Source: https://www.odwire.org/vision-service-plan-vs-united-states-america/
Timestamp: 2020-08-10 09:39:57
Document Index: 48609677

Matched Legal Cases: ['§501', '§ 501', '§ 501', '§ 1', '§ 1', '§ 1', '§ 1', 'art 1']

Vision Service Plan vs The United States of America - ODwire.org ODwire.org
AdminWolf April 11, 2008 44
Two recent court decisions likely will impact the competition among vision care plans. Twice in just over two years VSP has been handed stunning defeats in a protracted battle to regain its tax-exempt status. And the decisions might push VSP to make changes that, in time, will adversely impact your practice.
Here’s a look at why VSP lost and how, in my opinion, the collateral financial fallout could land squarely on your practice’s bottom line. I’ll also tell you about some financial revelations from the court cases that may partially answer a question so many ODs have asked for so many years: “Where does all the money go?”
From the beginning VSP’s mantra has been “By optometry; for optometry,” and at least initially it certainly seemed that this was the case. There is no question that many new patients have come into optometric practices as a result of VSP’s sales and marketing prowess. But over the years VSP’s policies, protocols, and participation requirements have evolved dramatically.
Where once most optometrists felt the organization was private practice optometry’s friend, now many opine that it has become too big, too powerful, and certainly too arrogant. From postings on Internet list-serv discussion boards it is clear that many ODs feel VSP has strayed far from its initial founding principles and has intruded beyond reason into their daily operations, even to the point of hurting them financially.
“Thanks a lot, VSP,” was the commonly expressed sentiment. And ODs rightly wondered why VSP imposed itself between the payor and doctors who already were providing medical eye care. What added value did VSP bring to ODs in this and similar arrangements? The only things obvious were that VSP would get paid to serve as the middleman, and that if ODs wished to continue seeing their medical eye care patients their now-reduced reimbursements would be coming from “optometry’s friend.”
A dollar here; a dollar there… Pretty soon it adds up to… Wow!!!
One enduring irritation for many optometrists is that while growing into a financial juggernaut, VSP has not openly shared financial information with the panel participants who provide the patient care. Not surprisingly, many ODs resent VSP’s secretive nature, and they wonder where the money goes once claims and administrative expenses have been paid.
In the September 2003 issue of Optometric Management I presented some financial information collected from the website of California’s Department of Managed Health Care, the regulator of most California health plans. Read at:
http://www.optometric.com/article.aspx?article=&loc=articles\2003\september\0903069.htm
Based on reader reaction, that VSP data must have been a revelation to most of the nation’s ODs. It indicated the enormity of VSP’s financial resources, particularly in terms of net income and cash-on-hand. And many ODs wondered why some of that profitability was not coming back to the very doctors who made it possible in the first place through the discounting of their professional services.
VSP promoted itself as non-profit, yet they certainly did not appear to be operating like a non-profit company. Rather, their business practices seemed more like those of for-profits. And, as it turns out, the IRS agreed.
VSP was set up as a tax-exempt entity under IRS code 26 U.S.C. (“IRC”) Section 501(c)(4). In 1999 the IRS started to look at VSP and, thereafter, concluded it was not entitled to tax-exempt status under 501(c)(4).
The IRS issued a final determination and revoked VSP’s 501(c)(4) status, effective prospectively from January 1, 2003. VSP paid the tax on its 2003 earnings and then filed suit in the United States district court, eastern district of California. (Vision Service Plan, Plaintiff, v. United States of America, Defendant NO. CIV. S-04-1993 LKK/JFM)
On November 7, 2005 the parties presented their cases before Judge Lawrence Karlton. VSP asked to be confirmed as a social welfare organization under 26 U.S.C. §501(c)(4). Further, it asked for return of the 2003 tax payments and an order that the United States issue it a private letter recognizing VSP’s 501(c)(4) status. In opposition, the government asked for summary judgment on the grounds that VSP did not qualify for tax exemption under 501(c)(4).
