10-Q 1 f10q_093002.txt MAMSI FORM 10-Q SEPTERMBER 30, 2002 1 ----------------------------------------------------------------------- ----------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------- FORM 10-Q [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 2002, or [ ] Transition report pursuant to Section 13 OR 15(d) of the Securities Exchange Act of 1934 For the transition period from to ------------------------------ COMMISSION FILE NUMBER 1-13340 ------------------------------ MID ATLANTIC MEDICAL SERVICES, INC. (Exact name of registrant as specified in its charter) DELAWARE (State or other jurisdiction of incorporation or organization) 52-1481661 (IRS Employer Identification Number) 4 TAFT COURT, ROCKVILLE, MARYLAND (Address of principal executive offices) 20850 (Zip code) (301) 294-5140 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No The number of shares outstanding of each of the issuer's classes of common stock was 47,861,522 shares of common stock, par value $.01, outstanding as of September 30, 2002. ----------------------------------------------------------------------- ----------------------------------------------------------------------- 2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS MID ATLANTIC MEDICAL SERVICES, INC. CONSOLIDATED CONDENSED BALANCE SHEETS (Note 1) (in thousands except share amounts)

Note: The balance sheet at December 31, 2001 has been extracted from the audited financial statements at that date. See accompanying notes to these financial statements. 3 MID ATLANTIC MEDICAL SERVICES, INC. CONSOLIDATED CONDENSED STATEMENTS OF INCOME (in thousands except share amounts) (Unaudited)

See accompanying notes to these financial statements. 4 MID ATLANTIC MEDICAL SERVICES, INC. CONSOLIDATED CONDENSED STATEMENTS OF INCOME (in thousands except share amounts) (Unaudited)

See accompanying notes to these financial statements. 5 MID ATLANTIC MEDICAL SERVICES, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (in thousands) (Unaudited)

See accompanying notes to these financial statements. 6 MID ATLANTIC MEDICAL SERVICES, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (in thousands) (Unaudited)

See accompanying notes to these financial statements. 7 MID ATLANTIC MEDICAL SERVICES, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS INTRODUCTION Mid Atlantic Medical Services, Inc. ("MAMSI") is a holding company whose subsidiaries are active in managed health care and other life and health insurance related activities. MAMSI's principal markets are currently in Maryland, Virginia, the District of Columbia, Delaware, West Virginia, North Carolina and Pennsylvania. MAMSI and its subsidiaries (collectively referred to as the "Company") have developed a broad range of health care and related ancillary products and deliver these services through health maintenance organizations ("HMOs"), a preferred provider organization ("PPO"), a life and health insurance company, home health care and home infusion services companies, a hospice company, a coordination of benefits identification and collections company and part ownership in an outpatient surgery center. MAMSI delivers managed health care services principally through HMOs. The HMOs, MD-Individual Practice Association, Inc. ("M.D. IPA"), Optimum Choice, Inc. ("OCI"), and Optimum Choice of the Carolinas, Inc. ("OCCI") arrange for health care services to be provided to an enrolled population for a predetermined, prepaid fee, regardless of the extent or nature of services provided to the enrollees. The HMOs offer a full complement of health benefits, including physician, hospital and prescription drug services. Other MAMSI subsidiaries include Alliance PPO, LLC, which provides a delivery network of physicians to employers and insurance companies in association with various health plans, and provides psychiatric services principally to third party payors or self-insured employer groups. MAMSI Life and Health Insurance Company develops and markets indemnity health products, and group life, accidental death and short-term disability insurance. HomeCall, Inc., FirstCall, Inc., and HomeCall Pharmaceutical Services, Inc. provide in-home medical care including skilled nursing, infusion and therapy to MAMSI's HMO members and other payors. HomeCall Hospice Services, Inc. provides services to terminally ill patients and their families. Beginning in January 2001, Alliance Recovery Services, LLC provides coordination of benefit identification and collection services to third party administrators and insurance companies. NOTE 1 - FINANCIAL STATEMENTS The consolidated balance sheet of the Company as of September 30, 2002, the consolidated statements of income for the three and nine months ended September 30, 2002 and 2001, and the consolidated statements of cash flows for the nine months ended September 30, 2002 and 2001 have been prepared by MAMSI without audit. