Regulatory Blues Squabble Over Financial Condition

Twenty minutes.

In just 20 minutes -- less than the length of a long coffee break -- legislators in Annapolis had heard enough from the state's top insurance regulator regarding his disturbing concerns about the state's top health insurer.


Blue Cross and Blue Shield of Maryland executives spent four and a half hours explaining the company's position. John A. Donaho, Maryland's Insurance Commissioner, then spent less than 20 minutes, including the time it took to answer questions.

The gathering, held before the House Economic Matters Committee, had been billed by Del. Casper R. Taylor Jr., who chairs the committee, as an opportunity to separate "fact from fiction" in the aftermath of Mr. Donaho's surprising testimony earlier in the month before a U.S. Senate subcommittee.


What it turned out to be was a missed opportunity.

Mr. Taylor had scheduled the hearing just days after Mr. Donaho testified in Washington that the Blue Cross and Blue Shield plan in Maryland was "barely solvent," displayed poor management and set up money-losing subsidiaries outside his regulatory purview. The General Assembly would be given an opportunity to examine the issues.

And for good reason. Roughly 1.4 million Marylanders depend on the Blues for insurance. The argument over the company's financial condition, its corporate structure and its management is more than a squabble between a well-paid corporate chairman and a frustrated bureaucrat. The answer to these questions affect what kind and how much health care these people receive.

Given the high cost of health care, the thousands of people in Maryland who cannot afford it and the importance of Blue Cross in shaping the kind of care state residents receive, one might have expected a committee eager to pepper Mr. Donaho with questions for hours -- if not days.

What's behind his concerns? What troubles him so much that he would be willing to create such a furor? Where are the specifics to back up his comments? What does he think should be done? What help does he want? And what help does Blue Cross need?

The dispute between the two sides -- regulators and the $H company -- is to be expected. Regulators want information and unimpeded access to a company's files. For the most part, it has that right under Maryland law.

Blue Cross wants to be left alone to run its business the way it wants, which, presumably, is part of corporate nature.

But beyond the clash of personalities, though that figures in, the disagreement between Mr. Donaho and Blue Cross chairman Carl J. Sardegna essentially stems from a difference of opinion about the direction and objectives of Blue Cross.


Is it just another big insurer that wants to compete with other insurance companies on equal footing?

Or does its size and non-profit status and special role in Maryland mean it demands intense scrutiny from state regulators?

Created under a 1937 law as the Associated Hospital Service of Baltimore, what is now Blue Cross and Blue Shield of Maryland is actually a "non-profit health service plan." It has no owner but is run by a board of directors who vote each other in. What rules it follows are ultimately set by the legislature.

Blue Cross has consistently -- and correctly -- argued that it is hamstrung by its special status. The company says the unique rules governing its operations hurt. Regulators argue that without those special rules, the citizens might be hurt.

But the fact is it is no longer 1937. Then, for 75 cents a month, an individual would be guaranteed medical care at 12 local hospitals. The cost was twice that amount for a husband and wife and $2 a month for a family, regardless of the number of children.

It was simple. All the money went into one big pool and when people got sick, the hospitals were paid from the funds.


While the company continues to offer insurance to all comers, it is a far different world. Now, with the cost of health care skyrocketing, with computer programs tracking medical histories, expenses, premiums and more, and with new and diverse types of insurance dominating much of the marketplace, little about the business is simple anymore.

While still exempt from state premium taxes, the company now pays federal taxes. It also competes against commercial insurers that can raise money through the sale of stock, the issuance of debt or from income earned on ventures not allowed to the Blues.

No longer is insurance even its primary business. Sixty percent of its operations deal essentially with doing the bookkeeping for other companies. For a fee, Blue Cross does the paperwork and the companies pay the medical bills. The HMO business, love it or hate it, is an increasingly large part of the pie. Together with group insurance policies, it accounts for about 25 percent of the whole.

What's left from the old days -- individuals who sign up for insurance for themselves or their families -- accounts for roughly 15 percent of the company's business. It is a piece that is too easily lost and forgotten, too easily mixed into the problems and concerns that plague the company as a whole, and too easily sapped of the importance with which it is imbued by its social purpose.

This new mix of business also clouds the issue of how much money it should keep in reserve to protect against future losses or unexpected claims. If more than half the Blues' customers are companies that pay medical bills for employees and simply use Blue Cross to process claims, why should Blue Cross need the money in reserve to protect these policies?

Blue Cross has tried to convert to a mutual insurance company, owned by its policyholders, but was denied approval by state officials. It is now seeking approval to sell stock in some of its subsidiaries, possibly to the public. In short, the non-profit company is trying to operate as close to a commercial insurer as possible. That might be fine except that when things go bad financially, losses are not paid out of shareholder profits.


One reason Blue Cross has been so anxious to expand into activities beyond basic insurance is to help smooth out a cycle of earnings and losses.

The industry has long explained many of its worst losses -- and justified many of its premium increases -- by reminding the public that its insurance operation has historically and consistently been at the mercy of a three-year cycle: three years of earnings, three years of losses, three years of earnings, three years of losses, etc.

The cycle, the industry explains, occurs primarily because while medical costs continue to rise each day, regulators tend to clamp down on rate increases when a company reaches strong profitability. By the time the level of income begins to shrink and regulators loosen the reins, costs have far outpaced rates and it then takes months before any new rate increases kick in.

Well, the three years of earnings at Maryland's Blue Cross are ending. And where are we?

From the end of 1989 through the first half of this year, the company earned enough to build its reserves, or net worth -- the amount left over after all medical bills and other debts are accounted for -- to nearly $102 million from $16.5 million.

While a hefty increase, it represents less than a month's worth of claims and about half what state regulations deem reasonable.


It would also be barely enough if the company suffers a series of losses like the ones suffered in the previous downturn, during which the company lost more than $100 million. A repeat, and the company could be faced with more debt than assets and in a potential pinch to pay claims.

The threat is real. The Blues plan in West Virginia was recently shut, leaving members scrambling. Others have needed the enactment of emergency legislative measures to keep them afloat.

To cope with the cycle, the Maryland Blues, beginning more than five years ago, created subsidiary after subsidiary to market computer services, sell stock, capitalize on its work for the federal Medicare program, and concentrate more heavily on managed care, which includes its health maintenance organizations.

And with many units falling outside the regulatory sphere, the state became increasingly frustrated in its attempt to monitor the company. Indeed, Mr. Donaho conditioned the company's purchase of the CareFirst HMO on an agreement with Blue Cross that it would finally shut some unregulated affiliates.

(The previous structure, for example, had allowed the company's Columbia and FreeState HMOs to report years of small profits and losses in its filings with regulators. Meanwhile, millions of dollars in losses were being absorbed by a nonregulated affiliate. Indeed, a recently released company document shows the HMOs and affiliates have lost more than $94 million in all.)

No one seems happy with the status quo. There are a number of ideas for dealing with the problems. For example, one proposal is to separate its old-fashioned insurance business from its newer expeditions into financial and computer services. The old-fashioned insurance could be regulated in the old-fashioned way. As to the new ventures, the company could sell stock to the public, pay its executives out of shareholders' profits and go about its business much the way other insurance companies do.


The problem is that such a change would first require that lawmakers have a clear and deep understanding of the structure of health insurance and health care in this state. The fact is that it would require the full attention and much creativity on the part of the legislature. The fiction is that this can be understood after listening to the state's top regulator for less than 20 minutes.