The HMO Graveyard

Why was this doctor allowed to start a health plan?

From the start, the HMO was a house of cards. Yet regulators did nothing--until the money to pay physicians had blown away.

By Wayne J. Guglielmo, Senior Editor

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It might have been a win-win deal.

In September 1995, the state of New Jersey was looking for HMOs to participate in its new mandatory Medicaid managed care program. Neurologist Magdy Elamir, who only the month before had been granted a state license to operate an HMO, was eager to take part. Initially approved to serve a single county, Elamir's HMO--American Preferred Provider Plan--was soon allowed into 13 counties and covered 42,000 Medicaid recipients.

Yet, barely three years after enrolling its first patient, APPP lay in financial ruins, its network doctors and hospitals were saddled with millions of dollars in unpaid claims, and its founder had retained the services of Michael Chertoff, a well-known criminal defense attorney. (Elamir, who declined to be interviewed for this story, continues to live and practice in New Jersey. Neither his lawyer nor the state would confirm or deny that the doctor is the subject of a criminal investigation.)

What went wrong?

The answers vary, but many point to regulatory negligence. "The state did things in a slap-dash manner," says Joan Quigley, a state legislator who's also the chief spokesperson for Franciscan Health System of New Jersey, one of the hospitals owed money by APPP. "Regulators wanted to get the managed Medicaid program up and running, and they took a lot of people and companies at face value."

In the case of Elamir and APPP, that lack of caution proved disastrous, as the story of the HMO's rise and fall dramatically shows.

Big dreams built upon a shaky foundation

Magdy El Sayed El Amir, a native of Egypt, received his medical degree from the University of Cairo in 1977. After moving to the US with his family, he completed his neurology and psychiatry residency before opening a storefront neurology practice in Jersey City, NJ, in 1982. The practice catered to the area's poor, many of whom were fee-for-service Medicaid beneficiaries.

Elamir (in this country, he'd begun eliding the two parts of his last name) did a brisk business. Before long, his medical practice became the nucleus for other health-related enterprises, including several MRI centers, a limousine and ambulance company, and a physician billing and management service. He also acquired real estate in Hudson County, where he practiced, and in several adjoining counties.

In 1990, Elamir and his wife, Wafaa, took advantage of a foreclosure sale to buy an unfinished house in the tony New Jersey suburb of Saddle River. The price was $950,000, and the Elamirs took out a $700,000 mortgage from the same Hoboken bank that sold them the property. In May 1993, they moved in. A year later, the house--featuring an indoor swimming pool and lighted tennis courts--was reappraised at $1.75 million.

The reappraisal was part of a complicated plan that allowed Elamir to purchase a l2-story office building, in poor repair, in central Newark. The building, acquired in 1994 for $650,000, was to serve as the headquarters for the medical entrepreneur's latest commercial venture, an HMO specializing in Medicaid managed care. Its ambitious name: American Preferred Provider Plan.

Purchasing the physical space to house his new HMO was one thing. Satisfying the equity requirements mandated by the state--cash and other assets available to the company to cover future liabilities--was quite another.

To meet the required $1.5 million minimum net worth, Elamir borrowed the full amount from the very bank that a year earlier had sold him the Newark office building. According to court papers later filed by his accountant, Mohammed Hanafy, Elamir used the office building and his home to secure the loan. A $300,000 certificate of deposit and a $2 million life insurance policy provided additional collateral.

The state also required that APPP have access to money beyond its initial capitalization--a so-called surplus fund. To satisfy this requirement, Elamir "executed guaranties" on two of his five MRI centers, all unlicensed by the state.

On Aug. 7, 1995, the state Department of Health (later changed to Department of Health and Senior Services) and the Department of Human Services issued APPP an HMO certificate of authority. The following month, DHS approved APPP as a Medicaid HMO. That meant the health plan could begin contracting with doctors and hospitals; it could also sign up beneficiaries, which it did, beginning with Hudson County. Before long, APPP was permitted to expand its recruitment to surrounding counties. It also received random assignments for beneficiaries who hadn't chosen an HMO.

Financial sleight of hand goes unquestioned

Success proved a mixed blessing: As APPP's enrollment grew, so did the capital requirements mandated by the state. By late 1996, APPP was violating its Medicaid contract, which required that an additional $3 million be added to the company's capital reserves.

Once again, acting in concert with his accountant, Elamir proved his financial wizardry. He personally borrowed $1.5 million, using his Saddle River house as collateral. With that, he paid off the mortgage on his Newark office building, the title of which had been transferred the year before to a realty company he also owned. The same rundown building that he had purchased just three years before for $650,000 was now, according to an appraisal conducted in late March 1997, worth an eye-opening $4.2 million.

