PacifiCare Health Systems, Inc. History

Company History:

PacifiCare Health Services ranks among the biggest and best of America's health maintenance organizations. The billion-dollar company has over 1.4 million members, half of whom are in California, with the remainder in Oregon, Texas, Florida, Oklahoma, and Washington. In 1993, a survey of over 400 health maintenance organizations (HMOs) by Health Plan Management Services ranked PacifiCare among the ten best, and a 1994 Fortune poll named the company the second most-admired firm in the health care industry. Throughout its history, PacifiCare has scored financial successes along with these kudos, having reported the longest record of profitability of any for-profit HMO company. The company experienced dramatic growth during the 1980s, which began to slow somewhat in the early years of the 1990s.

PacifiCare was founded as a nonprofit corporation by Samuel J. Tibbitts of the Lutheran Hospital Society of Southern California in 1975 and became a federally qualified health maintenance organization (HMO) three years later. Unlike standard indemnity insurance plans, in which members are reimbursed for specified medical expenses on a fee-for-service basis, HMOs provide health care services for a prepaid fee (often assumed by the enrollee's employer) with no deductible. These organizations, which have existed since the late 1940s, are able to save themselves and their customers money by buying medical care "wholesale" from a limited pool of physicians, limiting unnecessary procedures, and encouraging prevention and fitness.

One way HMOs keep costs low is by restricting members' choice of doctors and hospitals. Physicians and facilities employed by the HMO are either salaried or they agree to accept "capitation" (fixed per-member) fees. Members who want to choose their own physicians must pay a premium for the privilege. A primary physician--either selected by the patient or assigned by the HMO--controls members' access to specialists and testing. Supporters of such "managed care" feel that the elimination of fee-for-service payments reduces the temptation to provide extraordinary, expensive treatments when a simpler, cheaper option exists. HMO detractors assert that beneficial procedures are sometimes not administered for the sake of cost-cutting. Managed health care organizations like PacifiCare typically attract younger, healthier members with their low out-of-pocket costs. When employers offer a choice between a traditional indemnity plan or an HMO, older workers with established physician relationships favor the freedom of choice afforded by indemnity plans. Some industry observers assert that this "self-selection" also contributes to HMOs' low cost structure--young, healthy members usually consume fewer health services than their aging counterparts.

PacifiCare was incorporated in 1983 and, like many other HMOs, switched to for-profit status the following year. The company made its initial public stock offering in May 1985, but less than 20 percent of its stock was actually sold to the public: 70 percent was held by UniHealth America (which had retained its non-profit status) and another 11 percent was owned by insiders. In its two decades in operation, PacifiCare has grown organically, by creating new subsidiaries and drawing new members, as well as through acquisitions.

In 1985, PacifiCare created its first subsidiary outside California: PacifiCare of Oregon. The group would eventually become Oregon's largest and fastest-growing HMO. PacifiCare also established Secure Horizons that same year. This subsidiary won California's first "risk-sharing" contract with Medicare (federal health benefits). Under its agreement with the government health care program, PacifiCare provided all Medicare-covered benefits in exchange for a monthly fee known as the "adjusted community rate." Statisticians determine the ACR based on the "adjusted average per capita cost" (AAPCC), which takes 122 demographic factors like age, sex, and Medicaid (low-income federal health benefits) into account. Because the ACR can never exceed the amount Medicaid would normally have paid a traditional fee-for-service plan, the government agency theoretically saves money.

Although older members were notorious for using more medical services than HMOs' traditional young customers, PacifiCare was able to make significant profits from the Secure Horizons division. By 1991, in fact, PacifiCare CEO and President Terry Hartshorn told Barron's that "the 20 percent of his members who are Medicare patients generate half of the company's revenues." Independent observers, however, warned that operations like Secure Horizons were bound by the rate increases dictated by Medicare, and couldn't make rate hikes at their own discretion.

