Blue Shield positions itself to enter fray over small business coverage.

Blue Shield of California is getting ready to launch a Southern California campaign to sign up small employers -- which will mean extra competition for Blue Cross of California, Health Net, Kaiser Permanente and other health plans already fighting for their share of the small- and medium-sized business coverage pie.

By one estimate, there are about 205,323 businesses with 50 workers or less in Los Angeles County, which employ a total of about 1.17 million workers.

San Francisco-based Blue Shield is a major rival, with 3.5 million members statewide, and has been in business since 1939. Its new accent on smaller businesses may heat up competition.

Blue Shield, like other health insurers, in recent years has added health maintenance organization and preferred provider organization options to its traditional offering of indemnity health insurance.

Basically speaking, in an HMO, employees are covered for set monthly fees and go only to the HMO's doctors and hospitals. In a PPO arrangement, participating doctors are reimbursed for services rendered, although often at negotiated, discount rates. Employees have financial incentives to see only doctors who are participating in the PPO.

Both HMOs and PPOs offer lower-cost coverage to employers than do traditional indemnity plans, which are rapidly disappearing from the market. (In a traditional indemnity plan, doctors charge for services rendered, and insurers pay. Some say there is little need for doctor efficiency in a system in which doctors are essentially paid on a cost-plus basis, and thus costs become bloated.)

The $3.2 billion-in-revenues Blue Shield will in July begin offering two types of health plan coverage for small employers.

In one, no questions about the medical histories of employees will be asked, meaning that "high-risk" individuals will be able to get coverage. Such coverage will be relatively expensive, but it will be available -- which could not be said about health insurance in the late 1980s, when many small businesses found themselves priced out of the market or simply unable to get coverage at all.

In Blue Shield's second form of coverage, employees will be asked about their medical histories, and the coverage will be very competitively priced, said John Zervakos, vice president of sales at Blue Shield.

"It is our intent to make the coverage available to some better-risk groups that are healthier. If they fill out the forms, they will get better rates," he said.

The problem of who will insure small employers that have a few unhealthy employees has been a troubling one in California in recent years, due to a phenomenon known as "adverse selection."

Adverse selection occurs when one insurer has lower underwriting standards than do other insurers. Soon, the unhealthy small-employer groups, barred from most insurers, will gravitate to the insurer that will offer coverage.

In time, that insurer will come to have a high portion of high-risk groups under its wings, and its medical costs will balloon. It will have to raise rates, to make its budget balance. Higher rates will drive off the healthier groups, who can get lower rates at insurers with higher underwriting standards.

It is a cycle so vicious that some in the industry believe that statewide regulations are needed, to more or less require all insurers to bear their fair burden of the risky small employers.

Blue Shield will offer its new HMO system to employers with as few as two covered workers. It established its Southland HMO network here in 1990, making it available to employers with 50 or more workers.

Now that the network is up and running, it wants to broaden the target audience and go after the small employer also, said Zervakos.

Blue Shield will begin marketing its new coverage in May, through material sent to health insurance brokers and possibly in direct mailings to small employers, said Zervakos. No general advertising is planned. "We don't plan any advertising in print or electronic media," he said.

As tough as the health insurance market already is in Southern California, Zervakos expects the next three years to get even tougher, due to a long-standing "three-year cycle" that has historically plagued the health plan industry.

The way the cycle works is this: For three years, insurers make lots of money, because rates are high enough to cover medical bills, with plenty of money left over for administration and profits.

The lush market attracts new competitors, who price their products lower than existing rivals. Soon everybody is slashing their rates to hold onto their market share. For three years nobody makes any money.

After the losses have driven some insurers out of the market, some survivors raise rates to recover losses, and the whole cycle starts anew.

"The year 1992 marks the first year of the three-year down-cycle," commented Zervakos. "It will be a tough time to make money."