HD70 - Health Care Institutions' Diversification Into the Commercial Sector and Its Impact on Small Business and Health Care Costs

  • Published: 1993
  • Author: Virginia Health Services Cost Review Council
  • Enabling Authority: House Joint Resolution 237 (Regular Session, 1992)

Executive Summary:
House Joint Resolution Number (HJR) 237 (Appendix 1), agreed to during the 1992 Session of the Virginia General Assembly, requested the Virginia Health Services Cost Review Council (VHSCRC) to examine health care institutions' diversification into the commercial sector and its impact on small business and health care costs. In addition, the VHSCRC was to elicit testimony and comment concerning the impact of health care institutions' commercial diversification from citizens, small business owners, hospital representatives, and agencies of the Commonwealth.

To prepare this report, the VHSCRC first undertook a literature review of current publications and positions of individuals and advocacy groups related to "unfair competition". It then undertook an analysis of the Commercial Diversification Surveys (CDS) which the VHSCRC has issued for the years 1988 through 1992. Finally, the VHSCRC solicited written comment from a wide variety of interested parties and organizations.

The literature review gave no definitive answer as to whether "unfair competition" exists. Numerous complaints of unfair competition have been brought against the nonprofit community and nonprofits have countered with their own assertions that their income-producing activities further their exempt purposes. The review revealed only anecdotal evidence to substantiate claims of unfair competition. Anecdotal evidence has numerous limitations, but no definitive empirical studies have been designed or conducted to address the issue.

The literature review also revealed activity at the federal and state levels designed to address unfair competition. The principal federal public policy response to the possibility that tax exempt status may result in unfair competition is the tax on the unrelated business income of nonprofit organizations. However, problems have been identified in the administration of this tax. Claims of lax enforcement of the unrelated business income tax have been leveled against the IRS.

In the states, the Business Coalition for Fair Competition has been addressing issues related to activities it sees as unfair competition. It has drafted and published the Model State Unfair Competition Bill which is designed to prohibit government agencies, institutions of higher education and nonprofit organizations from providing goods and services that can be provided by for-profit business. The bill is based on laws passed in Arizona, Colorado, and Iowa. The American Bar Association Committee on Exempt Organizations opposes this model bill as it relates to non-profit organizations.

Available data from the CDS proved to be most useful in describing the nature and extent of diversification and competition from nonprofit hospital affiliates. It was limited in its ability to clarify the impact of nonprofit hospital diversification on small business and health care costs.

An analysis of the CDS revealed that diversification is a popular strategy among Virginia nonprofit hospitals but tends to be more extensive in organizations having larger numbers of beds. Nonprofit hospitals engage in a number of different patient care-related and unrelated activities including: home health; outpatient radiology, CT scan, and MRI; urgent care; other outpatient services; long-term care; pharmacy; medical equipment; insurance; physician billing; collection; fitness and wellness; real estate; and management and consulting services. Competition may be most extensive, as judged from gross revenues earned, in the patient-care related areas of: outpatient services other than radiology, CT scan and MRI; long-term care services; and medical equipment and supplies. In nonpatient care-related activities, competition may be strongest from holding company activities; real estate management and rental; and management and consulting services. Unfortunately, the types of business activities undertaken by holding companies cannot be determined from the data.

Virginia nonprofit hospitals tend to dominate their consolidated organizations. During 1992, they earned 92 percent of the gross revenues of all consolidated organizations and over 96 percent of net profits.

The CDS indicate that assets and equity may not be employed as productively in affiliates as in hospitals. The median return on assets and return on equity tend to be lower among affiliate organizations than among nonprofit hospitals. For-profit affiliates of nonprofit hospitals perform more poorly than their nonprofit counterparts, as judged by median profitability ratios. In fact, the median profitability ratios of for-profit affiliates of nonprofit hospitals have been zero or negative over the years, while the median profitability ratios of nonprofit affiliates have consistently been positive.

No determination can be made regarding why for-profit affiliates perform more poorly than nonprofit affiliates; however, judging from median profitability ratios, for-profit affiliates seem poorly situated to monetarily support the nonprofit activities of the larger corporation or lower the cost of health care. While, nonprofit affiliates are profitable, it is impossible to determine how their profits are used.

Although the VHSCRC actively sought their input, the feedback from interested parties and advocacy organizations from both the small business community and nonprofit hospitals was not sufficient to fully develop and respond to the issues raised in HJR 237.

Because determination of "unfairness" requires value judgments, it will always be difficult to study the extent of unfair competition between nonprofit hospitals and for-profit business. However, specific questions related to competitive advantages that nonprofit hospitals may enjoy over for-profit competitors could be investigated if additional legislation is enacted.

Some of these questions include: (1) Do nonprofit hospitals limit referrals to their own affiliates (captive referrals)? (2) Do nonprofit hospitals charge lower prices than for-profit firms providing the same services in the market area? (3) How efficiently are services provided through affiliates? (4) Do nonprofit hospitals avoid taxes on income generated in their for-profit subsidiaries? (5) Are after-tax profits channeled back to the nonprofit hospital or a foundation that raises money for the hospital?

Recently collected information on related party transactions collected by the VHSCRC pursuant to SB 518 (1992) may be useful in answering some of these questions. It is therefore suggested that a continuing resolution be adopted to have the VHSCRC further study these issues.

In addition, to more fully address the questions specified above, legislation will be required to authorize the VHSCRC to gather information on: (1) the types of services offered by each subsidiary; (2) the amount or number of each type of service provided; (3) referral information; (4) capital investments (past and new); (5) labor information; and (6)information concerning mergers or sales of subsidiaries including the proceeds of such sales and uses of these funds.