STATE OF MAINE
DEPARTMENT OF PROFESSIONAL AND FINANCIAL REGULATION
BUREAU OF INSURANCE

 

 

 

STATEMENT OF CASE

Blue Cross and Blue Shield of Maine ("BCBSME") and Anthem Insurance Company of Indiana ("Anthem") entered into an Asset Purchase Agreement ("the Agreement") on July 13, 1999. This Agreement was the culmination of a search by BCBSME for a solution to its deteriorating financial condition which resulted, in part, from underpricing by large, well capitalized competitors in the HMO market in Maine. It is apparent from the testimony presented that the proposal of Anthem to purchase the assets of BCBSME met the two major objectives of BCBSME: its need for capital in order to remain viable and competitive, and its desire to retain the Blue Cross Blue Shield emblem.

The Agreement sets forth a series of transactions which must be approved by the Superintendent. These transactions include the conversion of BCBSME from a non-profit hospital and medical service organization to a stock company; the purchase of the assets and assumption of the liabilities of BCBSME by Anthem Health Plan of Maine; and the liquidation and dissolution of BCBSME. If these transactions are approved by the Superintendent, it is Anthem’s intention, for the near future, to offer the same products now provided, and serve the same populations and geographical area now served, by BCBSME. In addition, Anthem intends to make an immediate infusion of capital to bring BCBSME to within 125% of risk-based capital levels and to invest additional resources on a regional and local basis to ensure BCBSME’s competitive viability.

Consistent with the statutory scheme enacted by the Maine Legislature in 1997, and the designation of ownership interests of the company approved by the Superior Court in 1998, as a condition to the proposed conversion and sale, 100% of the value of BCBSME is to be set aside to fund a charitable trust for the purpose of addressing the unmet health care needs of medically underserved and uninsured Maine citizens.

In connection with the consideration of the conversion plan, in addition to determining the fair market value of BCBSME to be transferred to the charitable trust, the Superintendent must find, among other things, that the terms and conditions of the conversion plan are fair and equitable and will not "adversely affect, in any manner, the services to be rendered subscribers." 24 M.R.S.A. § 9-D(E) and (L). Under the provisions of 24-A M.R.S.A. § 222(7), the Superintendent must be satisfied that the Agreement is not "unfair or prejudicial to policyholders[.]" All of these determinations are of utmost concern to the Attorney General.

ARGUMENT

1. Valuation Issues
   1. There is Insufficient Evidence in the Record to Ascertain the Current Value of BCBSME.

The conversion statute requires

an appraisal of the fair market value, or range of values, of the aggregate equity of the converted stock insurer to be outstanding upon completion of the conversion plan and, if a range of values, the methodology for fixing a final value coincident with the completion of the transactions provided for in the conversion plan.

24 M.R.S.A. § 2301(9-D)(I).

The conversion plan submitted by BCBSME included an appraisal performed by Houlihan, Lokey, Howard & Zukin which established the fair market value of BCBSME as of July 13, 1999 and presented a range of estimates of the fair market value of BCBSME’s equity as of that date. The conversion plan did not include a methodology for fixing a final value coincident with the completion of the transactions provided for in the plan.

BCBSME, through the testimony of Mr. McGinty, proposed a methodology that would adjust the Houlihan Lokey fair market value of BCBSME’s equity by certain items included in the calculation of total consideration (Medicare liability, financial shortfalls and transactions costs) set forth in the Agreement. This approach, which assumes that the range of values placed on the equity of BCBSME in July, 1999 was still valid, was said by Mr. Hoyer, the Superintendent’s consultant, to be reasonable. However, Mr. Hoyer testified that the numbers to be used to make the adjustments must be the market value of the adjustments rather than the numbers negotiated by BCBSME and Anthem. Mr. Hoyer did not indicate how the market value of these adjustments was to be ascertained, and did not provide any basis for his conclusion that the estimated proceeds of the transaction would exceed the fair market value of the equity of BCBSME at this time. Furthermore, both Mr. Hoyer and Mr. McGinty focused their attention on the factors that would tend to reduce the valuation and ignored the factors—such as increased membership, change in local market conditions and increased revenues—that would tend to increase the valuation.