PacifiCare grew rapidly during the mid-1980s, adding subsidiaries in Oklahoma and Texas and acquiring the Columbia General Life Insurance Company of Indiana (later renamed PacifiCare Life and Health) in 1986 alone. PacifiCare Life and Health was licensed to offer group life and health, supplemental life, and disability insurance in 34 states and the District of Columbia. That year, PacifiCare also jointly established LifeLink, a behavioral health managed care company later renamed PacifiCare Behavioral Health (except in California, where it continued to be known as LifeLink), with Treatment Centers of America. A 1994 study by the American Academy of Actuaries endorsed the application of managed care's cost-cutting techniques to mental health care. The investigation found that per-patient mental health care costs at HMOs averaged only $45 to $75 annually, at least 60 percent less than traditional fee-for-service plans. Other acquisitions in the last half of the 1980s included MultiMed, an Oklahoma City HMO, and Oregon's McLean Clinic. Rapid growth compelled PacifiCare's move into a larger corporate headquarters in Cypress, California, in 1986.

Secure Horizons was expanded into Oregon and Texas during the late 1980s, and was designated America's fastest-growing health plan for Medicare beneficiaries by the federal Health Care Financing Administration in 1991. The plan became California's largest Medicare risk program in 1992, and went national as Secure Horizons USA the following year. The national effort used partnerships with other HMOs to plan, develop, and market Secure Horizons to senior citizens eligible for Medicare across the country. Although some analysts warned that President Bill Clinton's plans to cut the growth of Medicare and Medicaid spending by $180 billion from 1996 to 2001 would squeeze the margins of programs like Secure Horizons, the national group's president, Craig Schub, said in a September 1993 Modern Healthcare that "the potential volume of Medicare patients and new revenues could outweigh the effects of spending restrictions." The Medicare segment of PacifiCare's business already contributed one-third of its total enrollment and over half of its $2.2 billion in annual revenues by that time.

From 1980 to 1990, membership in American HMOs quadrupled to 36.5 million people, or about 15 percent of the population. One-third of Californians were members of managed care groups by that time. PacifiCare signed on its 500,000th member, accomplished a two-for-one stock split, and made a successful public offering of 1.7 million shares in 1989. The corporation's operating revenue increased an average of 63 percent each year from 1985 to 1990, rising from $87.9 million to $975.8 million.

PacifiCare formed HMO National Network (now known as Covantage), a system of regional HMOs created to serve multistate employer groups, in 1991. The health care company increased its membership rolls by 18.7 percent and strengthened its California stronghold with the 1991 acquisition of one of the state's largest "independent physician association model" HMOs, Health Plan of America. This brand of managed care group, also known as a "group model HMO," employed physicians who had already banded together in partnership or as a professional organization. HMOs like Health Plan of America contracted with and paid the organization for services at a preset rate, and the association, in turn, paid its members. The addition of Health Plan of America brought PacifiCare's total membership to 825,000. The concurrent purchase of Execu-Fit Health Programs, a San Francisco-based national provider of on-site health education and wellness programs for businesses, gave PacifiCare one of the top programs of its kind. The company was renamed PacifiCare Wellness Company in 1993.

Mounting debt, which totaled nearly $200 million by the end of fiscal 1992 on September 30, compelled several changes in PacifiCare's stock. First, a recapitalization created a new class of nonvoting stock and each shareholder received one share of the issue for each share of the old. The company used the proceeds of two separate public offerings of 6.7 million shares of the new stock for debt repayment and general corporate purposes, including new products, services, and acquisitions.

In 1993, Alan Hoops replaced Terry Hartshorn as president and CEO. Hoops had worked at PacifiCare since 1977 and had quickly advanced to vice president of marketing and planning. With advanced degrees in psychology and health administration, he was named senior vice president in 1985 and executive vice president and chief operating officer the following year. Hartshorn stayed on as chairman in the early 1990s.

After a year of research and planning, PacifiCare's workers' compendsation subsidiary, COMPREMIER, teamed with Liberty Mutual Insurance Group, the United States's largest workers compensation insurer, to launch a workers compensation HMO product in 1993. The venture drew upon the aptitudes of each partner: PacifiCare brought its cost-cutting talents to the management of medical care for workers injured on the job, and Liberty Mutual offered rehabilitation case management, workplace safety programs, and indemnity benefit actuarial expertise. Liberty Mutual paid a local PacifiCare HMO a monthly per-employee fee on behalf of employer/clients, and PacifiCare agreed to provide any employee who filed a workers comp claim with a year of medical treatment. Long-term responsibility for employees' medical care then passed to Liberty Mutual. One unique cost-cutting aspect of the joint venture was a strictly monitored incentive bonus paid to doctors who encouraged patients to return to work as soon as possible.

