Presidential brother makes hay from education reform

BusinessWeek – October 16, 2006

By Keith Epstein

Across the country, some teachers complain that President George W. Bush’s makeover of public education promotes “teaching to the test.” The President’s younger brother Neil takes a different tack: He’s selling to the test.

The No Child Left Behind Act compels schools to prove students’ mastery of certain facts by means of standardized exams. Pressure to perform has energized the $1.9 billion-a-year instructional software industry.

Now, after five years of development and backing by investors like Saudi Prince Alwaleed Bin Talal and onetime junk-bond king Michael R. Milken, Neil Bush aims to roll his high-tech teacher’s helpers into classrooms nationwide. He calls them “curriculum on wheels,” or COWs. The $3,800 purple plug-and-play computer/projectors display lively videos and cartoons: the XYZ Affair of the late 1790s as operetta, the 1828 Tariff of Abominations as horror flick. The device plays songs that are supposed to aid the memorization of the 22 rivers of Texas or other facts that might crop up in state tests of “essential knowledge.”

Bush’s Ignite! Inc. has sold 1,700 COWs since 2005, mainly in Texas, where Bush lives and his brother was once governor. In August, Houston’s school board authorized expenditures of up to $200,000 for COWs. The company expects 2006 revenue of $5 million. Says Bush about the impact of his name: “I’m not saying it hasn’t opened any doors. It may have helped with some sales.” (In September, the U.S. Education Dept.’s inspector general accused the agency of improperly favoring at least five publishers, including The McGraw-Hill Companies, which owns BusinessWeek. A company spokesman says: “Our reading programs have been successful in advancing student achievement for decades; that’s why educators hold them in such high regard.”)

The stars haven’t always aligned for Bush, but at times financial support has. A foundation linked to the controversial Reverend Sun Myung Moon has donated $1 million for a COWs research project in Washington (D.C.)-area schools. In 2004 a Shanghai chip company agreed to give Bush stock then valued at $2 million for showing up at board meetings. (Bush says he received one-fifth of the shares.) In 1988 a Colorado savings and loan failed while he served on its board, making him a prominent symbol of the S&L scandal. Neil calls himself “the most politically damaged of the [Bush] brothers.”

While hardly the first brother to embarrass a President — remember Billy Carter’s Billy Beer or Roger Clinton’s cocaine? — Neil could be the first to seek profit from a hallmark Presidential crusade. And also that of a governor: Jeb makes school standards a centerpiece in Florida, too.

Neil says he never talks shop with his brothers. He attributes his interest in education to his struggles with dyslexia. His son, Pierce, also had difficulties in school, he says. “Not one of our investors has ever asked for any kind of special access — a visa, a trip to the Lincoln Bedroom, an autographed picture, or anything.”

BusinessWeek Cover Story

February 12, 2009

By Brian Grow, Keith Epstein and Robert Berner

The bad mortgages that got the current financial crisis started have produced a terrifying wave of home foreclosures. Unless the foreclosure surge eases, even the most extravagant federal stimulus spending won’t spur an economic recovery.

The Obama Administration is expected within the next few weeks to announce an initiative of $50 billion or more to help strapped homeowners. But with 1 million residences having fallen into foreclosure since 2006, and an additional 5.9 million expected over the next four years, the Obama plan—whatever its details—can’t possibly do the job by itself. Lenders and investors will have to acknowledge huge losses and figure out how to keep recession-wracked borrowers making at least some monthly payments.

So far the industry hasn’t shown that kind of foresight. One reason foreclosures are so rampant is that banks and their advocates in Washington have delayed, diluted, and obstructed attempts to address the problem. Industry lobbyists are still at it today, working overtime to whittle down legislation backed by President Obama that would give bankruptcy courts the authority to shrink mortgage debt. Lobbyists say they will fight to restrict the types of loans the bankruptcy proposal covers and new powers granted to judges.

The industry strategy all along has been to buy time and thwart regulation, financial-services lobbyists tell BusinessWeek . “We were like the Dutch boy with his finger in the dike,” says one business advocate who, like several colleagues, insists on anonymity, fearing career damage. Some admit that, in retrospect, their clients, which include Bank of America, Citigroup, and JPMorgan Chase, would have been better off had they agreed two years ago to address foreclosures systematically rather than pin their hopes on an unlikely housing rebound.

In public, financial institutions insist they’ve done their best to prevent foreclosures. Most argue that giving bankruptcy courts increased clout, known as cramdown authority, would reward irresponsible borrowers and result in higher borrowing costs. “What we’re trying to do now is target the bill to make it as narrow as possible,” says Scott Talbott, a lobbyist for the Financial Services Roundtable. On the defensive, the industry nevertheless benefits from one strain of popular opinion that home buyers who took on risky mortgages—even if the industry pushed those loans—don’t deserve to be rescued.

AN INDUSTRY IN DENIAL

However the skirmish ends, the industry’s contention that it has done as much as possible to limit foreclosures seems hollow. Some statistics it cites appear to be exaggerated. Even pro-industry figures such as Steven C. Preston, a Republican businessman who headed the Housing & Urban Development Dept. late in the Bush Administration, concede that many lenders have dragged their heels. “The industry still has not stepped up to the volume of the problem,” Preston says. One program, Hope for Homeowners—which Bush officials and banks promised last fall would shield 400,000 families from foreclosure—has so far produced only 25 refinanced loans.

Meanwhile, an already glutted market sinks beneath the weight of more foreclosed homes. Borrowers whose equity has evaporated have nothing to tap into if the recession costs them their jobs. Some lawmakers and regulators are calling for a foreclosure moratorium. “People are falling through the cracks,” Preston says. “That’s bad for communities, bad for the individuals losing their homes, and bad for investors.”

In early 2007, as overextended borrowers began to default on too-good-to-be-true subprime mortgages, housing experts sounded an alarm heard throughout Washington. Christopher Dodd (D-Conn.), chairman of the Senate Banking Committee, wanted to push a bill requiring banks to modify loans whose enticingly low “teaser” interest rates soon give way to tougher terms. But he knew that with Republicans strongly opposed, he lacked the muscle, according to Senate aides. So Dodd did what politicians often do. He convened a talkfest: the Homeownership Preservation Summit.

A who’s who of banking executives gathered on Apr. 18, 2007, behind closed doors in an ornate hearing room in the marble-faced Dirksen Senate Office Building. Dodd told them they needed to get out in front of the foreclosure fiasco by adjusting loan terms so borrowers would continue to make some payments, rather than stopping altogether. Foreclosure proceedings typically cost banks about 50% of a property’s value. That’s assuming the home can be resold—not a certainty when empty houses multiply in a neighborhood. “What are you doing?” Dodd asked the executives. “What do you need me to do to help you modify loans?”

Some from the industry denied a foreclosure problem existed, including Sandor E. Samuels, at the time chief legal officer of subprime giant Countrywide Financial. They vowed to continue selling loans with enticing introductory rates as well as those requiring minimal evidence of borrowers’ income. “We are going to keep making these loans until the last second they are legal,” Samuels later told a fellow participant.

On May 2, 2007, Dodd’s office issued a “Statement of Principles” stemming from the summit. It outlined seven vaguely worded industry aspirations, such as making “early contact” with strapped borrowers and offering modifications that could include lowering loan balances. The principles had no effect, some summit participants now concede.

Senate Banking chairman Chris Dodd

Much of Dodd’s attention shifted to his campaign for the Democratic Presidential nomination. Senate Banking Committee spokeswoman Kate Szostak says Dodd aggressively pursued the foreclosure issue, but “both the industry and the Bush Administration refused to heed his warnings.” The lawmaker accepted $5.9 million in contributions from the financial-services industry in 2007 and 2008.

Asked about his role at the summit, Samuels confirmed in an e-mail that he “did speak—formally and informally—about the performance” of subprime loans. But he declined to elaborate. He now works as a top in-house lawyer for Bank of America, which acquired Countrywide in July 2008.

A major reason financial institutions and investors are so determined to avoid modifying loan terms more aggressively has to do with accounting nuances, say industry lobbyists. If, for example, a bank lowered the balance of a certain mortgage, there would be a strong argument that it would have to reduce the value on its balance sheet of all similar mortgages in the same geographic area to reflect the danger that the region had hit an economic slump. Under this stringent approach, financial industry mortgage-related losses could far surpass even the grim $1.1 trillion estimated by Goldman Sachs (GS) in January. A desire to postpone this devastating situation helps explain lenders’ intransigence, says Rick Sharga, vice-president of marketing at RealtyTrac, an Irvine (Calif.) firm that analyzes foreclosure patterns.

By mid-2007, Bush Administration officials were deeply worried about the financial industry’s unwillingness to confront the growing catastrophe. Even banking lobbyists say they realized that their clients had lapsed into denial. The K Street representatives agreed that Treasury Secretary Henry Paulson needed to step in, says Erick R. Gustafson, then the chief lobbyist for the Mortgage Bankers Assn. “It was like an intervention,” he says. “We had to get Treasury involved to get the banks to give us information.”

That summer, Paulson, a former CEO of Goldman Sachs, summoned industry executives to the Cash Room, one of Treasury’s most elegant venues. There, beneath replica gaslight chandeliers, Neel T. Kashkari, a junior Goldman banker whom Paulson had brought to Treasury, urged industry leaders to move swiftly to keep more consumers from losing their homes. Bankers know how to adjust interest rates, extend loan durations, and, if necessary, lower principal, said Kashkari, who has temporarily remained in his post. A couple of months later, Paulson summoned the executives again, this time to his conference room. “We told them we need to get over the goal line,” recalls a former top Treasury official. “Cajoling is a euphemism for what we did. We pounded them.”

One product of the Treasury conclaves was the Hope Now Alliance, a government-endorsed private sector organization announced by Paulson on Oct. 10, 2007. Lenders promised to cooperate with nonprofit credit counselors who would help borrowers prevent defaults. Faith Schwartz, a former subprime mortgage executive, was put in charge.

WINDOW DRESSING?

The alliance got off to a shaky start. An early press release contended that there had been more foreclosures nationally than the Mortgage Bankers Assn. was conceding at the time. “We looked like the Keystone Kops,” says an industry lobbyist. Soon it became apparent that the program was primarily a public-relations effort, the lobbyist says. “Hope Now is really just a vehicle for collecting and marketing information to the Treasury, people on the Hill, and the news media.”

In a press release last Dec. 22, Hope Now said it had prevented 2.2 million foreclosures in 2008 by arranging for borrowers to catch up on delinquent payments and, in some cases, easing terms. But the data don’t reveal how many borrowers are falling back into default because many modifications don’t, in fact, reduce monthly payments. The alliance doesn’t receive this information from banks, says Schwartz.

There’s reason for skepticism. Federal banking regulators reported in December 2008 that fully 53% of consumers receiving loan modifications were again delinquent on their mortgages after six months. Alan M. White, a law professor at Valparaiso University, says the redefault rates are high because modifications often lead to higher rather than lower payments. An analysis White did of a sample of 21,219 largely subprime mortgages modified in November 2008 found that only 35% of the cases resulted in lower payments. In 18%, payments stayed the same; in the remaining 47%, they rose. The reason for this strange result: Lenders and loan servicers are tacking on missed payments, taxes, and big fees to borrowers’ monthly bills.

Consider the case of Ocbaselassie Kelete, a 41-year-old immigrant from Eritrea who called Hope Now last fall. Kelete, a naturalized U.S. citizen, bought a $540,000 townhouse in Hayward, Calif., in November 2006 with no down payment and 100% financing from First Franklin Financial, a subprime unit of Merrill Lynch. At the time, he and his wife earned $108,000 a year from his two jobs, with a pharmacy and an office-cleaning service, and hers as a janitor. Kelete says First Franklin and his realtor convinced him that he could afford a pair of mortgages, one with a 7.5% initial rate that would rise after three years, and a second with a fixed 12% rate. His monthly payment would total $3,600.

“WORK WITH ME”

“The realtor said, ‘Just make sacrifices for two years. Home prices will go up, and you can refinance at a lower rate,’ ” Kelete recalls. He regrets signing a mortgage he couldn’t afford—a mistake many people made during the subprime craze. Home prices didn’t go up. He lost his office-cleaning job. First Franklin modified his loans, but added on property taxes it had failed to collect earlier. Kelete’s monthly bill rose to $3,900. In October 2008, he called Hope Now. A counselor set up a conference call with First Franklin. The lender’s representative said Kelete should get another job or give up the house, the borrower says. Kelete responded that he’d already lost his second job cleaning offices and couldn’t find another in a faltering California economy. “Why don’t you work with me?” he asked First Franklin. The lender declined. The Hope Now counselor said there was nothing more to do. “Foreclosure is the only future I see,” Kelete says. A spokesman for BofA, which acquired Merrill in December, declined to comment, citing the borrower’s privacy. After BusinessWeek’s inquiries, however, First Franklin contacted Kelete about lowering his monthly payments.

Hope Now’s Schwartz acknowledges she is fighting an uphill battle. By her calculation, 45% of the borrowers her organization advises still end up in foreclosure. “If I seem frustrated,” she says, “it’s because we are dealing with nothing but an exploding problem.” She has a full-time staff of four in Washington; 500 counselors participate in the industry-funded hotline. “You shouldn’t take it lightly, what we have achieved,” Schwartz says. She bristles at suggestions that the statistics she disseminates are misleading. “I print what I know,” she says, noting that some of her bank members aren’t forthcoming about loan modifications. “It’s like herding and juggling cats.”

By early 2008 it was obvious that Hope Now wasn’t halting a significant percentage of foreclosures. Democrats in Congress began gathering ideas for a government-sponsored remedy. Many of those ideas came from the industry. Lobbyists and congressional aides referred to one concept as “the Credit Suisse plan.” Another, “the Bank of America plan,” would allow borrowers to refinance mortgages with loans guaranteed by the Federal Housing Administration. Representative Barney Frank (D-Mass.), the chairman of the House Financial Services Committee, had solicited BofA’s advice via an old Boston acquaintance, Anne Finucane, the bank’s chief marketing executive and a politically active Democrat. He assigned several aides, including Michael M. Paese and Rick Delfin, to work out the details.

Francis Creighton, a Democratic former staff member on the Financial Services panel who had gone to work as a lobbyist for the Mortgage Bankers Assn., negotiated with Paese and Delfin. Creighton’s Republican colleague Gustafson huddled with aides to such GOP lawmakers as Representative Spencer Bachus and Senator Richard Shelby, both of Alabama.

Before long, the anti-foreclosure provisions were being altered in ways the industry favored. Shelby, the ranking Republican on the Senate Banking Committee, along with other Republicans insisted on the pro-industry language in exchange for their support, aides say.

In the end, the program included stiff up-front and annual fees and a requirement that homeowners pay the government 50% of any future appreciation in the property’s value—all of which made it much less attractive to borrowers. Moreover, the banks’ participation was made entirely voluntary; there was no way to pressure them to cooperate.

Congress approved Hope for Homeowners on July 26, 2008, as part of a larger measure imposing restrictions on the mortgage finance firms Fannie Mae (FNM) and Freddie Mac (FRE). At the Mortgage Bankers Assn., lobbyists gathered in Gustafson’s corner office to lift plastic cups of wine in celebration.

Those familiar with Hope for Homeowners anticipated that its fine print would discourage all but a few borrowers. “We knew it was likely to have limited appeal,” says Preston, the former secretary of HUD, which oversees the FHA. George Miller, executive director of the American Securitization Forum, a Wall Street trade group, calls the program and its 25 refinanced loans “useless” because of the onerous details.

BROKEN BILL

Shelby, for his part, never expected Hope for Homeowners to accomplish much, according to Republican Senate aides. He agreed to it to gain Dodd’s support for greater regulation of Fannie and Freddie—and only when assured the program wouldn’t drain tax dollars. “My consistent aim throughout this crisis has been to protect the American taxpayer,” Shelby told BusinessWeek in a statement. He accepted $565,000 in contributions from the financial-services industry in 2007-2008.

Frank, whose industry contributions totaled $948,000 over the same period, says he became skeptical Hope for Homeowners could achieve its initial goal of helping 1 million people. But he expected much more progress than the mere 25 refinancings that have occurred so far, according to HUD. He blames Republicans and the industry for undercutting his legislation. “I didn’t have the votes to do more,” he says.

The Massachusetts liberal hasn’t given up hope of repairing Hope for Homeowners. He is working on changes that would cut borrowers’ up-front fees and provide bonus money for mortgage servicers that agree to participate in the voluntary program. Frank aides Paese and Delfin aren’t assisting with the fixes: They have left their congressional staff positions for lobbying jobs with the Securities Industry & Financial Markets Assn. in Washington. They say they are observing the one-year federal ban on speaking with their former boss about business they did on the Hill.

In the first days of 2009 it appeared that progress might be possible on a different front. A slumping Citigroup came back to the Treasury Dept. for a second round of bailout money. Bowing to pressure from regulators, Citi broke ranks with its rivals and dropped its opposition to bankruptcy cramdown.

Senator Dick Durbin (D-Ill.), who since 2007 had led unsuccessful efforts in Congress to give bankruptcy judges authority to modify home loans, dispatched his senior economic policy adviser, Brad J. McConnell, to talk with lobbyists for JPMorgan Chase and Bank of America. “Each agreed to take [the idea] back to their folks to see what they could do,” says a person familiar with the talks. Citi’s concession, the imminent Obama inauguration, and intensifying public hostility toward big banks contributed to an atmosphere Democrats assumed would be conducive to compromise.

TALKING POINTS

By the time McConnell talked to the JPMorgan and BofA representatives the next day, however, “they had gone on full defense mode and started to complain about how lousy a deal Citi had struck,” says the person familiar with the exchanges. Bank opposition, Durbin says, “was very shortsighted in light of the mess they have created in our economy.”

