Could Maryland's Blue Cross Blue Shield legally sell part of its for-profit HMO and managed-care subsidiaries to outside investors?

Plain-English summary

Maryland's Insurance Commissioner asked the Attorney General about a corporate restructuring by Blue Cross and Blue Shield of Maryland, a nonprofit health service plan regulated under a special subtitle of the Insurance Code. Blue Cross wanted to create "Newco," a new for-profit holding company to own its managed care subsidiaries (including HMOs and a mental health utilization review company, Greenspring), and then sell a minority stake in Newco, perhaps 20 percent, to outside investors. A similar sale had already happened with a 20 percent stake in Greenspring itself, sold to another regional Blue Cross plan. The Commissioner wanted to know whether creating Newco was legal, and whether he could approve selling a piece of it to private investors.

The Attorney General split the answer. Creating Newco itself was fine: if Blue Cross could lawfully own and operate for-profit subsidiaries (which prior AG advice letters going back to 1978 had already established, subject to a "reasonably incidental to its nonprofit purpose" test), it could also choose how to structure and govern them, including through a holding company. Selling a piece of that holding company to outsiders was a different matter. Once outside investors owned a minority stake, Blue Cross as majority shareholder would owe conflicting duties, to run the nonprofit plan solely for subscribers' benefit while also fairly treating minority investors in the for-profit subsidiary. The opinion concluded the Insurance Commissioner could not approve such a sale unless satisfied that this conflict of interest had been adequately addressed, either because the risk was acceptably low or because the sale terms locked in protections for Blue Cross subscribers in advance.

Currency note

This opinion was issued in 1992. Subsequent statutory amendments, court decisions, or later AG opinions may have changed the analysis. Treat this page as historical context, not current legal advice. Verify current law before relying on any specific rule, deadline, or remedy mentioned here.

Common questions

Could Blue Cross legally create a for-profit holding company to own its HMO and managed-care subsidiaries?
Yes. The opinion concluded there was no legal bar to creating Newco, since Blue Cross already had authority to operate for-profit subsidiaries reasonably incidental to its nonprofit purpose, and a business that may lawfully operate subsidiaries may also choose how to structure and govern them, including through a holding company.

Could Maryland's Insurance Commissioner approve selling a minority stake in that holding company to outside investors?
Not automatically. The opinion concluded the Commissioner could not approve such a sale unless satisfied that Blue Cross's duties as majority shareholder to the minority investors would remain compatible with its separate statutory duty to run the nonprofit plan for the benefit of its subscribers.

Why did selling a minority stake create a legal problem that keeping full ownership did not?
Because once outside investors held shares, Blue Cross as majority shareholder would owe them a duty not to abuse its control to their detriment, while still owing subscribers a duty to run the nonprofit health plan solely for their benefit. The opinion identified situations, like pursuing a business opportunity, where those two duties could point in different directions.

Could Blue Cross's sale terms be structured in advance to avoid this conflict problem?
Yes, potentially. The opinion suggested the Commissioner's approval could be conditioned on the sale terms making clear, upfront, that in areas of potential conflict Newco would continue to be run to benefit Blue Cross and its subscribers as a whole, so that outside investors would know the ground rules before buying in.

Background and statutory framework

Blue Cross and Blue Shield of Maryland operated as a "nonprofit health service plan" under Subtitle 20 of Article 48A of the Maryland Insurance Code, a status that came with regulatory and tax benefits in exchange for statutory limits on what Blue Cross could do. Since 1978, the Attorney General's office had built up a body of informal advice letters establishing that Blue Cross could operate for-profit subsidiary businesses (including the HMOs and managed-care companies at issue here) so long as those businesses were "reasonably incidental" to its nonprofit health plan purpose, could not become so large that Blue Cross's core purpose was no longer really "operating a nonprofit health service plan," and could not exist merely to generate profit with no connection to the subscriber plan.

