Coventry Health Care has become the nation's foster parent to orphaned HMOs.
Since pulling itself up by its bootstraps in the mid-1990s, the Bethesda, Md.-based health insurer has built a thriving business by adopting troubled health plans-often from providers that lack the wherewithal to run them--and using disciplined management to return them to profitability.
The company kicked off its buying binge in 1998, when then-753,000-member Coventry Corp., Nashville, acquired 674,000-member Principal Health Care in Bethesda. Since then, the company has expanded rapidly, buying 13 health plans and almost doubling its membership. With total assets of $1.64 billion, the company is now one of the nation's 10 largest health insurers, covering 2.2 million members in 14 states across the Midwest, mid-Atlantic and Southeast regions.
"Coventry runs an extremely tight ship," says Thomas Carroll, a healthcare analyst with Legg Mason, Baltimore.
So tight, in fact, that its top executives--President and Chief Executive Officer Allen Wise, Chief Financial Officer Dale Wolf and Chief Operating Officer Thomas McDonough--all declined interviews. "It's just a matter of us staying focused on running our business," says John Stelben, director of investor relations. "We just don't take out time to do media-type requests and interviews."
The Coventry formula
Coventry's growth strategy is relatively simple: The company looks to make an average of three acquisitions per year, seeking out midsize, local health plans that are losing millions of dollars and can be snatched up for a fraction of their value. It always pays in cash and often buys more than one plan within the same region to beef up its market presence and achieve greater economies of scale. Coventry also typically keeps the acquired plan's name and relies on a decentralized management structure so it can respond quickly to local market changes.
The company then slashes the acquired plan's overhead, rejiggers its provider contracts and raises premiums--something that small, independent plans often are reluctant to try on their own. "They go after plans that haven't been priced appropriately so that they can extract large rate increases right away," Carroll says.
Results tend to be quick and dramatic, with the ailing plan generally returning to the black within six to 24 months. Take WellPath Community Health Plans, Chapel Hill, N.C., which Coventry acquired from Duke University Health System in July 2000 for $25.5 million. That year, the 70,000-member HMO posted a loss of $26 million on $211 million in revenue, according to the North Carolina Department of Insurance.
By the end of 2001, Coventry had cropped the plan's annual loss to $610,000, largely by raising rates, cutting medical costs and jettisoning a money-draining account covering state workers, a move that cut its total enrollment by more than half. WellPath, which had bled $50 million over the previous four years, turned its first annual profit in 2002, netting $3.1 million on $141 million in revenue. And for the first six months of 2003, it's earned $3.8 million on revenue of $86.3 million.
"(Coventry has) a very streamlined operation and a very strong top management that's able to go in and evaluate the marketplace and make the kinds of adjustments that need to be made, whether it has to do with administration or products or pricing," says Joseph Marinucci, senior healthcare analyst with Standard & Poor's.
These dramatic turnarounds have been a windfall for Coventry, whose net income has climbed at a rapid 46% average annual clip over the past five years. In 2002 alone, net income jumped 73% to $145.6 million, or $2.38 per share, on a 13.7% increase in revenue, to $3.6 billion. And 2003 could prove equally bright, with per-share earnings projected to reach $3.95 to $4 on revenue of as much as $4.5 billion.
The company's steady climb to the top ranks of health insurers also has enriched its management. Last year, Wise was the managed-care industry's third-highest paid executive, with total direct compensation of $21.7 million. That included $3 million in salary and bonus, $7.3 million in restricted stock and other compensation, and $11.3 million in exercised stock options. He also held $10 million in unexercised options at year-end.
Coventry's administrative spending tends to fluctuate by quarter as it acquires and integrates new plans. On an annual basis, however, the company has pulled down its administrative costs to 12.2% of total revenue in 2002 from 13.8% in 1998. And it expects that ratio to reach 11.6% by year-end as it completes its overhaul of two recent acquisitions, PersonalCare Health Management and Mid-America Health Partners, Wise said during an April 29 conference call with analysts.
At Champaign, Ill.-based PersonalCare--which Coventry acquired this year from Provena Health for $18 million--the company plans to cut the staff by one-third to about 100 and relocate claims, customer-service and enrollment functions from Illinois to a centralized service center in Bismarck, N.D.