In the following weeks, banking lobbyists launched a renewed attack on the cramdown legislation, enlisting as an ally Republican Representative Lamar Smith of Texas, among others. Apart from Citi, “the industry remains united in that bankruptcy cramdown would destabilize the market” by creating widespread uncertainty about the value of numerous troubled mortgages, says Steve O’Connor, senior vice-president for government relations at the Mortgage Bankers Assn. His group is distributing talking points to key congressional aides laying out reasons why “Congress should defeat bankruptcy reform legislation.” These include the argument that if lenders can’t be confident that loan terms will survive, they will raise rates and reject riskier borrowers. Industry lobbyists are organizing home state bankers to pressure moderate Democrats they hope will be receptive to limiting the kinds of loans eligible for cramdown. One target: Senator Evan Bayh of Indiana.

Stefanie and James Smith of Santa Clarita, Calif., fear they may need the help of a bankruptcy court if they are to keep the subdivision home they bought for $579,000 in November 2005. Stefanie, 37, a university human resources coordinator, and James, 40, a federal law enforcement agent, borrowed the entire amount in two subprime loans that required a total monthly payment of $3,000. A representative of their lender, Countrywide, told them not to worry, says Stefanie: They would be able to refinance in a year.

By mid-2007 they were running late on payments, and refinancing options had dried up. With their monthly bill scheduled to jump to more than $4,000 this January due to a rising mortgage rate, Stefanie contacted Countrywide last summer. She asked for a loan modification so they could avoid default. In December the lender said it would be willing to increase their payment by $600. That was better than the scheduled rise of $1,100, so the Smiths agreed.

But now they are struggling to pay the higher amount. Countrywide’s parent, BofA, declined to comment, citing the Smiths’ privacy. After BusinessWeek’s questions, though, Countrywide called them to discuss cutting their payments.

“We knew when we bought that the payments would be a stretch,” says Stefanie. She regrets assuming they would be able to refinance at a lower rate. “We are not deadbeats,” she adds. “All we want is a mortgage we can afford.”

Stanford University – Summer 2005

How corporate donors use their gifts to help the bottom line

By Keith Epstein

For decades, the first stop for anyone in southern Arizona who wanted to raise funds for almost any good cause was the Hughes missile factory in Tucson. Since its founding by billionaire Howard Hughes in 1951, the place had always been associated with big money – both profits and a sweeping civic generosity. The company funded everything from the local symphony to the children’s museum, from the preservation of tribal lands to disaster relief.

Today the weapons complex is part of Raytheon, the fifth-largest defense contractor in the land, and Tucson’s largest employer. It also is still the area’s preeminent philanthropist, but the nature of its giving has undergone a profound transformation. That’s because about seven years ago Raytheon executives acted to realign their philanthropy more closely with the company’s commercial and strategic needs.

Why the change? “We were unfocused. We used to do a shotgun approach,” explains Diane H. Bissell, Raytheon’s community relations manager in Tucson. “It made a great number of people happy. But it didn’t force systemic changes in community programs or organizations important to us. We wanted to effect some change.” Specifically, the company decided to concentrate on efforts to improve math and science education throughout the region. Its reasoning was simple: Most of the people who work for Raytheon are engineers and scientists, and most of the people hired in the future will need these skills as well. “We’re building the workforce pipeline that will ultimately provide the whole region with economic stability and jobs,” adds Bissell. “It just makes good business sense.”

Today, Raytheon’s Tucson division gives away more money than ever, about $13 million each year, but not much of it goes to traditional causes like healthcare, social services, the arts, or the search for cures. While the children’s museum still gets some support, now it is for a hands-on exhibit on math and science. “We have engineers and scientists, and we need engineers and scientists,” explains Carol Ramsey, Raytheon’s corporate contributions director. “Why would we fund a program for nurses aides?” Adds Bissell just as bluntly, “We don’t do funding for the arts.”

Tying Community Gifts to the Corporate Bottom Line

According to industry experts and the best available statistics, what’s happening at Raytheon in Tucson is one facet of a broad, historic shift in the nature of corporate philanthropy nationwide – and beyond. Although it goes by a variety of names – strategic philanthropy, cause marketing, values-led marketing, or just plain corporate citizenship, what is happening here is clear: In an attempt to become more strategic in their philanthropy, corporate donors are tying their gifts more closely to their company’s business objectives, short-, medium-, and long-term. “Where ten years ago a corporation might fund just about anything the office felt was a good cause, now they tie the giving directly to the bottom line,” observes John Harvey, executive director of Grantmakers Without Borders, a global network of donors and foundations.

Tucson's symphony: No longer such a beneficiary

Recently the pace of change has become quite dramatic, according to the Committee to Encourage Corporate Philanthropy (CECP), whose 100 CEO and chairperson membership represents companies that account for about 45 percent of reported corporate giving.¹ Between 2002 and 2003, for example, “traditional” charitable philanthropy by CECP members declined from nearly 60 percent to the low forties; “strategic” giving rose 15 percent, and “commercial” – strictly sponsorship – doubled, from less than 10 percent to nearly 20 percent.

Many reasons are cited for this trend: At a time of heightened competition, economic downturn, corporate scandals, and belt-tightening that reduces money for advertising, companies are seeking to differentiate themselves as they woo customers and attract and retain employees. In addition, corporations that until a decade or so ago still considered themselves to have a local base somewhere, increasingly are seeing themselves as global entities with global audiences. Since social needs, and the nonprofit organizations set up to meet them, are local by nature, it can be harder to make their case to a corporation that no longer considers itself so much a member of the local community as a citizen of the world.

In addition, corporate philanthropists, like many other types of donors, are becoming more focused on having a measurable impact with their gifts. In a recent roundtable with SSIR, several corporate CEOs pointed to the importance of having a focus to their company’s philanthropy in order to achieve results. Not surprisingly, this broad change in corporate giving patterns is starting to ring alarm bells throughout the nonprofit world. “Companies are giving money for sexy cause-marketing on the issues of the day, and to that end are very savvy about publicity,” says Steven A. Rochlin, director of research and policy development at Boston College’s Center for Corporate Citizenship. “Meanwhile, they are leaving out groups that are doing critical work but are not grabbing the headlines.”

Mary Biasotti, economic development director for Harbor House Ministries Inc., a small Oakland, Calif., nonprofit that offers English classes to immigrants and emergency food to the hungry, agrees. “Corporations want to attach themselves to an entity that is regionally or nationally known,” laments Biasotti, leaving organizations such as hers to fend for themselves.

“It’s like it’s got to be Mom or apple pie – cancer research, the homeless, or food for the hungry,” complains David A. Nuttle, president of Needful Provision Inc., a small nonprofit in northeastern Oklahoma engaged in a variety of local projects such as supporting Laotian refugees. “We’re trying to do niche areas, but it’s tough. Smaller causes like ours just can’t get that corporate support. I sometimes worry the steamroller will just run over us.”

Even though corporate foundations account directly for only about 6 percent of overall philanthropy in the United States, the disruption for community groups who depend on it is real. “Even people in corporations who we know well and are devoted to the orchestra are telling us quite honestly, ‘I have to listen to my marketing director,’” laments Susan Franano, executive director of the Tucson Symphony Orchestra, which formerly benefited from Raytheon’s largesse. “Nowadays if you don’t – or can’t – offer concrete ways for businesses to connect with your audience or your cause, your chances of funding from corporations are probably not really very good anymore.”

For Some Execs, Philanthropy Is Just Another Word for PR

The changes in giving patterns are engendering controversy inside the corporations as well as the nonprofits. “There is a large, extended community of people within the world of corporate philanthropy who are absolutely fed up and have had it with this,” said the director of philanthropy for a major technology corporation. “Does it actually help anyone but the corporation? How many times does it even cover the cost of sponsorship, when you take out base pay and other costs? Do corporations support groups that are part of the solution – or Band-Aids?”

Indeed, not all corporate philanthropists are joining the trend – several high-profile firms such as Goldman Sachs and eBay continue to make a broad array of donations to groups unrelated to their specific business objectives.

Nevertheless, the overall trend line seems well established. Doug Guthrie, an economic sociologist at New York University who specializes in organizational theory and corporate giving, says: “Philanthropy is increasingly related to the bottom line. There’s a market logic that has really won the day. The fact that corporations define whether or not they should be positively engaged with communities as being a business issue is very problematic for the whole field.”

The many quiet contributions by corporate foundations in years past to a variety of deserving comers have, in many instances, given way to the publicized marathon, glitzy charity ball, the star-studded golf tournament, and even, in one instance, a national bake sale designed to promote products and brands on network TV and in national magazines.

The chosen ones – causes and organizations selected by corporate foundations in longer-term marketing relationships – sometimes reap huge rewards, and still more support, from their participation and increased visibility. The companies, meanwhile, believe these gifts enhance revenues and reputations, distinguish themselves from competitors while building customer and employee loyalty, solidifying relationships with business partners, selling more goods, and spreading goodwill.

Corporate executives realize, of course, that this approach overlooks many worthy causes. “There are some incredible needs out there,” acknowledges Anita Wheeler, president of the ConAgra Foods Foundation: “Physical suffering, human disease, social services, domestic violence, research needs – so much.” But she concedes that her company’s donations do not directly address those needs. Rather, ConAgra, which is among North America’s largest packaged foods manufacturers with annual revenues of $14 billion² (and brands like Butterball turkeys, Orville Redenbacher popcorn, and Chef Boyardee), devotes the majority of its philanthropy to one cause – albeit an important one – combating childhood hunger.

ConAgra underwrites 130 after school “cafés” in 37 states that serve hungry children hot meals,³ and a program that contributes hundreds of thousands of pounds of food to America’s Second Harvest, the nation’s largest hunger-relief organization, through a network of over 200 regional food banks.⁴ The company’s name is prominently displayed in the cafés and in media coverage of its efforts.

“What do we hope? That over time consumers will think: ‘Oh! ConAgra Foods! I really like their products and they are doing some good things and that makes me feel good about their company and want to buy their products,’” explains Wheeler. “It’s about reputation.” It’s also about sales: Just one cause-and-marketing promotion involving ConAgra’s County Line cheese in the fall of 2000, in which customers who bought cheese were told they were also helping feed hungry children, exceeded sales expectations by 16 percent.⁵

Critics of tying philanthropy too closely to short-term objectives such as sales increases include Michael E. Porter, a Harvard Business School specialist in competitive strategy, and Mark R. Kramer, managing director of the Foundation Strategy Group, who are also co-founders of the Center for Effective Philanthropy in Cambridge. “What passes for strategic philanthropy is almost never truly strategic, and often isn’t particularly effective as philanthropy,” they wrote in the Harvard Business Review. “Increasingly, philanthropy is used as a form of public relations or advertising.”⁶

Blending Philanthropy With Core Business Strategies

One promoter of the changing emphasis in corporate giving believes that nonprofits will eventually benefit from greater corporate investment in what she calls “cause branding.” “It’s not about pure philanthropy anymore, quietly giving,” says Carol Cone of marketing consultant Cone, Inc. “It’s about business strategy, attracting the best employees, earning the license to operate, differentiating your brand in a competitive environment, deepening relationships with core stakeholders. It’s no longer a ‘nice-to-do.’ It’s a ‘have-to-do.’”

A November 2004 analysis in Business Week cited evidence in support of this view: “Supporting a popular cause is no longer optional. It’s what you have to do just to get to the starting line with the newest generation of customers.”⁷ Spending on cause marketing has risen from $835 million in 2002 to perhaps $1.08 billion this year, up 58 percent from 1999, according to estimates by the IEG Sponsorship Report, a Chicago trade publication.⁸ Back in 1990, IEG tallied cause sponsorship spending at only around $120 million.⁹

There is some evidence that the strategy works to build brand loyalty among consumers. In a 2003 survey of teens by Alloy Inc., a youth marketing firm, 60 percent said they were more likely to buy from brands that support charitable causes they care about.¹⁰ When price and quality are equal, 86 percent of Americans would actually switch brands to help support a cause, according to a December 2004 Cone study.¹¹ A 2001 study estimated that 88 percent of employees aware of cause-related programs at their companies feel a “strong sense of loyalty” to their employers, while 53 percent chose to work there because of the programs.¹²

This modern marriage between marketing and social beneficence involves longer-term alliances that reinforce business relationships, enhance sales, and draw new customers using a wide range of integrated tactics, from enlisting business partners and employees as volunteers to major media campaigns.

Each year, a group called Share Our Strength organizes a “Great American Bake Sale” involving PARADE Magazine, ABC News, and the Betty Crocker division of General Mills. Stars from shows like “George Lopez,” “Hope & Faith,” “Married to the Kellys,” and “Life With Bonnie” participate on the shows.¹³ For its part, Betty Crocker wants to drive sales. ABC wants more people watching its network. The magazine, meanwhile, seeks to reinforce advertising relationships. Ordinary people do a lot of the heavy lifting, or baking – Girl Scout troops, college students, and others. Proceeds from their bake sales since 2003, sent to Share Our Strength, have amounted to $2.7 million.¹⁴

“In many cases today, the business objective is the primary motivation and the philanthropy is secondary,” explains Howard Byck, Share Our Strength’s chief director of creative enterprise and marketing. Byck says that means that many companies will no longer contribute or enter into partnerships without being convinced that four conditions can be met: The cause must be relevant to the company’s services and products; there must be a good fit with the company’s brand; the partnership must align well with the corporate mission; and finally, a specific business objective must be achievable through the partnership.

“You can’t just be a worthy cause anymore,” observes Byck. “You’ve got to be a really worthwhile cause – and there have got to be some marketable assets.”

Not every cause, of course, can make the cut. “A corporation that wants a national reach is looking for a national organization,” explains Byck. “If they want to market to your database, you’d better have a database. [The large senior citizens organization] AARP has a huge asset. Our big asset at Share Our Strength is this network of chefs and restaurateurs people want to gain access to. So by the nature of that, some nonprofits are disqualified – the smaller ones, the less sophisticated ones. Even those who have the sophistication but not the assets won’t make it.”

Ask Not: ‘What Can the Corporate Sector Do for Me…’

Hessekiel

Many practitioners of strategic philanthropy say they have no qualms about the changing relationship between corporate donors and nonprofit organizations. “I do not think there is anything shameful about a corporation thinking about business objectives,” says David Hessekiel, whose Cause Marketing Forum, Inc. develops what he terms “mutually beneficial commercial relationships” between companies and causes. The best nonprofit players in cause marketing, he says, are groups such as First Book, experts at generating publicity around book donations. One of the key questions from a corporation’s point of view, he says: “Does the nonprofit bring something to the party?”

People who complain about important causes left behind are “purists,” says Byck. “We aim to make that pie bigger. Some people still want to go the traditional philanthropic route, but it’s better, I think, to help companies achieve business objectives while doing good. The reality is they are rewarded by Wall Street. So if we can help them, and show that, and also help our cause, it’s all to the good.”

Advocates of cause marketing like Carol Cone argue that it provides the kind of boost the Third Sector and society need, especially when government-funded human services are declining and nonprofits are feeling squeezed for dollars. A case in point is the “Grow Up Great” program of Pennsylvania-based PNC Financial Services Group, which supports early childhood education. That focus arose because other banks were “gobbling up market share” and threatening to capture the attention of consumers. The chief executive wanted something to “wrap the brand around.” Cone came up with what she calls “a signature cause program” that would enhance the PNC brand and set it apart from the growing competition.

“Everybody says, ‘Why is a bank doing this?’” Cone acknowledges. “Well, if a bank doesn’t have a strong presence in its communities it won’t have a good business.” PNC garners, in effect, free advertising noticed by an estimated 564 million readers or viewers.¹⁵ Instead of having to buy expensive airtime, TV stations report vignettes on newscasts about early childhood, and offer time for free public service announcements, known as PSAs, explains Cone, so that “throughout the footprint you hear about all these great things PNC is doing. Does it help the business? Of course.”

There’s another advantage for companies, too – the one many nonprofits fear. “When you do a signature cause program, you can do an exit strategy from other causes and business objectives,” explains Cone. Having a set of factors on which to guide decisions about causes to keep and causes that are a bad match for strategic objectives “allows a company over time to get out of other causes. Over time, they will have a filter for all their philanthropy. In the case of PNC, it must be child-focused or it will not be supported. This can be immensely helpful in making decisions.”

The “filters” will separate the winners from the losers of corporate largesse. Who are the losers in PNC’s case? Like other corporations contacted for this article, the company declined to say, though it did confirm some are important institutions such as community hospitals.

Their flaw: They have nothing to do with the education of young people. “Yes, there are some causes and nonprofits in the communities where we do business where it won’t be a fit anymore,” acknowledges Patrick McMahon, PNC’s vice president for media relations. “Quite frankly, there are other, usually smaller local grants and sponsorships that we simply will no longer do. They don’t fit into the focus.”

What’s a charity to do? “Nonprofits are going to have to be more strategic,” warns Cone, noting that over the long term a “rising tide raises all ships.” She explains: “They’re going to have to offer more. They can’t just be doing good. Smaller nonprofits will have to be more sophisticated about what they deliver, if they want to partner with someone. The whole game has changed.”

1 CECP Web site: http://www.corphilanthropy.org/cdoc/cecp.html.

2 Omaha World-Herald: “ConAgra Foods, Inc.” March 27, 2005.

3 http://www.feedingchildrenbetter.org/pages/ourmission/kidscafe/map/index.jsp.

4 http://www.feedingchildrenbetter.org/pages/ourmission/kidscafe/map/index.jsp, http://www.conagrafoods.com/leadership/community_children.jsp.

