WellPoint Health Networks Inc.

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WellPoint Health Networks Inc.

21555 Oxnard Street
Woodland Hills, California 91367
U.S.A.
(818) 703-4000
Web site: http://www.wellpoint.com

Public Company
Incorporated: 1992
Employees: 10,100
Sales: $227.4 million (1996)
Stock Exchanges: New York
Ticker Symbol: WLP
SICs: 6324 Hospital & Medical Service Plans; 6719 Holding Companies, Not Elsewhere Classified

WellPoint Health Networks Inc. ranks among the largest publicly traded healthcare insurers in the United States. Its approximately 6.6 million members nationwide are served by two subsidiaries: Blue Cross of California and UNICARE. WellPoint offers a comprehensive selection of healthcare products, including health maintenance organizations (HMOs), preferred provider organizations (PPOs), point-of-service plans (POS), self-insured employer sponsored programs, and specialty plans for dental, optical, pharmacy, and mental health coverage. WellPoint’s principal products in California are the CaliforniaCare HMO and the Prudent Buyer Plan PPO. The latter is the state’s largest PPO with approximately 2.8 million members served by a network of some 42,000 physicians and 443 hospitals. On the national level, WellPoint’s most important plans are the UNICARE Classic POS modeled on the Prudent Buyer Plan and the UNICARE Health Plans HMO which as of March 1998 was still in the early start-up stage.

Beginnings in 1986

WellPoint Health Networks Inc. was organized in 1986 as the division responsible for the managed healthcare operations of Blue Cross of California (BCC). BCC was founded in 1937 as a nonprofit corporation whose purpose was to provide resi-dents of California with quality, affordable medical coverage. For nearly 50 years it was successful in this mission. In the mid-1980s, however, after a tumultuous period when the cost of medical care increased rapidly, the group found itself in precarious financial straits. As company CEO Leonard Schaeffer described the situation in Health Affairs, “BCC’s very existence was threatened.” Blue Cross ran a $55 million deficit in 1986. The sale of its Woodland Hills, California headquarters building provided temporary help, balancing out BCC’s 1987 stock market and underwriting losses. In April 1988 Schaeffer announced the worst was past. The following August, however, the group reported second quarter losses of $20.5 million and was only able to stave off insolvency at the end of the year when it found a buyer for its TakeCare HMO and was able to book it at an increased value in company books.

Restructuring of Blue Cross of California

In early 1989 BCC completed an initial restructuring implemented by Schaeffer. Within a few months, the group’s staff had been cut from 6,500 to 3,825 and BCC could report a fourth quarter profit of $41.9 million. A new California law enacted in the fall of 1990 enabled BCC to be licensed as a healthcare services plan. By 1991 BCC could report a dramatic turnaround. Under Schaeffer’s leadership, Blue Cross had earned $159.7 million in profits. It boasted the largest growth in enrollment and earnings of any healthcare plan in California, and of any Blue Cross or Blue Shield plan in the entire country. Nonetheless, as Schaeffer wrote in 1996, “BCC faced significant challenges: uncertainty over future government policy and regulations, limited access to capital markets, and increasing competition in a rapidly growing marketplace. BCC thus began to look for a way to compete on the same regulatory and marketing playing field with its competitors.”

Official Incorporation: 1992

Against this background WellPoint was incorporated in 1992. BCC’s most profitable operations were concentrated in the new company—the health maintenance organization, the preferred provider organization, and the various specialty plans. Blue Cross of California retained the traditional health insurance plans. In August 1992, BCC management presented a restructuring plan to the California Department of Corporations (DOC). It would create a wholly owned, for-profit subsidiary, WellPoint Health Networks, whose stock would be sold in a public offering. The plan was designed to further improve Blue Cross’s financial position by giving it access to the country’s capital markets.

