One of the nation’s largest health insurers owes Louisiana and two other states $180 million, and could face a criminal investigation for a decade-old scam to get rid of unprofitable HMOs.
Imagine that you own a company so unprofitable that you want nothing more than to get rid of it. The company is part of a highly regulated industry, and you’ve put millions of dollars into it just to keep it legal. Unfortunately, no one is going to purchase the company because it’s a bad investment.
Then you and your attorneys hit upon a plan nearly as brilliant as it is illegal: set up a sham corporation to buy it, draft papers so complicated and untruthful as to fool regulators in three states, transfer ownership of the failing company to the sham corporation and then sweep millions from bank accounts under the guise of payment for the sale.
In a nutshell, that’s what the Louisiana Supreme Court has concluded Woodland Hills, Calif.-based Health Net—one of the nation’s largest publicly traded health insurers—did in the case of three failing HMOs, one each in Louisiana, Texas and Oklahoma.
Health Net was ordered to pay $180 million to the states, and federal and state law-enforcement authorities are looking into its actions. On top of that, AmCareco’s directors and officers settled before trial for $8.7 million, PricewaterhouseCoopers settled for $3.5 million and a law firm involved in the matter settled for $1 million.
“It was a fairly sophisticated scheme, shall we say,” says J.E. Cullens Jr., the Baton Rouge lawyer who served as the lead attorney for receivers in Louisiana and Oklahoma. “It was almost buried in the details. The word that everyone used to describe it was ‘unique.'”
Health Net provides benefits to 6 million people through group and individual coverage, Medicare and Medicaid. The company also has sizable government contracts with the departments of Defense and Veterans Affairs, and its subsidy, Managed Health Network Inc., provides behavioral health, substance abuse and employee assistance programs to 5.1 million people.
Health Net Communications Director Brad Kieffer says no company officials would comment for this story. Publicly, however, Health Net did blame the case in part for a reported $108.2 million loss in the first quarter. Even so, Dow Jones Newswires notes, the company’s stock is up 50% in the past year.
Anatomy of a scheme
According to court records, the scheme dates back to 1997, when a company called Health Systems International, now known as Health Net, acquired Foundation Health Corp., the parent company of subsidiary HMOs in Louisiana, Texas and Oklahoma. The one operating in Louisiana was known as Foundation Health: A Louisiana Health Plan Inc.
Right away, Health Net wanted to divest itself of the three HMOs. They were the company’s smallest plans, with a combined membership of 75,000, and didn’t fit Health Net’s focus on the east and west coasts and the Department of Defense.
More significantly, the HMOs were a money drain because their insurance premiums were underpriced and their contracts with insurance providers were too low. From 1993-99, the HMOs required an infusion of $50 million just to remain in regulatory compliance in those states.
Health Net’s then-CEO, Dr. Malik Hasan, directed his senior management to wind down the plans, meaning no new policies would be written and the existing ones would be allowed to expire. But the company’s financial officers determined that would cost Health Net several more million dollars, so they recommended selling the HMOs.
Hasan was skeptical of finding a legitimate buyer, but he gave the go-ahead, stipulating that no attempt at a sale interfere with the winding down, so as not to cost Health Net additional money. The company retained the investment banking division of the accounting firm PricewaterhouseCoopers to find a buyer and structure the sale. One was eventually found in Thomas Lucksinger, who had a reputation for turning around unprofitable HMOs.
Lucksinger and others incorporated AmCareco to acquire, operate and expand the HMOs. There was one problem, however: AmCareco had no money to do so. And insurance regulators were unlikely to approve the sale of already-distressed HMOs to a company with no assets and no history of operating success. Plus, the longer the sale negotiations dragged on, the more money Health Net was going to have to put into the HMOs to ensure they met regulations.
So company officials devised a way for Health Net to remove the HMOs from its books and get back the money spent to keep them in regulatory compliance. Plus, if Lucksinger made a profitable go of it, Health Net also would retain 47% interest in the new holding company, plus favorable stock rights.
Although the financial transactions are purposely confusing and convoluted, the scheme was simple: The parties took money set aside as required by law to pay future claims that aren’t covered by premiums, labeled it a restructuring reserve—a one-time charge to earnings to cover the costs of “restructuring” a company, as in a sale—and any money left over after the sale would be considered an asset.
After Health Net transferred ownership of the HMOs to AmCareco, in what it dubbed a “cash sweep,” the company wired more than $2.5 million of those newfound assets out of the Louisiana HMO, leaving slightly less than $1.4 million in equity. It did so despite regulators’ insistence that they would approve the deal only if $4 million in capital remained after the sale. Texas and Oklahoma were left in worse shape: the first with a negative equity of more than $1.6 million, and the latter with just $102,000. That, too, was much less than promised to regulators.
