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    "ocrText": "http://thomas.loc.gov/cgi-bin/query/z?c105:H.R.443:\nTHIS SEARCH\nTHIS DOCUMENT\nGO TO\nNext Hit\nForward\nNew Bills Search\nPrev Hit\nBack\nHomePage\nHit List\nBest Sections\nHelp\nDoc Contents\nGPO's PDF\nReferences to this bill in the\nLink to the Bill\nFull Display - 9,841\nversion of this bill\nCongressional Record\nSummary & Status file.\nbytes.\nHelp\nMedicare Nonprofit Hospital Protection Act of 1997 (Introduced in the House)\nHR 443 IH\n105th CONGRESS\n1st Session\nH. R. 443\nTo amend part A of title XVIII of the Social Security Act to deny Medicare payment with respect to\nnon-profit hospitals that transfer assets or control to for-profit entities without approval.\nIN THE HOUSE OF REPRESENTATIVES\nJanuary 9, 1997\nMr. STARK (for himself, Mr. FILNER, Mr. KENNEDY of Rhode Island, Mr. BROWN of Ohio, Mr.\nWAXMAN, Mr. MCDERMOTT, and Mr. LEWIS of Georgia) introduced the following bill; which was\nreferred to the Committee on Ways and Means\nA BILL\nTo amend part A of title XVIII of the Social Security Act to deny Medicare payment with respect to\nnon-profit hospitals that transfer assets or control to for-profit entities without approval.\nBe it enacted by the Senate and House of Representatives of the United States of America in\nCongress assembled,\nSECTION 1. SHORT TITLE.\nThis Act may be cited as the `Medicare Nonprofit Hospital Protection Act of 1997'.\nSEC. 2. DISQUALIFICATION FROM MEDICARE PAYMENT OF NON-PROFIT\nHOSPITALS THAT TRANSFER ASSETS OR CONTROL TO A FOR-PROFIT\nENTITY WITHOUT APPROVAL.\n(a) IN GENERAL- Part A of title XVIII of the Social Security Act is amended by adding at the\nend the following new section:\n`DISQUALIFICATION OF CERTAIN NONPROFIT\n1 of 4\n10/30/98 10:27 AM\nhttp://thomas.loc.gov/cgi-bin/query/z?c105:H.R.43.\nHOSPITALS FROM PAYMENT IF ASSETS OR CONTROL\nTRANSFERRED TO A FOR-PROFIT ENTITY WITHOUT\nAPPROVAL\n`SEC. 1821. (a) REQUIREMENT- No payment may be made under this part with respect to\ninpatient hospital services of a hospital if the hospital, on or after January 7, 1997, was owned or\ncontrolled by a nonprofit entity and there is an impermissible transfer (as defined in subsection\n(b)) with respect to the hospital or the entity.\n'(b) IMPERMISSIBLE TRANSFERS-\n'(1) IN GENERAL- For purposes of this section, the term `impermissible transfer' means\nany covered transfer (as defined in paragraph (2)) that has not been considered to be\napproved in accordance with subsection (c).\n'(2) COVERED TRANSFER DEFINED- For purposes of this section, the term `covered\ntransfer' means, with respect to a hospital that is owned or controlled by a nonprofit entity--\n'(A) the sale, transfer, lease, exchange, option, conveyance, or other disposition of,\nthe assets of the hospital (or of the entity in relation to the hospital) to a for-profit\nentity, if a material amount of the assets relating to the hospital are involved in such\ndisposition; or\n`(B) the transfer of control, responsibility, or governance of a material amount of the\nassets or operation of the hospital (or of the entity in relation to the hospital) to any\nfor-profit entity.\nTransfers described in this paragraph may be effected through sale, joint venture, joint\noperating agreement, or any other means.\n'(3) OTHER DEFINITIONS- For purposes of this section:\n'(A) The term `acquired hospital' means, with respect to a covered transfer, the\nnon-profit hospital the assets or control of which are the subject of the transfer.\n`(B) The term `acquiring entity' means, with respect to a covered transfer, the\nfor-profit entity that is involved in the transfer.\n'(c) CONDITIONS FOR APPROVAL- Subject to subsection (d)--\n'(1) IN GENERAL- A covered transfer with respect to an acquired hospital owned or\ncontrolled by a nonprofit entity is not considered to be approved in accordance with this\nsubsection unless--\n'(A) the acquiring entity has disclosed to the Secretary, in a form and manner\nspecified by the Secretary, the information described in paragraph (2) relating to the\ntransfer;\n'(B) there has been an independent fairness review|conducted of the proposed transfer\nand the report on the review concludes that no assets of the acquired hospital in\nrelation to the nonprofit entity have inappropriately benefited any private parties; and\n'(C) the Secretary has approved the transfer.\n'(3) INFORMATION TO BE DISCLOSED- The information described in this paragraph is\na complete description of the terms of covered transfer, together with a description of all\n2 of 4\n10/30/98 10:28 AM\nhttp://thomas.loc.gov/cgi-bin/query/z?c105:H.R.443:\ncollateral arrangements, including information describing--\n'(A) the acquired hospital and the nonprofit entity that owns or controls the hospital;\n'(B) the acquiring entity;\n'(C) other parties to the transfer;\n'(D) terms of the proposed transfer;\n'(E) the value of consideration to be provided in connection with the transfer\n(including details as to the basis for the valuation);\n`(F) copies of documents relating to the transfer;\n'(G) the identity of individuals and persons who are officers, directors, or affiliates of\nthe nonprofit entity and whether they have any direct or indirect economic interest in\nthe transfer (including any promise or discussion of future employment); and\n'(H) such other information as the Secretary may require.\n'(3) PUBLIC DISCLOSURE- The Secretary shall provide for public disclosure (including\ndisclosure through electronic means on the Internet) of information described in paragraph\n(3) provided under paragraph (1)(A) and the report on the transfer described in paragraph\n(1)(B).\n'(4) CONDITIONS FOR APPROVAL OF TRANSFERS- The Secretary may not approve a\ncovered transfer relating to an acquired hospital owned or controlled by a nonprofit entity\nunless, after completion of the public hearing described in paragraph (6), the Secretary\ndetermines that the following conditions are met:\n'(A) Due care was exercised by the nonprofit entity in deciding to enter into the\ntransfer, selecting the acquiring entity, and negotiating the terms of the transfer.\n`(B) The nonprofit entity sought appropriate expert assistance in making decisions in\nrelation to the transfer.\n'(C) The nonprofit entity took all reasonable steps to avoid conflict of interests.\n'(D) The nonprofit entity will receive fair market value for its assets transferred in\nconnection with the covered transfer.\n'(E) No charitable funds are placed at risk in connection with the covered transfer.\n'(F) The amount of any compensation under any management contract entered into in\nconnection with the covered transfer is fair.\n'(G) The proceeds to the nonprofit entity in connection with the covered transfer will\nbe used only for appropriate charitable purposes consistent with the entity's non-profit\ncharter and for the promotion of health in the affected community and such proceeds\nwill be controlled as charitable funds independent of the acquiring entity.\n`(H) Any charitable corporation established to hold proceeds of the acquired hospital\nin connection with the covered transfer will be broadly based in the community.\n`(I) There are sufficient safeguards to assure the affected community continues to\nhave access to affordable hospital services.\n3 of 4\n10/30/98 10:28 AM\nhttp://thomas.loc.gov/cgi-bin/query/z?c105:H.R.443\n'(J) The acquiring entity has made a commitment to provide comparable care to the\ndisadvantaged, the uninsured, and the underinsured, and to provide benefits to the\naffected community.\n'(K) The acquiring entity has no contractual right to receive or direct future grants in\nrelation to the acquired hospital.\n'(L) The acquiring entity has paid the Secretary, with respect to the covered transfer, a\nfee sufficient to cover the costs of the Secretary in administering this section in\nrelation to such transfer.\n'(6) PUBLIC HEARING- Before approving a covered transfer, the Secretary shall provide\nfor notice and a public hearing to take place in the community of the acquired hospital\nconcerning the transfer and publication of a public report on testimony received at the\nhearing.\n(d) APPLICATION OF ALTERNATIVE STATE LAW REQUIREMENTS- A covered transfer\nis deemed to meet an applicable requirement of subsection (c) relating to the transfer to the extent\nthat the Secretary determines that there is a State law that imposes a requirement at least as\nstringent as the requirement involved with respect to the transfer.\n`(e) DELEGATION OF AUTHORITY- The Secretary may exercise the Secretary's authority\nunder this section through any appropriate official in the Department of Health and Human\nServices.\n'(f) NO EFFECT ON OTHER RIGHTS- The fact that the Secretary has approved a covered\ntransfer under this section shall not supersede other rights that any entity (including the federal\ngovernment or a State or local government) may have to challenge the transfer on any grounds.'.\n(b) EFFECTIVE DATE- The amendment made by this section shall apply with respect to covered\ntransfers for which agreements or transactions are entered into on or after January 7, 1997.\nTHIS SEARCH\nTHIS DOCUMENT\nGO TO\nNext Hit\nForward\nNew Bills Search\nPrev Hit\nBack\nHomePage\nHit List\nBest Sections\nHelp\nDoc Contents\n4 of 4\n10/30/98 10:28 AM\nBill Summary & Status\nhttp://thomas.loc.gov/cgi-bin/bdqu./-bdfcXZi@@@L/bss/d105query.html]\nBill Summary & Status for the 105th Congress\nItem 2 of 62\nPREVIOUS BILL\nI\nNEXT BILL\nPREVIOUS BILL:ALL I NEXT BILL:ALL\nNEW SEARCH I HOME I HELP\nH.R.443\nSPONSOR: Rep Stark (introduced 01/09/97)\nJump to: Titles, Status, Committees, Amendments, Cosponsors, Summary\nTITLE(S):\nSHORT TITLE(S) AS INTRODUCED:\nMedicare Nonprofit Hospital Protection Act of 1997\nOFFICIAL TITLE AS INTRODUCED:\nA bill to amend part A of title XVIII of the Social Security Act to deny Medicare payment with\nrespect to non profit hospitals that transfer assets or control to for profit entities without approval.\nSTATUS: Floor Actions\n***NONE***\nSTATUS: Detailed Legislative Status\nHouse Actions\nJan 9, 97:\nReferred to the House Committee on Ways and Means.\nJan 21, 97:\nReferred to the Subcommittee on Health.\nSTATUS: Congressional Record Page References\n01/09/97 Introductory remarks on Measure (CR E82-83)\nCOMMITTEE(S):\nCOMMITTEE(S) OF REFERRAL:\nHouse Ways and Means\nSUBCOMMITTEE(S):\nHsc Health\nAMENDMENT(S):\n***NONE***\n19 COSPONSORS:\n1 of 2\n10/30/98 10:30 AM\nBill Summary & Status\nhttp://thomas.loc.gov/cgi-bin/bdqu./-bdfcXZ:@@@L/bss/d105query.html]\nRep Filner - 01/09/97\nRep Kennedy, P. - 01/09/97\nRep Brown, S. - 01/09/97\nRep Waxman - 01/09/97\nRep McDermott - 01/09/97 Rep Lewis, John - 01/09/97\nRep Norton - 02/11/97\nRep Dellums - 02/11/97\nRep Rush - 02/11/97\nRep Weygand - 02/11/97\nRep Pelosi - 03/05/97\nRep Barrett, T. - 03/05/97\nRep Kennedy, J. - 03/20/97\nRep Wexler - 03/20/97\nRep Gejdenson - 03/20/97\nRep Kucinich - 04/17/97\nRep Gutierrez - 04/17/97\nRep Gonzalez - 04/30/97\nRep Sanders - 05/15/97\nSUMMARY:\n(AS INTRODUCED)\nMedicare Nonprofit Hospital Protection Act of 1997 - Amends part A (Hospital Insurance) of title XVIII\n(Medicare) of the Social Security Act to disqualify for Medicare payment any non-profit hospital that\ntransfers assets or control to a for-profit entity without appropriate approval by the Secretary of Health\nand Human Services.\n2 of 2\n10/30/98 10:30 AM\nCONVERSIONS\nState Experience In\nRegulating A Changing\nHealth Care System\nThe differing politics, experience, and legislative backdrops in\nstates around the country lead to substantial variation when it\ncomes to regulating nonprofit conversions.\nby Donald Shriber\nPROLOGUE: The recent wave of conversions of nonprofit health\nplans to for-profit status has brought new challenges to state\nofficials whose job it is to keep an eye on such transactions.\nStates traditionally have regulated insurers and hospitals; often\ntheir capabilities are stretched by the complexities\nsurrounding nonprofit-to-for-profit conversions, and the\n48\nSTATE\nmagnitude of the dollars involved raises the stakes still higher.\nISSUES\nChief among states' duties is to protect consumers, who often\nCurrer\nfail to grasp the significance of a plan's conversion until the\nhe:tas]\ndeal is in its final stages.\neficien\nIn this paper Donald Shriber examines four areas of law that\napply to conversions: corporate law; laws that govern the\nrequir\ndent\npowers of the attorney general or insurance commissioner in a\nWith n\nstate; laws governing health maintenance organizations\nbstrus\n(HMOs), insurance, hospitals, or Blue Cross/Blue Shield plans;\negalath\nand charitable trust law. Because the policies and environments\nto\nof the states differ, experiences with nonprofit conversions also\nThen\nhave varied greatly among the states that have seen such\nlaw. tha\nactivity. Conversions taking place in California, Colorado,\no the\nMaryland, Massachusetts, Missouri, and Ohio stand out as most\nhealth\ninstructive and in some cases have made national headlines.\nBlue\nShriber holds the position of associate director of the U.S.\nthere issue\nCenters for Disease Control and Prevention in Washington,\nother\nD.C. He served for eight years as counsel to the Commerce\ninclude\nCommittee of the U.S. House of Representatives, where he\n(govent\ndevoted much of his time to legislative and regulatory reform\nventur\nof private health insurance, managed care, and the\nstatute\npharmaceutical industry. He holds law and master of public\nproce\nhealth degrees from the University of California, Los Angeles.\nfor public\nHEALTH AFFAIRS Volume 16, Number 2\nHEA\n© 1997 The People-to-People Health Foundation, Inc.\nSTATE EXPERIENCE\nABSTRACT: Conversions of nonprofit hospitals, health maintenance or-\nganizations (HMOs), and Blue Cross and Blue Shield plans to for-profit\nstatus have tremendous social and economic consequences for com-\nmunities. Although some consensus exists on the legal principles gov-\nerning hospital conversions, a coherent legal framework for processing\nmany other conversions is often lacking. Rapid changes in the configu-\nration of health plans and providers complicate the situation. Litigation\nwill provide some resolution of the issues but is not an optimal way of\nmaking policy. Some state legislatures are stepping into the fray with\n; in\ndiffering solutions. Currently, the approach of a particular regulator is\nen it\noften the most important determinant of a given conversion.\nS CONVERSIONS OCCUR around the nation, state officials are\nA\nresponding in a wide variety of ways. This paper examines\nthe range of state responses, analyzes why and how they\nealth\narise, and highlights some of their strengths and weaknesses. The\ntate\ndiscussion draws upon interviews with regulators of and stake-\nis.\nholders in conversions that have occurred in several states. Regula-\n; often\ntion of the conversion process is an art, not a science, and is influ-\nenced as much if not more by the perspective and environment of\n:\nstate regulators as by any body of law.\nigher.\nCONVERSIONS\n49\noften\nCurrent Regulatory Authority\nhe\nThe task of intervening in conversions is complicated by two basic\ndeficiencies in the law: the absence of a clear statement of who owns\nthat\nnonprofits, and the lack of a clear definition of charity that includes\na requirement to register with the state.¹ Almost every state is defi-\nrina\ncient with regard to the former; only some, with regard to the latter.²\nWith no definition of ownership, one must search for clarity among\nlans;\nabstruse legal concepts (such as charitable trusts) and governing\nlegal theories. Without a definition of charitable law, regulators\nments\nis also\nhave too many authorities and too little guidance.\nThere are at least four major and potentially overlapping areas of\nlaw that apply to conversions: corporate law; laws speaking directly\nto the powers of the attorney general or insurance commissioners;\nis most\nhealth maintenance organization (HMO), insurance, hospital, or\nes.\nBlue Cross-specific law; and charitable trust law. Within these\nU.S.\nthere is significant variation among the states. There are a number of\non,\nother sources of authority that states may use with conversions,\nce\nincluding state constitutions; for-profit and not-for-profit laws\nhe\n(governing charter, formation, dissolution, merger, sale, and joint\nform\nventures and partnership); holding company and mutual insurance\nstatutes; certificate-of-need statutes; charities laws; codes of civil\nblic\nprocedure; tax (state and federal) and property laws; and statutes\ngeles.\nfor public records; and false statements.³ Much authority is based on\nHEALTH AFFAIRS March/April 1997\nCONVERSIONS\ncommon-law doctrines (developed through the decisions of courts\nThe list of authorities is long because conversions involve man\nissues. More importantly, often no one statute provides enoug\nguidance on how to consider a conversion. Until political consensi\ndevelops, lawyers will be free to develop new theories to add to the\nlist above.⁴ Only by laying broad common-law principles over\npatchwork of state laws can one assert that a harmonizing principl\nexists among the states. For now there is limited harmony. Mos\npeople agree that in straightforward sales of charitable hospitals\nattorneys general may intervene and use charitable trust principles\nBut many regulators are nervous about asserting charitable doctrine\nas the governing principle where the nature of the transaction is\nmuddled and statutory law is relatively undeveloped, and they are\neven less comfortable with charitable doctrine as a basis for review\nof Blue Cross plans.\nHospital conversions. The most common authority for view\ning hospital conversion cases is charitable trust doctrine. Under this\ndoctrine, the nonprofit entity is viewed as belonging to the public\nwith the directors and the state's attorney general acting as its\nrepresentatives. If the doctrine applies, a series of important conse-\n50\nSTATE\nquences will flow: The government will have a clear basis for inter-\nISSUES\nvening in the transaction. It will measure the conduct of the corpo-\nration's \"insiders\" (trustees, managers, or other persons who operate\ninside the nonprofit entity on its behalf). It will try to ensure that\nthe transaction was carried out to forward the mission of the non-\nprofit, that adequate value was received in the transaction for any-\nthing transferred, and that a foundation or other entity is estab-\nlished to carry on the original mission of the entity.\nThe best articulation of this basis for intervention appears in\nRobert Boisture's work on the sale of nonprofit hospitals and\nHMOs.⁵ Boisture argues that the authority is clear under common\nand statutory law in virtually every state. It rests, in his view, on the\nbroad common-law authority of the attorney general to review\ncharitable organizations and on two related principles.\nThe first principle is the requirement of court approval for a\nchange in the corporate purposes, the so-called cy pres doctrine.