Healthcare Management set up shop during a unique moment in history. It started managing poor people's care when state officials were not controlling profits and few knew how much money could be made from the Medicaid system, according to interviews with regulators, auditors and industry experts.

As early as in 1991, federal auditors were warning the state that Healthcare Management was in ``imminent danger'' of becoming ``a cash cow.''

By the end of 1995, when the firm's profits had become a clear trend in the eyes of state treasury auditors, they called the Pennsylvania Department of Public Welfare's oversight lax and ``inexcusable.''

Peg Dierkers, Welfare's policy director, acknowledged that the agency failed to limit profits for Healthcare Management and other Medicaid HMOs.

Even so, Dierkers said, the state is saving millions by placing the poor in HMOs. In the past, welfare recipients could go to individual doctors who accepted Medicaid patients and the medical bills were much higher.

Last year, she said, the Welfare Department moved to control profits by cutting premiums paid to HMOs statewide and forcing them to provide the same coverage for less cost. The move saved taxpayers $76 million, Dierkers said.

Those rate cuts have also helped push Healthcare Management into the red. The company reported a $1.8 million pretax loss in the first quarter of 1997.

Dierkers said she was not surprised that Healthcare Management and three other HMOs serving the poor in the Philadelphia region each posted first-quarter losses this year. She said that could change. She attributed the losses to start-up costs as managed-care companies adjust to a new state mandate that they enroll all welfare recipients.

In the interview, Welters said the rate cuts had hurt but added: ``We're not going to lose money forever.''

Until this year, Healthcare Management has been an industry leader in profits. Excluding management fees, the company's own numbers - in records filed with the state Department of Insurance - show that it was the state's most profitable HMO over the two-year period of 1995 and 1996. The firm paid no bonuses during those years.

The company's reported profit rate of 5.4 percent over 1995 and 1996 outpaced such industry giants as U.S. Healthcare, whose profit margin in Pennsylvania was 1.8 percent in that period.

Two years ago, Healthcare Management's financially attractive ledger enabled its owners to sell about one-third of the parent company to private investors, led by the CNA insurance company of Chicago and a General Motors pension fund, according to state records. General Motors alone paid $24 million for a 7.5 percent stake in the company, according to Internal Revenue Service public records. Welters and Lomax declined to discuss the sale.

Mercy Health Plan generated $50 million in pretax profits and fees from 1990 through 1993, the state Treasury Department said in a 1995 report that also criticized the Welfare Department's oversight.

In all, the HMO, now known as Keystone Mercy Health Plan, produced $88 million in profits and fees since 1990 - a 7.2 percent annual return, according to a report by the Treasury Department and a review of other records by The Inquirer.

A spokeswoman for Keystone Mercy said the company declined to comment. In a 1993 Inquirer article, Mercy officials said they were offering the poor better health care while saving the state money.

The Keystone Mercy HMO - half-owned by Independence Blue Cross - was outperformed during that period by Healthcare Management, which earned an 8.4 percent return, state records show.

Such earnings by Medicaid HMOs anger advocates for the poor, who feel that profits from Medicaid should be capped until recipients' health is improved.

``As a taxpayer and a health advocate for low-income children, it makes me sick,'' said Ann Torregrossa, who heads the Pennsylvania Health Law Project. ``The money should be going to health care for the poor.''

``We had long been saying, from the beginning, that there should have been a cap on [HMO] profits because this is a public-program area where there's a large number of unmet needs,'' said attorney Richard Weishaupt, who specializes in health care for Community Legal Services.

Healthcare Management has maintained that it provides quality care to the poor. In the interview, Welters and Lomax said the firm made many innovations and was the first to put a health clinic inside a public middle school.

Advocates for Medicaid patients who have reviewed HMO health-care data say none of the four welfare HMOs in Philadelphia is providing enough care.

