O'Sullivan: Overhaul vital for insurer

Southern Cross should take a long, hard look at itself, writes FRAN O'SULLIVAN.

Reform is now urgent at Southern Cross - New Zealand's largest health insurer.

The claims processing fiasco has upset a raft of the friendly society's members, medical specialists and private hospital operators.

It has also exposed the organisation's soft underbelly - and it is not a pretty sight.

Everything about the Southern Cross debacle raises questions - in particular, why was chief executive Roger Bowie allowed to spend nearly one-quarter of the $220 million reserves in the June 2001 year (an estimated $48 million although Mr Bowie will not confirm it) to buy competitor Aetna Health NZ - yet not bed down the asset well.

This acquisition was trumpeted as essential so Southern Cross could acquire intellectual property particularly in the IT area - a Diamond computer system, which would enable claims processing times for Southern Cross's own 770,000 clients to be cut, and a 40,000 client book.

But 18 months later, the huge goodwill component to the acquisition looks at risk as it becomes clear that Mr Bowie's management team had not learned the lessons from previous information system fiascos and claims delays of such an order that Southern Cross was forced to apologise to members in its 1999 annual report.

Southern Cross' basic operating performance is acknowledged as "poor" by rating agency Standard & Poor's. S&P gives Southern Cross an AA- credit rating based on its strong financial reserves. But with the 2001 group reserves pumped up to $220 million by the recognition of a $43 million goodwill component, the AA- rating will be at risk if Mr Bowie and his team cannot get the society's underlying financial performance out of the doldrums.

Southern Cross is suffering brand damage as a result of the claims processing issue: the firm was forced to abandon its January deadline for sorting out the mess, saying processing would not be reduced to a claimed three weeks average norm by the end of February.

On some key operational metrics Southern Cross' performance has slipped markedly in recent years - particularly the ballooning administration costs which were "held" at 12.7 per cent in both the June 2000 and June 2001 years (in 1999 they were 11 per cent).

This has seen Southern Cross report underwriting deficits (it has done so previously in expansionary times) although income from its conservatively cash-invested financial reserves had assured the firm's ability to record an overall surplus.

The difficulty for Southern Cross is that its ability to maximise its multimillion-dollar Aetna investment depends on it being able to quickly use the acquired technology for efficiency gains. It also depends on its ability to keep Aetna's clients in the fold along with its own more mobile younger members.

What should concern members is the huge amount of management churn since Mr Bowie was appointed in 1995. Southern Cross was in need of a management shakeup, but the subsequent churn far exceeds the norm for what has been a relationship-based industry.

The situation is not helped by the stance the Court of Appeal took late last year when it allowed Southern Cross to hold onto the Aetna book in face of the Commerce Commission's view that would cement a dominant position.

Allowing an already sluggish player to swallow a nifty junior competitor will not help overall sector efficiency gains.

In this environment the Government should move to axe Southern Cross' tax-free status as a number one priority.

Competitors like Tower Health's Jim Minto should not be shy about lobbying on this score.

The degree of vertical integration Southern Cross has achieved through establishing a network of private hospitals - either owned outright or through an affiliated provider scheme - demands performance at appropriate commercial levels. Members will not get a chance to exert their own influence on chairman Hylton LeGrice and his board until the friendly society's annual general meeting, which usually takes place in October.

But on the agenda of the board's next two-day "strategic planning" workshop should be a thorough examination of the reasons for the debacle, an independent scrutiny of why the project to bed down the Diamond system failed, and the poor and at times arrogant communications which have been employed.

Also on the agenda should be the extent of senior management churn and the persistently poor operating performance which is marring Southern Cross' image.

For seven years the Southern Cross board has been dominated by the personalities of Mr LeGrice and his chief executive.

Mr LeGrice was a member of the board subcommittee which appointed Mr Bowie to his role in 1985 to take the place of long-serving chief executive Peter Smith. His first priority as chairman was to "establish a close and mutually respected day-to-day working relationship with the new CEO - to be both an adviser and a mentor".

Mr LeGrice - Southern Cross' second-longest-serving director - has been on the board since 1984.

Three other directors have each served more than a decade: Mr Smith has been on the Southern Cross board since 1979, serving as chief executive for more than 25 years; Bruce Davidson, a partner in Rudd Watts, which is also Southern Cross's legal adviser (from 1989), and Bryan Kensington, a retired chairman of a national accounting firm (from 1991).

The remaining three directors are clinical haematologist John Matthews (1994), company director Dr Susan Macken (1996) and company director Jeff Todd (1998).

At issue now is whether it is time to bring a few more recent players onto the board - particularly some with a strong operating performance background to counterpoint the largely medical, accounting and legal professional expertise among the existing directors.

Unlike many New Zealand companies - Contact Energy is a case in point - the Southern Cross directors have not been back to the trough and sought huge fee increases in the face of poor operating performance. Fees for the past four years have remained constant at $280,000 in total (June 1998-2001 financial years).

Southern Cross outlines its governance principles in its annual report, and allows members to measure directors' performance by detailing their attendance at board meetings, board committee meetings and the annual general meeting.

But none of this is a substitute for basic operating and financial performance.

Southern Cross has long been the industry leader and a major advocate for change to the health system. It faces external issues - particularly the Government's approach to funding New Zealand's growing health sector demands.

But while Mr LeGrice has used his chairmanship to help steer Southern Cross' push into an integrated health care approach, there are endemic issues that now require a tough-minded approach.

It is time for changes at the top.

nzherald.co.nz/southerncross