A restated description of the risk factors associated with our business is set forth below. This description includes any material
changes to and supersedes the description of the risk factors associated with our business previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2012. The risks discussed below are not
the only ones facing our business. Please read the cautionary notice regarding forward-looking statements under the heading Managements Discussion and Analysis of Financial Condition and Results of Operations.
Risk factors related to our U.S. dialysis and related lab services, ancillary services and strategic initiatives: If the average rates that commercial
payors pay us decline significantly, it would have a material adverse effect on our revenues, earnings and cash flows.
Approximately 34% of our dialysis and related lab services revenues for the nine months ended September 30, 2013, were generated from
patients who have commercial payors as the primary payor. The majority of these patients have insurance policies that pay us on terms and at rates that are generally significantly higher than Medicare rates. The payments we receive from commercial
payors generate nearly all of our profit and all of our nonacute dialysis profits come from commercial payors. We continue to experience downward pressure on some of our commercial payment rates and it is possible that commercial payment rates could
be materially lower in the future. The downward pressure on commercial payment rates is a result of general conditions in the market, recent and future consolidations among commercial payors, increased focus on dialysis services and other factors.
We are continuously in the process of negotiating our existing or potentially new agreements with commercial payors who tend
to be aggressive in their negotiations with us. Sometimes many significant agreements are up for renewal or being renegotiated at the same time. In the event that our continual negotiations result in overall commercial rate reductions in excess of
overall commercial rate increases, the cumulative effect could have a material adverse effect on our financial results. Consolidations have significantly increased the negotiating leverage of commercial payors. Our negotiations with payors are also
influenced by competitive pressures. Some of our contracted rates with commercial payors may decrease or we may experience decreases in patient volume as our negotiations with commercial payors continue. In addition to downward pressure on
contracted commercial payor rates, payors have been attempting to impose restrictions and limitations on non-contracted or out-of-network providers. In some circumstances for some commercial payors, our centers are designated as out-of-network
providers. Rates for out-of-network providers are on average higher than rates for in-network providers. We believe commercial payors have or will begin to restructure their benefits to create disincentives for patients to select or remain with
out-of-network providers and to decrease payment rates for out-of-network providers. Decreases in out-of-network rates and restrictions on out-of-network access, our turning away new patients in instances where we are unable to come to agreement on
rates, or decreases in contracted rates could result in a significant decrease in our overall revenues derived from commercial payors. If the average rates that commercial payors pay us decline significantly, or if we see a decline in commercial
patients, it would have a material adverse effect on our revenues, earnings and cash flows. For additional details regarding specific risks we face regarding regulatory changes that could result in fewer patients covered under commercial plans or an
increase of patients covered under more restrictive commercial plans with lower reimbursement rates, see the discussion of individual and small group health plans in the risk factor below under the heading Health care reform could
substantially reduce our revenues, earnings and cash flows.
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If the number of patients with higher-paying commercial insurance declines, then our revenues, earnings
and cash flows would be substantially reduced.
Our revenue levels are sensitive to the percentage of our patients with
higher-paying commercial insurance coverage. A patients insurance coverage may change for a number of reasons, including changes in the patients or a family members employment status. Currently, for a patient covered by an employer
group health plan, Medicare generally becomes the primary payor after 33 months, or earlier, if the patients employer group health plan coverage terminates. When Medicare becomes the primary payor, the payment rate we receive for that patient
shifts from the employer group health plan rate to the lower Medicare payment rate. We have seen an increase in the number of patients who have government-based programs as their primary payors which we believe is largely a result of improved
mortality and recent economic conditions which have a negative impact on the percentage of patients covered under commercial insurance plans. To the extent there are sustained or increased job losses in the U.S., independent of whether general
economic conditions might be improving, we could experience a continued decrease in the number of patients covered under commercial plans. We could also experience a further decrease if changes to the healthcare regulatory system result in fewer
patients covered under commercial plans or an increase of patients covered under more restrictive commercial plans with lower reimbursement rates. In addition, our continuous process of negotiations with commercial payors under existing or
potentially new agreements could result in a decrease in the number of patients under commercial plans to the extent that we cannot reach agreement with commercial payors on rates and other terms, resulting in termination or non-renewals of existing
agreements or our inability to enter into new ones. If there is a significant reduction in the number of patients under higher-paying commercial plans relative to government-based programs that pay at lower rates, it would have a material adverse
effect on our revenues, earnings and cash flows.
Changes in the structure of, and payment rates under the Medicare ESRD program, including
the American Taxpayer Relief Act of 2012, the Budget Control Act of 2011 and other healthcare reform initiatives, could substantially reduce our revenues, earnings and cash flows.
Approximately 48% of our dialysis and related lab services revenues for the nine months ended September 30, 2013 was generated from
patients who have Medicare as their primary payor. For patients with Medicare coverage, all ESRD payments for dialysis treatments are made under a single bundled payment rate which provides a fixed payment rate to encompass all goods and services
provided during the dialysis treatment, including pharmaceuticals that were historically separately reimbursed to the dialysis providers, such as erythropoietin (EPO), vitamin D analogs and iron supplements, irrespective of the level of
pharmaceuticals administered or additional services performed. Most lab services that used to be paid directly to laboratories are also included in the bundled payment. The bundled payment rate is also adjusted for certain patient characteristics, a
geographic usage index and certain other factors.
The current bundled payment system presents certain operating, clinical and
financial risks, which include:
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Risk that our rates are reduced by CMS. The American Taxpayer Relief Act of 2012 mandates that the Secretary of Health and Human Services (HHS) reduce
dialysis payments beginning in January 2014 to reflect the Secretarys estimate of changes in patient utilization data from 2007 to 2012 for erythropoiesis stimulating agents (ESAs), other drugs and biologicals that would have been paid for
separately under the composite rate system, and laboratory services that would have been paid for separately under the composite rate system. The Secretary must also use the most recently available data on average sales prices and changes in prices
for drugs and biologicals reflected in the ESRD market basket percentage increase factor. CMS has asked for comment regarding phasing in any reduction over a one year or longer period. In the proposed 2014 ESRD PPS rule published on July 8,
2013, CMS determined that the ESRD Prospective Payment System (PPS) base rate that otherwise would apply in 2014 (inclusive of the market basket update of 2.5%) should be reduced to account for reductions in the use of drugs and biologicals between
2007 and 2012. This cut represents a significant reduction (inclusive of the market basket update of 2.5%) of 9.4% in Medicare payments that is proposed to take effect January 1, 2014 for calendar year 2014. Although the proposed rule is not
final,
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if it is implemented as proposed, it could have a materially adverse effect on our business and financial condition. Any reduction in dialysis payments will negatively impact our revenues,
earnings and cash flows.
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Risk that increases in our operating costs will outpace the Medicare rate increases we receive. We expect to continue experiencing increases in
operating costs that are subject to inflation, such as labor and supply costs, regardless of whether there is a compensating inflation-based increase in Medicare payment rates or in payments under the bundled payment rate system.
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Risk of federal budget sequestration cuts. As a result of the Budget Control Act of 2011 (BCA) and subsequent activity in Congress, a $1.2
trillion sequester (across-the-board spending cuts) in discretionary programs took effect on March 1, 2013. In particular, a 2% reduction to Medicare payments took effect on April 1, 2013. The across-the-board spending cuts pursuant to the
sequester have affected and will continue to adversely affect our revenues, earnings and cash flows.
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Risk that we may not be able to comply with the CMS ESRD Quality Incentive Program requirements. Under CMS proposed 2014 ESRD PPS rule published
on July 8, 2013, beginning in payment year 2016, CMS would adopt five new clinical and reporting measures, continue using six existing clinical and reporting measures, revise two existing clinical and reporting measures, and expand one existing
reporting measure. The proposed rule establishes calendar year 2014 as the performance period for all of the quality measures. To the extent we are not able to meet the quality measures proposed by CMS when the rules are finalized, it could have a
material adverse effect on our revenues, earnings and cash flows.
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Risk that CMS will inadequately price oral-only ESRD drugs for inclusion in the bundle. Under the ESRD PPS, beginning January 1, 2016, certain
oral-only ESRD drugs will be included in the ESRD bundled payment to dialysis facilities. Inadequate pricing could have a significant financial impact on our dialysis facilities given the volume and value of these drugs we use.
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For additional details regarding the risks we face for failing to adhere to our Medicare and Medicaid
regulatory compliance obligations, see the risk factor below under the heading If we fail to adhere to all of the complex government regulations that apply to our business, we could suffer severe consequences that would substantially reduce
our revenues, earnings, cash flows and stock price.
Health care reform could substantially reduce our revenues, earnings and cash
flows.
In March 2010, broad health care reform legislation was enacted in the U.S. Although many of the provisions of the
legislation did not take effect immediately and continue to be implemented, and some may be delayed, such as employer penalties and reporting, or further modified before implementation, the reforms could have an impact on our business in a number of
ways. We cannot predict how employers, private payors or persons buying insurance might react to these changes or what form many of these regulations will take before implementation.
In March 2012, HHS issued two final rules related to the establishment of health care insurance exchanges due to begin operating in
January 2014. These exchanges will provide a marketplace for eligible individuals and small employers to purchase health care insurance and a Notice of Benefit and Payment Parameters for 2014. We believe the establishment of health care insurance
exchanges could result in a reduction in patients covered by commercial insurance or an increase of patients covered through the exchanges under more restrictive commercial plans with lower reimbursement rates. To the extent that the implementation
of such exchanges results in a reduction in patients covered by commercial insurance or a reduction in reimbursement rates for our services from commercial and/or government payors, our revenues, earnings and cash flows could be adversely affected.
The CMS Center for Medicare & Medicaid Innovation (Innovation Center) is currently working with various healthcare
providers to develop and implement accountable care organizations (ACOs) and other
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innovative models of care for Medicare and Medicaid beneficiaries. We are currently uncertain of the extent to which these models of care, including ACOs, Bundled Payments for Care Improvement
Initiative, Comprehensive ESRD Care Model (which includes the development of ESRD Seamless Care Organizations or ESCOs), the Comprehensive Primary Care Initiative, the Duals Demonstration, or other models, will impact the health care market. Our
U.S. dialysis business may choose to participate in one or several of these models either as a partner with other providers or independently. We are currently seeking to participate in the Comprehensive ESRD Care Model with the Innovation Center.
Even if we do not participate in this or other programs, some of our patients may be assigned to a program, in which case the quality and cost of care that we furnish will be included in an ACOs or other programs calculations regardless
of our participation in the program. As new models of care emerge, we may be at risk for losing our Medicare patient base, which would have a materially adverse effect on our revenues, earnings and cash flow. Furthermore, other initiatives in the
government or private sector may arise, including the development of models similar to ACOs, IPAs and integrated delivery systems or evolutions of those concepts which could adversely impact our business.
In addition, the health care reform legislation introduced severe penalties for the knowing and improper retention of overpayments
collected from government payors. As a result, we made significant initial investments in new resources to accelerate the time it takes to identify and process overpayments. We may be required to make additional investments in the future. An
acceleration in our ability to identify and process overpayments could result in us refunding overpayments to government and other payors more rapidly than we have in the past. This could have a material adverse effect on our operating cash flows.
The failure to return identified overpayments within the specified time frame is now a violation of the federal False Claims Act (FCA), and therefore any failure to timely identify and return overpayments may result in significant additional
penalties, which may have a negative impact on our revenues, earnings and cash flows. Additionally, the American Taxpayer Relief Act of 2012 extended the look-back period for returning overpayments by two years, which increases the number of claims
that may need to be refunded, and which could have a negative impact on our revenues, earnings and cash flows.
The health
care reform legislation also reduced the timeline to file Medicare claims. The claims must now be filed with the government within one calendar year after the date of service. To comply with this reduced timeline, we must deploy significant
resources and may change our claims processing methods to ensure that our Medicare claims are filed in a timely fashion. Failure to file a claim within the one year window could result in payment denials, adversely affecting our revenues, earnings
and cash flows.
Effective March 2011, CMS instituted screening procedures which we expect will delay the Medicare contractor
approval process, potentially causing a delay in reimbursement. Ultimately, we anticipate the new screening and enrollment requirements will require additional personnel and financial resources and will potentially delay the enrollment and
revalidation of our centers which in turn will delay payment. These delays may negatively impact our revenues, earnings and cash flows.
Other reform measures allow CMS to place a moratorium on new enrollment of providers and to suspend payment to providers upon a credible allegation of fraud from any source. These types of reform
measures, as well as other measures, could adversely impact our revenues, earnings and cash flows depending upon the scope and breadth of the implementing regulations.
There is a considerable amount of uncertainty as to the prospective implementation of the federal healthcare reform legislation and what similar measures might be enacted at the state level. The enacted
reforms as well as future legislative changes could have a material adverse effect on our results of operations, including lowering our reimbursement rates and increasing our expenses.
The health care reform legislation added several new tax provisions that, among other things, impose various fees and excise taxes, and
limit compensation deductions for health insurance providers and their affiliates. These rules could negatively impact our cash flow and tax liabilities.
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Changes in state Medicaid or other non-Medicare government-based programs or payment rates could reduce
our revenues, earnings and cash flows.
Approximately 18% of our dialysis and related lab services revenues for the nine
months ended September 30, 2013 was generated from patients who have state Medicaid or other non-Medicare government-based programs, such as coverage through the Department of Veterans Affairs (VA), as their primary coverage. As state
governments and other governmental organizations face increasing budgetary pressure, we may in turn face reductions in payment rates, delays in the receipt of payments, limitations on enrollee eligibility or other changes to the applicable programs.
