[Senate Report 104-92]
[From the U.S. Government Publishing Office]



104th Congress                                                   Report
                                 SENATE       
 1st Session                                                     104-92
_______________________________________________________________________

 
  FOURTH INTERIM REPORT ON UNITED STATES GOVERNMENT EFFORTS TO COMBAT 
FRAUD AND ABUSE IN THE INSURANCE INDUSTRY: PROBLEMS IN BLUE CROSS/BLUE 
SHIELD PLANS IN WEST VIRGINIA, MARYLAND, WASHINGTON, DC, NEW YORK, AND 
                           FEDERAL CONTRACTS

                               __________

                            PREPARED BY THE

                PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

                                 OF THE

         COMMITTEE ON GOVERNMENTAL AFFAIRS UNITED STATES SENATE
                                     



                                     
                               JUNE 1995

                  June 5, 1995.--Ordered to be printed

                                     
           COMMITTEE ON GOVERNMENTAL AFFAIRS--104th CONGRESS

 WILLIAM V. ROTH, Jr., Delaware, 
             Chairman
SAM NUNN, Georgia                    TED STEVENS, Alaska
JOHN GLENN, Ohio                     WILLIAM S. COHEN, Maine
CARL LEVIN, Michigan                 FRED THOMPSON, Tennessee
DAVID PRYOR, Arkansas                THAD COCHRAN, Mississippi
JOSEPH I. LIEBERMAN, Connecticut     CHARLES E. GRASSLEY, Iowa
DANIEL K. AKAKA, Hawaii              JOHN McCAIN, Arizona
BYRONL. DORGAN, North Dakota         BOB SMITH, New Hampshire
 Franklin G. Polk, Staff Director 
         and Chief Counsel
  Leonard Weiss, Minority Staff 
             Director
  Michal Sue Prosser, Chief Clerk

                                 ______

                PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

 WILLIAM V. ROTH, Jr., Delaware, 
             Chairman
SAM NUNN, Georgia                    TED STEVENS, Alaska
JOHN GLENN, Ohio                     WILLIAM S. COHEN, Maine
CARL LEVIN, Michigan                 FRED THOMPSON, Tennessee
DAVID PRYOR, Arkansas                THAD COCHRAN, Mississippi
JOSEPH I. LIEBERMAN, Connecticut     CHARLES E. GRASSLEY, Iowa
DANIEL K. AKAKA, Hawaii              JOHN McCAIN, Arizona
BYRON L. DORGAN, North Dakota        BOB SMITH, New Hampshire
  Harold Damelin, Chief Counsel/
          Staff Director
 Dan Gelber, Chief Counsel to the 
             Minority
John F. Sopko Deputy Chief Counsel 
          to the Minority
     Carla Martin, Chief Clerk

                                 ______

           COMMITTEE ON GOVERNMENTAL AFFAIRS--103rd CONGRESS

    JOHN GLENN, Ohio, Chairman
WILLIAM V. ROTH, Jr., Delaware       SAM NUNN, Georgia
TED STEVENS, Alaska                  CARL LEVIN, Michigan
WILLIAM S. COHEN, Maine              JIM SASSER, Tennessee
THAD COCHRAN, Mississippi            DAVID PRYOR, Arkansas
JOHN McCAIN, Arizona                 JOSEPH I. LIEBERMAN, Connecticut
ROBERT F. BENNETT, Utah              DANIEL K. AKAKA, Hawaii
                                     BYRON L. DORGAN, North Dakota
   Leonard Weiss, Staff Director
 Franklin G. Polk, Minority Staff 
    Director and Chief Counsel
  Michal Sue Prosser, Chief Clerk

                                 ______

                PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

    SAM NUNN, Georgia, Chairman
  JOHN GLENN, Ohio, Vice Chairman
WILLIAM V. ROTH, Jr., Delaware       CARL LEVIN, Michigan
TED STEVENS, Alaska                  JIM SASSER, Tennessee
WILLIAM S. COHEN, Maine              DAVID PRYOR, Arkansas
THAD COCHRAN, Mississippi            JOSEPH I. LIEBERMAN, Connecticut
JOHN McCAIN, Arizona                 BYRON L. DORGAN, North Dakota
ROBERT F. BENNETT, Utah
   Eleanore Hill, Chief Counsel
Daniel F. Rinzel, Chief Counsel to 
           the Minority
  Mary D. Robertson, Chief Clerk


                            C O N T E N T S

                               __________
                                                                   Page

 I. INTRODUCTION......................................................1

II. THE BLUE CROSS/BLUE SHIELD SYSTEM.................................3

    A. GHistory of the Plans.....................................     3
    B. GUnique Status of Blue Cross/Blue Shield Plans............     3
    C. GThe Blue Cross and Blue Shield Association...............     4
    D. GAssociation Structure....................................     4
    E. GFinancial Information....................................     5
    F. Oversight of Member Plans.................................     5

III.FINDINGS..........................................................6


    THE WEST VIRGINIA, MARYLAND,DISTRICT OF COLUMBIA, & EMPIRE PLANS..6

    A. GMismanagement............................................     6
    B. GInadequate Oversight by the Boards of Directors..........     7
    C. GInadequate Regulation by State Insurance Departments.....     8
    D. GInadequate Oversight by the Blue Cross/Blue Shield 
      Association................................................     8

    FEDERAL CONTRACTS.................................................9

    A. GMismanagement............................................     9
    B. GInadequate Regulation....................................    10
    C. GInadequate Oversight by the Blue Cross/Blue Shield 
      Association................................................    10

IV. CONCLUSIONS......................................................10

 V. RECOMMENDATIONS..................................................11

VI. APPENDIX: CASE STUDIES...........................................18

    THE WEST VIRGINIA PLAN...........................................18

    A. GBackground/Organization..................................    18
    B. GFinancial Profile........................................    18
    C. GProblem Areas............................................    18
    D. GEffects..................................................    28

    THE MARYLAND PLAN................................................29

    A. GBackground/Organization..................................    29
    B. GFinancial Profile........................................    29
    C. GProblem Areas............................................    30
    D. GEffects..................................................    43

    THE NATIONAL CAPITAL AREA PLAN...................................45

    A. GBackground/Organization..................................    45
    B. GFinancial Profile........................................    45
    C. GProblem Areas............................................    46

    THE EMPIRE PLAN..................................................57

    A. GBackground/Organization..................................    57
    B. GFinancial Profile........................................    57
    C. GProblem Areas............................................    58
    D. GEffects..................................................    70

    FEDERAL CONTRACTS................................................72

    A. GBackground/Organization..................................    72
    B. GFinancial Profile........................................    73
    C. GProblem Areas............................................    74
                                                                       
104th Congress                                                   Report
                                 SENATE

 1st Session                                                     104-92
_______________________________________________________________________


  FOURTH INTERIM REPORT ON UNITED STATES GOVERNMENT EFFORTS TO COMBAT 
FRAUD AND ABUSE IN THE INSURANCE INDUSTRY: PROBLEMS IN BLUE CROSS/BLUE 
SHIELD PLANS IN WEST VIRGINIA, MARYLAND, WASHINGTON, DC, NEW YORK, AND 
                           FEDERAL CONTRACTS

                                _______
                                

                  June 5, 1995.--Ordered to be printed

_______________________________________________________________________


  Mr. Roth, from the Committee on Governmental Affairs, submitted the 
                               following

                              R E P O R T

                            I. INTRODUCTION

    For the past several years, the Senate Permanent 
Subcommittee on Investigations has been examining fraud, abuse, 
and inadequate regulation in the insurance industry. During 
this investigation, a number of regulators described problems 
they had encountered in trying to regulate and oversee the 
operations of Blue Cross/Blue Shield Plans in their states. 
Many of them noted that they spent a disproportionately greater 
amount of time regulating their ``not-for-profit Blues'' than 
they did on any ``for-profit'' insurance companies. Other 
regulators said that they knew little about their Blue Cross/
Blue Shield Plans, and that when they attempted to find out 
more about their operations, they were either denied access or 
were otherwise barred by their own State law from requiring 
full disclosure. Some regulators expressed concern that the 
philosophy guiding many of these Plans had changed from that of 
a non-profit organization primarily concerned with the 
subscribers' interests to that of a large corporation out to 
maximize short-term profits.
    In October, 1990, for the first time in the history of the 
Blue Cross/Blue Shield System one of its members--the West 
Virginia Plan--was declared insolvent and was seized by the 
West Virginia Insurance Department, leaving more than 51,000 
individuals with unpaid claims and thousands more with reduced 
or non-existent coverage. In the aftermath of this Plan's 
failure, press reports raised serious questions about its 
management and the regulatory oversight of its operations.
    In 1991, the National Association of Insurance 
Commissioners (NAIC) formed a Special Committee on Blue Cross 
Plans.\1\ The Special Committee's charge was to ``identify 
solvency issues related to Blues organizations, and review 
current regulatory oversight of these issues.'' This was the 
first time the NAIC had deemed it necessary to form such a 
committee on the Blue Cross/Blue Shield Plans.
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    \1\ The NAIC consists of the heads of the insurance departments of 
each of the 50 States, the District of Columbia and the four U.S. 
territories. For the last 120 years it has served as the primary 
vehicle for coordinating insurance regulatory activities and as a 
catalyst for developing a national program of insurance regulation.
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    Set against a backdrop of spiraling health care costs and 
growing public debate over the future of the American health 
care system, these concerns prompted then Subcommittee Chairman 
Sam Nunn to launch a specific inquiry regarding the nation's 
Blue Cross/Blue Shield Plans. This inquiry focused on 
allegations of mismanagement and misconduct on the part of 
several of these Plans and the ability of state insurance 
regulators to oversee their operations, as well as those of the 
other Plans in the Blue Cross/Blue Shield system. It led to a 
series of hearings, the first of which took place on July 2, 
1992, examining the Blue Cross/Blue Shield Plans of West 
Virginia, Maryland, the District of Columbia, and New York 
(Empire) and Blues contracts with the Federal government.
    At the July hearing, then Chairman Nunn noted that when the 
Senate last undertook a comprehensive review of the Blue Cross/
Blue Shield system in the early 1970s,\2\ it found evidence of 
mismanagement, excessive billings, exorbitant salaries and 
perks for Plan officials, as well as conflicts of interest and 
fraud. Then Chairman Nunn described the framework for the 
Subcommittee's subsequent efforts in its updated examination of 
the Blues, including the following issues:
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    \2\ The Senate Judiciary Committee, Subcommittee on Antitrust and 
Monopolies, Chaired by Senator Philip Hart.

        --Lthe financial integrity of the Blue Cross/Blue 
        Shield Plans;
        --Lthe role of the Blue Cross/Blue Shield Association 
        in ensuring that its member Plans are financially sound 
        and well managed;
        --Lthe propriety of not-for-profit Blue Cross/Blue 
        Shield Plans creating and operating ``for-profit'' 
        subsidiaries, and the impact these subsidiaries or 
        affiliates may have on the former's financial integrity 
        and stability;
        --Lthe effectiveness of State regulators in overseeing 
        their domiciled Blue Cross/Blue Shield Plans and their 
        subsidiaries and affiliates;
        --Lthe Plans' management style and philosophy, and 
        whether these have become inimical to effective State 
        regulation;
        --Lthe propriety of salaries and fringe benefits 
        received by Plans' officers and directors; and,
        --Lthe role of the Federal government in monitoring and 
        supervising the Federal employee programs administered 
        by the various Blue Cross/Blue Shield Plans.

    This investigation was conducted by the Subcommittee's 
Majority Staff at the direction of then Chairman Nunn, with the 
concurrence and support of then Ranking Minority Member, 
Senator William V. Roth, Jr. It was authorized pursuant to 
Senate Resolution 62, adopted February 28, 1991, and Senate 
Resolution 71, adopted February 25, 1993, which empower the 
Subcommittee to investigate ``all other aspects of crime and 
lawlessness within the United States which have an impact upon 
or affect the national health, welfare, and safety; including 
but not limited to investment fraud schemes, commodity and 
security fraud, computer fraud, and the use of offshore banking 
and corporate facilities to carry out criminal objectives.''

                 II. THE BLUE CROSS/BLUE SHIELD SYSTEM

                        A. History of the Plans

    The Blue Cross/Blue Shield organization is the largest and 
oldest provider of prepaid health care coverage in the nation. 
It is a nationwide federation of individual corporations, or 
Plans, each of which serves its community as a non-profit 
organization. Each Plan is a member of the national Blue Cross 
and Blue Shield Association, which serves as a coordinating 
agency for the Plans.
    Blue Cross and Blue Shield were originally two separate 
organizations. Blue Cross Plans were founded primarily to cover 
hospital expenses, though over time they have expanded into 
other areas, such as outpatient and home care. Blue Shield 
Plans were established primarily to cover physicians' services, 
though over time they also have expanded into other areas, such 
as dental, vision, and outpatient coverage. The Blue Cross 
Association and the Blue Shield Association began operating 
under one president in 1978 and merged into a joint corporation 
in 1982. Today, Blue Cross and Blue Shield Plans either 
cooperate closely, are joint corporations, or are separate 
entities whose benefits may overlap. At the end of 1991, the 
system's 73 Plans totaled approximately 94.3 million 
subscribers. Of these, 68.1 million were private subscribers 
(26.5 percent of the market share), and 33 million were 
Government subscribers.\3\
---------------------------------------------------------------------------
    \3\ About 6.8 million subscribers--Medicare recipients with 
supplemental Blue Cross/Blue Shield coverage--are counted as both 
Government and private subscribers.
---------------------------------------------------------------------------

            B. Unique Status of Blue Cross/Blue Shield Plans

    Ever since their establishment in the 1930s, Blue Cross/
Blue Shield Plans have been organized and regulated pursuant to 
special statutes in their various states of domicile. This 
special status is based on a number of considerations, 
including their: not-for-profit nature; \4\ presumed commitment 
to providing health care coverage at the lowest possible cost 
to the largest possible population; and, in some states, status 
as the health insurer of last resort. Unlike their for-profit 
counterparts, Blue Cross/Blue Shield Plans are looked on as 
having an intrinsic fiduciary responsibility to protect the 
interests of their subscribers. In line with their special role 
and responsibilities, Blue Cross/Blue Shield Plans are often 
accorded significant advantages not available to commercial 
insurers, such as being exempt from certain tax and other 
regulatory requirements.
---------------------------------------------------------------------------
    \4\ In recognition of changing market conditions and the special 
need to access capital markets, the Blue Cross/Blue Shield 
Association's Board of Directors has recently authorized Member Plans 
to change their organizational form to ``for-profit.''
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             C. The Blue Cross and Blue Shield Association

    The Blue Cross and Blue Shield Association (the Association 
or BCBSA) is a trade association and as such is neither the 
parent of the individual Plans nor a guarantor of their debts 
or other contractual and financial obligations. According to 
its articles of incorporation, the Association's purposes are 
to:

        --Lpromote the betterment of public health and 
        security, and to secure wide public acceptance of the 
        principle of voluntary, non-profit prepayment of health 
        service;
        --Lprotect the Blue Cross and Blue Shield service 
        marks;
        --Ldevelop and maintain the Association's membership 
        standards;
        --Lcooperate with federal, state, and local governments 
        for the provision of health services to the needy and 
        aged;
        --Lestablish and maintain support and other services to 
        Members through the exercise of authority delegated by 
        the Members; and,
        --Lconduct its affairs, to have offices within and 
        without the State of Illinois, and to exercise the 
        powers granted by the General Not-For-Profit 
        Corporation Act of the State of Illinois.

    A significant Association activity is to coordinate health 
care coverage for national employers with offices in more than 
one region of the country including, for example, the Federal 
Employee Health Benefits Program (FEHBP). Under that program, 
Blue Cross/Blue Shield Plans insure 3.5 of the 9 million 
participating Federal workers, retirees, and their families 
throughout the country. In addition, the Association is the 
prime contractor for the Blue Cross/Blue Shield organization's 
administration of Medicare (Part A). Under this program, the 
Association contracts with member Plans to perform a wide range 
of functions, such as claims processing, audits, utilization 
reviews, and other administrative tasks.

                        D. Association Structure

    The Association is governed by a Board of Directors, which 
consists for the most part of the Plan CEOs. The Board holds at 
least four regular meetings each year, in addition to any 
special meetings that may be called. Between meetings, its 
authority is vested in a 26-member Executive Committee. The 
Executive Committee Chairman also serves as the Chairman of the 
Board of Directors. Another Executive Committee member is the 
President of the Association, while the remaining 24 represent 
the 12 districts into which the member Plans are divided.

                        E. Financial Information

    In 1990, the Association reported systemwide total assets 
of $118,857,345, liabilities of $106,054,671, and equity of 
$12,811,674. In the same year, it reported total revenues of 
$109,129,527 and total expenses of $106,866,512. In terms of 
systemwide revenues, the Association maintains it is the same 
size as the fifth ranked corporation on the list of Fortune 500 
companies.
    Based on aggregated data derived from member Plan balance 
sheets, the Association reported total Plan assets of $30.1 
billion and reserves of $9.8 billion as of December 31, 1991. 
It should be noted, however, that the financial strength of any 
individual Plan relies not on these total figures but, rather, 
on the strength of its own assets and reserves.

                      F. Oversight of Member Plans

    At the outset of the Subcommittee's investigation, all 
Plans had to adhere to seven membership standards as a 
condition of membership.\5\ However, partly in response to the 
Subcommittee's investigation, as of June 1993 these standards 
had been revised and/or expanded to: clarify Plan Boards' 
oversight responsibilities; inform state regulators about Plan 
subsidiaries' activities; assure that subscribers' claims are 
paid and their coverage continued in the event of a Plan 
insolvency (effective December 31, 1994); inform the public on 
Plans' financial condition; and, assure that Plans are able to 
meet their inter-Plan program financial obligations.
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    \5\ These standards provided that Plans: be organized and operated 
on a non-profit basis; have a Board not controlled by any special 
interest group and which is comprised of a majority of persons other 
than health care providers; furnish reports and records to the 
Association to indicate compliance with these standards; maintain 
adequate financial resources to protect customers and meet long-term 
business obligations; use their best efforts to contract with cost-
effective health care providers; operate in a manner responsive to 
customer needs; and participate in each national program adopted by the 
Association.
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    These standards apply to all regular member Plans and 
membership renewal is contingent upon their compliance with 
them. Based on the degree of compliance with the standards, the 
Association has a range of options it can pursue.\6\ It can 
monitor Plans experiencing financial and/or operational 
difficulties, using authority it has to require records and 
other relevant data to be submitted. In the event that a Plan 
fails or is expected to fail to meet one or more of the 
membership standards, the Association can contact the Plan's 
Board or the concerned state insurance regulators to seek their 
input in this regard. If these efforts prove unsuccessful, the 
Association can seek judicial enforcement of the license 
agreement or, with a majority vote of the membership, move to 
terminate the Plan's license.
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    \6\ At the outset of the Subcommittee's investigation, Plans were 
subject to a somewhat different regime: they could be in substantial 
compliance with all seven membership standards; they could receive 
comments on specific issues where they were not in full compliance; 
they could fail to be in substantial compliance with any one membership 
standard, which would prompt their being placed on conditional status 
(being required to develop a rehabilitation plan and being subject to 
continuous monitoring by the Association); and, in the event that they 
failed to meet the membership standards, failed to meet terms agreed 
upon pursuant to conditional membership status, or failed to apply for 
renewal, their membership could be subject to non-renewal.
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                             III. FINDINGS

    The Subcommittee's examination of the West Virginia, 
Maryland, District of Columbia, and New York (Empire) Plans, 
and Blue Cross/Blue Shield's Federal employee and Medicare 
contracts, has revealed a pattern of gross mismanagement, 
ineffective oversight, and regulatory failings strikingly 
similar to that uncovered by the Senate Judiciary Committee in 
its investigation of the Blues more than twenty years ago. With 
the exception of the Federal contracts, these problems caused 
severe financial impairment in all of the Plans examined and, 
in the case of the West Virginia Plan, helped to bring about 
its demise.\7\ These problems also adversely impacted the 
Plans' ability to fulfill their responsibilities to 
policyholders, providers, and other health care industry 
interests. In the case of the Federal employee and Medicare 
contracts, these problems resulted in wasted taxpayers' 
dollars, unnecessary costs to the Federal government, and 
questionable charges and poor service to subscribers.
---------------------------------------------------------------------------
    \7\ While this investigation focused on the West Virginia, 
Maryland, District of Columbia, and Empire Plans, the Subcommittee also 
received information on other Blue Cross/Blue Shield Plans that have 
experienced some of the same problems discussed herein. For example, 
according to an April, 1994 GAO report, Blue Cross and Blue Shield: 
Experiences of Weak Plans Underscore the Role of Effective State 
Oversight (GAO/HEHS-94-71), Plans in Vermont, New Hampshire, Maine, 
Massachusetts, New Jersey, New York, and West Virginia (Mountain State, 
successor to the failed West Virginia Plan) have experienced such 
problems. In addition, the Subcommittee notes that the Colorado Plan's 
CEO was recently removed for misconduct and that the former CEO of the 
Louisiana/Mississippi Plan pled guilty in Federal Court to charges of 
having bribed the State Insurance Commissioner in an attempt to quash 
an audit critical of the Plan.
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   THE WEST VIRGINIA, MARYLAND, DISTRICT OF COLUMBIA, & EMPIRE PLANS

                            A. Mismanagement

    1. The Plans' CEOs created corporate cultures inimical to 
Blue Cross/Blue Shield's historical mission and non-profit 
status. These executives operated their Plans in an 
irresponsible and unsafe manner that ill befitted their status 
as non-profit health insurers whose primary mission was to 
provide affordable, quality health care to their policyholders 
and, in some cases, serve as the health insurer of last resort.
    2. Top managers failed to operate their Plans in accordance 
with their fiduciary responsibilities to the policyholders by 
making unsound business decisions and, in at least two 
instances (Empire and West Virginia), engaging in highly 
questionable, if not improper, conduct. The Subcommittee found 
that these managers at times acted for their own self-interest 
and/or enrichment and, in three of the four Plans examined, set 
up for-profit subsidiaries that had little to do with the 
Blues' primary mission and ended up losing hundreds of millions 
of dollars.
    3. The Plan CEOs and their management teams generally 
succeeded in resisting and/or evading duly constituted 
authorities--State Insurance Departments, Plan Boards of 
Directors, and the Blue Cross/Blue Shield Association--in the 
exercise of their oversight/regulatory functions.
    4. Top Plan managers abused their positions by obtaining 
exorbitant salaries and other fringe benefits and by incurring 
millions of dollars in unnecessary and/or unjustified travel 
and entertainment expenses, at a time when their Plans were in 
dire financial straits and subscriber premiums were being 
increased dramatically.
    5. All the Plans examined had extensive and recurring 
accounting, financial reporting and/or internal control 
deficiencies, which significantly impaired their operations and 
financial integrity. In the Maryland and Empire Plans, these 
deficiencies helped create circumstances that enabled major 
frauds to be perpetrated against them, resulting in tens of 
millions of dollars in losses.
    6. All the Plans examined had serious problems in their 
underwriting policies and practices, resulting in tens of 
millions of dollars in losses. In large part, these problems 
were caused by management decisions to systematically 
underprice their lines of business in order to gain market 
share.
    7. The Plans' problems had serious consequences for 
policyholders, providers, and other health care industry 
interests. The lives of thousands of West Virginia Plan 
policyholders and providers were thrown into turmoil as a 
result of its failure. In the Empire, Maryland and District of 
Columbia Plans, policyholders experienced poor service, a 
diminution in and/or loss of coverage, and dramatically 
increased premiums, while providers encountered ever-increasing 
problems in obtaining reimbursement for services rendered.

           B. Inadequate Oversight by the Boards of Directors

    8. The Plans' Boards of Directors failed to perform their 
requisite oversight functions, ignoring their responsibility to 
the policyholders whose interests they were charged with 
protecting. The Subcommittee found that:

          a. management was able to gain effective control of 
        Boards by circumventing and/or altering rules regarding 
        the process by which members were selected. As a 
        result, over time Boards tended to become unquestioning 
        ``rubberstamps'' for management decisions.
          b. many Board members failed to understand Plan 
        policies and procedures, were ignorant of the serious 
        problems and/or abuses occurring within the Plans, and 
        were easily manipulated and misled by management. This 
        was particularly evident in the case of the Maryland 
        and Empire Plans, where the CEOs used their dual roles 
        as Board Chairmen to control the information made 
        available to Board members.
          c. many Board members failed to understand their 
        fiduciary obligation to protect the policyholders' 
        interests and their responsibility to oversee 
        management's actions. Indeed, the West Virginia Plan's 
        Board Chairman was involved in an incident that 
        constituted a conflict of interest with his Board 
        responsibilities, and he also served as Board Chairman 
        for a number of the Plan's for-profit subsidiaries that 
        were designed for his benefit and that of other Plan 
        officials and Board members.

        C. Inadequate Regulation by State Insurance Departments

    9. State Insurance regulators were hesitant, reluctant, and 
even afraid to take decisive action against a Plan for fear of 
the effect such action might have on the large number of 
policyholders involved. In effect, the Plans examined became 
too-big-to-fail and/or to be effectively regulated, as 
reflected in the following:

          a. regulators overseeing the Plans examined often 
        accorded them special treatment and made forebearances 
        for them. The Subcommittee found instances where assets 
        of questionable value were allowed to be counted toward 
        meeting statutory reserve or other important reporting 
        requirements; official decisions were reversed when 
        such action accrued to a Plan's benefit; premium 
        increases were readily granted; and, Plans were allowed 
        to ignore regulations, directives, and remedial 
        recommendations with impunity.
          b. regulators in some cases ignored or failed to 
        fully utilize examination results and other information 
        available to them, which described the Plans' problems 
        and set forth specific recommendations for further 
        action.
          c. regulators in the concerned States failed to use 
        available means to enforce their authority over the 
        Plans.
          d. regulators in the concerned States were often 
        unaware of or not fully informed about significant Plan 
        activities, such as the establishment of for-profit 
        subsidiaries and the major problems they subsequently 
        caused.
          e. regulators in some cases were subject to political 
        pressure exerted on behalf of the Plans, which 
        undermined and/or negated oversight and enforcement 
        efforts.
          f. regulators in the concerned States were hampered 
        in their oversight efforts by inadequate staff, 
        resources, and/or statutory authority, and the Plans' 
        ability to evade and resist such efforts.

    10. As a result of a Federal statutory exemption from 
District of Columbia insurance regulation, oversight of the 
D.C. Plan rested on limited efforts by Maryland and Virginia 
regulators to oversee that portion of the Plan's business 
underwritten in their jurisdictions.

   D. Inadequate Oversight by the Blue Cross/Blue Shield Association

    11. While being aware of these Plans' serious problems, the 
Blue Cross/Blue Shield Association failed to act decisively to 
correct those problems. For example, the Association failed to 
enforce its membership standards, even after long-term 
monitoring had shown that a Plan was not meeting specified 
reserve and liquidity requirements.
    12. Association officials were extremely reluctant to act 
against the Plans, fearing that their only effective means of 
enforcement--i.e., the ``ultimate weapon'' of revoking the Blue 
Cross/Blue Shield trademarks--would seriously injure the image 
of the Blue Cross/Blue Shield system and leave them with the 
difficult task of having to find substitute coverage for the 
affected policyholders.
    13. The Association failed to systematically share in a 
timely manner the important information it had concerning the 
Maryland, District of Columbia, and Empire Plans' problems with 
the appropriate State insurance authorities and Plan Boards, 
even after the West Virginia Plan had failed and the other 
Plans had become seriously impaired.

                           FEDERAL CONTRACTS

                            A. Mismanagement

    14. Blue Cross/Blue Shield's mishandling of its Federal 
contract responsibilities has resulted in millions of dollars 
in unnecessary, wasteful, and/or questionable costs incurred by 
the Federal government and, in some instances, subscribers.
          a. excessive layers of bureaucracy involved in the 
        Federal Employee Program (FEP) contract--i.e., the Blue 
        Cross/Blue Shield Association, the FEP Director's 
        Office, the FEP Operations Center, and the 67 
        participating Plans--have added unnecessarily to the 
        Federal government's FEP program costs.
          b. Blue Cross/Blue Shield Plans participating as FEP 
        and Medicare contractors have billed the Federal 
        Government for tens of millions of dollars in charges 
        that have been questioned and/or disallowed. In the 
        FEP, since 1988 the Office of Personnel Management, 
        Office of Inspector General (OPM/OIG), has questioned 
        more than $78 million in contract charges and 
        disallowed $51.6 million (66%) of that amount. Since 
        1992, the Department of Health and Human Services, 
        Office of Inspector General (HHS/OIG) has recommended 
        disallowing more than $40 million for improper charges 
        by Blues Medicare contractors.
          c. Blue Cross/Blue Shield Plans have withheld 
        millions of dollars in hospital and provider discounts 
        from the Federal government and some FEP subscribers. 
        In the case of the subscribers, this has resulted in 
        higher and unfair out-of-pocket expenses.
          d. reflecting the same irresponsible management 
        outlook and disregard for cost-containment uncovered in 
        the West Virginia, Maryland, District of Columbia, and 
        New York (Empire) Plans, the Blue Cross/Blue Shield 
        Association has billed the Federal Government for 
        millions of dollars in questionable and/or unnecessary 
        charges for FEP conferences and meetings, promotional 
        items, and executive compensation.

    15. Poor performance on the part of some Blue Cross/Blue 
Shield Medicare contractors has resulted in their being placed 
on a ``watch list'' and/or being terminated by the Health Care 
Financing Administration (HCFA). Eight of the 41 Blue Cross/
Blue Shield Plans participating as Part A intermediaries in 
1993 were on the watch list and one of these was scheduled to 
be terminated at the end of the 1994 contract year. Seven of 
the 27 Blue Cross/Blue Shield Plans participating as Part B 
carriers were on the watch list in that same year and another 
three will not be renewed at the end of the 1994 contract year.
    16. Extensive and recurring internal control weaknesses 
among Blue Cross/Blue Shield Plans involved in the FEP have 
resulted in duplicate payments, coordination of benefits 
problems, and discrepancies in enrollment data that have caused 
erroneous premiums to be collected and benefits to be paid. 
These internal control deficiencies constitute an invitation to 
fraud, particularly since anti-fraud efforts have generally 
received minimal attention from the Blue Cross/Blue Shield 
Association and the individual Plans.

                        B. Inadequate Regulation

    17. Regulation by OPM and HCFA, the agencies responsible 
for overseeing the Blue Cross/Blue Shield contracts with the 
FEHBP and Medicare, has been marked by many of the same 
inadequacies that the Subcommittee found in connection with the 
West Virginia, Maryland, District of Columbia, and New York 
(Empire) Plans, including:

          a. uncooperative attitudes and evasive tactics on the 
        part of the Blue Cross/Blue Shield Association and the 
        individual participating Plans;
          b. a tendency by regulators to treat the Blues in an 
        unquestioning and deferential manner, owing to their 
        size and market share,--i.e., the ``too-big-to-
        regulate'' dilemma; and,
          c. a serious lack of regulatory resources; resulting, 
        for example, in an inability to audit the participating 
        Plans on a timely basis.

   C. Inadequate Oversight by the Blue Cross/Blue Shield Association

    18. The Association's performance regarding its Federal 
contract responsibilities exhibited most of the same 
shortcomings identified in its failed oversight of the West 
Virginia, Maryland, District of Columbia, and New York (Empire) 
Plans. For example, OPM officials indicated that a lack of 
guidance and oversight by the FEP Director's Office is the 
biggest problem in FEP operations and subscriber service. In 
the Medicare program, the Association does not monitor the 
performance of Blue Cross/Blue Shield contractors and is thus 
largely unaware of any problems they may be having in carrying 
out their functions.

