Blue Shield acquisition deal puts Medi-Cal enrollees in back of bus

Photo by Brad Lee.

Photo by Brad Lee.

Blue Shield’s plan for the combined corporate entity it would establish if its proposed acquisition of Care 1st Health Plan is approved would subordinate the interests of Care 1st’s mostly Medi-Cal enrollees to those of Blue Shield’s own enrollees, according to legal documents filed with regulators.

The documents also show that a goal of the proposed corporate structure is to enable Blue Shield to avoid paying Affordable Care Act taxes on the business it would operate under Care 1st.

The details are in my letter below to the regulator whose approval Blue Shield needs in order to complete the acquisition, California Department of Managed Health Care Director Shelley Rouillard.

Dear Ms. Rouillard:

I am writing to raise concerns about the corporate structure under which Blue Shield would operate Care 1st Health Plan following the proposed acquisition. That structure would subordinate the interests of Care 1st members, who are primarily Medi-Cal enrollees, to those of Blue Shield’s own enrollees.

Blue Shield’s arrangements for the operation of Care 1st are complex. Instead of purchasing Care 1st directly and integrating it into its own operations, Blue Shield has established a subsidiary holding company that would acquire and operate Care 1st as a separate, indirect subsidiary of Blue Shield.

Blue Shield’s reasons for this complex arrangement are unclear, but appear to include tax avoidance. Regardless, the effect would be to make the legal status of Care 1st enrollees within the post acquisition combined corporate entity inferior to that of Blue Shield enrollees.

The post-acquisition corporate structure would obligate Care 1st to operate for the benefit of Blue Shield and its enrollees.

Under the post-acquisition legal structure described by Blue Shield and Care 1st in their filings with the DMHC, Care 1st would be established as a nonprofit mutual benefit corporation with a single corporate member, Cumulus Holding Company. Cumulus, which was incorporated soon after the acquisition deal was signed, is also a nonprofit mutual benefit corporation with just one corporate member, which is Blue Shield.

As a mutual benefit corporation, Care 1st would be required to operate for the benefit of its sole corporate member in the same way that, for example, a trade association or homeowners association is required to operate for the benefit of its members. Since only Cumulus, and not enrollees of Care 1st, would be members of the mutual benefit corporation, Care 1st would be obligated to operate exclusively for the benefit of Cumulus. Similarly, Cumulus would have a duty to operate exclusively for the benefit of its sole corporate member, Blue Shield.

Blue Shield, itself, is also incorporated as a nonprofit mutual benefit corporation. While Blue Shield has no corporate members, it has asserted in a previous filing with the DMHC that “it operates only for the benefit of its policyholders.” Because Care 1st would be absorbed as a separate corporate entity, its enrollees would not become Blue Shield policyholders (enrollees) following the acquisition. Under the corporate structure described in the filings, each entity would be obligated to operate for the benefit of Blue Shield enrollees.

A clear example of how the structure would subordinate the interests of Care 1st enrollees to those of Blue Shield enrollees is the provision for distribution of assets upon dissolution. In the event of the dissolution of all three entities, the governing documents of the three organizations, as described to the DMHC by Blue Shield, provide that the remaining assets of Care 1st would go to Cumulus, which would pass along its remaining assets to Blue Shield, which, in turn, would distribute its remaining assets to Blue Shield enrollees.

Pursuant to the governing documents for the three entities, the interests of Blue Shield enrollees would reign supreme. This is not to say that Care 1st would have no obligations at all to its enrollees. Care 1st would be obligated to them as customers of the plan, just as for-profit plans are to their enrollees. But Care 1st’s fiduciary duty would be to its sole owner, Blue Shield, which has declared to the DMHC that its exclusive duty is to benefit Blue Shield’s enrollees.

What impact would this have on operational decisions such as the deployment of resources or the pricing of Care 1st coverage and the amount of profit Blue Shield would demand of Care 1st? Care 1st’s fiduciary duty to Blue Shield would dictate that those decisions be guided by what best serves the interests of Blue Shield enrollees. By happy coincidence, Care 1st enrollees may also benefit at times, but the post-acquisition corporate structure would make Blue Shield enrollees the exclusive beneficiaries of the combined entity.

