Merger Has Led to Strife at Blue Cross : Proposal to Combine With Blue Shield Hindered as a Result

The 3-year-old merger of California’s northern and southern Blue Cross chapters has spawned management dissension that has prompted the departure of several top officials, contributed to the loss of a key $221-million operating unit and sparked questions about the operation of the state’s largest health insurer.

The unsettled atmosphere is helping to scuttle another proposed merger. Blue Cross of California--which insures 4 million people--is being urged by the national Blue Cross and Blue Shield Assn. in Chicago to comply with a 3-year-old policy promoting mergers of competing Blue Cross and Blue Shield plans in the same state. In California, there has been slow progress, if any, toward a merger of the two organizations.

There are now 86 Blue Cross and Blue Shield plans across the country, down from 103 when the policy was adopted in November, 1982, an association spokeswoman said.

California’s northern and southern Blue Cross chapters, both founded in 1937, merged in June, 1982, after agreeing that they could operate more efficiently together.

As a tax-exempt, nonprofit concern, Blue Cross helped pioneer health insurance a half century ago when commercial insurance firms resisted insuring against health problems. Although Blue Shield of California began as a plan to pay physicians’ bills and Blue Cross as a plan to pay hospitals, both organizations now offer similar policies ranging from traditional fee-for-service plans to preferred-provider organizations. Yet the similarity of the two Blues has not facilitated a merger.

‘Different Points of View’

“There are no negotiations going on,” says Thomas C. Paton, president of Blue Shield of California, because “there’s nothing to say.” Asked why the two insurance concerns have not merged, Paton says tersely: “We have completely different points view.”

Blue Cross of California President Daniel Smith says a merger is “being evaluated (but) I don’t particularly want to disturb our employees with the idea of drumming up another merger when we are still talking about the first one.”

From the start, the union of California’s two Blue Cross chapters was a tenuous compromise. Half of Blue Cross’s 19 directors came from the Northern California plan and half from Blue Cross of Southern California. Co-chairmen, one from the south and one from the north, jointly presided over the board which included Smith as its 19th member.

There was no similar solution for parity in management jobs: Smith, former head of Blue Cross of Northern California became president of the merged plans; the No. 2 post, executive director, went to Manuel Sanchez of Blue Cross of Southern California. William A. Guy, the popular president of Blue Cross of Southern California said he concurred with the selections and retired amicably. But with Guy’s departure, the truce between the two Blue Cross camps seemed to unravel.

Two Dozen Executives Left

Some two dozen executives, mostly former Blue Cross of Southern California officials, and several of their subordinates have left Blue Cross of California since the merger. Of eight ex-staffers reached by the Times--including the general counsel and executives in the marketing and data-processing departments--all but Guy said they were fired or left disgruntled.

Observers say the departures have left Blue Cross short on experience in some areas--particularly marketing and data processing--sparking complaints from insurance brokers and consumers about delays in commission payments and claims processing. Insurance Department records show for example that, although the total premiums received by Blue Cross climbed 4% to $2.1 billion last year, total unpaid claims rose 11% to $418.6 million and unpaid claims in the process of being reviewed for payment jumped 18% to $79.7 million.

Blue Cross officials admit the company has had service problems, but they say those have eased as Blue Cross has tried to work out kinks in its new computer system.

Yet as Blue Cross made progress on that front, it suffered perhaps its most significant setback on July 16 when a Superior Court judge upheld the 1983 decision by Health Maintenance Network of Southern California, known as Health Net, to amend its bylaws to eliminate Blue Cross control over its business affairs.

Reasons for Move

Health Net, a $221-million-a-year subsidiary of Blue Cross and the nation’s sixth-largest HMO, said in court papers that it adopted the amendments, “to eliminate an unnecessary layer of administration” and “to prevent the recurrence of the past abuses” by Blue Cross, such as its alleged refusal to pay interest on subscriber fees that it collected for Health Net. In addition to those specific complaints, Health Net executives felt that support from Blue Cross management deteriorated after the 1982 merger.

Health Net, which shares office space with Blue Cross and pays it more than $4 million yearly under service agreements, reported a net gain of $34 million on operating revenue of $221 million in 1984, compared to a net gain of $16.7 million on revenue of $136 million in 1983.

Smith said the court decision was a blow to Blue Cross, which had nurtured Health Net through its lean years with $1.6 million in start-up funds: “I think there is no question that . . . to lose Health Net is a serious thing.” While Health Net retains a service agreement with Blue Cross and rents office space from the insurer, the elimination of formal ties means Blue Cross ultimately could lose that source of revenue.

Smith said Blue Cross, which argued that the amendments were invalid because they violated Health Net’s articles of incorporation, is awaiting a written court opinion before deciding whether to appeal.

Meanwhile, Smith--a tall silver-haired man whose hobby is collecting clocks--is keeping a close eye on the rest of Blue Cross, which has recovered impressively since it lost $44.8 million in 1982, the year the northern and southern Blue Cross plans merged.

The large losses, which occurred at a time when most health insurers were having financial difficulty, declined to $15.7 million in 1983 and Blue Cross of California posted a net gain of $69.8 million in 1984. The company said more moderate increases in medical costs and higher premium revenue were largely responsible for its first surplus ever.

But the financial gains did not come without some cost to morale.

