Blues' tax-exempt loss raises red flag

The belated disclosure that not-for-profit insurer Blue Shield of California lost its tax exemption last summer raises questions of whether other not-for-profit insurers and hospitals may face similar scrutiny of their finances and community-benefit record.

The Los Angeles Times reported last week that the California Franchise Tax Board quietly revoked Blue Shield's tax-exempt status in August, but the announcement was buried in the agency's “revoked exempt organizations list.”

Now lawmakers and consumers groups are pressing for answers on how the decision was handled.

Blue Shield, the third-largest California health insurer by market share, which claims 3.4 million members, has been criticized for extravagant executive pay and poor transparency, as well as higher-than-necessary reserves to pay future claims.

Blue Shield ended 2014 with $4.2 billion in its reserve “stabilization fund.” It pays no state taxes but does pay federal taxes.

The Blue Shield decision “is a significant development and, while speculative, we believe it could be a catalyst for other states to take similar action,” Chris Rigg, an analyst at Susquehanna Financial Group, said in a note to investors.

Rigg, who follows for-profit insurers, added that the decision could also spur Blue Shield to convert to a for-profit entity, “which if followed by others, could in turn drive further industry consolidation.”

A number of not-for-profit Blues insurers converted to for-profit status in the 1990s, including the plans now under the Anthem umbrella. They generally were required to place their assets in charitable foundations as part of their conversions.

California Insurance Commissioner Dave Jones last week said the Franchise Tax Board's decision to terminate Blue Shield's tax-exempt status “confirms what I have said for years—that Blue Shield charges excessive rates and acts like a for-profit health insurer.”

Blue Shield said in a written statement that it believes it still meets the requirements for state income-tax exemption and has challenged the state's ruling. “The decision has no bearing on our ability to continue to meet the needs of our members and community,” the company said. “Regardless of whether we prevail in our dispute, we will continue to fulfill our not-for-profit mission.”

It pointed to its 2011 decision to cap profits at 2% of annual revenue, its charitable foundation and its early support for universal health coverage.

“If they remain a nonprofit, then clearly there's a need for a broad debate for how they are using their reserves and what their contribution is to the community good,” said Sandra Shewry, director of state health policy at the California HealthCare Foundation, which was created when Blue Cross of California converted to a for-profit in 1996.

Not-for-profit insurers contend that their growing reserves are needed for unexpected expenses that go beyond catastrophic claims, such as for information technology and unforeseen changes to healthcare insurance regulations.

Similarly, many large not-for-profit health systems are sitting on growing piles of cash, even as they face requirements under the Affordable Care Act and state laws to demonstrate they are providing enough community benefits, such as charity care, to justify their tax-exempt status. Some local and state officials, as well as Sen. Charles Grassley (R-Iowa), have persistently pressed this issue.

In Pittsburgh, former Mayor Luke Ravenstahl sued healthcare giant UPMC in 2013 to revoke that system's tax-exempt status. The city argued UPMC did not meet the requirements of an “institution of purely public charity” because it did not benefit enough of the city's poorest residents and was overly focused on its bottom line. UPMC countersued. The two sides dropped the legal battle after Pittsburgh swore in a new mayor last year.

In Illinois, Decatur Memorial Hospital, Edward Hospital in Naperville and Northwestern Prentice Women's Hospital in Chicago lost their property tax-exempt status in 2011 based on their low levels of charity care. In Connecticut, a bill was introduced last year that would require not-for-profit hospitals to pay property taxes. That legislation is pending.

Bruce Hopkins, an attorney who represents tax-exempt organizations with the law firm Polsinelli, said hospitals' and insurers' tax exemptions are based on “totally different” rationales.

Large hospitals generally have had more success defending their tax-exempt status through community benefit reports and by setting up separate community foundations.

Hopkins said he is uncertain whether the loss of Blue Shield's tax- exempt status will spill over into the hospital sector. “This (Blue Shield) development is not going to help, but it shouldn't be a direct correlation,” he said.