Health Systems International, Inc. History

Address:

225 North Main Street
Pueblo, Colorado 81003
U.S.A.

Telephone: (719) 542-0500
Fax: (719) 542-4921

Public Company
Incorporated: 1985 as Qual-Med, Inc.
Employees: 2,367
Sales: $1.96 billion
Stock Exchanges: New York
SICs: 6324 Hospital and Medical Service Plans

Company History:

Health Systems International, Inc. (HSI) was formed in January 1994 by the merger of QualMed and Health Net, two leading managed health care providers. Serving about 1.4 million members in several western states, particularly California and Colorado, the company benefitted from the innovative and aggressive operational strategies of QualMed and Health Net.

QualMed was founded by Dr. Malik M. Hasan, a neurologist from Pakistan. The son of a wealthy Pakistani family, Hasan was discouraged from pursuing a professional career. Nevertheless, his entrepreneurial nature emerged early; he made his first fortune as a teenager by purchasing undeveloped land and selling it at a large profit when the Pakistani government announced plans to add infrastructure near his property.

Hasan soon abandoned his business ventures to study medicine, attending school in Pakistan before traveling to London to receive training in neurology. After returning to Pakistan, he became frustrated with what he perceived as limited intellectual opportunities and an inferior health care system, and, in 1970, he and his wife moved to Chicago, where he practiced medicine for five years. In 1975, Hasan and his family moved to Pueblo, Colorado, where Hasan joined a small, profitable neurological practice. The money he made there during the late 1970s and early 1980s, in addition to some smart investments, secured his financial future.

Besides accruing medical and business knowledge at his group neurology practice, Hasan was also exposed to the management dynamics of larger health care organizations, serving as a director on the boards of a hospital and a major regional medical society. During this time, the cost of medical care was increasing dramatically, and demand surfaced for a new type of care provider better able to contain costs. One popular alternative to traditional indemnity health insurance was the health maintenance organization (HMO). Under HMO plans, members were provided with medical services in exchange for subscription fees paid to the plan sponsor. Because HMO plans offered more efficient administrative and management services than those traditionally overseen by the health care provider, and worked to eliminate unnecessary treatments, the HMO was generally better able to contain costs.

In 1985, Hasan and six other physicians decided to become involved in this increasingly popular trend. With $100,000 in start-up capital, they formed QualMed, a company that then purchased the Pueblo-based San Luis Valley HMO, which had about 6,000 members. QualMed began operations in 1986 under the direction of Hasan and his partners. From the onset, Hasan focused on offering an alternative to traditional HMOs, which, he believed, limited a patient's choice of doctors and left critical decisions about health care in the hands of business people and bureaucrats rather than doctors and patients. While other HMOs controlled costs by relying heavily on clerks and nurses, rather than physicians, to review diagnoses and recommend treatment, Hasan's HMO emphasized physician-intensive management and improved communication between doctors.

Realizing that better medical care could be provided at a lower cost, Hasan soon became enamored by the business aspect of the operation. "The best medical care is actually the cheapest," Hasan explained in the January 31, 1991 Denver Post, noting that "we [physicians] know more about managing it than anybody else." Recognizing the market potential for physician-managed HMOs, Hasan began devising a strategy to expand QualMed. Eight more physicians joined the QualMed HMO in the late 1980s, bringing with them a larger client base, and, with an additional $2 million in capital, much of which came from Hasan, the company's services and membership expanded.

In 1987, QualMed purchased Health Dimensions of Colorado Springs. That acquisition, along with a general increase in the membership of its existing operations, made QualMed the eighth largest HMO in Colorado. Two years later, QualMed acquired HMO operations in Oregon, Washington, and New Mexico from Foundation Health Plan Inc., boosting QualMed's membership by 105,000. Foundation, a leading U.S. managed care provider, had experienced financial difficulty during the late 1980s typical of that faced by the entire managed care industry; a downturn in the health insurance underwriting industry had caught many competitors off guard. In fact, during 1987 and 1988, fewer than one-third of all U.S. HMOs turned a profit, enrollment growth practically stagnated, and many HMOs filed for bankruptcy.

Despite the industry shake-out, QualMed achieved a comparatively healthy financial performance during the late 1980s. Its losses in 1987 and 1988 were largely attributable to start-up costs and acquisition expenses. In 1989, QualMed posted its first profit--$3.24 million from sales of about $74 million--making it one of the few industry participants to realize a profit during that year. The purchase of Foundation's HMOs played a significant role in QualMed's success. Although some analysts had questioned the wisdom of the buyout, QualMed quickly improved the management and profitability of the Foundation holdings.

Entering the 1990s, Hasan's unique approach to the HMO was clearly a success. Among QualMed's innovations was its intense review process, particularly concerning patient referrals for specialty care. QualMed medical administrators reviewed every request for specialty procedures, averaging one administrator for every 25,000 members, a high ratio in the industry. Moreover, the company was unique in its focus on effective lines of communication between physicians and the company. While most competitors were forced to wait until after care had been provided before determining whether it had been necessary, QualMed's strategy allowed it to cut potentially unnecessary costs before treatment. Specifically, QualMed physicians communicated with each other and with plan administrators before providing many nonemergency treatments and were provided with continuous feedback in the form of quarterly reports that compared each doctor's use of medical services and costs per member served. "What we're after is the sentinel effect," Hasan stated in the Denver Post article, "making physicians think twice before they order a test or deliver a service."

