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Slide 1: UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q ≤ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2004 or n TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission Ñle number: 1-10864 UnitedHealth Group Incorporated (Exact name of registrant as speciÑed in its charter) Minnesota (State or other jurisdiction of incorporation or organization) 41-1321939 (I.R.S. Employer IdentiÑcation No.) UnitedHealth Group Center 9900 Bren Road East Minnetonka, Minnesota (Address of principal executive oÇces) 55343 (Zip Code) (952) 936-1300 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has Ñled all reports required to be Ñled 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 Ñle such reports), and (2) has been subject to such Ñling requirements for the past 90 days. Yes ¥ No n Indicate by check mark whether the registrant is an accelerated Ñler (as deÑned in Rule 12b-2 of the Exchange Act). Yes ¥ No n As of November 4, 2004, 653,628,555 shares of the registrant's Common Stock, $.01 par value per share, were issued and outstanding.
Slide 2: UNITEDHEALTH GROUP INDEX Page Number Part I. Financial Information Item 1. Financial Statements (Unaudited) Condensed Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003ÏÏÏ Condensed Consolidated Statements of Operations for the three and nine month periods ended September 30, 2004 and 2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Condensed Consolidated Statements of Cash Flows for the nine month periods ended September 30, 2004 and 2003 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Notes to Condensed Consolidated Financial Statements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Report of Independent Registered Public Accounting Firm ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 3. Quantitative and Qualitative Disclosures about Market Risk ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 4. Controls and Procedures ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Part II. Other Information Item 1. Legal Proceedings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 2. Issuer Purchases of Equity Securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 5. Other InformationÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Item 6. Exhibits and Reports on Form 8-K ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Signatures ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Exhibits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3 4 5 6 18 19 34 35 35 36 37 37 39 40 2
Slide 3: PART I. FINANCIAL INFORMATION Item 1. Financial Statements (unaudited) UNITEDHEALTH GROUP CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) (In millions, except share and per share data) September 30, 2004 December 31, 2003 ASSETS Current Assets Cash and Cash Equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Short-Term Investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accounts Receivable, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Assets Under ManagementÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred Income Taxes and Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Current Assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-Term Investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Property, Equipment, Capitalized Software, and Other Assets, netÏÏÏÏÏÏÏÏÏÏÏ Goodwill ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other Intangible Assets, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ TOTAL ASSETS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Medical Costs Payable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accounts Payable and Accrued Liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other Policy Liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Commercial Paper and Current Maturities of Long-Term Debt ÏÏÏÏÏÏÏÏÏÏÏ Unearned Premiums ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Current Liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-Term Debt, less current maturities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Future Policy BeneÑts for Life and Annuity ContractsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred Income Taxes and Other Liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Commitments and Contingencies (Note 12) Shareholders' Equity Common Stock, $0.01 par value Ì 1,500 shares authorized; 654 and 583 issued and outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Additional Paid-In Capital ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Retained Earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accumulated Other Comprehensive Income: Net Unrealized Gains on Investments, net of tax eÅects ÏÏÏÏÏÏÏÏÏÏÏ Total Shareholders' Equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ See notes to condensed consolidated Ñnancial statements 3 $ 3,635 774 910 1,959 918 8,196 8,091 1,196 9,165 1,249 $27,897 $ 2,262 486 745 2,019 608 6,120 6,729 1,096 3,509 180 $17,634 $ 5,541 2,149 1,965 150 762 10,567 3,750 1,642 871 $ 4,152 1,575 2,117 229 695 8,768 1,750 1,517 471 7 4,179 6,745 136 11,067 $27,897 6 58 4,915 149 5,128 $17,634
Slide 4: UNITEDHEALTH GROUP CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (In millions, except per share data) Three Months Ended September 30, 2004 2003 Nine Months Ended September 30, 2004 2003 REVENUES Premiums ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Services ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investment and Other Income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total RevenuesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ MEDICAL AND OPERATING COSTS Medical CostsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Operating Costs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Depreciation and Amortization ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Medical and Operating Costs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ EARNINGS FROM OPERATIONS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest ExpenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ EARNINGS BEFORE INCOME TAXES ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision for Income Taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ NET EARNINGS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ BASIC NET EARNINGS PER COMMON SHARE ÏÏÏÏÏÏÏ DILUTED NET EARNINGS PER COMMON SHAREÏÏÏÏ BASIC WEIGHTED-AVERAGE NUMBER OF COMMON SHARES OUTSTANDING ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ DILUTIVE EFFECT OF OUTSTANDING STOCK OPTIONSÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ DILUTED WEIGHTED-AVERAGE NUMBER OF COMMON SHARES OUTSTANDING ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $8,920 842 97 9,859 7,180 1,488 99 8,767 1,092 (34) 1,058 (360) $ 698 $ 1.09 $ 1.04 641 29 670 $6,395 780 63 7,238 5,174 1,226 75 6,475 763 (24) 739 (263) $ 476 $ 0.81 $ 0.77 589 28 617 $23,985 2,444 278 26,707 19,375 4,151 268 23,794 2,913 (86) 2,827 (979) $ 1,848 $ $ 2.99 2.85 618 30 648 $18,791 2,329 180 21,300 15,333 3,620 222 19,175 2,125 (71) 2,054 (736) $ 1,318 $ $ 2.23 2.13 592 28 620 See notes to condensed consolidated Ñnancial statements 4
Slide 5: UNITEDHEALTH GROUP CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In millions) Nine Months Ended September 30, 2004 2003 OPERATING ACTIVITIES Net Earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Noncash Items: Depreciation and Amortization ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred Income Taxes and Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net Change in Other Operating Items, net of eÅects from acquisitions and changes in AARP balances: Accounts Receivable and Other AssetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Medical Costs Payable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accounts Payable and Other Accrued LiabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unearned Premiums ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash Flows From Operating Activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ INVESTING ACTIVITIES Cash Paid for Acquisitions, net of cash assumed and other eÅects ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchases of Property, Equipment and Capitalized Software ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchases of Investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Maturities and Sales of Investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash Flows Used For Investing Activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ FINANCING ACTIVITIES Proceeds from Common Stock Issuances ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Common Stock Repurchases ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Repayments of Commercial Paper, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from Issuances of Long-Term Debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash Flows From (Used For) Financing Activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ INCREASE IN CASH AND CASH EQUIVALENTS ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ CASH AND CASH EQUIVALENTS, END OF PERIOD ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Supplementary schedule of noncash investing activities: Common stock issued for acquisitionsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,848 268 25 $1,318 222 28 (31) 335 606 (166) 2,885 (1,912) (240) (2,076) 2,420 (1,808) 440 (2,098) (79) 2,000 33 296 1,373 2,262 $3,635 $5,557 (17) 291 430 (139) 2,133 (87) (281) (1,927) 2,267 (28) 214 (1,362) (461) 450 (9) (1,168) 937 1,130 $2,067 $ Ì See notes to condensed consolidated Ñnancial statements 5
Slide 6: UNITEDHEALTH GROUP NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation and Use of Estimates Unless the context otherwise requires, the use of the terms the ""Company,'' ""we,'' ""us,'' and ""our'' in the following refers to UnitedHealth Group Incorporated and its subsidiaries. The accompanying unaudited condensed consolidated Ñnancial statements reÖect all adjustments, consisting solely of normal recurring adjustments, needed to present the Ñnancial results for these interim periods fairly. In accordance with the rules and regulations of the Securities and Exchange Commission, we have omitted certain footnote disclosures that would substantially duplicate the disclosures contained in our annual audited Ñnancial statements. Read together with the disclosures below, we believe the interim Ñnancial statements are presented fairly. However, these unaudited condensed consolidated Ñnancial statements should be read together with the consolidated Ñnancial statements and the notes included in our Annual Report on Form 10-K for the year ended December 31, 2003. These consolidated Ñnancial statements include certain amounts that are based on our best estimates and judgments. These estimates require us to apply complex assumptions and judgments, often because we must make estimates about the eÅects of matters that are inherently uncertain and will change in subsequent periods. The most signiÑcant estimates relate to medical costs, medical costs payable, revenues, contingent liabilities, and asset valuations, allowances and impairments. We adjust these estimates each period, as more current information becomes available, and any adjustment could have a signiÑcant impact on our consolidated operating results. The impact of any changes in estimates is included in the determination of earnings in the period in which the estimate is adjusted. 2. Stock-Based Compensation We account for activity under our stock-based employee compensation plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, ""Accounting for Stock Issued to Employees.'' Accordingly, we do not recognize compensation expense when we grant employee stock options because we grant stock options at exercise prices not less than the fair value of our common stock on the date of grant. The following table shows the eÅect on net earnings and earnings per share had we applied the fair value expense recognition provisions of Statement of Financial Accounting Standards (FAS) No. 123, ""Accounting for Stock-Based Compensation,'' to stock-based employee compensation (in millions, except per share data). Three Months Ended September 30, 2004 2003 Nine Months Ended September 30, 2004 2003 NET EARNINGS As Reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Compensation Expense, net of tax eÅect ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pro FormaÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ BASIC NET EARNINGS PER COMMON SHARE As Reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pro FormaÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ DILUTED NET EARNINGS PER COMMON SHARE As Reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pro FormaÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 6 $ 698 (31) $ 667 $1.09 $1.04 $1.04 $1.00 $ 476 (32) $ 444 $0.81 $0.75 $0.77 $0.72 $1,848 (95) $1,753 $ 2.99 $ 2.83 $ 2.85 $ 2.71 $1,318 (92) $1,226 $ 2.23 $ 2.07 $ 2.13 $ 1.98
Slide 7: UNITEDHEALTH GROUP NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) 3. Acquisitions On July 29, 2004, our Health Care Services business segment acquired Oxford Health Plans, Inc. (Oxford). Oxford provides health care and beneÑt services for individuals and employers, principally in New York City, northern New Jersey and southern Connecticut. This merger signiÑcantly strengthens our market position in this region and provides substantial distribution opportunities for our other UnitedHealth Group businesses. Under the terms of the purchase agreement, Oxford shareholders received 0.6357 shares of UnitedHealth Group common stock and $16.17 in cash for each share of Oxford common stock they owned. Total consideration issued was approximately $5.0 billion, comprised of approximately 52.2 million shares of UnitedHealth Group common stock (valued at approximately $3.4 billion based upon the average of UnitedHealth Group's share closing price for two days before, the day of and two days after the acquisition announcement date of April 26, 2004), approximately $1.3 billion in cash and UnitedHealth Group vested common stock options with an estimated fair value of $240 million issued in exchange for Oxford's outstanding vested common stock options. The purchase price and costs associated with the acquisition exceeded the preliminary estimated fair value of the net tangible assets acquired by approximately $4.1 billion. We have preliminarily allocated the excess purchase price over the fair value of the net tangible assets acquired to Ñnite-lived intangible assets of $735 million and associated deferred tax liabilities of $277 million, and goodwill of approximately $3.7 billion. The Ñnite-lived intangible assets consist primarily of member lists and health care physician and hospital networks, with an estimated weighted-average useful life of 15 years. The acquired goodwill is not deductible for income tax purposes. Our preliminary estimate of the fair value of the tangible assets/(liabilities) as of the acquisition date, which is subject to further reÑnement, is as follows: (in millions Ì unaudited) Cash, Cash Equivalents and InvestmentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accounts Receivable and Other Current Assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Property, Equipment, Capitalized Software and Other Assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Medical Costs Payable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other Current Liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net Tangible Assets AcquiredÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,680 169 37 (713) (317) $ 856 On February 10, 2004, our Health Care Services business segment acquired Mid Atlantic Medical Services, Inc. (MAMSI). MAMSI oÅers a broad range of health care coverage and related administrative services for individuals and employers in the mid-Atlantic region of the United States. This merger signiÑcantly strengthens UnitedHealthcare's market position in the mid-Atlantic region and provides substantial distribution opportunities for other UnitedHealth Group businesses. Under the terms of the purchase agreement, MAMSI shareholders received 0.82 shares of UnitedHealth Group common stock and $18 in cash for each share of MAMSI common stock they owned. Total consideration issued was approximately $2.7 billion, comprised of 36.4 million shares of UnitedHealth Group common stock (valued at $1.9 billion based on the average of UnitedHealth Group's share closing price for two days before, the day of and two days after the acquisition announcement date of October 27, 2003) and $800 million in cash. The purchase price and costs associated with the acquisition exceeded the preliminary estimated fair value of the net tangible assets acquired by approximately $2.1 billion. We have preliminarily allocated the excess purchase price over the fair value of the net tangible assets acquired to Ñnite-lived intangible assets of $360 million and associated deferred tax liabilities of $126 million, and goodwill of approximately $1.9 billion. The Ñnite-lived intangible assets consist primarily of member lists and health care physician and hospital networks, with an estimated weighted-average useful life of 19 years. The acquired goodwill is not deductible for income tax purposes. Our 7
Slide 8: UNITEDHEALTH GROUP NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) preliminary estimate of the fair value of the tangible assets/(liabilities) as of the acquisition date, which is subject to further reÑnement, is as follows: (in millions Ì unaudited) Cash, Cash Equivalents and Investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accounts Receivable and Other Current Assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Property, Equipment, Capitalized Software and Other Assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Medical Costs Payable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other Current LiabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net Tangible Assets Acquired ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $736 228 89 (297) (132) $624 The results of operations and Ñnancial condition of Oxford and MAMSI have been included in our Condensed Consolidated Statements of Operations and Condensed Consolidated Balance Sheets since the acquisition date. The unaudited pro forma Ñnancial information presented below assumes that the acquisitions of Oxford and MAMSI had occurred as of the beginning of each respective period presented below. The pro forma adjustments include the pro forma eÅect of UnitedHealth Group shares issued in the acquisitions, the amortization of Ñnite-lived intangible assets arising from the preliminary purchase price allocations, interest expense related to Ñnancing the cash portion of the purchase price and the associated income tax eÅects of the pro forma adjustments. Because the unaudited pro forma Ñnancial information has been prepared based on preliminary estimates of fair values, the actual amounts recorded as of the completion of the purchase price allocation may diÅer materially from the information presented below. The unaudited pro forma results have been prepared for comparative purposes only and do not purport to be indicative of the results of operations that would have occurred had the Oxford and MAMSI acquisitions been consummated at the beginning of the respective periods. For the Three Months Ended September 30, 2004 2003 For the Nine Months Ended September 30, 2004 2003 Proforma Ì unaudited (In millions, except per share data) RevenuesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net Earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Earnings Per Share Basic ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4. Cash, Cash Equivalents and Investments $10,302 $ 719 $ $ 1.09 1.05 $9,239 $ 611 $ 0.90 $ 0.86 $30,262 $ 2,037 $ $ 3.07 2.94 $27,269 $ 1,627 $ $ 2.39 2.29 As of September 30, 2004, the amortized cost, gross unrealized gains and losses, and fair value of cash, cash equivalents and investments were as follows (in millions): Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Cash and Cash Equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Debt Securities Ì Available for Sale ÏÏÏÏÏÏÏÏÏÏÏÏ Equity Securities Ì Available for SaleÏÏÏÏÏÏÏÏÏÏÏ Debt Securities Ì Held to MaturityÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Cash and Investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8 $ 3,635 8,334 182 143 $12,294 $Ì 213 9 Ì $222 $Ì (14) (2) Ì $(16) $ 3,635 8,533 189 143 $12,500