                            IV. CONCLUSIONS

A. Gross Mismanagement, Ineffective Regulation/Oversight Raise Concerns 
              About Blues' Ability to Serve Basic Purpose

    Based on its investigation, the Subcommittee is concerned 
about the ability of Blue Cross/Blue Shield Plans to continue 
to serve their basic purpose of providing quality health care 
coverage at an affordable price. In the cases we examined, the 
accountability triad of oversight by Plan Boards of Directors 
and the Blue Cross/Blue Shield Association, and regulation by 
State insurance authorities (and OPM and HHS in the case of the 
Federal contracts) did not ensure that the Plans performed 
efficiently and effectively. Plan executives were able to 
operate in a grossly inept and unsound manner, while 
deliberately blocking and evading the efforts of those charged 
with regulating and overseeing their activities. The evidence 
also highlighted the inability and/or unwillingness of 
regulators, Plan Boards, and the Blue Cross/Blue Shield 
Association to effectively carry out their responsibilities 
regarding the Plans and their policyholders.
    Accordingly, the Subcommittee believes that major 
improvements are needed across-the-board in response to the 
problems uncovered by its investigation. The management of Blue 
Cross/Blue Shield Plans has to be improved substantially and 
Plan operations have to be carried out in accordance with the 
Blues' mission. In addition, State insurance authorities (and 
OPM and HHS in the case of the Federal contracts), Plan Boards, 
and the Blue Cross/Blue Shield Association have to 
substantially improve their regulation and/or oversight of Plan 
management and operations. The Subcommittee notes that should 
States fail to improve their regulatory performance regarding 
the Blues, this may prompt the need to consider a Federal role 
beyond the narrow one maintained in terms of the FEHBP and 
Medicare contracts.

                 B. Implications for Health Care Reform

    The Subcommittee also believes that the serious problems 
revealed regarding the Blues Plans examined and those charged 
with their regulation and oversight may have implications for 
the current debate on health care reform. Specifically, the 
Subcommittee is concerned about the role Blue Cross/Blue Shield 
Plans can and/or should play in any new or substantial revision 
of the existing health care delivery system. They must correct 
their operational problems, lack of accountability, and 
inadequate performance in containing costs, to function 
effectively as part of a revised health care delivery system. 
Similarly, in considering the idea of a significant Blues role 
in a reformed health care delivery system, the Subcommittee 
notes that there is sufficient reason to question the ability 
of State insurance authorities, Plan Boards, and the Blue 
Cross/Blue Shield Association to effectively carry out whatever 
regulatory and/or oversight responsibilities they may be given 
in this regard. Indeed, one of the key dilemmas facing those 
concerned with health care reform is how to resolve the 
apparent problem posed by any potential role the Blues might 
play in our health care system and the Subcommittee's findings 
that the existing mix of State regulation and Association/Plan 
Boards oversight are inadequate. The essential question 
remains, if these entities cannot be counted on to do the job, 
to whom will these essential functions be assigned?

                           V. RECOMMENDATIONS

    In setting forth its recommendations,\8\ the Subcommittee 
intends that they serve the dual purpose of providing a 
blueprint for correcting the serious problems it has identified 
in the Blue Cross/Blue Shield system, while at the same time 
constituting an important reference point for the health care 
reform debate. The pivotal issues raised in this Blue Cross/
Blue Shield investigation--i.e., corporate performance and 
accountability, cost containment and protecting policyholders' 
interests, and regulatory capability--are clearly among those 
that will have to be addressed effectively for any proposed 
health care reform effort to succeed.
---------------------------------------------------------------------------
    \8\ The Subcommittee notes that in response to its investigation, 
remedial actions reflecting the findings and conclusions are under 
consideration and/or have already been instituted by the Maryland 
legislature and Insurance Division, the District of Columbia 
Superintendent of Insurance, the New York Insurance Department, the 
National Association of Insurance Commissioners (NAIC) and the Blue 
Cross/Blue Shield Association.
---------------------------------------------------------------------------
    With these thoughts in mind, the Subcommittee makes the 
following recommendations:

                 A. Plan Performance and Accountability

            1. eliminate management deficiencies and abuses

    The Subcommittee received overwhelming evidence showing 
that the problems--mismanagement, exorbitant salaries, wasteful 
travel and entertainment expenses, internal control 
deficiencies, and faulty underwriting--experienced by the Plans 
examined were a reflection of a corporate culture and 
operational approach that were inconsistent with Blue Cross/
Blue Shield Plans' non-profit status and special responsibility 
to their policyholders. Indeed, the Blue Cross/Blue Shield 
Association has already responded to some of the Subcommittee's 
findings in this regard by providing for its assessments of 
Plan performance to be communicated directly to the Boards 
rather than through Plan CEOs, and by requiring that the Boards 
adopt a code of conduct that shows that they are committed to 
the highest level of business ethics.
    While these measures are clearly steps in the right 
direction, the Subcommittee believes that additional remedial 
actions are needed and recommends that the Association:

        --Lestablish cost containment guidelines and develop 
        related incentives to assure compliance;
        --Ldevelop minimum standards regarding accounting and 
        internal control procedures and require that Plans 
        comply with them;
        --Lrequire that compensation packages, i.e., salaries, 
        bonuses, and other benefits for corporate officers and 
        senior managers be a matter of public record;
        --Lestablish guidelines to curtail waste and abuse in 
        travel and entertainment expenses;
        --Ldevelop a policy regarding compensation of Board 
        members that helps to assure their independence;
        --Lprohibit a Plan CEO from also serving at the same 
        time as Board Chairman;
        --Lrequire Plans to develop and implement detailed 
        programs to deter and detect fraud; and,
        --Lclosely monitor the performance of the Blue Cross/
        Blue Shield Plans participating in the FEP and 
        Medicare.

    In addition, in light of the mismanagement and extensive 
operational problems found in the Plans examined, and the Blues 
preeminent position in the health insurance industry, the 
Subcommittee is concerned that such problems may also exist 
among other health insurers. These concerns reflect testimony 
by Blue Cross/Blue Shield officials in which they attempted to 
justify questionable entertainment, travel, and marketing 
expenses by asserting that they were necessary in order to 
remain competitive and that others in their industry were doing 
the same thing. The Subcommittee believes that the possibility 
that such practices--and the underlying corporate culture that 
aids and abets them--may be more widespread needs to be 
examined, both in terms of their immediate effects and longer 
term health care reform implications. Such an undertaking 
should involve, but not necessarily be limited to, state 
insurance regulators, the NAIC, Congress, and concerned 
Executive Branch agencies.

                      2. plans must be accountable

    As non-profit corporations, the Plans of the Blue Cross/
Blue Shield system have no shareholders to whom they must 
answer and are not fully subject to the rigors of marketplace 
competition. In the cases examined by the Subcommittee, the 
Boards of Directors charged with holding Plan officials 
accountable failed to fulfill their responsibilities in this 
regard. While State insurance regulators are supposed to serve 
as the ultimate authority to whom an insurer must answer, the 
testimony presented demonstrated that they too failed to carry 
out their responsibilities.
    In light of these findings, the Subcommittee believes that 
the critically important question--to whom are Blue Cross/Blue 
Shield Plans accountable--needs to be examined, both in terms 
of correcting the problems revealed by this investigation and 
in the wider context of the current debate on health care 
reform. Every effort must be made to improve the performance of 
Boards of Directors and State insurance regulators in holding 
Plan officials accountable and protecting the policyholders' 
interests. For example, consideration should be given to 
mandating the establishment of voluntary subscriber watchdog 
groups, to monitor Plan performance and represent subscribers' 
interests before Plan Boards of Directors, State legislatures 
and regulatory bodies, and other relevant entities.\9\
---------------------------------------------------------------------------
    \9\ Similar consumer advocacy organizations were established in the 
late 1970s and early 1980s to represent the interests of utility 
ratepayers. These advocacy organizations, known as ``Citizens' Utility 
Boards'' (CUB), currently exist in states such as Wisconsin, 
California, Illinois, and Oregon.
---------------------------------------------------------------------------
    The Subcommittee also notes that the NAIC has recently 
formed a Special Committee to look at issues relating to the 
Blue Cross/Blue Shield Plans, and thus strongly recommends that 
the question of accountability be placed high on its agenda. In 
considering health care reform, this question of accountability 
must be carefully addressed by the President, Congress, as well 
as other interested parties.

                        3. insolvency safeguards

    The disastrous effects of the West Virginia Plan's 
failure--in unpaid claims and diminution in and/or loss of 
coverage--emphasized the need for measures to provide added 
protection for other Blue Cross/Blue Shield Plan subscribers in 
the event of an insolvency. At the time of our investigation, 
only 25 of the more than 70 Blue Cross/Blue Shield Plans were 
participating in state guaranty funds. The Subcommittee notes 
that the Blue Cross/Blue Shield Association has moved to 
require its member Plans to either participate in a state 
guaranty fund or institute some other acceptable type of 
financial safeguard (e.g. creating a special reserve). In 
addition, the National Association of Insurance Commissioners 
(NAIC) is presently considering whether and how Blue Cross/Blue 
Shield Plans can and/or should be integrated into state 
guaranty fund systems.
    While the Subcommittee is encouraged by the Association's 
action in this regard, we believe that State regulatory 
authorities also need to be involved to assure that concrete 
action to protect policyholders is undertaken as quickly as 
possible. Accordingly, we recommend that the NAIC expedite its 
efforts along these lines and that, in addition to these 
efforts, individual State legislatures and insurance 
departments act to ensure that Blue Cross/Blue Shield Plan 
policyholders in their jurisdictions are afforded protection 
against an insolvency.

                     4. uniform solvency standards

    A number of witnesses discussed the absence of uniform 
solvency standards and financial reporting requirements 
regarding the Plans of the Blue Cross/Blue Shield system. For 
example, the District of Columbia Superintendent of Insurance 
indicated that the dramatically different solvency standards in 
effect in the District, Maryland, and Virginia were not in the 
policyholders' best interests. The clear implication is that 
while the D.C. Plan might reach a stage where it would be 
considered insolvent in one State, it could theoretically still 
continue to operate in another State whose solvency 
requirements it had not violated.
    The Subcommittee recommends that the NAIC and Blue Cross/
Blue Shield Association, jointly or separately, develop 
specific solvency standards, financial reporting requirements, 
and other additional measures as needed, to apply uniformly to 
all Plans. The Subcommittee notes that both the NAIC and 
Association have already begun to consider such questions and 
urges them to make this effort a high priority and bring it to 
a successful conclusion as quickly as possible.
    The Subcommittee further recommends that the NAIC and State 
regulatory authorities mandate the use of Generally Accepted 
Accounting Principles (GAAP) for the reporting of financial 
information by insurers. As stated in the Subcommittee's Third 
Interim Report on efforts to combat fraud and abuse in the 
insurance industry,\10\ statutory accounting principles--the 
other accounting methodology used in the reporting of financial 
information--are too flexible to provide an accurate picture of 
an insurer's financial soundness.
---------------------------------------------------------------------------
    \10\ Third Interim Report on United States Government Efforts to 
Combat Fraud and Abuse in the Insurance Industry: Enhancing Solvency, 
Regulation and Disclosure Requirements--A Case Study of Guarantee 
Security Life Insurance Company, Senate Report 103-29, March 23, 1993. 
The other two reports issued by the Subcommittee pursuant to its 
investigation of the insurance industry are: Interim Report on 
Combatting Fraud and Abuse in Employer Sponsored Health Benefit Plans, 
Senate Report 102-262, March 12, 1992; and, Second Interim Report on 
U.S. Government Efforts to Combat Fraud and Abuse in the Insurance 
Industry: Problems with the Regulation of the Insurance and Reinsurance 
Industry, Senate Report 102-310, July 1, 1992.
---------------------------------------------------------------------------

                         5. information sharing

    The Subcommittee found that a great deal of important 
information regarding the financial problems and management 
abuses in the Plans examined was in the hands of the Blue 
Cross/Blue Shield Association and the concerned State 
regulatory authorities before the Plans became impaired. Such 
information, according to the Subcommittee staff and other 
witnesses, was not shared between or among these various 
entities, with clearly adverse effects. Without such 
information, state insurance authorities were not fully aware 
of the severity of the problems at a given Plan, nor did they 
have sufficient information upon which to make the most 
informed and timely regulatory decisions.
    In response to this situation, the Subcommittee recommends 
that:

        --Lthe Blue Cross/Blue Shield Association in a timely 
        manner share all relevant information regarding both 
        itself and the individual Plans with the appropriate 
        state and federal regulatory authorities;
        --Lstate insurance authorities improve and expand their 
        procedures to share information concerning a Plan 
        operating simultaneously in several jurisdictions, such 
        as the instant case of the D.C. Plan and its activities 
        in the District of Columbia, Maryland, and Virginia; 
        and,
        --Lagencies of the U.S. Government involved in some 
        official capacity with Blue Cross/Blue Shield Plans, 
        such as the Department of Health and Human Services and 
        the Office of Personnel Management, develop procedures 
        to make available to the appropriate state insurance 
        authorities all reports and reviews of Plan operations.

                        B. Regulation/Oversight

                6. more effective State and Federal role

    The Subcommittee received testimony conclusively showing 
that in the cases examined State insurance regulators, as well 
as OPM and HHS regarding the FEHBP and Medicare, were unable 
and/or unwilling to deal effectively with the Plans operating 
in their jurisdictions and/or areas of responsibility. The 
Subcommittee strongly believes that regulatory authorities can 
and should do more in their efforts to oversee the Plans of the 
Blue Cross/Blue Shield system and recommends that States:
        --Lprovide increased staff, training, and resources to 
        their insurance regulatory bodies;
        --Lestablish cost containment guidelines and develop 
        related incentives to encourage compliance;
        --Lrequire that the information used as the basis for 
        granting rate increases be made available to the 
        public;
        --Lutilize existing subpoena and/or investigatory 
        authority and, where none exists, seek such powers from 
        their legislatures; and,
        --Lseek enactment of statutory authority to:

                * Lprohibit the creation or alteration of 
                subsidiaries and affiliates without prior 
                written notice;
                * Lestablish specific reporting requirements 
                including, but not necessarily limited to, 
                audited financial statements for all wholly-
                owned subsidiaries or affiliates, detailed 
                consolidated financial statements, and internal 
                and external audits or studies;
                * Lexamine all books and records of affiliates 
                and subsidiaries at any time deemed necessary;
                * Lrequire that a Plan get prior written 
                approval for a sale or liquidation of any 
                significant assets;
                * Linstitute administrative fines applicable to 
                the Plan, as well as its Officers and 
                Directors, for failure to respond on a timely 
                basis to lawful orders;
                * Lremove Officers and Directors if, after due 
                process, a determination is made that members 
                of either and/or both groups have failed to 
                comply with lawful orders; and,
                * Lmake health insurance fraud a felony and 
                enhance existing criminal and civil penalties 
                for violation of relevant insurance laws and 
                regulations.

    Regarding the FEHBP and Medicare, we recommend that:

        --LCongress and the Administration consider giving both 
        OPM and HHS the authority to openly and competitively 
        bid the FEHBP and Medicare Parts A and B contracts, and 
        to contract directly with the Blue Cross/Blue Shield 
        Plans, rather than the Association, in connection with 
        the FEHBP and Medicare Part A contracts;
        --Lthe appropriate Congressional Committees review and 
        consider providing additional resources for OPM's 
        Contracting Office, the OPM Office of Inspector General 
        and HHS Office of Inspector General to enable them to 
        better perform their regulation and oversight 
        functions;
        --LOPM and HHS establish cost containment guidelines 
        and develop related incentives to encourage compliance;
        --LFederal contracts policies and procedures be revised 
        as appropriate to:

                * Lrequire Plans to collect, utilize, and 
                maintain standardized information before paying 
                claims;
                * Lallow easier termination of a contractor for 
                repeated violations of the contract or 
                regulations and for failing to: cooperate with 
                the Government in an audit or investigation; 
                promptly provide access to files and records; 
                and, resolve audit findings in an expeditious 
                and reasonable manner; and,
                * Lin the case of the FEHBP, establish a 
                centralized enrollment system.

        --LThe appropriate Committees of Congress should 
        carefully review the annual amount of individual 
        compensation health care contractors can charge the 
        Federal government in combined salary and benefits.

                  7. intermediate enforcement measures

    The Subcommittee found that State insurance regulators and 
officials of the Blue Cross/Blue Shield Association were 
severely hampered in their efforts to respond to the abuses and 
problems found in the Plans examined because they felt that the 
only enforcement tool available to them was in the form of ``an 
ultimate weapon.'' For State regulators, this meant declaring a 
Plan insolvent and placing it into receivership; for the 
Association, it meant acting to remove a Plan's Blue Cross/Blue 
Shield trademarks. The Subcommittee recommends that the 
Association, the NAIC, and/or individual State insurance 
authorities act expeditiously to develop and institute 
intermediate enforcement measures, including fines against the 
Association and/or its officers. Efforts along these lines 
might be undertaken by the NAIC and the Association jointly.

        8. federal criminal/civil sanctions for insurance fraud

    To ensure that health benefits and insurance premiums are 
adequately protected from internal fraud and abuse, Congress 
and the Administration should consider establishing Federal 
criminal and civil sanctions for the violation of fiduciary 
responsibilities within the insurance industry. The health 
insurance industry is entrusted with billions of dollars of 
subscribers premiums and, as such, has a fiduciary duty to see 
to it that those funds are not squandered or misappropriated. 
The Subcommittee believes that its Blue Cross/Blue Shield 
investigation highlights the need for such sanctions, for 
example, as indicated by the possibility that in certain cases 
involving hospital/provider discounts and coinsurance payments 
some Blues Plans may have violated prohibited transaction 
requirements stipulated by the Employee Retirement and Income 
Security Act (ERISA). Indeed, the Subcommittee further 
recommends that these potential ERISA violations be reviewed by 
the Department of Labor, the agency responsible for overseeing 
the activities carried out pursuant to this law.

               9. review of plan non-profit tax benefits

    The Subcommittee found that the Blues Plans examined abused 
their non-profit status, e.g., West Virginia Plan managers 
engaged in a highly risky type of investment trading that its 
auditors said was not appropriate for a company of its type. In 
addition, top managers of these Plans operated them in a 
grossly irresponsible manner, for example, by using 
policyholders' premiums for excessive executive compensation 
packages, lavish parties and entertainment, luxury travel and 
transportation, and charitable contributions. Given these 
abuses, the Subcommittee recommends that the Administration 
review the Federal tax status of the Blue Cross/Blue Shield 
Association and the individual Plans of the Blue Cross/Blue 
Shield system, to ascertain whether they continue to warrant 
the special tax advantages accorded them as non-profits.

         10. enhancing District of Columbia insurance authority

    The Subcommittee believes that the District of Columbia 
should continue its efforts to swiftly enact and implement the 
legislation and regulations necessary to enable its 
Superintendent of Insurance to effectively oversee GHMSI's 
operations. Toward this end, the Subcommittee recommends that 
the Congress provide all necessary support, including, but by 
no means limited to, enacting legislation to dissolve GHMSI's 
Congressional charter.

                       VI. APPENDIX: CASE STUDIES
                         THE WEST VIRGINIA PLAN

                       A. Background/Organization

    Blue Cross/Blue Shield of West Virginia, Inc. (the West 
Virginia Plan) was incorporated as a non-profit health service 
corporation in West Virginia in 1983. Headquartered in 
Charleston, it employed approximately 700 employees over the 
seven years it was in existence and, at its peak in 1983 had 
some 379,000 subscribers. It was formed as a result of a merger 
between Blue Cross/Blue Shield of Southern West Virginia 
(Charleston) and Blue Cross/Blue Shield of Northern West 
Virginia (Wheeling). In 1984, the Blue Cross/Blue Shield Plans 
of Morgantown merged with the West Virginia Plan, completing 
the consolidation of Blue Cross and Blue Shield operations in 
the State with one exception--West Central Blue Cross/Blue 
Shield (Parkersburg).
    During its seven-year existence, the West Virginia Plan's 
organizational structure consisted primarily of three types of 
entities: those involved in underwriting and servicing its core 
lines of Blue Cross/Blue Shield insurance business; a for-
profit stock holding company; and, a number of for-profit joint 
ventures with the Blue Cross/Blue Shield Plans of Maine, New 
Hampshire, and Vermont. The for-profit external business 
activities were deeply involved in the West Virginia Plan's 
rapid financial decline and ultimate collapse.

                          B. Financial Profile

    The Plan, according to its financial records, incurred 
losses in all but two years of its existence. Total losses 
amounted to approximately $69 million, while about $13 million 
was made in 1984 and 1985.\11\ By 1987, the Plan was insolvent 
and its reserves (or net worth) continued to decline 
drastically, so that by the end of 1989 they had reached a 
negative balance of $31 million. Ironically, while the number 
of subscribers dropped from a high of 379,385 at the end of 
1983 to 273,695 in 1989, during the same period the premium 
income increased from $213 million to $252 million. However, 
despite this increase in premium income, the Plan still lost 
money.
---------------------------------------------------------------------------
    \11\ Although Plan gains exceeded losses in 1984 and 1985, the Blue 
Cross/Blue Shield Association noted that the entire system experienced 
similar profitability trends at that time, influenced by an upturn in 
the underwriting cycle and a nationwide drop in health care claims.
---------------------------------------------------------------------------

                            C. Problem Areas

    The Plan's decline, insolvency, and ultimate seizure by the 
West Virginia Insurance Department in 1990 were primarily 
caused by a combination of: mismanagement; inadequate Board of 
Directors' oversight of management policies and actions; and, 
inadequate regulation and enforcement by the West Virginia 
Insurance Department.\12\ While not found to be a factor that 
directly contributed to the Plan's failure, inadequate 
oversight of Plan operations and activities on the part of the 
Blue Cross/Blue Shield Association was also a problem area.
---------------------------------------------------------------------------
    \12\ Plan officials James Heaton (President and Chief Executive 
Officer), Salvatore Torrisi (Executive Vice President and Chief 
Operating Officer), and Donald Wagenheim (Chairman of the Board of 
Directors) maintained that the Plan's problems and collapse were not a 
consequence of their mismanagement, but the result of factors beyond 
their control, including cost shifting from West Virginia hospitals and 
a general decline in the West Virginia economy. While such factors may 
have contributed to the Plan's problems in some small way, the 
overwhelming evidence accumulated by the Subcommittee shows they cannot 
explain the Plan's dramatic decline and ultimate failure. If 
controlling, such factors logically should have also affected the 
Parkersburg Blue Cross/Blue Shield Plan. However, there was no evidence 
of any major adverse effects on the Parkersburg Plan, which was 
profitable until its merger with Blue Cross/Blue Shield Mutual of Ohio 
(the Cleveland Plan).
---------------------------------------------------------------------------

                            1. Mismanagement

a. Flawed Management Approach
    Regulatory officials, Plan employees, Board members, 
consultants, and outside accountants provided testimony on 
management's questionable actions and decisions. The Plan's 
Labor Consultant from 1985-1990 said that the management was so 
bad he could only assume that the Plan was being ``managed to 
fail.'' A former Plan Executive Vice President, with 20 years 
of experience working at various Blue Cross/Blue Shield 
organizations resigned in 1986 after having concluded that Jim 
Heaton's policies and actions were leading the Plan to a 
``significant downward turn [and] turbulent financial ride.'' 
In addition, a management consultant with years of Blue Cross/
Blue Shield experience, hired by Heaton in 1984 to head the 
Plan's planning staff, advised the Subcommittee Staff that upon 
becoming familiar with Heaton's management style and major 
policy decisions, he concluded that the Plan was doomed and 
resigned.
    Fred E. Wright, the former Insurance Commissioner for the 
period 1985-1988, said the Plan's 1984 decision to buy the old 
Sears Building in South Charleston to turn into its new 
corporate headquarters was ``a crazy idea.'' He called the 
purchase ``puffery...an edifice to the glory of management,'' 
which was not justified by the Plan's needs, made at a time 
when the Plan had serious financial problems (e.g., in 1983, 
the Plan had $2.4 million in underwriting losses and, at the 
end of the same year, had a surplus sufficient to cover only 
one week's claims).
b. Proliferation of Subsidiaries
    Heaton and other Plan officers established a number of for-
profit subsidiaries and affiliates that were essentially for 
their personal gain rather than for the benefit of the 
subscribers. This scheme, which was part of a reorganization 
launched by Heaton in 1984, violated management's fiduciary 
responsibility to the subscribers. Though funded by Blue Cross/
Blue Shield money, the potential profits from these ventures 
would not have benefitted the Plan or its subscribers. Heaton 
said that he saw nothing wrong with establishing these for-
profit affiliates and subsidiaries, further underscoring his 
apparent lack of appreciation for any fiduciary responsibility 
to the Plan's subscribers.
    These for-profit external businesses also violated the 
``corporate opportunity doctrine,'' which holds that a director 
or officer of a corporation may not take advantage of a 
business opportunity that rightly belongs to the corporation. 
In a 1984 letter, for example, one of the Plan's legal advisors 
warned:

          The plan of reorganization * * * raises several areas 
        of concern dealing with the `corporate opportunity 
        doctrine'. * * * [A] sale of all of the stock of the 
        subsidiary of Blue Cross/Blue Shield to the individual 
        members, or a corporation controlled by the members, 
        even at fair market value, might raise concerns as to 
        whether the members were taking a 'business 
        opportunity' from Blue Cross/Blue Shield. * * * In the 
        present situation, corporate officers and directors 
        might be considered to be taking personal advantage of 
        an enterprise already profitable to Blue Cross/Blue 
        Shield. Although the motive for splitting-off the 
        subsidiary corporation is bona fide, the fact that 
        future profits may be diverted from the parent 
        corporation to individual directors or members raises 
        at least the specter of impropriety.

    Finally, these external ventures diverted millions of 
dollars (at least $1.8 million in start-up costs alone, 
according to Insurance Department figures) from other areas of 
activity at a time when the Plan was experiencing serious 
financial problems. As one Insurance Department auditor 
explained:

          The problem with the subsidiaries was especially 
        serious since it would appear to aggravate the already 
        shaky financial condition of the West Virginia Plan. It 
        is one matter to create subsidiaries, but it was 
        particularly troubling to find the Officers and Board 
        considering to diversify and create a multitude of 
        affiliates and subsidiaries when the parent Plan was 
        losing money. Our question was where the money would 
        come from to pay for these new ventures.
c. Internal Control Deficiencies
    In a 1987 examination, the Plan's outside accountants, 
Ernst & Young, identified numerous deficiencies in the Plan's 
internal system of controls, recordkeeping, and accounting 
practices. It took 68 pages in their report to detail the 
weaknesses found and to list the extensive improvements needed. 
Most significantly, Ernst & Young cited five material 
weaknesses in the Plan's internal accounting controls for 
accounts receivable and investment activity.\13\
---------------------------------------------------------------------------
    \13\ A material weakness is a deficiency in an entity's internal 
control structure so significant that there is more than a relatively 
low risk that errors or irregularities may occur and not be detected 
within a timely period.
---------------------------------------------------------------------------
    During this same internal control examination it was also 
discovered that the Plan was engaged in a highly risky type of 
investment trading--hedging and speculating in stock price 
fluctuations--which the auditors believed was neither 
appropriate for a company of its type nor permissible under the 
West Virginia Insurance Code.\14\ Records indicate that Plan 
management had only a limited knowledge of how the market for 
these investments actually worked or the potential for 
significant losses. While the Plan subsequently ceased this 
investment activity, its involvement still resulted in more 
than $2.3 million in losses.
---------------------------------------------------------------------------
    \14\ The Insurance Department subsequently determined that the 
Plan's participation in these investments was, in fact, a violation of 
the West Virginia Insurance Code because borrowed money was used to 
finance the transactions. The Department filed a $2.3 million suit 
against Shearson Lehman Brothers and E.F. Hutton, the firms that 
advanced loans for the transactions and advised the Plan on the 
specific investment strategy utilized. This suit was settled in August 
1993 for $775,000.
---------------------------------------------------------------------------
d. Questionable/Poor Underwriting Practices
    Numerous sources said that the Plan was consistently 
undermined by ill-advised underwriting decisions. The Vice 
President for Finance, for example, said that the Plan took on 
new clients without properly underwriting that business, in 
order to generate more cash through premiums and recapture lost 
market share. This decision, he added, resulted in the Plan 
assuming more liabilities than it could handle.
    In a 1990 document, Blue Cross/Blue Shield Association 
auditors reported that the Plan's financial predicament was, in 
part, a result of its tendency to ``focus on enrollment rather 
than profitability.'' An analysis by the West Virginia Hospital 
Association concluded that one of the major factors that 
contributed to the Plan's failure was ``terrible underwriting 
decisions * * * throughout the 1980's which found Blue Cross 
acquiring business and then losing millions of dollars as they 
gambled to expand marketshare.''
e. Excessive Salaries
    While salaries hardly increased for the Plan's 700 or so 
employees, those for Heaton and the other nine highest paid 
officers rose precipitously. These increases occurred most 
pointedly between 1984-1989, when the Plan was in serious 
financial difficulty. For example, while total salaries for the 
Plan's top ten officers was approximately $575,000 in 1984, by 
1989 that figure had risen to more than $900,000. During this 
same timeframe, Heaton's salary nearly doubled, from $85,000 to 
$160,000.

           2. Inadequate Oversight by the Board of Directors

    The Subcommittee received considerable testimony on the 
Board of Directors' failure to perform its requisite oversight 
of management policies and performance. Instead of protecting 
the subscribers' interests, the Board was routinely manipulated 
and misled by management and, in some instances, became 
intertwined with the latter in questionable activity.
    In January, 1984 Heaton moved to create a new governing 
body within the existing Board, which effectively undermined 
the Board's ability to properly perform its responsibilities. 
This new governing body, the ``Board of Voting Members,'' came 
to be known as the ``Super Board,'' and was comprised of 
Heaton, Board Chairman Don Wagenheim, and a group of their 
hand-picked associates. The new Board of Voting Members was the 
only body empowered to: change the corporation's by-laws; elect 
the directors on the Board; and, nominate new voting members. 
In Heaton's words, ``control of the voting members allows for 
control of the board.'' \15\ Among other things, this ability 
to control the Board enabled Heaton to establish and operate 
the Plan's highly questionable for-profit external ventures 
with virtually no opposition from the Board.\16\
---------------------------------------------------------------------------
    \15\ In a July 14, 1988 letter to the President of the District of 
Columbia Blue Cross/Blue Shield Plan.
    \16\ After discovering the creation of the Super Board in their 
1984 audit of the Plan, Insurance Department examiners concluded that 
it violated state-mandated requirements regarding the Board's 
appropriate composition and directed that it be dissolved. The 
Department's subsequent 1986 examination found that the Plan had not 
complied with the earlier directive and the Super Board was still in 
existence.
---------------------------------------------------------------------------
    In an affidavit submitted to the Subcommittee, one longtime 
Board member described the effect of the Super Board:

          This special creation of a ``Super Board'' caused 
        some full Board members to resign. * * * Members became 
        much, much less involved * * * [and] soon, the Board 
        just went along with whatever management suggested, and 
        questions were not asked at Board meetings. The Board 
        was controlled and silenced.

    The evidence also established that management routinely 
misled and/or failed to inform the Board:

        --Lregarding the Plan's involvement in the risky 
        investment activity--i.e., speculating in future stock 
        price fluctuations--described above, Board Chairman 
        Wagenheim told the Subcommittee Staff that ``he didn't 
        understand it then and * * * wouldn't understand it 
        today'';
        --Lthe Board was unaware that the Plan incurred more 
        than $240,000 in expenses in settling a lawsuit brought 
        by a female Plan employee in relation to her long-
        running affair with President Heaton; and,
        --Lalthough the Board was informed in early 1988 that 
        the Plan was in a ``negative reserve'' condition, a 
        Board member noted that the word ``insolvent'' was 
        never mentioned (even though the Plan was insolvent at 
        that time). She noted that:

                  * * * Mr. Torrisi would continue giving 
                optimistic forecasts for recovery. He would 
                flash slides on viewgraphs, but not give us 
                copies of the information. The graphs only gave 
                limited snapshots of the financial condition of 
                the Plan. Financial forecasts were handed out, 
                but no one ever explained that the forecasts 
                were just based on management's opinion.