Based on this new assessed valuation, APPP issued a $3.5 million mortgage to Elamir's realty company. The mortgage was then recorded on the HMO's books as an asset in the form of a debt to be collected. No money actually changed hands, since Elamir owned both companies and his realty company in effect contributed the mortgage amount back to APPP for an equity stake in the company. But on paper, at least, APPP's net worth increased by $3.5 million--$500,000 more than the new minimum capital requirement.

If the company's finances at this point resembled a house of cards, no one seemed to notice. The state signed off on Elamir's plan, and APPP continued to operate. By the end of 1997, it had 1,949 doctors, hospitals, and other medical providers under contract. According to its annual financial statement, APPP's net worth was $5,787,824.

That number had barely budged five months later, when APPP filed its first-quarter financial statement for 1998.

There was a problem, however, and again, no one seemed to notice: Listed prominently among the HMO's assets were a pair of loans that Elamir had made in late 1997 to two APPP affiliates--one in Michigan, the other in Washington, DC--that were trying to duplicate APPP's New Jersey model of building a Medicaid HMO. The loans were critical to Elamir's ultimate goal of transforming APPP into a national player.

But according to a complaint filed by the state at the end of 1998, the loans were more than 90 days past due at the time of APPP's first-quarter report. If the value of those loans had been deducted from APPP's reported net worth as of Dec. 31, 1997, the state argued, the HMO's actual net worth would have been only $1,416,694--less than half of the required amount.

The complaint also stated: "The said loans were not made in the ordinary course of business and were made without providing prior notice to the Commissioner [of the Department of Banking and Insurance]." Under New Jersey law, the "commissioner could have disapproved of the loan transaction if it would adversely affect the HMO and cause it to be in hazardous financial condition."

This is precisely what the loans did, and the undetected problem got worse by March 31, 1998. At this point, APPP's real net worth was in fact a negative $138,366. The further decline was the result of still more fund transfers, including fees to Elamir and his brother Mazhar, also a physician, for "consulting services"; reimbursements to Elamir's limousine and ambulance service for transporting Medicaid patients; and additional loans to APPP affiliates.

In papers submitted to the court in late 1998, Mohammed Hanafy, Elamir's accountant, defended these transfers as legitimate business expenditures. On the issue of consulting fees, for instance, he wrote: "APPP's records clearly demonstrate that Dr. Elamir took no compensation whatever (either in salary or consulting fees) from late 1993, when he began actively planning the founding of APPP, through July 1, 1996. Furthermore, Dr. Elamir has never submitted business expenses to APPP for reimbursement. . . . Dr. Elamir considered part of the transfer for consulting fees reimbursement for such expenses."

By this point, however, the state had retained its own accountant, and was in no mood for explanations from Elamir.

As complaints pile up, the state finally acts

Other problems were plaguing Elamir and APPP by early 1998.

For one thing, his back-office operation was a disaster. Whether due to bad management, faulty data systems, or both, the company was slow to collect premiums. That led to continuing cash flow deficits.

At the same time, cash flow from Elamir's MRI centers had started to dry up, compromising those businesses' ability to bail out APPP, as Elamir had promised they would. A local newspaper, The Record, reported that several insurance companies, including Allstate New Jersey, "cited Elamir and numerous other defendants in lawsuits alleging that they performed unnecessary medical procedures on 'victims' of staged auto accidents." Allstate, a major source of revenue for the centers, cut off payments to them.

Poor cash flow, mismanagement, and a continuing series of fund transfers contributed to APPP's deteriorating financial condition through the first half of 1998. Still, no one seemed to notice.

Almost no one, that is. In fact, the Department of Human Services and the Department of Health and Senior Services had begun receiving more-frequent complaints about the HMO. Patients angrily reported delays in service, and providers questioned their growing backlog of unpaid claims. DHS and DHSS alerted the Department of Banking and Insurance about a possible problem at APPP.

In August 1998, the Department of Banking and Insurance initiated a series of meetings between its staff and APPP's chief operating officer, management consultant, and legal counsel. APPP was reluctant to open its books, but it did provide estimates of where it stood financially. Current claims liability was reported to be $7 million, while monthly operating losses were estimated at around $500,000.

The picture was bad enough to cause the insurance commissioner, Jaynee LaVecchia, to place APPP under administrative supervision on Oct. 15. That gave her the legal authority to demand that APPP open its books. When it did, independent auditors informed department staff that the HMO had underreported its claims liability. The actual amount was $30,765,000.

