On the face of it, owning physician practices appears to be a failed strategy for hospitals, generating huge losses while offering advantages that are murky at best.
A recent survey of hospital-run practices showed 80% were losing money on operations (See chart).
After a mid-1990s practice-buying binge, some hospitals are deciding they can no longer afford to subsidize physician operations, and some have reconsidered physician employment because of doctors' unhappiness with hospital management and federal compliance issues.
"You have many, many hospitals that would dearly love to get out of these arrangements," says George Adams, a vice president in corporate finance at Chicago-based John Nuveen & Co., who has advised 25 hospital systems about divesting practices during the past seven years.
Predicting that more systems and hospitals will divest practices, some companies are offering help in unloading unprofitable medical groups.
But a recent report by management consulting company Towers Perrin predicts hospitals will not exit the physician business en masse, because primary-care networks are a key marketing advantage under any payer arrangement.
According to Towers Perrin, when a hospital system buys practices, costs automatically climb because of accreditation requirements, increased wages and benefits for staff, information and communication systems upgrades, and the loss of physician incentives to code clinical services properly.
Under best practices, hospitals can expect to lose $43,432 per physician, or $2.2 million per year, for a 50-physician network, the company says. Towers Perrin studied seven hospital-sponsored primary-care networks with 50 to 150 physicians. The networks lost an average of $83,290 per physician annually, and their negative margins ranged from $52,900 to $93,900.
"Many hospitals are actually succeeding when they think they are failing," says Daniel Zismer, national practice leader for health systems consulting at Towers Perrin in Minneapolis. Hospitals are shifting their focus from acquiring practices to improving practices' financial performance, he adds.
Unwinding employment arrangements is a delicate matter. Physicians typically don't want to abandon lucrative contracts, and many doctors balk at resuming management responsibilities or assuming debt to repurchase their practice assets. Hospitals, on the other hand, want to maintain physician loyalty once employment and management ties are cut.
Some companies are trying to structure new relationships that cushion the financial blow for all parties while preserving hospital-physician ties.
A new venture called Prime Practice Management, based in Leawood, Kan., says it is negotiating to buy practices, at the physicians' request, from several hospital systems. President and Chief Executive Officer Howard Wizig says the company is renegotiating employment contracts with physicians at lower salaries but promising to build stronger practices that will protect their incomes.
Prime Practice Management plans to pay fair market value for the practice assets and finance turnaround efforts by requiring the seller to pay one year's worth of anticipated losses.
"It could take the hospital eight years to turn the practice around. I'm taking the hospital off the hook at one year's loss," says Wizig, a former consultant at Towers Perrin and founder of a radiology practice management firm, Princeps Medical Practice Management, now based in Nashville.
Wizig says physicians do better as entrepreneurs because "a hospital's entire mind set is around pleasing and appeasing the physicians, which doesn't work when the physicians are employees."
In addition, he notes, deals that are particularly sweet for doctors could violate rules prohibiting payments for Medicaid or Medicare referrals or excessive payments to individuals by tax-exempt organizations.
Sovereign HealthCare, based in Des Moines, Iowa, plans to establish management services organizations in which the hospital, the physicians and Sovereign would have equity stakes. Key decisions about such issues as managed-care contracts and recruitment would be made by consensus.
Sovereign's goal is to restore most practices to profitability within two years.
Some expenses-such as the costs of increased wages and benefits, and health system accreditation-will "evaporate" by moving the practice out of the hospital system, says Sovereign Executive Vice President Robert Baudino Jr. He co-founded the firm with Douglas Lewis, a veteran of several for-profit healthcare ventures, including the former Hospital Corporation of America.
Baudino says Sovereign is in discussions with six systems.
A third player is PhyCor, a Nashville-based physician practice management firm. It is commonly viewed as a hospital competitor because it buys physician practices and invests in ancillary services. Last September, PhyCor announced it would market its management services to hospitals with an option for PhyCor to acquire equity in successful practices.
PhyCor CEO Joseph Hutts says discussions with several hospital systems are under way and he expects to announce a deal this month.
Wizig says many hospitals seem to fear being the first in the market to divest. "Once some start, I believe (a market) will unravel very quickly," he says.
Not necessarily, Adams says.
Divestiture sometimes makes sense, but he says he believes most hospitals and physicians will continue their employment ties and add physician productivity incentives when contracts expire.
If hospitals terminate a relationship, "that's a problem. You've lost that admitting physician," Adams says. That's why breaking ties can be a risk. In November, Moody's Investors Service revised its rating outlook on OhioHealth, an 11-hospital system in Columbus, to negative from stable. Moody's cited the system's decision to divest its 87 physician practices and 36 additional practices owned by Doctors Hospital, a three-hospital system it acquired last year.
The practices accounted for 7% of OhioHealth's admissions and 12% of Doctors', according to Moody's, which said it was concerned about a "potential alienation of these physicians."
OhioHealth officials declined to comment on the system's physician strategy.
Another option is fostering the development of a large, independent multispecialty group. But, Adams says, "then you have one group, and if that group leaves or disintegrates, you have a problem."
Mount Carmel Health System in Columbus, Ohio, has decided to keep its practices and even pick up some that were owned by rival OhioHealth. Mount Carmel, with three hospitals, boasts the largest primary-care network in central Ohio, employing 60 physicians.
President and CEO Joseph Calvaruso says the network is a marketing tool and helps meet the hospital's mission of serving needy areas. Mount Carmel is part of Holy Cross Health System, based in South Bend, Ind.
"We remain glad that we entered this business, because we don't know what the environment would have been like had we had our physicians work for other organizations" such as insurers or PPMs, Calvaruso says. "We still believe that having an extensive network of physicians is important for an organization-it's why banks have a lot of branches."
Mount Carmel is losing about $40,000 per physician in its current fiscal year, which amounts to half its losses for the previous year, Calvaruso says. The system cut losses through actions such as changing compensation from fixed to production-based when physician contracts expired, improving billing and coding procedures and combining practices to reduce overhead, he says.
Calvaruso adds that only about one-quarter of the practices are losing money now, and he predicts even those will break even when employment contracts are renewed under different terms.