It's likely 1994 will go down in healthcare history as the year dozens of hospitals claimed they were merging to form integrated delivery systems.
Only time will tell whether these hospitals can work together, and with physicians and other providers, to truly develop networks that can deliver a full spectrum of healthcare services at a reasonable price.
This article explores the post-merger behavior of small-market hospitals and its effect on competing hospitals, managed-care payers and business groups. An upcoming story will explore whether hospitals need greater-or less-antitrust protection to merge. And, in future issues, MODERN
HEALTHCARE will present case studies of other merged hospitals.
While more academic research is needed on merged hospitals, several facts are known about their post-merger behavior. In 1990, Baltimore-based
Health Care Investment Analysts conducted for MODERN HEALTHCARE the first study exploring the financial implications of hospitals before and after mergers since Medicare's prospective pricing system was introduced in 1983 (March 19, 1990, p. 24).
The study found that merged hospitals didn't pass on efficiency gains to consumers in the form of lower prices. In fact, on average, the 18 merged hospitals increased their prices a total of 9% two years after a merger, compared with a 1% price hike the year before the merger.
The post-merger price increases came even after adjusting for inflation and severity of illness-and after experiencing efficiency gains, the study said.
As a result, hospitals increased profits at higher rates in areas where they had greater market concentration, according to a 1993 American
Hospital Association study (Nov. 15, 1993, p. 4).
In a 1992 study, MODERN HEALTHCARE found that one reason hospitals in small markets raised prices was to purchase expensive technology, expand into tertiary services and become regional referral centers to capture more Medicare dollars and patients (Feb. 3, 1992, p. 36).
While the merged hospitals ended their local "medical arms race," a regional race heated up for tertiary care with hospitals as far as 50 miles away, the study found.
In this report, MODERN HEALTHCARE discovered another reason hospitals in smaller communities increased prices at higher rates after a merger: Nobody stepped forward to stop them.
As merged hospitals increased market concentration, they commanded greater market power and were less inclined to deal with businesses or payers seeking discounts.
Without managed care, businesses in smaller communities moved slowly to organize into coalitions that could collectively purchase healthcare services at reduced prices. Only when business groups joined forces and demanded price concessions did merged hospitals agree to reduce prices and pass along savings.
Hospitals that merge to become the sole or dominant acute-care provider in small or rural markets tout savings to the community as one of the main benefits of consolidation.
But managed-care and business coalition executives tell a different story. They contend negotiating price discounts with a hospital becomes more difficult after merger. Hospitals that are unwilling to pass on merger savings must be pressured to the bargaining table by the collective clout of businesses, they said.
"The consolidation of (two) hospitals into a one-horse town has negative implications on pricing of care because there is no incentive to contract with payers that deliver managed-care lives," said Jonathan Fuchs, vice president for managed care of Green Bay, Wis.-based Employers Health Insurance.
Without pressure to reduce prices from aggressive business coalitions or managed-care payers, "mergers in small markets increase market power and are anti-competitive," said Roice Luke, a healthcare professor at Virginia Commonwealth University, Richmond. "It increases a hospital's ability to refuse to discount services."
Mr. Luke, an expert on regional healthcare system development, said it could take three to five years for businesses in small markets to organize into coalitions to counter the new hospital monopoly. "When they realize their healthcare costs aren't decreasing, they begin to wonder where their money is going," he said.
Bernard Tresnowski, who retired Nov. 30 as president of the national Blue Cross and Blue Shield Association, agreed that sole provider hospitals need external pressure to cut costs and pass on savings to patients and businesses after their mergers.
"It's healthy for the business community to put pressure on small-market hospitals," Mr. Tresnowski said. "At Blue Cross, we'd prefer to develop partnerships with hospitals, but it's a long process that's more difficult in rural areas where there is just one hospital."
Merger mania.From 1980 to 1992, the
healthcare industry averaged about 16 hospital mergers each year, according to the American Hospital Association. More than 400 hospitals merged into 210 hospitals during that period, and about one-third of the mergers were in small or rural markets, the AHA said.
A drop in patient days per thousand residents-from 700 to about 350-and an increase in managed-care contracting by businesses have increased the pace of hospital mergers and encouraged the formation of integrated delivery systems, especially since 1993. According to MODERN HEALTHCARE estimates, more than 100 hospital mergers and acquisitions have been announced this year.
