1. 2001 Financial Examination Blue Cross Blue Shield of Michigan Michigan Office of Financial and Insurance Services Commissioner Frank M. Fitzgerald September, 2001

2. Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination 2  Michigan Office of Financial and Insurance Services’ (OFIS) role as regulator of Blue Cross Blue Shield of Michigan (BCBSM)  The purpose and scope of the financial examination

3. Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination 3  Over 50% of Michigan’s population depends on BCBSM for coverage and service  Michigan historically has relied on BCBSM for affordable and accessible health care coverage  BCBSM is Michigan’s “insurer of last resort” The Importance of BCBSM

4. Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination 4 BCBSM Family Organizational Chart PPOMThe Accident Fund Company Global Health Options 75% Ownership Health First 50% Ownership BCN Management Company Blue Cross Blue Shield of Michigan (BCBSM) BCN of Michigan BCN Service Company BCBSM Foundation Blue Care, Inc.

5. Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination 5 BCBSM Mix of Business Line of Business199319992001 Small Group (ARS)24.5%25.7%25.5% Large Group (ERS)16.0%15.9%17.0% Non Group 0.9% 0.5% 0.4% Group Conversion 1.0% 0.5% 0.5% Medigap 2.6% 2.1% 1.8% ASC (self-funded)53.8%54.2%54.8% All Lines100%100%100%

6. Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination 6 BCBSM AT A CROSSROADS Safe and solvent today, BCBSM shows disturbing trends and symptoms. Ignoring these problems will threaten BCBSM within the next decade.

7. Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination 7 Why BCBSM is at a crossroads  Losses in the small group market  Information systems  Cash strain  Inadequate investment return  Strain of Administrative Services Contract business  Management and board structure

8. Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination 8 Losses in the Small Group Market  Total BCBSM and Blue Care Network lives is 1,372,664  In the past 5 years, BCBSM has lost over $400 million in this market line Small Group Average Monthly Premiums for Hospital & Medical Coverage Individual2 personFamily ContractContractContract 1997 $178$375$419 1998 $198$414$464 Change11%10%11% 1999 $234$490$549 Change18%18%18% 2000 $248$522$584 Change6%7%6% Cumulative Change39%39%39%

9. Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination 9 Losses in the Small Group Market  BCBSM responded by making the loss an asset by using Financial Accounting Standard (FAS) 71 – a unique response  Making the loss an asset (a receivable) means it must be recovered within a reasonable amount of time or it will become a loss to BCBSM  Recovering the loss will add to future premium increases for small businesses caused by medical inflation

10. Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination 10 Information Systems  BCBSM has outdated technology systems  The OFIS financial examination showed serious shortcomings in the use of data by BCBSM  Ratemaking data is unavailable or not readily usable  The cost of upgrading the system is estimated at $300 million or more

11. Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination 11 Cash Strain – Blue Care Network (BCN)  $54 million expense to merge 4 regional Blue HMOs into BCN  $134.3 million BCN total loss from 1998 – 2000  $18.2 million BCN loss to date this year  Decline in BCN net worth from $190.7 in 1996 to $60.2 million on 2001  BCBSM is the “parent” that must support BCN

12. Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination 12 Cash Strain of Acquiring and Operating Affiliated Companies  BCBSM acquired Accident Fund Company and PPOM for cash – $272.1 million and $182.6 million respectively  Accident Fund Company provided no return for five years  Investments in affiliates account for 40% of total invested assets, almost 20% of total assets, and almost 100% of stock holdings

13. Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination 13 BCBSM Investment Return BCBSM INVESTED ASSETS Bonds824,339,31047% Common Stocks579,008,19533% Real Estate211,583,61812% Cash and Sort-Term Investments (28,579,345) -2% Other Invested Assets185,532,08410% Total Invested Assets 1,771,883,862100% Total Assets 3,669,366,663 Invested Assets as a % of Total Assets 48.3% Investment Return Excluding 56,271,523 Affiliated Investments and 1,186,159,184 Associated Dividend Income 4.7% Investment Return as a 56,271,523 Percentage of Total Assets 3,669,366,663 Excluding Affiliated Investments 1.8% = Net Investment Income /105,562,188 Average Invested Assets 1,737,189,640 The usual investment return includes 6.1% Results between 4.5% -10.0% INVESTED RETURN

14. Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination 14 Inadequate Investment Return  Real estate is 12% of total BCBSM assets  There is no return on these real estate assets  $108 million in appreciated BCBSM real estate value is not being used in any manner

15. Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination 15 Inadequate Investment Return  Common stock investment is 33% of invested assets – almost all in affiliated companies returning little to BCBSM  Overall return on investments as percentage of total assets (excluding affiliated investments) is 1.8%

16. Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination 16 Inadequate Investment Return – Advances to Providers  This is a monthly outflow of money that does not earn interest for BCBSM  BCBSM is historically put in the less favorable position of hospitals owing it money Advances To Providers: AssetLiabilityDifference 3/31/2001$265,429,232$194,069,851$71,359,381 12/31/2000 253,180,397 178,282,439 74,897,958 12/31/1999 172,869,563 183,288,855 (10,419,292) 12/31/1998 298,946,340 188,866,526110,079,814 12/31/1997 350,187,018 190,144,166160,042,852

17. Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination 17 Strain of Administrative Services Contract (ASC) Business  Traditionally, this represented half of BCBSM premium revenue  $4.5 billion returned $6.6 million in 1999  New reporting requirements will disallow reporting this as premium  It is questionable whether this business is appropriately leveraged by BCBSM to the benefit of subscribers

18. Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination 18 Management and Board Structure  1 Chief Executive Officer, 1 Executive Vice President, 10 Senior Vice Presidents and 27 additional Vice Presidents  Bonus plan and performance levels do not properly incentivize management  35 member board – large by industry standards  Statutory mission – PA 350, Section 550.1201

19. Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination 19 Consequences of maintaining status quo  Threat to affordability of and access to health care coverage  Declining BCBSM asset value for Michigan  Will BCBSM as we know it exist at decade’s end?  These possibilities do not leave Michigan with the best BCBSM health care asset  There are no easy or quick fixes for BCBSM

20. Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination 20 Age Rating Is Not The Answer  BCBSM controls 57% of the small group market  BCBSM and BCN control 71% of the small group market  Total BCBSM and BCN lives is 1,372,664 – the next largest competitor is 210,712  OFIS approved price adjustors for group size and participation percentages are stemming losses

21. Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination 21 BCBSM’s Board and Management Must Refocus  Greater attention to the BCBSM’s statutory “charitable and benevolent” mission  Acting competitively, not monopolistically  Leveraging BCBSM’s strengths in a competitive and changing health care coverage marketplace

22. Michigan Office of Financial and Insurance Services – BCBSM 2001 Financial Examination 22 Next Steps  Meet with Governor John Engler  Share findings with legislators  Take a more proactive approach toward BCBSM by OFIS and the Commissioner