Troubled Governance at Sentara

by James C. Sherlock

I have been studying and writing about Sentara Healthcare for 15 years. Sentara has during that time both expanded significantly and been mired in seemingly endless controversies regarding such widely reported issues as:

• its death grip on the COPN process and business practices, which together have strangled their much weaker competitors in Hampton Roads;
• its captive HMO Optima Health, which in 2018 raised ACA Individual Policy rates to the nation’s highest in Charlottesville and Albemarle County when Anthem pulled out of that market for a year and left Optima offering policies on the exchange. The severe financial distress to individual policyholders made headlines all over the state;
• the ongoing reporting of conflicts of interests by a Circuit Court judge who had served as a Sentara attorney before sitting and ruling in favor of Sentara;
• fierce pressure applied in the courts on people who could not pay their medical bills before the publicity and subsequent state and federal pressure effectively stopped it;
• a senior Sentara executive threatening political retribution against a member of the Virginia Senate;
• secret negotiations among Sentara, ODU, and a powerful group of businessmen in Hampton Roads to dump Eastern Virginia Medical School (EVMS) onto the taxpayers and take its profitable physicians practices; and
• other headlines too often reporting unseemly activities.

Those issues indicate poor executive leadership, ineffective board governance and a toxic culture.

I recently completed a private study of the corporate architecture of Sentara to see what might be in its DNA that produces such results. Consider this an analyst’s note to shareholders, the public served by Sentara.

I have compared Sentara’s structure and governance with those of Inova Health System, which suffers none of the regular scandals associated with Sentara. Sentara and Inova are each registered with the IRS as 501c3 not-for-profit, tax exempt public charities. Each has a state-awarded and state-protected regional monopoly.

But the similarities end there.

Inova is arguably the most successful non-profit hospital corporation in the country in terms of quality service to its service area. It runs five hospitals, each of which is rated five stars by Medicare.

The strategic planning, charitable missions, endowments, finances and management of each of those three Inova corporations are overseen by three independent boards.

Board oversight of major nonprofit corporations is not a game. From the IRS:

“The Internal Revenue Service encourages an active and engaged board believing that it is important to the success of a charity and to its compliance with applicable tax law requirements. Governing boards should be composed of persons who are informed and active in overseeing a charity’s operations and finances.”

The way the public can be assured of the careful consideration of nonprofit corporate decisions is by independent directors exercising oversight of the executives.

So let’s take a look at Inova and Sentara and see whether we can find differences that explain their profoundly different cultures and business practices.

I will use information from the latest available (2018) IRS Forms 990 Return of Organization Exempt From Income Tax and consolidated financials (2019/20) for each organization in an attempt to describe them as they describe themselves to the IRS.

Sentara parent Sentara Healthcare’s Forms 990 run on the order of 120 pages each year. Inova parent company Inova Health System Foundation’s 990’s are about 70 pages long, reflecting the differences in complexity between the two systems.

Inova Health System

Inova reported $9.43 billion in assets in its Dec 31, 2019 consolidated financials.

Inova takes governance seriously and is structured accordingly. It consists of three major organizations: a parent company to manage the charitable mission and two operating companies. Each of the three has a separate and independent-dominated board.

The Inova corporate architecture separates the management and governance of its charitable mission from those of its operating units.

The parent company is Inova Health System Foundation (IHSF). It ensures that Inova carries out its charitable mission and has established a structure that allows it to leave the close oversight of the operating companies to the independent boards of each.

The structure importantly allows each of the three boards to oversee what is in front of them in carrying out their own missions without too much concern for the others. The internal organizations of each component are relatively straightforward.

Parent company IHSF, with $5 billion in assets, is a holding company and works to ensure the total enterprise works towards its charitable goals. It makes very few transactions with the operating companies, netting about $13 million in 2018.