Healthcare Management - the third-largest Medicaid HMO in the five-county Philadelphia region, with 68,519 members - had the highest number of welfare clients opting to leave its plan in the first six months of this year, state records show. The firm lost 4,729 members.

Welters attributed the losses to start-up problems from the state's new plan placing all Philadelphia-area Medicaid recipients into managed care.

Andrew Wigglesworth, president of the Delaware Valley Healthcare Council, said one way for HMOs to make money is by not paying for patients' hospital stays after the care has been given - a practice known as ``denying days.''

A study by the Healthcare Council of seven Philadelphia HMOs found that in October 1994, Healthcare Management initially refused to pay 24 percent of days billed by hospitals - a rate three times greater than the next closest insurer's.

Healthcare Management officials contended that the hospital trade group's study was unfair because the HMO is not always notified when its Medicaid clients are treated in emergency rooms and hospitals. Wigglesworth said Healthcare Management has been trying to improve its procedures, but, he said, doctors and hospitals are still complaining that they are not receiving some payments from Healthcare Management.

Another way for HMOs to make gains is to pay bills slowly, Wigglesworth said. Healthcare Management's payment systems often did not pay bills on time, former employees said.

Their accounts are backed up by public audits. The state Insurance Department, which regulates HMOs, randomly selected a group of Healthcare Management's claims during a review in May 1995 and reported that the company paid 60 percent of doctor bills after the required payment period of 30 days.

``Company officials confirmed our finding,'' the report said. ``It was a business decision'' to pay some claims late, and the company ``agreed to implement internal controls'' to pay medical bills faster.

The company's late-payment problems continued before and after the Insurance Department's review. The Welfare Department has cited Healthcare Management for violations involving late payments and assessed a total of $745,000 in penalties since 1991, including $123,000 in penalties this year.

Welters said the department's on-time requirements are difficult to meet. Computer glitches had slowed payments this year, he said. Those problems have been fixed, he said.

The question of whether Healthcare Management pays all of its bills attracted the attention of the Pennsylvania Attorney General's Office, which has been conducting an investigation over the last 18 months, according to former employees who were interviewed.

A state grand jury has been asking whether the company refused to pay large bills from hospitals and doctors who treated Healthcare Management's clients, according to two officials close to the investigation. When the probe was first reported last October, a company spokesman denied any wrongdoing. In the interview last week, Welters and Lomax added that they had never been contacted by the Attorney General's Office and that they had no knowledge of such an inquiry.

Five companies submitted bids in 1989 for the Welfare Department contract to cover Medicaid recipients in South and West Philadelphia. Healthcare Management's bid was the lowest, but the Welfare Department ranked the firm last among the five, largely because it had no experience and lacked capital, according to a federal review.

John F. White Jr., then Welfare secretary, asked another committee in the department to reevaluate the bids - because, he said, Healthcare Management was not treated fairly in the first review. That committee ranked the firm second. White then awarded the $750 million contract - at the time the largest of any kind in state history - to Healthcare Management.

White said at the time of the award that the department chose Healthcare Management because it was the lowest bidder.

Within months, the U.S. Department of Health and Human Services sued the state Welfare Department, citing ``the appearance of favoritism in this contract award.''

To settle the suit, the state agency rebid the contract in 1991. After the rebidding, the agency again selected Healthcare Management because it was the low bidder.

As the contract recipient, the company had several advantages.

Those who failed to choose a health insurer were automatically assigned to Healthcare Management if they lived within its service area in South and West Philadelphia. No other HMO received referrals in that manner. Also, in its early years, Healthcare Management was the only firm allowed to solicit customers at tables set up inside welfare offices.

The company quickly became a financial success.

In 1991 and 1992, federal and state regulators concluded that the company was making large profits and understating them in its financial reports. The auditors said the company reduced the profits it reported by subtracting bonuses, management fees and loan guarantees and listing those items as expenses.