\nUnder cy pres, charitable organizations are impressed with a trust\nthat survives anything that happens to the organization. Histori-\ncally, cy pres was applied when it became impossible for a charity to\ncarry out its mission (for example, the \"further\" eradication of small-\npox). It provides that the charitable assets then should be devoted to\ncarrying out a purpose as near as possible to the entity's original\nmission. Should these conditions be violated, the attorney general\nwould have the authority to hold directors personally liable and to\nHEALTH AFFAIRS Volume 16, Number 2\nSTATE EXPERIENCE\ncourts).\nenjoin violative activities.\ne many\nThe second principle is that the entity's directors have a duty to\nenough\nact as fiduciaries and to exercise care in their dealings on behalf of\nnsensus\nthe nonprofit corporation. The directors must act in the interest of\nd to the\nthe nonprofit corporation, avoiding conflicts that might compro-\nover a\nmise that interest, and must exercise reasonable judgment in carry-\nrinciple\ning out their duties. Thus, they would undertake a conversion only if\ny. Most\nthey viewed it as the only or best alternative for continuing to carry\nospitals,\nout the purposes for which the hospital was established.\nnciples.\nBoisture's articulation of how hospital conversions should be\ndoctrine\nhandled reflects prevailing practice in states with very aggressive\nction is\nregulators and approximate practice in many other states. Although\nthey are\nBoisture's theory could become the basis for handling conversions\nC review\nnationally, not all attorneys general are equally confident in assert-\ning these prínciples. Many feel that they need to harmonize charita-\nor view-\nble trust law with other state laws. Some believe that they lack the\nder this\nclear authority, particularly in statute, to process even certain hospi-\n: public,\ntal cases. In addition, although cy pres is often cited by regulators,\ng as its\nthey rarely use it to mean the same thing, and they rarely enforce it\nt conse-\nstrictly.⁶\nor inter-\nBlue Cross/HMO conversions. The most contentious battles\nCONVERSIONS\n51\ne corpo-\nover ownership and definition are occurring with respect to Blue\noperate\nCross and Blue Shield plans.⁷ The ambiguity in the law has produced\nure that\na surfeit of legal theories. Some theorists have taken the position\nthe non-\nthat chartering legislation defines the plans as having a charitable\nfor any-\nmission.⁸ Others insist that the key to understanding the plans'\nS estab-\nownership lies in their articles of incorporation.9 Others argue that\nBlues plans have metamorphosed so many times and are such\npears in\nunique creatures that their ownership is unclear. Still others insist\ncals and\nthat Blue Cross plans are not-for-profit corporations subject to the\ncommon\ncommon-law doctrine of charitable trusts. In contrast, plans such as\nJ, on the\nBlue Cross in Missouri and Ohio insist that they are not subject to\nreview\ncharitable law. They, like many Blues plans, assert that ownership\ncan be determined by the terms of the latest transaction.\nal for a\nThere is no consensus among state regulators with regard to the\nloctrine:\ngoverning authority for Blue Cross/HMO conversions. The most\n1 a trust\ncomprehensive examination of the issue is by Eleanor Hamburger\nHistori-\nand colleagues. It rests on the view that charitable law is the gov-\nharity to\nerning doctrine through which state statutes should be read. The\nof small-\nauthors report that forty-eight states have laws that specifically\nvoted to\nregulate nonprofit corporations, but some do it through nonprofit\noriginal\ncorporation laws and others through regular corporate law.\" More-\ngeneral\nover, nearly every state has a sale, merger, or dissolution statute. The\ne and to\nstatutes may permit, forbid, or be ambiguous regarding the merger\nHEALTH AFFAIRS March/April 1997\nCONVERSIONS\n\"Today's transactions do not fit into the categories typically\nfound in most nonprofit statutes.\"\nof a nonprofit with a for-profit and the conversion of the resulting\ntheyo\ncorporation to for-profit status.\nchic\nCorporate statutes do not anticipate the multilayered transac-\nnfit cor]\ntions that have taken place or been proposed in several states, in-\nlaw d\ncluding those involving Blue Cross plans in Missouri, Maryland,\ndo no\nCalifornia, and Ohio. Further, while state provisions governing dis-\nmerger\nsolutions might be used to implicate charitable trust principles, it is\nuding M\noften unclear precisely when a dissolution has occurred or should\ntodiss\noccur. Hence, consumer groups have argued in Ohio, Missouri, and\nons. Hov\nelsewhere that conversions are covered by these provisions, while\nthat is not\nBlue Cross plans have claimed that their transactions are distinct\nCompl\nfrom those contemplated by the state statutes.\nkempt fr\nMany states have specific laws that regulate both HMOs and Blue\nometime\nCross plans, but the laws seldom provide clear guidance as to how\nventures\"\nconversions should be processed, or how those laws should be read\nsuch revie\nin conjunction with other state statutes and common law. In North\nlook to St\n52\nSTATE\nDakota proposed mutualization of the Blue Cross plan has high-\nlaw, such\nISSUES\nlighted the lack of clarity in the law.¹² There overlapping corporate\nventures\nand insurance statutes confuse the situation. Under nonprofit cor-\nmarriage\nporation law, a nonprofit may not be able to distribute its income.\nColumbi:\nHowever, some have argued that to mutualize, a corporation must\nformer) }\ntrigger dissolution statutes, which in turn might trigger the need to\nIn sho\ndistribute assets under a charitable trust theory. Meanwhile, expe-\nthe trans\nrience with the cy pres doctrine in North Dakota is very limited.¹³\nfor maki\nGrowing complexity. Complicating the issue of authority to\nversion t\nregulate transactions are the constant consolidation and changes in\nner may\nthe enterprises being governed. As the Ohio Blue Cross conversion\nShould t\nshows, the line between hospitals, HMOs, and health plans is be-\nports to\ncoming blurred. Many regulators have said that the increasing com-\nregulato\nplexity of today's health care transactions is requiring increasingly\nlawyers\nmore subtle, complex, and time-consuming analyses to determine\naction to\nwhether regulators even have jurisdiction over the transactions.\na more f\nA recent conversion of the Blue Cross plan in Virginia was de-\neral's off\nscribed as a \"reverse triangular merger.\" In Maryland, Ohio, Califor-\ngeneral\nnia, and Missouri Blue Cross transactions are multifaceted and\ninsuran\nhighly complex. They often involve the creation of subsidiaries and\nproach i\nchanges in the nonprofit that are so fundamental as to render them\nSome\nshell entities. \"Downstream subsidiaries\" (entities that are offspring\nof the converting organization), joint ventures, leases, and limited\nTo gain\npartnerships are replacing old-fashioned sales in other states. Fu-\nwe inte\nHEALTH AFFAIRS Volume 16, Number 2\nHEAL\nSTATE EXPERIENCE\nIly\nture transactions promise to become increasingly complex.\nToday's transactions do not fit into the categories typically found\nin most nonprofit statutes. Typically, these statutes describe catego-\nries of transactions (for example, sales, dissolutions, and mergers),\nne resulting\nand they often elaborate different standards and procedures govern-\ning each category. For example, Ohio law provides that a not-for-\ned transac-\nprofit corporation can only merge with another not-for-profit, but\n1 states, in-\nthe law does not prevent a dissolution or sale. Similarly, most stat-\nMaryland,\nutes do not address what occurs when there is a sale and a merger or\nverning dis-\na merger and a dissolution.¹⁴ Consumer groups in many states, in-\nnciples, it is\ncluding Missouri, have invoked dissolution statutes, arguing that de\nd or should\nfacto dissolutions have occurred along with other kinds of transac-\nissouri, and\ntions. However, in doing so they are forced to rely on a body of law\nsions, while\nthat is not well defined.\nare distinct\nComplicating matters further, some categories of transactions are\nexempt from review as conversions. Regulators report that they are\nOs and Blue\nsometimes constrained from looking at conversions labeled as \"joint\ne as to how\nventures\" because underlying state law either does not authorize\nould be read\nsuch review or forbids it. Others operating without such constraints\nW. In North\nlook to see whether the joint venture implicates elements of trust\nn has high-\nlaw, such as a fiduciary duty or public benefit.15 The issue of joint\nCONVERSIONS\n53\ng corporate\nventures strikes at the heart (and soul) of the conversion issue. A\nnprofit cor-\nmarriage between the Sisters of Charity chain in Cleveland and\nits income.\nColumbia/HCA (in which the latter purportedly bought half of the\nration must\nformer) has drawn much attention and controversy.\nthe need to\nIn short, most state nonprofit laws are based more on the form of\nwhile, expe-\nthe transactions than on their function. They provide an incentive\nimited.¹³\nfor making transactions overly complex and confusing, since a con-\nauthority to\nversion that is structured or labeled in a more straightforward man-\n1 changes in\nner may be easier to regulate. Regulators therefore face a dilemma:\nconversion\nShould they examine the form of the transaction and what it pur-\nplans is be-\nports to do or look at what it really accomplishes? Although many\neasing com-\nregulators feel constrained in their efforts to do what corporate\nincreasingly\nlawyers call \"piercing the veil\" (looking beyond the label of a trans-\n) determine\naction to see what it really accomplishes), some are moving toward\nactions.\na more functional approach. In Ohio, for example, the attorney gen-\nnia was de-\neral's office asserts that if charitable assets are involved, the attorney\nhio, Califor-\ngeneral will intervene-the form being secondary. However, Ohio\nfaceted and\ninsurance officials were slow to assert this kind of functional ap-\nidiaries and\nproach to the proposed Blue Cross conversions.\nrender them\nSome Examples: State Overview\ntre offspring\nand limited\nTo gain insight into state regulators' experience with conversions,\nstates. Fu-\nwe interviewed officials in state offices of attorneys general. Their\nHEALTH AFFAIRS March/April 1997\nCONVERSIONS\nresponses illustrate the great variety in law and practice that exists.\nIn California and Massachusetts aggressive attorneys general be-\nlieve that strong common-law authority exists for asserting charita-\nble trust principles but that it must be used or interpreted in light of\nclear statutes. 16 These offices are scarcely alone in this assertion, but\ntheir comprehensive and unyielding assertion of that authority dis-\ntinguishes them from other states. The attorneys general in Massa-\nchusetts and California are also unusual because they have devel-\noped written protocols for the charitable principles under which\nthey will assert authority and review conversions.⁷ These protocols\nrepresent strong assertions of power that govern how transactions\nwill be processed. They rest heavily on the beliefs that nonprofit\nentities belong to the public and that the public is represented by\nthe attorney general.\nOther states demonstrate unique statutory schemes or interpre-\ntations. In New York a statute governing not-for-profit corporations,\nis used to regulate the conversions of HMOs. However, operating a\nhospital as a for-profit stock corporation is effectively forbidden, so\nconversions of hospitals to for-profit status are generally not an\nissue.¹⁸\n54\nSTATE\nIn Maine, where experience has been limited to the proposed\nISSUES\nconversion of the state's Blue Cross plan, the attorney general's\noffice had cited a single statutory sentence giving the attorney gen-\neral the right to supervise charitable trusts.¹⁹ The office also may\nlook to the legal theory of ultra vires (the performance of unauthor-\nized acts by a corporation), for which Maine law permits injunctive\nrelief.²⁰ The Blue Cross case is now before the insurance department.\nUnder petition from Blue Cross, the insurance department is con-\nsidering whether to allow operation of downstream for-profit\nHMOs, jointly owned by Blue Cross and private hospitals.\nIn New Hampshire, common law, including cases dating back to\n1901, is the primary basis for intervention.² The attorney general's\noffice also relies on a cy pres statute, which recently was modified to\nplace all such proceedings before the probate court.²²\nIn Virginia, the attorney general's office, although taking a rela-\ntively modest view of the obligations of the converting Blues plan,\nran into a legislature that was anxious to leave its own imprint.\nUltimately, the legislature effectively determined the amount of the\nvaluation-a gross understatement in the view of some critics-but\ndirected the money toward the state's coffers, rather than toward\nmedical purposes, as the attorney general had sought.\nTexas. Texas is likely to have dozens of hospital conversions in\nthe coming years, and the state's Blue Cross plan is involved in\nmerger discussions with the Illinois plan. (The Texas Blues plan\nHEALTH AFFAIRS Volume 16, Number 2\nSTATE EXPERIENCE\nxists.\nalready operates four for-profit subsidiaries, and many regard the\n1 be-\nmerger as a prelude to a for-profit conversion.)²³ The relevant\nrita-\nauthorities identified by the Texas attorney general's office are ex-\nht of\nceptionally complicated. According to the attorney general's office, a\nbut\nmajor source of authority is the Miscellaneous Corporations Act,\ndis-\nwhich permits the attorney general to investigate the books and\nassa-\nrecords of any corporation doing business in Texas. Further, the\nevel-\nproperty code requires that the attorney general must be notified if\nhich\nthere is a proceeding involving a charitable trust. It permits voiding\ncols\nan action for which notice is not given. The not-for-profit statute\ntions\nnever mentions the need to notify the attorney general, but it ap-\nrofit\npears to govern the conduct of the not-for-profit health care entities.\nd by\nAnother provision of the Texas codes permits the attorney general\nto revoke the authority of an entity to function if the entity has\npre-\nviolated any Texas law. The attorney general may seek receivership\nions\nto rehabilitate an errant corporation, but this extreme measure is\nng a\ndifficult to use. Most importantly, the attorney general asserts\n1, so\ncommon-law authority to sue for breach of fiduciary duty, and this\nt an\nuse of authority has never been seriously challenged. The attorney\ngeneral may impose a \"constructive trust\" where charitable princi-\nsed\nples have been violated.\nCONVERSIONS\n55\nral's\nIronically, none of these laws was the basis for the Texas attorney\ngen-\ngeneral's recent role in blocking a conversion of St. Luke's Hospital.\nmay\nIn that case, the relevant issue was enforcement of a fiduciary duty\nor-\ncontained in a deed restriction, which limited the entity to not-for-\ntive\nprofit uses. The attorney general won the case. More recently, the\nent.\nTexas attorney general, citing multiple grounds, filed suit to block\non-\nthe possible merger of the Texas and Illinois Blues plans.\nofit\nMaryland. The rejection of a proposed reorganization of Mary-\nland's Blue Cross plan by that state's insurance commissioner dem-\nto\nonstrates how fluid the authority of that office can be, and how it\nal's\ncan be affected by public opinion. When the conversion was first\n1 to\nannounced, the commissioner of insurance seemed to embrace it\nand find no apparent obstacles.²⁴ After great public opposition and\nela-\nnumerous investigative articles in The Sun (Baltimore, Maryland), he\nan,\nfound a clear basis for objecting to the conversion.²⁵\nint.\nIn December 1995 the Maryland Blue Cross plan sought approval\nthe\nfrom the state Department of Insurance for its proposed \"reorgani-\nout\nzation.\" The plan involved the creation of a new for-profit health\nard\ninsurance company, a new general insurance agency, and a new\ndownstream holding company; the reactivation and expansion of a\nin\ncharitable foundation; and the transfer to a managed care company\nin\nof all the nonprofit's ownership in five HMOs, a third-party admini-\nan\nstration company, its real and personal property, and the vast major-\nHEALTH AFFAIRS March/April 1997\nCONVERSIONS\nity of its functions and employees. Blue Cross took the position that\nthis was not a conversion. Consumer groups disagreed.\nMaryland law provides specifically for the conversion of a non\nprofit health care service plan to for-profit status, upon submission\nof a plan to and approval by the insurance commissioner.²⁶ Maryland\nlaw also provides for distribution of assets upon dissolution. But\nMaryland corporate law prohibits nonstock corporations from opt\nerating as for-profit corporations. Moreover, the attorney general\nhas written that a nonprofit corporation may not engage in for\nprofit activity that may \"become so substantial that [it] may no\nlonger\nbe\ncharacterized\nas\noperating a nonprofit health service\nplan\" and \"would result in it being characterized as for-profit.\" The\nquestion in Maryland was how the Blue Cross transactions should\nbe characterized and treated.\nThe commissioner of insurance refused to approve the proposal\nto \"restructure\" because it did not accord with state law. The com-\nmissioner relied on the attorney general's opinion and found that\n\"the profit-making aspects of the entire enterprise would be so sub-\nstantial that BCBS [Blue Cross/Blue Shield] would lose its character\nas a nonprofit health services plan.\" The commissioner eschewed a\n56\nSTATE\nrigid legal analysis to determine which narrow category of Maryland\nISSUES\nlaw applied to the conversion structure and affirmed the need for a\nmore functional approach: \"I have concluded that the proposed reor-\nganization is in reality more than a mere reorganization but is in-\nstead tantamount to a conversion to [a] for-profit enterprise.\"\nFactors Affecting Regulation Of Conversions\nA number of practical matters may profoundly affect how and when\na conversion is regulated. These include how much regulators know\nabout possible pending conversions (through either formal notice,\ndiscussions with other regulators, or other means) and whether\nregulators have sufficient resources and expertise to carry out their\nresponsibility to protect the public trust. Other important issues are\nthe sometimes overlapping missions of regulators in a state and the\nphilosophy and approach of particular regulators.\nKnowledge of pending conversions. Regulators agree that if\nthey are to become involved in a conversion, it is best to do so early.\nEarly intervention prevents disrupting a transaction that is nearly\ncomplete (and wasting the resources that have gone into it), permits\nadequate time for review, prevents unlawful conflicts of interest,\nallows the use of experts on matters such as valuation, and improves\nthe chances of a cooperative relationship between the regulator and\nthe entity undergoing conversion. It also allows the regulator time\nto anticipate the future and to help structure a surviving or new\nHEALTH AFFAIRS - Volume 16, Number 2\nSTATE EXPERIENCE\nion that\n\"A striking number of regulators received notice from entities of their\nE a non-\nintent to change their status but did not comprehend the significance.