Montana Viewpoint

Should non-profit organizations be allowed to become for-profit?

August 21, 2006

There is some concern in the circles I travel in about the increasing trend of non-profit companies to become for-profit companies. Why would they do that? After all, non-profit companies are usually formed for the public good.

Notable are the conversions of Blue Cross and Blue Shield non-profits to for-profit companies. The Blue Cross concept was born in Texas in 1929, when a hospital insurance plan for teachers was created. For 50 cents a month a teacher could buy coverage from the Baylor University Hospital that would pay for up to a three week hospital stay.

Similarly, the Blue Shield concept began in Washington state in 1917 through an effort by employers in the woods and mining industries to keep their employees healthy. There, “medical service bureaus,” composed of groups of doctors, were formed. The employers paid the bureaus an insurance premium to guarantee that medical care would be available for sick and injured workers.

The two concepts merged in 1982, when Blue Cross Blue Shield was formed.

This type of organization is called a mutual benefit enterprise, because it is sort of owned by the people who participate in the plan. It is like a co-operative association. The board of directors is responsible to the participants rather than to the shareholders, as they are in a for-profit corporation. Their responsibility is to maximize the benefit for the member.

In a for-profit organization the duty of the directors is to maximize the wealth of the shareholder. The shareholder may see increased dividends when the company is performing well, the co-op member may see lower rates, “dividend” rebates, or expanded services.

A difficulty with mutual benefit organizations and cooperatives is that after time the boards of directors become increasingly independent of the membership, and power is concentrated in their hands, perhaps to the detriment of member benefits. I liken this phenomenon to a dynamic I’ve observed in school boards.

Knowledge is power, and the people with the most knowledge run the show. In the case of a school system, the superintendent has the knowledge; after all, it’s a full time job. As a result, board members, who serve part time for nothing, have to depend on the superintendent for know how and expertise.

So, while we elect school boards to run schools the way we want them run, and give them the ability to hire a superintendent and staff to help do it, the employee winds up directing the directors—the boss—because of the employee’s command of the issues.

Why would a company founded to benefit its members want to create a company that would benefit the owners? Well, to raise money, for the most part.

The major ways that mutual benefit companies can raise money are to expand the membership, manage more cheaply, or raise rates. That can create limited opportunity to raise operating capital. The way a for profit company raises money is to sell stock to individual investors, which is a lot quicker, lucrative, and a lot more flexible.

But what’s the reason these former “public benefit” companies are becoming for profit? One reason would be to raise operating money that they cannot now currently raise. Another is to raise money to take over other companies through merger. More cynical observers feel that conversion to for-profit status is motivated by the company executives so they can raise their pay.

Laws governing non-profits prohibit executives from receiving benefits that are beyond “reasonable compensation,” which I suppose can be pretty flexible. For-profit companies have no such restriction. A study by the Consumer’s Union points out that after about six months following conversion to a for-profit company, regulators approve pay increases for executives.

One case in point is CEO Leonard Schaffer of Wellpoint, formerly Blue Cross of California. In 1993, Schaffer’s salary as head of the company was $922,000, which is not pocket change anywhere. After the conversion to Wellpoint in 2003 his salary was increased 50% to $1,383,000, and in 2003 he received $19,260,000 in salary, benefits, and stock options.

Recent concerns about the possibility of Montana Blue Cross Blue Shield converting to a for-profit prompted a bill in the 2005 legislature to limit their ability to do so.

And why should that ability be limited? Well, there are a couple of reasons. One is that a mutual organization has built up a certain amount of worth through the money paid to it by its members, and that worth should remain in the community for public benefit, such as through community oriented trusts or charitable entities.

My main concern, however, is that a company which has built up its customer base with the special privilege of not having to pay taxes is then in competition with insurers who built up their base while paying taxes, thereby giving the former non-profit an unfair advantage in the marketplace. If Blue Cross Blue Shield organizations had been paying taxes all along they would not have been able to keep rates low, and it is low rates that account for the large customer base.

But competition is a good thing, and we might think that the for-profit companies could stand a little. Well, it’s not even close; Blue Cross Blue Shield organizations are semi-monopolies, with one third to one half of the health insurance market wherever they are, which is everywhere. In Montana Blue Cross Blue Shield has about 46% of the market while the next biggest company has about 4%.

The tendency of organizations to want to grow is not limited to private enterprise. We see it in the growth of governmental agencies and non-profit organizations. Usually the reason is the belief that by expanding they can offer better services to the public. Sometimes it’s just to make more money, and sometimes, it’s both, which is not a bad thing.


Jim Elliott
Phone: 406-444-1556
Mail: State Senate Helena, MT 59620