For example, certain state Medicaid programs and the VA have recently considered, proposed or implemented payment rate reductions.
On December 17, 2010, the VA published a final rule in which it materially changed the payment methodology and ultimately the amount paid for dialysis and laboratory services furnished to veterans in
non-VA centers such as ours. In the final rule, the VA adopted the bundled payment systems implemented by Medicare and estimated a reduction of 39% in payments for dialysis services provided to veterans at non-VA centers. Approximately 2% of our
dialysis and related lab services revenues for the nine months ended September 30, 2013 was generated by the VA. The VA payment methodology became effective February 15, 2011, but has not yet been implemented because it follows the
phase-in periods or other time schedules adopted by Medicare. To date, the VA payment reductions have not adversely impacted our revenues, earnings and cash flows but we believe there will be a significant negative impact on our revenues, earnings
and cash flows in the future due to the reduction in payment rates as well as a potential decrease in the number of VA patients we serve. We recently executed contractual agreements with the VA and there is some uncertainty as to when this rule will
take effect for the patients covered by these contracts. While at this time the contracts remain in force, these agreements provide for the right of the VA to terminate the agreements without cause on short notice. Further, patients who are not
covered by the contractual arrangements will likely be reimbursed at Medicare rates beginning with the date of implementation of the rule. If the VA proceeds with payment rate reductions or fails to renew our existing contracts, we may cease
accepting patients under this program and may be forced to close centers, which could adversely affect our revenues, earnings and cash flows.
State Medicaid programs are increasingly adopting Medicare-like bundled payment systems, but sometimes these payment systems are poorly defined and could include all drugs (even those oral-only drugs that
Medicare will not include in the bundled payment until 2014) and are implemented without any claims processing infrastructure, or patient or facility adjusters. If these payment systems are implemented without any adjusters and claims processing
changes, Medicaid payments will be substantially reduced and the costs to submit such claims may increase, which will have a negative impact on our revenues, earnings and cash flows. In addition, some state Medicaid program eligibility requirements
mandate that citizen enrollees in such programs provide documented proof of citizenship. If our patients cannot meet these proof of citizenship documentation requirements, they may be denied coverage under these programs, resulting in decreased
patient volumes and revenue. These Medicaid payment and enrollment changes, along with similar changes to other non-Medicare government programs could reduce the rates paid by these programs for dialysis and related services, delay the receipt of
payment for services provided, and further limit eligibility for coverage which could adversely affect our revenues, earnings and cash flows.
Changes in clinical practices, payment rates or regulations impacting EPO and other pharmaceuticals could reduce our revenues, earnings and cash
flows.
Historically, Medicare and most Medicaid programs paid for EPO outside of the composite rate. This separate payment
has long been the subject of discussions regarding appropriate dosing and payment in an effort to reduce escalating expenditures for EPO. Since January 1, 2011, Medicare has bundled EPO into the prospective payment system such that dosing
variations will not change the amount paid to a dialysis facility. Although some Medicaid programs and other payors suggest movement towards a bundled payment system inclusive of EPO, some non-Medicare payors continue to pay for EPO separately from
the treatment rate. The administration of EPO and other pharmaceuticals that are separately billable accounted for approximately 5% of
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our dialysis and related lab services revenues for the nine months ended September 30, 2013, with EPO alone accounting for approximately 3% of our dialysis and related lab services revenues
during that period. Changes in physician clinical practices that result in further decreased utilization of prescribed pharmaceuticals or changes in payment rates for those pharmaceuticals could reduce our revenues, earnings and cash flows.
Further evaluations and related actions by the U.S. Congress and federal agencies could result in further restrictions on the
utilization and reimbursement for ESAs. Commercial payors have also increasingly examined their administration policies for EPO and, in some cases, have modified those policies. Further changes in labeling of EPO and other pharmaceuticals in a
manner that alters physician practice patterns or accepted clinical practices, changes in private and governmental payment criteria, including the introduction of EPO administration policies or the conversion to alternate types of administration of
EPO or other pharmaceuticals that result in further decreases in utilization of EPO for patients covered by commercial payors could have a material adverse effect on our revenues, earnings and cash flows. Further increased utilization of EPO for
patients for whom the cost of EPO is included in a bundled reimbursement rate, or further decreases in reimbursement for EPO and other pharmaceuticals that are not included in a bundled reimbursement rate, could also have a material adverse effect
on our revenues, earnings and cash flows.
Changes in EPO pricing could materially reduce our earnings and cash flows and affect our
ability to care for our patients.
In November 2011, we entered into a seven year Sourcing and Supply Agreement with
Amgen USA Inc. Under the agreement we committed to purchase EPO in amounts necessary to meet no less than 90% of our requirements for ESAs. The agreement replaces in its entirety the prior one-year supply agreement between us and Amgen that expired
on December 31, 2011. As long as we meet certain conditions, the agreement limits Amgens ability to unilaterally decide to increase the price for EPO. Future increases in the cost of EPO without corresponding increases in payment rates
for EPO from commercial payors and without corresponding increases in the Medicare bundled rate could have a material adverse effect on our earnings and cash flows and ultimately reduce our income. Our agreement with Amgen for EPO provides for
discounted pricing and rebates for EPO. Some of the rebates are subject to various conditions including but not limited to future pricing levels of EPO by Amgen and data submission by us. In addition, the rebates are subject to certain limitations.
We cannot predict whether, over the seven year term of the agreement, we will continue to receive the rebates for EPO that we have received in the past, or whether we will continue to achieve the same levels of rebates within that structure as we
have historically achieved. In the initial years of the agreement, however, the total rebate opportunity is less than what was provided in the agreement that expired at the end of 2011, however, the opportunity for us to earn discounts and rebates
increases over the term of the agreement. Factors that could impact our ability to qualify for rebates provided for in our agreement with Amgen in the future include, but are not limited to, our ability to track certain data elements. We cannot
predict whether we will be able to meet the applicable qualification requirements for receiving rebates. Failure to meet certain targets and earn the specified rebates could have a material adverse effect on our earnings and cash flows. In 2012, we
experienced an increase in our overall EPO unit costs. In December 2012 we entered into an amendment to our agreement with Amgen that made non-material changes to certain terms of the agreement for the period from January 1, 2013 through
December 31, 2013. In addition, all of the other conditions as specified in the original agreement entered into in November 2011 still apply.
We are the subject of a number of investigations by the federal government and two private civil suits, any of which could result in substantial penalties or awards against us, the imposition of
certain obligations on our practices and procedures, exclusion from future participation in the Medicare and Medicaid programs and possible criminal penalties.
We are the subject of a number of investigations by the federal government. We have received subpoenas or other requests for documents from the federal government in connection with the Vainer private
civil suit, the 2010 U.S. Attorney physician relationship investigation, the 2011 U.S. Attorney physician relationship investigation and the 2011 U.S. Attorney Medicaid investigation. Certain current and former members of our
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Board, as well as executives and other teammates have been subpoenaed to testify before a grand jury in Colorado related to the 2011 U.S. Attorney physician relationship investigation. (See Note
7 to the condensed consolidated financial statements of this report for additional details regarding these matters.)
With
respect to the Vainer private civil suit, after investigation, the federal government did not intervene and is not actively pursuing this private civil suit. The United States Department of Justice reviewed the allegations contained in the Third
Amended Complaint in the Swoben civil suit and declined to intervene and is not actively pursuing this private civil suit other than its partial intervention for the purpose of settlement with and dismissal of the initial defendant in this
proceeding. In each of these private civil suits, a relator filed a complaint against us in federal court under the
qui tam
provisions of the FCA (and in the Swoben matter, provisions of the California False Claims Act, as well) and pursued
the claims independently after the government declined to intervene. The parties are engaged in active litigation in the Vainer private civil suit. With regard to the Swoben private civil suit, in July 2013, the court granted HCPs motion and
dismissed with prejudice all of the claims in the Third Amended Complaint, and in October 2013 the plaintiff filed an appeal of the dismissal, which is currently pending. (See Note 7 to the condensed consolidated financial statements of this report
for additional details regarding these matters).
We are cooperating with HHSs Office of Inspector General (OIG) and
those offices of the U.S. Attorney pursuing the matters mentioned above. Although it is uncertain when or if proceedings might be initiated by the federal government, the scope of such proceedings if initiated, or when the matters may be resolved,
it is not unusual for federal investigations to continue for a considerable period of time due to various phases related to document and witness requests and ongoing discussions with regulators. As noted elsewhere in this report on Form 10-Q,
we are engaged in good faith discussions with the attorneys from the United States Attorneys Office for the District of Colorado, the Civil Division of the United States Department of Justice and the OIG in an effort to find a mutually
acceptable resolution to the 2010 and 2011 U.S. Attorney physician relationship investigations. Discussions with federal regulators advanced to a point where we accrued an estimated loss contingency reserve of $300 million in the first quarter
of 2013 and an additional $97 million in the third quarter of 2013 in connection with offers to settle the related civil, administrative and criminal matters. However, the discussions are ongoing, and until concluded, there can be no certainty about
the timing or likelihood of a definitive resolution or to the scope of any potential restrictions or impact on future operations that may be agreed upon in connection with a settlement. As these discussions proceed and additional information becomes
available to us, the amount of the estimated loss contingency reserve may need to be adjusted further to reflect this new information. Responding to subpoenas, investigations and civil suits as well as defending ourselves in such matters will
continue to require managements attention and we will continue to incur significant legal expense. Any negative findings or certain terms and conditions that we might agree to accept as part of a negotiated resolution could result in
substantial financial penalties or awards against or substantial payments made by us, the imposition of certain obligations on our practices and procedures, exclusion from future participation in the Medicare and Medicaid programs and, in certain
cases, criminal penalties. It is possible that criminal proceedings may be initiated against us in connection with investigations by the federal government, including the 2011 U.S. Attorney physician relationship investigation. To our knowledge, no
proceedings have been initiated by the federal government against us at this time.
Changes in clinical practices relating to EPO could
adversely affect our operating results and financial condition as well as our ability to care for patients.
In response to clinical studies which identified risks in certain patient populations related to the utilization of EPO and other ESAs, i.e., Aranesp
®
, and in response to changes in the labeling of EPO and Aranesp
®
, there has been substantial media attention and government scrutiny resulting in hearings and legislation regarding pharmaceutical utilization and reimbursement.
Although we believe our anemia management practices and other pharmaceutical administration practices have been compliant with existing laws and regulations, as a result of the current high level of scrutiny and controversy, we may be subject to
increased inquiries from a variety of governmental bodies or claims by third parties. Additional inquiries from or audits by various agencies or claims by
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third parties with respect to these issues would continue to require managements attention and could result in significant legal expense. Further, any negative findings could result in
substantial financial penalties or repayment obligations, the imposition of certain obligations on our practices and procedures as well as the attendant financial burden on us to comply with the obligations, or exclusion from future participation in
the Medicare and Medicaid programs, and could have a material adverse effect on our revenues, earnings and cash flows.
If we fail to
adhere to all of the complex government regulations that apply to our business, we could suffer severe consequences that would substantially reduce our revenues, earnings, cash flows and stock price.
Our dialysis operations are subject to extensive federal, state and local government regulations, including Medicare and Medicaid payment
rules and regulations, federal and state anti-kickback laws, the physician self-referral law (Stark Law) and analogous state self-referral prohibition statutes, Federal Acquisition Regulations, the FCA and federal and state laws regarding the
collection, use and disclosure of patient health information and the storage, handling and administration of pharmaceuticals. The Medicare and Medicaid reimbursement rules related to claims submission, enrollment and licensing requirements, cost
reporting, and payment processes impose complex and extensive requirements upon dialysis providers as well. A violation or departure from any of these legal requirements may result in government audits, lower reimbursements, significant fines and
penalties, the potential loss of certification, recoupment efforts or voluntary repayments.
The regulatory scrutiny of
healthcare providers, including dialysis providers continues to increase. For example, CMS has indicated that with respect to the Medicare bundled payment system, it will monitor the use of EPO and other pharmaceuticals. In addition, Medicare has
increased the frequency and intensity of its certification inspections of dialysis centers. For example, we are required to provide substantial documentation related to the administration of pharmaceuticals, including EPO, and, to the extent that
any such documentation is found insufficient, we may be required to refund to government or commercial payors any payments received for such administration, and be subject to substantial penalties under applicable laws or regulations. In addition,
Medicare contractors have increased their prepayment and post-payment reviews.
We endeavor to comply with all legal
requirements, including those related to Medicare and Medicaid reimbursement, the storing, handling and administration of pharmaceuticals, and the collection, use and safeguarding of patient health information. We have experienced past security
breaches with regard to patient health information and there can be no assurance that we will not suffer security breaches in the future. We further endeavor to structure all of our relationships with physicians to comply with state and federal
anti-kickback and physician self-referral laws. We utilize considerable resources to monitor the laws and implement necessary changes. However, the laws and regulations in these areas are complex and often subject to varying interpretations. For
example, if an enforcement agency were to challenge the level of compensation that we pay our medical directors or the number of medical directors whom we engage, we could be required to change our practices, face criminal or civil penalties, pay
substantial fines or otherwise experience a material adverse effect as a result of a challenge to these arrangements. In addition, amendments to the FCA impose severe penalties for the knowing and improper retention of overpayments collected from
government payors. These amendments could subject our procedures for identifying and processing overpayments to greater scrutiny. We have made significant investments in new resources to decrease the time it takes to identify and process
overpayments and we may be required to make additional investments in the future. An acceleration in our ability to identify and process overpayments could result in us refunding overpayments to government and other payors more rapidly than we have
in the past which could have a material adverse affect on our operating cash flows. Additionally, amendments to the federal anti-kickback statute in the health reform law make anti-kickback violations subject to FCA prosecution, including
qui
tam
or whistleblower suits.