The effectiveness of QualMed's savings strategy was reflected in its medical loss ratio, which was one of the lowest in the HMO industry. QualMed's medical loss ratio--the percentage of premium revenues that are spent to pay medical bills--was about ten percent lower than the industry average in the early 1990s. Furthermore, QualMed's members had one of the lowest per capita hospitalization rates in the nation, 30 percent below the managed care average. Both measures were regarded as important indicators of HMO efficiency.

While many managed care providers retrenched in the late 1980s and early 1990s, QualMed sought to expand and diversify. In 1990, for example, Hasan led the buyout of contracts from the Greater Oregon Health Service, an indemnity insurer, representing a deviation from the core health care operation. Also in 1990, Hasan spearheaded the acquisition of HEALs Health Plan, an HMO based in Oakland, California, with nearly 100,000 members. As a result of expansion, QualMed's sales doubled in 1990 to $142 million, as its net income rose to $4.6 million. At the same time, QualMed's long-term debt load was kept to a healthy $6 million.

Inspired by the success of the flourishing company, Hasan took QualMed public in 1991 to raise cash for faster expansion. The stock offering put $43 million into QualMed's account. One month later, QualMed offered to purchase Health Net, the second largest HMO in California. However, this offer, as well as a second bid of $340 million plus $60 million in preferred stock, was rejected. Nevertheless, QualMed succeeded in picking up several other prime HMO properties in 1992. The company purchased PCA Health Plans, for instance, a 26,000-member HMO in Sacramento, and acquired Preferred Health work, another California managed care provider. QualMed also purchased two other HMO providers with about 86,000 members, and acquired Great Northern Insurance Annuity Corp., a Seattle-based indemnity insurer.

As a result of this aggressive expansion, QualMed experienced dramatic revenue gains; sales doubled in 1991 and again rose the following year, while profits also surged. By the end of 1992, QualMed's HMO work spanned six western states and served 327,000 members, revenues rose to over $450 million, and profits approached the $30 million mark. Furthermore, QualMed had bid for a $600 million military contract and had initiated plans to acquire several other managed care organizations. Also in 1992, QualMed moved into a new $2.4 million corporate headquarters building in Pueblo.

Hasan's expansion tactics were focused on purchasing financially troubled HMOs that he believed his QualMed managers could turn around within six months. Toward that end, QualMed's advanced information systems and medical management techniques, as well as its proven medical cost containment procedures, were all adapted for each new acquisition. Hasan purchased the indemnity insurers as a means of attracting larger employers to its system and to get new business from existing HMO clients, which consisted primarily of small and medium-sized employers.

During this period of rapid growth, QualMed became involved in several lawsuits and earned a reputation within the industry as overly aggressive, a "bully" by some accounts, in its expansionist pursuits. QualMed had filed suits on several occasions in an effort to protect its interests. The company sued Blue Cross and Blue Shield of Colorado, for example, claiming predatory pricing and unfair competition, and had tried to sue the state of Colorado for breaking a contract with QualMed.

QualMed's most prolific legal initiative was its action against Health Net, the giant HMO it had tried to purchase in 1991 in a $400 million hostile takeover. Health Net, which was founded in 1977, had operated as a nonprofit health care provider up until 1992, when its status changed to for-profit. QualMed sued Health Net for refusing to accept the offer, and Health Net countered with a suit charging that QualMed was squandering its corporate assets. As Health Net struggled to maintain its independence and QualMed sought to take over the company and expand its presence in California, the two companies became embroiled in a nasty court battle that was widely covered in the press.

To the surprise of industry analysts, Health Net and QualMed came to terms in mid-1993, announcing a merger of the two competitors into a new entity, which would be managed and run by both teams. While Health Net represented a huge addition to QualMed's operations, bringing about 900,000 new members to the company and promptly making QualMed a leader in the important California HMO market, Health Net also benefitted from QualMed's access to capital, operational strengths, and presence in markets outside of California. The merger resulted in the fifth largest managed care provider in the United States.

Pursuant to the agreement hammered out by Hasan and Health Net CEO Roger F. Greaves, the two companies joined to become Health Systems International, Inc. in January of 1994. In a unique arrangement, Hasan and Greaves each assumed the titles of "co-chairman, co-president, and co-chief executive officer." Together, the companies oversaw an organization with about 1.4 million members, 40,000 doctors, and about 400 member hospitals. HSI generated a staggering $1.96 billion in 1993 sales, representing an increase from $1.66 billion garnered by the two companies during 1992. Although net income slipped nearly 50 percent to $23.8 million, largely because of one-time costs associated with the merger, this figure was expected to rebound in 1994.

HSI continued to benefit from strong demand and increased interest in managed health care. Although critics cited HSI's unproven track record for growing the customer base of its existing operations, HSI management pointed to the company's relatively low debt load, strong operational skills, and cutting edge information and cost-containment systems as testimony to its long-term growth potential. "We think we are a national model for delivering health care more efficiently," Hasan related in the January 31, 1993 Denver Post, adding that "There are almost irresistible societal forces working in our favor."

Principal Subsidiaries: Health Net; QualMed.

Health Systems International, Inc. History

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