Consumers Union of U.S., Inc. v. State

• Citation: 5 N.Y.3d 327,840 N.E.2d 68
• Parties: CONSUMERS UNION OF U.S., INC., et al., Appellants-Respondents, v. STATE of New York et al., Respondents-Appellants, and The Charitable Asset Foundation, Appellant, et al., Respondents.
• Decision Date: 20 June 2005
• Court: New York Court of Appeals

Page 68

840 N.E.2d 68

5 N.Y.3d 327

CONSUMERS UNION OF U.S., INC., et al., Appellants-Respondents, v. STATE of New York et al., Respondents-Appellants, and The Charitable Asset Foundation, Appellant, et al., Respondents.

Court of Appeals of New York.

June 20, 2005.

COPYRIGHT MATERIAL OMITTED

Law Office of Mark Scherzer, New York City (Mark Scherzer and A. Christopher Wieber of counsel), for appellants-respondents.

Eliot Spitzer, Attorney General, New York City (Robert H. Easton and Caitlin J. Halligan of counsel), for State of New York and others, respondents-appellants.

Weil, Gotshal & Manges LLP, New York City (Steven Alan Reiss, Janet L. Horn and Adam K. Grant of counsel), and Hinman Straub P.C., Albany (Bartley J. Costello, III and Kimberly C. Lawrence of counsel), for Empire HealthChoice, Inc., respondent-appellant.

Proskauer Rose LLP, New York City (Steven E. Obus and Edward S. Kornreich of counsel), for appellant.

OPINION OF THE COURT

READ, J.

The issue in these appeals is whether plaintiffs have stated a viable cause of action to challenge the legislation authorizing the conversion of defendant Empire HealthChoice, Inc., doing business as Empire Blue Cross and Blue Shield (Empire) from a not-for-profit to a for-profit corporation, and directing that certain of Empire's assets be used for various public health and charitable purposes. For the reasons that follow, we conclude that plaintiffs' allegations are legally insufficient to support any cognizable cause of action.

I. Empire's Origins and Evolution

Empire began as the Associated Hospital Service (AHS), a membership corporation¹ formed in 1934 to provide workers with affordable hospital care. AHS was an outgrowth of "the Depression and one especially disturbing consequence of it: voluntary hospitals stood on the edge of bankruptcy because they lacked the revenues to stay in business while (the cause of their problems) millions of citizens went without hospital and other needed care because they lacked the money to pay for it" (Brown, Capture and Culture: Organizational Identity in New York Blue Cross, 16 J Health Pol., Pol'y & L. 651, 653 [Winter 1991]).²

AHS's "key organizational task" when founded was to "build[] a financing linkage between people who needed care and hospitals that needed revenue" (id. at 655). AHS did this by offering prepaid "hospital service plans," which channeled revenue to the hospitals and made affordable hospital care available to workers. For a monthly fee, AHS contracted with subscribers for up to 21 days of hospital care a year. AHS "work[ed] closely with the hospitals, paying them directly instead of indemnifying patients whom the hospitals then billed. [AHS] was, and was intended to be, the hospitals' exchequer, their financial alter ego" (id.).

Hospital service plans were not unique to New York. As they spread throughout the nation, "[a] number of state departments of insurance had ruled that hospital service contracts, even if issued by one hospital, were a form of insurance and that hospital service policies could be issued only by stock and mutual insurance companies which met the established requirements as to capital stock, reserves, and assessments" (Rorem, Enabling Legislation for Non-Profit Hospital Service Plans, 6 L. & Contemp. Probs. 528, 529 [1939]). This issue "came to a head" in New York in 1933, when the Superintendent of Insurance "advised that such a function, although desirable, could be performed only by a stock or mutual insurance company. New York civic leaders, hospital administrators and trustees, and physicians cooperated in drafting and sponsoring an enabling act" (id. at 529-530; see L. 1934, ch. 595; see also Comment, Group Health Plans: Some Legal and Economic Aspects, 53 Yale L.J. 162, 173-174 [1943] [discussing legislation adopting statutory controls adapted to group health plans]). The result was article 14 of the Insurance Law. In 1939, the Legislature recodified the Insurance Law and replaced article 14 with article IX-C, which addressed nonprofit medical indemnity corporations as well as hospital service corporations (L. 1939, ch. 882). These corporations were exempt from state and local taxes and were subject to tailored requirements. Article 43 of the present-day Insurance Law, which governs non-profit health plans, derives from articles 14 and IX-C.

