How Did So Many Nonprofit Hospitals Become So Profitable?

In June the Private Equity Stakeholders Project (PESP) released a new report documenting more than 500 joint ventures between private equity firms and U.S. nonprofit hospitals. A growing volume of research demonstrates that private equity ownership leads to higher costs, lower quality, lost services, and in some case closed facilities. Private equity exists to provide maximum financial returns to shareholders and owners, competing directly with medical care’s primary mission of service to patients. The new PESP report re-opens the question: Why are nonprofit medical care institutions doing this?

Another recent report from the journal Health Affairs documents how nonprofit hospitals have become “increasingly active participants in financial markets,” holding nearly $300 billion among 2,366 institutions in investment securities in 2023, a 56.6 percent increase since 2010. “Our analysis suggests that nonprofit hospitals are not merely passive participants in this transformation but are themselves financial actors, allocating substantial resources to complex investment instruments and increasingly resembling institutional investors.”

A 2021 Trilliant Health analysis found that 40 nonprofit hospital and health systems would have qualified for the Fortune 500 list had they been for profit. Appelbaum and Batt pose a key question: “…whether these hospitals engage in for-profit activities mainly to supplement their operating income and shore up their finances or whether they have become essentially financial services enterprises with a nonprofit hospital attached to protect their tax status.”

In my new book, America’s Wrong Turn: US Healthcare in the Neoliberal Era, I review the history, growth and spread of free market values and practices across U.S. medical care, especially during the neoliberal (aka free market fundamentalist) era between 1980-2020. I include nonprofit health and hospitals in that trend. One clear fact I identified is that federal policies aided and abetted the explosive growth of market forces inside our health systems that also transformed nonprofit medical care.

What were these policy changes? Here are the more significant ones in loose chronological order:

• Community Benefits: Before 1969, the Internal Revenue Service (IRS) required nonprofit hospitals to provide free or below-cost “charity care” to medically indigent persons to keep their 501(c)(3) charitable status. Following Medicare and Medicaid’s creation in 1965, the IRS issued Revenue Rule 69-545 replacing charity care with a broader, amorphous “community benefit” standard permitting hospitals to use their resources to attract commercially insured patients under the rubric “health promotion.”
• Tax Exempt Municipal Bond Financing & Leasebacks: In the 1970s, new federal and state policies allowed the use of tax-exempt municipal bonds to finance hospital capital projects, allowing nonprofit hospitals, for the first time, to retain facility ownership after debt retirement. To gain low-interest bond ratings, hospitals had to maintain corporate-style balance sheets, high profit margins, and more corporatized boards.
• Retention of Intellectual Property Rights and Commercial Patents: The 1980 Bayh-Dole Act permitted universities, academic medical centers, and non-profit research institutes to own the patents for new drugs and medical devices that they developed using National Institutes of Health (NIH) and other federal research funds. Research entities established technology transfer offices to patent new discoveries and license them to pharmaceutical and other firms while taking equity stakes in the commercial startups. Bayh-Dole transformed medical research from a pure public good into a lucrative corporate revenue stream, triggering explosive innovation and growth.
• Profit Making Commercial Ventures: Two major IRS rulings, in 1981 and in 1998, changed the landscape by which nonprofit hospitals could engage commercially. In 1981, the IRS ruled (PLR 8134021) that nonprofit hospitals could create new taxable for-profit subsidiaries that would not jeopardize their tax-exempt status, triggering a nationwide restructuring wave. A 1998 ruling, (Redlands Surgical Services & Rev. Rul. 98-15), opened the door for “whole hospital” joint ventures between nonprofit hospitals and for-profit companies. 
• 340B Drug Pricing Program: Created in 1992 under the Public Health Service Act, Section 340B requires drug makers to sell outpatient drugs at heavily discounted prices to covered entities, mostly public and nonprofit safety net hospitals and health centers. It neglected to require that savings be passed onto consumers or their insurance plans. Once high-cost specialty drugs entered the market, nonprofit hospitals made outpatient drug administration among their most profitable business lines. The 2010 Affordable Care Act broadly expanded the population of hospital providers eligible for 340B discounts. 
• “Efficiencies” Defense to Block Non-profit Anti-Trust: In 1996, the Federal Trade Commission and the Department of Justice rewrote their anti-trust guidelines to assert that nonprofit hospitals could never use monopoly power to raise prices because they lacked shareholders. This novel and naïve interpretation greenlit the modern era of health system mega-mergers evident today among the 40 non-profit systems whose revenues put them into the Fortune 500 class.
• “Provider-Based” Outpatient Billing: The 1997 Balanced Budget Act codified a new, lucrative mechanism called “provider-based status” so that a hospital acquiring a standalone physician practice or clinic can redesignate it as an “outpatient department of the hospital.” The hospital then can charge two bills for the same visit, a standard physician fee plus a “facility fee.” This launched a wholesale buying spree of independent primary care and specialist physician practices

These seven federal policies provided flexibilities and revenues to nonprofit hospitals creating the financial foundation we recognize today. These policy shifts altered the culture of nonprofit healthcare. By loosening charity care mandates, granting access to Wall Street tax-exempt debt markets, permitting for-profit corporate subsidiaries, incentivizing patent commercialization, and more, federal policy created incentives for nonprofit hospitals to prioritize market share, capital accumulation, and corporate financialization.

Many of these policies provided stability to enable hospitals to meet essential responsibilities. They also set the framework for today’s rich nation/poor nation world of nonprofit hospitals. In particular, academic medical centers taking advantage of Bayh-Dole patents became the corps of elite mega-providers while community hospitals struggle to survive. 

In the early 1980s, the Institute of Medicine commissioned a study of “For-Profit Enterprise in Health Care” that also explored nonprofit care in the new environment. We need a reassessment of our health care system’s structural elements, including our nonprofit systems.