A Scalpel, Please, for Maxicare : Sale of Assets Could Put Biggest HMO on Path to Recovery

Not too long ago, Fred W. Wasserman could be counted on to cultivate gorgeous roses at his Beverly Hills home and generous profits at his Los Angeles company, Maxicare Health Plans.

The roses are still blooming at the Art Deco home that Wasserman shares with his wife, Maxicare President Pamela K. Anderson. As for the profits--Maxicare hasn’t seen any of those for the past five quarters.

In fact, Maxicare reported a $60.9-million loss for 1987, which put the nation’s largest for-profit health maintenance organization in violation of some terms of its bank loans that must now be negotiated. The debt-laden company has laid off 600 people in the past year and is looking to sell assets and raise rates to turn the company around.

It seems that this fast-growing firm--once the darling of Wall Street--has developed a case of roaring indigestion thanks to two big acquisitions that it gulped down in 1986.

While Maxicare may not be terminal, the search for a cure is sure to be a long one in part because of problems in the HMO industry in general. The moves that Maxicare must make to heal itself will result in a smaller and much different company, industry diagnosticians say.

“They’ve got digestion problems out the wazoo,” one industry expert said. “Maxicare got this idea that they wanted to be national, and that is one of the debunked theories of the 1980s--the supermeds.”

“I think you’re going to see a radically different Maxi by the end of the year,” said Larry Selwitz, a health-care analyst with the Bateman Eichler, Hill Richards securities firm in Los Angeles. Selwitz sees membership shrinking to less than 1.5 million from the current 2.3-million level.

Chairman and Chief Executive Wasserman admits that the slump at the company he founded 15 years ago has taken its toll.

“There’s no one more anxious than myself about the profitability issue,” he said. “I’m so tired of looking at red ink. It’s gotten depressing.”

When Wasserman and 10 doctors from Hawthorne Community Medical Group raised $37,000 to start Maxicare, the idea of controlling health-care costs through health maintenance organizations was unusual, even though industry leader Kaiser Foundation Health Plans had been in business since 1942.

HMOs differ from the traditional “fee-for-service” method of health care by charging patients a prepaid fee and putting doctors on a set monthly budget rather than reimbursing them for specific services, although some fee-for-service arrangements do exist within HMOs.

Maxicare’s rates vary around the country, but in Southern California its basic health plan costs $93 per month for an individual and $249 for a family, most of which is paid by the member’s employer.

In general, Maxicare does not provide health care itself but contracts with doctors, hospitals and others to deliver services. (In some states, however, Maxicare owns clinics with salaried doctors and nurses.) A patient generally has the option of choosing a medical group or clinic and picking from its roster of doctors, or selecting an individual doctor who is affiliated with a Maxicare-contracted hospital.

In addition, Maxicare has a joint venture with Pritikin Programs to build diet centers that Pritikin manages.

Maxicare was one of the first HMOs to become a for-profit company when California allowed the switch in 1980. The company thrived, backed by a $15-million computer system that many thought to be the best in the health-care industry.

With Wasserman as the point man and strategist, and Anderson as the operations tactician, the then-regional HMO began an ambitious expansion program in the early 1980s. Membership jumped to nearly 700,000 in 1985, compared to 117,000 four years before and 4,200 at the company’s founding. Its net income soared to $20.4 million in 1985 from $857,000 in 1981.

Wasserman, 48, is the visible half of the team, while Anderson, 41, maintains a very low profile. Wasserman works long hours, but Anderson works even longer, usually coming to the office on Sundays and spending off hours at her computer terminal at home.

Wasserman is known as an avid racquetball player. And then there are the roses--about 90 bushes in a formal garden at the 1928 Beverly Hills house that once was home to Rita Hayworth and Prince Aly Khan. Anderson’s hobby appears to be her work.

“Fred’s a workaholic, but Pam’s a real workaholic,” Maxicare spokeswoman Tobi Nyberg said.

Maxicare’s 1982 purchase of CNA Health Plans took it out of California for the first time and into Illinois, Indiana and Wisconsin. Maxicare continued to expand its California operations and added other states--Texas in 1983; Utah, Missouri, Ohio and Louisiana in 1984, Arkansas, Nevada and Arizona in 1985.

Nationwide Expansion

Wasserman was determined to build a national company to attract large, national clients who were looking for a single HMO for their scattered employees. At the same time, a consolidation trend began to sweep the industry as increased competition and pricing pressures hit.

