For the first time in seven years, operating profits at not-for-profit healthcare systems declined while for-profit chains recorded double-digit margins in 1994, according to MODERN HEALTHCARE's 19th annual Multi-unit Providers Survey.
While many systems continued to aggressively cut costs and improve efficiency, executives of not-for-profits said managed care, reduced government payments and increased charity-care burdens have eroded revenues and in some cases reduced profit margins.
While not-for-profit systems, excluding public systems, reported a 3.5% decrease in operating income, investor-owned acute-care hospital chains entrenched themselves as the fastest-growing sector of the hospital industry, added dozens more facilities to their chains and reported a 16.1% increase in operating profits.
The for-profit chains also increased their total net revenues 7.6%, compared with an industrywide increase of 4.4%.
Executives of for-profit chains attributed their good year to significant efficiencies gained through consolidation. For example, when Columbia Healthcare Corp. merged with Hospital Corporation of America last year to create industry giant Columbia/HCA Healthcare Corp., the company said it expected to save $130 million annually, of which half would come from lower purchasing costs.
Just last month, Nashville, Tenn.-based Columbia completed another merger, this one the largest hospital-chain merger in history. The $5.6 billion deal to buy Healthtrust, another investor-owned chain, created a 318-hospital behemoth that is expected to save another $125 million annually through higher-volume buying and reduced overhead costs.
Such mergers fueled the for-profit sector's growth rate, which was twice that of the industry as a whole.
But, led by Nashville-based OrNda HealthCorp, the chains also took on substantially higher debt as they positioned themselves for expansion. Long-term liabilities for the sector were up 8.8% to $11.2 billion, according to the survey. OrNda added debt to acquire Summit Health and a not-for-profit system in Phoenix.
In 1994, 16 for-profit chains that responded to the survey owned or managed 831 hospitals, an 11.2% increase from 1993. The chains staffed 121,385 beds, a 5.6% increase from 1993, according to the survey.
Meanwhile, 156 responding not-for-profit systems, including 11 public systems, accounted for 1,070 hospitals, a 3.3% increase from 1993. The not-for-profits staffed 208,223 beds in 1994, 2.4% more than 1993.
Of the 172 systems that reported hospitals and bed totals for the survey, the 16 for-profit chains accounted for 43.7% of the hospitals and 36.8% of the staffed beds.
Data from the American Hospital Association indicate that 39% of the nation's 2,864 system hospitals were operated by for-profit concerns, compared with 44% operated by nongovernment, not-for-profit organizations in 1993, the last year for which figures are available.
Profits and losses.For the industry as a whole, operating profits rose 17.8% in 1994. By comparison, operating margins increased 7.3% in 1993, 28% in 1992, 44.8% in 1991, 95% in 1990, 10% in 1989 and 68% in 1988. The last decline in operating profits was in 1987, when they dipped 4.8%.
For the 10 for-profit chains that reported financial information for both years, operating income increased 16.1% in 1994 to $2.3 billion from $2 billion in 1993. The 1994 figure represents a 10.5% operating margin.
The 129 reporting not-for-profit systems-excluding nine public systems-experienced a 3.5% decrease in operating income to $2.4 billion in 1994 from $2.5 billion in 1993, for a 4.3% 1994 operating margin.
Not-for-profits' operating income slide was exacerbated by a 13% cut in
operating profits for the 75 secular not-for-profit systems. Those systems saw net operating income fall to $829.5 million in 1994.
For example, California Pacific Medical Center, a two-hospital secular system in San Francisco, lost $28.6 million in 1994 on net patient revenues of $308.9 million. Managed care and related restructuring accounted for the majority of the financial losses.
Even Kaiser Permanente, which had enjoyed increased profitability in the past several years, earned 3.7% less in 1994. Kaiser's operating profits were $815.3 million on total revenues of $12.3 billion.
But fueled by the for-profits, the 148 responding systems that reported financial information for both years saw total operating profits rise 17.7% in 1994 to $4.4 billion.
Total net income, which includes interest income, donations and business deductions, rose 8.1% to $3.8 billion in 1994 for 153 systems that reported such information for both years. Net income was reduced by one-time charges taken by the large investor-owned chains for mergers or the sale of operations.
Bigger is better.