If any of our operations are found to violate these or other government regulations, we could
suffer severe consequences that would have a material adverse effect on our revenues, earnings, cash flows and stock price, including:
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Suspension or termination of our participation in government payment programs;
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Refunds of amounts received in violation of law or applicable payment program requirements;
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Loss of required government certifications or exclusion from government payment programs;
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Loss of licenses required to operate health care facilities or administer pharmaceuticals in some of the states in which we operate;
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Reductions in payment rates or coverage for dialysis and ancillary services and related pharmaceuticals;
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Fines, damages or monetary penalties for anti-kickback law violations, Stark Law violations, FCA violations, civil or criminal liability based on
violations of law, or other failures to meet regulatory requirements;
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Enforcement actions by governmental agencies and/or state claims for monetary damages by patients who believe their protected health information has
been used, disclosed or not properly safeguarded in violation of federal or state patient privacy laws, including the federal Health Insurance Portability and Accountability Act of 1996 (HIPAA);
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Mandated changes to our practices or procedures that significantly increase operating expenses;
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Imposition of and compliance with Corporate Integrity Agreements that could subject us to ongoing audits and reporting requirements as well as
increased scrutiny of our billing and business practices which could lead to potential fines;
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Termination of relationships with medical directors; and
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Harm to our reputation which could impact our business relationships, affect our ability to obtain financing and decrease access to new business
opportunities.
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Delays in state Medicare and Medicaid certification of our dialysis centers could adversely affect our
revenues, earnings and cash flows.
Before we can begin billing for patients treated in our outpatient dialysis centers who
are enrolled in government-based programs, we are required to obtain state and federal certification for participation in the Medicare and Medicaid programs. As state agencies responsible for surveying dialysis centers on behalf of the state and
Medicare program face increasing budgetary pressure, certain states are having difficulty keeping up with certifying dialysis centers in the normal course resulting in significant delays in certification. If state governments continue to have
difficulty keeping up with certifying new centers in the normal course and we continue to experience significant delays in our ability to treat and bill for services provided to patients covered under government programs, it could cause us to incur
write-offs of investments or accelerate the recognition of lease obligations in the event we have to close centers or our centers operating performance deteriorates, and it could have an adverse effect on our revenues, earnings and cash flows.
If our joint ventures were found to violate the law, we could suffer severe consequences that would have a material adverse effect on our
revenues, earnings and cash flows.
As of September 30, 2013, we owned a controlling interest in numerous
dialysis-related joint ventures, which represented approximately 21% of our U.S. dialysis and related lab services revenues for the nine months ended September 30, 2013. In addition, we also owned minority equity investments in several other
dialysis related joint ventures. We may continue to increase the number of our joint ventures. Many of our joint ventures with physicians or physician groups also have certain physician owners providing medical director services to centers we own
and operate. Because our relationships with physicians are governed by the federal and state anti-kickback statutes, we have sought to structure our joint venture arrangements to satisfy as many federal safe harbor requirements as we believe are
commercially reasonable. However, our joint venture arrangements do not satisfy all of the elements of any safe harbor under the federal anti-kickback statute. Arrangements that do not meet all of the elements of a safe harbor are not automatically
prohibited under the federal anti-kickback statute but are susceptible to government scrutiny. We have received subpoenas and related requests for documents from the U.S. Attorneys Office and the
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OIG related to our joint ventures. We have been advised by the U.S. Department of Justice that it is conducting civil and grand jury investigations into our financial relationships with
physicians, including our joint ventures generally. For additional details about these investigations, see the risk factor above under the heading We are the subject of a number of investigations by the federal government and two private civil
suits, any of which could result in substantial penalties or awards against us, the imposition of certain obligations on our practices and procedures, exclusion from future participation in the Medicare and Medicaid programs and possible criminal
penalties.
We have been advised by the attorneys conducting the civil investigations that they believe that some or all
of our joint ventures do not comply with the anti-kickback statute or the FCA. We disagree with this assessment and believe that our joint venture model is widely used in the dialysis industry and other segments of the healthcare industry in
substantially the same form that we use. Further, we made significant effort to structure our joint ventures and individual transactions to comply with all legal requirements. However, we are currently talking with the federal government about
addressing its concerns. If our joint ventures are found to be in violation of federal or state anti-kickback statutes, the FCA or the Stark Law, or if we agree to certain terms and conditions as part of a negotiated resolution with the federal
government, we could be required to restructure the joint ventures or refuse to accept referrals from the physicians with whom the joint venture centers have a financial relationship.
We also could be required to repay reimbursement amounts we received from Medicare and certain other payors related to the alleged
non-compliant joint venture arrangements. Depending on the duration and number of alleged non-compliant arrangements, we could be subject to civil monetary penalties, exclusion from government healthcare programs and, if criminal proceedings are
brought against us, criminal penalties. If our joint venture centers are subject to any of these penalties or terms and conditions are agreed upon as part of a negotiated resolution, we could suffer severe consequences that would have a material
adverse effect on our revenues, earnings and cash flows.
There are significant estimating risks associated with the amount of dialysis
revenues and related refund liabilities that we recognize and if we are unable to accurately estimate our revenues and related refund liabilities, it could impact the timing and the amount of our revenues recognition or have a significant impact on
our operating results.
There are significant estimating risks associated with the amount of dialysis and related lab
services revenues and related refund liabilities that we recognize in a reporting period. The billing and collection process is complex due to ongoing insurance coverage changes, geographic coverage differences, differing interpretations of contract
coverage, and other payor issues. Determining applicable primary and secondary coverage for approximately 161,000 U.S. patients at any point in time, together with the changes in patient coverage that occur each month, requires complex,
resource-intensive processes. Errors in determining the correct coordination of benefits may result in refunds to payors. Revenues associated with Medicare and Medicaid programs are also subject to estimating risk related to the amounts not paid by
the primary government payor that will ultimately be collectible from other government programs paying secondary coverage, the patients commercial health plan secondary coverage or the patient. Collections, refunds and payor retractions
typically continue to occur for up to three years and longer after services are provided. We generally expect our range of U.S. dialysis and related lab services revenues estimating risk to be within 1% of net revenues for the segment, which can
represent as much as 5% of dialysis operating income. If our estimates of dialysis and related lab services revenues and related refund liabilities are materially inaccurate, it could impact the timing and the amount of our revenues recognition and
have a significant impact on our operating results.
Our ancillary services and strategic initiatives, including our international dialysis
operations, that we invest in now or in the future may generate losses and may ultimately be unsuccessful. In the event that one or more of these activities is unsuccessful, we may have to write off our investment and incur other exit costs.
Our ancillary services and strategic initiatives currently include pharmacy services, disease management services,
vascular access services, ESRD clinical research programs, physician services, direct primary care and
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our international dialysis operations. We expect to add additional service offerings and pursue additional strategic initiatives in the future as circumstances warrant, which could include
healthcare services not related to dialysis. Many of these initiatives require or would require investments of both management and financial resources and can generate significant losses for a substantial period of time and may not become
profitable. There can be no assurance that any such strategic initiative will ultimately be successful. Any significant change in market conditions, or business performance, or in the political, legislative or regulatory environment, may impact the
economic viability of any of these strategic initiatives. For example, during 2011 and 2012, several of our strategic initiatives generated net operating losses and some are expected to generate net operating losses in 2013 and beyond. If any of our
ancillary services or strategic initiatives, including our international dialysis operations, do not perform as planned, we may incur a material write-off or an impairment of our investment, including goodwill, in one or more of these activities or
we could incur significant termination costs if we were to exit a certain line of business.
If a significant number of physicians were to
cease referring patients to our dialysis centers, whether due to regulatory or other reasons, it would have a material adverse effect on our revenues, earnings and cash flows.
We believe that physicians prefer to have their patients treated at dialysis centers where they or other members of their practice
supervise the overall care provided as medical director of the center. As a result, the primary referral source for most of our centers is often the physician or physician group providing medical director services to the center. Neither our current
nor former medical directors have an obligation to refer their patients to our centers. If a medical director agreement terminates, whether before or at the end of its term, and a new medical director is appointed, it may negatively impact the
former medical directors decision to treat his or her patients at our center. If we are unable to enforce noncompetition provisions contained in the terminated medical director agreements, former medical directors may choose to provide medical
director services for competing providers or establish their own dialysis centers in competition with ours. Also, if the quality of service levels at our centers deteriorates, it may negatively impact patient referrals and treatment volumes.
Our medical director contracts are for fixed periods, generally three to ten years, and at any given time a large number of
them could be up for renewal at the same time. Medical directors have no obligation to extend their agreements with us, and there are a number of factors, including opportunities presented by our competitors or different affiliation models in the
changing healthcare environment, such as an increase in the number of physicians becoming employed by hospitals, that could negatively impact their decisions to extend their agreements with us. In addition, we may take actions to restructure
existing relationships or take positions in negotiating extensions of relationships to assure compliance with the anti-kickback statute, Stark Law and other similar laws. These actions also could negatively impact the decision of physicians to
extend their medical director agreements with us or to refer their patients to us. If the terms of any existing agreement are found to violate applicable laws, we may not be successful in restructuring the relationship which could lead to the early
termination of the agreement, or cause the physician to stop referring patients to our dialysis centers. If a significant number of physicians were to cease referring patients to our dialysis centers, whether due to regulatory or other reasons, then
our revenues, earnings and cash flows would be substantially reduced.
Current economic conditions as well as further disruptions in the
financial markets could have a material adverse effect on our revenues, earnings and cash flows and otherwise adversely affect our financial condition.
Current economic conditions could adversely affect our business and our profitability. Among other things, the potential decline in federal and state revenues that may result from such conditions may
create additional pressures to contain or reduce reimbursements for our services from Medicare, Medicaid and other government sponsored programs. Increasing job losses or slow improvement in the unemployment rate in the U.S. as a result of current
or recent economic conditions has and may continue to result in a smaller percentage of our patients being covered by an employer group health plan and a larger percentage being covered by lower paying Medicare and Medicaid programs. Employers may
also begin to select more restrictive commercial plans with
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lower reimbursement rates. To the extent that payors are negatively impacted by a decline in the economy, we may experience further pressure on commercial rates, a further slowdown in collections
and a reduction in the amounts we expect to collect. In addition, uncertainty in the financial markets could adversely affect the variable interest rates payable under our credit facilities or could make it more difficult to obtain or renew such
facilities or to obtain other forms of financing in the future, if at all. Any or all of these factors, as well as other consequences of the current economic conditions which cannot currently be anticipated, could have a material adverse effect on
our revenues, earnings and cash flows and otherwise adversely affect our financial condition.
If there are shortages of skilled clinical
personnel or if we experience a higher than normal turnover rate, we may experience disruptions in our business operations and increases in operating expenses.
We are experiencing increased labor costs and difficulties in hiring nurses due to a nationwide shortage of skilled clinical personnel. We compete for nurses with hospitals and other health care
providers. This nursing shortage may limit our ability to expand our operations. In addition, changes in certification requirements or increases in the required staffing levels for skilled clinical personnel can impact our ability to maintain
sufficient staff levels to the extent our teammates are not able to meet new requirements or competition for qualified individuals increases. If we are unable to hire skilled clinical personnel when needed, or if we experience a higher than normal
turnover rate for our skilled clinical personnel, our operations and treatment growth will be negatively impacted, which would result in reduced revenues, earnings and cash flows.
Our business is labor intensive and could be adversely affected if we were unable to maintain satisfactory relations with our employees or if union organizing activities were to result in significant
increases in our operating costs or decreases in productivity.
Our business is labor intensive, and our results are
subject to variations in labor-related costs, productivity and the number of pending or potential claims against us related to labor and employment practices. If political efforts at the national and local level result in actions or proposals that
increase the likelihood of union organizing activities at our facilities or if union organizing activities increase for other reasons, or if labor and employment claims, including the filing of class action suits, trend upwards, our operating costs
could increase and our employee relations, productivity, earnings and cash flows could be adversely affected.
Upgrades to our billing and
collections systems and complications associated with upgrades and other improvements to our billing and collections systems could have a material adverse effect on our revenues, cash flows and operating results.
We are continuously performing upgrades to our billing systems and expect to continue to do so in the near term. In addition, we
continuously work to improve our billing and collections performance through process upgrades, organizational changes and other improvements. We may experience difficulties in our ability to successfully bill and collect for services rendered as a
result of these changes, including a slow-down of collections, a reduction in the amounts we expect to collect, increased risk of retractions from and refunds to commercial and government payors, an increase in our provision for uncollectible
accounts receivable and noncompliance with reimbursement regulations. The failure to successfully implement the upgrades to the billing and collection systems and other improvements could have a material adverse effect on our revenues, cash flows
and operating results.
Our ability to effectively provide the services we offer could be negatively impacted if certain of our suppliers
are unable to meet our needs or if we are unable to effectively access new technology, which could substantially reduce our revenues, earnings and cash flows.
