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Blue Cross faces fight on sale of stock If nonprofit insurer goes public, who gets the proceeds?


SAN FRANCISCO, Calif. -- Blue Cross companies from California to Maryland are demanding the right to sell their nonprofit businesses and generate tens of billions of dollars. The question is: Who should profit?

The public will in California, where Blue Cross is contributing $3.2 billion to charitable foundations devoted to improving the health of all citizens.

But in Maryland, the public may not receive a dime.

The reason for this vast discrepancy is simple: While regulators and Blue Cross executives in California believe that the public is entitled to profit because the company received valuable tax breaks, Maryland regulators and Blue Cross officials do not agree, although the company also enjoyed tax benefits.

Blue Cross and Blue Shield of Maryland and its chief regulator, state Insurance Commissioner Dwight K. Bartlett III, face a battle on this issue. The outcome will decide the public's right to hundreds of millions of dollars and the future of the 1.3 million-subscriber insurance company.

"Those assets should be used for the public and not become part of the profit of stockholders," said E. Clinton Bamberger Jr., a prominent Maryland lawyer who was president of Blue Cross' board in the 1960s.

Blue Cross' proposal to restructure the company and obtain permission to sell stock is expected next month. Mr. Bartlett's decision will be binding, unless the General Assembly or the courts intervene.

Tens of billions of dollars are at stake nationally as increasing numbers of Blue Cross companies consider converting to for-profit businesses. Four of them, including California's, already have sold stock and converted part or all of their businesses. At least a dozen more are considering doing so.

The Blues are being forced to change because they have outgrown their Depression-era nonprofit roots. Created when no one else wanted to insure the general public, the companies now face brutal competition from dozens of for-profit insurers.

Many Blue Cross executives across the country believe that to survive they must invest heavily in HMOs and other new insurance products -- which means raising capital, usually by selling stock.

Mr. Bartlett and his counterpart in California, Corporations Commissioner Gary S. Mendoza, don't contest Blue Cross' need to sell stock. But they have taken strikingly different approaches to the issues of how the companies should restructure themselves and who should profit.

While Mr. Mendoza broadly interpreted state law to benefit all Californians, Mr. Bartlett is taking a narrower legal view of Blue Cross' obligation. And while Mr. Mendoza gave the public numerous opportunities to comment and took his time making a decision, Mr. Bartlett faces strong pressure from Blue Cross and state political leaders to help the company and rush the process.

In California, Mr. Mendoza ruled Sept. 7 that Blue Cross can convert to a for-profit company, issue stock and keep all of the 3 million subscribers. But the company must give up ownership of its stock and cash, which is worth $3.2 billion. Two charitable foundations will get it.

In Maryland, Blue Cross also wants to create a for-profit company and issue stock -- which could eventually be worth hundreds of millions of dollars when it is sold to investors. But neither Blue Cross officials nor Mr. Bartlett believes the company should have to give its stock and cash to foundations or benefit the general public in some other way.

Who would benefit from the stock and cash will remain unclear until the company fully unveils its proposal.

The differences in approaches between the two states are magnified because California is viewed by many as the model for all other states to follow in dealing with Blue Cross companies that wish to convert to for-profit status.

California's handling of the sensitive and complex issues should be used as "a prototype for health-care conversions in other parts of the country," said Consumers Union, publisher of Consumer Reports magazine.

"I think the lesson from California is these converting nonprofit organizations must deliver all of their assets to a charitable foundation to be used for improving the health of Maryland residents," said Harry Snyder, a national expert on Blue Cross conversions and co-director of the West Coast office of Consumers Union.

"This is a pot of gold," he said of the money involved. "And there's no getting away from that. You have to keep your eye on the pot of gold. Who's going to get it? A foundation whose purpose is dedicated to improving the health of Maryland? Or insiders [at Blue Cross] or people on Wall Street?"

A number of Marylanders agree that Blue Cross owes a big debt to the public: officials of the state Health Services Cost Review Commission, which regulates hospital rates, a health policy expert at Johns Hopkins, the Maryland Citizen Action Coalition and Mr. Bamberger.

Among the key issues in Maryland are:

* Blue Cross' obligation to the public.

"Our view is that the people of California are the shareholders of Blue Cross," Mr. Mendoza said in an interview in his San Francisco office. "They in effect are the ultimate beneficiaries of the assets."

Many Marylanders have long expressed the same view -- that Blue Cross is their company because of its mission and history. California Blue Cross and Maryland Blue Cross were created in 1937 to provide affordable insurance and were given exemptions from state and federal taxes.

The Maryland company saves $12 million a year because it doesn't pay the state tax on insurance premiums. It was exempt from federal taxes until 1986, when Congress curtailed this break.

In addition, Blue Cross receives a state-authorized discount on its subscribers' hospitals, saving it more than $25 million annually, according to the Health Services Cost Review Commission.

Maryland Blue Cross' value as a company was "created in large measure by exemptions paid from state and federal income tax, discounts on hospital rates and from the premiums paid by public subscribers," the commission said in a position paper it sent to Mr. Bartlett earlier this year.

Mr. Bartlett should calculate "the magnitude of both the public contribution and premium contribution" of Blue Cross subscribers and establish a fund to benefit the general public as well as subscribers, said the commission.

But neither Mr. Bartlett nor the Maryland Blues believe the general public is really entitled to the money.

The public has already received the benefit of the tax breaks, Mr. Bartlett said. "I would argue that that money has already been distributed back to the public in terms of lower premium rates," he said. "So the money is gone."

But a well-known Hopkins expert disagrees.