5 ConAgra press release: Nov. 14, 2001. “Country Line Promotion Helps Feed Hungry Kids.”

6 “The Competitive Advantage of Corporate Philanthropy,” Harvard Business Review, December 2002.

7 Lauren Grad, “We’re Good Guys, Buy From Us,” Business Week, Nov. 22, 2004.

8 IEG Sponsorship Report: April 11, 2005. Vol. 24, No. 6. http://www.iegsr.com.

9 Cause Marketing Forum: http://www.causemarketingforum.com/page.asp?ID=188.

10 Grad, “We’re Good Guys, Buy From Us.”

11 Cone, Inc. press release. “Multi-year study finds 21% Increase in Americans’ Support of Social Issues,” Dec. 8, 2004.

12 Carol L. Cone, Mark A. Feldman, and Alison T. DaSilva, “Causes and Effects,” Harvard Business Review, July 2003.

13 http://www.greatamericanbakesale.org/site/PageServer?pagename=meet_abc, http://www.strength.org/what/greatamericanbakesale/, http://www.greatamericanbakesale.org/site/PageServer?pagename=meet_home

14 http://www.strength .org/what/greatamericanbakesale/.

15 PRWeek Press Release: March 8, 2005 “PRWeek Awards 2005, Social Education & Philanthropy.”

Minorities and the poor — the largest group of uninsured Americans — suffer disproportionately from health problems. But would guaranteed coverage make everything better?

The short answer: No.

According to a little-noticed finding in a recent Institute of Medicine report: “Health insurance by itself will not eliminate ethnic and socioeconomic disparities in health.” [2]The conclusion is based on a University of California at San Francisco analysis of research spanning 16 years.

“While health insurance may alleviate financial barriers to care and improve the choice of providers,” the analysis said, “it does not address other individual and societal determinants of poor health experienced by ethnic minorities and the disadvantaged.” [3]

In short, the authors cautioned, the United States “should not be content to focus only on insurance [to correct] social disparities in health.” Scandinavia, Japan and the United Kingdom, for example, have failed to erase socioeconomic differences despite their well-established systems of universal health coverage. [4]

Less affluent persons might use a free health system more often, but that hardly guarantees the health outcomes enjoyed by the better off. For instance, a study of death rates among English civil servants — all covered by health insurance — determined that unskilled laborers and clerical staff had the greatest risk of dying within 10 years, while professionals and top administrators could be expected to live longer. [5]

In the United States, many assume that disadvantaged minorities would substantially benefit from equal access to medical practitioners, prevention and treatment. After all, racial and ethnic minorities with incomes below the federal poverty level represent a substantial proportion of the uninsured. Hispanics are three times more likely than whites to lack health insurance, and African-Americans twice as likely. [6]Indeed, some researchers suggest that racial and ethnic differences in health are due mostly to differences in socioeconomic status. [7]

Yet the University of California team showed that better care frequently failed to improve the health of minorities, the poor or the lesser educated. A study of 5,986 men, women and children with one of 17 chronic illnesses, all receiving free care or sharing in the cost, found that the poor were less likely to receive “appropriate” care than their better-off counterparts. [8]

Other studies suggest that the rates of receiving hospitalization and preventive care from health professionals depend not solely on whether people have insurance but also on race and ethnicity. Insurance also could narrow but not close the substantial gaps between the races in mortality — whites live an average six years longer than non-whites. Even when adjusting for differences in income, one-third of the difference in the mortality rate remains. [9]

Several factors tend to offset the potentially positive impact of free insurance on a person’s health, including low literacy skills, which make it harder to either understand a doctor’s instructions or choose between treatments. A person’s health beliefs, lifestyle practices and environmental influences can also affect his health. [10]People who are less educated may be less capable of communicating with a doctor, understand possible risks, appreciate the significance of symptoms, schedule an appointment or manage their conditions. [11]

The prejudices of medical professionals, cross-cultural communication failures and overt discrimination also may play a role, experts say. Other studies suggest an association between poor health and crowded neighborhoods, exposure to stressful life events and the inability to take time off from work to see a doctor.

Said Harold Freeman, president of the Ralph Lauren Cancer Center at New York City’s North General Hospital and for three decades a surgeon in Harlem: “Giving everyone an insurance card won’t solve health disparities.” [12]

[2] Committee on the Consequences of Uninsurance, Institute of Medicine, “Care Without Coverage: Too Little, Too Late,” May 2002. Copies also available athttp://www.nap.edu/.

[3] Jennifer S. Haas and Nancy E. Adler, “The Causes of Vulnerability: Disentangling the Effects of Race, Socioeconomic Status and Insurance Coverage on Health,” Institute of Medicine, October 2001.

[4] A.E. Kunst and J.P. Machenbach, “The Size of Mortality Differences Associated with Educational Level in Nine Industrialized Countries,” American Journal of Public Health, June 1994, pp. 932-937.

[5] M.G. Marmot, M.J. Shipley and G. Rose, “Inequalities in Death: Specific Explanations of a General Pattern?” Lancet, May 1984, pp. 1003-1006.

[6] Institute of Medicine, “Coverage Matters: Insurance and Health Care,” 2001. See also J. Rhodes and M. Chu, “Health Insurance Status of the Civilian Non-Institutionalized Population: 1999,” Agency for Healthcare Research and Policy, 2000.

[7] Paul D. Sorlie et al., “Mortality in the Uninsured Compared with that in Persons with Public and Private Health Insurance,” Archives of Internal Medicine, November 1994, pp. 2409-2416.

[8] The study, known as the “Rand Health Insurance Experiment,” is by R.H. Brook et al.., “Quality of Ambulatory Care: Epidemiology and Comparison by Insurance Status and Income,” Medical Care, May 1990, pp. 392-433.

[9] Jan E. Mutchler and Jeffrey A. Burr, “Racial Differences in Health and Health Care Service Utilization in Later Life: The Effect of Socioeconomic Status,” Journal of Health and Social Behavior, December 1991, pp. 342-356.

[10] Haas and Adler, op. cit., p. 26.

[11] S.K. Behera and Marilyn Winkleby, “Low Awareness of Cardiovascular Disease Risk Among Low-Income African-American Women,” American Journal of Health Promotion, May/June 2000, pp. 301-305.

[12] Quoted in Gabriele Amersbach, “Through the Lens of Race: Unequal Health Care in America,” Harvard Public Health Review, winter 2002.

The quest for guaranteed health care is an old one. Reformers have sought major changes five times during the last century, and at astonishingly regular intervals. From the sweeping pronouncements of Theodore Roosevelt at the dawn of the Progressive Era to President Clinton’s foundering attempts led by first lady Hillary in the mid-1990s, the story mostly repeats: Proposals to expand coverage are often considered but rarely enacted, and then only on a piecemeal basis.

Every 15 years or so, movements arouse great enthusiasm, only to fail spectacularly. [47]In the end, peripheral improvements have benefited specific populations — the elderly, the disabled, low-income children and certain low-income adults. But universal coverage, though enticing to both politicians and the body politic, is as elusive as the Holy Grail.

Theodore Roosevelt’s “Bull Moose” Progressive Party made national health insurance, modeled on workmen’s compensation, a main plank in its party platform in 1912. One of the most sweeping health-reform attempts ever advanced by a presidential candidate, it called for employers, employees and society at large to pay for safeguarding Americans “through insurance” from “the hazards of sickness, accident, invalidism, involuntary unemployment and old age.” [48]

Like every major plan to follow, it went nowhere. And yet certain ideas were set in motion. By 1917, model health-insurance bills began popping up in state legislatures, and in 1929 the forerunner of Blue Cross emerged, establishing the pattern: Major proposal, major defeat, small steps forward.

After Social Security was created in 1935, supporters began urging a second step — a national health-insurance system.

In 1945, President Harry S. Truman sought to include universal health insurance with Social Security, noting that “in a nation as rich as ours, it is a shocking fact that tens of millions lack adequate medical care.” [49]

In a stirring speech four years later, he again declared his commitment: “We need — and we must have without further delay — a system of prepaid medical insurance which will enable every American to afford good medical care.” [50]

Yet Truman faced formidable foes. The AMA branded his plan “socialized medicine.” Enemies kept asking his physician, Wallace H. Graham, “are you a socialist, doctor?” [51]By the end of his time in the White House, Truman had given up his vision of universal coverage.

During World War II, health insurance had become a common employee benefit, primarily as a way to attract workers in a tight labor market. During the four decades after the war, the number of Americans with some form of health insurance increased dramatically. In the 1960s, unions made health benefits a key demand in collective-bargaining negotiations. Many experts believed that because so many workers now could visit the doctor without ever seeing a bill, health insurance actually drove up demand for medical services.

Perhaps because of the growing popularity of health insurance, Truman’s idea of insuring Social Security beneficiaries persisted. In 1965, President Lyndon B. Johnson signed legislation launching Medicare in a ceremony held, as a tribute, in Truman’s hometown of Independence, Mo. It was the cornerstone of Johnson’s so-called Great Society program to end poverty.

Johnson also signed Medicaid into law, providing health benefits for low-income pregnant women and children, disabled Americans and low-income elderly needing long-term care. “No longer will older Americans be denied the healing miracle of modern medicine,” Johnson said. “No longer will illness crush and destroy the savings they have so carefully put away over a lifetime.” [52]

President Richard M. Nixon briefly revived the idea of universal health insurance when he proposed making comprehensive, high-quality health care “within the reach of every American.” In his 1974 State of the Union address, he suggested expanding Medicaid and Medicare to provide health insurance “to millions of Americans who cannot now obtain it or afford it.” [53]His proposal got serious attention in Congress — only to be doomed by the Watergate scandal that engulfed his presidency.

Meanwhile, skyrocketing hospital costs had caught the government’s attention. Nixon and another Republican president embraced HMOs as a way to control costs. In 1973, Nixon signed the Health Maintenance Organization Act, requiring businesses with more than 25 employees to offer at least one HMO as an alternative to conventional insurance. Then, in 1982, President Ronald Reagan gave Medicare patients the option of signing up for an HMO. Managed-care organizations composed of loose networks of doctors began to proliferate, and by 1995, nearly three-quarters of covered workers were insured by an HMO. [54]

Clinton Debacle

Suddenly, in 1991, health care resurfaced as a potent political force. Harris Wofford, an upstart Democratic Senate candidate from Pennsylvania, declared: “If a criminal has a right to a lawyer, working Americans have a right to a doctor.” His message had such appeal that he resoundingly defeated a popular two-time governor.

On the advice of Wofford’s adviser, James Carville, then-Gov. Clinton appropriated Wofford’s thunder, riding the health-care theme to the Democratic nomination in 1992. In his acceptance speech, Clinton vowed to “take on the health-care profiteers and make health care affordable for every family.”

In 1993, Clinton unveiled his “Health Security Act,” a plan largely crafted under the direction of Mrs. Clinton. Employers would pay 80 percent of the premiums to insure all workers, while the government subsidized coverage for everyone else. Clinton said he wanted “to reform the costliest and most wasteful system on the face of the Earth.” [55]

Yet the president’s own party fractured badly. Some Democrats proposed a “single-payer” government system, similar to Canada’s, which would pay private health-care providers. Others sought a scaled-down version of managed competition, which would have failed to guarantee coverage to many Americans. Republicans, meanwhile, preferred compelling every American to buy insurance, using government dollars only to help the poor.

Congressional Republicans accused Clinton of trying to establish yet another inefficient, expensive and uncaring big-government bureaucracy. Hillary Clinton, too, attracted criticism, in part for her secretive management style. A single, compelling television ad, part of a $17 million campaign by the Health Insurance Association of America, also helped torpedo the plan. Its simple message — in which a fictitious couple, Harry and Louise, tried to make sense of the 1,342 pages of details — preyed on public anxieties. Would people still be able to choose their own doctors? Could employers afford to cover workers? Would health-care decisions be left up to government bureaucrats?

Yet some of Clinton’s ideas have been adopted by managed-care plans, helping them achieve some efficiencies and savings. [56]Enrollment exploded between 1986 and 1995, from nearly 26 million to 58 million, according to the American Association of Health Plans — yet people grew disenchanted with having to change doctors, being refused services and losing access to specialists.

Managed care’s unpopularity led to the “patients’ bill of rights” legislation passed by the House last August, which would allow patients to sue their HMOs, but on a limited basis.

Deep-rooted ambivalence underlies America’s stance on health care. It is viewed as a social good, but also a market commodity. Americans seem to consider it a basic need to which everyone is entitled, but also something to be earned that should be subject to free-market forces. One commentator has described the conflict in health care as the “struggle for the soul of health insurance.” [57]

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[47] Jacob S. Hacker and Theda Skocpol, “The New Politics of U.S. Health Policy,” Journal of Health Politics, Policy and Law, April 1997, pp. 315-38.

[48] See Nathan Miller, Theodore Roosevelt: A Life (1992).

[49] State of the Union address, Jan. 5, 1945.

[50] State of the Union address, Jan. 5, 1949.

[51] See Niel M. Johnson, oral history for the Harry S. Truman Library, March 30, 1989.

[52] From a speech at Truman’s home in Independence, Mo., July 30, 1965.

[53] State of the Union address, Jan. 30, 1974.

[54] For background, see Sarah Glazer, “Managed Care,” The CQ Researcher, April 12, 1996, pp. 313-336.

[55] Address to Joint Session of Congress, Sept. 22, 1993.

[56] Health Research and Educational Trust, op. cit. Health-cost increases reached a low in 1996, but then began rising again. Average premiums increased nearly 5 percent in 1999, more than 8 percent in 2000 and 11 percent from mid-2000 to mid-2001.

[57] Deborah Stone, “The Struggle for the Soul of Health Insurance,” Journal of Health Politics, Policy and Law (1993), pp. 287-317. See also Rosemary Stevens, In Sickness and in Wealth: America’s Hospitals in the Twentieth Century (1989).

Drugs for the Elderly

Even before the distractions of national security, an economic slowdown and the deficits in federal and state budgets, few expected much to happen on the health-care front this year.

The Clinton administration’s blistering defeat fragmented and polarized Washington over the subject of health-care reform. With Congress so closely divided, only isolated, dike-plugging initiatives can survive, and action is more likely through the private insurance sector. Meanwhile, the numbers of uninsured undoubtedly will continue rising along with costs.

A longstanding barrier to change is the sheer clout of several players with a lot to win or lose. As commentator Robert G. Evans, a University of British Columbia economics professor, has pointed out, the U.S. health-care system is “inequitable, inefficient, unpopular and spectacularly expensive — but enormously profitable for some Americans.” [58]

The health-care industry, its profits severely diminished from the boom years of the 1990s, zealously guards its turf against any threat to the status quo. Health professionals so far have contributed nearly $58 million to the 2000 and 2002 presidential and congressional political campaigns, and the pharmaceutical industry has donated another $37 million. [59]

Another barrier to change is cost. Late last year, for example, while debating legislation to stimulate the economy, Congress avoided any discussion of extending coverage to all Americans, focusing instead on the less expensive option of providing coverage to those who lose their health insurance after losing their jobs.

But even that debate exposed an underlying fault line almost certain to keep Washington in gridlock. Democrats sought subsidies to help the newly unemployed keep their insurance or to cover them in the Medicaid program. Republicans favored giving the newly uninsured tax credits to help them buy insurance. The same philosophical debate underlies current sparring.

This year, at least one major health-care issue — the cost of prescription drugs for the elderly — appears to be emerging at the top of the political agenda. With both the House and Senate narrowly divided, the balance of power in Washington could rest in the hands of older Americans, who typically play a disproportionate role at the polls in midterm elections.

Winning seven more seats would give the Democrats control of the House; just one seat in the Senate would give Republicans control there. And though the issue certainly isn’t new, the volume at which it is being debated is a new wrinkle. Equally intense is the determination of skirmishing party leaders to pass a measure this year — or blame the opposition for the failure to accomplish anything.

“No senior should be forced to choose between putting food on the table or paying the rent or buying the medicines they need,” declared House Speaker J. Dennis Hastert, R-Ill., in May as he unveiled the Republicans’ $350 billion proposal to add a prescription drug benefit to Medicare. The same day, Senate Democrats unveiled their proposal, with a price tag of $400 billion to $500 billion. Other House Democrats and Senate moderates are working on alternatives, and President Bush has his own 10-year, $190 billion version.

A group supported by the drug industry, the United Seniors Association, launched a $3 million advertising campaign supporting House Republicans. The Democrats, meanwhile, released a video attacking a promise Bush made during the 2000 campaign to “help all people with prescription drugs.” Notes the ad: “By his own estimate, Bush leaves out more than two-thirds of seniors in need of prescription-drug coverage.”

A Republican campaign memo hinted at the reason for all the fuss: “Republicans passing a prescription-drug benefit would go a long way to leaving Democrats with very little on the table to try to use against us” in the midterm elections. [60]

Despite such traditional divisions, some compromise appears in the wind, given the coalescence of the once-adversarial special interests into the Covering the Uninsured coalition. The group, which includes older Americans, doctors, insurance carriers and hospitals as well as consumer and labor groups, is waging a huge media campaign urging an immediate solution to the problem of the uninsured.

Tax Credits

President Bush proposes to help the uninsured buy private health policies by offering tax credits — $1,000 for adults and $2,000 for families — costing a total of $89 billion. But only individuals with incomes below $30,000 or families with incomes below $60,000 would be eligible. “Too many workers get no coverage at all with their jobs,” the president said. Americans should receive “the help they need when they need it.” [61]

Economists at the University of Pennsylvania and Yale University say Bush’s plan could reduce the number of uninsured by about 8 million. The administration estimates that it would help 6 million uninsured people buy health insurance each year, but the amount of the tax credit and its reach are widely viewed as inadequate. [62]

“It’s like throwing a 10-foot rope to someone at the bottom of a 40-foot hole,” says Pollack of Families USA. For instance, a healthy, non-smoking 55-year-old woman living at the federal poverty level — less than $8,860 in income — would still have to spend $4,000 to buy health insurance, he points out.