Coventry already has cut 145 jobs at Kansas City, Mo.-based Mid-America, which it acquired in December 2002 from the former St. Luke's-Shawnee Mission Health System in a $40.2 million deal that doubled its local market share to 35%. As a rule of thumb, Coventry assumes a health plan should have two employees for every 1,000 enrollees; but with 120,000 members, Mid-America had 385 employees, well over the 240 it needed to operate efficiently, Wise said at a Bear, Stearns & Co. healthcare conference last year.
Coventry also faces having to enhance claims processing at Mid-America, which ranked among the four worst offenders of the state's prompt-payment law, according to a 2002 survey by the Missouri State Medical Association. Another Coventry HMO, Earth City, Mo.-based Group Health Plan, also made the list.
Coventry, which is working to reduce payment times by encouraging physicians to file claims electronically, has long espoused the financial advantages of investing heavily in claims-processing technology. "We try to negotiate as attractive rates as we can from the providers, and I think that we do better when we have a reputation of paying promptly and paying accurately," Wolf said during a February conference call with analysts.
Still, Coventry remains one of several insurers embroiled in a national class-action lawsuit filed on behalf of 950,000 active and retired doctors who claim the nation's leading HMOs have bilked them out of millions of dollars. The lawsuit, filed in 1999 and now before the U.S. District Court in Miami, alleges the insurers used computer systems to automatically delay, deny or reduce payments to physicians. Unlike Aetna and Cigna Corp., both of which recently settled their parts of the lawsuit out of court, Coventry and six other plans have opted to go to trial.
Separately, many providers remain frustrated by Coventry's strict management of medical costs.
The company has managed to steadily shear down its medical-loss ratio--or percentage of premium revenue spent on medical claims--from 86.9% in 1998 to 83.3% in 2002 and a projected 81% to 82% this year, according to analysts--largely by maintaining tight limits on coverage. "This is a company, when we have a member or a patient that's warehoused a couple of days in a hospital or waiting for the MRI to be repaired, it's two days that we don't pay for," Wise said during the April conference call.
According to Vickie Massey, immediate past president of the Metropolitan Medical Society of Greater Kansas City, several doctors have pulled out of Mid-America's network since the plan's change in ownership.
"Coventry manages its medical coverage a little tighter than some insurers, and it continues to have more precertification requirements than others," says Massey, an oncologist in Kansas City.
For example, the company no longer allows local pathologists to run certain blood tests in their offices and instead requires the samples to be sent to out-of-state laboratories with which it contracts. Such restrictions, Massey says, compromise the quality of healthcare by hampering physicians' ability to get timely test results.
Indeed, Coventry has been known to play hardball with providers. In August 2001, it sued Via Christi Health System, Wichita, Kan., and its two health plans for alleged violations of federal antitrust laws. The lawsuit claimed Via Christi favored its own health plans and illegally used its market power in inpatient care to freeze rival insurers out of the market.
Also in 2001, Coventry and several Pennsylvania insurers sued Pittsburgh-based UPMC Health System in an attempt to block the 12-hospital system's merger with 235-bed Children's Hospital of Pittsburgh, a $500 million transaction that the plaintiffs claimed would give UPMC a lock on pediatric services. The insurers dropped their legal action in October 2001 after the state attorney general crafted a consent decree that allowed the merger to proceed, but with several caveats to protect local health plans.
Pick of the litter
Still, Coventry has faced no shortage of struggling HMOs eager to turn their business over to a larger company rather than shut their doors.
Faced with rising costs and heightened competition from much larger rivals, a growing number of small, regional HMOs have been closing down or putting themselves on the auction block. According to InterStudy Publications, St. Paul, Minn., the number of HMOs nationwide has fallen to 454 as of Jan. 1 from 651 in January 1998.
The exodus has been particularly pronounced among provider-owned plans, which have struggled to stay afloat in the turbulent market. Last year, healthcare systems sold 10 plans, accounting for 31% of all HMO and PPO sales in 2002, according to Cain Bros., New York.
"Hospitals have decided they can't run HMOs," says Peter Kongstvedt, a healthcare analyst and vice president of Cap Gemini Ernst & Young, Washington. "Most have lost a lot of money and they want to get back to their bread and butter. These HMOs have been fertile acquisition territory for companies like Coventry."
Frankfort, Ill.-based Provena was one such system. Thomas Hansen, Provena's assistant vice president of business strategy and development, says selling off PersonalCare and several other noncore business lines was a key part of Provena's ongoing turnaround, an effort that vaulted the six-hospital system into the black last year for the first time since its formation in 1997.
"The insurance business, by its very definition, wants to lower the use of medical services. That's in direct conflict with our goal as a hospital system," Hansen says. "It's difficult for one organization to balance those two very different measures of success."
Rising from the ashes
Coventry has its roots in a company called HealthAmerica, co-founded in 1980 by healthcare entrepreneur Phil Bredesen, Nashville's former mayor and now governor of Tennessee.
Bredesen, who turns 60 this month, got the idea for HealthAmerica by studying large for-profit hospital chains, including Nashville-based HCA, then known as HCA-Hospital Corporation of America. The chains had enjoyed dramatic growth in the 1970s by acquiring not-for-profit hospitals, then updating their equipment and hiring savvy new management. Time and again, the formula turned financially marginal facilities into highly profitable ones.
Bredesen decided to apply the same strategy to HMOs, which had begun to enjoy an upswing thanks to a 1973 federal law that required employers to offer their workers an HMO option. In his first acquisition, he paid $2.2 million for Pittsburgh-based Penn Group Health Plan, started in 1975 by the University of Pittsburgh. The HMO was breaking even but had stalled at 17,000 members and lacked the capital to expand.
He quickly reinvigorated Penn Group by upgrading facilities and building credibility among local union workers. Within five years, the plan--renamed HealthAmerica Pennsylvania--had 86,000 members.
From there, Bredesen continued to buy salvageable health plans at a furious pace and began opening new ones, knowing that expansion would eventually become tougher once big health insurance companies decided to compete seriously in the HMO market. At its peak in 1985, HealthAmerica had 39 plans nationwide.
But Bredesen's aggressive growth strategy created problems that would cost him the company and its flagship Pennsylvania HMO--at least temporarily. High start-up costs and difficulty finding enough skilled managers to run the dozens of new plans began to cut deeply into earnings and prompted Bredesen's partners to bail out. In 1986, Bredesen reluctantly sold HealthAmerica to Maxicare Health Plans, Los Angeles, for $400 million.
Undaunted, Bredesen immediately co-founded Coventry Corp. as an indemnity carrier and staff-model HMO. And in 1988, Coventry and partner Montefiore Hospital, Pittsburgh, paid $10 million to jointly reacquire HealthAmerica Pennsylvania from Maxicare, which by then was spiraling toward bankruptcy.
Coventry continued to grow steadily, and in March 1991 raised $46 million in an initial public offering. That year, Bredesen stepped down as the company's chairman and was elected Nashville's mayor. He remained a Coventry director until leaving in June 1998.
But by 1993, Coventry had run into serious financial difficulties. Not only had it underpriced its policies to compete for business and allowed its costs to balloon, it also was suffering from anemic enrollment growth. The company lost $61.3 million in 1996--down from net income of $18 million in 1995 and $29.3 million in 1994--placing it in default on a $90 million bank loan, according to SEC filings. That year, Wise replaced then-CEO Philip Hertik in a management shake-up.
Reflecting a national trend, Coventry scrapped its staff-model strategy, which had become a drain on finances. In 1997, it sold off all 28 of its physician groups, 11 of them to Allegheny Health, Education and Research Foundation, Pittsburgh, which filed for bankruptcy one year later.
The company, which had catered to national Fortune 500 firms, also shifted its focus to midsize, local and regional employers to set itself apart. "Unlike an Aetna or a Cigna, which tend to target large metropolitan markets, they want to be the prominent alternative in (prime) secondary markets like Harrisburg," says analyst Carroll, adding that Coventry's main rivals tend to be the local Blues plans.
By 1997, Coventry had rebounded to a net profit of $11.9 million, largely by marketing more customized plans to meet local clients' needs--a strategy the company maintains to this day.
Having scarcely emerged from its own financial ashes, Coventry agreed in November 1997 to pay $375 million for Principal Health Care, the HMO unit of financial services giant Principal Financial Group, Des Moines, Iowa. That acquisition expanded Coventry from four markets to 21, doubled both its membership and revenue, and catapulted it into the ranks of the nation's 10 largest health plans. But Principal was hemorrhaging money--posting losses of $22.6 million in 1995, $40 million in 1996 and $14.9 million in the first nine months of 1997.
Wise, who was named CEO of the new company, immediately set about working Coventry's turnaround magic--slashing overhead, quitting lackluster markets and abandoning unprofitable business lines such as Medicaid.
By the end of 1998, the combined company had chopped its annual loss to $11.7 million, and has racked up accelerating profits ever since. The company has no plans to slow down.
"We will stay the course," Wise said in April. "This system has worked for almost seven years now, and it's going to work for the next several years, too."
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