Slide 9: UNITEDHEALTH GROUP NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) During the three and nine month periods ended September 30, we recorded realized gains and losses on the sale of investments, excluding the UnitedHealth Capital dispositions described below, as follows (in millions): Three Months Ended September 30, 2004 2003 Nine Months Ended September 30, 2004 2003 Gross Realized Gains ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gross Realized LossesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net Realized Gains ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $6 (6) $Ì $13 (5) $8 $26 (11) $15 $35 (21) $14 In addition, during the Ñrst quarter of 2004, we realized a capital gain of $25 million on the sale of certain UnitedHealth Capital investments. With the proceeds from this sale, we made a cash contribution of $25 million to the United Health Foundation in the Ñrst quarter of 2004. The realized gain of $25 million and the related contribution expense of $25 million are included in Investment and Other Income in the accompanying Condensed Consolidated Statement of Operations. 5. Goodwill and Other Intangible Assets Changes in the carrying amount of goodwill, by operating segment, for the nine months ended September 30, 2004 and 2003, were as follows (in millions): Health Care Services Uniprise Specialized Care Services Ingenix Consolidated Total Balance at December 31, 2003ÏÏÏÏÏÏÏÏÏÏ Acquisitions and Subsequent Payments ÏÏ Balance at September 30, 2004 ÏÏÏÏÏÏÏÏÏ $1,770 5,630 $7,400 Health Care Services $698 Ì $698 $409 Ì $409 Specialized Care Services $632 26 $658 $3,509 5,656 $9,165 Consolidated Total Uniprise Ingenix Balance at December 31, 2002ÏÏÏÏÏÏÏÏÏÏ Acquisitions and Subsequent Payments ÏÏ Balance at September 30, 2003 ÏÏÏÏÏÏÏÏÏ $1,693 12 $1,705 $698 Ì $698 $363 38 $401 $609 11 $620 $3,363 61 $3,424 The weighted-average useful life, gross carrying value, accumulated amortization and net carrying value of other intangible assets as of September 30, 2004 and December 31, 2003 were as follows (in millions): WeightedAverage Useful Life September 30, 2004 Gross Net Carrying Accumulated Carrying Value Amortization Value December 31, 2003 Gross Carrying Value Accumulated Amortization Net Carrying Value Customer Contracts and Membership Lists ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Patents, Trademarks and Technology ÏÏÏÏÏÏÏ Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 16 years 9 years 11 years 14 years $1,174 64 91 $1,329 $(31) (31) (18) $(80) $1,143 33 73 $1,249 $ 93 73 57 $223 $ (6) (26) (11) $(43) $ 87 47 46 $180 Amortization expense relating to other intangible assets was $18 million and $37 million for the three and nine months ended September 30, 2004 and $5 million and $13 million for the three and nine months ended September 30, 2003. 9
Slide 10: UNITEDHEALTH GROUP NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) Estimated amortization expense for the years ending December 31 relating to other intangible assets included in the September 30, 2004 Condensed Consolidated Balance Sheets is as follows (in millions): 2004 2005 2006 2007 2008 $60 6. $93 $92 $89 $87 Medical Costs and Medical Costs Payable Medical costs and medical costs payable include estimates of our obligations for medical care services that have been rendered on behalf of insured consumers but for which claims have either not yet been received or processed, and estimates of liabilities for physician, hospital and other medical cost disputes. We develop estimates for medical costs incurred but not reported using an actuarial process that is consistently applied, centrally controlled and automated. The actuarial models consider factors such as time from date of service to claim receipt, claim backlogs, care provider contract rate changes, medical care consumption and other medical cost trends. Each period, we re-examine previously established medical costs payable estimates based on actual claim submissions and other changes in facts and circumstances. As the liability estimates recorded in prior periods become more exact, we increase or decrease the amount of the estimates, with the changes in estimates included in medical costs in the period in which the change is identiÑed. In every reporting period, our operating results include the eÅects of more completely developed medical costs payable estimates associated with previously reported periods. Medical costs for the three months ended September 30, 2004 include approximately $50 million of favorable medical cost development related to prior Ñscal years and approximately $50 million of favorable medical cost development related to the Ñrst and second quarters of 2004. Medical costs for the three months ended September 30, 2003 include approximately $20 million of favorable medical cost development related to prior Ñscal years and approximately $80 million of favorable medical cost development related to the Ñrst and second quarters of 2003. Medical costs for the nine months ended September 30, 2004 and 2003 include approximately $200 million and $130 million, respectively, of favorable medical cost development related to prior years. Management believes the amount of medical costs payable is reasonable and adequate to cover the Company's liability for unpaid claims as of September 30, 2004. 10
Slide 11: UNITEDHEALTH GROUP NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) 7. Commercial Paper and Debt September 30, 2004 Carrying Fair Value Value December 31, 2003 Carrying Fair Value Value Commercial paper and debt consisted of the following (in millions): Commercial Paper ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Floating-Rate Notes due November 2004ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 7.5% Senior Unsecured Notes due November 2005ÏÏÏÏÏÏ 5.2% Senior Unsecured Notes due January 2007 ÏÏÏÏÏÏÏÏ 3.4% Senior Unsecured Notes due August 2007 ÏÏÏÏÏÏÏÏ 3.3% Senior Unsecured Notes due January 2008 ÏÏÏÏÏÏÏÏ 3.8% Senior Unsecured Notes due February 2009 ÏÏÏÏÏÏÏ 4.1% Senior Unsecured Notes due August 2009 ÏÏÏÏÏÏÏÏ 4.9% Senior Unsecured Notes due April 2013 ÏÏÏÏÏÏÏÏÏÏ 4.8% Senior Unsecured Notes due February 2014 ÏÏÏÏÏÏÏ 5.0% Senior Unsecured Notes due August 2014 ÏÏÏÏÏÏÏÏ Total Commercial Paper and Debt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Less Current Maturities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-Term Debt, less current maturities ÏÏÏÏÏÏÏÏÏÏÏÏ $ Ì 150 400 400 550 500 250 450 450 250 500 3,900 (150) $ Ì 150 422 417 549 497 249 454 456 250 507 3,951 (150) $ 79 150 400 400 Ì 500 Ì Ì 450 Ì Ì 1,979 (229) $ 79 150 438 427 Ì 499 Ì Ì 454 Ì Ì 2,047 (229) $3,750 $3,801 $1,750 $1,818 In July 2004, we issued $1.2 billion of commercial paper to fund the cash portion of the Oxford purchase price. In August 2004, we reÑnanced the commercial paper by issuing $550 million of 3.4% Ñxed-rate notes due August 2007, $450 million of 4.1% Ñxed-rate notes due August 2009 and $500 million of 5.0% Ñxed-rate notes due August 2014. In February 2004, we issued $250 million of 3.8% Ñxed-rate notes due February 2009 and $250 million of 4.8% Ñxed-rate notes due February 2014 to Ñnance a majority of the cash portion of the MAMSI purchase price. In December 2003, we issued $500 million of 3.3% Ñxed-rate notes due January 2008, and in March 2003, we issued $450 million of 4.9% Ñxed-rate notes due April 2013. We used the proceeds from these borrowings to repay commercial paper and term debt maturing in 2003, and for general corporate purposes including working capital, business acquisitions and share repurchases. We have interest rate swap agreements that qualify as fair value hedges to convert the majority of our interest rate exposure from a Ñxed to a variable rate. The interest rate swap agreements have aggregate notional amounts of $2.9 billion with variable rates that are benchmarked to the six-month LIBOR rate. At September 30, 2004, the rates used to accrue interest expense on these agreements ranged from 2.1% to 2.7%. The diÅerential between the Ñxed and variable rates to be paid or received is accrued and recognized over the life of the agreements as an adjustment to interest expense in the Condensed Consolidated Statements of Operations. The interest rates on our November 2004 Öoating-rate notes are reset quarterly to the three-month LIBOR (London Interbank OÅered Rate) plus 0.6%. As of September 30, 2004, the applicable rate on the notes was 2.3%. In June 2004, we executed a credit arrangement for a $1 billion Ñve-year revolving credit facility to support our commercial paper program. This credit facility replaced our $450 million revolving facility that was set to expire in July 2005, and our $450 million, 364-day facility that was set to expire in July 2004. In June 2004, we also executed a credit arrangement for a $1.5 billion 364-day bridge facility. The bridge facility was used to support the issuance of commercial paper to fund the cash portion of the Oxford purchase price in July 2004. The bridge facility was terminated in August 2004 in conjunction with the reÑnancing of the commercial paper discussed above. As of September 30, 2004, we had no amounts outstanding under these credit facilities. 11
Slide 12: UNITEDHEALTH GROUP NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) Our debt arrangements and credit facilities contain various covenants, the most restrictive of which require us to maintain a debt-to-total-capital ratio below 45% and to exceed speciÑed minimum interest coverage levels. We are in compliance with the requirements of all debt covenants. 8. AARP In January 1998, we initiated a 10-year contract to provide health insurance products and services to members of AARP. Under the terms of the contract, we are compensated for transaction processing and other services as well as for assuming underwriting risk. We are also engaged in product development activities to complement the insurance oÅerings under this program. Premium revenues from our portion of the AARP insurance oÅerings are approximately $4.5 billion annually. The underwriting gains or losses related to the AARP business are directly recorded as an increase or decrease to a rate stabilization fund (RSF). The primary components of the underwriting results are premium revenue, medical costs, investment income, administrative expenses, member services expenses, marketing expenses and premium taxes. Underwriting gains and losses are recorded as an increase or decrease to the RSF and accrue to AARP policyholders, unless cumulative net losses were to exceed the balance in the RSF. To the extent underwriting losses exceed the balance in the RSF, we would have to fund the deÑcit. Any deÑcit we fund could be recovered by underwriting gains in future periods of the contract. To date, we have not been required to fund any underwriting deÑcits. The RSF balance is reported in Other Policy Liabilities in the accompanying Condensed Consolidated Balance Sheets. We believe the RSF balance is suÇcient to cover potential future underwriting or other risks associated with the contract. The following AARP program-related assets and liabilities are included in our Condensed Consolidated Balance Sheets (in millions): Balance as of September 30, December 31, 2004 2003 Accounts Receivable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Assets Under ManagementÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Medical Costs Payable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other Policy Liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other Current Liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 382 $1,921 $ 888 $1,230 $ 185 $ 352 $1,959 $ 874 $1,275 $ 162 The eÅects of changes in balance sheet amounts associated with the AARP program accrue to AARP policyholders through the RSF balance. Accordingly, we do not include the eÅect of such changes in our Condensed Consolidated Statements of Cash Flows. Pursuant to our agreement, AARP assets under management are managed separately from our general investment portfolio and are used to pay costs associated with the AARP program. These assets are invested at our discretion, within investment guidelines approved by AARP. Interest earnings and realized investment gains and losses on these assets accrue to AARP policyholders through the RSF. As such, they are not included in our earnings. Assets under management are reported at their fair market value, and unrealized gains and losses are included directly in the RSF associated with the AARP program. As of September 30, 2004 and December 31, 2003, the amortized cost, gross unrealized gains and losses, and fair value of cash, 12
Slide 13: UNITEDHEALTH GROUP NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) cash equivalents and investments associated with the AARP insurance program, included in Assets Under Management, were as follows (in millions): September 30, 2004 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Cash and Cash Equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Debt Securities Ì Available for Sale ÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Cash and Investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 208 1,663 $1,871 Amortized Cost $Ì 52 $52 Gross Unrealized Gains $Ì (2) $(2) Gross Unrealized Losses $ 208 1,713 $1,921 Fair Value December 31, 2003 Cash and Cash Equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Debt Securities Ì Available for Sale ÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Cash and Investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 218 1,655 $1,873 $Ì 86 $86 $Ì Ì $Ì $ 218 1,741 $1,959 As of September 30, 2004 and December 31, 2003, respectively, debt securities consisted of $770 million and $711 million in U.S. Government and Agency obligations, $20 million and $16 million in state and municipal obligations and $923 million and $1,014 million in investment grade corporate obligations. At September 30, 2004 and December 31, 2003, respectively, debt securities with maturities of less than one year totaled $81 million and $52 million, debt securities maturing in one to Ñve years totaled $973 million and $1,404 million, debt securities maturing in Ñve to 10 years totaled $413 million and $160 million and debt securities with maturities more than 10 years totaled $246 million and $125 million. 9. Stock Repurchase Program Under our board of directors' authorization, we maintain a common stock repurchase program. Repurchases may be made from time to time at prevailing prices, subject to restrictions on volume, pricing and timing. During the nine months ended September 30, 2004, we repurchased 33.7 million shares through this program at an average price of approximately $63 per share and at an aggregate cost of $2.1 billion. In November 2004, the board of directors renewed the stock repurchase program. The Company is currently authorized to repurchase up to 65 million shares of common stock under the program. 10. Comprehensive Income The table below presents comprehensive income, deÑned as changes in the equity of our business excluding changes resulting from investments by and distributions to our shareholders, for the three and nine month periods ended September 30 (in millions): Three Months Ended September 30, 2004 2003 Nine Months Ended September 30, 2004 2003 Net Earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in Net Unrealized Gains on Investments, net of tax effects ÏÏ Comprehensive Income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $698 99 $797 $476 (29) $447 $1,848 (13) $1,835 $1,318 8 $1,326 13
Slide 14: UNITEDHEALTH GROUP NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) 11. Segment Financial Information The following is a description of the types of products and services from which each of our business segments derives its revenues: ‚ Health Care Services consists of the UnitedHealthcare, Ovations and AmeriChoice businesses. UnitedHealthcare coordinates network-based health and well-being services on behalf of local employers and consumers. Ovations delivers health and well-being services for Americans over the age of 50. AmeriChoice facilitates and manages health care services for state Medicaid programs and their beneÑciaries. The Ñnancial results of UnitedHealthcare, Ovations and AmeriChoice have been combined in the Health Care Services segment column in the tables presented below because these businesses have similar economic characteristics and have similar products and services, types of customers, distribution methods and operational processes, and operate in a similar regulatory environment, typically within the same legal entity. ‚ Uniprise provides network-based health and well-being access and services, business-to-business transaction processing services, consumer connectivity and technology support services to large employers and health plans. ‚ Specialized Care Services is a portfolio of health and well-being companies, each serving a specialized market need with an oÅering of beneÑts, networks, services and resources. ‚ Ingenix is a leader in the Ñeld of health care information serving pharmaceutical, biotechnology and medical device companies, health insurers and other payers, physicians and other health care providers, large employers and government agencies. Transactions between business segments principally consist of customer service and transaction processing services Uniprise provides to Health Care Services, certain product oÅerings sold to Uniprise and Health Care Services customers by Specialized Care Services, and sales of medical beneÑts cost, quality and utilization data and predictive modeling to Health Care Services and Uniprise by Ingenix. These transactions are recorded at management's best estimate of fair value, as if the services were purchased from or sold to third parties. All intersegment transactions are eliminated in consolidation. Assets and liabilities that are jointly used are assigned to each segment using estimates of pro-rata usage. Cash and investments are assigned such that each segment has minimum speciÑed levels of regulatory capital or working capital for non-regulated businesses. The ""Eliminations'' column includes eliminations of inter-segment transactions. 14
