Business Plan: Molina Healthcare - Claims System Replacement

Arend Pryor

Dec 20, 202115 min read

Updated: Jan 3, 2022

Author: Arend Pryor | Created: 08/20/2021

Details: Sharing content created as part of pursuing my MBA degree

Assignment:

Prepare a financial plan for the company you selected for your business plan (in OPSCB/574 and MGTCB/574). This financial plan will be included in your final business plan in your capstone course, STRCB/581.
Review the company you chose to work with for your business plan that you will complete for your Integrative Business Capstone.
Describe the business, including the type of business.
Create the business case:
- Determine why funding is needed for the company.
- Determine the sources of funding. Consider self-funding, borrowing, equity, venture capital, and so on.
- Evaluate the requirements of each funding source you determined appropriate.
- Analyze the associated risks of each funding source.
- Decide which sources are the best fit for your company based on the requirements of each. Justify your decision.
- Estimate the cost of capital for both short-term and long-term funding sources. Research current estimated APRs for your selected sources of funding. Consider creating a table or chart to display this information.
Create a profit-and-loss statement for a 3-year period. Project revenue. State any realistic assumptions, such as growth per year, in your projections.
Estimate direct costs, including capital, marketing, labor, and supply costs

EXECUTIVE SUMMARY

Molina Healthcare, Inc. has continued to grow over the years thanks to carefully thought out strategic plans, valuing our employees, and in providing our Members with extraordinary customer service. One of the risks we currently face is in the continued use of our outdated claims processing system. This application is the source of ongoing projects aimed at resolving inefficiencies, production issues, and in the automation of duplicate efforts and manual processes. After much time spent researching several claims system application options, the company has identified a clear choice that offers a wealth of benefits over our current system such as increased functionality, out of the box automation, and features that meet many of the regulatory guidelines set forth by the healthcare industry. Once implemented, the use of this system will not only save the company money due to increased productivity and more efficient processes, but will free up a large percentage of resources presently dedicated to the preservation of the current system. This document lays out additional details behind the issues currently being faced, information regarding the direct costs associated with the project, a list of our funding options with current loan rates, calculations showing the cost of capital, and three years of projected profit and loss data for the company. This information is being provided here to help our stakeholders decide on the company’s course of action.

COMPANY OVERVIEW

The Molina Healthcare Company started in 1980 as a result of an emergency room physician name David Molina, who set out to provide general health care services to low income families in Long Beach California. It started with a small number of primary care clinics and grew into a health plan offering managed care in three states with over 250,000 members as of the year 2000. Over the next six years, the company grew to serve one million members after their first initial public offering and moving into the states of New Mexico and Texas. Today, Molina Healthcare, Inc. is a fortune 500 company serving over 4.6 million Medicade and Medicare members via their managed health care services in 18 states (Molina Healthcare, 2021a). As of the 2020 annual report, the company had revenues of over $18 million dollars and is considered to be a large cap stock with a market cap of 16.3 billion (Molina Healthcare, 2020).

ABOUT THE PROJECT

While Molina Healthcare has grown considerably since their inception in 1980, several of our backend systems have become outdated resulting in increased costs associated with ongoing maintenance, upgrades, and expensive software development projects. The company has recently completed a review of several software application packages aimed at the replacement of our claims processing system and has settled on what we feel is the most advantageous choice for the company. This system offers increased functionality, plenty of out of the box automation, scalability for the future, and seamless integration with other software systems currently being used throughout the organization. Aside from the frequent projects aimed at retrofitting our current software application, the aging technology being used will require investing in new hardware within the next five years in order to move to the latest software release offered by the vendor. Based on a recent review, the funding required to purchase and implement this software application has been estimated to be $400,000. From a high-level, this amount will cover the cost of the software application, procurement of new hardware, and the hiring of a consulting company to aid with the installation lifecycle. While researching, it was also found that during projects such as this, it is important to over-budget to account for unforeseen expenses by at least 150%. This will allow us to be better prepared financially, should the need arise, rather than being caught unprepared resulting in delays to the project, while additional funding is secured (Markovic, 2021). At the completion of the project, any unused funds can be returned to their source.