\"\nmission\naryland\nion. But\nentity while involving interested parties in the community.\nrom op-\nRegulators learn of potential conversions in a variety of ways,\ngeneral\nwhich may or may not be related to statutory notice requirements.\nin for-\nIn some states word-of-mouth serves adequately to apprise regula-\nmay no\ntors of potential conversions. In New Hampshire, for instance, the\n1 service\nlaw does not require notice to regulators, but the attorney general's\nfit.\" The\noffice reports that attorneys representing health care providers do\nS should\nso much other business with the attorney general's office that they\ncannot pass a conversion by them without timely notification. In\nproposal\nOhio the attorney general's office complains of learning of hospital\nhe com-\nconversions through the media, as there is no requirement of notice.\nind that\nThe attorney general there has asked the Ohio Hospital Association\n: SO sub-\n(on behalf of its members) and Columbia/HCA to approach its office\nharacter\nearly with conversion proposals. They have met with some success,\nhewed a\nperhaps because the attorney general's office appears prepared to\nMaryland\nenjoin any transaction it has not reviewed.\nIn Texas, because there is no statutory notice requirement, regu-\nCONVERSIONS\n57\need for a\nsed reor-\nlators often learn of transactions close to the point at which they are\nout is in-\nscheduled to be consummated (and sometimes from the media).\ne.\"\nRegulators report that a large number of transactions have already\npassed them by, and they may not be able to review them. Regula-\ntors are willing to reopen transactions that have already been ap-\nnd when\nproved.\" However, the absence of a clear notice requirement can\nrs know\ncreate a political and economic dynamic that makes it difficult to\nil notice,\nslow down or reopen transactions and to review them thoughtfully.\nwhether\nThe power of a regulator to hold up a transaction can be even\nout\nmore important than a notice requirement. For example, California\nare\nhas a notice requirement for converting hospitals, but hospitals en-\n= the\nssues improves interest and permits that nearly early. their\nter into negotiations with the attorney general long before giving\nnotice. The parties do this because they know that the attorney\nee if\ngeneral has sufficient power to hold up a transaction by seeking\nso\nmore information, issuing subpoenas, or delaying approval.\nis\nIndeed, in most states parties to conversions enter into discus-\nsions with regulators well in advance of giving notice. They know\nthat notice could help a regulator who is lacking political or other\npower to hold up a transaction. It also could blunt the tactic used by\nlator and\nsome for-profit entities of developing political or community sup-\nator time\nport for a transaction to undercut a regulator's legal objections.\ng or new\nUltimately, the dynamic of power in what are often private discus-\nHEALTH AFFAIRS March/April 1997\nCONVERSIONS\nsions may foretell more than the existence of a notice requireme\ndoes about the outcome of a conversion.\nNotice is of little value if a regulator is not prepared to\nthoughtfully and decisively and does not understand the potenti\nimpact of a conversion. A striking number of regulators report th\nthey received notice from entities of their intent to change the\nstatus but did not comprehend the significance of the change. Pan\nticularly with regard to Blues plans, regulators have failed to com\nprehend fully the implications of certain actions that may have bee\npreludes to conversions. According to an official at the Nations\nAssociation of Insurance Commissioners (NAIC), over the past seve\neral years several Blues plans were successful in effecting legislative\nchanges that permitted them to change to mutual status, often with\nclear notice to regulators. Many regulators and legislators did not\nunderstand that these changes could portend additional moves to\nfor-profit status, so they pàid little attention to the proposals. Con-\nsumer groups have sought to educate regulators in many states\nabout the importance of incremental changes to corporate status.\nMany regulators report that it is only the observation of what\nplans in other states have done that has put them on notice that any\n58\nSTATE\nproposed change in the regulation of a Blues plan might portend a\nISSUES\nwholesale conversion to a stock company. With regulators from\ntwenty-six states now sitting on a special NAIC committee on Blues\nconversions, regulators are likely to be better informed. Nonethe\nless, in South Dakota a recent conversion of a Blue Cross plan arose\nwith relatively little attention or notice.\nSufficiency of resources. Many state agencies lack the re-\nsources to devote to conversions. This affects how and when regula-\ntors intervene. Some report giving smaller cases relatively little scru-\ntiny. Many are unable to study the implications of subtle or complex\ntransactions and thus allow them to go forward without study.\nMany rely on staff attorneys or other officials who have little time to\ndevote to these highly complex matters. They report extreme frus-\ntration at having limited resources to face what they see as the\nnear-infinite resources of the private entities that are seeking to\ntant\nconvert. Often they must rely heavily on the representations of the\nper\nregulated entities because of a lack of resources or expertise. Some\nor\nworry that with new legislation they will be given new responsibili-\nties but not the resources needed to carry them out.²⁸\ncor\nIntervening in the outcome of a conversion is the most visible part\nof a regulator's job, but an equally significant challenge is overseeing\nthe\nconversions as they unfold, foundations as they form, and for-profit\nTe\nentities as they evolve. Because converting entities rely on experts in\nfinance and law, and government resources often are unavailable or\nsu\nHEALTH AFFAIRS Volume 16, Number 2\nH\nSTATE EXPERIENCE\nrement\nnonexistent, many regulators are looking to outside experts to ad-\nvise them on any or all of these matters. In California, for example,\nto act\nthe Department of Corporations (DOC) hired an investment\ntential\nbanker, Bear Sterns, and a foundation and public health expert,\nort that\nNancy Kane, to advise it on the Blue Cross/WellPoint conversions.\ne their\nIn Virginia, Texas, and around the nation attorneys general and\nge. Par-\ninsurance departments are hiring consultants with distinct exper-\no com-\ntise in conversion law. In the midst of litigation in Ohio, the Depart-\nve been\nment of Insurance has retained Alex Brown, Inc., to advise it on\nlational\nvaluation. Selecting and interpreting the work of experts is itself\nast sev\ntime-consuming and complex, and the ability of regulators to work\nislative\neffectively with experts varies greatly from state to state.\nen with\nMost regulators assess the parties for the services of these ex-\ndid not\nperts-sometimes as much as $100,000. In many cases, regulators\noves to\nhave simply made the payment of such fees a condition of their\nls. Con\napproval of a deal. The requirement of payment of fees is typical of\ny states\nmany issues in the regulation of conversions: They are less impor-\ncatus.\ntant as matters of law than as a reflection of the balance of power\nof what\nbetween regulators and the entities concerned. So far, relatively\nthat any\nlittle controversy appears to have attended this area. However, some\nrtend a\nnew and proposed legislation includes provision for payment by\nCONVERSIONS\n59\nrs from\nparties to the transaction for experts to advise regulators. This legis-\non Blues\nlation reflects a fear in some states that regulators will be challenged\nonethe\nif they seek to obtain expert advice or require payment from the\nan arose\nparties without explicit statutory authority.\nAmbiguity of Jurisdiction. State law often lacks clear guidance\nthe re\non the precise roles of regulators in health care conversions, particu-\n1 regula\nlarly those involving the Blues. Offices of attorneys general are tradi-\ntle scru\ntionally the lead agency in interpreting and enforcing charitable law\ncomplex\nand hospital conversions; insurance departments typically oversee\nt study.\nthe Blues. But an attorney general may pursue other theories of law,\n: time to\nwhile an aggressive insurance commissioner may pursue a charita-\nme frus\nble doctrine. The contentious nature of conversions may force legis-\ne as the\nlators to define the roles of regulators more neatly. Some are reluc-\neking to\ntant to do this because they do not want to tamper with what they\nns of the\nperceive to be broad authority derived from common law, practice,\nse. Some\nor inherent power to enforce statutes.\nonsibili\nThe regulatory tangle can be exacerbated by politics. Insurance\ncommissioners and attorneys general may be elected officials who\nible part\nregard themselves as wholly independent of one another and even of\nerseeing\nthe state's governor. Conversions in Maryland, California, Ohio, and\nor-profit\nTennessee have become hot political issues.\nxperts in\nThe complexity of the roles played by attorneys general and in-\ntilable 04\nsurance commissioners also affects regulatory effectiveness. For in-\nHEALTH AFFAIRS March/April 1997\nCONVERSIONS\nstance, an attorney/client relationship may exist between these tw\nentities, so that the attorney general must represent the insurano\ndepartment in court. The role of the attorney general's office when\nis counsel to a state agency may be quite different than when it\nacting on its own. Theoretically, the client should give instruction to\nthe attorney as to the course it wants to take, but political reality\nmay dictate otherwise. Many insurance commissioners and attor\nneys general are unclear as to what their role is, particularly vis-à-vi\none another. One insurance department official reported that his\ndepartment must serve as a judge of the appropriateness of an in\nsurer's action. Hence, he claimed, it cannot advocate for the public\nMany attorneys general reported that they too wear many hats\nadvocate for the public but also arbiter of whether the public has\nbeen protected, attorney for their own offices and other state agen-\ncies, and negotiator and litigator.³⁰\nIn many states regulators are just beginning to define their re-\nspective roles. In some states efforts to clarify jurisdiction have been\nundertaken through legislation. For instance, in Colorado the insur-\nance commissioner is deemed the lead in the Blue Cross conversion.\nIn Nebraska both the attorney general and the director of health are\n60\nSTATE\ngiven lead roles in hospital conversions. In California a demarcation\nISSUES\nis made between HMO conversions, for which the DOC is given the\nlead (except with respect to foundation oversight, which falls to the\nattorney general), and hospital conversions, which are under the\npurview of the attorney general.\nIt is possible that a constructive sorting out of roles is taking\nplace. The confusion arises in part from lack of experience and un-\ncertainty about what is the relevant theory in the case. When this\nuncertainty surrounds a transaction, it creates inefficient regulation\nand obstacles to timely and thoughtful intervention. The question of\nwho should regulate is an important one. Officials in offices of attor-\nneys general assess their own ability to evaluate health policy issues\n(such as the ability of institutions to adequately serve the health\nneeds of communities) very differently. Some argue that conversions\npresent unique health policy questions and cannot be handled ade-\nquately by professional public prosecutors. Others believe that at-\nsuit\nthe)\ntorneys general are perfectly capable of analyzing the health policy\nfor\nissues involved in conversions.\nThe health policy issues that arise in conversions might be best\ngran\ndealt with by a team of state experts that includes health officials. So\nprof\nfar, this approach has been slow to develop, but some regulators are\ntran\nlooking increasingly to others in government for assistance.\nfail\nRegulatory will. Virtually every person consulted for this pa-\nlaw\nper agreed that the single most important determinant of the\nHE\nHEALTH AFFAIRS - Volume 16, Number 2\nSTATE EXPERIENCE\nen these two\noutcome of a conversion is the regulator-in particular, his or her\nhe insurance\nphilosophy, politics, political independence, aggressiveness, com-\nffice when it\nmitment, and willingness to take risks. The law is in a sufficient\nin when it is\nstate of flux and confusion that a regulator's interpretation and\ninstruction to\nstance will often be the critical factor.\nlitical reality\nChanges in political administration that bring into office leaders\nrs and attor-\nwith new philosophies of regulation can have profound conse-\niarly vis-à-vis\nquences. Massachusetts Attorney General Scott Harshbarger has\nrted that his\nbrought an aggressive and personal approach to conversion regula-\nless of an in-\ntion. Many commentators have noted as well that the single most\nor the public.\nimportant determinant of the outcome of the Blue Cross conversion\nr many hats:\nin California was that the new DOC director, Gary Mendoza, had an\nhe public has\nintense interest in and commitment to this matter. Under Mendoza,\ner state agen-\nthe conversion's yield to the public escalated from $100 million to\nmore than $2 billion. By contrast, observers point to a series of\nfine their re-\nearlier conversions in which regulation was far less aggressive and\nion have been\nfoundations were vastly undervalued.\"\nado the insur-\nNot discussed in this paper but critical to the outcome of a con-\nSS conversion.\nversion is the degree to which regulators consult with and involve\nr of health are\ncommunity and consumer representatives in the decision-making\n1 demarcation\nprocess. In virtually every state in which conversion activity has\nCONVERSIONS\n61\nC is given the\nvoccurred, consumer representatives have sought to educate both the\nich falls to the\npublic and regulators about the implications of conversions. The\nare under the\nresponse of regulators and the ultimate outcome of a conversion\noften reveal much about the degree to which the regulator was\noles is taking\nreceptive to this input.\nrience and un\nLitigation\nse. When this\nent regulation\nDisputes over the applicability of statutory and common-law\nhe question of\nauthorities to conversions are being played out at the state level in\nfices of attor\nthe courts. Lawsuits have been brought by state regulators (or by\nh policy issues\nonversion parties attempting to enjoin the actions of regulators) in\nrve the health\nveral conversion cases. Three current cases show how judges have\nat conversions\nsponded to the various parties' arguments.\ne handled ade\nMichigan. In June 1996 the Michigan attorney general brought\nelieve that at\nto enjoin a proposed joint venture between Columbia/HCA and\ne health policy\nMichigan Capital Medical Center.\" The joint venture provided\nColumbia/HCA to own one-half of the health care system and\nmight be bes\nanted primary control over many essential functions to that for-\nlth officials. So\nofit concern.\n: regulators an\nThe attorney general asserted a variety of theories to block the\nstance.\ninsaction, including breach of fiduciary duty, improper valuation,\nted for this\nThire to gain a tax law ruling, and violation of the state's nonprofit\nminant of th\nwhich prohibits for-profit hospital ownership. The judge re-\nLTH AFFAIRS March/April 1997\nCONVERSIONS\njected the first three theories but accepted the last. He appeared\nbe most comfortable relying on a specific provision of statute\nformally held that the joint venture was ultra vires (beyond\nauthority) and that the nonprofit had exceeded its purpose a:\nhospital under the state's nonprofit corporation law.\nMissourl. In 1994 Missouri's Blue Cross plan underwent\n\"reorganization\" under which it created a for-profit subsidia.\nRightCHOICE, in which it received shares of stock in return. BL\nCross sought and received approval from the director of insuran\nfor that transaction. Subsequently, Blue Cross sold 20 percent of ti\nstock at a public offering and retained the rest.\nThe director of insurance subsequently alleged that Blue Cros\nhad withheld from him material details of the transaction. The\nincluded amendments to its articles of incorporation allegedly\nmoving its original purposes and altering the scheme for asset distriction\nbution on dissolution, as well as information showing that all of if\nbusiness would be transferred to RightCHOICE. The director sub\nsequently adopted the position that the reorganization was a con\nversion not permitted under Missouri law and that if the conversion\nwas to occur, charitable trust principles should apply.\n62\nSTATE\nBlue Cross filed a preemptive lawsuit attempting to block the\nISSUES\ndirector from proceeding against it and seeking a declaratory judg\nment that it had no charitable obligation. Consumer groups then\nfiled an administrative petition with the Department of Insurance\nasking the department to force Blue Cross to turn over its assets to\nthe public. Blue Cross obtained a temporary restraining order to\nkeep the department from proceeding against them and to block any\naction on the consumers' petition. The Department of Insurance and\nthe attorney general counterclaimed (with respect to the Blue Cross\nsuit), with the department asserting charitable trust principles and\nthe attorney general relying on a narrower doctrine that Blue Cross\nhad violated the purposes of the state's health services corporation\nstatute by operating outside its scope as a nonprofit.\nThe judge in the case has issued two very different decisions in\nthe case, demonstrating just how volatile conversion cases can be. In\nthe first ruling, the judge held that under Missouri law, the attorney\ngeneral, not the director of insurance, would have jurisdiction over\nthe conversion. The judge has yet to rule on the attorney general's\nclaim or on an amended claim of the Department of Insurance as-\nserting a new theory.\nAbout one month later, however, the judge asserted from the\nbench that his September order was an interim ruling, not a final\none. In December he effectively reversed himself, ruling on behalf of\nthe attorney general that Blue Cross's conversion was impermissible\nHEALTH AFFAIRS - Volume 16, Number 2\nSTATE EXPERIENCE\nappeared to\nand ordering that there be a dissolution of the corporation. The\nstatute and\njudge indicated that he would look to reasonable alternatives to the\neyond their\ninitial conversion. Blue Cross has since entered into talks with a\nurpose as a\nnonprofit, BJC Health Systems, for a new and permissible merger\narrangement.\nnderwent a\nOhio. Pending lawsuits in Ohio over Columbia/HCA's pro-\nsubsidiary,\nposed joint venture with Blue Cross/Blue Shield of Ohio (BCBSO)\nreturn. Blue\nare significant because they raise all of the important issues related\nof insurance\nto conversion policy and because the marriage formed in the trans-\nercent of the\naction may represent a new and important form of health care fi-\nnance and delivery.