Slide 15: UNITEDHEALTH GROUP NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) The following table presents segment Ñnancial information for the three and nine month periods ended September 30, 2004 and 2003 (in millions): Three Months Ended September 30, 2004 Health Care Services Uniprise Specialized Care Services Ingenix Eliminations Consolidated Revenues Ì External Customers ÏÏ $ 8,627 $ 676 Revenues Ì Intersegment ÏÏÏÏÏÏÏÏ Ì 159 Investment and Other Income ÏÏÏÏ 85 7 Total Revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 8,712 $ 842 Earnings from Operations ÏÏÏÏÏÏÏÏ $ 763 $ 171 $ 346 229 5 $ 580 $ 124 Specialized Care Services $113 57 Ì $170 $ 34 $ Ì (445) Ì $ 9,762 Ì 97 $ 9,859 $ 1,092 $ (445) $ Ì Three Months Ended September 30, 2003 Health Care Services Uniprise Ingenix Eliminations Consolidated Revenues Ì External Customers ÏÏ $ 6,173 $ 625 Revenues Ì Intersegment ÏÏÏÏÏÏÏÏ Ì 145 Investment and Other Income ÏÏÏÏ 51 8 Total Revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 6,224 $ 778 Earnings from Operations ÏÏÏÏÏÏÏÏ $ 490 $ 154 $ 273 199 4 $ 476 $ 100 Specialized Care Services $104 44 Ì $148 $ 19 $ Ì (388) Ì $ 7,175 Ì 63 $ 7,238 $ 763 $ (388) $ Ì Nine Months Ended September 30, 2004 Health Care Services Uniprise Ingenix Eliminations Consolidated Revenues Ì External Customers ÏÏ $23,108 $2,013 Revenues Ì Intersegment ÏÏÏÏÏÏÏÏ Ì 485 Investment and Other Income ÏÏÏÏ 242 22 Total Revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $23,350 $2,520 Earnings from Operations ÏÏÏÏÏÏÏÏ $ 1,976 $ 508 Health Care Services $1,012 681 14 $1,707 $ 356 Specialized Care Services $296 160 Ì $456 $ 73 $ Ì (1,326) Ì $26,429 Ì 278 $26,707 $ 2,913 $(1,326) $ Ì Nine Months Ended September 30, 2003 Uniprise Ingenix Eliminations Consolidated Revenues Ì External Customers ÏÏ $18,196 $1,865 Revenues Ì Intersegment ÏÏÏÏÏÏÏÏ Ì 436 Investment and Other Income ÏÏÏÏ 148 21 Total Revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $18,344 $2,322 Earnings from Operations ÏÏÏÏÏÏÏÏ $ 1,342 $ 459 12. Commitments and Contingencies $ 790 592 11 $1,393 $ 281 $269 126 Ì $395 $ 43 $ Ì (1,154) Ì $(1,154) $ Ì $21,120 Ì 180 $21,300 $ 2,125 Legal Matters Because of the nature of our businesses, we are routinely made party to a variety of legal actions related to the design, management and oÅerings of our services. We record liabilities for our estimates of probable costs resulting from these matters. These matters include, but are not limited to, claims relating to health care beneÑts coverage, medical malpractice actions, contract disputes and claims related to disclosure of certain business practices. Following the events of September 11, 2001, the cost of business insurance coverage 15
Slide 16: UNITEDHEALTH GROUP NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) increased signiÑcantly. As a result, we have increased the amount of risk that we self-insure, particularly with respect to matters incidental to our business. In 1999, a number of class action lawsuits were Ñled against us and virtually all major entities in the health beneÑts business. Generally, the suits are purported class actions on behalf of physicians for alleged breaches of federal statutes, including the Employee Retirement Income Security Act of 1974, as amended (ERISA), and the Racketeer InÖuenced Corrupt Organization Act (RICO). The suits seek injunctive, compensatory and equitable relief as well as restitution, costs, fees and interest payments. All activity in the trial court has been stayed pending the industry defendants' appeal of an arbitration order. In March 2000, the American Medical Association Ñled a lawsuit against the Company in connection with the calculation of reasonable and customary reimbursement rates for non-network providers. The suit seeks declaratory, injunctive and compensatory relief as well as costs, fees and interest payments. An amended complaint was Ñled on August 25, 2000, which alleged two classes of plaintiÅs, an ERISA class and a nonERISA class. After the court dismissed certain ERISA claims and the claims brought by the American Medical Association, a third amended complaint was Ñled. On October 25, 2002, the court granted in part and denied in part our motion to dismiss the third amended complaint. We are engaged in discovery in this matter. Although the results of pending litigation are always uncertain, we do not believe the results of any such actions currently threatened or pending, including those described above, will, individually or in aggregate, have a material adverse eÅect on our consolidated Ñnancial position or results of operations. Government Regulation Our business is regulated at federal, state, local and international levels. The laws and rules governing our business and interpretations of those laws and rules are subject to frequent change. Broad latitude is given to the agencies administering those regulations. State legislatures and Congress continue to focus on health care issues as the subject of proposed legislation. Existing or future laws and rules could force us to change how we do business, restrict revenue and enrollment growth, increase our health care and administrative costs and capital requirements, and increase our liability in federal and state courts for coverage determinations, contract interpretation and other actions. Further, we must obtain and maintain regulatory approvals to market many of our products. We are regularly subject to routine, regular and special governmental audits, investigations and enforcement actions. In addition, a state Department of Insurance or other state or federal authority (including CMS, the OÇce of the Inspector General, the OÇce of Personnel Management, the OÇce of Civil Rights, the Department of Justice, and state attorneys general) may from time to time begin a special audit of one of our health plans, our insurance plans or one of our other operations to investigate issues such as utilization management; Ñnancial, eligibility or other data reporting; prompt claims payment; or coverage determinations for medical services, including emergency room care. Any such government actions can result in assessment of damages, civil or criminal Ñnes or penalties, or other sanctions, including loss of licensure or exclusion from participation in government programs. We record liabilities for our estimate of probable costs resulting from these matters. Although the results of pending matters are always uncertain, we do not believe the results of any of the current investigations, audits or reviews, individually or in the aggregate, will have a material adverse eÅect on our consolidated Ñnancial position or results of operations. Other Contingencies In 2002, Oxford Health Plans, Inc. (Oxford), which we acquired on July 29, 2004, entered into agreements with two insurance companies that guaranteed cost reduction targets related to certain orthopedic medical services. In 2003, the insurers sought to rescind or terminate the agreements claiming various misrepresentations and material breaches of the agreements by Oxford. Pursuant to the agreements, Oxford has Ñled claims 16
Slide 17: UNITEDHEALTH GROUP NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) to recover $25 million of costs incurred and expensed in excess of the cost reduction targets for the period from November 2002 to October 2003. Oxford also anticipates it will Ñle additional claims of $25 million for costs incurred and expensed in excess of the cost reduction targets for the period from November 2003 to October 2004. Both insurers have commenced arbitrations. An arbitration hearing is scheduled for 2005. We believe the insurers' claims are without merit and we will vigorously seek to enforce our rights. 13. Recently Issued Accounting Standards In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation (FIN) No. 46, ""Consolidation of Variable Interest Entities Ì an Interpretation of ARB No. 51.'' FIN No. 46, as revised in December 2003, requires an enterprise to consolidate a variable interest entity if that enterprise has a variable interest that will absorb a majority of the entity's expected losses, receive a majority of the entity's expected residual returns, or both. The adoption of FIN No. 46 did not have any impact on our consolidated Ñnancial position or results of operations. In March 2004, the FASB issued an exposure draft of a proposed standard entitled ""Share Based Payment'', which would amend FAS No. 123, ""Accounting for Stock-Based Compensation,'' and FAS No. 95, ""Statement of Cash Flows.'' The proposed standard, if adopted, would require expensing stock options issued by the Company based on their estimated fair value at the date of grant and would be eÅective for the third quarter of 2005. Upon issuance of a Ñnal standard, which is expected in late 2004, the Company will evaluate the impact on our consolidated Ñnancial position and results of operations. In March 2004, the FASB issued EITF Issue No. 03-1 (""EITF 03-1''), ""The Meaning of Other-Than Temporary Impairment and its Application to Certain Investments.'' EITF 03-1 includes new guidance for evaluating and recording impairment losses on certain debt and equity investments when the fair value of the investment security is less than its carrying value. The provisions of this rule are required to be applied prospectively to all current and future investments accounted for in accordance with FAS No. 115, ""Accounting for Certain Investments in Debt and Equity Securities,'' and other cost method investments beginning in the third quarter of 2004. In September 2004, the FASB delayed the eÅective date for the measurement and recognition provisions until the issuance of additional implementation guidance, expected in December 2004. The Company is currently evaluating the impact of this new accounting standard on its process for determining other-than-temporary impairments of applicable debt and equity securities. 17
Slide 18: REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders UnitedHealth Group Incorporated Minnetonka, Minnesota We have reviewed the accompanying condensed consolidated balance sheet of UnitedHealth Group Incorporated and Subsidiaries (the Company) as of September 30, 2004, and the related condensed consolidated statements of operations for the three-month and nine-month periods ended September 30, 2004 and 2003, and of cash Öows for the nine-month periods ended September 30, 2004 and 2003. These condensed consolidated Ñnancial statements are the responsibility of the Company's management. We conducted our review in accordance with standards of the Public Company Accounting Oversight Board (United States). A review of interim Ñnancial information consists principally of applying analytical procedures and making inquiries of persons responsible for Ñnancial and accounting matters. It is substantially less in scope than an audit conducted in accordance with standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the Ñnancial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modiÑcations that should be made to such condensed consolidated Ñnancial statements for them to be in conformity with accounting principles generally accepted in the United States of America. We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of UnitedHealth Group Incorporated and Subsidiaries as of December 31, 2003, and the related consolidated statements of operations, shareholders' equity, and cash Öows for the year then ended (not presented herein); and in our report dated February 10, 2004, we expressed an unqualiÑed opinion on those consolidated Ñnancial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2003 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. /s/ DELOITTE & TOUCHE LLP Minneapolis, Minnesota November 5, 2004 18
Slide 19: Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read together with the accompanying unaudited condensed consolidated Ñnancial statements and notes. In addition, the following discussion should be considered in light of a number of factors that aÅect the Company, the industry in which we operate, and business generally. These factors are described in the Cautionary Statements section of this Quarterly Report. Summary highlights of our third quarter 2004 results include: ‚ Diluted net earnings per common share of $1.04, an increase of 35% from $0.77 per share reported in the third quarter of 2003 and an increase of 12% from $0.93 per share reported in the second quarter of 2004. ‚ Consolidated revenues of approximately $9.9 billion increased $2.6 billion, or 36%, over the third quarter of 2003. Excluding the impact of acquisitions, consolidated revenues increased by approximately 8% over the prior year. ‚ Earnings from operations of $1.1 billion, up $329 million, or 43%, over the prior year and up $147 million, or 16%, sequentially over the second quarter of 2004. ‚ Consolidated operating margin of 11.1% improved from 10.5% in the third quarter of 2003. ‚ Cash Öows from operations of nearly $2.9 billion for the nine months ended September 30, 2004, an increase of 35% compared to $2.1 billion for the nine months ended September 30, 2003. Summary Operating Information Three Months Ended September 30, Percent 2004 2003 Change Nine Months Ended September 30, Percent 2004 2003 Change (In millions, except per share data) Total Revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Earnings from OperationsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net Earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted Net Earnings Per Common ShareÏÏÏÏ Medical Care RatioÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Medical Care Ratio, excluding AARP ÏÏÏÏÏÏÏ Operating Cost Ratio ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Return on Equity (annualized) ÏÏÏÏÏÏÏÏÏÏÏÏÏ Operating Margin ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Results of Operations Consolidated Financial Results Revenues $9,859 $1,092 $ 698 $ 1.04 80.5% 79.3% 15.1% 30.7% 11.1% $7,238 $ 763 $ 476 $ 0.77 80.9% 79.5% 16.9% 40.4% 10.5% 36% 43% 47% 35% $26,707 $ 2,913 $ 1,848 $ 2.85 80.8% 79.5% 15.5% 32.3% 10.9% $21,300 $ 2,125 $ 1,318 $ 2.13 81.6% 80.3% 17.0% 38.4% 10.0% 25% 37% 40% 34% Revenues are comprised of premium revenues from risk-based products; service revenues, which primarily include fees for management, administrative and consulting services; and investment and other income. Premium revenues are primarily derived from risk-based health insurance arrangements in which the premium is Ñxed, typically for a one-year period, and we assume the economic risk of funding our customers' health care services and related administrative costs. Service revenues consist primarily of fees derived from services performed for customers that self-insure the medical costs of their employees and their dependents. For both premium risk-based and fee-based customer arrangements, we provide coordination and facilitation of medical services, transaction processing, customer, consumer and care provider services, and access to contracted networks of physicians, hospitals and other health care professionals. 19
Slide 20: Consolidated revenues for the three and nine months ended September 30, 2004 of $9.9 billion and $26.7 billion, respectively, increased by $2.6 billion, or 36%, and $5.4 billion, or 25%, over the comparable 2003 periods. Consolidated revenues for the three and nine months ended September 30, 2004 increased over the comparable 2003 periods by approximately 28% and 17%, respectively, as a result of revenues from businesses acquired since the third quarter of 2003 with the remaining increase due primarily to rate increases on premium and fee-based services and growth across business segments. Following is a discussion of third quarter consolidated revenue trends for each of our three revenue components. Premium Revenues Consolidated premium revenues for the three and nine month periods ended September 30, 2004 of $8.9 billion and $24.0 billion, respectively, increased by $2.5 billion, or 39%, and $5.2 billion, or 28%, over the comparable 2003 periods. Excluding the impact of acquisitions, consolidated premium revenues increased by approximately 9% for both the three and nine months ended September 30, 2004 over the comparable 2003 periods primarily driven by premium rate increases. For the three and nine months ended September 30, 2004, UnitedHealthcare premium revenues increased by $2.0 billion and $3.9 billion, respectively, due mainly to the acquisitions of Oxford, MAMSI and Golden Rule Financial Corporation (Golden Rule) since the third quarter of 2003 and average net premium rate increases of approximately 9% to 10% on UnitedHealthcare's renewing commercial risk-based business, partially oÅset by a decrease in the number of individuals served by risk-based products. Ovations premium revenues increased by approximately 22% and 16% for the three and nine months ended September 30, 2004, respectively, over the comparable 2003 periods driven by an increase in the number of individuals served by Medicare supplement products provided to AARP members and by Medicare Advantage products and the related premium rate increases as well as the acquired Oxford Medicare business. Premium revenues from AmeriChoice Medicaid programs for the three and nine months ended September 30, 2004 increased by $131 million, or 20%, and $353 million, or 19%, respectively, over the comparable 2003 periods primarily driven by an increase in the number of individuals served and the acquisition of a Medicaid health plan in Michigan in February 2004. The remaining premium revenue increase is due mainly to strong growth in several of Specialized Care Services' businesses. Service Revenues Service revenues during the three and nine months ended September 30, 2004 of $842 million and $2.4 billion, respectively, increased $62 million, or 8%, and $115 million, or 5%, over the comparable 2003 periods. The increase in service revenues was driven primarily by aggregate growth of approximately 4%, excluding the impact of acquisitions, in the number of individuals served by Uniprise and UnitedHealthcare under fee-based arrangements during the nine months ended September 30, 2004 over the comparable 2003 period, as well as annual rate increases. Investment and Other Income Investment and other income during the three and nine months ended September 30, 2004 totaled $97 million and $278 million, respectively, representing increases of $34 million and $98 million over the comparable 2003 periods. Interest income for the three and nine months ended September 30, 2004 increased by $42 million and $97 million, respectively, over the comparable 2003 periods mainly due to the impact of increased levels of cash and Ñxed-income investments from the acquisitions of Oxford, MAMSI and Golden Rule. Net capital gains on sales of investments for the three and nine months ended September 30, 2004 were zero and $15 million, respectively, compared with $8 million and $14 million for the three and nine months ended September 30, 2003. Medical Costs The combination of pricing, beneÑt designs, consumer health care utilization and comprehensive care facilitation eÅorts is reÖected in the medical care ratio (medical costs as a percentage of premium revenues). 20