Then, almost overnight, Wasserman had his national company: In 1986, Maxicare made back-to-back purchases of Orange-based HealthCare USA and Nashville-based HealthAmerica, both intermittent money-losers.

HealthCare added plans in California, Kentucky and Michigan. HealthAmerica took Maxicare into Alabama, Florida, Georgia, Maryland, Nebraska, North Carolina, Pennsylvania, South Carolina, Virginia and Washington, and it added plans in states where Maxicare already operated. Maxicare also entered New York at this time. The purchases put Maxicare in 26 states and in 25 of the 30 largest health-care markets in the nation.

The two acquisitions loaded Maxicare with debt, led to a loss in the last quarter of 1986 and reduced net income by 79% for the year to $4.3 million. But Maxicare executives were confident that they could clean up and integrate the new plans and return them to the black.

That was not to be. For just as Maxicare was extending its reach, the health-care industry as a whole began to lose its grasp on profits.

“Group health is a cyclical business,” said Charlie Schetter, partner in charge of the health-care practice at the McKinsey & Co. consulting firm office in Los Angeles.

The industry hit a tough cycle late in 1985 as medical costs--the price of such things as drugs, blood tests and hospital rooms--soared. While that was happening, conventional health insurers cut their rates to compete better with the growing HMOs. And HMOs themselves were competing in price with each other.

“Nobody was willing to give up market share to increase prices,” said Bernard F. McDonagh, vice president of the Piper, Jaffray & Hopwood brokerage in Minneapolis.

In addition, many HMOs had started new plans to increase membership but found that the plans did not become profitable as quickly as had been hoped and were saddled with high overhead costs, Selwitz said. Some consultants now believe that regional HMOs perform better than national groups.

More Attrition

“All that just creamed the HMOs in 1986 and ’87 and going into ‘88,” Selwitz said.

The industry will rebound as HMOs raise rates and learn to control costs, but that might not begin to be felt until next year, Schetter said. In the meantime, “I think there’s going to be attrition in the managed-care business.”

Argued Wasserman: “It isn’t only Maxicare, it’s the whole HMO industry that is being perceived as a lackluster industry.”

In Maxicare’s case, the heavy debt burden slowed down the company at a time that it needed its financial agility most. Maxicare hasn’t released its year-end balance sheet, but as of September the company carried long-term debt of $468.5 million.

The high-flying company fell quickly. As the losses mounted in 1987, Wall Street analysts began to pan Maxicare. Financial World magazine in October named Maxicare one of the nation’s 10 worst-managed companies only six months after lauding Wasserman as the hospital management industry’s best chief executive. The magnitude of the 1987 loss--$60.9 million--surprised analysts who had been somewhat encouraged by improvements in each of the first three quarters of the year.

“If you look at our company and subtract out the amortization expenses and the depreciation expenses and the interest, this company is profitable,” Wasserman said. “The company is too leveraged for this kind of environment.” Interest expense alone accounted for $47.5 million of the loss last year.

And the acquisitions, particularly HealthAmerica, turned out to be in worse shape than Maxicare realized when it bought them.

“When they made those acquisitions, what they found out was that they really didn’t have anything,” analyst Selwitz said, “that the acquisition was dust.”

“We did thorough due diligence,” Wasserman said. “The one thing we could have done a better job on was the quality of the management available to run the plans. It wasn’t there.”

Another major problem: Rates in some plans were extremely low, “so in some markets there have been gigantic rate increases,” Wasserman said. In South Carolina, for example, Maxicare’s rates jumped 40% last year.

Acquisitions ‘OK’

HealthAmerica had no central accounting and data system for its many operations. Costs were high, and there was no way to control patient use. The company also lacked what Maxicare considered favorable contracts with doctors and hospitals.

After more than a year, “for the most part, the acquisitions on an operating basis are OK as a group,” Wasserman said. “But they can’t just be OK. They have to be profitable at a 5% to 7% pretax operating level.”

Some analysts dispute Wasserman’s assessment.

“The last quarter would indicate to me that they still have a long way to go to fix them,” said analyst McDonagh.

In yet another headache, Maxicare is embroiled in a bitter fight with Hawthorne Community Medical Group that has led to the cancellation of their 15-year contract. The two will spend the next year vying for the slightly more than 100,000 patients who use Hawthorne (see related story).