We have significant suppliers that are either the sole or primary source of products critical to the services we provide, including Amgen, Baxter Healthcare Corporation, NxStage Medical, Inc. and others
or to which we have committed obligations to make purchases including Gambro and Fresenius. If any of these suppliers are unable to meet our needs for the products they supply, including in the event of a product recall, or shortage, and
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we are not able to find adequate alternative sources, or if some of the drugs that we purchase are not reimbursed or not adequately reimbursed by commercial payors or through the bundled payment
rate by Medicare, our revenues, earnings and cash flows could be substantially reduced. In addition, the technology related to the products critical to the services we provide is subject to new developments and may result in superior products. If we
are not able to access superior products on a cost-effective basis or if suppliers are not able to fulfill our requirements for such products, we could face patient attrition which could substantially reduce our revenues, earnings and cash flows.
Risk factors related to HCP:
HCP is subject to many of the same risks to which our dialysis business is subject.
As a participant in the healthcare industry, HCP is subject to many of the same risks to which our dialysis business is subject to as
described in the risk factors set forth above in this Part II, Item 1A, any of which could materially and adversely affect HCPs revenues, earnings or cash flows. Among these risks are the following:
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The healthcare business is heavily regulated and changes in laws, regulations, or government programs could have a material impact on HCP;
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Failure to comply with complex governmental regulations could have severe consequences to HCP, including, without limitation, exclusion from
governmental payor programs like Medicare and Medicaid;
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HCP could become the subject of governmental investigations, claims, and litigation;
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HCP may be unable to continue to make acquisitions or to successfully integrate such acquisitions into its business, and such acquisitions may include
liabilities of which HCP was not aware; and
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As a result of the broad scope of HCPs medical practice, HCP is exposed to medical malpractice claims, as well as claims for damages and other
expenses, that may not be covered by insurance or for which adequate limits of insurance coverage may not be available.
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Under most of HCPs agreements with health plans, HCP assumes some or all of the risk that the cost of providing services will exceed its
compensation.
Substantially all of HCPs revenue is derived from Per Member Per Month (PMPM) fees paid by health
plans under capitation agreements with HCP or its associated physician groups. In Florida and New Mexico, and a significant portion in Nevada, HCP contracts directly with health plans under global capitation arrangements to assume financial
responsibility for both professional and institutional services. In California, HCP utilizes a capitation model in several different forms. While there are variations specific to each arrangement, HealthCare Partners Affiliates Medical Group and
HealthCare Partners Associates Medical Group, Inc. (collectively HCPAMG) generally contracts with health plans to receive a PMPM fee for professional services and assumes the financial responsibility for professional services only. In some cases,
the health plans separately enter into capitation contracts with third parties (typically hospitals) who receive directly a PMPM fee and assume contractual financial responsibility for hospital services. In other cases, the health plan does not pay
any portion of the PMPM fee to the hospital, but rather administers claims for hospital expenses itself. In both scenarios, HCP enters into managed care-related administrative services agreements or similar arrangements with those third parties
(hospitals) under which HCP agrees to be responsible for utilization review, quality assurance, and other managed care-related administrative functions and claim payments. As compensation for such administrative services, HCP is entitled to share a
percentage of the amount by which the institutional capitation revenue exceeds institutional expenses; any such risk-share amount to which HCP is entitled is recorded as medical revenues and HCP is also responsible for any short-fall in the event
that institutional expenses exceed institutional revenues.
To the extent that members require more care than is anticipated,
aggregate fixed PMPM amounts, or capitation payments, may be insufficient to cover the costs associated with treatment. If medical expenses exceed
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estimates, except in very limited circumstances, HCP will not be able to increase the PMPM fee received under these risk agreements during their then-current terms.
If HCP or its associated physician groups enter into capitation contracts or other risk sharing arrangements with unfavorable economic
terms, or a capitation contract is amended to include unfavorable terms, HCP could, directly or indirectly through its contracts with its associated physician groups, suffer losses with respect to such contract. Since HCP does not negotiate with CMS
or any health plan regarding the benefits to be provided under their Medicare Advantage plans, HCP often has just a few months to familiarize itself with each new annual package of benefits it is expected to offer.
Changes in HCPs or its associated physician groups ratio of medical expense to revenue can create significant changes in
HCPs financial results. Accordingly, the failure to adequately predict and control medical expenses and to make reasonable estimates and maintain adequate accruals for incurred but not reported claims, may have a material adverse effect on
HCPs financial condition, results of operations or cash flows.
Historically, HCPs and its associated physician
groups medical expenses as a percentage of revenue have fluctuated. Factors that may cause medical expenses to exceed estimates include:
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the health status of members;
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higher than expected utilization of new or existing healthcare services or technologies;
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an increase in the cost of healthcare services and supplies, including pharmaceuticals, whether as a result of inflation or otherwise;
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changes to mandated benefits or other changes in healthcare laws, regulations, and practices;
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periodic renegotiation of provider contracts with specialist physicians, hospitals, and ancillary providers;
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periodic renegotiation of contracts with HCPs associated primary care physicians;
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changes in the demographics of the participating members and medical trends;
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contractual or claims disputes with providers, hospitals, or other service providers within a health plans network;
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the occurrence of catastrophes, major epidemics, or acts of terrorism; and
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plans with declining premiums.
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Risk-sharing arrangements that HCP-associated physician groups have with health plans and hospitals could result in their costs exceeding the corresponding revenues, which could reduce or eliminate any
shared risk profitability.
Most of the agreements between health plans and HCP and its associated physician groups contain
risk-sharing arrangements under which the physician groups can earn additional compensation from the health plans by coordinating the provision of quality, cost-effective healthcare to members. However, such arrangements may require the physician
group to assume a portion of any loss sustained from these arrangements, thereby reducing HCPs net income. Under these risk-sharing arrangements, HCP and its associated physician groups are responsible for a portion of the cost of hospital
services or other services that are not capitated. The terms of the particular risk-sharing arrangement allocate responsibility to the respective parties when the cost of services exceeds the related revenue, which results in a deficit, or permit
the parties to share in any surplus amounts when actual costs are less than the related revenue. The amount of non-capitated medical and hospital costs in any period could be affected by factors beyond the control of HCP, such as changes in
treatment protocols, new technologies, longer lengths of stay by the patient, and inflation. To the extent that such non-capitated medical and hospital costs are higher than anticipated, revenue may not be sufficient to cover the risk-sharing
deficits the health plans and HCP are responsible for, which could reduce HCPs revenues and profitability. Certain of HCPs agreements with health plans stipulate that risk-sharing pool deficit amounts are carried forward to offset
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any future years surplus amounts HCP would otherwise be entitled to receive. HCP accrues for any such risk-sharing deficits.
Whenever possible, HCP seeks to contractually reduce or eliminate its liability for risk-sharing deficits. Notwithstanding the foregoing,
risk-sharing deficits could have a significant impact on future profitability.
Renegotiation, renewal, or termination of capitation
agreements with health plans could have a significant impact on HCPs future profitability.
Under most of HCPs
and its associated physician groups capitation agreements with health plans, the health plan is generally permitted to modify the benefit and risk obligations and compensation rights from time to time during the terms of the agreements. If a
health plan exercises its right to amend its benefit and risk obligations and compensation rights, HCP and its associated physician groups are generally allowed a period of time to object to such amendment. If HCP or its associated physician group
so objects, under some of the risk agreements, the relevant health plan may terminate the applicable agreement upon 60 to 90 days written notice. Depending on the health plan at issue and the amount of revenue associated with the health plans
risk agreement, the renegotiated terms or termination may have a material adverse effect on HCPs and DaVitas future revenues and profitability.
Laws regulating the corporate practice of medicine could restrict the manner in which HCP is permitted to conduct its business and the failure to comply with such laws could subject HCP to penalties or
require a restructuring of HCP.
Some states have laws that prohibit business entities, such as HCP, from practicing
medicine, employing physicians to practice medicine, exercising control over medical decisions by physicians (also known collectively as the corporate practice of medicine) or engaging in certain arrangements, such as fee-splitting, with physicians.
In some states these prohibitions are expressly stated in a statute or regulation, while in other states the prohibition is a matter of judicial or regulatory interpretation. Of the states in which HCP currently operates, California and Nevada
prohibit the corporate practice of medicine.
In California and Nevada, HCP operates by maintaining long-term contracts with
its associated physician groups which are each owned and operated by physicians and which employ or contract with additional physicians to provide physician services. Under these arrangements, HCP provides management services, receives a management
fee for providing non-medical management services, does not represent that it offers medical services, and does not exercise influence or control over the practice of medicine by the physicians or the associated physician groups.
In addition to the above management arrangements, HCP has certain contractual rights relating to the orderly transfer of equity interests
in certain of its associated California and Nevada physician groups through succession agreements and other arrangements with their physician equity holders. However, such equity interests cannot be transferred to or held by HCP or by any
non-professional organization. Accordingly, neither HCP nor HCPs subsidiaries directly own any equity interests in any physician groups in California and Nevada. In the event that any of these associated physician groups fails to comply with
the management arrangement or any management arrangement is terminated and/or HCP is unable to enforce its contractual rights over the orderly transfer of equity interests in its associated physician groups, such events could have a material adverse
effect on HCPs business, financial condition or results of operations.
HCP may be required to restructure its relationship with its
associated physician groups if HCPs management services agreements with such associated physician groups or HCPs succession agreements and other related arrangements with equity holders of any such associated physician groups are deemed
invalid under prohibitions against the corporate practice of medicine in California and Nevada.
Some of the relevant laws,
regulations, and agency interpretations relating to the corporate practice of medicine have been subject to limited judicial and regulatory interpretation. Moreover, state laws are subject to
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change and regulatory authorities and other parties, including HCPs group physicians, may assert that, despite these arrangements, HCP is engaged in the prohibited corporate practice of
medicine.
In light of the above, it is possible that a state regulatory agency or a court could determine that HCPs
agreements with physician equity holders of certain managed California and Nevada associated physician groups as described above, either independently or coupled with the management services agreements with such associated physician groups, confer
impermissible control over the business and/or medical operations of such associated physician groups, that the management fee payable under such arrangements results in profit sharing or that HCP is the beneficial owner of the associated physician
groups equity interests in violation of the corporate practice of medicine doctrine. If there were a determination that a corporate practice of medicine violation existed or exists, these arrangements could be deemed invalid, potentially
resulting in a loss of revenues and an adverse effect on results of operations derived from such associated physician groups. In addition, HCPs California and Nevada associated physician groups and HCP, as well as those physician equity
holders of associated physician groups who are subject to succession agreements with HCP, could be subject to criminal or civil penalties or an injunction for practicing medicine without a license or aiding and abetting the unlicensed practice of
medicine.
A determination that a corporate practice of medicine violation existed could also force a restructuring of
HCPs management arrangements with associated physician groups in California and/or Nevada. Such a restructuring might include revisions of the management services agreements, which might include a modification of the management fee, and/or
establishing an alternative structure, such as obtaining a California Knox-Keene license (a managed care plan license issued pursuant to the California Knox-Keene Health Care Service Plan Act of 1975 (the Knox-Keene Act)) or its Nevada equivalent,
which would permit HCP to contract with a physician network without violating the corporate practice of medicine prohibition. There can be no assurance that such a restructuring would be feasible, or that it could be accomplished within a reasonable
time frame without a material adverse effect on HCPs operations and financial results.
If HCPs agreements or arrangements with
any physician equity holder(s) of associated physicians, physician groups, or IPAs are deemed invalid under state law, including laws against the corporate practice of medicine, or federal law, or are terminated as a result of changes in state law,
or if there is a change in accounting standards by the Financial Accounting Standards Board (FASB) or the interpretation thereof affecting consolidation of entities, it could impact HCPs consolidation of total revenues derived from such
associated physician groups.
HCPs financial statements are consolidated and include the accounts of its
majority-owned subsidiaries and certain non-owned HCP-associated and managed physician groups, which consolidation is effectuated in accordance with applicable accounting standards. Such consolidation for accounting and/or tax purposes does not, is
not intended to, and should not be deemed to, imply or provide to HCP any, control over the medical or clinical affairs of such physician groups. In the event of a change in accounting standards promulgated by FASB or in interpretation of its
standards, or if there were an adverse determination by a regulatory agency or a court, or a change in state or federal law relating to the ability to maintain present agreements or arrangements with such physician groups, HCP may not be permitted
to continue to consolidate the total revenues of such organizations. A change in accounting for consolidation with respect to HCPs present agreement or arrangements would diminish HCPs reported revenues but would not be expected to
materially adversely affect its reported results of operations, while regulatory or legal rulings or changes in law interfering with HCPs ability to maintain its present agreements or arrangements could materially diminish both revenues and
results of operations.
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If HCPs associated physician group is not able to satisfy the California Department of Managed
Health Cares financial solvency requirements, HCPs associated physician group could become subject to sanctions and HCPs ability to do business in California could be limited or terminated.
The California DMHC has instituted financial solvency regulations. The regulations are intended to provide a formal mechanism for
monitoring the financial solvency of capitated physician groups. Under the regulations, HCPs associated physician group is required to, among other things:
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Maintain, at all times, a minimum cash-to-claims ratio (where cash-to-claims ratio means the organizations cash, marketable securities, and
certain qualified receivables, divided by the organizations total unpaid claims liability). The regulation currently requires a cash-to-claims ratio of 0.75.
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Submit periodic reports to the DMHC containing various data and attestations regarding performance and financial solvency, including incurred but not
reported calculations and documentation, and attestations as to whether or not the organization was in compliance with the Knox-Keene Act requirements related to claims payment timeliness had maintained positive tangible net equity (i.e., at least
$1.00), and had maintained positive working capital (i.e., at least $1.00).