Under the plan, Blue Cross of California would retain 80 percent of WellPoint and the BCC board would hold 97.5 percent of the voting shares in the new company. BCC would also restructure but would not convert to for-profit status. An important consideration in that decision was a Blue Cross and Blue Shield Association rule which prevented a for-profit entity from being the primary licensee of the Blue Cross name and trademark.

In January 1993 the California Department of Corporations approved BCC’s proposal. The first public offering of WellPoint stock took place in late January 1993. At first BCC planned to sell 15 million shares at a cost of $22 to $24 a share. “Brisk investor demand,” reported by the Wall Street Journal, led to the sale of some 18 million shares at $28 a share. The strong showing could be traced to WellPoint’s large membership base—423,000 HMO members, 1.5 million PPO members—and its healthy 1992 earnings of $142.8 million, an exceptionally good year for a Blue Cross division. WellPoint’s performance on the market, the Journal said, “underscores growing investor enthusiasm for managed-care companies.” Also contributing to investor interest were WellPoint’s high-profit services which indicated the company would probably experience quick growth.

WellPoint Public Offering Mires Nonprofit Blue Cross in Controversy

The deal created one of the largest public managed healthcare companies in the United States and brought $517 million to Blue Cross of California. Afterwards, though, the restructuring proved to be extremely controversial. Under California law, when a nonprofit converted to for-profit status it was required to compensate the public for the years it was allowed to operate on a tax-free basis. That normally entailed contributing the full value of the assets of the converted organization to a charitable foundation. In this case, however the nonprofit BCC had not itself converted to for-profit status, its subsidiary had, though, and BCC controlled it completely.

There was no provision in California law requiring a contribution in such a case. The Department of Corporation’s initial ruling absolved BCC from making any compensation. The decision drew criticism from the California Office of Consumers Union and the California Medical Association. In transferring most of its assets to WellPoint while remaining nonprofit, critics maintained Blue Cross had taken advantage of a loophole in the law and that Blue Cross executives, who also sat on the board of WellPoint, stood to profit personally from the change through stock option plans and the like.

In April members of the California legislature became involved in the dispute. Accusing Blue Cross of ducking its public responsibility, a bill was introduced that would penalize Blue Cross retroactively for hundreds of millions of dollars. Estimates of a fair settlement ranged from $500 million proposed by the California Medical Association to “a reasonable percentage of $2.6 billion” proposed by Gene Erbin, counsel for the Legislature’s Judiciary Committee, according to the San Francisco Chronicle. Erbin claimed $2.6 billion was the value the stock market had placed on WellPoint. Blue Cross offered $5 million a year for 20 years. Although Blue Cross and legislators negotiated for weeks, the talks did not hurt WellPoint’s standing with investors. Even after it was reported that California might demand $10-$20 million over 20 years, WellPoint stock closed up 50 cents. In the summer of 1993 an agreement was reached: BCC would pay a $100 million lump sum to charity as well as increasing its annual charitable contributions by $5 million. Once the issue had been settled, the bill that would have required retroactive payment was allowed to die.

In August 1993, however, Gary S. Mendoza was appointed to head the DOC. In December 1993 the new, more aggressive commissioner informed Blue Cross that he did not consider the agreement with the legislature to be sufficient. According to Leonard Schaeffer, Mendoza did not indicate to Blue Cross what he considered sufficient compensation.

Company Perspectives:

The WellPoint Companies provide health security by offering a choice of quality branded health services designed to meet the changing expectations of individuals, families and their sponsors throughout a lifelong relationship.

Many of the strengths that differentiate WellPoint from its competitors flow from our experience in California. Evolving from an underperforming Blue plan a decade ago, we learned how to succeed in one of the most competitive healthcare markets in the nation. We did this by carefully redesigning and incrementally rebuilding virtually every aspect of our business.

With a strong customer service value system and corporate goals focusing on member satisfaction, quality products and services, and corporate financial health, WellPoint hopes to redefine the managed care industry through a new generation of consumer-friendly products that put individuals back in control of their health and financial future.