Applying those settled principles, the opinion found the creation of Newco, a holding company structure for managed care subsidiaries Blue Cross already lawfully owned, raised no new legal problem, since choosing a corporate structure to govern subsidiaries one may already own is a matter of ordinary business judgment. The opinion also noted a practical financial angle: Blue Cross was required to maintain a "surplus reserve" under §355(b)(4) and (6), and a genuine arm's length sale of part of a subsidiary might help Blue Cross establish a value for its remaining interest that could count toward that reserve. The harder question was the sale of a minority interest to outside investors. Drawing on general corporate law principles that a majority shareholder owes a duty not to abuse its control to the detriment of minority shareholders, the opinion concluded that once Blue Cross had outside minority investors in Newco, it would face a structural tension between that duty and its separate statutory duty to run the underlying nonprofit plan solely for subscribers' benefit. Rather than declaring the sale categorically lawful or unlawful, the opinion left the Commissioner with a fact-specific approval standard: approve only if satisfied the conflict-of-interest risk to subscribers had been adequately addressed, whether by the low likelihood of actual conflict or by contractual terms locking in Blue Cross's priority in disputed situations.

Citations and references

Statutes:

• Subtitle 20 of Article 48A, governing Blue Cross as a nonprofit health service plan
• §354(a), defining a nonprofit health service plan corporation
• §355(b)(4) and (6), the Blue Cross surplus reserve requirement
• §359, governing permitted investments in unrelated business entities
• §19-702(a)(3)(i) of the Health-General Article, authorizing Blue Cross to operate HMOs

Cases:

• Woodyard v. Arkansas Diversified Ins. Co., 594 S.W.2d 13 (Ark. 1980), Arkansas Supreme Court
• Blue Cross of Southwestern Va. v. Commonwealth of Va., 338 S.E.2d 849 (Va. 1986), Virginia Supreme Court
• Twenty-Seven Trust v. Realty Growth Investors and RGI Holding Co., 533 F. Supp. 1028, 1039 (D. Md. 1982), federal district court
• Cooperative Milk Service v. Hepner, 198 Md. 104, 114, 81 A.2d 219 (1951), Maryland Court of Appeals
• Clagett v. Hutchison, 583 F.2d 1259, 1265 (4th Cir. 1978), federal appeals court

Source

• Landing page: https://oag.maryland.gov/resources-info/Pages/attorney-general%E2%80%99s-opinions.aspx
• Original PDF: https://oag.maryland.gov/resources-info/Documents/pdfs/Opinions/1992/Volume77_1992.pdf (this opinion appears at printed page 120 of the bound annual volume; Maryland's site does not publish a standalone PDF of this opinion)

Original opinion text

Best-effort transcription from a scanned PDF. Minor errors may remain — the linked PDF is authoritative.

INSURANCE

Health - Authority of Insurance Commissioner Over
Proposed Sale By Blue Cross and Blue Shield of
Maryland of a Minority Interest in a For-Profit
Subsidiary

                        October 15, 1992

Mr. John A. Donaho
Insurance Commissioner

   You have requested our opinion on certain issues related to the sale

by Blue Cross and Blue Shield of Maryland, Inc. ("Blue Cross") of an
interest in certain for-profit subsidiaries. Specifically, you ask:

   1. May Blue Cross create a new subsidiary corporation ("Newco")

to operate Blue Cross's managed care subsidiaries, with the intent of
selling a minority interest in Newco in an arms-length transaction?

  2. May the Insurance Commissioner approve the contemplated sale

of a portion of Newco, perhaps 20 percent, or the already consummated
sale of a 20 percent interest in Greenspring Mental Health Services, Inc.
and Greenspring Health Services, Inc. ("Greenspring"), for-profit
corporations providing utilization review and managed care of mental
health care services?

  For the reasons stated below, we conclude as follows:

  1. Blue Cross may create a new for-profit subsidiary, Newco, as a

holding company for the managed care subsidiaries that Blue Cross
currently owns.