BREAKDOWN OF DIRECT COSTS

The table below includes a detailed outline of the costs associated with the claims system project. The following is also a high-lever overview of these costs. Starting with General and Administrative costs, we see that software and hardware make up one of the largest portions of the cost at $272,000. This project will also require the purchase of a three year maintenance contract for general care of the system and the cost to host the application via the cloud, which adds additional layers of security and redundancy as this system would be located offsite from our headquarters. Next is the detailed cost of labor for the project, which will require a large investment of time from an external consulting agency. While the overall cost of hiring a consulting agency may seem high at $105,900, the benefits come in the form of the expertise we will receive from those who specialize in these types of projects and a savings of time for our business users who will not have to invest as much of their day-to-day on general project related activities. Lastly we come to the “Other” expenses section which includes two very important line items. The first is to cover the cost of the production launch to thank everyone for all of their hard work and to celebrate our success after the long haul this project has in store for on the road ahead. The final line item is an expense that was briefly mentioned in the project overview section on the prior page. The “Additionally Budgeted Amount” of $200,000 can be thought of as a safety net which represents over budgeting by 150% and will be available to cover unforeseen expenses. Planning ahead will help mitigate these types of issues, which can ultimate lead to costly delays.

FUNDING OPTIONS

Being that Molina Healthcare is an established company that’s been in business for over 30 years, there are two sources of funding that make sense for this project, long-term funding or self-funding. Pursuing a venture capital (VC) firm to request their financial backing would not seem wise for our company as some of the most common terms associated with funding deals such as these would not be a good match. This includes granting a VC firm a stake in the company that differs from those who purchase common stock as well as the possibility of requiring their input on company decisions. While one of the benefits of this relationship could be in the form of shared knowledge and expertise, our plan is to hire consultants for this project, which will help fill this gap. For each of the two funding options mentioned, included below are details for each, requirements to obtain this type of funding, perceived benefits, and their associated risks. Following this information will be the funding option recommended to be pursued.

Option 1: Long-Term Funding

Details: Long-term funding is considered a debt obligation where companies take out loans that allow for a repayment period of typically 5 years or more. These loans allow an organization to borrow lump sums of cash aimed at growth via the purchase of assets, company acquisitions, or even the consolidation of debt (Nicastro, 2021).
Requirements: In order to qualify for bank or government offered loans, our company would need to meet specific requirements. This can include, but is not limited to, being in business for at least two years, having favorable financials, excellent credit, and in some cases offering collateral to secure the loan.
Benefits: Benefits of this type of funding can include alignment of capital structure with organizational goals, a repayment duration that matches with the life cycle of the purchased asset(s), and mitigation of interest rate related risks as most lenders offer these loans with a fixed rate (The Benefits of Long-Term vs. Short-Term Financing, 2021).
Risks: When companies take on debt, one of the risks they can run into is in the limiting of cash-flow available on a monthly basis due to existing debt repayment obligations. This limitation can also impact money available to spend on additional investments, direct costs, or other potential growth opportunities. For companies that secure financing via collateral in order to obtain a favorable interest rate, the asset tied to this transaction is at risk of being forfeited if the company fails to repay the loan (The Benefits of Long-Term vs. Short-Term Financing, 2021).

Option 2: Self-Funding

Details: For companies who generate enough revenues to earn a decent size profit, self-funding can be explored as an option for covering the direct costs of their projects. Much like long-term financing, this type of funding can also be used to grow the business via the purchase of new assets, dividend payments, or even expanding the workforce (Investopedia Team, 2020).
Requirements: A company’s ability to self-fund will depend on the financial requirements of the project and whether the organization has the liquidity/cash to allocate the required amount. Meaning, if the company was to invest the cash required, would they still have the ability to meet their current debt and liability obligations and continue to generate profits (Investopedia Team, 2020).
Benefits: Companies who opt to self-fund their projects or investments retain much more financial control over how their money is spent and enjoy the increased flexibility, should the need arise to make changes in purchasing decisions. This type of funding also eliminates the need to take on additional debt and avoids the necessity of putting up collateral to secure funding (Chron Contributor, 2020).
Risks: The process of raising funds can be lengthy and during this time can limit a company’s ability to invest in other opportunities and even take away funds from regular operations (Chron Contributor, 2020). Another downside of this option is that it does not allow the opportunity to build up the company’s credit score via making on-time payments on a loan.

