Free Lunch (29 page)

The money paid
to buy FHP would create the FHP Foundation. Its charitable purpose was to cover copayments for prescription drugs and doctor
visits for FHP subscribers who could not pay them. In an HMO, the key to profits is keeping people healthy enough that they rarely
visit the emergency room, much less stay in the hospital. People with chronic conditions and illnesses, such as high blood
pressure and diabetes, go to the emergency room or the hospital more often when they do not take their
medications.

Poor people sometimes must choose between getting their medications and
going hungry. Sometimes that copayment could mean losing the roof over their heads. In such a contest pills usually lose out. But
with the FHP Foundation those concerns would be taken care of, the medicines issued and visits to the emergency rooms and
stays in the hospital prevented. Thus Gumbiner's charitable purpose would be worth much more to his bottom line than the cost of
these mini-grants to cover the copayments. There is a word for this conduct: self-dealing.

The
circular flow of the money, and its effect on costs, would enrich Gumbiner by making his business more profitable, exactly what the
settlement with Attorney General Younger forbade. But neither Gumbiner nor the FHP board saw it that way.

Gumbiner told me at the time that the price he offered for FHP was more than fair. He noted that Maxicare was
three times the size of Family Health Plan. Yet he was paying more than 50 times what Wasserman and Anderson had paid for
Maxicare's assets. That analysis ignored the issue of whether Wasserman and his wife had paid a fair price. Gumbiner also pointed
out that the $600,000 in annual grants the FHP Foundation pledged to make to cover copayments was more than twice the value of
the one unsecured note that Wasserman and Anderson had signed to acquire Maxicare.

The
job of deciding the fairness of the deal in 1985 fell to the California Department of Corporations, whose office had no track record of
looking out for charitable interests. Even so, the corporation commissioner's office could not stomach Gumbiner's deal, at least not
the $13.6 million price. In the previous year FHP had taken in almost $15 million more in revenue than it spent on caring for
subscribers, money that a business would call profit. Selling an enterprise for less than the profits earned in a single year fails the
basic obligation of a trustee to be prudent. FHP's own analysis showed that FHP was worth about $216 million based on stock
market values, an estimate that would turn out to be significant.

The corporation commissioner
set the price at $47 million. That price was a big bargain for Gumbiner, a real loss to the taxpayers, and a tiny fraction of that $216
million estimate from FHP's own analysis. Still, Gumbiner complained that it was too much. The corporation commissioner then
showed he could be accommodating, cutting the price to $36 million. It was an easy decision since the commissioner was not
giving up $11 million of his money, but the public's.

Among those who knew that Gumbiner
was getting a sweet deal was Wasserman. He sued to block the sale. Wasserman said that Maxicare would pay $50 million cash
without even inspecting FHP's books. Wasserman told me he would pay “up to between $60 million and $80 million” if he could
just get a look at FHP's books. He suggested that if the facts warranted it he would pay even more.

At this point, the attorney general, the guardian of charitable assets, tried to step in. He pointed to the 1977
settlement that prohibited self-dealing and said that was precisely what the charitable spending on copayments amounted to. And
the attorney general said the price was much too low, citing four centuries of unbroken legal history in Western civilization that the
only price for charitable assets was the highest price in the market.

Gumbiner countered that
protecting charitable assets had nothing to do with it. He said Maxicare was simply a predator, a big fish trying to eat up the smaller
fish like his Family Health Plan. Gumbiner argued that once Maxicare had swallowed the competition it could raise prices to
subscribers. He said eliminating competitors undermined the whole idea behind the law that Nixon signed encouraging
competition in health care. “If Maxicare prevails,” Gumbiner said, “they would effectively establish a law that anybody wanting to
convert would have to auction the assets, and then large companies would simply bid more than the fair market value to eliminate
competition.”

Gumbiner won. Ignoring competitive market principles and legal history, the
corporation commissioner, and later a Superior Court judge, did Gumbiner an immensely valuable favor by rejecting Maxicare's
higher bid. Gumbiner was not even required to match the higher offer. Remember that markets are supposed to be good for health
care by instilling competition and economic discipline. But here the market was thwarted. The highest price did not set the market.
Indeed, the market did not even affect the price.

The judge wrote that the legal standard “is not
whether [the offer] was the highest lawful bid, but whether there was a fair value. Those are two different questions…. It may well
have much higher value to a competitor than the fair market value….”

Seven months later, after
Gumbiner transformed FHP into a for-profit enterprise, the company sold shares at an initial public offering. The stock sale set the
value of FHP at $225 million, almost exactly what FHP's own analysis had shown was the real value of the assets that had been
built up by the taxpayers and entrusted to Gumbiner. Wall Street's valuation meant that Gumbiner paid about 17 cents for each
dollar of assets. Gumbiner's shares were worth about $115 million, vastly more than the new FHP Foundation received. Thus did
one man use government to grow rich at the expense of the many.

A new attorney general,
John Van de Kamp, appealed. Litigation continued until 1990 when a state appeals court also sided with Gumbiner. The reason
why is instructive for anyone eager to get rich by slipping public assets into his or her own pocket for pennies on the
dollar.

After Gumbiner settled with the state attorney general in 1977, he started working the
state legislature. Gumbiner persuaded the California legislature and Governor Jerry Brown to undo the limits in the settlement with
the attorney general. The legislature passed a law, which Brown signed, that changed FHP's status from a charity to another kind
of nonprofit. And the legislation added an unusual feature that no one except FHP seemed to appreciate at the time—it allowed
self-dealing. This special interest legislation slipped into the law books with no public debate, just as thousands of such favors are
enacted each year in Washington and the state capitals on behalf of campaign donors.

