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Valuation in HMO plan is debated Should price reflect future profits or their current status?


Marylanders may not get all of the millions of dollars that are due them from Blue Cross unless the state insurance commissioner takes a more aggressive approach toward calculating the value of the company's HMOs, several experts say.

Nonprofit Blue Cross and Blue Shield of Maryland wants to transfer its health maintenance organizations to a new for-profit business that could sell stock to investors. If the state approves this controversial proposal, the for-profit business would have to pay for the five HMOs, which are considered quite valuable. The payment would go to the public or to subscribers or to the nonprofit Blue Cross company that would remain in business and sell non-HMO policies.

Insurance Commissioner Dwight K. Bartlett III has asked the nation's biggest accounting companies to make bids on a contract for valuing the HMOs.

"I would require that there be fair and proper compensation" for the HMOs, said Mr. Bartlett, who hopes to award the contract this week.

But investment bankers, academic experts and consumer advocates say that Mr. Bartlett's approach could result in an unfairly low price being set for the HMOs, denying Marylanders proper compensation.

"It's probably going to lead to a sale at bargain basement prices," charged Judith Bell, co-director of the West Coast office of Consumers Union, publisher of Consumer Reports magazine.

Ms. Bell's organization helped California consumers net $3.2 bil

lion from the sale of Blue Cross HMOs in that state. Drawing on that experience, she faulted Mr. Bartlett's method and his reliance on an accounting firm.

Different approaches

The commissioner said the HMOs' values are based on the future profits they would make if they continued to be part of the current nonprofit Blue Cross company. The accounting company will be required to estimate future profits.

But that approach is equivalent to selling a house based on how much a conservative appraiser thinks it will appreciate, Ms. Bell and others suggested. A better way is to determine market value by finding out what a buyer would pay for the house, they said.

Ms. Bell and Doug Sherlock, who runs a consulting company in Pennsylvania that does valuations of HMOs, said there are a number of ways to determine market value:

* Wait for the new for-profit HMO company to sell some stock, establishing a market value for the HMOs.

* Look at comparable transactions. If another for-profit company recently bought some similar HMOs in other state, how much did it pay for them?

* Look at the value of comparable for-profit HMO companies. Based on this kind of comparison, Blue Cross of Maryland's HMOs, which have 300,000 subscribers, could be worth at least $300 million.

Ms. Bell and several experts said Mr. Bartlett ought to consult investment bankers because they know how to compute market value.

But Mr. Bartlett doesn't believe a market approach is appropriate. What's relevant, he said, is the value of the HMOs to the current Blue Cross company -- not what they might be worth down the road to investors of a new for-profit company.

Yet he agreed that the HMOs may have a greater value after being transferred to a for-profit company.

"It would not surprise me if the marketplace, with the new [for-profit] structure, says these HMOs are worth considerably more than they are as subsidiaries of [nonprofit] Blue Cross-Blue Shield," he said.

Blue Cross said Mr. Bartlett is following the appropriate procedure. There's no need to do a market evaluation because the HMOs would be transferred from the current nonprofit company to a new for-profit company and not sold

on the market, said John A. Picciotto, senior vice president and general counsel.

But Mr. Picciotto said that if the state requires the company to follow the example of Blue Cross of California, a market-based pricing method would be appropriate.

California experience

The nonprofit California insurer is converting completely to a for-profit company. Using the for-profit company's stock price as a market pricing guide, the state is requiring the company to contribute $3.2 billion to two charitable foundations.

Mr. Picciotto cautioned that Blue Cross of Maryland's restructuring plans are still under development. The company has been telling Mr. Bartlett and legislative leaders that it wants to split into new for-profit and nonprofit businesses, obtaining authority to sell stock and raise capital needed to compete against better-financed for-profit insurance companies.

"A lot of things are being discussed," said Mr. Picciotto,

suggesting that the company's final

plan could be different. The company hopes to unveil a plan in December.

Mr. Bartlett also hopes to receive a valuation report in December. Although the successful bidder among the accounting companies must have experience in valuing HMOs, according to the contract specifications, the report almost certainly will be questioned because of its methodology.

One investment banker termed Mr. Bartlett's approach "what they teach you in business school" -- a good first step but one that should be supported with market-based valuations.

Geoffrey Brooks, an assistant professor of management at the Wharton School of the University of Pennsylvania, said Mr. Bartlett's approach is risky because it is based on predictions of future performance.

"You have to understand that it's not foolproof and it's not the final answer because you're dealing with future cash flows, which are inherently unknowable," he said. "You know you're going to be wrong; the question is how much and on which side."

Valuing the HMOs solely on a market basis can also be risky, he said, because the initial stock price may not "reflect the intrinsic value of the company."

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