Moreover, some opponents worry that the president’s proposal could unravel the current employer-based system, which, in effect, indirectly uses premiums of the relatively healthy to cross-subsidize those needing more care.

However, even the most generous expansion of prescription-drug benefits for the elderly or tax credits for select populations would not tackle the larger problems of rising costs and America’s uninsured. Nor will they make up for ground being lost every day, as governments drastically scale back the existing social net.

Shrinking Safety Net

With dwindling discretionary reserves in the federal budget, money for Medicaid and CHIP has vanished, and many private doctors are refusing to accept new Medicare patients, because Medicare HMOs are paying them less. Some Medicare patients who can’t afford drugs are turning to the Veterans Affairs hospital system, where rising numbers of patients and pharmaceutical costs — which have nearly doubled since 1996 — are overwhelming an already strained system.

Recession-crippled state budgets, which partially finance and administer Medicaid and CHIP, are running deficits and anticipate fewer revenues. States are tapping rainy-day funds, laying off employees and making across-the-board cuts. The recession, the economic fallout from Sept. 11 and the explosion in Medicaid spending have caused a $40 billion to $50 billion shortfall — the largest ever — in more than 40 states. Thus, legislatures are trimming services and making cuts in the safety net just when the uninsured need it most.

In Illinois, for example, a “welfare-to-work” initiative during the late 1990s added 100,000 women to Medicaid — yet by the end of 2001 Republican Gov. George Ryan felt compelled to eliminate it. The action netted $17 million in savings and sent many of the women — who work in low-paying jobs that lack benefits — back to the ranks of the uninsured.

“Governors are dealing with unprecedented fiscal pressure,” said Raymond C. Scheppach, executive director of the National Governors’ Association. “The growth rate is simply unsustainable.” With Medicaid at a “breaking point,” states need more than money from Washington. “Absent serious structural changes to the program down the road, states will be unable to meet the needs of recipients.” [63]

Even in better economic times, the safety net misses many. Millions of low-income people who are eligible are not enrolled in government programs. Welfare reform, otherwise known as the Professional Responsibility and Work Opportunity Reconciliation Act of 1996, successfully moved people from cash assistance into jobs — but often into jobs without health coverage. Among women who have been off welfare for more than a year, only half have either Medicaid or private coverage. The other half seek care from strained safety-net institutions like faith-based charities. [64]

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[58] Robert G. Evans, “Sharing the Burden, Containing the Cost: Fundamental Conflicts in Health Care Finance,” in Theodore J. Litman and Leonard S. Robins, Health Politics and Policy (1997).

[59] Center for Responsive Politics, April 2002.

[60] Quoted in The Associated Press, May 9, 2002.

[61] From remarks Feb. 11, 2002, at Medical College of Wisconsin in Milwaukee.

[62] Some 25 percent of the uninsured would have enough money to obtain the policy they need, and another 25 percent would be able to buy policies by adding up to $169 a year per person, according to Mark Pauly and David Song, “Tax Credits, the Distribution of Subsidized Health Insurance Premiums, and the Uninsured,” National Bureau of Economic Research, Working Paper No. 8457, September 2001.

[63] Comments made in releasing the association’s Fiscal Survey of States, May 16, 2002.

[64] B. Garret and J. Holahan, “Health Insurance Coverage After Welfare,” Health Affairs, 19(1), January/February 2000.

The CQ Researcher • June 14, 2002 • VOLUME 12, No. 23
© 2002 Congressional Quarterly, Inc. All rights reserved.

The CQ Researcher • June 14, 2002 • VOLUME 12, No. 23
© 2002 Congressional Quarterly, Inc. All rights reserved.

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Also from Congressional Quarterly Researcher – June 14, 2002:

Universal Health Insurance: Not a Cure-All

Recurring Quest for Health Reform: First Enthusiasm, Then Failure

Local Health Reform: How Tampa Does It?

—————————————————————————–

It did not seem like a big thing. On the swing set at his rural North Carolina preschool three years ago, 5-year-old Dalton Dawes and a classmate bumped into each other. Then began his parents’ worst nightmare.

Dalton is a hemophiliac, and he began to bleed internally. Dalton had been receiving twice-weekly injections of a blood-clotting agent almost since birth. Now he would need them more often.

The drug would do more than simply allow him to live a normal child’s life, playing soccer and roaming the nearby woods. It would keep him from bleeding to death. Yet the family’s health insurer would not provide coverage. Nor could his parents, despite their good jobs, afford the $2,000 weekly expense — for years to come.

So Leonard Poe, a lawyer, and Heather Dawes, a paralegal, impoverished themselves. They sold off land and built a home from logs. They dispensed with the dishwasher and TV. By reducing their earnings to less than $23,000 a year, they qualified for Medicaid, the government health-insurance program for the poor.

After Dalton’s seventh birthday, his parents had to cut their income even further — to $15,492 — in order to remain eligible for Medicaid. Instead, they tried to enroll him in the Children’s Health Insurance Initiative (CHIP).

Congress passed CHIP in 1997 to tackle a worrisome statistic: the roughly 10 million American children whose families lacked health insurance. The largest single expansion of public health coverage in three decades, CHIP took direct aim at families too well off for Medicaid but too poor to afford private insurance.

Expensive medication makes a normal life possible for Dalton Dawes, a hemophiliac in rural North Carolina, but thecost forced his parents to impoverish themselves to qualify for Medicaid coverage.

Unfortunately, North Carolina’s CHIP program had run out of money by March 2001. And there were more than 23,000 other children besides Dalton waiting to join the program.

To keep up Dalton’s medication, his parents relied on drug-company charity and considered moving to a state with a CHIP program that was taking new clients.

By last September, when the North Carolina legislature restarted the program, Dalton had only three weeks’ worth of the life-preserving injections left. [1]

“It’s incredibly depressing,” Heather Dawes says. “The worst thing is, I wasn’t just fighting my own battle. There are millions of people in this county who are cut off from good medical care. They don’t deserve this. It’s awful.”

The United States spends $1.3 trillion on health care each year, more than any other industrialized nation, but it is the only developed country that does not assure universal access to basic health care. Unlike the British or Canadians, for instance, all Americans are not entitled to affordable medicine or treatment — or to keeping their existing coverage if their financial circumstances change. Partly as a result, the United States ranks 37th in the World Health Organization’s ranking of the world’s healthiest countries. [2]

Nearly one in seven Americans — 38.7 million people — lacks insurance, more than the combined populations of Texas, Florida and Connecticut. [3]Eight in 10 of the uninsured are members of working families — too well off for Medicaid and other public programs but too poor to pay private health insurance premiums.

The lack of universal coverage, some critics say, stems from the government’s historically piecemeal approach to health insurance — a complicated patchwork of private and government-subsidized coverage more like a sieve than a shield. And while there has been some progress in recent years — establishing the CHIP program and allowing workers to change or lose a job without losing insurance — many people still fall through the cracks in coverage. [4]For example, only 6 percent of the children eligible for CHIP benefits are enrolled in the program. [5]

The absence of universal health coverage has been called “one of the great, unsolved problems facing the United States at the onset of the 21st century.” [6]

The problem affects Americans regardless of their age, education or place of residence. More than half the uninsured are full-time workers or their dependents. Nearly 20 million are white, 11 million are Hispanic and 7 million are black, according to the Census Bureau. [7] Only Americans over 65 are theoretically assured of health security, through Medicare. But Medicare doesn’t cover the cost of most drugs, and critics say rising drug prices mean seniors are not really protected if they can see doctors but can’t afford the drugs they prescribe.

And the ranks of the uninsured have been rising for most of the last 15 years — even during recent periods of record-breaking economic prosperity. [8]Seven of every 10 American workers depend on their employers for health insurance, but as health-care costs have skyrocketed in recent years, companies have begun asking employees to pay a greater share of the cost, or eliminating coverage entirely. [9]

In Florida, a Chamber of Commerce survey found that only 77 percent of businesses offered health insurance to employees in late 2001, down sharply from 91 percent in 1999. [10]Nationwide, another survey found that 44 percent of U.S. employers were “very” or “somewhat” likely to increase workers’ out-of-pocket premiums during 2002. [11]

Others have solved the problem by downsizing their staffs and outsourcing work to contractors, who by definition do not qualify for medical benefits. During last year’s recession and layoffs, 2.2 million Americans lost their insurance, and a third of them probably lost their health coverage at the same time. [12]

“We face a crisis, and we need to act,” said Yank D. Coble Jr., president of the American Medical Association (AMA). “The good health of our patients — and our security as a nation — depends on it.” [13]

Even before the recession, real income and purchasing power were lagging behind the double-digit rates of inflation for drugs, health services and insurance, which are expected to rise 13 to 16 percent this year. “If we have more years of double-digit increases, people will be priced out of the market,” said Paul B. Ginsburg, president of the Center for Studying Health System Change.

And the situation is likely to get worse. According to the Centers for Medicare and Medicaid Services, health spending will reach $2.8 trillion by 2011 — a staggering 17 percent of the gross domestic product. [14]

Cash-strapped state governments — which pay for the bulk of Medicaid — can’t keep up with spiraling health costs. “Our challenge is to find a way to not cut services when we have less money than we had the year before,” said Gov. Paul E. Patton, D-Ky., vice chairman of the National Governors’ Association (NGA). [15]

State governments, collectively billions of dollars in the red, have begun trimming Medicaid benefits, sparking protests from Hawaii to Arkansas. [16]Dozens of states are trying to force drug manufacturers to provide discounts for the poor. [17]In Mississippi, the Medicaid program ran out of money in March. At least 14 states are considering increasing the eligibility requirements for Medicaid and CHIP, thus reducing the number of people who qualify for those safety-net services.

The health implications of inadequate insurance are stark. The Institute of Medicine estimates that 18,000 Americans die prematurely each year as a result of not having health insurance — usually because they discover too late that they have a treatable disease. [18] Others never receive timely treatment for diabetes, mental illness and other conditions and eventually must be hospitalized, a far more costly solution than early care in a doctor’s office. [19]

“The hard truth is that Americans without health-care coverage live sicker and die younger,” Coble said. “It’s bad fiscal policy. It’s bad public policy. And it’s bad medicine.” [20]

“Charitable physicians and the safety net of community clinics and public hospitals do not substitute for real health coverage,” said Adam Searing, project director of the North Carolina Health Access Coalition. “Need a concrete example? Look no farther than Dalton Dawes.” [21]

The issue brought together two Washington lobbying groups usually on opposite sides of the health-policy debate: the U.S. Chamber of Commerce and the AFL-CIO. In February, they helped create the Covering the Uninsured coalition — along with business groups, consumer and family advocates and health-care providers — dedicated to solving the problem. [22]

Nearly a third of voters want the health-care system “radically changed,” according to Republican pollster Bill McInturff. [23]President Bush has proposed new tax credits to help the uninsured pay for health coverage, a change he said would “reform health care in America.” [24]And both political parties have suggested prescription-drug subsidies for the elderly. [25]

Across the country this year, people are peppering campaigners for Congress with questions about health care. A Colorado candidate for the U.S. Senate expected a coal company executive to quiz him on energy issues — only to have him complain about the company’s $10 million annual bill for retired workers’ prescription drugs. [26]

The problem is hardly new. In 1912, presidential candidate Theodore Roosevelt pledged to make employees, employers and “the people at large” pay for insurance against the “hazards of sickness, accident, invalidism, involuntary unemployment and old age.” His proposal — often repeated by other politicians over the years — was most recently squelched in 1994, when President Bill Clinton’s call for universal coverage foundered spectacularly.

The failure of Clinton’s health-care reform “still hangs like a dark cloud over contemporary health-care debates,” writes Harvard political scientist Jacob Hacker. [27]And this year Washington again shows every sign of deferring the issue. “We’re not going to deal with it in an election year, that’s for sure,” said a key health-policy player, Sen. John B. Breaux, D-La. [28]People of both parties are “scared of being labeled Clintonites,” explained Robert Reischauer, who ran the Congressional Budget Office in 1993. [29]

Thus, while employers, hospitals, doctors and governors clamor for help, health-care proposals now pending in Congress would offer only limited benefits. Lawmakers believe — despite the opinion surveys — that Americans prefer their health-care progress in small doses and do not think a large federal bureaucracy can solve the problem.

Yet, if the situation isn’t remedied, the coming convergence over the next decade of escalating costs, budget shortfalls and vastly increased needs could overwhelm the health-care system and increase the ranks of the uninsured to as many as 61 million. “We are heading for a social and health-care debacle of gigantic proportions,” warned Harold G. Koenig, a professor of medicine at Duke University. [30]

As Congress, the White House and local leaders grapple with the nation’s uninsured, these are some of the questions being debated:

Can America afford health insurance for all?

On the surface, the nation shows every sign of not being able to afford caring for the uninsured and disenfranchised. Community and public health centers, hospital clinics, inpatient facilities and emergency rooms all are showing stresses from government cutbacks. As spending spirals to new levels, states, Congress, employers and insurers all are in the mood to cut and constrain — not add to financial obligations.

The Balanced Budget Act of 1997, for instance, reduced payments to federally licensed community health centers, cut Medicare reimbursement rates to hospitals and prevented hospitals from challenging the adequacy of Medicaid payments. Since then, states have cut back on Medicaid payments, and some large health plans have pulled out of the Medicaid market altogether. Communities are seeking creative solutions, but few at any level of government or industry are saying they can afford more. [31]

But Don Young, president of the Health Insurance Association of America, believes they can. “It’s more of a willingness to pay — and that willingness will have to come from a number of places,” he says. The task could be accomplished with expansions in Medicaid, CHIP, tax credits and tax incentives. “If the American public wants to do it, it is certainly affordable.”

Ron Pollack, executive director of the national consumer organization Families USA, agrees. “Covering the uninsured has never truly been a question of cost,” he says. “We’re the richest nation in the history of the planet. The question is whether we have the political will for it.”

But Kenneth S. Abramowitz, a managing director of the influential Carlyle Group investment firm and a longtime health-industry analyst, says Americans already pay for universal coverage — through higher health-care costs for everyone else.

“When you or I buy insurance — or the company we work for does — we’re paying for the uninsured,” says Abramowitz. Most insurance premiums are inflated by about 12.5 percent, he says, to compensate for non-payment or underpayment by others — a system called “cost shifting.”

The uninsured are “freeloaders,” he says bluntly. “When someone shoplifts a sweater, the rest of us have to pay for the sweater because it costs us more. The [uninsured] are shoplifters.”

Young admits that hospital revenues run at about 114 percent of costs — so the excess can subsidize the uninsured. Also, Medicare and Medicaid compensate hospitals that serve predominantly poor populations at a higher rate than other hospitals. “Those hidden costs are there,” Young says. “The uninsured are being covered — they’re getting services, paid for by the government through tax dollars and subsidies from private insurers.”

Abramowitz estimates that half the cost of any hypothetical government program to cover the uninsured is already being spent on the uninsured. It would cost less, he says, to compel every citizen to buy health insurance, with the poor receiving government vouchers for part of the cost and the poorest receiving certificates covering the entire amount. Others would receive tax credits, and employers would receive tax deductions.

“It would be cheaper — and everybody would be covered,” he says, estimating a total cost of between $11 billion and $86 billion a year. [32]

Under the current system, the uninsured end up using emergency rooms for most of their care because they tend to wait until their condition is critical before seeking care at hospitals, which must treat them. Research for the National Health Policy Forum shows that about three-fourths of all emergency room (ER) visits in which patients are not admitted should have been treated elsewhere.

Because ER care is one of the costliest forms of treatment, the current system helps drive up health-care costs, critics say. The lack of universal coverage prevents the poor from getting treatment more cheaply — in a primary physician’s office when their ailments are in their infancy — thus fueling the increase in health-care costs.

When the uninsured cannot afford emergency care, hospitals, businesses, insurers and taxpayers pick up the tab. Hospitals alone absorb an estimated $19 billion per year in uncompensated care for the uninsured. [33]

Such uncovered care amounts to “an unlegislated tax,” says Peter Schonfeld, senior vice president for policy of the Michigan Health and Hospital Association. Because legislators don’t want to raise taxes, he says, “They shift the cost elsewhere, hiding it from the public.”

And the hidden “tax” is going up. The number of emergency room visits increased 15 percent nationally between 1990 and 1999, according to the American Hospital Association, largely due to a surge in uninsured visits. In California, 82 percent of the more than 9.2 million patients who are treated in emergency rooms each year cost the hospitals money — up to $48 in uncompensated care per visit. [34]

Because of the overuse of emergency rooms and state and federal cutbacks in hospital reimbursements for Medicaid and Medicare patients, hospitals nationwide have begun diverting patients to other facilities. A survey by the Democratic staff of the House Government Reform Committee found that overcrowded ERs are causing “substantial problems accessing emergency services” in 22 states — especially in cities with large numbers of uninsured residents. Some hospitals simply close their doors to those unable to pay and for whom the hospital could collect no compensation elsewhere. [35]

More than 90 percent of large hospitals with 300 beds or more report emergency rooms at — or “over” — capacity. Hospitals over capacity place patients in other areas, such as hallways. [36]

“Unless the problem is solved in the near future,” cautioned the Annals of Emergency Medicine, “the general public may no longer be able to rely on emergency departments for quality and timely emergency care, placing the people of this country at risk.” [37]

An unprecedented alliance of normally adversarial business and consumer groups known as the Covering the Uninsured coalition has launched a nationwide publicity campaign to raise awareness about the 39 million Americans who lack health insurance. Covering the Uninsured Coalition

Should Medicare cover prescription drugs for the poorest seniors?