On pages 6 and 7 of his opinion the judge wrote, “Section 501(c)(4) of the Internal Revenue Code (26 U.S.C.A. § 501(c)(4)) provides federal tax exemption to a social welfare organization. Section 501 provides, in pertinent part, that ‘organizations not organized for profit but operated exclusively for the promotion of social welfare’ shall be exempt from taxation.” 26 U.S.C. §§ 501(a) and 501(c)(4)(A)
And he wrote, “In like fashion, the regulations provide: An organization is operated exclusively for the promotion of social welfare if it is primarily engaged in promoting in some way the common good and general welfare of the people of the community…. (and) … is operated primarily for the purpose of bringing about civic betterments and social improvements.” 26 C.F.R. § 1.501(c)(4)-1(a)(2)
Conversely, he pointed out that if an organization’s primary activity is doing business with the public in a manner similar to a for-profit organization, then it is not operated primarily for the promotion of social welfare. 26 C.F.R. § 1.501(c)(4)-1(a)(2)(ii).
VSP argued that it qualified for exemption under 501(c)(4) because its operations were primarily for the promotion of social welfare through direct (contracted) services to broad segments of the community as well as through charity work. While Judge Karlton described VSP’s charitable work as admirable, he found that VSP failed to establish it operated primarily for the promotion of civic betterments and social improvements within the meaning of the tax regulations. On page 8 he noted that, “[E]ven though there may be aspects of the organization that greatly benefit society, if the majority of the organization’s services benefit private members, the organization cannot qualify for an exemption under 501(c)(4).”
VSP’s client base (“We are the world”)
On page 11 he stated, “Servicing small employers or rural subscribers and enrollees does not equate to promoting social welfare… Small employers or rural employers are still paying for VSP’s services and VSP is making a profit from these contracts. VSP submits that the Internal Revenue Manual lists servicing smaller employers and rural enrollees as a factor in determining if an HMO qualifies for exemption under 501(c)(4)… This argument is unavailing… VSP is not an HMO.”
But Judge Karlton brushed aside VSP’s position. On page 18 he pointed out that, “The issue, however, is not whether plaintiff is a nonprofit corporation for corporation law purposes, but whether it is one for federal tax purposes…. According to the Treasury regulations, an organization is not operated primarily for the promotion of social welfare if its primary activity is ‘carrying on a business with the general public in a manner similar to organizations which are operated for profit.’” 26 C.F.R. § 1.501(c)(4)-1(a)(2)(ii).
One can only speculate as to which specific activities caused the judge to view VSP’s activities as more like those of for-profit companies than non-profits. Perhaps he wondered why a company professing non-profit status and whose business since 1955 had been the administration (i.e., paper-processing) of vision care benefits would, in the 1990s, get into the dramatically different business of importing and selling frames (Altair). Perhaps he found it incongruous that a “non-profit” company was into supply chain management.
Certainly no OD in this country has any misconception about why Luxottica, a for-profit company, is in managed vision care. They bought LensCrafters, gave a huge funding kick-start to EyeMed, and ramped-up those operations to build EyeMed into a major competitor for VSP. And everyone knows, understands, and accepts that Luxottica is in managed vision care through EyeMed to sell frames – to grow its profits. Perhaps Judge Karlton viewed it as incongruous when VSP argued its primary purpose was the promotion of social welfare, yet it had set up this new company with a sales force that actively promoted Altair frames to panel doctors.
Whatever his specific considerations, he presented a hard-hitting summation of financial matters, literally cutting out the heart of VSP’s argument that it did not operate like a for-profit company. His comments invite the question, “Where does the money go?”
He wrote, in part, on pages 18-20, “Moreover, a corporation that devotes much of its revenues to improving its ability to compete commercially through accumulation of large surpluses and expansion of its income producing facilities is not entitled to exemption under Section 501(c)(4)…. In this regard, I begin by noting that VSP engages in cost cutting measures common to for-profit businesses. For example, a portion of VSP’s bonus structure paid to its employees is directly tied to reducing VSP’s costs…
“The court concludes that VSP carries on business with the public ‘in a manner similar to organizations which are operated for profit.’” 26 C.F.R. § 1.501(c)(4)-1(a)(2)(ii) ”Therefore, VSP does not operate primarily for the promotion of social welfare.”
The potential ramifications of the decision were profound, and nobody expected VSP to fold its tent and accept this ruling without contest. They appealed to the Ninth Circuit Court of Appeals, and arguments were heard in December 2007.
