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http://thomas.loc.gov/cgi-bin/query/z?c105:H.R.443: THIS SEARCH THIS DOCUMENT GO TO Next Hit Forward New Bills Search Prev Hit Back HomePage Hit List Best Sections Help Doc Contents GPO's PDF References to this bill in the Link to the Bill Full Display - 9,841 version of this bill Congressional Record Summary & Status file. bytes. Help Medicare Nonprofit Hospital Protection Act of 1997 (Introduced in the House) HR 443 IH 105th CONGRESS 1st Session H. R. 443 To amend part A of title XVIII of the Social Security Act to deny Medicare payment with respect to non-profit hospitals that transfer assets or control to for-profit entities without approval. IN THE HOUSE OF REPRESENTATIVES January 9, 1997 Mr. STARK (for himself, Mr. FILNER, Mr. KENNEDY of Rhode Island, Mr. BROWN of Ohio, Mr. WAXMAN, Mr. MCDERMOTT, and Mr. LEWIS of Georgia) introduced the following bill; which was referred to the Committee on Ways and Means A BILL To amend part A of title XVIII of the Social Security Act to deny Medicare payment with respect to non-profit hospitals that transfer assets or control to for-profit entities without approval. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled, SECTION 1. SHORT TITLE. This Act may be cited as the `Medicare Nonprofit Hospital Protection Act of 1997'. SEC. 2. DISQUALIFICATION FROM MEDICARE PAYMENT OF NON-PROFIT HOSPITALS THAT TRANSFER ASSETS OR CONTROL TO A FOR-PROFIT ENTITY WITHOUT APPROVAL. (a) IN GENERAL- Part A of title XVIII of the Social Security Act is amended by adding at the end the following new section: `DISQUALIFICATION OF CERTAIN NONPROFIT 1 of 4 10/30/98 10:27 AM http://thomas.loc.gov/cgi-bin/query/z?c105:H.R.43. HOSPITALS FROM PAYMENT IF ASSETS OR CONTROL TRANSFERRED TO A FOR-PROFIT ENTITY WITHOUT APPROVAL `SEC. 1821. (a) REQUIREMENT- No payment may be made under this part with respect to inpatient hospital services of a hospital if the hospital, on or after January 7, 1997, was owned or controlled by a nonprofit entity and there is an impermissible transfer (as defined in subsection (b)) with respect to the hospital or the entity. '(b) IMPERMISSIBLE TRANSFERS- '(1) IN GENERAL- For purposes of this section, the term `impermissible transfer' means any covered transfer (as defined in paragraph (2)) that has not been considered to be approved in accordance with subsection (c). '(2) COVERED TRANSFER DEFINED- For purposes of this section, the term `covered transfer' means, with respect to a hospital that is owned or controlled by a nonprofit entity-- '(A) the sale, transfer, lease, exchange, option, conveyance, or other disposition of, the assets of the hospital (or of the entity in relation to the hospital) to a for-profit entity, if a material amount of the assets relating to the hospital are involved in such disposition; or `(B) the transfer of control, responsibility, or governance of a material amount of the assets or operation of the hospital (or of the entity in relation to the hospital) to any for-profit entity. Transfers described in this paragraph may be effected through sale, joint venture, joint operating agreement, or any other means. '(3) OTHER DEFINITIONS- For purposes of this section: '(A) The term `acquired hospital' means, with respect to a covered transfer, the non-profit hospital the assets or control of which are the subject of the transfer. `(B) The term `acquiring entity' means, with respect to a covered transfer, the for-profit entity that is involved in the transfer. '(c) CONDITIONS FOR APPROVAL- Subject to subsection (d)-- '(1) IN GENERAL- A covered transfer with respect to an acquired hospital owned or controlled by a nonprofit entity is not considered to be approved in accordance with this subsection unless-- '(A) the acquiring entity has disclosed to the Secretary, in a form and manner specified by the Secretary, the information described in paragraph (2) relating to the transfer; '(B) there has been an independent fairness review|conducted of the proposed transfer and the report on the review concludes that no assets of the acquired hospital in relation to the nonprofit entity have inappropriately benefited any private parties; and '(C) the Secretary has approved the transfer. '(3) INFORMATION TO BE DISCLOSED- The information described in this paragraph is a complete description of the terms of covered transfer, together with a description of all 2 of 4 10/30/98 10:28 AM http://thomas.loc.gov/cgi-bin/query/z?c105:H.R.443: collateral arrangements, including information describing-- '(A) the acquired hospital and the nonprofit entity that owns or controls the hospital; '(B) the acquiring entity; '(C) other parties to the transfer; '(D) terms of the proposed transfer; '(E) the value of consideration to be provided in connection with the transfer (including details as to the basis for the valuation); `(F) copies of documents relating to the transfer; '(G) the identity of individuals and persons who are officers, directors, or affiliates of the nonprofit entity and whether they have any direct or indirect economic interest in the transfer (including any promise or discussion of future employment); and '(H) such other information as the Secretary may require. '(3) PUBLIC DISCLOSURE- The Secretary shall provide for public disclosure (including disclosure through electronic means on the Internet) of information described in paragraph (3) provided under paragraph (1)(A) and the report on the transfer described in paragraph (1)(B). '(4) CONDITIONS FOR APPROVAL OF TRANSFERS- The Secretary may not approve a covered transfer relating to an acquired hospital owned or controlled by a nonprofit entity unless, after completion of the public hearing described in paragraph (6), the Secretary determines that the following conditions are met: '(A) Due care was exercised by the nonprofit entity in deciding to enter into the transfer, selecting the acquiring entity, and negotiating the terms of the transfer. `(B) The nonprofit entity sought appropriate expert assistance in making decisions in relation to the transfer. '(C) The nonprofit entity took all reasonable steps to avoid conflict of interests. '(D) The nonprofit entity will receive fair market value for its assets transferred in connection with the covered transfer. '(E) No charitable funds are placed at risk in connection with the covered transfer. '(F) The amount of any compensation under any management contract entered into in connection with the covered transfer is fair. '(G) The proceeds to the nonprofit entity in connection with the covered transfer will be used only for appropriate charitable purposes consistent with the entity's non-profit charter and for the promotion of health in the affected community and such proceeds will be controlled as charitable funds independent of the acquiring entity. `(H) Any charitable corporation established to hold proceeds of the acquired hospital in connection with the covered transfer will be broadly based in the community. `(I) There are sufficient safeguards to assure the affected community continues to have access to affordable hospital services. 3 of 4 10/30/98 10:28 AM http://thomas.loc.gov/cgi-bin/query/z?c105:H.R.443 '(J) The acquiring entity has made a commitment to provide comparable care to the disadvantaged, the uninsured, and the underinsured, and to provide benefits to the affected community. '(K) The acquiring entity has no contractual right to receive or direct future grants in relation to the acquired hospital. '(L) The acquiring entity has paid the Secretary, with respect to the covered transfer, a fee sufficient to cover the costs of the Secretary in administering this section in relation to such transfer. '(6) PUBLIC HEARING- Before approving a covered transfer, the Secretary shall provide for notice and a public hearing to take place in the community of the acquired hospital concerning the transfer and publication of a public report on testimony received at the hearing. (d) APPLICATION OF ALTERNATIVE STATE LAW REQUIREMENTS- A covered transfer is deemed to meet an applicable requirement of subsection (c) relating to the transfer to the extent that the Secretary determines that there is a State law that imposes a requirement at least as stringent as the requirement involved with respect to the transfer. `(e) DELEGATION OF AUTHORITY- The Secretary may exercise the Secretary's authority under this section through any appropriate official in the Department of Health and Human Services. '(f) NO EFFECT ON OTHER RIGHTS- The fact that the Secretary has approved a covered transfer under this section shall not supersede other rights that any entity (including the federal government or a State or local government) may have to challenge the transfer on any grounds.'. (b) EFFECTIVE DATE- The amendment made by this section shall apply with respect to covered transfers for which agreements or transactions are entered into on or after January 7, 1997. THIS SEARCH THIS DOCUMENT GO TO Next Hit Forward New Bills Search Prev Hit Back HomePage Hit List Best Sections Help Doc Contents 4 of 4 10/30/98 10:28 AM Bill Summary & Status http://thomas.loc.gov/cgi-bin/bdqu./-bdfcXZi@@@L/bss/d105query.html] Bill Summary & Status for the 105th Congress Item 2 of 62 PREVIOUS BILL I NEXT BILL PREVIOUS BILL:ALL I NEXT BILL:ALL NEW SEARCH I HOME I HELP H.R.443 SPONSOR: Rep Stark (introduced 01/09/97) Jump to: Titles, Status, Committees, Amendments, Cosponsors, Summary TITLE(S): SHORT TITLE(S) AS INTRODUCED: Medicare Nonprofit Hospital Protection Act of 1997 OFFICIAL TITLE AS INTRODUCED: A bill to amend part A of title XVIII of the Social Security Act to deny Medicare payment with respect to non profit hospitals that transfer assets or control to for profit entities without approval. STATUS: Floor Actions ***NONE*** STATUS: Detailed Legislative Status House Actions Jan 9, 97: Referred to the House Committee on Ways and Means. Jan 21, 97: Referred to the Subcommittee on Health. STATUS: Congressional Record Page References 01/09/97 Introductory remarks on Measure (CR E82-83) COMMITTEE(S): COMMITTEE(S) OF REFERRAL: House Ways and Means SUBCOMMITTEE(S): Hsc Health AMENDMENT(S): ***NONE*** 19 COSPONSORS: 1 of 2 10/30/98 10:30 AM Bill Summary & Status http://thomas.loc.gov/cgi-bin/bdqu./-bdfcXZ:@@@L/bss/d105query.html] Rep Filner - 01/09/97 Rep Kennedy, P. - 01/09/97 Rep Brown, S. - 01/09/97 Rep Waxman - 01/09/97 Rep McDermott - 01/09/97 Rep Lewis, John - 01/09/97 Rep Norton - 02/11/97 Rep Dellums - 02/11/97 Rep Rush - 02/11/97 Rep Weygand - 02/11/97 Rep Pelosi - 03/05/97 Rep Barrett, T. - 03/05/97 Rep Kennedy, J. - 03/20/97 Rep Wexler - 03/20/97 Rep Gejdenson - 03/20/97 Rep Kucinich - 04/17/97 Rep Gutierrez - 04/17/97 Rep Gonzalez - 04/30/97 Rep Sanders - 05/15/97 SUMMARY: (AS INTRODUCED) Medicare Nonprofit Hospital Protection Act of 1997 - Amends part A (Hospital Insurance) of title XVIII (Medicare) of the Social Security Act to disqualify for Medicare payment any non-profit hospital that transfers assets or control to a for-profit entity without appropriate approval by the Secretary of Health and Human Services. 2 of 2 10/30/98 10:30 AM CONVERSIONS State Experience In Regulating A Changing Health Care System The differing politics, experience, and legislative backdrops in states around the country lead to substantial variation when it comes to regulating nonprofit conversions. by Donald Shriber PROLOGUE: The recent wave of conversions of nonprofit health plans to for-profit status has brought new challenges to state officials whose job it is to keep an eye on such transactions. States traditionally have regulated insurers and hospitals; often their capabilities are stretched by the complexities surrounding nonprofit-to-for-profit conversions, and the 48 STATE magnitude of the dollars involved raises the stakes still higher. ISSUES Chief among states' duties is to protect consumers, who often Currer fail to grasp the significance of a plan's conversion until the he:tas] deal is in its final stages. eficien In this paper Donald Shriber examines four areas of law that apply to conversions: corporate law; laws that govern the requir dent powers of the attorney general or insurance commissioner in a With n state; laws governing health maintenance organizations bstrus (HMOs), insurance, hospitals, or Blue Cross/Blue Shield plans; egalath and charitable trust law. Because the policies and environments to of the states differ, experiences with nonprofit conversions also Then have varied greatly among the states that have seen such law. tha activity. Conversions taking place in California, Colorado, o the Maryland, Massachusetts, Missouri, and Ohio stand out as most health instructive and in some cases have made national headlines. Blue Shriber holds the position of associate director of the U.S. there issue Centers for Disease Control and Prevention in Washington, other D.C. He served for eight years as counsel to the Commerce include Committee of the U.S. House of Representatives, where he (govent devoted much of his time to legislative and regulatory reform ventur of private health insurance, managed care, and the statute pharmaceutical industry. He holds law and master of public proce health degrees from the University of California, Los Angeles. for public HEALTH AFFAIRS Volume 16, Number 2 HEA © 1997 The People-to-People Health Foundation, Inc. STATE EXPERIENCE ABSTRACT: Conversions of nonprofit hospitals, health maintenance or- ganizations (HMOs), and Blue Cross and Blue Shield plans to for-profit status have tremendous social and economic consequences for com- munities. Although some consensus exists on the legal principles gov- erning hospital conversions, a coherent legal framework for processing many other conversions is often lacking. Rapid changes in the configu- ration of health plans and providers complicate the situation. Litigation will provide some resolution of the issues but is not an optimal way of making policy. Some state legislatures are stepping into the fray with ; in differing solutions. Currently, the approach of a particular regulator is en it often the most important determinant of a given conversion. S CONVERSIONS OCCUR around the nation, state officials are A responding in a wide variety of ways. This paper examines the range of state responses, analyzes why and how they ealth arise, and highlights some of their strengths and weaknesses. The tate discussion draws upon interviews with regulators of and stake- is. holders in conversions that have occurred in several states. Regula- ; often tion of the conversion process is an art, not a science, and is influ- enced as much if not more by the perspective and environment of : state regulators as by any body of law. igher. CONVERSIONS 49 often Current Regulatory Authority he The task of intervening in conversions is complicated by two basic deficiencies in the law: the absence of a clear statement of who owns that nonprofits, and the lack of a clear definition of charity that includes a requirement to register with the state.¹ Almost every state is defi- rina cient with regard to the former; only some, with regard to the latter.² With no definition of ownership, one must search for clarity among lans; abstruse legal concepts (such as charitable trusts) and governing legal theories. Without a definition of charitable law, regulators ments is also have too many authorities and too little guidance. There are at least four major and potentially overlapping areas of law that apply to conversions: corporate law; laws speaking directly to the powers of the attorney general or insurance commissioners; is most health maintenance organization (HMO), insurance, hospital, or es. Blue Cross-specific law; and charitable trust law. Within these U.S. there is significant variation among the states. There are a number of on, other sources of authority that states may use with conversions, ce including state constitutions; for-profit and not-for-profit laws he (governing charter, formation, dissolution, merger, sale, and joint form ventures and partnership); holding company and mutual insurance statutes; certificate-of-need statutes; charities laws; codes of civil blic procedure; tax (state and federal) and property laws; and statutes geles. for public records; and false statements.³ Much authority is based on HEALTH AFFAIRS March/April 1997 CONVERSIONS common-law doctrines (developed through the decisions of courts The list of authorities is long because conversions involve man issues. More importantly, often no one statute provides enoug guidance on how to consider a conversion. Until political consensi develops, lawyers will be free to develop new theories to add to the list above.⁴ Only by laying broad common-law principles over patchwork of state laws can one assert that a harmonizing principl exists among the states. For now there is limited harmony. Mos people agree that in straightforward sales of charitable hospitals attorneys general may intervene and use charitable trust principles But many regulators are nervous about asserting charitable doctrine as the governing principle where the nature of the transaction is muddled and statutory law is relatively undeveloped, and they are even less comfortable with charitable doctrine as a basis for review of Blue Cross plans. Hospital conversions. The most common authority for view ing hospital conversion cases is charitable trust doctrine. Under this doctrine, the nonprofit entity is viewed as belonging to the public with the directors and the state's attorney general acting as its representatives. If the doctrine applies, a series of important conse- 50 STATE quences will flow: The government will have a clear basis for inter- ISSUES vening in the transaction. It will measure the conduct of the corpo- ration's "insiders" (trustees, managers, or other persons who operate inside the nonprofit entity on its behalf). It will try to ensure that the transaction was carried out to forward the mission of the non- profit, that adequate value was received in the transaction for any- thing transferred, and that a foundation or other entity is estab- lished to carry on the original mission of the entity. The best articulation of this basis for intervention appears in Robert Boisture's work on the sale of nonprofit hospitals and HMOs.