Foundation Health Corporation

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Foundation Health Corporation

3400 Data Drive
Rancho Cordova, California 95670
U.S.A.
(916) 631-5000
Fax: (916) 631-5882

Public Company
Incorporated: 1978
Employees: 5,000
Sales: $1.52 billion
Stock Exchanges: New York
SICs: 8210 Life and Health Insurance; 8320 Health Care

Foundation Health Corporation is a leading U.S. provider of managed healthcare services for industry and government. Through its subsidiaries, Foundation served approximately 2.7 million Americans in 1993. The company also provides various insurance, workers compensation, and specialty services. Foundation emerged from financial distress in the late 1980s and expanded its operations rapidly into the 1990s.

Foundation Health Corporation was founded in 1978 by a group of California health industry executives eager to capitalize on changes taking place in the healthcare and health insurance market. Indeed, as the cost of medical care mushroomed during the 1970s and 1980s, demand surfaced for a new type of healthcare provider that could do a better job of containing costs. A popular alternative to traditional indemnity health insurance during that period became managed care organizations, particularly health maintenance organizations (HMOs). Although HMOs had existed since the 1930s, favorable federal legislation was passed in the 1970s (i.e. the Federal Health Maintenance Organization Act of 1973) that bolstered their viability.

HMOs typically arrange to provide medical services for members in exchange for subscription fees paid to the plan sponsor. Members receive services from physicians or hospitals that also have a contract with the sponsor. Although they serve the same basic function as traditional insurance plans, managed care plans differ because the plan sponsors play a greater role in administering and managing the services that the healthcare providers furnish. For this reason, some managed care plans are able to provide a less-expensive alternative to traditional indemnity insurance plans.

Foundation was formed, like many other managed care companies created in the 1970s and early 1980s, to operate as an HMO. Under the direction of President George Duebel, Foundation would act as a middleman by contracting with both healthcare providers and enrollees to deliver medical services. The enrollees would pay a set fee to Foundation that entitled them to services. Foundation would supervise the health care providers, thus allowing subscribers to benefit from reduced health care costs. Doctors that contracted with Foundation would benefit from a guaranteed base of patients.

Foundation, along with the rest of the managed care industry, realized healthy growth during the late 1970s and early and mid-1980s. During the 1970s, in fact, the HMO industry grew by more than 25 percent to encompass a full 4 percent of the U.S. population by 1980. The early and mid-1980s, however, constituted the period of fastest expansion for the industry. As the number of HMOs soared past 700 in 1987, enrollment swelled to include 15 percent of all Americans. Furthermore, HMO-like plans, such as preferred provider organizations, also proliferated, generating additional revenue and profit growth for Foundation and its peers.

Although Foundation benefited from generally positive industry trends during its first eight years of existence, its success also reflected the superior efforts of its entrepreneurial management team. Through an aggressive program of expansion and diversification, Duebel and company had grown Foundation into the second largest HMO in the Sacramento region—the largest was Kaiser Foundation Health Plan, part of Kaiser Permanente Corp., which was started in the 1930s and dominated the managed care industry.

By the mid-1980s, Foundation was serving more than 200,000 enrollees. Besides its California operations, the company was offering its plan to members in five other states. It had also created four subsidiaries in its effort to diversify. Foundation created PAC Insurance Services in 1982 to provide long-term care insurance and related services. In 1983, Foundation Services Inc. was formed to provide data processing and information management for corporations and state governments. In 1984 Los Lagos Corp was set up as a real estate holding and development company. Finally, Foundation Group Contract Furnishings & Equipment Inc. was created in 1987 to distribute office furniture and accessories.

To benefit from Foundation’s rising strength in the local healthcare industry, Sutler Health purchased 30 percent of Foundation Health Corp. in a 1986 leveraged buyout (LBO). Sutter, with its Sacramento-based chain of six hospitals, hoped to benefit through a partnership with Foundation and one other provider that would allow it to eventually compete head-on with Kaiser. Foundation also benefited from the buyout; Sutter agreed in “sweetheart” contracts to treat Foundation’s enrollees at cut-rate prices.

