------------ ---------------------------- Title Date APPROVED: NATIONAL EMPLOYEE BENEFITS COMMITTEE By: _________________________ Secretary - 4 - EX-13 4 EXHIBIT 13 Exhibit 13 QUARTERLY FINANCIAL INFORMATION TRIGON HEALTHCARE, INC. AND SUBSIDIARIES
Quarters ended (In thousands, except per share data) March 31 June 30 September 30 December 31 =========================================================================================================================== 1997 Total revenues $511,764 510,041 524,115 517,700 Operating income (1) 2,076 4,084 6,260 8,105 Income before income taxes 44,498 23,155 42,747 34,270 Net income 29,233 15,342 27,966 22,512 Net income after Demutualization and IPO (2) 13,162 15,342 27,966 22,512 Earnings per share (2) Basic and diluted net income after Demutualization and IPO 0.31 0.36 0.66 0.53 Pro forma earnings per share (3) Basic and diluted pro forma net income 0.68 0.36 0.66 0.53 Basic pro forma net income, excluding realized gains and extraordinary items (4) 0.29 0.32 0.38 0.41 Diluted pro forma net income, excluding realized gains and extraordinary items (4) 0.29 0.32 0.38 0.40 1996 Total revenues $470,207 487,018 483,217 482,098 Operating income (1) 4,407 3,583 2,160 3,763 Income before gain on sale of subsidiary, income taxes and extraordinary items 30,814 34,329 29,773 25,719 Income before extraordinary items 25,389 28,391 87,887 54,847 Net income (loss) 23,150 24,042 (91,805) 50,307 Pro forma earnings per share (3) Basic and diluted pro forma income before extraordinary items 0.45 0.51 0.44 1.33 Basic and diluted pro forma net income (loss) 0.40 0.41 (3.81) 1.23 Basic and diluted pro forma net income, excluding realized gains and extraordinary items (4) 0.22 0.22 0.19 0.24
(1) Operating income is defined as premium and fee revenues and other revenues less medical and other benefit costs and selling, general and administrative expenses. (2) Reflects net income and net income per share for the period after February 5, 1997, the effective date of the Demutualization and Initial Public Offering (IPO). (3) Pro forma per share data gives effect to the Demutualization and IPO as if they had taken place on January 1, 1996. See note 1 to the consolidated financial statements for the pro forma assumptions used. In addition, the 1997 and 1996 pro forma per share data has been restated to comply with Statement of Financial Accounting Standards No. 128, Earnings Per Share. (4) Pro forma net income excluding realized gains and extraordinary items per share is calculated as pro forma net income per share excluding the pro forma after-tax amounts for net realized gains, extraordinary items and the gain on sale of a subsidiary in 1996. TRIGON 21 1997 SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA TRIGON HEALTHCARE, INC. AND SUBSIDIARIES
Years Ended December 31, (In thousands, except per share data and operating statistics) 1997 1996 1995 1994 1993 =========================================================================================================================== STATEMENT OF OPERATIONS DATA Revenues Premium and fee revenues Commercial $1,431,114 1,320,596 1,157,899 1,081,820 1,050,157 Federal Employee Program 377,722 356,741 329,243 303,250 279,058 Amounts attributable to self-funded arrangements 1,062,101 1,077,478 981,741 908,234 905,529 Less: amounts attributable to claims under self-funded arrangements (961,588) (988,353) (897,954) (827,869) (815,488) - --------------------------------------------------------------------------------------------------------------------------- 1,909,349 1,766,462 1,570,929 1,465,435 1,419,256 Investment income 74,684 47,312 45,861 39,962 34,279 Net realized gains 54,063 59,410 52,976 12,793 26,199 Other revenues 25,524 49,356 55,176 45,467 30,555 - --------------------------------------------------------------------------------------------------------------------------- Total revenues 2,063,620 1,922,540 1,724,942 1,563,657 1,510,289 - --------------------------------------------------------------------------------------------------------------------------- Expenses Medical and other benefit costs Commercial 1,194,641 1,086,388 959,328 802,666 795,921 Federal Employee Program 359,915 339,143 312,222 283,645 262,295 - --------------------------------------------------------------------------------------------------------------------------- 1,554,556 1,425,531 1,271,550 1,086,311 1,058,216 Selling, general and administrative expenses 359,792 376,374 346,353 322,391 308,412 Interest expense 4,602 -- -- -- -- Copayment refund program -- -- 47,073 36,432 -- - --------------------------------------------------------------------------------------------------------------------------- Total expenses 1,918,950 1,801,905 1,664,976 1,445,134 1,366,628 - --------------------------------------------------------------------------------------------------------------------------- Income before gain on sale of subsidiary, income taxes, cumulative effects of changes in accounting principles and extraordinary items 144,670 120,635 59,966 118,523 143,661 Gain on sale of subsidiary -- 62,253 -- -- -- - --------------------------------------------------------------------------------------------------------------------------- Income before income taxes, cumulative effects of changes in accounting principles and extraordinary items 144,670 182,888 59,966 118,523 143,661 Income tax expense (benefit) 49,617 (13,626) 8,264 24,564 35,803 - --------------------------------------------------------------------------------------------------------------------------- Income before cumulative effects of changes in accounting principles and extraordinary items 95,053 196,514 51,702 93,959 107,858 Cumulative effects of changes in accounting principles, net of income taxes -- -- -- -- 8,126 Extraordinary items, net of income taxes -- (190,820) (4,707) (644) -- - --------------------------------------------------------------------------------------------------------------------------- Net income $ 95,053 5,694 46,995 93,315 115,984 ===========================================================================================================================
TRIGON 22 1997
Years Ended December 31, 1997 1996 1995 1994 1993 =========================================================================================================================== Net income after Demutualization and IPO (1) $ 78,982 -- -- -- -- Earnings per share (1) Basic net income after Demutualization and IPO $ 1.87 -- -- -- -- Diluted net income after Demutualization and IPO $ 1.86 -- -- -- -- Pro forma earnings per share (2) Basic and diluted pro forma income before extraordinary items $ 2.23 2.73 0.84 -- -- Basic and diluted pro forma net income (loss) $ 2.23 (1.77) 0.73 -- -- Basic and diluted pro forma net income, excluding realized gains and extraordinary items (3) $ 1.40 0.87 0.75 -- -- OPERATING STATISTICS Medical loss ratio Commercial 83.5% 82.3% 82.9% 74.2% 75.8% Federal Employee Program 95.3% 95.1% 94.8% 93.5% 94.0% Selling, general and administrative expense ratio (4) 12.4% 13.4% 13.7% 13.8% 13.6% Operating margin (5) 1.1% 0.8% 0.5% 7.0% 5.9% December 31, 1997 1996 1995 1994 1993 =========================================================================================================================== BALANCE SHEET DATA Cash and investments $1,370,868 1,213,902 1,119,652 1,001,571 940,914 Total assets 1,928,820 1,833,148 1,565,331 1,403,104 1,266,952 Obligation for Commonwealth Payment -- 175,000 -- -- -- Long-term debt 90,147 4,880 4,145 -- -- Total surplus -- 739,780 740,071 655,875 606,146 Total shareholders' equity 958,737 -- -- -- --
(1) Reflects net income and net income per share for the period after February 5, 1997, the effective date of the Demutualization and Initial Public Offering (IPO). (2) The pro forma per share data gives effect to the Demutualization and IPO as if they had taken place on January 1, 1995. See note 1 to the consolidated financial statements for the pro forma assumptions used. In addition, the 1996 and 1995 pro forma per share data has been restated to comply with Statement of Financial Accounting Standards No. 128, Earnings Per Share. (3) Pro forma net income excluding realized gains and extraordinary items per share is calculated as pro forma net income per share excluding the pro forma after-tax amounts for net realized gains, extraordinary items, the gain on sale of a subsidiary in 1996 and the costs incurred under the 1995 Copayment Program. (4) The selling, general and administrative expense ratio is calculated as a percentage of total revenues excluding amounts attributable to claims under self-funded arrangements, investment income and net realized gains. (5) The operating margin ratio is calculated by dividing operating income by premium and fee revenues. Operating income is defined as premium and fee revenues and other revenues less medical and other benefit costs and selling, general and administrative expenses. TRIGON 23 1997 MANAGEMENT'S ANALYSIS OF OPERATING RESULTS TRIGON HEALTHCARE, INC. AND SUBSIDIARIES GENERAL Substantially all of the revenues of Trigon Healthcare, Inc. and subsidiaries (collectively, Trigon or the Company) are generated from premiums and fees received for health care services provided to its members and from investment income. Trigon's expenses are primarily related to health care services provided which consist of payments to physicians, hospitals and other providers. A portion of medical costs expense for each period consists of an actuarial estimate of claims incurred but not reported to Trigon during the period. The Company's results of operations depend in large part on its ability to accurately predict and effectively manage health care costs. The Company offers a diversified mix of managed care products, including health maintenance organizations (HMO), preferred provider organizations (PPO), point-of-service (POS) and traditional indemnity products with access to the Company's participating provider network (PAR). The Company also provides a broad array of Medicare supplement plans as well as specialty products including pharmacy, dental, life, worker's compensation, preventive care, disability, behavioral health, COBRA and flexible benefits account administration. The Company participates in the Federal Employee Program (FEP), a national contract with the U.S. Office of Personnel Management (OPM), to provide benefits through its PPO network for approximately 207,000 federal employees and their dependents living in Virginia. FEP revenues represent the reimbursement by OPM of medical costs incurred including the actual cost of administering the program, as well as a performance-based share of the national program's overall profit. Within the Company's network product offerings, employer groups may choose various funding options ranging from at-risk to partially or fully self-funded financial arrangements. While self-funded customers participate in Trigon's networks, the customers bear all or a portion of the underwriting risk. ENROLLMENT The following table sets forth the Company's enrollment data by network:
As of December 31, 1997 1996 1995 ======================================================================== Commercial: HMO 255,548 219,866 166,536 PPO 263,828 230,675 212,322 PAR 192,825 236,383 296,716 Medicaid HMO 35,488 28,306 6,357 Medicare Supplement 125,686 128,015 129,252 Non-Virginia 64,143 49,251 19,857 - ------------------------------------------------------------------------ Subtotal 937,518 892,496 831,040 Self-funded/ASO 679,667 700,482 705,459 Federal Employee Program 207,457 197,241 198,561 - ------------------------------------------------------------------------ Fully insured and self- funded enrollment 1,824,642 1,790,219 1,735,060 Processed for other Blue Cross and Blue Shield Plans (ASO) 15,728 70,330 64,558 - ------------------------------------------------------------------------ Total 1,840,370 1,860,549 1,799,618 ========================================================================
PREMIUM AND PREMIUM EQUIVALENTS BY NETWORK SYSTEM The following table sets forth the Company's premium and premium equivalents by network (in thousands):
Years ended December 31, 1997 1996 1995 ============================================================================= Commercial: HMO $ 410,723 320,217 181,052 PPO 374,514 328,291 271,252 PAR 352,630 410,074 485,412 Medicare Supplement 212,516 204,438 204,668 Non-Virginia 80,731 57,576 15,515 - ----------------------------------------------------------------------------- Subtotal 1,431,114 1,320,596 1,157,899 Self-funded/ASO 1,062,101 1,077,478 981,741 Federal Employee Program 377,722 356,741 329,243 - ----------------------------------------------------------------------------- Total $2,870,937 2,754,815 2,468,883 =============================================================================
TRIGON 24 1997 MANAGEMENT'S ANALYSIS OF OPERATING RESULTS CONTINUED YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996 Premium and fee revenues increased 8.1% to $1,909.3 million in 1997 from $1,766.5 million in 1996. The increase is due to a combination of commercial rate increases and enrollment growth in the Company's HMO and PPO networks, offset by expected declines in PAR network enrollment. Commercial HMO revenues increased 28.3% to $410.7 million in 1997 from $320.2 million in 1996. The $90.5 million increase in commercial HMO revenues is a result of increased enrollment attributable to a shift in members from PAR and PPO networks into the HMO networks and from enrollment of new HMO members as well as an increase of 4.3% in the average revenue per member. Commercial PPO revenues grew to $374.5 million in 1997 from $328.3 million in 1996, an increase of 14.1%, driven by enrollment growth. Commercial PAR revenues declined to $352.6 million in 1997 from $410.1 million in 1996 primarily as a result of the transition of members to the more tightly managed HMO and PPO networks. The full year impact of the Mid-South acquisition increased premium and fee revenues $21.8 million, with Mid-South revenues increasing to $74.7 million in 1997 from $52.9 million for the period from February 29, 1996 (the date of the acquisition) through December 31, 1996. Overall, premium revenues on a per member per month basis for the Company's commercial business increased 2.8% to $128.84 for 1997 from $125.33 for 1996. FEP revenues increased 5.9% to $377.7 million in 1997 from $356.7 million in 1996 primarily as a result of increased medical costs reimbursed by OPM and a 5.2% increase in enrollment. Net revenues from self-funded arrangements increased 12.8% to $100.5 million in 1997 from $89.1 million in 1996. The improvement is a result of higher administrative fees and favorable stop loss settlements. Total enrollment declined to 1,840,370 as of December 31, 1997 from 1,860,549 as of December 31, 1996. The 20,179 decline was the net result of an increase of 45,022 members in commercial business mainly from HMO and PPO network growth, FEP enrollment growth of 10,216 members offset by a decline of 75,417 self-funded/ASO members. Specifically, commercial enrollment increased 5.0% to 937,518 members as of December 31, 1997 from 892,496 members as of December 31, 1996. Enrollment in the HMO networks as of December 31, 1997 increased 17.3% over the prior year and accounts for 31.0% of the Company's commercial enrollment. Enrollment in the PPO networks increased 14.4% over the prior year and accounts for 28.1% of the Company's commercial enrollment. The increases in the HMO and PPO networks were offset by an expected decline of 18.4% for the Company's PAR network as members migrate into more tightly managed networks and partially as a result of ceding all student business with approximately 7,900 members. The PAR network enrollment represents 20.6% of the Company's total commercial enrollment. FEP enrollment increased 5.2% to 207,457 as of December 31, 1997 from 197,241 as of December 31, 1996. The commercial and FEP enrollment increases were offset by a 75,417 member decrease for self-funded/ASO business. The decline in self-funded/ASO enrollment reflects the Company's shift away from no risk, low margin ASO business and the migration of approximately 55,000 national account members from the Company's systems to a new interplan system where the Company continues to process claims for other Blue Cross and Blue Shield Plans (ASO). Investment income increased 57.9% to $74.7 million in 1997 from $47.3 million in 1996. Net realized gains decreased 9.0% to $54.1 million in 1997 from $59.4 million in 1996. The increase in investment income reflects the continued increase in the overall size of the investment portfolio over the past year and the Company's strategy to