⁵ Boisture argues that the authority is clear under common and statutory law in virtually every state. It rests, in his view, on the broad common-law authority of the attorney general to review charitable organizations and on two related principles. The first principle is the requirement of court approval for a change in the corporate purposes, the so-called cy pres doctrine. Under cy pres, charitable organizations are impressed with a trust that survives anything that happens to the organization. Histori- cally, cy pres was applied when it became impossible for a charity to carry out its mission (for example, the "further" eradication of small- pox). It provides that the charitable assets then should be devoted to carrying out a purpose as near as possible to the entity's original mission. Should these conditions be violated, the attorney general would have the authority to hold directors personally liable and to HEALTH AFFAIRS Volume 16, Number 2 STATE EXPERIENCE courts). enjoin violative activities. e many The second principle is that the entity's directors have a duty to enough act as fiduciaries and to exercise care in their dealings on behalf of nsensus the nonprofit corporation. The directors must act in the interest of d to the the nonprofit corporation, avoiding conflicts that might compro- over a mise that interest, and must exercise reasonable judgment in carry- rinciple ing out their duties. Thus, they would undertake a conversion only if y. Most they viewed it as the only or best alternative for continuing to carry ospitals, out the purposes for which the hospital was established. nciples. Boisture's articulation of how hospital conversions should be doctrine handled reflects prevailing practice in states with very aggressive ction is regulators and approximate practice in many other states. Although they are Boisture's theory could become the basis for handling conversions C review nationally, not all attorneys general are equally confident in assert- ing these prínciples. Many feel that they need to harmonize charita- or view- ble trust law with other state laws. Some believe that they lack the der this clear authority, particularly in statute, to process even certain hospi- : public, tal cases. In addition, although cy pres is often cited by regulators, g as its they rarely use it to mean the same thing, and they rarely enforce it t conse- strictly.⁶ or inter- Blue Cross/HMO conversions. The most contentious battles CONVERSIONS 51 e corpo- over ownership and definition are occurring with respect to Blue operate Cross and Blue Shield plans.⁷ The ambiguity in the law has produced ure that a surfeit of legal theories. Some theorists have taken the position the non- that chartering legislation defines the plans as having a charitable for any- mission.⁸ Others insist that the key to understanding the plans' S estab- ownership lies in their articles of incorporation.9 Others argue that Blues plans have metamorphosed so many times and are such pears in unique creatures that their ownership is unclear. Still others insist cals and that Blue Cross plans are not-for-profit corporations subject to the common common-law doctrine of charitable trusts. In contrast, plans such as J, on the Blue Cross in Missouri and Ohio insist that they are not subject to review charitable law. They, like many Blues plans, assert that ownership can be determined by the terms of the latest transaction. al for a There is no consensus among state regulators with regard to the loctrine: governing authority for Blue Cross/HMO conversions. The most 1 a trust comprehensive examination of the issue is by Eleanor Hamburger Histori- and colleagues. It rests on the view that charitable law is the gov- harity to erning doctrine through which state statutes should be read. The of small- authors report that forty-eight states have laws that specifically voted to regulate nonprofit corporations, but some do it through nonprofit original corporation laws and others through regular corporate law." More- general over, nearly every state has a sale, merger, or dissolution statute. The e and to statutes may permit, forbid, or be ambiguous regarding the merger HEALTH AFFAIRS March/April 1997 CONVERSIONS "Today's transactions do not fit into the categories typically found in most nonprofit statutes." of a nonprofit with a for-profit and the conversion of the resulting theyo corporation to for-profit status. chic Corporate statutes do not anticipate the multilayered transac- nfit cor] tions that have taken place or been proposed in several states, in- law d cluding those involving Blue Cross plans in Missouri, Maryland, do no California, and Ohio. Further, while state provisions governing dis- merger solutions might be used to implicate charitable trust principles, it is uding M often unclear precisely when a dissolution has occurred or should todiss occur. Hence, consumer groups have argued in Ohio, Missouri, and ons. Hov elsewhere that conversions are covered by these provisions, while that is not Blue Cross plans have claimed that their transactions are distinct Compl from those contemplated by the state statutes. kempt fr Many states have specific laws that regulate both HMOs and Blue ometime Cross plans, but the laws seldom provide clear guidance as to how ventures" conversions should be processed, or how those laws should be read such revie in conjunction with other state statutes and common law. In North look to St 52 STATE Dakota proposed mutualization of the Blue Cross plan has high- law, such ISSUES lighted the lack of clarity in the law.¹² There overlapping corporate ventures and insurance statutes confuse the situation. Under nonprofit cor- marriage poration law, a nonprofit may not be able to distribute its income. Columbi: However, some have argued that to mutualize, a corporation must former) } trigger dissolution statutes, which in turn might trigger the need to In sho distribute assets under a charitable trust theory. Meanwhile, expe- the trans rience with the cy pres doctrine in North Dakota is very limited.¹³ for maki Growing complexity. Complicating the issue of authority to version t regulate transactions are the constant consolidation and changes in ner may the enterprises being governed. As the Ohio Blue Cross conversion Should t shows, the line between hospitals, HMOs, and health plans is be- ports to coming blurred. Many regulators have said that the increasing com- regulato plexity of today's health care transactions is requiring increasingly lawyers more subtle, complex, and time-consuming analyses to determine action to whether regulators even have jurisdiction over the transactions. a more f A recent conversion of the Blue Cross plan in Virginia was de- eral's off scribed as a "reverse triangular merger." In Maryland, Ohio, Califor- general nia, and Missouri Blue Cross transactions are multifaceted and insuran highly complex. They often involve the creation of subsidiaries and proach i changes in the nonprofit that are so fundamental as to render them Some shell entities. "Downstream subsidiaries" (entities that are offspring of the converting organization), joint ventures, leases, and limited To gain partnerships are replacing old-fashioned sales in other states. Fu- we inte HEALTH AFFAIRS Volume 16, Number 2 HEAL STATE EXPERIENCE Ily ture transactions promise to become increasingly complex. Today's transactions do not fit into the categories typically found in most nonprofit statutes. Typically, these statutes describe catego- ries of transactions (for example, sales, dissolutions, and mergers), ne resulting and they often elaborate different standards and procedures govern- ing each category. For example, Ohio law provides that a not-for- ed transac- profit corporation can only merge with another not-for-profit, but 1 states, in- the law does not prevent a dissolution or sale. Similarly, most stat- Maryland, utes do not address what occurs when there is a sale and a merger or verning dis- a merger and a dissolution.¹⁴ Consumer groups in many states, in- nciples, it is cluding Missouri, have invoked dissolution statutes, arguing that de d or should facto dissolutions have occurred along with other kinds of transac- issouri, and tions. However, in doing so they are forced to rely on a body of law sions, while that is not well defined. are distinct Complicating matters further, some categories of transactions are exempt from review as conversions. Regulators report that they are Os and Blue sometimes constrained from looking at conversions labeled as "joint e as to how ventures" because underlying state law either does not authorize ould be read such review or forbids it. Others operating without such constraints W. In North look to see whether the joint venture implicates elements of trust n has high- law, such as a fiduciary duty or public benefit.15 The issue of joint CONVERSIONS 53 g corporate ventures strikes at the heart (and soul) of the conversion issue. A nprofit cor- marriage between the Sisters of Charity chain in Cleveland and its income. Columbia/HCA (in which the latter purportedly bought half of the ration must former) has drawn much attention and controversy. the need to In short, most state nonprofit laws are based more on the form of while, expe- the transactions than on their function. They provide an incentive imited.¹³ for making transactions overly complex and confusing, since a con- authority to version that is structured or labeled in a more straightforward man- 1 changes in ner may be easier to regulate. Regulators therefore face a dilemma: conversion Should they examine the form of the transaction and what it pur- plans is be- ports to do or look at what it really accomplishes? Although many easing com- regulators feel constrained in their efforts to do what corporate increasingly lawyers call "piercing the veil" (looking beyond the label of a trans- ) determine action to see what it really accomplishes), some are moving toward actions. a more functional approach. In Ohio, for example, the attorney gen- nia was de- eral's office asserts that if charitable assets are involved, the attorney hio, Califor- general will intervene-the form being secondary. However, Ohio faceted and insurance officials were slow to assert this kind of functional ap- idiaries and proach to the proposed Blue Cross conversions. render them Some Examples: State Overview tre offspring and limited To gain insight into state regulators' experience with conversions, states. Fu- we interviewed officials in state offices of attorneys general. Their HEALTH AFFAIRS March/April 1997 CONVERSIONS responses illustrate the great variety in law and practice that exists. In California and Massachusetts aggressive attorneys general be- lieve that strong common-law authority exists for asserting charita- ble trust principles but that it must be used or interpreted in light of clear statutes. 16 These offices are scarcely alone in this assertion, but their comprehensive and unyielding assertion of that authority dis- tinguishes them from other states. The attorneys general in Massa- chusetts and California are also unusual because they have devel- oped written protocols for the charitable principles under which they will assert authority and review conversions.⁷ These protocols represent strong assertions of power that govern how transactions will be processed. They rest heavily on the beliefs that nonprofit entities belong to the public and that the public is represented by the attorney general. Other states demonstrate unique statutory schemes or interpre- tations. In New York a statute governing not-for-profit corporations, is used to regulate the conversions of HMOs. However, operating a hospital as a for-profit stock corporation is effectively forbidden, so conversions of hospitals to for-profit status are generally not an issue.¹⁸ 54 STATE In Maine, where experience has been limited to the proposed ISSUES conversion of the state's Blue Cross plan, the attorney general's office had cited a single statutory sentence giving the attorney gen- eral the right to supervise charitable trusts.¹⁹ The office also may look to the legal theory of ultra vires (the performance of unauthor- ized acts by a corporation), for which Maine law permits injunctive relief.²⁰ The Blue Cross case is now before the insurance department. Under petition from Blue Cross, the insurance department is con- sidering whether to allow operation of downstream for-profit HMOs, jointly owned by Blue Cross and private hospitals. In New Hampshire, common law, including cases dating back to 1901, is the primary basis for intervention.² The attorney general's office also relies on a cy pres statute, which recently was modified to place all such proceedings before the probate court.²² In Virginia, the attorney general's office, although taking a rela- tively modest view of the obligations of the converting Blues plan, ran into a legislature that was anxious to leave its own imprint. Ultimately, the legislature effectively determined the amount of the valuation-a gross understatement in the view of some critics-but directed the money toward the state's coffers, rather than toward medical purposes, as the attorney general had sought. Texas. Texas is likely to have dozens of hospital conversions in the coming years, and the state's Blue Cross plan is involved in merger discussions with the Illinois plan. (The Texas Blues plan HEALTH AFFAIRS Volume 16, Number 2 STATE EXPERIENCE xists. already operates four for-profit subsidiaries, and many regard the 1 be- merger as a prelude to a for-profit conversion.)²³ The relevant rita- authorities identified by the Texas attorney general's office are ex- ht of ceptionally complicated. According to the attorney general's office, a but major source of authority is the Miscellaneous Corporations Act, dis- which permits the attorney general to investigate the books and assa- records of any corporation doing business in Texas. Further, the evel- property code requires that the attorney general must be notified if hich there is a proceeding involving a charitable trust. It permits voiding cols an action for which notice is not given. The not-for-profit statute tions never mentions the need to notify the attorney general, but it ap- rofit pears to govern the conduct of the not-for-profit health care entities. d by Another provision of the Texas codes permits the attorney general to revoke the authority of an entity to function if the entity has pre- violated any Texas law. The attorney general may seek receivership ions to rehabilitate an errant corporation, but this extreme measure is ng a difficult to use. Most importantly, the attorney general asserts 1, so common-law authority to sue for breach of fiduciary duty, and this t an use of authority has never been seriously challenged. The attorney general may impose a "constructive trust" where charitable princi- sed ples have been violated. CONVERSIONS 55 ral's Ironically, none of these laws was the basis for the Texas attorney gen- general's recent role in blocking a conversion of St. Luke's Hospital. may In that case, the relevant issue was enforcement of a fiduciary duty or- contained in a deed restriction, which limited the entity to not-for- tive profit uses. The attorney general won the case. More recently, the ent. Texas attorney general, citing multiple grounds, filed suit to block on- the possible merger of the Texas and Illinois Blues plans. ofit Maryland. The rejection of a proposed reorganization of Mary- land's Blue Cross plan by that state's insurance commissioner dem- to onstrates how fluid the authority of that office can be, and how it al's can be affected by public opinion. When the conversion was first 1 to announced, the commissioner of insurance seemed to embrace it and find no apparent obstacles.²⁴ After great public opposition and ela- numerous investigative articles in The Sun (Baltimore, Maryland), he an, found a clear basis for objecting to the conversion.²⁵ int. In December 1995 the Maryland Blue Cross plan sought approval the from the state Department of Insurance for its proposed "reorgani- out zation." The plan involved the creation of a new for-profit health ard insurance company, a new general insurance agency, and a new downstream holding company; the reactivation and expansion of a in charitable foundation; and the transfer to a managed care company in of all the nonprofit's ownership in five HMOs, a third-party admini- an stration company, its real and personal property, and the vast major- HEALTH AFFAIRS March/April 1997 CONVERSIONS ity of its functions and employees. Blue Cross took the position that this was not a conversion. Consumer groups disagreed. Maryland law provides specifically for the conversion of a non profit health care service plan to for-profit status, upon submission of a plan to and approval by the insurance commissioner.