OSF Healthcare System in Illinois got an unpleasant reminder last week of the risks inherent in an integrated delivery system strategy. Standard & Poor's lowered the credit rating for the system's bonds to A from A+.
The downgrade reflects weakened financial performance across the system, operating losses at five of the system's 10 hospitals, and "operating dilution from the nonobligated health plan," Standard & Poor's said.
The Peoria-based hospital system's wholly owned HMO, OSF Health Plans, lost $9.7 million in 1998, enough to drag the whole system into negative financial territory. Without the HMO, the hospital system would have been profitable, said Jennifer Neel, a Standard & Poor's analyst in New York.
OSF is only the latest hospital group whose HMO has caused problems. The risks of getting into managed care include not only the potential of direct losses that must be replaced by cash reserves but possible contamination of the parent system's credit rating. Down the line, that can raise the cost of capital for the whole obligated group.
Credit analysts aren't issuing a flood of re-evaluations because of HMO horror stories, but they can cite recent HMO-related credit changes off the top of their heads.
Moody's Investors Service dropped Baptist Hospital in Nashville to A2 from Aa3 on Jan. 4, affecting $105 million of outstanding debt, largely because of ballooning operating losses at Baptist's HealthNet HMO. Sagging profits at the flagship hospital could no longer cover those deficits.
Moody's recently notified Baptist Health System in Birmingham, Ala., that the system had been placed on the watchlist for a potential bond rating downgrade, affecting $274 million of debt. "The disappointing 1998 results appear to be driven largely by mounting operating losses by BHS' managed-care companies, reaching $33.7 million in 1998 compared with $23.8 million in 1997," Moody's noted on Feb. 4. Baptist's hospital group lost $8.8 million in 1998 compared with a profit of
$6.5 million in 1997.
Bob Greene, Baptist's chief financial officer, said system management has 90 days to explain the situation or Moody's will proceed with the downgrade.
The outlook of another hospital group, the Sisters of Charity of the Incarnate Word, Houston, was revised to negative from stable on Feb. 8. One factor was the weak performance of its one-third share in Advantage Health HMO, which has drained its three hospital owners of so much cash that they plan to close the HMO in July.
Some hospital groups have improved their ratings by dumping their money-losing HMOs. Another one-third owner of Advantage Health, Touro Infirmary in New Orleans, was put on Moody's watchlist Feb. 4 for a rating upgrade. Moody's cited the planned shutdown of the HMO as a favorable indicator. The plan has cost Touro more than $20 million in the past five years.
Touro hadn't been downgraded because of the HMO losses, "but we hadn't upgraded it, either," said Kay Sifferman, a Moody's analyst. "You had to look at the losses from the HMO. It was such a huge risk factor, not knowing how that would go."
Last October, Standard & Poor's gave a more favorable credit rating-A+ -to a small West Coast system, PeaceHealth, because it had sold its HMO. That HMO, SelectCare, had lost $20 million over three years.
"The fact that they had sold this HMO and gotten out of the business was a definite positive," said Cynthia Keller, an analyst at Standard & Poor's.
Roshan Parikh, corporate treasury director at PeaceHealth, in Bellevue, Wash., said: "We were the party that had to keep recapitalizing SelectCare" when the HMO had to increase its reserves to meet state insurance department requirements. "The obligated part of PeaceHealth couldn't keep raising money on our own on behalf of a non-obligated party."
That's an issue that analysts like Keller and Sifferman consider: The HMO subsidiary is often not part of the "obligated group," which is legally on the line to repay interest and principal.
Bond covenants usually restrict management's ability to transfer assets outside the obligated group. But management may use the resources of an obligated group member to support a nonobligated-group member in order to sustain the integrated system as a whole, Sifferman said.
The downgrades and outlook revisions don't cost the hospital systems immediately, because usually most of their debt is at fixed rates. Variable-rate debt can cost the system slightly more. The fallout from a rating downgrade most directly touches bondholders in the secondary market, who find their prices depressed when they sell.
Over the long haul, of course, a downgrade hurts a hospital system the next time it issues debt.