[Federal Register Volume 69, Number 210 (Monday, November 1, 2004)]
[Notices]
[Pages 63413-63417]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E4-2918]
=======================================================================
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Investment Company Act Release No. 26643; 812-12953]
PacifiCare of Arizona, Inc., et al.; Notice of Application and
Commission Statement
October 25, 2004.
AGENCY: Securities and Exchange Commission (``Commission'').
ACTION: (1) Notice of application for an order under sections 3(b)(2)
and 45(a) of the Investment Company Act of 1940 (the ``Act'') and (2) a
Commission statement that the Commission is considering clarifying the
primary business test under sections 3(b)(1) and (2) of the Act with
respect to health maintenance organizations and similar entities that
provide managed health care services (collectively, ``HMOs'').
-----------------------------------------------------------------------
Applicants: PacifiCare of Arizona, Inc., PacifiCare of California,
PacifiCare of Colorado, Inc., PacifiCare of Nevada,
[[Page 63414]]
Inc., PacifiCare of Oregon, Inc., PacifiCare of Texas, Inc. and
PacifiCare of Washington, Inc. (the ``PacifiCare HMOs'').
Summary of Application and Commission Statement: Applicants seek orders
under section 3(b)(2) of the Act declaring them to be primarily engaged
in a business other than that of investing, reinvesting, owning,
holding or trading in securities.\1\ Applicants are in the business of
offering managed care and other health insurance products. Applicants
also seek an order under section 45(a) of the Act granting confidential
treatment with respect to certain financial and other information. The
Commission also is issuing a statement that it is considering
clarifying the primary business test under sections 3(b)(1) and (2) of
the Act with respect to HMOs (see Commission Statement infra ).
---------------------------------------------------------------------------
\1\ On September 23, 2004, a temporary order was issued pursuant
to section 3(b)(2) of the Act exempting applicants from all the
provisions of the Act until the Commission takes final action on the
application or until November 22, 2004, if earlier. Investment
Company Act Release No. 26618 (September 23, 2004). Applicants also
received temporary orders on May 28, 2003 (Investment Company Act
Release No. 26060), September 29, 2003 (Investment Company Act
Release No. 26194), January 23, 2004 (Investment Company Act Release
No. 26339), and May 21, 2004 (Investment Company Act Release No.
26449).
Filing Dates: The application was filed on March 31, 2003, and amended
on May 23, 2003, September 15, 2003, January 21, 2004, May 17, 2004,
---------------------------------------------------------------------------
August 18, 2004, September 9, 2004 and September 22, 2004.
Hearing or Notification of Hearing: An order granting the requested
relief will be issued unless the Commission orders a hearing.
Interested persons may request a hearing by writing to the Commission's
Secretary and serving applicants with a copy of the request, personally
or by mail. Hearing requests should be received by the Commission by
5:30 p.m. on November 19, 2004, and should be accompanied by proof of
service on applicants, in the form of an affidavit or, for lawyers, a
certificate of service. Hearing requests should state the nature of the
writer's interest, the reason for the request, and the issues
contested. Persons who wish to be notified of a hearing may request
notification by writing to the Commission's Secretary.
ADDRESSES: Secretary, Securities and Exchange Commission, 450 Fifth
Street, NW., Washington, DC, 20549-0609. Applicants, c/o Barbara L.
Borden, Esq. and Frederick T. Muto, Esq., Cooley Godward LLP, 4401
Eastgate Mall, San Diego, CA 92121.
FOR FURTHER INFORMATION CONTACT: Marc R. Ponchione, Senior Counsel, at
(202) 942-7927, or Janet M. Grossnickle, Branch Chief, at (202) 942-
0564 (Division of Investment Management, Office of Investment Company
Regulation).
SUPPLEMENTARY INFORMATION: The following is a summary of the
application. The complete application may be obtained for a fee at the
Commission's Public Reference Branch, 450 Fifth Street, NW.,
Washington, DC, 20549-0102 (tel. 202-942-8090).