  2. The Insurance Commissioner may not approve the sale of a

minority interest in Newco or Greenspring to private investors unless the
Commissioner is satisfied that the duties imposed upon Blue Cross as
majority shareholder would be compatible with its statutory duties to its
health service plan subscribers.

                                     I

         Operation of For-Profit Subsidiaries By Blue Cross

   Blue Cross is a "nonprofit health service plan" regulated under

Subtitle 20 of Article 48A of the Maryland Code.1 That is, Blue Cross is
a "corporation without capital stock ... organized for the purpose of
establishing, maintaining and operating a nonprofit health service plan
whereby" certain health care services are provided to subscribers to the
plan. §354(a). In exchange for certain regulatory and tax benefits granted
to a Subtitle 20 corporation, Blue Cross must accept the limitations that
are imposed by the statute on a Subtitle 20 corporation.

   Many of these limitations are by no means self-evident from the

statutory text. Since 1978, the Attorney General's office has attempted to
discern criteria that give meaning to the legislative objectives underlying
Subtitle 20 and to apply them to an ever-changing array of subsidiary
endeavors by Blue Cross.

  We regard certain broad principles as settled, at least as far as the

Attorney General's Office is concerned.

   1. Blue Cross may not engage in an insurance or other activity that

is unrelated to the statutorily limited purpose of a Subtitle 20 corporation.
63 Opinions of the Attorney General 415 (1978). See Woodyard v.
Arkansas Diversified Ins. Co., 594 S.W.2d 13 (Ark. 1980); Blue Cross of
Southwestern Va. v. Commonwealth of Va., 338 S.E.2d 849 (Va. 1986).
A business endeavor by Blue Cross is permissible only if it is "reasonably
incidental" to one of the following:

              (i) Establishing, maintaining and operating an
          insurance product or plan which provides for coverage
          of medical expenses of subscribers in which [Blue
          Cross] assumes the risk of loss;

               (ii) The administration of a benefit plan through
          which an employer, government agency, or comparable
          entity provides, at its own risk of loss, for the coverage
          of medical expenses of employees or plan beneficiaries;
          or

           (iii) Other endeavors expressly authorized in, or
       regulated by, Subtitle 20, e.g. the operation of health
       maintenance organizations.2

Letter from Assistant Attorney General Francis X. Pugh to Deputy
Insurance Commissioner Martha C. Roach, at 4 (September 16, 1988)
("1988 Advice Letter").

  2. Blue Cross may invest in a business entity unrelated to its

purpose as a nonprofit health service plan, so long as the investment is
permitted by §359 and Blue Cross does not control or operate the
unrelated entity. 63 Opinions of the Attorney General at 419; letter from
Assistant Attorney General Francis X. Pugh to Insurance Commissioner
John A. Donaho (July 7, 1989).

   3. Blue Cross may "engage in profit-making activities that are

within the scope of its operations as a nonprofit subscription health
services plan." Letter from Assistant Attorneys General Francis X. Pugh
and Robert deV. Frierson to Insurance Commissioner Edward J. Muhl at
12 (January 2, 1987) ("1987 Advice Letter").

    4. Blue Cross "may engage in corporate activities (profit and

nonprofit) through subsidiaries that are reasonably incidental to its
corporate purpose under Subtitle 20." 1987 Advice Letter at 13.
Conversely, Blue Cross may not engage in an activity "without any
attendant connection to the subscriber plan other than generation of profits
for the effective administration of the ... plan ..." Id. at 15. See also letter
from Assistant Attorney General Francis X. Pugh to Insurance
Commissioner Edward J. Muhl at 4 (May 28, 1987). "[A]ny financing
activities by [Blue Cross] and any other Subtitle 20 licensee must also meet
the 'reasonably incidental' test. Clearly, a Subtitle 20 corporation may not
engage in financing activities more broadly as if it were a bank or other
financing institution." 1988 Advice Letter at 4 n. 7.

   5. If a subsidiary activity is otherwise permissible and is operated to

make a profit, the profitmaking endeavor may not "become so substantial
that the Commissioner could determine that [Blue Cross's] purpose may
no longer characterized as ... 'operating a nonprofit health service plan
....'" 1987 Advice Letter at 13.