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In the event that a physician
organization is not in compliance with any of the above criteria, the organization would be required to describe in a report submitted to the DMHC the reasons for non-compliance and actions to be taken to bring the organization into compliance.
Further, under these regulations, the DMHC can make public some of the information contained in the reports, including, but not limited to, whether or not a particular physician organization met each of the criteria. In the event HCPs
associated physician group is not able to meet certain of the financial solvency requirements, and fails to meet subsequent corrective action plans, HCPs associated physician group could be subject to sanctions, or limitations on, or removal
of, its ability to do business in California.
Reductions in Medicare Advantage health plan reimbursement rates stemming from recent
healthcare reforms and any future related regulations may negatively impact HCPs business, revenue and profitability.
A significant portion of HCPs revenue is directly or indirectly derived from the monthly premium payments paid by CMS to health
plans for medical services provided to Medicare Advantage enrollees. As a result, HCPs results of operations are, in part, dependent on government funding levels for Medicare Advantage programs. Any changes that limit or reduce Medicare
Advantage reimbursement levels, including those recently approved and effective in 2014, such as reductions in or limitations of reimbursement amounts or rates under programs, reductions in funding of programs, expansion of benefits without adequate
funding, elimination of coverage for certain benefits, or elimination of coverage for certain individuals or treatments under programs, could have a material adverse effect on HCP. As previously disclosed, we expect the Medicare provider
reimbursement cuts that we currently face will reduce HCPs Medicare Advantage reimbursement levels by approximately 6% to 9% in 2014.
The Health Reform Acts contain a number of provisions that negatively impact Medicare Advantage plans, which may each have an adverse effect on HCPs revenues, earnings, and cash flows. These
provisions include the following:
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Medicare Advantage benchmarks for 2011 were frozen at 2010 levels. Beginning in 2012, Medicare Advantage benchmark rates are being phased down from
current levels to levels that are between 95% and 115% of fee-for-service costs, depending on a plans geographic area. Failure to meet these revised benchmarks may have a significant negative impact on HCPs revenues, earnings and cash
flows.
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Rebates received by Medicare Advantage plans that underbid based on payment benchmarks will be reduced, with larger reductions for plans failing to
receive certain quality ratings.
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The Secretary of the HHS is granted explicit authority to deny Medicare Advantage plan bids that propose significant increases in cost sharing or
decreases in benefits. If HCP plan bids are denied, this would have a significant negative impact on HCPs revenues, earnings and cash flows.
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Beginning in 2014, Medicare Advantage plans with medical loss ratios below 85% will be required to pay a rebate to the Secretary of HHS. The remittance
amount will be the total revenue under the contract year multiplied by the difference between 85% and the plans actual medical loss ratio. The Secretary of HHS will halt enrollment in any plan failing to meet this ratio for three consecutive
years, and terminate any plan failing to meet the ratio for five consecutive years. If an HCP-contracting Medicare Advantage plan experiences a limitation on enrollment or is otherwise terminated from the Medicare Advantage program, HCP may suffer
materially adverse consequences to its business or financial condition.
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Since January 1, 2011, cost-sharing for certain services (such as chemotherapy and skilled nursing care) has been limited to the cost-sharing
permitted under the original fee-for-service Medicare program, which could reduce HCPs revenues, earnings and cash flows by reducing the amount that enrollees are permitted to pay for such services.
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Prescription drug plans are now required to cover all drugs on a list developed by the Secretary of HHS, which could increase the cost of providing
care to Medicare Advantage enrollees, and thereby reduce HCPs revenues. The Medicare part D premium subsidy for high-income beneficiaries has been reduced by 25%, which could lower the number of Medicare Advantage enrollees, which would have a
negative impact on HCPs revenues, earnings and cash flows.
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Beginning in 2014, CMS is required to increase coding intensity adjustments for Medicare Advantage plans, which is expected to reduce CMS payments to
Medicare Advantage plans, which in turn will likely reduce the amounts payable to HCP and its associated physicians, physician groups, and IPAs under its capitation agreements. President Obamas proposed budget for Fiscal Year 2014
further increases the coding intensity adjustments, which may further reduce HCPs revenues, earnings and cash flows.
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The BCA and the Sequestration Transparency Act of 2012 have reduced by 2% the Net Capitation Payments that CMS pays to Medicare Advantage plans. This reduction to Medicare Advantage plans may result in
reductions in payments to HCPs associated physicians, physician groups, and IPAs, who directly or indirectly contract with such Medicare Advantage plans. Reductions in payments to HCPs associated physicians, physician groups, and IPAs
could have an adverse effect on HCPs revenues, earnings, and cash flows.
On April 1, 2013, CMS published its final
2014 Call Letter CMSs annual notice to health plans regarding the coming years Medicare Advantage payment methodology and estimated rates. In a reversal of its previous estimates, which called for a 2.2% reduction in
the 2014 Medicare Advantage rates, CMS included in its final 2014 Call Letter an estimated 3.3% increase in the 2014 Medicare Advantage rates. This reversal was the result of CMSs new assumption that Congressional action would prospectively
fix the Medicare physician fee schedules sustainable growth rate (SGR) formula. By assuming an imminent solution to the SGR formulas automatic rate reductions, CMS was able to base its 2014 Medicare Advantage estimates on an assumed 0%
change in the Medicare physician fee schedule rates for 2014. As noted above, this change in CMSs assumption has a dramatic positive impact on the estimated Medicare Advantage rates for 2014. Although a congressionally-mandated change to the
SGR formula, as described above, would potentially have a significant positive impact on HCPs Medicare Advantage revenues and net income, the likelihood of increasing medical costs and the uncertainty of Congressional action mitigate against
the positive impact of CMSs recent Medicare Advantage estimates.
Coupled with the risk that Congress will be unable to
find a solution to the SGR formulas automatic rate reductions is the risk that both Medicare Advantage plan payments and Medicare Advantage program enrollment will be reduced as a result of the implementation of the Health Reform Acts. Such
payment and enrollment
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reductions would, if realized, reduce HCPs Medicare Advantage and overall revenues and net income. According to the Congressional Budget Office (CBO), after reaching a high of 26%
participation in Medicare Advantage plans in 2013, Medicare Advantage participation will decline to 17% in 2020. Notwithstanding the increase in Medicare Advantage rates predicted by the 2014 Call Letter, the CBO predicts that falling Medicare
Advantage enrollment, together with other changes under the Health Reform Act, will result in reductions in Medicare Advantage spending by CMS of up to an aggregate of $131.9 billion over 10 years.
Finally, although the Health Reform Acts provide for reductions in payments to Medicare Advantage plans, the Health Reform Acts also
provide for bonus payments to Medicare Advantage plans rated four or five stars based on quality measures. In November 2011, CMS announced a three-year demonstration project with an alternative bonus structure that awards bonuses to plans with three
or more stars. However, the Government Accountability Office (GAO) and MedPAC have criticized the demonstration project. Therefore, Congress may act to curb the CMS-initiated bonus structure. If Congress does take such action and successfully curbs
the bonus structure, HCPs Medicare Advantage and other revenues and net income would decrease.
HCPs operations are dependent
on competing health plans and, at times, a health plans and HCPs economic interests may diverge.
For the
period January 1, 2013 through September 30, 2013, 68% of HCPs consolidated capitated medical revenues were earned through contracts with three health plans.
HCP expects that, going forward, substantially all of its revenue will continue to be derived from these and other health plans. Each health plan may immediately terminate any of HCPs contracts
and/or any individual credentialed physician upon the occurrence of certain events. They may also amend the material terms of the contracts under certain circumstances. Failure to maintain the contracts on favorable terms, for any reason, would
materially and adversely affect HCPs results of operations and financial condition. A material decline in the number of members could also have a material adverse effect on HCPs results of operations.
Notwithstanding each health plans and HCPs current shared interest in providing service to HCPs members who are
enrolled in the subject health plans, the health plans may have different and, at times, opposing economic interests from those of HCP. The health plans provide a wide range of health insurance services across a wide range of geographic regions,
utilizing a vast network of providers. As a result, they and HCP may have different views regarding the proper pricing of services and/or the proper pricing of the various service providers in their provider networks, the cost of which HCP bears to
the extent that the services of such service providers are utilized. These health plans may also have different views than HCP regarding the efforts and expenditures that they, HCP, and/or other service providers should make to achieve and/or
maintain various quality ratings. In addition, several health plans have purchased or announced their intent to purchase provider organizations. If health plans with which HCP contracts make significant purchases, they may not continue to contract
with HCP or contract on less favorable terms or seek to prevent HCP from acquiring or entering into arrangements with certain providers. Similarly, as a result of changes in laws, regulations, consumer preferences, or other factors, the health plans
may find it in their best interest to provide health insurance services pursuant to another payment or reimbursement structure. In the event HCPs interests diverge from the interests of the health plans, HCP may have limited recourse or
alternative options in light of its dependence on these health plans. There can be no assurances that HCP will continue to find it mutually beneficial to work with the health plans. As a result of various restrictive provisions that appear in some
of the managed care agreements with health plans, HCP may, at times, have limitations on its ability to cancel an agreement with a particular health plan and immediately thereafter contract with a competing health plan with respect to the same
service area.
HCP and its associated physicians, physician groups and IPAs and other physicians may be required to continue providing
services following termination or renegotiation of certain agreements with health plans.
There are circumstances under
federal and state law pursuant to which HCP and its associated physician groups IPAs, and other physicians could be obligated to continue to provide medical services to HCP members in
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their care following a termination of their applicable risk agreement with health plans and termination of the receipt of payments thereunder. In certain cases, this obligation could require the
physician group or IPA to provide care to such member following the bankruptcy or insolvency of a health plan. Accordingly, the obligations to provide medical services to HCP members (and the associated costs) may not terminate at the time the
applicable agreement with the health plan terminates, and HCP may not be able to recover its cost of providing those services from the health plan, which could have a material adverse effect on HCPs financial condition, results of operations,
and/or cash flows.
HCP operates primarily in Arizona, California, Florida, Nevada and New Mexico. HCP may not be able to successfully
establish a presence in new geographic regions.
HCP derives substantially all of its revenue from operations in Arizona,
California, Florida, Nevada and New Mexico (Arizona, California, Florida, Nevada and New Mexico are hereinafter referred to as the Existing Geographic Regions). As a result, HCPs exposure to many of the risks described herein is not mitigated
by a greater diversification of geographic focus. Furthermore, due to the concentration of HCPs operations in the Existing Geographic Regions, it may be adversely affected by economic conditions, natural disasters (such as earthquakes or
hurricanes), or acts of war or terrorism that disproportionately affect the Existing Geographic Regions as compared to other states and geographic markets.
To expand the operations of its network outside of the Existing Geographic Regions, HCP must devote resources to identifying and exploring such perceived opportunities. Thereafter, HCP must, among other
things, recruit and retain qualified personnel, develop new offices, establish potentially new relationships with one or more health plans, and establish new relationships with physicians and other healthcare providers. The ability to establish such
new relationships may be significantly inhibited by competition for such relationships and personnel in the health care marketplace in the targeted new geographic regions. Additionally, HCP may face the risk that a substantial portion of the
patients served in a new geographic area may be enrolled in a Medicare fee-for-service program and will not desire to transition to a Medicare Advantage program, such as those offered through the health plans that HCP serves, or they may enroll with
other health plans with whom HCP does not contract to provide services, which could reduce substantially HCPs perceived opportunity in such geographic area. In addition, if HCP were to seek expansion outside of the Existing Geographic Regions,
HCP would be required to comply with laws and regulations of states that may differ from the ones in which it currently operates, and could face competitors with greater knowledge of such local markets. HCP anticipates that any geographic expansion
may require it to make a substantial investment of management time, capital, and/or other resources. There can be no assurance that HCP will be able to establish profitable operations or relationships in any new geographic markets.
Reductions in the quality ratings of the health plans HCP serves could have an adverse effect on its results of operations, financial condition,
and/or cash flow.
As a result of the Health Reform Acts, HCP anticipates that the level of reimbursement each health plan
receives from CMS will be dependent, in part, upon the quality rating of the Medicare plan that such health plan serves. Such ratings are expected to impact the percentage of any cost savings rebate and any bonuses earned by such health plan. Since
a significant portion of HCPs revenue for 2013 is expected to be calculated as a percentage of CMS reimbursements received by these health plans with respect to HCP members, reductions in the quality ratings of a health plan that HCP serves
could have an adverse effect on its results of operations, financial condition, and/or cash flows. In addition, CMS has announced its intention to terminate any plan that has a rating of less than three stars for three consecutive years. Medicare
Advantage plans with five stars are permitted to conduct enrollment throughout the year and enrollees in plans with 4.5 or fewer stars are permitted to change plans during the year. Currently, HCP does not contract with any five star plans. Given
each health plans control of its plans and the many other providers that serve such plans, HCP believes that it will have limited ability to influence the overall quality rating of any such plan. Accordingly, since low quality ratings can
potentially lead to the termination of a plan that HCP serves, HCP may not be able to prevent the potential
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termination of a contracting plan or a shift of patients to other plans based upon quality issues which could, in turn, have an adverse effect on HCPs results of operations, financial
condition, and/or cash flows.
HCPs records and submissions to a health plan may contain inaccurate or unsupportable information
regarding risk adjustment scores of members, which could cause HCP to overstate or understate its revenue and subject it to various penalties.
