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Dumb Investment of the Week: For-Profit Prison Industry

February 10, 2014 | About:

Strubel Investment Management‘s Dumb Investment of the Week for this week focuses on the private for-profit prison industry.

Since you know I happily invest in tobacco companies, alcoholic beverage manufacturers, and defense contractors, you know that the private prison industry must be pretty rotten if even I won’t invest in it.

The industry appears to operate a fundamentally flawed business model and seems thoroughly corrupt from top to bottom. We believe it is just a matter of time before Chaucer’s old adage about evil deeds being found out (“Murder will out, certain, it will not fail”) comes true.

Corrections Corporation of America (CXW), referred to hereafter by its better known industry acronym CCA, G4S plc (LSE:GFS), and The Geo Group, Inc (GEO)are the three main publicly traded companies that operate private for-profit prisons and detention centers.

These companies rode the dual wave of the war on drugs and deregulation/privatization (a better term might be “confiscation”) of public property and resources in the 1980s into a prominent political and financial force in the prison industry. A wave of overbuilding and lawsuits threatened the industry in the late 1990s, but the terrorist attacks of September 11 and a new focus on locating and detaining so called “illegal” immigrants have vaulted the private for-profit industry to record profits.

We believe the combination of a flawed business model and rampant abuse in the private prison industry will eventually outweigh the lobbying savvy of the companies and lead to the decline of the industry.

Industry Is Vulnerable to Abuse

The private prison industry stands unique among almost all other sectors of the economy in that the nature of its “customers” brings a very high risk of abuse.

It’s easy to take advantage of incarcerated persons. In many cases, the conviction of a crime strips individuals of certain right, their freedoms are severely restricted, and reduces or negates any sympathy society may feel toward them.

For instance, imagine if some large company perpetrated some abuse on my 80-year-old grandma. Well, let’s take a step back. First, it would be difficult for anyone to take advantage of her. As a free person, no company can truly force her to do anything. In addition, she has many family members, including my father and me, looking out for her. But, let’s suppose something did happen. As a non-convict and non-incarcerated person, she enjoys maximum rights under the law and would have a fairly easy time righting any wrongs through legal means. Also, as an 80-year-old widow and upstanding member of the community she presents a very sympathetic figure. Any media organization would eagerly take up her cause and be happy to publish a story on how some evil, faceless corporation took advantage of her. The community would likely be outraged and rally to her cause. Any local politician would be eager to help as well to show the voters how he’s “standing up for the little guy.”

With incarcerated people, the situation is very different. They are stripped of manyrights. The operator of the prison system has almost complete control over their behavior and their daily lives. Many incarcerated people have less robust family support systems than mine, and the media and many politicians are going to be much less likely to champion the cause of a wronged convict than of my grandma.

It’s this dynamic that creates an enormous potential for abuse as we will show later throughout this article. Prisoners are easily taken advantage of and the for-profit nature of private prisons creates an overwhelming incentive to neglect the well-being of prisoners in exchange for increased profits. With public companies, the pressure of meeting investor and Wall Street expectations may make the temptation even greater.

Business Model Depends on Cutting Corners

In many, if not most, businesses there are multiple ways a company can increase profitability. Take Ford Motor Company, for example. Management has many options to increase profitability. They could design and build better cars than their competitors and take market share away. They could try charging more for their vehicles if they thought they were better than the competition. They could develop a new small, urban-friendly vehicle targeted to millennials living in cities, which would increase sales by enlarging the total pool of potential car buyers. They could develop more efficient manufacturing processes and cut costs thereby increasing profitability, or they could spend more money on advertising, which might lead to more sales. The point is that for a company like Ford that makes things that are useful to consumers and that consumers actually need and want, there are many levers managers can pull to improve the profitability of the company.

The private for-profit industry is an entirely different beast. The companies are paid a per diem rate for each prisoner at the prisons they own and operate. FromCorrections Corp 10-K: “We are compensated for providing prison bed capacity and correctional services at an inmate per diem rate based upon actual or minimum guaranteed occupancy levels.”

Unlike Ford Motor Company, there is nothing a private for-profit prison operator can do to increase their top line “sales” figure without increasing bed capacity. They are compensated a fixed rate per prisoner. So, the only way that a private for-profit prison operator can increase profitability is cut costs. The less they spend per prisoner the greater their profit.

