Legislation & Regulation

California Blues Plan Insists It's Not-for-Profit

Others aren’t so sure. Public hearings demanded as a former executive alleges the insurer hasn’t acted like a not-for-profit.

In a land where storms are rare, Blue Shield of California has found itself in the midst of two of them, and critics are hoping they will serve as a precursor to the type of public scrutiny that other not-for-profit Blues could face.

The first storm struck in August 2014, when the California Franchise Tax Board quietly revoked the state tax exemption for Blue Shield of California (BSC). Then, in December, BSC launched a bid to acquire Care1st Health Plan, a privately owned Los Angeles-based Medicaid and Medicare plan with 520,000 members in three states. Those fronts collided in March, when word of the tax board’s decision leaked out—for seven months it had gone unnoticed—and then a former BSC executive, Michael Johnson, started raising questions about BSC’s not-for-profit status.

Others have piled on since. State Insurance Commissioner Dave Jones said BSC’s tax exemption enabled it to evade $100 million in state taxes annually. Jones and others are questioning BSC’s considerable surplus.

“As a tax-exempt company with a surplus of $4.2 billion, Blue Shield was able to accumulate an enormous amount of money on which it did not pay state taxes by evading the tax on the premiums it collects,” Jones said in a statement.

Meanwhile, BSC spokesman Steve Shivinsky counters that the company did, in fact, pay $392 million in taxes in 2014.

Michael Johnson

Blue Shield of California should use some of its surplus to “subsidize coverage for people in need,” says Michael Johnson, a former BSC executive who’s raised questions about the plan’s business practices.

Johnson, the former BSC director of public policy who went public with his criticisms after leaving the company, says BSC hasn’t lived up to its social welfare commitment as a not-for-profit organization. Legislators in Sacramento, as well as the state Department of Managed Health Care (DMHC), which is reviewing the Care1st bid, have noticed. The department may yet call public hearings on the deal.

But the process is murky. The Los Angeles Times broke the story of BSC losing its tax exemption shortly after Johnson left the company. The tax board has hardly been transparent. When asked why the board pulled the exemption, spokesman Daniel Tahara replied, “I am unable to speak to that as it is not public information.” A tax board spokeswoman told the Times that audits aren’t available for public review.

Julie Silas

Consumers want to know why the California Franchise Tax Board revoked the state tax exemption for Blue Shield of California, says Julie Silas, a senior attorney for Consumers Union.

As consumer groups and legislators push for public hearings on the Care1st acquisition, they would like to know the rationale behind the tax board’s decision. Julie Silas, a senior attorney for Consumers Union, the policy arm of Consumer Reports, asks, “Does that same thought pattern that was used by the Franchise Tax Board to make its decision have an implication on the not-for-profit status of Blue Shield of California?”

The tax board revoked Blue Shield of California’s exemption from state taxes, not its not-for-profit status per se, notes Shivinsky, and the company intends to continue operating as a not-for-profit. “The possible loss of state income tax exemption in no way threatens Blue Shield’s not-for-profit status,” he insists.

Exemption a holdover from the ’80s

BSC and other not-for-profit Blues were 501(c)(4) tax-exempt entities under the Internal Revenue Service code until the 1980s, when Congress—bowing to lobbying from for-profit insurers—removed most of the federal tax exemptions the Blues had. Originally, all Blues were not-for-profit, but that started to change in the 1990s when Blue Cross of California and what today is Anthem, among other Blues, started to convert to for-profit companies. For the Blues that retained their not-for-profit status with the IRS—now known as 501(m) entities—states have honored their previous 501(c)(4) filings and granted exemptions for state tax purposes.

So what are a not-for-profit’s “social welfare” obligations? Don’t look to the IRS for an answer, as Henry J. Aaron of the Brookings Institution notes; 501(c)(4) organizations also include political action committees. “Given that some of the most egregious examples of political activism by people who do not want to divulge their names occur through 501(c)(4)s, it seems that there are precious few standards. The very idea that there might be some [standards] got officials at the IRS in a bunch of trouble,” Aaron has written.

BSC maintains it is entitled to the exemption and will appeal the tax board’s decision. Its defense will uphold the Care1st purchase as an example of its public commitment.

Shivinsky says that having Care1st will enable BSC to serve more Californians by giving it an entry into Medi-Cal, the name for Medicaid in the state. “Blue Shield has been criticized for not being in the Medi-Cal business, but entering the Medicaid market is quite difficult,” he says. More than a third of all Californians are covered by Medi-Cal.

Embarrassment of riches?

The capital for that Care1st acquisition, with a winning bid of $1.5 billion, comes from BSC’s $4.2 billion surplus. Silas at Consumers Union says the surplus far exceeds the state minimum and Blue Cross Blue Shield Association guidelines. In her view, BSC amassed that surplus trading on the goodwill of the Blue Shield name while not paying all the state taxes a for-profit plan pays.

Johnson, the ex-BSC employee, wants to see his former employer do more for the state with that surplus: “I wouldn’t want to prescribe what that should be, but it could be things like, instead of spending [$1.5] billion to increase market share, to use that money to subsidize coverage for people in need, or providing access to insurance in rural parts of the state that the for-profit companies aren’t serving.”

Providing coverage to people in need is precisely the idea behind acquiring Care1st, counters BSC’s Shivinsky. After the Care1st acquisition, the BSC surplus will drop to around $3 billion—a level that independent actuaries confirm is needed to maintain an “A” financial rating; that’s a rating that is necessary to insure large employers across the state as well as the huge California Public Employees’ Retirement System, according to Shivinsky. “A minimum level in a savings account is not something that we think would be financially prudent for a company that’s covering over 3 million Californians,” he adds.

Another defense BSC might use for its tax exemption is the $325 million it has funneled into its own charitable foundation in the past decade along with its net income cap of 2% of revenues. That cap resulted in $560 million in refunds to members and community contributions last year and $392 million in taxes paid in 2014, most of them federal but also $39 million in state franchise taxes because of the loss of its exemption, according to Shivinsky.

Consumer groups have questioned BSC’s spending on other things, including executive pay. The Los Angeles Times reported that BSC did not list any executives by name in its state filing for 2012, only saying its top three officials each made more than $1 million a year. Also raising eyebrows: The company’s contribution of $10 million in 2014 to defeat a ballot measure that would have regulated insurance rates and its expenditure of $2.5 million (Shivinsky noted that it was over 10 years) for a luxury box at the new stadium for the 49ers.

Johnson is marshaling his forces. He’s started an online petition at Change.org demanding that BSC disburse its profits to improve access to health care. He’s advocating a model along the lines of Blue Cross of California’s conversion to a for-profit entity in the 1990s, when two foundations, the California Healthcare Foundation and the California Endowment, received $3 billion in proceeds from the conversion to fund their endowments. The foundations aim to expand access to care for disadvantaged Californians. Johnson says if the Care1st sale is a yardstick, BSC would be worth about $10 billion in such a conversion. (Shivinsky calls this Johnson’s “guesstimate ... that no one has attempted to validate.”)

Public hearings on the Care1st acquisition may give Johnson and others a chance to have their say, but they will also give BSC a platform from which to stage its defense with one mystery lingering in the background: Why exactly has BSC found itself in this position, fighting to regain its state tax exemption?


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