Battle of the blues: two of the largest and most successful health plans in Pennsylvania have severed a long-standing relationship. Who is poised to win the fight for the lucrative market of Central Pennsylvania? (Life/Health: Market Competition).

The breakup of Pennsylvania health plans Highmark and Capital Blue-Cross mimics a difficult divorce. The termination of the companies' jointly run health plan marketed in the Central Pennsylvania/ Lehigh Valley area is replete with bitter words, disagreements over who's at fault and a custody battle over subscribers. Seven months after the decision to disengage the 40-year-old joint operating agreement, the companies have invested a total of nearly $30 million in restructuring and have created competing Blue Cross Blue Shield plans at breakneck speed.

Under the agreement, Capital provided hospital coverage and Highmark provided a physician network to nearly 1.45 million people. Now both companies provide integrated health insurance coverage in the area, with Highmark marketing under the name Pennsylvania Blue Shield.

The shattered relationship is affecting both companies' providers and customers. Although the Pennsylvania Insurance Department has never witnessed a dissolution of a business relationship quite like this one, it doesn't see any harm to consumers. "It might be premature to speculate on the effect on consumers, but the spilt does create additional health products and services in the marketplace. Also, both entities are retaining relatively large provider networks," said Rosanne Placey, a department spokeswoman.

Since the plans are headquartered about five miles apart on opposite banks of the Susquehanna River in Harrisburg, and each chief executive officer has spent 30 years with his company, it's no surprise personal relationships come into play. The CEOs--Capital's Jim Mead and Highmark's John Brouse--are friends. Paul McMillen, executive vice president of the Pennsylvania Automotive Association and a Highmark customer, is also one of Mead's neighbors. As a former member of Capital's board, he "sat through the whole mess" and confesses the breakup "emotionally hurt me." Roger Longenderfer, who heads one of the region's largest hospitals, Pinnacle Health, said he still hears rumors they'll get back together.

The national Blue Cross Blue Shield Association wouldn't comment on the breakup, according to spokesman Terry Cooney. Both CEOs express regret over the breakup. Brouse said the "feelings were not good at all," and Mead offered that while the decision wasn't personal, "you can't help but have emotions about it; we've been in business for 40 years. Our differences are philosophical, not personal, and we have to implement what the boards want."

Uncorporate-like language has been fired from both companies since the spilt. And both sides claim the other tossed the first salvo. Mead said Highmark called him and another executive incompetent. Capital responded by reminding consumers that Highmark said it wants to "gorge itself on acquisitions:' Mead said the strongly worded responses "come from the environment we live in" and show that "we're not country bumpkins here:" Brouse said, "Talk is cheap and we ignore it."

The Breakup

The Pennsylvania Blues plans are among the odd ducks in the national Blues organization. In every U.S. state or territory except Pennsylvania and Washington state, the hospital and doctor coverage functions are integrated, although some use only one service mark, the cross or the shield. The plans are consolidating to leverage economies of scale to fight the competition--in 1990 there were 77 plans nationwide; now there are 42.

This urge to merge is the basis for the philosophical difference both companies say is at the heart of the breakup. Brouse and his board wanted the national model of merging the Blue Cross and Blue Shield organizations, and Mead and his board believed that health care is local.

As in nearly all breakups, each party accuses the other of causing the split. The companies point to different dates as the beginning of the termination. Capital, the smaller company with $630 million in reserves vs. Highmark's $2.3 billion, puts the end of the relationship at Sept. 10, 2001, when Highmark said it was dissolving the joint operating agreement. Highmark says the split occurred April 26, 2001, when Capital informed its employees it was reorganizing into an integrated health plan.

Brouse's former careers as an English teacher and a disc jockey are evident when his sonorous voice peppers his comments about the breakup with words like "truncated" and "vitriolic." The slim, nattily dressed 62-year-old CEO firmly states that Highmark's board came to its decision on Sept. 10 only after feeling all options were exhausted. Discussions to create a new business relationship with Capital began in 1998 and continued through 2001, he said.

On April 26, 2001, Capital notified Highmark of its decision to create an integrated company and invited Highmark to be a partner. But since that business model went against Highmark's plan to merge all the state's Blue Cross Blue Shield plans into one company to achieve economies of scale, its board declined the offer. "They told us they were going to create a new company and this company was going to provide a complete package. So to that extent they would have been competing with what we were providing here, and to the extent they would be successful we would be losing revenue and customers. And that doesn't work for us," Brouse said.

