Minnesota's nonprofit health care: Can you heal me now?

Minnesotans live in a state that consistently ranks near the top in health care measures. The percentage of Minnesotans who are insured is among the highest in the nation; clinical measures of health are above average; Minnesota's per-capita costs have never been high compared with national averages. Nonetheless, it is unsustainable for an increasingly large percentage of our resources to be devoted to health care.

Minnesota's enviable health rankings arise from a number of causes. Our state has a relatively strong economy with high levels of employment. Employers have provided comprehensive health coverage, and taxpayers provide generous public programs. We are also home to world-renowned medical education and research institutions, such as the Mayo Clinic and the University of Minnesota.

Many might also point to the fact that much of the health care in Minnesota is provided by hospitals and insurers that are classified as nonprofit.

This leads to two questions. The first is whether a high-performing health care system should be exclusively composed of nonprofit organizations. The second is whether Minnesota hospitals and insurers actually fulfill the kind of mission that would justify nonprofit status.

We believe the answer to both questions is no. When carefully examined, Minnesota's largest health care entities are hiding behind some very small nonprofit fig leaves.

Minnesota has always had a small number of insurers, with five covering more than 90 percent of the local market. The number of hospitals is also shrinking. Changes to payment systems and a transition to seeing more care provided at outpatient locations have put financial pressure on many Minnesota hospitals. This has led to significant consolidation. Minnesotans now receive care from hospitals that have morphed into a dwindling number of complex health systems, as in the acquisition of Park Nicollet by HealthPartners.

These health systems are big business in Minnesota. After subtracting government-run facilities, 72 percent of Minnesota hospitals are classified as nonprofit. According to the Star Tribune's 19th Annual Nonprofit 100, nonprofit health systems, hospitals and insurers comprise 19 of the 20 largest nonprofit organizations in Minnesota and take in 92 percent of the overall revenue among the top 100.

The top 15 among these organizations generated enough revenue in 2013 to rank them among the 50 largest publicly held companies headquartered in Minnesota. State taxpayers are generously subsidizing entities that, in certain cases, generate more revenue than Fortune 500 companies.

Meanwhile, the excess of revenue over expenses at these nonprofits is eye-popping. In 2013, Mayo Clinic had a margin of revenue over expenses of $612 million. While Mayo is a global brand, HealthPartners, Allina Health and Fairview Health Services also had margins totaling $848 million.

How can this be true? It largely stems from tradition.

Favorable tax treatment for nonprofit hospitals is deeply rooted in American public policy. Nonprofit hospitals became exempt from taxation as early as 1894, based on the rationale that they advanced the general welfare by providing charity care for the poor. It was not until 1954, however, that Congress enacted Section 501 of the Internal Revenue Code. Section 501 provided federal tax exemption to various types of "charitable" organizations.

For a hospital to be recognized as a charitable organization, it must satisfy something called the community benefits standard. Until 1969, the IRS required hospitals to provide charity care — that is, without expectation of payment — in order to meet this standard and qualify for nonprofit status. Unfortunately, today the current community benefits standard has no such requirement. The current standard is vague and overly broad. It takes into account as community benefits worthy but unrelated activities ranging from round-the-clock emergency rooms to providing bikes for children.

So, how profitable are "nonprofit" hospitals in the United States? McKinsey and Co. recently found that the 2,900 nonprofit hospitals in the U.S. had higher profit margins than their 1,000 for-profit counterparts.

Nonprofit health care executives appropriately argue that without a financial margin there is no mission. But it appears that too often the margin has become the mission.

Nonprofit hospitals supposedly operate for the benefit of their communities and are required to reinvest any profits back into the organization. In exchange for their charitable mission, nonprofit hospitals 1) are exempt from local, state and federal taxation, and 2) can receive tax-deductible donations.

According to the New England Journal of Medicine, tax exemptions saved nonprofit hospitals $13 billion nationwide in 2013. In 2005, according to the Minnesota Department of Health, the tax exemptions received by Minnesota nonprofit hospitals totaled $443.6 million, or $540.3 million in 2014 dollars. These numbers rival the controversial public subsidies for the new Vikings stadium. What do Minnesotans receive in exchange?

