Non-Profit Self Dealing at the Core of Health Care Inflation?

05/02/2010 05:12 am ET | Updated May 25, 2011

The New York Times published a cautionary article in March of 2008, "Report Sketches Crime Costing Billions: Theft From Charities." Charities are nearly exclusively operated as some form non-profit organization. The articles suggests that something like 13% of all charitable donations are stolen through fraudulent activities by functionaries of the organization. In the case of charities, out of the $665 billion in donations in 2006, $40 billion was appropriated for personal gain. The article goes on to point out that, 6% loss to fraud is more or less likely in both government and private companies.

Apply this generalization to the health care industry and one might come up with 13% of the $2.7 trillion we spend on health care, or $360 billion, lost to low level fraud. That's fairly consistent with the $47 billion estimated to be lost in the $440 billion Medicare system to fraud, detailed in the Washington Post. With the legal but unnecessary procedures, duplicate procedures, defensive medicine and the illegal outright fraud already costing 30% of your total health care tab, it is easy to see how a more tightly controlled health care system might cut costs by a third, comparable then to costs for countries with socialized medicine.

In examining the cost inflation of health care, a base rate of 30% corruption is horrible, but does not account for the extraordinary inflation of total cost. Low level corruption is layered on top of rising costs and therefore can't be the primary cause of cost inflation. If your health care tab went up 10%, then corruption by low level crime would carve off 30% of that, but would not be causal for the increase unless the rate of corruption itself increased. Given the astonishing levels of corruption, it is not hard to imagine it increasing, but not at a rate the of 25% more fraud per year, the amount of growth in fraud it would take to equal observed rate increases. Eliminating waste and fraud would be a one shot savings of enormous impact, but still, one shot.

Technology, facility expansion, mergers and acquisitions and billing complexity are widely accepted as what drives medical inflation, much more so than our, now historic, low background inflation for direct labor. Nursing wages have not increased despite shortages. Doctors have experienced 25% wage deflation over the last decade. Malpractice suits are a stable baseline, so like fraud, can't be viewed as a cost driver. The GOP claims that malpractice "reform" might subdue the practice of defensive medicine, but results in states that have adopted "tort reform" show that defensive medicine is an excuse not a reality. Private health insurance layers about 30% overhead onto the cost of the segment of health care it pays for, about 36% of the total of all care spending. It too is not a driver of increases, but layers on its 30% on top of increases sourced elsewhere.

Billing practices growth can be controlled by rationalizing disparate systems in theory. In practice it is one of those software projects that never gets done because of the size and scope of it, and competing interests in how it is done. But the current plate of account and billing spaghetti we have is probably near maxed out in complexity and size anyway, close to collapse already, so it may not be a source of much medical inflation going forward.

Mergers and acquisitions have boomed in the last decade and a half. Attorneys General of some states have studied the effects on regional health care markets and have determined the consistent outcome of M&A activity is higher prices. It is speculated that the unstated goal of most M&As is to form a monopoly in a regional market in order to extort higher remuneration rates from health insurers by limiting competition and access to a local market. Add to this price pressure the costs of M&A, LBOs and you get a significant impact on costs. The FTC has studied the impact of M&A activity in healthcare but has taken no comprehensive action. The question of why higher prices need be exacted by non profit hospitals in the same market with the same equipment and facilities is puzzling. There is much more smoke here than can be caused by the fires we know about.

To illustrate the scope of the money involved, nationally, hospitals bill for direct services and bill through from other sources some $1.8 trillion of the $2.7 trillion we spend on health care, or 66%. The remainder goes to non hospital care and pharmaceuticals. 70% of hospitals are private non profits, the remainder are for profit or government operated.

There is a rule of thumb in the medical facilities building field. You can build a hospital for $1 million a bed. With nurse/patient ratios running about 4 patients to 1 nurse, the cost of nursing is about $500 of per bed operating cost per day. Other direct costs, hospital food and laundry, janitorial, malpractice insurance, etc., might equal nursing cost when summed up. With current charges for a hospital bed running about, $5000 a day, averaging sources estimating from $2000 to $8000 a day, a hospital bed can be amortized in about 250 days of occupancy.

Bearing in mind that no hospital acheives 100% occupancy 100% of the time, it still begs the question of to what ends are the $1000 to $7000 of profit from a hospital bed, per day, is put after its construction cost has been covered? Or, if a hospital administration is so inept as to overbuild capacity so much that it is never untilized, whether that hospital should undertake to overcharge in covering that ineptitude? I don't know. You don't know. The Federal government or state governments may know, but they are not talking. All that is possible for the public is to guess.

The Revised Model Non Profit Corporation Act (RMNCA), a product of the American Bar Association, is a guideline for states in their jurisdiction over non profit corporations. Most have adopted these RMNCA guidelines. In Deborah A. DeMott, Duke Law School "Self-Dealing Transactions in Nonprofit Corporations", we find a clue as to what may be a strong contributor to escalating costs in non profit health care corporations. DeMott references section 8.31of the RMNCA as declaring that "a majority of disinterested directors may approve in advance a fellow director's proposed self dealing if the material facts of the transaction and the director's interest are disclosed or known to the disinterested contrast with many business corporation statutes, the approval immunizes the self dealing director from any individual liability arising from the transactions."

What is self dealing? Self dealing is directing business of the corporation to entities in which the director or board member may have interest. A practice that is substantially illegal in government is perfectly legal in a non profit. Directors may throw business to cronies and relatives at the discretion of the board, creating a moral hazard of the first order.

When non profits share directors, members of their boards, or if these directors have interests in common with other corporations, then the classic means of defrauding the public, the Trust, is enabled. The term Anti-Trust is derived from the practice of boards of corporate directors exercising their prerogatives of decision making in the interest of others in the "trust" that members of other corporate boards would act in collusion to advance mutual interests. Non profits have been given the gift of immunizing themselves from any sort of anti-trust violation by simply agreeing to the anti-trust violation.

Capital expenditures and consulting are particularly ripe for exploitation by a board of directors in collusion. Facilities building and technology are likely aggravated as sources of medical inflation because of self dealing. Both physical assets and consulting may be used to absorb and launder cash flows of enormous size, legally. Anticipation of a large increase in capacity for aging baby boomers seems to be the rationale of choice for squandering money. Is each facility anticipating capturing 100% of the boomer bubble in a local market? Who knows?

Couple mergers and acquisitions and non profit self dealing immunities and you get a probable source of demanding and then sinking the $4000 a day profits on a hospital bed. After all, a non profit charter is to show no profit, so all revenues must be spent. The driver of healthcare inflation must be in the observable growth of revenues of non profits and for profits. Because of collaborative immunity, it is feasible that revenue growth is undertaken in order to feed self dealing of those funds to collaborators. Self dealing may be as simple as equipment or facilities acquisitions that are gratuitous. Don't need the latest and greatest diagnostic tool? What the heck, buy it anyway. The money has to be spent. The combination of regional monopolies and self dealing fraud immunization loopholes is a deadly mix for the public, and there are plenty of investigations to indicate it. Just a few examples are: The Tarzana Treatment Center , and Social Vocational Services , Matt Kapp of Vanity Fair, or for the board perspective, a publication by the Forum of Regional Associations of Grantmakers.

Why the private health care system is a disaster is that systemic corruption is enabled in it by perverse incentives and defective law.