Blues review: Blue Cross & Blue Shield plans find conversion to for-profit status fraught with red tape. (Life/Health).

Traditionally, health plans have been structured as not-for-profit entities. Today, however, health plans take on a variety of corporate structures, including publicly traded companies.

The movement away from not-for-profit status is a direct response to the competitive changes in the health-care industry and the restrictions placed on the financial operations of not-for-profit health plans, including the inability to raise capital. The spectrum of health-plan corporate structures ranges from an independent not-for-profit plan with specific lines of business serving an exclusive geographic area to a publicly traded company offering multiple products in several geographical areas.

For example, Anthem Inc. has changed its corporate structure over the years. It began as a not-for-profit, converted to a mutual benefit company, acquired other not-for-profits, then demutualized and raised $2.1 billion in a recent initial public stock offering.

One of the primary reasons cited by health plans for changing their organizational structure is the underlying competitive pressures to acquire additional business and extend their business to other markets. This also has motivated mutual benefit companies to demutualize, since a mutual benefit company is limited in its ability to generate the capital necessary to fund expansion to other markets.

Once a mutual benefit company demutualizes, it is able to increase its financial flexibility through improved access to capital, which in turn enhances its ability to expand existing business, develop new business and improve its competitive position in the health industry. With increasing consolidation and competition in the health industry and the need to develop new business by expanding to other markets, mutual benefit companies will continue converting to publicly traded companies.

Anthem, an Indiana-based insurance company, provides health insurance and services, primarily under the Blue Cross & Blue Shield names, to customers in Colorado, Connecticut, Indiana, Kentucky, Maine, Nevada, New Hampshire and Ohio. Anthem began its acquisitions of the Blues when it merged in 1993 with the Blue Cross & Blue Shield Plan in Kentucky. In 1995, Anthem merged with Community Mutual, a Blue Cross & Blue Shield Plan in Ohio. It expanded into the eastern part of the country when it merged in 1997 with Blue Cross & Blue Shield of Connecticut; acquired Blue Cross & Blue Shield of New Hampshire and its subsidiary, Matthew Thornton Health Plan, in 1999; and acquired Blue Cross & Blue Shield of Maine in June 2000.

With its acquisitions of Blue Cross & Blue Shield of Colorado and Blue Cross & Blue Shield of Nebraska in October of 1999, Anthem created a western U.S. presence. Citing competitive pressures, Anthem began converting to a publicly traded company in February 2001 and closed its IPO on Nov. 2,2001. Anthem believes the conversion from a mutual benefit company to a publicly traded stock company will enable it to increase its business through acquisitions with greater financial flexibility.

Other companies have confronted major obstacles and delays in their attempts to convert to for-profit entities. Late in 1996, Empire Blue Cross & Blue Shield of New York announced that it would convert to a for-profit, agreeing to transfer all of its charitable assets to a charitable foundation, as required under New York not-for-profit law. Empire filed its conversion documents with the NewYork attomey general and Department of Insurance in August 1997; a series of public meetings and negotiations followed. In 1999, the NewYork superintendent of insurance approved the insurance aspects of Empire's conversion. On May 24, 2000, nearly four years after Empire's announcement of its plan, the New York attorney general approved Empire's conversion proposal. Before the conversion can go through, the state Legislature must pass a bill allowing for not-for-profit health plans to convert to for-profit entities.

Passage of the conversion legislation, however, was blocked when the Greater New York Hospital Association and Local 1199 of the Service Employees International Union opposed the conversion. In June 2001, the association and Local 1199 agreed to support the conversion, if Empire agreed to direct half of the charitable assets to a foundation that would benefit healthcare providers. Consumer groups are voicing outrage at the possibility of any of the charitable assets being diverted to the proposed foundation.

In mid-January, New York lawmakers passed a health-care reform bill that hinges on the conversion of Empire Blue Cross & Blue Shield to for-profit status. It would provide $2.1 billion over three years for a variety of health-care initiatives, about half of that to be funded by proceeds from Empire's conversion. Joseph L. Bruno, Republican majority leader of the state Senate, said Empire "is authorized to convert to a for-profit company with an estimated $1.1 billion in charitable assets" as part of the bill.

New York state legislators are assuming that Empire's conversion will generate that amount over the next three years. The rest of the funding for the health-care plan would come from a 39-cent-per-pack increase in the state tax on cigarettes, and a 3% increase in the federal Medicaid reimbursement rate--something Bruno said the state will seek from Congress.

Regulatory Patchwork

For a health plan to convert from not-for-profit to for-profit status, it must obtain approval of state regulators. The type of approvals needed depends on the state in which the health plan is domiciled. Some states have enacted laws specifically addressing health-plan conversions. But the extent of regulation varies, and in most cases the regulations do not fully address all of the issues raised when a company sheds its not-for-profit status. Other states have relied on common law and existing regulations of not-for-profit entities to address health-plan conversions. State attorneys general have successfully applied regulations governing charitable trusts to transactions that involve a change in the use of not-for-profit assets.

