[Senate Report 104-92]
[From the U.S. Government Publishing Office]
104th Congress Report
SENATE
1st Session 104-92
_______________________________________________________________________
FOURTH INTERIM REPORT ON UNITED STATES GOVERNMENT EFFORTS TO COMBAT
FRAUD AND ABUSE IN THE INSURANCE INDUSTRY: PROBLEMS IN BLUE CROSS/BLUE
SHIELD PLANS IN WEST VIRGINIA, MARYLAND, WASHINGTON, DC, NEW YORK, AND
FEDERAL CONTRACTS
__________
PREPARED BY THE
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
OF THE
COMMITTEE ON GOVERNMENTAL AFFAIRS UNITED STATES SENATE
JUNE 1995
June 5, 1995.--Ordered to be printed
COMMITTEE ON GOVERNMENTAL AFFAIRS--104th CONGRESS
WILLIAM V. ROTH, Jr., Delaware,
Chairman
SAM NUNN, Georgia TED STEVENS, Alaska
JOHN GLENN, Ohio WILLIAM S. COHEN, Maine
CARL LEVIN, Michigan FRED THOMPSON, Tennessee
DAVID PRYOR, Arkansas THAD COCHRAN, Mississippi
JOSEPH I. LIEBERMAN, Connecticut CHARLES E. GRASSLEY, Iowa
DANIEL K. AKAKA, Hawaii JOHN McCAIN, Arizona
BYRONL. DORGAN, North Dakota BOB SMITH, New Hampshire
Franklin G. Polk, Staff Director
and Chief Counsel
Leonard Weiss, Minority Staff
Director
Michal Sue Prosser, Chief Clerk
______
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
WILLIAM V. ROTH, Jr., Delaware,
Chairman
SAM NUNN, Georgia TED STEVENS, Alaska
JOHN GLENN, Ohio WILLIAM S. COHEN, Maine
CARL LEVIN, Michigan FRED THOMPSON, Tennessee
DAVID PRYOR, Arkansas THAD COCHRAN, Mississippi
JOSEPH I. LIEBERMAN, Connecticut CHARLES E. GRASSLEY, Iowa
DANIEL K. AKAKA, Hawaii JOHN McCAIN, Arizona
BYRON L. DORGAN, North Dakota BOB SMITH, New Hampshire
Harold Damelin, Chief Counsel/
Staff Director
Dan Gelber, Chief Counsel to the
Minority
John F. Sopko Deputy Chief Counsel
to the Minority
Carla Martin, Chief Clerk
______
COMMITTEE ON GOVERNMENTAL AFFAIRS--103rd CONGRESS
JOHN GLENN, Ohio, Chairman
WILLIAM V. ROTH, Jr., Delaware SAM NUNN, Georgia
TED STEVENS, Alaska CARL LEVIN, Michigan
WILLIAM S. COHEN, Maine JIM SASSER, Tennessee
THAD COCHRAN, Mississippi DAVID PRYOR, Arkansas
JOHN McCAIN, Arizona JOSEPH I. LIEBERMAN, Connecticut
ROBERT F. BENNETT, Utah DANIEL K. AKAKA, Hawaii
BYRON L. DORGAN, North Dakota
Leonard Weiss, Staff Director
Franklin G. Polk, Minority Staff
Director and Chief Counsel
Michal Sue Prosser, Chief Clerk
______
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
SAM NUNN, Georgia, Chairman
JOHN GLENN, Ohio, Vice Chairman
WILLIAM V. ROTH, Jr., Delaware CARL LEVIN, Michigan
TED STEVENS, Alaska JIM SASSER, Tennessee
WILLIAM S. COHEN, Maine DAVID PRYOR, Arkansas
THAD COCHRAN, Mississippi JOSEPH I. LIEBERMAN, Connecticut
JOHN McCAIN, Arizona BYRON L. DORGAN, North Dakota
ROBERT F. BENNETT, Utah
Eleanore Hill, Chief Counsel
Daniel F. Rinzel, Chief Counsel to
the Minority
Mary D. Robertson, Chief Clerk
C O N T E N T S
__________
Page
I. INTRODUCTION......................................................1
II. THE BLUE CROSS/BLUE SHIELD SYSTEM.................................3
A. GHistory of the Plans..................................... 3
B. GUnique Status of Blue Cross/Blue Shield Plans............ 3
C. GThe Blue Cross and Blue Shield Association............... 4
D. GAssociation Structure.................................... 4
E. GFinancial Information.................................... 5
F. Oversight of Member Plans................................. 5
III.FINDINGS..........................................................6
THE WEST VIRGINIA, MARYLAND,DISTRICT OF COLUMBIA, & EMPIRE PLANS..6
A. GMismanagement............................................ 6
B. GInadequate Oversight by the Boards of Directors.......... 7
C. GInadequate Regulation by State Insurance Departments..... 8
D. GInadequate Oversight by the Blue Cross/Blue Shield
Association................................................ 8
FEDERAL CONTRACTS.................................................9
A. GMismanagement............................................ 9
B. GInadequate Regulation.................................... 10
C. GInadequate Oversight by the Blue Cross/Blue Shield
Association................................................ 10
IV. CONCLUSIONS......................................................10
V. RECOMMENDATIONS..................................................11
VI. APPENDIX: CASE STUDIES...........................................18
THE WEST VIRGINIA PLAN...........................................18
A. GBackground/Organization.................................. 18
B. GFinancial Profile........................................ 18
C. GProblem Areas............................................ 18
D. GEffects.................................................. 28
THE MARYLAND PLAN................................................29
A. GBackground/Organization.................................. 29
B. GFinancial Profile........................................ 29
C. GProblem Areas............................................ 30
D. GEffects.................................................. 43
THE NATIONAL CAPITAL AREA PLAN...................................45
A. GBackground/Organization.................................. 45
B. GFinancial Profile........................................ 45
C. GProblem Areas............................................ 46
THE EMPIRE PLAN..................................................57
A. GBackground/Organization.................................. 57
B. GFinancial Profile........................................ 57
C. GProblem Areas............................................ 58
D. GEffects.................................................. 70
FEDERAL CONTRACTS................................................72
A. GBackground/Organization.................................. 72
B. GFinancial Profile........................................ 73
C. GProblem Areas............................................ 74
104th Congress Report
SENATE
1st Session 104-92
_______________________________________________________________________
FOURTH INTERIM REPORT ON UNITED STATES GOVERNMENT EFFORTS TO COMBAT
FRAUD AND ABUSE IN THE INSURANCE INDUSTRY: PROBLEMS IN BLUE CROSS/BLUE
SHIELD PLANS IN WEST VIRGINIA, MARYLAND, WASHINGTON, DC, NEW YORK, AND
FEDERAL CONTRACTS
_______
June 5, 1995.--Ordered to be printed
_______________________________________________________________________
Mr. Roth, from the Committee on Governmental Affairs, submitted the
following
R E P O R T
I. INTRODUCTION
For the past several years, the Senate Permanent
Subcommittee on Investigations has been examining fraud, abuse,
and inadequate regulation in the insurance industry. During
this investigation, a number of regulators described problems
they had encountered in trying to regulate and oversee the
operations of Blue Cross/Blue Shield Plans in their states.
Many of them noted that they spent a disproportionately greater
amount of time regulating their ``not-for-profit Blues'' than
they did on any ``for-profit'' insurance companies. Other
regulators said that they knew little about their Blue Cross/
Blue Shield Plans, and that when they attempted to find out
more about their operations, they were either denied access or
were otherwise barred by their own State law from requiring
full disclosure. Some regulators expressed concern that the
philosophy guiding many of these Plans had changed from that of
a non-profit organization primarily concerned with the
subscribers' interests to that of a large corporation out to
maximize short-term profits.
In October, 1990, for the first time in the history of the
Blue Cross/Blue Shield System one of its members--the West
Virginia Plan--was declared insolvent and was seized by the
West Virginia Insurance Department, leaving more than 51,000
individuals with unpaid claims and thousands more with reduced
or non-existent coverage. In the aftermath of this Plan's
failure, press reports raised serious questions about its
management and the regulatory oversight of its operations.
In 1991, the National Association of Insurance
Commissioners (NAIC) formed a Special Committee on Blue Cross
Plans.\1\ The Special Committee's charge was to ``identify
solvency issues related to Blues organizations, and review
current regulatory oversight of these issues.'' This was the
first time the NAIC had deemed it necessary to form such a
committee on the Blue Cross/Blue Shield Plans.
---------------------------------------------------------------------------
\1\ The NAIC consists of the heads of the insurance departments of
each of the 50 States, the District of Columbia and the four U.S.
territories. For the last 120 years it has served as the primary
vehicle for coordinating insurance regulatory activities and as a
catalyst for developing a national program of insurance regulation.
---------------------------------------------------------------------------
Set against a backdrop of spiraling health care costs and
growing public debate over the future of the American health
care system, these concerns prompted then Subcommittee Chairman
Sam Nunn to launch a specific inquiry regarding the nation's
Blue Cross/Blue Shield Plans. This inquiry focused on
allegations of mismanagement and misconduct on the part of
several of these Plans and the ability of state insurance
regulators to oversee their operations, as well as those of the
other Plans in the Blue Cross/Blue Shield system. It led to a
series of hearings, the first of which took place on July 2,
1992, examining the Blue Cross/Blue Shield Plans of West
Virginia, Maryland, the District of Columbia, and New York
(Empire) and Blues contracts with the Federal government.
At the July hearing, then Chairman Nunn noted that when the
Senate last undertook a comprehensive review of the Blue Cross/
Blue Shield system in the early 1970s,\2\ it found evidence of
mismanagement, excessive billings, exorbitant salaries and
perks for Plan officials, as well as conflicts of interest and
fraud. Then Chairman Nunn described the framework for the
Subcommittee's subsequent efforts in its updated examination of
the Blues, including the following issues:
---------------------------------------------------------------------------
\2\ The Senate Judiciary Committee, Subcommittee on Antitrust and
Monopolies, Chaired by Senator Philip Hart.
--Lthe financial integrity of the Blue Cross/Blue
Shield Plans;
--Lthe role of the Blue Cross/Blue Shield Association
in ensuring that its member Plans are financially sound
and well managed;
--Lthe propriety of not-for-profit Blue Cross/Blue
Shield Plans creating and operating ``for-profit''
subsidiaries, and the impact these subsidiaries or
affiliates may have on the former's financial integrity
and stability;
--Lthe effectiveness of State regulators in overseeing
their domiciled Blue Cross/Blue Shield Plans and their
subsidiaries and affiliates;
--Lthe Plans' management style and philosophy, and
whether these have become inimical to effective State
regulation;
--Lthe propriety of salaries and fringe benefits
received by Plans' officers and directors; and,
--Lthe role of the Federal government in monitoring and
supervising the Federal employee programs administered
by the various Blue Cross/Blue Shield Plans.
This investigation was conducted by the Subcommittee's
Majority Staff at the direction of then Chairman Nunn, with the
concurrence and support of then Ranking Minority Member,
Senator William V. Roth, Jr. It was authorized pursuant to
Senate Resolution 62, adopted February 28, 1991, and Senate
Resolution 71, adopted February 25, 1993, which empower the
Subcommittee to investigate ``all other aspects of crime and
lawlessness within the United States which have an impact upon
or affect the national health, welfare, and safety; including
but not limited to investment fraud schemes, commodity and
security fraud, computer fraud, and the use of offshore banking
and corporate facilities to carry out criminal objectives.''
II. THE BLUE CROSS/BLUE SHIELD SYSTEM
A. History of the Plans
The Blue Cross/Blue Shield organization is the largest and
oldest provider of prepaid health care coverage in the nation.
It is a nationwide federation of individual corporations, or
Plans, each of which serves its community as a non-profit
organization. Each Plan is a member of the national Blue Cross
and Blue Shield Association, which serves as a coordinating
agency for the Plans.
Blue Cross and Blue Shield were originally two separate
organizations. Blue Cross Plans were founded primarily to cover
hospital expenses, though over time they have expanded into
other areas, such as outpatient and home care. Blue Shield
Plans were established primarily to cover physicians' services,
though over time they also have expanded into other areas, such
as dental, vision, and outpatient coverage. The Blue Cross
Association and the Blue Shield Association began operating
under one president in 1978 and merged into a joint corporation
in 1982. Today, Blue Cross and Blue Shield Plans either
cooperate closely, are joint corporations, or are separate
entities whose benefits may overlap. At the end of 1991, the
system's 73 Plans totaled approximately 94.3 million
subscribers. Of these, 68.1 million were private subscribers
(26.5 percent of the market share), and 33 million were
Government subscribers.\3\
---------------------------------------------------------------------------
\3\ About 6.8 million subscribers--Medicare recipients with
supplemental Blue Cross/Blue Shield coverage--are counted as both
Government and private subscribers.
---------------------------------------------------------------------------
B. Unique Status of Blue Cross/Blue Shield Plans
Ever since their establishment in the 1930s, Blue Cross/
Blue Shield Plans have been organized and regulated pursuant to
special statutes in their various states of domicile. This
special status is based on a number of considerations,
including their: not-for-profit nature; \4\ presumed commitment
to providing health care coverage at the lowest possible cost
to the largest possible population; and, in some states, status
as the health insurer of last resort. Unlike their for-profit
counterparts, Blue Cross/Blue Shield Plans are looked on as
having an intrinsic fiduciary responsibility to protect the
interests of their subscribers. In line with their special role
and responsibilities, Blue Cross/Blue Shield Plans are often
accorded significant advantages not available to commercial
insurers, such as being exempt from certain tax and other
regulatory requirements.
---------------------------------------------------------------------------
\4\ In recognition of changing market conditions and the special
need to access capital markets, the Blue Cross/Blue Shield
Association's Board of Directors has recently authorized Member Plans
to change their organizational form to ``for-profit.''
---------------------------------------------------------------------------
C. The Blue Cross and Blue Shield Association
The Blue Cross and Blue Shield Association (the Association
or BCBSA) is a trade association and as such is neither the
parent of the individual Plans nor a guarantor of their debts
or other contractual and financial obligations. According to
its articles of incorporation, the Association's purposes are
to:
--Lpromote the betterment of public health and
security, and to secure wide public acceptance of the
principle of voluntary, non-profit prepayment of health
service;
--Lprotect the Blue Cross and Blue Shield service
marks;
--Ldevelop and maintain the Association's membership
standards;
--Lcooperate with federal, state, and local governments
for the provision of health services to the needy and
aged;
--Lestablish and maintain support and other services to
Members through the exercise of authority delegated by
the Members; and,
--Lconduct its affairs, to have offices within and
without the State of Illinois, and to exercise the
powers granted by the General Not-For-Profit
Corporation Act of the State of Illinois.
A significant Association activity is to coordinate health
care coverage for national employers with offices in more than
one region of the country including, for example, the Federal
Employee Health Benefits Program (FEHBP). Under that program,
Blue Cross/Blue Shield Plans insure 3.5 of the 9 million
participating Federal workers, retirees, and their families
throughout the country. In addition, the Association is the
prime contractor for the Blue Cross/Blue Shield organization's
administration of Medicare (Part A). Under this program, the
Association contracts with member Plans to perform a wide range
of functions, such as claims processing, audits, utilization
reviews, and other administrative tasks.
D. Association Structure
The Association is governed by a Board of Directors, which
consists for the most part of the Plan CEOs. The Board holds at
least four regular meetings each year, in addition to any
special meetings that may be called. Between meetings, its
authority is vested in a 26-member Executive Committee. The
Executive Committee Chairman also serves as the Chairman of the
Board of Directors. Another Executive Committee member is the
President of the Association, while the remaining 24 represent
the 12 districts into which the member Plans are divided.
E. Financial Information
In 1990, the Association reported systemwide total assets
of $118,857,345, liabilities of $106,054,671, and equity of
$12,811,674. In the same year, it reported total revenues of
$109,129,527 and total expenses of $106,866,512. In terms of
systemwide revenues, the Association maintains it is the same
size as the fifth ranked corporation on the list of Fortune 500
companies.
Based on aggregated data derived from member Plan balance
sheets, the Association reported total Plan assets of $30.1
billion and reserves of $9.8 billion as of December 31, 1991.
It should be noted, however, that the financial strength of any
individual Plan relies not on these total figures but, rather,
on the strength of its own assets and reserves.
F. Oversight of Member Plans
At the outset of the Subcommittee's investigation, all
Plans had to adhere to seven membership standards as a
condition of membership.\5\ However, partly in response to the
Subcommittee's investigation, as of June 1993 these standards
had been revised and/or expanded to: clarify Plan Boards'
oversight responsibilities; inform state regulators about Plan
subsidiaries' activities; assure that subscribers' claims are
paid and their coverage continued in the event of a Plan
insolvency (effective December 31, 1994); inform the public on
Plans' financial condition; and, assure that Plans are able to
meet their inter-Plan program financial obligations.
---------------------------------------------------------------------------
\5\ These standards provided that Plans: be organized and operated
on a non-profit basis; have a Board not controlled by any special
interest group and which is comprised of a majority of persons other
than health care providers; furnish reports and records to the
Association to indicate compliance with these standards; maintain
adequate financial resources to protect customers and meet long-term
business obligations; use their best efforts to contract with cost-
effective health care providers; operate in a manner responsive to
customer needs; and participate in each national program adopted by the
Association.
---------------------------------------------------------------------------
These standards apply to all regular member Plans and
membership renewal is contingent upon their compliance with
them. Based on the degree of compliance with the standards, the
Association has a range of options it can pursue.\6\ It can
monitor Plans experiencing financial and/or operational
difficulties, using authority it has to require records and
other relevant data to be submitted. In the event that a Plan
fails or is expected to fail to meet one or more of the
membership standards, the Association can contact the Plan's
Board or the concerned state insurance regulators to seek their
input in this regard. If these efforts prove unsuccessful, the
Association can seek judicial enforcement of the license
agreement or, with a majority vote of the membership, move to
terminate the Plan's license.
---------------------------------------------------------------------------
\6\ At the outset of the Subcommittee's investigation, Plans were
subject to a somewhat different regime: they could be in substantial
compliance with all seven membership standards; they could receive
comments on specific issues where they were not in full compliance;
they could fail to be in substantial compliance with any one membership
standard, which would prompt their being placed on conditional status
(being required to develop a rehabilitation plan and being subject to
continuous monitoring by the Association); and, in the event that they
failed to meet the membership standards, failed to meet terms agreed
upon pursuant to conditional membership status, or failed to apply for
renewal, their membership could be subject to non-renewal.
---------------------------------------------------------------------------
III. FINDINGS
The Subcommittee's examination of the West Virginia,
Maryland, District of Columbia, and New York (Empire) Plans,
and Blue Cross/Blue Shield's Federal employee and Medicare
contracts, has revealed a pattern of gross mismanagement,
ineffective oversight, and regulatory failings strikingly
similar to that uncovered by the Senate Judiciary Committee in
its investigation of the Blues more than twenty years ago. With
the exception of the Federal contracts, these problems caused
severe financial impairment in all of the Plans examined and,
in the case of the West Virginia Plan, helped to bring about
its demise.\7\ These problems also adversely impacted the
Plans' ability to fulfill their responsibilities to
policyholders, providers, and other health care industry
interests. In the case of the Federal employee and Medicare
contracts, these problems resulted in wasted taxpayers'
dollars, unnecessary costs to the Federal government, and
questionable charges and poor service to subscribers.
---------------------------------------------------------------------------
\7\ While this investigation focused on the West Virginia,
Maryland, District of Columbia, and Empire Plans, the Subcommittee also
received information on other Blue Cross/Blue Shield Plans that have
experienced some of the same problems discussed herein. For example,
according to an April, 1994 GAO report, Blue Cross and Blue Shield:
Experiences of Weak Plans Underscore the Role of Effective State
Oversight (GAO/HEHS-94-71), Plans in Vermont, New Hampshire, Maine,
Massachusetts, New Jersey, New York, and West Virginia (Mountain State,
successor to the failed West Virginia Plan) have experienced such
problems. In addition, the Subcommittee notes that the Colorado Plan's
CEO was recently removed for misconduct and that the former CEO of the
Louisiana/Mississippi Plan pled guilty in Federal Court to charges of
having bribed the State Insurance Commissioner in an attempt to quash
an audit critical of the Plan.
---------------------------------------------------------------------------
THE WEST VIRGINIA, MARYLAND, DISTRICT OF COLUMBIA, & EMPIRE PLANS
A. Mismanagement
1. The Plans' CEOs created corporate cultures inimical to
Blue Cross/Blue Shield's historical mission and non-profit
status. These executives operated their Plans in an
irresponsible and unsafe manner that ill befitted their status
as non-profit health insurers whose primary mission was to
provide affordable, quality health care to their policyholders
and, in some cases, serve as the health insurer of last resort.
2. Top managers failed to operate their Plans in accordance
with their fiduciary responsibilities to the policyholders by
making unsound business decisions and, in at least two
instances (Empire and West Virginia), engaging in highly
questionable, if not improper, conduct. The Subcommittee found
that these managers at times acted for their own self-interest
and/or enrichment and, in three of the four Plans examined, set
up for-profit subsidiaries that had little to do with the
Blues' primary mission and ended up losing hundreds of millions
of dollars.
3. The Plan CEOs and their management teams generally
succeeded in resisting and/or evading duly constituted
authorities--State Insurance Departments, Plan Boards of
Directors, and the Blue Cross/Blue Shield Association--in the
exercise of their oversight/regulatory functions.
4. Top Plan managers abused their positions by obtaining
exorbitant salaries and other fringe benefits and by incurring
millions of dollars in unnecessary and/or unjustified travel
and entertainment expenses, at a time when their Plans were in
dire financial straits and subscriber premiums were being
increased dramatically.
5. All the Plans examined had extensive and recurring
accounting, financial reporting and/or internal control
deficiencies, which significantly impaired their operations and
financial integrity. In the Maryland and Empire Plans, these
deficiencies helped create circumstances that enabled major
frauds to be perpetrated against them, resulting in tens of
millions of dollars in losses.
6. All the Plans examined had serious problems in their
underwriting policies and practices, resulting in tens of
millions of dollars in losses. In large part, these problems
were caused by management decisions to systematically
underprice their lines of business in order to gain market
share.
7. The Plans' problems had serious consequences for
policyholders, providers, and other health care industry
interests. The lives of thousands of West Virginia Plan
policyholders and providers were thrown into turmoil as a
result of its failure. In the Empire, Maryland and District of
Columbia Plans, policyholders experienced poor service, a
diminution in and/or loss of coverage, and dramatically
increased premiums, while providers encountered ever-increasing
problems in obtaining reimbursement for services rendered.
B. Inadequate Oversight by the Boards of Directors
8. The Plans' Boards of Directors failed to perform their
requisite oversight functions, ignoring their responsibility to
the policyholders whose interests they were charged with
protecting. The Subcommittee found that:
a. management was able to gain effective control of
Boards by circumventing and/or altering rules regarding
the process by which members were selected. As a
result, over time Boards tended to become unquestioning
``rubberstamps'' for management decisions.
b. many Board members failed to understand Plan
policies and procedures, were ignorant of the serious
problems and/or abuses occurring within the Plans, and
were easily manipulated and misled by management. This
was particularly evident in the case of the Maryland
and Empire Plans, where the CEOs used their dual roles
as Board Chairmen to control the information made
available to Board members.
c. many Board members failed to understand their
fiduciary obligation to protect the policyholders'
interests and their responsibility to oversee
management's actions. Indeed, the West Virginia Plan's
Board Chairman was involved in an incident that
constituted a conflict of interest with his Board
responsibilities, and he also served as Board Chairman
for a number of the Plan's for-profit subsidiaries that
were designed for his benefit and that of other Plan
officials and Board members.
C. Inadequate Regulation by State Insurance Departments
9. State Insurance regulators were hesitant, reluctant, and
even afraid to take decisive action against a Plan for fear of
the effect such action might have on the large number of
policyholders involved. In effect, the Plans examined became
too-big-to-fail and/or to be effectively regulated, as
reflected in the following:
a. regulators overseeing the Plans examined often
accorded them special treatment and made forebearances
for them. The Subcommittee found instances where assets
of questionable value were allowed to be counted toward
meeting statutory reserve or other important reporting
requirements; official decisions were reversed when
such action accrued to a Plan's benefit; premium
increases were readily granted; and, Plans were allowed
to ignore regulations, directives, and remedial
recommendations with impunity.
b. regulators in some cases ignored or failed to
fully utilize examination results and other information
available to them, which described the Plans' problems
and set forth specific recommendations for further
action.
c. regulators in the concerned States failed to use
available means to enforce their authority over the
Plans.
d. regulators in the concerned States were often
unaware of or not fully informed about significant Plan
activities, such as the establishment of for-profit
subsidiaries and the major problems they subsequently
caused.
e. regulators in some cases were subject to political
pressure exerted on behalf of the Plans, which
undermined and/or negated oversight and enforcement
efforts.
f. regulators in the concerned States were hampered
in their oversight efforts by inadequate staff,
resources, and/or statutory authority, and the Plans'
ability to evade and resist such efforts.
10. As a result of a Federal statutory exemption from
District of Columbia insurance regulation, oversight of the
D.C. Plan rested on limited efforts by Maryland and Virginia
regulators to oversee that portion of the Plan's business
underwritten in their jurisdictions.
D. Inadequate Oversight by the Blue Cross/Blue Shield Association
11. While being aware of these Plans' serious problems, the
Blue Cross/Blue Shield Association failed to act decisively to
correct those problems. For example, the Association failed to
enforce its membership standards, even after long-term
monitoring had shown that a Plan was not meeting specified
reserve and liquidity requirements.
12. Association officials were extremely reluctant to act
against the Plans, fearing that their only effective means of
enforcement--i.e., the ``ultimate weapon'' of revoking the Blue
Cross/Blue Shield trademarks--would seriously injure the image
of the Blue Cross/Blue Shield system and leave them with the
difficult task of having to find substitute coverage for the
affected policyholders.
13. The Association failed to systematically share in a
timely manner the important information it had concerning the
Maryland, District of Columbia, and Empire Plans' problems with
the appropriate State insurance authorities and Plan Boards,
even after the West Virginia Plan had failed and the other
Plans had become seriously impaired.
FEDERAL CONTRACTS
A. Mismanagement
14. Blue Cross/Blue Shield's mishandling of its Federal
contract responsibilities has resulted in millions of dollars
in unnecessary, wasteful, and/or questionable costs incurred by
the Federal government and, in some instances, subscribers.
a. excessive layers of bureaucracy involved in the
Federal Employee Program (FEP) contract--i.e., the Blue
Cross/Blue Shield Association, the FEP Director's
Office, the FEP Operations Center, and the 67
participating Plans--have added unnecessarily to the
Federal government's FEP program costs.
b. Blue Cross/Blue Shield Plans participating as FEP
and Medicare contractors have billed the Federal
Government for tens of millions of dollars in charges
that have been questioned and/or disallowed. In the
FEP, since 1988 the Office of Personnel Management,
Office of Inspector General (OPM/OIG), has questioned
more than $78 million in contract charges and
disallowed $51.6 million (66%) of that amount. Since
1992, the Department of Health and Human Services,
Office of Inspector General (HHS/OIG) has recommended
disallowing more than $40 million for improper charges
by Blues Medicare contractors.
c. Blue Cross/Blue Shield Plans have withheld
millions of dollars in hospital and provider discounts
from the Federal government and some FEP subscribers.
In the case of the subscribers, this has resulted in
higher and unfair out-of-pocket expenses.
d. reflecting the same irresponsible management
outlook and disregard for cost-containment uncovered in
the West Virginia, Maryland, District of Columbia, and
New York (Empire) Plans, the Blue Cross/Blue Shield
Association has billed the Federal Government for
millions of dollars in questionable and/or unnecessary
charges for FEP conferences and meetings, promotional
items, and executive compensation.
15. Poor performance on the part of some Blue Cross/Blue
Shield Medicare contractors has resulted in their being placed
on a ``watch list'' and/or being terminated by the Health Care
Financing Administration (HCFA). Eight of the 41 Blue Cross/
Blue Shield Plans participating as Part A intermediaries in
1993 were on the watch list and one of these was scheduled to
be terminated at the end of the 1994 contract year. Seven of
the 27 Blue Cross/Blue Shield Plans participating as Part B
carriers were on the watch list in that same year and another
three will not be renewed at the end of the 1994 contract year.
16. Extensive and recurring internal control weaknesses
among Blue Cross/Blue Shield Plans involved in the FEP have
resulted in duplicate payments, coordination of benefits
problems, and discrepancies in enrollment data that have caused
erroneous premiums to be collected and benefits to be paid.
These internal control deficiencies constitute an invitation to
fraud, particularly since anti-fraud efforts have generally
received minimal attention from the Blue Cross/Blue Shield
Association and the individual Plans.
B. Inadequate Regulation
17. Regulation by OPM and HCFA, the agencies responsible
for overseeing the Blue Cross/Blue Shield contracts with the
FEHBP and Medicare, has been marked by many of the same
inadequacies that the Subcommittee found in connection with the
West Virginia, Maryland, District of Columbia, and New York
(Empire) Plans, including:
a. uncooperative attitudes and evasive tactics on the
part of the Blue Cross/Blue Shield Association and the
individual participating Plans;
b. a tendency by regulators to treat the Blues in an
unquestioning and deferential manner, owing to their
size and market share,--i.e., the ``too-big-to-
regulate'' dilemma; and,
c. a serious lack of regulatory resources; resulting,
for example, in an inability to audit the participating
Plans on a timely basis.
C. Inadequate Oversight by the Blue Cross/Blue Shield Association
18. The Association's performance regarding its Federal
contract responsibilities exhibited most of the same
shortcomings identified in its failed oversight of the West
Virginia, Maryland, District of Columbia, and New York (Empire)
Plans. For example, OPM officials indicated that a lack of
guidance and oversight by the FEP Director's Office is the
biggest problem in FEP operations and subscriber service. In
the Medicare program, the Association does not monitor the
performance of Blue Cross/Blue Shield contractors and is thus
largely unaware of any problems they may be having in carrying
out their functions.