shift a larger portion of the investment portfolio to fixed income securities. This portfolio shift is also the primary factor for the net realized gains activity in 1997. Other revenues decreased by 48.3% to $25.5 million in 1997 from $49.4 million in 1996. The decrease is primarily a result of the sale of the Company's electronic communication services subsidiary, Health Communication Services, Inc. (HCS), on December 31, 1996. During 1996, HCS contributed $21.5 million in other revenues. TRIGON 25 1997 MANAGEMENT'S ANALYSIS OF OPERATING RESULTS CONTINUED Medical costs increased 9.1% to $1,554.6 million in 1997 from $1,425.5 million in 1996. The $129.0 million increase is primarily the result of overall commercial enrollment growth, an increase in FEP medical costs reimbursed by OPM, higher than normal utilization in the Medicare supplement products during the first half of the year, higher than expected utilization and cost per member in one of the Company's HMO plans and the full year impact of the Mid-South acquisition. The medical cost per member per month for the Company's commercial business increased 4.3% to $107.55 in 1997 from $103.10 in 1996. Combined with a 2.8% increase in commercial premium revenues per member per month, the loss ratio on commercial business increased to 83.5% in 1997 from 82.3% in 1996. The increase can be attributed partly to issues at one of the Company's HMO plans where, during 1997, the Company implemented extensive cost containment actions, pricing initiatives and processing controls, as well as a change in management, all aimed at bringing the plan's results to acceptable levels. The Company also experienced higher than expected Medicare supplement product medical costs in the first half of the year. The increase was caused by a greater number of high-dollar claims and higher medical costs driven by physician outpatient claims and pharmacy utilization. Management is encouraged by the loss ratio improvement exhibited in the second half of 1997. The commercial loss ratio averaged 84.1% for the first half of 1997 as compared to 82.9% for the last half of the year. The improvement reflected improved medical cost levels for the Company's Medicare supplement products, the impact of actions mentioned above regarding one of the Company's HMO plans and the overall impact of cost containment initiatives on the network-based PAR, PPO and HMO businesses. The Company expects the cost containment initiatives to continue to have a positive impact on the commercial loss ratio in 1998. Selling, general and administrative expenses (SG&A) declined by 4.4% to $359.8 million in 1997 from $376.4 million in 1996. The SG&A ratio was 12.4% in 1997 as compared to 13.4% in 1996. The decrease is a result of the sale of HCS on December 31, 1996 which contributed $21.3 million in SG&A expenses in 1996, along with the impact of Company-wide streamlining and cost containment activities, including a 10.5% reduction in headcount. In addition, the Company eliminated the postretirement medical benefit program for a substantial portion of its employees in the fourth quarter of 1997. The elimination of this benefit resulted in a one-time curtailment gain of nearly $4.0 million which was recorded as a reduction to SG&A expenses. The Company expects that this change will reduce the Company's future annual expenses by approximately $2.0 million. The decrease in expenses was partially offset by the full year impact of the Mid-South acquisition, $5.4 million in incremental costs related to modifying computer software for the year 2000 and other employee benefit-related accruals. Interest expense in 1997 was $4.6 million. There was no interest expense in 1996. Interest expense for 1997 is the result of the $85 million outstanding on the revolving credit agreement to fund a portion of the payment made to the Commonwealth of Virginia in February 1997 (Commonwealth Payment) in accordance with a Plan of Demutualization (Demutualization) and the Initial Public Offering (IPO). Income before income taxes and extraordinary items decreased 20.9% to $144.7 million in 1997 from $182.9 million in 1996. The decrease is primarily attributable to the sale of HCS resulting in a pretax gain of $62.3 million in 1996. The decrease also reflects a $5.3 million decline in net realized gains and interest expense of $4.6 million, offset by a $27.4 million increase in investment income and a $6.6 million improvement in operating income (defined as income before income taxes and extraordinary items excluding investment income, net realized gains, gain on sale of subsidiary and interest expense). TRIGON 26 1997 MANAGEMENT'S ANALYSIS OF OPERATING RESULTS CONTINUED The Company's effective tax rate was 34.3% in 1997 compared to an effective tax rate benefit of 7.5% in 1996. The effective tax rate benefit for 1996 is primarily due to a reduction in the valuation allowance on deferred tax assets caused by the realization of alternative minimum tax credits during 1996 and the elimination as of September 30, 1996 of the remaining $63.9 million valuation allowance. Excluding the effects of the elimination of the valuation allowance, the effective tax rate in 1996 was 27.5% due to the realization of alternative minimum tax credits during the year. YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995 Premium and fee revenues increased 12.4% to $1,766.5 million in 1996 from $1,570.9 million in 1995 primarily due to the growth in the Company's HMO and PPO networks, which was partially offset by declines in PAR network enrollment, and as a result of the Mid-South acquisition in February 1996. Commercial HMO revenues grew 76.9% to $320.2 million in 1996 from $181.1 million in 1995. The $139.1 million increase in commercial HMO revenues is attributable to a shift in members from PAR and PPO networks into the HMO networks and from enrollment of new HMO members, the conversion of 38,540 members from self-funded products to commercial products and a 3.9% increase in the average revenue per member. In addition, the Priority, Inc. HMO acquisition in May 1995 accounted for approximately $28.0 million of the increased HMO revenues. Commercial PPO revenues grew 21.0% to $328.3 million in 1996 from $271.3 million in 1995. Commercial PAR revenues declined to $410.1 million in 1996 from $485.4 million in 1995 as a result of groups transitioning into more tightly managed networks. Commercial revenues for 1996 also include $52.9 million of revenues from Mid-South, which was acquired on February 29, 1996. Total commercial premium per member per month increased 1.5% to $125.33 in 1996 from $123.48 in 1995. FEP revenues increased 8.4% to $356.7 million in 1996 from $329.2 million in 1995 as a result of increased medical costs reimbursed by OPM. Total enrollment increased 3.4% to 1,860,549 as of December 31, 1996 from 1,799,618 as of December 31, 1995. Commercial enrollment increased 7.4% to 892,496 members as of December 31, 1996 from 831,040 members as of December 31, 1995. The increase in commercial enrollment is a result of growth in the HMO networks of 75,279 members, the Mid-South acquisition which added 49,251 members and continued growth in the PPO network of 18,353 members, offset by a decrease of 80,190 members in the PAR network and out of state student and individual products due to declining enrollment. Investment income increased 3.2% to $47.3 million in 1996 from $45.9 million in 1995. Net realized gains increased 12.1% to $59.4 million in 1996 from $53.0 million in 1995. The increase in investment income is attributable to the increased size of the investment portfolio. The increase in net realized gains is due primarily to the sale of investment securities to fund the Mid-South acquisition as well as the sale of investment securities in an effort to shorten bond maturity levels. Other revenues decreased by 10.5% to $49.4 million in 1996 from $55.2 million in 1995. Increased revenues generated from health management services were offset by declining revenues from third party administration of health care claims. Prior year results also include nonrecurring gains of $5.4 million related to the sale of joint venture interests and other assets to unrelated parties. The Company sold its electronic communication services subsidiary, HCS, on December 31, 1996 and recognized an after tax gain of approximately $40 million as a result of this sale. In 1996, HCS contributed $21.5 million in other revenues. Medical costs increased 12.1% to $1,425.5 million in 1996 from $1,271.6 million in 1995. This increase is primarily the result of enrollment growth in the HMO's and the Priority and Mid-South acquisitions. The Company's medical loss ratio on commercial business improved to 82.3% in 1996 from 82.9% in 1995. The medical cost per member per month for the Company's commercial business increased 0.8% to $103.10 in 1996 from $102.31 in 1995. TRIGON 27 1997 MANAGEMENT'S ANALYSIS OF OPERATING RESULTS CONTINUED Selling, general and administrative expenses increased 8.7% to $376.4 million in 1996 from $346.4 million in 1995. The SG&A expense ratio was 13.4% in 1996 as compared to 13.7% in 1995. The Company incurred $14.4 million of additional costs related to increased HMO enrollment including the impact of the Priority acquisition in 1995. The acquisitions of Mid-South in 1996 and Healthy Homecomings, Inc. and Healthcare Ventures Associates in 1995 resulted in a $16.9 million increase in 1996. The Company continued to invest in managed care infrastructure and technology, increasing SG&A $8.5 million, for improved medical cost data analysis, internally developed managed mental health capabilities, expansion of appropriateness review, costs associated with obtaining NCQA accreditation and upgrading systems software for the century date change. In 1996, the Company incurred one-time charges of $6.1 million for severance costs, signing bonuses, relocation and employment agreement adjustments. Income before gain on sale of subsidiary, income taxes and extraordinary items, excluding the effect of the Copayment Program in 1995, increased by 12.7% to $120.6 million in 1996 from $107.0 million in 1995. The increase is a result of the effects of the improved medical loss ratio and increased investment income and net realized gains, partially offset by the decline in other revenues. The Company's effective tax rate for 1996 was a tax benefit of 7.5%. This rate differs from the 35% statutory federal rate primarily due to a reduction in the valuation allowance on deferred tax assets caused by the realization of alternative minimum tax credits during 1996 and the elimination of the remaining $63.9 million valuation allowance because the Demutualization and IPO made it more likely than not that the tax credits would be realized. Excluding the effects of the elimination of the valuation allowance, the effective tax rate would have been 27.5% for 1996. These items are not recurring and the Company believes that in the future its effective tax rate reflected in its consolidated financial statements should approximate the 35% federal statutory rate. In 1996, the Company reflected the $175 million obligation to the Commonwealth of Virginia as required by the Plan of Demutuali-zation as an extraordinary charge in the consolidated financial statements. The other extraordinary items represent administrative costs associated with the Demutualization. LIQUIDITY AND CAPITAL RESOURCES The Company's primary sources of cash are premiums and fees received and investment income. The primary uses of cash include health care benefit expenses and capitation payments, brokers' and agents' commissions, administrative expenses, income taxes and repayment of long-term debt. Trigon generally receives premium revenues in advance of anticipated claims for related health care services. The Company's investment policies are designed to provide liquidity to meet anticipated payment obligations and preserve capital. Trigon fundamentally believes that concentrations of investments in any one asset class are unwise due to constantly changing interest rates as well as market and economic conditions. Accordingly, the Company maintains a diversified investment portfolio consisting both of fixed income and equity securities, with the objective of reducing risk and maximizing overall return. The fixed income portfolio includes government and corporate securities, both domestic and international, with an average quality rating of A as of December 31, 1997. The portfolio had an average contractual maturity of 8.9 years as of December 31, 1997. A portion of the fixed income portfolio is designated as a short-term fixed income portfolio and is intended to cover near term cash flow needs and to serve as a buffer for unanticipated business needs. The equity portfolios contain readily marketable securities ranging from small growth to well-established Fortune 500 companies. The international equity portfolio is diversified by industry, country and currency-related exposure. The Company enters into foreign currency forward contracts and foreign currency options to manage its exposure to fluctuations in foreign currency exchange rates on its international debt and equity investments. The Company also enters into financial futures contracts for portfolio strategies such as minimizing interest rate risk and managing portfolio duration. As of December 31, 1997, the equity portfolio was TRIGON 28 1997 MANAGEMENT'S ANALYSIS OF OPERATING RESULTS CONTINUED 10.5% of the total portfolio, down from 27.8% as of December 31, 1996, with the majority of the shift occurring prior to March 31, 1997. The Company currently plans to maintain the equity portfolio at levels generally no greater than 15%. As a result of this shift, the Company experienced lower realized gains in 1997 and expects generally lower realized gains and a more consistent contribution to income from the investment portfolio in the future. Cash provided (used) by operating activities for the years ended December 31, 1997 and 1996 was $(117.0) million and $21.8 million, respectively. The significant decrease in cash provided by operations in 1997 is primarily due to the $175 million Commonwealth Payment made in the first quarter of 1997. This decrease in cash provided by operating activities is offset by increased cash provided by financing activities. Cash used by investing activities increased to $116.3 million for the year ended December 31, 1997 from $10.1 million for 1996. This increase is primarily due to investment purchases made with cash flows from net proceeds from the IPO in February 1997. Cash provided (used) by financing activities increased to $208.9 million in 1997 from $(9.5) million in 1996 primarily due to the IPO and borrowing under a credit agreement. Effective February 5, 1997, the Company completed its conversion from a mutual insurance company to a stock insurance company in accordance with a Plan of Demutualization. In accordance with the Demutualization, Blue Cross and Blue Shield of Virginia (Virginia BCBS) changed its name to Trigon Insurance Company (dba Trigon Blue Cross Blue Shield) and became a wholly owned subsidiary of Trigon Healthcare, Inc., a holding company. The membership interests of Virginia BCBS's eligible members were converted into Class A common stock of Trigon Healthcare, Inc., or, in certain circumstances, cash. The Plan of Demutualization also required the Company to complete an IPO of stock simultaneously with the conversion. Accordingly, Trigon Healthcare, Inc. issued 17.8 million shares of Class A common stock at $13 per share in the IPO generating net proceeds of $215.2 million. In connection with the Demutualization, the Company was required to make the $175 million Commonwealth Payment. The Company used approximately $90 million of the net proceeds and $85 million in borrowings under a revolving credit agreement to fund this payment. The Company also used approximately $91.1 million of the offering proceeds to pay certain eligible members cash in lieu of shares of common stock that would otherwise be issued to such eligible members pursuant to the Demutualization. In connection with the Demutualization and IPO, the Company entered into a $300 million five-year revolving credit agreement with a syndicate of banks. The credit agreement calls for various borrowing options and rates and requires the Company to pay a facility fee on a quarterly basis. The credit agreement also contains certain financial covenants and restrictions including minimum net worth requirements as well as limitations on dividend payments. As of December 31, 1997, $85 million had been borrowed and remained outstanding under this credit agreement, the proceeds of which were used to make a portion of the Commonwealth