Mendoza told BCC he believed their public benefit activity in 1993 had been minimal. Alfred G. Hagerty reported in National Underwriter Life & Health that after months of talks Mendoza finally told Blue Cross that its plan to spend $25 to $35 million in 1994 was “wide of the mark by an order of magnitude.” In April 1994 he informed Blue Cross it should commit not less than $100 million to charitable purposes in 1994, and at least 40 percent of Blue Cross of California’s WellPoint holdings to a new charitable foundation. By comparison, when Health Net, another California health insurance provider, went for-profit in 1992, it had to endow the California Wellness Foundation with $300 million and 80 percent of its stock; BCC was nearly ten times larger than Health Net.

The DOC’s demand took BCC by surprise. Blue Cross countered with an offer that included the original $100 million payment, an additional $25 million in 1994, and 12 million shares of WellPoint stock, equivalent to a 12 percent stake in the company. At the same time, BGC told Mendoza that it did not believe there was any statutory basis to justify the stock turnover or the loss of control of WellPoint that it would entail for BCC. On May 6, 1994, in apparent frustration, Mendoza sent Blue Cross “a stern letter,” quoted in part in the Wall Street Journal, urging BCC to come to an accommodation. The letter reiterated DOC’s previous demands and said the department had “begun to take the necessary steps to initiate an enforcement action … if the department concluded that it was necessary to do so.”

Leonard Schaeffer wrote later in Health Affairs of the “widespread confusion” the controversy caused around WellPoint. WellPoint customers, he said, were surprised that the company had so many surplus funds to distribute. WellPoint employees were uncertain whether they were working for a for-profit or nonprofit company. Company shareholders were concerned that the long, dragged-out dispute would depress the value of their stock and distract WellPoint management from their work.

In May 1994 an event occurred that seemed to offer a way out of the impasse. The Blue Cross and Blue Shield Association amended its bylaws to allow a for-profit organization to hold a primary Blue Cross license. Blue Cross of California drew up a new plan which it presented to DOC in September 1994. Blue Cross would separate its nonprofit and for-profit activities completely by donating all of its remaining assets to two brand new charitable foundations which it would found and then convert itself to for-profit status. All of BCC’s insurance activities would be merged into WellPoint, which would also take over the rights to the Blue Cross license and logo. Some analysts observed that Blue Cross was exactly where it would have been if it had acceded to critics demands in 1992. But to go completely for-profit at that time would have entailed surrendering the rights to the company’s respected—and valuable—Blue Cross affiliation.

All that remained to be established was WellPoint’s actual value as an asset. BCC proposed using the company’s publicly traded price as a yardstick—despite a year and a half of wrangling, it had remained remarkably stable at just over $27. “The DOC,” according to Schaeffer, “said that the company could be better valued by putting it up for auction through a ‘market assessment’ process.” While disagreeing fundamentally with this approach, WellPoint declined to challenge the position in court, a process that would probably have lasted years. As a result, he wrote, “the company was put up for sale.” By February three interested companies had signed confidentiality agreements enabling them to examine WellPoint’s books. The following month Blue Shield of California, attempting to develop its HMO business, offered first $4.5 billion, then $4.8 billion, for WellPoint. If its bid were successful, Blue Shield said, it would follow Well-Point’s example and convert to for-profit status.

Merger with Health Systems On, Then Off

WellPoint rejected both Blue Shield offers. It had been pursuing negotiations to acquire Health Systems International (HSI), a company headquartered near WellPoint in Woodland Hills, California. On April 4, 1995, the two companies formally announced that they were merging. Terms of the deal entailed the exchange of $1.9 billion in stock. The new company, which would operate under the Blue Cross name, would comprise a California HMO with 4.4 million members and $6 billion in annual revenues, second in the state only to Kaiser Permanente. The deal promised a new healthcare giant, a view Leonard Schaeffer seemed to confirm, telling the Wall Street Journal, “We expect this to be a national company.” WellPoint also expected the merger to save it approximately $200 million annually.

