Executive Summary, Findings and Recommendations of The Abell Foundation Study:

Policy Considerations Arising From A Sale of the Maryland Blue Cross/Blue Shield Plan

by Carl J. Schramm, Ph.D.
Maryland Blue Cross Blue Shield was founded in 1937 by Maryland’s charitable hospitals to enable people to “subscribe” to a hospital care insurance plan. Patients’ ability to pay through the plan, in turn, buttressed hospital solvency.

CareFirst is a holding company organized by the Maryland Blue Cross Blue Shield plan and is the owner of the Blue Cross Blue Shield plans of Delaware, the District of Columbia, and Maryland. Over the past five years, CareFirst has been reconfiguring and repositioning itself in the region’s health insurance marketplace by acquiring neighboring Blue plans, restructuring its target markets, and gradually backing away from its traditional role as Maryland’s insurer of last resort.

For more than a year, it has been common knowledge in the political arena and the health insurance industry that CareFirst is actively interested in being acquired by a for-profit insurer. Because the disappearance of CareFirst would have significant effects on the health care marketplace in Maryland, it is inevitable that public debate will commence. This report was commissioned by The Abell Foundation to inform and support that debate. It is intended to point community inquiry to the issues and facts that should be widely discussed and carefully considered before any conversion of Maryland Blue Cross is sanctioned. This study raises many more questions than it settles.
Dr. Schramm will discuss the proposed Blue Cross-Blue Shield privatization on Maryland Public Television’s “Jeff Salkin Show” at 7:30 p.m. on Tues., Jan. 8. The show will be rebroadcast at 11:30 p.m. the same night.

CareFirst declined to cooperate in this study. Citing concerns that an inquiry could be disruptive to a possible merger transaction, it informed The Abell Foundation that it would not participate. As a result, analysis of CareFirst’s current performance data was not possible, nor was any inquiry into its motivations in pursuit of a merger with a for-profit entity. Critical questions about CareFirst’s retreat from serving the individual and small group market for health insurance in Maryland could not be put to management.

It was not possible to discuss with management the evolution of CareFirst’s strategic blueprint, the apparent absence of which is an important issue to emerge from this study.

The community interest in the conversion of CareFirst into a for-profit insurer is based on the existence of Maryland Blue Cross Blue Shield, since its inception in 1937, as a special participant in the State’s health care system. The plan was founded by Maryland’s charitable hospitals to enable people to “subscribe” to a hospital care insurance plan. Patients’ ability to pay through the plan, in turn, buttressed hospital solvency.

As a sign of Maryland Blue’s unique role as a partner with the State to ensure access to affordable coverage for Marylanders, Maryland has sheltered the plan from income and premium taxes that other insurance carriers must pay. In addition, Maryland’s Health Services Cost Review Commission (HSCRC) has granted the Maryland Blue plan certain differentials in the payment of hospital charges that reward the plan’s assumption of risks in providing “substantial, available and affordable coverage” (the SAAC differential) to individuals who otherwise might be unable to obtain health insurance.

In many respects, the citizens of Maryland have relied on Blue Cross as the insurer of last resort, to provide coverage to persons who could not buy protection from other carriers, and have been allied with the company since its founding. As Maryland’s largest health insurer,

Blue Cross is the single most influential force in the State’s health care economy. It insures over two million people in Maryland, and has annual revenues of nearly five billion dollars.

More important than its statistical profile are the special expectations that arise from its unique history and status as Maryland’s Blue plan. Blue Cross of Maryland was founded in the Great Depression when thousands of Marylanders were without work. Worry about whether they could afford care kept many people from medical attention and the charitable care burden threatened the very existence of many hospitals.

Given the weakened condition of today’s economy, it is particularly timely to consider the future of health insurance in Maryland without a Blue Cross plan. As people lose jobs, slide down to lower paid jobs, and watch spouses become unemployed, the need for available and affordable coverage may be as critical today as in previous periods of high unemployment and economic uncertainty. In the past several years,

Maryland Blue Cross has declared that it no longer wants to be regarded as the State’s insurer of last resort, and has withdrawn from the Medicaid and Medicare HMO programs. Both of these programs provided comprehensive benefits to poor and elderly citizens and, in the case of the Medicare HMO, important drug coverage.

Likewise, CareFirst now is in the process of using its multi-state system of HMOs as the basis to exercise its right to withdraw from the HMO market for individuals and small groups in Maryland. This step has brought forth an unusual declaration from Maryland’s Insurance Commissioner, Steven B. Larsen, that the plan is choosing to bolster its profits by effectively rescinding the coverage of thousands of less healthy Marylanders. This retreat from that part of the market that most needs available and affordable insurance sheds light on the limits of the regulatory authority of the State’s Insurance Commissioner.

