2001 Financial Examination Blue Cross Blue Shield of Michigan

Michigan Office of Financial and Insurance Services

Commissioner Frank M. FitzgeraldSeptember, 2001

Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination 2

Michigan Office of Financial and Insurance Services’ (OFIS) role as regulator of Blue Cross Blue Shield of Michigan (BCBSM)

The purpose and scope of the financial examination

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Over 50% of Michigan’s population depends on BCBSM for coverage and service

Michigan historically has relied on BCBSM for affordable and accessible health care coverage

BCBSM is Michigan’s “insurer of last resort”

The Importance of BCBSM

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BCBSM Family Organizational Chart

PPOM The AccidentFund Company

Global HealthOptions

75% Ownership

Health First50% Ownership

BCN Management

Company

Blue Cross Blue Shieldof Michigan (BCBSM)

BCN of Michigan

BCN ServiceCompany

BCBSM Foundation

Blue Care, Inc.

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BCBSM Mix of Business

Line of Business 1993 1999 2001Small Group (ARS) 24.5% 25.7% 25.5%Large Group (ERS) 16.0% 15.9% 17.0%Non Group 0.9% 0.5% 0.4%Group Conversion 1.0% 0.5% 0.5%Medigap 2.6% 2.1% 1.8%ASC (self-funded) 53.8% 54.2% 54.8%

All Lines 100% 100% 100%

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BCBSM AT A CROSSROADS

Safe and solvent today, BCBSM shows disturbing trends and symptoms. Ignoring these problems will threaten BCBSM within the next decade.

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Why BCBSM is at a crossroads

Losses in the small group market Information systems Cash strain Inadequate investment return Strain of Administrative Services Contract

business Management and board structure

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Losses in the Small Group Market

Total BCBSM and Blue Care Network lives is 1,372,664 In the past 5 years, BCBSM has lost over $400 million in

this market lineSmall Group Average Monthly Premiums for Hospital & Medical Coverage

Individual 2 person FamilyContract Contract Contract

1997 $178 $375 $4191998 $198 $414 $464Change 11% 10% 11%1999 $234 $490 $549Change 18% 18% 18%2000 $248 $522 $584Change 6% 7% 6%Cumulative Change 39% 39% 39%

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Losses in the Small Group Market

BCBSM responded by making the loss an asset by using Financial Accounting Standard (FAS) 71 – a unique response

Making the loss an asset (a receivable) means it must be recovered within a reasonable amount of time or it will become a loss to BCBSM

Recovering the loss will add to future premium increases for small businesses caused by medical inflation

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Information Systems

BCBSM has outdated technology systems The OFIS financial examination showed serious

shortcomings in the use of data by BCBSM Ratemaking data is unavailable or not readily

usable The cost of upgrading the system is estimated at

$300 million or more

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Cash Strain – Blue Care Network (BCN)

$54 million expense to merge 4 regional Blue HMOs into BCN

$134.3 million BCN total loss from 1998 – 2000 $18.2 million BCN loss to date this year Decline in BCN net worth from $190.7 in 1996 to

$60.2 million on 2001 BCBSM is the “parent” that must support BCN

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Cash Strain of Acquiring and Operating Affiliated Companies

BCBSM acquired Accident Fund Company and PPOM for cash – $272.1 million and $182.6 million respectively

Accident Fund Company provided no return for five years

Investments in affiliates account for 40% of total invested assets, almost 20% of total assets, and almost 100% of stock holdings

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BCBSM Investment Return

BCBSM INVESTED ASSETSBonds 824,339,310 47%Common Stocks 579,008,195 33%Real Estate 211,583,618 12%Cash and Sort-Term Investments (28,579,345) -2%Other Invested Assets 185,532,084 10%Total Invested Assets 1,771,883,862 100%Total Assets 3,669,366,663Invested Assets as a % of Total Assets 48.3%

Investment Return Excluding 56,271,523Affiliated Investments and 1,186,159,184Associated Dividend Income 4.7%

Investment Return as a 56,271,523Percentage of Total Assets 3,669,366,663Excluding Affiliated Investments 1.8%

= Net Investment Income / 105,562,188 Average Invested Assets 1,737,189,640The usual investment return includes 6.1%Results between 4.5% -10.0%

INVESTED RETURN

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Inadequate Investment Return

Real estate is 12% of total BCBSM assets

There is no return on these real estate assets

$108 million in appreciated BCBSM real estate value is not being used in any manner

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Inadequate Investment Return

Common stock investment is 33% of invested assets – almost all in affiliated companies returning little to BCBSM

Overall return on investments as percentage of total assets (excluding affiliated investments) is 1.8%

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Inadequate Investment Return – Advances to Providers

This is a monthly outflow of money that does not earn interest for BCBSM

BCBSM is historically put in the less favorable position of hospitals owing it moneyAdvances To Providers:

Asset Liability Difference 3/31/2001 $265,429,232 $194,069,851 $71,359,38112/31/2000 253,180,397 178,282,439 74,897,95812/31/1999 172,869,563 183,288,855 (10,419,292)12/31/1998 298,946,340 188,866,526 110,079,81412/31/1997 350,187,018 190,144,166 160,042,852

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Strain of Administrative Services Contract (ASC) Business

Traditionally, this represented half of BCBSM premium revenue

$4.5 billion returned $6.6 million in 1999 New reporting requirements will disallow reporting

this as premium It is questionable whether this business is

appropriately leveraged by BCBSM to the benefit of subscribers

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Management and Board Structure

1 Chief Executive Officer, 1 Executive Vice President, 10 Senior Vice Presidents and 27 additional Vice Presidents

Bonus plan and performance levels do not properly incentivize management

35 member board – large by industry standards Statutory mission – PA 350, Section 550.1201

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Consequences of maintaining status quo

Threat to affordability of and access to health care coverage

Declining BCBSM asset value for Michigan Will BCBSM as we know it exist at decade’s end? These possibilities do not leave Michigan with the

best BCBSM health care asset There are no easy or quick fixes for BCBSM

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Age Rating Is Not The Answer

BCBSM controls 57% of the small group market BCBSM and BCN control 71% of the small group

market Total BCBSM and BCN lives is 1,372,664 – the

next largest competitor is 210,712 OFIS approved price adjustors for group size and

participation percentages are stemming losses

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BCBSM’s Board and Management Must Refocus

Greater attention to the BCBSM’s statutory “charitable and benevolent” mission

Acting competitively, not monopolistically Leveraging BCBSM’s strengths in a

competitive and changing health care coverage marketplace

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Next Steps

Meet with Governor John Engler Share findings with legislators Take a more proactive approach

toward BCBSM by OFIS and the Commissioner