This means that private for-profit prison companies are highly incentivized to do the following:

  • Incarcerate the maximum number of people for as long as possible
  • Build and maintain prisons as cheaply as possible
  • Staff prisons as leanly as possible
  • Compensate staff as little as possible
  • Minimize the amount of medical care utilized by prisoners

Every dollar saved from staffing costs and prisoner care results in another dollar added to the company’s bottom line. Unfortunately, it seems that this pursuit of profit has led to unsafe conditions and systemic abuse of inmates at private for-profit prisons.

Abuses of the System and Mistreatment of Inmates

The abuses in the private prison industry are literally too numerous to mention. In the following sections we will present several examples and anecdotes in each category of abuse and neglect as well as a summary of any relevant statistical information that shows how that type of abuse is rampant across the entire private prison complex system.

Maximize Incarceration Rates

Private prisons are most profitable when operating at maximum occupancy rates. While many private prison contracts specify minimum occupancy guarantees (an issue we will address later in this article), the rate guarantees are usually less than 100%. Many private prisons have resorted to other tactics to keep their prisons filled.

The most notorious case might be the “kids for cash” scandal where two judges in Luzerne County, PA, were found guilty of and sentenced to 17.5 years and 28 years, respectively, for taking over $2.6M in kickbacks from Mid Atlantic Youth Service Corporation to sentence youths convicted of minor crimes to jail at the their private prison facility.

A study of New Mexico prisons showed that prisoners at private prisons run by CCA lost “good behavior” time, or reductions in their original sentence, at a rate EIGHTtimes higher than inmates in New Mexico state-run prisons. It’s important to keep in mind that CCA is generally able, through their contracts, to cherry pick the best (meaning, least violent and disruptive) inmates to house in their prisons. For example, a 2004 study found that minimum or medium level security inmates made up 90% of the prison population at private prisons but only 69% of the population at state-run prisons.

The maximization of incarceration rates also runs counter to the public good. By keeping prisoners incarcerated when they otherwise should not be, private prison companies are draining money from the state and federal coffers that could otherwise be spent on more productive uses such as education and infrastructure.

Staff Prisons as Leanly as Possible

Another way that private prison operators maximize profits is by reducing staff and operational expenses to the detriment of prisoner safety.

The most notorious example of lax prisoner oversight and inadequate staffing levelsis the escape of three inmates from Kingman state prison in Arizona. Kingman was run by a private company, Management and Training Corp. One of the escaped prisoners, John McCluskey, murdered a New Mexico couple at a rest stop before being recaptured.

Another example is Idaho Correctional Center. This prison operated by CCA was so violent that prison staff and inmates referred to it as “gladiator school.” An investigation showed that the violence at ICC was three times higher than other prisons in Idaho. The reason for the violence was the lack of staff to adequately supervise prisoners. CCA was recently fined $1M by the state of Idaho for violating its contract and falsifying staff records to show that the prison was adequately staffed when, in fact, it was not.

In 2012, the assault rate at four privately run Mississippi prisons was THREE times higher than the average at state run prisons. Tennessee and Idaho also reportedhigher assault rates at private prisons than public ones.

The most violent prison of them all may be the Walnut Grove Youth Correctional facility in Mississippi. According to the Council of Juvenile Correctional Administrators, the average juvenile facility has one guard for every 10 to 12 inmates. At Walnut Grove, run by The GEO Group, there was one guard for every 60 inmates. This has led to skyrocketing violence. Walnut Grove won the title of Mississippi’s most violent prison in 2012.

The tales of prisoner beatings, rape, and mistreatment are too numerous to mentionbut are so bad the ACLU and the Southern Poverty Law Center filed suit. After ajudge stated that Walnut Grove was “a picture of such horror as should be unrealized anywhere in the civilized world” and “[the GEO Group] had been derelict in their duties and remain[ed] deliberately indifferent to the serious medical and mental health needs of the offenders” and the US Department of Justice also accused the facility of “systemic, egregious, and dangerous practices exacerbated by a lack of accountability and controls,” the state ended its contract with The GEO Group. (Not having learned their lesson, the facility is now run by another for-profit entity–Management and Training Group.)

Or take the case of a CCA injury settlement for 193 Colorado inmates over a prison riot. In that case, The Colorado Department of Corrections audit found that CCA was plagued by high staff turnover and was slow to correct problems at the Crowley County Correctional Facility.