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Certain information and disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. These financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's December 31, 2001 audited consolidated financial statements included in its annual report on Form 10-K for the year ended December 31, 2001 ("2001 Form 10-K"). The results of operations for the three and nine month periods ended September 30, 2002 are not necessarily indicative of the operating results for the full year. In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("Statement No. 142"), which establishes standards for financial accounting and reporting for intangible assets at acquisition and for goodwill and other intangible assets subsequent to their acquisition. Statement No. 142 is applied to existing goodwill and intangible assets for fiscal years beginning December 15, 2001. The Company adopted this Statement January 1, 2002, at which time amortization of the remaining book value of goodwill ceased. As the Company does not have a material amount of goodwill, the adoption of Statement No. 142 had no significant effect on the consolidated financial statements. The Company has entered into certain long-term medical services related vendor contracts, some of which include incentives or cost guarantees designed to provide savings to the Company over several years. The Company typically accounts for the benefit derived from these incentives or guarantees ratably 8 over the contract period as a reduction to medical expense. Because of the complexity of the Company's product offerings as well as obligations imposed under the contracts, and the timing of settlement of various contractual periods, disputes may arise as to the degree of satisfaction of the various contractual obligations which could result in material adjustments to the Company's financial statements. In the case of one of these contracts, a dispute with the Company's pharmacy benefits manager, Medco Health Solutions, Inc. (formerly known as Merck- Medco Managed Care, LLC) ("Merck"), had arisen which involved approximately $41.0 million MAMSI had recorded as a receivable related to the settlement of a cost guarantee for the year 2000. The Company is recording the benefit related to the 2000 guarantee over the three year term of the contract which expires on December 31, 2002. From inception through September 30, 2002, the Company has recognized approximately $37.7 million of the guarantee as a reduction of medical expense. On April 24, 2002, the Company reached a settlement of its dispute with Merck over its 2000 cost guarantee. Under the terms of the settlement, the Company has received payment of $41.0 million. NOTE 2 - EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share (in thousands except share amounts):

Options to purchase approximately 14,700 shares of common stock at various prices were outstanding at September 30, 2002, but were not included in the computation of diluted earnings per share because the option proceeds would exceed the average market price and, therefore, the effect would be antidilutive. During the first nine months of 2002 and 2001, total comprehensive income amounted to $67,047,000 and $42,960,000, respectively. The Company maintains a stock compensation trust ("SCT") to fund its obligations arising from its various stock option plans. Shares held by the SCT are excluded from the denominator used in calculating basic and diluted earnings per common share. NOTE 3 - FEDERAL EMPLOYEES' HEALTH BENEFIT PROGRAM M.D. IPA contracts with the Office of Personnel Management ("OPM") to provide or arrange health services under the Federal Employees Health Benefits Program ("FEHBP"). The contract with OPM and applicable government regulations establish premium rating requirements for the FEHBP. In the normal course of business, OPM audits health plans with which it contracts to verify, among other things, that the premiums calculated and charged to OPM are established in compliance with the best price community rating guidelines established by OPM. OPM typically audits plans once every five or six years, and each audit covers the prior five or six year period. While the government's initial on-site audits are usually followed by a post-audit briefing as well as a preliminary audit report in which the government indicates its preliminary results, final resolution and settlement of the audits can take two to three years. The results of these audits could result in material adjustments to the Company's financial statements. The Company has been audited through 1999. There were no significant findings related to 1999. 9 NOTE 4 - REPORTABLE SEGMENTS The Company's principal business is providing health insurance products. The Company has two reportable segments: commercial risk products and preferred provider organizations. The Company evaluates performance and allocates resources based on profit or loss from operations before income taxes, not including gains or losses on the Company's investment portfolio or investment income. Management does not allocate assets in the measurement of segment profit or loss. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies described in the Company's 2001 Form 10-K.

