Healthcare in Pennsylvania-and perhaps the country-will never be the same.
Last week Allegheny Health, Education and Research Foundation, one of the nation's brashest not-for-profit healthcare systems, filed for Chapter 11 bankruptcy protection from its creditors. The last-ditch move will allow AHERF, which is $1.3 billion in debt, to restructure money-losing operations and pave the way for the sale of its nine Philadelphia-area hospitals to for-profit Vanguard Health Systems of Nashville for $502 million.
Reverberations from the thud of more than 400 pages of documents filed in U.S. Bankruptcy Court in Pittsburgh on July 21 echoed far beyond Pennsylvania's borders, however.
AHERF may have been more aggressive than most in acquiring hospitals, buying physician practices and taking on insurance risk, but much of its strategy is being mirrored by other systems .
AHERF's humiliating descent into bankruptcy and forced liquidation of what were once seen as key strategic assets send a powerful warning to hospital executives everywhere.
"This is the kind of high-profile bankruptcy filing that will cause people to finally recognize that a financial crisis in the industry is upon us," said Keith Shapiro, a bankruptcy attorney active in healthcare at Holleb & Coff in Chicago.
Wall Street, too, pointed to AHERF's situation as a cautionary tale.
"This is an example, at its extreme, of mergers and acquisitions risk and integration risk," said Kevin Ramundo, an analyst with Moody's Investors Service, the New York bond rating agency, which cut the ratings on flagship Allegheny General Hospital debt to junk-bond status last week. "Clearly, this is going to further heighten (investors') concerns about healthcare," Ramundo said.
"It's got to be the largest not-for-profit bankruptcy," said Lawrence Handelsman, head of the bankruptcy group at the law firm Stroock & Stroock & Lavan in New York. "These days, it would rank among the largest of any kind."
Local reaction was somber, even from AHERF competitors.
"It's an unfortunate turn of events for Philadelphia and the region," said William Kelley, M.D., chief executive officer at University of Pennsylvania Health System, Philadelphia.
While perhaps not in AHERF's distress, other hospital systems are reeling from money-losing insurance contracts, overpayments for physician practices and the high costs of integrating acquisitions.
AHERF's use of bankruptcy to salve its financial wounds while greasing the way to divest poorly performing assets might foreshadow like moves by other health systems (See related story, p. 6).
But crossing the financial Rubicon into bankruptcy is not for the faint of heart. "These have been exceedingly stressful times, more so than I could have ever anticipated or probably could ever describe," said Anthony Sanzo, recently appointed AHERF CEO, during a press conference in Philadelphia to announce the Chapter 11 filing and sale to Vanguard. "We hope that with a new infusion of capital and a clean start, we can deal with the issues that led us here today," Sanzo said.
He emphasized that AHERF will no longer use cash from its bedrock Pittsburgh hospitals to fund struggling operations, such as physician practices and acquired hospitals. Every element in what remains of AHERF's fallen empire will have to be self-sustaining, Sanzo said.
But despite the stunning developments last week, Sanzo affirmed AHERF's original strategy. Crafted and relentlessly pursued by CEO Sherif Abdelhak until he was ousted by AHERF's board in June, the Pittsburgh-based system was conceived as a statewide, health system grounded in academic medicine.
It was "a good vision," said Sanzo, but it required more capital than AHERF could muster.
AHERF's Chapter 11 bankruptcy filing covers AHERF, the holding company and four subsidiaries. The operations seeking bankruptcy protection are Allegheny University Medical Practices, which owns groups employing 225 doctors in Pittsburgh and 365 in Philadelphia, eight of nine Philadelphia-area hospitals and Allegheny University of the Health Sciences, which comprises Hahnemann-MCP School of Medicine and three related health profession schools.
The bankruptcy filing left out AHERF's five Pittsburgh-area hospitals and its Allegheny University Hospitals, Rancocas, in Willingboro, N.J., because those institutions are still in the black.
Because of its complicated corporate structure and segregated borrowing groups, AHERF was able to declare bankruptcy for some subsidiaries but not others.
Filing for bankruptcy, AHERF officials stressed, is a means to the end of selling off the Philadelphia operations, including nearby Allegheny University Hospitals, Rancocas, and restructuring money-losing contracts with physicians and full-risk insurance contracts that have drained precious cash.
