The Impact of Healthcare Reform on Hospital Consolidation
Juniper Advisory and McGuireWoods presented a webinar titled “The Impact of Healthcare Reform on Hospital Consolidation” on September 16, 2010. Speakers included James E. Burgdorfer, principal of Juniper Advisory; Rex J. Burgdorfer, associate at Juniper Advisory; Thomas C. Brown Jr., a partner at McGuireWoods; Barton C. Walker, an attorney at McGuireWoods and Kristian A. Werling, an attorney at McGuireWoods. Below is a summary of the webinar.
Fragmentation of the hospital industry persists
Mr. James Burgdorfer said there continues to be a “staggering” level of fragmentation in the hospital industry. The number of hospitals in systems has increased from 4 percent in 1995 to 55 percent in 2008. Hospital mergers and acquisitions, which reached a high in recent years of 312 in 1996, have tapered off, reaching a recent-year low of 86 in 2003. There were 78 M&As in 2008, the last measured yearMany of these transactions involved just one or two hospitals, meaning consolidation has progressed slowly compared with other industries like pharmaceuticals, Mr. Burgdorfer said. In fact, the number of hospitals in each system has fallen from 8.1 percent to 7.1 percent from 1995-2008. Meanwhile, the number of separate entities in the hospital sector continues to be high. There were 330 systems and 2,000 independent hospitals in 2008, down from a total of 3,200 in 1995.
From 1995-2008, the number of community hospital systems rose by 63 percent while the number of Catholic systems fell by 32 percent, due to consolidation. The number of “meaningful” for-profit systems also fell from 20 to 15, following some mergers in the 1990s.
The largest hospital entity, HCA, controls only 4 percent of the market, compared with the airline industry, where the market leader controls 20-30 percent. One reason for hospital fragmentation is a lack of broad access to capital, Mr. Burgdorfer said. Another is a “deeply embedded view that hospitals are a local business,” he said. “These hospitals are managed by local boards and governed by local boards.” Other causes of fragmentation are the municipal bond market and increasing political opposition to mergers.
Mr. Brown said market forces have not been sufficient to bring consolidation to the hospital industry. “Someone said Americans end up doing the right thing but only because they have to,” he said. He said independent hospitals are under more pressure from such forces as healthcare reform and a less friendly bond market. “Market forces will very likely change,” Mr. Brown said. “The future is going to be very, very different.”
New forces will speed consolidation
Mr. Walker said healthcare reform will affect hospital consolidation in three ways: by decreasing revenues, increasing costs and rewarding integration. The federal government is rolling out value-based purchasing, which shifts payments to hospitals with high quality measures and reduces payments for the rest. Hospitals will consolidate to find new ways of reducing overhead. Because measuring quality takes a great deal of investment, “it wouldn’t surprise me if the larger organizations would be better able to compete,” he said.
Meanwhile, hospital costs will rise due to increasing compliance burdens under healthcare reform. For example, hospitals will have to gather information and make reports, such as compiling lists of standard charges and, in the case of not-for-profit hospitals, providing a community needs assessment every three years.
Mr. Walker noted that accountable care organizations under the new law will reward clinical integration. The details of ACOs have not been released, but it is already clear that they need shared governance and sophisticated quality reporting systems, which larger systems are more likely to have. He added that bundled payments, which are currently still in CMS pilots, also appear to favor larger organizations. Hospitals are under pressure to control the entire continuum of care.
Mr. Brown said he knew of no data clearly showing that larger systems are better positions for this new world of medical care, but it looks quite likely to be the case. He said he has been working with a system that has spent many years and many millions of dollars to measure quality, and that seems to have been good preparation for the changes to come. Mr. James Burgdorfer added that just setting up an electronic health record involves “an unbelievably large investment.”
A confused market in mergers and acquisitions
Mergers and acquisitions market is “more confused than at any time in the last 20 years,” Mr. James Burgdorfer said. Changes in who is buying and who is selling hospitals mean it has become more difficult to complete transactions. Historically, less than 5 percent of transactions failed after a letter of intent was signed; now, about 25-50 percent of transactions at this stage fail, with those in the Midwest at the high end. There are two reasons for this. While many of the new buyers are non-profit hospital systems, inexperienced in these transactions, many of the sellers are not as desperate as they used to be, he said. If their board has second thought about a deal, they can pull out and still survive.
