Ask your health plan to say "ahhh".

How to evaluate a managed care organization's financial health.

A health plan that fails less than a year after offering a tempting array of services for bottom dollar is not a good value. Many companies rely on CPAs and other financial executives to help choose which health insurance plans to offer employees. CPAs and others responsible for selecting health care plans for their firms or their client's company should factor in the plan's financial health; a plan that is not financially sound is apt to raise its premiums significantly or cut quality of care.

Most companies want good value for their health care dollar--quality care at an affordable price with a comfortable amount of flexibility for their employees when it comes to health care tradeoffs. Employees usually care a great deal about their health plan options, especially when they share the cost of premiums and have to make significant co-payments. All employees--including those CPAs recommending which plans to offer--want to be able to count on their plan being there when they need it.

Gary Davis, Esq., a partner at the Miami-based law firm Steel Hector & Davis, says, "I have always viewed a contract with managed care entities as similar to an investment portfolio. As such, it should be managed with the same diligence that one would use to manage a 401 (k) or stock portfolio."

MERGERS EVERYWHERE

That task gets more difficult every year. Exhibit 1, page 39, lists some factors that might affect a health plan's stability. At the top of the list: mergers and acquisitions. In a highly competitive market rife with mergers and acquisitions and frequent price changes, any health plan's future will be difficult to predict. A CPA considering a new plan should get answers to some questions first.

Exhibit 1: Is This Health Plan Financially Stable?

What to consider...

Mergers and acquisitions. Is the resulting company adequately financed? Do the organizations have compatible cultures and strategies?

IT capabilities. Can the company's IT systems accommodate expected growth?

Physician turnover. Do participating doctors stick with the plan or leave after a year or two?

Rates. Are the rates charged in line with other similar plans in the region? What might cause premiums to rise faster or slower than other comparable plans?

Size. Is the organization large enough to survive moderate setbacks?

Longevity. How long has the organization been offering similar services? Where?

Plan activities and the volume of those activities. What sort of routine care does the plan offer--how many well-child visits, annual physicals, mammograms, colon cancer screenings and the like? Has the plan taken on more than it can handle? Claims processing speed. Are claims taking longer and longer to process?

Customer service. Is the plan keeping your employees on hold? Does it process paperwork on new enrollees promptly? Answer questions fully?

Policy on potential liabilities. This includes provider selection and credentialing, open vs. closed formulary (the list of drugs that can be prescribed) and fiduciary functions such as stop-loss insurance. Is the plan being sued by dozens of unhappy customers denied coverage? Are the participating doctors and hospitals inadequate or the best in the region?

* Does management have an aggressive acquisition agenda? Can the balance sheet support such ambitions?

* Might the company be acquired by another? If so, how soon?

As the sector consolidates, ill-considered acquisitions could drive up premiums. Even if the merger partners are financially sound, the financing for the transaction can weaken the combined company's balance sheet. Also, a plan that was solvent the previous year may merge with another that has a different business strategy, or it may miscalculate costs when making a Medicare bid and put itself at much greater financial risk. Accordingly, any merger should signal to CPAs and others that it is time to reevaluate a particular plan's solvency.

Pamela Hymel, director of medical services and benefits for El Segundo, California-based Hughes Electronics Corp., an aerospace subsidiary of General Motors, says, "Sometimes an acquisition brings greater stability, other times it makes things worse." Hymel arranges health coverage for approximately 15,000 employees in California, Colorado and the mid-Atlantic region, with each enrolled in one of 10 different managed care organizations (MCOs).

One of them was FHP, a company based in Santa Ana, California. When PacifiCare, also based in Santa Ana, acquired FHP's California operations in February 1997, Hymel found the change positive. PacifiCare is a financially strong MCO, and at that time FHP was fiscally overextended and having financial problems associated with a merger between its parent, Foundation Health Corp., and Health Systems International. That merger had failed to bring about desired operational efficiencies and had disrupted access to care.

Another, Hughes Electronics on the East Coast, had offered its employees NYL Care, which was acquired in 1998 by Hartford, Connecticut-based Aetna/USHC, now the largest health plan in the country. Hymel is concerned about potential difficulties for her company's employees as NYL Care is assimilated by a company that has been formed by a recent amalgamation of disparate care cultures and delivery systems. Only a short time ago, Aetna was a relatively old-fashioned indemnity-style insurer, which contrasted with USHC's reputation for being lean and mean. Hymel says, "They are going slowly at NYL, and we are diligently monitoring that situation." However, the difference is large--between fee-for-service medicine and a tightly controlled HMO.