Looking at CareFirst purely as a business, it is hard to identify the strategic vision or plan under which the company is operating. In the past few years, it has been an acquiring plan, buying two of its neighboring plans. The plan has attempted, unsuccessfully, to become a publicly- traded, for-profit company. It also has asked the General Assembly to permit it to change form to become a mutual company, an action frustrated by the legislature. Now, it appears that the plan has offered itself up for sale. It is impossible to discern from the public record whether potential buyers have approached the plan or whether management is seeking offers. It is not hard to see, however, that management is attempting to change its relationship with the market in order to make the plan more attractive to a potential buyer.

For thirty years, Maryland has pursued innovative, explicit policies that have resulted in lower rates of health care cost inflation, reductions in overall health care spending, and protection of the State’s hospitals from bad debt which, in turn, has permitted Maryland hospitals to provide care to anyone regardless of ability to pay. In return for several forms of significant government support, Maryland Blue Cross has participated in this public/private policy partnership by sustaining a market for individuals and small groups that has kept the number of Marylanders without private insurance lower than it otherwise would have been. CareFirst’s withdrawal from providing coverage to this market segment could precipitate a crisis in the entire health care financing system in Maryland. Other carriers may be unwilling or unable to shoulder the burden of providing coverage to individuals and groups once covered by Blue Cross and may follow CareFirst out of the market. As a result of the inevitable increase in the number of citizens without insurance coverage, economic balance among hospitals and insurance companies, managed through the HSCRC, could be in jeopardy. The loss of Maryland’s commitment to a system that protects the poor and the otherwise uninsurable, while providing a predictable environment for the State’s hospitals and insurance companies, would be an intolerable price to pay for CareFirst’s corporate ambitions.


  1. Blue Cross of Maryland, the principal asset of CareFirst, is a quasi-public entity created to provide non-profit health insurance to Marylanders. By tradition, Blue Cross provided open enrollment coverage for individuals and persons with medical profiles who otherwise would be uninsurable. It also has provided affordable coverage for individuals and small groups.

    1. Blue Cross of Maryland was founded by the State’s charitable hospitals in order to advance their charitable purpose, i.e., providing care to those who could not pay for it while remaining solvent. All of Maryland’s hospitals continue to operate as charities.

    2. When chartering the Maryland plan by special legislation, the Maryland General Assembly established charitable expectations, including a requirement that the plan would operate as a non-profit, non-stock entity. These expectations continue in Maryland statute.

    3. The Maryland Blue plan and its parent have retreated from the charitable nature that once characterized the plan. The plan disclaims its historic status as insurer of last resort. It has retreated from offering HMO products that are particularly affordable to individuals and small groups.

    4. Maryland statute does not contain a “charities act” which would impose special statutory charitable fiduciary standards on Blue Cross management and directors.

    5. Blue Cross enjoys exemption from premium and income taxes because it has acted as a charitable entity by performing a public service that otherwise would fall to the State.

  2. CareFirst’s management appears to be offering the company for sale. In an attempt to make the plan more attractive to a potential acquirer, it has retreated from those higher risk parts of the market in which the need for insurance products is most acute. In so doing, the plan may precipitate an availability crisis that will force other carriers to exit the Maryland market.

    1. Over the last five years, CareFirst has attempted three different business strategies that would have resulted in major transformations of the company. Because it is the largest carrier in the State, its peripatetic pursuit of one strategy and then another creates costly instability in the insurance market.

    2. CareFirst has ample reserves that exceed the minimum established by the National Association of Insurance Commissioners by approximately 500 percent. Neither a merger nor conversion to for-profit form is necessary to protect either the company’s assets or its market position, now or in the foreseeable future.

    3. In 2000, the plan enjoyed a State premium tax exemption of approximately $13 million and also was exempt from Maryland income tax. In addition, the plan enjoyed an implicit subsidy of $31 million through the SAAC differential, the difference between the reduced amounts that CareFirst has been permitted to pay for Maryland hospital admissions and the actual cost of the plan’s coverage of hard-to- insure individuals in Maryland. Since 2000, a portion of that subsidy has been used to fund a short term prescription drug program mandated by the General Assembly.

    4. CareFirst’s recent decision to exit the individual HMO market may force Maryland’s remaining carriers to provide additional coverage to the individual and small group market, and may, in turn, cause these carriers to withdraw, with the result of even fewer coverage options in this market.

  3. There are no economic or business reasons why Blue Cross of Maryland should be sold. Similar transactions involving other Blue Cross plans have not benefited the communities in which those plans operate by achieving lower premiums or better service. The percentage of premiums that is paid out for medical claims is significantly lower in for-profit plans than non-profits.