“Some of the staff formerly associated with Blue Cross of Southern California considered the consolidation as a threat to them,” wrote Blue Cross of California lawyers in a brief submitted in the Health Net case. “Their perception, more imagined than real, was that because more of the high-level officers of the new organization. . .came from the North, they would somehow be treated as second-class citizens.”

Declined Comment

Steven Vogt, who retired as general counsel several months after the Blue Cross chapters merged, said he looked for outside opportunities after growing frustrated with the conflicts between northern and southern Blue Cross executives: “It was a totally different working environment. There is no question in my mind that certain resignations and conflicts, such as the (Health Net) lawsuit, would not have occurred but for the merger.”

Vogt now practices law with former Blue Cross executive director Manuel Sanchez. Sanchez declined to comment.

Health Net may be the most visible trouble sign, but sources say at the heart of Blue Cross’s woes is its multimillion-dollar Long Range System Planning (LRSP) computer software program. Blue Cross once boasted LRSP “has the potential to reduce Blue Cross’s costs by 30% to 40%--a reduction that can mean lower premiums.”

Yet LRSP, developed by the Blue Cross and Blue Shield Assn. and used by nine of its chapters, has not lived up to its promise in California.

According to Arnold Willner, a former Blue Cross vice president of data processing who was fired for giving a voluntary statement to Health Net attorneys, Blue Cross has spent about $25 million on LRSP since 1982 without realizing any appreciable improvement in productivity or cost savings. Willner said files from the old system that predated LRSP could not easily be reformatted onto LRSP. He said it took up to 12 weeks to code the health contracts of new beneficiaries onto LRSP.

LRSP Has Not worked Properly

Blue Cross President Smith admits that LRSP has not worked properly. He adds that Blue Cross’s decision to phase out the software system and operate on a newer, but more effective software package, has created some additional production snafus as work is transferred to the newer system.

“But we can’t shut our shop down like we are retooling to produce a new car,” Smith protests. “We have to keep paying claims. . . When you have a new system, or major overhaul--which is what we are doing--(all things considered) our problems are very minimal. But we do have problems--and will have them for another year and a half.”

Willner said, and a Blue Cross manager concedes, that despite the spending on automation, the new software system handles less than 25% of 30,000 claims that pour into Blue Cross’s offices daily. Willner added that as of February when he left Blue Cross, there was a backlog of about 250,000 insurance claims in the Woodland Hills office. Blue Cross officials say that total has since been cut in half.

Blue Cross general counsel Angele Khachadour explained that the delay in claims processing was due to a 4-month-long computer breakdown involving hardware snafus that started in November, 1984. During that period, she said, the average time for processing claims tripled to 19 days. She said operations have since returned to normal and that, as of June 30, claims in the process of being reviewed dropped to $62.5 million.

Whatever the reasons for the slow claims processing, Blue Cross customers are irritated.

“Because of some of the service difficulties that our clients have encountered with Blue Cross, we don’t use them as much as some other carriers,” said Bruce Hill, a vice president of West Coast Insurance Marketing Corp., an insurance brokerage firm in Tarzana.

As of Aug. 19, added a spokeswoman at Harbor Bank in Long Beach, “our current claims filed July 29 with Blue Cross have not been paid.” She said, “Claims are taking more than three weeks to process. Service is not nearly as good now as it was” four years ago when the bank was insured by Blue Cross of Southern California.

The service problems are not due to lack of manpower, officials concede. Despite spending heavily to automate its business operations, Blue Cross has increased its work force about 10% to 5,339 as of July 1, compared to 4,877 a year earlier.

The increase came mostly in the Woodland Hills office where more data processing and more Health Net workers were added, said Blue Cross lawyer Khachadour.

The hiring at Woodland Hills alone was nearly double the percentage increase in hiring by other major San Fernando Valley employers such as Lockheed, RCA and the St. Joseph Medical Center. The increases came at time when total paid claims at Blue Cross rose only slightly to $1.856 billion last year from $1.840 billion in 1983 and the number of policy holders actually declined to 3.974 million from 4.138 million in 1983.

Time of Austerity

Critics, including several former Blue Cross executives, note that the heavy spending on data processing and personnel comes at a time of austerity within the health-care industry. The federal government and most private insurers are trying to trim health care outlays both by trimming their administrative costs and controlling reimbursements to health care providers.

Private insurers, in particular, have de-emphasized the type of fee-for-service insurance that continues to dominate Blue Cross of California coverage in favor of alternative forms of health care, such as health maintenance organizations and preferred-provider organizations.

While Blue Cross of California has been active in those areas, it was late in the HMO field, where it faces competition from better established Kaiser Health Plans Inc. Blue Cross, however, was among the first insurers to offer a so-called preferred-provider organization, an HMO-like plan that reimburses participating hospitals and doctors at a fixed-fee schedule for treating Blue Cross customers. But experts say the plan faces competition from Blue Shield, which historically has had more support from the state’s physician community.

While critics concede that Blue Cross has improved financially, they say the rosy results are at least partially due to a better bottom line at Health Net, which Blue Cross no longer controls; the sale of its Oakland headquarters, which accounted for $20.5 million of the $69.8 million gain Blue Cross reported in 1984, and slower claims payments, which, the critics say, can’t continue without incurring the wrath of more insurance brokers and consumers.

“I would be worried about (Blue Cross’s) financial outlook,” said Guy, the former president of Blue Cross of Southern California. “I see the loss of Health Net as significant. I just don’t think the short-term gain in (fee-for-service) underwriting will sustain itself.”