\nt Blue Cross\nUnder a proposed transaction in Ohio, BCBSO would form a\nction. These\nstock company subsidiary, BlueCo, to which it would transfer 85\nallegedly re\npercent of its business and assets. BCBSO would own BlueCo,\nasset distri\nwhich would then be acquired by Columbia/HCA, or a newly cre-\nthat all of its\nated subsidiary, in return for $299.5 million. Of that, $77 million\ndirector sub\nwould go to Blue Cross, and the remainder, to a new for-profit\nn was a con\ncompany owned by Columbia/HCA. BCBSO would be BlueCo's\nle conversion\nreinsurer, and BlueCo would provide administrative services to\nBCBSO. BlueCo would later be able to purchase the portion of\nto block the\nBCBSO still held for one dollar. BCBSO is required to pay $25\nCONVERSIONS\n63\naratory judg\nmillion to Columbia if it accepts another offer to convert and to\ngroups thei\nontract at Blue Cross's highest reimbursement rates with certain\nof Insurance\nolumbia/HCA hospitals. Some of BCBSO's executives reportedly\nr its assets\nould receive lucrative contracts for consulting and noncompeti-\nning order\narrangements.\" Blue Cross has applied to the state's Depart-\n1 to block an\ntht of Insurance for approval of the transaction.\ninsurance and\nA suit was brought on behalf of policyholders against Blue Cross\nhe Blue Cro\nrecognize the interests of the policyholders in the conversion and\nprinciples an\nrecognize the transaction as a conversion under Ohio law. The\nat Blue Cro\ntorney general successfully intervened in the policyholders' suit\nS corporation\nIssued Blue Cross and its trustees for breach of fiduciary duty\nto protect the charitable assets held by Blue Cross. The policy-\nt decisions\nAders' suit was stayed pending a review (now under way) by the\nuses can be\nto Department of Insurance. The attorney general's suit has gone\nthe attorn\nward. Blue Cross filed a motion to dismiss the suit, alleging that\nisdiction OV\nsno charitable assets, and the attorney general has filed a re-\nmey genera\nonse. In addition, Consumers Union, Families USA, and the\nInsurance\nrican Association of Retired Persons (AARP) have filed amicus\nsupporting the attorney general's position. A lawsuit by the\nted from\nional Blue Cross Association to block the Ohio plan's use of the\nng, not a fit\nCross logo has been stayed.\ng on behal\nThe attorney general has asserted a charitable trust theory and\nimpermiss\nlikely look at inurement issues. The Department of Insurance,\nAFFAIRS March/April 1997\nCONVERSIONS\nby contrast, appeared initially to claim that charitable trust law\nnot operative and that it would look only at whether policyhold.\nwere protected. It is unclear whether that is still true. It also\nunclear whether the department is viewing the transaction as\ndemutualization or mere restructuring, and whether departme\npolicy is being informed by the view that the Blues plan may fac\nfinancial pressures that it cannot bear in the future.\nAn independent valuation might be the easiest answer to th\nclaim, and, under some public pressure, the Department of Insurant\nultimately retained the services of an investment bank to undertal\none. A petition arguing that the case is a clear conversion, requirin\na demutualization and implicating charitable trust principles,\nbefore the department.\nThe lawsuits in Michigan, Missouri, and Ohio expose unresolve\nissues and provide a process for addressing them. However, litiga\ntion is a lengthy process, and, given the important legal principle\nand the enormous amounts of money involved, appeals to highe\ncourts are inevitable. It could be several years before a clear pictur\nemerges of the legal authority of regulators and responsibilities or\nconverting through the courts. To date, not every case has been\n64\nSTATE\ntested in this forum. However, unless the underlying issues are han\nISSUES\ndled in another forum, many more cases can be expected.\nLegislation\nState legislatures provide another arena for dealing with issues of\nauthority and responsibility for conversions. In the past two years\nmany state legislatures have considered, and a few have passed\nlegislation to govern conversions.\nNebraska. In April 1996 Nebraska's governor signed the Non-\nprofit Hospital Sale Act into law.³ It arose in response to a proposed\nacquisition by Columbia/HCA of Clarkson hospital and the commu-\nnity's and state assembly's fears that local interests would lose con\ntrol over health care services to non-Nebraskans.\nUnder the new law, persons engaging in acquisitions of hospitals\nmust apply to the attorney general and the director of the Depart-\ndoner\nment of Health for approval. The regulators have ninety days follow-\nibe\ning receipt of a complete application to approve or disapprove the\nAft\nacquisition. Although the new statute has not been tested, it has\nplan\nlikely served to deter proposed mergers. Consumer groups point to\nofficia\nit as containing language that could form the basis of a national\nprovide\nmodel.\nvoted\nCalifornia. On 1 January 1996 a new California law went into\nreap\neffect governing conversions of nonprofit health care service plans.\"\nvalua\nThe law was enacted following great publicity about the conver-\nTh\nHEALTH AFFAIRS - Volume 16, Number 2\nHEA\nEXPERIENCE\n: trust law was\nsions of enormous entities such as Blue Cross and Health Net and\n: policyholders\nclaims that those conversions were processed without consistency\ntrue. It also is\nor reason because of ambiguity in the law.³⁸ The law's enactment\nansaction as a\nalso was influenced by claims that the conversions had resulted in\ner department\ngross undervaluations and enrichment of certain persons.\nplan may face\nThe new law requires that covered plans file applications with\nthe commissioner of corporations to establish their compliance with\nanswer to this\nthe law. The commissioner is empowered to disapprove applica-\nent of Insurance\ntions if the law is not followed and may consult other branches of\nak to undertake\ngovernment in reviewing an application for a conversion. The new\nrsion, requiring\nlaw is clearly rooted in charitable-trust principles and requires con-\nit principles, is\nverting HMOs to donate assets equal to their fair market value to an\nindependent foundation. The foundation must use those assets for\nbose unresolved\nserving the health care needs of the people of California, be free of\nHowever, litiga-\nconflicts of interest, and file postapproval reports showing contin-\nlegal principles\nued compliance with state law. The attorney general is charged with\npeals to higher\noverseeing the new foundations.\ne a clear picture\n51\nColorado. When the Colorado Blue Cross plan first contem-\nsponsibilities of\nplated conversion, it sought and gained passage of a law permitting\ny case has been\nit to mutualize. But, in 1995, beleaguered by bad press and lost\ngn issues are han\naccounts, the plan expressed interest in figuring out a direct path to\nCONVERSIONS\n65\nected.\nbecoming a stock company. It conveyed that interest to the insur-\nance department, and negotiations began. The Blue Cross plan even-\ntually conceded the application of charitable trust issues and the\ng with issues of\nnecessity of establishing a foundation for its assets.\ne past two years\nIn June 1996 the governor of Colorado signed into law an act\new have passed,\ncodifying negotiations between insurance officials, legislators, and\nthe state's Blue Cross plan. This law requires Blue Cross to file a\nsigned the Non,\nconversion plan with the commissioner for approval. The conver-\nise to a proposed\nsion plan must meet prescribed criteria relating to the transaction,\nand the commu\nthe obligations of the Blue Cross plan, valuation, and inurement. The\nwould lose con-\ncommissioner must approve the completed plan if he or she finds\nthat it meets the statutory criteria. However, the law gives much\ntions of hospital\ndiscretion to the commissioner. Among the criteria for the commis-\nor of the Depart\nsioner's review is that the plan \"will not be prejudicial to the sub-\nnety days follow\nscribers of the corporation or the citizens of the State of Colorado.\"\nor disapprove the\nAfter state officials in Nevada approved a merger of that state's\nen tested, it ha\nplan with the Colorado plan, the Colorado plan filed with its state\nT groups point\nofficials to convert formally to a stock company. The Colorado law\nasis of a nationa\nprovides for the value of the assets of the Colorado plan to be de-\nvoted to public purposes. Therefore, the citizens of that state may\nnia law went int\nare service plans,\nvaluation. reap a windfall with the inclusion of the Nevada plan's assets in any\nabout the conver\nThe laws adopted in Nebraska, California, and Colorado settle\nEALTH AFFAIRS March/April 1997\nCONVERSIONS\nmany of the important issues raised by conversions, including\nauthority of regulators to review proposed transactions, the prod\nfor review, and the charitable and fiduciary obligations of the pan\nto conversions. The apparent success of these states in clarify\nthese issues may mean that their laws will become models for oth\nstates as they grapple with proposed conversions.\nConclusion\nSubstantial variation among the states in the processing of conv\nsions reflects a diversity of experience, expertise, and politic\npower. It also reveals an area of law that is not clear enough to de\nwith a contentious social issue involving hundreds of billions\ndollars and the future delivery and financing of health care. TH\ncourts are a particularly poor place in which to resolve these issue\nLegislation has no guarantee of being rational, but it does permi\ndiscussion of a broader range of social and economic issues. Mos\nstates could benefit from legislation that clarifies the issues. Unles\nthat legislation is aimed at a particular transaction, it will need to\nbased on a functional approach that gives regulators some discretion\nAt a minimum, new laws should address the following issues:\n66\nSTATE\nway to ascribe ownership to nonprofit entities; a delineation of the\nISSUES\napplicable theory (charitable trust or another doctrine); harmoniza\ntion between conversion law and all other outstanding laws; clarifi\ncation of the role of public officials; a statement of who is entitled to\nthe assets of the converting entity and the method by which they\nshould be valued; a description of the responsibilities of the result\ning nonprofit or foundation; and a statement of rules governing\ninurement. The legislation also should include an enumeration of\nthe procedural rights to which members of the public are entitled in\nthe conversion process. The critical role that particular regulators\nplay should be encompassed in a framework that includes broad\npublic participation in resolving issues.\nNOTES\n1. As we shall see, the decision over whether a nonprofit is a charity will funda-\nmentally affect the outcome of the conversion.\nS\n2. Interestingly, some attorneys general have expressed the concern about enact-\ning \"clarifying\" legislation. They fear that legislation that defines their powers\nwith respect to charitable entities might only constrict what they regard to be\nsingularly broad common-law authority. For that reason, they often have\n16. 1\nsought to insert into proposed legislation a clause stating that nothing in the\nlegislation interferes with or diminishes their common-law authority.\n3. Federal tax law is an important adjunct to state law for many conversion\nissues, particularly those related to foundations. Its enforcement may, how-\never, fall through the cracks as state officials oversee conversions but can\n17.\nseldom seek to enforce federal tax law.\n4. Not surprisingly, no independent writer has yet tackled the job of producing\nHEALTH AFFAIRS - Volume 16, Number 2\nHE\nCONVERSIONS\nABSTRACT: The increasing number of nonprofit hospitals and health\nconverting to for-profit enterprises, public concern, and media attention\nbrought conversions to the top of state policy agendas. Conversions raise\npolicy issues because nonprofit corporations' legal status obligates the\noperate in the public interest, their tax subsidies should not inure to the be\nof private interests, and they often represent unique community resou\nproviding valuable services. This paper describes legal authority that states\nuse to oversee conversions and outlines several policy issues facing\nregulators that could be addressed by new legislation.\nESPITE LONG-STANDING AUTHORITY over charital\nD\ntrusts, attorneys general and insurance regulators have or\nrecently begun to examine conversions of nonprofit hospit\nand health plans to for-profit status. This paper describes existit\nand newly enacted legal authority that states can use to overs\nconversions and outlines fifteen policy issues facing state regulato\nthat could be addressed by new legislation.¹\nTraditional State Regulatory Authority\nState attorneys general historically have been responsible for enford\ning the body of law that applies to nonprofit hospitals and health\n70\nSTATE\nplans, including enabling statutes for nonprofit corporations that\nISSUES\nexist in most states and the common-law doctrine of charitable\ntrusts.² According to common law, the creation of a nonprofit or\nganization with charitable or other social welfare purposes results\nin a charitable trust that is irrevocably dedicated to the organiza\ntion's original mission.³ The organization's trustees are supposed to\nseek court approval if they wish to deviate from these purposes. On\nbehalf of the general public, attorneys general may sue to safeguard\nthe value of charitable assets and ensure that charitable organiza\ntions maintain their intended community benefit, such as the con\ntinuation of essential services.\nApplication of some of these laws is sometimes unclear. For ex\nample, although Blue Cross and Blue Shield plans were originally\nnonprofit corporations, they might not be chartered to serve \"chari-\ntable\" purposes, which makes it less certain whether they should be\nregulated under common-law charitable trust principles. In joint\nventures, in which a nonprofit and a for-profit appear to contribute\nand govern equally, the for-profit can actually gain control, but such\nventures may not be defined as conversions under existing law.\nSeveral attorneys general have become involved in hospital con-\nversion cases. For example, the Michigan attorney general recently\nobtained an injunction to prohibit Columbia/HCA from consum-\nmating a joint venture with a nonprofit hospital.⁵ In addition to\nrequiring creation of a charitable foundation, the Massachusetts\nHEALTH AFFAIRS - Volume 16, Number 2\nSTATE POLICY ISSUES\nalth plans\nattorney general has ordered for-profit successors acquiring non-\nntion have\nprofit hospitals to provide charity care and emergency services to\naise public\nthe community for specified periods of time and payment for his\nes them to\nstaff to monitor compliance with these obligations.6 The Tennessee\nthe benefit\nattorney general entered into a consent decree with parties propos-\nresources\ning the sale of a nonprofit hospital to a for-profit firm that included\nstates can\ncreation of a charitable foundation and established conflict-of-interest\nacing state\nprotections and accountability requirements for the foundation's\nboard.⁷ And in Texas the attorney general helped to negotiate an\nharitable\nagreement under which hospitals in Houston's Texas Medical Cen-\nhave only\nter must obtain permission from both the center's board and the\nhospitals\nattorney general before entering into joint ventures with for-profit\nS existing\ncorporations.8\n0 oversee\nSomewhat less successful attempts have been made by state regu-\nregulators\nlators to supervise conversions of Blue Cross or Blue Shield plans to\nfor-profit firms. After several years of negotiations, in 1996 the Cali-\nfornia commissioner of corporations required Blue Cross to create\ntwo foundations with combined assets of $3 billion.9 The Missouri\nor enforc-\ninsurance director recently won a case against a Blue Cross mutual\nnd health\nbenefit plan that transferred most of its assets into a for-profit sub-\ntions that\nsidiary (a part of which was sold to the public). On the other hand,\nCONVERSIONS\n71\ncharitable\nthe Virginia legislature voided negotiations between the attorney\nprofit or-\ngeneral and Blue Cross to create a community foundation when the\nes results\nplan converted first to a mutual benefit corporation and then to a\norganiza\nfor-profit firm; the legislature instead required that stock be issued\npposed to\ntopolicyholders and a payment made to the state treasury.\"\nposes.4 On\nsafeguard\nRecent State Legislation\norganiza\nUthough common law and existing state nonprofit corporation\nS the con,\nWS provide regulators with general jurisdiction to oversee many\nhospital conversions, some state regulators have found that their\ntr. For ex\nuthority over conversions is unclear. For example, some attorneys\noriginally\neneral believe that their authority is limited to litigation to stop\nve \"chari\ninversions that are under way rather than issuing advance ap-\nshould be\noval. Furthermore, Blue Cross conversions sometimes raise\nS. In joint\nque jurisdictional issues. Also, authority for oversight of hospital\ncontribute\naversions does not necessarily include authority over advance\n1, but such\notice, public hearings, or the use of resources for an independent\nJn law.\nvaluation, or the right to impose specific community obligations on\npital con\nther foundations or the successor for-profit entities. Conse-\nil recently\nently, several states have enacted explicit laws to prescribe proce-\n1 consum\nto review conversions; and other laws are under consideration.\nddition\nHospital conversion laws. In 1996 the California legislature\nsachusetti\ncted a statute confirming the attorney general's jurisdiction over\nHALTH AFFAIRS March/April 1997\nCONVERSIONS\nplan to inform the general public and the plan's subscribers. After\npublic hearing, the commissioner may approve the plan if it is fail\nand reasonable and not contrary to law or the interests of subscrib\ners, contract holders, or the public. The fair market value of the\nassets must be conveyed to one or more foundations, which are\nindependent of both the new stock corporation and the former non\nprofit's officers, directors, or staff, and must be used to promote of\nserve the health needs of Coloradans.\" Blue Cross directors, officers\nand employees cannot receive any compensation related to the con\nversion. For three years after the conversion, the new corporation is\nprohibited from lowering the value of any stock held by the founda\ntion by issuing stock with greater dividends or voting rights.\nConversion Legislation: Policy Issues\nExplicit statutory authority can help to resolve ambiguity in\ncommon-law standards or states' nonprofit corporation codes\nwhich often address sales or dissolutions but not partial transfers or\nmultistage arrangements. Clarification is particularly useful in the\ncase of Blue Cross conversions because of these plans' varying tax\nstatus and different structures (nonprofit or mutual) in many states.