IV. CONCLUSIONS
A. Gross Mismanagement, Ineffective Regulation/Oversight Raise Concerns
About Blues' Ability to Serve Basic Purpose
Based on its investigation, the Subcommittee is concerned
about the ability of Blue Cross/Blue Shield Plans to continue
to serve their basic purpose of providing quality health care
coverage at an affordable price. In the cases we examined, the
accountability triad of oversight by Plan Boards of Directors
and the Blue Cross/Blue Shield Association, and regulation by
State insurance authorities (and OPM and HHS in the case of the
Federal contracts) did not ensure that the Plans performed
efficiently and effectively. Plan executives were able to
operate in a grossly inept and unsound manner, while
deliberately blocking and evading the efforts of those charged
with regulating and overseeing their activities. The evidence
also highlighted the inability and/or unwillingness of
regulators, Plan Boards, and the Blue Cross/Blue Shield
Association to effectively carry out their responsibilities
regarding the Plans and their policyholders.
Accordingly, the Subcommittee believes that major
improvements are needed across-the-board in response to the
problems uncovered by its investigation. The management of Blue
Cross/Blue Shield Plans has to be improved substantially and
Plan operations have to be carried out in accordance with the
Blues' mission. In addition, State insurance authorities (and
OPM and HHS in the case of the Federal contracts), Plan Boards,
and the Blue Cross/Blue Shield Association have to
substantially improve their regulation and/or oversight of Plan
management and operations. The Subcommittee notes that should
States fail to improve their regulatory performance regarding
the Blues, this may prompt the need to consider a Federal role
beyond the narrow one maintained in terms of the FEHBP and
Medicare contracts.
B. Implications for Health Care Reform
The Subcommittee also believes that the serious problems
revealed regarding the Blues Plans examined and those charged
with their regulation and oversight may have implications for
the current debate on health care reform. Specifically, the
Subcommittee is concerned about the role Blue Cross/Blue Shield
Plans can and/or should play in any new or substantial revision
of the existing health care delivery system. They must correct
their operational problems, lack of accountability, and
inadequate performance in containing costs, to function
effectively as part of a revised health care delivery system.
Similarly, in considering the idea of a significant Blues role
in a reformed health care delivery system, the Subcommittee
notes that there is sufficient reason to question the ability
of State insurance authorities, Plan Boards, and the Blue
Cross/Blue Shield Association to effectively carry out whatever
regulatory and/or oversight responsibilities they may be given
in this regard. Indeed, one of the key dilemmas facing those
concerned with health care reform is how to resolve the
apparent problem posed by any potential role the Blues might
play in our health care system and the Subcommittee's findings
that the existing mix of State regulation and Association/Plan
Boards oversight are inadequate. The essential question
remains, if these entities cannot be counted on to do the job,
to whom will these essential functions be assigned?
V. RECOMMENDATIONS
In setting forth its recommendations,\8\ the Subcommittee
intends that they serve the dual purpose of providing a
blueprint for correcting the serious problems it has identified
in the Blue Cross/Blue Shield system, while at the same time
constituting an important reference point for the health care
reform debate. The pivotal issues raised in this Blue Cross/
Blue Shield investigation--i.e., corporate performance and
accountability, cost containment and protecting policyholders'
interests, and regulatory capability--are clearly among those
that will have to be addressed effectively for any proposed
health care reform effort to succeed.
---------------------------------------------------------------------------
\8\ The Subcommittee notes that in response to its investigation,
remedial actions reflecting the findings and conclusions are under
consideration and/or have already been instituted by the Maryland
legislature and Insurance Division, the District of Columbia
Superintendent of Insurance, the New York Insurance Department, the
National Association of Insurance Commissioners (NAIC) and the Blue
Cross/Blue Shield Association.
---------------------------------------------------------------------------
With these thoughts in mind, the Subcommittee makes the
following recommendations:
A. Plan Performance and Accountability
1. eliminate management deficiencies and abuses
The Subcommittee received overwhelming evidence showing
that the problems--mismanagement, exorbitant salaries, wasteful
travel and entertainment expenses, internal control
deficiencies, and faulty underwriting--experienced by the Plans
examined were a reflection of a corporate culture and
operational approach that were inconsistent with Blue Cross/
Blue Shield Plans' non-profit status and special responsibility
to their policyholders. Indeed, the Blue Cross/Blue Shield
Association has already responded to some of the Subcommittee's
findings in this regard by providing for its assessments of
Plan performance to be communicated directly to the Boards
rather than through Plan CEOs, and by requiring that the Boards
adopt a code of conduct that shows that they are committed to
the highest level of business ethics.
While these measures are clearly steps in the right
direction, the Subcommittee believes that additional remedial
actions are needed and recommends that the Association:
--Lestablish cost containment guidelines and develop
related incentives to assure compliance;
--Ldevelop minimum standards regarding accounting and
internal control procedures and require that Plans
comply with them;
--Lrequire that compensation packages, i.e., salaries,
bonuses, and other benefits for corporate officers and
senior managers be a matter of public record;
--Lestablish guidelines to curtail waste and abuse in
travel and entertainment expenses;
--Ldevelop a policy regarding compensation of Board
members that helps to assure their independence;
--Lprohibit a Plan CEO from also serving at the same
time as Board Chairman;
--Lrequire Plans to develop and implement detailed
programs to deter and detect fraud; and,
--Lclosely monitor the performance of the Blue Cross/
Blue Shield Plans participating in the FEP and
Medicare.
In addition, in light of the mismanagement and extensive
operational problems found in the Plans examined, and the Blues
preeminent position in the health insurance industry, the
Subcommittee is concerned that such problems may also exist
among other health insurers. These concerns reflect testimony
by Blue Cross/Blue Shield officials in which they attempted to
justify questionable entertainment, travel, and marketing
expenses by asserting that they were necessary in order to
remain competitive and that others in their industry were doing
the same thing. The Subcommittee believes that the possibility
that such practices--and the underlying corporate culture that
aids and abets them--may be more widespread needs to be
examined, both in terms of their immediate effects and longer
term health care reform implications. Such an undertaking
should involve, but not necessarily be limited to, state
insurance regulators, the NAIC, Congress, and concerned
Executive Branch agencies.
2. plans must be accountable
As non-profit corporations, the Plans of the Blue Cross/
Blue Shield system have no shareholders to whom they must
answer and are not fully subject to the rigors of marketplace
competition. In the cases examined by the Subcommittee, the
Boards of Directors charged with holding Plan officials
accountable failed to fulfill their responsibilities in this
regard. While State insurance regulators are supposed to serve
as the ultimate authority to whom an insurer must answer, the
testimony presented demonstrated that they too failed to carry
out their responsibilities.
In light of these findings, the Subcommittee believes that
the critically important question--to whom are Blue Cross/Blue
Shield Plans accountable--needs to be examined, both in terms
of correcting the problems revealed by this investigation and
in the wider context of the current debate on health care
reform. Every effort must be made to improve the performance of
Boards of Directors and State insurance regulators in holding
Plan officials accountable and protecting the policyholders'
interests. For example, consideration should be given to
mandating the establishment of voluntary subscriber watchdog
groups, to monitor Plan performance and represent subscribers'
interests before Plan Boards of Directors, State legislatures
and regulatory bodies, and other relevant entities.\9\
---------------------------------------------------------------------------
\9\ Similar consumer advocacy organizations were established in the
late 1970s and early 1980s to represent the interests of utility
ratepayers. These advocacy organizations, known as ``Citizens' Utility
Boards'' (CUB), currently exist in states such as Wisconsin,
California, Illinois, and Oregon.
---------------------------------------------------------------------------
The Subcommittee also notes that the NAIC has recently
formed a Special Committee to look at issues relating to the
Blue Cross/Blue Shield Plans, and thus strongly recommends that
the question of accountability be placed high on its agenda. In
considering health care reform, this question of accountability
must be carefully addressed by the President, Congress, as well
as other interested parties.
3. insolvency safeguards
The disastrous effects of the West Virginia Plan's
failure--in unpaid claims and diminution in and/or loss of
coverage--emphasized the need for measures to provide added
protection for other Blue Cross/Blue Shield Plan subscribers in
the event of an insolvency. At the time of our investigation,
only 25 of the more than 70 Blue Cross/Blue Shield Plans were
participating in state guaranty funds. The Subcommittee notes
that the Blue Cross/Blue Shield Association has moved to
require its member Plans to either participate in a state
guaranty fund or institute some other acceptable type of
financial safeguard (e.g. creating a special reserve). In
addition, the National Association of Insurance Commissioners
(NAIC) is presently considering whether and how Blue Cross/Blue
Shield Plans can and/or should be integrated into state
guaranty fund systems.
While the Subcommittee is encouraged by the Association's
action in this regard, we believe that State regulatory
authorities also need to be involved to assure that concrete
action to protect policyholders is undertaken as quickly as
possible. Accordingly, we recommend that the NAIC expedite its
efforts along these lines and that, in addition to these
efforts, individual State legislatures and insurance
departments act to ensure that Blue Cross/Blue Shield Plan
policyholders in their jurisdictions are afforded protection
against an insolvency.
4. uniform solvency standards
A number of witnesses discussed the absence of uniform
solvency standards and financial reporting requirements
regarding the Plans of the Blue Cross/Blue Shield system. For
example, the District of Columbia Superintendent of Insurance
indicated that the dramatically different solvency standards in
effect in the District, Maryland, and Virginia were not in the
policyholders' best interests. The clear implication is that
while the D.C. Plan might reach a stage where it would be
considered insolvent in one State, it could theoretically still
continue to operate in another State whose solvency
requirements it had not violated.
The Subcommittee recommends that the NAIC and Blue Cross/
Blue Shield Association, jointly or separately, develop
specific solvency standards, financial reporting requirements,
and other additional measures as needed, to apply uniformly to
all Plans. The Subcommittee notes that both the NAIC and
Association have already begun to consider such questions and
urges them to make this effort a high priority and bring it to
a successful conclusion as quickly as possible.
The Subcommittee further recommends that the NAIC and State
regulatory authorities mandate the use of Generally Accepted
Accounting Principles (GAAP) for the reporting of financial
information by insurers. As stated in the Subcommittee's Third
Interim Report on efforts to combat fraud and abuse in the
insurance industry,\10\ statutory accounting principles--the
other accounting methodology used in the reporting of financial
information--are too flexible to provide an accurate picture of
an insurer's financial soundness.
---------------------------------------------------------------------------
\10\ Third Interim Report on United States Government Efforts to
Combat Fraud and Abuse in the Insurance Industry: Enhancing Solvency,
Regulation and Disclosure Requirements--A Case Study of Guarantee
Security Life Insurance Company, Senate Report 103-29, March 23, 1993.
The other two reports issued by the Subcommittee pursuant to its
investigation of the insurance industry are: Interim Report on
Combatting Fraud and Abuse in Employer Sponsored Health Benefit Plans,
Senate Report 102-262, March 12, 1992; and, Second Interim Report on
U.S. Government Efforts to Combat Fraud and Abuse in the Insurance
Industry: Problems with the Regulation of the Insurance and Reinsurance
Industry, Senate Report 102-310, July 1, 1992.
---------------------------------------------------------------------------
5. information sharing
The Subcommittee found that a great deal of important
information regarding the financial problems and management
abuses in the Plans examined was in the hands of the Blue
Cross/Blue Shield Association and the concerned State
regulatory authorities before the Plans became impaired. Such
information, according to the Subcommittee staff and other
witnesses, was not shared between or among these various
entities, with clearly adverse effects. Without such
information, state insurance authorities were not fully aware
of the severity of the problems at a given Plan, nor did they
have sufficient information upon which to make the most
informed and timely regulatory decisions.
In response to this situation, the Subcommittee recommends
that:
--Lthe Blue Cross/Blue Shield Association in a timely
manner share all relevant information regarding both
itself and the individual Plans with the appropriate
state and federal regulatory authorities;
--Lstate insurance authorities improve and expand their
procedures to share information concerning a Plan
operating simultaneously in several jurisdictions, such
as the instant case of the D.C. Plan and its activities
in the District of Columbia, Maryland, and Virginia;
and,
--Lagencies of the U.S. Government involved in some
official capacity with Blue Cross/Blue Shield Plans,
such as the Department of Health and Human Services and
the Office of Personnel Management, develop procedures
to make available to the appropriate state insurance
authorities all reports and reviews of Plan operations.
B. Regulation/Oversight
6. more effective State and Federal role
The Subcommittee received testimony conclusively showing
that in the cases examined State insurance regulators, as well
as OPM and HHS regarding the FEHBP and Medicare, were unable
and/or unwilling to deal effectively with the Plans operating
in their jurisdictions and/or areas of responsibility. The
Subcommittee strongly believes that regulatory authorities can
and should do more in their efforts to oversee the Plans of the
Blue Cross/Blue Shield system and recommends that States:
--Lprovide increased staff, training, and resources to
their insurance regulatory bodies;
--Lestablish cost containment guidelines and develop
related incentives to encourage compliance;
--Lrequire that the information used as the basis for
granting rate increases be made available to the
public;
--Lutilize existing subpoena and/or investigatory
authority and, where none exists, seek such powers from
their legislatures; and,
--Lseek enactment of statutory authority to:
* Lprohibit the creation or alteration of
subsidiaries and affiliates without prior
written notice;
* Lestablish specific reporting requirements
including, but not necessarily limited to,
audited financial statements for all wholly-
owned subsidiaries or affiliates, detailed
consolidated financial statements, and internal
and external audits or studies;
* Lexamine all books and records of affiliates
and subsidiaries at any time deemed necessary;
* Lrequire that a Plan get prior written
approval for a sale or liquidation of any
significant assets;
* Linstitute administrative fines applicable to
the Plan, as well as its Officers and
Directors, for failure to respond on a timely
basis to lawful orders;
* Lremove Officers and Directors if, after due
process, a determination is made that members
of either and/or both groups have failed to
comply with lawful orders; and,
* Lmake health insurance fraud a felony and
enhance existing criminal and civil penalties
for violation of relevant insurance laws and
regulations.
Regarding the FEHBP and Medicare, we recommend that:
--LCongress and the Administration consider giving both
OPM and HHS the authority to openly and competitively
bid the FEHBP and Medicare Parts A and B contracts, and
to contract directly with the Blue Cross/Blue Shield
Plans, rather than the Association, in connection with
the FEHBP and Medicare Part A contracts;
--Lthe appropriate Congressional Committees review and
consider providing additional resources for OPM's
Contracting Office, the OPM Office of Inspector General
and HHS Office of Inspector General to enable them to
better perform their regulation and oversight
functions;
--LOPM and HHS establish cost containment guidelines
and develop related incentives to encourage compliance;
--LFederal contracts policies and procedures be revised
as appropriate to:
* Lrequire Plans to collect, utilize, and
maintain standardized information before paying
claims;
* Lallow easier termination of a contractor for
repeated violations of the contract or
regulations and for failing to: cooperate with
the Government in an audit or investigation;
promptly provide access to files and records;
and, resolve audit findings in an expeditious
and reasonable manner; and,
* Lin the case of the FEHBP, establish a
centralized enrollment system.
--LThe appropriate Committees of Congress should
carefully review the annual amount of individual
compensation health care contractors can charge the
Federal government in combined salary and benefits.
7. intermediate enforcement measures
The Subcommittee found that State insurance regulators and
officials of the Blue Cross/Blue Shield Association were
severely hampered in their efforts to respond to the abuses and
problems found in the Plans examined because they felt that the
only enforcement tool available to them was in the form of ``an
ultimate weapon.'' For State regulators, this meant declaring a
Plan insolvent and placing it into receivership; for the
Association, it meant acting to remove a Plan's Blue Cross/Blue
Shield trademarks. The Subcommittee recommends that the
Association, the NAIC, and/or individual State insurance
authorities act expeditiously to develop and institute
intermediate enforcement measures, including fines against the
Association and/or its officers. Efforts along these lines
might be undertaken by the NAIC and the Association jointly.
8. federal criminal/civil sanctions for insurance fraud
To ensure that health benefits and insurance premiums are
adequately protected from internal fraud and abuse, Congress
and the Administration should consider establishing Federal
criminal and civil sanctions for the violation of fiduciary
responsibilities within the insurance industry. The health
insurance industry is entrusted with billions of dollars of
subscribers premiums and, as such, has a fiduciary duty to see
to it that those funds are not squandered or misappropriated.
The Subcommittee believes that its Blue Cross/Blue Shield
investigation highlights the need for such sanctions, for
example, as indicated by the possibility that in certain cases
involving hospital/provider discounts and coinsurance payments
some Blues Plans may have violated prohibited transaction
requirements stipulated by the Employee Retirement and Income
Security Act (ERISA). Indeed, the Subcommittee further
recommends that these potential ERISA violations be reviewed by
the Department of Labor, the agency responsible for overseeing
the activities carried out pursuant to this law.
9. review of plan non-profit tax benefits
The Subcommittee found that the Blues Plans examined abused
their non-profit status, e.g., West Virginia Plan managers
engaged in a highly risky type of investment trading that its
auditors said was not appropriate for a company of its type. In
addition, top managers of these Plans operated them in a
grossly irresponsible manner, for example, by using
policyholders' premiums for excessive executive compensation
packages, lavish parties and entertainment, luxury travel and
transportation, and charitable contributions. Given these
abuses, the Subcommittee recommends that the Administration
review the Federal tax status of the Blue Cross/Blue Shield
Association and the individual Plans of the Blue Cross/Blue
Shield system, to ascertain whether they continue to warrant
the special tax advantages accorded them as non-profits.
10. enhancing District of Columbia insurance authority
The Subcommittee believes that the District of Columbia
should continue its efforts to swiftly enact and implement the
legislation and regulations necessary to enable its
Superintendent of Insurance to effectively oversee GHMSI's
operations. Toward this end, the Subcommittee recommends that
the Congress provide all necessary support, including, but by
no means limited to, enacting legislation to dissolve GHMSI's
Congressional charter.
VI. APPENDIX: CASE STUDIES
THE WEST VIRGINIA PLAN
A. Background/Organization
Blue Cross/Blue Shield of West Virginia, Inc. (the West
Virginia Plan) was incorporated as a non-profit health service
corporation in West Virginia in 1983. Headquartered in
Charleston, it employed approximately 700 employees over the
seven years it was in existence and, at its peak in 1983 had
some 379,000 subscribers. It was formed as a result of a merger
between Blue Cross/Blue Shield of Southern West Virginia
(Charleston) and Blue Cross/Blue Shield of Northern West
Virginia (Wheeling). In 1984, the Blue Cross/Blue Shield Plans
of Morgantown merged with the West Virginia Plan, completing
the consolidation of Blue Cross and Blue Shield operations in
the State with one exception--West Central Blue Cross/Blue
Shield (Parkersburg).
During its seven-year existence, the West Virginia Plan's
organizational structure consisted primarily of three types of
entities: those involved in underwriting and servicing its core
lines of Blue Cross/Blue Shield insurance business; a for-
profit stock holding company; and, a number of for-profit joint
ventures with the Blue Cross/Blue Shield Plans of Maine, New
Hampshire, and Vermont. The for-profit external business
activities were deeply involved in the West Virginia Plan's
rapid financial decline and ultimate collapse.
B. Financial Profile
The Plan, according to its financial records, incurred
losses in all but two years of its existence. Total losses
amounted to approximately $69 million, while about $13 million
was made in 1984 and 1985.\11\ By 1987, the Plan was insolvent
and its reserves (or net worth) continued to decline
drastically, so that by the end of 1989 they had reached a
negative balance of $31 million. Ironically, while the number
of subscribers dropped from a high of 379,385 at the end of
1983 to 273,695 in 1989, during the same period the premium
income increased from $213 million to $252 million. However,
despite this increase in premium income, the Plan still lost
money.
---------------------------------------------------------------------------
\11\ Although Plan gains exceeded losses in 1984 and 1985, the Blue
Cross/Blue Shield Association noted that the entire system experienced
similar profitability trends at that time, influenced by an upturn in
the underwriting cycle and a nationwide drop in health care claims.
---------------------------------------------------------------------------
C. Problem Areas
The Plan's decline, insolvency, and ultimate seizure by the
West Virginia Insurance Department in 1990 were primarily
caused by a combination of: mismanagement; inadequate Board of
Directors' oversight of management policies and actions; and,
inadequate regulation and enforcement by the West Virginia
Insurance Department.\12\ While not found to be a factor that
directly contributed to the Plan's failure, inadequate
oversight of Plan operations and activities on the part of the
Blue Cross/Blue Shield Association was also a problem area.
---------------------------------------------------------------------------
\12\ Plan officials James Heaton (President and Chief Executive
Officer), Salvatore Torrisi (Executive Vice President and Chief
Operating Officer), and Donald Wagenheim (Chairman of the Board of
Directors) maintained that the Plan's problems and collapse were not a
consequence of their mismanagement, but the result of factors beyond
their control, including cost shifting from West Virginia hospitals and
a general decline in the West Virginia economy. While such factors may
have contributed to the Plan's problems in some small way, the
overwhelming evidence accumulated by the Subcommittee shows they cannot
explain the Plan's dramatic decline and ultimate failure. If
controlling, such factors logically should have also affected the
Parkersburg Blue Cross/Blue Shield Plan. However, there was no evidence
of any major adverse effects on the Parkersburg Plan, which was
profitable until its merger with Blue Cross/Blue Shield Mutual of Ohio
(the Cleveland Plan).
---------------------------------------------------------------------------
1. Mismanagement
a. Flawed Management Approach
Regulatory officials, Plan employees, Board members,
consultants, and outside accountants provided testimony on
management's questionable actions and decisions. The Plan's
Labor Consultant from 1985-1990 said that the management was so
bad he could only assume that the Plan was being ``managed to
fail.'' A former Plan Executive Vice President, with 20 years
of experience working at various Blue Cross/Blue Shield
organizations resigned in 1986 after having concluded that Jim
Heaton's policies and actions were leading the Plan to a
``significant downward turn [and] turbulent financial ride.''
In addition, a management consultant with years of Blue Cross/
Blue Shield experience, hired by Heaton in 1984 to head the
Plan's planning staff, advised the Subcommittee Staff that upon
becoming familiar with Heaton's management style and major
policy decisions, he concluded that the Plan was doomed and
resigned.
Fred E. Wright, the former Insurance Commissioner for the
period 1985-1988, said the Plan's 1984 decision to buy the old
Sears Building in South Charleston to turn into its new
corporate headquarters was ``a crazy idea.'' He called the
purchase ``puffery...an edifice to the glory of management,''
which was not justified by the Plan's needs, made at a time
when the Plan had serious financial problems (e.g., in 1983,
the Plan had $2.4 million in underwriting losses and, at the
end of the same year, had a surplus sufficient to cover only
one week's claims).
b. Proliferation of Subsidiaries
Heaton and other Plan officers established a number of for-
profit subsidiaries and affiliates that were essentially for
their personal gain rather than for the benefit of the
subscribers. This scheme, which was part of a reorganization
launched by Heaton in 1984, violated management's fiduciary
responsibility to the subscribers. Though funded by Blue Cross/
Blue Shield money, the potential profits from these ventures
would not have benefitted the Plan or its subscribers. Heaton
said that he saw nothing wrong with establishing these for-
profit affiliates and subsidiaries, further underscoring his
apparent lack of appreciation for any fiduciary responsibility
to the Plan's subscribers.
These for-profit external businesses also violated the
``corporate opportunity doctrine,'' which holds that a director
or officer of a corporation may not take advantage of a
business opportunity that rightly belongs to the corporation.
In a 1984 letter, for example, one of the Plan's legal advisors
warned:
The plan of reorganization * * * raises several areas
of concern dealing with the `corporate opportunity
doctrine'. * * * [A] sale of all of the stock of the
subsidiary of Blue Cross/Blue Shield to the individual
members, or a corporation controlled by the members,
even at fair market value, might raise concerns as to
whether the members were taking a 'business
opportunity' from Blue Cross/Blue Shield. * * * In the
present situation, corporate officers and directors
might be considered to be taking personal advantage of
an enterprise already profitable to Blue Cross/Blue
Shield. Although the motive for splitting-off the
subsidiary corporation is bona fide, the fact that
future profits may be diverted from the parent
corporation to individual directors or members raises
at least the specter of impropriety.
Finally, these external ventures diverted millions of
dollars (at least $1.8 million in start-up costs alone,
according to Insurance Department figures) from other areas of
activity at a time when the Plan was experiencing serious
financial problems. As one Insurance Department auditor
explained:
The problem with the subsidiaries was especially
serious since it would appear to aggravate the already
shaky financial condition of the West Virginia Plan. It
is one matter to create subsidiaries, but it was
particularly troubling to find the Officers and Board
considering to diversify and create a multitude of
affiliates and subsidiaries when the parent Plan was
losing money. Our question was where the money would
come from to pay for these new ventures.
c. Internal Control Deficiencies
In a 1987 examination, the Plan's outside accountants,
Ernst & Young, identified numerous deficiencies in the Plan's
internal system of controls, recordkeeping, and accounting
practices. It took 68 pages in their report to detail the
weaknesses found and to list the extensive improvements needed.
Most significantly, Ernst & Young cited five material
weaknesses in the Plan's internal accounting controls for
accounts receivable and investment activity.\13\
---------------------------------------------------------------------------
\13\ A material weakness is a deficiency in an entity's internal
control structure so significant that there is more than a relatively
low risk that errors or irregularities may occur and not be detected
within a timely period.
---------------------------------------------------------------------------
During this same internal control examination it was also
discovered that the Plan was engaged in a highly risky type of
investment trading--hedging and speculating in stock price
fluctuations--which the auditors believed was neither
appropriate for a company of its type nor permissible under the
West Virginia Insurance Code.\14\ Records indicate that Plan
management had only a limited knowledge of how the market for
these investments actually worked or the potential for
significant losses. While the Plan subsequently ceased this
investment activity, its involvement still resulted in more
than $2.3 million in losses.
---------------------------------------------------------------------------
\14\ The Insurance Department subsequently determined that the
Plan's participation in these investments was, in fact, a violation of
the West Virginia Insurance Code because borrowed money was used to
finance the transactions. The Department filed a $2.3 million suit
against Shearson Lehman Brothers and E.F. Hutton, the firms that
advanced loans for the transactions and advised the Plan on the
specific investment strategy utilized. This suit was settled in August
1993 for $775,000.
---------------------------------------------------------------------------
d. Questionable/Poor Underwriting Practices
Numerous sources said that the Plan was consistently
undermined by ill-advised underwriting decisions. The Vice
President for Finance, for example, said that the Plan took on
new clients without properly underwriting that business, in
order to generate more cash through premiums and recapture lost
market share. This decision, he added, resulted in the Plan
assuming more liabilities than it could handle.
In a 1990 document, Blue Cross/Blue Shield Association
auditors reported that the Plan's financial predicament was, in
part, a result of its tendency to ``focus on enrollment rather
than profitability.'' An analysis by the West Virginia Hospital
Association concluded that one of the major factors that
contributed to the Plan's failure was ``terrible underwriting
decisions * * * throughout the 1980's which found Blue Cross
acquiring business and then losing millions of dollars as they
gambled to expand marketshare.''
e. Excessive Salaries
While salaries hardly increased for the Plan's 700 or so
employees, those for Heaton and the other nine highest paid
officers rose precipitously. These increases occurred most
pointedly between 1984-1989, when the Plan was in serious
financial difficulty. For example, while total salaries for the
Plan's top ten officers was approximately $575,000 in 1984, by
1989 that figure had risen to more than $900,000. During this
same timeframe, Heaton's salary nearly doubled, from $85,000 to
$160,000.
2. Inadequate Oversight by the Board of Directors
The Subcommittee received considerable testimony on the
Board of Directors' failure to perform its requisite oversight
of management policies and performance. Instead of protecting
the subscribers' interests, the Board was routinely manipulated
and misled by management and, in some instances, became
intertwined with the latter in questionable activity.
In January, 1984 Heaton moved to create a new governing
body within the existing Board, which effectively undermined
the Board's ability to properly perform its responsibilities.
This new governing body, the ``Board of Voting Members,'' came
to be known as the ``Super Board,'' and was comprised of
Heaton, Board Chairman Don Wagenheim, and a group of their
hand-picked associates. The new Board of Voting Members was the
only body empowered to: change the corporation's by-laws; elect
the directors on the Board; and, nominate new voting members.
In Heaton's words, ``control of the voting members allows for
control of the board.'' \15\ Among other things, this ability
to control the Board enabled Heaton to establish and operate
the Plan's highly questionable for-profit external ventures
with virtually no opposition from the Board.\16\
---------------------------------------------------------------------------
\15\ In a July 14, 1988 letter to the President of the District of
Columbia Blue Cross/Blue Shield Plan.
\16\ After discovering the creation of the Super Board in their
1984 audit of the Plan, Insurance Department examiners concluded that
it violated state-mandated requirements regarding the Board's
appropriate composition and directed that it be dissolved. The
Department's subsequent 1986 examination found that the Plan had not
complied with the earlier directive and the Super Board was still in
existence.
---------------------------------------------------------------------------
In an affidavit submitted to the Subcommittee, one longtime
Board member described the effect of the Super Board:
This special creation of a ``Super Board'' caused
some full Board members to resign. * * * Members became
much, much less involved * * * [and] soon, the Board
just went along with whatever management suggested, and
questions were not asked at Board meetings. The Board
was controlled and silenced.
The evidence also established that management routinely
misled and/or failed to inform the Board:
--Lregarding the Plan's involvement in the risky
investment activity--i.e., speculating in future stock
price fluctuations--described above, Board Chairman
Wagenheim told the Subcommittee Staff that ``he didn't
understand it then and * * * wouldn't understand it
today'';
--Lthe Board was unaware that the Plan incurred more
than $240,000 in expenses in settling a lawsuit brought
by a female Plan employee in relation to her long-
running affair with President Heaton; and,
--Lalthough the Board was informed in early 1988 that
the Plan was in a ``negative reserve'' condition, a
Board member noted that the word ``insolvent'' was
never mentioned (even though the Plan was insolvent at
that time). She noted that:
* * * Mr. Torrisi would continue giving
optimistic forecasts for recovery. He would
flash slides on viewgraphs, but not give us
copies of the information. The graphs only gave
limited snapshots of the financial condition of
the Plan. Financial forecasts were handed out,
but no one ever explained that the forecasts
were just based on management's opinion.