²⁶ Maryland law also provides for distribution of assets upon dissolution. But Maryland corporate law prohibits nonstock corporations from opt erating as for-profit corporations. Moreover, the attorney general has written that a nonprofit corporation may not engage in for profit activity that may "become so substantial that [it] may no longer be characterized as operating a nonprofit health service plan" and "would result in it being characterized as for-profit." The question in Maryland was how the Blue Cross transactions should be characterized and treated. The commissioner of insurance refused to approve the proposal to "restructure" because it did not accord with state law. The com- missioner relied on the attorney general's opinion and found that "the profit-making aspects of the entire enterprise would be so sub- stantial that BCBS [Blue Cross/Blue Shield] would lose its character as a nonprofit health services plan." The commissioner eschewed a 56 STATE rigid legal analysis to determine which narrow category of Maryland ISSUES law applied to the conversion structure and affirmed the need for a more functional approach: "I have concluded that the proposed reor- ganization is in reality more than a mere reorganization but is in- stead tantamount to a conversion to [a] for-profit enterprise." Factors Affecting Regulation Of Conversions A number of practical matters may profoundly affect how and when a conversion is regulated. These include how much regulators know about possible pending conversions (through either formal notice, discussions with other regulators, or other means) and whether regulators have sufficient resources and expertise to carry out their responsibility to protect the public trust. Other important issues are the sometimes overlapping missions of regulators in a state and the philosophy and approach of particular regulators. Knowledge of pending conversions. Regulators agree that if they are to become involved in a conversion, it is best to do so early. Early intervention prevents disrupting a transaction that is nearly complete (and wasting the resources that have gone into it), permits adequate time for review, prevents unlawful conflicts of interest, allows the use of experts on matters such as valuation, and improves the chances of a cooperative relationship between the regulator and the entity undergoing conversion. It also allows the regulator time to anticipate the future and to help structure a surviving or new HEALTH AFFAIRS - Volume 16, Number 2 STATE EXPERIENCE ion that "A striking number of regulators received notice from entities of their E a non- intent to change their status but did not comprehend the significance." mission aryland ion. But entity while involving interested parties in the community. rom op- Regulators learn of potential conversions in a variety of ways, general which may or may not be related to statutory notice requirements. in for- In some states word-of-mouth serves adequately to apprise regula- may no tors of potential conversions. In New Hampshire, for instance, the 1 service law does not require notice to regulators, but the attorney general's fit." The office reports that attorneys representing health care providers do S should so much other business with the attorney general's office that they cannot pass a conversion by them without timely notification. In proposal Ohio the attorney general's office complains of learning of hospital he com- conversions through the media, as there is no requirement of notice. ind that The attorney general there has asked the Ohio Hospital Association : SO sub- (on behalf of its members) and Columbia/HCA to approach its office haracter early with conversion proposals. They have met with some success, hewed a perhaps because the attorney general's office appears prepared to Maryland enjoin any transaction it has not reviewed. In Texas, because there is no statutory notice requirement, regu- CONVERSIONS 57 eed for a sed reor- lators often learn of transactions close to the point at which they are out is in- scheduled to be consummated (and sometimes from the media). e." Regulators report that a large number of transactions have already passed them by, and they may not be able to review them. Regula- tors are willing to reopen transactions that have already been ap- nd when proved." However, the absence of a clear notice requirement can rs know create a political and economic dynamic that makes it difficult to il notice, slow down or reopen transactions and to review them thoughtfully. whether The power of a regulator to hold up a transaction can be even out more important than a notice requirement. For example, California are has a notice requirement for converting hospitals, but hospitals en- = the ssues improves interest and permits that nearly early. their ter into negotiations with the attorney general long before giving notice. The parties do this because they know that the attorney ee if general has sufficient power to hold up a transaction by seeking so more information, issuing subpoenas, or delaying approval. is Indeed, in most states parties to conversions enter into discus- sions with regulators well in advance of giving notice. They know that notice could help a regulator who is lacking political or other power to hold up a transaction. It also could blunt the tactic used by lator and some for-profit entities of developing political or community sup- ator time port for a transaction to undercut a regulator's legal objections. g or new Ultimately, the dynamic of power in what are often private discus- HEALTH AFFAIRS March/April 1997 CONVERSIONS sions may foretell more than the existence of a notice requireme does about the outcome of a conversion. Notice is of little value if a regulator is not prepared to thoughtfully and decisively and does not understand the potenti impact of a conversion. A striking number of regulators report th they received notice from entities of their intent to change the status but did not comprehend the significance of the change. Pan ticularly with regard to Blues plans, regulators have failed to com prehend fully the implications of certain actions that may have bee preludes to conversions. According to an official at the Nations Association of Insurance Commissioners (NAIC), over the past seve eral years several Blues plans were successful in effecting legislative changes that permitted them to change to mutual status, often with clear notice to regulators. Many regulators and legislators did not understand that these changes could portend additional moves to for-profit status, so they pàid little attention to the proposals. Con- sumer groups have sought to educate regulators in many states about the importance of incremental changes to corporate status. Many regulators report that it is only the observation of what plans in other states have done that has put them on notice that any 58 STATE proposed change in the regulation of a Blues plan might portend a ISSUES wholesale conversion to a stock company. With regulators from twenty-six states now sitting on a special NAIC committee on Blues conversions, regulators are likely to be better informed. Nonethe less, in South Dakota a recent conversion of a Blue Cross plan arose with relatively little attention or notice. Sufficiency of resources. Many state agencies lack the re- sources to devote to conversions. This affects how and when regula- tors intervene. Some report giving smaller cases relatively little scru- tiny. Many are unable to study the implications of subtle or complex transactions and thus allow them to go forward without study. Many rely on staff attorneys or other officials who have little time to devote to these highly complex matters. They report extreme frus- tration at having limited resources to face what they see as the near-infinite resources of the private entities that are seeking to tant convert. Often they must rely heavily on the representations of the per regulated entities because of a lack of resources or expertise. Some or worry that with new legislation they will be given new responsibili- ties but not the resources needed to carry them out.²⁸ cor Intervening in the outcome of a conversion is the most visible part of a regulator's job, but an equally significant challenge is overseeing the conversions as they unfold, foundations as they form, and for-profit Te entities as they evolve. Because converting entities rely on experts in finance and law, and government resources often are unavailable or su HEALTH AFFAIRS Volume 16, Number 2 H STATE EXPERIENCE rement nonexistent, many regulators are looking to outside experts to ad- vise them on any or all of these matters. In California, for example, to act the Department of Corporations (DOC) hired an investment tential banker, Bear Sterns, and a foundation and public health expert, ort that Nancy Kane, to advise it on the Blue Cross/WellPoint conversions. e their In Virginia, Texas, and around the nation attorneys general and ge. Par- insurance departments are hiring consultants with distinct exper- o com- tise in conversion law. In the midst of litigation in Ohio, the Depart- ve been ment of Insurance has retained Alex Brown, Inc., to advise it on lational valuation. Selecting and interpreting the work of experts is itself ast sev time-consuming and complex, and the ability of regulators to work islative effectively with experts varies greatly from state to state. en with Most regulators assess the parties for the services of these ex- did not perts-sometimes as much as $100,000. In many cases, regulators oves to have simply made the payment of such fees a condition of their ls. Con approval of a deal. The requirement of payment of fees is typical of y states many issues in the regulation of conversions: They are less impor- catus. tant as matters of law than as a reflection of the balance of power of what between regulators and the entities concerned. So far, relatively that any little controversy appears to have attended this area. However, some rtend a new and proposed legislation includes provision for payment by CONVERSIONS 59 rs from parties to the transaction for experts to advise regulators. This legis- on Blues lation reflects a fear in some states that regulators will be challenged onethe if they seek to obtain expert advice or require payment from the an arose parties without explicit statutory authority. Ambiguity of Jurisdiction. State law often lacks clear guidance the re on the precise roles of regulators in health care conversions, particu- 1 regula larly those involving the Blues. Offices of attorneys general are tradi- tle scru tionally the lead agency in interpreting and enforcing charitable law complex and hospital conversions; insurance departments typically oversee t study. the Blues. But an attorney general may pursue other theories of law, : time to while an aggressive insurance commissioner may pursue a charita- me frus ble doctrine. The contentious nature of conversions may force legis- e as the lators to define the roles of regulators more neatly. Some are reluc- eking to tant to do this because they do not want to tamper with what they ns of the perceive to be broad authority derived from common law, practice, se. Some or inherent power to enforce statutes. onsibili The regulatory tangle can be exacerbated by politics. Insurance commissioners and attorneys general may be elected officials who ible part regard themselves as wholly independent of one another and even of erseeing the state's governor. Conversions in Maryland, California, Ohio, and or-profit Tennessee have become hot political issues. xperts in The complexity of the roles played by attorneys general and in- tilable 04 surance commissioners also affects regulatory effectiveness. For in- HEALTH AFFAIRS March/April 1997 CONVERSIONS stance, an attorney/client relationship may exist between these tw entities, so that the attorney general must represent the insurano department in court. The role of the attorney general's office when is counsel to a state agency may be quite different than when it acting on its own. Theoretically, the client should give instruction to the attorney as to the course it wants to take, but political reality may dictate otherwise. Many insurance commissioners and attor neys general are unclear as to what their role is, particularly vis-à-vi one another. One insurance department official reported that his department must serve as a judge of the appropriateness of an in surer's action. Hence, he claimed, it cannot advocate for the public Many attorneys general reported that they too wear many hats advocate for the public but also arbiter of whether the public has been protected, attorney for their own offices and other state agen- cies, and negotiator and litigator.³⁰ In many states regulators are just beginning to define their re- spective roles. In some states efforts to clarify jurisdiction have been undertaken through legislation. For instance, in Colorado the insur- ance commissioner is deemed the lead in the Blue Cross conversion. In Nebraska both the attorney general and the director of health are 60 STATE given lead roles in hospital conversions. In California a demarcation ISSUES is made between HMO conversions, for which the DOC is given the lead (except with respect to foundation oversight, which falls to the attorney general), and hospital conversions, which are under the purview of the attorney general. It is possible that a constructive sorting out of roles is taking place. The confusion arises in part from lack of experience and un- certainty about what is the relevant theory in the case. When this uncertainty surrounds a transaction, it creates inefficient regulation and obstacles to timely and thoughtful intervention. The question of who should regulate is an important one. Officials in offices of attor- neys general assess their own ability to evaluate health policy issues (such as the ability of institutions to adequately serve the health needs of communities) very differently. Some argue that conversions present unique health policy questions and cannot be handled ade- quately by professional public prosecutors. Others believe that at- suit the) torneys general are perfectly capable of analyzing the health policy for issues involved in conversions. The health policy issues that arise in conversions might be best gran dealt with by a team of state experts that includes health officials. So prof far, this approach has been slow to develop, but some regulators are tran looking increasingly to others in government for assistance. fail Regulatory will. Virtually every person consulted for this pa- law per agreed that the single most important determinant of the HE HEALTH AFFAIRS - Volume 16, Number 2 STATE EXPERIENCE en these two outcome of a conversion is the regulator-in particular, his or her he insurance philosophy, politics, political independence, aggressiveness, com- ffice when it mitment, and willingness to take risks. The law is in a sufficient in when it is state of flux and confusion that a regulator's interpretation and instruction to stance will often be the critical factor. litical reality Changes in political administration that bring into office leaders rs and attor- with new philosophies of regulation can have profound conse- iarly vis-à-vis quences. Massachusetts Attorney General Scott Harshbarger has rted that his brought an aggressive and personal approach to conversion regula- less of an in- tion. Many commentators have noted as well that the single most or the public. important determinant of the outcome of the Blue Cross conversion r many hats: in California was that the new DOC director, Gary Mendoza, had an he public has intense interest in and commitment to this matter. Under Mendoza, er state agen- the conversion's yield to the public escalated from $100 million to more than $2 billion. By contrast, observers point to a series of fine their re- earlier conversions in which regulation was far less aggressive and ion have been foundations were vastly undervalued." ado the insur- Not discussed in this paper but critical to the outcome of a con- SS conversion. version is the degree to which regulators consult with and involve r of health are community and consumer representatives in the decision-making 1 demarcation process. In virtually every state in which conversion activity has CONVERSIONS 61 C is given the voccurred, consumer representatives have sought to educate both the ich falls to the public and regulators about the implications of conversions. The are under the response of regulators and the ultimate outcome of a conversion often reveal much about the degree to which the regulator was oles is taking receptive to this input. rience and un Litigation se. When this ent regulation Disputes over the applicability of statutory and common-law he question of authorities to conversions are being played out at the state level in fices of attor the courts. Lawsuits have been brought by state regulators (or by h policy issues onversion parties attempting to enjoin the actions of regulators) in rve the health veral conversion cases. Three current cases show how judges have at conversions sponded to the various parties' arguments. e handled ade Michigan. In June 1996 the Michigan attorney general brought elieve that at to enjoin a proposed joint venture between Columbia/HCA and e health policy Michigan Capital Medical Center." The joint venture provided Columbia/HCA to own one-half of the health care system and might be bes anted primary control over many essential functions to that for- lth officials. So ofit concern. : regulators an The attorney general asserted a variety of theories to block the stance. insaction, including breach of fiduciary duty, improper valuation, ted for this Thire to gain a tax law ruling, and violation of the state's nonprofit minant of th which prohibits for-profit hospital ownership. The judge re- LTH AFFAIRS March/April 1997 CONVERSIONS jected the first three theories but accepted the last. He appeared be most comfortable relying on a specific provision of statute formally held that the joint venture was ultra vires (beyond authority) and that the nonprofit had exceeded its purpose a: hospital under the state's nonprofit corporation law. Missourl. In 1994 Missouri's Blue Cross plan underwent "reorganization" under which it created a for-profit subsidia. RightCHOICE, in which it received shares of stock in return. BL Cross sought and received approval from the director of insuran for that transaction. Subsequently, Blue Cross sold 20 percent of ti stock at a public offering and retained the rest. The director of insurance subsequently alleged that Blue Cros had withheld from him material details of the transaction. The included amendments to its articles of incorporation allegedly moving its original purposes and altering the scheme for asset distriction bution on dissolution, as well as information showing that all of if business would be transferred to RightCHOICE. The director sub sequently adopted the position that the reorganization was a con version not permitted under Missouri law and that if the conversion was to occur, charitable trust principles should apply. 