    1. Conversion of Blue plans does not result in demonstrable economic efficiencies. Profit margins for smaller non-profit plans and for consolidated non-profit plans, e.g., CareFirst, are higher than for larger plans and for investor-owned plans.

    2. For-profit Blue plans return significantly fewer dollars to providers of care than do non-profit plans. A significant portion of the profit margins of investor-owned Blue plans result from lower payment rates to health care providers.

    3. Profit levels in health insurance companies are highly tied to local market knowledge. This is particularly true in the large case market that is the majority of any Blue’s book of bus iness. Local market knowledge becomes attenuated in larger, geographically dispersed, insurance companies.

    4. Many Blue Cross plans are prospering as independent non-profit entities.

    5. There is no evidence that consumers benefit from the consolidation of non-profit Blue plans or from conversion to for-profit status. In many regulatory considerations of the conversion process, this subject is never contemplated.

    6. Many Blue plans have excessive surplus. Excess surplus capital is among the most attractive assets of a non-profit plan because the acquirer usually is able to use the assets of the acquired plan to pay for all or part of the transaction.

    7. Plans believe they must consolidate to fend off competitive threats from larger insurance entities that could enter their markets and compete. In Maryland, there is little evidence that competitors have sought or will seek to enter the market. Among other factors, the HSCRC’s uniform “all payer” rate system, under which payment rates are uniform and carriers may not bargain down rates with individual hospitals, has deterred other carriers from entering Maryland to compete with Blue Cross.

    8. CareFirst is the predominant carrier in each of its three markets and enjoys market penetration higher than most Blue plans. CareFirst’s accounts are disproportionately stable groups that are less sensitive to price than other customers, e.g., state and local government employers.

    9. Information systems, including member enrollment, claims adjudication, and processing systems, are very difficult to integrate in consolidated companies. As a result, many large health insurance companies maintain multiple legacy systems. No economies of scale result.

    10. While publicly- traded insurance companies have easier access to capital, the price of that capital remains closely related to the performance of the business.

    11. Acquiring plans generally make immediate changes to improve the profitability of the acquired plan including downsizing of its labor force and reducing the medical loss ratio.

  4. If Blue Cross of Maryland converts from non-profit to for-profit status, the methods used to value the public’s claim on the assets of the plan are critical. In many conversion transactions in other states, the transfer prices recovered have been significantly less than the values that the Blue plans represented to the new owners. Many communities effectively have made generous gifts of their quasi-public Blue plans to management and private investors.

    1. Conventional methods of calculating the transfer price of Blue plans overlook the value of the benefits conveyed to the plans by governments, hospitals, and others in exchange for its community functions, including open enrollment for individuals and small groups.

    2. Conventional means of calculating a transfer price are not appropriate when the business being acquired is organized as a charity.

  5. If the proceeds of the sale of the Maryland plan are placed in a foundation, as currently contemplated in State law, such proceeds should be applied to supporting the availability of insurance to individuals and small groups, that part of the market that Blue Cross has served as part of its charitable, quasi-public mission.

  6. Blue Cross has contributed to the success of Maryland’s unique approach to health care policy as it relates to financing acute hospital care. Maryland has controlled health care costs, protected hospitals from uncompensated care, and supported a hospital market in which there is no discrimination in the provision of care based on ability to pay. The continued development of this policy will be more difficult without a locally domiciled, non-profit company.


  1. As a matter of statute, the General Assembly should recognize private insurance companies as the predominant means of providing coverage to the citizens of Maryland. State health policy should reflect the joint goals of keeping total health care spending within acceptable limits, providing adequate rates to the State’s hospitals, and maintaining a viable market for private health insurance. Carriers should be able to make sufficient profits and maintain adequate reserves to protect policyholders and providers as well as ensure solvency. State policy also should take as its goal the expansion of private coverage. The General Assembly must reexamine its mandated benefits in the context of the goal of expanded coverage through basic coverage plans. Blue Cross of Maryland should play a critical role in developing products to advance this policy.

  2. The General Assembly should provide direction to the Insurance Commissioner and/or the Attorney General as to the charitable obligations of the Maryland Blue plan. Standards should be established in statute and regulation, including explicit standards as to the fiduciary responsibilities of plan management and directors.

  3. The General Assembly should expand the authority of the Insurance Commissioner to permit oversight of the operations of the Maryland plan to ensure that the company’s management and directors are conducting business in the best interest of the market.

  4. The Insurance Commissioner should possess the authority to remove and appoint directors of the plan if reserves fall below minimum requirements, or if the plan’s performance falls below established standards for efficient management, or if the plan violates market conduct rules.

  5. The Insurance Commissioner should be empowered to establish standards of performance relating to efficiency, medical loss ratios, customer satisfaction, and timely payment to hospitals and doctors.