If Congress does anything on health care this year, it most likely will involve a distinct population already receiving huge publicly financed benefits — seniors and disabled persons enrolled in Medicare. Currently, Medicare covers only a few drugs, such as certain cancer medications. Some seniors purchase supplemental coverage — such as Medigap or Medicare + Choice, and some states provide additional coverage for services or prescriptions.

President Bush, members of both parties in Congress and a wide range of interest groups want the government to subsidize the skyrocketing cost of pharmaceuticals for Medicare recipients. Their interest in the issue is not only a sign of the problem — but also of politics: The more than 10 million seniors and persons with disabilities who lack prescription-drug coverage could be critical to the outcome of midterm congressional elections this year, which could alter the balance of power in Washington.

Seniors and the disabled — among the nation’s most dependent users of medications — often must pay full price for drugs, while those with private group insurance plans often pay less because of their company’s purchasing power. For instance, a cholesterol-lowering medication can cost a senior more than $300 for three months, compared with only about $50 for someone with private insurance.

The big question for lawmakers is not whether to add prescription benefits to Medicare but how many seniors to give it to — in other words, how to pay for it. Facing a budget deficit, even the smallest new benefit would hit taxpayers hard.

The president wants to spend $190 billion over the next 10 years to provide free prescriptions to any Medicare recipient with an annual income under $11,610, or couples earning up to $17,415. The proposal is especially controversial because Medicare has never had salary caps before. Opponents say providing benefits only to the lowest-income seniors undermines Medicare’s original covenant with the elderly — to provide coverage to every person over 65, regardless of income. Otherwise, they argue, Medicare becomes a welfare program.

Nevertheless, House Republicans propose covering only the poorest seniors: The plan calls for the government covering part of the first $5,000 a year in drug expenses, and everything above $5,000. Seniors would pay $37 in monthly premiums. The plan would cost the government $350 billion and benefit only half the nation’s Medicare recipients. Couples with incomes over $18,000, or individuals earning above $13,000, would not be covered.

Republicans argue that in belt-tightening times — and when so much money is being diverted to fight terrorism — benefits should go to those who need them most. They point out that Medicare beneficiaries who can afford it already pay for supplemental coverage, some of which covers prescriptions. Providing free drugs for all seniors could “bankrupt the program,” hurting all Medicare beneficiaries, according to a GOP “Talking Points” memo prepared for House members. Instead, it suggested, any solution should focus on the 35 percent of Medicare recipients “who truly need a prescription-drug benefit.”

In the Senate, Democrats propose spending up to $500 billion, arguing that Bush’s plan only covers 3 million seniors — a third of those needing help. “The best way to help low-income seniors is to help all seniors,” says Rep. John D. Dingell, D-Mich. The president’s proposals are “temporary solutions” that “ignore the larger task at hand” — creating a universal Medicare drug benefit.

AARP, the influential seniors’ lobby, estimates it would cost around $750 million to cover prescription-drug benefits to every American over 65. Without it, the group says, millions of elderly Americans will continue the dangerous practices they now use to stretch their medicine budgets: skipping doses, splitting pills and sharing medications with friends.

Some seniors go without pills entirely. In a 1995 survey, Medicare beneficiaries lacking drug coverage were less likely than those with drug coverage to fill prescriptions for anti-hypertensive medications needed to lower the risk of heart attack, heart failure, stroke and kidney failure. [38]

The average Medicare beneficiary with drug coverage fills 22 prescriptions per year, while those without it fill just 14. The ramifications are clear: Those in poor health take far fewer medications than their healthy counterparts. [39]

Price discrimination is not unique to the drug industry. Business travelers, for example, pay much higher airline fares than leisure travelers. In the pharmaceutical world, health maintenance organizations (HMOs) and benefits plan administrators negotiate price breaks.

HMOs and other “third-party” buyers account for more than 90 percent of all pharmaceutical sales. By purchasing large volumes of drugs, they can negotiate steep discounts, sometimes shaving 25 percent or more off the price of a drug. In addition, state prescription-drug assistance plans, programs sponsored by pharmaceutical companies and organizations like AARP offer discounts and other benefits to distinct populations. But uninsured consumers enjoy no such clout.

Meanwhile, average prescription-drug prices have doubled in the past decade. [40]Drug companies have resisted lowering prices, arguing that research, development and testing represent a huge investment, not to mention a high risk.

Clinical trials are more complex and costs have increased, noted an August 2001 Ernst & Young analysis for the Pharmaceutical Research and Manufacturers of America. One successful pill can represent 10-15 years and $802 million of research and development, as the medicine moves from the laboratory bench to the pharmacy shelf, says the analysis. Only three of 10 marketed drugs produce revenues that match or exceed average development costs.

However, rising drug prices could drive up the cost of an eventual Medicare drug benefit, making it impossible to calculate the long-term price tag for a new Medicare benefit. And once in place, such a benefit — despite its high cost or federal budget shortfalls — would be difficult to withdraw. Programs with such a large and influential constituency are not easily eliminated.

Thus, some policymakers have suggested imposing price controls on prescription drugs. The pharmaceutical industry opposes price controls, arguing they would have a chilling effect on the quest for cures and would impede free-market forces.

Adding a prescription-drug benefit to Medicare is widely viewed as in keeping with Medicare’s original intent of lessening the burden of health care for all seniors. Nevertheless, both supporters and opponents of Medicare benefits for prescription drugs lament that the nation’s biggest health problem — uninsured Americans — remains unaddressed.

“It’s really a shame the focus is so much on drugs for seniors,” says Chip Kahn, president of the Federation of American Hospitals, “when most of the uninsured are low-income working families. They’re the ones who are totally exposed.”

Should small businesses be allowed to band together to buy health insurance for their employees?

Ninety-nine percent of the nation’s big companies (those with more than 200 employees) offer tax-subsidized health benefits, which cost the average worker about $2,426 a year. Because large employers enjoy greater economies of scale and can pool their risk, their employees pay considerably less than if they purchased health insurance individually.

But small-business owners like John Nicholson, who operates a flower shop in Arlington, Va., have no such purchasing clout. Nicholson could not afford coverage for his 10 employees, and most insurers offered no policies appropriate for a small work force. Eventually, he signed up with a local HMO, paying $3,300 per worker. [41]

Soaring health-care costs hit small businesses harder than larger companies, and their premium rates are rising faster. But it’s not just a problem for employers. Since a large percentage of all employees work for small businesses, the lack of affordable health insurance among small businesses dramatically impacts the nation’s overall health-care costs. [42]In fact, a third of uninsured Americans work for employers that do not offer any health coverage, and 82 percent of the uninsured are members of families in which at least one person works part or full time. [43]

And the situation is getting worse: Small businesses’ cost of insuring employees is expected to jump as much as 20 percent this year — on top of a 10-12 percent increase over the last three years. In some parts of the country, the situation is even more severe. Annual premium increases for small-business owners in Florida were expected to go up 20-30 percent this year, according to the National Federation of Independent Businesses of Florida. [44]

After at least four years of aggressive lobbying for a change, small businesses and their employees may finally be close to having an alternative. Proposed patients’-rights legislation allows small employers to band together across state lines to buy health insurance, giving them greater power to bargain for prices and coverage. The legislation passed the House last August and is awaiting Senate action.

The proposed law would permit trade and professional organizations like the National Restaurant Association or the U.S. Chamber of Commerce to sponsor and negotiate not-for-profit health-care plans known as association health plans. In theory, efficiencies and savings would be passed along to employers and employees through lower premiums.

The measure faces formidable opposition in the Senate, which agreed to a patients’-rights bill — giving patients more of a voice in their treatment by HMOs — but excluded any provision for association health plans. Similar bills passed the House four times in recent years, only to languish in the Senate, where they couldn’t garner sufficient support because of pressure from the insurance industry.

This year, with intensifying pressure to tackle health costs, the tide finally may turn in the Senate. Association health plans are attractive to many, including President Bush, because — at least in theory — they promise to add working Americans to the ranks of the privately insured without spending a dime of public money.

“Before adding millions in new federal spending and more mandates, shouldn’t we look for free-market solutions that empower individuals?” Dan Danner, senior vice president of the National Federation of Small Business, asked the House in a letter a year ago. [45]

The Blue Cross and Blue Shield Association, the dominant small-business health insurer in at least half the states, opposes the measure. Danner told the House the group opposes it because “they’re against anything that forces them to compete for business.”

But Mary Nell Lehnhard, a Blue Cross senior vice president, called the current proposal for association plans “a shell game rather than a serious proposal for the uninsured.”

Because the House stipulated that the new plans should not be regulated by the states, they would provide only temporary savings and trigger a collapse of the state-regulated market, Lehnhard said, leading to a return to higher premiums and undoing years of reforms.

Pollack of Families USA said that without being subject to state rules, association plans could exclude mental health services or home health care and might engage in discriminatory underwriting. For example, he said, benefit packages could be designed to attract healthy people, while discouraging sick people from joining. As a result, Pollack says that while he supports businesses banding together to buy insurance, “the measure approved by the House could make the problems existing today even worse.”

The NGA supports the idea, but not the bill. State oversight is necessary, the governors say, “to protect consumers and small businesses from fraud and abuse and underinsurance.” [46]

But Kahn of the hospital federation counters, “Nothing that expands health coverage to more people will be ideal,” he says. “We’re not talking about Cadillacs here; we’re talking about Chevys, at best. But at least we’re talking about Chevys for people who now have no car at all.”

Just how many people would be newly insured? The Congressional Budget Office (CBO) foresees the innovation worsening conditions for four in five workers. It says 20 million employees would face increases in premiums, while insurance would be less expensive for 4.6 million. Meanwhile, only 330,000 of the uninsured would gain coverage, the CBO said.

But a public-policy research firm, CONSAD, estimates that the measure would extend benefits to 4.5 million workers at affordable rates. According to former Rep. Jim Talent, R-Mo., small businesses could save 10-20 percent in health-care costs.

The key, Talent said, lies in breaking the grip of the Blue Cross monopolies — and conventional wisdom. “Nobody questions that big businesses can offer comprehensive plans,” Talent said. “But for some reason, they seem to distrust small businesses.”

♦  ♦  ♦

Also in this issue of Congressional Quarterly Researcher:

Universal Health Insurance: Not a Cure-All

Recurring Quest for Health Reform: First Enthusiasm, Then Failure

Local Health Reform: How Tampa Does It?

♦  ♦  ♦

[1] Dawes’ plight is described in Trish Wilson, “Kids’ Insurance Needs CPR,” News and Observer, March 9, 2001, and Karen Tumulty, “Health Care Has a Relapse,” Time, March 11, 2002, p. 42.

[2] World Health Organization, “World Health Report,” 2000.

[3] “Health Insurance Coverage 2000,” U.S. Census Bureau, Sept. 28, 2001.

[4] Terminated workers can continue the same health coverage for 18 months under COBRA, the Consolidated Omnibus Budget Reconciliation Act of 1995, which became law in 1996.

[5] See Elizabeth Simpson, “State Reaches Out to Uninsured,” Virginian-Pilot/Ledger Star, March 7, 2002.

[6] Karen Davis, “Universal Coverage in the United States: Lessons from Experience of the 20th Century,” Journal of Urban Health: Bulletin of the New York Academy of Medicine 78 (March 2001), p. 46-58.

[7] Census Bureau, op. cit.

[8] John Holahan and Johnny Kim, “Why Does the Number of Uninsured Americans Continue to Grow?” Health Affairs, July/August 2000, pp. 188-196.

[9] Census Bureau, op. cit.

[10] Florida Chamber of Commerce Federation, Jan. 24, 2002.

[11] “Employer Health Benefits: 2001 Annual Survey,” Kaiser Family Foundation and Health Research and Educational Trust, September 2001.

[12] Jeanne Lambrew, “How the Slowing Economy Threatens Employer-Based Health Insurance,” Commonwealth Fund, November 2001. Paul Fronstin, “Sources of Health Insurance and Characteristics of the Uninsured: Analysis of the March 2000 Current Population Survey,” Issue Brief No. 228, Employee Benefit Research Institute, 2000.

[13] Press conference, Coalition to Cover the Uninsured, Washington, D.C., Feb. 12, 2002.

[14] Mary Agnes Carey, “Analysts See a Seismic Shift in Health Policy Debate,” CQ Weekly, March 23, 2002.

[15] Ibid.

[16] In their biennial reports, the National Governors’ Association and National Association of State Budget Officers blamed the recession, fallout from the Sept. 11 terrorist attacks and Medicaid cost increases for creating a record $40 billion to $50 billion budget shortfall in more than 40 states in fiscal 2002. Meanwhile, 28 states had combined deficits of $7.1 billion in their Medicaid budgets.

[17] A federal judge in March 2002 allowed Maine to force pharmaceutical makers to provide discounts of up to 25 percent for those with incomes 300 percent of the poverty level. Under Maine’s law, the state would leverage its buying clout — $210 million in Medicaid drug purchases — to negotiate discounted prices for the 325,000 residents who lack health insurance and are not covered by Medicaid. If the drug makers refuse, the state could impose price caps in 2003. The industry is appealing the decision in Pharmaceutical Research and Manufacturers of America v. Commissioner, Maine Department of Human Services. The 1st U.S. Circuit Court of Appeals in Boston is considering the earlier ruling by U.S. District Judge D. Brock Hornby.

[18] “Care Without Coverage: Too Little Too Late,” Institute of Medicine, National Academy of Sciences, May 2002.

[19] Paul W. Newacheck, “Health Insurance Access to Primary Care for Children,” The New England Journal of Medicine, May 15, 2000, pp. 513-519.

[20] Quoted in Vicki Kemper, “Unlikely Coalition Declares Health Care Crisis,” Los Angeles Times, Feb. 13, 2002, p. A30.

[21] North Carolina Health Access Coalition newsletter, op. cit.

[22] The coalition also includes the American Medical Association, Service Employees International Union, Business Roundtable, American Nurses Association, Health Insurance Association of America, Families USA, American Hospital Association, Federation of American Hospitals, Catholic Health Association, AARP and the Robert Wood Johnson Foundation.

[23] From a September 2001 survey for the Institute for Legal Reform and the U.S. Chamber of Commerce.

[24] Speech at the Medical College of Wisconsin in Milwaukee, Feb. 25, 2002.

[25] For background, see Adriel Bettelheim, “Drugmakers Under Siege,” The CQ Researcher, Sept. 3, 1999, pp. 753-776, and Julie Rovner, “Prescription Drug Prices,” The CQ Researcher, July 17, 1992, pp. 597-620.

[26] Tumulty, op. cit.

[27] Jacob Hacker, “Health Care Reform: A Century of Defeat,” Harvard Health Policy Review, fall 2000.

[28] Carey, op. cit.

[29] Quoted in David Wessel, “After a Few Years of Relaxation, Health-Care Costs Rise Again,” The Wall Street Journal, May 9, 2002.

[30] Quoted in Bob Condor, “Look Beyond Politics Before Writing Off the Faith-Based Initiative,” Chicago Tribune, March 18, 2001, p. C3.

[31] For background, see Adriel Bettelheim, “Hospitals’ Financial Woes,” The CQ Researcher, Aug. 13, 1999, pp. 689-704.

[32] The amount depends largely on the breadth of benefits that would be offered, he says.

[33] Cited in testimony by Mary R. Grealy, president, Healthcare Leadership Council, House Energy and Commerce Subcommittee on Health, Feb. 28, 2002. HLC members include CEOs of pharmaceutical companies and major hospitals and clinics.

[34] California Medical Association figures, as of November 2001, cited by Norman Label, president, Emergency Physicians Medical Group, writing in the Sacramento, Calif., Business Journal, Feb. 1, 2002.

[35] “Emergency Crews Worry as Hospitals Say ‘No Vacancy,’ ” The New York Times, Dec. 17, 2000. See also “Trouble in the ER,” National Journal, May 19, 2001.

[36] “Emergency Department Overload: A Growing Crisis,” The Lewin Group for the American Hospital Association, April 2002.

[37] Robert W. Derlet and John R. Richards, “Overcrowding in the nation’s emergency departments: Complex causes and disturbing effects,” Annals of Emergency Medicine, January 2000, pp. 63-68.

[38] Jan Blustein, “Drug Coverage and Drug Purchases by Medicare Beneficiaries with Hypertension,” Health Affairs, March/April 2000, pp. 219-230.

[39] J.A. Poisal and L. Murray, “Growing Differences Between Medicare Beneficiaries With and Without Drug Coverage,” Health Affairs, March/April 2001, pp. 74-85.

[40] AARP Bulletin, March 2002.

[41] See J. Gabel et al, “Class and Benefits at the Workplace,” Health Affairs, May/June 1999, pp. 144-150.

[42] Small Business Administration, www.sba.gov/ advo/stats/sbfaq.txt

[43] Catherine Hoffman and Mary Pohl, Health Insurance Coverage in America: 1999 Data Update, Kaiser Commission on Medicaid and the Uninsured, 2000.

[44] National Federation of Independent Business (nationwide data); for Florida, “Florida’s Small Businesses Struggle with Rapidly Rising Health Insurance Costs,” Florida Times-Union, April 8, 2002.

[45] Letter to House of Representatives, March 2001.

[46] National Governors’ Association, position paper. www.nga.org.

The CQ Researcher • June 14, 2002 • VOLUME 12, No. 23
© 2002 Congressional Quarterly, Inc. All rights reserved.

