In a scathing audit, state tax officials slammed nonprofit health insurer Blue Shield of California for stockpiling "extraordinarily high surpluses" — more than $4 billion — and for failing to offer more affordable coverage or other public benefits.
The California Franchise Tax Board cited those reasons, among others, for revoking Blue Shield's state tax exemption last year, according to documents related to the audit that were reviewed by The Times. These details have remained secret until now because the insurer and tax board have refused to make public the audit and related records.
Blue Shield's operations are indistinguishable from those of its for-profit healthcare competitors, the auditors found, and it should be stripped of the tax break it has enjoyed since its founding in 1939. The insurance giant does not advance social welfare, the key test for preserving its tax exemption, according to the records.
"Blue Shield is not operating exclusively for the promotion of civic betterment or social welfare," tax board officials Christie Maddox and Eddie Murillo-Corona wrote to the insurer in a 16-page report sent June 3, 2014.
The August 2014 revocation came to light when The Times reported the news in March. The tax board rejected a public-records request for the audit and related information on Blue Shield, citing the confidentiality of taxpayer information under state law.
Since the revocation became public, Blue Shield has come under increasing scrutiny from regulators, lawmakers and consumer groups over its massive financial reserves and its proposed purchase of a Medicaid insurer for $1.2 billion.
Blue Shield is the state's third-largest health insurer with 3.4 million customers, 5,000 employees and $13.6 billion in revenue last year.
The health insurer argued in favor of its tax exemption, pointing to charitable giving of about $30 million annually and its voluntary 2% cap on profits.
The auditors were unimpressed. They also expressed concern that job descriptions for top executives directed them to "maximize profitability."
"These stated objectives, particularly those which stress profitability, are inconsistent with an organization organized as a nonprofit which desires tax-exempt status," officials wrote.
Paul Markovich, Blue Shield's chief executive, has defended its efforts to ensure quality, affordable care for all Californians. He has cited the company's support for health reform since 2002, when most of the industry fiercely opposed it.
Markovich has flatly rejected the notion raised by patient advocates that his company is a charitable organization or that its assets belong to the public.
But in confronting his critics, Markovich appeared to contradict previous statements Blue Shield made to the tax board about its corporate structure.
Markovich told healthcare regulators at a June 8 hearing that Blue Shield's assets would be distributed to the company's members, or enrollees, if the company were ever to dissolve.
However, the company took a different view before the tax board.
In a Dec. 18, 2013, letter to tax officials, Blue Shield's outside counsel wrote that federal tax law "makes it abundantly clear that Blue Shield would be prohibited from making distributions upon dissolution to anyone or any entity other than another [nonprofit] and most certainly not to its contracted physicians or members."
Three months later, Blue Shield repeated the same point to the tax board, saying it "may not distribute its assets to private persons."
Asked about the contradiction, the San Francisco company stood behind Markovich's comments.
"I want to be perfectly clear. Our public statements about what would happen if Blue Shield were ever dissolved are completely true and we stand by them 100%," said company spokesman Steve Shivinsky.
The company continues to appeal the state's revocation.
Winning an appeal might be difficult considering that the tax board soundly rejected many of Blue Shield's assertions that its actions benefit all Californians, according to correspondence reviewed by The Times.
In the June 2014 report, tax officials took special note of how Blue Shield's surplus nearly doubled from $2.26 billion in 2006 to $4.15 billion in 2012, the last year examined.
Auditors disputed the company's contention that it needed the extra cash cushion to deal with an extremely volatile market for health insurance, particularly during the rollout of the Affordable Care Act.
Tax officials reviewed the company's revenues and expenses for medical claims for a seven-year period and determined that the "market has not been particularly unpredictable."
"We assert that the extraordinarily high surpluses set aside as reserves by Blue Shield are not kept for the purposes of stabilizing the organization but rather for the commercial purpose of increasing competitiveness," state tax officials wrote in June 2014. "We observed that Blue Shield far exceeded the reserves required either by law or the best practices and standards of the healthcare industry."
The company said its reserves will be reduced to $3 billion after the acquisition of the Care1st Health Plan. It said independent actuaries have agreed that amount is fiscally sound.
But to justify its tax exemption, auditors said, Blue Shield needed to do more with its surplus to provide a community benefit.
"Blue Shield does not provide any free or significant below-cost healthcare plans to the general public," tax auditors said.
The company has often cited its move in 2011 to limit profits to 2% of annual revenue and return any excess to customers. The insurer said it gave back $560 million to customers and community groups from 2010 to 2012.
State officials said the cap on profits couldn't support the tax exemption because it could be canceled by the company's board, and the refunds have primarily gone to large employers rather than individual consumers.
All these matters have taken on more importance because Blue Shield is seeking regulatory approval for its purchase of Care1st for $1.2 billion. That money will be drawn from the company's $4.2-billion surplus.
The deal would mark Blue Shield's entry into Medi-Cal, the state's insurance program for lower-income residents.
Some consumer advocates are urging regulators to block the acquisition, saying it merely enriches the owners of Care1st, a for-profit health plan. Instead, they say Blue Shield should return hundreds of millions of dollars to the public that could be used to bolster the state's healthcare safety net.
Betsy Imholz, special projects director for Consumers Union in San Francisco, said Blue Shield has benefited for decades from a lucrative tax break and the public's stake in the company should be safeguarded.
"These dollars should be dedicated to the public welfare through reduced-price insurance and serving the health needs of vulnerable populations to truly differentiate the nonprofit from for-profit companies," Imholz said. "The public is the 'shareholder' of every nonprofit, including Blue Shield."
Michael Johnson, a former Blue Shield executive turned company critic, said the insurer's contradictory statements and lack of transparency warrant a full inquiry by regulators. The Department of Managed Health Care "needs to use its authority to investigate Blue Shield itself and whether it is shirking its duties as a nonprofit," Johnson said.
In the documents, the tax board estimated Blue Shield could owe $110.5 million in potential taxes for 2009 to 2012, the years covered by the examination. The tax board later said it ordered tax payments only for 2013 and 2014. Blue Shield said it has paid $62 million for those two years while its appeal is pending.
The company has paid federal income taxes for years under a change Congress made in 1986 that sought to treat large Blue Cross Blue Shield health plans the same as for-profit insurers.
In correspondence, Blue Shield's lawyers tried to persuade tax board officials to reconsider their position and sought a meeting in early 2014. The company stressed in its letter that the "exemption from the California franchise tax is extremely important to Blue Shield."