Applicants' Representations
1. Each of the PacifiCare HMOs is a wholly-owned subsidiary of
PacifiCare Health Plan Administrators, Inc. (``PHPA''), an Indiana
corporation formed in 1981. PHPA is a direct wholly-owned subsidiary of
PacifiCare Health Systems, Inc. (``PacifiCare''), a Delaware
corporation formed in 1996.\2\ PacifiCare offers managed care and other
health insurance products through the PacifiCare HMOs and its other
subsidiaries to employer groups and Medicare beneficiaries in the
United States and Guam. Each of the PacifiCare HMOs operates managed
care plans that develop health care provider networks by entering into
contracts with hospitals, physicians and other health care
professionals to deliver health care cost-effectively. Each of the
PacifiCare HMOs' managed care plans generally provides or arranges for
the provision of health care services to subscribers or enrollees, or
pays for or reimburses part of the cost for those services, in return
for a prepaid or periodic charge paid by or on behalf of the
subscribers or enrollees. Applicants state that the PacifiCare HMOs
serve approximately 3.0 million HMO members.
---------------------------------------------------------------------------
\2\ PacifiCare was the successor to a California corporation
formed in 1983 that was reincorporated as a Delaware corporation in
1985.
---------------------------------------------------------------------------
2. Applicants state that each of the PacifiCare HMOs maintains a
large portfolio of marketable securities and a cash position as part of
its management of its primary health care operations. Applicants state
that the PacifiCare HMOs historically have contracted with hospitals
and physicians on a prepaid, capitated fixed-fee per member per-month
basis, regardless of the services provided to each member, but have
recently experienced a shift to ``risk-retention contracts'' under
which they now bear a substantial amount of the direct risk that health
care costs of the subscribers or enrollees of their health care
products will differ from the prepaid or periodic charges paid by or on
behalf of such (``underwriting risk''). Under the risk-retention
contracts model, each PacifiCare HMO maintains a larger investment
portfolio primarily because each PacifiCare HMO assumes underwriting
risk that its per patient member costs may exceed its per member
premiums that it sets in advance each year. Applicants state that each
of the PacifiCare HMOs also maintains its portfolio to satisfy state
regulatory net worth requirements.
3. Applicants state that the PacifiCare HMOs' profitability
declined recently because of health care cost inflation, a lack of
corresponding increases in Medicare reimbursement rates and because
they did not fully anticipate the shift to risk-retention contracts in
recent years when they made pricing and underwriting decisions for
their products. At times during recent years, this decreased
profitability caused a reduction in income from operations and an
increased percentage of income attributable to the investment
portfolios of the PacifiCare HMOs.
4. Applicants state that each of the PacifiCare HMOs is licensed as
a HMO or similar entity in the state in which it operates and is
regulated by the insurance commissioner or similar official of that
state.\3\ Applicants also state that the PacifiCare HMOs are required
by law, regulation and governmental policy to meet minimum statutory
net worth requirements that generally mandate a diverse portfolio and
prohibit exclusive investment in government securities. Applicants
further state that each PacifiCare HMO must file financial information
and annual reports with state regulators and is subject to audits and/
or examination by state regulatory agencies on a regular basis.
---------------------------------------------------------------------------
\3\ PacifiCare of California, PacifiCare of Colorado, Inc.,
PacifiCare of Nevada, Inc., and PacifiCare of Texas, Inc. are
licensed as HMOs. PacifiCare of Arizona, Inc. and PacifiCare of
Washington, Inc. are licensed as health care services organizations.
PacifiCare of Oregon, Inc. is licensed as a health care service
plan.
---------------------------------------------------------------------------
Applicants' Legal Analysis
1. Section 3(a)(1)(A) of the Act defines the term ``investment
company'' to include an issuer that is or holds itself out as being
engaged primarily, or proposes to engage primarily, in the business of
investing, reinvesting or trading in securities. Section 3(a)(1)(C) of
the Act further defines an investment company as an issuer that is
engaged or proposes to engage in the business of investing,
reinvesting, owning, holding or trading in securities, and owns or
proposes to acquire investment securities having a value in excess of
40 percent of the value of the issuer's total
[[Page 63415]]
assets (exclusive of government securities and cash items) on an
unconsolidated basis. Under section 3(a)(2) of the Act, investment
securities include all securities except U.S. Government securities,
securities issued by employees' securities companies, and securities
issued by majority-owned subsidiaries of the owner which (a) are not
investment companies, and (b) are not relying on the exclusions from
the definitions of investment company in section 3(c)(1) or 3(c)(7) of
the Act.