Slide 21: The consolidated medical care ratio for the three and nine months ended September 30, 2004 of 80.5% and 80.8%, respectively, improved from 80.9% and 81.6% in the comparable 2003 periods. Excluding the AARP business,1 the medical care ratio for the three and nine months ended September 30, 2004 of 79.3% and 79.5%, respectively, improved from 79.5% and 80.3% in the comparable 2003 periods. These medical care ratio decreases resulted primarily from net premium rate increases that slightly exceeded overall medical beneÑt cost increases and changes in product, business and customer mix. Each period, our operating results include the eÅects of revisions in medical cost estimates related to all prior periods. Changes in medical cost estimates related to prior periods that are identiÑed in the current period are included in total medical costs reported for the current period. Medical costs for the third quarter of 2004 include approximately $50 million of favorable medical cost development related to the prior Ñscal years and $50 million of favorable medical cost development related to the Ñrst and second quarters of 2004. Medical costs for the third quarter of 2003 include approximately $20 million of favorable medical cost development related to prior Ñscal years and $80 million of favorable medical cost development related to the Ñrst and second quarters of 2003. Medical costs for the nine months ended September 30, 2004 and 2003 include approximately $200 million and $130 million, respectively, of favorable medical cost development related to prior years. On an absolute dollar basis, medical costs for the three and nine months ended September 30, 2004 increased $2.0 billion, or 39%, and $4.0 billion, or 26%, respectively, over the comparable 2003 periods. The increase was driven primarily by a rise in medical costs of approximately 9% due to medical cost inÖation and a moderate increase in health care consumption, and incremental medical costs related to businesses acquired since the third quarter of 2003. Operating Costs The operating cost ratio (operating costs as a percentage of total revenues) for the three and nine months ended September 30, 2004 of 15.1% and 15.5%, respectively, improved from 16.9% and 17.0% in the comparable 2003 periods. These decreases were driven primarily by revenue mix changes, with premium revenues growing at a faster rate than service revenues. Our premium-based products have lower operating cost ratios than our fee-based products. Additionally, the decrease in the operating cost ratio reÖects productivity gains from technology deployment and other cost management initiatives. On an absolute dollar basis, operating costs for the three and nine months ended September 30, 2004 increased $262 million, or 21%, and $531 million, or 15%, respectively, over the comparable 2003 periods. These increases were driven by a 2% increase in total individuals served by Health Care Services and Uniprise during the nine months ended September 30, 2004 over the comparable 2003 period excluding the impact of acquisitions, increases in broker commissions and premium taxes due to increased revenues, general operating cost inÖation and additional operating costs associated with businesses acquired since the third quarter of 2003. Depreciation and Amortization Depreciation and amortization for the three and nine months ended September 30, 2004 of $99 million and $268 million, respectively, increased from $75 million and $222 million in the comparable 2003 periods. The increases were due to additional depreciation and amortization resulting from higher levels of computer equipment, capitalized software and intangible assets as a result of technology enhancements, business growth and businesses acquired since the third quarter of 2003. 1 Management believes disclosure of the medical care ratio excluding the AARP business is meaningful since underwriting gains or losses related to the AARP business accrue to AARP policyholders through a rate stabilization fund (RSF). Although the Company is at risk for underwriting losses to the extent cumulative net losses exceed the balance in the RSF, the Company has not been required to fund any underwriting deÑcits to date and management believes the RSF balance is suÇcient to cover potential future underwriting or other risks associated with the contract during the foreseeable future. 21
Slide 22: Income Taxes Our eÅective income tax rate for the three and nine months ended September 30, 2004 was 34.0% and 34.6%, respectively, compared to 35.5% and 35.8% in the comparable 2003 periods. The decreases were driven by changes in business and income mix between states with diÅering income tax rates, as well as favorable settlements of prior year income tax returns. The eÅective tax rate excluding these settlements would have been approximately 35.0% for both the three and nine months ended September 30, 2004. Business Segments The following summarizes the operating results of our business segments for three and nine month periods ended September 30 (in millions): Revenues Three Months Ended September 30, Percent 2004 2003 Change Nine Months Ended September 30, Percent 2004 2003 Change Health Care Services ÏÏÏÏÏÏÏÏÏÏÏÏÏ Uniprise ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Specialized Care ServicesÏÏÏÏÏÏÏÏÏÏ Ingenix ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Eliminations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Revenues ÏÏÏÏÏÏÏÏÏÏ Earnings from Operations $8,712 842 580 170 (445) $9,859 $6,224 778 476 148 (388) $7,238 40% 8% 22% 15% n/a 36% $23,350 2,520 1,707 456 (1,326) $26,707 $18,344 2,322 1,393 395 (1,154) $21,300 27% 9% 23% 15% n/a 25% Three Months Ended September 30, Percent 2004 2003 Change Nine Months Ended September 30, Percent 2004 2003 Change Health Care Services ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Uniprise ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Specialized Care Services ÏÏÏÏÏÏÏÏÏÏÏÏÏ IngenixÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Earnings from Operations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Health Care Services $ 763 171 124 34 $1,092 $490 154 100 19 $763 56% 11% 24% 79% 43% $1,976 508 356 73 $2,913 $1,342 459 281 43 $2,125 47% 11% 27% 70% 37% The Health Care Services segment, comprised of the UnitedHealthcare, Ovations and AmeriChoice businesses, had revenues for the three and nine months ended September 30, 2004 of $8.7 billion and $23.4 billion, respectively, representing increases of $2.5 billion, or 40%, and $5.0 billion, or 27%, over the comparable 2003 periods. Excluding the impact of acquisitions, Health Care Services revenues for the three and nine months ended September 30, 2004 increased by approximately 8% and 7%, respectively, primarily driven by premium rate increases partially oÅset by a decrease in the number of individuals served by commercial risk-based products. The increase in Health Care Services revenues primarily resulted from an increase in UnitedHealthcare premium revenues for the three and nine months ended September 30, 2004 of $2.0 billion and $3.9 billion, respectively, due mainly to the acquisitions of Oxford, MAMSI and Golden Rule since the third quarter of 2003 and average net premium rate increases of approximately 9% to 10% on UnitedHealthcare's renewing commercial risk-based business, partially oÅset by a decrease in the number of individuals served by 22
Slide 23: risk-based products. The remaining increase in Health Care Services revenues was largely due to growth in the number of individuals served by UnitedHealthcare fee-based products, Ovations Medicare supplement products provided to AARP members, Ovations Medicare Advantage products, and AmeriChoice Medicaid products, as well as annual rate increases on these products. For the three and nine months ended September 30, 2004, Health Care Services earnings from operations of $763 million and $2.0 billion, respectively, increased $273 million, or 56%, and $634 million, or 47%, over the comparable 2003 periods. These increases primarily resulted from revenue growth and improved gross margins on UnitedHealthcare's risk-based products, growth in the number of individuals served by UnitedHealthcare's fee-based products, and the acquisitions of Oxford, MAMSI and Golden Rule since the third quarter of 2003. UnitedHealthcare's commercial medical care ratio decreased to 78.6% in the third quarter of 2004 from 79.2% in 2003. The decrease is mainly due to net premium rate increases that slightly exceeded overall medical beneÑt cost increases and changes in business and customer mix. Health Care Services' operating margin for the three and nine months ended September 30, 2004 improved to 8.8% and 8.5% from 7.9% and 7.3%, respectively, in the comparable 2003 periods. This was driven mainly by the lower medical care ratios and changes in business and customer mix discussed above. The following table summarizes individuals served by Health Care Services, by major market segment and funding arrangement, as of September 30 (in thousands)1: 2004 2003 Commercial Risk-based ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fee-based ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Commercial ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Medicare Advantage ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Medicaid ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total Health Care ServicesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1 7,635 3,200 10,835 315 1,240 12,390 5,005 2,855 7,860 225 1,090 9,175 Excludes individuals served by Ovations' Medicare supplement products to AARP members. The number of individuals served by UnitedHealthcare's commercial business as of September 30, 2004 was 10.8 million, an increase of approximately 3.0 million, or 38%, from September 30, 2003. Excluding the acquisitions of Oxford, MAMSI, Golden Rule and a smaller regional health plan, the number of individuals served by UnitedHealthcare's commercial business increased by 125,000. This was comprised of an increase of approximately 220,000 in the number of individuals served with commercial fee-based products, driven by new customer relationships and customers converting from risk-based products to fee-based products, partially oÅset by a 95,000 decrease in the number of individuals served by risk-based products, resulting from customers converting to self-funded, fee-based arrangements and a competitive commercial risk-based pricing environment. Excluding the Oxford acquisition, the number of individuals served by Ovations' Medicare Advantage increased by 20,000, or 9%, from September 30, 2003. AmeriChoice's Medicaid enrollment increased by 150,000, or 14%, due to strong organic growth in the number of individuals served and the acquisition of a Medicaid health plan in Michigan in February 2004, resulting in the addition of approximately 95,000 individuals served. Uniprise Uniprise revenues for the three and nine months ended September 30, 2004 of $842 million, and $2.5 billion, respectively, increased by $64 million, or 8%, and $198 million, or 9%, over the comparable 2003 periods. These increases were driven primarily by growth of approximately 3% in the number of individuals served by Uniprise during the nine months ended September 30, 2004 over the comparable 2003 period and annual rate 23
Slide 24: increases. Uniprise served 9.6 million individuals and 9.2 million individuals as of September 30, 2004 and 2003, respectively. Uniprise earnings from operations for the three and nine months ended September 30, 2004 of $171 million and $508 million, respectively, increased $17 million, or 11%, and $49 million, or 11%, over the comparable 2003 periods. Operating margin for the three months ended September 30, 2004 improved to 20.3% and 20.2%, respectively, from 19.8% for both of the comparable 2003 periods. Uniprise has expanded its operating margin through operating cost eÇciencies derived from process improvements, technology deployment and cost management initiatives that have reduced labor and occupancy costs in its transaction processing and customer service, billing and enrollment functions. Specialized Care Services For the three and nine months ended September 30, 2004, Specialized Care Services revenues of $580 million and $1.7 billion, respectively, increased by $104 million, or 22%, and $314 million, or 23%, over the comparable 2003 periods. These increases were principally driven by an increase in the number of individuals served by certain of its specialty beneÑt businesses and rate increases related to these businesses as well as revenues related to businesses acquired since the third quarter of 2003 of approximately $27 million and $79 million for the three and nine months ended September 30, 2004, respectively. Earnings from operations for the three and nine months ended September 30, 2004 of $124 million and $356 million, respectively, increased $24 million, or 24%, and $75 million, or 27%, over the comparable 2003 periods. Specialized Care Services' operating margin for the three and nine months ended September 30, 2004 improved to 21.4% and 20.9%, from 21.0% and 20.2%, respectively, in the comparable 2003 periods. These increases were driven primarily by operational and productivity improvements within several of Specialized Care Services' businesses. With the continuing growth of the Specialized Care Services segment, we are consolidating production and service operations to improve service, quality and consistency, and to enhance productivity and eÇciency. Ingenix For the three and nine months ended September 30, 2004, Ingenix revenues of $170 million and $456 million, respectively, increased by $22 million, or 15%, and $61 million, or 15%, over the comparable 2003 periods. This was driven mainly by new business growth in the health information and clinical research businesses. Earnings from operations for the three and nine month periods ended September 30, 2004 were $34 million and $73 million, respectively, increasing by 79% and 70% over the comparable 2003 periods. The operating margin for the three and nine months ended September 30, 2004 improved to 20.0% and 16.0%, from 12.8% and 10.9%, respectively, in the comparable 2003 periods. These increases were driven by growth and expanding margins in the health information and clinical research businesses. Ingenix typically generates higher revenues and operating margins in the second half of the year due to seasonally strong demand for its higher margin health information products. Financial Condition and Liquidity at September 30, 2004 Liquidity We manage our cash, investments and capital structure so we are able to meet the short- and long-term obligations of our business while maintaining strong Ñnancial Öexibility and liquidity. We forecast, analyze and monitor our cash Öows to enable prudent investment and Ñnancing activities within the conÑnes of our Ñnancial strategy. Our regulated subsidiaries generate signiÑcant cash Öows from operations. A majority of the assets held by our regulated subsidiaries are in the form of cash, cash equivalents and investments. After considering expected cash Öows from operating activities, we generally invest monies of regulated subsidiaries that exceed our shortterm obligations in longer term, investment-grade, marketable debt securities to improve our overall investment return while meeting capital adequacy requirements. Factors we consider in making these 24
Slide 25: investment decisions include our board of directors' approved investment policy, regulatory limitations, return objectives, tax implications, risk tolerance and maturity dates. Our long-term investments are also available for sale to meet short-term liquidity and other needs. Monies in excess of the capital needs of our regulated entities are paid to their non-regulated parent companies, typically in the form of dividends, for general corporate use, when and as permitted by applicable regulations. Our non-regulated businesses also generate signiÑcant cash Öows from operations for general corporate use. Cash Öows generated by these entities, combined with the issuance of commercial paper, long-term debt and the availability of our committed credit facility, further strengthens our operating and Ñnancial Öexibility. We generally use these cash Öows to reinvest in our businesses in the form of capital expenditures, to expand the depth and breadth of our services through business acquisitions, and to repurchase shares of our common stock, depending on market conditions. Cash generated from operating activities, our primary source of liquidity, is principally from net earnings, excluding depreciation and amortization. As a result, any future decline in our proÑtability may have a negative impact on our liquidity. The level of proÑtability of our risk-based business depends in large part on our ability to accurately predict and price for health care cost increases. This risk is partially mitigated by the diversity of our other businesses, the geographic diversity of our risk-based business and our disciplined underwriting and pricing processes, which seek to match premium rate increases with future health care costs. In 2003, a hypothetical 1% increase in commercial insured medical costs would have reduced net earnings by approximately $75 million. The availability of Ñnancing in the form of debt or equity is inÖuenced by many factors, including our proÑtability, operating cash Öows, debt levels, debt ratings, contractual restrictions, regulatory requirements and market conditions. We believe that our strategies and actions toward maintaining Ñnancial Öexibility mitigate much of this risk. Cash and Investments Cash Öows from operating activities were nearly $2.9 billion in the nine months ended September 30, 2004, representing an increase over the comparable 2003 period of $752 million, or 35%. This increase in operating cash Öows resulted primarily from an increase of $573 million in net income excluding depreciation, amortization and other noncash items. Operating cash Öows increased by $179 million due to cash generated by working capital changes. As premium revenues and related medical costs increase, we typically generate incremental operating cash Öows because we collect premium revenues in advance of the claim payments for related medical costs. We maintained a strong Ñnancial condition and liquidity position, with cash and investments of $12.5 billion at September 30, 2004. Total cash and investments increased by $3.0 billion since December 31, 2003, primarily due to cash and investments acquired in the Oxford and MAMSI acquisitions in 2004 and strong operating cash Öows, partially oÅset by capital expenditures, cash paid for business acquisitions and common stock repurchases. As further described under ""Regulatory Capital and Dividend Restrictions,'' many of our subsidiaries are subject to various government regulations that restrict the timing and amount of dividends and other distributions that may be paid to their parent companies. At September 30, 2004, approximately $310 million of our $12.5 billion of cash and investments was held by non-regulated subsidiaries and was available for general corporate use, including acquisitions and share repurchases. Financing and Investing Activities In addition to our strong cash Öows generated by operating activities, we use commercial paper and debt to maintain adequate operating and Ñnancial Öexibility. As of September 30, 2004 and December 31, 2003, we had commercial paper and debt outstanding of approximately $3.9 billion and $2.0 billion, respectively. Our debt-to-total-capital ratio was 26.1% and 27.8% as of September 30, 2004 and December 31, 2003, 25
