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Frank Talk About Profits

By Dr. David C. Pate, News and Community
August 6, 2012

After I wrote about the possibilities of medical tourism in May, I was asked this question on my blog:

Can you explain your statement, “The calculation is that even though some patients may be more costly, others can be managed under the fixed price at a profit,” in the context of St. Luke’s nonprofit, tax-exempt status? 

It’s a good question and a fair one, and I take pride in representing a health system that is both changing and becoming increasingly transparent in how it’s changing. Questions routinely come up about hospital organizations’ not-for-profit status, and I want to help answer some of them. Here are my thoughts:

Should not-for-profits make a profit?

They’d better. I agree with Sister Irene Kraus, the founding chief executive of the Daughters of Charity National Health System, when she said, “No margin, no mission.” If a not-for-profit doesn’t generate a margin, it won’t be in business very long and won’t be able to fulfill its mission. 

Consider Bogus Basin. Like St. Luke’s, Bogus Basin is community-owned and not-for-profit. If our much-loved ski area didn’t make enough of a profit to reinvest, there would not be high-speed chairlifts, a new lodge, programs for kids, or the jobs that come with all those things. The community gets the ski area it wants only if revenues exceed expenses. Neither Bogus Basin nor St. Luke’s makes a “profit” in that the margin, which is the difference between revenue and expenses, is money we invest back into the community-owned facilities, programs, and services.

What’s the difference between a for-profit and a not-for-profit?

The terminology can be confusing and there’s a lot of corporate legalese involved, but generally speaking, a for-profit distributes profits to its owners and investors. Management and board members are typically part owners of the company and they determine the amount of profits that will be distributed to owners and investors and the amount that will be reinvested in the company.  

A not-for-profit corporation, generally speaking, reinvests in its mission and its community. It has one use for its margin: investment in programs and services, often for those who otherwise would be unable to afford them or have nowhere else to turn. St. Luke’s, for example, invests in the health care needs of the community. Since not-for-profits don’t have shareholders, there are no distributions of profits to shareholders. Instead of paying shareholders, we invest in people, new technology, programs to improve health, and new services to meet the health care needs of the people we serve.

Another difference is tax status. A not-for-profit corporation is exempt from some, but not all, state and federal taxes. The premise behind encouraging not-for-profit organizations with certain tax exemptions is that in many cases, these organizations relieve a burden that the state or federal government would otherwise incur or benefit the state in other ways. St. Luke’s is a tax-exempt organization, yet we pay tens of millions of dollars each year in state and local property, federal payroll, and other taxes.

Where does the money come from? 

For-profit companies raise money through the investment of owners or from the sale of stock, which provides investors with an ownership interest proportional to their stock holdings and certain voting rights.

Not-for-profits can generate the money necessary to maintain and develop themselves in three ways: operations, borrowing, and philanthropy.

When it comes to borrowing, banks are not going to loan a not-for-profit money unless there is evidence it can repay the loan. And bondholders are not going to purchase bonds from an organization if its bond rating indicates that there is significant risk of default, that it cannot pay the bondholders back.

Rating agencies score organizations that issue bonds according to their risk of default. The higher the risk, the lower the rating – and the greater the interest rate the organization pays to bondholders. A small difference in rates can make a big difference. It was very important to St. Luke’s when we maintained our A rating earlier this year.

A not-for-profit organization can generate money through philanthropy, especially if it is also exempt from federal income taxes, so that donors get a tax deduction. Philanthropic investment is very important to St. Luke’s. And to fulfill St. Luke’s vision, we will need to expand community philanthropic investment going forward.    

What about accountability?

Not-for-profits are accountable to the communities they serve and are held accountable by boards of community leaders, who volunteer their time to ensure the community is well-served. It’s in everybody’s interest to make sure that a not-for-profit operates as efficiently as possible.

Such organizations must manage themselves much the same way as any other business, by attracting strong and capable leaders, controlling expenses, and formulating and executing on their strategic plans. They must use sound financial management strategies and invest wisely. They must be goal-oriented. And they must create an accountable culture.

If not successful, not-for-profits end up going out of business and are then unable to fulfill their mission. Not-for-profit misnomer aside, you won’t see unprofitable not-for-profits survive for very long! 

Are there other considerations?

Non-profits need the support of their communities. For St. Luke’s to carry out its mission, we rely on our volunteers, who give of their time, and our donors, who give of their financial resources. Without both, we would have to cut back on what we do.

St. Luke’s generates much of its capital from philanthropy, and is looking to those communities we serve to increase their philanthropic involvement. To provide the same level of care in the future, we need to increase the rate of philanthropic activity significantly in the next few years.

If you have questions about our philanthropic program, I’d welcome you to check out “Ways to Give.” You’ll find all sorts of information about St. Luke’s Health Foundation and the ways you can help us continue our journey of health care transformation.

About The Author

David C. Pate, M.D., J.D., is president and CEO of St. Luke's Health System, based in Boise, Idaho. Dr. Pate joined the System in 2009. He received his medical degree from Baylor College of Medicine in Houston and his law degree from the University of Houston Law Center.