Entering the late 1980s, Kaiser appeared to be in an excellent position to continue, and even to accelerate, the impressive growth rate it had achieved since its inception. Healthcare costs were escalating at a record pace, thus increasing the importance of the cost-containment role of the managed care industry. In addition, Americans were becoming more amenable to the concept of HMOs. Nevertheless, Kaiser spiraled into an ugly decline beginning in 1986. In fact, a health insurance underwriting downcycle caught much of the HMO industry off guard in the late 1980s. Industry executives, many of whom were entrepreneurs with only average long-term management expertise, were generally ill-equipped to deal with the downturn. During 1987 and 1988 fewer than one-third of all U.S. HMOs even turned a profit. Enrollee growth practically stagnated and many HMOs filed for bankruptcy.

Foundation was no exception to the problems that beset the industry during the late 1980s, but its difficulties were exacerbated by several factors. Most notable was its parent organization’s heavy debt load. Sutter had assumed $126 million in debt during the 1986 LBO, much of which was still burdening its balance sheet by 1988 and 1989. To meet its debt service, Sutter was intercepting cash flow from Foundation’s already pinched operations. In addition, Foundation’s ventures in the five states outside of California were either barely breaking even or losing money, as were its subsidiaries. Furthermore, Foundation was in danger of losing an immense, recently acquired military contract because of inadequate data processing systems.

After posting a loss in 1987, Foundation’s net income plummeted to minus $49 million in 1988, partly as a result of a devaluation of its assets. The company was teetering on the edge of bankruptcy when, in 1988, its board of directors asked Duebel to resign his post and take a leave of absence. Duebel was given the job of evaluating Foundation’s troubled subsidiaries and developing a strategy to improve their performance. Daniel D. Crowley was named president and CEO of the company in 1989. The 44-year-old Crowley had previously engineered the turnaround of Cleveland-based Blue Cross and Blue Shield Mutual of Northern Ohio, where he had taken the company from a $62 million loss to profits of $6 million in one year.

Under Crowley’s direction, Foundation immediately embarked on an aggressive reorganization plan. It scrapped its ailing New Mexico and Washington subsidiaries, while its New Jersey division was seized by state regulators. Crowley brought in a new management team that whipped Foundation’s operations into shape and jettisoned excess baggage from the overweight enterprise—70 managers were slashed from the payroll. In 1990, Crowley conducted a stock offering that brought in enough cash to all but eliminate its crushing load of debt. He also implemented smaller changes, such as biweekly breakfast meetings, called “the Breakfast of Champions,” where employees were allowed to air their concerns.

Crowley’s greatest contribution to the company from an operational standpoint was his relentless cost-cutting efforts. Besides dispatching unnecessary staff, he took back 60 company cars, eliminated cafeteria subsidies, took out several hundred phone lines, and began restricting long-distance calls. He also had automatic switches installed to turn off lights and air conditioners during nights and weekends, and he began personally checking employee expense accounts. Although some employees scoffed, shareholders applauded. “Crowley is definitely a take-charge kind of guy, and I’d have to say his track record is fairly impressive,” observed healthcare consultant Hal O’Donnell in an August 1989 issue of Business Journal-Sacramento. “He will make decisions, and they will not always be popular,” O’Donnell noted.

Perhaps Foundation’s most lucrative achievement after Crowley’s arrival was its retention of an experimental $3 billion contract with the Federal Government. In the mid-1980s, Foundation had won a bid to provide managed care services for 850,000 military employees and retirees in California and Hawaii through CHAMPÚS (Civilian Health and Medical Program of the Uniformed Services). The contract represented a massive infusion of cash into the struggling organization and an opportunity to immediately triple its customer base. Soon after Foundation began servicing the account, however, a massive backlog of medical claims accumulated as Foundation’s data processing systems became overloaded. Doctors and health providers complained and the Department of Defense threatened to cancel the vital contract.