\n74\nSTATE\nHowever, while specific statutory standards can guide regulators\nISSUES\n(for example, to assure that all conversions actually are reviewed), it\nmay be useful to provide regulatory flexibility on some issues (for\nexample, in determining exactly what constitutes a conversion, im\nposing conditions on successor for-profit organizations, or valuing\nassets) in view of the widely varying arrangements likely to emerge\nin the unpredictable and fast-changing health care environment. Il\nset out here fifteen policy questions for consideration.\nWhat entitles should be subject to a conversion law? Most\nstatutes have been drafted to address hospital and health plan con\nversions separately, perhaps because of the kinds of conversions\nthat have received most attention in the state. Separate laws may be\nappropriate, for example, in California, where different agencies are\nresponsible for supervising each type of organization. But because\nhealth plans may acquire interests in hospitals and hospitals may\nacquire or create health plans, conversion laws should be drafted, as\nproposed in Ohio, to apply to relationships among all types of health\ncare entities that ever had a federal tax exemption (including Blue\nCross and Blue Shield plans, which lost their federal tax exemptions\nin 1986).22 Because tax-exempt health plans have had different pub-\nlic missions than most nonprofit hospitals have had, a regulator\nmight impose different obligations on one type of organization than\non the other but should have the authority to review all of them.\nHow should conversion be defined? A fundamental issue in\nHEALTH AFFAIRS - Volume 16, Number 2\nSTATE POLICY ISSUES\n.fter a\nenacting a conversion law is defining the activities subject to the\nis fair\nreview procedure. Conversion occurs when a nonprofit provider or\nscrib-\nplan changes its form of ownership to for-profit status or cedes a\nof the\nconsiderable amount of control over its assets or activities to a for-\nh are\nprofit firm (even if a nonprofit shell remains). Because of the varied\nnon-\nways in which conversions can be designed (including not only\note or\nmergers and total acquisitions but creation of a for-profit subsidiary\nficers,\nand various levels of joint ventures), a functional definition may be\n= con-\nmore useful than a narrow structural one. For example, the defini-\nion is\ntion of conversion in California's hospital conversion law (a sale of\nunda-\nor transfer of control over a material amount of assets to a for-profit\ncorporation or mutual benefit plan) allows an examination of the\nactual effect of a proposed change. On the other hand, the Nebraska\nlaw's definition (ownership change of at least 20 percent or the\nty in\npurchaser owning at least 50 percent of the hospital) requires less\nodes,\nregulatory discretion but is easier to evade by a transaction that\ners or\ntransfers just less than the defined amounts of control. Furthermore,\nn the\nto apply to a hospital or health plan conversion that occurs in a\ng tax\nseries of small steps, a definition should include all transactions over\ntates.\nseveral previous years. California's health plan conversion law, for\nlators\nexample, appears to allow the corporations commissioner to treat a\nCONVERSIONS\n75\ned), it\nseries of related actions as a restructuring.\nS (for\nWith respect to health plans such as Blue Cross, policymakers\n1, im-\nshould decide whether becoming a mutual insurer constitutes a\nluing\nconversion subject to state review (as California's law provides).\nnerge\nThis issue is important because mutualization may precede change\nent. I\nto for-profit status, at which point it may be much more difficult to\nrequire a set-aside of assets, because a mutual benefit company may\nMost\nnot be viewed as having a \"charitable\" purpose or obligation.\ncon-\nWhich agency or agencies should regulate conversions?\nsions\nAttorneys general historically have been responsible for supervising\nay be\nchanges of mission and dissolutions of nonprofit organizations. Al-\nes are\nthough some have been more active than others, there does not\ncause\nappear to be any justification for changing their traditional role.² It\nmay\nmay, however, be appropriate to add review responsibilities for\ned, as\n(other state agencies with more expertise on issues raised by health\nealth\n(care organization conversions. For example, insurance regulators\nBlue\nhave experience in overseeing the operation of health plans, includ-\ntions\ning Blues plans, and should be involved in reviewing proposed\npub-\nhealth plan conversions. Because conversions may raise issues of\nlator\nhealth care access, costs, and financing, departments of health or\nthan\nother agencies with expertise in these matters, including certificate-\n1.\nof-need review, could be charged with reviewing such aspects of\nue in\nproposed hospital or health plan conversions. The lead agency could\nEALTH AFFAIRS March/April 1997\nCONVERSIONS\nOLIC\nbe authorized to consult with all interested state agencies, althou\nasse\ntimely cooperation is most likely to occur if each agency's respon\nsale ]\nbilities are set out in the law (and if, as discussed below, sufficie\nhose is\nresources are provided to carry them out). Unfortunately, sta\nsub\nagencies may have conflicting political interests, as, for examp\nthe\npro\nwhen an attorney general and the governor or an elected insurance\nexplici\ncommissioner come from different political parties.\nmay\nA related issue is whether private parties, such as policyholder\npropri\npotential beneficiaries of a charitable foundation, or members of\nthat\ngeneral public, should be given authority to enforce charitable tru\nefore t\nobligations or state conversion laws if state officials fail to do\nWhat op\nSome state laws allow individuals to act as \"private attorneys gen\nnverslo\neral\" and bring lawsuits in the public interest, usually after provid\nnd Mass\ning the attorney general an opportunity to pursue the case.²⁴\nind supp\nShould an Informal review process be avallable before\nonversio\npublic review? A prime objective of recently enacted conversion\nSugh stat\nlaws is to bring these proposals to public attention because of the\nIng the pu\nbroad community interest in nonprofit provider and health plan\nsponsibi\nassets and activities. Parties to these transactions may seek informal\nProcess is\ndiscussions with state regulators, particularly to explore whether\nmany \"pub\"\n76\nSTATE\nthe proposed action would constitute a conversion and examine\nthere ma\nISSUES\nother matters that may be controversial. One precedent for informal\nved by dif\nreview preceding the public process is antitrust enforcement, where\nin's policy}\nthe federal and many state enforcement officials will discuss pro-\nVerse views\nposed transactions and even issue formal opinions (business review\ncond, the 1\nletters). On the other hand, such an informal review of conversion\nhay create th\nproposals should not in any way be allowed to nullify or dilute the\nne) and full\nprocess of public scrutiny.25\nthese pr\nWhat provisions should be made for advance notice to\n27 Althou\nregulators and the public? One of the reasons for enacting explicit\nHetary, offi\nconversion laws is to assure that regulators are aware in advance of\n28 An op\nproposed conversions so that they can conduct a meaningful review\niscuss and\nand inform interested members of the public. The California hospi-\nealth care\ntal conversion statute requires sixty days' advance notice; other\nome nation\nrecent laws require advance notice but do not specify a time frame.\nible sophist\nThe attorney general's inherent power to supervise charitable trusts\nprovide usel\nis meaningless without advance notice because it is very difficult to\nprocess may\nundo these arrangements after contracts have been signed.\nnonprofit, V\nWhat conversion Information should be made public? Be-\nWhat\ncause conversions are often conducted behind closed doors, an im-\ncal issue th\nportant issue is the extent to which details of the plan are matters of\nreview pro\npublic record. Parties to a transaction tend to argue for secrecy in\nfor interest\norder not to jeopardize the deal (and attorneys general's investiga-\nlegislative\ntional files often are exempt from state public record acts). But\nspectrum\nHEALTH AFFAIRS - Volume 16, Number 2\nHEALTH\nSTATE POLICY ISSUES\nulthough\nconsumers assert that the purchase price, governing arrangements,\nesponsi-\nand use of sale proceeds should be public. Recent conversion laws,\nufficient\nsuch as those in California, Colorado, and Nebraska, state, that all\nly, state\ndocuments submitted in the conversion application (including de-\nexample,\ntails of the proposed transaction) must be in the public record.\nisurance\n(Unless explicitly addressed in law, however, conversion plan re-\ncords still may be exempt from disclosure as state investigational\nvholders;\nfiles or proprietary information.) California law also specifically\ners of the\nprovides that these records must be made available at least one\nble trust\nmonth before the public hearing on the conversion plan.\nto do so:\nWhat opportunities should be made for public Input Into\neys gen\nthe conversion review? In several states, such as California, Colo-\nr. provida\nrado, and Massachusetts, consumer advocates have actively encour-\n24\naged and supported state regulatory review of hospital and health\ne before\nplan conversions as well as legislation to clarify the review process.²⁶\nonversion\nAlthough state attorneys general are explicitly charged with repre-\nise of the\nsenting the public interest, and other regulators generally have simi-\nalth plan\nlar responsibilities, a specific role for public input into the conver-\ninformal;\nsion process is important for several reasons. First, there are likely to\nwhether\nbe many \"publics\" with different interests (beyond the \"general pub-\nexamine\nlic,\" there may be potential beneficiaries of a foundation, persons\nCONVERSIONS\n77\ninformal\nserved by different activities of a converting nonprofit hospital, a\nnt, where\nplan's policyholders, or a provider's or plan's employees), and their\ncuss pro-\ndiverse views are more likely to be heard through a public hearing.\nSS review\nSecond, the large amounts of money involved in these transactions\nonversion\nmay create the appearance of a conflict of interest (if not an actual\ndilute the\none), and fully open proceedings can encourage regulators to scruti-\nnize these proposals carefully and reassure the public that they are\nnotice to\nfair.\" Although some details of conversion proposals may be pro-\ng explicit\nprietary, offices of attorneys general report that they are likely to be\ndvance of\nfew.28 An open process provides an opportunity for policymakers to\nful review\ndiscuss and receive feedback on the implications of the proposal for\nnia hospi\nhealth care access and costs. Another value of public input is that\nice; other\nsome national and local consumer groups have developed consider-\nme frame\nable sophistication and expertise in reviewing conversions and can\nble trusts\nprovide useful technical input to state regulators.29 Finally, a public\nifficult to\nprocess may encourage other prospective purchasers to bid for the\nnonprofit, which makes it easier to value the assets.\niblic? Be\nWhat type of public hearing should be required? A techni-\nrs, an im\ncal issue that may have important consequences for the conversion\nmatters of\nreview process is the nature of the public hearing. An opportunity\nsecrecy in\nfor interested persons to comment and ask questions, similar to a\ninvestiga\nlegislative hearing, can be useful for obtaining input from a broad\nacts). But\npectrum of the public. A more formal (\"quasi-judicial\") hearing\nHEALTH AFFAIRS March/April 1997\nCONVERSIONS\ninvolving prepared statements by designated parties, invited\nnesses, and cross-examination (often the model used when in\nance regulators are investigating insurer misconduct) may pro-\nmore focused information to the decisionmaker, but it may redi\nthe opportunity for input from the general public. The type of h.\ning also is likely to determine who has a right to appeal the regi\ntor's final decision and whether an appeal can be made to a count\nanother administrative agency.\nWhat authority should regulators have to Impose con\ntions on the partles to a conversion? In addition to supervis\nthe disposition of the nonprofit provider's or plan's assets, sb\nregulators may want to impose conditions on the nonprofit (if\ncontinues to exist in some form) or the for-profit successor.\nexample, a for-profit hospital could be required to provide a certar\namount of charity care or to maintain an open emergency depar\nment (as the Massachusetts attorney general has required in son\nconversions). A health plan might be required to continue to,s\ncommunity-rated policies. One criterion the state can use under\nNebraska hospital conversion law is the purchaser's continued obf\ngation to serve disadvantaged and uninsured persons.³¹ Althoug\n78\nSTATE\nsuch obligations might not be needed in all cases, authority to in\nISSUES\npose them should be included in a conversion law, because without\nexplicit jurisdiction, an attorney general may feel unable to regular\nthe for-profit successor.³²\nHow should the converting nonprofit provider's or plan!\nassets be valued? One of the most contentious issues in a conver\nsion review is the valuation of the nonprofit's assets, which deten\nmines the amount of resources that must be set aside in a foundation\nor other organization to continue the nonprofit's mission and, in the\ncase of mutual insurers, transferred to policyholders. The extent to\nwhich the nonprofit is undervalued eventually will inure to the\nbenefit of private individuals. When several nonprofit California\nHMOs became for-profit firms in the 1980s, their successor founda\ntions received a fraction of the value that shareholders held after the\nconversion.\" Consequently, the proposed purchase price should not\nbe taken as the best measure of a nonprofit's value. Regulators\nshould be encouraged to consider multiple approaches to valuation,\nincluding the value of assets (both tangible and intangible, such as\ntrademark, reputation, provider contracts, subscriber lists, and gen-\neral benefits to the community), multiples of earnings over several\nyears, discounted cash flow, and future cash-flow projections that\ntake changing market conditions into account.³⁴ The price that the\nnonprofit would bring in an open, competitive market is difficult to\ndetermine because there are often no competing bidders, but the\nHEALTH AFFAIRS Volume 16, Number 2\nSTATE POLICY ISSUES\ninvited wit-\npotential for competition is another reason that the conversion re-\nwhen insur-\nview process should be public.\"\nmay provide\nBecause few state officials have expertise in valuing these types of\nit may reduce\nassets, they will need the assistance of consultants such as invest-\ntype of hear-\nment bankers, accountants, and actuaries. Conversion laws should\ncal the regula}\nauthorize the use of such outside experts and the ability to charge\ne to a court or\ntheir costs to the nonprofit applicant (as provided in the California,\nColorado, and Nebraska laws).\nnpose condi\nWhat entity should receive the former nonprofit's assets?\nto supervising\nThe typical model is to create a new charitable foundation to receive\nS assets, state\nthe assets of the former nonprofit entity and use them for continued\nnonprofit (if it\npublic benefit. Other possible recipients are an existing community\nsuccessor. For\nfoundation or a government agency. A key consideration in deciding\novide a certain\nwhich type of organization can best carry on the nonprofit's mission\nrgency depart\nis how to ensure that the funds are used for the desired purposes.\nquired in some\nFor example, to reduce the costs of administrative duplication, as-\nontinue to sell\nsets could be transferred to an existing community foundation with\n1 use under the\nthe same objectives as the former nonprofit organization and ear-\ncontinued obli.\nmarked for specific purposes, perhaps with some commitment to\nons.³¹ Although\nreport to state agencies on their use. Alternatively, a government\nuthority to im\nhealth program might be an appropriate recipient, since foundations\nCONVERSIONS\n79\necause without\nrarely fund direct services, which might be the desired use of funds\nable to regulate\n(for example, from a hospital that provided a large amount of charity\ncare). Because public agencies do not generally use the interest from\nder's or plan\nan endowment and might consume the assets more quickly than a\nues in a conver\nfoundation would, assets could be set aside in a public program that\nS, which deter\nis responsible for preserving the principal and using the interest for\nin a foundation\nthe designated health care purpose.\nssion and, in the\nHow should a successor foundation be structured? One\nS. The extent\nway to ensure that the new foundation remains independent from\nill inure to the\nboth the nonprofit and for-profit entities would be to engage sepa-\nrofit Californi\nrate counsel to represent the foundation during its initial develop-\nccessor foundi\nment and to help the foundation to define its purpose, tax status,\n:rs held after th\nand board membership.\nprice should no\nPurpose. Should the foundation have the same purpose as the non-\ndue. Regulator\nprofit, or a different purpose? By common law, a nonprofit organiza-\nhes to valuation\non whose purpose became impossible or impractical was required\ntangible, such\nSadopt a purpose as close as possible to its original mission. This\ner lists, and ge\npproach may be undesirable in health care organization conver-\nings over seven\nons because of the difficulty of determining the nonprofit's precise\nprojections the\naissions and because the community may not need hospital care, for\nhe price that\ntample, because of overcapacity. A successor foundation could be\nket is difficult\nuthorized to serve a broader mission (promoting the health needs\nbidders, but\nstate or community residents, health professional training, or\nEALTH AFFAIRS March/April 1997\nCONVERSIONS\npublic health education) or a narrower one (charity care to unit\nsured or underinsured persons or health care services to children\nBecause some foundations have been created from hospital sales\ninclude nonhealth missions, a conversion law should define accep\nable parameters for the foundation's activities.³⁶\nTax status. Federal charitable tax-exempt status as an Intern\nRevenue Code section 501(c)(3) private foundation is advisable be\ncause of its limits on political activity and private inurement and\nrequirements for public accountability. On the other hand, the\norganizations may not hold more than 20 percent of a corporation\nvoting stock, and it may be desirable to transfer the assets of th\nnonprofit in the form of the new organization's stock as a way\nensure that they are fairly valued.\" For this reason, California\nhealth plan conversion law permits the temporary use of a 501(c)(4\norganization (whose stock ownership is unlimited) to gradualli\nmonetize the value of the stock, but it imposes restrictions on the\n501(c)(4) entity (regarding political activity, self-dealing, and publi\nreporting) similar to those under 501(c)(3).\nBoard membership. Some successor foundations have been manage\nby board members of the former nonprofit and/or the successo\n80\nSTATE\nfor-profit enterprise.