``In our opinion, the recorded net earnings are extremely misleading and completely overlook the vast sums made by HMA's owners, directors and affiliated companies from the HealthPass contract,'' a 1991 federal report said.

A federal audit the next year said: ``We are not implying that by earning this amount, HMA, its owners/directors, and its affiliated companies violated any of the terms of the HealthPass contracts, committed any other types of violations, or underserved HealthPass clients.'' The report said the state should act to reduce Healthcare Management's profits.

Besides bonuses and management fees, federal auditors identified ``loan guarantees'' as another way owners were making money in the early years.

The company granted a Welters family-owned affiliate 30 percent of all profits over three years in exchange for co-signing bank credit for Healthcare Management in its early years, according to auditors. Under that arrangement, the affiliate ended up being paid a total of $12.7 million over three years for co-signing a $3 million line of credit, a federal review said.

Welters said he would have lost heavily if Healthcare Management had failed. The new venture was so risky that Lomax said he chose not to put his personal wealth on the line. In retrospect, he said, ``I wish I had participated in it'' because of the payback.

The auditors concluded that after adding back bonuses and other fees, Healthcare Management generated $16.6 million in earnings in its first 28 months of operation - more than twice what the firm had reported as profits.

The year 1994 was an even better one for Healthcare Management. Besides paying $4.59 million in management fees to affiliates, the company granted its four founders $13.9 million in bonuses, according to state audits. Their salaries were not listed publicly.

Those bonuses marked the high point, but they were not unusual. From 1990 to 1994, Healthcare Management paid $26.8 million in corporate bonuses to its four founders. Welters, the firm's top executive, received a total of $9.3 million, records show. Board vice chairman Lomax was granted $8.2 million during that four-year period, while board secretary Edgar G. Rios and treasurer Jess E. Sweely each was given nearly $4.7 million.

Healthcare Management claimed income of $9.3 million in 1994 - or 4.2 percent of revenues. State Treasury auditors said the firm's reported numbers were understated and called its real profits ``exorbitant.'' They said by adding the executive bonuses and management fees, the income was actually $27.8 million - a 12.6 percent profit rate. That margin was nearly triple the average for the state's profitable HMOs, Treasury auditors said.

Welters said Treasury's analysis was flawed. He said the firm's record keeping had been approved by the accounting firm Deloitte & Touche.

``We were the whipping boy between two gladiators,'' Welters added, referring to the state Treasury and Welfare Departments.

State agencies generally do not criticize one another. Then-Pennsylvania Treasurer Catherine Baker Knoll, a Democrat, was elected and served alongside the Democratic administration of then-Gov. Robert P. Casey Jr. Knoll's auditors repeatedly criticized the Welfare Department for poor oversight of Medicaid HMO contracts.

``I was truly appalled,'' Knoll said of Healthcare Management's profits in an interview before her term expired last January. ``I think everyone is entitled to a fair return. This was out of control.''

In a 1994 report of the Healthcare Management contracts, Knoll's auditors said the Welfare Department ``should have been aware of the trend of excessive profits and shell transactions'' with affiliates by Healthcare Management.

``Treasury feels a return of 7,600 percent [on a $200,000 investment] and profits three times the average on taxpayer dollars is excessive,'' the report added.

The firm stopped paying guarantee fees in 1991. Healthcare Management continues to pay management fees.

The Treasury auditors also criticized this practice. Management fees are paid when one company does work for another. The auditors said Healthcare Management ``could not provide a description of the services they received for the $4.59 million management fee'' paid to affiliates in 1994.

The Treasury audit also said the company was unable to show that its management fees were reasonable costs reflecting the going rate in the market.

The Department of Welfare levied a penalty of $4,390 against Healthcare Management for failing to get advance contract approval for paying management fees.

Welters said the penalty was unfair because state officials were apprised in the firm's early years that the management fees were for legitimate work, such as hiring, data processing and legal work.

``What I'm saying is that services were clearly rendered,'' Welters said in the interview. ``No question about it.''