Reconciliations of segment data to the Company's consolidated data is as follows:

10 MID ATLANTIC MEDICAL SERVICES, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING INFORMATION All forward-looking information contained in Management's Discussion and Analysis of Financial Condition and Results of Operations is based on management's current knowledge of factors, all of which have inherent risks and uncertainties, that affect MAMSI's business. MAMSI's actual results may differ materially if these assumptions prove invalid. Significant risk factors, while not all-inclusive, are: 1. The possibility of increasing price competition in the Company's service area. 2. The effect of a weak economy on the Company. 3. The effect on the Company due to the acts of terrorism and the threat of future attacks. 4. The possibility that the Company is not able to increase its market share at the anticipated premium rates. 5. The possibility of increased litigation, legislation or regulation (such as the numerous class action lawsuits that have been filed against managed care companies and the pending initiatives to increase health care regulation) that might have the potential for increased costs, and/or increased regulation of rates which might have the potential to decrease revenue. 6. The inability to predict and control medical expenses due to: - Increased utilization by the Company's membership. - Increased practitioner and pharmaceutical costs. - Federal or state mandates that increase benefits or limit the Company's oversight ability. - The potential for disputes under its risk-sharing arrangements, and the Company's ability to maintain and renew these arrangements. 7. The possibility that the Company is not able to negotiate new or renewal contracts with appropriate physicians, other health care practitioners, hospitals and facilities. The list of significant risk factors is not intended to be exhaustive. There may be other risk factors that would preclude the Company from realizing the predictions made in the forward-looking statements. While the Company may periodically update this discussion of risk factors, the Company does not undertake to update any forward-looking statement that may be made by or on behalf of the Company prior to its next required filing with the Securities and Exchange Commission. DISCUSSION OF MAMSI's BUSINESS AND IMPORTANT ACCOUNTING MATTERS MAMSI, through its 100% owned subsidiary companies, is predominately in the business of selling various forms of health insurance. In 2002, 97% of revenues were earned from the sale of health insurance products, mostly to employers who purchase health insurance for their employees. Since premium rates are generally fixed for a one year period, it is critical to the Company's continued financial success that its prices are set at levels that will at least cover the next policy year's medical costs for members plus administrative costs to pay claims, provide member services, pay taxes, and cover other related costs. This means that we have to carefully evaluate data and estimate both future utilization of medical services by our members and the cost of those services so that we can set premiums at adequate levels. This is the single most important factor in our business. Very simply, if our medical expenses are greater than our premiums, we lose money. While MAMSI's business is somewhat complex from an insurance regulatory standpoint, its consolidated balance sheet and income statement are straightforward and the accounting policies and procedures that we use to produce them are reasonable and appropriate. MAMSI does not own any special purpose entities, does not have any complex or extraordinarily risky investments nor does it have any off balance sheet financing arrangements. In fact, MAMSI has almost no debt outstanding. 11 The buildings that the Company owns and uses in its operations do not have mortgages; they are owned free and clear. The Company's funds are held in cash or invested in money market accounts, tax exempt securities and other debt securities. All of the bonds we own have investment ratings of "A" or better. Certain of our accounting policies are extremely important to the fair presentation of our results and financial position. We think that the single most important accounting issue we have is the recording, at the end of each reporting period, of an adequate liability and corresponding expense for medical services that have been provided to our members but for which we have not yet received a bill. This lag between date of service and date of billing is normal in the insurance business and the liability for these claims is called "liability for incurred, but not reported claims" ("IBNR"). The IBNR liability is included with medical claims payable in our balance sheet. The determination of the Company's IBNR is a fairly complex process. The Company employs its own actuary to aid in its determination. The primary method we use to estimate IBNR is consistent from period to period and uses historical claims data to develop the historical relationship of how many claims dollars have been reported in any given month to what was received in total, once all claims were received. This relationship gives us an indication of how much medical expense has been incurred in months for which we have not yet received all claims. While we use a consistent method in developing our IBNR estimate, considerable judgment is required. To the extent that we over or under estimate our IBNR at the end of any reporting period, the adjustment is included in the next period's results. Another important accounting policy relates to our risk sharing contracts. Certain of the Company's larger medical services related vendors offer various forms of "risk-sharing" or "guarantees" as a part of their contractual relationship with us. These arrangements are