ITEM 1. BUSINESS - ------- --------
GENERAL
Health Power, Inc. (the "Company" or "Health Power") is a holding company which was incorporated under Delaware law on March 6, 1985. During 1996, the Company had two operating subsidiaries, Health Power HMO, Inc., an Ohio corporation ("Health Power HMO"), and CompManagement, Inc., an Ohio corporation ("CompManagement"). CompManagement Health Systems, Inc., an Ohio corporation and a subsidiary of CompManagement ("CompManagement Health Systems"), began providing its services as a managed care organization in March 1997.
Health Power HMO provides comprehensive managed health care services to members of its health maintenance organization ("HMO"). Health Power has historically focused on serving Medicaid recipients enrolled in the Aid to Families with Dependent Children and Healthy Start ("ADC") programs and, to a lesser extent, commercial members enrolled through employer groups. As of December 31, 1996, Health Power HMO had approximately 46,716 members, of which approximately 78% were ADC Medicaid recipients. Health Power HMO's provider network consists of approximately 795 primary care physicians, 2,180 specialists, and 62 hospitals.
Health Power HMO operates in four service areas encompassing 19 Ohio counties in and around the cities of Columbus, Dayton, Cincinnati, Cleveland, and Youngstown. Health Power has been a leader in developing the HMO markets for ADC Medicaid recipients in its service areas. It was the first HMO to offer these services in the Columbus and Dayton markets and an early entrant in the Cincinnati market.
CompManagement offers claims management and medical cost containment services to employers with respect to their workers' compensation claims and, to a lesser extent, their unemployment compensation claims. CompManagement provides its services to approximately 10,000 employers located in all 88 Ohio counties. CompManagement began business in September 1984, and was acquired by the Company in July 1995. The acquisition was accounted for as a pooling of interests.
In November 1996, CompManagement Health Systems was certified as a state-wide managed care organization (an "MCO") under Ohio's recently implemented managed care workers' compensation system, and in March 1997, it began providing its MCO services to employers. Prior to November 1996, this entity was not operational. CompManagement Health Systems provides its MCO services to approximately 17,000 employers located in all 88 Ohio counties. As an MCO, CompManagement Health Systems provides, among other things, claims review and processing for workers' compensation claims, bill review and payment with respect to physician and hospital charges, quality assurance programs, and medical management and cost containment services for employers with respect to their workers' compensation claims. Because all workers' compensation claims are reimbursed by the Ohio Bureau of Workers' Compensation ("BWC"), CompManagement Health Systems does not assume any risk for the payment of medical or disability benefits to employees with respect to their workers' compensation claims.
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The Company also has three other subsidiaries. Health Power TPA, Inc., an Ohio corporation ("Health Power TPA"), offers third party administrator services to companies which self-insure their health care costs. Health Power Life Insurance Agency, Inc., an Ohio corporation ("Health Power Life Agency"), offers life insurance and other companion products as part of the benefit package offered to commercial HMO members. Health Power TPA and Health Power Life Agency have had insignificant operations to date. Health Power Management Corporation, an Ohio corporation ("Health Power Management"), provides various management and/or administrative services to the Company's other subsidiaries.
FINANCIAL INFORMATION ON INDUSTRY SEGMENTS
Financial information on industry segments as required by Item 101(b) of Regulation S-K is set forth in Footnote 15 of the Notes to the Consolidated Financial Statements, which footnote is part of the financial statements contained in Item 8 of this Annual Report on Form 10-K, which footnote is incorporated herein by reference.
HEALTH POWER HMO--HEALTH CARE SERVICES
OVERVIEW OF MANAGED HEALTH CARE
HMOs generally arrange for the provision of comprehensive health care services, including physician and hospital care, to their members for a fixed, prepaid premium regardless of frequency, extent, or type of the health care services provided. Except in cases of medical emergency, the members receive care from participating primary care physicians who provide all of the primary care services and coordinate services with participating specialists and hospitals. HMOs are frequently able to negotiate favorable rates with providers due to their large membership base and to control medical expenses to a greater extent than traditional health insurers. Typically, HMOs seek to enter into arrangements with hospitals calling for discounted charges or fixed per diem rates and with physicians for fixed monthly payments, regardless of the amount of health care services which are actually required, known as "capitation payments," or seek to contract with medical providers on a discounted fee-for-service basis.
HMOs seek to combine quality health care with management controls designed to encourage efficient and economical utilization of health care services. Such controls include monitoring physician services, the level of hospital care and lengths of stay, emergency room use, and the effective use of hospital based medical services. HMOs generally receive fixed monthly premiums for their members regardless of the health care services provided. Thus, HMOs have an incentive to maintain the health of their members through preventive medical programs while carefully monitoring expenses through the implementation of various cost control strategies and effective management.
The three basic HMO organizational models are primarily distinguishable by the relationship of the HMO with its physician network. Staff model HMOs employ physicians directly at HMO-controlled facilities and compensate each physician through salary and incentives. Network model HMOs, such as Health Power HMO, contract with a limited number of physician groups to provide health care services to each member on a capitated or a discounted fee-for-service basis. Individual practice association model HMOs contract with individual physicians, either directly or through a physicians' association, and each physician is typically compensated on a capitated or a discounted fee-for-service basis.
HMOs may be contrasted with indemnity health insurers, which generally provide reimbursement under a fee-for-service system in which the charges of physicians, hospitals, and
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other providers selected by the insured are in direct proportion to the quantity and complexity of the services provided. HMOs also rely to a lesser extent on member cost sharing or copayment features that are more characteristic of traditional indemnity insurance. Preferred provider organizations ("PPOs") are similar to indemnity plans but typically feature discounted fee-for-service charges by selected providers and financial incentives for members to use providers within the PPO system.
A growing number of hybrid managed care structures have evolved that incorporate characteristics of HMOs, PPOs, and indemnity insurance. Employers who offer these new structures give employees the option of enrolling in an HMO or, at an increased cost to the employee, obtaining health care from a PPO or other provider. Some of these "multiple option" HMO plans contain "point of service" options that allow employees to choose providers either within the HMO's network or outside such network at a higher out-of-pocket cost at the time service is rendered. The HMO point of service plans have gained favor with some large employer groups because they facilitate consolidation of health benefit programs. While increasingly popular as a means of expanding employees' choices, these alternatives may result in increased health care costs to employers and employees to the extent that employees select a health care option without the managed care feature of traditional HMOs.
MEMBERSHIP AND MARKETS
ADC Medicaid Membership
Health Power HMO offers health care services to ADC Medicaid recipients in the six Ohio counties of Butler, Cuyahoga, Franklin, Hamilton, Mahoning, and Montgomery. Health care services are offered to ADC Medicaid recipients pursuant to a contract with the Ohio Department of Human Services ("ODHS"). Under this contract, Health Power HMO is paid a fixed monthly capitation rate from ODHS for each ADC Medicaid recipient enrolled in its HMO. The capitation rate is established on an annual basis by ODHS, varies by county, and is based upon certain rate setting methodology and data assumptions adopted by ODHS. As of December 31, 1996, approximately 78% of Health Power HMO's members were ADC Medicaid recipients. Health Power HMO's current contract with ODHS is for a one-year term expiring in June 1997. For the years ended December 31, 1996, 1995, and 1994, ADC Medicaid revenues represented approximately 67%, 64%, and 65%, respectively, of the Company's consolidated revenues.
In all of the counties other than Mahoning, ADC Medicaid recipients are required, or "mandated" by legislature, to enroll in a managed care plan. In these counties, ADC Medicaid recipients either select Health Power HMO from among several managed care plans offered to them or, if no selection is made, they are assigned to a plan by ODHS. In Mahoning County, which is a "non-mandated" or "voluntary" county, ADC Medicaid recipients join Health Power HMO as an alternative to the traditional fee-for-service Medicaid program in which recipients receive a Medicaid medical card that enables them to receive medical services performed by participating providers. ADC Medicaid recipients in voluntary counties may change the managed care plan selected by them or the method in which they receive medical benefits (i.e., fee-for-service or managed care) on a monthly basis. ADC Medicaid recipients in mandated counties may change managed care plans only during the first month of enrollment or during two "open enrollment" months during the year.
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Commercial Membership
Commercial members are individuals who join Health Power HMO through their employer-sponsored health benefit plans. Premium rates are based on the plan selected and are contained in the contract between Health Power HMO and each employer. These contracts are generally for one-year terms. During a designated annual "open enrollment period," or at the time of their employment, employees may select their desired health care benefit program. Employees may be disenrolled as a result of termination of employment or may disenroll voluntarily during the open enrollment period.
During 1996, Health Power HMO offered health care services to employees of the State of Ohio in its Columbus, Dayton, and Cincinnati service areas pursuant to contracts with the Ohio Department of Administrative Services ("ODAS"). As of December 31, 1996, approximately 63% of Health Power HMO's commercial members were employees of the State of Ohio or their dependents. Health Power HMO's current one-year contracts with ODAS for the Columbus and Cincinnati service areas expire in June 1997. Health Power HMO terminated its contract with ODAS for its Dayton service area effective March 1, 1997. This termination was part of the Company's turnaround efforts for its HMO business. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. For the years ended December 31, 1996, 1995, and 1994, the revenues from this employer group represented approximately 14%, 16%, and 19%, respectively, of the Company's consolidated revenues.
