Commonwealth Health Plans focuses on the managed care industry. It presents two years of data and discusses benchmarking against primary competitors as well as the industry.

Commonwealth Health Pans in one of Virginia's largest managed care organizations (MCOs). In fact, it is the largest of the state's not-for-profit MCOs. It offers prepaid health coverage to more than 500,000 members in 17 counties, including the following major cities: Richmond, Norfolk, Virginia Beach Arlington, Alexandra, and Roanoke.

Commonwealth's various products include commercial health maintenance organizations (HMOs), (Medicare Advantage plans), preferred provider organizations (PPOs), and point-of-service (POS) plans. These plans are all designed to meet the needs of a wide segment of Virginia's population of approximately 8 million. The revenue breakdown of plan types is as follows:

Plan Type

Percent of Revenue

Commercial HMO

46

Medicare HMO

39

PPO

10

POS

5

100

Commonwealth was the first managed care organization in Virginia to seek and receive accreditation from the National Committee for Quality Assurance (NCQA),4and each of its component plans has been rated as excellent, the highest accreditation level. The NCQA judges a health plan on it performance in three areas: clinical performance (based on HEDIS [Healthcare Effectiveness Data and Information Set] results), member satisfaction (based on CAHPS [Consumer Assessment of Healthcare Providers and Systems] results), and a review of key for about 40 percent of the assessment for HMOs with performance against structure and process standards accounting for the remaining 60 percent. All three areas are important, and together they give an accurate overall assessment of the quality of a health plan.

A summary of Commonwealth's 2012 and 2013 HMO plan financial data (including both commercial and Medicare) is presented in Exhibit 2.1, While Exhibit 2.2 contains a summary of operating and enrollment data. To help in analyzing Commonwealth's performance, its managers have classified the following four Virginia HMOs as "primary competitors."

Number of

2013 Total

2013 Total

HMO

Counties Served

Enrollment

Assets (000s)

WellLife

23

516,858

$408,707

Signet Healthcare

15

360,252

178,662

Proxima

15

247,109

144,982

Sparta

28

205,296

103,504

These pans have the geographic coverage and financial resources to be prominent payers in the Virginia managed care industry. Furthermore, the primary competitors are operating in the same service areas and have a similar product mix as Commonwealth's performance with the state average as well as with the primary competitor list. Note, however, that not all relevant performance measures have a complete set of comparative data available.

Exhibit 2.3 contains selected financial and operating ratios for Commonwealth's primary competitors as well as the means and medians for all Virginia HMOs. Exhibit 2.4 contains selected national data, in which all comparative data are for HMO plans only.Exhibit 2.5 contains selected ratio definitions.

Assume that you have just started an administrative residency at Commonwealth Health Plans. On the first day at the organization, Robert Osborne, the chief executive officer, stated that the best way to get to know the financial and operating condition of any business is to do a brief financial statement and operating indicator analysis; thus, he assigned you the task. Although you agree that this is a great way to learn more about Commonwealth and its competitors' HMO plans, you wonder whether he has any hidden motives. Perhaps the company is having financial problems with these plans and he thinks that you can spot them, or perhaps he just wants to test you analytical skills.

In any event, he has already schedules a financial and operating performance analysis presentation for the next executive committee meeting as a way for you to demonstrate your skills to Commonwealth's senior managers. In preparing for the meeting, you called Amity Wallace, the previous administrative resident, to get some hints on how to prepare for your presentation to the executive committee. Amity just left Commonwealth for a great job with Humana. Her advice was to do a standard financial statement analysis, including statement of cash flows analysis, Du Point analysis and ratio and operating indicator analyses.

Your first impression was this task should be a "piece of cake," as you had performed a similar analysis for a hospital during your internship. However, as you began the task, it became apparent that the ratios used and their interpretations differ across industries, that is the ratios that are critical to identifying the financial condition of a hospital are not necessarily the same ratios that are critical to a managed care plan. In addition, many of the ratios that are relevant to both hospitals and managed care plans have values that differ substantially.

To illustrate, consider the medical loss ratio (defined as medical expenses divided by premium revenue), which measure the proportion of premium revenue that is spent on providing member healthcare services. Clearly, this ratio is not applicable to providers such as hospitals. Interestingly, healthcare reform (the Affordable Care Act) mandates that large group insurance plans spend at least 85 percent of premiums on medical services. If they fail to meet this requirement, insurers must pay a rebate to customers.

(Does Commonwealth meet this requirement? Also, what do you think of the choice of terminology for the medical loss ratio?)

To help the executive committee interpret your presentation, you plan to point out key differences between your analysis for a health plan and that for a hospital as they emerge.

In addition, you know that it is more important to identify key areas of concern and to recommend course of action than it is to merely go over the numbers.