    Questionable conduct on the part of Board Chairman 
Wagenheim may also partly explain the Board's failure to 
adequately carry out its responsibilities. In a number of 
instances while serving as Chairman and Board member, 
Wagenheim, at best, used very poor judgment or, at worst, 
behaved unethically and/or knowingly involved himself in an 
unlawful business transaction. Most notably, Wagenheim became 
deeply enmeshed in the process by which his firm, H.E. Neumann 
Construction Company, was awarded a $723,000 contract from the 
Plan to do work in connection with the renovation of its 
Charleston headquarters building.
    In the Insurance Department's 1986 examination of the Plan, 
the auditing team learned that Wagenheim's firm received the 
contract even though it had not submitted the low bid and had 
not been recommended by the architectural and design firm that 
oversaw the bid process. The auditors felt that this was a 
``sweetheart deal,'' in violation of West Virginia law and 
recommended that Wagenheim be removed as Board Chairman.\17\
---------------------------------------------------------------------------
    \17\ West Virginia law (Chapter 33, Sec. 4-17 and 33-24-4) strictly 
bars officers and directors of an insurance company and/or Blue Cross/
Blue Shield Plan from profiting from their position in transactions 
with the company. As explained below (see p. 24), the audit report 
containing this recommendation was never filed and, therefore, no 
action was taken to remove Wagenheim.
---------------------------------------------------------------------------
    When deposed by the Subcommittee Staff, Wagenheim admitted 
that he appointed the Building Committee that determined which 
contractors would be solicited for bids and what bids would be 
accepted. He also admitted that the Plan did not publicly 
advertise bids for the rehabilitation of the new headquarters 
renovation; instead, the Building Committee sent out 
invitations to a limited number of companies--including H.E. 
Neumann--to submit bids. In his deposition, Wagenheim saw no 
problem with his actions in connection with the contract award 
and no mention was made regarding it during Board and Executive 
Committee meetings at that time. Indeed, one member expressly 
said that she first heard about this situation only when 
informed by the Subcommittee Staff. Chairman Wagenheim, it 
should be noted, also served as Board Chairman of a number of 
the for-profit enterprises the Plan's management established 
during the 1980s, which were intended to benefit certain Plan 
officials and Board members.

          3. Inadequate Regulation by the Insurance Department

    The West Virginia Insurance Department's efforts to oversee 
the Plan and protect the interests of its subscribers were 
inadequate. While the regulators knew about the Plan's problems 
almost from its merger-based inception in 1983, they did not 
move against it until 1990, by which time it had been insolvent 
for almost three years and was essentially beyond any hope of 
recovery. This inaction resulted from both the Plan's ability 
to evade regulatory efforts and the Department's own inability 
and/or unwillingness to take appropriate action in a timely 
manner.
    Past and present senior Department officials testified that 
they had neither sufficient staff nor budget resources to 
properly oversee the Plan's operations and the other insurance 
companies under their jurisdiction. Former Commissioner Wright 
testified that when he took over, the Department was ``a 
mess,'' i.e., it had few experienced employees, was suffering 
from high turnover, and had no comprehensive management policy 
in place. In an affidavit provided to the Subcommittee, the 
Counsel to the Insurance Commissioner from 1982 to 1989 stated 
that:

          In 1982, the Department had a small number of 
        employees, approximately 25 to 30. Only a handful of 
        those employees were professionals and I was the only 
        in-house attorney. We were charged with regulating the 
        activities of approximately 20 to 25 domestic insurers, 
        overseeing the business practices of over 1000 non-
        domestic insurers and regulating the activities of 
        several thousand insurance agents and brokers. * * *

The former Counsel also notes that although resources increased 
over time, during her tenure the Department still never had 
sufficient staff or budget to be able to fully carry out its 
regulatory functions.
    The Department's ability to do its work was also hampered 
by a lack of expertise and turn-over in the ranks of senior 
employees. During the Plan's short-lived existence (1983-1990), 
for example, there were three Commissioners and three Chief 
Examiners. One of the Chief Examiners was removed for 
incompetence and two of the three had no prior field 
examination experience. Shortly after the completion of the 
Department's 1986 examination of the Plan, the Chief Examiner 
left to take a job with the Plan.
    The Subcommittee also received testimony indicating that 
the Department's failure to act against the Plan was also a 
matter of its apparent unwillingness to do so. In 1984 and 
1986, Department examiners reported the Plan's financial 
decline, as well as questionable conduct on the part of 
management and directors. In the 1986 report, the examiners 
recommended that the Department seek to remove Heaton, Torrisi, 
Wagenheim and most of the other Directors for violating their 
fiduciary duty.
    However, the Department did little if anything about either 
of these reports and their findings and recommendations. For 
reasons that remain unexplained, nearly a year intervened from 
the time the 1984 report was submitted to the Commissioner and 
when it was finally filed in 1985. The 1986 report was never 
filed and, therefore, remained unavailable to the public.
    In his deposition, former Commissioner Wright testified 
that the main reason that the 1986 report was never filed or 
acted upon was because ``there were just too many other more 
important and pressing things to do at the time,'' including 
the status of three financially distressed domestic insurers. 
Nevertheless, the point remains that the Department's failure 
to act on the report was to some considerable degree a matter 
of choice. Indeed, in his deposition former Commissioner Wright 
conceded that, in retrospect, he perhaps should have been more 
aggressive and followed up on his examiners' recommendations.
    The present Insurance Commissioner, Hanley C. Clark, told 
the Subcommittee Staff that in part he did not act sooner 
because he did not have the regulatory tools to do so.\18\ He 
said that when he obtained the needed additional regulatory 
authority in March, 1990, with the passage of West Virginia 
House Bill 4195, he started to proceed against the Plan. Some 
legal experts, however, informed the Staff that even from a 
cursory reading of the Code, the Insurance Commissioner clearly 
had the discretionary authority to refuse to renew, suspend or 
revoke the license of the Plan for being ``in an unsound 
condition or in such condition as to render its further 
transaction of insurance in West Virginia hazardous to its 
policyholders or to the people of West Virginia.'' \19\ Indeed, 
Department representatives, such as current General Counsel, 
Keith Huffman, and former Commissioner Wright, testified that 
they did not use regulatory tools available to them, such as 
public hearings and subpoena power, because of concerns about 
litigation:
---------------------------------------------------------------------------
    \18\ Prior to being named Commissioner in January, 1989, Mr. Clark 
was either the Deputy or acting Commissioner for much of the Plan's 
existence.
    \19\ West Virginia Insurance Code, Sec. 33-3-11 (4).
---------------------------------------------------------------------------
          Senator NUNN. But you had subpoena power, did you 
        not?
          Mr. HUFFMAN. He [Commissioner Clark] had subpoena 
        power, Senator, but * * * if the department would have 
        issued subpoenas to * * * garner evidence * * * [from] 
        the National [Blue Cross/Blue Shield Association or 
        from] * * * E & Y [Ernst & Young], I guarantee you what 
        would have happened is that those entities would have 
        called down the street to their 200- or 300-lawyer firm 
        and tied the department up [for] so long * * * that 
        those subpoenas would not have been very effective at 
        all. * * *
          Senator NUNN. Were you afraid to subpoena Blue Cross/
        Blue Shield of West Virginia * * * because of their 
        lawyers?
          Mr. WRIGHT. Senator, everything we did at that time 
        involving what I would call the bad insurance companies 
        or organizations developed into a war with lawyers. * * 
        *

    Former and current officials also testified that the Plan 
quite literally fought the regulators at every turn. Former 
Commissioner Wright's Counsel, for example, stated that:

          The relationship between Blue Cross and the 
        Department was rocky, full of contention and far from 
        pleasant. My perception of Blue Cross was that it made 
        little effort to cooperate with the Department and 
        seemed to almost automatically take a position in 
        opposition to suggestions or recommendations of the 
        Department. I questioned Blue Cross' willingness to 
        deal openly and fairly with the Department.

    Both the former and current Commissioners echoed the 
Counsel's remarks. In his testimony, for example, Commissioner 
Clark stated that:

          The relationship between the management of BCBSWV and 
        the Department could be characterized, at a minimum, as 
        very poor. In nearly every encounter with the BCBSWV 
        management, the Department staff came to expect 
        misinformation, deceit, arrogance, and defiance.

    Commissioners Wright and Clark indicated that nothing ever 
came easy in dealing with this Plan. Both described how they 
would have to threaten litigation before the Plan would 
voluntarily comply with a simple request that would be handled 
pro forma by any other insurance company.
    The Department's lead examiner on the 1986 exam, had this 
to say about his dealings with the Plan:

          Throughout this examination, the Plan's officers and 
        employees exhibited an arrogance to the law and an 
        unwillingness to cooperate with the examination. We 
        quickly learned that the Plan's Officers felt they were 
        'above the law,' and were very well connected 
        politically. The Plan's officers did not even attempt 
        to hide their displeasure that we were there.

   4. Inadequate Oversight by the Blue Cross/Blue Shield Association

    The Blue Cross/Blue Shield Association's role regarding the 
Plan, indicates that it had sufficient information about the 
Plan's problems and authority to take decisive action, but 
failed to do so in a timely manner. In addition, the 
Association failed to adequately convey its knowledge of and 
concerns about the Plan's problems to the West Virginia 
Insurance Department.
    Beginning in 1987, a year after the Plan's financial 
problems had led to a loss of nearly $3 million, the 
Association took the serious step of placing it on conditional 
status for failing to comply fully with a membership standard 
involving financial responsibility, i.e., failing to have 
sufficient reserves on hand to meet at least 1.5 months of 
potential claims. Conditional status was renewed in 1988, after 
Association staff made an on-site visit to the Plan to examine 
its 1987 performance results. In the March, 1988 report 
summarizing the results of their visit, the Association staff 
found that: the Plan's forecast of a $1.5 million gain in 1988 
was unlikely and, instead, that significant losses could occur; 
the Plan could be out of operating cash by late summer of that 
year; and, because of the Plan's deteriorating financial 
condition, there could be intervention by the State Insurance 
Department.
    In 1989, conditional status was again renewed, when the 
Plan failed to meet the same reserve and liquidity requirements 
it had not met in 1988, and also failed to satisfy a 
requirement that financial reports be submitted in an accurate 
and timely manner. The conditional status for 1989 reflected 
the Association's April, 1989 review of the Plan, which found 
that it had experienced four years of enrollment and market 
share decline, in addition to net losses of $22 million and $19 
million in 1987 and 1988, respectively. The April review also 
pointed out that it was the Plan's ``precarious financial 
condition'' that forced it to be placed on conditional status 
in 1987 and 1988, and that management's response to these 
problems had been largely unsuccessful.
    Finally, in the spring of 1990, the Association's Plan 
Performance and Monitoring Committee voted for non-renewal of 
the Plan's license, the most serious sanction available to it. 
However, a non-renewal recommendation could have been made at 
least a year earlier, after the Plan had experienced three 
consecutive years of declining financial performance and two 
consecutive years of non-compliance with the financial 
responsibility membership standard. At the very least, an 
earlier threat of non-renewal of the Plans's membership by the 
Association might have prompted an affiliation or some other 
action that could have helped avert the Plan's ultimate seizure 
and liquidation.
    According to Association officials, action was not taken 
sooner because of a series of promising developments, all of 
which, however, eventually ``fizzled.'' In 1988, the West 
Virginia Plan and the District of Columbia Plan (GHMSI) had 
begun affiliation negotiations. In addition, at the end of 1988 
the Plan's accountants, Ernst & Young, projected a $6.8 million 
gain for 1989. Although this projection did not materialize and 
West Virginia's problems continued in 1989, the Association 
officials noted that the talks with GHMSI were ongoing and 
Ernst & Young had again forecast positive results for 1990--a 
projected gain of $8.9 million.\20\ Then, in early 1990, hopes 
were again raised when Commissioner Clark approved a 
significant rate increase for the Plan and affiliation talks 
began with the Cleveland Plan. The Association officials also 
stated that they did not move earlier to rescind the Plan's 
membership status because that is a drastic measure they only 
use as a last resort.
---------------------------------------------------------------------------
    \20\ The Subcommittee staff were surprised to learn that 
Association officials were unaware that the Ernst & Young forecasts 
were compilations, rather than examinations. The officials told the 
staff that since the West Virginia Insurance Commissioner had requested 
and relied upon the forecasts, it never occurred to them that the 
forecasts were not independently audited or verified.
---------------------------------------------------------------------------
    According to the Insurance Department, the Association 
concealed the true nature and extent of its concerns regarding 
the Plan's problems and, by so doing, effectively contributed 
to delays on the regulator's part to act against the Plan 
before it became irreparably impaired. As early as 1986, the 
Association was fully aware of the Plan's deteriorating 
financial condition and had placed it on conditional status in 
1987. The Association, however, failed to notify the Department 
of this action and also failed to do so again in 1988 and 1989, 
when the Plan's conditional status was continued.\21\
---------------------------------------------------------------------------
    \21\ In his deposition, Plan President Heaton said that as a former 
member of the Association's Board of Directors and with his more than 
20 years of experience in the Blue Cross/Blue Shield system, he found 
that the Association uses three techniques to stave off a Plan's 
failure. It will first approach the regulators to get rate increases. 
If that doesn't work, it will put political pressure on the 
regulators--including, for example, going as far as threatening to pull 
a Plan's trademark and service marks, which Heaton said he saw done in 
the case of the New Jersey Plan. Finally, if all else fails, a merger 
with another Plan will be pursued.
---------------------------------------------------------------------------
    Commissioner Clark testified that in meetings from May 17-
23, 1988, Association representatives told Department staff 
that the Plan was not experiencing more financial difficulties 
than any other Plan in the Blue Cross/Blue Shield system, and 
that these problems were related to a normal downturn in the 
insurance cycle being experienced by all health insurers. 
According to this testimony, Department staff were told that 
the situation would improve in 1989. Commissioner Clark also 
testified that the Association representatives advised the 
Department that drastic action was not needed, although at the 
same time they said that the Department ought to continue to 
monitor the Plan.
    The Commissioner explained the Department's ``huge 
dilemma'' in this regard as follows:

          Under laws in existence in the State of West 
        Virginia, if the Department sought rehabilitation or 
        liquidation of the plan, it would be faced with a full 
        adversarial hearing * * * in which it would be 
        necessary to demonstrate (over the strenuous objections 
        of management) that [such action] was in the `interest 
        of the policyholders, creditors, stockholders, members, 
        subscribers, or the public'. * * * As a practical 
        matter, the Department needed the support of * * * the 
        National [Association] against BCBSWV management in 
        order to take affirmative action. * * * There would 
        have to be expert testimony that the plan was insolvent 
        and would not recover on its own * * *, as well as a 
        workout plan to help retire the liabilities of BCBSWV * 
        * * and provide a solvent merger or affiliation 
        partner. * * * However, * * * the National [was] 
        aligned against such measures.'' \22\
---------------------------------------------------------------------------
    \22\ In its role as Receiver, the Insurance Department filed a 
civil suit against the Association in January 1992, alleging that its 
conduct in connection with the Plan's failure was ``willful, wanton, 
and malicious'' and in violation of the West Virginia Unfair Trade 
Practices Act. The suit called for $34 million to cover outstanding 
claims resulting from the Plan's failure; $10 million in extra 
contractual damages for annoyance, inconvenience, hardship, and mental 
anguish; and, another $10 million for punitive damages. This suit was 
settled in March 1992, with the Association agreeing to pay the 
Department $8.6 million.
---------------------------------------------------------------------------

                               D. Effects

    For thousands of West Virginia subscribers, providers, and 
others, their lives and/or businesses were thrown into turmoil 
as a result of the Plan's failure. The Plan's demise left 
subscribers with more than $40 million in unpaid claims. An 
administrator of and participant in his small company's 
employee health benefits plan, testified that he personally 
lost $23,000 due to non-payment of benefits. The financial 
pressure placed on him and his family as a result of his unpaid 
medical bills became so great that at one point he seriously 
considered declaring bankruptcy.
    Another subscriber, who was left with more than $37,000 in 
unpaid medical bills for services rendered in treating her 
serious cancer condition, described the difficulties she faced:

          To stop the harassment from the medical providers for 
        payment that they had been denied by the failed Blue 
        Cross Plan, and to prevent creditors from putting a 
        judgment against my home, I had to start making monthly 
        payments. * * * Not only do I have to worry about 
        having cancer, I now have to worry about the bills. * * 
        *

          This constant worry about the medical bills and where 
        the money is going to come from to pay them has put me 
        under a lot of additional stress, as I worry about the 
        possibility of losing our home.

At the time of the Subcommittee's hearings this individual had 
no health insurance at all.
    Some West Virginia Plan subscribers were also dramatically 
affected by premium increases. For example, one of the 
witnesses who testified about the impact of the Plan's failure 
explained that in the wake of its demise many firms were 
unwilling to trust the successor plan, Mountain State Blue 
Cross/Blue Shield. When some of these firms signed up with 
other health insurers, Mountain State increased premiums for 
its high-risk subscribers by more than 60%. This action, he 
said, ``hit home'' for him because the pastor of his church had 
to drop his family's coverage when his premiums increased from 
$500 to over $800 a month. In their testimony, the Subcommittee 
Staff confirmed that many West Virginia Plan subscribers lost 
their coverage as a result of this staggering premium 
increase.\23\
---------------------------------------------------------------------------
    \23\ Generally speaking, the Plans examined by the Subcommittee had 
little difficulty in obtaining desired premium increases.
---------------------------------------------------------------------------
    Lastly, the Subcommittee also found that the Plan's failure 
had major consequences for providers. Testimony submitted by 
the West Virginia Hospital Association states that the more 
than $40 million in unpaid medical bills for services already 
provided to Plan subscribers had a ``substantial'' effect on 
providers.

                           THE MARYLAND PLAN

                       A. Background/Organization

    Tracing its roots back to predecessor organizations formed 
in the late 1930s, the Blue Cross/Blue Shield plan of Maryland 
(BCBSM) was established as a result of the 1985 merger of the 
State's separate Blue Cross and Blue Shield plans. 
Headquartered in Owings Mills, BCBSM was serving approximately 
1.4 million Marylanders (nearly 30% of the State's population) 
in 1992. In addition, at the time of the Subcommittee's 
hearing, BCBSM employed approximately 4,500 individuals and in 
1991 took in $1.7 billion in total revenue.
    From the mid-1980s onward, BCBSM's organizational structure 
included three types of operational entities: those involved in 
underwriting and servicing its core Blue Cross/Blue Shield 
insurance business; for-profit subsidiaries with some health-
related purpose; and, for-profit subsidiaries with no health-
related purpose. In 1985, BCBSM's structure was fairly simple, 
consisting of the parent company and two subsidiaries. By 1991, 
however, it had become extremely complicated by the addition of 
another 29 subsidiaries and three limited partnerships.

                          B. Financial Profile

    From 1986 through 1988, BCBSM incurred operating losses of 
$110 million and its net worth declined dramatically from $67 
million to $17 million.\24\ Reflecting these losses and reduced 
net worth, a 1987 Maryland Insurance Division examination found 
that BCBSM had achieved a deficit position of $1.2 million.\25\ 
Between 1985 and 1989 the Plan's reported reserves declined 
precipitously from $122 million to $16 million.
---------------------------------------------------------------------------
    \24\ Since 1989, BCBSM has reported operating gains of $121 million 
and an increase in net worth of $85 million as of June 30, 1992. 
However, according to the Subcommittee staff, these figures may be 
substantially overstated because accepted accounting rules and asset 
valuation procedures have not been strictly followed by BCBSM. See 
related discussion below, p. 42.
    \25\ This examination was never formally completed. See related 
discussion below, p. 39.
---------------------------------------------------------------------------
    In a July 17, 1992 letter to the Governor, the Maryland 
Insurance Commissioner, John A. Donaho, observed that, ``in 
broad terms, BCBSM may be 60-65 percent weaker at December 31, 
1991 than it was at December 31, 1984.'' On the basis of its 
April, 1992 business performance review of BCBSM, the Blue 
Cross/Blue Shield Association concluded that the Plan's reserve 
position was ``low and tenuous.''
    Since 1986, the Plan's subsidiary companies had incurred 
total losses of $120 million. During this same timespan the 
Plan made capital infusions of more than $170 million to its 
HMO and non-insurance subsidiaries. Between 1987 and 1990, 
BCBSM's external auditors refrained from issuing a ``going 
concern'' audit opinion on its HMO subsidiaries, but only after 
Plan officials said that they would guarantee the latters' 
solvency.\26\
---------------------------------------------------------------------------
    \26\ A going concern opinion indicates that the auditors have 
substantial doubt that the entity examined will be in business one year 
from the date of the audit.
---------------------------------------------------------------------------

                            C. Problem Areas

    Some of the same key factors associated with the demise of 
the West Virginia Plan were present in varying degrees at 
BCBSM.\27\ Specifically, the testimony established four broad 
problem areas: mismanagement; inadequate oversight by the Board 
of Directors; inadequate regulation by the Maryland Insurance 
Division; and, inadequate oversight by the Blue Cross/Blue 
Shield Association.\28\
---------------------------------------------------------------------------
    \27\ In their testimony the Subcommittee staff offered two 
cautionary notes on this point. First, they explained that while there 
were major similarities in the problems at the West Virginia and BCBSM 
Plans, there were also a number of important differences, including: no 
evidence was uncovered that top BCBSM officers or Board members had 
engaged in self-dealing or created subsidiaries for their personal 
enrichment; and, BCBSM's President did not create a ``Super Board,'' 
consisting of himself and certain hand-picked associates, in an effort 
to control the Plan and circumvent existing regulatory requirements. 
Second, the Staff cautioned that the similarities in the Plans' 
problems did not mean that BCBSM was on the verge of imminent failure. 
Rather, they suggested that BCBSM could ultimately become as impaired 
as the West Virginia Plan, if its problems were not addressed in a 
timely manner.
    \28\ BCBSM officials did not dispute the Subcommittee's findings, 
although in their testimony they did cite other factors--e.g., the 
1986-1988 downturn in the health insurance industry, increased 
competition from for-profit insurance companies, and dramatic changes 
in health care industry products and services--to explain the situation 
that confronted the Plan from the time of its establishment in 1985. 
However, within a week of the hearings, the Board met and removed Carl 
Sardegna as its Chairman and appointed a special committee to examine 
the issues raised by the Subcommittee. The results of this special 
committee's review corroborated virtually all of the Subcommittee's 
findings regarding BCBSM's management and operations.
---------------------------------------------------------------------------

                            1. Mismanagement

    As in the West Virginia Plan, mismanagement and 
questionable management decisions were inextricably bound up in 
BCBSM's financial difficulties. An August 11, 1992 letter from 
Commissioner Donaho to the Governor seriously questioned 
BCBSM's management decisions:

          The Blue's generally poor financial condition is a 
        result of years of a combination of mismanagement and 
        inadequate rates. By mismanagement, I am not suggesting 
        anything illegal just poor planning and execution, a 
        malady that frequently strikes managers in positions 
        where profit, that is return to investors, is not a 
        question.\29\
---------------------------------------------------------------------------
    \29\ Commissioner Donaho's concerns about BCBSM's management are 
shared by a number of his predecessors. In interviews with the Staff, 
for example, one former Commissioner called BCBSM's management 
structure ``awful,'' while another said that when it comes to the 
Plan's management, ``you don't know what they're doing as a regulator, 
then you realize that they don't know what they're doing, and what they 
do most of the time is wrong.''
---------------------------------------------------------------------------
  a. Proliferation of Subsidiaries
    In reviewing the 29 subsidiaries and three limited 
partnerships that BCBSM purchased or formed between 1985 and 
1991, the Subcommittee found a pattern of disjointed and 
confused management decisions surrounding their establishment 
and operation. There was no clearly stated long-term management 
strategy regarding these ventures and some of them were 
established but never became operational.
    When a subsidiary was having financial problems, BCBSM 
funds were routinely, and generally without question, used to 
bail them out. According to documents subpoenaed from BCBSM, 
the subsidiaries lost nearly $72 million between 1986 and 1991. 
BCBSM officials subsequently acknowledged that total subsidiary 
losses were in excess of $120 million. Again, comments by 
Commissioner Donaho in his August 11, 1992 letter to the 
Governor are revealing:

          Rather than approaching a new scheme conservatively 
        with careful estimates, they [BCBSM management] plunge 
        ahead without concern as to when or if the investment 
        will be returned. The Smart Card [LifeCard 
        International] and Health Credit Card [HealthLine] are 
        perfect examples of the drain of cash caused by 
        mismanagement of our Blues.\30\
---------------------------------------------------------------------------
    \30\ According to the Subcommittee staff's analysis, between 1987-
1991 total losses from HealthLine operations were $15.4 million; 
between 1985-1991, LifeCard International losses were $30 million. 
Examples of BCBSM mismanagement involving these subsidiaries include: 
the pilot program for BCBSM employees to acquire HealthLine's Medcash 
card (a credit card for charging medical bills, weight loss clinic and 
fitness center expenses, and medical products) had no credit standards, 
which resulted in significant delinquencies and defaults; and, fitness 
centers were known to be risky businesses for credit card purposes and, 
by 1992, nearly half of Medcash's charges (about $3.3 million) were 
from transactions at these concerns.
---------------------------------------------------------------------------
  b. Internal Control Deficiencies
    As in the West Virginia Plan, major problems for which 
management was ultimately responsible were also found in 
BCBSM's accounting and internal control procedures. Numerous 
audits by external and internal auditors, management 
consultants, and former employees between 1985-1991 disclosed 
recurring problems, including:

        --Lin 1985, 1986, 1989, and 1990 external auditors 
        expressed concern that weaknesses in the Plan's 
        information security procedures were allowing access to 
        the Plan's computer system by unauthorized persons. In 
        1987, auditors noted that data security 
        responsibilities were not fully defined or adequately 
        staffed and suffered from a lack of technical 
        expertise. In 1989, the auditors expressed the concern 
        that unauthorized persons could change program or data 
        files without being detected in a timely manner and, in 
        1990, it was noted that ``virtually all employees 
        (authorized and unauthorized) have access to the claims 
        processing system.''
        --Laudits in 1986, 1989, and 1990 found numerous and 
        repeated claims processing problems at one of the 
        Plan's subsidiaries. These various audits found that 
        claims control procedures were weak and processing 
        staff were untrained, inexperienced, and inadequately 
        supervised. The auditors also reported ongoing problems 
        in claims processing timeliness, accuracy, and 
        recordkeeping.
        --La former BCBSM Supervisory Auditor described an 
        incident wherein a former employee of the Plan's Willse 
        subsidiary embezzled over $4 million by writing checks 
        to fictitious entities. Although BCBSM auditors had 
        previously identified serious weaknesses regarding 
        access to Willse's checks and check writing procedures, 
        management had failed to correct these deficiencies.

    In one of BCBSM's recent cost-saving moves, the Corporate 
Audit Department's budget was reduced from $1.07 million to 
$857,000 (about 20%) and the staff was cut from 16 to 12 
employees. Plan documents indicate that this budget cut will 
significantly reduce the Internal Auditors' ability to cover 
known problem areas, such as subsidiary operations, corporate 
staff activities, and claims and billing system functions. At 
this reduced level of coverage, the Subcommittee staff 
estimated that it could take from 10 to 20 years before the 
Internal Auditors would be able to audit these areas 
completely.
  c. Blunders and Misjudgments: CARE, Project W, and Corporate 
        Downsizing
    The Subcommittee received evidence of a long list of major 
management blunders and misjudgments, which ended up costing 
the Plan tens of millions of dollars in unanticipated expenses 
and diminished its financial strength. For example, the Plan 
experienced serious problems with the development, cost-
effectiveness and ultimate functional advantages of the CARE 
claims processing system. While the system was to have been 
fully operational by mid-1990, at an estimated cost of $9 
million, it was not yet in full operation as of late 1992, and 
had already cost more than $25 million. According to one 
consultant's analysis, an additional $20-$30 million may be 
needed for the system to become fully operational. Worse yet, 
according to an October, 1991 consultant's study, the CARE 
system ``is unlikely to ever be as efficient'' as two other 
readily available systems and, in terms of computer resource 
utilization, will not likely ``ever equal that of the systems 
being replaced.''
    There are similar concerns about a little-known internal 
unit of BCBSM, Division W (Project W). Division W was created 
in January, 1991 to help management to ``rethink how BCBS of 
Maryland provides products and services to customers and to 
develop and implement new approaches from the basis of a `clean 
sheet of paper'.'' Division W purportedly has been developing a 
claims adjudication and payment processing system that would 
link physicians and other providers to the Plan electronically.
    Although Division W had spent about $12 million by late 
1992, it had produced little, if anything of significance by 
the time of the Subcommittee's hearings. A consultant's study 
described this organization as ``too ambitious'' and ``very 
futuristic,'' and concluded that it was ``off track and a 
muddle'' and ``would not become operational until the end of 
the decade at the earliest.''
    Another costly management blunder was described by the 
former Plan Supervisory Auditor in testimony regarding a 
``corporate downsizing'' instituted by BCBSM management in 
1986. While her testimony indicates that some cuts in BCBSM's 
2,500 employee workforce may have been in order, she explained 
that the way that management carried them out resulted in total 
costs of ``a staggering $10 million.'' As implemented, the 
downsizing included expensive severance packages for senior 
executives, overpayments of pension benefits, eight weeks of 
severance pay for a large number of employees, two weeks of pay 
for others who were laid off, and health care coverage for all 
through the end of the year. A decision was made immediately 
following this downsizing to reorganize the Plan into so-called 
Strategic Business Units. Over the next five years, this 
reorganization resulted in a dramatic increase in the size of 
the workforce to 4,500 employees; prompting yet another severe 
staff cutback in 1991.
  d. Questionable/Poor Underwriting Practices
    The testimony also confirmed management misjudgments in 
BCBSM's underwriting practices on so-called non-risk business, 
i.e., business in which the Plan only performs administrative 
functions, such as claims processing and customer service, 
while employers assume the health-related financial risk. This 
issue surfaced in the following exchange:

          Senator NUNN. Could you explain what you mean by non-
        risk underwriting loss?
          Commissioner DONAHO. * * * as this trend is 
        developing away from people purchasing insurance from 
        the Blues, * * * large employers * * * including the 
        State of Maryland, Baltimore City, Baltimore Gas & 
        Electric Company and others, * * * [are] engag[ing] the 
        Blues as administrators of their own so-called self-
        insurance plans. * * * Blue Cross, in effect, charges a 
        fee for administering a company's plan, and this is the 
        most amazing thing to us, because how can you lose 
        money on a business which you are charging a fee to 
        run?
          Senator NUNN. That is what I was going to ask you. * 
        * *
          Commissioner DONAHO. Well, my offhand conclusion, 
        until we research it, * * * is that their bids have 
        been cut in order to get the business, so that actually 
        the bid is based upon a loss. In other words, the 
        organization is emphasizing * * * keep[ing] its cash 
        flow going, * * * the reason most Blues survive is 
        because of their cash flow, not because they are 
        accumulating large amounts of surplus.