Whether or not Mr. McGinty’s and Mr. Hoyer’s proposed methodology for bringing Houlihan Lokey’s valuation current is reasonable, the Attorney General is not persuaded it meets the terms of statute. Mr. Collins of Houlihan Lokey was examined by Mr. Frank, counsel for BCBSME, and by the Superintendent regarding the current value of the equity of BCBSME. Consistent with the methodology he used for the July, 1999 valuation, Mr. Collins testified that in order to ascertain the fair market value of the equity of BCBSME, he would have to take into account changes in the company’s performance, its recent projected performance, market information, changes in trading prices of comparable companies, and recent merger and acquisition activity. (Trans., April 4, 2000, Morning Session, p. 84.) This testimony makes clear that a methodology far more complex than that set forth by Mr. Hoyer is required in order to update Houlihan Lokey’s July, 1999 valuation. The record does not contain such an updated valuation and therefore is insufficient to make a determination of the current fair market value of the equity of BCBSME.

Applicants’ argument that the Foundation will have acquired the fair market value of BCBSME because it will receive 100 percent of the "then-outstanding stock of the converted domestic stock insurer" does not answer the question of whether the Conversion Plan contains a methodology to enable the Superintendent to determine whether the outstanding stock represents the fair market value of the organization. 5 M.R.S.A. § 194-A(1)(G). In addition, this argument glosses over the fact that the Foundation will not own the outstanding stock for any measurable period of time. The stock issued will immediately be voted in favor of the sale of assets and the Foundation will receive the proceeds of the sale. The critical question in this proceeding then is whether the proceeds equal the fair market value of BCBSME.

2. The Fair Market Value Range Established by Houlihan Lokey Understates the Value of BCBSME.

Houlihan Lokey established a fair market value range of the equity of BCBSME and then established a market value of BCBSME of $102.5 million. The evidence presented shows that this value may understate the value of BCBSME in two respects. First, Houlihan Lokey, in essence, assigned a negative value to BCBSME’s 57% interest in Machigonne due to the inclusion of projected operating losses for Machigonne in its discounted cash flow analysis. Houlihan defended this approach by claiming that Machigonne was given a positive value in the market approach. This approach assigned a value to Machigonne by use of a value per member calculation. The Attorney General is not persuaded that this approach fully offsets the negative value included in the discounted cash flow and thus believes that BCBSME’s 57% interest in Machigonne is not given its full value of $5.7 million testified to by Mr. McGinty and Mr. Smith of Anthem. (Trans., April 3, 2000, Afternoon Session, p. 48; April 5, 2000, Afternoon Session, p. 83.) The opinion of Mr. McGinty was no doubt, in part, based on the valuation of Patriot Mutual’s interest in Machigonne performed by PriceWaterhouseCoopers. This detailed valuation included recent projections of profitability as early as year end 2000 and thus should be given great weight. (Applicants’ Exhibit C-21, p. B11528.) Second, Houlihan Lokey’s valuation methodology understates the value of BCBSME’s investment portfolio. The record includes an example where Houlihan Lokey’s methodology results in a $50 million understating of the value of BCBSME’s investment portfolio in 2001. (See Attorney General Exhibit 28.)

The February, 2000 forecast of BCBSME and the proformas submitted by Anthem also raise doubt about the relevance of Houlihan Lokey’s valuation. These documents show a projected price-earnings ratio highly favorable to Anthem. When Mr. DiBennedetto was confronted with the relationship of the current fair market value of the equity of BCBSME to Anthem’s projected profit margin, he was unable to state whether the Agreement price was fair. (See Attorney General Exhibit 27.) Moreover, he admitted that the purchase price did not include any synergies brought to the transaction, an obvious shortcoming in the negotiations with Anthem.

Houlihan’s questionable approach to Machigonne and BCBSME’s investment income raises the question about the extent to which the Superintendent can rely on its conclusion as to the fair market value of the equity of BCBSME. Another question about the reliability of the report is raised by Houlihan’s knowledge of the $120 million offer made by Anthem and its access to the Agreement which sets forth the maximum value adjustment of $17.5 million. It appears to be more than coincidence that Houlihan valued BCBSME at $102.5 million, an amount exactly $17.5 million below the offer of $120 million.

3. Medicare Reimbursement Liability Is Included in Houlihan Lokey’s Valuation.

Mr. Hoyer and Mr. McGinty testified that it was reasonable to adjust the fair market value of the equity of BCBSME set by Houlihan Lokey by the potential liability of BCBSME for administration of the Medicare reimbursement program. There is no justification for this adjustment. BCBSME has not recognized this liability in its financial statements and Houlihan Lokey did not specifically account for it in its evaluation. Furthermore, Mr. Collins testified that while Houlihan did not make a specific adjustment for the Medicare reimbursement liability, this potential liability was an industry condition that would be reflected in the stock price of comparable companies. Thus, it was implicitly considered in the Houlihan Lokey appraisal and adjusting the fair market value of BCBSME for any Medicare reimbursement liability would double count that liability and result in an understatement of value.