Exhibit 2.1 Commonwealth Health Plans: HMO Plan Financial Data (millions of dollars)

Statements of Operations

2012

2013

Premium revenue

$313.70

$357.60

Interest income

2.4

3.5

Total revenues

316.1

361.1

Operating expenses

Medical costs

$263.00

$291.80

Selling and administrative

36.8

43.6

Depreciation

4.7

5.0

Total operating expenses

$304.50

$340.40

Net income

$11.6

$20.70

Balance Sheets

Cash

$37.2

$27.2

Marketable Securities

42.7

60.9

Premiums receivables

3.7

7.4

Total current assets

$83.6

$95.5

Net fixed assets

30.0

31.7

Total assets

$113.6

$127.2

Medical costs payable

$44.8

$48.7

Accounts payable/accruals

15.4

17.3

Total current liabilities

$60.2

$66.0

Long-term debt

17.1

4.2

Net assets (equity)

36.3

57.0

Total liabilities and net assets

$113.6

$127.2

Other Data

Medical loss ratio

83.8%

81.6%

Administrative cost ratio

13.2%

13.6%

Total commercial premium revenue

$170.9

$205.6

Total Medicare revenue

$142.8

$152.0

Total physician services expense

$125.6

$127.1

Total inpatient expense

$80.8

$90.1

Total other medical expense

$56.6

$74.6

Exhibit 2.2 Commonwealth Health Plans: HMO Plan Operating and Enrollment Data (millions of dollars)

2012

2013

Commercial premium revenue PMPM

$127.82

$127.90

Medicare revenue PMPM

$449.37

$437.23

Commercial patient days per 1,000 enrollees

302.9

266.4

Medicare patient days per 1,000 enrollees

1,622.4

1418.1

Commercial member-months

1,337,036

1,607,036

Commercial physician encounters

594,381

622,749

Commercial inpatient days

43,661

39,763

Medicare member-months

317,778

347,643

Medicare physician encounters

149,622

185,283

PMPM: per member per month

Exhibit 2.3 Selected State HMO Industry Financial and Operating Data (millions of dollars)

2012

2013

Total Margin

WellLife

4.8%

5.8%

Signet Healthcare

3.0

3.2

Proxima

9.1

-0.7

Sparta

10.5

9.1

State average

3.8

-3.9

State median

4.8

4.7

Percent Administrative Expense

WellLife

12.1%

11.5%

Signet Healthcare

12.2

13.4

Proxima

13.6

16.4

Sparta

23.9

26.8

State average

3.8

17.4

State median

4.8

15.7

Percent Inpatient Expense

Well Life

32.2%

30.3%

Signet Healthcare

22.8

22.4

Proxima

21.2

23.0

Sparta

18.2

18.8

State average

25.2

23.3

State median

23.6

24.3

Percent Physician Expense

Well Life

54.1%

56.9

Signet Healthcare

31.3

30.3

Proxima

22.7

24.9

Sparta

12.8

18.6

State average

28.8

31.3

State median

31.1

31.6

Percent Other Medical Expense

Well Life

0.1%

0.1%

Signet Healthcare

8.9

7.8

Proxima

27.5

30.2

Sparta

45.7

35.0

State average

14.6

12.5

State median

10.2

8.9

Commercial Premium Revenue PMPM

Well Life

$108.68

$110.19

Signet Healthcare

39.86

27.50

Proxima

120.68

124.27

Sparta

88.41

95.06

State average

101.17

102.53

State median

108.32

108.95

Medicare Revenue PMPM

Well Life

$406.57

$421.57

Signet Healthcare

N/A

N/A

Proxima

N/A

N/A

Sparta

N/A

N/A

State average

365.12

376.04

State median

426.18

430.57

Commercial Inpatient Days per 1,000 Enrollees

Well Life

245.4

246.0

Signet Healthcare

258.4

248.8

Proxima

251.8

259.2

Sparta

198.2

248.9

State average

278.0

237.0

State median

279.1

248.8

Medicare Inpatient Days per 1,000 Enrollees

Well Life

1,388.4

1,323.8

Signet Healthcare

1,165.2

1,188.7

Proxima

1,518.8

1,382.2

Sparta

1,623.8

1,566.9

State average

1,432.1

1,375.5

State median

1,380.5

1,350.6

Commercial Physician Encounters per Member

Well Life

2.2

3.6

Signet Healthcare

1.5

1.4

Proxima

2.7

2.6

Sparta

3.5

3.6

State average

3.8

3.8

State median

3.9

3.7

Medicare Physician Encounters per Member

Well Life

9.8

9.6

Signet Healthcare

6.6

6.9

Proxima

10.1

10.0

Sparta

11.2

11.3

State average

9.1

9.1

State median

8.6

8.9

\

Create and interpret Commonwealth's statement of cash flows for 2013. What information does it provide regarding the HMO's sources and uses of cash over the past year?

Use the Du Pont equation to obtain a rough feel for Commonwealth's financial condition as compared to national averages. What are your conclusions? How do you come to those conclusions? Use the following equity multiplier.

2012: 3.13

2013: 2.23

Ind Avg: 3.16

Conduct a financial statement analysis and operating indicator analysis. After conducting both analyses, interpret the resulting data. Use both the national and state competitor data in the analysis. (Note:that all ratios do not have a complete set of comparative data.)

List Commonwealth's financial and operating strengths and weaknesses as identified by your analyses in Questions 2 and 3.

On the basis of the limited amount of information provided in the case, what are your recommendations to the board to correct any weaknesses noted? What additional information wouldbe useful in the analysis?

In your opinion, what are three key learning points from this case? How did you come to these learning points?