    In a subsequent October, 1992 letter submitted for the 
Record, the Commissioner pointed out that between 1986-1990, 
$100 million of BCBSM's total underwriting losses of $115.7 
million ``surprisingly'' came from non-risk business, 
suggesting a ``systematic problem in underpricing'' on the part 
of the Plan to gain marketshare. He concludes that 
``maintaining market share may have been a primary concern of 
BCBSM even to the point of absorbing losses from inadequate 
expense charges,'' and cites BCBSM's account with Maryland as 
an example:

          The State of Maryland account, recently awarded $945 
        million ($85 million for administration), is obviously 
        perceived to be critical by BCBSM management. The 
        bewildering concept is whether the State account is 
        more critical due to its high visibility, ``flagship'' 
        marketing value and not due to its underlying profit 
        potential.
  e. Excessive Salaries and Business Expenses
    Testimony before the Subcommittee also established a 
pattern of excessive administrative expenses. These excesses 
are important for two primary reasons: 1) they reveal 
management's profound misunderstanding of and/or insensitivity 
to BCBSM's status as a non-profit organization intended to 
provide ``access to quality care at an affordable price and to 
be the health insurer of last resort;'' and, 2) they took place 
at a time when the Plan was in dire financial straits and 
subscriber premiums were being increased significantly. These 
excesses occurred in two broad categories of expenses--
executive compensation packages (salaries, bonuses and other 
benefits) and corporate marketing efforts (entertainment, 
charitable contributions, and travel).
    In the area of executive compensation, the Staff's 
testimony highlighted the following examples:

        --Lbetween 1986-1991, Plan President and CEO, Carl 
        Sardegna's total compensation (i.e., salary plus 
        bonuses) nearly quadrupled, from $221,130 to $850,193. 
        According to the BCBS Association, Sardegna's 1991 
        compensation was more than double the average total 
        compensation for all BCBS Plan CEOs ($388,000) and 
        placed him well above the 98th percentile figure of 
        $710,000.\31\
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    \31\ BCBSM officials told the Staff that their high salaries were 
commensurate with the size of their plan. In fact, however, the BCBS 
Association has noted that BCBSM's 1.4 million subscribers place it 
just above the average Plan size of 1.2 million. Furthermore, BCBS 
Association data shows that of the 26 BCBS Plans with more than one 
million subscribers, the average total compensation for CEOs was 
$458,000; which places Sardegna well into the 90th percentile of all 
these Plan CEOs as well.

        --Lwhile total compensation for BCBSM's top ten 
        executives increased by more than 180 percent between 
        1986-1991, the increase for the Plan's employees in 
        general was just 28 percent during the same timeframe.
        --Lbetween 1986-1992, the number of BCBSM employees 
        paid $100,000 or more jumped from 11 to more than 40, 
        with nine of the 40 earning over $200,000 and five 
        $300,000 or more.\32\
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    \32\ The Staff's testimony also highlighted excessive financial 
benefits available to BCBSM executives. One such example, the Plan's 
policy on moving expenses, resulted in reimbursement costs of $1.8 
million between 1986-1988 for the relocation of just 32 employees (an 
average of more than $56,000 per employee). In addition, the Staff was 
told that the Plan paid for an employee to transport a horse pursuant 
to his relocation and, in at least two instances, stated in writing 
that employees would be reimbursed for the transport of their boats as 
part of their moving expenses.

    Mr. Sardegna attempted to justify the Plan's executive 
compensation levels by explaining that they were based on 
studies done by independent consultants. In one such study, 
however, the Staff found that in trying to compare BCBSM 
executives' salaries with those of other companies, the 
consulting firm's sample focused on 1,700 enterprises, the vast 
majority of which were for-profit and only one-quarter of which 
---------------------------------------------------------------------------
were insurance companies. The Staff testified that:

        --Lthere was no information on the tenure of the 
        executives at the companies used in the comparison. The 
        number of years an executive has served a company is 
        likely to be reflected in his or her compensation level 
        and thus a failure to include such information could 
        skew the study's results. Underscoring the potential 
        significance of this deficiency, the Staff point out 
        that Mr. Sardegna's compensation increased nearly 300% 
        in just four years.
        --Lthe names of the 1,700 companies used in the study 
        were not available, according to the consulting firm, 
        because their work was based on information collected 
        from other studies. In addition to questioning the 
        inherent validity of an analysis based on so many 
        unknown companies, the Staff note that without such 
        information, the relative affect of cost-of-living 
        differentials between BCBSM and the other companies 
        used in the comparison cannot be determined.

    The Staff also described questionable expenses in the area 
of corporate marketing activities:

        --Ldocuments subpoenaed from the Baltimore Orioles 
        baseball organization show that BCBSM leased a skybox 
        at the new Oriole Park at Camden Yards, at a cost of 
        $300,000 for the years 1992-1995 ($75,000 per annum). 
        The skybox suite includes 14 seats, two color 
        televisions, private bathrooms, heating and air 
        conditioning, a wet bar with bar stools, a 
        refrigerator, private elevator access and an internal 
        telephone to call caterers. The skybox fee was 
        exclusive of food or drink, which cost the Plan 
        anywhere from several hundred dollars to over $1,400 
        per game.
        --Lin 1990-1992, BCBSM or one of its subsidiaries 
        sponsored hospitality tents for the Preakness horse 
        race at Pimlico Race Course in Baltimore. In 1992, 
        BCBSM paid $32,500 to rent two tents adjacent to the 
        Preakness Winner's Circle, complete with astroturf, 
        dining tables and chairs for 150 guests, and four 
        closed-circuit television monitors displaying the races 
        of the day. More than $32,000 in additional expenses 
        were incurred on this occasion for catering, printing, 
        flower arrangements, gifts, and a photographer.
        --Lat Plan expense, five senior executives--the CEO, 
        the General Counsel, the Corporate Counsel, the 
        Director of Community Relations, and the Chief 
        Operating Officer--held memberships in one of 
        Baltimore's most exclusive restaurants, The Center 
        Club. The restaurant charges an initiation fee of 
        $1,250 per member, plus annual dues of $650 per member. 
        These five BCBSM executives, according to subpoenaed 
        records, spent a total of almost $9,000 at The Center 
        Club on lunches, dinners, flowers, and guest fees in 
        1992 alone.
        --LBCBSM purchased a corporate membership in the Cave's 
        Valley Golf Club in Owings Mills, Maryland. The 
        initiation fee was $75,000 and annual dues for 1991 and 
        1992 were $2,800 and $3,300, respectively.
        --Lin 1988, BCBSM paid $182,000 for 64 all-expenses-
        paid packages to the Olympics in Calgary, Alberta and, 
        in 1992, at a cost of $21,000, four all-expenses-paid 
        packages to the Barcelona Olympics were purchased. The 
        four Barcelona packages were purportedly given to a 
        major Plan account, Baltimore Gas and Electric Company, 
        when BCBSM's CEO decided not to make the trip.

    BCBSM's response to the above was expressed in Mr. 
Sardegna's statement for the Record as follows:

          These types of activities * * * provide BCBSM a 
        vehicle to market products to its customers and conduct 
        other business activities. As one of Maryland's large 
        employers, BCBSM has a corporate responsibility to 
        enhance the business climate. Both the Orioles and the 
        Preakness represent significant revenue to the State.

    BCBSM also made sizeable charitable contributions to 
Baltimore area organizations with no apparent healthcare-
related purpose. In recent years, for instance, BCBSM has made 
large donations to the Baltimore Symphony ($125,000), the 
National Aquarium ($53,000), the Center Stage ($37,000), the 
Walters Art Gallery ($18,000), and the Baltimore Museum of Art 
($17,000).
    Mr. Sardegna also expressly indicated that BCBSM is 
involved in these kinds of activities because its competitors 
do the same thing, a point which was disputed by Commissioner 
Donaho:

          Senator NUNN. Commissioner, what about the argument 
        that this is a competitive world, that they [BCBSM] are 
        basically competing, * * * [and] if they do not compete 
        for entertainment and that kind of thing, they will 
        lose business and the policyholders will suffer?
          Commissioner DONAHO. * * * I regulate 108 other 
        domestics and 1,400 licensees, and I know of only one 
        other insurance company that has a skybox. * * * I do 
        not know of any company offhand * * * that exceeds the 
        Blues in similar activities.

    Moreover, regarding the contributions to the Baltimore 
Symphony, Symphony officials told the Staff that Sardegna 
declined to have BCBSM's name appear on a marble wall in the 
lobby of Symphony Hall in Baltimore, even though it was 
entitled to do so for having donated more than $100,000. 
Regarding a $25,000 corporate gift, Sardegna wrote the Symphony 
Society's President in August, 1991 insisting that ``this 
contribution is not to be mentioned in any printed material.'' 
These requests for anonymity appear to be inconsistent with 
Sardegna's claim that BCBSM makes charitable contributions 
because their competitors do and because the company wants to 
be recognized in the community as a supporter of the arts.
    The Subcommittee believes that the key question that arises 
in connection with BCBSM's entertainment expenses and 
charitable contributions is how they benefit the policyholders. 
In 1987, for example, Mr. Sardegna accompanied the Baltimore 
Symphony on a trip to Russia at the Plan's expense--an 
occurrence which prompted the following pointed exchange at the 
hearing:

          Senator NUNN. Did the Plan pay for you to accompany 
        the Baltimore Symphony to Russia?
          Mr. SARDEGNA. Yes, it did, Senator.
          Senator NUNN. What was the business purpose of that 
        trip * * *?
          Mr. SARDEGNA. The business purpose was that there 
        were a significant number of businessmen who went with 
        the Baltimore Symphony and I went along with them.
          Senator NUNN. And all those business people had their 
        companies pay for it and deducted the expenses?
          Mr. SARDEGNA. * * * I do not know, Senator. * * *
          Senator NUNN. But you do not have any trouble 
        justifying that as a business purpose? I do not mind 
        you going to Russia with the Baltimore Symphony, but 
        you make a pretty good salary * * * [so] why could you 
        not pay for it out of your own pocket?
          Mr. SARDEGNA. Senator, in hindsight, I probably * * * 
        should have made a different decision.

    In the area of travel, in 1991 alone BCBSM spent over $2.8 
million. Though BCBSM conducts business solely within the State 
of Maryland, this included trips by its executives to 
Singapore, Hong Kong, London, Tokyo, Osaka, Seoul, Amsterdam, 
Brussels, and Bangkok. BCBSM travel expenses also included 
corporate functions held outside Maryland. For example, while 
special events to honor outstanding marketing division 
employees were held at a local restaurant in earlier years, in 
1991 and 1992 the ceremony was held at the Hilton Head resort 
in South Carolina. Subpoenaed documents included receipts for 
$10,000 in expenses for ground transportation and some $46,000 
for air transportation.

           2. Inadequate Oversight by the Board of Directors

    BCBSM's Board of Directors displayed an apparent 
unawareness of and/or insensitivity to its primary fiduciary 
responsibility to the Plan's subscribers. Arguably most 
important among the Board's problems in this regard are the 
inherent questions raised by Carl Sardegna's having served 
simultaneously as the Plan's CEO, President and Chairman of the 
Board. In a July 29, 1992 letter to the Governor, Commissioner 
Donaho stated:

          I am quite aware of your confidence in those Board 
        members of BCBSM with whom you have had long 
        experience. * * * The binder I gave you on July 3rd 
        last demonstrates, however, the many instances in which 
        Blue Cross management has not only failed to comply 
        with regulation and to notify us, but also failed to 
        keep the Board informed.

    Mr. Sardegna's successor as Board Chairman, Frank Gunther, 
in a letter to then Chairman Nunn following the Subcommittee's 
hearings formally acknowledges that the Board had not been 
fully apprised of many of the actions taken by Mr. Sardegna and 
his management team. He points out that ``while the Board knew 
the bottom line financial condition of the company, the method 
of presenting the results was always `spun' to highlight the 
positive and ignore the negative.'' Concerning BCBSM's poor 
provider and consumer service record, he concedes that although 
the Board understood that there were problems in these areas, 
it was not aware how ``acute'' they were.
    Management also failed to fully inform the Board of the 
BCBS Association's concerns about and actions regarding BCBSM's 
operations and financial condition, as confirmed by Mr. 
Gunther:

          Of most concern to the Board members was the fact 
        that until the second week in November, when I received 
        a copy of a letter from the Blue Cross and Blue Shield 
        Association regarding their monitoring of the Blue 
        Cross of Maryland, the Board was not aware that Mr. 
        Sardegna had submitted a plan to the Association to 
        improve the company's surplus, liquidity and service 
        with specific goals and timeframes. While we had been 
        told that the Association was monitoring Blue Cross, we 
        were led to believe that that monitoring was business 
        as usual. We were not aware of the specifics of the 
        plan of recovery with the Association or even that it 
        existed.\33\
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    \33\ Reliable sources advised the Subcommittee staff that the 
Board's discovery of this apparent deception on the part of Mr. 
Sardegna was the ultimate act that led to his ``resignation'' on 
December 4, 1992.

    To their discredit, Board members did participate in 
BCBSM's successful effort to forestall a 1991 management audit 
ordered by Commissioner Donaho. Three BCBSM Board members 
visited him in an attempt to persuade him to allow the Plan to 
substitute its own study. They justified their request by 
suggesting that a study initiated by the Insurance Division 
``would be an embarrassment and harmful to the image of the 
Blues.'' Some Board members also participated in BCBSM's 
efforts to circumvent the Commissioner by going directly to the 
Governor's staff and the Governor himself. According to the 
Commissioner, the study substituted by BCBSM failed to address 
seven of the eleven key concerns in his original proposal.\34\
---------------------------------------------------------------------------
    \34\ See related discussion below p. 39.
---------------------------------------------------------------------------
    The Board also failed to adequately oversee the Plan's 
operations and protect the subscribers' interests in its 
handling of salary and compensation issues. For example, the 
Board played a direct role in approving the excessive executive 
salaries and bonuses described above. Indeed, the Board 
determined Sardegna's $850,000 compensation package for 1991, 
as well as the package for the more than 40 top-level 
executives earning more than $100,000. The Board's actions in 
this regard were at best irresponsible, given the fact that the 
Plan was experiencing severe financial problems and 
subscribers' premiums were being increased substantially.\35\
---------------------------------------------------------------------------
    \35\ At the time of the hearing BCBSM Board members were annually 
receiving total compensation of almost $20,000 (an $8,000 stipend, plus 
$800 each for 12 monthly Board Meetings, and an additional $400 for 
Board Subcommittee Meetings). This amount, according to the BCBS 
Association, is more than double the average ($9,600) for directors of 
all BCBS Plans.
---------------------------------------------------------------------------

           3. Inadequate Regulation by the Insurance Division

    The testimony presented to the Subcommittee regarding the 
regulation of BCBSM reveals a pattern of problems similar to 
those described in connection with the failed West Virginia 
Plan. While the Maryland Insurance Division was generally 
informed about BCBSM's financial and management difficulties, 
its actions in response were at various times insufficient and/
or wholly ineffective. As in West Virginia, these failings were 
essentially the result of BCBSM's ability to block and evade 
regulatory efforts and/or the Division's inability or 
unwillingness to take appropriate action when necessary.
    For example, according to documents cited by the 
Subcommittee staff, a partially completed 1988 financial 
examination of BCBSM was suspended, ``as a matter of courtesy 
to BCBSM.'' This examination had been ordered by the then-
Commissioner in response to the huge losses reported by the 
Plan for the previous two years. The Commissioner had briefed 
the Governor on the examination in a March, 1988 memo in which 
the possibility was raised that if BCBSM's losses continued at 
the same rate, the Plan would be insolvent by the coming Fall. 
The examination's preliminary results in fact showed that, as 
of the end of 1987, BCBSM was already statutorily insolvent by 
virtue of having achieved a deficit position of $1.2 million. 
The decision to postpone the examination was made by the 
successor to the Commissioner who originally ordered it, over 
``the strong protestations'' of an Assistant Commissioner.
    Similarly, BCBSM successfully used its considerable 
political influence to see that a review of Plan operations 
being conducted by its own consultant was substituted for the 
independent management audit called for by the Commissioner in 
January, 1991. The call for this latter audit was in response 
to BCBSM's unremitting management and financial problems and, 
moreover, was expressly authorized by language in a bill passed 
by the Maryland Legislature.\36\
---------------------------------------------------------------------------
    \36\ In a May 13, 1991 letter to Commissioner Donaho, State 
Representative Timothy F. Maloney, Chairman of the Budget Subcommittee 
that was the source of the relevant language in this regard, affirmed 
that BCBSM was in fact a proper subject of an Insurance Division-
sponsored management audit as follows: ``John, I'm glad you're going 
full steam ahead with the management audit and hope you'll keep me 
posted on its progress. Blue Cross/Blue Shield needs a major 
overhaul.''
---------------------------------------------------------------------------
    According to documents cited by the Staff, after the 
Commissioner issued a Request for Proposals in 1991 regarding 
the management audit of BCBSM, ``Carl [Sardegna] subsequently 
worked hard to head off that audit, in part by hiring Booz 
Allen to do its own management audit of the Plan.'' Plan 
officials and representatives met with the Commissioner in an 
attempt to convince him to allow the substitution of their own 
study for the Division's proposed audit. On a number of 
occasions Plan officials and representatives tried to 
circumvent the Commissioner by taking their case directly to 
the Governor's then-Chief of Staff and the Governor himself. 
BCBSM President Sardegna, for example, had discussions with the 
Governor in which he argued that the Insurance Division's 
proposal was beyond the Commissioner's authority.
    As a result of these activities, the Governor first began 
to question the Commissioner's proposal and then, despite the 
latter's strong arguments in opposition, ultimately sided with 
BCBSM. According to the Commissioner, ``he [the Governor] was 
of the view that Blue Cross should be given the opportunity to 
undertake its own study.'' Based on the Governor's position, 
the Commissioner decided not to award the contract for the 
management audit.
    The Subcommittee has several concerns regarding this 
episode. First, it underscored the Commissioner's vulnerability 
to outside interference and weakened his ability to respond to 
future challenges to his legitimate authority. Second, not only 
was the Commissioner compromised, but the Legislature's intent 
in authorizing him to require such audits was also 
circumvented. Finally, the substitution of BCBSM's study for 
the State audit negatively affected the regulatory objectives 
that had prompted the Commissioner to order the audit in the 
first place. As the Staff noted:

        --Lthere were major differences in approach between the 
        Plan consultant's study and the Commissioner's proposed 
        management audit; e.g., the former was based on a top-
        down, strategic planning approach that would fail to 
        generate sufficient information on BCBSM's day-to-day 
        operations and management's involvement therein.
        --Lon a number of key issues, such as executive 
        compensation and valuation of subsidiary business, the 
        Plan's study relied on work by other consultants that 
        had been performed for purposes unrelated to those 
        stipulated in the Commissioner's proposed audit.
        --Lthere is reason to suspect the objectivity of the 
        Plan's study, since one of the consultants involved has 
        admitted that he has known Carl Sardegna for years and 
        has done numerous other reports for a company where Mr. 
        Sardegna was formerly employed. In addition, while this 
        same consultant claimed that his firm's work in behalf 
        of BCBSM was the result of a competitive bid process, 
        there was no evidence of this and the consultant could 
        not produce any evidence of an actual bid (including 
        price) by his firm.
        --Lto the extent that the usefulness of BCBSM's 
        substitute management review depended upon the timely 
        receipt of a finished product, it is notable that the 
        Commissioner did not receive a copy until nearly a year 
        (July, 1992) after the study was completed in 
        September, 1991. In the intervening period, the 
        Commissioner made at least two requests to obtain the 
        study and only finally received it after testifying 
        before this Subcommittee and after a Committee of the 
        Maryland Legislature determined to hold its own hearing 
        on BCBSM.

    The Subcommittee received testimony on other problems 
encountered by the Insurance Division in its efforts to oversee 
the Plan's activities. For example, all five of the 
Commissioners who headed up the Division between 1981 and 1992 
confronted problems with the establishment and operation of 
for-profit subsidiaries. The Acting Commissioner for the period 
late-1987 to mid-1988 stated that it was only by chance that 
one of her examiners happened on a BCBSM flowchart that listed 
a number of subsidiaries about which she had no knowledge. The 
Acting Commissioner became so frustrated by this situation that 
she issued an Order on March 30, 1988, which required all non-
profit health service plans to provide the Division with 30 
days advance written notice of any new transactions, ventures, 
or acquisitions.
    However, even with this 1988 Order in effect, the Plan 
failed to comply. The Subcommittee reviewed charts which 
compared organizational information provided by BCBSM in annual 
financial statements submitted to the Insurance Division, with 
flowcharts obtained by the Subcommittee pursuant to its 
subpoena of Plan documents. The information received by the 
Subcommittee was clearly more detailed than that provided to 
the Division and, indeed, revealed subsidiary operations that 
were not listed on the financial statements filed with the 
regulators. In effect, more than three years after the Order's 
issuance, the Division was still in the dark about some BCBSM 
subsidiary operations--a point underscored by Commissioner 
Donaho's acknowledgement that it was not until he saw the 
Subcommittee's charts that he fully realized that there were 
entities that he had neither heard of nor approved.
    Despite the regulators' constant concerns about BCBSM's 
management and financial problems, their actions display a 
pattern of hesitancy, reluctance, and even a fear of taking the 
difficult, but necessary, actions to deal with them. A former 
Commissioner who, in referring to his concerns upon having 
received BCBSM's disastrous 1986 year-end results stated, ``the 
last thing we needed was for Blue Cross Blue Shield to go belly 
up.'' This type of attitude apparently was the basis for a 
general reluctance on the regulators' part to take decisive 
action.
    For example, the Commissioner who suspended the 1988 
financial examination, even though the preliminary findings had 
shown BCBSM to be statutorily insolvent by $1.2 million, 
testified in deposition that:

          * * * I thought that the position of Insurance 
        Commissioner was three-fold. One was to look at the 
        solvency of the insurance companies, one was to protect 
        the consumers, and one was to implement legislation. 
        Sometimes those three things came into conflict, as it 
        did in this case, where solvency and consumers * * * 
        couldn't [be] serve[d] simultaneously.

          Secondly, $1.2 million is just not a lot of money in 
        insurance parlance. * * * The bottom line appeared that 
        the financials were turning around and my job was to 
        serve and protect the consumers of the State of 
        Maryland, and how do I best do that. I didn't see that 
        there would be any service to them, shutting down the 
        Blues, so I didn't. It really wasn't a complicated 
        decision.
          * * * * *
          Now, if you think about it, a company whose 
        financials are improving, who within a year or two is 
        going to break even, it doesn't make sense to take them 
        down when, in fact, the situation is turning around, 
        and * * * they were doing what they should have been 
        doing. * * * They were willing to be monitored closely. 
        It would have been foolish to shut them down. You would 
        have shut them down and three weeks later or six months 
        later started them up again, with what? They would have 
        lost a lot of their membership by then. That's not good 
        strategy, either for the consumers or the company.

    Finally, in an August 11, 1992 letter to the Governor, 
Commissioner Donaho explained:

          * * * I think it would be doing our citizens a 
        disservice if, at this time we declared Blue Cross/Blue 
        Shield insolvent and put them into some kind of 
        conservatorship.

          As a clear contrast to the ease of replacing both 
        property and casualty and life coverage in the event of 
        insolvency * * *, a Blue insolvency would create a 
        significant market shortage, as there would not be 
        health insurance capacity in this State to cover the 
        number of citizens who would be out of insurance. * * * 
        There is not current capacity in this State to insure 
        those people, nor is there guaranty fund capacity.
          * * * * *
          In addition, the cash flow would severely decrease as 
        the non-risk business would be easily moved elsewhere. 
        * * * It could be expected that many providers would 
        stop accepting a citizen's Blue Cross/Blue Shield 
        cards, as they would not think they would get paid for 
        services. We would see a significant increase in 
        expenses as attorneys, accountants, auditors, actuaries 
        and other consultants would be brought in to look at 
        various aspects of the operation. Considerable Division 
        time and energy would be spent on the issue detracting 
        from our overview of other companies. While this was 
        happening, a continual deterioration of the Blues would 
        take place lessening its value to an outside source who 
        will be willing to take it over. I do not see any 
        positive purpose the above scenario would have for our 
        citizens.

    The Division's attitude, as reflected in the statements 
cited above, suggests that BCBSM has become too large a 
presence in the State for the regulators to treat it as they 
would any other domiciled insurer. The prevailing attitude 
seemed to be that BCBSM was either too big to fail and/or too 
big to be taken down. This may have unwittingly resulted in the 
masking or perpetuation of certain Plan weaknesses. For 
example, the Staff mentioned decisions by several Commissioners 
to allow favorable consideration of BCBSM financial 
transactions which, if treated otherwise, could have negatively 
impacted its overall financial position, including:

        --Lin 1988, BCBSM was allowed to increase the value at 
        which it carried its Joppa Road headquarters on its 
        books from about $6 million to $12 million;
        --Lin 1988, BCBSM was allowed to increase the value at 
        which it carried its Columbia HMO by $23 million;
        --Lin 1989 or 1990, in connection with the resumption 
        of the suspended 1988 financial examination, the 
        regulators recognized as an admitted asset a 
        questionable $5 million receivable from BCBSM's Willse 
        subsidiary. This action, in turn, was one of the 
        primary factors that helped to turn the preliminary 
        examination finding of a $1.2 million deficit into a 
        surplus;
        --Lin 1992, despite their own stated ``reservations,'' 
        the regulators accepted a valuation of $29 million on 
        BCBSM's Carefirst HMO; and,
        --Lin 1992, BCBSM was allowed to carry as admitted 
        assets some $42 million in questionable receivables due 
        from its subsidiaries and $24.2 million in questionable 
        Pertek subsidiary assets.\37\
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    \37\ As a result of these and other exceptions from accepted 
statutory accounting rules approved by the Commissioner, BCBSM's 
reported net worth, i.e., the excess of its assets over its 
liabilities, may have been overstated by as much as $103 million at 
year-end 1991. Closer scrutiny of these exceptions might have raised 
questions about their validity and, in turn, BCBSM's true financial 
condition.
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   4. Inadequate Oversight by the Blue Cross/Blue Shield Association

    The testimony received regarding the BCBS Association's 
oversight of BCBSM shows a pattern of activity similar to that 
encountered in the case of the West Virginia Plan. On the one 
hand, the Association carried out a variety of evaluation and 
monitoring functions that effectively tracked the Plan's 
operations and performance. For example, reflecting its serious 
problems, beginning in 1988, BCBSM was placed on conditional 
status because of its failure to meet the Association's reserve 
and liquidity requirements. The Plan remained under this status 
until 1990, and then, pursuant to a change in the Association's 
monitoring system, was continued at a new ``concern'' stage 
because of its ongoing failure to meet certain financial and 
marketplace membership requirements. At the time of the 
Subcommittee's hearing, BCBSM was still being monitored under 
this new system. Also, the Association determined that BCBSM 
has been at or near the bottom of all BCBS Plans in claims 
processing and subscriber service since 1988.
    On the other hand, the Association did not share any of its 
considerable knowledge on BCBSM operations and deficiencies 
along these lines with the Insurance Commissioner. The 
Insurance Division needs to have access to all necessary 
documentation and material to help it make fully informed 
regulatory decisions. In this sense, the Association was remiss 
in failing to share the important information it had concerning 
BCBSM's operations and financial condition, even if the 
latter's problems were demonstrably less severe than those of 
the West Virginia Plan.

                               D. Effects

    As a result of the Plan's problems, BCBSM subscribers were 
confronted with diminished coverage and/or a denial of promised 
benefits. Commissioner Donaho testified that in 1991 alone his 
office received about 1,000 complaints from subscribers, the 
majority of which concerned inefficient claims handling, delays 
in payment, or unjustifiable denial of benefits. The 
Subcommittee Staff examined some of these complaints, focusing 
on those involving benefits denials, and found that the Plan 
was, at best, conservative and, at worst, irresponsible in its 
decisions in this regard.
    In addition to problems with coverage and benefits, BCBSM 
subscribers saw their premiums increase dramatically as a 
result of the Plan's overall difficulties.\38\ Under BCBSM's 
most popular option, the Group Conversion Comprehensive plan, a 
subscriber with a $250 deductible who paid $3,000 for a policy 
in 1988, was paying over $5,800 in annual premiums for the same 
coverage in 1992. In a letter received by the Subcommittee, one 
subscriber expressed his outrage at such increases:
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    \38\ The Subcommittee found that to some extent these rate 
increases were a result of the Plan's mismanagement and operational 
problems. For example, according to press reports cited in the Staff's 
testimony, BCBSM executives admitted that they raised premiums in order 
to cover the $120 million in losses by their Plan's subsidiaries. 
Indeed, in one article, BCBSM's chief legal officer confirms the 
practice of placing the burden of such losses on the subscribers by 
saying, ``the only way you can get it back is through rates. * * * the 
money has got to come from somewhere.'' Similarly, in their January 31, 
1991 letter to Commissioner Donaho, ``A Silent Majority of BCBS 
Employees'' point out that ``the management practices of our company 
have driven rates through the roof. * * *''

          ``These people are operating as a non-profit 
        insurance company with multi-purpose goals for profit. 
        This is an ideal business arrangement because they can 
        always obtain new capital simply by requesting the 
        Insurance Department of Maryland for an increase in 
        their rates and the money comes rolling from their 
        subscribers. The increases that have been granted for 
---------------------------------------------------------------------------
        my premium 65 Policy since October 1982 are obscene.''

    Extensive problems with BCBSM were also described by a 
primary care physician, who testified on his own behalf and in 
his capacity as President of the 600-member Maryland Society of 
Internal Medicine. In his testimony, this physician provided 
detailed accounts of ways BCBSM made it difficult for providers 
to receive prompt payment for services and/or placed burdensome 
and unnecessary administrative requirements on them. Another 
provider, the Director of a Maryland visiting nurses agency, 
described ``coverage * * * reimbursement and other associated 
problems'' with BCBSM, concluding that ``* * * it has reached 
the point that this whole process makes me reluctant to accept 
patients for care, once I find out they have Blue Cross and 
Blue Shield of Maryland.''
    Finally, the Subcommittee also learned that some providers 
and subscribers have for years been routinely denied interest 
owed them as a result of BCBSM's failure to pay claims within 
State-mandated timeframes.\39\ According to a 1991 Market 
Conduct examination of BCBSM by the Maryland Insurance 
Division, in numerous instances the Plan did not meet the 
specified payment timetable and failed to pay interest on 
claims that were not resolved within the stipulated 30 
days.\40\ An interoffice memorandum written by the Plan's 
Corporate Audit Division Director indicates that of $234 
million in total claims paid in 1991, almost 25 percent were 
subject to the interest calculation for having taken over 30 
days to process. Since the Plan has been required by law to 
calculate and pay such interest as of July 1, 1986, the chief 
market conduct examiner estimated that through December 31, 
1991, BCBSM has failed to pay interest on more than one million 
such claims.
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    \39\ Maryland law requires an insurer to acknowledge receipt of a 
claim within 10 working days, and to make payment on it within 15 
working days of receipt of all necessary forms and information. The law 
also requires a non-profit health service plan to pay interest on the 
amount of a claim that remains unpaid 30 days after it has been filed.
    \40\ Previous Market Conduct examinations turned up similar 
problems in BCBSM's claims processing and customer service. For 
example, an October 1986 report for the period December 1, 1984 to June 
30, 1986 stated that, ``the company's claim of processing claims within 
15 days is a distortion.'' According to the examiners, the Plan's 
practice was to assign several different identification numbers to the 
same claims thereby masking the true processing time for the claims.
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                     THE NATIONAL CAPITAL AREA PLAN

                       A. Background/Organization

    Group Hospitalization and Medical Services, Incorporated 
(GHMSI), doing business as Blue Cross and Blue Shield of the 
National Capital Area (BCBSNCA) was established pursuant to the 
1985 merger of Group Hospitalization Inc. and Medical Services 
of the District of Columbia. This merger was accomplished under 
the auspices of the U.S. Congress and the new entity retained 
the exemption from insurance regulation by the District of 
Columbia that Congress had granted its predecessor in 1939. 
GHMSI/BCBSNCA serves over one million subscribers in the 
District of Columbia, Prince Georges and Montgomery Counties in 
Maryland, and Arlington, Alexandria and part of Fairfax County 
in Virginia. As of 1991, it had annual revenues in excess of 
$1.5 billion, employed over 3,300 people, and ranked thirteenth 
among the BCBS system's 73 Plans in annual premium income.
    Like its West Virginia and Maryland counterparts, from the 
time of its establishment in 1985, GHMSI/BCBSNCA's corporate 
structure embraced three kinds of operational entities: those 
involved in underwriting and servicing its core Blue Cross/Blue 
Shield insurance business; for-profit subsidiaries with some 
health-related purpose; and, for-profit subsidiaries with no 
health-related purpose. By December 1992, the company was 
responsible for the operations of a total of 45 wholly owned 
and/or majority-owned or controlled subsidiaries. From the time 
of the 1985 merger until mid-1992, effective control of GHMSI's 
decision-making apparatus and overall operations rested in the 
hands of its President and CEO, Joseph P. Gamble.

