Low cash reserves are forcing New Jersey's only provider-sponsored HMO to seek a financial bailout from one of the nation's largest for-profit managed-care companies.
The rescue, necessitated by New Jersey insurance laws, is a living example of the debate raging in Washington over who-states or the federal government-should regulate provider-sponsored organizations that want to contract directly with Medicare (See story, p. 3).
The troubled for-profit New Jersey HMO is First Option Health Plan, based in Red Bank. Its savior is Foundation Health Systems of Woodland Hills, Calif.
Last week, First Option agreed to a more than $50 million shot in the arm from FHS, formed earlier this month through the merger of Foundation Health Corp. and Health Systems International.
By a majority vote, shareholders of First Option accepted FHS' offer to buy $43 million of convertible subordinated debentures from the troubled HMO. FHS also will invest as much as another $8.4 million in the plan before the end of the year. As the debt is converted to equity, FHS eventually will control 71% of the plan.
The bailout approved by First Option builds on an earlier financial commitment by HSI to the 168,000-enrollee HMO (Nov. 4, 1996, p. 4). Observers said the bailout should not be viewed as an indictment of provider-sponsored HMOs but rather a lesson in what is required to run a serious managed-care business.
"It certainly underscores that management of an HMO or any managed-care organization is, in fact, a complex and relatively involved function," said Peter Kongstvedt, a partner in the Washington office of Ernst & Young.
It is certainly not a scenario that founders of the HMO imagined when they announced First Option's formation to a packed auditorium of shareholders and reporters more than three years ago (Dec. 20-27, 1993, p. 24). At that time, they said the move was designed to help "providers control their own destinies."
"Obviously it's a change in direction, but I think unfortunately it was really required," said Christopher Dadlez, executive vice president for Saint Barnabas Health Care System, Livingston, N.J.
Dadlez started First Option out of his office in 1993 when he was chief executive officer of Monmouth Medical Center. The Long Branch, N.J.-based hospital was the initial investor; it put up $500,000 of its own money. Eventually, 42 hospitals and their physicians invested $30 million in the for-profit plan, but it wasn't enough.
Last year at this time, First Option was up the risk-bearing creek without a paddle. Not only did it lack sufficient working capital, but its net reserves had slipped below state insurance department requirements.
HMO and insurance department officials declined to disclose the amount of the deficit until the deal with FHS closes.
In part, First Option undermined its own capital position through its philosophy of capping profits, keeping premiums low and passing along savings to providers in the form of higher reimbursement rates, sources said.
"Quite frankly, our medical management was not empowered or resourced to properly perform that function. Our (provider) fees were significantly above other managed-care players in the market," said Dennis Wilson, First Option's vice president of sales and marketing.
Observers said the plan was operationally adrift as well. By attempting to expand into New York and Pennsylvania too quickly, management stretched its thin financial and management resources beyond capacity. First Option's marketing successes produced swift enrollment growth but strained its medical management and information systems.
In the first seven months of operation, the HMO entered agreements to cover more than 100,000 lives, including 35,000 hospital employees and their dependents.
"Because of that growth, the claims processing was lagging behind," noted Gale Simon, an assistant commissioner with New Jersey's department of insurance.