2. Applicants state that none of the PacifiCare HMOs has ever held
itself out as an investment company and that none of the PacifiCare
HMOs believes that it is an investment company as defined in section
3(a)(1)(A) of the Act. Applicants state that more than 40 percent of
the total unconsolidated assets of each of PacifiCare of Arizona, Inc.,
PacifiCare of Colorado, Inc., PacifiCare of Oregon, Inc., PacifiCare of
Nevada, Inc., PacifiCare of Texas, Inc., and PacifiCare of Washington,
Inc. consist of investment securities as defined in section 3(a)(2).
Accordingly, each of these PacifiCare HMOs may be deemed an investment
company within the meaning of section 3(a)(1)(C) of the Act.\4\
---------------------------------------------------------------------------
\4\ Applicants state that PacifiCare of California does not
currently meet the definition of an investment company under section
3(a)(1)(C). Applicants further state that PacifiCare of California
also needs to maintain a substantial investment portfolio.
Applicants assert that if any adverse development results in any
asset impairments, goodwill impairments or other reduction in
PacifiCare of California's total assets, its investment securities
as a percentage of its total assets could exceed 40 percent.
Applicants also state that the operating results of PacifiCare of
California during the past four fiscal quarters have fluctuated
widely. Applicants believe that it is more cost-effective for
PacifiCare of California to seek an order in conjunction with the
other PacifiCare HMOs.
---------------------------------------------------------------------------
3. Rule 3a-1 provides an exemption from the definition of
investment company if no more than 45 percent of a company's total
assets consist of, and not more than 45 percent of its net income over
the last four quarters is derived from, securities other than
Government securities and securities of majority-owned subsidiaries and
companies primarily controlled by it. Applicants state that none of the
PacifiCare HMOs currently are able to rely on rule 3a-1 because
investment securities comprise a large percentage of their total
assets. In recent years, some of the PacifiCare HMOs also would not
have been able to rely on rule 3a-1 because of operating losses.
4. Section 3(b)(2) of the Act provides that, notwithstanding
section 3(a)(1)(C), the Commission may issue an order declaring an
issuer to be primarily engaged in a business other than that of
investing, reinvesting, owning, holding or trading in securities
directly, through majority-owned subsidiaries, or controlled companies
conducting similar types of businesses. Applicants request orders under
section 3(b)(2) of the Act declaring that each of the PacifiCare HMOs
is primarily engaged in a business other than that of investing,
reinvesting, owning, holding or trading in securities, and therefore is
not an investment company as defined in the Act. Applicants submit that
each of the PacifiCare HMOs meets the requirements of section 3(b)(2)
because it is primarily engaged in the health care service business,
and not in the business of investing, reinvesting, owning, holding or
trading in securities, and its business operations are analogous to
those of insurance companies.
5. In determining whether an issuer is ``primarily engaged'' in a
non-investment company business under section 3(b)(2), the Commission
considers the following factors: (a) the company's historical
development, (b) its public representations of policy, (c) the
activities of its officers and directors, (d) the nature of its present
assets (the ``Asset Factor''), and (e) the sources of its present
income (the ``Income Factor'').\5\
---------------------------------------------------------------------------
\5\ Tonopah Mining Company of Nevada, 26 SEC 426, 427 (1947)
(``Tonopah'').
---------------------------------------------------------------------------
a. Historical Development
Applicants state that each PacifiCare HMO was formed for the
purpose of providing health care services and that each has provided
such services since inception. Applicants also state that each of the
PacifiCare HMOs has engaged in the pursuit of providing health care
services to the exclusion of other activities and that each intends to
continue to engage in the business of providing health care services.
b. Public Representations of Policy
Applicants state that PacifiCare's periodic reports describing the
business of the PacifiCare HMOs focus on improving net income from
health care services operations and have never emphasized the
possibility of significant appreciation from investment securities as a
material factor in PacifiCare's or the PacifiCare HMOs' future growth.