not significant in relation to the Company's financial statements with one exception; the Company's risk-sharing arrangement with its Pharmacy Benefits Manager ("PBM"). The Company's PBM is responsible for providing administrative and technical support as well as providing the ability to process pharmacy transactions on a real time basis. The Company's current PBM is Merck. As a part of its contract with us, Merck agreed to a pharmacy cost guarantee related to fiscal year 2000. We are recording the amount due under this guarantee over the contract term of three years, which commenced January 2000. The total value of the guarantee we estimated for financial statement purposes is approximately $41.0 million of which approximately $37.7 million has been recorded in our financial statements as a reduction of medical expense over the first two years and nine months of the contract. At December 31, 2001, approximately $28.1 million was also reported in the balance sheet as a reduction of medical claims payable. In April 2002 the Company received payment of $41.0 million from Merck. At September 30, 2002, the remaining $3.3 million of the guarantee yet to be recognized is reported on the balance sheet as unearned revenue. Another accounting policy that is very important to the fair presentation of our financial results is the proper valuation of the Company's accounts receivable. The Company bills the majority of its health insurance customers on a monthly basis. The premium bill is typically sent out 15 days in advance of the month being billed for, so that the Company can receive the cash at the start of the month for which the insurance is being provided. The vast majority of our customers pay in a timely fashion but some do not. After some communication, we generally receive payment but we do not always collect what we are due. This can happen for a variety of reasons such as customers having financial difficulties, disputes regarding the amount of the bill or a customer failing to notify us that they have obtained other health insurance. To properly value the accounts receivable at its net realizable value we must determine an allowance for doubtful accounts. The allowance for doubtful accounts reduces the gross amount of accounts receivable that are recorded, based on the bills sent, to the net amount that we actually think we will receive. The allowance also reduces premium revenue by the same amount. To determine how much to record as a reduction of the gross accounts receivable, we prepare an accounts receivable aging. This aging segments the total accounts receivable balance by category as to when it was due to the Company. This allows us to evaluate how old our accounts receivable are. We then prepare an evaluation based on historical collection percentages applied 12 to various categories of accounts. We also identify individual accounts that are unlikely to pay due to financial or other problems and analyze them individually. The aforementioned analyses are then summarized and an allowance is developed and recorded. The Company applies this methodology on a consistent basis from period to period. RESULTS OF OPERATIONS THE THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 30, 2001 Consolidated net income of the Company was $22,523,000 and $15,036,000 for the third quarters of 2002 and 2001, respectively. Diluted earnings per share were $.54 and $.36 in the third quarters of 2002 and 2001, respectively. This increase in earnings is attributable to an increase in members, an increase in premiums per member, the stability in medical expenses as a percentage of health premium revenue ("medical care ratio"), and a reduction in administrative expenses as a percentage of total revenue ("administrative expense ratio"). The Company has priced its health products competitively in order to increase its membership base and thereby enhance its strategic position in its marketplace. The Company currently has one of the largest HMO and managed care enrollments and also the largest network of contract providers of medical care in its service area (which includes the entire states of Maryland and Delaware, the District of Columbia, most counties and cities in Virginia and certain areas of West Virginia, North Carolina and Pennsylvania). Health premium revenue for the three months ended September 30, 2002 increased approximately $134.8 million or 30.4 percent over the three months ended September 30, 2001. A 16.6 percent increase in net average HMO and indemnity enrollment resulted in an increase of approximately $73.4 million in health premium revenue, while an 11.9 percent increase in average monthly premium per enrollee, combined for all products, resulted in a $61.4 million increase in health premium revenue. Management believes that commercial health premiums should continue to increase during the remainder of 2002 and in 2003 as the Company continues to increase its commercial membership and as new and renewing groups are charged higher premium rates due to legislatively mandated benefit enhancements and medical cost inflation, both of which cause the Company to increase its premium rates. This is a forward-looking statement. See "Forward Looking Information" above for a description of the risk factors that may effect health premiums per member. The Company has implemented increased premium rates across essentially all of its products. As the Company's contracts are generally for a one year period, increased pricing generally cannot be initiated until a contract reaches its renewal date. Therefore, price increases are not implemented across the Company's membership at the same time. Overall, commercial premium rate increases are expected to continue in 2002 and increase in 2003 by approximately 12.5%. Management believes that these rate increases may have the effect of slowing the Company's future