Minimal surplus leaves HMO vulnerable to seizure by state. (Up Front).

Universal Care Inc., the second largest Medi-Cal HMO in Los Angeles County, has been downgraded by the A.M. Best Co. insurance rating service over concerns that company losses have drained its capital -- and put it in a position to be taken over by state regulators.

The change of the Signal Hill-based company's rating, to B- from B+, follows by just weeks the conclusion of a state audit that found problems with the company's books, including a failure to set aside enough money in its 2001 fiscal year to cover claims.

The problems come amid a climate of skyrocketing health care costs that has seen five smaller health plans around California either fail or be seized by the state over the last two years, even as larger insurers like Blue Cross of California and Health Net Inc. show income growth.

Company officials say they are rectifying the problems and have been turning a profit after raising premiums on its commercial lines, where the losses occurred. But Isabelle Roman-Barrio, an A.M. Best analyst, said she couldn't give the company a clean bill of health.

"Our concern is the level of capital at the company after two years of losses," she said. "They have to increase their surplus."

Universal, which has 350,000 members, gains most of its business by serving Medi-Cal recipients. But it also has 142,000 members in its commercial business, which it plans to expand.

The company discovered in late 2001 that its actuarial projections had sharply underestimated the number of late claims it would receive for the 2001 fiscal year, forcing it pump up its reserve pool by $9.2 million.

That infusion of funds resulted in a loss of $1.3 million for the 2002 fiscal year. This also cut into its tangible net equity, a key measure of fiscal health related to its capital position.

As of June 30, its tangible net equity exceeded minimum state standards by just $91,700, the audit found. A company is at risk for seizure when that figure drops below the state minimum.

Company responds

Executives say they have tried to improve their financial position since then by raising commercial rates an average of 22 percent in the last fiscal year and 15 percent so far this year.

For the three months ended Sept. 30, net income was $1.5 million, according to the most recent filing with state regulators, raising tangible net equity to $1.1 million over minimum requirements.

"The commercial line of business that was operating at a loss is now operating at a profit" said Jeff Davis, Universal's chief operating officer.

The troubles can be traced back to 2001, when skyrocketing pharmaceutical costs and hospital claims caught the company off guard. "What we had, like just about every health plan, was a difficult year in our commercial line of business," Davis said.

The state audit was critical of Universal's actuarial efforts, and as a result the company has agreed to upgrade its method for organizing, collecting and reporting claims to improve future actuarial projections.

Company officials dispute that its capital position is as bleak as A.M. Best suggests, pointing out that real estate assets, such as medical office buildings, are undervalued because they are not booked at their current fair market value.

Also, Davis added, the $5.5 million in debt is not as burdensome as it might look because it all stems from family loans. (Universal was started in 1983 by President Howard Davis, who remains the sole owner, and is run by Davis and his children, including Jeff Davis.)

Even so, Universal is working to improve its capital position, though Davis would not disclose details. Roman-Barrio said she.has discussed the plan with the company and will watch for the results.

Small firms at risk

Smaller health insurers have had a tough time in the state over the past few years, with several going under. Last month, San Jose-based Lifeguard Inc. was seized by regulators, while locally based Tower Health and Maxicare Health Plans Inc. failed last year. Watts Health Plans, meanwhile, remains under conservatorship. Some other smaller Medi-Cal plans, such as Long Beach-based Molina Healthcare Inc., appear to be doing well.

Allan Baumgarten, a consultant who recently completed a study of the state's managed care industry for the California Healthcare Foundation, said he is not surprised by Universal Care's problems.

"HMOs are being pressed by hospitals to pay more and so they have to get their customers to buy into that," Baumgarten said. "The bigger plans have additional leverage in negotiating with the hospitals and additional leverage with their employee customers."

In this tight environment, economies of scale also play a role in allowing larger plans to spread their administrative costs over a larger base. Universal has about 350,000 members, a fraction of the millions of members that companies such as Blue Cross and Health Net have.

[GRAPH OMITTED]

RELATED ARTICLE: Headquarters: Signal Hill

Founded: 1983

Ownership: Wholly owned by founder and President Howard E. Davis on a for-profit basis

Members: 354,000

Major product lines: Medi-Cal, commercial, Healthy Families

Area of service: San Diego, Riverside, San Bernardino, Orange, Los Angeles, Ventura and Kern counties

Notable feature: Company also owns and operates nine medical clinics, 14 dental offices and 10 optometry facilities.