Questionable conduct on the part of Board Chairman
Wagenheim may also partly explain the Board's failure to
adequately carry out its responsibilities. In a number of
instances while serving as Chairman and Board member,
Wagenheim, at best, used very poor judgment or, at worst,
behaved unethically and/or knowingly involved himself in an
unlawful business transaction. Most notably, Wagenheim became
deeply enmeshed in the process by which his firm, H.E. Neumann
Construction Company, was awarded a $723,000 contract from the
Plan to do work in connection with the renovation of its
Charleston headquarters building.
In the Insurance Department's 1986 examination of the Plan,
the auditing team learned that Wagenheim's firm received the
contract even though it had not submitted the low bid and had
not been recommended by the architectural and design firm that
oversaw the bid process. The auditors felt that this was a
``sweetheart deal,'' in violation of West Virginia law and
recommended that Wagenheim be removed as Board Chairman.\17\
---------------------------------------------------------------------------
\17\ West Virginia law (Chapter 33, Sec. 4-17 and 33-24-4) strictly
bars officers and directors of an insurance company and/or Blue Cross/
Blue Shield Plan from profiting from their position in transactions
with the company. As explained below (see p. 24), the audit report
containing this recommendation was never filed and, therefore, no
action was taken to remove Wagenheim.
---------------------------------------------------------------------------
When deposed by the Subcommittee Staff, Wagenheim admitted
that he appointed the Building Committee that determined which
contractors would be solicited for bids and what bids would be
accepted. He also admitted that the Plan did not publicly
advertise bids for the rehabilitation of the new headquarters
renovation; instead, the Building Committee sent out
invitations to a limited number of companies--including H.E.
Neumann--to submit bids. In his deposition, Wagenheim saw no
problem with his actions in connection with the contract award
and no mention was made regarding it during Board and Executive
Committee meetings at that time. Indeed, one member expressly
said that she first heard about this situation only when
informed by the Subcommittee Staff. Chairman Wagenheim, it
should be noted, also served as Board Chairman of a number of
the for-profit enterprises the Plan's management established
during the 1980s, which were intended to benefit certain Plan
officials and Board members.
3. Inadequate Regulation by the Insurance Department
The West Virginia Insurance Department's efforts to oversee
the Plan and protect the interests of its subscribers were
inadequate. While the regulators knew about the Plan's problems
almost from its merger-based inception in 1983, they did not
move against it until 1990, by which time it had been insolvent
for almost three years and was essentially beyond any hope of
recovery. This inaction resulted from both the Plan's ability
to evade regulatory efforts and the Department's own inability
and/or unwillingness to take appropriate action in a timely
manner.
Past and present senior Department officials testified that
they had neither sufficient staff nor budget resources to
properly oversee the Plan's operations and the other insurance
companies under their jurisdiction. Former Commissioner Wright
testified that when he took over, the Department was ``a
mess,'' i.e., it had few experienced employees, was suffering
from high turnover, and had no comprehensive management policy
in place. In an affidavit provided to the Subcommittee, the
Counsel to the Insurance Commissioner from 1982 to 1989 stated
that:
In 1982, the Department had a small number of
employees, approximately 25 to 30. Only a handful of
those employees were professionals and I was the only
in-house attorney. We were charged with regulating the
activities of approximately 20 to 25 domestic insurers,
overseeing the business practices of over 1000 non-
domestic insurers and regulating the activities of
several thousand insurance agents and brokers. * * *
The former Counsel also notes that although resources increased
over time, during her tenure the Department still never had
sufficient staff or budget to be able to fully carry out its
regulatory functions.
The Department's ability to do its work was also hampered
by a lack of expertise and turn-over in the ranks of senior
employees. During the Plan's short-lived existence (1983-1990),
for example, there were three Commissioners and three Chief
Examiners. One of the Chief Examiners was removed for
incompetence and two of the three had no prior field
examination experience. Shortly after the completion of the
Department's 1986 examination of the Plan, the Chief Examiner
left to take a job with the Plan.
The Subcommittee also received testimony indicating that
the Department's failure to act against the Plan was also a
matter of its apparent unwillingness to do so. In 1984 and
1986, Department examiners reported the Plan's financial
decline, as well as questionable conduct on the part of
management and directors. In the 1986 report, the examiners
recommended that the Department seek to remove Heaton, Torrisi,
Wagenheim and most of the other Directors for violating their
fiduciary duty.
However, the Department did little if anything about either
of these reports and their findings and recommendations. For
reasons that remain unexplained, nearly a year intervened from
the time the 1984 report was submitted to the Commissioner and
when it was finally filed in 1985. The 1986 report was never
filed and, therefore, remained unavailable to the public.
In his deposition, former Commissioner Wright testified
that the main reason that the 1986 report was never filed or
acted upon was because ``there were just too many other more
important and pressing things to do at the time,'' including
the status of three financially distressed domestic insurers.
Nevertheless, the point remains that the Department's failure
to act on the report was to some considerable degree a matter
of choice. Indeed, in his deposition former Commissioner Wright
conceded that, in retrospect, he perhaps should have been more
aggressive and followed up on his examiners' recommendations.
The present Insurance Commissioner, Hanley C. Clark, told
the Subcommittee Staff that in part he did not act sooner
because he did not have the regulatory tools to do so.\18\ He
said that when he obtained the needed additional regulatory
authority in March, 1990, with the passage of West Virginia
House Bill 4195, he started to proceed against the Plan. Some
legal experts, however, informed the Staff that even from a
cursory reading of the Code, the Insurance Commissioner clearly
had the discretionary authority to refuse to renew, suspend or
revoke the license of the Plan for being ``in an unsound
condition or in such condition as to render its further
transaction of insurance in West Virginia hazardous to its
policyholders or to the people of West Virginia.'' \19\ Indeed,
Department representatives, such as current General Counsel,
Keith Huffman, and former Commissioner Wright, testified that
they did not use regulatory tools available to them, such as
public hearings and subpoena power, because of concerns about
litigation:
---------------------------------------------------------------------------
\18\ Prior to being named Commissioner in January, 1989, Mr. Clark
was either the Deputy or acting Commissioner for much of the Plan's
existence.
\19\ West Virginia Insurance Code, Sec. 33-3-11 (4).
---------------------------------------------------------------------------
Senator NUNN. But you had subpoena power, did you
not?
Mr. HUFFMAN. He [Commissioner Clark] had subpoena
power, Senator, but * * * if the department would have
issued subpoenas to * * * garner evidence * * * [from]
the National [Blue Cross/Blue Shield Association or
from] * * * E & Y [Ernst & Young], I guarantee you what
would have happened is that those entities would have
called down the street to their 200- or 300-lawyer firm
and tied the department up [for] so long * * * that
those subpoenas would not have been very effective at
all. * * *
Senator NUNN. Were you afraid to subpoena Blue Cross/
Blue Shield of West Virginia * * * because of their
lawyers?
Mr. WRIGHT. Senator, everything we did at that time
involving what I would call the bad insurance companies
or organizations developed into a war with lawyers. * *
*
Former and current officials also testified that the Plan
quite literally fought the regulators at every turn. Former
Commissioner Wright's Counsel, for example, stated that:
The relationship between Blue Cross and the
Department was rocky, full of contention and far from
pleasant. My perception of Blue Cross was that it made
little effort to cooperate with the Department and
seemed to almost automatically take a position in
opposition to suggestions or recommendations of the
Department. I questioned Blue Cross' willingness to
deal openly and fairly with the Department.
Both the former and current Commissioners echoed the
Counsel's remarks. In his testimony, for example, Commissioner
Clark stated that:
The relationship between the management of BCBSWV and
the Department could be characterized, at a minimum, as
very poor. In nearly every encounter with the BCBSWV
management, the Department staff came to expect
misinformation, deceit, arrogance, and defiance.
Commissioners Wright and Clark indicated that nothing ever
came easy in dealing with this Plan. Both described how they
would have to threaten litigation before the Plan would
voluntarily comply with a simple request that would be handled
pro forma by any other insurance company.
The Department's lead examiner on the 1986 exam, had this
to say about his dealings with the Plan:
Throughout this examination, the Plan's officers and
employees exhibited an arrogance to the law and an
unwillingness to cooperate with the examination. We
quickly learned that the Plan's Officers felt they were
'above the law,' and were very well connected
politically. The Plan's officers did not even attempt
to hide their displeasure that we were there.
4. Inadequate Oversight by the Blue Cross/Blue Shield Association
The Blue Cross/Blue Shield Association's role regarding the
Plan, indicates that it had sufficient information about the
Plan's problems and authority to take decisive action, but
failed to do so in a timely manner. In addition, the
Association failed to adequately convey its knowledge of and
concerns about the Plan's problems to the West Virginia
Insurance Department.
Beginning in 1987, a year after the Plan's financial
problems had led to a loss of nearly $3 million, the
Association took the serious step of placing it on conditional
status for failing to comply fully with a membership standard
involving financial responsibility, i.e., failing to have
sufficient reserves on hand to meet at least 1.5 months of
potential claims. Conditional status was renewed in 1988, after
Association staff made an on-site visit to the Plan to examine
its 1987 performance results. In the March, 1988 report
summarizing the results of their visit, the Association staff
found that: the Plan's forecast of a $1.5 million gain in 1988
was unlikely and, instead, that significant losses could occur;
the Plan could be out of operating cash by late summer of that
year; and, because of the Plan's deteriorating financial
condition, there could be intervention by the State Insurance
Department.
In 1989, conditional status was again renewed, when the
Plan failed to meet the same reserve and liquidity requirements
it had not met in 1988, and also failed to satisfy a
requirement that financial reports be submitted in an accurate
and timely manner. The conditional status for 1989 reflected
the Association's April, 1989 review of the Plan, which found
that it had experienced four years of enrollment and market
share decline, in addition to net losses of $22 million and $19
million in 1987 and 1988, respectively. The April review also
pointed out that it was the Plan's ``precarious financial
condition'' that forced it to be placed on conditional status
in 1987 and 1988, and that management's response to these
problems had been largely unsuccessful.
Finally, in the spring of 1990, the Association's Plan
Performance and Monitoring Committee voted for non-renewal of
the Plan's license, the most serious sanction available to it.
However, a non-renewal recommendation could have been made at
least a year earlier, after the Plan had experienced three
consecutive years of declining financial performance and two
consecutive years of non-compliance with the financial
responsibility membership standard. At the very least, an
earlier threat of non-renewal of the Plans's membership by the
Association might have prompted an affiliation or some other
action that could have helped avert the Plan's ultimate seizure
and liquidation.
According to Association officials, action was not taken
sooner because of a series of promising developments, all of
which, however, eventually ``fizzled.'' In 1988, the West
Virginia Plan and the District of Columbia Plan (GHMSI) had
begun affiliation negotiations. In addition, at the end of 1988
the Plan's accountants, Ernst & Young, projected a $6.8 million
gain for 1989. Although this projection did not materialize and
West Virginia's problems continued in 1989, the Association
officials noted that the talks with GHMSI were ongoing and
Ernst & Young had again forecast positive results for 1990--a
projected gain of $8.9 million.\20\ Then, in early 1990, hopes
were again raised when Commissioner Clark approved a
significant rate increase for the Plan and affiliation talks
began with the Cleveland Plan. The Association officials also
stated that they did not move earlier to rescind the Plan's
membership status because that is a drastic measure they only
use as a last resort.
---------------------------------------------------------------------------
\20\ The Subcommittee staff were surprised to learn that
Association officials were unaware that the Ernst & Young forecasts
were compilations, rather than examinations. The officials told the
staff that since the West Virginia Insurance Commissioner had requested
and relied upon the forecasts, it never occurred to them that the
forecasts were not independently audited or verified.
---------------------------------------------------------------------------
According to the Insurance Department, the Association
concealed the true nature and extent of its concerns regarding
the Plan's problems and, by so doing, effectively contributed
to delays on the regulator's part to act against the Plan
before it became irreparably impaired. As early as 1986, the
Association was fully aware of the Plan's deteriorating
financial condition and had placed it on conditional status in
1987. The Association, however, failed to notify the Department
of this action and also failed to do so again in 1988 and 1989,
when the Plan's conditional status was continued.\21\
---------------------------------------------------------------------------
\21\ In his deposition, Plan President Heaton said that as a former
member of the Association's Board of Directors and with his more than
20 years of experience in the Blue Cross/Blue Shield system, he found
that the Association uses three techniques to stave off a Plan's
failure. It will first approach the regulators to get rate increases.
If that doesn't work, it will put political pressure on the
regulators--including, for example, going as far as threatening to pull
a Plan's trademark and service marks, which Heaton said he saw done in
the case of the New Jersey Plan. Finally, if all else fails, a merger
with another Plan will be pursued.
---------------------------------------------------------------------------
Commissioner Clark testified that in meetings from May 17-
23, 1988, Association representatives told Department staff
that the Plan was not experiencing more financial difficulties
than any other Plan in the Blue Cross/Blue Shield system, and
that these problems were related to a normal downturn in the
insurance cycle being experienced by all health insurers.
According to this testimony, Department staff were told that
the situation would improve in 1989. Commissioner Clark also
testified that the Association representatives advised the
Department that drastic action was not needed, although at the
same time they said that the Department ought to continue to
monitor the Plan.
The Commissioner explained the Department's ``huge
dilemma'' in this regard as follows:
Under laws in existence in the State of West
Virginia, if the Department sought rehabilitation or
liquidation of the plan, it would be faced with a full
adversarial hearing * * * in which it would be
necessary to demonstrate (over the strenuous objections
of management) that [such action] was in the `interest
of the policyholders, creditors, stockholders, members,
subscribers, or the public'. * * * As a practical
matter, the Department needed the support of * * * the
National [Association] against BCBSWV management in
order to take affirmative action. * * * There would
have to be expert testimony that the plan was insolvent
and would not recover on its own * * *, as well as a
workout plan to help retire the liabilities of BCBSWV *
* * and provide a solvent merger or affiliation
partner. * * * However, * * * the National [was]
aligned against such measures.'' \22\
---------------------------------------------------------------------------
\22\ In its role as Receiver, the Insurance Department filed a
civil suit against the Association in January 1992, alleging that its
conduct in connection with the Plan's failure was ``willful, wanton,
and malicious'' and in violation of the West Virginia Unfair Trade
Practices Act. The suit called for $34 million to cover outstanding
claims resulting from the Plan's failure; $10 million in extra
contractual damages for annoyance, inconvenience, hardship, and mental
anguish; and, another $10 million for punitive damages. This suit was
settled in March 1992, with the Association agreeing to pay the
Department $8.6 million.
---------------------------------------------------------------------------
D. Effects
For thousands of West Virginia subscribers, providers, and
others, their lives and/or businesses were thrown into turmoil
as a result of the Plan's failure. The Plan's demise left
subscribers with more than $40 million in unpaid claims. An
administrator of and participant in his small company's
employee health benefits plan, testified that he personally
lost $23,000 due to non-payment of benefits. The financial
pressure placed on him and his family as a result of his unpaid
medical bills became so great that at one point he seriously
considered declaring bankruptcy.
Another subscriber, who was left with more than $37,000 in
unpaid medical bills for services rendered in treating her
serious cancer condition, described the difficulties she faced:
To stop the harassment from the medical providers for
payment that they had been denied by the failed Blue
Cross Plan, and to prevent creditors from putting a
judgment against my home, I had to start making monthly
payments. * * * Not only do I have to worry about
having cancer, I now have to worry about the bills. * *
*
This constant worry about the medical bills and where
the money is going to come from to pay them has put me
under a lot of additional stress, as I worry about the
possibility of losing our home.
At the time of the Subcommittee's hearings this individual had
no health insurance at all.
Some West Virginia Plan subscribers were also dramatically
affected by premium increases. For example, one of the
witnesses who testified about the impact of the Plan's failure
explained that in the wake of its demise many firms were
unwilling to trust the successor plan, Mountain State Blue
Cross/Blue Shield. When some of these firms signed up with
other health insurers, Mountain State increased premiums for
its high-risk subscribers by more than 60%. This action, he
said, ``hit home'' for him because the pastor of his church had
to drop his family's coverage when his premiums increased from
$500 to over $800 a month. In their testimony, the Subcommittee
Staff confirmed that many West Virginia Plan subscribers lost
their coverage as a result of this staggering premium
increase.\23\
---------------------------------------------------------------------------
\23\ Generally speaking, the Plans examined by the Subcommittee had
little difficulty in obtaining desired premium increases.
---------------------------------------------------------------------------
Lastly, the Subcommittee also found that the Plan's failure
had major consequences for providers. Testimony submitted by
the West Virginia Hospital Association states that the more
than $40 million in unpaid medical bills for services already
provided to Plan subscribers had a ``substantial'' effect on
providers.
THE MARYLAND PLAN
A. Background/Organization
Tracing its roots back to predecessor organizations formed
in the late 1930s, the Blue Cross/Blue Shield plan of Maryland
(BCBSM) was established as a result of the 1985 merger of the
State's separate Blue Cross and Blue Shield plans.
Headquartered in Owings Mills, BCBSM was serving approximately
1.4 million Marylanders (nearly 30% of the State's population)
in 1992. In addition, at the time of the Subcommittee's
hearing, BCBSM employed approximately 4,500 individuals and in
1991 took in $1.7 billion in total revenue.
From the mid-1980s onward, BCBSM's organizational structure
included three types of operational entities: those involved in
underwriting and servicing its core Blue Cross/Blue Shield
insurance business; for-profit subsidiaries with some health-
related purpose; and, for-profit subsidiaries with no health-
related purpose. In 1985, BCBSM's structure was fairly simple,
consisting of the parent company and two subsidiaries. By 1991,
however, it had become extremely complicated by the addition of
another 29 subsidiaries and three limited partnerships.
B. Financial Profile
From 1986 through 1988, BCBSM incurred operating losses of
$110 million and its net worth declined dramatically from $67
million to $17 million.\24\ Reflecting these losses and reduced
net worth, a 1987 Maryland Insurance Division examination found
that BCBSM had achieved a deficit position of $1.2 million.\25\
Between 1985 and 1989 the Plan's reported reserves declined
precipitously from $122 million to $16 million.
---------------------------------------------------------------------------
\24\ Since 1989, BCBSM has reported operating gains of $121 million
and an increase in net worth of $85 million as of June 30, 1992.
However, according to the Subcommittee staff, these figures may be
substantially overstated because accepted accounting rules and asset
valuation procedures have not been strictly followed by BCBSM. See
related discussion below, p. 42.
\25\ This examination was never formally completed. See related
discussion below, p. 39.
---------------------------------------------------------------------------
In a July 17, 1992 letter to the Governor, the Maryland
Insurance Commissioner, John A. Donaho, observed that, ``in
broad terms, BCBSM may be 60-65 percent weaker at December 31,
1991 than it was at December 31, 1984.'' On the basis of its
April, 1992 business performance review of BCBSM, the Blue
Cross/Blue Shield Association concluded that the Plan's reserve
position was ``low and tenuous.''
Since 1986, the Plan's subsidiary companies had incurred
total losses of $120 million. During this same timespan the
Plan made capital infusions of more than $170 million to its
HMO and non-insurance subsidiaries. Between 1987 and 1990,
BCBSM's external auditors refrained from issuing a ``going
concern'' audit opinion on its HMO subsidiaries, but only after
Plan officials said that they would guarantee the latters'
solvency.\26\
---------------------------------------------------------------------------
\26\ A going concern opinion indicates that the auditors have
substantial doubt that the entity examined will be in business one year
from the date of the audit.
---------------------------------------------------------------------------
C. Problem Areas
Some of the same key factors associated with the demise of
the West Virginia Plan were present in varying degrees at
BCBSM.\27\ Specifically, the testimony established four broad
problem areas: mismanagement; inadequate oversight by the Board
of Directors; inadequate regulation by the Maryland Insurance
Division; and, inadequate oversight by the Blue Cross/Blue
Shield Association.\28\
---------------------------------------------------------------------------
\27\ In their testimony the Subcommittee staff offered two
cautionary notes on this point. First, they explained that while there
were major similarities in the problems at the West Virginia and BCBSM
Plans, there were also a number of important differences, including: no
evidence was uncovered that top BCBSM officers or Board members had
engaged in self-dealing or created subsidiaries for their personal
enrichment; and, BCBSM's President did not create a ``Super Board,''
consisting of himself and certain hand-picked associates, in an effort
to control the Plan and circumvent existing regulatory requirements.
Second, the Staff cautioned that the similarities in the Plans'
problems did not mean that BCBSM was on the verge of imminent failure.
Rather, they suggested that BCBSM could ultimately become as impaired
as the West Virginia Plan, if its problems were not addressed in a
timely manner.
\28\ BCBSM officials did not dispute the Subcommittee's findings,
although in their testimony they did cite other factors--e.g., the
1986-1988 downturn in the health insurance industry, increased
competition from for-profit insurance companies, and dramatic changes
in health care industry products and services--to explain the situation
that confronted the Plan from the time of its establishment in 1985.
However, within a week of the hearings, the Board met and removed Carl
Sardegna as its Chairman and appointed a special committee to examine
the issues raised by the Subcommittee. The results of this special
committee's review corroborated virtually all of the Subcommittee's
findings regarding BCBSM's management and operations.
---------------------------------------------------------------------------
1. Mismanagement
As in the West Virginia Plan, mismanagement and
questionable management decisions were inextricably bound up in
BCBSM's financial difficulties. An August 11, 1992 letter from
Commissioner Donaho to the Governor seriously questioned
BCBSM's management decisions:
The Blue's generally poor financial condition is a
result of years of a combination of mismanagement and
inadequate rates. 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 a
question.\29\
---------------------------------------------------------------------------
\29\ Commissioner Donaho's concerns about BCBSM's management are
shared by a number of his predecessors. In interviews with the Staff,
for example, one former Commissioner called BCBSM's management
structure ``awful,'' while another said that when it comes to the
Plan's management, ``you don't know what they're doing as a regulator,
then you realize that they don't know what they're doing, and what they
do most of the time is wrong.''
---------------------------------------------------------------------------
a. Proliferation of Subsidiaries
In reviewing the 29 subsidiaries and three limited
partnerships that BCBSM purchased or formed between 1985 and
1991, the Subcommittee found a pattern of disjointed and
confused management decisions surrounding their establishment
and operation. There was no clearly stated long-term management
strategy regarding these ventures and some of them were
established but never became operational.
When a subsidiary was having financial problems, BCBSM
funds were routinely, and generally without question, used to
bail them out. According to documents subpoenaed from BCBSM,
the subsidiaries lost nearly $72 million between 1986 and 1991.
BCBSM officials subsequently acknowledged that total subsidiary
losses were in excess of $120 million. Again, comments by
Commissioner Donaho in his August 11, 1992 letter to the
Governor are revealing:
Rather than approaching a new scheme conservatively
with careful estimates, they [BCBSM management] plunge
ahead without concern as to when or if the investment
will be returned. The Smart Card [LifeCard
International] and Health Credit Card [HealthLine] are
perfect examples of the drain of cash caused by
mismanagement of our Blues.\30\
---------------------------------------------------------------------------
\30\ According to the Subcommittee staff's analysis, between 1987-
1991 total losses from HealthLine operations were $15.4 million;
between 1985-1991, LifeCard International losses were $30 million.
Examples of BCBSM mismanagement involving these subsidiaries include:
the pilot program for BCBSM employees to acquire HealthLine's Medcash
card (a credit card for charging medical bills, weight loss clinic and
fitness center expenses, and medical products) had no credit standards,
which resulted in significant delinquencies and defaults; and, fitness
centers were known to be risky businesses for credit card purposes and,
by 1992, nearly half of Medcash's charges (about $3.3 million) were
from transactions at these concerns.
---------------------------------------------------------------------------
b. Internal Control Deficiencies
As in the West Virginia Plan, major problems for which
management was ultimately responsible were also found in
BCBSM's accounting and internal control procedures. Numerous
audits by external and internal auditors, management
consultants, and former employees between 1985-1991 disclosed
recurring problems, including:
--Lin 1985, 1986, 1989, and 1990 external auditors
expressed concern that weaknesses in the Plan's
information security procedures were allowing access to
the Plan's computer system by unauthorized persons. In
1987, auditors noted that data security
responsibilities were not fully defined or adequately
staffed and suffered from a lack of technical
expertise. In 1989, the auditors expressed the concern
that unauthorized persons could change program or data
files without being detected in a timely manner and, in
1990, it was noted that ``virtually all employees
(authorized and unauthorized) have access to the claims
processing system.''
--Laudits in 1986, 1989, and 1990 found numerous and
repeated claims processing problems at one of the
Plan's subsidiaries. These various audits found that
claims control procedures were weak and processing
staff were untrained, inexperienced, and inadequately
supervised. The auditors also reported ongoing problems
in claims processing timeliness, accuracy, and
recordkeeping.
--La former BCBSM Supervisory Auditor described an
incident wherein a former employee of the Plan's Willse
subsidiary embezzled over $4 million by writing checks
to fictitious entities. Although BCBSM auditors had
previously identified serious weaknesses regarding
access to Willse's checks and check writing procedures,
management had failed to correct these deficiencies.
In one of BCBSM's recent cost-saving moves, the Corporate
Audit Department's budget was reduced from $1.07 million to
$857,000 (about 20%) and the staff was cut from 16 to 12
employees. Plan documents indicate that this budget cut will
significantly reduce the Internal Auditors' ability to cover
known problem areas, such as subsidiary operations, corporate
staff activities, and claims and billing system functions. At
this reduced level of coverage, the Subcommittee staff
estimated that it could take from 10 to 20 years before the
Internal Auditors would be able to audit these areas
completely.
c. Blunders and Misjudgments: CARE, Project W, and Corporate
Downsizing
The Subcommittee received evidence of a long list of major
management blunders and misjudgments, which ended up costing
the Plan tens of millions of dollars in unanticipated expenses
and diminished its financial strength. For example, the Plan
experienced serious problems with the development, cost-
effectiveness and ultimate functional advantages of the CARE
claims processing system. While the system was to have been
fully operational by mid-1990, at an estimated cost of $9
million, it was not yet in full operation as of late 1992, and
had already cost more than $25 million. According to one
consultant's analysis, an additional $20-$30 million may be
needed for the system to become fully operational. Worse yet,
according to an October, 1991 consultant's study, the CARE
system ``is unlikely to ever be as efficient'' as two other
readily available systems and, in terms of computer resource
utilization, will not likely ``ever equal that of the systems
being replaced.''
There are similar concerns about a little-known internal
unit of BCBSM, Division W (Project W). Division W was created
in January, 1991 to help management to ``rethink how BCBS of
Maryland provides products and services to customers and to
develop and implement new approaches from the basis of a `clean
sheet of paper'.'' Division W purportedly has been developing a
claims adjudication and payment processing system that would
link physicians and other providers to the Plan electronically.
Although Division W had spent about $12 million by late
1992, it had produced little, if anything of significance by
the time of the Subcommittee's hearings. A consultant's study
described this organization as ``too ambitious'' and ``very
futuristic,'' and concluded that it was ``off track and a
muddle'' and ``would not become operational until the end of
the decade at the earliest.''
Another costly management blunder was described by the
former Plan Supervisory Auditor in testimony regarding a
``corporate downsizing'' instituted by BCBSM management in
1986. While her testimony indicates that some cuts in BCBSM's
2,500 employee workforce may have been in order, she explained
that the way that management carried them out resulted in total
costs of ``a staggering $10 million.'' As implemented, the
downsizing included expensive severance packages for senior
executives, overpayments of pension benefits, eight weeks of
severance pay for a large number of employees, two weeks of pay
for others who were laid off, and health care coverage for all
through the end of the year. A decision was made immediately
following this downsizing to reorganize the Plan into so-called
Strategic Business Units. Over the next five years, this
reorganization resulted in a dramatic increase in the size of
the workforce to 4,500 employees; prompting yet another severe
staff cutback in 1991.
d. Questionable/Poor Underwriting Practices
The testimony also confirmed management misjudgments in
BCBSM's underwriting practices on so-called non-risk business,
i.e., business in which the Plan only performs administrative
functions, such as claims processing and customer service,
while employers assume the health-related financial risk. This
issue surfaced in the following exchange:
Senator NUNN. Could you explain what you mean by non-
risk underwriting loss?
Commissioner DONAHO. * * * as this trend is
developing away from people purchasing insurance from
the Blues, * * * large employers * * * including the
State of Maryland, Baltimore City, Baltimore Gas &
Electric Company and others, * * * [are] engag[ing] the
Blues as administrators of their own so-called self-
insurance plans. * * * Blue Cross, in effect, charges a
fee for administering a company's plan, and this is the
most amazing thing to us, because how can you lose
money on a business which you are charging a fee to
run?
Senator NUNN. That is what I was going to ask you. *
* *
Commissioner DONAHO. Well, my offhand conclusion,
until we research it, * * * is that their bids have
been cut in order to get the business, so that actually
the bid is based upon a loss. In other words, the
organization is emphasizing * * * keep[ing] its cash
flow going, * * * the reason most Blues survive is
because of their cash flow, not because they are
accumulating large amounts of surplus.
In a subsequent October, 1992 letter submitted for the
Record, the Commissioner pointed out that between 1986-1990,
$100 million of BCBSM's total underwriting losses of $115.7
million ``surprisingly'' came from non-risk business,
suggesting a ``systematic problem in underpricing'' on the part
of the Plan to gain marketshare. He concludes that
``maintaining market share may have been a primary concern of
BCBSM even to the point of absorbing losses from inadequate
expense charges,'' and cites BCBSM's account with Maryland as
an example:
The State of Maryland account, recently awarded $945
million ($85 million for administration), is obviously
perceived to be critical by BCBSM management. The
bewildering concept is whether the State account is
more critical due to its high visibility, ``flagship''
marketing value and not due to its underlying profit
potential.
e. Excessive Salaries and Business Expenses
Testimony before the Subcommittee also established a
pattern of excessive administrative expenses. These excesses
are important for two primary reasons: 1) they reveal
management's profound misunderstanding of and/or insensitivity
to BCBSM's status as a non-profit organization intended to
provide ``access to quality care at an affordable price and to
be the health insurer of last resort;'' and, 2) they took place
at a time when the Plan was in dire financial straits and
subscriber premiums were being increased significantly. These
excesses occurred in two broad categories of expenses--
executive compensation packages (salaries, bonuses and other
benefits) and corporate marketing efforts (entertainment,
charitable contributions, and travel).