Service Areas
Health Power HMO operates in four service areas encompassing 19 Ohio counties in and around the cities of Columbus, Dayton, Cincinnati, Cleveland, and Youngstown.
The Columbus service area encompasses the contiguous counties of Delaware, Fairfield, Franklin, Licking, Madison, Pickaway, and Union, with Franklin County being the only county in this group in which Health Power HMO is permitted to offer its health care services to ADC Medicaid recipients. For the years ended December 31, 1996, 1995, and 1994, the Columbus service area operations accounted for 34%, 41%, and 44%, respectively, of the Company's consolidated revenues.
The Dayton service area encompasses the contiguous counties of Butler, Clark, Greene, Miami, and Montgomery, with Butler and Montgomery Counties being the counties in this group in which Health Power HMO is permitted to offer its health care services to ADC Medicaid recipients. For the years ended December 31, 1996, 1995, and 1994, the Dayton service area operations accounted for 18%, 21%, and 22%, respectively, of the Company's consolidated revenues.
The Cincinnati service area encompasses the contiguous counties of Clermont, Hamilton, and Warren, with Hamilton County being the county in this group in which Health Power HMO is permitted to offer its health care services to ADC Medicaid recipients. For the years ended December 31, 1996, 1995, and 1994, the Cincinnati service area operations accounted for 38%, 29%, and 26%, respectively, of the Company's consolidated revenues.
The Northeast service area encompasses the Northeast Ohio counties of Cuyahoga, Lorain, Mahoning, and Summit, with Cuyahoga and Mahoning Counties being the only counties in this group in which Health Power HMO is permitted to offer its health care services to ADC Medicaid recipients. The expansion into the Northeast area occurred during 1996. For the year
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ended December 31, 1996, revenues from the Northeast service area operations were insignificant.
Membership Information
The following table sets forth the number of Health Power HMO's ADC Medicaid and commercial members at December 31 for the years indicated and member months for the years then ended:
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SERVICES AND PRODUCTS
Revenues from health care services consist of amounts earned under contracts with ODHS for ADC Medicaid recipients and with commercial groups. The following table sets forth the revenues from each of the foregoing and their approximate percentage contribution to revenues during the periods indicated:
ADC Medicaid
Health Power HMO provides a comprehensive range of health care services to ADC Medicaid members which are specified by ODHS. These services include primary care physician, specialist, and hospital care, physical therapy, mental health and substance abuse care, home health and skilled nursing care, pharmacy, eye care, diagnostic laboratory tests, x-ray examinations, ambulance services, and durable medical equipment. ADC Medicaid recipients do not pay any premiums, deductibles, or copayments for any of their health care services. Health Power HMO assumes the risk that the actual cost of health care services may exceed the monthly capitation fee received from the state.
Commercial
Commercial members or their employers can select coverages available from products which have varying levels of outpatient and inpatient copayments and deductibles. Health Power HMO has a variety of plans available ranging from a preferred basic plan, which provides basic health care coverages at a low monthly cost but with higher deductible and copayments, to a high plan which provides more comprehensive coverage at a higher monthly cost but with lower deductibles and copayments. Health Power HMO also has a matrix product which enables the employer to select benefits from a number of options, thereby allowing the employer to custom design its own HMO benefit package. Health Power HMO also markets a point of service option which allows members to utilize out-of-network physicians in return for paying higher deductibles and copayments at the point of service.
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PROVIDERS
Health Power HMO provides health care to its members through a provider network consisting of primary care physicians, specialists, and hospitals. The following table sets forth the total number of primary care physicians, specialists, and hospitals in each of Health Power HMO's service areas as of December 31, 1996.
Upon enrollment, each member selects a primary care physician from the list of physicians in Health Power HMO's physician network. Primary care physicians include family practitioners, pediatricians, and internists. Primary care physicians coordinate the health care requirements of the members, assume overall responsibility for the care of members, and coordinate the nature and extent of services provided to any member. These physicians provide preventive and routine health care services and are responsible for making referrals to specialists, hospitals, and other providers. Health care services provided directly by the primary care physicians include the treatment of illnesses not requiring referrals, periodic physician examinations, routine immunizations, maternity and well child care, and other preventive health care services. Specialists provide medical care to members when referred by the primary care physician. Certain specialist services, such as outpatient laboratory tests and x-ray examinations and self-referrals for obstetrics, do not require a referral.
The physician network and provider satisfaction are critical to the successful functioning of an HMO. Management believes that the number of primary care physicians and sites enhances the marketability of its health care program. Health Power HMO devotes significant resources to recruiting, credentialing, and educating physicians and their staffs. Furthermore, Health Power HMO operates plans that integrate the physician into the decision-making process through a structure of standing and ad hoc committees. The provider services department is responsible for responding directly with physicians and their staff concerning administrative inquiries to supplement the on-site provider relations program. Health Power HMO has established a continual quality improvement committee composed of physicians in each service area to work with physicians in monitoring and developing medical policies. The councils are supported by the provider relations staff through the health services department.
Health Power HMO has contracted with other entities to provide, among other things, dental care, mental health and chemical dependency care, eye care, home health care, skilled nursing care, diagnostic laboratory tests, x-ray examinations, ambulance services, physical therapy, a 24-hour nurse line, and durable medical equipment to its HMO members. Members of the HMO have access to approximately 300 pharmacies in its four service areas and approximately 30,000 pharmacies throughout the United States pursuant to an agreement with ValueRx Pharmacy Program, Inc.
MEDICAL COST CONTROLS
Health Power HMO uses a number of methods and procedures to control and manage medical costs. These include capitation and other fee arrangements with providers, concurrent and utilization review of inpatient hospital services, including advance approval procedures for elective hospital admissions, and underwriting procedures.
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Capitation Arrangements
As of December 31, 1996, approximately 62% of Health Power HMO's members were covered by primary care physicians who were capitated. Capitation is a method of compensation to providers in which payments by the HMO for health care services are based on a fixed monthly amount for each person served by such providers regardless of the actual number or nature of services provided. The primary benefits of the capitation system of payment are that it improves the forecasting of medical expenses and introduces an element of risk sharing between the HMO and the primary care physicians who are responsible for coordinating care with specialists, hospitals, and for other ancillary services. Health Power HMO's arrangements with other providers for vision, dental, and mental health and chemical dependency services are also capitated.
Health Power HMO provides incentives to capitated primary care physicians to promote appropriate utilization and control of hospital and ancillary medical costs. Risk-sharing funds are established using budgeted amounts and shared with primary care physicians based upon actual utilization and health care cost experience. Health Power HMO generally withholds 20% of fees due commercial primary care physicians and 10% of fees due ADC Medicaid primary care physicians as a reserve for potential excessive utilization. The balances in these reserve accounts are retained by Health Power HMO or remitted to the primary care physicians at the end of the year based upon the performance of the combined physician groups for such year. For 1996, all such amounts were retained by Health Power HMO. Health Power HMO annually reviews the capitation fee paid to primary care physicians and makes adjustments as necessary. Among the factors considered in capitation adjustments are utilization patterns and competitive market conditions.
Other Fee Arrangements
Health Power HMO presently reimburses primary care physicians representing approximately 38% of the HMO's total membership on an agreed-upon fee schedule. Despite the success of its capitation program, Health Power HMO has concluded that a significant number of primary care physicians prefer the fee schedule arrangement over capitation payments, and in order to attract more primary care physicians to its provider network, Health Power HMO offers fee schedule arrangements. Consistent with its capitation arrangements, Health Power HMO may withhold a portion of such fees to cover payments for fees to specialists and hospital costs in excess of such physician's budgeted amounts.
Health Power HMO's primary care physicians coordinate care for members with specialists participating in Health Power HMO's network. Health Power HMO's provider arrangements with specialists provide for payment for commercial services at fixed rates. Specialists' services to ADC Medicaid members are paid at rates established by ODHS. In order to encourage cost effective utilization of specialists' services, amounts paid to specialists in the aggregate that are in excess of budgeted amounts may be deducted from such primary care physician's capitation withhold (commercial members). For ADC Medicaid members, specialist payments for most capitated primary care providers are included in their monthly capitation payment.
With the exception of emergencies, all inpatient hospital services paid by Health Power HMO on behalf of the physicians are provided pursuant to contracts with various hospitals under a variety of arrangements, including discounted charges and per diem arrangements, and require advance approval from the patient's primary care physician and Health Power HMO's medical department. Emergencies which require medical care by physicians or hospitals not under contract with Health Power HMO are paid for by Health Power HMO. In order to encourage cost effective utilization of hospital services, if the aggregate amount of hospital costs exceed
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budgeted amounts, the excess attributable to a particular primary care physician may be deducted from such physician's capitation withhold.
In order to obtain high quality services at cost-effective rates, Health Power HMO has contracted with other providers for, among other things, physical therapy, home health care, skilled nursing care, pharmacy, diagnostic laboratory tests, x-ray examinations, ambulance services, and durable medical equipment.
Utilization Review
Health Power HMO believes that its ability to effectively manage the appropriateness of services in the most cost-effective setting is a key component of its operations. Health Power HMO seeks to manage medical costs by monitoring for inappropriate services. In addition to approval by a member's primary care physician, all elective hospital admissions must be approved in advance by Health Power HMO's utilization management department. When members are admitted to a hospital, Health Power HMO proactively and concurrently reviews all hospital admissions and coordinates with the admitting physician the medical necessity and appropriateness of hospital procedures and length of stay. Health Power HMO also coordinates arrangements for alternative care for members as they progress through the continuum of care. Health Power HMO conducts retrospective review of patient records after services are complete to determine appropriateness of hospital services and charges.
