Changes in Hospital Finance Drives Flurry of Mergers
In this first part of a three-part series, North Carolina Health News looks at the challenges facing rural hospitals and what it means for small communities when the local hospital merges with a larger hospital system.
Today’s story looks at the market and regulatory environments that are driving hospitals to merge.
By Brenda Porter-Rockwell
In late April, Alamance Regional Hospital in Burlington announced that, finally, a long-awaited partnership with Greensboro’s Cone Health System could go forward, after the Federal Trade Commission closed a year-and-a-half inquiry into the planned partnership.
“This is a great day for healthcare in the Triad,” said Cone Chief Executive Officer Tim Rice in a press release at the time.
“Our merger is a positive step for the future of both health systems.”
Also in April, Pardee Hospital in Hendersonville extended, from 10 to 25 years, an existing 2011 management agreement with Chapel Hill-based UNC Health Care System.
UNC was already managing all operations of the 222-bed Pardee in exchange for an annual $180,000 management fee. Under the revised agreement, UNC will have more control over Pardee’s clinical, business and financial operations, while investing more in the smaller facility and its operations.
Pardee’s lease with Henderson County for the hospital buildings and land was also extended as part of the deal.
Though these two hospital affiliations are structured differently, the two deals have one larger trend in common: In order to survive the current health care environment, many small, rural hospitals find themselves looking for the umbrella of a big hospital system to shelter them from the coming storm of change in health care.
Federal, state and local changes coincide
In the coming year, big changes are coming to hospitals as the federal Affordable Care Act rolls out. The federal law will change the way hospitals are reimbursed. For starters, underperforming hospitals will lose money not only because they’re doing a poor job but because federal programs will penalize those that have patients who cycle in and out more frequently.
Last week, the federal Centers for Medicare and Medicaid Services announced it was penalizing dozens of North Carolina hospitals that had too many Medicare patients readmitted for further care within 30 days of previous hospitalization. The penalties range from C.J Harris Community Hospital in Sylva having 0.01 percent of it’s annual Medicare reimbursement withheld to Richmond County’s Sandhills Regional Medical Center losing a full 1 percent of its annual Medicare payment.
The Affordable Care Act also cut the bonuses given to hospitals for caring for large numbers of the uninsured; the assumption in the law was that states would expand Medicaid, giving most of those uninsured patients some form of payment.
But North Carolina legislators declined to expand Medicaid early in the recently concluded legislative session.
According to Hugh Tilson, head of governmental affairs for the North Carolina Hospital Association, that decision will cost the state’s hospitals at least $413 million per year, hitting rural and small hospitals in poorer communities hard.
“We’ve got to transform our care into systems of care, focused on keeping everyone healthy” Tilson said. “We all know that the current volume-based system, where everyone makes more the more they do, has got to change.”
Tilson said other decisions made by the General Assembly will also cut reimbursement to hospitals: Legislators will be withholding $52 million per year, up from $43 million last year, from the reimbursement they give hospitals in return for providing Medicaid care. Lawmakers also created regional hospital rates that will probably trim reimbursement a little more. And they mandated that hospitals participate in a shared savings plan that withholds an additional 3 percent from Medicaid payments that hospitals can only begin earning back in 2015.
And in a nod to all of the hospital mergers taking place, North Carolina lawmakers also passed a law keeping reimbursement rates for smaller hospitals at their pre-merger levels.
“These businesses are very leveraged,” said health management professor Kevin Schulman from Duke’s Fuqua School of Business. “They’re very fixed cost heavy, and so they’re vulnerable to small changes in the marketplace.”
In this environment, executives at small hospitals say the only hope for long-term survival under the new rules is to seek out a partnership with a bigger health system that can provide the resources for new and expanded community benefits such as infrastructure repairs and expansion, medical sub-specialties and technology upgrades that the independent hospital just can’t afford to manage on its own.
And the numbers suggest it’s true: A recent study by the American Hospital Association found that over the last six years, about 550 of the nation’s 5,700 community hospitals have merged or been acquired by a larger hospital system.
Good for the bottom line?
In 2012, there were 120 independently owned community hospitals in North Carolina, said George Pink, a health economist at the Chapel Hill-based N.C. Rural Health Research and Policy Analysis Center.
But due to uncertainties in the future of the health care market, he estimated at least a dozen unaffiliated hospitals in North Carolina will likely merge themselves into larger hospital systems – and soon – leaving fewer standalone community hospitals.
“The reality is, the larger the hospital, the larger the system, generally speaking, the better they do from a financial point of view. The hospitals that are in jeopardy in the country are the real small ones that are free standing,” Pink said.
“They have a very small revenue base to spread their fixed costs over,” he said, “and you can see it directly in bond ratings. The large systems have got AA bond ratings and the small ones have got below AA bond ratings.”
Pink also pointed out that the knowledge to adjust to changes being pushed by the Affordable Care Act might be beyond the ken of many small hospital managers.
“All of those kinds of reforms that are in the health care law are really going to require some kind of system-level resources and expertise,” he said. “For a small hospital to do that on their own is really difficult.”
Urge to merge
Senior health care analyst Patrick Riley of the research firm Frost and Sullivan in Texas said there’s not only a cost-savings for community hospitals by engaging in the merger-and-acquisition process but an opportunity to deliver better care.
He pointed to the recent American Hospital Association report, which concluded, “The number of, and the stories behind, hospital transactions demonstrate that mergers and acquisitions are supporting the changing landscape of health in a positive way.”
Riley said he is convinced the merger-and- acquisition process yields positive results for the local community.
“I don’t see how health care costs are going to go up. Your logistical system, your tax structure … all becomes part of the larger system,” he said.
But other industry analysts are not as sanguine.
Sanjay Saxhena, a senior partner with the New York City consulting firm Booz & Company, recently wrote a report looking at mergers in the hospital industry. He agreed that the “urge to merge” will only strengthen, even though history shows mixed results.
“Our view, based on internal analysis, is that it’s not unlikely in the next five years [that] you’ll see the next thousand hospitals start to change hands,” Saxhena said. “Whether that’s full mergers or strong-form affiliations, you’ll see about 20 to 25 percent of the total market turning over in some fashion structurally.”
Initially, the deals promise local residents infrastructure improvements, access to more physician sub-specialties and access to a larger research hospital with cutting-edge developments.
For hospital boards, the deals provide access to capital at lower borrowing rates, increased prestige and the promise of more bells and whistles.
“A lot of boards will ask the questions, ‘What’s right for the community? Are we doing as much good as we can?'” said Saxhena.
His study found that most mergers have failed to live up to the hype. As many as one in five hospitals went from having positive margins to having negative ones after merging. He said hospitals considering merging need to examine the reasons they’re proceeding.
“If you’re a small system, you’re providing a high quality, high level of services to the population, and you’re ready to take care of populations under the population health-management push, then you may decide you don’t need any help,” Saxhena said.
If you don’t have a desire to expand across the state, he said, “You would argue then that the greatest community benefit is to remain independent.”