In the area of executive compensation, the Staff's
testimony highlighted the following examples:
--Lbetween 1986-1991, Plan President and CEO, Carl
Sardegna's total compensation (i.e., salary plus
bonuses) nearly quadrupled, from $221,130 to $850,193.
According to the BCBS Association, Sardegna's 1991
compensation was more than double the average total
compensation for all BCBS Plan CEOs ($388,000) and
placed him well above the 98th percentile figure of
$710,000.\31\
---------------------------------------------------------------------------
\31\ BCBSM officials told the Staff that their high salaries were
commensurate with the size of their plan. In fact, however, the BCBS
Association has noted that BCBSM's 1.4 million subscribers place it
just above the average Plan size of 1.2 million. Furthermore, BCBS
Association data shows that of the 26 BCBS Plans with more than one
million subscribers, the average total compensation for CEOs was
$458,000; which places Sardegna well into the 90th percentile of all
these Plan CEOs as well.
--Lwhile total compensation for BCBSM's top ten
executives increased by more than 180 percent between
1986-1991, the increase for the Plan's employees in
general was just 28 percent during the same timeframe.
--Lbetween 1986-1992, the number of BCBSM employees
paid $100,000 or more jumped from 11 to more than 40,
with nine of the 40 earning over $200,000 and five
$300,000 or more.\32\
---------------------------------------------------------------------------
\32\ The Staff's testimony also highlighted excessive financial
benefits available to BCBSM executives. One such example, the Plan's
policy on moving expenses, resulted in reimbursement costs of $1.8
million between 1986-1988 for the relocation of just 32 employees (an
average of more than $56,000 per employee). In addition, the Staff was
told that the Plan paid for an employee to transport a horse pursuant
to his relocation and, in at least two instances, stated in writing
that employees would be reimbursed for the transport of their boats as
part of their moving expenses.
Mr. Sardegna attempted to justify the Plan's executive
compensation levels by explaining that they were based on
studies done by independent consultants. In one such study,
however, the Staff found that in trying to compare BCBSM
executives' salaries with those of other companies, the
consulting firm's sample focused on 1,700 enterprises, the vast
majority of which were for-profit and only one-quarter of which
---------------------------------------------------------------------------
were insurance companies. The Staff testified that:
--Lthere was no information on the tenure of the
executives at the companies used in the comparison. The
number of years an executive has served a company is
likely to be reflected in his or her compensation level
and thus a failure to include such information could
skew the study's results. Underscoring the potential
significance of this deficiency, the Staff point out
that Mr. Sardegna's compensation increased nearly 300%
in just four years.
--Lthe names of the 1,700 companies used in the study
were not available, according to the consulting firm,
because their work was based on information collected
from other studies. In addition to questioning the
inherent validity of an analysis based on so many
unknown companies, the Staff note that without such
information, the relative affect of cost-of-living
differentials between BCBSM and the other companies
used in the comparison cannot be determined.
The Staff also described questionable expenses in the area
of corporate marketing activities:
--Ldocuments subpoenaed from the Baltimore Orioles
baseball organization show that BCBSM leased a skybox
at the new Oriole Park at Camden Yards, at a cost of
$300,000 for the years 1992-1995 ($75,000 per annum).
The skybox suite includes 14 seats, two color
televisions, private bathrooms, heating and air
conditioning, a wet bar with bar stools, a
refrigerator, private elevator access and an internal
telephone to call caterers. The skybox fee was
exclusive of food or drink, which cost the Plan
anywhere from several hundred dollars to over $1,400
per game.
--Lin 1990-1992, BCBSM or one of its subsidiaries
sponsored hospitality tents for the Preakness horse
race at Pimlico Race Course in Baltimore. In 1992,
BCBSM paid $32,500 to rent two tents adjacent to the
Preakness Winner's Circle, complete with astroturf,
dining tables and chairs for 150 guests, and four
closed-circuit television monitors displaying the races
of the day. More than $32,000 in additional expenses
were incurred on this occasion for catering, printing,
flower arrangements, gifts, and a photographer.
--Lat Plan expense, five senior executives--the CEO,
the General Counsel, the Corporate Counsel, the
Director of Community Relations, and the Chief
Operating Officer--held memberships in one of
Baltimore's most exclusive restaurants, The Center
Club. The restaurant charges an initiation fee of
$1,250 per member, plus annual dues of $650 per member.
These five BCBSM executives, according to subpoenaed
records, spent a total of almost $9,000 at The Center
Club on lunches, dinners, flowers, and guest fees in
1992 alone.
--LBCBSM purchased a corporate membership in the Cave's
Valley Golf Club in Owings Mills, Maryland. The
initiation fee was $75,000 and annual dues for 1991 and
1992 were $2,800 and $3,300, respectively.
--Lin 1988, BCBSM paid $182,000 for 64 all-expenses-
paid packages to the Olympics in Calgary, Alberta and,
in 1992, at a cost of $21,000, four all-expenses-paid
packages to the Barcelona Olympics were purchased. The
four Barcelona packages were purportedly given to a
major Plan account, Baltimore Gas and Electric Company,
when BCBSM's CEO decided not to make the trip.
BCBSM's response to the above was expressed in Mr.
Sardegna's statement for the Record as follows:
These types of activities * * * provide BCBSM a
vehicle to market products to its customers and conduct
other business activities. As one of Maryland's large
employers, BCBSM has a corporate responsibility to
enhance the business climate. Both the Orioles and the
Preakness represent significant revenue to the State.
BCBSM also made sizeable charitable contributions to
Baltimore area organizations with no apparent healthcare-
related purpose. In recent years, for instance, BCBSM has made
large donations to the Baltimore Symphony ($125,000), the
National Aquarium ($53,000), the Center Stage ($37,000), the
Walters Art Gallery ($18,000), and the Baltimore Museum of Art
($17,000).
Mr. Sardegna also expressly indicated that BCBSM is
involved in these kinds of activities because its competitors
do the same thing, a point which was disputed by Commissioner
Donaho:
Senator NUNN. Commissioner, what about the argument
that this is a competitive world, that they [BCBSM] are
basically competing, * * * [and] if they do not compete
for entertainment and that kind of thing, they will
lose business and the policyholders will suffer?
Commissioner DONAHO. * * * I regulate 108 other
domestics and 1,400 licensees, and I know of only one
other insurance company that has a skybox. * * * I do
not know of any company offhand * * * that exceeds the
Blues in similar activities.
Moreover, regarding the contributions to the Baltimore
Symphony, Symphony officials told the Staff that Sardegna
declined to have BCBSM's name appear on a marble wall in the
lobby of Symphony Hall in Baltimore, even though it was
entitled to do so for having donated more than $100,000.
Regarding a $25,000 corporate gift, Sardegna wrote the Symphony
Society's President in August, 1991 insisting that ``this
contribution is not to be mentioned in any printed material.''
These requests for anonymity appear to be inconsistent with
Sardegna's claim that BCBSM makes charitable contributions
because their competitors do and because the company wants to
be recognized in the community as a supporter of the arts.
The Subcommittee believes that the key question that arises
in connection with BCBSM's entertainment expenses and
charitable contributions is how they benefit the policyholders.
In 1987, for example, Mr. Sardegna accompanied the Baltimore
Symphony on a trip to Russia at the Plan's expense--an
occurrence which prompted the following pointed exchange at the
hearing:
Senator NUNN. Did the Plan pay for you to accompany
the Baltimore Symphony to Russia?
Mr. SARDEGNA. Yes, it did, Senator.
Senator NUNN. What was the business purpose of that
trip * * *?
Mr. SARDEGNA. The business purpose was that there
were a significant number of businessmen who went with
the Baltimore Symphony and I went along with them.
Senator NUNN. And all those business people had their
companies pay for it and deducted the expenses?
Mr. SARDEGNA. * * * I do not know, Senator. * * *
Senator NUNN. But you do not have any trouble
justifying that as a business purpose? I do not mind
you going to Russia with the Baltimore Symphony, but
you make a pretty good salary * * * [so] why could you
not pay for it out of your own pocket?
Mr. SARDEGNA. Senator, in hindsight, I probably * * *
should have made a different decision.
In the area of travel, in 1991 alone BCBSM spent over $2.8
million. Though BCBSM conducts business solely within the State
of Maryland, this included trips by its executives to
Singapore, Hong Kong, London, Tokyo, Osaka, Seoul, Amsterdam,
Brussels, and Bangkok. BCBSM travel expenses also included
corporate functions held outside Maryland. For example, while
special events to honor outstanding marketing division
employees were held at a local restaurant in earlier years, in
1991 and 1992 the ceremony was held at the Hilton Head resort
in South Carolina. Subpoenaed documents included receipts for
$10,000 in expenses for ground transportation and some $46,000
for air transportation.
2. Inadequate Oversight by the Board of Directors
BCBSM's Board of Directors displayed an apparent
unawareness of and/or insensitivity to its primary fiduciary
responsibility to the Plan's subscribers. Arguably most
important among the Board's problems in this regard are the
inherent questions raised by Carl Sardegna's having served
simultaneously as the Plan's CEO, President and Chairman of the
Board. In a July 29, 1992 letter to the Governor, Commissioner
Donaho stated:
I am quite aware of your confidence in those Board
members of BCBSM with whom you have had long
experience. * * * The binder I gave you on July 3rd
last demonstrates, however, the many instances in which
Blue Cross management has not only failed to comply
with regulation and to notify us, but also failed to
keep the Board informed.
Mr. Sardegna's successor as Board Chairman, Frank Gunther,
in a letter to then Chairman Nunn following the Subcommittee's
hearings formally acknowledges that the Board had not been
fully apprised of many of the actions taken by Mr. Sardegna and
his management team. He points out that ``while the Board knew
the bottom line financial condition of the company, the method
of presenting the results was always `spun' to highlight the
positive and ignore the negative.'' Concerning BCBSM's poor
provider and consumer service record, he concedes that although
the Board understood that there were problems in these areas,
it was not aware how ``acute'' they were.
Management also failed to fully inform the Board of the
BCBS Association's concerns about and actions regarding BCBSM's
operations and financial condition, as confirmed by Mr.
Gunther:
Of most concern to the Board members was the fact
that until the second week in November, when I received
a copy of a letter from the Blue Cross and Blue Shield
Association regarding their monitoring of the Blue
Cross of Maryland, the Board was not aware that Mr.
Sardegna had submitted a plan to the Association to
improve the company's surplus, liquidity and service
with specific goals and timeframes. While we had been
told that the Association was monitoring Blue Cross, we
were led to believe that that monitoring was business
as usual. We were not aware of the specifics of the
plan of recovery with the Association or even that it
existed.\33\
---------------------------------------------------------------------------
\33\ Reliable sources advised the Subcommittee staff that the
Board's discovery of this apparent deception on the part of Mr.
Sardegna was the ultimate act that led to his ``resignation'' on
December 4, 1992.
To their discredit, Board members did participate in
BCBSM's successful effort to forestall a 1991 management audit
ordered by Commissioner Donaho. Three BCBSM Board members
visited him in an attempt to persuade him to allow the Plan to
substitute its own study. They justified their request by
suggesting that a study initiated by the Insurance Division
``would be an embarrassment and harmful to the image of the
Blues.'' Some Board members also participated in BCBSM's
efforts to circumvent the Commissioner by going directly to the
Governor's staff and the Governor himself. According to the
Commissioner, the study substituted by BCBSM failed to address
seven of the eleven key concerns in his original proposal.\34\
---------------------------------------------------------------------------
\34\ See related discussion below p. 39.
---------------------------------------------------------------------------
The Board also failed to adequately oversee the Plan's
operations and protect the subscribers' interests in its
handling of salary and compensation issues. For example, the
Board played a direct role in approving the excessive executive
salaries and bonuses described above. Indeed, the Board
determined Sardegna's $850,000 compensation package for 1991,
as well as the package for the more than 40 top-level
executives earning more than $100,000. The Board's actions in
this regard were at best irresponsible, given the fact that the
Plan was experiencing severe financial problems and
subscribers' premiums were being increased substantially.\35\
---------------------------------------------------------------------------
\35\ At the time of the hearing BCBSM Board members were annually
receiving total compensation of almost $20,000 (an $8,000 stipend, plus
$800 each for 12 monthly Board Meetings, and an additional $400 for
Board Subcommittee Meetings). This amount, according to the BCBS
Association, is more than double the average ($9,600) for directors of
all BCBS Plans.
---------------------------------------------------------------------------
3. Inadequate Regulation by the Insurance Division
The testimony presented to the Subcommittee regarding the
regulation of BCBSM reveals a pattern of problems similar to
those described in connection with the failed West Virginia
Plan. While the Maryland Insurance Division was generally
informed about BCBSM's financial and management difficulties,
its actions in response were at various times insufficient and/
or wholly ineffective. As in West Virginia, these failings were
essentially the result of BCBSM's ability to block and evade
regulatory efforts and/or the Division's inability or
unwillingness to take appropriate action when necessary.
For example, according to documents cited by the
Subcommittee staff, a partially completed 1988 financial
examination of BCBSM was suspended, ``as a matter of courtesy
to BCBSM.'' This examination had been ordered by the then-
Commissioner in response to the huge losses reported by the
Plan for the previous two years. The Commissioner had briefed
the Governor on the examination in a March, 1988 memo in which
the possibility was raised that if BCBSM's losses continued at
the same rate, the Plan would be insolvent by the coming Fall.
The examination's preliminary results in fact showed that, as
of the end of 1987, BCBSM was already statutorily insolvent by
virtue of having achieved a deficit position of $1.2 million.
The decision to postpone the examination was made by the
successor to the Commissioner who originally ordered it, over
``the strong protestations'' of an Assistant Commissioner.
Similarly, BCBSM successfully used its considerable
political influence to see that a review of Plan operations
being conducted by its own consultant was substituted for the
independent management audit called for by the Commissioner in
January, 1991. The call for this latter audit was in response
to BCBSM's unremitting management and financial problems and,
moreover, was expressly authorized by language in a bill passed
by the Maryland Legislature.\36\
---------------------------------------------------------------------------
\36\ In a May 13, 1991 letter to Commissioner Donaho, State
Representative Timothy F. Maloney, Chairman of the Budget Subcommittee
that was the source of the relevant language in this regard, affirmed
that BCBSM was in fact a proper subject of an Insurance Division-
sponsored management audit as follows: ``John, I'm glad you're going
full steam ahead with the management audit and hope you'll keep me
posted on its progress. Blue Cross/Blue Shield needs a major
overhaul.''
---------------------------------------------------------------------------
According to documents cited by the Staff, after the
Commissioner issued a Request for Proposals in 1991 regarding
the management audit of BCBSM, ``Carl [Sardegna] subsequently
worked hard to head off that audit, in part by hiring Booz
Allen to do its own management audit of the Plan.'' Plan
officials and representatives met with the Commissioner in an
attempt to convince him to allow the substitution of their own
study for the Division's proposed audit. On a number of
occasions Plan officials and representatives tried to
circumvent the Commissioner by taking their case directly to
the Governor's then-Chief of Staff and the Governor himself.
BCBSM President Sardegna, for example, had discussions with the
Governor in which he argued that the Insurance Division's
proposal was beyond the Commissioner's authority.
As a result of these activities, the Governor first began
to question the Commissioner's proposal and then, despite the
latter's strong arguments in opposition, ultimately sided with
BCBSM. According to the Commissioner, ``he [the Governor] was
of the view that Blue Cross should be given the opportunity to
undertake its own study.'' Based on the Governor's position,
the Commissioner decided not to award the contract for the
management audit.
The Subcommittee has several concerns regarding this
episode. First, it underscored the Commissioner's vulnerability
to outside interference and weakened his ability to respond to
future challenges to his legitimate authority. Second, not only
was the Commissioner compromised, but the Legislature's intent
in authorizing him to require such audits was also
circumvented. Finally, the substitution of BCBSM's study for
the State audit negatively affected the regulatory objectives
that had prompted the Commissioner to order the audit in the
first place. As the Staff noted:
--Lthere were major differences in approach between the
Plan consultant's study and the Commissioner's proposed
management audit; e.g., the former was based on a top-
down, strategic planning approach that would fail to
generate sufficient information on BCBSM's day-to-day
operations and management's involvement therein.
--Lon a number of key issues, such as executive
compensation and valuation of subsidiary business, the
Plan's study relied on work by other consultants that
had been performed for purposes unrelated to those
stipulated in the Commissioner's proposed audit.
--Lthere is reason to suspect the objectivity of the
Plan's study, since one of the consultants involved has
admitted that he has known Carl Sardegna for years and
has done numerous other reports for a company where Mr.
Sardegna was formerly employed. In addition, while this
same consultant claimed that his firm's work in behalf
of BCBSM was the result of a competitive bid process,
there was no evidence of this and the consultant could
not produce any evidence of an actual bid (including
price) by his firm.
--Lto the extent that the usefulness of BCBSM's
substitute management review depended upon the timely
receipt of a finished product, it is notable that the
Commissioner did not receive a copy until nearly a year
(July, 1992) after the study was completed in
September, 1991. In the intervening period, the
Commissioner made at least two requests to obtain the
study and only finally received it after testifying
before this Subcommittee and after a Committee of the
Maryland Legislature determined to hold its own hearing
on BCBSM.
The Subcommittee received testimony on other problems
encountered by the Insurance Division in its efforts to oversee
the Plan's activities. For example, all five of the
Commissioners who headed up the Division between 1981 and 1992
confronted problems with the establishment and operation of
for-profit subsidiaries. The Acting Commissioner for the period
late-1987 to mid-1988 stated that it was only by chance that
one of her examiners happened on a BCBSM flowchart that listed
a number of subsidiaries about which she had no knowledge. The
Acting Commissioner became so frustrated by this situation that
she issued an Order on March 30, 1988, which required all non-
profit health service plans to provide the Division with 30
days advance written notice of any new transactions, ventures,
or acquisitions.
However, even with this 1988 Order in effect, the Plan
failed to comply. The Subcommittee reviewed charts which
compared organizational information provided by BCBSM in annual
financial statements submitted to the Insurance Division, with
flowcharts obtained by the Subcommittee pursuant to its
subpoena of Plan documents. The information received by the
Subcommittee was clearly more detailed than that provided to
the Division and, indeed, revealed subsidiary operations that
were not listed on the financial statements filed with the
regulators. In effect, more than three years after the Order's
issuance, the Division was still in the dark about some BCBSM
subsidiary operations--a point underscored by Commissioner
Donaho's acknowledgement that it was not until he saw the
Subcommittee's charts that he fully realized that there were
entities that he had neither heard of nor approved.
Despite the regulators' constant concerns about BCBSM's
management and financial problems, their actions display a
pattern of hesitancy, reluctance, and even a fear of taking the
difficult, but necessary, actions to deal with them. A former
Commissioner who, in referring to his concerns upon having
received BCBSM's disastrous 1986 year-end results stated, ``the
last thing we needed was for Blue Cross Blue Shield to go belly
up.'' This type of attitude apparently was the basis for a
general reluctance on the regulators' part to take decisive
action.
For example, the Commissioner who suspended the 1988
financial examination, even though the preliminary findings had
shown BCBSM to be statutorily insolvent by $1.2 million,
testified in deposition that:
* * * I thought that the position of Insurance
Commissioner was three-fold. One was to look at the
solvency of the insurance companies, one was to protect
the consumers, and one was to implement legislation.
Sometimes those three things came into conflict, as it
did in this case, where solvency and consumers * * *
couldn't [be] serve[d] simultaneously.
Secondly, $1.2 million is just not a lot of money in
insurance parlance. * * * The bottom line appeared that
the financials were turning around and my job was to
serve and protect the consumers of the State of
Maryland, and how do I best do that. I didn't see that
there would be any service to them, shutting down the
Blues, so I didn't. It really wasn't a complicated
decision.
* * * * *
Now, if you think about it, a company whose
financials are improving, who within a year or two is
going to break even, it doesn't make sense to take them
down when, in fact, the situation is turning around,
and * * * they were doing what they should have been
doing. * * * They were willing to be monitored closely.
It would have been foolish to shut them down. You would
have shut them down and three weeks later or six months
later started them up again, with what? They would have
lost a lot of their membership by then. That's not good
strategy, either for the consumers or the company.
Finally, in an August 11, 1992 letter to the Governor,
Commissioner Donaho explained:
* * * I think it would be doing our citizens a
disservice if, at this time we declared Blue Cross/Blue
Shield insolvent and put them into some kind of
conservatorship.
As a clear contrast to the ease of replacing both
property and casualty and life coverage in the event of
insolvency * * *, a Blue insolvency would create a
significant market shortage, as there would not be
health insurance capacity in this State to cover the
number of citizens who would be out of insurance. * * *
There is not current capacity in this State to insure
those people, nor is there guaranty fund capacity.
* * * * *
In addition, the cash flow would severely decrease as
the non-risk business would be easily moved elsewhere.
* * * It could be expected that many providers would
stop accepting a citizen's Blue Cross/Blue Shield
cards, as they would not think they would get paid for
services. We would see a significant increase in
expenses as attorneys, accountants, auditors, actuaries
and other consultants would be brought in to look at
various aspects of the operation. Considerable Division
time and energy would be spent on the issue detracting
from our overview of other companies. While this was
happening, a continual deterioration of the Blues would
take place lessening its value to an outside source who
will be willing to take it over. I do not see any
positive purpose the above scenario would have for our
citizens.
The Division's attitude, as reflected in the statements
cited above, suggests that BCBSM has become too large a
presence in the State for the regulators to treat it as they
would any other domiciled insurer. The prevailing attitude
seemed to be that BCBSM was either too big to fail and/or too
big to be taken down. This may have unwittingly resulted in the
masking or perpetuation of certain Plan weaknesses. For
example, the Staff mentioned decisions by several Commissioners
to allow favorable consideration of BCBSM financial
transactions which, if treated otherwise, could have negatively
impacted its overall financial position, including:
--Lin 1988, BCBSM was allowed to increase the value at
which it carried its Joppa Road headquarters on its
books from about $6 million to $12 million;
--Lin 1988, BCBSM was allowed to increase the value at
which it carried its Columbia HMO by $23 million;
--Lin 1989 or 1990, in connection with the resumption
of the suspended 1988 financial examination, the
regulators recognized as an admitted asset a
questionable $5 million receivable from BCBSM's Willse
subsidiary. This action, in turn, was one of the
primary factors that helped to turn the preliminary
examination finding of a $1.2 million deficit into a
surplus;
--Lin 1992, despite their own stated ``reservations,''
the regulators accepted a valuation of $29 million on
BCBSM's Carefirst HMO; and,
--Lin 1992, BCBSM was allowed to carry as admitted
assets some $42 million in questionable receivables due
from its subsidiaries and $24.2 million in questionable
Pertek subsidiary assets.\37\
---------------------------------------------------------------------------
\37\ As a result of these and other exceptions from accepted
statutory accounting rules approved by the Commissioner, BCBSM's
reported net worth, i.e., the excess of its assets over its
liabilities, may have been overstated by as much as $103 million at
year-end 1991. Closer scrutiny of these exceptions might have raised
questions about their validity and, in turn, BCBSM's true financial
condition.
---------------------------------------------------------------------------
4. Inadequate Oversight by the Blue Cross/Blue Shield Association
The testimony received regarding the BCBS Association's
oversight of BCBSM shows a pattern of activity similar to that
encountered in the case of the West Virginia Plan. On the one
hand, the Association carried out a variety of evaluation and
monitoring functions that effectively tracked the Plan's
operations and performance. For example, reflecting its serious
problems, beginning in 1988, BCBSM was placed on conditional
status because of its failure to meet the Association's reserve
and liquidity requirements. The Plan remained under this status
until 1990, and then, pursuant to a change in the Association's
monitoring system, was continued at a new ``concern'' stage
because of its ongoing failure to meet certain financial and
marketplace membership requirements. At the time of the
Subcommittee's hearing, BCBSM was still being monitored under
this new system. Also, the Association determined that BCBSM
has been at or near the bottom of all BCBS Plans in claims
processing and subscriber service since 1988.
On the other hand, the Association did not share any of its
considerable knowledge on BCBSM operations and deficiencies
along these lines with the Insurance Commissioner. The
Insurance Division needs to have access to all necessary
documentation and material to help it make fully informed
regulatory decisions. In this sense, the Association was remiss
in failing to share the important information it had concerning
BCBSM's operations and financial condition, even if the
latter's problems were demonstrably less severe than those of
the West Virginia Plan.
D. Effects
As a result of the Plan's problems, BCBSM subscribers were
confronted with diminished coverage and/or a denial of promised
benefits. Commissioner Donaho testified that in 1991 alone his
office received about 1,000 complaints from subscribers, the
majority of which concerned inefficient claims handling, delays
in payment, or unjustifiable denial of benefits. The
Subcommittee Staff examined some of these complaints, focusing
on those involving benefits denials, and found that the Plan
was, at best, conservative and, at worst, irresponsible in its
decisions in this regard.
In addition to problems with coverage and benefits, BCBSM
subscribers saw their premiums increase dramatically as a
result of the Plan's overall difficulties.\38\ Under BCBSM's
most popular option, the Group Conversion Comprehensive plan, a
subscriber with a $250 deductible who paid $3,000 for a policy
in 1988, was paying over $5,800 in annual premiums for the same
coverage in 1992. In a letter received by the Subcommittee, one
subscriber expressed his outrage at such increases:
---------------------------------------------------------------------------
\38\ The Subcommittee found that to some extent these rate
increases were a result of the Plan's mismanagement and operational
problems. For example, according to press reports cited in the Staff's
testimony, BCBSM executives admitted that they raised premiums in order
to cover the $120 million in losses by their Plan's subsidiaries.
Indeed, in one article, BCBSM's chief legal officer confirms the
practice of placing the burden of such losses on the subscribers by
saying, ``the only way you can get it back is through rates. * * * the
money has got to come from somewhere.'' Similarly, in their January 31,
1991 letter to Commissioner Donaho, ``A Silent Majority of BCBS
Employees'' point out that ``the management practices of our company
have driven rates through the roof. * * *''
``These people are operating as a non-profit
insurance company with multi-purpose goals for profit.
This is an ideal business arrangement because they can
always obtain new capital simply by requesting the
Insurance Department of Maryland for an increase in
their rates and the money comes rolling from their
subscribers. The increases that have been granted for
---------------------------------------------------------------------------
my premium 65 Policy since October 1982 are obscene.''
Extensive problems with BCBSM were also described by a
primary care physician, who testified on his own behalf and in
his capacity as President of the 600-member Maryland Society of
Internal Medicine. In his testimony, this physician provided
detailed accounts of ways BCBSM made it difficult for providers
to receive prompt payment for services and/or placed burdensome
and unnecessary administrative requirements on them. Another
provider, the Director of a Maryland visiting nurses agency,
described ``coverage * * * reimbursement and other associated
problems'' with BCBSM, concluding that ``* * * it has reached
the point that this whole process makes me reluctant to accept
patients for care, once I find out they have Blue Cross and
Blue Shield of Maryland.''
Finally, the Subcommittee also learned that some providers
and subscribers have for years been routinely denied interest
owed them as a result of BCBSM's failure to pay claims within
State-mandated timeframes.\39\ According to a 1991 Market
Conduct examination of BCBSM by the Maryland Insurance
Division, in numerous instances the Plan did not meet the
specified payment timetable and failed to pay interest on
claims that were not resolved within the stipulated 30
days.\40\ An interoffice memorandum written by the Plan's
Corporate Audit Division Director indicates that of $234
million in total claims paid in 1991, almost 25 percent were
subject to the interest calculation for having taken over 30
days to process. Since the Plan has been required by law to
calculate and pay such interest as of July 1, 1986, the chief
market conduct examiner estimated that through December 31,
1991, BCBSM has failed to pay interest on more than one million
such claims.
---------------------------------------------------------------------------
\39\ Maryland law requires an insurer to acknowledge receipt of a
claim within 10 working days, and to make payment on it within 15
working days of receipt of all necessary forms and information. The law
also requires a non-profit health service plan to pay interest on the
amount of a claim that remains unpaid 30 days after it has been filed.
\40\ Previous Market Conduct examinations turned up similar
problems in BCBSM's claims processing and customer service. For
example, an October 1986 report for the period December 1, 1984 to June
30, 1986 stated that, ``the company's claim of processing claims within
15 days is a distortion.'' According to the examiners, the Plan's
practice was to assign several different identification numbers to the
same claims thereby masking the true processing time for the claims.
---------------------------------------------------------------------------
THE NATIONAL CAPITAL AREA PLAN
A. Background/Organization
Group Hospitalization and Medical Services, Incorporated
(GHMSI), doing business as Blue Cross and Blue Shield of the
National Capital Area (BCBSNCA) was established pursuant to the
1985 merger of Group Hospitalization Inc. and Medical Services
of the District of Columbia. This merger was accomplished under
the auspices of the U.S. Congress and the new entity retained
the exemption from insurance regulation by the District of
Columbia that Congress had granted its predecessor in 1939.
GHMSI/BCBSNCA serves over one million subscribers in the
District of Columbia, Prince Georges and Montgomery Counties in
Maryland, and Arlington, Alexandria and part of Fairfax County
in Virginia. As of 1991, it had annual revenues in excess of
$1.5 billion, employed over 3,300 people, and ranked thirteenth
among the BCBS system's 73 Plans in annual premium income.
