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Resisting the Healthcare Consolidation Frenzy

 |  By Philip Betbeze  
   December 11, 2013

Merger and acquisition activity shows no signs of slowing, yet some hospital and health system leaders see independence as a viable strategy.

This article appears in the December issue of HealthLeaders magazine.

Hospital consolidation is on a tear. Whether the trend is ultimately attributable to a need for health systems to work more collaboratively, to deliver economies of scale, to recapitalize, or, for the more skeptical, to develop greater contracting power with commercial insurers, the consolidation trend is collecting a huge number of hospitals under a dwindling group of operators and shows no signs of slowing.

But there are hospitals and health systems that are determined to stay independent. They may collaborate with other facilities to a greater degree and may borrow expertise from other systems in order to better integrate, but on a governance and asset-ownership level, they want to buck the trend for a variety of reasons.

Moving faster

Some see an element of panic in the recent wave of consolidation. As hospitals and health systems contemplate a drastic-though-slow-moving shift in their business models from volume- to value-based reimbursement, many leaders and boards wonder whether they will be able to survive that switch on their own.

Based on a Booz & Company study and a conversation with Gary Ahlquist, a senior partner with the company, as many as 1,000 of the nation's roughly 5,000 hospitals will seek a merger within the next five to seven years. That shows that many leaders and boards don't appear to want to take the risk of continuing an independent existence. Ahlquist also predicts that hospitals can expect a revenue reduction of 20%–25% over the next 10 years, adding further fuel to the merger mania.

Hospitals and health systems seem to want to inoculate themselves against that revenue reduction by seeking safety in size. After all, it's reasonable that those most susceptible to pressure on revenues will be those that don't have the market clout to back up their reimbursement expectations.

Of course, the merger trend puts different parts of the government at loggerheads, too, as the Patient Protection and Affordable Care Act seems to encourage consolidation based on the effect it's expected to have in coordinating care, while a possible negative effect of consolidation is its impact on rate contracting with commercial insurers, which draws the attention of monopoly-busting priorities of the Federal Trade Commission.

Regardless of the uncertain business realities associated with predicting the future of reimbursement and federal permissiveness on monopoly power of some mergers, many leaders are determined to go it alone. Doug Luckett, president and CEO at CaroMont Health in Gastonia, N.C., goes as far as to say independence is his top strategic goal for the one-hospital system that also includes hospice, urgent care, specialty surgery, and a medical group, among other attributes.

"My top strategic goal is to keep CaroMont a viable and functioning independent health system," he says. "Unless circumstances change greatly, this gives us flexibility and agility and keeps capital invested in the local area instead of competing within a corporate entity."

He says top-line revenue compression is a serious issue that may get worse, and disproportionate share funding, on which his health system depends, faces erosion, as well. At the same time, CaroMont is dealing with North Carolina Medicaid outpatient reimbursements that have been cut by approximately 11% or more. Those are funding challenges CaroMont is facing now, and Luckett expects others to emerge.

"We do need to make margin to recapitalize the system," he says, "but we think it will be an opportunity because 10 of our specialty practices are Level 3 patient-centered medical homes and all our primary care practices are Level 3, as well."

Additionally, the health system has been experimenting with upside risk contracting with payers, and so far, it's been able to increase incremental value every quarter.

"We're moving faster as far as attainment than if we were part of a bigger system," Luckett is convinced.

However, there are concerns. One thing he fears is increased payer pressures and exclusions, and by extension the market clout that bigger players in his region are accumulating through mergers. Ultimately, CaroMont may not be able to resist that trend.

"As long as larger systems get bigger rates just for being bigger, we'll continue to be a target," he says.

Though Luckett says the system is stable for the near future and that it doesn't have to scramble for partners, he does see a need to aggregate the system's expense spending and overhead. CaroMont needs to find a way to reduce overhead in the same fashion as bigger systems and has explored contractual partnerships with bigger entities—even integrated delivery networks—that fall well short of asset transfer.

Some large systems with multiple hospitals have made massive investments in infrastructure so that when they add capacity they absorb much of the overhead costs through a centralized service center and not at the individual hospital level, Luckett says, adding that such systems can relatively easily add noncompeting hospitals to help recoup some of their overhead investment.

"Logistics are logistics, so they may provide us better terms and conditions and price points than traditional vendors," Luckett says. "They win, we win. They defray operating and overhead costs, and we remain independent."

CaroMont has already developed an RFP to establish such a relationship with either an IDN or a vendor.

Despite the strategy of staying independent, which the system is committed to executing, "we never want to get into spot where we run out of options. That's a failure of leadership and management." Luckett says when asked about the remote possibility of an eventual merger.

He concedes that independence may not necessarily continue to be the top priority, however, if the system faces unanticipated pressure from payers or attempts to exclude it from important networks.

"Increased payer pressures or exclusions will change our strategic direction," Luckett says. If that happens, he cautions, the payers will hand over the "master key" to the largest providers because such dominant organizations will control rates at that point.