The operating companies are:

• Inova Healthcare Services. $5 billion assets. (4 Hospitals inside/near the beltway, 46 healthcare facilities other than hospitals) Related Tax-Exempt Organizations – eight; related organizations Taxable as a Partnership – ten; organizations taxable as a C or S Corp – zero
• Inova Loudoun Hospital. $776 million assets. Related orgs taxable as partnerships – three; related orgs taxable as C Corp – one (Inova Holdings (Med Equip))

Sentara Healthcare System

Sometimes fast-growing corporations that focus on growth, especially through mergers and acquisitions, grow faster than the acquisitions can be smoothly integrated. From the evidence, that appears to be part of the issue with Sentara.

The Sentara Healthcare system reported total assets of $8.4 billion in its June 30, 2019, consolidated financials. So, it was in the same category on an asset basis as Inova.

In its IRS Form 990’s, Sentara corporate governance appears stretched very thin. Both the enterprise structure and the boards of individual companies controlled by the parent company each seem relatively unsuited for the scale, the mission and their individual purposes.

Most apparently, Sentara is astonishingly complex.

The system itself in 2018 was composed of 63 companies including 20 non-for-profit, untaxed organizations, 21 taxable partnerships and 22 taxable C corporations. Each filed its own federal and state returns.

Sentara can and does make money because of its Hampton Roads monopoly and the way it flexes the muscles of the vertical and horizontal components of that monopoly.

But the charitable mission for years took a back seat to profits and expansion. It even reported to the IRS for a few years that its CEO was incentivized to improve revenue and margins — profit — and win quality awards. I read nothing in that same explanation of his compensation about him being incentivized to improve the health of the poor.

Yet the health of the poorest among the population of Hampton Roads, officially a core concern of the parent company, is among the worst in the state.

The biggest public sign of trouble is that Sentara keeps getting caught in disreputable actions that a competent board with accurate, complete and timely information would correct before they happen. However the scale and structure of Sentara really begs the question of how likely it is that those information requirements can be regularly fulfilled.

Oversight of controlled entities

For people that don’t follow non-profits, independent board members are generally unpaid except for per diem. The Sentara Healthcare board has 17 unpaid independent members, largely local business people and a leader of the local Urban League. They have the right mix of skills. It is their span of control that is in question.

Parent company Sentara Healthcare is affiliated with its subsidiaries through the legal relationship of sole “member” or sole “stockholder.”

From an article “Sole Member Nonprofits Complicate Directors’ Fiduciary Duties” by Jeremy T. Coffey:

“there are unique risks to structures where a tax-exempt entity’s board is effectively controlled by other entities or individuals. … A nonprofit sole member structure puts directors of the subsidiary in a challenging position because their fiduciary duties to the nonprofit can sometimes put them at odds with the interests and direction of the sole member.”

The meaning of the sole member structure is that the 18-member board of Sentara Healthcare must oversee the charitable mission, the operations, finances, employee compensation and ethics of the entire enterprise. In an optimally designed sole member nonprofit structure,

“Potential pitfalls can be mitigated by embedding certain structural safeguards to protect the controlled nonprofit’s independence.”

In other words, it can be set up so that a light touch by the parent board will suffice.

Yet the boards of most of Sentara’s non-profit companies, including the two largest after the parent, don’t seem to meet reasonable standards for effective oversight of the large non-profits they each control.

Only three Sentara non-profits, including the parent company, have boards with any significant number of independent directors:

• The Sentara Healthcare board also directly oversees Princess Anne Hospital.
• Potomac Hospital Corporation of Prince William has directors split evenly between Sentara executives and independent members.

The parent company in 2018 held nearly $5 billion assets and had $456 million gross receipts.