Payment at the time of the Demutualization and IPO. The Company believes that cash flow generated by operations and its cash and investment balances will be sufficient to fund continuing operations, capital expenditures and debt repayment costs for the foreseeable future. The nature of the Company's operations is such that cash receipts are principally premium revenues typically received up to three months prior to the expected cash payment for related health care services. The Company's operations are not capital intensive, and there are currently no commitments for major capital expenditures to support existing business. The Company has developed and is currently executing a comprehensive plan to prepare the computer systems and application software for the year 2000. Project completion for the Company's systems and software is scheduled for the end of 1998, allowing adequate time for testing. The Company is using both external and internal resources for the project. The incremental costs for the project were $6.8 million through December 31, 1997 and are expected to approximate $20.0 million through 1999. The costs will be expensed as incurred and will be funded through operating cash flows. TRIGON 29 1997 MANAGEMENT'S ANALYSIS OF OPERATING RESULTS CONTINUED In addition, the Company is actively working with hospitals, providers and others depended upon for electronic commerce in an effort to ensure they are assessing and correcting any issues relating to the year 2000 which could impact their ability to conduct business with the Company. Lack of appropriate action on the part of these third parties could impact the Company's ability to serve its customers. The Company will continue to monitor the progress of these entities. NEW ACCOUNTING PRONOUNCEMENTS Statement of Financial Accounting Standards (SFAS) No. 130, Reporting Comprehensive Income, becomes effective for fiscal years beginning after December 15, 1997, and establishes standards for the reporting and display of comprehensive income. Comprehensive income includes all changes in equity resulting from transactions and economic events from nonowner sources. The standard does not require a specific format for the financial statement but does require equal prominence with other financial statements and reclassification of prior year comparative financial statements. SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, becomes effective for fiscal years beginning after December 15, 1997. This standard supersedes the current SFAS No. 14 and establishes new disclosure requirements about products and services, geographic areas and major customers on an annual and quarterly basis. The standard requires companies to disclose qualitative and quantitative segment data on the basis that is used by management for evaluating segment performance and deciding how to allocate resources. FORWARD-LOOKING STATEMENTS Certain statements in this discussion contain forward-looking statements with respect to the financial condition, results of operations and business of the Company and its subsidiaries within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to inherent risks and uncertainties, many of which are beyond the control of the Company, that may cause actual results to differ materially from those contemplated by such forward-looking statements. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, but are not limited to, rising health care costs, business conditions and competition in the managed care industry, development in health care reform and other regulatory issues. MARKET PRICES OF COMMON STOCK AND DIVIDEND DATA The Class A common stock, par value $0.01 per share, is traded on the New York Stock Exchange under the symbol TGH. The reported high and low closing prices by quarter from January 31, 1997, the first trading day after the Demutualization and IPO, to December 31, 1997 were as follows:
1997 High Low ======================================================================= ======================================================================= First quarter $19 1/2 16 Second quarter 24 1/4 17 3/4 Third quarter 25 5/16 21 Fourth quarter 26 13/16 23 1/8 =======================================================================
The Company has never paid any dividends on its common stock and anticipates that all earnings in the foreseeable future will be retained to finance the continuing development of its business. The payment of any future dividends will be at the discretion of the Company's Board of Directors and will depend upon the Company's earnings, financial condition, capital requirements, the revolving credit agreement restrictions on dividends and such other factors as the Company's Board of Directors deems relevant. To the extent that the Company determines to pay dividends in the future, the principal source of funds to pay dividends to shareholders would be dividends received by the Company from its subsidiaries. The Company is a holding company and insurance laws and regulations restrict the payment of dividends by health care insurance companies, such as Trigon Insurance Company, in a holding company structure. As of February 18, 1998, there were 105,841 shareholders of record of the Company's Class A common stock. TRIGON 30 1997 CONSOLIDATED BALANCE SHEETS TRIGON HEALTHCARE, INC. AND SUBSIDIARIES
December 31, 1997 and 1996 (In thousands, except per share data) 1997 1996 =================================================================================================================== ASSETS Current assets Cash $ 7,010 31,482 Investment securities, at estimated fair value (note 3) 1,363,858 1,182,420 Premiums and other receivables (note 4) 360,941 390,997 Deferred income taxes (note 10) -- 16,572 Other 7,607 10,035 - ------------------------------------------------------------------------------------------------------------------- Total current assets 1,739,416 1,631,506 - ------------------------------------------------------------------------------------------------------------------- Property and equipment, net (note 5) 43,912 49,545 Deferred income taxes (note 10) 45,185 48,170 Goodwill and other intangibles, net (note 18) 68,354 76,043 Restricted investments, at estimated fair value (note 3) 10,139 11,019 Other assets 21,814 16,865 - ------------------------------------------------------------------------------------------------------------------- Total assets $1,928,820 1,833,148 =================================================================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Medical and other benefits payable (note 6) $ 412,710 417,797 Unearned premiums 93,157 91,164 Accounts payable and accrued expenses 57,736 84,470 Deferred income taxes (note 10) 4,298 -- Other liabilities (note 8) 179,918 198,893 Obligation for Commonwealth Payment (note 1) -- 87,500 - ------------------------------------------------------------------------------------------------------------------- Total current liabilities 747,819 879,824 - ------------------------------------------------------------------------------------------------------------------- Obligation for Commonwealth Payment, noncurrent (note 1) -- 87,500 Obligations for employee benefits, noncurrent (note 12) 59,467 57,679 Medical and other benefits payable, noncurrent (note 6) 66,541 59,246 Long-term debt (note 11) 90,147 4,880 Minority interest in subsidiary 6,109 4,239 - ------------------------------------------------------------------------------------------------------------------- Total liabilities 970,083 1,093,368 - ------------------------------------------------------------------------------------------------------------------- Shareholders' equity Common stock, $0.01 par; 42,300 shares issued and outstanding (notes 1 and 13) 423 -- Capital in excess of par (note 1) 842,035 -- Retained earnings (note 1) 78,982 706,259 Net unrealized gain on investment securities, net of deferred income taxes of $20,083 and $18,032 (note 3) 37,297 33,521 - ------------------------------------------------------------------------------------------------------------------- Total shareholders' equity 958,737 739,780 Commitments and contingencies (notes 7 and 21) - ------------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $1,928,820 1,833,148 ===================================================================================================================
See accompanying summary of significant accounting policies and notes to consolidated financial statements. TRIGON 31 1997 CONSOLIDATED STATEMENTS OF OPERATIONS TRIGON HEALTHCARE, INC. AND SUBSIDIARIES
Years ended December 31, 1997, 1996 and 1995 (In thousands, except per share data) 1997 1996 1995 =========================================================================================================================== REVENUES Premium and fee revenues Commercial $1,431,114 1,320,596 1,157,899 Federal Employee Program 377,722 356,741 329,243 Amounts attributable to self-funded arrangements 1,062,101 1,077,478 981,741 Less: amounts attributable to claims under self-funded arrangements (961,588) (988,353) (897,954) - --------------------------------------------------------------------------------------------------------------------------- 1,909,349 1,766,462 1,570,929 Investment income (note 3) 74,684 47,312 45,861 Net realized gains (note 3) 54,063 59,410 52,976 Other revenues (note 9) 25,524 49,356 55,176 - --------------------------------------------------------------------------------------------------------------------------- Total revenues 2,063,620 1,922,540 1,724,942 =========================================================================================================================== EXPENSES Medical and other benefit costs (note 6) Commercial 1,194,641 1,086,388 959,328 Federal Employee Program 359,915 339,143 312,222 - --------------------------------------------------------------------------------------------------------------------------- 1,554,556 1,425,531 1,271,550 Selling, general and administrative expenses (notes 2 and 12) 359,792 376,374 346,353 Interest expense (note 11) 4,602 -- -- Copayment refund program (note 19) -- -- 47,073 - --------------------------------------------------------------------------------------------------------------------------- Total expenses 1,918,950 1,801,905 1,664,976 - --------------------------------------------------------------------------------------------------------------------------- Income before gain on sale of subsidiary, income taxes and extraordinary items 144,670 120,635 59,966 Gain on sale of subsidiary (note 18) -- 62,253 -- - --------------------------------------------------------------------------------------------------------------------------- Income before income taxes and extraordinary items 144,670 182,888 59,966 Income tax expense (benefit) (note 10) 49,617 (13,626) 8,264 - --------------------------------------------------------------------------------------------------------------------------- Income before extraordinary items 95,053 196,514 51,702 Extraordinary items - demutualization costs and Commonwealth Payment, net of income taxes of $833 and $2,535 (note 1) -- (190,820) (4,707) - --------------------------------------------------------------------------------------------------------------------------- Net income $ 95,053 5,694 46,995 =========================================================================================================================== Net income after Demutualization and IPO (notes 1 and 14) $ 78,982 =========================================================================================================================== Earnings per share (notes 1 and 14) Basic net income after Demutualization and IPO $1.87 =========================================================================================================================== Diluted net income after Demutualization and IPO $1.86 =========================================================================================================================== Proforma earnings per share (notes 1 and 14) Basic and diluted pro forma income before extraordinary items $2.23 2.73 0.84 =========================================================================================================================== Basic and diluted pro forma net income (loss) $2.23 (1.77) 0.73 ===========================================================================================================================
See accompanying summary of significant accounting policies and notes to consolidated financial statements. TRIGON 32 1997 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY TRIGON HEALTHCARE, INC. AND SUBSIDIARIES
Unrealized Capital gains (losses) Total Years ended December 31, 1997, 1996 and 1995 Common in excess Retained on investment shareholders' (In thousands) stock of par earnings securities, net equity =========================================================================================================================== BALANCE AT JANUARY 1, 1995 $-- -- 653,570 2,305 655,875 Net income -- -- 46,995 -- 46,995 Change in unrealized gains (losses) on investment securities, net (note 3) -- -- -- 37,201 37,201 - --------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1995 -- -- 700,565 39,506 740,071 Net income -- -- 5,694 -- 5,694 Change in unrealized gains (losses) on investment securities, net (note 3) -- -- -- (5,985) (5,985) - --------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1996 -- -- 706,259 33,521 739,780 Net income before Demutualization -- -- 16,071 -- 16,071 Issuance of 24,475 shares to eligible policyholders in the Demutualization and cash payments to eligible policyholders in lieu of shares of common stock 245 630,941 (722,330) -- (91,144) Issuance of 17,825 shares in the Initial Public Offering, net of expenses 178 215,027 -- -- 215,205 Other, principally Trigon shares purchased by consolidated grantor trusts -- (3,933) -- -- (3,933) Net income after Demutualization -- -- 78,982 -- 78,982 Change in unrealized gains (losses) on investment securities, net (note 3) -- -- -- 3,776 3,776 - --------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1997 $423 842,035 78,982 37,297 958,737 ===========================================================================================================================
See accompanying summary of significant accounting policies and notes to consolidated financial statements. TRIGON 33 1997 CONSOLIDATED STATEMENTS OF CASH FLOWS TRIGON HEALTHCARE, INC. AND SUBSIDIARIES
Years ended December 31, 1997, 1996 and 1995 (In thousands) 1997 1996 1995 =========================================================================================================================== Net cash provided (used) by operating activities (note 17) $ (116,982) 21,819 29,973 - --------------------------------------------------------------------------------------------------------------------------- Cash flows from investing activities Proceeds from sale of property and equipment and other assets 790 45 25 Capital expenditures (8,226) (14,147) (13,293) Investment securities purchased (4,784,150) (2,759,974) (2,694,188) Proceeds from investment securities sold 3,897,611 2,585,033 1,531,862 Maturities of fixed income securities 777,626 186,420 1,178,232 Cash paid for purchase of subsidiaries, net of cash acquired -- (84,497) (26,762) Proceeds from sale of subsidiary -- 76,979 -- Cash paid for other investments -- -- (7,500) - --------------------------------------------------------------------------------------------------------------------------- Net cash used by investing activities (116,349) (10,141) (31,624) - --------------------------------------------------------------------------------------------------------------------------- Cash flows from financing activities Proceeds from long-term debt 85,439 735 4,145 Payments on long-term debt (172) -- -- Payments to members in lieu of common stock pursuant to Plan of Demutualization (91,144) -- -- Net proceeds from issuance of common stock 215,205 -- -- Other, principally purchase of Trigon common stock by consolidated grantor trusts (3,933) -- -- Change in outstanding checks in excess of bank balance 3,464 (10,194) 15,667 - --------------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by financing activities 208,859 (9,459) 19,812 - --------------------------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash (24,472) 2,219 18,161 Cash - beginning of year 31,482 29,263 11,102 - --------------------------------------------------------------------------------------------------------------------------- Cash - end of year $ 7,010 31,482 29,263 ===========================================================================================================================
