The state's insurance commissioner halted a special examination of Blue Cross and Blue Shield of Maryland in 1988 after regulators found the insurer was insolvent, an action that averted a possible state takeover of the company and gave it time to improve its finances.
In their review, state examiners concluded that the company's reserves had a deficit of $1.2 million, a radically different figure from the $24 million surplus the Blues had reported in their 1987 annual report. The difference resulted mostly from the finding by examiners that the Blues had underestimated by at least $15.7 million the amount of claims they were obligated to pay in the future.
After that and other similar adjustments by state examiners, the Blues' surplus evaporated on paper to a shortfall that was far below the state's legal test for solvency. The company was required to have a minimum of $75,000 on hand, a reserve level among the lowest in the nation.
If the examiners had finished their work and formally found the insurer insolvent, the state would have been obligated under state law to publicly reveal the Blues' problems and take actions including going to court and, possibly, seeking to shut down or take over the company.
Instead, E. Susan Kellogg, then insurance commissioner, took the unusual step of recessing the examination. She did so despite objections from a key division official overseeing the examination, according to internal documents.
"As far as we were concerned it was a very serious situation," recalled Evia J. Christian, the examiner, who retired in the summer of 1991. "If we never put out a report, they [the Blues] never have any reason to do a thing. If somebody doesn't keep pushing the thing, it can be dropped and never handled."
The circumstances surrounding the 1988 examination, as reflected in internal Insurance Division memorandums obtained by The Sun, provide an inside look at the Blues' relationship with state regulators and the company's numerous attempts to improve its financial position in the face of increasing scrutiny from the state, including the inflation of its reserves. They also provide a glimpse of the many steps taken by the company to maintain a strong public image as the "name to trust."
Blue Cross today is reporting higher reserves than at any time since 1987, and it says it is no longer involved in subsidiary businesses that are not profitable. Yet it is still under fire, this time from a new insurance commissioner and a U.S. Senate subcommittee.
The Senate Permanent Subcommittee on Investigations has subpoenaed records from the state Insurance Division, the Blues and, most recently, from William A. Fogle Jr., the state secretary of licensing and regulation, as part of its investigation of fraud and abuse in the insurance industry.
The decision to halt the 1988 examination is the second instance to come to light recently in which state authorities acted to prevent public disclosure of the financial condition or operations of Blue Cross.
In 1990, board members of Blue Cross lobbied the insurance commissioner to prevent an independent examination of the company by the accounting firm Peat, Marwick. The examination had been sought by the current commissioner, John A. Donaho, who said he backed away from awarding the bid after speaking to Gov. William Donald Schaefer and learning that the governor sided with Blue Cross, which preferred to select its own examiner and keep the matter quiet.
The decision to abort the damaging examination occurred in the fall of 1988 -- a year in which state regulators had been closely monitoring the Blues and informing Gov. Schaefer of its precarious financial condition.
At the time, the insurer was beginning to invest millions of dollars in for-profit subsidiaries, some of which engaged in ventures that eventually failed. And, in early 1989, regulators at the Insurance Division reaffirmed their concerns about the company's solvency. They also said that because of a lack of information from the company, they couldn't determine whether the subsidiaries were a "cash drain" on the Blues' finances
"They are utilizing subscriber monies to create, fund and support all lower-tiered entities," Ms. Kellogg wrote in a March 7, 1989, memo to her boss, Mr. Fogle, whose department includes the Insurance Division. She wrote that she was also concerned because "BC/BS is pledging its assets as collateral for lines of credit and loans for its subsidiaries."
Ms. Kellogg outlined her concerns just as the Blues submitted a new annual report for 1988 that contained an inflated reserve level -- the second time state examiners would find the reserve inflated in as many years, the record shows.
Mr. Schaefer had been made aware of the Blues' financial plight by state regulators, officials said, but a spokesman for the governor refused to comment this week on what, if any, involvement the governor had with the events surrounding the 1988 examination.
Mr. Fogle denied this week that he had anything to do with the decision to halt the 1988 examination. Ms. Kellogg, however, said she briefed her boss.
"I know the decision was mine," said Ms. Kellogg, who was insurance commissioner for less than 10 months during 1988 and 1989. "It would have served no purpose to declare them insolvent and throw the entire insurance consumer market into chaos when there was hope. If there had been no hope, then insolvency would clearly have been the answer."
Blue Cross officials said this week that the company undoubtedly would have fought a finding of insolvency in 1988.
"We think the more important story is that we recovered substantially from that," said Peter J. Campisi, vice president and chief financial officer.
Five months after the state examination was halted in October 1988, the Blues were still struggling to show that they were solvent.
In March 1989, Blue Cross filed its annual report for the prior year and asked for a delay in submitting the independent auditor's certified statement, which is required by the state. The report -- -- an independent verification of a company's finances -- was submitted two months later.
Blue Cross officials conceded this week that its former auditor, Ernst & Young, had questions about the amount of medical claims Blue Cross had said it owed. The auditor wanted more time to prove the number, said Gary C. Baker, Blue Cross controller. In time, Blue Cross' number proved correct, he said.
At the same time, Mr. Fogle wanted assurances that Blue Cross was not fudging its books or about to go under. "Should BC/BS be declared insolvent?" the secretary asked in a 14-point memo to Ms. Kellogg dated Feb. 27, 1989.
The answer legally was no, she replied, since state law required an insurance company to have only $75,000 on hand.
But in her response, Ms. Kellogg took issue with $17 million of the $26.5 million the company listed as reserves in its 1988
Blue Cross had accounted for much of the extra money by increasing its valuation of its subsidiaries and building on Joppa Road. Ms. Kellogg said Blue Cross never sought Insurance Division permission to revalue its building or submitted the needed approvals from the National Association of Insurance Commissioners to increase the value of its health maintenance organizations by more than $11 million.
As it turned out, the higher values on the HMOs were not permitted under NAIC rules and were later disallowed.
In her memo, Ms. Kellogg said she expected the company to "break even" in 1989 and show a profit in 1990 based on information provided by Blue Cross. But most of her comments outlined what she called "serious concerns" about the company.
Ms. Kellogg said she planned to begin "a plan of action" to ensure the solvency of the Blues and to require the Blues to provide certified accounting statements on all corporate entities under the Blues umbrella.
That was never done, and the current insurance commissioner, Mr. Donaho, told Congress in July that the lack of such information prevented him from accurately assessing the financial condition of Blue Cross.
He also charged the company was "barely solvent" and displayed poor management.
The aborted state examination, which finally was completed two years ago, covered 1987 and 1988.
In the examination, Blue Cross conceded that it had improperly added $12 million to its 1988 reserve by increasing the value of its HMOs. 1988 was the only time since 1986 that Blue Cross reported an increase in the value of those subsidiaries, according to the company's annual reports.
On June 30 this year, Blue Cross reported reserves of $101 million, up from $16 million in 1989, in part because of a recently revalued subsidiary. This time, Mr. Campisi said, the company followed NAIC rules in determining the higher market price.