Hymel says, she will take action if it is warranted. "I am used to a certain level of customer service and administrative performance. If I'm not getting the level I expect, I will try to renegotiate the rates or consider switching plans"

PHYSICIAN TURNOVER

Exhibit 1 raises other issues to consider as well. A revolving door for doctors may signal impending financial problems. For example, Aetna/USHC has had contract trouble with its physicians, who complain that the company imposes terms unilaterally, that payments are very late, and that Aetna/USHC reserves final say on whether a medical procedure should be authorized and paid for until after the service has been given. Last October, those problems caused 400 doctors to defect en masse, leaving 45,000 Aetna/USHC members in the Dallas market scrambling for new physicians.

CPAs who manage employee benefits may also want to think about why Louisville, Kentucky-based Humana withdrew in August 1998 from a proposed $5.5-billion merger with Minnetonka, Minnesota's United HealthCare (UHC). UHC, which industry observers long considered one of the strongest national players, incurred a $900 million charge against earnings in the second quarter of 1998, shortly before the merger fell through. Even though UHC sought and got rate increases of 8% with most of its customers in 1997 and 1998, because of rising medical expenses, it does not seem to have fully resolved its struggles toward profitability.

Patricia Abbey, senior vice-president of human resources for Marketing Management, Inc., a 250-person distributor of coffee to retail chains based in Fort Worth, Texas, sums up the health plan merger climate, saying, "Eventually, there will only be a few major players." That would leave employees with fewer choices and employers with less negotiating power.

PREMIUM INFLATION

According to Business Insurance magazine, CPAs and other benefits managers can expect health insurance premiums to increase an average of 8% every year for the next two to three years. Another survey, conducted by Mercer/Foster Higgins (www.wmmercer.com), the Boston healthcare and group benefits practice, found an average budget increase of 7% in 1999 for health plan premiums. The survey covered nearly 4,000 companies nationwide in a variety of industries.

However, rapidly rising premiums are not a good indicator of solvency. Costs may be going up even faster, especially if the company is growing quickly. To evaluate a plan's financials, an observer must see both halves of the picture.

For example, Oxford Health Plan of Norwalk, Connecticut was once considered the industry leader by major corporations in New York, who made it the plan of choice. At $80 per share, its market cap was $6 billion in 1997, indicating widespread investor confidence in the company's financial future. Its Freedom Plan, which allowed doctors to charge their usual fees and patients to choose their own physicians, proved very attractive to new customers, causing the company to show a dramatic increase in revenues. Oxford attracted two million members at corporations from 1993 to 1997. But it was sliding toward bankruptcy. While the rising top line distracted Wall Street, the company's costs were completely out of control. Although Oxford managed to avert bankruptcy, it had to be completely reorganized.

The company blamed a second quarter 1998 pretax loss of $507.6 million on "computer problems." The software used to track costs failed to note all of them, and the financial managers who might have spotted alarming trends didn't have access to the data that signaled trouble. The stock price dropped to $7 per share after the second quarter loss was announced. To pull the company back from the brink of insolvency, CEO Norman Payson raised premiums an average of 10% and restricted Freedom Plan offerings. Oxford still offers a Freedom Plan, but it is now a more restrictive and traditional HMO product, imposing stronger financial incentives to stay within its network. The company also reined in its fee schedule for physicians.

The lesson for CPAs? Managed care revenues must keep pace with costs. When evaluating a health plan, consider whether the organization has the infrastructure to track the cost of its revenue growth.

Payson's new business strategy assumes that customers who value choice will be willing to pay for it. That may be true, but Oxford must still prove how much more customers are willing to pay for that choice. CPAs and other benefits managers dealing with Oxford have already had to make tough decisions or force employees to do so. Employers can pay a high, and possibly fast-growing, premium to retain the maximum number of choices; shift cost increases to those employees who insist on provider choice; switch participants to a cheaper and more restrictive Oxford plan; or find a new health care plan altogether.