Because of this state law, the appeals court ruled unanimously in 1990 that the attorney general no longer
had jurisdiction to challenge Gumbiner's actions. Moreover, that law “legitimized self-dealing transactions by health plans,” wrote
the appeals court judges, Justices Paul Turner, Herbert Ashby, and Roger Boren.

Thanks to all
three branches of state government—the legislature that passed the law, the governor who signed it, and the judges who blessed
it—Gumbiner got his free lunch. The taxpayers got stuck with the risk and with the bill. And it was all perfectly legal, embraced by
three judges—on the same court that enriched Barron Hilton—whose ruling contains not a single word of regard for the interests
of the taxpayers who pay their salaries or the propriety of how the law was enacted.

While the
judges in the Gumbiner case ignored how the taxpayers were being shortchanged, no one in the health care business did. It was
as if the Army had sent its guards home and left the Fort Knox vaults open. Across the nation a new gold rush was underway by
nonprofit executives eager to line their pockets with taxpayer money.

One of those who did
exceptionally well was Leonard Schaeffer. He became chief executive of California Blue Cross in 1986, as the conversion
movement was growing. Schaeffer effectively transformed the nonprofit California Blue Cross into the for-profit WellPoint without
paying a dollar for its assets, outdoing even Wasserman.

California Blue Cross was an
elephant compared to Maxicare and FHP. It was also troubled, so strapped for cash that it had to sell its building to raise cash in a
crunch.

Had Schaeffer converted the nonprofit sooner, he could have made a lot more than the
$100 million plus that he eventually pocketed, perhaps a billion dollars or more. But by the time that Schaeffer acted the staff of
Consumers Union, the publisher of the magazine
Consumer Reports
, was on to the
deal. With a shoestring budget and a lot of moxie, the San Francisco office of the consumer group organized what public
opposition it could to such a subtle and complex deal. The consumerists also posed inconvenient questions to for-profit
enterprises about the conversion of assets held in the public trust.

Schaeffer knew the
conversion deals were an outrage, a legalized theft of public assets, yet he defended his deal to create WellPoint. He adopted the
same viewpoint as Gumbiner, who said he was paying more than Wasserman. Schaeffer wrote that “there was no law, regulation,
or precedent that defined” the obligations of a newly formed public benefit entity. In 1995, his own deal still hanging in the balance,
Schaeffer said:

In 1996 Consumers Union managed
to get $3 billion for charity as the price for the conversion years earlier of California Blue Cross to a business. That was a lot more
than the effective price of zero that Schaeffer had arranged, but it was still a bargain. All told, across a variety of deals, Schaeffer
generated $6 billion for foundations. By that measure some might make him out to be a hero. But the prices paid were bargains. By
the end of 2005, WellPoint was vastly more valuable than the charities it endowed, with assets of $51 billion and a net worth of
about half that.

In an economy the size of the United States', a few bad deals for the taxpayers
can be dismissed cynically as drops in the proverbial bucket. But the stories of how Gumbiner, Wasserman and Anderson, and
Schaeffer got their free lunches are just a few examples of the early deals that set the pattern. Many more deals followed. Across
the nation nonprofit hospitals, health maintenance organizations, and insurance plans were sold for pennies on the dollar. Billions
of tax and charity dollars that were invested for the public's benefit were transferred to private hands. Every dollar less than true
value paid for these enterprises was nothing more than legally sanctified theft, a transfer from unwitting taxpayers to the forces of
greed.

Not everyone who passes by a bank whose front door and vault are open will rush in
and scoop up the money. Some people will make themselves into the guardian of those assets. Others will call 911. Some nonprofit
health executives refused to take advantage of the opportunity to line their own pockets, though the public may not appreciate
what they did not do.

One of them is Howard Berman, who in 1985 left Chicago to take charge
of the nonprofit Blue Cross/Blue Shield plan in Rochester, New York, widely regarded as a model for providing quality care at low
prices. Later Berman consolidated Rochester with the plans in Syracuse and Buffalo, the other two sizable cities in western New
York.

Berman calculated that if he converted the plan to a for-profit business the stock market
would value the enterprise at $2 billion. That means he could have pocketed tens of millions of dollars by following the path laid out
by Wasserman and Anderson, Gumbiner, and others.

So why didn't Berman go for the money?
His answer is short and to the point: “It would be wrong.”

What Berman saw was that shifting
from an enterprise whose purpose was to serve people into a for-profit business would mean something worse than enriching the
few at the expense of the many. It would also, inevitably, mean getting rich at the expense of people's health, not their betterment.
Among other problems that Berman said would have followed a conversion of the health plan he ran would be spending a smaller
share of health care premiums on actual care.

The year after Leonard Schaeffer turned Blue
Cross of California into WellPoint, the for-profit company boasted that it had reduced its “medical loss ratio.” That meant that a
smaller portion of the premiums collected from customers was spent on their health care, and a larger share counted as profit. This
effort to cut costs did not apply to Schaeffer's own compensation. His pay did not just jump; it went up like a rocket.

When Schaeffer ran California Blue Cross as a nonprofit, his pay cost subscribers $922,000, a princely sum
for a nonprofit executive, one that pushed the limits allowed under nonprofit law. A decade later the for-profit WellPoint paid him
$19.2 million, or 20 times as much. Then in 2004, when WellPoint merged with another insurer, Schaeffer received a $50 million
payment simply because control of the company changed. And since he was also retiring, he got about $60 million more in
deferred pay and cash-outs.