membership growth. The Company's future membership growth depends on several factors such as relative premium prices and product availability, future increases or decreases in the Company's service area, and increased competition in the Company's service area. The Company currently anticipates its 2003 membership growth to be in the 4% to 5% range. The Company's home health operations contributed $6.1 million in revenue in the third quarter of 2002 as compared with $5.6 million in the third quarter of 2001 reflective of an increase in services provided to non- affiliated companies. Life and short-term disability products contributed $2.3 million in revenue in the third quarter of 2002 as compared with $2.0 million for the third quarter of 2001. As investment balances continue to increase, investment income remained stable at $3.9 million in the third quarters of 2002 and 2001 primarily due to the decline in interest rates. The medical care ratio remained stable at 85.2% for the third quarters of 2002 and 2001. On a per member per month basis, medical expenses increased 11.9 13 percent. The stability in the medical care ratio is due to a combination of factors including continuing efforts by the Company to implement product specific cost containment controls, continued activity in specialized subrogation areas and claims review for dual health coverage, and also increased premiums per member. The ongoing initiatives should help to control the Company's medical care ratio. The medical expense trend is expected to be between 11.2% and 11.8% for 2002 and approximately 12% for 2003. The statements in this paragraph and the preceding paragraphs regarding future utilization rates, cost containment initiatives, total medical costs and trend and future increases in health premiums per member, are forward-looking statements. See "Forward-Looking Information" above for a description of risk factors that may affect medical expenses per member and the medical care ratio. The administrative expense ratio decreased to 10.5 percent for the third quarter of 2002 as compared to 11.5 percent for the same period in 2001. The decrease in the administrative expense ratio is principally due to increases in premium rates and membership, and management's efforts to control costs as the business volume increases. Management believes that the administrative expense ratio will be 10.7% or 10.8% for all of 2002 and 2003. Management's expectations concerning the administrative expense ratio is a forward-looking statement. The administrative expense ratio is affected by changes in health premiums and other revenues, development of the Company's expansion areas, increased administrative activity related to business volume and to price increases from the Company's vendors. The net margin rate increased from 3.3 percent in the third quarter of 2001 to 3.8 percent in the current quarter. This increase is consistent with the factors previously described. THE NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 2001 The Company's consolidated net income for the nine months ended September 30, 2002 increased to $59,799,000 from $39,904,000 for the nine months ended September 30, 2001. Diluted earnings per share on net income increased from $.98 in the first nine months of 2001 to $1.43 for the same period in 2002. The increase in earnings is primarily attributable to increased premiums per member and reduction in the medical care and administrative expense ratios. Health premium revenue for the nine months ended September 30, 2002 increased approximately $387.6 million or 30.2 percent over the nine months ended September 30, 2001. An 11.6 percent increase in average premiums per HMO and indemnity enrollee increased health premium revenue by approximately $174.0 million and a 16.7 percent increase in net average HMO and indemnity enrollment resulted in an increase of approximately $213.6 million in health premium revenue. The Company's home health operations contributed $16.4 million in revenue in the first nine months of 2002 as compared with $18.6 million in the first nine months of 2001 reflective of a decrease in services provided to non-affiliated companies. Revenue from life and short-term disability products contributed $6.7 million in revenue for the first nine months of 2002 as compared to $6.0 million in the first nine months of 2001. Investment income decreased from $11.3 million in the first nine months of 2001 to $10.8 million in the first nine months of 2002 primarily due to a decline in interest rates. The medical care ratio decreased to 85.5 percent for the nine months ended September 30, 2002 as compared to 85.7 percent for the comparable period in 2001. The reasons for this decrease are consistent with the items discussed in the quarterly analysis. The administrative expense ratio decreased to 10.7 percent for the first nine months of 2002 as compared to 11.7 percent for the comparable period in 2001. The reasons for this decrease are consistent with the items discussed in the quarterly analysis. The net margin rate increased from 3.0 percent for the first nine months of 2001 to 3.5 percent for the comparable period of 2002. This increase is consistent with the factors previously described. 