See accompanying summary of significant accounting policies and notes to consolidated financial statements. TRIGON 34 1997 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES TRIGON HEALTHCARE, INC. AND SUBSIDIARIES December 31, 1997 and 1996 ORGANIZATION Trigon Healthcare, Inc. is a stock holding company formed in 1996 as a wholly owned subsidiary of Blue Cross and Blue Shield of Virginia (dba Trigon Blue Cross Blue Shield) (Virginia BCBS) for the purpose of becoming the parent company of Virginia BCBS under a Plan of Demutualization (Demutualization). In accordance with the Demutualization, effective February 5, 1997, Virginia BCBS completed its conversion from a mutual insurance company to a stock insurance company, changed its name to Trigon Insurance Company (dba Trigon Blue Cross Blue Shield) and became a wholly-owned subsidiary of Trigon Healthcare, Inc. (Trigon Healthcare, Inc. and subsidiaries herein collectively referred to as the Company) (note 1). Trigon Healthcare, Inc. owns 100% of Trigon Insurance Company, HealthKeepers, Inc., Physicians Health Plan, Inc., Mid-South Insurance Company, Trigon Health and Life Insurance Company (formerly Monticello Life Insurance Company), Healthcare Support Corporation, Trigon Services, Inc., Consolidated Holdings Corporation, Trigon Administrators, Inc., Health Management Corporation, Monticello Service Agency, Inc., and Trigon Health Ventures, Inc. Additionally, Trigon Healthcare, Inc. owns 80% of Priority, Inc. and 51% of Peninsula Health Care, Inc. Through its subsidiary, Trigon Insurance Company, and other health maintenance organization (HMO) subsidiaries, the Company is the largest managed health care company in Virginia, providing approximately 1.8 million customers with a comprehensive spectrum of managed care products and services provided primarily through three provider network systems. Trigon Insurance Company also processes claims for Medicare and participates in a national contract with the U.S. Office of Personnel Management to provide benefits to Federal employees within Virginia through the Federal Employee Program (FEP). The various subsidiaries provide complementary products and services to customers and non-customers of Trigon Insurance Company including third-party administration for medical and workers' compensation, life and disability insurance, health promotion and other products. The significant accounting policies and practices followed by the Company are as follows: BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles. The Company follows Statement of Financial Accounting Standards (SFAS) No. 60, Accounting and Reporting by Insurance Enterprises, as it relates to its insurance business and Statement of Position 89-5, Financial Accounting and Reporting by Providers of Prepaid Healthcare Services, as it relates to its HMO business. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes, including disclosure of contingent assets and liabilities. Actual results could differ from those estimates. The consolidated financial statements include the accounts of Trigon Healthcare, Inc. and its majority-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Investments in other companies in which less than a majority interest is held and where the Company has significant influence over the operating and financial policies of the investee are accounted for under the equity method. RISKS AND UNCERTAINTIES The Company's profitability depends in large part on accurately predicting and effectively managing health care costs. The Company continually reviews its premium and benefit structure to reflect its underlying claims experience and revised actuarial data; however, several factors could adversely affect the medical loss ratios. Certain of these factors, which include changes in health care practices, inflation, new technologies, major epidemics, natural disasters and malpractice litigation, are beyond any health plan's control and could adversely affect the Company's ability to accurately predict and effectively control health care costs. Costs in excess of those anticipated could have a material adverse effect on the Company's results of operations. TRIGON 35 1997 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CONTINUED In addition, the managed care industry is highly competitive in both Virginia and in other states in the Southeastern and Mid-Atlantic United States where the Company principally intends to expand. There is no assurance that such competition will not exert strong pressures on the Company's profitability, its ability to increase enrollment, or its ability to successfully attain its expansion plans. Also, there can be no assurance that regulatory initiatives will not be undertaken at the state or federal level to reform the health care industry in order to reduce the escalation in health care costs or to make health care more accessible. Such reform could adversely affect the Company's profitability. INVESTMENT SECURITIES Investment securities are accounted for in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. All investment securities are considered available for sale and are recorded at estimated fair value, based on quoted market prices. The net unrealized gain or loss on investment securities, net of deferred income taxes, is included as a separate component of shareholders' equity. A decline in the fair value of any investment security below cost, that is deemed other than temporary, is recorded as a realized loss resulting in a new cost basis for the security. Costs of investments sold are determined on the first in, first out basis. Certain of the Company's investment securities are denominated in foreign currencies. The Company utilizes forward currency contracts and foreign currency options to hedge exposure to fluctuations in foreign currency exchange rates. The forward contracts and options are reflected as investment securities on the consolidated balance sheets at fair value. Unrealized gains and losses on these contracts are recorded as a separate component of shareholders' equity along with the unrealized gains and losses on the securities being hedged. When the securities hedged by these contracts are sold, realized gains or losses on these contracts are reflected in the consolidated statements of operations as net realized gains. The Company enters into financial futures contracts for portfolio strategies such as minimizing interest rate risk and managing portfolio duration. The notional amount of the futures is limited to that of the market value of the underlying portfolios. Should this limitation be exceeded, futures contracts are immediately terminated in order to comply with this restriction. Initial margins in the form of securities are maintained with the counterparties for these transactions. Changes in fair value of financial futures, determined on a daily basis, are recorded as realized gains or losses in the consolidated statements of operations. Terminations of contracts are accounted for in a similar manner. SOFTWARE DEVELOPMENT COSTS The Company expenses as incurred substantially all costs associated with the development of computer software for internal use, other than the initial purchase price of software packages. PROPERTY AND EQUIPMENT Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets, which are 40 to 50 years for buildings and 3 to 10 years for furniture and equipment. Leasehold improvements are amortized using the straight-line method over the shorter of the lease term or estimated useful life of the asset. Any gain or loss realized upon retirement or disposal is reflected in selling, general and administrative expenses. GOODWILL AND OTHER INTANGIBLES Costs in excess of fair value of net tangible and identified intangible assets of businesses acquired are amortized using the straight-line method over periods from 15 to 25 years. Recoverability is reviewed annually or sooner if events or changes in circumstances indicate that the carrying amount may exceed fair value. Recoverability is then determined by comparing the undiscounted net cash flows of the assets to which the goodwill applies to the net book value including goodwill of those assets. TRIGON 36 1997 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CONTINUED Amortization was $7,689,000, $4,633,000 and $1,399,000 for the years ended December 31, 1997, 1996 and 1995, respectively. Accumulated amortization as of December 31, 1997 and 1996 was $13,721,000 and $6,032,000, respectively. MEDICAL AND OTHER BENEFITS PAYABLE The Company establishes liabilities for claims in process of review and claims incurred but not reported. These liabilities are based on historical payment patterns using actuarial techniques. In addition, processing costs are accrued as operating expenses based on an estimate of the costs necessary to process these claims. The methods for making these estimates and for establishing the resulting liabilities are continually reviewed and updated, and any adjustments resulting therefrom are reflected in current operations. While the ultimate amount of claims and the related expenses paid are dependent on future developments, management is of the opinion that the liabilities for claims and claims processing costs are adequate to cover such claims and expenses. REVENUES All of the Company's individual and certain of the Company's group contracts provide for the individual or the group to be fully insured. Premiums for these contracts are billed in advance of the respective coverage periods and are initially recorded as premiums receivable and as unearned income. Unearned premiums are recognized as earned in the period of coverage. Certain other groups have contracts that provide for the group to be at risk for all or a portion of their claims experience. Most of these self-funded groups purchase aggregate and/or specific stop-loss coverage. In exchange for a premium, the group's aggregate liability or the group's liability on any one participant is capped for the year. The Company charges self-funded groups an administrative fee which is based on the number of members in a group or the group's claims experience. Under the Company's self-funded arrangements, amounts due are recognized based on incurred claims plus administrative and other fees and any stop-loss premiums. In addition, accounts for certain self-funded groups are charged or credited with interest expense or income as provided by the groups' contracts. AGENCY CONTRACTS As fiscal intermediary and administrative agent for Medicare and other plans, the Company allocates operating expenses to these lines of business to determine reimbursement due for services rendered in accordance with the contracts in force. Claims processed under these arrangements are not included in the accompanying consolidated statements of operations and the reimbursement of allocated operating expenses is recorded as a reduction of the Company's selling, general and administrative expenses. POSTRETIREMENT/POSTEMPLOYMENT BENEFITS Pension costs are accrued in accordance with SFAS No. 87, Employers' Accounting for Pensions, and are funded based on the minimum contribution requirements of the Employee Retirement Income Security Act of 1974. The actuarial cost method used is the projected unit credit method. The Company provides certain health and life insurance benefits to retired employees. These benefits are accrued in accordance with SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. The Company also provides certain disability related postemployment benefits. These benefits are accrued in accordance with SFAS No. 112, Employers' Accounting for Postemployment Benefits. The Company accrues the benefits when it becomes probable that such benefits will be paid and when sufficient information exists to make reasonable estimates of the amounts to be paid. TRIGON 37 1997 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CONTINUED STOCK-BASED COMPENSATION The Company applies Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for its stock-based compensation plans. Accordingly, no compensation expense has been recognized for the stock options granted and employee stock purchases. The Company has adopted the disclosure-only provisions of SFAS No. 123, Accounting for Stock Based Compensation. INCOME TAXES Income taxes are accounted for in accordance with SFAS No. 109, Accounting for Income Taxes. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. EARNINGS PER SHARE Effective December 31, 1997, the Company adopted SFAS No. 128, Earnings per Share. This statement replaces primary and fully diluted earnings per share with basic and diluted earnings per share. Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if all stock options and other stock-based awards, as well as convertible securities, were exercised and converted into common stock. All net income per share amounts for all periods have been presented and, where appropriate, restated to conform to SFAS No. 128 requirements. RECLASSIFICATIONS Certain 1996 and 1995 amounts have been reclassified to conform with the 1997 presentation. TRIGON 38 1997 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TRIGON HEALTHCARE, INC. AND SUBSIDIARIES December 31, 1997 and 1996 Consistent with the financial statement presentation, the following notes include information related to the consolidated balance sheets as of December 31, 1997 and 1996 and information related to the consolidated statements of operations and cash flows for each of the years in the three-year period ended December 31, 1997. NOTE 1. DEMUTUALIZATION AND IPO AND PRO FORMA FINANCIAL INFORMATION Effective February 5, 1997, Virginia BCBS (dba Trigon Blue Cross Blue Shield) completed its conversion from a mutual insurance company to a stock insurance company in accordance with a Plan of Demutualization (Demutualization). In accordance with the Demutualization, Virginia BCBS changed its name to Trigon Insurance Company (dba Trigon Blue Cross Blue Shield) and became a wholly-owned subsidiary of Trigon Healthcare, Inc. The membership interests of Virginia BCBS's eligible members were converted into Class A common stock of Trigon Healthcare, Inc., or, in certain circumstances, cash. The Demutualization also required the Company to complete an Initial Public Offering (IPO) of stock simultaneously with the conversion. Accordingly, Trigon Healthcare, Inc. issued 17.8 million shares of Class A common stock at $13 per share in the IPO, generating net proceeds of $215.2 million. In connection with the Demutualization, the Company was required to make a payment of $175 million to the Commonwealth of Virginia (Commonwealth Payment) in February 1997. The Commonwealth Payment was accrued and reflected as an extraordinary charge in the consolidated financial statements for 1996. The Company used approximately $90 million of the net proceeds and $85 million in borrowings under a revolving credit agreement to fund this payment (note 11). The Company also used approximately $91.1 million of the offering proceeds to pay certain eligible members cash in lieu of shares of common stock that would otherwise be issued to such eligible members pursuant to the Demutualization. The statements of changes in shareholders' equity and the statements of cash flows reflect the consolidated capitalization effects of the Demutualization and IPO for 1997. The following pro forma information for the years ended December 31, 1997, 1996 and 1995 gives effect to the Demutualization and IPO as if they had occurred on January 1, 1995, consistent with the Company's pro forma presentation in its Form S-1 filed on January 29, 1997 in connection with its IPO (in thousands):
1997 1996 1995 ===================================================================== As reported Income before income taxes and extraordinary items $144,670 182,888 59,966 Income tax expense (benefit) 49,617 (13,626) 8,264 Pro forma adjustments Pro forma interest expense 634 4,943 4,943 Pro forma income tax expense (benefit) (217) 75,907 10,994 - --------------------------------------------------------------------- Pro forma income before extraordinary items 94,636 115,664 35,765 Extraordinary items, net of income tax, as reported -- (190,820) (4,707) - --------------------------------------------------------------------- Pro forma net income (loss) $ 94,636 (75,156) 31,058 =====================================================================