“Through a series of questionable accounting maneuvers, the purchase took place,” says professor Edwin Sherman, an expert in complex litigation at the Tulane University School of Law. “They created a sham sale so Health Net could get the HMOs off their books, and ultimately these HMOs were not sustainable and ended up going into receivership.”
To make matters worse, AmCareco aggressively signed new insurance policies in an effort to instigate cash flow, using premiums from the new policyholders to pay the claims of existing members and recruiting more clients to pay the claims of those new clients.
The new company also created phony funds on the books of the HMOs to make them appear solvent to regulators. PricewaterhouseCoopers, the external auditor, signed off on financial statements, never alerting regulators to the existence of problems.
In August 2001, Lucksinger wrote in an e-mail to investors that AmCareco would have to cease operations without an infusion of money, and that he had “run out of smoke and mirrors.” By the time regulators took over the HMOs, they were insolvent by more than $60 million.
Going to court
In 2002, the three states seized their respective failing HMOs, beginning the lengthy process of shutting them down. A year later, then-Louisiana Insurance Commissioner Robert Wooley sued all the parties involved in the AmCareco deal. Oklahoma and Texas did the same; two years later, the lawsuits were consolidated.
The allegations were serious: negligence, fraud, conspiracy, aiding and abetting, unjust enrichment, breach of fiduciary duty, unfair or deceptive acts and breach of contract. The June 2005 trial lasted 11 days; jurors had difficulty understanding the complex business transactions, health insurance regulations, accounting principles and legal maneuverings.
“These kinds of cases are terribly complicated and difficult,” Sherman says. “You just hold your breath and hope that at least a few on the jury can understand it. Very often, lawyers don’t even understand it.”
The verdict: Health Net was at fault. The company appealed, and the 1st Circuit Court of Appeal ruled in its favor in 2009, dismissing all of the claims.
But in a 200-page ruling last month that resulted in a $180 million judgment against Health Net, the Louisiana Supreme Court said the appellate court “fundamentally misunderstood” the facts of the case—not surprising, given the complexity of the scheme.
“The business transactions—and their accompanying accounting treatment—are unusual,” the court wrote. “Most important in the consideration of the reasons for the court of appeal’s failure of understanding is the fact that what is at the core of these matters is a sophisticated deception which fooled even those individuals tasked with regulating the type of transaction at issue.”
The challenge of regulation
Although the case did expose scheming on the part of top Health Net officials, it also revealed a weakness in insurance regulation.
Sherman says regulators often are at a disadvantage vis-ŕ-vis the insurance companies they regulate because they don’t have the staff or resources to investigate mergers, sales or rate increases. They are forced to rely on the insurance companies themselves to be honest and forthcoming.
“One of the things I learned throughout this long litigation is how difficult of a job regulators have,” Cullens says. “It’s not like they have one or two files, or one or two insurance companies they’re looking at. They have quite a number of insurers they’re required to follow, and they have to rely on the regulated entities to provide truthful and open information. If the regulated industries aren’t open, forthcoming and truthful about what’s going on, it’s very difficult to unearth that fraud.”
Insurance Commissioner Jim Donelon says he doesn’t fault regulators, given that this particular fraud rose to the level of $180 million spread over three states.
“Our attorney described it adequately when he said this was a scheme that required significant legal resources and judicial oversight to penetrate,” Donelon says. “And in doing so, we were able to protect policyholders as well as health care providers from the misdeeds of this operation.”
Donelon “knows for a fact” that federal and state law-enforcement authorities have been monitoring information gleaned from the case. He predicts the judgment, and a possible criminal investigation, could prove to be a deterrent for other companies, with the exception of “those predisposed to such shenanigans. These kinds of outcomes do not deter those kinds of individuals.”
At this point, Health Net’s last hope is to request a stay and a hearing from the U.S. Supreme Court, which has proven reluctant to involve itself in state insurance regulation matters.
In the meantime, Louisiana’s receiver is preparing to collect the state’s $12 million portion of the judgment so that doctors, hospitals and policyholders across the state can get the money they lost when AmCareco went under.
“We hit a home run in this case,” says Marlon Harrison, the receiver for Louisiana. “This is probably the first time in Louisiana history that we’ll be able to pay all the providers, policyholders and enrollees everything they are owed, plus interest since 2005. We’ll make them whole again.”