Then, in January 2008 the Ninth issued its opinion, upholding the district court and Judge Karlton. (Vision Service Plan, Inc. v. United States of America, 2008 WL 268075 (9th Cir. Cal). How far this whole affair goes from here remains to be seen.
The hearing in the Ninth Circuit Court was held before a three-judge panel. But on March 13th VSP requested an “en banc” hearing before the same court, meaning its case would be presented to a larger panel of judges.
If VSP wanted to appeal to a higher court the next step would be the United States Supreme Court. But it’s hard to imagine that the Supreme Court would hear VSP’s appeal. That court likely could care less whether VSP is or is not a 501(c)(4), and it’s unlikely the Supreme Court would devote the time to making that sort of determination for one company.
As this story was being prepared in February and March 2008, VSP continued fighting on another front, this time in the United States District Court, Southern District of Ohio (2:07-MD-01829-JLG-TPK). There, VSP was arguing essentially the same case it unsuccessfully put before the district court in Sacramento.
In this instance, five local VSP affiliate companies are asking for the return of more than $26 million in corporate income taxes paid for the years between 1994 and 2000. And, again, the government has asked for summary judgment.
And so it is conceivable that this matter is far from settled, and we may be seeing the ophthalmic industry’s version of Microsoft in action – a company with essentially limitless financial resources litigating endlessly.
Assuming the decisions stand and there is no reversal, it seems reasonable to postulate that the loss of tax-exempt status may cause VSP to consider some changes to its business model. If VSP must now pay considerable taxes, then recovering that lost “profit” and maintaining or growing its present market-dominating position might be attempted in one or more of several ways including: 1) by raising the rates charged to health plans, employer groups, unions, etc. — a difficult undertaking given the unrelenting competitive pressure from EyeMed, Davis Vision, and others or, 2) reducing the fees paid to the providers of patient care (i.e., you!) or, 3) by pushing even harder into expanding its book of business as middleman-administrator of medical eye care services or, 4) by adding new charges to the doctors for certain goods and services.
I have no knowledge that these or other possibilities are under consideration at this time. But going forward if VSP is unsuccessful in its appeal, nothing should surprise given how the loss of tax-exempt status suddenly changes the game. And while you think about the possibilities, also consider this information that was made part of the court records.
Financial revelations from VSP vs the United States
The 2004 IRS Form 990s list that year’s compensation for some top executives as follows. (Note: deferred compensation is itemized separately.)
Roger Valine – $1,299,682
Gary Brooks – $474,530
Patricia Cochran – $366,713
Don Price – $256,431
Cheryl Johnson – $242,097
Walter Grubbs — $330,405
Richard Steere — $666,770
The depositions reveal that top executives can (and do) receive sizeable annual bonuses depending on corporate results and meeting individual performance targets. For example, on pages 112 and 115 of his August 10, 2005 deposition Richard Steere, Vice President of Sales stated that, “My bonus is based upon primarily growth in our business…That’s calculated on a percentage of our revenue and administrative income growth…and then I get a small portion of that.”
When asked approximately how much he received as a bonus Mr. Steere replied, “It could be three or $400,000 depending upon how much the company grows.”
Roger Valine’s deferred compensation agreement
Perhaps nothing about VSP has generated more speculation than Mr. Valine’s compensation. Certainly under his leadership VSP has grown and prospered. And there’s no doubt that ODs have benefited.
As CEO of a successful company he would be expected to earn a sizeable salary. And as noted above, the 2004 tax filings submitted to the court indicate he did that in spades. But he also was the beneficiary of a handsome deferred compensation package, the details of which were revealed in the various court documents.
Mr. Valine executed a new deferred compensation agreement on March 8th, 2002. Paragraph 2 of this bonus agreement states the following, “Measuring Account. VSP shall create a memorandum book account entitled, Vision Service Plan Executive Deferred Compensation Plan (hereinafter the “Measuring Account”) to track the amount of Officer’s deferred compensation generated as a result of this Agreement. This Agreement is intended to be an excess benefits plan that will provide Officer deferred compensation only to the extent that the Measuring Account exceeds the proceeds received from the sale or redemption of Officer’s stock in Altair Holding Company over his cost of acquiring the stock, including any interest paid.”
