The case against Blue Shield of California's tax-exempt status is growing, presenting an additional $40 million to the tax bill, but also the possibility of more drastic state action.
The heat is on this summer for Blue Shield of California, the state's third largest insurer. As the 76-year-old nonprofit company looks to complete a $1.2 billion acquisition to enter California's Medicaid market, its identity as a nonprofit company is being challenged.
In an audit last year, the California Franchise Tax Board concluded that Blue Shield of California was hard to differentiate from its for-profit competitors and should, at the least, be paying state income taxes--including back taxes for 2014 and 2015.
"Blue Shield is not operating exclusively for the promotion of civic betterment or social welfare," one of the key metrics for California's tax exemption, the Board concluded in a previously-sealed report last June that was accessed by the Los Angeles Times.
"These stated objectives, particularly those which stress profitability, are inconsistent with an organization organized as a nonprofit which desires tax-exempt status," the California Franchise Tax Board wrote, the LA Times reported.
"We assert that the extraordinarily high surpluses set aside as reserves by Blue Shield are not kept for the purposes of stabilizing the organization but rather for the commercial purpose of increasing competitiveness," the Board wrote, noting the near-doubling of Blue Shield's capital reserves from $2.26 billion in 2006 to $4.15 billion in 2012. "We observed that Blue Shield far exceeded the reserves required either by law or the best practices and standards of the healthcare industry."
The Board also concluded that Blue Shield's 2 percent pledge--limiting profits to 2 percent of revenue and returning surpluses to members--can't justify the tax exemption, in part because much of the refunds have gone to employers rather than the actual members in group and individual plans.
Michael Johnson, a former Blue Shield public affairs director who resigned in protest, argues that the audit is grounds for the California Department of Managed Health Care to launch a "full scale investigation" of the nonprofit insurer and consider turning over some of its assets to the public good.
Johnson jointed Blue Shield in 2003, drawn to a progressive stance on healthcare reform, but over the years he became "more and more frustrated" by the company's resemblance with the rest of the industry--premium hikes, health plan rescissions, seven-figure executive salaries.
"The public has a lot at stake here," Johnson wrote in reaction to the audit's findings in the LA Times. "Blue Shield has vowed since its founding to operate for community benefit, and because of that, reaped taxpayer subsidies for over 70 years. As a result, the company, which is worth approximately $10 billion, belongs to the community."
Johnson argues that Blue Shield should convert into a tax-paying, for-profit insurer and turn over an endowment to the public, as Anthem Blue Cross did in 1996.
The California Department Managed Health Care has the authority to investigate the company, and to ensure that "the public gets the value it deserves from the $10 billion in community assets that Blue Shield represents," Johnson said. The agency is already examining Blue Shield's proposed Care1st Health Plan acquisition, and said plans to include a review of the company's "charitable trust" duties, which remain legally murky and contested.
At a recent hearing, Blue Shield CEO Paul Markovich told the DMHC that "if the company ceases to do business and dissolves, any money that remains after the repayment of debts would be distributed to members," according to its bylaws. "That's what we've told everybody, consistently, because it's true."
Yet, in other areas, Blue Shield representatives have made a slightly different arguments about the nature of its assets, as Johnson, the LA Times and other observers noted.
In a December 2013 letter to the California Franchise Tax Board, Blue Shield's outside lawyers wrote that under federal law, it seems "abundantly clear that Blue Shield would be prohibited from making distributions upon dissolution to anyone or any entity other than another [nonprofit] and most certainly not to its contracted physicians or members."
In more recent a letter to the DMHC, Blue Shield vice president and general counsel Seth Jacobs argued that Blue Shield is a "social welfare organization," but not a charity with charitable assets.
"Blue Shield is a nonprofit corporation that is not a charity, is not a public benefit corporation, and is a full federal taxpayer that has been exempt from state franchise tax as a 'social welfare organization,'" Jacobs wrote. "In fact, under California law, Blue Shield could not hold all of its assets in charitable trust because, if it did, it could not have incorporated or lawfully maintained its existence."
Not every nonprofit corporation is a charity, he continued. "Mutual benefits are typically created for the benefit of the corporation's members. Examples of some large mutual benefits include the Academy of Motion Picture Arts and Sciences, the California Dental Association, the California Teachers Association, and the Olympic Club. Many homeowners' associations are mutual benefits."
Johnson argues that the DMHC has the authority to "investigate a nonprofit health plan for failure to meet its community benefit obligations and to take legal action to force it into compliance." Blue Shield, Johnson argues, "should be returning to the community at least $500 million a year in benefits, and the DMHC "should postpone consideration of the proposed acquisition until it can assure the public that Blue Shield is doing its full duty as a nonprofit.
Blue Shield is appealing the Franchise Tax Board's decision, which would see it paying around $40 million in state income taxes annually, but would still remain a nonprofit. "Blue Shield is not motivated by a mission to serve shareholders, but to provide Californians with affordable healthcare," Steve Shivinsky, vice president of corporate communications, said in May.
But Blue Shield may end up not being alone in paying state taxes, if some advocates have their way. The decision by the California Franchise Tax Board to end Blue Shield's exemption has left some wondering if other nonprofit healthcare organizations with billions in revenue and lavishly-paid non-clinical executives should also be taxed.
"The findings of the Blue Shield audit raise a lot of questions about Kaiser, Dignity, Sutter and others," said Carmen Balber, executive director of the California-based Consumer Watchdog. "Do they fail to meet the same benchmarks? At a glance, Kaiser suffers from exactly the same problems: astronomic reserves, huge executive salaries and little public benefit as consumers continue to pay sky high premiums. Each of these so-called nonprofits needs the scrutiny of a public audit, and to return money to consumers if they haven't met their public benefit obligations."