³ However, these persons may have little expe\nISSUES\nrience in making grants. Furthermore, close ties with the for-profit\nfirm may lead to conflicts of interest. Conversion laws in California\nand Nebraska require independent foundation directors with ap\npropriate philanthropic experience, although defining what consti\ntutes an independent board can present a challenge. Other ques\ntions regarding board composition are how many directors the\nboard should include (some general state nonprofit laws permit\nfew as three, which may be too few to carry out the foundation'\nresponsibilities), and how they are selected both initially and there\nafter. An outside expert might be engaged to recruit and recommend\nmembership for the first board.\nHow can private Inurement from the conversion be\navolded? In addition to transferring assets to an entity such as\nfoundation that is totally separate from the nonprofit and for-profit\nentities, the conversion should not enrich individuals, such as em;\nployees, board members, or fiduciaries (attorneys, accountants, or\nother consultants) of either the nonprofit or for-profit parties to the\nconversion. Previous conversions have resulted in private inurement\nto stockholders when assets are undervalued and to employees and\nboard members who receive consulting fees, low-price stock op\ntions, or employment in the successor for-profit entity or founda?\ntion. Some foundations have given grants or other subsidies to the\nfor-profit purchaser that also suggest conflicts of interest or private\nHEALTH AFFAIRS - Volume 16, Number 2\nSTATE POLICY ISSUES\ninurement. Health plan conversion laws in California and Colorado\n(driven by publicity over high compensation to nonprofit board\nmembers approving these transactions) prohibit private inurement\nand conflicts of interest, as does Nebraska's hospital conversion law.\nHow should conversions be monitored over time? Estab-\nlishing that a conversion meets common law or statutory require-\nments for fairness to the public is not the only responsibility for\nstate policymakers. Regulators also need to monitor whether the\nparties to the conversion have met required conditions, such as the\nprohibition on private inurement and self-dealing or any charitable\nobligations, and whether the successor foundation maintains inde-\nbendence and carries out its mission. Enforcement of these condi-\nnons is another important but potentially underfunded longer-term\nfunction that could involve various state agencies. Remedies such as\nfines and license revocation could be useful enforcement tools. It\nseems likely that an attorney general or insurance regulator can\nrequire reports on these matters under his or her inherent oversight\nauthority and as a condition for approving a conversion. To avoid\naged\nany uncertainty over this authority, state conversion laws should\nSSOP\ninclude an explicit reporting requirement, like those in California\nand Nebraska.\nCONVERSIONS\n81\nrofit\nWhat resources might state regulators need to Implement\nconversion law? Because of the expertise and time needed to\ndequately review a proposed hospital or health plan conversion\nmd to monitor compliance with the conditions of approval, state\nues\negulators are likely to need additional resources to carry out their\nsponsibilities under both current and newly enacted laws. In\nit\ntates with a great deal of conversion activity, attorneys general,\nion'\ninsurance commissioners, and state departments of health may need\nhere\naditional staff to process applications and evaluate their impact on\nffected communities. They also will need proficiencies not gener-\nШу used in state agencies, particularly to assess the fairness of the\nn\nSnprofit's asset valuation. Such competence is especially impor-\nas\nnt given the high level of expertise that the parties to a conversion\norofi\nafford to hire. In view of state budget constraints, it seems most\npropriate to permit state regulators to assess the nonprofit or-\nts,\nhization applying for conversion or the for-profit purchaser for\no\n6th the costs of engaging outside experts and the reasonable direct\nsts of reviewing and evaluating the application. Colorado's health\nS\nconversion law permits charging the cost of hiring experts,\nk\nhereas California's hospital and health plan conversion laws pro-\nund\nthe broader authority to charge all reasonable agency review\n0\nto the applicant. An alternative under consideration in Massa-\njusetts would permit charging costs to the for-profit purchaser to\nALTH AFFAIRS March/April 1997\nCONVERSIONS\npreserve the nonprofit's assets.\nConclusion\nConversions of nonprofit hospitals and health plans pose a ma\nchallenge for state health policymakers, who are obligated to enst\nthat charitable assets remain to serve the public. The public inter\nin a nonprofit hospital or health plan's assets justifies a fair and op\npublic process to review conversions. While public attention\noften piqued by the media's focus on windfall gains to nonpro\nboard members or executives, the real focus should be on how\nachieve sound health policy for the communities served by organiz\ntions proposing to convert. For-profit organizations may add vali\nby improving efficiency and paying taxes, but at the cost of losing\ninstitution that is uniquely dedicated to serving community need\nThese discussions can become contentious because they invol\noften strongly held views (not easily grounded in scientific eviden\non organizational performance) about the value of for-profit or nor\nprofit organizations. Yet philosophical debates may be moot if th\nincreasingly competitive U.S. health care environment is discoura\ning both nonprofit and for-profit hospitals from providing unprofit\n82\nSTATE\nable services that benefit the community or from serving person\nISSUES\nwho are unable to pay.\nIn drafting legislation and defining transactions subject to publi\noversight, policymakers need to be vigilant for new arrangement\nthat may fall just outside legal boundaries. One of the few certaintie\nin the unpredictable and fast-paced health care marketplace is that\nplans and providers will try to craft ventures to meet both explici\nand implicit corporate goals while avoiding regulatory oversight.\nThe author is grateful to Kim Belshé, Eileen Cody, Jack Ehnes, John McDonough\nElizabeth Mitchell, Linda Miller, David Schactman, and Steve Wessler for their\nvery helpful editing suggestions.\nNOTES\n1. See P.A. Butler, Profits and the Public Interest: A State Policymaker's Guide to Non\nProfit Hospital and Health Plan Conversion (Portland, Maine: National Academy for\nState Health Policy, 1996).\n2. D.M. Fox and P. Isenberg, \"Anticipating the Magic Moment: The Public Inter\nest in Health Plan Conversions in California,\" Health Affairs (Spring 1996);\n202-209; E. Hamburger, J. Finberg, and L. Alcantar, \"The Pot of Gold: Moni-\ntoring Health Care Conversions Can Yield Billions of Dollars for Health Care,\nClearinghouse Review (August/September 1995): 473-504; and A.W. Scott and\nW.F. Fratcher, The Law of Trusts (Boston: Little Brown, 1989), sec. 399.\n3. 18 Am. Jur. 2d Corporations, secs. 32-33 (1985); Greil Memorial Hospital V First\nAlabama Bank, 387 So. 2d 778 (Ala. 1980); and Queen of Angels Hospital V Younger, 136\nCal. Rptr. 36 (Cal. App. 1977).\n4. In a proceeding called cy pres, a court must determine that it is impossible or\nHEALTH AFFAIRS - Volume 16, Number 2\nCONVERSIONS\nABSTRACT: Conversions raise two critical policy questions: First, does ownership\nform (nonprofit or for-profit) make any difference to delivery of health care?\nSecond, when conversions occur, how are charitable assets and purpose pre-\nserved? This paper addresses both questions, based on a review of evidence and\nexperience. On the first question we conclude that, overall, nonprofit ownership\nenhances the potential for community benefit. However, that potential may be\nbetter realized by requiring nonprofits to meet minimum community benefit\nstandards and possibly by mitigating pressure on institutions to convert. On the\nsecond question, we conclude that more states should take legislative action to\nestablish a formal oversight process for conversions. Without public considera-\ntion of how much money to set aside and for what purpose, conversions pose the\nrisk that communities will lose significant services and resources.\nERHAPS NO HEALTH SYSTEM change arouses more emotion\nP\nand less rational policy discussion than the conversion of hos-\npitals and health plans from not-for-profit to for-profit status.\nAlthough the nation's hospitals and hospital beds remain over-\nwhelmingly not-for-profit and only a handful of Blue Cross/Blue\nShield plans have actually converted to for-profit status, nonprofit\nhospitals and health plans confront an increasingly competitive\nmarketplace and aggressive acquisition strategies by for-profit\n10\nOVERVIEW\nchains. Furthermore, the magnitude of the dollars at stake ($3 bil-\nlion in one Blue Cross conversion alone) makes the amount of public\nattention both understandable and appropriate.\nAttention, however, is not the same as thoughtful consideration.\nThe purpose of this paper is to encourage a thoughtful public dia-\nlogue by providing an overview of the issues that conversions raise\nfor the health care and health insurance systems. Our aim is to\nclarify what public policy issues are at stake. The paper addresses\ntwo fundamental questions. The first is whether tax status makes\nany difference to the delivery of health care or health insurance. If\nnot, tax policies conferring nonprofit status may warrant adjust-\nment or reconsideration. If SO, the desirability or the terms of con-\nversions come into question. The second question is how to regulate\nthe conversion process to protect charitable assets. When charita-\nble organizations convert to for-profit status, charitable trust law\nrequires that the value of those assets be set aside for charitable\npurposes (usually in a foundation) and not inure to the benefit of\nindividuals. But who is subject to charitable trust law, how much\nmoney is set aside, and how those funds are used are public policy\nissues of major procedural and substantive concern.\nBackground\nWe define conversion as any type of transaction that results in the\nshift of all or a substantial portion of the assets of nonprofit health\nHEALTH AFFAIRS - Volume 16, Number 2\ngary\nSteve\nPUBLIC POLICY OVERVIEW\nFeinman\ncare organizations to for-profit use. Conversions range from rela-\ntively simple transactions in which nonprofits' assets are exchanged\nat arm's length for cash to far more complicated transactions involv-\ning multiple organizational components, interlocking organiza-\ntional structures, and complex financial arrangements. The follow-\ning are some examples of the possible types of transactions.\nAsset sales. A common and straightforward form of conver-\nsion is asset sales. In such arrangements a nonprofit organization\ntypically sells its physical assets (such as a hospital plant), its name,\nand its accounts to a for-profit purchaser in exchange for cash,\nstock, notes, or other property. The proceeds of such a sale are\ngenerally received by a nonprofit foundation, which may be the\noriginal organization or a new nonprofit entity established to re-\nceive the proceeds of the sale.²\nJoint ventures. A more complicated type of transaction that\nmay result in a conversion is a joint venture. For example, a non-\ndoes the\nprofit hospital and a for-profit hospital organization might form a\nfor-profit partnership whose purpose is to offer hospital services.\nfornda time\nThe nonprofit contributes its hospital assets to the partnership in\nget cash? any\nexchange for cash and an ownership interest (say, 20 percent) in the\nnew venture. The for-profit contributes cash to the venture) (equal to\nCONVERSIONS\n11\n80 percent of value of the hospital assets) and receives ownership\ninterest (80 percent) in the venture.³ Proceeds of the transfer of a\nnonprofit's assets generally are placed in a nonprofit foundation. In\nthis case, the foundation becomes the holder of the nonprofit's 20\npercent interest in the venture.\nThere are several interesting aspects to such a transaction. The\nfor-profit company gains effective control of the hospital's assets\n(that is, it owns 80 percent of the assets and has a contract to\nmanage the hospital) without having to pay their entire value. The\ntrustees of the former nonprofit hospital maintain substantial influ-\nence over the hospital's operation through their 50 percent repre-\nsentation on the venture's board. By accepting an ownership inter-\nest in the venture as part of the consideration for transferring its\nhospital assets, the nonprofit has in essence gone at risk for 20\npercent of the amount of its hospital assets. The total amount that\nthe foundation ultimately receives for the nonprofit hospital assets\nwill depend on the venture's future success.\nOther types of reorganization. Other types of transactions\nmay be conversions as well. For example, several Blue Cross/Blue\nShield plans have either implemented or proposed reorganization\nplans that call for the nonprofit health plan to transfer a substantial\nportion of its assets to a for-profit subsidiary. The subsidiary would\noffer stock to the public, resulting in partial public ownership of the\nHEALTH AFFAIRS - March/April 1997\nCONVERSIONS\nplan's assets. Most of the insurance operations would be carried out\nthrough the for-profit subsidiary, which would have the same man-\nagement as the nonprofit parent.\nWhether this type of transaction should be considered a conver-\nsion-that is, whether the core enterprise of the nonprofit organiza-\ntion has been transformed-has been a matter of dispute. In Califor-\nnia a proposed reorganization with a similar structure was initially\naccepted by regulators as a restructuring of the nonprofit health\nplan, but after concerns were raised by consumer representatives\nand others, regulators ultimately treated it as a conversion. Similar\ndisputes have occurred or are occurring in several other states, in-\ncluding Missouri and Maryland.\nScope of conversion activity. Conversion activity has pro-\nceeded at different paces and in different ways across nonprofit\nhealth care organizations. The distribution of hospital beds by own-\nership has remained markedly stable.4 In 1994, as in 1984, about 70\npercent of all beds were nonprofit, 20 percent were public, and 10\npercent were for-profit.⁵ Nevertheless, there has been significant\nchange in a number of states. In New Hampshire, Utah, Idaho, and\nNew Mexico the for-profit share of beds in 1994 was about 10 per-\n12\nOVERVIEW\ncent higher than in the previous decade. Perhaps more significant,\nafter more than a decade in which approximately nine hospital con-\nversions occurred per year, thirty-four occurred in 1994 and fifty-\nnine occurred in 1995.6\nConversion activity also has increased among Blue Cross/Blue\nShield plans. Historically, the Blue Cross and Blue Shield Associa-\ntion (BCBSA) required that licensees of its trademarks be nonprofit.\nThat requirement was eliminated in June 1994, to permit plans to\nbetter adapt to the changing marketplace and to obtain access to\nequity capital.⁷ Since the change, three of the sixty-three plans\n(Georgia, California, and Virginia) have converted to for-profit own-\nership. Other plans, including those in Colorado, Maryland, Massa-\nchusetts, New York, and Ohio, are considering conversions.\nThe health maintenance organization (HMO) industry presents a\ndifferent picture. That industry began as almost exclusively non-\nprofit-fueled in part by the availability of federal grants for non-\nprofit organizations and BCBSA policies. However, over the past ten\nto fifteen years the HMO market has become predominantly for-\nprofit. In 1981, 82 percent of HMOs (accounting for 88 percent of\noverall membership) were nonprofit.8 By 1995 the proportion of\nnonprofit plans fell to 29 percent (accounting for 41 percent of mem-\nbers).⁹\nFurthermore, among the more loosely integrated HMOs that are\ngrowing most rapidly, for-profit organizations are most prevalent.\nHEALTH AFFAIRS - Volume 16, Number 2\nPUBLIC POLICY OVERVIEW\n\"Conversions can provide nonprofit organizations access to capital,\nwhich is particularly important in a managed care environment.\"\nFor-profit plans now account for 76 percent of enrollees in open-\nended plans, compared with only 57 percent in pure HMOs.¹⁰\nAmong preferred provider organizations (PPOs), which also are\ngrowing rapidly, 80 percent of plans are for-profit.\"\nReasons conversions occur. In many cases, conversion is\nsimply the outcome of a consolidation strategy, rather than a spe-\ncific organizational goal. In other cases, nonprofit organizations\nmay see disadvantages to their ownership status and explicitly pur-\nsue a conversion strategy. Here we describe how market and institu-\ntional factors are contributing to the surge of conversions.\nAccess to capital. Conversions can provide nonprofit organizations\nwith access to capital, which they can use to restructure operations\nand put themselves in a better competitive position. Health plans\nhave followed this strategy for several years, beginning with conver-\nsions of several nonprofit HMOs in the mid- and late 1980s and\nfollowed by several Blues plan conversions in recent years. Access to\nCONVERSIONS\n13\ncapital is particularly important in a managed care environment, in\nwhich substantial investments may be necessary for information\nsystems, network development, utilization management, and ex-\npanding market share.\nEquity can be a cheaper method of raising capital than debt,\nparticularly for firms with good growth potential whose stock may\nbe valued at a high multiple of its current earnings. For-profit firms\ncan acquire competitors by issuing stock, thereby expanding their\nmarket shares without reducing their reserves or accumulating sub-\nstantial debt. Managed care plans have followed this strategy suc-\ncessfully in the past several years. For example, it is estimated that\nUnited Healthcare issued more than sixteen million shares of stock\nto finance acquisitions in 1994 alone.¹²\nEfficiency. Competitive forces in the marketplace have forced hos-\npitals and health plans to be more efficient, and many have sought\nefficiencies through consolidation via mergers and acquisitions. In\nthe hospital industry a large overcapacity of inpatient beds has rein-\nforced this trend. For-profit consolidation activity is likely to focus\non nonprofit institutions because the vast majority of hospitals are\nnonprofit.\" Many advocates of for-profits also contend that the re-\nsulting conversions enhance efficiency through the greater manage-\nrial skill and market responsiveness of for-profit operations.\nMarket share and growth strategies. In today's competitive environ-\nHEALTH AFFAIRS - March/April 1997\nCONVERSIONS\nment, increasing market share is often a necessary strategy. Hospi-\ndvant\ntals need increased market share to build networks that will guaran-\nPote\ntee patient flow and to increase their bargaining power with man-\nonsur\naged care plans and physician groups. Health plans seek to build\nantia\nlarge enough networks to serve regional and national employers and\ndons I\nto give them increased leverage in their negotiations with providers.