Authorities have revoked the tax-exempt status of nonprofit Blue Shield of California, potentially putting it on the hook for tens of millions of dollars in state taxes each year.

The move by the California Franchise Tax Board comes as the state’s third-largest health insurer faces fresh criticism over its rate hikes, executive pay and $4.2 billion in financial reserves.

The state quietly stripped the San Francisco insurer of its exemption from California income taxes in August. The company held that since its founding in 1939.

A spokeswoman for the tax agency declined to comment on the reasons for revocation. The highly unusual action comes after a lengthy state audit that looked at the justification for Blue Shield’s taxpayer subsidy. The insurer has paid federal taxes for years.


Blue Shield said Tuesday that it’s protesting the decision. In the meantime, state officials have ordered it to file tax returns back to 2013.

Blue Shield has about 3.4 million customers and 5,000 employees and posted $13.6 billion in revenue last year. It trails only nonprofit Kaiser Permanente and for-profit Anthem Inc. in statewide enrollment.

Now, a company insider has sided with critics. Michael Johnson, who resigned as public policy director last week after 12 years at the company, said the insurer has been “shortchanging the public” for years by shirking its responsibility to Californians and operating too much like its for-profit competitors.

On Wednesday, Johnson plans to launch a public campaign calling on executives to convert the insurer into a for-profit company and return billions of dollars to the public that could be used to bolster the state’s healthcare safety net. He estimates the company could be worth as much as $10 billion.


Switching an insurer to for-profit status has happened before in California and across the country.

In 1996, a similar conversion of Blue Cross of California — now part of Anthem — generated $3 billion to establish the California Endowment and the California HealthCare Foundation.

“The public is not getting its money’s worth out of Blue Shield now,” Johnson said in an interview.

For years, Blue Shield has overcome similar criticisms, drawing on its powerful brand name and long history. But this time may be different if state officials ratchet up the pressure with hearings or legislation.


The company defends its work on behalf of Californians. It cites its long-standing support of health reform and numerous efforts to make coverage more affordable.

“Blue Shield as a company and management team firmly believes it is fulfilling its not-for-profit mission and commitment to the community,” said company spokesman Steve Shivinsky.

He declined to comment on Johnson’s effort until more details are available.

Blue Shield was one of the first U.S. health insurers to support universal healthcare starting in 2002 while other industry rivals opposed the idea.


In 2011, amid a backlash over rate increases, the insurer capped its profits at 2% of annual revenue and gave back about $560 million to customers and community groups from 2010 to 2012. Blue Shield has also contributed more than $325 million over the last decade to its own charitable foundation.

But some consumer advocates and health-policy experts say those gestures are lacking in light of the company’s stockpile of cash.

Blue Shield’s surplus of $4.2 billion at the end of 2014 is four times as much as the Blue Cross and Blue Shield Assn. requires its member insurers to hold to cover future claims.

Critics also note the company hasn’t served the state’s poorest residents on Medi-Cal and it has frequently run afoul of state regulators. The 2011 disclosure of a nearly $5-million salary for its former chief executive drew protests.


Consumer advocate Anthony Wright, executive director of Health Access, said the tax board’s decision could have a significant effect on the debate over Blue Shield’s future and on health policy statewide.

“It’s important to have this debate over Blue Shield’s public-service mission and how they are fulfilling it,” Wright said. “What would a white-hat insurer look like?”

Paul Ginsburg, a professor at USC’s Schaeffer Center for Health Policy and Economics, said it’s reasonable for the public to expect some return when a company has reaped the advantage of a state tax exemption for decades.

“The main motivation for any state that wants to see a conversion of a health plan is they would capture the assets,” he said.


That idea could prove popular in Sacramento, experts say, where state lawmakers are searching for money to boost Medi-Cal reimbursements for doctors and hospitals and to expand coverage for millions of uninsured Californians who don’t qualify for federal help under Obamacare.

Johnson, 52, said he raised his concerns about Blue Shield’s obligations as a nonprofit with senior management over the last six months. He said his proposals were dismissed.

To put public pressure on the company, Johnson is starting an online petition drive aimed at Blue Shield’s board, which includes former Defense secretary Leon Panetta.

Blue Shield was founded by the California Medical Assn. as part of a national movement by hospitals and doctors to form prepaid health plans.


The company is a “mutual benefit” nonprofit — “dedicated to charitable, religious or public purposes,” according to California corporation law.

On reserves, Blue Shield has said it’s been prudent given the uncertainties of the health-law rollout and the need to invest in new information technology.

Industry analysts also note that nonprofit health plans favor a bigger surplus because they don’t have the ability to issue stock like a for-profit company or access debt markets in the same way.

Dena Mendelsohn, a health policy analyst at Consumers Union in San Francisco, has objected to recent rate increases by Blue Shield with regulators on the grounds the company doesn’t need to further pad its financial cushion.


“Blue Shield’s surplus is significantly more than needed to protect their solvency,” she said.

Some consumer groups have also questioned whether certain Blue Shield spending is out of line with its nonprofit mission.

For instance, the company contributed about $10 million to defeat a ballot measure last year seeking rate regulation. It spent $2.5 million for a luxury box at the new professional football stadium in Santa Clara, Calif.

Blue Shield said the Prop. 45 initiative wasn’t in the best interests of consumers, and its spending at Levi’s Stadium was for sales purposes.


Critics have also long complained about Blue Shield’s lack of disclosure.

For instance, Blue Shield didn’t release its executive compensation until it had to comply with a state law. For 2010 and 2011, it said former Chief Executive Bruce Bodaken made $4.6 million annually.

In its most recent filing, for 2012, Blue Shield didn’t list any executives by name and said its top three officials were each paid more than $1 million a year. The company declined to comment on its executive compensation.

Mendelsohn of Consumers Union said “the lack of transparency makes it hard to understand whether Blue Shield is holding up their end of the bargain with the public.”


chad.terhune@latimes.com

Twitter: @chadterhune