Recommendation:

Given the details laid out above for the two funding options available for this project, the recommendation is to utilize long-term financing. The benefits associated with long-term financing are a good match for the company, specifically having a longer repayment option that closely matches with the extended lifecycle of the software and hardware for this project. The company has also been in business for over 30 years and as of 2020, has $9.5 million in total annual assets, both of which show the company as less of a risk and should contribute to qualifying for a favorable fixed interest rate (Molina Healthcare Total Assets 2006–2021 | MOH, 2021). Additionally, while a lower debt-to-equity ratio would be more advantageous as part of qualifying for a loan, as of June 2021, Molina Healthcare’s ratio was 3.44%, which is slightly more than double than that of a few of our competitors. That said, our total revenues for year-end 2020 were $19.5 billion, an increase of 15% from the year before and revenues forecasted for year-end 2021 are projected to hit $25 billion, an increase of 22% (Molina Healthcare, 2021b). This points to the continued growth and stability of the company, which should have a positive impact on decisions related to the terms offered on a long-term loan (Investors - Molina Healthcare, 2021).

Bank/SBA Loan Details:

The chart below includes a comparison of terms and requirements for long-term bank and Small Business Administration (SBA) loans. SBA 7(a) and 504 loans can be an attractive option for businesses as the rates and terms are very competitive, however, the process to obtain these loans can be lengthy (Lantern, 2021). If the company decides to go this route, starting the submission process early would be necessary.

COST OF CAPITAL (WACC)

Companies calculate their Weighted-Average Cost of Capital (WACC) in order to determine their expected rate of return based on the debt and equity securities issued by the organization (Brealey et al., 2019). The formulas and data used to calculate the WACC for Molina Healthcare, as well as the results, can be found via the screenshot below. An explanation of how this data was obtained and derived is also discussed in the paragraph below. This includes citations for all sources used to obtain the data for these calculations.

In order to calculate the WACC for Molina Healthcare, values for outstanding debt (D = $2.127 million) and equity (E = $2.096 million) were first obtained from the 2020 annual report and then summed to get the total capitalization of $4.223 million (Molina Healthcare, 2020). Also important to note, was that the $600,000 estimated as needed for the claims system upgrade project and obtained via long-term financing, would be added to the total outstanding debt and subsequently the total capitalization so as to be factored into the final result. Being less than one million, this amount is not seen in the calculations.

Next, the value for “expected return on equity” (r equity) was calculated via a formula using the risk free interest rate (rf = 4.63%), the market risk premium (rm = 6.05%) and the beta for Molina Healthcare of 0.71 (Yahoo Finance, 2021), giving us an “r equity” of 5.64%. Diving a little deeper into the calculations that contributed to the “r equity” result, the formula used to calculate the risk free interest rate (rf) of 4.63% involved subtracting the current inflation rate of 5.4% (US Inflation Calculator, 2021) from the treasury bond yield of 0.77% (5 Year Treasury Rate, 2021), which matched with our assumption of a five year project duration. Next, the market risk premium (rm) was calculated to be 6.05%, based on subtracting the expected market return rate, which was based on a 10 year average return rate of the Dow Jones Industrial Average (DJIA) of 10.68% (Cothern, 2021), from the risk free interest rate of 4.63% that we previously calculated above (Boyte-White, 2020).

Debtholders’ required rate of return (r debt), was then obtained from an external source and was found to be 5.34% (Molina Healthcare WACC %, 2021).

Lastly, the company’s corporate tax rate of 30% (aka effective interest rate) was obtained from the 2020 annual report (Molina Healthcare, 2020). Using the WACC formula and the values mentioned above, this resulted in a calculation of 4.68%. As a comparison, the WACC calculated for Molina Healthcare found via researching the web, was shown to be 4.96%, which is not far off.

It is also important to note that some of the calculations used from the online resource differed from those mentioned above. For example, an “r equity” of 5.09% was used as well as a corporate tax rate of 27.08% (Molina Healthcare WACC %, 2021). Differences aside, the result tells us that based on the outstanding debt and equity securities issued by the company, investors expect a return equal to the weighted average of 4.68%. As a side note, one interesting observation about the values used in this calculation are in the similarities when comparing one to the other. Examples include the amounts for outstanding debt versus equity, which are almost balanced, as well as a comparison of the required or expected rates of return for debt versus equity. In both cases, the values are relatively similar, which not surprisingly gives us a final value that is not far off from the debt and equity percentages used in the formula.

