Why did UnitedHealth report a loss in 1998 when it had record revenue?

The company recorded $725 million of operational realignment and other charges in the second quarter, including $451 million of asset impairments, plus $175 million of medical cost charges tied to Medicare contract losses and higher commercial medical cost estimates. Those charges, along with a $20 million preferred stock redemption premium, produced a net loss applicable to common shareholders of $214 million. Management argues the underlying business remained profitable, with earnings from operations of $858 million before the special items.

How much of the 1998 growth came from the AARP contract, and how profitable is that business?

The AARP program contributed $3.5 billion of premium revenue in 1998, starting January 1, 1998, covering about 4 million members. The business carries a medical care ratio of roughly 92%, which is well above the company's commercial ratio. Excluding AARP, consolidated premium revenue grew 19% to $12.0 billion, and the consolidated medical care ratio was 85.8%. Investors should note that the AARP contract is a ten-year arrangement, and the company's results depend on servicing these members profitably.

What are the main legal risks to investors?

Six federal securities class actions allege the company made materially false statements about Medicare profitability and realignment costs between February 12 and August 5, 1998. The stock fell from $52 7/8 to $37 7/8 after the company disclosed its true condition on August 6, 1998. Two pension funds also filed opt-out suits seeking about $12.1 million in damages. The company says it will defend these cases vigorously, and the filing does not quantify a probable loss from the class actions.

Is the company's dividend and capital position at risk?

The annual common dividend is $0.03 per share, payable April 15, 1999, a token amount that is not a meaningful income return. The balance sheet is sound, with $4.4 billion in cash and investments, although only about $500 million was available for general corporate use after regulatory restrictions. Subsidiaries can pay roughly $120 million in dividends to the parent without prior regulatory approval. Pending NAIC risk-based capital rules for HMOs could increase capital requirements for some subsidiaries, though management does not expect a significant aggregate impact.

What should investors expect for 1999?

Management expects medical cost trends of 4% to 5%, a medical care ratio improvement from premium yield increases of 7% to 8% on new and renewal commercial business, and about $75 million of realignment savings in 1999, rising to roughly $300 million annually by 2000. Medicare remains a concern because the company continues to exit unprofitable markets and cannot assure it will prevent future losses. The Year 2000 program is expected to be complete by September 30, 1999, and the company says it expects to avoid material operational disruption, though it acknowledges that failures by critical vendors or providers could still affect results.

UNH 10-K FY1998 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K/A filed April 22, 1999. Cited figures are marked; the original filing is the authoritative source.

UnitedHealth Group's 1998 10-K shows a year of sharp contrast: underlying results were strong, but reported results were a net loss.

Revenues rose 47% to a record $17.4 billion^a, driven mainly by the $3.5 billion AARP Medicare supplement program and same-store commercial enrollment growth in UnitedHealthcare. Excluding $725 million of realignment charges and $175 million of Medicare and medical cost charges (plus a $20 million preferred redemption premium), management reports earnings from operations of $858 million and diluted EPS of $2.62, up 16%. As reported, the company lost $214 million applicable to common shareholders, or $1.12 per diluted share, versus earnings of $2.26 in 1997.

The quality of earnings is the central issue for investors. The medical care ratio rose to 87.2% from 84.3%, with Medicare running at 92.0% after $111 million^b of contract losses in 13 of 24 Medicare markets. The company responded by withdrawing Medicare products from 86 counties effective January 1, 1999, and the filing discloses that re-entry is barred for five years.

Balance sheet and liquidity remain solid: cash and investments of $4.4 billion^c, over $1.0 billion of operating cash flow, shareholders' equity of $4.0 billion, and debt of $708 million after a $500 million preferred stock redemption. Management expects about $300 million of annual cost savings from the realignment by 2000, though only about $75 million is expected in 1999. The filing also flags material risks.

