Good Shepherd Medical Center is bursting at the seams.
The 320-bed stand-alone hospital in Longview, Texas, enjoyed a 40% surge in annual surgery volume between 1994 and 1998. Patient admissions jumped 33% to 15,531 during the period, and the number of emergency room visits ballooned 74% to 61,000. The 1999 numbers are projected to come in even higher.
Despite the impressive gains, profits are down in part because of the hospital's reliance on government payers, according to a recent report from Standard & Poor's. Operating income fell to $2 million, or a 1% operating margin, in fiscal 1999 ended Sept. 30 from $10 million in fiscal 1996.
Congress recently handed healthcare providers $18.1 billion in Medicare reimbursement relief over the next five years, but James Valenti, Good Shepherd's chief operating officer, says that won't undo all the damage.
"Regardless of what the government does to us, we have to provide for patient needs," he says.
Earlier this year, the board gave the initial go-ahead on what will be the biggest capital undertaking in the hospital's 65-year history: a $60 million project to build and equip a 135-bed new inpatient tower, expand its heart and ambulatory surgery centers, and revamp the emergency room.
Contrasting stories. Hospitals that have pared their services and cut noncore business have garnered enough publicity to overshadow the trend of a mini-boom in capital projects, including dozens of spanking new hospitals. It was a story not told in Washington over the past year as hospital lobbyists successfully pressed lawmakers for relief from the 1997 federal Balanced Budget Act. Part of their strategy was to portray all the nation's hospitals as cash-strapped institutions incapable of continuing existing services.
"Clearly there is a boom in terms of outpatient centers, ambulatory care, a lot of renovation and reaction to population shifts," says Joseph Beck, managing director and co-founder of Shattuck Hammond Partners, a New York-based healthcare investment banking firm.
Nationally, hospital construction has dipped slightly over the past year, according to figures from the U.S. Department of Commerce. Private hospital construction fell 1% from January to September, after adjusting for inflation and seasonal variation. Construction on public hospitals fell 3% in the same period. Most other industries tracked by the agency saw increased construction during those nine months.
But those figures mask what appears to be a surge in new construction by hospitals that fit a certain profile: profitable facilities, generally in growing communities with dominant market shares and a management team with the chutzpah to take on new debt and dip into reserves despite declining margins.
MODERN HEALTHCARE's annual survey of architect firms documented this trend. From 1997 to 1998, completed square feet of healthcare construction increased by 10.9%, and dollar volume rose by 12.7% (March 22, p. 23). Fewer projects broke ground in 1998 than were completed, indicating a possible slowdown in the number of projects in the pipeline, but total construction costs on the projects getting under way outpaced those completed by 7%.
New projects run the gamut from inpatient towers in Hackensack, N.J., and Memphis to ambulatory service centers in Fort Collins, Colo., and Burlington, Vt., and new heart hospitals in Dallas and Davenport, Iowa.
Like Good Shepherd, many of these hospitals are banking that new construction will cement their already oversized market shares and clinch their reputation with patients.
"The strong players are trying to capitalize on the uncertainty brought by reductions from the (balanced-budget law)," Beck says.
Boom in Boise. St. Luke's Regional Medical Center, a 326-bed hospital in Boise, Idaho, is one such hospital. With patient volume set to outpace capacity, the hospital is building a 62-bed facility in suburban Meridian.
"Boise has undergone one of the highest growth rates in the country, and we are reaching near-critical bed shortages," says Bill Bodnar, the hospital's vice president for corporate development.
"Our past financial performance has enabled us to have some level of reserves," he says.
The hospital reported earnings of $9.1 million on operating revenues of $215.6 million in the fiscal year ended Sept. 30, 1998. It also reported having $80.5 million in reserves and debt of $50.7 million.
The new hospital will cost $50 million to build and equip and will be financed through a combination of reserves, operating income and bonds. The exact amount of bonds will depend on income projections in the wake of the newly legislated Medicare givebacks, he says.
Poudre partnerships. While volume is driving expansion at Good Shepherd and St. Luke's, other hospitals are building partnerships with doctors.
"(The hospital must) find a way to legally align the incentives of the physicians with the hospital," says Rulon Stacey, chief executive officer of 254-bed Poudre Valley Health System in Fort Collins, Colo.
Poudre Valley is slated to issue $153 million of tax-exempt fixed-rate bonds in December to pay for just such a project. Of the $102 million in new debt, about $47 million is earmarked for renovations to the main hospital. The balance will fund an ambulatory-care center, which will house four joint ventures with doctor groups.
Poudre Valley is a profitable hospital with a 90% market share and a 7% operating margin, according to a report by Fitch IBCA, a New York-based credit-rating agency. Lower Medicare reimbursement under the balanced budget act is likely to continue eating away at those earnings, according to Fitch. But to Stacey, who says planning for the new campus began three years ago, that's no reason to back out of the plan.