Thus the Measuring Account was an accounting vehicle to determine the amount he potentially could receive at retirement and upon meeting all obligations. The amount ultimately available for distribution would be the fair market value of the Measuring Account reduced by the difference in the sale and acquisition prices of his stock in the Altair Holding Company. On page 75 of Mr.Valine’s deposition he states his acquisition cost for this stock was $150,000.
There were multiple streams of dollars feeding the Measuring Account. For all employees VSP contributed up to 15 percent of salary into a retirement account. At the time, the federal ceiling for such contributions was roughly $30,000.
But on pages 81 and 82 of his deposition Mr. Valine affirms to the government’s attorney that VSP contributed an additional amount in excess of that $30,000 limit to his Measuring Account. In fact, paragraph 5(a) of the Deferred Compensation Agreement states, “Excess Benefit Plan. VSP shall credit to the Measuring Account the excess amount which would have been contributed to the Officer’s qualified profit sharing plan account, but for the maximum limitations imposed by Internal Revenue Code section 415 and section 401(a)(17).”
So VSP was to pay in the amount in excess of $30,000 that equaled fifteen percent of his salary.
He also was entitled to a “Total Revenue Incentive.” As described on page 3 of the agreement, for each month in 2002 and each month thereafter VSP credited to the Measuring Account, “…an amount equal to VSP’s Total Revenue for the month, multiplied by .04% (.0004).”
How much did that represent on an annualized basis? First one must know what is being referenced as “Total Revenue.” On page 82 of his deposition Mr. Valine is asked if this meant the total revenue of VSP California or of VSP Consolidated? He replied that it was VSP Consolidated.
Then, for example, looking at the 2003 financial statements (“Combined Statements of Operations, VSP and Affiliated Corporations”) the annual revenues are stated as $1,968,488,157. Multiply that by .0004 and the result is $787,395.
Mr. Valine was also the beneficiary of a “Cost of Benefits Paid Incentive.” It is defined on page 3 of the deferred compensation agreement. “For each month in 2002, and for each month in each year thereafter, an amount equal to the Cost of Benefits Provided for that month by VSP multiplied by .05% (.0005).”
Again referring to Mr. Valine’s deposition, on page 83 he is asked to explain “Cost of Benefits Paid” and says, “It would be all costs associated with providing services to patients, so it’s not admin cost. It’s related to claim cost.” And, again, he confirmed that this was for VSP Consolidated.
Looking again at the 2003 financial statements, “Costs of benefits provided” are shown as $1,640,203,947. Multiplying by .0005, the result is $820,101.
Another potential source of bonus account growth was designated the “Administrative Expenses to Revenue Incentive.” This bonus was an incentive to drive down administrative costs and had nothing to do with claims expenses. On page 4 of the agreement the amount was defined as, “Such amount shall be equal to four thousand dollars ($4,000) for each one-tenth of one percent (1/10th%) that the Actual-Administration-to-Revenue-Ratio for the prior year is less than the Administration-to-Revenue Benchmark.”
The Actual-Administration-to-Benefit-Ratio was defined by this formula:
General and administrative expenses – Board approved adjustments + indirect marketing costs allocated to Altair Eyewear ÷ (total revenue – interest revenue). And the Administration-to-Revenue benchmark was pegged at 13%.
Note: Given the uncertainty of variables that could go into the calculation of this bonus pool — for example, the addition or subtraction of Board approved adjustments — it was not possible to estimate any amount paid in for 2003.
Mr. Valine could benefit from yet another potential bonus pool, the “Personal Performance Incentive,” described on pages 4 and 5 of the agreement as, “From time to time, the Board, in its sole discretion, may credit additional amounts to the Measuring Account based upon Officer’s performance in the prior year. Prior to the beginning of each year, the Board shall inform Officer of its objectives for the upcoming year, and based upon Officer’s actual performance, the Board may credit additional amounts to the Measuring Account.”
During his deposition Mr. Valine was asked if there were any upper limit on the amount the Board could give, and he replied that he was not aware of any. He also was asked if he had received this Board-approved bonus each year since 2002, and answered in the affirmative. And when asked how much he received as these bonuses he replied on pages 85 and 86 of the deposition that the amounts, “…would have been between $175,000 and $275,000.”