14 LIQUIDITY AND CAPITAL RESOURCES The Company's business is not capital intensive and the majority of the Company's expenses are payments to physicians and health care practitioners, which generally vary in direct proportion to the health premium revenues received by the Company. Although medical utilization rates vary by season, the payments for such expenses lag behind cash inflow from premiums because of the lag in provider billing procedures. In the past, the Company's cash requirements have been met principally from operating cash flow, and it is anticipated that this source, coupled with the Company's retained earnings and capital and operating line-of- credit, will continue to be sufficient in the future. The Company's cash and investment securities increased $145.0 million from $372.8 million at December 31, 2001 to $517.8 million at September 30, 2002, primarily due to the timing of medical expense payments which traditionally lag behind the receipt of increased premiums per member, the $41.0 million payment received from Merck in April 2002, cash received from exercise of stock options and net income offset by the effect of treasury stock purchases. Accounts receivable increased from $105.3 million at December 31, 2001 to $123.3 million at September 30, 2002, primarily due to increased membership. Prepaid expenses, advances and other increased from $27.2 million at December 31, 2001 to $39.3 million at September 30, 2002 primarily due to an increase in the unamortized portion of prepayments for insurance policies which cover the Company's assets and business operations and an increase in working capital advances paid to Maryland hospitals, offset by a reduction in income tax payments paid in advance. Net property and equipment increased from $57.3 million at December 31, 2001 to $59.6 million at September 30, 2002 primarily due to the purchase of furniture and computer hardware necessitated by the Company's growth, in addition to the purchase of a parcel of land adjacent to an existing Company owned facility. On October 31, 2002, the Company purchased three additional office buildings for approximately $22.0 million at the site of its corporate headquarters in Rockville, Maryland to provide additional contiguous office space for current and future operations. Medical claims payable increased from $212.0 million at December 31, 2001 to $321.9 million at September 30, 2002, primarily due to increased membership and an increase in medical expenses per member, the timing of payments to physicians and health care practitioners, and the receipt of the $41.0 million payment from Merck which had been recorded as a reduction of medical claims payable in the amount of $28.1 million at December 31, 2001. Deferred premium revenue decreased from $37.7 million at December 31, 2001 to $35.8 million at September 30, 2002 due to a decrease in cash payments received in advance of the premium coverage period. Unearned revenue increased from $1.7 million at December 31, 2001 to $15.2 million at September 30, 2002 primarily due to incentive cash payments received related to certain long-term medical services vendor contracts. Additional paid-in capital increased from $349.6 million at December 31, 2001 to $501.1 million at September 30, 2002, principally due to the exercise of employee stock options and an increase in the market value of the shares of the Company's stock held in the stock compensation trust ("SCT"). The value of the SCT increased from $204.7 million at December 31, 2001 to $310.3 million at September 30, 2002 primarily due to the increase in the market value of the shares of the Company's stock held in the SCT offset by the exercise of employee stock options. For financial reporting purposes, the SCT is consolidated with MAMSI. The fair market value of the shares held by the SCT is shown as a reduction to stockholders' equity in the Company's consolidated balance sheets. All transactions between the SCT and MAMSI are eliminated. The difference between the cost and the fair value of common stock held in the SCT is included in the consolidated financial statements as additional paid-in capital. Treasury stock increased from $185.1 million at December 31, 2001 to $246.6 million at September 30, 2002 due to the Company's purchase of 2,022,900 shares of its common stock at a total cost of $61.5 million. The Company currently has access to total revolving credit facilities of $29.0 million which are subject to annual renewal and collateral requirements, and are used to provide short-term capital resources for routine cash flow fluctuations. 15 At September 30, 2002, approximately $3.3 million was drawn against these facilities, and approximately $654,000 in letters of credit were outstanding. While no amounts have been drawn against these letters of credit, they reduce the Company's credit line availability. Following is a schedule of the short-term capital resources available to the Company (in thousands):

The Company believes that cash generated from operations along with its current liquidity and borrowing capabilities are adequate for both current and planned operations. The Company's major business operations are principally conducted through its HMOs and an insurance company. HMOs and insurance companies are subject to state regulations that, among other things, may require those companies to maintain certain levels of equity and risk based capital, and restrict the amount of dividends and other distributions that may be paid to their parent corporations. As of September 30, 2002, those subsidiaries of the Company were in compliance with all minimum capital requirements and exceeded all risk based capital requirements. During the three months ended September 30, 2002, the Company repurchased an additional 664,300 shares of its common stock for a total cost of approximately $21.3 million. On August 7, 2002, the Board of Directors authorized a $40.0 million stock repurchase program to begin immediately. This authorization included the $.5 million of unspent funds carried forward from the May 2002 authorization. At September 30, 2002, approximately $30.9 million of unspent authorization was available for future purchases. During the month of October 2002, the Company repurchased an additional 244,700 shares of its common stock for a total cost of approximately $9.1 million. As previously described in Note 1 to these consolidated condensed financial statements, in April 2002 the Company received payment of $41.0 million from Merck