As dozens of mergers swept the industry in 1994, the number of systems responding to the 1995 survey was down, but their average size was up. For example, MODERN HEALTHCARE's 1995 survey includes 249 systems, compared with 313 systems that responded last year, a 20% decrease. Among the long-term-care systems, the number of respondents dropped to 47 this year, compared with 71 in 1994, a 34% decline. MODERN HEALTHCARE defines a system as a healthcare organization that owns, operates or manages at least two or more acute-care hospitals, specialty hospitals, nursing homes, outpatient facilities or continuing-care communities. Some also operate or own HMOs, PPOs and physician group practices.
While total systems declined, their average size grew to 11.1 hospitals in 1994 from 10.4 in 1993. The average system also grew in number of staffed beds to 1,916 from 1,873, a 2.3% increase.
Overall, the average system reported a 17.7% increase in operating income to $29.8 million in 1994 from $25.3 million in 1993.
In the not-for-profit sector, the average system had 1994 operating earnings of $18.9 million, a 3.5% decrease from $19.6 million in 1993. For-profit chains had an average of $230.1 million in operating income in 1994, compared with $198.2 million in 1993, a 16.1% increase, the survey said.
As in previous years, the difference between the two sectors lies primarily in size.
The 16 reporting for-profit chains averaged 51.9 hospitals and 7,586.6 beds. The average not-for-profit system, including public hospitals, operated 6.8 hospitals with 1,495.8 beds. On a per-hospital basis, the average number of beds in a for-profit hospital is 146, compared with 236 beds for the average not-for-profit hospital. The 138 reporting not-for-profit systems, excluding public systems, averaged $533.4 million in net patient revenues, compared with $1.8 billion for 13 for-profit chains in 1994.
Organization.For the first time,
MODERN HEALTHCARE gleaned information on systems' organizational structures. Of 250 systems, 27.6%, or 69, own a physician-hospital organization; 22%, or 55, own a medical service organization; 12.8%, or 32, own a medical foundation; and 12.4%, or 31, own an independent practice association.
Thirty-seven, or 14.8%, of responding systems reported owning HMOs, and 22.4%, or 56, said they owned PPOs (May 1, p. 41). Another 5.2%, or 13, operated an HMO through a healthcare network and 8.4%, or 21, in a joint venture with an insurer.
Like most tax-exempt systems in California, Adventist Health System/West, Roseville, Calif., is linking its hospitals and other facilities with affiliated physician groups. It's also developing strategic alliances with other providers to contract with managed-care payers or employers on a prepaid basis.
"California is ahead of the curve. (Systems) are making the transition to managed care from fee-for-service," said Adrian Zytkoskee, AHS/West's senior vice president for integrated delivery systems. "It's a time of opportunities as well as challenges."
Ranked 27th in the nation based on net patient revenues of all systems, with $874.2 million, AHS/West reported a 27% increase in net operating income to $82.1 million in 1994, for a 10.6% margin. Revenues totaled $874.2 million. The 18-hospital system operated 2,601 staffed beds.
Zytkoskee attributed AHS/West's good year to controlling utilization, cutting overhead costs, improving productivity and refinancing debt.
In 1994, AHS/West reorganized to develop regional managed-care networks and to improve quality and utilization through the use of benchmarking among its hospitals and through comparisons with other systems, Zytkoskee said.
AHS/West has assigned a senior executive to oversee and integrate such services as nursing, professional services, quality improvement and information systems, Zytkoskee said.
Over the past two years, AHS/West has been doubling the number of physicians under contract with the system. It now stands fifth in the nation in number of group practices owned or managed with 46 practices representing 171 physicians.
AHS/West's strategy is to develop physician-hospital partnerships in each market, he said. AHS/West also is working with other acute and nonacute providers to develop a seamless care delivery system.
"We are trying to add more access points through physician groups and other arrangements," he said. "We aren't going to own everything. Some will be contractual, and some will be equity relationships. We are not looking to take assets and merge them."
In Chicago, the Northwestern Healthcare Network is part of a growing trend of hospital groups that want to coordinate healthcare services but don't want the burden of a marriage of assets.
As a corporate planning and oversight organization, Northwestern Healthcare's nine hospital members share planning, budgeting, managed-care contracting and quality assurance, said Bruce Spivey, M.D., Northwestern's president and chief executive officer.