A reasonable person might conclude that Minnesotans should receive, at the very least, charitable services equal to the value of the tax exemptions provided. In reality, Minnesotans receive a jumbled assortment of services that stray far afield from the original theory behind supporting tax-exempt hospitals. Services counted under the current community benefits standard include 1) charity care, 2) the "unreimbursed costs" of care for Medicaid and Medicare patients, 3) cash and in-kind contributions, 4) bad debt, 5) educational programs, 6) medical research and 7) "community-building activities."

Minnesota law neither specifies a minimum level of community benefits necessary to retain tax exemption nor requires the provision of any charity care.

We need a state standard that separates actual charitable activities from those that more closely resemble business promotion. Recent efforts by legislators to redefine community benefits stalled. People can reasonably disagree as to whether the current hodgepodge of "community benefits" provides appropriate flexibility or constitutes no standard at all. But Minnesota's nonprofit hospitals should be held accountable for the subsidies they receive.

Accountability starts with requiring nonprofit hospitals to provide charity care equal to at least half the value of the tax exemptions received. Hospitals that fail to meet this basic threshold should lose their nonprofit classification.

In addition, the boards of directors of Minnesota's nonprofit health systems ought to reflect the diversity of the communities they serve. A review of the composition of two of Minnesota's largest health system boards found them to be predominantly composed of white, male business executives. There is no question that business acumen is important, but governing boards should be more representative of the community and strive to provide culturally competent care. Hospitals and insurers should appoint appropriately diverse boards to maintain their nonprofit status.

If operating revenue is not expended in the provision of charity care or other charitable services, then it is important to explore how it is being utilized. One way revenue is being spent is through an increase in executive compensation.

In 2013, the average compensation for the four highest paid nonprofit CEOs in Minnesota — all leaders of health care systems — was $2.18 million. This trend is not limited to the C-suite. IRS 990 forms show that many lower-level executives are making more than $1 million a year.

Another way revenue is being spent is through a medical arms race for the latest technology and facilities, as a smaller number of health systems compete for customers and to provide the most profitable services.

Last, mounting financial pressure is driving acquisitions of physician groups and hospitals. Despite these pressures, some have maintained their independence.

Our concern is not that some hospitals and insurers are successful in terms of profitability. Rather, the problem concerns how profits are spent when Minnesota taxpayers are providing generous subsidies. We are not advocating for the dismantling of Minnesota's nonprofit hospital and insurer infrastructure. The provision of charity care, education and research are true community benefits. But other activities deserve heightened scrutiny.

Everyone sees the need for improvement in our health care system. Minnesota's nonprofit health care entities should be enthusiastic about innovations designed to improve care, satisfy patients and lower costs. Unfortunately, ostensibly nonprofit health care systems are often blind and deaf to alternatives, particularly when offered from the outside or when innovation threatens to decrease revenue. Examples of organizational ossification are not hard to find.

The fee-for-service payment system is a major force behind expensive care, and it is clear that bundled payments for an episode of care is one way to restrain costs and encourage collaboration. Pregnancy is the perfect episode of care to test bundled payments. Regrettably, when the idea was first proposed to various Minnesota health care executives, responses ranged from "what would it take for you to give this idea up?" to "you are talking about a for-profit entity." Fortunately, such attitudes are changing.

Two future health care scenarios appear plausible. One is further system consolidation until only two or three large systems remain. Some see this as desirable and inevitable, but we know how consolidation has worked out in other industries, such as airlines and cable television. This would result in health care entities that are "too big to fail."

The preferable course is a health care landscape built on reformed nonprofit organizations existing for reasons beyond boundless growth. Nonprofit health care systems and insurers should serve as platforms for innovation — even in collaboration with for-profit partners. Partnerships focusing on innovation will result in higher value care for all Minnesotans. That would be a real community benefit.

Steve Calvin is medical director of the Minnesota Birth Center. Theodore J Patton is an investigator for the Minnesota Department of Commerce. The views expressed here by Patton do not necessarily represent those of the Minnesota Department of Commerce.