\nous ca\nNetwork building is expensive and often is accomplished through\nto pur\nmerger and acquisition, regardless of organizational form. These con-\nvalue.\nsolidations often occur between nonprofits and for-profits and result\nbuyers\nin conversions. For-profits, because of their access to equity capital,\nAdvoc\nhave an inherent advantage in this realm.\nest ma\nFor investor-owned hospital chains, the dynamic of the stock\nnonpr\nmarket creates additional pressure. The stock of some companies is\nnow selling at a price that is a high multiple of earnings, which\nDoes\nreflects investors' expectations that these firms will maintain their\nNot-f\nrecent high rates of growth. Given hospital overcapacity, acquisi-\ntalan\ntions are a primary means for these firms to increase revenues at\nsubst\nrates necessary to meet their investors' growth expectations.\nprem\nSurvival and continuance of mission. For weaker nonprofit organiza-\nprovi\ntions threatened with closure, the sale of their health care assets to\namou\n14\nOVERVIEW\nor a joint venture with a for-profit firm might be seen as the best\ntax-e\nalternative to sustain any institutional presence and to preserve\nimpo\nwhat may be an important source of community employment. Even\nmuni\nif closure is not an immediate threat, some organizations may per-\nsions\nceive selling their nonprofit assets as an opportunity to generate\nthe o\nfunds to continue missions, such as medical education or charity\ndo, o\ncare, that are threatened by competitive pressures that limit operat-\ntions\ning revenues.\nconv\nReduced regulatory constraints. Another factor in an organization's\ndecision about conversions relates to the greater flexibility that for-\nsus 1\nprofit organizations have in compensating executives, staff, and\nreso\npartners. A hallmark of nonprofit organizations is that they exist for\nin th\npublic rather than private benefit, and federal and state tax rules\na re\nprohibit the earnings of nonprofit organizations from inuring to the\nexar\nbenefit of insiders or other individuals. However, this greatly limits\npita\nthe ability of nonprofit organizations to use flexible compensation\nUsit\narrangements, such as profit sharing, that some see as important\nfour\ntools for competing in the market. For example, permitting staff\nin t\nphysicians to share in hospital revenues from outpatient depart-\nleag\nments or other services is considered a way for hospitals to recruit\nout\nand maintain physicians and attract patients and referrals, but In-\nThe\nternal Revenue Service (IRS) rules limit nonprofit hospitals' ability\npub\nto enter into such arrangements. For-profit hospitals have greater\npro\nflexibility in this regard, which may provide them with a market\nto I\nHEALTH AFFAIRS - Volume 16, Number 2\nHE\nPUBLIC POLICY OVERVIEW\nadvantage.\nPotential benefit for directors and managers. Finally, as highlighted by\nconsumer groups, regulators, and others, the opportunity for sub-\nstantial personal financial gain by insiders of nonprofit organiza-\ntions may influence some conversion decisions.\" In several notori-\nous cases from the 1980s, key insiders of nonprofit HMOs were able\nto purchase their plans for prices apparently far below market\nvalue.¹⁶ In these cases, the insiders essentially were both sellers and\nbuyers and had a personal interest in paying less than full value.\nAdvocates have suggested that the same potential conflicts of inter-\nest may exist in some of the joint venture arrangements between\nnonprofit hospitals and investor-owned hospital chains today.\"\nDoes Profit Status Make Any Difference?\nNot-for-profit institutions have played dominant roles in the hospi-\ntal and health plan markets for decades. As such, they have received\nsubstantial subsidies from federal, state, and local governments,\npremised, at least in part, on the theory that these organizations\nprovide special benefits to the communities they serve. Whether the\namount of benefits they provide is sufficient to justify their\ntax-exempt status has been a matter of some controversy and raises\nCONVERSIONS\n15\nimportant questions for tax policy.¹⁸ If nonprofits provide more com-\nmunity benefits than their for-profit counterparts do, then conver-\nsions could result in the loss of such benefits to communities. If, on\nthe other hand, nonprofits provide fewer benefits than for-profits\ndo, or if the benefits provided are less valuable than the tax exemp-\ntions conferred, then the tax preference is subject to question, and\nconversions may result in a net benefit to communities.\nWhat are community benefits? Debate about nonprofit ver-\nsus for-profit community benefit is longstanding. Research has not\nresolved this controversy, in part because of considerable variation\nin the way community benefits have been defined and measured. As\na result, comparing findings across studies becomes complex. For\nexample, comparison of charity care in nonprofit and for-profit hos-\npitals has been studied both nationally and within individual states.\nUsing aggregate national data, several prominent organizations\nfound relatively small differences between nonprofits and for-profits\nin the provision of charitable care.¹⁹ But Lawrence Lewin and col-\nleagues contend that aggregate data may be deceiving.²⁰ They point\nout that most for-profits have been concentrated in thirteen states.\nThese states tend to have leaner Medicaid eligibility rules and fewer\npublic hospitals than do states that are chiefly populated by non-\nprofits. The demand for charity care in those thirteen states is likely\nto be relatively higher, so the amount of charity care for-profit hos-\nHEALTH AFFAIRS - March/April 1997\nCONVERSIONS\npitals provide relative to total revenue may be high compared with\nnational averages but low in relation to demand and what other\nnonprofits provide in that state. In comparing nonprofits and for-\nprofits within the same state, Lewin and colleagues find larger dif-\nferences in the provision of charity care than is the case in national\nstudies.²¹\nRecognizing that differences and controversies exist, we list here\nitems that might be included in measuring community benefits. The\nlist moves from relatively concrete and more easily measured bene-\nfits to benefits that are more abstract and difficult if not impossible\nto measure. Tax payments are listed last because of a lack of consen-\nsus as to the appropriateness of their inclusion. The list focuses\nprimarily on hospitals because they have received the most atten-\ntion in the literature, although a recent paper by Bradford Gray and\nMark Schlesinger also looks at HMOs through some indirect meas-\nures (for example, loss ratios and annual disenrollment by Medicare\nbeneficiaries).²\nCharity care. For hospitals, providing care to persons who are un-\nable to pay is almost universally considered a community benefit.\nFor health plans, the analogue of charity care might be accepting\n16\nOVERVIEW\napplicants without regard to health status (where it is not re-\nquired), subsidizing the premiums of persons with preexisting\nmedical conditions through community rating, or providing direct\npremium subsidies to persons who cannot afford insurance. Health\nplans that own hospitals or clinics can provide direct charity care.\nBad debt. In data sets that measure hospital uncompensated care,\nbad debt is often combined with charity care. Many analysts use this\nmeasure because studies have shown that most bad debt likely re-\nsults from patients who are unable to pay.2³ The level of bad debt so\nfar exceeds that of pure charity care that the question of whether to\ninclude it as a community benefit is not trivial. If bad debt is not\ncounted, actual charity care is underestimated, but if all of it is\nincluded, the amount of charity care is overstated. Some question\nthe inclusion of bad debt, citing reasons such as poor management of\nreceivables or free care given to staff and trustees. Both charity and\nbad debt are more accurately measured on a cost rather than a\ncharge basis, and data based on charges should be adjusted using a\ncost/charge ratio.\nLosses from serving public program enrollees. To the extent that Medi-\ncare and Medicaid set provider reimbursement rates below provider\ncost, the losses sustained by hospitals serving these patients may be\nconsidered as similar to charity care (for the extent of the losses).²⁴\nLosses from subsidizing necessary community services. Services such as\nburn units, twenty-four-hour trauma centers, or programs for\nHEALTH AFFAIRS - Volume 16, Number 2\nPUBLIC POLICY OVERVIEW\nspecial-needs populations such as hemophiliacs are medically im-\nportant but often unprofitable because of high costs or low volume.²⁵\nThe benefit to the community would be access to vital health care\nservices that otherwise might be unavailable.\nNet cost of research and education. Providing or participating in medi-\ncal education or research programs may be considered a community\nbenefit since health care organizations may not be fully reimbursed\nfor the total cost of these activities.\nLower prices. Some analysts contend that lower prices charged by\nnonprofits constitute a community benefit. They argue that non-\nprofits do not fully exploit their market power to maximize reve-\nnues, and as a result, the benefit of lower prices inures to consumers.\nCommunity needs assessments, education, and service programs. Health\ncare organizations can assess the health care needs of their commu-\nnities and develop specific initiatives (such as health screenings or\nprograms for high-risk groups) to address those needs. Including\nthese activities as community benefits has been criticized because\nhealth care organizations often use these types of services as a means\nof advertising and sometimes charge for these services.²⁶\nCommunity control and accountability. Control of health care organi-\nzations by local volunteer boards may be considered a community\nCONVERSIONS\n17\nbenefit on the theory that organizations controlled by community\nvolunteers will be more receptive and responsive to local health care\nneeds. Nonprofit organizations also provide a vehicle through\nwhich citizens can express their civic and charitable ideals.\nNonprofit orientation and trustworthiness. The lack of profit motive of\nnot-for-profit organizations itself is sometimes considered a com-\nmunity benefit. The theory for this proposition rests on the idea that\nhealth care is a complex good and that consumers do not under-\nstand their health care choices as well as do those providing care.²⁷\nIn such situations, suppliers can take advantage of consumers' lack\nof information by withholding services or by reducing quality. Firms\nwith a profit incentive are considered more likely to take advantage\nof these informational asymmetries because they can profit from\ndoing so. Not-for-profit firms, because they are constrained from\nusing any net earnings for personal benefit, are considered not to\nhave an incentive to exploit their information advantages.\nOne potential objection to this theory is that physicians play a\nmediating role that protects consumers from exploitation in these\nsituations.² However, the various economic ties between hospitals\nand physicians and the influence of third-party payment practices\nsuch as managed care bring into question the impartiality of physi-\ncians as mediators.²⁹\nTaxes. There is no consensus regarding whether taxes paid by\nHEALTH AFFAIRS - March/April 1997\nCONVERSIONS\n\"Nonprofit hospitals provide more community benefits than for-\nhose\nbe\nreceiving\nprofits. [But] there is wide variation among nonprofit hospitals.\"\nPo\nregardir\nfor-profit organizations should be counted as community benefits.\ntoward\nAdvocates of for-profits contend that all taxes should be counted.\nexempt\nOthers point out that few if any taxes contribute directly to the\nfor-prof\nbenefits\nhealth care needs of the local community, particularly federal and\ndvanta\nstate income taxes, which are both uncertain in amount and outside\nof community control. Some argue that property and other local\nciently\nsumes\ntaxes that remain under community control should be counted,\nbenefit\nwhile others recommend complete exclusion of taxes or the inclu-\nvide CC\nsion of only those taxes that are earmarked for health services.\nEvidence on community benefits. Examination of twenty\nsuggest\ndiscuss\nstudies of comparative community benefit (virtually all of those\nlinking\nfound in the literature) and numerous studies on price and cost\naccoun\ndifferentials yields the following major conclusions.³⁰\navailab\n(1) Nonprofit hospitals provide significantly more community\nprovid\nbenefits than for-profit hospitals provide. The differences are more\nlinked\nevident when comparisons are made across hospitals within states.\n18\nOVERVIEW\nincrea\n(2) There is wide variation among nonprofit hospitals in their\nerally\nprovision of benefits, with a large proportion of benefits being pro-\nA Si\nvided by a few nonprofit hospitals. Public hospitals (rather than\nsector\nnonprofit community hospitals) and major teaching hospitals pro-\ntion }\nvide a disproportionately large share of community benefits, and a\nunder\nsignificant number of nonprofit community hospitals provide few\nmend\ncommunity benefits.\nCath\n(3) When employing a reasonably broad definition of community\ntion.\nbenefits (charity care, bad debt, losses from public programs, and\nbenef\nnet cost of teaching and research), we find that nonprofit hospitals,\nUtah\nas a whole, contribute significantly more in benefits than the cost of\ning 0\ntheir tax exemption.\nbroac\n(4) Prices charged by nonprofit hospitals are generally lower than\ntax P\nthose charged by their for-profit counterparts for similar services.\nAc\n(5) If taxes paid by for-profit hospitals are counted as community\ndolla\nbenefits, then, overall, the benefits provided by for-profit hospitals\nties\nwould exceed those of nonprofits. However, the relation between\nAlth\ntaxes paid and community benefits is uncertain and tenuous, and\nconv\nalthough no consensus exists, it seems appropriate to count only\nrath\nthose taxes that are specifically earmarked for health services.\nmar]\nIn sum, the evidence indicates that there is a substantial differ-\ntors\nence between nonprofit and for-profit hospitals in terms of the com-\nregu\nmunity benefits they provide. However, the burden of providing\nprev\nHE\nHEALTH AFFAIRS Volume 16, Number 2\nPUBLIC POLICY OVERVIEW\nthose benefits is uneven, with many nonprofit community hospitals\nreceiving tax exemptions in excess of the benefits they dispense.\nPolicy Implications. Hospitals. These findings raise questions\nregarding current tax treatment of nonprofit hospitals and policies\ntoward conversions. Some have recommended eliminating the tax\nexemption and giving all health organizations, whether nonprofit or\nfor-profit, tax deductions for legitimate expenditures on community\nbenefits. From an economist's perspective, this approach would be\nadvantageous in terms of horizontal equity and would more effi-\nciently target tax expenditures. However, this policy proposal as-\nsumes a tighter connection between tax breaks and community\nbenefits than actually exists. The fact that nonprofits generally pro-\nvide community benefits worth more than their tax exemptions\nsuggests that the nonprofit ownership form has value. Further, as\ndiscussed above, not all community benefits are clearly definable;\nlinking tax breaks to expenditures would ignore benefits such as\naccountability or trustworthiness, which are difficult to define. The\navailability of a tax deduction is unlikely to induce for-profits to\nprovide new community services. Hence, the overall result of a\nlinked approach is likely to be a reduction in community benefits or\nincreased reliance on publicly owned hospitals, which are not gen-\nCONVERSIONS\n19\nerally viewed as the preferred providers of community services.\nA strong argument can be made for a focused and effective third\nsector (the private nonprofit hospital) that receives its tax exemp-\ntion based on a clearer standard of benefit provision than exists\nunder current law.³ Community benefit standards have been recom-\nmended by two of the most prominent nonprofit organizations, the\nCatholic Hospital Association and the Voluntary Hospital Associa-\ntion. Some states have already taken steps to define community\nbenefits for the purpose of state and local tax exemptions. Texas and\nUtah, for example, have adopted relatively narrow definitions focus-\ning on charity care. Other states, such as New York, have taken a\nbroader approach.\" Benefit standards could also be added to federal\ntax policy.\nAdding standards to tax preferences would improve value for the\ndollar in tax policy. However, it would not ensure that valued activi-\nties or organizations would survive in the face of market pressures.\nAlthough the goal of policy development should not be to prohibit\nconversions, it should be to ensure that conversion is an option\nrather than a necessity for nonprofits that are competing in the\nmarketplace. That assurance may require policymakers and regula-\ntors to facilitate access to alternatives to equity capital, reexamine\nregulatory constraints on nonprofit operations, and more effectively\nprevent inappropriate and illegal insider financial gains from con-\nHEALTH AFFAIRS March/April 1997\nCONVERSIONS\nversion transactions.\nPreserving community benefits also requires attention once con-\nversions occur. Oversight is needed to address both the redirection\nof a nonprofit's charitable assets and the service obligations of new\nfor-profit organizations. These topics are covered below.\nNonhospital organizations. The underwriting and coverage practices\nfollowed by nonprofit insurers today are similar to those of their\nfor-profit competitors, and the willingness to accept all applicants\nat community rates has virtually disappeared from the market-\nplace.\" Preferred tax status for Blue Cross and Blue Shield plans,\nwhich, at their origins, provided this community service, has already\nbeen eliminated. It seems unlikely that conversions will make any\nfurther difference in insurance behavior.\nA distinction must be made, however, between insurance compa-\nnies and plans that integrate the financing and delivery of care-that\nis, nonprofit HMOs. Although many nonprofit health plans operate\nin a fashion similar to their for-profit counterparts, some have the\ncapacity to provide significant community benefits through their\nown hospitals and clinics, through community needs assessment,\nand through their support of teaching and research. Although the\n20\nOVERVIEW\nliterature provides no evidence of quality differences between for-\nprofits and nonprofits, nonprofits also may offer intangible commu-\nnity benefits. Thus, while it may be desirable to apply benefit stand-\nards to these organizations in return for their tax-exempt status,\neliminating that status could jeopardize community benefits.\nBlue\nHow Can Conversions Be Regulated\ncross\nTo Protect Charitable Assets?