Underwriting
Health Power HMO's commercial underwriting practices are designed to provide appropriate premium rates and benefits for employer groups. Health Power HMO also monitors actual experience with each employer group and attempts to make appropriate premium rate adjustments when contracts are renewed with the employer.
With respect to commercial members, Health Power HMO establishes premiums primarily pursuant to a "community rating system by class" which generally means that it charges the same amount of premium per member within a geographic area actuarially modified for each employer group based upon the age and sex of its employees. In order to assure appropriately balanced risk selection, management has developed underwriting criteria which establish minimum requirements for each employer group to meet before qualifying for coverage with Health Power HMO and tailors the benefit coverage to each employer group. Since 1990, Health Power HMO has utilized the services of an independent actuary to assist it in establishing its membership premiums for commercial members and appropriate reserves for medical claims incurred but not yet reported to Health Power HMO.
Because of its contractual arrangement with ODHS which requires Health Power HMO to provide health care services to any ADC Medicaid recipient who selects its HMO, traditional underwriting guidelines do not apply to the ADC Medicaid program.
MARKETING
In mandatory counties (such as Butler, Cuyahoga, Franklin, Hamilton, and Montgomery), Health Power HMO and all other managed care plans are prohibited from directly marketing to potential enrollees. Instead, potential enrollees contact or visit enrollment information centers ("EICs") located in a mandatory county. EIC staff members review with enrollees information about each plan's performance (i.e., consumer satisfaction surveys), provider network, and any plan-specific advantages. Enrollees are also able to view a video about Health Power HMO and the other managed care plans operating in the mandatory county.
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In voluntary counties (such as Mahoning), Health Power HMO may (and does) directly market to potential enrollees. Health Power HMO markets its HMO directly to ADC recipients through a variety of methods, all of which require prior approval of ODHS. Health Power HMO markets its programs to ADC Medicaid recipients as an alternative to the traditional fee-for-service Medicaid program in which recipients receive a Medicaid medical card that enables them to receive medical services performed by participating physicians, hospitals, and other health care providers. Because ADC Medicaid recipients may change the method of receiving medical benefits on a monthly basis, Health Power HMO's representatives are responsible for monitoring member satisfaction after initial enrollment. Unless a member loses ADC Medicaid eligibility or chooses to disenroll, ADC Medicaid members are automatically renewed in Health Power HMO's program on a monthly basis.
Health Power HMO's commercial programs are marketed through a combination of its own sales force of four representatives and independent agents and brokers. Health Power HMO markets its plans to private employers as well as to federal, state, and municipal public employer groups. Employers who offer Health Power's HMO to their employees generally do so as an option to traditional coverage rather than as a required replacement. Therefore, marketing Health Power's HMO commercial programs requires a two-part sale. The employer must first decide to offer Health Power's HMO. The employee then chooses among Health Power's HMO, traditional health care insurance, and other options, including other HMOs. Each year employers conduct an open enrollment during which their employees may change health care plans. Health Power HMO utilizes various techniques to retain members and to attract additional members during open enrollment periods, including work-site presentations, direct mail, and local advertising.
Health Power HMO has a member services department which directly communicates with members concerning their health care and service needs. Health Power HMO conducts annual surveys questioning members about their level of satisfaction with the services they receive and satisfaction with primary care physicians. Health Power HMO has also established member advisory groups in each of its service areas, composed of members selected at random, to provide information to Health Power HMO concerning services to members. Management reviews any problems that are presented by members concerning the delivery of medical care and receives periodic reports summarizing member grievances.
QUALITY IMPROVEMENT
Health Power has developed policies and procedures to ensure that the health care services provided by its HMO meet the professional standards of care established by the medical community. During 1996, Health Power HMO received a one-year accreditation from the National Committee for Quality Assurance ("NCQA"). This accreditation is granted to HMOs which are found to have comprehensive functioning continual quality improvement programs and which satisfy all NCQA standards for accreditation.
Health Power HMO's methods for evaluating the quality and appropriateness of medical care include performing periodic medical care evaluation studies, analyzing the monthly utilization of certain services, conducting periodic member satisfaction studies and reviewing and responding to member and physician grievances. Health Power HMO also compiles statistical information and publishes monthly departmental summary reports concerning the utilization of various services, including emergency room care, member service activity, provider service activity, claims related volume, outpatient care, out-of-area services, hospital services and physician visits. Under-utilization as well as over-utilization are evaluated in an effort to control the provision of quality care to Health Power HMO's members.
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As part of its continual quality improvement program, Health Power HMO has established peer review procedures which are carried out by a quality improvement committee consisting of members of the physician groups in each service area. This committee reviews and evaluates the quality of health care delivered by the physician groups and study the various tests and procedures performed by physicians for specific diagnoses. Health Power HMO also reviews the effectiveness of the physician group continual quality improvement committee on a periodic basis. In addition, when a new physician group applies to become a provider, Health Power HMO has a thorough credentialing procedure. Health Power HMO evaluates the quality of the group's medical facility, medical records, laboratory and x-ray facilities and capacity to handle membership demands, performs an on-site inspection, and reviews malpractice complaints and relations with area hospitals. Once a physician group is selected, it is periodically reviewed in an attempt to ensure that members are receiving quality medical care and appropriate access.
RISK MANAGEMENT AND INSURANCE
Health Power HMO has reinsurance to limit its risks for hospital costs with respect to its ADC Medicaid members. This reinsurance provides that during each 12-month period, the reinsurer will pay 85% of hospital costs for each ADC Medicaid member above a stop-loss attachment amount of $50,000.
Health Power HMO also has reinsurance to limit its risks for commercial members' hospital costs exceeding certain amounts. The percentage of the hospital costs paid by reinsurance depends on whether the hospital has a provider agreement with Health Power HMO which provides for fixed charges for members for specified services (a "fixed fee hospital"), the type of services provided and the age of the member. Health Power HMO's commercial reinsurance arrangements provide, during each 12-month period, for coverage of the excess loss on hospital costs according to the following table:
The excess loss on hospital costs is calculated by subtracting the deductible, currently $75,000, to be paid by Health Power HMO from the "eligible hospital services." Eligible hospital services are limited to the average daily maximum set forth below per member, which limitation does not include operating room charges or post-operative charges on the day of a surgical procedure, and which are further limited to a maximum reinsurance amount.
The maximum lifetime reinsurance indemnity for each member is $2,000,000.
In addition, Health Power HMO has various types of liability insurance to limit the ordinary risks of being engaged in the HMO business. Health Power HMO requires each of its physician groups and contracting hospitals to have medical malpractice insurance. Additionally, Health Power HMO carries its own medical malpractice insurance. In the ordinary course of its business, Health Power HMO may be subject to claims for which it may not be fully insured,
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such as claims resulting from decisions regarding providers, claims resulting from decisions regarding medical circumstances or necessity of treatment, including failure to approve medical procedures or hospital admissions, claims against Health Power HMO for malpractice by providers in its network, claims for failure to provide coverage or for wrongful termination of coverage, claims resulting from other issues with employer groups, members, or providers, and other general liability claims. There is a risk that claims could exceed or not be covered by insurance.
COMPETITION
The health care industry is highly competitive. Health Power HMO faces substantial competition in each of its service areas from many types of competitors, including other for-profit and not-for-profit HMOs, PPOs, self-funded plans, and traditional indemnity insurance carriers, many of which have substantially larger enrollments and greater financial and other resources than Health Power HMO. Health Power HMO believes that the principal competitive factors affecting its ability to retain and increase membership include its provider network, the cost of health benefit plans offered, geographic areas served, reputation, financial stability, quality of staff, comprehensiveness of benefit coverage, diversity of product offerings, and market presence. The relative importance of each of these factors and Health Power HMO's key competitors vary by customer type and by market. In addition, a number of Health Power HMO's competitors offer diverse products, many of which are similar to those that Health Power HMO is currently offering or may be offering in the future. Furthermore, premium rates charged by Health Power HMO's competitors may have an impact on Health Power HMO's operations. The market for HMO and managed care products has been subject to historical changes in profitability resulting from increases in health care costs during periods when significant competition or other market factors prevent corresponding increases in premiums. During the last several years, competition in the commercial HMO market was intense, with many health insurers and HMOs reducing their premium rates.
Health Power HMO will face varying levels of established competition if it enters new markets or introduces new programs, products, and services. In addition, new competitors may compete with Health Power HMO in the future.
Health Power HMO also competes with other managed care plans to enter into contracts with independent physicians, physician groups and other providers. Competitive factors influencing a physician's or other provider's decision to contract with Health Power HMO include potential membership volume, reimbursement rates, timeliness of reimbursement and administrative service capabilities.
COMPMANAGEMENT--CLAIMS MANAGEMENT
OHIO'S WORKERS' AND UNEMPLOYMENT COMPENSATION SYSTEMS
The following is intended to provide a summary description of the Ohio workers' and unemployment compensation systems.