Admittedly, no one saw Oxford's troubles coming. But if analysts--or Oxford's customers--had asked more specific questions about the company's then-new IT capabilities, they might have grasped the direness of the situation sooner. Some questions to ask when your health plan upgrades its IT: What kind of data will the IT generate? Will the data be available to my company's human resources department or employees? How will the new technology change your service? Will I be able to get more frequent reports on the status of claims?

Like many other firms, COR Specialty Services, a physician management group with 24 offices and 300 employees in Irving, Texas, wants choice and looks closely at cost. According to Sara Owen, the group's director of human resources, COR "had an increase last year that was passed on to employees. That was an issue, but we stayed with Blue Cross because it's a huge plan with many providers. That's what our employees want, and they are willing to pay for it." The large pool of participating physicians was a reassuring indicator to COR which is part of the health care industry.

At American Information Systems, an Internet consultancy in Chicago with 60 employees, Peter Alfrejd, the comptroller and HR director, hopes to keep cost increases to 10% a year. Alfrejd says that cost is an issue for both employers and employees, who each pay 50% of the premiums. Alfrejd's company was sandbagged by a much greater increase from United Healthcare, which had offered low rates when it entered the Chicago market several years ago.

After signing up for what looked like a good deal with United, Alfrejd says, "in the second year we had a 40% raise in premium that had nothing to do with increased claims or our demographics changing. We should have realized that the company was growing market share too quickly." CPAs and other benefits managers can reduce the odds of falling into a similar trap by considering the factors in exhibit 1 before making a decision.

Marketing Management's Abbey has kept premiums down by trying to negotiate rate reductions annually, especially following years in which her company has had a good ratio of claims to premium. She succeeds at keeping some of the premium hikes down, but there is almost always an increase.

SIZE AND LONGEVITY

Because it can be difficult to get hard information about a plan's finances, many benefits administrators rely on size and longevity to gauge a plan's financial health. Not surprisingly, COR's Owen looks for a large provider network as an indicator of plan stability. If many physicians are willing to provide services under a plan, they're probably being paid adequately and promptly. That's why Owen selected Blue Cross/Blue Shield of Texas and has stuck with it for six years.

American Information Systems is now signed up with the Blues because Alfrejd is reassured by the plan's longevity. The Blues have been in the Chicago market since well before the advent of managed care. Having been burned previously by two other plans, he says: "It's guesswork to forecast the solvency and stability of a plan. Twice we signed on to new plans, and there wasn't much data available to guide us."

OTHER FACTORS

Other indicators can reflect a managed care organization's financial status indirectly. If a plan offers a very large range of services, for instance, it should charge a relatively high premium. If it doesn't, suspect a bait and switch: The organization reels in new customers by offering everything they could want at a low price; once signed up, the customers find their premiums rise rapidly and their services are restricted.

Claims processing speed is another area to ask about. Most companies take more time to pay their bills when they are in financial straits. Managed care organizations are no exception. They tend to take more time paying claims from patients and doctors when their finances are stretched.

Some companies have banded together and hired experts to monitor the health care market and to handle the purchasing of health care in the hope that, by contracting directly with health care providers, they can impose stability. One such coalition, the Buyers' Health Care Action Group (BHCAG) based in Minneapolis, counts among its self-insured corporate members Dayton Hudson, Cargill, American Express and General Mills.

WHERE TO GET THE SCOOP

Useful information on MCO finances can be difficult to get hold of and hard to interpret. Exhibit 2, at right, is a list of suggested sources of useful information.

Exhibit 2: Where to Look for Helpful Information

On All Plans

* Ask the health plan sales representative what's available. Request information on the factors laid out in exhibit 1, page 39.

* Read the newspaper and keep abreast of other news sources. Search the PR newswire, Bloomberg and online news services. Your company's library or investor relations department may have access to financial news services and/or be able to do a Lexis search for you.

* Talk to others in your industry and your community to find out if they are having problems with an HMO.

* Ask insurance brokers.

* Call the state insurance board.

* Ask benefits consultants.

* Ask buyers' coalitions such as BHCAG (Minneapolis); Pacific Business Action Group on Health (San Francisco); Washington Business Group on Health (Washington, D.C.); New York Buyers Group on Health (New York City); or the Midwest Business Group on Health (Chicago).