Slide 26: respectively. We believe the prudent use of debt leverage optimizes our cost of capital and return on shareholders' equity, while maintaining appropriate liquidity. On July 29, 2004, our Health Care Services business segment acquired Oxford Health Plans, Inc. (Oxford). Oxford provides health care and beneÑt services for individuals and employers, principally in New York City, northern New Jersey and southern Connecticut. This merger signiÑcantly strengthens our market position in this region and provides substantial distribution opportunities for our other UnitedHealth Group businesses. Under the terms of the purchase agreement, Oxford shareholders received 0.6357 shares of UnitedHealth Group common stock and $16.17 in cash for each share of Oxford common stock they owned. Total consideration issued was approximately $5.0 billion, comprised of approximately 52.2 million shares of UnitedHealth Group common stock (valued at approximately $3.4 billion based upon the average of UnitedHealth Group's share closing price for two days before, the day of and two days after the acquisition announcement date of April 26, 2004), approximately $1.3 billion in cash and UnitedHealth Group vested common stock options with an estimated fair value of $240 million issued in exchange for Oxford's outstanding vested common stock options. On February 10, 2004, our Health Care Services business segment acquired Mid Atlantic Medical Services, Inc. (MAMSI). Under the terms of the purchase agreement, MAMSI shareholders received 0.82 shares of UnitedHealth Group common stock and $18 in cash for each share of MAMSI common stock they owned. Total consideration issued was approximately $2.7 billion, comprised of 36.4 million shares of UnitedHealth Group common stock (valued at $1.9 billion based upon the average of UnitedHealth Group's share closing price for two days before, the day of and two days after the acquisition announcement date of October 27, 2003) and approximately $800 million in cash. In July 2004, we issued $1.2 billion of commercial paper to fund the cash portion of the Oxford purchase price. In August 2004, we reÑnanced the commercial paper by issuing $550 million of 3.4% Ñxed-rate notes due August 2007, $450 million of 4.1% Ñxed-rate notes due August 2009 and $500 million of 5.0% Ñxed-rate notes due August 2014. In February 2004, we issued $250 million of 3.8% Ñxed-rate notes due February 2009 and $250 million of 4.8% Ñxed-rate notes due February 2014. We used the proceeds from the February 2004 borrowings to Ñnance a majority of the cash portion of the MAMSI purchase price as described above. In December and March 2003, we issued $500 million of four-year, Ñxed-rate notes and $450 million of 10-year, Ñxed-rate notes with interest rates of 3.3% and 4.9%, respectively. We used the proceeds from the 2003 borrowings to repay commercial paper and maturing term debt, and for general corporate purposes, including working capital, capital expenditures, business acquisitions and share repurchases. We entered into interest rate swap agreements to convert our interest exposure on a majority of these 2003 and 2004 borrowings from a Ñxed to a variable rate. The interest rate swap agreements on these borrowings have aggregate notional amounts of $2.9 billion. At September 30, 2004, the rate used to accrue interest expense on these agreements ranged from 2.1% to 2.7%. The diÅerential between the Ñxed and variable rates to be paid or received is accrued and recognized over the life of the agreements as an adjustment to interest expense in the Condensed Consolidated Statements of Operations. In June 2004, we executed a credit arrangement for a $1 billion Ñve-year revolving credit facility to support our commercial paper program. This credit facility replaced our existing $450 million revolving facility that was set to expire in July 2005, and our $450 million, 364-day facility that was set to expire in July 2004. In June 2004, we also executed a credit arrangement for a $1.5 billion 364-day bridge facility. The bridge facility was used to support the issuance of commercial paper to fund the cash portion of the Oxford purchase price in July 2004. The bridge facility was terminated in August 2004 in conjunction with the reÑnancing of the commercial paper discussed above. As of September 30, 2004, we had no amounts outstanding under these credit facilities. Our debt arrangements and credit facilities contain various covenants, the most restrictive of which require us to maintain a debt-to-total-capital ratio below 45% and to exceed speciÑed minimum interest coverage levels. We are in compliance with the requirements of all debt covenants. 26
Slide 27: Our senior debt is rated ""A'' by Standard & Poor's (S&P) and Fitch, and ""A3'' with a positive outlook by Moody's. Our commercial paper is rated ""A-1'' by S&P, ""F-1'' by Fitch, and ""P-2'' with a positive outlook by Moody's. Consistent with our intention of maintaining our senior debt ratings in the ""A'' range, we intend to maintain our debt-to-total-capital ratio at approximately 30% or less. A signiÑcant downgrade in our debt or commercial paper ratings could adversely aÅect our borrowing capacity and costs. Under our board of directors' authorization, we maintain a common stock repurchase program. Repurchases may be made from time to time at prevailing prices, subject to certain restrictions on volume, pricing and timing. During the nine months ended September 30, 2004, we repurchased 33.7 million shares through this program at an average price of approximately $63 per share and an aggregate cost of approximately $2.1 billion. In November 2004, the board of directors renewed the stock repurchase program. The Company is currently authorized to repurchase up to 65 million shares of common stock under the program. Our common stock repurchase program is discretionary as we are under no obligation to repurchase shares. We repurchase shares because we believe it is a prudent use of capital. A decision by the company to discontinue share repurchases would signiÑcantly increase our liquidity and Ñnancial Öexibility. In June 2004, our new S-3 shelf registration statement (for common stock, preferred stock, debt securities and other securities) was declared eÅective by the Securities and Exchange Commission. Under this registration statement, the remaining issuing capacity of all covered securities is $500 million. We may publicly oÅer securities from time to time at prices and terms to be determined at the time of oÅering. Under our S-4 acquisition shelf registration statement, we have remaining issuing capacity of approximately 24.3 million shares of our common stock in connection with acquisition activities. We Ñled separate S-4 registration statements for the 36.4 million shares issued in connection with the February 2004 acquisition of MAMSI and for the 52.2 million shares issued in connection with the July 2004 acquisition of Oxford described above. Contractual Obligations, OÅ-Balance Sheet Arrangements And Commitments A summary of future obligations under our various contractual obligations, oÅ-balance sheet arrangements and commitments was disclosed in our December 31, 2003 Annual Report on Form 10-K. There have not been signiÑcant changes to the amounts of these obligations other than those items disclosed under the ""Financial Condition and Liquidity at September 30, 2004'' section. Additionally, we do not have any other material contractual obligations, oÅ-balance sheet arrangements or commitments that require cash resources; however, we continually evaluate opportunities to expand our operations. This includes internal development of new products, programs and technology applications, and may include acquisitions. AARP In January 1998, we initiated a 10-year contract to provide health insurance products and services to members of AARP. Under the terms of the contract, we are compensated for transaction processing and other services as well as for assuming underwriting risk. We are also engaged in product development activities to complement the insurance oÅerings under this program. Premium revenues from our portion of the AARP insurance oÅerings are approximately $4.5 billion annually. The underwriting gains or losses related to the AARP business are directly recorded as an increase or decrease to a rate stabilization fund (RSF). The primary components of the underwriting results are premium revenue, medical costs, investment income, administrative expenses, member services expenses, marketing expenses and premium taxes. Underwriting gains and losses are recorded as an increase or decrease to the RSF and accrue to AARP policyholders, unless cumulative net losses were to exceed the balance in the RSF. To the extent underwriting losses exceed the balance in the RSF, we would have to fund the deÑcit. Any deÑcit we fund could be recovered by underwriting gains in future periods of the contract. To date, we have not been required to fund any underwriting deÑcits. As further described in Note 8 to the condensed consolidated Ñnancial statements, the RSF balance is reported in Other Policy Liabilities in the accompanying Condensed Consolidated Balance Sheets. We believe the RSF balance is suÇcient to cover potential future underwriting or other risks associated with the contract. 27
Slide 28: Regulatory Capital And Dividend Restrictions We conduct a signiÑcant portion of our operations through companies that are subject to standards established by the National Association of Insurance Commissioners (NAIC). These standards, among other things, require these subsidiaries to maintain speciÑed levels of statutory capital, as deÑned by each state, and restrict the timing and amount of dividends and other distributions that may be paid to their parent companies. Generally, the amount of dividend distributions that may be paid by a regulated subsidiary, without prior approval by state regulatory authorities, is limited based on the entity's level of statutory net income and statutory capital and surplus. The agencies that assess our creditworthiness also consider capital adequacy levels when establishing our debt ratings. Consistent with our intent to maintain our senior debt ratings in the ""A'' range, we maintain an aggregate statutory capital level for our regulated subsidiaries that is signiÑcantly higher than the minimum level regulators require. Critical Accounting Policies And Estimates Critical accounting policies are those policies that require management to make the most challenging, subjective or complex judgments, often because they must estimate the eÅects of matters that are inherently uncertain and may change in subsequent periods. Critical accounting policies involve judgments and uncertainties that are suÇciently sensitive to result in materially diÅerent results under diÅerent assumptions and conditions. The following provides a summary of our accounting policies and estimation procedures surrounding medical costs. For a detailed description of all our critical accounting policies, see the Results of Operations section of the consolidated Ñnancial statements included in our Annual Report on Form 10-K for the year ended December 31, 2003. Medical Costs Each reporting period, we estimate our obligations for medical care services that have been rendered on behalf of insured consumers but for which claims have either not yet been received or processed, and for liabilities for physician, hospital and other medical cost disputes. We develop estimates for medical care services incurred but not reported using an actuarial process that is consistently applied, centrally controlled and automated. The actuarial models consider factors such as time from date of service to claim receipt, claim backlogs, seasonal variances in medical care consumption, provider contract rate changes, medical care utilization and other medical cost trends, membership volume and demographics, beneÑt plan changes, and business mix changes related to products, customers and geography. Depending on the health care provider and type of service, the typical billing lag for services can range from two to 90 days from the date of service. Substantially all claims related to medical care services are known and settled within nine to 12 months from the date of service. We estimate liabilities for physician, hospital and other medical cost disputes based upon an analysis of potential outcomes, assuming a combination of litigation and settlement strategies. Each period, we re-examine previously established medical costs payable estimates based on actual claim submissions and other changes in facts and circumstances. As the liability estimates recorded in prior periods become more exact, we increase or decrease the amount of the estimates, with the changes in estimates included in medical costs in the period in which the change is identiÑed. In every reporting period, our operating results include the eÅects of more completely developed medical costs payable estimates associated with previously reported periods. If the revised estimate of prior period medical costs is less than the previous estimate, we will decrease reported medical costs in the current period (favorable development). If the revised estimate of prior period medical costs is more than the previous estimate, we will increase reported medical costs in the current period (unfavorable development). Historically, the net impact of estimate developments has represented less than 1% of annual medical costs, less than 6% of annual earnings from operations and less than 3% of medical costs payable. In order to evaluate the impact of changes in medical cost estimates for any particular discrete period, one should consider both the amount of development recorded in the current period pertaining to prior periods and the amount of development recorded in subsequent periods pertaining to the current period. The accompanying 28
Slide 29: table provides a summary of the net impact of favorable development on medical costs and earnings from operations (in millions). Net Favorable Development Net Impact on Medical Costs(a) Medical Costs As Reported As Adjusted(b) Earnings from Operations As Reported As Adjusted(b) 2000ÏÏÏÏÏÏÏÏÏÏÏÏÏ 2001ÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002ÏÏÏÏÏÏÏÏÏÏÏÏÏ 2003ÏÏÏÏÏÏÏÏÏÏÏÏÏ (a) $ 15 $ 30 $ 70 $150 $ $ $ $ (15) (40) (80) (50)(c) $16,155 $17,644 $18,192 $20,714 $16,140 $17,604 $18,112 $20,664(c) $1,200 $1,566 $2,186 $2,935 $1,215 $1,606 $2,266 $2,985(c) The amount of favorable development recorded in the current year pertaining to the prior year less the amount of favorable development recorded in the subsequent year pertaining to the current year. Represents reported amounts adjusted to reÖect the net impact of medical cost development. For the nine months ended September 30, 2004, the Company recorded net favorable medical cost development of $200 million pertaining to 2003. The amount of prior period development in 2004 pertaining to 2003 may change as our December 31, 2003 medical costs payable estimate continues to develop throughout 2004. (b) (c) Our estimate of medical costs payable represents management's best estimate of the company's liability for unpaid medical costs as of September 30, 2004, developed using consistently applied actuarial methods. Management believes the amount of medical costs payable is reasonable and adequate to cover the company's liability for unpaid claims as of September 30, 2004; however, actual claim payments may diÅer from established estimates. Assuming a hypothetical 1% diÅerence between our September 30, 2004 estimates of medical costs payable and actual costs payable, excluding the AARP business, third quarter 2004 earnings from operations would increase or decrease by approximately $47 million and diluted net earnings per common share would increase or decrease by approximately $0.05 per share. InÖation The current national health care cost inÖation rate signiÑcantly exceeds the general inÖation rate. We use various strategies to lessen the eÅects of health care cost inÖation. These include setting commercial premiums based on anticipated health care costs and coordinating care with physicians and other health care providers. Through contracts with physicians and other health care providers, we emphasize preventive health care, appropriate use of health care services consistent with clinical performance standards, education and closing gaps in care. We believe our strategies to mitigate the impact of health care cost inÖation on our operating results have been and will continue to be successful. However, other factors including competitive pressures, new health care and pharmaceutical product introductions, demands from physicians and other health care providers and consumers, major epidemics, and applicable regulations may aÅect our ability to control the impact of health care cost inÖation. Because of the narrow operating margins of our risk-based products, changes in medical cost trends that were not anticipated in establishing premium rates can create signiÑcant changes in our Ñnancial results. Concentrations of Credit Risk Investments in Ñnancial instruments such as marketable securities and accounts receivable may subject UnitedHealth Group to concentrations of credit risk. Our investments in marketable securities are managed under an investment policy authorized by our board of directors. This policy limits the amounts that may be invested in any one issuer and generally limits our investments to U.S. Government and Agency securities, state and municipal securities and corporate debt obligations that are investment grade. Concentrations of credit risk with respect to accounts receivable are limited due to the large number of employer groups that 29
Slide 30: constitute our customer base. As of September 30, 2004, there were no signiÑcant concentrations of credit risk. Cautionary Statements The statements contained in this Quarterly Report on Form 10-Q include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the ""PSLRA''). When used in this Quarterly Report on Form 10-Q and in future Ñlings by us with the Securities and Exchange Commission, in our press releases, presentations to securities analysts or investors, and in oral statements made by or with the approval of one of our executive oÇcers, the words or phrases ""believes,'' ""anticipates,'' ""intends,'' ""will likely result,'' ""estimates,'' ""projects'' or similar expressions are intended to identify such forward-looking statements. These forward-looking statements involve risks and uncertainties that may cause our actual results to diÅer materially from the results discussed in the forward-looking statements. The following discussion contains certain cautionary statements regarding our business that investors and others should consider. This discussion is intended to take advantage of the ""safe harbor'' provisions of the PSLRA. Except to the extent otherwise required by federal securities laws, in making these cautionary statements, we do not undertake to address or update each factor in future Ñlings or communications regarding our business or operating results, and do not undertake to address how any of these factors may have caused results to diÅer from discussions or information contained in previous Ñlings or communications. In addition, any of the matters discussed below may have aÅected our past, as well as current, forward-looking statements about future results. Any or all forward-looking statements in this Quarterly Report of Form 10-Q and in any other public statements we make may turn out to be wrong. They can be aÅected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. Many factors discussed below will be important in determining future results. Consequently, no forward-looking statement can be guaranteed. Actual future results may vary materially from expectations expressed in our prior communications. We must eÅectively manage our health care costs. Under our risk-based product arrangements, we assume the risk of both medical and administrative costs for our customers in return for monthly premiums. Premium revenues from risk-based products (excluding AARP) have typically comprised approximately 75% to 80% of our total consolidated revenues. We generally use approximately 80% to 85% of our premium revenues to pay the costs of health care services delivered to our customers. The proÑtability of our risk-based products depends in large part on our ability to accurately predict, price for, and eÅectively manage health care costs. Total health care costs are aÅected by the number of individual services rendered and the cost of each service. Our premium revenue is typically Ñxed in price for a 12-month period and is generally priced one to four months before contract commencement. Services are delivered and related costs are incurred when the contract commences. Although we base the premiums we charge on our estimate of future health care costs over the Ñxed premium period, inÖation, regulations and other factors may cause actual costs to exceed what was estimated and reÖected in premiums. These factors may include increased use of services, increased cost of individual services, catastrophes, epidemics, the introduction of new or costly treatments and technology, new mandated beneÑts or other regulatory changes, insured population characteristics and seasonal changes in the level of health care use. Relatively small diÅerences between predicted and actual medical costs as a percentage of premium revenues can result in signiÑcant changes in our Ñnancial results. For example, if medical costs increased by one percent for UnitedHealthcare's commercial insured products, our annual net earnings for 2003 would have been reduced by approximately $75 million. In addition, the Ñnancial results we report for any particular period include estimates of costs incurred for which the underlying claims have not been received by us or for which the claims have been received but not processed. If these estimates prove too high or too low, the eÅect of the change will be included in future results. 30