                          B. Financial Profile

    For the eight-year period, 1985-1992, GHMSI incurred net 
losses of about $182 million and its net worth declined 
drastically from more than $180 million at the end of 1985 to a 
projected negative $25.1 million as of December 31, 1992. 
During this period, losses were reported in five of the eight 
years, as follows: $42 million (1986); $66 million (1987); $58 
million (1988); $7 million (1991); and, a projected $38 million 
for 1992. In the three years where gains were made, either the 
amounts earned were comparatively small--$2 million and $3 
million for 1989 and 1990, respectively--or, in the case of 
1985, the $25 million amount reflected the fact that the Plan's 
newly established subsidiaries had not yet incurred the 
sizeable and continuous losses they subsequently experienced.
    A review of GHMSI financial data also established that:

        --Lthe Plan's reserves declined $166 million between 
        year-end 1985 and year-end 1988 and, from 1991 to 1992, 
        according to projections, will decline again by some 
        $57 million (from $32 million to -$25.1 million).
        --Lthe Plan's losses between 1985-1991 occurred despite 
        the fact that premium income from its core BCBS 
        business almost doubled (from $808 million to $1.5 
        billion), while the total number of subscribers covered 
        increased by only 100,000 (from 1.1 million to 1.2 
        million).
        --LGHMSI's more than $100 million in cumulative losses 
        from its subsidiary operations have offset operating 
        gains from its BCBS core business; e.g., projected 1992 
        financial results show the latter's $8.1 million gain 
        being overwhelmed by nearly $50 million in subsidiary 
        losses. Financial data for 1989, 1990, and 1991 show 
        the same pattern of positive core business operating 
        results being offset by subsidiary losses.

                            C. Problem Areas

    Many of the same key factors associated with the West 
Virginia Plan's failure and BCBSM's serious financial decline 
were present in GHMSI and helped to bring it to the brink of 
financial disaster. Specifically, the Subcommittee found 
evidence of the four broad problem areas that were identified 
in connection with the West Virginia and Maryland Plans: 
mismanagement; inadequate oversight by the Board of Directors; 
inadequate regulation by the Virginia, Maryland, and District 
of Columbia Insurance Departments; and, inadequate oversight by 
the Blue Cross/Blue Shield Association.\41\
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    \41\ GHMSI did not dispute the Subcommittee's findings in this 
regard. In its prepared remarks, GHMSI testified that ``turn-around 
efforts initiated * * * in early 1992, in combination with the 
subsequent scrutiny of the Permanent Subcommittee on Investigations, 
has helped GHMSI to refocus its mission of fulfilling the interests and 
needs of its subscribers.'' This testimony goes on to say that:

    ``The process by which GHMSI has come to chart a new course has 
been a chastening experience for the enterprise and its trustees, 
officers and employees. Some of the facts that have come to light have 
been embarrassing. * * * In this testimony, GHMSI acknowledges 
responsibility for many of the problems that confront it today. 
Mistakes unquestionably were made.''
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                            1. Mismanagement

a. A Proliferation of Subsidiaries
    A significant part of GHMSI's management problems were a 
direct result of what one of the latter's former executives 
referred to as a ``frenzy of investments'' in a far-flung and 
highly complex network of for-profit subsidiary operations. Two 
years before the 1985 merger that established GHMSI, its 
predecessor, Group Hospitalization Inc., had just two 
subsidiaries. By 1992, in accordance with a strategic plan 
instituted by GHMSI's President and CEO, Joseph Gamble, the 
number of subsidiaries had grown to 45. Over the years, GHMSI 
has incurred cumulative losses in excess of $100 million from 
these subsidiaries.
    These enormous losses can be attributed largely to 
extensive mismanagement on the part of GHMSI and subsidiary 
officials. In a written statement for the record accompanying 
the testimony of GHMSI's President and CEO, Benjamin Giuliani, 
the following observations are made:

          In less than five years, GHMSI was transformed from 
        an organization focused on D.C. with a single basic 
        business to one with multiple subsidiaries and business 
        interests around the world. As the result of the 
        critical self-examination in which GHMSI has been 
        engaged for almost a year, it now must be conceded that 
        GHMSI simply did not have in place a management 
        structure capable of operating such a far-flung 
        undertaking.
          * * * * *
          A number of observations can be made concerning the 
        subsidiaries, particularly those that did not directly 
        complement the core business. Too often, GHMSI embarked 
        upon subsidiary ventures without a comprehensive 
        understanding of the business, a clearly defined 
        business strategy or objective management criteria for 
        measuring whether the subsidiary was meeting its 
        purpose.
          * * * * *
          The deficiencies in management were further 
        exacerbated by the absence of adequate management 
        controls.

    The Subcommittee found a long list of specific management 
deficiencies that contributed to the dismal performance of most 
GHMSI subsidiary and affiliate operations. For example, 
inadequate analysis was performed before subsidiaries or 
affiliates were created and, in some cases, limited or no ``due 
diligence'' examinations were made before sizeable financial 
and human resources were committed to their development. In the 
July, 1987 affiliation with the Blue Cross Plan of Jamaica 
(BCJ), GHMSI provided BCJ with $5 million in capital without 
having performed the kind of in-depth, on-site review warranted 
by an investment of this size. It was not until 1990 that an 
in-depth audit was conducted, revealing dozens of instances--
including some that preceded the 1987 affiliation--of gross 
mismanagement and questionable legal practices by former and 
then-current BCJ employees. GHMSI sustained losses of about $4 
million from its operations between 1989-1991, and lost $3.5 
million of its $6.5 million capital investment.
    In addition, after companies had been established, in many 
cases GHMSI subsidiary and affiliate managers focused almost 
entirely on efforts to generate revenue--particularly via 
clients with large numbers of actual or potential enrollees--
while paying little, if any, attention to rising overhead, 
increased liabilities, and mounting losses. Many subsidiaries' 
poor performance also reflected the fact that they were 
ventures in which the management had little or no experience. 
As one executive stated, ``they flew by the seat of their pants 
and utilized the deep pockets of GHMSI to support their 
exuberant inexperience.'' GHMSI's record statement bluntly 
conceded that:

          * * * it is now apparent that Mr. Gamble experienced 
        difficulty in selecting the right people to operate the 
        subsidiary businesses. People often were transferred 
        from a Blue Cross and Blue Shield job to start up one 
        of the subsidiaries or, in a few instances, they were 
        hired from the outside without the requisite business 
        expertise and management skills to operate a new 
        business.

    The Subcommittee also found that no matter how poorly run 
or unprofitable a subsidiary was, its senior executives 
operated with the attitude that they could always rely on 
continued funding from GHMSI. A former Vice-President of the 
National Capital Administrative Services (NCAS) subsidiary, for 
example, stated that when he raised questions about company 
expenditures, its President often responded with words to the 
effect--``Don't worry, it's the Plan's money.'' This attitude 
toward GHMSI's seemingly endless deep-pocket--``rubber money,'' 
as the former Vice President referred to it--was well-known 
within NCAS, according to other former employees. In a number 
of subsidiary financial statements, the auditors noted that the 
continued existence of the subsidiary depended on GHMSI's 
financial backing.
  b. Internal Control Deficiencies
    The testimony also confirmed extensive accounting and 
internal control problems in GHMSI and its subsidiaries and 
affiliates. GHMSI's own statement for the record acknowledges 
that:

          Financial reporting for the subsidiaries was 
        inadequate for an enterprise of GHMSI's size. 
        Particularly in 1990 and 1991, reports to the Board 
        indicating that the subsidiaries had ``turned the 
        corner'' were later amended at year end to show 
        dramatic losses. The need to improve accountability for 
        variances between actual and projected operating 
        results became clear. The inability to resolve that 
        problem continued to plague the enterprise [i.e., 
        GHMSI], however, until as late as the first quarter of 
        1992.

    The Staff testified to specific accounting and internal 
control problems in the subsidiaries' operations, including:

        --LEMTRUST (a joint venture between BCBSNCA and the 
        Fairfax Hospital holding company): management failed to 
        reconcile its corporate and trust accounts on a regular 
        basis, because internal controls were lacking. Among 
        other things, this facilitated the questionable 
        practice of paying one client's claims with funds 
        provided by other clients to cover their insured's 
        claims.
        --LThe International Division: the exact amount of 
        losses incurred by the subsidiaries operating under it 
        was hard to calculate, since the International Division 
        did not keep even the most rudimentary records until 
        five-and-a-half years after it started. The Division's 
        Chief Financial Officer told the Staff that even the 
        most basic financial control function--the tracking of 
        premiums received and claims paid--applicable to its 
        subsidiaries' joint ventures with foreign insurance 
        carriers ``was not standardized or well thought out 
        from the beginning.'' The deficiencies in this regard 
        continue to haunt GHMSI today, since lacking such 
        complete and/or accurate information, no one has been 
        able to determine precisely what has happened to these 
        lines of business and the extent of GHMSI's liability 
        therein.
        --LNCAS: audits in 1990 and 1991 found overly 
        complicated, confused, and/or wholly deficient 
        accounting systems for billing and calculating actual 
        costs of work performed and services provided. The 
        latter finding became especially problematic when, 
        using inaccurate and faulty data traceable, in part, to 
        this cost accounting deficiency, NCAS filed a claim for 
        hundreds of thousands of dollars in added reimbursement 
        beyond a U.S. Agency for International Development 
        contract's fixed-price stipulations. Also, in response 
        to a written question from the Staff on these problems, 
        NCAS' former Director of Finance and Administration 
        simply said that ``there were too many examples of bad 
        accounting to detail.''
        --LPROTOCOL (an entity established to sell health 
        insurance to foreign embassies and businesses in 
        Washington, D.C.): a 1991 GHMSI internal audit revealed 
        serious problems including: lack of written policies 
        and procedures; lack of written contracts; problems 
        with accounts payable and receivable, and journal 
        entries; three different billing systems used for the 
        B'nai B'rith account; and the inability to accurately 
        assess underwriting gains and losses for paid claims. 
        The auditors concluded that Protocol's accounting 
        procedures were not in keeping with GHMSI intercompany 
        practices and did not provide a clear understanding of 
        the company's financial position.
  c. Excessive Salaries and Business Expenses
    The Subcommittee's review of the corporation's salary 
structure, fringe benefits, and other administrative expenses 
yielded results much the same as those encountered in the West 
Virginia and BCBSM Plans. In brief, excessive spending and 
outright waste were rampant throughout GHMSI, including: 
excessive salaries and substantial fringe benefits for 
executives; exorbitant and questionable travel and 
entertainment expenses; and, unnecessary charitable 
contributions. These expenses occurred at a time when GHMSI/
BCBSNCA subscriber rates were increasing,\42\ benefits were 
decreasing, and the Plan's overall financial condition was 
deteriorating dramatically.
---------------------------------------------------------------------------
    \42\ From 1988 to 1991, premium rates for a family of non-group 
subscribers more than doubled, from $194 to $410 per month. During this 
same period, rates also nearly doubled for a family covered under one 
of GHMSI's group policies, from $82 to $156 per month.
---------------------------------------------------------------------------
    In the area of executive compensation, President and CEO, 
Joseph Gamble's total salary and benefits increased by more 
than 100% between 1987-1991, from $264,487 to $533,589. 
According to a 1991 BCBS Association survey, Mr. Gamble's 
salary was greater than 80% of the 60 Plan CEOs that responded, 
even though GHMSI/BCBSNCA, with only 1.1 million subscribers, 
was of average size for a BCBS Plan. From 1988-1991, in 
contrast to the 13% increase other Plan employees received, 
salaries and benefits for GHMSI's top eight executives 
(including Gamble) rose nearly 85%. For the most part, these 
major increases in salaries and benefits were approved at a 
time when GHMSI was losing millions of dollars annually.
    The Subcommittee also received evidence of questionable 
domestic and international travel by top executives and other 
GHMSI employees. While reasonable travel and entertainment may 
be a legitimate cost of doing business, the regular use of 
first-class or Supersonic air transportation by some of its 
executives was clearly inappropriate for a not-for-profit 
entity during a time of financial crisis. Equally disturbing 
was GHMSI's use of deluxe accommodations, along with allowances 
for seemingly limitless dining and entertainment expenses. 
Examples of these types of questionable expenditures include:

        --Lover an approximate six-year period (1987-1992), 
        three top GHMSI executives alone incurred a total of 
        more than $1 million for their domestic and 
        international travel. Nearly $450,000 of this amount 
        was for trips by the Plan's President and CEO, Joseph 
        Gamble.\43\
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    \43\ The sheer amount of Mr. Gamble's travel also raises some 
concerns about the affects of his being away from his office for such 
extended periods of time. For example, according to Mr. Gamble's date 
book and expense reports, he traveled extensively for the years 1988 to 
1991. In 1991, the year in which his travel began to decline, records 
indicate that he was away from the home office either on business 
travel or leave for 160 days (44% of the year). In 1990, he had his 
most extensive travel year, wherein he was away 202 days (55% of the 
year). In 1989 and 1988, he was away from the office for 173 and 193 
days, respectively.
---------------------------------------------------------------------------
        --Ltop GHMSI executives flew first-class routinely and 
        at least four of them used the Supersonic Concorde. In 
        terms of frequency, Mr. Gamble was by far the heaviest 
        user, with at least 22 trips over the years.\44\
---------------------------------------------------------------------------
    \44\ Based on their review of GHMSI executives' travel records, the 
Staff determined that when first class or Supersonic travel was used, 
the difference between their cost and the coach fare was charged to a 
separate ``Corporate Account.'' The Staff believe that the creation and 
use of this separate account amounted to a subterfuge by senior GHMSI 
managers to avoid close scrutiny of the excessive costs associated with 
the first-class or Supersonic travel. See also related discussion below 
pp. 52-53.
---------------------------------------------------------------------------
        --Lthere were numerous instances of unnecessarily 
        expensive hotel or lodging costs. For example, Mr. 
        Gamble stayed at the Grand Barbados Beach Resort in 
        1990 and 1992, at a charge of $450 per night and, in 
        1992, a GHMSI/BCBSNCA Vice President spent $635 a night 
        at the Loews Ventana Canyon Resort in Tucson, Arizona.
        --LGHMSI executives went on business trips in which 
        golf, dining or other leisure activities constituted a 
        larger portion of the trip than business activities. On 
        these trips entertainment and leisure activities, such 
        as tours and golf, were often paid for by the Plan.
        --LGHMSI also absorbed unnecessarily large expenses in 
        Plan-sponsored marketing incentive trips to reward 
        employees for superior job performance. Such trips, 
        which took place in each of the last six years, were 
        all-expenses-paid and cost the Plan $1,540,749.
        --Las a fringe benefit to many of its officers, GHMSI 
        paid their initiation fees and partial dues for 
        membership in area golf and other clubs. In some 
        instances, this fringe benefit was taken to extremes, 
        as in the case of the BCBSNCA Vice President who, 
        between 1988 and 1992, submitted $10,573 for golf and 
        golf-related items to the Plan as local business 
        expenses.

    Finally, on the matter of charitable activities, while it 
is difficult to criticize the Plan's good intentions, one 
questions the appropriateness of a non-profit company making 
such contributions at a time when it was losing millions of 
dollars. Indeed, several of the for-profit subsidiaries that 
were making the most generous contributions had continuously 
operated in the red and were in severe financial distress. For 
example, in 1988, the year in which it sustained its most 
serious financial loss (more than $10 million), CapitalCare 
(the Plan's Health Maintenance Organization) made $348,000 in 
charitable contributions. Similarly, while Protocol lost some 
$4.7 million in 1991, it spent $72,000 for charitable purposes. 
Overall, between 1988 and 1992, GHMSI and its subsidiaries 
sponsored events and made charitable contributions amounting to 
nearly $1.8 million.

            2. Inadequate Oversight by the Board of Trustees

    As in West Virginia and Maryland, GHMSI's Board of Trustees 
failed to adequately oversee the Plan's operations and 
management. The Board allowed itself to become an unquestioning 
and compliant rubberstamp body, effectively controlled by 
fellow trustee and Plan CEO, Joseph Gamble. The Board's failure 
along these lines often was a function of the fact that it was 
being misinformed, misled, and/or manipulated by Mr. Gamble.
    The evidence confirmed that the Board was co-opted by the 
management it was charged with overseeing and was negligent in 
the performance of its duties.\45\ With Mr. Gamble's active 
encouragement, the Board typically took a very broad policy 
approach to its job, rarely got involved with the details of 
the company's business dealings, and tended to accept without 
question management's projections, explanations, and decisions. 
For example, Chairman Nunn asked the former Chairman of the 
Board of Trustees, Charles P. Duvall, about the Board's 
involvement in reviewing expenditures:
---------------------------------------------------------------------------
    \45\ Once the Board finally became aware of the Plan's alarming 
financial condition in February 1992, one of their first actions in 
response was to seek advice regarding their own liability. Pursuant to 
the advice they received, their liability insurance was subsequently 
increased from $15 million to $20 million.

          Senator NUNN. * * * Dr. Duvall, did you know about * 
        * * the expenditures, lavish dinners and corporate 
        sponsorship * * *?
          Dr. DUVALL. I didn't know about them at all, Senator.
          * * * * *
          Senator NUNN. Did the Board have any policy about 
        [these] expenditures at all? Did you give any guidance 
        whatsoever to the executives of the company?
          Dr. DUVALL. The Board would have felt [that] this is 
        part of management's prerogative and [the] corporate 
        culture.
          Senator NUNN. So, if management wanted to fly first-
        class all over as a matter of policy, that wasn't a 
        matter for the Board to be concerned with?
          Dr. DUVALL. We didn't concern ourselves with it.\46\
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    \46\ According to some Board members, they were also not always 
aware of other important expenditures, such as compensation. In the 
case of Mr. Gamble, for example, they told the Staff that they did not 
actually know the exact amount of his total compensation, since they 
typically just voted on a percentage increase each year. It is also 
worth noting that Mr. Gamble's compensation increases were based on 
studies done by outside consultants who were hired by and reported to 
him. Only after Gamble received the results of these reports, was the 
Board's Compensation Committee informed of the findings.

    The Board's approach and attendant effects are readily 
apparent in its flawed performance regarding GHMSI's affiliates 
and subsidiaries. With the Board's approval, between January, 
1988 and December, 1992, GHMSI management formed or acquired 
controlling interests directly or indirectly in 28 subsidiaries 
and affiliates. However, while the Board approved these 
actions, it did so without consideration of such basic issues 
as the funding necessary to reach a break-even point or to 
achieve profitability.
    Indeed, based on remarks by Dr. Duvall, it appears that 
until early 1992, the Board was content to merely accept 
management's continual assurances that even though losses had 
been sustained, profits were always just around the corner. 
Regarding the subsidiaries, the Board failed to assure that 
management had: established adequate internal controls to 
monitor and administer their operations; obtained credible 
actuarial data prior to conducting business in foreign 
countries; and hired experienced personnel to operate certain 
ventures.
    In January 1985, at Mr. Gamble's suggestion, the Board 
voted to compensate itself. One trustee who refused this 
compensation said that he felt it was wrong for a non-profit 
corporation to pay its Board, because the Board then ``gets too 
close'' to management. This same trustee observed that after 
the Board members started to receive this compensation, over 
time they stopped acting as individuals and became Gamble's 
``yes men.''
    Some of the Board's problems were a result of 
misinformation from and/or manipulation by Mr. Gamble. 
According to Dr. Duvall, Mr. Gamble would usually brief the 
trustees on an idea and then insist on a vote that same night. 
As a result, another former member complained, the Board never 
had any time to think things over. Dr. Duvall also said Gamble 
periodically asked him to show up a few minutes in advance of a 
scheduled meeting to review the Corporate Account. Under these 
circumstances, there was no time for him to examine the 
supporting documentation, and thus he just reviewed the 
summaries and approved them.
    Mr. Gamble often failed to provide complete information to 
the Board. Although Dr. Duvall said that he saw documentation 
on the proposed affiliation with Blue Cross of Jamaica (BCJ), 
other former trustees said that there were no figures or 
documentation presented at the meeting where it was approved. 
One former trustee remarked that all he remembered about this 
venture was Gamble saying that ``the possibilities (in Jamaica) 
are endless.'' In many cases, Gamble had already established a 
subsidiary or was well on his way to purchasing it before the 
Board was aware or could protest. Likewise, Dr. Duvall noted 
that when subsidiary operations were discussed, Mr. Gamble 
usually focused on the ``big picture'' rather than the finances 
involved.
    Finally, Dr. Duvall did not become aware that GHMSI was 
being monitored by the BCBS Association until Mr. Gamble's 
successor informed him in the Spring of 1992. In fact, Dr. 
Duvall expressed considerable surprise when he learned from the 
Staff that the Association had been monitoring the Plan since 
1988.
    In other situations, Mr. Gamble deliberately misled the 
Board. For example, Gamble told Board members that the Plan 
withdrew from the Medicare Part A contract because it was ``not 
profitable.'' In fact, the Plan had tried very hard to keep 
this Federal contract, but had been removed against its wishes 
for poor performance. As late as May 6, 1990, some three years 
after the loss of this contract, Gamble was still telling the 
Board that the Plan ``got out of the Medicare business in an 
attempt to save money.''
    Gamble also apparently failed to inform the Board of the 
nature of the Plan's Corporate Account:

          Senator NUNN. Did you know about this corporate 
        account where the Concorde charges and other charges * 
        * * were basically accounted for * * *?
          Dr. DUVALL. I knew very little as to the exact nature 
        of the account. * * * I had no idea, Mr. Chairman, that 
        there was any Concorde in there once. That did not come 
        to my attention.

    3. Inadequate Regulation by District of Columbia, Maryland, and 
                     Virginia Insurance Authorities

    With one notable addition--the adverse affects resulting 
from GHMSI's unique status of being exempt from regulation by 
District of Columbia insurance authorities \47\--the regulatory 
difficulties regarding GHMSI are much the same as those 
described in connection with the West Virginia and Maryland 
Plans. Specifically, GHMSI was adept at evading and staving off 
appropriate regulatory efforts directed at it, and the 
insurance authorities with jurisdiction--i.e., Maryland and 
Virginia--were unable and/or unwilling to adequately oversee 
its operations.
---------------------------------------------------------------------------
    \47\ It was not until September, 1992, as a direct result of 
testimony presented to the Subcommittee by the District of Columbia's 
Superintendent of Insurance, that Congress acted to amend GHMSI's 
charter to provide such regulatory authority. The legislation was 
signed into law on October 5, 1992 and, since then, the D.C. Insurance 
Department has been developing the necessary policies and procedures to 
implement it.
---------------------------------------------------------------------------
    As a result of its Federal exemption from regulation by the 
District of Columbia, GHMSI was subject to a patchwork system 
of State regulation that was inherently inadequate. 
Essentially, pursuant to their authority to license insurers, 
Maryland and Virginia regulators have applied their rules to 
that portion of GHMSI's business underwritten within their 
respective States.
    Generally, reliance for the primary oversight of an 
insurance carrier rests with the authorities in the company's 
``State of domicile.'' However, this was not the case with 
GHMSI, as indicated in the testimony of the District of 
Columbia's Superintendent of Insurance, Robert M. Willis, at 
the Subcommittee's July 2, 1992 hearing:

          Superintendent WILLIS. * * * If we can imagine that a 
        raft is floating down a river and on the shoreline 
        stands the Commissioner * * * from the State of 
        Maryland, who has a gaff hook and has the ability to 
        snag the raft before it goes over Niagara Falls. That 
        is the nexus that he has through licensing the Blues 
        relative to the Maryland situation.
          The District of Columbia is situated beyond the edge 
        of the fall, in fact, at the bottom of the fall, and 
        can only report the result of the raft having gone over 
        the falls. * * * By law, I have the statutory duty to 
        tell the Corporation Counsel that I believe that 
        GHMSI--and I am not saying that is the case, but were 
        that the case--has reached the point where the 
        financial condition of the company is impaired. So I am 
        simply in a role of having to report what has happened, 
        that an insolvency has, in fact, occurred. * * *

    As a result of this situation, GHMSI has adeptly played 
Maryland, Virginia, and D.C. insurance regulators against one 
another.\48\ For example, Superintendent Willis observed:
---------------------------------------------------------------------------
    \48\ According to Superintendent Willis, three separate solvency 
standards are applicable to GHMSI: the District of Columbia requires 
life and health companies to maintain a surplus of $1.5 million; 
Maryland requires a minimum of $75,000 surplus or a maximum reserve 
equal to two months of claims and operating expenses; and, Virginia 
requires a minimum contingency reserve for up to 45 days of anticipated 
operating and incurred claims expenses.

          A recent example is the treatment of GHMSI 
        investments by Virginia in its examination process. 
        Under the Virginia laws certain investments are not 
        permitted, but may arguably be permitted under District 
        investment laws. GHMSI has taken the position that 
        District laws apply, irrespective of the language in 
        the Charter stating that GHMSI shall not be subject to 
---------------------------------------------------------------------------
        District statutes regulating the business of insurance.

    In his testimony, the Virginia Insurance Commissioner, 
Steven Foster, added:

    * * * there have been problems in the past trying to 
understand the extent to which GHMSI was or was not subject to 
the District's insurance laws. GHMSI would hire outside counsel 
and would make those kind of assertions

    .Neither Virginia nor Maryland authorities undertook strong 
regulatory action against the Plan until late 1992. In the 
intervening years (1987-1991), GHMSI lost nearly $120 million. 
A 1988 joint Maryland/Virginia quadrennial examination of GHMSI 
for the period 1984-1987 (the last two years of which saw 
losses of nearly $110 million), called for just minor 
adjustments to the Plan's reported financial statement. For 
example, the Plan was not permitted to claim as an asset the $5 
million investment in Blue Cross of Jamaica, and $1.5 million 
in uncollected premiums that could not be substantiated was 
disallowed.
    GHMSI's relationship with State insurance authorities was 
characterized by its ability to evade efforts to oversee its 
operations. Virginia's Insurance Commissioner testified that:

          Commissioner FOSTER. * * * I have never had a company 
        more difficult than GHMSI in trying to get straight 
        factual data regarding the financial condition of that 
        * * * company.
          Senator NUNN. In other words, they have been the 
        worst?
          Commissioner FOSTER. No question. In fact, I have 
        never told any other CEO that I would not meet with 
        that company's CFO [Chief Financial Officer] and 
        general counsel. I told that to this CEO [Mr. Gamble].
          Senator NUNN. When was that?
          Commissioner FOSTER. About three years ago. * * * In 
        the end, Mr. Gamble himself finally came to my office 
        to see if he could help straighten things out a little 
        bit, because his lieutenants, prior to that, just 
        simply were not dealing with us in a straightforward 
        manner.

    A former Maryland Acting Insurance Commissioner said that 
she faced continual problems with GHMSI, the most serious being 
they would never tell her the full truth about their activities 
in her State. She eventually issued an order requiring GHMSI to 
cease subscribing operations in Maryland unless it obtained 
prior written approval from her office. A former D.C. Insurance 
Superintendent observed that any time she asked for even the 
most basic information from the Plan, her requests were 
``politely ignored.''
    GHMSI also used existing requirements to undermine 
regulatory efforts. In one case, GHMSI dramatically increased 
its 1988 year-end reserves from $8.2 million to more than $103 
million by the end of 1989, because of a loophole in the 
Virginia Insurance statute. This loophole, which allowed the 
Plan to carry its headquarters at market value, rather than at 
cost, enabled the company to list the building at $80 million 
more than the value it had reported just a few months earlier. 
Although the law was eventually changed to close this loophole, 
prior valuations conducted pursuant to it were unaffected, and 
thus the Plan continues to carry its headquarters--a highly 
illiquid asset--at market value. The higher valuation also 
effectively masked critical reserve problems:

          Senator ROTH. But it was that reevaluation of the 
        value of the [headquarters] building that really 
        postponed the day of reckoning?
          Commissioner FOSTER. No question. * * * it is no 
        question, Senator, [that] their being able to admit the 
        full market value of the building is what kept them * * 
        * back in 1988, arguably, [from] being under * * * 
        [Virginia's minimum] 45-day [reserve] requirement.
4. Inadequate Oversight by the Blue Cross/Blue Shield Association
    The BCBS Association's dealings with GHMSI suggest problems 
almost identical to those described concerning the West 
Virginia and Maryland Plans. Regarding GHMSI, the Association 
did not:

        --Lobtain the financial information needed to enable it 
        to effectively monitor the Plan after it had been 
        placed on ``conditional'' membership status;
        --Ldetermine the financial condition of GHMSI's 
        subsidiaries and its attendant impact on the Plan as a 
        whole;
        --Lenforce its internal standards regarding GHMSI's 
        conduct and operations; and,
        --Lshare information with regulators and GHMSI's Board 
        of Trustees.

    The Association's failure to obtain adequate information 
partly reflected GHMSI's negative approach to Association 
requests. A member of the Association's Business Performance 
Review office--the entity responsible for plan monitoring--
stated that three words best described GHMSI management's 
behavior in this respect: ``uncooperative, difficult, and non-
disclosure.'' This attitude began with GHMSI's merger-based 
establishment in 1985, in contrast to the positive relationship 
that had existed with its predecessors.
    Prompted by concerns about GHMSI's financial condition, the 
Association in 1988 renewed the Plan's membership on a 
conditional basis. GHMSI's continuing financial problems 
necessitated this ongoing Association scrutiny through the Fall 
of 1992. According to Association officials, their monitoring 
efforts met with incomplete and/or misleading information, 
repeated requests for extensions, and postponements of 
scheduled site visits.
    In January, 1992, the Association developed a ``specific 
monitoring program'' for GHMSI, which was more intensive than 
the normal process and included on-site visits. However, 
Association staff were still denied access to subsidiary 
managers and the information available on their activities, as 
one Association representative put it, was nothing more than 
``what they thought everyone wanted to see.'' Disclosure 
improved after Mr. Gamble's successor, Mr. Giuliani, took 
control of GHMSI's daily operations in July, 1992. Even so, a 
representative of the Association's monitoring team was not 
able to obtain a full understanding of the extent of GHMSI's 
subsidiary activity until December, 1992.
    Despite the Plan's prolonged obstructionist behavior, the 
Association was unwilling and/or unable to force more thorough 
compliance. The Association only began to move toward action in 
the Fall of 1992, more than four years after it had first 
learned of GHMSI's serious financial problems. The 
Association's actions in late 1992, moreover, were not entirely 
self-generated, but rather were in part a response to the fact 
that the Virginia Insurance Bureau had initiated its joint 
quadrennial examination of GHMSI. As GHMSI's Board Chairman, 
Peter O'Malley, stated:

          The National Association is acting under pressure of 
        the regulatory environment we are in and wants to be in 
        a position of moving against GHMSI, if required, before 
        the Virginia Commissioner does.