  6. The Insurance Commissioner should be authorized to conduct comparative studies of efficiency and operations and be required to report such results to the General Assembly.

  7. The Insurance Commissioner should require that Blue Cross articulate its long-term corporate intentions and describe how its management decisions will impact the insurance market in Maryland.

  8. The Insurance Commissioner should be empowered to inquire periodically of the plan’s directors regarding their perspective on the plan’s commitment to non-profit operations.

  9. In the event of an acquisition of CareFirst by a for-profit insurer, the Insurance Commissioner should value the plan using a community economic value approach that accounts for the donative nature of the plan’s assets, the gain or loss to the welfare of the community, and the value of the plan as a going- forward business.

  10. CareFirst is an attractive acquisition candidate from a market perspective because it possesses strong reserves, predominant market penetration, and control of three markets.
         In determining the transfer price, the Insurance Commissioner should assume an informed and aggressive “defensive” posture. Many states have succeeded in bargaining the transfer price upwards by significant amounts.

  11. If a sale of CareFirst is approved, the General Assembly or the Insurance Commissioner should require that the transfer price be paid in cash, not stock of the acquiring company.

  12. If the General Assembly or the Insurance Commissioner is persuaded to take part of the consideration in stock of the acquiring company, the State also must require downside protection against declines in stock price.

  13. In determining the value of the plan, the Insurance Commissioner must evaluate the financial condition of the acquiring firm and its likely condition on a going- forward basis. The inquiry should involve a thorough test of pro forma assumptions, evaluation of management competence, and the firm’s long-term strategic plan. The State must take care to avoid endorsing a company whose future problems could be Maryland’s to solve.

  14. The General Assembly should direct the Insurance Commissioner to inquire as to the reasonableness of severance and employment arrangements for plan management in the event of a transaction. Such inquiry should include whether executives or directors will receive payments related to the completion of a transaction, including shares in the new company, from an acquiring company, and the terms of employment for any members of management and/or directors who continue as employees or directors of the new company. All matters pertinent to proposed compensation should be disclosed to the public. In addition, no downside protection of the value of insiders’ stock held in a post-deal lock- up should be permitted.

  15. When attempting to sell a private company, directors often protect themselves from shareholder suits based on fiduciary expectation by holding an auction. The Insurance Commissioner should be empowered to require this form of disposition if he or she determines that it would be the appropriate means by which to determine and realize the true market value of the plan.

  16. The General Assembly should direct the Health Services Cost Review Commission to establish the SAAC differential for CareFirst and other carriers on an audited cost basis such that the differential reflects the actual cost of SAAC policies to the carriers. The General Assembly should authorize appropriate incentive payments to Blue Cross and other carriers to encourage their participation in the SAAC program.

  17. Because debt markets are not open to the non-profit plan, the General Assembly should consider expanding the scope of a public agency, possibly the Maryland Health and Higher Education Facilities Authority, to permit CareFirst to sell revenue bonds in the event that the plan needs capital from time to time.

  18. The Insurance Commissioner should be empowered to facilitate the sale of either the D.C. or Delaware plans should CareFirst determine that the company needs capital, provided that the Commissioner determines that such a transaction is in the best interest of the public.

  19. The Insurance Commissioner should have the authority to regulate the use of the Blue Cross Blue Shield trademark in the State in the event that an acquirer withdraws from the State, is sold to a company determined not to be acting in the best interest of the insurance market, or fails.

  20. The General Assembly should direct that any foundation that receives proceeds from a sale of CareFirst should treat the proceeds as a corpus and distribute only the equivalent of an annuity payment at prevailing interest rates.

  21. The General Assembly should direct the foundation to apply the proceeds narrowly, in the spirit of the cy pres doctrine. The foundation should use its assets only to support the individual market, the small group market, or other groups that are determined to be in need of subsidies in order to access health insurance.

  22. The General Assembly should direct any foundation that receives proceeds from a sale of CareFirst to hold sufficient reserves for a period of ten years to fund the start up of a new non-profit community carrier in the event that the parent company is unable, for any reason, to meet market conduct standards imposed by the Insurance Commissioner.

  23. If CareFirst is sold, the Insurance Commissioner should require the acquirer to provide acceptable and affordable products to the individual and small group market. The company should be required to provide a product for a substantial portion of the uninsurable population. The company also should be required to operate in concert with the newly-funded foundation to establish product offerings that might be subsidized jointly by the company and the foundation.

Carl J. Schramm, who holds a Ph.D. in economics, conducted a lengthy analysis of the implications of privatizing Maryland Blue Cross Blue Shield, as well as this shorter summary of his findings.

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This story was published on Jan. 2, 2002.