Rosy Forecast for Blue Cross For-Profit Unit

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With all the troubles besetting California’s economy, where would you think to look for a bright spot? Moving services? Bankruptcy lawyers?

How about Blue Cross of California? Seriously. In one of the most remarkable turnarounds in recent California history, the state’s largest health insurer is back from the dead and doing so well that it has spun the bulk of its operations into a for-profit subsidiary. Next month the new unit, WellPoint Health Networks, will offer stock to the public.

At first blush, the Blue Cross plan looks suspicious. A quasi-public entity created during the Depression to insure people against hospital costs (and hospitals against unpaid bills and empty beds), Blue Cross has always been tax-exempt and nonprofit.


Should there be no public recoupment of all the tax-free growth that Blue Cross enjoyed? When Health Net, California’s second-largest health maintenance organization, decided to become for-profit, state regulators required it to endow a nonprofit foundation with $75 million in cash and $225 million more spread over 15 years.

And what about Blue Cross’s public purpose? Won’t charity lose out in the rush for profit? Won’t the profit come from the hides of the insured and the health care providers?

All reasonable questions. Surprisingly, the answer to all of them turns out to be: No. Contrary to what the California Medical Assn. might suggest, the decision by Blue Cross to put most of its operations into a for-profit subsidiary doesn’t mean Blue Cross will be charging more for less care in order to satisfy the insatiable demands of shareholders for profit.

Not at all. The decision is just more evidence of how brilliantly Blue Cross is managed, and the result should be good for everyone.

The first thing to understand about Blue Cross of California is that it isn’t much of a charity, and couldn’t be even if it tried. Unlike some of the other 72 Blue entities across the country, ours isn’t an insurer of last resort, meaning it isn’t required to take all comers, regardless of their health, and charge them the same premium.

Empire State Blue Cross, which has that role in New York, has seen a predictable flight of healthy customers and an influx of those unwanted by other insurers. The result has been an upward premium spiral and near-insolvency, which was only averted by a recent infusion from the state Legislature.


The fact is that no single insurer can solve California’s health insurance crisis. California can’t solve California’s health insurance crisis, because the problem is bigger than any one state. That’s one reason Bill Clinton was elected.

As things stand, Blue Cross has to compete with all the other health insurers in California, and in order to do so acts more or less just like them. You’d think being nonprofit would be an advantage; Blue Cross needn’t generate extra income for shareholders. But being nonprofit also means being shut out of capital markets. Too often, it also means a less competitive culture than might be best for all parties involved.

As for recoupment by the taxpayers, Blue Cross will own more than 80% of its new for-profit subsidiary, and will exercise 98% control because it owns a different class of stock with greater voting rights. So Blue Cross will get access to capital for growth, which illustrates one of the most important lessons in this affair: In health care, it’s grow or die. Almost everyone will have to get bigger.

Blue Cross will also get most of any future WellPoint value and profit, which presumably will make possible greater charitable undertaking than occurs today. Besides, the law doesn’t provide for any recoupment because WellPoint’s parent remains a nonprofit, says Nettie Hoag, a lawyer with Consumers Union in San Francisco.

The state of the law is one reason California’s savvy corporations commissioner, Thomas S. Sayles, approved the WellPoint plan. Another is that he probably understands reality: Up until now, Blue Cross has basically been a tax-exempt business. Why not let Sacramento collect?

Analysts say the Blue Cross offering is probably a pretty good deal for investors too, thanks to the growing California market and the skill of Leonard D. Schaeffer’s management group.


When Schaeffer became chief executive in 1986, Blue Cross of California was teetering on the brink of collapse. Schaeffer slashed expenses, improved operations, stepped up marketing and emphasized “managed care” options such as health maintenance organizations over traditional insurance lines. Talk about success: In 1987 Blue Cross of California lost $155 million. In the first nine months of 1992, it earned $201 million.

Assume for a minute that WellPoint had existed all along. According to the prospectus, operating income has increased every year since 1987. The proportion of premiums going for medical services has plunged to 72% from 92%, with no evidence that customers are being deprived of care. Administrative expenses have been cut to 12.3% of revenue, from 16.5%.

“Len Schaeffer did a phenomenal job in preventing Blue Cross from going into receivership,” says Jeffrey Goldsmith, president of Health Futures Inc., a Chicago health care consulting firm.

Goldsmith knows how tough Schaeffer can be: Schaeffer once fired him from a job. Nevertheless, Goldsmith describes his former nemesis as “arguably the finest health care manager in our country today.”

Dr. Richard Corlin, president of the California Medical Assn., complains about the Blue Cross plan that “health care costs are high enough without having to spin off profits to shareholders.” He says the association is discussing whether to start its own health insurer, much as doctors started Blue Shield decades ago to cover doctor bills.

Of course, a company that must spin off profit to shareholders might be more conscious of the profit earned by doctors. That’s one kind of profit the medical association has yet to complain about.