After Capital's April announcement, heavy negotiations were conducted into September, Brouse said--mostly due to nudging from the Blue Cross Blue Shield Association. Both sides say that during the critical negotiation time in the spring and summer of 2001, each stretched the limits to reach a decision to stay together. Highmark spokeswoman Karen Early recalls dozens of negotiation meetings that produced waist-high stacks of proposals with myriad configurations.

Mead said that when Highmark severed its ties on Sept. 10, there was a proposal on the table "they will live to regret they didn't take." Capital was willing to be a subsidiary of a larger company and even agreed to give up the Blue Cross trademark and license it to the holding company "I have to tell you I gave about a pint and a half of blood getting the board to agree that's the path we should take," Mead said.

Whereas Brouse is subdued, Mead is gregarious. Before a backdrop of photos showing him with dignitaries, including Alan Greenspan and President Bush, the burly, shirt-sleeved Mead told his company's tale sprinkled with anecdotes concerning his employees. A self-declared workaholic who comes in on weekends and chaired the board of the Federal Reserve Bank in Philadelphia as a hobby, Mead also isn't afraid to admit that a conservative businessman such as himself has to change with the times.

According to Mead, the beginning of the end came when Pennsylvania Blue Shield consolidated with Blue Cross of Western Pennsylvania in 1996. Until that time, Pennsylvania Blue Shield was offering physician coverage to complement Blue Cross' hospital networks. That consolidation created Highmark, an integrated company with 3 million customers in 29 western counties. Pennsylvania Blue Shield brought national dental, vision and life and casualty companies that cover more than 23 million lives, 16 million of which are outside Pennsylvania, to the consolidation. "I've always said that kind of upset the equilibrium. The merger hit the nose of the rocking horse and it would take a while for it to settle back down again," Mead said.

A local emphasis is important to Capital. "I think part of the problem is a national organization trying to apply a cookie-cutter solution to health care, and it doesn't work that way Our board thinks it's important to stay close to the customer and the provider," Mead said.

The local angle Capital extols fires up Brouse. Calling it a "nonsensical argument," he points Out that Highmark can be considered more local to the central Pennsylvania region than Capital on many levels. "Is it the number of employees? We win if that's the case. [Highmark has 5,700 to Capital's nearly 2,000] By virtue of where the CEO sits? Although I do business in Pittsburgh, I live in Harrisburg. We pay more taxes; we support the United Way more than they do," Brouse said.

When Highmark was created, Pennsylvania Blue Shield was also doing business with Blue Cross of Northeastern Pennsylvania and Independence Blue Cross in the Philadelphia area, and it continues to do so today. "Highmark was going to be a consolidator, and they were going to grow and centralize their power. At the same time, Aetna was threatening all of us," Mead said.

In addition, during this period Capital was looking at the problem of when to proceed with several projects it had put on hold while it was looking to see if it would have a partner. Because it didn't want to invest and then reinvest, Capital delayed upgrades to its information systems in response to the federal Health Insurance Portability and Accountability Act. "So the board said go ahead and begin to develop the infrastructure of the organization you want to be, but at all points leave the door open en to join Highmark, because that makes the most sense," Mead said.

Gloves Come Off

As in most troubled breakups, legal aspects arose. in January, Capital filed legal papers with Pennsylvania insurance regulators, alleging Highmark hadn't received state approval to expand in the central and Lehigh Valley regions of the state. At the time, Mead said the complaint was made because Highmark was operating at an unfair advantage and was depriving consumers of important safeguards. The petition asked the insurance department to put the brakes on Highmark's expansion until and unless it obtained the approvals required by law. A few weeks after the complaint was filed, however, the insurance department dismissed the petition, stating that no statute said Highmark couldn't do business as both a professional-service and hospitalization health insurer. "They raise no controversy or uncertainty whether Highmark currently is operating legally under its two certificates of authority. It is," Pennsylvania Insurance Commissioner M. Diane Koken said in her decision.

Currently, the issue isn't a major talking point for either side. Mead alluded to Highmark having a court case lurking that could challenge its existence, and Highmark's Early said all the parties have withdrawn from the lawsuit, except one physician.

Capital's action was based on a previous effort led by the Pennsylvania Society of Internal Medicine and Dr. Robert B. Sklaroff, who charged that public hearings never were held by state regulators when Pennsylvania Blue Shield consolidated with Blue Cross of Western Pennsylvania. Currently, the matter is pending before the insurance department.

