They say you should never accept the first offer an insurance company makes you. Gary Mendoza didn't, and as a result, the state of California is $3 billion richer.
WellPoint, California's Blue Cross and Blue Shield plan, decided a few years ago that it was time to become a for-profit company. When a nonprofit makes such a switch, it's supposed to turn its current economic value over to the state, so the original charitable mission can be continued. WellPoint offered to make charitable donations totaling $100 million. Mendoza, who had to approve the conversion as the state's Commissioner of Corporations, balked. He said the offer was in no way commensurate with the value the company had accrued through its original charitable status. In the end, after a marathon political fight that consumed virtually all of Mendoza's three-year tenure in office, WellPoint anted up its full market value: $3.2 billion.
It was neither Mendoza's charm nor hardball negotiating that brought in all that money. In large part, it was a series of corporate political mistakes. WellPoint had insulted a key legislative leader by claiming he didn't understand the complexities of the market when he wrote a bill to impose strict financial accountability on board members of nonprofits. Then the company irked Governor Pete Wilson by showing reluctance to join a small group-insurance purchasing pool that Wilson was promoting. But aside from these political mistakes, the law was on Mendoza's side.
The bottom line is that California is now home to two new health care foundations with endowments totaling more than $4 billion. In their first few years of existence, the foundations have already distributed more than $600 million worth of grants to clinics and other practitioners around the state.
"The fact that you had assets that ended up at $3.2 billion says a lot about the inherent veracity of the Blue Cross Blue Shield executives," says Phil Isenberg, who chaired the California Assembly's Judiciary Committee at the time of the negotiations. "It was just preposterous that they would be entitled to the money."
WellPoint doesn't quite put things that way. "I believe what happened here," says the company's general counsel, Tom Gaiser, "was the charitable interests were the beneficiaries of our good performance."
Not all taxpayers have been so lucky as those in California. Nevada's Blues were bought out in 1996 by their sisters in Colorado. Regulators in Nevada--including an insurance commissioner who had been a Blue Cross employee--neglected to value the plan before its charitable assets were transferred across the state border. Nevada and its Blue Cross subscribers then had no right to any assets that belonged to the plan at the time of the Colorado plan's conversion to for-profit status. All Nevada ever got was $1.5 million for a new children's health foundation--a tiny fraction of the actual charitable value.
A similar dynamic may play out in the mid-Atlantic region in the coming months. CareFirst, the Blue Cross and Blue Shield plan of Maryland, is laying the groundwork to become a for-profit company or sell out to one. Maryland already has a health foundation in place to hold the state's likely windfall. But no one from the District of Columbia, whose Blues plan merged with CareFirst in 1998, will have an official place at the table to bargain for Washington's fair share.
Many states have grappled with their local Blue Cross Blue Shield plans in the years since 1994, when the Blues' national association changed its rules to allow its member organizations to be owned by for-profit companies. There has been a stampede of Blues plans selling out, merging or simply becoming for-profits in their own right.
Some states have legal language on the books specifying that charitable assets revert to the state treasury when a nonprofit changes its status, but in all states, protection of charitable assets is understood to be implicit in common law. In Ohio, the rule protecting such assets for the public good dates back to 1852. But in much of the country, state regulators have been slow to recognize the policy implications of the sudden shift in the world of Blue Cross. Also, different state departments can work at cross purposes. The attorney general's office may decide to take on the role of preserving assets for the good of the public, but the insurance commissioner's primary concern may be to safeguard the solvency of the new for-profit insurance company. That might suggest a smaller transfer of charitable assets, or even none at all.
Legally, any new for-profit Blue Cross plan is supposed to start fresh, with a base of customers but without its previously accumulated wealth. In practice, though, some Blues plans have been able to relaunch on a profit-making basis with a good chunk of their old "charitable assets" safely stored in the corporate kitty. A portion of the money has found its way into multimillion-dollar bonuses for company executives, helping opponents seize the populist ground. "Any money that doesn't go to public foundations, as the law mandates," charges A.G. Newmyer III, chairman of the Fair Care Foundation, a patient advocacy group, "is routinely used by Blues execs to pad their compensation and stock-option programs."