At the urging of its member hospitals, AHS became the intermediary for Medicare Part A in New York in 1965. In taking on this role, Empire became even more thoroughly enmeshed in the operation of its member hospitals by specifying accounting practices, cost definitions and cost allocations for Medicare.

In 1944, United Medical Service, Inc. (UMS), also a membership corporation, was formed to provide coverage for physician services. AHS and UMS merged in 1974 to form Blue Cross and Blue Shield of Greater New York, a Type B corporation under the Not-For-Profit Corporation Law. This entity merged with Blue Cross of Northeastern New York, Inc. in 1985 and became Empire Blue Cross and Blue Shield.

Empire initially offered only group plans, but later added individual coverage. It fixed premiums according to "community rating," in which all subscribers in a given locality are charged the same rate regardless of health risk, and allowed "open enrollment," accepting all applicants. For many years, commercial insurers did not routinely offer health coverage, which was not viewed as profitable, and so Empire had no competition. Further, the federal government encouraged plans like Empire by granting them tax-exempt status under section 501(c)(4) of the Internal Revenue Code ([IRC] 26 USC) as social welfare organizations.³

Empire experienced financial difficulties almost from its very beginnings because of the high costs of open enrollment and community rating. Further, commercial insurers slowly began entering the health insurance market. By using experience rating, with premiums based on claims experience, and avoiding open enrollment, commercial insurers were able to offer lower premiums to healthier groups and individuals. While Empire also used experience rating for some products, it continued its open-enrollment and community rating policies as the "insurer of last resort."

Because of Empire's critical role in New York's health care delivery system and its high costs and continuing financial troubles, the Legislature favored it over its commercial counterparts. For example, Empire was allowed to reimburse hospitals on the basis of actual costs, while commercial insurers were required to reimburse hospital charges. When the Legislature in 1983 enacted the New York Prospective Hospital Reimbursement Methodology (NYPHRM), a system for cost controls and rate-setting at hospitals, Empire was afforded an advantage over commercial insurers, which were required to pay a surcharge over and above the rate paid by Empire. Empire was exempt from "every state, county, municipal and school tax" (see Insurance Law § 4310[j]).

In the mid-1980's, Empire suffered a severe blow when the United States General Accounting Office issued a report concluding that the underwriting practices of Empire and other Blue Cross plans were similar to those of commercial insurers. Congress responded by revoking the Blues' tax exemption.⁴

In the early 1990's, Empire was beset with management problems, high administrative expenses and fraud, all causing significant financial losses. The growth of health maintenance organizations (HMOs) in the 1990's further eroded Empire's subscriber base as healthier groups and individuals switched to more economical managed care plans.

By 1992, Empire's future looked bleak. Upon applying to the Superintendent for significant rate increases, Empire suggested that without them its cash reserves would be exhausted in a matter of months. In January 1993, the Legislature averted this crisis with a $100 million cash infusion (L. 1993, ch. 1).⁵ These funds were supposed to shore up Empire until a series of laws took effect, which were crafted to make Empire more competitive by eliminating the major distinctions between it and commercial insurers. For example, the Legislature required health maintenance organizations and commercial insurers in the small group market to use community rating (L. 1992, ch. 501); a "risk adjustment" process was enacted, which essentially required insurers and HMOs to compensate other providers who offered coverage to higher-risk populations (id.); and the Legislature mandated that HMOs offer policies to individuals on an open-enrollment/community rated basis (L. 1995, ch. 504). These statutes relieved Empire of its unique role as New York's "insurer of last resort." Accordingly, the Legislature soon removed the favorable rate differential that Empire had enjoyed under NYPHRM (L. 1996, ch. 639).

Empire's Original Restructuring Plan

Notwithstanding state subsidies and other favorable legislative action, Empire lost roughly $800 million and half its subscriber base in the 10-year period from 1986 to 1995. In light of its deteriorating prospects, Empire decided to restructure.

Under Empire's original restructuring plan, substantially all its assets, liabilities and businesses were to be transferred to wholly owned for-profit subsidiaries in exchange for 100% of the subsidiaries' outstanding and newly issued common stock. This transfer was to be followed by an initial public offering in which a portion of the stock would be sold to the public. Proceeds from the offering and all outstanding stock, approximating 100% of the value of the not-for-profit's assets, would then be transferred from "old" Empire to a newly formed tax-exempt charitable foundation "dedicated to promoting the availability and accessibility of high quality healthcare and related services to the people of the State of New York." "Old" Empire would dissolve and "new" Empire would continue to offer health insurance, but as a...