\nConversions not only affect health care organizations; they also af-\ned\nfect communities' access to and use of charitable assets. Yet most\nJuls\nstates have neither enacted specific legislation nor instituted any\nspecific process to oversee health industry conversions. Under cur-\ntrust\nrent law, state policies have been highly variable. As conversion\ninvo\nactivity has increased, so has the call for greater oversight of and\ntive,\npublic participation in the process. Here we review key areas in\nrelat\nwhich oversight is required.\nC\nState laws generally establish the legal framework under which\ncalli\ncorporations, including charitable organizations, are established.\nOCCU\nThese laws establish the procedural requirements for changes in\nand\ncorporate structure. In addition, the transfer of assets of a nonprofit\nfor\norganization is governed by state charitable trust law because the\ninit\nassets are considered to be held in charitable trust for the public.\nWhen a charitable organization is dissolved, however the transac-\nver\ntion is structured, its assets must be transferred to a nonprofit or-\ntha\nHEALTH AFFAIRS Volume 16, Number 2\nH\nPUBLIC POLICY OVERVIEW\nganization that will carry out the original purpose of the charitable\nn-\ntrust as nearly as possible. In many cases, a new foundation is\non\nformed for this purpose.\n:W\nChanges in nonprofit status have federal tax law implications as\nwell. Section 501(c)(3) of the Internal Revenue Code grants federal\nes\ntax exemption to organizations formed and operated exclusively for\neir\ncharitable purposes, provided that no part of the organization's net\nits\nearnings inure to the benefit of any private shareholder or individ-\n÷\nual. Penalties are imposed for violation of these rules.\nis,\nWhile virtually all nonprofit hospitals are organized as charities\ndy\nunder section 501(c)(3) of the Internal Revenue Code, many non-\nny\nprofit HMOs and Blue Cross and Blue Shield plans are not. Laws\napplicable to charitable trusts may not apply to these organizations\na-\nunless they have dedicated their assets for charitable purposes\nat\nthrough their corporate articles, bylaws, or some other means.\"\nte\nFor example, some Blue Cross and Blue Shield plans are organ-\nhe\nized as \"mutual benefit\" organizations, which generally are operated\neir\nfor the benefit of their members rather than for charitable purposes.\nit,\nWhen a mutual benefit organization converts from nonprofit to\nhe\nfor-profit status, the members of the organization, rather than the\nr-\ncommunity, may be entitled to the proceeds of the transaction. A\nCONVERSIONS\n21\nu-\ncontroversy may arise, however, if the mutual benefit organization\nd-\nwas originally incorporated as a charity, or if the mutual benefit\nIS,\norganization's corporate documents state that the organization is\noperated for the benefit of the public. An example is the case of\nBlue Cross and Blue Shield of Virginia (operating as Trigon Blue\nCross and Blue Shield).\nThe application of legal principles regarding conversions has var-\nied considerably among the states. In some states public offi-\nst\ncials-notably attorneys general and insurance commission-\nny\ners-have aggressively pursued their interpretations of charitable\nr-\ntrust and other laws to oversee conversions and promote public\non\ninvolvement. In other states, however, officials have been more reac-\nid\ntive, and the policy vacuum and limited resources have resulted in\nin\nrelatively little oversight.\nConsumer and other advocacy organizations have taken a lead in\nch\ncalling attention to the importance of oversight when conversions\nd.\noccur. They have frequently served as a resource for public officials\nin\nand the press in explaining what is at stake and what options exist\nit\nfor addressing policy concerns. In a number of instances, they have\ne\ninitiated or intervened in legal proceedings related to conversions.\nC.\nValuation of charitable assets. If states are not diligent, con-\n=-\nversions can clearly result in the loss of nonprofit charitable assets\nr-\nthat rightfully belong to a community. No issue is more critical to\nHEALTH AFFAIRS - March/April 1997\nCONVERSIONS\nthis than the valuation of the assets of the converting nonprofit,\norganization. Valuation is at the heart of two key policy issues\nraised by conversions: the potential for insiders to realize inappro-\npriate financial gain (inurement), and the level of funding that will\nbe available for future charitable activities.\" To prevent the former\nand promote the latter, public policy must address a number of\nissues regarding the valuation process.\n(1) Do the not-for-profit trustees have an obligation to solicit\ncompeting bids to determine the value of the not-for-profit assets\nthat are to be transferred? Without competing bids, it may be diffi-\ncult to ascertain the value of intangible assets of the converting\norganization, such as good will.\n(2) Do the not-for-profit trustees have an obligation to accept the\nhighest bid for the assets that are converted? By accepting the high-\nest bid for the conversion, the trustees would be maximizing the\namount available for future charitable purposes. There may be cir-\ncumstances, however, in which a lower bidder agrees to operate in\ncertain ways or to provide certain benefits that the trustees believe\nwould benefit the community. Or a potential purchaser may agree to\ngive the not-for-profit trustees (usually the trustees of the founda-\n22\nOVERVIEW\ntion accepting the consideration) a voice in the operations of the\nconverted enterprise. Placing a value on these agreements may be\ndifficult unless there are a number of competing purchasers.\n(3) Do the not-for-profit trustees or management personnel have\nany obligation to disclose potential conflicts of interest to the offi-\ncials with authority to oversee a conversion?\n(4) Should the not-for-profit organization or the for-profit pur-\nchaser have an obligation to fund an independent valuation of the\nconverting assets? State officials with oversight of conversions often\ndo not have the resources to independently value the assets that are\nbeing converted. Such a procedure may be particularly important\nwhere the management of the not-for-profit organization will be\nheavily involved with the for-profit enterprise, as has been the case\nin a number of health plan conversions.\n(5) Is it appropriate for not-for-profit trustees to accept consid-\neration that is contingent on the future success of the for-profit\nenterprise? This question arises when the charitable foundation is\nfunded through stock in the for-profit enterprise or when it accepts\na partnership percentage in a joint venture. On the one hand, past\nconversions have been criticized when the value of the converted\nentity later skyrocketed and the not-for-profit organization did not\nrealize any of the gains.³⁸ On the other hand, accepting stock or a\npromise of future earnings may place the charitable foundation at\nsignificant risk, particularly if the foundation's assets are concen-\nHEALTH AFFAIRS - Volume 16, Number 2\nPUBLIC POLICY OVERVIEW\nprofit\ntrated in the one enterprise.39\nissues\n(6) Should an independent representative to the conversion proc-\nppro-\nit will\ness be appointed to look out for the interests of the new charitable\nfoundation? This type of proposal recognizes that there may be\normer\nber of\nconflicts of interest within the converting not-for-profit organiza-\ntion, or that the not-for-profit trustees may be unable to adequately\nascertain the value of the assets being transferred.\nsolicit\nFailure to publicly address these questions could be detrimental\nassets\nto communities in which conversions occur.\ndiffi-\nContinued provision of health services in the community.\nerting\nCritics of hospital conversions have raised concerns that for-profit\nat the\nhospitals might provide fewer community benefits than their pre-\nconversion nonprofit predecessors provided. Some states have en-\nhigh-\nacted legislation and/or used their regulatory powers to negotiate\ng the\nwith successor for-profit entities for specific levels of charity care\ne cir-\nand health services after a conversion.\nite in\nIn the case of many hospital conversions or, for that matter, hos-\n:lieve\npital consolidations, there are often efficiencies to be gained by clo-\nee to\nsure or curtailment of certain services. What some consider as cost-\nnda-\nsaving efficiency, however, others may regard as reduction in\nf the\nnecessary community services. Hence, states and municipalities\nCONVERSIONS\n23\ny be\nhave negotiated with successor hospital entities for continuation of\nsuch services as twenty-four-hour emergency care, burn and trauma\nhave\nunits, neonatal intensive care units, and other services that may be\noffi-\ncostly, low volume, or unprofitable.\nStates also have negotiated with successor entities for provision\npur-\nof a minimum level of charity care or other community benefits. A\nthe\nfew states, such as California and Nebraska, have enacted legislation\nften\nthat specifically includes the consideration of future benefits to be\nare\nprovided to the community after a conversion. A process that spe-\nant\ncifically sets forth such authority can be valuable to effective public\nI be\npolicy. In a proposed Massachusetts conversion, for example, the\ncase\nattorney general initially received accolades for negotiating a three-\nid-\nyear postconversion agreement to maintain the level of charity care.\nofit\nLater, however, he was criticized for conducting a secretive process\nand for failing to obtain more than a three-year commitment.⁴⁰\n1 is\nRegulation of successor for-profit entities can have unintended\npts\nnegative consequences. Regulations that are too stringent can be\nast\nused to protect the status quo and keep out competition that might\ned\nbring about lower prices and, hence, increased access to care. In\nnot\nlegislating and implementing a regulatory process, states must find\nra\nthe appropriate balance for their communities.\nat\nPublic participation in the conversion process. Despite the\nn-\npotential impact of conversions on a community's health care serv-\nHEALTH AFFAIRS March/April 1997\nCONVERSIONS\nices or charitable assets, there is no process in most cases for the\ncommunity to express its views, raise objections, or intervene in\nconversion decisions. In theory, the trustees and management of\nnonprofit organizations have a fiduciary duty to ensure both that\nthe assets of the organization are used for the purposes stated in the\norganization's articles of incorporation and that the conversion is in\nthe best interests of the organization. In practice, however, exer-\ncise of this duty is fraught with conflicts of interest and is not\nself-enforced. Unlike investor-owned companies, nonprofit organi-\nzations generally do not have stockholders who must approve deci-\nsions about changes in ownership or who can intervene if the man-\nagement or directors are not operating in the firm's best interests.⁴²\nAs conversion activity has increased, so has the call for greater\noversight of and public participation in the conversion process. In\nsome cases, consumer groups, community organizations, and other\nadvocacy groups have been successful in focusing public attention\non proposed conversions. However, the lack of a formal public role\nhas left such interventions to chance and excluded other voices from\nthe conversion process. Although states' attorneys general are usu-\nally given the role of representing the public in these transactions,\n24\nOVERVIEW\nlimits on their resources and time may prevent them from recogniz-\ning the potential impact of a conversion on a community.\nPotential ways for the public to participate in conversions in-\nclude public hearings, formal input into a regulatory process, legal\nstanding to challenge transactions, and input into the disposition of\ncharitable assets. In deciding how to facilitate public input, states\nmust balance the need to prevent private abuses and the loss of\ncharitable assets with the need to provide an efficient-rather than\na cumbersome or obstructive-regulatory process.\nGovernance of new foundations. When a charitable organi-\nzation is dissolved, issues arise regarding the creation, initial gov-\nernance, independence, and mission of new charitable foundations\nthat are being established to carry out the original charitable pur-\npose. In 1996 Grantmakers In Health identified approximately sixty\nsuch foundations formed since January 1990 and successfully sur-\nveyed forty of them in seventeen states and the District of Columbia.\nCollectively, these foundations represented more than $5 billion in\n(alt\nassets (with three foundations holding more than $1 billion each).\nThey are likely to pay out about $250 million annually in charitable\ntior\nspending. Key issues include the application of tax rules to prevent\nard\nconflict of interest, the independence and expertise of foundation\nred\nboards, and the nature of foundation missions-all of which will\noth\ndetermine whether charitable purposes are in fact continued. Nancy\nKane delves into these issues in her paper in this volume.44\nHEALTH AFFAIRS - Volume 16, Number 2\nPUBLIC POLICY OVERVIEW\n:S for the\nIn making policy for new conversion foundations, it is important\nervene in\nto avoid overregulation once the initial governance and mission have\nement of\nbeen established. Here again, a vibrant third sector (the private\noth that\nnonprofit foundation) can provide services that might otherwise be\n:ed in the\nprovided only by the government.\nsion is in\nPolicy Implications. To ensure that state regulators appropri-\nver, exer-\nately and systematically address the policy issues conversions raise,\nd is not\nconsumers and other organizations, along with regulators and legis-\nit organi-\nlators in some states, are calling on states to enact legislation that\nove deci-\nclarifies regulatory authority and responsibility in the conversion\nthe man-\nprocess. A few states have passed such legislation affecting hospitals\nterests.\"\nand/or health plans. These legislative initiatives have addressed a\nor greater\nwide array of procedural and substantive issues, including the basis\nrocess. In\nfor and locus of regulatory authority; the kinds of transactions sub-\nand other\nject to that authority; the formulation of a regulatory process for\nattention\npreconversion submission and review; the requirement for inde-\nublic role\npendent and accurate valuation of assets; the proper role of citizens\nices from\nand community groups; the initial governance and mission of chari-\n1 are usu-\ntable foundations; and the evaluation of the impact of the transac-\nsactions,\ntion on the health care system. Although changing the rules under\nrecogniz-\nwhich transactions occur cannot guarantee that all parties or all\nCONVERSIONS\n25\nissues will get the attention they deserve, a more explicit process\nsions in-\nincreases the likelihood of good public policy.\ness, legal\nConclusion\nosition of\nut, states\nConversions of health organizations from nonprofit to for-profit\ne loss of\nstatus are interwoven into the changes occurring in the U.S. health\nther than\ncare industry. Some conversions have economic advantages in con-\nsolidating excess capacity and promoting efficiency. They may also\ne organi-\npose the risk that communities will lose valuable charitable assets\nitial gov-\nor important health services. The goal of public policy should not be\nndations\nto prevent conversions; such rigid policy could impede desirable\nable pur-\nchange. Rather, the goal should be to preserve valued functions and\ntely sixty\nresources in the context of a competitive marketplace.\nfully sur-\nA review of the literature on what difference ownership form\nolumbia.\nmakes leads us to conclude that the nonprofit organizational form\nbillion in\nenhances the potential for community benefits for hospitals and\non each).\n(albeit with less evidence) for some HMOs. To ensure that these\nharitable\nbenefits are realized, tax policy that supports nonprofit organiza-\n) prevent\ntions should be sustained but modified to require minimum stand-\nundation\nards for community benefits. Action also could be considered to\nhich will\nreduce pressure on nonprofit organizations to convert for reasons\nd. Nancy\nother than economic efficiency-for example, ready access to capi-\ntal, regulatory flexibility, or insider financial gains.\nHEALTH AFFAIRS\nMarch/April 1997\nCONVERSIONS\nA review of the conversion experience also reveals that effect\noversight can make the difference between a beneficial or a der\nmental conversion. Effective oversight does not require highly SH\ncific rules or stringent regulations. Rather, it requires the esta.\nlishment of a process that enables states to explicitly address an\nnegotiate the multiple issues that conversions raise. Consiste\nwith the action of a few states, other states could benefit fro\nenactment of legislation that provides such a process and th\navoids the problems that have occurred from lack of oversight.\nThe magnitude of charitable assets at risk and the potential\nconversions to affect, either positively or negatively, important\nmunity health services argue for greater attention. Until now, mar\nconversions have occurred with little public oversight or commi\nnity involvement. Given the stakes involved, policymakers shoul\ntake greater initiative.\nThis paper was prepared with support from The Henry J. Kaiser Family Foundo\ntion and The Robert Wood Johnson Foundation. The authors appreciate the assis\ntance of their colleagues Larry Levitt and Michelle Huckaby.\nNOTES\n26\nOVERVIEW\n1. There sometimes are disputes over whether an organization's assets are dedi\ncated to not-for-profit purposes or whether a change in an organization\nstructure constitutes a \"conversion\" to for-profit status. Differences regarding\nthe effect of \"reorganizations\" of several Blue Cross and Blue Shield plans an\nrecent examples.\n2. T. Silk, \"Conversions of the Tax-Exempt Nonprofit Organizations: Federal\nTax Law and State Charitable Law Issues\" (Presentation at the American Bar\nAssociation Section of Taxation Mid-Winter meeting, New Orleans, January\n1996).\n3. Ventures could be established with different ownership shares, such as fifty\nfifty.\n4. Changes have nevertheless occurred. Lewin Group analysis of American Hos\npital Association (AHA) data between 1980 and 1993 shows 488 hospitals\nchanging status. The most prevalent change (215) was public hospitals con\nverting to nonprofit status.\n5. Ibid.\n6. Irving Levin Associates, New Canaan, Connecticut.\n7. C.A. Ascari, \"Direct Testimony and Exhibits on Behalf of Blue Cross and Blue\nShield of Virginia (d/b/a Trigon Blue Cross and Blue Shield), in Application of\nBlue Cross and Blue Shield of Virginia (d/b/a Trigon Blue Cross and Blue\nShield) for Conversion from a Mutual Insurance Company to a Stock Corpo\nration,\" State Corporation Commission, Commonwealth of Virginia, 14 June\n1996.\n8. InterStudy, \"HMO Summary\" (Excelsior, Minn.: InterStudy, June 1985).\n9. InterStudy, The InterStudy Competitive Edge, Part II: Industry Report (Excelsior,\nMinn.: InterStudy, April 1996).\n10. Ibid.\n11. S. Findlay, \"When Nonprofits Decide to Make a Buck,\" Business and Health\n(March 1996): 38-46.\nHEALTH AFFAIRS - Volume 16, Number 2"
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