* Call some of the participating doctors and the state medical association.

On Plans Participating in Medicare Programs Check these Web sites:

* www.hcfa.gov/medicare/mcarpti.htm

* www.medicare.gov

* www.xact.org/health-policy.htm

On Publicly Traded HMOs

* Ask to be put on the mailing lists of securities analysts who track health care stocks and search for online research reports. Read the research.

* Look in the SEC's EDGAR database, particularly the MD&A sections of quarterly 10Q and annual 10K reports, prospectuses for new securities issues, 8K filings about unscheduled material changes and 13D filings about tender offers and other acquisition-related activity.

Source: Gary Davis, Esq., Steel Hector & Davis, Miami, Florida.

Pay attention to the news. If there's a new Medicare MCO in the region offering a fabulous deal--free eyeglasses, a $5 co-payment for prescriptions, full hearing aid coverage and cab fare to and from the doctor's office--watch out. Another participant is subsidizing that package.

Many benefits administrators lack the financial skills CPAs bring to the task of choosing a health plan, which is why the CPA's contribution can be so important. CPAs should read any financial statements the plan makes available and follow through on any questions they raise. Ask insurance brokers, benefits consultants and plan pitchmen for information, including the plan's written policy on potential liabilities.

Marketing Management's Abbey checks with state insurance boards. Such a check with New Jersey's board would have unearthed the New Jersey Banking and Insurance Commission's rescue plan for H.I.P. Health Plan of New Jersey. H.I.P., which had operated successfully as a nonprofit plan for many years, merged with a for-profit HMO, Pinnacle Health Enterprises, which used H.I.P.'s cash to start Medicaid HMOs in other states. Last December, doctors and hospitals agreed to accept 30 cents for each dollar of claims already incurred and 75% of usual fees for the next three months. The plan will be liquidated anyway, stranding 165,000 members.

To prevent future problems, New Jersey Banking and Insurance Commissioner Jaynee LaVecchia and the New Jersey Medical Society are pushing for legislation to create a guaranty fund, financed by the state's 23 HMOs. It would also prevent state-licensed HMOs from transferring assets to unlicensed contractors from other states. Georgia, Illinois and California have all passed laws within the last two years to make it difficult for HMOs to declare bankruptcy. Although such measures can help CPAs salvage a bad situation, their companies would be better off to avoid financially troubled plans in the first place. If a health plan is transferring assets out of state to subsidize new programs elsewhere, it is probably not wise to select it.

The federal Balanced Budget Act (BBA) of 1997 established financial standards to qualify hospitals and participating physician groups as Medicare provider service organizations (PSOs). Although the BBA applies to Medicare only, before it was passed Congress debated whether PSOs should be licensed at the state or federal level. The managed care industry lobbied hard for less-restrictive state solvency standards, while the Health and Human Services Department's Health Care Financing Administration (HCFA) wanted unified federal regulations.

It took a compromise to make the BBA law. Medicare providers can apply for a waiver of federal solvency rules in favor of state guidelines. When the Health Care Financing Administration issued financial requirements for Medicare providers under the BBA in April 1998, the agency called for PSOs to have an initial net worth of $1.5 million. However, the HCFA can reduce that to $1 million if the PSO has an existing administrative infrastructure enabling it to reduce start-up costs. At least $750,000 must be in cash or cash equivalents at start-up. Between 10% and 20% of the PSO's net worth could be offset by intangible assets, depending on how much of the minimum-net-worth requirement is met by cash or cash equivalents. HCFA also recommended that PSOs be required to prefund any losses expected in the first year of operation.

To further ensure solvency and stability, HCFA mandates that PSOs seeking to qualify for a contract under the managed Medicare program, Medicare Choice, must have a marketing plan enabling them to cover at least 1,500 people in urban areas, or 500 people in rural areas.

WHAT TO WORRY ABOUT

Exhibit 3, page 43, lists some financial warning signs that should alert CPAs and benefits managers. These include ratios such as "invoiced but not received" (IBNR) and the medical-loss ratio (MLR). The first of these is the amount that doctors have billed the plan for but haven't received. Loud doctor complaints about unpaid claims were one early indicator of Oxford's troubles.

Exhibit 3: Warning Signs

CPAs should look for the following indicators of impending financial problems.