The pro forma information assumes: o interest expense at 5.675% per annum for the year ended December 31, 1997 and 5.815% per annum for the years ended December 31, 1996 and 1995 on borrowings used to fund a portion of the Commonwealth Payment. The interest rate used for 1996 and 1995 reflects the weighted average rate in effect for the period the borrowings were outstanding during 1997. The pro forma interest expense reflected for the year ended December 31, 1997 represents interest expense for the period prior to the actual borrowing of funds used to make a portion of the Commonwealth Payment. Actual interest expense for the period subsequent to the borrowings is included in income before income taxes and extraordinary items. Actual interest rates can vary on the current borrowing. A 1/8 percent change in the interest rate of the current outstanding borrowings would have changed interest expense by approximately $106,000 per annum. TRIGON 39 1997 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED o adjustment of the effective income tax rate for 1996 and 1995 to the 35 percent statutory federal rate in conformity with the Company's pro forma presentation in its Form S-1 filing. o the actual effective income tax rate of 34.3% for 1997. The pro forma income tax benefit for the year ended December 31, 1997 represents the income tax benefit associated with the pro forma interest expense adjustment. The pro forma financial information above is used to present comparative earnings per share amounts for the years ended December 31, 1997, 1996 and 1995 on the consolidated statements of operations (note 14). Net income and net income per share after Demutualization and IPO on the consolidated statements of operations reflect net income and net income per share for the period after February 5, 1997, the effective date of the Demutualization and IPO. NOTE 2. AGENCY CONTRACTS The Company acts as an administrative agent for processing claims for certain agencies and other plans. Claims processed for others and the related reimbursed operating expenses, which are subject to their audit, were as follows for the years ended December 31, 1997, 1996 and 1995 (in thousands):
1997 1996 1995 =================================================================== Claims processed for Medicare $3,257,532 2,873,526 2,654,580 Other plans 106,486 55,480 37,046 - ------------------------------------------------------------------- $3,364,018 2,929,006 2,691,626 =================================================================== Operating expenses reimbursed by Medicare $ 12,535 11,634 11,605 Other plans 3,025 1,376 807 - ------------------------------------------------------------------- $ 15,560 13,010 12,412 ===================================================================
NOTE 3. INVESTMENT SECURITIES The amortized cost, gross unrealized gains and losses, and estimated fair value of investment securities as of December 31, 1997 and 1996 were as follows (in thousands):
1997 Gross Gross Estimated Amortized unrealized unrealized fair cost gains losses value =========================================================================================================================== Fixed income Domestic U.S. Treasury securities and obligations of U.S. government agencies $ 406,921 23,040 14 429,947 Mortgage-backed obligations of U.S. government agencies 72,117 1,429 93 73,453 States and political subdivision securities 31,914 1,325 7 33,232 Other mortgage-backed and asset-backed securities 139,504 791 379 139,916 Domestic corporate bonds 388,697 10,410 890 398,217 Short-term debt securities with maturities of less than one year 93,561 -- -- 93,561 Foreign Debt securities issued by foreign governments 41,066 2,296 490 42,872 Foreign corporate bonds 6,678 298 3 6,973 Short-term debt securities with maturities of less than one year 9,214 -- 32 9,182 - --------------------------------------------------------------------------------------------------------------------------- Total fixed income 1,189,672 39,589 1,908 1,227,353 - --------------------------------------------------------------------------------------------------------------------------- Equities Domestic 68,977 14,922 3,264 80,635 Foreign 57,476 15,034 8,813 63,697 - --------------------------------------------------------------------------------------------------------------------------- Total equities 126,453 29,956 12,077 144,332 - --------------------------------------------------------------------------------------------------------------------------- Derivative instruments 492 2,226 406 2,312 $1,316,617 71,771 14,391 1,373,997 =========================================================================================================================== Unrestricted $1,306,727 71,515 14,384 1,363,858 Restricted 9,890 256 7 10,139 - --------------------------------------------------------------------------------------------------------------------------- $1,316,617 71,771 14,391 1,373,997 ===========================================================================================================================
TRIGON 40 1997 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED
1996 Gross Gross Estimated Amortized unrealized unrealized fair cost gains losses value =========================================================================================================================== Fixed income Domestic U.S. Treasury securities and obligations of U.S. government agencies $ 308,205 478 3,667 305,016 Mortgage-backed obligations of U.S. government agencies 70,194 977 415 70,756 Other mortgage-backed and asset-backed securities 156,901 842 231 157,512 Domestic corporate bonds 103,221 1,056 353 103,924 Short-term debt securities with maturities of less than one year 164,239 26 7 164,258 Foreign Debt securities issued by foreign governments 38,496 1,941 249 40,188 Foreign corporate bonds 7,082 493 72 7,503 Short-term debt securities with maturities of less than one year 11,528 9 51 11,486 - --------------------------------------------------------------------------------------------------------------------------- Total fixed income 859,866 5,822 5,045 860,643 - --------------------------------------------------------------------------------------------------------------------------- Equities Domestic 148,111 34,359 2,018 180,452 Foreign 133,366 26,580 8,662 151,284 - --------------------------------------------------------------------------------------------------------------------------- Total equities 281,477 60,939 10,680 331,736 - --------------------------------------------------------------------------------------------------------------------------- Derivative instruments 543 965 448 1,060 $1,141,886 67,726 16,173 1,193,439 =========================================================================================================================== Unrestricted $1,130,808 67,718 16,106 1,182,420 Restricted 11,078 8 67 11,019 - --------------------------------------------------------------------------------------------------------------------------- $1,141,886 67,726 16,173 1,193,439 ===========================================================================================================================
Short-term investments consist principally of commercial paper and money market investments. Derivative instruments consist of foreign currency forward contracts and foreign currency options. The Company enters into foreign currency derivative instruments to hedge exposure to fluctuations in foreign currency exchange rates. Company policy only permits utilization of these instruments in its foreign denominated bond and equity portfolios. The counterparties to these transactions are major financial institutions. The Company may incur a loss with respect to these transactions to the extent that a counterparty fails to perform under a contract and exchange rates have changed unfavorably since the inception of the contract. The Company anticipates that the counterparties will be able to fully satisfy their obligations under the agreements. The forward contracts involve the exchange of one currency for another at a future date and typically have maturities of six months or less. As of December 31, 1997, the Company had forward contracts outstanding to purchase approximately $3.3 million in foreign currencies and to sell approximately $35.8 million in foreign currencies (primarily British Pound, German Mark and Canadian Dollar). The gross unrealized gains and losses related to these contracts as of December 31, 1997 aggregated $547,000 and $406,000, respectively. Foreign currency options are contracts that give the option purchaser the right, but not the obligation, to buy or sell, within a specific period of time, a financial instrument at a specified price. Foreign currency options to sell approximately $20.6 million of foreign currencies (Japanese Yen and German Mark) at set prices were outstanding as of December 31, 1997. These options generally expire within twelve months. The gross unrealized gains related to these options as of December 31, 1997 aggregated $1.7 million. There were no gross unrealized losses as of December 31, 1997. TRIGON 41 1997 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED The Company enters into financial futures contracts for portfolio strategies such as minimizing interest rate risk and managing portfolio duration. The notional amount of the futures, $174.8 million as of December 31, 1997, is limited to that of the market value of the underlying portfolios. The amortized cost and estimated fair value of fixed income securities as of December 31, 1997, by contractual maturity, were as follows (in thousands). Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Amortized Estimated cost fair value ==================================================================== Due in one year or less $ 170,100 170,751 Due after one year through five years 399,303 402,596 Due after five years through ten years 147,257 150,568 Due after ten years 261,391 290,069 Mortgage-backed and asset-backed securities 211,621 213,369 - --------------------------------------------------------------------- $1,189,672 1,227,353 =====================================================================
Included in investment securities as of December 31, 1997 are $10.1 million, at estimated fair value, of U.S. Treasury securities held by various states to meet security deposit requirements related to Trigon Insurance Company, its HMO subsidiaries, Trigon Health and Life Insurance Company and Mid-South Insurance Company. The major components of investment income for the years ended December 31, 1997, 1996 and 1995 were as follows (in thousands):
1997 1996 1995 ==================================================================== Interest on fixed income securities $73,940 36,985 37,789 Interest on short-term investments 4,450 8,654 9,764 Dividends 5,340 10,701 7,652 - -------------------------------------------------------------------- 83,730 56,340 55,205 Investment expenses 6,141 5,711 5,757 Group interest credits 2,905 3,317 3,587 - -------------------------------------------------------------------- Investment income $74,684 47,312 45,861 ====================================================================
Gross realized gains and losses for the years ended December 31, 1997, 1996 and 1995 are summarized as follows (in thousands):
1997 1996 1995 ==================================================================== Gross realized gains Fixed income securities $ 21,177 12,697 13,890 Equity securities 65,837 70,421 58,938 Derivative instruments 14,689 6,659 11,430 - -------------------------------------------------------------------- 101,703 89,777 84,258 - -------------------------------------------------------------------- Gross realized losses Fixed income securities 20,514 10,365 9,081 Equity securities 20,461 18,834 15,520 Derivative instruments 6,665 1,168 6,681 - -------------------------------------------------------------------- 47,640 30,367 31,282 - -------------------------------------------------------------------- Net realized gains $ 54,063 59,410 52,976 ====================================================================
Proceeds from the sale of investment securities were $3.9 billion, $2.6 billion and $1.5 billion during 1997, 1996 and 1995, respectively. Unrealized gains (losses) are computed as the difference between estimated fair value and amortized cost for fixed income securities or cost for equity securities. A summary of the change in unrealized gains (losses), less deferred income taxes, for the years ended December 31, 1997, 1996 and 1995 is as follows (in thousands):
1997 1996 1995 ==================================================================== Fixed income securities$ 36,904 (12,284) 31,921 Equity securities (32,380) 2,943 25,051 Derivative instruments 1,303 146 371 Provision for deferred income taxes (2,051) 3,210 (20,142) - -------------------------------------------------------------------- $ 3,776 (5,985) 37,201 ====================================================================
NOTE 4. PREMIUMS AND OTHER RECEIVABLES Premiums and other receivables as of December 31, 1997 and 1996 were as follows (in thousands):
1997 1996 ==================================================================== Premiums $ 75,265 72,687 Self-funded group receivables 133,613 156,076 Federal Employee Program 123,832 138,213 Investment income receivable 13,026 7,886 Other 15,205 16,135 - -------------------------------------------------------------------- $360,941 390,997 ====================================================================
TRIGON 42 1997 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED NOTE 5. PROPERTY AND EQUIPMENT Property and equipment as of December 31, 1997 and 1996 were as follows (in thousands):
1997 1996 ==================================================================== Land and improvements $ 2,971 2,977 Buildings and improvements 36,565 35,721 Furniture and equipment 70,315 69,703 Computer software 16,247 14,403 ==================================================================== 126,098 122,804 Less accumulated depreciation and amortization 82,186 73,259 ==================================================================== $ 43,912 49,545 ====================================================================
NOTE 6. MEDICAL AND OTHER BENEFITS PAYABLE Medical and other benefits payable as of December 31, 1997 and 1996 were as follows (in thousands):
1997 1996 ==================================================================== Medical and other benefits payable - current Commercial and FEP Claims reported but not paid $ 29,558 23,715 Claims incurred but not reported 228,775 226,444 ==================================================================== 258,333 250,159 Self-funded Claims reported but not paid 18,578 15,383 Claims incurred but not reported 129,635 151,465 ==================================================================== 148,213 166,848 Medical and other benefits payable - noncurrent (all commercial) 66,541 59,246 ==================================================================== 473,087 476,253 Liability for claims processing costs 17,939 17,283 Advances to providers (11,775) (16,493) ==================================================================== 479,251 477,043 Less medical and other benefits payable - noncurrent (66,541) (59,246) ==================================================================== $412,710 417,797 ====================================================================
A summary of the activity for commercial and FEP medical and other benefits payable for the years ended December 31, 1997, 1996 and 1995 is as follows (in thousands):
1997 1996 1995 ====================================================================== Medical and other benefits payable at beginning of year $ 476,253 402,476 355,836 Self-funded at beginning of year (166,848) (141,995) (134,659) ====================================================================== Balance at beginning of year 309,405 260,481 221,177 ====================================================================== Liabilities acquired with Mid-South -- 38,963 -- Incurred related to Current year 1,559,402 1,427,859 1,275,583 Prior years (4,846) (2,328) (4,033) ====================================================================== Total incurred 1,554,556 1,425,531 1,271,550 ====================================================================== Paid related to Current year 1,333,880 1,225,103 1,083,170 Prior years 205,207 190,467 149,076 ====================================================================== Total paid 1,539,087 1,415,570 1,232,246 ====================================================================== Balance at end of year 324,874 309,405 260,481 Self-funded at end of year 148,213 166,848 141,995 ====================================================================== Medical and other benefits payable at end of year $ 473,087 476,253 402,476 ======================================================================
