Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2005, for WellPoint, Inc. (formerly Anthem, Inc.). WellPoint is the largest publicly traded commercial health benefits company in the U.S. by membership, serving approximately 29 million members as of the reporting date. The company operates as an independent licensee of the Blue Cross Blue Shield Association in 13 states and nationally through HealthLink and UniCare. The financial results reflect the consolidation of WellPoint Health Networks Inc. (WHN), which merged with the company on November 30, 2004.
Key Financial Metrics
| Metric | Three Months Ended Sept 30, 2005 | Nine Months Ended Sept 30, 2005 |
|---|---|---|
| Total Revenues | $11,304.6 million | $33,703.7 million |
| Net Income | $640.7 million | $1,811.8 million |
| Diluted EPS | $1.02 | $2.90 |
| Operating Cash Flow (9mo) | $2,292.9 million | |
| Total Assets | $41,855.6 million | |
| Total Liabilities | $20,620.9 million | |
| Shareholders' Equity | $21,234.7 million | |
| Debt-to-Capital Ratio | 17.1% | |
| Benefit Expense Ratio | 79.9% | 80.8% |
Material Changes vs. Prior Period
Financial results for 2005 include the operations of the former WHN, whereas 2004 results represent only the former Anthem, Inc. Consequently, reported year-over-year growth is substantial, though "comparable basis" metrics (combining historical results of both entities) show more moderate organic growth.
- Revenue Growth: Total revenues increased 135% for the quarter and 141% for the nine months ended September 30, 2005, compared to 2004. On a comparable basis, operating revenue grew 6% for the quarter and 7% for the nine months.
- Profitability: Net income increased 165% for the quarter and 134% for the nine months. Diluted EPS rose 20% for the quarter and 7% for the nine months on a comparable basis.
- Membership: Total medical membership increased 6% on a comparable basis to 28.99 million. Self-funded membership grew 11%, while fully-insured membership grew 1%.
- Cost of Care: The benefit expense ratio improved (decreased) by 170 basis points for the quarter and 30 basis points for the nine months on a comparable basis, driven by disciplined pricing and moderating cost trends.
Guidance, Outlook, and Material Events
Pending Acquisition
On September 27, 2005, WellPoint signed a definitive merger agreement to acquire WellChoice, Inc., the largest health insurer in New York State. The transaction, valued at approximately $6.5 billion, is expected to close in the first quarter of 2006. The combined entity would serve over 33 million members.
Legal Settlements
The company reached a settlement agreement on July 11, 2005, to resolve multi-district class-action lawsuits involving over 700,000 physicians. The settlement includes cash payments totaling up to $198.0 million ($135.0 million to physicians, $5.0 million to a foundation, and up to $58.0 million in legal fees). A pre-tax expense of $103.0 million was recognized in the second quarter of 2005.
Stock Repurchase Program
The Board of Directors authorized an increase in the stock repurchase program to $2.0 billion in October 2005. During the nine months ended September 30, 2005, the company repurchased approximately 5.1 million shares for $333.4 million. No shares were repurchased in the third quarter due to the WellChoice negotiations.
Risks and Contingencies
- Medical Claims Liability: The liability for medical claims payable ($4,182.3 million) is the most judgmental accounting estimate. A 1% difference in the estimated liability could impact net income by approximately $27.2 million.
- Regulatory and Litigation: The company faces ongoing litigation regarding provider reimbursement rates and contract breaches (e.g., UniCare case in Illinois). It is also subject to audits by federal and state agencies regarding Medicare fiscal intermediary activities.
- Accounting Changes: The company expects the adoption of FAS 123R (Share-Based Payment) in 2006 to reduce earnings by approximately 3% to 5%.
Investor Verification Checklist
- WellChoice Merger Approval: Verify regulatory and shareholder approval status for the $6.5 billion WellChoice acquisition, expected to close in Q1 2006.
- Medical Claims Reserves: Monitor the development of medical claims liabilities, specifically the "prior year redundancies" which were 3.9% of prior year net incurred claims for the nine months ended Sept 30, 2005.
- Cost of Care Trends: Confirm that the aggregate cost of care trend remains below the management target of 8.5% for the full year 2005.
- Legal Settlement Finalization: Track the final court approval of the $198 million physician settlement scheduled for December 2, 2005.
- Debt Ratings: Monitor credit ratings (currently BBB+/A-/Baa1) as the company prepares to finance the WellChoice transaction with a bridge loan and potential new debt issuance.