The promised results: a debt-free, streamlined set of hospitals for Vanguard and a clean slate for what remains of AHERF. Vanguard and AHERF expect to complete due diligence and a definitive sales agreement this week and close their deal within 60 days.
As part of the announcement, AHERF CEO Sanzo publicly revealed for the first time how deeply the system had fallen into arrears. AHERF owes $500 million to unsecured creditors. Another $605 million is owed to bondholders. And there's another $200 million in intercompany debt-payments by the Pittsburgh hospitals to those in Philadelphia-that will be forgiven.
AHERF said negative cash flow averaged $27 million per month. Total revenues for fiscal 1998 were about $2.2 billion, and the annualized loss for that period was $324 million.
Dealing with the creditors promises to be nasty for AHERF, but it is a necessary evil to clean up the long-brewing mess. In particular, several legal experts said, bankruptcy is a useful way to clear the decks for the hospital sale.
"The bad guy has to be Allegheny, and the perfect mechanism for Allegheny is the bankruptcy courts," said Ivan Wood, a healthcare attorney in the Houston office of Baker & Hostetler.
But AHERF faces several hurdles before it can complete the sale of its nine Philadelphia-area hospitals. In June AHERF and Vanguard called off their first deal for six of the nine hospitals on the eve of the first-ever public hearing convened by Pennsylvania Attorney General Mike Fisher to examine the for-profit conversion.
Lawyers said the federal bankruptcy court will have the final say on any deal, potentially blunting the ability of state regulators and probate courts to scrutinize the conversion.
However, Sean Connolly, a spokesman for the attorney general's office, said the state's lawyers are working vigorously to establish a legal basis to ensure they can weigh in on the purchase price and handling of charitable assets in any sale.
"The attorney general is going to ask the bankruptcy court to segregate those charitable assets to protect them so they're not sold to pay the debts of the creditors," Connolly said.
Even if all regulatory requirements are satisfied, there's no guarantee Vanguard will be the purchaser of the nine hospitals.
"Most bankruptcy courts consider it an absolute obligation to consider other offers and to make sure that assets being sold have been widely and openly exposed to the marketplace," said Holleb & Coff's Shapiro.
AHERF's Sanzo confirmed last week that the system has talked about selling all or parts of its Philadelphia operations to Catholic Health East, Radnor, Pa.; Children's Hospital of Philadelphia; Jefferson Health System, Philadelphia; Temple University Health System, Philadelphia; and Tenet Healthcare Corp., Santa Barbara, Calif.
As the bankruptcy proceeds, the losing suitors may resurface with formal offers.
"Our current position is that we remain interested in the market and the situation in Philadelphia, and we'll monitor the situation closely," said Harry Anderson, a spokesman for Tenet.
Physicians whose practices were owned by AHERF are an important wild card as the bankruptcy and possible sale unfold. Many disaffected doctors might jump ship, imperiling patient referrals to the hospitals.
Until the Chapter 11 filing, most of the doctors in AHERF's practices had contracts that protected them from pay cuts. But with medical practices leading the red ink in Philadelphia, a permanent fix through abrogation of their contracts is now possible thanks to the bankruptcy laws.
"The test for (doctor) loyalty will come when they try to renegotiate their deals," said John Donnelly Jr., CEO at Roxborough Hospital, Philadelphia. And if the Vanguard deal collapses, Donnelly predicted, "even the most loyal physicians will bail out."
But assuming that deal does goes through, "Vanguard will try to get them to take substantial cuts," said Vasilios "Bill" Kalogredis, a lawyer in Wayne, Pa., who represents dozens of doctors employed by AHERF. Vanguard, he said, met with many of AHERF's physicians last week. "Basically, most if not all will end up being free agents of sorts in the end."
If Vanguard prevails in buying the AHERF hospitals, its work has only begun.
Charles Martin, Vanguard CEO, president and chairman, pledged to infuse $50 million to $100 million into the hospitals over the next five years, bring in new management and develop new relationships with doctors. With those changes, the Philadelphia hospitals, he said, are a "very viable system."
Some observers agreed.
"AHERF was highly centralized; Vanguard will do what works," said Gerald Katz, a healthcare consultant based in Plymouth Meeting, Pa. He predicted Vanguard could put the hospitals in "scintillating" condition with the right combination of capital and corporate support.
But not everyone is so sure.
"I'll be watching with considerable interest," said UPHS' Kelley. "There's a long way to go, and this is a very tough marketplace."