Ohio's workers' compensation system is a no-fault state insurance program whereby injured workers are provided with medical and disability benefits. Ohio law requires all employers, with certain exceptions, to provide their employees with workers' compensation coverage. Ohio's system is administered by the Ohio Bureau of Workers' Compensation (the "BWC"), which is responsible for managing the state insurance fund, determining premium rates and manual classifications, collecting premiums from employers, and paying benefits to or on behalf of injured workers. In determining the premium rates, the BWC first classifies occupations or industries with respect to their degree of hazard and then determines the risk of
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the different classes. The workers' compensation program is funded by premiums paid by employers into the state insurance fund, which premiums are based upon the classification of an employer's employees and such employer's specific risk experience. If certain conditions are satisfied, similar types of employers may participate in plans that group, for rating purposes, such employers in pools that spread each employer's risk among all of the employers participating in that group. Under these "group rating plans," the premium rates are based upon the risk experience of the group and not the individual employer participating in that group. Employers which generally have 500 or more employees in Ohio and have sufficient financial capabilities may be granted status by the BWC as a self-insuring employer, which means that such employers are not required to pay premiums into the state insurance fund, but instead pay the same compensation, medical, and disability benefits as required by the Ohio workers' compensation program directly to or for the benefit of their injured workers.
The Ohio workers' compensation system is currently undergoing substantial change. Effective March 1, 1997, the BWC began implementing a managed care system for workers' compensation claims known as the Health Partnership Program (the "HPP"). This program applies to all Ohio employers other than self-insured employers. The BWC has also implemented a similar program for self-insured employers known as the Qualified Health Plan.
Under the HPP, participating employers are required to select a BWC-certified managed care organization (an "MCO"), or have such an MCO assigned to them by the BWC, to manage their workers' compensation claims. The MCO is primarily responsible to provide medical management and cost containment services for employers with respect to their workers' compensation claims. In order to receive BWC certification, an MCO is required to have, among other things, a network of healthcare providers, a quality assurance program, and certain information system capabilities. The MCO provides, among other things, utilization review services, medical case management services, dispute resolution, rehabilitation, peer review, and quality assurance programs with respect to workers' compensation claims.
Ohio's unemployment compensation system provides compensation benefits to workers who are laid off or involuntarily separated from employment without just cause. This system is administered by the Ohio Bureau of Employment Services (the "OBES"), which is responsible for managing the unemployment compensation fund, determining contribution rates, collecting contributions from employers, maintaining each employer's account, determining eligibility for benefits, and paying benefits to eligible unemployed workers. Contribution rates are determined each year by the OBES and then assigned to the individual employers. Employers are assigned the standard contribution rate (an amount equal to a specified percentage of wages as determined by the OBES) or the average contribution rate for its industry, whichever is greater, until they become eligible for an experience rate. Thereafter, the annual contribution rate is based upon the specific experience of each employer. The unemployment compensation program is funded by contributions paid by employers into the unemployment compensation fund.
SERVICES
CompManagement provides claims management and medical cost containment services to employers with respect to their workers' and unemployment compensation claims. In the area of workers' compensation, such services include the review and processing of an employer's workers' compensation claims, the design of individual programs to improve an employer's experience ratings, representation of employers before the Ohio Industrial Commission and the BWC, the performance of risk analysis for an employer's experience rating, the review of premium audits on behalf of employers, and analysis of employers for inclusion in group rating plans. CompManagement also acts as a third party administrator ("TPA") of workers' compensation claims for self-insured employers. Each employer selects the types of services
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it desires and then enters into a contract with CompManagement to provide such services. These contracts are typically for a one-year period.
In the area of unemployment compensation, CompManagement's services are similar to its services in the area of workers' compensation. Such services include the review and processing of an employer's unemployment compensation claims and representation of employers before the OBES. Each employer selects the types of services it desires and then enters into a contract with CompManagement to provide such services. These contracts are typically for a one year period.
CompManagement currently provides its services to approximately 10,000 employers located in all 88 Ohio counties. A substantial number of these employers have entered into contracts with CompManagement because of their participation in group rating plans, discussed above, sponsored by trade associations of which such employers are members. Fees from employers participating in one of these group rating plans accounted for approximately 56%, 28%, and 18% of CompManagement's revenues for 1996, 1995, and 1994, respectively.
CompManagement Health Systems provides its MCO services to approximately 17,000 employers located in all 88 Ohio counties. In addition, CompManagement Health Systems has also entered into contractual arrangements with other MCOs pursuant to which it provides various MCO administrative services to such MCOs. As an MCO, CompManagement Health Services provides the following types of services: receiving and processing new workers' compensation claims; reporting injury and claim activity to the Bureau; reviewing and processing bills submitted by physicians and hospitals; paying physician and hospital bills once funds are received from the BWC; providing quality assurance programs; educating participating employers on the HPP program; providing utilization review programs; providing medical case management programs; providing a dispute resolution system for participants; providing rehabilitation programs; and providing a peer review system. Because all workers' compensation claims are reimbursed by the BWC, CompManagement Health Systems does not assume any risk for the payment of medical or disability benefits to employees with respect to their claims.
MARKETING
CompManagement markets its services through both its own sales force of three persons who directly contact prospective and existing employer groups and its relationships with over 500 insurance agents and brokers. CompManagement has service center locations in Akron, Cincinnati, Cleveland, and Toledo, in addition to its Dublin, Ohio offices.
CompManagement Health Systems primarily markets its MCO through its relationship with CompManagement, as well as its relationship with over 500 insurance agents and brokers. In addition, employers who do not select an MCO have one assigned to them by the BWC. In 1997, approximately 2,400 employees were assigned to CompManagement Health Systems' MCO.
COMPETITION
Claims management for workers' compensation and unemployment compensation claims is a highly competitive industry, with most of the market share concentrated among a few companies, including CompManagement. The principal competitive factors are types of services offered and responsive to customer needs. CompManagement's strategy is to effectively compete on the basis of quality and outstanding customer service, while offering a full range of services.
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Although newly implemented, managed care of workers' compensation claims is a highly competitive industry. Initially, 29 MCOs received state-wide certification and a total of 52 MCOs received county or state certification under the HPP program. CompManagement Health Systems competes with both state-wide certified MCOs as well as county-certified MCOs. CompManagement Health Systems believes that the principal competitive factors affecting its ability to retain and attract new employers include its reputation, relationship with its insurance agents and brokers, geographic areas served, financial stability, provider network, and responsiveness to customer needs. CompManagement Health Services' strategy is to effectively compete on the basis of quality and outstanding service. Many of its competitors have greater financial and other resources than CompManagement Health Systems.
GOVERNMENT REGULATION
Government Regulations
Ohio law governs all aspects of an Ohio HMO's business, including financial condition, solicitation of subscribers, contracts with health care providers, subscriber participation and the scope of benefits provided. In Ohio, myriad statutes and regulations subject HMOs to concurrent regulation by the Ohio Department of Health ("ODH"), ODI, and, for those HMOs participating in the Ohio ADC Medicaid program, ODHS. The Company believes that its HMO is currently in material compliance with all laws, regulations, and certification requirements applicable to it. However, in December 1996, Health Power HMO was placed under supervision by ODI for its failure to satisfy Ohio's statutory net worth requirements for HMOs. Health Power HMO was released from supervision on March 20, 1997, after it satisfied ODI's requirements of supervision.
An HMO may not commence or continue operations in the State of Ohio without a certificate of authority. The certificate of authority application procedure requires, among other things, satisfying the Director of Health of ODH (the "Director of Health") and the Superintendent of Insurance of ODI (the "Superintendent of Insurance") as to the adequacy of the HMO's organizational structure, financial resources, utilization review, quality assurance programs, and complaint procedures. In addition to the application for a certificate of authority, each HMO operating in Ohio must deposit a bond of cash, securities, or, with approval, corporate surety with the Superintendent of Insurance. Health Power HMO holds a certificate of authority to operate an HMO in Ohio.
Ohio HMOs must file annual reports with both the Director of Health and the Superintendent of Insurance, containing similar information as is required in the application for the certificate of authority, including: audited financial statements, summary of utilization review, description of enrollee population and composition, written complaints and their disposition, and disclosure of the organization's officers or partners. In addition, HMOs participating in the Ohio ADC Medicaid program must file annual and quarterly cost reports with ODHS. The Director of Health and the Superintendent of Insurance must also conduct periodic reviews of each HMO.
Ohio statutes require Ohio HMOs to maintain a certain minimum total admitted assets, with only certain assets and liabilities of the HMO considered in calculating such minimum total admitted assets. In addition, Ohio law requires HMOs to maintain statutory net worth in an amount such that admitted assets are equal to at least 110% of liabilities. On December 5, 1996, Health Power HMO was placed under supervision by ODI because of its failure to satisfy this statutory net worth requirement. On March 20, 1997, Health Power HMO was released from supervision after it satisfied ODI's requirements of supervision.
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Ohio law requires each HMO to deposit $250,000 with ODI. Finally, each HMO participating in the Ohio ADC Medicaid program are required to maintain a deposit with ODHS of $200,000. See Item 8. Financial Statements and Supplementary Data, Note 4 of the Notes to the Consolidated Financial Statements.
HMOs are included in the definition of "insurers" for purposes of the Ohio Insurance Holding Company Systems Act (the "Holding Company Act"), and as such, are subject to regulation under the Holding Company Act. Generally, the Holding Company Act requires HMOs to register with ODI and furnish information concerning the operations of companies within the holding company system that may materially affect the operations, management, or financial condition of the HMO. Pursuant to these laws, ODI may examine the HMO at any time, require disclosure of material transactions involving the HMO and the other members of the holding company system, and require prior notice and an opportunity to disapprove of certain "extraordinary" transactions, including, but not limited to, extraordinary dividends. Pursuant to these laws, all transactions within the holding company system affecting the HMO must be fair and equitable. In addition, approval of ODI is required prior to the consummation of transactions affecting the control of the HMO.
