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By Kathy Robertson
Sacramento Business Journal
Updated: 7:00 p.m. ET Dec. 18, 2005

Nonprofits' tax breaks questioned
State probes Kaiser, Sutter
The state is investigating 15 nonprofit healthcare organizations for excess profits, as legislators question whether they deserve to keep the tax-exempt status that saves them millions of dollars a year.

The list includes Kaiser Foundation Hospitals, which potentially means closer scrutiny of the healthcare giant's 30 California hospitals, even though a legislative hearing on the matter in Oakland last week put the heat on Sacramento-based Sutter Health instead.

Sutter is affiliated with nine of the names on the list -- although it sold one of them, a hospital, in 2001 -- and was slammed by the Service Employees International Union and others at the politically charged hearing. That's not a coincidence. SEIU has tried to organize Sutter's employees for years, with little success. Kaiser is a longtime friend to labor and signed a landmark, five-year contract with 29 unions, including SEIU, in September.

The Assembly Revenue and Taxation Committee called the hearing to consider the tax benefits granted to nonprofit hospitals in California, whether hospitals are giving back enough in exchange, and if not, what to do about it.

There's no bright line in California law that specifies how much profit a nonprofit hospital can earn.

State law says groups that own and operate hospitals aren't considered for-profit if operating income in the proceeding year exceeds expenses by 10 percent, but there are exceptions. Hospitals can use the extra money to pay debt, expand their facilities or put money aside for contingencies without jeopardizing nonprofit status.

"Question is: What is the acceptable threshold?" said Assemblyman Johan Klehs, a Hayward Democrat who chairs the committee. 

Audits due back soon

Legislators have the authority, under the California Constitution, to exempt properties from taxes if they are owned by nonprofits and used for religious, hospital or charitable purposes.

About 200 healthcare organizations in the state qualify for the "welfare exemption." They claim exemptions for about 1,000 hospital properties they own statewide. The exemption is jointly administered by county assessors and the state Board of Equalization. The board determines whether the organization is eligible for the exemption; county assessors determine whether an organization's specific property qualifies.

The board identified 15 out of the 200 organizations it oversees as having profits of more than 10 percent in 2004.

The state board has asked for more information and should have audits done by year's end, Margaret Shedd, legislative counsel to the board, told committee members last week. Depending what it finds, the board could take more action, but it's not clear what.

State law does not have a minimum standard for charity care for hospitals, Shedd said.

The list of 15 was obtained by the Business Journal this week, but it raises more questions than it answers.
List says money-loser reported profit

All Kaiser hospitals are clumped into one entry, but most Sutter affiliates are cited separately. The list includes Sutter Health at Work, a subsidiary Sutter says lost money last year and is being shut for lack of business. Also on the list is Sutter Merced Medical Center, sold four years ago to Catholic Healthcare West.

"Why is it on the list? I have no idea," CHW vice president Daniel Roach said midweek. "It never had a healthy operating margin." No other CHW hospital appears on the list. The other big provider in the Sacramento area, UC Davis, gives more charity care than any other local system.

Sutter Merced still has an active corporation that reported profits last year, and operating statements from Sutter Health at Work showed net income in 2004 after a loss in 2003, a board spokesman said.

Scrutinizing hospital profits is hard in an era when hospitals are linked together as healthcare systems to share costs. The idea is for profitable hospitals to offset the money-losers.

"It seems like a bad thing if nonprofit hospitals have positive operating margins, but if they didn't, you wouldn't have nonprofit hospitals," said Martin Gallegos, chief legislative advocate for the California Hospital Association, a trade group.

Most for-profit hospitals have left Northern California. The ones that remain are in affluent areas like San Ramon and Los Gatos, or a market with a big draw, like Modesto.

Furthermore, the big cost for all California hospitals these days is the new construction required to meet stiff state earthquake safety standards -- and the cost of long-term debt they must take on to pay for it. These expenses fall outside the 10 percent cap for nonprofit status.

"The critical issue is, what is any excess used for?" Raymond Baxter, a senior vice president at Kaiser Permanente, told committee members at the hearing. "Last year in California, we had a 12.7 percent margin, not counting debt retirement and capital construction. Once you subtract that out, we had a negative 2.7 percent."
Selective spotlight

Kaiser was not on the hot seat at the hearing even though the amount of charity care its 30 California hospitals provides is a third of what Sutter's 26 hospital does.

In 2004, Kaiser provided $50.5 million in charity care at its California hospitals. Sutter provided $155 million and CHW did $63 million, according to figures the individual health systems provided the Business Journal in September.

Kaiser is both a health plan and healthcare system and mostly treats its own members in its hospitals, and thus does very little direct charity care.

Yet SEIU policy director Fred Seavey blasted Sutter for inadequate levels of charity care, high prices and high executive pay. His suggestions for reform were better performance standards for nonprofit hospitals, transparent financial information, and beefed-up enforcement through tax sanctions that stop short of stripping healthcare systems of their tax-exempt status.

"Sutter Health is not the evil empire described by Fred Seavey and others," countered Sutter general counsel Gary Loveridge. "Traditional charity care is free care, most of it in the emergency room. Our charity-care policies have changed (in recent years) and become more liberal."

Hospital profits go up and down in waves, but must generate enough money for new construction when it is needed, Loveridge explained.

He urged the committee to consider profit trends over a number of years rather than putting a one-year profit threshold into statute.

"Nonprofit status revocation is a very heavy hammer, but we don't feel voluntary guidelines are enough," said Anthony Wright, executive director at Health Access, a San Francisco consumers' group. Health Access is sponsoring a bill to require hospitals to adopt specific charity-care policies for individuals without insurance who have to pay the bill themselves. Assembly Bill 774 by Democratic Assemblywoman Wilma Chan from Oakland stalled in a state Senate committee last summer but will be pushed again in 2006.
Nonprofits under investigation

Nonprofit healthcare organizations under investigation by the state for excess profits:

    * Kaiser Foundation Hospitals*
    * California Pacific Medical Center
    * Memorial Hospital Association
    * Mills-Peninsula Health Services
    * Sutter Delta Medical Center
    * Sutter Health at Work
    * Sutter Health Sacramento Sierra Region
    * Sutter Maternity and Surgery Center of Santa Cruz
    * Sutter Merced Medical Center**
    * Sutter Tracy Community Hospital
    * John Muir/Mount Diablo Health System
    * Lucile Salter Packard Children's Hospital at Stanford
    * QueensCare
    * Santa Ynez Valley Cottage Hospital Inc.
    * St. Jude Hospital

* The umbrella organization for Kaiser's 30 California hospitals

** Sold to Catholic Healthcare West in 2001