Because of the fractured nature of the private prison industry and the lack of oversight, it is difficult to find comprehensive data for the entire industry to compare staffing levels. CCA’s 2012 10-K discloses that the company has a capacity of 92,500 beds and 16,620 non-corporate staff. Some of these staff members are employed in the company’s prisoner transportation business. Additionally, not all beds may be occupied or a facility may be filled beyond its rated capacity. In any case, using the disclosed figures, CCA employs only one non-corporate staff member per 5.56 potential prisoners. While prison overcrowding has been a constant issue since the war on drugs began, the Federal Bureau of Prisons had one staff member for every 4.9 inmates, which was regarded as understaffed compared to a 3.7 to 1 ratio in 1997.

Also, a review of the literature, cited throughout this article, regarding audits of private prisons when negative events occur (riots, inmate abuse, escapes, etc.) has found low staffing levels and inadequate staff training to be a contributing factor in each incident.

Reduce Operating Costs

It also should come as no surprise that if private prisons are financially incentivized to cut back on staffing they also appear to cut back on the maintenance and capital expenditures needed to keep prisons operating safely and efficiently.

For example, since CCA purchased the Lake Erie Correctional Institution in 2011 from the state of Ohio, there has been a rash of problems. The purchase audits and inspections by the Correctional Institution Inspection Committee and Ohio Department of Rehabilitation and Correction have detailed poor living conditions and rising rates of criminal and violent activity at the prison. Inmate-on-inmate violence increased by 188% and inmate-on-staff violence increased 300% under CCA’s supervision, both rates well above average. A particularly notable incident came on March 10, 2013, when a supply fan broke and a building was flooded with toxic fumes, sickening 75% of the building’s inmates. The audits also showed that inmates had inadequate food, medical care, and in some cases inadequate housing.

In another example, former ACLU attorney Will Harrell was recently quoted as describing a Coke County, Texas, facility run by The GEO Group as “disgusting” and that “there was an infestation of insects everywhere you looked, including the kitchen. Insects in the food. It was horrible.” In 2007, The Texas Youth Commission, which was responsible for monitoring the facility, eventually fired several of its employees after it was found that they colluded with prison officials to cover up the conditions at the prison. An independent audit found prisoners living in filth (auditors visiting the prison got so much fecal matter on their shoes they had to wipe them off on the grass outside) without adequate access to toilets, denied access to medical care, denied access to legal counsel, and subject to racial segregation.

Minimize Medical Care

In addition to reducing expenses by cutting staffing costs and not properly maintaining capital infrastructure, private prisons also appear to reduce expenses by neglecting to provide adequate medical care to prisoners.

For example, after an inmate died recently, the Colorado Medical Board admonished the physician employed by CCA at Bent County Correctional Facility run by CCA, for providing inadequate medical care.

Another article details a 2005 investigation into Prison Health Services, a for-profit company that was responsible for the death of two prisoners in a two-month period because the company denied the prisoners their medications. The nurse admitted in a court deposition that she had joked to staff, “We save money because we skip the ambulance and bring them straight to the morgue.” There is also the case of Correctional Medical Services, which was the subject of a report that exposed how the company actively discouraged treatment for hepatitis among prisoners. Metro Correctional in Kentucky had seven inmates die in one year, and an investigation by the prison itself found that the prison may have been responsible for two of the deaths.

Comprehensive studies on the privatization of prison healthcare services and prison healthcare in general are very rare. A 1994 study by the Joint Legislative Audit Review Commission of the privatization of healthcare at the Greensville Correctional Center in Virginia found that it was a complete failure. Problems included inadequate care and staffing, cost overruns, and inadequate medical equipment.

The Private Prison Industry Runs Counter to the Public Good

Society benefits from having the minimum number of incarcerated persons, but the private for-profit prison industry does nothing to further this goal. The private prison industry benefits from locking up the maximum number of persons possible.

According to a recent article, 65% of private prison contracts have lockup quotas, meaning that the state guarantees that they will fill the prison to a certain capacity or will pay the difference. The most frequent lockup quota used in contracts is 90%, but three prisons in Arizona have lockup quotas of 100%.

This means that governments are paying to lock up prisoners whether or not there are any actual criminals to fill the jails! State and federal government entities areessentially guaranteeing profits to the private prison industry!