Applicants also state that the PacifiCare HMOs have never held
themselves out as investment companies within the meaning of the Act
and are unaware of any public representations that would indicate that
any of the PacifiCare HMOs are in any business other than the health
care services business. Applicants assert that press releases issued by
PacifiCare and the PacifiCare HMOs concern events regarding the
PacifiCare HMOs' operations and the development of new products and
services and that public statements by PacifiCare and the PacifiCare
HMOs emphasize PacifiCare's mission to create long-term stockholder
value as a leading health and consumer services company.
c. Activities of Officers and Directors
Applicants state that members of the boards of directors and the
officers of each of the PacifiCare HMOs generally have extensive
experience in the management and oversight of health care services
provider organizations and focus almost exclusively on the management
of their respective managed care plans and the further development of
their respective health care provider networks. Applicants also state
that other than adopting an investment policy and receiving periodic
reports, the PacifiCare HMOs' officers and directors have minimal
involvement with their respective PacifiCare HMO's investment
securities and typically spend substantially all of their time on
operating activities. Applicants further state that only the CFO and/or
treasurer or assistant treasurer of each of the PacifiCare HMOs spends
any time on cash and securities management. Applicants represent that
management of PacifiCare's investments involves the equivalent of nine
full-time employees, or 0.1% of a total of approximately 8,000
PacifiCare employees. Applicants state that the other employees of the
PacifiCare HMOs are involved in activities in connection with the day-
to-day operations and support of a health care services provider
organization, including provider and hospital contract management,
claims processing, medical bills review, member enrollment, accounting,
customer services, data entry and other activities.
d. Nature of Assets
Applicants state that each of the PacifiCare HMO's operations as a
health services company do not require substantial investments in
property, plant, equipment or other tangible assets. Further, each of
the PacifiCare HMOs maintains a large investment securities position
because of statutory net worth or regulatory capital requirements, the
need to manage the risk that the health care costs it underwrites will
exceed premiums, and working capital requirements. Excluding PacifiCare
of California, more than 40 percent of each of the PacifiCare HMO's
unconsolidated assets consist of investment securities and, in some
[[Page 63416]]
cases, investment securities constitute a large majority of total
unconsolidated assets. Each PacifiCare HMO has adopted an investment
policy that is designed to result in (1) each PacifiCare HMO holding
predominantly high quality instruments; (2) capital preservation; (3)
maintenance of sufficient liquidity to meet operating cash
requirements; (4) outperforming certain benchmarks; (5) centralizing
fiduciary control of all investment securities; and (6) adhering to
state and federal regulations. None of the PacifiCare HMOs invests or
trades in securities for short-term speculative purposes.
e. Sources of Income
Applicants state that each of the PacifiCare HMO's income from
operations fluctuated widely during the past several years due to the
greater than expected increase in risk-retention contracts and
unanticipated health care cost increases. Applicants state that less
than 45% of each PacifiCare HMO's total income for the last four fiscal
quarters combined was derived from investment securities. For the four
fiscal quarters ending on December 2002, however, most of the
PacifiCare HMOs recorded a net operating loss. Applicants state that
net investment income will continue to comprise a significant portion
of the PacifiCare HMOs' income as they adapt to the changing health
services market and because they use their investment securities to
manage the risks they underwrite. Applicants believe that their sources
of revenue are more representative of their activities as operating
companies than their sources of income. Applicants assert that each of
the PacifiCare HMO's income from investments constitutes only a small
portion of each PacifiCare HMO's gross revenue. Applicants state that
for each PacifiCare HMO, revenues from health care operations represent
approximately 99 percent of each PacifiCare HMO's gross revenue, while
revenues from investments constitute the remaining one percent. Each of
the PacifiCare HMOs expects that in the future the percentage of its
total revenue derived from health care operations will continue to be
substantial and the percentage of its revenue from investments will
continue to be minimal.