62 STATE Blue Cross filed a preemptive lawsuit attempting to block the ISSUES director from proceeding against it and seeking a declaratory judg ment that it had no charitable obligation. Consumer groups then filed an administrative petition with the Department of Insurance asking the department to force Blue Cross to turn over its assets to the public. Blue Cross obtained a temporary restraining order to keep the department from proceeding against them and to block any action on the consumers' petition. The Department of Insurance and the attorney general counterclaimed (with respect to the Blue Cross suit), with the department asserting charitable trust principles and the attorney general relying on a narrower doctrine that Blue Cross had violated the purposes of the state's health services corporation statute by operating outside its scope as a nonprofit. The judge in the case has issued two very different decisions in the case, demonstrating just how volatile conversion cases can be. In the first ruling, the judge held that under Missouri law, the attorney general, not the director of insurance, would have jurisdiction over the conversion. The judge has yet to rule on the attorney general's claim or on an amended claim of the Department of Insurance as- serting a new theory. About one month later, however, the judge asserted from the bench that his September order was an interim ruling, not a final one. In December he effectively reversed himself, ruling on behalf of the attorney general that Blue Cross's conversion was impermissible HEALTH AFFAIRS - Volume 16, Number 2 STATE EXPERIENCE appeared to and ordering that there be a dissolution of the corporation. The statute and judge indicated that he would look to reasonable alternatives to the eyond their initial conversion. Blue Cross has since entered into talks with a urpose as a nonprofit, BJC Health Systems, for a new and permissible merger arrangement. nderwent a Ohio. Pending lawsuits in Ohio over Columbia/HCA's pro- subsidiary, posed joint venture with Blue Cross/Blue Shield of Ohio (BCBSO) return. Blue are significant because they raise all of the important issues related of insurance to conversion policy and because the marriage formed in the trans- ercent of the action may represent a new and important form of health care fi- nance and delivery. t Blue Cross Under a proposed transaction in Ohio, BCBSO would form a ction. These stock company subsidiary, BlueCo, to which it would transfer 85 allegedly re percent of its business and assets. BCBSO would own BlueCo, asset distri which would then be acquired by Columbia/HCA, or a newly cre- that all of its ated subsidiary, in return for $299.5 million. Of that, $77 million director sub would go to Blue Cross, and the remainder, to a new for-profit n was a con company owned by Columbia/HCA. BCBSO would be BlueCo's le conversion reinsurer, and BlueCo would provide administrative services to BCBSO. BlueCo would later be able to purchase the portion of to block the BCBSO still held for one dollar. BCBSO is required to pay $25 CONVERSIONS 63 aratory judg million to Columbia if it accepts another offer to convert and to groups thei ontract at Blue Cross's highest reimbursement rates with certain of Insurance olumbia/HCA hospitals. Some of BCBSO's executives reportedly r its assets ould receive lucrative contracts for consulting and noncompeti- ning order arrangements." Blue Cross has applied to the state's Depart- 1 to block an tht of Insurance for approval of the transaction. insurance and A suit was brought on behalf of policyholders against Blue Cross he Blue Cro recognize the interests of the policyholders in the conversion and principles an recognize the transaction as a conversion under Ohio law. The at Blue Cro torney general successfully intervened in the policyholders' suit S corporation Issued Blue Cross and its trustees for breach of fiduciary duty to protect the charitable assets held by Blue Cross. The policy- t decisions Aders' suit was stayed pending a review (now under way) by the uses can be to Department of Insurance. The attorney general's suit has gone the attorn ward. Blue Cross filed a motion to dismiss the suit, alleging that isdiction OV sno charitable assets, and the attorney general has filed a re- mey genera onse. In addition, Consumers Union, Families USA, and the Insurance rican Association of Retired Persons (AARP) have filed amicus supporting the attorney general's position. A lawsuit by the ted from ional Blue Cross Association to block the Ohio plan's use of the ng, not a fit Cross logo has been stayed. g on behal The attorney general has asserted a charitable trust theory and impermiss likely look at inurement issues. The Department of Insurance, AFFAIRS March/April 1997 CONVERSIONS by contrast, appeared initially to claim that charitable trust law not operative and that it would look only at whether policyhold. were protected. It is unclear whether that is still true. It also unclear whether the department is viewing the transaction as demutualization or mere restructuring, and whether departme policy is being informed by the view that the Blues plan may fac financial pressures that it cannot bear in the future. An independent valuation might be the easiest answer to th claim, and, under some public pressure, the Department of Insurant ultimately retained the services of an investment bank to undertal one. A petition arguing that the case is a clear conversion, requirin a demutualization and implicating charitable trust principles, before the department. The lawsuits in Michigan, Missouri, and Ohio expose unresolve issues and provide a process for addressing them. However, litiga tion is a lengthy process, and, given the important legal principle and the enormous amounts of money involved, appeals to highe courts are inevitable. It could be several years before a clear pictur emerges of the legal authority of regulators and responsibilities or converting through the courts. To date, not every case has been 64 STATE tested in this forum. However, unless the underlying issues are han ISSUES dled in another forum, many more cases can be expected. Legislation State legislatures provide another arena for dealing with issues of authority and responsibility for conversions. In the past two years many state legislatures have considered, and a few have passed legislation to govern conversions. Nebraska. In April 1996 Nebraska's governor signed the Non- profit Hospital Sale Act into law.³ It arose in response to a proposed acquisition by Columbia/HCA of Clarkson hospital and the commu- nity's and state assembly's fears that local interests would lose con trol over health care services to non-Nebraskans. Under the new law, persons engaging in acquisitions of hospitals must apply to the attorney general and the director of the Depart- doner ment of Health for approval. The regulators have ninety days follow- ibe ing receipt of a complete application to approve or disapprove the Aft acquisition. Although the new statute has not been tested, it has plan likely served to deter proposed mergers. Consumer groups point to officia it as containing language that could form the basis of a national provide model. voted California. On 1 January 1996 a new California law went into reap effect governing conversions of nonprofit health care service plans." valua The law was enacted following great publicity about the conver- Th HEALTH AFFAIRS - Volume 16, Number 2 HEA EXPERIENCE : trust law was sions of enormous entities such as Blue Cross and Health Net and : policyholders claims that those conversions were processed without consistency true. It also is or reason because of ambiguity in the law.³⁸ The law's enactment ansaction as a also was influenced by claims that the conversions had resulted in er department gross undervaluations and enrichment of certain persons. plan may face The new law requires that covered plans file applications with the commissioner of corporations to establish their compliance with answer to this the law. The commissioner is empowered to disapprove applica- ent of Insurance tions if the law is not followed and may consult other branches of ak to undertake government in reviewing an application for a conversion. The new rsion, requiring law is clearly rooted in charitable-trust principles and requires con- it principles, is verting HMOs to donate assets equal to their fair market value to an independent foundation. The foundation must use those assets for bose unresolved serving the health care needs of the people of California, be free of However, litiga- conflicts of interest, and file postapproval reports showing contin- legal principles ued compliance with state law. The attorney general is charged with peals to higher overseeing the new foundations. e a clear picture 51 Colorado. When the Colorado Blue Cross plan first contem- sponsibilities of plated conversion, it sought and gained passage of a law permitting y case has been it to mutualize. But, in 1995, beleaguered by bad press and lost gn issues are han accounts, the plan expressed interest in figuring out a direct path to CONVERSIONS 65 ected. becoming a stock company. It conveyed that interest to the insur- ance department, and negotiations began. The Blue Cross plan even- tually conceded the application of charitable trust issues and the g with issues of necessity of establishing a foundation for its assets. e past two years In June 1996 the governor of Colorado signed into law an act ew have passed, codifying negotiations between insurance officials, legislators, and the state's Blue Cross plan. This law requires Blue Cross to file a signed the Non, conversion plan with the commissioner for approval. The conver- ise to a proposed sion plan must meet prescribed criteria relating to the transaction, and the commu the obligations of the Blue Cross plan, valuation, and inurement. The would lose con- commissioner must approve the completed plan if he or she finds that it meets the statutory criteria. However, the law gives much tions of hospital discretion to the commissioner. Among the criteria for the commis- or of the Depart sioner's review is that the plan "will not be prejudicial to the sub- nety days follow scribers of the corporation or the citizens of the State of Colorado." or disapprove the After state officials in Nevada approved a merger of that state's en tested, it ha plan with the Colorado plan, the Colorado plan filed with its state T groups point officials to convert formally to a stock company. The Colorado law asis of a nationa provides for the value of the assets of the Colorado plan to be de- voted to public purposes. Therefore, the citizens of that state may nia law went int are service plans, valuation. reap a windfall with the inclusion of the Nevada plan's assets in any about the conver The laws adopted in Nebraska, California, and Colorado settle EALTH AFFAIRS March/April 1997 CONVERSIONS many of the important issues raised by conversions, including authority of regulators to review proposed transactions, the prod for review, and the charitable and fiduciary obligations of the pan to conversions. The apparent success of these states in clarify these issues may mean that their laws will become models for oth states as they grapple with proposed conversions. Conclusion Substantial variation among the states in the processing of conv sions reflects a diversity of experience, expertise, and politic power. It also reveals an area of law that is not clear enough to de with a contentious social issue involving hundreds of billions dollars and the future delivery and financing of health care. TH courts are a particularly poor place in which to resolve these issue Legislation has no guarantee of being rational, but it does permi discussion of a broader range of social and economic issues. Mos states could benefit from legislation that clarifies the issues. Unles that legislation is aimed at a particular transaction, it will need to based on a functional approach that gives regulators some discretion At a minimum, new laws should address the following issues: 66 STATE way to ascribe ownership to nonprofit entities; a delineation of the ISSUES applicable theory (charitable trust or another doctrine); harmoniza tion between conversion law and all other outstanding laws; clarifi cation of the role of public officials; a statement of who is entitled to the assets of the converting entity and the method by which they should be valued; a description of the responsibilities of the result ing nonprofit or foundation; and a statement of rules governing inurement. The legislation also should include an enumeration of the procedural rights to which members of the public are entitled in the conversion process. The critical role that particular regulators play should be encompassed in a framework that includes broad public participation in resolving issues. NOTES 1. As we shall see, the decision over whether a nonprofit is a charity will funda- mentally affect the outcome of the conversion. S 2. Interestingly, some attorneys general have expressed the concern about enact- ing "clarifying" legislation. They fear that legislation that defines their powers with respect to charitable entities might only constrict what they regard to be singularly broad common-law authority. For that reason, they often have 16. 1 sought to insert into proposed legislation a clause stating that nothing in the legislation interferes with or diminishes their common-law authority. 3. Federal tax law is an important adjunct to state law for many conversion issues, particularly those related to foundations. Its enforcement may, how- ever, fall through the cracks as state officials oversee conversions but can 17. seldom seek to enforce federal tax law. 4. Not surprisingly, no independent writer has yet tackled the job of producing HEALTH AFFAIRS - Volume 16, Number 2 HE CONVERSIONS ABSTRACT: The increasing number of nonprofit hospitals and health converting to for-profit enterprises, public concern, and media attention brought conversions to the top of state policy agendas. Conversions raise policy issues because nonprofit corporations' legal status obligates the operate in the public interest, their tax subsidies should not inure to the be of private interests, and they often represent unique community resou providing valuable services. This paper describes legal authority that states use to oversee conversions and outlines several policy issues facing regulators that could be addressed by new legislation. ESPITE LONG-STANDING AUTHORITY over charital D trusts, attorneys general and insurance regulators have or recently begun to examine conversions of nonprofit hospit and health plans to for-profit status. This paper describes existit and newly enacted legal authority that states can use to overs conversions and outlines fifteen policy issues facing state regulato that could be addressed by new legislation.¹ Traditional State Regulatory Authority State attorneys general historically have been responsible for enford ing the body of law that applies to nonprofit hospitals and health 70 STATE plans, including enabling statutes for nonprofit corporations that ISSUES exist in most states and the common-law doctrine of charitable trusts.² According to common law, the creation of a nonprofit or ganization with charitable or other social welfare purposes results in a charitable trust that is irrevocably dedicated to the organiza tion's original mission.³ The organization's trustees are supposed to seek court approval if they wish to deviate from these purposes. On behalf of the general public, attorneys general may sue to safeguard the value of charitable assets and ensure that charitable organiza tions maintain their intended community benefit, such as the con tinuation of essential services. Application of some of these laws is sometimes unclear. For ex ample, although Blue Cross and Blue Shield plans were originally nonprofit corporations, they might not be chartered to serve "chari- table" purposes, which makes it less certain whether they should be regulated under common-law charitable trust principles. In joint ventures, in which a nonprofit and a for-profit appear to contribute and govern equally, the for-profit can actually gain control, but such ventures may not be defined as conversions under existing law. Several attorneys general have become involved in hospital con- version cases. For example, the Michigan attorney general recently obtained an injunction to prohibit Columbia/HCA from consum- mating a joint venture with a nonprofit hospital.⁵ In addition to requiring creation of a charitable foundation, the Massachusetts HEALTH AFFAIRS - Volume 16, Number 2 STATE POLICY ISSUES alth plans attorney general has ordered for-profit successors acquiring non- ntion have profit hospitals to provide charity care and emergency services to aise public the community for specified periods of time and payment for his es them to staff to monitor compliance with these obligations.6 The Tennessee the benefit attorney general entered into a consent decree with parties propos- resources ing the sale of a nonprofit hospital to a for-profit firm that included states can creation of a charitable foundation and established conflict-of-interest acing state protections and accountability requirements for the foundation's board.⁷ And in Texas the attorney general helped to negotiate an haritable agreement under which hospitals in Houston's Texas Medical Cen- have only ter must obtain permission from both the center's board and the hospitals attorney general before entering into joint ventures with for-profit S existing corporations.8 0 oversee Somewhat less successful attempts have been made by state regu- regulators lators to supervise conversions of Blue Cross or Blue Shield plans to for-profit firms. After several years of negotiations, in 1996 the Cali- fornia commissioner of corporations required Blue Cross to create two foundations with combined assets of $3 billion.9 The Missouri or enforc- insurance director recently won a case against a Blue Cross mutual nd health benefit plan that transferred most of its assets into a for-profit sub- tions that sidiary (a part of which was sold to the public). On the other hand, CONVERSIONS 71 charitable the Virginia legislature voided negotiations between the attorney profit or- general and Blue Cross to create a community foundation when the es results plan converted first to a mutual benefit corporation and then to a organiza for-profit firm; the legislature instead required that stock be issued pposed to topolicyholders and a payment made to the state treasury." poses.4 On safeguard Recent State Legislation organiza Uthough common law and existing state nonprofit corporation S the con, WS provide regulators with general jurisdiction to oversee many hospital conversions, some state regulators have found that their tr. For ex uthority over conversions is unclear. For example, some attorneys originally eneral believe that their authority is limited to litigation to stop ve "chari inversions that are under way rather than issuing advance ap- should be oval. Furthermore, Blue Cross conversions sometimes raise S. In joint que jurisdictional issues. Also, authority for oversight of hospital contribute aversions does not necessarily include authority over advance 1, but such otice, public hearings, or the use of resources for an independent Jn law. valuation, or the right to impose specific community obligations on pital con ther foundations or the successor for-profit entities. Conse- il recently ently, several states have enacted explicit laws to prescribe proce- 1 consum to review conversions; and other laws are under consideration. ddition Hospital conversion laws. In 1996 the California legislature sachusetti cted a statute confirming the attorney general's jurisdiction over HALTH AFFAIRS March/April 1997 CONVERSIONS plan to inform the general public and the plan's subscribers. After public hearing, the commissioner may approve the plan if it is fail and reasonable and not contrary to law or the interests of subscrib ers, contract holders, or the public. The fair market value of the assets must be conveyed to one or more foundations, which are independent of both the new stock corporation and the former non profit's officers, directors, or staff, and must be used to promote of serve the health needs of Coloradans." Blue Cross directors, officers and employees cannot receive any compensation related to the con version. For three years after the conversion, the new corporation is prohibited from lowering the value of any stock held by the founda tion by issuing stock with greater dividends or voting rights. Conversion Legislation: Policy Issues Explicit statutory authority can help to resolve ambiguity in common-law standards or states' nonprofit corporation codes which often address sales or dissolutions but not partial transfers or multistage arrangements. Clarification is particularly useful in the case of Blue Cross conversions because of these plans' varying tax status and different structures (nonprofit or mutual) in many states. 