ELV

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2002, for Anthem, Inc. (formerly operating as a mutual insurance company prior to demutualization in November 2001). Anthem is a major health benefits company and an independent licensee of the Blue Cross Blue Shield Association, serving over 8.3 million members across the Midwest, East, West, and Specialty segments. The filing details the company's transition to a public stockholder-owned entity and its ongoing expansion through acquisitions.

Key Financial Metrics

Note: Debt figures reflect balances as of June 30, 2002. Significant debt issuance occurred in July 2002 to fund the Trigon acquisition.

Material Changes vs. Prior Period

• Revenue Growth: Total operating revenue increased 12% year-over-year, driven by a 13% increase in premiums and a 68% increase in other revenue (primarily pharmacy benefit management). Membership grew 7% to 8.321 million.
• Profitability: Net income rose 44% to $206.0 million. This was driven by improved operating results, higher net investment income, and a reduction in goodwill amortization due to the adoption of FAS 142.
• Expense Ratios: The benefit expense ratio improved by 120 basis points to 84.0%, attributed to better-than-expected claims experience in the East and West segments and the sale of the TRICARE business in 2001.
• Investment Performance: Net realized gains on investments were $5.9 million in 2002, compared to net realized losses of $10.9 million in 2001.
• Divestiture Impact: The 2001 period included a $25.0 million gain on the sale of TRICARE operations, which was not present in the 2002 period.

Guidance, Outlook, and Risks

Significant Transactions and Outlook

• Trigon Acquisition: On July 31, 2002 (post-period end), Anthem completed the acquisition of Trigon Healthcare, Inc. for approximately $4.2 billion. This created a new "Southeast" segment. The purchase was funded by $950 million in new long-term notes, cash, and the issuance of approximately 39 million shares of Anthem stock.
• BCBS-Kansas Acquisition: A pending acquisition of Blue Cross and Blue Shield of Kansas is subject to regulatory appeal. The Kansas Supreme Court is reviewing a lower court ruling that vacated the Insurance Commissioner's disapproval of the deal.
• Cost Trends: Management reports overall cost of care trends of approximately 13% (rolling 12-month), with prescription drug costs rising 18% and inpatient costs rising 9%.

Risks and Contingencies

• Litigation: Anthem faces multiple class-action lawsuits in Connecticut regarding ERISA violations and provider reimbursement practices. A significant wrongful death/bad faith case in Ohio (Dardinger) is pending before the Supreme Court of Ohio regarding punitive damages.
• Government Audits: The company is subject to ongoing federal reviews of its Medicare fiscal intermediary operations (Parts A and B) and Federal Employee Program (FEP) operations. While management believes any potential fines would not be material, penalties for non-compliance are a risk.
• Regulatory: Future liquidity and operations depend on the outcome of the BCBS-Kansas regulatory appeal and the ability to secure premium rate increases to match rising healthcare costs.

Investor Verification Checklist

• Trigon Integration: Verify the actual synergies and cost savings realized from the Trigon acquisition in subsequent quarters, given the $4.2 billion purchase price.
• BCBS-Kansas Status: Monitor the final ruling by the Kansas Supreme Court regarding the acquisition of BCBS-Kansas, as this impacts future growth projections.
• Medical Cost Trends: Track the 13% medical cost trend and 18% prescription drug cost trend to ensure premium rate increases are sufficient to maintain margins.
• Litigation Exposure: Review updates on the Ohio Dardinger case and Connecticut class actions for potential material liability adjustments.
• Debt Servicing: Assess the impact of the new $950 million debt issuance (July 2002) on future interest expense and cash flow.