All text from: Congressional Research Service (CRS). “Tax Expenditures: Compendium of Background Materials on Individual Provisions.” December 2008. GPO: Washington DC.

Description

BlueCross and BlueShield and a number of smaller health insurance providers that existed on August 16, 1986, and other nonprofit health insurers that meet certain community-service standards receive special tax treatment. First, eligible health insurers are treated in the tax law as stock property and casualty insurance companies. Eligible organizations, however, can fully deduct unearned premiums, unlike other property and casualty insurance companies. Second, eligible companies may take a special deduction of 25 percent of the year’s health-related claims and expenses minus its accumulated surplus at the beginning of the year (if such claims and expenses exceed the accumulated surplus). For example, if an eligible health insurer had claims and related expenses of $150 million and an accumulated surplus of $110 million during a tax year, it could take a special deduction of $10 million (i.e., 25 percent of the difference between $150 million and $110 million). The special deduction is also known as the “three-month” deduction because when an eligible insurer’s health-related claims and expenses exceed its accumulated surplus, it may deduct a quarter of the difference for the year.

The special deduction only applies to net taxable income for the year and cannot be used in alternative minimum tax calculations. Therefore, net income for eligible organizations is subject to a minimum tax rate of 20 percent.

Impact

BlueCross BlueShield organizations traditionally provided community- rated health insurance. The special deduction for BlueCross BlueShield plans may help offset costs of providing high-risk and small-group coverage. The BlueCross BlueShield organizations are not owned by investors, so the special deduction could also benefit either their subscribers or all health insurance purchasers (through reduced premiums), their managers and employees (through increased compensation), or affiliated hospitals and physicians (through increased fees).

Rationale

The “Blues” had been ruled tax-exempt by Internal Revenue regulations since their inception in the 1930s, apparently because they were regarded as community service organizations. The Tax Reform Act of 1986 removed BlueCross BlueShield plans’ tax exemption because Congress believed that “exempt charitable and social welfare organizations that engage in insurance activities are engaged in an activity whose nature and scope is inherently commercial rather than charitable,” and that “the tax-exempt status of organizations engaged in insurance activities provided an unfair competitive advantage.” The 1986 Act, however, introduced the special deduction described above, in part because of their continuing, albeit more limited, role in providing community-rated health insurance. In particular, Section 833(c)2(c) links the special deduction for BlueCross BlueShield plans to the provision of high-risk and small-group coverage.

Assessment

Differences in price and coverage between the health insurance products offered by BlueCross and BlueShield plans and those offered by commercial insurers, in the view of Congress, have faded over time. Some of the plans have accumulated enough surplus to purchase unrelated businesses. Many receive a substantial part of their income from administering Medicare or self-insurance plans of other companies. Some have argued that these tax preferences have benefitted their managers and their affiliated hospitals and physicians more than their communities.

BlueCross and BlueShield organizations, however, retain a commitment to offer high-risk and small-group insurance coverage in their charters. Some continue to offer policies with premiums based on community payout experience (“community rated”). The tax exemption previously granted to the “Blues,” as well as the current special deduction, presumably have helped support these community-oriented activities.

Selected Bibliography

• Embry-Thompson, Leah D. and Robert K. Kolbe. “Federal Tax Exemption of Prepaid Health Care Plans after IRC 501(m).” Exempt Organizations 1992 Continuing Professional Education Text. Available at [www.irs.gov/pub/irs-tege/eotopicl92.pdf].
• Ernst & Young, Federal Income Taxation of Property and Casualty Insurance Companies, Hoboken, New Jersey: John Wiley and Sons, 1996.
• Law, Sylvia A. Blue Cross: What Went Wrong? New Haven: Yale University Press, 1974.
• McGovern, James J. “Federal Tax Exemption of Prepaid Health Care Plans.” The Tax Adviser 7 (February 1976), pp. 76-81.
• McNurty, Walter. “Big Questions for the Blues: Where to from Here?” Inquiry 33 (Summer 1996), pp. 110-117.
• Shill, Otto, “Revocation of Blue Cross and Blue Shield’s Tax-Exempt Status: An Unhealthy Change?” Boston University Journal of Tax Law, vol. 6, pp. 147-176.
• Starr, Paul. The Social Transformation of American Medicine. New York: Basic Books, 1983, pp.290-310.
• Taylor, Jack. Blue Cross/Blue Shield and Tax Reform. Library of Congress, Congressional Research Service Report 86-651 E. Washington, DC: April 9, 1986.
• — . Income Tax Treatment of Health Care Insurers. Library of Congress, Congressional Research Service Report 94-772 E. Washington, DC: October 5, 1994.
• U.S. Congress, Joint Committee on Taxation. “Tax Exempt Organizations Engaged in Insurance Activities.” In General Explanation of the Tax Reform Act of 1986. Joint Committee Print, 100th Congress, 1st session. Washington, DC: Government Printing Office, May 4, 1987, pp. 583-592.
• — . Description and Analysis of Title VII of H.R. 3600, S. 1757, and S. 1775 (“Health Security Act”), Joint Committee Print, 103rd Congress, 1st session. Washington, DC: Government Printing Office, December 20, 1993, pp. 82-96.
• U.S. General Accounting Office, Health Insurance: Comparing Blue Cross and Blue Shield Plans With Commercial Insurers, HRD-86-110, July 11, 1986 , available at [http://archive.gao.gov/d4t4/130462.pdf].
• U.S. Internal Revenue Service, “Conversion of Nonprofit Organizations, coordinated issue paper LMSB-04-0408-024, June 4, 2008, available at [http://www.irs.gov/businesses/article/0,,id=183646,00.html].
• Wasley, Terree P. “Health Care in the Twentieth Century: A History of Government Interference and Protection.” Business Economics 28 (April 1993), pp. 11-17.
• Weiner, Janet Ochs. “The Rebirth of the Blues.” Medicine and Health Supplement (February 18, 1991).

Source: Congressional Research Service, Tax Expenditures: Compendium of Background Materials on Individual Provisions, December 2008, Washington, DC: U.S. Government Printing Office.