ODI regulations require ODI approval if dividends or distributions of an HMO within a 12-month period were to exceed 15% of the HMO's statutory net worth as of the end of the preceding fiscal year. Additionally, each HMO must demonstrate its financial soundness to the Superintendent of Insurance and submit to monitoring of its financial condition by ODI.
Pursuant to Ohio regulations, each HMO must notify the Superintendent of Insurance of any major modification of its operations that affects, among other things, the HMO's solvency, the health care services the HMO provides or the manner in which the HMO conducts its business. If the modification is the result of action by the HMO, the modification is subject to prior approval by the Superintendent of Insurance.
Health Power HMO is not a federally qualified HMO. Federally qualified HMOs must file periodic financial disclosure reports with, and are subject to continuous oversight and periodic review by, the United States Department of Health and Human Services and the United States Health Care Financing Administration ("HCFA"). Subject to certain exceptions, federally qualified HMOs are required to set their premiums according to principles of community rating and to offer a minimum level of benefits which typically exceeds the level of benefits required by state regulation. Historically, the primary benefits of obtaining federal qualification were that it enabled an HMO to offer health care services to Medicare recipients and to be exempt from federal (and possibly state) enrollment mix requirements. However, non-federally qualified HMOs are now permitted to offer health care services to Medicare recipients. Health Power's management periodically reviews whether or not federal qualification would yield tangible benefits that would make the effort and expense of obtaining federal qualification worthwhile to the Company.
CompManagement's business is not subject to specific government regulation or oversight. However, its business is substantially dependent on the operation of Ohio's workers' and unemployment compensation systems.
CompManagement Health Systems is certified by the BWC to operate a state-wide MCO and is subject to regulation by the BWC as an MCO. In order to receive BWC certification, an MCO must demonstrate that it has, among other things, a satisfactory network of healthcare providers in each of its service area, a quality assurance program, and certain information system capabilities.
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Health Power TPA is licensed by ODI and is subject to regulation as a TPA. Health Power Life Agency is licensed by ODI and is subject to regulation as an insurance agency. The Company believes that these entities are presently in compliance with all laws, regulations, and certification requirements applicable to them.
Medicaid
Medicaid is a cooperative state and federal program which provides health care services to low income individuals in the United States. Medicaid is divided into several types of programs, including Aid to Families with Dependent Children and Healthy Start, blind and disabled persons, and persons requiring nursing home care (who may also be concurrently receiving Medicare benefits). Medicaid is sponsored by individual state governments, such as Ohio, which obtain significant financial support from the federal government in the form of matching funds. Ohio's Medicaid program is supervised and regulated by ODHS. Currently, only ADC Medicaid recipients are eligible to receive Medicaid medical benefits through a participating HMO.
Health Power HMO participates in Ohio's ADC Medicaid program through a provider agreement with ODHS. ODHS may enter into provider agreements for the provision of Medicaid services with HMOs that meet ODHS's definition of an HMO and that comply with certain other rules. As a participant in Ohio's ADC Medicaid program, Health Power HMO must comply with specific rules established for such participation. These rules contain specific requirements, including eligibility, enrollment, disenrollment, covered services, eligible providers, subcontractors, recordkeeping, reporting, quality assurance, and marketing. An HMO's compliance with these requirements is subject to monitoring by ODHS or its designee, the State of Ohio's auditor's office, and the United States Department of Human Services. The process by which ODHS evaluates an HMO's compliance with the quality assurance standards is an annual comprehensive quality assurance evaluation by a third party reviewing organization. In addition, the HMO must submit quarterly utilization reports. The most recent evaluations of Health Power HMO's HMO indicated that it was in compliance with ODHS quality assurance standards.
In voluntary counties, Ohio and federal regulations require HMOs participating in the ADC Medicaid program to derive, generally, at least 25% of their membership residing in a single county, or group of contiguous counties approved as a single service area, from non-Medicaid recipients. ODHS has the authority to waive the state requirement for an HMO on an annual basis for up to three years, provided that HCFA has also waived the federal enrollment mix requirement for such HMO. HCFA has the authority to waive the federal requirement for up to three years. Mahoning County is the only voluntary county in which Health Power HMO offers its services to ADC Medicaid recipients, and it currently has ODHS and HCFA waivers for this county. See also "-- Mandatory Managed Care Counties for ADC Medicaid Recipients."
Mandatory Managed Care Counties for ADC Medicaid Recipients
In January 1995, the State of Ohio received a waiver from HCFA which exempted the operation of Ohio's Medicaid program from many of the federal regulations applicable to Medicaid, such as the enrollment mix requirement described above. This waiver, however, was only applicable to the type of health care program approved by the Ohio General Assembly. The legislation adopted by the General Assembly grants authority to ODHS to "mandate" ADC Medicaid recipients residing in certain Ohio counties to enroll in managed care plans in order to receive medical services. Pursuant to this authority, ODHS has designated seven counties (Franklin, Montgomery, Hamilton, Butler, Cuyahoga, Summit, and Lucas) as mandatory counties. All ADC Medicaid recipients residing in a mandatory county must enroll with a
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managed care plan in order to receive medical services. In a mandatory county, all participating HMOs must accept all eligible ADC Medicaid recipients desiring to enroll in such HMO, without restriction, in the order in which such recipients apply to become enrollees of such HMO. Enrollment opportunities must remain open and available as long as the enrollment maximums determined by ODHS and found in the provider agreement with such HMO are not exceeded. Because of this requirement, participating HMOs are not be subject to the federal and state enrollment mix requirements, but instead, membership is limited as to the maximum number of enrollees by the ODHS provider agreement.
EMPLOYEES
As of March 1, 1997, the Company had 204 full-time employees. Of these, 66 were employed in connection with Health Power HMO's operations, 101 were employed in connection with CompManagement's operations, and 37 were employed in connection with CompManagement Health Systems' operations. The employees of the Company are not represented by a union. The Company considers its relations with such employees to be good.
ITEM 2.

ITEM 2. PROPERTIES - ------- ----------
The Company's subsidiary owns two three-story office buildings located at 556 and 560 East Town Street, Columbus, Ohio, which are used as Health Power HMO's principal office facilities. These facilities contain approximately 14,195 square feet of office space.
CompManagement currently leases approximately 39,000 square feet of office space at 5777 Frantz Road, Dublin, Ohio. This lease will expire in December 1997. CompManagement has entered into a lease for a building under construction located in Dublin, Ohio, which it expects to occupy in October 1997. CompManagement will initially lease approximately 50,000 square feet of office space in this new building. CompManagement also leases office space in Akron, Cleveland, and Toledo, Ohio, which is used as service centers for its operations.
Health Power HMO and CompManagement share office space which is leased in Cincinnati, Ohio.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS - ------- -----------------
Neither the Company nor any of its subsidiaries are currently a party to any material legal proceedings, nor, to the Company's knowledge, is any material legal proceeding threatened against the Company or any of its subsidiaries. On December 5, 1996, Health Power HMO was placed under supervision by the Ohio Department of Insurance because of its failure to satisfy Ohio's statutory net worth requirement for HMOs. On March 20, 1997, Heath Power HMO was released from supervision after it satisfied the Department's requirements for supervision.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------- ---------------------------------------------------
No matters were submitted to a vote of security holders during the fourth quarter of the Company's fiscal year ended December 31, 1996.
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EXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------
The executive officers of the Company and their respective ages and present positions with the Company are as follows:
Dr. Master has been the Chairman of the Board and Chief Executive Officer of the Company since its formation in March 1985. Since 1966, Dr. Master has been a practicing physician in Columbus, Ohio. Dr. Master is a senior attending physician at Doctors Hospital, Columbus, Ohio, and a member of the courtesy staff of Deaconess Hospital, Cincinnati, Ohio. Dr. Master is the sole stockholder of a corporation which operates two medical clinics which are providers for Health Power's HMO.
Mr. Beaty has been the President and Chief Operating Officer of the Company since May 1990, and Treasurer of the Company since August 1996. He was also the Treasurer of the Company from April 1992 to July 1995.
Mr. Wurtz has been the Controller of the Company since August 1990 and has been Chief Financial Officer since June 1996. He also served as Chief Financial Officer of the Company from November 1993 to July 1995.
Mr. Bossart has been an executive officer of CompManagement since its formation in 1984 and the chief executive officer of CompManagement Health Systems since September 1996.
Mr. Wagner has been an executive officer of CompManagement since its formation in 1984.
Mr. Kurth has been an executive officer of CompManagement since its formation in 1984.
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PART II
ITEM 5.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - ------- ---------------------------------------------------------------------
The Company's shares of common stock are traded on the Nasdaq National Market system under the symbol HPWR. The following table sets forth the range of the reported high and low sales prices of the Company's common stock by calendar quarter for 1995 and 1996:
The Company has not paid any dividends on its shares of common stock to date, and it intends to retain its earnings to finance the development and expansion of its business for the foreseeable future. The approval of ODI is required if dividends or distributions of an HMO, such as the Company's, within a 12-month period would exceed 15% of the HMO's statutory net worth as of the end of the preceding fiscal year.
