Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2006, for WellPoint, Inc. (formerly Anthem, Inc.). WellPoint is the largest health benefits company in the U.S. by commercial membership, serving over 34 million members. The company operates through three segments: Health Care, Specialty, and Other. A significant event impacting the reporting period was the acquisition of WellChoice, Inc., completed on December 28, 2005, which is fully consolidated in the 2006 results.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2006 | Nine Months Ended Sep 30, 2006 |
|---|---|---|
| Total Revenues | $14,425.9 million | $42,397.5 million |
| Net Income | $810.8 million | $2,293.8 million |
| Diluted EPS | $1.29 | $3.54 |
| Operating Cash Flow | N/A | $2,613.3 million |
| Cash and Equivalents | $2,229.5 million | $2,229.5 million (Ending Balance) |
| Total Debt (Current + Long-term) | $7,343.7 million | $7,343.7 million (Ending Balance) |
| Benefit Expense Ratio | 81.3% | 81.3% |
| SG&A Expense Ratio | 15.5% | 15.7% |
Material Changes vs. Prior Period
- Revenue Growth: Total operating revenue increased 29% year-over-year for the quarter and 27% for the nine-month period. This growth was primarily driven by the WellChoice acquisition, premium rate increases, and the launch of Medicare Part D plans.
- Profitability: Net income rose 27% for both the quarter and the nine-month period compared to 2005. Diluted EPS increased from $1.02 to $1.29 for the quarter and from $2.90 to $3.54 for the nine months.
- Expense Trends: Benefit expense increased 32% (quarter) and 29% (nine months), largely due to higher costs of care and the inclusion of WellChoice. SG&A expenses increased 19% (quarter) and 21% (nine months), influenced by volume-sensitive costs and the adoption of FAS 123R (share-based compensation).
- Investment Activity: Net investment income increased 44% for both periods due to higher interest rates and a larger asset base from the acquisition. However, the company recorded net realized losses on investments of $11.4 million for the nine months ended September 30, 2006, compared to gains of $1.4 million in the prior year, largely due to restructuring the investment portfolio.
Guidance, Outlook, and Risks
- Cost of Care: Management estimates the 2006 medical cost of care trend to be less than 8%. Trends are being driven by higher outpatient and inpatient unit costs, partially offset by generic drug usage and plan design changes.
- Medicare Part D: The company began marketing Medicare Part D plans in January 2006, reaching approximately 1.6 million members by September 30, 2006. Management notes risks regarding collectability and underwriting assumptions for this new business.
- Capital Allocation: The company repurchased approximately 53.4 million shares of common stock for $4.0 billion during the first nine months of 2006. As of September 30, $500 million remained authorized for future repurchases.
- Legal Contingencies: The company settled a major multi-district litigation (MDL) regarding RICO violations with physicians, with final payments of $209.5 million made in October 2006. The company remains a defendant in the Thomas Litigation involving the former WellChoice entity.
- Accounting Changes: The adoption of FAS 123R on January 1, 2006, increased share-based compensation expense, reducing net income by approximately $89.7 million for the nine-month period compared to the prior method.
Investor Verification Checklist
- Medical Claims Reserves: Verify the adequacy of the $5.3 billion medical claims payable liability, noting the $576.5 million in prior year redundancies recognized in the nine months ended September 30, 2006.
- WellChoice Integration: Assess the realization of synergies and the impact of the WellChoice acquisition on long-term margins, particularly in the New York market.
- Medicare Part D Performance: Monitor the profitability and enrollment stability of the new Medicare Part D business, which carries specific regulatory and underwriting risks.
- Investment Portfolio: Review the composition of the $17.4 billion investment portfolio and the impact of interest rate changes on fixed maturity securities.
- Share Repurchases: Confirm the remaining authorization and execution of the stock repurchase program, which significantly impacts share count and EPS.