Insurance chief bars $1.37 billion sale of CareFirst


In a stinging rebuke to the top management and board of directors of CareFirst BlueCross BlueShield, Maryland Insurance Commissioner Steven B. Larsen yesterday rejected the insurer's plan to convert to for-profit operation and sell itself.

Larsen said the process CareFirst used to develop the $1.37 billion deal was deeply flawed and violated Maryland law. An executive bonus plan, he said in a news conference, was "a central consideration in this deal" and amounted to "essentially a ransom a bidder would have to pay for the right to purchase the company."

He said the CareFirst board failed to consider its obligations as a nonprofit, that consultants used by the insurer had apparent conflicts of interest, that CareFirst hadn't negotiated to get the best price, that the company didn't have a business need to convert, and that would-be acquirer WellPoint Health Networks Inc. had refused to produce "critical" documents that would have allowed him to judge consumer impact.

Both CareFirst and California-based WellPoint said they need to study the rejection before deciding how to proceed, but the sweep and firmness of Larsen's ruling would appear to spell the end of the current deal, unless a court overturns it.

"It's about as dead as it can be," said Clifford A. Hewitt, a health care analyst at Legg Mason Wood Walker in Baltimore. "I think this is: 'Go back to square one.'"

Ken Ferber, a spokesman for WellPoint, said Larsen "made it very clear the current environment in Maryland is just not conducive to a conversion of CareFirst."

Daniel Altobello, CareFirst's board chairman, said he thought it would take "a minimum of a couple of weeks" for CareFirst to analyze the report and decide how to proceed. He said the company's options include "a range of things - from nothing, to [court] appeal, to restructuring the deal."

Eric Veiel, a health care analyst at Deutsche Bank Securities in Baltimore, said, "You can appeal this, but I don't see a lot of room. I don't see a court forcing this deal to get done."

Larsen's criticism of CareFirst touched off calls by advocates and legislators for the board and management to be reshaped, and perhaps even replaced. Legislative leaders were making plans yesterday to have Larsen present his findings Monday to a joint meeting of several House and Senate committees. The General Assembly has 90 days in which it could reverse Larsen's decision, but key lawmakers said there's no chance that would happen.

Some lawmakers also were beginning to work on legislation meant to ensure CareFirst sticks to the nonprofit mission it has had since its creation in 1937.

Larsen said he would also examine whether he could take regulatory action against management and the board. Asked whether he might act as well, Attorney General J. Joseph Curran said, "I really am not prepared to answer that right now." He said an earlier case had limited the action he could take against Blue Cross executives.

Altobello, however, said the board didn't think any changes were needed in structure or personnel. He defended its actions, saying, "We were looking constantly at how this would affect all our stakeholders, and that's looking after your mission.

"I think the board did a very professional job, and I serve on a lot of boards and have been involved in a lot of mergers."

William L. Jews, CareFirst's chief executive officer, was not available for comment.

CareFirst is the largest health insurer in the region. Based in Owings Mills, it operates the Blue Cross plans in the District of Columbia and Delaware as well as in Maryland, insuring more than 3 million people.

WellPoint is the publicly traded company that resulted when California Blue Cross went for-profit. It has bought Blues plans in Georgia and Missouri, as well as several non-Blues insurance companies.

Delaware and District of Columbia regulators said they were unsure whether they would proceed until they hear from WellPoint and CareFirst.

After CareFirst spent two years developing a strategic plan and negotiating with suitors, the two announced in November 2001 that WellPoint would buy CareFirst for $1.3 billion. Jews and his executive team were to become the management of a WellPoint regional subsidiary that would continue to be based in Owings Mills.

CareFirst said it needed to be part of a larger, for-profit company to get access to money it needed to buy new technology and develop new products.

The purchase price would have gone to health foundations or similar public purposes in Maryland and the other jurisdictions the insurer serves. CareFirst argued that this was a major benefit of the transaction - money that could generate tens of millions of dollars a year to provide coverage for the uninsured, subsidize clinics or address other health needs.

The deal ran into immediate opposition. The General Assembly moved last year to make the conversion process tougher and to ban the $119.7 million bonus plan for executives. In a late effort to salvage the deal, WellPoint and CareFirst renegotiated the bonus plan, producing a much smaller package of retention bonuses, and raised the purchase price to $1.37 billion to account for the dropped bonuses. Larsen ruled the renegotiated bonuses illegal as well.