Living Apart

Like all long relationships, this one is difficult to untangle. The companies still are managing about 55% of business together in their joint operating agreement. The 1.45 million lives they insure individually and through employer group plans, however, are slowly being switched as employer group renewal dates roll around and they choose Capital, Pennsylvania Blue Shield or a competitor, such as HealthAmerica or Aetna Health Inc. Highmark reports great success so far, picking up 62% of the contracts it jointly shared with Capital as of August. Highmark counts Harley-Davidson, Rite Aid, the State System of Higher Education and the Pennsylvania State Police among its larger contracts.

Capital announced it's "exactly on target," reporting it has signed 52% of the once-shared group memberships. Capital is writing business with Air Products and Chemicals, Densply and Harsco.

After Sept. 10, both companies tapped people to drive their transformations. Capital chose Anita Smith, executive vice president, chief operating officer, to create a new company in nine months. The slim executive, who plays tennis as a hobby but looks like a professional in the sport, said her early athletic training formed her natural competitive spirit. "I always wanted to work to improve health care. When the termination came along, and I wasn't able to focus on that because they said, 'we are coming after you'--I'm the kind of individual who will dig in and show that yes, something good can come out of this," Smith said.

Under Smith's leadership, Capital employed strategies that ranged from holding town meetings, to touching base with its customers, to celebrating small victories with impromptu conga lines. The biggest challenge was to sign 6,000 physicians and create a physician network.

Smith is proud that Capital came into the market, built a new claims system and technology platform and signed a network of physicians while operating as usual as the agent plan for the joint agreement, which meant it sold, serviced and enrolled groups. "We did this all at once while our competitor only had to come into the market. They didn't have to service the existing business'" Smith said.

To speed up the process of signing the network of physicians, Capital took suggestions from the Pennsylvania Medical Society and rewrote the contracts using a simple, easier-to-understand format. The simplification allowed the office managers to pass the contracts directly to the physicians for signing, bypassing any legal steps. Smith also encouraged her employees to reach the goal of signing 6,000 physicians by noting weekly progress on a seven-foot-high thermometer placed prominently near the company's main elevators. The company surpassed the goal in August. "Today our network is as large as the day we separated," Smith said.

But contract wording wasn't the only problem Capital encountered with physicians. Some physicians refused to sign Capital's contracts, protesting that the insurer's reimbursement rates were too low Bob Orzechowski, administrator of the AGES Obstetrics and Gynecology practice in Wyomissing, Pa., said Capital has come to terms on the reimbursement rates but now is facing another dilemma. As of late August, AGES' actual contract wasn't signed, although the practice had patients coming in for annual exams with Capital coverage. Orzechowski said that while he's sure he doesn't have a contract because Capital is backed up in that area, he is forced to charge patients the $100 fee for the visit because there is no contract in place. And after the contract is signed, credentialing will take another four to six weeks, he said. The holdup also plays havoc with physicians' cash flow because reimbursement doesn't occur until after the credentialing process is completed. "But most of the turbulence (related to the transit ion) is pretty much over," Orzechowski said.

Pennsylvania Blue Shield's transition team is headed by another athlete, Senior Vice President--Mid-Atlantic Region Mike Fiaschetti, who was responsible for the region during the joint agreement with Capital. The father of three, who was an active hockey coach, used those skills to erect a new company A five-year veteran with the company, Fiaschetti described the experience of building Pennsylvania Blue Shield "as the most intense 12 months of my whole career. It was like starting a whole new company; we had to do a lot of things all at once."

Fiaschetti assembled a 25-person cross-functional team after Capital's announcement in the spring of 2001. The team crafted a "where the rubber meets the road" business plan that would show how Highmark would implement each of the steps to be able to compete. The team worked on developing a sales forecast, sales-force structure, products and hospital contract wording, and investigated how to modify the company's information system to accept the coming changes. Pennsylvania Blue Shield invested around $15 million in preparing to operate in the Central region and added about 250 employees, Fiaschetti said.

Provider Concerns

The change is bringing a time of confusion to hospitals, also. When new health insurers enter a market, hospitals must educate physicians and consumers, said Pinnacle Health's Longenderfer. "There's always a period of confusion, and we try to gear up for that with our discharge, registration and utilization staff," Longenderfer said. Right now Longenderfer doesn't anticipate any problems with Pennsylvania Blue Shield since "they seem to have their act together in the Western part of the state.