* Increased invoiced but not received (IBNR)--how much the providers have invoiced the plan but have not yet been paid.

* Decreased medical-loss ratio (MLR.)--the total plan revenues minus administrative costs. The higher the MLR the better. An MLR of 80% means that 80% of revenues are passed through to providers, 20% are overhead.

* Decline in plan enrollment.

* Sudden large increase in plan enrollment.

* Decline in revenue-to-income ratio.

* Increase in disputed claims.

* Premiums are sharply higher or lower than local and regional norms.

The medical-loss ratio is an indicator of the cost efficiency of the organization. A managed care organization should pay for medical costs, not real estate, paper clips or executive junkets. If the medical-loss ratio, defined as revenues minus administrative costs, is too low, the plan is inefficient.

Although studying a health plan's financials is important, many managers believe that feedback from employees is one of the clearest and most reliable indicators of a plan's stability. If a plan is shaky, says COR's Owen, employee complaints about slow claims processing or disputed claims are the first signs of trouble. "Any complaint from an employee is a red flag to me," says Owen, who also relies on an insurance broker to monitor a plan's publicly available financial data.

Says Owen of the insurer that she selected, Blue Cross/Blue Shield of Texas, "They pay claims on time, have a good customer service department, and we get enrollment data promptly when a new employee comes on board."

Ann Robinow, BHCAG's executive director of care systems and finance, watches for any plan not paying claims in a timely way, inadequate response to BHCAG's requests for financial data and offerings out of sync with the market.

For example, BHCAG rates physician groups on two variables, awarding one to three stars (*) on quality and customer service as well as one to three dollar signs ($) on price. The more stars, the better the quality; the more dollar signs, the higher the price. A group rated * and $$$ would have a problem attracting and retaining customers.

Currently Robinow has another concern--a gyrating stock market. "Many health plans have been making money not on operations but on investments. We may see problems not just from the underlying increase of health care costs pushing up prices but also because MCOs need to recover losses from the stock market." Accordingly, if the stock market sours, expect premiums to increase. It behooves plan purchasers to raise questions about their insurer's investment strategy and make sure that it is suitably conservative and diversified.

Steel Hector & Davis's Gary Davis points out another warning sign to look for: aging receivables. "As the A/R creeps up, warning bells should go off. Look for signs that the HMO is looking for or creating reasons to delay payment--for example, a marked increase in the number of claims that are rejected for insufficient information to process the claim as submitted," he says. Company employees will probably start complaining when this happens.

Other public disclosure material can be informative as well. For plans that have gone public, SEC filings (www.sec.gov/ edgar) can reveal a lot. Davis recommends a thorough read of the management discussion and analysis (MD&A) section of recent filings.

COMPARISON SHOPPING

"We're looking for several things when we purchase health care," says Hughes's Hymel. She lists customer satisfaction, routine preventive care, employee co-payments and appropriateness of care, which are all weighed by Hughes's finance and HR team. "Two years ago we looked only at price, wanting the cheapest HMO. Now cost is only one factor. We've chosen one of the most expensive HMOs because of its high rating," says Hymel. The analysis was performed using Deloitte & Touche's computerized tool for comparative analysis of financial data, the Value Equation. Arthur Andersen, Ernst & Young, KPMG Peat Marwick and PricewaterhouseCoopers, among others, all have extensive health care practices with comparable products.

These tools specifically analyze a plan's financial stability, debt and problems with payments to providers. "This is particularly important where plan mergers and acquisitions are concerned" says Eileen Raney, who developed the Value Equation and is Deloitte & Touche's national co-leader for the integrated health group working out of Los Angeles. "When judging a plan's value, each employer's specific needs shape its selection process," she says. For example, one employer may rank member satisfaction as its top priority, followed by member services, then treatment outcomes. For another employer, treatment outcomes and cost may rank first and second. The Value Equation allows employers to benchmark all its plans on various measures of cost and quality, specifically: baseline plan costs; actuarial adjustments; plan financial metrics, including debt and income (at for-profit plans); and quality performance.

Marketing Management's Abbey has to purchase health care for employees in Texas and 25 other states. Her strategy has been to find a national provider that covers all company locations, even offices in states with a small number of employees. In her estimation, that plan, which is currently Great West of Denver, must have an "A+ financial and service record. We don't want our employees or providers having problems settling claims. We want a plan to be cost-effective for our company, but we balance that with what our employees want."