    Lastly, the Association failed to adequately inform the 
concerned insurance regulators and the GHMSI Board of Trustees 
about the Plan's continuing problems. During the hearings, the 
Virginia Insurance Commissioner emphatically addressed this 
point:

          Senator NUNN. The National Association has a unique 
        relationship with the 73 Blue Cross/Blue Shield Plans 
        that it franchises, but I am told they do not keep the 
        insurance commissioners informed of the restrictions 
        they place on any kind of troubled Plans. Is that your 
        understanding?
          Commissioner FOSTER. * * * I have never been informed 
        of such restrictions. * * *
          Senator NUNN. Does the NAIC [National Association of 
        Insurance Commissioners] have any kind of position on 
        that? Are you advocating or are you requesting that the 
        National Association begin to be more cooperative with 
        * * * [the NAIC]?
          Commissioner FOSTER. Yes, sir. One of the charges 
        that we are suggesting be given to our [Executive] 
        Committee * * * is to look at the appropriate oversight 
        role of the National Blue Cross/Blue Shield 
        Association.

    Similar views were expressed by GHMSI's former Board 
Chairman:

          Senator NUNN. What do you mean by that, if somebody 
        had picked up the phone?
          Dr. DUVALL. If I had heard about many of the things 
        we have discussed in the course of this hearing, some 
        segment of it from a credible witness our source, I 
        think things would have turned out differently. * * *
          I think if the Board could have seen how other Plans 
        ranked through the Association, they might have known 
        earlier what I learned later--that we stick way out 
        like a sore thumb in terms of liquidity. We are not 
        even close, and we are scrambling to make that 
        benchmark.

                            THE EMPIRE PLAN

                       A. Background/Organization

    As of June 1993, with more than 8.2 million subscribers, 
Empire Blue Cross and Blue Shield was the Nation's largest not-
for-profit health insurer and largest of the Blue Cross/Blue 
Shield system's Plans. In 1992, Empire collected about $6.6 
billion in premiums from its policyholders and paid out some 
$6.3 billion in claims. In that same year, it employed more 
than 10,000 people and had an annual payroll exceeding $300 
million.
    Reflecting its longstanding corporate mission--to provide 
affordable health insurance to as large a segment of the 
population as possible--Empire's organizational structure 
consists almost entirely of operational entities involved in 
underwriting and servicing its core Blue Cross/Blue Shield 
insurance business. Empire has historically relied on two key 
operational concepts: open enrollment and community rating. 
Under open enrollment, all who desire insurance are afforded 
access to it, regardless of their age, sex, health status, or 
where they live and/or work. Community rating denotes the 
outcome of the process whereby an average premium rate is 
determined for purchasers of insurance through open enrollment. 
The average premium, which is the same for all subscribers, is 
derived by placing the latter in ``risk pools'' and using their 
total, aggregated health care costs as the basis for 
calculating the rate.
    In his roles as Chief Executive Officer and Chairman of the 
Board of Directors, Albert A. Cardone effectively controlled 
Empire's management and operations from April, 1987 until his 
resignation in May, 1993. Prior to coming to Empire as the 
Plan's Deputy Chairman in July, 1985, Mr. Cardone was a partner 
at the public accounting firm, Deloitte, Haskins and Sells and 
held the position of National Industry Director for the firm's 
national health care practice.

                          B. Financial Profile

    The Subcommittee found Empire's financial condition to be 
precarious, at best. Between 1986 and 1992, the Plan incurred 
underwriting losses of $617 million, more than two-thirds ($444 
million) of which came in 1991 and 1992. Reflecting offsets of 
$421 million from investment income and smaller amounts from 
other sources, total operational losses for this same period 
amounted to $210 million. As a result of these losses, the Plan 
has had to rely on extraordinary measures to stay in business, 
including: rate increases of up to 20%; the receipt of $93.5 
million in a March, 1993 settlement of a lawsuit against the 
New York State Medical Malpractice Fund; and, the release of a 
reserve by New York State insurance regulators in August, 1992 
that contributed $80 million to the Plan's surplus.
    Empire's reserves also decreased dramatically in recent 
years. In 1991 and 1992, its reserves declined steeply from 
$295 million at December 31, 1990 to $40 million at December 
31, 1992.\49\ This $40 million reserve figure was $485 million 
below the statutory requirement prescribed by New York State. 
Indeed, from 1991 through April, 1993, the Plan has been 
consistently below 50% of the State's minimum statutory reserve 
requirement.
---------------------------------------------------------------------------
    \49\ Had it not been for the ruling by the New York Insurance 
Department in August, 1992 to release $80 million in supplemental 
reserves for hospital reimbursement, Empire's reserves would have 
fallen below zero.
---------------------------------------------------------------------------
    The $40 million Empire had on hand in 1992 to protect its 
more than 8 million subscribers, was less than that required 
for the far smaller District of Columbia Plan (GHMSI) and its 
1.1 million subscribers. While GHMSI's reserves amounted to 
$49.64 per policyholder, the comparable figure for Empire 
policyholders was just $4.84. Even though Empire is the largest 
of the Blue Cross/Blue Shield Plans, its reserves at the end of 
1992 were higher than only 14 other Plans.
    In both 1992 and 1993, Empire's external auditors were 
sufficiently concerned about the Plan's ability to stay in 
business to seek assurances from State Insurance Department 
officials that there would be no regulatory takeover of the 
Plan. In 1992, four days after receiving these assurances, the 
auditors issued an unqualified opinion on the Plan's financial 
statements. In 1993, the auditors again refrained from issuing 
a going concern qualification, only after Insurance Department 
officials expressly indicated they did not intend to take 
control of the Plan and affirmed their practice of granting the 
Plan ``substantially all'' requested rate increases.

                            C. Problem Areas

    With the notable exception of subsidiary-inspired 
difficulties, the testimony regarding Empire established the 
same serious problem areas experienced by the West Virginia, 
Maryland, and District of Columbia Plans: mismanagement; 
inadequate oversight by the Board of Directors; inadequate 
regulation by the State Insurance Department; and, inadequate 
oversight by the Blue Cross/Blue Shield Association.\50\
---------------------------------------------------------------------------
    \50\ Some witnesses, such as Empire's former and acting CEOs and 
the Superintendent of Insurance, testified that the Plan's problems 
were largely, if not entirely, the result of outside factors beyond its 
control. This testimony emphasized the adverse effects of selective 
underwriting (``cherry-picking'') and ``dumping'' of poor risks by 
competitor commercial carriers, intensified competition for large-group 
business, and the high cost of health care in downstate New York and 
New York City. While the Subcommittee acknowledges that these factors 
may have played a role in Empire's difficulties, the overwhelming 
evidence accumulated regarding this Plan and those of the other three 
Plans examined, shows a clear and strikingly similar pattern of 
problems that helped bring them to the state in which our investigation 
found them.
---------------------------------------------------------------------------

                            1. Mismanagement

a. Misrepresentation of Loss/Gain Figures
    The Subcommittee examined the role of Empire's CEO, Albert 
Cardone, and CFO, Jerry Weissman, in knowingly providing State 
insurance regulators with information on underwriting gains/
losses that misrepresented the Plan's performance in its 
Community-Rated and Experience-Rated market segments. This 
information was contained in statutorily required Interim and/
or Annual Statements filed by Empire with the State Insurance 
Department for the years 1989-1992.\51\ In each of these years, 
the periodic filings contained loss figures that differed 
significantly from that which was discovered on the same 
subject in other contemporaneous Plan financial records known 
as the ``Black Books.'' \52\ While it is not clear why the 
figures were altered, the changes made were to Empire's 
benefit.\53\
---------------------------------------------------------------------------
    \51\ The Interim and Annual Statements are commonly referred to as 
the ``Blanks'' or ``Statutory Blanks.'' At Empire, the Actuarial 
Department is responsible for preparing the sections of the Annual 
Statements pertaining to this discussion.
    \52\ The Black Book is an internal management report prepared by 
Empire's Accounting and Financial Reporting Department. It consists of 
a number of individual reports, many of which are generated monthly by 
the Plan's budget, accounting, and actuarial departments. The latter 
are based on primary source records and cover key areas of underwriting 
activity, including premiums earned, claims incurred, and expenses. The 
Black Book derives its name from the color of the binders into which 
the various reports are placed, and is neither a secret document nor 
part of a so-called ``separate set of books'' designed to conceal Plan 
financial problems.
    \53\ The Subcommittee staff expressed the belief that Empire was 
shifting results from its experience-rated accounts to its community-
rated accounts to avoid casting the Plan in an unfavorable light and to 
support a bill then pending before the Legislature. This bill, which 
was subsequently passed in July, 1992, was designed to spread the 
higher risk and associated costs incurred from community-rated accounts 
among other insurers and health maintenance organizations operating in 
New York State. Another possibility was that overstating community-
rated losses could be valuable in the event that the Plan wanted to 
obtain a rate increase.
---------------------------------------------------------------------------
    Two former Empire employees--a Vice President/Executive 
Assistant to the CEO, and her associate, a Director in the 
CEO's Office--provided pointed testimony in this regard. The 
former Executive Assistant explained that her associate brought 
these discrepancies to her attention on February 3, 1992 and 
that she confronted the CFO, Mr. Weissman, about it. Mr. 
Weissman, she said, explained that the Black Book figures were 
for internal purposes and the other set of figures, which had 
been developed by the Plan's actuarial department, were for 
external purposes. Mr. Weissman also told her that ``the Black 
Book figures were right and that the other figures were `more 
politically acceptable.' '' He added that the latter, which she 
said he referred to as the ``manipulated'' figures, were the 
ones that were used in the Annual Statement filings and that 
Mr. Cardone was aware of this. The former Executive Assistant 
testified that she was very disturbed by these responses and 
expressed her concern accordingly, whereupon Mr. Weissman told 
her to talk to Mr. Cardone about it.
    As a result, the next day she and her associate met with 
Mr. Cardone, who appeared to be surprised about this situation 
and said that he did not know anything about it. At one point, 
responding to the former Executive Assistant's observation that 
the Black Book figures were always relied upon as being 
accurate, Cardone said that:

          * * * nobody knows what figures are right. * * * I 
        can't rely on any numbers coming out of [the] actuarial 
        [department]. They're jelly. Neither you nor I know 
        which figures are accurate.

    The two former employees added that to the best of their 
knowledge nothing was done to address their concerns about the 
discrepancies and, most particularly, the very serious 
questions they posed regarding the accuracy of the figures used 
in the Annual Statements for 1989 and 1990. Within a matter of 
weeks of having brought this matter to Cardone's attention, 
they were removed from their positions and placed in sales-
related jobs in another building. Both witnesses noted that 
nothing in their experience qualified them for these new jobs. 
The Executive Assistant testified that after the February 5, 
1992 meeting Cardone excluded her from meetings to which she 
had previously been invited and, in general, treated her 
``coldly.'' \54\
---------------------------------------------------------------------------
    \54\ Shortly after moving to her new position, the former Executive 
Assistant left Empire to assume the position of Executive Vice 
President and Chief Operating Officer at another insurance company, and 
six months later, her associate likewise left the company voluntarily.
---------------------------------------------------------------------------
    Empire's Vice President in charge of the Audit Division 
testified that when she asked Mr. Weissman and his staff about 
the discrepancies, she was ``stonewalled'' for a couple of 
weeks by being given explanations that did not bear up under 
further scrutiny. However, as noted in an affidavit she 
provided to the Subcommittee, she ultimately had a conversation 
with Mr. Weissman on June 16, 1993 in which he stated that 
``there were no supportable reasons for these differences in 
1991 and that Mr. Cardone had told him to change the figures in 
the annual statement for 1991 to show a lower level of losses 
in the experience-rated market segment.'' When asked about this 
statement, Weissman disagreed, saying that it 
``mischaracterized'' what he had said.
    There was also conflicting testimony regarding CEO 
Cardone's role in this matter. For example, while the Audit 
Division Vice President's affidavit states that Weissman had 
changed the figures in the Annual Statements for 1991 at Mr. 
Cardone's direction, when asked at the hearing, both Cardone 
and Weissman denied that Cardone had ordered the changes. Mr. 
Weissman, however, did testify that he had discussed the 
situation with Cardone and had changed his initial figures as a 
direct result of that discussion:

          Senator NUNN. In your [Subcommittee] staff 
        deposition, * * * you stated, `I think I was upset that 
        he [Cardone] had questioned my numbers. That really had 
        not happened the 2\1/2\ years since I became CFO. I 
        felt extreme pressure that I better make sure that our 
        numbers are right. I don't know how you could do that 
        when you are dealing with some fairly sizable 
        projections, but you know he was a tough guy and this 
        was the way he dealt with us. I went back and took a 
        look at the reserves, and my recollection is that 
        whatever adjustments that I had recommended initially 
        between the internal accounting report [Black Books] 
        and the statutory report [Annual Statement], that I 
        increased the adjustment between the experience and the 
        community-rated business.' Is that correct?
          Mr. WEISSMAN. Yes, sir.
          Senator NUNN. Do you stand by that statement?
          Mr. WEISSMAN: Yes, sir, I do.\55\
---------------------------------------------------------------------------
    \55\ In his deposition with the Subcommittee staff Weissman stated 
that he did not think the new numbers were his best judgment because, 
in his own words, ``I think I went into Cardone with my best judgment 
early on, and he told me: you'd better take another look at it.'' 
Similarly, when he was later asked if he thought his original numbers 
were more accurate than the new numbers, Weissman answered, ``Obviously 
I thought they were more accurate. That was the basis on which I went 
in to Cardone in the first place.''

    The discrepancies and the conflicting testimony regarding 
them go to the heart of perhaps the key question that surfaced 
in the Subcommittee's investigation of Empire--the credibility 
of the Plan's management. Indeed, the contradictions in the 
testimony presented lead to the unavoidable conclusion that 
someone in Empire's top management was either lying or mistaken 
in their statements to the Subcommittee.\56\
---------------------------------------------------------------------------
    \56\ On October 18, 1994 Jerry Weissman was indicted by a grand 
jury sitting in the Southern District of New York on three counts of 
perjury in testimony given before the Subcommittee and one count of 
obstructing the Subcommittee's investigation of Empire.
---------------------------------------------------------------------------
    In addition, subsequent to the Subcommittee's hearings, the 
question of the discrepancies and their relationship to the 
Interim and Annual Statements filed for 1989-1992 was examined 
by a Special Counsel, former United States Attorney Otto G. 
Obermaier. This investigation's findings, which were set forth 
in a report issued on September 21, 1993,\57\ confirmed the 
existence of $83 million in discrepancies between the figures 
listed in the Annual Statements and those contained in the 
Black Books for the four-year period examined. Of this $83 
million, the report states, ``no contemporaneous documentation 
or explanation could be found or may not have existed'' for $63 
million of it.\58\ The effect of this $63 million in 
unexplained discrepancies, the report continues, was to 
overstate the Plan's losses in its Community-Rated market 
segment and understate its losses in its Experience-Rated 
business. In light of these findings, the Special Counsel 
recommended that Empire file amended Annual Statements for the 
years 1989-1992, eliminating the ``unexplained adjustments'' 
and making certain other related corrections.
---------------------------------------------------------------------------
    \57\ Report of Special Counsel to the Audit Committee of the Board 
of Directors of Empire Blue Cross and Blue Shield.
    \58\ Several Empire employees told the Special Counsel that in 1993 
Mr. Weissman instructed them to destroy documents pertaining to the 
differences between the Black Books and the company's periodic filings.
---------------------------------------------------------------------------
b. Internal Control/Information Systems Deficiencies
    As with the West Virginia, Maryland, and District of 
Columbia Plans, the Subcommittee found that inadequate internal 
control procedures were a serious problem at Empire. Internal 
control problems, coupled with major information system 
difficulties, made Empire highly vulnerable to both internal 
and external fraud and, in turn, helped bring about higher 
overall premiums for subscribers and some of the dramatic 
losses incurred by the Plan over the last few years.
    The Subcommittee reviewed 100 Internal Audit Reports 
performed by Plan auditors between 1987 and 1992. These reports 
revealed extensive system access and security problems 
involving the claims, purchasing, and other key corporate 
databases, including:

        --Lpurchasing system data files are subject to 
        unauthorized and excessive access;
        --LPlan employees can make unauthorized claims 
        submissions or changes;
        --Lcomputer IDs were found for a terminated employee 
        and in the name of another unknown individual; and
        --Lsystem files were not protected by security software 
        and inappropriate staff were authorized to modify 
        files.

    In almost 50 percent of the Internal Audits examined by the 
Staff, the problems found in the earlier audits were cited more 
than once. The Audit Reports often contained remarks indicating 
that management had failed to take action in response to their 
findings and recommendations; e.g., ``of the eight issues 
originally reported to senior management, none have been fully 
addressed'' and ``these problems were identified two years ago 
and were discussed with management * * * [but] corrective 
action was not taken. * * *''
    Empire's information systems problems are long-lived and 
deep-seated, and to a large extent are a result of the numerous 
mergers of separate Blues Plans that ultimately led to Empire's 
establishment in 1985. This situation did not improve very much 
over the years, even after intensive efforts were undertaken in 
the late 1980s to eliminate the duplication and develop one or 
more inter-operable systems. A recent management audit 
described Empire's current systems environment as still 
consisting of a number of disparate systems, many of which were 
built 15 to 20 years ago with now outdated technologies.\59\.
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    \59\ The Subcommittee staff's Statement details several examples of 
Empire's information systems problems, including: the Sigma Imaging 
System--a costly and yet-to-be-completed project to reduce claims 
processing costs; CS-90--a system, scheduled for completion in 1995 (at 
a projected cost of as much as $50 million), that will attempt to 
eliminate the redundant, non-integrated systems inherited from the 
various pre-Empire mergers; and, the InterPlan Data Reporting System--
the Blue Cross/Blue Shield Association's ``national'' claims payment 
system, established to facilitate reimbursement for claims paid by one 
Plan for another Plan's policyholder.
---------------------------------------------------------------------------
    The adverse effects of these combined internal control and 
information systems problems were most obvious in two areas: 
the use of so-called ``dummy codes'' to pay providers for 
services rendered to Plan subscribers; and, the failure to 
monitor the membership of its community-rated small group 
clients to ensure that claims were being paid for valid 
subscribers.
  Dummy Codes
    For years Empire has been routinely paying claims to 
doctors, dentists, pharmacies, hospitals and durable medical 
goods providers without verifying their status as valid Plan 
participants. In response to serious claims processing backlogs 
and delays caused by absent provider identification 
information, Empire managers authorized the use of dummy codes, 
i.e., data entries that allowed its computers to process claims 
without this essential information.\60\
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    \60\ When an Empire subscriber submits a claim, the information is 
eventually entered into a computer, where it goes through a number of 
edit checks. These checks determine if the person submitting the claim 
is a valid subscriber, that the procedure is proper, and that the 
provider is an approved one. If any of these checks fail to meet Plan 
specifications, the computer is programmed to stop processing the 
claim. When this occurs, an Empire employee must manually continue the 
procedure.
    In the case of the provider, if that person or firm is listed in 
the database, the system will automatically enter the appropriate 
identification number on the claim and continue on. If the provider is 
not listed in the database, a Plan employee must provide the number or 
use a dummy identification number in order for the claims process to 
proceed.
---------------------------------------------------------------------------
    The use of dummy codes made it difficult to verify that a 
service had been performed or provided by a licensed and 
credentialed physician, making the Plan exceedingly vulnerable 
to claims processing errors and fraud. In a September 26, 1991 
internal audit report, Empire's Vice President of Auditing 
concluded that:

          The potential for fraud and abuse and operational 
        errors, including duplicate claim payments, exists 
        because of the failure to restrict the assignment of 
        dummy codes to process claims from out-of-area 
        physicians, pharmacies, durable medical equipment 
        vendors, and registered private nurses. The use of 
        dummy codes limits management's ability to track 
        utilization trends and to detect fraudulent 
        practices.\61\
---------------------------------------------------------------------------
    \61\ The audit report also concluded, more broadly, that the Plan's 
system of internal controls was inadequate to ensure an accurate, 
complete, and valid physician database. Among the concerns cited in 
this regard were failures to: establish minimum credentialing criteria; 
validate physicians' credentials against independent sources (e.g., the 
American Medical Association); and, purge the Provider File (last done 
in 1984). Despite Empire officials' claims to the contrary, the 
Subcommittee is informed that there may be electronic data systems 
available that can address these internal control issues in a timely 
and cost-effective manner.
---------------------------------------------------------------------------
    In an April, 1993 interview, Acting Empire CEO, Donald 
Morchower, told the Subcommittee staff that in 1990 alone dummy 
code payments to non-credentialed physicians had amounted to 
some $219 million. Plan estimates indicate that for 1991 and 
1992, the total amount of dummy code-based payments was $723 
million.\62\ Empire's Director of Program Security during the 
period 1987-1993 testified that he had been deeply concerned 
about the potential for fraud from the use of dummy codes ever 
since his arrival at Empire. He cited a case wherein a Plan 
employee defrauded the company out of tens of thousands of 
dollars by entering dummy codes for a fictitious provider and a 
fictitious patient.
---------------------------------------------------------------------------
    \62\ In the April, 1993 interview, Mr. Morchower also said that, as 
of that time Empire officials had found 8,000 physicians who had 
received payment for services that could not be verified. He further 
indicated that they would have an approximation of the improper 
payments in this regard within a few weeks, but despite repeated 
requests from the Subcommittee staff, such figures were never provided.
---------------------------------------------------------------------------
  Community-Rated Small Groups
    Until recently Empire did not audit its small, community-
rated groups and as a result knew little about them.\63\ For 
instance, Empire management did not know their claims ratio 
(the difference between premiums collected and claims paid), 
whether they were meeting Plan underwriting standards, or if 
the groups actually existed.
---------------------------------------------------------------------------
    \63\ The reason for this, according to CFO, Jerry Weissman, lay in 
the nature of community-rated business, wherein Empire had to provide 
coverage for individuals and groups regardless of their health status. 
The Plan never concerned itself with a particular group's gains or 
losses, since it was assumed that any losses incurred could be 
recovered through premium increases applicable to the community-rated 
pool as a whole.
---------------------------------------------------------------------------
    Prompted by reports of a major fraudulent scheme 
perpetrated by some of these small groups,\64\ in July, 1991 
Plan officials directed that a special task force be 
established to examine the implications this scheme might have 
for other community-rated small groups. Initially, the task 
force visited nearly 500 such groups with high dollar losses, 
and found that more than 60% of them had some sort of 
significant problem; e.g., non-existent members, a failure to 
meet underwriting standards, or being fictitious entities.
---------------------------------------------------------------------------
    \64\ This case--known as the Finkelstein case, after one of the 
alleged perpetrators--involves a long-lived scheme, in which, among 
other things, foreigners were brought to the U.S. to receive treatment 
whose costs were covered by Empire. One Empire official estimated the 
total amount of the suspected fraud from the scheme at nearly $29 
million--by far, the biggest fraud in the Plan's history. Law 
enforcement officials have only recently initiated a criminal 
investigation of this case, even though both the Plan and the New York 
Insurance Department were alerted about it in 1986.
    The Subcommittee staff also found that after being briefed by Plan 
officials on this matter in 1991, U.S. Postal authorities expressed 
interest in undertaking a criminal investigation regarding it. However, 
Plan officials never pursued this option, instead deciding to proceed 
against the alleged perpetrators in a civil action. While the Plan 
initially sought $22.5 million in damages in this suit, it recently 
agreed to a settlement of just $250,000.
---------------------------------------------------------------------------
    These initial findings prompted a larger and more intensive 
review, the results of which were summarized in a 1992 Year-End 
Status Report \65\ The Report notes that audits conducted on 
just over 2,000 of the Plan's 60,000 small groups resulted in 
the cancellation of 377 of them. The latter were cancelled, 
according to the Report, either because they failed to meet the 
Plan's underwriting requirements, denied the auditors access to 
their files and records, or could not be found. These 377 
cancelled groups accounted for $25 million in losses to the 
Plan for the years 1990-1991.\66\
---------------------------------------------------------------------------
    \65\ Before the task force embarked on this second audit, any small 
group that had membership problems was given a month-long amnesty to 
admit their problems, in return for which the Plan would attempt to 
help them convert their coverage. This amnesty resulted in the 
cancellation of 1,229 groups, with some 19,000 subscribers.
    \66\ In 1993, the task force's institutional successor, the Group 
Integrity Department, scheduled audits for 1,603 small groups, which, 
in the previous year, had lost more than $115 million in 1992. At the 
time of the Subcommittee's hearings, 876 (55%) of the groups had been 
audited, resulting in the cancellation of 201 (23%) of them. Losses 
attributable to these 201 cancelled groups are estimated at $14.5 
million.
---------------------------------------------------------------------------
c. Questionable/Poor Underwriting Practices
    As in the West Virginia, Maryland, and District of Columbia 
Plans, the Subcommittee found that substantial mismanagement 
had occurred in Empire's underwriting practices. An internal 
management review, which was performed during the early part of 
1993, found that managers did not know the true administrative 
and operational costs of many of the products being marketed by 
the Plan. The review revealed that cost information was not 
consistently used in the sales/marketing decision process, 
either because the actual cost was unknown or such information 
was not communicated to the right persons. Cost allocations 
often did not accurately reflect the true expense of a product, 
thereby constraining Empire's ability to tailor its prices in 
order to either make a profit and/or meet a customer's specific 
service requirements.
    According to some Plan officials, such poor underwriting 
practices caused Empire to become involved in unprofitable 
contracts and/or lines of business. For example, in an 
interview with consultants, then Chief Operating Officer, 
Donald Morchower, stated that Empire had decided to ``buy 
Merrill Lynch business'' with low retention rates for the first 
three years--admittedly losing money on the contract for that 
period--in hopes of being able to recoup the losses by raising 
premiums in the fourth year. The Plan's CFO, Jerry Weissman, 
told the consultants that no one could deny that Empire had 
made ``bad deals'' like the Merrill Lynch contract. Indeed, in 
the area of ``National Accounts,'' \67\ since 1988 the Plan has 
lost contracts with 78 firms and other organizations, 
representing 350,000 employees.
---------------------------------------------------------------------------
    \67\ National Accounts are primarily large companies, like Merrill 
Lynch, headquartered in New York City, for whom Empire controls and 
services employee health benefit claims on a nationwide basis.
---------------------------------------------------------------------------
d. Excessive Salaries and Business Expenses
    In the case of Empire, the Subcommittee also found 
extravagant salaries, fringe benefits, and other administrative 
expenses incurred at a time of increased premiums, reduced 
benefits, and serious financial losses. For example, 
compensation for Empire's top 10 executives rose 56% between 
1987-1992, while in the same timespan, the Plan was sustaining 
$617 million in underwriting losses and $210 million in overall 
operating losses. CEO Cardone's salary rose from $325,000 in 
July, 1985 to $600,000 in 1992, and between 1990 and 1992--when 
the Plan lost some $217 million--total compensation for the 
Chief Operating Officer, Donald Morchower, increased from 
$363,527 to $427,141.
    In comparison to executive incentive programs operated by 
other large New York City firms, Empire's was exceedingly 
generous, especially in view of the Plan's serious financial 
problems at the time. When informed that some senior Empire 
executives had received average incentive payments ranging from 
11 to 13 percent in 1991 and 1992, a New York corporate 
benefits expert said:

          It would be highly unusual to give someone that size 
        bonus even every other year, especially if you're 
        losing money. You could do it once, maybe, but no Board 
        would let you do it every year.

    Empire executives also have received special allowances and 
benefits. For example, for the five-year period 1988-1992, the 
Plan paid more than $270,000 for officers' health and lunch 
club memberships, parking, and physical examinations. During 
this same period Empire purchased 82 automobiles (with a 
current market value of more than $1 million) for its officers 
to use for both personal and business purposes. (Some of these 
vehicles were used more for personal than business reasons.) 
Also, despite the availability of these 82 cars and another 41 
``pool'' vehicles, Empire still incurred sizeable expenses for 
limousines.\68\
---------------------------------------------------------------------------
    \68\ Over the past six years, for instance, the Plan spent $226,000 
for this purpose; indeed, while Empire was losing $150 million in 1991, 
costs incurred for limousine service exceeded $90,000. This figure 
includes $11,000 for limousines used by CEO Cardone for a two-month 
period to ride to and from his home in Connecticut to Plan headquarters 
in New York City. Mr. Cardone told the Staff that this expense was 
justified because his corporate car was being repaired at that time. 
When Staff asked if he considered using one of the Plan's ``pool'' 
vehicles instead of the limousine, Cardone responded indignantly, ``I 
was recruited by this company and I was promised a car.''
---------------------------------------------------------------------------
    Other unnecessary and/or excessive Plan expenses include 
those incurred for:

    Employee awards/gifts: from 1988 through 1992, Empire spent 
more than $1.1 million to recognize employee performance, 
attendance, and/or service accomplishments. Among the gifts/
awards provided for these purposes were jewelry, gold 
wristwatches, clocks, crystal glassware, flatware, and cash 
sums up to $2,500. After a company-wide Employee Recognition 
Program was established in 1992, in the first eight months of 
its existence it gave more than 7,000 awards to Empire's 10,000 
employees, at a cost of more than $250,000.
    Catering/meals: between 1989-1992, Empire subsidized its 
cafeteria costs to the tune of more than $7 million. The Plan 
also paid for food and beverage catering service which was 
routinely used for almost daily staff meetings. The costs 
incurred for such meetings typically ran into the hundreds of 
dollars.
    CEO Cardone: throughout his tenure, Mr. Cardone continually 
expended Plan funds without regard for the restraint one would 
expect from the head of a non-profit enterprise, let alone one 
that was experiencing major financial losses. Examples of such 
expenditures include:

        --Lfirst-class air travel, which he almost always used, 
        and which other Plan officers and employees often used 
        when they accompanied him on trips;
        --La corporate apartment maintained for his use from 
        1985 through 1989, at an annual cost of $48,000;
        --La luncheon membership at The Sky Club, which in 
        addition to annual dues ($1,800 in 1992), cost the Plan 
        more than $50,000 over the past five years. Empire's 
        food services group also provided meals delivered to 
        Mr. Cardone's office, at a cost of $26,000 for 1992, 
        alone;
        --La renovation of the Plan's executive offices and 
        boardroom, at a cost of $118,000. Not included in this 
        figure are an additional $84,000 in approved but not 
        expended funds for a breakfront, conference table, and 
        oriental rug. Mr. Cardone also purchased a $20,000 
        Chippendale desk for his own office;
        --La $30,000 Lincoln Town Car and a chauffeur to drive 
        it; and,
        --La $27,000 telecommunications system installed at his 
        home to provide a direct link with Empire headquarters.

