California's four largest health plans may be on the hook for $10 billion in state back taxes — and at least $1 billion every year going forward — if a closely watched legal case does not break their way.
Should that happen, insurance industry critics say, it would end one of the biggest tax code abuses in state history — one that for decades has allowed Kaiser Permanente, Anthem Blue Cross, Blue Shield of California and Health Net to avoid paying a state tax on health insurance premiums. The health plans, however, say they aren't insurers and thus shouldn't be subject to the tax.
If they lose in court, it could mean a huge windfall for the state's coffers, potentially pouring much-needed funds into the state's overwhelmed Medi-Cal program — and perhaps an El Niño-like deluge into Gov. Jerry Brown's Rainy Day Fund.
Yet some worry that such a defeat for the four plans — which control almost 70 percent of California's health insurance market — means consumers will end up footing their behemoth tax bills through higher premiums.
"This is clearly a monumental case for California and Californians," said state Sen. Bill Monning, D-Monterey, a member of the Senate Health Committee. "The reason it would be a good decision — from a public policy point of view — is that it would level the playing field so that everyone participating in the insurance market is held to the same standard."
Blue Shield and Blue Cross already lost a key round in a state appellate court. The case against Kaiser and Health Net heads to a Los Angeles court Friday.
At the heart of the debate is a century-old section in the state constitution that requires almost all insurers to pay a 2.35 percent tax on the premiums they collect each year. The tax is paid in lieu of almost all other state taxes.
Yet for decades, industry critics say, Kaiser, Blue Cross, Blue Shield and Health Net have managed to avoid paying the premium tax on the majority of their business.
The four say they are "health care service plans" that are in the business of providing medical services for a fixed monthly fee through a restricted network of hospitals and doctors. These plans, they say, require the doctors and hospitals to assume the financial risk of providing medical services to consumers. They contend they are different from "insurance plans,'' like Aetna and Cigna, which reimburse consumers for their medical expenses.
But according to the lawsuits, the difference between the plans has become blurred over time as the "health care service plans'' have come to resemble "insurance plans" in the way they pay doctors and hospitals Health care advocates and consumer advocates say Kaiser, Blue Cross, Blue Shield and Health Net are all essentially insurers — whether they call themselves that or not.
"If it walks like a duck and talks like a duck, then it's a duck," said Jerry Flanagan, an attorney with Consumer Watchdog, a nonprofit Santa Monica-based advocacy group that joined the case in September after the original 2013 lawsuit was expanded to include the nonprofit Kaiser and for-profit Health Net as parties in the case.
Flanagan and other attorneys involved in the case point to a 1968 California Supreme Court ruling that said if traditional insurance is a significant financial portion of a business, an insurer is responsible for the premium tax. And that's exactly what the attorneys for the plaintiff say is the case with the four plans.
Even though the state could reap a huge windfall if the four health plans lose the case, Gov. Brown's administration has sided with the plans, arguing that the 1968 case is being misapplied and that the state Legislature long ago determined these plans should be separately taxed and regulated. The lawsuit, the state's attorneys warn, could disrupt California's health care delivery system and cause consumers' premiums to soar.
But both Flanagan and Tim Morris, one of the plaintiff's Los Angeles attorneys, cite documents from the state Department of Managed Health Care — which oversees health maintenance organizations (HMOs) — that reveal the four plans have been paying out more cash for traditional fee-for-service claims than their HMO expenses.
The four plans contend that they were allowed to be regulated by the Department of Managed Health Care, where they are assessed a fee based on their volume of business, in addition to a corporation tax. Yet critics of the industry point out that those fees and taxes are hundreds of millions of dollars a year less than the premium tax imposed by the Department of Insurance, which regulates traditional insurers.
Kaiser spokesman John Nelson called the case "utterly meritless."
"Kaiser Permanente's focus is on providing health care services through our hospitals and contracted medical groups — not providing insurance like the other targets" of the lawsuit, he said in an email. "We are confident that the courts will not extend (the plaintiff's) novel theory to our unique integrated health care delivery system."
Blue Shield spokesman Steve Shivinsky said in an email that its "health care service plans" fall under the Department of Managed Health Care, so are not subject to the tax.
Anthem Blue Cross and Health Net declined to comment on the case.
Industry critics and some state officials argue that the tax a plan pays shouldn't depend on which bureaucracy regulates it.
"The constitution requires all insurers to pay the gross premium tax, and the insurers cannot get out of that obligation by moving their health insurance products out from under the California Department of Insurance to a different regulator," said Janice Rocco, the insurance department's deputy commissioner.The allegation that the plans are essentially gaming the system underlies the lawsuit filed in July 2013 against the state by Dr. Michael Myers, a Southern California family physician. Myers not only wants the state to determine that the four plans be considered "insurers" but that it collect eight years of back taxes from each one — the statutory limit — along with interest and penalties. Myers, 61, who originally sued the state insurance commissioner, state controller and state Board of Equalization, did not return calls for comment.
The Huntington Beach resident was initially stymied when a Los Angeles County Superior Court judge agreed with Blue Shield and Anthem Blue Cross and dismissed his lawsuit. But Myers' attorneys prevailed in the 2nd District state Court of Appeal in Los Angeles, where a three-judge panel in September unanimously reversed the lower court's ruling and allowed the legal claims against the two companies to proceed to trial. Blue Shield and Anthem Blue Cross then asked the California Supreme Court to take the case, but their request was denied last month.
While the appeals court ruling doesn't guarantee an outcome, legal experts say it provides ammunition for the plaintiffs when the case returns to the trial judge, who is expected to decide all of the cases without a jury.
Unless the plans can devise a new strategy, it will be a challenge to win their case, said Clark Kelso, associate dean at the University of the Pacific McGeorge School of Law and a one-time acting California insurance commissioner.
"I think they should have serious concerns that they will end up being subject to the additional tax.''
Contact Tracy Seipel at 408-920-5343. Follow her at Twitter.com/taseipel.
BILLIONS OWED TO STATE?
A lawsuit alleges these plans owe the state the following in premium taxes for an eight-year period:
Kaiser Health Plan: $6 billion
Anthem Blue Cross: $1.7 billion
Blue Shield of California: $1.4 billion
Health Net: $923 million
Source: Plaintiff's attorneys, based on Department of Managed Health Care figures
Kaiser Permanente: 35 percent, or $42.5 billion
Anthem Blue Cross: 14 percent, or $16.7 billion
Blue Shield of California: 9 percent, or $11 billion
Health Net: 8 percent, or $10.4 billion
United Healthcare: 7 percent, or $8.6 billion
Aetna: 3 percent, or $3.8 billion
All others: 24 percent, or $30 billion
Source: 2013 figures from California Healthcare Foundation