Mergers often are announced with promises of savings that draw support from the business community. For example, officials at the only two hospitals in Port Huron, Mich., unveiled a merger earlier this year with a pledge to save more than $53 million over five years.
Officials promise that part of the savings from the planned merger, which has drawn the attention of the Federal Trade Commission's antitrust investigators, will help reduce employers' healthcare costs.
Such savings may be possible, but they are the exception not the rule, MODERN HEALTHCARE's research shows.
Because managed care is predominantly an urban phenomenon, state legislation is needed to encourage managed-care penetration in rural areas, Mr. Luke said. At least seven states-including California, Florida and Minnesota-have approved reform measures to encourage managed-care contracting.
"The key now is for the buyer community-government, business coalitions and HMOs-to stimulate managed care," Mr. Luke said. "There needs to be discipline in markets imposed by managed care. Otherwise, merged hospitals gain too much market power."
Mr. Luke said history shows that high managed-care enrollment has stimulated consolidations in larger metropolitan markets such as Los Angeles and Minneapolis-St. Paul.
In smaller markets "it's evolving in just the opposite way, with hospitals merging first and managed care working to catch up," Mr. Luke said. "Hospitals will have the upper hand for a while, just like managed care did in the larger markets. Hospitals are consolidating without managed care, and they will call the shots until businesses demand change."
Merger benefits.Through mergers, hospitals set out to accomplish three primary goals.
First, they seek to reduce duplicative administrative and support services. With lower overhead and patient-care costs, previous studies conducted by MODERN HEALTHCARE and the AHA have found that most hospitals have become more efficient after mergers (March 19, 1990, p. 24; Nov. 15, 1993, p. 4).
However, many hospitals also increased their profits by hiking prices at a faster rate in the first three years after they merged, MODERN HEALTHCARE's 1992 merger study found (Feb. 3, 1992, p. 36).
For example, 14 merged hospitals increased their prices an average of 9.9% in the three years after merger, compared with an 8.6% average annual price increase in the three years before merger, the 1992 study concluded.
Hospitals also want to purchase new technology and expand into tertiary-level services. Executives maintain these investments increase quality of care delivered to patients.
As larger providers, these hospitals can be reclassified as "rural referral centers" under Medicare to receive higher reimbursement rates.
Hospitals that merge into dominant providers want to place themselves in stronger negotiating positions to reduce managed care's ability to force discounting of prices, experts said.
The merged hospitals also want to create a monopoly to prevent their staff physicians from using a competing hospital as a bargaining chip. Physicians often play one hospital off another in disputes to gain new services that can increase their incomes while decreasing a hospital's profits, experts said.
Higher prices.A 1992 University of Michigan study found that in three of four small-market cases, hospital prices increased at a higher rate after merger, and the merged hospitals were less willing to discount prices to local businesses.
The study concluded that two of the three hospitals that increased prices raised them by more than 20% in the two years after merger. Before merging, the hospitals' average annual price increases ranged from 2.5% to 6.5%. Researchers had incomplete financial data on the third hospital, but employers said it also raised prices after merging.
Unlike the MODERN HEALTHCARE studies, which were descriptive and based on common financial measurements, the university study was conducted using such economic formulas as "pooled cross-sectional time-series regressions." The regressions, which result in comparative ratios, enabled the researchers to reach their conclusions.
The study concluded that mergers "establish the potential for price reductions to purchasers" but don't guarantee such an outcome, said Jack Wheeler, chairman of the department of health administration at the University of Michigan. Mr. Wheeler was co-author of the study with Howard Zuckerman, now a healthcare professor at Arizona State University.
"A lot depends on the goals of the board, pressure from outside sources and the degree to which providers are enlightened," he said.
Battle Creek (Mich.) Health System, one of the four merged hospitals in the study, achieved several positive post-merger benefits, including reduced price increases, lower expenses and improved utilization. Battle Creek is a 241-bed hospital that resulted from the 1988 merger of Community Hospital and Leila Hospital.
After the merger, Battle Creek slowed its annual price increases to 5% from a pre-merger average of 10%. It also improved post-merger admission rates by reducing the number of patients seeking hospitalization outside of Battle Creek.