4. Any Medicare Reimbursement Liability Adjustment to the Purchase Price Must Be Limited.

The Applicants amended the Agreement on March 21, 2000 to provide that Anthem would pay for the assets of BCBSME $120 million less the Medicare liability cost and the Machigonne stock acquisition cost. The Medicare liability cost, as defined in the Agreement, means $5 million unless Anthem can obtain satisfactory insurance to cover the risk for less. If this adjustment to the total consideration is permitted by the Superintendent, $5 million less will be going to the Foundation even though BCBSME has not even recognized this risk in their financial statements. Mr. Frick testified that the $5 million represents the present value of assumed premiums due to insure the risk in the amount of $200,000,000 to $250,000,000. Mr. Frick’s estimate of the potential exposure far exceeds Mr. Hoyer’s estimate that the exposure may be less than $5 million.

If the Superintendent determines that it is appropriate to adjust the purchase price for this unrecognized liability, the Attorney General suggests that Anthem be required to escrow the adjustment amount in an interest bearing account. The escrowed amount, which should not be greater than $5 million, would be transferred to the Foundation if no claim is made for reimbursement within the applicable statute of limitations period.

The valuation issues discussed above call into question the adequacy of the record to make a determination of the current value of the equity of BCBSME and the reasonableness and reliability of the fair market value range set by Houlihan Lokey. Under these circumstances, the Attorney General believes it is necessary for the Superintendent to require Applicants to submit an updated valuation which fairly accounts for the value of Machigonne and the value of BCBSME’s investment portfolio. In addition, the updated valuation should consider changes in performance, projected performance, market information, changes in prices of comparable companies, changes in the local health insurance market and recent merger and acquisition activity, all as testified to by Mr. Collins.

 

B. Form A Issues

1. Anthem Should Be Required to Continue Operations of BCBSME.

Anthem representatives have indicated that they have every intention of carrying forward the existing operations of BCBSME. The Applicants’ Form A filing, for example, describes Anthem’s proposed operation of business: "Anthem is applying to the Bureau of Insurance on behalf of Anthem BCBSME for a Certificate of Authority to conduct accident and health insurance business and to operate a health maintenance organization as a line of business, all to the same extent that BCBSME presently operates." The testimony of Anthem’s executives reiterated that intention.

Several intervenors have raised concerns about the scope and reach of Anthem’s operations into the indefinite future, not just immediately after closing. They have questioned whether the company will continue the same product offerings and will retain members in the same statewide areas, including rural and remote areas, if some of those offerings or service areas prove to be less profitable. Anthem officials represented that such decisions would be largely made by local management based on the Maine markets. This is of critical importance because BCBSME holds such a large share of the health insurance market in Maine.

The Attorney General shares the concern of intervenors as to the continuation of existing product offerings and the geographic service area of the company into the future. Anthem’s present intentions do not rise to the level of enforceable commitments. The Attorney General believes that, unless Anthem’s ability to change product offerings and service is limited, the Conversion Plan will not be "fair and equitable" and will "adversely affect . . . the services to be rendered to subscribers." 24 M.R.S.A. § 2301(9-D)(L). Therefore, the Attorney General requests that the Superintendent require Anthem to continue existing operations of BCBSME, including the full scope of product offerings and the same geographic service, to the extent those operations have been required of BCBSME, for a period of not less than five years.

2. Any Deduction for Purchase of Blue Alliance’s Interest in Machigonne Should Be Consistent with Valuation of BCBSME’s Interest.

The Agreement, as amended, provides for a $4.2 million deduction from total consideration for the acquisition of Blue Alliance’s 43% equity interest in Machigonne. This amount is derived from the PriceWaterhouseCoopers valuation of that equity which, as discussed above, was based on projected profitability as early as the year ending December 31, 2000. See Applicants’ Exhibit C-21, page B11528. The Attorney General questions the reasonableness of this deduction in light of the deminimus value placed on BCBSME’s 57% equity interest in Machigonne. The Attorney General believes the best approach to the Machigonne valuation issue would be to assign to BCBSME’s equity interest in Machigonne, as well as Blue Alliance’s interest, its fair market value in reliance on the PriceWaterhouseCoopers valuation. Should the Superintendent reject this approach and the Attorney General’s argument that BCBSME’s equity interest in Machigonne be given its fair market value of $5.7 million, then he must refuse to approve the $4.2 million deduction from total consideration in the Agreement.