Like its West Virginia and Maryland counterparts, from the
time of its establishment in 1985, GHMSI/BCBSNCA's corporate
structure embraced three kinds of operational entities: those
involved in underwriting and servicing its core Blue Cross/Blue
Shield insurance business; for-profit subsidiaries with some
health-related purpose; and, for-profit subsidiaries with no
health-related purpose. By December 1992, the company was
responsible for the operations of a total of 45 wholly owned
and/or majority-owned or controlled subsidiaries. From the time
of the 1985 merger until mid-1992, effective control of GHMSI's
decision-making apparatus and overall operations rested in the
hands of its President and CEO, Joseph P. Gamble.
B. Financial Profile
For the eight-year period, 1985-1992, GHMSI incurred net
losses of about $182 million and its net worth declined
drastically from more than $180 million at the end of 1985 to a
projected negative $25.1 million as of December 31, 1992.
During this period, losses were reported in five of the eight
years, as follows: $42 million (1986); $66 million (1987); $58
million (1988); $7 million (1991); and, a projected $38 million
for 1992. In the three years where gains were made, either the
amounts earned were comparatively small--$2 million and $3
million for 1989 and 1990, respectively--or, in the case of
1985, the $25 million amount reflected the fact that the Plan's
newly established subsidiaries had not yet incurred the
sizeable and continuous losses they subsequently experienced.
A review of GHMSI financial data also established that:
--Lthe Plan's reserves declined $166 million between
year-end 1985 and year-end 1988 and, from 1991 to 1992,
according to projections, will decline again by some
$57 million (from $32 million to -$25.1 million).
--Lthe Plan's losses between 1985-1991 occurred despite
the fact that premium income from its core BCBS
business almost doubled (from $808 million to $1.5
billion), while the total number of subscribers covered
increased by only 100,000 (from 1.1 million to 1.2
million).
--LGHMSI's more than $100 million in cumulative losses
from its subsidiary operations have offset operating
gains from its BCBS core business; e.g., projected 1992
financial results show the latter's $8.1 million gain
being overwhelmed by nearly $50 million in subsidiary
losses. Financial data for 1989, 1990, and 1991 show
the same pattern of positive core business operating
results being offset by subsidiary losses.
C. Problem Areas
Many of the same key factors associated with the West
Virginia Plan's failure and BCBSM's serious financial decline
were present in GHMSI and helped to bring it to the brink of
financial disaster. Specifically, the Subcommittee found
evidence of the four broad problem areas that were identified
in connection with the West Virginia and Maryland Plans:
mismanagement; inadequate oversight by the Board of Directors;
inadequate regulation by the Virginia, Maryland, and District
of Columbia Insurance Departments; and, inadequate oversight by
the Blue Cross/Blue Shield Association.\41\
---------------------------------------------------------------------------
\41\ GHMSI did not dispute the Subcommittee's findings in this
regard. In its prepared remarks, GHMSI testified that ``turn-around
efforts initiated * * * in early 1992, in combination with the
subsequent scrutiny of the Permanent Subcommittee on Investigations,
has helped GHMSI to refocus its mission of fulfilling the interests and
needs of its subscribers.'' This testimony goes on to say that:
``The process by which GHMSI has come to chart a new course has
been a chastening experience for the enterprise and its trustees,
officers and employees. Some of the facts that have come to light have
been embarrassing. * * * In this testimony, GHMSI acknowledges
responsibility for many of the problems that confront it today.
Mistakes unquestionably were made.''
---------------------------------------------------------------------------
1. Mismanagement
a. A Proliferation of Subsidiaries
A significant part of GHMSI's management problems were a
direct result of what one of the latter's former executives
referred to as a ``frenzy of investments'' in a far-flung and
highly complex network of for-profit subsidiary operations. Two
years before the 1985 merger that established GHMSI, its
predecessor, Group Hospitalization Inc., had just two
subsidiaries. By 1992, in accordance with a strategic plan
instituted by GHMSI's President and CEO, Joseph Gamble, the
number of subsidiaries had grown to 45. Over the years, GHMSI
has incurred cumulative losses in excess of $100 million from
these subsidiaries.
These enormous losses can be attributed largely to
extensive mismanagement on the part of GHMSI and subsidiary
officials. In a written statement for the record accompanying
the testimony of GHMSI's President and CEO, Benjamin Giuliani,
the following observations are made:
In less than five years, GHMSI was transformed from
an organization focused on D.C. with a single basic
business to one with multiple subsidiaries and business
interests around the world. As the result of the
critical self-examination in which GHMSI has been
engaged for almost a year, it now must be conceded that
GHMSI simply did not have in place a management
structure capable of operating such a far-flung
undertaking.
* * * * *
A number of observations can be made concerning the
subsidiaries, particularly those that did not directly
complement the core business. Too often, GHMSI embarked
upon subsidiary ventures without a comprehensive
understanding of the business, a clearly defined
business strategy or objective management criteria for
measuring whether the subsidiary was meeting its
purpose.
* * * * *
The deficiencies in management were further
exacerbated by the absence of adequate management
controls.
The Subcommittee found a long list of specific management
deficiencies that contributed to the dismal performance of most
GHMSI subsidiary and affiliate operations. For example,
inadequate analysis was performed before subsidiaries or
affiliates were created and, in some cases, limited or no ``due
diligence'' examinations were made before sizeable financial
and human resources were committed to their development. In the
July, 1987 affiliation with the Blue Cross Plan of Jamaica
(BCJ), GHMSI provided BCJ with $5 million in capital without
having performed the kind of in-depth, on-site review warranted
by an investment of this size. It was not until 1990 that an
in-depth audit was conducted, revealing dozens of instances--
including some that preceded the 1987 affiliation--of gross
mismanagement and questionable legal practices by former and
then-current BCJ employees. GHMSI sustained losses of about $4
million from its operations between 1989-1991, and lost $3.5
million of its $6.5 million capital investment.
In addition, after companies had been established, in many
cases GHMSI subsidiary and affiliate managers focused almost
entirely on efforts to generate revenue--particularly via
clients with large numbers of actual or potential enrollees--
while paying little, if any, attention to rising overhead,
increased liabilities, and mounting losses. Many subsidiaries'
poor performance also reflected the fact that they were
ventures in which the management had little or no experience.
As one executive stated, ``they flew by the seat of their pants
and utilized the deep pockets of GHMSI to support their
exuberant inexperience.'' GHMSI's record statement bluntly
conceded that:
* * * it is now apparent that Mr. Gamble experienced
difficulty in selecting the right people to operate the
subsidiary businesses. People often were transferred
from a Blue Cross and Blue Shield job to start up one
of the subsidiaries or, in a few instances, they were
hired from the outside without the requisite business
expertise and management skills to operate a new
business.
The Subcommittee also found that no matter how poorly run
or unprofitable a subsidiary was, its senior executives
operated with the attitude that they could always rely on
continued funding from GHMSI. A former Vice-President of the
National Capital Administrative Services (NCAS) subsidiary, for
example, stated that when he raised questions about company
expenditures, its President often responded with words to the
effect--``Don't worry, it's the Plan's money.'' This attitude
toward GHMSI's seemingly endless deep-pocket--``rubber money,''
as the former Vice President referred to it--was well-known
within NCAS, according to other former employees. In a number
of subsidiary financial statements, the auditors noted that the
continued existence of the subsidiary depended on GHMSI's
financial backing.
b. Internal Control Deficiencies
The testimony also confirmed extensive accounting and
internal control problems in GHMSI and its subsidiaries and
affiliates. GHMSI's own statement for the record acknowledges
that:
Financial reporting for the subsidiaries was
inadequate for an enterprise of GHMSI's size.
Particularly in 1990 and 1991, reports to the Board
indicating that the subsidiaries had ``turned the
corner'' were later amended at year end to show
dramatic losses. The need to improve accountability for
variances between actual and projected operating
results became clear. The inability to resolve that
problem continued to plague the enterprise [i.e.,
GHMSI], however, until as late as the first quarter of
1992.
The Staff testified to specific accounting and internal
control problems in the subsidiaries' operations, including:
--LEMTRUST (a joint venture between BCBSNCA and the
Fairfax Hospital holding company): management failed to
reconcile its corporate and trust accounts on a regular
basis, because internal controls were lacking. Among
other things, this facilitated the questionable
practice of paying one client's claims with funds
provided by other clients to cover their insured's
claims.
--LThe International Division: the exact amount of
losses incurred by the subsidiaries operating under it
was hard to calculate, since the International Division
did not keep even the most rudimentary records until
five-and-a-half years after it started. The Division's
Chief Financial Officer told the Staff that even the
most basic financial control function--the tracking of
premiums received and claims paid--applicable to its
subsidiaries' joint ventures with foreign insurance
carriers ``was not standardized or well thought out
from the beginning.'' The deficiencies in this regard
continue to haunt GHMSI today, since lacking such
complete and/or accurate information, no one has been
able to determine precisely what has happened to these
lines of business and the extent of GHMSI's liability
therein.
--LNCAS: audits in 1990 and 1991 found overly
complicated, confused, and/or wholly deficient
accounting systems for billing and calculating actual
costs of work performed and services provided. The
latter finding became especially problematic when,
using inaccurate and faulty data traceable, in part, to
this cost accounting deficiency, NCAS filed a claim for
hundreds of thousands of dollars in added reimbursement
beyond a U.S. Agency for International Development
contract's fixed-price stipulations. Also, in response
to a written question from the Staff on these problems,
NCAS' former Director of Finance and Administration
simply said that ``there were too many examples of bad
accounting to detail.''
--LPROTOCOL (an entity established to sell health
insurance to foreign embassies and businesses in
Washington, D.C.): a 1991 GHMSI internal audit revealed
serious problems including: lack of written policies
and procedures; lack of written contracts; problems
with accounts payable and receivable, and journal
entries; three different billing systems used for the
B'nai B'rith account; and the inability to accurately
assess underwriting gains and losses for paid claims.
The auditors concluded that Protocol's accounting
procedures were not in keeping with GHMSI intercompany
practices and did not provide a clear understanding of
the company's financial position.
c. Excessive Salaries and Business Expenses
The Subcommittee's review of the corporation's salary
structure, fringe benefits, and other administrative expenses
yielded results much the same as those encountered in the West
Virginia and BCBSM Plans. In brief, excessive spending and
outright waste were rampant throughout GHMSI, including:
excessive salaries and substantial fringe benefits for
executives; exorbitant and questionable travel and
entertainment expenses; and, unnecessary charitable
contributions. These expenses occurred at a time when GHMSI/
BCBSNCA subscriber rates were increasing,\42\ benefits were
decreasing, and the Plan's overall financial condition was
deteriorating dramatically.
---------------------------------------------------------------------------
\42\ From 1988 to 1991, premium rates for a family of non-group
subscribers more than doubled, from $194 to $410 per month. During this
same period, rates also nearly doubled for a family covered under one
of GHMSI's group policies, from $82 to $156 per month.
---------------------------------------------------------------------------
In the area of executive compensation, President and CEO,
Joseph Gamble's total salary and benefits increased by more
than 100% between 1987-1991, from $264,487 to $533,589.
According to a 1991 BCBS Association survey, Mr. Gamble's
salary was greater than 80% of the 60 Plan CEOs that responded,
even though GHMSI/BCBSNCA, with only 1.1 million subscribers,
was of average size for a BCBS Plan. From 1988-1991, in
contrast to the 13% increase other Plan employees received,
salaries and benefits for GHMSI's top eight executives
(including Gamble) rose nearly 85%. For the most part, these
major increases in salaries and benefits were approved at a
time when GHMSI was losing millions of dollars annually.
The Subcommittee also received evidence of questionable
domestic and international travel by top executives and other
GHMSI employees. While reasonable travel and entertainment may
be a legitimate cost of doing business, the regular use of
first-class or Supersonic air transportation by some of its
executives was clearly inappropriate for a not-for-profit
entity during a time of financial crisis. Equally disturbing
was GHMSI's use of deluxe accommodations, along with allowances
for seemingly limitless dining and entertainment expenses.
Examples of these types of questionable expenditures include:
--Lover an approximate six-year period (1987-1992),
three top GHMSI executives alone incurred a total of
more than $1 million for their domestic and
international travel. Nearly $450,000 of this amount
was for trips by the Plan's President and CEO, Joseph
Gamble.\43\
---------------------------------------------------------------------------
\43\ The sheer amount of Mr. Gamble's travel also raises some
concerns about the affects of his being away from his office for such
extended periods of time. For example, according to Mr. Gamble's date
book and expense reports, he traveled extensively for the years 1988 to
1991. In 1991, the year in which his travel began to decline, records
indicate that he was away from the home office either on business
travel or leave for 160 days (44% of the year). In 1990, he had his
most extensive travel year, wherein he was away 202 days (55% of the
year). In 1989 and 1988, he was away from the office for 173 and 193
days, respectively.
---------------------------------------------------------------------------
--Ltop GHMSI executives flew first-class routinely and
at least four of them used the Supersonic Concorde. In
terms of frequency, Mr. Gamble was by far the heaviest
user, with at least 22 trips over the years.\44\
---------------------------------------------------------------------------
\44\ Based on their review of GHMSI executives' travel records, the
Staff determined that when first class or Supersonic travel was used,
the difference between their cost and the coach fare was charged to a
separate ``Corporate Account.'' The Staff believe that the creation and
use of this separate account amounted to a subterfuge by senior GHMSI
managers to avoid close scrutiny of the excessive costs associated with
the first-class or Supersonic travel. See also related discussion below
pp. 52-53.
---------------------------------------------------------------------------
--Lthere were numerous instances of unnecessarily
expensive hotel or lodging costs. For example, Mr.
Gamble stayed at the Grand Barbados Beach Resort in
1990 and 1992, at a charge of $450 per night and, in
1992, a GHMSI/BCBSNCA Vice President spent $635 a night
at the Loews Ventana Canyon Resort in Tucson, Arizona.
--LGHMSI executives went on business trips in which
golf, dining or other leisure activities constituted a
larger portion of the trip than business activities. On
these trips entertainment and leisure activities, such
as tours and golf, were often paid for by the Plan.
--LGHMSI also absorbed unnecessarily large expenses in
Plan-sponsored marketing incentive trips to reward
employees for superior job performance. Such trips,
which took place in each of the last six years, were
all-expenses-paid and cost the Plan $1,540,749.
--Las a fringe benefit to many of its officers, GHMSI
paid their initiation fees and partial dues for
membership in area golf and other clubs. In some
instances, this fringe benefit was taken to extremes,
as in the case of the BCBSNCA Vice President who,
between 1988 and 1992, submitted $10,573 for golf and
golf-related items to the Plan as local business
expenses.
Finally, on the matter of charitable activities, while it
is difficult to criticize the Plan's good intentions, one
questions the appropriateness of a non-profit company making
such contributions at a time when it was losing millions of
dollars. Indeed, several of the for-profit subsidiaries that
were making the most generous contributions had continuously
operated in the red and were in severe financial distress. For
example, in 1988, the year in which it sustained its most
serious financial loss (more than $10 million), CapitalCare
(the Plan's Health Maintenance Organization) made $348,000 in
charitable contributions. Similarly, while Protocol lost some
$4.7 million in 1991, it spent $72,000 for charitable purposes.
Overall, between 1988 and 1992, GHMSI and its subsidiaries
sponsored events and made charitable contributions amounting to
nearly $1.8 million.
2. Inadequate Oversight by the Board of Trustees
As in West Virginia and Maryland, GHMSI's Board of Trustees
failed to adequately oversee the Plan's operations and
management. The Board allowed itself to become an unquestioning
and compliant rubberstamp body, effectively controlled by
fellow trustee and Plan CEO, Joseph Gamble. The Board's failure
along these lines often was a function of the fact that it was
being misinformed, misled, and/or manipulated by Mr. Gamble.
The evidence confirmed that the Board was co-opted by the
management it was charged with overseeing and was negligent in
the performance of its duties.\45\ With Mr. Gamble's active
encouragement, the Board typically took a very broad policy
approach to its job, rarely got involved with the details of
the company's business dealings, and tended to accept without
question management's projections, explanations, and decisions.
For example, Chairman Nunn asked the former Chairman of the
Board of Trustees, Charles P. Duvall, about the Board's
involvement in reviewing expenditures:
---------------------------------------------------------------------------
\45\ Once the Board finally became aware of the Plan's alarming
financial condition in February 1992, one of their first actions in
response was to seek advice regarding their own liability. Pursuant to
the advice they received, their liability insurance was subsequently
increased from $15 million to $20 million.
Senator NUNN. * * * Dr. Duvall, did you know about *
* * the expenditures, lavish dinners and corporate
sponsorship * * *?
Dr. DUVALL. I didn't know about them at all, Senator.
* * * * *
Senator NUNN. Did the Board have any policy about
[these] expenditures at all? Did you give any guidance
whatsoever to the executives of the company?
Dr. DUVALL. The Board would have felt [that] this is
part of management's prerogative and [the] corporate
culture.
Senator NUNN. So, if management wanted to fly first-
class all over as a matter of policy, that wasn't a
matter for the Board to be concerned with?
Dr. DUVALL. We didn't concern ourselves with it.\46\
---------------------------------------------------------------------------
\46\ According to some Board members, they were also not always
aware of other important expenditures, such as compensation. In the
case of Mr. Gamble, for example, they told the Staff that they did not
actually know the exact amount of his total compensation, since they
typically just voted on a percentage increase each year. It is also
worth noting that Mr. Gamble's compensation increases were based on
studies done by outside consultants who were hired by and reported to
him. Only after Gamble received the results of these reports, was the
Board's Compensation Committee informed of the findings.
The Board's approach and attendant effects are readily
apparent in its flawed performance regarding GHMSI's affiliates
and subsidiaries. With the Board's approval, between January,
1988 and December, 1992, GHMSI management formed or acquired
controlling interests directly or indirectly in 28 subsidiaries
and affiliates. However, while the Board approved these
actions, it did so without consideration of such basic issues
as the funding necessary to reach a break-even point or to
achieve profitability.
Indeed, based on remarks by Dr. Duvall, it appears that
until early 1992, the Board was content to merely accept
management's continual assurances that even though losses had
been sustained, profits were always just around the corner.
Regarding the subsidiaries, the Board failed to assure that
management had: established adequate internal controls to
monitor and administer their operations; obtained credible
actuarial data prior to conducting business in foreign
countries; and hired experienced personnel to operate certain
ventures.
In January 1985, at Mr. Gamble's suggestion, the Board
voted to compensate itself. One trustee who refused this
compensation said that he felt it was wrong for a non-profit
corporation to pay its Board, because the Board then ``gets too
close'' to management. This same trustee observed that after
the Board members started to receive this compensation, over
time they stopped acting as individuals and became Gamble's
``yes men.''
Some of the Board's problems were a result of
misinformation from and/or manipulation by Mr. Gamble.
According to Dr. Duvall, Mr. Gamble would usually brief the
trustees on an idea and then insist on a vote that same night.
As a result, another former member complained, the Board never
had any time to think things over. Dr. Duvall also said Gamble
periodically asked him to show up a few minutes in advance of a
scheduled meeting to review the Corporate Account. Under these
circumstances, there was no time for him to examine the
supporting documentation, and thus he just reviewed the
summaries and approved them.
Mr. Gamble often failed to provide complete information to
the Board. Although Dr. Duvall said that he saw documentation
on the proposed affiliation with Blue Cross of Jamaica (BCJ),
other former trustees said that there were no figures or
documentation presented at the meeting where it was approved.
One former trustee remarked that all he remembered about this
venture was Gamble saying that ``the possibilities (in Jamaica)
are endless.'' In many cases, Gamble had already established a
subsidiary or was well on his way to purchasing it before the
Board was aware or could protest. Likewise, Dr. Duvall noted
that when subsidiary operations were discussed, Mr. Gamble
usually focused on the ``big picture'' rather than the finances
involved.
Finally, Dr. Duvall did not become aware that GHMSI was
being monitored by the BCBS Association until Mr. Gamble's
successor informed him in the Spring of 1992. In fact, Dr.
Duvall expressed considerable surprise when he learned from the
Staff that the Association had been monitoring the Plan since
1988.
In other situations, Mr. Gamble deliberately misled the
Board. For example, Gamble told Board members that the Plan
withdrew from the Medicare Part A contract because it was ``not
profitable.'' In fact, the Plan had tried very hard to keep
this Federal contract, but had been removed against its wishes
for poor performance. As late as May 6, 1990, some three years
after the loss of this contract, Gamble was still telling the
Board that the Plan ``got out of the Medicare business in an
attempt to save money.''
Gamble also apparently failed to inform the Board of the
nature of the Plan's Corporate Account:
Senator NUNN. Did you know about this corporate
account where the Concorde charges and other charges *
* * were basically accounted for * * *?
Dr. DUVALL. I knew very little as to the exact nature
of the account. * * * I had no idea, Mr. Chairman, that
there was any Concorde in there once. That did not come
to my attention.
3. Inadequate Regulation by District of Columbia, Maryland, and
Virginia Insurance Authorities
With one notable addition--the adverse affects resulting
from GHMSI's unique status of being exempt from regulation by
District of Columbia insurance authorities \47\--the regulatory
difficulties regarding GHMSI are much the same as those
described in connection with the West Virginia and Maryland
Plans. Specifically, GHMSI was adept at evading and staving off
appropriate regulatory efforts directed at it, and the
insurance authorities with jurisdiction--i.e., Maryland and
Virginia--were unable and/or unwilling to adequately oversee
its operations.
---------------------------------------------------------------------------
\47\ It was not until September, 1992, as a direct result of
testimony presented to the Subcommittee by the District of Columbia's
Superintendent of Insurance, that Congress acted to amend GHMSI's
charter to provide such regulatory authority. The legislation was
signed into law on October 5, 1992 and, since then, the D.C. Insurance
Department has been developing the necessary policies and procedures to
implement it.
---------------------------------------------------------------------------
As a result of its Federal exemption from regulation by the
District of Columbia, GHMSI was subject to a patchwork system
of State regulation that was inherently inadequate.
Essentially, pursuant to their authority to license insurers,
Maryland and Virginia regulators have applied their rules to
that portion of GHMSI's business underwritten within their
respective States.
Generally, reliance for the primary oversight of an
insurance carrier rests with the authorities in the company's
``State of domicile.'' However, this was not the case with
GHMSI, as indicated in the testimony of the District of
Columbia's Superintendent of Insurance, Robert M. Willis, at
the Subcommittee's July 2, 1992 hearing:
Superintendent WILLIS. * * * If we can imagine that a
raft is floating down a river and on the shoreline
stands the Commissioner * * * from the State of
Maryland, who has a gaff hook and has the ability to
snag the raft before it goes over Niagara Falls. That
is the nexus that he has through licensing the Blues
relative to the Maryland situation.
The District of Columbia is situated beyond the edge
of the fall, in fact, at the bottom of the fall, and
can only report the result of the raft having gone over
the falls. * * * By law, I have the statutory duty to
tell the Corporation Counsel that I believe that
GHMSI--and I am not saying that is the case, but were
that the case--has reached the point where the
financial condition of the company is impaired. So I am
simply in a role of having to report what has happened,
that an insolvency has, in fact, occurred. * * *
As a result of this situation, GHMSI has adeptly played
Maryland, Virginia, and D.C. insurance regulators against one
another.\48\ For example, Superintendent Willis observed:
---------------------------------------------------------------------------
\48\ According to Superintendent Willis, three separate solvency
standards are applicable to GHMSI: the District of Columbia requires
life and health companies to maintain a surplus of $1.5 million;
Maryland requires a minimum of $75,000 surplus or a maximum reserve
equal to two months of claims and operating expenses; and, Virginia
requires a minimum contingency reserve for up to 45 days of anticipated
operating and incurred claims expenses.
A recent example is the treatment of GHMSI
investments by Virginia in its examination process.
Under the Virginia laws certain investments are not
permitted, but may arguably be permitted under District
investment laws. GHMSI has taken the position that
District laws apply, irrespective of the language in
the Charter stating that GHMSI shall not be subject to
---------------------------------------------------------------------------
District statutes regulating the business of insurance.
In his testimony, the Virginia Insurance Commissioner,
Steven Foster, added:
* * * there have been problems in the past trying to
understand the extent to which GHMSI was or was not subject to
the District's insurance laws. GHMSI would hire outside counsel
and would make those kind of assertions
.Neither Virginia nor Maryland authorities undertook strong
regulatory action against the Plan until late 1992. In the
intervening years (1987-1991), GHMSI lost nearly $120 million.
A 1988 joint Maryland/Virginia quadrennial examination of GHMSI
for the period 1984-1987 (the last two years of which saw
losses of nearly $110 million), called for just minor
adjustments to the Plan's reported financial statement. For
example, the Plan was not permitted to claim as an asset the $5
million investment in Blue Cross of Jamaica, and $1.5 million
in uncollected premiums that could not be substantiated was
disallowed.
GHMSI's relationship with State insurance authorities was
characterized by its ability to evade efforts to oversee its
operations. Virginia's Insurance Commissioner testified that:
Commissioner FOSTER. * * * I have never had a company
more difficult than GHMSI in trying to get straight
factual data regarding the financial condition of that
* * * company.
Senator NUNN. In other words, they have been the
worst?
Commissioner FOSTER. No question. In fact, I have
never told any other CEO that I would not meet with
that company's CFO [Chief Financial Officer] and
general counsel. I told that to this CEO [Mr. Gamble].
Senator NUNN. When was that?
Commissioner FOSTER. About three years ago. * * * In
the end, Mr. Gamble himself finally came to my office
to see if he could help straighten things out a little
bit, because his lieutenants, prior to that, just
simply were not dealing with us in a straightforward
manner.
A former Maryland Acting Insurance Commissioner said that
she faced continual problems with GHMSI, the most serious being
they would never tell her the full truth about their activities
in her State. She eventually issued an order requiring GHMSI to
cease subscribing operations in Maryland unless it obtained
prior written approval from her office. A former D.C. Insurance
Superintendent observed that any time she asked for even the
most basic information from the Plan, her requests were
``politely ignored.''
GHMSI also used existing requirements to undermine
regulatory efforts. In one case, GHMSI dramatically increased
its 1988 year-end reserves from $8.2 million to more than $103
million by the end of 1989, because of a loophole in the
Virginia Insurance statute. This loophole, which allowed the
Plan to carry its headquarters at market value, rather than at
cost, enabled the company to list the building at $80 million
more than the value it had reported just a few months earlier.
Although the law was eventually changed to close this loophole,
prior valuations conducted pursuant to it were unaffected, and
thus the Plan continues to carry its headquarters--a highly
illiquid asset--at market value. The higher valuation also
effectively masked critical reserve problems:
Senator ROTH. But it was that reevaluation of the
value of the [headquarters] building that really
postponed the day of reckoning?
Commissioner FOSTER. No question. * * * it is no
question, Senator, [that] their being able to admit the
full market value of the building is what kept them * *
* back in 1988, arguably, [from] being under * * *
[Virginia's minimum] 45-day [reserve] requirement.
4. Inadequate Oversight by the Blue Cross/Blue Shield Association
The BCBS Association's dealings with GHMSI suggest problems
almost identical to those described concerning the West
Virginia and Maryland Plans. Regarding GHMSI, the Association
did not:
--Lobtain the financial information needed to enable it
to effectively monitor the Plan after it had been
placed on ``conditional'' membership status;
--Ldetermine the financial condition of GHMSI's
subsidiaries and its attendant impact on the Plan as a
whole;
--Lenforce its internal standards regarding GHMSI's
conduct and operations; and,
--Lshare information with regulators and GHMSI's Board
of Trustees.
The Association's failure to obtain adequate information
partly reflected GHMSI's negative approach to Association
requests. A member of the Association's Business Performance
Review office--the entity responsible for plan monitoring--
stated that three words best described GHMSI management's
behavior in this respect: ``uncooperative, difficult, and non-
disclosure.'' This attitude began with GHMSI's merger-based
establishment in 1985, in contrast to the positive relationship
that had existed with its predecessors.
Prompted by concerns about GHMSI's financial condition, the
Association in 1988 renewed the Plan's membership on a
conditional basis. GHMSI's continuing financial problems
necessitated this ongoing Association scrutiny through the Fall
of 1992. According to Association officials, their monitoring
efforts met with incomplete and/or misleading information,
repeated requests for extensions, and postponements of
scheduled site visits.
In January, 1992, the Association developed a ``specific
monitoring program'' for GHMSI, which was more intensive than
the normal process and included on-site visits. However,
Association staff were still denied access to subsidiary
managers and the information available on their activities, as
one Association representative put it, was nothing more than
``what they thought everyone wanted to see.'' Disclosure
improved after Mr. Gamble's successor, Mr. Giuliani, took
control of GHMSI's daily operations in July, 1992. Even so, a
representative of the Association's monitoring team was not
able to obtain a full understanding of the extent of GHMSI's
subsidiary activity until December, 1992.
Despite the Plan's prolonged obstructionist behavior, the
Association was unwilling and/or unable to force more thorough
compliance. The Association only began to move toward action in
the Fall of 1992, more than four years after it had first
learned of GHMSI's serious financial problems. The
Association's actions in late 1992, moreover, were not entirely
self-generated, but rather were in part a response to the fact
that the Virginia Insurance Bureau had initiated its joint
quadrennial examination of GHMSI. As GHMSI's Board Chairman,
Peter O'Malley, stated:
The National Association is acting under pressure of
the regulatory environment we are in and wants to be in
a position of moving against GHMSI, if required, before
the Virginia Commissioner does.
Lastly, the Association failed to adequately inform the
concerned insurance regulators and the GHMSI Board of Trustees
about the Plan's continuing problems. During the hearings, the
Virginia Insurance Commissioner emphatically addressed this
point:
Senator NUNN. The National Association has a unique
relationship with the 73 Blue Cross/Blue Shield Plans
that it franchises, but I am told they do not keep the
insurance commissioners informed of the restrictions
they place on any kind of troubled Plans. Is that your
understanding?
Commissioner FOSTER. * * * I have never been informed
of such restrictions. * * *
Senator NUNN. Does the NAIC [National Association of
Insurance Commissioners] have any kind of position on
that? Are you advocating or are you requesting that the
National Association begin to be more cooperative with
* * * [the NAIC]?
Commissioner FOSTER. Yes, sir. One of the charges
that we are suggesting be given to our [Executive]
Committee * * * is to look at the appropriate oversight
role of the National Blue Cross/Blue Shield
Association.
