Report 2011-126 Summary - August 2012

Nonprofit Hospitals: Statute Prevents State Agencies From Considering Community Benefits When Granting Tax-Exempt Status, While the Effects of Purchases and Consolidations on Prices of Care Are Uncertain


Our review of nonprofit hospitals with tax-exempt status highlighted the following:


The Legislature expects nonprofit hospitals to provide such community benefits as free or reduced-cost medical care to the poor in exchange for the State's favorable tax treatment of these hospitals. However, as noted in a 2007 report by the California State Auditor (state auditor), the amounts of community benefits the hospitals provide cannot be used to justify their tax-exempt status. Specifically, state law requires most tax-exempt hospitals to prepare annual community benefit plans1 that describe the activities that the hospitals have undertaken to address community needs and that report the amount of community benefits that the hospitals provided during the year. Community benefits can include health care services that hospitals render to vulnerable populations and for which the hospitals do not receive full compensation. This uncompensated care encompasses free care (full charity care) or discounted care (partial charity care) for financially qualified patients. However, as was the case during our 2007 audit, state law clearly states that state agencies cannot use a community benefit plan to justify the tax-exempt status of a nonprofit hospital. Since our 2007 report, the Internal Revenue Service has required nonprofit hospitals to provide additional information on their tax returns regarding the activities, policies, and practices of each hospital operated during the tax year. Nevertheless, federal law, like state law, does not require nonprofit hospitals to deliver specific amounts of community benefits for the hospitals to qualify for tax exemptions.

In reviewing four nonprofit hospitals—California Pacific Medical Center St. Luke's Hospital (St. Luke's), El Camino Hospital Los Gatos (Los Gatos), Mission Hospital Laguna Beach (Laguna Beach), and San Leandro Hospital (San Leandro)—we saw that each hospital had its own method to calculate its costs to provide health care services for which it did not receive compensation (costs of uncompensated care). Indeed, no statutory standard or methodology for calculating these amounts exists. We reviewed the methods that the four nonprofit hospitals used to quantify their community benefits and to determine what to include as costs of uncompensated care for the hospitals' fiscal year ending in 2010. All four followed guidance from Catholic Health Association of the United States (CHA), a national nonprofit organization representing Catholic institutions and other health care organizations. Using CHA guidance, none of the four hospitals we reviewed considered as a component of their respective overall community benefits the hospital's expenses pertaining to bad debt, which is the unpaid portion of bills for patients who have the ability to pay but who are unwilling to do so. Instead, the 2010 community benefit plans for the four hospitals included the costs of charity care and the unpaid costs of public programs, such as the California Medical Assistance Program (Medi-Cal) and county indigent programs. During our review, we also noted that one of the four hospitals used its cost-accounting system to help quantify the amount of community benefits it provided. Other hospitals estimated these amounts using a ratio that converts the charges for provided health care services to their actual costs.

Each of the four hospitals we reviewed have different standards for determining who can qualify for charity care. For example, a family of four with an income at 350 percent of the federal poverty level and no insurance may qualify for full charity care at one of the four hospitals we reviewed, but the same family would qualify only for partial charity care at the other three hospitals. The cause for this disparate treatment stems from state law, which requires only that nonprofit hospitals allow those whose incomes are at or below 350 percent of the federal poverty level to apply for charity care. Therefore, a nonprofit hospital can establish for itself the level of charity care it will provide patients based on the patients' financial status, so long as the hospital allows those at or below 350 percent of the federal poverty level to apply for at least partial charity care.

Although the amount of full or partial charity care provided by nonprofit hospitals varies according to the hospitals' policies, these amounts also vary among nonprofit hospitals with the same policies because the financial demographics of the hospitals' communities are different. For example, St. Luke's is one of five hospitals that are part of the California Pacific Medical Center (CPMC). All CPMC hospitals use the same financial assistance policies. Nevertheless, St. Luke's provided more uncompensated care during 2010 than did the other hospitals. Specifically, St. Luke's provided charity care during 2010 that was equal to roughly 17 percent of its net revenue. In contrast, the other four CPMC hospitals provided combined charity care equaling 4 percent of their net revenue. Officials at CPMC attribute the high uncompensated care for St. Luke's to the low income levels of patients who visit that hospital compared to the income levels of those who visit the other CPMC hospitals.

In addition to examining health care costs at the four nonprofit hospitals, we also attempted to evaluate whether prices for health care services changed when new owners or operators acquired the hospitals. However, because of limited data we could not determine whether the changes in prices for services at the four hospitals resulted directly from changes in ownership or operatorship. Specifically, the unavailability of pricing data for two of the four hospitals kept us from determining how changes in ownership or operatorship affected the prices of health care. State law required hospitals to submit their pricing data2 annually beginning July 1, 2004, which was after the purchase of the two hospitals. For the remaining two hospitals we reviewed, we could not determine how changes in each hospital's ownership affected the pricing of health care services. During our review, we noted that the new owners at both hospitals brought with them their own unique codes to group medical services and their related charges. As a result, it was not possible to identify the charges of certain medical services before and after a hospital was sold, and to determine whether there were significant price changes in particular procedures or hospital services. The Office of Statewide Health Planning and Development (Health Planning), does not require hospitals to provide their pricing data in a standardized format.

We also could not determine the effects on communities resulting from reductions or terminations of services after new owners or operators acquired the four nonprofit hospitals. We found that the new owners or operators for three of the four hospitals made some changes in services after the acquisition. However, they all cited safety or cost concerns for their decisions. For example, Eden Medical Center's board of directors decided to close San Leandro's skilled nursing unit in 2006. The hospital staff indicated that the decision to close the skilled nursing unit occurred after Medicare changed its reimbursement method. Further, hospital staff believed that other facilities in the area would meet community needs for such services.

On the other hand, costs of uncompensated care increased after a change in owners or operators for three of the four hospitals we reviewed. Laguna Beach was the only hospital that reported a decrease in costs of uncompensated care in 2010, a year after it was acquired by Mission Hospital Regional Medical Center. Between 2008 and 2010, the hospital reported a $6 million decrease in unreimbursed Medi-Cal costs. According to the hospital's controller, the previous owner's decision to discontinue labor and delivery services in 2008 and its skilled nursing unit in 2009, before the purchase, may have affected Medi-Cal patients' use of hospital services.

Finally, we assessed whether Health Planning adequately monitors hospitals' submissions of data required by state law. State law designates Health Planning as the office responsible for collecting certain information from hospitals. By collecting, tracking, and making this information available to the public, Health Planning increases the transparency of hospitals in California. Our review found that Health Planning identified 15 nonprofit hospitals that were required to submit community benefit plans in 2010 but did not do so. However, Health Planning stated that the law does not allow it to penalize those hospitals for failing to provide such plans.


If the Legislature intends for nonprofit hospitals' tax-exempt status under state law to depend on the amounts of community benefits they provide, it should consider amending state law to include such requirements.

If it expects each nonprofit hospital to follow a standard methodology for calculating the community benefits it delivers, the Legislature should either define a methodology in state law or direct Health Planning to develop regulations that define such a methodology.

If the Legislature intends to ensure compliance of all hospitals required to submit community benefit plans to Health Planning, it should consider revising state law to allow Health Planning to assess a penalty to those hospitals that do not comply.


Health Planning concurs with our findings.

1 The four hospitals we reviewed—St. Luke's, Los Gatos, Laguna Beach, and San Leandro—report their community benefits as part of the total community benefits delivered by their parent organization.

2 Health and Safety Code, Section 1339.55, requires hospitals to provide Health Planning with pricing data that must be shared with the public.