Taking a Lesson From New York’s Billion-Dollar Blue Cross Heist

Last month’s decision by the New York legislature to permit the conversion of Empire Blue Cross and Blue Shield into a for-profit company offers a cautionary tale for all nonprofit groups concerned about the government’s ability to usurp charitable assets for political and fiscal ends.

The deal, which was crafted by New York Gov. George Pataki, skims an estimated $1.1-billion from Empire Blue Cross’s assets and uses it to balance the state’s 2002 health-care budget and give raises to members of a politically powerful union.

Supporters of the measure whisked it through the state legislature late at night with a stealth that was startling even by New York standards. The secrecy allowed for little public discussion of how to use the proceeds from the sale of the company’s stock or who would control the money. Most observers assumed that the assets would be placed in a private foundation, the way similar conversions have been handled in most other states.

New York Attorney General Eliot Spitzer, never camera-shy when publicizing his office’s efforts to protect charitable assets, has been uncharacteristically silent about the state’s heist of Blue Cross funds. That is unfortunate, because state attorneys general are virtually the only officials responsible for guarding charitable assets. Only in rare circumstances do donors or other members of the public have a standing to sue over matters involving charities.

Hospitals established Blue Cross plans as nonprofit organizations in the 1930s to ensure that their patients — even the poorest — would have the means to pay for care. For years the plans enjoyed tax and regulatory exemptions because of their social missions. Subsequently, Blue Cross plans faced competition from health-maintenance organizations and a need for more capital to pay for rising medical costs. As premiums rose and other insurers entered the scene, New York’s Empire Blue Cross lost five million subscribers in a few years. In 1986, Blue Cross plans lost their federal tax-exempt status, though most — including Empire Blue Cross and Blue Shield — kept their exemption from state taxes.

More recently, many Blue Cross plans have merged or switched to for-profit status as the health-care climate continued to evolve. Therein lie the seeds of the New York debacle.

Under New York law, when a charity dissolves or sells its assets to a for-profit corporation, the proceeds must remain available for charitable use. Typically, the proceeds from a nonprofit group’s conversion to for-profit status are transferred to a private foundation that focuses on health care and, in part, seeks to fulfill the original mission of the nonprofit organization. The sum put into the foundation represents the value of the tax exemption over the years.

Most of the Blue Cross plans that have converted have established new foundations or revitalized existing ones with a substantial infusion of money. They have tried to serve the public with the same level of health care — much of it rendered free or at reduced cost to the poor — that the nonprofit group provided before the conversion.

In contrast, New York’s plan imposes a tax of 95 percent on Empire Blue Cross’s charitable assets, diverting them to the state treasury.

Several states have managed Blue Cross conversions in ways that put New York’s handling of the Empire Blue Cross case to shame.

In California, three foundations created from insurance-plan conversions have endowments of more than $1-billion each. According to surveys by Grantmakers in Health, in Washington, foundations created from health-plan conversions have cared for poor people who lack adequate medical care, provided preventive treatment for the indigent, offered access to health care for the uninsured, and reduced disparities in health among racial and ethnic groups. Conversion foundations have sponsored new programs for innovative, cost-effective, high-quality, local health care — the sorts of special projects that philanthropy can do so well and state governments do not.

If a private foundation had been created from Empire Blue Cross, $1.1-billion would be available in perpetuity to provide for the health-care needs of New Yorkers with low or moderate incomes. Assuming that the foundation paid out the federally required minimum of 5 percent annually and did nothing to increase the size of its assets, the foundation could give out $55-million in grants annually forever.

New York State, on the other hand, plans to create a foundation with a mere $50-million in assets, hardly enough to do much.

The plan follows the letter of federal law, to be sure, but not the spirit: The law allows nonprofit organizations that are dissolved to distribute their assets to a state or local government for a “public purpose.”

New York’s action creates a precedent that should be troubling to every charity official throughout the land. It is not farfetched to imagine that other states facing budget shortfalls could take charitable assets for immediate financial needs, such as balancing budget deficits in their health-care, social-service, educational, or cultural programs.

And if charitable assets can be taxed when a group converts to for-profit status, why not when one merges with another, or sells a building at a profit? Because states and municipalities often contribute a substantial percentage of nonprofit institutions’ budgets, why couldn’t they put strings on that money, using charitable assets as collateral for loans that help governments balance their own budgets?

Politicians and their financial advisers may find nonprofit resources too attractive to resist. Such efforts will be difficult to thwart, absent effective political lobbying and pressure from interest groups — hardly strengths of the nonprofit world.

New York’s diversion of charitable assets is bad policy and bad finance, and it casts a long shadow over the security of all tax-exempt resources.

James J. Fishman is a professor at the Pace University School of Law, in White Plains, N.Y.