Southern Cross Medical Care Society Posts Loss

MEDIA RELEASE
17 September 2002

Southern Cross Medical Care Society Posts Loss to 30 June 2002

Southern Cross Medical Care Society (comprising parent Southern Cross Medical Care Society and its subsidiary Aetna Health (NZ) Limited) today announced a $41.2 million loss to 30 June 2002 – a loss it said would be righted in the next financial year, which is forecast to produce an operating surplus.

$38.0 million of the loss represents the result from the Southern Cross Medical Care Society parent entity; a small profit from the Aetna subsidiary; and amortisation of goodwill on consolidation makes up the balance.

Southern Cross Medical Care Society’s result is made up of a one-off write down of $19.1 million in the value of its investment in subsidiary Aetna Health (NZ) Limited, together with a fall in the underwriting surplus, a fall in investment income and a rise in overheads.

A major factor in the fall in the underwriting surplus was the delay, from 1 April to 1 August, in putting in place Southern Cross’s rebalance of the premium structure and premium increases, because of operational problems associated with the new computer system. This delay cost approximately $17 million in lost premium income for the year under review.

As a result of the 2002 fiscal year’s loss, Group reserves stood at $179.6 million (30 June 2002), down from $220.8 million in the previous year. Reserves for the parent (Southern Cross Medical Care Society) stood at $184.5 million, down from $222.5 million last year. These remain adequate to meet the Group’s needs according to PricewaterhouseCoopers. However, the Society plans to rebuild reserves to near previous levels by 2005.

“The need to generate a surplus for a not-for-profit Friendly Society like Southern Cross is not driven by the need to service the capital invested but purely to protect the long-term interest of members, to provide adequate reserves to meet unforeseen circumstances, to cope with growth, to reinvest in fixed assets and working capital as required, and to ensure the Society is here to support members when help is needed,” said Southern Cross Chairman Bryan Kensington.

“Southern Cross remains financially strong. Investment in bank deposits and other readily realisable Government stocks and bonds for the Group remains strong at $199 million (up from $193 million last year). We have an A+ rating from international credit agency Standard & Poor’s. After implementing our much needed price increase, rebalancing premiums from August 2002, and placing stringent controls on costs, the next year’s financial results are budgeted to provide a surplus,” he said.

“Our management team, led by a new chief executive, is focused on restoring the operational excellence expected by our members while bringing down overheads. With the capabilities of the new computer system, and these disciplines in place, Southern Cross is on a much better footing for the future,” he said.

Claims reimbursement for Southern Cross Medical Care Society represented 96 cents in every premium dollar collected, which the insurer had widely acknowledged was unsustainable. For several years, Southern Cross has paid out more in claims and administration than it received in premiums. It rebalanced its premium structure effective 1 August so members in age groups that claimed more, paid more.

“It is essential for Southern Cross to reduce cross-subsidies in order to be competitive in the market, and in particular in the younger age groups, and at the same time generate a surplus,” he said.

Mr Kensington described the year as “difficult”, a year in which mistakes were made, some extremely difficult decisions were taken, and many issues resolved.

“In early 2000, we were planning a move to a new computer system. The Aetna purchase enabled us to take advantage of their IT system. In hindsight we recognise that in customising the system to cope with our volumes and products, we attempted too much too soon and made some fundamental errors along the way in implementation. The result, as many members know, was a delay in paying out claims in late 2001 and early 2002. These delays and operational problems were overcome within the financial year, and there have been significant improvements in service performance. The directors and management remain confident that the computer system will provide Southern Cross with an enhanced ability to provide new products and services and a competitive advantage. An independent report on the effectiveness of the new computer system supports our view,” he said.

Aetna Revaluation on Southern Cross’s Books

Mr Kensington stressed that the purchase of Aetna Health (NZ) Limited by the Southern Cross Medical Care Society was the correct decision viewed at the time, and with the benefit of hindsight, this is still the case. The price paid was below the independent valuation.

Other New Zealand insurers were competing to buy Aetna at the time. While Southern Cross committed to the purchase in July 2000, final approval for purchasing the customer base (140,000 customers) was not given until December 2001 when the Court of Appeal found in favour of Southern Cross.

“The delays caused by our court action to retain the Aetna book, closely followed by the claims processing difficulties, which arose during the change to the computer system we bought from Aetna, have reduced the cost efficiencies which we believe would have arisen from the prompt integration of the Southern Cross and Aetna books. We believe the delay cost us $8 million in unrealised synergistic gains,” said Mr Kensington.

This position has been exacerbated by a change in market conditions which have seen significant increases in claims throughout the health insurance market in the intervening period. In recognition of these changes, Southern Cross obtained a current valuation of the Aetna subsidiary. As a result, the board elected to write down the value of Aetna by $19.1 million in the books of the Southern Cross Medical Care Society. The Aetna subsidiary is now valued at $20 million, the lower end of the valuation range set by an independent valuer.

Mr Kensington stressed that the write down of Aetna had no influence on the need for the premium increase by Southern Cross. The premium increases were driven by increasing claims, the need to restore a surplus, and competitive pressures. “They would have been necessary irrespective of the Aetna purchase and the subsequent write down in value,” he said.

Structural improvements

Mr Kensington said that while key structural improvements for Southern Cross Health Insurance had been made in the 2002 financial year, including computer system implementation and premium restructuring, challenges still lay ahead.

“We are part of an industry where costs continue to escalate dramatically, and factors beyond our control such as the ageing population, advances in medical science and increased demand for primary and secondary care, will continue to put pressure on premiums. Overflow from a constrained public health system will continue to influence health insurance premiums. Southern Cross’s role as a Friendly Society in the competitive health insurance market will be to keep our costs as low as possible, deliver efficiency in our systems, and provide members with appropriate value for money health insurance cover. With the 2002 financial year behind us, and structural improvements in place, we are in a far better position to deliver,” Mr Kensington said.

Ends.

Editor’s Note:
Southern Cross Healthcare’s Annual Report is available as a PDF on the Southern Cross website.
Mr Kensington’s photo is also available from the website.
www.southerncross.co.nz

Media Release
17 September 2002

Media Backgrounder

Organisational Structure for Southern Cross Medical Care Society

Southern Cross Medical Care Society (Parent)

Aetna Health Insurance (Subsidiary)

Summary Key Financial Results

Parent
(Southern Cross Medical Care Society)

$m Subsidary
(Aetna Health (NZ) Ltd)

$m Group
(Southern Cross Medical Care Society & Aetna Health (NZ) Ltd)
$m
Operating Result
(18.9) 1.3 (17.6)
One off Write Down in investment –
Aetna Health
(19.1) (19.1)
Amortisation of Goodwill
(4.5)
Net Deficit
(38.0) (*41.2)
*The Medical Care Society’s loss is $38.0 million. The additional $3.2 million loss, bringing the
Group loss to $41.2 million, is attributable to the Aetna surplus of $1.3 million offset by the Aetna
goodwill amortisation of $4.5 million.

Reserves
184.5 179.6

Cash Deposits and Realisable Government Stock and Bonds 181.5 199.1

Ends

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