In the sometimes lucrative but increasingly volatile health maintenance organization business, California usually is the nation's pacesetter.
This is especially true in the area of HMO conversions--the leveraged buy-outs in which the managers of the nonprofit plans take over the companies they run and enter the for-profit sector. Of the approximately 25 nonprofit HMOs which have made the switch since 1980, 17 were based in California.
But these conversions are not without controversy, as was demonstrated by the recent battle over Fountain Valley-based FHP Inc.
Questions about who wins and who loses when an HMO converts continue to bedevil state regulators, legislators and the HMOs themselves.
Conversion can strengthen a marginal HMO, but the switch may translate into higher health care costs for HMO members, according to a recent Harvard University study. The study showed that members of for-profit HMOs often pay 10% more than members of nonprofit organizations for the same care.
Donation to Charity
The big winner in the conversion process is supposed to be charity. In some states, including California, nonprofit HMOs which seek to remake themselves into money-making enterprises first must agree to donate an amount equal to their net worth to charity, either by a direct donation to an already existing organization or by setting up a charitable trust.
However, in many conversions charity comes up short because the HMO managers undervalue the concerns, according to consumer groups, legislators and the state attorney general's office. Managers are essentially buying the plans for what the Consumers Union has charged are "bargain-basement prices."
The result, said Jim Schultz, a policy analyst with the San Francisco office of Consumers Union, the publisher of the magazine Consumer Reports, is a conflict between the managers' duties to the nonprofit corporation and their responsibility as buyers to pay the lowest possible price for a company.
"The managers are wearing two hats. First they are responsible as stewards of the nonprofit corporation, and they're the buyers of the plan," Schultz said in a recent interview. "You have a conflict because you don't have a separate buyer and seller."
The issue of a separate buyer and seller was central to the conflict that enveloped the controversial conversion last year of FHP Inc.
The 24-year-old FHP was a success in an industry now beginning to suffer from shakeout and consolidation.
Following lengthy negotiations between the state Department of Corporations and FHP's management, a conversion price of $36 million was reached in September.
Although the $36-million price tag already made the FHP conversion the most expensive ever, Maxicare Health Plans Inc. stepped in and offered $50 million for the company.
When FHP rebuffed Hawthorne-based Maxicare's offer, the giant HMO, which itself had gone for-profit in 1981, filed a lawsuit in Los Angeles Superior Court to block the conversion.
Despite the entry of the state attorney general's office on the side of Maxicare, a judge in October ruled that no law requires either a separate buyer nor competitive bidding for a conversion.
Nevertheless, argue critics of the FHP deal, the $11.5-million difference between Maxicare's $50-million bid and the $38.5 million at which the HMO finally converted was lost to charity.
In all, Schultz estimates, low valuations cost charity about $20 million between the FHP conversion and the February, 1984, conversion of Foundation Health Plan (no relation to FHP) of Sacramento, which converted to for-profit status at $10.6 million, despite a higher valuation of $19 million by the Bank of America.
"You can say that, but it's a specious argument," countered Richard Camilli, assistant corporations commissioner, who said the charitable contribution made by buyers of Foundation Health had grown in value to more than $50 million by mid-1985.
That, said Camilli, is $50 million more than charity would have gotten had Foundation never converted.
In FHP's case, said Camilli, the charitable trust established through the conversion gets $38.6 million, plus interest.
Had the state tried to force FHP to sell out to Maxicare, he said, FHP's directors merely would have canceled the plan's conversion and charity would have gotten nothing.
Endowments to Universities
Moreover, argued Stuart Byer, FHP's director of public affairs, the $3.3 million in endowments recently awarded by the FHP Foundation--established as a result of the FHP conversion--to UC Irvine, Cal State Long Beach and the University of Utah shows that charity benefited from the conversion.
Still, critics argue that determining fair-market value must include not only the net worth of converting HMO's assets but also what a willing buyer is prepared to pay in an actual sale.