The insurance commissioner, described by both admirers and critics as aggressive in protecting consumers, reviewed the deal for more than a year, holding 15 days of formal hearings, hiring 10 consultants and reviewing more than 85,000 pages of board minutes, correspondence and other documents. Under state law, WellPoint paid for that process - at a cost of more than $5 million.

In a 200-page report, beefed up with an additional 150 pages in exhibits, Larsen's key findings were:

Board's obligation as a nonprofit: CareFirst's articles of incorporation call for it to provide insurance at "minimum cost and expense," but "the minutes of the Board of Directors ... dramatically demonstrate that management of CareFirst did not view their corporate mission as restraining or guiding their business activities."

The drive for profitability, Larsen wrote, led CareFirst to seek "excessive" premiums for policies for members with chronic health problems, and to drop some sick members when its FreeState HMO was merged into a new HMO, BlueChoice.

"It is hard to imagine a more profit-oriented action taken at the expense of a relatively small but vulnerable population of sicker CareFirst members," he said in his report.

Conflicts of interest: Attorney Isaac Neuberger represented Jews in 1998 and 1999, when the CEO negotiated employment terms with CareFirst's board. Then, according to Jews, Neuberger represented CareFirst in negotiations with one of its potential acquirers, Trigon Inc. Since the board had its own legal advisers and didn't know that Neuberger was working for CareFirst, Larsen said, the record "supports the conclusion that Mr. Neuberger was representing the interests of the executives."

Larsen wrote that the executives and company had divergent goals: "Management's insistence on large bonuses and permanent roles in the combined company conflicted with CareFirst's interests because it impeded the ability to consummate the deal."

Larsen said apparent conflicts were also created when CareFirst's investment banker, Credit Suisse First Boston, which negotiated the deal, was asked to say whether the price it had negotiated was fair - and stood to collect $13 million only if the deal went through. And the consulting firm Accenture, which helped CareFirst develop its strategic plan, was hired to study whether the plan would be good for consumers - not, Larsen said, an independent judgment.

Price negotiations: "CareFirst ran what appeared to be an auction" between Trigon and WellPoint, Larsen said at the news conference, but "the auction was designed to end in a tie," which would "allow management to balance non-price factors." WellPoint was pushed to come up to Trigon's offer, he found, but Trigon was never pushed to offer more.

Business case: While CareFirst said it needed to convert and be sold to get more access to capital, Larsen wrote, CareFirst actually matched or exceeded other insurers - nonprofit and for-profit - on capital spending. Even CareFirst's own consultant found the company had enough money for all its needs, except to buy other companies. However, Larsen said, a CareFirst acquisition in its market was likely to run into anti-trust problems.

Moreover, Larsen said, CareFirst could have generated more cash itself, but since 1999 it had "sustained tens of millions of dollars in losses for reasons related to management decisions and action or inaction, rather than the reasons cited publicly by management, such as mandated benefits and inadequate rate approvals."

Among those decisions, Larsen said, were a subsidy to physician groups who were losing money, in part, on treating patients from other insurers, and a $24 million loss in 2001 on so-called "non-risk business," where CareFirst collects a fee for managing the plan of a self-insured employer or government.

"There is significant evidence," Larsen said at his news conference, "that there has been lax oversight of the financial performance of the company by the board of directors."

Excerpts of Maryland insurance commissioner's order

It is my conclusion under Title 6.5 of the State Government Article that the Amended Application for the conversion of CareFirst Inc. and CareFirst of Maryland Inc. is not in the public interest, and I find that:

Appropriate steps were not taken to ensure that the value of the public assets of CareFirst and of BCBS-MD are safeguarded

Appropriate steps were not taken to ensure that no part of the public assets of the acquisition inured directly or indirectly to officers of CareFirst and of BCBS-MD

Appropriate steps were not taken to ensure that no officer of CareFirst or of BCBS-MD receives any immediate or future remuneration as the result of the Proposed Transaction except in the form of compensation paid for continued employment with WellPoint

CareFirst did not exercise due diligence in deciding to engage in an acquisition, selecting the transferee, and negotiating the terms and conditions of the acquisition

The procedures that CareFirst used in making the decision to convert and to be acquired were flawed

Conflicts of interest existed that either were not disclosed or were not appreciated or considered by CareFirst