In 1995, the firm sought to more than double its management fees to $10 million. The state Insurance Department subsequently cut the firm's request by 60 percent. The agency allowed Healthcare Management to pay $3.8 million in management fees to its parent last year.

``I grew up in a family of asthmatics,'' he said. ``I understand what it is to get up in the middle of the night to run to the emergency room with a bunch of kids because your mother is under the tent.''

He said the welfare system provided abysmal care to his family when he was a child.

The 42-year-old lawyer now lives in a $1.75 million house in McLean, Va., a suburb of Washington. He socializes with prominent people, including President George Bush's former Health and Human Services secretary, Louis Sullivan. Supreme Court Justice Clarence Thomas is godfather to one of Welters' children.

A Republican activist, Welters has spent his adult life working for the government and, later, running companies with federal and state contracts.

He managed the New York state offices for the late Sen. Jacob Javits, was an Amtrak vice president, and served as an associate deputy transportation secretary in the Reagan administration from 1983 to 1985.

Welters also is a leading contributor to political campaigns. He gave two reasons: Welters said he wants to encourage African Americans to succeed in politics. He also said that, as a businessman, he understood the value of making contributions.

``When you come to the table, it makes a difference,'' he said.

As a member of the Governor's Club Board of Directors, he gave $20,000 to Gov. Ridge's 1998 reelection campaign and has pledged $30,000 more.

Welters and his wife, Beatrice, have given a total of $28,000 over the last two years to congressional and senatorial candidates and to party organizations, generally in states where Welters does business, campaign finance records show.

Lomax, 65, and his family gave $35,500 to candidates for federal office in the last two years, records show.

``I'm an ideological contributor,'' said Lomax. He said he gives to candidates who look out for ``human rights and poor people.'' He added: ``Ninety-nine percent of my candidates lose.''

Their other partners, Rios and Sweely and relatives gave $17,500 during the same period, according to records.

A spokesman for Healthcare Management said Welters spoke in behalf of Rios and Sweely, both of whom declined requests for interviews.

Sweely, 59, is an accountant and former real estate broker who joined another Welters family company, Atlantic Systems Inc., in 1988. Rios, 45, is a lawyer and a longtime Welters friend from New York City who worked for the IRS and in private practice.

The four men and their families own most of Healthcare Management's parent company, AmeriChoice, of Vienna, Va., which operates a Medicaid HMO in New York and which last month paid $19.5 million for a Medicaid HMO formerly owned by the State of New Jersey. The firm is now seeking to open a Medicaid HMO in Atlanta.

The company has spent heavily on consultants. Last year, Healthcare Management paid $1.2 million for various experts, including WHAT-AM talk show host Mary Mason, to represent the company in the community. Mason declined to discuss how much she is paid now, but in 1995, she described her pay as more than $300,000 a year.

Welters said Mason serves the same role for Healthcare Management as former Philadelphia Eagles coach Dick Vermeil does for Independence Blue Cross.

``We want to embrace the community we serve with people they respect,'' Welters said.

Healthcare Management has also spent thousands of dollars on travel and hotel expenses.

Last year, the company spent far more than any other Medicaid HMO in the Philadelphia region on travel and conferences. It spent $556,169.

As early as in 1989, the company spent $30,029 for rooms over eight days at Hotel Atop the Bellevue, according to a federal audit.

Welters said the week at the Bellevue was needed to gather 35 employees and executives to launch operations.

Records show that the firm also sent five executives and their wives to London in the summer of 1990 to host a Healthcare Management reception for Lloyd's of London, which was providing the firm insurance. Welters, Sweely and Rios then flew on to Hong Kong to meet with the firm brokering the insurance. The airfare alone was $39,963. The executives received an additional $35,670 in travel advances, company records show.

In the last three years, company meetings have been held at such Florida resorts as the Beach Club in Boca Raton and the Breakers in Palm Beach, former employees said.