2001 Financial Examination Blue Cross Blue Shield of Michigan

1. 2001 Financial ExaminationBlue Cross Blue Shield of Michigan Michigan Office of Financial and Insurance Services Commissioner Frank M. Fitzgerald September, 2001

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

3. The Importance of BCBSM • 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” Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination

4. BCBSM Family Organizational Chart Blue Cross Blue Shield of Michigan (BCBSM) PPOM The Accident Fund Company Global Health Options 75% Ownership Health First 50% Ownership BCN Management Company BCN of Michigan Blue Care, Inc. BCN Service Company BCBSM Foundation Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination

5. BCBSM Mix of Business Line of Business1993 1999 2001 Small 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% Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination

6. BCBSM AT A CROSSROADS Safe and solvent today, BCBSM shows disturbing trends and symptoms. Ignoring these problems will threaten BCBSM within the next decade. Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination

7. 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 Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination

8. 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 line • Small Group Average Monthly Premiums for Hospital & Medical Coverage • Individual 2 person Family • Contract Contract Contract • $178 $375 $419 • $198 $414 $464 • Change 11% 10% 11% • $234 $490 $549 • Change 18% 18% 18% • $248 $522 $584 • Change 6% 7% 6% Cumulative Change 39% 39% 39% Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination

9. 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 Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination

10. 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 Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination

11. 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 Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination

12. 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 Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination

13. BCBSM Investment Return BCBSM INVESTED ASSETS Bonds 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 3,669,366,663 Invested Assets as a % of Total Assets 48.3% INVESTED RETURN = Net Investment Income / 105,562,188 Average Invested Assets 1,737,189,640 The usual investment return includes 6.1% Results between 4.5% -10.0% Investment Return Excluding 56,271,523 Affiliated Investments and 1,186,159,184 Associated Dividend Income 4.7% Investment Return as a 56,271,523 Percentage of Total Assets 3,669,366,663 Excluding Affiliated Investments 1.8% Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination

14. 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 Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination

15. 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% Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination

16. 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 money Advances To Providers: Asset Liability Difference 3/31/2001 $265,429,232 $194,069,851 $71,359,381 12/31/2000 253,180,397 178,282,439 74,897,958 12/31/1999 172,869,563 183,288,855 (10,419,292) 12/31/1998 298,946,340 188,866,526 110,079,814 12/31/1997 350,187,018 190,144,166 160,042,852 Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination

17. 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 Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination

18. 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 Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination

19. 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 Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination

20. 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 Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination

21. 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 Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination

22. Next Steps • Meet with Governor John Engler • Share findings with legislators • Take a more proactive approach toward BCBSM by OFIS and the Commissioner Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination