Highmark closes the deal

One of the nation's largest insurers last week closed on a $1 billion deal to become a large integrated delivery system with a pledge that newly acquired hospitals and doctors would deliver savings for enrollees and patients.

As Pittsburgh-based Highmark moves into the business of providing healthcare, Pennsylvania insurance regulators are following the company into that arena to hold the company to its promises. The venture could serve as a natural experiment exposing whether the integrated networks can generate significant savings. The survival of the health system Highmark just absorbed may depend on it.

Last week, Highmark acquired West Penn Allegheny Health System after more than a year of legal wrangling and public fracas. The deal was closely watched nationally as one of the biggest of several recent transactions that seek to consolidate healthcare's traditionally fragmented services. Dr. William Winkenwerder, Highmark's president and CEO, said last week the deal would create one of the nation's largest integrated delivery networks. Highmark reported $14.8 billion in revenue in 2011.

Pennsylvania's Insurance Department set conditions on the approval it granted late last month for Highmark's deal. The company will have to report annually on savings achieved by uniting insurance, hospitals and doctors into a single operation. The conditions underscore the challenge such deals present to regulators with limited jurisdiction who are tasked with promoting consumers' best interests as markets consolidate. The deal also gives Pennsylvania insurance regulators oversight of hospital operations by Highmark.

“Our objective was to really hold Highmark to the promises it has made,” said Pennsylvania Insurance Commissioner Michael Consedine.

The Insurance Department sought to set conditions that would expand its limited jurisdiction over Highmark with new reporting and approval requirements when Highmark makes large investments in hospitals or medical groups, Consedine said. Transactions or operations that do not fall under the Insurance Department's control may nonetheless threaten the financial stability of the insurer, and laws have not changed to reflect that risk.

Highmark now includes an insurance subsidiary, to be known as Highmark Health Services, and a provider subsidiary called the Allegheny Health Network, which will include West Penn Allegheny Health System; Jefferson Regional Medical Center in Jefferson Hills, Pa.; Allegheny Clinic, the system's medical group; a group purchasing organization; and an administrative services organization. Highmark executive John Paul was named president and CEO of the Allegheny Health Network.

West Penn Allegheny's financial instability threatened to unravel the deal and more than doubled the cost of the transaction for Highmark.

The health system tried unsuccessfully to break things off as its finances deteriorated and its leaders balked at a possible debt restructuring in court. Highmark ultimately reached a deal with the health systems' investors to buy bonds for 87.5 cents on the dollar.

Highmark Chief Financial Officer Nanette DeTurk said bondholders sold 85% of West Penn Allegheny's bonds. That cost Highmark $528 million, and the insurer has pledged to invest as much as another $525 million.

As a condition of the insurance department's approval, Highmark will have to report on four savings measures and its turnaround of West Penn Allegheny's finances, which hemorrhaged $112.5 million on revenue of $1.6 billion in the fiscal year ended June 30, 2012.

Benchmarks for savings include whether Highmark's new integrated network has reduced premiums by $3,000 annually for a family of four by 2016 compared with projected premiums had the deal never occurred. Highmark must also report performance against targets to reduce spending for hospital care and outpatient services by 10% and other projected cost savings.

Still more reporting is required each year on savings across eight categories, which Highmark projected would total about $1.1 billion through 2016, according to consultants for the insurance department. The company said it would produce savings in part by caring for patients in low-cost settings, reducing hospital visits and duplicate tests and use of generic drugs.

If its contract with rival Pittsburgh health system UPMC continues beyond next year, savings target would be lower, at $796 million.

But that seems unlikely. A UPMC spokesman said in an e-mail that the system has no intention of renewing or extending its contract with Highmark. “It is important that consumers understand these changes so they can take the steps needed to continue accessing their preferred doctors and hospitals,” said UPMC spokesman Paul Wood. UPMC “looks forward to competing” with Highmark, he said.

If West Penn Allegheny's operating losses continue through June 30, 2015, Highmark must submit a corrective action plan. The health system has earned an operating profit only once since its formation in 1999, according to Moody's Investors Service. Highmark must also submit plans to turn around losses if it pours another $100 million into the system through June 30, 2015, and at least two ratings agencies continue to rate West Penn Allegheny's credit as speculative.

Highmark must disclose West Penn Allegheny's finances and key operating statistics—including hospital volume, which has dwindled—every three months through June 30, 1015.

Winkenwerder said executives would move quickly to turn around the system.

Three days after the deal closed, Moody's downgraded Highmark to Baa2, citing the additional debt needed to finance the deal. Analysts said Highmark was at risk to fall further because of concerns it cannot compete with UPMC.

Follow Melanie Evans on Twitter: @MHmevans