Slide 31: We face intense competition in many of our markets and customers have Öexibility in moving between competitors. Our businesses compete throughout the United States and face signiÑcant competition in all of the geographic markets in which they operate. For our Uniprise and Health Care Services businesses, competitors include Aetna Inc., Anthem Inc., Cigna Corporation, Coventry Health Care, Inc., Humana Inc., PaciÑCare Health Systems, Inc., WellPoint Health Networks Inc., numerous for proÑt and not-for-proÑt organizations operating under licenses from the Blue Cross Blue Shield Association and other enterprises concentrated in more limited geographic areas. Our Specialized Care Services and Ingenix businesses also compete with a number of businesses. Moreover, we believe that barriers to entry in many markets are not substantial, so the addition of new competitors can occur relatively easily, and customers enjoy signiÑcant Öexibility in moving between competitors. In particular markets, these competitors may have capabilities that give them a competitive advantage. Greater market share, established reputation, superior supplier arrangements, existing business relationships, and other factors all can provide a competitive advantage. In addition, signiÑcant merger and acquisition activity has occurred in the industries in which we operate, both as to our competitors and suppliers in these industries. This level of consolidation makes it more diÇcult for us to retain or increase customers, to improve the terms on which we do business with our suppliers, and to maintain or advance proÑtability. Our relationship with AARP is signiÑcant to our Ovations business. Under our 10-year contract with AARP which was initiated in 1998, we provide Medicare Supplement and Hospital Indemnity health insurance and other products to AARP members. As of September 30, 2004, our portion of AARP's insurance program represented approximately $4.5 billion in annual net premium revenue from approximately 3.8 million AARP members. The AARP contract may be terminated early by us or AARP under certain circumstances, including a material breach by either party, insolvency of either party, a material adverse change in the Ñnancial condition of either party, and by mutual agreement. The success of our AARP arrangement depends, in part, on our ability to service AARP and its members, develop additional products and services, price the products and services competitively, and respond eÅectively to federal and state regulatory changes. Additionally, events that adversely aÅect AARP or one of its other business partners for its member insurance program could have an adverse eÅect on the success of our arrangement with AARP. For example, if customers were dissatisÑed with the products AARP oÅered or its reputation, if federal legislation limited opportunities in the Medicare market, or if the services provided by AARP's other business partners were unacceptable, our business could be adversely aÅected. The eÅects of the new Medicare reform legislation on our business are uncertain. Recently enacted Medicare reform legislation is complex and wide-ranging. There are numerous provisions in the legislation that will inÖuence our business. The Centers for Medicare and Medicaid Services recently released draft regulations for comment on major aspects of the legislation. Until the Ñnal regulations are released, it is diÇcult to predict the extent to which our business will be aÅected. While uncertain as to impact, we believe the increased funding provided in the legislation will intensify competition in the seniors health services market. Our business is subject to intense government scrutiny and we must respond quickly and appropriately to frequent changes in government regulations. Our business is regulated at the federal, state, local and international levels. The laws and rules governing our business and interpretations of those laws and rules are subject to frequent change. Broad latitude is given to the agencies administering those regulations. Existing or future laws and rules could force us to change how we do business, restrict revenue and enrollment growth, increase our health care and administrative costs and capital requirements, and increase our liability in federal and state courts for coverage determinations, contract interpretation and other actions. We must obtain and maintain regulatory approvals to market many of our products, to increase prices for certain regulated products and to consummate our acquisitions and dispositions. Delays in obtaining or our failure to obtain or maintain these approvals could reduce our revenue or increase our costs. 31
Slide 32: We participate in federal, state and local government health care coverage programs. These programs generally are subject to frequent change, including changes that may reduce the number of persons enrolled or eligible, reduce the amount of reimbursement or payment levels, or increase our administrative or health care costs under such programs. Such changes have adversely aÅected our Ñnancial results and willingness to participate in such programs in the past and may do so in the future. State legislatures and Congress continue to focus on health care issues. Legislative and regulatory proposals at state and federal levels may aÅect certain aspects of our business, including contracting with physicians, hospitals and other health care professionals; physician reimbursement methods and payment rates; coverage determinations; claim payments and processing; drug utilization and patient safety eÅorts; use and maintenance of individually identiÑable health information; medical malpractice litigation; and governmentsponsored programs. We cannot predict if any of these initiatives will ultimately become binding law or regulation, or, if enacted, what their terms will be, but their enactment could increase our costs, expose us to expanded liability, require us to revise the ways in which we conduct business or put us at risk for a loss of business. We are also regularly subject to routine, regular and special governmental audits, investigations and enforcement actions. Such oversight could result in our loss of licensure or our right to participate in certain programs, or the imposition of civil or criminal Ñnes, penalties and other sanctions. In addition, disclosure of any adverse investigation or audit results or sanctions could damage our reputation in various markets and make it more diÇcult for us to sell our products and services. We are currently involved in various governmental audits, investigations, and reviews. These include routine, regular and special investigations, audits and reviews by the Centers for Medicare and Medicaid Services, state insurance and health and welfare departments and state attorneys general, the OÇce of Personnel Management, the OÇce of the Inspector General and U.S. Attorney General. We depend on our relationships with physicians, hospitals and other health care providers. We contract with physicians, hospitals, pharmaceutical beneÑt service providers and pharmaceutical manufacturers, and other health care providers for favorable prices. A number of organizations are advocating for legislation that would exempt certain of these physicians and health care professionals from federal and state antitrust laws. In any particular market, these physicians and health care professionals could refuse to contract, demand higher payments, or take other actions that could result in higher health care costs, less desirable products for customers or diÇculty meeting regulatory or accreditation requirements. In some markets, certain health care providers, particularly hospitals, physician/hospital organizations or multispecialty physician groups, may have signiÑcant market positions or near monopolies that could result in diminished bargaining power on our part. The nature of our business exposes us to signiÑcant litigation risks and our insurance coverage may not be suÇcient to cover some of the costs associated with litigation. Periodically, we become a party to the types of legal actions that can aÅect any business, such as employment and employment discrimination-related suits, employee beneÑt claims, breach of contract actions, tort claims, shareholder suits, and intellectual property-related litigation. In addition, because of the nature of our business, we are routinely made party to a variety of legal actions related to the design, management and oÅerings of our services. These matters include, but are not limited to, claims related to health care beneÑts coverage, medical malpractice actions, contract disputes and claims related to disclosure of certain business practices. In 1999, a number of class action lawsuits were Ñled against us and virtually all major entities in the health beneÑts business. The suits are purported class actions on behalf of physicians for alleged breaches of federal statutes, including the Employee Retirement Income Security Act of 1974 (""ERISA'') and the Racketeer InÖuenced Corrupt Organization Act (""RICO''). In March 2000, the American Medical Association Ñled a lawsuit against us in connection with the calculation of reasonable and customary reimbursement rates for non-network providers. Although the expenses which we have incurred to date in defending the 1999 class action lawsuits and the American Medical Association lawsuit have not been 32
Slide 33: material to our business, we will continue to incur expenses in the defense of these lawsuits and other matters, even if they are without merit. Following the events of September 11, 2001, the cost of business insurance coverage has increased signiÑcantly. As a result, we have increased the amount of risk that we self-insure, particularly with respect to matters incidental to our business. We believe that we are adequately insured for claims in excess of our selfinsurance; however, certain types of damages, such as punitive damages, are not covered by insurance. We record liabilities for our estimates of the probable costs resulting from self-insured matters. Although we believe the liabilities established for these risks are adequate, it is possible that the level of actual losses may exceed the liabilities recorded. Our businesses depend signiÑcantly on eÅective information systems and the integrity of the data in our information systems. Our ability to adequately price our products and services, provide eÅective and eÇcient service to our customers, and to accurately report our Ñnancial results depends signiÑcantly on the integrity of the data in our information systems. As a result of our acquisition activities, we have acquired additional systems. We have been taking steps to reduce the number of systems we operate and have upgraded and expanded our information systems capabilities. If the information we rely upon to run our businesses was found to be inaccurate or unreliable or if we fail to maintain eÅectively our information systems and data integrity, we could lose existing customers, have diÇculty attracting new customers, have problems in determining medical cost estimates and establishing appropriate pricing, have customer and physician and other health care provider disputes, have regulatory problems, have increases in operating expenses or suÅer other adverse consequences. We depend on independent third parties, such as International Business Machines Corporation (IBM), Unisys Corporation and Medco Health Solutions, Inc., with whom we have entered into agreements, for signiÑcant portions of our data center operations and pharmacy beneÑts management and processing. Even though we have appropriate provisions in our agreements with IBM, Unisys and Medco, including provisions with respect to speciÑc performance standards, covenants, warranties, audit rights, indemniÑcation, and other provisions, our dependence on these third parties makes our operations vulnerable to their failure to perform adequately under the contracts, due to internal or external factors. Although there are a limited number of service organizations with the size, scale and capabilities to eÅectively provide certain of these services, especially with regard to pharmacy beneÑts processing and management, we believe that other organizations could provide similar services on comparable terms. A change in service providers, however, could result in a decline in service quality and eÅectiveness or less favorable contract terms. Business acquisitions may increase costs and liabilities and create disruptions in our business. We have recently completed several business acquisitions. We review the records of companies we plan to acquire, however, even an in-depth review of records may not reveal existing or potential problems or permit us to become familiar enough with a business to assess fully its capabilities and deÑciencies. As a result, we may assume unanticipated liabilities, or an acquisition may not perform as well as expected. We face the risk that the returns on acquisitions will not support the expenditures or indebtedness incurred to acquire such businesses, or the capital expenditures needed to develop such businesses. We also face the risk that we will not be able to integrate acquisitions into our existing operations eÅectively. Integration may be hindered by, among other things, diÅering procedures, business practices and technology systems. We must comply with emerging restrictions on patient privacy, including taking steps to ensure compliance by our business associates who obtain access to sensitive patient information when providing services to us. The use of individually identiÑable data by our businesses is regulated at international, federal and state levels. These laws and rules are changed frequently by legislation or administrative interpretation. Various state laws address the use and maintenance of individually identiÑable health data. Most are derived from the privacy 33
Slide 34: provisions in the federal Gramm-Leach-Bliley Act and HIPAA. HIPAA also imposes guidelines on our business associates (as this term is deÑned in the HIPAA regulations). Even though we provide for appropriate protections through our contracts with our business associates, we still have limited control over their actions and practices. Compliance with these proposals, requirements, and new regulations may result in cost increases due to necessary systems changes, the development of new administrative processes, and the eÅects of potential noncompliance by our business associates. They also may impose further restrictions on our use of patient identiÑable data that is housed in one or more of our administrative databases. Our knowledge and information-related businesses depend signiÑcantly on our ability to maintain proprietary rights to our databases and related products. We rely on our agreements with customers, conÑdentiality agreements with employees, and our trade secrets, copyrights and patents to protect our proprietary rights. These legal protections and precautions may not prevent misappropriation of our proprietary information. In addition, substantial litigation regarding intellectual property rights exists in the software industry, and we expect software products to be increasingly subject to third-party infringement claims as the number of products and competitors in this industry segment grows. Such litigation and misappropriation of our proprietary information could hinder our ability to market and sell products and services. The eÅects of the war on terror and future terrorist attacks could have a severe impact on the health care industry. The terrorist attacks launched on September 11, 2001, the war on terrorism, the threat of future acts of terrorism and the related concerns of customers and providers have negatively aÅected, and may continue to negatively aÅect, the U.S. economy in general and our industry speciÑcally. Depending on the government's actions and the responsiveness of public health agencies and insurance companies, future acts of terrorism and bio-terrorism could lead to, among other things, increased use of health care services including, without limitation, hospital and physician services; loss of membership in health plans we administer as a result of layoÅs or other reductions of employment; adverse eÅects upon the Ñnancial condition or business of employers who sponsor health care coverage for their employees; disruption of our information and payment systems; increased health care costs due to restrictions on our ability to carve out certain categories of risk, such as acts of terrorism; and disruption of the Ñnancial and insurance markets in general. The market price of our common stock may be particularly sensitive due to the nature of the business in which we operate. The market prices of the securities of the publicly-held companies in the industry in which we operate have shown volatility and sensitivity in response to many external factors, including general market trends, public communications regarding managed care, litigation and judicial decisions, legislative or regulatory actions, health care cost trends, pricing trends, competition, earnings, membership reports of particular industry participants and acquisition activity. Despite our speciÑc outlook or prospects, the market price of our common stock may decline as a result of any of these external factors. By way of illustration, our stock price has ranged from $35.33 on December 31, 2001 to $73.74 on September 30, 2004 (as adjusted to reÖect stock splits and dividends). Item 3. Quantitative And Qualitative Disclosures About Market Risk Market risk represents the risk of changes in the fair value of a Ñnancial instrument caused by changes in interest rates and equity prices. The Company's primary market risk is exposure to changes in interest rates that could impact the fair value of our investments and long-term debt. Approximately $12.3 billion of our cash equivalents and investments at September 30, 2004 were Ñxed-income securities. Assuming a hypothetical and immediate 1% increase or decrease in interest rates applicable to our Ñxed-income investment portfolio at September 30, 2004, the fair value of our Ñxed-income investments would decrease or increase by approximately $330 million. We manage our investment portfolio to limit our 34
