Anatomy of a Turnaround at Highmark

By unifying far-flung IT systems and implementing pay-for-performance, CFO Robert Gray has helped spark a remarkable recovery at the health-care in...
Alix StuartOctober 1, 2001

Three years ago, soaring medical costs and shifting consumer demands put more than 80 percent of the nation’s 55 Blue Cross and Blue Shield plans in the red, according to insurance watchdog Weiss Ratings. A merger between Pennsylvania Blue Shield and Blue Cross of Western Pennsylvania produced one of the biggest bleeders: Highmark, the new $6.6 billion combined entity, saw an approximately $90 million operating loss in 1998, the second largest in the country.

Like most health-care insurers, Pittsburgh-based Highmark somewhat insulated itself from industry woes by maintaining a strong investment portfolio. But CFO Bob Gray, who started his career as a general manager at Pennsylvania Blue Shield in 1987, knew that a successful turnaround depended on curing operational ills as well. “Our business is not that complicated; it’s about pricing products appropriately and managing claims-processing costs,” says Gray. At the time he was promoted to CFO in 1998, however, both factors were out of control. The year before, medical costs had overwhelmed underwriting revenues, creating losses of about $1 million per day, and claims-processing expenses were unnaturally high, due to aged and redundant information technology.

Gray developed a three-year plan to address these issues and restore operations to profitability by 2000. Last year, the timetable met, the now-$9 billion company recorded a 1.7 percent operating profit margin, far above the 0.6 percent industry average cited by Weiss. In addition, more than $100 million has been sliced out of annual claims-processing expenses. And CEO John Brouse believes Gray, the winner of this year’s CFO Excellence Award for Turnaround Management, has set Highmark on course for “a sustainable, predictable level of financial performance” for years to come.

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Diagnostic Tools

Charting that course meant first addressing pricing inadequacies. That task, notes Highmark auditor Bob Sands, a partner in PricewaterhouseCoopers’s Philadelphia office, was hindered by the fact that insurers can generally change their prices only once a year (when subscribers renew), regardless of changes in medical costs. But after amplifying Highmark’s traditional 12-month trailing-cost analyses with rolling 6-month forecasts, Gray was able to up the premiums its nearly 5 million subscribers pay by an average 10 percent a year. As a result, underwriting revenues grew about 10 percent in both 1999 and 2000.

Addressing inefficient claims-processing was a little more complicated since, postmerger, Highmark had five different systems to handle claims, 50 different locations for medical provider data, and two customer service centers, along with a number of outsourcing relationships. Gray helped convince Highmark’s board of directors that the best solution was to allocate $111 million from reserves for an enterprisewide system called BluePrint, which streamlines operating processes and will eventually consolidate the data into one location.

Although that system is still evolving, huge efficiencies have already been gained. For example, employees are about five times more efficient when entering claims data, thanks to the scanning and processing system that replaced manual-entry procedures. Payment systems that were previously set up by type of claim are being reorganized by health-care provider, so Highmark can cut one check per hospital, rather than produce separate checks each time a subscriber sees a physician. As a result, administrative cost ratios have steadily declined, from 17.3 percent of revenues in 1998 to 14.9 percent in 2000. In addition, bringing all processing in-house and selling off excess facilities brought one-time gains of $15 million.

While BluePrint’s final tab will run nine figures, Gray expects it will save more than $40 million annually once the consolidation is complete. The new infrastructure means “the company is now recognizing the synergies from the merger,” says Christian Miles, an analyst with A.M. Best. And the effort, says John Rex, managing director at Bear, Stearns & Co., makes Highmark “one of the most technologically deep” companies in the industry.

Managed Care

The systems and administrative efforts represented most of the low-hanging fruit, says Gray. Consequently, by the end of 1999, he had turned his focus to minimizing medical costs, which typically account for 85 percent of total expenses. “The challenge is to identify the 20 percent of users who drive 80 percent of your costs, and actively manage them,” says Rex.

Part of the solution lay in motivating subscribers to maintain healthier lifestyles and reduce high-cost crisis episodes, says Gray. Efforts toward this goal range from a 24-hour nurse-staffed medical advice hotline for all subscribers to having case managers work directly with chronically ill patients to monitor their nutrition and medication. Gray estimates these programs saved the company $120 million in 1999, their first year, and medical claims incurred as a percentage of subscriber revenue have steadily dropped, from 90.3 percent in 1997 to 86.7 percent in 2000.

Meanwhile, BlueChoice, a splashy new consumer-oriented Web site with online enrollment capabilities, puts Highmark “ahead of the curve in being able to deal with the shift to defined-contribution health plans,” where employees get a capped health-care budget to spend at their discretion, says Jack Reichman, an analyst with Standard & Poor’s. With fewer than 5 percent of subscribers participating so far, it’s too early to see financial gains, says Gray, but he expects the site to mean less paperwork, better data accuracy, and a much faster enrollment process, ultimately leading to additional cost savings.

Gray has also wrung savings from Highmark’s other main stakeholders — physicians. For example, a popular online portal is fast replacing labor-intensive phone calls and faxes as a forum for questions on benefits eligibility, referrals, and claims tracking.

In addition, Gray is quick to credit Highmark’s 7,000 employees for their role in the turnaround. “Driving productivity goals has been very demanding,” he says, “but the reason we were able to do it was that our financial targets are known and understood by most employees, and their compensation is influenced by how they perform against those targets.” A new incentive structure has been key in developing “the mindset of a for-profit, investor-owned company,” he adds.

Lingering Effects

Highmark’s newfound financial strength has had its critics. While the company has consistently fulfilled its requirement as a nonprofit to reinvest 1.25 percent of direct written premiums back into the community, it has come under fire from local physician groups and even the American Medical Association for not doing more. Given that the bull market helped swell Highmark’s reserves to $2.03 billion last year, the groups complain that it is hoarding financial gains.

Gray disagrees. “Strong reserves and for-profit subsidiaries that create jobs for Western Pennsylvania are excellent for the community and help us meet our mission,” he says. Indeed, after recording a $12.9 million loss in 1999, the company’s subsidiaries (some of which are for-profit) constituted 30 percent of operating revenues last year.

Going forward, the rise of some formidable competitors threatens the approximately 60 percent market share Highmark enjoys across its territories. But overall, the company appears to be staying healthy. “We project that operating performance will be slightly better than planned,” says Gray, netting out to $225 million on a pretax consolidated basis. Highmark executives are now eyeing growth. A tentative first step toward an out-of-state alliance came last year in the form of a $10 million investment in West Virginia’s Mountain State Blue Cross & Blue Shield. Executives have also mulled the possibility of going public.

Gray, though, says the company’s top priority is to maintain financial stability. “We are trying to make it very clear to ourselves how we define success,” he says, “and then answer the next questions: Are the reasons we’re successful today going to be threatened in the future, and if so, how are we going to protect ourselves?”

Highmark Stops the Hemorrhaging

Premium hikes and cost controls have paid off.

1997 1998 1999 2000
Subscription revenue $6.65 bil $6.96 bil $7.69 bil $8.43 bil
Operating profits (unconsolidated) $-175.3 mil $-91.2 mil $-43.2 mil $139.5 mil
Operating cash flow $-330 mil $-9 mil $141 mil $265 mil

Source: Highmark