As of March 5, 1997, there were 87 stockholders of record of the Company's common stock and approximately 2,000 beneficial owners of such stock, and the last sales price per share on that date, as reported by the Nasdaq National Market system, was $3.88.
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ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected consolidated financial data, operating statistics, and membership data for the Company as of and for each of the years in the five-year period ended December 31, 1996. All periods in the table have been restated to reflect the acquisition of CompManagement, which was accounted for as a pooling of interests.
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ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ------- --------------------------------------------------------------- RESULTS OF OPERATIONS ---------------------
GENERAL
During 1996, the Company's operating subsidiaries were Health Power HMO and CompManagement. As further discussed below, CompManagement Health Systems began providing its MCO services to employers in March 1997. See "1996 Developments- CompManagement Health Systems."
Health Power HMO provides comprehensive managed health care services to members of its HMO in four service areas encompassing 19 Ohio counties in and around the cities of Columbus, Dayton, Cincinnati, Cleveland and Youngstown. Health Power HMO has historically focused on serving ADC Medicaid recipients and, to a lesser extent, commercial members enrolled through employer groups.
The Company acquired CompManagement on July 21, 1995. The acquisition was accounted for as a pooling of interests. CompManagement, which began business in September 1984, provides claims management and medical cost containment services to employers with respect to their workers' and unemployment compensation claims. CompManagement provides its services to approximately 10,000 employers located in all 88 Ohio counties.
This discussion should be read in conjunction with the consolidated financial statements, notes, and tables included elsewhere in this report. The Company cautions readers that any forward looking statements contained in this report involve risks and uncertainties and are subject to change based on various factors.
1996 DEVELOPMENTS
Supervision by the Ohio Department of Insurance
On December 5, 1996, Health Power HMO was placed under supervision by ODI because of its failure to satisfy Ohio's statutory net worth requirements for HMOs. On March 20, 1997, Health Power HMO was released from supervision after it satisfied ODI's requirements for supervision.
CompManagement Health Systems
In November 1996, CompManagement Health Systems was certified as a state-wide MCO under Ohio's recently implemented managed care workers' compensation system, and in March 1997, it began providing its MCO services to employers. CompManagement Health Systems provides its MCO services to approximately 17,000 employers located in all 88 Ohio counties. As an MCO, CompManagement Health Systems provides, among other things, claims review and processing for workers' compensation claims, bill review and payment with respect to physician and hospital charges, quality assurance programs, and medical management and cost containment services for employers with respect to their workers' compensation claims. Because all workers' compensation claims are reimbursed by the BWC, CompManagement Health Systems does not assume any risk for the payment of medical or disability benefits to employees with respect to their workers' compensation claims.
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NCQA Accreditation
In November 1996, Health Power HMO received one-year accreditation from NCQA. This accreditation is granted to HMOs which are found to have comprehensive functioning continual quality improvement programs and which satisfy all NCQA standards for accreditation.
Transaction with ChoiceCare
Health Power HMO acquired certain contract rights from ChoiceCare Health Plans, Inc., an Ohio corporation ("ChoiceCare"), which enabled approximately 12,000 Hamilton County ADC Medicaid recipients previously served by ChoiceCare to be automatically enrolled in Health Power HMO as of July 1, 1996. The purchase price for the contract rights was $5.0 million. The Results of Operations set forth below reflect the acquisition of such contract rights and the enrollment of the ADC Medicaid recipients previously served by ChoiceCare.
Private Label Product
In July 1996, Health Power HMO and Health Power Management entered into agreements with MedOhio Health, Inc. and MedOhio Health Plan, Inc. (collectively, "MedOhio Health") to offer and manage a private label managed care product known as the "University Healthcare Plan". Health Power HMO began offering the University Healthcare Plan to Franklin County ADC Medicaid recipients during the first quarter of 1997. As part of this transaction, MedOhio Health was granted an option to purchase 25,000 shares of Common Stock of the Company. See Item 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ------- -------------------------------------------
The Consolidated Financial Statements, including the Notes to Consolidated Financial Statements and the Report of Independent Accountants, appear following this page. Supplemental data is omitted because it is not applicable to the Company.
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REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors and Shareholders Health Power, Inc. Columbus, Ohio
We have audited the accompanying consolidated balance sheets of Health Power, Inc., and Subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Health Power, Inc., and Subsidiaries as of December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles.
/s/ COOPERS & LYBRAND L.L.P. Coopers & Lybrand L.L.P.
Columbus, Ohio March 5, 1997, except for Note 13 for which the date is March 20, 1997
HEALTH POWER, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
as of December 31, 1996 and 1995
CONTINUED HEALTH POWER, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of the consolidated financial statements.
HEALTH POWER, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
for the years ended December 31, 1996, 1995 and 1994
The accompanying notes are an integral part of the consolidated financial statements.
HEALTH POWER, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
for the years ended December 31, 1996, 1995 and 1994
The accompanying notes are an integral part of the consolidated financial statements.
HEALTH POWER, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended December 31, 1996, 1995 and 1994
CONTINUED HEALTH POWER, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of the consolidated financial statements.
HEALTH POWER, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
a. DESCRIPTION OF OPERATIONS: Health Power, Inc. (the Company) is a Delaware holding company that operates Health Power HMO, Inc., a health maintenance organization (HMO) in the Columbus, Cincinnati and Dayton, Ohio, areas for Aid to Families With Dependent Children (ADC) and Healthy Start Medicaid recipients as well as for commercial members. On November 18, 1996 the HMO received a National Committee for Quality Service Assurance (NCQA) certificate which expires February 18, 1998. The Company also provides full-service workers' and unemployment compensation consulting services through its CompManagement, Inc. (CompManagement) subsidiary (see Note 2) to employers in the state of Ohio. Effective March 1, 1997, CompManagement Health Systems, Inc., a subsidiary of CompManagement, will also begin operations as a managed care organization for the Ohio Bureau of Workers' Compensation.
b. BASIS OF PRESENTATION: The accompanying consolidated financial statements are presented in accordance with generally accepted accounting principles (GAAP). The Company's HMO subsidiary is subject to regulation by the Ohio Department of Insurance (the Department) and is required to file separate financial statements with the Department prepared in accordance with statutory accounting practices. Such practices differ in certain respects from GAAP. Significant statutory differences relate to certain assets designated as "nonadmitted" (principally intercompany accounts), which are charged directly to surplus and deferred federal income taxes and are not recognized for statutory reporting purposes.
c. PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
d. PER SHARE DATA: Earnings per common share have been computed by dividing net income by the weighted average number of common shares and common stock equivalents outstanding. Common stock equivalents included in the computation represent shares issuable on assumed exercise of stock options and stock warrants having exercise prices less than the average market price of the common stock using the treasury stock method.
e. CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS: It is the policy of the Company to classify investments with original maturities of three months or less as cash equivalents and original maturities greater than three months but less than one year as short-term investments.
Cash equivalents at December 31, 1996 include $12,809,000 deposited in an overnight sweep account and $1,472,844 invested in commercial paper and a money market fund.
HEALTH POWER, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
f. PROPERTY, EQUIPMENT AND SOFTWARE: Depreciation and amortization of property, equipment and software is computed using the straight-line method over the estimated useful lives of the assets, ranging from 3 to 25 years.
Expenditures for major betterments are capitalized, and expenditures for repairs and maintenance are charged to operations as incurred. When property and equipment are retired or sold, the cost and related accumulated depreciation and amortization are removed from the accounts, with any gain or loss reflected in operations.
Depreciation expense amounted to $359,855, $202,242 and $111,101 in 1996, 1995 and 1994, respectively.
g. REVENUES: Commercial and Medicaid revenues consist primarily of amounts earned under contracts with commercial groups and the Ohio Department of Human Services (ODHS) for Medicaid recipients. Such amounts are recognized when earned. Amounts received prior to the month of service are recorded as deferred revenues. For the year ended December 31, 1996, commercial group premiums from the State of Ohio approximated 59% of the Company's commercial revenues. Effective February 24, 1997, the Company gave notice to cancel its contract to provide services for a commercial group in the Dayton area; therefore, health care coverage for that group will cease on March 1, 1997. This group accounted for approximately 15% of the HMO's commercial revenue during 1996. Other commercial group coverage will continue as normal in the Dayton area.
Contract revenues are derived from claims management, administrative and consulting services, which are recorded as earned based on the requirements and duration of the related contract. Revenue on certain contracts has been deferred and is recognized into income on a pro rata basis over the related contract periods, which typically range between 3 and 12 months. Commission expense associated with these contracts is also deferred and recognized into expense on a pro rata basis over the related contract periods. For services related to group rating contracts, fees are paid to the group's sponsor and netted against contract revenues. For the year ended December 31, 1996, contract revenue from a major client approximated 32% of the Company's contract revenue.
h. HEALTH CARE COSTS: Health care costs include primary care and physician-related costs and hospital costs. Primary care and physician-related costs represent expenses incurred under contracts and arrangements with health care providers in rendering services to enrollees. Such costs include fee-for-service amounts and capitation (a monthly fixed fee per enrollee) recognized in providing medical, vision, pharmacy and other health care services.
Hospital costs are recognized when hospital services are provided to enrollees and include stop-loss insurance coverage premiums, net of recoveries (see Note 6).