"They're not green. But what's it going to be like five to 10 years from now?" Longenderfer said. According to Christian Miles, a life/health analyst at A.M. Best Co., Pennsylvania Blue Shield is in an extremely good position, since it can leverage the knowledge gained from running Highmark in running its new entity.

When Pennsylvania Automotive Association's McMillen chose Pennsylvania Blue Shield to insure the 1,300 new car dealers his group represents, it was a hard decision. As a former member of both boards, McMillen selected Blue Shield based on price and because it enabled him to manage his claims and contracts electronically, whereas at the time of his decision last April, Capital couldn't do so. He also knew that part of Capital's marketing team left to work for Blue Shield. "Look at it from my perspective: Pennsylvania Blue Shield had the rate advantage, I can communicate with them, I know all the players, and the guts went over there," McMillen said.

Tom Henshke, director of the Small Manufacturers Council, which represents 5,000 members statewide, recently chose Capital over Pennsylvania Blue Shield because of the "relationship equity." Although the council previously contracted with the Blues, Henshke decided on signing with Capital because of its competitive rates, flexible plan and the relationship he has with Mead. "You get to see him and talk to him; that's really important," Henshke said. Although Henshke saw several Capital employees leave to go to Pennsylvania Blue Shield, he was impressed with the competitive expertise that Capital hired to fill the vacated positions.

Employees did leave Capital for Highmark, including Highmark's current vice president of finance and chief actuary, William Cashion. The count is more than 50, according to Highmark, while three or four have left Highmark for Capital. Mead is philosophical on the subject: "Some people said, 'Capital has one hell of a job to do.' Not everybody is a big risk taker. If they didn't think we could pull this off, the best thing they could have done is to jump ship."

Changes Ahead

As the companies continue the separation process, they're approaching critical dates that will affect their viability. Jan. 1 is important because typically 50% to 60% of employer groups renew on that date. Another upcoming wild card is the announcement, expected in October, of a new CEO to fill Brouse's shoes when he retires next year. A.M. Best's Miles doesn't expect any surprises from the changing of the leadership. "There's no disadvantage due to the changing of the CEO for Highmark, because it has a seasoned, consistent senior management team and a lot of experience to choose from," Miles said.

Mead isn't ruffled by the impending CEO change, but thinks he would be more concerned if Highmark were still a partner. "You look at the successor of the competition differently than a business partner. It's like me worrying about who the next CEO of HealthAmerica will be," Mead said.

Highmark still has mergers on its mind. Brouse said the impending merger with the Independence Blue Cross plan is in suspended animation because of his retirement. If Highmark joins with Independence, it would create one of the largest health plans in the United States, a fact that might not be good news for Capital. The merger would create a combined total of almost 6 million customers in their core markets of Western and Southeastern Pennsylvania counties. Highmark's year-end 2001 products covered more than 23 million people, 16 million of whom reside outside of Pennsylvania. Independence Blue Cross' family of companies covered 4.2 million members as of year-end 2001, 1.3 million of whom live outside of Pennsylvania, adding up to a combined total of 27 million. In comparison, Aetna serves about 37 million members in its health. group and dental programs.

After all this, would Capital reconsider a merger with Highmark? "I believe never say never," Mead said. "But we don't have the time or energy, and it's not appropriate because the board gave us the direction to get this thing going and stabilized."

RELATED ARTICLE: Capital BlueCross

Headquarters: Harrisburg, Pa.

CEO: Jim Mead

Ranking in Pennsylvania according to net premiums written: No. 3 among Blues plans

Group members: 1.3 million

Number of employees: 2,000

Marketplace: 21 counties in central Pennsylvania and the Lehigh Valley

Major products: Traditional indemnity, preferred provider organization, point of service, Medicare supplemental and health maintenance organization (through Keystone Health Plan Central).

Web site: www.capbluecross.com

Highmark Inc.

Headquarters: Camp Hill, Pa., and Pittsburgh

CEO: John Brouse

Ranking in Pennsylvania according to net premiums written: No. 1

Group members as of July 2002:

Health insurance members: 4.8 million

Health insurance contracts: 2.7 million

Total members served nationwide: 23.9 million

Number of employees: more than 11,000

Marketplace: Health insurance in Pennsylvania; dental, vision, life and disability nationwide.