"Seventeen out of 110 hospitals in our state are independent. Between the metro area to my east and the large system to my west, we're it, as far as size, scope, and tertiary care is concerned," he says. "Once that corridor gets closed, providers will command a higher rate and insurers' leverage will be gone, which is why I don't understand why this grouping is being rewarded. We're not closed-minded about any of it. The FTC is at severe odds with HHS and the White House on consolidation, but the truth is rates are going through the roof."

The growth path and early warning

Methodist Health System President and CEO Stephen L. Mansfield, his board, and leadership team are committed to keeping the Dallas-based organization independent through aggressive growth. Though it has seven hospitals throughout the Dallas-Fort Worth metroplex, just a half decade ago it boasted only two and has gone from around $400 million in revenue five years ago to $1.1 billion in its most recent fiscal year. Still, in Texas, where everything is bigger, Methodist has much bigger systems—Baylor Scott & White Health ($5.8 billion total net operating revenue) and Texas Health Resources ($3.7 billion total operating revenue)—in its own backyard.

"Independence is something we wrestle with a lot," says Mansfield. "We have an obligation to assess that. But we have a strong growth appetite going forward. We'll grow to 35% more than we are today."

Mansfield and his board have agreed on certain "advance indicators" that they monitor to provide a level of early warning that the system might be better off with a merger partner. He monitors metrics on a constant basis around margin levels, budget adherence, medical staff growth, and alignment of medical staff and quality, to name a few of the 13 related directly to maintaining an independent track. He and his staff rate each green, yellow, or red, though he says there's no set formula on how many would have to be yellow or red in order for the system to change its dialogue.

"If we're going to be consolidated, we'd rather do it earlier than late," he says. "We're not shy about having that conversation."

Mansfield has been part of three systems during his career; Methodist is the smallest, but he says its cost structure is better than the two big systems of which he was a part.

When Methodist made a decision to grow from two to seven hospitals, "we made an effort to look at fixed and variable cost per adjusted discharge," he says. "If we didn't reduce both of those, then the acquisition was not a success."

Mansfield, who says he still comes in every day to fight the growth of corporate overhead, says Methodist's management team forced itself to fight that fight.

"It was work, because people want to add more full-time employees, and you have to manage that case by case to keep from letting corporate overhead costs get out of control."

He stresses that capital is a worry, but finding it in a big system is no easier than in a small one.

Going the legislative route

Arthur Gianelli, president and CEO of NuHealth, a safety-net health system in East Meadow, N.Y., with 2012 net patient service revenue of $565 million, is focused on staying independent but has buttressed his options through collaborative partnerships with the dominant health system in his area, North Shore-LIJ Health System, which has an annual revenue of around $6.3 billion.

He says the collaborative deal with North Shore has helped it make Investments in clinical decision-making that may not yield revenue today but will when contracts are risk-based.

"We are at the initial stages of that curve in terms of our contracts and infrastructure."

He says the imperatives in his market, like others, are toward consolidation, but that his board has a strong desire to remain autonomous to provide for its public mission.

"They want that autonomy, but they recognize that standalones are under great pressure, so they have given me parameters of affiliation that are as strong as we can make them while remaining autonomous," he says.

Gianelli has pursued the state legislative route to allow NuHealth to collaborate more closely with North Shore on contracting with managed care organizations such that the two systems could enter risk contracts together and collaborate on strategy and quality.

"North Shore can help ensure we're paid appropriately by commercial managed care organizations for the services we deliver," Gianelli adds. "We suffer from limited bargaining power. We need to be connected to a larger system for our financial structure to work. North Shore is our clinical partner, but to round it out, we need this protection afforded by the collaboration bill that the governor of New York signed into law on October 24."

(The state legislation, drafted in the wake of the U.S. Supreme Court decision in FTC v. Phoebe Putney Health System, was crafted to extend the state's antitrust immunity to NuHealth, according to a statement by Foley & Lardner, LLP.)

Even without legislative help, however, Gianelli says the system is well positioned because it is low cost, but he's concerned that without help from a bigger partner in contracting, NuHealth is too low cost.

"With the passage of the collaboration bill and partnership with North Shore, we hope to be positioned in the local market as a low-cost, high-quality provider and one where the commercial managed care payments are lower than, but competitive with, other hospitals in the area," he says.

Good advice

All three CEOs say their peers should use the new landscape to their strategic advantage, as they have.

"With a smaller chassis and high-touch service with faster adjustments, we can help employers continue to provide employee insurance," says Luckett of CaroMont. "I make that argument, but it falls on deaf ears."

Mansfield cautions fellow CEOs to avoid panicking and doing a deal out of perceived desperation.

"I see so many people who are running scared, and I don't know if they know what they're scared of," he says. "In an uncertain period, it's harder to see your way forward, but focus on things you can control. Work on strategy and if you can execute, pursue that very pragmatically. Not knowing the future is not a good reason for merging."

For Gianelli, he cautions fellow CEOs to avoid making rash judgments because an independent has the advantage of being more targeted and is able to make decisions more quickly than big systems.

"You might want to remain independent, but only an honest assessment will get you there," he says. "You can't start with the conclusion."

Reprint HLR1213-4


This article appears in the December issue of HealthLeaders magazine.

Philip Betbeze is the senior leadership editor at HealthLeaders.

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