One reason for the planned corporate structure is tax avoidance.

Why would Blue Shield propose a corporate structure for the control of Care 1st that would disadvantage Care 1st enrollees in this way? Blue Shield and Care 1st have offered vague explanations in response to inquiries from the DMHC about the structure. However, the proposed post-acquisition bylaws for Care 1st make it clear that one objective is tax avoidance.

Two versions of those bylaws have been filed with the DMHC. The first, which was filed January 30, 2015, included a provision directing that “the corporation shall not directly or indirectly carry on any activity that would prevent it from obtaining or maintaining exemption from Federal income tax exemption as an organization described in section 501(c)(4) of the Internal Revenue Code of 1986, as amended, or section 23701f of the California Revenue & Taxation Code.”

After obtaining that document through a Public Records Act request, I blogged about it in May, pointing to the provision as evidence of a ploy by Blue Shield to avoid having to pay corporate incomes taxes on this new business despite the recent revocation of its own tax exemption. On June 1, 2015, Care 1st filed a revised version of the proposed bylaws that deleted the above provision.

Care 1st also filed, a few days later, a response to a question from the DMHC about whether Care 1st would apply for state and federal tax exemption following the acquisition. Care 1st stated:

The Plan has been informed by Blue Shield that it has no current intention to cause the Plan to apply for tax exempt status under California or federal tax law, but reserves the right to evaluate, on a continuous basis, applicable federal and state tax laws, regulations and policies, including applying for tax exempt status under federal and/or state law.

In a filing with the DMHC on June 2, 2015, Blue Shield gave this response to the DMHC’s inquiry about the reasons for the post-acquisition corporate structure:

Blue Shield created Cumulus to make the purchase (which results in Care 1st being a direct subsidiary of Cumulus and an indirect subsidiary of Blue Shield) in order to: (a) maintain separation between Blue Shield’s and Care 1st ’s lines of business and their distinct legal and regulatory frameworks and requirements; and (b) provide organizational flexibility for possible future acquisitions using Cumulus as a holding company (however, no acquisitions besides Care 1st are contemplated at this time). There are no tax benefits of using Cumulus to acquire Care 1st.

However, Blue Shield and Care 1st neglected to mention that the revised bylaws for Care 1st filed on June 1 include a new provision written for the specific purpose of making Care 1st eligible for exemption from the federal tax imposed on health insurers under the Affordable Care Act. The new bylaw provision states:

No net earnings of the corporation shall inure to the benefit of any private individual. No substantial part of the activities of the corporation shall consist of carrying on propaganda, or otherwise attempting to influence legislation (except as otherwise provided in section 501(h) of the Internal Revenue Code of 1986, as amended). The corporation shall not participate in, or intervene in (including the publishing or distributing of statements) any political campaign on behalf of (or in opposition to) any candidate for public office.

The provision matches, virtually word-for-word, the requirements specified in IRS regulations for exemption from the new federal tax on insurers. While using Cumulus to acquire Care 1st may not confer any tax benefits, establishing Care 1st as a separate corporate entity certainly does, and Blue Shield is clearly intent on exploiting that advantage.  

Whatever are Blue Shield’s true reasons for structuring the combined corporate entity as described in the filings—whether it's tax avoidance, facilitating future acquisitions, or simplifying regulatory compliance—Blue Shield needs to explain how those reasons justify the disadvantaged position in which that entity would put the mostly Medi-Cal enrollees who make up the membership of Care 1st.

DMHC should make clear to Blue Shield its obligation to benefit the community. 

In previous filings Blue Shield has argued that it has no obligation as a nonprofit to benefit the community. Along with over a dozen consumer groups, I have argued to you that Blue Shield does have such an obligation by virtue of the community benefit claims and promises it has made over its history and the tax exemption it held until the FTB revoked it last year.

The complex corporate structure Blue Shield is proposing in connection with the proposed acquisition is a continuation of the corporate shell game Blue Shield has been playing for decades to avoid accountability for its duty to the public. The DMHC should make clear to Blue Shield that no matter its structure, it has a charitable trust obligation to benefit the community, including, on an equal basis, all enrollees under its corporate umbrella. 

Thank you for your consideration.

Sincerely,

Michael Johnson