"We've known for some time that rates are going down. It's important for us to be as diversified as possible and have opportunities in outpatient medicine," he says.
Construction on the building is already under way. The facility will include a catheter lab, an ambulatory surgery center, a radiology diagnostic center and an oncology diagnostic center. Total costs will run to $55 million, Stacey says.
The physicians are equity partners in each of the joint ventures and will pay between one-third and half the cost of the new project.
That lessens the capital strain on the hospital, but also cuts into its profits, which are divided according to ownership. But Stacey says the trade-off is well worth it.
"It really ties (the doctors) into cost containment," he says.
Pre-emptive strike. Part of what drove the deals was the knowledge that if the hospital didn't partner with the doctors and help build them new facilities, the doctors could build competing facilities, Stacey adds.
"We think this strategy allows us to maintain access to revenue streams that we otherwise might have lost," he says.
"In a time with (the balanced-budget act), with all these negatives, I don't want to imply that this (taking on additional debt) is not a scary thing to do, but we are confident that we are doing it the right way," Stacey says.
Stephanie Doughty, Poudre Valley's chief financial officer, says the timing of the bond issue is important.
"Investors are starting to get concerned with the (balanced-budget act), and in a way it is a pre-emptive move on our part to do this now. Investors are starting to get more and more skittish about healthcare," she says.
The new debt will actually contribute to the hospital's financial health, she adds.
"It's important to keep our cash levels fairly high just in case there are some downturns," she says. The hospital has about 222 days of cash on hand.
Baylor Health Care System is taking a similar tack in its effort to woo doctors through partnership and new facilities, and in its decision to fund the project through bonds rather than reserves.
The Dallas-based hospital system is building a new 60-bed heart hospital and medical office building in partnership with physicians.
The $10 million needed for the project will be raised through taxable bonds, says Tim Parris, COO of 891-bed Baylor University Medical Center. The project was not eligible for tax-exempt financing because most of the building will be leased to physicians for office space, he says. "Cash reserves are invested in vehicles that are drawing a greater return" than the cost of debt service," he says.
Build now, save later. Aurora Health Care, a 13-hospital system based in Milwaukee, issued $250 million in bonds earlier this year to pay for several capital projects, including a $40 million replacement facility for Two Rivers (Wis.) Community Hospital.
Spending that money now will actually help control costs in the long-run, according to Patrick Trotter, executive vice president of Aurora's central region.
"We need to take a broader view of what really drives costs in health care," he says. Labor, new technologies and pharmaceuticals, not bricks and mortar, are what drive costs, he says.
The new hospital, which will be closer to the system's three local clinics, will open for business next year.
Not everyone's a risk-taker. The boldness with which these hospital systems are charging ahead on construction is even more apparent when stacked up against the many hospital systems that have slowed or scrapped their expansion plans.
Christus Health, a 29-hospital system based in Irving, Texas, for instance, is putting all new capital projects on hold while it straightens out operational issues and gets back into the black. The system had a $160 million operating loss in its most recent fiscal year.
Seventeen-hospital Mercy Health Services, in Farmington Hills, Mich., scaled back its capital projects to $225 million from a planned $392 million just a year ago. Mercy is merging with Holy Cross Health System Corp. in South Bend, Ind. A Mercy spokesman says lower revenues from government payers were a major factor in those reductions. Operating income declined from $101 million in 1998 to $72 million in 1999.
On the other hand, a few unprofitable hospitals are turning to capital projects in the hope that volume increases from expanded facilities will help tip the balance of profitability back into the black.
Baptist Memorial Hospital in Memphis, Tenn., is planning a bond issue of $320 million next year. Some $186 million of the issue will finance renovations and build new space that will house beds transferred from the downtown hospital.
Baptist COO Don Pounds says the improvements will help attract patients and doctors who are not coming to the hospital's flagship 451-bed hospital.
"We have capacity in downtown Memphis, but no one wants to come here," he says. Doctors and patients would rather use a hospital on the fast-growing east side of town, he says.
Construction has already begun on a bed tower and women's hospital on the newer campus of 573-bed Baptist Memorial Hospital-East. Construction on the hospital's Collierville campus was recently completed.
The hospitals' parent system, Baptist Memorial Health Care Corp., lost $18 million on $1.6 billion in total revenues in 1998. And Pounds says his hospital will see substantial impact from the balanced-budget law. Revenues will drop $18 million in the current fiscal year and $20 million in each of the two following years, he says.
While declining Medicare revenues haven't stopped some hospitals from going ahead with new projects, climbing interest rates might, executives and credit analysts say.
"The (balanced-budget act) will affect our revenues, but that is built into our projections," Good Shepherd's Valenti says.
The hospital, which still needs board approval on its financing package, postponed its $75 million bond issue until next year because of rising interest rates.
Valenti says the hospital may further delay the project if interest rates aren't favorable by the end of March.
"If rates keep increasing, the expansion project would definitely be placed on hold," he says.