Sutter's Giant Sucking Sound

Sutter Health, which owns one of California's largest hospital empires, is a nonprofit, tax-exempt charity. Critics wonder why Sutter dispenses so little charity, and vacuums so much profit, from the hospitals it acquires.

Then, between 1984 and 1990, Sutter purchased or leased 11 hospitals, clinics, and nursing homes. The pace of acquisition grew to a crescendo in 1996, when the Sacramento nonprofit merged with San Francisco-based California Health System, the parent firm for the California Pacific Medical Center and Alta Bates, Marin General Health Systems, and Mills-Peninsula Health Services. The deal nearly doubled Sutter's size and made it a serious player in the health care battleground that is Northern California.

As Sutter was buying up and merging with other health care entities, managed care was reshaping the medical industry, especially in HMO-heavy California. For-profit giants like Columbia/HCA and Tenet California Health System were becoming big players in an industry that had traditionally been a nonprofit game. In short, Wall Street discovered health care, and charity hospitals, fearing they would go bankrupt if they stayed small in scale, began to behave like their merger-happy, for-profit competitors.

Sutter developed a particular taste for purchasing or leasing public hospitals, just as the people running those hospitals -- county officials or elected hospital district boards -- grew more wary of being involved in the increasingly competitive health care business.

So what began as a local hospital in Sacramento is now a $2.7 billion health care system that includes 26 hospitals, seven nursing homes, 21 home health care providers, a plethora of physicians, a health insurance company, a majority position in a health maintenance organization, several wholly or partly owned for-profit subsidiaries, and more than 22,000 employees.

In 1996, the most recent year for which data is available, Sutter posted revenues of $2.45 billion. Were it not a tax-exempt corporation, Sutter would make the Fortune 500 list. Because it is exempt, the overwhelming majority of its income and property is not taxed at all.

Sutter executives tend to blame the government for the current state of affairs in health care, which, they claim, has forced Sutter to operate like a Fortune 500 corporation. This tendency is ironic because, in fact, the government has been very good to Sutter Health.

And the way Sutter handles its finances has led critics to charge that the nonprofit is building an empire on the backs of formerly public hospitals, and through tax exemptions the government itself provides.

Sutter has grown by pooling its assets, many of which are hospitals leased or otherwise acquired from the public, and using them as security for ever more government-organized bond financing that is used to buy ever more hospitals.

The federal government allows nonprofit hospitals to borrow money through the sale of tax-exempt bonds. That is, the bond buyers do not have to pay taxes on the interest they earn, and Sutter is therefore able to borrow money at a lower interest rate than it otherwise would pay.

Sutter's nonprofit hospitals and medical centers are organized into something called the "Obligated Group." By definition, the group's assets are considered, in total, as security for Sutter's bonded debt. This arrangement provides Sutter with a more favorable bond rating and more ability to borrow than any one hospital would have on its own.

But the arrangement also obligates all of the hospitals for all of the debt, regardless of whether or not they get any of the money from the latest bond issue. (Of course, the for-profit companies under Sutter's umbrella are not part of the Obligated Group and therefore not on the hook for any of the bond debt.)

And Sutter has borrowed about as fast as it's grown. The system currently owes nearly $1 billion, most of it in state revenue bonds, according to bond documents. In 1996, Sutter Health reported a net income of $23.7 million on revenues of $2.5 billion -- not an impressive profit margin (about 1 percent) for a debt-heavy corporation with an insatiable appetite.

As it expands, the nonprofit parent collects and distributes money, pretty much as it sees fit, throughout its network of nonprofit hospitals and for-profit subsidiaries. Sutter contends that this structure allows it to prop up struggling hospitals, fund research, and otherwise spread its wealth for the public good. But that structure also allows money generated by nonprofit hospitals to be used in Sutter's private, for-profit business ventures.

By its own policy, Sutter may transfer every dollar beyond 14 days of budgeted operating expenses out of its affiliate hospitals -- California Pacific, Alta Bates, Marin General, and others -- and use the money wherever it sees fit.

"In good times, affiliates share a portion of their revenues in order to strengthen the system. In times of need, affiliates can count on the system to help make sure that their services continue to be available," Sutter spokesman Bill Gleason explains.

"In that sense, the system is like a family. It helps each other in good times and bad times. That's just how the system happens to operate."

Sutter collects a management fee of as much as $2 million a year from each of its affiliate hospitals. Those hospitals do, indeed, benefit from Sutter's administrative support and gross purchasing power. But the hospitals also are beholden to the Sutter parent for virtually every bandage they need.

The whole Sutter concept -- the sharing of wealth among nonprofit and for-profit entities, as huge amounts of debt are piled onto nonprofit community hospitals -- concerns critics to the north and south of San Francisco. In fact, the elected hospital district boards of two of Sutter's largest affiliates -- Marin General Health Systems and Mills-Peninsula Health Services -- have filed lawsuits to take back hospitals Sutter has leased from them.

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