HEALTH POWER, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Primary care and physician-related costs and hospital costs include management's estimate of services provided but not reported at year-end and expected future losses on contracts in effect at year-end. The Company recognizes expected future contract losses when it is probable that expected future health care costs and maintenance costs under a group of existing contracts will exceed anticipated future premiums and stop-loss insurance recoveries on those contracts. The reserve for expected future contract losses is approximately $266,175 and $398,000 as of December 31, 1996 and 1995, respectively, and is included with health care costs payable on the accompanying consolidated balance sheets. The methods of making such estimates and for establishing the resulting liabilities are continually reviewed and updated based on current circumstances, and any adjustments resulting therefrom are currently reflected in operations. It is reasonably possible that these circumstances may change in the near term.
Stop-loss reinsurance premiums are reported as health care costs and recoveries are reported as a reduction of health care costs.
Effective January 1, 1997, the HMO entered into an agreement to outsource the claims adjudication and payment process and other administrative functions related to the HMO's Medicaid and commercial members with a third-party administrator. The administrative and claim processing fees are subject to change on January 1 of each year, beginning January 1, 1998.
i. INCOME TAXES: Deferred income tax assets and liabilities are recognized for the tax consequences of "temporary differences" by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
j. ACQUISITION COSTS: The cost of acquiring new HMO members, consisting principally of commissions and underwriting costs, is expensed as incurred. Effective June 30, 1996, the HMO acquired by assignment from ChoiceCare Health Plans, Inc., an Ohio corporation (ChoiceCare), certain contract rights with respect to ChoiceCare's provider agreement with the ODHS. Under that provider agreement, ChoiceCare previously provided health care services to ADC and Healthy Start Medicaid recipients residing in Hamilton County, Ohio. Through its acquisition of such contract rights, approximately 12,000 ADC and Health Start Medicaid recipients previously served by ChoiceCare were enrolled in the Company's HMO effective July 1, 1996. The purchase price for the contract rights assigned to the Company's HMO was $5 million and was charged to operations in 1996.
k. STOCK-BASED COMPENSATION: Compensation cost is measured under the intrinsic value method. Pro forma disclosures of net income and earnings per share are presented as if the fair value based method has been applied (see Note 11).
HEALTH POWER, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
l. USE OF ESTIMATES: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
m. RECLASSIFICATION: Certain 1995 and 1994 amounts have been reclassified to conform with the 1996 presentation.
2. MERGER OF COMPMANAGEMENT, INC.:
On July 21, 1995, CompManagement was merged with and into the Company, and 634,878 shares of the Company's common stock were issued in exchange for all the outstanding common stock of CompManagement. The merger has been accounted for as a pooling of interests, and the financial statements have been restated to include CompManagement.
Separate results of the combined entities for the six months ended June 30, 1995 are as follows:
HEALTH POWER, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
3. ACCOUNTS RECEIVABLE:
Accounts receivable consist of the following:
Accounts receivable from primary care providers primarily represent amounts due for referral claims paid by the Company on behalf of capitated Medicaid primary care providers.
4. OTHER ASSETS:
Other assets consist of the following:
Certificates of deposit represent amounts held on deposit under the terms of the HMO's Certificate of Authority with the Ohio Department of Insurance and the Ohio Department of Human Services.
HEALTH POWER, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
5. RISK-SHARING FUNDS AND CAPITATION COSTS WITHHELD:
The Company's HMO provides incentives to capitated primary care providers to promote appropriate utilization and control of hospital and ancillary medical costs. Risk-sharing funds are established using budgeted amounts and shared with providers based on actual utilization and health care cost experience.
The Company's HMO withholds 10%-20% of fees due certain commercial primary care providers and 10% of fees due Medicaid primary care providers as a reserve for potential excessive utilization. The balances in these reserve accounts are retained by the Company or remitted to the providers at the end of the year at the discretion of the Company.
During 1996, the Company elected not to remit any capitation costs withheld and risk-sharing funds. In 1995, the Company's HMO remitted capitation costs withheld and risk-sharing funds amounting to $437,303. The Company retained $177,105 and $152,541 of capitation costs withheld from commercial primary care providers in 1996 and 1995, respectively, and retained $825,254 and $413,442 of capitation costs withheld from Medicaid primary care providers in 1996 and 1995, respectively.
6. COMMITMENTS:
The Company's HMO maintains stop-loss insurance coverage for 85% of inpatient hospital costs in excess of $50,000 ($40,000 prior to April 1, 1996 and $30,000 prior to April 1, 1995) per Medicaid member, per contract year. The HMO also maintains stop-loss insurance coverage for varying percentages (generally 80%) of inpatient hospital costs in excess of $75,000 per commercial member, per contract year, subject to certain limitations. These reinsurance contracts do not relieve the Company from its obligations to commercial members, and failure of reinsurers to honor their obligations could result in losses to the Company.
Stop-loss insurance premiums of $1,848,274, $1,500,957 and $1,507,576 are included in health care costs for 1996, 1995 and 1994, respectively. Stop-loss recoveries of $1,897,806, $1,248,179 and $1,294,189 are deducted from health care costs for 1996, 1995 and 1994, respectively.
CompManagement is party to employment agreements with certain employees. The agreements call for certain levels of commission expense to be paid by CompManagement to these individuals for selected contract revenue earned over a two-year period which ended in July 1996. Total commission expense paid in 1996 and 1995 in connection with these agreements was approximately $74,234 and $101,000, respectively.
HEALTH POWER, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
7. INCOME TAXES:
The Company and its subsidiaries file a consolidated federal income tax return.
The benefit (provision) for income taxes in 1996, 1995 and 1994 consists of the following:
The significant components of the deferred tax benefit (expense) for the years ended December 31, 1996, 1995 and 1994 were as follows:
A reconciliation of the Company's effective income tax rate, as reflected in the consolidated statement of operations, to the statutory federal tax rate is as follows:
The components of the net deferred benefit (tax) asset as of December 31, 1996 and 1995 were as follows:
HEALTH POWER, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Due to the uncertain nature of their ultimate realization based upon past levels of taxable income, the Company has established a full valuation allowance on the net deferred tax asset at December 31, 1996. While the need for this valuation allowance is subject to periodic review, if the allowance is reduced, the tax benefits of these tax assets will be recorded in future operations as a reduction of the Company's income tax expense.
At December 31, 1996, the Company had the following net federal investment credits and tax credit carryforwards available:
HEALTH POWER, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
8. OHIO DEPARTMENT OF HUMAN SERVICES CONTRACTS:
The Company's Medicaid revenue is derived from a contract with the ODHS. The Company's current contract with ODHS is for a one-year term through June 30, 1997.
9. LEASES:
The Company has various operating leases for office space and equipment. The leases have initial terms of up to five years, contain certain escalation clauses, and provide for renewal options for up to 10 years.
Through June 30, 1995, the Company leased office space from an affiliate. Rental expense was approximately $577,756, $549,824 and $583,800, for 1996, 1995 and 1994, respectively, which includes $60,460 and $140,425 paid to affiliates for 1995 and 1994, respectively.
As of December 31, 1996, future minimum rental payments under the leases are as follows:
In December 1996, CompManagement entered into a 15-year building lease. The agreement calls for lease payments of approximately $465,600 per year for years 1 through 7 and $536,000 for years 8 through 15. The lease will be accounted for as a capital lease, and the lease commencement date is anticipated to occur during the third quarter of 1997.
10. RELATED-PARTY TRANSACTIONS:
The Company engages in transactions with medical centers and companies controlled by certain shareholders and directors of the Company and its subsidiaries, which are herein referred to as affiliates or affiliated providers, as follows:
a. HEALTH CARE PROVIDERS: During 1996, 1995 and 1994, primary care and physician-related costs amounted to $2,854,159, $2,127,691 and $1,885,896, respectively, resulting from transactions between the Company's HMO and affiliated providers. As of December 31, 1996 and 1995, such transactions resulted in the following assets and liabilities:
HEALTH POWER, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
b. COMMERCIAL REVENUE: Certain affiliated providers have contracted with the Company's HMO to provide health care services to their employees and dependents. The Company recognized commercial premiums from these affiliated providers in the amounts of $137,223, $152,774 and $115,985 in 1996, 1995 and 1994, respectively.
Additionally, during 1995, the Company purchased land and buildings that had previously been leased from an affiliate for $1,130,631.
11. STOCK OPTIONS AND AWARDS:
a. STOCK-BASED COMPENSATION PLANS: The Company sponsors the various stock-based incentive compensation plans (the Plans). The Company applies APB Opinion 25 and related interpretations in accounting for the Plans. In 1995, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123 Accounting for Stock-Based Compensation (SFAS 123) which, if fully adopted by the Company, would change the methods the Company applies in recognizing the cost of the Plans. Adoption of the cost recognition provisions of SFAS 123 is optional, and the Company has decided not to elect these provisions of SFAS 123. However, pro forma disclosures as if the Company adopted the cost recognition provisions of SFAS 123 in 1995 are required by SFAS 123 and are presented below.