The Company uses paid claims and completion factors based on historical payment patterns to estimate incurred claims. Changes in payment patterns and claims trends can result in changes to prior years' claims estimates. TRIGON 43 1997 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED NOTE 7. LEASES The Company has noncancelable operating leases for real estate and equipment that expire over the next nine years and provide for purchase or renewal options. Future minimum lease payments under noncancelable operating leases as of December 31, 1997 were (in thousands):
Years ending December 31, ========================================================================== 1998 $10,101 1999 9,407 2000 7,176 2001 4,271 2002 3,804 Later years through 2006 6,028 ========================================================================== Total minimum lease payments $40,787 ==========================================================================
Total rental expense for operating leases for the years ended December 31, 1997, 1996 and 1995 was $14,221,000, $13,354,000 and $15,243,000, respectively. NOTE 8. OTHER LIABILITIES Other liabilities as of December 31, 1997 and 1996 were as follows (in thousands):
1997 1996 ========================================================================== Outstanding checks in excess of bank balance $ 43,815 40,351 Member related liabilities 3,783 4,637 Unearned premium reserve - Federal Employee Program 74,247 86,841 Self-funded group deposits 17,311 19,244 Current income taxes payable 15,659 29,023 Other 25,103 18,797 ========================================================================== $179,918 198,893 ==========================================================================
The FEP unearned premium reserve represents the Company's share of the FEP premium stabilization reserve. These funds are actually held by the Blue Cross Blue Shield Association on behalf of each Blue Cross and Blue Shield Plan participating in the Federal Employee Program. An offsetting receivable is recorded in premiums and other receivables. NOTE 9. OTHER REVENUES Other revenues include those revenues earned by non-core subsidiaries. A summary by type of revenue for the years ended December 31, 1997, 1996 and 1995 is included below (in thousands):
1997 1996 1995 ========================================================================== Electronic communication services $ -- 21,474 20,583 Employee benefits administration 4,346 6,957 9,435 Workers' compensation administration 8,877 9,682 9,707 Health management services 8,709 9,039 6,970 Other 3,592 2,204 8,481 ========================================================================== $25,524 49,356 55,176 ==========================================================================
Electronic communicaton services revenues relate to Health Communication Services, Inc. which was sold effective December 31, 1996. NOTE 10. INCOME TAXES Income tax expense (benefit) attributable to income before income taxes and extraordinary items, substantially all of which is federal, for the years ended December 31, 1997, 1996 and 1995 consists of (in thousands):
1997 1996 1995 ========================================================================== Current $28,074 45,857 19,206 Deferred 21,543 (59,483) (10,942) ========================================================================== $49,617 (13,626) 8,264 ==========================================================================
The differences between the statutory federal income tax rate and the actual tax rate applied to income before income taxes and extraordinary items for the years ended December 31, 1997, 1996 and 1995 were as follows:
1997 1996 1995 ========================================================================== Statutory federal income tax rate 35.0% 35.0 35.0 Tax exempt investment income (0.6) (0.3) (1.2) Change in valuation allowance -- (44.0) (19.4) Other, net (0.1) 1.8 (0.6) ========================================================================== Effective tax rate 34.3% (7.5) 13.8 ==========================================================================
TRIGON 44 1997 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED The components of the deferred tax assets and deferred tax liabilities as of December 31, 1997 and 1996 were as follows (in thousands):
1997 1996 ========================================================================== Deferred tax assets Employee benefit plans $22,984 22,880 Insurance reserves 26,200 27,492 Alternative minimum tax credit carryforward 943 21,658 Property and equipment 8,713 6,244 Other 2,933 5,055 ========================================================================== Gross deferred tax assets 61,773 83,329 ========================================================================== Deferred tax liabilities Investment securities 20,083 18,032 Other 803 555 ========================================================================== Gross deferred tax liabilities 20,886 18,587 ========================================================================== Net deferred tax asset $40,887 64,742 ==========================================================================
Deferred tax assets and liabilities as of December 31, 1997 and 1996 are presented on the accompanying consolidated balance sheets as follows:
1997 1996 ========================================================================== Deferred tax assets Current $ -- 16,572 Noncurrent 45,185 48,170 Deferred tax liabilities - current -- 4,298 ========================================================================== Net deferred tax asset $40,887 64,742 ==========================================================================
The Company, through its subsidiary Trigon Insurance Company, has qualified for a federal income tax deduction under IRC Section 833. This deduction is equal to the amount by which 25% of the sum of claims and expenses exceeds tax basis adjusted surplus. Prior to 1994, the effect of this deduction was to significantly reduce regular taxable income and subject the Company to alternative minimum tax. Because it had been unclear whether the Company would be subject to the regular tax in the future, the Company had maintained a valuation allowance with respect to its AMT credits and certain other long-term assets. The valuation allowance on the deferred tax assets was eliminated during 1996 as it was more likely than not that such assets would be realized. NOTE 11. LONG-TERM DEBT Long-term debt as of December 31, 1997 and 1996 is summarized as follows (in thousands):
1997 1996 ===================================================================== Revolving credit agreement $85,000 -- Promissory note, 5%, due June 30, 2000 1,300 1,300 Notes payable, at prime plus 1% 3,039 2,600 Line of credit, at prime 808 980 ===================================================================== $90,147 4,880 =====================================================================
Simultaneous with the Demutualization and IPO in February 1997, the Company entered into a $300 million five-year revolving credit agreement with a syndicate of banks. The credit agreement provides for various borrowing options and rates and requires the Company to pay a facility fee on a quarterly basis. The current borrowing terms require a facility fee of .075% per annum based on the $300 million commitment and bears interest at LIBOR plus a margin, adjusted monthly. The credit agreement also contains certain financial covenants and restrictions including minimum net worth requirements as well as limitations on dividend payments. As of December 31, 1997, $85 million had been borrowed and remained outstanding under the credit agreement, the proceeds of which were used to make a portion of the payment to the Commonwealth of Virginia in accordance with the Demutualization. The weighted average interest rate for the period the borrowings were outstanding during the year ended December 31, 1997 was 5.841%. The promissory note originated in 1995 in connection with the purchase of a subsidiary. The promissory note requires payment of the principal on June 30, 2000 and bears interest at 5%, payable annually. Two HMO subsidiaries entered into notes payable and a line of credit agreement with their minority shareholders for purposes of maintaining regulatory minimum net worth requirements. Interest on the notes payable is at the prime lending rate plus one percent (9.5% as of December 31, 1997). The notes have no scheduled maturity date and repayment of the notes is subject to approval by state regulatory authorities. Interest on the line of TRIGON 45 1997 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED credit is at the prime lending rate (8.5% as of December 31, 1997). The line of credit has no scheduled maturity date and repayment is subject to approval by state regulatory authorities. NOTE 12. EMPLOYEE BENEFIT PLANS The Company has a noncontributory defined benefit pension plan which is funded through the Blue Cross National Retirement Trust (Trust), a collective investment trust for the retirement programs of its participating employers. An employee may become eligible for participation after one year of continuous service and attainment of age 21. The Company's funding policy is to annually contribute amounts to the Trust sufficient to meet the minimum funding requirements outlined in the Employee Retirement Income Security Act of 1974, plus any additional amounts the Company may contribute from time to time. For the years ended December 31, 1997, 1996 and 1995, the Company made contributions to the Trust in the amounts of $6,154,000, $7,933,000 and $7,716,000, respectively. Assets in the Trust are primarily equity securities, U.S. Treasury bonds and notes, U.S. government agency securities, domestic corporate bonds, real estate funds and short-term investments. The following table sets forth the pension plan's funded status as of December 31, 1997 and 1996 (in thousands):
1997 1996 =========================================================================== Accumulated benefit obligation, including vested benefits of $74,524 and $59,656 $ 86,852 70,183 =========================================================================== Projected benefit obligation for service rendered to date 125,579 105,517 Plan assets at fair value (118,344) (99,352) =========================================================================== Excess of projected benefit obligation over assets 7,235 6,165 Unrecognized net asset at January 1, 1987 being recognized over 17 years 673 783 Unrecognized prior service cost (610) (697) Unrecognized net gain 3,779 3,988 =========================================================================== Accrued pension liability $ 11,077 10,239 ===========================================================================
Pension expense for the years ended December 31, 1997, 1996 and 1995 included the following components (in thousands):
1997 1996 1995 ======================================================================= Service cost - benefits earned during the year $ 7,159 7,765 6,705 Interest cost on projected benefit obligation 8,004 7,595 6,507 Actual return on plan assets (18,971) (13,714) (12,194) Net amortization and deferral 10,800 7,565 6,926 ======================================================================= Net periodic pension expense $ 6,992 9,211 7,944 =======================================================================
The weighted average discount rate was 7.25% and 7.75% as of December 31, 1997 and 1996, respectively. The expected long-term rate of return on assets was 9.0% as of December 31, 1997 and 1996. Age-related rates ranging from 3.5% to 7.0% were used for the rate of increase in future compensation levels as of December 31, 1997 and 1996. In addition to providing pension benefits, the Company provides certain health and life insurance benefits for retired employees. In October 1997, the Company amended its postretirement benefit plan by terminating benefits for substantially all future eligible retirees except those employees who will have at least 20 years of service and those employees between the ages of 40 and 45 with age plus years of service equal to 55 or more as of January 1, 1998. The changes in this plan resulted in a curtailment gain of $3,997,000 in the fourth quarter of 1997 which is included in selling, general and administrative expenses in the Company's consolidated statements of operations. The plan amendment also reduced the Company's accumulated postretirement benefit obligation to $4,589,000 which is being amortized as a reduction to net periodic postretirement benefit expense over approximately 7.5 years. This postretirement benefit plan is also funded through the Trust. The Company made a $2,500,000 contribution to the Trust in 1995. No contributions were made in 1997 and 1996. TRIGON 46 1997 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED The following table presents the funded status of the plan including the accumulated postretirement benefit obligation by type of participant as of December 31, 1997 and 1996 (in thousands):
1997 1996 ========================================================================= Retirees $ 8,331 7,069 Fully eligible active plan participants 3,699 3,825 Other active plan participants 15,699 18,861 ========================================================================= Accumulated postretirement benefit obligation 27,729 29,755 Plan assets at fair value (14,134) (12,218) ========================================================================= Excess of accumulated postretirement benefit obligation over plan assets 13,595 17,537 Unrecognized net gain 6,354 5,646 Unrecognized reduction in prior service cost 5,932 5,772 ========================================================================= Accrued postretirement benefit liability $ 25,881 28,955 =========================================================================
Postretirement benefit expense for the years ended December 31, 1997, 1996 and 1995 included the following components (in thousands):
1997 1996 1995 ========================================================================= Service cost - benefits attributed to service during the year $ 1,948 2,373 2,128 Interest cost on accumulated postretirement benefit obligation 2,004 2,044 1,843 Expected return on plan assets (1,167) (1,009) (622) Amortization of reduction in prior service cost (697) (661) (661) Amortization of gains (442) (29) -- ========================================================================= Net periodic postretirement benefit expense $ 1,646 2,718 2,688 =========================================================================