 

C. Liquidation and Dissolution Issues

1. Closing Tax Reserve Should Be Limited.

The original Charitable Trust Plan proposed by BCBSME included a provision to indemnify Anthem for liabilities arising out of the Excluded Liabilities as defined by Section 2.02 of the Asset Purchase Agreement. Among the liabilities excluded, and thus contemplated by the Applicants as being ultimately assumed by the Foundation, was the "Seller’s Aggregate Tax Liability." The Attorney General objected to the indemnification for the Excluded Liabilities, particularly to the extent the Foundation would be exposed to contingent liabilities, including any potential claim by the Internal Revenue Service in some unknown amount and at some unknown time in the future. The Modified Charitable Trust Plan as approved by the Superior Court struck the proposed indemnification provisions in the original Plan.

In Amendment No. 1 to the Asset Purchase Agreement, the Applicants eliminated certain of the Excluded Liabilities, and eliminated the requirement that the Foundation indemnify Anthem for Excluded Liabilities. The "Seller’s Aggregate Tax Liability" was not eliminated and remains an expressly excluded liability for which BCBSME and not Anthem is still responsible.

Applicants intend to establish a Closing Tax Reserve as a mechanism for covering the existing tax liabilities arising out of BCBSME’s operation and as a consequence of the proposed transactions, and for receiving any tax refunds in the immediate future. A substantially larger dollar amount is now planned for the Closing Tax Reserve than previously proposed in order that there be sufficient funds to cover any future tax liability that may be assessed by the IRS. These funds come out of the proceeds of the sale. Moreover, the Applicants now propose to extend the duration of the Liquidating Trust, the home of the Closing Tax Reserve after closing, to cover the full period of time within which the IRS might file and pursue a claim. Not until the IRS’ statute of limitations has run, or until any timely filed IRS claims have been pursued and paid, would any remaining balance be paid over to the Foundation.

Absent a sum of money being available in the Closing Tax Reserve to satisfy a contingent tax liability, it is not entirely clear who would pay for such liability. Mr. Vangeison and Mr. McGinty appeared to indicate that Anthem assumed that risk. Transcript, April 3, 2000 afternoon session at P19, L18-22, P21, L10-14. Attorney Foster testified that the Foundation would be liable for potential liabilities that the Liquidating Trust amounts were insufficient to cover (Transcript, April 7, 2000 evening session P74, L19 – P75, L2; P83, L9-19) and that Anthem would have priority over distributions from the tax reserve to cover claims it might have to pay that are the responsibility of AHS. (Transcript, April 7, 2000 evening session, P81, L3-13.) He further testified that it was in the interest of both Anthem and the Foundation to have in place the larger scope of coverage for potential tax liabilities. (Transcript, April 7, 2000 evening session, P84, L22 – P86, L6.) The retention of the "Seller’s Aggregate Tax Liability" as one of the excluded liabilities under the amended Asset Purchase Agreement seems to pose a real risk that any contingent liability will ultimately rest with the Foundation.

In any event, regardless of where the contingent liability may ultimately rest, funding generously for any contingent tax liability out of the sale proceeds and tying those funds up into the future shifts the burden of the entire existing and contingent tax liability onto the Foundation, and is thus inconsistent with the Modified Charitable Trust Plan as approved. While the Attorney General does not object to the formation of the Liquidating Trust and the Closing Tax Reserve as a mechanism for winding up the affairs of BCBSME in the near future, he takes issue with those mechanisms as a longterm tool for waiting out and funding the contingent tax liability. For the same reasons that he objected to the Foundation’s assumption of contingent liabilities in the proposed Charitable Trust Plan, the Attorney General objects to an unreasonable duration of the Closing Tax Reserve and suggests the duration be limited to the time reasonably necessary to wind up the affairs of the corporation without regard to a contingent tax liability. Moreover, the Attorney General requests that Anthem be required to indemnify the Foundation for that contingent tax liability.

2. Liquidating Trust Must Be More Accountable to Foundation.

The Attorney General understands the general purpose of the Liquidating Trust as being a vehicle for winding up the affairs of the AHS Liquidating Corporation, including payment of liabilities fully quantifiable only after closing. Any proceeds remaining in the Trust after transaction expenses, tax liabilities and administrative expenses have been fully addressed would be payable to the Foundation. The Trust is thus ultimately holding funds on behalf of the Foundation as the sole shareholder of the AHS Liquidating Corporation.