The three other merged hospitals are Samaritan Health System, Clinton, Iowa; Bromenn Healthcare, Bloomington, Ill.; and United Medical Center, Moline, Ill. All the merged hospitals in the University of Michigan study have been included in previous MODERN HEALTHCARE studies.
A measure of markups.One of the best measurements available to assess hospital pricing strategies is the "total ancillary markup ratio," according to HCIA, a Baltimore-based healthcare information company. Ancillary refers to medications and laboratory, radiology and outpatient services. Revenues from ancillary services typically average 60% of total hospital revenues, HCIA said. Markup ratios are calculated using the difference of costs and charges for each ancillary service. For example, a 2.30 total markup ratio indicates a hospital charged patients 130% above its costs for ancillary services.
In its most recent analysis, HCIA found that seven merged hospitals steadily increased their total ancillary markup ratios after merger. Six of them increased their markup ratio at a higher rate in the two years after merger than the two years before consolidation, HCIA said.
Those six merged hospitals also increased their markup ratios above national averages during those years, it said.
Ancillary fees are considered by many experts to be "hidden charges" to patients because they aren't as readily available to the public as are room and surgery rates, which can be easily compared from hospital to hospital.
For example, 157-bed Lower Florida Keys Health System, Key West, increased its markup ratio 0.33 points to 2.70 in 1993 from 2.37 in 1991, the year after its 1990 merger, HCIA said. Before merger, Lower Florida had increased its markup ratio 0.06 points to 1.61 in 1989 from 1.55 in 1988. (To arrive at pre-merger markup ratios, HCIA consolidated data from the two merging hospitals.)
Nationally, hospitals with 100 to 249 beds increased their markup ratios 0.13 points to 2.33 in 1992 from 2.20 in 1991, HCIA said. From 1988 to 1989, hospitals increased markup ratios 0.16 points to 1.93, it said.
Profiles of newly merged small-market hospitals studied by HCIA will be presented in future issues of MODERN HEALTHCARE.
Forcing prices down.Trustees at Holy Family Medical Center, Manitowoc, Wis., issued a public promise in 1991 not to raise prices for one year after the hospital merged with Manitowoc Memorial Hospital (See story, p. 42).
To gain support for closing Manitowoc Memorial and consolidating services at Holy Family, the board also promised to hold future price increases below regional averages, said David Semple, Holy Family's president and chief executive officer.
"Wisconsin is a public-data state, and the local business coalition quickly realized how to use that information in negotiations," Mr. Semple said.
Holy Family was able to achieve efficiency savings from its 1991 merger. But the hospital admittedly used its newly gained market clout to refuse a contract offer from a 300-member business group in the year after its merger.
Mr. Semple said Holy Family refused to discount its charges by 25% because it needed the revenue to cover merger costs and allow it time to consolidate operations.
"If a merged facility says it needs four years to eliminate redundancies, my response is, `I'll give you six months,'*" Mr. Tresnowski said.
Mr. Fuchs said hospitals like Holy Family that want to protect revenue streams might gain short-term advantage by telling payers or businesses "to pay our price or goodbye."
But, he added, "they'll be hurt if they won't contract with us. There will be other resources made available to take care of patients."
Alternative providers will be invited by business groups or will see opportunities on their own to build surgery, primary-care and diagnostic centers to provide price competition and seek tertiary referrals, Mr. Fuchs said.
"It's a classic strategy that sometimes is encouraged by local business groups that are thwarted in their attempt to negotiate fair contracts," Mr. Fuchs said.
In Roanoke, Va., the Blue Ridge Healthcare Coalition was unsuccessful in negotiating significant discounts with two hospitals owned by Roanoke-based Carilion Health System and Lewis-Gale Hospital in nearby Salem, Va., owned by Louisville, Ky.-based Columbia/HCA Healthcare Corp.
Desperate to slow rising healthcare costs, the 50-member business coalition invited John Deere Health Care to create an HMO product and negotiate contracts with the hospitals.
In May, John Deere, a national managed-care company that specializes in medium-sized markets, began negotiating with Carilion for acute-care and physician services. It cut a deal in October. John Deere now is enrolling businesses and their employees for a Jan. 1, 1995, startup, said Owen Poole, John Deere's marketing manager in Roanoke.
Blue Ridge member businesses will receive a preferred rate from John Deere, said Lisa Craft, Blue Ridge's executive director. The companies in the coalition have 30,000 employees in the Roanoke market, which has a population of 300,000.
