Blues woes show precarious role of consultants Firms' work raises alarming questions

December 20, 1992|By Patricia Meisol and Ann LoLordo | Patricia Meisol and Ann LoLordo,Staff Writers

When Blue Cross and Blue Shield of Maryland's board considered boosting top executives' salaries to allow it to

compete for talent amid a wider spectrum of industries, it asked a big-name consultant, Towers Perrin, for advice. Were the salaries of then-President Carl J. Sardegna and his top aides "competitive?"

Towers Perrin's short answer: No. And the consultant devised a package that raised the executives' salaries.

Asked recently how Mr. Sardegna's upgraded $850,000 compensation could be both "competitive" and higher than that of all but 20 insurance executives in the nation, the consultants offered an admittedly lame excuse: The board made them do it.

The firm merely supplied salary data for a range of companies chosen by Blue Cross' board, says John England, head of Towers Perrin's executive compensation practice in the East. If the board had requested advice on which pool of executives to use, or had sought a comparison to Blues plans nationally, it would have received a different answer.

"Please don't conclude that consultants are mindless drones," he says. Referring to criticism surrounding the high salaries his firm recommended, he adds, "Is all of this creating happy campers at Towers Perrin? No, it is not."

Towers Perrin's role illustrates the precarious existence of consultants -- from auditors to real estate experts -- hired by Blue Cross. They often walked a thin line between biting the hand that fed them and telling the harsh truth. And though their advice sometimes was taken to heart, more often it served to buttress expensive or unusual directions already taken by management.

Meanwhile, some consultants helped obscure the true financial position of the state's largest insurer -- by shading important information or by helping to puff up assets when the company's solvency was in question. Their stamp of approval helps explain how Blue Cross, which insures or administers insurance for 1.4 ++ million Marylanders, could report an increasing net worth or justify performance-based pay raises even as it was losing tens of millions of dollars.

Now, as the insurer's net worth begins to drop and its executive ranks are purged -- Mr. Sardegna was the latest to resign -- changes are occurring. Consultants such as Towers Perrin are having second thoughts about their role. The accounting industry already had proposed toughening the disclosure standards in financial reports. And Blue Cross' board, shocked by the consultants' bills -- at least $8 million last year -- plans to establish guidelines on using experts, including when such contracts must be approved by the board.

"The board is asking, 'Is it necessary, was it necessary and what benefit did we derive from a consultant's work?' " says board Chairman Frank M. Gunther Jr. "We want to look at it to be sure it's not habit-forming."

The controversy over Blue Cross focuses largely on one issue: the company's financial health, which could affect its ability to pay claims.

Special rules apply

U.S. Senate investigators, who held hearings on the Maryland company in September, portrayed a fragile insurer whose assets had been artificially inflated.

But the company maintained -- in state and congressional testimony as well as advertising -- that business was booming.

Why is the truth so hard to obtain? Consider the work conducted by Arthur Andersen & Co., whose outside audits were supposed to serve as an independent check on the company's financial health. Its reports were cited in hearings and newspaper ads as proof of the Blues' financial strength, but they omitted important explanatory material.

Since 1988, Arthur Andersen has reported a one-sentence disclaimer on the insurer's annual audits stating that, in addition to following generally accepted accounting rules, it had followed special rules of the Maryland insurance commissioner.

Those rules, which Blue Cross requested, were significant. Without them, the insurer would have been insolvent or barely solvent for several years. In 1988, for example, state regulators allowed Blue Cross to boost its reserves -- assets that could be converted into cash for emergency use -- by placing an unusually high value on its health maintenance organizations. But a national insurance regulators' group later questioned that value, leading state regulators to reduce it by at least $16 million the following year.

And only in mid-November did Blue Cross acknowledge publicly that $88.1 million of the $102.5 million it has listed in reserves for emergencies is there by special permission from state regulators.

But no one who read the company's annual report or the financial reports submitted to Maryland regulators could grasp the situation because such special exceptions were never spelled out.

Arthur Andersen declined comment for this story. And according to industry experts, it has no professional obligation to publicly report those exceptions.

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