Notwithstanding this interest, neither the Foundation nor the Attorney General, prior to the establishment of the Foundation, has any role in the oversight of the Liquidating Trust or the Trustee. While the Attorney General has no reason to doubt the good intentions of AHS officers and executives to consult with him and the Foundation in appointing a Trustee and managing the affairs of the Trust, the Attorney General believes it is appropriate for the Superintendent to formalize that arrangement in any order approving the Plan of Complete Liquidation and Dissolution and the Liquidating Trust. Specifically, the Attorney General requests provisions requiring that the Attorney General be consulted prior to the appointment of the Trustee; that the Trustee be required to consult the Attorney General prior to engaging any professionals to provide services relative to administration of the Trust; that both the appointment of the Trustee and the engagement of professionals be subject to the prior approval of the Attorney General; that, consistent with the Superintendent’s authority to monitor the administration of the Liquidating Trust, the Trustee be required to obtain the Attorney General's approval before making any disbursements from the trust; and that the Trustee be required to make periodic regular financial accountings to the Superintendent and the Attorney General. In addition, as discussed above, to the extent the proposed duration of the Liquidating Trust has been significantly extended apparently for the sole purpose of addressing any contingent tax liabilities that may be claimed in the future, the Attorney General requests that the Superintendent limit the duration of the Liquidating Trust to the time period reasonably necessary to wind up the affairs of AHS.

 

CONCLUSION

After careful and thorough review of the record in this proceeding, the Attorney General recommends that the following conditions be imposed in order to satisfy the requisite statutory standards.

1. The preparation by Houlihan Lokey of an updated valuation that includes an estimate of the range of values of the equity of BCBSME. In order not to unduly delay a closing, the updated valuation should be filed with the Superintendent two weeks after the issuance of the Superintendent’s decision on the pending applications. The Superintendent could then schedule evidentiary hearings on the updated valuation and close the record, no later than seven days after the valuation is filed.

2. As an alternative to Condition No. 1, and in order to permit Applicants to proceed with closing in a timely manner, the Superintendent could provide that Houlihan Lokey prepare an updated valuation of the range of values of the equity of BCBSME. The range of values determined by Houlihan Lokey would be used by the Superintendent to determine whether the proceeds from the sale of the assets of BCBSME are adequate to meet the requirement that the Foundation receive the fair market value of the assets of BCBSME. If the proceeds from the sale of the assets of BCBSME fall below the range of values approved by the Superintendent, then Anthem would pay to the Foundation, in addition to the proceeds from the sale of the assets of BCBSME, an amount sufficient to bring the transferred proceeds within the range of values approved. If the proceeds from the sale of the assets of BCBSME fall within or above the range of values approved by the Superintendent, then no further payments by Anthem would be required. The hearing schedule set forth in No. 1 would also be used in this alternative approach.

3. If the Superintendent allows an adjustment to total consideration for the Medicare reimbursement liability, and in the event Anthem is unable to obtain insurance to cover the potential Medicare reimbursement liability on or before the closing date, Anthem would escrow no more than $5 million in an interest bearing account. The amount escrowed shall be used only to pay any potential claims to the federal government arising out of BCBSME’s role as a Medicare fiscal intermediary. Anthem shall notify the Attorney General as soon as practicable of any intention by the federal government to assess such claims. If Anthem is not required to pay any claims within the applicable statute of limitations period, the amount escrowed, plus accrued interest, would be paid to the Foundation.

4. To address the concerns about product availability raised by consumers, and shared by the Attorney General, it is suggested the Superintendent require Anthem Health Plan of Maine, for a period of five years after closing, to seek the Superintendent’s approval before making any substantial change to the range of products now required to be offered by BCBSME. For a similar period of time, the Attorney General proposes that Anthem Health Plan of Maine be required to secure the Superintendent’s approval before reducing or changing the geographical area now served by BCBSME.

5. In order to protect the beneficiaries of the Foundation, the duration of the Closing Tax Reserve, and the Liquidating Trust, should be explicitly limited to the timeframe reasonably necessary to wind up the affairs of the AHS Liquidating Corporation, without regard to any contingent future tax liability.

6. To the extent consistent with the exercise of his authority over the Liquidating Trust, it is recommended that the Superintendent provide that the Attorney General must be consulted about and approve the appointment of the Trustee; the engagement of any professional services; and the disbursement of any money from the trust. In addition, the Trust should be required to provide periodic financial statements to the Superintendent and the Attorney General.

7. The Superintendent should confirm that in the event the conditions set forth in any Change of Control Agreement approved by the Board of Directors of BCBSME for the payment of severance benefits to BCBSME employees are triggered, all such severence benefits would be paid by Anthem and would not be deducted in any manner from the proceeds of the sale of the assets of BCBSME.

Respectfully submitted,

ANDREW KETTERER

Attorney General

 

 

Dated: April 14, 2000 ______________________________

WILLIAM H. LAUBENSTEIN, III

Assistant Attorney General

 

 

Dated: April 14, 2000 _______________________________

CHRISTINA HALL

Assistant Attorney General

6 State House Station

Augusta, ME 04333-0006

Telephone: (207) 626-8800

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