Similar views were expressed by GHMSI's former Board
Chairman:
Senator NUNN. What do you mean by that, if somebody
had picked up the phone?
Dr. DUVALL. If I had heard about many of the things
we have discussed in the course of this hearing, some
segment of it from a credible witness our source, I
think things would have turned out differently. * * *
I think if the Board could have seen how other Plans
ranked through the Association, they might have known
earlier what I learned later--that we stick way out
like a sore thumb in terms of liquidity. We are not
even close, and we are scrambling to make that
benchmark.
THE EMPIRE PLAN
A. Background/Organization
As of June 1993, with more than 8.2 million subscribers,
Empire Blue Cross and Blue Shield was the Nation's largest not-
for-profit health insurer and largest of the Blue Cross/Blue
Shield system's Plans. In 1992, Empire collected about $6.6
billion in premiums from its policyholders and paid out some
$6.3 billion in claims. In that same year, it employed more
than 10,000 people and had an annual payroll exceeding $300
million.
Reflecting its longstanding corporate mission--to provide
affordable health insurance to as large a segment of the
population as possible--Empire's organizational structure
consists almost entirely of operational entities involved in
underwriting and servicing its core Blue Cross/Blue Shield
insurance business. Empire has historically relied on two key
operational concepts: open enrollment and community rating.
Under open enrollment, all who desire insurance are afforded
access to it, regardless of their age, sex, health status, or
where they live and/or work. Community rating denotes the
outcome of the process whereby an average premium rate is
determined for purchasers of insurance through open enrollment.
The average premium, which is the same for all subscribers, is
derived by placing the latter in ``risk pools'' and using their
total, aggregated health care costs as the basis for
calculating the rate.
In his roles as Chief Executive Officer and Chairman of the
Board of Directors, Albert A. Cardone effectively controlled
Empire's management and operations from April, 1987 until his
resignation in May, 1993. Prior to coming to Empire as the
Plan's Deputy Chairman in July, 1985, Mr. Cardone was a partner
at the public accounting firm, Deloitte, Haskins and Sells and
held the position of National Industry Director for the firm's
national health care practice.
B. Financial Profile
The Subcommittee found Empire's financial condition to be
precarious, at best. Between 1986 and 1992, the Plan incurred
underwriting losses of $617 million, more than two-thirds ($444
million) of which came in 1991 and 1992. Reflecting offsets of
$421 million from investment income and smaller amounts from
other sources, total operational losses for this same period
amounted to $210 million. As a result of these losses, the Plan
has had to rely on extraordinary measures to stay in business,
including: rate increases of up to 20%; the receipt of $93.5
million in a March, 1993 settlement of a lawsuit against the
New York State Medical Malpractice Fund; and, the release of a
reserve by New York State insurance regulators in August, 1992
that contributed $80 million to the Plan's surplus.
Empire's reserves also decreased dramatically in recent
years. In 1991 and 1992, its reserves declined steeply from
$295 million at December 31, 1990 to $40 million at December
31, 1992.\49\ This $40 million reserve figure was $485 million
below the statutory requirement prescribed by New York State.
Indeed, from 1991 through April, 1993, the Plan has been
consistently below 50% of the State's minimum statutory reserve
requirement.
---------------------------------------------------------------------------
\49\ Had it not been for the ruling by the New York Insurance
Department in August, 1992 to release $80 million in supplemental
reserves for hospital reimbursement, Empire's reserves would have
fallen below zero.
---------------------------------------------------------------------------
The $40 million Empire had on hand in 1992 to protect its
more than 8 million subscribers, was less than that required
for the far smaller District of Columbia Plan (GHMSI) and its
1.1 million subscribers. While GHMSI's reserves amounted to
$49.64 per policyholder, the comparable figure for Empire
policyholders was just $4.84. Even though Empire is the largest
of the Blue Cross/Blue Shield Plans, its reserves at the end of
1992 were higher than only 14 other Plans.
In both 1992 and 1993, Empire's external auditors were
sufficiently concerned about the Plan's ability to stay in
business to seek assurances from State Insurance Department
officials that there would be no regulatory takeover of the
Plan. In 1992, four days after receiving these assurances, the
auditors issued an unqualified opinion on the Plan's financial
statements. In 1993, the auditors again refrained from issuing
a going concern qualification, only after Insurance Department
officials expressly indicated they did not intend to take
control of the Plan and affirmed their practice of granting the
Plan ``substantially all'' requested rate increases.
C. Problem Areas
With the notable exception of subsidiary-inspired
difficulties, the testimony regarding Empire established the
same serious problem areas experienced by the West Virginia,
Maryland, and District of Columbia Plans: mismanagement;
inadequate oversight by the Board of Directors; inadequate
regulation by the State Insurance Department; and, inadequate
oversight by the Blue Cross/Blue Shield Association.\50\
---------------------------------------------------------------------------
\50\ Some witnesses, such as Empire's former and acting CEOs and
the Superintendent of Insurance, testified that the Plan's problems
were largely, if not entirely, the result of outside factors beyond its
control. This testimony emphasized the adverse effects of selective
underwriting (``cherry-picking'') and ``dumping'' of poor risks by
competitor commercial carriers, intensified competition for large-group
business, and the high cost of health care in downstate New York and
New York City. While the Subcommittee acknowledges that these factors
may have played a role in Empire's difficulties, the overwhelming
evidence accumulated regarding this Plan and those of the other three
Plans examined, shows a clear and strikingly similar pattern of
problems that helped bring them to the state in which our investigation
found them.
---------------------------------------------------------------------------
1. Mismanagement
a. Misrepresentation of Loss/Gain Figures
The Subcommittee examined the role of Empire's CEO, Albert
Cardone, and CFO, Jerry Weissman, in knowingly providing State
insurance regulators with information on underwriting gains/
losses that misrepresented the Plan's performance in its
Community-Rated and Experience-Rated market segments. This
information was contained in statutorily required Interim and/
or Annual Statements filed by Empire with the State Insurance
Department for the years 1989-1992.\51\ In each of these years,
the periodic filings contained loss figures that differed
significantly from that which was discovered on the same
subject in other contemporaneous Plan financial records known
as the ``Black Books.'' \52\ While it is not clear why the
figures were altered, the changes made were to Empire's
benefit.\53\
---------------------------------------------------------------------------
\51\ The Interim and Annual Statements are commonly referred to as
the ``Blanks'' or ``Statutory Blanks.'' At Empire, the Actuarial
Department is responsible for preparing the sections of the Annual
Statements pertaining to this discussion.
\52\ The Black Book is an internal management report prepared by
Empire's Accounting and Financial Reporting Department. It consists of
a number of individual reports, many of which are generated monthly by
the Plan's budget, accounting, and actuarial departments. The latter
are based on primary source records and cover key areas of underwriting
activity, including premiums earned, claims incurred, and expenses. The
Black Book derives its name from the color of the binders into which
the various reports are placed, and is neither a secret document nor
part of a so-called ``separate set of books'' designed to conceal Plan
financial problems.
\53\ The Subcommittee staff expressed the belief that Empire was
shifting results from its experience-rated accounts to its community-
rated accounts to avoid casting the Plan in an unfavorable light and to
support a bill then pending before the Legislature. This bill, which
was subsequently passed in July, 1992, was designed to spread the
higher risk and associated costs incurred from community-rated accounts
among other insurers and health maintenance organizations operating in
New York State. Another possibility was that overstating community-
rated losses could be valuable in the event that the Plan wanted to
obtain a rate increase.
---------------------------------------------------------------------------
Two former Empire employees--a Vice President/Executive
Assistant to the CEO, and her associate, a Director in the
CEO's Office--provided pointed testimony in this regard. The
former Executive Assistant explained that her associate brought
these discrepancies to her attention on February 3, 1992 and
that she confronted the CFO, Mr. Weissman, about it. Mr.
Weissman, she said, explained that the Black Book figures were
for internal purposes and the other set of figures, which had
been developed by the Plan's actuarial department, were for
external purposes. Mr. Weissman also told her that ``the Black
Book figures were right and that the other figures were `more
politically acceptable.' '' He added that the latter, which she
said he referred to as the ``manipulated'' figures, were the
ones that were used in the Annual Statement filings and that
Mr. Cardone was aware of this. The former Executive Assistant
testified that she was very disturbed by these responses and
expressed her concern accordingly, whereupon Mr. Weissman told
her to talk to Mr. Cardone about it.
As a result, the next day she and her associate met with
Mr. Cardone, who appeared to be surprised about this situation
and said that he did not know anything about it. At one point,
responding to the former Executive Assistant's observation that
the Black Book figures were always relied upon as being
accurate, Cardone said that:
* * * nobody knows what figures are right. * * * I
can't rely on any numbers coming out of [the] actuarial
[department]. They're jelly. Neither you nor I know
which figures are accurate.
The two former employees added that to the best of their
knowledge nothing was done to address their concerns about the
discrepancies and, most particularly, the very serious
questions they posed regarding the accuracy of the figures used
in the Annual Statements for 1989 and 1990. Within a matter of
weeks of having brought this matter to Cardone's attention,
they were removed from their positions and placed in sales-
related jobs in another building. Both witnesses noted that
nothing in their experience qualified them for these new jobs.
The Executive Assistant testified that after the February 5,
1992 meeting Cardone excluded her from meetings to which she
had previously been invited and, in general, treated her
``coldly.'' \54\
---------------------------------------------------------------------------
\54\ Shortly after moving to her new position, the former Executive
Assistant left Empire to assume the position of Executive Vice
President and Chief Operating Officer at another insurance company, and
six months later, her associate likewise left the company voluntarily.
---------------------------------------------------------------------------
Empire's Vice President in charge of the Audit Division
testified that when she asked Mr. Weissman and his staff about
the discrepancies, she was ``stonewalled'' for a couple of
weeks by being given explanations that did not bear up under
further scrutiny. However, as noted in an affidavit she
provided to the Subcommittee, she ultimately had a conversation
with Mr. Weissman on June 16, 1993 in which he stated that
``there were no supportable reasons for these differences in
1991 and that Mr. Cardone had told him to change the figures in
the annual statement for 1991 to show a lower level of losses
in the experience-rated market segment.'' When asked about this
statement, Weissman disagreed, saying that it
``mischaracterized'' what he had said.
There was also conflicting testimony regarding CEO
Cardone's role in this matter. For example, while the Audit
Division Vice President's affidavit states that Weissman had
changed the figures in the Annual Statements for 1991 at Mr.
Cardone's direction, when asked at the hearing, both Cardone
and Weissman denied that Cardone had ordered the changes. Mr.
Weissman, however, did testify that he had discussed the
situation with Cardone and had changed his initial figures as a
direct result of that discussion:
Senator NUNN. In your [Subcommittee] staff
deposition, * * * you stated, `I think I was upset that
he [Cardone] had questioned my numbers. That really had
not happened the 2\1/2\ years since I became CFO. I
felt extreme pressure that I better make sure that our
numbers are right. I don't know how you could do that
when you are dealing with some fairly sizable
projections, but you know he was a tough guy and this
was the way he dealt with us. I went back and took a
look at the reserves, and my recollection is that
whatever adjustments that I had recommended initially
between the internal accounting report [Black Books]
and the statutory report [Annual Statement], that I
increased the adjustment between the experience and the
community-rated business.' Is that correct?
Mr. WEISSMAN. Yes, sir.
Senator NUNN. Do you stand by that statement?
Mr. WEISSMAN: Yes, sir, I do.\55\
---------------------------------------------------------------------------
\55\ In his deposition with the Subcommittee staff Weissman stated
that he did not think the new numbers were his best judgment because,
in his own words, ``I think I went into Cardone with my best judgment
early on, and he told me: you'd better take another look at it.''
Similarly, when he was later asked if he thought his original numbers
were more accurate than the new numbers, Weissman answered, ``Obviously
I thought they were more accurate. That was the basis on which I went
in to Cardone in the first place.''
The discrepancies and the conflicting testimony regarding
them go to the heart of perhaps the key question that surfaced
in the Subcommittee's investigation of Empire--the credibility
of the Plan's management. Indeed, the contradictions in the
testimony presented lead to the unavoidable conclusion that
someone in Empire's top management was either lying or mistaken
in their statements to the Subcommittee.\56\
---------------------------------------------------------------------------
\56\ On October 18, 1994 Jerry Weissman was indicted by a grand
jury sitting in the Southern District of New York on three counts of
perjury in testimony given before the Subcommittee and one count of
obstructing the Subcommittee's investigation of Empire.
---------------------------------------------------------------------------
In addition, subsequent to the Subcommittee's hearings, the
question of the discrepancies and their relationship to the
Interim and Annual Statements filed for 1989-1992 was examined
by a Special Counsel, former United States Attorney Otto G.
Obermaier. This investigation's findings, which were set forth
in a report issued on September 21, 1993,\57\ confirmed the
existence of $83 million in discrepancies between the figures
listed in the Annual Statements and those contained in the
Black Books for the four-year period examined. Of this $83
million, the report states, ``no contemporaneous documentation
or explanation could be found or may not have existed'' for $63
million of it.\58\ The effect of this $63 million in
unexplained discrepancies, the report continues, was to
overstate the Plan's losses in its Community-Rated market
segment and understate its losses in its Experience-Rated
business. In light of these findings, the Special Counsel
recommended that Empire file amended Annual Statements for the
years 1989-1992, eliminating the ``unexplained adjustments''
and making certain other related corrections.
---------------------------------------------------------------------------
\57\ Report of Special Counsel to the Audit Committee of the Board
of Directors of Empire Blue Cross and Blue Shield.
\58\ Several Empire employees told the Special Counsel that in 1993
Mr. Weissman instructed them to destroy documents pertaining to the
differences between the Black Books and the company's periodic filings.
---------------------------------------------------------------------------
b. Internal Control/Information Systems Deficiencies
As with the West Virginia, Maryland, and District of
Columbia Plans, the Subcommittee found that inadequate internal
control procedures were a serious problem at Empire. Internal
control problems, coupled with major information system
difficulties, made Empire highly vulnerable to both internal
and external fraud and, in turn, helped bring about higher
overall premiums for subscribers and some of the dramatic
losses incurred by the Plan over the last few years.
The Subcommittee reviewed 100 Internal Audit Reports
performed by Plan auditors between 1987 and 1992. These reports
revealed extensive system access and security problems
involving the claims, purchasing, and other key corporate
databases, including:
--Lpurchasing system data files are subject to
unauthorized and excessive access;
--LPlan employees can make unauthorized claims
submissions or changes;
--Lcomputer IDs were found for a terminated employee
and in the name of another unknown individual; and
--Lsystem files were not protected by security software
and inappropriate staff were authorized to modify
files.
In almost 50 percent of the Internal Audits examined by the
Staff, the problems found in the earlier audits were cited more
than once. The Audit Reports often contained remarks indicating
that management had failed to take action in response to their
findings and recommendations; e.g., ``of the eight issues
originally reported to senior management, none have been fully
addressed'' and ``these problems were identified two years ago
and were discussed with management * * * [but] corrective
action was not taken. * * *''
Empire's information systems problems are long-lived and
deep-seated, and to a large extent are a result of the numerous
mergers of separate Blues Plans that ultimately led to Empire's
establishment in 1985. This situation did not improve very much
over the years, even after intensive efforts were undertaken in
the late 1980s to eliminate the duplication and develop one or
more inter-operable systems. A recent management audit
described Empire's current systems environment as still
consisting of a number of disparate systems, many of which were
built 15 to 20 years ago with now outdated technologies.\59\.
---------------------------------------------------------------------------
\59\ The Subcommittee staff's Statement details several examples of
Empire's information systems problems, including: the Sigma Imaging
System--a costly and yet-to-be-completed project to reduce claims
processing costs; CS-90--a system, scheduled for completion in 1995 (at
a projected cost of as much as $50 million), that will attempt to
eliminate the redundant, non-integrated systems inherited from the
various pre-Empire mergers; and, the InterPlan Data Reporting System--
the Blue Cross/Blue Shield Association's ``national'' claims payment
system, established to facilitate reimbursement for claims paid by one
Plan for another Plan's policyholder.
---------------------------------------------------------------------------
The adverse effects of these combined internal control and
information systems problems were most obvious in two areas:
the use of so-called ``dummy codes'' to pay providers for
services rendered to Plan subscribers; and, the failure to
monitor the membership of its community-rated small group
clients to ensure that claims were being paid for valid
subscribers.
Dummy Codes
For years Empire has been routinely paying claims to
doctors, dentists, pharmacies, hospitals and durable medical
goods providers without verifying their status as valid Plan
participants. In response to serious claims processing backlogs
and delays caused by absent provider identification
information, Empire managers authorized the use of dummy codes,
i.e., data entries that allowed its computers to process claims
without this essential information.\60\
---------------------------------------------------------------------------
\60\ When an Empire subscriber submits a claim, the information is
eventually entered into a computer, where it goes through a number of
edit checks. These checks determine if the person submitting the claim
is a valid subscriber, that the procedure is proper, and that the
provider is an approved one. If any of these checks fail to meet Plan
specifications, the computer is programmed to stop processing the
claim. When this occurs, an Empire employee must manually continue the
procedure.
In the case of the provider, if that person or firm is listed in
the database, the system will automatically enter the appropriate
identification number on the claim and continue on. If the provider is
not listed in the database, a Plan employee must provide the number or
use a dummy identification number in order for the claims process to
proceed.
---------------------------------------------------------------------------
The use of dummy codes made it difficult to verify that a
service had been performed or provided by a licensed and
credentialed physician, making the Plan exceedingly vulnerable
to claims processing errors and fraud. In a September 26, 1991
internal audit report, Empire's Vice President of Auditing
concluded that:
The potential for fraud and abuse and operational
errors, including duplicate claim payments, exists
because of the failure to restrict the assignment of
dummy codes to process claims from out-of-area
physicians, pharmacies, durable medical equipment
vendors, and registered private nurses. The use of
dummy codes limits management's ability to track
utilization trends and to detect fraudulent
practices.\61\
---------------------------------------------------------------------------
\61\ The audit report also concluded, more broadly, that the Plan's
system of internal controls was inadequate to ensure an accurate,
complete, and valid physician database. Among the concerns cited in
this regard were failures to: establish minimum credentialing criteria;
validate physicians' credentials against independent sources (e.g., the
American Medical Association); and, purge the Provider File (last done
in 1984). Despite Empire officials' claims to the contrary, the
Subcommittee is informed that there may be electronic data systems
available that can address these internal control issues in a timely
and cost-effective manner.
---------------------------------------------------------------------------
In an April, 1993 interview, Acting Empire CEO, Donald
Morchower, told the Subcommittee staff that in 1990 alone dummy
code payments to non-credentialed physicians had amounted to
some $219 million. Plan estimates indicate that for 1991 and
1992, the total amount of dummy code-based payments was $723
million.\62\ Empire's Director of Program Security during the
period 1987-1993 testified that he had been deeply concerned
about the potential for fraud from the use of dummy codes ever
since his arrival at Empire. He cited a case wherein a Plan
employee defrauded the company out of tens of thousands of
dollars by entering dummy codes for a fictitious provider and a
fictitious patient.
---------------------------------------------------------------------------
\62\ In the April, 1993 interview, Mr. Morchower also said that, as
of that time Empire officials had found 8,000 physicians who had
received payment for services that could not be verified. He further
indicated that they would have an approximation of the improper
payments in this regard within a few weeks, but despite repeated
requests from the Subcommittee staff, such figures were never provided.
---------------------------------------------------------------------------
Community-Rated Small Groups
Until recently Empire did not audit its small, community-
rated groups and as a result knew little about them.\63\ For
instance, Empire management did not know their claims ratio
(the difference between premiums collected and claims paid),
whether they were meeting Plan underwriting standards, or if
the groups actually existed.
---------------------------------------------------------------------------
\63\ The reason for this, according to CFO, Jerry Weissman, lay in
the nature of community-rated business, wherein Empire had to provide
coverage for individuals and groups regardless of their health status.
The Plan never concerned itself with a particular group's gains or
losses, since it was assumed that any losses incurred could be
recovered through premium increases applicable to the community-rated
pool as a whole.
---------------------------------------------------------------------------
Prompted by reports of a major fraudulent scheme
perpetrated by some of these small groups,\64\ in July, 1991
Plan officials directed that a special task force be
established to examine the implications this scheme might have
for other community-rated small groups. Initially, the task
force visited nearly 500 such groups with high dollar losses,
and found that more than 60% of them had some sort of
significant problem; e.g., non-existent members, a failure to
meet underwriting standards, or being fictitious entities.
---------------------------------------------------------------------------
\64\ This case--known as the Finkelstein case, after one of the
alleged perpetrators--involves a long-lived scheme, in which, among
other things, foreigners were brought to the U.S. to receive treatment
whose costs were covered by Empire. One Empire official estimated the
total amount of the suspected fraud from the scheme at nearly $29
million--by far, the biggest fraud in the Plan's history. Law
enforcement officials have only recently initiated a criminal
investigation of this case, even though both the Plan and the New York
Insurance Department were alerted about it in 1986.
The Subcommittee staff also found that after being briefed by Plan
officials on this matter in 1991, U.S. Postal authorities expressed
interest in undertaking a criminal investigation regarding it. However,
Plan officials never pursued this option, instead deciding to proceed
against the alleged perpetrators in a civil action. While the Plan
initially sought $22.5 million in damages in this suit, it recently
agreed to a settlement of just $250,000.
---------------------------------------------------------------------------
These initial findings prompted a larger and more intensive
review, the results of which were summarized in a 1992 Year-End
Status Report \65\ The Report notes that audits conducted on
just over 2,000 of the Plan's 60,000 small groups resulted in
the cancellation of 377 of them. The latter were cancelled,
according to the Report, either because they failed to meet the
Plan's underwriting requirements, denied the auditors access to
their files and records, or could not be found. These 377
cancelled groups accounted for $25 million in losses to the
Plan for the years 1990-1991.\66\
---------------------------------------------------------------------------
\65\ Before the task force embarked on this second audit, any small
group that had membership problems was given a month-long amnesty to
admit their problems, in return for which the Plan would attempt to
help them convert their coverage. This amnesty resulted in the
cancellation of 1,229 groups, with some 19,000 subscribers.
\66\ In 1993, the task force's institutional successor, the Group
Integrity Department, scheduled audits for 1,603 small groups, which,
in the previous year, had lost more than $115 million in 1992. At the
time of the Subcommittee's hearings, 876 (55%) of the groups had been
audited, resulting in the cancellation of 201 (23%) of them. Losses
attributable to these 201 cancelled groups are estimated at $14.5
million.
---------------------------------------------------------------------------
c. Questionable/Poor Underwriting Practices
As in the West Virginia, Maryland, and District of Columbia
Plans, the Subcommittee found that substantial mismanagement
had occurred in Empire's underwriting practices. An internal
management review, which was performed during the early part of
1993, found that managers did not know the true administrative
and operational costs of many of the products being marketed by
the Plan. The review revealed that cost information was not
consistently used in the sales/marketing decision process,
either because the actual cost was unknown or such information
was not communicated to the right persons. Cost allocations
often did not accurately reflect the true expense of a product,
thereby constraining Empire's ability to tailor its prices in
order to either make a profit and/or meet a customer's specific
service requirements.
According to some Plan officials, such poor underwriting
practices caused Empire to become involved in unprofitable
contracts and/or lines of business. For example, in an
interview with consultants, then Chief Operating Officer,
Donald Morchower, stated that Empire had decided to ``buy
Merrill Lynch business'' with low retention rates for the first
three years--admittedly losing money on the contract for that
period--in hopes of being able to recoup the losses by raising
premiums in the fourth year. The Plan's CFO, Jerry Weissman,
told the consultants that no one could deny that Empire had
made ``bad deals'' like the Merrill Lynch contract. Indeed, in
the area of ``National Accounts,'' \67\ since 1988 the Plan has
lost contracts with 78 firms and other organizations,
representing 350,000 employees.
---------------------------------------------------------------------------
\67\ National Accounts are primarily large companies, like Merrill
Lynch, headquartered in New York City, for whom Empire controls and
services employee health benefit claims on a nationwide basis.
---------------------------------------------------------------------------
d. Excessive Salaries and Business Expenses
In the case of Empire, the Subcommittee also found
extravagant salaries, fringe benefits, and other administrative
expenses incurred at a time of increased premiums, reduced
benefits, and serious financial losses. For example,
compensation for Empire's top 10 executives rose 56% between
1987-1992, while in the same timespan, the Plan was sustaining
$617 million in underwriting losses and $210 million in overall
operating losses. CEO Cardone's salary rose from $325,000 in
July, 1985 to $600,000 in 1992, and between 1990 and 1992--when
the Plan lost some $217 million--total compensation for the
Chief Operating Officer, Donald Morchower, increased from
$363,527 to $427,141.
In comparison to executive incentive programs operated by
other large New York City firms, Empire's was exceedingly
generous, especially in view of the Plan's serious financial
problems at the time. When informed that some senior Empire
executives had received average incentive payments ranging from
11 to 13 percent in 1991 and 1992, a New York corporate
benefits expert said:
It would be highly unusual to give someone that size
bonus even every other year, especially if you're
losing money. You could do it once, maybe, but no Board
would let you do it every year.
Empire executives also have received special allowances and
benefits. For example, for the five-year period 1988-1992, the
Plan paid more than $270,000 for officers' health and lunch
club memberships, parking, and physical examinations. During
this same period Empire purchased 82 automobiles (with a
current market value of more than $1 million) for its officers
to use for both personal and business purposes. (Some of these
vehicles were used more for personal than business reasons.)
Also, despite the availability of these 82 cars and another 41
``pool'' vehicles, Empire still incurred sizeable expenses for
limousines.\68\
---------------------------------------------------------------------------
\68\ Over the past six years, for instance, the Plan spent $226,000
for this purpose; indeed, while Empire was losing $150 million in 1991,
costs incurred for limousine service exceeded $90,000. This figure
includes $11,000 for limousines used by CEO Cardone for a two-month
period to ride to and from his home in Connecticut to Plan headquarters
in New York City. Mr. Cardone told the Staff that this expense was
justified because his corporate car was being repaired at that time.
When Staff asked if he considered using one of the Plan's ``pool''
vehicles instead of the limousine, Cardone responded indignantly, ``I
was recruited by this company and I was promised a car.''
---------------------------------------------------------------------------
Other unnecessary and/or excessive Plan expenses include
those incurred for:
Employee awards/gifts: from 1988 through 1992, Empire spent
more than $1.1 million to recognize employee performance,
attendance, and/or service accomplishments. Among the gifts/
awards provided for these purposes were jewelry, gold
wristwatches, clocks, crystal glassware, flatware, and cash
sums up to $2,500. After a company-wide Employee Recognition
Program was established in 1992, in the first eight months of
its existence it gave more than 7,000 awards to Empire's 10,000
employees, at a cost of more than $250,000.
Catering/meals: between 1989-1992, Empire subsidized its
cafeteria costs to the tune of more than $7 million. The Plan
also paid for food and beverage catering service which was
routinely used for almost daily staff meetings. The costs
incurred for such meetings typically ran into the hundreds of
dollars.
CEO Cardone: throughout his tenure, Mr. Cardone continually
expended Plan funds without regard for the restraint one would
expect from the head of a non-profit enterprise, let alone one
that was experiencing major financial losses. Examples of such
expenditures include:
--Lfirst-class air travel, which he almost always used,
and which other Plan officers and employees often used
when they accompanied him on trips;
--La corporate apartment maintained for his use from
1985 through 1989, at an annual cost of $48,000;
--La luncheon membership at The Sky Club, which in
addition to annual dues ($1,800 in 1992), cost the Plan
more than $50,000 over the past five years. Empire's
food services group also provided meals delivered to
Mr. Cardone's office, at a cost of $26,000 for 1992,
alone;
--La renovation of the Plan's executive offices and
boardroom, at a cost of $118,000. Not included in this
figure are an additional $84,000 in approved but not
expended funds for a breakfront, conference table, and
oriental rug. Mr. Cardone also purchased a $20,000
Chippendale desk for his own office;
--La $30,000 Lincoln Town Car and a chauffeur to drive
it; and,
--La $27,000 telecommunications system installed at his
home to provide a direct link with Empire headquarters.
2. Inadequate Oversight by the Board of Directors
As in the case of the West Virginia, Maryland, and D.C.
Plans, Empire's Board failed to provide the necessary checks
and balances over the Plan's management, thereby abdicating
their responsibility to protect the interests of the
subscribers. Specifically, the Subcommittee's examination of
Empire found a Board that was self-perpetuating, ill-informed,
lacking in expertise, and dominated by management.
Empire's by-laws provide for a Board consisting of 18 to 20
Directors, to be elected by a separate body of 78 so-called
``voting members.'' The vast majority (55) of the voting
members are selected by the Directors themselves, the net
effect of which has been to create a self-perpetuating process
by which the Board selects those very individuals whose job it
is to select the Board.\69\
---------------------------------------------------------------------------
\69\ Further reinforcing this self-perpetuating process, the
Directors selected by the voting members come from a list of candidates
developed by the Nominating Committee of the Board. While the by-laws
provide that the voting members may independently place a name in
nomination with the support of twenty members, this has never been
done.
---------------------------------------------------------------------------
In his capacity as both CEO and Chairman of the Board, Mr.
Cardone was able to exert undue influence on the Board's
selection and composition. While the Board was comprised of 44
Directors when Cardone assumed the positions of CEO and
Chairman, over time he was able to drastically downsize it to
19 members. A former Empire officer stated that virtually every
Board member who might question Cardone's actions was removed,
leaving only those who could be counted on to ``rubberstamp''
his actions.
Another major Board shortcoming was the Directors' admitted
lack of technical expertise and the resultant hesitancy to
question management proposals and actions. One Director, for
instance, stated that the Board failed to delve deeply enough
into issues, instead accepting surface answers. A former Empire
Vice President stated that ``the Board didn't know what to ask
even if they wanted to find out what was going on.''