"In 1994, we spent a lot of time trying to complete a geographic capacity for the Chicago area," Spivey said. "We still are looking directly west (in suburban DuPage County). We are talking with people far beyond the traditional acute-care facility."
In 1994, Northwestern added four hospitals and increased its net patient revenues by 61.6% to $1.5 billion. As a secular not-for-profit system, Northwestern earned $86.7 million in operating profits in 1994 for a 17.5% margin.
For 1995, Spivey said developing physician and managed-care relationships, integrating information systems, and expanding outpatient and long-term-care services are the system's top priorities.
Spurred by strong growth, investor-owned chains appear to be picking up steam after a long slump.
The number of beds owned by investor-owned chains grew 5.6% in 1994, on top of a 13.2% rise in 1993. This ended a long slide for the for-profits, which saw a steady drop between 1986 and 1991.
Although the growth of chains like Columbia and OrNda has resulted primarily from buying other investor-owned chains, the survey figures signify that the gains aren't solely derived from mergers.
Columbia has become an industry Goliath in part because of its ability to convince not-for-profit boards to sell to a for-profit company. However, it isn't alone. Nearly all the other for-profit chains bought tax-exempt hospitals in 1994.
Last year's wave of mergers eliminated four investor-owned chains from the rankings. Columbia bought HCA, and OrNda, now the third-largest for-profit chain, bought Summit Health and merged with American Healthcare Management. In addition, Community Health Systems, Houston, bought Hallmark Healthcare, an Atlanta-based chain that owned the same type of rural and suburban hospitals as Community.
Although the investor-owned sector showed a drop in net income in 1994, that was skewed by a $425 million loss reported by National Medical Enterprises. Santa Monica, Calif.-based NME changed its name to Tenet Healthcare Corp. earlier this year.
NME's losses stemmed primarily from its psychiatric operations, which were $701 million in the red in the fiscal year ended May 31, 1994. That included the company's $379 million fine to settle federal criminal and civil charges against its psychiatric hospitals.
When NME's figures are excluded from the survey, investor-owned chains posted a 41% gain in net income to $1 billion.
In terms of net revenues, investor-owned chains reported a 7.6% increase, higher than the industry's 4.4%.
However, Edwin Gordon, senior director in the New York office of Furman Selz, an investing banking firm, pointed out that even 7% growth is "unsustainable" in today's industry unless systems acquire other providers or generate significant outpatient and home healthcare revenues.
Gordon contends that for-profit chains are better positioned to compete in local markets because they have "one leader to rationalize capacity. Consolidation is impossible without a `one market, one mind' mentality," he said.
For example, in Miami, Columbia merged the operations of four hospitals into two in 1994 to save operational costs.
In those markets where independent not-for-profit hospitals have formed loose networks for managed-care contracting, not-for-profit networks are less likely to close member hospitals.
It is quite common, however, for not-for-profit hospitals that have merged to close or convert one of their acute-care facilities. In addition, regional not-for-profit systems that own their hospitals have closed underutilized facilities or have reallocated services among their hospitals.
The process may occur over a period of time. For example, HealthEast, a four-hospital not-for-profit system based in St. Paul, Minn., has closed three not-for-profit hospitals since it was formed in 1986.
The 1994 figures appear to challenge the long-held belief that investor-owned hospitals won't cope well when managed care drives the delivery system. Most investor-owned hospitals historically were located in the South, where managed-care penetration is less than in places like California.
Yet, OrNda, Columbia and Tenet all gained market share in California last year, noted Furman Selz's Gordon.
In addition, Columbia and other investor-owned chains have managed to snag managed-care contracts away from not-for-profit systems in the Dallas/Fort Worth area and in Florida, noted John Runningen, first vice president of Robinson-Humphrey Co., an Atlanta-based investment banking firm.
"The volume shift of patients is significant," Runningen said. "It's going to make the income stream much more volatile for everyone."
OrNda has strong networks in Southern California and Phoenix, two big managed-care markets. When OrNda bought not-for-profit St. Luke's Health System, Phoenix, it acquired a Medicaid HMO with 300,000 capitated lives.