HCP, on behalf of itself and its associated physicians, physician groups and IPAs, submits to health plans claims and encounter data that support the risk adjustment factor, or RAF, scores attributable to
members. These RAF scores determine, in part, the revenue to which the health plans and, in turn, HCP is entitled for the provision of medical care to such members. The data submitted to CMS by each health plan is based on medical charts and
diagnosis codes prepared and submitted by HCP. Each health plan generally relies on HCP to appropriately document and support such RAF data in HCPs medical records. Each health plan also relies on HCP to appropriately code claims for medical
services provided to members. HCP may periodically review medical records and may find inaccurate or unsupportable coding or otherwise inaccurate records. Erroneous claims and erroneous encounter records and submissions could result in inaccurate
PMPM fee revenue and risk adjustment payments, which may be subject to correction or retroactive adjustment in later periods. This corrected or adjusted information may be reflected in financial statements for periods subsequent to the period in
which the revenue was recorded. HCP might also need to refund a portion of the revenue that it received, which refund, depending on its magnitude, could damage its relationship with the applicable health plan and could have a material adverse effect
on HCPs results of operations, financial condition or cash flows.
CMS audits Medicare Advantage plans for documentation
to support RAF-related payments for members chosen at random. The Medicare Advantage plans ask providers to submit the underlying documentation for members that they serve. It is possible that claims associated with members with higher RAF scores
could be subject to more scrutiny in a CMS audit. HCP has experienced increases in RAF scores attributable to its members, and thus there is a possibility that a Medicare Advantage plan may seek repayment from HCP as a result of CMS payment
adjustments to the Medicare Advantage plan. The plans also may hold HCP liable for any penalties owed to CMS for inaccurate or unsupportable RAF scores provided by HCP.
CMS has indicated that, starting with payment year 2011, payment adjustments will not be limited to RAF scores for the specific Medicare Advantage enrollees for which errors are found but may also be
extrapolated to the entire Medicare Advantage plan subject to a particular CMS contract. CMS has described its audit process as plan-year specific and CMS has stated that it will not extrapolate audit results for plan years prior to 2011.
CMS has not specifically stated that payment adjustments as a result of one plan years audit will not be extrapolated
to prior plan years. There can be no assurance that a health plan will not be randomly selected or targeted for review by CMS or that the outcome of such a review will not result in a material adjustment in HCPs revenue and profitability, even
if the information HCP submitted to the plan is accurate and supportable. Since the CMS rules, regulations, and statements regarding this audit program are still not well defined and, in some cases, have not been published in final form, there is
also a risk that CMS may adopt new rules and regulations that are inconsistent with their existing rules, regulations, and statements.
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failure to estimate incurred but not reported medical expense accurately could adversely affect HCPs profitability.
Patient care costs include estimates of future medical claims that have been incurred by the patient but for which the provider has not
yet billed HCP. These claim estimates are made utilizing actuarial methods and are continually evaluated and adjusted by management, based upon HCPs historical claims experience and other factors, including an independent assessment by a
nationally recognized actuarial firm. Adjustments, if necessary, are made to medical claims expense when the assumptions used to determine HCPs claims liability changes and when actual claim costs are ultimately determined.
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Due to the inherent uncertainties associated with the factors used in these estimates and
changes in the patterns and rates of medical utilization, materially different amounts could be reported in HCPs financial statements for a particular period under different conditions or using different, but still reasonable, assumptions. It
is possible that HCPs estimates of this type of claim may be inadequate in the future. In such event, HCPs results of operations could be adversely impacted. Further, the inability to estimate these claims accurately may also affect
HCPs ability to take timely corrective actions, further exacerbating the extent of any adverse effect on HCPs results.
HCP
faces certain competitive threats which could reduce HCPs profitability and increase competition for patients.
HCP
faces certain competitive threats based on certain features of the Medicare programs, including the following:
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As a result of the direct and indirect impacts of the Health Reform Acts, many Medicare beneficiaries may decide that an original fee-for-service
Medicare program is more attractive than a Medicare Advantage plan. As a result, enrollment in the health plans HCP serves may decrease.
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Managed care companies offer alternative products such as regional preferred provider organizations (PPOs) and private fee-for-service plans. Medicare
PPOs and private fee-for-service plans allow their patients more flexibility in selecting physicians than Medicare Advantage health plans, which typically require patients to coordinate care with a primary care physician. The Medicare Prescription
Drug, Improvement, and Modernization Act of 2003 has encouraged the creation of regional PPOs through various incentives, including certain risk corridors, or cost reimbursement provisions, a stabilization fund for incentive payments, and special
payments to hospitals not otherwise contracted with a Medicare Advantage plan that treat regional plan enrollees. The formation of regional Medicare PPOs and private fee-for-service plans may affect HCPs relative attractiveness to existing and
potential Medicare patients in their service areas.
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The payments for the local and regional Medicare Advantage plans are based on a competitive bidding process that may indirectly cause a decrease in the
amount of the PMPM fee or result in an increase in benefits offered.
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The annual enrollment process and subsequent lock-in provisions of the Health Reform Acts may adversely affect HCPs level of revenue growth as it
will limit the ability of a health plan to market to and enroll new Medicare beneficiaries in its established service areas outside of the annual enrollment period.
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CMS allows Medicare beneficiaries who are enrolled in a Medicare Advantage plan with a quality rating of 4.5 stars or less to enroll in a 5 star rated
Medicare Advantage plan at any time during the benefit year. None of the plans HCP serves are 5-star rated. Therefore, HCP may face a competitive disadvantage in recruiting and retaining Medicare beneficiaries.
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In addition to the competitive threats intrinsic to the Medicare programs, competition among health plans and among healthcare providers
may also have a negative impact on HCPs profitability. For example, HCPs Existing Geographic Regions have become increasingly attractive to health plans that may compete with HCP, including the health plans with which HCP and its
associated physicians, physician groups, and IPAs currently compete. HCP may not be able to continue to compete profitably in the healthcare industry if additional competitors enter the same market. If HCP cannot compete profitably, the ability of
HCP to compete with other service providers that contract with competing health plans may be substantially impaired. Similarly, HCPs Existing Geographic Regions have also become increasingly attractive to HCPs competitors due to the
large populations of Medicare beneficiaries. HCP may not be able to continue to compete effectively if additional competitors enter the same regions.
HCP competes directly with various regional and local companies that provide similar services in HCPs Existing Geographic Regions. HCPs competitors vary in size and scope and in terms of
products and services
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offered. HCP believes that some of its competitors and potential competitors may be significantly larger than HCP and have greater financial, sales, marketing, and other resources. Furthermore,
it is HCPs belief that some of its competitors may make strategic acquisitions or establish cooperative relationships among themselves.
A disruption in HCPs healthcare provider networks could have an adverse effect on HCPs operations and profitability.
In any particular service area, healthcare providers or provider networks could refuse to contract with HCP, demand higher payments, or
take other actions that could result in higher healthcare costs, disruption of benefits to HCPs members, or difficulty in meeting applicable regulatory or accreditation requirements. In some service areas, healthcare providers or provider
networks may have significant market positions. If healthcare providers or provider networks refuse to contract with HCP, use their market position to negotiate favorable contracts, or place HCP at a competitive disadvantage, then HCPs ability
to market or to be profitable in those service areas could be adversely affected. HCPs provider networks could also be disrupted by the financial insolvency of a large provider group. Any disruption in HCPs provider networks could result
in a loss of members or higher healthcare costs.
HCPs revenues and profits could be diminished if HCP fails to retain and attract
the services of key primary care physicians.
Key primary care physicians with large patient enrollment could retire,
become disabled, terminate their provider contracts, get lured away by a competing independent physician association or medical group, or otherwise become unable or unwilling to continue practicing medicine or contracting with HCP or its associated
physicians, physician groups, or IPAs. In addition, HCPs associated physicians, physician groups and IPAs could view the business model as unfavorable or unattractive to such providers, which could cause such associated physicians, physician
groups or IPAs to terminate their relationships with HCP. Moreover, given limitations relating to the enforcement of post-termination noncompetition covenants in California, it would be difficult to restrict a primary care physician from competing
with HCPs associated physicians, physician groups, or IPAs. As a result, members who have been served by such physicians could choose to enroll with competitors physician organizations or could seek medical care elsewhere, which could
reduce HCPs revenues and profits. Moreover, HCP may not be able to attract new physicians to replace the services of terminating physicians or to service its growing membership.
HCP regularly explores potential acquisitions, which if consummated could affect its financial condition, results of operations or other aspects of its business.
HCP regularly explores potential acquisitions, which if consummated could affect its financial condition, results of operations or other
aspects of its business. There can be no assurance that HCP will be able to identify suitable acquisition candidates or that, if identified, HCP would be able to consummate an acquisition on acceptable terms. There can also be no assurance that HCP
will be successful in completing any acquisitions that it might be considering, or integrating any acquired business into its overall operations, or that any such acquired business will operate profitably or will not otherwise adversely impact
HCPs results of operations.
Participation in Accountable Care Organization programs is new and subject to federal regulation,
supervision, and evolving regulatory developments and may result in financial liability.
The Health Reform Acts establish
a Medicare shared savings program (MSSP) for Accountable Care Organizations (ACOs), which took effect in January 2012. Under the MSSP, eligible organizations are accountable for the quality, cost and overall care of Medicare beneficiaries assigned
to an ACO and may be eligible to share in any savings below a specified benchmark amount. The Secretary of HHS is also authorized, but not required, to use capitation payment models with ACOs. HCP is evaluating ACOs in which it might participate
through one or more of its subsidiaries and expects to participate in one or more ACOs in the future. The continued development and expansion of ACOs will have an uncertain impact on HCPs revenue and profitability.
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The ACO programs are new and therefore operational and regulatory guidance is limited. It is
possible that the operations of HCPs subsidiary ACOs may not fully comply with current or future regulations and guidelines applicable to ACOs, may not achieve quality targets or cost savings, or may not attract or retain sufficient physicians
or patients to allow HCP to meet its objectives. Additionally, poor performance could put the HCP ACOs at financial risk with a potential obligation to CMS. Traditionally, other than fee-for-service billing by the medical clinics and healthcare
facilities operated by HCP, HCP has not directly contracted with CMS and has not operated any health plans or provider sponsored networks. Therefore, HCP may not have the necessary experience, systems, or compliance to successfully achieve a
positive return on its investment in the ACOs or to avoid financial or regulatory liability. To date, demonstration projects using healthcare delivery models substantially similar to an ACO have not resulted in savings. HCP believes that its
historical experience with fully delegated managed care will be applicable to operation of its subsidiary ACOs, but there can be no such assurance.
California hospitals may terminate their agreements with HCPAMG or reduce the fees they pay to HCP.
In California, HCPAMG maintains significant hospital arrangements designed to facilitate the provision of coordinated hospital care with those services provided to members by HCPAMG and its associated
physicians, physician groups, and IPAs. Through contractual arrangements with certain key hospitals, HCPAMG provides utilization review, quality assurance, and other management services related to the provision of patient care services to members by
the contracted hospitals and downstream hospital contractors. In the event that any one of these key hospital agreements is amended in a financially unfavorable manner or is otherwise terminated, such events could have a material adverse effect on
HCPs financial condition, and results of operations.
HCPs professional liability and other insurance coverage may not be
adequate to cover HCPs potential liabilities.
HCP maintains professional liability insurance and other insurance
coverage through California Medical Group Insurance Company, Risk Retention Group, an Arizona corporation in which HCP is a majority owner, and through excess coverage contracted through third-party insurers. HCP believes such insurance is adequate
based on its review of what it believes to be all applicable factors, including industry standards. Nonetheless, potential liabilities may not be covered by insurance, insurers may dispute coverage or may be unable to meet their obligations, the
amount of insurance coverage and/or related reserves may be inadequate, or the amount of any HCP self-insured retention may be substantial. There can be no assurances that HCP will be able to obtain insurance coverage in the future, or that
insurance will continue to be available on a cost-effective basis, if at all. Moreover, even if claims brought against HCP are unsuccessful or without merit, HCP would have to defend itself against such claims. The defense of any such actions may be
time-consuming and costly and may distract HCP managements attention. As a result, HCP may incur significant expenses and may be unable to effectively operate its business.
Changes in the rates or methods of third-party reimbursements may adversely affect HCP operations.
HCP derives a substantial portion of its revenue from direct billings to governmental healthcare programs, such as Medicare and Medicaid, and private health insurance companies and/or health plans,
including but not limited to those participating in the Medicare Advantage program. As a result, any negative changes in governmental capitation or fee-for-service rates or methods of reimbursement for the services HCP provides could have a
significant adverse impact on HCPs revenue and financial results.
Medicare program reimbursements for physician
services as well as other services to Medicare beneficiaries who are not enrolled in Medicare Advantage plans are based upon the fee-for-service rates set forth in the Medicare Physician Fee Schedule, which relies, in part, on a target-setting
formula system called the SGR. Each year, on January 1st, the Medicare program updates the Medicare Physician Fee Schedule reimbursement rates. Many private payors use the Medicare Physician Fee Schedule to determine their own reimbursement
rates. Based on the SGR, the annual fee schedule update is adjusted to reflect the comparison of actual expenditures to
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target expenditures. Because one of the factors for calculating the SGR is linked to the growth in the U.S. gross domestic product (GDP), the SGR formula may result in a negative payment update
if growth in Medicare beneficiaries use of services exceeds GDP growth, a situation which has occurred every year since 2002 and the reoccurrence of which HCP cannot predict.