The purchase price does not reflect the fair value of CareFirst

Because WellPoint refused to produce certain documents critical to the inquiry, I am unable to conclusively determine on this record whether the Proposed Transaction has the likelihood of creating a significant adverse effect on the availability or accessibility of health care services in the affected communities, but there is evidence that the proposed transaction could have such an impact

Because WellPoint refused to produce certain documents critical to the inquiry, I am unable to evaluate sufficiently on this record whether the Proposed Transaction includes sufficient safeguards to ensure that the affected communities will have continued access to affordable health care

The proposed Transaction is not equitable to insured and certificate holders of BCBC-MD or of the Maryland insureds and certificate holders of BCBS-NCA

CareFirst-WellPoint chronology

June 1999: The Strategic Planning Committee of CareFirst BlueCross BlueSheld's board tells the board it is engaging a consultant and developing a strategic plan.

November 1999: The CareFirst board adopts a strategic plan calling for CareFirst to grow and have access to more capital. Although the plan doesn't identify conversion and acquisition as the only option to achieve the goals, it recognizes it as an attractive choice.

Summer 2000: CareFirst executives and investment bankers talk with Trigon Inc., the for-profit Virginia Blues plan, and Highmark, a nonprofit Pennsylvania Blues plan.

December 2000: Investment bankers tell CareFirst's board that Trigon is "the primary partnership candidate," but discussions should be held with Indiana-based Anthem Inc. and California-based WellPoint Health Networks Inc.

January 2001: CareFirst CEO William L. Jews tells the Strategic Planning Committee that the field of suitors has been narrowed to WellPoint and Trigon.

February 2001: State officials confirm they have been told privately by CareFirst that it is seriously considering converting to for-profit operation and being acquired.

February 2001: Although Anthem has expressed interest in bidding, Jews, with advice from investment bankers, tells the board Anthem is not "a good strategic fit" and has not completed its public offering.

April 9, 2001: Shortly before adjourning, the General Assembly removes one potential barrier to conversion by dropping a requirement that CareFirst members vote on it.

April 26, 2001: Investment bankers tell the Strategic Planning Committee that the WellPoint offer is "clearly superior." The board decides to try to complete a deal with WellPoint, while keeping Trigon discussions open.

Nov. 20, 2001: CareFirst announces its plan to convert to for-profit operation and be sold to WellPoint for $1.3 billion.

Dec. 3, 2001: A report written by Carl J. Schramm, former head of the Johns Hopkins Center for Hospital Finance and Management, for the Abell Foundation says: "The loss of Maryland's commitment to a system that protects the poor and the otherwise uninsurable, while providing a predictable environment for the state's hospitals and insurance companies, would be an intolerable price to pay for CareFirst's corporate ambitions."

January-April 2002: The Maryland General Assembly imposes added conditions on the deal: no executive bonuses, deal must be all-cash rather than cash-and-stock, burden of proof placed on CareFirst/WellPoint. Legislators react very negatively to the deal.

March 7, 2002: As CareFirst files documents in advance of Maryland Insurance Commissioner Steven B. Larsen's first round of public hearings, the public learns that executives of the company stand to pocket $33.2 million - including $9.1 million for Jews - if the company's proposed sale goes through. In addition to the $33.2 million in "merger incentives" and "retention bonuses" related directly to completion of the WellPoint sale, the executives stand to collect $48.9 million - $18.9 million of that for Jews - if they are terminated by WellPoint or leave it for "good reason."

April 29, 2002: Anthem announces plans to buy Trigon for $4 billion, causing opponents in Maryland to question $1.3 billion price here.

Sept. 9, 2002: The Blackstone Group, investment banker advising Larsen, says CareFirst is worth more than $1.3 billion - probably hundreds of millions more. It presents a range of potential values, centering on about $1.8 billion.

Nov. 15, 2002: Jay Angoff, a consultant to Larsen, says the CareFirst executive bonuses violate state law. In addition to the bonuses and severance packages, Angoff reveals, the insurer was to pay the taxes on the bonuses. That would bring the total value of the package, Angoff says, to $119.7 million, including $39.4 million for Jews.

Jan. 22, 2003: WellPoint and CareFirst announce a revised deal with more modest retention bonuses if the executives continue to work for WellPoint. It adds $70 million to the price - the amount of bonuses knocked out - and gives a rival bidder 60 days to top its offer without a breakup fee.

Feb. 4, 2003: Angoff testifies that the modified retention bonus plan still appears to violate state law.

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