                                     II

                          Creation of Newco

   Blue Cross currently owns and operates through subsidiaries certain

"managed care" operations. These subsidiaries are: a health maintenance
organization, Columbia Medical Plan; two other health maintenance
organizations, FreeState and CareFirst, operated under single management;
and a managed care company specializing in mental health care services
and utilization review, Greenspring. All of these subsidiaries are operated
to make profits. We assume, having heard no suggestion to the contrary,
that the current operation of these subsidiaries is fully in accord with the
limiting principles outlined in Part I of this opinion.

  The questions that you raise are prompted by two events: the sale

of a 20 percent interest in Greenspring to a different Blue Cross plan,
operating in Western Pennsylvania; and a proposal by Blue Cross to create
a new subsidiary, Newco, that would operate the managed care
subsidiaries and attempt to sell a minority stake to outside investors. As
we understand it, Newco's directors would come from the ranks of Blue
Cross' directors, and Newco's officers would be the people holding
counterpart offices in Blue Cross. So, for example, the chief executive
officer of Blue Cross would become the CEO of Newco.

  In our view, there is no legal bar to your approval of the creation of

Newco. As a general proposition, if Blue Cross may lawfully operate
subsidiaries, it may also determine the corporate structure, including the
formation of a holding company, that most effectively permits governance
and operation of the subsidiaries. See 1987 Advice Letter at 14 n.15.3

   This conclusion does not mark any retreat from the principles

outlined in Part 1 of this opinion. The Insurance Commissioner continues
to have the authority to define the limits of the profit-making aspect of the
Blue Cross corporate structure:

        Conceptually, the profit-making activities of [Blue
        Cross] could become so substantial that the
        Commissioner could determine that its purpose may no
      longer be characterized as "establishing, maintaining
      and operating a nonprofit health service plan ..." §354
      in Subtitle 20. The determination of when this line is
      crossed so that [Blue Cross's] purpose is altered rests
      within the sound discretion of the Commissioner upon
      a proper evidentiary record.

1987 Advice Letter at 13. Our point in this context is a simple one: If the
activities to be encompassed by Newco collectively do not run afoul of this
"substantiality" test - and we assume that they do not - then the creation
of Newco itself does not alter the balance.

                                  III

                        Sale of Subsidiaries

  Furthermore, in our view, the sale by Blue Cross of an interest in a

for-profit subsidiary is not inherently unlawful. Rather, the Insurance
Commissioner has the discretion to approve or disapprove the proposed
transaction by assessing its nature and consequences.

   If Blue Cross successfully operates a for-profit subsidiary, it will

generate a future stream of profits. It basically has three choices about the
use of those future profits. It can continue to own the subsidiary entirely
and thereby retain fully both the future prospect of gain (and, of course,
the risk of loss); it can borrow against the value of the subsidiary, a part of
which would reflect an expectation about future profits; or it can extract
all or part of the present value of the anticipated stream of profits by the
sale of all or part of the subsidiary.

   In the abstract, Subtitle 20 does not force Blue Cross to exclude any

of these options from the exercise of its business judgment. The statute,
for example, does not bar Blue Cross from selling all of its interest in a for-
profit subsidiary or from selling enough of its interest so as to become an
investor in the business instead of its operator (assuming that such an
investment is legally permissible). Running a competitive business, even
a regulated one, often involves decisions of this kind.