In 1993 alone, PacifiCare acquired two healthcare companies in its home state--Freedom Plan and California Dental Health Plan&mdash well as Advantage Health Plans, Inc. (renamed PacifiCare of Florida), a Miami-based HMO. These acquisitions helped the company cross the one-million-member mark in 1993. Still, PacifiCare's revenue growth slowed from its hectic late 1980s pace to still-impressive 31.6 percent average annual increases in the early 1990s; revenue doubled from less than $1 billion in 1990 to $2.2 billion in 1993.

Late in 1993, UniHealth America reduced its stake in PacifiCare from 53 percent to 48.6 percent. Although the former parent would continue to be PacifiCare's single largest shareholder, it hoped that the divestment would allow the HMO more options when pursuing stock-swap acquisitions.

PacifiCare calls itself "an organization of dedicated people committed to improving the quality of those lives we touch." That corporate philosophy is reflected in programs designed for the society at large as well as the health care organization's own employees. In 1991, the company established PacifiCare Foundation, a nonprofit charitable and educational organization that, in keeping with the corporate focus, emphasized health, wellness, and welfare. The company was ranked among Working Mother magazine's 1992 list of the 100 best companies for working parents by virtue of its child care assistance and family leave programs. The following year, the firm responded to the needs of its corporate headquarters employees--75 percent of whom were women of child-bearing age--with the launch of the first corporate-sponsored child care facility in California's Orange County.

As social, corporate, and governmental pressure to control upwardly spiraling health care costs came to bear in the early 1990s, the entire industry anticipated fundamental changes. Despite its professed cost-cutting forte, PacifiCare came under criticism from U.S. Representative Fortney Stark for rate hikes in 1993. At the same time, some industry analysts predicted that high-flying health care earnings were due for a downward cycle under margin-squeezing pressure from physicians and hospitals demanding higher reimbursements, HMO members in search of more choices, and employers trying to decrease their share of the bill. Still, PacifiCare executives expressed confidence that the company would thrive in a government-regulated environment, asserting "plans to continue its strategy of controlled, national growth with the constant goal of being the market leader in whatever area it serves." John Persinos, an analyst for Kiplinger's Personal Finance Magazine added his vote of confidence when, in May 1994, he predicted that PacifiCare would prosper under health care reform.

The HMO's successful programs with federal agencies also indicated that it would do well in the event that a government-regulated health care system ever came into being. In 1993, PacifiCare established PacifiCare Military Health Systems, a subsidiary serving the Civilian Health and Medical Program for the Uniformed Services (CHAMPUS). Military Health Systems offered health benefits to military personnel and their dependents in 19 northeastern and midwestern states.

Although PacifiCare's financial performance was undeniably good in the early 1990s, the uncertainty imposed by industry forces made it impossible to predict the health maintenance organization's future prospects.

Principal Subsidiaries: PacifiCare of California; PacifiCare of Florida; PacifiCare of Oklahoma; PacifiCare of Oregon; PacifiCare of Texas; PacifiCare of Washington; Secure Horizons of California; Secure Horizons of Oklahoma; Secure Horizons of Oregon; Secure Horizons of Texas; Secure Horizons of Washington; California Dental Health Plan; PacifiCare Life & Health; PacifiCare Behavioral Health/LifeLink; PacifiCare Wellness Company; Covantage; Prescription Solutions; COMPREMIER; PacifiCare Military Health Systems; Preferred Health Resources, Inc.; Pasteur Health Plans.

Further Reading:

• de Lafuente, Della, "UniHealth Planning to Relinquish Its Majority Stake in PacifiCare," Modern Healthcare, August 23, 1993, p. 7.
• Kenkel, Paul J., "PacifiCare Unit to Boost Medicare Business," Modern Healthcare, September 20, 1993, p. 10.
• "PacifiCare, Liberty Mutual in Work Comp Venture," Business Insurance, February 28, 1994, p. 17.
• Paris, Ellen, "Marathon Man," Forbes, April 3, 1989, p. 166.
• Savitz, Eric J., "No Miracle Cure: HMOs Are Not the Rx for Spiraling Health-Care Costs," Barron's, August 5, 1991, pp. 8--9, 21--23.
• Shalowitz, Deborah, "PPO to Open Employee Child Care Center," Business Insurance, February 8, 1993, p. 6.

Source: International Directory of Company Histories, Vol. 11. St. James Press, 1995.

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