A Boom for Tax Prep

New tax breaks will drive fresh customers to H&R Block, Liberty Tax, and others. But the IRS fears increased fraud in the unregulated industry

BusinessWeek – April 2, 2009

By Ben Elgin, Keith Epstein and Brian Grow

As federal stimulus dollars begin to flow, one unlikely beneficiary is the $30 billion tax-preparation industry. Prep specialists from top dog H&R Block on down are celebrating as the Apr. 15 deadline approaches. The fresh treat: billions of dollars in new and expanded tax credits for individuals and small companies.

The good news for tax preparers could turn into bad news for the IRS, however, as well as an early illustration of what might be many unintended consequences stemming from the stimulus.

Tax-prep pioneer John Hewitt calls the huge federal spending package “the H&R Block and Liberty Tax Stimulus Plan.” Twenty-seven years ago, Hewitt founded Jackson Hewitt Tax Service, the second-largest chain in the business. He now runs No. 3 Liberty Tax Service.

Hewitt has instructed his staff to explore leasing additional stores being vacated by Starbucks and other victims of the recession. “I love it whenever [lawmakers] pass tax changes,” he says. “This one helps us because there are more tax changes that affect more people than any bill I’ve ever seen.”

Tax advocate Nina E. Olson

The mood is less cheerful at the IRS. Officials there are girding for a wave of questionable credit claims and outright fraud. A major problem, explains Nina E. Olson, the IRS taxpayer advocate (or ombudsman), is that most tax preparers are unregulated. The vast majority aren’t licensed accountants or lawyers. Only three states—California, Maryland, and Oregon—certify tax preparers. In an industry of more than 1 million service providers, the IRS imposes fewer than 300 penalties a year, most quite modest.

“There are too many areas of this country where you have to go through more work to be licensed as a beautician than to do someone’s taxes,” says Representative Xavier Becerra of California. A senior Democrat on the House Ways & Means Committee, he plans to introduce legislation this year to require that all preparers register with the IRS.

Olson fears that preparers will exploit the stimulus initiative’s multibillion-dollar expansion of the Earned Income Tax Credit, which last year transferred $47 billion to low-income families. The inspector general of the Treasury Dept. estimates that, even before the stimulus, the EITC was resulting in $10 billion to $13 billion a year in improper claims, many of which the agency contends are encouraged by unscrupulous preparers. While prep companies aren’t supposed to charge fees based on how much money they obtain from the IRS, in practice many set higher prices for customers seeking refunds.

The stimulus package also includes new or enlarged tax benefits for small businesses, first-time home buyers, certain parents and retirees, and people who improve the energy efficiency of their dwellings—all of which are susceptible to abuse in the hands of dishonest or incompetent tax preparers, says Olson. “Some of the provisions in the economic stimulus legislation will dwarf the EITC in terms of rate of fraud,” she predicts.

An estimated 60% of all tax returns are handled by paid preparers, up from 48% in 1990. The preparers have plenty to dig their teeth into: The stimulus legislation enacted in February provides for $154 billion in additional refundable tax credits to families and small businesses over the next three years. Using proprietary software, prep companies charge $200 to $450 for a basic return, with the fees often set toward the high end of the range if the taxpayer receives a credit-related refund. This creates a strong incentive to encourage customers to seek credits based on their income, number of children, willingness to insulate their homes, or a purchase of real estate.

Even when done properly, the tax-prep business can yield impressive profits. “We were charging people $300 to $400 for 10 minutes of work,” says Greg Gillihan, who ran a franchise in Kansas City in 2007 for the fourth-largest chain, Dayton-based Instant Tax Service, which has 1,200 offices.

Industry executives say that only a tiny handful of prep offices engage in fraud. “People trying to play by the rules are disadvantaged competitively and dismayed by some of what goes on,” says Robert A. Weinberger, H&R Block’s top lobbyist in Washington. John G. Ams, executive vice-president of the National Society of Accountants, agrees: “My members are tired of having to fix errors they find on someone else’s work product.” The group has pushed for self-regulation overseen by the IRS.

As for the industry’s rates, executives and their advocates point out that no one is forced to hire a preparer. “If you don’t like the price charged, go to somebody who does it cheaper,” says Mark Steber, Jackson Hewitt’s vice-president for tax resources. “It’s the free-market economy model.”

Unfortunately, the free market’s invisible hand sometimes has its thumb on the scale, to the detriment of the U.S. Treasury. In January, volunteers for Impact Alabama, a nonprofit activist group, secretly recorded meetings with employees at 13 outlets in that state, including one Jackson Hewitt franchise. Transcripts provided to BusinessWeek show that the volunteers posed as taxpayers seeking EITC refunds for which they were not eligible. Most of the tax preparers appeared willing to file false returns.

UNDERCOVER WORK

On Jan. 12, an Impact Alabama volunteer visited a Jackson Hewitt outlet in Montgomery, the state’s capital. Situated in a strip mall between a liquor store and swimming pool supply business, the Jackson Hewitt office has a sign in the window stating: “Confused about changing tax laws? We’re not.”

According to the transcript, a Jackson Hewitt employee told the undercover volunteer that she qualified for the EITC based on her occasional custody of two children. In fact, the supposed taxpayer should not have received a refund under the EITC because, as the volunteer made clear, neither child lived with her for the six months out of the year that the law requires.

The Jackson Hewitt employee prepared documents seeking what appears to have been an invalid $5,639 refund and charged a fee of $402, according to Impact Alabama. The nonprofit never filed for the refund.

When a BusinessWeek reporter visited the Jackson Hewitt office in early March, employees declined to comment. The owner of the franchise, Charlie West, said in a subsequent interview that the fee charged was “higher than usual” because of the complexity of the return in question. He said initially that he would look into the EITC fraud allegation but then failed to respond to follow-up calls. (On Mar. 31, Liberty Tax’s John Hewitt confirmed he is exploring a possible acquisition of his former company, Jackson Hewitt.)

Impact Alabama’s research is part of a campaign by its founder, Stephen Foster Black, director of the University of Alabama’s Center for Ethics & Social Responsibility, to persuade the state’s legislature to require licensing of all tax preparers. H&R Block has supported that effort. But 300 other individual tax-prep outlets and franchisees in Alabama and elsewhere have started a group called the National Independent Tax Preparers Assn., based in Montgomery, to oppose the bill that Black supports. Similar standoffs have kept preparers from facing meaningful policing in a number of states.

J.C. Snowden, who heads the tax preparers’ association, says the Impact Alabama investigation was sneaky and unfair. He favors a fine on preparers of up to $100 per tax-return violation. The legislation supported by Black would impose fines of $500 to $2,500 per violation. “We’re firmly behind regulating this industry,” Snowden says. For now, though, his lobbying is slowing down any changes.

In Washington, the IRS can’t track complaints against tax preparers because the agency has no central database to store the information, according to a Feb. 24 report by the Treasury Dept.’s inspector general. A Dec. 31, 2008, IG report found that the IRS generally doesn’t follow up on hundreds of thousands of questionable EITC returns, as identified by its own computerized filters.

FALSE INFORMATION

Even when the IRS does step in, the results are often uncertain. In 2007 the agency became suspicious of an eight-store Instant Tax franchise in Missouri. The agency received information from a former employee that Instant Tax was selling bogus personal information about made-up family members so that clients could apply for EITC refunds, according to an April 2007 affidavit for a search warrant filed by an IRS agent in federal court in Springfield, Mo. Another former employee complained to the IRS that the franchise owner, Kevin Edmonds, and his manager, Josh Lenz, were “taking advantage of mentally disabled and poor people” by adding false information “that resulted in fraudulent returns and fraudulent increases in earned income tax credit[s],” the affidavit said.

The IRS also found that the Instant Tax franchise was generating refunds on 99.3% of the returns it handled, according to the affidavit. “The entire business…is permeated [by] fraud,” the agent stated. The IRS searched the eight Instant Tax locations in October 2007, but it since has taken no further public action. An agency spokesman declined to comment.

Instant Tax issued a press release in August 2008 acknowledging that it had “allowed the franchisee [in Missouri] to expand too quickly” and had terminated its contract with the owner, Edmonds. But Instant Tax didn’t mention in the press release that it had sold two Florida locations to Lenz shortly after the October 2007 IRS raid. Edmonds, meanwhile, became an Instant Tax “area developer” in Oklahoma, a job he holds today. Edmonds and his attorney declined to comment. Lenz didn’t return calls seeking comment.

Fesum Ogbazion, Instant Tax’s CEO, says that Edmonds sells franchises in his current role and doesn’t prepare any returns. The company is concerned about the IRS investigation, says Ogbazion, but still sold franchises to Lenz because the probe hasn’t led to any charges.

BusinessWeek – May 21, 2007

COVER STORY
By Brian Grow & Keith Epstein

Roxanne Tsosie decided in late 2005 to pull her life together. She was 28 years old and still lived in her mother’s two-room apartment in a poor neighborhood in southeast Albuquerque known as the War Zone. She survived mostly on food stamps and welfare. The Tsosies are Navajo, and Roxanne’s mother wanted to move back to a reservation in western New Mexico where the family has a dilapidated house lacking electricity and running water. Roxanne, unmarried and with four children of her own, could make out her future, and she didn’t like what she saw.

With only a high school diploma, her employment options were limited. She landed a job as a home-health-care aide for the elderly and infirm. It paid $15,000 a year and required that she have a car to make her rounds of Albuquerque and its rambling desert suburbs. A friend told her about a used-car place called J.D. Byrider Systems Inc.

The bright orange car lot stands out amid a jumble of payday lenders, pawn shops, and rent-to-own electronics stores on Central Avenue in the War Zone. Signs in Spanish along the street promise “Financiamos a Todos“—Financing for All. On the same day she walked into Byrider, Tsosie drove off, jubilant, in a 1999 Saturn subcompact she bought entirely on credit. “I was starting to think I could actually get things I wanted,” she says.

In recent years, a range of businesses have made financing more readily available to even the riskiest of borrowers. Greater access to credit has put cars, computers, credit cards, and even homes within reach for many more of the working poor. But this remaking of the marketplace for low-income consumers has a dark side: Innovative and zealous firms have lured unsophisticated shoppers by the hundreds of thousands into a thicket of debt from which many never emerge.

Federal Reserve data show that in relative terms, that debt is getting more expensive. In 1989 households earning $30,000 or less a year paid an average annual interest rate on auto loans that was 16.8% higher than what households earning more than $90,000 a year paid. By 2004 the discrepancy had soared to 56.1%. Roughly the same thing happened with mortgage loans: a leap from a 6.4% gap to one of 25.5%. “It’s not only that the poor are paying more; the poor are paying a lot more,” says Sheila C. Bair, chairman of the Federal Deposit Insurance Corp.

Once, substantial businesses had little interest in chasing customers of the sort who frequent the storefronts surrounding the Byrider dealership in Albuquerque. Why bother grabbing for the few dollars in a broke man’s pocket? Now there’s a reason.

Armed with the latest technology for assessing credit risks—some of it so fine-tuned it picks up spending on cigarettes—ambitious corporations like Byrider see profits in those thin wallets. The liquidity lapping over all parts of the financial world also has enabled the dramatic expansion of lending to the working poor. Byrider, with financing from Bank of America Corp. and others, boasts 130 dealerships in 30 states. At company headquarters in Carmel, Ind., a profusion of colored pins decorates wall maps, marking the 372 additional franchises it aims to open from California to Florida. CompuCredit Corp., based in Atlanta, aggressively promotes credit cards to low-wage earners with a history of not paying their bills on time. And BlueHippo Funding, a self-described “direct response merchandise lender,” has retooled the rent-to-own model to sell PCs and plasma TVs.

The recent furor over subprime mortgage loans fits into this broader story about the proliferation of subprime credit. In some instances, marketers essentially use products as the bait to hook less-well-off shoppers on expensive loans. “It’s the finance business,” explains Russ Darrow Jr., a Byrider franchisee in Milwaukee. “Cars happen to be the commodity that we sell.” In another variation, tax-preparation services offer instant refunds, skimming off hefty fees. Attorneys general in several states say these techniques at times have violated consumer-protection laws.

Some economists applaud how the spread of credit to the tougher parts of town has raised home- and auto-ownership rates. But others warn that in the long run the development could slow upward mobility. Wages for the working poor have been stagnant for three decades. Meanwhile, their spending has consistently and significantly exceeded their income since the mid-1980s. They are making up the difference by borrowing more. From 1989 through 2004, the total amount owed by households earning $30,000 or less a year has grown 247%, to $691 billion, according to the most recent Federal Reserve data available.

“Having access to credit should be helping low-income individuals,” says Nouriel Roubini, an economics professor at New York University’s Stern School of Business. “But instead of becoming an opportunity for upward social and economic mobility, it becomes a debt trap for many trying to move up.”

HAPPY AS SHE WAS with the Saturn she bought in December, 2005, Roxanne Tsosie soon ran into trouble paying off the loan on it. The car had 103,000 miles on the odometer. She agreed to a purchase price of $7,922, borrowing the full amount at a sky-high 24.9%. Based on her conversation with the Byrider salesman, she thought she had signed up for $150 monthly installments. The paperwork indicated she owed that amount every other week. She soon realized she couldn’t manage the payments. Dejected, she agreed to give the car back, having already paid $900. “It kind of knocked me down,” Tsosie says. “I felt I’d never get anywhere.”

The abortive purchase meant Byrider could dust off and resell the Saturn. Nearly half of Byrider sales in Albuquerque do not result in a final payoff, and many vehicles are repossessed, says David Brotherton, managing partner of the dealership. A former factory worker, he says he sympathizes with customers who barely get by. “Many of these people are locked in a perpetual cycle” of debt, he says. “It’s all motivated by self-interest, of course, but we do want to help credit-challenged people get to the finish line.”

Byrider dealers say they can generally figure out which customers will pay back their loans. Salesmen, many of whom come from positions at banks and other lending companies, use proprietary software called Automated Risk Evaluator (ARE) to assess customers’ financial vital signs, ranging from credit scores from major credit agencies to amounts spent on alimony and cigarettes.

Unlike traditional dealers, Byrider doesn’t post prices—which average $10,200 at company-owned showrooms—directly on its cars. Salesmen, after consulting ARE, calculate the maximum that a person can afford to pay, and only then set the total price, down payment, and interest rate. Byrider calls this process fair and accurate; critics call it “opportunity pricing.”

So how did Byrider figure that Tsosie had $300 a month left over from her small salary for car payments? Barely a step up from destitution, she now lives in her own cramped apartment in a dingy two-story adobe-style building. Decorated with an old bow and arrow and sepia-tinted photographs of Navajo chiefs, the apartment is also home to her new husband, Joey A. Garcia, a grocery-store stocker earning $25,000 a year, his two children from a previous marriage, and two of Tsosie’s kids. She and Garcia are paying off several other high-interest loans, including one for his used car and another for the $880 wedding ring he bought her this year.

Asked by BusinessWeek to review Tsosie’s file, Byrider’s Brotherton raises his eyebrows, taps his keyboard, and studies the screen for a few minutes. “We probably should have spent more time explaining the terms to her,” he says. Pausing, he adds that given Tsosie’s finances, she should never have received a 24.9% loan for nearly $8,000.

That still leaves her $900 in Byrider’s till. “No excuses; I apologize,” Brotherton says. He promises to return the money (and later does). In most transactions, of course, there’s no reporter on the scene asking questions.

A QUARTER-CENTURY ago, Byrider’s founder, the late James F. Devoe, saw before most people the untapped profits in selling expensive, highly financed products to marginal customers. “The light went on that there was a huge market of people with subprime and unconventional credit being turned down,” says Devoe’s 38-year-old son, James Jr., who is now chief executive.

The formula produces profits. Last year, net income on used cars sold by outlets Byrider owns averaged $828 apiece. That compared with only $223 for used cars sold as a sideline by new-car dealers, and a $31 loss for the typical new car, according to the National Automobile Dealers Assn. Nationwide, Byrider dealerships reported sales last year of $700 million, up 7% from 2005.

“Good Cars for People Who Need Credit,” the company declares in its sunny advertising, but some law enforcers say Byrider’s inventive sales techniques are unfair. Joel Cruz-Esparza, director of consumer protection in the New Mexico Attorney General’s Office from 2002 to 2006, says he received numerous complaints from buyers about Byrider. His office contacted the dealer, but he never went to court. “They’re taking advantage of people, but it’s not illegal,” he says.

Officials elsewhere disagree. Attorneys general in Kentucky and Ohio have alleged in recent civil suits that opportunity pricing misleads customers. Without admitting liability, Byrider and several franchises settled the suits in 2005 and 2006, agreeing to inform buyers of “maximum retail prices.” Dealers now post prices somewhere on their premises, though still not on cars. Doing so would put them “at a competitive disadvantage,” says CEO Devoe. Sales reps flip through charts telling customers they have the right to know prices. Even so, Devoe says, buyers “talk to us about the price of the car less than 10% of the time.”

Tsosie recently purchased a 2001 Pontiac from another dealer. She’s straining to make the $277 monthly payment on a 14.9% loan.

Nobody, poor or rich, is compelled to pay a high price for a used car, a credit card, or anything else. Some see the debate ending there. “The only feasible way to run a capitalist society is to allow companies to maximize their profits,” says Tyler Cowen, an economist at George Mason University in Fairfax, Va. “That will sometimes include allowing them to sell things to people that will sometimes make them worse off.”

Others worry, however, that the widening income gap between the wealthy and the less fortunate is being exacerbated by the spread of high-interest, high-fee financing. “People are being encouraged to live beyond their means by companies that are preying on low-income consumers,” says Jacob S. Hacker, a political scientist at Yale.