in settlement of its dispute with Merck over its 2000 cost guarantee. MARKET RISK The Company is exposed to market risk through its investment in fixed and variable rate debt securities that are interest rate sensitive. The Company does not use derivative financial instruments. The Company places its investments in instruments that meet high credit quality standards, as specified in the Company's investment policy guidelines; the policy also limits the amount of credit exposure to any one issue, issuer, or type of instrument. A hypothetical ten percent change in market interest rates over the next year would not materially impact the Company's financial position or cash flow. The Company has no significant market risk with regard to liabilities and does not use special purpose entities. There are no material changes in market risk exposure at September 30, 2002 when compared with December 31, 2001. 16 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required by this Item is contained in Item 2 - "Management's Discussion and Analysis of Financial Condition and Results of Operations". ITEM 4. CONTROLS AND PROCEDURES Based on the evaluation by the Chief Executive Officer and Chief Financial Officer of the Company as of a date within 90 days of the filing date of this quarterly report, the Company's disclosure controls and procedures are adequately designed to ensure that the information required to be included in this report has been recorded, processed, summarized and reported on a timely basis. There have not been any significant changes in the Company's internal controls or in other factors that could significantly affect these controls and there have been no corrective actions taken with regard to significant deficiencies and material weaknesses subsequent to the date of such officers' evaluation. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In September 2000, the Company and other HMOs operating in Maryland were served with similar class action lawsuits challenging the constitutionality of the law which allows the Company to subrogate against other insurance companies. The action against the Company was filed in the Circuit Court for Montgomery County, Maryland. The Company filed a motion for removal of the case to federal court under the Employee Retirement Income Security Act of 1974 ("ERISA"). In a separate matter unrelated to the Company, but similar in facts, the Maryland Court of Appeals recently ruled that the retroactive portion of the law is unconstitutional under the Maryland constitution. The Company believes that its operations with respect to the law are valid and is pursuing all available defenses. However, the Company is not able to predict, at this time, the ultimate outcome of this action. The Company is involved in other various legal actions arising in the normal course of business, some of which seek substantial monetary damages. After review, including consultation with legal counsel, management believes that any ultimate liability that could arise from these other actions will not materially effect the Company's consolidated financial position or results of operations. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS None ITEM 3. DEFAULTS UPON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None ITEM 5. OTHER INFORMATION None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits - see exhibit index on page 21 of Form 10-Q (b) None 17 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereto duly authorized. MID ATLANTIC MEDICAL SERVICES, INC. -------------------------------------------- (Registrant) Date: November 14, 2002 /s/ Robert E. Foss ------------------------------------- Robert E. Foss Senior Executive Vice President and Chief Financial Officer (duly authorized officer and principal financial officer) 18 CERTIFICATION I, Thomas P. Barbera, Chief Executive Officer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Mid Atlantic Medical Services, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date. 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and to the audit committee of the registrant's board of directors: a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 14, 2002 /s/ Thomas P. Barbera ----------------- Thomas P. Barbera President and Chief Executive Officer 19 CERTIFICATION I, Robert E. Foss, Chief Financial Officer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Mid Atlantic Medical Services, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date. 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and to the audit committee of the registrant's board of directors: a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 14, 2002 /s/ Robert E. Foss -------------- Robert E. Foss Senior Executive Vice President and Chief Financial Officer 20 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Mid Atlantic Medical Services, Inc. ("Company") on Form 10-Q for the period ended September 30, 2002 as filed with the Securities and Exchange Commission on the date hereof ("Report"), the undersigned, in the capacity and on the date indicated below, hereby certifies pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to his knowledge: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: November 14, 2002 /s/ Thomas P. Barbera /s/ Robert E. Foss ----------------- -------------- Thomas P. Barbera Robert E. Foss President and Senior Executive Vice President and Chief Executive Officer Chief Financial Officer 21 6(a) List of Exhibits. EXHIBIT INDEX Location of Exhibit Exhibit In Sequential Number Description of Document Numbering System ------- ----------------------- ------------------- 10.45 Common Stock Purchase Agreement dated September 6, 2002 . . . . . . . . . . . . . . . . . . . . . 10.46 Allonge to Replacement Promissory Note dated September 6, 2002 . . . . . . . . . . . . . . . . . . . . .

MID ATLANTIC MEDICAL SERVICES INC 10-Q