On Dec. 2, in a complaint filed in the Superior Court of New Jersey, the commissioner asked that APPP be placed under her authority, stating: "Its substantial operating deficit renders continued operation of APPP in its present condition hazardous to its members, providers, and creditors." The complaint asked that Elamir return "inappropriately" transferred funds and deposit "cash and/or assets" from his MRI facilities to APPP, as he had earlier pledged.

Eight days later, the court appointed Commissioner LaVecchia rehabilitator of APPP, granting her broad powers to clean up the financial mess. Elamir's assets were frozen, pending further notice.

Two months later, in February 1999, the commissioner submitted the "final report of the rehabilitation" to the court. In it, she proposed selling the insolvent HMO to Horizon Healthcare of New Jersey. At $193 per member for APPP's remaining 23,000 members (thousands had already transferred to other plans), the tab worked out to about $4.4 million. For unpaid provider claims incurred prior to Dec. 10, 1998 (the new estimate was $37.4 million), she projected a "payout ratio" of 18 to 23 cents on the dollar. Claims incurred after Dec. 10 were to be paid in full.

The court approved the sale to Horizon and, two months later, authorized the liquidation of American Preferred Provider Plan. Magdy Elamir's dream of HMO riches was officially over.

Doctors and hospitals are left holding the bag

But the nightmare continued for those who did business with APPP.

Doctors and hospitals in certain areas were especially hard hit. One such area was the city of Paterson, in Passaic county, where APPP had enrolled more than half of a large Medicaid population.

Specialists such as Paterson otolaryngologist James LaBagnara took the toughest blows. According to LaBagnara, he's owed more than $31,000 from APPP. "We detected a lag in payments very early," he says. "We complained to the company, and when that didn't work, we alerted all the relevant state agencies. Then Dr. Elamir himself called and said he'd personally make sure our claims would be among the first paid. But it didn't happen."

Primary care doctors, who did most of their work for APPP under capitation contracts, fared somewhat better. The nine doctors at the Paterson Community Health Center, for example, feel lucky to have escaped with a mere $100,000 in unpaid fee-for-service charges, some of which they hope to collect. "We almost always got our monthly capitation check," says Mary Gardner, the group administrator.

Hospitals, on the other hand, got scorched. St. Joseph's Hospital and Medical Center in Paterson, for instance, has filed proof of claims with the state totaling approximately $16 million. It has also filed suit against the state for negligence in overseeing APPP's activities.

"It's hard to believe no one noticed the financial problems APPP was having," says Alan Zollo, the hospital's vice president for managed care. He's especially surprised that APPP "could pass the state's financial tests based on assets it didn't have.

"I was in the APPP office after the rehabilitator took over," recalls Zollo. "I literally thought I was going to fall through the elevator, the building was in such dilapidated condition. And this was a building that had been appraised at $4.2 million. If it was worth a fraction of that amount, I'd be surprised. Yet these were the types of assets APPP used to prove its financial solvency to the state."

Joan Quigley of Franciscan Health System, in Jersey City, levels much the same charge. "Elamir arrogantly thought he could make it all pay," she says, "but he couldn't, and no one was checking to make sure he did." Franciscan is owed a little more than $650,000.

This legislative session, New Jersey's medical and hospital associations both backed bills aimed at dealing with the financial aftermath of two HMO failures--APPP and HIP Health Plan of New Jersey (see page 170). The legislative proposals for a state guaranty fund--including bills supported by Gov. Christie Whitman--went nowhere.

Which is just fine with Paul R. Langevin Jr., president of the Trenton-based New Jersey Association of Health Plans, who objects to the surcharge that the guaranty fund would place on HMO premiums. "This whole thing is nothing more than a payment fund for doctors and hospitals," says Langevin. Consumers and well-managed HMOs, he argues, shouldn't have to pay for the sins of poorly managed health plans.

But backers of a state guaranty fund say they've been assured by top lawmakers that the issue isn't dead.

Meanwhile, New Jersey has stiffened its HMO regulations. It now requires a preoperational audit of a prospective HMO--at the HMO's expense--before issuing a certificate of authority. And it mandates that "60 percent of an HMO's admitted assets be in cash, cash equivalents . . . or other forms of investments acceptable to the commissioner." The new regulations also strengthen reporting and monitoring standards, making it less likely a health plan will founder for long, as APPP did, before regulators take notice.

Still, even the strongest regulations and laws are effective only if properly administered. "There's no statutory formula that can substitute for good judgment," says Julia Philips of the Minnesota Department of Commerce and a member of the National Association of Insurance Commissioners.

The story of Magdy Elamir and his house-of-cards HMO leaves little doubt of that.

Wayne Guglielmo. Why was this doctor allowed to start a health plan? Medical Economics Oct. 25, 1999;76:184.