For measurement purposes, a 6% annual rate of increase in the per capita cost of covered health care benefits was assumed for 1997 and subsequent years. The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rate by one percentage point would increase the accumulated postretirement benefit obligation as of December 31, 1997 by $4,346,000 and the aggregate of the service and interest cost components of net periodic postretirement benefit expense would increase by $1,092,000 for the year ended December 31, 1997. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.25% and 7.75% as of December 31, 1997 and 1996, respectively. The rate of increase in future compensation levels used in determining the accumulated postretirement benefit obligation was 4.5% as of December 31, 1997 and ranged from 3.5% to 7.0% as of December 31, 1996. The expected long term rate of return on assets was 9.0% as of December 31, 1997 and 1996. The Trust holding the plan assets is not subject to federal income taxes. The Company also has the Employees' Thrift Plan of Trigon Insurance Company under which substantially all employees who have completed six months of service may elect to save up to 16% of their annual earnings on a pretax basis, subject to certain limits, in the plan. Participants have the option of investing in stock of Trigon Healthcare, Inc. and several international and domestic investment funds. The Company contributes an amount equal to 50% of the participant's contributions limited to 3% of the employee's compensation. The Company's contributions are fully vested to the participant after three years of contributing participation. For the years ended December 31, 1997, 1996 and 1995, the Company's contribution to the Employees' Thrift Plan of Trigon Insurance Company was $3,111,000, $3,418,000 and $3,153,000, respectively. TRIGON 47 1997 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED NOTE 13. CAPITAL STOCK The Company has authorized 300 million shares of Class A Common Stock, par value $0.01 per share (Common Stock), of which 42,300,022 shares were issued and outstanding as of December 31, 1997. Common Stock shares are entitled to one vote per share. These shares were issued in February 1997 when the Company completed the Demutualization and IPO described in note 1. The Company has also authorized 300 million shares of Class B non-voting Common Stock, par value $0.01 per share (Non-Voting Common Stock). No shares of Non-Voting Common Stock were issued and outstanding as of December 31, 1997. The Non-Voting Common Stock has been authorized in connection with certain ownership and transfer restrictions included in the Company's amended and restated articles of incorporation. Non-Voting Common Stock shares are not entitled to vote on any matter except as otherwise required by law. The Company is authorized to issue up to 50 million shares of preferred stock, no par value per share, in one or more series and to provide the designations, preferences, limitations and rights of each series. Shareholder Rights Plan On July 16, 1997, the Board of Directors adopted a Shareholder Rights Plan (Rights Plan). Under the Rights Plan, the Board of Directors authorized three million preferred shares, the Series A Junior Participating Preferred Shares, and declared a dividend of one preferred share purchase right (Right) on each outstanding share of Trigon Class A Common Stock. Each Right entitles shareholders to purchase one one-hundredth of a Series A Junior Participating Preferred Share at an exercise price of $100, subject to adjustment. Subject to certain exceptions, the Right will be exercisable only if a person or group acquires 10% or more of the Company's Common Stock or announces a tender offer for 10% or more of the Company's outstanding Common Stock. Each holder of a Right (other than those held by the acquiring person) will then be entitled to purchase, at the Right's then current exercise price, a number of shares of Trigon Common Stock having a market value of twice the Right's exercise price. If the Company is acquired in a merger or other business combination transaction which has not been approved by the Board of Directors, each Right will entitle its holder to purchase, at the Right's then current exercise price, a number of shares of the acquiring company's Common Stock having a market value of twice the Right's exercise price. The date of record for the dividend distribution was July 29, 1997. The Rights will expire in 2007 and are redeemable by action of the Board of Directors at a price of $.001 per Right at any time prior to becoming exercisable. Common Stock Held by Grantor Trusts The Company has several grantor trusts which were established to fund future obligations under certain compensation and benefit plans. These grantor trusts are consolidated for financial reporting purposes with the Company. Beginning in the third quarter of 1997, shares of the Company's Common Stock were purchased in the open market by these grantor trusts. The purchase price of the shares held by the grantor trusts is shown as a reduction to capital in excess of par in the consolidated balance sheets. Stock Option Plans and Stock Purchase Plan The 1997 Stock Incentive Plan (Incentive Plan), as approved by the Company's shareholders, provides for the granting of stock options, restricted stock awards, performance stock awards, stock appreciation rights and cash performance awards to employees. The Company has reserved 3.55 million shares of its common stock for issuance under the Incentive Plan. Awards are granted by a committee appointed by the Board of Directors. Options vest and expire over terms as set by the committee at the time of grant. In accordance with the Incentive Plan, options to purchase shares at an amount equal to the fair market value of the stock at the date of grant were granted to eligible employees during 1997. These options generally vest at the end of one or three years, with certain grants vesting on a pro-rata basis over three years, depending on an employee's years of service, and in all cases expire 10 years from date of grant. TRIGON 48 1997 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED In addition, the shareholders of the Company approved the 1997 Non-Employee Directors Stock Incentive Plan (Non-Employee Plan). In accordance with the terms of the Non-Employee Plan, options to purchase 10,000 shares at an amount equal to the fair market value of the stock at the date of grant were granted to each of the Company's 16 non-employee directors. Under the Non-Employee Plan, newly-elected non-employee directors are granted nonqualified stock options to purchase 10,000 shares of common stock on the date of the first annual meeting of shareholders at which the director is elected. In addition, each eligible director will automatically be granted options to purchase 5,000 shares of common stock as of the date of each subsequent annual meeting of shareholders. All options are granted at the fair market value on the date of grant and become exercisable on a pro-rata basis over a three-year period. All options expire 10 years from the date of grant. The Company has reserved 550,000 shares of its common stock for issuance under the Non-Employee Plan. A summary of the activity in the stock option plans for the year ended December 31, 1997 is as follows:
Weighted Average Number of Exercise Options Price ===================================================================== Balance at January 1, 1997 -- $ -- Granted 2,180,982 21.96 Exercised -- -- Forfeited 108,628 22.13 ===================================================================== Balance at December 31, 1997 2,072,354 $21.95 ===================================================================== Options exercisable at December 31, 1997 -- $ -- =====================================================================
The following table summarizes information about stock options outstanding and exercisable as of December 31, 1997:
Options Outstanding Options Exercisable Weighted Average Weighted Weighted Remaining Average Average Range of Number Contractual Exercise Number Exercise Exercise Prices Outstanding Life Price Exercisable Price =========================================================================================================================== $18.125 - 25.25 2,072,354 9.45 years $21.95 -- -- ===========================================================================================================================
As of December 31, 1997, 2,027,646 shares were available for future grant. The Company's shareholders approved the Company's 1997 Employee Stock Purchase Plan (Stock Purchase Plan). The Stock Purchase Plan provides employees of the Company an opportunity to purchase the Company's common stock through payroll deductions. The Company has reserved one million shares of its common stock for issuance under the Stock Purchase Plan. Shares needed to satisfy the needs of the Stock Purchase Plan may be newly issued by the Company or acquired by purchase at the expense of the Company on the open market or in private transactions. Eligible employees may purchase up to $25,000 in fair value annually of the Company's common stock at 85% of the lower of the fair value on the first or last trading day of each calendar quarter. Employee contributions to the Stock Purchase Plan were approximately $749,000 for the year ended December 31, 1997. Pursuant to the Stock Purchase Plan, 23,971 shares of the Company's stock were purchased on the open market and issued to employees for the year ended December 31, 1997 and 15,026 shares were pending purchase as of December 31,1997. The pro forma information regarding net income and earnings per share as required by SFAS No. 123 has been determined as if the Company had accounted for its stock-based compensation under the fair value method of that Statement. The fair value for the stock options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for 1997:
====================================================================== Risk-free interest rate 5.54% Volatility factor 37.40% Dividend yield -- Weighted average expected life 5 years ======================================================================
TRIGON 49 1997 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's stock option grants have characteristics significantly different from those traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock option grants. For purposes of pro forma disclosures, compensation expense is increased for the estimated fair value of the options amortized over the options' vesting periods and for the difference between the market price of the stock and the discounted purchase price of the shares on the purchase date for the employee stock purchases. The Company's pro forma information for 1997 is as follows (in thousands, except per share data):
As Reported Pro Forma ======================================================================== Net income $95,053 91,372 Net income after Demutualization and IPO 78,982 75,718 Earnings per share Basic net income after Demutualization and IPO 1.87 1.79 Diluted net income after Demutualization and IPO 1.86 1.79 Pro forma earnings per share Basic and diluted pro forma net income 2.23 2.16 Weighted average fair value of options granted during the year -- 9.16 Weighted average fair value of employee stock purchases during the year -- 5.82 ========================================================================
NOTE 14. NET INCOME AND PRO FORMA NET INCOME PER SHARE The following table sets forth the computation of basic and diluted earnings per share for the period after the Demutualization and IPO through December 31, 1997 (in thousands, except per share data):
======================================================================== Numerator for basic and diluted earnings per share - net income $78,982 ======================================================================== Denominator Denominator for basic earnings per share - weighted average shares 42,300 Effect of dilutive securities - employee and director stock options 80 ======================================================================== Denominator for diluted earnings per share 42,380 ======================================================================== Basic net income per share $1.87 ======================================================================== Diluted net income per share $1.86 ========================================================================
The following table sets forth the computation of basic and diluted pro forma earnings per share for the years ended December 31, 1997, 1996 and 1995 (in thousands, except per share data):
1997 1996 1995 =========================================================================== Numerator for basic and diluted pro forma earnings per share (note 1) Pro forma income before extraordinary items $94,636 115,664 35,765 Extraordinary items, net of income tax, as reported -- (190,820) (4,707) - --------------------------------------------------------------------------- Pro forma net income (loss) $94,636 (75,156) 31,058 =========================================================================== Denominator Denominator for basic pro forma earnings per share - weighted average shares 42,300 42,300 42,300 Effect of dilutive securities - employee and director stock options 73 -- -- - --------------------------------------------------------------------------- Denominator for diluted pro forma earnings per share 42,373 42,300 42,300 =========================================================================== Basic and diluted earnings per share Pro forma income before extraordinary items $2.23 2.73 0.84 Extraordinary items, net of income tax, as reported -- (4.50) (0.11) - --------------------------------------------------------------------------- Pro forma net income (loss) $2.23 (1.77) 0.73 ===========================================================================
TRIGON 50 1997 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED The pro forma weighted average shares outstanding gives effect to the Demutualization and IPO as if they had occurred on January 1, 1995, consistent with the Company's pro forma presentation in its Form S-1 filed on January 29, 1997, in connection with its IPO (note 1). NOTE 15. STATUTORY FINANCIAL INFORMATION Trigon Insurance Company is required to file financial statements with, and is subject to audit by, the Commonwealth of Virginia, Bureau of Insurance. Such financial statements are prepared in accordance with statutory accounting practices prescribed or permitted by the Commonwealth of Virginia, Bureau of Insurance which differ from generally accepted accounting principles under which the accompanying consolidated financial statements have been prepared. Significant differences resulting from these accounting practices include certain investment valuation reserves and certain claims reserves recognized under statutory accounting as well as certain assets (primarily property and equipment) and deferred income taxes not recognized under statutory accounting practices. While the Bureau of Insurance has the authority to permit insurers to deviate from prescribed statutory accounting practices, Trigon Insurance Company has not received, nor requested, approval to adopt any such deviations. In accordance with the Insurance Code of Virginia (Code), Trigon Insurance Company's statutory surplus may be reduced by Category 2 investments that exceed a specified threshold. Category 2 investments consist primarily of domestic equity investments that exceed a specified percentage of admitted assets and foreign denominated investments. As of December 31, 1995, this reduction in statutory surplus due to excess Category 2 investments approximated $92.0 million. There were no excess Category 2 investments as of December 31, 1997 and 1996. Trigon Insurance Company's statutory surplus and net income were (in thousands):
Statutory surplus at: December 31, 1997 (unaudited) $617,578 December 31, 1996 618,999 Statutory net income for the years ended: December 31, 1997 (unaudited) $123,272 December 31, 1996 97,143 December 31, 1995 82,910
Trigon Insurance Company is required by the Commonwealth of Virginia, Bureau of Insurance to maintain statutory capital and surplus of at least $4.0 million. Under the Code, an insurance company may pay a dividend without prior permission of the Commonwealth of Virginia, Bureau of Insurance to the extent that such dividend together with other dividends or distributions within the preceding 12 months does not exceed the lesser of: (i) 10% of the insurer's statutory surplus as of the immediately preceding December 31, or (ii) the net statutory gain from operations (excluding realized gains on investments) for the 12-month period ended the immediately preceding December 31. Trigon Insurance Company may pay $61.8 million to the Company in cash dividends after certain dates during 1998 without prior permission. During 1997, Trigon Insurance Company received permission from the Bureau ofInsurance to pay a $238.7 million dividend to its parent company, Trigon Healthcare, Inc., consisting of $188.7 million in stock of a wholly-owned subsidiary and $50 million in cash. This dividend was effected on July 31, 1997. In addition, the Commonwealth of Virginia adopted the National Association of Insurance Commissioners (NAIC) Risk Based Capital Act in 1995. Under this Act, a company's risk based capital (RBC) is calculated by applying certain factors to various asset, premium and reserve items. If a company's calculated RBC falls below certain thresholds, regulatory intervention or oversight is required. Trigon Insurance Company's RBC level as calculated in accordance with the NAIC RBC Instructions exceeded all RBC thresholds as of December 31, 1997. Mid-South Insurance Company, Trigon Health and Life Insurance Company and the Company's HMO subsidiaries are also required to file statutory financial statements in each of the states in which they are licensed. TRIGON 51 1997 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED NOTE 16. SUPPLEMENTARY FINANCIAL DATA A reconciliation of net income - statutory basis for the years ended December 31, 1997, 1996 and 1995 and capital and surplus - statutory basis as of December 31, 1997 and 1996 as reported by Trigon Insurance Company to regulatory authorities to net income and shareholders' equity excluding unrealized gains/losses as reported in the accompanying consolidated financial statements follows (in thousands):