The nine largest of 21 nonprofit organizations (separate EINs, separate Form 990 filings, separate governance structures) controlled by the parent company are:

• Sentara Hospitals, an operating company that managed seven of the eight Sentara hospitals in Hampton Roads and Elizabeth City, seven Ambulatory Surgical Centers (ASCs) and 121 other non-hospital healthcare facilities. It had $1.8 billion assets; $2.85 billion gross receipts. It is one of the most complex of the organizations in the Sentara orbit, yet has only three voting members of the governing body, all of whom are Sentara executives.
• Optima Health Plan, a captive HMO, the largest Medicaid HMO in Virginia and another 501c3, had 2018 assets of $711 million and gross revenue $2.86 billion. The Optima board has ten voting members, only two of which are independent. It was Optima that got into the hot water at a cost to both the corporate public reputation and its relationship with the State Corporation Commission over the massive hikes to ACA individual market rates in 2018. It is hard to know if the board of Optima’s parent company knew of that strategy ahead of time.
• Sentara Princess Anne Hospital. $330 million assets. $317 million gross receipts. Directly overseen by the Sentara Healthcare board.
• Mpb Inc. $310 million assets; $44 million gross receipts. The Mob board has three voting members, all of whom are Sentara executives
• Sentara Rmh Medical Center. Assets $257 million. Gross receipts $477 million. – Board has three voting members, all of whom are Sentara executives.
• Martha Jefferson Hospital. Assets $233 million. Gross receipts $342 million. Board has three voting members, all of whom are Sentara executives
• Potomac Hospital Corporation of Prince William. Assets $200 million. Gross receipts $252 million. Board has eight voting members, four of whom are independent.
• Sentara Medical Group (SMG). Assets $101 million. Gross receipts $276 million. Board has 20 voting members, all Sentara executives and other employees.
• Sentara Enterprises. $44 million in assets and $131 million gross receipts. Board has five voting members, all employees.

That partial list of nonprofits of course doesn’t take into account the 43 for-profit companies controlled by Sentara.

So absent reliable boards of component companies, the only strategy would seem to be for the parent company board to maintain tight control. The issue is that strategy is not viable. Board members cannot reasonably be expected to closely control the structure they are charged to oversee.

Money transfers

It may be a sign of an attempt at tight control that the parent company reported nearly $2 billion changing hands in 56 financial transfers of eleven types with 24 subordinate organizations in 2018, netting $444 million for the parent company in 2018. More than $77 million of that net to the parent was from for-profit companies.

But it is hard for any outsider to know how much control the board of Sentara Healthcare and the boards of the subordinate companies had over the moving of that much money in so many different transactions.

Transfers that are other than for the actual value of goods or services rendered also can present management challenges to the subordinate companies as can being forced to send much of their earnings to the parent. For example, Optima transferred $60 million to its parent in a transaction classified as “Other transfer of cash or property from related organization(s)”.

Finally, the financial transfers make it hard to value a company if it is spun off or sold because a buyer cannot know either whether the financial transfers for goods and services were at fair market value or how that company would have developed with more independence and control over its money.

Within Inova, such transfers are rare and in relatively small amounts, likely for those reasons.

Bottom Line on Sentara

IRS guidelines say is important that each charity be thoughtful about the governance practices that are most appropriate for that charity in assuring sound operations.

I have every expectation that the independent members of the Sentara Healthcare board of directors are good people and skilled at their jobs on the board.

I find it unlikely, however, that a volunteer, unpaid board such as Sentara’s can meet four times a year — the IRS is told in the Form 990 that each independent board member works one hour per week — and provide the tight oversight required in an organization of the size and structural complexity of the 63 separate companies of Sentara.

Thus the evidence from Sentara’s own IRS reporting appears to suggest that the oversight and management issues at Sentara may be systemic.

My assessment is that the controversies are going to keep coming and Sentara’s business practices will remain periodically in question until the Sentara Healthcare board both makes major structural changes to the organization of the whole enterprise and improves the governance of its major components.

I hope they will do it.  Maybe they are already working on changes because of the pending merger discussed next.  If so, I hope these inputs help.

Final note

Sentara has a merger pending FTC approval with the Cone Health in Greensboro. Sentara will run the new combined corporation.

It is fair to ask whether adding this new system to the one that Sentara currently has in place bodes well for the future unless there are significant reforms to the organizational architecture and oversight at Sentara.

James Sherlock is a retired enterprise architect.