That has resulted in some plan changes in the last year as the company has shifted incentives from a preferred provider organization (PPO) to a more economical point of service (POS) plan. "We still give employees the option of a PPO, but it costs them a bit more," says Abbey. But plan stability is an issue: "Even an A+ rated plan can have stability problems. I keep in close contact with my service representative to find out if there's any significant change in plan operations." Among the things she wants to know about: physician satisfaction, physician turnover and trends in the number of disputed claims.

Relatively small employers can have a hard time assessing plan solvency, but the issue is as important to American Information Systems' Alfrejd as it would be to his counterpart at a Fortune 500 company. "As an accountant, I accumulate a variety of information from different plans and different carriers and do my own data analysis," he says. Mostly, that consists of trying to do a reality check on what the plans are Offering by comparing apples to apples wherever possible. In other words, if one offers A, B and C for $xx, and another A, C, D and E for $yy, what, if anything, does that imply about the price of B, D and E?

Since AIS'S employees are mostly young single males, Alfrejd has chosen a PPO with a large network of providers with evening hours. He remains leery of MCO mergers and acquisitions, believing that they can spur rate increases and drive doctors and hospitals to drop out of some plans. Alfrejd--twice burned by plans jacking up rates--tries to do his homework, but he still likens health plan selection to throwing darts. His word to the wise: "You can't just go with the cheapest option. If it looks too good to be true, it probably is.

EXECUTIVE SUMMARY

* CHECK THE BALANCE SHEET. CPAs should evaluate the solvency of health care plans they are considering for their company, a client or themselves. Price and quality of care are important, but financial stability over time may be even more so because instability can cause prices to go up or quality of care to go down.

* CONSIDER M&A POLICY. There has been a lot of merger and acquisition activity between health plans lately. Mergers can change the financial characteristics of a plan radically. A merger should trigger a reassessment of the plan's finances.

* COMPARE TO THE COMPETITION. Health care costs are rising about 10% per year. If a plan's premiums are rising at a significantly different rate, CPAs should ask why. A deal too good to be true probably means big premium increases in the near future.

* EVALUATE THE TRACK RECORD. Many benefits managers believe that size and longevity may be indicative of a plan's financial strength.

* CAST YOUR RESEARCH NET WIDE. Information on plan finances may be difficult to find and hard to interpret. News sources, insurance brokers, buyers' groups, benefits consultants, Wall Street research, state insurance boards and the administrators of the Medicare program may have data or analysis worth seeking out.

* PAY ATTENTION TO WARNING SIGNS. Some warning signs of potential financial trouble: declining revenue-income ratio, declining or rapidly increasing enrollment, increasing numbers of disputed claims, premiums significantly higher or lower than regional norms and declining profitability.

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RELATED ARTICLE: Criteria for Assessing a Health Plan's Financial Risks

Even though the Balanced Budget Act allowed the Health Care Financing Administration to set a minimum financial standard, providers considering a bid for a Medicare contract still have to decide if they can make a profit as a provider service organization. Bradley Engel, PhD, healthcare provider consultant at William Mercer, Inc.'s Chicago office, helped the American Hospital Association develop a risk-assessment tool for providers to determine their own financial and managerial fitness to enter or reenter the Medicare market. His criteria can be useful to CPAs and others selecting a plan.

* Pricing strategy. What can (does) a plan offer to "lock in" prepaid enrollees and still remain solvent?

* Cost management strategy. Does the MCO have a large, geographically dispersed primary and specialist network? Is it big enough to reap economies of scale? Can it track per capita costs of delivering care and identify cost differences between various parts of its delivery system?

* Marketing strategy. Does the MCO have a marketing plan? A brand name? Distribution channels to reach its target market effectively?

* Competition. Who is competing with the MCO in its market?

* Vulnerabilities. Is the MCO's management team sophisticated enough to identify and deal with inadequacies in care management? Economic incentives? IT? Human capital?

MARLENE PITURRO, PhD, MBA, is a business journalist and organizational consultant in Hastings-on-Hudson, New York. Her stories have appeared in The New York Times, Managed Healthcare News, CFO, PWC's BEAN (online) and Public Issues.