Major products: health, dental and vision insurance, as well as group life and disability insurance. Highmark also administers Medicare Part A and Part B for the federal government for Pennsylvania Medicare recipients.

Web site: www.pablueshield.com, www.highmark.com

What's at Stake

The Central Pennsylvania/Lehigh Valley region that Highmark/Pennsylvania Blue Shield and Capital BlueGross are battling over is a vital economic sector of the state. Both Highmark and Capital are attracted to the area's strong manufacturing base, stability created by the state government's workforce, potential significant market share and a younger demographic. "This is a vital region that is growing faster than either Philadelphia or Pittsburgh," said Highmark's Mike Fiaschetti, senior vice president of the MidAtlantic region.

Potential insurance contracts flow from the manufacturing base, including Harley-Davidson, Hershey Foods and Mack Truck. "This is a very stable area that historically has never experienced the wild swing the other parts have. There's a nice mix of manufacturing and government in the region," said Capital's president and chief executive officer, Jim Mead.

Highmark President and CEO John Brouse points to the area's attractive younger demographic, which helps to balance the aging factor of an insurer's risk pool. For example, the U.S. Census reports York County's population is bulging in the 25-to-54 age group. And the Lehigh Valley's projected demographics show that about 50% of its population will be in the 18-to-54 age group by 2006. With a population of about 3 million up for grabs in this region, the potential premium is the brass ring both companies are eyeing.

Capital is the company with more at stake in the battle for the millions in premium, said Christian Miles, a life/health analyst at A.M. Best Co. Even though Highmark/Pennsylvania Blue Shield has done business in the area for 40 years and has headquarters in the Harrisburg suburb of Camp Hill, 70% of its total health-care revenue is generated through the Highmark Blue Cross Blue Shield program in the western part of the state. "So Capital is defending its home turf," Miles said.

Looking for Recognition: A Hand and a Blue Man

Creating two new brand identities after presenting one face to the public for 40 years isn't easy. "To try to establish ourselves as a separate company is a challenge, because we took great pains to make sure people thought Blue Cross Blue Shield were one. Now we're saying we're not one--we're really different," said John Brouse, president and chief executive officer of Highmark Inc.

Highmark and Capital BlueCross have terminated a jointly run health plan they marketed in the Central Pennsylvania/Lehigh Valley area for the past 40 years. Now both companies offer their own, integrated hospital and physician coverage in the area, with Highmark marketing under the name Pennsylvania Blue Shield.

Highmark's advertising theme is "have a greater hand in your health." The campaign is based on Highmark's research finding that employers are concerned about the unending flow of health insurance rate increases. Highmark sees the answer in asking consumers to take a personal interest in their health care. Pennsylvania Blue Shield is backing the campaign with its myriad self-help programs available on either Blue Shield's or Highmark's Web site. Consumers can access information to join a stop-smoking group or the heart-healthy Dr. Dean Ornish program. The ads feature a blue hand appearing on a wall next to a woman jogging, or in a humorous tone, on the stomach of an overweight man. The campaign will be seen on local television, on billboards throughout the 21-county Blue Shield turf and in local newspapers. "There's quite a dichotomy between Capital's ads and our ads. Theirs are futuristic and ours are homespun, playing to the values of Central Pennsylvania," Brouse said.

Capital's advertising campaign featuring a blue man was born from a limited budget and the need to get a reassuring message to the community in a hurry. After Highmark announced Sept. 10, 2001, that it was pulling out of the joint agreement, Capital had to hit the air with a campaign by Jan. 1, said Anita Smith, Capital's executive vice president, chief operating officer. "We had to assure the community that we were going to be here," she said. Because of the limited budget, Capital opted for an animated commercial, and the agency created the blue man, which is actually the figure appearing inside the Blue Cross logo. Capital's second phase of its campaign highlights its "simple" approach to health coverage. The new ads still use the blue man and feature the voice of Tom Cavanagh, star of NBC's comedy show "Ed."

Capital President and CEO Jim Mead said the blue man's message is a powerful one. At a town meeting in Reading, a man holding a box approached Mead. "I looked at this guy and wondered what is this going to be. He opened the box and showed a little blue man made out of Nutty Putty. The guy told me, 'If your ads can get a six-year-old to take his Nutty Putty and make your ad, you are connected,'" Mead said.

"We took the man out of the center of the logo. The competition has a snake in. the center of their logo--we know they aren't going to take that out," Mead said.