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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
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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
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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.
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'(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.
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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
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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:
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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.
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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