74 STATE However, while specific statutory standards can guide regulators ISSUES (for example, to assure that all conversions actually are reviewed), it may be useful to provide regulatory flexibility on some issues (for example, in determining exactly what constitutes a conversion, im posing conditions on successor for-profit organizations, or valuing assets) in view of the widely varying arrangements likely to emerge in the unpredictable and fast-changing health care environment. Il set out here fifteen policy questions for consideration. What entitles should be subject to a conversion law? Most statutes have been drafted to address hospital and health plan con versions separately, perhaps because of the kinds of conversions that have received most attention in the state. Separate laws may be appropriate, for example, in California, where different agencies are responsible for supervising each type of organization. But because health plans may acquire interests in hospitals and hospitals may acquire or create health plans, conversion laws should be drafted, as proposed in Ohio, to apply to relationships among all types of health care entities that ever had a federal tax exemption (including Blue Cross and Blue Shield plans, which lost their federal tax exemptions in 1986).22 Because tax-exempt health plans have had different pub- lic missions than most nonprofit hospitals have had, a regulator might impose different obligations on one type of organization than on the other but should have the authority to review all of them. How should conversion be defined? A fundamental issue in HEALTH AFFAIRS - Volume 16, Number 2 STATE POLICY ISSUES .fter a enacting a conversion law is defining the activities subject to the is fair review procedure. Conversion occurs when a nonprofit provider or scrib- plan changes its form of ownership to for-profit status or cedes a of the considerable amount of control over its assets or activities to a for- h are profit firm (even if a nonprofit shell remains). Because of the varied non- ways in which conversions can be designed (including not only ote or mergers and total acquisitions but creation of a for-profit subsidiary ficers, and various levels of joint ventures), a functional definition may be = con- more useful than a narrow structural one. For example, the defini- ion is tion of conversion in California's hospital conversion law (a sale of unda- or transfer of control over a material amount of assets to a for-profit corporation or mutual benefit plan) allows an examination of the actual effect of a proposed change. On the other hand, the Nebraska law's definition (ownership change of at least 20 percent or the ty in purchaser owning at least 50 percent of the hospital) requires less odes, regulatory discretion but is easier to evade by a transaction that ers or transfers just less than the defined amounts of control. Furthermore, n the to apply to a hospital or health plan conversion that occurs in a g tax series of small steps, a definition should include all transactions over tates. several previous years. California's health plan conversion law, for lators example, appears to allow the corporations commissioner to treat a CONVERSIONS 75 ed), it series of related actions as a restructuring. S (for With respect to health plans such as Blue Cross, policymakers 1, im- should decide whether becoming a mutual insurer constitutes a luing conversion subject to state review (as California's law provides). nerge This issue is important because mutualization may precede change ent. I to for-profit status, at which point it may be much more difficult to require a set-aside of assets, because a mutual benefit company may Most not be viewed as having a "charitable" purpose or obligation. con- Which agency or agencies should regulate conversions? sions Attorneys general historically have been responsible for supervising ay be changes of mission and dissolutions of nonprofit organizations. Al- es are though some have been more active than others, there does not cause appear to be any justification for changing their traditional role.² It may may, however, be appropriate to add review responsibilities for ed, as (other state agencies with more expertise on issues raised by health ealth (care organization conversions. For example, insurance regulators Blue have experience in overseeing the operation of health plans, includ- tions ing Blues plans, and should be involved in reviewing proposed pub- health plan conversions. Because conversions may raise issues of lator health care access, costs, and financing, departments of health or than other agencies with expertise in these matters, including certificate- 1. of-need review, could be charged with reviewing such aspects of ue in proposed hospital or health plan conversions. The lead agency could EALTH AFFAIRS March/April 1997 CONVERSIONS OLIC be authorized to consult with all interested state agencies, althou asse timely cooperation is most likely to occur if each agency's respon sale ] bilities are set out in the law (and if, as discussed below, sufficie hose is resources are provided to carry them out). Unfortunately, sta sub agencies may have conflicting political interests, as, for examp the pro when an attorney general and the governor or an elected insurance explici commissioner come from different political parties. may A related issue is whether private parties, such as policyholder propri potential beneficiaries of a charitable foundation, or members of that general public, should be given authority to enforce charitable tru efore t obligations or state conversion laws if state officials fail to do What op Some state laws allow individuals to act as "private attorneys gen nverslo eral" and bring lawsuits in the public interest, usually after provid nd Mass ing the attorney general an opportunity to pursue the case.²⁴ ind supp Should an Informal review process be avallable before onversio public review? A prime objective of recently enacted conversion Sugh stat laws is to bring these proposals to public attention because of the Ing the pu broad community interest in nonprofit provider and health plan sponsibi assets and activities. Parties to these transactions may seek informal Process is discussions with state regulators, particularly to explore whether many "pub" 76 STATE the proposed action would constitute a conversion and examine there ma ISSUES other matters that may be controversial. One precedent for informal ved by dif review preceding the public process is antitrust enforcement, where in's policy} the federal and many state enforcement officials will discuss pro- Verse views posed transactions and even issue formal opinions (business review cond, the 1 letters). On the other hand, such an informal review of conversion hay create th proposals should not in any way be allowed to nullify or dilute the ne) and full process of public scrutiny.25 these pr What provisions should be made for advance notice to 27 Althou regulators and the public? One of the reasons for enacting explicit Hetary, offi conversion laws is to assure that regulators are aware in advance of 28 An op proposed conversions so that they can conduct a meaningful review iscuss and and inform interested members of the public. The California hospi- ealth care tal conversion statute requires sixty days' advance notice; other ome nation recent laws require advance notice but do not specify a time frame. ible sophist The attorney general's inherent power to supervise charitable trusts provide usel is meaningless without advance notice because it is very difficult to process may undo these arrangements after contracts have been signed. nonprofit, V What conversion Information should be made public? Be- What cause conversions are often conducted behind closed doors, an im- cal issue th portant issue is the extent to which details of the plan are matters of review pro public record. Parties to a transaction tend to argue for secrecy in for interest order not to jeopardize the deal (and attorneys general's investiga- legislative tional files often are exempt from state public record acts). But spectrum HEALTH AFFAIRS - Volume 16, Number 2 HEALTH STATE POLICY ISSUES ulthough consumers assert that the purchase price, governing arrangements, esponsi- and use of sale proceeds should be public. Recent conversion laws, ufficient such as those in California, Colorado, and Nebraska, state, that all ly, state documents submitted in the conversion application (including de- example, tails of the proposed transaction) must be in the public record. isurance (Unless explicitly addressed in law, however, conversion plan re- cords still may be exempt from disclosure as state investigational vholders; files or proprietary information.) California law also specifically ers of the provides that these records must be made available at least one ble trust month before the public hearing on the conversion plan. to do so: What opportunities should be made for public Input Into eys gen the conversion review? In several states, such as California, Colo- r. provida rado, and Massachusetts, consumer advocates have actively encour- 24 aged and supported state regulatory review of hospital and health e before plan conversions as well as legislation to clarify the review process.²⁶ onversion Although state attorneys general are explicitly charged with repre- ise of the senting the public interest, and other regulators generally have simi- alth plan lar responsibilities, a specific role for public input into the conver- informal; sion process is important for several reasons. First, there are likely to whether be many "publics" with different interests (beyond the "general pub- examine lic," there may be potential beneficiaries of a foundation, persons CONVERSIONS 77 informal served by different activities of a converting nonprofit hospital, a nt, where plan's policyholders, or a provider's or plan's employees), and their cuss pro- diverse views are more likely to be heard through a public hearing. SS review Second, the large amounts of money involved in these transactions onversion may create the appearance of a conflict of interest (if not an actual dilute the one), and fully open proceedings can encourage regulators to scruti- nize these proposals carefully and reassure the public that they are notice to fair." Although some details of conversion proposals may be pro- g explicit prietary, offices of attorneys general report that they are likely to be dvance of few.28 An open process provides an opportunity for policymakers to ful review discuss and receive feedback on the implications of the proposal for nia hospi health care access and costs. Another value of public input is that ice; other some national and local consumer groups have developed consider- me frame able sophistication and expertise in reviewing conversions and can ble trusts provide useful technical input to state regulators.29 Finally, a public ifficult to process may encourage other prospective purchasers to bid for the nonprofit, which makes it easier to value the assets. iblic? Be What type of public hearing should be required? A techni- rs, an im cal issue that may have important consequences for the conversion matters of review process is the nature of the public hearing. An opportunity secrecy in for interested persons to comment and ask questions, similar to a investiga legislative hearing, can be useful for obtaining input from a broad acts). But pectrum of the public. A more formal ("quasi-judicial") hearing HEALTH AFFAIRS March/April 1997 CONVERSIONS involving prepared statements by designated parties, invited nesses, and cross-examination (often the model used when in ance regulators are investigating insurer misconduct) may pro- more focused information to the decisionmaker, but it may redi the opportunity for input from the general public. The type of h. ing also is likely to determine who has a right to appeal the regi tor's final decision and whether an appeal can be made to a count another administrative agency. What authority should regulators have to Impose con tions on the partles to a conversion? In addition to supervis the disposition of the nonprofit provider's or plan's assets, sb regulators may want to impose conditions on the nonprofit (if continues to exist in some form) or the for-profit successor. example, a for-profit hospital could be required to provide a certar amount of charity care or to maintain an open emergency depar ment (as the Massachusetts attorney general has required in son conversions). A health plan might be required to continue to,s community-rated policies. One criterion the state can use under Nebraska hospital conversion law is the purchaser's continued obf gation to serve disadvantaged and uninsured persons.³¹ Althoug 78 STATE such obligations might not be needed in all cases, authority to in ISSUES pose them should be included in a conversion law, because without explicit jurisdiction, an attorney general may feel unable to regular the for-profit successor.³² How should the converting nonprofit provider's or plan! assets be valued? One of the most contentious issues in a conver sion review is the valuation of the nonprofit's assets, which deten mines the amount of resources that must be set aside in a foundation or other organization to continue the nonprofit's mission and, in the case of mutual insurers, transferred to policyholders. The extent to which the nonprofit is undervalued eventually will inure to the benefit of private individuals. When several nonprofit California HMOs became for-profit firms in the 1980s, their successor founda tions received a fraction of the value that shareholders held after the conversion." Consequently, the proposed purchase price should not be taken as the best measure of a nonprofit's value. Regulators should be encouraged to consider multiple approaches to valuation, including the value of assets (both tangible and intangible, such as trademark, reputation, provider contracts, subscriber lists, and gen- eral benefits to the community), multiples of earnings over several years, discounted cash flow, and future cash-flow projections that take changing market conditions into account.³⁴ The price that the nonprofit would bring in an open, competitive market is difficult to determine because there are often no competing bidders, but the HEALTH AFFAIRS Volume 16, Number 2 STATE POLICY ISSUES invited wit- potential for competition is another reason that the conversion re- when insur- view process should be public." may provide Because few state officials have expertise in valuing these types of it may reduce assets, they will need the assistance of consultants such as invest- type of hear- ment bankers, accountants, and actuaries. Conversion laws should cal the regula} authorize the use of such outside experts and the ability to charge e to a court or their costs to the nonprofit applicant (as provided in the California, Colorado, and Nebraska laws). npose condi What entity should receive the former nonprofit's assets? to supervising The typical model is to create a new charitable foundation to receive S assets, state the assets of the former nonprofit entity and use them for continued nonprofit (if it public benefit. Other possible recipients are an existing community successor. For foundation or a government agency. A key consideration in deciding ovide a certain which type of organization can best carry on the nonprofit's mission rgency depart is how to ensure that the funds are used for the desired purposes. quired in some For example, to reduce the costs of administrative duplication, as- ontinue to sell sets could be transferred to an existing community foundation with 1 use under the the same objectives as the former nonprofit organization and ear- continued obli. marked for specific purposes, perhaps with some commitment to ons.³¹ Although report to state agencies on their use. Alternatively, a government uthority to im health program might be an appropriate recipient, since foundations CONVERSIONS 79 ecause without rarely fund direct services, which might be the desired use of funds able to regulate (for example, from a hospital that provided a large amount of charity care). Because public agencies do not generally use the interest from der's or plan an endowment and might consume the assets more quickly than a ues in a conver foundation would, assets could be set aside in a public program that S, which deter is responsible for preserving the principal and using the interest for in a foundation the designated health care purpose. ssion and, in the How should a successor foundation be structured? One S. The extent way to ensure that the new foundation remains independent from ill inure to the both the nonprofit and for-profit entities would be to engage sepa- rofit Californi rate counsel to represent the foundation during its initial develop- ccessor foundi ment and to help the foundation to define its purpose, tax status, :rs held after th and board membership. price should no Purpose. Should the foundation have the same purpose as the non- due. Regulator profit, or a different purpose? By common law, a nonprofit organiza- hes to valuation on whose purpose became impossible or impractical was required tangible, such Sadopt a purpose as close as possible to its original mission. This er lists, and ge pproach may be undesirable in health care organization conver- ings over seven ons because of the difficulty of determining the nonprofit's precise projections the aissions and because the community may not need hospital care, for he price that tample, because of overcapacity. A successor foundation could be ket is difficult uthorized to serve a broader mission (promoting the health needs bidders, but state or community residents, health professional training, or EALTH AFFAIRS March/April 1997 CONVERSIONS public health education) or a narrower one (charity care to unit sured or underinsured persons or health care services to children Because some foundations have been created from hospital sales include nonhealth missions, a conversion law should define accep able parameters for the foundation's activities.³⁶ Tax status. Federal charitable tax-exempt status as an Intern Revenue Code section 501(c)(3) private foundation is advisable be cause of its limits on political activity and private inurement and requirements for public accountability. On the other hand, the organizations may not hold more than 20 percent of a corporation voting stock, and it may be desirable to transfer the assets of th nonprofit in the form of the new organization's stock as a way ensure that they are fairly valued." For this reason, California health plan conversion law permits the temporary use of a 501(c)(4 organization (whose stock ownership is unlimited) to gradualli monetize the value of the stock, but it imposes restrictions on the 501(c)(4) entity (regarding political activity, self-dealing, and publi reporting) similar to those under 501(c)(3). Board membership. Some successor foundations have been manage by board members of the former nonprofit and/or the successo 80 STATE for-profit enterprise.