Higher rates aren’t deterring low-income borrowers. Payday lenders, which provide expensive cash advances due on the customer’s next payday, have multiplied from 300 in the early 1990s to more than 25,000. Savvy financiers are rolling up payday businesses and pawn shops to form large chains. The stocks of five of these companies now trade publicly on the New York Stock Exchange (NYX ) and NASDAQ (NDAQ ). The investment bank Stephens Inc. estimates that the volume of “alternative financial services” provided by these sorts of businesses totals more than $250 billion a year.

Mainstream financial institutions are helping to fuel this explosion in subprime lending to the working poor. Wells Fargo & Co. (WFC ) and U.S. Bancorp (USB ) now offer their own versions of payday loans, charging $2 for every $20 borrowed. Based on a 30-day repayment period, that’s an annual interest rate of 120%. (Wells Fargo says the loans are designed for emergencies, not long-term financial needs.) Bank of America’s revolving credit line to Byrider provides up to $110 million. Merrill Lynch & Co. works with CompuCredit to package credit-card receivables as securities, which are bought by hedge funds and other big investors.

Once, major banks and companies avoided the poor side of town. “The mentality was: Low income means low revenue, so let’s not locate there,” says Matt Fellowes, a researcher at the Brookings Institution in Washington, D.C. Now, he says, a growing number of sizable corporations are realizing that viewed in the aggregate, the working poor are a choice target. Income for the 40 million U.S. households earning $30,000 or less totaled $650 billion in 2004, according to Federal Reserve data.

John T. Hewitt, a pioneer in the tax-software industry, recognized the opportunity. The founder of Jackson Hewitt Tax Service Inc. says that as his company grew in the 1980s, “we focused on the low-hanging fruit: the less affluent people who wanted their money quick.”

In the 1990s, Jackson Hewitt franchises blanketed lower-income neighborhoods around the country. They soaked up fees not just by preparing returns but also by loaning money to taxpayers too impatient or too desperate to wait for the government to send them their checks. During this period, Congress expanded the Earned-Income Tax Credit, a program that guarantees refunds to the working poor. Jackson Hewitt and rival tax-prep firms inserted themselves into this wealth-transfer system and became “the new welfare office,” observes Kathryn Edin, a visiting professor at Harvard University’s John F. Kennedy School of Government. Today, recipients of the tax credit are Jackson Hewitt’s prime customers.

“Money Now,” as Jackson Hewitt markets its refund-anticipation loans, comes at a steep price. Lakissisha M. Thomas learned that the hard way. For years, Thomas, 29, has bounced between government assistance and low-paying jobs catering to the wealthy of Hilton Head Island, S.C. She worked most recently as a cashier at a jewelry store, earning $8.50 an hour, until she was laid off in April. The single mother lives with her five children in a dimly lit four-bedroom apartment in a public project a few hundred yards from the manicured entrance of Indigo Run, a resort where homes sell for more than $1 million.

Thomas finances much of what she buys, but admits she usually doesn’t understand the terms. “What do you call it—interest?” she asks, sounding confused. Two years ago she borrowed $400 for rent and food from Advance America Cash Advance Centers Inc., a payday chain. She renewed the loan every two weeks until last November, paying more than $2,500 in fees.

This January, eager for a $4,351 earned-income credit, she took out a refund-anticipation loan from Jackson Hewitt. She used the money to pay overdue rent and utility bills, she says. “I thought it would help me get back on my feet.”

A public housing administrator who reviews tenants’ tax returns pointed out to Thomas that Jackson Hewitt had pared $453, or 10.4%, in tax-prep fees and interest from Thomas’ anticipated refund. Only then did she discover that various services for low-income consumers prepare taxes for free and promise returns in as little as a week. “Why should I pay somebody else, some big company, when I could go to the free service?” she asks.

The lack of sophistication of borrowers like Thomas helps ensure that the Money Now loan and similar offerings remain big sellers. “I don’t know whether I was more bothered by the ignorance of the customers or by the company taking advantage of the ignorance of the customers,” says Kehinde Powell, who worked during 2005 as a preparer at a Jackson Hewitt office in Columbus, Ohio. She changed jobs voluntarily.

State and federal law enforcers lately have objected to some of Jackson Hewitt’s practices. In a settlement in January of a suit brought by the California Attorney General’s Office, the company, which is based in Parsippany, N.J., agreed to pay $5 million, including $4 million in consumer restitution. The state alleged Jackson Hewitt had pressured customers to take out expensive loans rather than encourage them to wait a week or two to get refunds for free. The company denied liability. In a separate series of suits filed in April, the U.S. Justice Dept. alleged that more than 125 Jackson Hewitt outlets in Chicago, Atlanta, Detroit, and the Raleigh-Durham (N.C.) area had defrauded the Treasury by seeking undeserved refunds.

Jackson Hewitt stressed that the federal suits targeted a single franchisee. The company announced an internal investigation and stopped selling one type of refund-anticipation loan, known as a preseason loan. The bulk of refund loans are unaffected. More broadly, the company said in a written statement prepared for BusinessWeek that customers are “made aware of all options available,” including direct electronic filing with the IRS. Refund loan applicants, the company said, receive “a variety of both verbal and written disclosures” that include cost comparisons. Jackson Hewitt added that it provides a valuable service for people who “have a need for quick access to funds to meet a timely expense.” The two franchises that served Thomas declined to comment or didn’t return calls.

VINCENT HUMPHRIES, 61, has watched the evolution of low-end lending with a rueful eye. Raised in Detroit and now living in Atlanta, he never got past high school. He started work in the early 1960s at Ford Motor Co.’s hulking Rouge plant outside Detroit for a little over $2 an hour. Later he did construction, rarely earning more than $25,000 a year while supporting five children from two marriages. A masonry business he financed on credit cards collapsed. None of his children have attended college, and all hold what he calls “dead-end jobs.”

Over the years he has “paid through the nose” for used cars, furniture, and appliances, he says. He has borrowed from short-term, high-interest lenders and once worked as a deliveryman for a rent-to-own store in Atlanta that allowed buyers to pay for televisions over time but ended up charging much more than a conventional retailer. “You would have paid for it three times,” he says. As for himself, he adds: “I’ve had plenty of accounts that have gone into collection. I hope I can pay them before I die.” His biggest debts now are medical bills related to a heart condition. He lives on $875 a month from Social Security.

Around the time his health problems ended his work as a bricklayer eight years ago, Humphries picked up a new hobby, computer programming. The shelves of the tidy two-room apartment where he lives alone, in a high-rise on Atlanta’s crime-ridden South Side, are crammed with books on programming languages Java, C++, and HTML. He spends most days at his PC on a wooden desk nestled in the corner.

When his computer broke down in 2005, Humphries fretted that he would never be able to afford a new one. A solution appeared one night in a TV ad for a company with a catchy name. BlueHippo offered “top-of-the-line” PCs, no credit check necessary. He telephoned the next day.

He remembers the woman on the other end describing the computer in vague terms, but she was emphatic about getting his checking account information. She said BlueHippo would debit the account for $124, and Humphries then would owe 17 payments of $71.98 every other week. At the time, $800 would have bought a faster computer at Circuit City Stores, but he didn’t have the cash.

It wasn’t until a week after placing his order that he realized that BlueHippo’s terms meant he would pay $1,347.66 over nine months, Humphries says. He called to cancel. The company told him that would take as many as 10 days, he says. When he called again, a week later, a customer-service representative said cancellation would take an additional 15 days. “I sensed then that I had my hand in the lion’s mouth,” Humphries says. During his next call, a phone rep told him BlueHippo had a no-refund policy. He would lose his $124, even though he had never received a computer.

Humphries takes some responsibility for this frustrating encounter. “I should have done my homework” before ordering, he says. But he also believes he was “strong-armed” out of $124. He was angry enough to send a detailed complaint to the attorney general of Maryland, where BlueHippo is based. That led to his becoming a lead plaintiff in a private class action pending in California against the company. The suit alleges that scores of customers were similarly duped. BlueHippo denies the allegation and says it treats all customers fairly.

The attorneys general of New York and West Virginia are investigating the company, and the Illinois AG has filed a consumer-protection suit in that state. In response to a Freedom of Information Act request by BusinessWeek, the Federal Trade Commission says it has accumulated 8,000 pages of consumer complaints about BlueHippo. The FTC is investigating whether the company has engaged in deceptive practices.

Chief Executive Joseph K. Rensin started BlueHippo four years ago at the same Baltimore address where he had operated a company called Creditrust Corp. Creditrust, which bought other companies’ bad customer debts, enjoyed some success but ultimately slid into Chapter 11 bankruptcy proceedings. In 2005, Rensin and his insurer agreed to pay $7.5 million to settle shareholder allegations that he made misleading statements in an attempt to inflate Creditrust’s stock. Rensin and the company denied acting improperly.

Rensin established himself anew with BlueHippo, whose cartoon mascot adorns a sign in the lobby of its Baltimore building. Most of the 200 employees inside answer phones. Call-center training materials reviewed by BusinessWeek refer to BlueHippo’s prime prospects as families, “typically $25k/yr income & less” who “have had trouble getting credit.”

BlueHippo sells well-known brands such as Apple Inc. computers and Sony Corp. televisions. Gateway Inc. became a major supplier in December, 2003. “We’ve clearly been aware of their business model from the get-go,” says Gateway spokesman David Hallisey. More recently, Gateway became troubled by customer complaints and decided earlier this year to sever ties with BlueHippo. Given its knowledge all along about BlueHippo’s methods, why did the separation occur only this year? Hallisey explains: “We’re publicly traded and trying to make a profit, so that’s a consideration.”

Three former workers say BlueHippo typically tries to commit consumers to regular electronic debits, then, as in the Humphries case, stalls when they cancel orders or ask about receiving shipment. Many customers give up, according to these employees. Refusing refunds, the company keeps whatever money it receives, whether or not it ships a computer, the trio of former employees say. “We knew we were misleading people. They weren’t getting their computers,” says Quinn Smith, a former call-center salesman who says he was fired last December after complaining about these practices. Smith has provided information to the plaintiffs in the California class action but isn’t a party to the suit.

Rensin declined to comment. In a written statement, the company denied any impropriety. It said it ships purchases when promised, though it acknowledged that consumers who can purchase products outright “are better off” doing so, rather than using its “hybrid” layaway and installment financing. The company confirmed that it refuses refunds but said customers may “use any funds paid to purchase other items from BlueHippo.” It added that its prices are relatively high because of the “added risk of dealing with customers who have poor credit.” In contrast to its training materials, the company said its typical customer earns more than $40,000 a year.

A few months after his BlueHippo experience, Humphries did buy a new computer. He borrowed $400 from a friend and bought a General Quality PC from Fry’s Electronics, a retail chain. The loan covered the purchase of a 17-inch flat-screen monitor, a DVD burner, and a desktop computer with a 40-gigabyte hard drive. Humphries tightened his belt and paid his friend back in $100 installments over four months, interest-free.

JUST LIKE EVERYONE else, the working poor find their mailboxes stuffed with “pre-approved” credit card offers. Luisa and Rose Ajuria have trouble saying no. The Ajuria sisters live in a brown-brick bungalow on Chicago’s financially pressed South Side. They care for a niece named Caroline and five cats. Neither sister studied past high school or married. “Momma said I wasn’t college material,” says Luisa, 57. She and Rose, 54, lived most of their lives under the strict supervision of their father, Manuel, who died in 1993. A Mexican immigrant and former sheet-metal press operator, he dutifully paid all the bills. Every week, Luisa handed him her paycheck from Warshawsky & Co., an auto-parts seller where she worked as a supervisor.

The sisters now manage their finances themselves—by their own admission, badly. Their father had paid off the $60,000 mortgage. But twice in the past six years, Luisa refinanced the cluttered bungalow, using the money to pay bills and repair aging fixtures in two bathrooms and the kitchen of the 75-year-old house. Now there’s a new $140,000 mortgage, with Wells Fargo charging 8% interest. The $1,130 monthly payments eat up more than half of Luisa’s paycheck from her current job as a secretary at the IRS. If she also made full payments on a $9,000 home-equity line of credit from HSBC Finance Corp. and a half-dozen credit-card accounts, they would consume the rest. In total, Luisa owes creditors $169,585. “I don’t read things. I just sign them,” she says.

The debt has forced the Ajurias to consider selling their house and moving to an apartment. But it hasn’t stopped companies from offering more credit. Last year, Rose received a come-on for a Tribute MasterCard. She was surprised a company would offer her credit, since she brings in only about $7,500 a year in disability benefits and wages as a part-time worker at an adult-day-care center. She signed up for the card.

Caroline, the 32-year-old niece, who is agoraphobic and rarely leaves the house, quickly ran up $1,268 in charges on the Tribute card, shopping online for Christmas and birthday gifts. Of her newest card, Rose says: “I regret this one. Truly, I do.”

Terms of the Tribute MasterCard are a world away from the money-back and frequent-flier offers familiar to more prosperous cardholders. Marketed by Atlanta-based CompuCredit, a giant in the subprime card business, Tribute MasterCard offers no such fringe benefits. Rose Ajuria’s card carries an interest rate of 28%, compared with about 10% on a typical card. Since she’s paying only a nominal $10 a month, the debt her niece incurred is growing swiftly. “I think we’ve painted ourselves into a corner,” Rose says. Many Tribute MasterCard customers pay a lower 20% interest, but CompuCredit typically charges them a $150 annual fee, a separate $6 monthly fee, and a one-time payment of $20 required before using the card.

This is the sort of choppy water where many of CompuCredit’s customers paddle—and where the company manages to find profits. CompuCredit was co-founded 11 years ago by David G. Hanna, scion of a family that made a fortune in debt collection. Its 55-member analytics team has devised models to assess more than 200 categories of customer data, from the duration of past credit-card accounts to the number of bad debts. The algorithms apparently work: Last year, CompuCredit reported earnings of $107 million on $1.3 billion in revenue.

Whether the company will make money on Rose Ajuria’s account is uncertain at this point. CompuCredit says that customers offered the Tribute MasterCard at 28% generally have middling credit histories and that it is willing to work with those who have trouble paying their bills.

Executives say the company clearly discloses interest rates and imposes fees up front so consumers won’t be surprised later. But in February CompuCredit disclosed that the FTC and the FDIC had launched separate civil investigations into the marketing of one of its other credit cards. The company denies any wrongdoing. As a goodwill gesture, it says it has stopped charging late fees and interest on accounts more than 90 days past due.

On its Web sites and in its marketing brochures, CompuCredit says it helps customers “rebuild credit” by reporting all of their loan payments to credit bureaus, unlike traditional payday lenders. Not that altruism drives the operation, says co-founder Hanna. “We’re not going to chase somebody where we can’t make money.”

EVEN FOR THOSE WHO climb above the lowest rungs of the economic ladder, a legacy of debt can threaten to undercut progress. Connie McBride, a 44-year-old computer programmer who lives near Tacoma, Wash., grew up in foster homes and has led an adult life notably lacking in stability. She has held decent jobs but sometimes has subsisted on food stamps. She earns $47,000 a year as a freelance programmer, working from the weather-beaten aluminum trailer she rents for $590 a month. Wind whistles through small holes in the walls, and she keeps warm in the winter by feeding a wood-fired stove on a cracked cement foundation.

McBride showed an early aptitude for math and received a GED at age 16. In the late 1980s, she studied computer science at Washington State University, sometimes arriving for class with her three young children. “Taking those classes, given my life, I felt this was the only way out,” she says.

She graduated in 1992, owing $45,000 on student loans. That debt became her main financial burden, she says. The 9.5% interest rate isn’t particularly steep, but she tended to view the payments as less pressing than putting food on the table or paying rent. Late fees piled up. Today she owes $159,991, up from $117,000 only 18 months ago. When dunning notices arrive, she tosses them in the stove.

Personal bankruptcy proceedings in 2003 dissolved dozens of McBride’s liabilities. But by law her debt to student lender SLM Corp., better known as Sallie Mae, wasn’t affected. Every month, $450 is garnisheed from her wages, reducing her take-home pay to $1,338. The garnishment doesn’t even cover interest and penalties, let alone the principal. Says McBride: “There’s no way this thing will ever be paid off.”

New obligations are piling up. She pays $385 a month on a 21% car loan. And now she’s buying baby supplies. McBride says her adult son can’t deal with his 4-month-old daughter, who has medical problems. McBride can’t bear the thought of her granddaughter going to a foster home. So she is postponing nonessential expenditures such as fixing a badly chipped front tooth.

McBride acknowledges her mistakes. “My life is full of bad decisions,” she says. But if she had started out with the funds for college, she wonders whether she would at least be able to afford an apartment and a trip to the dentist. “If you have money to begin with, you don’t have these issues or these kinds of bills,” she says. “You don’t have to worry about the rent or pay double for a car.”

With Ben Elgin and Mara Der Hovanesian

BusinessWeek – April 23, 2009

By Chad Terhune, Keith Epstein and Catherine Arnst

CEO Patterson sees 'beautiful opportunity.'

Neal Patterson likens the current scramble in health information technology to the 19th century land rush that opened his native Oklahoma to homesteaders. Cerner, the large medical vendor Patterson heads, is jockeying for new business spurred by a $19.6 billion federal initiative to computerize a health system buried in paper. “It’s a beautiful opportunity for us,” the CEO says.

The billions in taxpayer funds—part of the $787 billion economic stimulus—also have energized tech titans General Electric, Intel, and IBM, all of which are challenging Cerner and other traditional medical suppliers. Microsoft and Google aim to put medical records in the hands of patients via the Web. Wal-Mart is teaming with computer maker Dell and digital vendor eClinicalWorks to sell information technology to doctors through Sam’s Club stores.