Slide 35: exposure to any one issuer or industry and largely limit our investments to U.S. Government and Agency securities, state and municipal securities, and corporate debt obligations that are investment grade. To mitigate the Ñnancial impact of changes in interest rates, we have entered into interest rate swap agreements to more closely match the interest rates of our long-term debt with those of our cash equivalents and short-term investments. Including the impact of our interest rate swap agreements, approximately $3.1 billion of our debt had variable rates of interest and $825 million had Ñxed rates as of September 30, 2004. A hypothetical 1% increase or decrease in interest rates would not be material to the fair value of our commercial paper and debt. At September 30, 2004, we had $189 million of equity investments, primarily held by our UnitedHealth Capital business in various public and non-public companies concentrated in the areas of health care delivery and related information technologies. Market conditions that aÅect the value of health care or technology stocks will likewise impact the value of our equity portfolio. Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures As of September 30, 2004, an evaluation was carried out under the supervision and with the participation of the Company's management, including our Chief Executive OÇcer and Chief Financial OÇcer, of the eÅectiveness of the design and operation of our disclosure controls and procedures (as deÑned in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, the Chief Executive OÇcer and the Chief Financial OÇcer concluded that the design and operation of these disclosure controls and procedures were eÅective to ensure that information required to be disclosed by the Company in the reports that it Ñles or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods speciÑed in the Securities and Exchange Commission rules and forms. Changes in Internal Control Over Financial Reporting During the Quarter Ended September 30, 2004 There were no signiÑcant changes in our internal control over Ñnancial reporting that occurred during the Company's quarter ended September 30, 2004 that have materially aÅected, or are reasonably likely to materially aÅect, our internal control over Ñnancial reporting. PART II. OTHER INFORMATION Item 1. Legal Proceedings In Re: Managed Care Litigation: MDL No. 1334. Beginning in 1999, a series of class action lawsuits were Ñled against us and virtually all major entities in the health beneÑts business. In December 2000, a multidistrict litigation panel consolidated several litigation cases involving UnitedHealth Group and our aÇliates in the Southern District Court of Florida, Miami division. Generally, the health care provider plaintiÅs allege violations of ERISA and RICO in connection with alleged undisclosed policies intended to maximize proÑts. Other allegations include breach of state prompt payment laws and breach of contract claims for failure to timely reimburse providers for medical services rendered. The consolidated suits seek injunctive, compensatory and equitable relief as well as restitution, costs, fees and interest payments. The trial court granted the health care providers' motion for class certiÑcation and that order was reviewed by the Eleventh Circuit Court of Appeals. The Eleventh Circuit aÇrmed the class action status of the RICO claims, but reversed as to the breach of contract, unjust enrichment and prompt payment claims. Through a series of motions and appeals, all direct claims against UnitedHealthcare have been compelled to arbitration. The trial court has denied UnitedHealthcare's further motion to compel the secondary RICO claims to arbitration. That order is currently on appeal in the Eleventh Circuit. All activity in the trial court has been stayed pending the outcome of this further arbitration appeal. The American Medical Association et al. v. Metropolitan Life Insurance Company, United HealthCare Services, Inc. and UnitedHealth Group. This lawsuit was Ñled on March 15, 2000, in the Supreme Court of 35
Slide 36: the State of New York, County of New York. On April 13, 2000, we removed this case to the United States District Court for the Southern District of New York. The suit alleges causes of action based on ERISA, as well as breach of contract and the implied covenant of good faith and fair dealing, deceptive acts and practices, and trade libel in connection with the calculation of reasonable and customary reimbursement rates for nonnetwork providers. The suit seeks declaratory, injunctive and compensatory relief as well as costs, fees and interest payments. An amended complaint was Ñled on August 25, 2000, which alleged two classes of plaintiÅs, an ERISA class and a non-ERISA class. After the Court dismissed certain ERISA claims and the claims brought by the American Medical Association, a third amended complaint was Ñled. On October 25, 2002, the court granted in part and denied in part our motion to dismiss the third amended complaint. We are engaged in discovery in this matter. On May 21, 2003, we Ñled a counterclaim complaint in this matter alleging antitrust violations against the American Medical Association and asserting claims based on improper billing practices against an individual provider plaintiÅ. On May 26, 2004, we Ñled a motion for partial summary judgment seeking the dismissal of certain claims and parties based, in part, on threshold standing grounds. On July 16, 2004, plaintiÅs Ñled a motion for leave to Ñle an amended complaint, seeking to assert RICO violations. Because of the nature of our business, we are routinely subject to lawsuits alleging various causes of action. Some of these suits may include claims for substantial non-economic, treble or punitive damages. We are also regularly subject to routine, regular and special governmental audits, investigations and enforcement actions. In addition, a state Department of Insurance or other state or federal authority (including CMS, the OÇce of the Inspector General, the OÇce of Personnel Management, the OÇce of Civil Rights, the Department of Justice, and state attorneys general) may from time to time begin a special audit of one of our health plans, our insurance plans or one of our other operations to investigate issues such as utilization management; Ñnancial, eligibility or other data reporting; prompt claims payment; or coverage determinations for medical services, including emergency room care. Any such government actions can result in assessment of damages, civil or criminal Ñnes or penalties, or other sanctions, including loss of licensure or exclusion from participation in government programs. We record liabilities for our estimate of probable costs resulting from these matters. Although the results of pending matters are always uncertain, we do not believe the results of any such actions, including those described above, or any other types of actions, investigations, audits or reviews, currently threatened or pending, individually or in the aggregate, will have a material adverse eÅect on our consolidated Ñnancial position or results of operations. Item 2. Issuer Purchases of Equity Securities Issuer Purchases of Equity Securities (1) Third Quarter 2004 (c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (d) Maximum Number of Shares that may yet be purchased under the plans or programs For the Month Ended (a) Total Number of Shares Purchased (b) Average Price Paid per Share July 31, 2004ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ August 31, 2004 ÏÏÏÏÏÏÏÏÏÏÏ September 30, 2004 ÏÏÏÏÏÏÏÏ TOTAL ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,020,000 6,679,000 3,006,000 13,705,000 $62.87 $63.56 $69.83 $64.80 4,020,000 6,679,000 3,006,000 13,705,000 11,502,300(2) (1) On November 4, 1997, the Company's Board of Directors adopted a share repurchase program, which the Board evaluates periodically and renews as necessary. The Company announced this program on November 6, 1997, and announced renewals of the program on November 5, 1998, October 27, 1999, February 14, 2002, October 25, 2002, July 30, 2003 and November 4, 2004. There is no established expiration date for the program. During the nine months ended September 30, 2004, the Company did not repurchase any shares other than through this publicly announced program. (2) On November 4, 2004, the Board renewed the share repurchase program and authorized the Company to repurchase up to 65 million shares of the Company's common stock at prevailing market prices. 36
Slide 37: Item 5. Other Information On November 4, 2004, the Audit Committee adopted a policy regarding rotation of the Company's independent registered public accounting Ñrm. Under the policy, in addition to the Audit Committee's annual evaluation of the independent accounting Ñrm, the Committee will also formally evaluate, not less frequently than every three years, whether there should be a rotation of the independent accounting Ñrm. The Audit Committee's policy on auditor rotation is reÖected in the revised Audit Committee Charter which is attached as an exhibit hereto. Item 6. Exhibits and Reports on Form 8-K (a) The following exhibits are Ñled in response to Item 601 of Regulation S-K. Exhibit Number Description Exhibit 4.1 Exhibit 4.2 Exhibit 4.3 Exhibit 10.1 Exhibit 10.2 Exhibit 10.3 Exhibit 10.4 Exhibit 10.5 Exhibit Exhibit Exhibit Exhibit 15 31 32 99 Ì Specimen of 2007 Note issued pursuant to an Underwriting Agreement dated August 11, 2004 (incorporated by reference to Exhibit 4.4 of the Company's Current Report on Form 8-K dated August 11, 2004) Ì Specimen of 2009 Note issued pursuant to an Underwriting Agreement dated August 11, 2004 (incorporated by reference to Exhibit 4.5 of the Company's Current Report on Form 8-K dated August 11, 2004) Ì Specimen of 2014 Note issued pursuant to an Underwriting Agreement dated August 11, 2004 (incorporated by reference to Exhibit 4.6 of the Company's Current Report on Form 8-K dated August 11, 2004) Ì Form of Agreement for Stock Option Grants to Executive OÇcers under the UnitedHealth Group Incorporated 2002 Stock Incentive Plan (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K dated September 24, 2004) Ì Form of Agreement for Stock Option Grants to Non-Employee Directors under the UnitedHealth Group Incorporated 2002 Stock Incentive Plan (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K dated September 24, 2004) Ì Form of Agreement for Initial Stock Option Grant to Non-Employee Directors under the UnitedHealth Group Incorporated 2002 Stock Incentive Plan (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K dated September 24, 2004) Ì Form of Restricted Stock Award Agreement under the UnitedHealth Group Incorporated 2002 Stock Incentive Plan (incorporated by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K dated September 24, 2004) Ì Form of Restricted Stock Unit Award Agreement under the UnitedHealth Group 2002 Stock Incentive Plan (incorporated by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K dated September 24, 2004) Ì Letter Re Unaudited Interim Financial Information Ì CertiÑcations Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Ì CertiÑcations Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Ì Audit Committee Charter, as amended November 4, 2004 The following Current Reports on Form 8-K were Ñled or furnished, as applicable, during the third quarter of 2004. 8-K dated July 15, 2004, together with press release, announcing second quarter earnings results, pursuant to Item 12 ""Results of Operations and Financial Condition.'' 8-K dated July 19, 2004, announcing the expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 regarding the proposed transaction between the Company and Oxford Health Plans, Inc., pursuant to Item 5 ""Other Events and Regulation FD Disclosure.'' 37
Slide 38: 8-K dated July 29, 2004, together with press release, announcing the completion of the acquisition of Oxford Health Plans, Inc., pursuant to Item 2 ""Acquisition or Disposition of Assets'' and Item 7 ""Financial Statements and Exhibits.'' 8-K dated August 6, 2004, updating previously announced 2004 Ñnancial expectations and announcing upcoming meetings with investors and analysts, pursuant to Item 9 ""Regulation FD Disclosure.'' 8-K/A dated August 9, 2004, together with consent, amending 8-K dated July 29, 2004, pursuant to Item 7 ""Financial Statements and Exhibits.'' 8-K dated August 11, 2004, together with Underwriting Agreement and related documents, announcing the issuance of debt securities, pursuant to Item 5 ""Other Events'' and Item 7 ""Financial Statements and Exhibits.'' 8-K dated September 10, 2004, announcing upcoming meetings with investors and analysts, pursuant to Item 7.01 ""Regulation FD Disclosure.'' 8-K dated September 24, 2004, providing forms of award grant agreements under the UnitedHealth Group 2002 Stock Incentive Plan, pursuant to Item 8.01 ""Other Events.'' 38
Slide 39: SIGNATURES Pursuant to the requirements 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. UNITEDHEALTH GROUP INCORPORATED /s/ STEPHEN J. HEMSLEY Stephen J. Hemsley PATRICK J. ERLANDSON Patrick J. Erlandson President and Chief Operating OÇcer Chief Financial OÇcer and Chief Accounting OÇcer Dated: November 8, 2004 /s/ Dated: November 8, 2004 39
Slide 40: EXHIBITS Exhibit Number Description Exhibit 4.1 Exhibit 4.2 Exhibit 4.3 Exhibit 10.1 Exhibit 10.2 Exhibit 10.3 Exhibit 10.4 Exhibit 10.5 Exhibit Exhibit Exhibit Exhibit 15 31 32 99 Ì Specimen of 2007 Note issued pursuant to an Underwriting Agreement dated August 11, 2004 (incorporated by reference to Exhibit 4.4 of the Company's Current Report on Form 8-K dated August 11, 2004) Ì Specimen of 2009 Note issued pursuant to an Underwriting Agreement dated August 11, 2004 (incorporated by reference to Exhibit 4.5 of the Company's Current Report on Form 8-K dated August 11, 2004) Ì Specimen of 2014 Note issued pursuant to an Underwriting Agreement dated August 11, 2004 (incorporated by reference to Exhibit 4.6 of the Company's Current Report on Form 8-K dated August 11, 2004) Ì Form of Agreement for Stock Option Grants to Executive OÇcers under the UnitedHealth Group Incorporated 2002 Stock Incentive Plan (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K dated September 24, 2004) Ì Form of Agreement for Stock Option Grants to Non-Employee Directors under the UnitedHealth Group Incorporated 2002 Stock Incentive Plan (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K dated September 24, 2004) Ì Form of Agreement for Initial Stock Option Grant to Non-Employee Directors under the UnitedHealth Group Incorporated 2002 Stock Incentive Plan (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K dated September 24, 2004) Ì Form of Restricted Stock Award Agreement under the UnitedHealth Group Incorporated 2002 Stock Incentive Plan (incorporated by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K dated September 24, 2004) Ì Form of Restricted Stock Unit Award Agreement under the UnitedHealth Group 2002 Stock Incentive Plan (incorporated by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K dated September 24, 2004) Ì Letter Re Unaudited Interim Financial Information Ì CertiÑcations Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Ì CertiÑcations Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Ì Audit Committee Charter, as amended November 4, 2004 40
Slide 41: EXHIBIT 15 LETTER RE UNAUDITED INTERIM FINANCIAL INFORMATION November 8, 2004 UnitedHealth Group Incorporated We have made a review, in accordance with standards of the Public Company Accounting Oversight Board (United States), of the unaudited interim Ñnancial information of UnitedHealth Group Incorporated and Subsidiaries for the periods ended September 30, 2004 and 2003, as indicated in our report dated November 5, 2004; because we did not perform an audit, we expressed no opinion on that information. We are aware that our report referred to above, which is included in your Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, is incorporated by reference in Registration Statement File Nos. 333-66013, 33-22310, 33-50282, 33-59083, 33-59623, 33-63885, 33-67918, 33-68300, 33-75846, 333-02525, 333-04875, 333-25923, 333-44613, 333-45289, 333-50461, 333-66013, 333-71007, 333-81337, 333-87243, 333-88506, 333-90247, 333-46284, 333-55666, 333-100027, 333-105875, 333-105877, 333-110356, 333-113755, 333-115327, 333-117769 and 333-118050. We also are aware that the aforementioned report, pursuant to Rule 436(c) under the Securities Act of 1933, is not considered a part of the Registration Statement prepared or certiÑed by an accountant or a report prepared or certiÑed by an accountant within the meaning of Sections 7 and 11 of that Act. /s/ DELOITTE & TOUCHE LLP Minneapolis, Minnesota
Slide 42: EXHIBIT 31 CERTIFICATIONS PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 CertiÑcation of Principal Executive OÇcer I, William W. McGuire, M.D., Chairman and Chief Executive OÇcer of UnitedHealth Group Incorporated, certify that: 1. I have reviewed this quarterly report on Form 10-Q of UnitedHealth Group Incorporated (the ""registrant''); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the Ñnancial statements, and other Ñnancial information included in this report, fairly present in all material respects the Ñnancial condition, results of operations and cash Öows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying oÇcer and I are responsible for establishing and maintaining disclosure controls and procedures (as deÑned in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the eÅectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the eÅectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over Ñnancial reporting that occurred during the registrant's most recent Ñscal quarter that has materially aÅected, or is reasonably likely to materially aÅect, the registrant's internal control over Ñnancial reporting; and 5. The registrant's other certifying oÇcer and I have disclosed, based on our most recent evaluation of internal control over Ñnancial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all signiÑcant deÑciencies and material weaknesses in the design or operation of internal control over Ñnancial reporting which are reasonably likely to adversely aÅect the registrant's ability to record, process, summarize and report Ñnancial information; and b) any fraud, whether or not material, that involves management or other employees who have a signiÑcant role in the registrant's internal control over Ñnancial reporting. Date: November 8, 2004 /s/ WILLIAM W. MCGUIRE, M.D. William W. McGuire, M.D. Chairman and Chief Executive OÇcer