    The sale of a minority interest in a subsidiary entails special

problems, as we shall explain. But from Blue Cross' perspective, it might
also yield a significant benefit beyond the money derived from the sale
itself. Blue Cross is required to maintain what we have termed a "surplus
reserve," which the Insurance Commissioner may require to be up to two
months' worth of the prior calendar year's claims and operating expenses.
See §355(b)(4) and (6). See generally letter from Attorney General J.
Joseph Curran, Jr. to Delegate Casper R. Taylor, Jr., (July 24, 1992). As
we understand the situation, a bona fide sale in an arm's length transaction
of a portion of a subsidiary might enable Blue Cross to assign a value to its
remaining interest in the subsidiary that could be recognized as part of its
surplus reserve. In this respect, you would act within your authority as
Insurance Commissioner to view such a sale as intended to achieve a
purpose consistent with the obligations of Blue Cross under Subtitle 20.4

   At the same time, Blue Cross' sale of a minority interest raises

unique issues about compliance with the purposes of Subtitle 20. As the
majority shareholder in Newco, Blue Cross will have a "duty not to abuse
its power of control to the minority's detriment." Twenty-Seven Trust v.
Realty Growth Investors and RGI Holding Co., 533 F. Supp. 1028, 1039
(D. Md. 1982). From the time of sale, Blue Cross will have a divided, and
potentially conflicting, duty: to operate a nonprofit health service plan
solely for the benefit of subscribers, while managing the for-profit
subsidiary with proper regard for the interests of the outside investors. In
general, majority shareholders may not "use their voting power for their
own benefit, for some ulterior purpose adverse to the interests of the
corporation and its stockholders as such ..." Cooperative Milk Service v.
Hepner, 198 Md. 104, 114, 81 A.2d 219 (1951). See also, e.g., Clagett
v. Hutchison, 583 F.2d 1259, 1265 (4th Cir. 1978). One can anticipate
situations - the pursuit of a business opportunity, for example - in which
the interest of Blue Cross and its subscribers might be adverse to the
interest of Newco and its minority stockholders.

   We do not know enough about the consequences either of the

already consummated sale of 20 percent of Greenspring or the proposed
sale of a portion of Newco to advise whether these transactions pose so
significant a risk of conflict as to warrant disapproval. Our conclusion,
however, is that you may not approve the transactions if you reasonably
judge this risk to be unacceptable. Alternatively, your approval of the
Newco transaction could be conditioned on resolution of key conflict
problems in advance. That is, the terms of the sale could make clear that
in areas of potential conflict, Newco will continue to be run to benefit Blue
Cross as a whole. If outside investors are told in offering documents that
these are the ground rules, the investors will have no grounds for
complaint later if they choose to go forward with their purchase.

   A legal analysis, in short, cannot itself determine the outcome. You

should be satisfied that you have enough information about the transactions
to judge the risk of harm to Blue Cross subscribers. If you determine that
the risk to the subscribers has not been adequately addressed, you must
disapprove the transactions. If, on the other hand, you determine that such
risks have been adequately addressed and that the transactions are
otherwise proper from a regulatory point of view, you may approve them.

                                IV

                           Conclusion

  In summary, it is our opinion that:

  1. Blue Cross may create a new for-profit subsidiary, Newco, as a

holding company for certain managed care subsidiaries that Blue Cross
currently owns.

  2. The Insurance Commissioner may not approve the sale of a

minority interest in Newco or Greenspring to private investors unless the
Commissioner is satisfied that the duties imposed upon Blue Cross as
majority shareholder would be compatible with its statutory duties to its
health service plan subscribers.

                                        J. Joseph Curran, Jr.
                                        Attorney General

                                        Jack Schwartz
                                        Chief Counsel
                                        Opinions & Advice

1
Except as otherwise specified, all statutory references in this opinion are
to Article 48A, the Insurance Code.

2
Blue Cross is expressly authorized by §19-702(a)(3)(i) of the Health-
General Article to operate health maintenance organizations.

3
There are limits to this generalization. In their advice letter, Assistant
Attorneys General Pugh and Frierson cautioned against a holding company
structure under which the Blue Cross parent "could become nothing more than a
corporate shell providing all the benefits of Subtitle 20 while circumventing its
prohibitions." 1987 Advice Letter at 14 n. 15. The Newco proposal does not
present this danger.

4
We are not called upon in this opinion to explore the details of this
valuation issue (including the question whether Blue Cross might achieve the same
objective by other means), and we express no conclusions about it.