All that stood in the way was approval by state and federal regulators, a process the Wall Street Journal speculated “could be difficult.” One, the California Department of Corporations had not yet formally approved the plan for conversion that Blue Cross had presented it the previous September. Commissioner Mendoza favored the Blue Shield takeover and urged WellPoint to reconsider that offer. Although part of the WellPoint-HSI merger proposal called for the transfer of $3 million in cash and stocks to two new foundations, Mendoza continued to stress his concern that any WellPoint merger should benefit the public significantly. “The public is an 80 percent holder in WellPoint, in effect, through an indirect interest in Blue Cross,” he told the San Francisco Chronicle. “We’ve been working with Blue Cross for some period of time to make sure the public receives appropriate benefits.” Mendoza said he would need two to three weeks to determine whether there were any problems with the HSI plan.

In July Commissioner Mendoza sent BCC an eight-page letter which the San Francisco Chronicle obtained. It outlined his “serious concerns” about the “fairness and reasonableness” of the plan for the two new foundations WellPoint wanted to endow. Mendoza was concerned that the foundations be independent charitable entities and not under the control of the WellPoint board. Consumer groups had also criticized the plan for the new charities. Their structure, a Consumers Union spokesperson said, was suspiciously similar to that of lobbying groups like the National Rifle Association. The group told the San Francisco Chronicle the plan was “infected with conditions and restrictions” that would make the foundations “a lobbying and research arm” of Blue Cross.

Leonard Schaeffer was impatient with the way DOC seemed to be dragging its feet. Invoking BCC’s right under California law to a decision within 20 days, he demanded the DOC act by August 22. Mendoza countered, charging Blue Cross had not been completely forthcoming with information the DOC needed to reach a decision. In the end the merger was approved contingent on the new foundations’ refraining from all political activity and changes being made in the foundation’s board of directors to weaken its ties to WellPoint.

After Mendoza had given his approval, the WellPoint-Health Systems International merger lingered on inconclusively and as autumn passed the deal seemed less and less likely. Its completion was postponed in November, a delay the Wall Street Journal blamed on “unresolved ‘contractual interruptions.’” It seemed likely that both WellPoint and HSI would hesitate to pull out on their own—the preliminary agreement stipulated a $50 million penalty if either party reneged.

The deal finally broke down completely when HSI management who had previously supported the merger revoked their approval, saying they had been misled by WellPoint. Outside observers said the deal was ruined when HSI and WellPoint management disagreed about who would have ultimate control over the future direction of the new company. “Over the past couple of weeks, it was harder to imagine how these two managements could have worked together than how they could separate,” one analyst was quoted in the Wall Street Journal. The California Medical Association speculated that what precipitated the merger was WellPoint’s vulnerability to outside takeover after DOC ruled it had to devote $2 billion to charity. “Leonard Schaeffer and his top people feared they could lose their jobs. That is what precipitated the HSI merger,” a CMA spokesperson told Rachel Kreier of American Medical News. Eventually negotiations were mutually terminated to avoid penalties and costly lawsuits.

In the wake of the failed merger, WellPoint filed a third recapitalization plan with the Department of Corporations in February 1996. It called for the creation of two foundations which would receive about 80 percent of Blue Cross’s WellPoint stock. WellPoint would pay out additional monies to acquire remaining Blue Cross commercial assets. The total endowment would amount to approximately $3 billion. Over a five-year period, the foundations would be required to reduce their voting share to less than five percent in WellPoint through sales or transfers. On May 20, 1996, Blue Cross of California and its remaining assets were merged into WellPoint, which assumed the rights to the Blue Cross name and logo.

WellPoint’s service plans and networks had been expanding under Leonard Schaeffer’s leadership during 1995. In May 1995 WellPoint acquired nine San Francisco Bay Area dental practices with 800,000 patients to form what it called a “dental service organization” (DSO), similar in organization to the management-services organization (MSO) in the medical world. Participating dentists would be part owners of the organization, and in effect pool their resources with WellPoint’s to create advantageous economies of scale. WellPoint’s DSO was said to be the first of its kind in the country and the company hoped within 18 months to have a network in place that would reach a quarter of all Californians.