Because state regulators have responded differently to health-plan conversions, generally due to the lack of laws specifically addressing such conversions, a health plan seeking to shed its not-for-profit status will face numerous legal challenges:

* whether the health plan is, in fact, a charitable organization;

* the impact of the conversion on access to health services;

* the protection of charitable assets for the public interest; and

* the lack of regulatory process.

Some health plans--in order to avoid being subject to not-for-profit laws--have argued that they are not charitable organizations. For example, in 1997, Blue Cross & Blue Shield of Kansas City filed a petition seeking a declaratory judgment that it was a mutual benefit corporation and not a public benefit corporation. As a mutual benefit corporation, the Kansas City Blues would not have any continuing obligations that its assets would remain devoted to a public purpose. If, however, the Kansas City Blues was found to be a public benefit corporation, it would be required upon dissolution to have its assets go to a corporation with a similar public purpose. In September 1998, a Missouri trial court declared that the plan was a public benefit corporation under Missouri's not-for-profit laws.

Consumer groups and regulators alike have voiced concerns that conversions of not-for-profit health plans to for-profit entities could adversely affect access to health-care services. Traditionally, not-for-profits have had special obligations to provide access to health-care services for the poor. Some enabling legislation has required the not-for-profit health plan to be the insurer of last resort. Accordingly, many regulatory reviews of conversions to a for-profit health plan require the resulting entity to protect access to health-care services for the poor and underprivileged.

The protection of charitable assets of not-for-profits converting to for-profit status has a long history in the health industry. Specifically, the requirement that a charitable trust be formed and funded has been a particularly problematic hurdle and, at times, the trigger for legal intervention resulting in significant delays of conversion plans. Similarly, when a for-profit entity acquires a not-for-profit, such a charitable trust or foundation must be established, again creating the opportunity for regulators to delay such acquisitions.

Historically, there have been numerous opponents to such acquisitions or conversions. These advocates argue that not-for-profit assets are being sold for less than fair-market value, causing private enrichment at the public's expense. Other arguments made by such advocates include failure to set aside not-for-profit assets in a charitable trust, insufficient funds being set aside and not-for-profit funds later being diverted to a for-profit entity. The lack of regulatory process in this area has prompted lawsuits from consumer groups, causing health plans to incur the expense of litigation and experience unforeseen delays.

Many lawsuits and legislative battles have forced health plans to put deals on hold and, in some instances, have caused deals to be abandoned altogether. For example, in August 2001, the Regence Group, which operates not-for-profit Blue Cross & Blue Shield plans in Oregon, Washington, Idaho and Utah, abandoned its plans to affiliate with Health Care Service Corp., a Chicago-based mutual insurance company. When first announced, the proposed affiliation drew much criticism from community advocates, who argued that the transaction would have transferred control of the not-for-profit plans to Health Care Service Corp. They argued that the change of control could jeopardize the charitable assets built up over the years in the plans. In addition, they warned that regulators in other states had been unable to adequately protect the charitable assets of the not-for-profit plans when mutual benefit companies later converted to for-profit entities.

State Challenges

In the past, for-profit entities, such as Anthem, have met some resistance in their acquisition of Blues plans, with critics arguing that such acquisitions hamper the not-for-profit purpose of the Blues. Arguments can be and have been made on both sides. Opponents of health plans being acquired by for-profit entities contend that the for-profit entities will provide less charitable care and fewer health benefits to communities. Advocates in favor of such acquisitions assert that for-profit entities will provide the not-for-profit entities with much-needed capital, allowing the not-for-profit to continue to survive in the health-care industry.

Perhaps it is these arguments that deter state legislatures from enacting specific legislation governing not-for-profit health-plan acquisitions and conversions. By regulating health-plan conversions, communities attempt to guarantee continuing access to healthcare services. The regulatory requirements, however, must be tempered so as not to foreclose the possibility of such acquisitions and conversions. Too much regulatory power could be counterproductive, in that it may limit competition among health plans. Absent legislation specifically addressing health-plan conversions, consumer advocates will continue to advocate for not-for-profit status of health plans to insure proper use of charitable assets, protection of public interest and access to health-care services in the community.

As more health plans attempt to convert, states will be forced either to take legislative initiatives that specifically address health industry conversions or continue to rely on regulators' applying potentially illsuited existing common law. Relying on existing law will continue to spur legal and legislative battles over health-plan conversions. As seen with Empire's attempt, conversion may require exhaustive measures and legislative changes to succeed.

Sharon O'Brien is an associate with the national law firm Edwards & Angell LLP. O'Brien concentrates her practice in health-care law and insurance law.

2000 Financial Results for Restructuring Blues Plan

($ Thousands)

                                                Net
                                           Premiums
Company                          Assets     Written  Net Income

Anthem Inc.                  $1,373,671  $1,964,104    $114,443
Empire Blue Cross & Blue         44,105     116,190     -28,591
Shield
Blue Cross & Blue Shield of     328,470     420,347      -3,879
Kansas City

Source: Best's Insurance Reports