The Board's performance was also heavily influenced by
management's ability to manipulate and control the flow of
information to it. Long-time Director and newly appointed Board
Chairman, Harold Vogt, admitted in an interview with the Staff
that he knew little or nothing about such key matters as major
lawsuits that had been filed against Empire,\70\ the
controversy surrounding a multi-million dollar information
systems contract, and the serious problems that had led to the
decision to recredential all of its small group clients. Vogt
told the Staff, ``I'm learning a lot here talking to you.''
---------------------------------------------------------------------------
\70\ One of these was a March, 1993 lawsuit filed against Empire by
AT&T, in which the latter claimed that the Plan had improperly withheld
hospital differentials obtained in its behalf. Mr. Vogt did not learn
about this matter until a meeting with the Superintendent of Insurance
a month-and-a-half later.
---------------------------------------------------------------------------
Some of the sharpest criticism of the Board came from
several former Empire executives and other employees. One of
these stated that the Board ``provided no checks on
management,'' and that no one in the Plan had much confidence
in the Board. Another characterized the Board as being ``asleep
at the switch,'' and stated that it did nothing more than rely
on Cardone. Several said that the Board was merely a
rubberstamp for senior management, and Cardone in particular.
One former employee commented that the latter description was
probably too kind because ``at least a rubberstamp leaves an
impression.''
3. Inadequate Regulation by the Insurance Department
The Subcommittee found that the New York Insurance
Department's performance in overseeing Empire's activities was
woefully inadequate, primarily because of a pattern of
regulatory forbearance which, at times, bordered on favoritism.
At times, the Department reversed itself when such action
accrued to Empire's benefit, failed to exercise its regulatory
authority over the Plan, and allowed Empire to ignore its
recommendations and/or regulations with impunity.
The Subcommittee also found that the Department's actions
regarding Empire, which insured nearly 45% of New York State's
citizens, reflected the same ``too-big-to-fail'' approach that
helped explain the Maryland Insurance Division's inability to
deal effectively with BCBSM. As Insurance Superintendent,
Salvatore Curiale, stated:
You have asked whether certain of the Blues Plans,
and now specifically Empire, are ``too big to fail?''
Under the law as it existed in New York prior to April
1, 1993, the effective date of health insurance reform
legislation, I would agree, Empire was too big to
fail.\71\
---------------------------------------------------------------------------
\71\ Elaborating on this point, Superintendent Curiale offered some
critically important additional remarks, which place Empire and BCBS
Plans in general in the wider context of the current debate on health
care reform: ``Senator, in your opening statement you asked the
question, can we build a health care system relying extensively on huge
non-profit organizations. I think the answer is clearly no. We must
devise a way to control health care costs and to share the burden of
financing them not only through not-for-profit insurers, but also
through for-profit, commercial insurers, self-insured employers and
organizations, and whatever financing vehicles may be fashioned in the
coming months and years.''
Among the cases that best represent the Department's failed
regulation of Empire is Healthnet, the Plan's HMO operation. In
this case, the Department reversed itself to Empire's benefit,
allowed it to ignore State regulations governing HMOs, and
failed to exercise and/or follow through on its authority over
HMO operations. As a result, Healthnet has been able to
continue in business, even though it has had only one year of
modest profitability during its seven-year existence and has
drained more than $115 million from the Plan's surplus.
The Department's handling of important issues relating to
Empire's Board of Directors is another area in which it
performed inadequately. In 1989, the Department determined that
the process for selecting Directors did not provide for
subscriber participation, and accordingly recommended that the
Board ``undertake a study of the election process and propose a
method * * * which would evidence greater accountability * * *
to the subscribers.'' The Department, however, chose not to
force this issue and thus the same process remains in effect
today.
Also during 1989, the Department expressed concerns that
under Mr. Cardone, Empire's by-laws had been changed to allow
him to simultaneously hold the positions of CEO and Board
Chairman. The Department's General Counsel determined that the
arrangement under which CEO Cardone was serving on the Board,
as a member representing Plan subscribers, was not in
conformance with existing statutory requirements.\72\
---------------------------------------------------------------------------
\72\ Because of its status as a non-profit insurer, the composition
of Empire's Board is set by statute. In 1989, this statute required
that the Board be comprised of representatives of three distinct
categories: 1) the provider community; 2) the subscriber community;
and, 3) the public interest. Empire had listed Cardone as falling under
the subscriber category.
---------------------------------------------------------------------------
As a result, the Department recommended that the Board
``furnish a formal description of the process by which the
change was made and its justification therefor.'' Empire's
response attributed the change to a 1981 Nominating Committee
recommendation (even though the change was made in 1987), and
justified it on the tenuous grounds that the company had
``grown to be a multi-billion dollar enterprise with complex
and important functions and operations....'' Upon receipt of
this reply, the Department dropped the matter and at least
until May, 1993, Cardone continued to hold the position of
Chairman of the Board under the newly-created category,
``officer-employee.'' \73\
---------------------------------------------------------------------------
\73\ It was not until 1993--apparently after the Subcommittee had
commenced its inquiry into Empire--that Superintendent Curiale decided
that perhaps these combined CEO/Board Chairman positions were not such
a good idea. For example, in a May, 1993 interview with The New York
Times, Mr. Curiale stated that he reached his decision ``in hindsight,
with three years of experience.'' Likewise, in an interview with the
Staff, he stated that his concern was that ``Cardone may have been
dominating the Board.''
---------------------------------------------------------------------------
The evidence suggests that the Department allowed Empire to
ignore its regulatory actions with virtual impunity, despite
the fact that it has a broad array of enforcement powers.\74\
The Department's examination report of Empire, for the period
ending December 31, 1983, noted that three of the Department's
four previous recommendations had not been complied with.
Likewise, the report for the period ending December 31, 1987
listed five recommendations from the 1983 report with which the
Plan had not complied. No penalties for this non-compliance
were assessed by the Department against Empire.
---------------------------------------------------------------------------
\74\ Included among these are the power to: 1) issue, suspend and
revoke licenses; 2) require reports; 3) make investigations and
examinations; 4) regulate finances and business operations; 5)
establish rates; 6) provide for the protection of consumers; and, 7)
impose penalties.
---------------------------------------------------------------------------
Other examples of this regulatory failure include:
--LEmpire's refusal to comply with a recommendation
made by the Department in 1989 that it change its
external auditors because a number of the Plan's
officers had formerly been associated with that same
firm; \75\
---------------------------------------------------------------------------
\75\ While the Department seemed content to allow Empire to
disregard this recommendation for four years, in an April 30, 1993
meeting with the Board, Superintendent Curiale again suggested that the
external auditors be rotated.
---------------------------------------------------------------------------
--Lthe Department allowed Empire to invade reserves on
a number of occasions, even though it was failing to
comply with regulatory requirements that made this
contingent upon the establishment and execution of a
plan to restore and add to these reserves;
--LEmpire's failure in 1990 and 1991 to make required
contributions from its experience-rated business to
subsidize its community-rated business and, for 1992,
contributing a substantially lower amount than the
specified minimum; and,
--Lin a 1992 meeting with BCBS Association officials,
Superintendent Curiale was told that Empire was in
danger of losing the Blue Cross/Blue Shield trademarks,
if its reserves declined into a negative status.
Shortly thereafter the Department declared
``redundant'' certain reserve funds held by the Plan to
pay hospital claims. This adjustment effectively made
$80 million available for Empire's reserves, saving
them from falling to a level of minus $40 million for
1992.
The Department's inadequate performance regarding Empire to
some extent reflected its lack of knowledge about important
matters affecting the Plan. Department officials said that they
were unaware of the large number of National Accounts that
Empire had lost. The Superintendent told the Staff that until
1992 he was unfamiliar with the Association's NMIS system and
had no knowledge of the Plan's poor performance ratings
therein.\76\ The Superintendent also stated that while he was
aware of the dummy codes issue, he had no idea that it involved
such enormous sums, e.g., $219 million in payments to non-
credentialed physicians in 1990 alone. Finally, he did not know
that the Plan had already identified more than $25 million in
payments made to ineligible groups in 1990-91.
---------------------------------------------------------------------------
\76\ The National Management Information Service (NMIS)
quantitatively measures service levels for all BCBS Plans on a
quarterly basis.
---------------------------------------------------------------------------
4. Inadequate Oversight by the Blue Cross/Blue Shield Association
As in the West Virginia, Maryland, and D.C. Plans, the
testimony confirmed that the Association, while long concerned
about Empire, failed to respond effectively to its
problems.\77\ For example, as long ago as 1987, the Association
recognized that Empire's reserves were unacceptably low and put
the Plan on conditional status in four of the next five years.
Yet, the Association failed to take decisive action and as late
as November 1992, was still being fended off by management's
refusal to cooperate fully with its legitimate oversight
requests. For instance, after the Association asked Empire for
certain internal audit reports on accounts receivable, HMO
operations, and systems implementation, Plan staff, at the
direction of CEO Cardone, refused the request. Cardone only
relented after months of phone calls, significantly delaying
the Association's ability to act on the information requested.
---------------------------------------------------------------------------
\77\ To its credit, and in marked contrast to its actions along
these lines regarding the other Plans examined by the Subcommittee, the
Association did discuss its concerns about Empire with both the Board
of Directors and New York insurance regulators. However, it did not do
so until 1992, when the Plan's long-lived and deep-seated problems had
already caused hundreds of millions of dollars in losses and
dramatically weakened its overall financial condition.
---------------------------------------------------------------------------
Moreover, during the preceding months, the Plan's condition
grew sufficiently worse to prompt significant additional
downgradings. In May, 1992, its conditional status was moved to
the ``concern'' level--the next to the highest level of
monitoring available. The Association also directed that CEO
Cardone develop a detailed recovery program for presentation in
September of that year.\78\ In August, 1992, Empire's problems
reached the stage where the Association placed it on the
highest level of monitoring, ``contingency protocol.''
---------------------------------------------------------------------------
\78\ When Cardone made his presentation, Association officials
found it unacceptable. They instructed him that they intended to
conduct site visits at the Plan and again warned that the Plan would
lose its BCBS membership status if it did not meet the operative
reserve requirements.
---------------------------------------------------------------------------
In addition to its monitoring efforts, the Association also
had access to numerous reports and other information on Empire,
which should have prompted more forceful and immediate action
in response to its problems. Notable in this regard is a
National Account Performance Review (NAPR), completed in
December, 1991:
Significant operational deficiencies were identified
Plan-wide for national accounts and the Federal
Employee Program (FEP). Performance levels for most
functions deteriorated during 1990 and 1991 * * * [and]
were below the National Account Performance Standards
in two thirds of the categories * * * [the FEP] index
score of 73.9 points * * * ranked the Plan 20 [out] of
[the] 26 monitored. * * *
D. Effects
Empire subscribers and providers experienced problems much
the same as those found in the West Virginia and Maryland
Plans. In 1992, for example, the New York Insurance Department
closed 4,200 complaints against Empire, while the Plan itself
received some 13,000 additional complaints from other sources,
such as the New York City Office of Consumer Affairs.\79\ These
complaints, once again, involved claims problems, payment
delays, and denial of benefits.
---------------------------------------------------------------------------
\79\ Not included in these figures are an undetermined, but
potentially large number of additional complaints that may have been
contained in the five million telephone contacts recorded by Empire
during this same period.
---------------------------------------------------------------------------
Complaints, and the poor customer service that prompted
them, played a substantial part in causing Empire's national
accounts to leave the Plan. The Subcommittee staff testified
that 18 of the 42 largest companies (those having between 1,100
and 57,000 employees enrolled) that have terminated their
contracts with Empire since 1988, did so because of poor
service involving claims processing, slow payment, and/or a
failure to respond to complaints. Representatives of these
former national accounts described the chronic service problems
at Empire:
--Ldealing with Empire was like dealing with a black
hole. You could never get anyone to deal with your
problems * * *;
--Ldifficult to get through to customer service and
poor follow-up on complaints * * *;
--Lclaims processing was slow and sloppy; and,
--Lthe billings were often wrong, the employees hated
it and we got fed up with it.
Empire subscribers also experienced excessive premium
increases. For instance, the cost of basic medical coverage
(Matrix II) for subscribers in the Plan's community-rated
groups increased 350% between 1989 and 1993--from $29.55 to
$138.90 monthly for individuals and $73.90 to $318.55 monthly
for families. During the same timeframe, community-rated group
subscribers with major medical coverage (Wraparound Plus) saw
their premiums rise by 230%--from $97.90 to $323.95 monthly for
individuals and $226.80 to $752.35 monthly for families.\80\
---------------------------------------------------------------------------
\80\ As in the case of BCBSM, these rate increases were also to
some extent a result of the Plan's mismanagement and other related
problems. One former Empire executive, who held the position of
Director of National Accounts, stated that ``the rank and file's
attitude, supported by management was, `I don't care what it costs--
we'll just pass it on.' '' Likewise, a senior vice president said that
management's attitude in the face of the huge losses Empire was
experiencing prior to his recent departure was that this was ``no
problem since in the end the community will cover it with increased
premiums.''
---------------------------------------------------------------------------
Lastly, Empire providers encountered problems similar to
those described in connection with the West Virginia and
Maryland Plans. For example, hospital administrators stated
that Empire often loses claims or denies ever having received
them, even when the latter have been transmitted electronically
or with a return-receipt requested. Officials at one hospital
stated that Empire does not respond to any inquiry concerning
the status of a claim until 30 days have passed since its
submission. At that point, Plan representatives have often
responded that they did not receive the medical records,
whereupon the whole cycle must begin again.
FEDERAL CONTRACTS
A. Background/Organization
Blue Cross/Blue Shield Plans are the single largest health
care service provider to the Federal Government.\81\ In a
unique set of Federal contracts, the Blue Cross/Blue Shield
Association (BCBSA) arranges for the individual Plans to
provide coverage for Medicare Part A (Hospital) and the Federal
Employees Health Benefits Program (FEHBP).\82\ The Blue Cross/
Blue Shield system insures about 40% of all Federal employees,
dependents, and annuitants covered by the FEHBP, and
administers over 90% of all Medicare Part A claims and 65% of
Medicare Part B (Medical) claims for elderly beneficiaries
nationwide.
---------------------------------------------------------------------------
\81\ Federal spending for health care in the United States accounts
for approximately one third of the estimated trillion dollars to be
spent in 1994 for this purpose.
\82\ The FEHBP was established by the Federal Employees Health
Benefits Act of 1959 (P.L. 86-382). Its purpose is to provide health
insurance benefits for Federal employees, annuitants, and dependents.
In 1960, 1.7 million Federal employees were enrolled in 36
participating FEHBP plans. Since then, it has grown enormously,
encompassing about 300 plans today (with a peak of over 440 in 1988)
providing coverage for some 9 million enrollees. FEHBP participants
receive health care coverage through either fee-for-service plans
(those that reimburse the claimant or provider for covered services) or
prepaid plans (those that provide comprehensive medical services
through their own doctors and hospitals). The FEHBP is financed through
premium payments made by the enrollee and the Government. Currently,
the Government pays about 70% and the enrollee pays 30%.
---------------------------------------------------------------------------
The Blue Cross/Blue Shield Service Benefit Plan, which is
commonly referred to as the Federal Employee Program (FEP), is
the largest FEHBP participant. FEP operations involve four
separate Blue Cross/Blue Shield entities:
--Lthe Chicago-based BCBSA, which acting on behalf of
the 67 independent Plans, contracts directly with the
Office of Personnel Management (OPM) to provide health
benefits to Federal employees who enroll in the FEP.
The BCBSA charges the Federal government for these
services, which between 1989-1993 averaged about $3.3
million annually.
--La Director's Office in Washington, D.C. that
provides centralized management of the FEP contract by
coordinating its administration with the BCBSA,
individual Blue Cross/Blue Shield Plans, and OPM. In
recent years the Director's Office has employed as many
as 119 ``staff equivalents'' to work on the FEP
contract. Between 1989-1993, the annual expenses of the
Director's Office averaged about $26 million.
--Lan Operations Center at GHMSI in Washington, D.C.
The Operations Center carries out certain
administrative functions and centralized record
keeping. It is linked with all the Plans via a
telecommunications and computer network, through which
it verifies subscriber eligibility, processes claims,
and maintains historical claims files. Annual charges
billed to the Federal contract for the Operations
Center averaged nearly $15.5 million between 1989-1993.
--Lthe 67 local Blue Cross/Blue Shield Plans that
actually provide the benefits to the Program
participants. Last year they paid out some $5.2 billion
in benefits and incurred $344 million in administrative
expenses.
Blue Cross/Blue Shield Plans also collectively serve as the
largest contractor for administering the Medicare program.
Medicare provides hospital insurance (Part A) and supplementary
medical insurance (Part B) for the aged and disabled.\83\ Part
A contractors are referred to as ``intermediaries'' and by law
are nominated to administer the Medicare contract by hospitals
in the community in which they serve. In many states, the local
Blue Cross/Blue Shield Plan is the only insurer large enough to
be considered for nomination and, thus, as of 1993, 41 of the
46 participating Part A intermediaries were Blues Plans.
Medicare Part B contractors are referred to as ``carriers''
and, in 1993, 25 of the 37 participating insurers were Blue
Cross/Blue Shield Plans.
---------------------------------------------------------------------------
\83\ Medicare Part A provides hospital insurance for the aged and
disabled, including medical services furnished by hospices, skilled
nursing facilities, and home health agencies. It is financed primarily
through Medicare's share of the FICA (Federal Insurance Contribution
Act) payroll tax and in 1993 covered an estimated 35.1 million
individuals. Medicare Part B provides supplementary medical insurance
for the aged and disabled for physician care, outpatient services,
durable medical equipment, and a variety of other non-institutional
services. Enrollment in Part B is voluntary and anyone enrolled in Part
A may enroll in it by paying a monthly premium ($41.10 in 1994).
Premium payments cover about 25% of Part B costs, with the remainder
being paid by Federal tax dollars. In 1993, Part B covered an estimated
34.3 million individuals.
---------------------------------------------------------------------------
The agency responsible for Medicare administration and
oversight, the Health Care Financing Administration (HCFA) of
the Department of Health and Human Services (HHS), contracts
with the BCBSA to administer the Part A program.\84\ The
individual Blues Plans serve as subcontractors to the
Association. The BCBSA is reimbursed for performing various
functions pursuant to this contract and in 1993 received about
$7.4 million for its efforts in this regard.\85\ In the case of
Medicare Part B, HCFA contracts directly with the individual
participating Plans.
---------------------------------------------------------------------------
\84\ HCFA was formed in 1977 to place responsibility for the
Medicare and Medicaid programs in a single Federal agency. It contracts
with private insurers to process claims and is responsible for
administering and overseeing Medicare and Medicaid program operations.
\85\ These functions include: determining whether services provided
are covered; receiving, disbursing, and accounting for funds in making
payments to service providers; auditing records of service providers;
assisting service providers in developing procedures regarding
utilization practices; assisting institutions, facilities, or agencies
interested in becoming a service provider; and, serving as a
communications link between service providers and HHS.
---------------------------------------------------------------------------
B. Financial Profile
A major difference between the Federal contracts and the
individual Blue Cross/Blue Shield Plans discussed previously is
that there is no concern about a possible insolvency affecting
subscribers, since the FEHBP and Medicare are backed by the
Government and are essentially self-insured. As a result, in
its review of the Federal contracts, the Subcommittee focused
on the alleged waste of taxpayer dollars and the
correspondingly adverse impact on the Federal budget.
In 1992, for the FEP's more than 1.7 million enrollees,
$5.16 billion in premiums were collected and $4.81 billion in
claims were paid. For that same year, FEP administrative costs
were $363 million and income from service charges was $38.4
million. Referring to the FEP in a March 1990 memorandum to
Blue Cross/Blue Shield Chief Executives, the BCBSA President
stated that, ``by a wide margin [the FEP] is the Blue Cross and
Blue Shield system's largest and most valuable single
account.''
Of the approximate $170 billion in total claims processed
annually by all Blue Cross/Blue Shield Plans, over 60% are
Federal claims--$106 billion for Medicare and $5.2 billion for
the FEHBP. Figures for 1993 show that the Plans of the Blue
Cross/Blue Shield system received the largest share of
Medicare's overall administrative costs--$1.1 of the total
$1.54 billion--and the largest portion of the FEHBP's total
administrative costs--$402 million of the total $702 million.
Federal funds constitute a significant portion (about 40%) of
the BCBSA's annual revenues; in 1992, for instance, revenue
from the FEHBP and Medicare amounted to $53.9 million of the
Association's $136.8 million in total revenue.
A large portion of the Blue Cross/Blue Shield Plans' total
overhead and fixed costs are paid for by the Government, which
some have suggested is most helpful to the Blues when they
compete for private business. As one health care analyst told
the Staff, the Federal contracts also tremendously increase
Blue Cross/Blue Shield's subscriber market share and, thereby,
improve their bargaining position with local hospitals and
doctors.
C. Problem Areas
The Subcommittee found that the relationship between Blue
Cross/Blue Shield and the Medicare and FEHBP contracts is
marked by some of the same problems uncovered in its previous
hearings. Specifically, as with the West Virginia, Maryland,
District of Columbia, and Empire Plans, the Subcommittee found
evidence of mismanagement; inadequate oversight by the Blue
Cross/Blue Shield Association; and inadequate regulation by
responsible regulatory authorities.
1. Mismanagement
a. Excessive Bureaucracy
The Subcommittee staff testified that the Blue Cross/Blue
Shield system has generated a multi-layered, complex
organizational structure that has resulted in additional and
unnecessary expenditures by the Federal government. The FEP
contract involves the BCBSA, an FEP Director's Office, an
Operations Center, and the 67 independent Plans nationwide. As
a result, the Federal government pays a substantial amount for
the direct and indirect costs of not just one insurance
company, but those of 67 separate insurers; i.e., 67 CEO's
salaries, 67 computer systems, 67 payroll offices, 67 building
expenses, etc.\86\ The Associate Director of OPM's Retirement
and Insurance Group commented that ``the Blues have the worst
bureaucracy; they * * * make the Federal government look
good.''
---------------------------------------------------------------------------
\86\ Total costs incurred by the Government between 1989-1993 for
the BCBSA, FEP Director's Office, and FEP Operations Center amounted to
$224.1 million. During the same timeframe, the total cost for the 67
participating Blue Cross/Blue Shield Plans was nearly $1.5 billion.
---------------------------------------------------------------------------
For example, while the Operations Center performs almost
all claims and payments processing, it does not actually pay
the claims. That step is performed by the 67 individual Plans,
because only they know what the actual discounted hospital and
provider charges are in their respective territories. These
charges are negotiated by each Plan with its local hospitals
and providers and are viewed as business proprietary
information.
b. Administrative Costs
In terms of administrative costs per $100 of benefits paid,
GAO reported that the FEP ranked second highest among 17 FEHBP
fee-for-service plans in 1988 and fifth among 15 plans in 1990.
For 1991 and 1992, data compiled by OPM showed that the FEP's
administrative costs were third and sixth highest,
respectively, among the FEHBP's 11 largest fee-for-service
plans. According to health benefits experts the Subcommittee
staff interviewed, taking into account the Blues' size and
experience it would be expected that they would have done much
better than the other FEHBP plans, since economies of scale
play a significant part in lowering administrative costs. These
same sources also said that the FEP administrative cost ratio
was exorbitant and should have been about half the 8% to 9%
range cited by GAO and OPM in their recent analyses of the
FEHBP fee-for-service plans.
c. Questionable/Poor Business Practices
The Staff testified that the 43 audit reports regarding the
FEP issued by the OPM/OIG since 1988 show that more than $78
million in contract charges were questioned and, of that
amount, $51.6 million (66%) was disallowed. Items questioned
and/or disallowed include: marketing charges (commissions,
awards, and bonuses); advertising costs; charitable
contributions; meals, entertainment, and travel expenses;
promotional costs; lobbying and legal fees; and, membership in
country clubs and other social organizations. For example:
--Lthe BCBSA charged the FEP $2.6 million between 1985
and 1990 for commissions, awards, and bonuses paid to
employees for efforts resulting in the acquisition and
retention of subscribers. The OIG's previous audit had
identified similar charges of $568,217 for 1983 and
1984, which were also disallowed.
--LBlue Shield of California charged the FEP more than
$48,000 for entertainment and promotional costs
associated with its 50th anniversary observance and
$148,000 in leasing costs for vehicles Plan employees
used for personal purposes.
--LBlue Cross/Blue Shield of the National Capital Area
charged the FEP nearly $600,000 for lost investment
income, $80,000 for lobbying activities, and $26,000
for promotional items.
Questionable charges were also identified among Blue Cross/
Blue Shield Medicare contractors audited by the Department of
Health and Human Services, Office of the Inspector General
(HHS/OIG). The OIG audits have recommended disallowing more
than $40 million since 1992 for improper charges, including
first-class airline tickets, golf course fees, alcoholic
beverages, tickets for sporting and cultural events, and family
travel.\87\
---------------------------------------------------------------------------
\87\ At the Subcommittee's request, the HHS/OIG audited some
expenses that had been questioned during its investigation of the
Maryland and Empire Plans and found almost $1 million in unallowable
salary charges.
---------------------------------------------------------------------------
The Subcommittee also received testimony that Blue Cross/
Blue Shield Plans have withheld millions of dollars in hospital
and provider discounts from the Federal government and FEP
subscribers.\88\ OPM first discovered that Blues Plans were not
complying with requirements that they credit the FEP for
hospital ``differentials'' (the difference between the
provider/hospital billed charge and the discounted amount
actually reimbursed) during a 1975 audit of the Illinois Plan.
Despite this audit finding and testimony provided by Blue
Cross/Blue Shield officials insisting that the differential
problem had been taken care of, some Plans have continued to
abuse this requirement:
---------------------------------------------------------------------------
\88\ Hospital and provider discounts are a long-lived Blues
practice, resulting from their tremendous purchasing power and the way
hospital bills are paid. Individual Plans negotiate discount prices
with hospitals and providers in return for sending patients to them.
The discounts vary from 2% to 75%.
--La 1992 OPM/OIG audit of the North Dakota Plan found
that it had overcharged the Government $585,000 by
paying hospitals a negotiated rate and then billing the
FEP for the full amount; and,
--Lan audit of Blue Cross/Blue Shield of the National
Capital Area reported that the Plan owed OPM $1.4
million in interest alone for failing to credit the
Government on a timely basis for funds received from
hospital settlements.
In the case of FEP subscribers, the Subcommittee found that
for years many Blue Cross/Blue Shield Plans have been using the
higher, non-discounted billed amount to determine coinsurance
(the percentage of a bill for which the insured is
responsible), resulting in unfair and higher out-of-pocket
costs for thousands of Federal employees. For example, the
Empire Plan told a subscriber that he owed more than $6,000 in
coinsurance for hospital services that cost $16,000. However,
after the hospital and the subscriber complained to OPM, it was
determined that he actually owed about half the amount the Plan
had charged him and, equally important, that the Plan owed more
than twice the $1,700 it had paid pursuant to its obligations.
The Subcommittee found that in other cases the Plan ended
up paying nothing on a claim, while the Federal employee's
coinsurance amounted to thousands of dollars. For instance,
after calculating their discounts and deductibles, Blue Cross/
Blue Shield of Colorado had determined that the total covered
charges for an $11,500 hospital bill was $3,700. The Federal
subscriber's coinsurance was calculated using the $11,500
amount and he was advised to pay the hospital $4,600. Since
this latter amount exceeded the total charges owed by the Plan
after its discounts had been factored in, the Plan ended up
paying nothing to the hospital. The Federal employee, it should
be noted, did not know this until after he complained about the
size of the original bill. OPM subsequently determined that his
actual coinsurance payment should have been about $1,500,
instead of the $3,700 called for by the Plan.\89\
---------------------------------------------------------------------------
\89\ OPM now prohibits the practice of calculating the coinsurance
payment on the billed versus the discounted amount, and Blue Cross/Blue
Shield officials testified that they are complying with this new
policy. While the effects of this practice have not been fully
assessed, OPM has determined that tens of millions of dollars are owed
thousands of Federal subscribers for certain mental health and
outpatient expenses incurred from 1990 to the present. In his testimony
before the Subcommittee, OPM's Associate Director for Retirement and
Insurance stated that he expects about $25 million in ``rebates'' to be
refunded to these FEP enrollees.
---------------------------------------------------------------------------
Serious problems were also identified in Blue Cross/Blue
Shield's Medicare program involvement. Out of the 41 Plans
operating as Part A intermediaries in 1993, eight had been
placed on a ``watch list'' for failing to meet basic
performance requirements--e.g., claims payment controls,
timeliness of claims processing, and customer service--
established by HCFA. One of these Plans, Blue Cross/Blue Shield
of Michigan, will be eliminated from the Medicare program at
the end of the 1994 contract year because HCFA discovered that
it had submitted false statements to cover up poor
performance.\90\ Likewise, seven of the 27 Blue Cross/Blue
Shield Part B carriers had been placed on the watch list by
HCFA for poor performance and another three will not be renewed
at the end of the 1994 contract year. It should also be noted
that two of the Part B Plans on the watch list have additional
problems with broader implications: the Justice Department has
filed suit against the Florida Plan, alleging that it incurred
$10 million in unwarranted Medicare program costs as a result
of trying to resolve computer generated backlogs in claims
payments; \91\ and, the Massachusetts Plan is under
investigation by the HHS/OIG and the FBI for allegedly
manipulating performance data to comply with the timeliness
requirements of the Medicare contract.
---------------------------------------------------------------------------
\90\ The HHS/OIG and the FBI are conducting a criminal
investigation of this case, which has already resulted in the firing of
21 Michigan Plan managers.
\91\ According to officials of the Florida Plan, it has agreed to
pay the Federal government $10 million. Of this amount, $9.5 million
will come from GTE Data Service, Inc., the company whose deficient
computer system caused the Medicare claims payment backlog.
---------------------------------------------------------------------------
In addition to these Part A and Part B problems, some Blue
Cross/Blue Shield Plans have mismanaged their Medicare
Secondary Payer Program (MSP) responsibilities, causing
hundreds of millions of actual and potential losses to the
Federal government.\92\ In the case of the Empire Plan, the
HHS/OIG found that it had billed the Federal government for $85
million in improper MSP payments.\93\ HCFA officials, moreover,
stated that they believe that the total amount owed by Blue
Cross/Blue Shield contractors for improper MSP payments is more
than $500 million.
