The HMO Graveyard

Why was this doctor allowed to start a health plan?

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

By Wayne J. Guglielmo, Senior Editor

It might have been a win-win deal.

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

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

What went wrong?

The answers vary, but many point to regulatory negligence. "Thestate did things in a slap-dash manner," says Joan Quigley, a statelegislator who's also the chief spokesperson for Franciscan Health Systemof New Jersey, one of the hospitals owed money by APPP. "Regulatorswanted to get the managed Medicaid program up and running, and they tooka 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 degreefrom the University of Cairo in 1977. After moving to the US with his family,he completed his neurology and psychiatry residency before opening a storefrontneurology practice in Jersey City, NJ, in 1982. The practice catered tothe 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 lastname) did a brisk business. Before long, his medical practice became thenucleus for other health-related enterprises, including several MRI centers,a limousine and ambulance company, and a physician billing and managementservice. 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 foreclosuresale to buy an unfinished house in the tony New Jersey suburb of SaddleRiver. The price was $950,000, and the Elamirs took out a $700,000 mortgagefrom the same Hoboken bank that sold them the property. In May 1993, theymoved in. A year later, the house--featuring an indoor swimming pool andlighted tennis courts--was reappraised at $1.75 million.

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

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

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

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

On Aug. 7, 1995, the state Department of Health (later changed to Departmentof Health and Senior Services) and the Department of Human Services issuedAPPP an HMO certificate of authority. The following month, DHS approvedAPPP as a Medicaid HMO. That meant the health plan could begin contractingwith doctors and hospitals; it could also sign up beneficiaries, which itdid, beginning with Hudson County. Before long, APPP was permitted to expandits recruitment to surrounding counties. It also received random assignmentsfor 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 thecapital requirements mandated by the state. By late 1996, APPP was violatingits Medicaid contract, which required that an additional $3 million be addedto the company's capital reserves.

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

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

If the company's finances at this point resembled a house of cards, noone seemed to notice. The state signed off on Elamir's plan, and APPP continuedto operate. By the end of 1997, it had 1,949 doctors, hospitals, and othermedical 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 itsfirst-quarter financial statement for 1998.

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

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

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

This is precisely what the loans did, and the undetected problem gotworse by March 31, 1998. At this point, APPP's real net worth was in facta negative $138,366. The further decline was the result of stillmore fund transfers, including fees to Elamir and his brother Mazhar, alsoa physician, for "consulting services"; reimbursements to Elamir'slimousine and ambulance service for transporting Medicaid patients; andadditional loans to APPP affiliates.

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

By this point, however, the state had retained its own accountant, andwas 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 dueto bad management, faulty data systems, or both, the company was slow tocollect premiums. That led to continuing cash flow deficits.

At the same time, cash flow from Elamir's MRI centers had started todry up, compromising those businesses' ability to bail out APPP, as Elamirhad promised they would. A local newspaper, The Record, reported that severalinsurance companies, including Allstate New Jersey, "cited Elamir andnumerous other defendants in lawsuits alleging that they performed unnecessarymedical 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 transferscontributed to APPP's deteriorating financial condition through the firsthalf of 1998. Still, no one seemed to notice.

Almost no one, that is. In fact, the Department of Human Services andthe Department of Health and Senior Services had begun receiving more-frequentcomplaints about the HMO. Patients angrily reported delays in service, andproviders questioned their growing backlog of unpaid claims. DHS and DHSSalerted the Department of Banking and Insurance about a possible problemat APPP.

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

The picture was bad enough to cause the insurance commissioner, JayneeLaVecchia, to place APPP under administrative supervision on Oct. 15. Thatgave her the legal authority to demand that APPP open its books. When itdid, independent auditors informed department staff that the HMO had underreportedits 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 APPPin its present condition hazardous to its members, providers, and creditors."The complaint asked that Elamir return "inappropriately" transferredfunds and deposit "cash and/or assets" from his MRI facilitiesto APPP, as he had earlier pledged.

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

Two months later, in February 1999, the commissioner submitted the "finalreport of the rehabilitation" to the court. In it, she proposed sellingthe insolvent HMO to Horizon Healthcare of New Jersey. At $193 per memberfor APPP's remaining 23,000 members (thousands had already transferred toother plans), the tab worked out to about $4.4 million. For unpaid providerclaims 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, authorizedthe liquidation of American Preferred Provider Plan. Magdy Elamir's dreamof 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. Onesuch area was the city of Paterson, in Passaic county, where APPP had enrolledmore than half of a large Medicaid population.

Specialists such as Paterson otolaryngologist James LaBagnara took thetoughest blows. According to LaBagnara, he's owed more than $31,000 fromAPPP. "We detected a lag in payments very early," he says. "Wecomplained to the company, and when that didn't work, we alerted all therelevant state agencies. Then Dr. Elamir himself called and said he'd personallymake 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 capitationcontracts, fared somewhat better. The nine doctors at the Paterson CommunityHealth Center, for example, feel lucky to have escaped with a mere $100,000in unpaid fee-for-service charges, some of which they hope to collect. "Wealmost always got our monthly capitation check," says Mary Gardner,the group administrator.

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

"It's hard to believe no one noticed the financial problems APPPwas having," says Alan Zollo, the hospital's vice president for managedcare. He's especially surprised that APPP "could pass the state's financialtests 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 theelevator, the building was in such dilapidated condition. And this was abuilding that had been appraised at $4.2 million. If it was worth a fractionof that amount, I'd be surprised. Yet these were the types of assets APPPused to prove its financial solvency to the state."

Joan Quigley of Franciscan Health System, in Jersey City, levels muchthe 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 hedid." Franciscan is owed a little more than $650,000.

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

Which is just fine with Paul R. Langevin Jr., president of the Trenton-basedNew Jersey Association of Health Plans, who objects to the surcharge thatthe guaranty fund would place on HMO premiums. "This whole thing isnothing more than a payment fund for doctors and hospitals," says Langevin.Consumers and well-managed HMOs, he argues, shouldn't have to pay for thesins of poorly managed health plans.

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

Meanwhile, New Jersey has stiffened its HMO regulations. It now requiresa preoperational audit of a prospective HMO--at the HMO's expense--beforeissuing a certificate of authority. And it mandates that "60 percentof an HMO's admitted assets be in cash, cash equivalents . . . or otherforms of investments acceptable to the commissioner." The new regulationsalso strengthen reporting and monitoring standards, making it less likelya health plan will founder for long, as APPP did, before regulators takenotice.

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

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

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