A seventh potential source of contributions to his Measuring Account came from what was called the “Phantom Stock Plan.” Described on page 5 of the agreement, the name is really something of a misnomer since there actually was no stock. Rather, this was another accounting vehicle whereby Mr. Valine was credited with 42,125 “shares” out of a total “share” count of 10,000,000.
The agreement states, “The amount credited to the Measuring Account shall be equal to the Actual Value per phantom share on the first day of January each year this Agreement is effective less the Actual Value per phantom share on the first day of January in the immediately preceding years multiplied by 42,125.”
The actual value of a share was the Cost of Benefits Provided during the preceding year ÷10,000,000. So if things went well from year to year the value of his “shares” would increase over the previous year’s value, and his Measuring Account would then receive an amount equal to the annual increase in a share’s value X 42,125.
Yet another source of potential funding into his retirement account came from a bonus described on pages 90-92 of his deposition, and designated the “Increase In Members Covered By MedVision, PEC, AEC, and IPEC Plans Incentive.” This was a straight-forward and simple measure of net gain increases in annual enrollment. If the number of lives covered by any of these plans rose, then Mr. Valine’s account was credited twenty cents per increased life.
Finally, page 6 of the deferred compensation agreement provided for an “Additional Phantom Stock Plan.” It granted Mr. Valine 1,024,000 phantom shares of Eyefinity, Inc. Again, these “shares” were simply an accounting tool.
Upon his retirement the Measuring Account would be credited an amount equal to the value of one share of Eyefinity stock multiplied by 1,024,000. If Eyefinity had done well and a share of stock had value, then 1,024,000 shares could represent a considerable sum.
Highlights from the 2003 financial statements
Court documents include the 2003 financial statements and a memo to the Board regarding them. Here are some interesting numbers.
1) Assets at an all time high – More than $850 million, a 15% increase over 2002,
2) Cash and marketable securities – More than $621 million, an 18% increase,
3) Cash and cash equivalents – Almost $104 million, a 22% increase,
4) Excess of revenues over costs and expenses (after income taxes) – More than $82 million. Described in the Board memo as “Actual Profit.”
And there were also these comparative figures:
If the prospect of VSP intruding into practices is worrisome, consider that the loss of tax-exempt status possibly could result in even more intrusion accompanied by lower reimbursements. Is it any wonder discussions on the various list-servs increasingly ask why practitioners continue to participate?
Many have opined in the past that they are fed up with the many ways VSP gets “into” their private practices. Given the financial revelations that have come out of these court cases member doctors are likely to say, “I’m mad as hell, and we must change our working relationship with VSP.”
One optometrist familiar with the recent decisions suggested to me that maybe it’s time VSP doctors took back control of what used to be their affiliate VSPs. He said, “We turned over control of our local VSP affiliate to VSP of California for marketing purposes. They have done a fantastic job marketing our services as a much-needed conduit for vision care, but they seem to have little regard for member doctor concerns such as low reimbursement and excessive control of our private practices. What we have now is the tail wagging the dog.”
He continued, “VSP Management places high priority on patient and employer satisfaction, as well as VSP employee job satisfaction, but clearly does not seem to value member doctor concerns. VSP member doctors should regain their rightful place at the head of the bargaining table rather than wait powerlessly to see what scraps are left over from the fruits of their labors. Enough is enough.”
And that’s certainly an interesting thought – to take back control and run local VSPs to serve local interests. Assuming compliance with antitrust laws and insurance regulations, and assuming establishment of a financially and administratively sound infrastructure, is that a possibility or is it wishful thinking?
VSP has done a lot of good things over the years. For example, its efforts on behalf of Hurricane Katrina victims were admirable. But a lot of other companies also provide much needed help to the needy, and they do it without wrapping themselves in the mantle of “social welfare.”
The decision of the district court and affirmation by the court of appeals told VSP it was time to drop pretenses.
Gil Weber, MBA is a nationally recognized author, lecturer, and practice management consultant to practitioners and the managed care and ophthalmic industries. You can reach him at (321) 433-0623, gil@gilweber.com or see his website, www.gilweber.com.
VSP Vision Care President, Jim McGrann (part 1 of 2) [#R030]
November 14, 2013 59
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