Six securities class action suits and two opt-out pension fund suits, seeking compensatory damages (the pension funds seek about $12.1 million^d), arise from statements about Medicare profitability during February to August 1998. The Year 2000 remediation is scheduled for completion by September 30, 1999, at a projected total cost of $79 million. Heavy regulation of Medicare, Medicaid and HMOs, along with ongoing government audits, remains an overhang.

02—Key points

Key Highlights

Record 1998 revenues of $17.4 billion, up 47% from $11.8 billion in 1997, driven largely by the $3.5 billion AARP Medicare supplement contract
Reported net loss applicable to common shareholders of $214 million ($1.12 per diluted share) after $725 million in realignment charges and $175 million in medical cost charges
Underlying diluted EPS of $2.62 excluding special charges, up 16% from $2.26 in 1997 (management's non-GAAP-style figure)
Consolidated medical care ratio worsened to 87.2% from 84.3%; Medicare ratio reached 92.0%, versus 85.8% excluding AARP for the consolidated company
Withdrawal of Medicare products from 86 of 206 counties effective January 1, 1999, affecting about 60,000 members and roughly $225 million of 1998 revenue, with re-entry barred for five years
Strong liquidity: $4.4 billion of cash and investments, over $1.0 billion of operating cash flow, $4.0 billion of shareholders' equity, and $708 million of debt after redeeming $500 million of convertible preferred stock
Pending securities class actions and pension fund opt-out suits tied to 1998 Medicare disclosures, alongside a $79 million Year 2000 remediation program due by September 1999

03—Questions

Frequently Asked Questions

Why did UnitedHealth report a loss in 1998 when it had record revenue?
The company recorded $725 million of operational realignment and other charges in the second quarter, including $451 million of asset impairments, plus $175 million of medical cost charges tied to Medicare contract losses and higher commercial medical cost estimates. Those charges, along with a $20 million preferred stock redemption premium, produced a net loss applicable to common shareholders of $214 million. Management argues the underlying business remained profitable, with earnings from operations of $858 million before the special items.
How much of the 1998 growth came from the AARP contract, and how profitable is that business?
The AARP program contributed $3.5 billion of premium revenue in 1998, starting January 1, 1998, covering about 4 million members. The business carries a medical care ratio of roughly 92%, which is well above the company's commercial ratio. Excluding AARP, consolidated premium revenue grew 19% to $12.0 billion, and the consolidated medical care ratio was 85.8%. Investors should note that the AARP contract is a ten-year arrangement, and the company's results depend on servicing these members profitably.
What are the main legal risks to investors?
Six federal securities class actions allege the company made materially false statements about Medicare profitability and realignment costs between February 12 and August 5, 1998. The stock fell from $52 7/8 to $37 7/8 after the company disclosed its true condition on August 6, 1998. Two pension funds also filed opt-out suits seeking about $12.1 million in damages. The company says it will defend these cases vigorously, and the filing does not quantify a probable loss from the class actions.
Is the company's dividend and capital position at risk?
The annual common dividend is $0.03 per share, payable April 15, 1999, a token amount that is not a meaningful income return. The balance sheet is sound, with $4.4 billion in cash and investments, although only about $500 million was available for general corporate use after regulatory restrictions. Subsidiaries can pay roughly $120 million in dividends to the parent without prior regulatory approval. Pending NAIC risk-based capital rules for HMOs could increase capital requirements for some subsidiaries, though management does not expect a significant aggregate impact.
What should investors expect for 1999?
Management expects medical cost trends of 4% to 5%, a medical care ratio improvement from premium yield increases of 7% to 8% on new and renewal commercial business, and about $75 million of realignment savings in 1999, rising to roughly $300 million annually by 2000. Medicare remains a concern because the company continues to exit unprofitable markets and cannot assure it will prevent future losses. The Year 2000 program is expected to be complete by September 30, 1999, and the company says it expects to avoid material operational disruption, though it acknowledges that failures by critical vendors or providers could still affect results.

04—Continue

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