Unaudited 1997 1996 1995 =========================================================================================================================== Trigon Insurance Company net income - statutory basis $123,272 97,143 82,910 Add (deduct) Parent operations 850 (175,000) -- Differences in investment carrying values (10,808) (3,972) (14,132) Deferred income taxes (19,155) 58,548 (260) Adjustments to claim reserves 7,177 22,392 -- Coinsurance refund program, net of taxes -- -- (35,931) Other (6,283) 6,583 14,408 =========================================================================================================================== Net income -GAAP basis $ 95,053 5,694 46,995 =========================================================================================================================== Unaudited 1997 1996 =========================================================================================================================== Trigon Insurance Company capital and surplus - statutory basis $617,578 618,999 Add (deduct) Parent equity 177,473 (175,000) Differences in investment carrying values 8,896 59,130 Employee benefit liabilities (37,974) (39,298) Asset valuation reserve 43,883 115,395 Deferred income taxes 53,213 72,369 Non-admitted assets 29,996 33,045 Additional claim reserves 19,669 12,492 Other 8,706 9,127 =========================================================================================================================== Shareholders' equity excluding unrealized gains/losses - GAAP basis $921,440 706,259 ===========================================================================================================================
The differences between statutory and GAAP for Mid-South Insurance Company, Trigon Health and Life Insurance Company and the Company's HMO subsidiaries were not significant to the consolidated totals above. The differences for these subsidiaries relate primarily to differences in investment carrying values, asset valuation reserve, deferred income taxes and non-admitted assets. TRIGON 52 1997 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED NOTE 17. ADDITIONAL CASH FLOW INFORMATION The reconciliation of net income to net cash provided by operating activities and supplemental disclosures of cash flow information for the years ended December 31, 1997, 1996 and 1995 are as follows (in thousands):
1997 1996 1995 =========================================================================================================================== Net income $ 95,053 5,694 46,995 Adjustments to reconcile net income to net cash provided (used) by operating activities, net of effects from purchase of subsidiaries Depreciation and amortization 20,242 19,971 14,578 Accretion of discounts and amortization of premiums, net (11,819) (1,315) (3,618) Change in allowance for doubtful accounts receivable 826 402 468 (Increase) decrease in premiums and other receivables 29,238 (59,999) (5,989) Increase in other assets (3,882) (3,740) (2,531) Increase in medical and other benefits payable 2,208 31,147 68,945 Increase (decrease) in unearned premiums 1,993 (6,888) (5,252) Increase (decrease) in accounts payable and accrued expenses (26,734) (7,672) 4,106 Increase (decrease) in other liabilities (20,384) 44,930 (26,919) Change in deferred income taxes 21,804 (60,678) (8,030) Increase (decrease) in obligation for Commonwealth Payment (175,000) 175,000 -- Increase (decrease) in minority interest 1,870 285 (703) Increase in obligations for employee benefits 1,788 6,131 784 Gain on the sale of subsidiary -- (62,253) -- (Gain) loss on disposal of property and equipment and other assets (122) 214 115 Realized investment gains, net (54,063) (59,410) (52,976) =========================================================================================================================== Net cash provided (used) by operating activities $(116,982) 21,819 29,973 =========================================================================================================================== Cash paid during the year for Interest $ 9,014 4,326 15,390 Income taxes 40,137 18,900 20,061 ===========================================================================================================================
NOTE 18. ACQUISITION AND DISPOSITION ACTIVITY Acquisitions In February 1996, the Company purchased all of the outstanding shares of Mid-South Insurance Company (Mid-South) for approximately $85.6 million. Mid-South is a Fayetteville, North Carolina based life and health insurance company. The acquisition was accounted for as a purchase and, accordingly, the results of operations of Mid-South are included in the consolidated financial statements since the date of acquisition. Goodwill and other intangible assets arising from the transaction amounted to $56.7 million and are being amortized over periods not exceeding 25 years. No pro forma information has been provided since Mid-South's results of operations prior to the Company's acquisition were not material to the Company. In November 1995, the Company paid $5.5 million for a 50% interest in Primary Care First, L.L.C. (PCF) and related assets. PCF was formed for the purpose of managing and developing primary care physician networks in the Richmond and South Hampton Roads areas of Virginia. The Company has also committed to provide up to $3.5 million to PCF for development of additional primary care physician networks. The Company funded $1,050,000 during 1996 and no amounts during 1997. This investment is accounted for under the equity method and is included in other assets. The excess of the Company's cost over its underlying equity in PCF and related assets amounted to $5.5 million and are being amortized over 15 years. In May 1995, the Company acquired 80% of the outstanding stock of Priority Health Care, Inc. (subsequently renamed Priority, Inc.) (Priority) for approximately $24.2 million including acquisition-related costs. The acquisition was accounted for as a purchase and, accordingly, the results of operations of Priority are included in the consolidated financial statements since the date of acquisition. Goodwill arising from the acquisition amounted to $21.1 million and is being amortized over 15 years. No pro forma information has been provided since Priority's results of operations prior to the Company's acquisition were not material to the Company. TRIGON 53 1997 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED Disposition Effective December 31, 1996, the Company sold its subsidiary, Health Communications Services (HCS), for $77.0 million cash. The Company recorded a pre-tax and after-tax gain on the sale of HCS of $62.3 million and $40.0 million, respectively. The Company's earnings and cash flows reflect the operations of HCS through December 31, 1996. NOTE 19. COPAYMENT REFUND PROGRAM The Company conducted a Copayment Refund Program (Copayment Program) in accordance with an agreement with the State Corporation Commission dated September 22, 1994. During the Copayment Program, members who had paid coinsurance on services rendered at the Company's network facilities from January 1, 1984 through December 31, 1993 were eligible for a refund. Refunds represented the difference between the member's original coinsurance payment, which had been based on the facility's undiscounted charges, and an adjusted coinsurance payment calculated using the Company's average discount percentage at the facility. The Company changed its methodology on January 1, 1994, to calculate coinsurance payments using the average percentage discount. Costs incurred under the Copayment Program included refunds, interest and administrative costs associated with the Copayment Program that the Company would not otherwise have incurred. In addition, the Company agreed to pay a $5 million civil forfeiture to the Commonwealth of Virginia which has been included in the cost of the Copayment Program. The cost of the Copayment Program in 1994 was $36.4 million or $30.0 million, net of income taxes. The Virginia General Assembly enacted legislation, effective July 1, 1994, that requires all insurers and HMOs to calculate coinsurance payments on the basis of their negotiated reimbursement rates with facilities. In accordance with an agreement with the State Corporation Commission dated November 17, 1995, the Company re-opened the Copayment Program. As part of the re-opening of the Copayment Program, the Company mailed refunds to approximately 300,000 members who had not filed a claim under the original program and for whom the Company had an address. In addition, the Company announced that it had determined that there were approximately 200,000 former members for whom the Company did not have an address. Any amounts not paid by December 31, 1996 were escheated to the Commonwealth of Virginia as unclaimed property in April 1997. The cost of the re-opening of the Copayment Program in 1995 was $47.1 million or $40.6 million, net of income taxes. NOTE 20. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK The carrying amounts of cash, premiums and other receivables, other current assets, medical and other benefits payable, unearned premiums, accounts payable and accrued expenses and other current liabilities approximate fair value because of the short-term nature of these instruments. The carrying amount of long-term debt with variable interest rates approximates fair value. The fair values of investment securities are estimated based on quoted market prices. Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of investment securities and premiums receivable. All of the investment securities are managed within established guidelines which limit the amounts which may be invested with one issue. The Company primarily conducts business within the Commonwealth of Virginia; therefore premiums receivable are concentrated with companies and individuals within Virginia. TRIGON 54 1997 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED NOTE 21. LEGAL AND REGULATORY PROCEEDINGS The Company is the defendant in three lawsuits that have been filed by self-funded employer groups in connection with the Company's past practices regarding provider discounts. The suits claim that the Company was obligated to credit each self-funded plan with the full amount of the discounts that the Company negotiated with facilities providing health care to members covered by the plans. Collectively, the suits seek $1.3 million in compensatory damages plus unspecified punitive and other damages. The Company is also presently the subject of four other claims by self-funded employer groups related to the Company's past practices regarding provider discounts, some of which involve larger amounts of withheld discounts. The Company is communicating with these groups, and lawsuits have not been filed in connection with these claims. The Company believes that additional discount-related claims may be made against it. Although the ultimate outcome of such claims and litigation cannot be estimated, the Company believes that the discount-related claims and litigation brought by these self-funded employer groups will not have a material adverse effect on the consolidated financial condition of the Company or the Company's results of operations in any particular period. The Company and certain of its subsidiaries are involved in other various legal actions occurring in the normal course of business. While the ultimate outcome of such litigation cannot be predicted with certainty, in the opinion of Company management, after consultation with counsel responsible for such litigation, the outcome of those actions is not expected to have a material adverse effect on the consolidated financial condition of the Company. TRIGON 55 1997 INDEPENDENT AUDITORS' REPORT AND MANAGEMENT REPORT TRIGON HEALTHCARE, INC. AND SUBSIDIARIES INDEPENDENT AUDITORS' REPORT The Board of Directors Trigon Healthcare, Inc.: We have audited the accompanying consolidated balance sheets of Trigon Healthcare, Inc. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Trigon Healthcare, Inc. and subsidiaries as of December 31, 1997 and 1996 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997 in conformity with generally accepted accounting principles. /s/ KPMG PEAT MARWICK LLP Richmond, Virginia February 4, 1998 MANAGEMENT REPORT The management of Trigon Healthcare, Inc. is responsible for the integrity and objectivity of the consolidated financial statements. These statements have been prepared in accordance with generally accepted accounting principles and include some amounts that are based on management's best estimates and judgment. The accounting systems and controls of the Company are designed to provide reasonable assurance that financial records are reliable for use in preparing financial statements and that assets are safeguarded. Management believes that the Company's system of internal controls for the year ended December 31, 1997 was effective and adequate to accomplish the above described objectives. The Board of Directors appoints to the Audit Committee members who are neither officers nor employees of the Company. The committee meets periodically with management, the internal auditors and the independent auditors to review financial reports, internal accounting controls and the scope and results of audit efforts. Both the internal auditors and the independent auditors have full and free access to the Audit Committee, with and without management representation. /s/ THOMAS G. SNEAD, JR. Thomas G. Snead, Jr. President and Chief Operating Officer /s/ THOMAS R. BYRD Thomas R. Byrd Senior Vice President and Chief Financial Officer TRIGON 56 1997 EX-21 5 EXHIBIT 21 Exhibit 21 SUBSIDIARIES OF THE REGISTRANT
Company Jurisdiction Trigon Insurance Company (dba Trigon Blue Cross Blue Shield)............................Virginia Healthcare Support Corporation......................................................Virginia HealthKeepers, Inc...............................................................Virginia Physicians Health Plan, Inc......................................................Virginia Trigon Administrators, Inc.......................................................Virginia Trigon Services, Inc.............................................................Virginia Peninsula Health Care, Inc. (3).....................................................Virginia Primary Care First, L.L.C. (2)......................................................Virginia Priority, Inc. (4)..................................................................Virginia Priority Health Care, Inc........................................................Virginia Priority Insurance Agency, Inc...................................................Virginia Monticello Service Agency, Inc..........................................................Virginia Capitation Risk Management, Inc.....................................................Virginia Consolidated Holdings Corporation...................................................Delaware Health Management Corporation.......................................................Virginia Healthy Homecomings, Inc.........................................................Missouri Healthy Homecomings Incorporated of St. Louis...................................Missouri Mid-South Insurance Company.........................................................North Carolina Trigon Health and Life Insurance Company (formerly Monticello Life Insurance Company...........................................................Virginia Trigon Health Ventures, Inc.........................................................Virginia
(1) Unless otherwise indicated, subsidiaries are 100% owned by the Registrant or the indicated parent company. (2) 50% owned (3) 51% owned (4) 80% owned EX-23 6 EXHIBIT 23.1 Exhibit 23.1 Consent of KPMG Peat Marwick LLP The Board of Directors Trigon Healthcare, Inc.: We consent to incorporation by reference in the registration statements (Nos. 333-22463, 333-26187, 333-26189 and 333-26191) on Form S-8 of Trigon Healthcare, Inc. of our report dated February 4, 1998, relating to the consolidated balance sheets of Trigon Healthcare, Inc. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1997, which report is incorporated by reference in this Form 10-K. We also consent to the incorporation by reference in the aforementioned registration statements of our report dated February 4, 1998, relating to the financial statement schedule of Trigon Healthcare, Inc., which report appears in this Form 10-K. /s/KPMG Peat Marwick LLP Richmond, Virginia March 27, 1998 EX-27 7 EXHIBIT 27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS INCLUDED IN THE TRIGON HEALTHCARE, INC. AND SUBSIDIARIES FORM 10-K FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS DEC-31-1997 DEC-31-1997 7,010 1,363,858 360,941 0 0 1,739,416 126,098 82,186 1,928,820 747,819 90,147 0 0 423 958,314 1,928,820 1,934,873 2,063,620 1,554,556 1,914,348 0 0 4,602 144,670 49,617 95,053 0 0 0 95,053 0 0
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