"I guess the question I would [ask] the insurance commissioner is, what advantages does having the tax exemption provide to Blue Cross in the past? Having a tax exemption is an economic value and there needs to be a payback to all of us taxpayers for not having paid taxes in the past," said Gerard F. Anderson, professor at the Johns Hopkins School of Public Health and head of the Center for Hospital Finance and Management.

Mr. Bartlett and company officials suggest that Blue Cross subscribers, not the general public, would receive some financial benefit from a restructuring of the company.

Blue Cross wants to split into two parts: a for-profit company that would take Blue Cross' five HMOs and a nonprofit company that would take Blue Cross' traditional insurance business. Company officials have refused to disclose any details.

Who would receive the proceeds of a stock sale? The new nonprofit company, according to Blue Cross documents submitted to Mr. Bartlett. Ultimately, Mr. Bartlett says, subscribers of the nonprofit company might benefit through lower premiums.

* Determining the company's value.

How would Mr. Bartlett calculate the payment that the for-profit company makes to the nonprofit company? Would he take into account the future value of the HMOs?

The HMOs are considered Blue Cross' most valuable asset because they're growing. The traditional insurance business is expected to shrink, losing subscribers to the HMOs.

In California, Mr. Mendoza hired top investment banking and PTC accounting companies, Bear Stearns & Co. and Ernst & Young, and consulted a Harvard University expert to help him calculate the company's value and assure that the public gets every dollar it deserves.

But Mr. Bartlett hasn't hired investment advisers. He's running a big risk, according to California Assemblyman Phillip L. Isenberg, who pressured Blue Cross of California to compensate the public.

"It staggers the mind to think of the magnitude of the money involved in this, and the opportunity to do good for people with the public's own money," Mr. Isenberg said. "It will be irretrievably lost if public officials, government officials, don't pay some attention, learn the issues and understand what's going on."

* Interpreting the law.

Although California laws didn't specifically require Blue Cross to endow two foundations, Mr. Mendoza negotiated that result. "We rely upon the broad grant of authority that we have to make sure that they meet their public benefit responsibilities and try to chart a course we believe they should follow to meet those responsibilities," he said.

Maryland's cost review commission has urged Mr. Bartlett to undertake a "thorough examination of the broader, public implications of the proposed reorganization."

But Mr. Bartlett has a narrower view of his options. Asked whether Maryland Blue Cross should transfer its assets to a foundation, he said, "I'm not aware that there's any such legal requirement in Maryland."

* The public's role.

"It was helpful not only to get some ideas but also to validate the process and give people a chance to have appropriate input in a matter of significant public interest," said Mr. Mendoza, who held two public hearings. "From our standpoint, the public is our client."

Mr. Bartlett said he will hold hearings, but he has been sharply criticized for meeting privately with Blue Cross officials in the past several months and not sharing his discussions with the public.

Although Mr. Bartlett said he doesn't have the "foggiest idea" what the company will propose, a Blue Cross attorney said the company has been in touch with Mr. Bartlett "pretty much weekly."

Documents obtained from the insurance commissioner show that Mr. Bartlett and his attorney have had extensive, detailed conversations about Blue Cross' restructuring plans.

* For-profit and nonprofit?

Blue Cross' goal of creating separate nonprofit and for-profit companies may not make business or practical sense or help the Maryland public.

The new nonprofit company would start life with what amounts to a dying line of insurance products, while the new for-profit company would have the biggest potential profit-makers, the HMOs.

This structure reflects Blue Cross President William L. Jews' main goal of expanding the HMOs. But it does not assure much of a future for the nonprofit company.

If the company did fully convert, the question of the public's claim to its money and stock would be easily answered. Blue Cross' own articles of incorporation spell out that the assets would have to be transferred to a tax-exempt organization, like a foundation -- just as California has done.

Blue Cross of California's experience also indicates that Maryland Blue Cross might be better off converting.

After initially receiving approval to create a combination nonprofit and for-profit company, Blue Cross sold stock and was obligated to make charitable contributions. But it couldn't satisfy critics who complained about how much it was giving and to whom, says company Vice President Ann Monroe.

So the company decided to fully convert to a for-profit business and spin off the value of its assets into the two foundations. In the end, Blue Cross was satisfied, according to Ms. Monroe, because while it gave up a lot of cash and stock, it got the 3 million subscribers and the right to be a for-profit company.

Endowing the foundations also increased the amount of money available to charity. Ms. Monroe said Blue Cross otherwise would have had to pay $600 million in federal taxes on the sale of stock it held. The foundations won't be taxed when they sell the stock and give away money.

The foundations will invest the $3.2 billion and spend a minimum of $160 million a year indefinitely. Their mission is to improve the health care of Californians, particularly the "underserved," said Ms. Monroe.

Maryland Blue Cross included a company-controlled foundation in its first restructuring proposal. The company said some of the value of an investor stock sale would have flowed to the foundation in the future, but it was unclear who would benefit and how.

It's not known whether Blue Cross will include a foundation in its new restructuring proposal next month.

Whatever the company proposes, Mr. Bartlett will be under pressure to act quickly.

Gov. Parris N. Glendening and legislative leaders have bought Blue Cross' argument that it needs the advantages of for-profit companies like Prudential -- the right to sell stock and less state regulation -- to survive.

Although the legislature could approve a restructuring, legislative leaders have told Mr. Bartlett they want him to work it out.

Mr. Bartlett said he will rule in the public's interest.

"I think absolutely one way or another the public has to have an opportunity to comment," he said. "This is not going to be a smoke-filled, back-room kind of deal."

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