This leads to a grotesque scenario where there is pressure to increase the severity of sentencing laws to keep the prisons full. Private prison companies have beenlobbied for three strike laws (mandates of 25 to life for multiple felony convictions) and truth-in-sentencing (keeping prisoners incarcerated for their entire sentence) legislation.

Privatization Deals Are Not Beneficial to Governments

All the abuses perpetrated by private prisons might be tolerable by the general public, since prisoners are usually not sympathetic figures, if the private prison industry lived up to its promises of incarcerating inmates more cheaply than public prisons. This is not the case; numerous studies have shown that incarcerating inmates at private facilities is more expensive than at public facilities or in a best case scenario costs the same.

When examining studies of the cost-effectiveness of private prisons, care must be taken to ensure that the underlying methodology of the study is valid. The private prison industry has a habit of generously donating to politicians and other groups to influence studies, showing the benefits of private prisons. There are enormous amounts of biased and poorly constructed studies that purport to show that private prisons offer cost savings over publicly run prisons. These studies, however, containmany flaws, such as the failure to adjust for differences in inmate populations, failure to include overhead costs, and comparisons to a hypothetical prison rather than actual operating facilities. A final trick used to present privatization as more effective is studies that highlight the cases of severely troubled state institutions after they are put under new, private management. In these cases, the state-run institutions are so poor that any new management, government or private, likely would have improved the prison.

The studies with the soundest methodology compare actual private prisons to actual state prisons with like characteristics (building size, location, prisoner demographics, security level, etc.).

The best study to date is the analysis of the 2010 data released by the Arizona Department of Corrections. This study compared like prisoners in actual, operating private and public prisons. The study found that using private prisons to hold minimum-security prisoners did not save any money, and that for medium-security prisoners was actually more expensive.

Another, albeit old, study that was well done and free from bias was the 1985 studyof the transfer of the Florida School for Boys at Okeechobee, a juvenile detention facility, to a private non-profit organization. The study addresses one of the key claims made by the private prison industry that the private sector can provide public goods (in this case incarceration services) more efficiently than government organizations. Despite being a non-profit organization, the private manager was unable to realize any cost savings. Of note is one particular finding: Staff at the facility had much lower morale after the transfer. This finding once again corresponds to the articles cited throughout this report that staff issues including lower morale are one of the prominent downsides to the privatization of detention facilities.

Social Mores and Budget Issues Impact Incarceration Rates

The final issue is the shifting tides of social mores. Society as a whole seems to have grown tired of the “war on drugs” that resulted in the mass incarceration of millions of Americans for non-violent, victimless crimes against the state.

(Graphic source: Wikipedia)

With the commencement of the war on drugs and emphasis on detaining immigrants, the incarceration rate has risen from a steady 100 persons per 100,000 to an astonishing 500 persons.

The cost to society for this misguided adventure has been enormous. With many states still facing budgetary pressures, reducing incarceration rates is an easy place to save money.

Finally, social mores threaten to reduce the number of persons convicted or held on drug related and immigration offenses, which are the two main drivers of the increase in incarceration rates. The recent legalization of marijuana in Colorado and Washington shows that the social mores on drug use are changing. Immigration reform has the potential to wind down the immigration equivalent of the war on drugs. As the social and demographic makeup of the United States changes, society is less likely to view the incarceration of drug users and immigrants as desirable.

With an enormous amount of bed capacity built up in the prison system (both public and private) to house quintupling of inmates, any drop in incarceration rates will radically affect private prison companies’ bottom lines. Almost every other civilized country has incarceration rates ranging from 150 to 50 odd people per 100,000, which is the historic range for the United States as well.

Summary

In summary, we find there is no economic or social reason for the private prison industry to exist. The horrific records of abuse at many private prisons and the changing social mores of the country place the profitability of these companies at risk.

Intense lobbying and generous campaign finance contributions by the private prison industry should keep the corporate coffers and jail cells filled in the short term. Also, with some private prison companies converting to REITs for the tax benefits, shareholders may reap a short-term windfall. Over the next ten years or so, however, the private prison industry is at great risk as its reason for existence begins to fade.

About the author:

Ben Strubel
President and Portfolio Manager of Strubel Investment Management, LLC a value oriented, independent, fee-only Registered Investment Advisor (RIA) based in Lancaster, PA.

Visit Ben Strubel's Website


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