           2. Inadequate Oversight by the Board of Directors

    As in the case of the West Virginia, Maryland, and D.C. 
Plans, Empire's Board failed to provide the necessary checks 
and balances over the Plan's management, thereby abdicating 
their responsibility to protect the interests of the 
subscribers. Specifically, the Subcommittee's examination of 
Empire found a Board that was self-perpetuating, ill-informed, 
lacking in expertise, and dominated by management.
    Empire's by-laws provide for a Board consisting of 18 to 20 
Directors, to be elected by a separate body of 78 so-called 
``voting members.'' The vast majority (55) of the voting 
members are selected by the Directors themselves, the net 
effect of which has been to create a self-perpetuating process 
by which the Board selects those very individuals whose job it 
is to select the Board.\69\
---------------------------------------------------------------------------
    \69\ Further reinforcing this self-perpetuating process, the 
Directors selected by the voting members come from a list of candidates 
developed by the Nominating Committee of the Board. While the by-laws 
provide that the voting members may independently place a name in 
nomination with the support of twenty members, this has never been 
done.
---------------------------------------------------------------------------
    In his capacity as both CEO and Chairman of the Board, Mr. 
Cardone was able to exert undue influence on the Board's 
selection and composition. While the Board was comprised of 44 
Directors when Cardone assumed the positions of CEO and 
Chairman, over time he was able to drastically downsize it to 
19 members. A former Empire officer stated that virtually every 
Board member who might question Cardone's actions was removed, 
leaving only those who could be counted on to ``rubberstamp'' 
his actions.
    Another major Board shortcoming was the Directors' admitted 
lack of technical expertise and the resultant hesitancy to 
question management proposals and actions. One Director, for 
instance, stated that the Board failed to delve deeply enough 
into issues, instead accepting surface answers. A former Empire 
Vice President stated that ``the Board didn't know what to ask 
even if they wanted to find out what was going on.''
    The Board's performance was also heavily influenced by 
management's ability to manipulate and control the flow of 
information to it. Long-time Director and newly appointed Board 
Chairman, Harold Vogt, admitted in an interview with the Staff 
that he knew little or nothing about such key matters as major 
lawsuits that had been filed against Empire,\70\ the 
controversy surrounding a multi-million dollar information 
systems contract, and the serious problems that had led to the 
decision to recredential all of its small group clients. Vogt 
told the Staff, ``I'm learning a lot here talking to you.''
---------------------------------------------------------------------------
    \70\ One of these was a March, 1993 lawsuit filed against Empire by 
AT&T, in which the latter claimed that the Plan had improperly withheld 
hospital differentials obtained in its behalf. Mr. Vogt did not learn 
about this matter until a meeting with the Superintendent of Insurance 
a month-and-a-half later.
---------------------------------------------------------------------------
    Some of the sharpest criticism of the Board came from 
several former Empire executives and other employees. One of 
these stated that the Board ``provided no checks on 
management,'' and that no one in the Plan had much confidence 
in the Board. Another characterized the Board as being ``asleep 
at the switch,'' and stated that it did nothing more than rely 
on Cardone. Several said that the Board was merely a 
rubberstamp for senior management, and Cardone in particular. 
One former employee commented that the latter description was 
probably too kind because ``at least a rubberstamp leaves an 
impression.''

          3. Inadequate Regulation by the Insurance Department

    The Subcommittee found that the New York Insurance 
Department's performance in overseeing Empire's activities was 
woefully inadequate, primarily because of a pattern of 
regulatory forbearance which, at times, bordered on favoritism. 
At times, the Department reversed itself when such action 
accrued to Empire's benefit, failed to exercise its regulatory 
authority over the Plan, and allowed Empire to ignore its 
recommendations and/or regulations with impunity.
    The Subcommittee also found that the Department's actions 
regarding Empire, which insured nearly 45% of New York State's 
citizens, reflected the same ``too-big-to-fail'' approach that 
helped explain the Maryland Insurance Division's inability to 
deal effectively with BCBSM. As Insurance Superintendent, 
Salvatore Curiale, stated:

          You have asked whether certain of the Blues Plans, 
        and now specifically Empire, are ``too big to fail?'' 
        Under the law as it existed in New York prior to April 
        1, 1993, the effective date of health insurance reform 
        legislation, I would agree, Empire was too big to 
        fail.\71\
---------------------------------------------------------------------------
    \71\ Elaborating on this point, Superintendent Curiale offered some 
critically important additional remarks, which place Empire and BCBS 
Plans in general in the wider context of the current debate on health 
care reform: ``Senator, in your opening statement you asked the 
question, can we build a health care system relying extensively on huge 
non-profit organizations. I think the answer is clearly no. We must 
devise a way to control health care costs and to share the burden of 
financing them not only through not-for-profit insurers, but also 
through for-profit, commercial insurers, self-insured employers and 
organizations, and whatever financing vehicles may be fashioned in the 
coming months and years.''

    Among the cases that best represent the Department's failed 
regulation of Empire is Healthnet, the Plan's HMO operation. In 
this case, the Department reversed itself to Empire's benefit, 
allowed it to ignore State regulations governing HMOs, and 
failed to exercise and/or follow through on its authority over 
HMO operations. As a result, Healthnet has been able to 
continue in business, even though it has had only one year of 
modest profitability during its seven-year existence and has 
drained more than $115 million from the Plan's surplus.
    The Department's handling of important issues relating to 
Empire's Board of Directors is another area in which it 
performed inadequately. In 1989, the Department determined that 
the process for selecting Directors did not provide for 
subscriber participation, and accordingly recommended that the 
Board ``undertake a study of the election process and propose a 
method * * * which would evidence greater accountability * * * 
to the subscribers.'' The Department, however, chose not to 
force this issue and thus the same process remains in effect 
today.
    Also during 1989, the Department expressed concerns that 
under Mr. Cardone, Empire's by-laws had been changed to allow 
him to simultaneously hold the positions of CEO and Board 
Chairman. The Department's General Counsel determined that the 
arrangement under which CEO Cardone was serving on the Board, 
as a member representing Plan subscribers, was not in 
conformance with existing statutory requirements.\72\
---------------------------------------------------------------------------
    \72\ Because of its status as a non-profit insurer, the composition 
of Empire's Board is set by statute. In 1989, this statute required 
that the Board be comprised of representatives of three distinct 
categories: 1) the provider community; 2) the subscriber community; 
and, 3) the public interest. Empire had listed Cardone as falling under 
the subscriber category.
---------------------------------------------------------------------------
    As a result, the Department recommended that the Board 
``furnish a formal description of the process by which the 
change was made and its justification therefor.'' Empire's 
response attributed the change to a 1981 Nominating Committee 
recommendation (even though the change was made in 1987), and 
justified it on the tenuous grounds that the company had 
``grown to be a multi-billion dollar enterprise with complex 
and important functions and operations....'' Upon receipt of 
this reply, the Department dropped the matter and at least 
until May, 1993, Cardone continued to hold the position of 
Chairman of the Board under the newly-created category, 
``officer-employee.'' \73\
---------------------------------------------------------------------------
    \73\ It was not until 1993--apparently after the Subcommittee had 
commenced its inquiry into Empire--that Superintendent Curiale decided 
that perhaps these combined CEO/Board Chairman positions were not such 
a good idea. For example, in a May, 1993 interview with The New York 
Times, Mr. Curiale stated that he reached his decision ``in hindsight, 
with three years of experience.'' Likewise, in an interview with the 
Staff, he stated that his concern was that ``Cardone may have been 
dominating the Board.''
---------------------------------------------------------------------------
    The evidence suggests that the Department allowed Empire to 
ignore its regulatory actions with virtual impunity, despite 
the fact that it has a broad array of enforcement powers.\74\ 
The Department's examination report of Empire, for the period 
ending December 31, 1983, noted that three of the Department's 
four previous recommendations had not been complied with. 
Likewise, the report for the period ending December 31, 1987 
listed five recommendations from the 1983 report with which the 
Plan had not complied. No penalties for this non-compliance 
were assessed by the Department against Empire.
---------------------------------------------------------------------------
    \74\ Included among these are the power to: 1) issue, suspend and 
revoke licenses; 2) require reports; 3) make investigations and 
examinations; 4) regulate finances and business operations; 5) 
establish rates; 6) provide for the protection of consumers; and, 7) 
impose penalties.
---------------------------------------------------------------------------
    Other examples of this regulatory failure include:

        --LEmpire's refusal to comply with a recommendation 
        made by the Department in 1989 that it change its 
        external auditors because a number of the Plan's 
        officers had formerly been associated with that same 
        firm; \75\
---------------------------------------------------------------------------
    \75\ While the Department seemed content to allow Empire to 
disregard this recommendation for four years, in an April 30, 1993 
meeting with the Board, Superintendent Curiale again suggested that the 
external auditors be rotated.
---------------------------------------------------------------------------
        --Lthe Department allowed Empire to invade reserves on 
        a number of occasions, even though it was failing to 
        comply with regulatory requirements that made this 
        contingent upon the establishment and execution of a 
        plan to restore and add to these reserves;
        --LEmpire's failure in 1990 and 1991 to make required 
        contributions from its experience-rated business to 
        subsidize its community-rated business and, for 1992, 
        contributing a substantially lower amount than the 
        specified minimum; and,
        --Lin a 1992 meeting with BCBS Association officials, 
        Superintendent Curiale was told that Empire was in 
        danger of losing the Blue Cross/Blue Shield trademarks, 
        if its reserves declined into a negative status. 
        Shortly thereafter the Department declared 
        ``redundant'' certain reserve funds held by the Plan to 
        pay hospital claims. This adjustment effectively made 
        $80 million available for Empire's reserves, saving 
        them from falling to a level of minus $40 million for 
        1992.

    The Department's inadequate performance regarding Empire to 
some extent reflected its lack of knowledge about important 
matters affecting the Plan. Department officials said that they 
were unaware of the large number of National Accounts that 
Empire had lost. The Superintendent told the Staff that until 
1992 he was unfamiliar with the Association's NMIS system and 
had no knowledge of the Plan's poor performance ratings 
therein.\76\ The Superintendent also stated that while he was 
aware of the dummy codes issue, he had no idea that it involved 
such enormous sums, e.g., $219 million in payments to non-
credentialed physicians in 1990 alone. Finally, he did not know 
that the Plan had already identified more than $25 million in 
payments made to ineligible groups in 1990-91.
---------------------------------------------------------------------------
    \76\ The National Management Information Service (NMIS) 
quantitatively measures service levels for all BCBS Plans on a 
quarterly basis.
---------------------------------------------------------------------------

   4. Inadequate Oversight by the Blue Cross/Blue Shield Association

    As in the West Virginia, Maryland, and D.C. Plans, the 
testimony confirmed that the Association, while long concerned 
about Empire, failed to respond effectively to its 
problems.\77\ For example, as long ago as 1987, the Association 
recognized that Empire's reserves were unacceptably low and put 
the Plan on conditional status in four of the next five years. 
Yet, the Association failed to take decisive action and as late 
as November 1992, was still being fended off by management's 
refusal to cooperate fully with its legitimate oversight 
requests. For instance, after the Association asked Empire for 
certain internal audit reports on accounts receivable, HMO 
operations, and systems implementation, Plan staff, at the 
direction of CEO Cardone, refused the request. Cardone only 
relented after months of phone calls, significantly delaying 
the Association's ability to act on the information requested.
---------------------------------------------------------------------------
    \77\ To its credit, and in marked contrast to its actions along 
these lines regarding the other Plans examined by the Subcommittee, the 
Association did discuss its concerns about Empire with both the Board 
of Directors and New York insurance regulators. However, it did not do 
so until 1992, when the Plan's long-lived and deep-seated problems had 
already caused hundreds of millions of dollars in losses and 
dramatically weakened its overall financial condition.
---------------------------------------------------------------------------
    Moreover, during the preceding months, the Plan's condition 
grew sufficiently worse to prompt significant additional 
downgradings. In May, 1992, its conditional status was moved to 
the ``concern'' level--the next to the highest level of 
monitoring available. The Association also directed that CEO 
Cardone develop a detailed recovery program for presentation in 
September of that year.\78\ In August, 1992, Empire's problems 
reached the stage where the Association placed it on the 
highest level of monitoring, ``contingency protocol.''
---------------------------------------------------------------------------
    \78\ When Cardone made his presentation, Association officials 
found it unacceptable. They instructed him that they intended to 
conduct site visits at the Plan and again warned that the Plan would 
lose its BCBS membership status if it did not meet the operative 
reserve requirements.
---------------------------------------------------------------------------
    In addition to its monitoring efforts, the Association also 
had access to numerous reports and other information on Empire, 
which should have prompted more forceful and immediate action 
in response to its problems. Notable in this regard is a 
National Account Performance Review (NAPR), completed in 
December, 1991:

          Significant operational deficiencies were identified 
        Plan-wide for national accounts and the Federal 
        Employee Program (FEP). Performance levels for most 
        functions deteriorated during 1990 and 1991 * * * [and] 
        were below the National Account Performance Standards 
        in two thirds of the categories * * * [the FEP] index 
        score of 73.9 points * * * ranked the Plan 20 [out] of 
        [the] 26 monitored. * * *

                               D. Effects

    Empire subscribers and providers experienced problems much 
the same as those found in the West Virginia and Maryland 
Plans. In 1992, for example, the New York Insurance Department 
closed 4,200 complaints against Empire, while the Plan itself 
received some 13,000 additional complaints from other sources, 
such as the New York City Office of Consumer Affairs.\79\ These 
complaints, once again, involved claims problems, payment 
delays, and denial of benefits.
---------------------------------------------------------------------------
    \79\ Not included in these figures are an undetermined, but 
potentially large number of additional complaints that may have been 
contained in the five million telephone contacts recorded by Empire 
during this same period.
---------------------------------------------------------------------------
    Complaints, and the poor customer service that prompted 
them, played a substantial part in causing Empire's national 
accounts to leave the Plan. The Subcommittee staff testified 
that 18 of the 42 largest companies (those having between 1,100 
and 57,000 employees enrolled) that have terminated their 
contracts with Empire since 1988, did so because of poor 
service involving claims processing, slow payment, and/or a 
failure to respond to complaints. Representatives of these 
former national accounts described the chronic service problems 
at Empire:

        --Ldealing with Empire was like dealing with a black 
        hole. You could never get anyone to deal with your 
        problems * * *;
        --Ldifficult to get through to customer service and 
        poor follow-up on complaints * * *;
        --Lclaims processing was slow and sloppy; and,
        --Lthe billings were often wrong, the employees hated 
        it and we got fed up with it.

    Empire subscribers also experienced excessive premium 
increases. For instance, the cost of basic medical coverage 
(Matrix II) for subscribers in the Plan's community-rated 
groups increased 350% between 1989 and 1993--from $29.55 to 
$138.90 monthly for individuals and $73.90 to $318.55 monthly 
for families. During the same timeframe, community-rated group 
subscribers with major medical coverage (Wraparound Plus) saw 
their premiums rise by 230%--from $97.90 to $323.95 monthly for 
individuals and $226.80 to $752.35 monthly for families.\80\
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    \80\ As in the case of BCBSM, these rate increases were also to 
some extent a result of the Plan's mismanagement and other related 
problems. One former Empire executive, who held the position of 
Director of National Accounts, stated that ``the rank and file's 
attitude, supported by management was, `I don't care what it costs--
we'll just pass it on.' '' Likewise, a senior vice president said that 
management's attitude in the face of the huge losses Empire was 
experiencing prior to his recent departure was that this was ``no 
problem since in the end the community will cover it with increased 
premiums.''
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    Lastly, Empire providers encountered problems similar to 
those described in connection with the West Virginia and 
Maryland Plans. For example, hospital administrators stated 
that Empire often loses claims or denies ever having received 
them, even when the latter have been transmitted electronically 
or with a return-receipt requested. Officials at one hospital 
stated that Empire does not respond to any inquiry concerning 
the status of a claim until 30 days have passed since its 
submission. At that point, Plan representatives have often 
responded that they did not receive the medical records, 
whereupon the whole cycle must begin again.

                           FEDERAL CONTRACTS

                       A. Background/Organization

    Blue Cross/Blue Shield Plans are the single largest health 
care service provider to the Federal Government.\81\ In a 
unique set of Federal contracts, the Blue Cross/Blue Shield 
Association (BCBSA) arranges for the individual Plans to 
provide coverage for Medicare Part A (Hospital) and the Federal 
Employees Health Benefits Program (FEHBP).\82\ The Blue Cross/
Blue Shield system insures about 40% of all Federal employees, 
dependents, and annuitants covered by the FEHBP, and 
administers over 90% of all Medicare Part A claims and 65% of 
Medicare Part B (Medical) claims for elderly beneficiaries 
nationwide.
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    \81\ Federal spending for health care in the United States accounts 
for approximately one third of the estimated trillion dollars to be 
spent in 1994 for this purpose.
    \82\ The FEHBP was established by the Federal Employees Health 
Benefits Act of 1959 (P.L. 86-382). Its purpose is to provide health 
insurance benefits for Federal employees, annuitants, and dependents. 
In 1960, 1.7 million Federal employees were enrolled in 36 
participating FEHBP plans. Since then, it has grown enormously, 
encompassing about 300 plans today (with a peak of over 440 in 1988) 
providing coverage for some 9 million enrollees. FEHBP participants 
receive health care coverage through either fee-for-service plans 
(those that reimburse the claimant or provider for covered services) or 
prepaid plans (those that provide comprehensive medical services 
through their own doctors and hospitals). The FEHBP is financed through 
premium payments made by the enrollee and the Government. Currently, 
the Government pays about 70% and the enrollee pays 30%.
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    The Blue Cross/Blue Shield Service Benefit Plan, which is 
commonly referred to as the Federal Employee Program (FEP), is 
the largest FEHBP participant. FEP operations involve four 
separate Blue Cross/Blue Shield entities:

        --Lthe Chicago-based BCBSA, which acting on behalf of 
        the 67 independent Plans, contracts directly with the 
        Office of Personnel Management (OPM) to provide health 
        benefits to Federal employees who enroll in the FEP. 
        The BCBSA charges the Federal government for these 
        services, which between 1989-1993 averaged about $3.3 
        million annually.
        --La Director's Office in Washington, D.C. that 
        provides centralized management of the FEP contract by 
        coordinating its administration with the BCBSA, 
        individual Blue Cross/Blue Shield Plans, and OPM. In 
        recent years the Director's Office has employed as many 
        as 119 ``staff equivalents'' to work on the FEP 
        contract. Between 1989-1993, the annual expenses of the 
        Director's Office averaged about $26 million.
        --Lan Operations Center at GHMSI in Washington, D.C. 
        The Operations Center carries out certain 
        administrative functions and centralized record 
        keeping. It is linked with all the Plans via a 
        telecommunications and computer network, through which 
        it verifies subscriber eligibility, processes claims, 
        and maintains historical claims files. Annual charges 
        billed to the Federal contract for the Operations 
        Center averaged nearly $15.5 million between 1989-1993.
        --Lthe 67 local Blue Cross/Blue Shield Plans that 
        actually provide the benefits to the Program 
        participants. Last year they paid out some $5.2 billion 
        in benefits and incurred $344 million in administrative 
        expenses.

    Blue Cross/Blue Shield Plans also collectively serve as the 
largest contractor for administering the Medicare program. 
Medicare provides hospital insurance (Part A) and supplementary 
medical insurance (Part B) for the aged and disabled.\83\ Part 
A contractors are referred to as ``intermediaries'' and by law 
are nominated to administer the Medicare contract by hospitals 
in the community in which they serve. In many states, the local 
Blue Cross/Blue Shield Plan is the only insurer large enough to 
be considered for nomination and, thus, as of 1993, 41 of the 
46 participating Part A intermediaries were Blues Plans. 
Medicare Part B contractors are referred to as ``carriers'' 
and, in 1993, 25 of the 37 participating insurers were Blue 
Cross/Blue Shield Plans.
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    \83\ Medicare Part A provides hospital insurance for the aged and 
disabled, including medical services furnished by hospices, skilled 
nursing facilities, and home health agencies. It is financed primarily 
through Medicare's share of the FICA (Federal Insurance Contribution 
Act) payroll tax and in 1993 covered an estimated 35.1 million 
individuals. Medicare Part B provides supplementary medical insurance 
for the aged and disabled for physician care, outpatient services, 
durable medical equipment, and a variety of other non-institutional 
services. Enrollment in Part B is voluntary and anyone enrolled in Part 
A may enroll in it by paying a monthly premium ($41.10 in 1994). 
Premium payments cover about 25% of Part B costs, with the remainder 
being paid by Federal tax dollars. In 1993, Part B covered an estimated 
34.3 million individuals.
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    The agency responsible for Medicare administration and 
oversight, the Health Care Financing Administration (HCFA) of 
the Department of Health and Human Services (HHS), contracts 
with the BCBSA to administer the Part A program.\84\ The 
individual Blues Plans serve as subcontractors to the 
Association. The BCBSA is reimbursed for performing various 
functions pursuant to this contract and in 1993 received about 
$7.4 million for its efforts in this regard.\85\ In the case of 
Medicare Part B, HCFA contracts directly with the individual 
participating Plans.
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    \84\ HCFA was formed in 1977 to place responsibility for the 
Medicare and Medicaid programs in a single Federal agency. It contracts 
with private insurers to process claims and is responsible for 
administering and overseeing Medicare and Medicaid program operations.
    \85\ These functions include: determining whether services provided 
are covered; receiving, disbursing, and accounting for funds in making 
payments to service providers; auditing records of service providers; 
assisting service providers in developing procedures regarding 
utilization practices; assisting institutions, facilities, or agencies 
interested in becoming a service provider; and, serving as a 
communications link between service providers and HHS.
---------------------------------------------------------------------------

                          B. Financial Profile

    A major difference between the Federal contracts and the 
individual Blue Cross/Blue Shield Plans discussed previously is 
that there is no concern about a possible insolvency affecting 
subscribers, since the FEHBP and Medicare are backed by the 
Government and are essentially self-insured. As a result, in 
its review of the Federal contracts, the Subcommittee focused 
on the alleged waste of taxpayer dollars and the 
correspondingly adverse impact on the Federal budget.
    In 1992, for the FEP's more than 1.7 million enrollees, 
$5.16 billion in premiums were collected and $4.81 billion in 
claims were paid. For that same year, FEP administrative costs 
were $363 million and income from service charges was $38.4 
million. Referring to the FEP in a March 1990 memorandum to 
Blue Cross/Blue Shield Chief Executives, the BCBSA President 
stated that, ``by a wide margin [the FEP] is the Blue Cross and 
Blue Shield system's largest and most valuable single 
account.''
    Of the approximate $170 billion in total claims processed 
annually by all Blue Cross/Blue Shield Plans, over 60% are 
Federal claims--$106 billion for Medicare and $5.2 billion for 
the FEHBP. Figures for 1993 show that the Plans of the Blue 
Cross/Blue Shield system received the largest share of 
Medicare's overall administrative costs--$1.1 of the total 
$1.54 billion--and the largest portion of the FEHBP's total 
administrative costs--$402 million of the total $702 million. 
Federal funds constitute a significant portion (about 40%) of 
the BCBSA's annual revenues; in 1992, for instance, revenue 
from the FEHBP and Medicare amounted to $53.9 million of the 
Association's $136.8 million in total revenue.
    A large portion of the Blue Cross/Blue Shield Plans' total 
overhead and fixed costs are paid for by the Government, which 
some have suggested is most helpful to the Blues when they 
compete for private business. As one health care analyst told 
the Staff, the Federal contracts also tremendously increase 
Blue Cross/Blue Shield's subscriber market share and, thereby, 
improve their bargaining position with local hospitals and 
doctors.

                            C. Problem Areas

    The Subcommittee found that the relationship between Blue 
Cross/Blue Shield and the Medicare and FEHBP contracts is 
marked by some of the same problems uncovered in its previous 
hearings. Specifically, as with the West Virginia, Maryland, 
District of Columbia, and Empire Plans, the Subcommittee found 
evidence of mismanagement; inadequate oversight by the Blue 
Cross/Blue Shield Association; and inadequate regulation by 
responsible regulatory authorities.

                            1. Mismanagement

a. Excessive Bureaucracy
    The Subcommittee staff testified that the Blue Cross/Blue 
Shield system has generated a multi-layered, complex 
organizational structure that has resulted in additional and 
unnecessary expenditures by the Federal government. The FEP 
contract involves the BCBSA, an FEP Director's Office, an 
Operations Center, and the 67 independent Plans nationwide. As 
a result, the Federal government pays a substantial amount for 
the direct and indirect costs of not just one insurance 
company, but those of 67 separate insurers; i.e., 67 CEO's 
salaries, 67 computer systems, 67 payroll offices, 67 building 
expenses, etc.\86\ The Associate Director of OPM's Retirement 
and Insurance Group commented that ``the Blues have the worst 
bureaucracy; they * * * make the Federal government look 
good.''
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    \86\ Total costs incurred by the Government between 1989-1993 for 
the BCBSA, FEP Director's Office, and FEP Operations Center amounted to 
$224.1 million. During the same timeframe, the total cost for the 67 
participating Blue Cross/Blue Shield Plans was nearly $1.5 billion.
---------------------------------------------------------------------------
    For example, while the Operations Center performs almost 
all claims and payments processing, it does not actually pay 
the claims. That step is performed by the 67 individual Plans, 
because only they know what the actual discounted hospital and 
provider charges are in their respective territories. These 
charges are negotiated by each Plan with its local hospitals 
and providers and are viewed as business proprietary 
information.
b. Administrative Costs
    In terms of administrative costs per $100 of benefits paid, 
GAO reported that the FEP ranked second highest among 17 FEHBP 
fee-for-service plans in 1988 and fifth among 15 plans in 1990. 
For 1991 and 1992, data compiled by OPM showed that the FEP's 
administrative costs were third and sixth highest, 
respectively, among the FEHBP's 11 largest fee-for-service 
plans. According to health benefits experts the Subcommittee 
staff interviewed, taking into account the Blues' size and 
experience it would be expected that they would have done much 
better than the other FEHBP plans, since economies of scale 
play a significant part in lowering administrative costs. These 
same sources also said that the FEP administrative cost ratio 
was exorbitant and should have been about half the 8% to 9% 
range cited by GAO and OPM in their recent analyses of the 
FEHBP fee-for-service plans.
c. Questionable/Poor Business Practices
    The Staff testified that the 43 audit reports regarding the 
FEP issued by the OPM/OIG since 1988 show that more than $78 
million in contract charges were questioned and, of that 
amount, $51.6 million (66%) was disallowed. Items questioned 
and/or disallowed include: marketing charges (commissions, 
awards, and bonuses); advertising costs; charitable 
contributions; meals, entertainment, and travel expenses; 
promotional costs; lobbying and legal fees; and, membership in 
country clubs and other social organizations. For example:

        --Lthe BCBSA charged the FEP $2.6 million between 1985 
        and 1990 for commissions, awards, and bonuses paid to 
        employees for efforts resulting in the acquisition and 
        retention of subscribers. The OIG's previous audit had 
        identified similar charges of $568,217 for 1983 and 
        1984, which were also disallowed.
        --LBlue Shield of California charged the FEP more than 
        $48,000 for entertainment and promotional costs 
        associated with its 50th anniversary observance and 
        $148,000 in leasing costs for vehicles Plan employees 
        used for personal purposes.
        --LBlue Cross/Blue Shield of the National Capital Area 
        charged the FEP nearly $600,000 for lost investment 
        income, $80,000 for lobbying activities, and $26,000 
        for promotional items.

    Questionable charges were also identified among Blue Cross/
Blue Shield Medicare contractors audited by the Department of 
Health and Human Services, Office of the Inspector General 
(HHS/OIG). The OIG audits have recommended disallowing more 
than $40 million since 1992 for improper charges, including 
first-class airline tickets, golf course fees, alcoholic 
beverages, tickets for sporting and cultural events, and family 
travel.\87\
---------------------------------------------------------------------------
    \87\ At the Subcommittee's request, the HHS/OIG audited some 
expenses that had been questioned during its investigation of the 
Maryland and Empire Plans and found almost $1 million in unallowable 
salary charges.
---------------------------------------------------------------------------
    The Subcommittee also received testimony that Blue Cross/
Blue Shield Plans have withheld millions of dollars in hospital 
and provider discounts from the Federal government and FEP 
subscribers.\88\ OPM first discovered that Blues Plans were not 
complying with requirements that they credit the FEP for 
hospital ``differentials'' (the difference between the 
provider/hospital billed charge and the discounted amount 
actually reimbursed) during a 1975 audit of the Illinois Plan. 
Despite this audit finding and testimony provided by Blue 
Cross/Blue Shield officials insisting that the differential 
problem had been taken care of, some Plans have continued to 
abuse this requirement:
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    \88\ Hospital and provider discounts are a long-lived Blues 
practice, resulting from their tremendous purchasing power and the way 
hospital bills are paid. Individual Plans negotiate discount prices 
with hospitals and providers in return for sending patients to them. 
The discounts vary from 2% to 75%.

        --La 1992 OPM/OIG audit of the North Dakota Plan found 
        that it had overcharged the Government $585,000 by 
        paying hospitals a negotiated rate and then billing the 
        FEP for the full amount; and,
        --Lan audit of Blue Cross/Blue Shield of the National 
        Capital Area reported that the Plan owed OPM $1.4 
        million in interest alone for failing to credit the 
        Government on a timely basis for funds received from 
        hospital settlements.

    In the case of FEP subscribers, the Subcommittee found that 
for years many Blue Cross/Blue Shield Plans have been using the 
higher, non-discounted billed amount to determine coinsurance 
(the percentage of a bill for which the insured is 
responsible), resulting in unfair and higher out-of-pocket 
costs for thousands of Federal employees. For example, the 
Empire Plan told a subscriber that he owed more than $6,000 in 
coinsurance for hospital services that cost $16,000. However, 
after the hospital and the subscriber complained to OPM, it was 
determined that he actually owed about half the amount the Plan 
had charged him and, equally important, that the Plan owed more 
than twice the $1,700 it had paid pursuant to its obligations.
    The Subcommittee found that in other cases the Plan ended 
up paying nothing on a claim, while the Federal employee's 
coinsurance amounted to thousands of dollars. For instance, 
after calculating their discounts and deductibles, Blue Cross/
Blue Shield of Colorado had determined that the total covered 
charges for an $11,500 hospital bill was $3,700. The Federal 
subscriber's coinsurance was calculated using the $11,500 
amount and he was advised to pay the hospital $4,600. Since 
this latter amount exceeded the total charges owed by the Plan 
after its discounts had been factored in, the Plan ended up 
paying nothing to the hospital. The Federal employee, it should 
be noted, did not know this until after he complained about the 
size of the original bill. OPM subsequently determined that his 
actual coinsurance payment should have been about $1,500, 
instead of the $3,700 called for by the Plan.\89\
---------------------------------------------------------------------------
    \89\ OPM now prohibits the practice of calculating the coinsurance 
payment on the billed versus the discounted amount, and Blue Cross/Blue 
Shield officials testified that they are complying with this new 
policy. While the effects of this practice have not been fully 
assessed, OPM has determined that tens of millions of dollars are owed 
thousands of Federal subscribers for certain mental health and 
outpatient expenses incurred from 1990 to the present. In his testimony 
before the Subcommittee, OPM's Associate Director for Retirement and 
Insurance stated that he expects about $25 million in ``rebates'' to be 
refunded to these FEP enrollees.
---------------------------------------------------------------------------
    Serious problems were also identified in Blue Cross/Blue 
Shield's Medicare program involvement. Out of the 41 Plans 
operating as Part A intermediaries in 1993, eight had been 
placed on a ``watch list'' for failing to meet basic 
performance requirements--e.g., claims payment controls, 
timeliness of claims processing, and customer service--
established by HCFA. One of these Plans, Blue Cross/Blue Shield 
of Michigan, will be eliminated from the Medicare program at 
the end of the 1994 contract year because HCFA discovered that 
it had submitted false statements to cover up poor 
performance.\90\ Likewise, seven of the 27 Blue Cross/Blue 
Shield Part B carriers had been placed on the watch list by 
HCFA for poor performance and another three will not be renewed 
at the end of the 1994 contract year. It should also be noted 
that two of the Part B Plans on the watch list have additional 
problems with broader implications: the Justice Department has 
filed suit against the Florida Plan, alleging that it incurred 
$10 million in unwarranted Medicare program costs as a result 
of trying to resolve computer generated backlogs in claims 
payments; \91\ and, the Massachusetts Plan is under 
investigation by the HHS/OIG and the FBI for allegedly 
manipulating performance data to comply with the timeliness 
requirements of the Medicare contract.
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    \90\ The HHS/OIG and the FBI are conducting a criminal 
investigation of this case, which has already resulted in the firing of 
21 Michigan Plan managers.
    \91\ According to officials of the Florida Plan, it has agreed to 
pay the Federal government $10 million. Of this amount, $9.5 million 
will come from GTE Data Service, Inc., the company whose deficient 
computer system caused the Medicare claims payment backlog.
---------------------------------------------------------------------------
    In addition to these Part A and Part B problems, some Blue 
Cross/Blue Shield Plans have mismanaged their Medicare 
Secondary Payer Program (MSP) responsibilities, causing 
hundreds of millions of actual and potential losses to the 
Federal government.\92\ In the case of the Empire Plan, the 
HHS/OIG found that it had billed the Federal government for $85 
million in improper MSP payments.\93\ HCFA officials, moreover, 
stated that they believe that the total amount owed by Blue 
Cross/Blue Shield contractors for improper MSP payments is more 
than $500 million.
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    \92\ The MSP covers individuals 65 or older, who are still employed 
and have private health insurance coverage through their employers. 
Under the MSP, the private health insurer is supposed to pay the 
insured's medical claims as the primary carrier, with Medicare serving 
as the secondary carrier responsible for charges not covered by the 
former. In July 1990, the Subcommittee's Ranking Minority Member, 
Senator William V. Roth, held hearings on the MSP, which found that the 
Federal government may have erroneously paid between $400 million and 
$1 billion annually in benefits to providers who should have been paid 
by the primary carrier.
    \93\ The HHS/OIG audit confirmed $85 million. However, Empire 
failed to provide justification for another $118 million and HCFA has 
indicated it expects to recover this additional amount if such 
justification is not received from the Plan.
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d. Internal Control Deficiencies
    As with the individual Plans discussed above, the 
Subcommittee found that inadequate internal controls exist in a 
significant number of the Blue Cross/Blue Shield Plans 
participating in the FEP. A 1989 OPM/OIG audit report, for 
example, lists a number of weaknesses found regarding the 
Massachusetts Plan, including:

        --Linadequate controls over coordination of benefits 
        with other carriers;
        --Linadequate procedures for investigating duplicate 
        payments; and,
        --Linadequate segregation of allowable and unallowable 
        administrative costs.

