Blue Shield Loses Tax-Exempt Status, Comes Under Scrutiny for Care1st Acquisition

Non-profit health insurer Blue Shield of California has come under public scrutiny for its huge cash reserves, history of large rate increases, and lack of disclosure to the taxpayers.  The California Franchise Tax Board punished Blue Shield by stripping the insurer of its tax-exempt status at the end of 2014.  Today, Blue Shield remains controversial.  The company announced in March that it had acquired insurance company Care1st, a health plan with more than 500,000 members, for $1.25 billion.  The deal, if approved by regulators, would mark Blue Shield’s first participation in Medi-Cal.  The news came after a four month struggle between Blue Shield and the public in which the insurer refused to disclose information related to the acquisition.  The Blue Shield case and the government’s response may have important implications for the future of tax-exempt healthcare organizations.

Revoked Tax-Exempt Status

The controversial practice of tax exemptions for profit-making healthcare insurers is coming under fire.  In Blue Shield’s case, its $4.2 billion in reserves, $13.6 billion in annual revenue, and multi-million dollar executive salaries did not sit well with tax authorities.

In its state filings, Blue Shield compared its reserves to two for-profit rivals, Anthem Inc. and Health Net Inc.  Real data suggests the comparison is inadequate.  Even after the Care1st acquisition, Blue Shield’s reserves are projected to be 476% greater than Anthem’s reserves and 535% greater than Health Net’s reserves.  Blue Shield is required by the Department of Managed Health Care (DMHC) to hold a minimum of $290 million in reserves in order to cover claims.  After the acquisition, the company will have 1,012% of the necessary surplus, or roughly $3 billion in reserves.

Blue Shield, California’s third-largest health insurer with 3.4 million members, is protesting the tax board’s decision and said it intends to remain a non-profit, which is a separate matter from tax-exempt status.

Care1st Acquisition and Controversy

Notably, Blue Shield refused to disclose the Care1st purchase price when it announced the deal in December and sought confidentiality from state regulators in late January.  Blue Shield said it did so to honor the terms of its agreement with Care1st, who hoped to keep the price private until the deal closed in the second or third quarter of 2015.

Blue Shield came under fire from many Californians for their secrecy, as many questioned whether the transaction was made to benefit the community, or simply to increase Blue Shield’s profits.  Although many publicly traded health insurers do not immediately disclose the price of certain deals, many consumer advocates argued that a tax-exempt company should not be acting like its for-profit rivals.

Some California lawmakers and consumer groups are trying to coerce Blue Shield to convert into a for-profit company and return its reserves to the state.  They question why, if Blue Shield earned billions of tax-exempt dollars by promising public good without delivering, does it still get to control that money?  Blue Shield’s opponents suggest the money could be used to bolster the state healthcare budget and strengthen programs such as Medi-Cal.

Implications for Tax-Exempt Healthcare Organizations

Blue Shield’s lost tax-exempt status appears to be one in a wave of potential moves by lawmakers and regulators to curb the monetary power of large healthcare organizations that currently enjoy tax exemptions.  Lawmakers in California have recently introduced two bills, SB 346 and AB 1046, that address how hospitals earn tax-exempt status.  SB 346 requires hospitals to allocate 90% of their community benefit funding to charity care and projects helping the most vulnerable Californians.  AB 1046 introduces more subtle changes, as it aims to streamline reporting and make the process more transparent by aligning state and federal community benefits.

The Affordable Care Act (ACA) also presents new challenges to hospital tax exemptions.  The law institutes new requirements on hospitals, intended to improve reporting and transparency.  Under the ACA, hospitals must perform community needs assessments and the IRS must report the amount each hospital spends on benefitting the community.  Further, if the ACA indeed lowers the uninsured rate, it will increase the difficulty of earning tax-exempt status.  Blue Shield went as far as to argue that it is facing unprecedented competition from the likes of Aetna, Cigna, and UnitedHealth Group, which are all growing and offering more choices thanks in part to the ACA and its subsidies to millions of formerly uninsured Americans.

If you have any questions related to health care law, or any other legal inquiries, please contact the attorneys at Carlson & Jayakumar at (949) 222-2008.

Keith W. Carlson & Jehan N. Jayakumar