³ However, these persons may have little expe ISSUES rience in making grants. Furthermore, close ties with the for-profit firm may lead to conflicts of interest. Conversion laws in California and Nebraska require independent foundation directors with ap propriate philanthropic experience, although defining what consti tutes an independent board can present a challenge. Other ques tions regarding board composition are how many directors the board should include (some general state nonprofit laws permit few as three, which may be too few to carry out the foundation' responsibilities), and how they are selected both initially and there after. An outside expert might be engaged to recruit and recommend membership for the first board. How can private Inurement from the conversion be avolded? In addition to transferring assets to an entity such as foundation that is totally separate from the nonprofit and for-profit entities, the conversion should not enrich individuals, such as em; ployees, board members, or fiduciaries (attorneys, accountants, or other consultants) of either the nonprofit or for-profit parties to the conversion. Previous conversions have resulted in private inurement to stockholders when assets are undervalued and to employees and board members who receive consulting fees, low-price stock op tions, or employment in the successor for-profit entity or founda? tion. Some foundations have given grants or other subsidies to the for-profit purchaser that also suggest conflicts of interest or private HEALTH AFFAIRS - Volume 16, Number 2 STATE POLICY ISSUES inurement. Health plan conversion laws in California and Colorado (driven by publicity over high compensation to nonprofit board members approving these transactions) prohibit private inurement and conflicts of interest, as does Nebraska's hospital conversion law. How should conversions be monitored over time? Estab- lishing that a conversion meets common law or statutory require- ments for fairness to the public is not the only responsibility for state policymakers. Regulators also need to monitor whether the parties to the conversion have met required conditions, such as the prohibition on private inurement and self-dealing or any charitable obligations, and whether the successor foundation maintains inde- bendence and carries out its mission. Enforcement of these condi- nons is another important but potentially underfunded longer-term function that could involve various state agencies. Remedies such as fines and license revocation could be useful enforcement tools. It seems likely that an attorney general or insurance regulator can require reports on these matters under his or her inherent oversight authority and as a condition for approving a conversion. To avoid aged any uncertainty over this authority, state conversion laws should SSOP include an explicit reporting requirement, like those in California and Nebraska. CONVERSIONS 81 rofit What resources might state regulators need to Implement conversion law? Because of the expertise and time needed to dequately review a proposed hospital or health plan conversion md to monitor compliance with the conditions of approval, state ues egulators are likely to need additional resources to carry out their sponsibilities under both current and newly enacted laws. In it tates with a great deal of conversion activity, attorneys general, ion' insurance commissioners, and state departments of health may need here aditional staff to process applications and evaluate their impact on ffected communities. They also will need proficiencies not gener- Шу used in state agencies, particularly to assess the fairness of the n Snprofit's asset valuation. Such competence is especially impor- as nt given the high level of expertise that the parties to a conversion orofi afford to hire. In view of state budget constraints, it seems most propriate to permit state regulators to assess the nonprofit or- ts, hization applying for conversion or the for-profit purchaser for o 6th the costs of engaging outside experts and the reasonable direct sts of reviewing and evaluating the application. Colorado's health S conversion law permits charging the cost of hiring experts, k hereas California's hospital and health plan conversion laws pro- und the broader authority to charge all reasonable agency review 0 to the applicant. An alternative under consideration in Massa- jusetts would permit charging costs to the for-profit purchaser to ALTH AFFAIRS March/April 1997 CONVERSIONS preserve the nonprofit's assets. Conclusion Conversions of nonprofit hospitals and health plans pose a ma challenge for state health policymakers, who are obligated to enst that charitable assets remain to serve the public. The public inter in a nonprofit hospital or health plan's assets justifies a fair and op public process to review conversions. While public attention often piqued by the media's focus on windfall gains to nonpro board members or executives, the real focus should be on how achieve sound health policy for the communities served by organiz tions proposing to convert. For-profit organizations may add vali by improving efficiency and paying taxes, but at the cost of losing institution that is uniquely dedicated to serving community need These discussions can become contentious because they invol often strongly held views (not easily grounded in scientific eviden on organizational performance) about the value of for-profit or nor profit organizations. Yet philosophical debates may be moot if th increasingly competitive U.S. health care environment is discoura ing both nonprofit and for-profit hospitals from providing unprofit 82 STATE able services that benefit the community or from serving person ISSUES who are unable to pay. In drafting legislation and defining transactions subject to publi oversight, policymakers need to be vigilant for new arrangement that may fall just outside legal boundaries. One of the few certaintie in the unpredictable and fast-paced health care marketplace is that plans and providers will try to craft ventures to meet both explici and implicit corporate goals while avoiding regulatory oversight. The author is grateful to Kim Belshé, Eileen Cody, Jack Ehnes, John McDonough Elizabeth Mitchell, Linda Miller, David Schactman, and Steve Wessler for their very helpful editing suggestions. NOTES 1. See P.A. Butler, Profits and the Public Interest: A State Policymaker's Guide to Non Profit Hospital and Health Plan Conversion (Portland, Maine: National Academy for State Health Policy, 1996). 2. D.M. Fox and P. Isenberg, "Anticipating the Magic Moment: The Public Inter est in Health Plan Conversions in California," Health Affairs (Spring 1996); 202-209; E. Hamburger, J. Finberg, and L. Alcantar, "The Pot of Gold: Moni- toring Health Care Conversions Can Yield Billions of Dollars for Health Care, Clearinghouse Review (August/September 1995): 473-504; and A.W. Scott and W.F. Fratcher, The Law of Trusts (Boston: Little Brown, 1989), sec. 399. 3. 18 Am. Jur. 2d Corporations, secs. 32-33 (1985); Greil Memorial Hospital V First Alabama Bank, 387 So. 2d 778 (Ala. 1980); and Queen of Angels Hospital V Younger, 136 Cal. Rptr. 36 (Cal. App. 1977). 4. In a proceeding called cy pres, a court must determine that it is impossible or HEALTH AFFAIRS - Volume 16, Number 2 CONVERSIONS ABSTRACT: Conversions raise two critical policy questions: First, does ownership form (nonprofit or for-profit) make any difference to delivery of health care? Second, when conversions occur, how are charitable assets and purpose pre- served? This paper addresses both questions, based on a review of evidence and experience. On the first question we conclude that, overall, nonprofit ownership enhances the potential for community benefit. However, that potential may be better realized by requiring nonprofits to meet minimum community benefit standards and possibly by mitigating pressure on institutions to convert. On the second question, we conclude that more states should take legislative action to establish a formal oversight process for conversions. Without public considera- tion of how much money to set aside and for what purpose, conversions pose the risk that communities will lose significant services and resources. ERHAPS NO HEALTH SYSTEM change arouses more emotion P and less rational policy discussion than the conversion of hos- pitals and health plans from not-for-profit to for-profit status. Although the nation's hospitals and hospital beds remain over- whelmingly not-for-profit and only a handful of Blue Cross/Blue Shield plans have actually converted to for-profit status, nonprofit hospitals and health plans confront an increasingly competitive marketplace and aggressive acquisition strategies by for-profit 10 OVERVIEW chains. Furthermore, the magnitude of the dollars at stake ($3 bil- lion in one Blue Cross conversion alone) makes the amount of public attention both understandable and appropriate. Attention, however, is not the same as thoughtful consideration. The purpose of this paper is to encourage a thoughtful public dia- logue by providing an overview of the issues that conversions raise for the health care and health insurance systems. Our aim is to clarify what public policy issues are at stake. The paper addresses two fundamental questions. The first is whether tax status makes any difference to the delivery of health care or health insurance. If not, tax policies conferring nonprofit status may warrant adjust- ment or reconsideration. If SO, the desirability or the terms of con- versions come into question. The second question is how to regulate the conversion process to protect charitable assets. When charita- ble organizations convert to for-profit status, charitable trust law requires that the value of those assets be set aside for charitable purposes (usually in a foundation) and not inure to the benefit of individuals. But who is subject to charitable trust law, how much money is set aside, and how those funds are used are public policy issues of major procedural and substantive concern. Background We define conversion as any type of transaction that results in the shift of all or a substantial portion of the assets of nonprofit health HEALTH AFFAIRS - Volume 16, Number 2 gary Steve PUBLIC POLICY OVERVIEW Feinman care organizations to for-profit use. Conversions range from rela- tively simple transactions in which nonprofits' assets are exchanged at arm's length for cash to far more complicated transactions involv- ing multiple organizational components, interlocking organiza- tional structures, and complex financial arrangements. The follow- ing are some examples of the possible types of transactions. Asset sales. A common and straightforward form of conver- sion is asset sales. In such arrangements a nonprofit organization typically sells its physical assets (such as a hospital plant), its name, and its accounts to a for-profit purchaser in exchange for cash, stock, notes, or other property. The proceeds of such a sale are generally received by a nonprofit foundation, which may be the original organization or a new nonprofit entity established to re- ceive the proceeds of the sale.² Joint ventures. A more complicated type of transaction that may result in a conversion is a joint venture. For example, a non- does the profit hospital and a for-profit hospital organization might form a for-profit partnership whose purpose is to offer hospital services. fornda time The nonprofit contributes its hospital assets to the partnership in get cash? any exchange for cash and an ownership interest (say, 20 percent) in the new venture. The for-profit contributes cash to the venture) (equal to CONVERSIONS 11 80 percent of value of the hospital assets) and receives ownership interest (80 percent) in the venture.³ Proceeds of the transfer of a nonprofit's assets generally are placed in a nonprofit foundation. In this case, the foundation becomes the holder of the nonprofit's 20 percent interest in the venture. There are several interesting aspects to such a transaction. The for-profit company gains effective control of the hospital's assets (that is, it owns 80 percent of the assets and has a contract to manage the hospital) without having to pay their entire value. The trustees of the former nonprofit hospital maintain substantial influ- ence over the hospital's operation through their 50 percent repre- sentation on the venture's board. By accepting an ownership inter- est in the venture as part of the consideration for transferring its hospital assets, the nonprofit has in essence gone at risk for 20 percent of the amount of its hospital assets. The total amount that the foundation ultimately receives for the nonprofit hospital assets will depend on the venture's future success. Other types of reorganization. Other types of transactions may be conversions as well. For example, several Blue Cross/Blue Shield plans have either implemented or proposed reorganization plans that call for the nonprofit health plan to transfer a substantial portion of its assets to a for-profit subsidiary. The subsidiary would offer stock to the public, resulting in partial public ownership of the HEALTH AFFAIRS - March/April 1997 CONVERSIONS plan's assets. Most of the insurance operations would be carried out through the for-profit subsidiary, which would have the same man- agement as the nonprofit parent. Whether this type of transaction should be considered a conver- sion-that is, whether the core enterprise of the nonprofit organiza- tion has been transformed-has been a matter of dispute. In Califor- nia a proposed reorganization with a similar structure was initially accepted by regulators as a restructuring of the nonprofit health plan, but after concerns were raised by consumer representatives and others, regulators ultimately treated it as a conversion. Similar disputes have occurred or are occurring in several other states, in- cluding Missouri and Maryland. Scope of conversion activity. Conversion activity has pro- ceeded at different paces and in different ways across nonprofit health care organizations. The distribution of hospital beds by own- ership has remained markedly stable.4 In 1994, as in 1984, about 70 percent of all beds were nonprofit, 20 percent were public, and 10 percent were for-profit.⁵ Nevertheless, there has been significant change in a number of states. In New Hampshire, Utah, Idaho, and New Mexico the for-profit share of beds in 1994 was about 10 per- 12 OVERVIEW cent higher than in the previous decade. Perhaps more significant, after more than a decade in which approximately nine hospital con- versions occurred per year, thirty-four occurred in 1994 and fifty- nine occurred in 1995.6 Conversion activity also has increased among Blue Cross/Blue Shield plans. Historically, the Blue Cross and Blue Shield Associa- tion (BCBSA) required that licensees of its trademarks be nonprofit. That requirement was eliminated in June 1994, to permit plans to better adapt to the changing marketplace and to obtain access to equity capital.⁷ Since the change, three of the sixty-three plans (Georgia, California, and Virginia) have converted to for-profit own- ership. Other plans, including those in Colorado, Maryland, Massa- chusetts, New York, and Ohio, are considering conversions. The health maintenance organization (HMO) industry presents a different picture. That industry began as almost exclusively non- profit-fueled in part by the availability of federal grants for non- profit organizations and BCBSA policies. However, over the past ten to fifteen years the HMO market has become predominantly for- profit. In 1981, 82 percent of HMOs (accounting for 88 percent of overall membership) were nonprofit.8 By 1995 the proportion of nonprofit plans fell to 29 percent (accounting for 41 percent of mem- bers).⁹ Furthermore, among the more loosely integrated HMOs that are growing most rapidly, for-profit organizations are most prevalent. HEALTH AFFAIRS - Volume 16, Number 2 PUBLIC POLICY OVERVIEW "Conversions can provide nonprofit organizations access to capital, which is particularly important in a managed care environment." For-profit plans now account for 76 percent of enrollees in open- ended plans, compared with only 57 percent in pure HMOs.¹⁰ Among preferred provider organizations (PPOs), which also are growing rapidly, 80 percent of plans are for-profit." Reasons conversions occur. In many cases, conversion is simply the outcome of a consolidation strategy, rather than a spe- cific organizational goal. In other cases, nonprofit organizations may see disadvantages to their ownership status and explicitly pur- sue a conversion strategy. Here we describe how market and institu- tional factors are contributing to the surge of conversions. Access to capital. Conversions can provide nonprofit organizations with access to capital, which they can use to restructure operations and put themselves in a better competitive position. Health plans have followed this strategy for several years, beginning with conver- sions of several nonprofit HMOs in the mid- and late 1980s and followed by several Blues plan conversions in recent years. Access to CONVERSIONS 13 capital is particularly important in a managed care environment, in which substantial investments may be necessary for information systems, network development, utilization management, and ex- panding market share. Equity can be a cheaper method of raising capital than debt, particularly for firms with good growth potential whose stock may be valued at a high multiple of its current earnings. For-profit firms can acquire competitors by issuing stock, thereby expanding their market shares without reducing their reserves or accumulating sub- stantial debt. Managed care plans have followed this strategy suc- cessfully in the past several years. For example, it is estimated that United Healthcare issued more than sixteen million shares of stock to finance acquisitions in 1994 alone.