CURRENT AND PROJECTED PROFIT AND LOSS

The table below shows current and projected profit and loss data for Molina Healthcare in an effort to show past performance versus future predictions. Current information includes 2018 through 2020 and was used as the basis for creating projected revenues as well as expenses that include direct costs such as those for medical care, labor, general and administrative and marketing for years 2021 through 2024. Additional details on the specifics of these calculations follow the table.

(a): Labor costs were estimated to be 40% of Total Revenue and subtracted from the expense, “Medical Care Costs,” in order to provide visibility into values forecasted for 2021, 2022, 2023, and 2024

(b): Marketing was estimated to be 5% of Total Revenue and subtracted from the expense, “General and Administrative” to provide visibility into values forecasted for 2021, 2022, 2023, and 2024

(c): Although not shown due to the data above being in the millions, the $600,000 being proposed for the claims system upgrade project was included as part of the estimated expenses for “General and Administrative” and “Labor” expenses for 2021.

Revenue: Beginning with revenue in 2021, data for the second quarter had been posted as of the creation date of this business plan and is based on these figures. The company is projecting $25 billion in revenue by end of year (Molina Healthcare, 2021b). Revenue for 2022 is projected to increase by a rate of 22%, however, with a lack of projections available for 2023 and 2024, an increase of 13% was used to forecast revenue for these years, which is based on historical performance (Pendergraft, 2021). Using these revenues as the starting point for our remaining calculations, the amount calculated for “Premium Tax Revenue” was based on a rate of 3.9%, giving us $975 million for 2021. Premium tax revenue increases have been seen in the past years and have been a result of increases in taxes assessed by the states in which the company operates. A rate of 4% of revenue was used for 2022 to estimate this value. Going forward, an increase of 0.05% was added to the previous rate leading to 4.5% for 2023 and 5% for 2024. A similar approach was used to forecast values for “Other Revenues,” leading to a rate of 5.6% of total revenue for the projected years.

Expenses:

“Medical Care Costs” make up the largest expense the company incurs as part of doing business and includes operations conducted for the areas of fee-for-service, pharmacy, and capitation. Based on historical data, this expense accounts for an average cost of 80% of total revenue. The annual increase was found to be roughly 0.5%, which was used to forecast this expense for the forecasted periods (Molina Healthcare, 2020). One important caveat, is that this expense includes the direct cost of “Labor,” however, it is displayed as one amount. Without knowing the exact cost of labor, research was performed to conclude an assumption that “Labor” would account for 40% of Molina’s total revenue, giving us a value for 2021 of $10,000, which is based on total revenue of $25 billion for the year (Adkins, 2019). This amount was then subtracted from the total expense of “Medical Care Costs” for this 2021 and the process repeated for the years forecasted.

A similar approach was used to calculate the direct cost of marketing as the assumption was that it is rolled into “General and Administrative” expenses. With some companies spending an average of 5 – 12% of their total revenues on Marketing, the low end of five percent was selected for this forecast giving us a value of $1,250 for 2021 and again, this process was repeated to forecast results for the future (Leone, 2020). This amount was then subtracted from the total for “General and Administrative” expenses in order to be represented separately.

Based on past data, the rates used to calculate “Premium Tax Expense” and “Health Insurer Fees” were held constant at 3.3% and 1.6% respectively for forecasted data. Forecasting an expense for “Depreciation and Amortization” was based on past values, which led to keeping it a constant value of $99 as this did not appear to be an expense that would fluctuate based on changes in total revenue.

The values posted for “Other Expenses” are made up of losses or gains associated with debt repayments of long-term loans as well as interest expenses. Based on limited information showing increases in the past, the decision was to increase this value by 10% each year in order to provide forecasted data. Values shown as “Total Operating Expenses” are the sum of all expenses shown, with “Operating Income” being the difference between total revenue and total operating expenses.

With limited knowledge of “Total Other Expenses,” this value was kept constant at $110 million, which was slightly higher than the average taken for the historical values between 2018 and 2020. “Income Before Taxes” was based on the difference between “Operating Income” and “Total Other Expenses,” which was then used to calculate the company’s “Income Tax Expense.” With the current corporate tax rate being lowered to 21%, this value was used to calculate the forecasted tax amounts for 2022 through 2024, however, it is important to note that this rate may change in the future (Kagan, 2021).