OPM/OIG reports issued in 1992 and 1993 regarding the FEP 
operations of the Florida, Virginia, and Arizona Plans cite 
similar findings:

        --Lclaims processing system weaknesses;
        --Lduplicate payments;
        --Lfailure to properly coordinate benefits with other 
        carriers;
        --Lweaknesses in accounting systems for administrative 
        expenses; and,
        --Linadequate procedures to ensure that refunds were 
        properly credited to the contract.

    As was the case in the Maryland, District of Columbia, and 
Empire Plans, the weaknesses listed above have been recurring; 
e.g., the OPM/OIG's December 1992 audit report on the 
Massachusetts Plan cited the same problems described in the 
report issued three years earlier. In their review of the 43 
OPM/OIG audit reports issued since January 1988, the 
Subcommittee staff found that 34 cited problems with duplicate 
payments, 12 mentioned coordination of benefits difficulties, 
and 12 made reference to unsupported charges.
    Internal control weaknesses can constitute an open 
invitation to fraud. Throughout the Subcommittee's Blue Cross/
Blue Shield investigation, the evidence has indicated that 
anti-fraud efforts receive inadequate attention from the 
individual Plans, the BCBSA, and regulatory authorities.\94\ As 
noted previously, for example, in its examination of the Empire 
Plan, the Subcommittee found that one small criminal group was 
able to defraud the Plan of about $29 million owing to faults 
in its subscriber enrollment system.
---------------------------------------------------------------------------
    \94\ See related discussion below p. 85.
---------------------------------------------------------------------------
    Subscriber enrollment system problems in the FEHBP in 
general and the FEP in particular were identified as long ago 
as December, 1979 in a GAO report, Errors in Health Benefits 
Enrollment Data Push Up Health Insurance Costs (FGMSD-80-8). In 
that report, GAO stated that discrepancies in the enrollment 
data kept by the Federal agencies and insurance carriers caused 
erroneous premiums and benefits to be collected and paid, 
respectively. GAO noted that a 1976 audit of FEP files found a 
10% overall discrepancy rate among the Blue Cross/Blue Shield 
Plans and that half of these showed employees listed on the 
carriers' rolls as being eligible to receive benefits when they 
were not listed in the records of the Federal agency for which 
they presumably worked. GAO estimated that the Federal 
government was losing more than $1.5 million in premiums 
annually as a result of these discrepancies, but did not 
attempt to determine losses that may have occurred from 
fraudulent claims filed by ineligible individuals.\95\
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    \95\ The OPM Inspector General testified that in recent years his 
office has investigated several cases where, because of the lack of 
enrollee reconciliations by Blue Cross/Blue Shield, individuals have 
continued to receive health benefits for years after leaving Federal 
service. In some cases, these individuals received benefits to which 
they were not entitled worth more than $200,000 and in one case a 
former Federal employee received health benefits from Blue Cross/Blue 
Shield for 17 years after she had been fired from her job with the Navy 
Department.
---------------------------------------------------------------------------
    Enrollment system problems were also identified in almost 
yearly findings by outside accountants hired to audit the FEP 
Director's Office. For example, in 1979, the auditors noted 
that:

        reports of the previous audit firm noted there was no 
        reconciliation of the FEP enrollment system master 
        files, the various payroll offices' subscriber files, 
        and the various transmittal forms for subscriber input 
        and enrollment changes.

Inexplicably, it was not until 1989 that the Director's Office 
and OPM agreed to examine the enrollment system issue.
e. Questionable Business Expenses
    The Subcommittee's review of the FEP revealed the same 
irresponsible management outlook and apparent disregard for 
cost containment uncovered in the West Virginia, Maryland, D.C. 
and Empire Plans. Specifically, questionable and/or unnecessary 
charges were found in several areas, including conferences and 
meetings, promotional items, and executive compensation.
    Among the most questionable expenses charged to the Federal 
government are those associated with FEP National Conferences. 
Hundreds of employees and their spouses attend these events, 
which in recent years have been held at various resort and/or 
luxury hotels located in Scottsdale, Arizona (1990), New 
Orleans (1991), Palm Springs, California (1992), and Atlanta 
(1993). The Conferences consist of a mixture of lavish stage 
productions, informational speeches and workshops, and 
entertainment. One of the largest conference expenses is for 
the private production companies, which are retained to 
``design, produce, direct and stage'' the conference.\96\ For 
the 1990-1993 Conferences, the total cost of these production 
contracts was more than $1.1 million, all of which was billed 
to and paid by the Federal government.\97\
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    \96\ The production company is required to develop a theme that is 
carried on throughout the conference and must also provide ``speech 
preparation and support, audio visual and teleprompter speaker support 
for presentations, speaker rehearsal, * * * talent, props, costumes, 
sets, studio, editing suites equipment, duplication and delivery of 
finished 1/2" VHS tape cassettes for duplication.''
    \97\ The Government paid an additional $850,000 for food, 
beverages, meeting facilities, and other miscellaneous expenses 
incurred at these four conferences.
---------------------------------------------------------------------------
    The extent to which these costs are chargeable to the 
Government is based on a Federal Acquisition Regulations (FAR) 
standard of ``reasonableness.'' Section 31.201-3 of the FAR 
states that:

          A cost is reasonable if, in its nature and amount, it 
        does not exceed that which would be incurred by a 
        prudent person in the conduct of competitive business * 
        * * [and if] it is the type of cost generally 
        recognized as ordinary and necessary for the conduct of 
        contractor's business or the contract performance.

Then Chairman Nunn asked the HCFA Bureau of Program Operations 
Director, Carol J. Walton, and the OPM Associate Director for 
Retirement and Insurance, Curtis J. Smith, whether they 
considered these conference expenses to be appropriate Federal 
charges:

          Senator NUNN: * * * from what you have seen here,\98\ 
        would HCFA permit those kinds of expenses on 
        conferences to be charged to the Federal government?
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    \98\ Then Chairman Nunn was referring to a videotape shown during 
the Subcommittee staff's testimony, in which highlights of the 1991 and 
1992 conferences were depicted. The videotape showed lavish, Broadway-
style productions, complete with costumes, singing, dancing, etc.
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          Ms. WALTON: I would say that the video on the 
        conference to be financed by Federal funds is 
        offensive, and we would not permit that to be paid with 
        Medicare trust funds.
          Senator NUNN: Where do you draw the line?
          Ms. WALTON: I think conferences are totally business 
        affairs when they are financed by Government funds.
          Senator NUNN: And anything that goes beyond business 
        ought to be paid for outside of public funds.
          Ms. WALTON: * * * Yes, sir.
          Senator NUNN: Mr. Smith, do you generally agree with 
        that?
          Mr. SMITH: Yes. * * *

    Blue Cross/Blue Shield officials told the Subcommittee 
staff that these production costs--i.e., the value of ``Super 
Plan'' (an entertainer dressed in a Superman-like costume) at 
the 1991 conference and ``Dr. FEHBAR'' (creator of futuristic 
robots that had traveled back in time to study the success of 
the FEP) at the 1992 conference--were appropriate because they 
``didn't want people falling asleep.'' These officials also 
asserted that many U.S. companies hold similarly elaborate 
meetings. However, when the Staff asked the other 13 
participating FEHBP fee-for-service, not-for-profit plans about 
their conferences, none of the nine that responded indicated 
that they held such elaborate and expensive events.
    The FEP also holds annual Marketing Meetings, with about 
200 marketing representatives from the 67 participating Plans 
usually attending. Staging and production are part of the 
meeting format and are paid for by the Federal government. 
These costs amounted to about $180,000 in 1992 and 1993 
respectively, with the Government's total share being nearly 
$330,000.\99\
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    \99\ These are the only years for which the Subcommittee was able 
to obtain information from Blue Cross/Blue Shield.
---------------------------------------------------------------------------
    In addition, the BCBSA has hosted more than 200 meetings 
since 1990, including quarterly Board of Directors meetings 
that also have been held at luxury hotels or resorts, such as 
The Breakers in Palm Beach, Florida, the Colonial Williamsburg 
Inn in Virginia, and Westcourt in the Buttes in Tempe, Arizona. 
These meetings, which last two or three days and are attended 
by 80 directors and their spouses, cost as much as $60,000, 
one-third of which is typically charged to the Federal 
government. The Government also routinely pays a portion of the 
cost of entertaining the spouses, including items such as 
dinner theater performances, a tour of Victorian homes, and a 
champagne lunch and private tour of Liberace's estate.
    Promotional items have also been charged to the Federal 
government. In recent years the Government was charged for 
Customer Service Motivational Kits, including $23,000 for 
10,000 coffee mugs, $59,260 for 8,200 liquid paperweights, and 
$87,300 for 200 kits containing mirrors, buttons, memo pads, 
banners, balloons on sticks, and mobiles. Regarding such 
expenses, in an audit report dated October 20, 1992, OPM stated 
that:

          The Association charged the FEHBP for unallowable 
        advertising costs related to premium items and 
        giveaways that were used to enhance [its] * * * overall 
        image and to assist the marketing sales force during 
        annual open season campaigns. * * * [W]e determined 
        that the FEHBP was charged $224,399 in [such] 
        unallowable costs from 1985 through 1990 * * * [for] * 
        * * items * * * [including] * * * pocket calendars, 
        tote bags, ceramic, mugs, lapel pins, biofeedback 
        cards, and key chains.

    The Subcommittee's investigation also questioned executive 
compensation and miscellaneous personal expenses that were 
charged to the Federal government. The Government pays a 
portion of the salaries for 122 BCBSA management positions, 
including the President/CEO, the Chief Operating Officer, four 
Senior Vice Presidents, 10 Vice Presidents, 15 Executive 
Directors, 36 Directors, and 55 Managers. This included, in 
1993, $274,000 of the President/CEO's $866,000 total 
compensation; $143,504 of the Chief Operating Officer's 
$451,155 total compensation; and, $154,175 of the Senior Vice 
President of Business Services' $236,075 total compensation.
    In the case of Medicare, the HHS Inspector General 
testified that her office found unreasonable salary increases 
charged to the program by the Empire, Maryland, and 
Pennsylvania Plans. The OIG reported that top executives at 
these three Blues contractors received increases in their 
compensation packages that were greatly in excess of the 
Department of Labor's Employment Cost Index (ECI). For the 
period examined (1989-1992), while the ECI increased 14.6 
percent, the average compensation of the 12 top BCBSM 
executives rose 107.7 percent; for the eight top Pennsylvania 
Plan executives, the increase was 56.6 percent; and, for 
Empire's top four executives, the increase was 89 percent.\100\
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    \100\ The Empire figures are based on a six-year period, 1987-1992. 
As a result of these findings, the OIG has recommended that HCFA 
establish a ceiling on executive compensation increases that 
contractors can allocate to the Medicare program. According to the 
Inspector General's testimony, HCFA officials have agreed in principle 
that Medicare should not be charged unreasonable or excessive increases 
in executive compensation.
---------------------------------------------------------------------------
    The Subcommittee questioned the appropriateness of other 
BCBSA expenses that were charged to the Federal government:

        --Lthe Government paid $400 of the $1,200 cost of two 
        folding wardrobe bags for the President/CEO;
        --Lthe Government paid $700 of the $2,275 bill for 
        preparing the President/CEO's income tax returns;
        --Lthe Government paid $8,000 of a $40,000 annual 
        contract that provides fitness training to BCBSA 
        employees;
        --Lthe Government paid $600 of a $2,000 gift 
        certificate for a retiring member of the Board of 
        Directors; and,
        --Lthe Government provided tuition reimbursement for 
        FEP employees, including one that was attending law 
        school.\101\
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    \101\ The Subcommittee asked the OPM/OIG to examine similar expense 
items that had surfaced in the investigation of the Maryland, D.C., and 
Empire Plans. The OIG found that each of these Plans had improperly 
charged the Government for portions of their limousines, charitable 
contributions, country club memberships, first-class airfare, and/or 
salaries. In the case of the Maryland Plan, the unallowable costs that 
resulted from this review were $21,000; for the D.C. Plan, $15,000; 
and, for Empire, $132,000.
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                        2. Inadequate regulation

    The regulatory agencies responsible for overseeing the Blue 
Cross/Blue Shield contracts with the FEHBP and Medicare--OPM 
and HCFA, respectively--have encountered problems similar to 
those experienced by their State counterparts in connection 
with the West Virginia, Maryland, D.C., and Empire Plans. Both 
OPM and HCFA have dealt with uncooperative attitudes and 
evasive tactics on the part of the BCBSA and individual 
participating Plans, and OPM, in particular, has encountered 
considerable difficulty in being able to regulate them 
effectively.
    For example, in interviews with the Subcommittee staff, OPM 
contract officers referred to the FEP Director's Office and 
many of the individual participating Plans as being 
``arrogant,'' ``obstructionist,'' and ``uncooperative'' in 
their responses to legitimate regulatory requests and/or 
actions. OPM/OIG staff described similar problems, explaining 
that one of the reasons why it takes so long to finalize a 
draft audit report is that the BCBSA takes an inordinate amount 
of time to provide its comments. In reviewing some two dozen of 
the 43 audit reports issued by the OPM/OIG regarding the FEP 
since 1988, the Subcommittee staff found that BCBSA took an 
average of nearly 9 months to comment; in two cases nearly two 
years elapsed before the comments were received and, in 
another, it took nearly two-and-a-half years.
    These regulatory inadequacies can be attributed to limited 
resources as well as the problems inherent in trying to 
regulate entities as large as Blue Cross/Blue Shield Plans:
a. The ``Too-Big-To-Regulate'' Dilemma
    The Subcommittee staff testified that because Blue Cross/
Blue Shield Plans have about 40% of the FEHBP market share, 
regulators are forced to tread lightly, for fear that they 
might decide to pull out of the program. The Staff said they 
found evidence in the past, such as the early 1980s, that Blue 
Cross/Blue Shield officials made such threats prior to 
obtaining large increases in their service charges from OPM. A 
former OPM Assistant Director stated that ``one of OPM's worst 
nightmares was having the Blues drop out of the program,'' 
adding that they had threatened to do precisely that ``a couple 
of times.'' The present Assistant Administrator of OPM stated: 
``what would we do with the people [i.e., the subscribers] if 
we got rid of the [Blues] contract? It is impossible to 
terminate them because of their size.''
    This attitude, and the unquestioning and deferential 
treatment it has engendered, have undermined OPM's ability to 
regulate Blue Cross/Blue Shield effectively. It has made it 
difficult for OPM to take strong action when required and has 
led to unnecessary and wasteful expenditures, as demonstrated 
by the following:

        --Lspurred by criticism from GAO,\102\ OPM made a 
        concerted effort in 1992 to reduce administrative costs 
        in the FEHBP by 5%. Blue Cross/Blue Shield adamantly 
        opposed this initiative and it was not until almost a 
        year after it was announced that an agreement was 
        reached. The agreement provided for a reduction of only 
        1% per year spread over a three-year period, which for 
        1993 meant that Blue Cross/Blue Shield's administrative 
        savings decreased from the proposed $17 million to 
        $10.2 million. Other FEHBP carriers did not object as 
        strongly as Blue Cross/Blue Shield did and, in fact, 
        most accepted the initial request without much 
        complaint,
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    \102\ In May 1989, GAO testified (GAO/T-GGD-89-26) before the 
Subcommittee on Compensation and Employee Benefits of the House Post 
Office and Civil Service Committee, that OPM's cost control efforts 
were inadequate to contain excessive administrative expenses. A 
subsequent report in February 1992 (GAO/GGD-92-37) confirmed that 
stronger controls were still needed to reduce administrative costs in 
the FEHBP.
---------------------------------------------------------------------------
        --Lalthough a not-for-profit, the BCBSA is paid a 
        service charge by the Federal government for its role 
        in administering the FEP contract.\103\ From 1960, when 
        the contract first became operative, the amount of this 
        charge has grown almost every year and between 1981 
        (when a new formula was instituted) and 1993, it rose 
        from $6.4 million to $39.4 million (more than 
        500%).\104\ The Staff testified that in the eyes of 
        many OPM officials this new formula was flawed from the 
        start because, if applied correctly, it would result in 
        lower service charges unacceptable to the carriers. As 
        a result, OPM has basically ``force-fitted'' the 
        formula to produce the profits the Blues have 
        requested. Indeed, the Staff found that no one at OPM 
        had focused on this matter very much before 1992. 
        Typically, all the file contained was a handwritten 
        note from someone in the Insurance Group stating that 
        the service charge proposed by BCBSA ``looks good'' or 
        ``ok to me.'' Moreover, the Staff found that the 
        process used to determine the service charge has become 
        an incentive for BCBSA to increase costs, rather than 
        to reduce them as provided for in the formula's cost 
        containment criteria, since the higher the amount of 
        claims paid and administrative costs for processing 
        them, the greater the potential service charge.
---------------------------------------------------------------------------
    \103\ At the time of the FEHBP's inception, Blue Cross/Blue Shield 
insisted on a ``risk charge'' as a condition for participating in the 
program. According to OPM, since the original statute was written so 
that the Blues were the only real candidate able to administer the 
Government-wide Service Benefit Plan, ``* * * we had to allow the risk 
charge BC/BS was insisting on.'' As early as 1966, OPM's predecessor, 
the Civil Service Commission, proposed to do away with the risk charge 
because the original reasons behind it had been effectively eliminated 
by the establishment of reserves, Medicare, and experience rating. 
Indeed, reflecting the decreased risk to FEHBP carriers, the risk 
charge was renamed ``service charge'' in 1971.
    \104\ The formula developed in 1982 continues in effect today 
essentially unchanged, with the exception of a 1987 alteration that 
allows carriers to receive up to 1.1% of a combination of 
administrative expenses and claims incurred. The profit, i.e., ``that 
element of potential remuneration that contractors receive for contract 
performance over and above allowable costs,'' is determined by 
multiplying a number of weighted factors with the Plan's administrative 
costs and claims paid. The factors are: contractor performance; 
contract cost risk; Federal socio-economic programs; capital 
investments; cost control and other past accomplishments; and, 
independent development.
---------------------------------------------------------------------------
        --Las part of indirect costs, OPM is billed for a 
        portion of the membership dues individual Blue Cross/
        Blue Shield Plans pay to support the BCBSA. Between 
        1988-1992, the Federal government paid $11.7 million 
        for such membership dues. In 1975, when the current OPM 
        Inspector General's predecessor ruled that such charges 
        could not be billed to the Government, the BCBSA fought 
        to overturn this ruling, successfully accomplishing a 
        reversal in 1988. OPM officials could not provide the 
        Subcommittee with any justification for this payment 
        and said that they have continued it because of the 
        difficulty they knew they would encounter should an 
        attempt be made to exclude it.
b. Inadequate Resources
    Limited resources are among the more serious problems faced 
by OPM in trying to administer the FEHBP and oversee Blue 
Cross/Blue Shield's involvement therein. Funding for OPM, for 
example, has been widely recognized as being inadequate for 
years. While 1% of the total FEHBP premium is allotted for 
administering the program, the actual amount received by OPM is 
only 1/8 of 1% because the funds must be appropriated by 
Congress and the Office of Management and Budget has allowed 
OPM to only request that amount.
    In 1993 OPM had 166 employees, including 36 OPM/OIG staff, 
available to operate and oversee the $15 billion FEHBP; in 
contrast, there were 300 staff employed by the BCBSA's 
Director's Office to ``coordinate'' its Federal contract 
responsibilities. OPM's Contracts Division III, the group 
directly responsible for the FEP and 94 other contracts, had 
only $4,000 in travel funds for FY 1993 and none for FY 1994. 
As a result, the staff has not gone on a site visit to any of 
the participating Blue Cross/Blue Shield Plans for a number of 
years. Likewise, the Division's training budget is almost non-
existent; for 1993, the entire Insurance Group, of which 
Division III is a part, spent only $47,000 for conferences, 
seminars, and training, and only $2,000 has been budgeted for 
these purposes for the first six months of 1994.
    Given their limited resources, OPM officials admitted that 
there ``is no way for OPM to conduct the oversight and auditing 
necessary to make sure the contractors are properly 
administering the program and holding costs to a minimum.'' 
They rely substantially on the OPM/OIG for such audits and 
oversight--a situation which is itself problematic, since the 
OPM/OIG's goal of auditing all carriers, including Blue Cross/
Blue Shield Plans, on a three-year cycle has slipped to more 
than nine years, in some instances, as a result of the latter's 
own resource problems. Indeed, according to OIG officials, the 
last year in which an audit was performed on 47 of the 67 
participating Plans was 1986 or earlier and, in at least four 
of those, audits had not been done since the 1970s. Since FEHBP 
contracts have a five-year record retention requirement, this 
means that there are years that will never be audited because a 
carrier can simply say that records are no longer available for 
years outside the specified limit.
    The sizable intervals between audits also inhibit the 
probability of corrective action. One frustrated OIG auditor 
told the Subcommittee staff that the Blues feel comfortable in 
the knowledge that there will not be another audit for years 
ahead. OPM/OIG officials expressed similar frustration, 
observing that the Plans know that they will be audited only 
every five years or longer and, therefore, take risks. At 
worst, these officials added, even if certain charges are 
disallowed, the Plans will have had the benefit in the interim 
of the interest-free use of the questioned funds.
    Resource limitations force OPM to rely on Blue Cross/Blue 
Shield for essential information and to accept whatever they 
provide without verifying its accuracy. For example, OPM 
officials ``took it on faith'' that the Blues' calculations of 
subscriber refunds for improper coinsurance payments were 
accurate. Blue Cross/Blue Shield's original refund estimate of 
$160.5 million in November 1993, shrank markedly to slightly 
more than $80 million by May 1994. By the time of the 
Subcommittee's August hearings, this amount had declined even 
further to just $25 million, with apparently little concern on 
OPM's part as to accuracy:

          Senator NUNN: What happened to get [the estimate] 
        down from $160 million to $25 million?
          Mr. SMITH: I do not know the answer to that. The 
        estimate came from Blue Cross, and * * * as they did 
        more and more data collection and data analysis, the 
        number kept dropping and has ended up today at $25 
        million.
          Senator NUNN: So you are relying on basically a Blue 
        Cross computation here?
          Mr. SMITH: That is correct. They have the claims data 
        upon which the payments will be made and upon which the 
        calculation will be made.

    Finally, the Staff initially found a paucity of publicly 
reported internal or external fraud cases concerning the FEHBP 
and after examining the issue more closely concluded that the 
simple reason why there had been such few cases is because no 
one, outside of the understaffed OPM/OIG, was seriously looking 
for fraud. In 1989, GAO criticized OPM's anti-fraud efforts and 
concluded that OPM could not reasonably assure that FEHBP funds 
are adequately protected from fraud and abuse. More recently, 
the persistence of these weaknesses in anti-fraud efforts has 
resulted in the Office of Management and Budget placing the 
FEHBP among those programs classified as being at ``high-risk'' 
to fraud and abuse.

   3. Inadequate Oversight/Performance by the Blue Cross/Blue Shield 
                              Association

    The Subcommittee found inadequacies in BCBSA's ability to 
effectively oversee its Federal contract responsibilities. For 
example, the Staff testified that almost every OPM official 
with whom they spoke complained about the fact that the more 
than sixty participating Blue Cross/Blue Shield Plans do not 
have to answer to the FEP Director's Office.\105\ One official 
commented that the biggest problem she sees in FEP operations 
and subscriber service is the need for greater guidance and 
oversight by the Director's Office. She cited several areas 
where the Director's Office has performed inadequately, 
including: initial review of claims disputes between 
subscribers and individual Plans; keeping the FEP contract 
manual up to date, and cooperating with the OPM Contracts 
Office and OIG. She cited the example of a major fraud case 
involving a medical lab, in which the Director's Office failed 
to provide adequate data on a timely basis. She explained that 
``if all other carriers were as bad as the Blues * * * OPM 
would not have recovered anything in the case.'' \106\
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    \105\ The FEP Director's Office is part of the BCBSA and thus 
throughout this discussion its actions are treated as being the 
Association's ultimate responsibility.
    \106\ In their review of OPM internal files and correspondence, the 
Subcommittee staff came across other items that corroborate these 
observations, including the BCBSA's failure to: educate local Plans 
regarding changes in the FEP; submit financial statements in a timely 
manner; establish adequate procedures for the communication of appeals; 
and, resolve inconsistencies about who in Washington is responsible for 
handling various aspects of the FEP.
---------------------------------------------------------------------------
    From 1989 through 1993, the Federal government paid 
$500,000 annually for audits by the Director's Office intended 
to uncover mismanagement, fraud, and/or violations of the 
contract. Even though the Federal government had paid for these 
audits, prior to 1992 OPM could not get a copy, being 
restricted to just an ``on-site review'' by OIG staff. The OPM 
Inspector General also testified that the Director's Office was 
not reporting any internal fraud cases and few external fraud 
cases to his office. He added that even after being formally 
directed to do so in March 1994, ``they have not been 
responsive.''
    Similar problems exist in the Association's oversight of 
the Medicare contract. BCBSA officials expressly believe that 
monitoring of Medicare contracts is HCFA's responsibility, not 
the Association's. As a consequence, BCBSA is generally unaware 
of problems at the participating Plans until HCFA takes some 
type of action. For example, the Association was completely in 
the dark until after HCFA had notified Blue Cross/Blue Shield 
of Michigan in March 1994 that it was being terminated as both 
a Medicare Part A and Part B contractor, for allegedly 
falsifying data to enhance its Contractor Performance 
Evaluation Program (CPEP) scores.\107\ At the time of the 
Subcommittee's investigation nearly a dozen other Blue Cross/
Blue Shield Part A and/or Part B Plans had been placed on 
HCFA's watch list. If nothing else, the poor performance 
reflected in the significant number of Plans terminated and/or 
on the watch list should have generated considerable concern on 
the Association's part.
---------------------------------------------------------------------------
    \107\ HCFA uses CPEP to assess a Plan's compliance with Medicare 
program requirements and as a means of ranking its performance in 
relation to other contractors. Plans whose CPEP scores fall below the 
20th percentile of all other participating contractors can be dismissed 
from the program. Such removal of a contractor, according to HCFA 
officials, is a rare occurrence, with only three Part B carriers having 
been terminated in the past three years. Notably, all three of these 
have been Blues Plans; i.e., the King County Plan in Washington State 
(May, 1993), Blue Cross/ Blue Shield of Michigan (March, 1994), and 
Blue Cross/Blue Shield of Maryland (May, 1994).
---------------------------------------------------------------------------

           4. Response to Blue Cross/Blue Shield's Testimony

    In their testimony and submissions for the Record, Blue 
Cross/Blue Shield officials asserted that the Subcommittee 
staff's Statement contained ``serious misunderstandings or 
errors.'' In support of their contentions, they cited reports 
and other data, which in their view refuted some of the Staff's 
findings regarding FEP costs, the FEP service charge, the 
discount/co-payment issue, Medicare oversight, and the Medicare 
Secondary Payer Program. For example, they cited a Towers, 
Perrin study as evidence that FEP administrative costs are 
``reasonable in comparison to the administrative expenses of 
other health benefit plans.'' Also emphasized was a Miller and 
Chevalier study, which purportedly refutes the Subcommittee 
staff's testimony regarding lavish, unwarranted costs charged 
to the FEP by Blue Cross/Blue Shield.
    However, the Subcommittee notes that these reports were 
admittedly commissioned in response to its investigation and 
were not mentioned before the hearings. As then Chairman Nunn 
observed:

          I find it very strange and somewhat frustrating that 
        these studies are taking place during the same period 
        that we were having [this] investigation and you chose 
        not to share them with us or to even tell us about 
        them. * * * It looks like to me * * * [that] you hired 
        your own consultants, paid them * * * out of your own 
        funds and basically attempted to preempt the findings 
        without telling us about it.

    Moreover, only one of the reports was actually produced 
after the hearings and only at then Chairman Nunn's insistence. 
The other (the Miller and Chevalier study) the Subcommittee was 
informed, was a ``legal analysis'' performed by Blue Cross/Blue 
Shield's lawyers, not a report. Despite Mr. Tresnowski's 
testimony that he ``would be glad to submit that,'' this 
document was withheld on grounds that it was subject to 
attorney/client privilege, which Tresnowski refused to waive. 
Blue Cross/Blue Shield's refusal to produce this analysis makes 
it impossible for the Subcommittee to accurately evaluate Mr. 
Tresnowski's testimony based on it that disputes some of the 
Staff's findings.
    In addition, portions of Blue Cross/Blue Shield's testimony 
and use of these studies purportedly refuted ``statements'' or 
``conclusions'' that were mischaracterizations of what the 
Subcommittee staff said in their Statement. For example, the 
officials maintained that the Subcommittee staff had said that: 
``Blue Cross and Blue Shield shouldn't earn a profit;'' ``it is 
improper to use portions of the service charge to pay 
unallowable expenses;'' and, ``Blue Cross Blue Shield got the 
benefit of [the billed versus the discounted amount of 
coinsurance].'' In each case, the statements had not been made, 
prompting then Chairman Nunn to observe:

          Mr. Tresnowski, you have again set up a straw man. I 
        don't think you will find anything where the staff says 
        that. * * * What you are doing here is setting up one 
        exaggerated staff finding after another and knocking 
        them down. It is a very skillful job, but you are 
        quoting things from the staff study without putting 
        quote marks on it. You are deducing your own 
        [conclusions] and you are implying things and then 
        knocking them down. That is just not accurate.
    The following Senators, who were members of the Permanent 
Subcommittee on Investigations at the time of the hearings, 
have approved this report:

    William V. Roth, Jr.                Sam Nunn
    Ted Stevens                         John Glenn
    William S. Cohen                    Carl Levin
    Thad Cochran                        David Pryor
    John McCain                         Joseph Lieberman
                                        Byron L. Dorgan

    The following Senators who are currently Members of the 
Subcommittee but were not Members at the time of the hearing 
and did not participate in the hearing on which the report was 
prepared have taken no part in the preparation and submission 
of the report except to authorize its filing as a report made 
by the Subcommittee:

    Fred Thompson                       Daniel K. Akaka
    Charles Grassley                 
    Bob Smith

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