The Blues have worked hard to maintain control of their funds, writing favorable provisions into bills during the closing hours of legislative sessions, contributing generously to gubernatorial and state legislative campaigns, and running advertisements against attorneys general who have fought them on the issue. At the same time, however, activist groups such as Consumers Union and Community Catalyst have sought to discredit these moves as corporate greed. This has had its effect. Over the past couple of years, states have cut fewer sweetheart deals.
The national associations of attorneys general and insurance commissioners have drafted model legislation and provided guidance to states suddenly faced with the Blues transfer issue. "I think they have done a very good job in getting up to speed to meet this onslaught of Blue Cross conversions, but there are still a number of states where it's legitimate to question whether the full value of the nonprofit entity is being paid back to the public," says Linda Miller, president of Volunteer Trustees Foundation, a consortium of hospital governing boards.
The idea that the state has authority over the value of a private charitable enterprise is based on the legal doctrine of "cy pres," a Norman French phrase meaning "as close as possible." Common law holds that if a charitable organization changes its function or tax status, its assets must be used for a purpose as close as possible to the original one.
Blue Cross Blue Shield plans were founded during the 1930s by doctors and hospitals and granted charitable charters at the state level. In their earliest manifestation, they insured anyone who desired coverage, regardless of health status, using community ratings to set uniform premium rates for any local resident who signed up. (They are now the insurer of last resort only in Michigan.) In exchange for this community-service mission, the plans have long enjoyed tax breaks and special regulatory treatment. Hospital rate regulation in New York, for example, used to allow the Blues to pay the lowest reimbursement rates possible.
Over the years, however, these companies have increasingly come to resemble other health insurance providers, trying to attract the healthiest individuals and vying with managed care and other plans to offer the cheapest rates. "Once the commercials and managed care companies got very aggressive in the health insurance market," says Sylvia A. Law, a Columbia University law professor and author of a book on Blue Cross Blue Shield, "it became impossible for the Blues to compete unless they became like the rest of the market. It's reality and it's kind of tragic. They performed an important community service, albeit imperfectly, for a long time."
There are a total of 45 Blues plans today, insuring a total of 80 million Americans. That is down from 110 separate plans in 1982 and 62 just a couple of years ago. Enrollment in Blue Cross plans is actually increasing, but making money in health insurance is an elusive goal these days. The Blues overall generated a modest 0.8 percent profit margin in 1999, compared with a 2.5 percent profit margin for publicly traded Blues plans, all of which are for-profit. This has stepped up the pressure to consolidate and become for-profit in hopes of gathering more capital to compete with bigger rivals. "I'm not saying this will happen to every plan, but given the environment, we expect there will be more mergers of all kinds and more conversions to for- profit status," says Samuel Levitt, author of a study on Blues solvency for Conning & Co.
As the Blues sell out and change status, the question of just who owns a non-profit company has been one of the major stumbling blocks in regulating the conversion process. Trust law and the "cy pres" doctrine leave a lot of wiggle room for interpreting the proper stewardship of charitable assets. The insurers have managed in many cases to blur the issue further by setting up holding companies and subsidiaries or switching to a "mutual" form of ownership (meaning the plans are technically owned by policyholders).
Most state laws do not clarify exactly how the conversion process should work. Legislatures have the option of writing such provisions, but that can be a complex and rather circuitous process. North Carolina, for example, enacted a law during the Depression that confirmed the charitable status of Blue Cross Blue Shield in that state, but left hazy the question of what would happen to the charitable assets if the Blues plans ever converted. Four years ago, Blue Cross and Blue Shield of North Carolina sought to clear the matter up. They hired as their chief lobbyist a former top legislative aide to the governor. With his help, they secured consideration of a complicated bill allowing the company to convert to for-profit status without providing any payback to the state.
Before it could become law, however, the state's public health lobby succeeded in shining a spotlight on the process, delaying the bill long enough to elicit opposition from the nonprofit and foundation communities and arousing the interest of the attorney general and insurance commissioner. The legislature placed a moratorium on Blues conversion while a commission studied the issue. The bill that eventually passed the legislature required the Blues to turn over their full value to a foundation dedicated to the public health.
