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Blues' ventures often went awry Dubious projects hurt customers, regulators say


They call it Division W, but few at Blue Cross and Blue Shiel of Maryland know it exists. In a year and a half, the Blues have spent $12 million on the company president's pet project and have little more than planning documents and reports to show for it.

It is "off track and a muddle," a Blues consultant warns in internal company documents that also characterize Division W -- a project to speed claims processing electronically -- as "too ambitious."

To congressional investigators who questioned the financial stability of Maryland's largest health insurer, Division W is an example of the kind of technology experiment on which Blues management is too willing to spend precious premium dollars. It reflects President Carl J. Sardegna's penchant to explore a brave new world of health care options despite the potential cost to the Blues' 1.4 million customers, they say.

In a lengthy report on the Maryland Blues, the staff of the U.S. Senate Permanent Subcommittee on Investigations scrutinized the 29 Blues subsidiaries. Investigators discovered "a series of management decisions that confused regulators, hid corporate entities and in many cases lost policyholder money," the report says.

Since 1986, the Blues have lost at least $120 million on subsidiaries, which included health maintenance organizations, an arbitrage firm, a collection agency, pharmacies, and the international arm of a claims processing firm.

Along the way, the Blues' internal auditors alerted company officials to a series of questionable business practices at the three ventures aimed at capitalizing on new advances in technology: LifeCard International Inc., Health Line Inc. and Pertek Inc. There were allegations of impropriety and misuse of funds, questionable loans and insider deals. An employee of another subsidiary embezzled $4 million and financed gambling trips to Las Vegas and Atlantic City.

Mr. Sardegna, in recent testimony to the Senate subcommittee, defended the subsidiaries as an extension of the Blues' core business.

He conceded that Blue Cross "probably overestimated the pace and promise of technology" associated with several of the ventures. And while Mr. Sardegna acknowledged the company's multimillion-dollar losses from subsidiaries, he said it "is not unusual for a company our size" to invest $120 million over six years in what he called research and development.

The Blues say subsidiary officials who "abused" the company's trust were dealt with. Commenting on an $80 million loss from HMOs, Mr. Sardegna says the corporate parent "lost" because it was keeping HMO rates low.

And when subsidiaries faltered, Mr. Sardegna says, they were shut down or given new directions. "Today, the subsidiaries of BCBSM are profitable, have significant value and are helping to offset the rising costs of health care," the company said in a response to the Senate report.

Senate staffers, after a two-month review of company finances and management practices, reached a different conclusion: "After sinking millions upon millions into them, none of the subsidiaries have yet become the rising star executives had hoped for."

Rapid growth

In 1985, the organizational chart at Blue Cross and Blue Shield was relatively simple. The Blues had five subsidiaries, with for-profit business concentrated in two HMOs and a health plan administrator. The company ended the year with a $23.6 million surplus.

The arrival of Carl J. Sardegna in late 1985 preceded by several months the Blues' entry into the worst economic cycle in recent company history, a downturn that spanned at least three years. He sought to create new businesses to generate profits and to compete in a rapidly changing marketplace. At least 16 subsidiaries were formed in the ensuing six years.

As the Blues tried to lower costs by limiting health care options, the company reorganized its HMOs, expanded their services and acquired a third HMO. Meanwhile, the company sought to cash in on new technology and created subsidiaries to find new ways to process claims, serve providers and offer health care products.

But Senate staffers found "no clear long-term strategy" as the subsidiaries began to multiply. Subsidiaries formed their own subsidiaries, which had their own companies.

Some subsidiaries were created and never activated, such as Employers Compliance Services Inc. and Blue Employee Benefit Service Inc. The latter company was formed, the Senate report says, because a Blues executive "simply didn't like the name" of the former. The Blues invested $200,000 in the firms, even though neither became operational, according to Senate staff.

And there were several subsidiary officials who, company auditors later found, had engaged in questionable business practices. The companies they oversaw -- LifeCard International, Health Line and Pertek -- failed miserably. Between 1988 and 1990, internal and federal auditors identified several problems to Blues officials:

* LifeCard, the Blues' foray into research and development, lost $30 million between 1985 and 1991, according to financial statements reviewed by Senate staffers and their interviews with Blues officials. Among its projects: a pocket-sized medical history card that eventually was shelved when the venture proved too costly.

Despite company losses in 1987, LifeCard President James Nakopoulos received a $20,000 bonus and a 7 percent pay raise. In September 1988, internal auditors found questionable expenses by the company president, including $2,800 worth of items from jewelry and clothing stores and undocumented hotel bills.

Mr. Nakopoulos resigned in 1988, and about $21,900 in cash and unallowable expenses were returned to the Blues. The company, however, paid up to 70 percent of his salary for three months, helped him find a job and gave him an office to work from after he left the company.

* Health Line was the Blues' attempt to get into the business of financing health care costs for consumers and providers. But the documentation on loans worth millions of dollars was "dangerously lacking," company auditors found.

The Blues have been trying to sell Health Line and its Medcash credit card operation. A prospective buyer claimed Medcash "was managed in a reckless manner," according to the Senate staff report.

* Pertek, formed as a subsidiary of Health Line in September 1987, was created to research computer systems for use by the Blues. It eventually handled the Blues' Medicare processing work. Federal auditors found that the company president, Claude Holeman, ran a consulting firm out of Georgia, charged the Medicare program for costs related to the sale of his Atlanta house and overbilled the government for processing claims.

In 1989, the Blues' auditors raised several questions about the subsidiary. Among them: the $25,000 purchase of an operating license from a Virginia firm by MedPay of Maryland, an independent company created and controlled by Blues officials, that was charged to Pertek; a $500,000 advance to MedPay; improperly calculated bonuses for Pertek executives; and the sale of computers by Pertek to another firm.

The computer deal involved an alleged conflict of interest that led to the termination of Edward T. Zimmerman, a Blue Cross executive active in both Health Line and Pertek.

The combined losses of Health Line and Pertek from 1987 to 1991 were $15.4 million, according to the Senate staff report.

Increasing state review

This summer, as Senate investigators tracked the trail of Blues subsidiaries, they discovered that the Blues repeatedly didn't notify state regulators of new ventures -- in violation of a 1988 order.

Maryland Insurance Commissioner John A. Donaho told congressional investigators that he was continually frustrated in trying to regulate the Blues and its subsidiaries. And like the Senate investigators, he has criticized the Blues' management.

"By mismanagement, I am not suggesting anything illegal, just poor planning and execution, a malady that frequently strikes managers in positions where profit, that is return to investors, is not in question," he said in an Aug. 11 letter to Gov. William Donald Schaefer.

During its inquiry, the Senate staff found that when the Blues' subsidiaries ran into financial difficulties, the parent company injected more than $100 million to stabilize them. And yet, as they scoured internal documents and interviewed Blues officials, investigators wondered if the executives had "a complete handle on their own Enterprise" -- as Blues executives referred to their company.

When Mr. Sardegna testified before the Senate subcommittee last month, he assured its members that the company had turned the corner.

"Our managed care subsidiaries are repaying the investments we put in them," he insisted. "They will continue to do so for many years to come and they will help make health care more affordable for our customers."

In coming months, the Blues will begin reporting financial data on all its subsidiary operations to state regulators for the first time. Mr. Donaho also is seeking legislation that would increase his power to regulate those businesses, including the authority to examine their books and records.

"Once we get a complete inventory of all of the subsidiaries, their current financial status and their functions," said Mr. Donaho, "we can then begin our analysis of which [subsidiaries] are related to or unrelated to their basic mission."

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