6. Section 3(c)(3) of the Act excludes insurance companies from the
definition of investment company. Applicants believe, however, that
none of the PacifiCare HMOs would be considered an insurance company
within the meaning of the Act because none of the PacifiCare HMOs is
organized as a traditional indemnity insurance company and the
PacifiCare HMOs primarily offer HMO products that are not regulated as
insurance products under state insurance laws. Applicants submit that
managed care companies, which developed after enactment of the Act and
far more recently than insurance companies, are subject to similar
regulatory schemes. Applicants believe that each of the PacifiCare
HMO's operations and use of investment portfolio are substantially
analogous to those of insurance companies. Applicants state that,
similar to insurance companies, the PacifiCare HMOs manage the
underwriting risk of excess health care costs in part through returns
in their investment portfolios, are regulated under state law, and are
required to maintain statutory net worth and comply with state
investment regulations.
7. The PacifiCare HMOs thus assert that they qualify for an order
under section 3(b)(2) of the Act.
Section 45(a) of the Act
1. Section 45(a) provides that information contained in any
application filed with the Commission under the Act shall be made
available to the public, unless the Commission finds that public
disclosure is neither necessary nor appropriate in the public interest
or for the protection of investors. Each of the PacifiCare HMOs
requests an order under section 45(a) of the Act granting confidential
treatment to information submitted in Appendix 7 to the application
containing financial and other information about the PacifiCare HMOs,
PacifiCare and PHPA.
2. The PacifiCare HMOs submit that the information disclosed in the
application is sufficient to fully apprise any interested member of the
public of the basis for the requested relief. Applicants state that
from the presentation in the Application, the public can see the
general nature of certain of the PacifiCare HMO's assets.
3. Applicants believe that public disclosure of certain financial
and other information about the PacifiCare HMOs, PacifiCare and PHPA
would cause the PacifiCare HMOs and PacifiCare competitive harm.
Applicants state that they do not normally disclose specific financial
information about the PacifiCare HMOs, the precise make-up of their
consolidated investment portfolios and their internal investment
policies. Applicants also state that their competitors would benefit
from access to such information and neither PacifiCare nor the
PacifiCare HMOs has access to similar information about its
competitors. Applicants further state that disclosure of certain
financial information regarding the PacifiCare HMOs may confuse
investors because the limited publicly available financial information
concerning the PacifiCare HMOs is prepared for the purpose of complying
with state regulations and in some cases is not calculated in
accordance with GAAP, and therefore it may be different than the
financial information set forth in the application. For these reasons,
applicants believe that public disclosure of the information in
Appendix 7 is neither necessary nor appropriate in the public interest
or for the protection of investors.
4. The Freedom of Information Act generally provides that all
information provided to or generated by the government should be made
available to the general public, with certain exceptions set forth in
the statute. One of those exceptions is for ``trade secrets and
commercial or financial information obtained from a person and
privileged or confidential.'' Each of the PacifiCare HMOs believes that
the information with respect to which applicants request confidential
treatment falls within the exception described, and is thus eligible
for protection under the Freedom of Information Act.\6\
---------------------------------------------------------------------------
\6\ Applicants understand that any relief granted pursuant to
section 45(a) will not be dispositive in connection with any request
the Commission might receive pursuant to the Freedom of Information
Act.
---------------------------------------------------------------------------
Commission Statement
It does not appear that the circumstances that have led the
PacifiCare HMOs to seek orders pursuant to section 3(b)(2) of the Act
are unique. The Commission thus is considering clarifying the primary
business test under sections 3(b)(1) and 3(b)(2) of the Act with
respect to HMOs in the context of the order that would be issued to the
PacifiCare HMOs.\7\ In place of the Asset Factor, the Commission is
focusing on an HMO's bearing a substantial amount of underwriting risk,
using its investment securities consistent with its business, and being
licensed and supervised by a state. In connection with the Income
Factor, the Commission is focusing on clarifying that an HMO may
consider the sources of its present revenue so long as it derives
substantially all of its total revenues from the health care
operations.
---------------------------------------------------------------------------
\7\ See, e.g., ICOS Corp., Investment Company Act Release No.
19334 (Mar. 16, 1993).
[[Page 63417]]
---------------------------------------------------------------------------
By the Commission.
Jill M. Peterson,
Assistant Secretary.
[FR Doc. E4-2918 Filed 10-29-04; 8:45 am]
BILLING CODE 8010-01-P