Schaeffer’s sights were set much higher though: “We are committed to being a national company,” he told Medical Economies’ Cathy Tokarski. A key step in this direction took place in January 1996 when WellPoint acquired the Group Life & Health subsidiary (L&H) of Massachusetts Mutual Life Insurance Company for $380 million. L&H’s one million members, combined with WellPoint’s 2.8 million, created the second largest publicly held managed health company in the United States. It was WellPoint’s first major acquisition outside California and enabled the company to expand its coverage into ten states, including Massachusetts, New York, and New Jersey, and to add Mass Mutual’s sizable dental insurance and group life and disability insurance business to its own rosters.

In late 1996 WellPoint bought the Group Benefit Operations of the John Hancock Mutual Life Insurance Company for $86.7 million. The unit, WellPoint announced, would continue to concentrate on serving the needs of large employers. The pur-chase extended WellPoint’s presence to a number of new states, including Michigan, Texas, and the mid-Atlantic area. The purchase of the Hancock and Mass Mutual units, with their more traditional types of policies, reflected WellPoint’s unconventional conviction at the time: the popularity of HMOs had peaked and both employers and workers were looking for healthcare plans that offered them greater latitude. WellPoint made its UNICARE subsidiary responsible for the Mass Mutual and Hancock operations. UNICARE continued to expand in 1997. A joint venture was begun with Blue Cross of Idaho in May; in July it won a major contract with the state of Illinois.

A Tarnished Reputation?: The 1990s

Despite WellPoint’s healthy profits—even in 1994 during the uncertainty with the Department of Corporations its profit margin was 13 percent—it had a bad reputation among California doctors. Cathy Tokarski wrote in Medical Economics, they complained of WellPoint’s “bargain-basement reimbursement rates and strong-arm tactics against physicians.” One group of doctors complained to DOC that WellPoint had kicked them out of its PPO because they had left its HMO. WellPoint countered it had only excluded the doctors after they signed an exclusive agreement with one of its competitors.

Hospitals also complained, in particular in the summer of 1995 when WellPoint announced it was organizing a two-tiered network of hospitals in California. Hospitals who provided convincing plans for cutting costs and providing increased quality in healthcare would be placed in the first tier. Those institutions would get a higher volume of WellPoint patients, while patients who used tier two hospitals would be required to make higher co-payments. Most hospitals chose to cooperate and complete WellPoint’s questionnaire rather than be squeezed out of the extensive WellPoint network altogether.

Studies released by the California Medical Association between 1994 and 1996 claimed that WellPoint’s CaliforniaCare HMO spent less of its total revenues on patient care and more on profits and overhead than any other plan in California. For example, the CMA found that WellPoint spent only 73 percent of its revenues on patients in 1995 and that at the same time its CEO Leonard Schaeffer was one of the highest paid healthcare executives in California. By contrast, the nonprofit Kaiser Permanente put 96.8 percent on medical care. WellPoint maintained the CMA’s survey was flawed pointing out that it ignored differences in accounting practice in nonprofit and for-profit entities, and the higher overhead required to support independent sales agents.

Other groups gave WellPoint poor ratings as well. The Pacific Business Group, an organization of employers in California, rated 13 HMOs in 14 service categories. WellPoint’s CaliforniaCare was the only plan that did not receive a single “A” in any category. In addition, the National Committee for Quality Assurance which evaluates managed healthcare refused to give its accreditation to the WellPoint HMO.

WellPoint’s results in 1997 continued to be good. Its operating income at the end of 1997 was up 14 percent while its stock rose 23 percent. Membership that year increased 19 percent, partly because of the Hancock and Mass Mutual acquisitions and also because of strong growth in its co-payment plan. The company hoped to finish the decade on the same strong footing.