¹² Efficiency. Competitive forces in the marketplace have forced hos- pitals and health plans to be more efficient, and many have sought efficiencies through consolidation via mergers and acquisitions. In the hospital industry a large overcapacity of inpatient beds has rein- forced this trend. For-profit consolidation activity is likely to focus on nonprofit institutions because the vast majority of hospitals are nonprofit." Many advocates of for-profits also contend that the re- sulting conversions enhance efficiency through the greater manage- rial skill and market responsiveness of for-profit operations. Market share and growth strategies. In today's competitive environ- HEALTH AFFAIRS - March/April 1997 CONVERSIONS ment, increasing market share is often a necessary strategy. Hospi- dvant tals need increased market share to build networks that will guaran- Pote tee patient flow and to increase their bargaining power with man- onsur aged care plans and physician groups. Health plans seek to build antia large enough networks to serve regional and national employers and dons I to give them increased leverage in their negotiations with providers. ous ca Network building is expensive and often is accomplished through to pur merger and acquisition, regardless of organizational form. These con- value. solidations often occur between nonprofits and for-profits and result buyers in conversions. For-profits, because of their access to equity capital, Advoc have an inherent advantage in this realm. est ma For investor-owned hospital chains, the dynamic of the stock nonpr market creates additional pressure. The stock of some companies is now selling at a price that is a high multiple of earnings, which Does reflects investors' expectations that these firms will maintain their Not-f recent high rates of growth. Given hospital overcapacity, acquisi- talan tions are a primary means for these firms to increase revenues at subst rates necessary to meet their investors' growth expectations. prem Survival and continuance of mission. For weaker nonprofit organiza- provi tions threatened with closure, the sale of their health care assets to amou 14 OVERVIEW or a joint venture with a for-profit firm might be seen as the best tax-e alternative to sustain any institutional presence and to preserve impo what may be an important source of community employment. Even muni if closure is not an immediate threat, some organizations may per- sions ceive selling their nonprofit assets as an opportunity to generate the o funds to continue missions, such as medical education or charity do, o care, that are threatened by competitive pressures that limit operat- tions ing revenues. conv Reduced regulatory constraints. Another factor in an organization's decision about conversions relates to the greater flexibility that for- sus 1 profit organizations have in compensating executives, staff, and reso partners. A hallmark of nonprofit organizations is that they exist for in th public rather than private benefit, and federal and state tax rules a re prohibit the earnings of nonprofit organizations from inuring to the exar benefit of insiders or other individuals. However, this greatly limits pita the ability of nonprofit organizations to use flexible compensation Usit arrangements, such as profit sharing, that some see as important four tools for competing in the market. For example, permitting staff in t physicians to share in hospital revenues from outpatient depart- leag ments or other services is considered a way for hospitals to recruit out and maintain physicians and attract patients and referrals, but In- The ternal Revenue Service (IRS) rules limit nonprofit hospitals' ability pub to enter into such arrangements. For-profit hospitals have greater pro flexibility in this regard, which may provide them with a market to I HEALTH AFFAIRS - Volume 16, Number 2 HE PUBLIC POLICY OVERVIEW advantage. Potential benefit for directors and managers. Finally, as highlighted by consumer groups, regulators, and others, the opportunity for sub- stantial personal financial gain by insiders of nonprofit organiza- tions may influence some conversion decisions." In several notori- ous cases from the 1980s, key insiders of nonprofit HMOs were able to purchase their plans for prices apparently far below market value.¹⁶ In these cases, the insiders essentially were both sellers and buyers and had a personal interest in paying less than full value. Advocates have suggested that the same potential conflicts of inter- est may exist in some of the joint venture arrangements between nonprofit hospitals and investor-owned hospital chains today." Does Profit Status Make Any Difference? Not-for-profit institutions have played dominant roles in the hospi- tal and health plan markets for decades. As such, they have received substantial subsidies from federal, state, and local governments, premised, at least in part, on the theory that these organizations provide special benefits to the communities they serve. Whether the amount of benefits they provide is sufficient to justify their tax-exempt status has been a matter of some controversy and raises CONVERSIONS 15 important questions for tax policy.¹⁸ If nonprofits provide more com- munity benefits than their for-profit counterparts do, then conver- sions could result in the loss of such benefits to communities. If, on the other hand, nonprofits provide fewer benefits than for-profits do, or if the benefits provided are less valuable than the tax exemp- tions conferred, then the tax preference is subject to question, and conversions may result in a net benefit to communities. What are community benefits? Debate about nonprofit ver- sus for-profit community benefit is longstanding. Research has not resolved this controversy, in part because of considerable variation in the way community benefits have been defined and measured. As a result, comparing findings across studies becomes complex. For example, comparison of charity care in nonprofit and for-profit hos- pitals has been studied both nationally and within individual states. Using aggregate national data, several prominent organizations found relatively small differences between nonprofits and for-profits in the provision of charitable care.¹⁹ But Lawrence Lewin and col- leagues contend that aggregate data may be deceiving.²⁰ They point out that most for-profits have been concentrated in thirteen states. These states tend to have leaner Medicaid eligibility rules and fewer public hospitals than do states that are chiefly populated by non- profits. The demand for charity care in those thirteen states is likely to be relatively higher, so the amount of charity care for-profit hos- HEALTH AFFAIRS - March/April 1997 CONVERSIONS pitals provide relative to total revenue may be high compared with national averages but low in relation to demand and what other nonprofits provide in that state. In comparing nonprofits and for- profits within the same state, Lewin and colleagues find larger dif- ferences in the provision of charity care than is the case in national studies.²¹ Recognizing that differences and controversies exist, we list here items that might be included in measuring community benefits. The list moves from relatively concrete and more easily measured bene- fits to benefits that are more abstract and difficult if not impossible to measure. Tax payments are listed last because of a lack of consen- sus as to the appropriateness of their inclusion. The list focuses primarily on hospitals because they have received the most atten- tion in the literature, although a recent paper by Bradford Gray and Mark Schlesinger also looks at HMOs through some indirect meas- ures (for example, loss ratios and annual disenrollment by Medicare beneficiaries).² Charity care. For hospitals, providing care to persons who are un- able to pay is almost universally considered a community benefit. For health plans, the analogue of charity care might be accepting 16 OVERVIEW applicants without regard to health status (where it is not re- quired), subsidizing the premiums of persons with preexisting medical conditions through community rating, or providing direct premium subsidies to persons who cannot afford insurance. Health plans that own hospitals or clinics can provide direct charity care. Bad debt. In data sets that measure hospital uncompensated care, bad debt is often combined with charity care. Many analysts use this measure because studies have shown that most bad debt likely re- sults from patients who are unable to pay.2³ The level of bad debt so far exceeds that of pure charity care that the question of whether to include it as a community benefit is not trivial. If bad debt is not counted, actual charity care is underestimated, but if all of it is included, the amount of charity care is overstated. Some question the inclusion of bad debt, citing reasons such as poor management of receivables or free care given to staff and trustees. Both charity and bad debt are more accurately measured on a cost rather than a charge basis, and data based on charges should be adjusted using a cost/charge ratio. Losses from serving public program enrollees. To the extent that Medi- care and Medicaid set provider reimbursement rates below provider cost, the losses sustained by hospitals serving these patients may be considered as similar to charity care (for the extent of the losses).²⁴ Losses from subsidizing necessary community services. Services such as burn units, twenty-four-hour trauma centers, or programs for HEALTH AFFAIRS - Volume 16, Number 2 PUBLIC POLICY OVERVIEW special-needs populations such as hemophiliacs are medically im- portant but often unprofitable because of high costs or low volume.²⁵ The benefit to the community would be access to vital health care services that otherwise might be unavailable. Net cost of research and education. Providing or participating in medi- cal education or research programs may be considered a community benefit since health care organizations may not be fully reimbursed for the total cost of these activities. Lower prices. Some analysts contend that lower prices charged by nonprofits constitute a community benefit. They argue that non- profits do not fully exploit their market power to maximize reve- nues, and as a result, the benefit of lower prices inures to consumers. Community needs assessments, education, and service programs. Health care organizations can assess the health care needs of their commu- nities and develop specific initiatives (such as health screenings or programs for high-risk groups) to address those needs. Including these activities as community benefits has been criticized because health care organizations often use these types of services as a means of advertising and sometimes charge for these services.²⁶ Community control and accountability. Control of health care organi- zations by local volunteer boards may be considered a community CONVERSIONS 17 benefit on the theory that organizations controlled by community volunteers will be more receptive and responsive to local health care needs. Nonprofit organizations also provide a vehicle through which citizens can express their civic and charitable ideals. Nonprofit orientation and trustworthiness. The lack of profit motive of not-for-profit organizations itself is sometimes considered a com- munity benefit. The theory for this proposition rests on the idea that health care is a complex good and that consumers do not under- stand their health care choices as well as do those providing care.²⁷ In such situations, suppliers can take advantage of consumers' lack of information by withholding services or by reducing quality. Firms with a profit incentive are considered more likely to take advantage of these informational asymmetries because they can profit from doing so. Not-for-profit firms, because they are constrained from using any net earnings for personal benefit, are considered not to have an incentive to exploit their information advantages. One potential objection to this theory is that physicians play a mediating role that protects consumers from exploitation in these situations.² However, the various economic ties between hospitals and physicians and the influence of third-party payment practices such as managed care bring into question the impartiality of physi- cians as mediators.²⁹ Taxes. There is no consensus regarding whether taxes paid by HEALTH AFFAIRS - March/April 1997 CONVERSIONS "Nonprofit hospitals provide more community benefits than for- hose be receiving profits. [But] there is wide variation among nonprofit hospitals." Po regardir for-profit organizations should be counted as community benefits. toward Advocates of for-profits contend that all taxes should be counted. exempt Others point out that few if any taxes contribute directly to the for-prof benefits health care needs of the local community, particularly federal and dvanta state income taxes, which are both uncertain in amount and outside of community control. Some argue that property and other local ciently sumes taxes that remain under community control should be counted, benefit while others recommend complete exclusion of taxes or the inclu- vide CC sion of only those taxes that are earmarked for health services. Evidence on community benefits. Examination of twenty suggest discuss studies of comparative community benefit (virtually all of those linking found in the literature) and numerous studies on price and cost accoun differentials yields the following major conclusions.³⁰ availab (1) Nonprofit hospitals provide significantly more community provid benefits than for-profit hospitals provide. The differences are more linked evident when comparisons are made across hospitals within states. 18 OVERVIEW increa (2) There is wide variation among nonprofit hospitals in their erally provision of benefits, with a large proportion of benefits being pro- A Si vided by a few nonprofit hospitals. Public hospitals (rather than sector nonprofit community hospitals) and major teaching hospitals pro- tion } vide a disproportionately large share of community benefits, and a under significant number of nonprofit community hospitals provide few mend community benefits. Cath (3) When employing a reasonably broad definition of community tion. benefits (charity care, bad debt, losses from public programs, and benef net cost of teaching and research), we find that nonprofit hospitals, Utah as a whole, contribute significantly more in benefits than the cost of ing 0 their tax exemption. broac (4) Prices charged by nonprofit hospitals are generally lower than tax P those charged by their for-profit counterparts for similar services. Ac (5) If taxes paid by for-profit hospitals are counted as community dolla benefits, then, overall, the benefits provided by for-profit hospitals ties would exceed those of nonprofits. However, the relation between Alth taxes paid and community benefits is uncertain and tenuous, and conv although no consensus exists, it seems appropriate to count only rath those taxes that are specifically earmarked for health services. mar] In sum, the evidence indicates that there is a substantial differ- tors ence between nonprofit and for-profit hospitals in terms of the com- regu munity benefits they provide. However, the burden of providing prev HE HEALTH AFFAIRS Volume 16, Number 2 PUBLIC POLICY OVERVIEW those benefits is uneven, with many nonprofit community hospitals receiving tax exemptions in excess of the benefits they dispense. Policy Implications. Hospitals. These findings raise questions regarding current tax treatment of nonprofit hospitals and policies toward conversions. Some have recommended eliminating the tax exemption and giving all health organizations, whether nonprofit or for-profit, tax deductions for legitimate expenditures on community benefits. From an economist's perspective, this approach would be advantageous in terms of horizontal equity and would more effi- ciently target tax expenditures. However, this policy proposal as- sumes a tighter connection between tax breaks and community benefits than actually exists. The fact that nonprofits generally pro- vide community benefits worth more than their tax exemptions suggests that the nonprofit ownership form has value. Further, as discussed above, not all community benefits are clearly definable; linking tax breaks to expenditures would ignore benefits such as accountability or trustworthiness, which are difficult to define. The availability of a tax deduction is unlikely to induce for-profits to provide new community services. Hence, the overall result of a linked approach is likely to be a reduction in community benefits or increased reliance on publicly owned hospitals, which are not gen- CONVERSIONS 19 erally viewed as the preferred providers of community services. A strong argument can be made for a focused and effective third sector (the private nonprofit hospital) that receives its tax exemp- tion based on a clearer standard of benefit provision than exists under current law.³ Community benefit standards have been recom- mended by two of the most prominent nonprofit organizations, the Catholic Hospital Association and the Voluntary Hospital Associa- tion. Some states have already taken steps to define community benefits for the purpose of state and local tax exemptions. Texas and Utah, for example, have adopted relatively narrow definitions focus- ing on charity care. Other states, such as New York, have taken a broader approach." Benefit standards could also be added to federal tax policy. Adding standards to tax preferences would improve value for the dollar in tax policy. However, it would not ensure that valued activi- ties or organizations would survive in the face of market pressures. Although the goal of policy development should not be to prohibit conversions, it should be to ensure that conversion is an option rather than a necessity for nonprofits that are competing in the marketplace. That assurance may require policymakers and regula- tors to facilitate access to alternatives to equity capital, reexamine regulatory constraints on nonprofit operations, and more effectively prevent inappropriate and illegal insider financial gains from con- HEALTH AFFAIRS March/April 1997 CONVERSIONS version transactions. Preserving community benefits also requires attention once con- versions occur. Oversight is needed to address both the redirection of a nonprofit's charitable assets and the service obligations of new for-profit organizations. These topics are covered below. Nonhospital organizations. The underwriting and coverage practices followed by nonprofit insurers today are similar to those of their for-profit competitors, and the willingness to accept all applicants at community rates has virtually disappeared from the market- place." Preferred tax status for Blue Cross and Blue Shield plans, which, at their origins, provided this community service, has already been eliminated. It seems unlikely that conversions will make any further difference in insurance behavior. A distinction must be made, however, between insurance compa- nies and plans that integrate the financing and delivery of care-that is, nonprofit HMOs. Although many nonprofit health plans operate in a fashion similar to their for-profit counterparts, some have the capacity to provide significant community benefits through their own hospitals and clinics, through community needs assessment, and through their support of teaching and research. Although the 20 OVERVIEW literature provides no evidence of quality differences between for- profits and nonprofits, nonprofits also may offer intangible commu- nity benefits. Thus, while it may be desirable to apply benefit stand- ards to these organizations in return for their tax-exempt status, eliminating that status could jeopardize community benefits. Blue How Can Conversions Be Regulated cross To Protect Charitable Assets? Conversions not only affect health care organizations; they