Humana Wheels Itself To Surgery

David A. Jones has always been quick to respond to opportunities. Two decades ago, the Humana Inc. chief executive and co-founder Wendell Cherry transformed Humana from the nation's leading nursing-home operator into a top hospital chain. Then, in 1983, they started a health-insurance business to help fill Humana's beds. The goal was to create an integrated health-care provider.

Now, Humana, based in Louisville, is undergoing yet another metamorphosis--this one prompted more by perils than opportunities. The strategy that Humana so zestfully pursued in the 1980s has turned against it. Hospital admissions are down. Enrollments in its health plans have stalled. And company earnings are plummeting (charts). To recover, Jones has proposed some radical surgery: splitting Humana apart. If, as expected, shareholders approve the plan at the Feb. 18 annual meeting, Humana will focus solely on health insurance, while its hospitals will be grouped into a new corporation, Galen Health Care Inc.

START SLASHING. Still, it remains to be seen whether Humana and Galen can solve their problems by going their separate ways. Carl F. Pollard, Humana's current president and Galen's would-be CEO, must rebuild admissions and earnings at a time when health-care providers are under pressure to restrain prices. For his part, Jones, 61, who will head the insurance business, must slash its steep overhead and medical costs. Excluding special charges, it earned only $4 million in fiscal 1992 on revenues of $2.8 billion.

What's more, the two executives must attempt their turnarounds under the cloud of a federal grand jury investigation. U.S. prosecutors, probing widespread corruption in the Kentucky state legislature, have subpoenaed documents from Humana as part of an inquiry into whether local lawmakers sold favors to special-interest groups. Jones has said Humana itself isn't a target of the investigation. Still, he fired the company's senior vice-president for public affairs, George L. Atkins, last September for an unspecified violation of corporate policy that turned up as a result of the subpoena. Although Jones said he didn't believe anyone had broken the law, he has begun an internal investigation.

Company officials are tight-lipped about the U.S. investigation, but they're quite ready these days to admit the shortcomings of their vertical-integration strategy. In the end, there was a clear contradiction: Health plans aim to cut usage and costs, while hospitals attempt to increase admissions and revenues. As a result, Humana's two operations were hurting one another. "As we began to control costs, we began to experience problems on the hospital side," concedes W. Roger Drury, Humana's chief financial officer.

Physicians, vital when it comes to referring patients to hospitals, often felt squeezed by Humana's competing interests. Many doctors were angered when Humana's health plans--nearly all of which are HMOs or other forms of managed care--started clamping down on charges. At the same time, they felt that their fully insured patients were being forced to pay hefty hospital rates to offset the discounts received by others enrolled in Humana health plans. Many retaliated by taking business elsewhere. "There's no question physicians, including myself, didn't do as many lab tests there because they perceived third-party insured patients were subsidizing the health plan," says Dr. Randall C. Bell, who just stepped down as chief of staff at Humana Hospital-San Antonio.

Even some patients rebelled against Humana after ABC News aired allegations in 1991 that its hospitals were overcharging. For example, the report said Humana was charging $11.80 for a 60 thermometer. Congressional inquiries into whether the company was gouging patients and overcharging the medicare program fueled the negative publicity. Humana insisted that its pricing was in line with industry practice and that with widespread discounting, few people ended up paying such huge markups. Still, admissions soon sagged.

Humana's health-insurance business didn't fare much better, largely because of its high medical costs and overhead. Administrative costs, such as claims-processing and marketing, stood at almost 15% of total expenses in fiscal 1992, compared with an HMO industry average of 11%. To maintain margins, Humana raised rates by an average of 10% last year, frightening away potential customers.

Faced with the prospect of further disappointments, Jones and his management team spent much of early 1992 reexamining their strategy. In July, they proposed a breakup. The board approved a plan in August in which stockholders would receive a share in Galen for every share of Humana.

Splitting apart surely will eliminate the tensions that arose as Humana pursued both the hospital and health-plan businesses. Rival health insurers say they're more likely to do business with Galen. And as an independent company, Galen--named after the early Greek physician and one of the fathers of medicine--will try to repair its relations with doctors. Already, administrators are beginning to "discuss with doctors the reason they're mad at us," says Richard A. Schweinhart, Galen's future CFO.

DISCOUNT OPERATIONS. To increase admissions, Galen will also have to fight the perception that it has high prices. In Louisville, Humana hospitals slashed prices last summer by as much as 35% on a wide range of services, from outpatient fees to open-heart surgery, in an effort to win back customers.

Those price cuts, though, come at a time when cost pressures are bound to intensify as managed-care plans and the government seek to hold down spending. "We think margins will be under pressure," Schweinhart allows. "If we could just maintain them, we'll be tickled pink." Sanford C. Bernstein & Co. analyst Kenneth S. Abramowitz estimates Galen's profits could drop 11% this fiscal year, to $254 million, on a 1% revenue rise to $4.1 billion. To cut overhead and help the bottom line, Galen has already shed some staff and might sell some of its 77 hospitals.

While Galen struggles, Humana may fare better as it focuses on health-care plans. More corporations are already moving toward managed-care programs to cut costs. Most analysts believe that Humana and other health-plan providers will also be helped by the policies of

the incoming Clinton Administration, which favors some form of managed-health-care competition.

Humana will receive one important boost from an increase in medicare reimbursements. After years of smaller increases, the Health Care Financing Administration is giving a 12% price increase this year to Humana on medicare contracts, which account for 39% of the company's health-plan revenue. Analyst Abramowitz believes overall revenues will rise 12%, to $3.1 billion, in fiscal 1993, with earnings expected to rise sharply--albeit to a still-disappointing $25 million to $30 million. Humana may try to buy other health plans with the $385 million in cash and notes it would receive as part of the breakup.

Even if Humana can regain its earnings luster, though, it may yet be tarnished by legal problems. Last November, a Kentucky newsletter that focuses on state politics reported that former executive Atkins was fired because of a payment he made to former state Senator Helen Garrett. George Salem Jr., Garrett's lawyer, acknowledges that she was paid $5,000 by the company in 1991 for a report she did after leaving the state legislature on Humana's relationship with that body. Garrett was one of two state senators who changed their vote in 1990 to repeal state regulations governing hospital construction and capital expenditures. Humana had lobbied hard for the repeal. Garrett had opposed the measure earlier.

Last year, Garrett and seven others, including four former state lawmakers, pleaded guilty to accepting money from the horse-racing industry to influence legislation. Salem denies there was anything improper about the payment and says Garrett changed her vote to allow a non-Humana hospital in her district to expand services. Atkins' attorney says that his client "is not guilty of any misconduct." Humana won't comment, citing its cooperation with the grand jury.

Whatever the outcome, the plans for splitting Humana won't be affected. True, there's no clear evidence that Humana's offspring will succeed where the parent failed. But Jones, who is quick to react to opportunities, is convinced that a breakup is the best hope for resuscitating Humana's bottom line.

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