Slide 43: CertiÑcation of Principal Financial OÇcer I, Patrick J. Erlandson, Chief Financial OÇcer of UnitedHealth Group Incorporated, certify that: 1. I have reviewed this quarterly report on Form 10-Q of UnitedHealth Group Incorporated (the ""registrant''); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the Ñnancial statements, and other Ñnancial information included in this report, fairly present in all material respects the Ñnancial condition, results of operations and cash Öows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying oÇcer and I are responsible for establishing and maintaining disclosure controls and procedures (as deÑned in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the eÅectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the eÅectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over Ñnancial reporting that occurred during the registrant's most recent Ñscal quarter that has materially aÅected, or is reasonably likely to materially aÅect, the registrant's internal control over Ñnancial reporting; and 5. The registrant's other certifying oÇcer and I have disclosed, based on our most recent evaluation of internal control over Ñnancial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all signiÑcant deÑciencies and material weaknesses in the design or operation of internal control over Ñnancial reporting which are reasonably likely to adversely aÅect the registrant's ability to record, process, summarize and report Ñnancial information; and b) any fraud, whether or not material, that involves management or other employees who have a signiÑcant role in the registrant's internal control over Ñnancial reporting. Date: November 8, 2004 /s/ PATRICK J. ERLANDSON Patrick J. Erlandson Chief Financial OÇcer
Slide 44: EXHIBIT 32 CERTIFICATIONS PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of UnitedHealth Group Incorporated (the ""Company'') on Form 10-Q for the period ending September 30, 2004 as Ñled with the Securities and Exchange Commission on the date hereof (the ""Report''), I, William W. McGuire, M.D., Chairman and Chief Executive OÇcer of the Company, certify, pursuant to 18 U.S.C. Û 1350, as adopted pursuant to Û 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the Ñnancial condition and results of operations of the Company. /s/ WILLIAM W. MCGUIRE, M.D. William W. McGuire, M.D. Chairman and Chief Executive OÇcer November 8, 2004 In connection with the Quarterly Report of UnitedHealth Group Incorporated (the ""Company'') on Form 10-Q for the period ended September 30, 2004 as Ñled with the Securities and Exchange Commission on the date hereof (the ""Report''), I, Patrick J. Erlandson, Chief Financial OÇcer of the Company, certify, pursuant to 18 U.S.C. Û 1350, as adopted pursuant to Û 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the Ñnancial condition and results of operations of the Company. /s/ PATRICK J. ERLANDSON Patrick J. Erlandson Chief Financial OÇcer November 8, 2004
Slide 45: Exhibit 99 UNITEDHEALTH GROUP BOARD OF DIRECTORS AUDIT COMMITTEE CHARTER (as amended, November 4, 2004) Introduction and Purpose UnitedHealth Group Incorporated (the ""Company'') is a publicly-held company and operates in a complex, dynamic, highly competitive, and regulated environment. In order to assure the kind of informed decision making beneÑcial to the Company, much of the Board of Director's oversight occurs through its standing committees, such as the Audit Committee (the ""Committee''). The primary purpose of the Committee is (a) to assist the Board of Directors (the ""Board'') in fulÑlling its oversight responsibilities relating to (i) the integrity of the Company's Ñnancial statements, (ii) the Company's compliance with legal and regulatory requirements (a responsibility which the Committee shares with the Compliance and Government AÅairs Committee), (iii) the performance, qualiÑcations and independence of the Company's independent outside auditor, and (iv) the performance of the Company's General Auditor and outsourced internal audit function, and (b) to prepare the report required by the Securities and Exchange Commission (""SEC'') to be included in the Company's annual proxy statement. The Committee's job is one of oversight. The Company's management is responsible for preparing the Company's Ñnancial statements and the independent outside auditor is responsible for auditing the annual Ñnancial statements and reviewing the quarterly Ñnancial statements. The Committee recognizes that Ñnancial management (including the General Auditor and outsourced internal auditing function), as well as the independent outside auditor, have more direct knowledge and detailed information about the Company than do Committee members. Consequently, in carrying out its oversight responsibilities, the Committee is not providing any expert or special assurance as to the Company's Ñnancial statements or any professional certiÑcation as to the independent outside auditor's work. Composition The Committee shall be comprised of three or more directors, each of whom the Board has determined meets the independence and experience requirements of the New York Stock Exchange (""NYSE'') and the SEC. The Board shall determine whether any member of the Committee is an ""audit committee Ñnancial expert'' as deÑned by SEC rules. Committee members may enhance their familiarity with Ñnance and accounting by participating in educational programs conducted by the Company or an outside consultant. No director may serve as a member of the Committee if such director serves on the audit committees of more than two other public companies unless the Board determines that such simultaneous service would not impair the ability of such director to serve eÅectively on the Committee, and discloses this determination in the Company's annual proxy statement. No member of the Committee may receive, directly or indirectly, any compensation from the Company other than (i) director's fees, which may be received in cash, common stock, equity-based awards or other in-kind consideration ordinarily available to directors; (ii) a pension or other deferred compensation for prior service that is not contingent on continued service; and (iii) any other regular beneÑts that other directors receive. The members of the Committee are appointed by the Board at the annual organizational meeting of the Board and serve until their successors are duly appointed or until their retirement, resignation, death or removal by the Board. Unless a Chair is elected by the full Board, the members of the Committee may designate a Chair by majority vote of the full Committee membership. Meetings The Committee shall meet at least quarterly, or more frequently as circumstances dictate. To the extent practicable, each of the Committee members shall attend each of the regularly scheduled meetings in person.
Slide 46: As part of its job to foster open communication, time shall be periodically set aside at meetings for the Committee to meet with management, the independent outside auditor and the outsourced internal audit function in separate sessions to discuss any matters that the Committee or each of these groups believe should be discussed privately. The Committee may ask members of management or others to attend the meetings and provide pertinent information, as necessary. A majority of the Committee members currently holding oÇce constitutes a quorum for the transaction of business. The Committee shall take action by the aÇrmative vote of a majority of the Committee members present at a duly held meeting. Responsibilities and Duties The Committee shall be subject to the following principles and shall undertake the following responsibilities and duties. Documents/Reports Review ‚ Discuss with management and the independent outside auditor the Company's annual and quarterly Ñnancial statements, including key highlights of quarterly reports on Form 10-Q and disclosures under Management's Discussion and Analysis of Financial Condition and Results of Operations. ‚ Review the Company's Annual Report to Shareholders, Annual Report on Form 10-K and Proxy Statement prior to Ñling. ‚ Discuss with management earnings press releases, as well as Ñnancial information and earnings guidance provided to analysts and rating agencies. Discussion of earnings releases as well as Ñnancial information and earnings guidance may be done generally (i.e., discussions of the types of information to be disclosed and the type of presentation to be made). ‚ Discuss signiÑcant Ñndings and recommendations of the Company's independent outside auditor and the Company's General Auditor and outsourced internal auditors, together with management's responses. Independent Outside Auditor ‚ Make all decisions relating to the selection, evaluation, retention and replacement of the Company's independent outside auditor, and approve all fees and other terms of the Company's independent outside auditor. On an annual basis, the Committee shall receive from the independent outside auditor and review a report describing: the auditor's internal quality-control procedures; any material issues raised by the most recent internal quality-control review, or peer review, of the auditor, or by any inquiry or investigation by governmental or professional authorities, within the preceding Ñve years, respecting one or more independent audits carried out by the auditor, and any steps taken to deal with any such issues; and, to assess the auditor's independence, all relationships between the auditor and the Company. The Committee is responsible for actively engaging in a dialogue with the independent outside auditor with respect to any disclosed relationship or services that may impact the objectivity and independence of the independent outside auditor. The independent outside auditor shall report directly to the Committee. ‚ Pre-approve, or adopt appropriate procedures to pre-approve, all audit and non-audit services to be provided by the independent outside auditor, and consider whether the auditor's provision of non-audit services to the Company is compatible with maintaining the independence of the independent outside auditor. ‚ Review and evaluate the performance, qualiÑcations and independence of the Company's independent outside auditor, taking into account the opinions of management, the General Auditor and the outsourced internal audit function. ‚ Review and evaluate the qualiÑcations, performance and independence of the lead partner of the independent auditor, discuss with management the timing and process for implementing the rotation of the lead audit partner, the concurring partner and any other active audit engagement team partner; and, at least every three years, evaluate whether there should be a rotation of the audit Ñrm itself. 2
Slide 47: ‚ Review the prior year's audit fee and the current year's fee estimate. ‚ Periodically consult with the Company's independent outside auditor, outside of the presence of management, about the auditor's judgments about the quality, and not just the acceptability, of the Company's accounting principles as applied to its Ñnancial reporting, and the Company's internal controls and the fullness and accuracy of the Company's Ñnancial statements. ‚ Obtain from the independent outside auditor in connection with any audit a timely report relating to the Company's annual audited Ñnancial statements describing all critical accounting policies and practices to be used, all alternative treatments of Ñnancial information within generally accepted accounting principles that have been discussed with management, ramiÑcations of the use of such alternative disclosures and treatments, and the treatment preferred by the independent outside auditor, and any material written communications between the independent outside auditor and management, such as any ""management'' letter or schedule of unadjusted diÅerences. Financial Reporting Processes ‚ In consultation with the Company's independent outside auditor, the General Auditor, the Business Risk Management Group and outsourced internal auditors, consider the integrity of the Company's Ñnancial reporting processes, both internal and external. ‚ Discuss with management, the independent outside auditor, the General Auditor and the outsourced internal audit function, as appropriate: (a) any major issues regarding accounting principles and Ñnancial statement presentations, including any signiÑcant changes in the Company's selection or application of accounting principles, and major issues as to the adequacy of the Company's internal controls and any special audit steps adopted in light of material control deÑciencies; (b) analyses prepared by management and/or the independent outside auditor setting forth signiÑcant Ñnancial reporting issues and judgments made in connection with the preparation of the Ñnancial statements, including analyses of the eÅects of alternative GAAP methods on the Ñnancial statements; (c) the eÅect of regulatory and accounting initiatives, as well as oÅ-balance sheet structures, on the Ñnancial statements of the Company; and (d) the type and presentation of information to be included in earnings press releases (paying particular attention to any use of ""pro forma'' or ""adjusted'' non-GAAP information). Process Analysis and Review ‚ Establish regular and separate systems of reporting to the Committee by each of management and the independent outside auditor regarding any signiÑcant judgments made in management's preparation of the Ñnancial statements and the view of each as to appropriateness of such judgments. ‚ Discuss the scope of the annual audit plans for both the outsourced internal auditors and the independent outside auditor. ‚ Discuss with the independent outside auditor any audit problems or diÇculties and management's responses, any diÇculties the auditor encountered during the course of the audit work, including any restrictions on the scope of the auditor's activities or on access to requested information, and any signiÑcant disagreements with management. The discussions with the independent outside auditor should address, to the extent applicable, any accounting adjustments that were noted or proposed by the independent outside auditor but were ""passed'' (as immaterial or otherwise), any communications between the audit team and its national oÇce with respect to auditing or accounting issues presented by the engagement; and any ""management'' or ""internal control'' letter issued, or proposed to be issued, by the independent outside auditor to the Company. ‚ Discuss any signiÑcant disagreement between management and the independent outside auditor in connection with the preparation of the Ñnancial statements, and resolve any disagreements between management and the independent outside auditor regarding Ñnancial reporting. 3
Slide 48: ‚ Consider with the Company's independent outside auditor, the Business Risk Management Group, the General Auditor, the Company's outsourced internal audit function and management the extent to which changes or improvements in Ñnancial or accounting practices, as approved by the Committee, have been implemented. ‚ Inquire of the Company's Chief Executive OÇcer and Chief Financial OÇcer as to the existence of any signiÑcant deÑciencies in the design or operation of internal controls that could adversely aÅect the Company's ability to record, process, summarize and report Ñnancial data, any material weaknesses in internal controls, and any fraud, whether or not material, that involves management or other employees who have a signiÑcant role in the Company's internal controls. Other Activities ‚ Consider any tax issues and/or legal and regulatory matters brought to the attention of the Committee that may have a material impact on the Ñnancial statements and related reserve positions. ‚ Discuss regularly with the Company's General Auditor, Business Risk Management Group and the independent outside auditor the outsourced internal audit budget and staÇng, including responsibilities, organizational structure, auditor qualiÑcations, and quality assurance reviews. ‚ Review and concur in the appointment, replacement, reassignment, or dismissal of the Company's outsourced internal audit vendor(s). ‚ Review with management the system the Company has in place to ensure that the Company's Ñnancial statements, reports, and other Ñnancial information disseminated to governmental organizations and the public satisfy legal requirements. ‚ Discuss with management, including the Business Risk Management Group, signiÑcant business/Ñnancial risks and exposures and the Company's guidelines and policies for assessing and managing these risks and exposures. ‚ Establish policies governing the hiring by the Company of any current or former employee of the Company's independent outside auditor. ‚ Discuss and evaluate with management the Company's investment policy. ‚ Establish procedures for the receipt, retention and treatment of complaints received by the Company regarding accounting, internal accounting controls or auditing matters, and for the conÑdential, anonymous submission by Company employees of concerns regarding questionable accounting or auditing matters. ‚ Prepare the report required by SEC rules to be included in the Company's annual proxy statement. ‚ Report regularly to the Board on Committee actions and any signiÑcant issues considered by the Committee. ‚ Perform such other functions as assigned by law, the Company's Articles of Incorporation or Bylaws, or the Board. Delegation The Committee may, in its discretion, form and delegate authority to subcommittees when appropriate and to the extent permitted by the listing standards of the NYSE. The Committee may, in its discretion, delegate to one or more of its members the authority to pre-approve any audit or non-audit services to be performed by the independent auditor, provided that any such approvals are presented to the Committee at its next scheduled meeting. Any member of the Audit Committee is authorized to meet (in person or by telephone) with the Company's independent outside auditor in connection with the independent outside auditor's required communications with the Audit Committee prior to issuance of its consent to the Company's Ñlings with the Securities and Exchange Commission; provided, however, that such Committee member provides an update 4
Slide 49: of such meeting with the independent auditor to the full Audit Committee at its next regularly scheduled meeting. Performance Evaluation The Committee shall conduct an annual performance evaluation of the Committee, which evaluation shall compare the performance of the Committee with the requirements of this charter. The performance evaluation shall also include a review of the adequacy of this charter and shall recommend to the Board any revisions to this charter deemed necessary or desirable, although the Board shall have the sole authority to amend this charter. The performance evaluation shall be conducted in such manner as the Committee deems appropriate. Resources and Authority of the Committee The Committee shall have the resources (including funding) and authority appropriate to discharge its duties and responsibilities, including conducting investigations into any matters within the Committee's scope of responsibilities, the selection, retention, termination and approval of fees and other retention terms of special counsel, accountants, or other experts or consultants, as it deems necessary or appropriate, and funding for ordinary administrative expenses of the Committee, without seeking approval of the Board or management. 5