Mr. Brown said he sees three trends in mergers and acquisitions in the Mid-Atlantic region. First, larger not-for-profits have become more aggressive, moving outside of their catchment area and even across state lines. Second, acquiring systems have moved away from putting money into existing local foundations and are now interested in investing money directly it the hospital system. Third, not-for-profit systems are willing to pay premium prices for hospitals, competing head-to-head with for-profit companies that have access to private equity.
Landmark private equity acquisitions
Private equity acquisitions in Detroit and Boston are “incredibly important,” Mr. Rex Burgdorfer said. Cerberus Capital Management, a New York private equity firm, has a bid to buy Caritas Christi Health Care, with six Catholic community hospitals in Massachusetts, and Vanguard Health Systems plans to buy Detroit Medical Center. Both states have traditionally been hostile to for-profit hospitals. Caritas Christi approached Cerberus only after it had tried to sell to a Catholic system. There could be more for-profit takeovers, reaching a level that has not been seen for the past decade, he added.
How to put a hospital up for sale
Mr. Brown said transparency and early notice are important when putting a hospital up for sale. Some sales have met with a community backlash because residents had not been prepared for the sale, he said. “There was the thinking that the hospital had been sold in the middle of the night, without community input,” he said. Since selling a hospital can be an emotionally charged issue for the community, it is important for boards to prepare the community before the sale is announced, he said. He suggested hiring a public relations firm. While the hospital cannot reveal whom it is talking to, it should announce that a search process is under way. It is also helpful to have an on-staff physician involved in the process and to brief local politicians in advance of the announcement.
Mr. Brown said transactions should be structured so the community can benefit. Leave the local board in place, even is they are subject to certain reserve powers and require a number of board members to reside in the community. Also, emphasize the system’s commitment to charity care, maintain certain care services for at least a period of time, and think about adding new clinical services. And find an independent entity to oversee enforcement of commitments that were made.
Mr. James Burgdorfer said a typical concern in an acquisition is “are we ceding control with little consideration?” In the Midwest, some hospitals hand themselves over with little or no consideration. A consideration could be a purchase price, assuming liability, including pensions, and a commitment to making capital expenditures.
Mr. Brown added in states like Virginia, the state attorney general must review the fairness of the transaction, so it is important to communicate often and early with the attorney general’s office. “If you give them a taste of what the transaction is about and the reason for it, it helps in the final review,” he said.
Mr. Walker said there are steps the selling hospital can make to prepare for a consolidation. Acquiring systems “don’t like to buy into big problems,” he said, therefore the hospital should review inspection reports by the Joint Commission, Medicare and others to make sure the deficiencies that were cited have been addressed. It should also review its relationships with physicians for potential legal violations and review billing and reimbursements. “You need to ferret out any kind of systemic issues,” he said.
Alternatives to consolidation
A consolidation can be something looser than an outright merger, such as a management arrangement or a joint venture, Mr. Walker said. Under the healthcare reform law, ACOs will have shared governance, but it is still not clear just what that means. Mr. Werling added cooperative arrangements can move to a merger. “Management or a clinical affiliation can be a great first step,” he said.
In summation, Mr. James Burgdorfer said both for-profits and not-for-profits have some room for improvement. Large not-for-profits have to get experience with acquisitions and for-profits have to move beyond just buying and selling hospitals and do better job with consolidations. The for-profit acquisitions of not-for-profit systems in Boston and Detroit this year are “the most important transactions in the last 50 years,” he said. In the Boston deal, Cerberus abandoned the usual procedure of private equity firms working through an existing management team.
Consolidating practices, home health and other services
Turning to vertical consolidation of hospitals with other kinds of providers, Mr. Werling said hospitals’ acquisition of physician groups has been led by a few specialties, such as cardiology, following a plunge in reimbursements for office-based cardiology procedures. It also includes the full gamut of specialties, even primary care. Until recently, hospitals had been spinning off services like home health, but in the past six months they have been buying up home health. Here, too, large organizations have an advantage in the race to acquire home health, physical therapy and other providers, he added.