Under the Plans, the Company is authorized to issue shares of common stock pursuant to "awards" granted in various forms, including incentive stock options (intended to qualify under Section 422 of the Internal Revenue Code of 1986, as amended), nonqualified stock options, and other similar stock-based awards to directors and eligible employees of the Company for up to 340,000 common shares of the Company. The Company granted stock options in 1995 and 1996 under the Plans in the form of incentive stock options and nonqualified stock options. In January 1997, the Company registered 35,000 shares of common stock for the 1996 directors stock award plan.
b. EMPLOYEE AND DIRECTOR STOCK OPTIONS: The Company granted market price stock options in 1995 and 1996 to employees and directors. The stock options granted in 1995 and 1996 have terms of 10 years. The options granted to directors were vested immediately on the grant date. The options granted to employees vest at the rate of 25% per year on each of the
HEALTH POWER, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
first four anniversaries of the date of grant. Options granted to various executives vest 100% at the end of six years (subject to acceleration to a two-year period depending on the performance of the Company or at the discretion of the Compensation Committee). In accordance with APB 25, the Company has not recognized any compensation cost for these stock options granted in 1995 and 1996.
A summary of the status of the Company's stock options as of December 31, 1996 and 1995, and the changes during the years ended on those dates is presented below:
The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for grants in 1995 and 1996, respectively: no dividend yield for all years; risk-free interest rates are different for each grant and range from 5.44% to 7.06%; the expected lives of options are estimated to be five years; and a volatility of 54.73% for all grants.
HEALTH POWER, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The following table summarizes information about stock options outstanding at December 31, 1996:
c. PROFORMA NET INCOME AND NET INCOME PER COMMON SHARE: Had the compensation cost for the Company's stock-based compensation plans been determined consistent with SFAS 123, the Company's net income and net income per common share for 1995 and 1996 would approximate the pro forma amounts below:
The effects of applying SFAS 123 in this pro forma disclosure are not indicative of future amounts. SFAS 123 does not apply to awards prior to 1995.
d. MEDOHIO STOCK OPTIONS: During 1996, the Company entered into a management agreement with Med Ohio Health, Inc. and Med Ohio Health Plan, Inc. to offer a managed care product. In connection with this agreement, MedOhio was granted the option to purchase 25,000 shares of common stock of the Company. Each option has an exercise price of $6.50 per share. This option vests based on performance over the four-year period beginning with the year closing on June 30, 1997 and ending with the year closing on June 30, 2000. At the end of each year within this period, 6,250 options will vest if a predetermined number of new members are added by MedOhio for the year (otherwise, the 6,250 options are forfeited).
HEALTH POWER, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Each of the 25,000 options has a fair value of $3.36 for purposes of SFAS 123. The fair value of each stock option is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: no dividend yield; a risk-free interest rate of 6.64%; an expected life of five years; and a volatility of 54.73%. Based on the current status of the Company and Med Ohio's performance (number of new members added) to date, the Company has made no determination that it is likely that the 1996 options will vest. As a consequence and in accordance with SFAS 123, the Company has not yet recognized any expense for these options. All these options are outstanding at December 31, 1996 (the first vesting has not yet ended) and have a remaining contractual life of five and one-half years and an exercise price of $6.50 per share.
e. STOCK INCENTIVE BONUS: The Company had an agreement with its president to award shares of common stock as part of an incentive stock bonus plan. During 1993, the president was awarded 35,458 shares of common stock. Compensation expense was recognized as earned over a two-year vesting period based on the estimated fair value of the shares awarded.
12. EMPLOYEE BENEFITS PLANS:
The Company maintains 401(k) plans for its employees meeting certain age requirements and completing one year of employment. The Company may make discretionary contributions not to exceed 1% and 6% of the participant's compensation for the plan year for Health Power HMO and CompManagement, respectively. The Company's discretionary contributions to the 401(k) plans were approximately $37,829, $40,221 and $32,600 for 1996, 1995 and 1994, respectively.
13. AGREEMENTS WITH THE OHIO DEPARTMENT OF INSURANCE:
On December 5, 1996, due to the Company's HMO's statutory deficit, the Department issued an order placing the HMO under supervision. The order also placed certain financial and other restrictions on the HMO and required the HMO to submit to the Department a corrective action plan, by January 17, 1997, describing management's proposed actions to improve the HMO's financial position.
On March 20, 1997, the Company's HMO was released from the order of supervision by the Department. The release occurred after affiliates of the HMO paid cash and transferred property in payment of, and pledged a certificate of deposit as security for, amounts due to the HMO, which actions satisfied the Department's requirements of supervision.
HEALTH POWER, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Payment of dividends by HMOs is subject to prior approval by the Department when the fair market value of the divided or distribution, inclusive of any other dividends or distributions made within the preceding 12 months, is in excess of 15% of the HMO's total statutory net worth as of the preceding December 31. At December 31, 1996, no dividends can be paid by the HMO to the Company.
14. INITIAL PUBLIC OFFERING:
In March 1994, the Company issued 915,060 shares of common stock in connection with an initial public offering. Net proceeds of the offering of $8,614,974, after deducting $746,090 of costs incurred in connection with the offering, were credited to stockholders' equity in 1994.
In connection with the initial public offering, the Company issued warrants to its underwriters to purchase 30,000 shares of common stock at an exercise price of $13.20. None of the warrants has been exercised as of December 31, 1996. The warrants expire on March 3, 1999.
HEALTH POWER, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
15. SEGMENTS:
The Company operates in two business segments, HMO and workers' and unemployment compensation consulting services. Separate results of the consolidated Company's segments for the period ended December 31, 1996 are as follows:
Operating (loss) profit is total revenue less operating expenses. In computing operating (loss) profit, the following items are not included: general corporate expenses, interest expense and income taxes. Depreciation for the HMO and consulting services segments for the year ended December 31, 1996 was $15,617 and $73,618, respectively. Capital expenditures for the two segments were $24,803 and $49,487, respectively.
Identifiable assets by industry are those assets that are used in the Company's operations in each segment. Corporate assets are principally cash and property, plant and equipment.
HEALTH POWER, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
16. SIGNIFICANT FOURTH-QUARTER ADJUSTMENTS:
During the fourth quarter, the Company made the following adjustments to the financial statements:
The Company decreased its estimate of health care costs payable by approximately $132,291 related to premium deficiencies on contracts in effect at December 31, 1996.
The Company elected to retain certain capitation costs withheld from its providers resulting in an approximate $1 million reduction in costs (see Note 5).
The Health Power HMO subsidiary was declared to be exempt from Ohio Franchise and Net Income Tax due to its status as an insurance company as determined under the regulations of the Department. Therefore, the Company was able to file refund claims with the Ohio Department of Treasury resulting in additional income tax income of $684,455.
The Company established a 100% valuation allowance on the deferred tax asset of $2,457,049.
17. PARENT COMPANY ONLY:
Condensed balance sheets of Health Power, Inc. (parent company only) as of December 31, 1996 and 1995 and the condensed statements of operations and cash flows for the years ended December 31, 1996, 1995 and 1994 are as follows:
CONDENSED BALANCE SHEETS
HEALTH POWER, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
CONDENSED STATEMENTS OF OPERATIONS
HEALTH POWER, INC., AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
CONDENSED STATEMENTS OF CASH FLOWS
There were no cash dividends paid by the Company's consolidated subsidiaries to the Company in 1996, 1995, or 1994.
ITEM 9.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT - -------- ----------------------------------------------
Information required under this Item with respect to directors will be contained in the Company's proxy statement to be filed within 120 days of December 31, 1996, and is hereby incorporated herein by reference. Information regarding the executive officers of the Company may be found under the caption "Executive Officers of the Company" in Part I, and is also incorporated by reference into this Item 10.
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION - -------- ----------------------
Information required under this Item will be contained in the Company's proxy statement to be filed within 120 days of December 31, 1996, and is hereby incorporated herein by reference.
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - -------- --------------------------------------------------------------
Information required under this Item will be contained in the Company's proxy statement to be filed within 120 days of December 31, 1996, and is hereby incorporated herein by reference.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - -------- ----------------------------------------------
Information required under this Item will be contained in the Company's proxy statement to be filed within 120 days of December 31, 1996, and is hereby incorporated herein by reference.
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - -------- ----------------------------------------------------------------
(a)(1) Financial Statements --------------------
The following financial statements of the Company are included in Item 8:
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(a)(2) Financial Statement Schedules
All financial statement schedules have been omitted because they are not applicable or the required information is included in the Company's consolidated financial statements or notes thereto.
(a)(3) Listing of Exhibits -------------------
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*Executive compensation plans and arrangements required to be filed pursuant to Item 601(b)(10) of Regulation S-K.
(b) Reports on Form 8-K -------------------
The Company filed a Form 8-K on December 18, 1996, reporting under items 5 and 7 of such report.
(c) Exhibits --------
The exhibits in response to this portion of Item 14 are submitted following the signatures.
(d) Financial Statement Schedules -----------------------------
All financial statement schedules have been omitted because they are not applicable or the required information is included in the Company's consolidated financial statements or notes thereto.
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SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) 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.
HEALTH POWER, INC.
Date: March 28, 1997 By /s/Dr. Bernard F. Master ------------------------ Dr. Bernard F. Master, Chairman of the Board and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Registrant and in the capacities and on the dates indicated.
*The undersigned, Thomas E. Beaty, Jr., by signing his name hereto, does hereby execute this Annual Report on Form 10-K for the Registrant's fiscal year ended December 31, 1996, on behalf of each of the other above-named directors of the Registrant pursuant to Powers of Attorney executed by such directors and filed with the Securities and Exchange Commission as an exhibit to this report.
/s/ Thomas E. Beaty, Jr. - -------------------------- Thomas E. Beaty, Jr., Attorney in Fact
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EXHIBIT INDEX
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