Despite Maxicare’s financial problems, a sampling of hospitals, doctors and employers found no major downturn in the company’s level of service or quality of care. Many are content with the relationship and say Maxicare’s financial problems have not been apparent.

According to a spokesman for Ford Motor Co., which has more than 10,000 employees enrolled in Maxicare plans, “We continue to receive fine service from Maxicare.”

“The only complaints we’ve heard on Maxicare in the last year and a half have been in their administrative capabilities,” said Roy Gonella of Mercer Meidinger Hanson, a consulting firm that advises companies on benefits plans. “They’ve had some problems in getting some data on a timely basis to employers.”

Some employers admit that, in Maxicare’s defense, getting data out of any HMO on costs or employee usage is almost impossible.

“It hasn’t affected, in our case, the care that anybody has gotten,” said Earl Mink, group insurance manager at Lockheed. But Maxicare has had trouble keeping Lockheed up to date on which employees are eligible to enroll in the HMO and “being able to react promptly when a mess occurs,” he said.

“Three or four years ago, if you’d asked most anybody who is the most effective HMO around these parts, they’d say Maxicare,” Mink said. “Now the answer would be just as spontaneous, but it wouldn’t be in the same direction.”

Torrance Memorial Hospital has “no quarrel with Maxicare,” a spokeswoman said. “We are currently being paid in a timely manner.” Financial difficulties at Maxicare would never mean reduced quality of care at Torrance Memorial or any hospital, because “we are the care giver, so nothing Maxicare would do would jeopardize the kind of care we give,” she said.

At Hollywood Presbyterian Hospital, “Maxicare has been a little bit slower, but they haven’t been unreasonable in payment,” a spokeswoman said. “Our problems don’t seem to be significant.”

“We’ve been monitoring the situation for about six months,” said Robert Shaw, chief executive of Robert F. Kennedy Medical Center in Hawthorne. “They seem to be, as far as we’re concerned, making an effort to see that they are current.”

To stop its financial bleeding, Maxicare has said that it intends to raise its rates an average of 15% this year, cut administrative expenses by $9 million and sell $100 million of what it calls “non-essential” assets--that is, money-losing health plans in various parts of the country. The company already has sold its Florida HMO and its MetroHealth plan in Indianapolis for $23 million. But Wasserman denied reports that Maxicare as a whole is up for sale or that assets will be unloaded at rock-bottom prices.

“This is not a fire sale by any means,” he said, adding that Maxicare remains interested in forming joint ventures with health-care insurers.

Analysts said Maxicare’s banks are sure to pressure the company to sell some assets quickly. Maxicare’s 1987 loss put it in violation of some covenants of its bank loans, which must be renegotiated by March 31.

“The company is clearly in a weakened financial condition to negotiate with the banks,” said Margo L. Vignola, an analyst with the investment firm Salomon Bros. “If the banks decided to be obnoxious, you know what the options are. The banks could force them into Chapter 11 (bankruptcy), but I don’t think that will happen.”

Rumors that Maxicare has been targeted for takeover are hard to believe, analysts said, because there are so few companies with the resources and desire to buy such a large and ailing HMO.

“If anybody is interested, they’re vulnerable,” Vignola said.

With a little help from an industry rebound, successful asset sales and employer acceptance of the planned rate hikes, Maxicare could actually turn a profit by the end of the year, analysts said.

“The talent is there,” analyst Selwitz said.

“It’s going to be a slow, steady and probably very painful recovery process,” Vignola said. “But they do have the potential to do it.”

Atmosphere Changed

Michael M. LeConey, managing director of Liberty Street Capital Corp., an investment bank specializing in health companies, worried that Wasserman and Anderson’s closeness to the company might keep them from aggressively selling pieces of it.

“It will all come back to whether Fred can downsize the company,” LeConey said. “He hasn’t gone after that with anything like the intensity that I had expected would occur. . . . It’s just very difficult for them.”

The experience of the last 18 months has changed the atmosphere at Maxicare, observers said.

“You can sense an attitude shift in the sense of not being as cocky,” Selwitz said. “It’s a very sobering reality over there.”

“I would say that the management of this company wants Maxicare to survive very badly,” Wasserman said, “that the providers we deal with want Maxicare to survive and that the 2.3 million members want Maxicare to survive. . . . I think everyone wants the company to be successful.”