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The affiliation of six Blue Cross plans is a key strategic move for the not-for-profit organizations as they attempt to keep pace with the nation's other large health insurers, experts and company officials say.

"For the Blues, their biggest problem today is their relative weakness compared to national carriers," says Jack Reichman, an analyst with Standard & Poor's who follows health insurers. "Even though they're in every corner of the country, the company hasn't been as effective as an Aetna or CIGNA."

Blue Cross plans that span six states — Idaho, Illinois, regon, Texas, Utah, and Washington — announced their intent on Aug. 11 to affiliate with each other. Under the agreement, Health Care Service Corp. (HCSC), the parent of the Illinois and Texas Blues, will affiliate with The Regence Group, the parent of the other four Blues. The move is expected to be completed in early 2001.

The affiliation will make the new group the country's largest not-for-profit health insurance organization, upstaging Kaiser Foundation Health Plans Inc. It will become the fourth-largest health insurer overall, after Aetna, UnitedHealthcare, and CIGNA.

The announcement prompted S&P to place HCSC on CreditWatch with negative implications, despite its expectations that the affiliation will position the Blues plans to enhance their geographical presence and improve operational effectiveness through economies of scale. Such a ratings downgrade is routine when a company S&P rates — in this case, HCSC — affiliates with a company it doesn't rate — Regence, Reichman says.

HCSC already has a deal pending to acquire Blue Cross and Blue Shield of New Mexico. In late 1999, HCSC acquired two large NYLCare HMO plans in Texas from Aetna.

But it's an affiliation of this magnitude that is seen as pivotal in helping the Blues plans muscle their way to better contracts with doctors and hospitals while also reducing overhead costs. The affiliation will create a massive group, with nearly 10 million customers and $15 billion in premiums. "They're setting the groundwork for a broader regional organization," Reichman says. "It gives them greater marketing power. They are limiting themselves with an affiliation, but time is of the essence. It's going to look very different than it does today."

Their agreement is not a merger — that would involve the exchange of assets among the companies. Rather, through an affiliation, the six Blues plans will be able to combine some administrative functions, such as claims processing and certain information technology functions, to avoid duplication of costs.

By all accounts, one of the main advantages of an affiliation is that the plans will be able to jump the regulatory hurdles much faster than if they were merging.

Local independence remains

The new organization will operate under the Regence name and maintain its headquarters in Chicago, with key corporate offices also in Portland, Ore. The agreement calls for creating a combined board of directors and a single management team. Raymond F. McCaskey, president and CEO of HCSC, will be named CEO of the new Regence Group.

Each of the Blues plans will remain independent, company officials say, and customers should not see any changes in their coverage or benefits. Provider networks will continue to be maintained locally.

"The Regence Group approach has been to combine functions that are invisible to the customer so that we can operate more efficiently and invest in enhancements to our service," says Richard L. Woolworth, chairman and CEO of Regence.

Reduced overhead — but not premiums

Robert Kieckhefer, a spokesman for HCSC, says that combining administrative functions will make each plan stronger and more efficient. For example, health insurers now are contending with the daunting process of implementing new electronic privacy regulations required by the federal Health Insurance Portability and Accountability Act (HIPAA). "We'll be spending incredible amounts of money to implement that," Kieckhefer says. "We would have to do it twice if we had two corporations. Now we can do it once. We can share some of the solutions, the technological developments."

Company officials offer no promises to reduce insurance costs after the affiliation. "I think it would be Pollyanna-ish to say premium prices will come down," Kieckhefer says. "It might be able to mitigate the increases we see from inflation in the health insurance business."

Still, it remains to be seen how the affiliation will truly unfold. And it's not clear what will happen if one Blues plan performs poorly financially. "I don't know at this point how things will shake out," Kieckhefer concedes. "Will there be a sharing of money? It's obviously an issue, but we don't have the answers yet. This is one of the things we will have to look at."

Regulators plan careful review

Insurance regulators in the six states also will closely observe the affiliation. By merely affiliating rather than merging, the Blues plans will sidestep the need for regulatory approval in each of the six states — such as Illinois, for instance. Even so, insurance officials will be watching to make sure the move does not hurt consumers — and the Blues plans want to make sure they have the blessing of each state to move forward.

The Illinois Blues plan is financially stable, says Nan Nases, a spokesperson for the Illinois Department of Insurance. Consumer complaints have been about average, with the insurer ranking 17 out of 38 in the number of complaints filed against it by its customers. "We don't see any problems or any negative impact on Illinois policyholders as a result of the affiliation," Nases says. The agreement does not need formal approval from Illinois regulators.

Washington is regarded as one of the most heavily regulated states in the health insurance industry, and insurers anticipate a keen eye from regulators there. "The issue for us will be protecting the interests of the consumers," says Barbara Stenson, a spokesperson for the Washington Department of Insurance.

Regence BlueShield of Washington, the state's largest health insurer, has "huge" reserves, Stenson says. "We're very concerned about those assets and want to make sure they'll be there for Washington subscribers, and that certainly seems to be their intent."

Texas, too, plans to have its say. But only because the Illinois Blues agreed to a special provision as part of its acquisition of the Texas Blues will Texas regulators be able to formally review the affiliation agreement, says insurance department spokesperson Lee Jones. The Illinois Blue is not domiciled in Texas but consented to be subjected to state regulations as if it were, he says.