Under the federal stimulus program enacted in February, hospitals can seek several million dollars apiece for tech purchases over the next five years. Individual physicians can receive up to $44,000. These carrots should encourage the proliferation of technology that will computerize physician orders, automate dispensing of drugs, and digitally store patient records. If providers participate broadly, those files are supposed to be accessible no matter where a consumer goes for treatment. President Barack Obama says the changes will improve care, eliminate errors, and eventually save billions of dollars a year. There’s also a stick: The federal government will cut Medicare reimbursement for hospitals and medical practices that don’t go electronic by 2015.

The incentives are working. R. Andrew Eckert, CEO of tech provider Eclipsys, says one client, a 250-bed hospital that shelved a software order in the fall after losing $50 million in the stock market, has reinstated the order. The move is “100% due to the stimulus,” says Eckert (who won’t name the hospital). Brandon Savage, chief medical officer at GE’s health unit, says his company’s technology will leapfrog the competition by not just replacing paper but also guiding doctors to the best, least-costly treatments.

In Washington, where partisan bickering over how to revive the economy flares on several fronts, sweet consensus reigns on health-tech spending. Congressional Republicans sound just as enthusiastic as the White House. Encouraged by former House Speaker Newt Gingrich, now an influential industry consultant, lawmakers cheer electronic records as a business-based remedy for much that ails medical care.

High Cost, Questionable Quality

That rare agreement, however, is obscuring the checkered history of computerized medical files and drowning out legitimate questions about their effectiveness. Cerner, based in Kansas City, Mo., and other industry leaders are pushing expensive systems with serious shortcomings, some doctors say. The high cost and questionable quality of products currently on the market are important reasons why barely 1 in 50 hospitals has a comprehensive electronic records system, according to a study published in March in the New England Journal of Medicine. Only 17% of physicians use any type of electronic records.

Hospitals and medical practices that plugged in early have experienced pricey setbacks and serious computer errors. Suddenly dumping more money on hospitals, which will then funnel the cash to tech vendors, won’t necessarily improve the situation, say many doctors and administrators.

Studies have shown that some large networks, such as the Veterans Administration and the Kaiser Permanente system, based in Oakland, Calif., have used electronic records to help cut costs and improve care. But so far there’s little conclusive evidence that computerizing all of medicine will yield significant savings. And improvements to patient care may be modest. An analysis of four years of Medicare data published in March in the scholarly journal Health Affairs found only marginal improvement in patient safety due to electronic records—specifically, the avoidance of two infections a year at the average U.S. hospital. “Health IT’s true value remains uncertain,” wrote Stephen Parente and Jeffrey McCullough, researchers at the University of Minnesota.

Part of the problem stems from a fundamental tension. Info tech companies want to sell mass-produced software. But officials at large hospitals say such systems, once installed, require time-consuming and costly customization. The alterations often make it difficult for different hospitals and medical offices to share data—a key goal. Meantime, the health IT industry has successfully lobbied against government oversight.

“Most big health IT projects have been clear disasters,” says Dr. David Kibbe, senior technology adviser to the American Academy of Family Physicians. “This [digital push] is a microcosm for health-care reform….Will the narrow special interests win out over the public good?”

Overlooking Red Flags

Britain’s experience shows that technology alone doesn’t offer an automatic advantage. An $18.6 billion initiative to digitize Britain’s government-run health system is four years behind schedule because of software snafus and vendor troubles. Few British doctors have been able to use electronic records, and there’s little proof that they have saved money or helped patients. “There is a belief that technology solves all of our problems,” says Ross Koppel, a sociologist at the University of Pennsylvania School of Medicine. “[But] more data does not equate to better medical care.”

Administration officials insist they are proceeding cautiously and will learn from any missteps. But red flags raised by doctors and researchers haven’t gotten much attention in Washington, in part because the health-tech industry has forged strong ties to the President, his top medical advisers, and Republican heavyweights such as Gingrich.

Nancy-Ann DeParle, the new White House health-reform czar, recently stepped down after eight years as a member of Cerner’s board of directors. A former administrator of Medicare and Medicaid during the Clinton Administration, DeParle worked from 2006 through 2008 as a managing director at CCMP Capital Advisors, a private equity firm that invests in health-care businesses. She has sold shares in Cerner for about $950,000 and is disposing of investments related to CCMP, according to the White House.

DeParle declined to comment. Obama spokeswoman Linda Douglass says DeParle will delegate any decisions related to Cerner to a subordinate. “She is not going to be involved in implementing health IT,” Douglass adds. Cerner CEO Patterson says DeParle’s ascension won’t benefit his company, which had $1.7 billion in revenue in 2008. “I think that actually works to our disadvantage,” he argues. “I’m not sure I’ll even be able to talk with her now.”

Glen Tullman, CEO of Allscripts-Misys Healthcare Solutions, a big Chicago vendor to doctors, became acquainted with Obama when he ran for the Senate in 2004. The pair worked out at the same Chicago gym and occasionally played basketball. At that time, Tullman gave Obama a personal demonstration of his company’s software at Allscripts’ headquarters and went on to serve on Obama’s Presidential campaign finance committee. “I feel fortunate that before he became President we had the opportunity to help him better understand the value of electronic health records as a necessary condition to fixing health care,” Tullman says.

Shortly after the stimulus became law two months ago, Tullman and Gingrich hosted a Webcast for thousands of hospital officials and doctors promoting the financial incentives. Since then, Tullman has worked with a client, the University of South Florida Health system in Tampa, to seek $15 million in stimulus money to hire 130 e-health “ambassadors” who would pass out free samples of Allscripts’ prescribing software to physicians. If the funding comes through, the $50,000-a-year representatives would receive a two-week training course from Allscripts, though the marketers otherwise are supposed to be independent of the company.

“This is all about getting doctors moving and considering an electronic health record,” Tullman says. “The market is so big, we will get our fair share.” U.S. Representative Kathy Castor, a Tampa Democrat, is helping. She has brought the Allscripts proposal to the attention of officials at the U.S. Health & Human Services Dept. whose job it is to dole out the tech incentives. Castor says the program will create good jobs during a recession.

Allscripts’ rivals want their share, too. Lobbyists for McKesson, a large medical supplier based in San Francisco that already generates $3 billion a year in health technology sales, are distributing a position paper to members of Congress and Administration officials that could help steer stimulus dollars toward the company. The document, reviewed by BusinessWeek, addresses the definition of “meaningful use” of electronic records. That is the standard Congress set for hospitals and doctors seeking incentive money; it is now up to the Obama Administration to refine the term. The McKesson paper urges a requirement that recipients “build on existing technologies”—language that could favor products of McKesson and other established vendors.

Dr. David Blumenthal, the new head of health tech at HHS, will play a big role in fine-tuning this language. Formerly director of the Institute for Health Policy at Harvard Medical School, he declined to comment. HHS spokesman Nicholas Papas says: “Health IT has the potential to save the federal government more than $12 billion over 10 years, improve the quality of care, and make our health-care system more efficient. We have work to do to achieve this potential… and we will ensure that everyone has a seat at the table.” McKesson says it’s just trying to speed the process. “Our big message is: ‘Please do this quickly. Uncertainty creates a slowdown,’ ” says Ann Richardson Berkey, senior vice-president for government strategy.

There are potential benefits to patients and taxpayers if the promise of electronic medical records can be fulfilled. In theory, a computer screen can supplant reams of paper and offer instant access to patient histories, dangerous drug interactions, and allergies. Treatment of diabetes, cancer, and other illnesses can be tracked more effectively.

Spikes in Pharmacy Errors

Geisinger Health System in Danville, Pa., wanted all that when it spent $35 million to purchase and install software from Epic Systems, a large vendor in Verona, Wis. But in June 2005, during a pilot run of a computerized order-entry system at Geisinger’s flagship medical center, errors began appearing at a rate of several a week in the hospital’s psychiatric unit. “The pharmacy would interpret an order as one drug at one dosage, and the patients were ordered the wrong medications at different dosages,” recalls Jean Adams, a nurse in charge of the IT team. Fortunately, astute staffers discovered the problem after a few weeks and began verifying the computer drug orders using the phone. Full implementation of the Epic system was put on hold. Adams says Geisinger traced the trouble to incompatibility between a common pharmacy database and Epic’s system.

Epic CEO Judith Faulkner says the episode at Geisinger, and similar incidents at other hospitals, taught her company that physician orders and pharmacy records cannot use distinct technologies. “It doesn’t work when you mix and match vendors,” Faulkner says. “It has to be one system, or it can be dangerous for patients.”

To resolve its problem, Geisinger spent an additional $2 million on fixes that took 18 months, according to Dr. James M. Walker, the hospital chain’s chief health information officer. An internist and former minister, Walker is one of health technology’s best-known advocates. Tech boosters frequently cite Geisinger as an illustration of IT’s sunny future. But Walker concedes that the stimulus-fueled rush to adopt existing technology could cause other providers to suffer through expensive fixes with potentially harmful consequences for patients. Vendors such as Epic, Walker says, sell relatively rudimentary electronic tools and expect hospitals and doctors to assure accuracy and safety. “This can be very tricky,” Walker adds. “A lot of us are trying to say: ‘Look, let’s slow down.’ ”

No Way to Report Problems

The Joint Commission, a nonprofit group that inspects and accredits 15,000 health-care organizations, has expressed similar caution. The commission, based in Oakbrook Terrace, Ill., issued a warning in December about problems with complex health-tech systems. It cited one U.S. pharmaceutical database that found 43,372 medication mistakes, or about 25% of the total reported in 2006, involved computer technology. The problems included flaws in data entry, inadequate software, and confusing screens.

Koppel, the researcher at Penn, has sounded some of the loudest alarms. In 2005 he published a study in The Journal of the American Medical Association that examined an Eclipsys system at the university’s academic hospital. He found that use of computers introduced 22 new types of medication errors. His goal was to discover why young medical interns make so many errors. He hypothesized that long hours were to blame. To his surprise, the problems stemmed mostly from software installed to prevent mistakes.

Eclipsys CEO Eckert says Koppel’s study examined a technology that has been updated. “The industry has grown up,” he says. “There are months of testing by the client and us before someone activates a system.”

When health technology fails for one medical provider, there is no central mechanism for reporting problems to others who use it. The federal government collects and disseminates this kind of information on drugs and medical devices. But tech contracts routinely bar medical providers from disclosing systemic flaws. Koppel contends this is unethical and risky: “We need to collect what we know and head off [any potential] tragedy.”

Companies counter that confidentiality agreements protect their proprietary technology and that privacy laws prevent disclosure of patient and physician information without consent. “To the extent we are required to report information, or are allowed to, we would, of course, like to do that,” says Allscripts CEO Tullman. He compares the skeptics of health info tech to doctors who questioned the introduction of the stethoscope in the 19th century: “There have been Luddites in every industry.”

Disputes over health-tech failures are often resolved in private, making them difficult to sort out. Seattle Children’s Hospital sued Eclipsys in 2002, claiming the company missed installation deadlines and failed to fix software errors. This resulted in “sizeable cost overruns and delays,” the suit alleged. Eclipsys and the hospital reached a confidential settlement in 2003. A spokeswoman for Eclipsys says “isolated problems in Seattle don’t reflect our company’s overall success. Every vendor in the industry has had accounts with implementation issues.”

“That was a bad marriage,” says Dr. Mark Del Beccaro, chief medical information officer at Seattle Children’s Hospital. “It taught us to get a better prenuptial agreement next time.” The hospital turned to Cerner for a new system, but Del Beccaro soon became troubled by incidents of children suffering medication overdoses despite alerts from the Cerner software. He asked the doctors involved whether they had seen the alerts onscreen. “They told me, ‘I get so many alerts, I click through [them],’ ” Del Beccaro says. “They do become mind-numbing.”

“Alert fatigue” is a common concern at hospitals. The Joint Commission, in its December bulletin, warned about doctors and nurses overriding them and impairing patient safety. At Seattle Children’s, Del Beccaro says, it took considerable effort to reduce online warnings. “There are definitely times Cerner could be more responsive to our problems, but we are pretty happy with them,” he says.

Children’s National Medical Center in Washington, D.C., has had a similar experience. In 2006 doctors and nurses there say they discovered an eightfold increase in dosage errors for high-risk medications. They attributed the trend to a Cerner system installed six months earlier. The mistakes were caught, and no patients were harmed, according to the center. But the hospital reverted to a process using paper notes. “I felt betrayed by a system I was supposed to trust,” says Cherise Aldridge, a neonatal intensive-care nurse.

For three years, Cerner has resisted making adjustments to its software, which cost the Children’s Center $30 million, says Linda Talley, the hospital’s director of nursing systems. Today nurses use the Cerner network in combination with one assembled by the hospital’s tech department. Nurses retype drug dosages, babies’ weights, and other information from the Cerner computer into the homemade system to double-check how much medicine to administer. This time-consuming process has brought the dosage-error rate back down, says Talley. But she warns that other hospitals use the Cerner system without a backstop like the one her institution cobbled together.

Dick Flanigan, a senior vice-president at Cerner, says the company responds swiftly to requests for improvements and is “absolutely focused on making systems as safe and effective as possible.” There are divergent opinions as to which technology works best, he adds. Cerner has developed a more expensive system that uses bar codes for medication and is capable of better integrating a wide array of data, he says. “We are flexible on this, and at times we incorporate what is done by the client.” CEO Patterson adds that hospitals “are much safer [with Cerner technology] than without it.”

The company faced more questions over its technology at the University of Pittsburgh Medical Center (UPMC). In 2005 researchers there found that at the university’s Children’s Hospital, patient deaths more than doubled, to 6.6% of intensive-care admissions, in the five months following the installation of a computerized order-entry system. The research on child patient deaths at the University of Pittsburgh found a “direct association between [computerized records] and increased mortality,” according to an article published in December 2005 in the medical journal Pediatrics. Digital technology slowed treatment in several ways, the researchers concluded. One example: Doctors and nurses in the intensive-care unit were accustomed to ordering medications and tests while a sick child was en route to the hospital. The Cerner system required that orders be submitted only when the patient arrived, costing crucial time. The authors of the Pediatrics article acknowledged that their work clashed with other studies showing that digitization decreases errors and shortens hospital stays.

G. Daniel Martich, chief medical information officer at UPMC, says the Pediatrics study was flawed. Factors other than the installation of computers, such as the centralization of pharmacy services, also disrupted care, he emphasizes. The problems identified in the 2005 paper have all been resolved, Martich adds. “There were workflow issues,” he says. “We learned the hard way because we were pioneers.” Over the long run, he says, technology has helped decrease mortality rates and cut medication errors in half at Children’s Hospital since 2003 .

Cursory Product Testng

Cerner CEO Patterson says the 2005 Pittsburgh study “certainly got our attention” and prompted an internal review. But that inquiry and others since have found no pattern of ill effects, he says. “We have more clients doing more orders than anybody,” Patterson says. “If I had a systemic problem, you’d be reading about it on the front page.”

The U.S. Food & Drug Administration has been considering whether to regulate health technology in the manner it oversees medication and implants. That decision now falls to the Obama Administration, which faces opposition from industry groups arguing that additional red tape would impede adoption of helpful technology.

Companies are lobbying the Administration to keep product-testing and standard-setting within the sole jurisdiction of a nonprofit body called the Certification Commission for Healthcare Information Technology. Founded in 2004 with industry money and grants from nonprofits, CCHIT has received $2.5 million a year under a contract with the federal government. The other half of CCHIT’s $5 million budget comes from fees paid by companies.

Mark Leavitt, chairman of CCHIT, is a former tech vendor. He sold his electronic health-records company to GE (GE) in 2002 and later became chief medical officer of the Healthcare Information & Management Systems Society, a trade group in Chicago. Seven of the CCHIT’s 19 voting members work for vendors or for-profit tech consulting firms. “We try to strike a fair balance between medical providers and vendors,” Leavitt says. “People need to trust what we do.”

But another commissioner at the CCHIT, Michael L. Kappel, the senior vice-president for government and industry relations at McKesson Technology Solutions, acknowledges that preserving purely private-sector oversight will be tough in the wake of the financial crisis. “I’m having a hard time with this issue because people read about these financial companies, and there is a feeling that government lacks enough regulation,” Kappel says. But regulating health info tech “is a recipe for disaster,” he adds. “I am very sensitive to criticism that [CCHIT] is vendor-dominated. That couldn’t be further from the truth.”

Blumenthal, the new Obama health-tech chief, declined to comment on CCHIT. But in an article published this month in the New England Journal of Medicine, he said the body needs to set stricter standards: “Many certified [electronic health records] are neither user-friendly nor designed to meet [the stimulus law's] ambitious goal of improving quality and efficiency in the health-care system.”

Sharona Hoffman, a professor of law and bioethics at Case Western Reserve University in Cleveland, says CCHIT’s product testing, typically completed in a single day, isn’t rigorous enough. In an article last December in the Harvard Journal of Law & Technology, she and a co-author faulted the group for telling vendors the testing scenarios in advance and for not conducting ongoing monitoring. Without better oversight, she argues, hospitals and doctors probably will not spend their stimulus money wisely.

Barry Hendrix, a primary-care physician in Paragould, Ark., says he paid dearly for just such a mistake, wasting $100,000 on an electronic records system. “It was a complete disaster,” he says of the equipment he bought from NextGen in 2005 and abandoned within months. The system generated patient notes with stray asterisks and other gibberish, he says, and it didn’t work properly with NextGen’s billing software. Hendrix says he couldn’t get technical support from the company or its authorized reseller. NextGen, a unit of Quality Systems in Horsham, Pa., counters that Hendrix is a rare exception among thousands of loyal customers. It adds that it has terminated the reseller that served him.

Hendrix, however, has advice for doctors looking to go electronic: “Never believe a slick salesman.”