"(Carilion was) much more difficult to negotiate rates with after merger," Ms. Craft said. "Carilion wanted to control and dictate all the terms, but since we brought John Deere into the market, the relationship has improved."
Tom Maxfield, president of Carilion Health Plans, a subsidiary of Carilion Health System, said the problem with negotiating a contract with the coalition was that it was unwilling to guarantee volume in exchange for discounts.
"If we are going to give discounts, we want benefit differentials, or steerage (of patients to Carilion hospitals)," Mr. Maxfield said. "We have done that for a number of employers here."
The contract with John Deere includes incentives for enrollees to use Carilion's hospitals, Mr. Poole said. HMO subscribers can choose other hospitals, but they will be required to pay unspecified copayments, he said.
Nevertheless, Ms. Craft said, businesses in the coalition felt Carilion was saving money through the merger but was unwilling to pass it on to businesses without restricting employees choice of provider.
"(Hospital systems) here have an attitude that they can control the market because they know it is too far for people to travel to those other hospitals," Ms. Craft said.
Some 50 miles to the north in Fishersville, Va., Augusta Medical Center last summer opened the doors of a new 255-bed hospital. Augusta Medical, which was formed by the 1988 link of Community Hospital, Waynesboro, Va., and King's Daughters' Hospital, Staunton, Va., also reduced its costs through the merger, according to HCIA.
But that didn't mean Augusta executives were any more willing to discount their charges to local employers.
"We are philosophically opposed to just giving discounts," said Richard Graham, Augusta's president and CEO. "If we gave one to DuPont just because they are the largest company in the area, it wouldn't be fair to some of the smaller employers."
Mr. Graham said the hospital is concerned about employer backlash and the possibility competitors might enter the market with lower prices. But, he added, "we never promised discounts. It's stupid. We talked about increasing access, quality and satisfaction (from the merger). We've done that. If we gave discounts, we might not survive."
However, HCIA said Augusta's post-merger operating margins range was 9% to 12% from 1989 to 1993. For its size, Augusta is one of the most profitable hospitals in Virginia, state officials said.
To pressure Augusta into negotiating discounts, more than a dozen of the largest businesses in Augusta County recently created the Waynesboro Healthcare Coalition.
"DuPont's idea was, since we are such a large employer and the hospital is saving money on its merger, let's get a discount," said Steven Moser, M.D., a healthcare professor at Mary Baldwin College, Staunton.
"That got the attention of the hospital, but up to this point Augusta does not give discounts to employers, only insurers. Other major employers also were told no," said Dr. Moser, who also is on Augusta's community advisory committee. "I expect it will take a year or so for the hospital to do business with the coalition."
Hospitals' view.Most hospitalexecutives involved in mergers, like Mr. Graham, contend that elimination of competition saves patients money.
Michael Halseth, executive director of 683-bed University of Virginia Medical Center in Charlottesville, said a monopolistic merger can end costly "medical arms races" between competitors.
Mr. Halseth said a hospital monopoly eliminates unnecessary beds and duplicative services that add unnecessary costs. The medical center is located about 25 miles east of Fishersville and is working with Augusta to develop specific tertiary services and may include the hospital in its regional managed-care plan, he said.
"The more competition you have, the higher prices go up," Mr. Halseth said. "With less competition, prices go up at a slower rate."
He said he based his observation on 20 years' experience and his evaluation of markets in northern Virginia that only have one hospital.
Mr. Halseth said hospitals in Virginia towns such as Harrisonburg, Culpeper and Lynchburg have lower patient costs than other areas in the state, he said.
"From state data, we know that this region of Virginia has the lowest prices in the state," Mr. Halseth said. "I believe you lose more from lots of competitors in a given market in terms of price."
Mr. Halseth and other hospital administrators agree that savings sometimes are difficult to achieve, primarily because of political pressure from hospital constituencies.
"Hospitals (that merge) are slow to take advantage of savings," said Holy Family's Mr. Semple. "Everybody has a pet program, a board member or a physician, and they will fight against closing services."
Mr. Semple said some hospitals that merge in small markets find it difficult to reduce staff to efficient levels or to close one of the hospital facilities.
"It's a reflection of a lack of discipline in management and the board," Mr. Semple said. "Hospitals need to be watched and held to their promises."