In Southern California, OrNda serves more than 200,000 enrollees under capitated contracts. Between the second quarter of fiscal 1994 and 1995, OrNda's managed-care business increased to 26.6% from 19.8% as a percentage of its total business. What's more significant is that its operating margin on managed-care business grew to 14.8% from 14%, San Francisco-based investment banking firm Robertson Stephens & Co. reported.
Competition for contracts means that market share shifts constantly, however. In Louisville, Ky., last year, Humana dropped Columbia and its Galen hospitals there to sign a managed-care contract with Jewish Hospital and Alliant Health System, according to Michael Carroll, vice president and manager of the Tampa office of Tribrook Associates. Humana had been contracting with Galen Hospitals, which used to be part of the same company.
For the third year, the survey requested financial data on community benefits, defined as the costs, not charges, of providing charity care, nonbilled services, research, education and training of healthcare professionals, and cash donations to community agencies. Excluded are unpaid costs of Medicare and Medicaid programs, services generating low or negative margins, various taxes and bad debt.
The 80 systems that reported community benefits provided an average of $35 million per system in 1994, a 9.8% increase from $31.9 million in 1993.
Leading the way were the eight non-Catholic religious systems, which provided average community benefits of $83.8 million per system, or 18.8% of net patient revenues. Next were the 25 Catholic systems, which provided an average of $49.7 million per system, or 5.4% of net patient revenues. Three for-profit chains reported providing an average of $29.5 million per chain, or 5.9% of revenues.
Although taxes aren't considered community benefits in this survey, 10 for-profit chains paid an average of $132.3 million in taxes, a 37.1% increase from 1993. The non-Catholic religious systems reported paying an average of $64.3 million in 1994, a 36.4% decrease from 1993. The 24 secular not-for-profit systems paid an average of $5.1 million in taxes, and the eight reporting Catholic systems said they paid an average of $2.4 million in taxes in 1994.
The 104 systems reported a 57.3% increase in group practices owned or m naged to 1,145 in 1994 from 728 in 1993. Not all systems reported numbers of physicians. Of the 98 reporting systems, the number of physicians increased 30.1% to 8,033 in 1994, or 82 per system, from 6,174 in 1993, or 63 physicians per system.
The 56 reporting secular not-for-profit systems led the way with a total of 416 groups in 1994, a 41% increase from 1993. Also adding physician groups were 27 Catholic systems, which reported a 52.4% increase in owned or managed groups to 419 from 275.
Bad debt for 151 reporting systems averaged 5.1% of net patient revenues in 1994 compared with 5% in 1993. All sectors were able to reduce their bad debt except for the public systems and for-profit chains. Bad debt for the nine public systems increased to 10.8% in 1994 from 9.7%. Bad debt for the 11 for-profit chains increased to 6% last year from 5.6% in 1993.
As the ranks of the uninsured reached an estimated 44 million in 1994, charity-care expenses rose to 4.9% of net patient revenues in 1994 for the 146 systems reporting such data from 4.8% in 1993.
As expected, public systems had the highest level of charity care as a percentage of net patient revenues, 24.1% in 1994 compared with 24.9% in 1993. For-profits had the lowest, 1.8% in 1994, up from 1.7% in 1993. Secular not-for-profits averaged 4.4%, up from 4.2%. Other religious systems averaged 4.3%, up from 4.1%, and Catholic systems had comparable averages of 3.3% and 3.2% for the two years.
A little more than one-third of the 94 responding systems said they were providing healthcare services through prepaid contracts. Those 35 systems said average revenues from capitated contracts were 6.9% of net patient revenues. Eighteen systems reported more than 10% of revenues from capitated contracts. They include Kaiser Permanente (100%), Henry Ford Health System (35%), UniHealth America (25%), IHC Hospitals (20%), Presbyterian Healthcare Services (18%), Mercy Health Services (15%) and AvMed-Santa Fe (10%).
Respondent profile: systems by category
Type of facility Total systems
Acute-care hospitals 181
Freestanding psychiatric hospitals 54
Freestanding rehabilitation hospitals 39
Other freestanding specialty facilities
(outpatient, surgicenters) 22
Freestanding nursing homes 157
Continuing-care retirement communities 74
Freestanding outpatient-care facilities 166
Group practices 101
Includes aggregate number for each response; double counting may occur.
Modern Healthcare / May 22, 1995