---------------------------------------------------------------------------
\92\ The MSP covers individuals 65 or older, who are still employed
and have private health insurance coverage through their employers.
Under the MSP, the private health insurer is supposed to pay the
insured's medical claims as the primary carrier, with Medicare serving
as the secondary carrier responsible for charges not covered by the
former. In July 1990, the Subcommittee's Ranking Minority Member,
Senator William V. Roth, held hearings on the MSP, which found that the
Federal government may have erroneously paid between $400 million and
$1 billion annually in benefits to providers who should have been paid
by the primary carrier.
\93\ The HHS/OIG audit confirmed $85 million. However, Empire
failed to provide justification for another $118 million and HCFA has
indicated it expects to recover this additional amount if such
justification is not received from the Plan.
---------------------------------------------------------------------------
d. Internal Control Deficiencies
As with the individual Plans discussed above, the
Subcommittee found that inadequate internal controls exist in a
significant number of the Blue Cross/Blue Shield Plans
participating in the FEP. A 1989 OPM/OIG audit report, for
example, lists a number of weaknesses found regarding the
Massachusetts Plan, including:
--Linadequate controls over coordination of benefits
with other carriers;
--Linadequate procedures for investigating duplicate
payments; and,
--Linadequate segregation of allowable and unallowable
administrative costs.
OPM/OIG reports issued in 1992 and 1993 regarding the FEP
operations of the Florida, Virginia, and Arizona Plans cite
similar findings:
--Lclaims processing system weaknesses;
--Lduplicate payments;
--Lfailure to properly coordinate benefits with other
carriers;
--Lweaknesses in accounting systems for administrative
expenses; and,
--Linadequate procedures to ensure that refunds were
properly credited to the contract.
As was the case in the Maryland, District of Columbia, and
Empire Plans, the weaknesses listed above have been recurring;
e.g., the OPM/OIG's December 1992 audit report on the
Massachusetts Plan cited the same problems described in the
report issued three years earlier. In their review of the 43
OPM/OIG audit reports issued since January 1988, the
Subcommittee staff found that 34 cited problems with duplicate
payments, 12 mentioned coordination of benefits difficulties,
and 12 made reference to unsupported charges.
Internal control weaknesses can constitute an open
invitation to fraud. Throughout the Subcommittee's Blue Cross/
Blue Shield investigation, the evidence has indicated that
anti-fraud efforts receive inadequate attention from the
individual Plans, the BCBSA, and regulatory authorities.\94\ As
noted previously, for example, in its examination of the Empire
Plan, the Subcommittee found that one small criminal group was
able to defraud the Plan of about $29 million owing to faults
in its subscriber enrollment system.
---------------------------------------------------------------------------
\94\ See related discussion below p. 85.
---------------------------------------------------------------------------
Subscriber enrollment system problems in the FEHBP in
general and the FEP in particular were identified as long ago
as December, 1979 in a GAO report, Errors in Health Benefits
Enrollment Data Push Up Health Insurance Costs (FGMSD-80-8). In
that report, GAO stated that discrepancies in the enrollment
data kept by the Federal agencies and insurance carriers caused
erroneous premiums and benefits to be collected and paid,
respectively. GAO noted that a 1976 audit of FEP files found a
10% overall discrepancy rate among the Blue Cross/Blue Shield
Plans and that half of these showed employees listed on the
carriers' rolls as being eligible to receive benefits when they
were not listed in the records of the Federal agency for which
they presumably worked. GAO estimated that the Federal
government was losing more than $1.5 million in premiums
annually as a result of these discrepancies, but did not
attempt to determine losses that may have occurred from
fraudulent claims filed by ineligible individuals.\95\
---------------------------------------------------------------------------
\95\ The OPM Inspector General testified that in recent years his
office has investigated several cases where, because of the lack of
enrollee reconciliations by Blue Cross/Blue Shield, individuals have
continued to receive health benefits for years after leaving Federal
service. In some cases, these individuals received benefits to which
they were not entitled worth more than $200,000 and in one case a
former Federal employee received health benefits from Blue Cross/Blue
Shield for 17 years after she had been fired from her job with the Navy
Department.
---------------------------------------------------------------------------
Enrollment system problems were also identified in almost
yearly findings by outside accountants hired to audit the FEP
Director's Office. For example, in 1979, the auditors noted
that:
reports of the previous audit firm noted there was no
reconciliation of the FEP enrollment system master
files, the various payroll offices' subscriber files,
and the various transmittal forms for subscriber input
and enrollment changes.
Inexplicably, it was not until 1989 that the Director's Office
and OPM agreed to examine the enrollment system issue.
e. Questionable Business Expenses
The Subcommittee's review of the FEP revealed the same
irresponsible management outlook and apparent disregard for
cost containment uncovered in the West Virginia, Maryland, D.C.
and Empire Plans. Specifically, questionable and/or unnecessary
charges were found in several areas, including conferences and
meetings, promotional items, and executive compensation.
Among the most questionable expenses charged to the Federal
government are those associated with FEP National Conferences.
Hundreds of employees and their spouses attend these events,
which in recent years have been held at various resort and/or
luxury hotels located in Scottsdale, Arizona (1990), New
Orleans (1991), Palm Springs, California (1992), and Atlanta
(1993). The Conferences consist of a mixture of lavish stage
productions, informational speeches and workshops, and
entertainment. One of the largest conference expenses is for
the private production companies, which are retained to
``design, produce, direct and stage'' the conference.\96\ For
the 1990-1993 Conferences, the total cost of these production
contracts was more than $1.1 million, all of which was billed
to and paid by the Federal government.\97\
---------------------------------------------------------------------------
\96\ The production company is required to develop a theme that is
carried on throughout the conference and must also provide ``speech
preparation and support, audio visual and teleprompter speaker support
for presentations, speaker rehearsal, * * * talent, props, costumes,
sets, studio, editing suites equipment, duplication and delivery of
finished 1/2" VHS tape cassettes for duplication.''
\97\ The Government paid an additional $850,000 for food,
beverages, meeting facilities, and other miscellaneous expenses
incurred at these four conferences.
---------------------------------------------------------------------------
The extent to which these costs are chargeable to the
Government is based on a Federal Acquisition Regulations (FAR)
standard of ``reasonableness.'' Section 31.201-3 of the FAR
states that:
A cost is reasonable if, in its nature and amount, it
does not exceed that which would be incurred by a
prudent person in the conduct of competitive business *
* * [and if] it is the type of cost generally
recognized as ordinary and necessary for the conduct of
contractor's business or the contract performance.
Then Chairman Nunn asked the HCFA Bureau of Program Operations
Director, Carol J. Walton, and the OPM Associate Director for
Retirement and Insurance, Curtis J. Smith, whether they
considered these conference expenses to be appropriate Federal
charges:
Senator NUNN: * * * from what you have seen here,\98\
would HCFA permit those kinds of expenses on
conferences to be charged to the Federal government?
---------------------------------------------------------------------------
\98\ Then Chairman Nunn was referring to a videotape shown during
the Subcommittee staff's testimony, in which highlights of the 1991 and
1992 conferences were depicted. The videotape showed lavish, Broadway-
style productions, complete with costumes, singing, dancing, etc.
---------------------------------------------------------------------------
Ms. WALTON: I would say that the video on the
conference to be financed by Federal funds is
offensive, and we would not permit that to be paid with
Medicare trust funds.
Senator NUNN: Where do you draw the line?
Ms. WALTON: I think conferences are totally business
affairs when they are financed by Government funds.
Senator NUNN: And anything that goes beyond business
ought to be paid for outside of public funds.
Ms. WALTON: * * * Yes, sir.
Senator NUNN: Mr. Smith, do you generally agree with
that?
Mr. SMITH: Yes. * * *
Blue Cross/Blue Shield officials told the Subcommittee
staff that these production costs--i.e., the value of ``Super
Plan'' (an entertainer dressed in a Superman-like costume) at
the 1991 conference and ``Dr. FEHBAR'' (creator of futuristic
robots that had traveled back in time to study the success of
the FEP) at the 1992 conference--were appropriate because they
``didn't want people falling asleep.'' These officials also
asserted that many U.S. companies hold similarly elaborate
meetings. However, when the Staff asked the other 13
participating FEHBP fee-for-service, not-for-profit plans about
their conferences, none of the nine that responded indicated
that they held such elaborate and expensive events.
The FEP also holds annual Marketing Meetings, with about
200 marketing representatives from the 67 participating Plans
usually attending. Staging and production are part of the
meeting format and are paid for by the Federal government.
These costs amounted to about $180,000 in 1992 and 1993
respectively, with the Government's total share being nearly
$330,000.\99\
---------------------------------------------------------------------------
\99\ These are the only years for which the Subcommittee was able
to obtain information from Blue Cross/Blue Shield.
---------------------------------------------------------------------------
In addition, the BCBSA has hosted more than 200 meetings
since 1990, including quarterly Board of Directors meetings
that also have been held at luxury hotels or resorts, such as
The Breakers in Palm Beach, Florida, the Colonial Williamsburg
Inn in Virginia, and Westcourt in the Buttes in Tempe, Arizona.
These meetings, which last two or three days and are attended
by 80 directors and their spouses, cost as much as $60,000,
one-third of which is typically charged to the Federal
government. The Government also routinely pays a portion of the
cost of entertaining the spouses, including items such as
dinner theater performances, a tour of Victorian homes, and a
champagne lunch and private tour of Liberace's estate.
Promotional items have also been charged to the Federal
government. In recent years the Government was charged for
Customer Service Motivational Kits, including $23,000 for
10,000 coffee mugs, $59,260 for 8,200 liquid paperweights, and
$87,300 for 200 kits containing mirrors, buttons, memo pads,
banners, balloons on sticks, and mobiles. Regarding such
expenses, in an audit report dated October 20, 1992, OPM stated
that:
The Association charged the FEHBP for unallowable
advertising costs related to premium items and
giveaways that were used to enhance [its] * * * overall
image and to assist the marketing sales force during
annual open season campaigns. * * * [W]e determined
that the FEHBP was charged $224,399 in [such]
unallowable costs from 1985 through 1990 * * * [for] *
* * items * * * [including] * * * pocket calendars,
tote bags, ceramic, mugs, lapel pins, biofeedback
cards, and key chains.
The Subcommittee's investigation also questioned executive
compensation and miscellaneous personal expenses that were
charged to the Federal government. The Government pays a
portion of the salaries for 122 BCBSA management positions,
including the President/CEO, the Chief Operating Officer, four
Senior Vice Presidents, 10 Vice Presidents, 15 Executive
Directors, 36 Directors, and 55 Managers. This included, in
1993, $274,000 of the President/CEO's $866,000 total
compensation; $143,504 of the Chief Operating Officer's
$451,155 total compensation; and, $154,175 of the Senior Vice
President of Business Services' $236,075 total compensation.
In the case of Medicare, the HHS Inspector General
testified that her office found unreasonable salary increases
charged to the program by the Empire, Maryland, and
Pennsylvania Plans. The OIG reported that top executives at
these three Blues contractors received increases in their
compensation packages that were greatly in excess of the
Department of Labor's Employment Cost Index (ECI). For the
period examined (1989-1992), while the ECI increased 14.6
percent, the average compensation of the 12 top BCBSM
executives rose 107.7 percent; for the eight top Pennsylvania
Plan executives, the increase was 56.6 percent; and, for
Empire's top four executives, the increase was 89 percent.\100\
---------------------------------------------------------------------------
\100\ The Empire figures are based on a six-year period, 1987-1992.
As a result of these findings, the OIG has recommended that HCFA
establish a ceiling on executive compensation increases that
contractors can allocate to the Medicare program. According to the
Inspector General's testimony, HCFA officials have agreed in principle
that Medicare should not be charged unreasonable or excessive increases
in executive compensation.
---------------------------------------------------------------------------
The Subcommittee questioned the appropriateness of other
BCBSA expenses that were charged to the Federal government:
--Lthe Government paid $400 of the $1,200 cost of two
folding wardrobe bags for the President/CEO;
--Lthe Government paid $700 of the $2,275 bill for
preparing the President/CEO's income tax returns;
--Lthe Government paid $8,000 of a $40,000 annual
contract that provides fitness training to BCBSA
employees;
--Lthe Government paid $600 of a $2,000 gift
certificate for a retiring member of the Board of
Directors; and,
--Lthe Government provided tuition reimbursement for
FEP employees, including one that was attending law
school.\101\
---------------------------------------------------------------------------
\101\ The Subcommittee asked the OPM/OIG to examine similar expense
items that had surfaced in the investigation of the Maryland, D.C., and
Empire Plans. The OIG found that each of these Plans had improperly
charged the Government for portions of their limousines, charitable
contributions, country club memberships, first-class airfare, and/or
salaries. In the case of the Maryland Plan, the unallowable costs that
resulted from this review were $21,000; for the D.C. Plan, $15,000;
and, for Empire, $132,000.
---------------------------------------------------------------------------
2. Inadequate regulation
The regulatory agencies responsible for overseeing the Blue
Cross/Blue Shield contracts with the FEHBP and Medicare--OPM
and HCFA, respectively--have encountered problems similar to
those experienced by their State counterparts in connection
with the West Virginia, Maryland, D.C., and Empire Plans. Both
OPM and HCFA have dealt with uncooperative attitudes and
evasive tactics on the part of the BCBSA and individual
participating Plans, and OPM, in particular, has encountered
considerable difficulty in being able to regulate them
effectively.
For example, in interviews with the Subcommittee staff, OPM
contract officers referred to the FEP Director's Office and
many of the individual participating Plans as being
``arrogant,'' ``obstructionist,'' and ``uncooperative'' in
their responses to legitimate regulatory requests and/or
actions. OPM/OIG staff described similar problems, explaining
that one of the reasons why it takes so long to finalize a
draft audit report is that the BCBSA takes an inordinate amount
of time to provide its comments. In reviewing some two dozen of
the 43 audit reports issued by the OPM/OIG regarding the FEP
since 1988, the Subcommittee staff found that BCBSA took an
average of nearly 9 months to comment; in two cases nearly two
years elapsed before the comments were received and, in
another, it took nearly two-and-a-half years.
These regulatory inadequacies can be attributed to limited
resources as well as the problems inherent in trying to
regulate entities as large as Blue Cross/Blue Shield Plans:
a. The ``Too-Big-To-Regulate'' Dilemma
The Subcommittee staff testified that because Blue Cross/
Blue Shield Plans have about 40% of the FEHBP market share,
regulators are forced to tread lightly, for fear that they
might decide to pull out of the program. The Staff said they
found evidence in the past, such as the early 1980s, that Blue
Cross/Blue Shield officials made such threats prior to
obtaining large increases in their service charges from OPM. A
former OPM Assistant Director stated that ``one of OPM's worst
nightmares was having the Blues drop out of the program,''
adding that they had threatened to do precisely that ``a couple
of times.'' The present Assistant Administrator of OPM stated:
``what would we do with the people [i.e., the subscribers] if
we got rid of the [Blues] contract? It is impossible to
terminate them because of their size.''
This attitude, and the unquestioning and deferential
treatment it has engendered, have undermined OPM's ability to
regulate Blue Cross/Blue Shield effectively. It has made it
difficult for OPM to take strong action when required and has
led to unnecessary and wasteful expenditures, as demonstrated
by the following:
--Lspurred by criticism from GAO,\102\ OPM made a
concerted effort in 1992 to reduce administrative costs
in the FEHBP by 5%. Blue Cross/Blue Shield adamantly
opposed this initiative and it was not until almost a
year after it was announced that an agreement was
reached. The agreement provided for a reduction of only
1% per year spread over a three-year period, which for
1993 meant that Blue Cross/Blue Shield's administrative
savings decreased from the proposed $17 million to
$10.2 million. Other FEHBP carriers did not object as
strongly as Blue Cross/Blue Shield did and, in fact,
most accepted the initial request without much
complaint,
---------------------------------------------------------------------------
\102\ In May 1989, GAO testified (GAO/T-GGD-89-26) before the
Subcommittee on Compensation and Employee Benefits of the House Post
Office and Civil Service Committee, that OPM's cost control efforts
were inadequate to contain excessive administrative expenses. A
subsequent report in February 1992 (GAO/GGD-92-37) confirmed that
stronger controls were still needed to reduce administrative costs in
the FEHBP.
---------------------------------------------------------------------------
--Lalthough a not-for-profit, the BCBSA is paid a
service charge by the Federal government for its role
in administering the FEP contract.\103\ From 1960, when
the contract first became operative, the amount of this
charge has grown almost every year and between 1981
(when a new formula was instituted) and 1993, it rose
from $6.4 million to $39.4 million (more than
500%).\104\ The Staff testified that in the eyes of
many OPM officials this new formula was flawed from the
start because, if applied correctly, it would result in
lower service charges unacceptable to the carriers. As
a result, OPM has basically ``force-fitted'' the
formula to produce the profits the Blues have
requested. Indeed, the Staff found that no one at OPM
had focused on this matter very much before 1992.
Typically, all the file contained was a handwritten
note from someone in the Insurance Group stating that
the service charge proposed by BCBSA ``looks good'' or
``ok to me.'' Moreover, the Staff found that the
process used to determine the service charge has become
an incentive for BCBSA to increase costs, rather than
to reduce them as provided for in the formula's cost
containment criteria, since the higher the amount of
claims paid and administrative costs for processing
them, the greater the potential service charge.
---------------------------------------------------------------------------
\103\ At the time of the FEHBP's inception, Blue Cross/Blue Shield
insisted on a ``risk charge'' as a condition for participating in the
program. According to OPM, since the original statute was written so
that the Blues were the only real candidate able to administer the
Government-wide Service Benefit Plan, ``* * * we had to allow the risk
charge BC/BS was insisting on.'' As early as 1966, OPM's predecessor,
the Civil Service Commission, proposed to do away with the risk charge
because the original reasons behind it had been effectively eliminated
by the establishment of reserves, Medicare, and experience rating.
Indeed, reflecting the decreased risk to FEHBP carriers, the risk
charge was renamed ``service charge'' in 1971.
\104\ The formula developed in 1982 continues in effect today
essentially unchanged, with the exception of a 1987 alteration that
allows carriers to receive up to 1.1% of a combination of
administrative expenses and claims incurred. The profit, i.e., ``that
element of potential remuneration that contractors receive for contract
performance over and above allowable costs,'' is determined by
multiplying a number of weighted factors with the Plan's administrative
costs and claims paid. The factors are: contractor performance;
contract cost risk; Federal socio-economic programs; capital
investments; cost control and other past accomplishments; and,
independent development.
---------------------------------------------------------------------------
--Las part of indirect costs, OPM is billed for a
portion of the membership dues individual Blue Cross/
Blue Shield Plans pay to support the BCBSA. Between
1988-1992, the Federal government paid $11.7 million
for such membership dues. In 1975, when the current OPM
Inspector General's predecessor ruled that such charges
could not be billed to the Government, the BCBSA fought
to overturn this ruling, successfully accomplishing a
reversal in 1988. OPM officials could not provide the
Subcommittee with any justification for this payment
and said that they have continued it because of the
difficulty they knew they would encounter should an
attempt be made to exclude it.
b. Inadequate Resources
Limited resources are among the more serious problems faced
by OPM in trying to administer the FEHBP and oversee Blue
Cross/Blue Shield's involvement therein. Funding for OPM, for
example, has been widely recognized as being inadequate for
years. While 1% of the total FEHBP premium is allotted for
administering the program, the actual amount received by OPM is
only 1/8 of 1% because the funds must be appropriated by
Congress and the Office of Management and Budget has allowed
OPM to only request that amount.
In 1993 OPM had 166 employees, including 36 OPM/OIG staff,
available to operate and oversee the $15 billion FEHBP; in
contrast, there were 300 staff employed by the BCBSA's
Director's Office to ``coordinate'' its Federal contract
responsibilities. OPM's Contracts Division III, the group
directly responsible for the FEP and 94 other contracts, had
only $4,000 in travel funds for FY 1993 and none for FY 1994.
As a result, the staff has not gone on a site visit to any of
the participating Blue Cross/Blue Shield Plans for a number of
years. Likewise, the Division's training budget is almost non-
existent; for 1993, the entire Insurance Group, of which
Division III is a part, spent only $47,000 for conferences,
seminars, and training, and only $2,000 has been budgeted for
these purposes for the first six months of 1994.
Given their limited resources, OPM officials admitted that
there ``is no way for OPM to conduct the oversight and auditing
necessary to make sure the contractors are properly
administering the program and holding costs to a minimum.''
They rely substantially on the OPM/OIG for such audits and
oversight--a situation which is itself problematic, since the
OPM/OIG's goal of auditing all carriers, including Blue Cross/
Blue Shield Plans, on a three-year cycle has slipped to more
than nine years, in some instances, as a result of the latter's
own resource problems. Indeed, according to OIG officials, the
last year in which an audit was performed on 47 of the 67
participating Plans was 1986 or earlier and, in at least four
of those, audits had not been done since the 1970s. Since FEHBP
contracts have a five-year record retention requirement, this
means that there are years that will never be audited because a
carrier can simply say that records are no longer available for
years outside the specified limit.
The sizable intervals between audits also inhibit the
probability of corrective action. One frustrated OIG auditor
told the Subcommittee staff that the Blues feel comfortable in
the knowledge that there will not be another audit for years
ahead. OPM/OIG officials expressed similar frustration,
observing that the Plans know that they will be audited only
every five years or longer and, therefore, take risks. At
worst, these officials added, even if certain charges are
disallowed, the Plans will have had the benefit in the interim
of the interest-free use of the questioned funds.
Resource limitations force OPM to rely on Blue Cross/Blue
Shield for essential information and to accept whatever they
provide without verifying its accuracy. For example, OPM
officials ``took it on faith'' that the Blues' calculations of
subscriber refunds for improper coinsurance payments were
accurate. Blue Cross/Blue Shield's original refund estimate of
$160.5 million in November 1993, shrank markedly to slightly
more than $80 million by May 1994. By the time of the
Subcommittee's August hearings, this amount had declined even
further to just $25 million, with apparently little concern on
OPM's part as to accuracy:
Senator NUNN: What happened to get [the estimate]
down from $160 million to $25 million?
Mr. SMITH: I do not know the answer to that. The
estimate came from Blue Cross, and * * * as they did
more and more data collection and data analysis, the
number kept dropping and has ended up today at $25
million.
Senator NUNN: So you are relying on basically a Blue
Cross computation here?
Mr. SMITH: That is correct. They have the claims data
upon which the payments will be made and upon which the
calculation will be made.
Finally, the Staff initially found a paucity of publicly
reported internal or external fraud cases concerning the FEHBP
and after examining the issue more closely concluded that the
simple reason why there had been such few cases is because no
one, outside of the understaffed OPM/OIG, was seriously looking
for fraud. In 1989, GAO criticized OPM's anti-fraud efforts and
concluded that OPM could not reasonably assure that FEHBP funds
are adequately protected from fraud and abuse. More recently,
the persistence of these weaknesses in anti-fraud efforts has
resulted in the Office of Management and Budget placing the
FEHBP among those programs classified as being at ``high-risk''
to fraud and abuse.
3. Inadequate Oversight/Performance by the Blue Cross/Blue Shield
Association
The Subcommittee found inadequacies in BCBSA's ability to
effectively oversee its Federal contract responsibilities. For
example, the Staff testified that almost every OPM official
with whom they spoke complained about the fact that the more
than sixty participating Blue Cross/Blue Shield Plans do not
have to answer to the FEP Director's Office.\105\ One official
commented that the biggest problem she sees in FEP operations
and subscriber service is the need for greater guidance and
oversight by the Director's Office. She cited several areas
where the Director's Office has performed inadequately,
including: initial review of claims disputes between
subscribers and individual Plans; keeping the FEP contract
manual up to date, and cooperating with the OPM Contracts
Office and OIG. She cited the example of a major fraud case
involving a medical lab, in which the Director's Office failed
to provide adequate data on a timely basis. She explained that
``if all other carriers were as bad as the Blues * * * OPM
would not have recovered anything in the case.'' \106\
---------------------------------------------------------------------------
\105\ The FEP Director's Office is part of the BCBSA and thus
throughout this discussion its actions are treated as being the
Association's ultimate responsibility.
\106\ In their review of OPM internal files and correspondence, the
Subcommittee staff came across other items that corroborate these
observations, including the BCBSA's failure to: educate local Plans
regarding changes in the FEP; submit financial statements in a timely
manner; establish adequate procedures for the communication of appeals;
and, resolve inconsistencies about who in Washington is responsible for
handling various aspects of the FEP.
---------------------------------------------------------------------------
From 1989 through 1993, the Federal government paid
$500,000 annually for audits by the Director's Office intended
to uncover mismanagement, fraud, and/or violations of the
contract. Even though the Federal government had paid for these
audits, prior to 1992 OPM could not get a copy, being
restricted to just an ``on-site review'' by OIG staff. The OPM
Inspector General also testified that the Director's Office was
not reporting any internal fraud cases and few external fraud
cases to his office. He added that even after being formally
directed to do so in March 1994, ``they have not been
responsive.''
Similar problems exist in the Association's oversight of
the Medicare contract. BCBSA officials expressly believe that
monitoring of Medicare contracts is HCFA's responsibility, not
the Association's. As a consequence, BCBSA is generally unaware
of problems at the participating Plans until HCFA takes some
type of action. For example, the Association was completely in
the dark until after HCFA had notified Blue Cross/Blue Shield
of Michigan in March 1994 that it was being terminated as both
a Medicare Part A and Part B contractor, for allegedly
falsifying data to enhance its Contractor Performance
Evaluation Program (CPEP) scores.\107\ At the time of the
Subcommittee's investigation nearly a dozen other Blue Cross/
Blue Shield Part A and/or Part B Plans had been placed on
HCFA's watch list. If nothing else, the poor performance
reflected in the significant number of Plans terminated and/or
on the watch list should have generated considerable concern on
the Association's part.
---------------------------------------------------------------------------
\107\ HCFA uses CPEP to assess a Plan's compliance with Medicare
program requirements and as a means of ranking its performance in
relation to other contractors. Plans whose CPEP scores fall below the
20th percentile of all other participating contractors can be dismissed
from the program. Such removal of a contractor, according to HCFA
officials, is a rare occurrence, with only three Part B carriers having
been terminated in the past three years. Notably, all three of these
have been Blues Plans; i.e., the King County Plan in Washington State
(May, 1993), Blue Cross/ Blue Shield of Michigan (March, 1994), and
Blue Cross/Blue Shield of Maryland (May, 1994).
---------------------------------------------------------------------------
4. Response to Blue Cross/Blue Shield's Testimony
In their testimony and submissions for the Record, Blue
Cross/Blue Shield officials asserted that the Subcommittee
staff's Statement contained ``serious misunderstandings or
errors.'' In support of their contentions, they cited reports
and other data, which in their view refuted some of the Staff's
findings regarding FEP costs, the FEP service charge, the
discount/co-payment issue, Medicare oversight, and the Medicare
Secondary Payer Program. For example, they cited a Towers,
Perrin study as evidence that FEP administrative costs are
``reasonable in comparison to the administrative expenses of
other health benefit plans.'' Also emphasized was a Miller and
Chevalier study, which purportedly refutes the Subcommittee
staff's testimony regarding lavish, unwarranted costs charged
to the FEP by Blue Cross/Blue Shield.
However, the Subcommittee notes that these reports were
admittedly commissioned in response to its investigation and
were not mentioned before the hearings. As then Chairman Nunn
observed:
I find it very strange and somewhat frustrating that
these studies are taking place during the same period
that we were having [this] investigation and you chose
not to share them with us or to even tell us about
them. * * * It looks like to me * * * [that] you hired
your own consultants, paid them * * * out of your own
funds and basically attempted to preempt the findings
without telling us about it.
Moreover, only one of the reports was actually produced
after the hearings and only at then Chairman Nunn's insistence.
The other (the Miller and Chevalier study) the Subcommittee was
informed, was a ``legal analysis'' performed by Blue Cross/Blue
Shield's lawyers, not a report. Despite Mr. Tresnowski's
testimony that he ``would be glad to submit that,'' this
document was withheld on grounds that it was subject to
attorney/client privilege, which Tresnowski refused to waive.
Blue Cross/Blue Shield's refusal to produce this analysis makes
it impossible for the Subcommittee to accurately evaluate Mr.
Tresnowski's testimony based on it that disputes some of the
Staff's findings.
In addition, portions of Blue Cross/Blue Shield's testimony
and use of these studies purportedly refuted ``statements'' or
``conclusions'' that were mischaracterizations of what the
Subcommittee staff said in their Statement. For example, the
officials maintained that the Subcommittee staff had said that:
``Blue Cross and Blue Shield shouldn't earn a profit;'' ``it is
improper to use portions of the service charge to pay
unallowable expenses;'' and, ``Blue Cross Blue Shield got the
benefit of [the billed versus the discounted amount of
coinsurance].'' In each case, the statements had not been made,
prompting then Chairman Nunn to observe:
Mr. Tresnowski, you have again set up a straw man. I
don't think you will find anything where the staff says
that. * * * What you are doing here is setting up one
exaggerated staff finding after another and knocking
them down. It is a very skillful job, but you are
quoting things from the staff study without putting
quote marks on it. You are deducing your own
[conclusions] and you are implying things and then
knocking them down. That is just not accurate.
The following Senators, who were members of the Permanent
Subcommittee on Investigations at the time of the hearings,
have approved this report:
William V. Roth, Jr. Sam Nunn
Ted Stevens John Glenn
William S. Cohen Carl Levin
Thad Cochran David Pryor
John McCain Joseph Lieberman
Byron L. Dorgan
The following Senators who are currently Members of the
Subcommittee but were not Members at the time of the hearing
and did not participate in the hearing on which the report was
prepared have taken no part in the preparation and submission
of the report except to authorize its filing as a report made
by the Subcommittee:
Fred Thompson Daniel K. Akaka
Charles Grassley
Bob Smith
-