CMS determined that, effective January 1, 2013, the SGR formula results in a decrease to the physician Medicare fee schedule
reimbursement by 26.5%. Congress, however, enacted the American Taxpayer Relief Act of 2012 which provides, in part, that Medicare physician fee schedule rates for 2012 are extended through December 31, 2013. Therefore, the Medicare fee
schedule rates for 2013 are neither subject to the 26.5% SGR formula-driven reduction nor are they subject to any increase over and above the 2012 fee schedule rates. In addition, CMS recently announced that the estimated physician fee schedule
update for 2014 would be reduced by 24.4% due to the SGR formula.
While Congress has repeatedly intervened to mitigate the
negative reimbursement impact associated with the SGR formula, there is no guarantee that Congress will continue to do so in the future. On July 31, 2013, the House Energy and Commerce Committee unanimously approved a Medicare physician payment
bill that would abolish the SGR formula and provide a 0.5% physician payment increase for the next five years. However, the Committee did not propose a solution for paying for a repeal of the SGR, which the CBO estimates would cost approximately
$200 billion, and the bill was not sent to the full House for consideration. Moreover, the existing methodology may result in significant yearly fluctuations in the Medicare Physician Fee Schedule amounts, which may be unrelated to changes in the
actual costs of providing physician services. Unless Congress enacts a change to the SGR methodology, the uncertainty regarding reimbursement rates and fluctuation will continue to exist. Moreover, if Congress does change the SGR methodology or
substitute a new system for physician fee-for-service payments, it may require reductions in other Medicare programs including Medicare Advantage to offset such additional costs.
Another provision that affects physician payments under the Medicare Physician Fee Schedule is an adjustment under the Medicare statute
to reflect the geographic variation in the cost of delivering physician services, by comparing those costs to the national average. Medicare payments to physicians under the Medicare Physician Fee Schedule are geographically adjusted to reflect the
varying cost of delivering physician services across areas. The adjustments are made by indices, known as the Geographic Practice Cost Indices (GPCI) that reflect how each geographic area compares to the national average. In 2003, Congress
established that for three years there would be a floor of 1.0 on the work component of the Medicare Physician Fee Schedule formula used to determine physician payments, which meant that physician payments would not be reduced in a geographic area
just because the relative cost of physician work in that area fell below the national average. Congress extended the GPCI work floor several times since its enactment in 2003. The ATRA provides another extension through December 31, 2013.
Although Congress has extended the GPCI work floor several times, there is no guarantee that Congress will block the adjustment in the future, which could result in a decrease in payments HCP receives for physician services.
In addition, CMS announced on January 31, 2013 a call for applications to participate in a new Comprehensive ESRD Care model, under
which health care providers, including dialysis facilities, nephrologists, and other Medicare providers and suppliers, will be clinically and financially responsible for all care offered to a group of matched beneficiaries, not only dialysis care or
care related to ESRD. The participating ESCOs will have an opportunity to share in Medicare savings with CMS, but could also suffer reduced profitability if participating providers are unable to contain the cost of care for such beneficiaries.
Although participation in the Comprehensive ESRD Care model is voluntary and limited to fifteen organizations, it signals CMSs desire to shift the risk of rising health care costs to providers. CMS has stated that it will evaluate the
effectiveness of the ESRD Seamless Care Organizations over a five year period. Mandatory adoption of similar models in the future could adversely affect HCPs revenues from Medicare.
Congress has a strong interest in reducing the federal debt, which may lead to new proposals designed to achieve savings by altering
payment policies. The BCA established a Joint Select Committee on Deficit
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Reduction, which had the goal of achieving a reduction in the federal debt level of at least $1.2 trillion. As a result of the Joint Select Committees failure to draft a proposal by the
BCAs deadline, automatic sequestration cuts in various federal programs (excluding cuts to Medicaid) commenced on March 1, 2013, and a 2% cut to Medicare payments began on April 1, 2013, which has had, and we expect may continue to
have, a negative impact on our revenues. In addition, certain Congressional members have stated that the automatic federal spending cuts under the BCA are insufficient to achieve the BCAs goals of reducing federal spending and, in turn, the
federal deficit. Such members have said that the way to achieve these goals is to implement changes to federal entitlement programs, such as Medicare. Therefore it is not possible at this time to estimate what further impact, if any, other federal
Medicare provider reimbursement cuts will have on our integrated care business or results of operations. However, as previously disclosed, we expect the Medicare provider reimbursement cuts that we currently face will reduce HCPs Medicare
Advantage reimbursement levels by approximately 6% to 9% in 2014.
Because governmental healthcare programs generally
reimburse on a fee schedule basis rather than on a charge-related basis, HCP generally cannot increase its revenues from these programs by increasing the amount it charges for its services. Moreover, if HCPs costs increase, HCP may not be able
to recover its increased costs from these programs. Government and private payors have taken and may continue to take steps to control the cost, eligibility for, use, and delivery of healthcare services due to budgetary constraints, and cost
containment pressures as well as other financial issues. HCP believes that these trends in cost containment will continue. These cost containment measures, and other market changes in non-governmental insurance plans have generally restricted
HCPs ability to recover, or shift to non-governmental payors, any increased costs that HCP experiences. HCPs business and financial operations may be materially affected by these cost containment measures, and other market changes.
HCPs business model depends on numerous complex management information systems and any failure to successfully maintain these
systems or implement new systems could materially harm HCPs operations and result in potential violations of healthcare laws and regulations.
HCP depends on a complex, specialized, and integrated management information system and standardized procedures for operational and financial information, as well as for HCPs billing operations. HCP
may experience unanticipated delays, complications, or expenses in implementing, integrating, and operating these integrated systems. Moreover, HCP may be unable to enhance its existing management information system or implement new management
information systems where necessary. HCPs management information system may require modifications, improvements, or replacements that may require both substantial expenditures as well as interruptions in operations. HCPs ability to
implement and operate its integrated systems is subject to the availability of information technology and skilled personnel to assist HCP in creating and maintaining these systems.
HCPs failure to successfully implement and maintain all of its systems could have a material adverse effect on its business,
financial condition, and results of operations. For example, HCPs failure to successfully operate its billing systems could lead to potential violations of healthcare laws and regulations. If HCP is unable to handle its claims volume, or if
HCP is unable to pay claims timely, HCP may become subject to a health plans corrective action plan or de-delegation until the problem is corrected, and/or termination of the health plans agreement with HCP. This could have a material
adverse effect on HCPs operations and profitability. In addition, if HCPs claims processing system is unable to process claims accurately, the data HCP uses for its incurred but not received (IBNR) estimates could be incomplete and
HCPs ability to accurately estimate claims liabilities and establish adequate reserves could be adversely affected. Finally, if HCPs management information systems are unable to function in compliance with applicable state or federal
rules and regulations, including, without limitation, medical information confidentiality laws such as HIPAA, possible penalties and fines due to this lack of compliance could have a material adverse effect on HCPs financial condition, and
results of operations.
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Federal and state privacy and information security laws are complex and HCP may be subject to government
or private actions due to privacy and security breaches.
HCP must comply with numerous federal and state laws and
regulations governing the collection, dissemination, access, use, security and privacy of PHI, including HIPAA and its implementing privacy and security regulations, as amended by the federal HITECH Act and collectively referred to as HIPAA. In the
event that HCPs non-compliance with existing or new laws and regulations related to PHI results in privacy or security breaches, HCP could be subject to monetary fines, civil suits, civil penalties or criminal sanctions and requirements to
disclose the breach publicly.
HCP may be impacted by eligibility changes to government and private insurance programs.
Due to potential decreased availability of healthcare through private employers, the number of patients who are uninsured or participate
in governmental programs may increase. The Health Reform Acts will increase the participation of individuals in the Medicaid program in states that elect to participate in the expanded Medicaid coverage. A shift in payor mix from managed care and
other private payors to government payors as well as an increase in the number of uninsured patients may result in a reduction in the rates of reimbursement to HCP or an increase in uncollectible receivables or uncompensated care, with a
corresponding decrease in net revenue. Changes in the eligibility requirements for governmental programs such as the Medicaid program under the Health Reform Acts and state decisions on whether to participate in the expansion of such programs also
could increase the number of patients who participate in such programs and the number of uninsured patients. Even for those patients who remain in private insurance plans, changes to those plans could increase patient financial responsibility,
resulting in a greater risk of uncollectible receivables. These factors and events could have a material adverse effect on HCPs business, financial condition, and results of operations.
Negative publicity regarding the managed healthcare industry generally or HCP in particular could adversely affect HCPs results of operations or business.
Negative publicity regarding the managed healthcare industry generally, the Medicare Advantage program or HCP in particular, may result in
increased regulation and legislative review of industry practices that further increase HCPs costs of doing business and adversely affect HCPs results of operations or business by:
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requiring HCP to change its products and services;
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increasing the regulatory, including compliance, burdens under which HCP operates, which, in turn, may negatively impact the manner in which HCP
provides services and increase HCPs costs of providing services;
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adversely affecting HCPs ability to market its products or services through the imposition of further regulatory restrictions regarding the
manner in which plans and providers market to Medicare Advantage enrollees; or
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adversely affecting HCPs ability to attract and retain members.
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Risk factors related to our overall business and ownership of our common stock:
Disruptions in federal government operations and funding create uncertainty in our industry and could have a material adverse effect on our revenues,
earnings and cash flows and otherwise adversely affect our financial condition.
After a 16-day federal government shutdown
in October 2013, the U.S. House and Senate passed legislation in October 2013 that was signed into law by the President and funds the federal government through January 15, 2014 and extends the federal debt ceiling through February 7,
2014. Because a substantial portion of our revenues is dependent on federal healthcare program reimbursement, any subsequent shutdown of the federal government, failure to raise the debt ceiling and/or failure to enact annual appropriations for
fiscal year 2014 could immediately affect our cash flow as well as regulatory approvals and guidance that are important to our
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operations, and create uncertainty about the pace of upcoming developments in the health care regulatory arena. In addition, if the U.S. government defaults on its debt, there could be broad
macroeconomic effects that could raise our cost of borrowing funds, and delay or prevent our future growth and expansion. Any future federal government shutdown, U.S. government default on its debt and/or failure of the U.S. government to enact
annual appropriations for fiscal year 2014 could have a material adverse effect on our revenues, earnings and cash flows.
Changes in CMS
diagnosis and inpatient procedure coding require us to make modifications to processes and information systems, which could result in significant development costs and which if unsuccessful could adversely affect our revenues, earnings and cash
flows.
CMS has mandated the use of new patient codes for reporting medical diagnosis and inpatient procedures, referred to
as ICD-10. CMS is requiring all providers, payors, clearinghouses, and billing services to utilize ICD-10 when submitting claims for payment. ICD-10 will affect diagnosis and inpatient procedure coding for everyone covered by HIPAA, not just those
who submit Medicare or Medicaid claims. Claims for services provided on or after October 1, 2014 must use ICD-10 for medical diagnosis and inpatient procedures or they will not be paid.
We anticipate that if our services, processes or information systems or those of our payors do not comply with ICD-10 requirements at any
future date, it could potentially delay or even reduce reimbursement payments to us. These delays or reductions could negatively impact our revenues, earnings and cash flows.
We may engage in acquisitions, mergers or dispositions, which may affect our results of operations, debt-to-capital ratio, capital expenditures or other aspects of our business.
We may engage in acquisitions, mergers or dispositions, which may affect our results of operations, debt-to-capital ratio, capital
expenditures, or other aspects of our business. There can be no assurance that we will be able to identify suitable acquisition targets or merger partners or that, if identified, we will be able to acquire these targets on acceptable terms or agree
to terms with merger partners. There can also be no assurance that we will be successful in completing any acquisitions, mergers or dispositions that we might be considering or announce, or integrating any acquired business into our overall
operations or operate them successfully as stand-alone businesses, or that any such acquired business will operate profitably or will not otherwise adversely impact our results of operations. Further, we cannot be certain that key talented
individuals at the business being acquired will continue to work for us after the acquisition or that they will be able to continue to successfully manage or have adequate resources to successfully operate any acquired business.
HCP operates in a different line of business from our historical business. We may face challenges managing HCP as a new business and may not realize
anticipated benefits.
As a result of the HCP transaction, we are now significantly engaged in a new line of business. We
may not have the expertise, experience, and resources to pursue all of our businesses at once, and we may be unable to successfully operate all businesses in the combined Company. The administration of HCP will require implementation of appropriate
operations, management, and financial reporting systems and controls. We may experience difficulties in effectively implementing these and other systems. The management of HCP will require the focused attention of our management team, including a
significant commitment of its time and resources. The need for management to focus on these matters could have a material and adverse impact on our revenues and operating results. If the HCP operations are less profitable than we currently
anticipate or we do not have the experience, the appropriate expertise, or the resources to pursue all businesses in the combined company, the results of operations and financial condition may be materially and adversely affected.
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If we fail to successfully integrate HCP into our internal control over financial reporting or if the
internal control of HCP over financial reporting were found to be ineffective, the integrity of our, and/or HCPs, financial reporting could be compromised which could result in a material adverse effect on our reported financial results.
As a private company, HCP has not been subject to the requirements of the Securities Exchange Act of 1934, as amended,
with respect to internal control over financial reporting, and for a period of time after the consummation of the HCP transaction our management evaluation and auditor attestation regarding the effectiveness of our internal control over financial
reporting will be permitted to exclude the operations of HCP. The integration of HCP into our internal control over financial reporting has required and will continue to require significant time and resources from our management and other personnel
and will increase our compliance costs. If we fail to successfully integrate these operations into our internal control over financial reporting, our internal control over financial reporting may not be effective. Failure to achieve and maintain an
effective internal control environment could have a material adverse effect on our ability to accurately report our financial results and the markets perception of our business and our stock price. In addition, if HCPs internal control
over financial reporting were found to be ineffective, the integrity of HCPs past financial reporting could be adversely impacted.