Consumer groups have tried to win passage of such laws in other places prior to conversion but generally have not had much success. Some states have just taken what they were offered, without any public hearing or audit process to determine the true market value of the insurance companies. In Wisconsin, for example, the Blues gave $250 million to the state's two largest medical schools, rather than creating independent foundations to make grants for the public health, as had happened elsewhere. Blue Cross Blue Shield United of Wisconsin secured early backing for this donation from the governor and attorney general, who appeared with company officials at a news conference, sealing the deal. In Virginia, the attorney general negotiated a $175 million payoff from Trigon Blue Cross Blue Shield, which the commonwealth deposited in its general fund, applying the money to debt relief.
Colorado is the rare example of a state that passed legislation ahead of time. The law made clear that the plan's charitable assets would be put to work for the commonweal, with a foundation, Caring for Colorado, to be established for that purpose. Blue Cross and Blue Shield of Colorado then began to move down the road toward for-profit status. Because the plans were struggling financially, though, their managers decided to put them up for sale, cutting a deal with Anthem Inc. This move short-circuited a hearing process that was under way to determine the full market value of the Colorado Blues.
Instead, the state began negotiating with Anthem, which opened the bidding with a pledge of $100 million to Caring for Colorado. As WellPoint and other suitors began to express interest in the Colorado plans, Anthem raised its offer, eventually matching another company's bid of $155 million. Jack Ehnes, the state's former insurance commissioner, says that free-market bidding probably offers a better real-world assessment of a company's value than any hearings or theoretical audit. But the price of the Colorado Blues was almost certainly deflated because Anthem had already negotiated a contract that included hefty fees the Blues plan would have to pay Anthem if it were to pull out of the deal, which ultimately dissuaded other potential buyers.
Several states that initially granted the Blues permission to convert without securing their charitable assets have managed to take a second look--and had their second opinions prevail in court. The St. Louis- based Blue Cross and Blue Shield of Missouri, for instance, was allowed to restructure and put about 80 percent of its business into a for-profit subsidiary. Insurance regulators later realized they'd let the plan's charitable assets slip away and sought to recover them. BCBSMO, in response, sued both the insurance commissioner and the attorney general. It lost. An out-of-court settlement led to the establishment of a health foundation that received company stock now worth about $400 million.
Across the state in Kansas City, a separate Blues plan filed a petition against the attorney general claiming never to have been a charity in the first place. A state court ruled that the plan had, in fact, taken advantage of tax breaks and other privileges as a charity for more than 50 years, and Missouri's appellate court upheld a ruling ensuring that the Kansas City plan's charitable assets will be turned over to the state if it ever does go public.
"In a strictly for-profit world, these sorts of combinations, be they joint ventures or stock purchases, would be appropriate," says Craig Mayton, Ohio's assistant attorney general. "But within the charitable context, you can't ignore history. These were originally founded as charitable and benevolent associations, they enjoyed tax breaks, their foundational capital came from the charitable world, and they acted as agents for charitable entities."
In Georgia, a consortium of nine consumer groups went to court to fight the state insurance commissioner's approval of a for-profit switch before the attorney general could assess the value of the Atlanta plan's charitable assets. The challengers won a settlement estimated at $70 million. In Connecticut, the attorney general recused his office from taking on a merger between Blue Cross Blue Shield and Anthem because the Blues had aided in his lawsuit against tobacco companies. A special attorney general, though, sued to keep the plan's charitable assets in the state. Anthem launched a public relations campaign, sending mailers to policyholders and taking out ads threatening higher premiums if the state prevailed. This was similar to an effort Anthem had run under similar circumstances in Kentucky. The special AG prevailed, however, winning a settlement worth $41 million for a foundation.
For all the controversy, even those Blues plans that have had to write big checks to charities have come out fine. WellPoint, despite having had to fork over $3 billion to California's new health foundations, is now the fourth-largest health insurer in the country, and has watched its stock price triple since the conversion. "No company prefers to pay out that kind of money," says general counsel Tom Gaiser, "but it is beneficial to the company to resolve issues of this kind."