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A change in spending habits
Technology, construction budgets take hits as systems refocus priorities

By Melanie Evans
Posted: February 8, 2013 - 12:01 am ET

Late last year, one of the nation's largest not-for-profit hospital systems plunged deeper into the managed-care market with a move to purchase a majority stake in Soundpath Health, a Washington state insurer.

Catholic Health Initiatives' proposed $24 million acquisition—while only a small fraction of the system's capital investment last year—wasn't its first insurance deal and likely won't be the last for the Englewood, Colo.-based system.

CHI's escalating foray into insurance is part of a significant shift under way in capital spending by the nation's hospital operators, which is moderately expanding again this year after the major slowdown triggered by the financial crisis and recession.

More traditional capital expenses—major hospital construction and costly, high-technology equipment—are losing ground. Systems are channeling their limited capital dollars into investments that diversify operations and reduce costs, which hospital executives contend are necessary to adapt to changes under health reform and market pressure.

And, as has been a major emphasis in recent years, system operators are continuing to invest in areas that knit together their operations in ways that improve quality and lower cost.

“You see a lot of money being spent on information technology” to prepare for financial risk and better coordinate care, says Andrew Majka, managing director and chief operating officer for Kaufman Hall, a healthcare financial advisory firm based in Skokie, Ill. “You see a lot of money being spent on ambulatory networks. You see a lot of money being spent on physician alignment.”

Nationally, spending by hospitals and other healthcare providers on structures and equipment was projected by the CMS to grow 3.3% last year, only slightly less than the moderate growth of 3.6% in 2011. That follows a sharp decline the prior two years. Plant and equipment investments plunged 8.7% in 2009 and 1% in 2010, the first time since data was first collected in 1960 that the industry has seen capital spending drop for two consecutive years.

The declines were a response to volatile markets in 2008 and 2009 that strained hospital balance sheets as the nation struggled through a deep and prolonged recession that stripped millions of U.S. households of paychecks and health insurance. But as balance sheets recovered, hospitals have remained reticent to pour money into costly hospital capacity thanks to market and public policy initiatives that have targeted hospital use and cost as one way to improve efficiency.

New insurance models—such as accountable care and bundled payments—seek to tie hospital profits and losses to overall spending on patients' medical care, increasing the incentive to treat patients in less costly locations, such as clinics or the home.

At Catholic Health Initiatives, spending on deals for doctors, ambulatory services and other growth opportunities—including insurance deals—increased to 27% of capital spending of $1.4 billion last year. That total budget included $320 million to help finance a deal with Jewish Hospital & St. Mary's HealthCare in Louisville, Ky. It was still an increase from capital budgets of $850 million in 2011 and $830 million in 2010, says John DiCola, CHI's senior vice president for strategy and business development.

Financial risk under new payment models has also prompted heightened interest in information technology to analyze patients' medical and spending data for ways to improve care and reduce costs. Data analytics and other information technology accounted for 21% of CHI's capital spending last year, up from 6% in 2010, he says.

Building and design firms and major hospital equipment suppliers, on the other hand, are losing ground as priorities shift. Spending on facilities or on new and replacement equipment dropped to 52% of the CHI's capital budget last year compared with 84% in 2010.

The new priorities are driving the system's spending this year as well. CHI's capital budget for the year that ends in June is $1 billion, and that doesn't include the estimated $500 million to $550 million it will spend to buy out its partners in Alegent Creighton Health, which operates in Nebraska and Iowa.

At Geisinger Health System, Danville, Pa., which has its own insurance arm, early indications that Medicaid could expand under healthcare reform prompted the system to begin plans to launch a Medicaid managed-care business, says Kevin Brennan, executive vice president and chief financial officer. Pennsylvania's governor has rejected Medicaid expansion in the state, but the planning allowed Geisinger to bid on a Medicaid managed-care expansion for the existing enrollees, Brennan says.

Other health systems have also moved to expand operations outside their walls. Dignity Health, a San Francisco-based not-for-profit health system with 37 hospitals in three states, acquired the for-profit urgent-care and occupational medicine network U.S. HealthWorks for $458.9 million last August.

The emphasis on cost-cutting and integration may be subtracting from traditional capital needs for now, but construction and renovation projects and equipment upgrades can be deferred only so long. Barnabas Health, a West Orange, N.J., system that owns seven New Jersey hospitals, will spend $25 million, or one-fifth of its capital budget, to finance upfront costs that will help prepare the system for accountable care, says Barry Ostrowsky, the system's president and CEO.

That's a significant increase from the prior two years, he says, when spending for such costs was less than $25 million combined.

“I think many of us are faced with investment in existing infrastructure to be effective and an additional layer of capital investment to get us ready for a different environment,” he says.

Nonetheless, hospital construction continues. In 2008, Eastern Maine Healthcare Systems won state approval to expand its flagship hospital. But that was before the financial crisis erupted and the nation's economy sank into a deep recession.

The recession continued into the next year, to be followed by a weak and fitful recovery. Then Congress and the White House enacted sweeping legislation with incentives to overhaul healthcare delivery and the potential to significantly expand access to healthcare.

And so executives halted construction of the 327,400-square-foot expansion of the Eastern Maine Medical Center, Bangor. Now construction is scheduled to begin in March, nearly 4 1/2 years later, but only after executives reconsidered the $164 million project to see if it would still be viable.

It was, says Deborah Carey Johnson, president and CEO of the medical center, despite projections that new efforts to manage the chronically ill will reduce patients' need for hospital stays. Eastern Maine Healthcare in 2011 was named one of the first to test Medicare's accountable care initiative, which seeks to reduce health spending and better coordinate medical care for costly, complex patients.

However, demand at Eastern Maine has increased in recent years because rural hospitals have cut back operations to remain eligible as critical-access providers, a federal designation that pays remote hospitals more. But it is available only to the nation's smallest hospitals. Eastern Maine Medical Center, the state's second-largest hospital based on bed count, has struggled to absorb the overflow. The hospital operates at capacity and must turn away patients, she says.

The system is also using its limited capital dollars to acquire other operations, believing the combining operations will better prepare both facilities for healthcare reform. Eastern Maine Healthcare last year pledged $115 million in a deal to acquire Mercy Hospital in Portland, which, if successful, will boost the system's efficiency, says Derrick Hollings, the system's senior vice president, treasurer and CFO. That would help the system compete on price as consumers shop for health insurance through exchanges that launch next year under health reform.

“We are investing our way to a lower unit-cost environment,” he says.

(This article has been updated to indicate that the acquisition of Soundpath Health has not been completed.)

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