Under accounting standards applicable to the contingent consideration obligations, we must estimate the fair value of such obligations on a quarterly
basis and record any changes in our financial statements. Any increases in the fair value of the contingent consideration obligations will be recorded as an expense and may have an adverse impact on our earnings and our ability to predict the amount
of earnings.
A portion of the consideration for the HCP transaction was contingent upon HCPs performance for the
calendar years ending December 31, 2012 and 2013. The accounting standards applicable to contingent consideration require that we estimate the fair value of this contingent consideration on a quarterly basis. To the extent that the fair value
estimate in any quarter exceeds the prior quarters estimate, we will be required to record the increase in fair value as an expense in our financial statements. Any such expense will reduce our net income in the quarter in which it is
recognized. These requirements will also limit our ability to predict our earnings in the quarters in which we must assess the fair value of the contingent consideration, and projections of such changes have not been included in any of our existing
earnings guidance. As a result of HCP achieving certain financial performance targets for calendar year 2012, we made contingent earn-out payments to the former owners and common unit holders of HCP (HCP Sellers) in April 2013 that related to
the 2012 contingent earn-out consideration. During the third quarter of 2013, we reached agreement with the representative of the HCP Sellers to settle certain post-closing adjustments, including the 2013 contingent earn-out payment for $68.75
million, an amount equal to its carrying value at June 30, 2013. This agreement resulted in payments to the HCP Sellers of approximately 50% of the 2013 contingent earn-out consideration that could have been earned by the HCP Sellers.
The market price of our common stock may be affected by factors different from those affecting the shares of our common stock prior to
consummation of the HCP transaction.
Our historical business differs substantially from that of HCP. Accordingly, the
results of operations of the combined company and the market price of our common stock may be affected by factors different from those that previously affected the independent results of operations of each of the Company and HCP.
If we are not able to continue to make acquisitions, or maintain an acceptable level of non-acquired growth, or if we face significant patient
attrition to our competitors or a reduction in the number of our medical directors or associated physicians, it could adversely affect our business.
Acquisitions, patient retention and medical director and physician retention are an important part of our growth strategy. We face intense competition from other companies for acquisition targets. In our
U.S. dialysis
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business, we continue to face increased competition from large and medium-sized providers which compete directly with us for acquisition targets as well as for individual patients and medical
directors. In addition, as we continue our international dialysis expansion into various international markets, we will face competition from large and medium-sized providers for these acquisition targets as well. Because of the ease of entry into
the dialysis business and the ability of physicians to be medical directors for their own centers, competition for growth in existing and expanding markets is not limited to large competitors with substantial financial resources. Occasionally, we
have experienced competition from former medical directors or referring physicians who have opened their own dialysis centers. In addition, Fresenius, our largest competitor, manufactures a full line of dialysis supplies and equipment in addition to
owning and operating dialysis centers. This may give it cost advantages over us because of its ability to manufacture its own products. If we are not able to continue to make acquisitions, continue to maintain acceptable levels of non-acquired
growth, or if we face significant patient attrition to our competitors or a reduction in the number of our medical directors or associated physicians, it could adversely affect our business.
If businesses we acquire, including HCP, have liabilities that we are not aware of, we could suffer severe consequences that would substantially reduce our earnings and cash flows or otherwise
materially and adversely affect our business.
Our business strategy includes growth through acquisitions of dialysis
centers and other businesses. Businesses we acquire, including HCP, may have unknown or contingent liabilities or liabilities that are in excess of the amounts that we originally estimated, which liabilities become consolidated into the
Companys. Businesses we acquire, including HCP, may have other issues, including those related to internal controls over financial reporting or issues that could affect our ability to comply with other applicable laws, including healthcare
laws and regulations. As a result, we cannot make any assurances that the acquisitions we consummate, including the HCP transaction, will be successful or will not, in fact, harm our business.
Although we generally seek indemnification from the sellers of businesses we acquire for matters that are not properly disclosed to us,
we are not always successful. We have limited indemnification rights in connection with matters affecting HCP. In addition, even in cases where we are able to obtain indemnification, we may discover liabilities greater than the contractual limits,
the amounts held in escrow for our benefit (if any), or the financial resources of the indemnifying party. In the event that we are responsible for liabilities substantially in excess of any amounts recovered through rights to indemnification or
alternative remedies that might be available to us, or any applicable insurance, we could suffer severe consequences that would substantially reduce our earnings and cash flows or otherwise materially and adversely affect our business.
Expansion of our operations to and offering our services in markets outside of the U.S. subjects us to political, economical, legal, operational and
other risks that could adversely affect our business, results of operations and cash flows.
We are continuing an expansion
of our operations by offering our services outside of the U.S., which increases our exposure to the inherent risks of doing business in international markets. Depending on the market, these risks include, without limitation, those relating to:
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changes in the local economic environment;
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political instability, armed conflicts or terrorism;
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intellectual property legal protections and remedies;
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procedures and actions affecting approval, production, pricing, reimbursement and marketing of products and services;
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repatriating or moving to other countries cash generated or held abroad, including considerations relating to tax-efficiencies and changes in tax laws;
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lack of reliable legal systems which may affect our ability to enforce contractual rights;
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changes in local laws or regulations;
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potentially longer ramp-up times for starting up new operations and for payment and collection cycles;
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financial and operational, and information technology systems integration; and
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failure to comply with U.S. or local laws that prohibit us or our intermediaries from making improper payments to foreign officials for the purpose of
obtaining or retaining business.
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Additionally, some factors that will be critical to the success of our
international business and operations will be different than those affecting our domestic business and operations. For example, conducting international operations requires us to devote significant management resources to implement our controls and
systems in new markets, to comply with local laws and regulations and to overcome the numerous new challenges inherent in managing international operations, including those based on differing languages, cultures and regulatory environments, and
those related to the timely hiring, integration and retention of a sufficient number of skilled personnel to carry out operations in an environment with which we are not familiar.
We anticipate expanding our international operations through acquisitions of varying sizes or through organic growth, which could
increase these risks. Additionally, though we might invest material amounts of capital and incur significant costs in connection with the growth and development of our international operations, there is no assurance that we will be able to operate
them profitably anytime soon, if at all. As a result, we would expect these costs to be dilutive to our earnings over the next several years as we start-up or acquire new operations.
These risks could have a material adverse effect on our financial condition, results of operations and cash flows.
The level of our current and future debt could have an adverse impact on our business and our ability to generate cash to service our indebtedness
depends on many factors beyond our control.
We have substantial debt outstanding, we incurred a substantial amount of
additional debt in connection with the HCP transaction and we may incur additional indebtedness in the future. The high level of our indebtedness, among other things, could:
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make it difficult for us to make payments on our debt securities;
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increase our vulnerability to general adverse economic and industry conditions;
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require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our
cash flow to fund working capital, capital expenditures, acquisitions and investments and other general corporate purposes;
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limit our flexibility in planning for, or reacting to, changes in our business and the markets in which we operate;
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place us at a competitive disadvantage compared to our competitors that have less debt; and
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limit our ability to borrow additional funds.
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Our ability to make payments on our indebtedness and to fund planned capital expenditures
and expansion efforts, including any strategic acquisitions we may make in the future, will depend on our ability to generate cash. This, to a certain extent, is subject to general economic, financial, competitive, regulatory and other factors that
are beyond our control.
We cannot provide assurance that our business will generate sufficient cash flow from operations in
the future or that future borrowings will be available to us in an amount sufficient to enable us to service our indebtedness or to fund other liquidity needs. If we are unable to generate sufficient funds to service our outstanding indebtedness, we
may be required to refinance, restructure, or otherwise amend some or all of such obligations, sell assets, or raise additional cash through the sale of our equity. We cannot make any assurances that we would be able to obtain such refinancing on
terms as favorable as our existing financing terms or that such restructuring activities, sales of assets, or issuances of equity can be accomplished or, if accomplished, would raise sufficient funds to meet these obligations.
The borrowings under our Senior Secured Credit Facilities are guaranteed by a substantial portion of our direct and indirect wholly-owned
domestic subsidiaries and are secured by a substantial portion of DaVita HealthCare Partners Inc.s and its subsidiaries assets.
Increases in interest rates may increase our interest expense and adversely affect our earnings and cash flow and our ability to service our
indebtedness.
A portion of our outstanding debt bears interest at variable rates. We are subject to LIBOR-based interest
rate volatility from a floor of 1.50% to a cap of 2.50% on $1,250 million notional amounts of our Term Loan B outstanding debt as a result of several interest rate cap agreements that were entered into in March 2013. The remaining $452 million of
outstanding debt on the Term Loan B is subject to LIBOR-based interest rate volatility above a floor of 1.50%. At September 30, 2013, we were also subject to LIBOR-based interest rate volatility above a floor of 1.00% to a cap of 2.50% on
$1,485 million of outstanding debt associated with our Term Loan B-2. The remaining $153 million of outstanding debt on the Term Loan B-2 is subject to LIBOR-based interest rate volatility above a floor of 1.00%. At September 30, 2013, we
were also subject to LIBOR-based interest rate volatility on Term Loan A-3 and Term Loan A but as a result of our swap agreements the LIBOR-based variable component of our interest rate is economically fixed at September 30, 2013.
We also have approximately $350 million of additional borrowings available of which approximately $99 million was committed for
outstanding letters of credit, under our Senior Secured Credit Facilities that are subject to LIBOR-based interest rate volatility and approximately $1 million committed for our outstanding letter of credit related to HCP secured by a certificate of
deposit. We may also incur additional variable rate debt in the future. Increases in interest rates would increase our interest expense of the variable portion of our indebtedness, which could negatively impact our earnings and cash flow and our
ability to service our indebtedness which would be particularly significant in the event of rapid and substantial increases in interest rates.
At September 30, 2013, if interest rates were to hypothetically increase by 100 basis points it would increase our interest expense by approximately $3.0 million, which increase relates to our Term
Loan B-2 that is subject to LIBOR-based interest rate volatility above a floor of 1.00%. See Item 3Quantitative and Qualitative Disclosures about Market Risk for more information.
We may be subject to liability claims for damages and other expenses not covered by insurance that could reduce our earnings and cash flows.
Our operations and how we manage the Company may subject the Company, as well as its officers and directors to whom the
Company owes certain defense and indemnity obligations, to litigation and liability for damages. Our business, profitability and growth prospects could suffer if we face negative publicity or we pay damages or defense costs in connection with a
claim that is outside the scope or limits of coverage of any
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applicable insurance coverage, including claims related to adverse patient events, contractual disputes, professional and general liability, and directors and officers duties. In
addition, we have received several notices of claims from commercial payors and other third parties related to our historical billing practices and the historical billing practices of the centers acquired from Gambro Healthcare and other matters
related to their settlement agreement with the Department of Justice. Although the ultimate outcome of these claims cannot be predicted, an adverse result with respect to one or more of these claims could have a material adverse effect on our
financial condition, results of operations, and cash flows. We currently maintain insurance coverage for those risks we deem are appropriate to insure against and make determinations about whether to self-insure as to other risks or layers of
coverage. However, a successful claim, including a professional liability, malpractice or negligence claim which is in excess of any applicable insurance coverage, or that is subject to our self-insurance retentions, could have a material adverse
effect on our earnings and cash flows.
In addition, if our costs of insurance and claims increase, then our earnings could
decline. Market rates for insurance premiums and deductibles have been steadily increasing. Our earnings and cash flows could be materially and adversely affected by any of the following:
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the collapse or insolvency of our insurance carriers;
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further increases in premiums and deductibles;
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increases in the number of liability claims against us or the cost of settling or trying cases related to those claims; and
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an inability to obtain one or more types of insurance on acceptable terms, if at all.
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Provisions in our charter documents, compensation programs and Delaware law may deter a change of control that our stockholders would otherwise
determine to be in their best interests.
Our charter documents include provisions that may deter hostile takeovers, delay
or prevent changes of control or changes in our management, or limit the ability of our stockholders to approve transactions that they may otherwise determine to be in their best interests. These include provisions prohibiting our stockholders from
acting by written consent; requiring 90 days advance notice of stockholder proposals or nominations to our Board of Directors; and granting our Board of Directors the authority to issue preferred stock and to determine the rights and preferences of
the preferred stock without the need for further stockholder approval.
Most of our outstanding employee stock-based
compensation awards include a provision accelerating the vesting of the awards in the event of a change of control. We also maintain a change of control protection program for our employees who do not have a significant number of stock awards, which
has been in place since 2001, and which provides for cash bonuses to the employees in the event of a change of control. Based on the market price of our common stock and shares outstanding on September 30, 2013, these cash bonuses would total
approximately $476 million if a change of control transaction occurred at that price and our Board of Directors did not modify this program. These change of control provisions may affect the price an acquirer would be willing to pay for our Company.
We are also subject to Section 203 of the Delaware General Corporation Law that, subject to exceptions, would prohibit
us from engaging in any business combinations with any interested stockholder, as defined in that section, for a period of three years following the date on which that stockholder became an interested stockholder.
These provisions may discourage, delay or prevent an acquisition of our Company at a price that our stockholders may find attractive.
These provisions could also make it more difficult for our stockholders to elect directors and take other corporate actions and could limit the price that investors might be willing to pay for shares of our common stock.
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