also af- ed fect communities' access to and use of charitable assets. Yet most Juls states have neither enacted specific legislation nor instituted any specific process to oversee health industry conversions. Under cur- trust rent law, state policies have been highly variable. As conversion invo activity has increased, so has the call for greater oversight of and tive, public participation in the process. Here we review key areas in relat which oversight is required. C State laws generally establish the legal framework under which calli corporations, including charitable organizations, are established. OCCU These laws establish the procedural requirements for changes in and corporate structure. In addition, the transfer of assets of a nonprofit for organization is governed by state charitable trust law because the init assets are considered to be held in charitable trust for the public. When a charitable organization is dissolved, however the transac- ver tion is structured, its assets must be transferred to a nonprofit or- tha HEALTH AFFAIRS Volume 16, Number 2 H PUBLIC POLICY OVERVIEW ganization that will carry out the original purpose of the charitable n- trust as nearly as possible. In many cases, a new foundation is on formed for this purpose. :W Changes in nonprofit status have federal tax law implications as well. Section 501(c)(3) of the Internal Revenue Code grants federal es tax exemption to organizations formed and operated exclusively for eir charitable purposes, provided that no part of the organization's net its earnings inure to the benefit of any private shareholder or individ- ÷ ual. Penalties are imposed for violation of these rules. is, While virtually all nonprofit hospitals are organized as charities dy under section 501(c)(3) of the Internal Revenue Code, many non- ny profit HMOs and Blue Cross and Blue Shield plans are not. Laws applicable to charitable trusts may not apply to these organizations a- unless they have dedicated their assets for charitable purposes at through their corporate articles, bylaws, or some other means." te For example, some Blue Cross and Blue Shield plans are organ- he ized as "mutual benefit" organizations, which generally are operated eir for the benefit of their members rather than for charitable purposes. it, When a mutual benefit organization converts from nonprofit to he for-profit status, the members of the organization, rather than the r- community, may be entitled to the proceeds of the transaction. A CONVERSIONS 21 u- controversy may arise, however, if the mutual benefit organization d- was originally incorporated as a charity, or if the mutual benefit IS, organization's corporate documents state that the organization is operated for the benefit of the public. An example is the case of Blue Cross and Blue Shield of Virginia (operating as Trigon Blue Cross and Blue Shield). The application of legal principles regarding conversions has var- ied considerably among the states. In some states public offi- st cials-notably attorneys general and insurance commission- ny ers-have aggressively pursued their interpretations of charitable r- trust and other laws to oversee conversions and promote public on involvement. In other states, however, officials have been more reac- id tive, and the policy vacuum and limited resources have resulted in in relatively little oversight. Consumer and other advocacy organizations have taken a lead in ch calling attention to the importance of oversight when conversions d. occur. They have frequently served as a resource for public officials in and the press in explaining what is at stake and what options exist it for addressing policy concerns. In a number of instances, they have e initiated or intervened in legal proceedings related to conversions. C. Valuation of charitable assets. If states are not diligent, con- =- versions can clearly result in the loss of nonprofit charitable assets r- that rightfully belong to a community. No issue is more critical to HEALTH AFFAIRS - March/April 1997 CONVERSIONS this than the valuation of the assets of the converting nonprofit, organization. Valuation is at the heart of two key policy issues raised by conversions: the potential for insiders to realize inappro- priate financial gain (inurement), and the level of funding that will be available for future charitable activities." To prevent the former and promote the latter, public policy must address a number of issues regarding the valuation process. (1) Do the not-for-profit trustees have an obligation to solicit competing bids to determine the value of the not-for-profit assets that are to be transferred? Without competing bids, it may be diffi- cult to ascertain the value of intangible assets of the converting organization, such as good will. (2) Do the not-for-profit trustees have an obligation to accept the highest bid for the assets that are converted? By accepting the high- est bid for the conversion, the trustees would be maximizing the amount available for future charitable purposes. There may be cir- cumstances, however, in which a lower bidder agrees to operate in certain ways or to provide certain benefits that the trustees believe would benefit the community. Or a potential purchaser may agree to give the not-for-profit trustees (usually the trustees of the founda- 22 OVERVIEW tion accepting the consideration) a voice in the operations of the converted enterprise. Placing a value on these agreements may be difficult unless there are a number of competing purchasers. (3) Do the not-for-profit trustees or management personnel have any obligation to disclose potential conflicts of interest to the offi- cials with authority to oversee a conversion? (4) Should the not-for-profit organization or the for-profit pur- chaser have an obligation to fund an independent valuation of the converting assets? State officials with oversight of conversions often do not have the resources to independently value the assets that are being converted. Such a procedure may be particularly important where the management of the not-for-profit organization will be heavily involved with the for-profit enterprise, as has been the case in a number of health plan conversions. (5) Is it appropriate for not-for-profit trustees to accept consid- eration that is contingent on the future success of the for-profit enterprise? This question arises when the charitable foundation is funded through stock in the for-profit enterprise or when it accepts a partnership percentage in a joint venture. On the one hand, past conversions have been criticized when the value of the converted entity later skyrocketed and the not-for-profit organization did not realize any of the gains.³⁸ On the other hand, accepting stock or a promise of future earnings may place the charitable foundation at significant risk, particularly if the foundation's assets are concen- HEALTH AFFAIRS - Volume 16, Number 2 PUBLIC POLICY OVERVIEW profit trated in the one enterprise.39 issues (6) Should an independent representative to the conversion proc- ppro- it will ess be appointed to look out for the interests of the new charitable foundation? This type of proposal recognizes that there may be ormer ber of conflicts of interest within the converting not-for-profit organiza- tion, or that the not-for-profit trustees may be unable to adequately ascertain the value of the assets being transferred. solicit Failure to publicly address these questions could be detrimental assets to communities in which conversions occur. diffi- Continued provision of health services in the community. erting Critics of hospital conversions have raised concerns that for-profit at the hospitals might provide fewer community benefits than their pre- conversion nonprofit predecessors provided. Some states have en- high- acted legislation and/or used their regulatory powers to negotiate g the with successor for-profit entities for specific levels of charity care e cir- and health services after a conversion. ite in In the case of many hospital conversions or, for that matter, hos- :lieve pital consolidations, there are often efficiencies to be gained by clo- ee to sure or curtailment of certain services. What some consider as cost- nda- saving efficiency, however, others may regard as reduction in f the necessary community services. Hence, states and municipalities CONVERSIONS 23 y be have negotiated with successor hospital entities for continuation of such services as twenty-four-hour emergency care, burn and trauma have units, neonatal intensive care units, and other services that may be offi- costly, low volume, or unprofitable. States also have negotiated with successor entities for provision pur- of a minimum level of charity care or other community benefits. A the few states, such as California and Nebraska, have enacted legislation ften that specifically includes the consideration of future benefits to be are provided to the community after a conversion. A process that spe- ant cifically sets forth such authority can be valuable to effective public I be policy. In a proposed Massachusetts conversion, for example, the case attorney general initially received accolades for negotiating a three- id- year postconversion agreement to maintain the level of charity care. ofit Later, however, he was criticized for conducting a secretive process and for failing to obtain more than a three-year commitment.⁴⁰ 1 is Regulation of successor for-profit entities can have unintended pts negative consequences. Regulations that are too stringent can be ast used to protect the status quo and keep out competition that might ed bring about lower prices and, hence, increased access to care. In not legislating and implementing a regulatory process, states must find ra the appropriate balance for their communities. at Public participation in the conversion process. Despite the n- potential impact of conversions on a community's health care serv- HEALTH AFFAIRS March/April 1997 CONVERSIONS ices or charitable assets, there is no process in most cases for the community to express its views, raise objections, or intervene in conversion decisions. In theory, the trustees and management of nonprofit organizations have a fiduciary duty to ensure both that the assets of the organization are used for the purposes stated in the organization's articles of incorporation and that the conversion is in the best interests of the organization. In practice, however, exer- cise of this duty is fraught with conflicts of interest and is not self-enforced. Unlike investor-owned companies, nonprofit organi- zations generally do not have stockholders who must approve deci- sions about changes in ownership or who can intervene if the man- agement or directors are not operating in the firm's best interests.⁴² As conversion activity has increased, so has the call for greater oversight of and public participation in the conversion process. In some cases, consumer groups, community organizations, and other advocacy groups have been successful in focusing public attention on proposed conversions. However, the lack of a formal public role has left such interventions to chance and excluded other voices from the conversion process. Although states' attorneys general are usu- ally given the role of representing the public in these transactions, 24 OVERVIEW limits on their resources and time may prevent them from recogniz- ing the potential impact of a conversion on a community. Potential ways for the public to participate in conversions in- clude public hearings, formal input into a regulatory process, legal standing to challenge transactions, and input into the disposition of charitable assets. In deciding how to facilitate public input, states must balance the need to prevent private abuses and the loss of charitable assets with the need to provide an efficient-rather than a cumbersome or obstructive-regulatory process. Governance of new foundations. When a charitable organi- zation is dissolved, issues arise regarding the creation, initial gov- ernance, independence, and mission of new charitable foundations that are being established to carry out the original charitable pur- pose. In 1996 Grantmakers In Health identified approximately sixty such foundations formed since January 1990 and successfully sur- veyed forty of them in seventeen states and the District of Columbia. Collectively, these foundations represented more than $5 billion in (alt assets (with three foundations holding more than $1 billion each). They are likely to pay out about $250 million annually in charitable tior spending. Key issues include the application of tax rules to prevent ard conflict of interest, the independence and expertise of foundation red boards, and the nature of foundation missions-all of which will oth determine whether charitable purposes are in fact continued. Nancy Kane delves into these issues in her paper in this volume.44 HEALTH AFFAIRS - Volume 16, Number 2 PUBLIC POLICY OVERVIEW :S for the In making policy for new conversion foundations, it is important ervene in to avoid overregulation once the initial governance and mission have ement of been established. Here again, a vibrant third sector (the private oth that nonprofit foundation) can provide services that might otherwise be :ed in the provided only by the government. sion is in Policy Implications. To ensure that state regulators appropri- ver, exer- ately and systematically address the policy issues conversions raise, d is not consumers and other organizations, along with regulators and legis- it organi- lators in some states, are calling on states to enact legislation that ove deci- clarifies regulatory authority and responsibility in the conversion the man- process. A few states have passed such legislation affecting hospitals terests." and/or health plans. These legislative initiatives have addressed a or greater wide array of procedural and substantive issues, including the basis rocess. In for and locus of regulatory authority; the kinds of transactions sub- and other ject to that authority; the formulation of a regulatory process for attention preconversion submission and review; the requirement for inde- ublic role pendent and accurate valuation of assets; the proper role of citizens ices from and community groups; the initial governance and mission of chari- 1 are usu- table foundations; and the evaluation of the impact of the transac- sactions, tion on the health care system. Although changing the rules under recogniz- which transactions occur cannot guarantee that all parties or all CONVERSIONS 25 issues will get the attention they deserve, a more explicit process sions in- increases the likelihood of good public policy. ess, legal Conclusion osition of ut, states Conversions of health organizations from nonprofit to for-profit e loss of status are interwoven into the changes occurring in the U.S. health ther than care industry. Some conversions have economic advantages in con- solidating excess capacity and promoting efficiency. They may also e organi- pose the risk that communities will lose valuable charitable assets itial gov- or important health services. The goal of public policy should not be ndations to prevent conversions; such rigid policy could impede desirable able pur- change. Rather, the goal should be to preserve valued functions and tely sixty resources in the context of a competitive marketplace. fully sur- A review of the literature on what difference ownership form olumbia. makes leads us to conclude that the nonprofit organizational form billion in enhances the potential for community benefits for hospitals and on each). (albeit with less evidence) for some HMOs. To ensure that these haritable benefits are realized, tax policy that supports nonprofit organiza- ) prevent tions should be sustained but modified to require minimum stand- undation ards for community benefits. Action also could be considered to hich will reduce pressure on nonprofit organizations to convert for reasons d. Nancy other than economic efficiency-for example, ready access to capi- tal, regulatory flexibility, or insider financial gains. HEALTH AFFAIRS March/April 1997 CONVERSIONS A review of the conversion experience also reveals that effect oversight can make the difference between a beneficial or a der mental conversion. Effective oversight does not require highly SH cific rules or stringent regulations. Rather, it requires the esta. lishment of a process that enables states to explicitly address an negotiate the multiple issues that conversions raise. Consiste with the action of a few states, other states could benefit fro enactment of legislation that provides such a process and th avoids the problems that have occurred from lack of oversight. The magnitude of charitable assets at risk and the potential conversions to affect, either positively or negatively, important munity health services argue for greater attention. Until now, mar conversions have occurred with little public oversight or commi nity involvement. Given the stakes involved, policymakers shoul take greater initiative. This paper was prepared with support from The Henry J. Kaiser Family Foundo tion and The Robert Wood Johnson Foundation. The authors appreciate the assis tance of their colleagues Larry Levitt and Michelle Huckaby. NOTES 26 OVERVIEW 1. There sometimes are disputes over whether an organization's assets are dedi cated to not-for-profit purposes or whether a change in an organization structure constitutes a "conversion" to for-profit status. Differences regarding the effect of "reorganizations" of several Blue Cross and Blue Shield plans an recent examples. 2. T. Silk, "Conversions of the Tax-Exempt Nonprofit Organizations: Federal Tax Law and State Charitable Law Issues" (Presentation at the American Bar Association Section of Taxation Mid-Winter meeting, New Orleans, January 1996). 3. Ventures could be established with different ownership shares, such as fifty fifty. 4. Changes have nevertheless occurred. Lewin Group analysis of American Hos pital Association (AHA) data between 1980 and 1993 shows 488 hospitals changing status. The most prevalent change (215) was public hospitals con verting to nonprofit status. 5. Ibid. 6. Irving Levin Associates, New Canaan, Connecticut. 7. C.A. Ascari, "Direct Testimony and Exhibits on Behalf of Blue Cross and Blue Shield of Virginia (d/b/a Trigon Blue Cross and Blue Shield), in Application of Blue Cross and Blue Shield of Virginia (d/b/a Trigon Blue Cross and Blue Shield) for Conversion from a Mutual Insurance Company to a Stock Corpo ration," State Corporation Commission, Commonwealth of Virginia, 14 June 1996. 8. InterStudy, "HMO Summary" (Excelsior, Minn.: InterStudy, June 1985). 9. InterStudy, The InterStudy Competitive Edge, Part II: Industry Report (Excelsior, Minn.: InterStudy, April 1996). 10. Ibid. 11. S. Findlay, "When Nonprofits Decide to Make a Buck," Business and Health (March 1996): 38-46. HEALTH AFFAIRS - Volume 16, Number 2