In a move that would not only save the CHAMPÚS contract but would also provide much of the infrastructure necessary for Foundation’s future expansion, Crowley hired Electronic Data Systems (EDS) to revamp its information systems. Working day and night, EDS and Foundation employees quickly turned the processing system around and created an operation capable of processing 1.5 million claims annually. “CHAMPÚS was basically taking Foundation under,” recalled Mark Fox, EDS regional director of public affairs, in a June 1990 issue of Sacramento Bee, adding, “They asked us to save the contract.”

As debt payments and operating costs quickly declined, CHAMPÚS revenues kicked in, and managed care markets began to recover, Foundation’s sales and profits soared. Its receipts bolted to $822 million in 1989, to $978 million in 1990, and to a record $1.1 billion in 1991. Likewise, net income shot to $11.5 million in 1990 following three straight years of losses, and then to a whopping $29.4 million in 1991. “It all started to really gel for us,” recalled Crowley in a January 1992 issue of Sacramento Bee. “It got to the point where we could begin to grow the company by strategic acquisitions.”

By strategic acquisitions, Crowley was referring to the aggressive expansion strategy that Foundation had initiated in the late 1980s to extend its reach into related healthcare fields. Indeed, by the early 1990s Foundation had launched successful subsidiary operations designed to serve vision, dental, mental health, pharmaceutical, and life insurance markets. Several of the initiatives had been hugely successful. In 1992, in fact, Foundation boosted enrollment in all of its non-CHAMPUS plans from 292,000 to 767,000. Furthermore, its doctor enrollment increased from 5,000 to 7,550. Sales and net income ballooned during 1992 to $1.33 billion and $52.6, respectively, making it by far the best year in the company’s history.

Also buoying the struggling managed care provider during its lean late-1980s years was its choice contracts with Sutter Health. Besides cutting the low-rate contracts with former CEO Duebel, Sutter had also provided infusions of cash into the ailing Foundation during the late 1980s and had worked to insure its survival. Sutter benefited by retaining an important source of patients. However, Crowley’s management goals soon clashed with those of Sutler’s president, Patrick Hays; both men wanted to turn their companies into leaders in their respective industries and were unwilling to compromise their independence for the partnership. When Sutter tried to raise the fees originally guaranteed by Foundation’s contracts, a bitter feud erupted that was played out in full-page advertisements in local newspapers. Sutter began dumping its Foundation Healthcare stock in 1991, effectively terminating the partnership but leaving Foundation with a quality source of low-cost care for its members.

Low costs and membership gains continued to fuel Foundation’s rapid rise into 1993—sales jumped to $1.5 billion and net income rose to $62 million. However, those gains cloaked a bombshell that shook up the giant managed care provider in July of 1993. To Crowley’s surprise, the Department of Defense informed Foundation that it planned to transfer its CHAMPÚS business to Aetna when the contract terminated in 1994. Foundation management was stunned. CHAMPÚS had delivered nearly half of Foundation’s revenues in 1993 and made up about one half of the company’s total customer base. “I lost my breath,” Crowley said (about the phone call informing him of the decision) in a March 1994 issue of Financial World.” I thought that he was joking or had made a mistake.”

Foundation’s stock price fell 35 percent the day after Crowley’s phone call. By then, however, the company was already strategizing to overcome the dilemma. It began devising a plan to boost enrollment in its traditional HMOs and to place increased emphasis on the development of its specialty services. Revenues from its specialty operations had already soared from $16 million in 1989 to $86.7 million by 1993. At least two outside analysts in early 1994 expected that figure to swell to $546 million by 1995, representing over 30 percent of Foundation’s sales. By mid-1994, in fact, Foundation had already replaced many of the customers that would be lost to CHAMPÚS through stellar gains in non-CHAMPUS plans. With shareholder confidence restored, Foundation’s stock price increased well past its June 1993 level.

As it prepared to enter 1995, Foundation was looking forward to healthy growth and increased profits. Besides political and market conditions that favored general growth in the managed care industry, Foundation Health Corporation’s management had earned a reputation as one of the most adept in the industry. In addition, it remained committed to a single, underlying goal: Crowley asserted in a March 1994 issue of Financial World, “We think we can give the public a less expensive product and still increase our margins.”